LOANS

9 Months Ended

Sep. 30, 2012

Receivables [Abstract]

Loans, Notes, Trade and Other Receivables Disclosure [Text Block]

NOTE G - LOANS

Following is a summary of loans at September 30, 2012 and December 31, 2011:

	2012						2011
				Percent						Percent
	Amount			of total			Amount			of total
	(In thousands)
Real estate loans:
1-to-4 family residential	$	47,076			12.19	%	$	52,182			12.49	%
Commercial real estate		189,598			49.11	%		192,047			45.98	%
Multi-family residential		21,296			5.52	%		23,377			5.60	%
Construction		51,443			13.32	%		70,846			16.96	%
Home equity lines of credit (“HELOC”)		34,988			9.06	%		38,702			9.27	%
Total real estate loans		344,401			89.20	%		377,154			90.30	%
Other loans:
Commercial and industrial		33,175			8.59	%		33,146			7.94	%
Loans to individuals & overdrafts		8,946			2.32	%		7,671			1.84	%
Total other loans		42,121			10.91	%		40,817			9.78	%
Gross loans		386,522						417,971
Less deferred loan origination fees, net		(426	)		(.11	)%		(347	)		(.08	)%
Total loans		386,096			100.00	%		417,624			100.00	%
Allowance for loan losses		(8,588	)					(10,034	)
Total loans, net	$	377,508					$	407,590

Loans are primarily made in southeastern North Carolina. Real estate loans can be affected by the condition of the local real estate market and by the local economic conditions.

At September 30, 2012, the Company had pre-approved but unused lines of credit for customers totaling $55.5 million. In management’s opinion, these commitments, and undisbursed proceeds on loans reflected above, represent no more than normal lending risk to the Company and will be funded from normal sources of liquidity.

A description of the various loan products provided by the Bank is presented below.

1-to-4 Family Residential Loans

Residential 1-to-4 family loans are mortgage loans secured by residential real estate within the Bank’s market areas. These loans may also include loans that convert from construction loans into permanent financing and are secured by properties within the Bank’s market areas.

Commercial Real Estate Loans

Commercial real estate loans are underwritten based on the borrower’s ability to generate adequate cash flow to repay the subject debt within reasonable terms. Commercial real estate loans typically include both owner and non-owner occupied properties with higher principal loan amounts and the repayment of these loans is generally dependent on the successful management of the property. Commercial real estate loans are sensitive to market and general economic conditions. Repayment analysis must be performed and consists of an identified primary/cash flow source of repayment and a secondary/liquidation source of repayment. The primary source of repayment is cash flow from income generated from rental or lease of the property. However, the cash flow can be supplemented with the borrower's and guarantor's global cash flow position. Other credit issues such as the business fundamentals and financial strength of the borrower/guarantor can be considered in determining adequacy of repayment ability. The secondary source of repayment is liquidation of the collateral, supplemented by a liquidation cushion provided by the financial assets of the borrower/guarantor. Management monitors and evaluates commercial real estate loans based on collateral, market area, and risk grade.

Multi-family Residential Loans

Multi-family residential loans are typically non-farm properties with 5 or more dwelling units in structures which include apartment buildings used primarily to accommodate households on a more or less permanent basis. Successful performance of these types of loans is primarily dependant on occupancy rates, rental rates, and property management.

Construction Loans

Construction loans are non-revolving extensions of credit secured by real property of which the proceeds are used to acquire and develop land and to construct commercial or residential buildings. The primary source of repayment for these types of loans is the sale of the improved property or permanent financing in which case the property is expected to generate the cash flow necessary for repayment on a permanent loan basis. Property cash flow may be supplemented with financial support from the borrowers/guarantors. Proper underwriting of a construction loan consists of the initial process of obtaining, analyzing, and approving various aspects of information pertaining to: the analysis of the permanent financing source, creditworthiness of the borrower and guarantors, ability of contractor to perform under the terms of the contract, and the feasibility, marketability, and valuation of the project.

