6. Loans and Allowance For Loan Losses

6 Months Ended

Jun. 30, 2013

Notes

6. Loans and Allowance For Loan Losses

6. Loans and Allowance for Loan Losses

The composition of the Bank’s loan portfolio is as follows:

(Dollars in thousands)	June 30, 2013	December 31, 2012
Commercial and industrial	$2,992	$3,734
Commercial real estate	32,876	31,381
Consumer real estate	4,361	4,619
Consumer loans other	1,624	1,768
Total loans	$41,853	$41,502

The determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance is the accumulation of three components that are calculated based on various independent methodologies that are based on management’s estimates.  The three components are as follows:

·       Specific Loan Evaluation Component – Includes the specific evaluation of impaired loans.  

·       Historical Charge-Off Component – Applies an eight-quarter rolling historical charge-off rate to all pools of non-classified loans.

·       Qualitative Factors Component – The loan portfolio is broken down into multiple homogenous sub classifications, upon which multiple factors (such as delinquency trends, economic conditions, concentrations, growth/volume trends, and management/staff ability) are evaluated, resulting in an allowance amount for each of the sub classifications. The sum of these amounts comprises the Qualitative Factors Component.

All of these factors may be susceptible to significant change.  There were no changes in qualitative factors during period.  In addition, the average historical loss factor for commercial and industrial loans increased as a result of a $340,000 charge-off during the quarter. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods.

The following table presents an analysis of the allowance for loan losses.

(in 000's)	For the Three months ended June 30, 2013
	Commercial and industrial	Commercial real estate	Consumer real estate	Consumer loans other	Total
Beginning balance	$614	$275	$48	-	$937
Provision (credit) for loan losses	15	(65)	(6)	1	(55)
Charge-offs	(184)	-	-	(4)	(188)
Recoveries	1	78	2	3	84
Net charge-offs	(183)	78	2	(1)	(104)
Ending balance	$446	$288	$44	-	$778

(in 000's)	For the Three Months ended June 30, 2012
	Commercial and industrial	Commercial real estate	Consumer real estate	Consumer loans other	Total
Beginning balance	$417	$412	$35	-	$864
Provision for loan losses	79	(47)	(2)	-	30
Charge-offs	-	-		-	-
Recoveries	-	2	10	-	12
Net charge-offs	-	2	10	-	12
Ending balance	$496	$367	$43	-	$906

(in 000’s)	For the Six months ended June 30, 2013
	Commercial and industrial	Commercial real estate	Consumer real estate	Consumer loans other	Total
Beginning balance	$891	$308	$5	-	$1,204
Provision for loan losses	77	(98)	35	1	15
Charge-offs	(524)	-	-	(4)	(528)
Recoveries	2	78	4	3	87
Net charge-offs	(522)	78	4	(1)	(441)
Ending balance	$446	$288	$44	-	$778

(in 000's)	For the Six months ended June 30, 2012
	Commercial and industrial	Commercial real estate	Consumer real estate	Consumer loans other	Total
Beginning balance	$387	$412	$68	-	$867
Provision for loan losses	109	(50)	-	1	60
Charge-offs	-	-	(38)	(9)	(47)
Recoveries	-	5	13	8	26
Net charge-offs	-	5	(21)	(1)	(21)
Ending balance	$496	$367	$43	-	$906

(in 000's)	June 30, 2013
	Commercial and industrial	Commercial real estate	Consumer real estate	Consumer loans other	Total
Period-end amount allocated to:
Loans indivdually evaluated for impairment	$349	-	-	-	349
Loans collectively  evaluated for impairment	97	288	44	-	429
	$446	$288	$44	-	$778
Loans, ending balance:
Loans individually evaluated for impairment	$526	$1,291	-	-	1,817
Loans collectively  evaluated for impairment	2,466	31,585	4,361	1,624	40,036
Total	$2,992	$32,876	$4,361	$1,624	$41,853

(in 000's)	December 31, 2012
	Commercial and industrial	Commercial real estate	Consumer real estate	Consumer loans other	Total
Period-end amount allocated to:
Loans indivdually evaluated for impairment	843	-	-	-	843
Loans collectively  evaluated for impairment	48	308	5	-	361
	$891	$308	$5	-	$1,204
Loans, ending balance:
Loans indivdually evaluated for impairment	$1,021	$1,323	-	-	$2,344
Loans collectively  evaluated for impairment	2,713	30,058	4,619	1,768	39,158
Total	$3,734	$31,381	$4,619	$1,768	$41,502

Nonperforming and Nonaccrual and Past Due Loans

An age analysis of past due loans, segregated by class of loans, as of June 30, 2013 is as follows:

		Accruing
	Loans	Loans 90 or
(In 000's)	30-89 Days	More Days		Total Past	Current
	Past Due	Past Due	Nonaccrual	Due Loans	Loans	Total Loans
Commercial and industrial:
Commercial	-	-	$477	$477	$487	$964
SBA loans		-	-	-	117	117
Asset-based	125	-	-	125	1,786	1,911
Total Commercial and industrial	125	-	477	602	2,390	2,992
Commercial real estate:
Commercial mortgages	213	-	638	851	16,362	17,213
SBA loans	-	-	-	-	607	607
Construction	-	-	-	-	2,244	2,244
Religious organizations	-	-	653	653	12,159	12,812
Total Commercial real estate	213	-	1,291	1,504	31,372	32,876
Consumer real estate:
Home equity loans	358	-	123	481	885	1,366
Home equity lines of credit	-	-	-	-	25	25
1-4 family residential mortgages	54	-	242	296	2,674	2,970
Total consumer real estate	412	-	365	777	3,584	4,361
Total real estate	625	-	1,656	2,281	34,956	37,237
Consumer and other:
Consumer installment	-	-	-	-	23	23
Student loans	103	132	-	235	1,221	1,456
Other	2	-	-	2	143	145
Total consumer and other	105	132	-	237	1,387	1,624
Total loans	$855	$132	$2,133	$3,120	$38,733	$41,853

An age analysis of past due loans, segregated by class of loans, as of December 31, 2012 is as follows:

		Accruing
	Loans	Loans 90 or
	30-89 Days	More Days		Total Past	Current
(In 000's)	Past Due	Past Due	Nonaccrual	Due Loans	Loans	Total Loans
Commercial and industrial:
Commercial	$15	-	$873	888	$574	$1,462
SBA loans	-	-	-	-	125	125
Asset-based	83	-	99	182	1,965	2,147
Total Commercial and industrial	98	-	972	1,070	2,664	3,734
Commercial real estate:
Commercial mortgages	306	-	649	955	13,765	14,720
SBA loans	-	-	-	-	621	621
Construction	-	-	-	-	3,398	3,398
Religious organizations	-	-	674	674	11,968	12,642
Total Commercial real estate	306	-	1,323	1,629	29,752	31,381
Consumer real estate:
Home equity loans	274	44	63	381	1,072	1,453
Home equity lines of credit	-	26	-	26	-	26
1-4 family residential mortgages	69	-	226	295	2,845	3,140
Total consumer real estate	343	70	289	702	3,917	4,619
Total real estate	649	70	1,612	2,331	33,669	36,000
Consumer and other:
Consumer installment	-	-	-	-	30	30
Student loans	87	141	-	228	1,360	1,588
Other	5	-	-	5	145	150
Total consumer and other	92	141	-	233	1,535	1,768
Total loans	$839	$211	$2,584	$3,634	$37,867	$41,502

Loan Origination/Risk Management.  The Bank has lending policies and procedures in place to maximize loan income within an acceptable level of risk.  Management reviews and approves these policies and procedures on a regular basis.  A reporting system supplements the review process by providing management with periodic reports related to loan origination, asset quality, concentrations of credit, loan delinquencies and non-performing and emerging problem loans.  Diversification in the portfolio is a means of managing risk with fluctuations in economic conditions.

Credit Quality Indicators.  For commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality.  Each loan’s internal risk weighting is assigned at origination and updated at least annually and more frequently if circumstances warrant a change in risk rating.  The Bank uses a 1 through 8 loan grading system that follows regulatory accepted definitions as follows:

·       Risk ratings of “1” through “3” are used for loans that are performing and 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.  Loans with these risk ratings are reflected as “Good/Excellent” and “Satisfactory” in the following table.

·       Risk ratings of “4” are assigned to “Pass/Watch” loans which may require a higher degree of regular, careful attention.  Borrowers may be exhibiting weaker balance sheets and positive but inconsistent cash flow coverage. Borrowers in this classification generally exhibit a higher level of credit risk and are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Loans with this rating would not normally be acceptable as new credits unless they are adequately secured and/or carry substantial guarantors. Loans with this rating are reflected as “Pass” in the following table.

·       Risk ratings of “5” are assigned to “Special Mention” loans that do not presently expose the Bank to a significant degree of risks, but have potential weaknesses/deficiencies deserving Management’s closer attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. No loss of principal or interest is envisioned.  Borrower is experiencing adverse operating trends, which potentially could impair debt, services capacity and may necessitate restructuring of credit.  Secondary sources of repayment are accessible and considered adequate to cover the Bank's exposure. However, a restructuring of the debt should result in repayment.  The asset is currently protected, but is potentially weak.  This category may include credits with   inadequate loan agreements, control over the collateral or an unbalanced position in the balance sheet which has not reached a point where the liquidation is jeopardized but exceptions are considered material. These borrowers would have limited ability to obtain credit elsewhere.

