Loans, Allowance for Credit Losses and Credit Quality

6 Months Ended

Jun. 30, 2012

Loans, Allowance for Credit Losses and Credit Quality [Abstract]

Loans, Allowance For Credit Losses And Credit Quality

Note F – Loans, Allowance For Credit Losses And Credit Quality

Major classifications of loans are as follows:

	June 30, 2012			December 31, 2011
Commercial	$	47,111		$	47,683
Real estate
Commercial		121,661			114,883
Construction		37,221			35,026
One to four-family		48,816			48,314
Home equity		34,724			36,005
Consumer		8,253			8,870
		297,786			290,781
Deferred loan fees, net		(402	)		(315	)
Allowance for credit losses		(6,908	)		(7,182	)
		(7,310	)		(7,497	)
Loans, net	$	290,476		$	283,284

The maturity and rate repricing distribution of the loan portfolio is as follows:

Repricing or maturing within one year	$	99,373	$	100,804
Maturing over one to five years		128,884		132,637
Maturing over five years		69,529		57,340
	$	297,786	$	290,781

The Company’s goal is to mitigate risks inherent in the loan portfolio. Commercial loans and loans secured by real estate make up the majority of the loan portfolio, accounting for 97% of the portfolio as of June 30, 2012 and December 31, 2011. To mitigate risk, commercial loans are generally secured by receivables, inventories, equipment and other assets of the business. Personal guarantees of the borrowers are generally required.

Loans secured by commercial real estate properties generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through its underwriting standards, which require such loans to be qualified on the basis of the property’s value, debt service coverage ratio, and, under certain circumstances, additional collateral. The Bank generally also requires personal guarantees on its commercial real estate loans.

Construction loans are generally considered to involve a higher degree of credit risk than long-term financing of improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the security property’s value upon completion of construction as compared to the estimated costs of construction, including interest. Also, the Bank assumes certain risks associated with the borrowers’ ability to complete construction in a timely and workmanlike manner. If the estimate of value proves to be inaccurate, or if construction is not performed timely or accurately, the Bank may be faced with a project which, when completed, has a value that is insufficient to assure full repayment.

The Bank currently originates one- to four-family residential mortgage loans in amounts typically up to 80% (or higher with private mortgage insurance) of the lower of the appraised value or the selling price of the property securing the loan. The origination of adjustable-rate residential mortgage loans, as opposed to fixed-rate residential mortgage loans, helps to reduce the Bank’s exposure to increases in interest rates. However, adjustable-rate loans generally pose credit risks not inherent in fixed-rate loans, primarily because as interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default. Periodic and lifetime caps on interest rate increases help to reduce the risks associated with the Bank’s adjustable-rate loans, but also limit the interest rate sensitivity of its adjustable-rate mortgage loans.

Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.

The Bank’s allowance for credit losses is established through a provision for loan losses based on management’s evaluation of the risks inherent in its loan portfolio and the general economy.

The determination of the allowance for loan losses is based on the Bank’s historical loss experience and ten (10) qualitative factors for specific categories and types of loans. The Bank’s historical loss experience is calculated by aggregating the actual loan losses by category for the previous eight quarters and converting that total into a percentage for each loan category.

Previously (in 2011), due to the Bank’s limited historical loss experience, the loss experience factor was the greater of either the Bank’s historical loss experience or the peer group average historical loss experience.

The following table shows the allowance for credit losses and recorded investment in loans receivable for the three and six month periods ended June 30, 2012:

Allowance for Credit Losses and Recorded Investment in Loans Receivable

for the Three Months Ended June 30, 2012
(Dollars in thousands)	Commercial			Commercial Real Estate			Residential			Consumer			Unallocated		Total
Allowance for credit losses
Beginning balance, March 31, 2012	$	1,048		$	3,832		$	1,602		$	283		$	0	$	6,765
Charge-offs		0			0			0			0			0		0
Recoveries		18			0			3			12			0		33
Provision		(23	)		130			42			(39	)		0		110
Ending balance, June 30, 2012	$	1,043		$	3,962		$	1,647		$	256		$	0	$	6,908
for the Six Months Ended June 30, 2012
	Commercial			Commercial Real Estate			Residential			Consumer			Unallocated		Total
Allowance for credit losses
Beginning balance, December 31, 2011	$	1,387		$	3,972		$	1,422		$	401		$	0	$	7,182
Charge-offs		32			0			340			231			0		603
Recoveries		28			0			4			20			0		52
Provision		(340	)		(10	)		561			66			0		277
Ending balance, June 30, 2012	$	1,043		$	3,962		$	1,647		$	256		$	0	$	6,908
Period ending amount: Individually evaluated for impairment	$	444		$	1,198		$	1,011		$	67		$	0	$	2,720
Period ending amount: Collectively evaluated for impairment	$	599		$	2,764		$	636		$	189		$	0	$	4,188
Period ending amount: Loans acquired with deteriorating credit quality	$	0		$	0		$	0		$	0		$	0	$	0
Loans individually evaluated for impairment	$	1,265		$	2,683		$	2,682		$	132		$	0	$	6,762
Loans collectively evaluated for impairment	$	45,846		$	156,199		$	80,858		$	8,121		$	0	$	291,024
for the Three Months Ended June 30, 2011
(Dollars in thousands)	Commercial			Commercial Real Estate			Residential			Consumer			Unallocated		Total
Allowance for credit losses
Beginning balance, March 31, 2011	$	1,886		$	3,054		$	1,434		$	518		$	0	$	6,892
Charge-offs		301			49			133			81			0		564
Recoveries		5			0			253			7			0		265
Provision		(187	)		1,072			(160	)		(46	)		0		679
Ending balance, June 30, 2011	$	1,403		$	4,077		$	1,394		$	398		$	0	$	7,272

for the Six Months Ended June 30, 2011
	Commercial		Commercial Real Estate		Residential		Consumer		Unallocated		Total
Allowance for credit losses
Beginning balance, December 31, 2010	$	1,868	$	3,205	$	1,257	$	523	$	0	$	6,853
Charge-offs		772		49		133		136		0		1,090
Recoveries		10		0		253		10		0		273
Provision		297		921		17		1		0		1,236
Ending balance, June 30, 2011	$	1,403	$	4,077	$	1,394	$	398	$	0	$	7,272
Period ending amount: Individually evaluated for impairment	$	63	$	1,199	$	465	$	46	$	0	$	1,773
Period ending amount: Collectively evaluated for impairment	$	1,340	$	2,878	$	929	$	352	$	0	$	5,499
Period ending amount: Loans acquired with deteriorating credit quality	$	0	$	0	$	0	$	0	$	0	$	0
Loans individually evaluated for impairment	$	126	$	4,668	$	1,526	$	82	$	0	$	6,402
Loans collectively evaluated for impairment	$	51,219	$	136,104	$	87,050	$	9,606	$	0	$	283,979

Nonaccrual loans totaled approximately $6.2 million at both June 30, 2012 and December 31, 2011. There was one loan for $285,000 past due greater than 90 days and still accruing at June 30, 2012. At December 31, 2011, there were no loans past due greater than 90 days and still accruing. As of June 30, 2012, $2.7 million of loan loss allowances were allocated to all loans classified as impaired with $1.6 million of loan loss allowances allocated to all loans classified as impaired at December 31, 2011.

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management assigns a Risk Assessment Rating (‘Risk Rating”) to extensions of credit based upon the degree of risk, the likelihood of repayment and the effect on the Bank’s safety and soundness. The Risk Rating, applied consistently, enables lending personnel and bank management to monitor the loan portfolio. The Risk Rating is an integral part of the bank’s loan loss provision formulation process and, properly maintained, the Risk Rating assessment can provide an early warning signal of deterioration in a credit.

