NOTE 3 - Loans and Allowance for Loan Losses

The following table summarizes the composition of our loan portfolio.



		June 30, 2011				December 31, 2010
(dollars in thousands)		Amount		% of Total		Amount		% of Total
Commercial
Owner occupied RE	$	145,637		25.2	%	137,873		24.1	%
Non-owner occupied RE		162,545		28.1	%	163,971		28.6	%
Construction		14,373		2.5	%	11,344		2.0	%
Business		107,276		18.6	%	109,450		19.1	%
Total commercial loans		429,831		74.4	%	422,638		73.8	%
Consumer
Real estate		50,752		8.8	%	54,161		9.5	%
Home equity		82,883		14.3	%	79,528		13.9	%
Construction		6,300		1.1	%	8,569		1.5	%
Other		8,756		1.5	%	8,079		1.4	%
Total consumer loans		148,691		25.7	%	150,337		26.3	%
Deferred origination fees, net		(542	)	(0.1	)%	(583	)	(0.1	)%
Total gross loans, net of deferred fees		577,980		100.0	%	572,392		100.0	%
Less—allowance for loan losses		(8,719	)			(8,386	)
Total loans, net	$	569,261				564,006

Maturities and Sensitivity of Loans to Changes in Interest Rates

The information in the following tables summarizes the loan maturity distribution by type and related interest rate characteristics based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below, because borrowers have the right to prepay obligations with or without prepayment penalties.



						June 30, 2011
(dollars in thousands)		One year or less		After one but within five years		After five years			Total
Commercial
Owner occupied RE	$	25,696		94,204		25,737			145,637
Non-owner occupied RE		55,522		100,502		6,521			162,545
Construction		7,603		3,127		3,643			14,373
Business		52,613		51,860		2,803			107,276
Total commercial loans		141,434		249,693		38,704			429,831
Consumer
Real estate		15,292		23,736		11,724			50,752
Home equity		11,502		26,817		44,564			82,883
Construction		5,085		77		1,138			6,300
Other		4,089		3,943		724			8,756
Total consumer loans		35,968		54,573		58,150			148,691
Deferred origination fees, net		(166	)	(285	)	(91	)		(542	)
Total gross loans, net of deferred fees	$	177,236		303,981		96,763			577,980
Loans maturing after one year with:
Fixed interest rates								$	210,150
Floating interest rates									190,594



						December 31, 2010
		One year or less		After one but within five years		After five years			Total
Commercial:
Owner occupied RE	$	19,214		98,713		19,946			137,873
Non-owner occupied RE		55,593		100,252		8,126			163,971
Construction		6,661		4,010		673			11,344
Business		53,677		53,933		1,840			109,450
Total commercial loans		135,145		256,908		30,585			422,638
Consumer
Real estate		14,813		27,286		12,062			54,161
Home equity		9,406		31,398		38,724			79,528
Construction		7,139		649		781			8,569
Other		4,162		3,338		579			8,079
Total consumer		35,520		62,671		52,146			150,337
Deferred origination fees, net		(180	)	(319	)	(84	)		(583	)
Total gross loan, net of deferred fees	$	170,485		319,260		82,647			572,392
Loans maturing after one year with:
Fixed interest rates								$	200,230
Floating interest rates									201,677

Portfolio Segment Methodology

Commercial

Commercial loans are assessed for estimated losses by grading each loan using various risk factors identified through periodic reviews. We apply historic grade-specific loss factors to each funded loan. In the development of our statistically derived loan grade loss factors, we observe historical losses over a relevant period for each loan grade. These loss estimates are adjusted as appropriate based on additional analysis of external loss data or other risks identified from current economic conditions and credit quality trends. The allowance also includes an amount for the estimated impairment on nonaccrual commercial loans and commercial loans modified in a troubled debt restructuring ("TDR"), whether on accrual or nonaccrual status.

