Note 6. Loan Quality

Management utilizes a risk rating scale ranging from 1 (Prime) to 9 (Loss) to evaluate loan quality. This risk rating scale is used primarily for commercial purpose loans. Consumer purpose loans are identified as either a pass or substandard rating. Substandard consumer loans are loans that are 90 days or more past due and still accruing. Loans rated 1 – 4 are considered pass credits. Loans that are rated 5 are pass credits, but have been identified as credits that are likely to warrant additional attention and monitoring. Loans rated 6 (Special Mention) or worse begin to receive enhanced monitoring and reporting by the Bank. Loans rated 7 (Substandard) or 8 (Doubtful) exhibit the greatest financial weakness and present the greatest possible risk of loss to the Bank. Nonaccrual loans are rated no better than 7. The following represents some of the factors used in determining the risk rating of a borrower: cash flow, debt coverage, liquidity, management, and collateral. Risk ratings, for pass credits, are generally reviewed annually for term debt and at renewal for revolving or renewing debt. The Bank monitors loan quality by reviewing four measurements: (1) loans rated 6 or worse (collectively “watch list”), (2) delinquent loans, (3) other real estate owned (OREO), and (4) net-charge-offs. Management compares trends in these measurements with the Bank’s internally established targets, as well as its national peer group.

The following table reports on the credit rating for those loans in the portfolio that are assigned an individual credit rating as of December 31, 2015 and 2014




(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total

December 31, 2015
Residential Real Estate 1-4 Family
First liens	$	157,514	$	2,122	$	1,842	$	-	$	161,478
Junior liens and lines of credit		50,685		28		200		-		50,913
Total		208,199		2,150		2,042		-		212,391
Residential real estate - construction		7,386		-		502		-		7,888
Commercial real estate		319,985		6,175		14,535		-		340,695
Commercial		213,492		1,978		472		-		215,942
Consumer		5,100		-		-		-		5,100
Total	$	754,162	$	10,303	$	17,551	$	-	$	782,016



December 31, 2014
Residential Real Estate 1-4 Family
First liens	$	155,676	$	1,919	$	3,719	$	-	$	161,314
Junior liens and lines of credit		43,559		29		207		-		43,795
Total		199,235		1,948		3,926		-		205,109
Residential real estate - construction		8,784		-		931		-		9,715
Commercial real estate		301,149		10,578		14,755		-		326,482
Commercial		170,774		5,413		2,884		-		179,071
Consumer		6,137		-		17		-		6,154
Total	$	686,079	$	17,939	$	22,513	$	-	$	726,531

Delinquent loans are a result of borrowers’ cash flow and/or alternative sources of cash being insufficient to repay loans. The Bank’s likelihood of collateral liquidation to repay the loans becomes more probable the further behind a borrower falls, particularly when loans reach 90 days or more past due. Management monitors the performance status of loans by the use of an aging report. The aging report can provide an early indicator of loans that may become severely delinquent and possibly result in a loss to the Bank. The following table presents the aging of payments in the loan portfolio as of December 31, 2015 and 2014.



(Dollars in thousands)			Loans Past Due and Still Accruing										Total
	Current		30-59 Days		60-89 Days		90 Days+		Total		Non-Accrual		Loans
December 31, 2015
Residential Real Estate 1-4 Family
First liens	$	159,998	$	44	$	416	$	214	$	674	$	806	$	161,478
Junior liens and lines of credit		50,541		217		50		-		267		105		50,913
Total		210,539		261		466		214		941		911		212,391
Residential real estate - construction		7,209		177		-		-		177		502		7,888
Commercial real estate		330,953		5,713		196		152		6,061		3,681		340,695
Commercial		215,449		210		5		2		217		276		215,942
Consumer		5,041		55		4		-		59		-		5,100
Total	$	769,191	$	6,416	$	671	$	368	$	7,455	$	5,370	$	782,016



December 31, 2014
Residential Real Estate 1-4 Family
First liens	$	158,197	$	1,531	$	297	$	165	$	1,993	$	1,124	$	161,314
Junior liens and lines of credit		43,424		174		28		-		202		169		43,795
Total		201,621		1,705		325		165		2,195		1,293		205,109
Residential real estate - construction		8,784		-		-		-		-		931		9,715
Commercial real estate		317,576		336		-		140		476		8,430		326,482
Commercial		177,407		12		15		-		27		1,637		179,071
Consumer		6,056		59		22		17		98		-		6,154
Total	$	711,444	$	2,112	$	362	$	322	$	2,796	$	12,291	$	726,531

Impaired loans generally represent Management’s determination that the borrower will be unable to repay the loan in accordance with its contractual terms and that collateral liquidation may or may not fully repay both interest and principal. It is the Bank’s policy to evaluate the probable collectability of principal and interest due under terms of loan contracts for all loans 90-days or more, nonaccrual loans, or impaired loans. Further, it is the Bank’s policy to discontinue accruing interest on loans that are not adequately secured and in the process of collection. Upon determination of nonaccrual status, the Bank subtracts any current year accrued and unpaid interest from its income, and any prior year accrued and unpaid interest from the allowance for loan losses. Management continually monitors the status of nonperforming loans, the value of any collateral and potential of risk of loss. Nonaccrual loans are rated no better than 7 (Substandard).

