NOTE

LOANS

Outstanding loan balances consisted of the following at

March

31,

2017,

and

December

31,

2016.

(Amounts in thousands)	March 31,			December 31,
Loan Portfolio	2017			2016
Commercial	$	145,635		$	153,844
Commercial real estate:
Real estate - construction and land development		46,228			57,771
Real estate - commercial non-owner occupied		305,802			287,455
Real estate - commercial owner occupied		164,166			151,516
Residential real estate:
Real estate - residential - Individual Tax Identification Number (“ITIN”)		44,211			45,566
Real estate - residential - 1-4 family mortgage		19,710			20,425
Real estate - residential - equity lines		33,019			35,953
Consumer and other		51,423			51,681
Gross loans		810,194			804,211
Deferred fees and costs		1,446			1,324
Loans, net of deferred fees and costs		811,640			805,535
Allowance for loan and lease losses		(11,641	)		(11,544	)
Net loans	$	799,999		$	793,991

Gross loan balances in the table above include net purchase discounts of

$2.8

million and

$2.9

million as of

March

31,

2017

, and

December

31,

2016,

respectively.

Age analysis of gross loan balances for past due loans, segregated by class of loans, as of

March

31,

2017,

and

December

31,

2016,

was as follows.

					Greater								Recorded
(Amounts in thousands)	30-59		60-89		Than 90								Investment >
Past Due Loans at	Days Past		Days Past		Days Past		Total Past						90 Days and
March 31, 2017	Due		Due		Due		Due		Current		Total		Accruing
Commercial	$	—	$	—	$	—	$	—	$	145,635	$	145,635	$	—
Commercial real estate:
Real estate - construction and land development		—		—		—		—		46,228		46,228		—
Real estate - commercial non-owner occupied		—		—		1,196		1,196		304,606		305,802		—
Real estate - commercial owner occupied		147		—		—		147		164,019		164,166		—
Residential real estate:
Real estate - residential - ITIN		664		90		857		1,611		42,600		44,211		—
Real estate - residential - 1-4 family mortgage		140		—		853		993		18,717		19,710		—
Real estate - residential - equity lines		121		—		—		121		32,898		33,019		—
Consumer and other		165		77		—		242		51,181		51,423		—
Total	$	1,237	$	167	$	2,906	$	4,310	$	805,884	$	810,194	$	—

					Greater								Recorded
(Amounts in thousands)	30-59		60-89		Than 90								Investment >
Past Due Loans at	Days Past		Days Past		Days Past		Total Past						90 Days and
December 31, 2016	Due		Due		Due		Due		Current		Total		Accruing
Commercial	$	51	$	—	$	—	$	51	$	153,793	$	153,844	$	—
Commercial real estate:
Real estate - construction and land development		—		—		—		—		57,771		57,771		—
Real estate - commercial non-owner occupied		—		—		1,196		1,196		286,259		287,455		—
Real estate - commercial owner occupied		—		—		114		114		151,402		151,516		—
Residential real estate:
Real estate - residential - ITIN		567		80		1,149		1,796		43,770		45,566		—
Real estate - residential - 1-4 family mortgage		147		—		856		1,003		19,422		20,425		—
Real estate - residential - equity lines		68		36		48		152		35,801		35,953		—
Consumer and other		166		70		11		247		51,434		51,681		—
Total	$	999	$	186	$	3,374	$	4,559	$	799,652	$	804,211	$	—

The following tables summarize impaired loans by loan class as of

March

31,

2017,

and

December

31,

2016.

	As of March 31, 2017
			Unpaid
(Amounts in thousands)	Recorded		Principal		Related
Impaired Loans	Investment		Balance		Allowance
With no related reserve recorded:
Commercial	$	1,613	$	2,511	$	—
Commercial real estate:
Real estate - commercial non-owner occupied		1,196		1,196		—
Real estate - commercial owner occupied		654		685		—
Residential real estate:
Real estate - residential - ITIN		5,893		7,560		—
Real estate - residential - 1-4 family mortgage		1,337		2,142		—
Real estate - residential - equity lines		906		1,341		—
Total with no related allowance recorded	$	11,599	$	15,435	$	—

