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)

	March 31, 2014				December 31, 2013
Real Estate-Residential	$	156,651	31.5	%	$	158,842	31.6	%
Commercial		265,571	53.5			273,144	54.2
Construction		21,400	4.3			20,551	4.1
Commercial, financial and agricultural		37,606	7.6			35,745	7.1
Consumer loans to individuals		15,245	3.1			15,295	3.0
Total loans		496,473	100.0	%		503,577	100.0	%
Deferred fees, net		(457)				(480)
Total loans receivable		496,016				503,097
Allowance for loan losses		(5,727)				(5,708)
Net loans receivable	$	490,289			$	497,389

Changes in the accretable yield for purchased credit-impaired loans were as follows for the three months ended March 31 (in thousands):



	2014		2013
Balance at beginning of period	$	20	$	76
Accretion		(7)		(23)
Reclassification and other		-		-
Balance at end of period	$	13	$	53

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



	March 31, 2014		December 31, 2013

Outstanding Balance	$	1,098	$	1,110
Carrying Amount	$	1,085	$	1,090

There were no material increases or decreases in the expected cash flows of these loans between May 31, 2011 (the “acquisition date”) and March 31, 2014. There has been no allowance for loan losses recorded for acquired loans with specific evidence of deterioration in credit quality as of May 31, 2011. In addition, there has been no allowance for loan losses on these loans reversed. For loans that were acquired without specific evidence of deterioration in credit quality, adjustments to the allowance for loan losses have been accounted for through the allowance for loan loss adequacy calculation.

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
March 31, 2014	(In thousands)

Individually evaluated for impairment	$	-	$	10,634	$	-	$	-	$	-	$	10,634
Loans acquired with deteriorated credit quality		237		848		-		-		-		1,085
Collectively evaluated for impairment		156,414		254,089		21,400		37,606		15,245		484,754
Total Loans	$	156,651	$	265,571	$	21,400	$	37,606	$	15,245	$	496,473



	Real Estate Loans
							Commercial		Consumer
	Residential		Commercial		Construction		Loans		Loans		Total
	(In thousands)
December 31, 2013

Individually evaluated for impairment	$	-	$	11,519	$	-	$	-	$	-	$	11,519
Loans acquired with deteriorated credit quality		242		848		-		-		-		1,090
Collectively evaluated for impairment		158,600		260,777		20,551		35,745		15,295		490,968
Total Loans	$	158,842	$	273,144	$	20,551	$	35,745	$	15,295	$	503,577

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
March 31, 2014				(in thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	237	$	245	$	-
Commercial		9,310		12,631		-
Subtotal		9,547		12,876		-
With an allowance recorded:
Real Estate Loans
Commercial		2,172		2,882		203
Subtotal		2,172		2,882		-
Total:
Real Estate Loans
Residential		237		245		-
Commercial		11,482		15,513		203
Total Impaired Loans	$	11,719	$	15,758	$	203



			Unpaid Principal
	Recorded		Principal		Associated
	Investment		Balance		Allowance
December 31, 2013				(in thousands)
With no related allowance recorded:
Real Estate Loans
Residential	$	242	$	251	$	-
Commercial		10,644		14,400		-
Subtotal		10,886		14,651		-
With an allowance recorded:
Real Estate Loans
Commercial		1,723		1,723		53
Subtotal		1,723		1,723		53
Total:
Real Estate Loans
Residential		242		251		-
Commercial		12,367		16,123		53
Total Impaired Loans	$	12,609	$	16,374	$	53

The following information for impaired loans is presented (in thousands) for the three months ended March 31, 2014 and 2013:



	Average Recorded				Interest Income
	Investment				Recognized
	2014		2013		2014		2013
Total:
Real Estate Loans
Residential	$	240	$	262	$	1	$	1
Commercial		11,754		10,839		57		19
Total Loans	$	11,994	$	11,101	$	58	$	20

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 March 31, 2014, troubled debt restructured loans totaled $9.1 million and resulted in specific reserves of $203,000. As of December 31, 2013, troubled debt restructured loans totaled $9.2 million and resulted in specific reserves of $53,000. For the periods ended March 31, 2014 and 2013, 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.

