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Note 8 - Loans and the Allowance for Loan Losses

6 Months Ended

Jun. 30, 2012

Loans And The Allowance For Loan Losses [Text Block]

NOTE 8 -- LOANS AND THE ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio was as follows:

	June 30, 2012		December 31, 2011

Commercial	$	50,914	$	62,609

Agricultural		22,392		61,251

Agricultural Real Estate		53,328		60,523
Commercial Real Estate		230,902		235,103
Commercial Real Estate Development		30,124		58,279
Residential Real Estate		91,793		97,172

Total real estate		406,147		451,077

Consumer		41,196		46,084

Total	$	520,649	$	621,021

At June 30, 2012 and December 31, 2011, the Corporation held $230,902 and $235,103 in commercial real estate loans and $30,124 and $58,279 in commercial real estate development loans, respectively. Generally, those loans are collateralized by the real estate being financed. The loans are expected to be repaid from cash flows or from proceeds of sale of the real estate of the borrowers.

At June 30, 2012 and December 31, 2011, the Corporation held $22,392 and $61,251 in agricultural production loans and $53,328 and $60,523 in agricultural real estate loans, respectively. Generally, those loans are collateralized by the assets of the borrower. The loans are expected to be repaid from cash flows or from proceeds of sale of selected assets of the borrowers.

The primary lending market includes the Illinois counties of Aurora, Bureau, DeKalb, Henry, Kane, Kendall, LaSalle, McHenry and Will as well as adjacent counties in Illinois. Generally, loans are collateralized by assets, primarily real estate, of the borrowers and guaranteed by individuals. The loans are expected to be repaid from cash flows of the borrowers or from proceeds from the sale of selected assets of the borrowers.

Management reviews and approves the Corporation’s lending policies and procedures on a regular basis. Management regularly (at least quarterly) reviews the allowance for loan losses and reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. The Corporation’s underwriting standards are designed to encourage relationship banking rather than transactional banking. Relationship banking implies a primary banking relationship with the borrower that includes, at minimum, an active deposit banking relationship in addition to the lending relationship. The integrity and character of the borrower are significant factors in the Corporation’s loan underwriting. As a part of underwriting, tangible positive or negative evidence of the borrower’s integrity and character are sought out. Additional significant underwriting factors beyond location, duration, the sound and profitable cash flow basis underlying the loan and the borrower’s character are the quality of the borrower’s financial history, the liquidity of the underlying collateral and the reliability of the valuation of the underlying collateral.

The Corporation’s policies and loan approval limits are established by the Board of Directors. The loan officers generally have authority to approve secured loans up to $100,000 and unsecured loans or exposures up to $50,000. Managing Officers (those with designated loan approval authority) generally have authority to approve secured loans up to $250,000 and unsecured loans or exposures up to $100,000. The Senior Commercial Banking Officer has authority to approve new secured loans up to $750,000 and unsecured loans or exposures up to $250,000. The Chief Credit Officer has authority to approve new secured loans up to $1,500,000 and unsecured loans or exposures up to $250,000. In addition, in certain circumstances any two consumer officers may combine their loan authority limits to approve a loan, while only the President and Chief Executive Officer, Chief Credit Officer and Senior Commercial Banking Manager may combine their loan authority limits to approve a commercial loan. The Executive Loan Committee may approve new secured one-to-four family residential mortgage loans up to $2,500,000, commercial real estate loans, multi-family real estate loans and land loans up to $3,500,000 in aggregate, and unsecured loans or exposures up to $1,000,000. All loans above the established limits must be approved by the Directors Loan Committee, consisting of the Chairman, the President and Chief Executive Officer and up to three other Board members. At no time will the Corporation originate a loan where a borrower's total borrowing relationship exceeds the Corporation’s regulatory lending limit. Loans to related parties, including executive officers and the Corporation’s directors, are reviewed for compliance with regulatory guidelines by the board of directors at least quarterly.

The Corporation conducts internal loan reviews that validate the loans against the Corporation’s loan policy quarterly for mortgage, consumer, and small commercial loans on a sample basis, and all larger commercial loans on an annual basis. Beginning in 2011, the Corporation also began receiving independent loan reviews performed by a third party on larger commercial loans to be performed annually. In addition to compliance with the Corporation’s policy, the loan review process reviews the risk assessments made by its credit department, lenders and loan committees. Results of these reviews are presented to management and the board of directors.

The Corporation’s lending can be summarized into six primary areas; one- to four-family residential mortgage loans, commercial real estate and multi-family real estate loans, home equity lines of credits, real estate construction, commercial business loans, and consumer loans. The primary lending market includes the Illinois counties of Aurora, Bureau, DeKalb, Henry, Kane, Kendall, LaSalle, McHenry and Will as well as the adjacent counties in Illinois.

