6. Loans

The composition of the loan portfolio by segment, excluding loans held for resale, is presented below:



		June 30, 2012				December 31, 2011				June 30, 2011
	Dollar		Percent		Dollar		Percent		Dollar		Percent
	Amount		of Total		Amount		of Total		Amount		of Total
		(In Thousands)
Commercial	$	240,395	36.6	%	$	252,689	39.1	%	$	232,765	36.7	%
Real estate construction		40,922	6.2	%		40,182	6.2	%		47,639	7.5	%
Real estate term		340,530	51.8	%		315,860	48.9	%		314,093	49.5	%
Home equity lines and other consumer		38,260	5.8	%		39,834	6.2	%		42,458	6.7	%
Subtotal	$	660,107			$	648,565			$	636,955
Less: Unearned origination fee,
net of origination costs		(3,257)	(0.5)	%		(3,003)	(0.5)	%		(2,825)	(0.4)	%
Total loans	$	656,850			$	645,562			$	634,130

At June 30, 2012, approximately 19% of the portfolio was scheduled to mature over the next 12 months, and 20% was scheduled to mature between July 1, 2013, and June 30, 2017.

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends in past due and nonaccrual loans, gross and net charge offs, and movement in loan balances within the risk classifications. The Company utilizes a risk grading matrix to assign a risk classification to each of its loans. Loans are graded on a scale of 1 to 8. A description of the general characteristics of the eight risk classifications are as follows:

Risk Code 1 - Excellent: Loans in this grade are those where the borrower has substantial financial capacity, above average profit margins, and excellent liquidity. Cash flow has been consistent and is well in excess of debt servicing requirements. Loans in this grade may be secured by cash and/or negotiable securities having a readily ascertainable market value and may also be fully guaranteed by the U.S. Government, and other approved government and financial institutions. Loans in this grade have borrowers with exceptional credit ratings and would compare to AA ratings as established by Standard & Poor's.

Risk Code 2 – Good: Loans in this grade are those to borrowers who have demonstrated satisfactory asset quality, earnings history, liquidity and other adequate margins of creditor protection. Borrowers exhibit positive fundamentals in terms of working capital, cash flow sufficient to service the debt, and debt to worth ratios. Borrowers for loans in this grade are capable of absorbing normal economic or other setbacks without difficulty. The borrower may exhibit some weaknesses or varying historical profitability. Management is considered adequate in all cases. Borrowing facilities may be unsecured or secured by customary acceptable collateral with well-defined market values. Additional support for the loan is available from secondary repayment sources and/or adequate guarantors.

Risk Code 3 – Satisfactory: Loans in this grade represent moderate credit risk due to some instability in borrower capacity and financial condition. These loans generally require average loan officer attention. Characteristics of assets in this classification may include: marginal debt service coverage, newly established ventures, limited or unstable earnings history, some difficulty in absorbing normal setbacks, and atypical maturities, collateral or other exceptions to established loan policies. In all cases, such weaknesses are offset by well secured collateral positions and/or acceptable guarantors.

Risk Code 4 - Watch List: Loans in this grade are acceptable, but additional attention is needed. This is an interim classification reserved for loans that are intrinsically creditworthy but which require specific attention. Loans may have documentation deficiencies that are deemed correctable, may be contrary to current lending policies, or may have insufficient credit or financial information. Loans in this grade may also be characterized by borrower failure to comply with loan covenants or to provide other required information. If such conditions are not resolved within 90 days from the date of the assignment of Risk Code 4, the loan may warrant further downgrade.

Risk Code 5 - Special Mention: Loans in this grade have had a deterioration of financial condition or collateral value, but are still reasonably secured by collateral or net worth of the borrower. Although the Company is presently protected from loss, potential weaknesses are apparent which, if not corrected, could cause future problems. Loans in this classification warrant more than the ordinary amount of attention but have not yet reached the point of concern for loss. Loans in this category have deteriorated sufficiently that they would have difficulty in refinancing. Loans in this classification may show one or more of the following characteristics: inadequate loan documentation, deteriorating financial condition or control over collateral, economic or market conditions which may adversely impact the borrower in the future, unreliable or insufficient credit or collateral information, adverse trends in operations that are not yet jeopardizing repayment, or adverse trends in secondary repayment sources.

Risk Code 6 – Substandard: Loans in this grade are no longer adequately protected due to declining net worth of the borrower, lack of earning capacity, or insufficient collateral. The possibility for loss of some portion of the loan principal cannot be ruled out. Loans in this grade exhibit well-defined weaknesses that bring normal repayment into doubt. Some of these weaknesses may include: unprofitable or poor earnings trends of the borrower or property, declining liquidity, excessive debt, significant unfavorable industry comparisons, secondary repayment sources are not available, or there is a possibility of a protracted work-out.

