Note 4 - Loans and Allowance for Loan Losses

Categories of loans include:

	(Dollars in Thousands)
	June 30, 2014			December 31, 2013

Commercial	$	45,712		$	45,254
Commercial real estate:
Construction	15,668			15,052
Other	167,271			154,975
Residential real estate	77,267			74,040
Consumer:
Auto	2,088			2,544
Other	3,449			3,203
Total loans	311,455			295,068
Less allowance for loan losses	(4,953		)	(4,653		)
Net loans	$	306,502		$	290,415

The following table sets forth an analysis of our allowance for loan losses for the three months ending June 30, 2014 and 2013.

	(Dollars In Thousands)
	Commercial			Commercial Real Estate		Residential Real Estate			Consumer			Unallocated		Total
June 30, 2014 Allowance for loan losses:
Beginning balance	$	937		$	3,013	$	699		$	71		$	107	$	4,827
Provision for loan losses	(77		)	165		15			5			42		150
Loans charged-off	—			—		(71		)	(10		)	—		(81		)
Recoveries	42			11		3			1			—		57
Total ending allowance balance	$	902		$	3,189	$	646		$	67		$	149	$	4,953

	(Dollars In Thousands)
	Commercial			Commercial Real Estate		Residential Real Estate			Consumer			Unallocated		Total
June 30, 2013 Allowance for loan losses:
Beginning balance	$	3,282		$	2,584	$	507		$	81		$	196	$	6,650
Provision for loan losses	(714		)	656		30			(3		)	81		50
Loans charged-off	(653		)	—		(19		)	(6		)	—		(678		)
Recoveries	7			31		3			1			—		42
Total ending allowance balance	$	1,922		$	3,271	$	521		$	73		$	277	$	6,064

The following table sets forth an analysis of our allowance for loan losses for the six months ending June 30, 2014 and 2013.

	(Dollars In Thousands)
	Commercial			Commercial Real Estate		Residential Real Estate			Consumer			Unallocated			Total
June 30, 2014 Allowance for loan losses:
Beginning balance	$	1,420		$	2,079	$	703		$	86		$	365		$	4,653
Provision for loan losses	(577		)	1,052		24			(8		)	(216		)	275
Loans charged-off	—			—		(90		)	(13		)	—			(103		)
Recoveries	59			58		9			2			—			128
Total ending allowance balance	$	902		$	3,189	$	646		$	67		$	149		$	4,953

	(Dollars In Thousands)
	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Unallocated		Total
June 30, 2013 Allowance for loan losses:
Beginning balance	$	2,156		$	2,635		$	589		$	90		$	251	$	5,721
Provision for loan losses	746			590			(60		)	(2		)	26		1,300
Loans charged-off	(987		)	(14		)	(19		)	(17		)	—		(1,037		)
Recoveries	7			60			11			2			—		80
Total ending allowance balance	$	1,922		$	3,271		$	521		$	73		$	277	$	6,064

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of June 30, 2014 and December 31, 2013. As of June 30, 2014 and December 31, 2013, accrued interest receivable of $1.3 million is not considered significant and therefore not included in the recorded investment in loans presented in the following tables. Net deferred loan fees of $355,000 and $280,000, respectively, are included in the following tables.

	(Dollars In Thousands)
	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Unallocated		Total
June 30, 2014 Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	147	$	389	$	60	$	17	$	—	$	613
Collectively evaluated	755		2,800		586		50		149		4,340
Total ending allowance balance	$	902	$	3,189	$	646	$	67	$	149	$	4,953
Loans:
Individually evaluated for impairment	$	2,617	$	1,561	$	1,261	$	30	$	—	$	5,469
Collectively evaluated	43,095		181,378		76,006		5,507		—		305,986
Total ending loans balance	$	45,712	$	182,939	$	77,267	$	5,537	$	—	$	311,455

	(Dollars In Thousands)
	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Unallocated		Total
December 31, 2013 Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	676	$	369	$	307	$	35	$	—	$	1,387
Collectively evaluated	744		1,710		396		51		365		3,266
Total ending allowance balance	$	1,420	$	2,079	$	703	$	86	$	365	$	4,653
Loans:
Individually evaluated for impairment	$	3,085	$	2,021	$	1,383	$	36	$	—	$	6,525
Collectively evaluated	42,169		168,006		72,657		5,711		—		288,543
Total ending loans balance	$	45,254	$	170,027	$	74,040	$	5,747	$	—	$	295,068

The following table presents information related to impaired loans by class of loans as of June 30, 2014 and December 31, 2013. In this table presentation the unpaid principal balance of the loans has not been reduced by partial net charge-offs. In this table presentation the recorded investment of the loans was reduced by partial net charge-offs.

