NOTE 3 - LOANS

Major classifications of loans at June 30, 2013 and December 31, 2012 consisted of:

(Amounts in thousands)

	June 30,			December 31,
	2013			2012
Commercial and Industrial	$	27,620		$	28,714
Tax-exempt - real estate and other		36,437			29,192
Commercial real estate		218,895			221,338
Residential real estate		146,982			143,002
Real estate mortgages - Held-for-sale		307			4,009
Consumer		6,049			6,473
Gross loans		436,290			432,728
Add (deduct): Unearned discount and		(116	)		(170	)
Net deferred loan fees and costs		410			338
Total loans, net of unearned income	$	436,584		$	432,896

Activity in the allowance for loan losses for the six months ended June 30, 2013 and the year ended December 31, 2012:

(Amounts in thousands)

	June 30,			December 31,
	2013			2012
Balance at beginning of period	$	5,772		$	5,929
Provision charged to operations		600			1,600
Loans charged off		(468	)		(1,832	)
Recoveries		26			75
Balance at end of period	$	5,930		$	5,772

The Bank utilizes a risk grading matrix as a tool for managing credit risk in the loan portfolio and assigns an Asset Quality Rating (risk grade) to all retail, commercial and industrial, and commercial real estate borrowing relationships. An asset quality rating is assigned using the guidance provided in the Bank's loan policy. Primary responsibility for assigning the asset quality rating rests with the lender. The asset quality rating is validated periodically by both an internal and external loan review process.

The grading system focuses on a borrower's financial strength and performance, experience and depth of management, primary and secondary sources of repayment, the nature of the business and the outlook for the particular industry. Primary emphasis will be on the financial condition and trends. The grade also reflects current economic and industry conditions; as well as other variables such as liquidity, cash flow, revenue/earnings trends, management strengths or weaknesses, quality of financial information, and credit history.

Risk grade characteristics are as follows:

Risk Grade 1 - MINIMAL RISK through Risk Grade 6 - MANAGEMENT ATTENTION (Pass Grade Categories)

Risk is evaluated via examination of several attributes including but not limited to financial trends, strengths and weaknesses, likelihood of repayment when considering both cash flow and collateral, sources of repayment, leverage position, management expertise, and repayment history.

At the low-risk end of the rating scale, a risk grade of 1 - Minimal Risk is the grade reserved for loans with exceptional credit fundamentals and virtually no risk of default or loss. Loan grades then progress through escalating ratings of 2 through 6 based upon risk. Risk Grade 2 - Modest Risk are loans with sufficient cash flows; Risk Grade 3 - Average Risk are loans with key balance sheet ratios slightly above the borrower's peers; Risk Grade 4 - Acceptable Risk are loans with key balance sheet ratios usually near the borrower's peers, but one or more ratios may be higher; and Risk Grade 5 - Marginally Acceptable are loans with strained cash flow, increasing leverage and/or weakening markets. Risk Grade 6 - Management Attention are loans with weaknesses resulting from declining performance trends and the borrower's cash flows may be temporarily strained. Loans in this category are performing according to terms, but present some type of potential concern.

Risk Grade 7 − SPECIAL MENTION (Non-Pass Category)

Generally, these loans or assets are currently protected, but are "Potentially Weak". They constitute an undue and unwarranted credit risk but not to the point of justifying a classification of substandard.

Assets in this category are currently protected but have potential weakness which may, if not checked or corrected, weaken the asset or inadequately protect the Bank's credit position at some future date. No loss of principal or interest is envisioned, however they constitute an undue credit risk that may be minor but is unwarranted in light of the circumstances surrounding a specific asset. Risk is increasing beyond that at which the loan originally would have been granted. Historically, cash flows are inconsistent; financial trends show some deterioration. Liquidity and leverage are above industry averages. Financial information could be incomplete or inadequate. A Special Mention asset has potential weaknesses that deserve management's close attention.

Risk Grade 8 − SUBSTANDARD (Non-Pass Category)

Generally, these assets are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have "well-defined" weaknesses that jeopardize the full liquidation of the debt. There is a distinct possibility that the Bank will sustain some loss.

They are characterized by the distinct possibility that the Bank will sustain some loss if in the aggregate amount of substandard assets, is not fully covered by the liquidation of the collateral used as security. Substandard loans are inadequately protected by current sound net worth, paying capacity of the borrower, or pledged collateral, and have a high probability of payment default, or they have other well-defined weaknesses. Such assets require more intensive supervision by Bank Management.

