Loans and the Allowance for Loan Losses

6 Months Ended

Jun. 30, 2011

Loans and the Allowance for Loan Losses

Loans and the Allowance for Loan Losses

Note 5 — Loans and the Allowance for Loan Losses

Loans are stated at their principal amounts inclusive of net deferred loan origination fees. Interest income is credited as earned except when a loan becomes past due 90 days or more and doubt exists as to the ultimate collection of interest or principal; in those cases the recognition of income is discontinued. Loans that are past due 90 days or more that are both well secured and in the process of collection will remain on an accruing basis. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income.

In July 2010, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") No. 2010-20, "Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses," which requires that the Corporation provide a greater level of disaggregated information about the credit quality of the Corporation's loans and leases and the allowance for loan and lease losses (the "Allowance"). This ASU also requires the Corporation to disclose on a prospective basis, additional information related to credit quality indicators, non-accrual loans and leases, and past due information. The Corporation adopted the provisions of this ASU in preparing the Consolidated Financial Statements as of and for the year ended December 31, 2010. As this ASU amends only the disclosure requirements for loans and leases and the Allowance, the adoption of this ASU for the quarter and six month period ended June 30, 2011 and the year ended December 31, 2010, respectively, had no impact on the Corporation's statements of income and condition. The required disclosures are presented in the following tables and related discussion later in this Note.

Portfolio segments are defined as the level at which an entity develops and documents a systematic methodology to determine its Allowance. Management has determined that the Corporation has two portfolio segments of loans and leases (commercial and consumer) in determining the Allowance. Both quantitative and qualitative factors are used by management at the portfolio segment level in determining the adequacy of the Allowance for the Corporation. Classes of loans and leases are a disaggregation of a Corporation's portfolio segments. Classes are defined as a group of loans and leases which share similar initial measurement attributes, risk characteristics, and methods for monitoring and assessing credit risk. Management has determined that the Corporation has five classes of loans and leases (Commercial and industrial (including lease financing), Commercial – real estate, Construction, Residential mortgage (including home equity) and Installment.

Generally, all classes of commercial and consumer loans and leases are placed on non-accrual status upon becoming contractually past due 90 days or more as to principal or interest (unless loans and leases are adequately secured by collateral, are in the process of collection, and are reasonably expected to result in repayment), when terms are renegotiated below market levels, or where substantial doubt about full repayment of principal or interest is evident. For certain installment loans the entire outstanding balance on the loan is charged-off when the loan becomes 60 days past due.

Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and six months of payments to demonstrate that the borrower can continue to meet the loan terms. Loan origination fees and certain direct loan origination costs are deferred and recognized over the life of the loan as an adjustment to the loan's yield using the level yield method.

Impaired Loans

The Corporation accounts for impaired loans in accordance with FASB ASC 310-10-35 (previously SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan — Income Recognition and Disclosures"). The value of impaired loans is based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or at the fair value of the collateral if the loan is collateral dependent.

The Corporation has defined its population of impaired loans to include all non-accrual and troubled debt restructuring loans. As part of the evaluation of the value of impaired loans, the Corporation reviews all non-homogeneous loans in each instance above an established dollar threshold of $200,000 for impairment internally classified as substandard or below. Smaller impaired non-homogeneous loans and impaired homogeneous loans are not measured for specific reserves and are covered under the Corporation's general reserve.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will not be able to collect all amounts due from the borrower in accordance with the contractual terms of the loan, including scheduled interest payments. Impaired loans include all classes of commercial and consumer non-accruing loans and all loans modified in a troubled debt restructuring ("TDR").

When a loan has been identified as being impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral-dependent. If the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net of deferred loan fees or costs and unamortized premiums or discounts), an impairment is recognized by creating or adjusting an existing allocation of the Allowance, or by recording a partial charge-off of the loan to its fair value. Interest payments made on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest income may be accrued or recognized on a cash basis.

Loans Modified in a Troubled Debt Restructuring

Loans are considered to have been modified in a TDR when due to a borrower's financial difficulties, the Corporation makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a TDR remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status.

Reserve for Credit Losses

The Corporation's reserve for credit losses is comprised of two components, the Allowance and the reserve for unfunded commitments (the "Unfunded Commitments").

Allowance for Loan Losses

The allowance for loan losses is maintained at a level determined adequate to provide for probable loan losses. The allowance is increased by provisions charged to operations and reduced by loan charge-offs, net of recoveries. The allowance is based on management's evaluation of the loan portfolio considering economic conditions, the volume and nature of the loan portfolio, historical loan loss experience and individual credit situations.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.

The ultimate collectability of a substantial portion of the Bank's loan portfolio is susceptible to changes in the real estate market and economic conditions in the State of New Jersey and the impact of such conditions on the creditworthiness of the borrowers.

