Credit Quality

9 Months Ended

Sep. 30, 2011

Credit Quality [Abstract]

CREDIT QUALITY

NOTE 4 — CREDIT QUALITY

Allowance for Credit Losses

The allowance consists of both specific and general components. The specific component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the collateral value, or value of expected discounted cash flows of the impaired loan, is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical charge-off experience and expected loss given default derived from the Bank’s internal risk rating process. Management utilizes historical loss rates in the calculation by applying weights, so that the most recent data bears a larger impact on future loss rate calculations. Management has the ability to adjust these loss rates by utilizing risk ratings based on current period trends. If current period trends differ either positively or negatively from the given weighted historical loss rates, adjustments can be made. The risk ratings either increase the expected loss rates, or decrease the expected loss rates, depending on the variance on actual versus historical trends. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risking rating data.

Management also utilizes its assessment of general economic conditions, and other localized economic data to more fully support its loan loss estimates. General economic data may include: inflation rates, savings rates and national unemployment rates. Local data may include: unemployment rates; housing starts; real estate valuations; and other economic data specific to the Corporation’s market area. Though not specific to individual loans, these economic trends can have an impact on portfolio performance as a whole.

A loan is impaired when full payment of interest and principal under the original contractual loan terms is not expected. Commercial and industrial loans, commercial real estate, including construction, land development and multi-family real estate loans are individually evaluated for impairment. If a loan is impaired, the loan amount exceeding fair value based on the most current information available is reserved. Management has developed a process by which commercial and commercial real estate loans receiving an internal grade of substandard or doubtful are individually evaluated for impairment through a loan quality review (“LQR”). The LQR details the various attributes of the relationship and collateral and determines based on the most recent available information if a specific reserve needs to be applied and at what level. The LQR process for all loans meeting the specific review criteria is completed on a quarterly basis.

Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, such loans are not separately identified for impairment disclosures. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Uncollectability is usually determined based on a pre-determined number of days in the case of consumer loans, or, in the case of commercial loans, is based on delinquency, collateral and other legal considerations. Consumer loans are charged-off prior to 120 days of delinquency, but could be charged off earlier, depending on the individual circumstances. Mortgage loans are charged down prior to 180 days of delinquency, but could be charged off sooner, again, depending upon individual circumstance. Typically, loans collateralized by consumer real estate are partially charged down to the estimated liquidation value, which is generally based on appraisal less costs to hold and liquidate. Commercial and commercial real estate loans are evaluated for impairment and typically reserved based on the results of the analysis, then subsequently charged down to a recoverable value when loan repayment is deemed to be collateral dependent. Both consumer and commercial loans can be partially charged down depending on a number of factors including: the remaining strength of the borrower and guarantor; the type and value of the collateral, and the ease of liquidating collateral; and whether or not collateral is brought onto the bank’s balance sheet via repossession.

In the case of commercial and commercial real estate loans, charge-off, partial or whole, takes place when Management determines that full collectability of principal balance is unlikely to occur. Subsequent recoveries, if any, are credited to the allowance. Management’s policies for determining impairment, reserves and charge-offs are reviewed and approved by the Board of Directors on an annual basis, and were not materially changed in 2011. Management estimates the required allowance balance based on past loan loss experience, augmented by additional estimates related to the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors.

An individual loan is placed on a non-accruing status if, in the judgment of Management, it is unlikely that all principal and interest will be received according to the terms of the note. Loans on non-accrual may be eligible to be returned to an accruing status after six months of compliance. However, there are number of factors that could prevent a loan from returning to accruing status, even after remaining in compliance with loan terms for the aforementioned six month period. For example: deteriorating collateral, negative cash flow changes and inability to reduce debt to income ratios.

The following table depicts the charge-offs, recoveries and provision for various categories of loans in the Corporation’s portfolios and indicates whether loans in those categories were individually or collectively evaluated for impairment. It also provides the dollar amount of reserves allocated to those portfolios based on Management’s analysis. Note that the reduced provision for commercial and industrial loans is the result of loans that were individually evaluated for impairment and assigned reserves in prior periods either improving their credit quality or paying off which subsequently reduced the need for carrying reserves.