One-to-Four Family Residential Mortgage Loans

The Corporation offers one-to-four family residential mortgage loans that conform to Fannie Mae and Freddie Mac underwriting standards (conforming loans) as well as non-conforming loans. In recent years there has been an increased demand for long-term fixed-rate loans, as market rates dropped and remained near historic lows. As a result, the Corporation has sold a substantial portion of fixed-rate one-to-four family residential mortgage loans with terms of 15 years or greater. Generally, the Corporation retains fixed-rate one-to-four family residential mortgage loans with terms of less than 15 years, although this has represented a small percentage of the fixed-rate loans originated in recent years due to the favorable long-term rates for borrower.

In addition, the Corporation also offers home equity loans that are secured by a second mortgage on the borrower’s primary or secondary residence. Home equity loans are generally underwritten using the same criteria used to underwrite one-to-four family residential mortgage loans.

As one-to-four family residential mortgage and home equity loan underwriting are subject to specific regulations, the Corporation typically underwrites its one-to-four family residential mortgage loans and home equity loans to conform to generally accepted standards. Several factors are considered in underwriting including the value of the underlying real estate and the debt to income and credit history of the borrower. The Corporation has established minimum standards and underwriting guidelines for all residential real estate loan collateral types.

Commercial Real Estate and Multi-Family Real Estate Loans

Commercial real estate mortgage loans are primarily secured by office buildings, owner-occupied businesses, strip mall centers, farms and churches. In underwriting commercial real estate loans and multi-family real estate loans, the Corporation considers a number of factors which include the projected net cash flow to the loan’s debt service requirement, the age and condition of the collateral, the financial resources and income level of the borrower and the borrower’s experience in owning or managing similar properties. Personal guarantees are typically obtained from commercial real estate and multi-family real estate borrowers. In addition, the borrower’s financial information on such loans is monitored on an ongoing basis by requiring periodic financial statement updates. The repayment of these loans is primarily dependent on the cash flows of the underlying property; however, the commercial real estate loan generally must be supported by an adequate underlying collateral value. The performance and the value of the underlying property may be adversely affected by economic factors or geographical and/or industry specific factors. These loans are subject to other industry guidelines that are closely monitored by the Corporation.

Home Equity Lines of Credit

In addition to traditional one-to-four family residential mortgage loans and home equity loans, the Corporation offers home equity lines of credit that are secured by the borrower’s primary or secondary residence. Home equity lines of credit are generally underwritten using the same criteria used to underwrite one-to-four family residential mortgage loans. As home equity line of credit underwriting is subject to specific regulations, the Corporation typically underwrites its home equity lines of credit to conform to widely accepted standards. Several factors are considered in underwriting including the value of the underlying real estate and the debt to income and credit history of the borrower.

Commercial Business Loans

The Corporation originates commercial non-mortgage business (term) loans and adjustable lines of credit. These loans are generally originated to small and medium sized companies in the Corporation’s primary market area. Commercial business loans (including agricultural loans) are generally used for working capital purposes or for acquiring equipment, inventory or furniture, and are primarily secured by business assets other than real estate, such as business equipment and inventory, accounts receivable or stock.

The commercial business loan portfolio consists primarily of secured loans. When making commercial business loans, the Corporation considers the financial statements, lending history and debt service capabilities of the borrower, the projected cash flows of the business and the value of collateral. The cash flows of the underlying borrower, however, may not perform consistent with historical or projected information. Further, the collateral securing the loans may fluctuate in value due to individual economic or other factors. Virtually all of the Corporation’s loans are guaranteed by the principals of the borrower. The Corporation has established minimum standards and underwriting guidelines for all commercial loan types.

Real Estate Construction Loans

The Corporation originates construction loans for one-to-four family residential properties and commercial real estate properties, including multi-family properties. The Corporation generally requires that a commitment for permanent financing be in place prior to closing the construction loan. The repayment of these loans is typically through permanent financing following completion of the construction. Real estate construction loans are inherently more risky than loans on completed properties as the unimproved nature and the financial risks of construction significantly enhance the risks of commercial real estate loans. These loans are closely monitored and subject to other industry guidelines.

Consumer Loans

Consumer loans consist of installment loans to individuals, primarily automotive loans. These loans are centrally underwritten utilizing the borrower’s financial history, including the Fair Isaac Corporation (“FICO”) credit scoring and information as to the underlying collateral. Repayment is expected from the cash flow of the borrower. Consumer loans may be underwritten with terms up to seven years, fully amortized. Unsecured loans are limited to twenty four months. Loan-to-value ratios vary based on the type of collateral. The Corporation has established minimum standards and underwriting guidelines for all consumer loan types.

