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 incurred credit losses 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.

The general component covers non‑impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent three years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

Activity in the allowance for loan losses by segment for the three months ended March 31, 2014 and 2013 are summarized as follows:



Three Months Ended March 31, 2014
	Commercial Real Estate			Commercial			Residential Real Estate			Home Equity Loans			Indirect			Consumer			Total
	(Dollars in thousands)
Allowance for loan losses:
Balance, beginning of period	$	10,122		$	497		$	1,411		$	3,484		$	1,593		$	398		$	17,505
Losses charged off	(546		)	—			(77		)	(222		)	(70		)	(83		)	(998		)
Recoveries	6			1			2			11			58			12			90
Provision charged to expense	662			(34		)	147			205			(68		)	(12		)	900
Balance, end of period	$	10,244		$	464		$	1,483		$	3,478		$	1,513		$	315		$	17,497
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	838		$	73		$	6		$	—		$	—		$	—		$	917
Collectively evaluated for impairment	9,406			391			1,477			3,478			1,513			315			16,580
Total ending allowance balance	$	10,244		$	464		$	1,483		$	3,478		$	1,513		$	315		$	17,497
Loans:
Individually evaluated for impairment	$	16,175		$	460		$	1,254		$	980		$	190		$	65		$	19,124
Collectively evaluated for impairment	392,292			82,837			67,417			121,844			209,504			17,171			891,065
Total ending loans balance	$	408,467		$	83,297		$	68,671		$	122,824		$	209,694		$	17,236		$	910,189



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 period	$	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 period	$	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



Year Ended December 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	(2,325		)	(121		)	(754		)	(1,775		)	(678		)	(366		)	(6,019		)
Recoveries	697			8			350			66			335			56			1,512
Provision charged to expense	364			(225		)	256			2,836			706			438			4,375
Balance, end of year	$	10,122		$	497		$	1,411		$	3,484		$	1,593		$	398		$	17,505
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	865		$	73		$	—		$	—		$	—		$	—		$	938
Collectively evaluated for impairment	9,257			424			1,411			3,484			1,593			398			16,567
Total ending allowance balance	$	10,122		$	497		$	1,411		$	3,484		$	1,593		$	398		$	17,505
Loans:
Individually evaluated for impairment	$	17,842		$	472		$	1,731		$	1,111		$	195		$	160		$	21,511
Collectively evaluated for impairment	383,749			88,174			64,776			121,965			206,128			15,996			880,788
Total ending loans balance	$	401,591		$	88,646		$	66,507		$	123,076		$	206,323		$	16,156		$	902,299

Delinquencies

Management monitors delinquency and potential problem loans. Bank-wide delinquency at March 31, 2014 was 1.64% of total loans. Total 30-59 day delinquency and 60-89 day delinquency was 0.25% and 0.25% of total loans at March 31, 2014, respectively. Bank-wide delinquency at December 31, 2013 was 1.69% of total loans. Total 30-59 day delinquency and 60-89 day delinquency was 0.26% and 0.19% of total loans at December 31, 2013, respectively. Information regarding delinquent loans as of March 31, 2014 and December 31, 2013 is as follows:

Age Analysis of Past Due Loans as of March 31, 2014



(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Commercial real estate	$	741	$	1,260	$	6,319	$	8,320	$	400,147	$	408,467	$	—
Commercial	68		—		159		227		83,070		83,297		—
Residential real estate	422		340		2,076		2,838		65,833		68,671		—
Home equity loans	872		591		1,643		3,106		119,718		122,824		—
Indirect	169		51		5		225		209,469		209,694
Consumer	33		60		95		188		17,048		17,236		—
Total	$	2,305	$	2,302	$	10,297	$	14,904	$	895,285	$	910,189	$	—

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



(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Commercial real estate	$	525	$	4	$	7,401	$	7,930	$	393,661	$	401,591	$	—
Commercial	—		18		219		237		88,409		88,646		—
Residential real estate	347		960		2,252		3,559		62,948		66,507		158
Home equity loans	932		707		1,078		2,717		120,359		123,076		43
Indirect	332		30		23		385		205,938		206,323
Consumer	183		25		191		399		15,757		16,156		—
Total	$	2,319	$	1,744	$	11,164	$	15,227	$	887,072	$	902,299	$	201

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. Consumer 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, 2014 and December 31, 2013 are as follows:



	At March 31, 2014						Three Months Ended March 31, 2014
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Balance
	(Dollars in thousands)
With no related allowance recorded:
Commercial real estate	$	12,512	$	16,899	$	—	$	14,021
Commercial	202		255		—		208
Residential real estate	1,233		1,371		—		1,482
Home equity loans	980		1,563		—		1,045
Indirect	190		263		—		192
Consumer	65		97		—		113
With allowance recorded:
Commercial real estate	3,663		5,553		838		2,988
Commercial	258		258		73		258
Residential real estate	21		82		6		11
Home equity loans	—		—		—		—
Indirect	—		—		—		—
Consumer	—		—		—		—
Total	$	19,124	$	26,341	$	917	$	20,318

	At December 31, 2013						Twelve Months Ended December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Balance
	(Dollars in thousands)
With no related allowance recorded:
Commercial real estate	$	15,530	$	20,438	$	—	$	16,705
Commercial	214		267		—		186
Residential real estate	1,731		1,940		—		1,832
Home equity loans	1,111		1,623		—		847
Indirect	195		268		—		178
Consumer	160		204		—		111
With allowance recorded:
Commercial real estate	2,312		2,319		865		4,374
Commercial	258		258		73		346
Residential real estate	—		—		—		—
Home equity loans	—		—		—		—
Indirect	—		—		—		—
Consumer	—		—		—		—
Total	$	21,511	$	27,317	$	938	$	24,579

*impaired loans shown in the tables 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 of these loans have been specifically allocated for as part of the Corporation's normal loan loss provisioning methodology. The Corporation has allocated reserves of $40 for the TDR loans at March 31, 2014.