Also much consideration needs to be given to the cost of the project and sources of funds needed to complete construction as well as identifying any sources of equity funding. Construction loans are traditionally considered to be higher risk loans involving technical and legal requirements inherently different from other types of loans; however with thorough credit underwriting, proper loan structure, and diligent loan servicing, these risks can often be mitigated. Some examples of risks inherent in this type of lending include: underestimated costs, inflation of material and labor costs, site difficulties (i.e. rock, soil), project not built to plans, weather delays and natural disasters, borrower/contractor/subcontractor disputes which prompt liens, interest rates increasing beyond budget.

Home Equity Lines of Credit

Home equity lines of credit are consumer-purpose revolving extensions of credit which are secured by first or second liens on owner-occupied residential real estate. Appropriate risk management and compliance practices are exercised to ensure that loan-to-value, lien perfection, and compliance risks are addressed and managed within the Bank’s established guidelines. The degree of utilization of revolving commitments within this loan segment is reviewed periodically to identify changes in the behavior of this borrowing group.

Commercial and Industrial Loans

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to generate positive cash flow, operate profitably and prudently expand its business. Underwriting standards are designed to promote relationships to include a full range of loan, deposit, and cash management services. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower and the guarantors. The cash flows of the borrower, however, may not be as expected and the collateral securing these loans may fluctuate in value. In the case of loans secured by accounts receivable, the availability of funds for repayment can be impacted by the borrower’s ability to collect amounts due from its customers.

Loans to Individuals & Overdrafts

Consumer loans are approved using Bank policies and procedures established to evaluate each credit request. All lending decisions and credit risks are clearly documented. Several factors are considered in making these decisions such as credit score, adjusted net worth, liquidity, debt ratio, disposable income, credit history, and loan-to-value of the collateral. This process combined with the relatively smaller loan amounts spreads the risk among many individual borrowers. Overdrafts on customer accounts are classified as loans for reporting purposes.

The following tables present an age analysis of past due loans, segregated by class of loans as of September 30, 2012 and December 31, 2011, respectively:

	September 30, 2012
	30+		Non-		Total
	Days		Accrual		Past				Total
	Past Due		Loans		Due		Current		Loans
	(In thousands)
Commercial and industrial	$	157	$	240	$	397	$	32,778	$	33,175
Construction		437		2,714		3,151		48,292		51,443
Multi-family residential		-		1,515		1,515		19,781		21,296
Commercial real estate		506		8,424		8,930		180,668		189,598
Loans to individuals & overdrafts		43		101		144		8,802		8,946
1-to-4 family residential		646		1,357		2,003		45,073		47,076
HELOC		30		637		667		34,321		34,988
Deferred loan (fees) cost, net										(426	)
	$	1,819	$	14,988	$	16,807	$	369,715	$	386,096

At September 30, 2012, there was one loan with a balance of $15,000 that was more than 90 days past due and still accruing interest.

	December 31, 2011
	30+		Non-		Total
	Days		Accrual		Past				Total
	Past Due		Loans		Due		Current		Loans
	(In thousands)
Commercial and industrial	$	48	$	171	$	219	$	32,927	$	33,146
Construction		568		4,072		4,640		66,206		70,846
Multi-family residential		1,540		-		1,540		21,837		23,377
Commercial real estate		1,013		10,425		11,438		180,609		192,047
Loans to individuals & overdrafts		10		176		186		7,485		7,671
1-to-4 family residential		735		1,875		2,610		49,572		52,182
HELOC		333		904		1,237		37,465		38,702
Deferred loan (fees) cost, net										(347	)
	$	4,247	$	17,623	$	21,870	$	396,101	$	417,624

At December 31, 2011 there were three loans totaling $108,000 that were 90 days or more past due and still accruing interest.

