Loans and Allowance for Loan Losses

General. The Bank provides to its customers a full range of short- to medium-term commercial, agricultural, Small Business Administration guaranteed, mortgage, home equity, and personal loans, both secured and unsecured. The Bank also makes real estate mortgage and construction loans.

The following table presents loans at March 31, 2012 and December 31, 2011 by class:



	March 31,			December 31,
	2012			2011
	(in thousands)
Construction and land development	$	196,991		$	202,803
Commercial real estate:
Owner occupied	339,576			348,931
Non-owner occupied	223,024			242,827
Residential mortgages:
1-4 family	173,263			179,047
Multifamily	36,240			39,881
Home equity lines of credit	196,818			201,220
Commercial	164,601			177,047
Consumer and other	56,309			58,283
Total	1,386,822			1,450,039
Less: Net deferred loan origination fees	1,052			885
Allowance for loan losses	(30,062		)	(32,848		)
Loans, net	$	1,357,812		$	1,418,076

Real Estate Loans. Real estate loans include construction and land development loans, commercial real estate loans, home equity lines of credit, and residential mortgages.

Commercial real estate loans totaled $562.6 million and $591.8 million at March 31, 2012 and December 31, 2011, respectively. This lending has involved loans secured by owner-occupied commercial buildings for office, storage and warehouse space, as well as non-owner occupied commercial buildings. The Bank generally requires the personal guaranty of borrowers and a demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate may be larger in size and may involve a greater degree of risk than one-to-four family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties.

Construction/development lending totaled $197.0 million and $202.8 million at March 31, 2012 and December 31, 2011, respectively. The Bank originates one-to-four family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provides financing to builders and consumers for the construction of pre-sold homes. The Bank generally receives a pre-arranged permanent financing commitment from an outside banking entity prior to financing the construction of pre-sold homes. The Bank also makes commercial real estate construction loans, primarily for owner-occupied properties. The Bank limits its construction lending risk through adherence to established underwriting procedures.

Residential one-to-four family loans amounted to $173.3 million and $179.0 million at March 31, 2012 and December 31, 2011, respectively. The Bank's residential mortgage loans are typically construction loans that convert into permanent financing and are secured by properties located within the Bank's market areas.

During the quarter, the decision was made by management to transfer a pass graded non-owner occupied commercial real estate loan in the amount of $7.6 million from loans held-for-investment to loans held-for-sale. As a result of this transfer, approximately $912,000 was charged-off in order to record the loan at fair value at time of transfer.

Commercial Loans. At March 31, 2012 and December 31, 2011, the Bank's commercial loan portfolio totaled $164.6 million and $177.0 million, respectively. Commercial loans include both secured and unsecured loans for working capital, expansion, and other business purposes. Short-term working capital loans are secured by accounts receivable, inventory and/or equipment. The Bank also makes term commercial loans secured by equipment and real estate. Lending decisions are based on an evaluation of the financial strength, cash flow, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment. Commercial loans generally provide greater yields and reprice more frequently than other types of loans, such as real estate loans.

Loans to Individuals. Loans to individuals (consumer loans) include automobile loans, boat and recreational vehicle financing, and miscellaneous secured and unsecured personal loans and totaled $56.3 million and $58.3 million at March 31, 2012 and December 31, 2011, respectively. Consumer loans generally can carry significantly greater risks than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Bank manages the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.

Loan Approvals. The Bank's loan policies and procedures establish the basic guidelines governing its lending operations. The guidelines address the type of loans that the Bank seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower's total outstanding indebtedness to the Bank, including any indebtedness as a guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan reviews by independent, outside professionals experienced in loan review. Responsibility for loan review and loan underwriting resides with the Chief Credit Officer position. This position is responsible for loan underwriting and approval. On an annual basis, the Board of Directors of the Bank determines officers lending authority. Authorities may include loans, letters of credit, overdrafts, uncollected funds and such other authorities as determined by the Board of Directors.

