Loans and Allowance for Loan Losses

The allowance for loan losses is maintained by the Corporation at a level considered by Management to be adequate to cover probable credit losses inherent in the loan portfolio. The amount of the provision for loan losses charged to operating expenses is the amount necessary, in the estimation of Management, to maintain the allowance for loan losses at an adequate level. While management’s periodic analysis of the allowance for loan losses may dictate portions of the allowance be allocated to specific problem loans, the entire amount is available for any loan charge-offs that may occur. Loan losses are charged off against the allowance when management believes that the full collectability of the loan is unlikely. Recoveries of amounts previously charged-off are credited to the allowance.

The allowance is comprised of a general allowance and a specific allowance for identified problem loans. The general allowance is determined by applying estimated loss factors to the credit exposures from outstanding loans. For residential real estate, installment and other loans, loss factors are applied on a portfolio basis. Loss factors are based on the Corporation’s historical loss experience and are reviewed for appropriateness on a quarterly basis, along with other factors affecting the collectability of the loan portfolio. These other factors include but are not limited to; changes in lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices; changes in national and local economic and business conditions, including the condition of various market segments; changes in the nature and volume of the portfolio; changes in the experience, ability, and depth of lending management and staff; changes in the volume and severity of past due and classified loans, the volume of nonaccrual loans, troubled debt restructurings and other loan modifications; the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and the effect of external factors, such as legal and regulatory requirements, on the level of estimated credit losses in the Corporation’s current portfolio. Specific allowances are established for all impaired loans when management has determined that, due to identified significant conditions, it is probable that a loss will be incurred.

Activity in the allowance for loan losses by segment for the three months ended March 31, 2013 and 2012 are summarized as follows:



Three Months Ended March 31, 2013
	Commercial Real Estate			Commercial			Residential Real Estate			Home Equity Loans			Indirect			Consumer			Total
	(Dollars in thousands)
Allowance for loan losses:
Balance, beginning of year	$	11,386		$	835		$	1,559		$	2,357		$	1,230		$	270		$	17,637
Losses charged off	(123		)	(63		)	(513		)	(436		)	(216		)	(77		)	(1,428		)
Recoveries	7			4			64			47			94			31			247
Provision charged to expense	(486		)	(242		)	554			980			502			42			1,350
Balance, end of year	$	10,784		$	534		$	1,664		$	2,948		$	1,610		$	266		$	17,806
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,778		$	192		$	—		$	—		$	—		$	—		$	1,970
Collectively evaluated for impairment	9,006			342			1,664			2,948			1,610			266			15,836
Total ending allowance balance	$	10,784		$	534		$	1,664		$	2,948		$	1,610		$	266		$	17,806
Loans:
Individually evaluated for impairment	$	23,941		$	564		$	1,991		$	483		$	99		$	59		$	27,137
Collectively evaluated for impairment	391,812			75,345			62,495			121,281			199,865			11,996			862,794
Total ending loans balance	$	415,753		$	75,909		$	64,486		$	121,764		$	199,964		$	12,055		$	889,931

Three Months Ended March 31, 2012
	Commercial Real Estate			Commercial			Residential Real Estate			Home Equity Loans			Indirect			Consumer			Total
	(Dollars in thousands)
Allowance for loan losses:
Balance, beginning of year	$	10,714		$	1,409		$	1,331		$	2,289		$	891		$	429		$	17,063
Losses charged off	(979		)	—			(467		)	(403		)	(178		)	(49		)	(2,076		)
Recoveries	20			17			67			4			103			17			228
Provision charged to expense	1,896			(841		)	643			408			(9		)	(197		)	1,900
Balance, end of year	$	11,651		$	585		$	1,574		$	2,298		$	807		$	200		$	17,115
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	3,635		$	145		$	37		$	—		$	—		$	—		$	3,817
Collectively evaluated for impairment	8,016			440			1,537			2,298			807			200			13,298
Total ending allowance balance	$	11,651		$	585		$	1,574		$	2,298		$	807		$	200		$	17,115
Loans:
Individually evaluated for impairment	$	29,328		$	592		$	1,279		$	—		$	—		$	—		$	31,199
Collectively evaluated for impairment	381,453			72,865			59,733			125,298			178,433			13,239			831,021
Total ending loans balance	$	410,781		$	73,457		$	61,012		$	125,298		$	178,433		$	13,239		$	862,220

