SBA Loans: SBA loans, on which the SBA provides guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products. The Company's SBA loans are generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment. SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses' major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.

SBA 504 Loans: The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. SBA 504 loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type.

Commercial Loans: Commercial credit is extended primarily to middle market and small business customers. Commercial loans are generally made in the Company's market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans will generally be guaranteed in full or for a meaningful amount by the businesses' major owners. Commercial loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type.

Residential Mortgage and Consumer Loans: The Company originates mortgage and consumer loans including principally residential real estate and home equity lines and loans. Each loan type is evaluated on debt to income, type of collateral and loan to collateral value, credit history and Company relationship with the borrower.

Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan. A borrower's inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans. The Company minimizes its credit risk by loan diversification and adhering to credit administration policies and procedures. Due diligence on loans begins when we initiate contact regarding a loan with a borrower. Documentation, including a borrower's credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval. The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.

The Company's extension of credit is governed by the Credit Risk Policy which was established to control the quality of the Company's loans. These policies and procedures are reviewed and approved by the Board of Directors on a regular basis.

Credit Ratings:

For SBA 7(a), SBA 504 and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality. A loan's internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating. The Company uses a 1 through 10 loan grading system that follows regulatory accepted definitions.

Pass: Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments. These performing loans are termed "Pass".

Special Mention: Criticized loans are assigned a risk rating of 7 and termed "Special Mention", as the borrowers exhibit potential credit weaknesses or downward trends deserving management's close attention. If not checked or corrected, these trends will weaken the Bank's collateral and position. While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated. As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification. Included in "Special Mention" could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in start up or deteriorating industries, or borrowers with a poor market share in an average industry. "Special Mention" loans may include an element of asset quality, financial flexibility, or below average management. Management and ownership may have limited depth or experience. Regulatory agencies have agreed on a consistent definition of "Special Mention" as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank's credit position at some future date. This definition is intended to ensure that the "Special Mention" category is not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.

Substandard: Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed "Substandard". A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt. The loan is inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified "Substandard". A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Serious problems exist to the point where partial loss of principal is likely. The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans' classification as estimated losses is deferred until a more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans. Partial charge-offs are likely.

Loss: Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a "Loss", and charged-off immediately. Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.

For residential mortgage and consumer loans, management uses performing versus nonperforming as the best indicator of credit quality. Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.

The tables below detail the Company's loan portfolio by class according to their credit quality indicators discussed in the paragraphs above as of September 30, 2011 and December 31, 2010:

	September 30, 2011
	SBA, SBA 504 & Commercial Loans - Internal Risk Ratings
(In thousands)	Pass		Special Mention		Substandard		Total
SBA loans	$	51,798	$	9,808	$	14,041	$	75,647
SBA 504 loans		37,715		5,937		11,868		55,520
Commercial loans
Commercial other		20,400		5,737		1,861		27,998
Commercial real estate		187,816		50,541		8,765		247,122
Commercial real estate construction		6,616		1,710		600		8,926
Total commercial loans		214,832		57,988		11,226		284,046
Total SBA, SBA 504 and Commercial loans	$	304,345	$	73,733	$	37,135	$	415,213

	September 30, 2011
	Residential Mortgage & Consumer Loans - Performing/Nonperforming
(In thousands)	Performing		Nonperforming		Total
Residential mortgage loans
Residential mortgages	$	124,440	$	2,030	$	126,470
Residential construction		2,240		-		2,240
Purchased residential mortgages		6,192		2,040		8,232
Total residential mortgage loans		132,872		4,070		136,942
Consumer loans
Home equity		49,442		273		49,715
Consumer other		1,754		9		1,763
Total consumer loans	$	51,196	$	282	$	51,478
Total loans					$	603,633

	December 31, 2010
	SBA, SBA 504 & Commercial Loans - Internal Risk Ratings
(In thousands)	Pass		Special Mention		Substandard		Total
SBA loans	$	48,500	$	25,668	$	11,970	$	86,138
SBA 504 loans		30,235		15,366		18,675		64,276
Commercial loans
Commercial other		17,402		4,764		2,102		24,268
Commercial real estate		169,093		67,305		10,493		246,891
Commercial real estate construction		6,197		2,715		1,134		10,046
Total commercial loans		192,692		74,784		13,729		281,205
Total SBA, SBA 504 and Commercial loans	$	271,427	$	115,818	$	44,374	$	431,619

	December 31, 2010
	Residential Mortgage & Consumer Loans - Performing/Nonperforming
(In thousands)	Performing		Nonperforming		Total
Residential mortgage loans
Residential mortgages	$	114,716	$	2,453	$	117,169
Residential construction		2,711		-		2,711
Purchased residential mortgages		5,888		2,632		8,520
Total residential mortgage loans		123,315		5,085		128,400
Consumer loans
Home equity		54,024		249		54,273
Consumer other		1,644		-		1,644
Total consumer loans	$	55,668	$	249	$	55,917
Total loans					$	615,936

Nonperforming and Past Due Loans:

Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt. When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest previously recognized as income is reversed and charged against current period income. Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal, until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income. Loans past due 90 days or more and still accruing interest are not included in nonperforming loans and generally represent loans that are well collateralized and in a continuing process expected to result in repayment or restoration to current status.