Impaired Loans

The following tables present information on loans that were considered to be impaired as of September 30, 2012 and December 31, 2011:

							Three months ended				Nine months ended
							September 30, 2012				September 30, 2012
			Contractual						Interest Income				Interest Income
			Unpaid				Average		Recognized on		Average		Recognized on
	Recorded		Principal		Related		Recorded		Impaired		Recorded		Impaired
	Investment		Balance		Allowance		Investment		Loans		Investment		Loans
	(In thousands)
With no related allowance recorded:
Commercial and industrial	$	494	$	785	$	-	$	503	$	4	$	483	$	17
Construction		2,787		3,567		-		2,550		10		2,017		16
Commercial real estate		9,140		10,324		-		11,411		-		10,989		233
Loans to individuals & overdrafts		96		107		-		108		-		153		-
Multi-family residential		1,475		1,475		-		1,492		-		1,516		-
1 to 4 family residential		1,549		1,830		-		1,616		26		1,800		39
HELOC		699		813		-		1,018		-		954		5
Subtotal:		16,240		18,901		-		18,698		40		17,912		310
With an allowance recorded:
Commercial and industrial		209		209		124		108		10		84		10
Construction		274		274		60		733		-		1,631		5
Commercial real estate		4,133		4,616		532		2,492		40		3,165		53
Loans to individuals & overdrafts		28		28		5		22		2		29		2
Multi-family residential		40		40		9		41		-		21		-
1 to 4 family residential		2,195		2,216		328		1,503		63		1,129		87
HELOC		75		75		16		128		-		249		3
Subtotal:		6,954		7,458		1,074		5,027		115		6,308		160
Totals:
Commercial		18,552		21,290		725		19,330		64		19,906		334
Consumer		124		135		5		130		2		182		2
Residential		4,518		4,934		344		4,265		89		4,132		134
Grand Total:	$	23,194	$	26,359	$	1,074	$	23,725	$	155	$	24,220	$	470

							December 31, 2011
			Contractual				Year to Date
			Unpaid				Average		Interest Income
	Recorded		Principal		Related		Recorded		Recognized on
	Investment		Balance		Allowance		Investment		Impaired Loans
	(In thousands)
With no related allowance recorded:
Commercial and industrial	$	478	$	808	$	-	$	290	$	25
Construction		1,011		1,166		-		1,539		23
Commercial real estate		9,195		10,085		-		7,889		158
Loans to individuals & overdrafts		217		234		-		175		4
Multi-family residential		1,540		1,540		-		1,041		102
1-to-4 family residential		2,100		2,930		-		1,746		33
HELOC		730		823		-		406		-
Subtotal:		15,271		17,586		-		13,086		345
With an allowance recorded:
Commercial and industrial		-		-		-		272		-
Construction		3,365		4,085		674		1,269		4
Commercial real estate		5,039		5,929		498		4,043		71
Loans to individuals & overdrafts		16		16		15		102		1
Multi-family residential		-		-		-		-		-
1-to-4 family residential		736		774		170		1,999		35
HELOC		408		435		158		321		10
Subtotal:		9,564		11,239		1,515		8,006		121
Totals:
Commercial		20,628		23,613		1,172		16,343		383
Consumer		233		250		15		277		5
Residential		3,974		4,962		328		4,472		78
Grand Total:	$	24,835	$	28,825	$	1,515	$	21,092	$	466

Loans are placed on non-accrual status when it has been determined that all contractual principal and interest will not be received. Any payments received on these loans are applied to principal first and then to interest only after all principal has been collected. In the case of an impaired loan that is still on accrual basis, payments are applied to both principal and interest.