Substantially all of the Company's loans have been granted to customers in the Piedmont, foothills, northwestern mountains, and the Research Triangle regions of North Carolina and the upstate region of South Carolina.

Credit Review and Evaluation. The Bank has a credit risk review department that reports to the Chief Credit Officer. The focus of the department is on policy compliance and proper grading of higher credit risk loans as well as new and existing loans on a sample basis. Additional reporting for problem/criticized assets has been developed along with an after-the-fact loan review.

The Bank uses a risk grading program to facilitate the evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses for real estate, commercial and consumer loans. In this program, risk grades are initially assigned by loan officers, reviewed by regional credit officers, and reviewed by internal credit review analysts on a test basis. The Bank strives to maintain the loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of the Bank's market area. Every effort is made to identify and minimize the credit risks associated with such lending strategies.

Loans over $20,000 are risk graded on a scale from 1 (highest quality) to 8 (loss). Acceptable loans at inception are grades 1 through 4, and these grades have underwriting requirements that at least meet the minimum requirements of a secondary market source. If borrowers do not meet credit history requirements, other mitigating criteria such as substantial liquidity and low loan-to-value ratios could be considered and would generally have to be met in order to make the loan. The Bank's loan policy states that a guarantor may be necessary if reasonable doubt exists as to the borrower's ability to repay. The Board of Directors has authorized the loan officers to have individual approval authority for risk grade 1 through 4 loans up to maximum exposure limits for each customer. New or renewed loans that are graded 5 (special mention) or lower must have approval from a regional credit officer. Any changes in risk assessments as determined by loan officers, credit administrators, regulatory examiners and management are also considered.

The risk grades, normally assigned by the loan officers when the loan is originated and reviewed by the regional credit officers, are based on several factors including historical data, current economic factors, composition of the portfolio, and evaluations of the total loan portfolio and assessments of credit quality within specific loan types. In some cases the risk grades are assigned by regional executives, depending upon dollar exposure. Because these factors are dynamic, the provision for loan losses can fluctuate. Credit quality reviews are based primarily on analysis of borrowers' cash flows, with asset values considered only as a second source of payment. Regional credit officers work with lenders in underwriting, structuring and risk grading the Bank's credits. The Risk Review Officer focuses on lending policy compliance, credit risk grading, and credit risk reviews on larger dollar exposures. Management uses the information developed from the procedures above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in determining the appropriate levels of the allowance for loan losses.

The following is a summary of the credit risk grade definitions for all loan types:

“1” - Highest Quality- These loans represent a credit extension of the highest quality. The borrower's historic (at least five years) cash flows manifest extremely large and stable margins of coverage. Balance sheets are conservative, well capitalized, and liquid. After considering debt service for proposed and existing debt, projected cash flows continue to be strong and provide ample coverage. The borrower typically reflects broad geographic and product diversification and has access to alternative financial markets.

“2” - Good Quality- These loans have a sound primary and secondary source of repayment. The borrower may have access to alternative sources of financing, but sources are not as widely available as they are to a higher graded borrower. This loan carries a normal level of risk, with minimal loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are satisfactory but vulnerable to more rapid deterioration than the highest quality loans.

“3” - Satisfactory- The borrowers are a reasonable credit risk and demonstrate the ability to repay the debt from normal business operations. Risk factors may include reliability of margins and cash flows, liquidity, dependence on a single product or industry, cyclical trends, depth of management, or limited access to alternative financing sources. Historic financial information may indicate erratic performance, but current trends are positive. Quality of financial information is adequate, but is not as detailed and sophisticated as information found on higher graded loans. If adverse circumstances arise, the impact on the borrower may be significant.

“4” - Satisfactory - Merits Attention- These credit facilities have potential developing weaknesses that deserve extra attention from the account manager and other management personnel. If the developing weakness is not corrected or mitigated, there may be deterioration in the ability of the borrower to repay the bank's debt in the future.

