Note 4 – Allowance for Loan Losses

A summary of the transactions in the allowance for loan losses for the years ended December 31, 2015 and 2014 appears below:

	2015			2014
Balance, beginning of period	$	3,164		$	3,360
Loans charged off		(141	)		(551)
Recoveries		81			49
Net charge-offs		(60	)		(502	)
Provision for loan losses		463			306
Balance, December 31	$	3,567		$	3,164

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Company has segmented certain loans in the portfolio by product type. Within these segments, the Company has sub-segmented its portfolio by classes, based on the associated risks within these classes.

Loan Classes by Segments

Commercial loan segment:

Commercial and industrial - organic

Commercial and industrial - syndicated

Real estate construction and land loan segment:

Residential construction

Other construction and land

Real estate mortgage loan segment:

1-4 family residential

Home equity lines of credit

Multifamily

Commercial owner occupied

Commercial non-owner occupied

Consumer loan segment:

Consumer revolving credit

Consumer all other credit

Student loans purchased

Based upon the internal risk ratings assigned to each credit, a historical loss factor is assigned to the principal balances for each loan class. The historical loss factor is calculated by averaging the actual loan losses, for each loan class, from the previous twelve quarters.

The Company's internal creditworthiness grading system is based on experiences with similarly graded loans. Category ratings are reviewed quarterly by experienced senior lenders based on each borrower's situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

Loans that trend upward toward more positive risk ratings generally have a lower risk factor associated. Conversely, loans that migrate toward more negative ratings generally will result in a higher risk factor being applied to those related loan balances.

Risk Ratings And Historical Loss Factor Applied

Excellent

0% applied, as these loans are secured by cash and represent a minimal risk. The Company has never experienced a loss within this category.

Good

0% applied, as these loans represent a low risk and are secured by marketable securities within margin. The Company has never experienced a loss within this category.

Pass

Historical loss factor for loans rated “pass” is applied to current balances of like-rated loans, pooled by class. Loans with the following risk ratings are pooled by class and considered together as “pass”:

Satisfactory - modest risk loans where the borrower has strong and liquid financial statements and more than adequate cash flow

Average – average risk loans where the borrower has reasonable debt service capacity

Marginal – acceptable risk loans where the borrower has acceptable financial statements but is leveraged

Watch – acceptable risk loans which require more attention than normal servicing

Special Mention

These potential problem loans are currently protected but are potentially weak. Historical loss factor for loans rated “special mention” is applied to current balances of like-rated loans pooled by class.

Substandard

These problem loans are inadequately protected by the sound worth and paying capacity of the borrower and/or the value of any collateral pledged. These loans may be considered impaired and evaluated on an individual basis. Otherwise, an historical loss factor for loans rated “substandard” is applied to current balances of all other “substandard” loans pooled by class.

Doubtful

Loans with this rating have significant deterioration in the sound worth and paying capacity of the borrower and/or the value of any collateral pledged, making collection or liquidation of the loan in full highly questionable. These loans would be considered impaired and evaluated on an individual basis.

The following represents the loan portfolio designated by the internal risk ratings assigned to each credit at year-end:

							Special		Sub-
December 31, 2015		Excellent		Good		Pass	Mention		standard		Doubtful		TOTAL
Commercial
Commercial and industrial - organic	$	1,238	$	30,221	$	15,700	$	25	$	31	$	-	$	47,215
Commercial and industrial - syndicated		-		-		20,691		-		2,962		-		23,653
Real estate construction
Residential construction		-		-		2,178		-		-		-		2,178
Other construction and land		-		-		15,591		515		627		-		16,733
Real estate mortgages
1-4 family residential		-		1,500		60,801		650		593		-		63,544
Home equity lines of credit		-		-		27,517		-		82		-		27,599
Multifamily		-		-		20,209		-		-		-		20,209
Commercial owner occupied		-		-		65,497		-		747		-		66,244
Commercial non-owner occupied		-		-		89,619		1,061		1,125		-		91,805
Consumer
Consumer revolving credit		104		16,524		540		-		6		-		17,174
Consumer all other credit		232		10,063		1,319		-		41		-		11,655
Student loans purchased		-		-		35,655		-		-		-		35,655
Total Loans	$	1,574	$	58,308	$	355,317	$	2,251	$	6,214	$	-	$	423,664

							Special		Sub-
December 31, 2014		Excellent		Good		Pass	Mention		standard			Doubtful		TOTAL
Commercial
Commercial and industrial - organic	$	3,579	$	23,261	$	18,487	$	64	$	734	$	-	$	46,125
Commercial and industrial - syndicated		-		-		14,815		-		-		-		14,815
Real estate construction
Residential construction		-		-		337		-		-		-		337
Other construction and land		-		-		10,903		507		165		-		11,575
Real estate mortgages
1-4 family residential		-		1,910		56,968		455		829		-		60,162
Home equity lines of credit		-		-		25,411		-		87		-		25,498
Multifamily		-		-		26,462		-		-		-		26,462
Commercial owner occupied		-		-		58,890		-		1,978		-		60,868
Commercial non-owner occupied		-		-		54,012		-		-		-		54,012
Consumer
Consumer revolving credit		34		3,054		332		-		8		-		3,428
Consumer all other credit		200		7,856		1,867		-		49		-		9,972
Total Loans	$	3,813	$	36,081	$	268,484	$	1,026	$	3,850	$	-	$	313,254

In addition to the historical factors, the adequacy of the Company's allowance for loan losses is evaluated through reference to eight qualitative factors, listed below and ranked in order of importance:

1)	Changes in national and local economic conditions, including the condition of various market segments;

2)	Changes in the value of underlying collateral;

3)	Changes in volume of classified assets, measured as a percentage of capital;

4)	Changes in volume of delinquent loans;

5)	The existence and effect of any concentrations of credit and changes in the level of such concentrations;

6)	Changes in lending policies and procedures, including underwriting standards;

7)	Changes in the experience, ability and depth of lending management and staff; and

8)	Changes in the level of policy exceptions.

