Note 4. Loans and Allowance for Loan Losses

At June 30, 2013 and December 31, 2012, loans are summarized as follows (in thousands):

	June 30,					December 31,
	2013		Percent			2012		Percent
Commercial real estate-mortgage:
Owner-occupied	$	60,725		22.00	%	$	58,425		21.09	%
All other		67,416		24.42	%		66,747		24.10	%
Consumer real estate-mortgage		67,345		24.39	%		71,195		25.70	%
Construction and land development		36,185		13.11	%		38,557		13.92	%
Commercial and industrial		42,374		15.35	%		40,140		14.49	%
Consumer and other		2,018		0.73	%		1,927		0.70	%
Total loans		276,063		100.00	%		276,991		100.00	%
Less: Allowance for loan losses		(5,095)					(6,141)

Loans, net	$	270,968				$	270,850

Cornerstone follows the loan impairment accounting guidance in ASC Topic 310. A loan is considered impaired when, based on current information and events, it is probable that Cornerstone will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming loans and loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in interest rates, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collections.

The composition of loans by loan classification for impaired and performing loan status at June 30, 2013 and December 31, 2012, is summarized in the tables below (amounts in thousands):

June 30, 2013	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
	Mortgage		Mortgage		Development		Industrial		and Other		Total
Performing loans	$	117,910	$	63,782	$	35,762	$	39,620	$	2,018	$	259,092
Impaired loans		10,231		3,563		423		2,754		-		16,971
Total	$	128,141	$	67,345	$	36,185	$	42,374	$	2,018	$	276,063

December 31, 2012	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
	Mortgage		Mortgage		Development		Industrial		and Other		Total
Performing loans	$	115,959	$	69,329	$	37,607	$	36,980	$	1,927	$	261,802
Impaired loans		9,213		1,866		950		3,160		-		15,189
Total	$	125,172	$	71,195	$	38,557	$	40,140	$	1,927	$	276,991

The following tables show the allowance for loan losses allocation by loan classification for impaired and performing loans as of June 30, 2013 and December 31, 2012 (amounts in thousands):

June 30, 2013	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
Allowance related to:	Mortgage		Mortgage		Development		Industrial		and Other		Total
Performing loans	$	500	$	966	$	325	$	61	$	13	$	1,865
Impaired loans		2,573		280		-		377		-		3,230
Total	$	3,073	$	1,246	$	325	$	438	$	13	$	5,095

December 31, 2012	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
Allowance related to:	Mortgage		Mortgage		Development		Industrial		and Other		Total
Performing loans	$	319	$	952	$	781	$	29	$	14	$	2,095
Impaired loans		2,230		576		460		780		-		4,046
Total	$	2,549	$	1,528	$	1,241	$	809	$	14	$	6,141

The following tables detail the changes in the allowance for loan losses for the six month period ending June 30, 2013 and year ending December 31, 2012, by loan classification (amounts in thousands):

June 30, 2013	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
	Mortgage		Mortgage		Development		Industrial		and Other		Total
Beginning balance	$	2,549	$	1,528	$	1,241	$	809	$	14	$	6,141
Charged-off loans		(281)		(640)		(1,180)		(341)		(19)		(2,461)
Recovery of charge-offs		54		218		775		66		2		1,115
Provision for (reallocation of) loan losses		751		(140)		(511)		(96)		16		300
Ending balance	$	3,073	$	1,246	$	325	$	438	$	13	$	5,095

December 31, 2012	Commercial Real Estate- Mortgage		Consumer Real Estate- Mortgage		Construction and Land Development		Commercial and Industrial		Consumer and Other		Total
Beginning balance	$	3,557	$	2,518	$	827	$	482	$	16	$	7,400
Charged-off loans		(958)		(1,022)		(782)		(74)		(33)		(2,869)
Recovery of charge-offs		838		36		145		144		17		1,180
Provision for (reallocation of) loan losses		(888)		(4)		1,051		257		14		430
Ending balance	$	2,549	$	1,528	$	1,241	$	809	$	14	$	6,141

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 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.

Loan relationships greater than or equal to $500 thousand are reviewed by the Bank’s external loan review provider on an annual basis.

The Bank’s internal loan review department samples approximately 33 percent of all other loan relationships less than $500 thousand 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 or external loan review providers.

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 or doubtful, a specific allowance for loan losses may be established.

