Note 4 – Loans

The Company had $1.2 million in loans held for sale at December 31, 2015 as compared to $459 thousand in loans held for sale at December 31, 2014. Due to materiality, these loans are included in the Consumer Real Estate and Agricultural Real Estate loan categories at the lower of cost or market.

Loans at December 31 are summarized below:


	(In Thousands)
Loans:	2015			2014
Consumer Real Estate	$	88,189		$	97,550
Agricultural Real Estate		58,525			50,895
Agricultural		82,654			74,611
Commercial Real Estate		322,762			270,188
Commercial and Industrial		100,125			100,126
Consumer		27,770			24,277
Industrial Development Bonds		6,491			4,698

	$	686,516		$	622,345
Less: Net deferred loan fees and costs		(638	)		(419	)

		685,878			621,926
Less: Allowance for loan losses		(6,057	)		(5,905	)

Loans - Net	$	679,821		$	616,021

Following are the characteristics and underwriting criteria for each major type of loan the Bank offers:

Commercial Real Estate: Construction, purchase, and refinance of business purpose real estate. Risks include loan amount in relation to construction delays and overruns, vacancies, collateral value subject to market value fluctuations, interest rate, market demands, borrower’s ability to repay in orderly fashion, and others. The Bank does employ stress testing on higher balance loans to mitigate risk by ensuring the customer’s ability to repay in a changing rate environment before granting loan approval.

Agricultural Real Estate: Purchase of farm real estate or for permanent improvements to the farm real estate. Cash flow from the farm operation is the repayment source and is therefore subject to the financial success of the farm operation.

Consumer Real Estate: Purchase, refinance, or equity financing of one to four family owner occupied dwelling. Success in repayment is subject to borrower’s income, debt level, character in fulfilling payment obligations, employment, and others.

Commercial and Industrial: Loans to proprietorships, partnerships, or corporations to provide temporary working capital and seasonal loans as well as long term loans for capital asset acquisition. Risks include adequacy of cash flow, reasonableness of profit projections, financial leverage, economic trends, management ability, and others. The Bank does employ stress testing on higher balance loans to mitigate risk by ensuring the customer’s ability to repay in a changing rate environment before granting loan approval.

Agricultural: Loans for the production and housing of crops, fruits, vegetables, and livestock or to fund the purchase or re-finance of capital assets such as machinery and equipment, and livestock. The production of crops and livestock is especially vulnerable to commodity prices and weather. The vulnerability to commodity prices is offset by the farmer’s ability to hedge their position by the use of future contracts. The risk related to weather is often mitigated by requiring federal crop insurance.

Consumer: Funding for individual and family purposes. Success in repayment is subject to borrower’s income, debt level, character in fulfilling payment obligations, employment, and others.

Industrial Development Bonds (IDB): Funds for public improvements in the Bank’s service area. Repayment ability is based on the continuance of the taxation revenue as the source of repayment.

The following is a maturity schedule by major category of loans at December 31, 2015:


	(In Thousands)
	Within One Year		After One Year Within Five Years		After Five Years		Total
Consumer Real Estate	$	1,270	$	11,486	$	75,433	$	88,189
Agricultural Real Estate		1,073		3,300		54,152		58,525
Agricultural		52,939		24,239		5,476		82,654
Commercial Real Estate		13,030		70,699		239,033		322,762
Commercial and Industrial		45,971		34,791		19,363		100,125
Consumer		5,480		17,228		5,062		27,770
Industrial Development Bonds		1,300		185		5,006		6,491

	$	121,063	$	161,928	$	403,525	$	686,516

The distribution of fixed rate loans and variable rate loans by major loan category is as follows as of December 31, 2015:


	(In Thousands)
	Fixed Rate		Variable Rate
Consumer Real Estate	$	54,940	$	33,249
Agricultural Real Estate		42,480		16,045
Agricultural		47,305		35,349
Commercial Real Estate		206,383		116,379
Commercial and Industrial loans		54,669		45,456
Consumer, Master Card and Overdrafts		23,305		4,465
Industrial Development Bonds		6,350		141

As of December 31, 2015 and 2014 one to four family residential mortgage loans amounting to $20.0 million and $20.8 million, respectively, have been pledged as security for loans the Bank has received from the Federal Home Loan Bank.

