4.	CREDIT QUALITY OF LOANS AND ALLOWANCE FOR LOAN LOSSES

During 2011, the following circumstances occurred which represent the primary factors contributing to changes in the AFLL:

•

The Company experienced a significant decline in the outstanding balance of construction and land development as well as commercial and industrial loans. Additionally, the overall risk grade of the remaining loans within these segments has improved. Given the significance of historical loss rates attributable to these loan segments, the declining loan balances and improved average risk grades had a substantial impact on our general reserves, effectively lowering them by approximately 41 basis points, or $1.9 million, as compared to prior year end.

•

During 2011, management also conducted an impairment migration study using the Bank's historical data from the preceding two years. From this study we determined that our years to impairment AFLL model assumption should be reduced in all but two of our loan segments. Management also evaluated the AFLL model's unallocated internal and external qualitative factor percentages during 2011. In doing so, we determined that certain internal controls of the credit function had strengthened, thereby resulting in specific internal factors which have been scored to ensure they were consistent with such improved Bank policies and procedures. We further determined that increases in certain internal and external factors were warranted, primarily as a result of continued suppressed market conditions and trends in portfolio key performance indicators. Overall, our net internal and external qualitative factors increased by approximately 47 basis points, or $2.1 million, as compared to the prior year end.

Management's migration study was supplemented by an independent study of the allowance model. During 2011, the Bank also engaged an independent specialist to perform a loss migration analysis on the Bank's loan portfolio in order to provide additional statistical data and validation for the Bank's AFLL modeling process. That analysis provided the Bank with useful data regarding its loss migration history and mean level of loss history given our credit migration, and served as an independent validation of our overall allowance position at period end. Management and the Board of Directors have evaluated the impact of these AFLL model updates and determined that the allowance represents an amount necessary to absorb estimated probable losses in the loan portfolio.

An analysis of the allowance for loan losses for the years ended December 31, 2011, 2010 and 2009 follows:


	December 31,
	2011			2010			2009
	(Dollars in thousands)
Beginning balance	$	13,247		$	9,725		$	5,931
Provision for loan losses		8,483			12,980			11,100
Recoveries		320			287			260
Loans charged off		(9,958	)		(9,745	)		(7,566	)

Ending balance	$	12,092		$	13,247		$	9,725

The following table summarizes the balances by loan category of the allowance for loan losses with changes arising from charge-offs, recoveries and provision expense for the years ending December 31, 2011 and December 31, 2010:

Allowance for Loan Losses

As of December 31, 2011


Allowance for Credit Losses	Real Estate Construction and Land Development			Real Estate Secured by Farmland			Real Estate Secured by Residential Properties			Real Estate Secured by Nonfarm Nonresidential			Consumer Installment			Credit Cards and Related Plans			Commercial and Industrial			Loans to Finance Agricultural Production			All Other Loans			General Qualitative Portion			Total
	(Dollars in thousands)
Beginning balance	$	6,168		$	28		$	3,450		$	1,007		$	12		$	21		$	882		$	18		$	139		$	1,522		$	13,247
Charge-offs		(5,150	)		(—	)		(1,985	)		(1,887	)		(20	)		(294	)		(385	)		(—	)		(237	)		(—	)		(9,958	)
Recoveries		10			—			12			43			5			3			103			—			144			—			320
Provisions		2,627			(13	)		941			2,577			49			288			(45	)		97			(20	)		1,982			8,483

Ending Balance	$	3,655		$	15		$	2,418		$	1,740		$	46		$	18		$	555		$	115		$	26		$	3,504		$	12,092

Ending Balance
Individually evaluated for impairment	$	637		$	—		$	480		$	1,181		$	—		$	—		$	165		$	—		$	—		$	—		$	2,463

Ending Balance
Collectively evaluated for impairment	$	3,018		$	15		$	1,938		$	559		$	46		$	18		$	390		$	115		$	26		$	3,504		$	9,629

Loans
Ending Balance	$	67,127		$	29,890		$	110,374		$	203,063		$	6,620		$	1,661		$	45,679		$	21,539		$	10,589		$	—		$	496,542

Ending Balance: individually evaluated for impairment	$	10,074		$	—		$	5,514		$	14,029		$	—		$	—		$	561		$	1,111		$	—		$	—		$	31,289

Ending Balance: collectively evaluated for impairment	$	57,053		$	29,890		$	104,860		$	189,034		$	6,620		$	1,661		$	45,118		$	20,428		$	10,589		$	—		$	465,253