During the first quarter of 2014 there were no loans that were modified as a TDR.

The following table provides the number of loans modified in a TDR and the recorded investment and unpaid principal balance by loan segment as of March 31, 2014 and 2013.



	Three Months Ended March 31, 2014
	(Dollars in thousands)
	Number of Contracts	Recorded Investment	Unpaid Principal
Commercial real estate	18	$6,214	$8,530
Commercial	1	—	171
Residential real estate	13	964	1,070
Home equity loans	28	786	1,322
Indirect Loans	39	190	263
Consumer Loans	1	65	65
Total	100	$8,219	$11,421



	Three Months Ended March 31, 2013
	(Dollars in thousands)
	Number of Contracts	Recorded Investment	Unpaid Principal
Commercial real estate	14	$6,796	$8,772
Commercial	1	—	171
Residential real estate	10	946	973
Home equity loans	14	483	688
Indirect Loans	14	99	161
Consumer Loans	1	59	59
Total	54	$8,383	$10,824

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



At December 31, 2013
	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Commercial real estate	3	$93	$93
Residential real estate	3	$236	$236
Home equity loans	15	$774	$774
Indirect Loans	25	$195	$195
Consumer Loans	3	$34	$34

There were no loans modified in a TDR that subsequently defaulted during the twelve months periods ended March 31, 2014 and 2013 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 OCC 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 $628 of additional commitments to lend additional funds to the related debtors whose terms have been modified in a TDR at March 31, 2014.

Nonaccrual Loans

Nonaccrual loan balances at March 31, 2014 and December 31, 2013 are as follows:



Loans On Non-Accrual Status	March 31, 2014		December 31, 2013
	(Dollars in thousands)
Commercial real estate	$	10,145	$	11,241
Commercial	227		289
Residential real estate	5,127		5,231
Home equity loans	4,845		4,464
Indirect	362		443
Consumer	212		318
Total Nonaccrual Loans	$	20,918	$	21,986

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, 2014 and December 31, 2013:


•	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 tables present 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, 2014 and December 31, 2013:



Commercial Credit Exposure	Commercial Real Estate		Commercial		Residential Real Estate*		Home Equity Loans		Indirect		Consumer		Total
Commercial Credit Exposure	March 31, 2014
	(Dollars in thousands)
Loans graded by internal credit risk grade:
Grade 1 — Minimal	$	—	$	51	$	—	$	—	$	—	$	—	$	51
Grade 2 — Modest	—		39		—		—		—		—		39
Grade 3 — Better than average	848		—		—		—		—		—		848
Grade 4 — Average	20,204		164		611		—		—		—		20,979
Grade 5 — Acceptable	361,379		79,884		5,654		—		—		—		446,917
Total Pass Credits	382,431		80,138		6,265		—		—		—		468,834
Grade 6 — Special mention	3,341		118		32		—		—		—		3,491
Grade 7 — Substandard	22,695		3,041		615		—		—		—		26,351
Grade 8 — Doubtful	—		—		—		—		—		—		—
Grade 9 — Loss	—		—		—		—		—		—		—
Total loans internally credit risk graded	408,467		83,297		6,912		—		—		—		498,676
Loans not monitored by internal risk grade:
Current loans not internally risk graded	—		—		59,525		119,718		209,469		17,048		405,760
30-59 days past due loans not internally risk graded	—		—		65		872		169		33		1,139
60-89 days past due loans not internally risk graded	—		—		340		591		51		60		1,042
90+ days past due loans not internally risk graded	—		—		1,829		1,643		5		95		3,572
Total loans not internally credit risk graded	—		—		61,759		122,824		209,694		17,236		411,513
Total loans internally and not internally credit risk graded	$	408,467	$	83,297	$	68,671	$	122,824	$	209,694	$	17,236	$	910,189


*	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, 2013
	(Dollars in thousands)
Loans graded by internal credit risk grade:
Grade 1 — Minimal	$	—	$	52	$	—	$	—	$	—	$	—	$	52
Grade 2 — Modest	—		37		—		—		—		—		37
Grade 3 — Better than average	857		—		—		—		—		—		857
Grade 4 — Average	22,580		271		613		—		—		—		23,464
Grade 5 — Acceptable	352,781		84,979		5,589		—		—		—		443,349
Total Pass Credits	376,218		85,339		6,202		—		—		—		467,759
Grade 6 — Special mention	2,146		2,891		35		—		—		—		5,072
Grade 7 — Substandard	23,227		416		625		—		—		—		24,268
Grade 8 — Doubtful	—		—		—		—		—		—		—
Grade 9 — Loss	—		—		—		—		—		—		—
Total loans internally credit risk graded	401,591		88,646		6,862		—		—		—		497,099
Loans not monitored by internal risk grade:
Current loans not internally risk graded	—		—		56,390		120,359		205,938		15,757		398,444
30-59 days past due loans not internally risk graded	—		—		64		932		332		183		1,511
60-89 days past due loans not internally risk graded	—		—		960		707		30		25		1,722
90+ days past due loans not internally risk graded	—		—		2,231		1,078		23		191		3,523
Total loans not internally credit risk graded	—		—		59,645		123,076		206,323		16,156		405,200
Total loans internally and not internally credit risk graded	$	401,591	$	88,646	$	66,507	$	123,076	$	206,323	$	16,156	$	902,299

* 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 90 days or greater past due. This information is provided in the above past due loans table.