LOANS AND ALLOWANCE FOR LOAN LOSSES

The Company routinely generates 1-4 family mortgages for sale into the secondary market. During 2016, 2015 and 2014, the Company recognized sales proceeds of $1.7 billion, $1.3 billion and $881.3 million, resulting in mortgage fee income of $35.7 million, $29.5 million and $17.6 million, respectively.

The components of loans in the Consolidated Balance Sheet at December 31, were as follows:



(Dollars in thousands)	2016		2015
Commercial and Non-Residential Real Estate	$	757,516	$	729,319
Residential Real Estate	215,452		217,366
Home Equity	65,386		68,124
Consumer	14,511		17,361
Total Loans	$	1,052,865	$	1,032,170

All loan origination fees and direct loan origination costs are deferred and recognized over the life of the loan. As of December 31, 2016 and 2015, net deferred fees of $897 thousand and $1.1 million, respectively, were included in the carrying value of loans.

The following table summarizes the primary segments of the loan portfolio as of December 31, 2016 and 2015:



(Dollars in thousands)	Commercial		Residential		Home Equity		Consumer		Total
December 31, 2016
Individually evaluated for impairment	$	10,781	$	1,161	$	132	$	78	$	12,152
Collectively evaluated for impairment	746,735		214,291		65,254		14,433		1,040,713
Total Loans	$	757,516	$	215,452	$	65,386	$	14,511	$	1,052,865
December 31, 2015
Individually evaluated for impairment	$	14,177	$	1,067	$	28	$	103	$	15,375
Collectively evaluated for impairment	715,142		216,299		68,096		17,258		1,016,795
Total Loans	$	729,319	$	217,366	$	68,124	$	17,361	$	1,032,170

Loans are considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Company also separately evaluates individual consumer loans for impairment. The Chief Credit Officer identifies these loans individually by monitoring the delinquency status of the Bank’s portfolio. Once identified, the Bank’s ongoing communications with the borrower allow Management to evaluate the significance of the payment delays and the circumstances surrounding the loan and the borrower.

Once the determination has been made that a loan is impaired, the amount of the impairment is measured using one of three valuation methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis, with management primarily utilizing the fair value of collateral method. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis.

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of December 31, 2016 and 2015:



	Impaired Loans with Specific Allowance				Impaired Loans with No Specific Allowance		Total Impaired Loans
(Dollars in thousands)	Recorded Investment		Related Allowance		Recorded Investment		Recorded Investment		Unpaid Principal Balance
December 31, 2016
Commercial
Commercial Business	$	—	$	—	$	3,342	$	3,342	$	4,102
Commercial Real Estate	2,757		302		892		3,649		3,676
Acquisition & Development	264		74		3,526		3,790		6,059
Total Commercial	3,021		376		7,760		10,781		13,837
Residential	783		122		378		1,161		1,166
Home Equity	62		36		70		132		135
Consumer	16		9		62		78		285
Total Impaired Loans	$	3,882	$	543	$	8,270	$	12,152	$	15,423

December 31, 2015
Commercial
Commercial Business	$	574	$	4	$	3,260	$	3,834	$	3,834
Commercial Real Estate	7,587		513		—		7,587		7,587
Acquisition & Development	1,800		191		956		2,756		4,131
Total Commercial	9,961		708		4,216		14,177		15,552
Residential	1,045		276		22		1,067		1,067
Home Equity	28		28		—		28		28
Consumer	103		1		—		103		103
Total Impaired Loans	$	11,137	$	1,013	$	4,238	$	15,375	$	16,750

Impaired loans have decreased by $3.2 million, or 21%, during 2016, primarily the result of the net impact of seven commercial loan relationships. A $5.0 million loan to finance commercial real estate property in the Northern Virginia market, which had as primary tenants, government contractors that have vacated the premises as a result of losing significant contracts with the United States government, was purchased from another financial institution in late 2013. In 2016, this $5.0 million loan was repurchased by the selling financial institution thereby decreasing total impaired loans by $5.0 million.

In contrast, five of the seven relationships generated increases to the impaired loan total since 2015, the largest of which was a $950 thousand commercial real estate loan (net of a $361 thousand participation) that was identified as impaired in 2016 as a result of an extended stabilization and interest only period, as well as a lack of project specific cash flows. Charge-offs of $701 thousand were incurred on this loan in 2016. The remaining four relationships that generated increases to the impaired loan total included thirteen commercial real estate and/or acquisition and development loans that totaled $3.9 million as of December 31, 2016, a net increase of $1.2 million specific to these relationships since 2015.

