LOANS

The portfolio of loans outstanding consists of the following:



	June 30, 2015				December 31, 2014
	Amount		Percentage of Total Loans		Amount		Percentage of Total Loans
	(amounts in thousands)
Commercial and Industrial	$	36,813	5.0	%	$	30,092	4.2	%
Real Estate Construction:
Residential	6,238		0.9		5,859		0.8
Commercial	47,432		6.5		47,921		6.7
Real Estate Mortgage:
Commercial – Owner Occupied	157,335		21.6		176,649		24.8
Commercial – Non-owner Occupied	266,571		36.5		237,918		33.4
Residential – 1 to 4 Family	186,384		25.5		171,894		24.1
Residential – Multifamily	19,086		2.6		25,173		3.5
Consumer	10,121		1.4		17,555		2.5
Total Loans	$	729,980	100.0	%	$	713,061	100.0	%

Loan Origination/Risk Management: In the normal course of business the Company is exposed to a variety of operational, reputational, legal, regulatory, and credit risks that could adversely affect our financial performance. Most of our asset risk is primarily tied to credit (lending) risk. The Company has lending policies, guidelines and procedures in place that are designed to maximize loan income within an acceptable level of risk. The Board of Directors reviews and approves these policies, guidelines and procedures. When we originate a loan we make certain subjective judgments about the borrower’s ability to meet the loan’s terms and conditions. We also make objective and subjective value assessments on the assets we finance. The borrower’s ability to repay can be adversely affected by economic changes. Likewise, changes in market conditions and other external factors can affect asset valuations. The Company actively monitors the quality of its loan portfolio. A reporting system supplements the credit review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit risk, loan delinquencies, troubled debt restructures, nonperforming and potential problem loans. Diversification in the loan portfolio is another means of managing risk associated with fluctuations in economic conditions.

Construction Loans: With respect to construction loans to developers and builders that are secured by non-owner occupied properties, loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analyses of the developers and property owners. Construction loans are also generally underwritten based upon estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial Real Estate: Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. Commercial real estate loans may be riskier than loans for one-to-four family residences and are typically larger in dollar size. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. The repayment of these loans is generally largely dependent on the successful operation and management of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location within our market area. This diversity helps reduce the Company's exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. The Company also monitors economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Residential Mortgage: The Company originates adjustable and fixed-rate residential mortgage loans. Such mortgage loans are generally originated under terms, conditions and documentation acceptable to the secondary mortgage market. Although the Company has placed all of these loans into its portfolio, a substantial majority of such loans can be sold in the secondary market or pledged for potential borrowings.

Consumer Loans: Consumer loans may carry a higher degree of repayment risk than residential mortgage loans. Repayment is typically dependent upon the borrower’s financial stability which is more likely to be adversely affected by job loss, illness, or personal bankruptcy. To monitor and manage consumer loan risk, policies and procedures have been developed and modified as needed. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. Historically the Company’s losses on consumer loans have been negligible.

The Company maintains an outsourced independent loan review program that reviews and validates the credit risk assessment program on a periodic basis. Results of these external independent reviews are presented to management. The external independent loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit risk management personnel.

Non-accrual and Past Due Loans: Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management's opinion, the borrower may be unable to meet payment obligations as they become due, as well as when a loan is 90 days past due, unless the loan is well secured and in the process of collection, as required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

An age analysis of past due loans by class at June 30, 2015 and December 31, 2014 follows:



June 30, 2015	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days and Not Accruing		Total Past Due		Current		Total Loans
	(amounts in thousands)
Commercial and Industrial	$	—	$	—	$	2,462	$	2,462	$	34,351	$	36,813
Real Estate Construction:
Residential	—		—		—		—		6,238		6,238
Commercial	—		—		7,140		7,140		40,292		47,432
Real Estate Mortgage:
Commercial – Owner Occupied	833		—		106		939		156,396		157,335
Commercial – Non-owner Occupied	59		—		5,220		5,279		261,292		266,571
Residential – 1 to 4 Family	590		76		6,526		7,192		179,192		186,384
Residential – Multifamily	360		—		—		360		18,726		19,086
Consumer	107		—		65		172		9,949		10,121
Total Loans	$	1,949	$	76	$	21,519	$	23,544	$	706,436	$	729,980