Risk Grade 9 − DOUBTFUL (Non-Pass Category)

Generally, loans graded doubtful have all the weaknesses inherent in a substandard loan with the added factor that the weaknesses are pronounced to a point where upon analysis of current information, conditions, and values, collection or liquidation in full is highly improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to strengthen the asset, its classification is deferred until, for example, a proposed merger, acquisition, liquidation procedures, capital injection, perfection of liens on additional collateral and/or refinancing plans are completed. Loans are graded doubtful if they contain weaknesses so serious that collection or liquidation in full is questionable.

The credit quality indicators by loan segment are summarized below at June 30, 2013 and December 31, 2012:

	Commercial and				Commercial Real Estate
(Amounts in thousands)	Industrial				Construction
	June 30,		December 31,		June 30,			December 31,
	2013		2012		2013			2012
Grade:
1-6 Pass	$	59,255	$	53,154	$	4,891		$	4,387
7 Special Mention		555		617		0			0
8 Substandard		28		299		0			0
9 Doubtful		0		0		0			0
Add (deduct): Unearned discount and		0		0		0			0
Net deferred loan fees and costs		143		116		(6	)		(2	)
Loans, net of unearned income	$	59,981	$	54,186	$	4,885		$	4,385

	Commercial Real Estate						Residential Real Estate
	Other						Including Home Equity
	June 30,			December 31,			June 30,		December 31,
	2013			2012			2013		2012
Grade:
1-6 Pass	$	212,065		$	214,545		$	145,945	$	145,700
7 Special Mention		1,845			2,129			136		136
8 Substandard		4,313			4,112			1,208		1,176
9 Doubtful		0			0			0		0
Add (deduct): Unearned discount and		0			0			0		0
Net deferred loan fees and costs		(22	)		(15	)		208		156
Loans, net of unearned income	$	218,201		$	220,771		$	147,497	$	147,168

							Loans,
	Consumer Loans						Net of Unearned Income
	June 30,			December 31,			June 30,			December 31,
	2013			2012			2013			2012
Grade:
1-6 Pass	$	6,047		$	6,458		$	428,203		$	424,244
7 Special Mention		2			2			2,538			2,884
8 Substandard		0			13			5,549			5,600
9 Doubtful		0			0			0			0
Add (deduct): Unearned discount and		(116	)		(170	)		(116	)		(170	)
Net deferred loan fees and costs		87			83			410			338
Loans, net of unearned income	$	6,020		$	6,386		$	436,584		$	432,896

Commercial and Industrial and Commercial Real Estate Other include loans categorized as tax free loans.

The activity in the allowance for loan losses, by loan segment, is summarized below for the periods indicated.

(Amounts in thousands)	Commercial		Commercial			Residential
	and Industrial		Real Estate			Real Estate			Consumer			Unallocated		Total
Six months ended June 30, 2013:
Allowance for Loan Losses:
Beginning balance	$	573	$	2,837		$	1,524		$	80		$	758	$	5,772
Charge-offs		0		(175	)		(271	)		(22	)		0		(468	)
Recoveries		19		0			4			3			0		26
Provision		108		173			190			15			114		600
Ending Balance		700		2,835			1,447			76			872		5,930
Ending balance: individually evaluated for impairment		0		221			15			0			0		236
Ending balance: collectively evaluated for impairment	$	700	$	2,614		$	1,432		$	76		$	872	$	5,694

Financing Receivables:
Ending Balance	$	59,981	$	223,086		$	147,498		$	6,019		$	0	$	436,584
Ending balance: individually evaluated for impairment		28		3,090			870			0			0		3,988
Ending balance: collectively evaluated for impairment	$	59,953	$	219,996		$	146,628		$	6,019		$	0	$	432,596

(Amounts in thousands)	Commercial			Commercial			Residential
	and Industrial			Real Estate			Real Estate			Consumer			Unallocated		Total
Year ended December 31, 2012:
Allowance for Loan Losses:
Beginning balance	$	489		$	3,507		$	1,228		$	137		$	568	$	5,929
Charge-offs		(264	)		(1,077	)		(404	)		(87	)		0		(1,832	)
Recoveries		23			22			1			29			0		75
Provision		325			385			699			1			190		1,600
Ending Balance		573			2,837			1,524			80			758		5,772
Ending balance: individually evaluated for impairment		0			111			112			0			0		223
Ending balance: collectively evaluated for impairment	$	573		$	2,726		$	1,412		$	80		$	758	$	5,549

Financing Receivables:
Ending Balance	$	54,186		$	225,156		$	147,168		$	6,386		$	0	$	432,896
Ending balance: individually evaluated for impairment		248			1,312			803			0			0		2,363
Ending balance: collectively evaluated for impairment	$	53,938		$	223,844		$	146,365		$	6,386		$	0	$	430,533

From time to time, the Bank may agree to modify the contractual terms of a borrower's loan. In cases where the modifications represent a concession to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring ("TDR"). Loans classified in troubled debt restructurings may or may not be placed on non-accrual status.

