Loans and Allowance for Loan Losses

Loans are stated at the principal amount outstanding net of unearned discounts, unearned income and allowance for loan losses. Unearned income includes deferred loan origination fees reduced by loan origination costs and is amortized to interest income over the life of the related loan using methods that approximated the effective interest rate method. Interest on substantially all loans is credited to income based on the principal amount outstanding. A summary of loans at September 30, 2012 and December 31, 2011 follows (in thousands):



	September 30, 2012		December 31, 2011
Construction and land development	$	25,117	$	23,136
Farm loans	83,413		72,586
1-4 Family residential properties	188,768		180,738
Multifamily residential properties	44,292		19,847
Commercial real estate	313,621		321,908
Loans secured by real estate	655,211		618,215
Agricultural loans	63,294		63,182
Commercial and industrial loans	154,190		150,631
Consumer loans	16,242		16,274
All other loans	9,370		11,430
Gross loans	898,307		859,732
Less:
Net deferred loan fees, premiums and discounts	330		704
Allowance for loan losses	11,645		11,120
Net loans	$	886,332	$	847,908

Loans expected to be sold are classified as held for sale in the consolidated financial statements and are recorded at the lower of aggregate cost or market value, taking into consideration future commitments to sell the loans. These loans are primarily for 1-4 family residential properties. The balance of loans held for sale of $1,390,000 and $1,046,000 at September 30, 2012 and December 31, 2011, respectively.

Most of the Company’s business activities are with customers located within central Illinois. At September 30, 2012, the Company’s loan portfolio included $146.7 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $125.8 million was concentrated in other grain farming. Total loans to borrowers whose businesses are directly related to agriculture increased $10.9 million from $135.8 million at December 31, 2011 while loans concentrated in other grain farming increased $5.7 million from $120.1 million at December 31, 2011. While the Company adheres to sound underwriting practices, including collateralization of loans, any extended period of low commodity prices, drought conditions, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio.

In addition, the Company has $46.2 million of loans to motels and hotels. The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region. While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in nonperforming loans to this business segment and potentially in loan losses. The Company also has $92.8 million of loans to lessors of non-residential buildings and $60.5 million of loans to lessors of residential buildings and dwellings.

The structure of the Company’s loan approval process is based on progressively larger lending authorities granted to individual loan officers, loan committees, and ultimately the Board of Directors. Outstanding balances to one borrower or affiliated borrowers are limited by federal regulation; however, limits well below the regulatory thresholds are generally observed. The vast majority of the Company’s loans are to businesses located in the geographic market areas served by the Company’s branch bank system. Additionally, a significant portion of the collateral securing the loans in the portfolio is located within the Company’s primary geographic footprint. In general, the Company adheres to loan underwriting standards consistent with industry guidelines for all loan segments.

The Company’s lending can be summarized into the following primary areas:

Commercial Real Estate Loans. Commercial real estate loans are generally comprised of loans to small business entities to purchase or expand structures in which the business operations are housed, loans to owners of real estate who lease space to non-related commercial entities, loans for construction and land development, loans to hotel operators, and loans to owners of multi-family residential structures, such as apartment buildings. Commercial real estate loans are underwritten based on historical and projected cash flows of the borrower and secondarily on the underlying real estate pledged as collateral on the debt. For the various types of commercial real estate loans, minimum criteria have been established within the Company’s loan policy regarding debt service coverage while maximum limits on loan-to-value and amortization periods have been defined. Maximum loan-to-value ratios range from 65% to 80% depending upon the type of real estate collateral, while the desired minimum debt coverage ratio is 1.20x. Amortization periods for commercial real estate loans are generally limited to twenty years. The Company’s commercial real estate portfolio is well below the thresholds that would designate a concentration in commercial real estate lending, as established by the federal banking regulators.

