NOTE 5. Allowance for Loan Losses

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



	Nine Months Ended			Year Ended			Nine Months Ended
	September 30,			December 31,			September 30,
	2013			2012			2012
				(in thousands)
Balance, beginning	$	6,577		$	8,743		$	8,743
Provision charged to operating expense	767			1,660			1,650
Recoveries added to the allowance	204			337			215
Loan losses charged to the allowance	(830		)	(4,163		)	(2,647		)
Balance, ending	$	6,718		$	6,577		$	7,961

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



	September 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	$	46	$	101	$	1,197	$	1,344	$	17,880	$	19,224	$	—	$	1,325
Commercial Real Estate:
Owner Occupied	359		444		649		1,452		91,472		92,924		—		725
Non-owner occupied	1,078		1,013		—		2,091		50,553		52,644		—		191
Construction and Farmland:
Residential	—		—		22		22		6,038		6,060		22		—
Commercial	—		—		167		167		29,682		29,849		125		118
Consumer:
Installment	95		24		—		119		13,818		13,937		—		—
Residential:
Equity Lines	122		8		92		222		31,075		31,297		—		265
Single family	1,845		160		781		2,786		183,555		186,341		—		1,505
Multifamily	—		—		—		—		2,828		2,828		—		—
All Other Loans	—		—		—		—		2,960		2,960		—		—
Total	$	3,545	$	1,750	$	2,908	$	8,203	$	429,861	$	438,064	$	147	$	4,129



	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 September 30, 2013 and December 31, 2012 were as follows:



	As of and for the Nine Months Ended
	September 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	—			(364		)	—		(403		)	(49		)	(14		)	—		(830		)
Recoveries	4			105			5		42			42			6			—		204
Provision	(182		)	127			428		(46		)	(14		)	(40		)	494		767
Ending balance	$	1,102		$	2,688		$	1,615	$	473		$	86		$	74		$	680	$	6,718
Ending balance: Individually evaluated for impairment	$	204		$	1,095		$	280	$	94		$	—		$	—		$	—	$	1,673
Ending balance: collectively evaluated for impairment	$	898		$	1,593		$	1,335	$	379		$	86		$	74		$	680	$	5,045
Financing receivables:
Ending balance	$	35,909		$	220,466		$	145,568	$	19,224		$	13,937		$	2,960		$	—	$	438,064
Ending balance individually evaluated for impairment	$	1,368		$	7,207		$	5,971	$	1,419		$	—		$	—		$	—	$	15,965
Ending balance collectively evaluated for impairment	$	34,541		$	213,259		$	139,597	$	17,805		$	13,937		$	2,960		$	—	$	422,099



	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 September 30, 2013 and December 31, 2012 were as follows:



	As of
	September 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	$	1,325	$	1,325	$	—	$	1,520	$	57
Commercial Real Estate:
Owner Occupied	2,427		2,431		—		2,694		75
Non-owner occupied	2,246		2,255		—		2,340		84
Construction and Farmland:
Residential	—		—		—		—		—
Commercial	1,015		1,016		—		1,051		29
Residential:
Equity lines	449		450		—		645		5
Single family	3,269		3,274		—		3,621		35
Multifamily	—		—		—		—		—
Other Loans	—		—		—		—		—
	$	10,731	$	10,751	$	—	$	11,871	$	285
With an allowance recorded:
Commercial - Non Real Estate:
Commercial & Industrial	$	94	$	95	$	94	$	96	$	4
Commercial Real Estate:
Owner Occupied	—		—		—		—		—
Non-owner occupied	1,298		1,300		280		1,313		49
Construction and Farmland:
Residential	—		—		—		—		—
Commercial	353		353		204		358		12
Residential:
Equity lines	216		217		216		217		5
Single family	3,273		3,286		879		3,314		109
Multifamily	—		—		—		—		—
Other Loans	—		—		—		—		—
	$	5,234	$	5,251	$	1,673	$	5,298	$	179
Total:
Commercial	$	1,419	$	1,420	$	94	$	1,616	$	61
Commercial Real Estate	5,971		5,986		280		6,347		208
Construction and Farmland	1,368		1,369		204		1,409		41
Residential	7,207		7,227		1,095		7,797		154
Other	—		—		—		—		—
Total	$	15,965	$	16,002	$	1,673	$	17,169	$	464

The average recorded investment of impaired loans for the third quarter of 2013 was $17.1 million. The interest income recognized on impaired loans for the three months ended September 30, 2013 was $141 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 September 30, 2013 and December 31, 2012 was as follows:



	As of
	September 30, 2013
	(in thousands)
INTERNAL RISK RATING GRADES	Pass		Watch		Special Mention		Substandard		Doubtful		Loss		Total
Commercial - Non Real Estate:
Commercial & Industrial	$	15,087	$	2,555	$	92	$	1,362	$	128	$	—	$	19,224
Commercial Real Estate:
Owner Occupied	79,927		6,082		2,998		3,841		76		—		92,924
Non-owner occupied	29,755		13,507		4,208		5,174		—		—		52,644
Construction and Farmland:
Residential	5,938		122		—		—		—		—		6,060
Commercial	23,382		1,955		591		3,921		—		—		29,849
Residential:
Equity Lines	29,518		691		418		578		92		—		31,297
Single family	154,790		11,753		9,939		9,051		808		—		186,341
Multifamily	1,911		917		—		—		—		—		2,828
All other loans	2,960		—		—		—		—		—		2,960
Total	$	343,268	$	37,582	$	18,246	$	23,927	$	1,104	$	—	$	424,127



	Performing		Nonperforming
Consumer Credit Exposure by Payment Activity	$	13,818	$	119



	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