NOTE 7 — Loans

Details regarding the Company’s loans are as follows:


As of:	June 30, 2013		December 31, 2012
Loans secured by real estate:
Construction and land development
Residential real estate	$	1,320	$	3,231
Commercial real estate		17,036		17,617
Secured by 1-4 family residential properties:
Revolving, open-end loans		28,718		29,947
Secured by first liens		200,899		194,324
Secured by junior liens		17,847		18,504
Secured by multi-family properties		17,456		15,906
Secured by non-farm, non-residential properties		208,996		199,879
Commercial and industrial loans to U.S. addressees		56,013		56,396
Loans to individuals for household, family and other personal expenditures:
Credit card and related plans		3,031		3,199
Other (installment and student loans, etc.)		49,732		49,199
Obligations of states & political subdivisions		28,616		22,586
All other loans		12,689		12,742

Gross Loans		642,353		623,530
Less: Unearned income on loans		—		—

Loans, net of unearned income	$	642,353	$	623,530

The Company has not engaged in any sub-prime residential mortgage lending. Therefore, the Company is not subject to any credit risks associated with such loans. The Company’s loan portfolio consists of residential and commercial mortgage loans secured by properties primarily located in Northeastern Pennsylvania and subject to what the Company believes are conservative underwriting standards.

Age Analysis of Past Due Loans

As of June 30, 2013


	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

Commercial	$	166	$	5	$	325	$	496	$	96,822	$	97,318	$	—
Commercial real estate:
Commercial real estate - construction		—		—		—		—		17,036		17,036		—
Commercial real estate - other		211		353		323		887		208,109		208,996		9
Consumer:
Consumer - credit card		13		3		16		32		2,999		3,031		16
Consumer - other		4		—		4		8		5,315		5,323		—
Consumer - auto		112		38		10		160		33,697		33,857		—
Student loans - TERI		33		13		38		84		5,680		5,764		—
Student loans - other		58		3		74		135		4,653		4,788		74
Residential:
Residential - prime		2,887		645		2,505		6,037		260,203		266,240		603

Total	$	3,484	$	1,060	$	3,295	$	7,839	$	634,514	$	642,353	$	702

Age Analysis of Past Due Loans

As of December 31, 2012


	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

Commercial	$	23	$	49	$	304	$	376	$	91,348	$	91,724	$	—
Commercial real estate:
Commercial real estate construction		—		—		—		—		17,617		17,617		—
Commercial real estate - other		1,448		200		145		1,793		198,086		199,879		—
Consumer:
Consumer - credit card		16		1		25		42		3,157		3,199		25
Consumer - other		74		86		10		170		5,694		5,864		1
Consumer - auto		212		17		11		240		31,944		32,184		8
Student loans - TERI		77		43		19		139		5,749		5,888		—
Student loans - other		119		123		180		422		4,841		5,263		180
Residential:
Residential - prime		2,680		1,198		2,043		5,921		255,991		261,912		243

Total	$	4,649	$	1,717	$	2,737	$	9,103	$	614,427	$	623,530	$	457

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, management tracks certain credit quality indicators including trends related to loan delinquency, the level of classified commercial loans, net charge-offs, non-performing loans and the general economic conditions in the Company’s market area.

The Bank utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 8. A description of the general characteristics of the 8 risk grades is as follows:

Pass 1 (Minimal Risk – Cash equivalent or exceptional credit)

This classification includes loans which are fully secured by liquid collateral. Examples include: deposits, life insurance, certificates of deposit and securities.

The borrower demonstrates exceptional credit fundamentals, including stable and predictable profit margins and cash flows, strong liquidity and a conservative balance sheet with superior asset quality. Excellent cash flow coverage of existing and projected debt service. Historic and projected performance indicates borrower is able to meet obligations under almost any economic circumstances. The company has very good, professional management with an excellent track record and good depth in successor management.

Pass 2 (Average Risk)

This classification includes all loans which have no identifiable risk of collection and conform in all aspects to the Bank’s policies and procedures as well as federal and state regulations. Documentation exceptions must be minimal and in the process of correction and not of a type that could subsequently introduce loan loss risk.

Borrower generates sufficient cash flow to fund debt service and some working assets and/or capital expansion needs. Profitability and key balance sheet ratios are at or slightly above peers. Current trends are positive or stable. Earnings are level or above the last two years.

Management has average to good experience with similar business activities and markets. The present venture appears to be well within management’s capacity. Management has depth, less formal but acceptable succession plan and limited turnover in key positions.

