Note 4 – Loans and Allowance for Loan Losses

The following table summarizes the primary segments of the allowance for loan losses (“ALL”), segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of September 30, 2015:


					Home
(in thousands)	Commercial		Residential		Equity		Consumer		Total
ALL balance June 30, 2015	$	5,201	$	1,018	$	632	$	196	$	7,047
Charge-offs		(299)		—		—		(5)		(304)
Recoveries		—		—		—		9		9
Provision		515		101		78		(58)		636
ALL balance September 30, 2015	$	5,417	$	1,119	$	710	$	142	$	7,388


					Home
	Commercial		Residential		Equity		Consumer		Total
ALL balance December 31, 2014	$	4,363	$	962	$	691	$	207	$	6,223
Charge-offs		(708)		(14)		—		(5)		(727)
Recoveries		21		1		1		13		36
Provision		1,741		170		18		(73)		1,856
ALL balance September 30, 2015	$	5,417	$	1,119	$	710	$	142	$	7,388
Individually evaluated for impairment	$	595	$	301	$	28	$	6	$	930
Collectively evaluated for impairment	$	4,822	$	818	$	682	$	136	$	6,458

The following table summarizes the primary segments of the Company loan portfolio as of September 30, 2015:



(in thousands)	Commercial		Residential		Home Equity		Consumer		Total
Individually evaluated for impairment	$	12,036	$	849	$	28	$	6	$	12,919
Collectively evaluated for impairment		687,623		210,997		65,617		17,677		981,914
Total Loans	$	699,659	$	211,846	$	65,645	$	17,683	$	994,833


					Home
(in thousands)	Commercial		Residential		Equity		Consumer		Total
ALL balance June 30, 2014	$	4,485	$	685	$	825	$	246	$	6,241
Charge-offs		(634)		(30)		—		(1)		(665)
Recoveries		3		—		2		—		5
Provision		633		224		(38)		(36)		783
ALL balance September 30, 2014	$	4,487	$	879	$	789	$	209	$	6,364


					Home
	Commercial		Residential		Equity		Consumer		Total
ALL balance December 31, 2013	$	3,609	$	519	$	554	$	253	$	4,935
Charge-offs		(632)		(133)		—		(11)		(776)
Recoveries		7		—		3		3		13
Provision		1,503		493		232		(36)		2,192
ALL balance September 30, 2014	$	4,487	$	879	$	789	$	209	$	6,364
Individually evaluated for impairment	$	893	$	278	$	29	$	10	$	1,210
Collectively evaluated for impairment	$	3,594	$	601	$	760	$	199	$	5,154

The following table summarizes the primary segments of the Company loan portfolio as of September 30, 2014:


(in thousands)	Commercial		Residential		Equity		Consumer		Total
Individually evaluated for impairment	$	5,764	$	837	$	29	$	16	$	6,646
Collectively evaluated for impairment		543,327		151,331		43,576		18,046		756,280
Total Loans	$	549,091	$	152,168	$	43,605	$	18,062	$	762,926

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.

All loan origination fees and direct loan origination costs are deferred and recognized over the life of the loan. As of September 30, 2015 and 2014, net deferred fees and costs of $1,228 and $1,402, respectively, were included in the carrying value of loans.

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, with the exception of one, 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. The loan that has been individually evaluated for impairment is discussed in further detail below in the discussion of impaired loans.

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 September 30, 2015 and December 31, 2014 (in thousands):


					Impaired
					Loans with
	Impaired Loans with				No Specific
	Specific Allowance				Allowance		Total Impaired Loans
									Unpaid
	Recorded		Related		Recorded		Recorded		Principal
September 30, 2015	Investment		Allowance		Investment		Investment		Balance
Commercial
Commercial Business	$	—	$	—	$	2,758	$	2,758	$	2,758
Commercial Real Estate		6,522		498		—		6,522		6,522
Acquisition & Development		269		97		2,487		2,756		4,431
Total Commercial		6,791		595		5,245		12,036		13,711
Residential		827		301		22		849		849
Home Equity		28		28		—		28		28
Consumer		6		6		—		6		6
Total impaired loans	$	7,652	$	930	$	5,267	$	12,919	$	14,594

