7. ALLOWANCE FOR LOAN LOSSES

Management considers the accounting policy on the allowance for loan losses to be the most critical and requires complex management judgment as discussed below. The judgments made regarding the allowance for loan losses can have a material effect on the results of operations of the Company.

The allowance for loan losses is established and maintained through a provision for loan losses based on probable incurred losses inherent in the Bank’s loan portfolio. Management evaluates the adequacy of the allowance on a quarterly basis. The allowance is comprised of both individual valuation allowances and loan pool valuation allowances.

The Bank monitors its entire loan portfolio on a regular basis, with consideration given to detailed analysis of classified loans, repayment patterns, probable incurred losses, past loss experience, current economic conditions, and various types of concentrations of credit. Additions to the allowance are charged to expense and realized losses, net of recoveries, are charged to the allowance.

Individual valuation allowances are established in connection with specific loan reviews and the asset classification process including the procedures for impairment testing under FASB Accounting Standard Codification (“ASC”) No. 310, “Receivables”. Such valuation, which includes a review of loans for which full collectibility in accordance with contractual terms is not reasonably assured, considers the estimated fair value of the underlying collateral less the costs to sell, if any, or the present value of expected future cash flows, or the loan’s observable market value. Any shortfall that exists from this analysis results in a specific allowance for the loan. Pursuant to our policy, loan losses must be charged-off in the period the loans, or portions thereof, are deemed uncollectible. Assumptions and judgments by management, in conjunction with outside sources, are used to determine whether full collectibility of a loan is not reasonably assured. These assumptions and judgments are also used to determine the estimates of the fair value of the underlying collateral or the present value of expected future cash flows or the loan’s observable market value. Individual loan analyses are periodically performed on specific loans considered impaired. For collateral dependent impaired loans, appraisals are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, the Credit Administration department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources, such as recent market data or industry-wide statistics. On a quarterly basis, the Company compares the actual selling price of collateral that has been sold, based on these independent sources, as well as recent appraisals associated with current loan origination activity, to the most recent appraised value to determine if additional adjustments should be made to the appraisal value to arrive at fair value. Adjustments to fair value are made only when the analysis indicates a probable decline in collateral values. Individual valuation allowances could differ materially as a result of changes in these assumptions and judgments. Individual loan analyses are periodically performed on specific loans considered impaired. The results of the individual valuation allowances are aggregated and included in the overall allowance for loan losses.

Loan pool valuation allowances represent loss allowances that have been established to recognize the inherent risks associated with our lending activities, but which, unlike individual allowances, have not been allocated to particular problem assets. Pool evaluations are broken down into loans with homogenous characteristics by loan type and include commercial real estate mortgages, owner and non-owner occupied; multi-family mortgages; residential real estate mortgages, first lien and home equity; commercial loans, secured and unsecured; installment/consumer loans; and real estate construction and land loans. The determination of the adequacy of the valuation allowance is a process that takes into consideration a variety of factors. The Bank has developed a range of valuation allowances necessary to adequately provide for probable incurred losses inherent in each pool of loans. We consider our own charge-off history along with the growth in the portfolio as well as the Bank’s credit administration and asset management philosophies and procedures, and concentrations in the portfolio when determining the allowances for each pool. In addition, we evaluate and consider the credit’s risk rating which includes management’s evaluation of: cash flow, collateral and trends in current values, guarantor support, financial disclosures, industry trends and strength of borrowers’ management, the impact that economic and market conditions may have on the portfolio as well as known and inherent risks in the portfolio. Finally, we evaluate and consider the allowance ratios and coverage percentages of both peer group and regulatory agency data. These evaluations are inherently subjective because, even though they are based on objective data, it is management’s interpretation of that data that determines the amount of the appropriate allowance. If the evaluations prove to be incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in the loan portfolio, resulting in additions to the allowance for loan losses.

The Credit Risk Management Committee is comprised of Bank management. The adequacy of the allowance is analyzed quarterly, with any adjustment to a level deemed appropriate by the Credit Risk Management Committee, based on its risk assessment of the entire portfolio. Based on the Credit Risk Management Committee’s review of the classified loans and the overall allowance levels as they relate to the entire loan portfolio at September 30, 2013, management believes the allowance for loan losses has been established at levels sufficient to cover the probable incurred losses in the Bank’s loan portfolio. Future additions or reductions to the allowance may be necessary based on changes in economic, market or other conditions. Changes in estimates could result in a material change in the allowance. In addition, various regulatory agencies, as an integral part of the examination process, periodically review the allowance for loan losses. Such agencies may require the Bank to recognize adjustments to the allowance based on their judgments of the information available to them at the time of their examination.

The following table represents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment, as defined under ASC 310-10, and based on impairment method as of September 30, 2013 and December 31, 2012. Additionally, the following tables represent the changes in the allowance for loan losses for the three month and nine month period ended September 30, 2013 and 2012, and the twelve month period ended December 31, 2012, by portfolio segment, as defined under ASC 310-10. The loan segment represents the categories that the Bank develops to determine its allowance for loan losses.

