NOTE 4 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 (dollars in thousands):

	June 30, 2014		December 31, 2013
Commercial and agricultural:
Commercial and industrial	$	158,151	$	144,787
Agricultural		726		576
Commercial mortgages:
Construction		39,106		27,440
Commercial mortgages		383,187		345,707
Residential mortgages		194,603		195,997
Consumer loans:
Credit cards		1,604		1,756
Home equity lines and loans		99,023		95,905
Indirect consumer loans		187,082		164,846
Direct consumer loans		20,871		18,852
Total loans, net of deferred origination fees and costs, and unearned income	$	1,084,353	$	995,866
Interest receivable on loans		2,402		2,597
Total recorded investment in loans	$	1,086,755	$	998,463

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, 2014 and 2013 (dollars in thousands):

	Six Months Ended
	June 30, 2014
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Unallocated		Total
Beginning balance:	$	1,979		$	6,243		$	1,517		$	3,037		$	-	$	12,776
Charge Offs:		(355	)		(358	)		(7	)		(776	)		-		(1,496	)
Recoveries:		193			83			28			307			-		611
Net recoveries (charge offs)		(162	)		(275	)		21			(469	)		-		(885	)
Provision		(68	)		944			(40	)		905			-		1,741
Ending balance	$	1,749		$	6,912		$	1,498		$	3,473		$	-	$	13,632

	Six Months Ended
	June 30, 2013
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages		Residential Mortgages			Consumer Loans			Unallocated			Total
Beginning balance:	$	1,708		$	4,428	$	1,565		$	2,706		$	26		$	10,433
Charge Offs:		(18	)		-		(54	)		(398	)		-			(470	)
Recoveries:		294			19		39			124			-			476
Net recoveries (charge offs)		276			19		(15	)		(274	)		-			6
Provision		(105	)		687		(35	)		360			(26	)		881
Ending balance	$	1,879		$	5,134	$	1,515		$	2,792		$	-		$	11,320

	Three Months Ended
	June 30, 2014
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Unallocated		Total
Beginning balance:	$	1,945		$	6,484		$	1,552		$	3,174		$	-	$	13,155
Charge Offs:		(300	)		(315	)		-			(308	)		-		(923	)
Recoveries:		100			45			28			124			-		297
Net recoveries (charge offs)		(200	)		(270	)		28			(184	)		-		(626	)
Provision		4			698			(82	)		483			-		1,103
Ending balance	$	1,749		$	6,912		$	1,498		$	3,473		$	-	$	13,632

	Three Months Ended
	June 30, 2013
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages		Residential Mortgages			Consumer Loans			Unallocated		Total
Beginning balance:	$	1,993		$	4,673	$	1,557		$	2,602		$	-	$	10,825
Charge Offs:		(1	)		-		(10	)		(201	)		-		(212	)
Recoveries:		152			10		39			56			-		257
Net recoveries (charge-offs)		151			10		29			(145	)		-		45
Provision		(265	)		451		(71	)		335			-		450
Ending balance	$	1,879		$	5,134	$	1,515		$	2,792		$	-	$	11,320

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, 2014 and December 31, 2013 (dollars in thousands):

	June 30, 2014
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		$	132		$	201		$	-		$	2		$	-		$	335
Collectively evaluated for Impairment			1,617			5,244			1,486			3,471			-			11,818
Loans acquired with deteriorated credit quality			-			1,467			12			-			-			1,479
Total ending allowance balance		$	1,749		$	6,912		$	1,498		$	3,473		$	-		$	13,632

	December 31, 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		$	576		$	466		$	-		$	4		$	-		$	1,046
Collectively evaluated for impairment			1,403			4,407			1,497			3,033			-			10,340
Loans acquired with deteriorated credit quality			-			1,370			20			-			-			1,390
Total ending allowance balance		$	1,979		$	6,243		$	1,517		$	3,037		$	-		$	12,776

