7. Loans Receivable and Allowance for Loan Losses

Set forth below is selected data relating to the composition of the loan portfolio at the dates indicated:



	Types of loans
	(dollars in thousands)

	June 30, 2013			December 31, 2012
Real Estate-Residential	$	158,595	33.0%	$	150,043	31.4%
Commercial		266,204	55.3		274,484	57.5
Construction		17,319	3.6		13,435	2.8
Commercial, financial and agricultural		24,723	5.1		25,113	5.3
Consumer loans to individuals		14,398	3.0		14,154	3.0
Total loans		481,239	100.0%		477,229	100.0%
Deferred fees, net		(524)			(519)
Total loans receivable		480,715			476,710
Allowance for loan losses		(5,749)			(5,502)
Net loans receivable	$	474,966		$	471,208

Changes in the accretable yield for purchased credit-impaired loans were as follows for the six months ended June 30 (in thousands):



	2013		2012
Balance at beginning of period	$	76	$	171
Accretion		(42)		(47)
Reclassification and other		-		-
Balance at end of period	$	34	$	124

The following table presents additional information regarding loans acquired and accounted for in accordance with ASC 310-30 (in thousands):



	June 30, 2013		December 30, 2012

Outstanding Balance	$	1,081	$	1,145
Carrying Amount	$	1,046	$	1,069

There were no material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the “acquisition date”) and June 30, 2013. There has been no allowance for loan losses recorded for acquired loans with or without specific evidence of deterioration in credit quality as of May 31, 2011 as well as those acquired without specific evidence of deterioration in credit quality as of June 30, 2013. In addition, there has been no allowance for loan losses reversed.

The Company maintains a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified losses based on a review of such information. A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probably that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans identified as impaired are evaluated independently. We do not aggregate such loans for evaluation purposes. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or are classified as a troubled debt restructuring.

A loan is considered to be a troubled debt restructuring (“TDR”) loan when the Company grants a concession to the borrower because of the borrower’s financial condition that it would not otherwise consider. Such concessions include the reduction of interest rates, forgiveness of principal or interest, or other modifications of interest rates that are less than the current market rate for new obligations with similar risk.

The following table shows the amount of loans in each category that were individually and collectively evaluated for impairment at the dates indicated:



	Real Estate Loans
							Commercial		Consumer
	Residential		Commercial		Construction		Loans		Loans		Total
June 30, 2013	(In thousands)

Individually evaluated for impairment	$	-	$	8,703	$	-	$	-	$	-	$	8,703
Loans acquired with deteriorated credit quality		250		796		-		-		-		1,046
Collectively evaluated for impairment		158,345		256,705		17,319		24,723		14,398		471,490
Total Loans	$	158,595	$	266,204	$	17,319	$	24,723	$	14,398	$	481,239



	Real Estate Loans
							Commercial		Consumer
	Residential		Commercial		Construction		Loans		Loans		Total
	(In thousands)
December 31, 2012

Individually evaluated for impairment	$	-	$	10,246	$	-	$	310	$	-	$	10,556
Loans acquired with deteriorated credit quality		270		799		-		-		-		1,069
Collectively evaluated for impairment		149,773		263,439		13,435		24,803		14,154		465,604
Total Loans	$	150,043	$	274,484	$	13,435	$	25,113	$	14,154	$	477,229

The following table includes the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired.



			Unpaid Principal
	Recorded		Principal		Associated
	Investment		Balance		Allowance
June 30, 2013
With no related allowance recorded:
Real Estate Loans
Residential	$	250	$	259	$	-
Commercial		9,499		9,525		-
Subtotal		9,749		9,784		-
With an allowance recorded:
Subtotal		-		-		-
Total:
Real Estate Loans
Residential		250		259		-
Commercial		9,499		9,525		-
Total Impaired Loans	$	9,749	$	9,784	$	-



			Unpaid Principal
	Recorded		Principal		Associated
	Investment		Balance		Allowance
December 31, 2012
With no related allowance recorded:
Real Estate Loans
Residential	$	270	$	286	$	-
Commercial		10,494		10,554		-
Commercial Loans		310		310		-
Subtotal		11,074		11,120		-
With an allowance recorded:
Real Estate Loans
Commercial		551		551		9
Subtotal		551		551		9
Total:
Real Estate Loans
Residential		270		286		-
Commercial		11,045		11,105		9
Commercial Loans		310		310		-
Total Impaired Loans	$	11,625	$	11,701	$	9