The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The current state of the economy and the downturn in the real estate market have resulted in increased loan delinquencies and defaults. In some cases, these factors have also resulted in significant impairment to the value of loan collateral. The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market. In response to the credit risk in its portfolio, the Company has increased staffing in its credit monitoring department and increased efforts in the collection and analysis of borrowers' financial statements and tax returns.

The following tables set forth an aging analysis of past due and nonaccrual loans by loan class as of September 30, 2011 and December 31, 2010:

	September 30, 2011
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days and Still Accruing		Nonaccrual (1)		Total Past Due		Current		Total Loans
SBA loans	$	2,438	$	600	$	84	$	6,801	$	9,923	$	65,724	$	75,647
SBA 504 loans		1,333		-		-		3,752		5,085		50,435		55,520
Commercial loans
Commercial other		187		172		806		58		1,223		26,775		27,998
Commercial real estate		6,040		-		907		5,035		11,982		235,140		247,122
Commercial real estate construction		-		-		-		600		600		8,326		8,926
Residential mortgage loans
Residential mortgages		3,477		1,861		394		2,030		7,762		118,708		126,470
Residential construction		2,200		40		-		-		2,240		-		2,240
Purchased residential mortgages		-		4		-		2,040		2,044		6,188		8,232
Consumer loans
Home equity		834		-		-		273		1,107		48,608		49,715
Consumer other		13		-		-		9		22		1,741		1,763
Total loans	$	16,522	$	2,677	$	2,191	$	20,598	$	41,988	$	561,645	$	603,633

(1) At September 30, 2011, nonaccrual loans included $3.8 million of troubled debt restructurings ("TDRs") and $1.3 million of loans guaranteed by the SBA. The remaining TDRs are in accrual status because they are performing in accordance with their restructured terms.

	December 31, 2010
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days and Still Accruing		Nonaccrual (1)		Total Past Due		Current		Total Loans
SBA loans	$	1,297	$	1,181	$	374	$	8,162	$	11,014	$	75,124	$	86,138
SBA 504 loans		-		1,339		-		2,714		4,053		60,223		64,276
Commercial loans
Commercial other		693		86		-		179		958		23,310		24,268
Commercial real estate		3,051		176		-		4,139		7,366		239,525		246,891
Commercial real estate construction		-		-		-		1,134		1,134		8,912		10,046
Residential mortgage loans
Residential mortgages		2,123		144		-		2,453		4,720		112,449		117,169
Residential construction		-		-		-		-		-		2,711		2,711
Purchased residential mortgages		117		-		-		2,632		2,749		5,771		8,520
Consumer loans
Home equity		175		325		-		249		749		53,524		54,273
Consumer other		5		-		-		-		5		1,639		1,644
Total loans	$	7,461	$	3,251	$	374	$	21,662	$	32,748	$	583,188	$	615,936

(1) At December 31, 2010, nonaccrual loans included $2.7 million of loans guaranteed by the SBA. There were no nonaccrual TDRs.

Impaired Loans:

The Company has defined impaired loans to be all nonperforming loans and troubled debt restructurings. Management considers a loan impaired when, based on current information and events, it is determined that the company will not be able to collect all amounts due according to the loan contract. Impairment is evaluated in total for smaller-balance loans of a similar nature, (consumer and residential mortgage loans), and on an individual basis for other loans.

The following tables provide detail on the Company's impaired loans with the associated allowance amount, if applicable, as of September 30, 2011 and December 31, 2010:

	September 30, 2011
(In thousands)	Outstanding Principal Balance		Related Allowance		Net Exposure (balance less specific reserves)
With no related allowance:
SBA loans (1)	$	2,074	$	-	$	2,074
SBA 504 loans		5,170		-		5,170
Commercial loans
Commercial other		985		-		985
Commercial real estate		6,869		-		6,869
Commercial real estate construction		-		-		-
Total commercial loans		7,854		-		7,854
Total impaired loans with no related allowance	$	15,098	$	-	$	15,098

