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 three months ended March 31, 2013 and 2012. 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 March 31, 2013 and December 31, 2012.


(In thousands)		Commercial and industrial		Commercial real estate		Residential real estate		Home equity		Consumer		DDA overdrafts		Total
Three months ended March 31, 2013:
Allowance for loan loss
Beginning balance	$	498	$	10,440	$	5,229	$	1,699	$	81	$	862	$	18,809
Charge-offs		62		203		591		116		3		339		1,314
Recoveries		1		18		48		-		147		274		488
Provision		67		554		1,189		52		(149)		25		1,738
Ending balance	$	504	$	10,809	$	5,875	$	1,635	$	76	$	822	$	19,721

Three months ended March 31, 2012:
Allowance for loan loss
Beginning balance	$	590	$	11,666	$	3,591	$	2,773	$	88	$	701	$	19,409
Charge-offs		69		1,989		198		509		59		335		3,159
Recoveries		3		96		4		1		29		295		428
Provision		25		682		353		701		51		138		1,950
Ending balance	$	549	$	10,455	$	3,750	$	2,966	$	109	$	799	$	18,628

As of March 31, 2013:
Allowance for loan loss
Evaluated for impairment:
Individually	$	-	$	750	$	-	$	-	$	-	$	-	$	750
Collectively		504		10,059		5,875		1,635		76		822		18,971
Acquired with deteriorated
credit quality		-		-		-		-		-		-		-
Total	$	504	$	10,809	$	5,875	$	1,635	$	76	$	822	$	19,721

Loans
Evaluated for impairment:
Individually	$	-	$	12,719	$	466	$	298	$	-	$	-	$	13,483
Collectively		142,647		952,515		1,146,718		135,425		55,274		2,875		2,435,454
Acquired with deteriorated
credit quality		7,030		36,219		2,227		2,610		-		-		48,086
Total	$	149,677	$	1,001,453	$	1,149,411	$	138,333	$	55,274	$	2,875	$	2,497,023

As of December 31, 2012:
Allowance for loan loss
Evaluated for impairment:
Individually	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Collectively		498		10,440		5,229		1,699		81		862		18,809
Acquired with deteriorated
credit quality		-		-		-		-		-		-		-
Total	$	498	$	10,440	$	5,229	$	1,699	$	81	$	862	$	18,809

Loans
Evaluated for impairment:
Individually	$	-	$	9,912	$	469	$	298	$	-	$	-	$	10,679
Collectively		107,044		807,060		1,030,840		142,724		36,453		4,551		2,128,672
Acquired with deteriorated
credit quality		1,695		4,998		126		88		111		-		7,018
Total	$	108,739	$	821,970	$	1,031,435	$	143,110	$	36,564	$	4,551	$	2,146,369

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: Pass, 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 pass. 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
Pass ratings:
(a) 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.

(b) 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.

(c) 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.

(d) 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 rating	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 rating	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 rating	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 table presents the Company’s commercial loans by credit quality indicators, by class:


	Commercial				Total
	and		Commercial		Commercial
	Industrial		Real Estate		Loans
March 31, 2013:
Pass	$	136,926	$	911,280	$	1,048,206
Special mention		4,866		34,554		39,420
Substandard		7,330		53,295		60,625
Doubtful		555		2,324		2,879
Total	$	149,677	$	1,001,453	$	1,151,130

December 31, 2012:
Pass	$	105,690	$	771,617	$	877,307
Special mention		878		15,015		15,893
Substandard		2,171		35,338		37,509
Doubtful		-		-		-
Total	$	108,739	$	821,970	$	930,709

The following table presents the Company’s non-commercial loans by payment performance, by class:


			Non-
	Performing		Performing		Total
March 31, 2013:
Residential real estate	$	1,146,028	$	3,383	$	1,149,411
Home equity - junior lien		138,275		58		138,333
Consumer		55,273		1		55,274
DDA overdrafts		2,875		-		2,875
Total	$	1,342,451	$	3,442	$	1,345,893

