Loans and Allowance For Loan Losses

6 Months Ended

Jun. 30, 2011

Loans and Allowance For Loan Losses [Abstract]

LOANS AND ALLOWANCE FOR LOAN LOSSES

NOTE 5. LOANS AND ALLOWANCE FOR LOAN LOSSES

Outstanding loan balances consist of the following at June 30, 2011 and December 31, 2010:

(Dollars in thousands)	June 30, 2011		December 31, 2010
Commercial	$	140,610	$	130,579
Real estate — construction loans		26,357		41,327
Real estate — commercial (investor)		218,535		215,697
Real estate — commercial (owner occupied)		68,327		68,055
Real estate — 1-4 family ITIN loans		67,675		70,585
Real estate — 1-4 family mortgage		22,116		19,299
Real estate — equity lines		46,850		48,178
Consumer		5,271		6,775
Other		91		301
Total gross loans	$	595,832	$	600,796
Less:
Deferred loan fees, net		51		90
Allowance for loan losses		13,363		12,841
Total net loans	$	582,418	$	587,865

Gross loan balances in the table above include net premiums of $199 thousand and $168 thousand for the periods ending June 30, 2011 and December 31, 2010, respectively.

Age analysis of past due loans, segregated by class of loans, as of June 30, 2011 and December 31, 2010 were as follows:

													Recorded
	30-59		60-89		Greater								Investment >
	Days Past		Days Past		Than 90		Total Past						90 Days and
(Dollars in thousands)	Due		Due		Days		Due		Current		Total		Accruing
June 30, 2011
Commercial	$	163	$	—	$	414	$	577	$	140,033	$	140,610	$	—
Commercial real estate:
Construction		1,874		—		26		1,900		24,457		26,357		—
Other		13,839		377		—		14,216		272,646		286,862		—
Residential:
1-4 family		5,646		1,004		7,486		14,136		75,655		89,791		953
Home equities		755		744		—		1,499		45,351		46,850		—
Consumer		—		—		—		—		5,362		5,362		—
Total	$	22,277	$	2,125	$	7,926	$	32,328	$	563,504	$	595,832	$	953
December 31, 2010
Commercial	$	1,625	$	—	$	677	$	2,302	$	128,277	$	130,579	$	—
Commercial real estate:
Construction		342		—		—		342		40,985		41,327		—
Other		5,168		—		2,520		7,688		276,064		283,752		—
Residential:
1-4 family		7,857		2,404		6,720		16,981		53,604		70,585		—
Home equities		450		—		—		450		67,027		67,477		—
Consumer		19		—		—		19		7,057		7,076		—
Total	$	15,461	$	2,404	$	9,917	$	27,782	$	573,014	$	600,796	$	—

The Company’s practice is to place an asset on nonaccrual status when one of the following events occur: (1) any installment of principal or interest is 90 days or more past due (unless in management’s opinion the loan is well-secured and in the process of collection), (2) management determines the ultimate collection of principal or interest to be unlikely or, (3) the terms of the loan have been renegotiated due to a serious weakening of the borrower’s financial condition. Nonperforming loans may be on nonaccrual, 90 days past due and still accruing, or have been restructured. Accruals are resumed on loans only when they are brought fully current with respect to interest and principal and when the loan is estimated to be fully collectible. Restructured loans are those loans on which concessions in terms have been granted because of the borrower’s financial or legal difficulties. Interest is generally accrued on such loans in accordance with the new terms, after a period of sustained performance by the borrower.

One exception to the 90 days past due policy for nonaccruals is the Company’s pool of home equity loans and lines purchased from a private equity firm. The purchase of this pool of loans included a put option allowing the bank to sell a portion of the loan pool back to the private equity firm in the event of default by the borrower. At 90 days past due a loan in this pool will be sold back to the private equity firm for the outstanding principal balance, unless a workout plan has been put in place with the borrower. Once this put reserve is exhausted, the bank will charge off any loans that become 90 days past due. Management believes that charging the loan off at the time it becomes impaired is more conservative than placing it on nonaccrual status.

