NOTE 6. LOAN LOSS ALLOWANCE

Activity in the allowance for loan losses for the six months ended June 30, 2014 and 2013 was as follows:

Business Activities Loans

(In thousands)	Residential mortgages			Commercial real estate		Commercial and industrial loans		Consumer		Unallocated		Total
June 30, 2014
Balance at beginning of period	$	6,937		$	13,705	$	5,173	$	3,644	$	68	$	29,527
Charged-off loans	1,159			1,645		1,426		571		—		4,801
Recoveries on charged-off loans	64			6		22		177		—		269
Provision for loan losses	(299		)	2,389		1,396		1,597		143		5,226
Balance at end of period	$	5,543		$	14,455	$	5,165	$	4,847	$	211	$	30,221
Individually evaluated for impairment	57			712		475		—		—		1,244
Collectively evaluated	5,486			13,743		4,690		4,847		211		28,977
Total	$	5,543		$	14,455	$	5,165	$	4,847	$	211	$	30,221

Business Activities Loans

(In thousands)	Residential mortgages		Commercial real estate		Commercial and industrial loans		Consumer		Unallocated		Total
June 30, 2013
Balance at beginning of period	$	5,928	$	18,863	$	5,605	$	1,466	$	29	$	31,891
Charged-off loans	836		2,015		694		600		—		4,145
Recoveries on charged-off loans	150		451		81		113		—		795
Provision for loan losses	389		777		376		1,919		117		3,578
Balance at end of period	$	5,631	$	18,076	$	5,368	$	2,898	$	146	$	32,119
Individually evaluated for impairment	302		1,812		903		295		—		3,312
Collectively evaluated	5,329		16,264		4,465		2,603		146		28,807
Total	$	5,631	$	18,076	$	5,368	$	2,898	$	146	$	32,119

Acquired Loans

(In thousands)	Residential mortgages		Commercial real estate		Commercial and industrial loans		Consumer		Unallocated		Total
June 30, 2014
Balance at beginning of period	$	625	$	2,339	$	597	$	235	$	—	$	3,796
Charged-off loans	723		495		176		638		—		2,032
Recoveries on charged-off loans	161		1		24		23		—		209
Provision for loan losses	599		246		624		690		—		2,159
Balance at end of period	$	662	$	2,091	$	1,069	$	310	$	—	$	4,132
Individually evaluated for impairment	60		306		20		—		—		386
Collectively evaluated	602		1,785		1,049		310		—		3,746
Total	$	662	$	2,091	$	1,069	$	310	$	—	$	4,132

Acquired Loans

(In thousands)	Residential mortgages			Commercial real estate		Commercial and industrial loans		Consumer		Unallocated			Total
June 30, 2013
Balance at beginning of period	$	509		$	390	$	96	$	314	$	8		$	1,317
Charged-off loans	422			682		134		574		—			1,812
Recoveries on charged-off loans	(4		)	11		23		72		—			102
Provision for loan losses	435			706		112		519		(250		)	1,522
Balance at end of period	$	518		$	425	$	97	$	331	$	(242	)	$	1,129
Individually evaluated for impairment	70			29		—		—		—			99
Collectively evaluated	448			396		97		331		(242		)	1,030
Total	518			425		97		331		(242		)	1,129

Credit Quality Information

Business Activities Loans Credit Quality Analysis

The Company monitors the credit quality of its portfolio by using internal risk ratings that are based on regulatory guidance. Loans that are given a Pass rating are not considered a problem credit. Loans that are classified as Special Mention loans are considered to have potential credit problems and are evaluated closely by management. Substandard and non-accruing loans are loans for which a definitive weakness has been identified and which may make full collection of contractual cash flows questionable. Doubtful loans are those with identified weaknesses that make full collection of contractual cash flows, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The Company assigns an internal risk rating at origination and reviews the rating annually, semiannually or quarterly depending on the risk rating. The rating is also reassessed at any point in time when management becomes aware of information that may affect the borrower’s ability to fulfill their obligations.

