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.

The following summarizes the activity in the allowance for loan loss, by portfolio segment, for the nine months ended September 30, 2013 and 2012 (in thousands). 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, 2013 and December 31, 2012 (in thousands).



	Commercial &		Commercial		Residential						DDA
	Industrial		Real Estate		Real Estate		Home equity		Consumer		Overdrafts		Total
Nine months ended September 30, 2013
Allowance for loan loss
Beginning balance	$	498	$	10,440	$	5,229	$	1,699	$	81	$	862	$	18,809
Charge-offs	772		803		1,598		278		326		1,102		4,879
Recoveries	51		669		137		—		242		674		1,773
Provision	1,460		201		2,481		268		79		414		4,903
Ending balance	$	1,237	$	10,507	$	6,249	$	1,689	$	76	$	848	$	20,606

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

As of September 30, 2013
Allowance for loan loss
Evaluated for impairment:
Individually	$	—	$	880	$	—	$	—	$	—	$	—	$	880
Collectively	1,237		9,537		6,249		1,689		76		848		19,636
Acquired with deteriorated
credit quality	—		90		—		—		—		—		90
Total	$	1,237	$	10,507	$	6,249	$	1,689	$	76	$	848	$	20,606

Loans
Evaluated for impairment:
Individually	$	—	$	12,082	$	461	$	297	$	—	$	—	$	12,840
Collectively	148,262		987,711		1,186,995		138,285		50,649		4,508		2,516,410
Acquired with deteriorated
credit quality	2,923		22,485		1,385		2,305		108		—		29,206
Total	$	151,185	$	1,022,278	$	1,188,841	$	140,887	$	50,757	$	4,508	$	2,558,456

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 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
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	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 commercial loans by credit quality indicators, by class (in thousands):



	Commercial and industrial		Commercial real estate		Total
September 30, 2013
Pass	$	140,999	$	939,942	$	1,080,941
Special mention	693		23,123		23,816
Substandard	9,057		58,720		67,777
Doubtful	436		493		929
Total	$	151,185	$	1,022,278	$	1,173,463

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 (in thousands):



	Performing		Non-Performing		Total
September 30, 2013
Residential real estate	$	1,185,616	$	3,225	$	1,188,841
Home equity - junior lien	140,769		118		140,887
Consumer	50,710		47		50,757
DDA overdrafts	4,506		2		4,508
Total	$	1,381,601	$	3,392	$	1,384,993

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.

A loan acquired and accounted for under ASC Topic 310-30 is reported as an accruing loan and a performing asset provided that the loan is performing in accordance with the initial expectations. The loan would be considered non-performing if the loan's performance deteriorates below the initial expectations.

The following presents an aging analysis of the Company’s accruing and non-accruing loans, by class, as of September 30, 2013 and December 31, 2012 (in thousands):



	Originated Loans
	September 30, 2013
	Accruing
	Current		30-59 days		60-89 days		Over 90 days		Purchased-Credit Impaired		Non-accrual		Total
Residential real estate	$	1,072,148	$	4,484	$	696	$	234	$	—	$	2,286	$	1,079,848
Home equity - junior lien	139,614		716		5		11		—		107		140,453
Commercial and industrial	127,856		5		—		—		—		303		128,164
Commercial real estate	816,383		408		204		—		—		13,540		830,535
Consumer	34,095		86		10		—		—		—		34,191
DDA overdrafts	4,228		270		8		2		—		—		4,508
Total	$	2,194,324	$	5,969	$	923	$	247	$	—	$	16,236	$	2,217,699

	Acquired Loans
	September 30, 2013
	Accruing
	Current		30-59 days		60-89 days		Over 90 days		Purchased-Credit Impaired		Non-accrual		Total
Residential real estate	$	107,321	$	848	$	119	$	65	$	—	$	640	$	108,993
Home equity - junior lien	411		23		—		—		—		—		434
Commercial and industrial	20,504		202		40		59		1,865		351		23,021
Commercial real estate	180,111		1,261		178		—		5,885		4,308		191,743
Consumer	15,863		579		77		47		—		—		16,566
DDA overdrafts	—		—		—		—		—		—		—
Total	$	324,210	$	2,913	$	414	$	171	$	7,750	$	5,299	$	340,757

	Total Loans
	September 30, 2013
	Accruing
	Current		30-59 days		60-89 days		Over 90 days		Purchased-Credit Impaired		Non-accrual		Total
Residential real estate	$	1,179,469	$	5,332	$	815	$	299	$	—	$	2,926	$	1,188,841
Home equity - junior lien	140,025		739		5		11		—		107		140,887
Commercial and industrial	148,360		207		40		59		1,865		654		151,185
Commercial real estate	996,494		1,669		382		—		5,885		17,848		1,022,278
Consumer	49,958		665		87		47		—		—		50,757
DDA overdrafts	4,228		270		8		2		—		—		4,508
Total	$	2,518,534	$	8,882	$	1,337	$	418	$	7,750	$	21,535	$	2,558,456