December 31, 2014	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days and Not Accruing		Total Past Due		Current		Total Loans
	(amounts in thousands)
Commercial and Industrial	$	—	$	1,874	$	61	$	1,935	$	28,157	$	30,092
Real Estate Construction:
Residential	—		—		238		238		5,621		5,859
Commercial	—		—		10,773		10,773		37,148		47,921
Real Estate Mortgage:
Commercial – Owner Occupied	—		—		735		735		175,914		176,649
Commercial – Non-owner Occupied	—		—		8,624		8,624		229,294		237,918
Residential – 1 to 4 Family	629		20		6,367		7,016		164,878		171,894
Residential – Multifamily	364		—		—		364		24,809		25,173
Consumer	—		—		94		94		17,461		17,555
Total Loans	$	993	$	1,894	$	26,892	$	29,779	$	683,282	$	713,061

Impaired Loans: Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments.

All impaired loans have are assessed for recoverability based on an independent third-party full appraisal to determine the net realizable value (“NRV”) based on the fair value of the underlying collateral, less cost to sell and other costs, such as unpaid real estate taxes, that have been identified, or the present value of discounted cash flows in the case of certain impaired loans that are not collateral dependent. The appraisal will be based on an "as-is" valuation and will follow a reasonable valuation method that addresses the direct sales comparison, income, and cost approaches to market value, reconciles those approaches, and explains the elimination of each approach not used. Appraisals are generally updated every 12 months or sooner if we have identified possible further deterioration in value. Prior to receiving the updated appraisal, we will establish a specific reserve for any estimated deterioration, based upon our assessment of market conditions, adjusted for estimated costs to sell and other identified costs. If the NRV is greater than the loan amount, then no impairment loss exists. If the NRV is less than the loan amount, the shortfall is recognized by a specific reserve. If the borrower fails to pledge additional collateral in the ninety day period, a charge-off equal to the difference between the loan’s carrying value and NRV will occur. In certain circumstances, however, a direct charge-off may be taken at the time that the NRV calculation reveals a shortfall. All impaired loans are evaluated based on the criteria stated above on a quarterly basis and any change in the reserve requirements are recorded in the period identified. All partially charged-off loans remain on nonaccrual status until they are brought current as to both principal and interest and have at least nine months of payment history and future collectability of principal and interest is assured.

Impaired loans at June 30, 2015 and December 31, 2014 are set forth in the following tables.



June 30, 2015	Recorded Investment		Unpaid Principal Balance		Related Allowance
	(amounts in thousands)
With no related allowance recorded:
Commercial and Industrial	$	36	$	36	$	—
Real Estate Construction:
Residential	—		—		—
Commercial	2,964		3,056		—
Real Estate Mortgage:
Commercial – Owner Occupied	106		106		—
Commercial – Non-owner Occupied	2,052		2,052		—
Residential – 1 to 4 Family	5,759		6,624		—
Residential – Multifamily	—		—		—
Consumer	—		—		—
	10,917		11,874		—
With an allowance recorded:
Commercial and Industrial	2,883		2,884		1,621
Real Estate Construction:
Residential	—		—		—
Commercial	7,360		9,814		497
Real Estate Mortgage:
Commercial – Owner Occupied	4,736		4,765		85
Commercial – Non-owner Occupied	24,085		25,575		796
Residential – 1 to 4 Family	2,142		2,274		255
Residential – Multifamily	360		360		5
Consumer	65		65		7
	41,631		45,737		3,266
Total:
Commercial and Industrial	2,919		2,920		1,621
Real Estate Construction:
Residential	—		—		—
Commercial	10,324		12,870		497
Real Estate Mortgage:
Commercial – Owner Occupied	4,842		4,871		85
Commercial – Non-owner Occupied	26,137		27,627		796
Residential – 1 to 4 Family	7,901		8,898		255
Residential – Multifamily	360		360		5
Consumer	65		65		7
	$	52,548	$	57,611	$	3,266