December 31, 2014
Commercial
Commercial Business	$	—	$	—	$	3,606	$	3,606	$	3,606
Commercial Real Estate		1,527		260		5,021		6,548		6,548
Acquisition & Development		273		102		3,355		3,628		4,703
Total Commercial		1,800		362		11,982		13,782		14,857
Residential		969		298		—		969		969
Home Equity		28		28		—		28		28
Consumer		2		2		—		2		2
Total impaired loans	$	2,799	$	690	$	11,982	$	14,781	$	15,856

Impaired loans have decreased during 2015, primarily as the result of three loans, of which the recorded investment of each has decreased for various reasons. A loan that is dependent upon the condition of the coal industry, which had a balance of $3.6 million as of December 31, 2014, was reduced by principal payments totaling $848 and now represents a recorded investment of $2.8 million. Meanwhile, two unrelated acquisition and development loans with a total December 31, 2014 balance of $3.1 million were reduced as the result of a principal curtailment of a $268 and a $600 charge-off. These two loans now represent a total recorded investment of $2.2 million. Meanwhile, it is important to note that $7.8 million, or 60%, of the $12.9 million total recorded investment in impaired loans as of September 30, 2015 was concentrated in just two impaired loans. Furthermore, one of the two loans had a balance of $5.0 million and is a loan to finance a 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. This loan was purchased from another financial institution in late 2013 but it is the Bank’s position that the “Loan Sales Agreement” has been breached by the selling institution and legal recourse is being pursued by the Bank.

The following tables present the average recorded investment in impaired loans and related interest income recognized for the periods indicated (in thousands):


	Nine months ended						Three months ended
	September 30, 2015						September 30, 2015
			Interest		Interest				Interest		Interest
	Average		Income		Income		Average		Income		Income
	Investment		Recognized		Recognized on		Investment		Recognized		Recognized
	in Impaired		on Accrual		Cash		in Impaired		on Accrual		on Cash
	Loans		Basis		Basis		Loans		Basis		Basis
Commercial
Commercial Business	$	3,228	$	117	$	114		2,945		39		39
Commercial Real Estate		6,533		44		37		6,525		15		12
Acquisition & Development		3,210		7		7		2,957		2		2
Total Commercial		12,971		168		158		12,427		56		53
Residential		935		15		11		909		5		7
Home Equity		28		1		1		28		—		—
Consumer		1		—		—		1		—		—
Total	$	13,935	$	184	$	170	$	13,365	$	61	$	60


	Nine months ended						Three months ended
	September 30, 2014						September 30, 2014
	Average		Interest		Interest		Average		Interest		Interest
	Investment		Income		Income		Investment		Income		Income
	in Impaired		Recognized on		Recognized on		in Impaired		Recognized on		Recognized on
	Loans		Accrual Basis		Cash Basis		Loans		Accrual Basis		Cash Basis
Commercial
Commercial Business	$	—	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate		1,854		94		50		1,740		31		8
Acquisition & Development		4,635		119		92		4,583		2		4
Total Commercial		6,489		213		142		6,323		33		12
Residential		779		15		14		868		5		5
Home Equity		28		1		—		28		—		—
Consumer		25		1		1		16		—		—
Total	$	7,321	$	230	$	157	$	7,235	$	38	$	17

As of September 30, 2015, the Bank held three foreclosed residential real estate properties representing $174, or 64%, of the total balance of other real estate owned. Meanwhile, there are two additional consumer mortgage loans collateralized by residential real estate properties in the process of foreclosure. The total recorded investment in these loans was $249 as of September 30, 2015.

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 Bank 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. All loans greater than 90 days past due are considered Substandard. The portion of any loan that represents a specific allocation of the allowance for loan losses is placed in the Doubtful category. Any portion of a loan that has been 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 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 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 September 30, 2015 and December 31, 2014 (in thousands):


			Special
September 30, 2015	Pass		Mention		Substandard		Doubtful		Total
Commercial
Commercial Business	$	318,871	$	5,334	$	2,902	$	—	$	327,107
Commercial Real Estate		270,414		10,933		7,341		—		288,688
Acquisition & Development		78,168		2,940		1,224		1,532		83,864
Total Commercial		667,453		19,207		11,467		1,532		699,659
Residential		208,667		2,075		1,047		57		211,846
Home Equity		65,320		262		63		—		65,645
Consumer		17,258		424		1		—		17,683
Total Loans	$	958,698	$	21,968	$	12,578	$	1,589	$	994,833