The following table presents the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method for the six months ended June 30, 2012:

	Commercial		Agricultural			Agricultural Real Estate		Commercial Real Estate			Commercial Real Estate Development		Residential Real Estate		Consumer		Unallocated		Total
Allowance for Loan Losses
Balance, beginning of year	$	5,240	$	55		$	548	$	11,606		$	8,771	$	2,855	$	1,338	$	-	$	30,413
Provision charged to expense		225		(39	)		920		(60	)		7,362		1,173		510		9		10,100
Less: loans charged off		1,544		-			911		1,956			13,474		1,194		667		-		19,746
Recoveries		120		-			-		342			1,114		35		94		-		1,705
Balance, end of period	$	4,041	$	16		$	557	$	9,932		$	3,773	$	2,869	$	1,275	$	9	$	22,472
Ending Balance: individually evaluated for impairment	$	1,290	$	-		$	173	$	2,004		$	1,512	$	1,727	$	187	$	0	$	6,892
Ending Balance: collectively evaluated for impairment	$	2,751	$	16		$	384	$	7,928		$	2,261	$	1,142	$	1,088	$	9	$	15,580
Loans
Ending Balance	$	50,914	$	22,392		$	53,328		230,837		$	30,124	$	94,129	$	41,196	$	-	$	520,649
Ending Balance: individually evaluated for impairment	$	4,413	$	-		$	3,545	$	33,590		$	20,393	$	9,547	$	1,067	$	-	$	72,555
Ending Balance: collectively evaluated for impairment	$	46,501	$	22,392		$	49,783	$	197,247		$	9,731	$	84,582	$	40,129	$	-	$	448,094

The following table presents the changes in the allowance for loan losses for the three months ended June 30, 2012:

	Commercial		Agricultural			Agricultural Real Estate		Commercial Real Estate		Real Estate Development		Commercial Residential Real Estate		Consumer		Unallocated			Total
Allowance for Loan Losses
Balance, beginning of year	$	5,055	$	28		$	284	$	10,189	$	10,297	$	2,555	$	1,316	$	16		$	29,740
Provision charged to expense		268		(12	)		1,184		713		6,781		753		346		(7	)		10,026
Less: loans charged off		1,303		-			911		1,292		13,455		457		445		-			17,863
Recoveries		21		-			-		322		150		18		58		-			569
Balance, end of period	$	4,041	$	16		$	557	$	9,932	$	3,773	$	2,869	$	1,275	$	9		$	22,472

The following table presents the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of December 31, 2011:

	Commercial		Agricultural			Agricultural Real Estate			Commercial Real Estate		Commercial Real Estate Development		Residential Real Estate		Consumer		Unallocated			Total
Allowance for Loan Losses
Balance, beginning of year	$	4,435	$	99		$	107		$	6,029	$	15,526	$	1,897	$	1,595	$	38		$	29,726
Provision charged to expense		4,494		(35	)		(2,675	)		24,479		14,564		4,489		1,175		(38	)		51,803
Less: loans charged off		4,059		16			2,242			18,951		21,401		3,541		1,667		-			51,877
Recoveries		370		7			8			49		82		10		235		-			761
Balance, end of period	$	5,240	$	55		$	548		$	11,606	$	8,771	$	2,855	$	1,338	$	-		$	30,413
Ending Balance: individually evaluated for impairment	$	2,632	$	-		$	229		$	2,337	$	8,215	$	1,584	$	219	$	-		$	15,216
Ending Balance: collectively evaluated for impairment	$	2,608	$	55		$	319		$	9,269	$	556	$	1,271	$	1,119	$	-		$	15,197
Loans
Ending Balance	$	62,609	$	61,251		$	60,523			235,103	$	58,279	$	97,172	$	46,084	$	-		$	621,021
Ending Balance: individually evaluated for impairment	$	4,803	$	-		$	5,530		$	35,042	$	45,944	$	11,291	$	1,680	$	-		$	104,290
Ending Balance: collectively evaluated for impairment	$	57,806	$	61,251		$	54,993		$	200,661	$	12,335	$	85,881	$	44,404	$	-		$	516,731

The following table presents the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of June 30, 2011:

	Commercial			Agricultural			Agricultural Real Estate		Commercial Real Estate		Commercial Real Estate Development		Residential Real Estate		Consumer		Unallocated			Total
Allowance for Loan Losses
Balance, beginning of year	$	4,435		$	99		$	107	$	6,029	$	15,526	$	1,897	$	1,595	$	38		$	29,726
Provision charged to expense		(592	)		(26	)		24		7,812		1,182		1,461		124		(12	)		9,925
Less: loans charged off		1,556			16			22		8,481		8,462		1,438		682		-			20,657
Recoveries		44			-			-		-		-		8		83		-			135
Balance, end of period	$	2,331		$	57		$	61	$	5,360	$	8,246	$	1,928	$	1,120	$	26		$	19,129
Ending Balance: individually evaluated for impairment	$	1,879		$	-		$	-	$	1,169	$	4,722	$	757	$	298	$	-		$	8,825
Ending Balance: collectively evaluated for impairment	$	452		$	57		$	61	$	4,191	$	3,524	$	1,171	$	822	$	26		$	10,304
Loans
Ending Balance	$	129,771		$	64,354		$	49,391		201,571	$	75,126	$	86,673	$	50,801	$	-		$	657,687
Ending Balance: individually evaluated for impairment	$	11,477		$	1,822		$	1,078	$	31,919	$	40,345	$	9,899	$	1,066	$	-		$	97,606
Ending Balance: collectively evaluated for impairment	$	118,294		$	62,532		$	48,313	$	169,652	$	34,781	$	76,774	$	49,735	$	-		$	560,081

Management’s opinion as to the ultimate collectability of loans is subject to estimates regarding future cash flows from operations and the value of property, real and personal, pledged as collateral. These estimates are affected by changing economic conditions and the economic prospects of borrowers.

