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

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

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


	As of:
	March 31,	December 31,
	2018	2017

Commercial	$96,983	$96,127
Commercial real estate	261,619	251,807
Consumer	85,076	83,746
Residential	62,870	64,094

Total loans (1)	506,548	495,774

Less allowance for loan losses	4,671	4,752

Net loans	$501,877	$491,022

(1)

Includes net deferred costs and premiums of $764 and $940 as of March 31, 2018 and December 31, 2017, 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.

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.

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

“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.

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


Loans on Non-Accrual Status
(dollars in thousands)
	As of
	March 31, 2018	December 31, 2017
Commercial	$699	$727
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	1,308	1,465
Commercial Mortgages-Non-Owner Occupied	278	468
Commercial Construction	90	-
Consumer
Consumer Unsecured	-	-
Consumer Secured	491	566
Residential:
Residential Mortgages	623	1,025
Residential Consumer Construction	56	58

Totals	$3,545	$4,309

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 $2,096 on March 31, 2018 from $2,650 on December 31, 2017. The following table represents the changes in OREO balance during the three months ended March 31, 2018 and year ended December 31, 2017.


OREO Changes
(dollars in thousands)
	Three months ended	Year ended
	March 31, 2018	December 31, 2017
Balance at the beginning of the year (net)	$2,650	$2,370
Transfers from loans	-	815
Capitalized costs	-	40
Valuation adjustments	(34)	(60)
Sales proceeds	(525)	(514)
Gain (loss) on disposition	5	(1)
Balance at the end of the period (net)	$2,096	$2,650

At March 31, 2018 and December 31, 2017, the Company had $0 of consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held no residential real estate properties in other real estate owned as of March 31, 2018 and three residential real estate properties carried on the books at a value of $520 in other real estate owned as of December 31, 2017.

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, 2018
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2018	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$768	$788	$ -	$847	$8
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,340	2,434	-	2,384	30
Commercial Mortgage Non-Owner Occupied	427	439	-	551	8
Commercial Construction	-	-	-	-	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	398	494	-	339	6
Residential
Residential Mortgages	1,459	1,538	-	1,520	19
Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
Commercial	$438	$846	$134	$378	$4
Commercial Real Estate
Commercial Mortgages-Owner Occupied	517	517	81	591	8
Commercial Mortgage Non-Owner Occupied	72	72	18	73	1
Commercial Construction	90	703	1	130	-
Consumer
Consumer Unsecured	2	2	2	2	-
Consumer Secured	157	233	112	292	2
Residential
Residential Mortgages	197	204	35	174	-
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$1,206	$1,634	$134	$1,225	$12
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,857	2,951	81	2,975	38
Commercial Mortgage Non-Owner Occupied	499	511	18	624	9
Commercial Construction	90	703	1	130	-
Consumer
Consumer Unsecured	2	2	2	2	-
Consumer Secured	555	727	112	631	8
Residential
Residential Mortgages	1,656	1,742	35	1,694	19
Residential Consumer Construction	-	-	-	-	-
	$6,865	$8,270	$383	$7,281	$86

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


	Impaired Loans
	(dollars in thousands)
	As of and For the Year Ended December 31, 2017
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2017	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$925	$1,505	$ -	$812	$54
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,427	2,539	-	2,723	179
Commercial Mortgage Non-Owner Occupied	675	690	-	512	30
Commercial Construction	-	-	-	-	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	279	283	-	149	11
Residential
Residential Mortgages	1,580	1,673	-	1,568	63
Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
Commercial	$317	$323	$112	$919	$16
Commercial Real Estate
Commercial Mortgages-Owner Occupied	665	665	93	1,126	39
Commercial Mortgage Non-Owner Occupied	73	73	18	74	5
Commercial Construction	169	695	79	169	-
Consumer
Consumer Unsecured	2	2	2	1	-
Consumer Secured	427	445	255	269	11
Residential
Residential Mortgages	151	178	4	425	3
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$1,242	$1,828	$112	$1,731	$70
Commercial Real Estate
Commercial Mortgages-Owner Occupied	3,092	3,204	93	3,849	218
Commercial Mortgage Non-Owner Occupied	748	763	18	586	35
Commercial Construction	169	695	79	169	-
Consumer
Consumer Unsecured	2	2	2	1	-
Consumer Secured	706	728	255	418	22
Residential
Residential Mortgages	1,731	1,851	4	1,993	66
Residential Consumer Construction	-	-	-	-	-
	$7,690	$9,071	$563	$8,747	$411

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, 2018

		Commercial
2018	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Loan Losses:
Beginning Balance	$1,264	$1,738	$1,172	$578	$4,752
Charge-offs	(13)	(82)	(145)	-	(240)
Recoveries	98	-	39	-	137
Provision	56	(72)	(3)	41	22
Ending Balance	$1,405	$1,584	$1,063	$619	$4,671

