Note 7: Loans

Categories of loans at March 31, 2013 and December 31, 2012 include:

	March 31,			December 31,
	2013			2012
Commercial
Real estate	$	202,046		$	203,613
Construction and development		17,061			17,462
Other		68,276			67,773
		287,383			288,848

Residential Mortgage
One- to four- family		491,133			502,619

Consumer loans
Real estate		100,461			100,516
Auto		15,082			15,572
Boat/RVs		75,205			76,416
Other		6,293			6,598
		197,041			199,102
Total loans		975,557			990,569

Undisbursed loans in process		(6,015	)		(7,418	)
Unamortized deferred loan costs, net		2,325			2,432
Allowance for loan losses		(15,991	)		(16,038	)
Net loans	$	955,876		$	969,545

The risk characteristics of each loan portfolio segment are as follows:

Commercial

Commercial real estate

These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Construction and Development

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates and financial analyses of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial other

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Mortgage and Consumer

With respect to residential loans that are secured by 1-4 family residences and are primarily owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires PMI if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Nonaccrual Loan and Past Due Loans.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Non-accrual loans, segregated by class of loans, as of March 31, 2013 and December 31, 2012 are as follows:

	March 31,		December 31,
	2013		2012
Commercial
Real Estate	$	2,686	$	2,450
Construction and development		5,532		5,989
Other		1,712		1,315
Residential Mortgage		10,765		10,791
Consumer
Real estate		1,795		1,656
Auto		27		37
Boat/RV		1,249		1,076
Other		62		96

	$	23,828	$	23,410

An age analysis of Company’s past due loans, segregated by class of loans, as of March 31, 2013 and December 31, 2012 is as follows:

	March 31, 2013
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days and Accruing
Commercial
Real Estate	$	1,969	$	-	$	2,686	$	4,655	$	197,391	$	202,046	$	-
Construction and development		520		-		4,702		5,222		11,839		17,061		-
Other		1,191		-		729		1,920		66,356		68,276		-
Residential Mortgage		7,522		2,226		6,295		16,043		475,090		491,133		813
Consumer
Real estate		875		358		1,183		2,416		98,045		100,461		-
Auto		49		28		1		78		15,004		15,082		-
Boat/RV		1,291		751		352		2,394		72,811		75,205		-
Other		153		25		49		227		6,066		6,293		-

	$	13,570	$	3,388	$	15,997	$	32,955	$	942,602	$	975,557	$	813

	December 31, 2012
													Total Loans
					Greater						Total		> 90 Days
	30-59 Days		60-89 Days		Than 90		Total Past				Loans		and
	Past Due		Past Due		Days		Due		Current		Receivable		Accruing
Commercial
Real Estate	$	1,097	$	992	$	2,350	$	4,439	$	199,174	$	203,613	$	-
Construction and development		192		-		4,912		5,104		12,358		17,462		-
Other		259		223		735		1,217		66,556		67,773		-
Residential Mortgage		12,487		2,732		8,356		23,575		479,044		502,619		177
Consumer
Real estate		1,302		358		1,119		2,779		97,737		100,516		-
Auto		47		18		15		80		15,492		15,572		-
Boat/RV		1,508		756		497		2,761		73,655		76,416		-
Other		234		21		95		350		6,248		6,598		96

	$	17,126	$	5,100	$	18,079	$	40,305	$	950,264	$	990,569	$	273

Impaired Loans.

Loans are considered impaired in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

Loans are individually evaluated for impairment based on internal limits outlined in our lending policies. The current threshold for these evaluations is set at $250,000. Although all troubled debt restructurings are considered impaired loans they are not necessarily individually evaluated for impairment based on the guidelines noted previously.

Interest on impaired loans is recorded based on the performance of the loan. All interest received on impaired loans that are on nonaccrual is accounted for on the cash-basis method until qualifying for return to accrual. Interest is accrued per contract for impaired loans that are performing.