Allowance for Loan Losses

The allowance for loan losses represents an estimate of the amount of losses believed inherent in the Corporation’s loan portfolio at the balance sheet date. The allowance calculation involves a high degree of estimation that management attempts to mitigate through the use of objective historical data where available. Loan losses are charged against the allowance for loan losses when management believes the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Overall, management believes the reserve to be consistent with prior periods and adequate to cover the estimated losses in the Corporation’s loan portfolio.

The Corporation’s methodology for assessing the appropriateness of the allowance for loan losses consists of two key elements: (1) specific allowances for estimated credit losses on individual loans that are determined to be impaired through the Corporation’s review for identified problem loans; and (2) a general allowance based on estimated credit losses inherent in the remainder of the loan portfolio.

The specific allowance is measured by determining the present value of expected cash flows, the loan’s observable market value, or for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expense. Factors used in identifying a specific problem loan include: (1) the strength of the customer’s personal or business cash flows; (2) the availability of other sources of repayment; (3) the amount due or past due; (4) the type and value of collateral; (5) the strength of the collateral position; (6) the estimated cost to sell the collateral; and (7) the borrower’s effort to cure the delinquency. In addition for loans secured by real estate, the Corporation also considers the extent of any past due and unpaid property taxes applicable to the property serving as collateral on the mortgage.

The Corporation establishes a general allowance for loans that are not deemed impaired to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, has not been allocated to particular problem assets. The general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on the Corporation’s historical loss experience, delinquency trends, and management’s evaluation of the collectability of the loan portfolio. The allowance is then adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors may include: (1) Management’s assumptions regarding the minimal level of risk for a given loan category; (2) changes in lending policies and procedures, including changes in underwriting standards, and charge-off and recovery practices not considered elsewhere in estimating credit losses; (3) changes in international, national, regional and local economics and business conditions and developments that affect the collectability of the portfolio, including the conditions of various market segments; (4) changes in the nature and volume of the portfolio and in the terms of loans; (5) changes in the experience, ability, and depth of the lending officers and other relevant staff; (6) changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified loans; (7) changes in the quality of the loan review system; (8) changes in the value of the underlying collateral for collateral-dependent loans; (9) the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and (10) the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.

The applied loss factors are re-evaluated quarterly to ensure their relevance in the current environment.

Although the Corporation’s policy allows for a general valuation allowance on certain smaller-balance, homogenous pools of loans classified as substandard, the Corporation has historically evaluated every loan classified as substandard, regardless of size, for impairment as part of the review for establishing specific allowances. The Corporation’s policy also allows for general valuation allowance on certain smaller-balance, homogenous pools of loans which are loans criticized as special mention or watch. A separate general allowance calculation is made on these loans based on historical measured weakness, and which is a multiple of the amount of the general allowance calculated on the non-classified loans.

During 2011, in evaluating the adequacy of the allowance for loan losses, the Corporation implemented loan migration analysis to further analyze the risk in the loan portfolio based on previous loan risk rating, current loan risk rating and charge off history associated with each individual loan pool. The loans with risk rating 1 through 4 (“pass loan pools”) that have experienced high historical losses during the past three years of economic downturn have been adjusted with negative qualitative adjustments to reflect the estimation of future losses within these pools based on the most recent migration analysis. The loss migration analysis of these pass loan pools reflected less than a 1% charge off rate compared to a significantly higher charge off rate for loans with risk rating of 5 and 6 (“substandard loan pools”). These qualitative adjustments to the pass loan pool component of the allowance for loan losses analysis reflect the results of this migration analysis, as well as the seasoned nature of the loans comprising the pass loan pool that have been evaluated by an independent loan review process with over 80% loan review penetration.

The Corporation also utilizes migration analysis to analyze the risk in the substandard loan pools. The migration analysis tracks all classified loans and the resulting charge offs that have resulted from these classified loans. In certain loan sectors, the qualitative adjustment factors have been increased due to the risks reflected in the most recent migration analysis. This is primarily in loan sectors, such as commercial real estate, where the Corporation has experienced recent elevated charge off history.

Credit Quality Indicators

The Corporation 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, credit documentation, public information and current economic trends among other factors. The Corporation analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on all loans at origination. Subsequently, analyses are reviewed on an annual basis by the Risk Management department and rating changes are made as necessary. Interim reviews are performed if borrower circumstances warrant a more timely review.

The Corporation has established a uniform internal risk rating methodology for commercial loans utilizing risk grades from 1 through 7, with 1 being considered “excellent” and the rating of 7 being considered “doubtful.” A summary of the general definitions for the risk ratings follows:

Prime Quality: This category includes all obligors whose balance sheet, current position, capitalization, profitability and cash flow have been demonstrated to be consistently of such high quality that the potential for significant disruption in their financial performance is virtually nonexistent. Such borrowers have excellent management in place with depth, well defined and established product lines or services, and operate businesses generally isolated from the normal influences of the business cycle.

