Note 3 – Loans

Major classifications of loans were as follows:


	September 30, 2016		December 31, 2015
Commercial	$	169,824	$	130,362
Real estate - commercial		617,280		605,721
Real estate - construction		28,786		19,806
Real estate - residential		357,846		351,007
Consumer		3,325		4,216
Overdraft		403		483
Lease financing receivables		14,210		10,953
Other		10,114		10,130
		1,201,788		1,132,678
Net deferred loan costs		1,064		1,037
Total loans	$	1,202,852	$	1,133,715

It is the policy of the Company to review each prospective credit prior to making a loan in order to determine if an adequate level of security or collateral has been obtained. The type of collateral, when required, will vary from liquid assets to real estate. The Company’s access to collateral, in the event of borrower default, is assured through adherence to lending laws, the Company’s lending standards and credit monitoring procedures. With selected exceptions, the Bank makes loans solely within its market area. There are no significant concentrations of loans where the customers’ ability to honor loan terms is dependent upon a single economic sector, although the real estate related categories listed above represent 83.5% and 86.1% of the portfolio at September 30, 2016, and December 31, 2015, respectively.

Aged analysis of past due loans by class of loans was as follows:


															Recorded
															Investment
															90 days or
					90 Days or										Greater Past
	30-59 Days		60-89 Days		Greater Past		Total Past								Due and
September 30, 2016	Past Due		Past Due		Due		Due		Current		Nonaccrual		Total Loans		Accruing
Commercial1	$	182	$	-	$	-	$	182	$	183,269	$	583	$	184,034	$	-
Real estate - commercial
Owner occupied general purpose		96		-		-		96		125,733		1,492		127,321		-
Owner occupied special purpose		-		-		-		-		167,664		397		168,061		-
Non-owner occupied general purpose		789		-		-		789		159,923		2,463		163,175		-
Non-owner occupied special purpose		-		-		-		-		103,990		1,013		105,003		-
Retail properties		-		-		-		-		37,685		1,980		39,665		-
Farm		22		1,350		-		1,372		12,683		-		14,055		-
Real estate - construction
Homebuilder		-		-		-		-		612		-		612		-
Land		-		-		-		-		1,237		-		1,237		-
Commercial speculative		-		-		-		-		8,901		76		8,977		-
All other		102		-		-		102		17,858		-		17,960		-
Real estate - residential
Investor		419		132		454		1,005		129,302		910		131,217		454
Owner occupied		-		70		-		70		119,854		5,654		125,578		-
Revolving and junior liens		112		102		29		243		98,640		2,168		101,051		29
Consumer		10		-		-		10		3,315		-		3,325		-
Other2		-		-		-		-		11,581		-		11,581		-
Total	$	1,732	$	1,654	$	483	$	3,869	$	1,182,247	$	16,736	$	1,202,852	$	483


															Recorded
															Investment
															90 days or
					90 Days or										Greater Past
	30-59 Days		60-89 Days		Greater Past		Total Past								Due and
December 31, 2015	Past Due		Past Due		Due		Due		Current		Nonaccrual		Total Loans		Accruing
Commercial1	$	394	$	-	$	-	$	394	$	140,848	$	73	$	141,315	$	-
Real estate - commercial
Owner occupied general purpose		652		119		-		771		123,479		1,254		125,504		-
Owner occupied special purpose		358		-		-		358		170,827		763		171,948		-
Non-owner occupied general purpose		-		-		-		-		166,668		975		167,643		-
Non-owner occupied special purpose		-		-		-		-		92,387		-		92,387		-
Retail properties		-		-		-		-		34,352		-		34,352		-
Farm		-		-		-		-		12,615		1,272		13,887		-
Real estate - construction
Homebuilder		-		-		-		-		2,604		-		2,604		-
Land		-		-		-		-		1,137		-		1,137		-
Commercial speculative		-		-		-		-		2,117		83		2,200		-
All other		6		77		65		148		13,717		-		13,865		65
Real estate - residential
Investor		101		-		-		101		125,611		972		126,684		-
Owner occupied		1,083		446		-		1,529		110,885		6,378		118,792		-
Revolving and junior liens		344		68		-		412		102,500		2,619		105,531		-
Consumer		4		-		-		4		4,212		-		4,216		-
Other2		-		-		-		-		11,650		-		11,650		-
Total	$	2,942	$	710	$	65	$	3,717	$	1,115,609	$	14,389	$	1,133,715	$	65

1 The “Commercial” class includes lease financing receivables.

2 The “Other” class includes overdrafts and net deferred costs.

Credit Quality Indicators

The Company categorizes loans into credit risk categories based on current financial information, overall debt service coverage, comparison against industry averages, historical payment experience, and current economic trends. This analysis includes loans with outstanding balances or commitments greater than $50,000 and excludes homogeneous loans such as home equity lines of credit and residential mortgages. Loans with a classified risk rating are reviewed quarterly regardless of size or loan type. The Company uses the following definitions for classified risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

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

Credits that are not covered by the definitions above are pass credits, which are not considered to be adversely rated.

