Note 7: Loans and Allowance

Classes of loans at March 31, 2016 and December 31, 2015 include:



	March 31,		December 31,
	2016		2015
Real estate
Commercial	$	248,893	$	236,895
Commercial construction and development		18,039		15,744
Consumer closed end first mortgage		487,389		491,451
Consumer open end and junior liens		70,911		70,990
		825,232		815,080
Other loans
Consumer loans
Auto		15,506		15,480
Boat/RVs		126,810		123,621
Other		5,785		6,171
Commercial and industrial		118,275		123,043
		266,376		268,315
Total loans		1,091,608		1,083,395
Undisbursed loans in process		(9,644)		(7,432)
Unamortized deferred loan costs, net		4,927		4,882
Allowance for loan losses		(12,670)		(12,641)
Net loans	$	1,074,221	$	1,068,204

The risk characteristics of each loan portfolio segment are as follows:

Commercial

Real estate

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 generally 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 more 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 and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Construction and Development

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates and financial analyses of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction 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 risks 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.

Commercial and Industrial

Commercial loans are primarily 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 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.

Consumer Real Estate and Other Consumer Loans

With respect to residential loans that are secured by consumer closed end first mortgages and are primarily owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires PMI if that ratio is exceeded. Consumer open end and junior lien loans are typically secured by a subordinate interest in 1-4 family residences, and other consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Nonaccrual Loans and Past Due Loans

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions, but never greater than 90 days past due.

All interest accrued but not collected for loans that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured and generally only after six months of satisfactory performance.

Nonaccrual loans, segregated by class of loans, as of March 31, 2016 and December 31, 2015 are as follows:



	March 31,		December 31,
	2016		2015
Real estate
Commercial	$	2,109	$	2,356
Commercial construction and development		22		-
Consumer closed end first mortgage		3,180		3,592
Consumer open end and junior liens		635		783
Consumer loans
Auto		15		-
Boat/RVs		90		81
Other		20		67
Commercial and industrial		2		25
Total nonaccrual loans	$	6,073	$	6,904

An age analysis of the Company’s past due loans, segregated by class of loans, as of March 31, 2016 and December 31, 2015 are as follows:



	March 31, 2016
		30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable		Total Loans 90 Days or More Past Due and Accruing
Real estate
Commercial	$	725	$	149	$	1,968	$	2,842	$	246,051	$	248,893	$	-
Commercial construction and development		-		-		2		2		18,037		18,039		-
Consumer closed end first mortgage		5,607		2,189		3,319		11,115		476,274		487,389		385
Consumer open end and junior liens		222		202		635		1,059		69,852		70,911		-
Consumer loans
Auto		53		3		15		71		15,435		15,506		-
Boat/RVs		534		101		77		712		126,098		126,810		-
Other		121		18		20		159		5,626		5,785		-
Commercial and industrial		50		36		-		86		118,189		118,275		-
Total	$	7,312	$	2,698	$	6,036	$	16,046	$	1,075,562	$	1,091,608	$	385


	December 31, 2015
		30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable		Total Loans 90 Days or More Past Due and Accruing
Real estate
Commercial	$	922	$	20	$	2,212	$	3,154	$	233,741	$	236,895	$	-
Commercial construction and development		-		-		-		-		15,744		15,744		-
Consumer closed end first mortgage		7,272		1,328		3,091		11,691		479,760		491,451		267
Consumer open end and junior liens		296		187		765		1,248		69,742		70,990		-
Consumer loans
Auto		89		-		-		89		15,391		15,480		-
Boat/RVs		1,135		102		71		1,308		122,313		123,621		-
Other		89		14		62		165		6,006		6,171		-
Commercial and industrial		192		383		5		580		122,463		123,043		-
Total	$	9,995	$	2,034	$	6,206	$	18,235	$	1,065,160	$	1,083,395	$	267

Impaired Loans

Loans are considered impaired in accordance with the impairment accounting guidance (ASC 310-10-35-16), when, based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming loans but also 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, forgiveness of principal, forbearance or other actions intended to maximize collection.

Interest on impaired loans is recorded based on the performance of the loan. All interest received on impaired loans that are on nonaccrual status is accounted for on the cash-basis method until qualifying for return to accrual status. Interest is accrued per the contract for impaired loans that are performing.

The following tables present impaired loans as of and for the three month periods ended March 31, 2016 and 2015 and the year ended December 31, 2015. There were no loans with a specific valuation allowance as of March 31, 2015.