The Company risk rates its residential mortgages, including 1-4 family and residential construction loans, based on a three rating system: Pass, Special Mention and Substandard. Loans that are current within 59 days are rated Pass. Residential mortgages that are 60-89 days delinquent are rated Special Mention. Loans delinquent for 90 days or greater are rated Substandard and generally placed on non-accrual status. Home equity loans are risk rated based on the same rating system as the Company’s residential mortgages.

Ratings for other consumer loans, including auto loans, are based on a two rating system. Loans that are current within 119 days are rated Performing while loans delinquent for 120 days or more are rated Non-performing. Other consumer loans are placed on non-accrual at such time as they become Non-performing.

Acquired Loans Credit Quality Analysis

Upon acquiring a loan portfolio, our internal loan review function assigns risk ratings to the acquired loans, utilizing the same methodology as it does with business activities loans. This may differ from the risk rating policy of the predecessor bank. Loans which are rated Substandard or worse according to the rating process outlined below are deemed to be credit impaired loans accounted for under ASC 310-30, regardless of whether they are classified as performing or non-performing.

The Bank utilizes an eleven grade internal loan rating system for each of its acquired commercial real estate, construction and commercial loans as outlined in the Credit Quality Information section of this Note. The Company risk rates its residential mortgages, including 1-4 family and residential construction loans, based on a three rating system: Pass, Special Mention and Substandard. Residential mortgages that are current within 59 days are rated Pass. Residential mortgages that are 60 — 89 days delinquent are rated Special Mention. Residential mortgages delinquent for 90 days or greater are rated Substandard. Home equity loans are risk rated based on the same rating system as the Company’s residential mortgages. Other consumer loans are rated based on a two rating system. Other consumer loans that are current within 119 days are rated Performing while loans delinquent for 120 days or more are rated Non-performing. Non-performing other consumer loans are deemed to be credit impaired loans accounted for under ASC 310-30.

The Company subjects loans that do not meet the ASC 310-30 criteria to ASC 450-20 by collectively evaluating these loans for an allowance for loan loss. The Company applies a methodology similar to the methodology prescribed for business activities loans, which includes the application of environmental factors to each category of loans. The methodology to collectively evaluate the acquired loans outside the scope of ASC 310-30 includes the application of a number of environmental factors that reflect management’s best estimate of the level of incremental credit losses that might be recognized given current conditions. This is reviewed as part of the allowance for loan loss adequacy analysis. As the loan portfolio matures and environmental factors change, the loan portfolio will be reassessed each quarter to determine an appropriate reserve allowance.

A decrease in the expected cash flows in subsequent periods requires the establishment of an allowance for loan losses at that time for ASC 310-30 loans. At June 30, 2014, the allowance for loan losses related to acquired loans was $4.1 million using the above mentioned criteria.

The Company presented several tables within this footnote separately for business activity loans and acquired loans in order to distinguish the credit performance of the acquired loans from the business activity loans.

The following table presents the Company’s loans by risk rating at June 30, 2014 and December 31, 2013:

Business Activities Loans

Residential Mortgages

Credit Risk Profile by Internally Assigned Grade

	1-4 family				Construction				Total residential mortgages
(In thousands)	June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013
Grade:
Pass	$	1,068,377	$	1,019,732	$	17,162	$	18,117	$	1,085,539	$	1,037,849
Special mention	169		623		—		—		169		623
Substandard	4,885		7,382		—		41		4,885		7,423
Total	$	1,073,431	$	1,027,737	$	17,162	$	18,158	$	1,090,593	$	1,045,895

Commercial Real Estate

Credit Risk Profile by Creditworthiness Category

	Construction				Single and multi-family				Other				Total commercial real estate
(In thousands)	June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013
Grade:
Pass	$	161,733	$	120,071	$	86,250	$	59,636	$	940,577	$	800,672	$	1,188,560	$	980,379
Special mention	—		—		137		140		5,015		8,150		5,152		8,290
Substandard	3,543		5,176		3,297		3,717		61,603		61,807		68,443		70,700
Doubtful	—		—		—		—		73		642		73		642
Total	$	165,276	$	125,247	$	89,684	$	63,493	$	1,007,268	$	871,271	$	1,262,228	$	1,060,011

