Allowance for Credit Losses

The allowance for credit losses is an estimate of probable credit losses inherent in the Company's loan portfolio that have been incurred as of the balance-sheet date. The allowance consists of two primary components, specific reserves related to impaired loans and general reserves for inherent losses related to loans that are not impaired.

The determination of the general reserve for loans that are not impaired is based on estimates made by management, including but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors including economic trends in the Company's service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company's underwriting policies, the character of the loan portfolio, and probable losses inherent in the portfolio taken as a whole. Each quarter management assesses which period of time is most appropriate when factoring in historical loan losses into the general reserve calculation. From time to time, this look back period changes in order to be reflective of management's expectations which are driven by a number of factors including economic data, the relevance of past periods' losses to the current period and the estimated point in the credit cycle that we are in. During the quarter ended September 30, 2012, management determined that the most recent 16 quarters was an appropriate look back period based on several factors including the current global economic uncertainty and various national and local economic indicators. The impact to the general reserve, as a result of moving from a 12 quarter rolling average to a 16 quarter rolling average, did not have a material impact on the level of allowance required, but it did ensure that the significant loss years for the Bank that began in 2009 would continue to be factored into the general reserve analysis.

The following table shows the summary of activities for the allowance for loan losses as of and for the three months ended September 30, 2012 and 2011 by portfolio segment of loans (in thousands):



	Commercial			Real Estate			Consumer			Unallocated			Total
Allowance for credit losses:
Beginning balance, July 1, 2012	$	2,799		$	5,474		$	1,494		$	373		$	10,140
Provision charged to operations	(329		)	532			151			(354		)	—
Losses charged to allowance	(1		)	—			(219		)	—			(220		)
Recoveries	209			—			85			—			294
Ending balance, September 30, 2012	$	2,678		$	6,006		$	1,511		$	19		$	10,214
Allowance for credit losses:
Beginning balance, July 1, 2011	$	2,926		$	5,508		$	1,296		$	1,305		$	11,035
Provision charged to operations	(179		)	965			690			(1,076		)	400
Losses charged to allowance	(38		)	(286		)	(401		)	—			(725		)
Recoveries	69			175			77			—			321
Ending balance, September 30, 2011	$	2,778		$	6,362		$	1,662		$	229		$	11,031

The following table shows the summary of activities for allowance for credit losses as of and for the nine month period ended September 30, 2012 and 2011 by portfolio segment (in thousands):



	Commercial			Real Estate			Consumer			Unallocated			Total
Allowance for credit losses:
Beginning balance, January 1, 2012	$	2,266		$	7,155		$	1,836		$	139		$	11,396
Provision charged to operations	33			643			(56		)	(120		)	500
Losses charged to allowance	(123		)	(1,792		)	(486		)	—			(2,401		)
Recoveries	502			—			217			—			719
Ending balance, September 30, 2012	$	2,678		$	6,006		$	1,511		$	19		$	10,214

Allowance for credit losses:
Beginning balance, January 1, 2011	$	2,437		$	5,836		$	2,503		$	238		$	11,014
Provision charged to operations	376			610			(227		)	(9		)	750
Losses charged to allowance	(254		)	(312		)	(900		)	—			(1,466		)
Recoveries	219			228			286			—			733
Ending balance, September 30, 2011	$	2,778		$	6,362		$	1,662		$	229		$	11,031

The following is a summary of the allowance for credit losses by impairment methodology and portfolio segment as of September 30, 2012 and December 31, 2011 (in thousands):



	Commercial		Real Estate		Consumer		Unallocated		Total
Allowance for credit losses:
Ending balance, September 30, 2012	$	2,678	$	6,006	1,511		$	19	$	10,214
Ending balance: individually evaluated for impairment	$	42	$	909	14		$	—	$	965
Ending balance: collectively evaluated for impairment	$	2,636	$	5,097	1,497		$	19	$	9,249