The last of the seven commercial relationships that contributed to the net decrease in impaired loans since 2015 included two loans that were identified as impaired in 2016 as a result of a decline in the coal industry. In 2016, these two loans, along with a third related loan that was previously impaired, required orderly liquidation of the related collateral, resulting in $796 thousand in principal curtailment and a total of partial charge-offs in the amount of $759 thousand. The net effect of these seven significant impairment items on the total of impaired loans was $3.4 million.

The remaining $200 thousand of the net decrease in impaired loans since December 31, 2015 was the net effect of multiple other factors, including the identification of additional impaired loans, foreclosures, loan sales, payoffs, principal curtailments, partial charge-offs, and normal loan amortization.

The following table presents the average recorded investment in impaired loans and related interest income recognized for the years ended:

	December 31, 2016						December 31, 2015						December 31, 2014
(Dollars in thousands)	Average Investment in Impaired Loans		Interest Income Recognized on Accrual Basis		Interest Income Recognized on Cash Basis		Average Investment in Impaired Loans		Interest Income Recognized on Accrual Basis		Interest Income Recognized on Cash Basis		Average Investment in Impaired Loans		Interest Income Recognized on Accrual Basis		Interest Income Recognized on Cash Basis
Commercial
Commercial Business	$	4,027	$	155	$	104	$	3,153	$	156	$	114	$	301	$	14	$	61
Commercial Real Estate	3,590		100		75		6,618		63		61		2,213		149		105
Acquisition & Development	3,983		9		112		2,408		9		10		4,456		112		94
Total Commercial	11,600		264		291		12,179		228		185		6,970		275		260
Residential	928		20		28		920		12		13		804		20		20
Home Equity	50		1		1		28		1		1		28		1		1
Consumer	245		—		—		1		—		—		20		1		1
Total	$	12,823	$	285	$	320	$	13,128	$	241	$	199	$	7,822	$	297	$	282

As of December 31, 2016, the Bank held two foreclosed residential real estate properties representing $214 thousand, or 52%, of the total balance of other real estate owned. There are six additional consumer mortgage loans collateralized by residential real estate properties in the process of foreclosure. The total recorded investment in these loans was $464 thousand as of December 31, 2016. These loans are included in the table above and have a total of $59 thousand in specific allowance allocated to them.

Bank management uses a nine point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. Any portion of a loan that has been or is expected to be charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as past due status, bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s Chief Credit Officer is responsible for the timely and accurate risk rating of the loans in the portfolio at origination and on an ongoing basis. The Credit Department ensures that a review of all commercial relationships of one million dollars or greater is performed annually.

Review of the appropriate risk grade is included in both the internal and external loan review process, and on an ongoing basis. The Bank has an experienced Credit Department that continually reviews and assesses loans within the portfolio. The Bank engages an external consultant to conduct independent loan reviews on at least an annual basis. Generally, the external consultant reviews larger commercial relationships or criticized relationships. The Bank’s Credit Department compiles detailed reviews, including plans for resolution, on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table represents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system as of December 31, 2016 and 2015:



(Dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Total
December 31, 2016
Commercial
Commercial Business	$	377,631	$	2,933	$	6,833	$	69	$	387,466
Commercial Real Estate	240,851		26,340		3,532		737		271,460
Acquisition & Development	90,875		1,905		2,584		3,226		98,590
Total Commercial	709,357		31,178		12,949		4,032		757,516
Residential	212,869		1,664		787		132		215,452
Home Equity	64,706		582		98		—		65,386
Consumer	14,134		302		13		62		14,511
Total Loans	$	1,001,066	$	33,726	$	13,847	$	4,226	$	1,052,865

December 31, 2015
Commercial
Commercial Business	$	288,549	$	7,949	$	3,411	$	574	$	300,483
Commercial Real Estate	299,560		9,761		8,436		—		317,757
Acquisition & Development	105,585		2,739		1,223		1,532		111,079
Total Commercial	693,694		20,449		13,070		2,106		729,319
Residential	214,184		1,764		1,168		250		217,366
Home Equity	67,645		416		63		—		68,124
Consumer	16,679		311		371		—		17,361
Total Loans	$	992,202	$	22,940	$	14,672	$	2,356	$	1,032,170

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.

A loan that has deteriorated and requires additional collection efforts by the Bank could warrant non-accrual status. A thorough review is presented to the Chief Credit Officer and or the Management Loan Committee ("MLC"), as required with respect to any loan which is in a collection process and to make a determination as to whether the loan should be placed on non-accrual status. The placement of loans on non-accrual status is subject to applicable regulatory restrictions and guidelines. Generally, loans should be placed in non-accrual status when the loan reaches 90 days past due, when it becomes likely the borrower cannot or will not make scheduled principal or interest payments, when full repayment of principal and interest is not expected, or when the loan displays potential loss characteristics. Normally, all accrued interest is charged off when a loan is placed in non-accrual status, unless Management believes it is likely the accrued interest will be collected. Any payments subsequently received are applied to principal. To remove a loan from non-accrual status, all principal and interest due must be paid up to date and the Bank is reasonably sure of future satisfactory payment performance. Usually, this requires a six-month recent history of payments due. Removal of a loan from non-accrual status will require the approval of the Chief Credit Officer and or MLC.