Industrial Development Bonds are included in the commercial and industrial category for the remainder of the tables in this Note 4, unless specifically noted separately.

The following table represents the contractual aging of the recorded investment in past due loans by portfolio classification of loans as of December 31, 2015 and 2014, net of deferred loan fees and costs:


December 31, 2015	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 Days and Accruing
Consumer Real Estate	$	303	$	47	$	357	$	707	$	87,240	$	87,947	$	—
Agricultural Real Estate		—		—		162		162		58,301		58,463		—
Agricultural		—		145		—		145		82,617		82,762		—
Commercial Real Estate		236		—		841		1,077		321,153		322,230		—
Commercial and Industrial		51		—		20		71		106,618		106,689		—
Consumer		19		9		—		28		27,759		27,787		—

Total	$	609	$	201	$	1,380	$	2,190	$	683,688	$	685,878	$	—


December 31, 2014	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 Days and Accruing
Consumer Real Estate	$	713	$	50	$	436	$	1,199	$	96,351	$	97,550	$	—
Agricultural Real Estate		—		—		—		—		50,895		50,895		—
Agricultural		25		—		—		25		74,586		74,611		—
Commercial Real Estate		78		204		709		991		269,197		270,188		—
Commercial and Industrial		—		8		—		8		104,816		104,824		—
Consumer		25		8		29		62		23,796		23,858		—

Total	$	841	$	270	$	1,174	$	2,285	$	619,641	$	621,926	$	—

The following table presents the recorded investment in nonaccrual loans by portfolio class of loans as of December 31, 2015 and December 31, 2014:


	(In Thousands)
	2015		2014
Consumer real estate	$	1,155	$	628
Agricultural real estate		162		—
Agriculture		—		—
Commercial real estate		484		709
Commercial		202		339
Consumer		38		29

Total	$	2,041	$	1,705

The Bank uses a nine tier risk rating system to grade its loans. The grade of a loan may change during the life of the loan. The risk ratings are described as follows.

Zero (0) Unclassified. Any loan which has not been assigned a classification.

One (1) Excellent. Credit to premier customers having the highest credit rating based on an extremely strong financial condition, which compares favorably with industry standards (upper quartile of The Risk Management Association ratios). Financial statements indicate a sound earnings and financial ratio trend for several years with satisfactory profit margins and excellent liquidity exhibited. Prime credits may also be borrowers with loans fully secured by highly liquid collateral such as traded stocks, bonds, certificates of deposit, savings account, etc. No credit or collateral exceptions exist and the loan adheres to the Bank’s loan policy in every respect. Financing alternatives would be readily available and would qualify for unsecured credit. This grade is summarized by high liquidity, minimum risk, strong ratios, and low handling costs.

Two (2) Good. Desirable loans of somewhat less stature than Grade 1, but with strong financial statements. Loan supported by financial statements containing strong balance sheets, generally with a leverage position less than 1.50, and a history of profitability. Probability of serious financial deterioration is unlikely. Possessing a sound repayment source (and a secondary source), which would allow repayment in a reasonable period of time. Individual loans backed by liquid personal assets, established history and unquestionable character.

Three (3) Satisfactory. Satisfactory loans of average or slightly above average risk – having some deficiency or vulnerability to changing economic conditions, but still fully collectible. Projects should normally demonstrate acceptable debt service coverage. Generally, customers should have a leverage position less than 2.00. May be some weakness but with offsetting features of other support readily available. Loans are meeting the terms of repayment.

