6.	Loans and Allowance for Loan Losses

The composition of the Company’s loan portfolio as of June 30, 2013 and December 31, 2012 was as follows:


	June 30, 2013						December 31, 2012
(Dollars in thousands)	Amount			Percent			Amount			Percent
Commercial loans	$	195,439			26.8	%	$	170,792			23.4	%
Commercial real estate loans – owner occupied		156,215			21.4	%		165,922			22.7	%
Commercial real estate loans – all other		158,179			21.7	%		150,189			20.6	%
Residential mortgage loans – multi-family		97,383			13.4	%		105,119			14.4	%
Residential mortgage loans – single family		75,241			10.3	%		87,263			11.9	%
Land development loans		19,653			2.7	%		24,018			3.3	%
Consumer loans		27,106			3.7	%		27,296			3.7	%

Gross loans		729,216			100.0	%		730,599			100.0	%

Deferred fee (income) costs, net		(275	)					(461	)
Allowance for loan losses		(11,123	)					(10,881	)

Loans, net	$	717,818					$	719,257

At June 30, 2013 and December 31, 2012, real estate loans of approximately $216 million and $162 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 to increase or replenish the ALL.

The ALL is first determined by (i) 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 (ii) 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 estimated costs to sell, with a specific reserve established for any “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 factors based on external economic conditions and trends 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 ALL allocation process, applying specific monitoring policies and procedures in analyzing the existing loan portfolios. Set forth below is a summary of the activity in the ALL during the following periods:


	Three Months Ended June 30, 2013			Six Months Ended June 30, 2013			Year Ended December 31, 2012
(Dollars in thousands)
Balance, beginning of period	$	11,018			10,881		$	15,627
Charged off loans		(1,433	)		(2,918	)		(8,574	)
Recoveries on loans previously charged off		1,538			2,010			1,878
Provision for loan losses		—			1,150			1,950

Balance, end of period	$	11,123			11,123		$	10,881

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, 2013, June 30, 2012, and the year ended December 31, 2012 (excluding mortgage loans held for sale).


(Dollars in thousands)	Commercial			Real Estate⁽¹⁾			Land Development			Consumer and Single Family Mortgages			Total
Allowance for Loan Losses:
Six months ended June 30, 2013
Balance at beginning of period	$	6,340		$	3,487		$	248		$	806		$	10,881
Charge offs		(2,603	)		(308	)		(5	)		(2	)		(2,918	)
Recoveries		1,932			2			54			22			2,010
Provision		1,284			(327	)		—			193			1,150

Balance at end of period	$	6,953		$	2,854		$	297		$	1,019		$	11,123

Three months ended June 30, 2013
Balance at beginning of period	$	6,850		$	3,053		$	216		$	899		$	11,018
Charge offs		(1,433	)		—			—			—			(1,433	)
Recoveries		1,532			1			—			5			1,538
Provision		4			(200	)		81			115			—

Balance at end of period	$	6,953		$	2,854		$	297		$	1,019		$	11,123

ALL balance at end of period related to:
Loans individually evaluated for impairment	$	2,158		$	—		$	—		$	—		$	2,158

Loans collectively evaluated for impairment	$	4,795		$	2,854		$	297		$	1,019		$	8,965

Loans balance at end of period:
Loans individually evaluated for impairment	$	11,867		$	18,016		$	414		$	788		$	31,085
Loans collectively evaluated for impairment		183,572			393,761			19,239			101,559			698,131

Ending Balance	$	195,439		$	411,777		$	19,653		$	102,347		$	729,216

ALL for the six months ended June 30, 2012:
Balance at beginning of quarter	$	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 quarter	$	8,408		$	4,904		$	726		$	610		$	14,648

ALL 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

ALL for the year ended December 31, 2012:
Balance at beginning of year	$	8,908		$	5,777		$	316		$	626		$	15,627
Charge offs		(6,664	)		(1,184	)		(158	)		(568	)		(8,574	)
Recoveries		1,657			198			—			23			1,878
Provision		2,439			(1,304	)		90			725			1,950

