(5) Credit Quality of Loans and Allowance for Loan Losses

Management closely monitors the quality of the loan portfolio and has established a loan review process designed to help grade the quality and profitability of the Company’s loan portfolio. The credit quality grade helps management make a consistent assessment of each loan relationship’s credit risk. Consistent with regulatory guidelines, The Bank of Greene County provides for the classification of loans considered being of lesser quality. Such ratings coincide with the “Substandard,” “Doubtful” and “Loss” classifications used by federal regulators in their examination of financial institutions. Generally, an asset is considered Substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged. Substandard assets include those characterized by the distinct possibility that the insured financial institution will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all the weaknesses inherent in assets classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable. Assets classified as Loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a full loss reserve and/or charge-off is not warranted. Assets that do not currently expose the insured financial institutions to sufficient risk to warrant classification in one of the aforementioned categories but otherwise possess weaknesses are designated “Special Mention.” Management also maintains a listing of loans designated “Watch.” These loans represent borrowers with declining earnings, strained cash flow, increasing leverage and/or weakening market fundamentals that indicate above average risk.

When The Bank of Greene County classifies problem assets as either Substandard or Doubtful, it generally establishes a specific valuation allowance or “loss reserve” in an amount deemed prudent by management. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular loans. When The Bank of Greene County identifies problem loans as being impaired, it is required to evaluate whether the Bank will be able to collect all amounts due either through repayments or the liquidation of the underlying collateral. If it is determined that impairment exists, the Bank is required either to establish a specific allowance for losses equal to the amount of impairment of the assets, or to charge-off such amount. The Bank of Greene County’s determination as to the classification of its loans and the amount of its valuation allowance is subject to review by its regulatory agencies, which can order the establishment of additional general or specific loss allowances. The Bank of Greene County reviews its portfolio monthly to determine whether any assets require classification in accordance with applicable regulations.

The Bank primarily has four segments within its loan portfolio that it considers when measuring credit quality: real estate loans, home equity, consumer installment and commercial loans. The real estate portfolio consists of residential, nonresidential, and construction loan classes. The inherent risk within the loan portfolio varies depending upon each of these loan types.

The Bank of Greene County’s primary lending activity is the origination of residential mortgage loans, including home equity loans, which are collateralized by residences. Generally, residential mortgage loans are made in amounts up to 80.0% of the appraised value of the property. However, The Bank of Greene County will originate residential mortgage loans with loan-to-value ratios of up to 95.0%, with private mortgage insurance. In the event of default by the borrower, The Bank of Greene County will acquire and liquidate the underlying collateral. By originating the loan at a loan-to-value ratio of 80% or less or obtaining private mortgage insurance, The Bank of Greene County limits its risk of loss in the event of default. However, the market values of the collateral may be adversely impacted by declines in the economy. Home equity loans may have an additional inherent risk if The Bank of Greene County does not hold the first mortgage. The Bank of Greene County may stand in a secondary position in the event of collateral liquidation resulting in a greater chance of insufficiency to meet all obligations.

Construction lending generally involves a greater degree of risk than other residential mortgage lending. The repayment of the construction loan is, to a great degree, dependent upon the successful and timely completion of the construction of the subject property within specified cost limits. The Bank of Greene County completes inspections during the construction phase prior to any disbursements. The Bank of Greene County limits its risk during the construction as disbursements are not made until the required work for each advance has been completed. Construction delays may further impair the borrower’s ability to repay the loan.

Loans collateralized by nonresidential mortgage loans, and multi-family loans, such as apartment buildings generally are larger than residential loans and involve a greater degree of risk. Commercial mortgage loans often involve large loan balances to single borrowers or groups of related borrowers. Payments on these loans depend to a large degree on the results of operations and management of the properties or underlying businesses, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of nonresidential mortgage loans makes them more difficult for management to monitor and evaluate.

Consumer loans generally have shorter terms and higher interest rates than residential mortgage loans. In addition, consumer loans expand the products and services offered by The Bank of Greene County to better meet the financial services needs of its customers. Consumer loans generally involve greater credit risk than residential mortgage loans because of the difference in the nature of the underlying collateral. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance because of the greater likelihood of damage, loss or depreciation in the underlying collateral. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections depend on the borrower’s personal financial stability. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.

