4. LOANS AND THE ALLOWANCE FOR LOAN LOSSES

Outstanding loans are summarized below, in thousands:

	September 30,			December 31,
	2016			2015

Commercial	$	41,942		$	37,084
Agricultural		49,046			39,856
Real estate – residential		22,987			25,474
Real estate – commercial		215,166			192,095
Real estate – construction and land development		18,952			16,188
Equity lines of credit		41,743			38,327
Auto		53,464			48,365
Other		3,613			3,582
		446,913			400,971
Deferred loan costs, net		1,963			1,940
Allowance for loan losses		(6,477	)		(6,078	)
	$	442,399		$	396,833

Changes in the allowance for loan losses, in thousands, were as follows:

	September 30,			December 31,
	2016			2015

Balance, beginning of year	$	6,078		$	5,451
Provision charged to operations		600			1,100
Losses charged to allowance		(757	)		(827	)
Recoveries		556			354
Balance, end of year	$	6,477		$	6,078

The recorded investment in impaired loans totaled $5,832,000 and $6,461,000 at September 30, 2016 and December 31, 2015, respectively. The Company had specific allowances for loan losses of $480,000 on impaired loans of $1,678,000 at September 30, 2016 as compared to specific allowances for loan losses of $751,000 on impaired loans of $2,346,000 at December 31, 2015. The balance of impaired loans in which no specific reserves were required totaled $4,153,000 and $4,115,000 at September 30, 2016 and December 31, 2015, respectively. The average recorded investment in impaired loans for the nine months ended September 30, 2016 and September 30, 2015 was $5,398,000 and $6,892,000, respectively. The Company recognized $105,000 and $89,000 in interest income for impaired loans during the nine months ended September 30, 2016 and 2015, respectively. No interest was recognized on nonaccrual loans accounted for on a cash basis during the nine months ended September 30, 2016 and 2015.

Included in impaired loans are troubled debt restructurings. A troubled debt restructuring is a formal restructure of a loan where the Company for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower. The concessions may be granted in various forms to include one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

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.

The carrying value of troubled debt restructurings at September 30, 2016 and December 31, 2015 was $4,739,000 and $4,661,000, respectively. The Company has allocated $386,000 and $311,000 of specific reserves on loans to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2016 and December 31, 2015, respectively. The Company has not committed to lend additional amounts on loans classified as troubled debt restructurings at September 30, 2016 and December 31, 2015. There were no troubled debt restructurings that occurred during the nine months ending September 30, 2016 or September 30, 2015. There were no troubled debt restructurings for which there was a payment default within twelve months following the modification during the nine months ended September 30, 2016 and 2015, respectively.

At September 30, 2016 and December 31, 2015, nonaccrual loans totaled $3,100,000 and $4,546,000, respectively. Interest foregone on nonaccrual loans totaled $157,000 and $270,000 for the nine months ended September 30, 2016 and 2015, respectively. Interest foregone on nonaccrual loans totaled $51,000 and $66,000 for the three months ended September 30, 2016 and 2015, respectively. There were no loans past due 90 days or more and on accrual status at September 30, 2016 and December 31, 2015.

Salaries and employee benefits totaling $1,437,000 and $1,035,000 have been deferred as loan origination costs during the nine months ended September 30, 2016 and 2015, respectively. Salaries and employee benefits totaling $495,000 and $319,000 have been deferred as loan origination costs during the three months ended September 30, 2016 and 2015, respectively.

The Company assigns a risk rating to all loans, with the exception of automobile and other loans and periodically, but not less than annually, performs detailed reviews of all such loans over $100,000 to identify credit risks and to assess the overall collectability of the portfolio. These risk ratings are also subject to examination by independent specialists engaged by the Company and the Company’s regulators. During these internal reviews, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans. These credit quality indicators are used to assign a risk rating to each individual loan.

The balance of other real estate includes $0 and $84 thousand of foreclosed residential real estate properties recorded as a result of obtaining physical possession of the property as of September 30, 2016 and December 31, 2015, respectively. The recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceeds are in process was $243 thousand and $23 thousand as of September 30, 2016 and December 31, 2015, respectively.

The risk ratings can be grouped into five major categories, defined as follows:

Pass

– A pass loan is a strong credit with no existing or known potential weaknesses deserving of management's close attention.

Watch

– A Watch loan has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Company’s credit position at some future date. Watch loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Substandard

– A substandard loan is not adequately protected by the current sound worth and paying capacity of the borrower or the value of the collateral pledged, if any. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Well defined weaknesses include a project's lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project's failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful

– Loans classified 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 known facts, conditions and values, highly questionable and improbable.

Loss

– Loans classified as loss are considered uncollectible and charged off immediately.

