Note 4 — Allowance for Loan Losses

Suffolk management determined that is was not properly identifying loan losses in the period incurred. This was the result of deficiencies in Suffolk's internal controls with respect to credit administration and credit risk management, primarily with regard to risk-rating as well as with respect to the timing and recognition of charge-offs, impaired loans, and classified loans. As a result, certain loans should have been considered impaired, classified, or charged-off. See Note 1 (A) on page 36 for a detailed description of the financial statement restatement.

Suffolk takes into account applicable guidance under U.S. GAAP, including particularly "ASC 855 – Subsequent Events." Under this statement, subsequent events are defined as events or transactions that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement requires that entities recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed as of the balance sheet date, including any estimates underlying the financial statements. The entity should not recognize subsequent events that provide evidence about conditions that arose after the balance sheet date, but should disclose those events which are so important that nondisclosure would make the financial statements misleading.

One result of the analysis of subsequent events is that certain loans which would have been downgraded or charged off during 2011 (through December 20, 2011, the date of Suffolk's 2010 Form 10-K/A filing) because of their continuing deterioration, have been recognized in the restated allowance for loan losses for the year ended December 31, 2010 since the credit deterioration could be traced to 2010 even though it had been identified after December 31, 2010. This resulted in an increase in charged-off loans totaling approximately $8.0 million for the year ended December 31, 2010. These charge-offs were reflected in the allowance for loan losses calculations as of December 31, 2010.

An analysis of the changes in the allowance for loan losses follows: (in thousands)


Year ended December 31,	2011			2010 Restated		2009
Year ended December 31,	2011			2010 Restated		2009
Balance, January 1,	$	28,419		$	12,333	$	9,051
Loans charged-off:
Commercial, financial & agricultural loans		9,490			8,501		806
Commercial real estate mortgages		4,059			2,788		—
Real estate — construction loans		232			3,548		—
Residential mortgages (1st and 2nd liens)		411			769		—
Home equity loans		191			315		—
Consumer loans		214			317		404
Other loans		—			—		—

Total Charge-offs	$	14,597		$	16,238	$	1,210


Loans recovered after charge-off:
Commercial, financial & agricultural loans	$	781		$	69	$	41
Commercial real estate mortgages		—			—		—
Real estate — construction loans		415			—		—
Residential mortgages (1st and 2nd liens)		3			—		—
Home equity loans		2			—		—
Consumer loans		97			118		176
Other loans		—			—		—

Total recoveries	$	1,298		$	187	$	217

Net loans charged-off		13,299			16,051		993
Reclass to Allowance for
Contingent Liabilities (1)		(50	)		51		—
Provision for loan losses		24,888			32,086		4,275

Balance, December 31,	$	39,958		$	28,419	$	12,333

(1)	2009 amount not reclassified due to immateriality.

At December 31, 2011 and 2010, respectively, the Bank's investment in impaired loans and the related allowance for loan losses follows: (in thousands)


			2010
	2011		Restated
Recorded investment	$	135,100	$	100,241
Allowance for loan losses		10,626		9,416

The qualitative factors utilized by Suffolk in computing its allowance for loan losses are determined based on the various risk characteristics of each loan class. Relevant risk characteristics are as follows:

Commercial, industrial and agricultural loans – Loans in this class are made to businesses. Generally these loans are secured by assets of the business and repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer and/or business spending will have an effect on the credit quality in this loan class.

Commercial real estate mortgages – Loans in this class include income-producing investment properties and owner-occupied real estate used for business purposes. The underlying properties are generally located largely in our primary market area. The cash flows of the income producing investment properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on credit quality. Generally, management seeks to obtain annual financial information for borrowers with loans in excess of $250 thousand in this category. In the case of owner-occupied real estate used for business purposes, a weakened economy and resultant decreased consumer and/or business spending will have an adverse effect on credit quality.

Real estate-construction loans – Loans in this class primarily include land loans to local individuals, contractors and developers for developing the land for sale or for the purpose of making improvements thereon. Repayment is derived from sale of the lots/ units including any pre-sold units. Credit risk is affected by market conditions, time to sell at an adequate price and cost overruns. To a lesser extent this class includes commercial development projects Suffolk finances, which in most cases require interest only during construction, and then convert to permanent financing. Credit risk is affected by construction delays, cost overruns, market conditions and the availability of permanent financing, to the extent such permanent financing is not being provided by us.