The following tables outline the amount of each loan classification and the amount categorized into each risk rating as of June 30, 2013 and December 31, 2012 (amounts in thousands):

June 30, 2013	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		and		Consumer
	Mortgage		Mortgage		Development		Industrial		and Other		Total
Pass	$	115,228	$	54,884	$	35,213	$	35,050	$	2,018	$	242,393
Special mention		2,185		6,171		98		4,392		-		12,846
Substandard		497		2,727		451		178		-		3,853
Substandard-impaired		8,957		3,563		423		2,754		-		15,697
Doubtful		1,274		-		-		-		-		1,274
	$	128,141	$	67,345	$	36,185	$	42,374	$	2,018	$	276,063

December 31, 2012	Commercial		Consumer		Construction		Commercial
	Real Estate-		Real Estate-		and Land		And		Consumer
	Mortgage		Mortgage		Development		Industrial		and Other		Total
Pass	$	111,313	$	57,959	$	36,802	$	36,482	$	1,904	$	244,460
Special mention		4,145		8,401		198		330		18		13,092
Substandard		501		2,969		607		168		5		4,250
Substandard-impaired		9,213		1,866		950		3,160		-		15,189
	$	125,172	$	71,195	$	38,557	$	40,140	$	1,927	$	276,991

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 June 30, 2013 and December 31, 2012 (in thousands):

							For the quarter ended
	At June 30, 2013						June 30, 2013
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
Impaired loans without a valuation allowance:
Commercial real estate – mortgage	$	5,324	$	5,390	$	-	$	4,719	$	148
Consumer real estate – mortgage		2,315		2,867		-		1,784		74
Construction and land development		423		436		-		379		8
Commercial and industrial		1,988		2,048		-		2,048		26
Total	$	10,050	$	10,741	$	-	$	8,930	$	256

Impaired loans with a valuation allowance:
Commercial real estate – mortgage	$	4,907	$	4,965	$	2,573	$	5,271	$	115
Consumer real estate – mortgage		1,248		1,248		280		1,182		47
Construction and land development		-		-		-		395		-
Commercial and industrial		766		767		377		853		40
Total	$	6,921	$	6,980	$	3,230	$	7,701	$	202

Total impaired loans	$	16,971	$	17,721	$	3,230	$	16,631	$	458

							For the year ended
	At December 31, 2012						December 31, 2012
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
Impaired loans without a valuation allowance:
Commercial real estate – mortgage	$	3,406	$	3,453	$	-	$	4,389	$	180
Consumer real estate – mortgage		513		540		-		1,538		52
Construction and land development		244		251		-		358		19
Commercial and industrial		2,111		2,155		-		2,277		55
Total	$	6,274	$	6,399	$	-	$	8,562	$	306

Impaired loans with a valuation allowance:
Commercial real estate – mortgage	$	5,807	$	5,848	$	2,230	$	6,616	$	215
Consumer real estate – mortgage		1,353		1,353		576		2,606		61
Construction and land development		706		706		460		642		49
Commercial and industrial		1,049		1,049		780		700		132
Total	$	8,915	$	8,956	$	4,046	$	10,564	$	457

Total impaired loans	$	15,189	$	15,355	$	4,046	$	19,126	$	763

The following tables present an aged analysis of past due loans as of June 30, 2013 and December 31, 2012 (in thousands):

June 30, 2013	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-mortgage:
Owner-occupied	$	1,852	$	-	$	605	$	2,457	$	58,268	$	60,725
All other		1,501		-		2,419		3,920		63,496		67,416
Consumer real estate-mortgage		872		-		787		1,659		65,686		67,345
Construction and land development		113		-		45		158		36,027		36,185
Commercial and industrial		772		-		3,027		3,799		38,575		42,374
Consumer and other		1		-		-		1		2,017		2,018
Total	$	5,111	$	-	$	6,883	$	11,994	$	264,069	$	276,063

December 31, 2012	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-mortgage:
Owner-occupied	$	2,738	$	-	$	956	$	3,694	$	54,731	$	58,425
All other		636		-		1,913		2,549		64,198		66,747
Consumer real estate-mortgage		1,858		-		616		2,474		68,721		71,195
Construction and land development		100		-		53		153		38,404		38,557
Commercial and industrial		1,227		-		2,467		3,694		36,446		40,140
Consumer and other		35		-		-		35		1,892		1,927
Total	$	6,594	$	-	$	6,005	$	12,599	$	264,392	$	276,991

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. At June 30, 2013 and December 31, 2012, the Bank has loans of approximately $8,366,000 and $9,403,000, respectively, that were modified for troubled debt restructuring. 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.

The following table presents a summary of loans that were modified as troubled debt restructurings during the six month period ending June 30, 2013 (amounts in thousands):

June 30, 2013		Pre-Modification		Post-Modification
		Outstanding Recorded		Outstanding Recorded
	Number of Contracts	Investment		Investment

Commercial real estate-mortgage	2	$	555	$	555
Consumer real estate-mortgage	1		66		66
Construction and land development	3		898		898
Commercial and industrial	3		2,389		2,389

June 30, 2012		Pre-Modification		Post-Modification
		Outstanding Recorded		Outstanding Recorded
	Number of Contracts	Investment		Investment

Consumer real estate-mortgage	1	$	65	$	65
Construction and land development	3		1,178		1,178
Commercial and industrial	3		2,389		2,389

There were no loans that were modified as troubled debt restructurings during the past twelve months and for which there was a subsequent payment default.