NOTE 6. LOAN LOSS ALLOWANCE

Activity in the allowance for loan losses for the nine months ended September 30, 2014 and 2013 was as follows:

Business Activities Loans

(In thousands)	Residential mortgages			Commercial real estate		Commercial and industrial loans		Consumer		Unallocated			Total
September 30, 2014
Balance at beginning of period	$	6,937		$	13,705	$	5,173	$	3,644	$	68		$	29,527
Charged-off loans	1,253			2,327		2,007		806		—			6,393
Recoveries on charged-off loans	118			8		87		229		—			442
Provision for loan losses	(224		)	4,966		1,534		2,278		(26		)	8,528
Balance at end of period	$	5,578		$	16,352	$	4,787	$	5,345	$	42		$	32,104
Individually evaluated for impairment	30			2,409		312		—		—			2,751
Collectively evaluated	5,548			13,943		4,475		5,345		42			29,353
Total	$	5,578		$	16,352	$	4,787	$	5,345	$	42		$	32,104

Business Activities Loans

(In thousands)	Residential mortgages			Commercial real estate		Commercial and industrial loans		Consumer		Unallocated			Total
September 30, 2013
Balance at beginning of period	$	5,928		$	18,863	$	5,605	$	1,466	$	29		$	31,891
Charged-off loans	1,180			3,293		1,631		815		—			6,919
Recoveries on charged-off loans	153			500		87		180		—			920
Provision for loan losses	1,827			779		1,472		2,309		(339		)	6,048
Balance at end of period	$	6,728		$	16,849	$	5,533	$	3,140	$	(310	)	$	31,940
Individually evaluated for impairment	697			783		441		21		—			1,942
Collectively evaluated	6,031			16,066		5,092		3,119		(310		)	29,998
Total	$	6,728		$	16,849	$	5,533	$	3,140	$	(310	)	$	31,940

Acquired Loans

(In thousands)	Residential mortgages		Commercial real estate		Commercial and industrial loans		Consumer		Unallocated		Total
September 30, 2014
Balance at beginning of period	$	625	$	2,339	$	597	$	235	$	—	$	3,796
Charged-off loans	1,087		1,287		422		1,004		—		3,800
Recoveries on charged-off loans	171		1		101		51		—		324
Provision for loan losses	818		5		725		994		—		2,542
Balance at end of period	$	527	$	1,058	$	1,001	$	276	$	—	$	2,862
Individually evaluated for impairment	—		—		—		—		—		—
Collectively evaluated	527		1,058		1,001		276		—		2,862
Total	$	527	$	1,058	$	1,001	$	276	$	—	$	2,862

Acquired Loans

(In thousands)	Residential mortgages		Commercial real estate			Commercial and industrial loans		Consumer		Unallocated			Total
September 30, 2013
Balance at beginning of period	$	509	$	390		$	96	$	314	$	8		$	1,317
Charged-off loans	437		933			200		886		—			2,456
Recoveries on charged-off loans	1		11			80		125		—			217
Provision for loan losses	360		806			430		705		(71		)	2,230
Balance at end of period	$	433	$	274		$	406	$	258	$	(63	)	$	1,308
Individually evaluated for impairment	233		374			—		—		—			607
Collectively evaluated	200		(100		)	406		258		(63		)	701
Total	$	433	$	274		$	406	$	258	$	(63	)	$	1,308

Credit Quality Information

Business Activities Loans Credit Quality Analysis

The Company monitors the credit quality of its portfolio by using internal risk ratings that are based on regulatory guidance. Loans that are given a Pass rating are not considered a problem credit. Loans that are classified as Special Mention loans are considered to have potential credit problems and are evaluated closely by management. Substandard and non-accruing loans are loans for which a definitive weakness has been identified and which may make full collection of contractual cash flows questionable. Doubtful loans are those with identified weaknesses that make full collection of contractual cash flows, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The Company assigns an internal risk rating at origination and reviews the rating annually, semiannually or quarterly depending on the risk rating. The rating is also reassessed at any point in time when management becomes aware of information that may affect the borrower’s ability to fulfill their obligations.