With an allowance recorded:
Commercial	$	1,662	$	1,674	$	491
Commercial real estate:
Real estate - commercial non-owner occupied		808		808		142
Residential real estate:
Real estate - residential - ITIN		2,199		2,271		403
Real estate - residential - equity lines		450		450		225
Consumer and other		39		39		13
Total with an allowance recorded	$	5,158	$	5,242	$	1,274

By loan class:
Commercial	$	3,275	$	4,185	$	491
Commercial real estate		2,658		2,689		142
Residential real estate		10,785		13,764		628
Consumer and other		39		39		13
Total impaired loans	$	16,757	$	20,677	$	1,274

	As of December 31, 2016
(Amounts in thousands)	Recorded		Principal		Related
Impaired Loans	Investment		Balance		Allowance
With no related reserve recorded:
Commercial	$	1,573	$	2,438	$	—
Commercial real estate:
Real estate - commercial non-owner occupied		1,196		1,196		—
Real estate - commercial owner occupied		784		841		—
Residential real estate:
Real estate - residential - ITIN		6,047		7,685		—
Real estate - residential - 1-4 family mortgage		1,914		2,722		—
Real estate - residential - equity lines		917		1,342		—
Consumer and other		210		216		—
Total with no related allowance recorded	$	12,641	$	16,440	$	—

With an allowance recorded:
Commercial	$	1,952	$	1,957	$	641
Commercial real estate:
Real estate - commercial non-owner occupied		808		808		21
Real estate - commercial owner occupied		337		337		64
Residential real estate:
Real estate - residential - ITIN		2,562		2,617		494
Real estate - residential - equity lines		454		454		227
Consumer and other		40		40		14
Total with an allowance recorded	$	6,153	$	6,213	$	1,461

By loan class:
Commercial	$	3,525	$	4,395	$	641
Commercial real estate		3,125		3,182		85
Residential real estate		11,894		14,820		721
Consumer and other		250		256		14
Total impaired loans	$	18,794	$	22,653	$	1,461

Nonaccrual loans, segregated by loan class, were as follows as of

March

31,

2017

and

December

31,

2016.

(Amounts in thousands)	March 31,		December 31,
Nonaccrual Loans	2017		2016
Commercial	$	2,534	$	2,749
Commercial real estate:
Real estate - commercial non-owner occupied		1,196		1,196
Real estate - commercial owner occupied		654		784
Residential real estate:
Real estate - residential - ITIN		3,331		3,576
Real estate - residential - 1-4 family mortgage		1,337		1,914
Real estate - residential - equity lines		906		917
Consumer and other		39		250
Total	$	9,997	$	11,386

Had nonaccrual loans performed in accordance with their contractual terms, we would have recognized additional interest income, net of tax, of approximately

$104

thousand and

$84

thousand for the

three

months ended

March

31,

2017

and

2016,

respectively.

The following table summarizes average recorded investment and interest income recognized on impaired loans by loan class for the

three

months ended

March

31,

2017

and

2016.

	Three Months Ended				Three Months Ended
	March 31, 2017				March 31, 2016
	Average		Interest		Average		Interest
(Amounts in thousands)	Recorded		Income		Recorded		Income
Average Recorded Investment and Interest Income	Investment		Recognized		Investment		Recognized
Commercial	$	3,396	$	10	$	2,215	$	1
Commercial real estate:
Real estate - commercial non-owner occupied		2,004		11		2,020		12
Real estate - commercial owner occupied		809		2		1,449		6
Residential real estate:
Real estate - residential - ITIN		8,272		40		9,158		40
Real estate - residential - 1-4 family mortgage		1,728		—		1,753		—
Real estate - residential - equity lines		1,361		5		1,120		6
Consumer and other		175		—		32		—
Total	$	17,745	$	68	$	17,747	$	65

The impaired loans for which these interest income amounts were recognized primarily relate to accruing troubled debt restructured loans.

Loans are reported as troubled debt restructurings when we grant a concession(s) to a borrower experiencing financial difficulties that we would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s) significantly, or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as we will not collect all amounts due, either principal or interest, in accordance with the terms of the original loan agreement.

March

31,

2017

and

December

31,

2016,

impaired loans of

$6.8

million and

$7.1

million, respectively, were classified as performing restructured loans.