Delinquencies

Management monitors delinquency and potential problem loans. Bank-wide delinquency at March 31, 2013 was 2.58% of total loans. Total 30-59 day delinquency and 60-89 day delinquency was 0.75% and 0.23% of total loans at March 31, 2013, respectively. Bank-wide delinquency at December 31, 2012 was 2.89% of total loans. Total 30-59 day delinquency and 60-89 day delinquency was 0.61% and 0.32% of total loans at December 31, 2012, respectively. Information regarding delinquent loans as of March 31, 2013 and December 31, 2012 is as follows:

Age Analysis of Past Due Loans as of March 31, 2013



(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Commercial real estate	$	2,869	$	1,901	$	10,215	$	14,985	$	400,768	$	415,753	$	—
Commercial	1,308		5		462		1,775		74,134		75,909		—
Residential real estate	1,094		—		2,267		3,361		61,125		64,486		—
Home equity loans	730		57		1,009		1,796		119,968		121,764		—
Indirect	299		104		56		459		199,505		199,964
Consumer	409		2		188		599		11,456		12,055		—
Total	$	6,709	$	2,069	$	14,197	$	22,975	$	866,956	$	889,931	$	—

Age Analysis of Past Due Loans as of December 31, 2012



(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Commercial real estate	$	3,681	$	1,004	$	12,398	$	17,083	$	396,922	$	414,005	$	—
Commercial	—		—		376		376		68,329		68,705		—
Residential real estate	394		1,094		2,827		4,315		60,668		64,983		184
Home equity loans	630		494		1,510		2,634		120,196		122,830		—
Indirect	645		227		69		941		198,983		199,924
Consumer	26		40		123		189		11,912		12,101		—
Total	$	5,376	$	2,859	$	17,303	$	25,538	$	857,010	$	882,548	$	184

Impaired Loans

A loan is considered impaired when it is probable that not all principal and interest amounts will be collected according to the loan contract. Residential mortgage, installment and other consumer loans are evaluated collectively for impairment. Individual commercial loans are evaluated for impairment. Impaired loans are written down by the establishment of a specific allowance where necessary. Interest income recognized on impaired loans while the loan was considered impaired was immaterial for all periods.

Impaired loans for the Period Ended March 31, 2013 and December 31, 2012 are as follows:



	At March 31, 2013						Three Months Ended March 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Balance
	(Dollars in thousands)
With no related allowance recorded:
Commercial real estate	$	19,035	$	24,826	$	—	$	17,207
Commercial	123		294		—		130
Residential real estate	1,991		2,209		—		1,800
Home equity loans	483		689		—		441
Indirect	99		161		—		50
Consumer	59		59		—		61
With allowance recorded:							0
Commercial real estate	4,906		5,867		1,778		6,424
Commercial	441		442		192		450
Residential real estate	—		—		—		—
Home equity loans	—		—		—
Indirect	—		—		—		—
Consumer	—		—		—		—
Total	$	27,137	$	34,547	$	1,970	$	26,563

	At December 31, 2012						Three Months Ended March 31, 2012
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Balance
	(Dollars in thousands)
With no related allowance recorded:
Commercial real estate	$	15,378	$	20,086	$	—	$	9,786
Commercial	138		138		—		287
Residential real estate	1,610		1,686		—		1,449
Home equity loans	398		398		—		—
Indirect	—		—		—		—
Consumer	61		61		—		—
With allowance recorded:
Commercial real estate	7,942		9,876		1,449		18,567
Commercial	459		459		209		269
Residential real estate	181		1,452		15		72
Home equity loans	—		—		—		—
Indirect	—		—		—		—
Consumer	—		—		—		—
Total	$	26,167	$	34,156	$	1,673	$	30,430

*impaired loans shown in the table above included loans that were classified as troubled debt restructurings ("TDRs'). The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.