Risk Code 7 – Doubtful: Loans in this grade exhibit the same weaknesses as those classified Substandard, but the traits are more pronounced. Collection in full is improbable, however the extent of the loss may be indeterminable due to pending factors which may yet occur that could salvage the loan, such as possible pledge of additional collateral, sale of assets, merger, acquisition or refinancing. Borrowers in this grade may be on the verge of insolvency or bankruptcy, and stringent action is required on the part of the loan officer.

Risk Code 8 – Loss: Loans in this grade are those that are largely non-collectible or those in which ultimate recovery is too distant in the future to warrant continuance as a bankable asset. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer charging the loan off even though recovery may be affected in the future.

A risk rating is assigned for each loan at origination. The risk ratings for commercial, real estate construction, and real estate term loans may change throughout the life of the loan as a multitude of risk factors change. The risk rating for consumer loans may change as loans become delinquent. Delinquent loans are those that are thirty days or more past due.

The loan portfolio, segmented by risk class for the periods indicated, is shown below:



	Commercial		Real estate construction		Real estate term		Home equity lines and other consumer		Total
		(In Thousands)
June 30, 2012
Risk Code 1 - Excellent	$	968	$	-	$	-	$	426	$	1,394
Risk Code 2 - Good		61,999		289		62,521		818		125,627
Risk Code 3 - Satisfactory		159,236		36,769		264,425		34,274		494,704
Risk Code 4 - Watch		6,837		451		1,370		1,909		10,567
Risk Code 5 - Special Mention		8,717		370		3,910		167		13,164
Risk Code 6 - Substandard		2,215		3,043		8,132		666		14,056
Risk Code 7 - Doubtful		423		-		172		-		595
Subtotal	$	240,395	$	40,922	$	340,530	$	38,260	$	660,107
Less: Unearned origination fees, net of origination costs										(3,257)
									$	656,850

December 31, 2011
Risk Code 1 - Excellent	$	540	$	-	$	-	$	575	$	1,115
Risk Code 2 - Good		65,315		-		55,617		849		121,781
Risk Code 3 - Satisfactory		164,767		29,063		247,330		35,914		477,074
Risk Code 4 - Watch		8,033		3,579		1,102		1,497		14,211
Risk Code 5 - Special Mention		9,671		-		3,339		364		13,374
Risk Code 6 - Substandard		3,694		7,540		8,026		635		19,895
Risk Code 7 - Doubtful		669		-		446		-		1,115
Subtotal	$	252,689	$	40,182	$	315,860	$	39,834	$	648,565
Less: Unearned origination fees, net of origination costs										(3,003)
									$	645,562

June 30, 2011
Risk Code 1 - Excellent	$	725	$	-	$	-	$	704	$	1,429
Risk Code 2 - Good		75,285		-		58,182		908		134,375
Risk Code 3 - Satisfactory		131,788		33,918		240,814		37,698		444,218
Risk Code 4 - Watch		8,842		3,431		1,285		2,193		15,751
Risk Code 5 - Special Mention		10,834		-		3,260		496		14,590
Risk Code 6 - Substandard		4,822		10,290		10,552		459		26,123
Risk Code 7 - Doubtful		469		-		-		-		469
Subtotal	$	232,765	$	47,639	$	314,093	$	42,458	$	636,955
Less: Unearned origination fees, net of origination costs										(2,825)
									$	634,130

Loans are carried at their principal amount outstanding, net of charge-offs, unamortized fees and direct loan origination costs. Loan balances are charged to the Allowance for Loan Losses (“Allowance”) when management believes that collection of principal is unlikely. Interest income on loans is accrued and recognized on the principal amount outstanding except for loans in a nonaccrual status. All classes of loans are placed on nonaccrual and considered impaired when management believes doubt exists as to the collectability of the interest or principal. Cash payments received on nonaccrual loans are directly applied to the principal balance. Generally, a loan may be returned to accrual status when the delinquent principal and interest are brought current in accordance with the terms of the loan agreement. Additionally, certain ongoing performance criteria, which generally includes a performance period of six months, must be met in order for a loan to be returned to accrual status. Loans are reported as past due when installment payments, interest payments, or maturity payments are past due based on contractual terms.