“5” - Watch or Special Mention - These loans are typically existing loans, made using the passing grades outlined above, that have deteriorated to the point that cash flow is not consistently adequate to meet debt service or current debt service coverage is based on projections. Secondary sources of repayment may include specialized collateral or real estate that is not readily marketable or undeveloped, making timely collection in doubt.

“6” - Substandard- Loans and other credit extensions bearing this grade are considered inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These obligations, even if apparently protected by collateral value, have well-defined weaknesses related to adverse financial, managerial, economic, market, or political conditions jeopardizing repayment of principal and interest as originally intended. Clear loss potential, however, does not have to exist in any individual assets classified as substandard.

“7” - Substandard Impaired (also includes any loans over 90 days past due, excluding sold mortgages )- Loans and other credit extensions graded “7” have all the weaknesses inherent in those graded “6,” with the added characteristic that the severity of the weaknesses makes collection or liquidation in full highly questionable or improbable based upon currently existing facts, conditions, and values. The probability of some loss is extremely high, but because of certain important and reasonably specific factors, the amount of loss cannot be determined.

“8” - Loss- Loans in this classification are considered uncollectible and cannot be justified as a viable asset of the bank. Such loans are to be charged-off or charged-down. This classification does not mean the loan has absolutely no recovery value, but that it is neither practical nor desirable to defer writing off this loan even though partial recovery may be obtained in the future.

The following is a summary of credit quality indicators by class at March 31, 2012 and December 31, 2011:



Real Estate Credit Exposure as of March 31, 2012
			Commercial Real Estate
	Construction		Owner occupied		Non-owner occupied		1-4 Family		Multifamily		Home Equity
	(in thousands)
High Quality	$	—	$	124	$	—	$	417	$	—	$	126
Good Quality	517		30		83		1,557		—		7,465
Satisfactory	30,022		104,790		58,706		94,981		8,677		121,573
Merits Attention	89,911		177,958		125,948		55,672		25,494		58,727
Special Mention	42,507		27,088		25,451		9,712		653		4,520
Substandard	6,936		7,875		3,402		3,720		623		1,774
Substandard impaired	27,098		21,711		9,434		7,204		793		2,633
Loss	—		—		—		—		—		—
	$	196,991	$	339,576	$	223,024	$	173,263	$	36,240	$	196,818



Other Credit Exposures as of March 31, 2012
	Commercial		Consumer and other
	(in thousands)
High Quality	$	2,572	$	1,974
Good Quality	5,505		1,321
Satisfactory	45,453		26,033
Merits Attention	78,942		25,268
Special Mention	12,602		1,125
Substandard	9,181		73
Substandard impaired	10,346		515
Loss	—		—
	$	164,601	$	56,309



Real Estate Credit Exposure as of December 31, 2011
			Commercial Real Estate
	Construction		Owner occupied		Non-owner occupied		1-4 Family		Multifamily		Home Equity
	(in thousands)
High Quality	$	—	$	126	$	—	$	423	$	—	$	132
Good Quality	543		32		117		1,701		—		7,545
Satisfactory	30,446		110,051		61,416		98,992		8,789		125,932
Merits Attention	93,974		180,173		134,247		57,310		28,824		58,576
Special Mention	41,739		23,326		24,307		9,112		697		4,807
Substandard	5,054		10,069		11,162		3,586		629		2,006
Substandard impaired	31,047		25,154		11,578		7,923		942		2,222
Loss	—		—		—		—		—		—
	$	202,803	$	348,931	$	242,827	$	179,047	$	39,881	$	201,220



Other Credit Exposures as of December 31, 2011
	Commercial		Consumer and other
	(in thousands)
High Quality	$	2,690	$	1,831
Good Quality	5,472		1,482
Satisfactory	55,309		27,508
Merits Attention	80,064		25,607
Special Mention	12,224		1,189
Substandard	10,367		118
Substandard impaired	10,921		548
Loss	—		—
	$	177,047	$	58,283

