3.	PORTFOLIO LOANS AND ALLOWANCE FOR LOAN LOSSES

The Company originates both adjustable and fixed rate loans. The adjustable rate loans have interest rate adjustment limitations and are indexed to various indices. Adjustable residential mortgages are generally indexed to the one year Treasury constant maturity rate; adjustable consumer loans are generally indexed to the prime rate; adjustable commercial loans are generally indexed to either the prime rate or the one, three or five year Treasury constant maturity rate. Future market factors may affect the correlation of the interest rates the Company pays on the short-term deposits that have been primarily utilized to fund these loans.

The Company originates and purchases commercial and commercial mortgage loans, which totaled $518.0 million and $550.7 million at December 31, 2011 and 2010, respectively. These loans are considered by management to be of somewhat greater risk of collectability due to the dependency on income production or future development of the real estate. Collateral for commercial and commercial mortgage loans includes manufacturing equipment, real estate, inventory, accounts receivable, and securities. Terms of these loans are normally for up to ten years and have adjustable rates tied to the reported prime rate and Treasury indices. Generally, commercial and commercial mortgage loans are considered to involve a higher degree of risk than residential real estate loans. However, commercial and commercial mortgage loans generally carry a higher yield and are made for a shorter term than residential real estate loans.

Certain residential mortgage products have contractual features that may increase credit exposure to the Company in the event of a decline in housing prices. These types of mortgage products offered by the Company include high loan-to-value ("LTV") ratios and multiple loans on the same collateral that when combined result in a high LTV. Typically a residential mortgage loan is combined with a home equity loan for a LTV at origination of over 90% and less than or equal to 100%. The balance including unused lines of these loans over 90% LTV at December 31, 2011 was $6.9 million.

Under the capital standards provisions of FIRREA, the loans-to-one-borrower limitation is generally 15% of unimpaired capital and surplus, which, for the Bank, was approximately $16.3 million and $16.6 million at December 31, 2011 and 2010, respectively. As of December 31, 2011 and 2010, the Bank was in compliance with this limitation.

The Company follows a policy of offering to its directors, officers, and employees real estate mortgage loans secured by their principal residence, consumer loans, and, in certain cases, commercial loans. Loans to directors, director nominees, executive officers, and their associates (including immediate family members) totaled $3.2 million, or 3.7% of equity capital, and $4.6 million, or 5.2% of equity capital, as of December 31, 2011 and 2010, respectively. All such loans were made in the ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with persons not related to the Company, and did not involve more than normal risk of collectability or present other unfavorable features. For the years ended December 31, 2011 and 2010, loans of $1.9 million and $3.7 million were disbursed to officers and directors and repayments of $3.3 million and $3.4 million were received from officers and directors, respectively.

At December 31, 2011 and December 31, 2010, deposit overdrafts of $134,000 and $145,000, respectively, were included in portfolio loans.

The following tables present, by portfolio segment, the activity in the allowance for loan losses for the twelve months ended December 31, 2011 and 2010 and balance in the allowance for loan losses and the recorded investment in loans based on the Company's loan portfolio and impairment method as of December 31, 2011 and 2010. (dollars in thousands)

	Commercial and commercial mortgage loans			Residential mortgage loans			Second and home equity loans			Other consumer loans			Total
Twelve months ended December 31, 2011
Allowance for loan losses:
Balance at beginning of period	$	12,640		$	799		$	858		$	309		$	14,606
Provision for loan losses		19,491			(147	)		70			95			19,509
Loan charge-offs		(18,834	)		(162	)		(411	)		(345	)		(19,752	)
Recoveries		394			14			39			174			621
Balance at End of Period	$	13,691		$	504		$	556		$	233		$	14,984
Ending balance: individually evaluated for impairment	$	545		$	0		$	0		$	0		$	545
Ending balance: collectively evaluated for impairment	$	13,146		$	504		$	556		$	233		$	14,439
Loans:
Balance at End of Period	$	517,970		$	93,757		$	86,059		$	9,533		$	707,319
Ending balance: individually evaluated for impairment	$	41,075		$	0		$	0		$	0		$	41,075
Ending balance: collectively evaluated for impairment	$	476,895		$	93,757		$	86,059		$	9,533		$	666,244

