Loans and Allowance for Loan Losses

All loan origination fees and direct loan origination costs are deferred and recognized over the life of the loan. As of September 30, 2016 and 2015, net deferred fees of $796 thousand and $1.2 million, respectively, were included in the carrying value of loans.

An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

The Bank’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Bank’s ALL.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by qualified factors.

The segments as presented in this note, which are based on the Federal call code assigned to each loan, provide the starting point for the ALL analysis. Company and Bank management tracks the historical net charge-off activity at the call code level. A historical charge-off factor is calculated utilizing a defined number of consecutive historical quarters. All pools currently utilize a rolling 12 quarters.

“Pass” rated credits are segregated from “Criticized” credits for the application of qualitative factors. Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors.

Company and Bank management have identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volume and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint. The combination of historical charge-off and qualitative factors are then weighted for each risk grade. These weightings are determined internally based upon the likelihood of loss as a loan risk grading deteriorates.

To estimate the liability for off-balance sheet credit exposures, Bank management analyzed the portfolios of letters of credit, non-revolving lines of credit, and revolving lines of credit, and based its calculation on the expectation of future advances of each loan category. Letters of credit were determined to be highly unlikely to advance since they are generally in place only to ensure various forms of performance of the borrowers. In the Bank’s history, there have been no letters of credit drawn upon. In addition, many of the letters of credit are cash secured and do not warrant an allocation. Non-revolving lines of credit were determined to be highly likely to advance as these are typically construction lines. Meanwhile, the likelihood of revolving lines of credit advancing varies with each individual borrower. Therefore, the future usage of each line was estimated based on the average line utilization of the revolving line of credit portfolio as a whole.

Once the estimated future advances were calculated, an allocation rate, which was derived from the Bank’s historical losses and qualitative environmental factors, was applied in the similar manner as those used for the allowance for loan loss calculation. The resulting estimated loss allocations were totaled to determine the liability for unfunded commitments related to these loans. The liability for unfunded commitments was $224 thousand and $194 thousand respectively as of September 30, 2016 and 2015.

Bank management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

The allowance for loan losses is based on estimates, and actual losses will vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

The following tables summarize the primary segments of the ALL, segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of September 30, 2016:



(Dollars in thousands)	Commercial			Residential		Home Equity		Consumer			Total
ALL balance June 30, 2016	$	6,956		$	1,011	$	758	$	366		$	9,091
Charge-offs	(768		)	—		—		(250		)	(1,018		)
Recoveries	1			1		—		—			2
Provision	967			11		2		95			1,075
ALL balance September 30, 2016	$	7,156		$	1,023	$	760	$	211		$	9,150



(Dollars in thousands)	Commercial			Residential			Home Equity		Consumer			Total
ALL balance December 31, 2015	$	6,066		$	1,095		$	715	$	130		$	8,006
Charge-offs	(1,448		)	(124		)	—		(272		)	(1,844		)
Recoveries	3			2			7		1			13
Provision	2,535			50			38		352			2,975
ALL balance September 30, 2016	$	7,156		$	1,023		$	760	$	211		$	9,150
Individually evaluated for impairment	$	1,288		$	38		$	—	$	20		$	1,346
Collectively evaluated for impairment	$	5,868		$	985		$	760	$	191		$	7,804

The following table summarizes the primary segments of the Company loan portfolio as of September 30, 2016:



(Dollars in thousands)	Commercial		Residential		Home Equity		Consumer		Total
Individually evaluated for impairment	$	10,922	$	673	$	51	$	141	$	11,787
Collectively evaluated for impairment	739,122		242,814		67,788		14,562		1,064,286
Total Loans	$	750,044	$	243,487	$	67,839	$	14,703	$	1,076,073



(Dollars in thousands)	Commercial			Residential		Home Equity		Consumer			Total
ALL balance June 30, 2015	$	5,201		$	1,018	$	632	$	196		$	7,047
Charge-offs	(299		)	—		—		(5		)	(304		)
Recoveries	—			—		—		9			9
Provision	515			101		78		(58		)	636
ALL balance September 30, 2015	$	5,417		$	1,119	$	710	$	142		$	7,388



(Dollars in thousands)	Commercial			Residential			Home Equity		Consumer			Total
ALL balance December 31, 2014	$	4,363		$	962		$	691	$	207		$	6,223
Charge-offs	(708		)	(14		)	—		(5		)	(727		)
Recoveries	21			1			1		13			36
Provision	1,741			170			18		(73		)	1,856
ALL balance September 30, 2015	$	5,417		$	1,119		$	710	$	142		$	7,388
Individually evaluated for impairment	$	595		$	301		$	28	$	6		$	930
Collectively evaluated for impairment	$	4,822		$	818		$	682	$	136		$	6,458

