Note 5: Loans and Allowance

Classes of loans at December 31, 2012 and 2011 include:

	2012			2011
Commercial
Real estate	$	203,613		$	197,390
Construction and development		17,462			20,831
Other		67,773			64,628
		288,848			282,849

Residential mortgage		502,619			434,976

Consumer loans
Real estate		100,516			96,864
Auto		15,572			15,203
Boat/RVs		76,416			83,557
Other		6,598			6,760
		199,102			202,384
Total loans		990,569			920,209
Undisbursed loans in process		(7,418	)		(5,352	)
Unamortized deferred loan costs, net		2,432			2,418
Allowance for loan losses		(16,038	)		(16,815	)

Net loans	$	969,545		$	900,460

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

	2012		2011
Commercial
Real estate	$	2,450	$	7,592
Construction and development		5,989		9,314
Other		1,315		1,160
Residential mortgage		10,791		10,080
Consumer loans
Real estate		1,656		2,081
Auto		37		24
Boat/RVs		1,076		371
Other		96		89

	$	23,410	$	30,711

Nonaccrual Loan 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 managements’ opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions, but never later than 90 days past due. When interest accrual is discontinued, all unpaid accrued interest 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.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured and generally only after six months of satisfactory performance.

An age analysis of the Company’s past due loans, segregated by class of loans, as of December 31, 2012 and 2011 are as follows:

	December 31, 2012
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days and Accruing
Commercial
Real Estate	$	1,097	$	992	$	2,350	$	4,439	$	199,174	$	203,613	$	—
Construction and development		192		—		4,912		5,104		12,358		17,462		—
Other		259		223		735		1,217		66,556		67,773		—

Residential mortgage		12,487		2,732		8,356		23,575		479,044		502,619		177
Consumer
Real estate		1,302		358		1,119		2,779		97,737		100,516		—
Auto		47		18		15		80		15,492		15,572		—
Boat/RV		1,508		756		497		2,761		73,655		76,416		—
Other		234		21		95		350		6,248		6,598		96

	$	17,126	$	5,100	$	18,079	$	40,305	$	950,264	$	990,569	$	273

	December 31, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days and Accruing
Commercial
Real Estate	$	870	$	1,023	$	7,592	$	9,485	$	187,905	$	197,390	$	—
Construction and development		845		—		9,314		10,159		10,672		20,831		—
Other		791		99		1,160		2,050		62,578		64,628		—

Residential mortgage		13,309		3,427		11,207		27,943		407,033		434,976		1,127
Consumer
Real estate		1,395		1,167		2,081		4,643		92,221		96,864		—
Auto		143		28		24		195		15,008		15,203		—
Boat/RV		2,084		825		371		3,280		80,277		83,557		—
Other		227		5		89		321		6,439		6,760		—

	$	19,664	$	6,574	$	31,838	$	58,076	$	862,133	$	920,209	$	1,127

Impaired Loans

Loans are considered impaired in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company 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.

Interest on impaired loans is recorded based on the performance of the loan. All interest received on impaired loans that are on nonaccrual is accounted for on the cash-basis method until qualifying for return to accrual. Interest is accrued per the contract for impaired loans that are performing.

The following tables present impaired loans for the years ended December 31, 2012 and 2011:

	December 31, 2012
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Commercial
Real estate	$	5,341	$	6,354	$	—	$	5,384	$	248
Construction and development		3,632		7,078		—		4,884		30
Other		972		972		—		2,828		117
Residential mortgage		2,583		3,522		—		3,755		58

Loans with a specific valuation allowance
Commercial
Real estate		208		947		100		211		12
Construction and development		4,639		5,157		959		5,230		78
Other		912		912		257		921		30
Residential mortgage		834		834		57		654		—

Total
Commercial
Real estate	$	5,549	$	7,301	$	100	$	5,595	$	260
Construction and development	$	8,271	$	12,235	$	959	$	10,114	$	108
Other	$	1,884	$	1,884	$	257	$	3,749	$	147
Residential mortgage	$	3,417	$	4,356	$	57	$	4,409	$	58

	December 31, 2011
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Commercial
Real estate	$	4,883	$	5,275	$	—	$	4,221	$	137
Construction and development		5,872		11,801		—		9,451		348
Other		4,030		4,167		—		1,480		211
Residential mortgage		5,378		6,870		—		5,532		142

Loans with a specific valuation allowance
Commercial
Real estate		2,083		2,489		209		1,086		74
Construction and development		7,071		7,281		1,437		3,775		233
Other		1,470		1,524		543		246		60
Residential mortgage		537		537		36		67		36

Total
Commercial
Real estate	$	6,966	$	7,764	$	209	$	5,307	$	211
Construction and development	$	12,943	$	19,082	$	1,437	$	13,226	$	581
Other	$	5,500	$	5,691	$	543	$	1,726	$	271
Residential mortgage	$	5,915	$	7,407	$	36	$	5,599	$	178

	December 31, 2010
	Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Commercial
Real estate	$	3,826	$	137
Construction and development		2,390		27
Other		388		12
Residential mortgage		4,580		183

Loans with a specific valuation allowance
Commercial
Real estate		5,395		329
Construction and development		4,238		226
Residential mortgage		128		—

Total
Commercial
Real estate	$	9,221	$	466
Construction and development	$	6,628	$	253
Other	$	388	$	12
Residential mortgage	$	4,708	$	183

The following information presents the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of December 31, 2012.