Nonaccrual loans totaled $5.9 million, $7.4 million and $9.6 million at June 30, 2012, December 31, 2011, and June 30, 2011, respectively. Nonaccrual loans at the periods indicated, by segment are presented below:



	June 30, 2012		December 31, 2011		June 30, 2011
		(In Thousands)
Commercial	$	2,169	$	3,360	$	4,218
Real estate construction		843		2,355		2,033
Real estate term		2,602		1,477		3,094
Home equity lines and other consumer		308		169		286
Total	$	5,922	$	7,361	$	9,631

Past due loans and nonaccrual loans at the periods indicated are presented below by loan class:



	30-59 Days Past Due Still Accruing		60-89 Days Past Due Still Accruing		Greater Than 90 Days Still Accruing		Nonaccrual		Total Past Due		Current		Total Financing Receivables
		(In Thousands)
June 30, 2012
Risk Code 1 - Excellent	$	-	$	-	$	-	$	-	$	-	$	1,394	$	1,394
Risk Code 2 - Good		-		-		-		-		-		125,627		125,627
Risk Code 3 - Satisfactory		111		-		-		-		111		494,593		494,704
Risk Code 4 - Watch		3,037		-		-		-		3,037		7,530		10,567
Risk Code 5 - Special Mention		-		-		-		148		148		13,016		13,164
Risk Code 6 - Substandard		54		-		91		5,179		5,324		8,732		14,056
Risk Code 7 - Doubtful		-		-		-		595		595		-		595
Subtotal	$	3,202	$	-	$	91	$	5,922	$	9,215	$	650,892	$	660,107
Less: Unearned origination fees, net of origination costs														(3,257)
													$	656,850

December 31, 2011
Risk Code 1 - Excellent	$	-	$	-	$	-	$	-	$	-	$	1,115	$	1,115
Risk Code 2 - Good		-		-		-		-		-		121,781		121,781
Risk Code 3 - Satisfactory		-		-		-		-		-		477,074		477,074
Risk Code 4 - Watch		387		170		-		-		557		13,654		14,211
Risk Code 5 - Special Mention		86		-		-		170		256		13,118		13,374
Risk Code 6 - Substandard		-		21		-		6,076		6,097		13,798		19,895
Risk Code 7 - Doubtful		2		-		-		1,115		1,117		(2)		1,115
Subtotal	$	475	$	191	$	-	$	7,361	$	8,027	$	640,538	$	648,565
Less: Unearned origination fees, net of origination costs														(3,003)
													$	645,562

June 30, 2011
Risk Code 1 - Excellent	$	-	$	-	$	-	$	-	$	-	$	1,429	$	1,429
Risk Code 2 - Good		-		-		-		-		-		134,375		134,375
Risk Code 3 - Satisfactory		-		-		-		-		-		444,218		444,218
Risk Code 4 - Watch		99		22		-		-		121		15,630		15,751
Risk Code 5 - Special Mention		240		443		225		-		908		13,682		14,590
Risk Code 6 - Substandard		1,247		-		-		9,163		10,410		15,713		26,123
Risk Code 7 - Doubtful		-		-		-		468		468		1		469
Subtotal	$	1,586	$	465	$	225	$	9,631	$	11,907	$	625,048	$	636,955
Less: Unearned origination fees, net of origination costs														(2,825)
													$	634,130

The Company considers a loan to be impaired when it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan agreement. Once a loan is determined to be impaired, the impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, except that if the loan is collateral dependent, the impairment is measured by using the fair value of the loan’s collateral. Nonperforming loans greater than $50,000 are individually evaluated for impairment based upon the borrower’s overall financial condition, resources, and payment record, and the prospects for support from any financially responsible guarantors.

At June 30, 2012, December 31, 2011 and June 30, 2011, the recorded investment in loans that are considered to be impaired was $14.2 million, $9.5 million, and $12.7 million, respectively. The following table presents information about impaired loans by class as of the periods indicated:



	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
		(In Thousands)
June 30, 2012
With no related allowance recorded
Commercial - risk code 4 watch	$	192	$	192	$	-	$	260	$	7
Commercial - risk code 5 special mention		294		294		-		285		11
Commercial - risk code 6 substandard		1,559		2,203		-		1,822		6
Commercial - risk code 8 loss		-		224		-		112		-
Real estate construction - risk code 3 satisfactory		2,827		2,827		-		2,900		134
Real estate term - risk code 5 special mention		1,074		1,152		-		1,068		32
Real estate term - risk code 6 substandard		4,035		4,035		-		4,071		163
Home equity lines and other consumer - risk code 4 watch		94		94		-		96		3
Home equity lines and other consumer - risk code 6 substandard		113		113		-		118		4
	$	10,188	$	11,134	$	-	$	10,732	$	360
With an allowance recorded
Commercial - risk code 6 substandard	$	265	$	265	$	141	$	280	$	-
Commercial - risk code 7 doubtful		423		423		401		434		-
Real estate construction - risk code 6 substandard		843		843		263		924		-
Real estate term - risk code 6 substandard		2,078		2,358		61		2,398		-
Real estate term - risk code 7 doubtful		172		446		6		309		-
Home equity lines and other consumer - risk code 6 substandard		227		227		49		228		-
	$	4,008	$	4,562	$	921	$	4,573	$	-
Total
Commercial - risk code 4 watch	$	192	$	192	$	-	$	260	$	7
Commercial - risk code 5 special mention		294		294		-		285		11
Commercial - risk code 6 substandard		1,824		2,468		141		2,102		6
Commercial - risk code 7 doubtful		423		423		401		434		-
Commercial - risk code 8 loss		-		224		-		112		-
Real estate construction - risk code 3 satisfactory		2,827		2,827		-		2,900		134
Real estate construction - risk code 6 substandard		843		843		263		924		-
Real estate term - risk code 5 special mention		1,074		1,152		-		1,068		32
Real estate term - risk code 6 substandard		6,113		6,393		61		6,469		163
Real estate term - risk code 7 doubtful		172		446		6		309		-
Home equity lines and other consumer - risk code 4 watch		94		94		-		96		3
Home equity lines and other consumer - risk code 6 substandard		340		340		49		346		4
	$	14,196	$	15,696	$	921	$	15,305	$	360

December 31, 2011
With no related allowance recorded
Commercial - risk code 5 special mention	$	327	$	327	$	-	$	430	$	23
Commercial - risk code 6 substandard		2,166		2,810		-		2,380		5
Real estate construction - risk code 6 substandard		1,349		1,527		-		1,463		-
Real estate term - risk code 5 special mention		170		248		-		193		-
Real estate term - risk code 6 substandard		2,455		2,545		-		2,371		102
Home equity lines and other consumer - risk code 5 special mention		97		97		-		49		5
Home equity lines and other consumer - risk code 6 substandard		52		52		-		53		-
	$	6,616	$	7,606	$	-	$	6,939	$	135
With an allowance recorded
Commercial - risk code 6 substandard	$	511	$	511	$	44	$	687	$	-
Commercial - risk code 7 doubtful		669		669		576		707		-
Real estate construction - risk code 6 substandard		1,006		1,006		494		1,024		-
Real estate term - risk code 6 substandard		204		204		5		215		-
Real estate term - risk code 7 doubtful		446		446		62		447		-
	$	2,836	$	2,836	$	1,181	$	3,080	$	-
Total
Commercial - risk code 5 special mention	$	327	$	327	$	-	$	430	$	23
Commercial - risk code 6 substandard		2,677		3,321		44		3,067		5
Commercial - risk code 7 doubtful		669		669		576		707		-
Real estate construction - risk code 6 substandard		2,355		2,533		494		2,487		-
Real estate term - risk code 5 special mention		170		248		-		193		-
Real estate term - risk code 6 substandard		2,659		2,749		5		2,586		102
Real estate term - risk code 7 doubtful		446		446		62		447		-
Home equity lines and other consumer - risk code 5 special mention		97		97		-		49		5
Home equity lines and other consumer - risk code 6 substandard		52		52		-		53		-
	$	9,452	$	10,442	$	1,181	$	10,019	$	135

June 30, 2011
With no related allowance recorded
Commercial - risk code 5 special mention	$	3,327	$	3,925	$	-	$	3,423	$	17
Commercial - risk code 6 substandard		552		552		-		596		19
Real estate construction - risk code 6 substandard		1,381		1,460		-		1,407		9
Real estate term - risk code 6 substandard		4,688		4,778		-		4,718		42
Home equity lines and other consumer - risk code 6 substandard		209		209		-		163		2
	$	10,157	$	10,924	$	-	$	10,307	$	89
With an allowance recorded
Commercial - risk code 6 Substandard	$	499	$	499	$	183	$	678	$	-
Commercial - risk code 7 doubtful		465		465		456		475		-
Real estate construction - risk code 6 substandard		1,568		1,613		57		1,573		-
Real estate term - risk code 6 Substandard		-		-		-		-		-
Home equity lines and other consumer - risk code 6 Substandard		-		-		-		-		-
	$	2,532	$	2,577	$	696	$	2,726	$	-
Total
Commercial - risk code 5 special mention	$	3,327	$	3,925	$	-	$	3,423	$	17
Commercial - risk code 6 substandard		1,051		1,051		183		1,274		19
Commercial - risk code 7 doubtful		465	-	465	-	456	-	475	-	-
Real estate construction - risk code 6 substandard		2,949		3,073		57		2,980		9
Real estate term - risk code 6 substandard		4,688		4,778		-		4,718		42
Home equity lines and other consumer - risk code 6 substandard		209		209		-		163		2
	$	12,689	$	13,501	$	696	$	13,033	$	89

The unpaid principal balance included in the table above represents the recorded investment at the dates indicated, plus amounts charged off for book purposes.

