NOTE 5. Allowance for Loan Losses

Changes in the allowance for loan losses for the six months ended June 30, 2013 and 2012 and the year ended December 31, 2012 were as follows:



	Six Months Ended			Year Ended			Six Months Ended
	June 30,			December 31,			June 30,
	2013			2012			2012
				(in thousands)
Balance, beginning	$	6,577		$	8,743		$	8,743
Provision charged to operating expense	767			1,660			600
Recoveries added to the allowance	80			337			131
Loan losses charged to the allowance	(446		)	(4,163		)	(846		)
Balance, ending	$	6,978		$	6,577		$	8,628

Nonaccrual and past due loans by class at June 30, 2013 and December 31, 2012 were as follows:



	June 30, 2013
	(in thousands)
	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due		Total Past Due		Current		Total Loans		90 or More Days Past Due Still Accruing		Nonaccrual Loans
Commercial - Non Real Estate:
Commercial & Industrial	$	66	$	—	$	230	$	296	$	20,526	$	20,822	$	—	$	230
Commercial Real Estate:
Owner Occupied	753		452		—		1,205		93,660		94,865		—		81
Non-owner occupied	1,022		197		—		1,219		51,498		52,717		—		197
Construction and Farmland:
Residential	—		22		—		22		4,921		4,943		—		—
Commercial	41		42		—		83		26,852		26,935		—		121
Consumer:
Installment	138		1		5		144		13,293		13,437		5		—
Residential:
Equity Lines	310		21		—		331		31,508		31,839		—		271
Single family	2,387		373		666		3,426		181,163		184,589		196		1,495
Multifamily	—		—		—		—		2,782		2,782		—		—
All Other Loans	—		—		—		—		3,428		3,428		—		—
Total	$	4,717	$	1,108	$	901	$	6,726	$	429,631	$	436,357	$	201	$	2,395



	December 31, 2012
	(in thousands)
	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due		Total Past Due		Current		Total Loans		90 or More Past Due Still Accruing		Nonaccrual Loans
Commercial - Non Real Estate:
Commercial & Industrial	$	822	$	225	$	—	$	1,047	$	20,593	$	21,640	$	—	$	230
Commercial Real Estate:
Owner Occupied	610		374		90		1,074		84,090		85,164		—		90
Non-owner occupied	234		582		—		816		38,402		39,218		—		209
Construction and Farmland:
Residential	—		—		—		—		9,706		9,706		—		—
Commercial	93		44		—		137		28,033		28,170		—		131
Consumer:
Installment	116		10		9		135		13,172		13,307		9		—
Residential:
Equity Lines	109		—		—		109		31,593		31,702		—		287
Single family	4,059		733		524		5,316		177,601		182,917		199		1,467
Multifamily	—		—		—		—		2,808		2,808		—		—
All Other Loans	—		—		—		—		3,465		3,465		—		—
Total	$	6,043	$	1,968	$	623	$	8,634	$	409,463	$	418,097	$	208	$	2,414

Allowance for loan losses by segment at June 30, 2013 and December 31, 2012 were as follows:



	As of and For the Six Months Ended
	June 30, 2013
	(in thousands)
	Construction and Farmland		Residential Real Estate			Commercial Real Estate		Commercial			Consumer			All Other Loans			Unallocated			Total
Allowance for credit losses:
Beginning Balance	$	1,280	$	2,820		$	1,182	$	880		$	107		$	122		$	186		$	6,577
Charge-Offs	—		(218		)	—		(174		)	(43		)	(11		)	—			(446		)
Recoveries	3		15			3		24			30			5			—			80
Provision	28		304			433		219			—			(29		)	(188		)	767
Ending balance	$	1,311	$	2,921		$	1,618	$	949		$	94		$	87		$	(2	)	$	6,978
Ending balance: Individually evaluated for impairment	$	204	$	1,386		$	289	$	520		$	—		$	—		$	—		$	2,399
Ending balance: collectively evaluated for impairment	$	1,107	$	1,535		$	1,329	$	429		$	94		$	87		$	(2	)	$	4,579
Financing receivables:
Ending balance	$	31,878	$	219,210		$	147,582	$	20,822		$	13,437		$	3,428		$	—		$	436,357
Ending balance individually evaluated for impairment	$	1,381	$	7,208		$	5,032	$	681		$	—		$	—		$	—		$	14,302
Ending balance collectively evaluated for impairment	$	30,497	$	212,002		$	142,550	$	20,141		$	13,437		$	3,428		$	—		$	422,055