Commercial and Industrial Loans. Commercial and industrial loans are primarily comprised of working capital loans used to purchase inventory and fund accounts receivable that are secured by business assets other than real estate. These loans are generally written for one year or less. Also, equipment financing is provided to businesses with these loans generally limited to 80% of the value of the collateral and amortization periods limited to seven years. Commercial loans are often accompanied by a personal guaranty of the principal owners of a business. Like commercial real estate loans, the underlying cash flow of the business is the primary consideration in the underwriting process. The financial condition of commercial borrowers is monitored at least annually with the type of financial information required determined by the size of the relationship. Measures employed by the Company for businesses with higher risk profiles include the use of government-assisted lending programs through the Small Business Administration and U.S. Department of Agriculture.

Agricultural and Agricultural Real Estate Loans. Agricultural loans are generally comprised of seasonal operating lines to cash grain farmers to plant and harvest corn and soybeans and term loans to fund the purchase of equipment. Agricultural real estate loans are primarily comprised of loans for the purchase of farmland. Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop. Loan-to-value ratios on loans secured by farmland generally do not exceed 65% and have amortization periods limited to twenty five years. Federal government-assistance lending programs through the Farm Service Agency are used to mitigate the level of credit risk when deemed appropriate.

Residential Real Estate Loans. Residential real estate loans generally include loans for the purchase or refinance of residential real estate properties consisting of one-to-four units and home equity loans and lines of credit. The Company sells the vast majority of its long-term fixed rate residential real estate loans to secondary market investors. The Company also releases the servicing of these loans upon sale. The Company retains all residential real estate loans with balloon payment features. Balloon periods are limited to five years. Residential real estate loans are typically underwritten to conform to industry standards including criteria for maximum debt-to-income and loan-to-value ratios as well as minimum credit scores. Loans secured by first liens on residential real estate held in the portfolio typically do not exceed 80% of the value of the collateral and have amortization periods of twenty five years or less. The Company does not originate subprime mortgage loans.

Consumer Loans. Consumer loans are primarily comprised of loans to individuals for personal and household purposes such as the purchase of an automobile or other living expenses. Minimum underwriting criteria have been established that consider credit score, debt-to-income ratio, employment history, and collateral coverage. Typically, consumer loans are set up on monthly payments with amortization periods based on the type and age of the collateral.

Other Loans. Other loans consist primarily of loans to municipalities to support community projects such as infrastructure improvements or equipment purchases. Underwriting guidelines for these loans are consistent with those established for commercial loans with the additional repayment source of the taxing authority of the municipality.

Allowance for Loan Losses

The allowance for loan losses represents the Company’s best estimate of the reserve necessary to adequately account for probable losses existing in the current portfolio. The provision for loan losses is the charge against current earnings that is determined by the Company as the amount needed to maintain an adequate allowance for loan losses.

In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, the Company relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company’s credit exposure. The review process is directed by the overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty. Once identified, the magnitude of exposure to individual borrowers is quantified in the form of specific allocations of the allowance for loan losses. The Company considers collateral values and guarantees in the determination of such specific allocations. Additional factors considered by the Company in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and troubled debt restructurings, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates.

The Company estimates the appropriate level of allowance for loan losses by separately evaluating large impaired loans, large adversely classified loans and nonimpaired loans.

Impaired loans

The Company individually evaluates certain loans for impairment. In general, these loans have been internally identified via the Company’s loan grading system as credits requiring management’s attention due to underlying problems in the borrower’s business or collateral concerns. This evaluation considers expected future cash flows, the value of collateral and also other factors that may impact the borrower’s ability to make payments when due. For loans greater than $100,000 in the commercial, commercial real estate, agricultural, agricultural real estate segments, impairment is individually measured each quarter using one of three alternatives: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price, if available; or (3) the fair value of the collateral less costs to sell for collateral dependent loans and loans for which foreclosure is deemed to be probable. A specific allowance is assigned when expected cash flows or collateral do not justify the carrying amount of the loan. The carrying value of the loan reflects reductions from prior charge-offs.

