NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES

The Company, through the Bank, grants residential, consumer and commercial loans to customers located primarily in Northeastern Ohio and Western Pennsylvania.

The following represents the composition of the loan portfolio for the period ending:

	(Amounts in thousands)
	December 31,
	2017				2016
	Balance		%		Balance		%
Commercial	$	113,341		23.3	$	96,281		22.9
Commercial real estate		283,135		58.1		238,692		56.9
Residential real estate		62,071		12.7		57,008		13.6
Consumer - home equity		26,018		5.3		25,061		6.0
Consumer - other		2,925		0.6		2,726		0.6
Total loans	$	487,490			$	419,768

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 loans in the portfolio by product type. Loans are segmented into the following pools: commercial loans, commercial real estate loans, residential real estate loans and consumer loans. The pools of commercial real estate loans and commercial loans are also broken down further by industry sectors when analyzing the related pools. Using the largest concentrations as the qualifier, these industry sectors include non-residential buildings; skilled nursing and nursing care; residential real estate lessors, agents and managers; hotel and motels, and trucking. The Company also sub-segments the consumer loan portfolio into the following two classes: home equity loans and other consumer loans. Historical loss percentages for each risk category are calculated and used as the basis for calculating allowance allocations. These historical loss percentages are calculated over multiple periods for all portfolio segments. Management evaluates these results and utilizes the most reflective period in the calculation. Certain qualitative factors are then added to the historical allocation percentage to get the adjusted factor.

These factors include, but are not limited to, the following:

Factor Considered:		Risk Trend:
Levels of and trends in charge-offs, classifications and non-accruals		Stable
Trends in volume and terms		Increasing
Changes in lending policies and procedures		Stable
Experience, depth and ability of management, including loan review function		Stable
Economic trends, including valuation of underlying collateral		Stable
Concentrations of credit		Decreasing

The following factors are analyzed and applied to loans internally graded with higher risk credit in addition to the above factors for non-classified loans:

Factor Considered:		Risk Trend:
Levels and trends in classification		Stable
Declining trends in financial performance		Stable
Structure and lack of performance measures		Increasing
Migration between risk categories		Stable

The provision charged to operations can be allocated to a loan classification either as a positive or negative value as a result of any material changes to: net charge-offs or recovery which influence the historical allocation percentage, qualitative risk factors or loan balances.

The following is an analysis of changes in the allowance for loan losses for the periods ended:

	(Amounts in thousands)
December 31, 2017	Commercial			Commercial real estate			Residential real estate			Consumer - home equity			Consumer - other			Total
Balance at beginning of period	$	1,394		$	3,072		$	163		$	150		$	89		$	4,868
Loan charge-offs		—			(654	)		(14	)		(26	)		(146	)		(840	)
Recoveries		388			—			5			10			47			450
Net loan recoveries (charge-offs)		388			(654	)		(9	)		(16	)		(99	)		(390	)
Provision charged to operations		(191	)		284			(37	)		(64	)		108			100
Balance at end of period	$	1,591		$	2,702		$	117		$	70		$	98		$	4,578

	(Amounts in thousands)
December 31, 2016	Commercial			Commercial real estate			Residential real estate			Consumer - home equity			Consumer - other			Total
Balance at beginning of period	$	1,977		$	2,926		$	153		$	52		$	86		$	5,194
Loan charge-offs		—			(287	)		(35	)		(144	)		(148	)		(614	)
Recoveries		117			35			2			23			61			238
Net loan recoveries (charge-offs)		117			(252	)		(33	)		(121	)		(87	)		(376	)
Provision charged to operations		(700	)		398			43			219			90			50
Balance at end of period	$	1,394		$	3,072		$	163		$	150		$	89		$	4,868

	(Amounts in thousands)
December 31, 2015	Commercial			Commercial real estate			Residential real estate			Consumer - home equity			Consumer - other			Total
Balance at beginning of period	$	2,064		$	2,754		$	229		$	60		$	95		$	5,202
Loan charge-offs		(470	)		(84	)		(45	)		—			(124	)		(723	)
Recoveries		134			10			37			17			62			260
Net loan recoveries (charge-offs)		(336	)		(74	)		(8	)		17			(62	)		(463	)
Provision charged to operations		249			246			(68	)		(25	)		53			455
Balance at end of period	$	1,977		$	2,926		$	153		$	52		$	86		$	5,194

The total allowance reflects management’s estimate of loan losses inherent in the loan portfolio at the Consolidated Balance Sheet date.

