Note 4. Loans and Allowance for Loan Losses

At September 30, 2011 and December 31, 2010, loans are summarized as follows (amounts in thousands):

	September 30,			December 31,
	2011			2010
Commercial real estate-mortgage:
Owner-occupied	$	63,405		$	64,971
All other		62,009			64,060
Consumer real estate-mortgage		68,466			71,878
Construction and land development		32,808			29,848
Commercial and industrial		40,880			51,160
Consumer and other		2,833			3,330
Total loans		270,401			285,247
Less: Allowance for loan losses		(6,864	)		(9,132	)

Loans, net	$	263,537		$	276,115

The composition of loans by primary loan classification as well as impaired and performing loan status at September 30, 2011 and December 31, 2010 is summarized in the tables below (amounts in thousands):

September 30, 2011	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
	Mortgage		Mortgage		Development		Industrial		and Other		Total
Performing loans	$	113,077	$	61,561	$	31,131	$	40,075	$	2,833	$	248,677
Impaired loans		12,337		6,905		1,677		805		-		21,724
Total	$	125,414	$	68,466	$	32,808	$	40,880	$	2,833	$	270,401

December 31, 2010	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
	Mortgage		Mortgage		Development		Industrial		and Other		Total
Performing loans	$	119,084	$	61,455	$	27,774	$	50,492	$	3,279	$	262,084
Impaired loans		9,947		10,423		2,074		668		51		23,163
Total	$	129,031	$	71,878	$	29,848	$	51,160	$	3,330	$	285,247

The following tables show the allowance allocation by loan classification for impaired and performing loans as of September 30, 2011 and December 31, 2010 (amounts in thousands):

September 30, 2011	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
Allowance related to:	Mortgage		Mortgage		Development		Industrial		and Other		Total
Performing loans	$	1,798	$	993	$	467	$	596	$	52	$	3,906
Impaired loans		1,312		1,214		40		392		-		2,958
Total	$	3,110	$	2,207	$	507	$	988	$	52	$	6,864

December 31, 2010	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
Allowance related to:	Mortgage		Mortgage		Development		Industrial		and Other		Total
Performing loans	$	887	$	691	$	3,178	$	588	$	48	$	5,392
Impaired loans		906		2,420		60		337		17		3,740
Total	$	1,793	$	3,111	$	3,238	$	925	$	65	$	9,132

The following tables detail the changes in the allowance for loan losses for the nine month period ending September 30, 2011 and year ending December 31, 2010 by loan classification (amounts in thousands):

September 30, 2011	Commercial			Consumer			Construction			Commercial
	Real Estate-			Real Estate-			and Land			and			Consumer
	Mortgage			Mortgage			Development			Industrial			and Other			Total
Beginning balance	$	1,793		$	3,111		$	3,238		$	925		$	65		$	9,132
Charged-off loans		(1,221	)		(1,509	)		(73	)		(28	)		(24	)		(2,855	)
Recovery of charge-offs		250			33			58			72			29			442
Provision for loan losses		2,288			572			(2,716	)		19			(18	)		145
Ending balance	$	3,110		$	2,207		$	507		$	988		$	52		$	6,864

December 31, 2010	Commercial			Consumer			Construction			Commercial
	Real Estate-			Real Estate-			and Land			and			Consumer
	Mortgage			Mortgage			Development			Industrial			and Other			Total
Beginning balance	$	1,189		$	719		$	3,179		$	786		$	32		$	5,905
Charged-off loans		(2,309	)		(562	)		(1,260	)		(443	)		(114	)		(4,688	)
Recovery of charge-offs		213			54			19			282			56			624
Provision for loan losses		2,700			2,900			1,300			300			91			7,291
Ending balance	$	1,793		$	3,111		$	3,238		$	925		$	65		$	9,132

Credit quality indicators:

Federal regulations require the Bank to review and classify its assets on a regular basis. To fulfill this requirement the Bank systematically reviews its loan portfolio to ensure the Bank’s large loan relationships are being maintained within its loan policy guidelines, remains properly underwritten and is properly classified by loan grade. This review process is performed by the Bank's management, loan review, internal auditors, external auditors, and state and federal regulators.

