Note 9 – Loans, allowance for loan losses and OREO

Management has an established methodology used to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Bank has segmented certain loans in the portfolio by product type. Within these segments, the Bank has sub-segmented its portfolio into classes, based on the associated risks. The classifications set forth below do not correspond directly to the classifications set forth in the call report (Form FFIEC 041). Management has determined that the classifications set forth below are more appropriate for use in identifying and managing risk in the loan portfolio.

Loan Segments:		Loan Classes:
Commercial		Commercial and industrial loans
Commercial real estate		Commercial mortgages – owner occupied
		Commercial mortgages – non-owner occupied
		Commercial construction
Consumer		Consumer unsecured
		Consumer secured
Residential		Residential mortgages
		Residential consumer construction

A summary of loans, net is as follows (dollars in thousands):


	As of:
	September 30,	December 31,
	2014	2013

Commercial	$ 65,050	$ 55,803
Commercial real estate	190,675	172,117
Consumer	72,528	71,165
Residential	50,011	46,095

Total loans	378,264	345,180

Less allowance for loan losses	4,874	5,186

Net loans	$ 373,390	$ 339,994

The Bank’s internal risk rating system is in place to grade commercial and commercial real estate loans. Category ratings are reviewed periodically by lenders and the credit review area of the Bank based on the borrower’s individual situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

Note 9 – Loans, allowance for loan losses and OREO (continued)

Below is a summary and definition of the Bank’s risk rating categories:

RATING 1	Excellent
RATING 2	Above Average
RATING 3	Satisfactory
RATING 4	Acceptable / Low Satisfactory
RATING 5	Monitor
RATING 6	Special Mention
RATING 7	Substandard
RATING 8	Doubtful
RATING 9	Loss

We segregate loans into the above categories based on the following criteria and we review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

“Pass.” These are loans having risk ratings of 1 through 4. Pass loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.

“Monitor.” These are loans having a risk rating of 5. Monitor loans have currently acceptable risk but may have the potential for a specific defined weakness in the borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history may currently or in the future be characterized by late payments. The Bank’s risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

“Special Mention.” These are loans having a risk rating of 6. Special Mention loans have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the bank’s credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. These loans do warrant more than routine monitoring due to a weakness caused by adverse events.

“Substandard.” These are loans having a risk rating of 7. Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank’s credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provides evidence that it is probable that the Bank will be unable to collect all amounts due.

“Doubtful.” These are loans having a risk rating of 8. Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but 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. The possibility of loss is extremely high.

Note 9 – Loans, allowance for loan losses and OREO (continued)

“Loss.” These are loans having a risk rating of 9. Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.


Financing Receivables on Non-Accrual Status
(dollars in thousands)
	As of
	September 30, 2014	December 31, 2013
Commercial	$ 2,116	$ 1,585
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	212	537
Commercial Mortgages-Non-Owner Occupied	72	353
Commercial Construction	460	375
Consumer
Consumer Unsecured	-	-
Consumer Secured	-	33
Residential:
Residential Mortgages	312	183
Residential Consumer Construction	91	-

Totals	$ 3,263	$ 3,066

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank either through purchase at foreclosure or received from the borrower through a deed in lieu of foreclosure. OREO decreased to $1,160,000 on September 30, 2014 from $1,451,000 on December 31, 2013. The following table represents the changes in OREO balance during the nine months ended September 30, 2014.


OREO Changes
(dollars in thousands)
	Nine Months ended
	September 30, 2014
Balance at the beginning of the year (net)	$ 1,451
Transfers from loans	459
Capitalized costs	-
Writedowns	(178)
Sales proceeds	(573)
Gain on disposition	1
Balance at the end of the period (net)	$ 1,160

Note 9 – Loans, allowance for loan losses and OREO (continued)