Nonaccrual loans and past due loans. Nonperforming assets include loans classified as nonaccrual, foreclosed bank-owned property and loans past due 90 days or more on which interest is still being accrued. It is the general policy of the Bank to stop accruing interest for all classes of loans past due 90 days or when it is apparent that the collection of principal and/or interest is doubtful. In addition, certain restructured loans are placed on nonaccrual status until sufficient evidence of timely payment is obtained. When a loan is placed on nonaccrual status, any interest previously accrued but not collected is reversed against interest income in the current period. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. There were no financing receivables past due over 90 days accruing interest as of March 31, 2012 and December 31, 2011.

Nonperforming loans as of March 31, 2012 totaled $66.1 million, or 4.69% of total loans, compared with $70.4 million, or 4.78% of total loans, as of December 31, 2011. The Bank aggressively pursues the collection and repayment of all loans. Other nonperforming assets, such as repossessed and foreclosed collateral is aggressively liquidated by the Bank's collection department. The total number of loans on nonaccrual status has decreased from 505 to 454 since December 31, 2011.

The following is a breakdown of nonaccrual loans as of March 31, 2012 and December 31, 2011:



	March 31, 2012		December 31, 2011
	(in thousands)
Financing Receivables on Nonaccrual status
Construction	$	23,320	$	26,575
Commercial Real Estate:
Owner occupied	17,055		16,339
Non-owner occupied	7,816		7,634
Mortgages:
1-4 Family first lien	6,245		7,271
Multifamily	793		942
Home Equity lines of credit	2,633		2,222
Commercial	7,782		8,896
Consumer and other	445		475
Total	$	66,089	$	70,354

Past due loans reported in the following table do not include loans granted forbearance terms since payments terms have been modified or extended, although the loans are past due based on original contract terms. All loans with forbearance terms are included and reported as impaired loans.

Loans are considered past due if the required principal and interest income have not been received as of the date such payments were due. The following table presents the Bank's aged analysis of past due loans:



	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans
March 31, 2012	(in thousands)
Construction	$	1,227	$	1,059	$	13,496	$	15,782	$	181,209	$	196,991
Commercial real estate:
Owner occupied	2,304		2,678		3,655		8,637		330,939		339,576
Non-owner occupied	1,354		10		4,820		6,184		216,840		223,024
Commercial	984		1,871		1,549		4,404		160,197		164,601
Mortgages:
Secured 1-4 family- first lien	4,149		867		1,443		6,459		166,804		173,263
Multifamily	10		—		779		789		35,451		36,240
Home equity lines of credit	1,240		462		1,252		2,954		193,864		196,818
Consumer and other	648		280		46		974		55,335		56,309
Total	$	11,916	$	7,227	$	27,040	$	46,183	$	1,340,639	$	1,386,822

December 31, 2011
Construction	$	2,265	$	402	$	15,538	$	18,205	$	184,598	$	202,803
Commercial real estate:
Owner occupied	4,342		1,215		3,727		9,284		339,647		348,931
Non-owner occupied	9,723		86		4,679		14,488		228,339		242,827
Commercial	586		1,432		2,087		4,105		172,942		177,047
Mortgages:
Secured 1-4 family- first lien	3,441		1,049		2,955		7,445		171,602		179,047
Multifamily	277		—		896		1,173		38,708		39,881
Home equity lines of credit	—		634		856		1,490		199,730		201,220
Consumer and other	375		61		128		564		57,719		58,283
Total	$	21,009	$	4,879	$	30,866	$	56,754	$	1,393,285	$	1,450,039

Impaired Loans. Management considers certain loans graded “substandard impaired” (loans graded 7) or “loss” (loans graded 8) to be individually impaired and may consider “substandard” loans (loans graded 6) individually impaired depending on the borrower's payment history. The Bank measures impairment based upon probable cash flows or the value of the collateral. Collateral value is assessed based on collateral value trends, liquidation value trends, and other liquidation expenses to determine logical and credible discounts that may be needed. Updated appraisals are required for all impaired loans and typically at renewal or modification of larger loans if the appraisal is more than 12 months old.