The outstanding balance of TDRs as of June 30, 2013 and December 31, 2012 was $3,397,000 and $0, respectively. The increase in TDRs was attributable to deterioration in the respective borrowers' financial position, and in some cases a declining collateral value, along with the Bank's proactive monitoring of the loan portfolio. As of June 30, 2013, there were no unfunded commitments on any TDRs.

During the second quarter of 2013, one loan with a post modification balance of $25,000 was classified as a TDR, as compared to the second quarter of 2012, when no loans were classified as TDRs. For the six months ended June 30, 2013, nine loans were classified as TDRs as compared to June 30, 2012 when no loans were classified as TDRs. The loan modifications consisted of one term modification beyond the original stated term, two interest rate modifications, and six payment modifications.

The following table presents the unpaid balance of TDRs at the dates indicated:

(Amounts in thousands)
	June 30,		June 30,
	2013		2012
TDRs included in nonperforming loans	$	1,772	$	0
TDRs in compliance with modified terms and performing		1,625		0
Total	$	3,397	$	0

The following tables present information regarding the loan modifications categorized as TDRs during the three months and six months ended June 30, 2013 and June 30, 2012:

(Amounts in thousands, except number of contracts)

	Three Months Ended June 30, 2013						Three Months Ended June 30, 2012
			Pre-		Post-				Pre-		Post-
			Modification		Modification				Modification		Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
	of		Recorded		Recorded		of		Recorded		Recorded
	Contracts		Investment		Investment		Contracts		Investment		Investment
Commercial and Industrial		0	$	0	$	0		0	$	0	$	0
Commercial real estate		1		25		25		0		0		0
Residential real estate		0		0		0		0		0		0
Total		1	$	25	$	25		0	$	0	$	0

(Amounts in thousands, except number of contracts)

	Six Months Ended June 30, 2013						Six Months Ended June 30, 2012
			Pre-		Post-				Pre-		Post-
			Modification		Modification				Modification		Modification
	Number		Outstanding		Outstanding		Number		Outstanding		Outstanding
	of		Recorded		Recorded		of		Recorded		Recorded
	Contracts		Investment		Investment		Contracts		Investment		Investment
Commercial and Industrial		0	$	0	$	0		0	$	0	$	0
Commercial real estate		9		3,638		3,638		0		0		0
Residential real estate		0		0		0		0		0		0
Total		9	$	3,638	$	3,638		0	$	0	$	0

The following table provides detail regarding the types of loan modifications made for loans categorized as TDRs during the three months and six months ended June 30, 2013 and June 30, 2012 with the total number of each type of modification performed.

	Three Months Ended June 30, 2013								Three Months Ended June 30, 2012
	Rate		Term		Payment		Number		Rate		Term		Payment		Number
	Modification		Modification		Modification		Modified		Modification		Modification		Modification		Modified
Commercial and Industrial		0		0		0		0		0		0		0		0
Commercial real estate		0		1		0		1		0		0		0		0
Residential real estate		0		0		0		0		0		0		0		0
Total		0		1		0		1		0		0		0		0

	Six Months Ended June 30, 2013								Six Months Ended June 30, 2012
	Rate		Term		Payment		Number		Rate		Term		Payment		Number
	Modification		Modification		Modification		Modified		Modification		Modification		Modification		Modified
Commercial and Industrial		0		0		0		0		0		0		0		0
Commercial real estate		2		1		6		9		0		0		0		0
Residential real estate		0		0		0		0		0		0		0		0
Total		2		1		6		9		0		0		0		0

Impaired loans at June 30, 2013 and December 31, 2012 were $3,988,000 and $2,363,000, respectively. The gross interest that would have been recorded if these loans had been current in accordance with their original terms and the amounts actually recorded in income were as follows:

(Amounts in thousands)
	June 30,			December 31,
	2013			2012
Gross interest due under terms to date	$	336		$	279
Amount included in income year-to-date		(19	)		(34	)
Interest income not recognized to date	$	317		$	245

The Corporation's impaired loans are summarized below for the periods ended June 30, 2013 and December 31, 2012.