Management believes that the allowance for loan losses is adequate. Management uses available information to recognize loan losses; however, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examinations.

Reserve for Unfunded Commitments

The reserve for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities and is included in other liabilities in the consolidated statements of condition. The determination of the adequacy of the reserve is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience, and credit risk. Net adjustments to the reserve for unfunded commitments are included in other expense.

The following table sets forth the composition of the Corporation's loan portfolio including net deferred fees and costs, at June 30, 2011 and December 31, 2010:

	June 30,		December 31,
	2011		2010
	(Dollars in Thousands)
Commercial and industrial	$	126,304	$	121,034
Commercial real estate		371,768		372,001
Construction		40,402		49,744
Residential mortgage		159,321		165,154
Installment		353		511
Total loans	$	698,148	$	708,444

Included in the loan balances above are net deferred loan costs of $83,000 and $258,000 at June 30, 2011 and December 31, 2010, respectively.

At June 30, 2011 and December 31, 2010, loans to executive officers and directors aggregated approximately $2,862,000 and $5,456,000, respectively. During the period ended June 30, 2011, the Corporation made no new loans to executive officers and directors; payments by such persons during 2011 aggregated $2,594,000.

Management is of the opinion that the above loans were made on the same terms and conditions as those prevailing for comparable transactions with non-related borrowers.

At June 30, 2011 and December 31, 2010, loan balances of approximately $352.6 million and $435.9 million, respectively, were pledged to secure short term borrowings from the Federal Reserve Bank of New York and Federal Home Loan Bank Advances.

The following table presents information about loan receivables on non-accrual status at June 30, 2011 and December 31, 2010:

Loans Receivable on Non-Accrual Status
	June 30, 2011		December 31, 2010
	(Dollars in Thousands)
Commercial and Industrial	$	100	$	456
Commercial Real Estate		374		3,563
Construction		6,297		5,865
Residential Mortgage		3,366		1,290
Total loans receivable on non-accrual status	$	10,137	$	11,174

The Corporation continuously monitors the credit quality of its loans receivable. In addition to the internal staff, the Corporation utilizes the services of a third party loan review firm to rate the credit quality of its loans receivable. Credit quality is monitored by reviewing certain credit quality indicators. Assets classified "Pass" are deemed to possess average to superior credit quality, requiring no more than normal attention. Assets classified as "Special Mention" have generally acceptable credit quality yet possess higher risk characteristics/circumstances than satisfactory assets. Such conditions include strained liquidity, slow pay, stale financial statements, or other conditions that require more stringent attention from the lending staff. These conditions, if not corrected, may weaken the loan quality or inadequately protect the Corporation's credit position at some future date. Assets are classified "Substandard" if the asset has a well defined weakness that requires management's attention to a greater degree than for loans classified special mention. Such weakness, if left uncorrected, could possibly result in the compromised ability of the loan to perform to contractual requirements. An asset is classified as "Doubtful" if it is inadequately protected by the net worth and/or paying capacity of the obligor or of the collateral, if any, that secures the obligation. Assets classified as doubtful include assets for which there is a "distinct possibility" that a degree of loss will occur if the inadequacies are not corrected. All loans past due 90 days or more and all impaired loans are included in the appropriate category below. The following table presents information about the loan credit quality at June 30, 2011 and December 31, 2010:

Credit Quality Indicators

					June 30, 2011
					(Dollars in Thousands)
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial and industrial	$	122,427	$	2,379	$	1,498	$	—	$	126,304
Commercial real estate		331,267		26,472		14,029		—		371,768
Construction		34,106		—		6,296		—		40,402
Residential mortgage		153,167		—		6,154		—		159,321
Installment		353		—		—		—		353
Total loans	$	641,320	$	28,851	$	27,977	$	—	$	698,148
Credit Quality Indicators
					December 31, 2010
					(Dollars in Thousands)
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial and industrial	$	116,741	$	1,929	$	2,364	$	—	$	121,034
Commercial real estate		345,096		15,383		11,522		—		372,001
Construction		43,879		—		3,588		2,277		49,744
Residential mortgage		161,558		—		3,596		—		165,154
Installment		511		—		—		—		511
Total loans	$	667,785	$	17,312	$	21,070	$	2,277	$	708,444

The following table provides an analysis of the impaired loans at June 30, 2011 and December 31, 2010:

Impaired Loans
	At or for the six months ended June 30, 2011
	(Dollars in Thousands)
					Related
	Recorded Investment		Unpaid Principal Balance		Allowance
No related allowance recorded:
Commercial real estate	$	1,671	$	1,972	$	—
Construction		2,277		5,054		—
Residential mortgage		—		—		—
Total	$	3,948	$	7,026	$	—
With An Allowance Recorded
Commercial real estate	$	4,554	$	4,554	$	581
Construction		4,020		4,020		648
Residential mortgage		3,207		3,207		61
Total	$	11,781	$	11,781	$	1,290
Total
Commercial and industrial	$	—	$	—	$	—
Commercial real estate		6,225		6,526		581
Construction		6,297		9,074		648
Residential mortgage		3,207		3,207		61
Total (including related allowance)	$	15,729	$	18,807	$	1,290
Impaired Loans
	At or for the year ended December 31, 2010
	(Dollars in Thousands)
					Related
	Recorded Investment		Unpaid Principal Balance		Allowance
No related allowance recorded:
Commercial and industrial	$	1,364	$	1,908	$	—
Commercial real estate		3,984		4,625		—
Construction		5,865		8,642		—
Residential mortgage		1,462		1,765		—
Total	$	12,675	$	16,940	$	—
With An Allowance Recorded
Commercial real estate	$	4,180	$	4,180	$	618
Residential mortgage		1,354		1,354		21
Total	$	5,534	$	5,534	$	639
Total
Commercial and industrial	$	1,364	$	1,908	$	—
Commercial real estate		8,164		8,805		618
Construction		5,865		8,642		—
Residential mortgage		2,816		3,119		21
Total (including related allowance)	$	18,209	$	22,474	$	639

	Three Months Ended June 30, 2011				Six Months Ended June 30, 2011				For the Year Ended December 31, 2011
	(Dollars in Thousands)
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Impaired loans with no related allowance recorded:
Commercial and industrial	$	499	$	—	$	703	$	11	$	1,933	$	87
Commercial real estate		3,622		79		3,773		84		4,274		78
Construction		2,277		—		2,277		—		6,855		112
Residential mortgage		—		—		—		—		1,711		27
Total	$	6,398	$	79	$	6,753	$	95	$	14,773	$	304
Impaired loans with an allowance recorded:
Commercial and industrial	$	—	$	—	$	—	$	—	$	—	$	—
Commercial real estate		4,517		34		4,554		68		4,181		204
Construction		4,029		—		4,029		—		—		—
Residential mortgage		2,992		16		3,210		30		1,356		76
Total	$	11,538	$	50	$	11,793	$	98	$	5,537	$	280
Impaired loans:
Commercial and industrial	$	499	$	—	$	703	$	11	$	1,933	$	87
Commercial real estate		8,139		113		8,327		152		8,455		282
Construction		6,306		—		6,306		—		6,855		112
Residential mortgage		2,992		16		3,210		30		3,067		103
Total	$	17,936	$	129	$	18,546	$	193	$	20,310	$	584

The Corporation defines an impaired loan as a loan for which it is probable, based on information available at the determination date, that the Corporation will not collect all amounts due under the contractual terms of the loan. At June 30, 2011 impaired loans were primarily collateral dependent, and totaled $15.7 million. Specific allowance for loan loss of $1.3 million was assigned to impaired loans of $11.8 million. Loans in the amount of $3.9 million had no specific allowance allocation.

Loans are considered to have been modified in a troubled debt restructuring when due to a borrower's financial difficulties, the Corporation makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a troubled debt restructuring remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status. Included in impaired loans at June 30, 2011 are loans that are deemed troubled debt restructurings. Of these loans, $8.2 million, 94% of which are included in the tables above, are performing under the restructured terms and are accruing interest.

The following table provides an analysis of the age of loans that are past due at June 30, 2011 and December 31, 2010:

Aging Analysis
	June 30, 2011
	(Dollars in Thousands)
													Loans
													Receivable >
	30-59 Days Past		60-89 Days Past		Greater Than		Total Past				Total Loans		90 Days And
	Due		Due		90 Days		Due		Current		Receivable		Accruing
Commercial and Industrial	$	1,311	$	82	$	350	$	1,743	$	124,561	$	126,304	$	250
Commercial Real Estate		383		1,396		826		2,605		369,163		371,768		452
Construction		—		—		6,297		6,297		34,105		40,402		—
Residential Mortgage		387		105		3,677		4,169		155,152		159,321		311
Installment		2		—		—		2		351		353		—
Total	$	2,083	$	1,583	$	11,150	$	14,816	$	683,332	$	698,148	$	1,013
	December 31, 2010
	(Dollars in Thousands)
													Loans
													Receivable >
	30-59 Days Past		60-89 Days Past		Greater Than		Total Past				Total Loans		90 Days And
	Due		Due		90 Days		Due		Current		Receivable		Accruing
Commercial and Industrial	$	1,509	$	476	$	456	$	2,441	$	118,593	$	121,034	$	—
Commercial Real Estate		4,290		2,229		3,563		10,082		361,919		372,001		—
Construction		170		449		5,865		6,484		43,260		49,744		—
Residential Mortgage		1,814		309		2,004		4,127		161,027		165,154		714
Installment		9		—		—		9		502		511		—
Total	$	7,792	$	3,463	$	11,888	$	23,143	$	685,301	$	708,444	$	714

