The Bank has a management Allowance for Loan and Lease Losses ("ALLL") Committee, which is responsible for, among other things, regularly reviewing the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The ALLL Committee reviews and approves loans and leases recommended for impaired status. The ALLL Committee also approves removing loans and leases from impaired status. The Bank's Audit and Compliance Committee provides board oversight of the ALLL process and reviews and approves the ALLL methodology on a quarterly basis.

Our methodology for assessing the appropriateness of the ALLL consists of three key elements, which include 1) the formula allowance; 2) the specific allowance; and 3) the unallocated allowance. By incorporating these factors into a single allowance requirement analysis, all risk-based activities within the loan portfolio are simultaneously considered.

The Bank performs regular credit reviews of the loan and lease portfolio to determine the credit quality and adherence to underwriting standards. When loans and leases are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process. The Company's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The 10 risk rating categories are a primary factor in determining an appropriate amount for the formula allowance.

The formula allowance is calculated by applying risk factors to various segments of pools of outstanding loans. Risk factors are assigned to each portfolio segment based on management's evaluation of the losses inherent within each segment. Segments or regions with greater risk of loss will therefore be assigned a higher risk factor.

Base risk – The portfolio is segmented into loan categories, and these categories are assigned a Base Risk factor based on an evaluation of the loss inherent within each segment.

Extra risk – Additional risk factors provide for an additional allocation of ALLL based on the loan risk rating system and loan delinquency, and reflect the increased level of inherent losses associated with more adversely classified loans.

Changes to risk factors – Risk factors are assigned at origination and may be changed periodically based on management's evaluation of the following factors: loss experience; changes in the level of non-performing loans; regulatory exam results; changes in the level of adversely classified loans (positive or negative); improvement or deterioration in local economic conditions; and any other factors deemed relevant.

Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALLL Committee which reviews and approves designated loans as impaired. A loan is considered impaired when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we either recognize an impairment reserve as a Specific Allowance to be provided for in the allowance for loan and lease losses or charge-off the impaired balance on collateral dependent loans if it is determined that such amount represents a confirmed loss. Loans determined to be impaired with a specific allowance are excluded from the formula allowance so as not to double-count the loss exposure. The non-accrual impaired loans as of period end have already been partially charged off to their estimated net realizable value, and are expected to be resolved over the coming quarters with no additional material loss, absent further decline in market prices.

The combination of the formula allowance component and the specific allowance component lead to an allocated allowance for loan and lease losses.

The Bank may also maintain an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises less than 10% of the allowance, but may be maintained at higher levels during times of deteriorating economic conditions characterized by falling real estate values. The unallocated amount is reviewed quarterly with consideration of factors including, but not limited to:

These factors are evaluated through a management survey of the Chief Credit Officer, Chief Lending Officers, Special Asset Manager, and Credit Review Manager. The survey requests responses to evaluate current changes in the nine qualitative factors. This information is then incorporated into our understanding of the reasonableness of the formula factors and our evaluation of the unallocated portion of the ALLL.

Management believes that the ALLL was adequate as of June 30, 2011. There is, however, no assurance that future loan losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review. Approximately 80% of our loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the allowance for loan and lease losses. The U.S. recession, the housing market downturn, and declining real estate values in our markets have negatively impacted aspects of our residential development, commercial real estate, commercial construction and commercial loan portfolios. A continued deterioration in our markets may adversely affect our loan portfolio and may lead to additional charges to the provision for loan and lease losses.

The reserve for unfunded commitments ("RUC") is established to absorb inherent losses associated with our commitment to lend funds, such as with a letter or line of credit. The adequacy of the ALLL and RUC are monitored on a regular basis and are based on management's evaluation of numerous factors. For each portfolio segment, these factors include:

There have been no significant changes to the Bank's methodology or policies in the periods presented.

