NOTE 7 – Allowance for Loan Losses and Impaired Assets

Analysis and Determination of the Allowance for Loan Losses. We maintain an allowance for loan losses to absorb probable losses inherent in the existing portfolio. When a loan, or portion thereof, is considered uncollectible and reasonably estimable, it is charged against the allowance. Recoveries of amounts previously charged-off are added to the allowance when collected. The adequacy of the allowance for loan losses is evaluated on a regular basis by management. Based on management's judgment, the allowance for loan losses covers all known losses and inherent losses in the loan portfolio.

Our methodology for assessing the appropriateness of the allowance for loan losses consists of specific allowances for identified problem loans and a general valuation allowance on the remainder of the loan portfolio. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available for the entire portfolio.

Specific Allowances for Identified Problem Loans. We establish an allowance on identified problem loans based on factors including, but not limited to: (1) the borrower's ability to repay the loan; (2) the type and value of the collateral; (3) the strength of our collateral position; and (4) the borrower's repayment history.

General Valuation Allowance on the Remainder of the Portfolio. We also establish a general allowance by applying loss factors to the remainder of the loan portfolio to capture the inherent losses associated with the lending activity. This general valuation allowance is determined by segregating the loans by loan category and assigning loss factors to each category. The loss factors are determined based on our historical loss experience, delinquency trends and management's evaluation of the collectability of the loan portfolio. Based on management's judgment, we may adjust the loss factors due to: (1) changes in lending policies and procedures; (2) changes in existing general economic and business conditions affecting our primary market area; (3) credit quality trends; (4) collateral value; (5) loan volumes and concentrations; (6) seasoning of the loan portfolio; (7) recent loss experience in particular segments of the portfolio; (8) duration of the current business cycle; and (9) bank regulatory examination results. Loss factors are re-evaluated quarterly to ensure their relevance in the current real estate environment.

Activity in the allowance for loan losses is summarized below:


					Home
					Equity			Commercial			Consumer			Commercial
		Residential			Loans			Real Estate			Loans			Loans			Total
		(In thousands)
Balance March 31, 2012	$	789		$	127		$	2,794		$	64		$	1,923		$	5,697
Provision		143			87			(186	)		(8	)		324			360
Charge Offs		(143	)		(71	)		(44	)		--			(24	)		(282	)
Recoveries		28			--			--			3			9			40
Balance June 30, 2012	$	817		$	143		$	2,564		$	59		$	2,232		$	5,815

Balance March 31, 2011	$	738		$	154		$	1,981		$	99		$	2,714		$	5,686
Provision		7			4			179			(3	)		172			359
Charge Offs		(170	)		0			(191	)		(9	)		(87	)		(457	)
Recoveries		0			0			0			6			3			9
Balance June 30, 2011	$	575		$	158		$	1,969		$	93		$	2,802		$	5,597

The following table presents the balance in the allowance for loan losses by portfolio segment and based on impairment evaluation method as of June 30, 2012:


		Individually		Collectively
		Evaluated for		Evaluated for
		Impairment		Impairment		Total
	(In thousands)
Allowance for loan losses:
1-4 Family Residential	$	358	$	459	$	817
Home equity loans		--		143		143
Commercial real estate		861		1,703		2,564
Consumer loans		--		59		59
Commercial loans		834		1,398		2,232
Total allowance for loan losses	$	2,053	$	3,762	$	5,815

Loan balances:
1-4 Family Residential	$	2,152	$	119,064	$	121,216
Home equity loans		--		36,078		36,078
Commercial real estate		3,665		295,701		299,366
Consumer loans		--		9,639		9,639
Commercial loans		2,530		95,465		97,995
Total loan balances	$	8,347	$	555,947	$	564,294

The following table presents the balance in the allowance for loan losses by portfolio segment and based on impairment evaluation method as of March 31, 2012:


		Individually		Collectively
		Evaluated for		Evaluated for
		Impairment		Impairment		Total
	(In thousands)
Allowance for loan losses:
1-4 Family Residential	$	15	$	774	$	789
Home equity loans		--		127		127
Commercial real estate		207		2,587		2,794
Consumer loans		--		64		64
Commercial loans		372		1,551		1,923
Total allowance for loan losses	$	594	$	5,103	$	5,697

Loan balances:
1-4 Family Residential	$	1,247	$	124,389	$	125,636
Home equity loans		--		37,724		37,724
Commercial real estate		9,961		279,096		289,057
Consumer loans		--		9,772		9,772
Commercial loans		4,103		90,565		94,668
Total loan balances	$	15,311	$	541,546	$	556,857

There have been no significant changes in the Company's methodology for evaluating the allowance for loan losses.