In order for a restructured loan to be on accrual status, the loan’s collateral coverage must generally be greater than or equal to

100%

of the loan balance, the loan payments must be current, and the borrower must demonstrate the ability to make payments from a verified source of cash flow. As of

March

31,

2017,

we had

one

restructured commercial line of credit in nonaccrual status

that had

$231

thousand in available credit. We had

other obligations to lend additional funds on any other restructured loans as of

March

31,

2017

December

31,

2016.

As of

March

31,

2017,

we had

$11.3

million in troubled debt restructurings compared to

$12.1

million as of

December

31,

2016.

As of

March

31,

2017,

we had

118

loans that qualified as troubled debt restructurings, of which

110

loans were performing according to their restructured terms. Troubled debt restructurings represented

1.40%

of gross loans as of

March

31,

2017,

compared to

1.50%

December

31,

2016.

The types of modifications offered can generally be described in the following categories:

Rate

– A modification in which the interest rate is changed.

Maturity

– A modification in which the maturity date, timing of payments or frequency of payments are changed.

Payment deferral

– A modification in which a portion of the principal is deferred.

Principal reduction

– A modification in which a portion of the owing principal is decreased.

There were no new troubled debt restructurings during the

three

months ended

March

31,

2017

March

31,

2016.

There were no loans modified as troubled debt restructuring during the

-month periods preceding

March

31,

2017

and

2016,

for which there was a payment default during the

three

months ended

March

31,

2017

and

2016.

We define a performing loan as a loan where any installment of principal or interest is not

days or more past due, and management believes the ultimate collection of original contractual principal and interest is likely. We define a nonperforming loan as an impaired loan, which

may

be on nonaccrual,

days past due and still accruing, or has been restructured and does not comply with its modified terms, and our ultimate collection of original contractual principal and interest is uncertain.

Performing and nonperforming loans, segregated by class of loans, were as follows at

March

31,

2017

and

December

31,

2016.

(Amounts in thousands)	March 31, 2017
Performing and Nonperforming Loans	Performing		Nonperforming		Total
Commercial	$	143,101	$	2,534	$	145,635
Commercial real estate:
Real estate - construction and land development		46,228		—		46,228
Real estate - commercial non-owner occupied		304,606		1,196		305,802
Real estate - commercial owner occupied		163,512		654		164,166
Residential real estate:
Real estate - residential - ITIN		40,880		3,331		44,211
Real estate - residential - 1-4 family mortgage		18,373		1,337		19,710
Real estate - residential - equity lines		32,113		906		33,019
Consumer and other		51,384		39		51,423
Total	$	800,197	$	9,997	$	810,194

(Amounts in thousands)	December 31, 2016
Performing and Nonperforming Loans	Performing		Nonperforming		Total
Commercial	$	151,095	$	2,749	$	153,844
Commercial real estate:
Real estate - construction and land development		57,771		—		57,771
Real estate - commercial non-owner occupied		286,259		1,196		287,455
Real estate - commercial owner occupied		150,732		784		151,516
Residential real estate:
Real estate - residential - ITIN		41,990		3,576		45,566
Real estate - residential - 1-4 family mortgage		18,511		1,914		20,425
Real estate - residential - equity lines		35,036		917		35,953
Consumer and other		51,431		250		51,681
Total	$	792,825	$	11,386	$	804,211

The foundation or primary factor in determining the appropriate credit quality indicators is the degree of a debtor’s willingness and ability to perform as agreed. In conjunction with evaluating the performing versus nonperforming nature of our loan portfolio, management evaluates the following credit risk and other relevant factors in determining the appropriate credit quality indicator (rating) for each loan class:

Pass Grade:

A Pass loan is a strong credit with no existing or known weaknesses that

may

require management’s close attention. Some pass loans require short-term enhanced monitoring to determine when the credit relationship would merit either an upgrade or a downgrade. Loans classified as Pass Grade specifically demonstrate:

●

Strong Cash Flows – borrower’s cash flows must meet or exceed our minimum debt service coverage ratio.

●

Collateral Margin – generally, the borrower must have pledged an acceptable collateral class with an adequate collateral margin.

●

Qualitative Factors – in addition to meeting our minimum cash flow and collateral requirements, a number of other qualitative factors are also factored into assigning a Pass Grade including the borrower’s level of leverage (debt to equity), prospects, history and experience in their industry, credit history, and any other relevant factors including a borrower’s character.

