8. Loans Receivable and Allowance for Loan Losses

Included in the 2011 growth are balances acquired from North Penn as follows (in thousands):

Real Estate –	Residential	$	36,221
	Commercial		70,789
	Construction		358
Commercial, financial and agricultural			10,499
Consumer loans to individuals			1,831
Total loans		$	119,698

Set forth below is selected data relating to the composition of the loan portfolio at the dates indicated:

Types of loans
(dollars in thousands)
	June 30, 2011					December 31, 2010

Real Estate-Residential	$	152,772		32.9	%	$	124,562		34.9	%
Commercial		258,719		55.6			184,094		51.5
Construction		11,832		2.6			12,638		3.5
Commercial, financial and agricultural		27,215		5.8			22,386		6.3
Consumer loans to individuals		14,544		3.1			13,668		3.8
Total loans		465,082		100.0	%		357,348		100.0	%

Deferred fees (net)		(436	)				(493	)
		464,646					356,855
Allowance for loan losses		(5,267	)				(5,616	)
Net loans receivable	$	459,379				$	351,239

Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date without a carryover of the related allowance for loan losses.

Upon acquisition, the Company evaluated whether each acquired loan (regardless of size) was within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality. Purchased credit-impaired loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. The carrying value of purchased loans acquired with deteriorated credit quality was $1.5 million at June 30, 2011. There were no material increases or decreases in the expected cash flows of covered loans between May 31, 2011 (the "acquisition date") and June 30, 2011. The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral.

U.S. generally accepted accounting principles prohibits carrying over an allowance for loan losses for impaired loans purchased in the North Penn acquisition. On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the North Penn acquisition was $1.9 million and the estimated fair value of the loans was $1.5 million. Total contractually required payments on these loans, including interest, at the acquisition date was $3.6 million. However, the Company's preliminary estimate of expected cash flows was $1.9 million. At such date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from the customer nor liquidation of collateral) of $1.7 million relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $329,000 on the acquisition date relating to these impaired loans.

The carrying value of covered loans acquired and accounted for in accordance with ASC Subtopic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, was determined by projecting discounted contractual cash flows. The table below presents the components of the purchase accounting adjustments related to the purchased impaired loans acquired in the North Penn acquisition:

	2011
(In thousands)
Unpaid principal balance	$	1,936
Interest		1,669
Contractual cash flows		3,605
Non-accretable discount		(1,724	)
Expected cash flows		1,881
Accretable discount		(329	)
Estimated fair value	$	1,552

The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified losses based on a review of such information. A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probably that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans identified as impaired are evaluated independently. We do not aggregate such loans for evaluation purposes. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring.

A loan is considered to be a troubled debt restructuring ("TDR") loan when the Company grants a concession to the borrower because of the borrower's financial condition that it would not otherwise consider. Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates that are less than the current market rate for new obligations with similar risk. TDR loans that are in compliance with their modified terms and that yield a market rate may be removed from the TDR status after a period of performance.

The following table shows the amount of loans in each category that were individually and collectively evaluated for impairment at the dates indicated:

	Real Estate Loans
	Residential		Commercial		Construction		Commercial Loans		Consumer Loans		Total
June 30, 2011					(In thousands)
Total Loans	$	152,772	$	258,719	$	11,832	$	27,215	$	14,544	$	465,082



Individually evaluated for impairment	$	-	$	15,782	$	-	$	508	$	-	$	16,290
Collectively evaluated for impairment	$	152,772	$	242,937	$	11,832	$	26,707	$	14,544	$	448,792

	Real Estate Loans
	Residential		Commercial		Construction		Commercial Loans		Consumer Loans		Total
December 31, 2010					(In thousands)
Total Loans	$	124,562	$	184,094	$	12,638	$	22,386	$	13,668	$	357,348



Individually evaluated for impairment	$	-	$	14,239	$	-	$	513	$	-	$	14,752
Collectively evaluated for impairment	$	124,562	$	169,855	$	12,638	$	21,873	$	13,668	$	342,596

The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired.

	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
June 30, 2011 With no related allowance recorded:	(In thousands)
Real Estate Loans
Residential	$	-	$	-	$	-	$	-	$	-
Construction		-		-		-		-		-
Commercial		4,981		4,981		-		4,135		135
Commercial Loans		508		508		-		511		-
Consumer Loans		-		-		-		-		-
Total		5,489		5,489		-		4,646		135
With an allowance recorded:
Real Estate Loans
Residential		-		-		-		-		-
Construction		-		-		-		-		-
Commercial		10,801		10,801		1,678		11,370		92
Commercial Loans		-		-		-		-		-
Consumer Loans		-		-		-		-		-
Total		10,801		10,801		1,678		11,370		92
Total:
Real Estate loans
Residential		-		-		-		-		-
Construction		-		-		-		-		-
Commercial		15,782		15,782		1,678		15,505		227
Commercial Loans		508		508		-		511		-
Consumer Loans		-		-		-		-		-
Total Impaired Loans	$	16,290	$	16,290	$	1,678	$	16,016	$	227

	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2010 With no related allowance recorded:	(In thousands)
Real Estate Loans
Residential	$	-	$	-	$	-	$	-	$	-
Construction		-		-		-		-		-
Commercial		5,598		5,598		-		5,088		266
Commercial Loans		513		513		-		115		-
Consumer Loans		-		-		-		-		-
Total		6,111		6,111		-		5,203		266
With an allowance recorded:
Real Estate Loans
Residential		-		-		-		-		-
Construction		-		-		-		-		-
Commercial		8,641		8,548		1,648		4,734		119
Commercial Loans		-		-		-		159		-
Consumer Loans		-		-		-		-		-
Total		8,641		8,548		1,648		4,893		119
Total:
Real Estate loans
Residential		-		-		-		-		-
Construction		-		-		-		-		-
Commercial		14,239		14,146		1,648		9,822		385
Commercial Loans		513		513		-		274		-
Consumer Loans		-		-		-		-		-
Total Impaired Loans	$	14,752	$	14,659	$	1,648	$	10,096	$	385

