NOTE 4 – ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY OF FINANCING RECEIVABLES

The following table presents changes in the allowance for loan losses disaggregated by the class of loans receivable for the three and nine months ended September 30, 2013 and 2012:



	Commercial				Commercial		Residential		Consumer
	and				Real		Real		and
(Dollars in	Industrial		Construction		Estate		Estate		Other		Unallocated		Total
thousands)
Three Months Ended:
September 30, 2013
Beginning balance	$	249	$	400	$	3,472	$	990	$	15	$	521	$	5,647
Charge-offs		-		(19)		(747)		(89)		(7)		-		(862)
Recoveries		-		-		343		24		3		-		370
Provision		(10)		16		358		(58)		4		190		500
Ending balance	$	239	$	397	$	3,426	$	867	$	15	$	711	$	5,655


September 30, 2012
Beginning balance	$	430	$	170	$	4,547	$	1,055	$	11	$	47	$	6,260
Charge-offs		-		(122)		(264)		(266)		(8)		-		(660)
Recoveries		-		-		2		-		15		-		17
Provision		183		131		153		393		(10)		254		1,104
Ending balance	$	613	$	179	$	4,438	$	1,182	$	8	$	301	$	6,721

Nine Months Ended:
September 30, 2013
Beginning balance	$	271	$	223	$	3,395	$	869	$	38	$	180	$	4,976
Charge-offs		(6)		(141)		(1,759)		(155)		(22)		-		(2,083)
Recoveries		-		-		387		24		9		-		420
Provision		(26)		315		1,403		129		(10)		531		2,342
Ending balance	$	239	$	397	$	3,426	$	867	$	15	$	711	$	5,655

September 30, 2012
Beginning balance	$	304	$	294	$	4,833	$	987	$	9	$	783	$	7,210
Charge-offs		-		(830)		(2,081)		(546)		(53)		-		(3,510)
Recoveries		2		-		71		-		26		-		99
Provision		307		715		1,615		741		26		(482)		2,922
Ending balance	$	613	$	179	$	4,438	$	1,182	$	8	$	301	$	6,721

The following table presents the balance of the allowance of loan losses and loans receivable by class at September 30, 2013 and December 31, 2012, disaggregated on the basis of our impairment methodology.



	Allowance for Loan Losses						Loans Receivable
			Balance		Balance
			Related to		Related to
			Loans		Loans
			Individually		Collectively				Individually		Collectively
			Evaluated for		Evaluated for				Evaluated for		Evaluated for
(Dollars in thousands)	Balance		Impairment		Impairment		Balance		Impairment		Impairment

September 30, 2013
Commercial and industrial	$	239	$	-	$	239	$	17,999	$	-	$	17,999
Construction		397		27		370		9,649		269		9,380
Commercial real estate		3,426		308		3,118		256,976		10,930		246,046
Residential real estate		867		99		768		106,448		2,819		103,629
Consumer and other loans		15		-		15		1,615		-		1,615
Unallocated		711		-		-		-		-		-
Total	$	5,655	$	434	$	4,510	$	392,687	$	14,018	$	378,669

December 31, 2012
Commercial and industrial	$	271	$	27	$	244	$	16,158	$	27	$	16,131
Construction		223		42		181		7,004		2,462		4,542
Commercial real estate		3,395		230		3,165		225,345		12,682		212,663
Residential real estate		869		66		803		98,301		3,351		94,950
Consumer and other loans		38		-		38		1,255		-		1,255
Unallocated		180		-		-		-		-		-
Total	$	4,976	$	365	$	4,431	$	348,063	$	18,522	$	329,541

An age analysis of loans receivable which were past due as of September 30, 2013 and December 31, 2012, is as follows:



													Recorded
													Investment
					Greater						Total		> 90 Days
	30-59 Days		60-89 days		Than		Total Past				Financing		and
(Dollars in thousands)	Past Due		Past Due		90 Days (a)		Due		Current		Receivables		Accruing

September 30, 2013
Commercial and industrial	$	-	$	-	$	50	$	50	$	17,949	$	17,999	$	50
Construction		-		-		269		269		9,380		9,649		-
Commercial real estate		988		260		10,319		11,567		245,409		256,976		-
Residential real estate		372		407		2,962		3,741		102,707		106,448		144
Consumer and other		2		5		3		10		1,605		1,615		3
Total	$	1,362	$	672	$	13,603	$	15,637	$	377,050	$	392,687	$	197

December 31, 2012
Commercial and industrial	$	-	$	-	$	27	$	27	$	16,131	$	16,158	$	-
Construction		-		-		2,462		2,462		4,542		7,004		-
Commercial real estate		1,103		1,303		12,127		14,533		210,812		225,345		65
Residential real estate		207		127		3,315		3,649		94,652		98,301		-
Consumer and other		12		3		144		159		1,096		1,255		143
Total	$	1,322	$	1,433	$	18,075	$	20,830	$	327,233	$	348,063	$	208


(a) includes loans greater than 90 days past due and still accruing and non-accrual loans.

