NOTE 3 – LOANS

Loans consist of the following:


(Dollars in thousands)	September 30, 2014		December 31, 2013
Commercial	$	126,843	$	117,478
Commercial real estate		141,417		129,828
Residential real estate		120,739		111,445
Construction & land development		12,855		13,444
Consumer		7,726		6,687

Total loans before deferred costs		409,580		378,882
Deferred loan costs		328		243

Total Loans	$	409,908	$	379,125

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, 2014 and December 31, 2013, approximately 77% 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 $71 million and $70.2 million at September 30, 2014 and December 31, 2013, 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, 2014 and December 31, 2013, 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, 2014 and 2013. 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 and industrial loans was due to the increase in specific allocation amounts related to impaired loans and also the increase in loan balances. The increase in the provision related to commercial real estate loans was affected by an increase in loan balances and charge-offs that occurred during the nine months ended September 30, 2014. The decrease in the provision related to commercial real estate loans during the three months ended September 30, 2014, was due to the leveling off of loan balances in this category, as well as the payoff of an impaired loan. The decrease in the provision related to residential real estate loans was affected by the decrease in the specific allocation amounts related to impaired residential real estate loans during the three and nine months ended September 30, 2014.


(Dollars in thousands)	Commercial			Commercial Real Estate			Residential Real Estate			Construction & Land Development			Consumer			Unallocated			Total
Three months ended September 30, 2014
Beginning balance	$	1,322		$	2,087		$	1,158		$	51		$	43		$	402		$	5,063
Provision for possible loan losses		398			(240	)		(157	)		(11	)		45			88			123
Charge-offs		(5	)		(1	)		(1	)		—			(2	)					(9	)
Recoveries		2			1			5			—			3						11

Net charge-offs		(3	)		—			4			—			1						2

Ending balance	$	1,717		$	1,847		$	1,005		$	40		$	89		$	490		$	5,188

Nine months ended September 30, 2014
Beginning balance	$	1,219		$	1,872		$	1,205		$	178		$	91		$	520		$	5,085
Provision for possible loan losses		512			328			(206	)		(138	)		(8	)		(30	)		458
Charge-offs		(24	)		(354	)		(6	)		—			(5	)					(389	)
Recoveries		10			1			12			—			11						34

Net charge-offs		(14	)		(353	)		6			—			6						(355	)

Ending balance	$	1,717		$	1,847		$	1,005		$	40		$	89		$	490		$	5,188

Three months ended September 30, 2013
Beginning balance	$	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

Nine months ended September 30, 2013
Beginning balance	$	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

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, 2014 and December 31, 2013:


(Dollars in thousands)	Commercial		Commercial Real Estate		Residential Real Estate		Construction		Consumer		Unallocated		Total
September 30, 2014
Allowance for loan losses:
Individually evaluated for impairment	$	862	$	343	$	85	$	—	$	—	$	—	$	1,290
Collectively evaluated for impairment		855		1,504		920		40		89		490		3,898

Total ending allowance balance	$	1,717	$	1,847	$	1,005	$	40	$	89	$	490	$	5,188

Loans:
Loans individually evaluated for impairment	$	6,757	$	1,393	$	1,691	$	—	$	—			$	9,841
Loans collectively evaluated for impairment		120,086		140,024		119,048		12,855		7,726				399,739

Total ending loans balance	$	126,843	$	141,417	$	120,739	$	12,855	$	7,726			$	409,580

December 31, 2013
Allowance for loan losses:
Individually evaluated for impairment	$	241	$	331	$	212	$	—	$	—	$	—	$	784
Collectively evaluated for impairment		978		1,541		993		178		91		520		4,301

Total ending allowance balance	$	1,219	$	1,872	$	1,205	$	178	$	91	$	520	$	5,085

Loans:
Loans individually evaluated for impairment	$	5,576	$	3,220	$	1,844	$	—	$	—			$	10,640
Loans collectively evaluated for impairment		111,902		126,608		109,601		13,444		6,687				368,242

Total ending loans balance	$	117,478	$	129,828	$	111,445	$	13,444	$	6,687			$	378,882

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2014 and December 31, 2013:


(Dollars in thousands)	Unpaid Principal Balance		Recorded Investment with no Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance
September 30, 2014
Commercial	$	6,855	$	4,617	$	2,154	$	6,771	$	862
Commercial real estate		1,528		220		1,172		1,392		343
Residential real estate		1,806		901		793		1,694		85

Total impaired loans	$	10,189	$	5,738	$	4,119	$	9,857	$	1,290

December 31, 2013
Commercial	$	5,595	$	7	$	5,580	$	5,587	$	241
Commercial real estate		3,540		563		2,658		3,221		331
Residential real estate		2,001		337		1,510		1,847		212

Total impaired loans	$	11,136	$	907	$	9,748	$	10,655	$	784

The following table presents the average recorded investment in impaired loans and related interest income recognized for the periods indicated.