Residential mortgages and home equity loans – Loans in these classes are made to and secured by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this loan class. The Bank generally does not originate loans with a loan-to-value ratio greater than 80 percent and does not grant sub-prime loans.

Consumer loans – Loans in this class may be either secured or unsecured and repayment is dependent on the credit quality of the individual borrower and, if applicable, sale of the collateral securing the loan (such as automobile, mobile home). Therefore, the overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this loan class.

Further information pertaining to the allowance for loan losses at December 31, 2011 is as follows: (in thousands)


	Commercial, financial, and agricultural		Commercial real estate mortgages		Real estate construction loans		Residential mortgages (1st and 2nd liens)		Home equity loans		Consumer loans		Total
Allowance for loan losses:
Ending balance (total allowance)	$	25,080	$	11,029	$	623	$	2,401	$	512	$	313	$	39,958
Ending balance: individually evaluated for impairment		7,477		3,092		57		—		—		—		10,626
Ending balance: collectively evaluated for impairment		17,603		7,937		566		2,401		512		313		29,332
Loan balances:
Ending balance (loan portfolio) (1)	$	206,652	$	428,646	$	49,704	$	160,619	$	79,684	$	43,831	$	969,136
Ending balance: individually evaluated for impairment		36,559		66,402		19,251		8,345		3,897		646		135,100
Ending balance: collectively evaluated for impairment		170,093		362,244		30,453		152,274		75,787		43,185		834,036

(1)	Other loans of $543, not included here, consist primarily of advances under lines of credit.

Further information pertaining to the allowance for loan losses at December 31, 2010 is as follows: (in thousands)


	Commercial, financial, and agricultural		Commercial real estate		Real estate construction loans		Residential mortgages (1st and 2nd liens)		Home equity loans		Consumer loans		Total
	Restated
Allowance for loan losses:
Ending balance (total allowance)	$	13,826	$	9,226	$	3,177	$	519	$	1,392	$	279	$	28,419
Ending balance: individually evaluated for impairment		2,845		5,636		935		—		—		—		9,416
Ending balance: collectively evaluated for impairment		10,981		3,590		2,242		519		1,392		279		19,003
Loan balances:
Ending balance (loan portfolio) (1) (2)	$	248,750	$	431,179	$	82,720	$	195,993	$	84,696	$	67,814	$	1,111,152
Ending balance: individually evaluated for impairment		17,277		51,540		26,897		3,466		986		75		100,241
Ending balance: collectively evaluated for impairment		231,473		379,639		55,823		192,527		83,710		67,739		1,010,911

(1)	Other loans of $1,127, not included here, consist primarily of overdraft advances, nearly all of which have been repaid subsequent to year-end.

(2)	Net of unearned discount totaling $28 at December 31, 2010

The following is a summary of current and past due loans at December 31, 2011: (in thousands)


	Past Due
	30-59 days		60-89 days		90 days & over		Total		Current		Total
Commercial:
Commercial, financial, and agricultural	$	9,774	$	8,574	$	16,867	$	35,215	$	171,437	$	206,652
Commercial real estate mortgages		4,981		4,843		45,344		55,168		373,478		428,646
Real estate construction loans		1,282		—		6,978		8,260		41,444		49,704
Consumer:
Residential mortgages (1st and 2nd liens)		3,479		1,144		7,028		11,651		148,968		160,619
Home equity loans		—		198		3,897		4,095		75,589		79,684
Consumer loans		215		78		646		939		42,892		43,831

Total (1)	$	19,731	$	14,837	$	80,760	$	115,328	$	853,808	$	969,136

(1)	Other loans of $543, not included here, consist primarily of advances under lines of credit.

The following is a summary of current and past due loans at December 31, 2010 (restated): (in thousands)


	Past Due
	30-59 days		60-89 days		90 days & over		Total		Current		Total
Commercial:
Commercial, financial, and agricultural	$	212	$	81	$	2,382	$	2,675	$	246,075	$	248,750
Commercial real estate		4,375		243		11,601		16,219		414,960		431,179
Real estate construction loans		—		—		10,481		10,481		72,239		82,720
Consumer:
Residential mortgages (1st and 2nd liens)		2,162		1,934		3,466		7,562		188,431		195,993
Home equity loans		637		1,140		986		2,763		81,933		84,696
Consumer loans (2)		408		108		75		591		67,223		67,814

Total (1)	$	7,794	$	3,506	$	28,991	$	40,291	$	1,070,861	$	1,111,152

(1)	Other loans of $1,127, not included here, consist primarily of overdraft advances, nearly all of which have been repaid subsequent to year-end.

