Note 4 – Loans and Allowance for Loan Losses

All loan origination fees and direct loan origination costs are deferred and recognized over the life of the loan. As of March 31, 2016 and 2015, net deferred fees and costs of $1.0 million and $1.4 million, respectively, were included in the carrying value of loans.

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.

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 as presented in 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 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. The liability for unfunded commitments was $224 thousand and $108 thousand respectively as of March 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 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.

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 March 31, 2016:


					Home
(in thousands)	Commercial		Residential		Equity		Consumer		Total
ALL balance December 31, 2015	$	6,066	$	1,095	$	715	$	130	$	8,006
Charge-offs		(102)		(67)		—		(22)		(191)
Recoveries		—		—		—		7		7
Provision		257		129		32		207		625
ALL balance March 31, 2016	$	6,221	$	1,157	$	747	$	322	$	8,447
Individually evaluated for impairment	$	946	$	212	$	—	$	211	$	1,369
Collectively evaluated for impairment	$	5,275	$	945	$	747	$	111	$	7,078

The following table summarizes the primary segments of the Company loan portfolio as of March 31, 2016:



(in thousands)	Commercial		Residential		Home Equity		Consumer		Total
Individually evaluated for impairment	$	10,974	$	1,049	$	28	$	375	$	12,426
Collectively evaluated for impairment		742,824		235,594		68,290		16,472		1,063,180
Total Loans	$	753,798	$	236,643	$	68,318	$	16,847	$	1,075,606


					Home
	Commercial		Residential		Equity		Consumer		Total
ALL balance December 31, 2014	$	4,363	$	962	$	691	$	207	$	6,223
Charge-offs		(409)		(14)		—		—		(423)
Recoveries		21		—		1		—		22
Provision		672		9		(12)		(10)		659
ALL balance March 31, 2015	$	4,647	$	957	$	680	$	197	$	6,481
Individually evaluated for impairment	$	554	$	284	$	28	$	2	$	868
Collectively evaluated for impairment	$	4,093	$	673	$	652	$	195	$	5,613

The following table summarizes the primary segments of the Company loan portfolio as of March 31, 2015:


(in thousands)	Commercial		Residential		Equity		Consumer		Total
Individually evaluated for impairment	$	13,185	$	949	$	28	$	2	$	14,164
Collectively evaluated for impairment		578,573		173,667		48,202		16,679		817,121
Total Loans	$	591,758	$	174,616	$	48,230	$	16,681	$	831,285

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.

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. As of March 31, 2016 and December 31, 2015, these balances totaled $33.1 million and $46.8 million, respectively. Of the $41.2 million decrease, MVB refinanced $17.2 million, sold a participation totaling $2.9 million and sold $9.7 million back to the institution from which the loans were originally purchased in December 2013. The weighted average yield on the remaining portfolio is 5.02%.

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 March 31, 2016 and December 31, 2015 (in thousands):


					Impaired
					Loans with
	Impaired Loans with				No Specific
	Specific Allowance				Allowance		Total Impaired Loans
									Unpaid
	Recorded		Related		Recorded		Recorded		Principal
March 31, 2016	Investment		Allowance		Investment		Investment		Balance
Commercial
Commercial Business	$	679	$	107	$	3,266	$	3,945	$	3,945
Commercial Real Estate		4,377		754		—		4,377		4,377
Acquisition & Development		267		85		2,385		2,652		4,129
Total Commercial		5,323		946		5,651		10,974		12,451
Residential		865		212		184		1,049		1,116
Home Equity		—		—		28		28		28
Consumer		273		211		102		375		378
Total impaired loans	$	6,461	$	1,369	$	5,965	$	12,426	$	13,973

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 $2.9 million, or 19% during the first quarter of 2016, primarily the result of the net impact of two loans. 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 the first quarter of 2016, this $5.0 million loan was repurchased by the selling financial institution thereby decreasing total impaired loans by $5.0 million. In contrast, a $1.8 million commercial real estate loan (net of a $651 thousand participation) was identified as impaired in the first quarter of 2016 as a result of an extended stabilization and interest only period, as well as a lack of project specific cash flows. The net effect of these two significant impairment items was $3.2 million. The remaining $400 thousand of the decrease in impaired loans since December 31, 2015 was the net effect of multiple other factors, including $167 thousand in partial charge-offs and normal loan amortization.