Those borrowers who qualify for unsecured loans must fully demonstrate above average cash flows and strong

secondary

sources of repayment to mitigate the lack of unpledged collateral.

Watch Grade:

The credit is acceptable but the borrower has experienced a temporary setback or adverse information has been received, and

may

exhibit

one

or more of the characteristics shown in the list below. This risk grade could apply to credits on a temporary basis pending a full review. Credits with this risk grade will require more handling time and increased management. The list below contains characteristics of this risk grade, but individually do not automatically cause the loan to be assigned a Watch Grade.

●

The primary source of repayment

may

be weakening causing greater reliance on the

secondary

source of repayment or

●

The primary source of repayment is adequate, but the

secondary

source of repayment is insufficient

●

In-depth financial analysis would compare to the lower quartile in

two

or more of the major components of the Risk Management Association Annual Statement Studies

●

Volatile or deteriorating collateral

●

Management decisions

may

be called into question

●

Delinquencies in bank credits or other financial/trade creditors

●

Frequent overdrafts

●

Significant change in management/ownership

Special Mention Grade:

Credits in this grade are potentially weak and deserve management's close attention. If left uncorrected, these potential weaknesses

may

result in deterioration of the repayment prospects of the credit. Special Mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. The list below exhibits the characteristics of this grade, but individually do not automatically cause the borrower to be assigned a grade of Special Mention:

●

Inadequate or incomplete loan documentation or perfection of collateral, or any other deviation from prudent lending practices

●

Credit is structured in a manner in which the timing of the repayment source does not match the payment schedule or maturity, materially jeopardizing repayment

●

Current economic or market conditions exist which

may

affect the borrower's ability to perform or affect the Bank's collateral position

●

Adverse trends in the borrower's operations or continued deterioration in the borrower’s financial condition that has not yet reached a point where the retirement of debt is jeopardized. A credit in this grade should have favorable prospects of the deteriorating financial trends reversing within a reasonable timeframe.

●

The borrower is less than cooperative or unable to produce current and adequate financial information

Substandard Grade:

A Substandard credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard credits have a well-defined weakness or weaknesses that jeopardize the liquidation or timely collection of the debt. Substandard credits are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. However, a potential loss does not have to be recognizable in an individual credit for it to be considered a substandard credit. As such, substandard credits

may

not be graded as impaired.

The following represents, but is not limited to, the potential characteristics of a Substandard Grade and do not necessarily generate automatic reclassification into this loan grade:

●

Sustained or substantial deteriorating financial trends,

●

Unresolved management problems,

●

Collateral is insufficient to repay debt; collateral is not sufficiently supported by independent sources, such as asset-based financial audits, appraisals, or equipment evaluations,

●

Improper perfection of lien position, which is not readily correctable,

●

Unanticipated and severe decline in market values,

●

High reliance on

secondary

source of repayment,

●

Legal proceedings, such as bankruptcy or a divorce, which has substantially decreased the borrower’s capacity to repay the debt,

●

Fraud committed by the borrower,

●

IRS liens that take precedence,

●

Forfeiture statutes for assets involved in criminal activities,

●

Protracted repayment terms outside of policy that are for longer than the same type of credit in our portfolio,

●

Any other relevant quantitative or qualitative factor that negatively affects the current net worth and paying capacity of the borrower or of the collateral pledged, if any.

Doubtful Grade:

A Doubtful loan has all the weaknesses inherent in

one

classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain pending factors that

may

work to the advantage and strengthening of the credit, its classification as an estimated loss is deferred until its more exact status

may

be determined. Pending factors

may

include, but are not limited to:

●

Proposed merger(s),

●

Acquisition or liquidation procedures,

●

Capital injection,

●

Perfecting liens on additional collateral,

●

Refinancing plans.

Generally, a Doubtful Grade does not remain outstanding for a period greater than

six

months. After

six

months, the pending events should have either occurred or not occurred. The credit grade should have improved or the principal balance charged against the ALLL.

The following table summarizes internal risk grades by loan class as of

March

31,

2017

and

December

31,

2016.