Loans may be graded 3 when there is no recent information on which to base a current risk evaluation and the following conditions apply:

At inception, the loan was properly underwritten and did not possess an unwarranted level of credit risk;

At inception, the loan was secured with collateral possessing a loan value adequate to protect the Bank from loss;

The loan exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance;

During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or the business is in an industry which is known to be experiencing problems. If any of the credit weaknesses is observed, a lower risk grade is warranted.

Four (4) Satisfactory / Monitored. A “4” (Satisfactory/Monitored) risk grade may be established for a loan considered satisfactory but which is of average credit risk due to financial weakness or uncertainty. The loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in Satisfactory/Monitored classification is considered acceptable and within normal underwriting guidelines, so long as the loan is given management supervision.

Five (5) Special Mention. Loans that possess some credit deficiency or potential weakness which deserves close attention, but which do not yet warrant substandard classification. Such loans pose unwarranted financial risk that, if not corrected, could weaken the loan and increase risk in the future. The key distinctions of a 5 (Special Mention) classification are that (1) it is indicative of an unwarranted level of risk, and (2) weaknesses are considered “potential”, versus “defined”, impairments to the primary source of loan repayment and collateral.

Six (6) Substandard. One or more of the following characteristics may be exhibited in loans classified substandard:

Loans, which possess a defined credit weakness and the likelihood that a loan will be paid from the primary source, are uncertain. Financial deterioration is underway and very close attention is warranted to ensure that the loan is collected without loss

Loans are inadequately protected by the current net worth and paying capacity of the borrower.

The primary source of repayment is weakened, and the Bank is forced to rely on a secondary source of repayment such as collateral liquidation or guarantees.

Loans are characterized by the distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

Unusual courses of action are needed to maintain a high probability of repayment.

The borrower is not generating enough cash flow to repay loan principal; however, continues to make interest payments.

The lender is forced into a subordinate position or unsecured collateral position due to flaws in documentation.

Loans have been restructured so that payment schedules, terms and collateral represent concessions to the borrower when compared to the normal loan terms.

The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan

There is significant deterioration in the market conditions and the borrower is highly vulnerable to these conditions.

Seven (7) Doubtful. One or more of the following characteristics may be exhibited in loans classified Doubtful:

Loans have all of the weaknesses of those classified as Substandard. Additionally, however, these weaknesses make collection or liquidation in full based on existing conditions improbable.

The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.

The possibility of loss is high, but, because of certain important pending factors which may strengthen the loan, loss classification is deferred until its exact status is known. A Doubtful classification is established deferring the realization of the loss.

Eight (8) Loss. Loans are considered uncollectable and of such little value that continuing to carry them as assets on the institution’s financial statements is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

The following table represents the risk category of loans by portfolio class, net of deferred fees, based on the most recent analysis performed as of the time periods shown of December 31, 2015 and December 31, 2014.


	(In Thousands)
	Agricultural Real Estate				Agricultural				Commercial Real Estate				Commercial and Industrial				Industrial Development Bonds
	2015		2014		2015		2014		2015		2014		2015		2014		2015		2014
1-2	$	5,841	$	4,319	$	12,025	$	11,490	$	597	$	1,072	$	261	$	1,771	$	—	$	—
3		16,593		15,780		21,247		26,871		24,264		34,229		22,300		15,582		3,100		4,289
4		35,475		30,472		49,220		36,225		293,381		225,015		76,855		80,079		3,391		409
5		192		111		250		—		1,738		7,083		57		2,299		—		—
6		362		213		—		—		1,828		2,080		543		165		—		—
7		—		—		20		25		422		709		182		230		—		—
8		—		—		—		—		—		—		—		—		—		—

Total	$	58,463	$	50,895	$	82,762	$	74,611	$	322,230	$	270,188	$	100,198	$	100,126	$	6,491	$	4,698

For consumer residential real estate, and other, the Company also evaluates credit quality based on the aging status of the loan, which was previously stated, and by payment activity. The following tables present the recorded investment in those classes based on payment activity and assigned risk grading as of December 31, 2015 and December 31, 2014.