Allowance for Loan Losses

As of December 31, 2010


Allowance for Credit Losses	Real Estate Construction and Land Development			Real Estate Secured by Farmland			Real Estate Secured by Residential Properties			Real Estate Secured by Nonfarm Nonresidential			Consumer Installment			Credit Cards and Related Plans			Commercial and Industrial			Loans to Finance Agricultural Production			All Other Loans			General Qualitative & Quantitative Portion			Total
	(Dollars in thousands)
Beginning balance	$	4,623		$	25		$	2,383		$	541		$	23		$	13		$	523		$	16		$	169		$	1,409		$	9,725
Charge-offs		(5,977	)		(—	)		(2,022	)		(213	)		(54	)		(11	)		(1,191	)		(—	)		(277	)		(—	)		(9,745	)
Recoveries		111			—			19			—			7			1			19			—			130			—			287
Provisions		7,411			3			3,070			679			36			18			1,531			2			117			113			12,980

Ending Balance	$	6,168		$	28		$	3,450		$	1,007		$	12		$	21		$	882		$	18		$	139		$	1,522		$	13,247

Ending Balance
Individually evaluated for impairment	$	803		$	—		$	916		$	546		$	—		$	—		$	102		$	—		$	—		$	—		$	2,367

Ending Balance
Collectively evaluated for impairment	$	5,365		$	28		$	2,534		$	461		$	12		$	21		$	780		$	18		$	139		$	1,522		$	10,880

Loans
Ending Balance	$	90,145		$	26,661		$	120,278		$	217,709		$	4,209		$	2,261		$	60,238		$	28,215		$	17,915		$	—		$	567,631

Ending Balance: individually evaluated for impairment	$	15,940		$	—		$	6,103		$	3,812		$	—		$	—		$	397		$	—		$	—		$	—		$	26,252

Ending Balance: collectively evaluated for impairment	$	74,205		$	26,661		$	114,175		$	213,897		$	4,209		$	2,261		$	59,841		$	28,215		$	17,915		$	—		$	541,379

Loans are closely monitored by management for changes in quality. This monitoring includes assessing the appropriateness of the credit quality indicator in relation to the risk of the loan. Management uses the following indicators to grade the risk of each loan based on a system of eight possible ratings.

Pass: Include loans that are risk rated one through three. The primary source of repayment for pass loans is very likely to be sufficient, with secondary sources readily available; strong financial position; minimal risk; profitability, liquidity and capitalization are better than industry norms.

Weak Pass: Include loans that are risk rated four. The asset quality for weak pass assets is generally acceptable. Primary source of loan repayment is acceptable and secondary sources are likely to be realized, if needed; acceptable business credit, but borrowers operations, cash flow, or financial condition evidence more than average risk; requires above average levels of supervision and attention from Loan Officer. The source of increased risk has been identified, can be effectively managed/corrected, and the increased risk is not significant to warrant a more severe rating.

Special Mention: Include loans that are risk rated five. A special mention asset is considered to be high risk due to potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Company's credit position at some future date. Special mention assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Substandard: Include loans that are risk rated six through eight. Loans rated as substandard are considered to be very high risk. A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weakness that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Some loans that are substandard do not meet the definition of an impaired loan and therefore are not deemed impaired.

The following tables present loans as of December 31, 2011 and December 31, 2010 classified by risk type:

Credit Quality Indicators

As of December 31, 2011


	Pass		Weak Pass		Special Mention		Substandard		Total
	(Dollars in thousands)
Real Estate—Construction and Land Development Loans	$	27,833	$	23,237	$	4,853	$	11,204	$	67,127
Real Estate—Secured by Farmland		22,008		4,430		3,452		—		29,890
Real Estate—Secured by Residential Properties		60,121		31,146		12,302		6,805		110,374
Real Estate—Secured by Nonfarm Nonresidential		90,099		75,384		18,663		18,917		203,063
Consumer Installment		4,025		2,212		254		129		6,620
Credit Cards and Related Plans		850		529		279		3		1,661
Commercial and Industrial		25,133		16,146		2,686		1,714		45,679
Loans to Finance Agriculture Production		16,473		3,290		584		1,192		21,539
All Other Loans		3,171		7,393		25		—		10,589

Total	$	249,713	$	163,767	$	43,098	$	39,964	$	496,542

Credit Quality Indicators

As of December 31, 2010


	Pass		Weak Pass		Special Mention		Substandard		Total
	(Dollars in thousands)
Real Estate—Construction and Land Development Loans	$	35,356	$	27,978	$	9,466	$	17,345	$	90,145
Real Estate—Secured by Farmland		17,869		6,294		2,495		3		26,661
Real Estate—Secured by Residential Properties		64,457		43,364		3,469		8,988		120,278
Real Estate—Secured by Nonfarm Nonresidential		94,208		96,287		20,107		7,107		217,709
Consumer Installment		2,466		1,460		265		18		4,209
Credit Cards and Related Plans		1,211		869		89		92		2,261
Commercial and Industrial		33,416		22,805		3,292		725		60,238
Loans to Finance Agriculture Production		18,346		7,230		2,639		—		28,215
All Other Loans		8,442		9,341		119		13		17,915