Adversely classified loans

A detailed analysis is also performed on each adversely classified (substandard or doubtful rated) borrower with an aggregate, outstanding balance of $100,000 or more. This analysis includes commercial, commercial real estate, agricultural, and agricultural real estate borrowers who are not currently identified as impaired but pose sufficient risk to warrant in-depth review. Estimated collateral shortfalls are then calculated with allocations for each loan segment based on the five-year historical average of collateral shortfalls adjusted for environmental factors including changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is periodically assessed and adjusted when appropriate.

Non-classified and Watch loans

For loans, in all segments of the portfolio, that are considered to possess levels of risk commensurate with a pass rating, management establishes base loss estimations which are derived from historical loss experience. Use of a five-year historical loss period eliminates the effect of any significant losses that can be attributed to a single event or borrower during a given reporting period. The base loss estimations for each loan segment are adjusted after consideration of several environmental factors influencing the level of credit risk in the portfolio. In addition, loans rated as watch are further segregated in the commercial / commercial real estate and agricultural / agricultural real estate segments. These loans possess potential weaknesses that, if unchecked, may result in deterioration to the point of becoming a problem asset. Due to the elevated risk inherent in these loans, an allocation of twice the adjusted base loss estimation of the applicable loan segment is determined appropriate.

Due to weakened economic conditions during recent years, the Company established allocations for each of the loan segments at levels above the base loss estimations. Some of the economic factors included the potential for reduced cash flow for commercial operating loans from reduction in sales or increased operating costs, decreased occupancy rates for commercial buildings, reduced levels of home sales for commercial land developments, the uncertainty regarding grain prices and increased operating costs for farmers, and increased levels of unemployment and bankruptcy impacting consumer’s ability to pay. Each of these economic uncertainties was taken into consideration in developing the level of the reserve. The Company has not materially changed any aspect of its overall approach in the determination of the allowance for loan losses. However, on an on-going basis the Company continues to refine the methods used in determining management’s best estimate of the allowance for loan losses.

The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method for the three and nine-months ended September 30, 2012 and 2011 and for the year ended December 31, 2011 (in thousands):



Three months ended September 30, 2012	Commercial/ Commercial Real Estate			Agricultural/ Agricultural Real Estate			Residential Real Estate			Consumer			Unallocated			Total
Allowance for loan losses:
Balance, beginning of period	$	9,007		$	701		$	743		$	395		$	609		$	11,455
Provision charged to expense	782			(97		)	232			8			(205		)	720
Losses charged off	(308		)	—			(232		)	(45		)	—			(585		)
Recoveries	19			3			2			31			—			55
Balance, end of period	$	9,500		$	607		$	745		$	389		$	404		$	11,645
Ending balance:
Individually evaluated for impairment	$	768		$	—		$	—		$	—		$	—		$	768
Collectively evaluated for impairment	$	8,732		$	607		$	745		$	389		$	404		$	10,877
Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—
Three months ended September 30, 2011
Allowance for loan losses:
Balance, beginning of period	$	8,312		$	556		$	462		$	396		$	969		$	10,695
Provision charged to expense	866			70			139			50			(397		)	728
Losses charged off	(789		)	(50		)	(137		)	(82		)	—			(1,058		)
Recoveries	35			3			—			26			—			64
Balance, end of period	$	8,424		$	579		$	464		$	390		$	572		$	10,429
Ending balance:
Individually evaluated for impairment	$	978		$	—		$	—		$	—		$	—		$	978
Collectively evaluated for impairment	$	7,446		$	579		$	464		$	390		$	572		$	9,451
Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—
Nine months ended September 30, 2012
Allowance for loan losses:
Balance, beginning of year	$	8,791		$	546		$	636		$	378		$	769		$	11,120
Provision charged to expense	1,530			3			523			60			(365		)	1,751
Losses charged off	(906		)	(12		)	(437		)	(140		)	—			(1,495		)
Recoveries	85			70			23			91			—			269
Balance, end of period	$	9,500		$	607		$	745		$	389		$	404		$	11,645
Ending balance:
Individually evaluated for impairment	$	768		$	—		$	—		$	—		$	—		$	768
Collectively evaluated for impairment	$	8,732		$	607		$	745		$	389		$	404		$	10,877
Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—
Loans:
Ending balance	$	556,026		$	144,883		$	182,234		$	16,014		$	210		$	899,367
Ending balance:
Individually evaluated for impairment	$	5,627		$	899		$	—		$	—		$	—		$	6,526
Collectively evaluated for impairment	$	550,399		$	143,984		$	182,234		$	16,014		$	210		$	892,841
Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—