December 31, 2014	Recorded Investment		Unpaid Principal Balance		Related Allowance
	(amounts in thousands)
With no related allowance recorded:
Commercial and Industrial	$	61	$	401	$	—
Real Estate Construction:
Residential	—		—		—
Commercial	4,033		4,161		—
Real Estate Mortgage:
Commercial – Owner Occupied	735		1,132		—
Commercial – Non-owner Occupied	8,175		10,616		—
Residential – 1 to 4 Family	2,548		3,291		—
Residential – Multifamily	—		—		—
Consumer	94		94		—
	15,646		19,695		—
With an allowance recorded:
Commercial and Industrial	2,346		2,346		1,040
Real Estate Construction:
Residential	238		979		238
Commercial	10,025		10,025		2,535
Real Estate Mortgage:
Commercial – Owner Occupied	5,216		5,245		114
Commercial – Non-owner Occupied	22,232		22,232		828
Residential – 1 to 4 Family	5,412		5,575		573
Residential – Multifamily	364		364		5
Consumer	—		—		—
	45,833		46,766		5,333
Total:
Commercial and Industrial	2,407		2,747		1,040
Real Estate Construction:
Residential	238		979		238
Commercial	14,058		14,186		2,535
Real Estate Mortgage:
Commercial – Owner Occupied	5,951		6,377		114
Commercial – Non-owner Occupied	30,407		32,848		828
Residential – 1 to 4 Family	7,960		8,866		573
Residential – Multifamily	364		364		5
Consumer	94		94		—
	$	61,479	$	66,461	$	5,333

The following tables present by loan portfolio class, the average recorded investment and interest income recognized on impaired loans for the six and three months ended June 30, 2015 and 2014:



	Six Months Ended June 30,
	2015				2014
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(amounts in thousands)
Commercial and Industrial	$	4,239	$	38	$	822	$	8
Real Estate Construction:
Residential	—		—		652		—
Commercial	13,073		123		18,348		231
Real Estate Mortgage:
Commercial – Owner Occupied	5,888		101		6,868		133
Commercial – Non-owner Occupied	27,867		496		32,658		624
Residential – 1 to 4 Family	8,969		103		12,776		115
Residential – Multifamily	362		14		368		12
Consumer	65		—		94		1
Total	$	60,463	$	875	$	72,586	$	1,124

	Three Months Ended June 30,
	2015				2014
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(amounts in thousands)
Commercial and Industrial	$	4,045	$	6	$	753	$	4
Real Estate Construction:
Residential	—		—		588		—
Commercial	13,008		51		18,329		115
Real Estate Mortgage:
Commercial – Owner Occupied	5,854		50		6,783		59
Commercial – Non-owner Occupied	27,732		267		32,111		304
Residential – 1 to 4 Family	8,943		49		12,580		56
Residential – Multifamily	361		8		367		6
Consumer	65		—		94		1
Total	$	60,008	$	431	$	71,605	$	545

Troubled debt restructurings: Periodically management evaluates our loans in order to determine the appropriate risk rating, interest accrual status and potential classification as a troubled debt restructuring (TDR), some of which are performing and accruing interest. A TDR is a loan on which we have granted a concession due to a borrower’s financial difficulty. These are concessions that would not otherwise be considered. The terms of these modified loans may include extension of maturity, renewals, changes in interest rate, additional collateral requirements or infusion of additional capital into the project by the borrower to reduce debt or to support future debt service. On construction and land development loans we may modify the loan as a result of delays or other project issues such as slower than anticipated sell-outs, insufficient leasing activity and/or a decline in the value of the underlying collateral securing the loan. Management believes that working with a borrower to restructure a loan provides us with a better likelihood of collecting our loan. It is our policy not to renegotiate the terms of a commercial loan simply because of a delinquency status. However, we will use our Troubled Debt Restructuring Program to work with delinquent borrowers when the delinquency is temporary. We consider all TDRs to be impaired.

At the time a loan is modified in a TDR, we consider the following factors to determine whether the loan should accrue interest:


•	Whether there is a period of current payment history under the current terms, typically 6 months;


•	Whether the loan is current at the time of restructuring; and


•	Whether we expect the loan to continue to perform under the restructured terms with a debt coverage ratio that complies with the Bank’s credit underwriting policy of 1.25 times debt service.

We also review the financial performance of the borrower over the past year to be reasonably assured of repayment and performance according to the modified terms. This review consists of an analysis of the borrower’s historical results; the borrower’s projected results over the next four quarters; current financial information of the borrower and any guarantors. The projected repayment source needs to be reliable, verifiable, quantifiable and sustainable. In addition, all TDRs are reviewed quarterly to determine the amount of any impairment. At the time of restructuring, the amount of the loan principal for which we are not reasonably assured of repayment is charged-off, but not forgiven.

A borrower with a restructured loan must make a minimum of six consecutive monthly payments at the restructured level and be current as to both interest and principal to be returned to accrual status.

Performing TDRs (not reported as non-accrual loans) totaled $31.0 million and $32.7 million with related allowances of $711,000 and $812,000 as of June 30, 2015 and December 31, 2014, respectively. Nonperforming TDRs totaled $7.4 million and $9.5 million with related allowances of $0 and $293,000 as of June 30, 2015 and December 31, 2014, respectively. All TDRs are classified as impaired loans and are included in the impaired loan disclosures above.