	Commercial and commercial mortgage loans			Residential mortgage loans			Second and home equity loans			Other consumer loans			Total
Twelve months ended December 31, 2010
Allowance for loan losses:
Balance at beginning of period	$	10,564		$	910		$	1,152		$	487		$	13,113
Provision for loan losses		6,442			460			174			103			7,179
Loan charge-offs		(4,447	)		(697	)		(502	)		(439	)		(6,085	)
Recoveries		81			126			34			158			399
Balance at End of Period	$	12,640		$	799		$	858		$	309		$	14,606
Ending balance: individually evaluated for impairment	$	3,455		$	0		$	0		$	0		$	3,455
Ending balance: collectively evaluated for impairment	$	9,185		$	799		$	858		$	309		$	11,151
Loans:
Balance at End of Period	$	550,686		$	92,796		$	92,557		$	11,614		$	747,653
Ending balance: individually evaluated for impairment	$	54,450		$	0		$	0		$	0		$	54,450
Ending balance: collectively evaluated for impairment	$	496,236		$	92,796		$	92,557		$	11,614		$	693,203

The risk characteristics of each loan portfolio segment are as follows:

Commercial and Commercial Mortgage (including commercial construction loans)

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial mortgage loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial mortgage lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial mortgage loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company's nonresidential and multi-family real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates these loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied real estate loans versus non-owner occupied loans.

Commercial mortgage construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Residential Mortgage, Seconds, Home Equity and Consumer

With respect to residential loans that are secured by one-to-four family residences and are generally owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance ("PMI") if that ratio is exceeded. Second and home equity loans are typically secured by a subordinate interest in one-to-four family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes non-homogeneous loans, such as commercial and commercial mortgage loans, with an outstanding balance greater than $750,000 individually by classifying the loans as to credit risk. Loans less than $750,000 in homogeneous categories that are 90 days past due are classified into risk categories. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

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 of the Company's credit position at some future date.

Substandard		Loans classified as substandard are inadequately protected by the current net worth and paying capacity 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.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans along with homogeneous loans that were not 60 day or more delinquent. As of December 31, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows: (dollars in thousands)

As of December 31, 2011	Commercial and commercial mortgage loans		Construction loans		Residential mortgage loans		Second and home equity loans		Other consumer loans		Total
Rating:
Pass	$	435,266	$	32,825	$	87,278	$	85,751	$	9,462	$	650,582
Special mention		9,521		0		313		44		0		9,878
Substandard		37,856		7,951		717		264		71		46,859
Balance at End of Period	$	482,643	$	40,776	$	88,308	$	86,059	$	9,533	$	707,319

As of December 31, 2010	Commercial and commercial mortgage loans		Construction loans		Residential mortgage loans		Second and home equity loans		Other consumer loans		Total
Rating:
Pass	$	435,503	$	42,921	$	85,045	$	91,790	$	11,342	$	666,601
Special mention		15,682		2,134		372		78		0		18,266
Substandard		51,750		8,745		1,330		689		272		62,786
Balance at End of Period	$	502,935	$	53,800	$	86,747	$	92,557	$	11,614	$	747,653

The following tables present the Company's loan portfolio aging analysis as of December 31, 2011 and December 31, 2010: (dollars in thousands)

As of December 31, 2011	Commercial and commercial mortgage loans		Construction loans		Residential mortgage loans		Second and home equity loans		Other consumer loans		Total
Loans:
30 to 59 days past due	$	479	$	0	$	874	$	526	$	109	$	1,988
60 to 89 days past due		0		0		0		44		1		45
Past due 90 days or more		0		0		87		0		0		87
Nonaccrual		25,962		6,826		849		264		70		33,971
Total Past Due		26,441		6,826		1,810		834		180		36,091
Current		456,202		33,950		86,498		85,225		9,353		671,228
Total Loans	$	482,643	$	40,776	$	88,308	$	86,059	$	9,533	$	707,319