Commercial and Industrial Loans

Credit Risk Profile by Creditworthiness Category

	Asset based lending				Other				Total comm. and industrial loans
(In thousands)	June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013
Grade:
Pass	$	328,681	$	294,241	$	326,244	$	313,984	$	654,925	$	608,225
Special mention	—		—		1,266		884		1,266		884
Substandard	—		—		10,291		7,725		10,291		7,725
Doubtful	—		—		—		603		—		603
Total	$	328,681	$	294,241	$	337,801	$	323,196	$	666,482	$	617,437

Consumer Loans

Credit Risk Profile Based on Payment Activity

	Home equity				Auto and other				Total consumer loans
(In thousands)	June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013
Performing	$	239,017	$	231,594	$	296,630	$	212,922	$	535,647	$	444,516
Nonperforming	1,284		1,083		380		249		1,664		1,332
Total	$	240,301	$	232,677	$	297,010	$	213,171	$	537,311	$	445,848

Acquired Loans

Residential Mortgages

Credit Risk Profile by Internally Assigned Grade

	1-4 family				Construction				Total residential mortgages
(In thousands)	June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013
Grade:
Pass	$	302,182	$	330,353	$	1,043	$	1,081	$	303,225	$	331,434
Special mention	801		437		—		—		801		437
Substandard	2,612		2,577		—		3,931		2,612		6,508
Total	$	305,595	$	333,367	$	1,043	$	5,012	$	306,638	$	338,379

Commercial Real Estate

Credit Risk Profile by Creditworthiness Category

	Construction				Single and multi-family				Other				Total commercial real estate
(In thousands)	June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013
Grade:
Pass	$	4,211	$	7,154	$	48,043	$	46,961	$	227,566	$	254,787	$	279,820	$	308,902
Special mention	342		—		827		4,799		6,796		9,034		7,965		13,833
Substandard	2,271		6,616		12,550		13,067		14,666		14,691		29,487		34,374
Total	$	6,824	$	13,770	$	61,420	$	64,827	$	249,028	$	278,512	$	317,272	$	357,109

Commercial and Industrial Loans

Credit Risk Profile by Creditworthiness Category

	Asset based lending				Other				Total comm. and industrial loans
(In thousands)	June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013
Grade:
Pass	$	—	$	3,130	$	54,037	$	59,615	$	54,037	$	62,745
Special mention	—		—		3,156		2,396		3,156		2,396
Substandard	—		—		4,284		4,715		4,284		4,715
Total	$	—	$	3,130	$	61,477	$	66,726	$	61,477	$	69,856

Consumer Loans

Credit Risk Profile Based on Payment Activity

	Home equity				Auto and other				Total consumer loans
(In thousands)	June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013		June 30, 2014		Dec. 31, 2013
Performing	$	68,791	$	73,552	$	136,769	$	170,275	$	205,560	$	243,827
Nonperforming	917		602		1,825		1,559		2,742		2,161
Total	$	69,708	$	74,154	$	138,594	$	171,834	$	208,302	$	245,988

The following table summarizes information about total loans rated Special Mention or lower as of June 30, 2014 and December 31, 2013. The table below includes consumer loans that are special mention and substandard accruing that are classified in the above table as performing based on payment activity.

	June 30, 2014						December 31, 2013
(In thousands)	Business Activities Loans		Acquired Loans		Total		Business Activities Loans		Acquired Loans		Total
Non-Accrual	$	17,739	$	8,319	$	26,058	$	18,472	$	8,983	$	27,455
Substandard Accruing	67,583		30,635		98,218		70,667		38,891		109,558
Total Classified	85,322		38,954		124,276		89,139		47,874		137,013
Special Mention	6,621		12,094		18,715		10,081		17,853		27,934
Total Criticized	$	91,943	$	51,048	$	142,991	$	99,220	$	65,727	$	164,947