The Bank’s loan grading process is as follows:

All loans are assigned a loan grade at the time of origination by the relationship manager. Typically, a loan is assigned a loan grade of “pass” at origination.

Loans greater than or equal to $500 thousand are reviewed by the Bank’s internal loan review department within 90 days of origination.

Loan relationships greater than or equal to $1 million are reviewed annually by the internal loan review department.

The Bank’s internal loan review department samples approximately 25 percent of all other loans less than $1 million on an annual basis for review.

If a loan is delinquent 60 days or more or a pattern of delinquency exists the loan will be selected for review.

Generally, all loans on the Bank’s internal watchlist are reviewed annually by internal loan review.

The Bank also contracts with an independent third party to perform loan reviews. This external party reviews approximately 40 percent of the Bank’s loan portfolio annually.

If a loan is classified as a problem asset it will be assigned one of the following loan grades: substandard, substandard-impaired, doubtful, and loss. “Substandard assets” must have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. “Doubtful assets” have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified “loss” is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations also provide for a “special mention” category, described as assets which do not currently expose an institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving close attention. When the Bank classifies an asset as substandard, substandard-impaired or doubtful a specific allowance for loan losses may be established.

The following table outlines the amount of each loan classification and the amount categorized into each risk rating as of September 30, 2011 and December 31, 2010 (amounts in thousands):

September 30, 2011	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
	Mortgage		Mortgage		Development		Industrial		and Other		Total
Pass	$	101,772	$	52,582	$	28,579	$	34,363	$	2,791	$	220,087
Special mention		10,199		5,146		1,692		5,435		18		22,490
Substandard		1,106		3,833		860		277		24		6,100
Substandard-impaired		9,802		6,905		1,677		805		-		19,189
Doubtful		2,535		-		-		-		-		2,535
	$	125,414	$	68,466	$	32,808	$	40,880	$	2,833	$	270,401

December 31, 2010	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
	Mortgage		Mortgage		Development		Industrial		and Other		Total
Pass	$	97,692	$	49,974	$	24,401	$	41,963	$	3,215	$	217,245
Special mention		19,289		3,786		2,121		7,405		54		32,655
Substandard		2,103		7,695		1,252		1,124		10		12,184
Substandard-impaired		9,947		10,423		2,074		668		51		23,163
	$	129,031	$	71,878	$	29,848	$	51,160	$	3,330	$	285,247

After the Bank’s independent loan review department completes the loan grade assignment, a loan impairment analysis is performed on loans graded substandard or worse. The following tables present summary information pertaining to impaired loans by loan classification as of September 30, 2011 and December 31, 2010 (amounts in thousands):

							For the nine months ended
	At September 30, 2011						September 30, 2011
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
Impaired loans without a valuation allowance:
Commercial real estate – mortgage	$	8,002	$	8,005	$	-	$	4,705	$	434
Consumer real estate – mortgage		2,864		2,996		-		3,758		54
Construction and land development		1,379		1,379		-		1,341		13
Commercial and industrial		282		282		-		552		32
Consumer and other		-		-		-		-
Total	$	12,527	$	12,662	$	-	$	10,356	$	533

Impaired loans with a valuation allowance:
Commercial real estate – mortgage	$	4,335	$	4,347	$	1,312	$	5,573	$	131
Consumer real estate – mortgage		4,041		4,203		1,214		6,141		125
Construction and land development		298		300		40		145		-
Commercial and industrial		523		523		392		807		55
Consumer and other		-		-		-		49		-
Total	$	9,197	$	9,373	$	2,958	$	12,715		311

Total impaired loans	$	21,724	$	22,035	$	2,958	$	23,071	$	844

							For the year ended
	At December 31, 2010						December 31, 2010
			Unpaid				Average
	Recorded		Principal		Related		Recorded
	Investment		Balance		Allowance		Investment
Impaired loans without a valuation allowance:
Commercial real estate – mortgage	$	1,663	$	2,163	$	-	$	2,747
Consumer real estate – mortgage		998		998		-		776
Construction and land development		1,793		1,793		-		1,526
Commercial and industrial		70		70		-		782
Consumer and other		2		2		-		1
Total	$	4,526	$	5,026	$	-	$	5,832

