Note 3 – Loans

Major classifications of loans were as follows:



	June 30, 2014		December 31, 2013
Commercial	$	106,752	$	94,736
Real estate - commercial		599,796		560,233
Real estate - construction		32,265		29,351
Real estate - residential		368,592		390,201
Consumer		3,064		2,760
Overdraft		381		628
Lease financing receivables		8,722		10,069
Other		12,700		12,793
		1,132,272		1,100,771
Net deferred loan costs		475		485
	$	1,132,747	$	1,101,256

It is the policy of the Company to review each prospective credit in order to determine if an adequate level of security or collateral was obtained prior to making a loan. The type of collateral, when required, will vary from liquid assets to real estate. The Company’s access to collateral, in the event of borrower default, is assured through adherence to lending laws, the Company’s lending standards and credit monitoring procedures. The Bank generally makes loans solely within its market area. There are no significant concentrations of loans where the customers’ ability to honor loan terms is dependent upon a single economic sector although the real estate related categories listed above represent 88.3% and 89.0% of the portfolio at June 30, 2014, and December 31, 2013, respectively.

Aged analysis of past due loans by class of loans were as follows:



															Recorded
															Investment
															90 days or
					90 Days or										Greater Past
	30-59 Days		60-89 Days		Greater Past		Total Past								Due and
June 30, 2014	Past		Past Due		Due		Due		Current		Nonaccrual		Total Loans		Accruing
Commercial	$	-	$	-	$	35	$	35	$	115,418	$	21	$	115,474	$	35
Real estate - commercial
Owner occupied general purpose		708		-		-		708		126,728		2,911		130,347		-
Owner occupied special purpose		-		246		-		246		165,709		3,530		169,485		-
Non-owner occupied general purpose		462		-		-		462		149,077		6,397		155,936		-
Non-owner occupied special purpose		-		-		-		-		87,810		540		88,350		-
Retail properties		-		-		-		-		36,616		3,012		39,628		-
Farm		-		-		-		-		16,050		-		16,050		-
Real estate - construction
Homebuilder		-		-		-		-		3,408		-		3,408		-
Land		-		-		-		-		2,210		209		2,419		-
Commercial speculative		-		-		-		-		17,150		-		17,150		-
All other		-		-		-		-		8,690		598		9,288		-
Real estate - residential
Investor		886		73		144		1,103		127,840		3,788		132,731		144
Owner occupied		35		618		-		653		110,230		5,293		116,176		-
Revolving and junior liens		452		13		-		465		117,021		2,199		119,685		-
Consumer		-		-		-		-		3,064		-		3,064		-
All other1		-		-		-		-		13,556		-		13,556		-
	$	2,543	$	950	$	179	$	3,672	$	1,100,577	$	28,498	$	1,132,747	$	179



															Recorded
															Investment
															90 days or
					90 Days or										Greater Past
	30-59 Days		60-89 Days		Greater Past		Total Past								Due and
December 31, 2013	Past		Past Due		Due		Due		Current		Nonaccrual		Total Loans		Accruing
Commercial	$	-	$	-	$	-	$	-	$	104,778	$	27	$	104,805	$	-
Real estate - commercial
Owner occupied general purpose		290		526		-		816		117,938		3,180		121,934		-
Owner occupied special purpose		511		-		-		511		164,277		7,671		172,459		-
Non-owner occupied general purpose		218		-		-		218		132,331		5,708		138,257		-
Non-owner occupied special purpose		-		-		-		-		73,325		661		73,986		-
Retail properties		-		-		-		-		34,034		3,144		37,178		-
Farm		-		-		-		-		16,419		-		16,419		-
Real estate - construction
Homebuilder		-		-		-		-		3,515		168		3,683		-
Land		-		-		-		-		4,436		209		4,645		-
Commercial speculative		-		-		-		-		11,235		1,913		13,148		-
All other		32		-		-		32		7,404		439		7,875		-
Real estate - residential
Investor		581		171		-		752		140,926		6,615		148,293		-
Owner occupied		4,414		308		87		4,809		106,184		5,967		116,960		87
Revolving and junior liens		650		76		-		726		121,013		3,209		124,948		-
Consumer		5		-		-		5		2,755		-		2,760		-
All other1		-		-		-		-		13,906		-		13,906		-
	$	6,701	$	1,081	$	87	$	7,869	$	1,054,476	$	38,911	$	1,101,256	$	87

1. The “All other” class includes overdrafts and net deferred costs.

Credit Quality Indicators:

The Company categorizes loans into credit risk categories based on current financial information, overall debt service coverage, comparison against industry averages, historical payment experience, and current economic trends. This analysis includes loans with outstanding balances or commitments greater than $50,000 and excludes homogeneous loans such as home equity lines of credit and residential mortgages. Loans with a classified risk rating are reviewed quarterly regardless of size or loan type. The Company uses the following definitions for classified risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Credits that are not covered by the definitions above are pass credits, which are not considered to be adversely rated.