Impaired loans for all classes of loans typically include nonaccrual loans, loans over 90 days past due still accruing, troubled debt restructured loans and other potential problem loans considered impaired based on other underlying factors. Troubled debt restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower's weakened financial condition. Interest on troubled debt restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur and a sustained payment performance period is obtained. Due to the borrowers' inability to make the payments required under the original loan terms, the Bank modifies the terms by granting a longer amortized repayment structure or reduced interest rates. Potential problem loans are loans which are currently performing and are not included in nonaccrual or restructured loans above, but about which we have serious doubts as to the borrower's ability to comply with present repayment terms. These loans are likely to be included later in nonaccrual, past due or troubled debt restructured loans, so they are considered by management in assessing the adequacy of the allowance for loan losses. Impaired loans under $250,000 are typically not individually evaluated for impairment.

The following table presents the Bank's investment in loans considered to be impaired and related information on those impaired loans as of March 31, 2012 and December 31, 2011:



							Quarter to Date
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
March 31, 2012	(in thousands)

Impaired loans without a related allowance for loan losses
Construction	$	24,316	$	34,688	$	—	$	25,801	$	114
Commercial real estate:
Owner occupied	16,720		19,599		—		18,574		286
Non-owner occupied	7,499		9,019		—		13,713		2
Commercial	5,862		5,969		—		5,997		102
Mortgages:
Secured 1-4 family real estate	3,832		4,330		—		3,853		24
Multifamily	730		905		—		692		4
Home equity lines of credit	1,240		1,475		—		1,093		7
Consumer and other	25		27		—		—		—
Impaired loans with a related allowance for loan losses
Construction	$	7	$	104	$	7	$	258	$	—
Commercial real estate:
Owner occupied	8,342		8,475		476		6,563		—
Non-owner occupied	—		—		—		243		—
Commercial	3,316		3,747		2,657		3,122		164
Mortgages:
Secured 1-4 family real estate	555		567		198		257		—
Multifamily	—		—		—		75		7
Home equity lines of credit	119		130		50		190		—
Consumer and other	9		9		9		5		—
Total impaired loans
Construction	$	24,323	$	34,792	$	7	$	26,059	$	114
Commercial real estate:
Owner occupied	25,062		28,074		476		25,137		286
Non-owner occupied	7,499		9,019		—		13,956		2
Commercial	9,178		9,716		2,657		9,119		266
Mortgages:
Secured 1-4 family real estate	4,387		4,897		198		4,110		24
Multifamily	730		905		—		767		11
Home equity lines of credit	1,359		1,605		50		1,283		7
Consumer and other	34		36		9		5		—
Total impaired loans individually reviewed for impairment	$	72,572	$	89,044	$	3,397	$	80,436	$	710



	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(in thousands)
December 31, 2011
Impaired loans without a related allowance for loan losses
Construction	$	28,067	$	40,045	$	—	$	27,010	$	234
Commercial real estate:
Owner occupied	17,586		20,070		—		15,319		272
Non-owner occupied	8,639		11,255		—		8,803		210
Commercial	6,381		6,436		—		4,280		132
Mortgages:
Secured 1-4 family real estate	3,843		4,285		—		3,051		35
Multifamily	295		309		—		302		—
Home equity lines of credit	525		694		—		682		—
Consumer and other	—		—		—		—		—
Impaired loans with a related allowance for loan losses
Construction	$	1,011	$	1,011	$	570	$	7,195	$	50
Commercial real estate:
Owner occupied	6,459		6,533		585		4,044		53
Non-owner occupied	975		1,363		143		3,255		8
Commercial	2,914		2,920		2,511		3,655		92
Mortgages:
Secured 1-4 family real estate	498		517		45		1,473		6
Multifamily	300		319		135		654		—
Home equity lines of credit	403		412		112		100		4
Consumer and other	—		—		—		—		—
Total impaired loans
Construction	$	29,078	$	41,056	$	570	$	34,205	$	284
Commercial real estate:
Owner occupied	24,045		26,603		585		19,363		325
Non-owner occupied	9,614		12,618		143		12,058		218
Commercial	9,295		9,356		2,511		7,935		224
Mortgages:
Secured 1-4 family real estate	4,341		4,802		45		4,524		41
Multifamily	595		628		135		956		—
Home equity lines of credit	928		1,106		112		782		4
Consumer and other	—		—		—		—		—
Total impaired loan individually reviewed for impairment	$	77,896	$	96,169	$	4,101	$	79,823	$	1,096