The following tables present impaired loans for the three month periods ended March 31, 2013 and 2012 and the year ended December 31, 2012.

	March 31, 2013
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Commercial
Real estate	$	3,992	$	5,056	$	-	$	4,136	$	41
Construction and development		2,667		4,842		-		2,804		8
Other		936		936		-		954		3
Residential Mortgage		2,341		3,280		-		2,463		13

Loans with a specific valuation allowance
Commercial
Real estate		208		208		100		208		3
Construction and development		5,265		7,879		1,159		5,297		6
Other		634		634		380		773		6
Residential Mortgage		833		833		57		833		9

Total
Commercial
Real estate	$	4,200	$	5,264	$	100	$	4,344	$	44
Construction and development	$	7,932	$	12,721	$	1,159	$	8,101	$	14
Other	$	1,570	$	1,570	$	380	$	1,727	$	9
Residential Mortgage	$	3,174	$	4,113	$	57	$	3,296	$	22

	December 31, 2012
							Average
			Unpaid				Investment in		Interest
	Recorded		Principal		Specific		Impaired		Income
	Balance		Balance		Allowance		Loans		Recognized
Loans without a specific valuation allowance
Commercial
Real estate	$	5,341	$	6,354	$	-	$	5,384	$	248
Construction and development		3,632		7,078		-		4,884		30
Other		972		972		-		2,828		117
Residential Mortgage		2,583		3,522		-		3,755		58

Loans with a specific valuation allowance
Commercial
Real estate		208		947		100		211		12
Construction and development		4,639		5,157		959		5,230		78
Other		912		912		257		921		30
Residential Mortgage		834		834		57		654		-

Total
Commercial
Real estate	$	5,549	$	7,301	$	100	$	5,595	$	260
Construction and development	$	8,271	$	12,235	$	959	$	10,114	$	108
Other	$	1,884	$	1,884	$	257	$	3,749	$	147
Residential Mortgage	$	3,417	$	4,356	$	57	$	4,409	$	58

	March 31, 2012
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Commercial
Real estate	$	4,840	$	5,690	$	-	$	5,158	$	13
Construction and development		4,216		9,152		-		5,044		10
Other		3,292		3,292		-		3,609		2
Residential Mortgage		3,892		5,383		-		4,635		22

Loans with a specific valuation allowance
Commercial
Real estate		1,092		1,592		144		1,342		-
Construction and development		7,071		7,281		1,437		7,071		-
Other		1,470		1,470		543		1,470		-
Residential Mortgage		533		533		37		535		-

Total
Commercial
Real estate	$	5,932	$	7,282	$	144	$	6,500	$	13
Construction and development	$	11,287	$	16,433	$	1,437	$	12,115	$	10
Other	$	4,762	$	4,762	$	543	$	5,079	$	2
Residential Mortgage	$	4,425	$	5,916	$	37	$	5,170	$	22

Commercial Loan Grades

Definition of Loan Grades. Loan grades are numbered 1 through 8. Grades 1-4 are "pass" credits, grade 5 [Special Mention] loans are "criticized" assets, and grades 6 [Substandard], 7 [Doubtful] and 8 [Loss] are "classified" assets. The use and application of these grades by the Bank are uniform and conform to the Bank's policy and regulatory definitions.

Pass. Pass credits are loans in grades prime through fair. These are at least considered to be credits with acceptable risks and would be granted in the normal course of lending operations.

Special Mention. Special mention credits have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the Bank’s credit position at some future date. If weaknesses cannot be identified, classifying as special mention is not appropriate. Special mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

Substandard. Credits which are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged. Financial statements normally reveal some or all of the following: poor trends, lack of earnings and cash flow, excessive debt, lack of liquidity, and the absence of creditor protection. Credits 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.

Doubtful. An extension of credit “doubtful” has 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 that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans. A Doubtful classification for an entire credit should be avoided when collection of a specific portion appears highly probable with the adequately secured portion graded Substandard.