	Originated Loans
	December 31, 2012
	Accruing



	Current		30-59 days		60-89 days		Over 90 days		Purchased-Credit Impaired		Non-accrual		Total
Residential real estate	$	1,008,190	$	4,910	$	599	$	239	$	—	$	2,054	$	1,015,992
Home equity - junior lien	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
Total	$	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		Purchased-Credit Impaired		Non-accrual		Total
Residential real estate	$	15,443	$	—	$	—	$	—	$	—	$	—	$	15,443
Home equity - junior lien	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	—		—		—		—		—		—		—
Total	$	62,422	$	9	$	47	$	—	$	2,741	$	—	$	65,219

	Total Loans
	December 31, 2012
	Accruing
	Current		30-59 days		60-89 days		Over 90 days		Purchased-Credit Impaired		Non-accrual		Total
Residential real estate	$	1,023,633	$	4,910	$	599	$	239	$	—	$	2,054	$	1,031,435
Home equity - junior lien	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		1,737		15,930		821,970
Consumer	36,443		113		8		—		—		—		36,564
DDA overdrafts	4,270		270		8		3		—		—		4,551
Total	$	2,114,206	$	8,374	$	1,574	$	280	$	2,741	$	19,194	$	2,146,369

The following presents the Company’s impaired loans, by class, as of September 30, 2013 and December 31, 2012 (in thousands). The difference between the unpaid principal balance and the recorded investment generally reflects amounts that have been previously charged-off.



	September 30, 2013						December 31, 2012
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
	Investment		Balance		Allowance		Investment		Balance		Allowance
With no related allowance recorded:
Residential real estate	$	461	$	461	$	—	$	469	$	469	$	—
Home equity - junior liens	297		297		—		298		298		—
Commercial and industrial	—		—		—		—		—		—
Commercial real estate	8,575		10,455		—		9,912		14,781		—
Consumer	—		—		—		—		—		—
DDA overdrafts	—		—		—		—		—		—
Total	$	9,333	$	11,213	$	—	$	10,679	$	15,548	$	—

With an allowance recorded
Residential real estate	$	—	$	—	$	—	$	—	$	—	$	—
Home equity - junior liens	—		—		—		—		—		—
Commercial and industrial	—		—		—		—		—		—
Commercial real estate	3,507		5,307		880		—		—		—
Consumer	—		—		—		—		—		—
DDA overdrafts	—		—		—		—		—		—
Total	$	3,507	$	5,307	$	880	$	—	$	—	$	—

The following table presents information related to the average recorded investment and interest income recognized on the Company’s impaired loans, by class (in thousands):



	For the nine months ended
	September 30, 2013				September 30, 2012
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
With no related allowance recorded:
Residential real estate	$	464	$	—	$	—	$	—
Home equity - junior liens	297		—		—		—
Commercial and industrial	—		—		81		4
Commercial real estate	9,200		24		7,472		232
Consumer	—		—		—		—
DDA overdrafts	—		—		—		—
Total	$	9,961	$	24	$	7,553	$	236

With an allowance recorded
Residential real estate	$	—	$	—	$	1,254	$	36
Home equity - junior liens	—		—		1,354		30
Commercial and industrial	—		—		203		7
Commercial real estate	3,277		—		11,197		378
Consumer	—		—		—		—
DDA overdrafts	—		—		—		—
Total	$	3,277	$	—	$	14,008	$	451

Approximately $0.4 million and $0.7 million of interest income would have been recognized during the nine months ended September 30, 2013 and 2012, 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, 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 2011-2, 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 (in thousands):



	September 30, 2013						December 31, 2012
			Non-						Non-
	Accruing		Accruing		Total		Accruing		Accruing		Total
Commercial and industrial	$	91	$	—	$	91	$	101	$	—	$	101
Commercial real estate	1,567		—		1,567		734		—		734
Residential real estate	19,416		964		20,380		15,083		162		15,245
Home equity	2,758		14		2,772		7,068		418		7,486
Consumer	—		—		—		142		—		142
	$	23,832	$	978	$	24,810	$	23,128	$	580	$	23,708



	New TDRs					New TDRs
	For the nine months ended					For the nine months ended
	September 30, 2013					September 30, 2012
		Pre		Post			Pre		Post
		Modification		Modification			Modification		Modification
		Outstanding		Outstanding			Outstanding		Outstanding
	Number of	Recorded		Recorded		Number of	Recorded		Recorded
	Contracts	Investment		Investment		Contracts	Investment		Investment
Commercial and industrial	1	$	91	$	91	—	$	—	$	—
Commercial real estate	3	1,567		1,567		—	—		—
Residential real estate	30	2,808		2,808		—	—		—
Home equity	12	323		323		—	—		—
Consumer	—	—		—		1	144		144
	46	$	4,789	$	4,789	1	$	144	$	144