Ending Balance: Individually evaluated for impairment	$134	$100	$114	$35	$383

Ending Balance: Collectively evaluated for impairment	1,271	1,484	949	584	4,288


Totals:	$1,405	$1,584	$1,063	$619	$4,671

Loans:

Ending Balance: Individually evaluated for impairment	$1,206	$3,446	$557	$1,656	$6,865

Ending Balance: Collectively evaluated for impairment	95,777	258,173	84,519	61,214	499,683

Totals:	$96,983	$261,619	$85,076	$62,870	$506,548

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, 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	(1,652)	(91)	(246)	(105)	(2,094)
Recoveries	6	41	51	39	137
Provision	718	(321)	413	183	993
Ending Balance	$1,264	$1,738	$1,172	$578	$4,752

Ending Balance: Individually evaluated for impairment	$112	$190	$257	$4	$563

Ending Balance: Collectively evaluated for impairment	1,152	1,548	915	574	4,189


Totals:	$1,264	$1,738	$1,172	$578	$4,752

Loans:

Ending Balance: Individually evaluated for impairment	$1,242	$4,009	$708	$1,731	$7,690

Ending Balance: Collectively evaluated for impairment	94,885	247,798	83,038	62,363	488,084

Totals:	$96,127	$251,807	$83,746	$64,094	$495,774

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


	Age Analysis of Past Due Loans as of
	March 31, 2018
	(dollars in thousands)
			Greater				Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Total	> 90 Days &
2018	Past Due	Past Due	90 Days	Due	Current	Loans	Accruing
Commercial	$294	$250	$457	$1,001	$95,982	$96,983	$ -
Commercial Real Estate:
Commercial Mortgages- Owner Occupied	705	-	226	931	102,001	102,932	-
Commercial Mortgages-Non-Owner Occupied	205	174	60	439	147,674	148,113	-
Commercial Construction	-	-	90	90	10,484	10,574	-
Consumer:
Consumer Unsecured	6	-	-	6	7,323	7,329	-
Consumer Secured	376	229	174	779	76,968	77,747	-
Residential:
Residential Mortgages	1,951	233	435	2,619	50,837	53,456	-
Residential Consumer Construction	-	-	56	56	9,358	9,414	-
Total	$3,537	$886	$1,498	$5,921	$500,627	$506,548	$ -


	Age Analysis of Past Due Loans as of
	December 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	$320	$ -	$250	$570	$95,557	$96,127	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	904	64	177	1,145	92,504	93,649	-
Commercial Mortgages-Non-Owner Occupied	-	361	299	660	138,101	138,761	-
Commercial Construction	-	-	169	169	19,228	19,397	-
Consumer:
Consumer Unsecured	3	-	-	3	6,977	6,980	-
Consumer Secured	245	139	462	846	75,920	76,766	-
Residential:
Residential Mortgages	706	414	532	1,652	51,545	53,197	-
Residential Consumer Construction	-	-	58	58	10,839	10,897	-
Total	$2,178	$978	$1,947	$5,103	$490,671	$495,774	$ -

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



	Credit Quality Information - by Class
	March 31, 2018
	(dollars in thousands)
2018	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$94,358	$845	$483	$1,297	$ -	$96,983
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	93,507	2,846	3,667	2,912	-	102,932
Commercial Mortgages-Non Owner Occupied	145,009	1,589	911	604	-	148,113
Commercial Construction	10,294	-	190	90	-	10,574
Consumer
Consumer Unsecured	7,317	-	10	2	-	7,329
Consumer Secured	77,005	-	-	742	-	77,747
Residential:
Residential Mortgages	51,158	-	240	2,058	-	53,456
Residential Consumer Construction	9,358	-	-	56	-	9,414

Totals	$488,006	$5,280	$5,501	$7,761	$ -	$506,548



	Credit Quality Information - by Class
	December 31, 2017
	(dollars in thousands)
2017	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$93,571	$1,217	$4	$1,335	$ -	96,127
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	83,834	2,926	3,734	3,155	-	93,649
Commercial Mortgages-Non Owner Occupied	135,855	1,898	152	856	-	138,761
Commercial Construction	18,423	-	805	169	-	19,397
Consumer
Consumer Unsecured	6,978	-	-	2	-	6,980
Consumer Secured	75,774	90	-	902	-	76,766
Residential:
Residential Mortgages	50,816	-	241	2,140	-	53,197
Residential Consumer Construction	10,839	-	-	58	-	10,897

Totals	$476,090	$6,131	$4,936	$8,617	$ -	$495,774

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

Troubled Debt Restructurings (TDR)

There were no loan modifications that would have been classified as TDRs during the three months ended March 31, 2018 and 2017.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three months ended March 31, 2018 and 2017.

At March 31, 2018 and December 31, 2017, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.