7.	Loans Receivable, Net and Allowance for Loan Losses

Loans receivable consist of the following (in thousands):


	June 30, 2014		September 30, 2013
Held for investment:
Real Estate Loans:
Residential	$	667,316	$	686,651
Construction		1,800		2,288
Commercial		188,343		159,469
Commercial		23,331		10,125
Obligations of states and political subdivisions		50,096		33,445
Home equity loans and lines of credit		40,866		41,923
Auto Loans		83,619		61
Other		3,590		2,332

		1,058,961		936,294
Less allowance for loan losses		8,836		8,064

Net loans	$	1,050,125	$	928,230

Included in the June 30, 2014 balances are loans acquired from FNCB, as of the acquisition date of January 24,2014 as follows:


Real Estate Loans:
Residential	$	933
Home equity loans and lines of credit		77
Other		20

Total loans	$	1,030

Included in the June 30, 2014 balances are loans acquired from Franklin Security Bank, as of the acquisition date of April 4, 2014 as follows:


Real Estate Loans:
Residential	$	17,151
Commercial		38,247
Commercial		9,308
Obligations of states and political subdivisions		7,309
Home equity loans and lines of credit		16
Auto loans		78,794
Other		1,363

Total loans	$	152,188


	Total Loans		Individually Evaluated for Impairment		Loans Acquired with Deteriorated Credit Quality		Collectively Evaluated for Impairment

June 30, 2014
Real Estate Loans:
Residential	$	667,316	$	13,093	$	109	$	654,114
Construction		1,800		—		—		1,800
Commercial		188,343		17,912		5,151		165,280
Commercial		23,331		536		293		22,502
Obligations of states and political subdivisions		50,096		—		—		50,096
Home Equity loans and lines of credit		40,866		220		—		40,646
Auto Loans		83,619		—		—		83,619
Other		3,590		—		—		3,590

Total	$	1,058,961	$	31,761	$	5,553	$	1,021,647


	Total Loans		Individually Evaluated for Impairment		Loans Acquired with Deteriorated Credit Quality		Collectively Evaluated for Impairment

September 30, 2013
Real Estate Loans:
Residential	$	686,651	$	14,018	$	271	$	672,362
Construction		2,288		—		—		2,288
Commercial		159,469		15,478		6,355		137,636
Commercial		10,125		220		502		9,403
Obligations of states and political subdivisions		33,445		—		—		33,445
Home Equity loans and lines of credit		41,923		379		3		41,541
Auto Loans		61		—		—		61
Other		2,332		—		—		2,332

Total	$	936,294	$	30,095	$	7,131	$	899,068

We maintain a loan review system that allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified losses based on a review of such information. A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans identified as impaired are evaluated independently. We do not aggregate such loans for evaluation purposes. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring.

A loan is considered to be a troubled debt restructuring (“TDR”) loan when the Company grants a concession to the borrower because of the borrower’s financial condition that it would not otherwise consider. Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates that are less than the current market rate for new obligations with similar risk. TDR loans that are in compliance with their modified terms and that yield a market rate may be removed from the TDR status after a period of performance.

The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired.


	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
June 30, 2014
With no specific allowance recorded:
Real Estate Loans
Residential	$	8,512	$	10,603	$	—	$	9,566	$	242
Construction		—		—		—		—		—
Commercial		22,252		23,205		—		20,241		553
Commercial		829		834		—		1,764		49
Obligations of states and political subdivisions		—		—		—		—		—
Home equity loans and lines of credit		183		458		—		285		4
Auto Loans		—		—		—		—		—
Other		—		—		—		—		—


Total		31,776		35,100		—		31,856		848


With an allowance recorded:
Real Estate Loans
Residential		4,690		5,258		531		3,425		79
Construction		—		—		—		—		—
Commercial		811		847		96		1,896		—
Commercial		—		—		—		—		—
Obligations of states and political subdivisions		—		—		—		—		—
Home equity loans and lines of credit		37		45		37		17		—
Auto Loans		—		—		—		—		—
Other		—		—		—		—		—


Total		5,538		6,150		664		5,338		79


Total:
Real Estate Loans
Residential		13,202		15,861		531		12,991		321
Construction		—		—		—		—		—
Commercial		23,063		24,052		96		22,137		553
Commercial		829		834		—		1,764		49
Obligations of states and political subdivisions		—		—		—		—		—
Home equity loans and lines of credit		220		503		37		302		4
Auto Loans		—		—				—		—
Other		—		—		—		—		—


