ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY OF FINANCING RECEIVABLES

The following table presents changes in the allowance for loan losses disaggregated by the class of loans receivable for the three and nine months ended September 30, 2016 and 2015:

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(Dollars in thousands)	Commercial and Industrial			Construction			Commercial Real Estate			Residential Real Estate			Consumer and Other			Unallocated			Total
Three Months Ended:
September 30, 2016
Beginning balance	$	199		$	208		$	4,020		$	914		$	17		$	630		$	5,988
Charge-offs	—			—			(91		)	(25		)	(11		)	—			(127		)
Recoveries	5			—			2			1			4			—			12
Provision	5			106			(24		)	(48		)	8			411			458
Ending balance	$	209		$	314		$	3,907		$	842		$	18		$	1,041		$	6,331

September 30, 2015
Beginning balance	$	86		277			$	3,613		$	898		$	86		$	792		$	5,752
Charge-offs	—			—			(119		)	—			(6		)	—			(125		)
Recoveries	5			—			3			4			1			—			13
Provision	(8		)	(57		)	134			26			5			(99		)	1
Ending balance	$	83		$	220		$	3,631		$	928		$	86		$	693		$	5,641

Nine Months Ended:
September 30, 2016
Beginning balance	$	85		220			$	3,646		$	784		$	87		$	768		$	5,590
Charge-offs	(138		)	—			(156		)	(59		)	(30		)	—			(383		)
Recoveries	21			—			36			7			6			—			70
Provision	241			94			381			110			(45		)	273			1,054
Ending balance	$	209		$	314		$	3,907		$	842		$	18		$	1,041		$	6,331

September 30, 2015
Beginning balance	$	231		383			$	3,491		$	903		$	19		$	614		$	5,641
Charge-offs	(19		)	—			(542		)	—			(17		)	—			(578		)
Recoveries	10			—			39			17			6			—			72
Provision	(139		)	(163		)	643			8			78			79			506
Ending balance	$	83		$	220		$	3,631		$	928		$	86		$	693		$	5,641

The following table presents the balance of the allowance of loan losses and loans receivable by class at September 30, 2016 and December 31, 2015 disaggregated on the basis of our impairment methodology.

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	Allowance for Loan Losses						Loans Receivable
(Dollars in thousands)	Balance		Balance Loans Individually Evaluated for Impairment		Balance Related to Loans Collectively Evaluated for Impairment		Balance		Individually Evaluated for Impairment		Collectively Evaluated for Impairment
September 30, 2016
Commercial and industrial	$	209	$	—	$	209	$	34,152	$	20	$	34,132
Construction	314		—		314		21,912		—		21,912
Commercial real estate	3,907		90		3,817		465,600		4,293		461,307
Residential real estate	842		2		840		141,466		1,608		139,858
Consumer and other loans	18		—		18		1,060		—		1,060
Unallocated	1,041		—		—		—		—		—
Total	$	6,331	$	92	$	5,198	$	664,190	$	5,921	$	658,269



December 31, 2015
Commercial and industrial	$	85	$	—	$	85	$	20,023	$	20	$	20,003
Construction	220		—		220		13,348		—		13,348
Commercial real estate	3,646		112		3,534		382,262		5,160		377,102
Residential real estate	784		79		705		127,204		1,546		125,658
Consumer and other loans	87		73		14		1,253		138		1,115
Unallocated	768		—		—		—		—		—
Total	$	5,590	$	264	$	4,558	$	544,090	$	6,864	$	537,226

An age analysis of loans receivable, which were past due as of September 30, 2016 and December 31, 2015, is as follows:

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(Dollars in thousands)	30-59 Days Past Due		60-89 days Past Due		Greater Than 90 Days (a)		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 Days and Accruing
September 30, 2016
Commercial and industrial	$	306	$	16	$	202	$	524	$	33,628	$	34,152	$	182
Construction	216		—		—		216		21,696		21,912		—
Commercial real estate	3,881		1,908		3,282		9,071		456,529		465,600		111
Residential real estate	882		367		1,485		2,734		138,732		141,466		93
Consumer and other	3		1		—		4		1,056		1,060		—
Total	$	5,288	$	2,292	$	4,969	$	12,549	$	651,641	$	664,190	$	386



December 31, 2015
Commercial and industrial	$	5	$	—	$	20	$	25	$	19,998	$	20,023	$	—
Construction	—		—		—		—		13,348		13,348		—
Commercial real estate	758		1,461		4,016		6,235		376,027		382,262		—
Residential real estate	335		247		1,138		1,720		125,484		127,204		—
Consumer and other	16		1		138		155		1,098		1,253		—
Total	$	1,114	$	1,709	$	5,312	$	8,135	$	535,955	$	544,090	$	—

(a) includes loans greater than 90 days past due and still accruing and non-accrual loans.

