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:
	June 30,	December 31,
	2016	2015

Commercial	$86,323	$76,773
Commercial real estate	223,922	217,125
Consumer	83,309	81,531
Residential	63,377	59,699

Total loans (1)	456,931	435,128

Less allowance for loan losses	4,887	4,683

Net loans	$452,044	$430,445

(1)

Includes deferred costs of $225 and $263, respectively.

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
	June 30, 2016	December 31, 2015
Commercial	$369	$483
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	865	799
Commercial Mortgages-Non-Owner Occupied	-	514
Commercial Construction	291	367
Consumer
Consumer Unsecured	-	31
Consumer Secured	63	269
Residential:
Residential Mortgages	806	695
Residential Consumer Construction	146	248

Totals	$2,540	$3,406

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 $2,420,000 on June 30, 2016 from $1,965,000 on December 31, 2015. The following table represents the changes in OREO balance during the six months ended June 30, 2016 and year ended December 31, 2015.


OREO Changes
(dollars in thousands)
	Six months ended	Year ended
	June 30, 2016	December 31, 2015
Balance at the beginning of the year (net)	$1,965	$956
Transfers from loans	475	1,425
Capitalized costs	-	25
Writedowns	-	(75)
Sales proceeds	(21)	(360)
Gain (loss) on disposition	1	(6)
Balance at the end of the period (net)	$2,420	$1,965

At June 30, 2016 and December 31, 2015, the Company had no consumer mortgage loan secured by residential real estate for which foreclosure was in process. The Company held one residential real estate property in other real estate owned as of June 30, 2016 and no residential real estate property in other real estate owned as of December 31, 2015.

Note 9 – Loans, allowance for loan losses and OREO (continued)
	Impaired Loans
	(dollars in thousands)
	As of and For the Six Months Ended June 30, 2016
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2016	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$ -	$ -	$ -	$ -	$ -
Commercial Real Estate
Commercial Mortgages-Owner Occupied	1,973	1,999	-	2,528	50
Commercial Mortgage Non-Owner Occupied	531	581	-	354	18
Commercial Construction	-	-	-	14	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	54	102	-	37	1
Residential
Residential Mortgages	1,750	1,795	-	1,874	32
Residential Consumer Construction	-	-	-	86	-

With An Allowance Recorded:
Commercial	$998	$1,083	$505	$1,089	$16
Commercial Real Estate
Commercial Mortgages-Owner Occupied	1,707	1,719	314	1,292	52
Commercial Mortgage Non-Owner Occupied	75	75	20	374	3
Commercial Construction	204	637	114	272	-
Consumer
Consumer Unsecured	-	-	-	16	-
Consumer Secured	111	111	111	151	4
Residential
Residential Mortgages	306	323	56	478	11
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$998	$1,083	$505	$1,089	$16
Commercial Real Estate
Commercial Mortgages-Owner Occupied	3,680	3,718	314	3,820	102
Commercial Mortgage Non-Owner Occupied	606	656	20	728	21
Commercial Construction	204	637	114	286	-
Consumer
Consumer Unsecured	-	-	-	16	-
Consumer Secured	165	213	111	188	5
Residential
Residential Mortgages	2,056	2,118	56	2,352	43
Residential Consumer Construction	-	-	-	86	-
	$7,709	$8,425	$1,120	$8,565	$187

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


	Impaired Loans
	(dollars in thousands)
	As of and For the Year Ended December 31, 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	3,082	3,100	-	2,959	174
Commercial Mortgage Non-Owner Occupied	177	177	-	628	12
Commercial Construction	27	514	-	244	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	20	20	-	21	1
Residential
Residential Mortgages	1,997	2,027	-	1,466	86
Residential Consumer Construction	171	176	-	86	4

With An Allowance Recorded:
Commercial	$1,180	$1,256	$610	$1,293	$38
Commercial Real Estate
Commercial Mortgages-Owner Occupied	877	883	163	865	35
Commercial Mortgage Non-Owner Occupied	672	738	175	399	38
Commercial Construction	340	700	75	170	-
Consumer
Consumer Unsecured	31	32	31	16	1
Consumer Secured	190	193	153	155	10
Residential
Residential Mortgages	650	800	87	740	42
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$1,180	$1,256	$610	$2,302	$38
Commercial Real Estate
Commercial Mortgages-Owner Occupied	3,959	3,983	163	3,824	209
Commercial Mortgage Non-Owner Occupied	849	915	175	1,027	50
Commercial Construction	367	1,214	75	414	-
Consumer
Consumer Unsecured	31	32	31	16	1
Consumer Secured	210	213	153	176	11
Residential
Residential Mortgages	2,647	2,827	87	2,206	128
Residential Consumer Construction	171	176	-	86	4
	$9,414	$10,616	$1,294	$10,051	$441

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 Six Months Ended June 30, 2016

		Commercial
2016	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Loan Losses:
Beginning Balance	$1,195	$1,751	$1,073	$664	$4,683
Charge-offs	(89)	(121)	(168)	-	(378)
Recoveries	3	101	28	-	132
Provision	528	(100)	(40)	62	450
Ending Balance	$1,637	$1,631	$893	$726	$4,887