Pursuant to Company policy, payments received on loans that are on nonaccrual status are applied to principal until such time the loan is reclassified to accrual status. It is the Company’s policy to resume the accrual of interest on any loan on nonaccrual status when, at a minimum, six consecutive payments of the original or modified contractual terms has occurred, and it is more likely than not that contractual or modified payment amounts will continue into the foreseeable future. Had nonaccrual loans performed in accordance with their contractual terms, the Company would have recognized additional interest income, net of tax, of approximately $120 thousand and $108 thousand for the three months ended June 30, 2011 and 2010, respectively. The Company would have recognized additional interest income, net of tax, of approximately $218 thousand and $154 thousand during the six months ended June 30, 2011 and 2010, respectively.

Nonaccrual loans, segregated by loan class, were as follows:

(Dollars in thousands)	June 30, 2011		December 31, 2010
Commercial	$	901	$	2,302
Commercial real estate:
Construction		1,999		342
Other		3,282		7,066
Residential:
1-4 family		12,741		10,704
Home equities		—		97
Consumer		—		—
Total	$	18,923	$	20,511

The Company considers and defines a loan as impaired when, based on current information and events, it is probable that the Company will be unable to collect all interest and principal payments due according to the contractual terms of the loan agreement. Management assesses all loans, either individually or in aggregate (homogenous retail credits), that meet the Company’s definition of impairment. Management classifies all troubled debt restructures (TDRs) as impaired. The Company generally applies all cash payments received on impaired loans towards the reduction of outstanding principal.

Pursuant to Company policy, interest income is recognized on TDRs with certain terms. When determining whether to accrue interest on a TDR, the following criteria is applied on a loan-by-loan basis:

• An impairment assessment has been completed on the TDR loan, as prescribed by ASC 310, and no impairment has been identified,

• the borrower has not been delinquent 90 or more days prior to the loan modification date, and

• it is more likely than not that the modified payment amounts will continue into the foreseeable future.

Under the circumstances when a TDR is delinquent 90 or more days at the date of the modification, it is the Company’s policy to maintain the TDR on nonaccrual status. Pursuant to such status, all cash payments received are applied to principal until such time the TDR borrower has made a minimum of six consecutive payments in conformance with the modified contractual terms, and it is more likely than not that the borrower’s modified payment amounts will continue into the foreseeable future.

The following table summarizes our impaired loans by loan class as of June 30, 2011 and December 31, 2010:

(Dollars in thousands)	As of June 30, 2011
	Recorded		Unpaid Principal		Related
	Investment		Balance		Allowance
With no related allowance recorded:
Commercial	$	414	$	1,153	$	—
Commercial real estate:
Construction		1,874		2,949		—
Other		3,083		4,808		—
Residential:
1-4 family		1,672		3,089		—
Home equities		—		—		—
Total with no related allowance recorded	$	7,043	$	11,999	$	—
With an allowance recorded:
Commercial	$	487	$	496	$	414
Commercial real estate:
Construction		233		395		75
Other		17,503		17,508		712
Residential:
1-4 family		17,638		18,944		2,235
Home equities		968		968		97
Total with an allowance recorded	$	36,829	$	38,311	$	3,533
Subtotal:
Commercial	$	901	$	1,649	$	414
Commercial real estate	$	22,693	$	25,660	$	787
Residential	$	20,278	$	23,001	$	2,332
Total	$	43,872	$	50,310	$	3,533

(Dollars in thousands)	As of December 31, 2010
	Recorded		Unpaid Principal		Related
	Investment		Balance		Allowance
With no related allowance recorded:
Commercial	$	120	$	120	$	—
Commercial real estate:
Construction		718		947		—
Other		9,527		12,421		—
Residential:
1-4 family		8,067		9,745		—
Home equities		97		105		—
Total with no related allowance recorded	$	18,529	$	23,338	$	—
With an allowance recorded:
Commercial	$	2,182	$	5,028	$	449
Commercial real estate:
Construction		2,428		3,347		139
Other		1,160		3,022		111
Residential:
1-4 family		8,716		9,298		599
Home equities		901		901		90
Total with an allowance recorded	$	15,387	$	21,596	$	1,388
Subtotal:
Commercial	$	2,302	$	5,148	$	449
Commercial real estate	$	13,833	$	19,737	$	250
Residential	$	17,781	$	20,049	$	689
Total	$	33,916	$	44,934	$	1,388