Commercial lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential and nonresidential mortgage lending. Real estate lending is generally considered to be collateral-based, with loan amounts based on fixed loan-to-collateral values, and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial loans may be collateralized by equipment or other business assets, the liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because equipment and other business assets may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment.

Loan balances by internal credit quality indicator as of March 31, 2013 are shown below.


(In thousands)	Performing	Watch	Special Mention	Substandard	Total
Residential mortgage	$ 204,086	$ 292	$ -	$ 4,357	$ 208,735
Nonresidential mortgage	84,238	156	998	2,248	87,640
Residential construction and land	2,007	-	-	-	2,007
Commercial construction	1,564	-	415	1,063	3,042
Multi-family	4,420	-	423	729	5,572
Home equity	21,164	25	-	28	21,217
Consumer installment	4,158	2	-	-	4,160
Commercial loans	22,583	115	353	1,001	24,052
Total gross loans	$ 344,220	$ 590	$ 2,189	$ 9,426	$ 356,425

Loan balances by internal credit quality indicator as of June 30, 2012 are shown below.


(In thousands)	Performing	Watch	Special Mention	Substandard	Total
Residential mortgage	$ 188,446	$ -	$ 557	$ 4,375	$ 193,378
Nonresidential mortgage	77,761	-	588	2,445	80,794
Residential construction and land	2,156	-	-	-	2,156
Commercial construction	669	-	290	1,075	2,034
Multi-family	4,185	-	780	557	5,522
Home equity	22,708	-	-	100	22,808
Consumer installment	4,044	1	-	25	4,070
Commercial loans	20,045	39	762	842	21,688
Total gross loans	$ 320,014	$ 40	$ 2,977	$ 9,419	$ 332,450

The Company had no loans classified Doubtful or Loss at March 31, 2013 or June 30, 2012.

Nonaccrual Loans

Management places loans on nonaccrual status once the loans have become 90 days or more delinquent. A nonaccrual loan is defined as a loan in which collectability is questionable and therefore interest on the loan will no longer be recognized on an accrual basis. A loan is not placed back on accrual status until the borrower has demonstrated the ability and willingness to make timely payments on the loan. A loan does not have to be 90 days delinquent in order to be classified as nonaccrual. Nonaccrual loans consisted primarily of loans secured by real estate at March 31, 2013 and June 30, 2012. While the Bank makes every reasonable effort to work with the borrowers to collect amounts due, the number of loans in process of foreclosure has grown substantially over the past several years. This growth has been the result of adverse changes within the economy and increases in local unemployment. The growth is also due in part to the extended length of time required to meet all of the legal requirements mandated by New York state law prior to a foreclosure sale, which may be in excess of two years. Loans on nonaccrual status totaled $6.9 million at March 31, 2013 of which $4.1 million were in the process of foreclosure. Included in nonaccrual loans, were $1.7 million of loans which were less than 90 days past due at March 31, 2013, but have a recent history of delinquency greater than 90 days past due. These loans will be returned to accrual status once they have demonstrated a history of timely payments. Included in total loans past due were $1.6 million of loans which were making payments pursuant to forbearance agreements. Under the forbearance agreements, the customers have made arrangements with the Bank to bring the loans current over a specified period of time (resulting in an insignificant delay in repayment). During this term of the forbearance agreement, the Bank has agreed not to continue foreclosure proceedings.

The following table sets forth information regarding delinquent and/or nonaccrual loans as of March 31, 2013:


(In thousands)	30-59 days past due	60-89 days past due	90 days or more past due	Total past due	Current	Total Loans	Loans on Non-accrual
Residential mortgage	$ 1,407	$ 423	$ 3,489	$ 5,319	$ 203,416	$ 208,735	$ 4,094
Nonresidential mortgage	1,622	1,220	1,243	4,085	83,555	87,640	1,911
Residential construction and land	-	-	-	-	2,007	2,007	-
Commercial construction	-	-	-	-	3,042	3,042	-
Multi-family	-	146	463	609	4,963	5,572	463
Home equity	87	25	-	112	21,105	21,217	28
Consumer installment	48	2	-	50	4,110	4,160	-
Commercial loans	866	25	185	1,076	22,976	24,052	367
Total gross loans	$ 4,030	$ 1,841	$ 5,380	$ 11,251	$ 345,174	$ 356,425	$ 6,863