Nine Months Ended September 30, 2011

										Residential
										Real Estate
	Consumer and			Commercial and			Commercial			and Home
	Credit Card			Industrial			Real Estate			Equity			Total
Beginning Balance	$	796		$	4,174		$	6,786		$	491		$	12,247
Charge Offs		(458	)		(1,861	)		(3,772	)		(78	)		(6,169	)
Recoveries		197			51			25			8			281
Provision		14			(482	)		4,416			(112	)		3,836
Ending Balance	$	549		$	1,882		$	7,455		$	309		$	10,195
Individually evaluated for impairment	$	—		$	288		$	6,377		$	—		$	6,665
Collectively evaluated for impairment		549			1,594			1,078			309			3,530
Ending Balance	$	549		$	1,882		$	7,455		$	309		$	10,195
Financing Receivables
Individually evaluated for impairment	$	—		$	14,054		$	39,745		$	—		$	53,799
Collectively evaluated for impairment		20,544			118,149			99,512			88,619			326,824
Total	$	20,544		$	132,203		$	139,257		$	88,619		$	380,623

Year Ended December 31, 2010

										Residential
										Real Estate
	Consumer and			Commercial and			Commercial			and Home
	Credit Card			Industrial			Real Estate			Equity			Total
Beginning Balance	$	874		$	2,476		$	6,817		$	312		$	10,479
Charge Offs		(824	)		(2,261	)		(6,175	)		(498	)		(9,758	)
Recoveries		200			270			4			12			486
Provision		546			3,689			6,140			665			11,040
Ending Balance	$	796		$	4,174		$	6,786		$	491		$	12,247
Individually evaluated for impairment	$	—		$	2,812		$	5,158		$	—		$	7,970
Collectively evaluated for impairment		796			1,362			1,628			491			4,277
Ending Balance	$	796		$	4,174		$	6,786		$	491		$	12,247
Financing Receivables
Individually evaluated for impairment	$	—		$	18,967		$	42,104		$	—		$	61,071
Collectively evaluated for impairment		23,411			136,443			110,270			93,646			363,770
Total	$	23,411		$	155,410		$	152,374		$	93,646		$	424,841

Impaired Loans

A loan is considered impaired when based on current information and events, it is probable the Bank will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. Generally, commercial and commercial real estate loans with risk grades Substandard, Vulnerable, Doubtful, or Loss, with aggregate relationships greater than $250 are evaluated for impairment. Interest income on impaired loans is recognized when accrued, for loans that remain in a performing status. Loans that are not performing and in a non-accrual status recognize interest only on cash basis if circumstances warrant.

The following tables indicate impaired loans with and without an allocated allowance:

At and for the nine months ended September 30, 2011

			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With No Related Allowance Recorded
Consumer and Credit Card	$	—	$	—	$	—	$	—	$	—
Commercial and Industrial		3,902		3,980		—		4,441		145
Commercial Real Estate		9,900		14,362		—		12,711		281
Residential RE and Home Equity		—		—		—		—		—
With Allowance Recorded
Consumer and Credit Card		—		—		—		—		—
Commercial and Industrial		10,152		12,336		288		11,384		447
Commercial Real Estate		29,845		35,861		6,377		27,132		1,126
Residential RE and Home Equity		—		—		—		—		—
Total
Consumer and Credit Card		—		—		—		—		—
Commercial and Industrial		14,054		16,316		288		15,825		592
Commercial Real Estate		39,745		50,223		6,377		39,843		1,407
Residential RE and Home Equity		—		—		—		—		—
Total	$	53,799	$	66,539	$	6,665	$	55,668	$	1,999

At and for the year ended December 31, 2010

			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With No Related Allowance Recorded
Consumer and Credit Card	$	—	$	—	$	—	$	—	$	—
Commercial and Industrial		5,615		5,757		—		4,196		295
Commercial Real Estate		17,529		20,855		—		14,597		993
Residential RE and Home Equity		—		—		—		—		—
With Allowance Recorded
Consumer and Credit Card		—		—		—		—		—
Commercial and Industrial		13,352		15,238		2,812		13,651		741
Commercial Real Estate		24,575		28,823		5,158		25,209		821
Residential RE and Home Equity		—		—		—		—		—
Total
Consumer and Credit Card		—		—		—		—		—
Commercial and Industrial		18,967		20,995		2,812		17,847		1,036
Commercial Real Estate		42,104		49,678		5,158		39,806		1,814
Residential RE and Home Equity		—		—		—		—		—
Total	$	61,071	$	70,673	$	7,970	$	57,653	$	2,850

The allowance for impaired loans is included in the Corporation’s overall allowance for loan losses. The provision necessary to increase this allowance is included in the Corporation’s overall provision for losses on loans.

