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:
	March 31,	December 31,
	2017	2016

Commercial	$89,288	$88,085
Commercial real estate	239,520	237,638
Consumer	85,023	85,099
Residential	58,129	59,247

Total loans (1)	471,960	470,069

Less allowance for loan losses	5,716	5,716

Net loans	$466,244	$464,353

(1)

Includes net deferred costs of $235 and $182 as of March 31, 2017 and December 31, 2016, 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
	March 31, 2017	December 31, 2016
Commercial	$894	$915
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	827	855
Commercial Mortgages-Non-Owner Occupied	71	-
Commercial Construction	239	256
Consumer
Consumer Unsecured	-	-
Consumer Secured	177	80
Residential:
Residential Mortgages	874	1,292
Residential Consumer Construction	65	67

Totals	$3,147	$3,465

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 $2,750 on March 31, 2017 from $2,370 on December 31, 2016. The following table represents the changes in OREO balance during the three months ended March 31, 2017 and year ended December 31, 2016.


OREO Changes
(dollars in thousands)
	Three months ended	Year ended
	March 31, 2017	December 31, 2016
Balance at the beginning of the year (net)	$2,370	$1,965
Transfers from loans	535	470
Capitalized costs	-	-
Valuation adjustments	-	(45)
Sales proceeds	(147)	(21)
Gain (loss) on disposition	(8)	1
Balance at the end of the period (net)	$2,750	$2,370

At March 31, 2017 and December 31, 2016, the Company had $76 and $294 of consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held three residential real estate properties in other real estate owned as of March 31, 2017 and no residential real estate property in other real estate owned as of December 31, 2016.

Note 9 – Loans, allowance for loan losses and OREO (continued)
	Impaired Loans
	(dollars in thousands)
	As of and For the Three Months Ended March 31, 2017
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2017	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$252	$255	$ -	$475	$2
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,262	2,348	-	2,641	46
Commercial Mortgage Non-Owner Occupied	418	421	-	384	5
Commercial Construction	-	-	-	-	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	18	18	-	18	-
Residential
Residential Mortgages	1,588	1,673	-	1,572	10
Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
Commercial	$1,499	$1,511	$1,128	$1,510	$9
Commercial Real Estate
Commercial Mortgages-Owner Occupied	1,225	1,225	233	1,406	16
Commercial Mortgage Non-Owner Occupied	74	74	19	74	1
Commercial Construction	169	666	78	169	-
Consumer
Consumer Unsecured	3	3	3	2	-
Consumer Secured	109	109	109	110	2
Residential
Residential Mortgages	262	276	17	481	2
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$1,751	$1,766	$1,128	$1,985	$11
Commercial Real Estate
Commercial Mortgages-Owner Occupied	3,487	3,573	233	4,047	62
Commercial Mortgage Non-Owner Occupied	492	495	19	458	6
Commercial Construction	169	666	78	169	-
Consumer
Consumer Unsecured	3	3	3	2	-
Consumer Secured	127	127	109	128	2
Residential
Residential Mortgages	1,850	1,949	17	2,053	12
Residential Consumer Construction	-	-	-	-	-
	$7,879	$8,579	$1,587	$8,842	$93

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


	Impaired Loans
	(dollars in thousands)
	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 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 Three Months Ended March 31, 2017

		Commercial
2017	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Loan Losses:
Beginning Balance	$2,192	$2,109	$954	$461	$5,716
Charge-offs	(5)	(17)	(3)	(105)	(130)
Recoveries	1	13	15	1	30
Provision	(67)	115	(7)	59	100
Ending Balance	$2,121	$2,220	$959	$416	$5,716

Ending Balance: Individually evaluated for impairment	$1,128	$330	$112	$17	$1,587

Ending Balance: Collectively evaluated for impairment	993	1,890	847	399	4,129


Totals:	$2,121	$2,220	$959	$416	$5,716

Loans:

Ending Balance: Individually evaluated for impairment	$1,751	$4,148	$130	$1,850	$7,879

Ending Balance: Collectively evaluated for impairment	87,537	235,372	84,893	56,279	464,081

Totals:	$89,288	$239,520	$85,023	$58,129	$471,960

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


	Age Analysis of Past Due Loans as of
	March 31, 2017
	(dollars in thousands)
			Greater				Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Total	> 90 Days &
2017	Past Due	Past Due	90 Days	Due	Current	Loans	Accruing
Commercial	$155	$819	$150	$1,124	$88,164	$89,288	$ -
Commercial Real Estate:
Commercial Mortgages- Owner Occupied	57	937	495	1,489	89,542	91,031	-
Commercial Mortgages-Non-Owner Occupied	48	-	71	119	134,493	134,612	-
Commercial Construction	-	-	239	239	13,638	13,877	-
Consumer:
Consumer Unsecured	39	-	-	39	8,435	8,474	-
Consumer Secured	319	245	129	693	75,856	76,549	-
Residential:
Residential Mortgages	684	34	498	1,216	50,146	51,362	-
Residential Consumer Construction	-	-	65	65	6,702	6,767	-
Total	$1,302	$2,035	$1,647	$4,984	$466,976	$471,960	$ -


	Age Analysis of Past Due Loans as of
	December 31, 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	$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	$ -

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



	Credit Quality Information - by Class
	March 31, 2017
	(dollars in thousands)
2017	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$85,272	$1,250	$837	$1,185	$744	$89,288
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	83,365	4,011	100	3,555	-	91,031
Commercial Mortgages-Non Owner Occupied	131,716	1,754	519	623	-	134,612
Commercial Construction	12,550	1,088	-	239	-	13,877
Consumer
Consumer Unsecured	8,474	-	-	-	-	8,474
Consumer Secured	76,098	-	-	451	-	76,549
Residential:
Residential Mortgages	48,972	-	243	2,147	-	51,362
Residential Consumer Construction	6,702	-	-	65	-	6,767

Totals	$453,149	$8,103	$1,699	$8,265	$744	$471,960



	Credit Quality Information - by Class
	December 31, 2016
	(dollars in thousands)
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

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 March 31, 2017 and 2016.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three months ended March 31, 2017 and 2016.

At March 31, 2017 and December 31, 2016, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.