4. Loans, net

Loans receivable consisted of the following (dollars in thousands):

	June 30,			December 31,
	2013			2012
Mortgage loans:
Fixed-rate residential	$	5,740		$	6,329
Adjustable-rate residential		3,230			3,376
Commercial real estate		74,383			75,210
Construction		414			59
Total mortgage loans		83,767			84,974
Commercial nonreal estate		9,120			9,024
Consumer loans:
Home equity		13,045			14,063
Consumer and installment		17,100			19,468
Consumer lines of credit		267			267
Total consumer loans		30,412			33,798
Total loans		123,299			127,796
Adjustments:
Unamortized loan discount		(169	)		(181	)
Loans in process		1,141			--
Allowance for loan losses		(4,312	)		(4,367	)
Net deferred loan origination costs		129			166
Total, net	$	120,088		$	123,414
Weighted-average interest rate of loans		4.90	%		5.15	%

Information about impaired loans for the periods ended June 30, 2013 and December 31, 2012 is as follows (in thousands):

	June 30,		December 31,
	2013		2012

Loans receivable for which there is a related allowance for credit losses determined in accordance with ASC 310-10/Statement No. 114	$	4,944	$	5,339
Other impaired loans		15,755		20,508
Total impaired loans	$	20,699	$	25,847
Average monthly balance of impaired loans	$	19,161	$	29,171
Specific allowance for credit losses	$	2,135	$	2,385

Impaired Loans

For the Periods Ended June 30, 2013 and December 31, 2012

(in thousands)

June 30, 2013	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment

With no related allowance recorded:

Commercial
Commercial real estate	$	9,929	$	8,499	$	--	$	9,214
Commercial non real estate		2,353		2,002		--		2,178

Consumer
Consumer – other		3,989		3,036		--		3,513
Consumer - home equity		689		646		--		667

Residential real estate
1-4 Family		1,773		1,572		--		1,672

With a related allowance recorded:

Commercial
Commercial real estate	$	5,597	$	3,340	$	1,273	$	4,468
Commercial non real estate		112		95		47		104

Consumer
Consumer – other		1,778		1,509		815		1,644

Residential real estate
1-4 Family		--		--		--		--

Total:	$	26,220	$	20,699	$	2,135	$	23,460
Commercial		17,991		13,936		1,320		15,964
Consumer		6,456		5,191		815		5,824
Residential		1,773		1,572		--		1,672

December 31, 2012	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment

With no related allowance recorded:

Commercial
Commercial real estate	$	14,778	$	13,273	$	--	$	14,025
Commercial non real estate		2,004		1,680		--		1,842

Consumer
Consumer - other		4,611		3,696		--		4,154
Consumer - home equity		566		536		--		551

Residential real estate
1-4 Family		1,448		1,323		--		1,385

With a related allowance recorded:

Commercial
Commercial real estate	$	5,622	$	3,388	$	1,260	$	4,505
Commercial non real estate		206		189		49		198

Consumer
Consumer – other		1,363		1,354		962		1,358

Residential real estate
1-4 Family		416		408		114		412

Total:	$	31,014	$	25,847	$	2,385	$	28,430
Commercial		22,610		18,530		1,309		20,570
Consumer		6,540		5,586		962		6,063
Residential		1,864		1,731		114		1,797

Loans Receivable on Nonaccrual Status

As of June 30, 2013 and December 31, 2012

(in thousands)

	June 30,		December 31,
	2013		2012
Commercial
Commercial real estate	$	6,878	$	8,734
Commercial non real estate		917		835

Consumer
Consumer – other		2,733		2,287
Consumer – automobile		7		19
Consumer – home equity		440		329

Residential real estate
1-4 family		1,228		970
Total	$	12,203	$	13,174

Allowance for Loan Losses and Recorded Investment in Loans Receivable

(in thousands)

			Commercial
	Commercial		Real Estate			Consumer			Residential			Total

June 30, 2013

Allowance for loan losses:

Beginning balance	$	1,040	$	1,675		$	1,301		$	351		$	4,367
Charge-offs		--		(299	)		(337	)		(15	)		(651	)
Recoveries		3		65			22			5			95
Provisions		--		400			204			(104	)		500
Ending balance	$	1,043	$	1,841		$	1,190		$	238		$	4,312

Loans receivable:

Ending balances:
Individually evaluated for impairment	$	2,097	$	11,839		$	5,191		$	1,572		$	20,699
Allowance for loan losses		47		1,273			815			--			2,135
Collectively evaluated for impairment imprimpairment	$	7,023	$	62,544		$	25,221		$	7,812		$	102,518
Allowance for loan losses		996		568			375			238			2,177
Ending balance	$	9,120	$	74,383		$	30,412		$	9,384		$	123,217
Total allowance for loan losses	$	1,043	$	1,841		$	1,190		$	238		$	4,312

