6. LOANS

The following table sets forth the major classifications of loans:

(In thousands)	September 30, 2013			December 31, 2012
Commercial real estate mortgage loans	$	421,382		$	332,782
Multi-family mortgage loans	102,740			66,080
Residential real estate mortgage loans	153,871			143,703
Commercial, financial, and agricultural loans	199,690			197,448
Real estate construction and land loans	45,492			48,632
Installment/consumer loans	8,626			9,167
Total loans	931,801			797,812
Net deferred loan costs and fees	1,433			634
	933,234			798,446
Allowance for loan losses	(15,483		)	(14,439		)
Net loans	$	917,751		$	784,007

Lending Risk

The principal business of the Bank is lending, primarily in commercial real estate mortgage loans, multi-family mortgage loans, residential real estate mortgage loans, construction loans, home equity loans, commercial and industrial loans, land loans and consumer loans. The Bank considers its primary lending area to be eastern Long Island in Suffolk County, New York, and a substantial portion of the Bank’s loans are secured by real estate in this area. Accordingly, the ultimate collectability of such a loan portfolio is susceptible to changes in market and economic conditions in this region.

Commercial Real Estate Mortgages

Loans in this classification include income producing investment properties and owner occupied real estate used for business purposes. The underlying properties are generally located in our primary market area. The cash flows of the income producing investment properties can be adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, can have an effect on credit quality. Generally, management seeks to obtain annual financial information for borrowers with loans in excess of $0.25 million 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 can have an adverse effect on credit quality.

Multi-Family Mortgages

Loans in this classification include income producing residential investment properties of 5 or more families. The loans are usually made in areas with limited single family residences generating high demand for these facilities. Loans are made to established owners with a proven and demonstrable record of strong performance. Loans are secured by a first mortgage lien on the subject property with a loan to value ratio generally not exceeding 75%. Repayment is derived generally from the rental income generated from the property and may be supplemented by the owners’ personal cash flow. Credit risk arises with an increase in vacancy rates, property mismanagement and the predominance of non-recourse loans that are customary in the industry.

Residential Real Estate Mortgages and Home Equity Loans

Loans in these classifications 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, can 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% and does not grant subprime loans.

Commercial, Industrial and Agricultural Loans

Loans in this classification 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 can have an effect on the credit quality in this loan class.

Real Estate Construction and Land Loans

Loans in this classification 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 primarily 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 that the Company 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.

Installment and Consumer Loans

Loans in this classification 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 automobiles. Therefore, the overall health of the economy, including unemployment rates and housing prices, can have an effect on the credit quality in this loan class.

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt including repayment patterns, probable incurred losses, past loss experience, current economic conditions, and various types of concentrations of credit. Assigned risk rating grades are continuously updated as new information is obtained. Loans risk rated special mention, substandard and doubtful are reviewed on a quarterly basis. The Company uses the following definitions for risk rating grades:

Pass: Loans classified as pass include current loans performing in accordance with contractual terms, pools of homogenous residential real estate and installment/consumer loans that are not individually risk rated and loans which do not exhibit certain risk factors that require greater than usual monitoring by management.

Special mention: Loans classified as special mention, while generally not delinquent, have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Bank’s credit position at some future date.

Substandard: Loans classified as substandard have a well defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in a substandard loan, and may also be at delinquency status and have defined weaknesses based on currently existing facts, conditions and values making collection or liquidation in full highly questionable and improbable.

The following table represents loans by class categorized by internally assigned risk grades as of September 30, 2013 and December 31, 2012:

Grades:

September 30, 2013

Pass

Special Mention

Substandard

Doubtful

Total

(In thousands)

Commercial real estate:

Owner occupied

152,472

12,124

9,203

—

173,799

Non-owner occupied

236,680

7,059

3,844

—

247,583

Multi-Family

102,740

—

102,740

Residential real estate:

Residential mortgage

85,474

423

2,775

617

89,289

Home equity

61,982

1,020

1,467

113

64,582

Commercial:

Secured

86,839

1,157

4,061

—

92,057

Unsecured

105,044

1,462

1,127

—

107,633

Real estate construction and land loans

42,089

—

3,403

—

45,492

Installment/consumer loans

8,432

150

—

8,626

Total loans

881,752

23,289

26,030

730

931,801

	Grades:
December 31, 2012	Pass		Special Mention		Substandard		Doubtful		Total
(In thousands)
Commercial real estate:
Owner occupied	$	138,675	$	11,285	$	11,039	$	—	$	160,999
Non-owner occupied	159,967		7,523		4,293		—		171,783
Multi-Family	66,080		—		—		—		66,080
Residential real estate:
Residential mortgage	72,158		—		2,846		717		75,721
Home equity	65,955		745		1,282		—		67,982
Commercial:
Secured	81,661		1,447		5,605		—		88,713
Unsecured	105,454		1,948		1,234		99		108,735
Real estate construction and land loans	45,178		—		3,454		—		48,632
Installment/consumer loans	9,058		—		109		—		9,167
Total loans	$	744,186	$	22,948	$	29,862	$	816	$	797,812

Past Due and Nonaccrual Loans

The following table represents the aging of the recorded investment in past due loans as of September 30, 2013 and December 31, 2012 by class of loans, as defined by ASC 310-10:

September 30, 2013	30-59 Days Past Due		60-89 Days Past Due		>90 Days Past Due and Accruing		Nonaccrual Including 90 Days or More Past Due		Total Past Due and Nonaccrual		Current		Total Loans
(In thousands)
Commercial real estate:
Owner occupied	$	—	$	—	$	551	$	1,086	$	1,637	$	172,162	$	173,799
Non-owner occupied	195		—		—		617		812		246,771		247,583
Multi-Family	—		—		—		—		—		102,740		102,740
Residential real estate:
Residential mortgages	—		—		—		1,298		1,298		87,991		89,289
Home equity	—		291		—		1,042		1,333		63,249		64,582
Commercial:
Secured	180		966		—		75		1,221		90,836		92,057
Unsecured	15		—		—		161		176		107,457		107,633
Real estate construction and land loans	—		—		—		—		—		45,492		45,492
Installment/consumer loans	1		—		—		—		1		8,625		8,626
Total loans	$	391	$	1,257	$	551	$	4,279	$	6,478	$	925,323	$	931,801

December 31, 2012	30-59 Days Past Due		60-89 Days Past Due		>90 Days Past Due and Accruing		Nonaccrual Including 90 Days or More Past Due		Total Past Due and Nonaccrual		Current		Total Loans
(In thousands)
Commercial real estate:
Owner occupied	$	—	$	1,265	$	491	$	492	$	2,248	$	158,751	$	160,999
Non-owner occupied	—		—		—		—		—		171,783		171,783
Multi-Family	—		—		—		—		—		66,080		66,080
Residential real estate:
Residential mortgages	—		158		—		1,203		1,361		74,360		75,721
Home equity	965		—		—		1,010		1,975		66,007		67,982
Commercial:
Secured	—		—		—		136		136		88,577		88,713
Unsecured	22		—		—		426		448		108,287		108,735
Real estate construction and land loans	—		—		—		22		22		48,610		48,632
Installment/consumer loans	—		—		—		—		—		9,167		9,167
Total loans	$	987	$	1,423	$	491	$	3,289	$	6,190	$	791,622	$	797,812

All loans 90 days or more past due that are still accruing interest represent loans that were acquired from Hamptons State Bank on May 27, 2011 and were recorded at fair value upon acquisition. These loans are considered to be accruing as management can reasonably estimate future cash flows on these acquired loans and expect to fully collect the carrying value of these loans. Therefore, the difference between the carrying value of these loans and their expected cash flows is being accreted into income.

Impaired Loans

As of September 30, 2013 and December 31, 2012, the Company had impaired loans as defined by FASB ASC No. 310, “Receivables” of $9.1 million and $8.2 million, respectively. For a loan to be considered impaired, management determines after review whether it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Management applies its normal loan review procedures in making these judgments. Impaired loans include individually classified nonaccrual loans and troubled debt restructured (“TDR”) loans. For impaired loans, the Bank evaluates the impairment of the loan in accordance with FASB ASC 310-10-35-22. Impairment is determined based on the present value of expected future cash flows discounted at the loan’s effective interest rate. For loans that are collateral dependent, the fair value of the collateral is used to determine the fair value of the loan. The fair value of the collateral is determined based upon recent appraised values. The fair value of the collateral or present value of expected cash flows is compared to the carrying value to determine if any write-down or specific loan loss allowance allocation is required.