	Impaired Loans
	(dollars in thousands)
	As of and For the Nine Months Ended September 30, 2014
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2014	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$2,558	$ 2,798	$ -	$ 2,912	$ 68
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,300	2,350	-	1,420	110
Commercial Mortgage Non-Owner Occupied	712	712	-	858	32
Commercial Construction	84	531	-	418	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	21	21	-	21	1
Residential
Residential Mortgages	463	463	-	467	47
Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
Commercial	$ 1,806	$ 2,234	$ 832	$ 1,190	$ 32
Commercial Real Estate
Commercial Mortgages-Owner Occupied	1,056	1,225	60	1,738	45
Commercial Mortgage Non-Owner Occupied	306	306	33	263	12
Commercial Construction	376	644	17	188	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	119	119	119	80	6
Residential
Residential Mortgages	1,497	1,659	284	1,591	50
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$ 4,364	$ 5,032	$ 832	$ 4,102	$ 100
Commercial Real Estate
Commercial Mortgages-Owner Occupied	3,356	3,575	60	3,158	155
Commercial Mortgage Non-Owner Occupied	1,018	1,018	33	1,121	44
Commercial Construction	460	1,175	17	606	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	140	140	119	101	7
Residential
Residential Mortgages	1,960	2,122	284	2,058	97
Residential Consumer Construction	-	-	-	-	-
	$ 11,298	$ 13,062	$ 1,345	$ 11,146	$ 403

Note 9 – Loans, allowance for loan losses and OREO (continued)


	Impaired Loans
	(dollars in thousands)
	As of and For the Year Ended December 31, 2013
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2013	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$ 3,265	$ 3,699	$ -	$ 2,898	$ 101
Commercial Real Estate
Commercial Mortgages-Owner Occupied	539	593	-	1,566	38
Commercial Mortgage Non-Owner Occupied	1,003	1,003	-	3,686	47
Commercial Construction	751	1,274	-	746	8
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	21	21	-	245	1
Residential
Residential Mortgages	470	517	-	1,304	24
Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
Commercial	$ 573	$ 573	$ 406	$ 597	$ 38
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,420	2,617	280	3,046	108
Commercial Mortgage Non-Owner Occupied	220	221	14	530	15
Commercial Construction	-	-	-	412	-
Consumer
Consumer Unsecured	-	-	-	1	-
Consumer Secured	40	40	40	285	3
Residential
Residential Mortgages	1,684	1,820	224	1,350	118
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$ 3,838	$ 4,272	$ 406	$ 3,495	$ 139
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,959	3,210	280	4,612	146
Commercial Mortgage Non-Owner Occupied	1,223	1,224	14	4,216	62
Commercial Construction	751	1,274	-	1,158	8
Consumer
Consumer Unsecured	-	-	-	1	-
Consumer Secured	61	61	40	530	4
Residential
Residential Mortgages	2,154	2,337	224	2,654	142
Residential Consumer Construction	-	-	-	-	-
	$ 10,986	$ 12,378	$ 964	$ 16,666	$ 501

Note 9 – Loans, allowance for loan losses and OREO (continued)


	Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands) For the Nine Months Ended September 30, 2014

		Commercial
2014	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Credit Losses:
Beginning Balance	$ 1,015	$ 2,631	$ 935	$ 605	$ 5,186
Charge-offs	(165)	(188)	(34)	(40)	(427)
Recoveries	27	9	24	-	60
Provision	473	(490)	(182)	254	55
Ending Balance	$ 1,350	$ 1,962	$ 743	$ 819	$ 4,874

Ending Balance: Individually evaluated for impairment	$ 832	$ 110	$ 119	$ 284	$ 1,345

Ending Balance: Collectively evaluated for impairment	518	1,852	624	535	3,529


Totals:	$ 1,350	$ 1,962	$ 743	$ 819	$ 4,874

Financing Receivables:

Ending Balance: Individually evaluated for impairment	$ 4,364	$ 4,834	$ 140	$ 1,960	$ 11,298

Ending Balance: Collectively evaluated for impairment	60,686	185,841	72,388	48,051	366,966

Totals:	$ 65,050	$ 190,675	$ 72,528	$ 50,011	$ 378,264

Note 9 – Loans, allowance for loan losses and OREO (continued)


	Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands) For the Year Ended December 31, 2013

		Commercial
2013	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Credit Losses:
Beginning Balance	$ 987	$ 2,849	$ 1,057	$ 642	$ 5,535
Charge-offs	(19)	(932)	(126)	(28)	(1,105)
Recoveries	37	42	137	-	216
Provision	10	672	(133)	(9)	540
Ending Balance	$ 1,015	$ 2,631	$ 935	$ 605	$ 5,186

Ending Balance: Individually evaluated for impairment	$ 406	$ 294	$ 40	$ 224	$ 964

Ending Balance: Collectively evaluated for impairment	609	2,337	895	381	4,222


Totals:	$ 1,015	$ 2,631	$ 935	$ 605	$ 5,186

Financing Receivables:

Ending Balance: Individually evaluated for impairment	$ 3,838	$ 4,933	$ 61	$ 2,154	$ 10,986

Ending Balance: Collectively evaluated for impairment	51,965	167,184	71,104	43,941	334,194

Totals:	$ 55,803	$ 172,117	$ 71,165	$ 46,095	$ 345,180

Note 9 – Loans, allowance for loan losses and OREO (continued)


	Age Analysis of Past Due Financing Receivables as of
	September 30, 2014
	(dollars in thousands)
			Greater			Total	Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Financing	> 90 Days &
2014	Past Due	Past Due	90 Days	Due	Current	Receivables	Accruing
Commercial	$ 88	$ 94	$ 2,116	$ 2,298	$ 62,752	$ 65,050	$ -
Commercial Real Estate:
Commercial Mortgages- Owner Occupied	646	857	212	1,715	68,798	70,513	-
Commercial Mortgages-Non-Owner Occupied	-	55	72	127	111,078	111,205	-
Commercial Construction	-	-	460	460	8,497	8,957	-
Consumer:
Consumer Unsecured	32	-	-	32	4,204	4,236	-
Consumer Secured	379	107	-	486	67,806	68,292	-
Residential:
Residential Mortgages	595	657	312	1,564	41,347	42,911	-
Residential Consumer Construction	-	-	-	-	7,100	7,100	-
Total	$ 1,740	$ 1,770	$ 3,172	$ 6,682	$ 371,582	$ 378,264	$ -


	Age Analysis of Past Due Financing Receivables as of
	December 31, 2013
	(dollars in thousands)
			Greater			Total	Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Financing	> 90 Days &
2013	Past Due	Past Due	90 Days	Due	Current	Receivables	Accruing
Commercial	$ 389	$-	$ 1,586	$ 1,975	$ 53,828	$ 55,803	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	1,099	-	409	1,508	63,813	65,321	-
Commercial Mortgages-Non-Owner Occupied	96	-	85	181	94,542	94,723	-
Commercial Construction	-	-	375	375	11,698	12,073	-
Consumer:
Consumer Unsecured	5	-	-	5	4,717	4,722	-
Consumer Secured	71	-	33	104	66,339	66,443	-
Residential:
Residential Mortgages	704	-	183	887	39,909	40,796	-
Residential Consumer Construction	-	95	-	95	5,204	5,299	-
Total	$ 2,364	$ 95	$ 2,671	$ 5,130	$ 340,050	$ 345,180	$ -

Note 9 – Loans, allowance for loan losses and OREO (continued)


	Credit Loss Disclosures
	Credit Quality Information - by Class
	September 30, 2014
	(dollars in thousands)
2014	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$ 59,258	$ 1,210	$ 90	$ 4,492	$ -	$ 65,050
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	65,844	1,098	308	3,263	-	70,513
Commercial Mortgages-Non Owner Occupied	104,323	1,809	4,338	735	-	111,205
Commercial Construction	8,073	424	-	460	-	8,957
Consumer
Consumer Unsecured	4,236	-	-	-	-	4,236
Consumer Secured	67,260	510	97	425	-	68,292
Residential:
Residential Mortgages	39,149	776	843	2,143	-	42,911
Residential Consumer Construction	7,009	-	-	91	-	7,100

Totals	$ 355,152	$ 5,827	$ 5,676	$ 11,609	$-	$ 378,264


	Credit Loss Disclosures
	Credit Quality Information - by Class
	December 31, 2013
	(dollars in thousands)
2013	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$ 48,827	$ 2,109	$ 979	$ 3,888	$ -	$ 55,803
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	58,740	2,355	1,356	2,870	-	65,321
Commercial Mortgages-Non Owner Occupied	85,474	2,737	5,468	1,044	-	94,723
Commercial Construction	11,455	-	-	618	-	12,073
Consumer
Consumer Unsecured	4,721	-	-	1	-	4,722
Consumer Secured	65,056	814	283	290	-	66,443
Residential:
Residential Mortgages	36,962	786	589	2,459	-	40,796
Residential Consumer Construction	5,299	-	-	-	-	5,299

Totals	$ 316,534	$ 8,801	$ 8,675	$ 11,170	$ -	$ 345,180

Note 9 – Loans, allowance for loan losses and OREO (continued)

There were no loan modifications that would have been classified as Troubled Debt Restructurings (TDR) during the three and nine months ended September 30, 2014 and 2013.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three and nine months ended September 30, 2014 and 2013.