The following table presents the classes of the loan portfolio summarized by aging categories of performing loans and nonaccrual loans as of December 31, 2016 and 2015:



(Dollars in thousands)	Current		30-59 Days Past Due		60-89 Days Past Due		90+ Days Past Due		Total Past Due		Total Loans		Non-Accrual		90+ Days Still Accruing
December 31, 2016
Commercial
Commercial Business	$	387,208	$	15	$	169	$	74	$	258	$	387,466	$	74	$	—
Commercial Real Estate	270,339		229		—		892		1,121		271,460		1,375		—
Acquisition & Development	96,014		—		—		2,576		2,576		98,590		3,526		—
Total Commercial	753,561		244		169		3,542		3,955		757,516		4,975		—
Residential	212,502		2,067		419		464		2,950		215,452		1,072		—
Home Equity	64,791		525		—		70		595		65,386		104		—
Consumer	14,354		55		34		68		157		14,511		78		—
Total Loans	$	1,045,208	$	2,891	$	622	$	4,144	$	7,657	$	1,052,865	$	6,229	$	—

December 31, 2015
Commercial
Commercial Business	$	299,515	$	300	$	—	$	668	$	968	$	300,483	$	687	$	—
Commercial Real Estate	307,029		436		4,731		5,561		10,728		317,757		5,020		541
Acquisition & Development	107,607		678		—		2,794		3,472		111,079		2,488		307
Total Commercial	714,151		1,414		4,731		9,023		15,168		729,319		8,195		848
Residential	214,326		1,838		576		626		3,040		217,366		803		—
Home Equity	67,908		23		193		—		216		68,124		36		—
Consumer	16,921		48		21		371		440		17,361		371		—
Total Loans	$	1,013,306	$	3,323	$	5,521	$	10,020	$	18,864	$	1,032,170	$	9,405	$	848

An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

Interest income on loans would have increased by approximately $396 thousand, $639 thousand and $221 thousand for 2016, 2015 and 2014, respectively, if loans had performed in accordance with their terms.

The Bank’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Bank’s ALL.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by qualified factors.

The segments described above, which are based on the Federal call code assigned to each loan, provide the starting point for the ALL analysis. Company and bank management tracks the historical net charge-off activity at the call code level. A historical charge-off factor is calculated utilizing a defined number of consecutive historical quarters. All pools currently utilize a rolling 12 quarters.

“Pass” rated credits are segregated from “Criticized” credits for the application of qualitative factors. Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors.

Company and Bank management have identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volume and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint. The combination of historical charge-off and qualitative factors are then weighted for each risk grade. These weightings are determined internally based upon the likelihood of loss as a loan risk grading deteriorates.

To estimate the liability for off-balance sheet credit exposures, Bank management analyzed the portfolios of letters of credit, non-revolving lines of credit, and revolving lines of credit, and based its calculation on the expectation of future advances of each loan category. Letters of credit were determined to be highly unlikely to advance since they are generally in place only to ensure various forms of performance of the borrowers. In the Bank’s history, there have been no letters of credit drawn upon. In addition, many of the letters of credit are cash secured and do not warrant an allocation. Non-revolving lines of credit were determined to be highly likely to advance as these are typically construction lines. Meanwhile, the likelihood of revolving lines of credit advancing varies with each individual borrower. Therefore, the future usage of each line was estimated based on the average line utilization of the revolving line of credit portfolio as a whole.

Once the estimated future advances were calculated, an allocation rate, which was derived from the Bank’s historical losses and qualitative environmental factors, was applied in the similar manner as those used for the allowance for loan loss calculation. The resulting estimated loss allocations were totaled to determine the liability for unfunded commitments related to these loans, which Management considers necessary to anticipate potential losses on those commitments that have a reasonable probability of funding. The liability for unfunded commitments was $284 thousand and $224 thousand respectively as of December 31, 2016 and 2015.