The following table sets forth information regarding delinquent and/or nonaccrual loans as of June 30, 2012:


(In thousands)	30-59 days past due	60-89 days past due	90 days or more past due	Total past due	Current	Total Loans	Loans on Non-accrual
Residential mortgage	$ 99	$ 1,674	$ 3,850	$ 5,623	$ 187,755	$ 193,378	$ 4,206
Nonresidential mortgage	424	1,088	1,041	2,553	78,241	80,794	1,868
Residential construction and land	-	-	-	-	2,156	2,156	-
Commercial construction	-	-	-	-	2,034	2,034	-
Multi-family	-	-	431	431	5,091	5,522	431
Home equity	52	-	100	152	22,656	22,808	60
Consumer installment	76	4	24	104	3,966	4,070	25
Commercial loans	3	596	257	856	20,832	21,688	303
Total gross loans	$ 654	$ 3,362	$ 5,703	$ 9,719	$ 322,731	$ 332,450	$ 6,893

The Bank of Greene County had accruing loans delinquent 90 days or more as of March 31, 2013 totaling $178,000 and had accruing loans delinquent more than 90 days as of June 30, 2012 totaling $124,000. The loans delinquent more than 90 days and accruing consist of loans that are well collateralized and the borrowers have demonstrated the ability and willingness to pay. The borrowers have made arrangements with the Bank to bring the loan current within a specified time period and have made a series of payments as agreed.

The table below details additional information related to nonaccrual loans:


	For the nine months ended March 31,		For the three months ended March 31
(In thousands)	2013	2012	2013	2012
Interest income that would have been recorded if loans had been performing in accordance with original terms	$ 398	$ 442	$ 123	$ 103
Interest income that was recorded on nonaccrual loans	180	211	54	88

Impaired Loan Analysis

The Company identifies impaired loans and measures the impairment in accordance with FASB ASC subtopic “Receivables – Loan Impairment.” Management may consider a loan impaired once it is classified as nonaccrual and when it is probable that the borrower will be unable to repay the loan according to the original contractual terms of the loan agreement or the loan is restructured in a troubled debt restructuring. It should be noted that management does not evaluate all loans individually for impairment. Generally, The Bank of Greene County considers residential mortgages, home equity loans and installment loans as small, homogeneous loans, which are evaluated for impairment collectively based on historical loan experience and other factors. In contrast, large commercial mortgage, construction, multi-family, business loans and select larger balance residential mortgage loans are reviewed individually and considered impaired if it is probable that The Bank of Greene County will not be able to collect scheduled payments of principal and interest when due, according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the fair value of the underlying collateral. The majority of The Bank of Greene County loans, including most nonaccrual loans, are small homogenous loan types adequately supported by collateral. Management considers the payment status of loans in the process of evaluating the adequacy of the allowance for loan losses among other factors. Loans that are either delinquent a minimum of 60 days or are on nonaccrual status, and are not individually evaluated for impairment, are either designated as Special Mention or Substandard, and the allocation of the allowance for loan loss is based upon the risk associated with such designation.

The tables below detail additional information on impaired loans at the date or periods indicated:


	As of March 31, 2013			For the nine months ended March 31, 2013		For the three months ended March 31, 2013
(In thousands)	Recorded Investment	Unpaid Principal	Related Allowance	Average Recorded Investment	Interest Income Recognized	Average Recorded Investment	Interest Income Recognized
With no related allowance recorded:
Residential mortgage	$ 643	$ 643	$ -	$ 432	$ 32	$ 915	$ 14
Nonresidential mortgage	1,259	1,259	-	1,265	57	1,360	15
Commercial loans	-	-	-	108	13	77	3
	1,902	1,902	-	1,805	102	2,352	32
With an allowance recorded:
Residential mortgage	2,437	2,487	363	2,243	26	1,951	11
Nonresidential mortgage	1,082	1,082	291	1,015	13	985	5
Commercial construction	1,063	1,063	335	1,068	-	1,063	-
Multi-family	886	886	149	885	4	886	-
Home equity	-	-	-	257	4	-	-
Commercial loans	571	571	3	572	3	571	-
	6,039	6,089	1,141	6,040	50	5,456	16