There were no new loans modified as a TDR during the three months and six months periods ended June 30, 2015 and 2014.

There were no loans that were modified and deemed TDRs that subsequently defaulted during the three and six months ended June 30, 2015. Some loans classified as TDRs may not ultimately result in the full collection of principal and interest, as modified, and result in potential incremental losses. These potential incremental losses have been factored into our overall allowance for loan losses estimate. The level of any re-defaults will likely be affected by future economic conditions. Once a loan becomes a TDR, it will continue to be reported as a TDR until it is repaid in full, foreclosed, sold or it meets the criteria to be removed from TDR status.

Credit Quality Indicators: As part of the on-going monitoring of the credit quality of the Company's loan portfolio, management tracks certain credit quality indicators including trends related to the risk grades of loans, the level of classified loans, net charge-offs, nonperforming loans (see details above) and the general economic conditions in the region.

The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 7. Grades 1 through 4 are considered “Pass”. A description of the general characteristics of the seven risk grades is as follows:


1.	Good: Borrower exhibits the strongest overall financial condition and represents the most creditworthy profile.


2.	Satisfactory (A): Borrower reflects a well-balanced financial condition, demonstrates a high level of creditworthiness and typically will have a strong banking relationship with the Bank.


3.	Satisfactory (B): Borrower exhibits a balanced financial condition and does not expose the Bank to more than a normal or average overall amount of risk. Loans are considered fully collectable.


4.	Watch List: Borrower reflects a fair financial condition, but there exists an overall greater than average risk. Risk is deemed acceptable by virtue of increased monitoring and control over borrowings. Probability of timely repayment is present.

Other Assets Especially Mentioned (OAEM): Financial condition is such that assets in this category have a potential weakness or pose unwarranted financial risk to the Bank even though the asset value is not currently impaired. The asset does not currently warrant adverse classification but if not corrected could weaken and could create future increased risk exposure. Includes loans which require an increased degree of monitoring or servicing as a result of internal or external changes.

Substandard: This classification represents more severe cases of #5 (OAEM) characteristics that require increased monitoring. Assets are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral. Asset has a well-defined weakness or weaknesses that impairs the ability to repay debt and jeopardizes the timely liquidation or realization of the collateral at the asset’s net book value.

Doubtful: Assets which have all the weaknesses inherent in those assets classified #6 (Substandard) but the risks are more severe relative to financial deterioration in capital and/or asset value; accounting/evaluation techniques may be questionable and the overall possibility for collection in full is highly improbable. Borrowers in this category require constant monitoring, are considered work-out loans and present the potential for future loss to the Bank.

An analysis of the credit risk profile by internally assigned grades as of June 30, 2015 and December 31, 2014 is as follows:



At June 30, 2015	Pass		OAEM		Substandard		Doubtful		Total
	(amounts in thousands)
Commercial and Industrial	$	33,681	$	615	$	2,517	$	—	$	36,813
Real Estate Construction:
Residential	6,238		—		—		—		6,238
Commercial	23,439		16,853		7,140		—		47,432
Real Estate Mortgage:
Commercial – Owner Occupied	152,511		4,351		473		—		157,335
Commercial – Non-owner Occupied	250,737		5,404		10,430		—		266,571
Residential – 1 to 4 Family	176,925		1,183		8,276		—		186,384
Residential – Multifamily	18,726		—		360		—		19,086
Consumer	10,001		55		65		—		10,121
Total	$	672,258	$	28,461	$	29,261	$	—	$	729,980



At December 31, 2014	Pass		OAEM		Substandard		Doubtful		Total
	(amounts in thousands)
Commercial and Industrial	$	27,104	$	642	$	2,346	$	—	$	30,092
Real Estate Construction:
Residential	5,621		—		238		—		5,859
Commercial	34,255		2,893		10,773		—		47,921
Real Estate Mortgage:
Commercial – Owner Occupied	170,685		4,051		1,913		—		176,649
Commercial – Non-owner Occupied	218,230		5,791		13,897		—		237,918
Residential – 1 to 4 Family	162,787		613		8,494		—		171,894
Residential – Multifamily	24,809		—		364		—		25,173
Consumer	17,461		—		94		—		17,555
Total	$	660,952	$	13,990	$	38,119	$	—	$	713,061