Note 8. Loans and the Allowance for Loan Losses

Loans are stated at their principal amounts inclusive of net deferred loan origination fees. Interest income is credited as earned except when a loan becomes past due 90 days or more and doubt exists as to the ultimate collection of interest or principal; in those cases the recognition of income is discontinued. Loans that are past due 90 days or more that are both well secured and in the process of collection will remain on an accruing basis. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income.

Portfolio segments are defined as the level at which an entity develops and documents a systematic methodology to determine its Allowance. Management has determined that the Corporation has two portfolio segments of loans and leases (commercial and consumer) in determining the Allowance. Both quantitative and qualitative factors are used by management at the portfolio segment level in determining the adequacy of the Allowance for the Corporation. Classes of loans and leases are a disaggregation of a Corporation's portfolio segments. Classes are defined as a group of loans and leases which share similar initial measurement attributes, risk characteristics, and methods for monitoring and assessing credit risk. Management has determined that the Corporation has five classes of loans and leases commercial and industrial (including lease financing), commercial – real estate, construction, residential mortgage (including home equity) and installment.

Generally, all classes of commercial and consumer loans and leases are placed on non-accrual status upon becoming contractually past due 90 days or more as to principal or interest (unless loans and leases are adequately secured by collateral, are in the process of collection, and are reasonably expected to result in repayment), when terms are renegotiated below market levels, or where substantial doubt about full repayment of principal or interest is evident. For certain installment loans the entire outstanding balance on the loan is charged-off when the loan becomes 60 days past due.

Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and six months of payments to demonstrate that the borrower can continue to meet the loan terms. Loan origination fees and certain direct loan origination costs are deferred and recognized over the life of the loan as an adjustment to the loan's yield using the level yield method.

Impaired Loans

The Corporation accounts for impaired loans in accordance with FASB ASC 310-10-35. The value of impaired loans is based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or at the fair value of the collateral if the loan is collateral dependent.

The Corporation has defined its population of impaired loans to include all non-accrual and troubled debt restructuring loans. As part of the evaluation of the value of impaired loans, the Corporation reviews for impairment all non-homogeneous loans (in each instance, above an established dollar threshold of $200,000) internally classified as substandard or below. Smaller impaired non-homogeneous loans and impaired homogeneous loans are not measured for specific reserves and are covered under the Corporation's general reserve.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will not be able to collect all amounts due from the borrower in accordance with the contractual terms of the loan, including scheduled interest payments. Impaired loans include all classes of commercial and consumer non-accruing loans and all loans modified in a troubled debt restructuring ("TDR").

When a loan has been identified as being impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral-dependent. If the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net of deferred loan fees or costs and unamortized premiums or discounts), an impairment is recognized by creating or adjusting an existing allocation of the Allowance, or by recording a partial charge-off of the loan to its fair value. Interest payments made on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest income may be accrued or recognized on a cash basis.

Loans Modified in a Troubled Debt Restructuring

Loans are considered to have been modified in a TDR when due to a borrower's financial difficulties, the Corporation makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a TDR remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status.

Reserve for Credit Losses

The Corporation's reserve for credit losses is comprised of two components, the allowance and the reserve for unfunded commitments (the "Unfunded Commitments").

Allowance for Loan Losses

The allowance for loan losses is maintained at a level determined adequate to provide for probable loan losses. The allowance is increased by provisions charged to operations and reduced by loan charge-offs, net of recoveries. The allowance is based on management's evaluation of the loan portfolio considering economic conditions, the volume and nature of the loan portfolio, historical loan loss experience and individual credit situations.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.

The ultimate collectability of a substantial portion of the Bank's loan portfolio is susceptible to changes in the real estate market and economic conditions in the State of New Jersey and the impact of such conditions on the creditworthiness of the borrowers.

Management believes that the allowance for loan losses is adequate. Management uses available information to recognize loan losses; however, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examinations.

Reserve for Unfunded Commitments

The reserve for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities and is included in other liabilities in the consolidated statements of condition. The determination of the adequacy of the reserve is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience, and credit risk. Net adjustments to the reserve for unfunded commitments are included in other expense.

Risk Related to Representation and Warranty Provisions

The Corporation sells residential mortgage loans in the secondary market primarily to Fannie Mae. The Corporation sells residential mortgage loans to Fannie Mae that includes various representations and warranties regarding the origination and characteristics of the residential mortgage loans. Although the specific representations and warranties vary, they typically cover ownership of the loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan, compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state, and local laws, and other matters.

As of June 30, 2012, the unpaid principal balance of the Corporation's portfolio of residential mortgage loans sold to Fannie Mae was $9.4 million. These loans are generally sold on a non-recourse basis. The agreements under which the Corporation sells residential mortgage loans require the Corporation to deliver various documents to the investor or its document custodian. Although these loans are primarily sold on a non-recourse basis, the Corporation may be obligated to repurchase residential mortgage loans where required documents are not delivered or are defective. Investors may require the immediate repurchase of a mortgage loan when an early payment default discovered in an underwriting review reveals significant underwriting deficiencies, even if the mortgage loan has subsequently been brought current. As of June 30, 2012, there were no pending repurchase requests related to representation and warranty provisions.

