Note 7 – Credit Quality of Loans

9 Months Ended

Sep. 30, 2011

Note 7 – Credit Quality of Loans

Loan Payment Status. The following tables present an aging analysis of the Company’s past due loans by loan category at September 30, 2011 and December 31, 2010.

	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Nonaccrual		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
September 30, 2011	(Dollars in thousands)
Real estate:
One-to-four family residential	$	1,338	$	1,214	$	-	$	9,539	$	12,091	$	139,765	$	151,856	$	-
Multifamily residential		-		-		-		216		216		21,559		21,775		-
Construction		-		-		-		845		845		20,240		21,085		-
Commercial land		257		335		-		9,737		10,329		32,884		43,213		-
Residential development		349		500		-		10,919		11,768		17,307		29,075		-
Other commercial real estate		2,890		2,085		378		20,921		26,274		280,649		306,923		389
Consumer real estate		1,097		375		103		2,697		4,272		109,320		113,592		104
Total real estate		5,931		4,509		481		54,874		65,795		621,724		687,519		493
Commercial business		53		212		-		1,271		1,536		49,615		51,151		-
Other consumer		118		86		-		973		1,177		11,158		12,335		-
Total	$	6,102	$	4,807	$	481	$	57,118	$	68,508	$	682,497	$	751,005	$	493


December 31, 2010
Real estate:
One-to-four family residential	$	1,512	$	1,761	$	-	$	5,332	$	8,605	$	125,164	$	133,769	$	-
Multifamily residential		-		-		-		-		-		23,667		23,667		-
Construction		240		391		-		63		694		19,727		20,421		-
Commercial land		1,224		2,056		-		10,463		13,743		76,912		90,655		-
Residential development		1,892		909		2,000		-		4,801		-		4,801		2,027
Other commercial real estate		3,302		3,956		472		18,632		26,362		257,507		283,869		482
Consumer real estate		679		419		37		2,726		3,861		114,160		118,021		37
Total real estate		8,849		9,492		2,509		37,216		58,066		617,137		675,203		2,546
Commercial business		236		201		17		1,338		1,792		46,261		48,053		18
Other consumer		539		239		-		876		1,654		11,600		13,254		-
Total	$	9,624	$	9,932	$	2,526	$	39,430	$	61,512	$	674,998	$	736,510	$	2,564

Troubled Debt Restructurings. The Company adopted the amendments in Accounting Standards Update (“ASU”) No. 2011-02, during the current period ended September 30, 2011, and has reassessed all restructurings that occurred on or after the beginning of the current fiscal year for identification as troubled debt restructurings (“TDRs”). The Company identified as TDRs certain receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology (ASC 450-20). Upon identifying the reassessed receivables as TDRs, the Company also identified them as impaired under the new guidance in ASC 310-10-35. The amendments in ASU No. 2011-02 require prospective application of the impairment measurement guidance in Section 310-10-35 for those receivables newly identified as impaired. At the end of the first interim period of adoption for the Company, the recorded investment in the receivables for which the allowance for credit losses was previously measured under a general allowance for credit losses methodology and are now impaired under Section 310-10-35 was $1.3 million (310-40-65-1(b)), and there was no allowance for credit losses associated with those receivables, on the basis of a current evaluation of loss (310-40-65-1(b)).

The modification or restructuring of a debt constitutes a TDR if we, for economic or legal reasons related to the borrower’s financial difficulties, grant a concession to the borrowers that we would not otherwise consider. Some examples of modifications are described below:

Rate modification – A modification in which only the interest rate is changed.

Term modification – A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Interest only modification – A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Transfer of Assets Modification – A modification in which a transfer of assets has occurred to partially satisfy debt, including foreclosure and repossession.

Combination Modification – Any other type of modification, including the use of multiple categories above.