The following table summarizes our average recorded investment and interest income recognized on impaired loans by loan class for the three and six months ended June 30, 2011 and 2010:

	Three Months Ended				Six Months Ended				Three Months Ended				Six Months Ended
(Dollars in thousands)	June 30, 2011				June 30, 2011				June 30, 2010				June 30, 2010
	Average		Interest		Average		Interest		Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income		Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized		Investment		Recognized		Investment		Recognized
Commercial	$	1,554	$	—	$	2,066	$	1	$	1,808	$	5	$	1,185	$	8
Commercial real estate:
Construction		898		1		654		2		4,764		30		4,118		48
Other		16,907		107		13,868		164		11,130		25		10,309		60
Residential:
1-4 family		18,284		49		17,730		101		10,400		46		8,219		79
Home equities		1,151		18		1,297		43		295		—		247		—
Total	$	38,794	$	175	$	35,615	$	311	$	28,397	$	106	$	24,078	$	195

The foundation or primary factor in determining the appropriate credit quality indicators is the degree of a debtor’s willingness and ability to perform as agreed. The Company defines a performing loan as a loan where any installment of principal or interest is not 90 days or more past due, and management believes the ultimate collection of principal and interest is likely. The Company defines a nonperforming loan as an impaired loan which may be on nonaccrual, is 90 days past due and still accruing, or has been restructured and is not in compliance with its modified terms.

Performing and nonperforming loans, segregated by class of loans, are as:

(Dollars in thousands)	June 30, 2011
	Performing		Nonperforming		Total
Commercial	$	139,709	$	901	$	140,610
Commercial real estate:
Construction		24,358		1,999		26,357
Other		283,580		3,282		286,862
Residential:
1-4 family		76,097		13,694		89,791
Home equities		46,850		—		46,850
Consumer		5,362		—		5,362
Total	$	575,956	$	19,876	$	595,832

(Dollars in thousands)	December 31, 2010
	Performing		Nonperforming		Total
Commercial	$	128,277	$	2,302	$	130,579
Commercial real estate:
Construction		40,985		342		41,327
Other		276,686		7,066		283,752
Residential:
1-4 family		59,881		10,704		70,585
Home equities		67,380		97		67,477
Consumer		7,076		—		7,076
Total	$	580,285	$	20,511	$	600,796

In conjunction with evaluating the performing versus nonperforming nature of the Company’s loan portfolio, management evaluates the following credit risk and other relevant factors in determining the appropriate credit quality indicator (grade) for each loan class:

Pass Grade — Borrowers classified as Pass Grades specifically demonstrate:

• Strong cashflows — borrower’s cashflows must meet or exceed the Company’s minimum Debt Service Coverage Ratio.

• Collateral margin — generally, the borrower must have pledged an acceptable collateral class with an adequate collateral margin.

Those borrowers who qualify for unsecured loans must fully demonstrate above average cashflows and strong secondary sources of repayment to mitigate the lack of unpledged collateral.

• Qualitative Factors — in addition to meeting the Company’s minimum cashflow and collateral requirements, a number of other quantitative and qualitative factors are also factored into assigning a pass grade including the borrower’s level of leverage (Debt to Equity), prospects, history and experience in their industry, credit history, and any other relevant factors including a borrower’s character.

Watch Grade — Generally, borrowers classified as Watch exhibit some level of deterioration in one or more of the following:

• Adequate Cashflows — borrowers in this category demonstrate adequate cashflows and Debt Service Coverage Ratios, but also exhibit one or more less than positive conditions such as declining trends in the level of cashflows, increasing or sole reliance on secondary sources of cashflows, and/or do not meet the Company’s minimum Debt Service Coverage Ratio. However, cashflow remains at acceptable levels to meet debt service requirements.

