NOTE 5 LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio, net of deferred origination fees and cost, and unearned income is summarized as follows:

	June 30, 2013		December 31, 2012
Commercial and agricultural:
Commercial and industrial	$	134,617,505	$	133,154,615
Agricultural		711,904		696,666
Commercial mortgages:
Construction		19,275,080		43,269,303
Other		323,413,353		276,928,123
Residential mortgages		198,071,941		200,475,097
Consumer loans:
Credit cards		1,680,116		1,851,145
Home equity lines and loans		90,494,092		87,045,421
Indirect consumer loans		146,624,572		130,573,200
Direct consumer loans		19,151,022		19,523,371
Total loans, net of deferred origination fees and costs, and unearned income		934,039,585	$	893,516,941
Interest receivable on loans		2,389,020		2,383,998
Total recorded investment in loans	$	936,428,605	$	895,900,939

The Corporation's concentrations of credit risk by loan type are reflected in the preceding table. The concentrations of credit risk with standby letters of credit, committed lines of credit and commitments to originate new loans generally follow the loan classifications in the table above.

The following tables present the activity in the allowance for loan losses by portfolio segment for the three and six-month periods ending June 30, 2013 and 2012:

	Six Months Ended
	June 30, 2013
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages		Residential Mortgages			Consumer Loans			Unallocated			Total
Beginning balance:	$	1,707,596		$	4,427,698	$	1,565,571		$	2,705,639		$	26,146		$	10,432,650
Charge Offs:		(18,475	)		-		(53,753	)		(397,783	)		-			(470,011	)
Recoveries:		294,696			19,276		38,610			123,520			-			476,102
Net recoveries (charge offs)		276,221			19,276		(15,143	)		(274,263	)		-			6,091
Provision		(105,120	)		687,436		(35,004	)		360,318			(26,146	)		881,484
Ending balance	$	1,878,697		$	5,134,410	$	1,515,424		$	2,791,694		$	-		$	11,320,225

	Six Months Ended
	June 30, 2012
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Unallocated				Total
Beginning balance:	$	3,143,372		$	2,570,149		$	1,309,649		$	2,192,729		$	443,420		$	9,659,319
Reclassification of acquired loan discount		73,227			50,332			-			-			-			123,559
Charge Offs:		(5,792	)		(57,352	)		(72,613	)		(273,428	)		-			(409,185	)
Recoveries:		351,763			30,496			-			107,723			-			489,982
Net recoveries (charge-offs)		345,971			(26,856	)		(72,613	)		(165,705	)		-	)		80,797
Provision		(558,359	)		482,087			187,780			447,161		$	(29,772)			528,897
Ending balance	$	3,004,211		$	3,075,712		$	1,424,816		$	2,474,185		$	413,648		$	10,392,572

	Three Months Ended June 30, 2013
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages		Residential Mortgages			Consumer Loans			Unallocated		Total
Beginning balance:	$	1,992,884		$	4,672,637	$	1,557,098		$	2,602,074		$	-	$	10,824,693
Charge Offs:		(1,863	)		-		(9,393	)		(200,419	)		-		(211,675	)
Recoveries:		152,271			10,301		38,610			55,551			-		256,733
Net recoveries (charge offs)		150,408			10,301		29,217			(144,868	)		-		45,058
Provision		(264,595	)		451,472		(70,891	)		334,488			-		450,474
Ending balance	$	1,878,697		$	5,134,410	$	1,515,424		$	2,791,694		$	-	$	11,320,225

	Three Months Ended June 30, 2012
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Unallocated		Total
Beginning balance:	$	3,361,393		$	3,030,504		$	1,417,252		$	2,100,433		$	373,708	$	10,283,290
Charge Offs:		(5,792	)		(8,295	)		(58,273	)		(115,109	)		-		(187,469	)
Recoveries:		179,156			20,261			-			45,741			-		245,158
Net recoveries (charge offs)		173,364			11,966			(58,273	)		(69,368	)		-		57,689
Provision		(530,546	)		33,242			65,837			443,120			39,940		51,593
Ending balance	$	3,004,211		$	3,075,712		$	1,424,816		$	2,474,185		$	413,648	$	10,392,572

