NOTE 4 - LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Set forth below is selected data relating to the composition of the loan portfolio at December 31:





	December 31, 2013				December 31, 2012
Real Estate-Residential	$	158,842	31.6	%	$	150,043	31.4	%
Commercial		273,144	54.2			274,484	57.5
Construction		20,551	4.1			13,435	2.8
Commercial, financial and agricultural		35,745	7.1			25,113	5.3
Consumer loans to individuals		15,295	3.0			14,154	3.0
Total loans		503,577	100.0	%		477,229	100.0	%

Deferred fees, net		(480)				(519)
Total loans receivable		503,097				476,710
Allowance for loan losses		(5,708)				(5,502)
Net loans receivable	$	497,389			$	471,208

Purchased loans acquired in a business combination are recorded at 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. There were no material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the “acquisition date”) and December 31, 2013. The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral. The carrying value of purchased loans acquired with deteriorated credit quality was $1.1 million at December 31, 2013.

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 the loans acquired and accounted for in accordance with ASC 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 as of May 31, 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

Changes in the accretable yield for purchased credit-impaired loans were as follows for the twelve months ended December 31:

(In thousands)



	2013		2012		2011
Balance at beginning of period	$	76	$	171	$	329
Accretion		(56)		(95)		(67)
Reclassification and other		-		-		(91)
Balance at end of period	$	20	$	76	$	171

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



	December 31, 2013		December 31, 2012

Outstanding Balance	$	1,110	$	1,145
Carrying Amount	$	1,090	$	1,069

There were not material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the acquisition date) and December 31, 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. Said 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 probable 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. The Company does 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
December 31, 2013
Individually evaluated for impairment	$	-	$	11,519	$	-	$	-	$	-	$	11,519
Loans acquired with deteriorated credit quality		242		848		-		-		-		1,090
Collectively evaluated for impairment		158,600		260,777		20,551		35,745		15,295		490,968
Total Loans	$	158,842	$	273,144	$	20,551	$	35,745	$	15,295	$	503,577



	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.



			Unpaid
	Recorded		Principal		Associated
	Investment		Balance		Allowance
December 31, 2013	(In thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	242	$	251	$	-
Commercial		10,644		14,400		-
Subtotal		10,886		14,651		-
With an allowance recorded:
Real Estate Loans
Commercial		1,723		1,723		53
Subtotal		1,723		1,723		53
Total:
Real Estate Loans
Residential		242		251		-
Commercial		12,367		16,123		53
Total Impaired Loans	$	12,609	$	16,374	$	53



			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 for the year ended December 31, 2013 and 2012:



	Average Recorded				Interest Income
	Investment				Recognized
	2013		2012		2013		2012
	(In thousands)
Total:
Real Estate Loans
Residential	$	252	$	281	$	5	$	5
Commercial		10,328		12,108		236		226
Commercial Loans		-		340		-		2
Total Loans	$	10,580	$	12,729	$	241	$	233

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 December 31, 2013, troubled debt restructured loans totaled $9.2 million and resulted in specific reserves of $53,000. During 2013, there were five new loans identified as troubled debt restructurings totaling $5.1 million based on extended deferrals of principal payments. During 2013, there were no loan modifications classified as troubled debt restructurings that subsequently defaulted. As of December 31, 2012, troubled debt restructured loans totaled $5.6 million and resulted in specific reserves of $9,000. During 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.

The following is a summary of troubled debt restructurings granted during the twelve month period ended December 31, 2013 (in thousands):


	For the Twelve Months Ended December 31, 2013
	Number Of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Real Estate Loans: Commercial	5	$5,147	$5,147

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 Company 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 December 31, 2013 and December 31, 2012 (in thousands):



			Special
	Pass		Mention		Substandard		Doubtful		Loss		Total
December 31, 2013
Commercial real estate loans	$	250,566	$	3,651	$	18,927	$	-	$	-	$	273,144
Commercial loans		35,745		-		-		-		-		35,745
Total	$	286,311	$	3,651	$	18,927	$	-	$	-	$	308,889



			Special
	Pass		Mention		Substandard		Doubtful		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 December 31, 2013 and December 31, 2012 (in thousands):



	Performing		Nonperforming		Total
December 31, 2013
Residential real estate loans	$	157,138	$	1,704	$	158,842
Construction		20,551		-		20,551
Consumer loans		15,295		-		15,295
Total	$	192,984	$	1,704	$	194,688



