NOTE 3 – LOANS

Loans consist of the following:


(Dollars in thousands)	September 30, 2013		December 31, 2012
Commercial	$	116,190	$	104,899
Commercial real estate		126,423		119,192
Residential real estate		112,819		110,412
Construction & land development		14,904		23,358
Consumer		6,838		6,480

Total loans before deferred costs		377,174		364,341
Deferred loan costs		260		239

Total Loans	$	377,434	$	364,580

Loan Origination/Risk Management

The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. The Company’s management examines current and occasionally projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At September 30, 2013 and December 31, 2012, approximately 80% and 81%, respectively of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.

With respect to loans to developers and builders that are secured by non-owner occupied properties, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction and land development loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction and land development loans are generally based upon estimates of costs and value associated with the completed project. These estimates may be inaccurate.

Construction and land development loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risk than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

The Company originates consumer loans utilizing a judgmental underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk.

The Company maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. 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.

Loans serviced for others approximated $59.0 million and $60.2 million at September 30, 2013 and December 31, 2012, respectively.

Concentrations of Credit

Nearly all of the Company’s lending activity occurs within the state of Ohio, including the four (4) counties of Holmes, Stark, Tuscarawas and Wayne, as well as other markets. The majority of the Company’s loan portfolio consists of commercial and industrial and commercial real estate loans. As of September 30, 2013 and December 31, 2012, there were no concentrations of loans related to any single industry.

Allowance for Loan Losses

The following table details activity in the allowance for loan losses by portfolio segment for the three and nine month periods ended September 30, 2013 and 2012. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories. The increase in the provision for possible loan losses related to commercial loans was affected by a qualitative adjustment for loans rated special mention, as well as changes in volume and credit quality of loans in this category. The provision for possible loan losses related to residential real estate increased during third quarter 2013 as a result of a increase in non performing loans within this category.


(Dollars in thousands)	Commercial			Commercial Real Estate			Residential Real Estate			Construction & Land Development		Consumer			Unallocated		Total
Three months ended September 30, 2013
Beginning balance, June 30, 2013	$	1,316		$	1,815		$	1,174		$	162	$	144		$	334	$	4,945
Provision for possible loan losses		27			(5	)		95			18		(48	)		123		210
Charge-offs		(54	)		—			(28	)		—		(9	)				(91	)
Recoveries		5			—			3			—		5					13

Net charge-offs		(49	)		—			(25	)		—		(4	)				(78	)

Ending balance	$	1,294		$	1,810		$	1,244		$	180	$	92		$	457	$	5,077


(Dollars in thousands)	Commercial			Commercial Real Estate			Residential Real Estate			Construction & Land Development			Consumer			Unallocated		Total
Nine months ended September 30, 2013
Beginning balance, December 31, 2012	$	933		$	1,902		$	1,096		$	253		$	76		$	320	$	4,580
Provision for possible loan losses		455			(41	)		162			(73	)		(10	)		137		630
Charge-offs		(112	)		(51	)		(28	)		—			(11	)				(202	)
Recoveries		18			—			14			—			37					69

Net charge-offs		(94	)		(51	)		(14	)		—			26					(133	)

Ending balance	$	1,294		$	1,810		$	1,244		$	180		$	92		$	457	$	5,077


(Dollars in thousands)	Commercial		Commercial Real Estate		Residential Real Estate			Construction & Land Development		Consumer			Unallocated			Total
Three months ended September 30, 2012
Beginning balance, June 30, 2012	$	896	$	1,927	$	1,051		$	217	$	64		$	316		$	4,471
Provision for possible loan losses		94		108		(45	)		85		46			(82	)		206
Charge-offs		—		—		—			—		(39	)					(39	)
Recoveries		2		—		10			—		11						23

Net charge-offs		2		—		10			—		(28	)					(16	)

Ending balance	$	992	$	2,035	$	1,016		$	302	$	82		$	234		$	4,661


(Dollars in thousands)	Commercial			Commercial Real Estate			Residential Real Estate			Construction & Land Development		Consumer			Unallocated		Total
Nine months ended September 30, 2012
Beginning balance, December 31, 2011	$	1,024		$	1,673		$	894		$	180	$	78		$	233	$	4,082
Provision for possible loan losses		(33	)		376			127			122		24			1		617
Charge-offs		(15	)		(14	)		(104	)		—		(70	)		—		(203	)
Recoveries		16			—			99			—		50			—		165

Net charge-offs		1			(14	)		(5	)		—		(20	)		—		(38	)

