5.LOANS AND LEASES

The classifications of loans and leases at December 31, 2014 and 2013 are summarized as follows:



(dollars in thousands)	2014		2013

Commercial and industrial	$	80,301	$	74,551
Commercial real estate:
Non-owner occupied		94,771		89,255
Owner occupied		95,780		86,294
Construction		5,911		10,765
Consumer:
Home equity installment		32,819		34,480
Home equity line of credit		42,188		36,836
Auto loans and leases		27,972		22,261
Other		6,501		5,205
Residential:
Real estate		119,154		110,365
Construction		10,298		8,188
Total		515,695		478,200
Less:
Allowance for loan losses		(9,173)		(8,928)
Unearned lease revenue		(195)		(56)

Loans and leases, net	$	506,327	$	469,216

Net deferred loan costs of $1.4 million and $1.1 million have been added to the carrying values of loans at December 31, 2014 and 2013, respectively.

Unearned lease revenue represents the difference between the lessor’s investment in the property and the gross investment in the lease. Unearned revenue is accrued over the life of the lease using the effective income method.

The Company services real estate loans for investors in the secondary mortgage market which are not included in the accompanying consolidated balance sheets. The approximate amount of mortgages serviced amounted to $256.8 million and $250.2 million as of December 31, 2014 and 2013.

The Company utilizes an external independent loan review firm that reviews and validates the credit risk program on at least an annual basis. Results of these reviews are presented to management and the board of directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

Non-accrual loans

The decision to place loans on non-accrual status is made on an individual basis after considering factors pertaining to each specific loan. Commercial and industrial and commercial real estate loans are placed on non-accrual status when management has determined that payment of all contractual principal and interest is in doubt or the loan is past due 90 days or more as to principal and interest, unless well-secured and in the process of collection. Consumer loans secured by real estate and residential mortgage loans are placed on non-accrual status at 120 days past due as to principal and interest and unsecured consumer loans are charged off when the loan is 90 days or more past due as to principal and interest. The Company considers all non-accrual loans to be impaired loans.

Non-accrual loans, segregated by class, at December 31, were as follows:



(dollars in thousands)	2014		2013

Commercial and industrial	$	27	$	62
Commercial real estate:
Non-owner occupied		620		1,518
Owner occupied		2,013		1,422
Construction		256		635
Consumer:
Home equity installment		312		393
Home equity line of credit		417		254
Auto loans and leases		1		12
Other		20		22
Residential:
Real estate		549		1,350
Total	$	4,215	$	5,668

Troubled Debt Restructuring

A modification of a loan constitutes a troubled debt restructuring (TDR) when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company considers all TDRs to be impaired loans. The Company offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Commercial and industrial (C&I) loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested. Commercial real estate (CRE) loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Commercial real estate construction loans modified in a TDR may also involve extending the interest-only payment period. Residential mortgage loans modified in a TDR are primarily comprised of loans where monthly payments are lowered to accommodate the borrowers’ financial needs for an extended period of time. After the lowered monthly payment period ends, the borrower would revert back to paying principal and interest pursuant to the original terms with the maturity date adjusted accordingly. Consumer loan modifications are typically not granted and therefore standard modification terms do not exist for loans of this type.

Loans modified in a TDR may or may not be placed on non-accrual status. As of December 31, 2014, total TDRs amounted to $1.6 million (consisting of 4 CRE loans and 1 C&I loan to 3 unrelated borrowers), of which one with a balance of $0.9 million was on non-accrual status, compared to $2.0 million (consisting of 5 CRE loans and 2 C&I loans to 5 unrelated borrowers) and $1.0 million, respectively, as of December 31, 2013. Of the TDRs outstanding as of December 31, 2014 and 2013, when modified, the concessions granted consisted of temporary interest-only payments or a reduction in the rate of interest to a below-market rate for a contractual period of time. Other than the TDR that was on non-accrual status, the TDRs were performing in accordance with their modified terms.

Loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. There were no loans modified in a TDR during the twelve months ended December 31, 2014 and 2013, respectively.

The allowance for loan losses (allowance) may be increased, adjustments may be made in the allocation of the allowance or partial charge offs may be taken to further write-down the carrying value of the loan. An allowance for impaired loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price. If the loan is collateral dependent, the estimated fair value of the collateral, less any selling costs, is used to establish the allowance.

