Note 4 - Loans

The following table summarizes the primary segments of the allowance for loan losses (“ALL”), segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of September 30, 2013. Activity in the allowance is presented for the periods indicated (in thousands):

						Home						Credit
	Commercial			Residential		Equity			Installment			Card		Total
ALL balance 6/30/12	$	2,553		$	419	$	241		$	247		$	20	$	3,480
Charge-offs	(374		)	—		(75		)	(117		)	—		(566		)
Recoveries	1			—		1			1			—		3
Provision	570			14		70			121			—		775
ALL balance 9/30/12	$	2,750		$	433	$	237		$	252		$	20	$	3,692

						Home						Credit
	Commercial			Residential		Equity			Installment			Card		Total
ALL balance 12/31/11	$	2,164		$	366	$	249		$	255		$	11	$	3,045
Charge-offs	(1,290		)	—		(84		)	(123		)	—		(1,497		)
Recoveries	3			—		3			13			—		19
Provision	1,873			67		69			107			9		2,125
ALL balance 9/30/12	$	2,750		$	433	$	237		$	252		$	20	$	3,692
Individually evaluated for impairment	$	503		$	16	$	—		$	7		$	—	$	526
Collectively evaluated for impairment	$	2,247		$	417	$	237		$	245		$	20	$	3,166

							Home				Credit
	Commercial			Residential			Equity		Installment		Card		Total
ALL balance 6/30/13	$	3,740		$	490		$	351	$	231	$	16	$	4,828
Charge-offs	(485		)	(36		)	—		—		—		(521		)
Recoveries	30			24			1		—		—		55
Provision	135			57			96		38		—		326
ALL balance 9/30/13	$	3,420		$	535		$	448	$	269	$	16	$	4,688

							Home				Credit
	Commercial			Residential			Equity		Installment		Card			Total
ALL balance 12/31/12	$	3,107		$	514		$	242	$	200	$	13		$	4,076
Charge-offs	(1,457		)	(38		)	—		—		(11		)	(1,506		)
Recoveries	55			60			9		1		—			125
Provision	1,715			(1		)	197		68		14			1,993
ALL balance 9/30/13	$	3,420		$	535		$	448	$	269	$	16		$	4,688
Individually evaluated for impairment	$	871		$	180		$	—	$	11	$	—		$	1,061
Collectively evaluated for impairment	$	2,549		$	355		$	448	$	258	$	16		$	3,627

The ALL is based on estimates, and actual losses will vary from current estimates. Company and Bank management believe that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

The following table summarizes the primary segments of the Company loan portfolio as of December 31, 2012 (in thousands):

December 31, 2012	Commercial		Residential		Home Equity		Installment		Credit Cards		Total

Total Loans	$	299,639	$	113,212	$	16,800	$	16,174	$	618	$	446,443
Individually evaluated for impairment	$	3,074	$	43	$	0	$	1	$	0	$	3,118
Collectively evaluated for impairment	$	296,565	$	113,169	$	16,800	$	16,173	$	618	$	443,325

The following table summarizes the primary segments of the Company loan portfolio as of September 30, 2013 (in thousands):

September 30, 2013	Commercial		Residential		Home Equity		Installment		Credit Cards		Total

Total Loans	$	352,624	$	124,820	$	25,489	$	18,604	$	609	$	522,146
Individually evaluated for impairment	$	3,539	$	264	$	—	$	20	$	—	$	3,823
Collectively evaluated for impairment	$	349,085	$	124,556	$	25,489	$	18,584	$	609	$	518,323

Of the $3,823 in impaired loans presented above, only $270 were non-performing loans as of September 30, 2013. The remaining $3,553 represents troubled debt restructured loans that are performing under modified terms.

Bank management evaluates individual loans in all of the commercial segments for possible impairment. Loans are considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by Bank management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Bank management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Bank also separately evaluates individual consumer and residential mortgage loans for impairment.

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis, with management primarily utilizing the fair value of collateral method. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis.

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of December 31, 2012 (in thousands):

					Impaired
					Loans with
	Impaired Loans with				No Specific
	Specific Allowance				Allowance		Total Impaired Loans
									Unpaid
	Recorded		Related		Recorded		Recorded		Principal
Dec 31, 2012	Investment		Allowance		Investment		Investment		Balance

Commercial	$	3,074	$	683	$	—	$	3,074	$	3,074
Residential	43		16		—		43		43
Home Equity	—		—		—		—		—
Installment	1		24		—		1		1
Credit Card	—		—		—		—		—
Total impaired loans	$	3,118	$	723	$	—	$	3,118	$	3,118

					Impaired
					Loans with
	Impaired Loans with				No Specific
	Specific Allowance				Allowance		Total Impaired Loans
									Unpaid
	Recorded		Related		Recorded		Recorded		Principal
Sept. 30, 2013	Investment		Allowance		Investment		Investment		Balance

Commercial	$	3,420	$	871	$	119	$	3,539	$	3,641
Residential	264		180		—		264		264
Home Equity	—		—		—		—		—
Installment	20		11		—		20		20
Credit Card	—		—		—		—		—
Total impaired loans	$	3,704	$	1,061	$	119	$	3,823	$	3,925

