Note 9 – Loans, allowance for loan losses and OREO

Management has an established methodology used to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Bank has segmented certain loans in the portfolio by product type. Within these segments, the Bank has sub-segmented its portfolio by classes within the segments, based on the associated risks within these classes. The classifications set forth below do not correspond directly to the classifications set forth in the call report (Form FFIEC 041). Management has determined that the classifications set forth below are more appropriate for use in identifying and managing risk in the loan portfolio.

Loan Segments: Loan Classes:

Commercial Commercial and industrial loans

Commercial real estate Commercial mortgages – owner occupied

Commercial mortgages – non-owner occupied

Commercial construction

Consumer Consumer unsecured

Consumer secured

Residential Residential mortgages

Residential consumer construction

A summary of loans, net is as follows (dollars in thousands):

	As of:
	September 30,	December 31,
	2011	2010

Commercial	$ 63,867	$ 62,786
Commercial real estate	146,255	143,428
Consumer	69,799	68,289
Residential	44,855	51,679

Total loans	324,776	326,182

Less allowance for loan losses	5,461	5,467

Net loans	$ 319,315	$ 320,715

The Bank's internal risk rating system is in place to grade commercial and commercial real estate loans. Category ratings are reviewed periodically by lenders and the credit review area of the Bank based on the borrower's individual situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

Below is a summary and definition of the Bank's risk rating categories:

RATING 1 Excellent

RATING 2 Above Average

RATING 3 Satisfactory

RATING 4 Acceptable / Low Satisfactory

RATING 5 Monitor

RATING 6 Special Mention

RATING 7 Substandard

RATING 8 Doubtful

RATING 9 Loss

We segregate loans into the above categories based on the following criteria and we review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

· "Pass." These are loans having risk ratings of 1 through 4. Pass loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.

· "Monitor." These are loans having a risk rating of 5. Monitor loans have currently acceptable risk but may have the potential for a specific defined weakness in the borrower's operations and the borrower's ability to generate positive cash flow on a sustained basis. The borrower's recent payment history may currently or in the future be characterized by late payments. The Bank's risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

· "Special Mention." These are loans having a risk rating of 6. Special Mention loans have weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the bank's credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. These loans do warrant more than routine monitoring due to a weakness caused by adverse events.

· "Substandard." These are loans having a risk rating of 7. Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank's credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower's performance and financial condition provides evidence that it is probable that the Bank will be unable to collect all amounts due.

· "Doubtful." These are loans having a risk rating of 8. Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but 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. The possibility of loss is extremely high.

Financing Receivables on Non-Accrual Status (dollars in thousands)
	As of
	September 30, 2011	December 31, 2010
Commercial	$ 4,044	$ 756
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	2,269	1,157
Commercial Mortgages-Non-Owner Occupied	1,571	2,504
Commercial Construction	549	923
Consumer
Consumer Unsecured	-	83
Consumer Secured	1,062	1,153
Residential:
Residential Mortgages	1,384	1,725
Residential Consumer Construction	-	65

Totals	$ 10,879	$ 8,366

We also classify other real estate owned (OREO) as a nonperforming asset. OREO, which is accounted for in the "other assets" section of the Consolidated Balance Sheets, represents real property owned by the Bank either through purchase at foreclosure or received from the borrower through a deed in lieu of foreclosure. OREO increased to $5,216,000 on September 30, 2011 from $3,440,000 on December 31, 2010. The following table represents the changes in OREO balance during the nine months ended September 30, 2011.

OREO Changes (Dollars in Thousands)
	Nine months ended September 30, 2011
Balance at the beginning of the year (gross)	$ 3,440
Transfers from loans	3,682
Transfer from premises and equipment	-
Capitalized costs	18
Charge-Offs	(394)
Sales proceeds	(1,346)
Gain (loss) on disposition	(184)
Balance at the end of the period (gross)	$ 5,216
Less valuation allowance	-
Balance at the end of the period (net)	$ 5,216

		Impaired Loans (dollars in thousands)
		For the Nine months Ended September 30, 2011
2011		Recorded Investment	Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
With No Related Allowance Recorded:
	Commercial	$ 5,341	$ 5,557	$ -	$ 9,970	$ 194
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	2,112	2,686	-	2,408	69
	Commercial Mortgage Non-Owner Occupied	2,189	2,201	-	4,072	87
	Commercial Construction	1,577	1,577	-	1,221	41
	Consumer
	Consumer Unsecured	-	-	-	-	-
	Consumer Secured	956	1,295	-	661	4
	Residential
	Residential Mortgages	625	906	-	514	10
	Residential Consumer Construction	-	-	-	33	-