Total Impaired Loans	$	37,314	$	41,250	$	664	$	37,194	$	927


	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
September 30, 2013
With no specific allowance recorded:
Real Estate Loans
Residential	$	11,251	$	13,013	$	—	$	9,716	$	159
Construction		—		—		—		—		—
Commercial		18,711		20,258		—		20,751		615
Commercial		722		731		—		1,034		9
Obligations of states and political subdivisions		—		—		—		—		—
Home equity loans and lines of credit		382		683		—		373		3
Other		—		—		—		18		—


Total		31,066		34,685		—		31,892		786


With an allowance recorded:
Real Estate Loans
Residential		3,038		3,221		518		2,655		74
Construction		—		—		—		—		—
Commercial		3,122		3,178		301		2,839
Commercial		—		—		—		—		—
Obligations of states and political subdivisions		—		—		—		—		—
Home equity loans and lines of credit		—		—		—		—
Other		—		—		—		—		—


Total		6,160		6,399		819		5,494		74


Total:
Real Estate Loans
Residential		14,289		16,234		518		12,371		233
Construction		—		—		—		—		—
Commercial		21,833		23,436		301		23,590		615
Commercial		722		731		—		1,034		9
Obligations of states and political subdivisions		—		—		—		—		—
Home equity loans and lines of credit		382		683		—		373		3
Other		—		—		—		18		—


Total Impaired Loans	$	37,226	$	41,084	$	819	$	37,386	$	860

Management uses a ten point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. The portion of any loan that represents a specific allocation of the allowance for loan losses is placed in the Doubtful category. Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Bank’s Commercial Loan Officers perform an annual review of all commercial relationships $250,000 or greater. Confirmation of the appropriate risk grade is included in the review on an ongoing basis. The Bank engages an external consultant to conduct loan reviews on at least a semi-annual basis. Generally, the external consultant reviews commercial relationships greater than $500,000 and/or all criticized relationships. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following tables present the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system as of June 30, 2014 and September 30, 2013 (in thousands):


	Pass		Special Mention		Substandard		Doubtful		Total
June 30, 2014
Commercial real estate loans	$	157,359	$	8,576	$	22,106	$	302	$	188,343
Commercial		22,295		375		661		—		23,331
Obligations of states and political subdivisions		50,096		—		—		—		50,096


Total	$	229,750	$	8,951	$	22,767	$	302	$	261,770


	Pass		Special Mention		Substandard		Doubtful		Total
September 30, 2013
Commercial real estate loans	$	129,799	$	9,440	$	20,230	$	—	$	159,469
Commercial		9,466		436		223		—		10,125
Obligations of states and political subdivisions		33,445		—		—		—		33,445


Total	$	172,710	$	9,876	$	20,453	$	—	$	203,039

All other loans are underwritten and structured using standardized criteria and characteristics, primarily payment performance, and are normally risk rated and monitored collectively on a monthly basis. These are typically loans to individuals in the consumer categories and are delineated as either performing or non-performing. The following tables present the risk ratings in the consumer categories of performing and non-performing loans at June 30, 2014 and September 30, 2013 (in thousands):


	Performing		Non-performing		Total
June 30, 2014
Real estate loans:
Residential	$	656,893	$	10,423	$	667,316
Construction		1,800		—		1,800
Home Equity loans and lines of credit		40,613		253		40,866
Auto Loans		83,594		25		83,619
Other		3,577		13		3,590


Total	$	786,477	$	10,714	$	797,191


	Performing		Non-performing		Total
September 30, 2013
Real estate loans:
Residential	$	675,706	$	10,945	$	686,651
Construction		2,288		—		2,288
Home Equity loans and lines of credit		41,584		339		41,923
Auto loans		61		—		61
Other		2,332		—		2,332


Total	$	721,971	$	11,284	$	733,255

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of June 30, 2014 and September 30, 2013 (in thousands):