Balance at end of year	$	6,340		$	3,487		$	248		$	806		$	10,881

ALL balance at end of year related to:
Loans individually evaluated for impairment	$	2,428		$	—		$	—		$	—		$	2,428

Loans collectively evaluated for impairment	$	3,912		$	3,487		$	248		$	806		$	8,453

Loans balance at end of year:
Loans individually evaluated for impairment	$	16,180		$	21,918		$	314		$	839		$	39,251
Loans collectively evaluated for impairment		154,612			399,312			23,704			113,720			691,348

Ending Balance	$	170,792		$	421,230		$	24,018		$	114,559		$	730,599

Credit Quality

The amounts of nonperforming assets and delinquencies that occur within our loan portfolio factors in our evaluation of the adequacy of the ALL.

The following table provides a summary of the delinquency status of loans by portfolio type at June 30, 2013 and December 31, 2012:


(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 still Accruing Interest
June 30, 2013
Commercial loans	$	103	$	4,489	$	756	$	5,348	$	190,091	$	195,439	$	—
Commercial real estate loans – owner-occupied		—		—		—		—		156,215		156,215		—
Commercial real estate loans – all other		—		4,792		2,117		6,909		151,270		158,179		—
Residential mortgage loans – multi-family		—		—		—		—		97,383		97,383		—
Residential mortgage loans – single family		—		—		—		—		75,241		75,241		—
Land development loans		—		—		—		—		19,653		19,653		—
Consumer loans		—		—		—		—		27,106		27,106		—

Total	$	103	$	9,281	$	2,873	$	12,257	$	716,959	$	729,216	$	—

December 31, 2012
Commercial loans	$	1,321	$	778	$	4,295	$	6,394	$	164,398	$	170,792	$	—
Commercial real estate loans – owner occupied		—		—		3,232		3,232		162,690		165,922		—
Commercial real estate loans – all other		—		—		2,599		2,599		147,590		150,189		—
Residential mortgage loans – multi-family		—		—		—		—		105,119		105,119		—
Residential mortgage loans – single family		259		378		359		996		86,267		87,263		—
Land development loans		—		—		314		314		23,704		24,018		—
Consumer loans		—		—		—		—		27,296		27,296		—

Total	$	1,580	$	1,156	$	10,799	$	13,535	$	717,064	$	730,599	$	—

As the above table indicates, total past due loans decreased by $1.2 million, to $12.3 million at June 30, 2013 from $13.5 million at December 31, 2012. Loans past due 90 days or more decreased by $7.9 million, to $2.9 million at June 30, 2013, from $10.8 million at December 31, 2012, primarily due to the foreclosure, and transfers of $5.6 million of real estate loans to OREO and $1.5 million in loan charge offs during the six months ended June 30, 2013.

Loans 30-89 days past due increased by $6.6 million to $9.4 million at June 30, 2013, from $2.7 million at December 31, 2012, primarily due to bankruptcy filings on a $4.8 million commercial real estate loan and a $4.3 million commercial loan relationship.

Generally, the accrual of interest on a loan is discontinued when principal or interest payments become more than 90 days past due, unless we believe that 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, 2013 or December 31, 2012. 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 such 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 becomes expected.

The following table provides information, as of June 30, 2013 and December 31, 2012, with respect to loans on nonaccrual status, by portfolio type:


	June 30, 2013		December 31, 2012
	(Dollars in thousands)
Nonaccrual loans:
Commercial loans	$	3,595	$	6,846
Commercial real estate loans – owner occupied		1,811		3,232
Commercial real estate loans – all other		2,117		6,424
Residential mortgage loans – single family		788		839
Land development loans		414		314

Total	$	8,725	$	17,655

At June 30, 2013 nonaccrual loans totaled to $8.7 million, down from $17.7 million at December 31, 2012, primarily due to (i) the restoration to accrual status of a $2.0 million commercial real estate-all other loan as a result of the receipt from the borrower of loan payments in accordance with the modified terms over a period of time, (ii) the foreclosure of $5.6 million of loans collateralized primarily by commercial real estate, and (iii) impairment write-downs of $1.8 million, based on our loan impairment analysis.