Past due loans

Loans are considered past due when the contractual principal and/or interest is not received by the due date. An aging analysis of past due loans, segregated by class of loans, as of the period indicated is as follows (dollars in thousands):



														Recorded
					Past due									investment past
	30 - 59 Days		60 - 89 Days		90 days		Total				Total			due ≥ 90 days
December 31, 2014	past due		past due		or more (1)		past due		Current		loans			and accruing

Commercial and industrial	$	34	$	76	$	55	$	165	$	80,136	$	80,301		$	28
Commercial real estate:
Non-owner occupied		624		126		719		1,469		93,302		94,771			99
Owner occupied		366		292		2,113		2,771		93,009		95,780			100
Construction		-		-		256		256		5,655		5,911			-
Consumer:
Home equity installment		170		142		767		1,079		31,740		32,819			455
Home equity line of credit		13		-		417		430		41,758		42,188			-
Auto loans and leases		545		111		16		672		27,105		27,777	(2)		15
Other		38		147		40		225		6,276		6,501			20
Residential:
Real estate		700		548		892		2,140		117,014		119,154			343
Construction		-		-		-		-		10,298		10,298			-
Total	$	2,490	$	1,442	$	5,275	$	9,207	$	506,293	$	515,500		$	1,060

(1) Includes $4.2 million of non-accrual loans. (2) Net of unearned revenue of $0.2 million.



														Recorded
					Past due									investment past
	30 - 59 Days		60 - 89 Days		90 days		Total				Total			due ≥ 90 days
December 31, 2013	past due		past due		or more (1)		past due		Current		loans			and accruing

Commercial and industrial	$	111	$	212	$	69	$	392	$	74,159	$	74,551		$	7
Commercial real estate:
Non-owner occupied		484		35		1,518		2,037		87,218		89,255			-
Owner occupied		1,714		545		1,422		3,681		82,613		86,294			-
Construction		-		-		635		635		10,130		10,765			-
Consumer:
Home equity installment		229		72		393		694		33,786		34,480			-
Home equity line of credit		-		114		275		389		36,447		36,836			21
Auto loans and leases		165		14		23		202		22,003		22,205	(2)		11
Other		52		23		22		97		5,108		5,205			-
Residential:
Real estate		158		1,340		1,466		2,964		107,401		110,365			116
Construction		-		-		-		-		8,188		8,188			-
Total	$	2,913	$	2,355	$	5,823	$	11,091	$	467,053	$	478,144		$	155

(1) Includes $5.7 million of non-accrual loans. (2) Net of unearned revenue of $56 thousand.

Impaired loans

A loan is considered impaired when, based on current information and events; it is probable that the Company will be unable to collect the scheduled payments in accordance with the contractual terms of the loan. Factors considered in determining impairment include payment status, collateral value and the probability of collecting payments when due. The significance of payment delays and/or shortfalls is determined on a case-by-case basis. All circumstances surrounding the loan are taken into account. Such factors include the length of the delinquency, the underlying reasons and the borrower’s prior payment record. Impairment is measured on these loans on a loan-by-loan basis. Impaired loans include non-accrual loans, TDRs and other loans deemed to be impaired based on the aforementioned factors.

At December 31, 2014, impaired loans consisted of accruing TDRs totaling $0.7 million, $4.2 million of non-accrual loans and a $1.2 million accruing loan. At December 31, 2013, impaired loans consisted of accruing TDRs totaling $1.0 million and $5.7 million of non-accrual loans. As of December 31, 2014 and 2013, the non-accrual loans included non-accruing TDRs of $0.9 million and $1.0 million, respectively. Payments received from non-accruing impaired loans are first applied against the outstanding principal balance, then to the recovery of any charged-off amounts. Any excess is treated as a recovery of interest income. Payments received from accruing impaired loans are applied to principal and interest, as contractually agreed upon.