Loans for which the accrual of interest has been discontinued at September 30, 2016 and December 31, 2015 were:

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(Dollars in thousands)	September 30, 2016		December 31, 2015
Commercial and industrial	$	20	$	20
Commercial real estate	3,171		4,016
Residential real estate	1,392		1,138
Consumer and other	—		138
Total	$	4,583	$	5,312

In determining the adequacy of the allowance for loan losses, we estimate losses based on the identification of specific problem loans through our credit review process and also estimate losses inherent in other loans on an aggregate basis by loan type. The credit review process includes the independent evaluation of the loan officer assigned risk ratings by the Chief Credit Officer and a third party loan review company. Such risk ratings are assigned loss component factors that reflect our loss estimate for each group of loans. It is management’s and the Board of Directors’ responsibility to oversee the lending process to ensure that all credit risks are properly identified, monitored, and controlled, and that loan pricing, terms and other safeguards against non-performance and default are commensurate with the level of risk undertaken and is rated as such based on a risk-rating system. Factors considered in assigning risk ratings and loss component factors include: borrower specific information related to expected future cash flows and operating results, collateral values, financial condition and payment status; levels of and trends in portfolio charge-offs and recoveries; levels in portfolio delinquencies; effects of changes in loan concentrations and observed trends in the economy and other qualitative measurements.

Our risk-rating system is consistent with the classification system used by regulatory agencies and with industry practices. Loan classifications of Substandard, Doubtful or Loss are consistent with the regulatory definitions of classified assets. The classification system is as follows:


•	Pass: This category represents loans performing to contractual terms and conditions and the primary source of repayment is adequate to meet the obligation. We have five categories within the Pass classification depending on strength of repayment sources, collateral values and financial condition of the borrower.


•	Special Mention: This category represents loans performing to contractual terms and conditions; however the primary source of repayment or the borrower is exhibiting some deterioration or weaknesses in financial condition that could potentially threaten the borrowers’ future ability to repay our loan principal and interest or fees due.

•

Substandard: This category represents loans that the primary source of repayment has significantly deteriorated or weakened which has or could threaten the borrowers’ ability to make scheduled payments. The weaknesses require close supervision by management and there is a distinct possibility that we could sustain some loss if the deficiencies are not corrected. Such weaknesses could jeopardize the timely and ultimate collection of our loan principal and interest or fees due. Loss may not be expected or evident, however, loan repayment is inadequately supported by current financial information or pledged collateral.

•

Doubtful: Loans so classified have all the inherent weaknesses of a substandard loan with the added provision that collection or liquidation in full is highly questionable and not reasonably assured. The probability of at least partial loss is high, but extraneous factors might strengthen the asset to prevent loss. The validity of the extraneous factors must be continuously monitored. Once these factors are questionable the loan should be considered for full or partial charge-off.


•	Loss: Loans so classified are considered uncollectible, and of such little value that their continuance as active assets is not warranted. Such loans are fully charged off.

The following tables illustrate our corporate credit risk profile by creditworthiness category as of September 30, 2016 and December 31, 2015: ໿

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(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total
September 30, 2016
Commercial and industrial	$	34,023	$	95	$	34	$	—	$	34,152
Construction	21,912		—		—		—		21,912
Commercial real estate	451,289		8,717		5,594		—		465,600
Residential real estate	139,133		563		1,770		—		141,466
Consumer and other	1,060		—		—		—		1,060
	$	647,417	$	9,375	$	7,398	$	—	$	664,190