The following tables present the Bank’s loans classified as TDRs by loan type as of September 30, 2011 and December 31, 2010:

	September 30, 2011
	Accrual Status		Non-accrual Status		Total Contracts		Total TDRs
	(Dollars in thousands)

Real estate:
Commercial land	$	-	$	471		1	$	471
Other commercial real estate		4,819		955		18		5,774
Total real estate		4,819		1,426		19		6,245
Commercial business		-		10		2		10
Total	$	4,819	$	1,436		21	$	6,255



	December 31, 2010
	Accrual Status		Non-accrual Status		Total Contracts		Total TDRs
	(Dollars in thousands)

Real estate:
One-to-four family residential	$	-	$	1,084		1	$	1,084
Commercial land		-		471		1		471
Other commercial real estate		1,882		2,163		13		4,045
Total real estate		1,882		3,718		15		5,600
Other consumer		17		-		1		17
Total	$	1,899	$	3,718		16	$	5,617

The following tables present newly restructured loans that occurred during the three- and nine-month periods ended September 30, 2011 and 2010, respectively:

	Three months ended
	September 30, 2011
	Term Modifications		Interest Only Modifications		Payment Modifications		Total Modifications		Total Number of Contracts
	(Dollars in thousands)
Pre-modification outstanding recorded investment:
Commercial real estate	$	-	$	-	$	720	$	720		4
Total	$	-	$	-	$	720	$	720		4

Post-modification outstanding recorded investment:
Commercial real estate	$	-	$	-	$	720	$	720		4
Total	$	-	$	-	$	720	$	720	$	4


	Three months ended
	September 30, 2010
	Term Modifications		Interest Only Modifications		Payment Modifications		Total Modifications		Total Number of Contracts
	(Dollars in thousands)
Pre-modification outstanding recorded investment:
Residential real estate	$	1,157	$	-	$	-	$	1,157		7
Commercial real estate		1,080		-		-		1,080		3
Total	$	2,237	$	-	$	-	$	2,237		10

Post-modification outstanding recorded investment:
Residential real estate	$	1,157	$	-	$	-	$	1,157		7
Commercial real estate		1,080		-		-		1,080		3
Total	$	2,237	$	-	$	-	$	2,237		10

	Nine months ended
	September 30, 2011
	Term Modifications		Interest Only Modifications		Payment Modifications		Total Modifications		Total Number of Contracts
	(Dollars in thousands)
Pre-modification outstanding recorded investment:
Commercial real estate	$	593	$	905	$	720	$	2,218		8
Commercial business		10		-		-		10		2
Total	$	603	$	905	$	720	$	2,228		10

Post-modification outstanding recorded investment:
Commercial real estate	$	593	$	905	$	720	$	2,218		8
Commercial business		10		-		-		10		2
Total	$	603	$	905	$	720	$	2,228		10


	Nine months ended
	September 30, 2010
	Term Modifications		Interest Only Modifications		Payment Modifications		Total Modifications		Total Number of Contracts
	(Dollars in thousands)
Pre-modification outstanding recorded investment:
Residential real estate	$	1,157	$	-	$	-	$	1,157		7
Commercial real estate		1,080		494		-		1,574		5
Total	$	2,237	$	494	$	-	$	2,731		12

Post-modification outstanding recorded investment:
Residential real estate	$	1,157	$	-	$	-	$	1,157		7
Commercial real estate		1,080		494		-		1,574		5
Total	$	2,237	$	494	$	-	$	2,731		12

All TDRs are not automatically placed on nonaccrual status. Generally, those TDRs that are placed on non-accrual status may return to accrual status when the borrower has sustained repayment performance in accordance with the modified terms. The number of payments needed to meet these criteria varies from loan to loan. However, as a general rule, most non-accrual loans should be able to return to accrual status after the payment of six consecutive regular scheduled payments.

During the three and nine month periods ended September 30, 2011, there was one payment default on a residential TDR. The collateral for this residential loan was acquired through foreclosure and was sold during the third quarter of 2011. The loan had an original principal balance of $1.1 million and the resulting loss from the disposition of the collateral was approximately $335,000.

Also, in the normal course of business, the Company will make loan restructurings or modifications to borrowers for reasons unrelated to the borrower’s financial condition. These restructurings or modifications are made based on the prevailing interest rates and terms offered to other borrowers for similar types of loans at the time of the modification. These types of debt restructurings or loan modifications would not be considered troubled debt restructurings.