The Company risk rates its residential mortgages, including 1-4 family and residential construction loans, based on a three rating system: Pass, Special Mention and Substandard. Loans that are current within 59 days are rated Pass. Residential mortgages that are 60-89 days delinquent are rated Special Mention. Loans delinquent for 90 days or greater are rated Substandard and generally placed on non-accrual status. Home equity loans are risk rated based on the same rating system as the Company’s residential mortgages.

Ratings for other consumer loans, including auto loans, are based on a two rating system. Loans that are current within 119 days are rated Performing while loans delinquent for 120 days or more are rated Non-performing. Other consumer loans are placed on non-accrual at such time as they become Non-performing.

Acquired Loans Credit Quality Analysis

Upon acquiring a loan portfolio, our internal loan review function assigns risk ratings to the acquired loans, utilizing the same methodology as it does with business activities loans. This may differ from the risk rating policy of the predecessor bank. Loans which are rated Substandard or worse according to the rating process outlined below are deemed to be credit impaired loans accounted for under ASC 310-30, regardless of whether they are classified as performing or non-performing.

The Bank utilizes an eleven grade internal loan rating system for each of its acquired commercial real estate, construction and commercial loans as outlined in the Credit Quality Information section of this Note. The Company risk rates its residential mortgages, including 1-4 family and residential construction loans, based on a three rating system: Pass, Special Mention and Substandard. Residential mortgages that are current within 59 days are rated Pass. Residential mortgages that are 60 — 89 days delinquent are rated Special Mention. Residential mortgages delinquent for 90 days or greater are rated Substandard. Home equity loans are risk rated based on the same rating system as the Company’s residential mortgages. Other consumer loans are rated based on a two rating system. Other consumer loans that are current within 119 days are rated Performing while loans delinquent for 120 days or more are rated Non-performing. Non-performing other consumer loans are deemed to be credit impaired loans accounted for under ASC 310-30.

The Company subjects loans that do not meet the ASC 310-30 criteria to ASC 450-20 by collectively evaluating these loans for an allowance for loan loss. The Company applies a methodology similar to the methodology prescribed for business activities loans, which includes the application of environmental factors to each category of loans. The methodology to collectively evaluate the acquired loans outside the scope of ASC 310-30 includes the application of a number of environmental factors that reflect management’s best estimate of the level of incremental credit losses that might be recognized given current conditions. This is reviewed as part of the allowance for loan loss adequacy analysis. As the loan portfolio matures and environmental factors change, the loan portfolio will be reassessed each quarter to determine an appropriate reserve allowance.

A decrease in the expected cash flows in subsequent periods requires the establishment of an allowance for loan losses at that time for ASC 310-30 loans. At September 30, 2014, the allowance for loan losses related to acquired loans was $2.9 million using the above mentioned criteria.

The Company presented several tables within this footnote separately for business activity loans and acquired loans in order to distinguish the credit performance of the acquired loans from the business activity loans.

The following table presents the Company’s loans by risk rating at September 30, 2014 and December 31, 2013:

Business Activities Loans

Residential Mortgages

Credit Risk Profile by Internally Assigned Grade

	1-4 family				Construction				Total residential mortgages
(In thousands)	Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013
Grade:
Pass	$	1,131,284	$	1,019,732	$	23,512	$	18,117	$	1,154,796	$	1,037,849
Special mention	347		623		—		—		347		623
Substandard	4,720		7,382		—		41		4,720		7,423
Total	$	1,136,351	$	1,027,737	$	23,512	$	18,158	$	1,159,863	$	1,045,895

Commercial Real Estate

Credit Risk Profile by Creditworthiness Category

	Construction				Single and multi-family				Other				Total commercial real estate
(In thousands)	Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013
Grade:
Pass	$	149,266	$	120,071	$	119,092	$	59,636	$	964,548	$	800,672	$	1,232,906	$	980,379
Special mention	—		—		—		140		3,068		8,150		3,068		8,290
Substandard	2,794		5,176		3,147		3,717		64,923		61,807		70,864		70,700
Doubtful	—		—		—		—		73		642		73		642
Total	$	152,060	$	125,247	$	122,239	$	63,493	$	1,032,612	$	871,271	$	1,306,911	$	1,060,011