The following information for impaired loans is presented (in thousands) for the six months ended June 30, 2013 and 2012:



	Average Recorded				Interest Income
	Investment				Recognized
	2013		2012		2013		2012
Total:
Real Estate Loans
Residential	$	258	$	289	$	2	$	2
Commercial		10,359		13,666		17		146
Commercial Loans		-		-		-		-
Total Loans	$	10,617	$	13,955	$	19	$	148

The following information for impaired loans is presented (in thousands) for the three months ended June 30, 2013 and 2012:



	Average Recorded				Interest Income
	Investment				Recognized
	2013		2012		2013		2012
Total:
Real Estate Loans
Residential	$	252	$	275	$	1	$	1
Commercial		9,856		13,536		-		71
Commercial Loans		309		385		-		-
Total Loans	$	10,417	$	14,916	$	1	$	72

Troubled debt restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources. As of June 30, 2013, troubled debt restructured loans totaled $6.0 million and had no specific reserves. During 2013, one loan with a balance of $1.3 million was classified as a troubled debt restructuring. The restructuring resulted in a decrease in the borrower’s debt but the remaining balance was classified as troubled debt since it would be unlikely that the borrower could obtain comparable financing elsewhere. As of December 31, 2012, troubled debt restructured loans totaled $5.6 million and resulted in specific reserves of $9,000. For the period ended June 30, 2013, there were no loans identified as troubled debt restructurings that subsequently defaulted during the period. For the period ended June 30, 2012, there were no new loans identified as troubled debt restructurings, nor were there any loan modifications classified as troubled debt restructurings that subsequently defaulted during the period.

The following is a summary of troubled debt restructurings granted during the three and six month periods ended June 30, 2013 (dollars in thousands):



	For the Three Months Ended June 30, 2013
			Pre-Modification		Post-Modification
			Outstanding Recorded		Outstanding Recorded
	Number of Contracts		Investment		Investment
Troubled Debt Restructurings

Real Estate Loans:
Commercial	1	$	1,259	$	1,259



	For the Six Months Ended June 30, 2013
			Pre-Modification		Post-Modification
			Outstanding Recorded		Outstanding Recorded
	Number of Contracts		Investment		Investment
Troubled Debt Restructurings

Real Estate Loans:
Commercial	1	$	1,259	$	1,259

Management uses an eight point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first four categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as non performance, repossession, or death occurs to raise awareness of a possible credit event. The Company’s Loan Review Department is responsible for the timely and accurate risk rating of the loans on an ongoing basis. Every credit which must be approved by Loan Committee or the Board of Directors is assigned a risk rating at time of consideration. Loan Review also annually reviews relationships of $500,000 and over to assign or re-affirm risk ratings. Loans in the Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard, Doubtful and Loss within the internal risk rating system as of June 30, 2013 and December 31, 2012 (in thousands):



			Special
	Pass		Mention		Substandard		Doubtful		Total
June 30, 2013
Commercial real estate loans	$	240,670	$	15,194	$	10,340	$	-	$	266,204
Commercial loans		24,723		-		-		-		24,723
Total	$	265,393	$	15,194	$	10,340	$	-	$	290,927



			Special
	Pass		Mention		Substandard		Doubtful		Total
December 31, 2012
Commercial real estate loans	$	251,484	$	11,245	$	11,755	$	-	$	274,484
Commercial loans		24,427		318		368		-		25,113
Total	$	275,911	$	11,563	$	12,123	$	-	$	299,597

For residential real estate loans, construction loans and consumer loans, the Company evaluates credit quality based on the performance of the individual credits. The following table presents the recorded investment in the loan classes based on payment activity as of June 30, 2013 and December 31, 2012 (in thousands):



	Performing		Nonperforming		Total
June 30, 2013
Residential real estate loans	$	156,187	$	2,408	$	158,595
Construction		17,319		-		17,319
Consumer loans		14,398		-		14,398
Total	$	187,904	$	2,408	$	190,312



	Performing		Nonperforming		Total
December 31, 2012
Residential real estate loans	$	147,197	$	2,846	$	150,043
Construction		13,435		-		13,435
Consumer loans		14,154		-		14,154
Total	$	174,786	$	2,846	$	177,632

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of June 30, 2013 and December 31, 2012 (in thousands):