Consumer

For consumer loans, we determine the allowance on a collective basis utilizing forecasted losses to represent our best estimate of inherent loss. We pool loans, generally by product types with similar risk characteristics. In addition, we further stratify the pools risk grade and then apply historical loss rates over a relevant period to the stratified loan pools. In addition, we establish an allowance for consumer loans that have been modified in a TDR, whether on accrual or nonaccrual status.

Credit Quality Indicators

Commercial

We manage a consistent process for assessing commercial loan credit quality by monitoring our loan grading trends and past due statistics. All loans are subject to individual risk assessment. Our categories include Pass, Special Mention, Substandard, and Doubtful, each of which are defined by banking regulatory agencies. Delinquency statistics are also an important indicator of credit quality in the establishment of our allowance for credit losses.

The tables below provide a breakdown of outstanding commercial loans by risk category.



					June 30, 2011
(dollars in thousands)		Owner occupied RE	Non-owner occupied RE	Construction	Business	Total
Pass	$	136,319	140,078	11,978	95,729	384,104
Special Mention		4,316	6,399	-	3,092	13,807
Substandard		5,002	16,068	2,395	8,455	31,920
Doubtful		-	-	-	-	-
Loss		-	-	-	-	-
	$	145,637	162,545	14,373	107,276	429,831



					December 31, 2010
		Owner occupied RE	Non-owner occupied RE	Construction	Business	Total
Pass	$	127,959	145,166	8,887	101,985	383,997
Special Mention		4,762	3,365	-	2,774	10,901
Substandard		5,152	15,314	2,457	4,691	27,614
Doubtful		-	126	-	-	126
Loss		-	-	-	-	-
	$	137,873	163,971	11,344	109,450	422,638

The following tables provide past due information for outstanding commercial loans and include loans on non-accrual.



					June 30, 2011
(dollars in thousands)		Owner occupied RE	Non-owner occupied RE	Construction	Business	Total
Current	$	143,693	160,576	13,063	102,585	419,917
30-59 days past due		1,143	93	-	488	1,724
60-89 days past due		-	160	-	1,591	1,751
Greater than 90 Days		801	1,716	1,310	2,612	6,439
	$	145,637	162,545	14,373	107,276	429,831


					December 31, 2010
		Owner occupied RE	Non-owner occupied RE	Construction	Business	Total
Current	$	132,830	160,633	9,967	107,603	411,033
30-59 days past due		2,093	-	-	532	2,625
60-89 days past due		2,027	143	-	646	2,816
Greater than 90 Days		923	3,195	1,377	669	6,164
	$	137,873	163,971	11,344	109,450	422,638

Consumer

We manage a consistent process for assessing consumer loan credit quality by monitoring our loan grading trends and past due statistics. All loans are subject to individual risk assessment. Our categories include Pass, Special Mention, Substandard, and Doubtful, each of which are defined by banking regulatory agencies. Delinquency statistics is also an important indicator of credit quality in the establishment of our allowance for credit losses.

The tables below provide a breakdown of outstanding consumer loans by risk category.



					June 30, 2011
(dollars in thousands)		Real estate	Home equity	Construction	Other	Total
Pass	$	47,602	80,488	6,300	8,298	142,688
Special Mention		138	983	-	50	1,171
Substandard		3,012	1,412	-	408	4,832
Doubtful		-	-	-	-	-
Loss		-	-	-	-	-
	$	50,752	82,883	6,300	8,756	148,691


					December 31, 2010
		Real estate	Home equity	Construction	Other	Total
Pass	$	51,468	77,064	8,569	7,526	144,627
Special Mention		477	1,237	-	395	2,109
Substandard		2,216	1,227	-	158	3,601
Doubtful		-	-	-	-	-
Loss		-	-	-	-	-
	$	54,161	79,528	8,569	8,079	150,337

The following tables provide past due information for outstanding consumer loans and include loans on non-accrual.