Troubled Debt Restructurings

The following table presents loans that were modified as troubled debt restructurings (“TDRs”) for which there was a payment default together with a breakdown of the types of concessions made by loan class during the previous twelve months:

	Twelve months ended September 30, 2012
			Pre-		Post-
			Modification		Modification
			Outstanding		Outstanding
	Number		Recorded		Recorded
	of loans		Investment		Investment
	(Dollars in thousands)
Below market interest rate:
Commercial and industrial		-	$	-	$	-
Construction		-		-		-
Commercial real estate		-		-		-
Loans to individuals & overdrafts		-		-		-
1-to-4 family residential		-		-		-
Multi-family residential		-		-		-
HELOC		-		-		-
Total		-		-		-
Extended payment terms:
Commercial and industrial		1		116		114
Construction		-		-		-
Commercial real estate		4		1,281		1,127
Loans to individuals & overdrafts		-		-		-
1-to-4 family residential		3		211		206
Multi-family residential		1		1,524		1,514
HELOC		-		-		-
Total		9		3,132		2,961
Forgiveness of principal:
Commercial and industrial		-		-		-
Construction		-		-		-
Commercial real estate		-		-		-
Loans to individuals & overdrafts		-		-		-
1- to-4 family residential		-		-		-
Multi-family residential		-		-		-
HELOC		-		-		-
Total		-		-		-
Total		9	$	3,132	$	2,961

The following table presents loans that were modified as TDRs with a breakdown of the types of concessions made by loan class during the three months and nine months ended September 30, 2012:

	Three months ended				Nine months ended
	September 30, 2012				September 30, 2012
	Number		Recorded		Number		Recorded
	of loans		investment		of loans		investment
	(Dollars in thousands)
Below market interest rate:
Commercial and industrial		-	$	-		-	$	-
Construction		-		-		-		-
Commercial real estate		-		-		-		-
Loans to individuals & overdrafts		-		-		-		-
1-to-4 family residential		-		-		-		-
Multi-family residential		-		-		-		-
HELOC		-		-		-		-
Total		-		-		-		-
Extended payment terms:
Commercial and industrial		-		-		1		114
Construction		-		-		2		286
Commercial real estate		-		-		4		1,128
Loans to individuals & overdrafts		-		-		-		-
1-to-4 family residential		2		96		2		96
Multi-family residential		1		1,514		1		1,514
HELOC		-		-		-		-
Total		3		1,610		10		3,138
Forgiveness of principal:
Commercial and industrial		-		-		-		-
Construction		-		-		-		-
Commercial real estate		-		-		-		-
Loans to individuals and overdrafts		-		-		-		-
1-to-4 family residential		-		-		-		-
Multi-family residential		-		-		-		-
HELOC		-		-		-		-
Total		-		-		-		-
Other:
Commercial and industrial		-		-		-		-
Construction		-		-		-		-
Commercial real estate		-		-		2		842
Loans to individuals and overdrafts		-		-		-		-
1-to-4 family residential		1		79		5		241
Multi-family residential		-		-		-		-
HELOC		-		-		-		-
Total		1		79		7		1,083
Total		4	$	1,689	$	17	$	4,221

All loans extended to borrowers that are considered TDRs and have characteristics that are not within the normal lending guidelines and practices when extending credit are included in the Other category.

The following table presents the successes and failures of the types of modifications within the previous nine months as of September 30, 2012:

	Paid in full				Paying as restructured				Converted to non-accrual				Foreclosure/Default
	Number		Recorded		Number		Recorded		Number		Recorded		Number		Recorded
	of loans		Investment		of loans		Investment		of loans		Investment		of loans		Investment
	(In thousands)
Below market interest rate		-	$	-		-	$	-		-	$	-		-	$	-
Extended payment terms		-		-		2		286		7		2,577		1		275
Forgiveness of principal		-		-		-		-		-		-		-		-
Other		-		-		7		1,083		-		-		-		-
Total		-	$	-		9	$	1,369		7	$	2,577		1	$	275

At September 30, 2012, the Company had 34 loans with a balance of $9.9 million that were considered to be troubled debt restructurings. Of those TDRs, 18 loans with a balance totaling $3.6 million were still accruing as of September 30, 2012. The remaining 16 TDRs with a balance totaling $6.3 million as of September 30, 2012 were in non-accrual status.

