NOTE 3. Loans and Allowance

The Corporation’s primary lending focus is small business and middle market commercial and residential real estate, auto and small consumer lending, which results in portfolio diversification. The following tables show the composition in our loan portfolio, loan grades and the allowance for loan losses excluding loans held for sale. Residential real estate loans held for sale at June 30, 2011 and December 31, 2010 were $4,846,000 and $21,469,000, respectively.

The following table shows the composition of the corporation’s loan portfolio by loan class for the periods indicated:

	June 30,			December 31,
	2011			2010
Loans:
Commercial and industrial loans	$	529,742		$	530,322
Agricultural production financing and other loans to farmers		99,360			95,516
Real estate loans:
Construction		96,308			106,615
Commercial and farm land		1,171,901			1,229,037
Residential		495,256			522,051
Home Equity		191,839			201,969
Individual's loans for household and other personal expenditures		94,123			115,295
Lease financing receivables, net of unearned income		4,399			5,157
Other loans		41,094			29,721
		2,724,022			2,835,683
Allowance for loan losses		(77,133	)		(82,977	)
Total Loans	$	2,646,889		$	2,752,706

The Corporation maintains an allowance for loan losses to cover probable credit losses identified during its loan review process. The allowance is increased by the provision for loan losses and decreased by charge offs less recoveries. All charge offs are approved by the Bank’s senior loan officers or loan committees, depending on the amount of the charge off, and are reported to the Bank’s Board of Directors. The Bank charges off loans when a determination is made that all or a portion of a loan is uncollectible. The allowance for loan losses is maintained through the provision for loan losses, which is a charge against earnings.

The amount provided for loan losses in a given period may be greater than or less than net loan losses, and is based on management’s judgment as to the appropriate level of the allowance for loan losses. The determination of the provision amount in a given period is based on management’s continuing review and evaluation of the loan portfolio, including an internally administered loan "watch" list and an independent loan review. The evaluation takes into consideration identified credit problems, the possibility of losses inherent in the loan portfolio that are not specifically identified and management’s judgment as to the impact of current economic conditions on the portfolio.

Management believes that the allowance for loan losses is adequate to cover probable incurred losses inherent in the loan portfolio at June 30, 2011. The process for determining the adequacy of the allowance for loan losses is critical to the Corporation’s financial results. It requires management to make difficult, subjective and complex judgments, as estimates about the effect of uncertain matters are needed. The allowance for loan losses considers current factors, including economic conditions and ongoing internal and external examination processes and will increase or decrease as deemed necessary to ensure the allowance for loan losses remains adequate. In addition, the allowance as a percentage of charge offs and nonperforming loans will change at different points in time based on credit performance, loan mix and collateral values.

The historical loss allocation for loans not deemed impaired according to ASC 310 is the product of the volume of loans within the non-impaired criticized and non-criticized risk grade classifications, each segmented by call code, and the historical loss factor for each respective classification and call code segment. The historical loss factors are based upon actual loss experience within each risk and call code classification. The historical look back period for non-criticized loans looks to the most recent rolling-four-quarter average and aligns with the look up back period for non-impaired criticized loans. Each of the rolling four quarter periods used to obtain the average, include all charge offs for the previous twelve-month period, therefore the historical look back period includes seven quarters. The resulting allocation is reflective of current conditions. Criticized loans are grouped based on the risk grade assigned to the loan. Loans with a special mention grade are assigned a loss factor and loans with a classified grade but not impaired are assigned a separate loss factor. The loss factor computation for this allocation includes a segmented historical loss migration analysis of criticized risk grades to charge off.

In addition to the specific reserves and historical loss components of the allowance, consideration is given to various environmental factors to help ensure that losses inherent in the portfolio are reflected in the allowance for loan losses. The environmental component adjusts the historical loss allocations for commercial and consumer loans to reflect relevant current conditions that, in management’s opinion, have an impact on loss recognition. Environmental factors that management reviews in the analysis include: national and local economic trends and conditions; trends in growth in the loan portfolio and growth in higher risk areas; levels of, and trends in, delinquencies and non-accruals; experience and depth of lending management and staff; adequacy of, and adherence to, lending policies and procedures including those for underwriting; industry concentrations of credit; and adequacy of risk identification systems and controls through the internal loan review and internal audit processes.