Impaired loans, segregated by class, as of the period indicated are detailed below:



			Recorded		Recorded										Cash basis
	Unpaid		investment		investment		Total				Average		Interest		interest
	principal		with		with no		recorded		Related		recorded		income		income
(dollars in thousands)	balance		allowance		allowance		investment		allowance		investment		recognized		recognized
December 31, 2014
Commercial & industrial	$	326	$	-	$	52	$	52	$	-	$	67	$	1	$	-
Commercial real estate:
Non-owner occupied		2,494		1,949		355		2,304		547		1,557		27		-
Owner occupied		2,375		447		1,825		2,272		87		1,996		15		-
Construction		350		-		256		256		-		342		-		-
Consumer:
Home equity installment		466		-		312		312		-		358		11		-
Home equity line of credit		469		128		289		417		1		382		20		-
Auto loans and leases		1		-		1		1		-		2		-		-
Other		33		-		20		20		-		22		-		-
Residential:
Real estate		612		304		245		549		35		762		7		-
Construction		-		-		-		-		-		-		-		-
Total	$	7,126	$	2,828	$	3,355	$	6,183	$	670	$	5,488	$	81	$	-



			Recorded		Recorded										Cash basis
	Unpaid		investment		investment		Total				Average		Interest		interest
	principal		with		with no		recorded		Related		recorded		income		income
(dollars in thousands)	balance		allowance		allowance		investment		allowance		investment		recognized		recognized
December 31, 2013
Commercial & industrial	$	134	$	64	$	33	$	97	$	31	$	80	$	2	$	-
Commercial real estate:
Non-owner occupied		2,146		174		1,827		2,001		27		2,173		31		78
Owner occupied		2,136		622		1,327		1,949		90		3,203		36		-
Construction		1,024		-		635		635		-		903		-		-
Consumer:
Home equity installment		501		125		268		393		23		723		37		-
Home equity line of credit		340		-		254		254		-		355		2		-
Auto		12		12		-		12		1		5		-		-
Other		22		-		22		22		-		29		-		-
Residential:
Real estate		1,511		437		913		1,350		110		1,682		71		-
Construction		-		-		-		-		-		-		-		-
Total	$	7,826	$	1,434	$	5,279	$	6,713	$	282	$	9,153	$	179	$	78

Credit Quality Indicators

Commercial and industrial and commercial real estate

The Company utilizes a loan grading system and assigns a credit risk grade to its loans in the commercial and industrial and commercial real estate portfolios. The grading system provides a means to measure portfolio quality and aids in the monitoring of the credit quality of the overall loan portfolio. The credit risk grades are arrived at using a risk rating matrix to assign a grade to each of the loans in the commercial and industrial and commercial real estate portfolios.

The following is a description of each risk rating category the Company uses to classify each of its commercial and industrial and commercial real estate loans:

Pass

Loans in this category have an acceptable level of risk and are graded in a range of one to five. Secured loans generally have good collateral coverage. Current financial statements reflect acceptable balance sheet ratios, sales and earnings trends. Management is considered to be good, and there is some depth existing. Payment experience on the loans has been good with minor or no delinquency experience. Loans with a grade of one are of the highest quality in the range. Those graded five are of marginally acceptable quality.

Special Mention

Loans in this category are graded a six and may be protected but are potentially weak. They constitute a credit risk to the Company, but have not yet reached the point of adverse classification. Some of the following conditions may exist: little or no collateral coverage; lack of current financial information; delinquency problems; highly leveraged; available financial information reflects poor balance sheet ratios and profit and loss statements reflect uncertain trends; and document exceptions. Cash flow may not be sufficient to support total debt service requirements. Loans in this category should not remain on the list for an inordinate period of time (no more than one year) and then the loan should be passed or classified appropriately.

Substandard

Loans in this category are graded a seven and have a well-defined weakness which may jeopardize the ultimate collectability of the debt. The collateral pledged may be lacking in quality or quantity. Financial statements may indicate insufficient cash flow to service the debt; and/or do not reflect a sound net worth. The payment history indicates chronic delinquency problems. Management is considered to be weak. There is a distinct possibility that the Company may sustain a loss. All loans on non-accrual are rated substandard. Other loans that are included in the substandard category can be accruing, as well as loans that are current or past due. Loans 90 days or more past due, unless otherwise fully supported, are classified substandard. Also, borrowers that are bankrupt or have loans categorized as troubled debt restructures can be graded substandard.

