LOANS

The composition of the Company's loan portfolio, by loan class, is as follows:

($ in thousands)	March 31, 2013			December 31, 2012

Commercial	$	94,253		$	88,810
Commercial Real Estate		196,081			188,426
Agriculture		40,012			52,747
Residential Mortgage		51,760			51,266
Residential Construction		7,984			7,586
Consumer		57,553			59,393
		447,643			448,228
Allowance for loan losses		(8,846	)		(8,554	)
Net deferred origination fees and costs		838			775

Loans, net	$	439,635		$	440,449

The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk rating standards and criteria similar to those employed by state and federal banking regulatory agencies.

Residential mortgage loans, which are secured by real estate, are primarily susceptible to four risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfalls in collateral value. In general, non-payment is usually due to loss of employment and follows general economic trends in the economy, particularly the upward movement in the unemployment rate, loss of collateral value, and demand shifts.

Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner occupied real estate are primarily susceptible to changes in the market conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles. These same risks apply to commercial loans whether secured by equipment, receivables or other personal property or unsecured. Losses on loans secured by owner occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resulting over-supply of space. Losses are dependent on the value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means. Collateral valuations are obtained at origination of the credit and periodically thereafter (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Construction loans, whether owner occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction, including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion. Losses are primarily related to underlying collateral value and changes therein as described above. Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower. Based on this information the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, or repossession or foreclosure of the underlying collateral. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Collateral valuations are obtained at origination of the credit and periodically thereafter (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or service. Agricultural loans are generally secured by inventory, receivables, equipment, and other real property. Agricultural loans primarily are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as adverse weather conditions. Problem agricultural loans are generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections. Based on this information, the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Collateral valuations are obtained at origination of the credit and periodically thereafter (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses. These loans are generally secured by the receivables, equipment, and other real property of the business and are susceptible to the related risks described above. Problem commercial loans are generally identified by periodic review of financial information that may include financial statements, tax returns, and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Collateral valuations are obtained at origination of the credit and periodically thereafter (generally every 3 – 6 months depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

Consumer loans, whether unsecured or secured are primarily susceptible to four risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfall in collateral value. In general, non-payment is usually due to loss of employment and will follow general economic trends in the economy, particularly the upward movements in the unemployment rate, loss of collateral value, and demand shifts.

As of March 31, 2013, approximately 43% in principal amount of the Company's loans were secured by commercial real estate, which consists of construction and land development loans loans secured by commercial properties. Approximately 12% of the Company's loans were residential mortgage loans. Approximately 2% of the Company's loans were residential construction loans. Approximately 9% of the Company's loans were for agriculture and 21% of the Company's loans were for general commercial uses including professional, retail and small businesses. Approximately 13% of the Company's loans were consumer loans.

Once a loan becomes delinquent and repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal payment. If this is not forthcoming and payment in full is unlikely, the Company will estimate its probable loss, using a recent valuation as appropriate to the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount. Depending on the length of time until final collection, the Company may periodically revalue the underlying collateral and take additional charge-offs as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when collateral is liquidated and actual loss is known. Unpaid balances on loans after or during collection and liquidation may also be pursued through legal action and attachment of wages or judgment liens on the borrower's other assets.

All loans at March 31, 2013 and December 31, 2012 were pledged under a blanket collateral lien to secure actual and potential borrowings from the Federal Home Loan Bank and Federal Reserve.

Non-accrual and Past Due Loans

The Company's non-accrual loans by loan class, as of March 31, 2013 and December 31, 2012 were as follows:

($ in thousands)	March 31, 2013		December 31, 2012

Commercial	$	2,747	$	2,853
Commercial Real Estate		1,840		1,879
Agriculture		—		—
Residential Mortgage		1,940		2,095
Residential Construction		—		—
Consumer		282		441

	$	6,809	$	7,268

Non-accrual loans amounted to $6,809,000 at March 31, 2013 and were comprised of seven residential mortgage loans totaling $1,940,000, four commercial real estate loans totaling $1,840,000, nine commercial loans totaling $2,747,000 and five consumer loans totaling $282,000. Non-accrual loans amounted to $7,268,000 at December 31, 2012 and were comprised of seven residential mortgage loans totaling $2,095,000, five commercial real estate loans totaling $1,879,000, eleven commercial loans totaling $2,853,000 and seven consumer loans totaling $441,000. It is generally the Company's policy to charge-off the portion of any non-accrual loan that the Company does not expect to collect by writing the loan down to the estimated net realizable value of the underlying collateral.

