Note F –Allowance For Loan Losses

Management systematically monitors the loan portfolio and the adequacy of the allowance for loan losses on a quarterly basis to provide for probable losses inherent in the portfolio. Management assesses the risk in each loan type based on historical trends, the general economic environment of its local markets, individual loan performance and other relevant factors.

Individual credits are selected throughout the year for detailed loan reviews, which are utilized by management to assess the risk in the portfolio and the adequacy of the allowance. Due to the nature of commercial lending, evaluation of the adequacy of the allowance as it relates to these types of loan types is often based more upon specific credit reviews, with consideration given to the potential impairment of certain credits and historical loss rates, adjusted for economic conditions and other inherent risk factors.

A loan acquired and accounted for under ASC Topic 310-30 is reported as an accruing loan and a performing asset.

The following summarizes the activity in the allowance for loan loss, by portfolio segment, for the six months ended June 30, 2012 and 2011. The following also presents the balance in the allowance for loan loss disaggregated on the basis of the Company’s impairment measurement method and the related recorded investment in loans, by portfolio segment, as of June 30, 2012 and December 31, 2011.


(In thousands)	Commercial and industrial	Commercial real estate	Residential real estate	Home equity	Consumer	DDA overdrafts	Total
Six months ended
June 30, 2012:
Allowance for loan loss
Beginning balance	$ 590	$ 11,666	$ 3,591	$ 2,773	$ 88	$ 701	$ 19,409
Charge-offs	(117)	(2,015)	(494)	(856)	(95)	(710)	(4,287)
Recoveries	2	97	7	11	64	524	705
Provision	110	1,341	720	1,009	171	274	3,625
Ending balance	$ 585	$ 11,089	$ 3,824	$ 2,937	$ 228	$ 789	$ 19,452

Six months ended
June 30, 2011:
Allowance for loan loss
Beginning balance	$ 1,864	$ 8,488	$ 4,149	$ 2,640	$ 95	$ 988	$ 18,224
Charge-offs	(75)	(200)	(927)	(405)	(58)	(826)	(2,491)
Recoveries	6	28	18	5	49	733	839
Provision	(851)	1,707	1,062	437	4	13	2,372
Ending balance	$ 944	$ 10,023	$ 4,302	$ 2,677	$ 90	$ 908	$ 18,944

As of June 30, 2012:
Allowance for loan loss
Evaluated for impairment:
Individually	$ -	$ 1,295	$ -	$ -	$ -	$ -	$ 1,295
Collectively	585	9,794	3,824	2,937	228	789	18,157
Acquired with deteriorated
credit quality	-	-	-	-	-	-	-
Total	$ 585	$ 11,089	$ 3,824	$ 2,937	$ 228	$ 789	$ 19,452

Loans
Evaluated for impairment:
Individually	$ -	$ 12,640	$ 472	$ 299	$ -	$ -	$ 13,411
Collectively	116,288	748,896	694,046	445,599	37,383	3,326	2,045,538
Acquired with deteriorated
credit quality	-	6,640	-	-	-	-	6,640
Total	$ 116,288	$ 768,176	$ 694,518	$ 445,898	$ 37,383	$ 3,326	$ 2,065,589

As of December 31, 2011:
Allowance for loan loss
Evaluated for impairment:
Individually	$ -	$ 2,666	$ -	$ -	$ -	$ -	$ 2,666
Collectively	590	9,000	3,591	2,773	88	701	16,743
Total	$ 590	$ 11,666	$ 3,591	$ 2,773	$ 88	$ 701	$ 19,409

Loans
Evaluated for impairment:
Individually	$ 81	$ 15,311	$ 476	$ 298	$ -	$ -	$ 16,166
Collectively	130,818	716,835	638,109	432,702	35,845	2,628	1,956,937
Total	$ 130,899	$ 732,146	$ 638,585	$ 433,000	$ 35,845	$ 2,628	$ 1,973,103