December 31, 2012:
Residential real estate	$	1,029,142	$	2,293	$	1,031,435
Home equity - junior lien		141,961		1,149		143,110
Consumer		36,564		-		36,564
DDA overdrafts		4,548		3		4,551
Total	$	1,212,215	$	3,445	$	1,215,660

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. Commercial loans are generally charged off when the loan becomes 120 days past due. 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 March 31, 2013 and December 31, 2012:


	Originated Loans
	March 31, 2013
	Accruing
		Current		30 - 59 days		60 - 89 days		Over 90 days		Non-accrual		Total
Residential real estate	$	1,051,487	$	5,132	$	434	$	323	$	3,060	$	1,060,436
Home equity – junior liens		103,007		718		108		32		26		103,891
Commercial and industrial		104,758		79		224		17		121		105,199
Commercial real estate		767,733		736		767		-		14,313		783,549
Consumer		32,665		76		6		1		-		32,748
DDA overdrafts		2,538		333		3		1		-		2,875
	$	2,062,188	$	7,074	$	1,542	$	374	$	17,520	$	2,088,698

	Acquired Loans
	March 31, 2013
	Accruing
		Current		30 - 59 days		60 - 89 days		Over 90 days		Non-accrual		Total
Residential real estate	$	86,216	$	1,641	$	42	$	1,076	$	-	$	88,975
Home equity – junior liens		34,442		-		-		-		-		34,442
Commercial and industrial		33,233		1,961		668		8,616		-		44,478
Commercial real estate		210,657		812		-		6,435		-		217,904
Consumer		21,662		719		73		72		-		22,526
DDA overdrafts		-		-		-		-		-		-
	$	386,210	$	5,133	$	783	$	16,199	$	-	$	408,325

	Total Loans
	March 31, 2013
	Accruing
		Current		30 - 59 days		60 - 89 days		Over 90 days		Non-accrual		Total
Residential real estate	$	1,137,703	$	6,773	$	476	$	1,399	$	3,060	$	1,149,411
Home equity – junior liens		137,449		718		108		32		26		138,333
Commercial and industrial		137,991		2,040		892		8,633		121		149,677
Commercial real estate		978,390		1,548		767		6,435		14,313		1,001,453
Consumer		54,327		795		79		73		-		55,274
DDA overdrafts		2,538		333		3		1		-		2,875
	$	2,448,398	$	12,207	$	2,325	$	16,573	$	17,520	$	2,497,023


	Originated Loans
	December 31, 2012
	Accruing
		Current	30 - 59 days	60 - 89 days	Over 90 days	Non-accrual	Total
Residential real estate		1,008,190	4,910	599	239	2,054	1,015,992
Home equity – junior liens		132,847	2,379	477	37	1,112	136,852
Commercial and industrial		105,989	260	236	-	98	106,583
Commercial real estate		766,404	433	199	1	15,930	782,967
Consumer		34,084	113	8	-	-	34,205
DDA overdrafts		4,270	270	8	3	-	4,551
		2,051,784	8,365	1,527	280	19,194	2,081,150

	Acquired Loans
	December 31, 2012
	Accruing
		Current	30 - 59 days	60 - 89 days	Over 90 days	Non-accrual	Total
Residential real estate		15,443	-	-	-	-	15,443
Home equity – junior liens		6,258	-	-	-	-	6,258
Commercial and industrial		1,152	-	-	1,004	-	2,156
Commercial real estate		37,210	9	47	1,737	-	39,003
Consumer		2,359	-	-	-	-	2,359
DDA overdrafts		-	-	-	-	-	-
		62,422	9	47	2,741	-	65,219