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2013 and December 31, 2012:

	June 30, 2013
Allowance for loan losses	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Unallocated		Total
Ending allowance balance attributable to loans:
Individually evaluated for Impairment	$	315,962	$	450,245	$	-	$	4,020	$	-	$	770,227
Collectively evaluated for impairment		1,395,165		3,828,486		1,495,747		2,787,674		-		9,507,072
Acquired with deteriorated credit quality		167,570		855,679		19,677		-		-		1,042,926
Total ending allowance balance	$	1,878,697	$	5,134,410	$	1,515,424	$	2,791,694	$	-	$	11,320,225

	December 31, 2012
Allowance for loan losses	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Unallocated		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	133,437	$	59,201	$	-	$	-	$	-	$	192,638
Collectively evaluated for impairment		1,459,432		3,533,365		1,565,571		2,705,639		26,146		9,290,153
Acquired with deteriorated credit quality		114,727		835,132		-		-		-		949,859
Total ending allowance balance	$	1,707,596	$	4,427,698	$	1,565,571	$	2,705,639	$	26,146	$	10,432,650

	June 30, 2013
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	2,227,900	$	9,945,029	$	125,420	$	102,914	$	12,401,263
Loans collectively evaluated for impairment		132,554,915		324,521,166		198,223,145		258,518,832		913,818,058
Loans acquired with deteriorated credit quality		882,814		9,073,632		252,838		-		10,209,284
Total ending loans balance	$	135,665,629	$	343,539,827	$	198,601,403	$	258,621,746	$	936,428,605

	December 31, 2012
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	1,907,395	$	10,620,274	$	131,909	$	-	$	12,659,578
Loans collectively evaluated for impairment		131,045,609		301,172,164		200,622,600		239,689,455		872,529,828
Loans acquired with deteriorated credit quality		1,241,418		9,225,847		244,268		-		10,711,533
Total ending loans balance	$	134,194,422	$	321,018,285	$	200,998,777	$	239,689,455	$	895,900,939

The following tables present loans individually evaluated for impairment recognized by class of loans as of June 30, 2013 and December 31, 2012, the average recorded investment and interest income recognized by class of loans as of the three and six-month periods ending June 30, 2013 and 2012:

	June 30, 2013						December 31, 2012
With no related allowance recorded:	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Unpaid Principal Balance			Recorded Investment		Allowance for Loan Losses Allocated
Commercial and agricultural:
Commercial & industrial	$	1,852,772	$	1,655,206	$	-	$	2,059,027	$	1,462,157	$	-
Commercial mortgages:
Construction		3,177,618		3,154,238		-		5,168,353		5,166,853		-
Other		6,031,853		5,669,704		-		5,678,565		5,090,399		-
Residential mortgages		125,420		125,420		-		131,909		131,909		-
Consumer loans:
Home equity lines & loans		43,975		44,772		-		-		-		-
With an allowance recorded:
Commercial and agricultural:
Commercial & industrial		972,894		572,694		315,962		446,330		445,238		133,437
Commercial mortgages:
Other		1,130,969		1,121,087		450,245		364,423		363,022		59,201
Consumer loans:
Home equity lines & loans		57,876		58,142		4,020		-		-		-
Total	$	13,393,377	$	12,401,263	$	770,227	$	13,848,607	$	12,659,578	$	192,638