December 31, 2015
Commercial and industrial	$	19,983	$	5	$	35	$	—	$	20,023
Construction	13,348		—		—		—		13,348
Commercial real estate	367,305		8,957		6,000		—		382,262
Residential real estate	124,915		743		1,546		—		127,204
Consumer and other	1,115		—		138		—		1,253
	$	526,666	$	9,705	$	7,719	$	—	$	544,090

The following table reflects information about our impaired loans by class as of September 30, 2016 and December 31, 2015:



	September 30, 2016						December 31, 2015
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance

With no related allowance recorded:
Commercial and industrial	$	20	$	20	$	—	$	20	$	20	$	—
Commercial real estate	1,985		1,985		—		2,684		2,684		—
Residential real estate	1,383		1,409		—		1,123		1,152		—



With an allowance recorded:
Commercial real estate	2,308	2,399	90	2,476	2,476	112
Residential real estate	225	225	2	423	423	79
Consumer and other	—	—	—	138	138	73



Total:
Commercial and industrial	20		20		—		20		20		—
Commercial real estate	4,293		4,384		90		5,160		5,160		112
Residential real estate	1,608		1,634		2		1,546		1,575		79
Consumer and other	—		—		—		138		138		73
	$	5,921	$	6,038	$	92	$	6,864	$	6,893	$	264

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The following table presents the average recorded investment and income recognized for the three and nine months ended September 30, 2016 and 2015:



	For the Three Months Ended September 30, 2016				For the Three Months Ended September 30, 2015
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	20	$	—	$	20	$	—
Commercial real estate	2,002		4		2,119		10
Residential real estate	1,316		3		904		1
Total impaired loans without a related allowance	3,338		7		3,043		11

With an allowance recorded:
Commercial real estate	2,394		8		2,762		8
Residential real estate	184		—		992		3
Consumer and other	—		—		104		—
Total impaired loans with an allowance	2,578		8		3,858		11
Total impaired loans	$	5,916	$	15	$	6,901	$	22



	For the Nine Months Ended September 30, 2016				For the Nine Months Ended September 30, 2015
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	20	$	—	$	15	$	—
Commercial real estate	2,224		16		2,439		24
Residential real estate	1,188		6		1,267		5
Total impaired loans without a related allowance	3,432		22		3,721		29

With an allowance recorded:
Commercial and industrial	—		—		24		—
Commercial real estate	2,546		25		2,764		25
Residential real estate	281		—		753		8
Consumer and other	69		—		104		—
Total impaired loans with an allowance	2,896		25		3,645		33
Total impaired loans	$	6,328	$	47	$	7,366	$	62

We recognize interest income on performing impaired loans as payments are received. On non-performing impaired loans we do not recognize interest income as all payments are recorded as a reduction of principal on such loans.

Impaired loans include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, postponement or forgiveness of principal, forbearance or other actions intended to maximize collection. The concessions rarely result in the forgiveness of principal or accrued interest. In addition, we attempt to obtain additional collateral or guarantor support when modifying such loans. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible.

The following table presents the recorded investment in troubled debt restructured loans, based on payment performance status:



(Dollars in thousands)	Commercial Real Estate		Residential Real Estate		Total

September 30, 2016
Performing	$	1,012	$	130	$	1,142
Non-performing	1,931		—		1,931
Total	$	2,943	$	130	$	3,073



December 31, 2015
Performing	$	1,144	$	409	$	1,553
Non-performing	1,831		194		2,025
Total	$	2,975	$	603	$	3,578

Troubled debt restructured loans are considered impaired and are included in the previous impaired loans disclosures in this footnote. As of September 30, 2016, we have not committed to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings.

There were no troubled debt restructurings that occurred during the three and nine months ended September 30, 2016 and 2015.

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There were no troubled debt restructurings for which there was a payment default within twelve months following the date of the restructuring for the three and nine months ended September 30, 2016 and 2015.

We may obtain physical possession of residential real estate collateralizing a consumer mortgage loan via foreclosure on an in-substance repossession. As of September 30, 2016, we did not hold any foreclosed residential real estate properties. As of December 31, 2015, we held $130 thousand in foreclosed residential real estate properties as a result of obtaining physical possession. In addition, as of September 30, 2016 and December 31, 2015, respectively, we had consumer loans with a carrying value of $673 thousand and $945 thousand collateralized by residential real estate property for which formal foreclosure proceedings were in process.