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,
	2019	2018

Commercial	$106,178	$92,877
Commercial real estate	298,163	289,171
Consumer	83,314	86,191
Residential	69,043	66,358

Total loans (1)	556,698	534,597

Less allowance for loan losses	4,724	4,581

Net loans	$551,974	$530,016

(1)

Includes net deferred costs and premiums of $409 and $457 as of June 30, 2019 and December 31, 2018, 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.

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

“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
	June 30, 2019	December 31, 2018
Commercial	$957	$973
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	421	317
Commercial Mortgages-Non-Owner Occupied	557	173
Commercial Construction	-	-
Consumer
Consumer Unsecured	-	-
Consumer Secured	54	84
Residential:
Residential Mortgages	1,496	1,391
Residential Consumer Construction	-	-

Totals	$3,485	$2,939

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank which was acquired through purchase at foreclosure or from the borrower through a deed in lieu of foreclosure. OREO decreased to $2,413 on June 30, 2019 from $2,430 on December 31, 2018. The following table represents the changes in OREO balance during the six months ended June 30, 2019 and year ended December 31, 2018.


OREO Changes
(dollars in thousands)
	Six months ended	Year ended
	June 30, 2019	December 31, 2018
Balance at the beginning of the year (net)	$2,430	$2,650
Transfers from loans	460	850
Capitalized costs	-	-
Valuation adjustments	(115)	(185)
Sales proceeds	(349)	(846)
Loss on disposition	(13)	(39)
Balance at the end of the period (net)	$2,413	$2,430

At June 30, 2019 and December 31, 2018, the Company had no consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held two residential real estate properties carried on the books in other real estate owned at a value of $228 as of June 30, 2019 and four residential real estate properties carried on the books at a value of $156 in other real estate owned as of December 31, 2018.

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, 2019
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2019	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$1,409	$1,938	$ -	$1,420	$20
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,492	2,681	-	2,453	92
Commercial Mortgage Non-Owner Occupied	557	570	-	344	15
Commercial Construction	-	-	-	-	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	84	84	-	86	3
Residential
Residential Mortgages	1,928	2,004	-	1,902	39
Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
Commercial	$9	$9	$9	$20	$ -
Commercial Real Estate
Commercial Mortgages-Owner Occupied	19	19	19	29	1
Commercial Mortgage Non-Owner Occupied	16	16	9	53	1
Commercial Construction	-	-	-	-	-
Consumer
Consumer Unsecured	-	-	-	1	-
Consumer Secured	-	-	-	53	-
Residential
Residential Mortgages	302	319	48	339	7
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$1,418	$1,947	$9	$1,440	$20
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,511	2,700	19	2,482	93
Commercial Mortgage Non-Owner Occupied	573	586	9	397	16
Commercial Construction	-	-	-	-	-
Consumer
Consumer Unsecured	-	-	-	1	-
Consumer Secured	84	84	-	139	3
Residential
Residential Mortgages	2,230	2,323	48	2,241	46
Residential Consumer Construction	-	-	-	-	-
	$6,816	$7,640	$85	$6,700	$178

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


	Impaired Loans
	(dollars in thousands)
	As of and For the Year Ended December 31, 2018
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2018	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$1,430	$1,922	$ -	$1,178	$24
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,414	2,511	-	2,421	167
Commercial Mortgage Non-Owner Occupied	131	132	-	403	8
Commercial Construction	-	-	-	-	-
Consumer
Consumer Unsecured	-	-	-	-	-
Consumer Secured	88	88	-	184	6
Residential
Residential Mortgages	1,876	1,953	-	1,728	89
Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
Commercial	$31	$31	$15	$174	$3
Commercial Real Estate
Commercial Mortgages-Owner Occupied	39	132	36	352	3
Commercial Mortgage Non-Owner Occupied	90	90	20	82	6
Commercial Construction	-	-	-	85	-
Consumer
Consumer Unsecured	1	1	1	2	-
Consumer Secured	105	105	105	266	7
Residential
Residential Mortgages	375	390	61	263	11
Residential Consumer Construction	-	-	-	-	-

Totals:
Commercial	$1,461	$1,953	$15	$1,352	$27
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,453	2,643	36	2,773	170
Commercial Mortgage Non-Owner Occupied	221	222	20	485	14
Commercial Construction	-	-	-	85	-
Consumer
Consumer Unsecured	1	1	1	2	-
Consumer Secured	193	193	105	450	13
Residential
Residential Mortgages	2,251	2,343	61	1,991	100
Residential Consumer Construction	-	-	-	-	-
	$6,580	$7,355	$238	$7,138	$324

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, 2019

		Commercial
2019	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Loan Losses:
Beginning Balance	$1,136	$1,831	$956	$658	$4,581
Charge-offs	(24)	(6)	(168)	(21)	(219)
Recoveries	2	5	26	3	36
Provision	280	(2)	21	27	326
Ending Balance	$1,394	$1,828	$835	$667	$4,724