• Adequate Collateral Margin — the collateral securing the debt remains adequate but also exhibits a declining trend in value or expected volatility due to macro or industry specific conditions. The current collateral value, less selling costs, remains adequate to cover the outstanding debt under a liquidation scenario.

• Qualitative Factors — while the borrower’s cashflow and collateral margin generally remain adequate, one or more quantitative and qualitative factors may also factor into assigning a Watch Grade including the borrower’s level of leverage (Debt to Equity), deterioration in prospects, limited experience in their industry, newly formed company, overall deterioration in the industry, negative trends or recent events in a borrower’s credit history, deviation from core business, and any other relevant factors.

Special Mention Grade — Generally, borrowers classified as Special Mention exhibit a greater level of deterioration than Watch graded loans and warrant management’s close attention. If left uncorrected, the potential weaknesses could threaten repayment prospects in the future. Special Mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant an adverse risk grade.

The following represents potential characteristics of a Special Mention Grade but do not necessarily generate automatic reclassification into this loan grade:

• Adequate Cashflows — borrowers in this category demonstrate adequate cashflows and Debt Service Coverage Ratios, but also reflect adverse trends in operations or continuing financial deterioration that, if it does not stabilize and reverse in a reasonable timeframe, retirement of the debt may be jeopardized.

• Adequate Collateral Margin — the collateral securing the debt remains adequate but also exhibits a continuing declining trend in value or volatility due to macro or industry specific conditions. The current collateral value, less selling costs, remains adequate, but should the negative collateral trend continue, the full recovery of the outstanding debt under a liquidation scenario could be jeopardized.

• Qualitative Factors — while the borrower’s cashflow and/or collateral margin continue to deteriorate but generally remain adequate, one or more quantitative and qualitative factors may also be factoring into assigning a Special Mention Grade including inadequate or incomplete loan documentation, perfection of collateral, inadequate credit structure, borrower unable or unwilling to produce current and adequate financial information, and any other relevant factors.

Substandard Grade — A Substandard credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard credits have a well-defined weakness or weaknesses that jeopardize the liquidation or timely collection of the debt. Substandard credits are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. However, a potential loss does not have to be recognizable in an individual credit for it to be considered a substandard credit. As such, substandard credits may or may not be classified as impaired.

The following represents, but is not limited to, the potential characteristics of a Substandard Grade and do not necessarily generate automatic reclassification into this loan grade:

• Sustained or substantial deteriorating financial trends,

• Unresolved management problems,

• Collateral is insufficient to repay debt; collateral is not sufficiently supported by independent sources, such as asset-based financial audits, appraisals, or equipment evaluations,

• Improper perfection of lien position, which is not readily correctable,

• Unanticipated and severe decline in market values,

• High reliance on secondary source of repayment,

• Legal proceedings, such as bankruptcy or a divorce, which has substantially decreased the borrower’s capacity to repay the debt,

• Fraud committed by the borrower,

• IRS liens that take precedence,

• Forfeiture statutes for assets involved in criminal activities,

• Protracted repayment terms outside of policy that are for longer than the same type of credit in the Company portfolio,

• Any other relevant quantitative or qualitative factor that negatively affects the current net worth and paying capacity of the borrower or of the collateral pledged, if any.

Doubtful Grade — A credit risk rated as Doubtful has all the weaknesses inherent in a credit classified Substandard with 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. As such, all doubtful loans are considered impaired. The possibility of loss is extremely high, but because of certain pending factors that may work to the advantage and strengthening of the credit, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include, but are not limited to:

• Proposed merger(s),

• Acquisition or liquidation procedures,

• Capital injection,

• Perfecting liens on additional collateral,

• Refinancing plans.

Generally, a Doubtful grade does not remain outstanding for a period greater than six months. After six months, the pending events should have either occurred or not occurred. The credit grade should have improved or the principal balance charged against the ALL.

