9. Loans

Loans are stated at the principal amounts outstanding adjusted for purchase premiums/discounts, deferred net loan fees and costs, and unearned income. Classes are generally disaggregations of a portfolio segment. The Company's portfolio segments are: Commercial and agricultural, Real estate - construction, Real estate - residential, Real estate – commercial and other consumer loans. The classes within the Commercial and agricultural portfolio are: owner occupied and non-owner occupied. The classes within the Real estate -construction portfolio are: Retail properties, Multi-family, Industrial and Warehouse, and Other commercial real estate. The classes within the Real estate - residential portfolio are: first-lien and second-lien loans and home equity lines of credit. The other consumer loan portfolios are not further segregated into classes.

Loan fees and the incremental direct costs associated with making loans are deferred and subsequently recognized over the life of the loan as an adjustment of interest income. The premium or discount on purchased loans is amortized over the expected life of the loans and is included in interest and fees on loans.

The majority of residential mortgage loans held for sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements, calculated on the aggregate loan basis. A portion of loans held for sale are hedged to take advantage of interest rate locks and changes in the market. These loans are carried at fair value.

The following summary sets forth the major categories of loans.


(dollars in thousands)	At June 30, 2011				At December 31, 2010
Loans held for investment:
Commercial and agricultural	$	67,654	6.6	%	$	93,747	7.2	%
Real estate-construction		166,783	16.4			276,976	21.2
Real estate-mortgage:
1-4 family residential		377,607	37.1			388,859	29.8
Commercial		360,477	35.4			494,861	38.0
Consumer		45,753	4.5			49,532	3.8

Total loans	$	1,018,274	100.0	%	$	1,303,975	100.0	%

Loans included in the preceding loan composition table are net of participations sold. Loans as presented are reduced by net deferred loan fees of $32,000 and $26,000 at June 30, 2011 and December 31, 2010, respectively.

Mortgage loans serviced for others are not included in the consolidated balance sheet. The unpaid principal balance of mortgage loans serviced for others amounted to $787,400 at June 30, 2011 and $493.7 million at December 31, 2010.

In accordance with instructions from Fannie Mae, the Bank entered into an agreement on December 29, 2010 to sell mortgage servicing rights on approximately $492.9 million of Fannie Mae loans and recognized a loss of $3.0 million, including transaction costs. The Bank continued to service these loans until January 31, 2011.

To borrow from the FHLB, members must pledge collateral to secure advances and letters of credit. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. Gross loans of $416.7 million and $468.4 million were pledged to collateralize FHLB advances and letters of credit at June 30, 2011 and December 31, 2010, respectively, of which there was no availability for borrowing capacity at either period. At June 30, 2011, $33.5 million of loans and $25.3 million of securities were pledged to collateralize potential borrowings from the Federal Reserve Discount Window, of which $24.1 million was available as borrowing capacity.

The Bank implemented in 2009 a stimulus loan program to facilitate the sale of residential real estate held as collateral for some of the Bank's nonperforming and performing loans and certain Bank-owned properties. The purpose of the program was to reduce the Bank's credit concentrations and nonperforming assets by providing attractive terms that both filled the mortgage lending void created by the ongoing recession and incented potential buyers to purchase real estate. The Bank offered a reduced interest rate to qualified new borrowers to encourage them to purchase properties in this program. New borrowers qualified according to the Bank's normal consumer and mortgage underwriting standards. The Bank recorded these loans at fair value at time of issue. Existing unimpaired development loans that become part of the program were considered impaired upon inclusion in the stimulus loan program. The Bank discontinued the program, and the last stimulus loan was booked, in the first quarter of 2011. The Bank currently has $41.6 million in loans under the stimulus loan program, of which, $15.2 million required a fair value adjustment of $92,700 as of June 30, 2011. The fair value adjustment is recorded as a reduction of the outstanding loan balance on the balance sheet and accreted into interest income over the contractual life of the loan. The Company will continue to report stimulus loan information, as indicated above, through the filing of the annual report on Form 10-K for the year ending December 31, 2011.

Interest income on loans is generally calculated by using the interest method based on the daily outstanding balance. The recognition of interest income is discontinued when, in management's opinion, the collection of all or a portion of interest becomes doubtful. Loans are returned to accrual status when the factors indicating doubtful collectibility cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time. The past due status of loans is based on the contractual payment terms. Had nonaccruing loans been on accruing status, interest income would have been higher by $3.5 million and $7.6 million for the three- and six-month periods ended June 30, 2011, respectively. At June 30, 2011 and December 31, 2010, the Bank had certain impaired loans of $207.9 million and $325.1 million, respectively, which were on nonaccruing interest status.

The following is a summary of nonperforming assets for the periods ended as presented.


(dollars in thousands)	June 30, 2011		December 31, 2010
Loans on nonaccrual status:
Held for sale	$	9,450	$	—
Held for investment		198,439		325,068
Loans more than 90 days delinquent, still on accrual		—		4,818
Real estate owned/repossessed assets		101,531		62,196
Assets of discontinued operations		—		168

Total nonperforming assets	$	309,420	$	392,250

An impaired loan is one for which the Bank will not be repaid all principal and interest due per the terms of the original contract or within reasonably modified contracted terms. If the loan has been modified to provide relief to the borrower, the loan is deemed to be impaired if all principal and interest will not be repaid according to the original contract. All loans meeting the definition of Doubtful should be considered impaired.