	Total Loans
	December 31, 2012
	Accruing
		Current	30 - 59 days	60 - 89 days	Over 90 days	Non-accrual	Total
Residential real estate		1,023,633	4,910	599	239	2,054	1,031,435
Home equity – junior liens		139,105	2,379	477	37	1,112	143,110
Commercial and industrial		107,141	260	236	1,004	98	108,739
Commercial real estate		803,614	442	246	1,738	15,930	821,970
Consumer		36,443	113	8	-	-	36,564
DDA overdrafts		4,270	270	8	3	-	4,551
		2,114,206	8,374	1,574	3,021	19,194	2,146,369

Impaired Loans

The following presents the Company’s impaired loans, by class:


	March 31, 2013						December 31, 2012
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
	Investment		Balance		Allowance		Investment		Balance		Allowance
With no related allowance recorded:
Commercial and industrial	$	-	$	-	$	-	$	-	$	-	$	-
Commercial real estate		9,594		13,274		-		9,912		14,781		-
Residential real estate		466		466		-		469		469		-
Home equity - junior liens		298		298		-		298		298		-
Consumer		-		-		-		-		-		-
DDA overdrafts		-		-		-		-		-		-
Total	$	10,358	$	14,038	$	-	$	10,679	$	15,548	$	-

With an allowance recorded
Commercial and industrial	$	-	$	-	$	-	$	-	$	-	$	-
Commercial real estate		3,126		3,126		750		-		-		-
Residential real estate		-		-		-		-		-		-
Home equity - junior liens		-		-		-		-		-		-
Consumer		-		-		-		-		-		-
DDA overdrafts		-		-		-		-		-		-
Total	$	3,126	$	3,126	$	750	$	-	$	-	$	-

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 three months ended				For the three months ended
	March 31, 2013				March 31, 2012
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized

With no related allowance recorded:
Commercial and industrial	$	-	$	-	$	-	$	-
Commercial real estate		10,340		-		5,216		50
Residential real estate		-		-		-		-
Home equity - junior liens		-		-		-		-
Consumer		-		-		-		-
DDA overdrafts		-		-		-		-
Total	$	10,340	$	-	$	5,216	$	50

With an allowance recorded
Commercial and industrial	$	-	$	-	$	118	$	2
Commercial real estate		3,137		-		13,447		147
Residential real estate		-		-		1,052		11
Home equity - junior liens		-		-		1,521		6
Consumer		-		-		-		-
DDA overdrafts		-		-		-		-
Total	$	3,137	$	-	$	16,138	$	166

On non-accrual and impaired loans, approximately $0.1 million and $0.2 million of interest income would have been recognized during the three months ended March 31, 2013 and 2012, if such loans had been current in accordance with their original terms. The impaired loan information does not include purchased credit-impaired loans and no allowance for loan losses has been recorded at March 31, 2013 relating to such loans. There were no commitments to provide additional funds on non-accrual, impaired or other potential problem loans at March 31, 2013.

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.

During the third quarter of 2012, regulatory guidance was clarified to require 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. The impact on the allowance for loan losses of this reclassification was insignificant. Prior to this reclassification, the Company's TDRs were insignificant.

The following tables set forth the Company’s TDRs:


		March 31, 2013						December 31, 2012
(In thousands)		Accruing		Non-Accruing		Total		Accruing		Non-Accruing		Total

Commercial and industrial	$	101	$	-	$	101	$	101	$	-	$	101
Commercial real estate		1,805		-		1,805		734		-		734
Residential real estate		15,372		131		15,503		15,083		162		15,245
Home equity - junior lien		7,580		79		7,659		7,068		418		7,486
Consumer		142		-		142		142		-		142
	$	25,000	$	210	$	25,210	$	23,128	$	580	$	23,708


	New TDRs						New TDRs
		For the three months ended March 31, 2013						For the three months ended March 31, 2012
(In thousands)		Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment

Commercial and industrial		-	$	-	$	-		-	$	-	$	-
Commercial real estate		1		1,071		1,071		-		-		-
Residential real estate		9		853		853		-		-		-
Home equity - junior lien		17		1,075		1,075		-		-		-
Consumer		-		-		-		-		-		-
		27	$	2,999	$	2,999		-	$	-	$	-