	June 30, 2014
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	1,589	$	9,655	$	111	$	126	$	11,481
Loans collectively evaluated for impairment		156,987		405,519		194,727		309,143		1,066,376
Loans acquired with deteriorated credit quality		631		7,997		270		-		8,898
Total ending loans balance	$	159,207	$	423,171	$	195,108	$	309,269	$	1,086,755

	December 31, 2013
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	2,946	$	10,703	$	117	$	131	$	13,897
Loans collectively evaluated for impairment		142,108		354,636		196,147		281,979		974,870
Loans acquired with deteriorated credit quality		678		8,757		261		-		9,696
Total ending loans balance	$	145,732	$	374,096	$	196,525	$	282,110	$	998,463

The following tables present loans individually evaluated for impairment recognized by class of loans as of June 30, 2014 and December 31, 2013, the average recorded investment and interest income recognized by class of loans as of the three and six-month periods ended June 30, 2014 and 2013 (dollars in thousands):

	June 30, 2014						December 31, 2013
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 and industrial	$	1,364	$	1,369	$	-	$	1,906	$	1,909	$	-
Commercial mortgages:
Construction		1,944		1,929		-		2,329		2,319		-
Commercial mortgages		6,599		6,487		-		7,406		7,439		-
Residential mortgages		111		111		-		117		117		-
Consumer loans:
Home equity lines and loans		68		70		-		71		73		-
With an allowance recorded:
Commercial and agricultural:
Commercial and industrial		520		220		132		1,037		1,037		576
Commercial mortgages:
Commercial mortgages		1,245		1,239		201		951		945		466
Consumer loans:
Home equity lines and loans		56		56		2		58		58		4
Total	$	11,907	$	11,481	$	335	$	13,875	$	13,897	$	1,046

	Six-Months Ended June 30, 2014				Six-Months Ended June 30, 2013				Three Months Ended June 30, 2014				Three Months Ended June 30, 2013
	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 and industrial	$	1,566	$	30	$	1,524	$	35	$	1,386	$	16	$	1,554	$	17
Commercial mortgages:
Construction		2,231		51		4,168		64		2,101		25		3,669		32
Commercial mortgages		6,806		129		5,685		118		6,489		66		5,983		66
Residential mortgages		114		-		129		-		112		-		127		-
Consumer loans:
Home equity lines and loans		72		1		30		1		71		1		45		1
With an allowance recorded:
Commercial and agricultural:
Commercial and industrial		784		-		499		-		512		-		526		-
Commercial mortgages:
Commercial mortgages		912		-		614		-		1,010		-		740		-
Consumer loans:
Consumer loans:
Home equity lines and loans		58		2		39		1		57		1		58		1
Direct consumer loans		-		-		5		-		-		-		7		-
Total	$	12,543	$	213	$	12,693	$	219	$	11,738	$	109	$	12,709	$	117

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, 2014 and December 31, 2013 (dollars in thousands):


June 30, 2014	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 and industrial	$	156,888	$	468	$	-	$	631	$	493	$	158,480
Agricultural		727		-		-		-		-		727
Commercial mortgages:
Construction		35,496		1,313		1,449		774		155		39,187
Commercial mortgages		373,640		262		-		7,223		2,859		383,984
Residential mortgages		189,337		2,113		-		270		3,388		195,108
Consumer loans:
Credit cards		1,583		14		7		-		-		1,604
Home equity lines and loans		98,029		725		-		-		506		99,260
Indirect consumer loans		185,732		1,439		-		-		300		187,471
Direct consumer loans		20,833		90		-		-		11		20,934
Total	$	1,062,265	$	6,424	$	1,456	$	8,898	$	7,712	$	1,086,755

(1) Includes all loans on non-accrual status regardless of the number of days such loans were delinquent as of June 30, 2014.