(2)	Net of unearned discount totaling $28 at December 31, 2010.

Suffolk allocated $2,600,000 and $4,400,000 of specific reserves to customers whose loan terms have been modified in Troubled Debt Restructurings ("TDRs") as of December 31 2011 and 2010, respectively. These loans involved the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower payment requirement based upon their current cash flow. These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit.

The following is a summary of impaired loans at December 31, 2011 and 2010: (in thousands)


	December 31, 2011								December 31, 2010 Restated
	Impaired Loans with Valuation Reserves		Impaired Loans without Valuation Reserves		Total Impaired Loans		Total Valuation Reserves		Impaired Loans with Valuation Reserves		Impaired Loans without Valuation Reserves		Total Impaired Loans		Total Valuation Reserves
Commercial, financial & agricultural loans	$	15,674	$	20,885	$	36,559	$	7,477	$	8,227	$	9,050	$	17,277	$	2,845
Commercial real estate mortgages		19,715		46,687		66,402		3,092		34,301		17,239		51,540		5,636
Real estate construction loans		2,207		17,044		19,251		57		6,569		20,328		26,897		935
Residential mortgages (1st & 2nd liens)		—		8,345		8,345		—		—		3,466		3,466		—
Home equity loans		—		3,897		3,897		—		—		986		986		—
Consumer loans		—		646		646		—		—		75		75		—

Total	$	37,596	$	97,504	$	135,100	$	10,626	$	49,097	$	51,144	$	100,241	$	9,416


	Years Ended December 31,
	2011		2010 Restated		2009
Average investment in impaired loans	$	120,174	$	63,101	$	20,838
Interest income recognized on impaired loans		4,762		4,264		957
Interest income recognized on a cash basis on impaired loans		—		—		—

The following is a summary of information pertaining to impaired and non-accrual loans: (in thousands)


	December 31,
	2011		2010 Restated
Impaired loans without a valuation allowance	$	97,504	$	51,144
Impaired loans with a valuation allowance		37,596		49,097

Total impaired loans	$	135,100	$	100,241

Valuation allowance related to impaired loans	$	10,626	$	9,416
Total non-accrual loans		80,760		28,991
Total loans past due 90 days or more and still accruing		—		—
Troubled debt restructurings accruing interest		5,479		11,904
Troubled debt restructurings-nonaccruing		20,996		12,140

Additional interest income of approximately $4,267,000, $1,510,000, and $874,000 respectively, would have been recorded during the years ended December 31, 2011, 2010 and 2009, respectively, if the loans had performed in accordance with their original terms. No additional funds are committed to be advanced in connection with impaired loans.

The following table summarizes loan balances and allocates the allowance for loan losses by risk rating as of December 31, 2011: (in thousands)


	Commercial, financial, and agricultural			Commercial real estate mortgages			Real estate construction loans			Residential mortgages (1st and 2nd liens)			Home equity loans			Consumer loans (4)			Total
Unimpaired loans:
Total pass loans (1)	$	144,952		$	289,856		$	4,932		$	152,274		$	75,787		$	43,185		$	710,986
Loss factor (2)		10.43	%		2.19	%		1.74	%		1.58	%		0.68	%		0.72	%		3.49	%

Reserve		15,121			6,359			86			2,401			512			313			24,792

Total special mention loans		16,448			41,283			7,772			—			—			—			65,503
Loss factor		8.68	%		2.18	%		1.88	%											3.78	%

Reserve		1,428			900			146			—			—			—			2,474

Total substandard loans		8,693			31,105			17,749			—			—			—			57,547
Loss factor		12.12	%		2.18	%		1.88	%											3.59	%

Reserve		1,054			678			334			—			—			—			2,066

Impaired loans:
Total substandard loans		36,316			66,402			17,639			8,345			3,897			646			133,245
Loss factor		20.52	%		4.66	%		0.32	%(3)											7.96	%

Reserve		7,452			3,092			57			—			—			—			10,601

Total doubtful loans		243			—			1,612			—			—			—			1,855
Loss factor		10.29	%					0.00	%											1.35	%

Reserve		25			—			—			—			—			—			25
Total unimpaired loans	$	170,093		$	362,244		$	30,453		$	152,274		$	75,787		$	43,185		$	834,036
Total reserve on unimpaired loans	$	17,603		$	7,937		$	566		$	2,401		$	512		$	313		$	29,332

(1)	Other loans of $543, not included here, consist primarily of advances under lines of credit.