High Quality: Borrowers assigned this rating are considered above average with high quality and excellent credit standards based on leverage, liquidity and debt coverage ratios, as well as having excellent management in critical areas.

Satisfactory “Average” Quality: This category includes borrowers that have average leverage, liquidity and debt service ratios that comparefavorably with industry standards.

Low Pass: This risk rating includes borrowers that have below average leverage, liquidity and debt service coverage ratios and management thatmay not be as solid on a historical basis or may compare less favorably with industry standards but are still considered acceptable.

Watch/Special Mention (OAEM): A borrower assigned to this rating category exhibits potential weaknesses or early warning signals that deserve close monitoring by management. If left uncorrected, these potential weaknesses may result in the borrower being unable to meet its financial obligations at some future date.

Substandard: A substandard rating is assigned to a borrower whose credit is inadequately protected by the paying capacity of the borrower, or by the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. These credits are characterized by the distinct possibility that the Corporation will sustain some loss if deficiencies are not corrected.

Doubtful: Borrowers assigned to this rating category have all of the weaknesses inherent in a substandard rating with the added factor that the weaknesses are pronounced to the point where, on the basis of current facts, conditions and values, collection or liquidation in full is highly questionable or improbable. While the possibility of loss is extremely high, the existence of specific pending factors, which may work to the borrower’s advantage, warrants that the estimated loss be deferred until a more exact status can be determined.

The Corporation classifies consumer loans in the risk rating classifications of Pass, Special Mention, Substandard and Doubtful. These classifications generally conform to the risk rating methodology for commercial loans as follows: Pass - risk rating 1 through 4; Special Mention - risk rating 5; Substandard - risk rating 6; Doubtful - risk rating 7.

The following tables present the credit risk profile of the Corporation’s loan portfolio based on rating category and payment activity as of June 30, 2012:

Commercial Credit Exposure: Credit Risk Profile by Creditworthiness Category

Risk Rating:	Commercial		Agricultural		Agricultural Real Estate		Commercial Real Estate		Commercial Real Estate Development		Total
1-2	$	3,312	$	8,659	$	15,580	$	24,411	$	161	$	52,123
3		23,140		12,307		18,609		74,378		3,070		131,504
4		16,144		1,401		13,780		61,469		946		93,740
5		2,151		-		1,089		13,130		5,310		21,680
6		6,167		25		2,571		57,514		18,776		85,053
7		-		-		1,699		-		1,861		3,560
Total	$	50,914	$	22,392	$	53,328	$	230,902	$	30,124	$	387,660

Consumer Credit Exposure: Credit Risk Profile by Creditworthiness Category

	Residential
Risk Rating:	Real Estate		Consumer		Total
Pass	$	79,355	$	38,529	$	117,884
Special Mention		284		171		455
Substandard		11,979		2,468		14,447
Doubtful		175		28		203
Total	$	91,793	$	41,196	$	132,989

The following tables present the credit risk profile of the Corporation’s loan portfolio based on rating category and payment activity as of December 31, 2011:

Commercial Credit Exposure: Credit Risk Profile by Creditworthiness Category

Risk Rating:	Commercial		Agricultural		Agricultural Real Estate		Commercial Real Estate		Commercial Real Estate Development		Total
1-2	$	4,509	$	25,979	$	14,832	$	26,075	$	376	$	71,771
3		30,037		27,348		24,142		87,772		8,348		177,647
4		18,892		7,096		13,434		54,909		1,744		96,075
5		1,970		381		1,769		4,582		-		8,702
6		7,201		447		4,647		61,111		35,673		109,079
7		-		-		1,699		654		12,138		14,491
Total	$	62,609	$	61,251	$	60,523	$	235,103	$	58,279	$	477,765

Consumer Credit Exposure: Credit Risk Profile by Creditworthiness Category

	Residential
Risk Rating:	Real Estate		Consumer		Total
Pass	$	83,381	$	42,826	$	126,207
Special Mention		253		125		378
Substandard		13,358		3,113		16,471
Doubtful		180		20		200
Total	$	97,172	$	46,084	$	143,256

The following tables present the credit risk profile of the Corporation’s loan portfolio based on rating category and payment activity as of June 30, 2011:

Commercial Credit Exposure: Credit Risk Profile by Creditworthiness Category

Risk Rating:	Commercial		Agricultural		Agricultural Real Estate		Commercial Real Estate		Commercial Real Estate Development		Total
1-2	$	14,869	$	20,023	$	14,327	$	11,712	$	407	$	61,338
3		53,622		31,303		21,672		72,560		8,941		188,098
4		31,031		9,324		10,016		40,664		1,965		93,000
5		10,526		1,170		1,928		29,112		3,270		46,006
6		19,584		2,534		1,448		47,523		60,543		131,632
7		139		-0-		-0-		-0-		-0-		139
Total	$	129,771	$	64,354	$	49,391	$	201,571	$	75,126	$	520,213

Consumer Credit Exposure: Credit Risk Profile by Creditworthiness Category

	Residential
Risk Rating:	Real Estate		Consumer		Total
Pass	$	75,087	$	48,141	$	123,228
Special Mention		924		283		1,207
Substandard		10,450		2,377		12,827
Doubtful		212		0		212
Total	$	86,673	$	50,801	$	137,474

The accrual of interest on 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 non-accrual or charged-off at the earlier date if collection of principal and interest is considered doubtful.