Credit Quality Indicators

As part of the on-going monitoring of the credit quality of the loan portfolio, management utilizes a risk grading matrix to assign a risk grade to each of the Company’s loans. All non-consumer loans are graded on a scale of 1 to 9. A description of the general characteristics of these nine different risk grades is as follows:

· Risk Grade 1 (Superior) - Credits in this category are virtually risk-free and are well-collateralized by cash-equivalent instruments. The repayment program is well-defined and achievable. Repayment sources are numerous. No material documentation deficiencies or exceptions exist.

· Risk Grade 2 (Very Good) - This grade is reserved for loans secured by readily marketable collateral, or loans within guidelines to borrowers with liquid financial statements. A liquid financial statement is a financial statement with substantial liquid assets relative to debts. These loans have excellent sources of repayment, with no significant identifiable risk of collection, and conform in all respects to Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).

· Risk Grade 3 (Good) - These loans have excellent sources of repayment, with no significant identifiable risk of collection. Generally, loans assigned this risk grade will demonstrate the following characteristics: Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).

o Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.

o Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.

· Risk Grade 4 (Acceptable) - This grade is given to acceptable loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this risk grade will demonstrate the following characteristics:

o General conformity to the Bank's policy requirements, product guidelines and underwriting standards, with limited exceptions. Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.

o Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.  

o Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor

· Risk Grade 5 (Acceptable With Care) - This grade is given to acceptable loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.  Loans assigned this grade may demonstrate some or all of the following characteristics:

o Additional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank.  Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.

o Unproven, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time.  Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance.

o Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.

Risk Grade 5-NAC (No Additional Credit) - This grade is given to acceptable loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss. Loans assigned this grade may demonstrate some or all of the following characteristics:

· Loans where adverse economic conditions develop subsequent to the loan origination, that do not jeopardize liquidation of the debt but do substantially increase the level of risk, may also warrant this rating.

· The borrower has experienced negative financial trends on the income statement or the balance sheet, however, the financial conditions have improved, which is evident by the acceptable repayment of the loan over the previous six months.

· The financial information was incomplete, or inadequate, in the past. However, all financial information is now current, and acceptable.

· Previous documentation issues have been corrected, resulting in no additional risk to the Bank.

· Improved detail of underwriting, supporting current and/or future source of repayment.

· Improved collateral position.

· Improved credit position.

o Additional guarantor strength.

o Additional income producing property.

· Risk Grade 6 (Watch List or Special Mention) – Loans in this category can have the following characteristics:

o Loans with underwriting guideline tolerances and/or exceptions and with no mitigating factors.

o Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.

o Loans where adverse economic conditions that develop subsequent to the loan origination that don't jeopardize liquidation of the debt but do substantially increase the level of risk may also warrant this rating.

· Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as Substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans consistently not meeting the repayment schedule should be downgraded to substandard. Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action.

· Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. However, these loans are not yet rated as loss because certain events may occur which would salvage the debt.

· Risk Grade 9 (Loss) - Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though partial recovery may be affected in the future.

Consumer loans are graded on a scale of 1 to 9. A description of the general characteristics of the nine risk grades is as follows:

· Risk Grades 1 – 5 (Pass) – The loans in this category range from loans secured by cash with no risk of principal deterioration (Risk Grade 1) to loans that show signs of weakness in either adequate sources of repayment or collateral but have demonstrated mitigating factors that minimize the risk of delinquency or loss (Risk Grade 5).

· Risk Grade 6 (Watch List or Special Mention) - Watch List or Special Mention loans include the following characteristics:

o Loans within guideline tolerances or with exceptions of any kind that have not been mitigated by other economic or credit factors.

o Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.

o Loans where adverse economic conditions that develop subsequent to the loan origination that don't jeopardize liquidation of the debt but do substantially increase the level of risk may also warrant this rating.

· Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as Substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

· Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. However, these loans are not yet rated as loss because certain events may occur which would salvage the debt.

· Risk Grade 9 (Loss) - Loans classified Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be affected in the future.