Risk Characteristics by Portfolio Segment. Loans secured by one- to four-family residential real estate have historically been the least risky loan type. However they are affected by declines in the general residential housing market, unemployment and under-employment, and the tightening of lending requirements and standards. Loans secured by commercial real estate, including multi-family loans, generally have larger balances and involve a greater degree of risk than one- to four-family residential mortgage loans. Of primary concern in commercial real estate lending is the borrower's creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy. Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property's value at completion of construction and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the building. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a building having a value which is insufficient to assure full repayment. Commercial loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value. Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower's continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

Credit Risk Management. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans.

When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status. We make initial contact with the borrower when the loan becomes 15 days past due. If payment is not received by the 30^thday of delinquency, additional letters and phone calls generally are made. Typically, when the loan becomes 60 days past due, we send a letter notifying the borrower that we may commence legal proceedings if the loan is not paid in full within 30 days. Generally, loan workout arrangements are made with the borrower at this time; however, if an arrangement cannot be structured before the loan becomes 90 days past due, we will send a formal demand letter and, once the time period specified in that letter expires, commence legal proceedings against any real property that secures the loan or attempt to repossess any business assets or personal property that secures the loan. If a foreclosure action is instituted and the loan is not brought current, paid in full or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure.

We consider repossessed assets and loans that are 90 days or more past due to be non-performing assets. Past due status is based on contractual terms of the loan. When a loan becomes 90 days delinquent, the loan is placed on non-accrual status at which time the accrual of interest ceases and an allowance for any uncollectible accrued interest is established and charged against operations. Typically, payments received on a non-accrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Management informs the Boards of Directors monthly of the amount of loans delinquent more than 90 days, all loans in foreclosure and all foreclosed and repossessed property that we own.

Banking regulations require us to review and classify our assets on a regular basis. In addition, the Connecticut Department of Banking and FDIC have the authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. "Substandard assets" must have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. "Doubtful assets" have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable and there is a high possibility of loss. An asset classified "loss" is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations also provide for a "special mention" category, described as assets that do not currently expose us to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving our close attention. When we classify an asset as substandard or doubtful, we establish a specific allowance for loan losses. If we classify an asset as loss, we charge off an amount equal to 100% of the portion of the asset classified as loss.

The following table shows the risk rating grade of the loan portfolio broken-out by type as of June 30, 2012. There were no loans rated doubtful or loss as of June 30, 2012.


				Real Estate Loans
		Residential		Home Equity		Commercial		Consumer		Commercial		Total
	(In thousands)
Grade:
Pass	$	--	$	--	$	281,999	$	---	$	89,671	$	371,670
Special mention		--		--		6,681		--		1,481		8,162
Substandard		4,700		219		10,686		48		6,843		22,496
Not formally rated		116,516		35,859		--		9,591		--		161,966
Total	$	121,216	$	36,078	$	299,366	$	9,639	$	97,995	$	564,294

The following table shows the risk rating grade of the loan portfolio broken-out by type as of March 31, 2012. There were no loans rated doubtful or loss as of March 31, 2012.


	Real Estate Loans
		Residential		Home Equity		Commercial		Consumer		Commercial		Total
						(In thousands)
Grade:
Pass	$	--	$	--	$	266,757	$	---	$	86,360	$	353,117
Special mention		--		--		7,896	-	--		1,356		9,252
Substandard		4,285		310		14,404		32		6,952		25,983
Not formally rated		121,351		37,414		--		9,740		--		168,505
Total	$	125,636	$	37,724	$	289,057	$	9,772	$	94,668	$	556,857

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 the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. 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. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

The following table shows the Company's impaired loans at June 30, 2012 and for the three months ended June 30, 2012.