We classify our loan portfolio using internal credit quality ratings. The following table provides a summary of loans by portfolio type and our internal credit quality ratings as of June 30, 2013 and December 31, 2012, respectively.


(Dollars in thousands)	June 30, 2013		December 31, 2012		Increase (Decrease)
Pass:
Commercial loans	$	173,199	$	146,952	$	26,247
Commercial real estate loans – owner occupied		152,691		162,689		(9,998	)
Commercial real estate loans – all other		140,186		135,274		4,912
Residential mortgage loans – multi family		97,383		104,747		(7,364	)
Residential mortgage loans – single family		73,264		84,237		(10,973	)
Land development loans		11,106		12,461		(1,355	)
Consumer loans		26,544		27,296		(752	)

Total pass loans	$	674,373	$	673,656	$	717

Special Mention:
Commercial loans	$	217	$	2,381	$	(2,164	)
Commercial real estate loans – owner occupied		—		—		—
Commercial real estate loans – all other		4,523		3,859		664
Residential mortgage loans – multi family		—		373		(373	)
Residential mortgage loans – single family		—		990		(990	)
Land development loans		—		8,201		(8,201	)
Consumer loans		562		—		562

Total special mention loans	$	5,302	$	15,804	$	(10,502	)

Substandard:
Commercial loans	$	21,047	$	21,347	$	(300	)
Commercial real estate loans – owner occupied		3,523		3,232		291
Commercial real estate loans – all other		13,470		11,057		2,413
Residential mortgage loans – multi family		—		—		—
Residential mortgage loans – single family		1,978		2,036		(58	)
Land development loans		8,547		3,355		5,192
Consumer loans		—		—		—

Total substandard loans	$	48,565	$	41,027	$	7,538

Doubtful:
Commercial loans	$	976	$	112	$	864
Commercial real estate loans – owner occupied		—		—		—
Commercial real estate loans – all other		—		—		—
Residential mortgage loans – multi family		—		—		—
Residential mortgage loans – single family		—		—		—
Land development loans		—		—		—
Consumer loans		—		—		—

Total doubtful loans	$	976	$	112	$	864

Total Outstanding Loans, gross:	$	729,216	$	730,599	$	(1,383	)

As the above table indicates, loans totaled approximately $729 million at June 30, 2013, a decrease of $1.4 million from $731 million at December 31, 2012. The disaggregation of the loan portfolio by risk rating in the table above reflects the following changes between December 31, 2012 and June 30, 2013:

•

Loans rated “pass” totaled $674 million, approximately the same as December 31, 2012. The composition of the loan portfolio has changed due primarily to a $26 million increase in commercial loans between December 31, 2012 and June 30, 2013, offset by decreases of $11 million in residential mortgage single-family loans, $10 million in commercial real estate owner-occupied real estate loans and a $7 million in residential mortgage multi-family loans.

•

Loans rated “special mention” decreased by $10.5 million to $5.3 million at June 30, 2013 from $15.8 million at year-end 2012. The decrease was primarily the result of the downgrade of a $10.7 million loan relationship, comprised of $9.5 million in commercial real estate loans-all other and a $1.1 million commercial loan. Those real estate loans are collateralized and through June 30, 2013 borrower payments had been current.

•

Loans rated “substandard” increased by $7.6 million to $48.6 million at June 30, 2013, from $41.0 million at year-end 2012. The increase was comprised of $11.5 million of loans transferred from “special mention” and $5.1 million of loans from “pass” to substandard, partially offset by $2.3 million of loan charge offs and the foreclosure and transfer to OREO of $5.6 million of real estate loans during the six months ended June 30, 2013.