Troubled Debt Restructuring

A restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. That concession either stems from an agreement between the creditor and the debtor or is imposed by law or a court. The Corporation adheres to ASC 310-40, Troubled Debt Restructurings by Creditors, to determine whether a troubled debt restructuring applies in a particular instance. Prior to loans being modified and classified as a TDR, specific reserves are generally assessed, as most these loans have been specifically allocated for as part of the Corporation's normal loan loss provisioning methodology. The Corporation has allocated reserves of $371 for the TDR loans at March 31, 2013.

The following table summarizes the loans that were modified as a TDR during the period ended March 31, 2013 and 2012.



At March 31, 2013
	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Residential real estate	1	$34	$23
Home equity loans	6	$361	$243
Indirect Loans	14	$161	$99



At March 31, 2012	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Commercial real estate	5	$4,559	$3,041

There were no loans modified in a TDR that subsequently defaulted during the twelve months periods ended March 31, 2013 and 2012 respectively (i.e., 90 days or more past due following a modification).

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Commercial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor may be requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period. Land loans are also included in the class of commercial real estate loans. Land loans are typically structured as interest-only monthly payments with a balloon payment due at maturity. Land loans modified in a TDR typically involve extending the balloon payment by one to three years and changing the monthly payments from interest-only to principal and interest, while leaving the interest rate unchanged.

Loans modified in a TDR are typically already on nonaccrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Corporation may have the financial effect of increasing the specific allowance associated with the loan. The allowance for impaired loans that have been modified in a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows discounted at the loan’s effective interest rate. Management exercises significant judgment in developing these estimates.

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 and the borrower has not reaffirmed the debt, regardless of the delinquency status of the loan. The filing of bankruptcy by the borrower is evidence of financial difficulty and the discharge of the obligation by the bankruptcy court is deemed to be a concession granted to the borrower.

The Corporation had approximately $390 of additional commitments to lend additional funds to the related debtors whose terms have been modified in a TDR.

Nonaccrual Loans

Nonaccrual loan balances at March 31, 2013 and December 31, 2012 are as follows:



Loans On Non-Accrual Status	March 31, 2013		December 31, 2012
	(Dollars in thousands)
Commercial real estate	$	16,978	$	16,349
Commercial	372		472
Residential real estate	5,148		5,622
Home equity loans	5,156		4,293
Indirect	551		711
Consumer	309		349
Total Nonaccrual Loans	$	28,514	$	27,796

Credit Risk Grading

Sound credit systems, practices and procedures such as credit risk grading systems; effective credit review and examination processes; effective loan monitoring, problem identification, and resolution processes; and a conservative loss recognition process and charge-off policy are integral to management’s proper assessment of the adequacy of the allowance. Many factors are considered when grades are assigned to individual loans such as current and historic delinquency, financial statements of the borrower, current net realizable value of collateral and the general economic environment and specific economic trends affecting the portfolio. Commercial, commercial real estate and residential construction loans are assigned internal credit risk grades. The loan’s internal credit risk grade is reviewed on at least an annual basis and more frequently if needed based on specific borrower circumstances. Credit quality indicators used in management’s periodic analysis of the adequacy of the allowance include the Corporation’s internal credit risk grades which are described below and are included in the table below for March 31, 2013 and December 31, 2012:


•	Grades 1 -5: defined as “Pass” credits — loans which are protected by the borrower’s current net worth and paying capacity or by the value of the underlying collateral. Pass credits are current or have not displayed a significant past due history.


•	Grade 6: defined as “Special Mention” credits — loans where a potential weakness or risk exists, which could cause a more serious problem if not monitored. Loans listed for special mention generally demonstrate a history of repeated delinquencies, which may indicate a deterioration of the repayment abilities of the borrower.


•	Grade 7: defined as “Substandard” credits — loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected.


•	Grade 8: defined as “Doubtful” credits — loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable.


•	Grade 9: defined as “Loss” credits — loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.

For the residential real estate segment, the Corporation monitors credit quality using a combination of the delinquency status of the loan and/or the Corporation’s internal credit risk grades as indicated above.