				Unpaid				Average		Interest
		Recorded		Principal		Related Allowance		Recorded		Income
		Investment		Balance				Investment		Recognized
	(In thousands)
With no related allowance recorded:
Residential real estate:
1-4 family	$	2,654	$	3,206	$	---	$	1,795	$	25
Home equity loans		218		219		--		109		2
Commercial real estate		6,240		7,418		--		7,375		60
Consumer loans		48		52		--		24		--
Commercial loans		3,431		4,344		--		3,323		25
Total impaired with no related
allowance recorded	$	12,591	$	15,239	$	---	$	12,626	$	112

With an allowance recorded:
Residential real estate:
1-4 family	$	2,152	$	2,215	$	358	$	1,232	$	21
Home equity loans		--		--		--		--		--
Commercial real estate		3,665		3,665		861		2,558		54
Consumer loans		--		--		--		--		--
Commercial loans		2,530		2,530		834		1,709		29
Total impaired with an
allowance recorded	$	8,347	$	8,410	$	2,053	$	5,499	$	104

Total:
Residential real estate:
1-4 family	$	4,806	$	5,421	$	358	$	3,027	$	46
Home equity loans		218		219	-	--		109		2
Commercial real estate		9,905		11,083		861		9,933		114
Consumer loans		48		52	-	--		24	-	-
Commercial loans		5,961		6,874		834		5,032		54
Total impaired loans	$	20,938	$	23,649	$	2,053	$	18,125	$	216

The following table shows the Company's impaired loans at March 31, 2012.


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Residential real estate:
1-4 family	$ 936	$ 973		$ ---		$ 1,843		$ 44
Home equity loans	---	---		---		184		---
Commercial real estate	8,510	8,590		---		5,458		501
Consumer loans	---	---		---		44		---
Commercial loans	3,214	3,967		---		2,482		162
Total impaired with no related allowance recorded	$ 12,660	$ 13,530		$ ---		$ 10,011		$ 707

With an allowance recorded:
Residential real estate:
1-4 family	$ 311	$ 389		$ 15		$ 1,470		$ 20
Home equity loans	---	---		---		---		---
Commercial real estate	1,451	1,482		207		3,792		72
Consumer loans	---	---		---		50		---
Commercial loans	889	913		372		2,156		45
Total impaired with an allowance recorded	$ 2,651	$ 2,784		$ 594		$ 7,468		$ 137

Total:
Residential real estate:
1-4 family	$ 1,247	$ 1,362		$ 15		$ 3,313		$ 64
Home equity loans	---	---		---		184		---
Commercial real estate	9,961	10,072		207		9,250		573
Consumer loans	---	---		---		94		---
Commercial loans	4,103	4,880		372		4,638		207
Total impaired loans	$ 15,311	$ 16,314		$ 594		$ 17,479		$ 844

Delinquencies. The following table provides information about delinquencies in our loan portfolio as of June 30, 2012.


				Greater		Greater				90 Days
		30-59		Than 60-89		Than		Total		or More and		Nonaccrual
		Days		Days		90 Days		Past Due		Accruing		loans
	(In thousands)

Residential real estate:
1-4 family	$	--	$	380	$	1,684	$	2,064	$	--	$	3,391
Home equity loans		38		--		50		88		--		219
Commercial real estate		1,401		1,070		5,810		8,281		--		7,318
Consumer loans		80		--		17		97		--		48
Commercial loans		1,767		626		3,112		5,505		--		3,906
Total	$	3,286	$	2,076	$	10,673	$	16,035	$	--	$	14,882

The following table provides information about delinquencies in our loan portfolio as of March 31, 2012.


				Greater						90 Days
				Than		Greater				or More
		30-59		60-89		Than		Total		and		Nonaccrual
		Days		Days		90 Days		Past Due		Accruing		loans
	(Dollars in Thousands)

Residential real estate	$	2,771	$	--	$	2,217	$	4,988	$	--	$	3,734
Commercial real estate		1,702		1,152		4,976		7,830		--		7,141
Home equity loans		112		154		84		350		--		170
Consumer loans		100		49		47		196		--		56
Commercial loans		1,641		154		3,545		5,340		--		4,072
Total	$	6,326	$	1,509	$	10,869	$	18,704	$	--	$	15,173

Troubled Debt Restructuring. The Bank did not restructure any troubled debt during the quarter ended June 30, 2012.