	March 31, 2016
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Real estate
Commercial	$	3,150	$	3,150	$	-	$	3,172	$	23
Commercial construction and development		859		859		-		934		12
Consumer closed end first mortgage		1,126		1,126		-		1,126		-
Consumer open end and junior liens		485		485		-		483		-
Commercial and industrial		208		208		-		212		-

Loans with a specific valuation allowance
Real estate
Commercial		517		517		100		596		-

Total
Real estate
Commercial	$	3,667	$	3,667	$	100	$	3,768	$	23
Commercial construction and development	$	859	$	859	$	-	$	934	$	12
Consumer closed end first mortgage	$	1,126	$	1,126	$	-	$	1,126	$	-
Consumer open end and junior liens	$	485	$	485	$	-	$	483	$	-
Commercial and industrial	$	208	$	208	$	-	$	212	$	-

Total	$	6,345	$	6,345	$	100	$	6,523	$	35



	December 31, 2015
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Real estate
Commercial	$	3,608	$	3,608	$	-	$	4,115	$	172
Commercial construction and development		595		595		-		735		31
Consumer closed end first mortgage		1,126		1,126		-		1,131		-
Consumer open end and junior liens		481		481		-		381		-
Commercial and industrial		214		214		-		423		2

Loans with a specific valuation allowance
Real estate
Commercial		676		676		100		793		20

Total
Real estate
Commercial	$	4,284	$	4,284	$	100	$	4,908	$	192
Commercial construction and development	$	595	$	595	$	-	$	735	$	31
Consumer closed end first mortgage	$	1,126	$	1,126	$	-	$	1,131	$	-
Consumer open end and junior liens	$	481	$	481	$	-	$	381	$	-
Commercial and industrial	$	214	$	214	$	-	$	423	$	2

Total	$	6,700	$	6,700	$	100	$	7,578	$	225



	March 31, 2015
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Real estate
Commercial	$	5,225	$	5,225	$	-	$	5,079	$	56
Commercial construction and development		851		1,628		-		891		7
Consumer closed end first mortgage		1,138		1,138		-		1,138		-
Consumer open end and junior liens		476		476		-		238		-
Commercial and industrial		702		733		-		730		1

Total	$	8,392	$	9,200	$	-	$	8,076	$	64

The following information presents the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of March 31, 2016.

Commercial Loan Grades

Definition of Loan Grades. Loan grades are numbered 1 through 8. Grades 1-4 are "pass" credits, grade 5 [Special Mention] loans are "criticized" assets, and grades 6 [Substandard], 7 [Doubtful] and 8 [Loss] are "classified" assets. The use and application of these grades by the Bank conform to the Bank's policy and regulatory definitions.

Pass. Pass credits are loans in grades prime through fair. These are at least considered to be credits with acceptable risks and would be granted in the normal course of lending operations.

Special Mention. Special mention credits have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the Bank’s credit position at some future date. If weaknesses cannot be identified, classifying as special mention is not appropriate. Special mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

Substandard. Substandard credits are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged. Financial statements normally reveal some or all of the following: poor trends, lack of earnings and cash flow, excessive debt, lack of liquidity, and the absence of creditor protection. Credits so classified must have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful. A doubtful extension of credit has all the weaknesses inherent in a substandard asset 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. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans. Doubtful classification for an entire credit should be avoided when collection of a specific portion appears highly probable with the adequately secured portion graded Substandard.

Retail Loan Grades

Pass. Pass credits are loans that are currently performing as agreed and are not troubled debt restructurings.

Substandard. Substandard credits are loans that have reason to be considered to have a weakness and placed on non-accrual. This would include all retail loans over 90 days and troubled debt restructurings.



	March 31, 2016
		Commercial								Consumer
		Pass		Special Mention		Substandard		Doubtful		Pass		Special Mention		Substandard		Total
Real estate
Commercial		$	236,382	$	6,995	$	5,483	$	33							$	248,893
Commercial construction and development			16,060		1,095		884		-								18,039
Consumer closed end first mortgage										$	481,227	$	-	$	6,162		487,389
Consumer open end and junior liens											70,200		-		711		70,911

Other loans
Consumer loans
Auto											15,491		-		15		15,506
Boat/RVs											126,662		-		148		126,810
Other											5,760		-		25		5,785
Commercial and industrial			114,787		3,295		193		-								118,275
		$	367,229	$	11,385	$	6,560	$	33	$	699,340	$	-	$	7,061	$	1,091,608



	December 31, 2015
		Commercial								Consumer
		Pass		Special Mention		Substandard		Doubtful		Pass		Special Mention		Substandard		Total
Real estate
Commercial		$	226,439	$	4,137	$	6,319	$	-							$	236,895
Commercial construction and development			13,986		1,309		449		-								15,744
Consumer closed end first mortgage										$	484,658	$	-	$	6,793		491,451
Consumer open end and junior liens											70,086		-		904		70,990

Other loans
Consumer loans
Auto											15,480		-		-		15,480
Boat/RVs											123,490		-		131		123,621
Other											6,097		-		74		6,171
Commercial and industrial			119,540		3,300		203		-								123,043
		$	359,965	$	8,746	$	6,971	$	-	$	699,811	$	-	$	7,902	$	1,083,395

Allowance for Loan Losses.

We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, including the general allowance and specific allowances for identified problem loans and portfolio segments. In addition, the allowance incorporates the results of measuring impaired loans as provided in FASB ASC 310, Receivables. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. The general allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the general allowance. Loss factors are based on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.

The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan. Senior management reviews these conditions quarterly in discussions with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the loss related to this condition is reflected in the general allowance for loan losses. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the general allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.

