(4)	LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans at December 31, 2011 and 2010 consisted of the following:


(In thousands)	2011			2010
Real estate mortgage loans:
Residential	$	116,338		$	130,143
Land		9,910			9,534
Residential construction		10,988			8,151
Commercial real estate		57,680			59,901
Commercial real estate construction		743			0
Commercial business loans		20,722			21,911
Consumer loans:
Home equity and second mortgage loans		38,641			43,046
Automobile loans		20,627			19,384
Loans secured by savings accounts		767			1,042
Unsecured loans		3,126			3,076
Other consumer loans		5,312			5,732

Gross loans		284,854			301,920

Deferred loan origination fees, net		143			222
Undisbursed portion of loans in process		(4,768	)		(3,119	)
Allowance for loan losses		(4,182	)		(4,473	)

Loans, net	$	276,047		$	294,550

At December 31, 2011, residential mortgage loans secured by residential properties without private mortgage insurance or government guarantee and with loan-to-value ratios exceeding 90% amounted to approximately $4.6 million.

Mortgage loans serviced for the benefit of others amounted to $269,000 and $279,000 at December 31, 2011 and 2010, respectively.

The Bank has entered into loan transactions with certain directors, officers and their affiliates (i.e., related parties). In the opinion of management, such indebtedness was incurred in the ordinary course of business on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with unrelated persons.

The following table represents the aggregate activity for related party loans during the year ended December 31, 2011. The beginning balance has been adjusted to reflect new directors and officers, as well as directors and officers that are no longer with the Company.


(In thousands)
Beginning balance, as adjusted			$6,441
New loans			8,728
Payments			(9,309)

Ending balance			$5,860

A director of the Bank is a shareholder of a farm implement dealership that contracts with the Bank to provide sales financing to the dealership’s customers. In the opinion of management, these transactions were made in the ordinary course of business on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with unrelated parties. During the year ended December 31, 2011, the Bank purchased approximately $444,000 of loans to customers of the corporation and the aggregate outstanding balance of all loans purchased from the corporation was approximately $1.2 million and $1.4 million at December 31, 2011 and 2010, respectively.

The following table provides the components of the Company’s recorded investment in loans for each portfolio segment at December 31, 2011 and 2010:


	Residential Real Estate		Land		Construction		Commercial Real Estate		Commercial Business			Home Equity and Second Mortgage		Other Consumer		Total
	(In thousands)
December 31, 2011:
Principal loan balance	$	116,338	$	9,910	$	6,963	$	57,680	$	20,722		$	38,641	$	29,832	$	280,086
Accrued interest receivable		463		60		16		160		64			162		202		1,127
Net deferred loan origination fees and costs		67		2		0		0		(10	)		84		0		143

Recorded investment in loans	$	116,868	$	9,972	$	6,979	$	57,840	$	20,776		$	38,887	$	30,034	$	281,356

December 31, 2010:
Principal loan balance	$	130,143	$	9,534	$	5,032	$	59,901	$	21,911		$	43,046	$	29,234	$	298,801
Accrued interest receivable		480		54		16		174		68			171		199		1,162
Net deferred loan origination fees and costs		91		1		—		10		—			120		—		222

Recorded investment in loans	$	130,714	$	9,589	$	5,048	$	60,085	$	21,979		$	43,337	$	29,433	$	300,185

An analysis of the allowance for loan losses and recorded investment in loans as of and for the year ended December 31, 2011 is as follows:


	Residential Real Estate			Land		Construction		Commercial Real Estate			Commercial Business			Home Equity and Second Mortgage			Other Consumer			Total
	(In thousands)
Allowance for Loan Losses:
Beginning balance	$	1,024		$	55	$	21	$	1,051		$	1,251		$	606		$	465		$	4,473
Provisions		609			38		8		614			197			322			37			1,825
Charge-offs		(819	)		0		0		(396	)		(333	)		(577	)		(302	)		(2,427	)
Recoveries		14			0		4		0			45			49			199			311

Ending balance	$	828		$	93	$	33	$	1,269		$	1,160		$	400		$	399		$	4,182

Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	183		$	0	$	0	$	539		$	936		$	0		$	0		$	1,658
Collectively evaluated for impairment		645			93		33		730			224			400			399			2,524
Acquired with deteriorated credit quality		0			0		0		0			0			0			0			0

Ending balance	$	828		$	93	$	33	$	1,269		$	1,160		$	400		$	399		$	4,182

Recorded Investment in Loans:
Individually evaluated for impairment	$	2,281		$	5	$	247	$	2,853		$	1,928		$	87		$	0		$	7,401
Collectively evaluated for impairment		114,587			9,967		6,732		54,987			18,848			38,800			30,034			273,955
Acquired with deteriorated credit quality		0			0		0		0			0			0			0			0