Ending Balance: Individually evaluated for impairment	$9	$28	$ -	$48	$85

Ending Balance: Collectively evaluated for impairment	1,385	1,800	835	619	4,639


Totals:	$1,394	$1,828	$835	$667	$4,724

Loans:

Ending Balance: Individually evaluated for impairment	$1,418	$3,084	$84	$2,230	$6,816

Ending Balance: Collectively evaluated for impairment	104,760	295,079	83,230	66,813	549,882

Totals:	$106,178	$298,163	$83,314	$69,043	$556,698

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, 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	(395)	(230)	(405)	(34)	(1,064)
Recoveries	113	4	60	-	177
Provision	154	319	129	114	716
Ending Balance	$1,136	$1,831	$956	$658	$4,581

Ending Balance: Individually evaluated for impairment	$15	$56	$106	$61	$238

Ending Balance: Collectively evaluated for impairment	1,121	1,775	850	597	4,343


Totals:	$1,136	$1,831	$956	$658	$4,581

Loans:

Ending Balance: Individually evaluated for impairment	$1,461	$2,674	$194	$2,251	$6,580

Ending Balance: Collectively evaluated for impairment	91,416	286,497	85,997	64,107	528,017

Totals:	$92,877	$289,171	$86,191	$66,358	$534,597

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


	Age Analysis of Past Due Loans as of
	June 30, 2019
	(dollars in thousands)
			Greater				Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Total	> 90 Days &
2019	Past Due	Past Due	90 Days	Due	Current	Loans	Accruing
Commercial	$87	$78	$214	$379	$105,799	$106,178	$ -
Commercial Real Estate:
Commercial Mortgages- Owner Occupied	503	125	289	917	100,339	101,256	-
Commercial Mortgages-Non-Owner Occupied	143	-	431	574	177,122	177,696	-
Commercial Construction	-	-	-	-	19,211	19,211	-
Consumer:
Consumer Unsecured	80	1	-	81	8,593	8,674	-
Consumer Secured	307	47	-	354	74,286	74,640	-
Residential:
Residential Mortgages	1,721	244	419	2,384	55,209	57,593	-
Residential Consumer Construction	-	-	-	-	11,450	11,450	-
Total	$2,841	$495	$1,353	$4,689	$552,009	$556,698	$ -


	Age Analysis of Past Due Loans as of
	December 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	$54	$56	$220	$330	$92,547	$92,877	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	209	-	307	516	97,910	98,426	-
Commercial Mortgages-Non-Owner Occupied	149	468	-	617	174,657	175,274	-
Commercial Construction	-	-	-	-	15,471	15,471	-
Consumer:
Consumer Unsecured	8	1	-	9	8,745	8,754	-
Consumer Secured	369	44	-	413	77,024	77,437	-
Residential:
Residential Mortgages	882	164	567	1,613	56,559	58,172	-
Residential Consumer Construction	-	-	-	-	8,186	8,186	-
Total	$1,671	$733	$1,094	$3,498	$531,099	$534,597	$ -

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




	Credit Quality Information - by Class
	June 30, 2019
	(dollars in thousands)
2019	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$99,842	$270	$4,603	$1,463	$ -	$106,178
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	89,994	458	8,292	2,512	-	101,256
Commercial Mortgages-Non-Owner Occupied	174,461	2,158	415	662	-	177,696
Commercial Construction	18,921	290	-	-	-	19,211
Consumer
Consumer Unsecured	8,674	-	-	-	-	8,674
Consumer Secured	74,391	53	-	196	-	74,640
Residential:
Residential Mortgages	54,298	893	-	2,402	-	57,593
Residential Consumer Construction	11,309	141	-	-	-	11,450

Totals	$531,890	$4,263	$13,310	$7,235	$ -	$556,698



	Credit Quality Information - by Class
	December 31, 2018
	(dollars in thousands)
2018	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$90,142	$818	$374	$1,543	$ -	$92,877
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	90,995	1,461	3,517	2,453	-	98,426
Commercial Mortgages-Non -Owner Occupied	172,342	2,285	332	315	-	175,274
Commercial Construction	14,892	579	-	-	-	15,471
Consumer
Consumer Unsecured	8,747	-	6	1	-	8,754
Consumer Secured	77,092	-	88	257	-	77,437
Residential:
Residential Mortgages	55,336	334	-	2,502	-	58,172
Residential Consumer Construction	8,186	-	-	-	-	8,186

Totals	$517,732	$5,477	$4,317	$7,071	$-	$534,597

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 and six months ended June 30, 2019 and 2018.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three and six months ended June 30, 2019 and 2018.

At June 30, 2019 and December 31, 2018, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.