An age analysis of past due loans, segregated by loan class, as of March 31, 2013 and December 31, 2012 is as follows:

($ in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or more Past Due		Total Past Due		Current		Total Loans
March 31, 2013
Commercial	$	159	$	103	$	146	$	408	$	93,845	$	94,253
Commercial Real Estate		345		—		549		894		195,187		196,081
Agriculture		156		—		—		156		39,856		40,012
Residential Mortgage		467		—		347		814		50,946		51,760
Residential Construction		52		—		—		52		7,932		7,984
Consumer		7		—		189		196		57,357		57,553
Total	$	1,186	$	103	$	1,231	$	2,520	$	445,123	$	447,643

December 31, 2012
Commercial	$	2,255	$	—	$	170	$	2,425	$	86,385	$	88,810
Commercial Real Estate		1,272		—		566		1,838		186,588		188,426
Agriculture		—		—		—		—		52,747		52,747
Residential Mortgage		570		103		335		1,008		50,258		51,266
Residential Construction		53		—		—		53		7,533		7,586
Consumer		8		747		126		881		58,512		59,393
Total	$	4,158	$	850	$	1,197	$	6,205	$	442,023	$	448,228

The Company had no loans 90 days or more past due and still accruing at March 31, 2013 and December 31, 2012.

Impaired Loans

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. Loans to be considered for impairment include non-accrual loans, troubled debt restructurings and loans with a risk rating of 6 (substandard) or worse. Once identified, impaired loans are measured individually for impairment using one of three methods: present value of expected cash flows discounted at the loan's effective interest rate; the loan's observable market price; fair value of collateral if the loan is collateral dependent. In general, any portion of the recorded investment in a collateral dependent loan in excess of the fair value of the collateral that can be identified as uncollectible, and is, therefore, deemed a confirmed loss, should be promptly charged-off against the allowance for loan losses.

Impaired loans, segregated by loan class, as of March 31, 2013 and December 31, 2012 were as follows:

($ in thousands)	Unpaid Contractual Principal Balance		Recorded Investment with no Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance
March 31, 2013
Commercial	$	3,732	$	2,678	$	732	$	3,410	$	82
Commercial Real Estate		2,993		1,840		1,153		2,993		22
Agriculture		—		—		—		—		—
Residential Mortgage		5,167		1,940		2,714		4,654		448
Residential Construction		1,141		—		1,091		1,091		370
Consumer		1,162		343		625		968		103
Total	$	14,195	$	6,801	$	6,315	$	13,116	$	1,025

December 31, 2012
Commercial	$	3,628	$	2,769	$	519	$	3,288	$	95
Commercial Real Estate		3,629		1,872		1,170		3,042		26
Agriculture		—		—		—		—		—
Residential Mortgage		5,831		1,860		2,963		4,823		417
Residential Construction		1,148		—		1,097		1,097		433
Consumer		1,416		502		629		1,131		101
Total	$	15,652	$	7,003	$	6,378	$	13,381	$	1,072

Interest income on impaired loans recognized using a cash-basis method of accounting during the three-month periods ended March 31, 2013 and March 2012 was as follows:

($ in thousands)	Three Months Ended March 31, 2013				Three Months Ended March 31, 2012
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Commercial	$	3,531	$	8	$	3,642	$	10
Commercial Real Estate		4,018		22		7,175		23
Agriculture		345		—		1,823		25
Residential Mortgage		4,592		27		4,878		29
Residential Construction		1,115		11		1,318		13
Consumer		1,009		8		622		7
Total	$	14,610	$	76	$	19,458	$	107

None of the interest on impaired loans was recognized using a cash basis of accounting for the three-month periods ended March 31, 2013 and March 31, 2012.

Troubled Debt Restructurings

The Company's loan portfolio includes certain loans that have been modified in a Troubled Debt Restructuring ("TDR"), which are loans on which concessions in terms have been granted because of the borrowers' financial difficulties. These concessions typically result from the Company's loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are placed on non-accrual status at the time of restructure and may only be returned to accruing status after considering the borrower's sustained repayment performance for a reasonable period, generally six months.