Commercial and Industrial Loans

Credit Risk Profile by Creditworthiness Category

	Asset based lending				Other				Total comm. and industrial loans
(In thousands)	Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013
Grade:
Pass	$	341,584	$	294,241	$	329,989	$	313,984	$	671,573	$	608,225
Special mention	—		—		950		884		950		884
Substandard	—		—		7,515		7,725		7,515		7,725
Doubtful	—		—		—		603		—		603
Total	$	341,584	$	294,241	$	338,454	$	323,196	$	680,038	$	617,437

Consumer Loans

Credit Risk Profile Based on Payment Activity

	Home equity				Auto and other				Total consumer loans
(In thousands)	Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013
Performing	$	247,103	$	231,594	$	338,099	$	212,922	$	585,202	$	444,516
Nonperforming	1,397		1,083		337		249		1,734		1,332
Total	$	248,500	$	232,677	$	338,436	$	213,171	$	586,936	$	445,848

Acquired Loans

Residential Mortgages

Credit Risk Profile by Internally Assigned Grade

	1-4 family				Construction				Total residential mortgages
(In thousands)	Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013
Grade:
Pass	$	282,089	$	330,353	$	1,032	$	1,081	$	283,121	$	331,434
Special mention	301		437		—		—		301		437
Substandard	2,576		2,577		—		3,931		2,576		6,508
Total	$	284,966	$	333,367	$	1,032	$	5,012	$	285,998	$	338,379

Commercial Real Estate

Credit Risk Profile by Creditworthiness Category

	Construction				Single and multi-family				Other				Total commercial real estate
(In thousands)	Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013
Grade:
Pass	$	4,357	$	7,154	$	45,213	$	46,961	$	205,393	$	254,787	$	254,963	$	308,902
Special mention	—		—		625		4,799		5,650		9,034		6,275		13,833
Substandard	2,244		6,616		12,305		13,067		12,702		14,691		27,251		34,374
Total	$	6,601	$	13,770	$	58,143	$	64,827	$	223,745	$	278,512	$	288,489	$	357,109

Commercial and Industrial Loans

Credit Risk Profile by Creditworthiness Category

	Asset based lending				Other				Total comm. and industrial loans
(In thousands)	Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013
Grade:
Pass	$	—	$	3,130	$	46,508	$	59,615	$	46,508	$	62,745
Special mention	—		—		1,981		2,396		1,981		2,396
Substandard	—		—		4,433		4,715		4,433		4,715
Total	$	—	$	3,130	$	52,922	$	66,726	$	52,922	$	69,856

Consumer Loans

Credit Risk Profile Based on Payment Activity

	Home equity				Auto and other				Total consumer loans
(In thousands)	Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013		Sept. 30, 2014		Dec. 31, 2013
Performing	$	67,108	$	73,552	$	122,591	$	170,275	$	189,699	$	243,827
Nonperforming	485		602		1,441		1,559		1,926		2,161
Total	$	67,593	$	74,154	$	124,032	$	171,834	$	191,625	$	245,988

The following table summarizes information about total loans rated Special Mention or lower as of September 30, 2014 and December 31, 2013. The table below includes consumer loans that are special mention and substandard accruing that are classified in the above table as performing based on payment activity.

	September 30, 2014						December 31, 2013
(In thousands)	Business Activities Loans		Acquired Loans		Total		Business Activities Loans		Acquired Loans		Total
Non-Accrual	$	16,499	$	6,388	$	22,887	$	18,472	$	8,983	$	27,455
Substandard Accruing	68,859		29,961		98,820		70,667		38,891		109,558
Total Classified	85,358		36,349		121,707		89,139		47,874		137,013
Special Mention	4,521		8,910		13,431		10,081		17,853		27,934
Total Criticized	$	89,879	$	45,259	$	135,138	$	99,220	$	65,727	$	164,947