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:
	March 31,	December 31,
	2013	2012

Commercial	$ 57,408	$ 55,084
Commercial real estate	156,912	153,416
Consumer	70,441	70,639
Residential	46,355	46,318

Total loans	331,116	325,457

Less allowance for loan losses	5,606	5,535

Net loans	$ 325,510	$ 319,922

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
	March 31, 2013	December 31, 2012
Commercial	$ 1,882	$ 2,100
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	1,431	1,431
Commercial Mortgages-Non-Owner Occupied	1,201	853
Commercial Construction	726	849
Consumer
Consumer Unsecured	9	-
Consumer Secured	77	-
Residential:
Residential Mortgages	714	1,113
Residential Consumer Construction	-	-

Totals	$ 6,040	$ 6,346

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 increased to $2,318,000 on March 31, 2013 from $2,112,000 on December 31, 2012. The following table represents the changes in OREO balance during the three months ended March 31, 2013.

OREO Changes (dollars in thousands)
	Three Months ended March 31, 2013
Balance at the beginning of the year (net)	$ 2,112
Transfers from loans	411
Capitalized costs	-
Writedowns	(25)
Sales proceeds	(159)
(Loss) on disposition	(21)
Balance at the end of the period (net)	$ 2,318

		Impaired Loans (dollars in thousands)
		For the Nine Months Ended March 31, 2013
2013		Recorded Investment	Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
With No Related Allowance Recorded:
	Commercial	$ 3,887	$ 4,062	$ -	$ 3,209	$ 27
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	1,778	1,789	-	2,185	14
	Commercial Mortgage Non-Owner Occupied	3,975	4,144	-	5,172	47
	Commercial Construction	672	672	-	706	9
	Consumer
	Consumer Unsecured	-	-	-	-	-
	Consumer Secured	355	355	-	412	5
	Residential
	Residential Mortgages	1,431	1,467	-	1,785	22
	Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
	Commercial	$ 176	$ 176	$ 176	$ 398	$ 3
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	4,141	4,505	737	3,906	63
	Commercial Mortgage Non-Owner Occupied	1,169	1,173	198	1,005	12
	Commercial Construction	731	956	107	777	-
	Consumer
	Consumer Unsecured	1	1	1	1	-
	Consumer Secured	401	401	179	466	7
	Residential
	Residential Mortgages	1,145	1,433	158	1,080	20
	Residential Consumer Construction	-	-	-	-	-

Totals:
	Commercial	$ 4,063	$ 4,238	$ 176	$ 3,607	$ 30
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	5,919	6,294	737	6,091	77
	Commercial Mortgage Non-Owner Occupied	5,144	5,317	198	6,177	59
	Commercial Construction	1,403	1,628	107	1,483	9
	Consumer
	Consumer Unsecured	1	1	1	1	-
	Consumer Secured	756	756	179	878	12
	Residential
	Residential Mortgages	2,576	2,900	158	2,865	42
	Residential Consumer Construction	-	-	-	-	-
		$ 19,862	$ 21,134	$ 1,556	$ 21,102	$ 229

		Impaired Loans (dollars in thousands)
		For the Year Ended December 31, 2012
2012		Recorded Investment	Unpaid Principal Balance	Related Allowance	Average Recorded Investment	Interest Income Recognized
With No Related Allowance Recorded:
	Commercial	$ 2,530	$ 2,683	$ -	$ 2,944	$ 30
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	2,592	2,754	-	2,402	167
	Commercial Mortgage Non-Owner Occupied	6,369	6,528	-	5,625	330
	Commercial Construction	740	742	-	922	52
	Consumer
	Consumer Unsecured	-	-	-	-	-
	Consumer Secured	469	554	-	381	34
	Residential
	Residential Mortgages	2,138	2,263	-	1,500	112
	Residential Consumer Construction	-	-	-	-	-

With An Allowance Recorded:
	Commercial	$ 620	$ 780	$ 373	$ 1,794	$ 42
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	3,671	3,869	525	3,094	226
	Commercial Mortgage Non-Owner Occupied	840	842	189	1,715	42
	Commercial Construction	823	1,048	94	1,262	2
	Consumer
	Consumer Unsecured	1	1	1	1	-
	Consumer Secured	530	530	195	736	35
	Residential
	Residential Mortgages	1,015	1,303	160	1,469	42
	Residential Consumer Construction	-	-	-	-	-

Totals:
	Commercial	$ 3,150	$ 3,463	$ 373	$ 4,738	$ 72
	Commercial Real Estate
	Commercial Mortgages-Owner Occupied	6,263	6,623	525	5,496	393
	Commercial Mortgage Non-Owner Occupied	7,209	7,370	189	7,340	372
	Commercial Construction	1,563	1,790	94	2,184	54
	Consumer
	Consumer Unsecured	1	1	1	1	-
	Consumer Secured	999	1,084	195	1,117	69
	Residential
	Residential Mortgages	3,153	3,566	160	2,969	154
	Residential Consumer Construction	-	-	-	-	-
		$ 22,338	$ 23,897	$ 1,537	$ 23,845	$ 1,114

Allowance for Credit Losses and Recorded Investment in Financing Receivables
(dollars in thousands)
For the Three Months Ended March 31, 2013

		Commercial
2013	Commercial	Real Estate	Consumer	Residential	Total

Allowance for Credit Losses:
Beginning Balance	$ 987	$ 2,849	$ 1,057	$ 642	$ 5,535
Charge-offs	(19)	(149)	(7)	(11)	(186)
Recoveries	8	-	14	-	22
Provision	(120)	329	77	(51)	235
Ending Balance	$ 856	$ 3,029	$ 1,141	$ 580	$ 5,606