Impaired Loans

A loan is generally classified as impaired and placed on nonaccrual status when, in our judgment, principal or interest is not likely to be collected in accordance with the contractual terms of the loan agreement. We measure 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 impaired loans, at June 30, 2013 and December 31, 2012:


(Dollars in thousands)	June 30, 2013		December 31, 2012
Impaired loans:
Nonaccruing loans	$	3,846	$	12,018
Nonaccruing restructured loans		4,879		5,637
Accruing restructured loans⁽¹⁾		22,360		21,596
Accruing impaired loans		—		—

Total impaired loans	$	31,085	$	39,251

Impaired loans less than 90 days delinquent and included in total impaired loans	$	30,328	$	28,452

⁽¹⁾	See “Trouble Debt Restructurings” below for a description of accruing restructured loans at June 30, 2013 and December 31, 2012.

The $8.2 million decrease in impaired loans to $31.1 million at June 30, 2013, from $39.3 million at December 31, 2012, was primarily attributable to the foreclosure and transfer to OREO of $5.6 million of nonaccrual loans and $2.9 million in write downs to impaired loans. Accruing restructured loans were comprised of a number of loans performing in accordance with modified terms, which included a lowering of interest rates, deferral of payments, or modifications to payment terms. Based on an internal analysis, using the current estimated fair values of the collateral or the discounted present values of the future estimated cash flows of the impaired loans, we concluded that, at June 30, 2013, $2.2 million of specific reserves were required on a $4.3 million troubled debt restructured (“TDR”) loan relationship and that the other impaired loans were well secured and adequately collateralized.

The following tables contain additional information with respect to impaired loans, by portfolio type, at June 30, 2013 and December 31, 2012:


(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance ⁽¹⁾		Average Recorded Investment		Interest Income Recognized
2013 Loans with no specific reserves established:
Commercial loans	$	7,555	$	9,678	$	—	$	8,699	$	104
Commercial real estate loans – owner occupied		3,205		3,266		—		4,365		28
Commercial real estate loans – all other		14,811		15,420		—		17,373		290
Residential mortgage loans – multi-family		—		—		—		—		—
Residential mortgage loans – single family		788		1,017		—		812		—
Land development loans		414		417		—		261		15
Consumer loans		—		—		—		—		—
2013 Loans with specific reserves established:
Commercial loans	$	4,312	$	4,325	$	2,158	$	5,125	$	64
Commercial real estate loans – owner occupied		—		—		—		—		—
Commercial real estate loans – all other		—		—		—		—		—
Residential mortgage loans – multi-family		—		—		—		—		—
Residential mortgage loans – single family		—		—		—		—		—
Land development loans		—		—		—		—		—
Consumer loans		—		—		—		—		—
2013 Total:
Commercial loans	$	11,867	$	14,003	$	2,158	$	13,824	$	168
Commercial real estate loans – owner occupied		3,205		3,266		—		4,365		28
Commercial real estate loans – all other		14,811		15,420		—		17,373		290
Residential mortgage loans – multi-family		—		—		—		—		—
Residential mortgage loans – single family		788		1,017		—		812		—
Land development loans		414		417		—		261		15
Consumer loans		—		—		—		—		—
2012 Loans with no specific reserves established:
Commercial loans	$	11,782	$	12,770	$	—	$	7,733	$	377
Commercial real estate loans – owner occupied		4,644		4,649		—		5,584		92
Commercial real estate loans – all other		17,274		17,317		—		10,893		703
Residential mortgage loans – multi-family		—		—		—		45		—
Residential mortgage loans – single family		839		1,033		—		1,050		41
Land development loans		314		318		—		424		33
Consumer loans		—		—		—		—		—
2012 Loans with specific reserves established:
Commercial loans	$	4,398	$	4,398	$	2,428	$	6,976	$	221
Commercial real estate loans – owner occupied		—		—		—		—		—
Commercial real estate loans – all other		—		—		—		2,053		—
Residential mortgage loans – multi-family		—		—		—		—		—
Residential mortgage loans – single family		—		—		—		—		—
Land development loans		—		—		—		—		—
Consumer loans		—		—		—		—		—
2012 Total:
Commercial loans	$	16,180	$	17,168	$	2,428	$	14,709	$	598
Commercial real estate loans – owner occupied		4,644		4,649		—		5,584		92
Commercial real estate loans – all other		17,274		17,317		—		12,946		703
Residential mortgage loans – multi-family		—		—		—		45		—
Residential mortgage loans – single family		839		1,033		—		1,050		41
Land development loans		314		318		—		424		33
Consumer loans		—		—		—		—		—