The industry is relatively established and the borrower is well established within the industry. Over-capacity and competitive forces are consistent with normal business cycles.

Pass 3 (Acceptable Risk)

This classification includes loans with terms and conditions that may deviate from the Bank’s loan policy. Collateral marketability and margins may exceed policy. Significant administration may be required.

Borrower generates sufficient cash flow to fund debt service, but most working asset and all capital expansion needs are provided from external sources. Borrower is able to meet payments. Profitability ratios and key balance sheet ratios are usually close to peers but one or more ratios e.g. leverage may be higher than peer. Earnings may be trending down over the last three years. Borrower may be able to obtain similar financing from other banks with comparable or less favorable terms.

Some management weakness may be evident, primarily in lack of depth. Management may come from unrelated industries or have more limited but acceptable experience. Key management succession may not be clear.

Borrower generally has limited capacity for additional debt. The Borrower has modest but sufficient debt coverage. Loans are protected by collateral. Business may be adversely affected by deteriorating industry conditions, internal operations problems, pending litigation or declining collateral quality. Potential adverse conditions are manageable.

Industry may be transitional or historically volatile or may be trending down. Long-term outlook is acceptable. Firm may be established but not quite as strong or large as the average firm in the industry, or firm may be new in the industry.

Pass 4 (Watch)

This category can cover many different situations. A typical watch situation is one where a strong or moderately strong borrower suffers business reversals which are not long term but require attention.

The borrower has weaknesses resulting from performance trends or management concerns. The financial condition of the company has taken a negative turn and may be temporarily strained. Borrowers may exhibit excessive growth, declining earnings, strained cash flow, increasing leverage and/or weakening market position that indicate above average risk. Interim losses and/or adverse trends may occur, but not to the level that would affect the Bank’s position. Cash flow may be weak but minimally acceptable.

Loans rated 4 are not considered criticized or classified assets. The rating is effective until the credit is strengthened or the relationship is moved out of the Bank. Therefore, the category does not include loans with undue or unwarranted credit risks that constitute identifiable weaknesses.

Criticized – Other Assets Especially Mentioned (Rated 5)

A “Criticized” (OAEM) classification includes loans which are fundamentally sound, but exhibit potential weaknesses which require corrective action to avoid any future credit risk. Close monitoring by the loan officer is warranted. Assets with this classification do not expose the Bank to sufficient risk to justify an adverse classification.

The following criteria are representative of a Criticized grade:

•

An inadequate loan agreement or an inability to obtain the necessary loan documents or financial statements.

•

Loans for which the loan agreement terms or covenants have been violated or waived.

•

Adverse economic and market conditions which, in the future, may affect the borrower’s repayment ability.

•

An adverse trend in the borrower’s financial condition that has not yet reached the point where the original payment terms are jeopardized.

•

A payment schedule which delays principal amortization.

•

Loans with collateral values where there is little margin between liquidation value and the amount of the loan commitment, or where the collateral has shown evidence of deterioration.

•

Loan officers must work closely with the borrower and explore alternate means to diminish risk. Loans classified OAEM should be considered candidates for management by the Asset Recovery Officer.

Classified – Substandard (Rated 6)

Classified assets include loans with well-defined weaknesses which are inadequately protected by current net worth, repayment capacity, or pledged collateral of the borrower. Loans are classified when they have one or more weaknesses that could jeopardize debt repayment and/or liquidation, primarily resulting in the possibility that the Bank may sustain some loss if the deficiencies are not corrected.

A substandard loan may exhibit one or more of the following conditions:

•

Borrower is unable to generate enough cash flow for debt reduction.

•

Primary source of repayment is impaired or no longer available, and the Bank is relying upon the secondary source.

•

Loss does not seem likely, but sufficient problems have arisen to cause the Bank to go to abnormal lengths to protect its position in order to maintain a high probability of repayment.

•

Deterioration in the condition of the collateral or inadequate inspection or verification of value.

•

Documentation flaws leaving the Bank in a subordinated or unsecured position.

•

All substandard loans should be managed by the Asset Recovery Officer.

Doubtful (Rated 7)

An asset classified as Doubtful has all weaknesses inherent in the substandard category where collection or liquidation in full is highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, liquidation proceedings, capital injection, perfecting liens on additional collateral, and business restructure plans.