The following tables summarizes activity related to the allowance for non-covered loan and lease losses by non-covered loan portfolio segment for the three and six months ended June 30, 2011 and 2010, respectively:


	Three Months Ended June 30, 2011
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Unallocated			Total
Balance, beginning of period	$	63,528	$	20,798	$	5,626	$	856	$	7,025		$	97,833
Charge-offs		(12,883)		(3,179)		(2,195)		(354)		-			(18,611)
Recoveries		2,208		695		100		111		-			3,114
Provision		9,129		5,436		1,623		255		(984	)		15,459

Balance, end of period	$	61,982	$	23,750	$	5,154	$	868	$	6,041		$	97,795


	Three Months Ended June 30, 2010
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Unallocated			Total
Balance, beginning of period	$	70,460	$	20,890	$	8,235	$	863	$	10,336		$	110,784
Charge-offs		(19,605)		(9,961)		(1,201)		(787)		-			(31,554)
Recoveries		4,312		370		50		185		-			4,917
Provision		13,048		8,548		2,689		587		4,895			29,767

Balance, end of period	$	68,215	$	19,847	$	9,773	$	848	$	15,231		$	113,914


	Six Months Ended June 30, 2011
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Unallocated			Total
Balance, beginning of period	$	64,405	$	22,146	$	5,926	$	803	$	8,641		$	101,921
Charge-offs		(24,314)		(11,355)		(2,929)		(888)		-			(39,486)
Recoveries		3,453		1,091		121		206		-			4,871
Provision		18,438		11,868		2,036		747		(2,600)			30,489

Balance, end of period	$	61,982	$	23,750	$	5,154	$	868	$	6,041		$	97,795


	Six Months Ended June 30, 2010
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Unallocated			Total
Balance, beginning of period	$	67,281	$	24,583	$	5,811	$	455	$	9,527		$	107,657
Charge-offs		(35,535)		(32,865)		(1,837)		(1,076)		-			(71,313)
Recoveries		4,596		649		170		282		-			5,697
Provision		31,873		27,480		5,629		1,187		5,704			71,873

Balance, end of period	$	68,215	$	19,847	$	9,773	$	848	$	15,231		$	113,914

The following table presents the allowance and recorded investment in non-covered loans by portfolio segment and balances individually or collectively evaluated for impairment as of June 30, 2011 and 2010, respectively:


	June 30, 2011
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Unallocated		Total
Allowance for non-covered loans and leases:
Collectively evaluated for impairment	$	59,277	$	20,812	$	5,136	$	868	$	6,041	$	92,134
Individually evaluated for impairment		2,705		2,938		18		-		-		5,661

Total	$	61,982	$	23,750	$	5,154	$	868	$	6,041	$	97,795

Non-covered loans and leases:
Collectively evaluated for impairment	$	3,663,034	$	1,330,749	$	522,309	$	34,584			$	5,550,676
Individually evaluated for impairment		166,464		29,921		178		-				196,563

Total	$	3,829,498	$	1,360,670	$	522,487	$	34,584			$	5,747,239


	June 30, 2010
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Unallocated		Total
Allowance for non-covered loans and leases:
Collectively evaluated for impairment	$	61,127	$	19,836	$	9,548	$	848	$	15,231	$	106,590
Individually evaluated for impairment		7,088		11		225		-				7,324

Total	$	68,215	$	19,847	$	9,773	$	848	$	15,231	$	113,914

Non-covered loans and leases:
Collectively evaluated for impairment	$	3,783,102	$	1,203,558	$	465,633	$	34,215			$	5,486,508
Individually evaluated for impairment		194,373		52,295		4,502		-				251,170

Total	$	3,977,475	$	1,255,853	$	470,135	$	34,215			$	5,737,678

(1)	The gross non-covered loan and lease balance excludes deferred loans fees of $11.7 million at June 30, 2011 and $11.0 million at June 30, 2010.

The following tables present a summary of activity in the reserve for unfunded commitments ("RUC") and unfunded commitments for the three and six months ended June 30, 2011 and 2010, respectively:


	Three Months Ended June 30, 2011
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Total
Balance, beginning of period	$	76	$	621	$	162	$	52	$	911
Net change to other expense		(15)		84		7		1		77

Balance, end of period	$	61	$	705	$	169	$	53	$	988


	Three Months Ended June 30, 2010
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Total
Balance, beginning of period	$	47	$	531	$	140	$	47	$	765
Net change to other expense		(6)		(21)		(4)		-		(31)