All interest accrued but not collected for loans that are placed on non-accrual or charged-off are 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 principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following table presents the Corporation’s loan portfolio aging analysis as of June 30, 2012:

	30-59 Days Past Due		60-89 Days Past Due		>90 Days Total		Past Due Past Due		Total Current		Total Loans		>90 Days & Accruing
Commercial	$	424	$	74	$	-	$	498	$	46,985	$	47,483	$	-
Agricultural		-		-		-		-		22,392		22,392		-
Agricultural Real Estate		-		-		-		-		49,783		49,783		-
Commercial Real Estate		460		-		-		460		198,687		199,147		-
Commercial Real Estate Development		-		-		-		-		11,869		11,869		-
Residential Real Estate		31		418		-		-449		84,807		85,256		-
Consumer		278		139		-		417		40,229		40,646		-
Non-Accrual		22		1,536		54,851		56,409		7,664		64,073		-
Total	$	1,215	$	2,167	$	54,851	$	58,233	$	462,416	$	520,649	$	-

The following table presents the Corporation’s loan portfolio aging analysis as of December 31, 2011:

	30-59 Days Past Due		60-89 Days Past Due		>90 Days Past Due		Total Past Due		Total Current		Total Loans		>90 Days & Accruing
Commercial	$	1,205	$	248	$	63	$	1,516	$	57,411	$	58,927	$	63
Agricultural		-		-		-		-		61,251		61,251		-
Agricultural Real Estate		80		18		-		98		54,895		54,993		-
Commercial Real Estate		3,631		1,702		1,588		6,921		195,302		202,223		1,588
Commercial Real Estate Development		-		114		-		114		14,656		14,770		-
Residential Real Estate		3,308		342		-		3,650		87,877		88,527		-
Consumer		540		349		-		889		44,194		45,083		-
Non-Accrual		4,375		7,414		62,579		74,368		20,879		95,247		-
Total	$	13,139	$	10,187	$	64,230	$	87,556	$	533,465	$	621,021	$	1,651

The following table presents the Corporation’s loan portfolio aging analysis as of June 30, 2011:

	30-59 Days Past Due		60-89 Days Past Due		>90 Days Past Due		Total Past Due		Total Current		Total Loans		>90 Days & Accruing
Commercial	$	790	$	1,052	$	274	$	2,116	$	117,808	$	119,924	$	274
Agricultural		656		-		-		656		61,876		62,532		-
Agricultural Real Estate		20		-		-		20		48,293		48,313		-
Commercial Real Estate		4,350		3,238		-		7,588		169,126		176,714		-
Commercial Real Estate Development		698		-		2,195		2,893		39,575		42,468		2,195
Residential Real Estate		-		1,763		-		1,763		77,819		79,582		-
Consumer		880		343		-		1,223		48,907		50,130		-
Non-Accrual		272		722		74,582		75,576		2,448		78,024		-
Total	$	7,666	$	7,118	$	77,051	$	91,835	$	565,852	$	657,687	$	2,469

A loan is 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 Corporation will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include non-performing 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.

The following table presents impaired loans as of June 30, 2012:

							Six Months Ended						Three Months Ended
							Average				Interest		Average		Accrued		Interest
			Unpaid				Investment		Interest		Income		Investment		Interest		Income
	Recorded		Principal		Specific		in Impaired		Income		Recognized		in Impaired		Income		Recognized
	Balance		Balance		Allowance		Loans		Recognized		Cash Basis		Loans		Recognized		Cash Basis

With no related allowance recorded:
Commercial	$	2,933	$	-	$	3,323	$	46	$	61	$	3,209	$	3,317	$	17	$	17
Commercial Real Estate		25,140		-		26,502		230		238		38,660		25,823		141		136
Commercial & Agricultural
Real Estate Development		9,767		-		9,922		71		81		18,104		9,907		34		31
Residential Real Estate		4,013		-		4,228		43		46		5,254		4,163		23		17
Consumer		400		-		466		11		11		1,057		446		5		5

With an allowance recorded:
Commercial	$	1,479	$	1,139	$	1,589	$	15	$	22	$	1,510	$	1,578	$	8	$	5
Commercial Real Estate		11,996		1,229		13,167		16		33		16,981		12,157		15		15
Commercial & Agricultural
Real Estate Development		10,627		983		16,279		11		11		27,678		16,022		7		7
Residential Real Estate		5,533		1,491		5,697		102		92		6,121		5,540		34		23
Consumer		667		153		691		16		15		971		688		8		5

Total:
Commercial	$	61,942	$	3,351	$	70,782	$	389	$	446	$	106,142	$	68,796	$	222	$	211
Residential	$	9,546	$	1,491	$	9,925	$	145	$	138	$	11,375	$	9,703	$	57	$	40
Consumer	$	1,067	$	153	$	1,157	$	27	$	26	$	2,028	$	1,134	$	13	$	10

Interest income recognized on impaired loans includes interest accrued and collected on the outstanding balance of accrued impaired loans as well as interest cash collections on non-accruing impaired loans for which ultimate collectability is uncertain.