With an allowance:
SBA loans(1)	$	4,795	$	1,931	$	2,864
SBA 504 loans		2,972		226		2,746
Commercial loans
Commercial other		58		58		-
Commercial real estate		8,872		1,914		6,958
Commercial real estate construction		600		149		451
Total commercial loans		9,530		2,121		7,409
Total impaired loans with a related allowance	$	17,297	$	4,278	$	13,019

Total individually evaluated impaired loans:
SBA loans (1)	$	6,869	$	1,931	$	4,938
SBA 504 loans		8,142		226		7,916
Commercial loans
Commercial other		1,043		58		985
Commercial real estate		15,741		1,914		13,827
Commercial real estate construction		600		149		451
Total commercial loans		17,384		2,121		15,263
Total individually evaluated impaired loans	$	32,395	$	4,278	$	28,117

Homogeneous collectively evaluated impaired loans:
Residential mortgage loans
Residential mortgages	$	2,030	$	-	$	2,030
Purchased mortgages		2,040		-		2,040
Total residential mortgage loans		4,070		-		4,070
Consumer loans
Home equity		273		-		273
Consumer other		9		-		9
Total consumer loans		282		-		282
Total homogeneous collectively evaluated impaired loans		4,352		-		4,352

Total impaired loans	$	36,747	$	4,278	$	32,469

(1) Balances are reduced by amount guaranteed by the Small Business Administration of $1.3 million at September 30, 2011.

	December 31, 2010
(In thousands)	Outstanding Principal Balance		Related Allowance		Net Exposure (balance less specific reserves)
With no related allowance:
SBA loans (1)	$	2,362	$	-	$	2,362
SBA 504 loans		8,145		-		8,145
Commercial loans
Commercial other		179		-		179
Commercial real estate		7,891		-		7,891
Total commercial loans		8,070		-		8,070
Total impaired loans with no related allowance	$	18,577	$	-	$	18,577

With an allowance:
SBA loans(1)	$	4,526	$	1,761	$	2,765
SBA 504 loans		2,477		87		2,390
Commercial loans
Commercial real estate		990		226		764
Commercial real estate construction		1,134		383		751
Total commercial loans		2,124		609		1,515
Total impaired loans with a related allowance	$	9,127	$	2,457	$	6,670

Total individually evaluated impaired loans:
SBA loans (1)	$	6,888	$	1,761	$	5,127
SBA 504 loans		10,622		87		10,535
Commercial loans
Commercial other		179		-		179
Commercial real estate		8,881		226		8,655
Commercial real estate construction		1,134		383		751
Total commercial loans		10,194		609		9,585
Total individually evaluated impaired loans	$	27,704	$	2,457	$	25,247

Homogeneous collectively evaluated impaired loans:
Residential mortgage loans
Residential mortgages	$	2,453	$	-	$	2,453
Purchased mortgages		2,632		-		2,632
Total residential mortgage loans		5,085		-		5,085
Consumer loans
Home equity		249		-		249
Total homogeneous collectively evaluated for impaired loans		5,334		-		5,334

Total impaired loans	$	33,038	$	2,457	$	30,581

(1) Balances are reduced by amount guaranteed by the Small Business Administration of $2.7 million at September 30, 2010.

The following tables present the average recorded investments in impaired loans and the related amount of interest recognized during the time period in which the loans were impaired for the three and nine months ended September 30, 2011 and 2010. The average balances are calculated based on the month-end balances of impaired loans. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal under the cost recovery method, therefore no interest income is recognized. Any interest income recognized on a cash basis during the three and nine months ended September 30, 2011 and 2010 was immaterial. The interest recognized on impaired loans noted below represents accruing troubled debt restructurings only.

	For the three months ended
	September 30, 2011				September 30, 2010
(In thousands)	Average Recorded Investment		Interest Income Recognized on Impaired Loans		Average Recorded Investment		Interest Income Recognized on Impaired Loans
SBA loans (1)	$	6,768	$	57	$	5,070	$	29
SBA 504 loans		8,284		67		6,638		53
Commercial loans
Commercial other		1,388		8		342		-
Commercial real estate		16,366		120		11,731		31
Commercial real estate construction		600		-		708		-
Residential mortgage loans
Residential mortgages		2,202		-		4,514		-
Purchased mortgages		2,251		-		2,080		-
Consumer loans
Home equity		269		-		362		-
Consumer other		9		-		-		-
Total	$	38,137	$	252	$	31,445	$	113

(1) Balances are reduced by the average amount guaranteed by the Small Business Administration of $1.7 million for the three months ended September 30, 2011 and 2010.