With An Allowance Recorded:
	Commercial	$ 3,243	$ 3,313	$ 564	$ 2,307	$ 84
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	3,780	3,963	526	4,447	157
	Commercial Mortgage Non-Owner Occupied	4,758	4,810	513	2,942	145
	Commercial Construction	582	594	132	1,895	10
	Consumer
	Consumer Unsecured	-	-	-	286	-
	Consumer Secured	1,049	1,062	492	753	37
	Residential
	Residential Mortgages	2,189	2,454	244	1,981	77
	Residential Consumer Construction	-	-	-	-	-

Totals:
	Commercial	$ 8,584	$ 8,870	$ 564	$ 12,277	$ 278
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	5,892	6,649	526	6,855	226
	Commercial Mortgage Non-Owner Occupied	6,947	7,011	513	7,014	232
	Commercial Construction	2,159	2,171	132	3,116	51
	Consumer
	Consumer Unsecured	-	-	-	286	-
	Consumer Secured	2,005	2,357	492	1,414	41
	Residential
	Residential Mortgages	2,184	3,360	244	2,495	87
	Residential Consumer Construction	-	-	-	33	-
		$ 28,401	$ 30,418	$ 2,471	$ 33,490	$ 915

		Impaired Loans (dollars in thousands)
		For the Year Ended December 31, 2010
2010		Recorded Investment	Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
With No Related Allowance Recorded:
	Commercial	$ 14,598	$ 14,787	$ -	$ 14,794	$ 687
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	2,703	2,729	-	2,740	177
	Commercial Mortgage Non-Owner Occupied	5,955	6,569	-	6,035	171
	Commercial Construction	864	864	-	876	45
	Consumer
	Consumer Unsecured	-	-	-	-	-
	Consumer Secured	366	660	-	371	13
	Residential
	Residential Mortgages	403	613	-	406	8
	Residential Consumer Construction	65	68	-	66	1

With An Allowance Recorded:
	Commercial	$ 1,371	$ 1,371	$ 195	$ 1,388	$ 82
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	5,114	5,144	1,218	5,184	177
	Commercial Mortgage Non-Owner Occupied	1,125	1,132	53	1,141	21
	Commercial Construction	3,208	3,355	437	3,252	103
	Consumer
	Consumer Unsecured	572	589	75	578	15
	Consumer Secured	456	456	195	461	25
	Residential
	Residential Mortgages	1,772	1,923	257	1,794	124
	Residential Consumer Construction	-	-	-	-	-

Totals:
	Commercial	$ 15,969	$ 16,158	$ 195	$ 16,182	$ 769
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	7,817	7,873	1,218	7,924	354
	Commercial Mortgage Non-Owner Occupied	7,080	7,701	53	7,176	192
	Commercial Construction	4,072	4,219	437	4,128	148
	Consumer
	Consumer Unsecured	572	589	75	578	15
	Consumer Secured	822	1,116	195	832	38
	Residential
	Residential Mortgages	2,175	2,536	257	2,200	132
	Residential Consumer Construction	65	68	-	66	1
		$ 38,572	$ 40,260	$ 2,430	$ 39,086	$ 1,649

		Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands)
		For the Nine months Ended September 30, 2011
		Commercial	Commercial Real Estate	Consumer	Residential	Total

2011

Allowance for Credit Losses:
Beginning Balance		$ 473	$ 2,897	$ 1,207	$ 890	$ 5,467
	Charge-offs	(498)	(1,519)	(541)	(238)	(2,796)
	Recoveries	8	-	23	2	33
	Provision	1,068	1,158	383	148	2,757
Ending Balance		1,051	2,536	1,072	802	5,461

Ending Balance: Individually evaluated for impairment		$ 564	$ 1,171	$ 492	$ 244	$ 2,471

Ending Balance: Collectively evaluated for impairment		487	1,367	578	558	2,990


Totals:		$ 1,051	$ 2,538	$ 1,070	$ 802	$ 5,461

Financing Receivables:

Ending Balance: Individually evaluated for impairment		8,584	14,998	2,005	2,814	28,401

Ending Balance: Collectively evaluated for impairment		55,283	131,257	67,794	42,041	296,375

Totals:		$ 63,867	$146,255	$ 69,799	$ 44,855	$ 324,776

	Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands)
	For the Year Ended December 31, 2010
	Commercial	Commercial Real Estate	Consumer	Residential	Total

2010

Allowance for Credit Losses:

Ending Balance: Individually evaluated for impairment	$ 195	$ 1,708	$ 270	$ 257	$ 2,430

Ending Balance: Collectively evaluated for impairment	278	1,189	937	633	3,037


Totals:	$ 473	$2,897	$ 1,207	$ 890	$ 5,467

Financing Receivables:

Ending Balance: Individually evaluated for impairment	15,969	18,969	1,394	2,240	38,572

Ending Balance: Collectively evaluated for impairment	46,817	124,459	66,895	49,439	287,610