	As of and for the Twelve Months Ended
	December 31, 2012
	(in thousands)
	Construction and Farmland			Residential Real Estate			Commercial Real Estate			Commercial			Consumer			All Other Loans			Unallocated			Total
Allowance for credit losses:
Beginning Balance	$	2,618		$	3,544		$	1,057		$	1,077		$	131		$	123		$	193		$	8,743
Charge-Offs	(1,313		)	(1,381		)	(1,118		)	(207		)	(116		)	(28		)	—			(4,163		)
Recoveries	4			67			146			36			73			11			—			337
Provision	(29		)	590			1,097			(26		)	19			16			(7		)	1,660
Ending balance	$	1,280		$	2,820		$	1,182		$	880		$	107		$	122		$	186		$	6,577
Ending balance: Individually evaluated for impairment	$	141		$	1,176		$	305		$	737		$	—		$	—		$	—		$	2,359
Ending balance: collectively evaluated for impairment	$	1,139		$	1,644		$	877		$	143		$	107		$	122		$	186		$	4,218
Financing receivables:
Ending balance	$	37,876		$	217,427		$	124,382		$	21,640		$	13,307		$	3,465		$	—		$	418,097
Ending balance individually evaluated for impairment	$	1,326		$	7,695		$	5,246		$	985		$	—		$	—		$	—		$	15,252
Ending balance collectively evaluated for impairment	$	36,550		$	209,732		$	119,136		$	20,655		$	13,307		$	3,465		$	—		$	402,845

Impaired loans by class at June 30, 2013 and December 31, 2012 were as follows:



	As of
	June 30, 2013
	(in thousands)
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial - Non Real Estate:
Commercial & Industrial	$	160	$	173	$	—	$	332	$	5
Commercial Real Estate:
Owner Occupied	1,467		1,472		—		1,689		38
Non-owner occupied	2,259		2,269		—		2,347		54
Construction and Farmland:
Residential	—		—		—		—		—
Commercial	1,028		1,029		—		1,057		20
Residential:
Equity lines	456		456		—		647		3
Single family	2,069		2,072		—		3,535		16
Multifamily	—		—		—		—		—
Other Loans	—		—		—		—		—
	$	7,439	$	7,471	$	—	$	9,607	$	136
With an allowance recorded:
Commercial - Non Real Estate:
Commercial & Industrial	$	521	$	521	$	521	$	574	$	9
Commercial Real Estate:
Owner Occupied	—		—		—		—		—
Non-owner occupied	1,306		1,309		289		1,318		33
Construction and Farmland:
Residential	—		—		—		—		—
Commercial	353		355		204		360		8
Residential:
Equity lines	220		221		220		216		3
Single family	4,463		4,478		1,165		4,498		103
Multifamily	—		—		—		—		—
Other Loans	—		—		—		—		—
	$	6,863	$	6,884	$	2,399	$	6,966	$	156
Total:
Commercial	$	681	$	694	$	521	$	906	$	14
Commercial Real Estate	5,032		5,050		289		5,354		125
Construction and Farmland	1,381		1,384		204		1,417		28
Residential	7,208		7,227		1,385		8,896		125
Other	—		—		—		—		—
Total	$	14,302	$	14,355	$	2,399	$	16,573	$	292

The average recorded investment of impaired loans for the second quarter of 2013 was $16.4 million. The interest income recognized on impaired loans for the three months ended June 30, 2013 was $139 thousand.



	As of
	December 31, 2012
	(in thousands)
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial - Non Real Estate:
Commercial & Industrial	$	—	$	—	$	—	$	—	$	—
Commercial Real Estate:
Owner Occupied	1,632		1,636		—		2,323		130
Non-owner occupied	2,290		2,296		—		2,378		147
Construction and Farmland:
Residential	—		—		—		—		—
Commercial	1,102		1,103		—		1,159		18
Residential:
Equity lines	287		287		—		469		1
Single family	4,406		4,417		—		5,683		210
Multifamily	—		—		—		—		—
Other Loans	—		—		—		—		—
	$	9,717	$	9,739	$	—	$	12,012	$	506
With an allowance recorded:
Commercial - Non Real Estate:
Commercial & Industrial	$	985	$	994	$	737	$	1,062	$	53
Commercial Real Estate:
Owner Occupied	—		—		—		—		—
Non-owner occupied	1,324		1,327		305		1,337		38
Construction and Farmland:
Residential	—		—		—		—		—
Commercial	224		225		141		227		9
Residential:
Equity lines	358		359		252		366		12
Single family	2,644		2,652		924		2,674		125
Multifamily	—		—		—		—		—
Other Loans	—		—		—		—		—
	$	5,535	$	5,557	$	2,359	$	5,666	$	237
Total:
Commercial	$	985	$	994	$	737	$	1,062	$	53
Commercial Real Estate	5,246		5,259		305		6,038		315
Construction and Farmland	1,326		1,328		141		1,386		27
Residential	7,695		7,715		1,176		9,192		348
Other	—		—		—		—		—
Total	$	15,252	$	15,296	$	2,359	$	17,678	$	743