Credit Quality Indicators by class of loans were as follows:



June 30, 2014			Special
	Pass		Mention		Substandard 1		Doubtful		Total
Commercial	$	106,100	$	9,062	$	312	$	-	$	115,474
Real estate - commercial
Owner occupied general purpose		121,431		5,632		3,284		-		130,347
Owner occupied special purpose		162,233		3,270		3,982		-		169,485
Non-owner occupied general purpose		145,381		1,739		8,816		-		155,936
Non-owner occupied special purpose		78,080		9,730		540		-		88,350
Retail Properties		35,221		1,395		3,012		-		39,628
Farm		16,050		-		-		-		16,050
Real estate - construction
Homebuilder		3,408		-		-		-		3,408
Land		2,210		-		209		-		2,419
Commercial speculative		13,627		-		3,523		-		17,150
All other		8,690		-		598		-		9,288
Real estate - residential
Investor		127,109		310		5,312		-		132,731
Owner occupied		110,335		-		5,841		-		116,176
Revolving and junior liens		116,199		389		3,097		-		119,685
Consumer		3,063		-		1		-		3,064
All other		13,556		-		-		-		13,556
Total	$	1,062,693	$	31,527	$	38,527	$	-	$	1,132,747



December 31, 2013			Special
	Pass		Mention		Substandard 1		Doubtful		Total
Commercial	$	96,371	$	7,953	$	481	$	-	$	104,805
Real estate - commercial
Owner occupied general purpose		105,683		9,048		7,203		-		121,934
Owner occupied special purpose		162,586		1,968		7,905		-		172,459
Non-owner occupied general purpose		122,844		1,826		13,587		-		138,257
Non-owner occupied special purpose		59,674		9,840		4,472		-		73,986
Retail Properties		30,059		2,989		4,130		-		37,178
Farm		16,419		-		-		-		16,419
Real estate - construction
Homebuilder		1,745		1,770		168		-		3,683
Land		4,436		-		209		-		4,645
Commercial speculative		7,674		3,561		1,913		-		13,148
All other		7,109		32		734		-		7,875
Real estate - residential
Investor		135,136		3,407		9,750		-		148,293
Owner occupied		109,261		-		7,699		-		116,960
Revolving and junior liens		120,589		388		3,971		-		124,948
Consumer		2,759		-		1		-		2,760
All other		13,906		-		-		-		13,906
Total	$	996,251	$	42,782	$	62,223	$	-	$	1,101,256

1 The substandard credit quality indicator includes both potential problem loans that are currently performing and nonperforming loans

Impaired loans by class of loan were as follows:



							Six Months Ended
	As of June 30, 2014						June 30, 2014
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial	$	21	$	29	$	-	$	24	$	-
Commercial real estate
Owner occupied general purpose		2,511		3,025		-		2,527		2
Owner occupied special purpose		2,930		3,966		-		3,151		-
Non-owner occupied general purpose		6,500		7,138		-		5,964		30
Non-owner occupied special purpose		540		829		-		600		-
Retail properties		3,012		3,679		-		3,078		-
Farm		-		-		-		-		-
Construction
Homebuilder		1,791		1,791		-		1,904		47
Land		209		311		-		209		-
Commercial speculative		-		-		-		369		-
All other		309		349		-		156		-
Residential
Investor		2,605		3,651		-		4,294		1
Owner occupied		9,788		11,131		-		9,483		88
Revolving and junior liens		1,929		2,743		-		1,851		3
Consumer		-		-				-		-
Total impaired loans with no recorded allowance		32,145		38,642		-		33,610		171
With an allowance recorded
Commercial		-		-		-		-		-
Commercial real estate
Owner occupied general purpose		487		522		207		609		-
Owner occupied special purpose		600		679		182		2,450		-
Non-owner occupied general purpose		551		838		414		745		-
Non-owner occupied special purpose		-		-		-		-		-
Retail properties		-		-		-		-		-
Farm		-		-		-		-		-
Construction
Homebuilder		-		-		-		84		-
Land		-		-		-		-		-
Commercial speculative		-		-		-		587		-
All other		289		318		135		363		-
Residential
Investor		1,236		1,594		230		960		-
Owner occupied		492		596		105		1,028		7
Revolving and junior liens		329		359		167		914		-
Consumer		-		-		-		-		-
Total impaired loans with a recorded allowance		3,984		4,906		1,440		7,740		7
Total impaired loans	$	36,129	$	43,548	$	1,440	$	41,350	$	178

Impaired loans by class of loans were as follows:



							Six Months Ended
	As of December 31, 2013						June 30, 2013
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial	$	27	$	34	$	-	$	124	$	-
Commercial real estate
Owner occupied general purpose		2,543		3,006		-		3,681		2
Owner occupied special purpose		3,371		4,117		-		6,335		-
Non-owner occupied general purpose		5,428		6,709		-		12,215		104
Non-owner occupied special purpose		661		919		-		464		-
Retail properties		3,144		3,811		-		7,880		-
Farm		-		-		-		1,259		-
Construction
Homebuilder		2,016		2,016		-		3,736		69
Land		209		308		-		127		-
Commercial speculative		738		742		-		2,739		-
All other		4		35		-		190		-
Residential
Investor		5,984		8,338		-		7,948		5
Owner occupied		9,179		10,451		-		8,968		98
Revolving and junior liens		1,771		2,313		-		1,378		3
Consumer		-		-				11		-
Total impaired loans with no recorded allowance		35,075		42,799		-		57,055		281
With an allowance recorded
Commercial		-		-		-		309		-
Commercial real estate
Owner occupied general purpose		730		792		264		1,166		-
Owner occupied special purpose		4,300		4,702		759		2,811		-
Non-owner occupied general purpose		939		1,030		129		1,993		-
Non-owner occupied special purpose		-		-		-		492		-
Retail properties		-		-		-		1,685		-
Farm		-		-		-		-		-
Construction
Homebuilder		168		604		76		97		-
Land		-		-		-		127		-
Commercial speculative		1,175		1,808		17		2,323		-
All other		436		468		262		487		-
Residential
Investor		684		913		160		3,894		-
Owner occupied		1,565		1,831		170		4,960		12
Revolving and junior liens		1,498		1,848		558		2,284		-
Consumer		-		-		-		-		-
Total impaired loans with a recorded allowance		11,495		13,996		2,395		22,628		12
Total impaired loans	$	46,570	$	56,795	$	2,395	$	79,683	$	293

Troubled debt restructurings (“TDRs”) are loans for which the contractual terms have been modified and both of these conditions exist: (1) there is a concession to the borrower and (2) the borrower is experiencing financial difficulties. Loans are restructured on a case-by-case basis during the loan collection process with modifications generally initiated at the request of the borrower. These modifications may include reduction in interest rates, extension of term, deferrals of principal, and other modifications. The Bank participates in the U.S. Department of the Treasury’s (the “Treasury”) Home Affordable Modification Program (“HAMP”) which gives qualifying homeowners an opportunity to refinance into more affordable monthly payments.

The specific allocation of the allowance for loan losses on a TDR is determined by either discounting the modified cash flows at the original effective rate of the loan before modification or is based on the underlying collateral value less costs to sell, if repayment of the loan is collateral-dependent. If the resulting amount is less than the recorded book value, the Bank either establishes a valuation allowance (i.e. specific reserve) as a component of the allowance for loan losses or charges off the impaired balance if it determines that such amount is a confirmed loss. This method is used consistently for all segments of the portfolio. The allowance for loan losses also includes an allowance based on a loss migration analysis for each loan category on loans that are not individually evaluated for specific impairment. All loans charged-off, including TDRs charged-off, are factored into this calculation by portfolio segment.

TDRs that were modified during the period are as follows:



	TDR Modifications					TDR Modifications
	Three months ending June 30, 2014					Six months ending June 30, 2014

	# of	Pre-modification		Post-modification		# of	Pre-modification		Post-modification
	contracts	recorded investment		recorded investment		contracts	recorded investment		recorded investment
Troubled debt restructurings
Real estate - commercial
Other1	-	$	-	$	-	2	$	1,320	$	1,159
Real estate - residential
Owner occupied
HAMP2	-		-		-	1		102		75
Deferral3	1		107		107	2		344		231
	1	$	107	$	107	5	$	1,766	$	1,465

	TDR Modifications					TDR Modifications
	Three months ending June 30, 2013					Six months ending June 30, 2013

	# of	Pre-modification		Post-modification		# of	Pre-modification		Post-modification
	contracts	recorded investment		recorded investment		contracts	recorded investment		recorded investment
Troubled debt restructurings
Real estate - commercial
Deferral3	1	$	610	$	472	1	$	610	$	472
Real estate - residential
Owner occupied
Deferral3	-		-		-	1		137		137
Revolving and junior liens
Other1	1		30		29	1		30		29
	2	$	640	$	501	3	$	777	$	638

1 Other: Change of terms from bankruptcy court

2 HAMP: Home Affordable Modification Program

3 Deferral: Refers to the deferral of principal

TDRs are classified as being in default on a case-by-case basis when they fail to be in compliance with the modified terms. The following table presents TDRs that defaulted during the periods shown and were restructured within the 12 month period prior to default. There was no TDR default activity for the three and six months ended June 30, 2014.



	TDR Default Activity			TDR Default Activity
	Three months ending June 30, 2013			Six months ending June 30, 2013
Troubled debt restructurings that	# of		Pre-modification outstanding	# of		Pre-modification outstanding
Subsequently Defaulted	contracts		recorded investment	contracts		recorded investment
Real estate - residential
Investor	-	$	-	1	$	155
	-	$	-	1	$	155