The Bank considers Doubtful to be a temporary classification and will only classify an asset, or portion of an asset, as such when the information is not available to conclude as to classification or more clearly define the potential for loss. All loans classified as Doubtful are placed on non-accrual status and assigned to the Asset Recovery Officer for supervision.

Loss (Rated 8)

An asset classified as Loss is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. All losses should be recognized in the quarter in which they are identified. These loans are to be managed by the Asset Recovery Officer.

Credit Quality Indicators as of June 30, 2013

Commercial Credit Exposure

Credit Risk Profile by Creditworthiness Category


	Commercial		Commercial Real Estate - Construction		Commercial Real Estate - Other
Pass / Watch	$	95,321	$	17,036	$	194,904
Criticized		872		—		7,154
Substandard		1,125		—		6,938

Total	$	97,318	$	17,036	$	208,996

Consumer Credit Exposure

Credit Risk Profile by Payment Activity


	Residential Real Estate		Consumer - Credit Card		Consumer - Other		Consumer - Auto		Student Loans - TERI		Student Loans - Other
Performing	$	264,338	$	3,031	$	5,319	$	33,847	$	5,726	$	4,788
Non-performing		1,902		—		4		10		38		—

Total	$	266,240	$	3,031	$	5,323	$	33,857	$	5,764	$	4,788

Credit Quality Indicators as of December 31, 2012

Commercial Credit Exposure

Credit Risk Profile by Creditworthiness Category


	Commercial		Commercial Real Estate - Construction		Commercial Real Estate - Other
Pass / Watch	$	90,128	$	17,399	$	187,114
Criticized		876		218		6,222
Substandard		720		—		6,543

Total	$	91,724	$	17,617	$	199,879

Consumer Credit Exposure

Credit Risk Profile by Payment Activity


	Residential Real Estate		Consumer - Credit Card		Consumer - Other		Consumer - Auto		Student Loans - TERI		Student Loans - Other
Performing	$	259,869	$	3,174	$	5,854	$	32,173	$	5,869	$	5,083
Non-performing		2,043		25		10		11		19		180

Total	$	261,912	$	3,199	$	5,864	$	32,184	$	5,888	$	5,263

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Impaired Loans

June 30, 2013


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial real estate	$	314	$	314	$	—	$	287	$	—
Commercial		325		325		—		280		—
Consumer - TERI		38		38		—		61		—
Consumer - other		4		4		—		3		—
Consumer - auto		10		10		—		6		—
Residential real estate		1,437		1,437		—		1,047		—
With an allowance recorded:
Commercial real estate - construction		—		—		—		—		—
Commercial real estate - other		1,443		1,443		300		1,445		38
Commercial		612		612		612		532		12
Residential real estate		665		665		262		1,233		6

Total:	$	4,848	$	4,848	$	1,174	$	4,894	$	56

Commercial real estate	$	1,757	$	1,757	$	300	$	1,732	$	38
Commercial	$	937	$	937	$	612	$	812	$	12
Consumer	$	52	$	52	$	—	$	70	$	—
Residential real estate	$	2,102	$	2,102	$	262	$	2,280	$	6

Impaired Loans

December 31, 2012


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial real estate	$	145	$	145	$	—	$	201	$	—
Commercial		304		304		—		152		—
Consumer - TERI		19		19		—		48		—
Consumer - other		9		9		—		5		—
Consumer - auto		3		3		—		15		—
Residential - real estate		928		928		—		1,152		—
With an allowance recorded:
Commercial real estate construction		—		—		—		—		—
Commercial real estate - other		2,015		2,015		550		2,104		114
Commercial		351		351		351		351		17
Residential real estate		1,497		1,497		325		1,040		44

Total:	$	5,271	$	5,271	$	1,226	$	5,068	$	175

Commercial real estate	$	2,160	$	2,160	$	550	$	2,305	$	114
Commercial	$	655	$	655	$	351	$	503	$	17
Consumer	$	31	$	31	$	—	$	68	$	—
Residential real estate	$	2,425	$	2,425	$	325	$	2,192	$	44

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest income is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured with at least a six month positive payment history.