Ending balance	$	992		$	2,035		$	1,016		$	302	$	82		$	234	$	4,661

The following table presents the balance in the allowance for loan losses and the ending loan balances by portfolio segment and based on the impairment method as of September 30, 2013 and December 31, 2012:


(Dollars in thousands)	Commercial		Commercial Real Estate		Residential Real Estate		Construction & Land Development		Consumer		Unallocated		Total
September 30, 2013
Allowance for loan losses:
Ending allowance balances attributable to loans:
Individually evaluated for impairment	$	185	$	442	$	292	$	—	$	—	$	—	$	919
Collectively evaluated for impairment		1,109		1,368		952		180		92		457		4,158

Total ending allowance balance	$	1,294	$	1,810	$	1,244	$	180	$	92	$	457	$	5,077


Loans:
Loans individually evaluated for impairment	$	3,898	$	3,460	$	1,832	$	—	$	—			$	9,190
Loans collectively evaluated for impairment		112,292		122,963		110,987		14,904		6,838				367,984

Total ending loans balance	$	116,190	$	126,423	$	112,819	$	14,904	$	6,838			$	377,174


December 31, 2012
Allowance for loan losses:
Ending allowance balances attributable to loans:
Individually evaluated for impairment	$	85	$	522	$	172	$	—	$	—	$	—	$	779
Collectively evaluated for impairment		848		1,380		924		253		76		320		3,801

Total ending allowance balance	$	933	$	1,902	$	1,096	$	253	$	76	$	320	$	4,580


Loans:
Loans individually evaluated for impairment	$	4,315	$	4,573	$	1,137	$	166	$	—			$	10,191
Loans collectively evaluated for impairment		100,584		114,619		109,275		23,192		6,480				354,150

Total ending loans balance	$	104,899	$	119,192	$	110,412	$	23,358	$	6,480			$	364,341

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2013 and December 31, 2012:


(Dollars in thousands)	Unpaid Principal Balance		Recorded Investment with no Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
September 30, 2013
Commercial	$	3,913	$	7	$	3,902	$	3,909	$	185	$	3,917	$	126
Commercial real estate		3,767		306		3,155		3,461		442		3,730		125
Residential real estate		1,942		583		1,237		1,820		292		1,270		29
Construction & land development		—		—		—		—		—		28		2

Total impaired loans	$	9,622	$	896	$	8,294	$	9,190	$	919	$	8,945	$	282

December 31, 2012
Commercial	$	4,315	$	—	$	4,329	$	4,329	$	85	$	4,123	$	167
Commercial real estate		4,906		1,723		2,849		4,572		522		4,396		152
Residential real estate		1,223		86		1,057		1,143		172		770		18
Construction & land development		173		166		—		166		—		167		—

Total impaired loans	$	10,617	$	1,975	$	8,235	$	10,210	$	779	$	9,456	$	337

The following table presents the aging of past due loans and nonaccrual loans as of September 30, 2013 and December 31, 2012 by class of loans:


(Dollars in thousands)	Current		30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days + Past Due		Non-Accrual		Total Past Due and Non- Accrual		Total Loans
September 30, 2013
Commercial	$	115,714	$	405	$	—	$	—	$	71	$	476	$	116,190
Commercial real estate		124,753		271		216		—		1,183		1,670		126,423
Residential real estate		110,681		767		257		36		1,078		2,138		112,819
Construction & land development		13,954		950		—		—		—		950		14,904
Consumer		6,616		137		85		—		—		222		6,838

Total Loans	$	371,718	$	2,530	$	558	$	36	$	2,332	$	5,456	$	377,174


December 31, 2012
Commercial	$	104,348	$	60	$	8	$	—	$	483	$	551	$	104,899
Commercial real estate		117,372		41		34		—		1,745		1,820		119,192
Residential real estate		108,574		472		430		131		805		1,838		110,412
Construction & land development		23,180		—		5		—		173		178		23,358
Consumer		6,325		132		23		—		—		155		6,480

Total Loans	$	359,799	$	705	$	500	$	131	$	3,206	$	4,542	$	364,341

Troubled Debt Restructurings

All troubled debt restructurings (“TDR’s) are individually evaluated for impairment and a related allowance is recorded, as needed. Loans whose terms have been modified as TDR’s totaled $8.2 million as of September 30, 2013, and $8.7 million as of December 31, 2012, with $823 thousand and $718 thousand of specific reserves allocated to those loans, respectively. At September 30, 2013, $7.5 million of the loans classified as TDR’s were performing in accordance with their modified terms. Of the remaining $736 thousand, all were in nonaccrual of interest status.