The following table presents impaired loans as of December 31, 2011:

							Average				Interest
			Unpaid				Investment		Interest		Income
	Recorded		Principal		Specific		in Impaired		Income		Recognized
	Balance		Balance		Allowance		Loans		Recognized		Cash Basis
With no related allowance recorded:
Commercial	$	1,300	$	1,631	$	-0-	$	5,593	$	74 $77
Commercial Real Estate		33,494		55,356		-0-		24,916		721		861
Commercial Real Estate Development		23,970		46,275		-0-		25,961		323		371
Residential Real Estate		7,305		9,773		-0-		5,993		173		205
Consumer		1,119		1,359		-0-		559		50		54
With an allowance recorded:
Commercial	$	3,566	$	3,566	$	2,632	$	2,737	$	148	$	165
Commercial Real Estate		8,666		8,666 2,566		13,398		424		478
Commercial Real Estate Development		21,974		21,974 8,215		20,241		1,335 1,420
Residential Real Estate		3,986		4,365 1,584		3,930 157		172
Consumer		561		561		219		665		23		24
Total:
Commercial	$	92,970	$	137,468	$	13,413	$	92,845	$	3,025	$	3,372
Residential	$	11,291	$	14,138	$	1,584	$	9,923	$	330	$	377
Consumer	$	1,680	$	1,920	$	219	$	1,224	$	73	$	78

The following table presents impaired loans as of June 30, 2011:

							Six Months Ended				Three Months Ended
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized		Average Investment in Impaired Loans		Interest Income Recognized
With no related allowance recorded:
Commercial	$	9,737	$	11,450	$	-0-	$	9,812	$	55	$	9,922	$	27
Commercial Real Estate		25,852		34,249		-0-		19,378		36	$	29,481	$	13
Commercial Real Estate Development		25,631		42,877		-0-		26,163		96	$	29,627	$	46
Residential Real Estate		6,374		7,588		-0-		5,527		15	$	6,846	$	4
Consumer		657		783		-0-		329		8	$	731	$	3

With an allowance recorded:
Commercial	$	3,562	$	3,930	$	1,879	$	2,735	$	8	$	3,691	$	2
Commercial Real Estate		7,145		7,351		1,169		12,638		181	$	7,159	$	85
Commercial Real Estate Development		14,714		15,294		4,722		16,611		151	$	14,799	$	73
Residential Real Estate		3,525		3,615		757		3,699		36	$	3,548	$	11
Consumer		409		409		298		589		6	$	412	$	3

Total:
Commercial	$	86,641	$	115,151	$	7,770	$	87,336	$	527	$	94,677	$	246
Residential	$	9,899	$	11,203	$	757	$	9,226	$	51	$	10,394	$	15
Consumer	$	1,066	$	1,192	$	298	$	917	$	14	$	1,143	$	6

Included in certain loan categories in the impaired loans are troubled debt restructurings, where economic concessions have been granted to borrowers who have experienced financial difficulties that were classified as impaired. 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. Troubled debt restructurings are considered impaired at the time of restructuring and typically are returned to accrual status after considering the borrower’s sustained repayment performance, as agreed, for a reasonable period of at least six months, or once the granted concessions have ended or are no longer applicable.

When a loan is modified into a troubled debt restructuring, the Corporation evaluated 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, and uses the current fair value of the collateral, less selling costs for collateral dependent loans. If the Corporation determines that the value of the modified loan is less than recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance for loan losses. In periods subsequent to modification, the Corporation evaluates all troubled debt restructurings, including those that have payment defaults, for possible impairment through the allowance for loan losses.

The following tables present the recorded balance of troubled debt restructurings as of June 30, 2012 and December 31, 2011.

	June 30, 2012
	Total Troubled Debt		Troubled debt restructurings performing in accordance with modified terms				Troubled debt restructurings not performing in accordance
	Restructurings		Accruing		Nonaccrual		with modified terms

Commercial	$	1,185	$	1,118	$	48	$	19
Agricultural		-		-		-		-
Agricultural Real Estate		-		-		-		-
Commercial Real Estate		11,694		1,562		-		10,132
Commercial Real Estate Development		2,684		-		42		2,642
Residential Real Estate		4,707		2,448		258		2,001
Consumer		48		7		41		-

Total	$	20,318	$	5,135	$	389	$	14,794

	December 31, 2011
	Total Troubled Debt		Troubled debt restructurings performing in accordance with modified terms				Troubled debt restructurings not performing in accordance
	Restructurings		Accruing		Nonaccrual		with modified terms

