2. LOANS

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

($ in thousands)	March 31, 2014			December 31, 2013

Commercial	$	112,778		$	110,644
Commercial Real Estate		243,945			235,296
Agriculture		40,926			51,730
Residential Mortgage		52,755			52,809
Residential Construction		9,387			10,444
Consumer		52,780			54,079

		512,571			515,002
Allowance for loan losses		(8,646	)		(9,353	)
Net deferred origination fees and costs		1,165			1,201

Loans, net	$	505,090		$	506,850

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.

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.

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.

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, including drought conditions such as those affecting California in early 2014. 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.

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.

Residential 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.

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, 2014, approximately 48% in principal amount of the Company’s loans were secured by commercial real estate, which consists primarily of construction and land development loans and loans secured by commercial properties. Approximately 10% in principal amount of the Company’s loans were residential mortgage loans. Approximately 2% in principal amount of the Company’s loans were residential construction loans. Approximately 8% in principal amount of the Company’s loans were for agriculture and 22% in principal amount of the Company’s loans were for general commercial uses including professional, retail and small businesses. Approximately 10% in principal amount 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 consider the loan to be collateral dependent and 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.

At March 31, 2014 and December 31, 2013, all loans were pledged under a blanket collateral lien to secure actual and potential borrowings from the Federal Home Loan Bank and the Federal Reserve Bank.

Non-accrual and Past Due Loans

The Company’s non-accrual loans by loan class, as of March 31, 2014 and December 31, 2013 were as follows:

($ in thousands)	March 31, 2014		December 31, 2013

Commercial	$	3,895	$	2,609
Commercial Real Estate		2,578		2,607
Agriculture		1,029		1,590
Residential Mortgage		2,123		2,166
Residential Construction		87		93
Consumer		564		505

	$	10,276	$	9,570

Non-accrual loans amounted to $10,276,000 at March 31, 2014 and were comprised of seven residential mortgage loans totaling $2,123,000, two residential construction loans totaling $87,000, nine commercial real estate loans totaling $2,578,000, three agricultural loans totaling $1,029,000, ten commercial loans totaling $3,895,000 and seven consumer loans totaling $564,000. Non-accrual loans amounted to $9,570,000 at December 31, 2013 and were comprised of seven residential mortgage loans totaling $2,166,000, two residential construction loans totaling $93,000, nine commercial real estate loans totaling $2,607,000, three agricultural loans totaling $1,590,000, nine commercial loans totaling $2,609,000 and five consumer loans totaling $505,000. 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, 2014 and December 31, 2013 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, 2014
Commercial	$	430	$	1,997	$	530	$	2,957	$	109,821	$	112,778
Commercial Real Estate		1,085		—		1,019		2,104		241,841		243,945
Agriculture		—		476		—		476		40,450		40,926
Residential Mortgage		685		—		99		784		51,971		52,755
Residential Construction		121		—		—		121		9,266		9,387
Consumer		460		27		35		522		52,258		52,780
Total	$	2,781	$	2,500	$	1,683	$	6,964	$	505,607	$	512,571

December 31, 2013
Commercial	$	200	$	96	$	269	$	565	$	110,079	$	110,644
Commercial Real Estate		49		341		531		921		234,375		235,296
Agriculture		—		—		—		—		51,730		51,730
Residential Mortgage		207		—		99		306		52,503		52,809
Residential Construction		40		8		—		48		10,396		10,444
Consumer		26		—		23		49		54,030		54,079
Total	$	522	$	445	$	922	$	1,889	$	513,113	$	515,002

The Company had one loan with a balance of $200,000 that was 90 days or more past due and still accruing at March 31, 2014. The Company had no loans 90 days or more past due and still accruing at December 31, 2013.

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; and their 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, is promptly charged-off against the allowance for loan losses.

Impaired loans, segregated by loan class, as of March 31, 2014 and December 31, 2013 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, 2014
Commercial	$	5,230	$	3,887	$	615	$	4,502	$	54
Commercial Real Estate		3,710		2,578		1,114		3,692		56
Agriculture		1,029		1,029		—		1,029		—
Residential Mortgage		6,343		2,123		3,271		5,394		693
Residential Construction		1,103		87		844		931		118
Consumer		2,242		1,144		530		1,674		19
Total	$	19,657	$	10,848	$	6,374	$	17,222	$	940

December 31, 2013
Commercial	$	5,794	$	5,010	$	656	$	5,666	$	83
Commercial Real Estate		3,746		2,607		1,122		3,729		63
Agriculture		1,878		1,591		—		1,591		—
Residential Mortgage		6,524		2,166		3,409		5,575		701
Residential Construction		1,115		94		849		943		254
Consumer		1,621		563		690		1,253		24
Total	$	20,678	$	12,031	$	6,726	$	18,757	$	1,125

The average recorded investment in impaired loans and the amount of interest income recognized on impaired loans during the three-month periods ended March 31, 2014 and March 31, 2013 was as follows:

($ in thousands)	Three Months Ended March 31, 2014				Three Months Ended March 31, 2013
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Commercial	$	4,210	$	9	$	3,531	$	8
Commercial Real Estate		3,526		19		4,018		22
Agriculture		655		—		345		—
Residential Mortgage		5,640		32		4,592		27
Residential Construction		949		10		1,115		11
Consumer		1,180		14		1,009		8
Total	$	16,160	$	84	$	14,610	$	76

None of the interest on impaired loans was recognized using a cash basis of accounting for the three-month periods ended March 31, 2014 and March 31, 2013.