	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non- Accrual		Total Loans
June 30, 2014
Real estate loans
Residential	$	652,247	$	3,857	$	789	$	—	$	10,423	$	15,069	$	667,316
Construction		1,800		—		—		—		—		—		1,800
Commercial		177,162		283		—		—		10,898		11,181		188,343
Commercial		21,682		204		127		—		1,318		1,649		23,331
Obligations of states and political subdivisions		50,077		19		—		—		—		19		50,096
Home equity loans and lines of credit		40,514		69		30		—		253		352		40,866
Auto Loans		83,312		282		—		—		25		307		83,619
Other		3,517		51		9		—		13		73		3,590

Total	$	1,030,311	$	4,765	$	955	$	—	$	22,930	$	28,650	$	1,058,961


	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non- Accrual		Total Loans
September 30, 2013
Real estate loans
Residential	$	671,850	$	2,866	$	990	$	—	$	10,945	$	14,801	$	686,651
Construction		2,288		—		—		—		—		—		2,288
Commercial		146,062		2,589				—		10,818		13,407		159,469
Commercial		8,948		—		—		—		1,177		1,177		10,125
Obligations of states and political subdivisions		33,445		—		—		—		—		—		33,445
Home equity loans and lines of credit		41,380		127		77		—		339		543		41,923
Auto loans		61		—		—		—		—		—		61
Other		2,275		57		—		—		—		57		2,332

Total	$	906,309	$	5,639	$	1,067	$	—	$	23,279	$	29,985	$	936,294

Our allowance for loan losses is maintained at a level necessary to absorb loan losses that are both probable and reasonably estimable. Management, in determining the allowance for loan losses, considers the losses inherent in its loan portfolio and changes in the nature and volume of loan activities, along with the general economic and real estate market conditions. Our allowance for loan losses consists of two elements: (1) an allocated allowance, which comprises allowances established on specific loans and class allowances based on historical loss experience and current trends, and (2) an allocated allowance based on general economic conditions and other risk factors in our markets and portfolios. We maintain a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of the loan portfolio, current economic conditions, management’s judgment and losses which are probable and reasonably estimable. The allowance is increased through provisions charged against current earnings and recoveries of previously charged-off loans. Loans that are determined to be uncollectible are charged against the allowance. While management uses available information to recognize probable and reasonably estimable loan losses, future loss provisions may be necessary, based on changing economic conditions. Payments received on impaired loans generally are either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. The allowance for loan losses as of June 30, 2014 is maintained at a level that represents management’s best estimate of losses inherent in the loan portfolio, and such losses were both probable and reasonably estimable.

In addition, the FDIC and the Pennsylvania Department of Banking, as an integral part of their examination process, have periodically reviewed our allowance for loan losses. The banking regulators may require that we recognize additions to the allowance based on its analysis and review of information available to it at the time of its examination.

Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

The following tables summarize changes in the primary segments of the ALL for the three and nine month periods ending June 30, 2014 and 2013:


	Real Estate Loans
	Residential			Construction			Commercial			Commercial Loans			Obligations of States and Political Subdivisions			Home Equity Loans and Lines of Credit			Auto Loans		Other Loans			Unallocated		Total
ALL balance at March 31, 2014		5,920			26			1,003			369			106			500			—		26			712		8,662
Charge-offs		(332	)		—			(23	)		—			—			(10	)		—		—			—		(365	)
Recoveries		34			—			—			2			—			—			—		3			—		39
Provision		312			(2	)		(399	)		222			10			(17	)		56		(3	)		321		500

ALL balance at June 30, 2014		5,934			24			581			593			116			473			56		26			1,033		8,836


March 31, 2013		5,791			28			837			350			106			496			—		19			44		7,671
Charge-offs		(509	)		—			(74	)		(16	)		—			—			—		—			—		(599	)
Recoveries		9			—			—			—			—			3			—		—			—		12
Provision		676			16			262			27			7			97			—		1			14		1,100

ALL balance at June 30, 2013		5,967			44			1,025			361			113			596			—		20			58		8,184

ALL balance at September 30, 2013		5,787			20			946			337			130			430			—		21			393		8,064
Charge-offs		(1,255	)		—			(73	)		(48	)		—			(73	)		—		—			—		(1,449	)
Recoveries		112			—			83			14			—			—			—		12			—		221
Provision		1,290			4			(375	)		290			(14	)		116			56		(7	)		640		2,000

ALL balance at June 30, 2014		5,934			24			581			593			116			473			56		26			1,033		8,836

September 30, 2012		5,401			29			699			474			127			499			—		22			51		7,302
Charge-offs		(1,752	)		—			(288	)		(16	)		—			(67	)		—		(6	)		—		(2,129	)
Recoveries		50			—			2			—			—			9			—		—			—		61
Provision		2,268			15			612			(97	)		(14	)		155			—		4			7		2,950

ALL balance at June 30, 2013		5,967			44			1,025			361			113			596			—		20			58		8,184

Acquired loans are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses.