	(Dollars in Thousands) June 30, 2014						(Dollars in Thousands) December 31, 2013
	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
With no related allowance recorded:
Commercial	$	783	$	783	$	—	$	1,880	$	1,880	$	—
Commercial real estate:
Construction	—		—		—		—		—		—
Other	111		111		—		843		843		—
Residential real estate	1,037		1,037		—		337		337		—
Consumer:
Auto	—		—		—		1		1		—
Other	—		—		—		—		—		—
Subtotal	1,931		1,931		—		3,061		3,061		—
With an allowance recorded:
Commercial	1,834		1,834		147		1,205		1,205		676
Commercial real estate:
Construction	—		—		—		—		—		—
Other	1,450		1,450		389		1,178		1,178		369
Residential real estate	224		224		60		1,046		1,046		307
Consumer:
Auto	17		17		17		21		21		21
Other	13		13		—		14		14		14
Subtotal	3,538		3,538		613		3,464		3,464		1,387
Total	$	5,469	$	5,469	$	613	$	6,525	$	6,525	$	1,387

Information on impaired loans for the three months ending June 30, 2014 and 2013 is as follows:

	(Dollars in Thousands) June 30, 2014						(Dollars in Thousands) June 30, 2013
	Average Recorded Investment		Interest Income Recognized		Cash Basis Interest Recognized		Average Recorded Investment		Interest Income Recognized		Cash Basis Interest Recognized
Commercial	$	2,710	37		26		$	6,287	99		52
Commercial real estate:
Construction	—		—		—		—		—		—
Other	1,547		20		15		7,607		120		13
Residential real estate	1,305		16		11		682		13		8
Consumer:
Auto	18		—		—		27		—		—
Other	13		—		—		4		—		—
Total	$	5,593	$	73	$	52	$	14,607	$	232	$	73

Information on impaired loans for the six months ending June 30, 2014 and 2013 is as follows:

	(Dollars in Thousands) June 30, 2014						(Dollars in Thousands) June 30, 2013
	Average Recorded Investment		Interest Income Recognized		Cash Basis Interest Recognized		Average Recorded Investment		Interest Income Recognized		Cash Basis Interest Recognized
Commercial	$	2,851	68		53		$	5,851	161		94
Commercial real estate:
Construction	—		—		—		—		—		—
Other	1,791		40		29		7,128		208		44
Residential real estate	1,322		31		20		528		16		9
Consumer:
Auto	19		1		—		28		1		—
Other	14		—		—		3		—		—
Total	$	5,997	$	140	$	102	$	13,538	$	386	$	147

The recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of June 30, 2014 and December 31, 2013 are summarized below:

	(Dollars in Thousands) As of June 30, 2014				(Dollars in Thousands) As of December 31, 2013
	Loans Past Due Over 90 Days and Still Accruing		Nonaccrual		Loans Past Due Over 90 Days and Still Accruing		Nonaccrual

Commercial	$	—	$	816	$	—	$	153
Commercial real estate:
Construction	—		—		—		—
Other	—		535		—		362
Residential real estate	42		473		—		643
Consumer:
Auto	—		17		—		22
Other	—		—		—		—
Total	$	42	$	1,841	$	—	$	1,180

Nonaccrual loans and loans past due 90 days still on accrual include individually classified impaired loans.

The following tables present the aging of the recorded investment in past due loans as of June 30, 2014 and December 31, 2013 by class of loans. Non-accrual loans are included and have been categorized based on their payment status:

	(Dollars In Thousands)
	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Loans Not Past Due		Total
June 30, 2014
Commercial	$	181	$	—	$	688	$	869	$	44,843	$	45,712
Commercial real estate:
Construction	—		—		—		—		15,668		15,668
Other	—		45		440		485		166,786		167,271
Residential real estate	68		23		513		604		76,663		77,267
Consumer:
Auto	—		—		—		—		2,088		2,088
Other	—		—		—		—		3,449		3,449
Total	$	249	$	68	$	1,641	$	1,958	$	309,497	$	311,455