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 and, as a result, the Company receives less than the current market based compensation for the loan. These concessions may 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 $10,118,000 and $9,929,000 in TDR loans as of March 31, 2014 and December 31, 2013, respectively. Specific reserves for TDR loans totaled $922,000 and $1,096,000 as of March 31, 2014 and December 31, 2013, respectively. TDR loans performing in compliance with modified terms totaled $6,946,000 and $6,750,000 as of March 31, 2014 and December 31, 2013, respectively. There are no commitments to advance more funds on existing TDR loans as of March 31, 2014.

Loans modified as troubled debt restructurings during the three-month periods ended March 31, 2014 and March 31, 2013 were as follows:

($ in thousands)	Three Months Ended March 31, 2014
	Number of Contracts		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment
Consumer		2	$	498	$	498
Total		2	$	498	$	498

($ 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

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 periods ended March 31, 2014 and March 31, 2013.

Credit Quality Indicators

All 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, 2013.

The following table presents the risk ratings by loan class as of March 31, 2014 and December 31, 2013.

($ in thousands)	Pass		Special Mention		Substandard		Doubtful		Loss		Total
March 31, 2014
Commercial	$	102,066	$	2,250	$	8,462	$	—	$	—	$	112,778
Commercial Real Estate		228,475		5,079		10,391		—		—		243,945
Agriculture		39,897		—		1,029		—		—		40,926
Residential Mortgage		49,058		—		3,697		—		—		52,755
Residential Construction		8,593		667		127		—		—		9,387
Consumer		47,162		2,497		3,121		—		—		52,780
Total	$	475,251	$	10,493	$	26,827	$	—	$	—	$	512,571

December 31, 2013
Commercial	$	98,755	$	2,762	$	9,127	$	—	$	—	$	110,644
Commercial Real Estate		218,884		5,978		10,434		—		—		235,296
Agriculture		50,139		—		1,591		—		—		51,730
Residential Mortgage		48,519		539		3,751		—		—		52,809
Residential Construction		7,823		1,167		1,454		—		—		10,444
Consumer		48,903		2,585		2,591		—		—		54,079
Total	$	473,023	$	13,031	$	28,948	$	—	$	—	$	515,002

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, 2014 and March 31, 2013.

Three-month period ended March 31, 2014
($ in thousands)	Commercial			Commercial Real Estate			Agriculture			Residential Mortgage			Residential Construction			Consumer			Unallocated			Total
Balance as of December 31, 2013	$	3,199		$	2,290		$	557		$	1,216		$	441		$	1,023		$	627		$	9,353
Provision for (reversal of) loan losses		1,133			(140	)		(118	)		(43	)		(185	)		203			(250	)		600

Charge-offs		(1,062	)		—			—			—			—			(302	)		—			(1,364	)
Recoveries		12			—			—			—			2			43			—			57
Net charge-offs		(1,050	)		—			—			—			2			(259	)		—			(1,307	)
Balance as of March 31, 2014	$	3,282		$	2,150		$	439		$	1,173		$	258		$	967		$	377		$	8,646
Period-end amount allocated to:
Loans individually evaluated for impairment		54			56			—			693			118			19			—			940
Loans collectively evaluated for impairment		3,228			2,094			439			480			140			948			377			7,706
Balance as of March 31, 2014	$	3,282		$	2,150		$	439		$	1,173		$	258		$	967		$	377		$	8,846

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 (reversal of) 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

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, 2013.

Year ended December 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 (reversal of) loan losses		91			533			(360	)		244			(201	)		301			592		1,200

Charge-offs		(168	)		(17	)		(1	)		(333	)		(127	)		(572	)		—		(1,218	)
Recoveries		377			51			3			157			45			184			—		817
Net charge-offs		209			34			2			(176	)		(82	)		(388	)		—		(401	)
Ending Balance		3,199			2,290			557			1,216			441			1,023			627		9,353
Period-end amount allocated to:
Loans individually evaluated for impairment		83			63			—			701			254			24			—		1,125
Loans collectively evaluated for impairment		3,116			2,227			557			515			187			999			627		8,228
Balance as of December 31, 2013	$	3,199		$	2,290		$	557		$	1,216		$	441		$	1,023		$	627	$	9,353

The Company’s investment in loans as of March 31, 2014, March 31, 2013, and December 31, 2013 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, 2014
Loans individually evaluated for impairment	$	4,502	$	3,692	$	1,029	$	5,394	$	931	$	1,674	$	17,222
Loans collectively evaluated for impairment		108,276		240,253		39,897		47,361		8,456		51,106		495,349
Ending Balance	$	112,778	$	243,945	$	40,926	$	52,755	$	9,387	$	52,780	$	512,571

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

December 31, 2013
Loans individually evaluated for impairment	$	5,666	$	3,729	$	1,591	$	5,575	$	943	$	1,253	$	18,757
Loans collectively evaluated for impairment		104,978		231,567		50,139		47,234		9,501		52,826		496,245
Ending Balance	$	110,644	$	235,296	$	51,730	$	52,809	$	10,444	$	54,079	$	515,002