9.	Loans and Allowance for Loan Losses

The composition of the Company’s loan portfolio as of June 30, 2012 and December 31, 2011 was as follows:


	June 30, 2012						December 31, 2011
(Dollars in thousands)	Amount			Percent			Amount			Percent
Commercial loans	$	173,637			24.5	%	$	179,305			27.2	%
Commercial real estate loans — owner occupied		158,039			22.3	%		170,960			26.0	%
Commercial real estate loans — all other		155,118			21.9	%		121,813			18.5	%
Residential mortgage loans — multi-family		74,930			10.6	%		65,545			10.0	%
Residential mortgage loans — single family		87,227			12.3	%		68,613			10.4	%
Construction loans		—			—	%		2,047			0.3	%
Land development loans		27,488			3.9	%		25,638			3.9	%
Consumer loans		31,959			4.5	%		24,358			3.7	%

Gross loans		708,398			100.0	%		658,279			100.0	%

Deferred fee (income) costs, net		(635	)					(690	)
Allowance for loan losses		(14,648	)					(15,627	)

Loans, net	$	693,115					$	641,962

At June 30, 2012 and December 31, 2011, real estate loans of approximately $141 million and $161 million, respectively, were pledged to secure borrowings obtained from the Federal Home Loan Bank.

Allowance for Loan Losses

The allowance for loan losses (“ALL”) represents our estimate of credit losses inherent in the loan portfolio at the balance sheet date. We employ economic models that are based on bank regulatory guidelines, industry standards and our own historical loan loss experience, as well as a number of more subjective qualitative factors, to determine both the sufficiency of the ALL and the amount of the provisions that are required to be made for potential loan losses.

The ALL is first determined by analyzing all classified loans (graded as “Substandard” or “Doubtful” under our internal credit quality grading parameters — see below) on non-accrual status for loss exposure and establishing specific reserves as needed. ASC 310-10 defines loan impairment as the existence of uncertainty concerning collection of all principal and interest in accordance with the contractual terms of a loan. For collateral dependent loans, impairment is typically measured by comparing the loan amount to the fair value of collateral, less closing costs to sell, with a specific reserve established for the “shortfall” amount. Other methods can be used in estimating impairment, including market price and the present value of expected future cash flows discounted at the loan’s original interest rate.

On a quarterly basis, we utilize a classification migration model and individual loan review analytical tools as starting points for determining the adequacy of the ALL for homogenous pools of loans that are not subject to specific reserve allocations. Our loss migration analysis tracks a certain number of quarters of loan loss history and industry loss factors to determine historical losses by classification category for each loan type, except certain consumer loans. We then apply these calculated loss factors, together with a qualitative factor based on external economic factors and internal assessments, to the outstanding loan balances in each homogenous group of loans, and then, using our internal credit quality grading parameters, we grade the loans as “Pass,” “Special Mention,” “Substandard” or “Doubtful”. We also conduct individual loan review analysis, as part of the allowance for loan losses allocation process, applying specific monitoring policies and procedures in analyzing the existing loan portfolios. Set forth below is a summary of the Company’s activity in the ALL during the following periods:


	Three Months Ended June 30, 2012			Six Months Ended June 30, 2012			Year Ended December 31, 2011
	(Dollars in thousands)
Balance, beginning of period	$	13,634		$	15,627		$	18,101
Charged off loans		(991	)		(2,661	)		(2,736	)
Recoveries on loans previously charged off		155			232			1,095
Provision for loan losses		1,850			1,450			(833	)

Balance, end of period	$	14,648		$	14,648		$	15,627

Set forth below is information regarding loan balances and the related allowance for loan losses, by portfolio type, for the six months ended June 30, 2012 and the year ended December 31, 2011.