When a loan is modified, it is measured based upon the present value of future cash flows discounted at the contractual interest rate of the original loan agreement, or the fair value of collateral less selling costs if the loan is collateral dependent. If the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through a specific allowance or a charge-off of the loan.

The Company had $7,085,000 and $6,905,000 in TDR loans as of March 31, 2013 and December 31, 2012, respectively. Specific reserves for TDR loans totaled $918,000 and $939,000 as of March 31, 2013 and December 31, 2012, respectively. TDR loans performing in compliance with modified terms totaled $6,234,000 and $6,040,000 as of March 31, 2013 and December 31, 2012, respectively. There are no commitments to advance more funds on existing TDR loans as of March 31, 2013.

Loans modified as troubled debt restructurings during the three-month periods ended March 31, 2013 and March 31, 2012 were as follows:

($ in thousands)	Three Months Ended March 31, 2013
	Number of Contracts		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment
Commercial		1	$	244	$	244
Total		1	$	244	$	244

($ in thousands)	Three Months Ended March 31, 2012
	Number of Contracts		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment
Commercial		2	$	220	$	220
Consumer		2		151		151
Total		4	$	371	$	371

The loan modifications generally involved reductions in the interest rate, payment extensions, forgiveness of principal, and forbearance. There were no loans modified as a troubled debt restructuring within the previous 12 months and for which there was a payment default during the three-month period ended March 31, 2013. There was one commercial loan with a recorded investment of $136,000 that was modified as a troubled debt restructuring within the previous 12 months and for which there was a payment default during the three-month period ended March 31, 2012.

Credit Quality Indicators

All new loans are rated using the credit risk ratings and criteria adopted by the Company. Risk ratings are adjusted as future circumstances warrant. All credits risk rated 1, 2, 3 or 4 equate to a Pass as indicated by Federal and State regulatory agencies; a 5 equates to a Special Mention; a 6 equates to Substandard; a 7 equates to Doubtful; and 8 equates to a Loss. For the definitions of each risk rating, see Note 4 to our condensed consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.

The following table presents the risk ratings by loan class as of March 31, 2013 and December 31, 2012.

($ in thousands)	Pass		Special Mention		Substandard		Doubtful		Loss		Total
March 31, 2013
Commercial	$	84,915	$	3,735	$	5,603	$	—	$	—	$	94,253
Commercial Real Estate		177,639		9,225		9,217		—		—		196,081
Agriculture		37,080		152		2,780		—		—		40,012
Residential Mortgage		47,032		1,146		3,582		—		—		51,760
Residential Construction		5,709		2,012		263		—		—		7,984
Consumer		50,831		4,444		2,278		—		—		57,553
Total	$	403,206	$	20,714	$	23,723	$	—	$	—	$	447,643

December 31, 2012
Commercial	$	78,078	$	4,393	$	6,339	$	—	$	—	$	88,810
Commercial Real Estate		170,676		9,049		8,701		—		—		188,426
Agriculture		49,613		172		2,962		—		—		52,747
Residential Mortgage		45,962		604		4,700		—		—		51,266
Residential Construction		5,512		1,212		862		—		—		7,586
Consumer		51,444		4,822		3,054		73		—		59,393
Total	$	401,285	$	20,252	$	26,618	$	73	$	—	$	448,228

Allowance for Loan Losses

The following table details activity in the allowance for loan losses by loan class for the three-month periods ended March 31, 2013 and March 31, 2012.

Three-month period ended March 31, 2013
($ in thousands)	Commercial			Commercial Real Estate		Agriculture			Residential Mortgage			Residential Construction			Consumer			Unallocated		Total
Balance as of December 31, 2012	$	2,899		$	1,723	$	915		$	1,148		$	724		$	1,110		$	35	$	8,554
Provision for loan losses		25			371		(104	)		(97	)		(175	)		(13	)		393		400

