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:
		June 30,		December 31,
		2012		2011

Commercial	$	56,846	$	59,623
Commercial real estate		151,937		150,622
Consumer		71,283		72,488
Residential		44,843		41,633

Total loans		324,909		324,366

Less allowance for loan losses		5,693		5,612

Net loans	$	319,216	$	318,754

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.
"Loss." These are loans having a risk rating of 9. Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan.
Loss rated loans are fully charged off.

Financing Receivables on Non-Accrual Status (dollars in thousands)


	As of
		June 30, 2012		December 31, 2011
Commercial	$	2,257	$	3,570
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		909		1,610
Commercial Mortgages-Non-Owner Occupied		1,600		2,793
Commercial Construction		1,352		782
Consumer
Consumer Unsecured		-		-
Consumer Secured		133		415
Residential:
Residential Mortgages		939		1,205
Residential Consumer Construction		-		-

Totals	$	7,190	$	10,375

We also classify other real estate owned (OREO) as a nonperforming asset. OREO 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 decreased to $2,263,000 on June 30, 2012 from $3,253,000 on December 31, 2011. The following table represents the changes in OREO balance during the six months ended June 30, 2012.

OREO Changes (Dollars in Thousands)


		Six months ended
		June 30, 2012
Balance at the beginning of the year (gross)	$	3,253
Transfers from loans		1,374
Capitalized costs		5
Charge-Offs		(200	)
Sales proceeds		(2,088	)
(Loss) on disposition		(81	)
Balance at the end of the period (gross)		2,263
Less valuation allowance		-
Balance at the end of the period (net)	$	2,263


		Impaired Loans (dollars in thousands) For the Year Ended June 30, 2012
				Unpaid			Average			Interest
		Recorded		Principal	Related		Recorded			Income
2012		Investment		Balance	Allowance		Investment			Recognized
With No Related Allowance Recorded:
Commercial	$	3,467	$	3,575	$	-	$	3,412	$	42
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		2,305		2,360		-		2,258		93
Commercial Mortgage Non-Owner
Occupied		5,908		6,080		-		5,394		131
Commercial Construction		1,202		1,312		-		1,153		27
Consumer
Consumer Unsecured		-		-		-		-		-
Consumer Secured		133		364		-		213		5
Residential
Residential Mortgages		1,873		2,027		-		1,368		43
Residential Consumer Construction		-		-		-		-		-

With An Allowance Recorded:
Commercial	$	1,685	$	1,698	$	428	$	2,327	$	34
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		2,225		2,515		613		2,371		63
Commercial Mortgage Non-Owner
Occupied		690		866		88		1,640		16
Commercial Construction		1,797		2,072		315		1,749		-
Consumer
Consumer Unsecured		1		1		1		1		-
Consumer Secured		856		858		486		899		5
Residential
Residential Mortgages		1,132		1,404		133		1,527		20
Residential Consumer Construction		-		-		-		-		-

Totals:
Commercial	$	5,152	$	5,273	$	428	$	5,739	$	76
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		4,530		4,875		613		4,629		156
Commercial Mortgage Non-Owner
Occupied		6,598		6,946		88		7,034		147
Commercial Construction		2,999		3,384		315		2,902		27
Consumer
Consumer Unsecured		1		1		1		1		-
Consumer Secured		989		1,222		486		1,112		10
Residential
Residential Mortgages		3,005		3,431		133		2,895		63
Residential Consumer Construction		-		-		-		-		-
	$	23,274	$	25,132	$	2,064	$	24,312	$	479


	Impaired Loans
	(dollars in thousands)
	For the Year Ended December 31, 2011
				Unpaid			Average			Interest
		Recorded		Principal	Related		Recorded			Income
2011		Investment		Balance	Allowance		Investment			Recognized
With No Related Allowance Recorded:
Commercial	$	3,357	$	3,570	$	-	$	8,978	$	118
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		2,211		3,108		-		2,457		124
Commercial Mortgage Non-Owner
Occupied		4,880		5,170		-		5,418		227
Commercial Construction		1,103		1,103		-		984		38
Consumer
Consumer Unsecured		-		-		-		-		-
Consumer Secured		293		642		-		330		6
Residential
Residential Mortgages		862		1,007		-		633		15
Residential Consumer Construction		-		-		-		33		-