(Dollars in thousands)	Commercial			Real Estate			Construction and Land Development			Consumer and Single Family Mortgages			Total
Six Months Ended June 30, 2012
Allowance for loan losses:
Balance at beginning of period	$	8,908		$	5,777		$	316		$	626		$	15,627
Charge offs		(1,668	)		(655	)		(80	)		(258	)		(2,661	)
Recoveries		221			1			0			10			232
Provision		947			(219	)		490			232			1,450

Balance at end of period	$	8,408		$	4,904		$	726		$	610		$	14,648

Three Months Ended June 30, 2012
Allowance for loan losses:
Balance at beginning of period	$	6,223		$	6,363		$	265		$	783		$	13,634
Charge offs		(948	)		—			(29	)		(14	)		(991	)
Recoveries		148			—			—			7			155
Provision		2,985			(1,459	)		490			(166	)		1,850

Balance at end of period	$	8,408		$	4,904		$	726		$	610		$	14,648

Allowance balance at June 30, 2012 related to:
Loans individually evaluated for impairment	$	4,049		$	189		$	—		$	—		$	4,238

Loans collectively evaluated for impairment	$	4,359		$	4,715		$	726		$	610		$	10,410

Loans balance at June 30, 2012:
Loans individually evaluated for impairment	$	18,761		$	16,921		$	528		$	733		$	36,943
Loans collectively evaluated for impairment		154,876			371,166			26,960			118,453			671,455

Ending Balance	$	173,637		$	388,087		$	27,488		$	119,186		$	708,398

December 31, 2011
Allowance for loan losses:
Balance at beginning of year	$	10,017		$	6,351		$	830		$	903		$	18,101
Charge offs		(1,218	)		(1,315	)		(138	)		(65	)		(2,736	)
Recoveries		1,067			3			—			25			1,095
Provision		(958	)		738			(376	)		(237	)		(833	)

Balance at end of year	$	8,908		$	5,777		$	316		$	626		$	15,627

Allowance balance at end of year related to:
Loans individually evaluated for impairment	$	1,648		$	1,135		$	—		$	—		$	2,783

Loans collectively evaluated for impairment	$	7,260		$	4,642		$	316		$	626		$	12,844

Loans balance at end of year:
Loans individually evaluated for impairment	$	5,140		$	10,088		$	2,597		$	570		$	18,395
Loans collectively evaluated for impairment		174,165			348,230			25,088			92,401			639,884

Ending Balance	$	179,305		$	358,318		$	27,685		$	92,971		$	658,279

Credit Quality

The quality of the loans in the Company’s loan portfolio is assessed as a function of net credit losses and the amounts of the nonperforming assets and delinquencies that occur within our loan portfolio. These factors are an important part of our overall credit risk management process and our evaluation of the adequacy of the ALL.

The following table provides a summary of the delinquency status of loans by portfolio type:


(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater		Total Past Due		Current		Total Loans Outstanding		Loans >90 Days and Accruing⁽¹⁾
June 30, 2012
Commercial loans	$	8,757	$	3,482	$	4,775	$	17,014	$	156,623	$	173,637	$	—
Commercial real estate loans – owner-occupied		—		—		5,491		5,491		152,548		158,039		—
Commercial real estate loans – all other		—		—		—		—		155,118		155,118		—
Residential mortgage loans – multi-family		—		—		—		—		74,930		74,930		—
Residential mortgage loans – single family		347		—		—		347		86,880		87,227		—
Construction loans		—		—		—		—		—		—		—
Land development loans		320		—		528		848		26,640		27,488		—
Consumer loans		2		—		—		2		31,957		31,959		—

Total	$	9,426	$	3,482	$	10,794	$	23,702	$	684,696	$	708,398	$	—

December 31, 2011
Commercial loans	$	1,877	$	159	$	2,021	$	4,057	$	175,248	$	179,305	$	—
Commercial real estate loans – owner occupied		—		2,016		—		2,016		168,944		170,960		—
Commercial real estate loans – all other		—		—		—		—		121,813		121,813		—
Residential mortgage loans – multi-family		—		859		—		859		64,686		65,545		—
Residential mortgage loans – single family		80		1,050		492		1,622		66,991		68,613		—
Construction loans		—		—		2,047		2,047		—		2,047		—
Land development loans		—		—		550		550		25,088		25,638		—
Consumer loans		—		—		—		—		24,358		24,358		—

Total	$	1,957	$	4,084	$	5,110	$	11,151	$	647,128	$	658,279	$	—

(1)	At June 30, 2012 the Company did not have any loans that were past due 90 days or more and still accruing interest.