	For the Three Months Ended September 30, 2013
(In thousands)	Commercial Real Estate Mortgage Loans		Multi-Family		Residential Real Estate Mortgage Loans		Commercial, Financial and Agricultural Loans			Real Estate Construction and Land Loans			Installment/ Consumer Loans			Total
Allowance for Loan Losses:
Beginning balance	$	5,200	$	1,430	$	2,691	$	3,995		$	1,602		$	212		$	15,130
Charge-offs	—		—		—		(152		)	—			(3		)	(155		)
Recoveries	—		—		1		6			—			1			8
Provision	540		200		124		9			(356		)	(17		)	500
Ending Balance	$	5,740	$	1,630	$	2,816	$	3,858		$	1,246		$	193		$	15,483

	For the Nine Months Ended September 30, 2013
(In thousands)	Commercial Real Estate Mortgage Loans		Multi- Family		Residential Real Estate Mortgage Loans			Commercial, Financial and Agricultural Loans			Real Estate Construction and Land Loans			Installment/ Consumer Loans			Total
Allowance for Loan Losses:
Beginning balance	$	4,445	$	1,239	$	2,803		$	4,349		$	1,375		$	228		$	14,439
Charge-offs	—		—		(201		)	(412		)	(22		)	(53		)	(688		)
Recoveries	—		—		4			73			2			3			82
Provision	1,295		391		210			(152		)	(109		)	15			1,650
Ending Balance	$	5,740	$	1,630	$	2,816		$	3,858		$	1,246		$	193		$	15,483

Ending balance: individually evaluated for impairment	$	83	$	—	$	117		$	—		$	—		$	—		$	200

Ending balance: collectively evaluated for impairment	$	5,657	$	1,630	$	2,699		$	3,858		$	1,246		$	193		$	15,283

Loans	$	421,382	$	102,740	$	153,871		$	199,690		$	45,492		$	8,626		$	931,801

Ending balance: individually evaluated for impairment	$	5,964	$	—	$	2,622		$	495		$	—		$	—		$	9,081

Ending balance: collectively evaluated for impairment	$	414,627	$	102,740	$	151,249		$	198,952		$	45,161		$	8,626		$	921,355

Ending balance: loans acquired with deteriorated credit quality	$	791	$	—	$	—		$	243		$	331		$	—		$	1,365

	For the Twelve Months Ended December 31, 2012
(In thousands)	Commercial Real Estate Mortgage Loans		Multi- Family		Residential Real Estate Mortgage Loans			Commercial, Financial and Agricultural Loans			Real Estate Construction and Land Loans			Installment/ Consumer Loans			Total
Allowance for Loan Losses:
Beginning balance	$	3,530	$	395	$	2,280		$	2,895		$	1,465		$	272		$	10,837
Charge-offs	—		—		(1,210		)	(285		)	—			(15		)	(1,510		)
Recoveries	—		—		7			83			—			22			112
Provision	915		844		1,726			1,656			(90		)	(51		)	5,000
Ending Balance	$	4,445	$	1,239	$	2,803		$	4,349		$	1,375		$	228		$	14,439

Ending balance: individually evaluated for impairment	$	—	$	—	$	141		$	228		$	—		$	—		$	369

Ending balance: collectively evaluated for impairment	$	4,445	$	1,239	$	2,662		$	4,121		$	1,375		$	228		$	14,070

Loans	$	332,782	$	66,080	$	143,703		$	197,448		$	48,632		$	9,167		$	797,812

Ending balance: individually evaluated for impairment	$	4,776	$	—	$	2,549		$	883		$	—		$	—		$	8,208

Ending balance: collectively evaluated for impairment	$	327,282	$	66,080	$	141,154		$	196,350		$	48,331		$	9,167		$	788,364

Ending balance: loans acquired with deteriorated credit quality	$	724	$	—	$	—		$	215		$	301		$	—		$	1,240

	For the Three Months Ended September 30, 2012
(In thousands)	Commercial Real Estate Mortgage Loans		Multi-Family		Residential Real Estate Mortgage Loans			Commercial, Financial and Agricultural Loans		Real Estate Construction and Land Loans			Installment/ Consumer Loans			Total
Allowance for Loan Losses:
Beginning balance	$	4,447	$	1,049	$	2,879		$	3,570	$	1,328		$	283		$	13,556
Charge-offs	—		—		(150		)	—		—			—			(150		)
Recoveries	—		—		2			35		—			1			38
Provision	126		172		153			204		(42		)	(13		)	600
Ending Balance	$	4,573	$	1,221	$	2,884		$	3,809	$	1,286		$	271		$	14,044

	For the Nine Months Ended September 30, 2012
(In thousands)	Commercial Real Estate Mortgage Loans		Multi-Family		Residential Real Estate Mortgage Loans			Commercial, Financial and Agricultural Loans			Real Estate Construction and Land Loans			Installment/ Consumer Loans			Total
Allowance for Loan Losses:
Beginning balance	$	3,530	$	395	$	2,280		$	2,895		$	1,465		$	272		$	10,837
Charge-offs	—		—		(700		)	(102		)	—			(13		)	(815		)
Recoveries	—		—		5			70			—			22			97
Provision	1,043		826		1,299			946			(179		)	(10		)	3,925
Ending Balance	$	4,573	$	1,221	$	2,884		$	3,809		$	1,286		$	271		$	14,044