The following table presents the average recorded investment in impaired loans and related interest income recognized for the periods indicated (in thousands):

	Nine months				Three Months
	September 30				September 30
	2013		2012		2013		2012
Average investment in impaired loans	$	4,578	$	3,681	$	4,241	$	3,397
Interest income recognized on an accrual basis on impaired loans	$	86	$	109	$	33	$	35

Bank management uses a nine point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by Bank management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. The portion of any loan that represents a specific allocation of the allowance for loan losses is placed in the Doubtful category. Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s Chief Credit Officer is responsible for the timely and accurate risk rating of the loans in the portfolio at origination and on an ongoing basis. The Bank’s Credit Department performs an annual review of all commercial relationships $750,000 or greater. Confirmation of the appropriate risk grade is included in the review on an ongoing basis. The Bank has an experienced Credit Department that continually reviews and assesses loans within the portfolio. The Bank engages an external consultant to conduct loan reviews on at least an annual basis. Generally, the external consultant reviews larger commercial relationships or criticized relationships. The Bank’s Credit Department compiles detailed reviews, including plans for resolution, on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table represents the classes of the Company loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk rating system as of December 31, 2012 and September 30, 2013 (in thousands):

			Special
Dec. 31, 2012	Pass		Mention		Substandard		Doubtful		Total

Commercial	$	286,472	$	8,646	$	1,770	$	2,751	$	299,639
Residential	110,663		2,260		289		—		113,212
Home Equity	16,540		260		—		—		16,800
Installment	15,806		354		13		1		16,174
Credit Card	589		29		—		—		618
Total	$	430,070	$	11,549	$	2,072	$	2,752	$	446,443

			Special
September 30, 2013	Pass		Mention		Substandard		Doubtful		Total

Commercial	$	334,137	$	13,335	$	5,152	$	—	$	352,624
Residential	121,789		2,766		265		—		124,820
Home Equity	25,153		336		—		—		25,489
Installment	18,106		479		18		1		18,604
Credit Card	597		12		—		—		609
Total	$	499,782	$	16,928	$	5,435	$	1	$	522,146

Bank management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans as of December 31, 2012 and September 30, 2013 (in thousands):

Dec. 31, 2012	Current		30-59 Days Past Due		60-89 Days Past Due		90 Days Past Due		Total Past Due		Non- Accrual		Total Loans

Commercial	$	295,295	$	767	$	221	$	275	$	1,263	$	3,081	$	299,639
Residential	111,053		1,772		293		51		2,116		43		113,212
Home Equity	16,772		28		—		—		28		—		16,800
Installment	15,991		179		—		3		182		1		16,174
Credit Card	589		24		5		—		29		—		618
Total	$	439,700	$	2,770	$	519	$	329	$	3,618	$	3,125	$	446,443

			30-59		60-89		90
			Days		Days		Days		Total		Non-		Total
Sept. 30, 2013	Current		Past Due		Past Due		Past Due		Past Due		Accrual		Loans

Commercial	$	349,581	$	1,337	$	994	$	472	$	2,803	$	240	$	352,624
Residential	124,154		36		573		28		637		29		124,820
Home Equity	25,433		28		—		28		56		—		25,489
Installment	18,391		130		79		3		212		1		18,604
Credit Card	584		13		—		12		25		—		609
Total	$	518,143	$	1,544	$	1,646	$	543	$	3,733	$	270	$	522,146

The ALL is maintained to absorb losses from the loan portfolio. The ALL is based on the Bank management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

The Bank’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Bank’s ALL.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualified factors.

The classes described above, which are based on the Federal call code assigned to each loan, provide the starting point for the ALL analysis. Company and Bank management track the historical net charge-off activity at the call code level. A historical charge-off factor is calculated utilizing a defined number of consecutive historical quarters. Commercial, Mortgage and Consumer pools currently utilize a rolling 12 quarters.

“Pass” rated credits are segregated from “Criticized” credits for the application of qualitative factors. Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors.

Company and Bank management have identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volume and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint.

Bank management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

Historically, management has utilized an internally developed spreadsheet to track and apply the various components of the allowance.

The following table presents details related to loans identified as Troubled Debt Restructurings (“TDRs”) for the periods indicated (in thousands):

	New TDRs (1)
	For the Nine months Ended					For the Three Months Ended
	September 30, 2013					September 30, 2013
(Unaudited, dollars in thousands)	Number of Contracts	Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Contracts	Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Commercial real estate:	1	$	352	$	250	—	$	—	$	—
Land and construction	2	1,617		1,616		1	280		279
Other	—	—		—		—	—		—
Total commercial real estate	3	1,969		1,866		1	280		279
Commercial and industrial	2	119		119		—	—		—
Residential real estate	—	—		—		—	—		—
Home equity	—	—		—		—	—		—
Consumer	3	8		7		—	—		—
Total	8	$	2,096	$	1,992	1	$	280	$	279

(1) Excludes loans that were either paid off or charged-off by period end. The pre-modification balance represents the balance outstanding at the beginning of the period. The post-modification balance represents the outstanding balance at period end.