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is in nonaccrual status, all payments are applied to principal under the cost-recovery method. For financial statement purposes, the recorded investment in nonaccrual loans is the actual principal balance reduced by payments that would otherwise have been applied to interest. When reporting information on these loans to the applicable customers, the unpaid principal balance is reported as if payments were applied to principal and interest under the original terms of the loan agreements. Therefore, the unpaid principal balance reported to the customer would be higher than the recorded investment in the loan for financial statement purposes. When the ultimate collectability of the total principal of the impaired loan is not in doubt and the loan is in nonaccrual status, contractual interest is credited to interest income when received under the cash-basis method.

The Company uses a rating system for evaluating the risks associated with non-consumer loans. Consumer loans are not evaluated for risk unless the characteristics of the loan fall within classified categories. Descriptions of these ratings are as follows:




Pass	Pass loans exhibit acceptable operating trends, balance sheet trends, and liquidity. Sufficient cash flow exists to service the loan. All obligations have been paid by the borrower in an as agreed manner.

Watch	Watch loans exhibit income volatility, negative operating trends, and a highly leveraged balance sheet. A higher level of supervision is required for these loans as the potential for a negative event could impact the borrower’s ability to repay the loan.

Special mention	Special mention loans exhibit a potential weakness, which if left uncorrected, may negatively affect the borrower’s ability to repay its debt obligation. The risk of default is not imminent and the borrower still demonstrates sufficient cash flow to support the loan.

Substandard	Substandard loans exhibit well defined weaknesses and have a potential of default. The borrowers exhibit adverse financial trends but still have the ability to service debt obligations.

Doubtful	Doubtful loans exhibit all of the characteristics inherent in substandard loans but the weaknesses make collection or full liquidation highly questionable.

Loss	Loss loans are considered uncollectible and of such little value that its continuance as a bankable asset is not warranted.

Credit quality information by class at June 30, 2013 and December 31, 2012 was as follows:



	As of
	June 30, 2013
	(in thousands)
INTERNAL RISK RATING GRADES	Pass		Watch		Special Mention		Substandard		Doubtful		Loss		Total
Commercial - Non Real Estate:
Commercial & Industrial	$	16,560	$	2,002	$	433	$	1,597	$	230	$	—	$	20,822
Commercial Real Estate:
Owner Occupied	80,103		8,466		2,364		3,851		81		—		94,865
Non-owner occupied	31,209		11,186		3,594		6,728		—		—		52,717
Construction and Farmland:
Residential	4,821		122		—		—		—		—		4,943
Commercial	20,251		2,151		594		3,939		—		—		26,935
Residential:
Equity Lines	30,277		501		373		596		92		—		31,839
Single family	151,628		12,741		9,961		9,725		534		—		184,589
Multifamily	1,854		928		—		—		—		—		2,782
All other loans	3,428		—		—		—		—		—		3,428
Total	$	340,131	$	38,097	$	17,319	$	26,436	$	937	$	—	$	422,920



	Performing		Nonperforming
Consumer Credit Exposure by Payment Activity	$	13,293	$	144



	As of
	December 31, 2012
	(in thousands)
INTERNAL RISK RATING GRADES	Pass		Watch		Special Mention		Substandard		Doubtful		Loss		Total
Commercial - Non Real Estate:
Commercial & Industrial	$	16,132	$	2,289	$	1,099	$	1,891	$	229	$	—	$	21,640
Commercial Real Estate:
Owner Occupied	72,916		6,503		1,737		3,918		90		—		85,164
Non-owner occupied	22,810		5,303		4,332		6,773		—		—		39,218
Construction and Farm land:
Residential	9,548		158		—		—		—		—		9,706
Commercial	21,155		1,777		854		4,384		—		—		28,170
Residential:
Equity Lines	30,165		426		172		843		96		—		31,702
Single family	148,904		12,048		10,672		10,780		513		—		182,917
Multifamily	1,905		903		—		—		—		—		2,808
All other loans	3,465		—		—		—		—		—		3,465
Total	$	327,000	$	29,407	$	18,866	$	28,589	$	928	$	—	$	404,790



	Performing		Nonperforming
Consumer Credit Exposure by Payment Activity	$	13,172	$	135