Credit grade definitions, including qualitative factors, for all credit grades are reviewed and approved annually by the Company’s Loan Committee. The following table summarizes our internal risk rating by loan class as of June 30, 2011 and December 31, 2010:

(Dollars in thousands)	June 30, 2011
	Pass		Watch		Special Mention		Substandard		Doubtful		Total
Commercial	$	117,926	$	12,690	$	825	$	8,268	$	901	$	140,610
Commercial real estate:
Construction		13,679		7,546		3,025		2,008		99		26,357
Other		235,961		19,312		10,421		20,968		200		286,862
Residential:
1-4 family		66,956		636		1,023		21,176		—		89,791
Home equities		26,249		3,054		10,983		5,596		968		46,850
Consumer		5,134		94		53		81		—		5,362
Total	$	465,905	$	43,332	$	26,330	$	58,097	$	2,168	$	595,832

(Dollars in thousands)	December 31, 2010
	Pass		Watch		Special Mention		Substandard		Doubtful		Total
Commercial	$	96,691	$	17,100	$	2,454	$	12,153	$	2,181	$	130,579
Commercial real estate:
Construction		26,960		8,228		44		5,995		100		41,327
Other		237,086		34,420		1,125		8,401		2,720		283,752
Residential:
1-4 family		57,390		—		—		13,195		—		70,585
Home equities		39,085		4,428		12,765		10,298		901		67,477
Consumer		6,544		362		73		97		—		7,076
Total	$	463,756	$	64,538	$	16,461	$	50,139	$	5,902	$	600,796

Allowance for Credit Losses and Recorded Investment in Financing Receivables:

(Dollars in thousands)	As of June 30, 2011
				Commercial
	Commercial			Real Estate			Consumer			Residential			Unallocated		Total
Allowance for credit losses:
Beginning balance	$	4,185		$	3,900		$	46		$	4,561		$	149	$	12,841
Charge offs		(2,081	)		(2,155	)		(25	)		(871	)		—		(5,132	)
Recoveries		46			22			3			603			—		674
Provision		1,402			1,661			7			1,602			308		4,980
Ending balance	$	3,552		$	3,428		$	31		$	5,895		$	457	$	13,363
Ending balance:
individually evaluated for impairment	$	414		$	787		$	—		$	2,332		$	—	$	3,533
Ending balance:
collectively evaluated for impairment	$	3,138		$	2,641		$	31		$	3,563		$	457	$	9,830
Financing receivables:
Ending balance	$	140,610		$	313,219		$	5,362		$	136,641		$	—	$	595,832
Ending balance individually evaluated for impairment	$	901		$	22,693		$	—		$	20,278		$	—	$	43,872
Ending balance collectively evaluated for impairment	$	139,709		$	290,526		$	5,362		$	116,363		$	—	$	551,960

(Dollars in thousands)	As of December 31, 2010
				Commercial
	Commercial			Real Estate			Consumer		Residential			Unallocated			Total
Allowance for credit losses:
Beginning balance	$	5,306		$	3,535		$	35	$	2,059		$	272		$	11,207
Charge offs		(4,192	)		(3,391	)		—		(4,506	)		—			(12,089	)
Recoveries		393			154			8		318			—			873
Provision		2,678			3,602			3		6,690			(123	)		12,850
Ending balance	$	4,185		$	3,900		$	46	$	4,561		$	149		$	12,841
Ending balance:
individually evaluated for impairment	$	449		$	250		$	—	$	689		$	—		$	1,388
Ending balance:
collectively evaluated for impairment	$	3,736		$	3,650		$	46	$	3,872		$	149		$	11,453
Financing receivables
Ending balance	$	130,579		$	325,079		$	7,076	$	138,062		$	—		$	600,796
Ending balance individually evaluated for impairment	$	2,302		$	13,833		$	—	$	17,781		$	—		$	33,916
Ending balance collectively evaluated for impairment	$	128,277		$	311,246		$	7,076	$	120,281		$	—		$	566,880

The ALL totaled $13.4 million or 2.24% of total loans at June 30, 2011 compared to $12.8 million or 2.14% at December 31, 2010. The related allowance allocation for the Individual Tax Identification Number (ITIN) portfolio was $3.0 million and $2.9 million at June 30, 2011 and December 31, 2010, respectively. In addition, as of June 30, 2011, the Company has $138.6 million in commitments to extend credit, and recorded a reserve for off balance sheet commitments of $422 thousand in other liabilities.