			Special
December 31, 2014	Pass		Mention		Substandard		Doubtful		Total
Commercial
Commercial Business	$	234,547	$	618	$	3,713	$	—	$	238,878
Commercial Real Estate		262,215		11,242		7,323		—		280,780
Acquisition & Development		34,391		3,075		1,496		2,132		41,094
Total Commercial		531,153		14,935		12,532		2,132		560,752
Residential		171,395		2,147		965		—		174,507
Home Equity		45,684		223		28		—		45,935
Consumer		16,477		624		2		—		17,103
Total Loans	$	764,709	$	17,929	$	13,527	$	2,132	$	798,297

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 is in a collection process could warrant non-accrual status. A thorough review is to be 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 will be subject to applicable regulatory restrictions and guidelines. Generally, loans should be placed in non-accrual status when the loan approaches 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 should be charged off when a loan is placed in non-accrual status. Any payments subsequently received should be 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 the aging categories of performing loans and nonaccrual loans as of September 30, 2015 and December 31, 2014 (in thousands):


			30-59 Days		60-89 Days		90 Days +		Total				Non-		90+ Days
September 30, 2015	Current		Past Due		Past Due		Past Due		Past Due		Total Loans		Accrual		Still Accruing
Commercial
Commercial Business	$	323,621	$	2,758	$	615	$	113	$	3,486	$	327,107	$	85	$	27
Commercial Real Estate		278,150		47		4,794		5,697		10,538		288,688		5,020		677
Acquisition & Development		81,070		—		—		2,794		2,794		83,864		2,488		307
Total Commercial		682,841		2,805		5,409		8,604		16,818		699,659		7,593		1,011
Residential		211,013		23		195		615		833		211,846		397		254
Home Equity		65,350		290		5		—		295		65,645		35		—
Consumer		17,519		57		—		107		164		17,683		—		107
Total	$	976,723	$	3,175	$	5,609	$	9,326	$	18,110	$	994,833	$	8,025	$	1,372


			30-59 Days		60-89 Days		90 Days +		Total				Non-		90+ Days
December 31, 2014	Current		Past Due		Past Due		Past Due		Past Due		Total Loans		Accrual		Still Accruing
Commercial
Commercial Business	$	233,464	$	3,738	$	1,500	$	176	$	5,414	$	238,878	$	107	$	69
Commercial Real Estate		270,600		234		4,925		5,021		10,180		280,780		—		5,021
Acquisition & Development		37,739		—		—		3,355		3,355		41,094		3,355		—
Total Commercial		541,803		3,972		6,425		8,552		18,949		560,752		3,462		5,090
Residential		167,392		4,478		2,126		511		7,115		174,507		487		216
Home Equity		45,815		120		—		—		120		45,935		—		—
Consumer		16,692		411		—		—		411		17,103		—		—
Total	$	771,702	$	8,981	$	8,551	$	9,063	$	26,595	$	798,297	$	3,949	$	5,306

The ALL is maintained to absorb losses from the loan portfolio. The ALL is based on the Bank 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.

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 other qualified factors.

The segments as presented within this note, which are based on the Federal call code assigned to each loan, provide the starting point for the ALL analysis. Company and Bank management track 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’s risk grading deteriorates.

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.

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 off-balance sheet liability related to these loans.

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 September 30, 2015 and December 31, 2014, the Bank had specific reserve allocations for TDR’s of $597 and $582, respectively.

Loans considered to be troubled debt restructured loans totaled $7.6 million and $9.4 million as of September 30, 2015 and December 31, 2014, respectively. $2.5 million and $3.4 million, respectively, represent three loans to two borrowers that have defaulted under the restructured terms. All three loans are acquisition and development loans that were considered restructured 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 September 30, 2015 and December 31, 2014.

The following tables present details related to loans identified as TDR’s for the periods indicated (in thousands):


	New TDRs (1)
	For the Nine months ended					For the Three months ended
	September 30, 2014					September 30, 2014
		Pre-Modification		Post-Modification			Pre-Modification		Post-Modification
		Outstanding		Outstanding			Outstanding		Outstanding
	Number of	Recorded		Recorded		Number of	Recorded		Recorded
	Contracts	Investment		Investment		Contracts	Investment		Investment
Commercial
Acquisition and development	1	$	496	$	375	—	$	—	$	—
Total Commercial	1		496		375	—		—		—
Residential Real Estate	1		389		385	—		—		—
Total	2	$	885	$	760	—	$	—	$	—

(1)

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

There were no new TDR’s for the nine and three months ended September 30, 2015.