Ending Balance: Individually evaluated for impairment	$ 176	$ 1,042	$ 180	$ 158	$ 1,556

Ending Balance: Collectively evaluated for impairment	680	1,987	961	422	4,050


Totals:	$ 856	$ 3,029	$ 1,141	$ 580	$ 5,606

Financing Receivables:

Ending Balance: Individually evaluated for impairment	4,063	12,466	757	2,576	19,862

Ending Balance: Collectively evaluated for impairment	53,345	144,446	69,684	43,779	311,254

Totals:	$ 57,408	$ 156,912	$ 70,441	$ 46,355	$ 331,116

Allowance for Credit Losses and Recorded Investment in Financing Receivables
(dollars in thousands)
For the Year Ended December 31, 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	(739)	(1,061)	(697)	(102)	(2,599)
)Recoveries	18	129	77	9	233
Provision	816	1,104	191	178	2,289
Ending Balance	$ 987	$ 2,849	$ 1,057	$ 642	$ 5,535

Ending Balance: Individually evaluated for impairment	$ 373	$ 808	$ 196	$ 160	$ 1,537

Ending Balance: Collectively evaluated for impairment	614	2,041	861	482	3,998


Totals:	$ 987	$ 2,849	$ 1,057	$ 642	$ 5,535

Financing Receivables:

Ending Balance: Individually evaluated for impairment	$ 3,150	$ 15,035	$ 1,000	$ 3,153	$ 22,338

Ending Balance: Collectively evaluated for impairment	51,934	138,381	69,639	43,165	303,119

Totals:	$ 55,084	$ 153,416	$ 70,639	$ 46,318	$ 325,457

	Age Analysis of Past Due Financing Receivables as of March 31, 2013 (dollars in thousands)
2013	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	$ 184	$ -	$ 1,882	$ 2,066	$ 55,342	$ 57,408	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	1,202	535	168	1,905	56,665	58,570	-
Commercial Mortgages-Non-Owner Occupied	497	406	1,019	1,922	86,419	88,341	-
Commercial Construction	139	-	726	865	9,136	10,001	-
Consumer:
Consumer Unsecured	3	-	4	7	3,516	3,523	-
Consumer Secured	46	15	77	138	66,780	66,918	-
Residential:
Residential Mortgages	321	289	76	686	40,120	40,806	-
Residential Consumer Construction	-	-	-	-	5,549	5,549	-
Total	$ 2,392	$ 1,245	$ 3,952	$ 7,589	$ 323,527	$ 331,116	$ -

	Age Analysis of Past Due Financing Receivables as of December 31, 2012 (dollars in thousands)
2012	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	$ 223	$ 14	$ 2,100	$ 2,337	$ 52,747	$ 55,084	$ -
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	351	-	168	519	59,412	59,931	-
Commercial Mortgages-Non-Owner Occupied	559	50	853	1,462	82,654	84,116	-
Commercial Construction	547	-	849	1,396	7,973	9,369	-
Consumer:
Consumer Unsecured	2	8	-	10	3,494	3,504	-
Consumer Secured	193	-	-	193	66,942	67,135	-
Residential:
Residential Mortgages	590	68	472	1,130	40,290	41,420	-
Residential Consumer Construction	-	-	-	-	4,898	4,898	-
Total	$ 2,465	$ 140	$ 4,442	$ 7,047	$ 318,410	$ 325,457	$ -

Credit Loss Disclosures
Credit Quality Information - by Class
March 31, 2013
(dollars in thousands)
2013	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$ 50,031	$ 1,676	$ 1,600	$ 4,101	$ -	$ 57,408
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	49,593	2,933	125	5,919	-	58,570
Commercial Mortgages-Non0Owner Occupied	78,068	2,352	2,411	5,510	-	88,341
Commercial Construction	8,565	-	-	1,436	-	10,001
Consumer
Consumer Unsecured	3,518	-	-	5	-	3,523
Consumer Secured	63,773	1,356	775	1,014	-	66,918
Residential:
Residential Mortgages	37,379	84	480	2,863	-	40,806
Residential Consumer Construction	5,549	-	-	-	-	5,549

Totals	$ 296,476	$ 8,401	$ 5,391	$ 20,848	$ -	$ 331,116

Credit Loss Disclosures
Credit Quality Information - by Class
December 31, 2012
(dollars in thousands)
2012	Pass	Monitor	Special	Substandard	Doubtful	Totals
			Mention
Commercial	$ 49,162	$ 1,422	$ 1,350	$ 3,150	$ -	$ 55,084
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	49,717	2,952	1,000	6,262	-	59,931
Commercial Mortgages-Non Owner Occupied	72,120	2,212	2,576	7,208	-	84,116
Commercial Construction	7,806	-	-	1,563	-	9,369
Consumer
Consumer Unsecured	3,503	-	-	1	-	3,504
Consumer Secured	63,948	1,343	867	977	-	67,135
Residential:
Residential Mortgages	37,784	-	483	3,153	-	41,420
Residential Consumer Construction	4,898	-	-	-	-	4,898

Totals	$ 288,938	$ 7,929	$ 6,276	$ 22,314	$ -	$ 325,457

There were no loan modifications that would have been classified as Troubled Debt Restructurings (TDR) during the three months ended March 31, 2013 and 2012.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three months ended March 31, 2013.

The following table describes TDRs that defaulted within 12 months of the modification during the three months ended March 31, 2012.


For the Three Months Ended March 31, 2012
(dollars in thousands)
Troubled Debt Restructurings That Subsequently Defaulted	Number of Contracts	Recorded Investment

Commercial	2	$ 590