Management employs its best judgment given available and relevant information in determining the adequacy of the allowance; however, there are a number of factors beyond the Company’s control, including the performance of the loan portfolio, changes in interest rates, economic conditions, and regulatory views towards loan classifications. As such, the ultimate adequacy of the allowance may differ significantly from the Company’s estimation.

The Company has lending policies and procedures in place with the objective of optimizing loan income within an accepted risk tolerance level. Management reviews and approves these policies and procedures annually. Monitoring and reporting systems supplement the review process with regular frequency as related to loan production, loan quality, concentrations of credit, potential problem loans, loan delinquencies, and nonperforming loans.

The following is a brief summary, by loan type, of management’s evaluation of the general risk characteristics and underwriting standards:

Commercial Loans — Commercial loans are underwritten after evaluating the borrower’s financial ability to maintain profitability including future expansion objectives. In addition, the borrower’s qualitative qualities are evaluated, such as management skills and experience, ethical traits, and overall business acumen.

Commercial loans are primarily extended based on the cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The borrower’s cash flow may deviate from initial projections, and the value of collateral securing these loans may vary.

Most commercial loans are generally secured by the assets being financed and other business assets such as accounts receivable or inventory. Management may also incorporate a personal guarantee; however, some short term loans may be extended on an unsecured basis. Repayment of commercial loans secured by accounts receivable may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial Real Estate (CRE) Loans — CRE loans are subject to similar underwriting standards and processes as commercial loans. CRE loans are viewed predominantly as cash flow loans and secondarily as loans collateralized by real estate.

Generally, CRE lending involves larger principal amounts with repayment largely dependent on the successful operation of the property securing the loan or the business conducted on the collateralized property. CRE loans tend to be more adversely affected by conditions in the real estate markets or by general economic conditions. The properties securing the Company’s CRE portfolio are diverse in terms of type and primary source of repayment. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single industry. Management monitors and evaluates CRE loans based on occupancy status (investor versus owner-occupied), collateral, geography, and risk grade criteria.

Generally, CRE loans to developers and builders that are secured by non-owner occupied properties require the borrower to have had an existing relationship with the Company and a proven record of success. Construction loans are underwritten utilizing feasibility studies, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of cost and value associated with the complete project (as-is value). These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment largely dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long term lenders, sales of developed property, or an interim loan commitment from the Company until permanent financing is secured. These loans are closely monitored by on-site inspections, and are considered to have higher inherent risks than other CRE loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long term financing.

Consumer Loans — The Company’s consumer loan portfolio is generally limited to home equity loans with nominal originations in unsecured personal loans and credit cards. The Company is highly dependent on third party credit scoring analysis to supplement the internal underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by management and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time, and documentation requirements.

The Company maintains an independent loan review program that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to the Board of Directors Audit Committee. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

The Company’s ALL is a reserve established through a provision for probable loan losses charged to expense. The ALL represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans as of the financial statement date presented.

The Company’s ALL methodology significantly incorporates management’s current judgments, and reflects the reserve amount that is necessary for estimated loan losses and risks inherent in the loan portfolio in accordance with ASC Topic 450 (Contingencies) and ASC Topic 310 (Receivables).

Management’s continuing evaluation of all known relevant quantitative and qualitative internal and external risk factors provide the foundation for the three major components of the Company’s ALL: (1) historical valuation allowances established in accordance with ASC 450 for groups of similarly situated loan pools; (2) general valuation allowances established in accordance with ASC 450 and based on qualitative credit risk factors; and (3) specific valuation allowances established in accordance with ASC 310 and based on estimated probable losses on specific impaired loans. All three components are aggregated and constitute the Company’s ALL; while portions of the allowance may be allocated to specific credits, the allowance net of specific reserves is available for the remaining credits that management deems as “loss.”