The following tables present information on risk ratings of the commercial and consumer loan portfolios, segregated by loan class as of September 30, 2012 and December 31, 2011, respectively:

September 30, 2012
Commercial
Credit
Exposure By	Commercial				Commercial
Internally	and				real		Multi-family
Assigned Grade	industrial		Construction		estate		residential
			(In thousands)
Superior	$	421	$	53	$	-	$	-
Very good		28		3		304		-
Good		6,377		703		14,481		1,670
Acceptable		10,987		5,024		61,276		7,126
Acceptable with care		13,500		38,292		76,193		9,959
Special mention		1,157		4,194		22,039		1,026
Substandard		705		3,174		15,305		1,515
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	33,175	$	51,443	$	189,598	$	21,296

Consumer Credit
Exposure By
Internally	1-to-4 family
Assigned Grade	residential		HELOC
Pass	$	39,842	$	32,702
Special mention		3,175		1,213
Substandard		4,059		1,073
	$	47,076	$	34,988

Consumer Credit
Exposure Based	Loans to
On Payment	individuals &
Activity	overdrafts
Pass	$	8,390
Non –pass		556
	$	8,946

December 31, 2011
Commercial
Credit
Exposure By	Commercial				Commercial
Internally	and				real		Multi-family
Assigned Grade	industrial		Construction		estate		residential
			(In thousands)
Superior	$	722	$	59	$	-	$	-
Very good		154		6		429		-
Good		5,184		2,369		16,510		1,064
Acceptable		8,224		6,685		67,922		12,828
Acceptable with care		15,048		54,087		60,604		7,820
Special mention		3,062		2,671		27,177		125
Substandard		752		4,969		19,405		1,540
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	33,146	$	70,846	$	192,047	$	23,377
Consumer Credit
Exposure By
Internally		1-to-4 family
Assigned Grade		residential		HELOC
Pass	$	43,647	$	35,127
Special mention		2,925		1,391
Substandard		5,610		2,184
	$	52,182	$	38,702
Consumer Credit
Exposure Based		Loans to
On Payment		individuals &
Activity		overdrafts
Pass	$	7,447
Non-pass		224
	$	7,671

Non-performing assets at September 30, 2012 and December 31, 2011 consist of the following:

	September 30, 2012		December 31, 2011
	(In thousands)
Non-accrual loans	$	14,988	$	17,623
Accruing TDRs		3,625		2,013
Total non-performing loans		18,613		19,636
Foreclosed real estate		2,849		3,031
Total non-performing assets	$	21,462	$	22,667

Allowance for Loan Losses

The allowance for loan losses is a reserve established through provisions for loan losses charged to income and represents management’s best estimate of probable loans losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated losses and risk inherent in the loan portfolio. The Company’s allowance for loan loss methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of reserves is designed to account for changes in credit quality as they occur. The provision for loan losses reflect loan quality trends, including the levels of and trends related to past due loans and economic conditions at the local and national levels. It also considers the quality and risk characteristics of the Company’s loan origination and servicing policies and practices.

In determining the loss history to be applied to its ASC 450 loan pools within the allowance for loan losses, the Company has previously used net charge-off history for most recent eight consecutive quarters. For the September 30, 2012 allowance for loan losses, the loss history was expanded to nine consecutive quarters of net charge-offs. Since the most recent quarters have contained a large number of recoveries and thus have a lower loss history than quarters from 2010 and 2011, management determined that the expansion of loss history better reflects the inherent losses in the current loan portfolio. The impact of this adjustment to the allowance for loan losses resulted in a $1.2 million increase to our loan loss reserves as compared to the methodology previously used.

Individual reserves are calculated according to ASC Section 310-10-35 against loans evaluated individually and deemed to most likely be impaired.  All loans in non-accrual status and all substandard loans that are deemed to be collateral dependent are assessed for impairment.