	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 December 31, 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
December 31, 2013
Real Estate loans
Residential	$	156,066	$	1,018	$	54	$	-	$	1,704	$	2,776	$	158,842
Commercial		263,837		977		487		-		7,843		9,307		273,144
Construction		20,551		-		-		-		-		-		20,551
Commercial loans		35,717		28		-		-		-		28		35,745
Consumer loans		15,228		57		10		-		-		67		15,295
Total	$	491,399	$	2,080	$	551	$	-	$	9,547	$	12,178	$	503,577



	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 changes in the allowance for loan losses:



	Year ended December 31,
	(dollars in thousands)
	2013		2012		2011

Allowance at beginning of period	$	5,502	$	5,458	$	5,616
Charge-offs:
Commercial and all other		(4)		(24)		(2)
Real Estate		(2,131)		(2,354)		(1,735)
Consumer		(90)		(59)		(109)
Total		(2,225)		(2,437)		(1,846)
Recoveries:
Commercial and all other		-		-		5
Real Estate		9		7		51
Consumer		22		24		57
Total		31		31		113
Provision for loan losses		2,400		2,450		1,575
Allowance at end of period	$	5,708	$	5,502	$	5,458

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		(603)		(1,488)		(40)		(4)		(90)		(2,225)
Recoveries		9		-		-		-		22		31
Provision for loan losses		238		1,330		819		(35)		48		2,400
Ending balance, December 31, 2013	$	1,441	$	3,025	$	898	$	184	$	160	$	5,708
Ending balance individually evaluated for impairment	$	-	$	53	$	-	$	-	$	-	$	53
Ending balance collectively evaluated for impairment	$	1,441	$	2,972	$	898	$	184	$	160	$	5,655



(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		(541)		(1,632)		(181)		(24)		(59)		(2,437)
Recoveries		7		-		-		-		24		31
Provision for loan losses		1,074		977		228		100		71		2,450
Ending balance, December 31, 2012	$	1,797	$	3,183	$	119	$	223	$	180	$	5,502
Ending balance individually evaluated for impairment	$	-	$	9	$	-	$	-	$	-	$	9
Ending balance collectively evaluated for impairment	$	1,797	$	3,174	$	119	$	223	$	180	$	5,493

The recorded investment in impaired loans, not requiring an allowance for loan losses was $10,886,000 (net of charge-offs against the allowance for loan losses of $3,714,000) and $11,074,000 (net of charge-offs against the allowance for loan losses of $1,500,000) at December 31, 2013 and 2012, respectively. The recorded investment in impaired loans requiring an allowance for loan losses was $1,723,000 (net of a charge-off against the allowance for loan losses of $0) and $551,000 (net of a charge-off against the allowance for loan losses of $710,000) at December 31, 2013 and 2012, respectively. The specific reserve related to impaired loans was $53,000 for 2013 and $9,000 for 2012. For the years ended December 31, 2013 and 2012, the average recorded investment in these impaired loans was $10,580,000, and $12,729,000 and the interest income recognized on these impaired loans was $241,000 and $233,000, respectively.

Interest income that would have been recorded on loans accounted for on a non-accrual basis under the original terms of the loans was $724,000, $666,000 and $535,000 for 2013, 2012 and 2011, respectively.

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. The Company does not have any significant concentrations to any one customer.

As of December 31, 2013 and 2012, the Company considered its concentration of credit risk to be acceptable. As of December 31, 2013, the three highest concentrations are in the hospitality lodging industry, property owners associations and automobile dealers, with loans outstanding of $36.9 million, or 38.5% of bank capital, to the hospitality lodging industry, $12.7 million, or 13.2% of bank capital to property owners associations, and $10.8 million, or 11.2% of bank capital to the automobile dealer industry. Charge-offs on loans within these concentrations were $0, $0 and $948,000 for the years ended December 31, 2013, 2012 and 2011, respectively..

Gross realized gains and gross realized losses on sales of residential mortgage loans were $74,000 and $7,000, respectively, in 2013 compared to $270,000 and $0, respectively, in 2012 and $241,000 and $21,000, respectively, in 2011. The proceeds from the sales of residential mortgage loans totaled $4.1 million, $7.2 million and $8.9 million for the years ended December 31, 2013, 2012 and 2011, respectively.