Balance, end of period	$	41	$	510	$	136	$	47	$	734


	Six Months Ended June 30, 2011
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Total
Balance, beginning of period	$	33	$	575	$	158	$	52	$	818
Net change to other expense		28		130		11		1		170

Balance, end of period	$	61	$	705	$	169	$	53	$	988


	Six Months Ended June 30, 2010
	Commercial Real Estate		Commercial		Residential		Consumer & Other		Total
Balance, beginning of period	$	57	$	484	$	144	$	46	$	731
Net change to other expense		(16)		26		(8)		1		3

Balance, end of period	$	41	$	510	$	136	$	47	$	734


	Commercial Real Estate		Commercial		Residential		Consumer & Other		Total
Unfunded commitments:
June 30, 2011	$	61,478	$	674,210	$	226,790	$	45,483	$	1,007,961
June 30, 2010		41,354		501,667		209,643		39,938		792,602

In the course of managing the loan portfolio, at certain times, management may decide to sell loans prior to resolution. The following table summarizes loans sold by loan portfolio during the three and six months ended June 30, 2011 and 2010, respectively:

We manage asset quality and control credit risk through diversification of the non-covered loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. The Bank's Credit Quality Group is charged with monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. Reviews of non-performing, past due non-covered loans and larger credits, designed to identify potential charges to the allowance for loan and lease losses, and to determine the adequacy of the allowance, are conducted on an ongoing basis. These reviews consider such factors as the financial strength of borrowers, the value of the applicable collateral, loan loss experience, estimated loan losses, growth in the loan portfolio, prevailing economic conditions and other factors.

A loan is considered impaired when based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Generally, when loans are identified as impaired they are moved to our Special Assets Division. When we identify a loan as impaired, we measure the loan for potential impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of collateral, less selling costs. The starting point for determining the fair value of collateral is through obtaining external appraisals. Generally, external appraisals are updated every six to nine months. We obtain appraisals from a pre-approved list of independent, third party, local appraisal firms. Approval and addition to the list is based on experience, reputation, character, consistency and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is: (a) currently licensed in the state in which the property is located, (b) is experienced in the appraisal of properties similar to the property being appraised, (c) is actively engaged in the appraisal work, (d) has knowledge of current real estate market conditions and financing trends, (e) is reputable, and (f) is not on Freddie Mac's nor the Bank's Exclusionary List of appraisers and brokers. In certain cases appraisals will be reviewed by our Real Estate Valuation Services group to ensure the quality of the appraisal and the expertise and independence of the appraiser. Upon receipt and review, an external appraisal is utilized to measure a loan for potential impairment. Our impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification. Typical justified adjustments might include discounts for continued market deterioration subsequent to appraisal date, adjustments for the release of collateral contemplated in the appraisal, or the value of other collateral or consideration not contemplated in the appraisal. An appraisal over one year old in most cases will be considered stale dated and an updated or new appraisal will be required. Any adjustments from appraised value to net realizable value are detailed and justified in the impairment analysis, which is reviewed and approved by senior credit quality officers and the Company's Allowance for Loan and Lease Losses ("ALLL") Committee. Although an external appraisal is the primary source to value collateral dependent loans, we may also utilize values obtained through purchase and sale agreements, negotiated short sales, broker price opinions, or the sales price of the note. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed and approved on a quarterly basis at or near the end of each reporting period. Based on these processes, we do not believe there are significant time lapses for the recognition of additional loan loss provisions or charge-offs from the date they become known.

Loans are classified as non-accrual when collection of principal or interest is doubtful—generally if they are past due as to maturity or payment of principal or interest by 90 days or more—unless such loans are well-secured and in the process of collection. Additionally, all loans that are impaired are considered for non-accrual status. Loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear relatively certain.

Loans are reported as restructured when the Bank grants a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as the Bank will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan's carrying value. These impairment reserves are recognized as a specific component to be provided for in the allowance for loan and lease losses.

Loans are reported as past due when installment payments, interest payments, or maturity payments are past due based on contractual terms. All loans determined to be impaired are individually assessed for impairment except for impaired consumer loans which are collectively evaluated for impairment in accordance with ASC 450, Contingencies. The specific factors considered in determining that a loan is impaired include borrower financial capacity, current economic, business and market conditions, collection efforts, collateral position and other factors deemed relevant. Generally, impaired loans are placed on non-accrual status and all cash receipts are applied to the principal balance. Continuation of accrual status and recognition of interest income is generally limited to performing restructured loans.