Impaired loans acquired in business combinations without a related allowance for loan losses includes loans for which no additional reserves have been recorded in excess of credit discounts for purchased impaired loans. Impaired loans acquired with subsequent deterioration and related allowance for loan losses are loans in which additional impairment has been identified in excess of credit discounts resulting in additional reserves. These additional reserves are included in the allowance for loan losses related to purchased impaired loans and were $27,000 and $49,000 as of March 31, 2012 and December 31, 2011, respectively. The following table presents information regarding the change in all purchased impaired loans from the Company's acquisition of American Community on April 17, 2009 through March 31, 2012.



	Contractual
	Principal			Nonaccretable		Carrying
	Receivable			Difference		Amount
	(in thousands)
Balance at December 31, 2010	$	1,655		$	72	$	1,583
Change due to payoff received	(6		)	—		(6		)
Transfer to foreclosed real estate	—			—		—
Change due to charge-offs	—			—		—
Balance at March 31, 2011	$	1,649		$	72	$	1,577

Balance at December 31, 2011	$	474		$	45	$	429
Transfer to foreclosed real estate	(78		)	—		(78		)
Balance at March 31, 2012	$	396		$	45	$	351

At March 31, 2012, the outstanding balance of purchased impaired loans from American Community, which includes principal, interest and fees due, was $351,325. Because of the uncertainty of the expected cash flows, the Company is accounting for each purchased impaired loan under the cost recovery method, in which all cash payments are applied to principal. Thus, there is no accretable yield associated with the above loans.

Troubled Debt Restructured Loans. Total amount of troubled debt restructured loans outstanding as of March 31, 2012 were $38.6 million with related reserves of $2.0 million. Approximately $15.3 million of troubled debt restructured loans are accruing interest as of March 31, 2012, as these loans have sufficient evidence of paying according to the new restructured terms. Total amount of troubled debt restructured loans outstanding as of December 31, 2011 were $43.5 million with related reserves of $2.3 million. Approximately $17.2 million of troubled debt restructured loans are accruing interest as of December 31, 2011, as these loans have sufficient evidence of paying according to the new restructured terms.

The following table includes the recorded investment and number of modifications for troubled debt restructured loans for the quarter ended March 31, 2012. The Company reports the recorded investment in the loans prior to a modification and also the recorded investment in the loans after the loans were restructured. Reductions in the recorded investment are primarily due to the partial charge-off of the principal balance prior to modification.



	Three Months Ended March 31, 2012
	Number of Loans	Recorded Investment Prior to Modification		Recorded Investment After Modification		Adjustment to Reserves as a Result of the Restructuring
	(in thousands)
Extended payment terms
Commercial real estate:
Owner occupied	2	$	666	$	664	$	(28	)
Commercial	5	1,636		1,246		(31		)
1-4 Family Residential	3	827		751		13
Consumer	1	27		24		(5		)
Total	11	$	3,156	$	2,685	$	(51	)
Principal payment reduction
Commercial real estate:
Owner occupied	1	$	171	$	172	$	(7	)
Consumer	1	165		9		9
Total	2	$	336	$	181	$	2

Total	13	$	3,492	$	2,866	$	(49	)

The following table presents loans that were modified as troubled debt restructurings during the previous twelve months and for which there was a payment default during the three months ended March 31, 2012.