The following table presents the recorded investment of commercial real estate, commercial and residential real estate loans by internal credit risk grade and the recorded investment of residential real estate, home equity, indirect and consumer loans based on delinquency status as of March 31, 2013 and December 31, 2012:



Commercial Credit Exposure	Commercial Real Estate		Commercial		Residential Real Estate*		Home Equity Loans		Indirect		Consumer		Total
Commercial Credit Exposure	March 31, 2013
	(Dollars in thousands)
Loans graded by internal credit risk grade:
Grade 1 — Minimal	$	—	$	113	$	—	$	—	$	—	$	—	$	113
Grade 2 — Modest	—		—		—		—		—		—		—
Grade 3 — Better than average	1,091		3		—		—		—		—		1,094
Grade 4 — Average	30,126		3,576		622		—		—		—		34,324
Grade 5 — Acceptable	346,812		68,567		5,909		—		—		—		421,288
Total Pass Credits	378,029		72,259		6,531		—		—		—		456,819
Grade 6 — Special mention	10,470		3,128		41		—		—		—		13,639
Grade 7 — Substandard	27,254		522		1,353		—		—		—		29,129
Grade 8 — Doubtful	—		—		—		—		—		—		—
Grade 9 — Loss	—		—		—		—		—		—		—
Total loans internally credit risk graded	415,753		75,909		7,925		—		—		—		499,587
Loans not monitored by internal risk grade:
Current loans not internally risk graded	—		—		53,834		119,968		199,505		11,456		384,763
30-59 days past due loans not internally risk graded	—		—		1,094		730		299		409		2,532
60-89 days past due loans not internally risk graded	—		—		—		57		104		2		163
90+ days past due loans not internally risk graded	—		—		1,633		1,009		56		188		2,886
Total loans not internally credit risk graded	—		—		56,561		121,764		199,964		12,055		390,344
Total loans internally and not internally credit risk graded	$	415,753	$	75,909	$	64,486	$	121,764	$	199,964	$	12,055	$	889,931


*	Residential loans with an internal commercial credit risk grade include loans that are secured by non owner occupied 1-4 family residential properties and conventional 1-4 family residential properties.



Commercial Credit Exposure	Commercial Real Estate		Commercial		Residential Real Estate*		Home Equity Loans		Indirect		Consumer		Total
Commercial Credit Exposure	December 31, 2012
	(Dollars in thousands)
Loans graded by internal credit risk grade:
Grade 1 — Minimal	$	—	$	114	$	—	$	—	$	—	$	—	$	114
Grade 2 — Modest	—		—		—		—		—		—		—
Grade 3 — Better than average	1,100		6		—		—		—		—		1,106
Grade 4 — Average	30,604		4,547		626		—		—		—		35,777
Grade 5 — Acceptable	342,067		60,023		5,584		—		—		—		407,674
Total Pass Credits	373,771		64,690		6,210		—		—		—		444,671
Grade 6 — Special mention	12,201		3,394		42		—		—		—		15,637
Grade 7 — Substandard	27,268		621		1,468		—		—		—		29,357
Grade 8 — Doubtful	765		—		—		—		—		—		765
Grade 9 — Loss	—		—		—		—		—		—		—
Total loans internally credit risk graded	414,005		68,705		7,720		—		—		—		490,430
Loans not monitored by internal risk grade:
Current loans not internally risk graded	—		—		54,416		120,196		198,983		11,912		385,507
30-59 days past due loans not internally risk graded	—		—		394		630		645		26		1,695
60-89 days past due loans not internally risk graded	—		—		1,094		494		227		40		1,855
90+ days past due loans not internally risk graded	—		—		1,359		1,510		69		123		3,061
Total loans not internally credit risk graded	—		—		57,263		122,830		199,924		12,101		392,118
Total loans internally and not internally credit risk graded	$	414,005	$	68,705	$	64,983	$	122,830	$	199,924	$	12,101	$	882,548

* Residential loans with an internal commercial credit risk grade include loans that are secured by non owner occupied 1-4 family residential properties and conventional 1-4 family residential properties.

The Corporation adheres to underwriting standards consistent with its Loan Policy for indirect and consumer loans. Final approval of a consumer credit depends on the repayment ability of the borrower. Repayment ability generally requires the determination of the borrower’s capacity to meet current and proposed debt service requirements. A borrower’s repayment ability is monitored based on delinquency, generally for time periods of 30 to 59 days past due, 60 to 89 days past due and greater than 90 days past due. This information is provided in the above past due loans table.