Ending balance, December 31, 2011	$	2,266	$	7,155	$	1,836	$	139	$	11,396
Ending balance: individually evaluated for impairment	$	231	$	3,764	$	373	$	—	$	4,368
Ending balance: collectively evaluated for impairment	$	2,035	$	3,391	$	1,463	$	139	$	7,028

The following table shows the ending balances of loans as of September 30, 2012 and December 31, 2011 by portfolio segment and by impairment methodology (in thousands):



	Commercial		Real Estate		Consumer		Total
Loans:
Ending balance, September 30, 2012	$	113,077	$	234,185	$	52,460	$	399,722
Ending balance: individually evaluated for impairment	$	2,464	$	13,454	$	1,866	$	17,784
Ending balance: collectively evaluated for impairment	$	110,613	$	220,731	$	50,594	$	381,938

Loans:
Ending balance, December 31, 2011	$	108,047	$	259,241	$	60,871	$	428,159
Ending balance: individually evaluated for impairment	$	3,857	$	17,359	$	2,428	$	23,644
Ending balance: collectively evaluated for impairment	$	104,190	$	241,882	$	58,443	$	404,515

The following table shows the loan portfolio by class allocated by management’s internal risk ratings at September 30, 2012 (in thousands):



	Pass		Special Mention		Substandard		Doubtful		Total
Commercial:
Commercial and industrial	$	65,758	$	844	$	4,837	$	—	$	71,439
Agricultural land and production	41,638		—		—		—		41,638
Real Estate:
Owner occupied	101,350		2,183		5,698		—		109,231
Real estate construction and other land loans	18,057		3,598		11,579		—		33,234
Commercial real estate	43,767		5,940		4,439		—		54,146
Agricultural real estate	27,502		1,906		—		—		29,408
Other real estate	8,166		—		—		—		8,166
Consumer:
Equity loans and lines of credit	41,875		279		2,181		—		44,335
Consumer and installment	8,029		84		12		—		8,125
Total	$	356,142	$	14,834	$	28,746	$	—	$	399,722

The following table shows the loan portfolio by class allocated by management’s internally assigned risk grade ratings at December 31, 2011 (in thousands):



	Pass		Special Mention		Substandard		Doubtful		Total
Commercial:
Commercial and industrial	$	70,093	$	2,595	$	5,401	$	—	$	78,089
Agricultural land and production	29,958		—		—		—		29,958
Real Estate:
Owner occupied	105,308		3,125		4,750		—		113,183
Real estate construction and other land loans	15,717		4,056		13,274		—		33,047
Commercial real estate	47,323		5,035		10,165		—		62,523
Agricultural real estate	40,808		1,788		—		—		42,596
Other real estate	7,672		220		—		—		7,892
Consumer:
Equity loans and lines of credit	46,939		1,047		3,120		—		51,106
Consumer and installment	9,570		105		90		—		9,765
Total	$	373,388	$	17,971	$	36,800	$	—	$	428,159

The following table shows an aging analysis of the loan portfolio by class and the time past due at September 30, 2012 (in thousands):



	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days Accruing		Non-accrual
Commercial:
Commercial and industrial	$	—	$	—	$	—	$	—	$	71,439	$	71,439	$	—	$	—
Agricultural land and production	—		—		—		—		41,638		41,638		—		—
Real estate:	—						—		—		—
Owner occupied	—		—		294		294		108,937		109,231		—		1,896
Real estate construction and other land loans	702		—		—		702		32,532		33,234		—		6,428
Commercial real estate	—		—		—		—		54,146		54,146		—		—
Agricultural real estate	—		—		—		—		29,408		29,408		—		—
Other real estate	—		—		—		—		8,166		8,166		—		—
Consumer:							—		—		—
Equity loans and lines of credit	—		—		—		—		44,335		44,335		—		1,866
Consumer and installment	59		—		—		59		8,066		8,125		—		—
Total	$	761	$	—	$	294	$	1,055	$	398,667	$	399,722	$	—	$	10,190

The following table shows an aging analysis of the loan portfolio by class and the time past due at December 31, 2011 (in thousands):