The Company uses a risk rating matrix to assign a risk grade to each loan. The Risk Ratings are divided into five general categories:

1. Risk Ratings 1 - 6 are assigned to “Pass” credits.

2. Risk Rating 7 is assigned to “Pass” credits that are also considered “Watch” credits.

3. Risk Rating 8 is assigned to “Criticized” credits.

4. Risk Ratings 9 and 10 are assigned to “Classified” credits.

5. Risk Rating 11 is assigned to “Loss” credits.

A general description of the characteristics of the risk ratings are described below:

• Risk ratings 1, 2 and 3 – these ratings have the highest degree of probability of repayment. Borrowers in this category are established entities, well-positioned within their industry with a proven track record of solid financial performance. These ratings are usually reserved for the strongest customers of the Bank, who have strong capital, stable earnings and alternative sources of financing.

• Risk ratings 4 and 5 – these ratings have a below and average degree of risk. The customers have, generally strong to adequate net worth, stable earnings trends and strong to moderate liquidity.

• Risk rating 6 – this category represents an above average degree of risk as to repayment with minimal loss potential. Borrowers in this category generally exhibit adequate operating trends, satisfactory balance sheet trends, moderate leverage and adequate liquidity; however, there is minimal excess operating cushion.

• Risk rating 7 – this rating includes loans on management’s “Watch” list. Borrowers in this category generally exhibit characteristics of an acceptable/adequate credit, but may be experiencing income volatility, negative operating trends, and a more highly leveraged balance sheet.

• Risk rating 8 – this rating is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This rating generally includes loans to borrowers with currently protected, but potentially weak assets that deserve management’s close attention.

• Risk rating 9 – this rating is for loans considered “Substandard” in accordance with regulatory guidelines. This rating represents assets inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged. These assets have a well-defined weakness, or weaknesses, that jeopardize liquidation of the debt and are characterized by the distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

• Risk rating 10 – this rating is for loans considered “Doubtful” in accordance with regulatory guidelines. Borrowers in this category have all the weaknesses inherent in a “Substandard” credit with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly improbable.

• Risk rating 11 – this rating is for loans considered “Loss” in accordance with regulatory guidelines. This category represents loans that are considered uncollectible and of such little value that their continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but simply it is neither practical nor desirable to defer writing off all or some portion of the credit, even though partial recovery may be effected in the future.

The following table presents credit quality indicators:

Credit Quality Indicators

as of June 30, 2012

(Dollars in thousands)

			Commercial Real Estate
	Commercial		Construction		Other
	2012		2012		2012
Risk Rating:
Pass	$	41,896	$	31,776	$	105,228
Other Assets Especially Mentioned		2,936		2,422		13,865
Substandard		2,089		1,871		1,318
Doubtful		190		1,152		1,250
	$	47,111	$	37,221	$	121,661

	Residential		Consumer Installment
	2012		2012
Risk Rating:
Pass	$	75,281	$	7,746
Other Assets Especially Mentioned		4,267		286
Substandard		2,566		156
Doubtful		1,426		65
	$	83,540	$	8,253

Credit Quality Indicators

as of December 31, 2011

(Dollars in thousands)

			Commercial Real Estate
	Commercial		Construction		Other
	2011		2011		2011
Risk Rating:
Pass	$	41,899	$	29,456	$	102,495
Other Assets Especially Mentioned		2,181		2,432		7,944
Substandard		3,571		1,986		3,194
Doubtful		32		1,152		1,250
	$	47,683	$	35,026	$	114,883

	Residential		Consumer Installment
	2011		2011
Risk Rating:
Pass	$	78,402	$	8,017
Other Assets Especially Mentioned		1,867		290
Substandard		2,632		348
Doubtful		1,418		215
	$	84,319	$	8,870

The following table presents an age analysis of past due loans receivable:

Age Analysis of Past Due Loans Receivable

As of June 30, 2012

(Dollars in thousands)