Total	$	275,771	$	215,628	$	41,941	$	34,291	$	567,631

The following table summarizes the past due loans by category as of December 31, 2011 and December 31, 2010:

Past Due Loans

As of December 31, 2011


	30 -59 Days Past Due		60 -89 Days Past Due		Greater than 89 Days (1)		Total Past Due		Current		Total
	(Dollars in thousands)
Real Estate Construction and Land Development	$	447	$	198	$	6,142	$	6,787	$	60,340	$	67,127
Real Estate Secured by Farmland		—		—		—		—		29,890		29,890
Real Estate Secured by Residential Properties		1,055		993		1,278		3,326		107,048		110,374
Real Estate Secured by Nonfarm Nonresidential		2,357		—		4,446		6,803		196,260		203,063
Consumer Installment		65		—		22		87		6,533		6,620
Credit Cards and Related Plans		2		2		—		4		1,657		1,661
Commercial and Industrial		294		—		205		499		45,180		45,679
Loans to Finance Agricultural Production		—		—		—		—		21,539		21,539
All Other Loans		—		—		—		—		10,589		10,589

Total	$	4,220	$	1,193	$	12,093	$	17,506	$	479,036	$	496,542

Non-accrual Loans Included in above Totals	$	1,426	$	588	$	12,093	$	14,107	$	1,866	$	15,973

(1)	There were no loans outstanding that were past due ninety days or more that were still accruing at December 31, 2011.

Past Due Loans

As of December 31, 2010


	30 -59 Days Past Due		60 -89 Days Past Due		Greater than 89 Days (1)		Total Past Due		Current		Total
	(Dollars in thousands)
Real Estate Construction and Land Development	$	2,997	$	929	$	9,627	$	13,553	$	76,592	$	90,145
Real Estate Secured by Farmland		—		—		—		—		26,661		26,661
Real Estate Secured by Residential Properties		251		389		2,526		3,166		117,112		120,278
Real Estate Secured by Nonfarm Nonresidential		545		—		919		1,464		216,245		217,709
Consumer Installment		35		6		5		46		4,163		4,209
Credit Cards and Related Plans		3		—		—		3		2,258		2,261
Commercial and Industrial		111		19		553		683		59,555		60,238
Loans to Finance Agricultural Production		—		—		—		—		28,215		28,215
All Other Loans		22		4		—		26		17,889		17,915

Total	$	3,964	$	1,347	$	13,630	$	18,941	$	548,690	$	567,631

Non-accrual Loans Included in above Totals	$	53	$	625	$	13,630	$	14,308	$	1,588	$	15,896

(1)	There were no loans outstanding that were past due ninety days or more that were still accruing at December 31, 2010.

The following table presents impaired loans as of December 31, 2011 and December 31, 2010. The recorded investment balance includes the loan balance and accrued interest. The deferred fees that have yet to be recognized are not material for both periods.

Impaired Loans

As of December 31, 2011


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Dollars in thousands)
With no related allowance recorded:
Real Estate Construction and Land Development	$	6,280	$	11,137	$	—	$	7,940	$	143
Real Estate Secured by Farmland		—		—		—		—		—
Real Estate Secured by Residential Properties		2,135		2,611		—		3,575		77
Real Estate Secured by Nonfarm Nonresidential		7,075		7,484		—		3,209		98
Consumer Installment		—		—		—		—		—
Credit Cards and Related Plans		—		—		—		—		—
Commercial and Industrial		379		500		—		364		14
Loans to Finance Agricultural Production		1,109		1,110		—		93		6
All Other Loans		—		—		—		—		—

Total impaired loans with no related allowance recorded	$	16,978	$	22,842	$	—	$	15,181	$	338

With an allowance recorded:
Real Estate Construction and Land Development	$	3,806	$	3,794	$	637	$	6,410		116
Real Estate Secured by Farmland		—		—		—		—		—
Real Estate Secured by Residential Properties		3,391		3,382		480		4,099		89
Real Estate Secured by Nonfarm Nonresidential		6,976		6,957		1,181		4,550		139
Consumer Installment		—		—		—		—		—
Credit Cards and Related Plans		—		—		—		150		5
Commercial and Industrial		186		186		165		625		24
Loans to Finance Agricultural Production		—		—		—		—		—
All Other Loans		—		—		—		—		—

Total impaired loans with related allowance recorded	$	14,359	$	14,319	$	2,463	$	15,834	$	373

Total
Construction and Land Development	$	10,086	$	14,931	$	637	$	14,350	$	259
Residential		5,526		5,993		480		7,674		166
Commercial		15,725		16,237		1,346		8,841		281
Consumer		—		—		—		150		5