	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days Accruing		Non- accrual
Commercial:
Commercial and industrial	$	57	$	—	$	236	$	293	$	77,796	$	78,089	$	—	$	267
Agricultural land and production	—		—		—		—		29,958		29,958		—		—
Real estate:	—
Owner occupied	—		—		122		122		113,061		113,183		—		1,372
Real estate construction and other land loans	1,532		—		—		1,532		31,515		33,047		—		6,823
Commercial real estate	—		—		3,544		3,544		58,979		62,523		—		3,544
Agricultural real estate	—		—		—		—		42,596		42,596		—		—
Other real estate	—		—		—		—		7,892		7,892		—		—
Consumer:
Equity loans and lines of credit	123		—		97		220		50,886		51,106		—		2,354
Consumer and installment	29		74		—		103		9,662		9,765		—		74
Total	$	1,741	$	74	$	3,999	$	5,814	$	422,345	$	428,159	$	—	$	14,434

The following table shows information related to impaired loans by class at September 30, 2012 (in thousands):



	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial:
Commercial and industrial	$	744	$	744	$	—
Agricultural land and production	—		—		—
Total commercial	744		744		—
Real estate:
Owner occupied	714		719		—
Real estate construction and other land loans	6,428		7,762		—
Commercial real estate	—		—		—
Agricultural real estate	—		—		—
Other real estate	—		—		—
Total real estate	7,142		8,481		—
Consumer:
Equity loans and lines of credit	1,554		1,835		—
Consumer and installment	—		—		—
Total consumer	1,554		1,835		—
Total with no related allowance recorded	9,440		11,060		—

With an allowance recorded:
Commercial:
Commercial and industrial	1,720		1,720		42
Agricultural land and production	—		—		—
Total commercial	1,720		1,720		42
Real estate:
Owner occupied	1,182		1,314		11
Real estate construction and other land loans	5,130		5,130		898
Commercial real estate	—		—		—
Agricultural real estate	—		—		—
Other real estate	—		—		—
Total real estate	6,312		6,444		909
Consumer:
Equity loans and lines of credit	312		324		14
Consumer and installment	—		—		—
Total consumer	312		324		14
Total with an allowance recorded	8,344		8,488		965
Total	$	17,784	$	19,548	$	965

The following table shows information related to impaired loans by class at December 31, 2011 (in thousands):



	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial:
Commercial and industrial	$	2,140	$	2,160	$	—
Agricultural land and production	—		—		—
Total commercial	2,140		2,160		—
Real estate:
Owner occupied	231		243		—
Real estate construction and other land loans	1,532		1,906		—
Commercial real estate	1,801		1,801		—
Agricultural real estate	—		—		—
Other real estate	—		—		—
Total real estate	3,564		3,950		—
Consumer:
Equity loans and lines of credit	—		—		—
Consumer and installment	—		—		—
Total consumer	—		—		—
Total with no related allowance recorded	5,704		6,110		—

With an allowance recorded:
Commercial:
Commercial and industrial	1,717		1,718		231
Agricultural land and production	—		—		—
Total commercial	1,717		1,718		231
Real estate:
Owner occupied	1,141		1,216		268
Real estate construction and other land loans	10,911		11,490		2,130
Commercial real estate	1,743		1,743		1,366
Agricultural real estate	—		—		—
Other real estate	—		—		—
Total real estate	13,795		14,449		3,764
Consumer:
Equity loans and lines of credit	2,354		2,581		350
Consumer and installment	74		74		23
Total consumer	2,428		2,655		373
Total with an allowance recorded	17,940		18,822		4,368
Total	$	23,644	$	24,932	$	4,368

The following presents by class, information related to the average recorded investment and interest income recognized on impaired loans for the three months ended September 30, 2012 and 2011.



