NOTE 3. LOANS AND ALLOWANCE FOR LOAN LOSSES

The Company routinely generates 1-4 family mortgages for sale into the secondary market. During 2015, 2014 and 2013, the Company recognized sales proceeds of $1.3 billion, $881.3 million and $1.0 billion, resulting in mortgage fee income of $29.5 million, $17.6 million and $20.8 million, respectively.

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


(in thousands)	2015		2014

Commercial and non-residential real estate	$	729,319	$	560,752
Residential real estate		217,366		174,507
Home equity		68,124		45,935
Consumer		17,361		17,103
Total Loans		1,032,170		798,297

All loan origination fees and direct loan origination costs are deferred and recognized over the life of the loan. As of December 31, 2015 and 2014, net deferred (fees) and costs of $1.1 million and $1.4 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, 2015 and 2014 (in thousands):


					Home
	Commercial		Residential		Equity		Consumer		Total
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
December 31, 2014
Individually evaluated for impairment	$	13,782	$	969	$	28	$	2	$	14,781
Collectively evaluated for impairment		546,970		173,538		45,907		17,101		783,516
Total Loans	$	560,752	$	174,507	$	45,935	$	17,103	$	798,297

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 and residential mortgage 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 determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three 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, 2015 and 2014 (in thousands):


					Impaired
					Loans with
					No
	Impaired Loans with				Specific
	Specific Allowance				Allowance		Total Impaired Loans
									Unpaid
	Recorded		Related		Recorded		Recorded		Principal
	Investment		Allowance		Investment		Investment		Balance
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

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 increased slightly during 2015, primarily as the result of four loans. 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 thousand for a year-end recorded investment of $2.8 million. However, this loan was purchased, along with a related, unimpaired loan with a recorded investment of $500 thousand, by a newly formed entity that was spun-off from the original borrower for the purpose of repositioning company assets. The $500 thousand loan was reduced from $1.5 million as the result of a $1 million principal curtailment just prior to the purchase of these two loans. As of December 31, 2015, the Bank held a single impaired loan to the new entity for the combined recorded investment of $3.3 million. In addition, 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 $268 thousand and a $600 thousand charge-off. These two loans represent a December 31, 2015 recorded investment of $2.2 million. The last of the four loans that had the greatest impact on total recorded investment of impaired loans was a commercial real estate loan with a recorded investment of $1.1 million that was considered impaired in the fourth quarter of 2015. In addition, $8.3 million, or 54%, of the $15.4 million total recorded investment in impaired loans as of December 31, 2015 was concentrated in two unrelated impaired loans. One of these two loans is the $3.3 million loan discussed previously that is dependent on the coal industry. The other of these two loans has a balance of $5.0 million and is a loan to finance commercial real estate property in the Northern Virginia market, which has 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 table presents the average recorded investment in impaired loans and related interest income recognized for the years ended (in thousands):



	December 31, 2015						December 31, 2014						December 31, 2013
	Average		Interest		Interest		Average		Interest		Interest		Average		Interest		Interest
	Investment		Income		Income		Investment		Income		Income		Investment		Income		Income
	in Impaired		Recognized on		Recognized on		in Impaired		Recognized on		Recognized on		in Impaired		Recognized on		Recognized on
	Loans		Accrual Basis		Cash Basis		Loans		Accrual Basis		Cash Basis		Loans		Accrual Basis		Cash Basis
Commercial
Commercial Business	$	3,153	$	156	$	114	$	301	$	14	$	61	$	—	$	—	$	—
Commercial Real Estate		6,618		63		61		2,213		149		105		1,878		38		58
Acquisition & Development		2,408		9		10		4,456		112		94		2,360		74		91
Total Commercial		12,179		228		185		6,970		275		260		4,238		112		149
Residential		920		12		13		804		20		20		356		7		6
Home Equity		28		1		1		28		1		1		2		1		—
Consumer		1		—		—		20		1		1		19		1		2
Total	$	13,128	$	241	$	199	$	7,822	$	297	$	282	$	4,615	$	121	$	157

As of December 31, 2015, the Bank held three foreclosed residential real estate properties representing $157 thousand, or 66%, of the total balance of other real estate owned. 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 thousand as of December 31, 2015. These loans are included in the table above and have a total of $123 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, 2015 and 2014 (in thousands):


			Special
	Pass		Mention		Substandard		Doubtful		Total
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

December 31, 2014

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 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 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 aging categories of performing loans and nonaccrual loans as of December 31, 2015 and 2014 (in thousands):


							90
			30-59		60-89		Days +		Total						90+ Days
			Days		Days		Past		Past		Total		Non-		Still
	Current		Past Due		Past Due		Due		Due		Loans		Accrual		Accruing
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	$	1,013,306	$	3,323	$	5,521	$	10,020	$	18,864	$	1,032,170	$	9,405	$	848

December 31, 2014
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

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 $639 thousand, $221 thousand and $47 thousand for 2015, 2014 and 2013, 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 off-balance sheet liability related to these loans. The off-balance sheet liability was $224 thousand and $56 thousand respectively as of December 31, 2015 and 2014.

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 table summarizes 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, 2015 and 2014. Activity in the allowance is presented for the periods indicated (in thousands):


					Home
	Commercial		Residential		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


					Home
	Commercial		Residential		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


					Home
	Commercial		Residential		Equity		Consumer		Total
ALL balance at December 31, 2012	$	3,107	$	514	$	242	$	213	$	4,076
Charge-offs		(1,458)		(38)		—		(33)		(1,529)
Recoveries		57		60		10		1		128
Provision		1,903		(17)		302		72		2,260
ALL balance at December 31, 2013	$	3,609	$	519	$	554	$	253	$	4,935
Individually evaluated for impairment	$	1,243	$	175	$	28	$	12	$	1,458
Collectively evaluated for impairment	$	2,366	$	344	$	526	$	241	$	3,477

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 previously in the discussion of impaired loans.

At December 31, 2015 and 2014, these balances totaled $46.8 million and $51.3 million, respectively. Of the $27.5 million decrease, MVB refinanced $15.1 million and sold a participation totaling $2.9 million. The weighted average yield on the remaining portfolio is 5.02%.

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, 2015 and 2014, the Bank had specific reserve allocations for TDR’s of $672 thousand and $582 thousand, respectively.

Loans considered to be troubled debt restructured loans totaled $9.3 million and $9.4 million as of December 31, 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 December 31, 2015 and December 31, 2014.

The following table presents details related to loans identified as Troubled Debt Restructurings during the years ended December 31, 2015 and 2014.


	New TDR's (1)
	December 31, 2015					December 31, 2014
		Pre-		Post-			Pre-		Post-
		Modification		Modification			Modification		Modification
	Number	Outstanding		Outstanding		Number	Outstanding		Outstanding
	of	Recorded		Recorded		of	Recorded		Recorded
(Dollars in thousands)	Contracts	Investment		Investment		Contracts	Investment		Investment

Commercial
Commercial Business	—	$	—	$	—	1	$	3,606	$	3,606
Commercial Real Estate	1		1,076		1,076	1		496		300
Acquisition and Development	—		—		—	—		—		—
Total Commercial	1		1,076		1,076	2		4,102		3,906
Residential Real Estate	1		90		90	1		389		382
Home Equity	—		—		—	—		—		—
Consumer	—		—		—	—		—		—
Total	2	$	1,166	$	1,166	3	$	4,491	$	4,288

(1)

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