·       Risk ratings of “6” are assigned to “Substandard” loans which are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets must have a well-defined weakness. They are characterized by the distinct possibility that some loss is possible if the deficiencies are not corrected. The borrower’s recent performance indicated an inability to repay the debt, even if restructured. Primary source of repayment is gone or severely impaired and the Bank may have to rely upon the secondary source. Secondary sources of repayment (e.g., guarantors and collateral) should be adequate for a full recovery. Flaws in documentation may leave the bank in a subordinated or unsecured position when the collateral is needed for the repayment.

·       Risk ratings of “7” are assigned to “Doubtful” loans which have all the weaknesses inherent in those classified “Substandard” with the added characteristic that the weakness makes the collection or liquidation in full, on the basis of current existing facts, conditions, and values, highly questionable and improbable.  The borrower's recent performance indicates an inability to repay the debt.  Recovery from secondary sources is uncertain.  The possibility of a loss is extremely high, but because of certain important and reasonably- specific pending factors, its classification as a loss is deferred.

·       Risk rating of “8” are assigned to “Loss” loans which are considered non-collectible and do not warrant classification as active assets.  They are recommended for charge-off if attempts to recover will be long term in nature.  This classification does not mean that an asset has no recovery or salvage value, but rather, that it is not practical or desirable to defer writing off the loss, although a future recovery may be possible.  Loss should always be taken in the period in which they surface and are identified as non-collectible as a result there is no tabular presentation.

For consumer and residential mortgage 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 contractual terms is in doubt.  These credit quality indicators are updated on an ongoing basis.  A loan is placed on nonaccrual status as soon as management believes there is doubt as to the ultimate ability to collect interest on a loan, but no later than 90 days past due.

The tables below detail the Bank’s loans by class according to their credit quality indictors discussed above.

(In 000's)	Commercial Loans June 30, 2013
	Good/ Excellent	Satisfactory	Pass	Special Mention	Substandard	Doubtful	Total
Commercial and industrial:
Commercial	$250	$9	$220	$8	$84	$393	$964
SBA loans	-	25	-	43	49	-	117
Asset-based	-	1,737	125	49	-	-	1,911
	250	1,771	345	100	133	393	2,992
Commercial real estate:
Commercial mortgages	-	14,976	1,372	158	618	89	17,213
SBA Loans	-	607	-	-	-	-	607
Construction	-	2,244	-	-	-	-	2,244
Religious organizations	-	9,201	2,328	-	1,283	-	12,812
	-	27,028	3,700	158	1,901	89	32,876
Total commercial loans	$250	$28,799	$4,045	$258	$2,034	$482	$35,868

	Residential Mortgage and Consumer Loans June 30, 2013
	Performing	Nonperforming	Total
Consumer Real Estate:
Home equity	$1,243	$123	$1,366
Home equity line of credit	25	-	25
1-4 family residential mortgages	2,728	242	2,970
	3,996	365	4,361
Consumer Other:
Consumer Installment	23	-	23
Student loans	1,456	-	1,456
Other	145	-	145
	1,624	-	1,624
Total  consumer loans	$5,620	$365	$5,985
Total loans				$      41,853

(In 000's)	Commercial Loans, December 31, 2012
	Good/ Excellent	Satisfactory	Pass	Special Mention	Substandard	Doubtful	Total
Commercial and industrial:
Commercial	$250	$104	$15	$220	$480	$393	$1,462
SBA loans	-	27	-	49	49	-	125
Asset-based	-	1,869	125	54	99	-	2,147
	250	2,000	140	323	628	393	3,734
Commercial real estate:
Commercial mortgages	-	12,678	1,322	-	403	317	14,721
SBA Loans	-	621	-	-	-	-	621
Construction	-	2,767	-	-	631	-	3,398
Religious organizations	-	8,183	3,623	162	674	-	12,642
	-	24,349	4,945	162	1,708	317	31,381
Total commercial loans	$250	$26,249	$5,085	$485	$2,336	$710	$33,115

	Residential Mortgage and Consumer Loans December 31, 2012
	Performing	Nonperforming	Total
Consumer Real Estate:
Home equity	$1,390	$63	$1,453
Home equity line of credit	26	-	26
1-4 family residential mortgages	2,914	226	3,140
	4,330	289	4,619
Consumer Other:
Consumer Installment	30	-	30
Student loans	1,588	-	1,588
Other	150	-	150
	1,768	-	1,768
Total  consumer loans	$6,098	$289	$6,387
Total loans				$ 41,502

Impaired Loans. The Bank 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. The Bank recognizes interest income on impaired loans under the cash basis when the collateral on the loan is sufficient to cover the outstanding obligation to the Bank.   If these factors do not exist, the Bank will record interest payments on the cost recovery basis.