		Six-Months Ended June 30, 2013				Six-Months Ended June 30, 2012				Three Months Ended June 30, 2013				Three Months Ended June 30, 2012
		Average Recorded Investment		Interest Income Recognized			Average Recorded Investment		Interest Income Recognized	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and agricultural:
Commercial & industrial	$	1,523,566	$	34,558		$	1,067,170	$	-	$	1,554,270	$	17,407	$	143,367	$	-
Commercial mortgages:
Construction		4,168,038		63,924			10,454		-		3,668,630		32,132		10,454		-
Other		5,685,324		118,310	1		827,553		-		5,982,787		65,768		811,005		-
Residential mortgages		128,559		-			111,368		-		126,884		-		77,384		-
Consumer loans:
Home equity lines & loans		30,104		681			19,856		2,289		45,156		428		29,784		1,123
With an allowance recorded:
Commercial and agricultural:
Commercial & industrial		498,852		-			2,347,963		-		525,660		-		2,341,810		-
Commercial mortgages:
Construction		-		-			5,530		-		-		-		4,148		-
Other		614,402		-			2,109,919		-		740,092		-		1,302,796		-
Residential mortgages		-		-			42,668		-		-		-		-		-
Consumer loans:
Home equity lines & loans		38,730		1,249			-		-		58,094		1,082		-		-
Direct consumer loans		5,083		-			-		-		7,625		-		-		-
Total	$	12,692,658	$	218,722		$	6,542,481	$	2,289	$	12,709,198	$	116,817	$	4,720,748	$	1,123

(1)	Cash basis interest income approximates interest income recognized.

The following tables present the recorded investment in past due and non-accrual status by class of loans as of June 30, 2013 and December 31, 2012:


June 30, 2013	Current		30-89 Days Past Due		90 Days or more Past Due and accruing			Loans acquired with deteriorated credit quality	Non-Accrual (1)			Total
Commercial and agricultural:
Commercial & industrial	$	132,448,955	$	679,194	$	-	$	882,814	$	940,993	$	134,951,956
Agricultural		713,673		-		-		-		-		713,673
Commercial mortgages:
Construction		15,076,034		-		2,183,858		1,092,697		970,380		19,322,969
Other		313,754,610		545,878		-		7,980,935		1,935,435		324,216,858
Residential mortgages		193,556,426		1,987,955		-		252,838		2,804,184		198,601,403
Consumer loans:
Credit cards		1,653,581		10,798		15,737		-		-		1,680,116
Home equity lines & loans		89,954,325		296,430		-		-		475,671		90,726,426
Indirect consumer loans		145,819,447		896,746		-		-		280,817		146,997,010
Direct consumer loans		19,093,867		63,451		-		-		60,876		19,218,194
Total	$	912,070,918	$	4,480,452	$	2,199,595	$	10,209,284	$	7,468,356	$	936,428,605

(1) Includes all loans on non-accrual status regardless of the number of days such loans were delinquent as of June 30, 2013.


December 31, 2012	Current		30-89 Days Past Due		90 Days or more Past Due and accruing				Loans acquired with deteriorated credit quality	Non-Accrual (1)			Total
Commercial and agricultural:
Commercial & industrial	$	131,404,371	$	183,269	$	-		$	1,241,418	$	666,912	$	133,495,970
Agricultural		698,452		-		-			-		-		698,452
Commercial mortgages:
Construction		36,988,222		294,565		4,481,066			1,182,037		434,338		43,380,228
Other		266,261,798		1,750,806		-			8,043,810		1,581,643		277,638,057
Residential mortgages		194,185,616		4,145,868		-	`		244,268		2,423,024		200,998,776
Consumer loans:
Credit cards		1,847,837		-		3,308			-		-		1,851,145
Home equity lines & loans		86,486,782		211,739		-			-		571,365		87,269,886
Indirect consumer loans		129,789,672		852,818		-			-		335,285		130,977,775
Direct consumer loans		19,481,693		89,619		-			-		19,338		19,590,650
Total	$	867,144,443	$	7,528,684	$	4,484,374		$	10,711,533	$	6,031,905	$	895,900,939

(1) Includes all loans on non-accrual status regardless of the number of days such loans were delinquent as of December 31, 2012.

Troubled Debt Restructurings:

As of June 30, 2013 and December 31, 2012, the Corporation has a recorded investment in troubled debt restructurings of $7,566,209 and $5,728,610, respectively. There were specific reserves of $242,692 allocated for troubled debt restructurings at June 30, 2013 and no specific reserves allocated at December 31, 2012. As of June 30, 2013, troubled debt restructurings totaling $6,245,177 were accruing interest under the modified terms and $1,321,032 were on non-accrual status. As of December 31, 2012, troubled debt restructurings totaling $5,363,712 were accruing interest under the modified terms and $364,898 were on non-accrual status. The Corporation has committed to lend additional amounts totaling up to $56,000 and $130,000 as of June 30, 2013 and December 31, 2012, respectively, to customers with outstanding loans that are classified as troubled debt restructurings.