				Commercial
	Commercial			Real Estate			Consumer			Residential			Total

December 31, 2012

Allowance for loan losses:

Beginning balance	$	1,887		$	1,920		$	484		$	258		$	4,549
Charge-offs		(118	)		(339	)		(576	)		(8	)		(1,041	)
Recoveries		52			94			5			4			155
Provisions		(781	)		--			1,388			97			704
Ending Balance	$	1,040		$	1,675		$	1,301		$	351		$	4,367

Loans receivable:

Ending balances:
Individually evaluated for impairment	$	1,869		$	16,661		$	5,586		$	1,731		$	25,847
Allowance for loan losses		49			1,260			962			114			2,385
Collectively evaluated for impairment imprimpairment	$	7,155		$	58,549		$	28,212		$	8,033		$	101,949
Allowance for loan losses		991			415			339			237			1,982
Ending balance	$	9,024		$	75,210		$	33,798		$	9,764		$	127,796
Total allowance for loan losses	$	1,040		$	1,675		$	1,301		$	351		$	4,367

Credit Quality Indicators

As of June 30, 2013 and December 31, 2012

(in thousands)

Credit Quality Indicators: The Corporation regularly monitors the credit quality of its loan portfolio. Credit quality refers to the current and expected ability of borrowers to repay their obligations according to the contractual terms of such loans. Credit quality is evaluated through assignment of individual loan grades, as well as past-due and performing status analysis. Credit quality indicators allow the Corporation to assess the inherent loss on certain individual and pools of loans.

Commercial Credit Exposure (1)

Credit Risk Profile by Creditworthiness Category

	Commercial non real estate				Commercial real estate
	June 30,		December 31,		June 30,		December 31,
	2013		2012		2013		2012
Grade 1 Superior quality	$	53	$	58	$	--	$	--
Grade 2 Good quality		--		--		--		--
Grade 3 Satisfactory		215		209		6,565		7,238
Grade 4 Acceptable		3,379		4,148		25,928		24,844
Grade 5 Watch		2,631		2,433		27,316		23,762
Grade 6 Special mention		1,165		1,125		3,930		6,860
Grade 7 Substandard		1,582		957		9,394		11,256
Grade 8 Doubtful		95		94		1,250		1,250
Total	$	9,120	$	9,024	$	74,383	$	75,210

(1) Credit quality indicators are reviewed and updated as applicable on an ongoing basis in accordance with credit policies.

The Corporation uses an internal risk rating system to classify and monitor the credit quality of loans. Loan risk ratings are based on a graduated scale representing increasing likelihood of loss. Primary responsibility for the assignment of risk ratings of loans is with the individual loan officer assigned to each loan, subject to verification by the Credit Administration department. Risk ratings are also reviewed periodically by an independent third party loan review firm that reports directly to the Board of Directors.

Consumer Credit Exposure (1)

Credit Risk Profile by Internally Assigned Grade

	Residential				Consumer
	June 30,		December 31,		June 30,		December 31,
	2013		2012		2013		2012
Grade:
Pass	$	7,619	$	7,905	$	25,470	$	27,976
Special mention		383		732		791		1,366
Substandard		1,382		1,127		4,151		4,456
Total	$	9,384	$	9,764	$	30,412	$	33,798

(1) Credit quality indicators are reviewed and updated as applicable on an ongoing basis in accordance with credit policies.

Consumer Credit Exposure (1)

Credit Risk Profile Based on Payment Activity

													Residential real estate
	Other				Consumer automobile				Home equity				1-4 family
	June 30,		December 31,		June 30,		December 31,		June 30,		December 31,		June 30,		December 31,
	2013		2012		2013		2012		2013		2012		2013		2012

Performing	$	13,843	$	16,676	$	784	$	753	$	12,605	$	13,734	$	8,156	$	8,794
Nonperforming		2,733		2,287		7		19		440		329		1,228		970
Total	$	16,576	$	18,963	$	791	$	772	$	13,045	$	14,063	$	9,384	$	9,764

(1) Credit quality indicators are reviewed and updated as applicable on an ongoing basis in accordance with credit policies.

Loans graded one through five are considered “pass” credits. As of June 30, 2013, approximately 80% of the loan portfolio was considered pass credits. For loans to qualify for these grades, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment.

