Note 4.

Loans and Leases

Major classifications of LHFI are as follows:

	June 30,		December 31,
(In thousands)	2013		2012
Commercial real estate	$	180,601	$	167,115
Construction and land development		34,696		37,215
Commercial and industrial		66,985		40,560
Multi-family		11,736		11,756
Residential real estate		15,873		24,981
Leases		38,497		37,347
Tax certificates		18,578		24,569
Consumer		901		1,139
Total gross loans	$	367,867	$	344,682
Deferred fees, net*		-		(517	)
Total loans and leases	$	367,867	$	344,165

*For the 2013 period net deferred fees were allocated among the loan types.

The Company grants commercial and real estate loans, including construction and land development loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside our geographic area. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at June 30, 2013. A substantial portion of its debtors’ ability to honor their contracts is dependent upon the housing sector specifically and the economy in general.

Loans and leases are classified as LHFI when management has the intent and ability to hold the loan or lease for the foreseeable future or until maturity or payoff. LHFI are stated at their outstanding unpaid principal balances, net of an allowance for loan and leases losses (“ALLL”) and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (Interest Income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan.

At June 30, 2013 and December 31, 2012, the Company’s LHFS were $1.4 million and $1.6 million, respectively, and were comprised of one non-accrual commercial real estate loan. This loan was transferred from LHFI at the lower of cost or fair market value using expected net sales proceeds. For the three and six months ended June 30, 2013, the Company recorded additional impairment of $53,000 and $153,000, respectively.

The Company classifies its leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between the Company’s gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method.

The Company uses a nine point grading risk classification system commonly used in the financial services industry as the credit quality indicator. The first five classifications are rated Pass. The riskier classifications include Special Mention, Substandard, Doubtful and Loss. The risk rating is related to the underlying credit quality and probability of default. These risk ratings are used to calculate the historical loss component of the allowance.

Pass: includes credits that demonstrate a low probability of default;

Pass-Watch: a warning classification which includes credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals;

Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of the Company’s position at some future date. While potentially weak, credits in this classification are marginally acceptable and loss of principal or interest is not anticipated;

Substandard accrual: includes credits that exhibit a well-defined weakness which currently jeopardizes the repayment of debt and liquidation of collateral even though they are currently performing. These credits are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected;

Non-accrual (substandard non-accrual, doubtful, loss): includes credits that demonstrate serious problems to the point that it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement.

All loans, at the time of presentation to the appropriate loan committee, are given an initial loan “risk” rating by the Chief Credit Officer. From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.

The following tables present risk ratings for each loan portfolio segment at June 30, 2013 and December 31, 2012, excluding LHFS.

June 30, 2013					Special
(In thousands)	Pass		Pass-Watch		Mention		Substandard		Non-accrual		Total
Commercial real estate	$	95,756	$	50,340	$	22,118	$	3,703	$	8,684	$	180,601
Construction and land development		5,235		13,910		12,221		575		2,755		34,696
Commercial and industrial		39,394		12,721		674		10,514		3,682		66,985
Multi-family		9,025		2,130		581		-		-		11,736
Residential real estate		15,382		-		-		-		491		15,873
Leases		38,050		195		12		-		240		38,497
Tax certificates		18,094		-		-		-		484		18,578
Consumer		831		70		-		-		-		901
Total LHFI	$	221,767	$	79,366	$	35,606	$	14,792	$	16,336	$	367,867

December 31, 2012					Special
(In thousands)	Pass		Pass-Watch		Mention		Substandard		Non-accrual		Total
Commercial real estate	$	64,308	$	69,510	$	19,529	$	3,423	$	10,345	$	167,115
Construction and land development		2,139		13,872		16,343		581		4,280		37,215
Commercial and industrial		14,764		10,774		92		9,969		4,961		40,560
Multi-family		9,019		2,034		703		-		-		11,756
Residential real estate		15,125		6,634		602		1,626		994		24,981
Leases		36,755		325		16		-		251		37,347
Tax certificates		23,968		-		-		-		601		24,569
Consumer		926		213		-		-		-		1,139
Subtotal LHFI	$	167,004	$	103,362	$	37,285	$	15,599	$	21,432	$	344,682
Less: Deferred loan fees												(517	)
Total LHFI											$	344,165

The past due status of all classes of loans and leases receivable is determined based on contractual due dates for loan payments. Generally, a loan is placed on non-accruing status when it has been delinquent for a period of 90 days or more. The following tables present an aging analysis of past due payments for each loan portfolio segment at June 30, 2013 and December 31, 2012, excluding LHFS.

June 30, 2013	30-59 Days		60-89 Days		Accruing		Total
(In thousands)	Past Due		Past Due		90+ Days		Non-accrual		Current		Total
Commercial real estate	$	176	$	-	$	-	$	8,684	$	171,741	$	180,601
Construction and land development		-		-		-		2,755		31,941		34,696
Commercial and industrial		-		-		-		3,682		63,303		66,985
Multi-family		-		-		-		-		11,736		11,736
Residential real estate		595		299		-		491		14,488		15,873
Leases		194		12		-		240		38,051		38,497
Tax certificates		-		-		-		484		18,094		18,578
Consumer		-		-		-		-		901		901
Total LHFI	$	965	$	311	$	-	$	16,336	$	350,255	$	367,867