Retail Loan Grades

Pass. Pass credits are loans that are currently performing as agreed and are not troubled debt restructurings.

Substandard. Substandard credits are loans that have reason to be considered to have a well defined weakness and placed on non-accrual. This would include all retail loans over 90 days and troubled debt restructurings which were delinquent at the time of modification.

The following information presents the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of March 31, 2013 and December 31, 2012.

March 31, 2013
Commercial Credit Exposure Credit Risk Profile
Internal Rating	Real estate		Construction and Development		Other

Pass	$	185,917	$	9,320	$	65,626
Special Mention		6,383		150		202
Substandard		9,746		7,591		1,838
Doubtful		-		-		610

Total	$	202,046	$	17,061	$	68,276

Retail Credit Exposure Credit Risk Profile
	Mortgage		Consumer
	Residential		Real Estate		Auto		Boat/RV		Other

Pass	$	474,762	$	98,107	$	15,050	$	73,723	$	6,152
Special Mention		1,991		-		-		-		-
Substandard		14,380		2,354		32		1,482		141

Total	$	491,133	$	100,461	$	15,082	$	75,205	$	6,293

December 31, 2012
Commercial Credit Exposure Credit Risk Profile
			Construction
			and
Internal Rating	Real estate		Development		Other

Pass	$	185,794	$	9,314	$	63,413
Special Mention		6,692		172		255
Substandard		11,127		7,976		3,281
Doubtful		-		-		824

Total	$	203,613	$	17,462	$	67,773

Retail Credit Exposure Credit Risk Profile
	Mortgage		Consumer
	Residential		Real Estate		Auto		Boat/RV		Other

Pass	$	486,027	$	97,972	$	15,533	$	75,026	$	6,434
Special Mention		2,012		-		-		-		-
Substandard		14,580		2,544		39		1,390		164

Total	$	502,619	$	100,516	$	15,572	$	76,416	$	6,598

Allowance for Loan Losses.

We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, including the general allowance and specific allowances for identified problem loans and portfolio segments. In addition, the allowance incorporates the results of measuring impaired loans as provided in FASB ASC 310, Receivables. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. The general allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the general allowance. Loss factors are based on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.

The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan. Senior management reviews these conditions quarterly in discussions with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the loss related to this condition is reflected in the general allowance for loan losses. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the general allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available. Due to the loss of numerous manufacturing jobs in the communities we serve during recent years and the increase in higher risk loans, like consumer and commercial loans, as a percentage of total loans, management has concluded that our allowance for loan losses should be greater than historical loss experience and specifically identified losses would otherwise indicate.

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2013 and 2012 and year ended December 31, 2012. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other segments.

	Three Months Ended March 31, 2013
	Commercial			Mortgage			Consumer			Total
Allowance for loan losses:
Balance, beginning of year	$	9,908		$	3,394		$	2,736		$	16,038
Provision charged to expense		200			500			250			950
Losses charged off		(237	)		(383	)		(480	)		(1,100	)
Recoveries		2			23			78			103
Balance, end of period	$	9,873		$	3,534		$	2,584		$	15,991

Ending balance:
Individually evaluated for impairment	$	1,639		$	57		$	-		$	1,696
Collectively evaluated for impairment		8,234			3,477			2,584			14,295
Total allowance for loan losses	$	9,873		$	3,534		$	2,584		$	15,991

Loans:
Ending balance
Individually evaluated for impairment	$	13,702		$	3,174		$	-		$	16,876
Collectively evaluated for impairment		273,681			487,959			197,041			958,681
Total loans	$	287,383		$	491,133		$	197,041		$	975,557

	Year Ended December 31, 2012
	Commercial			Mortgage			Consumer			Total
Allowance for loan losses:
Balance, beginning of year	$	10,602			3,444			2,769			16,815
Provision charged to expense		3,213			1,612			1,200			6,025
Losses charged off		(4,493	)		(1,901	)		(1,608	)		(8,002	)
Recoveries		586			239			375			1,200
Balance, end of period	$	9,908			3,394			2,736			16,038