The risk characteristics of the Corporation’s material portfolio segments are as follows:

Commercial

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

Commercial real estate

These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Residential and Consumer

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

The following tables summarize changes in the allowance for loan losses by loan segment for the three and six months ended June 30, 2011:

	Three Months Ended June 30, 2011
	Commercial			Real Estate Commercial			Consumer			Residential			Finance Leases			Total
Allowance for loan losses:
Balances, April 1	$	30,206		$	37,240		$	3,098		$	10,371		$	21		$	80,936
Provision for losses		(11,993	)		14,264			(253	)		3,617			(10	)		5,625
Recoveries on loans		6,351			545			332			225			3			7,456
Loans charged off		(849	)		(13,381	)		(318	)		(2,336	)		-			(16,884	)
Balances, June 30, 2011	$	23,715		$	38,668		$	2,859		$	11,877		$	14		$	77,133

	Six Months Ended June 30, 2011
	Commercial			Real Estate Commercial			Consumer			Residential			Finance Leases			Total
Allowance for loan losses:
Balances, January 1	$	32,508		$	36,341		$	3,622		$	10,408		$	98		$	82,977
Provision for losses		(13,875	)		21,190			(468	)		4,459			(87	)		11,219
Recoveries on loans		6,998			866			618			697			3			9,182
Loans charged off		(1,916	)		(19,729	)		(913	)		(3,687	)		-			(26,245	)
Balances, June 30, 2011	$	23,715		$	38,668		$	2,859		$	11,877		$	14		$	77,133

The following tables summarize changes in the allowance for loan losses for the year ended December 31, 2010:

	2010
Allowance for loan losses:
Balance, January 1	$	92,131
Provision for losses		46,483
Recoveries on loans		11,935
Loans charged off		(67,572	)
Balance, December 31, 2010	$	82,977

The following table shows the Corporation’s allowance for credit losses and loan portfolio by loan segment for the periods indicated:

	June 30, 2011
	Commercial		Commercial Real Estate		Consumer		Residential		Finance Leases		Total
Allowance Balances:
Individually evaluated for impairment	$	7,882	$	4,995	$		$	838	$		$	13,715
Collectively evaluated for impairment		15,833		33,673		2,859		11,039		14		63,418
Total Allowance for Loan Losses	$	23,715	$	38,668	$	2,859	$	11,877	$	14	$	77,133

Loan Balances (includes loans held for sale):
Individually evaluated for impairment	$	34,584	$	62,718	$		$	11,022	$		$	108,324
Collectively evaluated for impairment		635,612		1,205,491		94,123		676,073		4,399		2,615,698
Total Loans	$	670,196	$	1,268,209	$	94,123	$	687,095	$	4,399	$	2,724,022

	December 31, 2010
	Commercial		Commercial Real Estate		Consumer		Residential		Finance Leases		Total
Allowance Balances:
Individually evaluated for impairment	$	5,726	$	7,545	$	-	$	643	$	-	$	13,914
Collectively evaluated for impairment		26,782		28,796		3,622		9,765		98		69,063
Total Allowance for Loan Losses	$	32,508	$	36,341	$	3,622	$	10,408	$	98	$	82,977

Loan Balances (includes loans held for sale):
Individually evaluated for impairment	$	28,965	$	77,705	$	-	$	9,534	$	-	$	116,204
Collectively evaluated for impairment		626,594		1,257,947		115,295		714,486		5,157		2,719,479
Total Loans	$	655,559	$	1,335,652	$	115,295	$	724,020	$	5,157	$	2,835,683

Information on non-performing assets, including non-accruing, real estate owned and renegotiated loans, plus accruing loans contractually past due 90 days or more, is summarized below:

	June 30,		December 31,
	2011		2010
Non-Performing Assets:
Non-accrual loans	$	87,583	$	90,591
Renegotiated loans		6,269		7,139
Non-performing loans (NPL)		93,852		97,730
Real estate owned and repossessed assets		15,437		20,927
Non-performing assets (NPA)		109,289		118,657
90+ days delinquent and still accruing		227		1,330
NPAs & 90+ days delinquent	$	109,516	$	119,987