	(In Thousands)
	Consumer Real Estate
	2015		2014
Grade
Pass	$	87,292	$	97,007
Special mention (5)		48		—
Substandard (6)		332		446
Doubtful (7)		275		97

Total	$	87,947	$	97,550


	Consumer - Credit Card				Consumer - Other
	2015		2014		2015		2014
Performing	$	3,901	$	3,987	$	23,863	$	19,846
Nonperforming		—		—		23		25

Total, net of deferred fees	$	3,901	$	3,987	$	23,886	$	19,871

Information about impaired loans as of and for the years ended December 31, 2015 and 2014 are as follows:


	(In Thousands)
	2015		2014
Impaired loans without a valuation allowance	$	1,257	$	675
Impaired loans with a valuation allowance		879		1,168

Total impaired loans	$	2,136	$	1,843

Valuation allowance related to impaired loans	$	330	$	387

Total non-accrual loans	$	2,041	$	1,705

Total loans past-due ninety days or more and still accruing	$	—	$	—


	(In Thousands)
	2015		2014		2013
Average investment in impaired loans	$	2,509	$	1,929	$	3,274

Interest income recognized on impaired loans	$	96	$	87	$	60

Interest income recognized on a cash basis on impaired loans	$	60	$	51	$	17

No additional funds are committed to be advanced in connection with impaired loans.

The Bank had approximately $1.1 million of its impaired loans classified as trouble debt restructured as of December 31, 2015 as compared to $797.2 thousand of its impaired loans classified as trouble debt restructured as of December 31, 2014.

The following table represents the years ended December 31, 2015 and 2014.


December 31, 2015 Troubled Debt Restructurings	Number of Contracts Modified in the Last 12 Months		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		December 31, 2014 Troubled Debt Restructurings	Number of Contracts Modified in the Last 12 Months		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Commercial Real Estate		1	$	528	$	430	Commercial Real Estate		0	$	—	$	—
Commercial and Industrial		1		25		24	Commercial and Industrial		0		—		—

For the years ended December 31, 2015 and 2014, there were no TDRs that subsequently defaulted after modification.

For the majority of the Bank’s impaired loans, the Bank will apply the observable market price methodology. However, the Bank may also utilize a measurement incorporating the present value of expected future cash flows discounted at the loan’s effective rate of interest. To determine observable market price, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months for chattels and titled vehicles and every two years for real estate. In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated appraisals are received, the Bank may discount the collateral value used.

The Bank uses the following guidelines as stated in policy to determine when to realize a charge-off, whether a partial or full loan balance. A charge down in whole or in part is realized when unsecured consumer loans, credit card credits and overdraft lines of credit reach 90 days delinquency. At 120 days delinquent, secured consumer loans are charged down to the value of the collateral, if repossession of the collateral is assured and/or in the process of repossession. Consumer mortgage loan deficiencies are charged down upon the sale of the collateral or sooner upon the recognition of collateral deficiency. Commercial and agricultural credits are charged down at 120 days delinquency, unless an established and approved work-out plan is in place or litigation of the credit will likely result in recovery of the loan balance. Upon notification of bankruptcy, unsecured debt is charged off. Additional charge-off may be realized as further unsecured positions are recognized.