Ending balance	$	116,868		$	9,972	$	6,979	$	57,840		$	20,776		$	38,887		$	30,034		$	281,356

An analysis of the allowance for loan losses and recorded investment in loans as of and for the year ended December 31, 2010 is as follows:


	Residential Real Estate			Land			Construction			Commercial Real Estate			Commercial Business			Home Equity and Second Mortgage			Other Consumer			Total
	(In thousands)
Allowance for Loan Losses:
Beginning balance	$	1,208		$	121		$	107		$	1,633		$	1,264		$	217		$	381		$	4,931
Provisions		427			(6	)		(86	)		680			7			648			367			2,037
Charge-offs		(620	)		(61	)		0			(1,265	)		(29	)		(299	)		(457	)		(2,731	)
Recoveries		9			1			0			3			9			40			174			236

Ending balance	$	1,024		$	55		$	21		$	1,051		$	1,251		$	606		$	465		$	4,473

Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	458		$	0		$	0		$	607		$	1,089		$	338		$	0		$	2,492
Collectively evaluated for impairment		566			55			21			444			162			268			465			1,981
Acquired with deteriorated credit quality		0			0			0			0			0			0			0			0

Ending balance	$	1,024		$	55		$	21		$	1,051		$	1,251		$	606		$	465		$	4,473

Recorded Investment in Loans:
Individually evaluated for impairment	$	2,951		$	0		$	279		$	1,780		$	2,148		$	390		$	0		$	7,548
Collectively evaluated for impairment		127,763			9,589			4,769			58,305			19,831			42,947			29,433			292,637
Acquired with deteriorated credit quality		0			0			0			0			0			0			0			0

Ending balance	$	130,714		$	9,589		$	5,048		$	60,085		$	21,979		$	43,337		$	29,433		$	300,185

At December 31, 2011 and 2010, for each loan portfolio segment management applied an overall qualitative factor of 1.15 to the Company’s historical loss factors based on the most eight recent calendar quarters. The overall qualitative factor is derived from management’s analysis of changes and trends in the following qualitative factors:

•

Underwriting Standards – Management reviews the findings of periodic internal audit loan reviews, independent outsourced loan reviews and loan reviews performed by the banking regulators to evaluate the risk associated with changes in underwriting standards. At December 31, 2011 and 2010, management assessed the risk associated with this component as neutral, requiring no adjustment to the historical loss factors.

•

Economic Conditions – Management analyzes trends in housing and unemployment data in the Harrison, Floyd and Clark counties of Indiana, the Company’s primary market area, to evaluate the risk associated with economic conditions. Due to a decrease in new home construction and an increase in unemployment in the Company’s primary market area, management assigned a risk factor of 1.20 for the component at December 31, 2011 and 2010.

•

Past Due Loans – Management analyzes trends in past due loans for the Company to evaluate the risk associated with delinquent loans. In general, past due loan ratios have remained at elevated levels compared to historical amounts since 2007, and management assigned a risk factor of 1.20 for the component at December 31, 2011 and 2010.

•

Other Internal and External Factors – This component includes management’s consideration of other qualitative factors such as loan portfolio composition. The Company has focused on the origination of commercial business and real estate loans in an effort to convert the Company’s balance sheet from that of a traditional thrift institution to a commercial bank. In addition, the Company has increased its investment in mortgage loans in which it does not hold a first lien position. Commercial loans and second mortgage loans generally entail greater credit risk than residential mortgage loans secured by a first lien. As a result of changes in the loan portfolio composition, management assigned a risk factor of 1.20 for this component at December 31, 2011 and 2010.

Each of the four factors above was assigned an equal weight to arrive at an average for the overall qualitative factor of 1.15 at December 31, 2011 and 2010. The effect of the overall qualitative factor was to increase the estimated allowance for loan losses by $317,000 and $258,000 at December 31, 2011 and 2010, respectively.

Management also applies additional loss factor multiples to loans classified as watch, special mention and substandard that are not individually evaluated for impairment. The multiples consider the increased likelihood of loss on classified loans based on the Company’s historical experience. The multiples remained unchanged from December 31, 2010 to December 31, 2011, and the effect of the loss factor multiples for classified loans was to increase the estimated allowance for loan losses by $172,000 and $248,000 at December 31, 2011 and 2010, respectively.