Interest not recognized on nonaccrual loans was $335 thousand, $752 thousand and $96 thousand for the years ended December 31, 2015, 2014 and 2013, respectively. In addition to monitoring nonaccrual loans, the Bank also closely monitors impaired loans and troubled debt restructurings. A loan is considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect all interest and principal payments due according to the originally contracted terms of the loan agreement. Nonaccrual loans, excluding consumer purpose loans, and troubled-debt restricting (TDR) loans are considered impaired. For impaired loans with balances less than $250 thousand and consumer purpose loans, a specific reserve analysis is not performed and these loans are added to the general allocation pool. Impaired loans totaled $16.8 million at year-end 2015 compared to $26.6 million at December 31, 2014.

The following table presents information on impaired loans.



	Impaired Loans
	With No Allowance				With Allowance
(Dollars in thousands)			Unpaid				Unpaid
	Recorded		Principal		Recorded		Principal		Related
December 31, 2015	Investment		Balance		Investment		Balance		Allowance
Residential Real Estate 1-4 Family
First liens	$	1,523	$	1,725	$	-	$	-	$	-
Junior liens and lines of credit		105		133		-		-		-
Total		1,628		1,858		-		-		-
Residential real estate - construction		502		546		-		-		-
Commercial real estate		14,431		15,007		-		-		-
Commercial		267		330		9		10		9
Consumer		-		-		-		-		-
Total	$	16,828	$	17,741	$	9	$	10	$	9



December 31, 2014
Residential Real Estate 1-4 Family
First liens	$	1,804	$	2,002	$	-	$	-	$	-
Junior liens and lines of credit		169		195		-		-		-
Total		1,973		2,197		-		-		-
Residential real estate - construction		931		977		-		-		-
Commercial real estate		21,487		25,744		862		1,001		60
Commercial		78		80		1,274		1,990		171
Consumer		-		-		-		-		-
Total	$	24,469	$	28,998	$	2,136	$	2,991	$	231


	Twelve Months Ended				Twelve Months Ended				Twelve Months Ended
	December 31, 2015				December 31, 2014				December 31, 2013
	Average		Interest		Average		Interest		Average		Interest
(Dollars in thousands)	Recorded		Income		Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized		Investment		Recognized
Residential Real Estate 1-4 Family
First liens	$	1,531	$	13	$	2,619	$	4	$	3,365	$	4
Junior liens and lines of credit		105		-		136		-		417		-
Total		1,636		13		2,755		4		3,782		4
Residential real estate - construction		505		-		686		-		544		-
Commercial real estate		14,509		122		23,801		118		31,730		118
Commercial		278		-		1,890		-		2,112		-
Consumer		-		-		-		-		-		-
Total	$	16,928	$	135	$	29,132	$	122	$	38,168	$	122

A loan is considered a troubled debt restructuring (TDR) if the creditor (the Bank), for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. These concessions may include lowering the interest rate, extending the maturity, reamortization of payment, or a combination of multiple concessions. The Bank reviews all loans rated 6 or worse when it is providing a loan restructure, modification or new credit facility to determine if the action is a TDR. If a TDR loan is placed on nonaccrual status, it remains on nonaccrual status for at least six months to ensure performance. However, TDR loans are always considered impaired until paid-off. All TDR loans are in compliance with their modified terms except one, as reported below. The following table identifies TDR loans as of December 31, 2015 and 2014:



								Trouble Debt
								Restructurings
								That Have Defaulted on
								Modified Terms in the
(Dollars in thousands)	Troubled Debt Restructurings							Last Twelve Months
	Number of	Recorded						Number of	Recorded
	Contracts	Investment			Performing*		Nonperforming*	Contracts	Investment
December 31, 2015
Residential real estate - construction	1	$	502	$	502	$	-	-	$	-
Residential real estate	4		654		503		151	-		-
Commercial real estate	10		12,125		12,125		-	-		-
Total	15	$	13,281	$	13,130	$	151	-	$	-



December 31, 2014
Residential real estate - construction	1	$	521	$	-	$	521	-	$	-
Residential real estate	5		699		673		26	-		-
Commercial	12		15,748		14,283		1,465	-		-
Total	18	$	16,968	$	14,956	$	2,012	-	$	-

*The performing status is determined by the loan’s compliance with the modified terms.

There were no new TDR loans made during the year ended December 31, 2015.

The following table reports new TDR loans made during 2014, concession granted and the recorded investment as of December 31, 2014.