Nine months ended September 30, 2011	Commercial/ Commercial Real Estate			Agricultural/ Agricultural Real Estate			Residential Real Estate			Consumer			Unallocated			Total
Allowance for loan losses:
Balance, beginning of year	$	8,307		$	404		$	440		$	392		$	850		$	10,393
Provision charged to expense	2,334			222			223			83			(278		)	2,584
Losses charged off	(2,358		)	(50		)	(200		)	(158		)	—			(2,766		)
Recoveries	141			3			1			73			—			218
Balance, end of period	$	8,424		$	579		$	464		$	390		$	572		$	10,429
Ending balance:
Individually evaluated for impairment	$	978		$	—		$	—		$	—		$	—		$	978
Collectively evaluated for impairment	$	7,446		$	579		$	464		$	390		$	572		$	9,451
Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—
Loans:
Ending balance	$	485,504		$	125,220		$	187,361		$	17,001		$	405		$	815,491
Ending balance:
Individually evaluated for impairment	$	6,925		$	1,149		$	—		$	—		$	—		$	8,074
Collectively evaluated for impairment	$	478,579		$	124,071		$	187,361		$	17,001		$	405		$	807,417
Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—
Year ended December 31, 2011
Allowance for loan losses:
Balance, beginning of year	$	8,307		$	404		$	440		$	392		$	850		$	10,393
Provision charged to expense	2,309			205			546			122			(81		)	3,101
Losses charged off	(3,077		)	(66		)	(363		)	(254		)	—			(3,760		)
Recoveries	1,252			3			13			118			—			1,386
Balance, end of year	$	8,791		$	546		$	636		$	378		$	769		$	11,120
Ending balance:
Individually evaluated for impairment	$	575		$	—		$	—		$	—		$	—		$	575
Collectively evaluated for impairment	$	8,216		$	546		$	636		$	378		$	769		$	10,545
Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—
Loans:
Ending balance	$	505,693		$	130,595		$	185,151		$	16,270		$	22,365		$	860,074
Ending balance:
Individually evaluated for impairment	$	4,719		$	1,149		$	—		$	—		$	—		$	5,868
Collectively evaluated for impairment	$	500,974		$	129,446		$	185,151		$	16,270		$	22,365		$	854,206
Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—

During the two years since the acquisition of branches from First Bank in 2010, a majority of the loans acquired from First Bank have been rewritten or renewed in accordance with First Mid Bank’s underwriting standards. Accordingly, during the second quarter of 2012, management concluded that the acquired loans that have been rewritten or renewed and are currently performing should be assigned risk factors that are consistent with other First Mid Bank loans that have similar risk characteristics. The effect of this decision was to increase, in total, the amount of allowance allocated to non-classified loans and to decrease the unallocated portion of the allowance. This is the primary reason for the decline in the unallocated allowance balance.

Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.

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.

Credit Quality

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, collateral support, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes loans with an outstanding balance greater than $100,000 and non-homogenous loans, such as commercial and commercial real estate loans. This analysis is performed on a continuous basis. The Company uses the following definitions for risk ratings:

Watch. Loans classified as watch have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current sound-worthiness and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing factors, conditions and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered pass rated loans. The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of September 30, 2012 and December 31, 2011 (in thousands):



	Construction & Land Development				Farm Loans				1-4 Family Residential Properties				Multifamily Residential Properties
	2012		2011		2012		2011		2012		2011		2012		2011
Pass	$	20,949	$	19,708	$	78,781	$	67,637	$	187,434	$	180,247	$	44,085	$	19,638
Watch	2,147		2,168		2,472		2,496		430		497		—		—
Substandard	2,021		1,260		2,172		2,452		2,375		1,105		207		208
Doubtful	—		—		—		—		—		—		—		—
Total	$	25,117	$	23,136	$	83,425	$	72,585	$	190,239	$	181,849	$	44,292	$	19,846