When a loan in any class has been determined to be impaired, the amount of the impairment is measured using the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent. When the present value of expected future cash flows is used, the effective interest rate is the original contractual interest rate of the loan adjusted for any premium or discount. When the contractual interest rate is variable, the effective interest rate of the loan changes over time. A specific reserve is established as a component of the Allowance for Loan Losses when a loan has been determined to be impaired. Subsequent to the initial measurement of impairment, if there is a significant change to the impaired loan's expected future cash flows, or if actual cash flows are significantly different from the cash flows previously estimated, the Bank recalculates the impairment and appropriately adjusts the specific reserve. Similarly, if the Bank measures impairment based on the observable market price of an impaired loan or the fair value of the collateral of an impaired collateral-dependent loan, the Bank will adjust the specific reserve if there is a significant change in either of those bases.

When a loan within any class is impaired, interest income is recognized unless the receipt of principal and interest is in doubt when contractually due. If receipt of principal and interest is in doubt when contractually due, interest income is not recognized. Cash receipts received on nonaccruing impaired loans within any class are generally applied entirely against principal until the loan has been collected in full, after which time any additional cash receipts are recognized as interest income. Cash receipts received on accruing impaired loans within any class are applied in the same manner as accruing loans that are not considered impaired.

The following table summarizes information relative to impaired loans at the dates and for the periods indicated.


	June 30, 2011				December 31, 2010
(dollars in thousands)	Balance		Associated Reserves		Balance		Associated Reserves
Impaired loans, not individually reviewed for impairment	$	5,297	$	—	$	717	$	—
Impaired loans, individually reviewed, with no impairment		90,273		—		132,435		—
Impaired loans, individually reviewed, with impairment		104,715		33,054		208,040		70,888

Total impaired loans *	$	200,285	$	33,054	$	341,192	$	70,888

Average impaired loans calculated using a simple average	$	291,741			$	355,131

*	Included at June 30, 2011 and December 31, 2010 were $1.8 million and $6.5 million, respectively, in restructured and performing loans.

Impaired loans also include loans for which the Bank may elect to grant a concession, providing terms more favorable than those prevalent in the market (e.g., rate, amortization term), and formally restructure due to the weakening credit status of a borrower. Restructuring is designed to facilitate a repayment plan that minimizes the potential losses that the Bank otherwise may have to incur. If these impaired loans are on nonaccruing status as of the date of restructuring, the loans are included in nonperforming loans. Nonperforming restructured loans will remain as nonperforming until the borrower can demonstrate adherence to the restructured terms for a period of no less than six months or when it is otherwise determined that continued adherence is reasonably assured. Some restructured loans continue as accruing loans after restructuring due to the borrower's not being past due at the time of restructuring, adequate collateral valuations supporting the restructured loans, and the cash flows of the underlying business appearing adequate to support the restructured debt service. Not included in nonperforming loans are loans that have been restructured that were performing as of the restructure date. At June 30, 2011, there was $80.4 million in restructured loans, of which $1.8 million in loans were accruing and in a performing status. At December 31, 2010, there was $146.5 million in restructured loans, of which loans amounting to $6.5 million were accruing and in a performing status.

All loan classes are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. When the Bank cannot reasonably expect full and timely repayment of its loan, the loan is placed on nonaccrual. The Bank may calculate forgone interest on a monthly basis, but does not recognize the income.

All loan classes on which principal or interest is in default for 90 days or more are put on nonaccrual status, unless there is sufficient documentation to conclude that the loan is well secured and in the process of collection. A debt is "well-secured" if collateralized by liens on or pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt in full; or by the guarantee of a financially responsible party. A debt is "in process of collection" if collection is proceeding in due course either through legal action, including judgment enforcement procedures, or, in appropriate circumstances, through collection efforts not involving legal action that are reasonably expected to result in repayment of the debt or its restoration to a current status.

Loans that are less delinquent may also be placed on nonaccrual if approved due to deterioration in the financial condition of the borrower that increases the possibility of less than full repayment.

For all loan classes a nonaccrual loan may be returned to accrual status when the Bank can reasonably expect continued timely payments until payment in full. All prior arrearage does not have to be eliminated, nor do all previously charged-off amounts need to have been recovered, but the loan can still be returned to accrual status if the following conditions are met: (1) all principal and interest amounts contractually due (including arrearage) are reasonably assured of repayment within a reasonable period; and (2) there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms involving payments of cash or cash equivalents.

At the time a loan is placed on nonaccrual, all accrued, unpaid interest is charged-off, unless it is documented that repayment of all principal and presently accrued but unpaid interest is probable. Charge-offs of accrued and unpaid interest must be against the current year's interest income; it cannot be charged to the current Allowance for Loan Losses.

For all classes within all loan portfolios, cash receipts received on nonaccrual loans are applied entirely against principal until the loan or lease has been collected in full, after which time any additional cash receipts are recognized as interest income.

For all loan classes, as soon as any loan becomes uncollectible, the loan will be charged down or charged off as follows:

•

If unsecured, the loan must be charged off in full.

•

If secured, the outstanding principal balance of the loan should be charged down to the net liquidation value of the collateral.

Loans should be considered uncollectible when:

•

No regularly scheduled payment has been made within four months and the determination is made that any further payment is unlikely, or

•

The loan is unsecured, the borrower files for bankruptcy protection and there is no other (guarantor, etc.) support from an entity outside of the bankruptcy proceedings.

Based on a variety of credit, collateral and documentation issues, loans with lesser degrees of delinquency or obvious loss may also be deemed uncollectible.

Potential problem loans that are not included in nonperforming assets are classified separately within the Bank's portfolio as Special Mention and carry a risk grade rating of "6." These loans are defined as those with potential weaknesses that may affect repayment capacity but do not pose sufficient risk as to require an adverse classification. As of June 30, 2011, the balance of such loans was $85.7 million compared with a balance of $130.8 million as of December 31, 2010.