In accordance with guidance provided by ASC 310-10, Accounting by Creditors for Impairment of a Loan, management employs one of three methods to determine and measure impairment: the Present Value of Future Cash Flow Method; the Fair Value of Collateral Method; or the Observable Market Price of a Loan Method.  To perform an impairment analysis, the Company reviews a loan’s internally assigned grade, its outstanding balance, guarantors, collateral, strategy, and a current report of the action being implemented. Based on the nature of the specific loans, one of the impairment methods is chosen for the respective loan and any impairment is determined, based on criteria established in ASC 310-10.

The Company makes partial charge-offs of impaired loans when the impairment is deemed permanent and is considered a loss.  To date, these charge-offs have only included the unguaranteed portion of Small Business Administration (“SBA”) loans.  Specific reserves are allocated to cover “other-than-permanent” impairment for which the underlying collateral value may fluctuate with market conditions. During the three and six months ended June 30, 2013 and 2012, there were no partial charge-offs of impaired loans.

Consumer real estate and other loans are not individually evaluated for impairment, but collectively evaluated, because they are pools of smaller balance homogeneous loans.

Impaired loans as of June 30, 2013 are set forth in the following table.

(In 000's)	Unpaid Contractual	Recorded Investment	Recorded Investment	Total
	Principal	With No	With	Recorded	Related
	Balance	Allowance	Allowance	Investment	Allowance
Commercial and industrial:
Commercial	$477	$77	$400	$477	$300
SBA  loans	49	-	49	49	49
Total commercial and industrial	526	77	449	526	349
Commercial real estate:
Commercial mortgages	638	638	-	638	-
Religious organizations	653	653	-	653	-
Total commercial real estate	1,291	1,291	-	1,291	-
Total loans	$1,817	$1,368	$449	$1,817	$349

Impaired loans as of December 31, 2012 are set forth in the following table.

(In 000's)	Unpaid Contractual	Recorded Investment	Recorded Investment	Total
	Principal	With No	With	Recorded	Related
	Balance	Allowance	Allowance	Investment	Allowance
Commercial and industrial:
Commercial	$873	$78	$795	$873	$695
SBA loans	49	-	49	49	49
Asset-based	99	-	99	99	99
Total commercial and industrial	1,021	78	943	1,021	843
Commercial real estate:
Commercial mortgages	649	649	-	649	-
Religious organizations	674	674	-	674	-
Total commercial real estate	1,323	1,323	-	1,323	-
Total loans	$2,344	$1,401	$943	$2,344	$843

The Bank recognizes interest income on impaired loans under the cash basis when the collateral on the loan is sufficient to cover the outstanding obligation to the Bank.   If these factors do not exist, the Bank will record interest payments on the cost recovery basis. The following tables present additional information about impaired loans for the three and six months ended June 30, 2013 and 2012.

	Three Months Ended		Three Months Ended
(In 000's)	June 30, 2013		June 30, 2012
	Average	Interest recognized	Average	Interest recognized
	Recorded	on impaired	Recorded	on impaired
	Investment	loans	Investment	loans
Commercial and industrial:
Commercial	$512	-	$482	-
SBA  loans	49	-	17	1
Asset-based	88	-	138	-
Total commercial and industrial	649	-	637	1
Commercial real estate:
Commercial mortgages	639	-	666	-
SBA loans	-	-	-	-
Religious organizations	657	-	399	-
Total commercial real estate	1,296	-	1,065	-
Total loans	$1,945	-	$1,702	1

	Six Months Ended		Six Months Ended
(In 000's)	June 30, 2013		June 30, 2012
	Average	Interest recognized	Average	Interest recognized
	Recorded	on impaired	Recorded	on impaired
	Investment	loans	Investment	loans
Commercial and industrial:
Commercial	$626	-	$482	-
SBA  loans	49	-	8	1
Asset-based	99	-	119	-
Total commercial and industrial	774	-	609	1
Commercial real estate:
Commercial mortgages	640	-	670	-
Religious organizations	614	-	405	-
Total commercial real estate	1,254	-	1,075	-
Total loans	$2,028	-	$1,075	$1

Troubled debt restructurings (“TDRs”).  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, such as a below market interest rate, extending the maturity of a loan, or a combination of both. The Company made modifications to certain loans in its commercial loan portfolio that included the term out of lines of credit to begin the amortization of principal.  The terms of these loans do not include any financial concessions and are consistent with the current market.  Management reviews all loan modifications to determine whether the modification qualifies as a troubled debt restructuring (i.e. whether the creditor has been granted a concession or is experiencing financial difficulties).  Based on this review and evaluation, none of the modified loans met the criteria of a troubled debt restructuring.  Therefore, the Company had no troubled debt restructurings at June 30, 2013 and December 31, 2012.