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


	Three months ended
	March 31, 2016
			Interest		Interest
	Average		Income		Income
	Investment		Recognized		Recognized on
	in Impaired		on Accrual		Cash
	Loans		Basis		Basis
Commercial
Commercial Business	$	3,838	$	39	$	26
Commercial Real Estate		6,541		28		25
Acquisition & Development		2,722		2		3
Total Commercial		13,101		69		54
Residential		1,059		5		3
Home Equity		28		—		—
Consumer		198		—		—
Total	$	14,386	$	74	$	57


	Three months ended
	March 31, 2015
	Average		Interest		Interest
	Investment		Income		Income
	in Impaired		Recognized on		Recognized on
	Loans		Accrual Basis		Cash Basis
Commercial
Commercial Business	$	3,511	$	39	$	36
Commercial Real Estate		6,542		13		4
Acquisition & Development		3,527		85		1
Total Commercial		13,580		137		41
Residential		950		5		2
Home Equity		28		—		—
Consumer		2		—		—
Total	$	14,560	$	142	$	43

As of March 31, 2016, the Bank held three foreclosed residential real estate properties representing $144 thousand, or 64%, 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 $790 thousand as of March 31, 2016. These loans are included in the table above and have a total of $132 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 March 31, 2016 and December 31, 2015 (in thousands):


			Special
March 31, 2016	Pass		Mention		Substandard		Doubtful		Total
Commercial
Commercial Business	$	330,961	$	6,096	$	5,849	$	576	$	343,482
Commercial Real Estate		296,720		1,231		7,160		—		305,111
Acquisition & Development		99,266		2,980		1,529		1,430		105,205
Total Commercial		726,947		10,307		14,538		2,006		753,798
Residential		233,520		1,810		1,111		202		236,643
Home Equity		67,696		536		86		—		68,318
Consumer		16,174		298		375		—		16,847
Total Loans	$	1,044,337	$	12,951	$	16,110	$	2,208	$	1,075,606


			Special
December 31, 2015	Pass		Mention		Substandard		Doubtful		Total
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 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 March 31, 2016 and December 31, 2015 (in thousands):


			30-59 Days		60-89 Days		90 Days +		Total				Non-		90+ Days
March 31, 2016	Current		Past Due		Past Due		Past Due		Past Due		Total Loans		Accrual		Still Accruing
Commercial
Commercial Business	$	341,548	$	65	$	1,020	$	849	$	1,934	$	343,482	$	849	$	—
Commercial Real Estate		303,829		416		139		727		1,282		305,111		2,214		384
Acquisition & Development		102,397		273		150		2,385		2,808		105,205		2,692		—
Total Commercial		747,774		754		1,309		3,961		6,024		753,798		5,755		384
Residential		232,833		2,169		232		1,409		3,810		236,643		1,313		401
Home Equity		68,174		144		—		—		144		68,318		59		—
Consumer		16,387		84		1		375		460		16,847		375		—
Total	$	1,065,168	$	3,151	$	1,542	$	5,745	$	10,438	$	1,075,606	$	7,502	$	785


			30-59 Days		60-89 Days		90 Days +		Total				Non-		90+ Days
December 31, 2015	Current		Past Due		Past Due		Past Due		Past Due		Total Loans		Accrual		Still Accruing
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

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 March 31, 2016 and December 31, 2015, the Bank had specific reserve allocations for TDR’s of $518 thousand and $672, thousand respectively.

Loans considered to be troubled debt restructured loans totaled $9.2 million and $9.3 million as of March 31, 2016 and December 31, 2015, respectively. $2.4 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 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 March 31, 2016 and December 31, 2015. Two additional restructured loans, a $241 thousand commercial real estate loan and a $377 thousand mortgage loan, are considered non-performing as of March 31, 2016. Both of these loans were also considered restructured due to extended interest only periods and /or unsatisfactory repayment structures.

There were no new TDR’s for the three months ended March 31, 2016 and 2015.