ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management's best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company's allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, "Receivables" and allowance allocations calculated in accordance with ASC Topic 450, "Contingencies." Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company's process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of, and trends related to, nonaccrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for possible loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

The level of the allowance reflects management's continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management's judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company's loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor's ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a grade of 6 or higher, the loan is analyzed to determine whether the loan is impaired and, if impaired, whether there is a need to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower's ability to repay amounts owed, any collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower's industry, among other things.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company's pools of similar loans include similarly risk-graded groups of commercial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Bank's lending management and staff; (ii) the effectiveness of the Bank's loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, high-moderate, moderate, low-moderate or low degree of risk. The results are then input into a "general allocation matrix" to determine an appropriate general valuation allowance.

An analysis of the allowance for loan losses for the six and three month periods ended June 30, 2015 and 2014 is as follows:



Allowance for Loan Losses:	For the six months ended June 30, 2015
	Beginning Balance		Charge-offs			Recoveries		Provisions (Credits)			Ending Balance
	(amounts in thousands)
Commercial and Industrial	$	1,679	$	—		$	32	$	646		$	2,357
Real Estate Construction:
Residential	316		(238		)	—		119			197
Commercial	3,015		(2,380		)	—		1,030			1,665
Real Estate Mortgage:
Commercial – Owner Occupied	3,296		—			10		(307		)	2,999
Commercial – Non-owner Occupied	4,962		(381		)	398		492			5,471
Residential – 1 to 4 Family	4,156		(128		)	33		(200		)	3,861
Residential – Multifamily	357		—			—		(86		)	271
Consumer	262		—			—		(104		)	158
Total	$	18,043	$	(3,127	)	$	473	$	1,590		$	16,979



Allowance for Loan Losses:	For the six months ended June 30, 2014
	Beginning Balance		Charge-offs			Recoveries		Provisions (Credits)			Ending Balance
	(amounts in thousands)
Commercial and Industrial	$	591	$	(395	)	$	—	$	504		$	700
Real Estate Construction:
Residential	414		—			5		(330		)	89
Commercial	948		—			—		(272		)	676
Real Estate Mortgage:
Commercial – Owner Occupied	4,735		(263		)	2		(179		)	4,295
Commercial – Non-owner Occupied	7,530		—			—		(1,504		)	6,026
Residential – 1 to 4 Family	3,612		(2,437		)	11		3,810			4,996
Residential – Multifamily	389		—			—		(7		)	382
Consumer	341		(24		)	—		(22		)	295
Total	$	18,560	$	(3,119	)	$	18	$	2,000		$	17,459



Allowance for Loan Losses:	For the three months ended June 30, 2015
	Beginning Balance		Charge-offs		Recoveries		Provisions (Credits)			Ending Balance
	(amounts in thousands)
Commercial and Industrial	$	1,869	$	—	$	14	$	474		$	2,357
Real Estate Construction:
Residential	186		—		—		11			197
Commercial	1,618		—		—		47			1,665
Real Estate Mortgage:
Commercial – Owner Occupied	3,344		—		—		(345		)	2,999
Commercial – Non-owner Occupied	4,581		—		—		890			5,471
Residential – 1 to 4 Family	4,045		—		32		(216		)	3,861
Residential – Multifamily	279		—		—		(8		)	271
Consumer	261		—		—		(103		)	158
Total	$	16,183	$	—	$	46	$	750		$	16,979



Allowance for Loan Losses:	For the three months ended June 30, 2014
	Beginning Balance		Charge-offs			Recoveries		Provisions (Credits)			Ending Balance
	(amounts in thousands)
Commercial and Industrial	$	873	$	(395	)	$	—	$	222		$	700
Real Estate Construction:
Residential	138		—			5		(54		)	89
Commercial	749		—			—		(73		)	676
Real Estate Mortgage:
Commercial – Owner Occupied	4,710		(182		)	—		(233		)	4,295
Commercial – Non-owner Occupied	5,973		—			—		53			6,026
Residential – 1 to 4 Family	6,001		(2,417		)	11		1,401			4,996
Residential – Multifamily	370		—			—		12			382
Consumer	319		—			—		(24		)	295
Unallocated	304		—			—		(304		)	—
Total	$	19,437	$	(2,994	)	$	16	$	1,000		$	17,459



Allowance for Loan Losses, at June 30, 2015	Individually evaluated for impairment		Collectively evaluated for impairment		Total
	(amounts in thousands)
Commercial and Industrial	$	1,621	$	736	$	2,357
Real Estate Construction:
Residential	—		197		197
Commercial	497		1,168		1,665
Real Estate Mortgage:
Commercial – Owner Occupied	85		2,914		2,999
Commercial – Non-owner Occupied	796		4,675		5,471
Residential – 1 to 4 Family	255		3,606		3,861
Residential – Multifamily	5		266		271
Consumer	7		151		158
Total	$	3,266	$	13,713	$	16,979



Allowance for Loan Losses, at December 31, 2014	Individually evaluated for impairment		Collectively evaluated for impairment		Total
	(amounts in thousands)
Commercial and Industrial	$	1,040	$	639	$	1,679
Real Estate Construction:
Residential	238		78		316
Commercial	2,535		480		3,015
Real Estate Mortgage:
Commercial – Owner Occupied	114		3,182		3,296
Commercial – Non-owner Occupied	828		4,134		4,962
Residential – 1 to 4 Family	573		3,583		4,156
Residential – Multifamily	5		352		357
Consumer	—		262		262
Total	$	5,333	$	12,710	$	18,043



Loans, at June 30, 2015:	Individually evaluated for impairment		Collectively evaluated for impairment		Total
	(amounts in thousands)
Commercial and Industrial	$	2,919	$	33,894	$	36,813
Real Estate Construction:
Residential	—		6,238		6,238
Commercial	10,324		37,108		47,432
Real Estate Mortgage:
Commercial – Owner Occupied	4,842		152,493		157,335
Commercial – Non-owner Occupied	26,137		240,434		266,571
Residential – 1 to 4 Family	7,901		178,483		186,384
Residential – Multifamily	360		18,726		19,086
Consumer	65		10,056		10,121
Total	$	52,548	$	677,432	$	729,980



Loans, at December 31, 2014:	Individually evaluated for impairment		Collectively evaluated for impairment		Total
	(amounts in thousands)
Commercial and Industrial	$	2,407	$	27,685	$	30,092
Real Estate Construction:
Residential	238		5,621		5,859
Commercial	14,058		33,863		47,921
Real Estate Mortgage:
Commercial – Owner Occupied	5,951		170,698		176,649
Commercial – Non-owner Occupied	30,407		207,511		237,918
Residential – 1 to 4 Family	7,960		163,934		171,894
Residential – Multifamily	364		24,809		25,173
Consumer	94		17,461		17,555
Total	$	61,479	$	651,582	$	713,061