	As of March 31, 2017
					Special
(Amounts in thousands)	Pass		Watch		Mention		Substandard		Doubtful		Total
Commercial	$	102,548	$	33,887	$	6,012	$	3,188	$	—	$	145,635
Commercial real estate:
Real estate - construction and land development		42,375		3,853		—		—		—		46,228
Real estate - commercial non-owner occupied		296,187		5,351		499		3,765		—		305,802
Real estate - commercial owner occupied		152,754		10,092		489		831		—		164,166
Residential real estate:
Real estate - residential - ITIN		37,427		—		—		6,784		—		44,211
Real estate - residential - 1-4 family mortgage		17,564		809		—		1,337		—		19,710
Real estate - residential - equity lines		29,678		2,018		70		1,253		—		33,019
Consumer and other		51,356		2		—		65		—		51,423
Total	$	729,889	$	56,012	$	7,070	$	17,223	$	—	$	810,194

	As of December 31, 2016
					Special
(Amounts in thousands)	Pass		Watch		Mention		Substandard		Doubtful		Total
Commercial	$	124,089	$	21,684	$	4,570	$	3,501	$	—	$	153,844
Commercial real estate:
Real estate - construction and land development		57,761		10		—		—		—		57,771
Real estate - commercial non-owner occupied		277,765		5,398		1,321		2,971		—		287,455
Real estate - commercial owner occupied		142,419		7,301		496		1,300		—		151,516
Residential real estate:
Real estate - residential - ITIN		38,279		—		—		7,287		—		45,566
Real estate - residential - 1-4 family mortgage		17,696		815		—		1,914		—		20,425
Real estate - residential - equity lines		33,828		858		—		1,267		—		35,953
Consumer and other		51,398		2		—		281		—		51,681
Total	$	743,235	$	36,068	$	6,387	$	18,521	$	—	$	804,211

The following tables summarize the ALLL by portfolio for the

three

months ended

March

31,

2017

and

2016.

	For the Three Months Ended March 31, 2017
(Amounts in thousands)				Commercial		Residential
ALLL by Loan Class	Commercial			Real Estate		Real Estate			Consumer			Unallocated		Total
Beginning balance	$	2,849		$	5,578	$	1,716		$	955		$	446	$	11,544
Charge-offs		(51	)		—		(169	)		(227	)		—		(447	)
Recoveries		199			27		75			43			—		344
Provision		(348	)		358		(132	)		303			19		200
Ending balance	$	2,649		$	5,963	$	1,490		$	1,074		$	465	$	11,641

	For the Three Months Ended March 31, 2016
(Amounts in thousands)				Commercial			Residential
ALLL by Loan Class	Commercial			Real Estate			Real Estate			Consumer			Unallocated			Total
Beginning balance	$	2,493		$	5,784		$	1,577		$	770		$	556		$	11,180
Charge-offs		(85	)		(6	)		(73	)		(143	)		—			(307	)
Recoveries		32			528			8			54			—			622
Provision		26			(414	)		449			133			(194	)		—
Ending balance	$	2,466		$	5,892		$	1,961		$	814		$	362		$	11,495

The following tables summarize the ALLL and the recorded investment in loans and leases as of

March

31,

2017

and

December

31,

2016.

	As of March 31, 2017
			Commercial		Residential
(Amounts in thousands)	Commercial		Real Estate		Real Estate		Consumer		Unallocated		Total
ALLL:
Individually evaluated for impairment	$	491	$	142	$	628	$	13	$	—	$	1,274
Collectively evaluated for impairment		2,158		5,821		862		1,061		465		10,367
Total	$	2,649	$	5,963	$	1,490	$	1,074	$	465	$	11,641
Gross loans:
Individually evaluated for impairment	$	3,275	$	2,658	$	10,785	$	39	$	—	$	16,757
Collectively evaluated for impairment		142,360		513,538		86,155		51,384		—		793,437
Total gross loans	$	145,635	$	516,196	$	96,940	$	51,423	$	—	$	810,194

	As of December 31, 2016
			Commercial		Residential
(Amounts in thousands)	Commercial		Real Estate		Real Estate		Consumer		Unallocated		Total
ALLL:
Individually evaluated for impairment	$	641	$	85	$	721	$	14	$	—	$	1,461
Collectively evaluated for impairment		2,208		5,493		995		941		446		10,083
Total	$	2,849	$	5,578	$	1,716	$	955	$	446	$	11,544
Gross loans:
Individually evaluated for impairment	$	3,525	$	3,125	$	11,894	$	250	$	—	$	18,794
Collectively evaluated for impairment		150,319		493,617		90,050		51,431		—		785,417
Total gross loans	$	153,844	$	496,742	$	101,944	$	51,681	$	—	$	804,211

The ALLL totaled

$11.6

million or

1.44%

of total gross loans at

March

31,

2017

and

$11.5

million or

1.44%

December

31,

2016.