	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment 90 Days and Accruing
2012
Commercial	$	4,299	$	197	$	0	$	4,496	$	42,615	$	47,111	$	0
Commercial Real Estate
Construction		0		0		1,152		1,152		36,069		37,221		0
Other		0		0		285		285		121,376		121,661		285
Residential		80		7		1,992		2,079		81,461		83,540		0
Consumer		4		0		19		23		8,230		8,253		0
	$	4,383	$	204	$	3,448	$	8,035	$	289,751	$	297,786	$	285

Age Analysis of Past Due Loans Receivable

As of December 31, 2011

(Dollars in thousands)

	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment 90 Days and Accruing
2011
Commercial	$	0	$	32	$	178	$	210	$	47,473	$	47,683	$	0
Commercial Real Estate
Construction		229		0		1,152		1,381		33,645		35,026		0
Other		482		0		0		482		114,401		114,883		0
Residential		687		0		1,972		2,659		81,660		84,319		0
Consumer		23		0		342		365		8,505		8,870		0
	$	1,421	$	32	$	3,644	$	5,097	$	285,684	$	290,781	$	0

Total past due loans at June 30, 2012 increased $2.9 million to $8.0 million from $5.1 million as of December 31, 2011. New loans considered past due totaled $5.7 million and included one loan for $4.2 million that was past due at June 30, 2012 and current at December 31, 2011. Offsetting a portion of the increase in past due loans were payoffs and the return of loans to performing totaling $1.7 million, charge-offs of loans deemed uncollectible of $452,000 and transfers to real estate owned and repossessed assets of $378,000.

Loans are considered impaired when, based on current information it is probable that the Bank will not collect all principal and interest payments according to contractual terms. Generally, loans are considered impaired once principal and interest payments are past due and they are placed on non-accrual. When a loan is placed on nonaccrual status, the Bank shall debit all accrued and unpaid income outstanding on the account. Management also considers the financial condition of the borrower, cash flows of the loan and the value of the related collateral. Impaired loans do not include large groups of smaller balance homogeneous credits such as residential real estate and consumer installment loans, which are evaluated collectively for impairment. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (usually ninety days or less) provided eventual collection of all amounts due is expected. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Bank may measure impairment based on a loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. Interest payments on impaired loans are typically applied to principal unless collectability is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans or portions thereof, are charged-off when deemed uncollectible.

The Company’s policy states that when the probability for full repayment of a loan is unlikely, the Bank will initiate a full charge-off or a partial write-down of the asset based upon the status of the loan.

Consumer loans less than $25,000 for which payments of principal and/or interest are past due ninety (90) days are charged-off and referred for collection. Consumer loans of $25,000 or more are evaluated for charge-off or partial write-down at the discretion of Bank management.

Any other loan over 120 days past due is evaluated for charge-off or partial write-down at the discretion of Bank management.

Generally, real estate secured loans are charged-off on a deficiency basis after liquidation of the collateral. Bank management may determine that when the full loan balance is clearly uncollectible and some loss is anticipated a charge-off or write-down is appropriate prior to liquidation of the collateral. An updated evaluation or appraisal of the property may be required to determine the appropriate level of charge-off or write-down.

The following tables presents a summary of impaired loans as of and for the six months ended June 30, 2012 and as of December 31, 2011 and for the year then ended:

Impaired Loans

as of and for the Six Month Period Ended June 30, 2012

(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded
Commercial	$	918	$	918	$	0
Commercial real estate		528		528		0
Residential real estate		358		358		0
Consumer		16		16		0
		1,820		1,820		0
With an allowance recorded
Commercial		493		493		444
Commercial real estate		2,440		2,440		1,198
Residential real estate		2,683		2,683		1,011
Consumer		132		132		67
		5,748		5,748		2,720
Total
Commercial		1,411		1,411		444
Commercial real estate		2,968		2,968		1,198
Residential real estate		3,041		3,041		1,011
Consumer		148		148		67
	$	7,568	$	7,568	$	2,720

