7. Loans Receivable and Allowance for Loan Losses

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



	Types of loans
	(dollars in thousands)

	September 30, 2013			December 31, 2012
Real Estate-Residential	$	160,034	32.8%	$	150,043	31.4%
Commercial		267,385	54.9		274,484	57.5
Construction		20,146	4.1		13,435	2.8
Commercial, financial and agricultural		24,520	5.0		25,113	5.3
Consumer loans to individuals		15,379	3.2		14,154	3.0
Total loans		487,464	100.0%		477,229	100.0%
Deferred fees, net		(496)			(519)
Total loans receivable		486,968			476,710
Allowance for loan losses		(5,559)			(5,502)
Net loans receivable	$	481,409		$	471,208

Changes in the accretable yield for purchased credit-impaired loans were as follows for the nine months ended September 30 (in thousands):



	2013		2012
Balance at beginning of period	$	76	$	171
Accretion		(49)		(71)
Reclassification and other		-		-
Balance at end of period	$	27	$	100

The following table presents additional information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands):



	September 30, 2013		December 31, 2012

Outstanding Balance	$	1,121	$	1,145
Carrying Amount	$	1,094	$	1,069

There were no material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the “acquisition date”) and September 30, 2013. There has been no allowance for loan losses recorded for acquired loans with specific evidence of deterioration in credit quality as of May 31, 2011. In addition, there has been no allowance for loan losses on these loans reversed. For loans that were acquired without specific evidence of deterioration in credit quality, adjustments to the allowance for loan losses have been accounted for through the allowance for loan loss adequacy calculation.

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.

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
							Commercial		Consumer
	Residential		Commercial		Construction		Loans		Loans		Total
September 30, 2013	(In thousands)

Individually evaluated for impairment	$	-	$	8,275	$	-	$	-	$	-	$	8,275
Loans acquired with deteriorated credit quality		245		849		-		-		-		1,094
Collectively evaluated for impairment		159,789		258,261		20,146		24,520		15,379		478,095
Total Loans	$	160,034	$	267,385	$	20,146	$	24,520	$	15,379	$	487,464



	Real Estate Loans
							Commercial		Consumer
	Residential		Commercial		Construction		Loans		Loans		Total
	(In thousands)
December 31, 2012

Individually evaluated for impairment	$	-	$	10,246	$	-	$	310	$	-	$	10,556
Loans acquired with deteriorated credit quality		270		799		-		-		-		1,069
Collectively evaluated for impairment		149,773		263,439		13,435		24,803		14,154		465,604
Total Loans	$	150,043	$	274,484	$	13,435	$	25,113	$	14,154	$	477,229

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.



			Unpaid Principal
	Recorded		Principal		Associated
	Investment		Balance		Allowance
September 30, 2013				(in thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	245	$	254	$	-
Commercial		9,124		9,141		-
Subtotal		9,369		9,395		-
With an allowance recorded:
Subtotal		-		-		-
Total:
Real Estate Loans
Residential		245		254		-
Commercial		9,124		9,141		-
Total Impaired Loans	$	9,369	$	9,395	$	-



			Unpaid Principal
	Recorded		Principal		Associated
	Investment		Balance		Allowance
December 31, 2012				(in thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	270	$	286	$	-
Commercial		10,494		10,554		-
Commercial Loans		310		310		-
Subtotal		11,074		11,150		-
With an allowance recorded:
Real Estate Loans
Commercial		551		551		9
Subtotal		551		551		9
Total:
Real Estate Loans
Residential		270		286		-
Commercial		11,045		11,105		9
Commercial Loans		310		310		-
Total Impaired Loans	$	11,625	$	11,701	$	9

The following information for impaired loans is presented (in thousands) for the nine months ended September 30, 2013 and 2012:



	Average Recorded				Interest Income
	Investment				Recognized
	2013		2012		2013		2012
Total:
Real Estate Loans
Residential	$	255	$	284	$	4	$	4
Commercial		10,120		12,937		47		206
Commercial Loans		-		401		-		-
Total Loans	$	10,375	$	13,622	$	51	$	210

The following information for impaired loans is presented (in thousands) for the three months ended September 30, 2013 and 2012:



	Average Recorded				Interest Income
	Investment				Recognized
	2013		2012		2013		2012
Total:
Real Estate Loans
Residential	$	245	$	275	$	2	$	1
Commercial		9,124		13,536		30		71
Commercial Loans		-		385		-		-
Total Loans	$	9,369	$	14,916	$	32	$	72

Troubled debt restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources. As of September 30, 2013, troubled debt restructured loans totaled $7.7 million and had no specific reserves. During 2013, four loans with a balance of $3.4 million were classified as a troubled debt restructuring. One credit in the amount of $1.2 million resulted in a decrease in the borrower’s debt but the remaining balance was classified as troubled debt since it would be unlikely that the borrower could obtain comparable financing elsewhere. Three credits in the amount of $2.2 million were classified as troubled debt restructurings based on extended periods of principal deferrals on the loans. As of December 31, 2012, troubled debt restructured loans totaled $5.6 million and resulted in specific reserves of $9,000. For the period ended September 30, 2013, there were no loans identified as troubled debt restructurings that subsequently defaulted during the period. For the period ended September 30, 2012, there were no new loans identified as troubled debt restructurings, nor were there any loan modifications classified as troubled debt restructurings that subsequently defaulted during the period.