As the above table indicates, total past due loans increased by $12.6 million, to $23.7 million at June 30, 2012, from $11.2 million at December 31, 2011. Loans past due 90 days or more increased by $5.7 million, to $10.8 million at June 30, 2012, from $5.1 million at December 31, 2011. That increase in loans 90 days or more past due was attributable primarily to (i) a $2.8 million increase in past due commercial loans as a result of the bankruptcy of a borrower, and (ii) a $5.5 million increase in past due owner-occupied commercial real estate loans to three borrowers, partially offset by the foreclosure and resulting transfer of a $2.0 million construction loan into other real estate owned. These loans are in various stages of collection and the adequacy of the collateral securing the repayment of and the prospects for recoveries on these loans are reflected in the allowance for loan losses at June 30, 2012.

Between December 31, 2011 and June 30, 2012, loans 30-59 days past due increased by $7.5 million, primarily as a result of an $8.2 million commercial loan relationship, with respect to which we had established specific reserves of $2.6 million during the second quarter of 2012. This relationship was current and no longer past due at July 31, 2012.

Generally, the accrual of interest on a loan is discontinued when principal or interest payments become more than 90 days past due, unless management believes the loan is adequately collateralized and it is in the process of collection. There were no loans 90 days or more past due and still accruing interest at June 30, 2012 or December 31, 2011. In certain instances, when a loan is placed on non-accrual status, previously accrued but unpaid interest is reversed against current income. Subsequent collections of cash are applied as principal reductions when received, except when the ultimate collectability of principal is probable, in which case payments are applied to accrued and unpaid interest, which is credited to income. Non-accrual loans may be restored to accrual status when principal and interest become current and full repayment is expected.

The following table provides information, as of June 30, 2012 and December 31, 2011, with respect to loans on nonaccrual status, by portfolio type:


	June 30, 2012		December 31, 2011
	(Dollars in thousands)
Nonaccrual loans:
Commercial loans	$	10,280	$	4,702
Commercial real estate loans – owner occupied		5,491		2,016
Commercial real estate loans – all other		4,071		4,214
Residential mortgage loans – single family		524		570
Construction loans		—		2,047
Land development loans		528		550
Consumer loans		—		—

Total	$	20,894	$	14,099

As the above table indicates, at June 30, 2012, nonaccrual loans increased to $20.9 million from $14.1 million at December 31, 2011 (after giving effect to the foreclosure and transfer of a $2.1 million nonaccrual loan into other real estate owned in the first quarter of 2012). During July 2012, we renegotiated one of the nonaccrual loans, in the amount of $3.4 million, on terms pursuant to which the borrower made a $2.4 million principal reduction payment to us in cash, leaving a fully collateralized unpaid balance of $1.0 million on that loan, which is now current. Another $6.1 million of the increase in nonaccrual loans during the six months ended June 30, 2012 was attributable to a bankruptcy filing by the borrower. However, that borrower’s loans are collateralized and we are seeking a relief from the stay in bankruptcy to be able to foreclose or sell the collateral. Nonaccrual loans which had been brought current and were being paid by the borrowers in accordance with their terms increased to $6.6 million at June 30, 2012 from $5.0 million at December 31, 2011.

The Company classifies its loan portfolio using internal credit quality ratings. The following table provides a summary of loans by portfolio type and the Company’s internal credit quality ratings as of June 30, 2012 and December 31, 2011, respectively.


(Dollars in thousands)	June 30, 2012		December 31, 2011		Increase (Decrease)
Pass:
Commercial loans	$	135,717	$	149,522		(13,805	)
Commercial real estate loans – owner occupied		137,474		148,380		(10,906	)
Commercial real estate loans – all other		134,013		109,482		24,531
Residential mortgage loans – multi family		71,020		61,190		9,830
Residential mortgage loans – single family		85,418		66,631		18,787
Construction loans		—		—		—
Land development loans		12,035		16,758		(4,723	)
Consumer loans		31,959		24,358		7,601

Total pass loans	$	607,636	$	576,321	$	31,315

Special Mention:
Commercial loans	$	10,250	$	4,570	$	5,680
Commercial real estate loans – owner occupied		—		6,826		(6,826	)
Commercial real estate loans – all other		3,888		2,553		1,335
Residential mortgage loans – multi family		3,910		3,316		594
Residential mortgage loans – single family		347		1,014		(667	)
Construction loans		—		—		—
Land development loans		8,254		8,330		(76	)
Consumer loans		—		—		—

Total special mention loans	$	26,649	$	26,609	$	40

Substandard:
Commercial loans	$	27,670	$	24,551	$	3,119
Commercial real estate loans – owner occupied		20,565		15,754		4,811
Commercial real estate loans – all other		17,218		9,778		7,440
Residential mortgage loans – multi family		—		1,039		(1,039	)
Residential mortgage loans – single family		1,461		968		493
Construction loans		—		2,047		(2,047	)
Land development loans		7,199		550		6,649
Consumer loans		—		—		—

Total substandard loans	$	74,113	$	54,687	$	19,426

Doubtful:
Commercial loans	$	—	$	662	$	(662	)
Commercial real estate loans – owner occupied		—		—		—
Commercial real estate loans – all other		—		—		—
Residential mortgage loans – multi family		—		—		—
Residential mortgage loans – single family		—		—		—
Construction loans		—		—		—
Land development loans		—		—		—
Consumer loans		—		—		—

Total doubtful loans	$	—	$	662	$	(662	)

Total Outstanding Loans, gross:	$	708,398	$	658,279	$	50,119

As the above table indicates, the Company’s total loans approximated $708 million at June 30, 2012, an increase of $50 million from $658 million at December 31, 2011. The disaggregation of the portfolio by risk rating in the table above reflects the following changes between December 31, 2011 and June 30, 2012:

•

Loans rated “pass” increased $32 million to $608 million at June 30, 2012 from $576 million at December 31,2011, due primarily to the $50 million increase in total loans outstanding, partially offset by approximately $21 million in loans downgraded to “substandard”.

•

Loans classified “substandard” increased to $74.1 million at June 30, 2012, from $54.7 million at December 31, 2011, due primarily to net transfers of $21 million of loans into “substandard” from “pass”. Although those loans are being paid in accordance with their terms by the borrowers and are collateralized by real properties, they were downgraded to substandard as a result of recent liquidity weaknesses and uncertainties regarding the future debt service capabilities of the borrowers.

•

A $662,000 loan that had been classified as “doubtful” at December 31, 2011 was subsequently upgraded to “substandard” after the borrower brought the loan current during the second quarter of 2012.

At June 30, 2012, we had no loans that were classified as “doubtful”.

The ALL at June 30, 2012, totaled nearly $14.6 million, or 2.07% of the loans then outstanding. That amount was $1.0 million higher than the ALL at March 31, 2012, which totaled $13.6 million, or 1.98% of loans then outstanding, This increase was due to the transfers of loans into “substandard” from “pass” at noted above, and an increase in delinquent loans at June 30, 2012 from March 31, 2012. The ALL at June 30, 2012 was $1.0 million lower than at December 31, 2011, when the ALL was $15.6 million, or 2.37% of the loans then outstanding. This decrease was due to net charge-offs of $2.4 million, partially offset by a $1.4 million provision that we made for possible loan losses during the six months ended June 30, 2012.

Impaired Loans

A loan is generally classified as impaired and placed on nonaccrual status when, in management’s opinion, the principal or interest will not be collectible in accordance with the contractual terms of the loan agreement. The Company measures and reserves for impairment, on a loan-by-loan basis, using either the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if the loan is collateral dependent.

The following table sets forth information regarding nonaccrual loans and restructured loans, at June 30, 2012 and December 31, 2011:


(Dollars in thousands)	June 30, 2012		December 31, 2011
Impaired loans:
Nonaccruing loans	$	14,714	$	9,885
Nonaccruing restructured loans		6,180		4,214
Accruing restructured loans		16,180		—
Accruing impaired loans		1,282		4,296

Total impaired loans	$	38,356	$	18,395

Impaired loans less than 90 days delinquent and included in total impaired loans	$	24,163	$	13,285

The increase of $10.9 million in impaired loans to $24.2 million at June 30, 2012, from $13.3 million at December 31, 2012, was primarily attributable to two loans aggregating $8.2 million to a single borrower for which there are adequate collateral or reserves.

The table below contains additional information with respect to impaired loans, by portfolio type, for the periods ended June 30, 2012 and December 31, 2011:


	Recorded Investment		Unpaid Principal Balance		Related Allowance⁽¹⁾		Average Recorded Investment		Interest Income Recognized
(Dollars in thousands)
June 30, 2012
With no related allowance recorded:
Commercial loans	$	8,082	$	10,102	$	—	$	4,170	$	164
Commercial real estate loans – owner occupied		6,919		7,400		—		5,883		12
Commercial real estate loans – all other		5,471		5,471		—		4,350		163
Residential mortgage loans – multi-family		—		—		—		45		—
Residential mortgage loans – single family		1,001		1,125		—		1,063		15
Construction loans		—		—		—		512		—
Land development loans		528		554		—		652		—
Consumer loans		—		—		—		—		—
With an allowance recorded:
Commercial loans	$	12,284	$	12,340	$	4,049	$	5,232	$	268
Commercial real estate loans – owner occupied		—		—		—		965		—
Commercial real estate loans – all other		4,071		4,772		189		4,178		98
Residential mortgage loans – multi-family		—		—		—		45		—
Residential mortgage loans – single family		—		—		—		—		—
Construction loans		—		—		—		512		—
Land development loans		—		—		—		—		—
Consumer loans		—		—		—		—		—
Total:
Commercial loans	$	20,366	$	22,442	$	4,049	$	9,402	$	432
Commercial real estate loans – owner occupied		6,919		7,400		—		6,848		12
Commercial real estate loans – all other		9,542		10,243		189		8,528		261
Residential mortgage loans – multi-family		—		—		—		90		—
Residential mortgage loans – single family		1,001		1,125		—		1,063		15
Construction loans		—		—		—		1,024		—
Land development loans		528		554		—		652		—
Consumer loans		—		—		—		—		—


	Recorded Investment		Unpaid Principal Balance		Related Allowance⁽¹⁾		Average Recorded Investment		Interest Income Recognized
(Dollars in thousands)
December 31, 2011
2011 With no related allowance recorded:
Commercial loans	$	1,636	$	2,361	$	—	$	1,395	$	38
Commercial real estate loans – owner occupied		3,583		3,583		—		4,621		340
Commercial real estate loans – all other		96		96		—		3,420		3
Residential mortgage loans – multi-family		—		—		—		—		—
Residential mortgage loans – single family		570		581		—		790		15
Construction loans		2,047		2,215		—		621		—
Land development loans		550		554		—		632		11
Consumer loans		—		—		—		32		—
2011 With an allowance recorded:
Commercial loans	$	3,503	$	3,527	$	1,648	$	1,722	$	203
Commercial real estate loans – owner occupied		2,016		2,016		659		3,015		48
Commercial real estate loans – all other		4,214		4,818		347		9,281		—
Residential mortgage loans – multi-family		180		180		129		45		14
Residential mortgage loans – single family		—		—		—		273		—
Construction loans		—		—		—		1,604		—
Land development loans		—		—		—		—		—
Consumer loans		—		—		—		—		—
2011 Total:
Commercial loans	$	5,139	$	5,888	$	1,648	$	3,117	$	241
Commercial real estate loans – owner occupied		5,599		5,599		659		7,636		388
Commercial real estate loans – all other		4,310		4,914		347		12,701		3
Residential mortgage loans – multi-family		180		180		129		45		14
Residential mortgage loans – single family		570		581		—		1,063		15
Construction loans		2,047		2,215		—		2,225		—
Land development loans		550		554		—		632		11
Consumer loans		—		—		—		32		—