Loans are reclassified to a non-accruing status when, in management’s judgment, the collateral value and financial condition of the borrower do not justify accruing interest. Interest previously recorded, but not deemed collectible, is reversed and charged against current income. Payments subsequently received on nonaccrual loans are applied to principal. A loan is returned to accrual status when principal and interest are no longer past due and collectability is probable, typically after a minimum of six consecutive months of performance. Payments received on impaired accruing or delinquent loans are applied to interest income as accrued.

The following table summarizes the Corporation’s non-accrual loans by loan class for the periods indicated:

Non Accruals by Class
	June 30,		December 31,
	2011		2010
Commercial and Industrial	$	21,097	$	9,812
Agriculture production financing and other loans		306		544
Real Estate Loans:
Construction		14,121		17,164
Commercial and farm land		33,787		45,308
Residential		14,948		15,115
Home Equity		2,723		2,648
Individuals loans for household and other personal expenditures
Lease financing receivables, net of unearned income
Other Loans		601
Total	$	87,583	$	90,591

Impaired loans include all non-accrual loans and renegotiated loans as well as substandard, doubtful and loss grade loans that were still accruing but deemed impaired according to guidance set forth in ASC 310. Also included in impaired loans are accruing loans that are contractually past due 90 days or more. A loan is deemed impaired when, based on current information or events, it is probable that all amounts due of principal and interest according to the contractual terms of the loan agreement will not be collected.

Impaired loans are measured by the present value of expected future cash flows or the fair value of the collateral of the loans, if collateral dependent. The fair value for impaired loans is measured based on the value of the collateral securing those loans and is determined using several methods. The fair value of real estate is generally based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis. Fair value on other collateral such as business assets is typically valued by using the financial information such as financial statements and aging reports provided by the borrower and is discounted as considered appropriate.

The following table shows the composition of the Corporation’s impaired loans by loan class as of June 30, 2011, and December 31, 2010:

							Three Months Ended				Six Months Ended
	June 30, 2011						June 30, 2011				June 30, 2011
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Impaired loans with no related allowance:
Commercial and industrial	$	30,307	$	18,532			$	19,087	$	152	$	19,857	$	285
Agriculture production financing and
other loans to farmers		705		306				312		-		385		-
Real Estate Loans:
Construction		20,435		13,286				14,485		-		15,661		-
Commercial and farm land		53,747		33,538				35,939		205		37,301		401
Residential		8,495		6,151				6,391		2		6,566		5
Home equity		5,272		2,026				1,816		4		1,816		8
Individuals loans for household and
other personal expenditures		-		-				-		-		-
Lease financing receivables, net of
unearned income		-		-				-		-		-
Other loans		94		12				12		-		13
Total	$	119,055	$	73,851			$	78,042	$	363	$	81,599	$	699

Impaired loans with related allowance:
Commercial and industrial	$	15,284	$	15,144	$	7,284	$	15,262	$	44	$	15,324	$	127
Agriculture production financing and
other loans to farmers		-		-		-		-		-		-		-
Real Estate Loans:
Construction		677		677		301		697		-		707		-
Commercial and farm land		16,982		15,214		4,694		16,378		43		16,797		67
Residential		2,907		2,846		838		2,944		8		2,991		15
Home equity		-		-		-		-		-		-		-
Individuals loans for household and
other personal expenditures		-		-		-		-		-		-		-
Lease financing receivables, net of
unearned income		-		-		-		-		-		-		-
Other loans		604		592		598		601		-		605		-
Total	$	36,454	$	34,473	$	13,715	$	35,882	$	95	$	36,424	$	209

Total Impaired Loans	$	155,509	$	108,324	$	13,715	$	113,924	$	458	$	118,023	$	908