					June 30, 2011
(dollars in thousands)		Real estate	Home equity	Construction	Other	Total
Current	$	49,504	82,299	6,300	8,717	146,820
30-59 days past due		163	130	-	23	316
60-89 days past due		158	-	-	-	158
Greater than 90 Days		927	454	-	16	1,397
	$	50,752	82,883	6,300	8,756	148,691


					December 31, 2010
		Real estate	Home equity	Construction	Other	Total
Current	$	53,283	79,002	8,569	8,059	148,913
30-59 days past due		457	234	-	7	698
60-89 days past due		338	101	-	13	452
Greater than 90 Days		83	191	-	-	274
	$	54,161	79,528	8,569	8,079	150,337

Nonperforming assets

The following table shows the nonperforming assets and the related percentage of nonperforming assets to total assets and gross loans. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of the contractual interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received.



(dollars in thousands)		June 30, 2011		December 31, 2010
Commercial
Owner occupied RE	$	800		1,183
Non-owner occupied RE		1,423		3,311
Construction		1,310		1,377
Business		2,315		1,781
Consumer
Real estate		1,085		928
Home equity		487		251
Construction		-		-
Other		21		7
Non-accruing troubled debt restructurings		2,760		488
Total nonaccrual loans		10,201		9,326
Other real estate owned		2,934		5,629
Total nonperforming assets	$	13,135		14,955
Nonperforming assets as a percentage of:
Total assets		1.73	%	2.03	%
Gross loans		2.27	%	2.61	%
Loans over 90 days past due (1)	$	7,993		6,439
Accruing troubled debt restructurings		3,691		-

(1) Loans over 90 days are included in nonaccrual loans

Impaired Loans

The tables below summarize key information for impaired loans. Our impaired loans include loans on nonaccrual status and loans modified in a TDR, whether on accrual or nonaccrual status. These impaired loans may have estimated impairment which is included in the allowance for loan losses.



				June 30, 2011
			Recorded investment
				Impaired loans
		Unpaid		with related	Related
		Principal	Impaired	allowance for	allowance for
(dollars in thousands)		Balance	loans	loan losses	loan losses
Commercial:
Owner occupied RE	$	4,443	4,443	3,902	960
Non-owner occupied RE		2,380	1,983	1,129	459
Construction		4,052	1,310	862	48
Business		4,251	3,701	3,307	1,540
Total commercial		15,126	11,437	9,200	3,007
Consumer:
Real estate		1,947	1,947	1,418	213
Home equity		487	487	487	73
Construction		-	-	-	-
Other		21	21	21	3
Total consumer		2,455	2,455	1,926	289
Total	$	17,581	13,892	11,126	3,296


				December 31, 2010
			Recorded investment
				Impaired loans
		Unpaid		with related	Related
		Principal	Impaired	allowance for	allowance for
		Balance	loans	loan losses	loan losses
Commercial:
Owner occupied RE	$	1,316	1,183	1,186	-
Non-owner occupied RE		3,754	3,455	1,207	772
Construction		4,052	1,377	-	-
Business		2,675	2,125	1,885	771
Total commercial		11,797	8,140	4,278	1,543
Consumer:
Real estate		929	929	929	344
Home equity		250	250	250
Construction		-	-	-	-
Other		7	7	-	-
Total consumer		1,186	1,186	1,179	344
Total	$	12,983	9,326	5,457	1,887

The following tables disaggregate our allowance for loan losses and recorded investment in loans by impairment methodology.



