Note 4. Allowance for Loan Losses

The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's quarterly evaluation of the collectability of the loan portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. To determine the total allowance for loan losses, the Company estimates the reserves needed for each segment of the portfolio, including loans analyzed individually and loans analyzed on a pooled basis. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows.

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Company has segmented certain loans in the portfolio by product type. Within these segments, the Company has sub-segmented its portfolio by classes within the segments, based on the associated risks within these classes.

Loan Classes by Segments
Commercial loan segment:
	Commercial and industrial loans

Real estate construction and land loan segment:
	Residential construction loans
	Other construction and land loans

Real estate mortgage loan segment:
	1-4 family mortgages
	Home equity lines of credit
	Multifamily mortgages
	Commercial owner occupied real estate
	Commercial non-owner occupied real estate

Consumer loan segment:
	Consumer revolving credit
	Consumer all other credit

Based on the internal risk ratings assigned to each credit, a historical loss factor is assigned to the balances for each class of loans, using a cumulative historical loss rate for the most recent twelve quarters. The Company's internal creditworthiness grading system is based on experiences with similarly graded loans. Higher risk-rated credits are reviewed quarterly by experienced senior lenders based on each borrower's situation. Additionally, internal monitoring and review of credits is conducted on an annual basis and sixty percent of the loan portfolio is reviewed by an external loan review group.

Loans that trend upward on the risk ratings scale, toward more positive risk ratings, generally exhibit lower risk factor characteristics. Conversely, loans that migrate toward more negative ratings generally will result in a higher risk factor being applied to those related loan balances.

Risk Ratings And Historical Loss Factor Applied

Excellent

0% applied, as these loans are secured by cash and represent a minimal risk. The Company has never experienced a loss within this category.

Good

0% applied, as these loans are secured by marketable securities within margin and represent a low risk. The Company has never experienced a loss within this category.

Pass

Historical loss factor for loans rated "pass" is applied to current balances of like-rated loans, pooled by class. Loans with the following risk ratings are pooled by class and considered together as "pass":

Satisfactory - modest risk loans where the borrower has strong and liquid financial statements and more than adequate cash flow
Average - average risk loans where the borrower has reasonable debt service capacity
Marginal - acceptable risk loans where the borrower has acceptable financial statements but is leveraged
Watch - acceptable risk loans which require more attention than normal servicing

Special Mention

These potential problem loans are currently protected but are potentially weak. Historical loss factor for loans rated "special mention" is applied to current balances of like-rated loans pooled by class.

Substandard

These problem loans are inadequately protected by the sound worth and paying capacity of the borrower and/or the value of any collateral pledged. These loans may be considered impaired and evaluated on an individual basis. Otherwise, an historical loss factor for loans rated "substandard" is applied to current balances of all other "substandard" loans pooled by class.

Doubtful

Loans with this rating have significant deterioration in the sound worth and paying capacity of the borrower and/or the value of any collateral pledged, making collection or liquidation of the loan in full highly questionable. These loans would be considered impaired and evaluated on an individual basis.

The following represents the loan portfolio designated by the internal risk ratings assigned to each credit as of March 31, 2014 and December 31, 2013.

Internal Risk Rating Grades							Special		Sub-
as of March 31, 2014	Excellent		Good		Pass		Mention		standard		Doubtful		TOTAL
(dollars in thousands)
Commercial loans	$	3,905	$	21,250	$	23,574	$	5	$	707	$	-	$	49,441
Real estate construction
Residential construction		-		-		937		-		-		-		937
Other construction and land		-		-		17,442		525		101		-		18,068
Real estate mortgages
1-4 family mortgages		-		1,928		50,414		416		817		-		53,575
Home equity lines of credit		-		-		28,252		-		242		-		28,494
Multifamily mortgages		-		-		18,961		-		-		-		18,961
Commercial owner occupied		-		-		54,613		-		2,264		-		56,877
Commercial nonowner occupied		-		-		50,818		562		801		-		52,181
Consumer loans
Consumer revolving credit		-		1,523		511		-		8		-		2,042
Consumer all other credit		385		8,943		2,101		-		53		-		11,482
Total Loans	$	4,290	$	33,644	$	247,623	$	1,508	$	4,993	$	-	$	292,058