The following table details activity in the allowance for loan losses by portfolio segment for the three month periods ended March 31, 2016 and 2015, respectively. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other segments.



	Three Months Ended March 31, 2016
	Commercial		Mortgage		Consumer		Total
Allowance for loan losses:
Balance, beginning of period	$	7,090	$	2,683	$	2,868	$	12,641
Provision charged to expense		120		62		18		200
Losses charged off		(4)		(120)		(138)		(262)
Recoveries		2		4		85		91
Balance, end of period	$	7,208	$	2,629	$	2,833	$	12,670



	Three Months Ended March 31, 2015
	Commercial		Mortgage		Consumer		Total
Allowance for loan losses:
Balance, beginning of period	$	7,085	$	3,471	$	2,612	$	13,168
Provision charged (credited) to expense		(396)		188		208		-
Losses charged off		-		(93)		(117)		(210)
Recoveries		205		1		53		259
Balance, end of period	$	6,894	$	3,567	$	2,756	$	13,217

The following tables provide a breakdown of the allowance for loans losses and loan portfolio balances by segment as of March 31, 2016 and December 31, 2015.



	Three Months Ended March 31, 2016
	Commercial		Mortgage		Consumer		Total
Allowance balances
Individually evaluated for impairment	$	100	$	-	$	-	$	100
Collectively evaluated for impairment		7,108		2,629		2,833		12,570
Total allowance for loan losses	$	7,208	$	2,629	$	2,833	$	12,670
Loan balances
Individually evaluated for impairment	$	4,734	$	1,126	$	485	$	6,345
Collectively evaluated for impairment		380,473		486,263		218,527		1,085,263
Gross loans	$	385,207	$	487,389	$	219,012	$	1,091,608



	Year Ended December 31, 2015
	Commercial		Mortgage		Consumer		Total
Allowance balances
Individually evaluated for impairment	$	100	$	-	$	-	$	100
Collectively evaluated for impairment		6,990		2,683		2,868		12,541
Total allowance for loan losses	$	7,090	$	2,683	$	2,868	$	12,641
Loan balances
Individually evaluated for impairment	$	5,093	$	1,126	$	481	$	6,700
Collectively evaluated for impairment		370,589		490,325		215,781		1,076,695
Gross loans	$	375,682	$	491,451	$	216,262	$	1,083,395

Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral.

For all loan portfolio segments except consumer real estate and other consumer loans, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

The Company charges-off consumer real estate and other consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge-down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged-off.

Troubled Debt Restructurings

Certain categories of impaired loans include loans that have been modified in a troubled debt restructuring; that involves granting economic concessions to borrowers who have experienced financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.

When we modify loans in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or we use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determine that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific reserve or a charge-off to the allowance.

Loans retain their accrual status at the time of their modification. As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual until a period of satisfactory performance, generally six months, is obtained. If a loan is on accrual at the time of the modification, the loan is evaluated to determine if the collection of principal and interest is reasonably assured and generally stays on accrual.

At March 31, 2016, the Company had a number of loans that were modified in troubled debt restructurings. The modification of terms of such loans included one or a combination of the following: an extension of maturity, a reduction of the stated interest rate or a permanent reduction of the recorded investment in the loan.

The following tables describe troubled debts restructured during the three month periods ended March 31, 2016 and 2015:



	Three Months Ended March 31, 2016					Three Months Ended March 31, 2015
	No. of Loans	Pre-Modification Recorded Balance		Post-Modification Recorded Balance		No. of Loans	Pre-Modification Recorded Balance		Post-Modification Recorded Balance
Real estate
Commercial	-	$	-	$	-	2	$	1,172	$	1,170
Construction and development	-		-		-	1		155		134
Consumer closed end first mortgage	5		419		428	3		156		154

Other loans
Consumer loans
Auto	1		4		4	-		-		-
Boat/RVs	2		48		48	-		-		-
Commercial and industrial	1		83		83	1		88		83

The impact on the allowance for loan losses was insignificant as a result of these modifications.

Newly restructured loans by type for the three months ended March 31, 2016 and 2015 are as follows:



	Three Months Ended March 31, 2016
		Rate		Term		Combination		Total Modification
Real Estate
Consumer closed end first mortgage	$	-	$	-	$	428	$	428

Other loans
Consumer loans
Auto		-		-		4		4
Boat/RVs		-		48		-		48
Commercial and industrial		-		83		-		83



	Three Months Ended March 31, 2015
		Rate		Term		Combination		Total Modification
Real Estate
Commercial	$	-	$	1,170	$	-	$	1,170
Commercial construction and development		-		-		134		134
Consumer closed end first mortgage		-		-		154		154

Other loans
Commercial and industrial		-		-		83		83

There were no defaults on loans modified as troubled debt restructurings made in the three months ended March 31, 2016 or 2015. Defaults are defined as any loans that become 90 days past due.

At March 31, 2016, the Company held residential real estate held for sale as a result of foreclosure totaling $712,000 and real estate in the process of foreclosure of $1.9 million.