Commercial Loan Grades

Definition of Loan Grades. Loan grades are numbered 1 through 8. Grades 1-4 are "pass" credits, grade 5 [Special Mention] loans are "criticized" assets, and grades 6 [Substandard], 7 [Doubtful] and 8 [Loss] are "classified" assets. The use and application of these grades by the Bank conform to the Bank's policy and regulatory definitions.

Pass. Pass credits are loans in grades prime through fair. These are at least considered to be credits with acceptable risks and would be granted in the normal course of lending operations.

Special Mention. Special mention credits have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the Bank’s credit position at some future date. If weaknesses cannot be identified, classifying as special mention is not appropriate. Special mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

Substandard. Substandard credits are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged. Financial statements normally reveal some or all of the following: poor trends, lack of earnings and cash flow, excessive debt, lack of liquidity, and the absence of creditor protection. Credits so classified must have a 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 of the deficiencies are not corrected.

Doubtful. A doubtful extension of credit has all the weaknesses inherent in a substandard asset with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, 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, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans. Doubtful classification for an entire credit should be avoided when collection of a specific portion appears highly probable with the adequately secured portion graded Substandard.

Retail Loan Grades

Pass. Pass credits are loans that are currently performing as agreed and are not troubled debt restructurings.

Special Mention. Special mention credits have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the Bank’s credit position at some future date. If weaknesses cannot be identified, classifying as special mention is not appropriate. Special mention credits are not adversely classified and do not expose the Bank to sufficient risk to warrant an adverse classification. No apparent loss of principal or interest is expected.

Substandard. Substandard credits are loans that have reason to be considered to have a weakness and placed on non-accrual. This would include all retail loans over 90 days and troubled debt restructurings.

December 31, 2012
Commercial Credit Exposure Credit Risk Profile
Internal Rating	Real estate		Construction and Development		Other

Pass	$	185,794	$	9,314	$	63,413
Special Mention		6,692		172		255
Substandard		11,127		7,976		3,281
Doubtful		—		—		824

Total	$	203,613	$	17,462	$	67,773

Retail Credit Exposure Credit Risk Profile
	Residential		Consumer
	Mortgage		Real Estate		Auto		Boat/RV		Other

Pass	$	486,027	$	97,972	$	15,533	$	75,026	$	6,434
Special Mention		2,012		—		—		—		—
Substandard		14,580		2,544		39		1,390		164

Total	$	502,619	$	100,516	$	15,572	$	76,416	$	6,598

December 31, 2011
Commercial Credit Exposure Credit Risk Profile
Internal Rating	Real estate		Construction and Development		Other

Pass	$	167,991	$	8,093	$	56,691
Special Mention		11,940		538		880
Substandard		16,488		12,105		6,260
Doubtful		971		95		797

Total	$	197,390	$	20,831	$	64,628

Retail Credit Exposure Credit Risk Profile
	Residential		Consumer
	Mortgage		Real Estate		Auto		Boat/RV		Other

Pass	$	417,772	$	94,066	$	15,135	$	82,639	$	6,680
Special Mention		2,473		—		—		—		—
Substandard		14,731		2,798		68		918		80

Total	$	434,976	$	96,864	$	15,203	$	83,557	$	6,760

Allowance for Loan Losses

The risk characteristics of each loan portfolio segment are as follows:

Commercial Loans

Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Commercial construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates and financial analyses of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial business loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Residential and Consumer

With respect to residential loans that are secured by one-to-four family residences and are primarily owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance (PMI) if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in one-to-four family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

The following tables detail activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2012, 2011 and 2010. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses on other segments.

	December 31, 2012
	Commercial			Mortgage			Consumer			Total
Allowance for loan losses:
Balance, beginning of year	$	10,602		$	3,444		$	2,769		$	16,815
Provision charged to expense		3,213			1,612			1,200			6,025
Losses charged off		(4,493	)		(1,901	)		(1,608	)		(8,002	)
Recoveries		586			239			375			1,200

Balance, end of period	$	9,908		$	3,394		$	2,736		$	16,038

Ending balance:
Individually evaluated for impairment	$	1,316		$	57		$	—		$	1,373
Collectively evaluated for impairment	$	8,592		$	3,337		$	2,736		$	14,665

Loans:
Ending balance
Individually evaluated for impairment	$	15,704		$	3,417		$	—		$	19,121
Collectively evaluated for impairment	$	273,144		$	499,202		$	199,102		$	971,448

