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,
	2015	2014

Commercial	$ 73,372	$ 63,259
Commercial real estate	218,827	207,262
Consumer	80,296	76,380
Residential	59,103	52,462

Total loans	431,598	399,363

Less allowance for loan losses	4,748	4,790

Net loans	$ 426,850	$ 394,573

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.


Loans on Non-Accrual Status
(dollars in thousands)
	As of
	September 30, 2015	December 31, 2014
Commercial	$ 485	$ 1,965
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	164	212
Commercial Mortgages-Non-Owner Occupied	141	70
Commercial Construction	367	460
Consumer
Consumer Unsecured	-	-
Consumer Secured	151	20
Residential:
Residential Mortgages	198	689
Residential Consumer Construction	87	90

Totals	$ 1,593	$ 3,506

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 increased to $2,265,000 on September 30, 2015 from $956,000 on December 31, 2014. The following table represents the changes in OREO balance during the nine months ended September 30, 2015 and year ended December 31, 2014.


OREO Changes
(dollars in thousands)
	Nine Months ended	Year ended
	September 30, 2015	December 31, 2014
Balance at the beginning of the year (net)	$ 956	$ 1,451
Transfers from loans	1,425	473
Capitalized costs	25	-
Writedowns	(75)	(167)
Sales proceeds	(66)	(780)
(Loss) on disposition	-	(21)
Balance at the end of the period (net)	$ 2,265	$ 956

At September 30, 2015 and December 31, 2014, the Company had 1 consumer mortgage loan secured by residential real estate for which foreclosure was in process. The Company held $0 and $65,000 of residential real estate in other real estate owned as of September 30, 2015 and December 31, 2014, respectively.

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, 2015
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2015	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$ -	$ -	$ -	$ 1,009	$ -
Commercial Real Estate
Commercial Mortgages-Owner Occupied	3,250	3,250	-	3,043	138
Commercial Mortgage Non-Owner Occupied	179	179	-	629	9
Commercial Construction	27	506	-	244	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	115	115	-	68	3
Residential
Residential Mortgages	1,502	1,518	-	1,218	84
Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
Commercial	$ 950	$ 1,013	$ 500	$ 1,178	$ 21
Commercial Real Estate
Commercial Mortgages-Owner Occupied	1,143	1,146	179	998	41
Commercial Mortgage Non-Owner Occupied	867	917	178	497	44
Commercial Construction	340	688	78	170	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	191	191	155	155	10
Residential
Residential Mortgages	801	945	103	815	38
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	950	$ 1,013	$ 500	$ 2,187	$ 21
Commercial Real Estate
Commercial Mortgages-Owner Occupied	4,393	4,396	179	4,041	179
Commercial Mortgage Non-Owner Occupied	1,046	1,096	178	1,126	53
Commercial Construction	367	1,194	78	414	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	306	306	155	223	13
Residential
Residential Mortgages	2,303	2,463	103	2,033	122
Residential Consumer Construction	-	-	-	-	-
	$ 9,365	$ 10,468	$ 1,193	$ 10,024	$ 388

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


	Impaired Loans
	(dollars in thousands)
	As of and For the Year Ended December 31, 2014
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2014	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$ 2,017	$ 2,280	$ -	$ 2,641	$ 63
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,835	2,835	-	1,687	152
Commercial Mortgage Non-Owner Occupied	1,078	1,128	-	1,041	75
Commercial Construction	460	1,194	-	606	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	21	21	-	21	1
Residential
Residential Mortgages	934	1,058	-	702	58
Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
Commercial	$ 1,406	$ 1,861	$ 713	$ 990	$ 29
Commercial Real Estate
Commercial Mortgages-Owner Occupied	852	1,029	63	1,636	36
Commercial Mortgage Non-Owner Occupied	126	126	32	173	7
Commercial Construction	-	-	-	-	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	119	119	119	80	7
Residential
Residential Mortgages	829	968	131	1,257	52
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$ 3,423	$ 4,141	$ 713	$ 3,631	$ 92
Commercial Real Estate
Commercial Mortgages-Owner Occupied	3,687	3,864	63	3,323	188
Commercial Mortgage Non-Owner Occupied	1,204	1,254	32	1,214	82
Commercial Construction	460	1,194	-	606	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	140	140	119	101	8
Residential
Residential Mortgages	1,763	2,026	131	1,959	110
Residential Consumer Construction	-	-	-	-	-
	$ 10,677	$ 12,619	$ 1,058	$ 10,834	$ 480

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


	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands) As of and For the Nine Months Ended September 30, 2015

		Commercial
2015	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Loan Losses:
Beginning Balance	$ 1,235	$ 2,194	$ 812	$ 549	$ 4,790
Charge-offs	(256)	(64)	(169)	-	(489)
Recoveries	13	73	48	36	170
Provision	86	2	17	172	277
Ending Balance	$ 1,078	$ 2,205	$ 708	$ 757	$ 4,748

Ending Balance: Individually evaluated for impairment	$ 500	$ 435	$ 155	$ 103	$ 1,193

Ending Balance: Collectively evaluated for impairment	578	1,770	553	654	3,555


Totals:	$ 1,078	$ 2,205	$ 708	$ 757	$ 4,748

Loans:

Ending Balance: Individually evaluated for impairment	$ 950	$ 5,806	$ 306	$ 2,303	$ 9,365

Ending Balance: Collectively evaluated for impairment	72,422	213,021	79,990	56,800	422,233

Totals:	$ 73,372	$ 218,827	$ 80,296	$ 59,103	$ 431,598

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


	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands) As of and For the Year Ended December 31, 2014