The following table represents impaired loans by class at September 30, 2013 and December 31, 2012:

September 30, 2013	Recorded Investment		Unpaid Principal Balance		Related Allocated Allowance
(In thousands)
With no related allowance recorded:
Commercial real estate:
Owner occupied	$	3,711	$	3,810	$	—
Non-owner occupied	916		916		—
Residential real estate:
Residential mortgages	1,478		2,218		—
Home equity	912		1,388		—
Commercial:
Secured	352		391		—
Unsecured	143		182		—
Real estate construction and land loans	—		—		—
Installment/consumer loans	—		—		—
Total with no related allowance recorded	$	7,512	$	8,905	$	—

With an allowance recorded:
Commercial real estate - Owner occupied	$	720	$	720	$	78
Commercial real estate - Non-owner occupied	617		617		5
Residential real estate - Residential mortgage	152		156		37
Residential real estate - Home equity	80		89		80
Total with an allowance recorded:	$	1,569	$	1,582	$	200

Total:
Commercial real estate:
Owner occupied	$	4,431	$	4,530	$	78
Non-owner occupied	1,533		1,533		5
Residential real estate:
Residential mortgages	1,630		2,374		37
Home equity	992		1,477		80
Commercial:
Secured	352		391		—
Unsecured	143		182		—
Real estate construction and land loans	—		—		—
Installment/consumer loans	—		—		—
Total	$	9,081	$	10,487	$	200

December 31, 2012	Recorded Investment		Unpaid Principal Balance		Related Allocated Allowance
(In thousands)
With no related allowance recorded:
Commercial real estate:
Owner occupied	$	3,860	$	3,931	$	—
Non-owner occupied	916		916		—
Residential real estate:
First lien	1,539		2,151		—
Home equity	736		1,094		—
Commercial:
Secured	515		520		—
Unsecured	95		97		—
Total with no related allowance recorded	$	7,661	$	8,709	$	—

With an allowance recorded:
Residential real estate - Home equity	$	274	$	287	$	141
Commercial - Unsecured	273		302		228
Total with an allowance recorded:	$	547	$	589	$	369

Total:
Commercial real estate:
Owner occupied	$	3,860	$	3,931	$	—
Non-owner occupied	916		916		—
Residential real estate:
First lien	1,539		2,151		—
Home equity	1,010		1,381		141
Commercial:
Secured	515		520		—
Unsecured	368		399		228
Total	$	8,208	$	9,298	$	369

The following table represents the average recorded investment and interest income recognized for impaired loans by class for the three and nine months ended September 30, 2013 and 2012:

	Three months ended September 30,
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
(In thousands)	2013				2012
With no related allowance recorded:
Commercial real estate:
Owner occupied	$	3,715	$	29	$	4,363	$	30
Non-owner occupied	916		16		916		15
Multi-family	—		—		—		—
Residential real estate:
Residential mortgages	1,432		6		1,431		7
Home equity	898		—		737		—
Commercial:
Secured	450		7		540		2
Unsecured	237		2		—		—
Real estate construction and land loans	—		—		—		—
Installment/consumer loans	—		—		—		—
Total with no related allowance recorded	$	7,648	$	60	$	7,987	$	54

With an allowance recorded:
Commercial real estate:
Owner occupied	$	721	$	—	$	—	$	—
Non-owner occupied	617		—		—		—
Residential real estate:
Residential mortgages	152		—		—		—
Home equity	80		—		463		—
Commercial:
Unsecured	—		—		370		—
Total with an allowance recorded:	$	1,570	$	—	$	833	$	—

Total:
Commercial real estate:
Owner occupied	$	4,436	$	29	$	4,363	$	30
Non-owner occupied	1,533		16		916		15
Multi-family	—		—		—		—
Residential real estate:
Residential mortgages	1,584		6		1,431		7
Home equity	978		—		1,200		—
Commercial:
Secured	450		7		540		2
Unsecured	237		2		370		—
Real estate construction and land loans	—		—		—		—
Installment/consumer loans	—		—		—		—
Total	$	9,218	$	60	$	8,820	$	54

	Nine months ended September 30,
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
(In thousands)	2013				2012
With no related allowance recorded:
Commercial real estate:
Owner occupied	$	3,740	$	88	$	4,387	$	116
Non-owner occupied	916		45		916		45
Multi-family	—		—		—		—
Residential real estate:
Residential mortgages	1,487		20		1,481		22
Home equity	870		—		890		—
Commercial:
Secured	457		20		531		12
Unsecured	243		4		—		—
Real estate construction and land loans	—		—		—		—
Installment/consumer loans	—		—		—		—
Total with no related allowance recorded	$	7,713	$	177	$	8,205	$	195