Loans are deemed uncollectible at the discretion of the Chief Credit Officer, based on a variety of credit, collateral, documentation and other issues. In the case of uncollectible receivables, the collateral is considered unsecured and therefore fully charged off.

The following tables present a roll forward of the Company’s allowance for loan losses by loan class for the three month and nine month periods ended September 30, 2012 and September 30, 2011, respectively:

	Three months ended  September 30, 2012
	Commercial									1-to-4						Loans to			Multi-
	and						Commercial			family						individuals &			family
Allowance for loan losses	industrial			Construction			real estate			residential			HELOC			overdrafts			residential		Total
										(In thousands)
Balance, beginning of period 6/30/2012	$	386		$	482		$	5,228		$	1,314		$	897		$	80		$	123	$	8,510
Provision (recovery) for loan losses		31			664			(192	)		(166	)		(150	)		(6	)		8		189
Loans charged-off		(7	)		(187	)		(50	)		(63	)		(83	)		(8	)		-		(398	)
Recoveries		13			3			120			91			51			9			-		287
Balance, end of period 9/30/2012	$	423		$	962		$	5,106		$	1,176		$	715		$	75		$	131	$	8,588
Ending balance: individually evaluated for impairment	$	124		$	60		$	532		$	328		$	16		$	5		$	9	$	1,074
Ending balance: collectively evaluated for impairment	$	299		$	902		$	4,574		$	848		$	699		$	70		$	122	$	7,514
Loans:
Ending balance	$	33,175		$	51,443		$	189,598		$	47,076		$	34,988		$	8,946		$	21,296	$	386,522
Ending balance: individually evaluated for impairment	$	703		$	3,061		$	13,273		$	3,744		$	774		$	124		$	1,515	$	23,194
Ending balance: collectively evaluated for impairment	$	32,472		$	48,382		$	176,325		$	43,332		$	34,214		$	8,822		$	19,781	$	363,328

	Nine months ended September 30, 2012
	Commercial									1-to-4						Loans to			Multi-
	and						Commercial			family						individuals &			family
Allowance for loan losses	industrial			Construction			real estate			residential			HELOC			overdrafts			residential		Total
										(In thousands)
Balance, beginning of period 1/1/2012	$	719		$	1,540		$	4,771		$	1,661		$	1,122		$	94		$	127	$	10,034
Provision (recovery) for loan losses		(2,925	)		(247	)		1,165			(535	)		(16	)		(43	)		4		(2,597	)
Loans charged-off		(58	)		(645	)		(1,031	)		(162	)		(459	)		(62	)		-		(2,417	)
Recoveries		2,687			314			201			212			68			86			-		3,568
Balance, end of period 9/30/2012	$	423		$	962		$	5,106		$	1,176		$	715		$	75		$	131	$	8,588
Ending balance: individually evaluated for impairment	$	124		$	60		$	532		$	328		$	16		$	5		$	9	$	1,074
Ending balance: collectively evaluated for impairment	$	299		$	902		$	4,574		$	848		$	699		$	70		$	122	$	7,514
Loans:
Ending balance	$	33,175		$	51,443		$	189,598		$	47,076		$	34,988		$	8,946		$	21,296	$	386,522
Ending balance: individually evaluated for impairment	$	703		$	3,061		$	13,273		$	3,744		$	774		$	124		$	1,515	$	23,194
Ending balance: collectively evaluated for impairment	$	32,472		$	48,382		$	176,325		$	43,332		$	34,214		$	8,822		$	19,781	$	363,328

During the nine months ended September 30, 2012 the Company recorded recoveries on loans previously charged-off in the amount of $3.6 million. These recoveries were primarily a result of $2.7 million in recoveries on commercial and industrial loans during the nine month period These recoveries combined with the decrease in total loans outstanding at September 30, 2012 resulted in a $2.6 million recovery in the provision for loan losses.