December 31, 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 and industrial	$	143,100	$	29	$	-	$	678	$	1,348	$	145,155
Agricultural		577		-		-		-		-		577
Commercial mortgages:
Construction		24,742		-		1,454		774		540		27,510
Commercial mortgages		335,123		1,138		-		7,983		2,342		346,586
Residential mortgages		187,448		5,458		-		261		3,358		196,525
Consumer loans:
Credit cards		1,729		9		19		-		-		1,757
Home equity lines and loans		95,349		150		-		-		635		96,134
Indirect consumer loans		163,810		1,235		-		-		249		165,294
Direct consumer loans		18,830		50		-		-		45		18,925
Total	$	970,708	$	8,069	$	1,473	$	9,696	$	8,517	$	998,463

(1) Includes all loans on non-accrual status regardless of the number of days such loans were delinquent as of December 31, 2013.

Troubled Debt Restructurings:

A modification of a loan may result in classification as a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of modifications which may involve a change in the schedule of payments, a reduction in the interest rate, an extension of the maturity date, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, requesting additional collateral, releasing collateral for consideration, substituting or adding a new borrower or guarantor, a permanent reduction of the recorded investment in the loan or a permanent reduction of the interest on the loan.

As of June 30, 2014 and December 31, 2013, the Corporation has a recorded investment in troubled debt restructurings of $7.1 million and $7.9 million, respectively. There were specific reserves of less than $0.1 million and $0.3 million allocated for troubled debt restructurings at June 30, 2014 and December 31, 2013, respectively. As of June 30, 2014, troubled debt restructurings totaling $6.4 million were accruing interest under the modified terms and $0.7 million were on non-accrual status. As of December 31, 2013, troubled debt restructurings totaling $6.8 million were accruing interest under the modified terms and $1.1 million were on non-accrual status. The Corporation has committed to lend additional amounts totaling up to less than $0.1 million and $0.2 million as of June 30, 2014 and December 31, 2013, respectively, to customers with outstanding loans that are classified as troubled debt restructurings.

During the six months ended June 30, 2014 and 2013, the terms of certain loans were modified as troubled debt restructurings. The modification of terms of such loans included one or a combination of the following: a change in the schedule of payments, a reduction in the interest rate, an extension of the maturity date, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk or a permanent reduction of the recorded investment in the loan.

The following table presents loans by class modified as troubled debt restructurings that occurred during the six months ended June 30, 2014 and June 30, 2013 (dollars in thousands):

Six months ended June 30, 2014	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial and agricultural:
Commercial and industrial		1	$	503	$	503
Commercial mortgages:
Commercial mortgages		2		367		323
Total		3	$	870	$	826


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 and industrial		4	$	841	$	841
Commercial mortgages:
Commercial mortgages		1		133		133
Consumer loans:
Home equity lines and loans		2		104		104
Total		7	$	1,078	$	1,078

The troubled debt restructurings described above did not increase the allowance for loan losses and resulted in less than $0.1 million in charge offs during the six months ended June 30, 2014. The troubled debt restructurings described above increased the allowance for loan losses by less than $0.1 million and resulted in no charge offs during the six months ended June 30, 2013.

There were no payment defaults on any loans previously modified as troubled debt restructurings during the six months ending June 30, 2014 or 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.

There were no loans modified as troubled debt restructurings during the three months ended June 30, 2014.

The following table presents loans by class modified as troubled debt restructurings that occurred during the three months ended June 30, 2013 (dollars in thousands):


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 and industrial		2	$	410	$	410
Commercial mortgages:
Commercial mortgages		1		133		133
Total		3	$	543	$	543

The troubled debt restructurings described above increased the allowance for loan losses by $0.1 million and resulted in no charge offs during the three months ended June 30, 2013.