Total impaired loans	$	31,337	$	37,161	$	2,463	$	31,015	$	711

Impaired Loans

As of December 31, 2010


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Dollars in thousands)
With no related allowance recorded:
Real Estate Construction and Land Development	$	9,212	$	13,354	$	—	$	9,146	$	190
Real Estate Secured by Farmland		—		—		—		—		—
Real Estate Secured by Residential Properties		2,700		2,972		—		3,909		81
Real Estate Secured by Nonfarm Nonresidential		1,029		1,097		—		5,662		117
Consumer Installment		—		—		—		—		—
Credit Cards and Related Plans		—		—		—		—		—
Commercial and Industrial		218		217		—		385		8
Loans to Finance Agricultural Production		—		—		—		—		—
All Other Loans		—		—		—		—		—

Total impaired loans with no related allowance recorded	$	13,159	$	17,640	$	—	$	19,102	$	396

With an allowance recorded:
Real Estate Construction and Land Development	$	6,771	$	9,497	$	803	$	6,571		136
Real Estate Secured by Farmland		—		—		—		—		—
Real Estate Secured by Residential Properties		3,411		3,405		915		3,312		69
Real Estate Secured by Nonfarm Nonresidential		2,794		2,784		546		1,241		26
Consumer Installment		—		—		—		—		—
Credit Cards and Related Plans		—		—		—		—		—
Commercial and Industrial		179		199		102		925		19
Loans to Finance Agricultural Production		—		—		—		—		—
All Other Loans		—		—		—		—		—

Total impaired loans with related allowance recorded	$	13,155	$	15,885	$	2,366	$	12,049	$	250

Total
Construction and Land Development	$	15,983	$	22,851	$	803	$	15,717	$	326
Residential		6,111		6,377		915		7,221		150
Commercial		4,220		4,297		648		8,213		170
Consumer		—		—		—		—		—

Total impaired loans	$	26,314	$	33,525	$	2,366	$	31,151	$	646

The following table presents nonaccrual loans as of December 31, 2011 and December 31, 2010 by loan category:

Nonaccrual Loans


	December 31, 2011		December 31, 2010
	(Dollars in thousands)
Real Estate Construction and Land Development	$	6,795	$	10,839
Real Estate Secured by Farmland		—		—
Real Estate Secured by Residential Properties		2,113		3,268
Real Estate Secured by Nonfarm Nonresidential		6,767		1,231
Consumer Installment		22		5
Credit Cards and Related Plans		—		—
Commercial and Industrial		276		553
Loans to Finance Agricultural Production		—		—
All Other Loans		—		—

Total	$	15,973	$	15,896

Interest income not recognized due to loans being on nonaccrual status during the years ended December 31, 2011 and 2010 was approximately $850 thousand and $1.1 million, respectively.

For the year ended December 31, 2011 the following table presents a breakdown of the types of concessions made by loan class. The recorded investment balances presented are balances at the time of concessions.

Troubled Debt Restructurings


	December 31, 2011
	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(Dollars in thousands)
Below market interest rate:
Real Estate Secured by Residential Properties		1	$	219	$	219
Real Estate Secured by Nonfarm Nonresidential		4		3,424		3,424
Credit Cards and Related Plans		1		33		33

Total below market interest rate		6	$	3,676	$	3,676

Extended payment terms:
Real Estate Construction and Land Development		2	$	258	$	258
Real Estate Secured by Residential Properties		3		1,549		1,549
Real Estate Secured by Nonfarm Nonresidential		3		918		918
Commercial and Industrial		2		227		227

Total Extended Payment Terms		10	$	2,952	$	2,952

Forgiveness of principal:
Real Estate Construction and Land Development		10	$	925	$	860

Total forgiveness of principal		10	$	925	$	860

Total		26	$	7,553	$	7,488

The following table presents the successes and failures of the types of modifications for the year ended December 31, 2011. The recorded investment balances presented are as of December 31, 2011.


	Paid in Full				Paying as Restructured				Converted to Non-accrual				Foreclosure/Default
	Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment
	(Dollars in thousands)
Below market interest rate		—	$	—		6	$	3,679		—	$	—		—	$	—
Extended payment terms		1		—		8		2,750		1		161		—		—
Forgiveness of principal		10		—		—		—		—		—		—		—

Total		11	$	—		14	$	6,429		1	$	161	$	—	$	—

There were no loans that were restructured during the year ending on December 31, 2011 that were ninety or more past due and therefore had a payment default. As noted in the previous table there was one loan that, while the loan was not ninety days past due, was moved into nonaccrual status due to payment concerns.

Loans which management identifies as impaired generally will be nonperforming loans or restructured loans (also known as "troubled debt restructurings" or "TDRs"). As a result of adopting the amendments in ASU 2011-02, the Company reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are considered TDRs under the amended guidance. The Company identified no loans as TDRs which the allowance for loan losses had previously been measured under a general allowance methodology. TDRs are treated as impaired loans in determining the adequacy of the allowance for loan loss.