The following is a summary of troubled debt restructurings granted during the three and nine month periods ended September 30, 2013 (dollars in thousands):



	For the Three Months Ended September 30, 2013
			Pre-Modification		Post-Modification
			Outstanding Recorded		Outstanding Recorded
	Number of Contracts		Investment		Investment
Troubled Debt Restructurings

Real Estate Loans:
Commercial	3	$	2,165	$	2,165



	For the Nine Months Ended September 30, 2013
			Pre-Modification		Post-Modification
			Outstanding Recorded		Outstanding Recorded
	Number of Contracts		Investment		Investment
Troubled Debt Restructurings

Real Estate Loans:
Commercial	4	$	3,424	$	3,424

Management uses an eight point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first four 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 Company’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 September 30, 2013 and December 31, 2012 (in thousands):



			Special					Doubtful
	Pass		Mention		Substandard		and Loss		Total
September 30, 2013
Commercial real estate loans	$	240,217	$	17,371	$	9,797	$	-	$	267,385
Commercial loans		24,520		-		-		-		24,520
Total	$	264,737	$	17,371	$	9,797	$	-	$	291,905



			Special					Doubtful
	Pass		Mention		Substandard		and Loss		Total
December 31, 2012
Commercial real estate loans	$	251,484	$	11,245	$	11,755	$	-	$	274,484
Commercial loans		24,427		318		368		-		25,113
Total	$	275,911	$	11,563	$	12,123	$	-	$	299,597

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 September 30, 2013 and December 31, 2012 (in thousands):



	Performing		Nonperforming		Total
September 30, 2013
Residential real estate loans	$	158,083	$	1,951	$	160,034
Construction		20,146		-		20,146
Consumer loans		15,379		-		15,379
Total	$	193,608	$	1,951	$	195,559



	Performing		Nonperforming		Total
December 31, 2012
Residential real estate loans	$	147,197	$	2,846	$	150,043
Construction		13,435		-		13,435
Consumer loans		14,154		-		14,154
Total	$	174,786	$	2,846	$	177,632

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 September 30, 2013 and December 31, 2012 (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
September 30, 2013
Real Estate loans
Residential	$	157,035	$	1,038	$	10	$	-	$	1,951	$	2,999	$	160,034
Commercial		254,215		2,038		2,798		-		8,334		13,170		267,385
Construction		20,146		-		-		-		-		-		20,146
Commercial loans		24,490		30		-		-		-		30		24,520
Consumer loans		15,336		43		-		-		-		43		15,379
Total	$	471,222	$	3,149	$	2,808	$	-	$	10,285	$	16,242	$	487,464



	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, 2012
Real Estate loans
Residential	$	146,847	$	94	$	256	$	-	$	2,846	$	3,196	$	150,043
Commercial		261,527		2,333		598		-		10,026		12,957		274,484
Construction		13,363		72		-		-		-		72		13,435
Commercial loans		24,785		-		-		-		328		328		25,113
Consumer loans		14,029		114		11		-		-		125		14,154
Total	$	460,551	$	2,613	$	865	$	-	$	13,200	$	16,678	$	477,229

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, 2012	$	1,797	$	3,183	$	119	$	223	$	180	$	5,502
Charge Offs		(547)		(1,308)		(40)		-		(74)		(1,969)
Recoveries		9		-		-		-		17		26
Provision Expense		406		1,288		329		(76)		53		2,000
Ending balance, September 30, 2013	$	1,665	$	3,163	$	408	$	147	$	176	$	5,559
Ending balance individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-
Ending balance collectively evaluated for impairment	$	1,665	$	3,163	$	408	$	147	$	176	$	5,559



(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, June 30, 2013	$	1,764	$	3,318	$	363	$	147	$	157	$	5,749
Charge Offs		(157)		(380)		(40)		-		(28)		(605)
Recoveries		9		-		-		-		6		15
Provision Expense		49		225		85		-		41		400
Ending balance, September 30, 2013	$	1,665		3,163		408		147		176	$	5,559



(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, December 31, 2011	$	1,257	$	3,838	$	72	$	147	$	144	$	5,458
Charge Offs		(402)		(1,316)		(7)		(23)		(46)		(1,794)
Recoveries		6		1		-		-		20		27
Provision Expense		836		594		10		158		52		1,650
Ending balance, September 30, 2012	$	1,697	$	3,117	$	75	$	282	$	170	$	5,341
Ending balance individually evaluated for impairment	$	-	$	89	$	-	$	-	$	-	$	89
Ending balance collectively evaluated for impairment	$	1,697	$	3,028	$	75	$	282	$	170	$	5,252



(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, June 30, 2012	$	1,559	$	3,691	$	87	$	263	$	175	$	5,775
Charge Offs		(94)		(1,220)		-		(23)		(13)		(1,350)
Recoveries		5		1		-		-		10		16
Provision Expense		227		645		(12)		42		(2)		900
Ending balance, September 30, 2012	$	1,697	$	3,117	$	75	$	282	$	170	$	5,341

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 September 30, 2013, the Company considered its concentration of credit risk to be acceptable. The highest concentrations are in the hospitality lodging industry and property owners associations with loans outstanding of $37.4 million, or 39.5% of capital, to the hospitality lodging industry and $12.6 million, or 13.3% of capital, to property owners associations. There were no losses recognized on loans within these concentrations during the current period.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $32,000 and $7,000, respectively, in the first nine months of 2013 compared to $163,000 and $0, respectively, in the same period in 2012. The proceeds from the sales of residential mortgage loans totaled $1.6 million and $4.5 million for the nine months ended September 30, 2013 and 2012, respectively.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $0 and $0 respectively, for the three months ended September 30, 2013 compared to $88,000 and $0, respectively, in the same period in 2012. The proceeds from the sales of residential mortgage loans totaled $0 and $2.2 million for the three months ended September 30, 2013 and 2012, respectively.