It is the Company’s policy to classify a credit as loss with a concurrent charge off when management considers the credit uncollectible and of such little value that its continuance as a bankable asset is not warranted. A loss classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer recognizing the likely credit loss of a valueless asset even though partial recovery may occur in the future.

In accordance with ASC 450, historical valuation allowances are established for loan pools with similar risk characteristics common to each loan grouping. The Company’s loan portfolio is evaluated by general loan class including commercial, commercial real estate (which includes construction and other real estate), residential real estate (which includes 1-4 family and home equity loans), consumer and other loans.

These loan pools are similarly risk-graded and each portfolio is evaluated by identifying all relevant risk characteristics that are common to these segmented groups of loans. These characteristics include a significant emphasis on historical losses within each loan group, inherent risks for each, and specific loan class characteristics such as trends related to nonaccrual loans, past due loans, criticized loans, net charge offs or recoveries, among other relevant credit risk factors. Management periodically reviews and updates its historical loss ratios based on net charge off experience for each loan class. Other credit risk factors are also reviewed periodically and adjusted as necessary to account for any changes in potential loss exposure.

General valuation allowances, as prescribed by ASC 450, are based on qualitative factors such as changes in asset quality trends, concentrations of credit or changes in concentrations of credit, changes in underwriting standards, changes in experience or depth of lending staff or management, the effectiveness of loan grading and the internal loan review function, and any other relevant factors. Management evaluates each qualitative component quarterly to determine the associated risks to the quality of the Company’s loan portfolio.

Valuation allowances specific to the ITIN and purchased Home Equity Portfolios

ITIN Portfolio — During fiscal year 2010, management increased the general valuation allowance for the portfolio to 4.05%, and currently as of June 30, 2011 had allocated 4.45% of the outstanding principal balance. The following factors were considered in determining the reserve increase during 2010:

• Increased delinquencies — 20% of the portfolio was delinquent 30 days or more as of December 31, 2010.

• Servicer modification efforts were generally extending beyond a typical timeframe.

• Mortgage insurance — A small number of mortgage insurance claims have been denied and management has not been able to identify a trend regarding any potential future denials.

• Sale of OREO — An emerging trend in the lengthening disposition of ITIN OREO had developed, including the potential for decreased recoveries and consequently increased net charge offs.

• Lack of loss guaranty due to settlement.

In August of 2010, the Company settled and terminated the put reserve provided on the ITIN loan pool purchase. Subsequent to the settlement of the put reserve, the ITIN portfolio experienced approximately $640 thousand and $316 thousand in charge offs during the remainder of 2010, and the six months ended June 30, 2011, respectively. Management has estimated that related recoveries will approximate 90% of amounts charged off. As of June 30, 2011, 19.06% of the ITIN loan portfolio was delinquent 30 days or more.

Home Equity Portfolio — On March 12, 2010, the Company completed a loan swap transaction which included the purchase of a pool of residential mortgage home equity loans with a par value of $22.0 million. As of December 31, 2010, the Company’s specific valuation allowance pertaining to this loan pool was $758 thousand or 4.25% of the outstanding principal balance. As of June 30, 2011 the Company’s specific valuation allowance pertaining to this pool was $1.5 million or 9.48% of the outstanding principal balance.

An accompanying $1.5 million put reserve was also part of the loan swap transaction and represents a credit enhancement. As such, management considers this put reserve in estimating potential losses in the home equity portfolio. The put reserve is an irrevocable first loss guarantee from the seller that provides us the right to put back delinquent home equity loans to the seller that become 90 days or more delinquent, up to an aggregate amount of $1.5 million. As of June 30, 2011 the Company had a put reserve balance of $221.9 thousand or 1.38% of the outstanding principal balance of $16.1 million. This guarantee is backed by a seller cash deposit with the Company that is restricted for this sole purpose. The seller’s cash deposit is classified as a deposit liability on the Company’s consolidated balance sheet. At the end of the three year term of this loss guarantee, on March 11, 2013, the Company will be required to return the unused portion of the put reserve in the form of a cash deposit to the seller.