(Dollars in thousands)

New During Period

Number of

Pre-TDR

After-TDR

Recorded

Twelve Months Ended December 31, 2014

Contracts

Modification

Investment

Concession

Residential real estate

168

multiple

Allowance for Loan Losses:

Management monitors loan performance on a monthly basis and performs a quarterly evaluation of the adequacy of the allowance for loan losses (ALL). The ALL is determined by segmenting the loan portfolio based on the loan’s collateral. When calculating the ALL, consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, diversification of the loan portfolio, delinquency statistics, results of internal loan reviews, historical charge-offs, the adequacy of the underlying collateral (if collateral dependent) and other relevant factors. The Bank begins enhanced monitoring of all loans rated 6 (OAEM) or worse, and obtains a new appraisal or asset valuation for any placed on nonaccrual and rated 7 (substandard) or worse. Management, at its discretion, may determine that additional adjustments to the appraisal or valuation are required. Valuation adjustments will be made as necessary based on factors, including, but not limited to: the economy, deferred maintenance, industry, type of property/equipment, age of the appraisal, etc. and the knowledge Management has about a particular situation. In addition, the cost to sell or liquidate the collateral is also estimated and deducted from the valuation in order to determine the net realizable value to the Bank. When determining the allowance for loan losses, certain factors involved in the evaluation are inherently subjective and require material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. Management monitors the adequacy of the allowance for loan losses on an ongoing basis and reports its adequacy quarterly to the Credit Risk Oversight Committee of the Board of Directors. Management believes that the allowance for loan losses at December 31, 2015 is adequate.

The following table shows, by loan class, the activity in the ALL, for the years ended December 31, 2015, 2014 and 2013.



	Residential Real Estate 1-4 Family
			Junior Liens
	First		& Lines				Commercial
(Dollars in thousands)	Liens		of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total

Allowance at December 31, 2012	$	744	$	260	$	882	$	6,078	$	1,437	$	181	$	797	$	10,379
Charge-offs		(547)		(45)		-		(2,855)		(363)		(162)		-		(3,972)
Recoveries		13		-		-		203		100		59		-		375
Provision		703		13		(606)		1,770		925		60		55		2,920
Allowance at December 31, 2013	$	913	$	228	$	276	$	5,196	$	2,099	$	138	$	852	$	9,702

Allowance at December 31, 2013	$	913	$	228	$	276	$	5,196	$	2,099	$	138	$	852	$	9,702
Charge-offs		(291)		-		(41)		(408)		(644)		(189)		-		(1,573)
Recoveries		21		-		-		50		65		82		-		218
Provision		351		43		(21)		140		(5)		96		160		764
Allowance at December 31, 2014	$	994	$	271	$	214	$	4,978	$	1,515	$	127	$	1,012	$	9,111

Allowance at December 31, 2014	$	994	$	271	$	214	$	4,978	$	1,515	$	127	$	1,012	$	9,111
Charge-offs		(43)		(39)		(21)		-		(270)		(198)		-		(571)
Recoveries		7		-		18		14		148		74		-		261
Provision		31		76		(17)		657		126		99		313		1,285
Allowance at December 31, 2015	$	989	$	308	$	194	$	5,649	$	1,519	$	102	$	1,325	$	10,086

The following table shows, by loan class, the loans that were evaluated for the ALL under a specific reserve (individually) and those that were evaluated under a general reserve (collectively), and the amount of the allowance established in each category as of December 31, 2015 and 2014.



	Residential Real Estate 1-4 Family
			Junior Liens
	First		& Lines				Commercial
(Dollars in thousands)	Liens		of Credit		Construction		Real Estate		Commercial		Consumer		Unallocated		Total

December 31, 2015
Loans evaluated for allowance:
Individually	$	930	$	51	$	502	$	14,309	$	230	$	-	$	-	$	16,022
Collectively		160,548		50,862		7,386		326,386		215,712		5,100		-		765,994
Total	$	161,478	$	50,913	$	7,888	$	340,695	$	215,942	$	5,100	$	-	$	782,016

Allowance established for loans evaluated:
Individually	$	-	$	-	$	-	$	-	$	9	$	-	$	-	$	9
Collectively		989		308		194		5,649		1,510		102		1,325		10,077
Allowance at December 31, 2015	$	989	$	308	$	194	$	5,649	$	1,519	$	102	$	1,325	$	10,086

December 31, 2014
Loans evaluated for allowance:
Individually	$	1,171	$	51	$	931	$	22,307	$	1,298	$	-	$	-	$	25,758
Collectively		160,143		43,744		8,784		304,175		177,773		6,154		-		700,773
Total	$	161,314	$	43,795	$	9,715	$	326,482	$	179,071	$	6,154	$	-	$	726,531

Allowance established for loans evaluated:
Individually	$	-	$	-	$	-	$	60	$	171	$	-	$	-	$	231
Collectively		994		271		214		4,918		1,344		127		1,012		8,880
Allowance at December 31, 2014	$	994	$	271	$	214	$	4,978	$	1,515	$	127	$	1,012	$	9,111