The Company has written down impaired, non-accrual loans as of June 30, 2011 to their estimated net realizable value, generally based on disposition value, and expects resolution with no additional material loss, absent further decline in market prices.

The following table summarizes our non-covered non-accrual loans and loans past due by loan class as of June 30, 2011 and December 31, 2010:


	June 30, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days and Accruing		Total Past Due		Nonaccrual		Current		Total Non-covered Loans and Leases
Commercial real estate
Term & multifamily	$	15,154	$	16,940	$	555	$	32,649	$	53,059	$	3,446,426	$	3,532,134
Construction & development		99		-		-		99		8,093		176,515		184,707
Residential development		2,573		-		-		2,573		25,858		84,226		112,657
Commercial
Term		1,548		957		750		3,255		8,070		561,077		572,402
LOC & other		476		495		5,713		6,684		14,809		766,775		788,268
Residential
Mortgage		1,357		908		4,467		6,732		-		238,302		245,034
Home equity loans & lines		1,800		1,277		1,123		4,200		-		273,253		277,453
Consumer & other		207		60		529		796		-		33,788		34,584

Total	$	23,214	$	20,637	$	13,137	$	56,988	$	109,889	$	5,580,362	$	5,747,239

Deferred loan fees, net														(11,686	)

Total													$	5,735,553


	December 31, 2010
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days and Accruing		Total Past Due		Nonaccrual		Current		Total Non-covered Loans and Leases
Commercial real estate
Term & multifamily	$	14,596	$	8,328	$	3,008	$	25,932	$	49,162	$	3,408,381	$	3,483,475
Construction & development		2,172		6,726		-		8,898		20,124		218,792		247,814
Residential development		640		-		-		640		34,586		112,587		147,813
Commercial
Term		2,010		932		-		2,942		6,271		500,240		509,453
LOC & other		5,939		1,418		18		7,375		28,034		712,010		747,419
Residential
Mortgage		1,314		1,101		3,372		5,787		-		216,629		222,416
Home equity loans & lines		1,096		1,351		232		2,679		-		275,906		278,585
Consumer & other		361		233		441		1,035		-		32,008		33,043

Total	$	28,128	$	20,089	$	7,071	$	55,288	$	138,177	$	5,476,553	$	5,670,018

Deferred loan fees, net														(11,031	)

Total													$	5,658,987

The following table summarizes our impaired non-covered loans by loan class as of June 30, 2011 and December 31, 2010:


	June 30, 2011
	Unpaid Principal Balance		Recorded Investment		Related Allowance
With no related allowance recorded:
Commercial real estate
Term & multifamily	$	65,617	$	53,059	$	-
Construction & development		33,793		22,446		-
Residential development		50,608		35,396		-
Commercial
Term		10,498		8,923		-
LOC & other		46,650		15,087		-
Residential
Mortgage		-		-		-
Home equity loans & lines		-		-		-
Consumer & other		-		-		-
With an allowance recorded:
Commercial real estate
Term & multifamily		12,705		12,705		396
Construction & development		13,363		12,343		122
Residential development		30,515		30,515		2,187
Commercial
Term		198		198		7
LOC & other		5,713		5,713		2,931
Residential
Mortgage		178		178		18
Home equity loans & lines		-		-		-
Consumer & other		-		-		-
Total:
Commercial real estate		206,601		166,464		2,705
Commercial		63,059		29,921		2,938
Residential		178		178		18
Consumer & other		-		-		-

Total	$	269,838	$	196,563	$	5,661


	December 31, 2010
	Unpaid Principal Balance		Recorded Investment		Related Allowance
With no related allowance recorded:
Commercial real estate
Term & multifamily	$	62,605	$	49,790	$	-
Construction & development		33,091		25,558		-
Residential development		63,859		39,011		-
Commercial
Term		8,024		6,969		-
LOC & other		56,046		19,814		-
Residential
Mortgage		-		-		-
Home equity loans & lines		-		-		-
Consumer & other		-		-		-