The following table summarizes the primary segments of the Company loan portfolio as of September 30, 2015:



(Dollars in thousands)	Commercial		Residential		Equity		Consumer		Total
Individually evaluated for impairment	$	12,036	$	849	$	28	$	6	$	12,919
Collectively evaluated for impairment	687,623		210,997		65,617		17,677		981,914
Total Loans	$	699,659	$	211,846	$	65,645	$	17,683	$	994,833

Loans are considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating impairment include current risk grade payment status and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Company also separately evaluates individual consumer loans for impairment. The Chief Credit Officer identifies these loans individually by monitoring the delinquency status of the Bank’s portfolio. Once identified, the Bank’s ongoing communications with the borrower allow Management to evaluate the significance of the payment delays and the circumstances surrounding the loan and the borrower.

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis, with management primarily utilizing the fair value of collateral method. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis.

During December 2013, the Bank purchased $74.3 million in performing commercial real estate secured loans in the northern Virginia area. At the time of acquisition, none of these loans were considered impaired. They were acquired at a premium of roughly 1.024 or $1.8 million, which is being amortized in accordance with ASC 310-20. These loans are collectively evaluated for impairment under ASC 450. The loans continue to be individually monitored for payoff activity, and any necessary adjustments to the premium are made accordingly. As of September 30, 2016 and December 31, 2015, these balances totaled $25.8 million and $46.8 million, respectively. Of the $48.5 million decrease since originally purchased, MVB refinanced $19.6 million, sold participations totaling $7.5 million and sold $9.7 million back to the institution from which the loans were originally purchased in December 2013. The remainder of the decrease was the result of principal paydowns. The weighted average yield on the remaining portfolio is 5.91%.

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of September 30, 2016 and December 31, 2015 (Dollars in thousands):



	Impaired Loans with Specific Allowance				Impaired Loans with No Specific Allowance		Total Impaired Loans
September 30, 2016	Recorded Investment		Related Allowance		Recorded Investment		Recorded Investment		Unpaid Principal Balance
Commercial
Commercial Business	$	—	$	—	$	3,756	$	3,756	$	4,521
Commercial Real Estate	3,712		1,154		384		4,096		4,719
Acquisition & Development	535		134		2,535		3,070		4,547
Total Commercial	4,247		1,288		6,675		10,922		13,787
Residential	480		38		193		673		678
Home Equity	—		—		51		51		51
Consumer	20		20		121		141		388
Total impaired loans	$	4,747	$	1,346	$	7,040	$	11,787	$	14,904

December 31, 2015
Commercial
Commercial Business	$	574	$	4	$	3,260	$	3,834	$	3,834
Commercial Real Estate	7,587		513		—		7,587		7,587
Acquisition & Development	1,800		191		956		2,756		4,131
Total Commercial	9,961		708		4,216		14,177		15,552
Residential	1,045		276		22		1,067		1,067
Home Equity	28		28		—		28		28
Consumer	103		1		—		103		103
Total impaired loans	$	11,137	$	1,013	$	4,238	$	15,375	$	16,750

Impaired loans have decreased by $3.6 million, or 23% during the first nine months of 2016, primarily the result of the net impact of four commercial loans. A $5.0 million loan to finance commercial real estate property in the Northern Virginia market, which had as primary tenants, government contractors that have vacated the premises as a result of losing significant contracts with the United States government, was purchased from another financial institution in late 2013. In the first quarter of 2016, this $5.0 million loan was repurchased by the selling financial institution thereby decreasing total impaired loans by $5.0 million. In contrast, a $1.8 million commercial real estate loan (net of a $619 thousand participation) was identified as impaired in the first quarter of 2016 as a result of an extended stabilization and interest only period, as well as a lack of project specific cash flows. A charge-off of $535 thousand was incurred on this loan in the second quarter of 2016. The remaining two loans that caused the most significant change to total impaired loans in 2016, which are related commercial loans within a single relationship, totaled $1.0 million and were identified as impaired in the second quarter of 2016 as a result of a decline in the coal industry. In the third quarter of 2016, these two loans, along with a third related loan that was previous impaired, required orderly liquidation of the related collateral, resulting in $435 thousand in principal curtailment and a total of partial charge offs in the amount of $679 thousand. The net effect of these three significant impairment items was $4.0 million. The remaining $400 thousand of the decrease in impaired loans since December 31, 2015 was the net effect of multiple other factors, including the identification of ten impaired commercial loans with a total balance of $855 thousand, the identification of two impaired installment loans with a total balance of $368 thousand, the identification of one impaired home equity line of credit with a balance of $23 thousand, a total of $630 thousand in partial charge-offs related to these various loans, the foreclosure upon a $127 thousand impaired residential real estate loan, and normal loan amortization.