The following table summarizes the primary segments of the ALL, segregated into amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of June 30, 2014 (in thousands):


	Real Estate Loans
	Residential		Construction		Commercial		Commercial Loans		Obligations of States and Political Subdivisions		Home Equity Loans and Lines of Credit		Auto Loans		Other Loans		Unallocated		Total
Individually evaluated for impairment		531		—		96		—		—		37		—		—		—		664
Collectively evaluated for impairment		5,403		24		485		593		116		436		56		26		1,033		8,172

ALL Balance at June 30, 2014		5,934		24		581		593		116		473		56		26		1,033		8,836

Individually evaluated for impairment		518		—		301		—		—		—		—		—		—		819
Collectively evaluated for impairment		5,269		20		645		337		130		430		—		21		393		7,245

ALL balance at September 30, 2013		5,787		20		946		337		130		430		—		21		393		8,064

The allowance for loan losses is based on estimates, and actual losses will vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date. The Company allocated increased provisions to the residential real estate, commercial loans, home equity loans and lines of credit segments for the nine month period ending June 30, 2014 due to increased charge off activity and impairment evaluations in those segments. Despite the above allocations, the allowance for loan losses is general in nature and is available to absorb losses from any loan segment.

The following is a summary of troubled debt restructuring granted during the three and nine months ended June 30, 2014 and 2013.


	For the Three Months Ended June 30, 2014
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Real estate loans:
Residential		2	$	236	$	236
Construction		—		—		—
Commercial		—		—		—
Commercial		—		—		—
Obligations of states and political subdivisions		—		—		—
Home equity loans and lines of credit		—		—		—
Auto Loans		—		—		—
Other		—		—		—


Total		2	$	236	$	236

Of the two new troubled debt restructurings granted for the three months ended June 30, 2014, one loan totaling $208,000 was granted terms and rate concessions and one loan totaling $28,000 was granted terms concessions.


	For the Three Months Ended June 30, 2013
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Real estate loans:
Residential		8	$	989	$	989
Construction		—		—		—
Commercial		—		—		—
Commercial		—		—		—
Obligations of states and political subdivisions		—		—		—
Home equity loans and lines of credit		1		98		98
Auto Loans		—		—		—
Other		—		—		—


Total		9	$	1,087	$	1,087

Of the nine new troubled debt restructurings granted for the three months ended June 30, 2013, six loans totaling $751,000 were granted terms and rate concessions and three loans totaling $336,000 were granted terms concessions.


	For the Nine Months Ended June 30, 2014
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Real estate loans:
Residential		9	$	1,293	$	1,293
Construction		—		—		—
Commercial		1		197		197
Commercial		—		—		—
Obligations of states and political subdivisions		—		—		—
Home equity loans and lines of credit		—		—		—
Auto Loans		—		—		—
Other		—		—		—


Total		10	$	1,490	$	1,490

Of the ten new troubled debt restructurings granted for the nine months ended June 30, 2014, six loans totaling $883,000 were granted terms and rate concessions and four loans totaling $607,000 were granted terms concessions.


	For the Nine Months Ended June 30, 2013
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Real estate loans:
Residential		12	$	1,589	$	1,589
Construction		—		—		—
Commercial		—		—		—
Commercial		—		—		—
Obligations of states and political subdivisions		—		—		—
Home equity loans and lines of credit		1		98		98
Auto Loans
Other		—		—		—


Total		13	$	1,687	$	1,687

Of the 13 new troubled debt restructurings granted for the nine months ended June 30, 2013, eight loans totaling $1.3 million were granted terms and rate concessions and five loans totaling $410,000 were granted terms concessions. There were no troubled debt restructurings that have subsequently defaulted within one year of modification for the three and nine months ended June 30, 2014 and 2013.