(2)	Loss factor calculation is specific reserve as a percentage of balance for a portfolio segment.

(3)	Loss factor is driven by higher collateral positions and charge-offs taken within this portfolio segment.

(4)	Net of unearned discount.

The following table summarizes loan balances and allocates the allowance for loan losses by risk rating as of December 31, 2010 (restated): (in thousands)


	Commercial, financial, and agricultural			Commercial real estate			Real estate construction loans			Residential mortgages (1st and 2nd liens)			Home equity loans			Consumer loans (4)			Total
Unimpaired loans:
Total pass loans (1)	$	202,926		$	314,447		$	39,530		$	192,527		$	83,710		$	67,739		$	900,879
Loss factor (2)		4.80	%		0.95	%		3.96	%		0.27	%		1.66	%		0.41	%		1.83	%

Reserve		9,731			2,996			1,567			519			1,392			279			16,484

Total special mention loans		6,291			28,823			1,773			—			—			—			36,887
Loss factor		4.43	%		0.91	%		4.12	%											1.67	%

Reserve		279			263			73			—			—			—			615

Total substandard loans		22,256			36,369			14,520			—			—			—			73,145
Loss factor		4.36	%		0.91	%		4.15	%											2.60	%

Reserve		971			331			602			—			—			—			1,904

Impaired loans:
Total substandard loans		16,792			51,540			26,226			3,466			986			75			99,085
Loss factor		14.37	%		10.94	%		1.01	% (3)											8.39	%

Reserve		2,413			5,636			264			—			—			—			8,313

Total doubtful loans		485			—			671			—			—			—			1,156
Loss factor		89.07	%					100.00	%											95.42	%

Reserve		432			—			671			—			—			—			1,103
Total unimpaired loans	$	231,473		$	379,639		$	55,823		$	192,527		$	83,710		$	67,739		$	1,010,911
Total reserve on unimpaired loans	$	10,981		$	3,590		$	2,242		$	519		$	1,392		$	279		$	19,003

(1)	Other loans of $1,127, not included here, consist primarily of overdraft advances, nearly all of which have been repaid subsequent to year-end.

(2)	Loss factor calculation is specific reserves as a percentage of balance for a portfolio segment.

(3)	Loss factor is driven by higher collateral positions and charge offs taken within this portfolio segment.

(4)	Net of unearned discount.

Suffolk's total TDRs of $26,475,000 at December 31, 2011 included the additional TDRs identified upon adoption of the new accounting standard ASU 2011-02, "A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring."

According to accounting standards, not all loan modifications are TDRs. TDRs are modifications or renewals where Suffolk has granted a concession to a borrower in financial distress. Suffolk reviews all modifications and renewals for determination of TDR status. In some infrequent situations a borrower may be experiencing financial distress, but Suffolk does not provide a concession. These modifications are not considered TDRs. In other cases, Suffolk might provide a concession, such as a reduction in interest rate, but the borrower is not experiencing financial distress. This could be the case if Suffolk is matching a competitor's interest rate. These modifications would also not be considered TDRs.

CREDIT QUALITY INFORMATION

The Bank utilizes an eight-grade risk rating system for commercial loans, commercial real estate and construction loans as follows:

Risk Grade 1 - 4 Pass

Risk Grade 5 Special Mention:

Loans which possess some credit deficiency or potential weakness which deserves close attention. Such loans pose an unwarranted financial risk that, if not corrected, could weaken the loan by adversely impacting the future repayment ability of the borrower. The key distinctions of a Special Mention classification are that (1) it is indicative of an unwarranted level of risk and (2) weaknesses are considered "potential," not "defined," impairments to the primary source of repayment.

Risk Grade 6 Substandard:

One or more of the following characteristics may be exhibited in loans classified Substandard:

•

Loans which possess a defined credit weakness. The likelihood that a loan will be paid from the primary source of repayment is uncertain. Financial deterioration is under way and very close attention is warranted to ensure that the loan is collected without loss.

•

Loans are inadequately protected by the current net worth and paying capacity of the obligor.

•

The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment, such as collateral liquidation or guarantees.

•

Loans have a distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

•

Unusual courses of action are needed to maintain a high probability of repayment.