Loans for which the accrual of interest has been discontinued at September 30, 2013 and December 31, 2012, were:



(Dollars in thousands)	September 30, 2013		December 31, 2012

Commercial and industrial	$	-	$	27
Construction		269		2,462
Commercial real estate		10,319		12,062
Residential real estate		2,818		3,315
Consumer and other		-		1
Total	$	13,406	$	17,867

In determining the adequacy of the allowance for loan losses, we estimate losses based on the identification of specific problem loans through our credit review process and also estimate losses inherent in other loans on an aggregate basis by loan type. The credit review process includes the independent evaluation of the loan officer assigned risk ratings by the Chief Credit Officer and a third party loan review company. Such risk ratings are assigned loss component factors that reflect our loss estimate for each group of loans. It is management’s and the Board of Directors’ responsibility to oversee the lending process to ensure that all credit risks are properly identified, monitored, and controlled, and that loan pricing, terms, and other safeguards against non-performance and default are commensurate with the level of risk undertaken and is rated as such based on a risk-rating system. Factors considered in assigning risk ratings and loss component factors include: borrower specific information related to expected future cash flows and operating results, collateral values, financial condition, payment status and other information; levels of and trends in portfolio charge-offs and recoveries; levels in portfolio delinquencies; effects of changes in loan concentrations and observed trends in the economy and other qualitative measurements.

Our risk-rating system as defined below is consistent with the system used by regulatory agencies and consistent with industry practices. Loan classifications of Substandard, Doubtful or Loss are consistent with the regulatory definitions of classified assets.

Pass: This category represents loans performing to contractual terms and conditions and the primary source of repayment is adequate to meet the obligation. We have five categories within the Pass classification depending on strength of repayment sources, collateral values and financial condition of the borrower.

Special Mention: This category represents loans performing to contractual terms and conditions; however the primary source of repayment or the borrower is exhibiting some deterioration or weaknesses in financial condition that could potentially threaten the borrowers’ future ability to repay our loan principal and interest or fees due.

Substandard: This category represents loans that the primary source of repayment has significantly deteriorated or weakened which has or could threaten the borrowers’ ability to make scheduled payments. The weaknesses require close supervision by management and there is a distinct possibility that we could sustain some loss if the deficiencies are not corrected. Such weaknesses could jeopardize the timely and ultimate collection of our loan principal and interest or fees due. Loss may not be expected or evident, however, loan repayment is inadequately supported by current financial information or pledged collateral.

Doubtful: Loans so classified have all the inherent weaknesses of a substandard loan with the added provision that collection or liquidation in full is highly questionable and not reasonably assured. The probability of at least partial loss is high, but extraneous factors might strengthen the asset to prevent loss. The validity of the extraneous factors must be continuously monitored. Once these factors are questionable the loan should be considered for full or partial charge-off.

Loss: Loans so classified are considered uncollectible, and of such little value that their continuance as active assets is not warranted. Such loans are fully charged off.

The following tables illustrate our corporate credit risk profile by creditworthiness category as of September 30, 2013 and December 31, 2012:



			Special
(Dollars in thousands)	Pass		Mention		Substandard		Doubtful		Total
September 30, 2013
Commercial and industrial	$	17,936	$	63	$	-	$	-	$	17,999
Construction		9,380		-		269		-		9,649
Commercial real estate		234,820		7,188		14,968		-		256,976
Residential real estate		102,371		1,045		3,017		15		106,448
Consumer and other		1,474		141		-		-		1,615
	$	365,981	$	8,437	$	18,254	$	15	$	392,687

December 31, 2012
Commercial and industrial	$	15,860	$	269	$	23	$	6	$	16,158
Construction		4,542		-		2,462		-		7,004
Commercial real estate		203,106		4,648		17,256		335		225,345
Residential real estate		93,563		253		4,485		-		98,301
Consumer and other		1,112		-		143		-		1,255
	$	318,183	$	5,170	$	24,369	$	341	$	348,063

The following table reflects information about our impaired loans by class as of September 30, 2013 and December 31, 2012:



		September 30, 2013						December 31, 2012
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
(Dollars in thousands)	Investment		Balance		Allowance		Investment		Balance		Allowance