Bank management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

The following tables summarize the primary segments of the ALL, segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of December 31, 2016, 2015, and 2014. Activity in the allowance is presented for the periods indicated:



(Dollars in thousands)	Commercial			Residential			Home Equity			Consumer			Total
ALL balance at December 31, 2015	$	6,066		$	1,095		$	715		$	130		$	8,006
Charge-offs	(1,995		)	(124		)	(100		)	(338		)	(2,557		)
Recoveries	9			2			9			1			21
Provision	3,101			17			104			409			3,631
ALL balance at December 31, 2016	$	7,181		$	990		$	728		$	202		$	9,101
Individually evaluated for impairment	$	376		$	122		$	36		$	9		$	543
Collectively evaluated for impairment	$	6,805		$	868		$	692		$	193		$	8,558



(Dollars in thousands)	Commercial			Residential			Home Equity			Consumer			Total
ALL balance at December 31, 2014	$	4,363		$	962		$	691		$	207		$	6,223
Charge-offs	(708		)	(28		)	(5		)	(6		)	(747		)
Recoveries	20			2			4			11			37
Provision	2,391			159			25			(82		)	2,493
ALL balance at December 31, 2015	$	6,066		$	1,095		$	715		$	130		$	8,006
Individually evaluated for impairment	$	708		$	276		$	28		$	1		$	1,013
Collectively evaluated for impairment	$	5,358		$	819		$	687		$	129		$	6,993



(Dollars in thousands)	Commercial			Residential			Home Equity		Consumer			Total
ALL balance at December 31, 2013	$	3,609		$	519		$	554	$	253		$	4,935
Charge-offs	(1,110		)	(130		)	—		(68		)	(1,308		)
Recoveries	7			—			3		4			14
Provision	1,857			573			134		18			2,582
ALL balance at December 31, 2014	$	4,363		$	962		$	691	$	207		$	6,223
Individually evaluated for impairment	$	362		$	298		$	28	$	2		$	690
Collectively evaluated for impairment	$	4,001		$	664		$	663	$	205		$	5,533

During December 2013, the Bank purchased $74.3 million in performing commercial real estate secured loans in the northern Virginia area. At the time of acquisition, none of these loans were considered impaired. They were acquired at a premium of roughly 1.024 or $1.8 million, which is being amortized in accordance with ASC 310-20. These loans are collectively evaluated for impairment under ASC 450. The loans continue to be individually monitored for payoff activity, and any necessary adjustments to the premium are made accordingly.

At December 31, 2016 and 2015, these balances totaled $20.5 million and $46.8 million, respectively. Of the $53.8 million decrease since originally purchased, MVB refinanced $19.6 million and sold participations totaling $10.5 million and sold $9.7 million back to the institution from which the loans were originally purchased in December 2013. The remainder of the decrease was the result of $6.2 million in loan amortization and $7.8 million in principal paydowns and/or loan payoffs. The weighted average yield on the remaining portfolio is 5.57%.

The allowance for loan losses is based on estimates, and actual losses will vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

Troubled Debt Restructurings

The restructuring of a loan is considered a troubled debt restructuring (“TDR”) if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. At December 31, 2016 and 2015, the Bank had specific reserve allocations for TDR’s of $348 thousand and $672 thousand, respectively.

Loans considered to be troubled debt restructured loans totaled $8.8 million and $9.3 million as of December 31, 2016 and December 31, 2015, respectively. Of these totals, $5.9 million and $6.1 million, respectively, represent accruing troubled debt restructured loans and represent 49% and 40%, respectively of total impaired loans. Meanwhile, $2.3 million and $2.5 million, respectively, represent three loans to two borrowers that have defaulted under the restructured terms. All three loans are commercial acquisition and development loans that were considered TDR's due to extended interest only periods and/or unsatisfactory repayment structures once transitioned to principal and interest payments. These borrowers have experienced continued financial difficulty and are considered non-performing loans as of December 31, 2016 and December 31, 2015. Two additional restructured loans, a $214 thousand commercial real estate loan and a $348 thousand mortgage loan, are considered non-performing as of December 31, 2016. Both of these were also considered TDR's due to interest only periods and/or unsatisfactory repayment structures.

The following table presents details related to loans identified as Troubled Debt Restructurings during the years ended December 31, 2016 and 2015.



	New TDR's ¹
	December 31, 2016					December 31, 2015
(Dollars in thousands)	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial
Commercial Business	—	$	—	$	—	—	$	—	$	—
Commercial Real Estate	—	—		—		1	1,076		1,076
Acquisition & Development	—	—		—		—	—		—
Total Commercial	—	—		—		1	1,076		1,076
Residential	—	—		—		1	90		90
Home Equity	—	—		—		—	—		—
Consumer	—	—		—		—	—		—
Total	—	$	—	$	—	2	$	1,166	$	1,166

¹ The pre-modification and post-modification balances represent the balances outstanding immediately before and after modification of the loan.