There were no payment defaults on any loans previously modified as troubled debt restructurings during the three months ending June 30, 2014 or 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 residential mortgages, indirect and direct consumer loans, home equity lines and loans, and credit cards, 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 at 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 pass rated loans. Loans listed as not rated are included in groups of homogeneous loans. Based on the analyses performed as of June 30, 2014 and December 31, 2013, the risk category of the recorded investment of loans by class of loans is as follows (dollars in thousands):

	June 30, 2014
	Not Rated		Pass		Loans acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful
Commercial and agricultural:
Commercial and industrial	$	-	$	146,698	$	631	$	7,775	$	3,156	$	220
Agricultural		-		727		-		-		-		-
Commercial mortgages:
Construction		-		34,885		774		3,373		155		-
Commercial mortgages		-		350,244		7,223		14,159		12,184		174
Residential mortgages		191,368		-		270		-		3,470		-
Consumer loans:
Credit cards		1,604		-		-		-		-		-
Home equity lines and loans		98,678		-		-		-		582		-
Indirect consumer loans		187,161		-		-		-		310		-
Direct consumer loans		20,922		-		-		-		12		-
Total	$	499,733	$	532,554	$	8,898	$	25,307	$	19,869	$	394

	December 31, 2013
	Not Rated		Pass		Loans acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful
Commercial and agricultural:
Commercial and industrial	$	-	$	133,615	$	678	$	5,117	$	4,724	$	1,021
Agricultural		-		577		-		-		-		-
Commercial mortgages:
Construction		-		23,087		774		2,783		866		-
Commercial mortgages		-		313,956		7,983		13,611		11,036		-
Residential mortgages		192,995		-		261		-		3,269		-
Consumer loans
Credit cards		1,757		-		-		-		-		-
Home equity lines and loans		95,422		-		-		-		712		-
Indirect consumer loans		165,045		-		-		-		249		-
Direct consumer loans		18,880		-		-		-		45		-
Total	$	474,099	$	471,235	$	9,696	$	21,511	$	20,901	$	1,021

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, 2014 and December 31, 2013 (dollars in thousands):

	June 30, 2014
				Consumer Loans
	Residential Mortgages			Credit Card			Home Equity Lines and Loans			Indirect Consumer Loans			Other Direct Consumer Loans
Performing		$	191,720		$	1,604		$	98,754		$	187,171		$	20,923
Non-Performing			3,388			-			506			300			11
Total		$	195,108		$	1,604		$	99,260		$	187,471		$	20,934

	December 31, 2013
				Consumer Loans
	Residential Mortgages			Credit Card			Home Equity Lines and Loans			Indirect Consumer Loans			Other Direct Consumer Loans
Performing		$	193,167		$	1,757		$	95,499		$	165,045		$	18,880
Non-Performing			3,358			-			635			249			45
		$	196,525		$	1,757		$	96,134		$	165,294		$	18,925

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, 2014 to June 30, 2014 and April 1, 2014 to June 30, 2014 (dollars in thousands):

Six months ended June 30, 2014	Balance at December 31, 2013			Income Accretion		All Other Adjustments			Balance at June 30, 2014
Contractually required principal and interest	$	11,230		$	-	$	(1,173	)	$	10,057
Contractual cash flows not expected to be collected (nonaccretable discount)		(543	)		-		57			(486	)
Cash flows expected to be collected		10,687			-		(1,116	)		9,571
Interest component of expected cash flows (accretable yield)		(991	)		344		(26	)		(673	)
Fair value of loans acquired with deteriorating credit quality	$	9,696		$	344	$	(1,142	)	$	8,898

Three months ended June 30, 2014	Balance at March 31, 2014			Income Accretion		All Other Adjustments			Balance at June 30, 2014
Contractually required principal and interest	$	11,073		$	-	$	(1,016	)	$	10,057
Contractual cash flows not expected to be collected (nonaccretable discount)		(435	)		-		(51	)		(486	)
Cash flows expected to be collected		10,638			-		(1,067	)		9,571
Interest component of expected cash flows (accretable yield)		(876	)		145		58			(673	)
Fair value of loans acquired with deteriorating credit quality	$	9,762		$	145	$	(1,009	)	$	8,898