With no related allowance recorded:
Construction	$	-	$	-	$	-	$	2,421	$	2,743	$	-
Commercial real estate		8,039		8,398		-		10,466		13,581		-
Residential real estate		2,182		2,237		-		2,675		2,768		-

With an allowance recorded:
Commercial and industrial		-		-		-		27		27		27
Construction		269		391		27		42		42		42
Commercial real estate		2,891		3,967		308		2,216		3,135		230
Residential real estate		637		730		99		675		675		66

Total:
Commercial and industrial		-		-		-		27		27		27
Construction		269		391		27		2,463		2,785		42
Commercial real estate		10,930		12,365		308		12,682		16,716		230
Residential real estate		2,819		2,967		99		3,350		3,443		66
	$	14,018	$	15,723	$	434	$	18,522	$	22,971	$	365

The following table presents the average recorded investment and income recognized for the three and nine months ended September 30, 2013 and 2012:


	For the Three Months Ended September 30, 2013				For the Three Months Ended September 30, 2012
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Dollars in thousands)	Investment		Recognized		Investment		Recognized
With no related allowance recorded:
Construction	$	-	$	-	$	2,251	$	-
Commercial real estate		8,386		11		4,538		12
Residential real estate		2,261		22		1,964		9
Total impaired loans without a related allowance		10,647		33		8,753		21

With an allowance recorded:
Commercial and industrial		-		-		398		-
Construction		328		-		1,765		3
Commercial real estate		2,764		-		13,092		10
Residential real estate		887		-		991		2
Total impaired loans with an allowance		3,979		-		16,246		15
Total impaired loans	$	14,626	$	33	$	24,999	$	36


	For the Nine Months Ended September 30, 2013				For the Nine Months Ended September 30, 2012
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Dollars in thousands)	Investment		Recognized		Investment		Recognized
With no related allowance recorded:
Construction	$	329	$	-	$	1,986	$	-
Commercial real estate		8,334		51		6,505		42
Residential real estate		2,288		24		1,756		41
Total impaired loans without a related allowance		10,951		75		10,247		83

With an allowance recorded:
Commercial and industrial		-		-		189		-
Construction		374		-		1,405		3
Commercial real estate		2,927		-		14,610		59
Residential real estate		946		3		786		17
Total impaired loans with an allowance		4,247		3		16,990		79
Total impaired loans	$	15,198	$	78	$	27,237	$	162

We recognize income on impaired loans under the cash basis when the collateral on the loan is sufficient to cover the outstanding obligation to us. If these factors do not exist, we will record all payments as a reduction of principal on such loans.

Impaired loans include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, postponement or forgiveness of principal, forbearance or other actions intended to maximize collection. The concessions rarely result in the forgiveness of principal or accrued interest. In addition, we attempt to obtain additional collateral or guarantor support when modifying such loans. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible.

The following table presents the recorded investment in troubled debt restructured loans, based on payment performance status:



(Dollars in thousands)		Commercial Real Estate	Commercial & Industrial		Residential Real Estate		Total

September 30, 2013
Performing	$	612	$	-	$	-	$	612
Non-performing		4,720		-		527		5,247
Total	$	5,332	$	-	$	527	$	5,859

December 31, 2012
Performing	$	603	$	-	$	5	$	608
Non-performing		1,829		6		228		2,063
Total	$	2,432	$	6	$	233	$	2,671

Troubled debt restructured loans are considered impaired and are included in the previous impaired loans disclosures in this footnote. As of September 30, 2013, we have not committed to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings.

The following table summarizes troubled debt restructurings that occurred during the three and nine months ended September 30, 2013:


		Pre-Modification		Post-Modification
		Outstanding		Outstanding
	Number of	Recorded		Recorded
(Dollars in thousands)	Loans	Investment		Investment

Three months ended September 30, 2013
Commercial real estate	1	$	1,201	$	1,201

Nine months ended September 30, 2013
Commercial real estate	3	$	3,100	$	3,100
Residential real estate	1		302		302

The troubled debt restructurings presented in the table above resulted in an allocation of the allowance for credit losses of $49 thousand and $112 thousand for the three and nine months ended September 30, 2013, respectively. These specific reserves are included in the allowance for credit losses for loans individually evaluated for impairment. There were $200 thousand in charge-offs on the troubled debt restructurings presented in the table above during the three and nine months ended September 30, 2013.

There were no troubled debt restructurings that occurred during the three and nine months ended September 30, 2012, therefore, no allocation for the allowance for credit losses or charge-offs were required on loans modified as troubled debt restructurings during the three and nine months ended September 30, 2012.

There were no troubled debt restructurings for which there was a payment default within twelve months following the date of the restructuring for the three and nine months ended September 30, 2013 and 2012.