	Three months ended March 31, 2012
	Number of loans	Recorded investment
Below Market Rate
Construction	2	$	1,061
Total	2	$	1,061
Extended payment terms
Commercial	1	$	120
Secured 1-4 family mortgages	1	100
Total	2	$	220
Principal payment reduction
Construction	1	$	257
Home equity lines of credit	1	165
Total	2	$	422

Total	6	$	1,703

Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management's best estimate for probable losses that have been incurred within the existing portfolio of loans. The primary risks inherent in the Bank's loan portfolio, including the adequacy of the allowance or reserve for loan losses, are based on management's assumptions regarding, among other factors, general and local economic conditions, which are difficult to predict and are beyond the Bank's control. In estimating these risks, and the related loss reserve levels, management also considers the financial conditions of specific borrowers and credit concentrations with specific borrowers, groups of borrowers, and industries.

The allowance for loan losses is adjusted by direct charges to provision expense. Losses on loans are charged against the allowance for loan losses in the accounting period in which they are determined by management to be uncollectible. Recoveries during the period are credited to the allowance for loan losses. The provision for loan losses was $2.4 million for the quarter ended March 31, 2012 as compared to $4.9 million for the quarter ended March 31, 2011. The provision expense is determined by management with the use of the Bank's allowance for loan losses model. The components of the model are specific reserves for impaired loans and a general allocation for unimpaired loans. The general allocation has two components, an estimate based on historical loss experience and an additional estimate based on internal and external environmental factors due to the uncertainty of historical loss experience in predicting current embedded losses in the portfolio that will be realized in the future.

The portion of the general allocation on environmental factors includes estimates of losses related to interest rate trends, unemployment trends, real estate characteristics, past due and nonaccrual trends, watch list trends, charge-off trends, and underwriting and servicing assessments. Markets served by the Bank continue to experience softening from the general economy and declines in real estate values. The real estate characteristics component includes trends in real estate concentrations, exceptions to FDIC guidelines for loan-to-value ratios, and changes in real estate market values. Other factors impacting the allowance at March 31, 2012 were watch list trends, unemployment rate trends, and underwriting and servicing assessments.

The following table presents changes in the allowance for loan losses for the three months ended March 31, 2012:



	December 31, 2011		Charge-offs		Recoveries		Provision			March 31, 2012
	(Amounts in thousands)
Construction	$	8,214	$	1,828	$	107	$	1,464		$	7,957
Commercial real estate:
Owner occupied	5,792		683		7		218			5,334
Non-owner occupied	4,668		1,312		1		369			3,726
Commercial	5,712		425		85		142			5,514
Mortgages:
Secured 1-4 family- first lien	3,726		375		11		(9		)	3,353
Multifamily	805		202		—		(97		)	506
Home equity lines of credit	3,310		471		10		250			3,099
Consumer and other	621		82		21		13			573
	$	32,848	$	5,378	$	242	$	2,350		$	30,062

	December 31, 2010		Charge-offs		Recoveries		Provision			March 31, 2011
	(Amounts in thousands)
Construction	$	12,014	$	3,778	$	73	$	1,283		$	9,592
Commercial real estate:
Non owner occupied	7,150		977		—		(904		)	5,269
Owner occupied	5,958		739		76		1,939			7,234
Commercial	4,335		218		68		754			4,939
Mortgages:
Secured 1-4 family- first lien	3,706		541		30		1,128			4,323
Multifamily	424		12		—		74			486
Home equity lines of credit	3,298		532		39		339			3,144
Consumer and other	867		284		36		254			873
	$	37,752	$	7,081	$	322	$	4,867		$	35,860



