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 nine months ended September 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 September 30, 2012 and December 31, 2011.


(In thousands)		Commercial and industrial		Commercial real estate		Residential real estate		Home equity		Consumer		DDA overdrafts		Total
Nine months ended
September 30, 2012:
Allowance for loan loss
Beginning balance	$	590	$	11,666	$	3,591	$	2,773	$	88	$	701	$	19,409
Charge-offs		126		2,860		746		989		148		1,128		5,997
Recoveries		12		100		15		12		90		745		974
Provision		45		1,684		955		1,250		75		591		4,600
Ending balance	$	521	$	10,590	$	3,815	$	3,046	$	105	$	909	$	18,986

Nine months ended
September 30, 2011:
Allowance for loan loss
Beginning balance	$	1,864	$	8,488	$	4,149	$	2,640	$	95	$	988	$	18,224
Charge-offs		275		341		1,191		614		133		1,318		3,872
Recoveries		8		1,982		19		6		107		1,002		3,124
Provision		(1,032)		1,942		744		538		23		157		2,372
Ending balance	$	565	$	12,071	$	3,721	$	2,570	$	92	$	829	$	19,848

As of September 30, 2012:
Allowance for loan loss
Evaluated for impairment:
Individually	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Collectively		521		10,590		3,815		3,046		105		909		18,986
Acquired with deteriorated
credit quality		-		-		-		-		-		-		-
Total	$	521	$	10,590	$	3,815	$	3,046	$	105	$	909	$	18,986

Loans
Evaluated for impairment:
Individually	$	-	$	10,002	$	471	$	297	$	-	$	-	$	10,770
Collectively		105,027		771,716		1,007,710		142,674		38,177		2,670		2,067,974
Acquired with deteriorated
credit quality		-		6,169		124		87		108		-		6,488
Total	$	105,027	$	787,887	$	1,008,305	$	143,058	$	38,285	$	2,670	$	2,085,232

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		929,312		141,499		35,845		2,628		1,956,937
Total	$	130,899	$	732,146	$	929,788	$	141,797	$	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 September 30, 2012 and December 31, 2011:


(In thousands)		Commercial and industrial		Commercial real estate		Residential real estate		Home equity		Consumer		DDA overdrafts		Total
September 30, 2012:
Risk Grade
Exceptional	$	3,508	$	1,813		-		-		-		-	$	5,321
Good		6,466		98,231		-		-		-		-		104,697
Acceptable		68,504		456,116		-		-		-		-		524,620
Pass/watch		23,320		177,974		-		-		-		-		201,294
Special mention		1,066		15,831		-		-		-		-		16,897
Substandard		2,163		37,922		-		-		-		-		40,085
Doubtful		-		-		-		-		-		-		-
Total	$	105,027	$	787,887										892,914

Payment Activity
Performing						1,005,522		141,950		38,274		2,666	$	1,188,412
Non-performing						2,783		1,108		11		4		3,906
Total					$	1,008,305	$	143,058	$	38,285	$	2,670	$	2,085,232

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					$	928,789	$	139,996	$	35,845	$	2,616	$	1,107,246
Non-performing						999		1,801		-		12		2,812
Total					$	929,788	$	141,797	$	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 September 30, 2012 and December 31, 2011:


(In thousands)		Commercial and industrial		Commercial real estate		Residential real estate		Home equity		Consumer		DDA overdrafts		Total
September 30, 2012:
30 – 59 days past due	$	25	$	1,168	$	4,332	$	2,473	$	110	$	309	$	8,417
60 – 89 days past due		-		102		231		135		15		6		489
Over 90 days past due		-		1		346		35		11		4		397
Non-accrual		1,426		17,650		2,437		1,073		-		-		22,586
		1,451		18,921		7,346		3,716		136		319		31,889
Current		103,576		768,966		1,000,959		139,342		38,149		2,351		2,053,343
Total	$	105,027	$	787,887	$	1,008,305	$	143,058	$	38,285	$	2,670	$	2,085,232

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		923,469		137,862		35,707		1,719		1,937,839
Total	$	130,899	$	732,146	$	929,788	$	141,797	$	35,845	$	2,628	$	1,973,103

Impaired Loans

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


(In thousands)		Commercial and industrial		Commercial real estate		Residential real estate		Home equity		Consumer		DDA overdrafts		Total
September 30, 2012:
With no related allowance recorded
Recorded investment	$	1,113	$	11,843	$	219	$	29	$	-	$	-	$	13,204
Unpaid principal balance		1,369		17,594		219		29		-		-		19,211

With an allowance recorded
Recorded investment	$	313	$	5,808	$	2,564	$	1,079	$	11	$	4	$	9,779
Unpaid principal balance		313		5,808		2,564		1,079		11		4		9,779
Related allowance		41		758		314		86		1		4		1,204

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

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 nine months ended September 30, 2012 and 2011:


(In thousands)		Commercial and industrial		Commercial real estate		Residential real estate		Home equity		Consumer		DDA overdrafts		Total
September 30, 2012:
With no related allowance recorded
Average recorded investment	$	81	$	7,472	$	-	$	-	$	-	$	-	$	7,553
Interest income recognized		4		232		-		-		-		-		236

With an allowance recorded
Average recorded investment	$	203	$	11,197	$	1,254	$	1,354	$	-	$	-	$	14,008
Interest income recognized		7		378		36		30		-		-		451

September 30, 2011:
With no related allowance recorded
Average recorded investment	$	-	$	12,350	$	320	$	698	$	-	$	-	$	13,368
Interest income recognized		-		206		15		5		-		-		226

With an allowance recorded
Average recorded investment	$	248	$	14,192	$	996	$	526	$	-	$	-	$	15,962
Interest income recognized		-		157		-		-		-		-		157

Approximately $0.7 million and $0.6 million of interest income would have been recognized during the nine months ended September 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 September 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.

As of September 30, 2012, the Company reclassified $21.1 million of loans as TDRs in accordance with recent regulatory guidance. The regulatory guidance requires loans to be accounted for as collateral-dependent loans when borrowers have filed Chapter 7 bankruptcy, the debt has been discharged by the bankruptcy court and the borrower has not reaffirmed the debt. The filing of bankruptcy is deemed to be evidence that the borrower is in financial difficulty and the discharge of the debt by the bankruptcy court is deemed to be a concession granted to the borrower. As of September 30, 2012, less than 5% of these loans were non-accruing loans. There was no material difference between the pre-modification and post-modification balances. The impact on the allowance for loan losses of this reclassification was insignificant.

The following tables set forth the Company’s TDRs at September 30, 2012:


		September 30, 2012
(In thousands)		Accruing		Non-Accruing		Total

Commercial and industrial	$	-	$	-	$	-
Commercial real estate		227		-		227
Residential real estate		14,098		185		14,283
Home equity		6,400		422		6,822
Consumer		144		-		144
	$	20,869	$	607	$	21,476

During the three month and nine months ended September 30, 2012, no other loans were identified as TDRs. There were no TDRs that defaulted during the three or nine months ended September 30, 2012.