Loans classified as troubled debt restructurings totaled $12.1 million, $4.5 million, and $3.7 million at June 30, 2012, December 31, 2011, and June 30, 2011, respectively. A troubled debt restructuring is a loan to a borrower that is experiencing financial difficulty that has been modified from its original terms and conditions in such a way that the Company is granting the borrower a concession of some kind. The Company has granted a variety of concessions to borrowers in the form of loan modifications. The modifications granted can generally be described in the following categories:

Rate Modification: A modification in which the interest rate is changed.

Term Modification: A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Payment Modification: A modification in which the dollar amount of the payment is changed, or in which a loan is converted to interest only payments for a period of time are included in this category.

Combination Modification: Any other type of modification, including the use of multiple categories above.

The following table presents newly restructured loans that occurred during the six months ended June 30, 2012:



		June 30, 2012
	Accrual		Nonaccrual		Total
	Status		Status		Modifications
New Troubled Debt Restructurings		(In Thousands)
Commercial risk code 5 - special mention	$	107	$	-	$	107
Commercial risk code 6 - substandard		85		-		85
Real estate construction risk code 3 - satisfactory		2,827		-		2,827
Real estate construction risk code 6 - substandard				843		843
Real estate term risk code 5 - special mention		397		-		397
Real estate term risk code 6 - substandard		1,886		2,077		3,963
Subtotal	$	5,302	$	2,920	$	8,222

Existing Troubled Debt Restructurings		2,840		1,067		3,907
Total	$	8,142	$	3,987	$	12,129

The following table presents newly restructured loans that occurred during the six months ended June 30, 2012 by concession (terms modified):



			June 30, 2012
	Number	Rate		Term		Payment		Combination		Total
	of Contracts	Modification		Modification		Modification		Modification		Modifications
Pre-Modification Outstanding Recorded Investment:			(In Thousands)
Commercial risk code 5 - special mention	1	$	-	$	108	$	-	$	-	$	108
Commercial risk code 6 - substandard	1		-		86		-		-		86
Real estate construction risk code 3 - satisfactory	1		-		-				2,827		2,827
Real estate construction risk code 6 - substandard	1		-		1,015		-		-		1,015
Real estate term risk code 5 - special mention	1		-		-		-		403		403
Real estate term risk code 6 - substandard	3		-		-		2,589		1,886		4,475
Total	8	$	-	$	1,209	$	2,589	$	5,116	$	8,914

Post-Modification Outstanding Recorded Investment:
Commercial risk code 5 - special mention	1	$	-	$	107	$	-	$	-	$	107
Commercial risk code 6 - substandard	1		-		85		-		-		85
Real estate construction risk code 3 - satisfactory	1		-		-		-		2,827		2,827
Real estate construction risk code 6 - substandard	1		-		843		-		-		843
Real estate term risk code 5 - special mention	1		-		-		-		397		397
Real estate term risk code 6 - substandard	3		-		-		2,077		1,886		3,963
Total	8	$	-	$	1,035	$	2,077	$	5,110	$	8,222

The following table presents TDRs that occurred during the last twelve months that have defaulted in 2012. These loans are past due, and they are nonaccrual loans:



		June 30, 2012		June 30, 2011
	Number	Recorded		Recorded
	of Contracts	Investment		Investment
Troubled Debt Restructurings that Subsequently Defaulted:	(In Thousands)
Commercial risk code 5 - special mention	1	$	192	$	-
Commercial risk code 6 - substandard	2		478		-
Commercial risk code 7 - doubtful	1		216		-
Real estate construction risk code 6 - substandard	1		842		-
Real estate term risk code 6 - substandard	1		881		-
Home equity lines and other consumer risk code 5 - special mention	1		94		-
Total	7	$	2,703	$	-

The Company had no commitments to extend additional credit to borrowers owing receivables whose terms have been modified in troubled debt restructurings. All troubled debt restructurings are also classified as impaired loans and are included in the loans individually evaluated for impairment in the calculation of the Allowance. There were two charge offs totaling $280,000 in the six months ended June 30, 2012 on loans that were later classified as troubled debt restructurings in the real estate term category. Six troubled debt restructurings with a total recorded investment of $3.5 million had a specific impairment amount totaling $815,000 at June 30, 2012.