The following table details the amount of loans receivable that are evaluated individually, and collectively, for impairment, and the related portion of the allowance for loan loss that is allocated to each loan portfolio segment:

Allowance for loan and lease losses

	June 30, 2011
	(Dollars in Thousands)
	C & I		Comm R/E		Construction		Res Mtge		Installment		Unallocated		Total
Allowance for loan and lease losses:
Individually evaluated for impairment	$	—	$	581	$	648	$	61	$	—	$	—	$	1,290
Collectively evaluated for impairment		1,376		5,574		482		944		56		114		8,546
Total	$	1,376	$	6,155	$	1,130	$	1,005	$	56	$	114	$	9,836
Loans Receivable
Individually evaluated for impairment	$	1,079	$	14,210	$	6,296	$	3,208	$	—	$	—	$	24,793
Collectively evaluated for impairment		125,225		357,558		34,106		156,113		353		—		673,355
Total	$	126,304	$	371,768	$	40,402	$	159,321	$	353	$	—	$	698,148

Allowance for loan and lease losses
	December 31, 2010
	(Dollars in Thousands)
	C & I		Comm R/E		Construction		Res Mtge		Installment		Unallocated		Total
Allowance for loan and lease losses:
Individually evaluated for impairment	$	—	$	618	$	—	$	21	$	—	$	—	$	639
Collectively evaluated for impairment		1,272		5,097		551		1,017		52		239		8,228
Total	$	1,272	$	5,715	$	551	$	1,038	$	52	$	239	$	8,867
Loans Receivable
Individually evaluated for impairment	$	2,748	$	11,960	$	5,865	$	1,354	$	—	$	—	$	21,927
Collectively evaluated for impairment		118,286		360,041		43,879		163,800		511		—		686,517
Total	$	121,034	$	372,001	$	49,744	$	165,154	$	511	$	—	$	708,444

The Corporation's allowance for loan losses is analyzed quarterly. Many factors are considered, including growth in the portfolio, delinquencies, nonaccrual loan levels, and other factors inherent in the extension of credit. There have been no material changes to the allowance for loan loss methodology as disclosed in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2010.

 A summary of the activity in the allowance for loan losses is as follows:

	Three Months Ended June 30, 2011
	(Dollars in Thousands)
	C & I			Comm R/E			Construction		Res Mtge			Installment			Unallocated			Total
Balance at April 1,	$	1,378		$	6,183		$	900	$	952		$	51		$	127		$	9,591
Charge offs		(20	)		—			—		—			(4	)		—			(24	)
Recoveries		—			15			—		2			2			—			19
Provision		18			(43	)		230		51			7			(13	)		250
Balance at June 30,	$	1,376		$	6,155		$	1,130	$	1,005		$	56		$	114		$	9,836
	Six Months Ended June 30, 2011
	(Dollars in thousands)
	C & I			Comm R/E			Construction		Res Mtge			Installment			Unallocated			Total
Balance at January 1,	$	1,272		$	5,715		$	551	$	1,038		$	52		$	239		$	8,867
Charge offs		(185	)		—			—		(23	)		(7	)		—			(215	)
Recoveries		35			15			—		2			4			—			56
Provision		254			425			579		(12	)		7			(125	)		1,128
Balance at June 30,	$	1,376		$	6,155		$	1,130	$	1,005		$	56		$	114		$	9,836

The amount of interest income that would have been recorded on non-accrual loans during the six months ended June 30, 2011, the year ended December 31, 2010, had payments remained in accordance with the original contractual terms, was $324,000 and $598,000, respectively.

At June 30, 2011, there were no commitments to lend additional funds to borrowers whose loans were on non-accrual status or were contractually past due in excess of 90 days and still accruing interest.

The policy of the Corporation is to generally grant commercial, mortgage and installment loans to New Jersey residents and businesses within its market area. The borrowers' abilities to repay their obligations are dependent upon various factors, including the borrowers' income and net worth, cash flows generated by the borrowers' underlying collateral, value of the underlying collateral, and priority of the lender's lien on the property. Such factors are dependent upon various economic conditions and individual circumstances beyond the control of the Corporation. The Corporation is therefore subject to risk of loss. The Corporation believes its lending policies and procedures adequately minimize the potential exposure to such risks and that adequate provisions for loan losses are provided for all known and inherent risks. Collateral and/or personal guarantees are required for virtually all loans.