	December 31, 2010
	Unpaid Principal Balance		Recorded Investment		Related Allowance
Impaired loans with no related allowance recorded:
Commercial and industrial	$	30,006	$	16,572
Agriculture production financing and other loans to farmers		966		530
Real Estate Loans:
Construction		12,598		9,150
Commercial and farm land		64,064		43,653
Residential		7,909		5,153
Home equity		4,460		1,245
Individuals loans for household and other personal expenditures
Lease financing receivables, net of unearned income
Other loans		101		14
Total	$	120,104	$	76,317

Impaired loans with an allowance recorded:
Commercial and industrial	$	11,477	$	11,374	$	5,250
Agriculture production financing and other loans to farmers
Real Estate Loans:
Construction		9,353		7,824		2,049
Commercial and farm land		17,984		17,076		5,496
Residential		2,740		2,691		465
Home equity		458		446		178
Individuals loans for household and other personal expenditures
Lease financing receivables, net of unearned income
Other loans		476		476		476
Total	$	42,488	$	39,887	$	13,914

Total Impaired Loans	$	162,592	$	116,204	$	13,914

As part of the on-going monitoring of the credit quality of the Corporation’s loan portfolio, management tracks certain credit quality indicators including trends related to: (i) the level of criticized commercial loans, (ii) net charge offs, (iii) non-performing loans and (iv) the general national and local economic conditions.

The Corporation utilizes a risk grading of pass, special mention, substandard, doubtful and loss to assess the overall credit quality of large commercial loans. A description of the general characteristics of these grades is as follows:

·	Pass – Loans that are considered to be of acceptable credit quality.

Special Mention – Loans which possess some credit deficiency or potential weakness, which deserves close attention. A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Corporation’s credit position at some future date. Special mention assets are not adversely classified and do not expose the Corporation to sufficient risk to warrant adverse classification. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan adversely impacting the future repayment ability of the borrower. The key distinctions of this category’s classification are that it is indicative of an unwarranted level of risk; and weaknesses are considered “potential”, not “defined”, impairments to the primary source of repayment. Examples include businesses that may be suffering from inadequate management, loss of key personnel or significant customer or litigation.

Substandard – A substandard loan is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified have a well-defined weakness that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Other characteristics may include:

o	the likelihood that a loan will be paid from the primary source of repayment is uncertain or financial deterioration is underway and very close attention is warranted to ensure that the loan is collected without loss,

o	the primary source of repayment is gone, and the Corporation is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees,

o	loans have a distinct possibility that the Corporation will sustain some loss if deficiencies are not corrected,

o	unusual courses of action are needed to maintain a high probability of repayment,

o	the borrower is not generating enough cash flow to repay loan principal; however, it continues to make interest payments,

o	the Corporation is forced into a subordinated or unsecured position due to flaws in documentation,

o	loans have been restructured so that payment schedules, terms and collateral represent concessions to the borrower when compared to the normal loan terms,

o	the Corporation is seriously contemplating foreclosure or legal action due to the apparent deterioration of the loan, and

o	there is significant deterioration in market conditions to which the borrower is highly vulnerable.

Doubtful – Loans that have all of the weaknesses of those classified as Substandard. However, based on currently existing facts, conditions and values, these weaknesses make full collection of principal highly questionable and improbable. Other credit characteristics may include the primary source of repayment is gone or there is considerable doubt as to the quality of the secondary sources of repayment. The possibility of loss is high, but because of certain important pending factors that may strengthen the loan, loss classification is deferred until the exact status of repayment is known.

Loss – Loans that are considered uncollectible and of such little value that continuing to carry them as an asset is not warranted. Loans will be classified as Loss when it is neither practical not desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

The following table summarizes the credit quality of the Corporation’s loan portfolio, by loan class for the periods indicated. Consumer Non-Performing loans include accruing consumer loans 90 plus days delinquent and consumer non-accrual loans. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified date.