With an allowance recorded:
Commercial real estate
Term & multifamily		29,926		28,070		1,614
Construction & development		-		-		-
Residential development		46,059		44,504		906
Commercial
Term		205		205		9
LOC & other		9,878		8,519		2,702
Residential
Mortgage		179		179		8
Home equity loans & lines		-		-		-
Consumer & other		-		-		-
Total:
Commercial real estate		235,540		186,933		2,520
Commercial		74,153		35,507		2,711
Residential		179		179		8
Consumer & other		-		-		-

Total	$	309,872	$	222,619	$	5,239

Loans with no related allowance reported generally represent non-accrual loans. The Company recognizes the charge-off of impairment reserves on impaired loans in the period it arises for collateral dependent loans. Therefore, the non-accrual loans as of June 30, 2011 have already been written-down to their estimated net realizable value, based on disposition value, and are expected to be resolved with no additional material loss, absent further decline in market prices. The valuation allowance on impaired loans primarily represents the impairment reserves on performing restructured loans, and is measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan's carrying value.

At June 30, 2011 and December 31, 2010, impaired loans of $81.0 million and $84.4 million were classified as accruing restructured loans, respectively. The restructurings were granted in response to borrower financial difficulty, and generally provide for a temporary modification of loan repayment terms. The restructured loans on accrual status and one loan included in loans past due 90+ days and accruing represent the only impaired loans accruing interest at June 30, 2011. The restructured loans on accrual status represent the only impaired loans accruing interest at December 31, 2010. In order for a restructured loan to be considered for accrual status, the loan's collateral coverage generally will be greater than or equal to 100% of the loan balance, the loan is current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow. The Company had no obligations to lend additional funds on the restructured loans as of June 30, 2011.

The following table summarizes our average recorded investment and interest income recognized on impaired non-covered loans by loan class for the three months and six months ended June 30, 2011 and 2010:


	For the three months ended June 30, 2011				For the three months ended June 30, 2010
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial real estate
Term & multifamily	$	54,086	$	-	$	57,851	$	-
Construction & development		21,063		-		24,668		-
Residential development		37,841		-		31,695		-
Commercial
Term		8,307		-		10,768		-
LOC & other		17,978		-		42,009		-
Residential
Mortgage		-		-		-		-
Home equity loans & lines		-		-		-		-
Consumer & other		-		-		-		-

With an allowance recorded:
Commercial real estate
Term & multifamily		15,733		233		29,731		220
Construction & development		8,905		266		4,264		-
Residential development		32,943		320		60,605		506
Commercial
Term		202		11		225		12
LOC & other		2,857		-		-		4
Residential
Mortgage		178		1		4,474		62
Home equity loans & lines		-		-		35		-
Consumer & other		-		-		-		-
Total:
Commercial real estate		170,571		819		208,814		726
Commercial		29,344		11		53,002		16
Residential		178		1		4,509		62
Consumer & other		-		-		-		-

Total	$	200,093	$	831	$	266,325	$	804


	For the six months ended June 30, 2011				For the six months ended June 30, 2010
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial real estate
Term & multifamily	$	54,725	$	-	$	60,241	$	-
Construction & development		23,238		-		28,665		-
Residential development		37,762		-		39,438		-
Commercial
Term		8,678		-		10,673		-
LOC & other		24,724		-		46,905		-
Residential
Mortgage		-		-		-		-
Home equity loans & lines		-		-		-		-
Consumer & other		-		-		-		-
With an allowance recorded:
Commercial real estate
Term & multifamily		19,995		424		32,856		451
Construction & development		6,506		338		2,843		-
Residential development		40,165		670		60,053		937
Commercial
Term		268		23		296		24
LOC & other		2,532		-		200		8
Residential
Mortgage		1,369		3		4,705		121
Home equity loans & lines		7		-		23		1
Consumer & other		-		-		-		-
Total:
Commercial real estate		182,391		1,432		224,096		1,388
Commercial		36,202		23		58,074		32
Residential		1,376		3		4,728		122
Consumer & other		-		-		-		-

Total	$	219,969	$	1,458	$	286,898	$	1,542

The impaired loans for which these interest income amounts were recognized primarily relate to accruing restructured loans.

