NOTE 3 – LOANS

Loans consist of the following:


(Dollars in thousands)	June 30, 2018		December 31, 2017
Commercial	$	142,019	$	140,273
Commercial real estate		182,034		179,663
Residential real estate		162,184		157,172
Construction & land development		30,706		22,886
Consumer		17,918		16,306

Total loans before deferred costs		534,861		516,300
Deferred loan costs		566		530

Total Loans	$	535,427	$	516,830

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 $85.4 million and $82.7 million at June 30, 2018 and December 31, 2017, respectively.

Concentrations of Credit

Nearly all of the Company’s lending activity occurs within the state of Ohio, including the four 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 June 30, 2018 and December 31, 2017, 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 six months ended June 30, 2018 and 2017. 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 six months ended June 30, 2018 related to commercial loans was primarily due to the increase in substandard loans in this category. The decrease in the provision related to commercial real estate loans is due to the decrease of loan delinquencies in this category. The increase in the provision related to consumer loans is primarily due to the increase loan volume and charge-offs of loans in this category.

The increase in the provision for loan losses for the three months ended June 30, 2017 related to commercial loans was primarily due to the increase in the specific allocation related to two commercial relationships. The decrease in the provision related to residential real estate is due to the improvement in the historical losses of loans in this category. The increase in the provision for loan losses related to commercial real estate was due to the increase in the specific allocation for one relationship, the increase in nonaccrual loans in this category and the increase of special mention loan balances. The decrease in the provision for loan losses for the six months ended June 30, 2017 related to commercial loans was primarily due to the recovery of prior loan charge-offs from one relationship.

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 June 30, 2018
Beginning balance	$	1,884		$	1,699		$	1,196		$	244	$	188		$	422		$	5,633
Provision for loan losses		(31	)		(87	)		39			35		107			261			324
Charge-offs		(9	)		0			0			0		(36	)					(45	)
Recoveries		5			0			1			0		0						6

Net charge-offs		(4	)		0			1			0		(36	)					(39	)

Ending balance	$	1,849		$	1,612		$	1,236		$	279	$	259		$	683		$	5,918

Six months ended June 30, 2018
Beginning balance	$	1,813		$	1,735		$	1,273		$	237	$	175		$	371		$	5,604
Provision for loan losses		226			(61	)		(1	)		42		130			312			648
Charge-offs		(203	)		(62	)		(37	)		0		(46	)					(348	)
Recoveries		13			0			1			0		0						14

Net charge-offs		(190	)		(62	)		(36	)		0		(46	)					(334	)

Ending balance	$	1,849		$	1,612		$	1,236		$	279	$	259		$	683		$	5,918

Three months ended June 30, 2017
Beginning balance	$	1,704		$	1,538		$	1,303		$	184	$	165		$	560		$	5,454
Provision for loan losses		675			180			(47	)		38		18			(19	)		845
Charge-offs		(32	)		—			—			—		(2	)					(34	)
Recoveries		15			—			8			—		1						24

Net charge-offs		(17	)		—			8			—		(1	)					(10	)

Ending balance	$	2,362		$	1,718		$	1,264		$	222	$	182		$	541		$	6,289

Six months ended June 30, 2017
Beginning balance	$	2,207		$	1,264		$	1,189		$	178	$	141		$	312		$	5,291
Provision for loan losses		(156	)		454			67			44		47			229			685
Charge-offs		(40	)		—			—			—		(7	)		—			(47	)
Recoveries		351			—			8			—		1			—			360

Net charge-offs		311			—			8			—		(6	)		—			313

Ending balance	$	2,362		$	1,718		$	1,264		$	222	$	182		$	541		$	6,289

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 June 30, 2018 and December 31, 2017:


(Dollars in thousands)	Commercial		Commercial Real Estate		Residential Real Estate		Construction		Consumer		Unallocated		Total
June 30, 2018
Allowance for loan losses:
Individually evaluated for impairment	$	4	$	46	$	16	$	—	$	—	$	—	$	66
Collectively evaluated for impairment		1,845		1,566		1,220		279		259		683		5,852

Total ending allowance balance	$	1,849	$	1,612	$	1,236	$	279	$	259	$	683	$	5,918

Loans:
Loans individually evaluated for impairment	$	1,096	$	3,458	$	1,374	$	—	$	—			$	5,928
Loans collectively evaluated for impairment		140,923		178,576		160,810		30,706		17,918				528,933

Total ending loans balance	$	142,019	$	182,034	$	162,184	$	30,706	$	17,918			$	534,861

December 31, 2017
Allowance for loan losses:
Individually evaluated for impairment	$	74	$	151	$	19	$	—	$	—	$	—	$	244
Collectively evaluated for impairment		1,739		1,584		1,254		237		175		371		5,360

Total ending allowance balance	$	1,813	$	1,735	$	1,273	$	237	$	175	$	371	$	5,604

Loans:
Loans individually evaluated for impairment	$	1,726	$	4,686	$	1,470	$	—	$	—			$	7,882
Loans collectively evaluated for impairment		138,547		174,977		155,702		22,886		16,306				508,418

Total ending loans balance	$	140,273	$	179,663	$	157,172	$	22,886	$	16,306			$	516,300

The following table presents loans individually evaluated for impairment by class of loans as of June 30, 2018 and December 31, 2017:


(Dollars in thousands)	Unpaid Principal Balance		Recorded Investment with no Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance
June 30, 2018
Commercial	$	2,722	$	1,093	$	4	$	1,097	$	4
Commercial real estate		3,656		3,145		319		3,464		46
Residential real estate		1,525		1,019		359		1,378		16

Total impaired loans	$	7,903	$	5,257	$	682	$	5,939	$	66

December 31, 2017
Commercial	$	3,352	$	1,329	$	399	$	1,728	$	74
Commercial real estate		4,826		3,117		1,566		4,683		151
Residential real estate		1,654		1,119		352		1,471		19

Total impaired loans	$	9,832	$	5,565	$	2,317	$	7,882	$	244

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


	Three months				Six months
	ended June 30,				ended June 30,
(Dollars in thousands)	2018		2017		2018		2017
Average recorded investment:
Commercial	$	1,190	$	2,794	$	1,491	$	3,505
Commercial real estate		2,700		3,600		3,595		2,019
Residential real estate		1,131		1,540		1,287		1,514

Average recorded investment in impaired loans	$	5,021	$	7,934	$	6,373	$	7,038

Interest income recognized:
Commercial	$	10	$	17	$	21	$	31
Commercial real estate		4		2		8		2
Residential real estate		12		15		26		30

Interest income recognized on a cash basis on impaired loans	$	26	$	34	$	55	$	63

The following table presents the aging of past due loans and nonaccrual loans as of June 30, 2018 and December 31, 2017 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
June 30, 2018
Commercial	$	141,180	$	43	$	75	$	—	$	721	$	839	$	142,019
Commercial real estate		178,927		55		—		—		3,052		3,107		182,034
Residential real estate		160,667		585		326		82		524		1,517		162,184
Construction & land development		30,706		—		—		—		—		—		30,706
Consumer		17,706		111		81		—		20		212		17,918

Total Loans	$	529,186	$	794	$	482	$	82	$	4,317	$	5,675	$	534,861

December 31, 2017
Commercial	$	138,908	$	148	$	65	$	—	$	1,152	$	1,365	$	140,273
Commercial real estate		175,062		177		—		40		4,384		4,601		179,663
Residential real estate		155,488		757		38		401		488		1,684		157,172
Construction & land development		22,886		—		—		—		—		—		22,886
Consumer		16,048		193		8		—		57		258		16,306

Total Loans	$	508,392	$	1,275	$	111	$	441	$	6,081	$	7,908	$	516,300

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 $2.8 million as of June 30, 2018, and $2.9 million as of December 31, 2017, with $38 thousand of specific reserves allocated to those loans for both periods. At June 30, 2018, $1.9 million of the loans classified as TDR’s were performing in accordance with their modified terms. Of the remaining $833 thousand, all were in nonaccrual of interest status.

The Company held no other real estate at June 30, 2018 or December 31, 2017. Consumer mortgage loans in the process of foreclosure were $35 thousand at June 30, 2018 and $114 thousand at December 31, 2017.


(Dollars in thousands)	Number of loans restructured		Pre-Modification Recorded Investment		Post-Modification Recorded Investment
For the three months ended June 30, 2018
Commercial		1	$	200	$	200

Total Restructured Loans		1	$	200	$	200

For the six months ended June 30, 2018
Commercial		1	$	200	$	200

Total Restructured Loans		1	$	200	$	200

For the three months ended June 30, 2017
Commercial Real Estate		4	$	288	$	288
Residential Real Estate		1		14		14

Total Restructured Loans		5	$	302	$	302

For the six months ended June 30, 2017
Commercial Real Estate		4	$	288	$	288
Residential Real Estate		1		14		14

Total Restructured Loans		5	$	302	$	302

The loans restructured were modified by changing the monthly payment to interest only and extending the maturity dates. 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 defaulted in the second quarter of 2017.

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 June 30, 2018 and December 31, 2017:


(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Not Rated		Total
June 30, 2018
Commercial	$	119,590	$	4,850	$	16,564	$	—	$	1,015	$	142,019
Commercial real estate		164,149		8,834		7,858		—		1,193		182,034
Residential real estate		200		—		266		—		161,718		162,184
Construction & land development		26,614		—		—		—		4,092		30,706
Consumer		—		—		21		—		17,897		17,918

Total	$	310,553	$	13,684	$	24,709	$	—	$	185,915	$	534,861

December 31, 2017
Commercial	$	116,833	$	13,685	$	8,841	$	—	$	914	$	140,273
Commercial real estate		162,012		8,220		8,620		—		811		179,663
Residential real estate		205		—		470		—		156,497		157,172
Construction & land development		18,493		880		—		—		3,513		22,886
Consumer		—		—		57		—		16,249		16,306

Total	$	297,543	$	22,785	$	17,988	$	—	$	177,984	$	516,300

The following table presents loans that are not rated by class of loans as of June 30, 2018 and December 31, 2017. Nonperforming loans include loans past due 90 days or more and loans on nonaccrual of interest status.


(Dollars in thousands)	Performing		Non-Performing		Total
June 30, 2018
Commercial	$	1,015	$	—	$	1,015
Commercial real estate		1,193		—		1,193
Residential real estate		161,112		606		161,718
Construction & land development		4,092		—		4,092
Consumer		17,877		20		17,897

Total	$	185,289	$	626	$	185,915

December 31, 2017
Commercial	$	914	$	—	$	914
Commercial real estate		811		—		811
Residential real estate		155,608		889		156,497
Construction & land development		3,513		—		3,513
Consumer		16,249		57		16,306

Total	$	177,095	$	946	$	178,041