Credit Quality Indicators

All commercial loans within the portfolio are subject to internal risk grading. All non-commercial loans are evaluated based on payment history. The Company’s internal risk ratings for commercial loans are: Exceptional, Good, Acceptable, Pass/Watch, Special Mention, Substandard and Doubtful. Each internal risk rating is defined in the loan policy using the following criteria: balance sheet yields, ratios and leverage, cash flow spread and coverage, prior history, capability of management, market position/industry, potential impact of changing economic, legal, regulatory or environmental conditions, purpose structure, collateral support, and guarantor support. Risk grades are generally assigned by the primary lending officer and are periodically evaluated by the Company’s internal loan review process. Based on an individual loan’s risk grade, estimated loss percentages are applied to the outstanding balance of the loan to determine the amount of probable loss.

The Company categorizes loans into risk categories based on relevant information regarding the customer’s debt service ability, capacity, overall collateral position along with other economic trends, and historical payment performance. The risk grades for each credit are updated when the Company receives current financial information, the loan is reviewed by the Company’s internal loan review/credit administration departments, or the loan becomes delinquent or impaired. The risk grades are updated a minimum of annually for loans rated exceptional, good, acceptable, or pass/watch. Loans rated special mention, substandard or doubtful are reviewed at least quarterly. The Company uses the following definitions for its risk ratings:

Risk Rating	Description

Exceptional	Loans classified as exceptional are secured with liquid collateral conforming to the internal loan policy. Loans rated within this category pose minimal risk of loss to the bank and the risk grade within this pool of loans is generally updated on an annual basis.

Good	Loans classified as good have similar characteristics that include a strong balance sheet, satisfactory debt service coverage ratios, strong management and/or guarantors, and little exposure to economic cycles. Loans within this category are generally reviewed on an annual basis. Loans in this category generally have a low chance of loss to the bank.

Acceptable	Loans classified as acceptable have acceptable liquidity levels, adequate debt service coverage ratios, experienced management, and have average exposure to economic cycles. Loans within this category generally have a low risk of loss to the bank.

Pass/watch	Loans classified as pass/watch have erratic levels of leverage and/or liquidity, cash flow is volatile and the borrower is subject to moderate economic risk. A borrower in this category poses a low to moderate risk of loss to the bank.

Special mention	Loans classified as special mention have a potential weakness(es) that deserves management’s close attention. The potential weakness could result in deterioration of the loan repayment or the bank’s credit position at some future date. A loan rated in this category poses a moderate loss risk to the bank.

Substandard	Loans classified as substandard reflect a customer with a well defined weakness that jeopardizes the liquidation of the debt. Loans in this category have the possibility that the bank will sustain some loss if the deficiencies are not corrected and the bank’s collateral value is weakened by the financial deterioration of the borrower.

Doubtful	Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristics that make collection of the full contract amount highly improbable. Loans rated in this category are most likely to cause the bank to have a loss due to a collateral shortfall or a negative capital position.

The following presents loans by the Company’s credit quality indicators, by class, as of June 30, 2012 and December 31, 2011:


(In thousands)	Commercial and industrial	Commercial real estate	Residential real estate	Home equity	Consumer	DDA overdrafts	Total
June 30, 2012:
Risk Grade
Exceptional	$ 3,364	$ 1,825	-	-	-	-	$ 5,189
Good	6,209	104,033	-	-	-	-	110,242
Acceptable	69,666	436,010	-	-	-	-	505,676
Pass/watch	34,031	173,810	-	-	-	-	207,841
Special mention	1,036	15,337	-	-	-	-	16,373
Substandard	1,982	36,933	-	-	-	-	38,915
Doubtful	-	228	-	-	-	-	228
Total	$ 116,288	$ 768,176					884,464

Payment Activity
Performing			$ 692,334	$ 444,983	$ 37,367	$ 3,323	$ 1,178,007
Non-performing			2,184	915	16	3	3,118
Total			$ 694,518	$ 445,898	$ 37,383	$ 3,326	$ 2,065,589