Impaired loans with a valuation allowance:
Commercial real estate – mortgage	$	8,284	$	8,284	$	906	$	8,494
Consumer real estate – mortgage		9,425		9,425		2,420		8,968
Construction and land development		281		281		60		2,674
Commercial and industrial		598		598		337		1,060
Consumer and other		49		49		17		178
Total	$	18,637	$	18,637	$	3,740	$	21,374

Total impaired loans	$	23,163	$	23,663	$	3,740	$	27,206

Interest income recognized on impaired loans was approximately $943,000 for the year ending December 31, 2010.

The following tables present an aged analysis of past due loans as of September 30, 2011 and December 31, 2010 (amounts in thousands):

September 30, 2011	30-89 Days		Past Due 90
	Past Due and		Days or More				Total		Current		Total
	Accruing		and Accruing		Nonaccrual		Past Due		Loans		Loans
Commercial real estate:
Owner-occupied	$	124	$	-	$	2,833	$	2,957	$	60,448	$	63,405
All other		99		-		789		888		61,121		62,009
Consumer real estate-mortgage		1,528		-		3,244		4,772		63,694		68,466
Construction and land development		249		-		1,614		1,863		30,945		32,808
Commercial and industrial		67		-		65		132		40,748		40,880
Consumer and other		21		-		15		36		2,797		2,833
Total	$	2,088	$	-	$	8,560	$	10,648	$	259,753	$	270,401

December 31, 2010	30-89 Days		Past Due 90
	Past Due and		Days or More				Total		Current		Total
	Accruing		and Accruing		Nonaccrual		Past Due		Loans		Loans
Commercial real estate:
Owner-occupied	$	985	$	-	$	618	$	1,603	$	63,368	$	64,971
All other		203		-		7,808		8,011		56,049		64,060
Consumer real estate-mortgage		631		-		5,114		5,745		66,133		71,878
Construction and land development		317		-		-		317		29,531		29,848
Commercial and industrial		116		-		75		191		50,969		51,160
Consumer and other		54		-		18		72		3,258		3,330
Total	$	2,306	$	-	$	13,633	$	15,939	$	269,308	$	285,247

Impaired loans also include loans that the Bank has elected to formally restructure when, due to the weakening credit status of a borrower, the restructuring may facilitate a repayment plan that seeks to minimize the potential losses that the Bank may have to otherwise incur. If on nonaccruing status as of the date of restructuring, the loans are included in nonperforming loans and are classified as impaired loans. Loans that have been restructured that were performing as of the restructure date are reported as troubled debt restructurings. At September 30, 2011 and December 31, 2010, there were $2.5 million and $948 thousand, respectively, of troubled debt restructurings that were performing as of the restructure date. Troubled commercial loans are restructured by specialists within our Special Asset department and all restructurings are approved by committees and credit officers separate and apart from the normal loan approval process. These specialists are trained to reduce the Bank’s overall risk and exposure to loss in the event of a restructuring through obtaining either or all of the following: improved documentation, additional guaranties, increase in curtailments, reduction in collateral terms, additional collateral or other similar strategies.

As a result of adopting the amendments in Accounting Standards Update No. 2011-02 in the third quarter of 2011, the Bank reassessed all restructurings that occurred on or after January 1, 2011 for identification as troubled debt restructurings. The Bank's reassessment resulted in no additional restructurings than those previously identified.

The following table presents a summary of loans that were modified as troubled debt restructurings during the period as of September 30, 2011 (amounts in thousands):

		Pre-Modification		Post-Modification
		Outstanding Recorded		Outstanding Recorded
	Number of Contracts	Investment		Investment
Troubled Debt Restructurings
Consumer real estate-mortgage	4	$	790	$	789
Construction and land development	2		748		748
Commercial and industrial	1		20		20

The following table presents a summary of loans that were modified as troubled debt restructurings during the past twelve months and for which there was a payment default during the period as of September 30, 2011 (amounts in thousands):

	Number of Contracts	Recorded Investment
Troubled Debt Restructurings
That Subsequently Defaulted
Consumer real estate-mortgage	2	$	92