The following table presents loans individually evaluated for impairment by portfolio class of loans as of December 31, 2015 and 2014:


	(In Thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Recognized Cash Basis
2015
With no related allowance recorded:
Consumer real estate	$	156	$	156	$	—	$	158	$	5	$	5
Agricultural real estate		63		63		—		120		—		—
Agricultural		—		—		—		—		—		—
Commercial real estate		1,038		1,038		—		421		27		27
Commercial and Industrial		—		—		—		429		27		—
Consumer		—		—		—		—		—		—
With a specific allowance recorded:
Consumer real estate		275		323		64		181		7		6
Agricultural real estate		—		—		—		—		—		—
Agricultural		—		—		—		—		—		—
Commercial real estate		422		422		152		907		30		22
Commercial and Industrial		182		182		114		291		—		—
Consumer		—		—		—		2		—		—

Totals:
Consumer real estate	$	431	$	479	$	64	$	339	$	12	$	11

Agricultural real estate	$	63	$	63	$	—	$	120	$	—	$	—

Agricultural	$	—	$	—	$	—	$	—	$	—	$	—

Commercial real estate	$	1,460	$	1,460	$	152	$	1,328	$	57	$	49

Commercial and Industrial	$	182	$	182	$	114	$	720	$	27	$	—

Consumer	$	—	$	—	$	—	$	2	$	—	$	—


	(In Thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Recognized Cash Basis
2014
With no related allowance recorded:
Consumer real estate	$	204	$	229	$	—	$	52	$	1	$	1
Agricultural real estate		—		—		—		93		7		—
Agricultural		—		—		—		—		—		—
Commercial real estate		471		471		—		740		7		5
Commercial and Industrial		—		—		—		319		45		18
Consumer		—		—		—		—		—		—
With a specific allowance recorded:
Consumer real estate		97		97		36		118		6		6
Agricultural real estate		—		—		—		15		—		—
Agricultural		25		25		25		2		—		—
Commercial real estate		709		709		111		83		21		21
Commercial and Industrial		326		326		204		506		—		—
Consumer		11		11		11		1		—		—

Totals:
Consumer real estate	$	301	$	326	$	36	$	170	$	7	$	7

Agricultural real estate	$	—	$	—	$	—	$	108	$	7	$	—

Agricultural	$	25	$	25	$	25	$	2	$	—	$	—

Commercial real estate	$	1,180	$	1,180	$	111	$	823	$	28	$	26

Commercial and Industrial	$	326	$	326	$	204	$	825	$	45	$	18

Consumer	$	11	$	11	$	11	$	1	$	—	$	—

On January 1, 2015, the Company adopted Accounting Standards Update (ASU) 2014-04, Receivables, - “Troubled Debt Restructuring by Creditors. As of December 31, 2015 the Company had $477 thousand of foreclosed residential real estate property obtained by physical possession and $425 thousand of consumer mortgage loans secured by residential real estate properties for which foreclosure proceedings are in process according to local jurisdictions.

The ALLL has a direct impact on the provision expense. An increase in the ALLL is funded through recoveries and provision expense. The following tables summarize the activities in the allowance for credit losses.

The following is an analysis of the allowance for credit losses for the years ended December 31:


	(In Thousands)
	2015			2014			2013
Allowance for Loan Losses
Balance at beginning of year	$	5,905		$	5,194		$	5,224
Provision for loan loss		625			1,191			858
Loans charged off		(1,030	)		(778	)		(1,262	)
Recoveries		557			298			374

Balance at ending of year	$	6,057		$	5,905		$	5,194

Allowance for Unfunded Loan Commitments & Letters of Credit	$	208		$	207		$	163

Total Allowance for Credit Losses	$	6,265		$	6,112		$	5,357

The Company segregates its Allowance for Loan and Lease Losses (ALLL) into two reserves: The ALLL and the Allowance for Unfunded Loan Commitments and Letters of Credit (AULC). When combined, these reserves constitute the total Allowance for Credit Losses (ACL).

The AULC is reported within other liabilities on the balance sheet while the ALLL is netted within the loans, net asset line. The ACL presented above represents the full amount of reserves available to absorb possible credit losses.

The following table breaks down the activity within ALLL for each loan portfolio segment and shows the contribution provided by both the recoveries and the provision along with the reduction of the allowance caused by charge-offs.