⁽¹⁾

When the discounted cash flows, collateral value or market price equals or exceeds the recorded investment in the loan, then specific reserves are not required to be set aside for the loan within the ALL. This typically occurs when the impaired loans have been partially charged-off and/or there have been interest payments received and applied to the balance of the principal outstanding.

At June 30, 2013 and December 31, 2012 there were $26.8 million and $34.9 million, respectively, of impaired loans to which no specific reserves had been allocated because these loans, in our judgment, were sufficiently collateralized. Of the impaired loans at June 30, 2013 for which no specific reserves were allocated, $30.7 million had been deemed impaired in prior quarters and the deficiencies were charged off during the periods in which the loans were determined to have become impaired.

We had average investments in impaired loans of $36.6 million and $34.8 million for the six months ended June 30, 2013 and the 12 months ended December 31, 2012, respectively. The interest that would have been earned, in the second quarter of 2013, had the impaired loans remained current in accordance with their original terms was approximately $325,000.

Troubled Debt Restructurings

Pursuant to the 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 $27.2 million at both June 30, 2013 and December 31, 2012. TDRs consist of loans to which modifications have been made for the purpose of alleviating temporary impairments of the borrowers’ financial condition and cash flows. Those modifications 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. The modifications are made as part of workout plans we enter into with the borrowers that are designed to provide a bridge for the borrowers’ cash flow shortfalls in the near term. If a borrower works through the near term issues, then in most cases, the original contractual terms of the borrower’s loan will be reinstated.

Of the $27.2 million of TDRs outstanding at June 30, 2013, $22.4 million were performing in accordance with their terms and accruing interest; and $4.9 million were not. We carried $2.2 million of specific reserves for $4.3 million of TDRs, of which $1.0 million were nonperforming and $3.3 million were performing at June 30, 2013. The TDR totals have remained relatively unchanged between June 30, 2013 and December 31, 2012.


	June 30, 2013
(Dollars in thousands)	Number of Loans		Pre- Modification Outstanding Recorded Investment		Post Modification Outstanding Recorded Investment		End of Period Balance
Performing
Commercial loans		2	$	8,310	$	8,310	$	8,273
Commercial real estate – all other		6		16,451		16,451		12,693
Land development loans		1		1,429		1,429		1,394

		9		26,190		26,190		22,360
Nonperforming
Commercial loans		6		4,944		3,830		2,599
Commercial real estate – owner occupied		1		1,872		1,867		1,811
Land development loans		1		439		439		414
Residential mortgage loans – single family		1		171		64		55

		9		7,426		6,200		4,879

Total Troubled Debt Restructurings		18	$	33,616	$	32,390	$	27,239


	December 31, 2012
(Dollars in thousands)	Number of Loans		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		End of Period Balance
Performing
Commercial loans		4	$	9,754	$	9,754	$	9,334
Commercial real estate – all other		4		10,897		10,897		10,849
Land development loans		1		1,429		1,429		1,412

		9		22,080		22,080		21,595
Nonperforming
Commercial loans		3		1,943		1,855		1,753
Commercial real estate – all other		2		6,814		6,685		3,825
Residential mortgage loans – single family		1		171		64		59

		6		8,928		8,604		5,637

Total Troubled Debt Restructurings		15	$	31,008	$	30,684	$	27,232