As previously noted, the Company's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The Bank differentiates its lending portfolios into homogeneous loans (generally consumer loans) and non-homogeneous loans (generally all non-consumer loans). The 10 risk rating categories can be generally described by the following groupings for non-homogeneous loans:

Minimal Risk – A minimal risk loan, risk rated 1, is to a borrower of the highest quality. The borrower has an unquestioned ability to produce consistent profits and service all obligations and can absorb severe market disturbances with little or no difficulty.

Low Risk – A low risk loan, risk rated 2, is similar in characteristics to a minimal risk loan. Margins may be smaller or protective elements may be subject to greater fluctuation. The borrower will have a strong demonstrated ability to produce profits, provide ample debt service coverage and to absorb market disturbances.

Modest Risk – A modest risk loan, risk rated 3, is a desirable loan with excellent sources of repayment and no currently identifiable risk of collection. The borrower exhibits a very strong capacity to repay the credit in accordance with the repayment agreement. The borrower may be susceptible to economic cycles, but will have reserves to weather these cycles.

Average Risk – An average risk loan, risk rated 4, is an attractive loan with sound sources of repayment and no material collection or repayment weakness evident. The borrower has an acceptable capacity to pay in accordance with the agreement. The borrower is susceptible to economic cycles and more efficient competition, but should have modest reserves sufficient to survive all but the most severe downturns or major setbacks.

Acceptable Risk – An acceptable risk loan, risk rated 5, is a loan with lower than average, but still acceptable credit risk. These borrowers may have higher leverage, less certain but viable repayment sources, have limited financial reserves and may possess weaknesses that can be adequately mitigated through collateral, structural or credit enhancement. The borrower is susceptible to economic cycles and is less resilient to negative market forces or financial events. Reserves may be insufficient to survive a modest downturn.

Watch – A watch loan, risk rated 6, is still pass-rated, but represents the lowest level of acceptable risk due to an emerging risk element or declining performance trend. Watch ratings are expected to be temporary, with issues resolved or manifested to the extent that a higher or lower rating would be appropriate. The borrower should have a plausible plan, with reasonable certainty of success, to correct the problems in a short period of time. Borrowers rated Watch are characterized by elements of uncertainty, such as:

Special Mention – A Special Mention loan, risk rated 7, has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the institutions credit position at some future date. They contain unfavorable characteristics and are generally undesirable. Loans in this category are currently protected but are potentially weak and constitute an undue and unwarranted credit risk, but not to the point of a Substandard classification. A Special Mention loan has potential weaknesses, which if not checked or corrected, weaken the asset or inadequately protect the Bank's position at some future date. Such weaknesses include:

Substandard – A substandard asset, risk rated 8, 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 weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. Loans are classified as Substandard when they have unsatisfactory characteristics causing unacceptable levels of risk. A substandard loan normally has one or more well-defined weaknesses that could jeopardize repayment of the debt. The likely need to liquidate assets to correct the problem, rather than repayment from successful operations is the key distinction between Special Mention and Substandard. The following are examples of well-defined weaknesses:

Doubtful/Loss – Loans classified as doubtful, risk rated 9 to 10, have all the weaknesses inherent in one classified 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. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work towards strengthening of the asset, classification as a loss (and immediate charge-off) is deferred until more exact status may be determined. Pending factors include proposed merger, acquisition, liquidation procedures, capital injection, and perfection of liens on additional collateral and refinancing plans. In certain circumstances, a Doubtful rating will be temporary, while the Bank is awaiting an updated collateral valuation. In these cases, once the collateral is valued and appropriate margin applied, the remaining un-collateralized portion will be charged off. The remaining balance, properly margined, may then be upgraded to Substandard, however must remain on non-accrual. A loss rating is assigned to loans considered un-collectible and of such little value that the continuance as an active Bank asset is not warranted. This rating does not mean that the loan has no recovery or salvage value, but rather that the loan should be charged off now, even though partial or full recovery may be possible in the future.

Impaired – Loans are classified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due, in accordance with the terms of the original loan agreement, without unreasonable delay. This generally includes all loans classified as non-accrual and troubled debt restructurings.

The following table summarizes our internal risk rating by loan class as of June 30, 2011 and December 31, 2010: