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 (in thousands):

	March 31, 2015		December 31, 2014
Commercial and agricultural:
Commercial and industrial	$	170,677	$	165,385
Agricultural		1,155		1,021
Commercial mortgages:
Construction		49,392		54,831
Commercial mortgages		430,993		397,762
Residential mortgages		198,628		196,809
Consumer loans:
Credit cards		1,526		1,654
Home equity lines and loans		98,706		99,354
Indirect consumer loans		173,722		184,763
Direct consumer loans		18,773		19,995
Total loans, net of deferred loan fees	$	1,143,572	$	1,121,574
Interest receivable on loans		2,673		2,780
Total recorded investment in loans	$	1,146,245	$	1,124,354

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-month periods ending March 31, 2015 and 2014 (in thousands):

	Three Months Ended
	March 31, 2015
Allowance for loan losses	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages			Consumer Loans			Total
Beginning balance:	$	1,460	$	6,326	$	1,572		$	4,328		$	13,686
Charge-offs:		-		-		(21	)		(369	)		(390	)
Recoveries:		15		67		-			124			206
Net recoveries (charge-offs)		15		67		(21	)		(245	)		(184	)
Provision		196		137		43			14			390
Ending balance	$	1,671	$	6,530	$	1,594		$	4,097		$	13,892

	Three Months Ended
	March 31, 2014
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Beginning balance:	$	1,979		$	6,243		$	1,517		$	3,037		$	12,776
Charge-offs:		(55	)		(44	)		(7	)		(467	)		(573	)
Recoveries:		92			38			-			183			313
Net recoveries (charge-offs)		37			(6	)		(7	)		(284	)		(260	)
Provision		(71	)		247			42			421			639
Ending balance	$	1,945		$	6,484		$	1,552		$	3,174		$	13,155

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 March 31, 2015 and December 31, 2014 (in thousands):

	March 31, 2015
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment		$	301		$	1,280		$	-		$	-		$	1,581
Collectively evaluated for impairment			1,370			5,214			1,572			4,097			12,253
Loans acquired with deteriorated credit quality			-			36			22			-			58
Total ending allowance balance		$	1,671		$	6,530		$	1,594		$	4,097		$	13,892

	December 31, 2014
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment		$	89		$	1,145		$	-		$	1		$	1,235
Collectively evaluated for impairment			1,335			5,145			1,550			4,327			12,357
Loans acquired with deteriorated credit quality			36			36			22			-			94
Total ending allowance balance		$	1,460		$	6,326		$	1,572		$	4,328		$	13,686

	March 31, 2015
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	1,973	$	13,767	$	249	$	483	$	16,472
Loans collectively evaluated for impairment		170,254		465,960		198,622		292,920		1,127,756
Loans acquired with deteriorated credit quality		-		1,761		256		-		2,017
Total ending loans balance	$	172,227	$	481,488	$	199,127	$	293,403	$	1,146,245

	December 31, 2014
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	1,452	$	13,712	$	254	$	486	$	15,904
Loans collectively evaluated for impairment		164,748		438,246		196,783		306,042		1,105,819
Loans acquired with deteriorated credit quality		620		1,761		250		-		2,631
Total ending loans balance	$	166,820	$	453,719	$	197,287	$	306,528	$	1,124,354

The following tables present loans individually evaluated for impairment recognized by class of loans as of March 31, 2015 and December 31, 2014, the average recorded investment and interest income recognized by class of loans as of the three-month periods ended March 31, 2015 and 2014 (in thousands):

	March 31, 2015						December 31, 2014
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	$	1,668	$	1,670	$	-	$	1,359	$	1,364	$	-
Commercial mortgages:
Construction		1,919		1,899		-		1,927		1,910		-
Commercial mortgages other		7,686		7,593		-		7,803		7,708		-
Residential mortgages		249		249		-		253		253		-
Consumer loans:
Home equity lines and loans		480		483		-		429		432		-
With an allowance recorded:
Commercial and agricultural:
Commercial and industrial		301		303		301		89		89		89
Commercial mortgages:
Commercial mortgages other		4,394		4,275		1,280		4,210		4,094		1,145
Consumer loans:
Home equity lines and loans		-		-		-		54		54		1
Total	$	16,697	$	16,472	$	1,581	$	16,124	$	15,904	$	1,235

	Three Months Ended March 31, 2015				Three Months Ended March 31, 2014
With no related allowance recorded:	Average Recorded Investment		Interest Income Recognized (1)		Average Recorded Investment		Interest Income Recognized (1)
Commercial and agricultural:
Commercial and industrial	$	1,517	$	15	$	1,656	$	14
Commercial mortgages:
Construction		1,904		25		2,296		25
Commercial mortgages other		7,674		63		7,005		63
Residential mortgages		252		1		115		-
Consumer loans:
Home equity lines & loans		458		6		72		1
With an allowance recorded:
Commercial and agricultural:
Commercial and industrial		196		3		921		-
Commercial mortgages:
Commercial mortgages other		4,184		23		863		-
Consumer loans:
Home equity lines and loans		27		-		58		1
Total	$	16,212	$	136	$	12,986	$	104

(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 March 31, 2015 and December 31, 2014 (in thousands):

March 31, 2015	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	$	170,397	$	317	$	24	$	-	$	331	$	171,069
Agricultural		1,158		-		-		-		-		1,158
Commercial mortgages:
Construction		47,913		-		1,444		-		148		49,505
Commercial mortgages		424,367		536		-		1,761		5,319		431,983
Residential mortgages		193,684		1,482		-		256		3,705		199,127
Consumer loans:
Credit cards		1,505		13		8		-		-		1,526
Home equity lines and loans		97,626		672		-		-		655		98,953
Indirect consumer loans		172,573		1,266		-		-		249		174,088
Direct consumer loans		18,781		43		-		-		12		18,836
Total	$	1,128,004	$	4,329	$	1,476	$	2,017	$	10,419	$	1,146,245

(1) Includes all loans on non-accrual status regardless of the number of days such loans were delinquent as of March 31, 2015.

December 31, 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	$	164,109	$	756	$	-	$	620	$	312	$	165,797
Agricultural		1,023		-		-		-		-		1,023
Commercial mortgages:
Construction		53,371		-		1,446		-		150		54,967
Commercial mortgages		391,096		3,064		-		1,761		2,831		398,752
Residential mortgages		191,089		2,333		-		250		3,615		197,287
Consumer loans:
Credit cards		1,641		5		8		-		-		1,654
Home equity lines and loans		98,340		736		-		-		515		99,591
Indirect consumer loans		183,103		1,789		-		-		325		185,217
Direct consumer loans		19,988		48		-		-		30		20,066
Total	$	1,103,760	$	8,731	$	1,454	$	2,631	$	7,778	$	1,124,354

(1) Includes all loans on non-accrual status regardless of the number of days such loans were delinquent as of December 31, 2014.

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 March 31, 2015 and December 31, 2014, the Corporation has a recorded investment in TDRs of $10.0 million and $9.7 million, respectively. There were specific reserves of $0.5 million and $0.3 million allocated for TDRs at March 31, 2015 and December 31, 2014, respectively. As of March 31, 2015, TDRs totaling $9.1 million were accruing interest under the modified terms and $0.9 million were on non-accrual status. As of December 31, 2014, TDRs totaling $8.7 million were accruing interest under the modified terms and $1.0 million were on non-accrual status. The Corporation had committed additional amounts up to less than $0.1 million as of both March 31, 2015 and December 31, 2014, to customers with outstanding loans that are classified as TDRs.

During the three months ended March 31, 2015 and 2014, the terms of certain loans were modified as TDRs. The modification of the terms of such loans included one or a combination of the following: reduced scheduled payments for greater than three 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 TDRs that occurred during the three months ended March 31, 2015 and 2014 (in thousands):

March 31, 2015	Number of Loans		Pre-Modification Outstanding Recorded Investment			Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial and agricultural:
Commercial and industrial		1		$	477		$	477
Total		1		$	477		$	477

March 31, 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

The TDRs described above did not increase the allowance for loan losses and resulted in no charge-offs during the three months ended March 31, 2015. The TDRs described above did not increase the allowance for loan losses and resulted in less than $0.1 million in charge-offs during the three months ended March 31, 2014.

There were no payment defaults on any loans previously modified as TDRs during the three months ending March 31, 2015 or 2014, 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 March 31, 2015 and December 31, 2014, the risk category of the recorded investment of loans by class of loans is as follows (in thousands):

	March 31, 2015
	Not Rated		Pass		Loans acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful		Total
Commercial and agricultural:
Commercial and industrial	$	-	$	164,385	$	-	$	4,220	$	2,285	$	179	$	171,069
Agricultural		-		1,158		-		-		-		-		1,158
Commercial mortgages:
Construction		-		47,607		-		1,750		148		-		49,505
Commercial mortgages		-		403,633		1,761		9,021		13,368		4,200		431,983
Residential mortgages		195,166		-		256		-		3,705		-		199,127
Consumer loans
Credit cards		1,526		-		-		-		-		-		1,526
Home equity lines and loans		98,298		-		-		-		655		-		98,953
Indirect consumer loans		173,835		-		-		-		253		-		174,088
Direct consumer loans		18,824		-		-		-		12		-		18,836
Total	$	487,649	$	616,783	$	2,017	$	14,991	$	20,426	$	4,379	$	1,146,245

	December 31, 2014
	Not Rated		Pass		Loans acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful		Total
Commercial and agricultural:
Commercial and industrial	$	-	$	158,140	$	620	$	3,695	$	3,306	$	36	$	165,797
Agricultural		-		1,023		-		-		-		-		1,023
Commercial mortgages:
Construction		-		51,525		-		3,292		150		-		54,967
Commercial mortgages		-		365,448		1,761		20,871		10,266		406		398,752
Residential mortgages		193,422		-		250		-		3,615		-		197,287
Consumer loans
Credit cards		1,654		-		-		-		-		-		1,654
Home equity lines and loans		99,076		-		-		-		515		-		99,591
Indirect consumer loans		184,940		-		-		-		277		-		185,217
Direct consumer loans		20,045		-		-		-		21		-		20,066
Total	$	499,137	$	576,136	$	2,631	$	14,991	$	20,426	$	442	$	1,124,354

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 March 31, 2015 and December 31, 2014 (in thousands):

	March 31, 2015
				Consumer Loans
	Residential Mortgages			Credit Card			Home Equity Lines and Loans			Indirect Consumer Loans			Other Direct Consumer Loans
Performing		$	195,422		$	1,526		$	98,298		$	173,839		$	18,824
Non-Performing			3,705			-			655			249			12
		$	199,127		$	1,526		$	98,953		$	174,088		$	18,836

	December 31, 2014
				Consumer Loans
	Residential Mortgages			Credit Card			Home Equity Lines and Loans			Indirect Consumer Loans			Other Direct Consumer Loans
Performing		$	193,672		$	1,654		$	99,076		$	184,892		$	20,036
Non-Performing			3,615			-			515			325			30
		$	197,287		$	1,654		$	99,591		$	185,217		$	20,066

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, 2015 to March 31, 2015 (in thousands):

	Balance at December 31, 2014			Income Accretion		All Other Adjustments			Balance at March 31, 2015
Contractually required principal and interest	$	3,621		$	-	$	(676	)	$	2,945
Contractual cash flows not expected to be collected (nonaccretable discount)		(570	)		-		(25	)		(595	)
Cash flows expected to be collected		3,051			-		(701	)		2,350
Interest component of expected cash flows (accretable yield)		(420	)		63		(24	)		(333	)
Fair value of loans acquired with deteriorating credit quality	$	2,631		$	63	$	(677	)	$	2,017