Doubtful

Loans in this category are graded an eight and have a better than 50% possibility of the Company sustaining a loss, but the loss cannot be determined because of specific reasonable factors which may strengthen credit in the near-term. Many of the weaknesses present in a substandard loan exist. Liquidation of collateral, if any, is likely. Any loan graded lower than an eight is considered to be uncollectible and charged-off.

Consumer and residential

The consumer and residential loan segments are regarded as homogeneous loan pools and as such are not risk rated. For these portfolios, the Company utilizes payment activity, history and recency of payment in assessing performance. Non-performing loans are considered to be loans past due 90 days or more and accruing and non-accrual loans. All loans not classified as non-performing are considered performing.

The following table presents loans, segregated by class, categorized into the appropriate credit quality indicator category as of the period indicated:

Commercial credit exposure

Credit risk profile by creditworthiness category



					Commercial real estate -				Commercial real estate -				Commercial real estate -
	Commercial and industrial				non-owner occupied				owner occupied				construction
(dollars in thousands)	12/31/2014		12/31/2013		12/31/2014		12/31/2013		12/31/2014		12/31/2013		12/31/2014		12/31/2013

Pass	$	76,902	$	71,122	$	83,387	$	78,069	$	88,256	$	82,975	$	5,073	$	9,026
Special mention		2,202		2,244		3,611		2,734		2,933		656		502		1,037
Substandard		1,197		1,185		7,773		8,452		4,591		2,663		336		702
Doubtful		-		-		-		-		-		-		-		-
Total	$	80,301	$	74,551	$	94,771	$	89,255	$	95,780	$	86,294	$	5,911	$	10,765

Consumer credit exposure

Credit risk profile based on payment activity



	Home equity installment				Home equity line of credit				Auto loans and leases				Other
(dollars in thousands)	12/31/2014		12/31/2013		12/31/2014		12/31/2013		12/31/2014		12/31/2013		12/31/2014		12/31/2013

Performing	$	32,052	$	34,087	$	41,771	$	36,561	$	27,761	$	22,182	$	6,461	$	5,183
Non-performing		767		393		417		275		16		23		40		22
Total	$	32,819	$	34,480	$	42,188	$	36,836	$	27,777	$	22,205	$	6,501	$	5,205

Mortgage lending credit exposure

Credit risk profile based on payment activity



	Residential real estate					Residential construction
(dollars in thousands)	12/31/2014		12/31/2013		12/31/2014		12/31/2013

Performing	$	118,262	$	108,899	$	10,298	$	8,188
Non-performing		892		1,466		-		-
Total	$	119,154	$	110,365	$	10,298	$	8,188

Allowance for loan losses

Management continually evaluates the credit quality of the Company’s loan portfolio and performs a formal review of the adequacy of the allowance for loan losses (the allowance) on a quarterly basis. The allowance reflects management’s best estimate of the amount of credit losses in the loan portfolio. Management’s judgment is based on the evaluation of individual loans, past experience, the assessment of current economic conditions and other relevant factors including the amounts and timing of cash flows expected to be received on impaired loans. Those estimates may be susceptible to significant change. Loan losses are charged directly against the allowance when loans are deemed to be uncollectible. Recoveries from previously charged-off loans are added to the allowance when received.

Management applies two primary components during the loan review process to determine proper allowance levels. The two components are a specific loan loss allocation for loans that are deemed impaired and a general loan loss allocation for those loans not specifically allocated. The methodology to analyze the adequacy of the allowance for loan losses is as follows:

identification of specific impaired loans by loan category;

identification of specific loans that are not impaired, but have an identified potential for loss;

calculation of specific allowances where required for the impaired loans based on collateral and other objective and quantifiable evidence;

determination of loans with similar credit characteristics within each class of the loan portfolio segment and eliminating the impaired loans;

application of historical loss percentages (trailing twelve-quarter average) to pools to determine the allowance allocation;

application of qualitative factor adjustment percentages to historical losses for trends or changes in the loan portfolio.

Qualitative factor adjustments include:

levels of and trends in delinquencies and non-accrual loans;

levels of and trends in charge-offs and recoveries;

trends in volume and terms of loans;

changes in risk selection and underwriting standards;

changes in lending policies, procedures and practices;

experience, ability and depth of lending management;

national and local economic trends and conditions; and

changes in credit concentrations.