With an allowance recorded:
Commercial real estate:
Owner occupied	$	320	$	—	$	—	$	—
Non-owner occupied	481		—		—		—
Residential real estate:
Residential mortgages	137		—		—		—
Home equity	82		—		469		—
Commercial:
Unsecured	—		—		387		—
Total with an allowance recorded:	$	1,020	$	—	$	856	$	—

Total:
Commercial real estate:
Owner occupied	$	4,060	$	88	$	4,387	$	116
Non-owner occupied	1,397		45		916		45
Residential real estate:
Residential mortgages	1,624		20		1,481		22
Home equity	952		—		1,359		—
Commercial:
Secured	457		20		531		12
Unsecured	243		4		387		—
Real estate construction and land loans	—		—		—		—
Installment/consumer loans	—		—		—		—
Total	$	8,733	$	177	$	9,061	$	195

The Bank had no foreclosed real estate at September 30, 2013 and $0.3 million at December 31, 2012

Troubled Debt Restructurings

The terms of certain loans were modified and are considered TDRs. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan. The modification of these loans involved borrowers who were experiencing financial difficulties.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed to determine if that borrower is currently in payment default under any of its obligations or whether there is a probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.

The following table presents loans, by class, modified as troubled debt restructurings during the nine months ended September 30, 2013 and 2012:

	For the Nine Months Ended
	September 30, 2013
(In thousands)	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial real estate:
Owner occupied	—	$	—	$	—
Non-owner occupied	1	620		620
Multi-Family	—	—		—
Residential real estate:
First lien	—	—		—
Home equity	—	—		—
Commercial:
Secured	—	—		—
Unsecured	2	48		48
Installment/consumer loans	—	—		—
Real estate construction and land loans	—	—		—
Total loans	3	$	668	$	668

	For the Nine Months Ended
	September 30, 2012
(In thousands)	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial real estate:
Owner occupied	1	$	163	$	161
Non-owner occupied	—	—		—
Multi-Family	—	—		—
Residential real estate:
First lien	—	—		—
Home equity	—	—		—
Commercial:
Secured	1	387		387
Unsecured	1	42		42
Installment/consumer loans	—	—		—
Real estate construction and land loans	—	—		—
Total loans	3	$	592	$	590

There was one loan modified as a TDR for which there was a payment default within twelve months following the modification. This loan has since been moved to non performing. A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.

The troubled debt restructurings described above increased the allowance for loan losses by $5,000 and did not result in any charge offs during the three months and nine months ending September 30, 2013. The troubled debt restructurings described did not increase the allowance for loan losses or result in charge offs during the three months and nine months ending September 30, 2012.

The non-owner occupied commercial real estate loan that was modified as a TDR during the nine months ended September 30, 2013, represents the only TDR for which there was a payment default within twelve months following the modification. A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.

As of September 30, 2013 and December 31, 2012, the Company had $1.4 million and $1.0 million, respectively, of nonaccrual TDR loans. As of September 30, 2013, two borrowers with loans totaling $0.2 million are complying with the modified terms of the loans and are currently making payments. Two borrowers with loans totaling $1.2 million are currently in default and foreclosure proceedings have been initiated. In addition, there were no charge-offs on TDR’s during the third quarter 2013. Total nonaccrual TDR loans are secured with collateral that has an appraised value of $3.1 million. Furthermore, the Bank has no commitment to lend additional funds to these debtors.

In addition, the Company has eight borrowers with performing TDR loans of $5.0 million at September 30, 2013 that are current and secured with collateral that has an appraised value of approximately $12.0 million as well as personal guarantees. At December 31, 2012, the Company had six borrowers with performing TDR loans of $5.0 million that were current and secured with collateral that had an appraised value of approximately $12.3 million as well as personal guarantees. Management believes that the ultimate collection of principal and interest is reasonably assured and therefore continues to recognize interest income on an accrual basis. In addition, the Bank has no commitment to lend additional funds to these debtors.

The terms of certain other loans were modified during the three months and nine months ending September 30, 2013 and 2012, that did not meet the definition of a TDR. The loans modified during the three months and nine months ended September 30, 2013, had a total recorded investment as of $5.4 million and $68.1 million, respectively. The loans modified during the three months and nine months ended September 30, 2012, had a total recorded investment as of $12.6 million and $40.4 million, respectively. The modification of these loans involved a modification of the terms of loans to borrowers who were not experiencing financial difficulties or did not involve a concession to the borrower.