(1)

When the discounted cash flows and collateral value or market price equals or exceeds the recorded investment in the loan, then the loan does not require an allowance. This typically occurs when the impaired loans have been partially charged-off and/or there have been interest payments received and applied to the loan balance.

The allowance for loan losses at June 30, 2012 included $4.2 million of reserves for $38 million of impaired loans, as compared to $2.8 million of reserves for $18.4 million of impaired loans at December 31, 2011. At June 30, 2012 and December 31, 2011 there were impaired loans of $22.0 million and $8.5 million, respectively, for which no specific reserves were allocated because these loans, in our judgment, were sufficiently collateralized. Of the impaired loans at June 30, 2012 for which no specific reserves were allocated, $17.5 million had been deemed impaired in prior quarters and the deficiency was charged off during the quarter the loans were deemed impaired.

We had average investments in impaired loans of $27.6 million and $27.5 million for the period ended June 30, 2012 and December 31, 2011, respectively. The interest that would have been earned, during the three and six months ended June 30, 2012 had the impaired loans remained current in accordance with their original terms was $151,000 and $188,000, respectively.

Troubled Debt Restructurings

Pursuant to FASB’s Accounting Standard Update No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring (“ASU No. 2011-02”), the Bank’s troubled debt restructured loans (“TDRs”) totaled $22.4 million as of June 30, 2012, as compared to $4.2 million as of December 31, 2011. The restructured loans represent financing receivables modified for the purpose of alleviating temporary impairments to the borrowers’ financial condition. The modifications that the Bank has extended to borrowers have come in the forms of changes in amortization terms, reductions in interest rates, interest only payments and, in limited cases, concessions to outstanding loan balances. Workout plans between borrowers and the Bank are designed to provide a bridge for cash flow shortfalls in the near term. As a borrower works through the near term issues, in most cases, the original contractual terms will be reinstated.

As of June 30, 2012, Troubled debt restructurings totaled $22.4 million, accruing TDRs’ totaled $16.2 million and nonperforming TDRs’ totaled $6.2 million. Nonperforming TDRs’ increased by $2.0 million to $6.2 million at June 30, 2012, primarily due to three loans including one at $1.1 million for which specific reserves of $166,000 had been established. There were no performing TDRs’ at December 31, 2011, compared to $16.2 million at June 30, 2012, as a result of two loans one of which required specific reserves of $3.3 million, while no reserves were required on the other. The modified loans are all classified as substandard as of June 30, 2012.


	June 30, 2012
(Dollars in thousands)	Number of Loans		Pre- Modification Outstanding Recorded Investment		Post Modification Outstanding Recorded Investment		End of Period Balance
Performing
Commercial loans		3	$	9,280	$	9,280	$	9,280
Commercial real estate – all other		3		5,471		5,471		5,471
Land development loans		1		1,429		1,429		1,429

		7		16,180		16,180		16,180
Nonperforming
Commercial loans		4		2,294		2,057		2,045
Commercial real estate – all other		1		4,942		4,818		4,071
Residential mortgage loans – single family		1		171		64		64

		6		7,407		6,939		6,180
Total Troubled Debt Restructurings		13	$	23,587	$	23,119	$	22,360


	December 31, 2011
	Number of loans		Pre- Modification Outstanding Recorded Investment		Post Modification Outstanding Recorded Investment		End of Period Balance
Nonperforming
Commercial real estate-all other		1		4,942		4,818		4,214

Total troubled debt restructurings		1	$	4,942	$	4,818	$	4,214