(Amounts in thousands)			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
June 30, 2013:	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial and Industrial	$	28	$	174	$	0	$	177	$	0
Commercial real estate		2,560		3,088		0		3,127		16
Residential real estate		807		1,209		0		1,217		0

With an allowance recorded:
Commercial and Industrial		0		0		0		0		0
Commercial real estate		530		530		221		532		3
Residential real estate		63		63		15		66		0
Total	$	3,988	$	5,064	$	236	$	5,119	$	19

Total consists of:
Commercial and Industrial	$	28	$	174	$	0	$	177	$	0
Commercial real estate	$	3,090	$	3,618	$	221	$	3,659	$	19
Residential real estate	$	870	$	1,272	$	15	$	1,283	$	0

Loans classified as TDRs on non-accrual status were included in the table on the previous page. At June 30, 2013, $1,772,000 of loans classified as TDRs were on non-accrual status with a total allocated allowance of $0.

(Amounts in thousands)			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
December 31, 2012:	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial and Industrial	$	248	$	547	$	0	$	785	$	4
Commercial real estate		1,108		1,495		0		1,529		7
Residential real estate		544		737		0		748		13

With an allowance recorded:
Commercial and Industrial		0		0		0		0		0
Commercial real estate		204		322		111		322		0
Residential real estate		259		259		112		261		10
Total	$	2,363	$	3,360	$	223	$	3,645	$	34

Total consists of:
Commercial and Industrial	$	248	$	547	$	0	$	785	$	4
Commercial real estate	$	1,312	$	1,817	$	111	$	1,851	$	7
Residential real estate	$	803	$	996	$	112	$	1,009	$	23

As of December 31, 2012, there were no loans classified as TDRs.

The recorded investment represents the loan balance reflected on the consolidated balance sheets net of any charge-offs. The unpaid balance is equal to the gross amount due on the loan. The average recorded investment is calculated on the daily loan balance.

Financing receivables on non-accrual status and foreclosed assets as of June 30, 2013 and December 31, 2012 were as follows:

(Amounts in thousands)
	June 30,		December 31,
	2013		2012
Commercial and Industrial	$	28	$	248
Commercial real estate		3,090		1,312
Residential real estate		870		803
Total impaired (including non-accrual TDRs)		3,988		2,363
Loans past-due 90 days or more and still accruing		58		952
Foreclosed assets		515		468
Total non-performing assets	$	4,561	$	3,783

Total TDRs in compliance with modified terms and performing	$	1,625	$	0

At June 30, 2013 and December 31, 2012, the recorded investment in impaired loans as defined by FASB ASC 310-10-35, Receivables Subsequent Measurements, was $3,988,000 and $2,363,000, and the impaired loans allowances were $236,000 and $223,000, respectively. The average recorded balance in impaired loans during the period ended June 30, 2013 and December 31, 2012 was approximately $5,119,000 and $3,645,000, respectively.

The following tables present the aging of past-due loans by major classification of loans at June 30, 2013 and December 31, 2012:

(Amounts in thousands)
					90 Days				Non-				Total
	30-59 Days		60-89 Days		or Greater		Total		Performing				Financing
	Past Due		Past Due		Past Due		Past Due		Assets		Current		Receivables
June 30, 2013:
Commercial and Industrial	$	86	$	8	$	46	$	140	$	28	$	59,813	$	59,981
Commercial real estate		1,154		157		0		1,311		3,090		218,685		223,086
Residential real estate		899		118		0		1,017		870		145,610		147,497
Consumer		54		4		12		70		0		5,950		6,020
Total	$	2,193	$	287	$	58	$	2,538	$	3,988	$	430,058	$	436,584

(Amounts in thousands)
					90 Days				Non-				Total
	30-59 Days		60-89 Days		or Greater		Total		Performing				Financing
	Past Due		Past Due		Past Due		Past Due		Assets		Current		Receivables
December 31, 2012:
Commercial and Industrial	$	10	$	136	$	0	$	146	$	248	$	53,792	$	54,186
Commercial real estate		760		605		952		2,317		1,312		221,527		225,156
Residential real estate		1,060		584		0		1,644		803		144,721		147,168
Consumer		56		0		0		56		0		6,330		6,386
Total	$	1,886	$	1,325	$	952	$	4,163	$	2,363	$	426,370	$	432,896

Loans past due 90 days or more and still accruing interest were $58,000 at June 30, 2013 and $952,000 at December 31, 2012. The decrease was the result of the payoff of the two Commercial real estate loans previously classified as 90 days or greater past due, coupled with the addition of two Commercial and Industrial loans with outstanding balances totaling $46,000, and one Consumer loan with an outstanding balance of $12,000.

At June 30, 2013 and December 31, 2012, there were no commitments to lend additional funds with respect to non-accrual and restructured loans.