	(Dollars In Thousands)
	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Loans Not Past Due		Total
December 31, 2013
Commercial	$	53	$	—	$	—	$	53	$	45,201	$	45,254
Commercial real estate:
Construction	—		—		—		—		15,052		15,052
Other	321		—		303		624		154,351		154,975
Residential real estate	98		66		574		738		73,302		74,040
Consumer:
Auto	6		1		—		7		2,537		2,544
Other	—		—		—		—		3,203		3,203
Total	$	478	$	67	$	877	$	1,422	$	293,646	$	295,068

Troubled Debt Restructurings:

The Company reported total troubled debt restructurings of $4.4 million and $5.5 million as of June 30, 2014 and December 31, 2013, respectively. The Company has no commitments to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings. Troubled debt restructurings are included in impaired loans. Of the 14 troubled debt restructurings reported at quarter end, 11 loans totaling $3.6 million were accruing and 3 loans totaling $806,000 were on nonaccrual status.

During the quarter ending June 30, 2014, one previously identified troubled debt restructuring was further modified and will continue the current amortization at the current interest rate, as the subject loan had matured. No other troubled debt restructurings were added during the second quarter of 2014.

The following table presents loans by class modified as troubled debt restructurings outstanding as of June 30, 2014:

		(Dollars in thousands)
	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings:
Commercial	6	$	3,326	$	3,326
Commercial real estate:
Other	3	1,109		1,109
Residential real estate	4	757		759
Consumer	1	16		15
Total	14	$	5,208	$	5,209

The following table presents loans by class modified as troubled debt restructurings outstanding as of December 31, 2013:

		(Dollars in thousands)
	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings:
Commercial	10	$	2,716	$	2,716
Commercial real estate:
Other	1	604		604
Residential real estate	3	841		854
Consumer other	1	16		15
Total	15	$	4,177	$	4,189

The following table presents loans by class modified as troubled debt restructurings that occurred during the quarter ending June 30, 2014:

		(Dollars in thousands)
	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings:
Commercial real estate	1	$	924	$	924
Total	1	$	924	$	924

The following table presents loans by class modified as troubled debt restructurings that occurred during the quarter ending June 30, 2013:

		(Dollars in thousands)
	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings:
Commercial	4	$	795	$	1,195
Total	4	$	795	$	1,195

Specific allocations of $337,000 and $1.1 million were reported for troubled debt restructurings as of June 30, 2014 and December 31, 2013. No payment defaults were reported for troubled debt restructurings during the quarter ending June 30, 2014 or June 30, 2013. Specific allocations of $1.9 million were reported for the troubled debt restructurings as of June 30, 2013. No charge offs were taken on troubled debt restructurings during the quarter ending June 30, 2014 or June 30, 2013.

The terms of certain other loans were modified during the six months ending June 30, 2014 and 2013 that did not meet the definition of a troubled debt restructuring. These loans modified during the six months ending June 30, 2014 have a total recorded investment of $13.9 million as of June 30, 2014. The loans modified during the six months ending June 30, 2013 have a total recorded investment of $3.7 million as of June 30, 2013. The modification of these loans involved either a modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.

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 loans individually by classifying the loans as to credit risk. This analysis includes commercial and commercial real estate loans with an outstanding balance greater than $25 thousand and is reviewed on a monthly basis. For residential real estate and consumer loans the analysis primarily involves monitoring the past due status of these loans and at such time that these loans are past due, the Company evaluates the loans to determine if a change in risk category is warranted. The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position 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. All loans in all loan categories are assigned risk ratings. Based on the most recent analyses performed, the risk category of loans by class of loans is as follows:

	Pass		Special Mention		Substandard		Doubtful		Total
June 30, 2014
Commercial	$	41,754	$	69	$	3,889	$	—	$	45,712
Commercial real estate:
Construction	15,668		—		—		—		15,668
Other	159,994		—		7,277		—		167,271
Residential real estate	76,259		161		847		—		77,267
Consumer
Auto	2,088		—		—		—		2,088
Other	3,442		—		7		—		3,449
Total	$	299,205	$	230	$	12,020	$	—	$	311,455

	Pass		Special Mention		Substandard		Doubtful		Total
December 31, 2013
Commercial	$	41,968	$	77	$	3,209	$	—	$	45,254
Commercial real estate:
Construction	15,052		—		—		—		15,052
Other	147,429		—		7,546		—		154,975
Residential real estate	72,264		164		1,612		—		74,040
Consumer:
Auto	2,543		—		1		—		2,544
Other	3,203		—		—		—		3,203
Total	$	282,459	$	241	$	12,368	$	—	$	295,068