Period-end non-accrual loans, segregated by class of loans, were as follows:


	June 30, 2013		December 31, 2012
Commercial	$	325	$	304
Commercial real estate:
Commercial real estate - construction		—		—
Commercial real estate - other		314		145
Consumer:
Student loans - TERI		38		19
Student loans - other		—		—
Consumer - other		4		9
Consumer - auto		10		3
Residential:
Residential real estate		1,902		1,800

Total	$	2,593	$	2,280

The Allowance for Loan and Lease Losses and Recorded Investment in Loans for the six months ended June 30, 2013 is as follows:


	Commercial		Commercial Real Estate		Consumer			Residential			Credit Card			Unallocated		Total
Allowance for Loan and Lease Losses:
Beginning balance 12/31/12	$	799	$	2,304	$	540		$	2,981		$	326		$	—	$	6,950
Charge-offs		—		—		(72	)		(207	)		(45	)		—		(324	)
Recoveries		—		—		20			106			—			—		126
Provision		400		—		76			212			112			—		800

Ending balance 06/30/13	$	1,199	$	2,304	$	564		$	3,092		$	393		$	—	$	7,552

Ending balance: Individually evaluated for impairment		612		300		—			262			—			—		1,174


Ending balance: Collectively evaluated for impairment	$	587	$	2,004	$	564		$	2,830		$	393		$	—	$	6,378


Ending balance: Loans acquired with deteriorated credit quality	$	—	$	—	$	—		$	—		$	—		$	—	$	—

Loans:
Ending balance	$	97,318	$	226,032	$	49,732		$	266,240		$	3,031		$	—	$	642,353


Ending balance: Individually evaluated for impairment		937		1,757		52			2,102			—			—		4,848


Ending balance: Collectively evaluated for impairment	$	96,381	$	224,275	$	49,680		$	264,138		$	3,031		$	—	$	637,505


Ending balance: Loans acquired with deteriorated credit quality	$	—	$	—	$	—		$	—		$	—		$	—	$	—

The Allowance for Loan and Lease Losses and Recorded Investment in Loans for the year ended December 31, 2012 is as follows:


	Commercial			Commercial Real Estate			Consumer			Residential			Credit Card			Unallocated		Total
Allowance for Loan and Lease Losses:
Beginning balance 12/31/11	$	793		$	2,294		$	450		$	2,855		$	319		$	—	$	6,711
Charge-offs		(78	)		(33	)		(235	)		(431	)		(40	)		—		(817	)
Recoveries		1			6			57			67			1			—		132
Provision		83			37			268			490			46			—		924

Ending balance 12/31/12	$	799		$	2,304		$	540		$	2,981		$	326		$	—	$	6,950

Ending balance: Individually evaluated for impairment		351			550			—			325			—			—		1,226


Ending balance: Collectively evaluated for impairment	$	448		$	1,754		$	540		$	2,656		$	326		$	—	$	5,724


Ending balance: Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—	$	—

Loans:
Ending balance	$	91,724		$	217,496		$	49,199		$	261,912		$	3,199		$	—	$	623,530


Ending balance: Individually evaluated for impairment		655			2,160			31			2,425			—			—		5,271


Ending balance: Collectively evaluated for impairment	$	91,069		$	215,336		$	49,168		$	259,487		$	3,199		$	—	$	618,259


Ending balance: Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—	$	—

The Company had one commercial loan whose terms had been modified in a troubled debt restructuring as of June 30, 2013 and December 31, 2012; monthly payments were lowered to accommodate the borrower’s financial needs for a period of time.

Modification

June 30, 2013


	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings Commercial	1	$	808	$	346

There were no troubled debt restructurings that subsequently defaulted during the six months ended June 30, 2013.

Modification

December 31, 2012


	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings Commercial	1	$	808	$	351

The loan classified as a Troubled Debt Restructuring (TDR), was charged down during 2010 to a balance of $401 and the entire pre-modification balance was split into two notes. The customer is currently paying principal and interest on one note and interest only on the other note. Nonetheless, the loan is fully reserved based on management’s evaluation of both the customer’s ability to maintain its cash flow and the value of the underlying collateral.

Changes in the credit fair value adjustment on specific loans purchased are as follows:


	Carrying Value		Credit Fair Value Adjustment		Net Amount
Commercial Loans:
Balance, December 31, 2012	$	—	$	—	$	—
Charge-offs		—		—		—
Loans transferred to other real estate owned		—		—		—
Payments		—		—		—

Balance, June 30, 2013	$	—	$	—	$	—


	Carrying Value		Credit Fair Value Adjustment		Net Amount
Commercial Loans:
Balance, December 31, 2011	$	211	$	211	$	—
Charge-offs		—		—		—
Loans transferred to other real estate owned		—		—		—
Payments		3		3		—

Balance, June 30, 2012	$	208	$	208	$	—