Management uses a seven point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first three categories are considered not criticized, and are aggregated as "Pass" rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as non performance, repossession, or death occurs to raise awareness of a possible credit event. The Bank's Loan Review Department is responsible for the timely and accurate risk rating of the loans on an ongoing basis. Every credit which must be approved by Loan Committee or the Board of Directors is assigned a risk rating at time of consideration. Loan Review also annually reviews relationships of $500,000 and over to assign or re-affirm risk ratings. Loans in the Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard, Doubtful and Loss within the internal risk rating system as of June 30, 2011 and December 31, 2010 (in thousands):

	Pass		Special Mention		Substandard		Doubtful		Loss		Total
June 30, 2011
Commercial real estate loans	$	233,564	$	3,859	$	21,296	$	-	$	-	$	258,719
Commercial loans		27,207		-		8		-		-		27,215
Total	$	260,771	$	3,859	$	21,304	$	-	$	-	$	285,934

	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2010
Commercial real estate loans	$	165,226	$	1,780	$	17,088	$	-	$	-	$	184,094
Commercial loans		21,759		75		552		-		-		22,386
Total	$	186,985	$	1,855	$	17,640	$	-	$	-	$	206,480

For residential real estate loans, construction loans and consumer loans, the Company evaluates credit quality based on the performance of the individual credits. The following table presents the recorded investment in the loan classes based on payment activity as of June 30, 2011 and December 31, 2010 (in thousands):

June 30, 2011	Performing		Nonperforming		Total
Residential real estate loans	$	150,907	$	1,865	$	152,772
Construction		11,832		-	$	11,832
Consumer loans		14,511		33	$	14,544
Total	$	177,250	$	1,898	$	179,148

December 31, 2010	Performing		Nonperforming		Total
Residential real estate loans	$	123,623	$	939	$	124,562
Construction		12,638		-	$	12,638
Consumer loans		13,668		-	$	13,668
Total	$	149,929	$	939	$	150,868

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of June 30, 2011 and December 31, 2010 (in thousands):

	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
June 30, 2011
Real Estate loans
Residential	$	150,300	$	461	$	146	$	-	$	1,865	$	2,472	$	152,772
Construction		11,566		266		-		-		-		266		11,832
Commercial		251,068		1,224		-		-		6,427		7,651		258,719
Commercial loans		26,536		171		-		-		508		679		27,215
Consumer loans		14,402		80		29		-		33		142		14,544
Total	$	453,872	$	2,202	$	175	$	-	$	8,833	$	11,210	$	465,082

	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
December 31, 2010
Real Estate loans
Residential	$	123,177	$	407	$	-	$	39	$	939	$	1,385	$	124,562
Construction		12,622		16		-		-		-		16		12,638
Commercial		176,981		3,047		1,478		-		2,588		7,113		184,094
Commercial loans		21,858		15		-		-		513		528		22,386
Consumer loans		13,642		24		2		-		-		26		13,668
Total	$	348,280	$	3,509	$	1,480	$	39	$	4,040	$	9,068	$	357,348

The following table presents changes in the allowance for loan losses:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010
	(dollars in thousands)
Allowance balance at beginning of period	$	5,780		$	5,362		$	5,616		$5,453
Charge-offs:		(958	)		(95	)		(1,033	)	(524)
Recoveries:		15			4			34		12
Provision expense		430			150			650		480
Allowance balance at end of period	$	5,267		$	5,421		$	5,267		$5,421

The following table presents the allowance for loan losses by the classes of the loan portfolio:

(In thousands)	Residential Real Estate			Commercial Real Estate			Construction			Commercial			Consumer			Total


Beginning balance, December 31, 2010	$	1,167		$	3,976		$	110		$	171		$	192		$	5,616
Charge Offs		(226	)		(764	)		-			(2	)		(41	)		(1,033	)
Recoveries		7			-			-			5			22			34
Provision Expense		148			463			(19	)		84			(26	)		650
Ending balance, June 30, 2011	$	1,096		$	3,675		$	91		$	258		$	147		$	5,267
Ending balance individually evaluated for impairment	$	-		$	1,678		$	-		$	-		$	-		$	1,678
Ending balance collectively evaluated for impairment	$	1,096		$	1,997		$	91		$	258		$	147		$	3,589

The Company's primary business activity is with customers located in northeastern Pennsylvania. Accordingly, the Company has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region's economy.

As of June 30, 2011, the Company considered its concentration of credit risk to be acceptable. The highest concentrations are in the hospitality lodging industry, builders/contractors and summer camps, with loans outstanding of $57.9 million, or 69.2% of capital, to the hospitality lodging industry; $18.2 million, or 21.8% of capital, to builders/contractors; and $14.6 million, or 17.5% of capital, to summer camps. As of June 30, 2011, one motel loan with an outstanding balance of $2.2 million was on nonaccrual status and considered impaired. During the second quarter, the Company recognized a write-down of $750,000 on the loan based on the receipt of a current appraisal. There were no losses recognized on loans to builders/contractors or summer camps in 2011.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $94,000 and $0 respectively, in the first six months of 2011 compared to $150,000 and $11,000, respectively, in the same period in 2010. The proceeds from the sales of residential mortgage loans totaled $6.7 million and $10.6 million for the six months ended June 30, 2011 and 2010, respectively.