•

The borrower is not generating enough cash flow to repay loan principal, but continues to make interest payments.

•

The lender is forced into a subordinated or unsecured position due to flaws in documentation.

•

Loans have been restructured so that payment schedules, terms, and collateral represent concessions to the borrower when compared to the normal loan terms.

•

The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.

•

There is a significant deterioration in market conditions to which the borrower is highly vulnerable.

Risk Grade 7 Doubtful:

One or more of the following characteristics may be present in loans classified Doubtful:

•

Loans have all of the weaknesses of those classified as Substandard. However, based on existing conditions, these weaknesses make full collection of principal highly improbable.

•

The primary source of repayment is gone and there is considerable doubt as to the quality of the secondary source of repayment.

•

The possibility of loss is high but because of certain important pending factors which may strengthen the loan, loss classification is deferred until the exact status of repayment is known.

Risk Grade 8 Loss:

Loans are considered uncollectible and of such little value that continuing to carry them as assets is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

The Bank considers real estate, home equity and consumer loans secured by real estate that are contractually past due 90 days or more or where legal action has commenced against the borrower to be substandard. The Bank follows the Federal Financial Institutions Examination Council ("FFIEC") Uniform Retail Credit Classification guidelines.

The Bank formally reviews the ratings on all commercial and industrial, commercial real estate and construction loans greater than $250 thousand annually. Quarterly, the Bank engages an independent third-party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its annual review process.

The following table identifies credit risk by the internally assigned grade at December 31, 2011: (in thousands)


	Credit Risk Profile By Internally Assigned Grade
	Commercial Credit Exposure						Consumer Credit Exposure
	Commercial, financial, and agricultural		Commercial real estate mortgages		Real estate construction loans		Residential mortgages (1st and 2nd liens)		Home equity loans		Consumer loans		Total
Grade:
Pass (1)	$	153,645	$	320,961	$	22,681	$	152,274	$	75,787	$	43,185	$	768,533
Special mention		16,448		41,283		7,772		—		—		—		65,503
Substandard		36,316		66,402		17,639		8,345		3,897		646		133,245
Doubtful		243		—		1,612		—		—		—		1,855

Total	$	206,652	$	428,646	$	49,704	$	160,619	$	79,684	$	43,831	$	969,136

(1)	Other loans of $543, not included here, consist primarily of advances under lines of credit.

The following table identifies credit risk by the internally assigned grade at December 31, 2010: (in thousands)


	Credit Risk Profile By Internally Assigned Grade (Restated)
	Commercial Credit Exposure						Consumer Credit Exposure
	Commercial, financial, and agricultural		Commercial real estate mortgages		Real estate construction loans		Residential mortgages (1st and 2nd liens)		Home equity loans		Consumer loans (2)		Total
Grade:
Pass (1)	$	202,926	$	314,447	$	39,530	$	192,527	$	83,710	$	67,739	$	900,879
Special mention		6,291		28,823		1,773		—		—		—		36,887
Substandard		39,048		87,909		40,746		3,466		986		75		172,230
Doubtful		485		—		671		—		—		—		1,156

Total	$	248,750	$	431,179	$	82,720	$	195,993	$	84,696	$	67,814	$	1,111,152

(1)	Other loans of $1,127, not included here, consist primarily of overdraft advances, nearly all of which have been repaid subsequent to year-end.

(2)	Net of unearned discount totalling $28 at December 31, 2010

The following table summarizes loans that have been modified as troubled debt restructurings during 2011: (dollars in thousands)


Troubled Debt Restructurings	Number of Loans		Pre-Modification Recorded Principal Balance		Post-Modification Recorded Principal Balance
Commercial, financial, and agricultural		29	$	4,099	$	4,123
Commercial, secured by real estate		8		8,697		8,697
Real estate construction loans		—		—		—
Residential mortgages		5		1,437		1,622
Home Equity		1		291		291
Consumer		1		34		34

Total		44	$	14,558	$	14,767

The following loans, modified as troubled debt restructurings within the last twelve months, became over 30 days past due during the twelve months ended December 31, 2011 (amounts at period-end, dollars in thousands)


Defaulted Troubled Debt Restructurings	Number of Loans		Recorded Principal Balance
Commercial, financial, and agricultural		11	$	2,222
Commercial, secured by real estate		3		7,544
Real estate construction loans		—		—
Residential mortgages		1		502
Home Equity		—		—
Consumer		—		—

Total		15	$	10,268