Financing receivables on nonaccrual status at September 30, 2011 and December 31, 2010 are as follows:

	September 30,		December 31,
	2011		2010
Consumer and credit card	$	46	$	33
Commercial and industrial		3,053		6,043
Commercial real estate		8,722		10,102
Residential real estate and home equity		685		389
Total	$	12,506	$	16,567

Credit Quality Indicators

Corporate risk exposure by risk profile was as follows at September 30, 2011:

	Commercial and		Commercial Real
Category	Industrial		Estate
Prime-1	$	4,456	$	561
Good-2		17,450		17,918
Fair-3		39,554		30,423
Compromised-4		32,137		42,390
Vulnerable-5		18,794		4,673
Substandard-6		19,812		43,292
Doubtful-7		—		—
Loss-8		—		—
Total	$	132,203	$	139,257

Corporate risk exposure by risk profile was as follows at December 31, 2010:

	Commercial and		Commercial Real
Category	Industrial		Estate
Prime-1	$	8,459	$	561
Good-2		22,355		20,404
Fair-3		45,853		39,067
Compromised-4		31,628		27,692
Vulnerable-5		22,154		11,785
Substandard-6		24,959		52,865
Doubtful-7		2		—
Loss-8		—		—
Total	$	155,410	$	152,374

Risk Category Descriptions

Prime — 1

Prime loans based on liquid collateral, with adequate margin or supported by a strong financial statement audited with an unqualified opinion from a CPA firm. The character and repayment ability of the borrowers are excellent and without question. High liquidity, minimum risk, strong ratios, and low handling costs are common to these loans. This classification will also include all loans secured by CDs or cash equivalents.

Good — 2

Good loans of above average quality. Borrowers have a modest degree of risk. The margin of protection is good. Elements of strength are present in areas such as liquidity, stability of margins and cash flows, diversity of assets, and lack of dependence on one type of business or customer. Reasonable access to alternative bank financing is present and borrowers can obtain favorable rates and terms. These are well established regional firms and excellent local companies operating in a reasonably stable industry that may be moderately affected by the business cycle. Management and owners have unquestioned character, as demonstrated by repeated performance.

Fair — 3

Satisfactory loans of average or slightly above average risk — having some deficiency or vulnerability to changing economic conditions, but still fully collectible. Projects should clearly demonstrate at least break even debt service coverage. May be some weakness but with offsetting features of other support readily available. These loans are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered.

Compromised — 4

This risk grade may be established for a loan considered satisfactory but which is of below average credit risk due to financial weaknesses or uncertainty. The loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in Compromised classification is considered acceptable and within normal underwriting guidelines, so long as the loan is given the proper level of management supervision. Loans are considered Compromised when the following conditions apply:

• At inception, the loan was properly underwritten and did not possess an unwarranted level of credit risk; also the loan met the above criteria for a risk grade of 1 (Prime), 2 (Good), 3 (Fair) or 4 (Compromised).

• At inception, the loan was secured with collateral possessing a loan-to-value adequate to protect the Bank from loss.

• The loan exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance.

• During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or the business is in an industry which is known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted.

Vulnerable (Special Mention) — 5

Loans which possess some credit deficiency or potential weakness which deserves close attention, but which do not yet warrant substandard classification. Such loans pose unwarranted financial risk that, if not corrected, could weaken the loan and increase risk in the future. The key distinctions of a Vulnerable (Special Mention) classification are that (1) it is indicative of an unwarranted level of risk, and (2) weaknesses are considered “potential”, versus “well-defined”, impairments to the primary source of loan repayment.

Substandard — 6

Loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. One or more of the following characteristics may be exhibited in loans classified Substandard:

• Loans, which possess a defined credit weakness and the likelihood that a loan will be paid from the primary source, is uncertain. Financial deterioration is underway and very close attention is warranted to ensure that the loan is collected without loss.

• Loans are inadequately protected by the current net worth and paying capacity of the obligor.

• The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment such as collateral liquidation or guarantees.

• Loans are characterized by the distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

• Unusual courses of action are needed to maintain a high probability of repayment.

• The borrower is not generating enough cash flow to repay loan principal; however, continues to make interest payments.

• The lender is forced into a subordinated or unsecured position due to flaws in documentation.

• Loans have been restructured so that payment schedules, terms and collateral represent concessions to the borrower when compared to the normal loan terms.

• The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.

• There is a significant deterioration in the market conditions and the borrower is highly vulnerable to these conditions.

Doubtful — 7

One or more of the following characteristics may be exhibited in loans classified Doubtful:

• Loans have all of the weaknesses of those classified as Substandard. Additionally, however, these weaknesses make collection or liquidation in full based on existing conditions improbable.

• The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.

• The possibility of loss is high, but, because of certain important pending factors, which may strengthen the loan, loss classification is deferred until its exact status is known. A Doubtful classification is established during this period of deferring the realization of the loss.

Loss — 8

Loans are considered uncollectible and of such little value that continuing to carry them as assets on the institution’s financial statements is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

Consumer Risk

Consumer risk based on payment activity at September 30, 2011 is as follows.

			Residential Real
	Consumer and		Estate and Home
Payment Category	Credit Card		Equity
Performing	$	20,333	$	87,763
Non-Performing		211		856
Total	$	20,544	$	88,619

Consumer risk based on payment activity at December 31, 2010 is as follows.