As of December 31, 2010	Commercial and commercial mortgage loans		Construction loans		Residential mortgage loans		Second and home equity loans		Other consumer loans		Total
Loans:
30 to 59 days past due	$	2,770	$	0	$	1,447	$	687	$	68	$	4,972
60 to 89 days past due		0		0		0		78		21		99
Past due 90 days or more		0		0		92		0		0		92
Nonaccrual		12,893		5,189		1,412		678		106		20,278
Total Past Due		15,663		5,189		2,951		1,443		195		25,441
Current		487,272		48,611		83,796		91,114		11,419		722,212
Total Loans	$	502,935	$	53,800	$	86,747	$	92,557	$	11,614	$	747,653

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial and commercial mortgage loans (including construction loans) but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

The following is a summary by class of information pertaining to impaired loans as of December 31, 2011 and December 31, 2010: (dollars in thousands)

As of December 31, 2011	Recorded Investment		Unpaid Principal Balance		Related Allowance for Loan Losses
Impaired Loans with No Related Allowance Recorded (1):
Commercial and commercial mortgage loans	$	29,829	$	41,381	$	0
Construction loans		6,826		9,276		0
Total Impaired Loans with No Related Allowance Recorded	$	36,655	$	50,657	$	0


Impaired Loans with an Allowance Recorded:
Commercial and commercial mortgage loans	$	3,295	$	3,295	$	447
Construction loans		1,125		1,125		98
Total Impaired Loans with an Allowance Recorded	$	4,420	$	4,420	$	545


Impaired Loans:
Commercial and commercial mortgage loans	$	33,124	$	44,676	$	447
Construction loans		7,951		10,401		98
Total Impaired Loans	$	41,075	$	55,077	$	545
1) Residential mortgages of $128,000 and consumer loans of $145,000 all individually less than $130,000 are not individually reviewed and are excluded from the table as they were deemed not significant to the financial statements.

As of December 31, 2010	Recorded Investment		Unpaid Principal Balance		Related Allowance for Loan Losses
Impaired Loans with No Related Allowance Recorded:
Commercial and commercial mortgage loans	$	18,141	$	18,478	$	0
Construction loans		3,984		5,810		0
Total Impaired Loans with No Related Allowance Recorded	$	22,125	$	24,288	$	0


Impaired Loans with an Allowance Recorded:
Commercial and commercial mortgage loans	$	27,593	$	30,435	$	2,325
Construction loans		4,732		4,732		1,130
Total Impaired Loans with an Allowance Recorded	$	32,325	$	35,167	$	3,455


Impaired Loans:
Commercial and commercial mortgage loans	$	45,734	$	48,913	$	2,325
Construction loans		8,716		10,542		1,130
Total Impaired Loans	$	54,450	$	59,455	$	3,455

The following is a summary by class of information related to the average recorded investment and interest income recognized on impaired loans for the twelve months ended December 31, 2011 and 2010: (dollars in thousands)

	Twelve Months Ended				Twelve Months Ended
	December 31, 2011				December 31, 2010
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Impaired Loans:
Commercial and commercial mortgage loans	$	43,522	$	1,589	$	34,708	$	1,354
Construction loans		8,089		186		11,507		273
Total Impaired Loans	$	51,611	$	1,775	$	46,215	$	1,627
Commercial and commercial mortgage loans cash basis interest included above			$	123			$	67
Construction loans cash basis interest included above			$	0			$	10

Troubled Debt Restructurings

In the course of working with borrowers, the Company may choose to restructure the contractual terms of certain loans. In restructuring the loan, the Company attempts to work-out an alternative payment schedule with the borrower in order to optimize collectability of the loan. For all loan classes, any loans that are modified are reviewed by the Company to identify if a troubled debt restructuring ("TDR") has occurred, which is when, for reasons related to a borrower's financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay based on their current financial status and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two. Also, additional collateral, a co-borrower, or a guarantor is often requested. If such efforts by the Company do not result in a satisfactory arrangement, foreclosure proceedings are initiated. At any time prior to a sale of the property at foreclosure, the Company may terminate foreclosure proceedings if the borrower is able to work-out a satisfactory payment plan.