	Reserves for loans individually evaluated for impairment		Loans individually evaluated for impairment		Reserves for loans collectively evaluated for impairment		Loans collectively evaluated for impairment
As of March 31, 2012	(Amounts in thousands)
Construction	$	7	$	24,323	$	7,950	$	172,668
Commercial real estate:
Owner occupied	476		25,062		4,858		314,514
Non-owner occupied	—		7,499		3,726		215,525
Commercial	2,657		9,178		2,857		155,423
Mortgages:
Secured 1-4 family- first lien	198		4,387		3,155		168,876
Multifamily	—		730		506		35,510
Home equity lines of credit	50		1,359		3,049		195,459
Consumer and other	9		34		564		56,275
	$	3,397	$	72,572	$	26,665	$	1,314,250

	Reserves for loans individually evaluated for impairment		Loans individually evaluated for impairment		Reserves for loans collectively evaluated for impairment		Loans collectively evaluated for impairment
As of December 31, 2011	(Amounts in thousands)
Construction	$	570	$	29,078	$	7,644	$	173,725
Commercial real estate:
Owner occupied	585		24,045		5,207		324,886
Non-owner occupied	143		9,614		4,525		233,213
Commercial	2,511		9,295		3,201		167,752
Mortgages:
Secured 1-4 family- first lien	45		4,341		3,681		174,706
Multifamily	135		595		670		39,286
Home equity lines of credit	112		928		3,198		200,292
Consumer and other	—		—		621		58,283
	$	4,101	$	77,896	$	28,747	$	1,372,143

The allowance model is applied to determine the specific allowance balance for impaired loans and the general allowance balance for unimpaired loans grouped by loan type.

The Company's loan charge-off policy for all loan classes is to charge down loans to net realizable value once a portion of the loan is determined to be uncollectable, and the underlying collateral shortfall is assessed. Unsecured loans (primarily consumer loans) are charged off against the reserve once the loan becomes 90 days past due or it is determined that a portion of the loan is uncollectable. Secured loans (primarily construction, real estate, commercial and other loans) are moved to nonaccrual status when the loan becomes 90 days delinquent or a portion of the loan is determined to be uncollectable and supporting collateral is not considered to be sufficient to cover potential losses. Nonaccrual loans are reviewed at least quarterly to determine if all or a portion of the loan is uncollectable. Nonaccrual loans that are determined to be solely collateral dependent are promptly charged down to net realizable value upon determination that they are impaired.

In addition to the allowance for loan losses, the Company also estimates probable losses related to unfunded lending commitments, such as letters of credit, financial guarantees and unfunded loan commitments. Unfunded lending commitments are analyzed and segregated by loan classification. These classifications, in conjunction with an analysis of historical loss experience, current economic conditions, performance trends within specific portfolio segments and any other pertinent information, result in the estimation of the reserve for unfunded lending commitments. The reserve for credit losses related to unfunded lending commitments was $220,000 and $221,000 as of March 31, 2012 and December 31, 2011, respectively.

The Company maintains reserves for mortgage loans sold to agencies and investors in the event that, either through error or disagreement between the parties, the Company is required to indemnify the purchase. The reserves take into consideration risks associated with underwriting, key factors in the mortgage industry, loans with specific reserve requirements, past due loans and potential indemnification by the Company. Reserves are estimated based on consideration of factors in the mortgage industry such as declining collateral values and rising levels of delinquency, default and foreclosure, coupled with increased incidents of quality reviews at all levels of the mortgage industry seeking justification for pushing back losses to loan originators and wholesalers. As of March 31, 2012, the Company had reserves for mortgage loans sold of $1.8 million, and charges against reserves for the three months ended March 31, 2012 were $173,553. For the three months ended March 31, 2012, the Company recorded $108,986 in provision expense related to potential repurchase and warranties exposure on the $65.5 million in loan sales that occurred during that period. For the three months ended March 31, 2011, the Company recorded $14,000 in provision expense related to potential repurchase and warranties exposure and charges against reserves were $32,000. For the quarters ended March 31, 2012 and 2011, the Company did not repurchase any mortgage loans sold. As of December 31, 2011, the Company had reserves for mortgage loans sold of $1.8 million.