Residential mortgage	3,080	3,130	363	2,675	58	2,866	25
Nonresidential mortgage	2,341	2,341	291	2,280	70	2,345	20
Commercial construction	1,063	1,063	335	1,068	-	1,063	-
Multi-family	886	886	149	885	4	886	-
Home equity	-	-	-	257	4	-	-
Commercial loans	571	571	3	680	16	648	3
	$ 7,941	$ 7,991	$ 1,141	$ 7,845	$ 152	$ 7,808	$ 48


	As of June 30, 2012			For the nine months ended March 31, 2012		For the three months ended March 31, 2012
(In thousands)	Recorded Investment	Unpaid Principal	Related Allowance	Average Recorded Investment	Interest Income Recognized	Average Recorded Investment	Interest Income Recognized
With no related allowance recorded:
Residential mortgage	$ 213	$ 276	$ -	$ 213	$ -	$ 213	$ -
Nonresidential mortgage	1,148	1,148	-	535	40	736	19
Multi-family	433	433	-	49	4	146	4
	1,794	1,857	-	797	44	1,095	23
With an allowance recorded:
Residential mortgage	200	200	10	106	4	224	2
Nonresidential mortgage	648	648	208	819	19	651	6
Commercial construction	1,075	1,075	365	119	5	356	5
Multi-family	428	428	155	432	18	431	6
Commercial loans	562	562	35	535	27	563	10
	2,913	2,913	773	2,011	73	2,225	29

Residential mortgage	413	476	10	319	4	437	2
Nonresidential mortgage	1,796	1,796	208	1,354	59	1,387	25
Commercial construction	1,075	1,075	365	119	5	356	5
Multi-family	861	861	155	481	22	577	10
Commercial loans	562	562	35	535	27	563	10
	$ 4,707	$ 4,770	$ 773	$ 2,808	$ 117	$ 3,320	$ 52

The table below details loans that have been modified as a troubled debt restructuring during the nine months ended March 31, 2013. There were no such restructurings for the three months ended March 31, 2013.


	As of March 31, 2013
(Dollars in thousands)	Number of Contracts	Pre-Modification Outstanding Recorded Investment	Post-Modification Outstanding Recorded Investment	Current Outstanding Recorded Investment
Residential mortgage	1	$246	$261	$261

This loan has been classified as troubled debt restructurings due to concessions granted to the debtor that The Bank of Greene County would not otherwise consider as a result of financial difficulties of the borrower. For this loan, additional funds were advanced, the interest rate was reduced and the term extended. At March 31, 2013, this loan was not in default but is currently included in non-accrual loans. If the borrower performs under the terms of the modification, and the ultimate collectability of all amounts contractually due under the modified terms is not in doubt, this loan will be returned to accrual status. This loan identified as a troubled debt restructuring has been evaluated for impairment and the impact to the allowance for loan loss was immaterial.

There were no troubled debt restructurings modified within the last twelve months that subsequently defaulted.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risk inherent in the loan portfolio, the composition of the loan portfolio, specific impaired loans and current economic conditions. Such evaluation, which includes a review of certain identified loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, payment status of the loan, historical loan loss experience and other factors that warrant recognition in providing for the loan loss allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review The Bank of Greene County’s allowance for loan losses. Such agencies may require The Bank of Greene County to recognize additions to the allowance based on their judgment about information available to them at the time of their examination. The Bank of Greene County charges loans off against the allowance for credit losses when it becomes evident that a loan cannot be collected within a reasonable amount of time or that it will cost the Bank more than it will receive, and all possible avenues of repayment have been analyzed, including the potential of future cash flow, the value of the underlying collateral, and strength of any guarantors or co-borrowers. Generally, consumer loans and smaller business loans (not secured by real estate) in excess of 90 days are charged-off against the allowance for loan losses, unless equitable arrangements are made. For loans secured by real estate, a charge-off is recorded when it is determined that the collection of all or a portion of a loan may not be collected and the amount of that loss can be reasonably estimated.

The following tables set forth the activity and allocation of the allowance for loan losses by loan category during and at the periods indicated. The allowance is allocated to each loan category based on historical loss experience, current economic conditions, and other considerations.