Internal Risk Rating Grades							Special		Sub-
as of December 31, 2013	Excellent		Good		Pass		Mention		standard		Doubtful		TOTAL
(dollars in thousands)
Commercial loans	$	4,056	$	19,464	$	24,015	$	5	$	520	$	-	$	48,060
Real estate construction
Residential construction		-		-		794		-		-		-		794
Other construction and land		-		-		17,031		530		106		-		17,667
Real estate mortgages
1-4 family mortgages		-		1,934		50,945		593		828		-		54,300
Home equity lines of credit		-		-		29,367		-		245		-		29,612
Multifamily mortgages		-		-		22,560		-		-		-		22,560
Commercial owner occupied		-		-		56,668		-		2,134		-		58,802
Commercial nonowner occupied		-		-		51,884		567		2,184		-		54,635
Consumer loans
Consumer revolving credit		-		1,926		319		-		9		-		2,254
Consumer all other credit		371		8,772		2,153		-		54		-		11,350
Total Loans	$	4,427	$	32,096	$	255,736	$	1,695	$	6,080	$	-	$	300,034

In addition to the historical factors, the adequacy of the Company's allowance for loan losses is evaluated through reference to eight qualitative factors, listed below and ranked in order of importance:

1)		Changes in national and local economic conditions, including the condition of various market segments
2)		Changes in the value of underlying collateral
3)		Changes in volume of classified assets, measured as a percentage of capital
4)		Changes in volume of delinquent loans
5)		The existence and effect of any concentrations of credit and changes in the level of such concentrations
6)		Changes in lending policies and procedures, including underwriting standards
7)		Changes in the experience, ability and depth of lending management and staff
8)		Changes in the level of policy exceptions

It has been the Company's experience that the first four factors drive losses to a much greater extent than the last four factors; therefore, the first four factors are weighted more heavily. Although the markets served by the Company remain stronger than the national economy as a whole, management continues to pay close attention on a case-by-case basis for any yet unforeseen potential ripple effects of the housing downturn and the related financial market fallout.

Like the historical factors, qualitative factors are not assessed against loans rated "excellent" or rated "good," since these are fully collateralized by cash or readily marketable securities.

For each segment and class of loans, management must exercise significant judgment to determine the estimation method that fits the credit risk characteristics of its various segments. Although this evaluation is inherently subjective, qualified management utilizes its significant knowledge and experience related to both the market and history of the Company's loan losses.

Impaired loans are individually evaluated and, if deemed appropriate, a specific allocation is made for these loans. In reviewing the nine loans in the amount of $1,839,000 classified as impaired loans at March 31, 2014, there was no specific valuation allowance on any of these loans after consideration was given for each borrowing as to the fair value of the collateral on the loan or the present value of expected future cash flows from the customer.

Allowance for Credit Losses Rollforward by Portfolio Segment
For the period ended March 31, 2014
(dollars in thousands)	Commercial			Real Estate		Real Estate			Consumer
	Loans			Construction		Mortgages			Loans			Unallocated			Total
Allowance for Credit Losses:
Balance as of January 1, 2014	$	340		$	198	$	2,807		$	34		$	(19	)	$	3,360
Charge-offs		-			-		(2	)		-			-			(2	)
Recoveries		6			-		1			8			-			15

Provision for (recovery of) loan losses		(29	)		7		9			(6	)		19			-
Ending Balance	$	317		$	205	$	2,815		$	36		$	-		$	3,373

Ending Balance:
Individually evaluated for impairment	$	-		$	-	$	-		$	-		$	-		$	-
Collectively evaluated for impairment		317			205		2,815			36			-			3,373

Financing Receivables:
Ending Balance:
Individually evaluated for impairment	$	-		$	102	$	1,737		$	-		$	-		$	1,839
Collectively evaluated for impairment		49,441			18,903		208,351			13,524			-			290,219
	$	49,441		$	19,005	$	210,088		$	13,524		$	-		$	292,058