	December 31, 2011
	Commercial			Mortgage			Consumer			Total
Allowance for loan losses:
Balance, beginning of year	$	10,124		$	2,212		$	4,036		$	16,372
Provision charged to expense		8,592			4,390			118			13,100
Losses charged off		(8,260	)		(3,432	)		(2,126	)		(13,818	)
Recoveries		146			274			741			1,161

Balance, end of period	$	10,602		$	3,444		$	2,769		$	16,815

Ending balance:
Individually evaluated for impairment	$	2,189		$	36		$	—		$	2,225
Collectively evaluated for impairment	$	8,413		$	3,408		$	2,769		$	14,590

Loans:
Ending balance
Individually evaluated for impairment	$	25,409		$	5,915		$	—		$	31,324
Collectively evaluated for impairment	$	257,440		$	429,061		$	202,384		$	888,885

	December 31, 2010
	Commercial			Mortgage			Consumer			Total
Allowance for loan losses:
Balance, beginning of year	$	10,003		$	2,359		$	4,052		$	16,414
Provision charged to expense		1,780			2,900			2,370			7,050
Losses charged off		(1,752	)		(3,345	)		(3,195	)		(8,292	)
Recoveries		93			298			809			1,200

Balance, end of period	$	10,124		$	2,212		$	4,036		$	16,372

Ending balance:
Individually evaluated for impairment	$	1,340		$	69		$	—		$	1,409
Collectively evaluated for impairment	$	8,784		$	2,143		$	4,036		$	14,963

Loans:
Ending balance
Individually evaluated for impairment	$	20,309		$	6,928		$	—		$	27,237
Collectively evaluated for impairment	$	293,622		$	451,091		$	227,785		$	972,498

Troubled Debt Restructurings

Certain categories of impaired loans include loans that have been modified in a troubled debt restructuring, that involves granting economic concessions to borrowers who have experienced financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.

When we modify loans in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or we use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determine that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific reserve or a charge-off to the allowance.

Loans retain their accrual status at the time of their modification. As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual until a period of satisfactory performance, generally six months, is obtained. If a loan is on accrual at the time of the modification, the loan is evaluated to determine the collection of principal and interest is reasonably assured and generally stays on accrual.

During 2011, the Bank reassessed all restructurings that occurred on or after the beginning of its current fiscal year ended December 31, 2011, to determine if they were troubled debt restructurings. The Bank designated certain receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology as troubled debt restructurings. Upon identifying those receivables as troubled debt restructurings, the Bank identified them as impaired.

At December 31, 2012, the Company had a number of loans that were modified in troubled debt restructurings and impaired. The modification of terms of such loans included one or a combination of the following: an extension of maturity, a reduction of the stated interest rate or a permanent reduction of the recorded investment in the loan.

The following tables describe troubled debts restructured during the years ended December 31, 2012 and 2011.

December 31, 2012
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	No. of Loans		Recorded Balance		Recorded Balance
Commercial
Real estate		10	$	2,239	$	2,399
Construction and development		3		1,047		1,133
Other		6		325		386
Residential mortgage		43		3,477		3,713
Consumer
Real estate		28		972		975
Auto		4		34		33
Boat/RV		7		154		153
Other		4		53		52

December 31, 2011
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	No. of Loans		Recorded Balance		Recorded Balance
Commercial
Real estate		6	$	1,931	$	1,887
Construction and development		3		4,146		4,146
Other		2		396		396
Residential mortgage		27		2,898		3,020
Consumer
Real estate		31		831		854
Auto		1		10		10
Boat/RV		13		395		376
Other		1		14		3

The impact on the allowance for loan losses was insignificant as a result of these modifications.

Newly restructured loans by type for the years ended December 31, 2012 and 2011 are as follows:

	December 31, 2012
	Interest Only		Term		Combination		Total Modification
Commercial
Real Estate	$	—	$	1,281	$	1,118	$	2,399
Construction and development		—		961		172		1,133
Other		—		143		243		386
Residential mortgage		320		961		2,432		3,713
Consumer
Real estate		—		117		858		975
Auto		—		29		4		33
Boat/RV		—		153		—		153
Other		—		8		44		52

	December 31, 2011
	Interest Only		Term		Combination		Total Modification
Commercial
Real Estate	$	885	$	494	$	508	$	1,887
Construction and development		—		4,146		—		4,146
Other		—		293		103		396
Residential mortgage		1,471		11		1,538		3,020
Consumer
Real estate		—		133		721		854
Auto		—		10		—		10
Boat/RV		75		208		93		376
Other		—		3		—		3

Defaults of any loans modified as troubled debt restructurings made in the years ended December 31, 2012 and 2011, respectively, are listed in the table below. Defaults are defined as any loans that become 90 days past due.

December 31, 2012
			Post-Modification Outstanding
	No. of Loans		Recorded Balance
Commercial
Real estate		1	$	109
Other		1		518
Residential mortgage		2		61
Consumer
Other		1		14

December 31, 2011
			Post-Modification Outstanding
	No. of Loans		Recorded Balance
Residential mortgage		3	$	733
Consumer
Other		2		48