NOTE 3 – LOANS

Loans consist of the following:


(Dollars in thousands)	September 30, 2017		December 31, 2016
Commercial	$	137,459	$	134,268
Commercial real estate		177,588		159,475
Residential real estate		153,281		144,489
Construction & land development		23,915		23,428
Consumer		16,686		13,308

Total loans before deferred costs		508,929		474,968
Deferred loan costs		529		481

Total Loans	$	509,458	$	475,449

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.

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 $79.8 million and $85.9 million at September 30, 2017 and December 31, 2016, 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 commercial real estate loans. As of September 30, 2017 and December 31, 2016, there were no concentrations of loans related to any single industry.

Allowance for Loan Losses

The following tables detail activity in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2017 and 2016. 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 loan losses for the three months ended September 30, 2017 related to commercial loans was primarily due to the increase in historical losses of loans in this category. The decrease in the provision related to commercial real estate loans was due to the decrease in the specific impairment amount related to one loan relationship. The decrease in the provision related to residential real estate loans is due to the decrease of loan delinquencies in this category.

The increase in the provision for loan losses related to commercial loans for the nine months ended September 30, 2017 was due to the increase in the historical loss rate and the increase of special mention loans in this category. The increase in the provision related to commercial real estate loans was due to the increase in nonaccrual loans in this category and the increase of adversely classified loan balances.

The changes in the provision for loan losses for the three and nine months ended September 30, 2016 related to commercial loans were primarily due to charge-offs of loans in this category as well as an increase in the specific reserve for one commercial relationship. The decrease in the provision related to commercial real estate loans for the nine month period in 2016 was primarily due to a recovery of a prior charge-off. The increase in the provision for consumer loans during the three and nine month periods of 2016 relates to charge-offs of loans in this category as well as the increase in loan volume.

Summary of Allowance for Loan Losses


(Dollars in thousands)	Commercial			Commercial Real Estate			Residential Real Estate			Construction & Land Development		Consumer			Unallocated			Total
Three months ended September 30, 2017
Beginning balance	$	2,362		$	1,718		$	1,264		$	222	$	182		$	541		$	6,289
Provision for loan losses		881			(88	)		(53	)		21		(5	)		(476	)		280
Charge-offs		(1,138	)		—			—			—		—						(1,138	)
Recoveries		4			—			—			—		1						5

Net charge-offs		(1,134	)		—			—			—		1						(1,133	)

Ending balance	$	2,109		$	1,630		$	1,211		$	243	$	178		$	65		$	5,436

Nine months ended September 30, 2017
Beginning balance	$	2,207		$	1,264		$	1,189		$	178	$	141		$	312		$	5,291
Provision for loan losses		725			366			14			65		42			(247	)		965
Charge-offs		(1,178	)		—			—			—		(7	)					(1,185	)
Recoveries		355			—			8			—		2						365

Net charge-offs		(823	)		—			8			—		(5	)					(820	)

Ending balance	$	2,109		$	1,630		$	1,211		$	243	$	178		$	65		$	5,436

Three months ended September 30, 2016
Beginning balance	$	2,376		$	1,262		$	1,095		$	127	$	110		$	186		$	5,156
Provision for loan losses		77			63			50			24		74			(124	)		164
Charge-offs		(261	)		(38	)		—			—		(47	)					(346	)
Recoveries		27			—			1			—		—						28

Net charge-offs		(234	)		(38	)		1			—		(47	)					(318	)

Ending balance	$	2,219		$	1,287		$	1,146		$	151	$	137		$	62		$	5,002

Nine months ended September 30, 2016
Beginning balance	$	1,664		$	1,271		$	1,086		$	123	$	86		$	432		$	4,662
Provision for loan losses		797			(117	)		57			28		98			(370	)		493
Charge-offs		(276	)		(50	)		—			—		(48	)					(374	)
Recoveries		34			183			3			—		1						221

Net charge-offs		(242	)		133			3			—		(47	)					(153	)

Ending balance	$	2,219		$	1,287		$	1,146		$	151	$	137		$	62		$	5,002

The following table presents the balance in the allowance for loan losses and the ending loan balances by portfolio class and based on the impairment method as of September 30, 2017 and December 31, 2016:


(Dollars in thousands)	Commercial		Commercial Real Estate		Residential Real Estate		Construction & Land Development		Consumer		Unallocated		Total
September 30, 2017
Allowance for loan losses:
Individually evaluated for impairment	$	5	$	20	$	24	$	—	$	—	$	—	$	49
Collectively evaluated for impairment		2,104		1,610		1,187		243		178		65		5,387

Total ending allowance balance	$	2,109	$	1,630	$	1,211	$	243	$	178	$	65	$	5,436

Loans:
Loans individually evaluated for impairment	$	1,241	$	3,703	$	1,486	$	—	$	—			$	6,430
Loans collectively evaluated for impairment		136,218		173,885		151,795		23,915		16,686				502,499

Total ending loans balance	$	137,459	$	177,588	$	153,281	$	23,915	$	16,686			$	508,929

December 31, 2016
Allowance for loan losses:
Individually evaluated for impairment	$	705	$	—	$	24	$	—	$	—	$	—	$	729
Collectively evaluated for impairment		1,502		1,264		1,165		178		141		312		4,562

Total ending allowance balance	$	2,207	$	1,264	$	1,189	$	178	$	141	$	312	$	5,291

Loans:
Loans individually evaluated for impairment	$	5,028	$	621	$	1,507	$	—	$	—			$	7,156
Loans collectively evaluated for impairment		129,240		158,854		142,982		23,428		13,308				467,812

Total ending loans balance	$	134,268	$	159,475	$	144,489	$	23,428	$	13,308			$	474,968

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2017 and December 31, 2016:


(Dollars in thousands)	Unpaid Principal Balance		Recorded Investment with no Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance
September 30, 2017
Commercial	$	2,868	$	1,238	$	5	$	1,243	$	5
Commercial real estate		3,901		3,653		51		3,704		20
Residential real estate		1,667		1,095		392		1,487		24

Total impaired loans	$	8,436	$	5,986	$	448	$	6,434	$	49

December 31, 2016
Commercial	$	5,476	$	1,690	$	3,354	$	5,044	$	705
Commercial real estate		796		600		21		621		—
Residential real estate		1,681		1,036		472		1,508		24

Total impaired loans	$	7,953	$	3,326	$	3,847	$	7,173	$	729

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)	2017		2016		2017		2016
Average recorded investment:
Commercial	$	3,084	$	6,389	$	3,376	$	6,393
Commercial real estate		4,712		660		2,934		799
Residential real estate		1,370		1,460		1,471		1,504

Average recorded investment in impaired loans	$	9,166	$	8,509	$	7,781	$	8,696

Interest income recognized:
Commercial	$	10	$	54	$	41	$	176
Commercial real estate		7		3		9		9
Residential real estate		13		15		43		44

Interest income recognized on a cash basis on impaired loans	$	30	$	72	$	93	$	229

The following table presents the aging of past due loans and nonaccrual loans as of September 30, 2017 and December 31, 2016 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, 2017
Commercial	$	136,544	$	28	$	—	$	144	$	743	$	915	$	137,459
Commercial real estate		173,989		160		—		40		3,399		3,599		177,588
Residential real estate		151,684		914		108		68		507		1,597		153,281
Construction & land development		23,915		—		—		—		—		—		23,915
Consumer		16,561		87		9		1		28		125		16,686

Total Loans	$	502,693	$	1,189	$	117	$	253	$	4,677	$	6,236	$	508,929

December 31, 2016
Commercial	$	133,630	$	151	$	62	$	—	$	425	$	638	$	134,268
Commercial real estate		158,504		435		—		39		497		971		159,475
Residential real estate		142,926		816		61		196		490		1,563		144,489
Construction & land development		23,428		—		—		—		—		—		23,428
Consumer		13,234		21		16		—		37		74		13,308

Total Loans	$	471,722	$	1,423	$	139	$	235	$	1,449	$	3,246	$	474,968

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 $3.1 million as of September 30, 2017, and $6.4 million as of December 31, 2016, with $24 thousand and $711 thousand of specific reserves allocated to those loans, respectively. At September 30, 2017, $2.0 million of the loans classified as TDR’s were performing in accordance with their modified terms. Of the remaining $1.1 million, all were in nonaccrual of interest status.

The Company held no foreclosed real estate as of September 30, 2017, or December 31, 2016. Consumer mortgage loans in the process of foreclosure were $154 thousand at September 30, 2017 and $448 thousand at December 31, 2016.

The following table presents loans restructured during the three and nine month periods ended September 30, 2017 and 2016.


(Dollars in thousands)	Number of loans restructured		Pre- Modification Recorded Investment		Post- Modification Recorded Investment
For the three months ended September 30, 2017
Residential Real Estate		1	$	38	$	38

Total Restructured Loans		1	$	38	$	38

For the nine months ended September 30, 2017
Commercial Real Estate		4	$	288	$	288
Residential Real Estate		2		52		52

Total Restructured Loans		6	$	340	$	340

For the three months ended September 30, 2016
Residential Real Estate		—	$	—	$	—

Total Restructured Loans		—	$	—	$	—

For the nine months ended September 30, 2016
Residential Real Estate		3	$	327	$	327

Total Restructured Loans		3	$	327	$	327

The restructured loans were modified by changing the monthly payment to interest only. No principal reductions were made. There was one commercial loan in the amount of $3.3 million that was restructured in the fourth quarter of 2016 that has defaulted in 2017. None of the loans that were restructured in 2015 have subsequently defaulted in the nine month period ended September 30, 2016.

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 $300 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 a minimum represent an acceptable risk to the Bank. Borrowers in this rating may have leveraged but acceptable balance sheet positions, satisfactory asset quality, 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 $300 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, 2017 and December 31, 2016:


(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Not Rated		Total
September 30, 2017
Commercial	$	115,301	$	16,167	$	5,130	$	—	$	861	$	137,459
Commercial real estate		160,677		9,933		6,744		—		234		177,588
Residential real estate		208		—		183		—		152,890		153,281
Construction & land development		18,171		1,410		—		—		4,334		23,915
Consumer		—		—		—		—		16,686		16,686

Total	$	294,357	$	27,510	$	12,057	$	—	$	175,005	$	508,929

December 31, 2016
Commercial	$	116,739	$	6,874	$	9,704	$	—	$	951	$	134,268
Commercial real estate		149,630		4,168		4,766		—		911		159,475
Residential real estate		216		—		175		—		144,098		144,489
Construction & land development		17,183		981		504		—		4,760		23,428
Consumer		—		—		—		—		13,308		13,308

Total	$	283,768	$	12,023	$	15,149	$	—	$	164,028	$	474,968

The following table presents loans that are not rated by class of loans as of September 30, 2017 and December 31, 2016. 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, 2017
Commercial	$	861	$	—	$	861
Commercial real estate		234		—		234
Residential real estate		152,315		575		152,890
Construction & land development		4,334		—		4,334
Consumer		16,657		29		16,686

Total	$	174,401	$	604	$	175,005

December 31, 2016
Commercial	$	951	$	—	$	951
Commercial real estate		911		—		911
Residential real estate		143,440		658		144,098
Construction & land development		4,760		—		4,760
Consumer		13,271		37		13,308

Total	$	163,333	$	695	$	164,028