	Commercial Real Estate (Nonfarm/Nonresidential)				Agricultural Loans				Commercial & Industrial Loans				Consumer Loans
	2012		2011		2012		2011		2012		2011		2012		2011
Pass	$	283,605	$	288,539	$	57,912	$	58,133	$	150,578	$	147,591	$	16,213	$	16,271
Watch	24,465		24,664		1,542		1,840		1,953		280		15		—
Substandard	4,960		7,798		3,911		3,284		1,770		2,845		14		—
Doubtful	—		—		—		—		—		—		—		—
Total	$	313,030	$	321,001	$	63,365	$	63,257	$	154,301	$	150,716	$	16,242	$	16,271



	All Other Loans				Total Loans
	2012		2011		2012		2011
Pass	$	9,356	$	11,413	$	848,913	$	809,177
Watch	—		—		33,024		31,945
Substandard	—		—		17,430		18,952
Doubtful	—		—		—		—
Total	$	9,356	$	11,413	$	899,367	$	860,074

The following table presents the Company’s loan portfolio aging analysis at September 30, 2012 and December 31, 2011 (in thousands):



September 30, 2012	30-59 days Past Due		60-89 days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 days & Accruing
Construction and land development	$	758	$	—	$	—	$	758	$	24,359	$	25,117	$	—
Farm loans	493		—		70		563		82,862		83,425		—
1-4 Family residential properties	391		240		1,345		1,976		188,263		190,239		—
Multifamily residential properties	207		—		—		207		44,085		44,292		—
Commercial real estate	223		478		238		939		312,091		313,030		—
Loans secured by real estate	2,072		718		1,653		4,443		651,660		656,103		—
Agricultural loans	242		—		704		946		62,419		63,365		—
Commercial and industrial loans	148		155		218		521		153,780		154,301		—
Consumer loans	80		70		15		165		16,077		16,242		—
All other loans	—		—		—		—		9,356		9,356		—
Total loans	$	2,542	$	943	$	2,590	$	6,075	$	893,292	$	899,367	$	—
December 31, 2011
Construction and land development	$	—	$	—	$	—	$	—	$	23,136	$	23,136	$	—
Farm loans	377		111		737		1,225		71,360		72,585		—
1-4 Family residential properties	1,079		200		1,033		2,312		179,537		181,849		—
Multifamily residential properties	—		—		—		—		19,846		19,846		—
Commercial real estate	399		101		228		728		320,273		321,001		—
Loans secured by real estate	1,855		412		1,998		4,265		614,152		618,417		—
Agricultural loans	—		—		673		673		62,584		63,257		—
Commercial and industrial loans	950		73		585		1,608		149,108		150,716		—
Consumer loans	94		36		7		137		16,134		16,271		—
All other loans	—		—		—		—		11,413		11,413		—
Total loans	$	2,899	$	521	$	3,263	$	6,683	$	853,391	$	860,074	$	—

Impaired Loans

Within all loan portfolio segments, loans are considered impaired 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. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date. Impaired loans, excluding certain troubled debt restructured loans, are placed on nonaccrual status. Impaired loans include nonaccrual loans and 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. It is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being modified remain on nonaccrual status until, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. If the restructured loan is on accrual status prior to being modified, the loan is reviewed to determine if the modified loan should remain on accrual status.

The Company’s policy is to discontinue the accrual of interest income on all loans for which principal or interest is ninety days past due. The accrual of interest is discontinued earlier when, in the opinion of management, there is reasonable doubt as to the timely collection of interest or principal. Once interest accruals are discontinued, accrued but uncollected interest is charged against current year income. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Interest on loans determined to be troubled debt restructurings is recognized on an accrual basis in accordance with the restructured terms if the loan is in compliance with the modified terms. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.