December 31, 2011:
Risk Grade
Exceptional	$ 4,220	$ 42	-	-	-	-	$ 4,262
Good	6,728	107,718	-	-	-	-	114,446
Acceptable	93,077	411,721	-	-	-	-	504,798
Pass/watch	25,246	161,598	-	-	-	-	186,844
Special mention	470	16,802	-	-	-	-	17,272
Substandard	1,037	34,265	-	-	-	-	35,302
Doubtful	121	-	-	-	-	-	121
Total	$ 130,899	$ 732,146					863,045

Payment Activity
Performing			$ 637,586	$ 431,199	$ 35,845	$ 2,616	1,107,246
Non-performing			999	1,801	-	12	2,812
Total			$ 638,585	$ 433,000	$ 35,845	$ 2,628	$ 1,973,103

Aging Analysis of Accruing and Non-Accruing Loans

Interest income on loans is accrued and credited to operations based upon the principal amount outstanding, using methods that generally result in level rates of return. Loan origination fees, and certain direct costs, are deferred and amortized as an adjustment to the yield over the term of the loan. The accrual of interest generally is discontinued when a loan becomes 90 days past due as to principal or interest for all loan types. However, any loan may be placed on non-accrual if the Company receives information that indicates a borrower is unable to meet the contractual terms of their respective loan agreement. Other indicators considered for placing a loan on non-accrual status include the borrower’s involvement in bankruptcies, foreclosures, repossessions, litigation and any other situation resulting in doubt as to whether full collection of contractual principal and interest is attainable. When interest accruals are discontinued, unpaid interest recognized in income in the current year is reversed, and interest accrued in prior years is charged to the allowance for loan losses. Management may elect to continue the accrual of interest when the net realizable value of collateral exceeds the principal balance and related accrued interest, and the loan is in the process of collection.

Generally for all loan classes, interest income during the period the loan is non-performing is recorded on a cash basis after recovery of principal is reasonably assured. Cash payments received on nonperforming loans are typically applied directly against the outstanding principal balance until the loan is fully repaid. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

Generally, all loan types are considered past due when the contractual terms of a loan are not met and the borrower is 30 days or more past due on a payment. Furthermore, residential and home equity loans are generally subject to charge-off when the loan becomes 120 days past due, depending on the estimated fair value of the collateral less cost to dispose, versus the outstanding loan balance. Unsecured commercial loans are generally charged off when the loan becomes 120 days past due. Secured commercial loans are generally charged off when the loan becomes 120 days past due and open-end consumer loans are generally charged off when the loan becomes 180 days past due.

The following presents an aging analysis of the Company’s accruing and non-accruing loans, by class, as of June 30, 2012 and December 31, 2011:


(In thousands)	Commercial and industrial	Commercial real estate	Residential real estate	Home equity	Consumer	DDA overdrafts	Total
June 30, 2012:
30 – 59 days past due⁽¹⁾	$ 540	$ 3,315	$ 4,247	$ 1,668	$ 59	$ 352	$ 10,181
60 – 89 days past due⁽¹⁾	-	1,183	1,222	166	15	9	2,595
Over 90 days past due⁽¹⁾	-	1,627	106	30	16	3	1,782
Non-accrual	341	18,422	2,078	885	-	-	21,726
	881	24,547	7,653	2,749	90	364	36,284
Current	115,407	743,629	686,865	443,149	37,293	2,962	2,029,305
Total	$ 116,288	$ 768,176	$ 694,518	$ 445,898	$ 37,383	$ 3,326	$ 2,065,589

December 31, 2011:
30 – 59 days past due	$ 1,243	$ 576	$ 4,912	$ 1,906	$ 133	$ 883	$ 9,653
60 – 89 days past due	-	2,839	408	228	5	14	3,494
Over 90 days past due	-	-	42	112	-	12	166
Non-accrual	375	18,930	957	1,689	-	-	21,951
	1,618	22,345	6,319	3,935	138	909	35,264
Current	129,281	709,801	632,266	429,065	35,707	1,719	1,937,839
Total	$ 130,899	$ 732,146	$ 638,585	$ 433,000	$ 35,845	$ 2,628	$ 1,973,103

(1) A loan acquired and accounted for under ASC Topic 310-30, in which the Company can reasonably estimate the cash flows of the loan, is reported as an accruing loan and a performing asset. Included in the 30-59 day, 60-89 day and over 90 day categories above are $0.2 million, $1.1 million and $1.6 million, respectively, of such loans at June 30, 2012.