	Three months ended September 30,				Nine months ended September 30,
(Dollars in thousands)	2014		2013		2014		2013
Average recorded investment:
Commercial	$	7,148	$	3,777	$	6,780	$	3,917
Commercial real estate		2,811		3,518		3,328		3,730
Residential real estate		1,775		499		1,832		1,270
Construction & land development		—		—		—		28

Average recorded investment in impaired loans	$	12,324	$	7,794	$	11,940	$	8,945

Interest income recognized:
Commercial	$	53	$	41	$	156	$	126
Commercial real estate		6		40		76		125
Residential real estate		15		—		46		29
Construction & land development		—		—		—		2

Interest income recognized on a cash basis on impaired loans	$	74	$	81	$	278	$	282

The following table presents the aging of past due loans and nonaccrual loans as of September 30, 2014 and December 31, 2013 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, 2014
Commercial	$	124,561	$	119	$	—	$	—	$	2,163	$	2,282	$	126,843
Commercial real estate		139,318		517		105		100		1,377		2,099		141,417
Residential real estate		119,003		357		348		67		964		1,736		120,739
Construction & land development		12,844		—		—		11		—		11		12,855
Consumer		7,592		131		3		—		—		134		7,726

Total Loans	$	403,318	$	1,124	$	456	$	178	$	4,504	$	6,262	$	409,580

December 31, 2013
Commercial	$	117,342	$	15	$	37	$	—	$	84	$	136	$	117,478
Commercial real estate		128,462		111		107		40		1,108		1,366		129,828
Residential real estate		109,274		616		467		46		1,042		2,171		111,445
Construction & land development		12,494		—		—		950		—		950		13,444
Consumer		6,524		123		40		—		—		163		6,687

Total Loans	$	374,096	$	865	$	651	$	1,036	$	2,234	$	4,786	$	378,882

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 $6.6 million as of September 30, 2014, and $8.6 million as of December 31, 2013, with $103 thousand and $583 thousand of specific reserves allocated to those loans, respectively. At September 30, 2014, $6.1 million of the loans classified as TDR’s were performing in accordance with their modified terms. Of the remaining $541 thousand, all were in nonaccrual of interest status.

The following table presents loans restructured during the nine month period ended September 30, 2014 and the three and nine month periods ended September 30, 2013. There were no loan modifications of loans that were considered troubled debt restructurings completed during the three month period ending September 30, 2014.


(Dollars in thousands)	Number of loans restructured		Pre- Modification Recorded Investment		Post- Modification Recorded Investment
For the Nine Months Ended September 30, 2014
Residential Real Estate		1	$	84	$	84

Total Restructured Loans		1	$	84	$	84

For the Three Months Ended September 30, 2013
Commercial		1	$	7	$	7
Residential Real Estate		2		188		188

Total Restructured Loans		3	$	195	$	195

For the Nine Months Ended September 30, 2013
Commercial		3	$	83	$	83
Residential Real Estate		2		188		188

Total Restructured Loans		5	$	271	$	271

The loans restructured were modified by changing the monthly payment to interest only. No principal reduction was made. None of the loans that were restructured in 2012 or 2013 have subsequently defaulted in the three or nine month periods ended September 30, 2014 and 2013.

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. This analysis 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 not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. Loans listed as not rated are either less than $275 thousand or are included in groups of homogeneous loans. Based on the most recent analysis performed, the risk category of loans by class is as follows as of September 30, 2014 and December 31, 2013:


(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Not Rated		Total
September 30, 2014
Commercial	$	113,425	$	4,545	$	7,770	$	—	$	1,103	$	126,843
Commercial real estate		131,925		5,256		3,730		—		506		141,417
Residential real estate		219		—		41		—		120,479		120,739
Construction & land development		8,895		1,976		—		—		1,984		12,855
Consumer		—		—		—		—		7,726		7,726

Total	$	254,464	$	11,777	$	11,541	$	—	$	131,798	$	409,580

December 31, 2013
Commercial	$	101,195	$	10,352	$	5,066	$	—	$	865	$	117,478
Commercial real estate		115,265		9,076		4,041		—		1,446		129,828
Residential real estate		237		—		47		—		111,161		111,445
Construction & land development		9,470		587		1,884		—		1,503		13,444
Consumer		—		—		—		—		6,687		6,687

Total	$	226,167	$	20,015	$	11,038	$	—	$	121,662	$	378,882

The following table presents loans that are not rated by class of loans as of September 30, 2014 and December 31, 2013. Nonperforming loans include loans past due 90 days or more and loans on nonaccrual of interest status.


(Dollars in thousands)	Performing		Non-Performing		Total
September 30, 2014
Commercial	$	1,103	$	—	$	1,103
Commercial real estate		506		—		506
Residential real estate		119,489		990		120,479
Construction & land development		1,984		—		1,984
Consumer		7,726		—		7,726

Total	$	130,808	$	990	$	131,798

December 31, 2013
Commercial	$	865	$	—	$	865
Commercial real estate		1,446		—		1,446
Residential real estate		110,119		1,042		111,161
Construction & land development		1,503		—		1,503
Consumer		6,687		—		6,687

Total	$	120,620	$	1,042	$	121,662