Impaired Loans

as of December 31, 2011

(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded
Commercial	$	242	$	242	$	0
Commercial real estate		0		0		0
Residential real estate		1,074		1,074		0
Consumer		195		195		0
		1,511		1,511		0
With an allowance recorded
Commercial	$	1,156	$	1,156	$	195
Commercial real estate		2,444		2,444		731
Residential real estate		1,981		1,981		475
Consumer		289		289		161
		5,870		5,870		1,562
Total
Commercial	$	1,398	$	1,398	$	195
Commercial real estate		2,444		2,444		731
Residential real estate		3,055		3,055		475
Consumer		484		484		161
	$	7,381	$	7,381	$	1,562

The following presents information related to the average recorded investment and interest income recognized on impaired loans for the three and six months ended June 30, 2012 and 2011.

	Three Months Ended June 30, 2012					Three Months Ended June 30, 2011
	Average Recorded Investment		Interest Income Recognized			Average Recorded Investment		Interest Income Recognized
(Dollars in thousands)
With no related allowance recorded
Commercial	$	434	$	29		$	976	$	20
Commercial real estate		438		6			899		0
Residential real estate		519		3			1,422		49
Consumer		66		0			247		8
		1,457		38			3,544		77
With an allowance recorded
Commercial	$	850	$	5		$	462	$	2
Commercial real estate		4,991		47			2,344		0
Residential real estate		2,447		(19	)		1,648		8
Consumer		135		4			144		1
		8,423		37			4,598		11
Total
Commercial	$	1,284	$	34		$	1,438	$	22
Commercial real estate		5,429		53			3,243		0
Residential real estate		2,966		(16	)		3,070		57
Consumer		201		4			391		9
	$	9,880	$	75		$	8,142	$	88

	Six Months Ended June 30, 2012				Six Months Ended June 30, 2011
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
(Dollars in thousands)
With no related allowance recorded
Commercial	$	302	$	33	$	600	$	32
Commercial real estate		302		6		429		30
Residential real estate		734		5		733		36
Consumer		72		1		105		11
		1,410		45		1,867		109
With an allowance recorded
Commercial		976		21		346		3
Commercial real estate		4,367		260		931		16
Residential real estate		2,233		27		779		12
Consumer		191		8		105		5
		7,767		316		2,161		36
Total
Commercial	$	1,278	$	54	$	946	$	35
Commercial real estate		4,669		266		1,360		46
Residential real estate		2,967		32		1,512		48
Consumer		263		9		210		16
	$	9,177	$	361	$	4,028	$	145

The Company considers a loan to be a troubled debt restructuring when for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. The Company may consider granting a concession in an attempt to protect as much of its investment as possible.

The restructuring of a loan may include, but is not necessarily limited to: (1) the transfer from the borrower to the Bank of real estate, receivables from third parties, other assets, or an equity interest in the borrower in full or partial satisfaction of the loan (2) the issuance or other granting of an equity interest to the Company by the borrower to satisfy fully or partially a debt unless the equity interest is granted pursuant to existing terms for converting the debt in to an equity interest (3) a modification of the loan terms, such as a reduction of the stated interest rate, principal, or accrued interest or an extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk, or (4) a reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement and (5) a reduction of accrued interest. The current outstanding balance of troubled debt restructurings as of June 30, 2012 included $852,000 of loans in accrual status and $1.7 million of loans classified as nonaccrual. During the six months ended June 30, 2012 no new loans were added to those considered to be troubled debt restructurings and none of the loans currently classified as troubled debt restructurings have defaulted. The following table is a summary of loans determined to be troubled debt restructurings for the twelve months ended December 31, 2011.

	Modifications made during the year ended December 31, 2011
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial		3	$	840	$	840
Commercial Real Estate		2		1,863		1,298
Residential Real Estate		3		453		453
Consumer		1		46		46
		9	$	3,202	$	2,637

	Number of Contracts		Recorded Investment
Troubled Debt Restructurings that Subsequently Defaulted
Commercial		0	$	0
Commercial Real Estate		0		0
Residential Real Estate		0		0
Consumer		0		0
		0	$	0