Totals:	$ 62,786	$143,428	$ 68,289	$ 51,679	$ 326,182

	Age Analysis of Past Due Financing Receivables as of September 30, 2011 (dollars in thousands)
2011	30-59 Days Past Due	60-89 Days Past Due	Greater than 90 Days	Total Past Due	Current	Total Financing Receivables	Recorded Investment > 90 Days & Accruing
Commercial	$ 333	$ -	$ 4,043	$ 4,376	$ 59,491	$ 63,867	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	844	212	2,040	3,096	58,491	61,587	-
Commercial Mortgages-Non-Owner Occupied	2,408	-	1,571	3,979	70,234	74,213	-
Commercial Construction	-	-	549	549	9,906	10,455	-
Consumer:
Consumer Unsecured	4	10	-	14	3,073	3,087	-
Consumer Secured	143	120	1,052	1,315	65,397	66,712	-
Residential:
Residential Mortgages	605	-	1,246	1,851	40,399	42,250	-
Residential Consumer Construction	-	-	-	-	2,605	2,605	-
Total	$ 4,337	$ 342	$ 10,501	$ 11,866	$ 309,596	$ 324,776	$ -

	Age Analysis of Past Due Financing Receivables as of December 31, 2010 (dollars in thousands)
2010	30-59 Days Past Due	60-89 Days Past Due	Greater than 90 Days	Total Past Due	Current	Total Financing Receivables	Recorded Investment > 90 Days & Accruing
Commercial	$ 726	$ 180	$ 576	$ 1,482	$ 61,304	$ 62,786	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	1,390	299	553	2,242	62,120	64,362	-
Commercial Mortgages-Non-Owner Occupied	1,169	253	2,503	3,925	62,619	66,544	-
Commercial Construction	-	-	923	923	11,599	12,522	-
Consumer:
Consumer Unsecured	8	-	83	91	2,824	2,915	-
Consumer Secured	564	230	731	1,525	63,849	65,374	-
Residential:
Residential Mortgages	1,072	68	793	1,933	39,834	41,767	-
Residential Consumer Construction	-	-	65	65	9,847	9,912	-
Total	$ 4,929	$ 1,030	$ 6,227	$ 12,186	$ 313,996	$ 326,182	$ -

		Credit Quality Information - by Class September 30, 2011 (dollars in thousands)
		Pass	Monitor	Special Mention	Substandard	Doubtful	Totals
		Pass	Monitor	Special Mention	Substandard	Doubtful	Totals
Commercial		$ 51,267	$ 3,220	$ 3,085	$ 6,131	$ 164	$ 63,867
Commercial Real Estate:
	Commercial Mortgages-Owner Occupied	50,405	4,417	1,168	5,450	147	61,587
	Commercial Mortgages-Non-Owner Occupied	61,673	3,849	1,744	6,947	-	74,213
	Commercial Construction	8,190	106	-	2,159	-	10,455
Consumer
	Consumer Unsecured	3,087	-	-	-	-	3,087
	Consumer Secured	63,984	489	306	1,933	-	66,712
Residential:
	Residential Mortgages	38,870	333	233	2,814	-	42,250
	Residential Consumer Construction	2,605	-	-	-	-	2,605

	Totals	$ 280,081	$12,414	$ 6,536	$ 25,434	$ 311	$ 324,776

		Credit Quality Information - by Class December 31, 2010 (dollars in thousands)
		Pass	Monitor	Special Mention	Substandard	Doubtful	Totals
Commercial		$ 41,328	$ 2,732	$ 9,471	$ 9,075	$ 180	$ 62,786
Commercial Real Estate:
	Commercial Mortgages-Owner Occupied	50,485	5,535	1,378	6,814	150	64,362
	Commercial Mortgages-Non-Owner Occupied	52,004	2,337	6,354	5,849	-	66,544
	Commercial Construction	7,571	855	1,446	2,650	-	12,522
Consumer
	Consumer Unsecured	2,805	-	1	34	75	2,915
	Consumer Secured	63,225	475	349	1,325	-	65,374
Residential:
	Residential Mortgages	38,504	77	-	3,014	172	41,767
	Residential Consumer Construction	9,475	-	372	65	-	9,912

	Totals	$ 265,397	$12,011	$ 19,371	$ 28,826	$ 577	$ 326,182

Troubled Debt Restructurings

For the Nine months Ended September 30, 2011
(dollars in thousands)
Troubled Debt Restructurings	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment

Commercial Real Estate	5	$3,345,376	$3,345,376

The five contracts referenced above were modified in the form of interest rate reductions. After modification, each loan was individually reevaluated for impairment. As a result of the evaluation, it was determined that there was no additional impact to the allowance for loan loss.

There were no loan modifications during the three months ended September 30, 2011.

For the Nine months Ended September 30, 2011
(dollars in thousands)
Troubled Debt Restructurings That Subsequently Defaulted	Number of Contracts	Recorded Investment

Commercial	1	$ 182,592
Consumer	1	29,999
Residential	2	482,097
Total	4	$ 694,688

There were no Troubled Debt Restructurings that defaulted during the three months ended September 30, 2011.