Additional analysis related to the allowance for credit losses as of December 31, 2015 and 2014 is as follows:


	(In Thousands)
	Consumer Real Estate			Agricultural Real Estate		Agricultural			Commercial Real Estate			Commercial and Industrial			Consumer			Unfunded Loan Commitment & Letters of Credit		Unallocated		Total
2015
ALLOWANCE FOR CREDIT LOSSES:
Beginning balance	$	537		$	184	$	547		$	2,367		$	1,421		$	323		$	207	$	526	$	6,112
Charge Offs		(38	)		—		—			(143	)		(536	)		(313	)		—		—		(1,030	)
Recoveries		41			—		64			204			91			157			—		—		557
Provision (Credit)		(202	)		27		(29	)		88			253			170			—		318		625
Other Non-interest expense related to unfunded		—			—		—			—			—			—			1		—		1

Ending Balance	$	338		$	211	$	582		$	2,516		$	1,229		$	337		$	208	$	844	$	6,265

Ending balance: individually evaluated for impairment	$	64		$	—	$	—		$	152		$	114		$	—		$	—	$	—	$	330

Ending balance: collectively evaluated for impairment	$	274		$	211	$	582		$	2,364		$	1,115		$	337		$	208	$	844	$	5,935

Ending balance: loans acquired with deteriorated credit quality	$	1		$	—	$	—		$	—		$	—		$	—		$	—	$	—	$	1

FINANCING RECEIVABLES:
Ending balance	$	87,947		$	58,463	$	82,762		$	322,230		$	106,689		$	27,787		$	—	$	—	$	685,878

Ending balance: individually evaluated for impairment	$	431		$	63	$	—		$	1,460		$	182		$	—		$	—	$	—	$	2,136

Ending balance: collectively evaluated for impairment	$	87,516		$	58,400	$	82,762		$	320,770		$	106,507		$	27,787		$	—	$	—	$	683,742

Ending balance: loans acquired with deteriorated credit quality	$	507		$	—	$	—		$	—		$	—		$	—		$	—	$	—	$	507


	Consumer Real Estate			Agricultural Real Estate		Agricultural		Commercial Real Estate			Commercial and Industrial		Consumer			Unfunded Loan Commitment & Letters of Credit		Unallocated			Total
ALLOWANCE FOR CREDIT LOSSES:
Beginning balance	$	257		$	131	$	326	$	2,107		$	1,359	$	292		$	163	$	722		$	5,357
Charge Offs		(168	)		—		—		(229	)		—		(381	)		—		—			(778	)
Recoveries		34			—		44		4			20		196			—		—			298
Provision (Credit)		414			53		177		485			42		216			—		(196	)		1,191
Other Non-interest expense related to unfunded		—			—		—		—			—		—			44		—			44

Ending Balance	$	537		$	184	$	547	$	2,367		$	1,421	$	323		$	207	$	526		$	6,112

Ending balance: individually evaluated for impairment	$	36		$	—	$	25	$	111		$	204	$	11		$	—	$	—		$	387

Ending balance: collectively evaluated for impairment	$	501		$	184	$	522	$	2,256		$	1,217	$	312		$	207	$	526		$	5,725

Ending balance: loans acquired with deteriorated credit quality	$	2		$	—	$	—	$	—		$	—	$	—		$	—	$	—			2

FINANCING RECEIVABLES:
Ending balance	$	97,550		$	50,895	$	74,611	$	270,188		$	104,824	$	23,858		$	—	$	—		$	621,926

Ending balance: individually evaluated for impairment	$	301		$	—	$	25	$	1,179		$	327	$	11		$	—	$	—		$	1,843

Ending balance: collectively evaluated for impairment	$	97,249		$	50,895	$	74,586	$	269,009		$	104,497	$	23,847		$	—	$	—		$	620,083

Ending balance: loans acquired with deteriorated credit quality	$	526		$	—	$	—	$	—		$	—	$	—		$	—	$	—		$	526