	December 31, 2011
	Commercial						1-to-4				Loans to		Multi-
	and				Commercial		family				individuals &		family
Allowance for loan losses	industrial		Construction		real estate		residential		HELOC		overdrafts		residential		Total
							(In thousands)
Loans:
Ending Balance	$	33,146	$	70,846	$	192,047	$	52,182	$	38,702	$	7,671	$	23,377	$	417,971
Ending Balance: individually evaluated for impairment	$	478	$	4,376	$	14,234	$	2,836	$	1,138	$	233	$	1,540	$	24,835
Ending Balance: collectively evaluated for impairment	$	32,668	$	66,470	$	177,813	$	49,346	$	37,564	$	7,438	$	21,837	$	393,136

	Three Months Ended September 30, 2011
	Commercial									1-to-4						Loans to			Multi-
	and						Commercial			family						individuals &			family
Allowance for loan losses	industrial			Construction			real estate			residential			HELOC			overdrafts			residential			Total
										(In thousands)
Balance, beginning of period 6/30/2011	$	1,052		$	1,172		$	4,502		$	1,892		$	1,450		$	136		$	174		$	10,378
Provision (recovery) for loan losses		(134	)		4			1,068			742			481			55			(22	)		2,194
Other		(5	)		(10	)		(26	)		(13	)		-			(1	)		(4	)		(59	)
Loans charged-off		(186	)		(83	)		(783	)		(695	)		(497	)		(53	)		-			(2,297	)
Recoveries		19			9			34			33			9			18			-			122
Balance, end of period 9/30/2011	$	746		$	1,092		$	4,795		$	1,959		$	1,443		$	155		$	148		$	10,338
Ending balance: individually evaluated for impairment	$	50		$	116		$	440		$	604		$	-		$	70		$	-		$	1,280
Ending balance: collectively evaluated for impairment	$	696		$	976		$	4,355		$	1,355		$	1,443		$	85		$	148		$	9,058
Loans:
Ending balance	$	36,691		$	72,858		$	200,681		$	56,615		$	38,829		$	8,013		$	26,078		$	439,765
Ending balance: individually evaluated for impairment	$	381		$	4,140		$	14,557		$	4,558		$	-		$	251		$	1,543		$	25,430
Ending balance: collectively evaluated for impairment	$	36,310		$	68,718		$	186,124		$	52,057		$	38,829		$	7,762		$	24,535		$	414,335

	Nine months ended September 30, 2011
	Commercial									1-to-4						Loans to			Multi-
	and						Commercial			family						individuals &			family
Allowance for loan losses	industrial			Construction			real estate			residential			HELOC			overdrafts			residential			Total
										(In thousands)
Balance, beginning of period 1/1/2011	$	1,052		$	349		$	3,111		$	1,985		$	1,348		$	1,530		$	640		$	10,015
Provision (recovery) for loan losses		26			1,718			4,201			1,038			712			(1,307	)		(488	)		5,900
Other		(5	)		(10	)		(79	)		(13	)		-			(1	)		(4	)		(112	)
Loans charged-off		(4,066	)		(974	)		(2,482	)		(1,295	)		(631	)		(140	)		-			(9,588	)
Recoveries		3,739			9			44			244			14			73			-			4,123
Balance, end of period 9/30/2011	$	746		$	1,092		$	4,795		$	1,959		$	1,443		$	155		$	148		$	10,338
Ending balance: individually evaluated for impairment	$	50		$	116		$	440		$	604		$	-		$	70		$	-		$	1,280
Ending balance: collectively evaluated for impairment	$	696		$	976		$	4,355		$	1,355		$	1,443		$	85		$	148		$	9,058
Loans:
Ending balance	$	36,691		$	72,858		$	200,681		$	56,615		$	38,829		$	8,013		$	26,078		$	439,765
Ending balance: individually evaluated for impairment	$	381		$	4,140		$	14,557		$	4,558		$	-		$	251		$	1,543		$	25,430
Ending balance: collectively evaluated for impairment	$	36,310		$	68,718		$	186,124		$	52,057		$	38,829		$	7,762		$	24,535		$	414,335