Impaired Loans. The Company evaluates impairment of its non-covered residential mortgage and consumer loans on a collective basis, while non-covered commercial and construction loans are evaluated individually for impairment. The Company identifies a non-covered loan as impaired when it is probable that principal and interest will not be collected according to the contractual terms of the loan agreement. Specific allowances or principal write-downs are established for certain individual non-covered loans that management considers impaired. The remainder of the portfolio of non-covered loans is segmented into groups of loans with similar risk characteristics for evaluation and analysis.

The following table details the Company’s impaired loans at September 30, 2011 and December 31, 2010:

	Recorded Investment		Unpaid Principal Balance		Principal Write-down		Net Principal Balance		Related Allowance
	(Dollars in thousands)

September 30, 2011
Commercial land	$	2,105	$	3,969	$	1,992	$	1,977	$	-
Residential development		5,636		7,769		2,289		5,480		-
Commercial real estate - office		3,683		4,347		673		3,674		-
Commercial real estate - other		2,142		2,801		732		2,069		-
Consumer real estate		59		205		170		35		-
Commercial business		21		138		128		10		-
Total impaired loans	$	13,646	$	19,229	$	5,984	$	13,245	$	-



December 31, 2010
One-to-four family residential	$	804	$	964	$	200	$	764	$	-
Commercial land		2,792		3,403		774		2,629		-
Residential development		4,142		7,613		1,389		4,101		416
Commercial real estate - office		3,729		4,249		539		3,709		-
Commercial real estate - retail		1,863		4,162		2,320		1,823		-
Commercial real estate - other		174		445		298		147		-
Consumer real estate		235		696		487		205		-
Total impaired loans	$	13,739	$	21,532	$	6,007	$	13,378	$	416

Loan Classification. We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debts such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. This analysis is performed on at least a quarterly basis. We use the following definitions for risk ratings: Special Mention - Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of our credit position at some future date. Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have one or more well-defined weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values highly questionable and improbable. Loans not meeting the criteria above as part of the above described process are considered to be Pass rated loans. The Company’s portfolio of FDIC-covered loans was considered to be Pass rated loans at September 30, 2011 and December 31, 2010, as the loans were marked to fair value at acquisition and have FDIC loss-share agreements to cover at least 80% of any future losses.

As of September 30, 2011 and December 31, 2010, the risk category of loans is as follows:

			Criticized Loans
September 30, 2011	Pass		Special Mention		Substandard		Doubtful		Total
	(Dollars in thousands)

Real estate:
One-to-four family residential	$	149,378	$	541	$	1,937	$	-	$	151,856
Multifamily residential		21,510		265		-		-		21,775
Construction		21,085		-		-		-		21,085
Commercial land		34,325		5,002		3,886		-		43,213
Residential development		17,659		1,806		9,610		-		29,075
Other commercial real estate		276,993		13,703		16,227		-		306,923
Consumer real estate		109,421		1,140		3,031		-		113,592
Total real estate		630,371		22,457		34,691		-		687,519
Commercial business		45,222		5,392		537		-		51,151
Other consumer		12,103		103		129		-		12,335
Total loans	$	687,696	$	27,952	$	35,357	$	-	$	751,005

			Criticized Loans
December 31, 2010	Pass		Special Mention		Substandard		Doubtful		Total
	(Dollars in thousands)

Real estate:
One-to-four family residential	$	131,072	$	1,167	$	1,530	$	-	$	133,769
Multifamily residential		23,394		273		-		-		23,667
Construction		18,488		1,933		-		-		20,421
Land and development		66,105		10,533		16,012		75		92,725
Other commercial real estate		257,769		7,882		20,949		-		286,600
Consumer real estate		113,036		1,327		3,523		135		118,021
Total real estate		609,864		23,115		42,014		210		675,203
Commercial business		47,423		376		254		-		48,053
Other consumer		11,200		-		2,054		-		13,254
Total loans	$	668,487	$	23,491	$	44,322	$	210	$	736,510