Ending balance:
Individually evaluated for impairment	$	1,316			57			-			1,373
Collectively evaluated for impairment		8,592			3,337			2,736			14,665
Total allowance for loan losses	$	9,908		$	3,394		$	2,736		$	16,038

Loans:
Ending balance
Individually evaluated for impairment	$	15,704			3,417			-			19,121
Collectively evaluated for impairment		273,144			499,202			199,102			971,448
Total loans	$	288,848		$	502,619		$	199,102		$	990,569

	Three Months Ended March 31, 2012
	Commercial			Mortgage			Consumer			Total
Allowance for loan losses:
Balance, beginning of year	$	10,602		$	3,444		$	2,769		$	16,815
Provision charged to expense		390			465			495			1,350
Losses charged off		(901	)		(441	)		(525	)		(1,867	)
Recoveries		153			3			180			336
Balance, end of period	$	10,244		$	3,471		$	2,919		$	16,634

Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral.

For all loan portfolio segments except 1-4 family residential properties and consumer, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

The Company charges-off 1-4 family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge-down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged-off.

Troubled Debt Restructurings

Included in certain loan categories of impaired loans are certain loans that have been modified in a troubled debt restructuring, where economic concessions have been granted to borrowers who have experienced financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.

When we modify loans in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determined that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific reserve or a charge-off to the allowance.

Loans retain their accrual status at the time of their modification. As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual until a period of satisfactory performance, generally six months, is obtained. If a loan is on accrual at the time of the modification, the loan is evaluated to determine the collection of principal and interest is reasonably assured and generally stays on accrual.

The following tables provide detail regarding troubled debts restructured in the three month period ended March 31, 2013 and 2012.

Three Months Ended March 31, 2013
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	No. of Loans		Recorded Balance		Recorded Balance
Commercial
Real Estate		1	$	50	$	50
Other		2		1,009		723
Residential Mortgage		11		750		1,056
Consumer
Real estate		4		220		229
Auto		2		22		22
Boat/RV		1		30		30
Other		1		11		11

Three Months Ended March 31, 2012
			Pre- Modification		Post- Modification
			Outstanding		Outstanding
	No. of Loans		Recorded Balance		Recorded Balance
Commercial
Real Estate		1	$	403	$	403
Other		1		97		97
Residential Mortgage		9		839		863
Consumer
Real estate		7		325		326
Auto
Boat/RV		1		10		10

The impact to the allowance for loan losses due to these modifications was insignificant.

Newly restructured loans by types are as follows:

	Three Months Ended March 31, 2013
	Interest Only		Term		Combination		Total Modification
Commercial
Real Estate	$	-	$	-	$	50	$	50
Other		-		88		635		723
Residential Mortgage		-		-		1,057		1,057
Consumer
Real estate		-		213		16		229
Auto		-		4		18		22
Boat/RV		-		30		-		30
Other		-		-		11		11

	Three Months Ended March 31, 2012
	Interest Only		Term		Combination		Total Modification
Commercial
Real Estate	$	-	$	403	$	1,117	$	1,520
Construction and development		-		-		172		172
Other		-		143		181		324
Residential Mortgage		320		169		2,107		2,596
Consumer
Real estate		-		55		775		830
Auto		-		11		4		15
Boat/RV		-		153		-		153
Other		-		8		44		52

The following tables provide detail regarding troubled debts restructured in the last twelve months that have defaulted in the quarter ended March 31, 2013.

Three Months Ended March 31, 2013
			Post-Modification
			Outstanding
	No. of Loans		Recorded Balance
Commercial
Real Estate		1	$	518
Other		1		109

We had no defaults of any loans modified as troubled debt restructurings made for the three months ended March 31, 2012. Default is defined as any loan that becomes more than 90 days past due.