It has been the Company's experience that the first four factors drive losses to a much greater extent than the last four factors; therefore, the first four factors are weighted more heavily.

Historical factors and qualitative factors are not assessed against loans rated “excellent” or rated “good,” since these are fully collateralized by cash or readily marketable securities.

For each segment and class of loans, management must exercise significant judgment to determine the estimation method that fits the credit risk characteristics of its various segments. Although this evaluation is inherently subjective, qualified management utilizes its significant knowledge and experience related to both the market and history of the Company's loan losses.

During these evaluations, particular characteristics associated with a segment of the loan portfolio are also considered. These characteristics are detailed below:

•	Commercial loans not secured by real estate carry risks associated with the successful operation of a business, and the repayment of these loans depend on the profitability and cash flows of the business. Additional risk relates to the value of collateral where depreciation occurs and the valuation is less precise.
•	Commercial loans purchased from the syndicated loan market generally represent shared national credits, which are participations in loans or loan commitments that are shared by three or more banks. Included in the Company's shared national credit portfolio are purchased participations in leveraged lending transactions. Leveraged lending transactions are generally used to support a merger- or acquisition-related transaction, to back a recapitalization of a company's balance sheet or to refinance debt. When considering a participation in the leveraged lending market, the Company participates only in first lien senior secured term loans. To further minimize risk, the Company has developed policies to limit overall credit exposure to the syndicated market as a whole and to each borrower.
•	Loans secured by commercial real estate also carry risks associated with the success of the business and the ability to generate a positive cash flow sufficient to service debts. Real estate security diminishes risks only to the extent that a market exists for the subject collateral.
•	Consumer loans carry risks associated with the continued creditworthiness of the borrower and the value of the collateral, such as automobiles which may depreciate more rapidly than other assets. In addition, these loans may be unsecured. Consumer loans are more likely than real estate loans to be immediately affected in an adverse manner by job loss, divorce, illness or personal bankruptcy. Consumer loans are further segmented into student loans purchased, consumer revolving lines and all other consumer loans. The risk of the portfolio of student loans purchased is mitigated by the surety bond purchased that fully insures the loans.
•	Real estate secured construction loans carry risks that a project will not be completed as scheduled and budgeted and that the value of the collateral may, at any point, be less than the principal amount of the loan. Additional risks may occur if the general contractor, who may not be a loan customer, is unable to finish the project as planned due to financial pressures unrelated to the project.
•	Residential real estate loans carry risks associated with the continued creditworthiness of the borrower and changes in the value of the collateral. In addition, for investor-owned residential real estate, the repayment may be volatile as leases are generally shorter term in nature.

Impaired loans are individually evaluated and, if deemed appropriate, a specific allocation is made for these loans. In reviewing the six loans in the amount of $1.6 million classified as impaired loans at December 31, 2015, there was no valuation allowance on any of these loans after consideration was given for each borrowing as to the fair value of the collateral on the loan or the present value of expected future cash flows from the customer.

Allowance for Loan Losses Rollforward by Portfolio Segment
as of and for the year ended December 31, 2015
				Real Estate
	Commercial			Construction		Real Estate			Consumer
	Loans			and Land		Mortgages			Loans			Total
Allowance for Loan Losses:
Balance as of January 1, 2015	$	674		$	102	$	2,360		$	28		$	3,164
Charge-offs		(126	)		-		(12	)		(3	)		(141	)
Recoveries		35			-		46			-			81
Provision for (recovery of) loan losses		214			57		198			(6	)		463
Ending Balance	$	797		$	159	$	2,592		$	19		$	3,567

Ending Balance:
Individually evaluated for impairment	$	-		$	-	$	-		$	-		$	-
Collectively evaluated for impairment		797			159		2,592			19			3,567
Loans:
Individually evaluated for impairment	$	-		$	59	$	1,560		$	-		$	1,619
Collectively evaluated for impairment		70,868			18,852		267,841			64,484			422,045
Ending Balance:	$	70,868		$	18,911	$	269,401		$	64,484		$	423,664


As of and for the year ended December 31, 2014
				Real Estate
	Commercial			Construction		Real Estate			Consumer
	Loans			and Land		Mortgages			Loans			Total
Allowance for Loan Losses:
Balance as of January 1, 2014	$	340		$	198	$	2,788		$	34		$	3,360
Charge-offs		(286	)		-		(262	)		(3)			(551	)
Recoveries		32			-		10			7			49
Provision for (recovery of) loan losses		588			(96)		(176)			(10	)		306
Ending Balance	$	674		$	102	$	2,360		$	28		$	3,164

Ending Balance:
Individually evaluated for impairment	$	-		$	-	$	-		$	-		$	-
Collectively evaluated for impairment		674			102		2,360			28			3,164
Loans:
Individually evaluated for impairment	$	-		$	69	$	1,628		$	-		$	1,697
Collectively evaluated for impairment		60,940			11,843		225,374			13,400			311,557
Ending Balance:	$	60,940		$	11,912	$	227,002		$	13,400		$	313,254