As of

March

31,

2017

and

December

31,

2016,

we had commitments to extend credit of

$217.8

million and

$229.4

million, respectively. The reserve for unfunded commitments recorded in

Other Liabilities

in the

Consolidated Balance Sheets

March

31,

2017

and

December

31,

2016

was

$695

thousand.

The ALLL is based upon estimates of loan and lease losses and is maintained at a level considered adequate to provide for probable losses inherent in the outstanding loan portfolio. Our ALLL methodology significantly incorporates management’s current judgments, and reflects the reserve amount that is necessary for estimated loan and lease losses and risks inherent in the loan portfolio in accordance with ASC Topic

450

Contingencies

and ASC Topic

310

Receivables.

The allowance is increased by provisions charged to expense and reduced by net charge-offs. In periodic evaluations of the adequacy of the allowance balance, management considers past loan and lease loss experience by type of credit, known and inherent risks in the portfolio, adverse situations that

may

affect a borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions and other factors. We formally assess the adequacy of the ALLL on a monthly basis. These assessments include the periodic re-grading of classified loans based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment and other factors as warranted. Loans are initially rated when originated. They are reviewed as they are renewed, when there is a new loan to the same borrower and/or when identified facts demonstrate heightened risk of default. Confirmation of the quality of our grading process is obtained by independent reviews conducted by outside consultants specifically hired for this purpose and by periodic examination by various bank regulatory agencies.

Management monitors delinquent loans continuously and identifies problem loans to be evaluated individually for impairment testing. For loans that are determined impaired, a formal impairment measurement is performed at least quarterly on a loan-by-loan basis.

Our method for assessing the appropriateness of the allowance includes specific allowances for identified problem loans, an allowance factor for categories of credits and allowances for changing environmental factors (e.g., portfolio trends, concentration of credit, growth, economic factors). Allowances for identified problem loans are based on specific analysis of individual credits. Loss estimation factors for loan categories are based on analysis of local economic factors applicable to each loan category. Allowances for changing environmental factors are management’s best estimate of the probable impact these changes have had on the loan portfolio as a whole.

We believe that the ALLL was adequate as of

March

31,

2017.

There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Company,

may

require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review.

As of

March

31,

2017,

approximately

75%

of our gross loan portfolio is secured by real estate, and a significant decline in real estate market values

may

require an increase in the ALLL. Deterioration in our markets

may

adversely affect our loan portfolio and

may

lead to additional charges to the provision for loan and lease losses.

All impaired loans are individually evaluated for impairment. If the measurement of each impaired loans’ value is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the ALLL. For collateral dependent loans, this can be accomplished by charging off the impaired portion of the loan based on the underlying value of the collateral. For non-collateral dependent loans, we establish a specific component within the ALLL based on the present value of the future cash flows. If we determine the sources of repayment will not result in a reasonable probability that the carrying value of a loan can be recovered, the amount of a loan’s specific impairment is charged off against the ALLL. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the ALLL.

The unallocated portion of ALLL provides for coverage of credit losses inherent in the loan portfolio but not captured in the credit loss factors that are utilized in the risk rating-based component, or in the specific impairment reserve component of the ALLL, and acknowledges the inherent imprecision of all loss prediction models. As of

March

31,

2017

and

December

31,

2016,

the unallocated allowance amount represented

of the ALLL. While the ALLL composition is an indication of specific amounts or loan categories in which future charge-offs

may

occur, actual amounts

may

differ.

We have lending policies and procedures in place with the objective of optimizing loan income within an accepted risk tolerance level. We review and approve these policies and procedures annually. Monitoring and reporting systems supplement the review process with regular frequency as related to loan production, loan quality, concentrations of credit, potential problem loans, loan delinquencies, and nonperforming loans.