The following tables present impaired loans as of September 30, 2012 and December 31, 2011 (in thousands):



	September 30, 2012						December 31, 2011
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Recorded Balance		Unpaid Principal Balance		Specific Allowance
Loans with a specific allowance:
Construction and land development	$	397	$	812	$	206	$	833	$	1,070	$	295
Farm loans	—		—		—		—		—		—
1-4 Family residential properties	489		489		58		71		71		27
Multifamily residential properties	—		—		—		—		—		—
Commercial real estate	592		592		119		1,414		1,693		183
Loans secured by real estate	1,478		1,893		383		2,318		2,834		505
Agricultural loans	—		—		—		—		—		—
Commercial and industrial loans	749		749		385		382		382		70
Consumer loans	—		—		—		—		—		—
All other loans	—		—		—		—		—		—
Total loans	$	2,227	$	2,642	$	768	$	2,700	$	3,216	$	575
Loans without a specific allowance:
Construction and land development	$	1,156	$	1,257	$	—	$	—	$	—	$	—
Farm loans	199		210		—		532		532		—
1-4 Family residential properties	1,459		1,790		—		1,641		1,818		—
Multifamily residential properties	—		—		—		—		—		—
Commercial real estate	1,699		1,720		—		1,226		1,256		—
Loans secured by real estate	4,513		4,977		—		3,399		3,606		—
Agricultural loans	822		822		—		673		673		—
Commercial and industrial loans	253		421		—		660		1,255		—
Consumer loans	29		35		—		8		20		—
All other loans	—		—		—		—		—		—
Total loans	$	5,617	$	6,255	$	—	$	4,740	$	5,554	$	—
Total loans:
Construction and land development	$	1,553	$	2,069	$	206	$	833	$	1,070	$	295
Farm loans	199		210		—		532		532		—
1-4 Family residential properties	1,948		2,279		58		1,712		1,889		27
Multifamily residential properties	—		—		—		—		—		—
Commercial real estate	2,291		2,312		119		2,640		2,949		183
Loans secured by real estate	5,991		6,870		383		5,717		6,440		505
Agricultural loans	822		822		—		673		673		—
Commercial and industrial loans	1,002		1,170		385		1,042		1,637		70
Consumer loans	29		35		—		8		20		—
All other loans	—		—		—		—		—		—
Total loans	$	7,844	$	8,897	$	768	$	7,440	$	8,770	$	575

The following tables present average recorded investment and interest income recognized on impaired loans for the three and nine- month periods ended September 30, 2012 and 2011 (in thousands):



	For the three months ended
	September 30, 2012				September 30, 2011
	Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized
Construction and land development	$	1,750	$	—	$	1,174	$	—
Farm loans	199		—		533		—
1-4 Family residential properties	1,972		—		2,231		—
Multifamily residential properties	—		—		—		—
Commercial real estate	2,299		7		3,934		7
Loans secured by real estate	6,220		7		7,872		7
Agricultural loans	837		—		695		—
Commercial and industrial loans	1,019		3		1,242		3
Consumer loans	30		—		5		—
All other loans	—		—		—		—
Total loans	$	8,106	$	10	$	9,814	$	10



	For the nine months ended
	September 30, 2012				September 30, 2011
	Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized
Construction and land development	$	1,736	$	—	$	1,179	$	—
Farm loans	199		—		534		—
1-4 Family residential properties	1,982		—		2,242		—
Multifamily residential properties	—		—		—		—
Commercial real estate	2,319		21		3,968		15
Loans secured by real estate	6,236		21		7,923		15
Agricultural loans	867		—		695		—
Commercial and industrial loans	1,063		10		1,382		11
Consumer loans	32		1		5		—
All other loans	—		—		—		—
Total loans	$	8,198	$	32	$	10,005	$	26

The amount of interest income recognized by the Company within the periods stated above was due to loans modified in a troubled debt restructuring that remained on accrual status. The balance of loans modified in a troubled debt restructuring included in the impaired loans stated above that were still accruing was $6,000 of 1-4 Family residential properties, $388,000 of commercial real estate, $304,000 of commercial and industrial and $14,000 of consumer loans at September 30, 2012 and $396,000 of commercial real estate at September 30, 2011. For the nine months ended September 30, 2012 and 2011, the amount of interest income recognized using a cash-basis method of accounting during the period that the loans were impaired was not material.