Loans with a credit grade of six are not considered classified; however they are categorized as a special mention or watch list credit. This classification is utilized by us when we have an initial concern about the financial health of a borrower. These loans are designated as such in order to be monitored more closely than other credits in our portfolio. We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either reclassify the loan as “substandard” or back to its original risk rating after a review of the information. There are times when we may leave the loan on the watch list, if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we determine to review the loan on a more regular basis. Loans on the watch list are not considered problem loans until they are determined by management to be classified as substandard. As of June 30, 2013, we had loans totaling $6.3 million rated as Special Mention.

Loans graded seven or greater are considered classified credits. Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. The loan has well-defined weaknesses that jeopardize the liquidation value and has the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have the weaknesses of Substandard but have additional factors that make collection or liquidation in full highly questionable and improbable. At June 30, 2013, classified loans totaled $17.9 million, with all but one loan being collateralized by real estate. This compares to classified loans of $19.1 million at December 31, 2012. Classified credits are evaluated for impairment on a quarterly basis.

The following are past due loans for the Corporation’s loans receivable for the periods ended June 30, 2013 and December 31, 2012 (in thousands).

					Greater
	30 -59 Days		60 - 89 Days		Than		Total Past				Total Loans
	Past Due		Past Due		90 Days		Due		Current		Receivable
June 30, 2013

Commercial:
Commercial non real estate	$	75	$	64	$	854	$	993	$	8,127	$	9,120
Commercial real estate		931		1,459		4,536		6,926		67,457		74,383
Consumer:
Consumer – other		635		322		1,161		2,118		14,458		16,576
Consumer – automobile		2		3		2		7		784		791
Consumer – home equity		148		--		163		311		12,734		13,045
Residential 1-4 family		156		162		278		596		8,788		9,384
Total	$	1,947	$	2,010	$	6,994	$	10,951	$	112,348	$	123,299

December 31, 2012

Commercial:
Commercial non real estate	$	146	$	110	$	646	$	902	$	8,122	$	9,024
Commercial real estate		2,525		482		6,047		9,054		66,156		75,210
Consumer:
Consumer – other		638		419		1,045		2,102		16,861		18,963
Consumer – automobile		11		5		3		19		753		772
Consumer – home equity		157		7		168		332		13,731		14,063
Residential 1-4 family		259		406		970		1,635		8,129		9,764
Total	$	3,736	$	1,429	$	8,879		14,044	$	113,752	$	127,796

Troubled Debt Restructurings

As a result of adopting the amendments in ASU 2011-02, the Corporation reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they were considered troubled debt restructurings (TDRs) under the amended guidance. The Corporation identified as TDRs certain loans for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying those loans as TDRs, the Corporation identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those loans newly identified as impaired. At June 30, 2013, the recorded investment in loans for which the allowance was previously measured under a general allowance methodology and are now impaired under ASC 310-10-35 was $3.9 million, and the allowance for loan losses associated with those loans, on the basis of a current evaluation of loss was $238,000. The following are loan modifications for the Corporation’s loans receivable for the three and six month periods ended June 30, 2013.

	Three Months Ended June 30, 2013					Six Months Ended June 30, 2013
		Pre		Post			Pre		Post
		Modification		Modification			Modification		Modification
	Number	Outstanding		Outstanding		Number	Outstanding		Outstanding
Troubled Debt Restructurings	of New	Recorded		Recorded		of New	Recorded		Recorded
Added during current period	Contracts	Investment		Investment		Contracts	Investment		Investment
	(in thousands)					(in thousands)
Commercial:
Commercial non real estate	-	$	--	$	--	--	$	--	$	--
Commercial real estate	2		326		326	2		326		326
Consumer:
Consumer – other	2		261		261	3		346		341
Residential 1-4 family	1		49		49	1		49		49
Total	5	$	636	$	636	6	$	721	$	716

	Three Months Ended June 30, 2013					Six Months Ended June 30, 2013
		Post					Post
		Modification					Modification
	Number	Outstanding		Defaulted		Number	Outstanding		Defaulted
Troubled Debt Restructurings	of New	Recorded		Recorded		of New	Recorded		Recorded
Defaulted during the period	Contracts	Investment		Investment		Contracts	Investment		Investment
Added since last twelve months	(in thousands)

Commercial:
Commercial non real estate	--	$	--	$	--	--	$	--	$	--
Commercial real estate	--		--		--	--		--		--
Consumer:
Consumer – other	2		187		187	2		187		187
Total	2	$	187	$	187	2	$	187	$	187

During the six months ended June 30, 2013, the Corporation modified 6 loans that were considered to be troubled debt restructurings. We extended the terms for 6 of these loans and the interest rate was lowered for 2 of these loans. During the six months ended June 30, 2013, the Corporation had 2 loans default that had previously been restructured. A default occurs when a loan does not perform as agreed under the new terms to the point it becomes 90 days or more past due.