Commercial	$	928	$	928	$	-0-	$	-0-
Agricultural		-0-		-0-		-0-		-0-
Agricultural Real Estate		-0-		-0-		-0-		-0-
Commercial Real Estate		11,588		506		-0-		11,082
Commercial Real Estate Development		2,711		-0-		-0-		2,711
Residential Real Estate		3,963		1,618		884		1,461
Consumer		188		145		43		-0-

Total		19,378		3,197		927		15,254

The following table presents loans modified as troubled debt restructurings during the six months ended June 30, 2012 and the year ended December 31, 2011:

	Period Ended June 30, 2012				Year Ended December 31, 2011
	Number of		Recorded		Number of		Recorded
	Modifications		Investment		Modifications		Investment
Commercial		3	$	19		1	$	928
Agricultural		-		-		0		0
Agricultural Real Estate		-		-		0		0
Commercial Real Estate		1		1,063		1		506
Commercial Real Estate Development		-		-		0		0
Residential Real Estate		5		1,058		13		2,463
Consumer		1		9		0		0

Total		10	$	2,149		15	$	3,897

During the six months ended June 30, 2012, the Corporation modified five residential real estate loans with a recorded investment of $1,058 prior to modification which was deemed a troubled debt restructuring. This modification, which was in conjunction with the Federal Home Loan Affordable Modification program (HAMP), involved a reduction in the contractual interest rate. This restructuring was considered to be collateral dependent, but the modifications resulted in the recording of no specific allowance based upon the fair value of the collateral.

In addition, the Corporation modified three commercial loans during the six months ended June 30, 2012 which had a recorded investment of $67 prior to modification and was deemed a troubled debt restructuring. The Corporation modified the loan payment terms to grant an interest only payment period. Based on the fair value of the collateral, a specific reserve was determined necessary for the entire amount of the restructured loan.

The Corporation modified one commercial real estate loan during the six months ended June 30, 2012 which had a recorded investment of $1,067 prior to modification and was deemed a troubled debt restructuring. The Corporation modified the loan payment terms to grant a concession by lengthening the amortization. Based on the fair value of the collateral, no specific reserve was determined necessary for this restructured loan.

During the six months ended June 30, 2012, three out of a total of forty-one troubled debt restructuring loans held by the Corporation were either charged down or charged off by a total of $27. These loans were primarily commercial real estate or commercial real estate development loans. Since these loans were collateral dependent, they were written down to the fair market value of the collateral minus estimated selling costs.

During the year ended December 31, 2011, the Corporation modified thirteen residential real estate loans with a recorded investment of $2,463 prior to modification which were deemed troubled debt restructurings. A total of twelve modifications totaling $2,234 were in conjunction with the Federal Home Affordable Modification program (HAMP). These modifications generally involved a reduction in the contractual interest rate or an adjusted loan amortization schedule. One of the modifications, with a recorded investment of $229 was completed outside of the HAMP program and resulted in a reduction of the contractual interest rate and extension of the loan’s maturity date. Of these residential troubled debt restructurings, eight were considered to be collateral dependent, and the modifications resulted in the recording of a specific allowance of $467, based upon the fair value of the collateral.

In addition, the Corporation modified one commercial loan during the year ended December 31, 2011 which had a recorded investment of $928 prior to modification and was deemed a troubled debt restructuring. The Corporation modified the loan payment terms to grant an interest only payment period. Based on the fair value of the collateral, no specific reserve was determined necessary for this loan.

The Corporation modified one commercial real estate loan during the year ended December 31, 2011 which had a recorded investment of $506 prior to modification and was deemed a troubled debt restructuring. The Corporation modified the loan payment terms to grant a concession by lengthening the amortization. Based on the fair value of the collateral, no specific reserve was determined necessary for this loan.

During the year ended December 31, 2011, seven out of a total of thirty-four troubled debt restructuring loans held by the Corporation were either charged down or charged off by a total of $2,774. These loans were primarily commercial real estate or commercial real estate development loans. Since these loans were collateral dependent, they were written down to the fair market value of the collateral minus estimated selling costs.

At June 30, 2011, the Corporation had $937 of commercial loans, $15,071 of commercial real estate loans, $5,293 of commercial real estate development loans, $3,461 of residential real estate loans and $188 of consumer loans that were modified in troubled debt restructurings and impaired. Of these amounts, the Corporation had troubled debt restructurings that were performing in accordance with their modified terms of $937 of commercial loans, $4,868 of commercial real estate loans, $5,293 of commercial real estate development loans, $3,186 of residential real estate loans and $188 of consumer loans at June 30, 2011.

The following table presents the Corporation’s non-accrual loans at June 30, 2012, December 31, 2011 and June 30, 2011. This table excludes accruing troubled debt restructurings.

	June 30, 2012		December 31, 2011		June 30, 2011
Commercial	$	3,431	$	3,682	$	9,847
Agricultural		-		-		1,822
Agricultural Real Estate		3,545		5,530		1,078
Commercial Real Estate		31,755		32,880		24,857
Commercial Real Estate Development		18,255		43,510		32,658
Residential Real Estate		6,537		8,644		7,091
Consumer		550		1,001		671
Total	$	64,073	$	95,247	$	78,024