Non Accrual Loans

The following table presents the Company’s recorded balance of nonaccrual loans as September 30, 2012 and December 31, 2011 (in thousands). This table excludes purchased impaired loans and performing troubled debt restructurings.



	September 30, 2012		December 31, 2011
Construction and land development	$	1,553	$	833
Farm loans	199		532
1-4 Family residential properties	1,941		1,712
Multifamily residential properties	—		—
Commercial real estate	1,903		2,245
Loans secured by real estate	5,596		5,322
Agricultural loans	823		673
Commercial and industrial loans	698		720
Consumer loans	15		8
All other loans	—		—
Total loans	$	7,132	$	6,723

Interest income that would have been recorded under the original terms of such nonaccrual loans totaled $165,000 and $361,000 for the nine months ended September 30, 2012 and 2011, respectively.

Troubled Debt Restructuring

The balance of troubled debt restructurings at September 30, 2012 and December 31, 2011 was $3,530,000 and $1,834,000, respectively. Approximately $459,000 and $140,000 in specific reserves have been established with respect to these loans as of September 30, 2012 and December 31, 2011, respectively. As troubled debt restructurings, these loans are included in nonperforming loans and are classified as impaired which requires that they be individually measured for impairment. The modification of the terms of these loans included one or a combination of the following: a reduction of stated interest rate of the loan; an extension of the maturity date and change in payment terms; or a permanent reduction of the recorded investment in the loan.

The increase in TDRs during the nine months ended September 30, 2012 was a result of various factors, including the following:


•	Two notes restructured in 2011 to lower the monthly payments by re-amortizing the debt were combined with three other non-accrual notes (not considered TDRs). The new note remains on non-accrual however the terms of the new note are considered to be market terms.


•	Four construction and land development notes to multiple borrowers that were in non-accrual status were modified to lower interest rates due to cash flow difficulties of the borrower or for changes in payment terms. The notes remain in non-accrual status.


•	One 1-4 Family residential property note that was in non-accrual status was modified to a single-pay note due in six months. The note remains in non-accrual status.


•	One 1-4 Family residential property note that was in accrual status was restructured to lower the monthly payments by re-amortizing the debt. The note remains in accrual status.


•	Four commercial and industrial notes to multiple borrowers that were in non-accrual status were modified to extend the original maturity dates and lower the interest rates of the notes or for changes in payment terms. The notes remain in non-accrual status.


•	One consumer note that was in accrual status was modified to extend the maturity terms of the note. The note remains in accrual status.

With respect to TDRs during the nine months ended September 30, 2011:


•	1 commercial real estate loan was modified by charging down the loan and the combining of several past due notes which lowered the monthly payment of the notes.


•	1 commercial loan was modified to interest-only payments for a period with the maturity date extended. The interest rate remained unchanged. The loan is 75% guaranteed by the Small Business Administration.

The following table presents the Company’s recorded balance of troubled debt restructurings at September 30, 2012 and December 31, 2011 (in thousands).



Troubled debt restructurings:	September 30, 2012		December 31, 2011
Construction and land development	$	1,554	$	—
1-4 Family residential properties	462		393
Commercial real estate	1,011		952
Loans secured by real estate	3,027		1,345
Commercial and industrial loans	489		489
Consumer Loans	14		—
Total	$	3,530	$	1,834
Performing troubled debt restructurings:
1-4 Family residential properties	$	6	$	—
Commercial real estate	388		395
Loans secured by real estate	394		395
Commercial and industrial loans	304		322
Consumer Loans	14		—
Total	$	712	$	717

A loan is considered to be in payment default once it is 90 days past due under the modified terms. There were no loans modified as troubled debt restructurings during the prior twelve months that experienced defaults during the nine months ended September 30, 2012. There were two loans totaling $215,000 modified as troubled debt restructurings during the prior twelve months that experienced defaults during the year ended December 31, 2011.