The following table summarizes the Company’s impaired loans by class of loans as of and for the year ended December 31, 2011:


			Unpaid				Average		Interest		Interest
	Recorded		Principal		Related		Recorded		Income		Recognized –
	Investment		Balance		Allowance		Investment		Recognized		Cash Method
	(In thousands)
Loans with no related allowance recorded:
Residential real estate	$	1,149	$	1,507	$	0	$	978	$	0	$	29
Land		5		6		0		5		0		0
Construction		247		249		0		261		0		0
Commercial real estate		1,215		1,280		0		514		0		9
Commercial business		0		0		0		14		0		0
Home equity and second mortgage		87		94		0		32		0		1
Other consumer		0		0		0		4		0		0

		2,703		3,136		0		1,808		0		39

Loans with an allowance recorded:
Residential real estate		1,132		1,233		183		2,035		0		9
Land		0		0		0		0		0		0
Construction		0		0		0		56		0		0
Commercial real estate		1,638		1,933		539		1,208		0		0
Commercial business		1,928		2,023		936		2,036		0		0
Home equity and second mortgage		0		0		0		282		0		0
Other consumer		0		0		0		5		0		0

		4,698		5,189		1,658		5,622		0		9

Total:
Residential real estate		2,281		2,740		183		3,013		0		38
Land		5		6		0		5		0		0
Construction		247		249		0		317		0		0
Commercial real estate		2,853		3,213		539		1,722		0		9
Commercial business		1,928		2,023		936		2,050		0		0
Home equity and second mortgage		87		94		0		314		0		1
Other consumer		0		0		0		9		0		0

	$	7,401	$	8,325	$	1,658	$	7,430	$	0	$	48

The following table summarizes the Company’s impaired loans by class of loans as of and for the year ended December 31, 2010:


			Unpaid				Average		Interest		Interest
	Recorded		Principal		Related		Recorded		Income		Recognized –
	Investment		Balance		Allowance		Investment		Recognized		Cash Method
	(In thousands)
Loans with no related allowance recorded:
Residential real estate	$	703	$	822	$	0	$	1,082	$	0	$	1
Land		0		0		0		68		0		0
Construction		0		0		0		0		0		0
Commercial real estate		398		412		0		1,107		0		0
Commercial business		0		0		0		0		0		0
Home equity and second mortgage		17		18		0		140		0		0
Other consumer		0		0		0		25		0		0

		1,118		1,252		0		2,422		0		1

Loans with an allowance recorded:
Residential real estate		2,248		2,358		458		1,532		0		4
Land		0		0		0		0		0		0
Construction		279		281		0		140		0		0
Commercial real estate		1,382		1,424		607		963		0		0
Commercial business		2,148		2,175		1,089		2,190		0		0
Home equity and second mortgage		373		379		338		347		0		2
Other consumer		0		0		0		0		0		0

		6,430		6,617		2,492		5,172		0		6

Total:
Residential real estate		2,951		3,180		458		2,614		0		5
Land		0		0		0		68		0		0
Construction		279		281		0		140		0		0
Commercial real estate		1,780		1,836		607		2,070		0		0
Commercial business		2,148		2,175		1,089		2,190		0		0
Home equity and second mortgage		390		397		338		487		0		2
Other consumer		0		0		0		25		0		0

	$	7,548	$	7,869	$	2,492	$	7,594	$	0	$	7

Nonperforming loans consists of nonaccrual loans and loans over 90 days past due and still accruing interest. The following table presents the recorded investment in nonperforming loans by class of loans at December 31, 2011 and 2010:


	December 31, 2011						December 31, 2010
	Nonaccrual Loans		Loans 90+ Days Past Due Still Accruing		Total Nonperforming Loans		Nonaccrual Loans		Loans 90+ Days Past Due Still Accruing		Total Nonperforming Loans
	(In thousands)
Residential real estate	$	2,281	$	143	$	2,424	$	2,951	$	334	$	3,285
Land		5		38		43		0		0		0
Construction		247		0		247		279		0		279
Commercial real estate		2,853		0		2,853		1,780		0		1,780
Commercial business		1,928		0		1,928		2,148		20		2,168
Home equity and second mortgage		87		159		246		390		8		398
Other consumer		0		23		23		0		17		17

Total	$	7,401	$	363	$	7,764	$	7,548	$	379	$	7,927

The following table presents the aging of the recorded investment loans by class of loans at December 31, 2011:


	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Current		Total Loans
	(In thousands)
Residential real estate	$	5,205	$	1,068	$	1,035	$	7,308	$	109,560	$	116,868
Land		442		43		43		528		9,444		9,972
Construction		0		0		247		247		6,732		6,979
Commercial real estate		676		0		1,258		1,934		55,906		57,840
Commercial business		256		0		0		256		20,520		20,776
Home equity and second mortgage		558		72		246		876		38,011		38,887
Other consumer		306		37		23		366		29,668		30,034

Total	$	7,443	$	1,220	$	2,852	$	11,515	$	269,841	$	281,356

The following table presents the aging of the recorded investment in loans by class of loans at December 31, 2010:


	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Current		Total Loans
	(In thousands)
Residential real estate	$	5,652	$	581	$	1,590	$	7,823	$	122,891	$	130,714
Land		143		6		0		149		9,440		9,589
Construction		135		0		279		414		4,634		5,048
Commercial real estate		788		337		678		1,803		58,282		60,085
Commercial business		143		0		2,001		2,144		19,835		21,979
Home equity and second mortgage		596		352		298		1,246		42,091		43,337
Other consumer		362		93		17		472		28,961		29,433

Total	$	7,819	$	1,369	$	4,863	$	14,051	$	286,134	$	300,185

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, public information, historical payment experience, credit documentation, and current economic trends, among other factors. The Company classifies loans based on credit risk at least quarterly. The Company uses the following regulatory definitions for risk ratings:

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss: Loans classified as loss are considered uncollectible and of such little value that their continuance on the Company’s books as an asset, without establishment of a specific valuation allowance or charge-off, is not warranted.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

The following table presents the recorded investment in loans by risk category and class of loans as of the date indicated:


	Residential Real Estate		Land		Construction		Commercial Real Estate		Commercial Business		Home Equity and Second Mortgage		Other Consumer		Total
	(In thousands)
December 31, 2011:
Pass	$	113,037	$	7,578	$	6,217	$	46,544	$	16,961	$	38,513	$	29,976	$	225,826
Special mention		862		255		307		5,392		1,462		63		44		8,385
Substandard		688		2,134		208		3,051		425		224		14		6,744
Doubtful		2,281		5		247		2,853		1,928		87		0		7,401
Loss		0		0		0		0		0		0		0		—

Total	$	116,868	$	9,972	$	6,979	$	57,840	$	20,776	$	38,887	$	30,034	$	281,356

December 31, 2010:
Pass	$	121,604	$	9,172	$	4,588	$	50,742	$	18,568	$	42,014	$	29,275	$	275,963
Special mention		2,691		308		0		4,937		765		695		158		9,554
Substandard		3,468		109		181		2,626		498		238		0		7,120
Doubtful		2,951		0		279		1,780		2,148		390		0		7,548
Loss		0		0		0		0		0		0		0		0

Total	$	130,714	$	9,589	$	5,048	$	60,085	$	21,979	$	43,337	$	29,433	$	300,185

The following table summarizes the Company’s TDRs by class of loan and accrual status as of December 31, 2011 and 2010:


	December 31, 2011								December 31, 2010
	Accruing		Nonaccrual		Total		Related Allowance for Loan Losses		Accruing		Nonaccrual		Total		Related Allowance for Loan Losses
	(In thousands)
Residential real estate	$	112	$	516	$	628	$	11	$	0	$	623	$	623	$	71
Land		135		0		135		0		0		0		0		0
Construction		207		247		454		0		0		279		279		0
Commercial real estate		0		1,603		1,603		211		0		1,057		1,057		444
Commercial business		0		1,843		1,843		914		0		1,909		1,909		914
Home equity and second mortgage		8		0		8		0		0		0		0		0
Other consumer		0		0		0		0		0		75		75		75

Total	$	462	$	4,209	$	4,671	$	1,136	$	0	$	3,943	$	3,943	$	1,504

At December 31, 2011 and 2010, commitments to lend additional funds to debtors whose loan terms have been modified in a TDR (both accruing and nonaccruing) totaled $192,000 and $61,000, respectively. These commitments represent the undisbursed portion of construction loans to borrowers that have outstanding loans classified as TDRs.

The following table summarizes information in regard to TDRs that were restructured during the year ended December 31, 2011:


	Number of Contracts		Pre- Modification Outstanding Balance		Post- Modification Outstanding Balance
	(In thousands)
Residential real estate		4	$	331	$	331
Land		1		135		135
Construction		2		454		454
Commercial real estate		2		1,139		1,139
Home equity and second mortgage		1		8		8

Total		10	$	2,067	$	2,067

For the TDRs listed above, the terms of modification included temporary interest-only payment periods, reduction of the stated interest rate and the deferral of past due principal and interest until maturity, or the consolidation of outstanding loans at a reduced interest rate. There were no principal charge-offs recorded as a result of TDRs during 2011.

There were no TDRs modified within the previous 12 months for which there was a subsequent payment default (defined as the loan becoming more than 90 days past due, being moved to nonaccrual status, or the collateral being foreclosed upon) during the year ended December 31, 2011. In the event that a TDR subsequently defaults, the Company evaluates the restructuring for possible impairment. As a result, the related allowance for loan losses may be increased or charge-offs may be taken to reduce the carrying amount of the loan.