NOTE 5, Loans and Allowance for Loan Losses

The following is a summary of the balances in each class of the Company’s loan portfolio as of the dates indicated:

	December 31, 2018			December 31, 2017
	(in thousands)
Mortgage loans on real estate:
Residential 1-4 family	$	110,009		$	101,021
Commercial - owner occupied		155,245			159,268
Commercial - non-owner occupied		131,287			107,514
Multifamily		28,954			22,900
Construction		32,383			27,489
Second mortgages		17,297			17,918
Equity lines of credit		57,649			56,610
Total mortgage loans on real estate		532,824			492,720
Commercial and industrial loans		63,398			60,398
Consumer automobile loans		120,796			119,251
Other consumer loans		48,342			54,974
Other (1)		8,649			11,197
Total loans		774,009			738,540
Less: Allowance for loan losses		(10,111	)		(9,448	)
Loans, net of allowance and deferred fees (2)	$	763,898		$	729,092

(1) Overdrawn deposit accounts are reclassified as loans and included in the Other category in the table above. Overdrawn deposit accounts, excluding internal use accounts, totaled $628 thousand and $424 thousand at December 31, 2018 and December 31, 2017, respectively.
(2) Net deferred loan costs totaled $864 thousand and $916 thousand at December 31, 2018 and December 31, 2017, respectively.

ACQUIRED LOANS

The Company had no acquired loans as of December 31, 2017. The outstanding principal balance and the carrying amount of total acquired loans included in the consolidated balance sheet as of December 31, 2018 are as follows:

	December 31, 2018
	(in thousands)
Outstanding principal balance	$	31,940
Carrying amount		31,497

The outstanding principal balance and related carrying amount of acquired impaired loans, for which the Company applies FASB ASC 310-30 to account for interest earned, as of December 31, 2018 are as follows:

	December 31, 2018
	(in thousands)
Outstanding principal balance	$	246
Carrying amount		91

The following table presents changes in the accretable yield on acquired impaired loans, for which the Company applies FASB ASC 310-30, at December 31, 2018:

	December 31, 2018
	(in thousands)
Balance at January 1, 2018	$	-
Additions from acquisition of Citizens		110
Accretion		(98	)
Other changes, net		-
Ending balance	$	12

CREDIT QUALITY INFORMATION

The Company uses internally-assigned risk grades to estimate the capability of borrowers to repay the contractual obligations of their loan agreements as scheduled or at all. The Company’s internal risk grade system is based on experiences with similarly graded loans. Credit risk grades are updated at least quarterly as additional information becomes available, at which time management analyzes the resulting scores to track loan performance.

The Company’s internally assigned risk grades are as follows:

·	Pass: Loans are of acceptable risk.

·	Other Assets Especially Mentioned (OAEM): Loans have potential weaknesses that deserve management’s close attention.

·	Substandard: Loans reflect significant deficiencies due to several adverse trends of a financial, economic or managerial nature.

·	Doubtful: Loans have all the weaknesses inherent in a substandard loan with added characteristics that make collection or liquidation in full based on currently existing facts, conditions and values highly questionable or improbable.

·	Loss: Loans have been identified for charge-off because they are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.

The following table presents credit quality exposures by internally assigned risk ratings as of the dates indicated:

	Credit Quality Information As of December 31, 2018
	Pass		OAEM		Substandard		Total
					(in thousands)
Mortgage loans on real estate:
Residential 1-4 family	$	108,274	$	-	$	1,735	$	110,009
Commercial - owner occupied		140,664		4,067		10,514		155,245
Commercial - non-owner occupied		121,523		3,937		5,827		131,287
Multifamily		28,954		-		-		28,954
Construction		31,896		71		416		32,383
Second mortgages		17,007		-		290		17,297
Equity lines of credit		56,893		-		756		57,649
Total mortgage loans on real estate		505,211		8,075		19,538		532,824
Commercial and industrial loans		60,967		1,987		444		63,398
Consumer automobile loans		120,365		-		431		120,796
Other consumer loans		48,298		-		44		48,342
Other		8,649		-		-		8,649
Total	$	743,490	$	10,062	$	20,457	$	774,009

	Credit Quality Information As of December 31, 2017
	Pass		OAEM		Substandard		Total
					(in thousands)
Mortgage loans on real estate:
Residential 1-4 family	$	98,656	$	-	$	2,365	$	101,021
Commercial - owner occupied		142,778		4,944		11,546		159,268
Commercial - non-owner occupied		98,597		5,582		3,335		107,514
Multifamily		22,900		-		-		22,900
Construction		26,694		74		721		27,489
Second mortgages		17,211		431		276		17,918
Equity lines of credit		56,318		-		292		56,610
Total mortgage loans on real estate		463,154		11,031		18,535		492,720
Commercial and industrial loans		58,091		1,469		838		60,398
Consumer automobile loans		119,211		-		40		119,251
Other consumer loans		54,926		-		48		54,974
Other		11,197		-		-		11,197
Total	$	706,579	$	12,500	$	19,461	$	738,540

As of December 31, 2018 and 2017 the Company did not have any loans internally classified as Loss or Doubtful.

AGE ANALYSIS OF PAST DUE LOANS BY CLASS

All classes of loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Interest and fees continue to accrue on past due loans until the date the loan is placed in nonaccrual status, if applicable. The following table includes an aging analysis of the recorded investment in past due loans as of the dates indicated. Also included in the table below are loans that are 90 days or more past due as to interest and principal and still accruing interest, because they are well-secured and in the process of collection. Loans in nonaccrual status that are also past due are included in the aging categories in the table below.

Age Analysis of Past Due Loans as of December 31, 2018
	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due		Acquired Impaired		Total Current Loans (1)		Total Loans		Recorded Investment > 90 Days Past Due and Accruing
	(in thousands)
Mortgage loans on real estate:
Residential 1-4 family	$	1,165	$	553	$	536	$	-	$	107,755	$	110,009	$	179
Commercial - owner occupied		1,059		83		-		91		154,012		155,245		-
Commercial - non-owner occupied		-		-		2,970		-		128,317		131,287		-
Multifamily		-		-		-		-		28,954		28,954		-
Construction		-		-		622		-		31,761		32,383		205
Second mortgages		65		-		135		-		17,097		17,297		136
Equity lines of credit		60		-		-		-		57,589		57,649		-
Total mortgage loans on real estate		2,349		636		4,263		91		525,485		532,824		520
Commercial and industrial loans		1,595		-		-		-		61,803		63,398		-
Consumer automobile loans		1,645		291		114		-		118,746		120,796		113
Other consumer loans		1,333		621		1,852		-		44,536		48,342		1,852
Other		133		8		12		-		8,496		8,649		12
Total	$	7,055	$	1,556	$	6,241	$	91	$	759,066	$	774,009	$	2,497

(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the past due totals include student and small business loans with principal and interest amounts that are 97 - 100% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $4.0 million at December 31, 2018.

Age Analysis of Past Due Loans as of December 31, 2017
	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due		Total Current Loans (1)		Total Loans		Recorded Investment > 90 Days Past Due and Accruing
	(in thousands)
Mortgage loans on real estate:
Residential 1-4 family	$	229	$	153	$	1,278	$	99,361	$	101,021	$	261
Commercial - owner occupied		194		595		1,753		156,726		159,268		-
Commercial - non-owner occupied		-		176		-		107,338		107,514		-
Multifamily		-		-		-		22,900		22,900		-
Construction		-		-		721		26,768		27,489		-
Second mortgages		15		-		163		17,740		17,918		45
Equity lines of credit		75		19		53		56,463		56,610		-
Total mortgage loans on real estate		513		943		3,968		487,296		492,720		306
Commercial and industrial loans		709		-		1,060		58,629		60,398		471
Consumer automobile loans		517		122		41		118,571		119,251		41
Other consumer loans		2,222		544		2,360		49,848		54,974		2,360
Other		84		9		4		11,100		11,197		4
Total	$	4,045	$	1,618	$	7,433	$	725,444	$	738,540	$	3,182

(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the other consumer category includes student loans with principal and interest amounts that are 97 - 100% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $4.2 million at December 31, 2017.

NONACCRUAL LOANS

The Company generally places commercial loans (including construction loans and commercial loans secured and not secured by real estate) in nonaccrual status when the full and timely collection of interest or principal becomes uncertain, part of the principal balance has been charged off and no restructuring has occurred or the loan reaches 90 days past due, unless the credit is well-secured and in the process of collection.

Under regulatory rules, consumer loans, which are loans to individuals for household, family and other personal expenditures, and consumer loans secured by real estate (including residential 1 - 4 family mortgages, second mortgages, and equity lines of credit) are not required to be placed in nonaccrual status. Although consumer loans and consumer loans secured by real estate are not required to be placed in nonaccrual status, the Company may elect to place these loans in nonaccrual status, if necessary to avoid a material overstatement of interest income. Generally, consumer loans secured by real estate are placed in nonaccrual status only when payments are 120 days past due.

Generally, consumer loans not secured by real estate are placed in nonaccrual status only when part of the principal has been charged off. If a charge-off has not occurred sooner for other reasons, a consumer loan not secured by real estate will generally be placed in nonaccrual status when payments are 120 days past due. These loans are charged off or written down to the net realizable value of the collateral when deemed uncollectible, when classified as a "loss," when repayment is unreasonably protracted, when bankruptcy has been initiated, or when the loan is 120 days or more past due unless the credit is well-secured and in the process of collection.

When management places a loan in nonaccrual status, the accrued unpaid interest receivable is reversed against interest income and the loan is accounted for by the cash basis or cost recovery method, until it qualifies for return to accrual status or is charged off. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, or when the borrower has resumed paying the full amount of the scheduled contractual interest and principal payments for at least six months.

The following table presents loans in nonaccrual status by class of loan as of the dates indicated:

Nonaccrual Loans by Class

	December 31, 2018		December 31, 2017
	(in thousands)
Mortgage loans on real estate:
Residential 1-4 family	$	1,386	$	1,447
Commercial - owner occupied		5,283		7,824
Commercial - non-owner occupied		4,371		1,644
Construction		417		721
Second mortgages		155		118
Equity lines of credit		231		292
Total mortgage loans on real estate		11,843		12,046
Commercial and industrial loans		298		836
Consumer loans		-		-
Total	$	12,141	$	12,882

The following table presents the interest income that the Company would have earned under the original terms of its nonaccrual loans and the actual interest recorded by the Company on nonaccrual loans for the periods presented:

	Years Ended December 31,
	2018			2017
	(in thousands)
Interest income that would have been recorded under original loan terms		$	533	$	474
Actual interest income recorded for the period			336		281
Reduction in interest income on nonaccrual loans		$	197	$	193

TROUBLED DEBT RESTRUCTURINGS

The Company’s loan portfolio includes certain loans classified as TDRs, where economic concessions have been granted to borrowers who are experiencing financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reduction in the interest rate below current market rates for borrowers with similar risk profiles, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. The Company defines a TDR as nonperforming if the TDR is in nonaccrual status or is 90 days or more past due and still accruing interest at the report date. When the Company modifies a loan, management evaluates any possible impairment as discussed further below under Impaired Loans.

The following tables present TDRs during the periods indicated, by class of loan:

Troubled Debt Restructurings by Class For the Year Ended December 31, 2018
	Number of Modifications		Recorded Investment Prior to Modification		Recorded Investment After Modification		Current Investment on December 31, 2018
	(dollars in thousands)
Mortgage loans on real estate:
Residential 1-4 family		1	$	296	$	187	$	188
Equity lines of credit		1		248		231		231
Total mortgage loans on real estate		2		544		418		419
Commercial and industrial loans		1		146		138		139
Total		3	$	690	$	556	$	558

Troubled Debt Restructurings by Class For the Year Ended December 31, 2017
	Number of Modifications		Recorded Investment Prior to Modification		Recorded Investment After Modification		Current Investment on December 31, 2017
	(dollars in thousands)
Mortgage loans on real estate:
Residential 1-4 family		1	$	142	$	142	$	140
Commercial - owner occupied		2		3,663		3,663		3,663
Commercial - non-owner occupied		1		1,469		1,469		1,469
Total		4	$	5,274	$	5,274	$	5,272

Of the loans restructured in 2018, one was given a below-market rate for debt with similar risk characteristics and two were granted terms that the Company would not otherwise extend to borrowers with similar risk characteristics. Two of the loans restructured in 2017 were given below-market rates for debt with similar risk characteristics and two were granted terms that the Company would not otherwise extend to borrowers with similar risk characteristics.

At December 31, 2018 and 2017, the Company had no outstanding commitments to disburse additional funds on any TDR. There were no loans secured by residential 1 - 4 family real estate that were in the process of foreclosure at December 31, 2018. At December 31, 2017, the Company had $77 thousand in loans secured by residential 1 - 4 family real estate that were in the process of foreclosure.

In the years ended December 31, 2018 and 2017 there were no defaulting TDRs where the default occurred within twelve months of restructuring. The Company considers a TDR in default when any of the following occurs: the loan, as restructured, becomes 90 days or more past due; the loan is moved to nonaccrual status following the restructure; the loan is restructured again under terms that would qualify it as a TDR if it were not already so classified; or any portion of the loan is charged off.

All TDRs are factored into the determination of the allowance for loan losses and included in the impaired loan analysis, as discussed below.

IMPAIRED LOANS

A loan is considered 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. Impaired loans include nonperforming loans and loans modified in a TDR. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole or remaining source of repayment for the loan is the operation or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs, when foreclosure is probable, instead of the discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance.

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is in nonaccrual status, all payments are applied to principal under the cost recovery method. For financial statement purposes, the recorded investment in the loan is the actual principal balance reduced by payments that would otherwise have been applied to interest. When reporting information on these loans to the applicable customers, the unpaid principal balance is reported as if payments were applied to principal and interest under the original terms of the loan agreements. Therefore, the unpaid principal balance reported to the customer would be higher than the recorded investment in the loan for financial statement purposes. When the ultimate collectability of the total principal of the impaired loan is not in doubt and the loan is in nonaccrual status, contractual interest is credited to interest income when received under the cash basis method.

The following table includes the recorded investment and unpaid principal balances (a portion of which may have been charged off) for impaired loans with the associated allowance amount, if applicable, as of the dates presented. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized for the periods presented. The average balances are calculated based on daily average balances.

Impaired Loans by Class
	As of December 31, 2018												For the Year Ended December 31, 2018
				Recorded Investment
	Unpaid Principal Balance			Without Valuation Allowance			With Valuation Allowance			Associated Allowance			Average Recorded Investment			Interest Income Recognized
	(in thousands)
Mortgage loans on real estate:
Residential 1-4 family		$	2,057		$	1,686		$	239		$	51		$	2,073		$	66
Commercial			15,254			12,721			-			-			14,232			455
Construction			509			417			92			18			665			7
Second mortgages			496			347			148			33			508			15
Equity lines of credit			232			-			232			3			301			1
Total mortgage loans on real estate		$	18,548		$	15,171		$	711		$	105		$	17,779		$	544
Commercial and industrial loans			384			78			220			11			446			5
Consumer loans			38			-			-			-			43			-
Total		$	18,970		$	15,249		$	931		$	116		$	18,268		$	549

Impaired Loans by Class
	As of December 31, 2017												For the Year Ended December 31, 2017
				Recorded Investment
	Unpaid Principal Balance			Without Valuation Allowance			With Valuation Allowance			Associated Allowance			Average Recorded Investment			Interest Income Recognized
	(in thousands)
Mortgage loans on real estate:
Residential 1-4 family		$	2,873		$	2,499		$	316		$	52		$	2,525		$	90
Commercial			15,262			11,622			1,644			1			13,541			579
Construction			814			721			92			18			406			23
Second mortgages			473			318			135			14			464			20
Equity lines of credit			293			53			239			10			261			-
Total mortgage loans on real estate		$	19,715		$	15,213		$	2,426		$	95		$	17,197		$	712
Commercial and industrial loans			1,115			836			-			-			1,388			30
Consumer loans			-			-			-			-			41			-
Total		$	20,830		$	16,049		$	2,426		$	95		$	$ 18,626		$	742

ALLOWANCE FOR LOAN LOSSES

Loans are either individually evaluated for impairment or pooled with like loans and collectively evaluated for impairment. Also, various qualitative factors are applied to each segment of the loan portfolio. The allowance for loan losses is the accumulation of these components. Management’s estimate is based on certain observable, historical data and other factors that management believes are most reflective of the underlying credit losses being estimated.

Management provides an allocated component of the allowance for loans that are individually evaluated for impairment. An allocated allowance is established when the discounted value of expected future cash flows from the impaired loan (or the collateral value or observable market price of the impaired loan) is lower than the carrying value of that loan. This allocation represents the sum of management’s estimated losses on each loan.

Loans collectively evaluated for impairment are pooled, with a historical loss rate, based on migration analysis, applied to each pool, segmented by risk grade or days past due, depending on the type of loan. Based on credit risk assessments and management’s analysis of qualitative factors, additional loss factors are applied to loan balances. These additional qualitative factors include: economic conditions, trends in growth, loan concentrations, changes in certain loans, changes in underwriting, changes in management and changes in the legal and regulatory environment.

ALLOWANCE FOR LOAN LOSSES BY SEGMENT

The following table presents, by portfolio segment, the changes in the allowance for loan losses and the recorded investment in loans for the periods presented. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS
(in thousands)
For the Year Ended December 31, 2018	Commercial			Real Estate - Construction			Real Estate - Mortgage			Consumer			Other			Total
Allowance for Loan Losses:
Balance at the beginning of period	$	1,889		$	541		$	5,217		$	1,644		$	157		$	9,448
Charge-offs		(81	)		-			(1,625	)		(769	)		(367	)		(2,842	)
Recoveries		140			-			158			262			84			644
Provision for loan losses		392			(385	)		2,206			217			431			2,861
Ending balance		2,340			156			5,956			1,354			305			10,111
Ending balance individually evaluated for impairment		11			18			87			-			-			116
Ending balance collectively evaluated for impairment		2,329			138			5,869			1,354			305			9,995
Ending balance acquired impaired loans		-			-			-			-			-			-
Ending balance		2,340			156			5,956			1,354			305			10,111
Loan Balances:
Ending balance individually evaluated for impairment		298			509			15,373			-			-			16,180
Ending balance collectively evaluated for impairment		63,009			31,874			485,068			169,138			8,649			757,738
Ending balance acquired impaired loans		91			-			-			-			-			91
Ending balance	$	63,398		$	32,383		$	500,441		$	169,138		$	8,649		$	774,009

For the Year Ended December 31, 2017	Commercial			Real Estate - Construction			Real Estate - Mortgage			Consumer			Other			Total
Allowance for Loan Losses:
Balance at the beginning of period	$	1,493		$	846		$	5,267		$	455		$	184		$	8,245
Charge-offs		(807	)		-			(1,934	)		(279	)		(267	)		(3,287	)
Recoveries		37			104			45			56			88			330
Provision for loan losses		1,166			(409	)		1,839			1,412			152			4,160
Ending balance		1,889			541			5,217			1,644			157			9,448
Ending balance individually evaluated for impairment		-			18			77			-			-			95
Ending balance collectively evaluated for impairment		1,889			523			5,140			1,644			157			9,353
Ending balance		1,889			541			5,217			1,644			157			9,448
Loan Balances:
Ending balance individually evaluated for impairment		836			813			16,826			-			-			18,475
Ending balance collectively evaluated for impairment		59,562			26,676			448,405			174,225			11,197			720,065
Ending balance	$	60,398		$	27,489		$	465,231		$	174,225		$	11,197		$	738,540