	For the nine months ended
	September 30, 2011				September 30, 2010
(In thousands)	Average Recorded Investment		Interest Income Recognized on Impaired Loans		Average Recorded Investment		Interest Income Recognized on Impaired Loans
SBA loans (1)	$	6,631	$	174	$	4,944	$	88
SBA 504 loans		9,223		172		5,518		114
Commercial loans
Commercial other		1,118		17		481		-
Commercial real estate		14,206		277		11,522		94
Commercial real estate construction		813		-		647		-
Residential mortgage loans
Residential mortgages		2,166		-		5,029		-
Purchased mortgages		2,165		-		1,649		-
Consumer loans
Home equity		282		-		382		-
Consumer other		4		-		-		-
Total	$	36,608	$	640	$	30,172	$	296

(1) Balances are reduced by the average amount guaranteed by the Small Business Administration of $2.4 million and $1.9 million for the nine months ended September 30, 2011 and 2010, respectively.

Troubled Debt Restructurings:

The Company's loan portfolio also includes certain loans that have been modified in a troubled debt restructuring ("TDR"). TDRs occur when a creditor, for economic or legal reasons related to a debtor's financial condition, grants a concession to the debtor that it would not otherwise consider, unless it results in a delay in payment that is insignificant. These concessions typically include reductions in interest rate, extending the maturity of a loan, or a combination of both. When the Company modifies a loan, management evaluates for any possible impairment using either the discounted cash flows method, where the value of the modified loan is based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or by using the fair value of the collateral less selling costs. If management determines that the value of the modified loan is less than the recorded investment in the loan, impairment is recognized by segment or class of loan, as applicable, through an allowance estimate or charge-off to the allowance. This process is used, regardless of loan type, as well as for loans modified as TDRs that subsequently default on their modified terms. Effective September 30, 2011, the Company adopted the amendments in Accounting Standards Update ("ASU") No. 2011-02, Receivables (Topic 310): A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring, and did not identify any additional TDRs as a result of this adoption.

TDRs of $21.3 million are included in the impaired loan numbers listed above, of which $3.8 million are in nonaccrual status. The remaining TDRs are in accrual status since they continue to perform in accordance with their restructured terms. There are no commitments to lend additional funds on these loans.

The following table details loans modified during the three months ended September 30, 2011, including the number of modifications, the recorded investment at the time of the modification and the quarter-to-date impact to interest income as a result of the modification. There were no loans modified as TDRs within the previous 12 months where a concession was made and the loan subsequently defaulted at some point during the three months ended September 30, 2011. In this case, subsequent default is defined as being transferred to nonaccrual status.

	For the three months ended
	September 30, 2011
(In thousands, except number of contracts)	Number of Contracts		Recorded Investment at Time of Modification		Impact of Interest Rate Change on Income
Commercial loans
Commercial real estate		2	$	1,082	$	-
Total		2	$	1,082	$	-

The following table details loans modified during the nine months ended September 30, 2011, including the number of modifications, the recorded investment at the time of the modification and the year-to-date impact to interest income as a result of the modification.

	For the nine months ended
	September 30, 2011
(In thousands, except number of contracts)	Number of Contracts		Recorded Investment at Time of Modification		Impact of Interest Rate Change on Income
SBA loans		1	$	46	$	-
SBA 504 loans		1		1,339		12
Commercial loans
Commercial other		1		985		4
Commercial real estate		6		7,720		6
Total		9	$	10,090	$	22

The following table presents the recorded investment and number of modifications for loans modified as TDRs within the previous 12 months where a concession was made and the loan subsequently defaulted at some point during the nine months ended September 30, 2011. In this case, subsequent default is defined as being transferred to nonaccrual status.

	For the nine months ended
	September 30, 2011
(In thousands, except number of contracts)	Number of Contracts		Recorded Investment
SBA loans		1	$	52
Commercial loans
Commercial real estate		2		729
Total		3	$	781

During the three months ended September 30, 2011, our TDRs consisted of interest rate reductions and interest only periods with interest rate reductions. There was no principal forgiveness. The following table shows the types of modifications done during the three months ended September 30, 2011, with the respective loan balances as of September 30, 2011:

(In thousands)	Commercial real estate
Type of Modification:
Reduced interest rate	$	590
Interest only with reduced interest rate		492
Total TDRs	$	1,082

During the nine months ended September 30, 2011, our TDRs consisted of interest rate reductions, interest only periods and combinations of both. There was no principal forgiveness. The following table shows the types of modifications done during the nine months ended September 30, 2011, with the respective loan balances as of September 30, 2011:

(In thousands)	SBA			SBA 504	Commercial other		Commercial real estate		Total
Type of Modification:
Interest only	$	-	$	-	$	-	$	1,617	$	1,617
Reduced interest rate		-		-		-		590		590
Interest only with reduced interest rate		-		-		985		5,512		6,497
Interest only with nominal principal		44		-		-		-		44
Previously modified back to original terms		-		1,333		-		-		1,333
Total TDRs	$	44	$	1,333	$	985	$	7,719	$	10,081