Credit Quality Indicators by class of loans were as follows:


September 30, 2016			Special
	Pass		Mention		Substandard 1		Doubtful		Total
Commercial	$	177,082	$	4,650	$	2,302	$	-	$	184,034
Real estate - commercial
Owner occupied general purpose		124,359		645		2,317		-		127,321
Owner occupied special purpose		165,333		2,330		398		-		168,061
Non-owner occupied general purpose		160,463		249		2,463		-		163,175
Non-owner occupied special purpose		100,191		-		4,812		-		105,003
Retail Properties		36,435		-		3,230		-		39,665
Farm		11,014		1,240		1,801		-		14,055
Real estate - construction
Homebuilder		612		-		-		-		612
Land		1,237		-		-		-		1,237
Commercial speculative		8,901		-		76		-		8,977
All other		17,782		-		178		-		17,960
Real estate - residential
Investor		130,046		-		1,171		-		131,217
Owner occupied		119,146		-		6,432		-		125,578
Revolving and junior liens		97,973		-		3,078		-		101,051
Consumer		3,324		-		1		-		3,325
Other		11,554		27		-		-		11,581
Total	$	1,165,452	$	9,141	$	28,259	$	-	$	1,202,852


December 31, 2015			Special
	Pass		Mention		Substandard 1		Doubtful		Total
Commercial	$	136,078	$	3,208	$	2,029	$	-	$	141,315
Real estate - commercial
Owner occupied general purpose		123,827		-		1,677		-		125,504
Owner occupied special purpose		171,185		-		763		-		171,948
Non-owner occupied general purpose		163,956		1,908		1,779		-		167,643
Non-owner occupied special purpose		88,468		-		3,919		-		92,387
Retail Properties		30,432		1,490		2,430		-		34,352
Farm		12,615		-		1,272		-		13,887
Real estate - construction
Homebuilder		2,604		-		-		-		2,604
Land		1,137		-		-		-		1,137
Commercial speculative		2,117		-		83		-		2,200
All other		13,865		-		-		-		13,865
Real estate - residential
Investor		125,548		-		1,136		-		126,684
Owner occupied		111,713		-		7,079		-		118,792
Revolving and junior liens		102,476		-		3,055		-		105,531
Consumer		4,215		-		1		-		4,216
Other		11,650		-		-		-		11,650
Total	$	1,101,886	$	6,606	$	25,223	$	-	$	1,133,715

1 The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans.

The Company had $2.2 million and $3.9 million residential assets in the process of foreclosure as of September 30, 2016, and December 31, 2015, respectively.

Impaired loans, which include nonaccrual loans and troubled debt restructurings, by class of loans for the September 2016 periods listed were as follows:


							Nine Months Ended
	As of September 30, 2016						September 30, 2016
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial	$	382	$	464	$	-	$	226	$	-
Commercial real estate
Owner occupied general purpose		2,509		2,807		-		2,412		66
Owner occupied special purpose		397		525		-		580		-
Non-owner occupied general purpose		2,263		2,458		-		1,655		2
Non-owner occupied special purpose		1,013		1,649		-		506		-
Retail properties		1,980		2,364		-		990		-
Farm		-		-		-		636		-
Construction
Homebuilder		-		-		-		-		-
Land		-		-		-		-		-
Commercial speculative		76		83		-		80		-
All other		-		-		-		-		-
Residential
Investor		1,822		2,156		-		1,864		35
Owner occupied		9,294		10,720		-		9,916		120
Revolving and junior liens		2,322		3,336		-		2,527		9
Consumer		201		268		-		100		-
Total impaired loans with no recorded allowance		22,259		26,830		-		21,492		232

With an allowance recorded
Commercial		-		-		-		2		-
Commercial real estate
Owner occupied general purpose		-		-		-		-		-
Owner occupied special purpose		-		-		-		-		-
Non-owner occupied general purpose		264		603		264		132		31
Non-owner occupied special purpose		-		-		-		-		-
Retail properties		-		-		-		-		-
Farm		-		-		-		-		-
Construction
Homebuilder		-		-		-		-		-
Land		-		-		-		-		-
Commercial speculative		-		-		-		-		-
All other		-		-		-		-		-
Residential
Investor		-		-		-		-		-
Owner occupied		600		639		250		356		-
Revolving and junior liens		-		-		-		23		-
Consumer		-		-		-		-		-
Total impaired loans with a recorded allowance		864		1,242		514		513		31
Total impaired loans	$	23,123	$	28,072	$	514	$	22,005	$	263