Activity for the three months ended March 31, 2013


(In thousands)	Balance December 31, 2012	Charge-offs	Recoveries	Provision	Balance March 31, 2013
Residential mortgage	$ 2,429	$ 13	$ -	$ 74	$ 2,490
Nonresidential mortgage	2,246	119	-	178	2,305
Residential construction and land	43	-	-	(15)	28
Commercial construction	391	-	-	24	415
Multi-family	286	-	-	(21)	265
Home equity	361	-	-	(84)	277
Consumer installment	281	69	28	(37)	203
Commercial loans	727	-	-	47	774
Unallocated	-	-	-	165	165
Total	$ 6,764	$ 201	$ 28	$ 331	$ 6,922

Activity for the nine months ended March 31, 2013


(In thousands)	Balance June 30, 2012	Charge-offs	Recoveries	Provision	Balance March 31, 2013
Residential mortgage	$ 2,163	$ 286	$ -	$ 613	$ 2,490
Nonresidential mortgage	2,076	139	-	368	2,305
Residential construction and land	19	-	-	9	28
Commercial construction	407	-	-	8	415
Multi-family	337	-	-	(72)	265
Home equity	187	-	-	90	277
Consumer installment	207	201	70	127	203
Commercial loans	645	15	-	144	774
Unallocated	136	-	-	29	165
Total	$ 6,177	$ 641	$ 70	$ 1,316	$ 6,922


	Allowance for Loan Losses		Loans Receivable
	Ending Balance March 31, 2013 Impairment Analysis		Ending Balance March 31, 2013 Impairment Analysis
(In thousands)	Individually Evaluated	Collectively Evaluated	Individually Evaluated	Collectively Evaluated
Residential mortgage	$ 363	$ 2,127	$ 3,080	$ 205,655
Nonresidential mortgage	291	2,014	2,341	85,299
Residential construction and land	-	28	-	2,007
Commercial construction	335	80	1,063	1,979
Multi-family	149	116	886	4,686
Home equity	-	277	-	21,217
Consumer installment	-	203	-	4,160
Commercial loans	3	771	571	23,481
Unallocated	-	165	-	-
Total	$ 1,141	$ 5,781	$ 7,941	$ 348,484

Activity for the three months ended March 31, 2012


(In thousands)	Balance December 31, 2011	Charge-offs	Recoveries	Provision	Balance March 31, 2012
Residential mortgage	$ 2,147	$ 114	$ -	$ 65	$ 2,098
Nonresidential mortgage	1,947	-	-	(83)	1,864
Residential construction and land	31	-	-	(8)	23
Commercial construction	78	-	-	402	480
Multi-family	408	-	-	(55)	353
Home equity	217	-	-	(23)	194
Consumer installment	233	65	23	120	311
Commercial loans	556	35	-	90	611
Unallocated	-	-	-	33	33
Total	$ 5,617	$ 214	$ 23	$ 541	$ 5,967

Activity for the nine months ended March 31, 2012


(In thousands)	Balance June 30, 2011	Charge-offs	Recoveries	Provision	Balance March 31, 2012
Residential mortgage	$ 1,767	$ 172	$ 4	$ 499	$ 2,098
Nonresidential mortgage	1,859	212	-	217	1,864
Residential construction and land	27			(4)	23
Commercial construction	89			391	480
Multi-family	410			(57)	353
Home equity	186			8	194
Consumer installment	203	183	57	234	311
Commercial loans	528	35	2	116	611
Unallocated	-			33	33
Total	$ 5,069	$ 602	$ 63	$ 1,437	$ 5,967


	Allowance for Loan Loss		Loans Receivable
	Ending Balance June 30, 2012 Impairment Analysis		Ending Balance June 30, 2012 Impairment Analysis
(In thousands)	Individually Evaluated	Collectively Evaluated	Individually Evaluated	Collectively Evaluated
Residential mortgage	$ 10	$ 2,153	$ 413	$ 192,965
Nonresidential mortgage	208	1,868	1,796	78,998
Residential construction and land	-	19	-	2,156
Commercial construction	365	42	1,075	959
Multi-family	155	182	861	4,661
Home equity	-	187	-	22,808
Consumer installment	-	207	-	4,070
Commercial loans	35	610	562	21,126
Unallocated	-	136	-	-
Total	$ 773	$ 5,404	$ 4,707	$ 327,743