As a result of adopting the amendments in Accounting Standards Update No. 2011-02 (the ASU), the Company reassessed all restructurings that occurred on or after January 1, 2011 for identification as troubled debt restructurings. The Company did not identify as troubled debt restructurings any additional receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology as a result of this assessment.

It is the Company's practice to have any restructured loans which are on nonaccrual status prior to being restructured remain on nonaccrual status until six months of satisfactory borrower performance at which time management would consider its return to accrual status. The balance of nonaccrual restructured loans, which is included in nonaccrual loans, was $1.2 million at December 31, 2011. If the restructured loan is on accrual status prior to being restructured, it is reviewed to determine if the restructured loan should remain on accrual status. The balance of accruing restructured loans was $3.1 million at December 31, 2011.

Loans that are considered TDRs are classified as performing, unless they are on nonaccrual status or greater than 90 days delinquent as of the end of the most recent quarter. All TDRs are considered impaired by the Company, unless it is determined that the borrower has met the six month satisfactory performance period under modified terms. On a quarterly basis, the Company individually reviews all TDR loans to determine if a loan meets this criterion.

Performing commercial TDR loans at December 31, 2011 consisted of three commercial real estate loans totaling $2.6 million that are interest only and one commercial real estate loan totaling $200,000 that is amortizing. The Company does not generally forgive principal or interest on restructured loans. However, when a loan is restructured, income and principal are generally received on a delayed basis as compared to the original repayment schedule. The Company generally receives more interest than originally scheduled, as the loan remains outstanding for longer periods of time, sometimes with higher average balances than originally scheduled. The average yield on modified commercial real estate loans was 4.6%, compared to 5.8% earned on the entire commercial real estate loan portfolio as of December 31, 2011.

Performing consumer TDR loans at December 31, 2011 consisted of nine retail loans including one residential and two second mortgages which comprise $251,000 of the total retail TDR balance of $274,000. The consumer TDR loans have been restructured at less than market terms and include rate modifications, extension of maturity, and forbearance. The average yield on modified residential mortgage and second mortgage loans was 5.8%, compared to 4.5% earned on the entire residential mortgage and second mortgage loan portfolio as of December 31, 2011.

With regard to determination of the amount of the allowance for credit losses, all accruing restructured loans are considered to be impaired. As a result, the determination of the amount of impaired loans for each portfolio segment within troubled debt restructurings is the same as detailed above.

The following tables present information regarding troubled debt restructurings by class for the twelve months ended December 31, 2011. (in thousands)

	Twelve Months Ended
	December 31, 2011
Newly classified troubled debt restructurings (1)	Number of Loans		Pre Modification Recorded Balance (1)		Post Modification Recorded Balance
Commercial and commercial mortgages		5	$	2,754	$	2,754
Construction loans
Residential mortgage loans
Second and home equity loans
Other consumer loans		2		11		11
Total		7	$	2,765	$	2,765

(1)	The troubled debt restructuring did not have a material impact on the financial statements.

One $112,000 commercial TDR loan modified in 2011 subsequently defaulted in the third quarter. The collateral for this loan was sold to an unrelated third party in the fourth quarter of 2011. The Bank financed the new owners' loan at the prevailing terms for similar loans.

Commercial and consumer loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan. The Company defines default for the above disclosure as generally greater than ninety days past due. In certain circumstances the Company may consider default to have occurred prior to being ninety days past due, if the Company believes payments in the near term are uncertain.