Charge-offs		(111	)		—		(1	)		(78	)		—			(58	)		—		(248	)
Recoveries		75			1		3			—			41			20			—		140
Net charge-offs		(36	)		1		2			(78	)		41			(38	)		—		(108	)
Balance as of March 31, 2013		2,888			2,095		813			973			590			1,059			428		8,846
Period-end amount allocated to:
Loans individually evaluated for impairment		82			22		—			448			370			103			—		1,025
Loans collectively evaluated for impairment		2,806			2,073		813			525			220			956			428		7,821
Balance as of March 31, 2013	$	2,888		$	2,095	$	813		$	973		$	590		$	1,059		$	428	$	8,846

Three-month period ended March 31, 2012
($ in thousands)	Commercial			Commercial Real Estate			Agriculture			Residential Mortgage			Residential Construction			Consumer			Unallocated		Total
Balance as of December 31, 2011	$	3,598		$	1,747		$	1,934		$	1,135		$	1,198		$	796		$	—	$	10,408
Provision for loan losses		320			(32	)		(769	)		90			(74	)		781			234		550

Charge-offs		(542	)		—			—			(31	)		—			(264	)		—		(837	)
Recoveries		206			—			2			—			1			27			—		236
Net charge-offs		(336	)		—			2			(31	)		1			(237	)		—		(601	)
Balance as of March 31, 2012		3,582			1,715			1,167			1,194			1,125			1,340			234		10,357
Period-end amount allocated to:
Loans individually evaluated for impairment		368			199			—			636			737			394			—		2,334
Loans collectively evaluated for impairment		3,214			1,516			1,167			558			388			946			234		8,023
Balance as of March 31, 2012	$	3,582		$	1,715		$	1,167		$	1,194		$	1,125		$	1,340		$	234	$	10,357

The following table details activity in the allowance for loan losses and the amount allocated to loans individually and collectively evaluated for impairment as of and for the period ended December 31, 2012.

($ in thousands)	Commercial			Commercial Real Estate			Agriculture			Residential Mortgage			Residential Construction			Consumer			Unallocated		Total
Balance as of December 31, 2011	$	3,598		$	1,747		$	1,934		$	1,135		$	1,198		$	796		$	—	$	10,408
Provision for loan losses		2,493			351			(907	)		877			(648	)		1,075			35		3,276

Charge-offs		(3,498	)		(375	)		(116	)		(864	)		(167	)		(875	)		—		(5,895	)
Recoveries		306			—			4			—			341			114			—		765
Net charge-offs		(3,192	)		(375	)		(112	)		(864	)		174			(761	)		—		(5,130	)
Balance as of December 31, 2012		2,899			1,723			915			1,148			724			1,110			35		8,554
Period-end amount allocated to:
Loans individually evaluated for impairment		95			26			—			417			433			101			—		1,072
Loans collectively evaluated for impairment		2,804			1,697			915			731			291			1,009			35		7,482
Balance as of December 31, 2012	$	2,899		$	1,723		$	915		$	1,148		$	724		$	1,110		$	35	$	8,554

The Company's investment in loans as of March 31, 2013, March 31, 2012, and December 31, 2012 related to each balance in the allowance for loan losses by loan class and disaggregated on the basis of the Company's impairment methodology was as follows:

($ in thousands)	Commercial		Commercial Real Estate		Agriculture		Residential Mortgage		Residential Construction		Consumer		Total
March 31, 2013
Loans individually evaluated for impairment	$	3,410	$	2,993	$	—	$	4,654	$	1,091	$	968	$	13,116
Loans collectively evaluated for impairment		90,843		193,088		40,012		47,106		6,893		56,585		434,527
Ending Balance	$	94,253	$	196,081	$	40,012	$	51,760	$	7,984	$	57,553	$	447,643

March 31, 2012
Loans individually evaluated for impairment	$	3,840	$	4,670	$	1,570	$	3,534	$	1,294	$	942	$	15,850
Loans collectively evaluated for impairment		85,130		172,588		36,443		48,454		6,521		61,863		410,999
Ending Balance	$	88,970	$	177,258	$	38,013	$	51,988	$	7,815	$	62,805	$	426,849

December 31, 2012
Loans individually evaluated for impairment	$	3,288	$	3,042	$	—	$	4,823	$	1,097	$	1,131	$	13,381
Loans collectively evaluated for impairment		85,522		185,384		52,747		46,443		6,489		58,262		434,847
Ending Balance	$	88,810	$	188,426	$	52,747	$	51,266	$	7,586	$	59,393	$	448,228