Allowance for Credit Losses Rollforward by Portfolio Segment
For the year ended December 31, 2013
(dollars in thousands)	Commercial			Real Estate		Real Estate			Consumer
	Loans			Construction		Mortgages			Loans			Unallocated			Total
Allowance for Credit Losses:
Balance as of January 1, 2013	$	303		$	168	$	2,750		$	46		$	-		$	3,267
Charge-offs		(22	)		-		(139	)		-			-			(161	)
Recoveries		22			-		48			24			-			94

Provision for (recovery of) loan losses		37			30		148			(36	)		(19	)		160
Ending Balance	$	340		$	198	$	2,807		$	34		$	(19	)	$	3,360

Ending Balance:
Individually evaluated for impairment	$	-		$	-	$	-		$	-		$	-		$	-
Collectively evaluated for impairment		340			198		2,807			34			(19	)		3,360

Financing Receivables:
Ending Balance:
Individually evaluated for impairment	$	-		$	77	$	1,659		$	-		$	-		$	1,736
Collectively evaluated for impairment		48,060			18,384		218,250			13,604			-			298,298
	$	48,060		$	18,461	$	219,909		$	13,604		$	-		$	300,034

As previously mentioned, one of the major factors that the Company uses in evaluating the adequacy of its allowance for loan losses is changes in the volume of delinquent loans. Management monitors payment activity on a regular basis. For all classes of loans, the Company considers the entire balance of the loan to be contractually delinquent if the minimum payment is not received by the due date. Interest and fees continue to accrue on past due loans until they are changed to non-accrual status.

The following tables show the aging of past due loans as of March 31, 2014 and December 31, 2013. Also included are loans that are 90 or more days past due but still accruing, because they are well secured and in the process of collection.

Past Due Aging as of													90 Days
March 31, 2014	30-59		60-89		90 Days or								Past Due
(dollars in thousands)	Days Past		Days Past		More Past		Total Past				Total		and Still
	Due		Due		Due		Due		Current		Loans		Accruing
Commercial loans	$	50	$	9	$	-	$	59	$	49,382	$	49,441	$	-
Real estate construction
Residential construction		-		-		-		-		937		937		-
Other construction and land		60		-		138		198		17,870		18,068		-
Real estate mortgages
1-4 family mortgages		452		59		147		658		52,917		53,575		-
Home equity lines of credit		155		-		35		190		28,304		28,494		-
Multifamily mortgages		-		-		-		-		18,961		18,961		-
Commercial owner occupied		-		-		-		-		56,877		56,877		-
Commercial non owner occupied		-		-		-		-		52,181		52,181		-
Consumer loans
Consumer revolving credit		-		-		-		-		2,042		2,042		-
Consumer all other credit		2		-		-		2		11,480		11,482		-
Total Loans	$	719	$	68	$	320	$	1,107	$	290,951	$	292,058	$	-

Past Due Aging as of													90 Days
December 31, 2013	30-59		60-89		90 Days or								Past Due
(dollars in thousands)	Days Past		Days Past		More Past		Total Past				Total		and Still
	Due		Due		Due		Due		Current		Loans		Accruing
Commercial loans	$	123	$	35	$	-	$	158	$	47,902	$	48,060	$	-
Real estate construction
Residential construction		-		-		-		-		794		794		-
Other construction and land		34		-		29		63		17,604		17,667		29
Real estate mortgages
1-4 family mortgages		60		26		149		235		54,065		54,300		149
Home equity lines of credit		-		-		-		-		29,612		29,612		-
Multifamily mortgages		-		-		-		-		22,560		22,560		-
Commercial owner occupied		-		-		-		-		58,802		58,802		-
Commercial non owner occupied		-		139		91		230		54,405		54,635		-
Consumer loans
Consumer revolving credit		-		-		-		-		2,254		2,254		-
Consumer all other credit		93		30		-		123		11,227		11,350		-
Total Loans	$	310	$	230	$	269	$	809	$	299,225	$	300,034	$	178