None of the loans that were restructured in 2011 or 2012 have subsequently defaulted in the three or nine month periods ended September 30, 2013 and 2012. Loan modifications that are considered TDR’s completed during the three and nine month periods ended September 30, 2013 and 2012 were as follows:


	For the Three Months Ended September 30, 2013
(Dollars in thousands)	Number of loans restructured		Pre- Modification Recorded Investment		Post- Modification Recorded Investment
Commercial		1	$	7	$	7
Residential Real Estate		2		188		188

Total Restructured Loans		3	$	195	$	195


	For the Nine Months Ended September 30, 2013
(Dollars in thousands)	Number of loans restructured		Pre- Modification Recorded Investment		Post- Modification Recorded Investment
Commercial		3	$	83	$	83
Residential Real Estate		2		188		188

Total Restructured Loans		5	$	271	$	271


	For the Three Months Ended September 30, 2012
(Dollars in thousands)	Number of loans restructured		Pre- Modification Recorded Investment		Post- Modification Recorded Investment
Commercial Real Estate		1	$	140	$	140
Residential Real Estate		5		333		333

Total Restructured Loans		6	$	473	$	473


	For the Nine Months Ended September 30, 2012
(Dollars in thousands)	Number of loans restructured		Pre- Modification Recorded Investment		Post- Modification Recorded Investment
Commercial Real Estate		1	$	140	$	140
Residential Real Estate		7		488		488

Total Restructured Loans		8	$	628	$	628

The loans restructured during the three and nine months ended September 30, 2013 and 2012 were modified by changing the monthly payment to interest only. No principal reductions were made.

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes commercial loans individually by classifying the loans as to credit risk. This analysis includes commercial loans with an outstanding balance greater than $275 thousand and is performed on an annual basis.

The Company uses the following definitions for risk ratings:

Pass. Loans classified as pass (Acceptable, Low Acceptable or Pass Watch) may exhibit a wide array of characteristics but at minimum represent an acceptable risk to the Bank. Borrowers in this rating may have leveraged but acceptable balance sheet positions, satisfactory asset quality, and stable to favorable sales and earnings trends, acceptable liquidity and adequate cash flow. Loans are considered fully collectible and require an average amount of administration. While generally adhering to credit policy, these loans may exhibit occasional exceptions that do not result in undue risk to the Bank. Borrowers are generally capable of absorbing setbacks, financial and otherwise, without the threat of failure.

Special Mention. Loans classified as special mention have material weaknesses that deserve management’s close attention. If left uncorrected, these weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, 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.

Loans that do not meet the criteria for special mention, substandard or doubtful classification, when analyzed individually as part of the above described process are considered to be pass rated loans. As of September 30, 2013 and December 31, 2012, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:


(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Not Rated		Total
September 30, 2013
Commercial	$	100,746	$	9,850	$	5,170	$	—	$	424	$	116,190
Commercial real estate		111,168		7,553		5,879		—		1,823		126,423
Residential real estate		243		—		48		—		112,528		112,819
Construction & land development		11,598		—		2,040		—		1,266		14,904
Consumer		—		—		—		—		6,838		6,838

Total	$	223,755	$	17,403	$	13,137	$	—	$	122,879	$	377,174


December 31, 2012
Commercial	$	92,123	$	5,854	$	6,637	$	—	$	285	$	104,899
Commercial real estate		102,602		5,671		8,459		—		2,460		119,192
Residential real estate		200		—		53		—		110,159		110,412
Construction & land development		18,063		2,750		1,244		—		1,301		23,358
Consumer		—		—		—		—		6,480		6,480

Total	$	212,988	$	14,275	$	16,393	$	—	$	120,685	$	364,341

Loans listed as not rated are either less than $275 thousand or are included in groups of homogeneous loans. The following table presents loans that are not rated by class of loans as of September 30, 2013 and December 31, 2012. Non-performing loans include loans past due 90 days and greater and loans on nonaccrual of interest.


(Dollars in thousands)	Performing		Non-Performing		Total
September 30, 2013
Commercial	$	424	$	—	$	424
Commercial real estate		1,823		—		1,823
Residential real estate		111,462		1,066		112,528
Construction & land development		1,266		—		1,266
Consumer		6,838		—		6,838

Total	$	121,813	$	1,066	$	122,879


December 31, 2012
Commercial	$	285	$	—	$	285
Commercial real estate		2,460		—		2,460
Residential real estate		109,276		883		110,159
Construction & land development		1,294		7		1,301
Consumer		6,480		—		6,480

Total	$	119,795	$	890	$	120,685