With An Allowance Recorded:
Commercial	$	2,968	$	3,052	$	440	$	2,170	$	106
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		2,516		2,686		555		3,815		137
Commercial Mortgage Non-Owner
Occupied		2,590		3,129		228		1,858		117
Commercial Construction		1,700		1,964		275		2,454		42
Consumer
Consumer Unsecured		-		-		-		286		-
Consumer Secured		942		1,021		357		699		49
Residential
Residential Mortgages		1,922		2,180		128		1,847		89
Residential Consumer Construction		-		-		-		-		-

Totals:
Commercial	$	6,325	$	6,622	$	440	$	11,147	$	224
Commercial Real Estate
Commercial Mortgages-Owner
Occupied		4,727		5,794		555		6,272		261
Commercial Mortgage Non-Owner
Occupied		7,470		8,299		228		7,275		344
Commercial Construction		2,803		3,067		275		3,438		80
Consumer
Consumer Unsecured		-		-		-		286		-
Consumer Secured		1,235		1,663		357		1,029		55
Residential
Residential Mortgages		2,784		3,187		128		2,480		104
Residential Consumer Construction		-		-		-		33		-
	$	25,344	$	28,632	$	1,983	$	31,960	$	1,068


	Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands) For the Six months Ended June 30, 2012

					Commercial
2012		Commercial			Real Estate			Consumer			Residential			Total

Allowance for Credit Losses:
Beginning Balance	$	892		$	2,677		$	1,486		$	557		$	5,612
Charge-offs		(175	)		(631	)		(413	)		(12	)		(1,231	)
Recoveries		13			109			9			6			137
Provision		131			761			197			86			1,175
Ending Balance		861			2,916			1,279			637			5,693

Ending Balance: Individually
evaluated for impairment	$	428		$	1,016		$	487		$	133		$	2,064

Ending Balance: Collectively
evaluated for impairment		433		$	1,900			792			504			3,629


Totals:	$	861		$	2,916		$	1,279		$	637		$	5,693

Financing Receivables:

Ending Balance: Individually
evaluated for impairment		5,152			14,127			990			3,005			23,274

Ending Balance: Collectively
evaluated for impairment		51,694			137,810			70,293			41,838			301,635

Totals:	$	56,846		$	151,937		$	71,283		$	44,843		$	324,909


	Allowance for Credit Losses and Recorded Investment in Financing Receivables
	(dollars in thousands)
	For the Year Ended December 31, 2011

					Commercial
2011		Commercial			Real Estate			Consumer			Residential			Total

Allowance for Credit Losses:
Beginning Balance	$	473		$	2,897		$	1,207		$	890		$	5,467
Charge-offs		(702	)		(2,738	)		(817	)		(459	)		(4,716	)
Recoveries		16			3			31			4			54
Provision		1,105			2,515			1,065			122			4,807
Ending Balance		892			2,677			1,486			557			5,612

Ending Balance: Individually
evaluated for impairment	$	440		$	1,058		$	357		$	128		$	1,983

Ending Balance: Collectively
evaluated for impairment		452			1,619			1,129			429			3,629


Totals:	$	892		$	2,677		$	1,486		$	557		$	5,612

Financing Receivables:

Ending Balance: Individually
evaluated for impairment		6,325			15,000			1,235			2,784			25,344

Ending Balance: Collectively
evaluated for impairment		53,298			135,622			71,253			38,849			299,022

Totals:	$	59,623		$	150,622		$	72,488		$	41,633		$	324,366


	Age Analysis of Past Due Financing Receivables as of
	June 30, 2012
	(dollars in thousands)
													Recorded
						Greater						Total	Investment
		30-59 Days		60-89 Days		than	Total Past					Financing	> 90 Days &
2012		Past Due		Past Due		90 Days	Due			Current		Receivables	Accruing
Commercial	$	550	$	167	$	2,257	$	2,974	$	53,872	$	56,846	$	-
Commercial Real Estate:
Commercial Mortgages-Owner
Occupied		513		5		909		1,427		60,024		61,451		-
Commercial Mortgages-Non-
Owner Occupied		1,450		8		299		1,757		78,996		80,753		-
Commercial Construction		492		638		279		1,409		8,324		9,733		-
Consumer:
Consumer Unsecured		286		-		-		286		2,977		3,263		-
Consumer Secured		282		32		133		447		67,573		68,020		-
Residential:
Residential Mortgages		207		130		809		1,146		38,729		39,875		-
Residential Consumer
Construction		-		-		-		-		4,968		4,968		-
Total	$	3,780	$	980	$	4,686	$	9,446	$	315,463	$	324,909	$	-