Ending Balance: Individually evaluated for impairment	$505	$448	$111	$56	$1,120

Ending Balance: Collectively evaluated for impairment	1,132	1,183	782	670	3,767


Totals:	$1,637	$1,631	$893	$726	$4,887

Loans:

Ending Balance: Individually evaluated for impairment	$998	$4,490	$165	$2,056	$7,709

Ending Balance: Collectively evaluated for impairment	85,325	219,432	83,144	61,321	449,222

Totals:	$86,323	$223,922	$83,309	$63,377	$456,931

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, 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	(294)	(64)	(257)	-	(615)
Recoveries	14	122	54	36	226
Provision	240	(501)	464	79	282
Ending Balance	$1,195	$1,751	$1,073	$664	$4,683

Ending Balance: Individually evaluated for impairment	$610	$413	$184	$87	$1,294

Ending Balance: Collectively evaluated for impairment	585	1,338	889	577	3,389


Totals:	$1,195	$1,751	$1,073	$664	$4,683

Loans:

Ending Balance: Individually evaluated for impairment	$1,180	$5,175	$241	$2,818	$9,414

Ending Balance: Collectively evaluated for impairment	75,593	211,950	81,290	56,881	425,714

Totals:	$76,773	$217,125	$81,531	$59,699	$435,128

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


	Age Analysis of Past Due Loans as of
	June 30, 2016
	(dollars in thousands)
			Greater				Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Total	> 90 Days &
2016	Past Due	Past Due	90 Days	Due	Current	Loans	Accruing
Commercial	$14	$ -	$369	$383	$85,940	$86,323	$ -
Commercial Real Estate:
Commercial Mortgages- Owner Occupied	702	100	865	1,667	79,963	81,630	-
Commercial Mortgages-Non-Owner Occupied	-	-	-	-	129,808	129,808	-
Commercial Construction	-	-	291	291	12,193	12,484	-
Consumer:
Consumer Unsecured	14	9	-	23	7,016	7,039	-
Consumer Secured	496	15	35	546	75,724	76,270	-
Residential:
Residential Mortgages	518	202	754	1,474	50,808	52,282	-
Residential Consumer Construction	-	-	146	146	10,949	11,095	-
Total	$1,744	$326	$2,460	$4,530	$452,401	$456,931	$ -


	Age Analysis of Past Due Loans as of
	December 31, 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	$ -	$244	$483	$727	$76,046	$76,773	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	425	571	426	1,422	75,549	76,971	-
Commercial Mortgages-Non-Owner Occupied	189	90	438	717	126,138	126,855	-
Commercial Construction	-	-	367	367	12,932	13,299	-
Consumer:
Consumer Unsecured	2	-	31	33	6,828	6,861	-
Consumer Secured	198	68	128	394	74,276	74,670	-
Residential:
Residential Mortgages	512	468	543	1,523	48,490	50,013	-
Residential Consumer Construction	-	-	248	248	9,438	9,686	-
Total	$1,326	$1,441	$2,664	$5,431	$429,697	$435,128	$ -

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



	Credit Quality Information - by Class
	June 30, 2016
	(dollars in thousands)
2016	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$82,372	$1,605	$1,293	$1,053	$ -	$86,323
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	73,500	2,272	2,103	3,755	-	81,630
Commercial Mortgages-Non Owner Occupied	125,012	3,568	658	570	-	129,808
Commercial Construction	12,193	-	-	291	-	12,484
Consumer
Consumer Unsecured	7,039	-	-	-	-	7,039
Consumer Secured	75,645	238	-	387	-	76,270
Residential:
Residential Mortgages	49,701	-	248	2,333	-	52,282
Residential Consumer Construction	11,022	-	-	73	-	11,095

Totals	$436,484	$7,683	$4,302	$8,462	$ -	$456,931



	Credit Quality Information - by Class
	December 31, 2015
	(dollars in thousands)
2015	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$73,831	$290	$1,457	$1,195	$ -	$76,773
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	68,813	1,353	2,801	4,004	-	76,971
Commercial Mortgages-Non Owner Occupied	120,462	1,558	3,895	940	-	126,855
Commercial Construction	12,932	-	-	367	-	13,299
Consumer
Consumer Unsecured	6,830	-	-	31	-	6,861
Consumer Secured	73,825	276	50	519	-	74,670
Residential:
Residential Mortgages	47,180	-	-	2,833	-	50,013
Residential Consumer Construction	9,438	-	-	248	-	9,686

Totals	$413,311	$3,477	$8,203	$10,137	$ -	$435,128

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 and six months ended June 30, 2016.

The following table describe the loan modifications classified as TDRs during the three and six months ended June 30, 2015:

For the Three Months Ended June 30, 2015

(dollars in thousands)

Troubled Debt Restructurings During the Period

Number of Contracts

Pre-Modification Outstanding Recorded Investment

Post-Modification Outstanding Recorded Investment

Commercial Real Estate

$454


For the Six Months Ended June 30, 2015 (dollars in thousands)
Troubled Debt Restructurings During the Period	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Commercial	1	$20	$20
Commercial Real Estate	2	$454	$454

The loans noted in the table above were modified during the period to extend maturity only. These loans are factored into the determination of the allowance for loan losses as of the period 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 six months ended June 30, 2016 and 2015.

At June 30, 2016 and December 31, 2015, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.