The following is a brief summary, by loan type, of management’s evaluation of the general risk characteristics and underwriting standards:

Commercial Loans

– Commercial loans are underwritten after evaluating the borrower’s financial ability to maintain profitability including future expansion objectives. In addition, the borrower’s qualitative qualities are evaluated, such as management skills and experience, ethical traits, and overall business acumen. Commercial loans are primarily extended based on the cash flows of the borrower and

secondarily

on the underlying collateral provided by the borrower. The borrower’s cash flow

may

deviate from initial projections, and the value of collateral securing these loans

may

vary.

Most commercial loans are generally secured by the assets being financed and other business assets such as accounts receivable or inventory. Management

may

also incorporate a personal guarantee; however, some short-term loans

may

be extended on an unsecured basis. Repayment of commercial loans secured by accounts receivable

may

be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial Real Estate (“CRE”) Loans

– CRE loans are subject to similar underwriting standards and processes as commercial loans. CRE loans are viewed predominantly as cash flow loans and

secondarily

as loans collateralized by real estate. Generally, CRE lending involves larger principal amounts with repayment largely dependent on the successful operation of the property securing the loan or the business conducted on the collateralized property. CRE loans

tend

to be more adversely affected by conditions in the real estate markets or by general economic conditions.

The properties securing the CRE portfolio are diverse in terms of type and primary source of repayment. This diversity helps reduce our exposure to adverse economic events that affect any single industry. We monitor and evaluate CRE loans based on occupancy status (investor versus owner occupied), collateral, geography, and risk grade criteria.

Generally, CRE loans to developers and builders that are secured by non-owner occupied properties require the borrower to have had an existing relationship with the Company and a proven record of success. Construction loans are underwritten utilizing feasibility studies, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates

may

be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment largely 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, or an interim loan commitment from the Company until permanent financing is secured. These loans are closely monitored by on-site inspections, and are considered to have higher inherent risks than other CRE loans due to their ultimate repayment sensitivity to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.

Consumer Loans

– Our consumer loan originations are generally limited to home equity loans with nominal originations in unsecured personal loans. The portfolio also includes unsecured consumer home improvement loans and residential solar panel loans secured by UCC filings. We are highly dependent on

third

party credit scoring analysis to supplement the internal underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by management and staff personnel. 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.

We maintain an independent loan review program that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to the Board of Directors and Audit Committee. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.

Management’s continuing evaluation of all known relevant quantitative and qualitative internal and external risk factors provides the foundation for the

three

major components of the ALLL:

(1)

historical valuation allowances established in accordance with ASC

450,

Contingencies (“ASC

450”)

for groups of similarly situated loan pools;

(2)

general valuation allowances established in accordance with ASC

450

and based on qualitative credit risk factors; and

(3)

specific valuation allowances established in accordance with ASC

310,

Receivables (“ASC

310”)

and based on estimated probable losses on specific impaired loans. All

three

components are aggregated and constitute the ALLL; while portions of the allowance

may

be allocated to specific credits, the allowance net of specific reserves is available for the remaining credits that management deems as “loss.” It is our policy to classify a credit as loss with a concurrent charge-off when management considers the credit uncollectible and of such little value that its continuance as a bankable asset is not warranted. A loss classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer recognizing the likely credit loss of a valueless asset even though partial recovery

may

occur in the future.

Our loan portfolio is evaluated by general loan class including commercial, commercial real estate (which includes construction and other real estate), residential real estate (which includes

family and home equity loans), consumer and other loans. In accordance with ASC

450,

historical valuation allowances are established for loan pools with similar risk characteristics common to each loan grouping. These loan pools are similarly risk-graded and each portfolio is evaluated by identifying all relevant risk characteristics that are common to these segmented groups of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge-offs or recoveries, among other relevant credit risk factors. We periodically review and update our historical loss ratios based on net charge-off experience for each loan and lease class. Other credit risk factors are also reviewed periodically and adjusted as necessary to account for any changes in potential loss exposure.

General valuation allowances, as prescribed by ASC

450,

are based on qualitative factors such as changes in asset quality trends, concentrations of credit or changes in concentrations of credit, changes in underwriting standards, changes in experience or depth of lending staff or management, the effectiveness of loan grading and the internal loan review function, and any other relevant factors. Management evaluates each qualitative component quarterly to determine the associated risks to the quality of our loan portfolio.