December 31, 2012	30-59 Days		60-89 Days		Accruing		Total
(In thousands)	Past Due		Past Due		90+ Days		Non-accrual		Current		Total
Commercial real estate	$	1,548	$	1,486	$	-	$	10,345	$	153,736	$	167,115
Construction and land development		-		-		-		4,280		32,935		37,215
Commercial and industrial		200		-		-		4,961		35,399		40,560
Multi-family		-		-		-		-		11,756		11,756
Residential real estate		562		486		-		994		22,939		24,981
Leases		325		16		-		251		36,755		37,347
Tax certificates		-		-		-		601		23,968		24,569
Consumer		-		-		-		-		1,139		1,139
Subtotal LHFI	$	2,635	$	1,988	$	-	$	21,432	$	318,627	$	344,682
Less: Deferred loan fees												(517	)
Total LHFI											$	344,165

The following tables detail the composition of the non-accrual loans at June 30, 2013 and December 31, 2012.

	June 30, 2013				December 31, 2012
(In thousands)	Loan balance		Specific reserves		Loan balance		Specific reserves
Non-accrual loans held for investment
Commercial real estate	$	8,684	$	605	$	10,345	$	835
Construction and land development		2,755		-		4,280		820
Commercial and industrial		3,682		12		4,961		255
Residential real estate		491		15		994		14
Leases		240		67		251		55
Tax certificates		484		101		601		47
Total non-accrual LHFI	$	16,336	$	800	$	21,432	$	2,026
Non-accrual loans held for sale
Commercial real estate	$	1,419	$	-	$	1,572	$	-
Total non-accrual LHFS	$	1,419	$	-	$	1,572	$	-
Total non-accrual loans	$	17,755	$	800	$	23,004	$	2,026

Total non-accrual loans at June 30, 2013 were $17.8 million and were comprised of $16.4 million in LHFI and $1.4 million in LHFS. Total non-accrual loans at December 31, 2012 were $23.0 million and were comprised of $21.4 million in LHFI and $1.6 million in LHFS. The $5.2 million decrease was the result of a $4.3 million reduction in existing non-accrual loan balances through payments and payoffs, $2.2 million in charge-offs related to specific reserves on LHFI, $153,000 write down on the LHFS and $100,000 in transfers to OREO, which were partially offset by additions of $1.6 million. If interest had been accrued, such income would have been approximately $453,000 and $979,000 for the three and six months ended June 30, 2013, respectively. The Company had no loans past due 90 days or more on which it has continued to accrue interest during the quarter. Typically, loans are restored to accrual status when the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.

Impaired Loans

The Company identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Impaired loans include troubled debt restructurings (“TDRs”). The Company does not accrue interest income on impaired non-accrual loans. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis. The Company recognizes income under the accrual basis when the principal payments on the loans become current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company does not recognize income.

Total cash collected on impaired loans during the six months ended June 30, 2013 and June 30, 2012 was $5.9 million and $17.8 million respectively, of which $5.6 million and $15.6 million was credited to the principal balance outstanding on such loans, respectively.

The following is a summary of information pertaining to impaired loans:

	June 30,		December 31,
(In thousands)	2013		2012
Impaired loans with a valuation allowance	$	8,401	$	9,405
Impaired loans without a valuation allowance		17,885		19,423
Impaired LHFS		1,419		1,572
Total impaired loans	$	27,705	$	30,400

Valuation allowance related to impaired loans	$	800	$	2,026

Troubled Debt Restructurings

A loan modification is deemed a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made by the Company that would not otherwise be considered for a borrower or collateral with similar credit risk characteristics. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual restructured principal and interest is no longer in doubt. At June 30, 2013, the Company had 14 TDRs, of which seven are on non-accrual status, with a total carrying value of $20.4 million. At the time of the modifications, seven of the loans were already classified as impaired loans. At December 31, 2012, the Company had 12 TDRs with a total carrying value of $21.1 million. The Company’s policy for TDRs is to recognize income on currently performing restructured loans under the accrual method. During 2013, the Company received pay downs and payoffs of $3.4 million and recorded specific reserve charge-offs of $1.1 million.

The following table details the Company’s TDRs that are on an accrual status and a non-accrual status at June 30, 2013.

(In thousands)	Number of loans		Accrual Status		Non-Accrual Status		Total TDRs

Construction and land development		4	$	1,328	$	512	$	1,840
Commercial real estate		5		4,338		7,483		11,821
Commercial and industrial		3		4,536		2,054		6,590
Residential real estate		2		-		134		134
Total		14	$	10,202	$	10,183	$	20,385

At June 30, 2013, all of the TDRs were in compliance with their restructured terms.

The following tables present the newly restructured loans that occurred during the three and six months ended June 30, 2013. There were no newly restructured loans for the comparable periods in 2012.

	Modifications by type for the three months ended June 30, 2013
(Dollars in thousands)	Number of loans		Rate		Term		Payment		Combination of types		Total		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial real estate		2	$	-	$	-	$	-	$	3,741	$	3,741	$	3,761	$	3,761
Total		2	$	-	$	-	$	-	$	3,741	$	3,741	$	3,761	$	3,761

	Modifications by type for the six months ended June 30, 2013
(Dollars in thousands)	Number of loans		Rate		Term		Payment		Combination of types		Total		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial real estate		2	$	-	$	-	$	-	$	3,741	$	3,741	$	3,761	$	3,761
Commercial and industrial		1		-		-		-		83		83		87		87
Total		3	$	-	$	-	$	-	$	3,824	$	3,824	$	3,848	$	3,848