The following table shows the loan portfolio allocated by management's internal risk ratings at the dates indicated, in thousands:

September 30, 2016	Commercial Credit Exposure
	Credit Risk Profile by Internally Assigned Grade
Grade:	Commercial		Agricultural		Real Estate- Residential		Real Estate- Commercial		Real Estate- Construction		Equity LOC		Total
Pass	$	41,074	$	48,715	$	22,819	$	211,813	$	18,171	$	41,408	$	384,000
Watch		491		289		-		1,271		-		-		2,051
Substandard		377		42		168		2,082		781		335		3,785
Doubtful		-		-		-		-		-		-		-
Total	$	41,942	$	49,046	$	22,987	$	215,166	$	18,952	$	41,743	$	389,836

December 31, 2015	Commercial Credit Exposure
	Credit Risk Profile by Internally Assigned Grade
Grade:	Commercial		Agricultural		Real Estate- Residential		Real Estate- Commercial		Real Estate- Construction		Equity LOC		Total
Pass	$	35,508	$	39,426	$	25,220	$	185,739	$	15,048	$	37,983	$	338,924
Watch		883		387		149		2,442		247		-		4,108
Substandard		693		43		105		3,914		893		344		5,992
Doubtful		-		-		-		-		-		-		-
Total	$	37,084	$	39,856	$	25,474	$	192,095	$	16,188	$	38,327	$	349,024

	Consumer Credit Exposure						Consumer Credit Exposure
	Credit Risk Profile Based on Payment Activity						Credit Risk Profile Based on Payment Activity
	September 30, 2016						December 31, 2015
	Auto		Other		Total		Auto		Other		Total
Grade:
Performing	$	53,343	$	3,613	$	56,956	$	48,300	$	3,582	$	51,882
Non-performing		121		-		121		65		-		65
Total	$	53,464	$	3,613	$	57,077	$	48,365	$	3,582	$	51,947

The following tables show the allocation of the allowance for loan losses at the dates indicated, in thousands:

Nine months ended 9/30/16:	Commercial			Agricultural			Real Estate- Residential			Real Estate- Commercial			Real Estate- Construction			Equity LOC			Auto			Other			Total
Allowance for Loan Losses
Beginning balance	$	639		$	294		$	341		$	2,525		$	874		$	528		$	784		$	93		$	6,078
Charge-offs		(200	)		-			-			(252	)		(5	)		(23	)		(222	)		(55	)		(757	)
Recoveries		23			-			39			3			359			2			106			24			556
Provision		225			177			(82	)		341			(333	)		70			171			31			600
Ending balance	$	687		$	471		$	298		$	2,617		$	895		$	577		$	839		$	93		$	6,477
Three months ended 9/30/16:
Allowance for Loan Losses
Beginning balance	$	835		$	416		$	322		$	2,465		$	883		$	573		$	841			95		$	6,430
Charge-offs		(127	)		-			-			-			(5	)		-			(64	)		(31	)		(227	)
Recoveries		6			-			3			1			30			1			24			9			74
Provision		(27	)		55			(27	)		151			(13	)		3			38			20			200
Ending balance	$	687		$	471		$	298		$	2,617		$	895		$	577		$	839		$	93		$	6,477
Nine months ended 9/30/15:
Allowance for Loan Losses
Beginning balance	$	574		$	225		$	379		$	1,701		$	1,227		$	691		$	581		$	73		$	5,451
Charge-offs		(88	)		(3	)		(132	)		-			(54	)		(59	)		(309	)		(27	)		(672	)
Recoveries		102			6			6			-			-			4			84			36			238
Provision		(30	)		33			80			758			(231	)		(97	)		397			(10	)		900
Ending balance	$	558		$	261		$	333		$	2,459		$	942		$	539		$	753		$	72		$	5,917
Three months ended 9/30/15:
Allowance for Loan Losses
Beginning balance	$	628		$	242		$	399		$	2,140		$	1,031		$	534		$	717		$	89		$	5,780
Charge-offs		(34	)		-			(79	)		-			1			-			(105	)		(5	)		(222	)
Recoveries		12			6			2			-			-			1			29			9			59
Provision		(48	)		13			11			319			(90	)		4			112			(21	)		300
Ending balance	$	558		$	261		$	333		$	2,459		$	942		$	539		$	753		$	72		$	5,917
September 30, 2016:
Allowance for Loan Losses
Ending balance: individually evaluated for impairment	$	2		$	-		$	53		$	152		$	248		$	25		$	-		$	-		$	480
Ending balance: collectively evaluated for impairment	$	685		$	471		$	245		$	2,465		$	647		$	552		$	839		$	93		$	5,997
Loans
Ending balance	$	41,942		$	49,046		$	22,987		$	215,166		$	18,952		$	41,743		$	53,464		$	3,613		$	446,913
Ending balance: individually evaluated for impairment	$	16		$	257		$	1,632		$	2,588		$	913		$	305		$	121		$	-		$	5,832
Ending balance: collectively evaluated for impairment	$	41,926		$	48,789		$	21,355		$	212,578		$	18,039		$	41,438		$	53,343		$	3,613		$	441,081
December 31, 2015:
Allowance for Loan Losses
Ending balance: individually evaluated for impairment	$	26		$	-		$	54		$	371		$	269		$	31		$	-		$	-		$	751
Ending balance: collectively evaluated for impairment	$	613		$	294		$	287		$	2,154		$	605		$	497		$	784		$	93		$	5,327
Loans
Ending balance	$	37,084		$	39,856		$	25,474		$	192,095		$	16,188		$	38,327		$	48,365		$	3,582		$	400,971
Ending balance: individually evaluated for impairment	$	73		$	260		$	1,593		$	3,129		$	1,029		$	311		$	66		$	-		$	6,461
Ending balance: collectively evaluated for impairment	$	37,011		$	39,596		$	23,881		$	188,966		$	15,159		$	38,016		$	48,299		$	3,582		$	394,510