The following tables present the average recorded investment in impaired loans and related interest income recognized for the periods indicated (Dollars in thousands):



	Nine Months Ended September 30, 2016						Three Months Ended September 30, 2016
	Average Investment in Impaired Loans		Interest Income Recognized on Accrual Basis		Interest Income Recognized on Cash Basis		Average Investment in Impaired Loans		Interest Income Recognized on Accrual Basis		Interest Income Recognized on Cash Basis
Commercial
Commercial Business	$	4,296	$	116	$	104	$	4,730	$	39	$	40
Commercial Real Estate	5,008		84		75		6,864		28		25
Acquisition & Development	1,927		7		9		2,958		2		3
Total Commercial	11,231		207		188		14,552		69		68
Residential	885		15		22		731		5		8
Home Equity	30		1		1		35		—		—
Consumer	284		—		—		286		—		—
Total	$	12,430	$	223	$	211	$	15,604	$	74	$	76



	Nine Months Ended September 30, 2015						Three Months Ended September 30, 2015
	Average Investment in Impaired Loans		Interest Income Recognized on Accrual Basis		Interest Income Recognized on Cash Basis		Average Investment in Impaired Loans		Interest Income Recognized on Accrual Basis		Interest Income Recognized on Cash Basis
Commercial
Commercial Business	$	3,228	$	117	$	114	$	2,945	$	39	$	39
Commercial Real Estate	6,533		44		37		6,525		15		12
Acquisition & Development	3,210		7		7		2,957		2		2
Total Commercial	12,971		168		158		12,427		56		53
Residential	935		15		11		909		5		7
Home Equity	28		1		1		28		—		—
Consumer	1		—		—		1		—		—
Total	$	13,935	$	184	$	170	$	13,365	$	61	$	60

As of September 30, 2016, the Bank held two foreclosed residential real estate properties representing $158 thousand, or 66%, of the total balance of other real estate owned. There are five additional consumer mortgage loans collateralized by residential real estate properties in the process of foreclosure. The total recorded investment in these loans was $529 thousand as of September 30, 2016.

Bank management uses a nine point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. Any portion of a loan that has been or is expected to be charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as past due status, bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s Chief Credit Officer is responsible for the timely and accurate risk rating of the loans in the portfolio at origination and on an ongoing basis. The Credit Department ensures that a review of all commercial relationships of one million dollars or greater is performed annually.

Review of the appropriate risk grade is included in both the internal and external loan review process, and on an ongoing basis. The Bank has an experienced Credit Department that continually reviews and assesses loans within the portfolio. The Bank engages an external consultant to conduct independent loan reviews on at least an annual basis. Generally, the external consultant reviews larger commercial relationships or criticized relationships. The Bank’s Credit Department compiles detailed reviews, including plans for resolution, on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table represents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system as of September 30, 2016 and December 31, 2015 (Dollars in thousands):



September 30, 2016	Pass		Special Mention		Substandard		Doubtful		Total
Commercial
Commercial Business	$	327,404	$	3,170	$	7,242	$	488	$	338,304
Commercial Real Estate	290,791		5,014		4,809		1,447		302,061
Acquisition & Development	103,633		2,976		1,527		1,543		109,679
Total Commercial	721,828		11,160		13,578		3,478		750,044
Residential	241,028		1,476		484		499		243,487
Home Equity	67,105		650		84		—		67,839
Consumer	14,196		299		27		181		14,703
Total Loans	$	1,044,157	$	13,585	$	14,173	$	4,158	$	1,076,073



December 31, 2015	Pass		Special Mention		Substandard		Doubtful		Total
Commercial
Commercial Business	$	288,549	$	7,949	$	3,411	$	574	$	300,483
Commercial Real Estate	299,560		9,761		8,436		—		317,757
Acquisition & Development	105,585		2,739		1,223		1,532		111,079
Total Commercial	693,694		20,449		13,070		2,106		729,319
Residential	214,184		1,764		1,168		250		217,366
Home Equity	67,645		416		63		—		68,124
Consumer	16,679		311		371		—		17,361
Total Loans	$	992,202	$	22,940	$	14,672	$	2,356	$	1,032,170

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.

