Note 5 - Loans and allowance for loan losses

The allowance represents an amount that, in management’s judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

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 by classes within the segments, based on the associated risks within these classes. 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

Note 5 - Loans and allowance for loan losses (continued)

The evaluation also considers the following risk characteristics of each loan segment:

Commercial loans carry risks associated with the successful operation of a business because the repayment of these loans may be dependent upon the profitability and cash flows of the business or project. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.

Commercial real estate loans carry risks associated with a real estate project and other risks associated with the ownership of real estate. In addition, for real estate construction loans there is a risk that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.

Consumer loans carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral (e.g., rapidly-depreciating assets such as automobiles), or lack thereof. Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy. Unsecured consumer loans carry additional risks associated with the continued credit-worthiness of borrowers who may be unable to meet payment obligations.

Residential mortgage and construction loans carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.

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.

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

Based on the above criteria, we segregate loans into the above categories for special mention, substandard, doubtful and loss from non-classified, or pass rated, loans. We review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

Note 5 - Loans and allowance for loan losses (continued)

“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 provide 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 high.

“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.

Note 5 - Loans and allowance for loan losses (continued)

The Bank grants primarily commercial, real estate, and installment loans to customers throughout its market area, which consists primarily of Region 2000 which includes the counties of Amherst, Appomattox, Bedford and Campbell, the Town of Bedford, and the City of and the City of Lynchburg, Virginia. The real estate portfolio can be affected by the condition of the local real estate market. The commercial and installment loan portfolio can be affected by the local economic conditions.

A summary of loans, net is as follows:



	December 31,
	2016	2015

Commercial	$88,085	$76,773
Commercial real estate	237,638	217,125
Consumer	85,099	81,531
Residential	59,247	59,699

Total loans (1)	470,069	435,128

Less allowance for loan losses	5,716	4,683

Net loans	$464,353	$430,445

(1)

Includes net deferred loan costs of $182 and $263, respectively.

The amount of overdrafts reclassified as loans was $54 and $17 as of December 31, 2016 and 2015, respectively.

The Company’s officers, directors and their related interests have various types of loan relationships with the Bank. The total outstanding balances of these related party loans at December 31, 2016 and 2015 were $15,869 and $16,674 respectively. During 2016, new loans and advances amounted to $1,186 and repayments amounted to $1,991. It should be noted that the beginning balance as of December 31, 2015 was adjusted upward to account for the existing loan relationships maintained by individuals who were newly designated as executive officers in 2016 as defined by Regulation O.

Note 5 - Loans and allowance for loan losses (continued)

The following tables set forth information regarding impaired and non-accrual loans as of December 31, 2016 and 2015:



Loans on Non-Accrual Status


	As of December 31,
	2016	2015
Commercial	$915	$483
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	855	799
Commercial Mortgages-Non-Owner Occupied	-	514
Commercial Construction	256	367
Consumer
Consumer Unsecured	-	31
Consumer Secured	80	269
Residential:
Residential Mortgages	1,292	695
Residential Consumer Construction	67	248

Totals	$3,465	$3,406

Note 5 - Loans and allowance for loan losses (continued)


		Impaired Loans
		As of and for the Year Ended December 31, 2016
			Unpaid		Average	Interest
		Recorded	Principal	Related	Recorded	Income
2016		Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
	Commercial	$ 698	$ 698	$ -	$ 349	$ 37
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	3,019	3,077	-	3,051	142
	Commercial Mortgage Non-Owner Occupied	349	349	-	263	23
	Commercial Construction	-	-	-	14	-
	Consumer
	Consumer Unsecured	-	-	-	-	-
	Consumer Secured	18	18	-	19	1
	Residential
	Residential Mortgages	1,555	1,687	-	1,776	55
	Residential Consumer Construction	-	-	-	86	-

With an Allowance Recorded:
	Commercial	$ 1,521	$ 1,521	$ 1,233	$ 1,351	$ 81
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	1,587	1,618	249	1,232	81
	Commercial Mortgage Non-Owner Occupied	74	74	20	373	6
	Commercial Construction	169	657	76	255	-
	Consumer
	Consumer Unsecured	-	-	-	16	-
	Consumer Secured	110	110	110	150	8
	Residential
	Residential Mortgages	699	736	83	675	30
	Residential Consumer Construction	-	-	-	-	-