	Three Months Ended September 30, 2012				Three Months Ended September 30, 2011
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial:
Commercial and industrial	$	600	$	—	$	1,291	$	—
Agricultural land and production	—		—		—		—
Total commercial	600		—		1,291		—
Real estate:
Owner occupied	992		—		709		—
Real estate construction and other land loans	4,778		—		3,563		—
Commercial real estate	—		—		2,237		—
Agricultural real estate	—		—		—		—
Other real estate	—		—		—		—
Total real estate	5,770		—		6,509		—
Consumer:
Equity loans and lines of credit	1,615		—		1,987		—
Consumer and installment	—		—		—		—
Total consumer	1,615		—		1,987		—
Total with no related allowance recorded	7,985		—		9,787		—

With an allowance recorded:
Commercial:
Commercial and industrial	1,849		50		1,170		—
Agricultural land and production	—		—		—		—
Total commercial	1,849		50		1,170		—
Real estate:
Owner occupied	646		—		1,282		—
Real estate construction and other land loans	6,833		92		5,596		—
Commercial real estate	—		—		—		—
Agricultural real estate	—		—		932		—
Other real estate	—		—		—		—
Total real estate	7,479		92		7,810		—
Consumer:
Equity loans and lines of credit	289		—		391		—
Consumer and installment	23		—		—		—
Total consumer	312		—		391		—
Total with an allowance recorded	9,640		142		9,371		—
Total	$	17,625	$	142	$	19,158	$	—

The following presents by class, information related to the average recorded investment and interest income recognized on impaired loans for the nine months ended September 30, 2012 and 2011.



	Nine Months Ended September 30, 2012				Nine Months Ended September 30, 2011
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial:
Commercial and industrial	$	1,235	$	—	$	1,404	$	—
Agricultural land and production	—		—		—		—
Total commercial	1,235		—		1,404		—
Real estate:
Owner occupied	747		—		840		—
Real estate construction and other land loans	5,551		—		3,491		—
Commercial real estate	200		—		1,914		—
Agricultural real estate	—		—		—		—
Other real estate	—		—		221		—
Total real estate	6,498		—		6,466		—
Consumer:
Equity loans and lines of credit	1,566		—		347		—
Consumer and installment	—		—		—		—
Total consumer	1,566		—		347		—
Total with no related allowance recorded	9,299		—		8,217		—

With an allowance recorded:
Commercial:
Commercial and industrial	1,624		178		721		—
Agricultural land and production	—		—		—		—
Total commercial	1,624		178		721		—
Real estate:
Owner occupied	662		—		1,182		—
Real estate construction and other land loans	6,387		285		5,751		—
Commercial real estate	193		—		932		—
Agricultural real estate	—		—		—		—
Other real estate	—		—		2,037		—
Total real estate	7,242		285		9,902		—
Consumer:
Equity loans and lines of credit	543		—		219		—
Consumer and installment	48		—		27		—
Total consumer	591		—		246		—
Total with an allowance recorded	9,457		463		10,869		—
Total	$	18,756	$	463	$	19,086	$	—

The recorded investment in loans excludes accrued interest receivable and net loan origination fees, due to immateriality.

Foregone interest on nonaccrual loans totaled $525,000 and $749,000 for the nine month periods ended September 30, 2012 and 2011, respectively. For the three month periods ended September 30, 2012 and 2011, foregone interest on nonaccrual loans totaled $181,000 and $281,000 respectively.

Included in the impaired and nonaccrual loans above at September 30, 2012 are 11 loans considered troubled debt restructurings totaling $17,036,000.

Troubled Debt Restructurings:

The Company has allocated $943,000 of specific reserves to loans whose terms have been modified in troubled debt restructurings as of September 30, 2012. The Company has committed to lend additional amounts totaling up to $700,000 as of September 30, 2012 to customers with outstanding loans that are classified as troubled debt restructurings.

For the nine months ending September 30, 2012 the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan or an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk. During the same period, there were no troubled debt restructurings in which the amount of principal or accrued interest owed from the borrower were forgiven.