	Age Analysis of Past Due Financing Receivables as of
	December 31, 2011
	(dollars in thousands)
													Recorded
		30-59			Greater							Total	Investment
		Days		60-89 Days	than		Total Past					Financing	> 90 Days &
2011		Past Due		Past Due	90 Days		Due			Current		Receivables	Accruing
Commercial	$	532	$	26	$	3,570	$	4,128	$	55,495	$	59,623	$	-
Commercial Real Estate:
Commercial Mortgages-Owner
Occupied		2,614		130		1,610		4,354		56,400		60,754		-
Commercial Mortgages-Non-
Owner Occupied		504		72		2,793		3,369		74,520		77,889		-
Commercial Construction		782		-		424		1,206		10,773		11,979		-
Consumer:
Consumer Unsecured		6		-		-		6		3,231		3,237		-
Consumer Secured		202		277		415		894		68,357		69,251		-
Residential:
Residential Mortgages		523		162		863		1,548		37,450		38,998		-
Residential Consumer
Construction		-		-		-		-		2,635		2,635		-
Total	$	5,163	$	667	$	9,675	$	15,505	$	308,861	$	324,366	$	-


	Credit Loss Disclosures
	Credit Quality Information - by Class
	June 30, 2012
	(dollars in thousands)
2012					Special
		Pass		Monitor	Mention		Substandard			Doubtful		Totals
Commercial	$	47,529	$	2,573	$	2,074	$	4,670	$	-	$	56,846
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		49,184		3,447		4,290		4,410		120		61,451
Commercial Mortgages-Non0Owner
Occupied		69,130		2,661		2,364		6,598		-		80,753
Commercial Construction		6,734		-		-		2,999		-		9,733
Consumer
Consumer Unsecured		3,262		-		-		1		-		3,263
Consumer Secured		64,556		1,594		903		967		-		68,020
Residential:
Residential Mortgages		35,848		603		419		3,005		-		39,875
Residential Consumer Construction		4,968		-		-		-		-		4,968

Totals	$	281,211	$	10,878	$	10,050	$	22,650	$	120	$	324,909


	Credit Loss Disclosures
	Credit Quality Information - by Class
	December 31, 2011
	(dollars in thousands)
2011						Special
		Pass		Monitor		Mention	Substandard		Doubtful			Totals
Commercial	$	47,021	$	3,978	$	2,901	$	5,723	$	-	$	59,623
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		48,622		3,003		4,696		4,283		150		60,754
Commercial Mortgages-Non Owner
Occupied		63,934		3,326		3,159		7,470		-		77,889
Commercial Construction		9,000		176		-		2,803		-		11,979
Consumer
Consumer Unsecured		3,237		-		-		-		-		3,237
Consumer Secured		67,295		488		304		1,164		-		69,251
Residential:
Residential Mortgages		35,109		557		548		2,784		-		38,998
Residential Consumer Construction		2,635		-		-		-		-		2,635

Totals	$	276,853	$	11,528	$	11,608	$	24,227	$	150	$	324,366

Troubled Debt Restructurings

There were no loan modifications during the three and six months ended June 30, 2012.

The following table describes Troubled Debt Restructurings made within the last twelve months that defaulted during the three and six months ended June 30, 2012.


For the Three Months Ended June 30, 2012
(dollars in thousands)

Troubled Debt	Number
Restructurings That	of		Recorded
Subsequently Defaulted	Contracts		Investment

Commercial	2	$	208


For the Six Months Ended June 30, 2012
(dollars in thousands)
Troubled Debt	Number
Restructurings That	of		Recorded
Subsequently Defaulted	Contracts		Investment

Commercial	4	$	798