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 months ended June 30, 2014 and 2013:



	Commercial				Commercial		Residential		Consumer
	and				Real		Real		and
(Dollars in	Industrial		Construction		Estate		Estate		Other		Unallocated		Total
thousands)
Three Months Ended:
June 30, 2014
Beginning balance	$	289	$	315	$	3,687	$	862	$	19	$	265	$	5,437
Charge-offs		(1)		-		-		1		(9)		-		(9)
Recoveries		3		-		17		3		3		-		26
Provision		(34)		39		46		(29)		-		378		400
Ending balance	$	257	$	354	$	3,750	$	837	$	13	$	643	$	5,854

June 30, 2013
Beginning balance	$	275		401		3,452		899		12		267	$	5,306
Charge-offs		-		(80)		(273)		(38)		(6)		-		(397)
Recoveries		-		-		37		-		1		-		38
Provision		(26)		79		256		129		8		254		700
Ending balance	$	249	$	400	$	3,472	$	990	$	15	$	521	$	5,647

Six Months Ended:
June 30, 2014
Beginning balance	$	222	$	308	$	3,399	$	941	$	16	$	535	$	5,421
Charge-offs		(1)		-		(358)		(85)		(22)		-		(466)
Recoveries		15		-		21		4		6		-		46
Provision		21		46		688		(23)		13		108		853
Ending balance	$	257	$	354	$	3,750	$	837	$	13	$	643	$	5,854

June 30, 2013
Beginning balance	$	271		223		3,395		869		38		180	$	4,976
Charge-offs		(6)		(122)		(1,012)		(66)		(15)		-		(1,221)
Recoveries		-		-		44		-		6		-		50
Provision		(16)		299		1,045		187		(14)		341		1,842
Ending balance	$	249	$	400	$	3,472	$	990	$	15	$	521	$	5,647

The following table presents the balance of the allowance of loan losses and loans receivable by class at June 30, 2014 and December 31, 2013, 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

June 30, 2014
Commercial and industrial	$	257	$	-	$	257	$	19,189	$	-	$	19,189
Construction		354		-		354		8,923		-		8,923
Commercial real estate		3,750		547		3,203		292,620		9,559		283,061
Residential real estate		837		88		749		106,471		2,229		104,242
Consumer and other loans		13		-		13		1,488		-		1,488
Unallocated		643		-		-		-		-		-
Total	$	5,854	$	635	$	4,576	$	428,691	$	11,788	$	416,903

December 31, 2013
Commercial and industrial	$	222	$	-	$	222	$	15,205	$	-	$	15,205
Construction		308		-		308		7,307		-		7,307
Commercial real estate		3,399		322		3,077		260,664		10,894		249,770
Residential real estate		941		163		778		107,992		2,626		105,366
Consumer and other loans		16		-		16		1,617		-		1,617
Unallocated		535		-		-		-		-		-
Total	$	5,421	$	485	$	4,401	$	392,785	$	13,520	$	379,265

An age analysis of loans receivable which were past due as of June 30, 2014 and December 31, 2013, 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

June 30, 2014
Commercial and industrial	$	62	$	-	$	-	$	62	$	19,127	$	19,189	$	-
Construction		-		-		-		-		8,923		8,923		-
Commercial real estate		2,396		338		8,375		11,109		281,511		292,620		-
Residential real estate		177		-		1,824		2,001		104,470		106,471		-
Consumer and other		6		-		1		7		1,481		1,488		-
Total	$	2,641	$	338	$	10,200	$	13,179	$	415,512	$	428,691	$	-

December 31, 2013
Commercial and industrial	$	13	$	-	$	-	$	13	$	15,192	$	15,205	$	-
Construction		-		-		-		-		7,307		7,307		-
Commercial real estate		2,139		775		9,823		12,737		247,927		260,664		123
Residential real estate		495		247		2,192		2,934		105,058		107,992		-
Consumer and other		7		1		-		8		1,609		1,617		-
Total	$	2,654	$	1,023	$	12,015	$	15,692	$	377,093	$	392,785	$	123


(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 June 30, 2014 and December 31, 2013, were:



(Dollars in thousands)	June 30, 2014		December 31, 2013

Commercial real estate	$	8,375	$	9,700
Residential real estate		1,824		2,192
Consumer and other		1		-
Total	$	10,200	$	11,892

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 June 30, 2014 and December 31, 2013:



			Special
(Dollars in thousands)	Pass		Mention		Substandard		Doubtful		Total
June 30, 2014
Commercial and industrial	$	19,170	$	19	$	-	$	-	$	19,189
Construction		8,923		-		-		-		8,923
Commercial real estate		274,480		6,358		11,651		131		292,620
Residential real estate		103,963		117		2,391		-		106,471
Consumer and other		1,487		-		1		-		1,488
	$	408,023	$	6,494	$	14,043	$	131	$	428,691

December 31, 2013
Commercial and industrial	$	15,192	$	13	$	-	$	-	$	15,205
Construction		7,307		-		-		-		7,307
Commercial real estate		240,204		7,378		12,917		165		260,664
Residential real estate		104,383		871		2,738		-		107,992
Consumer and other		1,477		140		-		-		1,617
	$	368,563	$	8,402	$	15,655	$	165	$	392,785

The following table reflects information about our impaired loans by class as of June 30, 2014 and December 31, 2013:



		June 30, 2014						December 31, 2013
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
(Dollars in thousands)	Investment		Balance		Allowance		Investment		Balance		Allowance

With no related allowance recorded:
Commercial real estate	$	4,279	$	5,141	$	-	$	7,394	$	7,967	$	-
Residential real estate		1,687		1,712		-		1,849		1,874		-

With an allowance recorded:
Commercial real estate		5,280		6,375		547		3,500		4,595		322
Residential real estate		542		542		88		777		871		163

Total:
Commercial real estate		9,559		11,516		547		10,894		12,562		322
Residential real estate		2,229		2,254		88		2,626		2,745		163
	$	11,788	$	13,770	$	635	$	13,520	$	15,307	$	485

The following table presents the average recorded investment and income recognized for the three and six months ended June 30, 2014 and 2013:


	For the Three Months Ended June 30, 2014				For the Three Months Ended June 30, 2013
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Dollars in thousands)	Investment		Recognized		Investment		Recognized
With no related allowance recorded:
Construction	$	-	$	-	$	494	$	-
Commercial real estate		4,321		10		5,181		1
Residential real estate		1,683		9		1,516		-
Total impaired loans without a related allowance		6,004		19		7,191		1

With an allowance recorded:
Construction		-		-		427		-
Commercial real estate		5,298		-		6,246		32
Residential real estate		678		3		1,924		2
Total impaired loans with an allowance		5,977		3		8,597		34
Total impaired loans	$	11,981	$	22	$	15,788	$	35


	For the Six Months Ended June 30, 2014				For the Six Months Ended June 30, 2013
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Dollars in thousands)	Investment		Recognized		Investment		Recognized
With no related allowance recorded:
Construction	$	-	$	-	$	993	$	-
Commercial real estate		5,372		18		5,431		3
Residential real estate		1,792		29		1,519		-
Total impaired loans without a related allowance		7,164		47		7,943		3

With an allowance recorded:
Commercial and industrial		-		-		9		-
Construction		-		-		441		-
Commercial real estate		4,672		1		6,415		37
Residential real estate		747		7		1,891		5
Total impaired loans with an allowance		5,420		8		8,756		42
Total impaired loans	$	12,584	$	55	$	16,699	$	45

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	Residential Real Estate		Total

June 30, 2014
Performing	$	1,184	$	427	$	1,611
Non-performing		2,965		225		3,190
Total	$	4,149	$	652	$	4,801

December 31, 2013
Performing	$	1,195	$	433	$	1,628
Non-performing		3,000		496		3,496
Total	$	4,195	$	929	$	5,124

Troubled debt restructured loans are considered impaired and are included in the previous impaired loans disclosures in this footnote. As of June 30, 2014, we have not committed to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings.

There were no troubled debt restructurings that occurred during the three and six months ended June 30, 2014. The following table summarizes troubled debt restructurings that occurred during the three and six months ended June 30, 2013:


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

Three Months Ended:
June 30, 2013
Commercial real estate	1	$	1,736	$	1,736

Six Months Ended:
June 30, 2013
Commercial real estate	2	$	1,899	$	1,899
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 $31 thousand and $63 thousand for the three and six months ended June 30, 2013. These specific reserves are included in the allowance for credit losses for loans individually evaluated for impairment. There were no charge-offs on the troubled debt restructurings presented in the table above during the three and six months ended June 30, 2013.

There were no troubled debt restructurings that occurred during the three and six months ended June 30, 2014, 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 six months ended June 30, 2014.

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 six months ended June 30, 2014 and 2013.