Totals:
	Commercial	$ 2,219	$ 2,219	$ 1,233	$ 1,700	$ 118
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	4,606	4,695	249	4,283	223
	Commercial Mortgage Non-Owner Occupied	423	423	20	636	29
	Commercial Construction	169	657	76	269	-
	Consumer
	Consumer Unsecured	-	-	-	16	-
	Consumer Secured	128	128	110	169	9
	Residential
	Residential Mortgages	2,254	2,423	83	2,451	85
	Residential Consumer Construction	-	-	-	86	-
		$ 9,799	$ 10,545	$ 1,771	$ 9,610	$ 464

Note 5 - Loans and allowance for loan losses (continued)


		Impaired Loans
		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	$ 6100	$ 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 5 - Loans and allowance for loan losses (continued)

The following tables set forth the allowance for loan losses activity for the years ended December 31, 2016 and 2015:

Allowance for Loan Losses and Recorded Investment in Loans

For the Year Ended December 31, 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	(328)	(156)	(275)	-	(759)
Recoveries	7	127	44	2	180
Provision	1,318	387	112	(205)	1,612
Ending Balance	$2,192	$2,109	$954	$461	$5,716

Ending Balance: Individually evaluated for impairment	$1,233	$345	$110	$83	$1,771

Ending Balance: Collectively evaluated for impairment	959	1,764	844	378	3,945


Totals:	$2,192	$2,109	$954	$461	$5,716

Loans:

Ending Balance: Individually evaluated for impairment	$2,219	$5,198	$128	$2,254	$9,799

Ending Balance: Collectively evaluated for impairment	85,866	232,440	84,971	56,993	460,270

Totals:	$88,085	$237,638	$85,099	$59,247	$470,069

Note 5 - Loans and allowance for loan losses (continued)

Allowance for Loan Losses and Recorded Investment in Loans

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 5 - Loans and allowance for loan losses (continued)


Age Analysis of Past Due Loans as of December 31, 2016
2016	30-59 Days Past Due	60-89 Days Past Due	Greater than 90 Days	Total Past Due	Current	Total Loans	Recorded Investment > 90 Days & Accruing
Commercial	$283	$5	$78	$366	$87,719	$88,085	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	1,136	72	855	2,063	88,698	90,761	-
Commercial Mortgages-Non-Owner Occupied	140	-	-	140	134,262	134,402	-
Commercial Construction	-	-	256	256	12,219	12,475	-
Consumer:
Consumer Unsecured	9	-	-	9	8,558	8,567	-
Consumer Secured	531	301	-	832	75,700	76,532	-
Residential:
Residential Mortgages	539	161	1,063	1,763	49,525	51,288	-
Residential Consumer Construction	-	-	67	67	7,892	7,959	-
Total	$2,638	$539	$2,319	$5,496	$464,573	$470,069	$ -


Age Analysis of Past Due Loans as of December 31, 2015
2015	30-59 Days Past Due	60-89 Days Past Due	Greater than 90 Days	Total Past Due	Current	Total Loans	Recorded Investment > 90 Days & 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 5 - Loans and allowance for loan losses (continued)

Credit Quality Information - by Class

December 31, 2016

2016	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$83,912	$1,473	$301	$1,484	$915	$88,085
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	83,008	2,975	101	4,677	-	90,761
Commercial Mortgages-Non-Owner Occupied	129,794	3,525	525	558	-	134,402
Commercial Construction	11,774	-	445	256	-	12,475
Consumer
Consumer Unsecured	8,567	-	-	-	-	8,567
Consumer Secured	76,215	-	-	317	-	76,532
Residential:
Residential Mortgages	48,366	-	245	2,677	-	51,288
Residential Consumer Construction	7,892	-	-	67	-	7,959

Totals	$449,528	$7,973	$1,617	$10,036	$915	$470,069

Credit Quality Information - by Class

December 31, 2015

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 5 - Loans and allowance for loan losses (continued)

Troubled Debt Restructurings (TDRs)

There were no loan modifications that would have been classified as Troubled Debt Restructurings (TDR) during the twelve months ended December 31, 2016.

The following tables describe the loan modifications classified as TDRs during the twelve months ended December 31, 2015: For the Twelve Months Ended December 31, 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	$21	$21
Commercial Real Estate	2	$456	$456

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 period indicated and are included in the Bank’s impaired loan analysis and individually evaluated for impairment.

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

There were no loan modifications classified as TDRs within the last twelve months that defaulted (90 days past due) during the twelve months ended December 31, 2016 and 2015.