		Commercial
2014	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Loan Losses:
Beginning Balance	$ 1,015	$ 2,631	$ 935	$ 605	$ 5,186
Charge-offs	(165)	(187)	(79)	(120)	(551)
Recoveries	51	10	39	-	100
Provision	334	(260)	(83)	64	55
Ending Balance	$ 1,235	$ 2,194	$ 812	$ 549	$ 4,790

Ending Balance: Individually evaluated for impairment	$ 713	$ 95	$ 119	$ 131	$ 1,058

Ending Balance: Collectively evaluated for impairment	522	2,099	693	418	3,732


Totals:	$ 1,235	$ 2,194	$ 812	$ 549	$ 4,790

Loans:

Ending Balance: Individually evaluated for impairment	$ 3,423	$ 5,351	$ 140	$ 1,763	$ 10,677

Ending Balance: Collectively evaluated for impairment	59,836	201,911	76,240	50,699	388,686

Totals:	$ 63,259	$ 207,262	$ 76,380	$ 52,462	$ 399,363

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


	Age Analysis of Past Due Loans as of
	September 30, 2015
	(dollars in thousands)
			Greater				Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Total	> 90 Days &
2015	Past Due	Past Due	90 Days	Due	Current	Loans	Accruing
Commercial	$ 38	$ 222	$ 485	$ 745	$ 72,627	$ 73,372	$ -
Commercial Real Estate:
Commercial Mortgages- Owner Occupied	702	639	164	1,505	76,789	78,294	-
Commercial Mortgages-Non-Owner Occupied	-	-	64	64	124,838	124,902	-
Commercial Construction	-	-	367	367	15,264	15,631	-
Consumer:
Consumer Unsecured	32	-	-	32	5,714	5,746	-
Consumer Secured	141	-	-	141	74,409	74,550	-
Residential:
Residential Mortgages	488	245	198	931	48,867	49,798	-
Residential Consumer Construction	171	-	87	258	9,047	9,305	-
Total	$ 1,572	$ 1,106	$ 1,365	$ 4,043	$ 427,555	$ 431,598	$ -


	Age Analysis of Past Due Loans as of
	December 31, 2014
	(dollars in thousands)
			Greater				Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Total	> 90 Days &
2014	Past Due	Past Due	90 Days	Due	Current	Loans	Accruing
Commercial	$ 21	$ 80	$ 1,965	$ 2,066	$ 61,193	$ 63,259	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	192	-	212	404	77,304	77,708	-
Commercial Mortgages-Non-Owner Occupied	86	-	70	156	119,019	119,175	-
Commercial Construction	-	-	460	460	9,919	10,379	-
Consumer:
Consumer Unsecured	11	-	-	11	5,749	5,760	-
Consumer Secured	15	-	-	15	70,605	70,620	-
Residential:
Residential Mortgages	626	48	525	1,199	43,745	44,944	-
Residential Consumer Construction	29	-	-	29	7,489	7,518	-
Total	$ 980	$ 128	$ 3,232	$ 4,340	$ 395,023	$ 399,363	$ -

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



	Credit Quality Information - by Class
	September 30, 2015
	(dollars in thousands)
2015	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$ 70,827	$ 302	$ 1,277	$ 966	$ -	$ 73,372
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	70,084	1,366	2,367	4,477	-	78,294
Commercial Mortgages-Non Owner Occupied	118,371	1,759	3,823	949	-	124,902
Commercial Construction	15,264	-	-	367	-	15,631
Consumer
Consumer Unsecured	5,746	-	-	-	-	5,746
Consumer Secured	73,656	278	50	566	-	74,550
Residential:
Residential Mortgages	47,303	-	-	2,495	-	49,798
Residential Consumer Construction	9,218	-	-	87	-	9,305

Totals	$ 410,469	$ 3,705	$ 7,517	$ 9,907	$ -	$ 431,598



	Credit Quality Information - by Class
	December 31, 2014
	(dollars in thousands)
2014	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$ 58,745	$ 725	$ 224	$ 3,565	$ -	$ 63,259
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	71,087	1,718	1,216	3,687	-	77,708
Commercial Mortgages-Non Owner Occupied	112,560	1,586	3,971	1,058	-	119,175
Commercial Construction	9,919	-	-	460	-	10,379
Consumer
Consumer Unsecured	5,673	-	-	87	-	5,760
Consumer Secured	69,527	554	136	403	-	70,620
Residential:
Residential Mortgages	41,578	1,258	120	1,988	-	44,944
Residential Consumer Construction	7,428	-	-	90	-	7,518

Totals	$ 376,517	$ 5,841	$ 5,667	$ 11,338	$ -	$ 399,363

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

There were no loan modifications that would have been classified as TDRs during the three months ended September 30, 2015.

The following table describe the loan modifications classified as TDRs during the nine months ended September 30, 2015:

For the Nine Months Ended September 30, 2015 (dollars in thousands)
Troubled Debt Restructurings During the Period	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Pre-Modification Outstanding Recorded Investment
Commercial	1	$ 19	$ 19
Commercial Real Estate	2	$ 452	$ 452

There were no loan modifications that would have been classified as TDRs during the three and nine months ended September 30, 2014.

The loans noted in the table above were modified during the periods to extend maturity only. These loans are factored into the determination of the allowance for loan losses as of the periods indicated and are included in the Bank’s impaired loan analysis and individually evaluated for impairment.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three and nine months ended September 30, 2015 and 2014.

At September 30, 2015 and December 31, 2014, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.