The following table presents loans by class modified as troubled debt restructurings that occurred during the nine months ended September 30, 2012 (in thousands):



Troubled Debt Restructurings:	Number of Loans	Pre-Modification Outstanding Recorded Investment (1)		Principal Modification (2)		Post Modification Outstanding Recorded Investment (3)		Outstanding Recorded Investment
Real Estate - Owner occupied	2	$	500	$	—	$	500	$	493


(1)	Amounts represent the recorded investment in loans before recognizing effects of the TDR, if any.


(2)	Principal Modification includes principal forgiveness at the time of modification, contingent principal forgiveness granted over the life of the loan based on borrower performance, and principal that has been legally separated and deferred to the end of the loan, with zero percent contractual interest rate.


(3)	Balance outstanding after principal modification, if any borrower reduction to recorded investment.

The following table presents loans by class modified as troubled debt restructurings that occurred during the nine months ended September 30, 2011 (in thousands):



Troubled Debt Restructurings:	Number of Loans	Pre-Modification Outstanding Recorded Investment (1)	Principal Modification (2)	Post Modification Outstanding Recorded Investment (3)	Outstanding Recorded Investment
Commercial:
Commercial and Industrial	2	3,089		3,089	2,643
Total commercial	2	3,089	—	3,089	2,643
Real Estate:
Owner occupied	1	1,074		1,074	1,034
Real estate construction and other land loans	3	11,094		11,094	10,989
Commercial real estate	1	1,211		1,211	1,211
Other	1	2,271		2,271	1,681
Total real estate	6	15,650	—	15,650	14,915
TOTAL	8	18,739	—	18,739	17,558


(1)	Amounts represent the recorded investment in loans before recognizing effects of the TDR, if any.


(2)	Principal Modification includes principal forgiveness at the time of modification, contingent principal forgiveness granted over the life of the loan based on borrower performance, and principal that has been legally separated and deferred to the end of the loan, with zero percent contractual interest rate.


(3)	Balance outstanding after principal modification, if any borrower reduction to recorded investment.

During the three months ended September 30, 2012, no loans were modified as troubled debt restructurings.

The following table presents loans by class modified as troubled debt restructurings that occurred during the three months ending September 30, 2011 (in thousands):



Troubled Debt Restructurings:	Number of Loans	Pre-Modification Outstanding Recorded Investment (1)	Principal Modification (2)	Post Modification Outstanding Recorded Investment (3)	Outstanding Recorded Investment
Commercial:
Commercial and Industrial	2	3,089	—	3,089	2,643
Total commercial	2	3,089	—	3,089	2,643
Real Estate:
Real estate-construction and other land loans	3	11,094	—	11,094	10,989
Commercial real estate	1	1,211	—	1,211	1,211
Total real estate	4	12,305	—	12,305	12,200
TOTAL	6	15,394	—	15,394	14,843


(1)	Amounts represent the recorded investment in loans before recognizing effects of the TDR, if any.


(2)	Principal Modification includes principal forgiveness at the time of modification, contingent principal forgiveness granted over the life of the loan based on borrower performance, and principal that has been legally separated and deferred to the end of the loan, with zero percent contractual interest rate.


(3)	Balance outstanding after principal modification, if any borrower reduction to recorded investment.

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There was one default on troubled debt restructurings, within twelve months following the modification, during the nine months ended September 30, 2012. There were no defaults on troubled debt restructurings, within twelve months following the modification, during the three months ended September 30, 2012. The recorded investment of the one default is zero at September 30, 2012.

The troubled debt restructurings described above resulted in an increase to the specific reserves added to the allowance for credit losses of $6,000 during the three month and nine month periods ending September 30, 2012 compared to $427,000 specific reserves added to allowance for credit losses during the three month and nine month periods ending September 30, 2011. The commercial real estate restructured debt outstanding at September 30, 2011 was charged off and transferred to other real estate owned the first quarter of 2012. The property has subsequently been sold. Only one other restructured debt outstanding at September 30, 2011 reported above under real estate owner occupied was charged off in the second quarter of 2012.