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 March 31, 2014 and December 31, 2013 (in thousands):



			Special					Doubtful
	Pass		Mention		Substandard		and Loss		Total
March 31, 2014
Commercial real estate loans	$	244,455	$	3,752	$	17,364	$	-	$	265,571
Commercial loans		37,606		-		-		-		37,606
Total	$	282,061	$	3,752	$	17,364	$	-	$	303,177



			Special					Doubtful
	Pass		Mention		Substandard		and Loss		Total
December 31, 2013
Commercial real estate loans	$	250,566	$	3,651	$	18,927	$	-	$	273,144
Commercial loans		35,745		-		-		-		35,745
Total	$	286,311	$	3,651	$	18,927	$	-	$	308,889

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 March 31, 2014 and December 31, 2013 (in thousands):



	Performing		Nonperforming		Total
March 31, 2014
Residential real estate loans	$	155,022	$	1,629	$	156,651
Construction		21,400		-		21,400
Consumer loans		15,245		-		15,245
Total	$	191,667	$	1,629	$	193,296



	Performing		Nonperforming		Total
December 31, 2013
Residential real estate loans	$	157,138	$	1,704	$	158,842
Construction		20,551		-		20,551
Consumer loans		15,295		-		15,295
Total	$	192,984	$	1,704	$	194,688

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 March 31, 2014 and December 31, 2013 (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
March 31, 2014
Real Estate loans
Residential	$	154,518	$	377	$	127	$	-	$	1,629	$	2,133	$	156,651
Commercial		257,381		287		-		-		7,903		8,190		265,571
Construction		21,400		-		-		-		-		-		21,400
Commercial loans		37,584		22		-		-		-		22		37,606
Consumer loans		15,134		96		15		-		-		111		15,245
Total	$	486,017	$	782	$	142	$	-	$	9,532	$	10,456	$	496,473



	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, 2013
Real Estate loans
Residential	$	156,066	$	1,018	$	54	$	-	$	1,704	$	2,776	$	158,842
Commercial		263,837		977		487		-		7,843		9,307		273,144
Construction		20,551		-		-		-		-		-		20,551
Commercial loans		35,717		28		-		-		-		28		35,745
Consumer loans		15,228		57		10		-		-		67		15,295
Total	$	491,399	$	2,080	$	551	$	-	$	9,547	$	12,178	$	503,577

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, 2013	$	1,441	$	3,025	$	898	$	184	$	160	$	5,708
Charge Offs		(75)		(329)		-		-		(11)		(415)
Recoveries		-		-		-		-		14		14
Provision Expense		(34)		1,146		(667)		-		(25)		420
Ending balance, March 31, 2014	$	1,332	$	3,842	$	231	$	184	$	138	$	5,727
Ending balance individually evaluated for impairment	$	-	$	203	$	-	$	-	$	-	$	203
Ending balance collectively evaluated for impairment	$	1,332	$	3,639	$	231	$	184	$	138	$	5,524



(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		(250)		(313)		-		-		(19)		(582)
Recoveries		-		-		-		-		6		6
Provision Expense		427		420		5		(47)		(5)		800
Ending balance, March 31, 2013	$	1,974	$	3,290	$	124	$	176	$	162	$	5,726
Ending balance individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-
Ending balance collectively evaluated for impairment	$	1,974	$	3,290	$	124	$	176	$	162	$	5,726

The Company’s primary business activity as of March 31, 2014 and December 31, 2013 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 March 31, 2014, the Company considered its concentration of credit risk to be acceptable. The highest concentrations are in the hospitality lodging industry, automobile dealers, property owners associations and resorts with loans outstanding of $37.2 million, or 42.8% of capital, to the hospitality lodging industry, $14.3 million, or 16.5% of capital to automobile dealers, $12.1 million, or 13.9% of capital, to property owners associations and $9.1 million, or 10.6% of capital, to the resort industry. During the current period, the Company recorded a write down of $300,000 on a motel property.

Gross realized gains and gross realized losses on sales of residential mortgage loans were $42,000 and $0, respectively, in the first three months of 2014 compared to $18,000 and $7,000, respectively, in the same period in 2013. The proceeds from the sales of residential mortgage loans totaled $1.1 million for each of the three month periods ended March 31, 2014 and 2013, respectively.