	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
June 30, 2013
Real Estate loans
Residential	$	155,980251,398155,980		86		121		-		2,408		2,615		158,595
Commercial		251,398251,398		710		4,923		-		9,173		14,806		266,204
Construction		17,315		4		-		-		-		4		17,319
Commercial loans		24,689		34		-		-		-		34		24,723
Consumer loans		14,348		40		10		-		-		50		14,398
Total	$	463,730463,730		874		5,054		-		11,581		17,509		481,239



	Current		31-60 Days Past Due		61-90 Days Past Due		Greater than 90 Days Past Due and still accruing		Non-Accrual		Total Past Due and Non-Accrual		Total Loans
December 31, 2012
Real Estate loans
Residential	$	146,847146,847	$	94	$	256	$	-	$	2,846	$	3,196	$	150,043
Commercial		261,527261,527		2,333		598		-		10,026		12,957		274,484
Construction		13,363		72		-		-		-		72		13,435
Commercial loans		24,785		-		-		-		328		328		25,113
Consumer loans		14,029		114		11		-		-		125		14,154
Total	$	460,551460,551	$	2,613	$	865	$	-	$	13,200	$	16,678	$	477,229

The following table presents the allowance for loan losses by the classes of the loan portfolio:



(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, December 31, 2012	$	1,797	$	3,183	$	119	$	223	$	180	$	5,502
Charge Offs		(390)		(928)		-		-		(46)		(1,364)
Recoveries		-		-		-		-		11		11
Provision Expense		357		1,063		244		(76)		12		1,600
Ending balance, June 30, 2013	$	1,764		3,318		363		147		157		5,749
Ending balance individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-
Ending balance collectively evaluated for impairment	$	1,764	$	3,318	$	363	$	147	$	157	$	5,749

(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, March 31, 2013	$	1,974	$	3,290	$	124	$	176	$	162	$	5,726
Charge Offs		(140)		(615)		-		-		(27)		(782)
Recoveries		-		-		-		-		5		5
Provision Expense		(70)		643		239		(29)		17		800
Ending balance, June 30, 2013	$	1,764		3,318		363		147		157		5,749



(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, December 31, 2011	$	1,257	$	3,838	$	72	$	147	$	144	$	5,458
Charge Offs		(308)		(96)		(7)		-		(33)		(444)
Recoveries		1		-		-		-		10		11
Provision Expense		609		(51)		22		116		54		750
Ending balance, June 30, 2012	$	1,559	$	3,691	$	87	$	263	$	175	$	5,775
Ending balance individually evaluated for impairment	$	-	$	1,120	$	-	$	-	$	-	$	1,120
Ending balance collectively evaluated for impairment	$	1,559	$	2,571	$	87	$	263	$	175	$	4,655

(In thousands)	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Consumer		Total
Beginning balance, March 31, 2012	$	1,199	$	4,007	$	75	$	191	$	146	$	5,618
Charge Offs		(247)		-		-		-		(1)		(248)
Recoveries		-		-		-		-		5		5
Provision Expense		607		(316		12		72		25		400
Ending balance, June 30, 2012	$	1,559	$	3,691	$	87	$	263	$	175	$	5,775

The Company’s primary business activity is with customers located in northeastern Pennsylvania. Accordingly, the Company has extended credit primarily to commercial entities and individuals in this area whose ability to honor their contracts is influenced by the region’s economy.

As of June 30, 2013, the Company considered its concentration of credit risk to be acceptable. The highest concentrations are in the hospitality lodging industry, property owners associations and bars/restaurants with loans outstanding of $37.8 million, or 40.4% of capital, to the hospitality lodging industry, $11.7 million, or 12.5% of capital, to property owners associations, and $10.0 million, or 10.7% of capital, to bars/restaurants. There were no losses recognized on loans within these concentrations during the current period.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $32,000 and $7,000 respectively, in the first six months of 2013 compared to $74,000 and $0, respectively, in the same period in 2012. The proceeds from the sales of residential mortgage loans totaled $1.6 million and $2.3 million for the six months ended June 30, 2013 and 2012, respectively.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $14,000 and $0 respectively, for the three months ended June 30, 2013 compared to $69,000 and $0, respectively, in the same period in 2012. The proceeds from the sales of residential mortgage loans totaled $523,000 and $2.2 million for the three months ended June 30, 2013 and 2012, respectively.