			Residential Real
	Consumer and		Estate and Home
Payment Category	Credit Card		Equity
Performing	$	22,970	$	92,832
Non-Performing		441		814
Total	$	23,411	$	93,646

Age Analysis of Past Due Loans

The following table presents past due loans aged as of September 30, 2011.

													Recorded
			60-89										Investment
			Days		90 Days						Total		> 90 days
	30-59 Days		Past		and Greater		Total				Financing		and
Category	Past Due		Due		Past Due		Past Due		Current		Receivables		Accruing
Consumer and Credit Card	$	142	$	52	$	211	$	405	$	20,139	$	20,544	$	165
Commercial and Industrial		205		16		819		1,040		131,163		132,203		819
Commercial Real Estate		82		—		7,996		8,078		131,179		139,257		—
Residential Real Estate and Home Equity		23		211		856		1,090		87,529		88,619		172
Total	$	452	$	279	$	9,882	$	10,613	$	370,010	$	380,623	$	1,156

The following table presents past due loans aged as of December 31, 2010.

													Recorded
			60-89										Investment
			Days		90 Days						Total		> 90 days
	30-59 Days		Past		and Greater		Total				Financing		and
Category	Past Due		Due		Past Due		Past Due		Current		Receivables		Accruing
Consumer and Credit Card	$	300	$	104	$	441	$	845	$	22,566	$	23,411	$	407
Commercial and Industrial		359		3		1,373		1,735		153,675		155,410		991
Commercial Real Estate		885		2,050		10,118		13,053		139,321		152,374		35
Residential Real Estate and Home Equity		472		123		814		1,409		92,237		93,646		425
Total	$	2,016	$	2,280	$	12,746	$	17,042	$	407,799	$	424,841	$	1,858

Troubled Debt Restructurings

Information regarding Troubled Debt Restructuring (“TDR”) loans for the three and nine month periods ended September 30, 2011 is as follows:

	Three Months Ended				Nine Months Ended
	September 30, 2011				September 30, 2011
			Post-Modification				Post-Modification
	Number of		Outstanding		Number of		Outstanding
	Contracts		Recorded Investment		Contracts		Recorded Investment
Consumer and Credit Card		—	$	—		9	$	56
Commercial and Industrial		—		—		3		1,583
Commercial Real Estate		9		4,854		18		17,437
Residential Real Estate and Home Equity		—		—		2		14
Total		9	$	4,854		32	$	19,090

The following presents by class loans modified in a TDR from October 1, 2010 through September 30, 2011 that subsequently defaulted (i.e. 60 days or more past due following a modification) during the three and nine month periods ended September 30, 2011.

	Loans modified as a TDR within the previous				Loans modified as a TDR within the previous 12
	12 months that subsequently defaulted during				months that subsequently defaulted during
	the Three Months Ended				the Nine Months Ended
	September 30, 2011				September 30, 2011
	Number of		Recorded Investment		Number of		Recorded Investment
	Contracts		as of period end (1)		Contracts		as of period end (1)
Consumer and Credit Card		2	$	18		2	$	18
Commercial and Industrial		—		—		—		—
Commercial Real Estate		—		—		4		3,381
Residential Real Estate and Home Equity		—		—		—		—
Total		2	$	18		6	$	3,399

(1) Period end balances are inclusive of all partial pay downs and charge-offs since the modification date. Loans modified in a TDR that were fully paid down, charged off, or foreclosed upon by period end are not reported.

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Depending on the financial condition of the borrower, the purpose of the loan and the type of collateral supporting the loan structure; modifications can be either short-term (12 months of less) or long term (greater than one year). Commercial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor may be requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period.

Land loans are also included in the class of commercial real estate loans. Land loans are typically structured as interest-only monthly payments with a balloon payment due at maturity. Land loans modified in a TDR typically involve extending the balloon payment by one to three years, changing the monthly payments from interest-only to principal and interest, while leaving the interest rate unchanged.

Loans modified in a TDR are typically already on nonaccrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Corporation may have the financial effect of increasing the specific allowance associated with the loan. The allowance for impaired loans that have been modified in a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows discounted at the loan’s effective interest rate. Management exercises significant judgment in developing these estimates.

As mentioned above, an individual loan is placed on a non-accruing status if, in the judgment of Management, it is unlikely that all principal and interest will be received according to the terms of the note. Loans on non-accrual may be eligible to be returned to an accruing status after six months of compliance with the modified terms. However, there are number of factors that could prevent a loan from returning to accruing status, even after remaining in compliance with loan terms for the aforementioned six month period. For example: deteriorating collateral, negative cash flow changes and inability to reduce debt to income ratios.