During the six months ended June 30, 2013 and 2012, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: reduced scheduled payments for greater than 3 months or an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk.

The following table presents loans by class modified as troubled debt restructurings that occurred during the six months ended June 30, 2013 and June 30, 2012:

Six months ended June 30, 2013	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial and agricultural:
Commercial & industrial		4	$	841,162	$	841,162
Commercial mortgages:
Other		1		133,000		133,000
Consumer loans:
Home equity lines & loans		2		103,587		103,587
Total		7	$	1,077,749	$	1,077,749

Six months ended June 30, 2012
Troubled debt restructurings:
Consumer loans:
Home equity lines & loans		1	$	58,823	$	58,823
Total		1	$	58,823	$	58,823

The troubled debt restructurings described above increased the allowance for loan losses by $97,629 and resulted in no charge offs during the six months ended June 30, 2013. The troubled debt restructurings described above did not increase the allowance for loan losses and resulted in no charge offs during the six months ended June 30, 2012.

The following table presents loans by class modified as troubled debt restructurings that occurred during the three months ended June 30, 2013 and June 30, 2012:

Three months ended June 30, 2013	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial and agricultural:
Commercial & industrial		2	$	409,869	$	409,869
Commercial mortgages:
Other		1		133,000		133,000
Total		1	$	542,869	$	542,869

There were no loans modified as troubled debt restructurings during the three months ended June 30, 2012. The troubled debt restructurings described above increased the allowance for loan losses by $112,040 and resulted in no charge offs during the three months ending June 30, 2013.

There were no payment defaults on any loans previously modified as troubled debt restructurings during the six months ending June 30, 2013 or June 30, 2012, within twelve months following the modification. Additionally there were no payment defaults on any loans previously modified as troubled debt restructurings during the three months ending June 30, 2013, within twelve months following the modification. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

Credit Quality Indicators

The Corporation establishes a risk rating at origination for all commercial loans. The main factors considered in assigning risk ratings include, but are not limited to: historic and future debt service coverage, collateral position, operating performance, liquidity, leverage, payment history, management ability, and the customer’s industry. Commercial relationship managers monitor all loans in their respective portfolios for any changes in the borrower’s ability to service their debt and affirm the risk ratings for the loans at least annually.

For the retail loans, which include lines of credit, installment, mortgage, and home equity loans, once a loan is properly approved and closed, the Corporation evaluates credit quality based upon loan repayment.

The Corporation uses the risk rating system to identify criticized and classified loans. Commercial relationships within the criticized and classified risk ratings are analyzed quarterly. The Corporation uses the following definitions for criticized and classified loans (which are consistent with regulatory guidelines):

Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position as some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capability of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be not rated loans. Based on the analyses performed as of June 30, 2013 and December 31, 2012, the risk category of the recorded investment of loans by class of loans is as follows:

	June 30, 2013
		Not Rated		Pass		Loans acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful
Commercial and agricultural:
Commercial & industrial		$	-	$	120,052,546	$	882,814	$	10,577,534	$	2,973,687	$	465,375
Agricultural			-		713,673		-		-		-		-
Commercial mortgages:
Construction			-		13,124,675		1,092,697		3,809,440		1,296,157		-
Other			-		292,560,550		7,980,935		13,797,377		9,877,996		-
Residential mortgages			195,544,381		-		252,838		-		2,804,184		-
Consumer loans
Credit cards			1,680,116		-		-		-		-		-
Home equity lines & loans			90,067,828		-		-		-		658,598		-
Indirect consumer loans			146,716,193		-		-		-		280,817		-
Direct consumer loans			19,157,318		-		-		-		60,876		-
Total		$	453,165,836	$	426,451,444	$	10,209,284	$	28,184,351	$	17,952,315	$	465,375

	December 31, 2012
		Not Rated		Pass		Loans acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful
Commercial and agricultural:
Commercial & industrial		$	-	$	121,145,761	$	1,241,418	$	8,008,002	$	2,606,529	$	494,260
Agricultural			-		698,452		-		-		-		-
Commercial mortgages:
Construction			-		34,882,896		1,182,037		5,153,918		2,161,377		-
Other			-		247,793,150		8,043,810		11,974,716		9,826,381		-
Residential mortgages			198,336,641		-		244,268		-		2,417,868		-
Consumer loans
Credit cards			1,851,145		-		-		-		-		-
Home equity lines & loans			86,615,392		-		-		-		654,493		-
Indirect consumer loans			130,642,490		-		-		-		335,285		-
Direct consumer loans			19,571,312		-		-		-		19,338		-
Total		$	437,016,980	$	404,520,259	$	10,711,533	$	25,136,636	$	18,021,271	$	494,260

The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential and consumer loans based on payment activity as of June 30, 2013 and December 31, 2012:

	June 30, 2013
			Consumer Loans
	Residential Mortgages		Credit Card		Home Equity Lines & Loans		Indirect Consumer Loans		Other Direct Consumer Loans
Performing	$	195,797,219	$	1,664,379	$	90,250,755	$	146,716,193	$	19,157,318
Non-Performing		2,804,184		15,737		475,671		280,817		60,876
Total	$	198,601,403	$	1,680,116	$	90,726,426	$	146,997,010	$	19,218,194

	December 31, 2012
			Consumer Loans
	Residential Mortgages		Credit Card		Home Equity Lines & Loans		Indirect Consumer Loans		Other Direct Consumer Loans
Performing	$	198,575,753	$	1,847,838	$	86,698,520	$	130,642,490	$	19,571,312
Non-Performing		2,423,024		3,307		571,365		335,285		19,338
	$	200,998,777	$	1,851,145	$	87,269,885	$	130,977,775	$	19,590,650

At the time of the merger with Fort Orange Financial Corp., the Corporation identified certain loans with evidence of deteriorated credit quality, and the probability that the Corporation would be unable to collect all contractually required payments from the borrower. These loans are classified as PCI loans. The Corporation adjusted its estimates of future expected losses, cash flows, and renewal assumptions on the PCI loans during the current year. These adjustments were made for changes in expected cash flows due to loans refinanced beyond original maturity dates, impairments recognized subsequent to the acquisition, advances made for taxes or insurance to protect collateral held and payments received in excess of amounts originally expected.

The table below summarizes the changes in total contractually required principal and interest cash payments, management’s estimate of expected total cash payments and carrying value of the PCI loans from January 1, 2013 to June 30, 2013 and April 1, 2013 to June 30, 2013:

Six months ended June 30, 2013	Balance at December 31, 2012			Income Accretion		All Other Adjustments			Balance at June 30, 2013
Contractually required principal and interest	$	16,896,078		$	-	$	(2,195,740	)	$	14,700,338
Contractual cash flows not expected to be collected (nonaccretable discount)		(3,655,500	)		-		1,716,743			(1,938,757	)
Cash flows expected to be collected		13,240,578			-		(478,997	)		12,761,581
Interest component of expected cash flows (accretable yield)		(2,529,045	)		663,861		(687,113	)		(2,552,297	)
Fair value of loans acquired with deteriorating credit quality	$	10,711,533		$	663,861	$	(1,166,110	)	$	10,209,284

Three months ended June 30, 2013	Balance at March 31, 2013			Income Accretion		All Other Adjustments			Balance at June 30, 2013
Contractually required principal and interest	$	15,255,412		$	-	$	(555,074	)	$	14,700,338
Contractual cash flows not expected to be collected (nonaccretable discount)		(2,276,866	)		-		338,109			(1,938,757	)
Cash flows expected to be collected		12,978,546			-		(216,965	)		12,761,581
Interest component of expected cash flows (accretable yield)		(2,376,643	)		170,041		(345,695	)		(2,552,297	)
Fair value of loans acquired with deteriorating credit quality	$	10,601,903		$	170,041	$	(562,660	)	$	10,209,284