The following table shows an aging analysis of the loan portfolio by the time past due, in thousands:

September 30, 2016	30-89 Days		90 Days and Still				Total Past Due and
	Past Due		Accruing		Nonaccrual		Nonaccrual		Current		Total

Commercial	$	77	$	-	$	-	$	77	$	41,865	$	41,942
Agricultural		800		-		-		800		48,246		49,046
Real estate – residential		54		-		155		209		22,778		22,987
Real estate – commercial		172		-		1,738		1,910		213,256		215,166
Real estate – construction & land		-		-		781		781		18,171		18,952
Equity Lines of Credit		216		-		305		521		41,222		41,743
Auto		580		-		121		701		52,763		53,464
Other		26		-		-		26		3,587		3,613
Total	$	1,925	$	-	$	3,100	$	5,025	$	441,888	$	446,913

December 31, 2015	30-89 Days		90 Days and Still				Total Past Due and
	Past Due		Accruing		Nonaccrual		Nonaccrual		Current		Total

Commercial	$	457	$	-	$	56	$	513	$	36,571	$	37,084
Agricultural		-		-		-		-		39,856		39,856
Real estate – residential		472		-		90		562		24,912		25,474
Real estate – commercial		-		-		3,130		3,130		188,965		192,095
Real estate – construction & land		9		-		893		902		15,286		16,188
Equity Lines of Credit		8		-		312		320		38,007		38,327
Auto		586		-		65		651		47,714		48,365
Other		15		-		-		15		3,567		3,582
Total	$	1,547	$	-	$	4,546	$	6,093	$	394,878	$	400,971

The following tables show information related to impaired loans at the dates indicated, in thousands:

			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
As of September 30, 2016:	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial	$	-	$	-			$	-	$	-
Agricultural		257		257				259		15
Real estate – residential		1,390		1,401				1,334		57
Real estate – commercial		1,985		2,422				1,806		18
Real estate – construction & land		204		204				213		-
Equity Lines of Credit		197		197				94		-
Auto		121		121				54		-
Other		-		-				-		-
With an allowance recorded:
Commercial	$	16	$	16	$	2	$	16	$	1
Agricultural		-		-		-		-		-
Real estate – residential		242		242		53		243		8
Real estate – commercial		603		811		152		542		-
Real estate – construction & land		709		709		248		726		6
Equity Lines of Credit		108		108		25		111		-
Auto		-		-		-		-		-
Other		-		-		-		-		-
Total:
Commercial	$	16	$	16	$	2	$	16	$	1
Agricultural		257		257		-		259		15
Real estate – residential		1,632		1,643		53		1,577		65
Real estate – commercial		2,588		3,233		152		2,348		18
Real estate – construction & land		913		913		248		939		6
Equity Lines of Credit		305		305		25		205		-
Auto		121		121		-		54		-
Other		-		-		-		-		-
Total	$	5,832	$	6,488	$	480	$	5,398	$	105

			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
As of December 31, 2015:	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial	$	47	$	47			$	39	$	1
Agricultural		260		260				262		20
Real estate – residential		1,347		1,359				1,346		79
Real estate – commercial		1,976		2,622				2,057		-
Real estate – construction & land		221		221				232		-
Equity Lines of Credit		199		199				156		-
Auto		65		65				21		-
Other		-		-				-		-
With an allowance recorded:
Commercial	$	26	$	26	$	26	$	29	$	-
Agricultural		-		-		-		-		-
Real estate – residential		245		245		54		246		11
Real estate – commercial		1,154		1,154		371		1,203		-
Real estate – construction & land		808		808		269		822		8
Equity Lines of Credit		113		113		31		115		-
Auto		-		-		-		-		-
Other		-		-		-		-		-
Total:
Commercial	$	73	$	73	$	26	$	68	$	1
Agricultural		260		260		-		262		20
Real estate – residential		1,592		1,604		54		1,592		90
Real estate – commercial		3,130		3,776		371		3,260		-
Real estate – construction & land		1,029		1,029		269		1,054		8
Equity Lines of Credit		312		312		31		271		-
Auto		65		65		-		21		-
Other		-		-		-		-		-
Total	$	6,461	$	7,119	$	751	$	6,528	$	119