Impaired loans by class of loans as of December 31, 2015 and for the nine months ended September 30, 2015 were as follows:


							Nine Months Ended
	As of December 31, 2015						September 30, 2015
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial	$	70	$	149	$	-	$	1,014	$	-
Commercial real estate
Owner occupied general purpose		2,314		3,004		-		4,857		62
Owner occupied special purpose		763		871		-		1,288		-
Non-owner occupied general purpose		1,047		1,065		-		2,583		-
Non-owner occupied special purpose		-		-		-		712		-
Retail properties		-		-		-		-		-
Farm		1,272		1,338		-		636		-
Construction
Homebuilder		-		-		-		896		-
Land		-		-		-		-		-
Commercial speculative		83		86		-		1,780		-
All other		-		-		-		266		-
Residential
Investor		1,906		2,259		-		2,050		33
Owner occupied		10,539		11,999		-		11,309		128
Revolving and junior liens		2,731		3,947		-		2,500		4
Consumer		-		-		-		-		-
Total impaired loans with no recorded allowance		20,725		24,718		-		29,891		227

With an allowance recorded
Commercial		3		8		3		2		-
Commercial real estate
Owner occupied general purpose		-		-		-		-		-
Owner occupied special purpose		-		-		-		-		-
Non-owner occupied general purpose		-		-		-		38		-
Non-owner occupied special purpose		-		-		-		-		-
Retail properties		-		-		-		-		-
Farm		-		-		-		-		-
Construction
Homebuilder		-		-		-		-		-
Land		-		-		-		-		-
Commercial speculative		-		-		-		-		-
All other		-		-		-		135		-
Residential
Investor		-		-		-		67		-
Owner occupied		112		112		31		12		-
Revolving and junior liens		46		46		-		364		2
Consumer		-		-		-		-		-
Total impaired loans with a recorded allowance		161		166		34		618		2
Total impaired loans	$	20,886	$	24,884	$	34	$	30,509	$	229

Troubled debt restructurings (“TDRs”) are loans for which the contractual terms have been modified and both of these conditions exist: (1) there is a concession to the borrower and (2) the borrower is experiencing financial difficulties. Loans are restructured on a case-by-case basis during the loan collection process with modifications generally initiated at the request of the borrower. These modifications may include reduction in interest rates, extension of term, deferrals of principal, and other modifications. The Bank participates in the U.S. Department of the Treasury’s (the “Treasury”) Home Affordable Modification Program (“HAMP”) which gives qualifying homeowners an opportunity to refinance into more affordable monthly payments.

The specific allocation of the allowance for loan losses for all loans, including TDRs, is determined by either discounting the modified cash flows at the original effective rate of the loan before modification or is based on the underlying collateral value less costs to sell, if repayment of the loan is collateral-dependent. If the resulting amount is less than the recorded book value, the Bank either establishes a valuation allowance (i.e. specific reserve) as a component of the allowance for loan losses or charges off the impaired balance if it determines that such amount is a confirmed loss. This method is used consistently for all segments of the portfolio. The allowance for loan losses also includes an allowance based on a loss migration analysis for each loan category on loans that are not individually evaluated for specific impairment. All loans charged-off, including TDRs charged-off, are factored into this calculation by portfolio segment.

TDRs that were modified during the period are as follows:


	TDR Modifications					TDR Modifications
	Three Months Ended September 30, 2016					Nine Months Ended September 30, 2016
	# of	Pre-modification		Post-modification		# of	Pre-modification		Post-modification
	contracts	recorded investment		recorded investment		contracts	recorded investment		recorded investment
Troubled debt restructurings
Real estate - commercial
Other1	-	$	-	$	-	2	$	312	$	211
Real estate - residential
Owner occupied
HAMP2	-		-		-	1		239		235
Revolving and junior liens
HAMP2	-		-		-	4		469		433
Other1	1		70		70	1		70		70
Total	1	$	70	$	70	8	$	1,090	$	949


	TDR Modifications					TDR Modifications
	Three Months Ended September 30, 2015					Nine Months Ended September 30, 2015
	# of	Pre-modification		Post-modification		# of	Pre-modification		Post-modification
	contracts	recorded investment		recorded investment		contracts	recorded investment		recorded investment
Troubled debt restructurings
Real estate - residential
Owner occupied
Other1	-	$	-	$	-	3	$	404	$	412
Revolving and junior liens
HAMP2	1		45		11	4		178		142
Other1	3		378		349	3		378		349
Total	4	$	423	$	360	10	$	960	$	903

1 Other: Change of terms from bankruptcy court

2 HAMP: Home Affordable Modification Program

TDRs are classified as being in default on a case-by-case basis when they fail to be in compliance with the modified terms. There was no TDR default activity for three and nine months ending September 30, 2016, and September 30, 2015, for loans that were restructured within the 12 month period prior to default.