The following tables present a full breakdown by portfolio classification, the changes in the allowance for loan losses and the recorded investment in loans for the periods ended December 31, 2017 and 2016:

	(Amounts in thousands)
December 31, 2017	Commercial		Commercial real estate		Residential real estate		Consumer - home equity		Consumer - other		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	625	$	—	$	—	$	—	$	—	$	625
Collectively evaluated for impairment		966		2,702		117		70		98		3,953
Total ending allowance balance	$	1,591	$	2,702	$	117	$	70	$	98	$	4,578
Loan Portfolio:
Individually evaluated for impairment	$	5,581	$	4,664	$	—	$	—	$	—	$	10,245
Collectively evaluated for impairment		107,760		278,471		62,071		26,018		2,925		477,245
Total ending loan balance	$	113,341	$	283,135	$	62,071	$	26,018	$	2,925	$	487,490

	(Amounts in thousands)
December 31, 2016	Commercial		Commercial real estate		Residential real estate		Consumer - home equity		Consumer - other		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	178	$	—	$	—	$	—	$	178
Collectively evaluated for impairment		1,394		2,894		163		150		89		4,690
Total ending allowance balance	$	1,394	$	3,072	$	163	$	150	$	89	$	4,868
Loan Portfolio:
Individually evaluated for impairment	$	106	$	6,860	$	—	$	—	$	—	$	6,966
Collectively evaluated for impairment		96,175		231,832		57,008		25,061		2,726		412,802
Total ending loan balance	$	96,281	$	238,692	$	57,008	$	25,061	$	2,726	$	419,768

The increase in the total allowance for commercial loans is primarily due to volume of loans in this category. The decrease in the overall allowance in commercial real estate loans is due mainly to a decrease in the overall historical factor when analyzing the pool broken out by industry sectors, which help to offset the full impact of the loan charge-offs. The decrease in residential real estate and consumer – home equity allowance is due primarily to historical factors. Along with the impact of classified loans, the amount of net charge-offs impacts the provision charged to operations for any category of loans. Charge-offs affect the historical rate applied to each category, and the amount needed to replenish the charge off to the allowance. This impacted all categories other than commercial loans.

The following tables represent credit exposures by internally assigned grades for years ended December 31, 2017 and 2016, respectively. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The Company’s internal credit risk grading system is based on experiences with similarly graded loans.

The Company’s internally assigned grades are as follows:

•

Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. Within this category, there are grades of exceptional, quality, acceptable and pass monitor.

•

Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.

•

Substandard – loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

•

Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset but with the severity which makes collection in full highly questionable and improbable, based on existing circumstances.

•

Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted. This rating does not mean that the assets have no recovery or salvage value but rather that the assets should be charged off now, even though partial or full recovery may be possible in the future.

The following is a summary of credit quality indicators by internally assigned grade as of December 31, 2017 and 2016.

	(Amounts in thousands)
	Commercial		Commercial real estate
December 31, 2017
Pass	$	100,436	$	252,960
Special Mention		4,836		24,307
Substandard		8,069		5,868
Doubtful		—		—
Ending Balance	$	113,341	$	283,135

	(Amounts in thousands)
	Commercial		Commercial real estate
December 31, 2016
Pass	$	80,644	$	208,337
Special Mention		12,836		22,633
Substandard		2,801		7,722
Doubtful		—		—
Ending Balance	$	96,281	$	238,692

The Company evaluates the classification of consumer, home equity and residential loans primarily on a pooled basis. If the Company becomes aware that adverse or distressed conditions exist that may affect a particular loan, the loan is downgraded following the above definitions of special mention and substandard. Nonaccrual loans in these categories are evaluated for charge off or charge down, and the remaining balance has the same allowance factor as pooled loans.

The following is a summary of consumer credit exposure as of December 31, 2017 and 2016.

	(Amounts in thousands)
	Residential real estate		Consumer - home equity		Consumer- other
December 31, 2017
Performing	$	61,824	$	25,889	$	2,925
Nonperforming		247		129		—
Total	$	62,071	$	26,018	$	2,925

	(Amounts in thousands)
	Residential real estate		Consumer - home equity		Consumer- other
December 31, 2016
Performing	$	55,743	$	25,006	$	2,726
Nonperforming		1,265		55		—
Total	$	57,008	$	25,061	$	2,726

Loans are considered to be nonperforming when they become 90 days past due or on nonaccrual status, though the Company may be receiving partial payments of interest and partial repayments of principal on such loans. When a loan is placed in non-accrual status, previously accrued but unpaid interest is recorded against interest income. Loans in foreclosure are considered nonperforming. At December 31, 2017, there were $378,000 of loans in the process of foreclosure.

The following is a summary of classes of loans on non-accrual status as of:

	(Amounts in thousands)
	December 31,
	2017		2016
Commercial	$	—	$	—
Commercial real estate		506		1,458
Residential real estate		247		1,265
Consumer:
Consumer - home equity		129		55
Consumer - other		—		—
Total	$	882	$	2,778

Gross income that should have been recorded in income on nonaccrual loans was $57,000, $160,000 and $293,000 for the years ended December 31, 2017, 2016 and 2015, respectively. Actual interest included in income on these nonaccrual loans amounts to $16,000, $41,000 and $26,000 in 2017, 2016 and 2015, respectively.