Allocation of the allowance for different categories of loans is based on the methodology as explained above. A key element of the methodology to determine the allowance is the Company’s credit risk evaluation process, which includes credit risk grading of individual commercial and industrial and commercial real estate loans. Commercial and industrial and commercial real estate loans are assigned credit risk grades based on the Company’s assessment of conditions that affect the borrower’s ability to meet its contractual obligations under the loan agreement. That process includes reviewing borrowers’ current financial information, historical payment experience, credit documentation, public information and other information specific to each individual borrower. Upon review, the commercial loan credit risk grade is revised or reaffirmed as the case may be. The credit risk grades may be changed at any time management feels an upgrade or downgrade may be warranted. The credit risk grades for the commercial and industrial and commercial real estate loan portfolios are taken into account in the reserve methodology and loss factors are applied based upon the credit risk grades. The loss factors applied are based upon the Company’s historical experience as well as what we believe to be best practices and common industry standards. Historical experience reveals there is a direct correlation between the credit risk grades and loan charge-offs. The changes in allocations in the commercial and industrial and commercial real estate loan portfolio from period to period are based upon the credit risk grading system and from periodic reviews of the loan portfolio. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies.

Each quarter, management performs an assessment of the allowance for loan losses. The Company’s Special Assets Committee meets monthly and the applicable lenders discuss each relationship under review and reach a consensus on the appropriate estimated loss amount, if applicable, based on current accounting guidance. The Special Assets Committee’s focus is on ensuring the pertinent facts are considered regarding not only loans considered for specific reserves, but also the collectability of loans that may be past due in payment. The assessment process also includes the review of all loans on a non-accruing basis as well as a review of certain loans to which the lenders or the Company’s Credit Administration function have assigned a criticized or classified risk rating.

The Company’s policy is to charge off unsecured consumer loans when they become 90 days or more past due as to principal and interest. In the other portfolio segments, amounts are charged off at the point in time when the Company deems the balance, or a portion thereof, to be uncollectible.

Information related to the change in the allowance for loan losses and the Company’s recorded investment in loans by portfolio segment as of the period indicated is as follows:



As of and for the year ended December 31, 2014
	Commercial &		Commercial				Residential
(dollars in thousands)	industrial		real estate		Consumer		real estate		Unallocated		Total
Allowance for Loan Losses:
Beginning balance	$	944	$	4,253	$	1,482	$	1,613	$	636	$	8,928
Charge-offs		309		239		361		93		-		1,002
Recoveries		32		91		30		34		-		187
Provision		385		567		368		(238)		(22)		1,060
Ending balance	$	1,052	$	4,672	$	1,519	$	1,316	$	614	$	9,173
Ending balance: individually evaluated for impairment	$	-	$	634	$	1	$	35			$	670
Ending balance: collectively evaluated for impairment	$	1,052	$	4,038	$	1,518	$	1,281			$	7,889
Loans Receivables:
Ending balance	$	80,301	$	196,462	$	109,285	$	129,452			$	515,500
Ending balance: individually evaluated for impairment	$	52	$	4,832	$	750	$	549			$	6,183
Ending balance: collectively evaluated for impairment	$	80,249	$	191,630	$	108,535	$	128,903			$	509,317



As of and for the year ended December 31, 2013
	Commercial &		Commercial				Residential
(dollars in thousands)	industrial		real estate		Consumer		real estate		Unallocated		Total
Allowance for Loan Losses:
Beginning balance	$	922	$	4,908	$	1,639	$	1,503	$	-	$	8,972
Charge-offs		56		2,091		400		218		-		2,765
Recoveries		30		30		110		1		-		171
Provision		48		1,406		133		327		636		2,550
Ending balance	$	944	$	4,253	$	1,482	$	1,613	$	636	$	8,928
Ending balance: individually evaluated for impairment	$	31	$	117	$	24	$	110			$	282
Ending balance: collectively evaluated for impairment	$	913	$	4,136	$	1,458	$	1,503			$	8,010
Loans Receivables:
Ending balance	$	74,551	$	186,314	$	98,726	$	118,553			$	478,144
Ending balance: individually evaluated for impairment	$	97	$	4,585	$	681	$	1,350			$	6,713
Ending balance: collectively evaluated for impairment	$	74,454	$	181,729	$	98,045	$	117,203			$	471,431