Impaired Loans

The following presents the Company’s impaired loans, by class, as of June 30, 2012 and December 31, 2011:


(In thousands)	Commercial and industrial	Commercial real estate	Residential real estate	Home equity	Consumer	DDA overdrafts	Total
June 30, 2012:
With no related allowance recorded
Recorded investment	$ -	$ 2,791	$ -	$ -	$ -	$ -	$ 2,791
Unpaid principal	-	6,986	-	-	-	-	6,986
balance

With an allowance recorded
Recorded investment	$ 340	$ 15,632	$ 2,184	$ 916	$ 10	$ 2	$ 19,084
Unpaid principal	340	15,632	2,184	916	10	2	19,084
balance	-	-	-	-	-	-	-
Related allowance	42	1,921	270	113	1	2	2,349

December 31, 2011:
With no related allowance recorded
Recorded investment	$ 78	$ 2,840	$ -	$ -	$ -	$ -	$ 2,918
Unpaid principal	78	6,036	-	-	-	-	6,114
balance

With an allowance recorded
Recorded investment	$ 297	$ 16,090	$ 1,000	$ 1,801	$ -	$ 12	$ 19,200
Unpaid principal
balance	297	16,090	1,000	1,801	-	12	19,200
Related allowance	53	3,044	139	240	-	12	3,488

The following table presents information related to the average recorded investment and interest income recognized on the Company’s impaired loans, by class, for the six months ended June 30, 2012 and 2011:


(In thousands)	Commercial and industrial	Commercial real estate	Residential real estate	Home equity	Consumer	DDA overdrafts	Total
June 30, 2012:
With no related allowance recorded
Average recorded
investment	$ -	$ 4,337	$ -	$ -	$ -	$ -	$ 4,337
Interest income
recognized	-	85	-	-	-	-	85

With an allowance recorded
Average recorded
investment	$ 184	$ 14,409	$ 936	$ 1,657	$ -	$ -	$ 17,186
Interest income
recognized	5	298	22	20	-	-	345

June 30, 2011:
With no related allowance recorded
Average recorded
investment	$ -	$ 12,047	$ 479	$ 1,047	$ -	$ -	$ 13,573
Interest income
recognized	-	206	15	5	-	-	226

With an allowance recorded
Average recorded
investment	$ 129	$ 17,166	$ 700	$ 314	$ -	$ -	$ 18,309
Interest income
recognized	-	157	-	-	-	-	157

Approximately $0.4 million and $0.1 million of interest income would have been recognized during the six months ended June 30, 2012 and 2011, if such loans had been current in accordance with their original terms. There were no commitments to provide additional funds on non-accrual, impaired or other potential problem loans at June 30, 2012.

Loan Modifications

The Company’s policy on loan modifications typically does not allow for modifications that would be considered a concession from the Company. However, when there is a modification, the Company evaluates each modification to determine if the modification constitutes a troubled debt restructuring (“TDR”) in accordance with ASU 2011-02, whereby a modification of a loan would be considered a TDR when both of the following conditions are met: (1) a borrower is experiencing financial difficulty and (2) the modification constitutes a concession. When determining whether the borrower is experiencing financial difficulties, the Company reviews whether the debtor is currently in payment default on any of its debt or whether it is probable that the debtor would be in payment default in the foreseeable future without the modification. Other indicators of financial difficulty include whether the debtor has declared or is in the process of declaring bankruptcy, the debtor’s ability to continue as a going concern, or the debtor’s projected cash flow to service its debt (including principal and interest) in accordance with the contractual terms for the foreseeable future, without a modification.

At June 30, 2012, the Company’s TDRs totaled less than $0.4 million. There was no material difference between the pre-modification and post-modification balances. The impact on the allowance for loan losses was insignificant. There were no TDRs that defaulted during the three or six months ended June 30, 2012.