	June 30, 2011
	Commercial Pass		Commercial Special Mention		Commercial Substandard		Commercial Doubtful		Commercial Loss		Consumer Performing		Consumer Non-Performing		Total Loans
Commercial and industrial	$	459,932	$	18,628	$	49,110	$	2,072	$	-	$	-	$	-	$	529,742
Agriculture production financing and other loans		94,721		2,308		2,331		-		-		-		-		99,360
Real Estate Loans:																-
Construction		65,630		6,415		19,321		4,785		-		-		157		96,308
Commercial and farm land		997,215		38,929		131,089		4,628		-		-		40		1,171,901
Residential		134,058		11,904		19,190		678		-		322,710		6,716		495,256
Home equity		15,488		25		3,605		12		-		171,697		1,012		191,839
Individuals loans for household and other personal expenditures		-		-		-		-		-		94,122		1		94,123
Lease financing receivables, net of unearned income		162		-		9		-		-		4,228		-		4,399
Other loans		40,324		76		102		592		-		-		-		41,094
Total	$	1,807,530	$	78,285	$	224,757	$	12,767	$	-	$	592,757	$	7,926	$	2,724,022

	December 31, 2010
	Commercial Pass		Commercial Special Mention		Commercial Substandard		Commercial Doubtful		Commercial Loss		Consumer Performing		Consumer Non Performing		Total Loans
Commercial and industrial	$	454,305	$	19,928	$	53,199	$	2,870	$	20					$	530,322
Agriculture production financing and other loans		92,293		574		2,649										95,516
Real Estate Loans:
Construction		66,918		10,100		28,167		1,430								106,615
Commercial and farm land		1,038,861		38,676		146,213		5,287								1,229,037
Residential		144,163		9,220		18,747		1,169			$	340,932	$	7,820		522,051
Home equity		17,913		283		2,872		524				178,470		1,907		201,969
Individuals loans for household and other personal expenditures												115,239		56		115,295
Lease financing receivables, net of unearned income		280				18						4,859				5,157
Other loans		27,642		1,295		784										29,721
Total	$	1,842,375	$	80,076	$	252,649	$	11,280	$	20	$	639,500	$	9,783	$	2,835,683

The following table shows a past due aging of the Corporation’s loan portfolio, by loan class for June 30, 2011, and December 31, 2010:

	June 30, 2011
	Current		30-59 Days Past Due		60-89 Days Past Due		Loans > 90 Days And Accruing		Non-Accrual		Total Past Due & Non-Accrual		Total Loans
Commercial and industrial	$	506,817	$	1,664	$	149	$	15	$	21,097	$	22,925	$	529,742
Agriculture production financing and other loans		98,930		124		-		-		306		430		99,360
Real Estate Loans:
Construction		81,819		138		230		-		14,121		14,489		96,308
Commercial and farm land		1,120,389		6,056		11,669		-		33,787		51,512		1,171,901
Residential		472,620		5,327		2,248		113		14,948		22,636		495,256
Home equity		186,969		1,451		598		98		2,723		4,870		191,839
Individuals loans for household and other personal expenditures		92,812		1,139		171		1		-		1,311		94,123
Lease financing receivables, net of unearned income		4,399		-		-		-		-		-		4,399
Other loans		40,493		-		-		-		601		601		41,094
Total	$	2,605,248	$	15,899	$	15,065	$	227	$	87,583	$	118,774	$	2,724,022

	December 31, 2010
	Current		30-59 Days Past Due		60-89 Days Past Due		Loans > 90 Days And Accruing		Non-Accrual		Total Past Due & Non-Accrual		Total Loans
Commercial and industrial	$	518,683	$	1,477	$	211	$	139	$	9,812	$	11,639	$	530,322
Agriculture production financing and other loans		94,972								544		544		95,516
Real Estate Loans:
Construction		86,710		1,543		996		202		17,164		19,905		106,615
Commercial and farm land		1,171,580		6,769		5,380		-		45,308		57,457		1,229,037
Residential		498,066		5,261		3,363		246		15,115		23,985		522,051
Home equity		196,276		1,825		534		686		2,648		5,693		201,969
Individuals loans for household and other personal expenditures		112,760		1,989		489		57				2,535		115,295
Lease financing receivables, net of unearned income		5,157										-		5,157
Other loans		29,721										-		29,721
Total	$	2,713,925	$	18,864	$	10,973	$	1,330	$	90,591	$	121,758	$	2,835,683

See the information regarding the analysis of loan loss experience in the Loan Quality/Provision for Loan Losses section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included as ITEM 2 of this Form 10-Q.