A loan that has deteriorated and is in a collection process could warrant non-accrual status. A thorough review is to be presented to the Chief Credit Officer and or the Management Loan Committee ("MLC"), as required with respect to any loan which is in a collection process and to make a determination as to whether the loan should be placed on non-accrual status. The placement of loans on non-accrual status will be subject to applicable regulatory restrictions and guidelines. Generally, loans should be placed in non-accrual status when the loan approaches 90 days past due, when it becomes likely the borrower cannot or will not make scheduled principal or interest payments, when full repayment of principal and interest is not expected, or when the loan displays potential loss characteristics. Normally, all accrued interest should be charged off when a loan is placed in non-accrual status. Any payments subsequently received should be applied to principal. To remove a loan from non-accrual status, all principal and interest due must be paid up to date and the Bank is reasonably sure of future satisfactory payment performance. Usually, this requires a six-month recent history of payments due. Removal of a loan from non-accrual status will require the approval of the Chief Credit Officer and or MLC.

The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of September 30, 2016 and December 31, 2015 (Dollars in thousands):



September 30, 2016	Current		30-59 Days Past Due		60-89 Days Past Due		90 Days + Past Due		Total Past Due		Total Loans		Non- Accrual		90+ Days Still Accruing
Commercial
Commercial Business	$	337,569	$	142	$	100	$	493	$	735	$	338,304	$	493	$	—
Commercial Real Estate	296,153		1,184		—		4,724		5,908		302,061		2,202		3,659
Acquisition & Development	106,219		655		—		2,805		3,460		109,679		2,805		—
Total Commercial	739,941		1,981		100		8,022		10,103		750,044		5,500		3,659
Residential	243,180		43		83		181		307		243,487		845		—
Home Equity	67,771		45		—		23		68		67,839		57		—
Consumer	14,461		82		19		141		242		14,703		141		—
Total	$	1,065,353	$	2,151	$	202	$	8,367	$	10,720	$	1,076,073	$	6,543	$	3,659



December 31, 2015	Current		30-59 Days Past Due		60-89 Days Past Due		90 Days + Past Due		Total Past Due		Total Loans		Non- Accrual		90+ Days Still Accruing
Commercial
Commercial Business	$	299,515	$	300	$	—	$	668	$	968	$	300,483	$	687	$	—
Commercial Real Estate	307,029		436		4,731		5,561		10,728		317,757		5,020		541
Acquisition & Development	107,607		678		—		2,794		3,472		111,079		2,488		307
Total Commercial	714,151		1,414		4,731		9,023		15,168		729,319		8,195		848
Residential	214,326		1,838		576		626		3,040		217,366		803		—
Home Equity	67,908		23		193		—		216		68,124		36		—
Consumer	16,921		48		21		371		440		17,361		371		—
Total	$	1,013,306	$	3,323	$	5,521	$	10,020	$	18,864	$	1,032,170	$	9,405	$	848

Troubled Debt Restructurings

The restructuring of a loan is considered a troubled debt restructuring (“TDR”) if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. At September 30, 2016 and December 31, 2015, the Bank had specific reserve allocations for TDR’s of $292 thousand and $672 thousand, respectively.

Loans considered to be troubled debt restructured loans totaled $8.4 million and $9.3 million as of September 30, 2016 and December 31, 2015, respectively. $6.0 million and $6.0 million, respectively, represent accruing troubled debt restructured loans and represent 51% and 46%, respectively of total impaired loans, Meanwhile, $2.6 million and $2.5 million, respectively, represent three loans to two borrowers that have defaulted under the restructured terms. All three loans are commercial acquisition and development loans that were considered restructured due to extended interest only periods and/or unsatisfactory repayment structures once transitioned to principal and interest payments. These borrowers have experienced continued financial difficulty and are considered non-performing loans as of September 30, 2016 and December 31, 2015. Two additional restructured loans, a $214 thousand commercial real estate loan and a $348 thousand mortgage loan, are considered non-performing as of September 30, 2016. Both of these loans were also considered restructured due to extended interest only periods and/or unsatisfactory repayment structures.

There were no new TDR’s for the three months ended September 30, 2016 and 2015.