						June 30, 2011
		Allowance for loan losses			Recorded investment in loans
(dollars in thousands)		Commercial	Consumer	Total	Commercial	Consumer	Total
Individually evaluated	$	3,007	-	3,007	11,437	-	11,437
Collectively evaluated		4,791	921	5,712	418,394	148,691	567,085
Total	$	7,798	921	8,719	429,831	148,691	578,522


						December 31, 2010
		Allowance for loan losses			Recorded investment in loans
		Commercial	Consumer	Total	Commercial	Consumer	Total
Individually evaluated	$	1,552	-	1,552	8,140	-	8,140
Collectively evaluated		5,154	1,447	6,601	414,498	150,337	564,835
Total	$	6,706	1,447	8,153	422,638	150,337	572,975

Allowance for Loan Losses

The allowance for loan losses is management's estimate of credit losses inherent in the loan portfolio at the balance sheet date. We have an established process to determine the adequacy of the allowance for loan losses that assesses the losses inherent in our portfolio. While we attribute portions of the allowance to specific portfolio segments, the entire allowance is available to absorb credit losses inherent in the total loan portfolio. Our process involves procedures to appropriately consider the unique risk characteristics of our commercial and consumer loan portfolio segments. For each portfolio segment, impairment is measured collectively for groups of smaller loans with similar characteristics and individually for larger impaired loans. Our allowance levels are influenced by loan volumes, loan grade migration or delinquency status, historic loss experience and other economic conditions. As of June 30, 2011, we have modified our allowance methodology related to the commercial and consumer loan portfolios to use historical loss rates in determining the appropriate level of allowance needed. In addition, we have allocated the unallocated component of the allowance that existed at December 31, 2010 into the commercial and consumer portfolio segments.

Included in the allowance for loan losses for both portfolio segments is a component that reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Uncertainties and subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity or problem loans, quality of loan review and board of director oversight, concentrations of credit, and peer group comparisons are factors considered.

The following table summarizes the activity related to our allowance for loan losses:



		Six months ended June 30,
(dollars in thousands)		2011		2010
Balance, beginning of period	$	8,386		7,760
Provision for loan losses		1,375		3,700
Loan charge-offs:
Commercial:
Owner occupied RE		(72	)	(2	)
Non-owner occupied RE		(164	)	(525	)
Construction		(67	)	-
Business		(529	)	(2,181	)
Total commercial		(832	)	(2,708	)
Consumer:
Real estate		(19	)	(214	)
Home equity		(75	)	(261	)
Construction		-		-
Other		(183	)	(46	)
Total consumer		(277	)	(521	)
Total loan charge-offs		(1,109	)	(3,229	)
Loan recoveries:
Commercial:
Owner occupied RE		1		1
Non-owner occupied RE		40		-
Business		25		119
Construction		-		-
Total commercial		66		120
Consumer:		-		-
Real estate		-		-
Home equity		1		1
Construction		-		-
Other		-		-
Total consumer		1		1
Total recoveries		67		121
Net loan charge-offs		(1,042	)	(3,108	)
Balance, end of period	$	8,719		8,352
Net charge-offs to average loans (annualized)		0.36	%	1.08	%
Allowance for loan losses to gross loans		1.51	%	1.44	%
Allowance for loan losses to nonperforming loans		85.47	%	67.62	%

The following tables summarize the activity in the allowance for loan losses by our commercial and consumer portfolio segments.



				Six months ended June 30, 2011
(dollars in thousands)		Commercial		Consumer		Unallocated		Total
Balance, beginning of period	$	6,706		1,447		233		8,386
Provision		1,858		(250	)	(233	)	1,375
Loan charge-offs		(832	)	(277	)	-		(1,109	)
Loan recoveries		66		1				67
Net loan charge-offs		(766	)	(276	)	-		(1,042	)
Balance, end of period	$	7,798		921		-		8,719


						Year ended December 31, 2010
		Commercial		Consumer		Unallocated	Total
Balance, beginning of period	$	6,204		1,545		11	7,760
Provision		3,999		1,389		222	5,610
Loan charge-offs		(3,665	)	(1,495	)	-	(5,160	)
Loan recoveries		168		8		-	176
Net loan charge-offs		(3,497	)	(1,487	)	-	(4,984	)
Balance, end of period	$	6,706		1,447		233	8,386