Troubled Debt Restructuring

Nonperforming loans also include certain loans that have been modified in troubled debt restructurings (TDRs) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

There were no loans modified as TDRs during the years ended December 31, 2017 and 2016. The following presents, by class, information related to loans modified in a TDR during the periods ended December 31, 2015.

	(Dollar amounts in thousands)
	December 31, 2015
	Number of contracts		Pre-modification recorded investment		Post-modification recorded investment		Increase in the allowance
Commercial real estate		2	$	3,154	$	3,154	$	—
Subsequently defaulted		—	$	—

In 2015, the two commercial real estate loans were to the same customer. There was no interest rate impact, only a change in loan terms to six months interest only. None of the loans that were classified as TDRs in 2015 have subsequently defaulted in the year ended December 31, 2016.

The following is an aging analysis of the recorded investment of past due loans as of the periods ended December 31, 2017 and 2016:

	(Amounts in thousands)
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
December 31, 2017
Commercial	$	—	$	—	$	—	$	—	$	113,341	$	113,341	$	—
Commercial real estate		173		12		390		575		282,560		283,135		—
Residential real estate		240		29		216		485		61,586		62,071		—
Consumer:
Consumer - home equity		—		82		28		110		25,908		26,018		—
Consumer - other		15		—		—		15		2,910		2,925		—
Total	$	428	$	123	$	634	$	1,185	$	486,305	$	487,490	$	—

	(Amounts in thousands)
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or Greater		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
December 31, 2016
Commercial	$	377	$	—	$	—	$	377	$	95,904	$	96,281	$	—
Commercial real estate		1,189		83		1,347		2,619		236,073		238,692		—
Residential real estate		58		9		1,184		1,251		55,757		57,008		—
Consumer:
Consumer - home equity		—		46		55		101		24,960		25,061		—
Consumer - other		13		—		—		13		2,713		2,726		—
Total	$	1,637	$	138	$	2,586	$	4,361	$	415,407	$	419,768	$	—

An impaired loan is a loan on which, based on current information and events, it is probable that a creditor will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the loan agreement. However, an insignificant delay or insignificant shortfall in amount of payments on a loan does not indicate that the loan is impaired.

When a loan is determined to be impaired, impairment should be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. However, as a practical expedient, the Company will measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

The following are the criteria for selecting individual loans / relationships for impairment analysis. Non-homogenous loans which meet the criteria below are evaluated quarterly.

•

All borrowers whose loans are classified doubtful by examiners and internal loan review

•

All loans on non-accrual status

•

Any loan in foreclosure

•

Any loan with a specific reserve

•

Any loan determined to be collateral dependent for repayment

•

Loans classified as troubled debt restructuring

Commercial loans and commercial real estate loans evaluated for impairment are excluded from the general pool of loans in the ALLL calculation regardless if a specific reserve was determined. 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.

The following table presents the recorded investment and unpaid principal balances for impaired loans, excluding homogenous loans for which impaired analyses are not necessarily performed, with the associated allowance amount, if applicable, at December 31, 2017 and 2016. Also presented are the average recorded investments in the impaired balances and interest income recognized after impairment for the years ended December 31, 2017, 2016 and 2015.

	(Amounts in thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance
December 31, 2017
With no related allowance recorded:
Commercial	$	65	$	65	$	—
Commercial real estate		4,664		4,742		—
With an allowance recorded:
Commercial		5,516		5,516		625
Commercial real estate		—		—		—
Total:
Commercial	$	5,581	$	5,581	$	625
Commercial real estate	$	4,664	$	4,742	$	—

	(Amounts in thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance
December 31, 2016
With no related allowance recorded:
Commercial	$	106	$	106	$	—
Commercial real estate		5,681		5,789		—
With an allowance recorded:
Commercial		—		—		—
Commercial real estate		1,179		1,179		178
Total:
Commercial	$	106	$	106	$	—
Commercial real estate	$	6,860	$	6,968	$	178

	(Amounts in thousands)
	Average Recorded Investment		Interest Income Recognized
December 31, 2017
With no related allowance recorded:
Commercial	$	85	$	6
Commercial real estate		5,062		291
With an allowance recorded:
Commercial		460		—
Commercial real estate		527		—
Total:
Commercial	$	545	$	6
Commercial real estate	$	5,589	$	291

	(Amounts in thousands)
	Average Recorded Investment		Interest Income Recognized
December 31, 2016
With no related allowance recorded:
Commercial	$	146	$	8
Commercial real estate		6,072		335
With an allowance recorded:
Commercial		279		—
Commercial real estate		1,209		85
Total:
Commercial	$	425	$	8
Commercial real estate	$	7,281	$	420

	(Amounts in thousands)
	Average Recorded Investment		Interest Income Recognized
December 31, 2015
With no related allowance recorded:
Commercial	$	322	$	13
Commercial real estate		4,842		181
With an allowance recorded:
Commercial		1,341		—
Commercial real estate		1,160		84
Total:
Commercial	$	1,663	$	13
Commercial real estate	$	6,002	$	265