Composition of Loan Portfolio

The following table sets forth the composition of the Corporation's loan portfolio, including net deferred fees and costs, at June 30, 2012 and December 31, 2011:


	June 30,		December 31,
	2012		2011
	(in thousands)
Commercial and industrial	$	168,137	$	146,711
Commercial real estate		448,624		408,164
Construction		33,521		39,388
Residential mortgage		156,664		160,771
Installment		345		959
Subtotal		807,291		755,993
Net deferred loan costs		163		17
Total loans	$	807,454	$	756,010

At June 30, 2012 and December 31, 2011, loans to executive officers and directors aggregated approximately $19,616,000 and $10,279,000, respectively. During the six months ended June 30, 2012, the Corporation made new loans to executive officers and directors in the amount of $2,850,000; payments by such persons during 2012 aggregated $3,423,000. On March 30, 2012, the Corporation appointed Frederick S. Fish to the Board of Directors. Mr. Fish had a prior lending relationship with the Bank, and as of June 30, 2012, total loans to Mr. Fish were approximately $9,705,000 and were reflected in the aggregate amount for June 30, 2012.

Management is of the opinion that the above loans were made on the same terms and conditions as those prevailing for comparable transactions with non-related borrowers.

At June 30, 2012 and December 31, 2011, loan balances of approximately $526.8 million and $469.5 million, respectively, were pledged to secure short term borrowings from the Federal Reserve Bank of New York and Federal Home Loan Bank Advances.

The following table presents information about loan receivables on non-accrual status at June 30, 2012 and December 31, 2011:


Loans Receivable on Non-Accrual Status
	June 30, 2012		December 31, 2011
	(in thousands)
Commercial and industrial	$	233	$	125
Commercial real estate		408		225
Construction		—		3,044
Residential mortgage		3,302		3,477
Total loans receivable on non-accrual status	$	3,943	$	6,871

The amount of interest income that would have been recorded on non-accrual loans during the six months ended June 30, 2012 and the year ended December 31, 2011, had payments remained in accordance with the original contractual terms, was $103,000 and $378,000, respectively.

The Corporation continuously monitors the credit quality of its loans receivable. In addition to the internal staff, the Corporation utilizes the services of a third party loan review firm to rate the credit quality of its loans receivable. Credit quality is monitored by reviewing certain credit quality indicators. Assets classified "Pass" are deemed to possess average to superior credit quality, requiring no more than normal attention. Assets classified as "Special Mention" have generally acceptable credit quality yet possess higher risk characteristics/circumstances than satisfactory assets. Such conditions include strained liquidity, slow pay, stale financial statements, or other conditions that require more stringent attention from the lending staff. These conditions, if not corrected, may weaken the loan quality or inadequately protect the Corporation's credit position at some future date. Assets are classified "Substandard" if the asset has a well defined weakness that requires management's attention to a greater degree than for loans classified special mention. Such weakness, if left uncorrected, could possibly result in the compromised ability of the loan to perform to contractual requirements. An asset is classified as "Doubtful" if it is inadequately protected by the net worth and/or paying capacity of the obligor or of the collateral, if any, that secures the obligation. Assets classified as doubtful include assets for which there is a "distinct possibility" that a degree of loss will occur if the inadequacies are not corrected. All loans past due 90 days or more and all impaired loans are included in the appropriate category below. The following table presents information, including deferred fees and costs, about the loan credit quality at June 30, 2012 and December 31, 2011:


Credit Quality Indicators
	June 30, 2012
	Pass		Special Mention		Substandard		Doubtful		Total
	(in thousands)
Commercial and industrial	$	164,073	$	2,744	$	1,320	$	—	$	168,137
Commercial real estate		416,855		17,028		14,741		—		448,624
Construction		33,521		—		—		—		33,521
Residential mortgage		149,437		392		6,835		—		156,664
Installment		345		—		—		—		345
Total loans	$	764,231	$	20,164	$	22,896	$	—	$	807,291


Credit Quality Indicators
	December 31, 2011
	Pass		Special Mention		Substandard		Doubtful		Total
	(in thousands)
Commercial and industrial	$	143,097	$	2,022	$	1,592	$	—	$	146,711
Commercial real estate		371,519		24,282		12,363		—		408,164
Construction		36,344		—		3,044		—		39,388
Residential mortgage		155,098		—		5,673		—		160,771
Installment		959		—		—		—		959
Total loans	$	707,017	$	26,304	$	22,672	$	—	$	755,993

The following table provides an analysis of the impaired loans at June 30, 2012 and December 31, 2011:



	Six Months Ended June 30, 2012
	Recorded Investment		Unpaid Principal Balance		Related Allowance
No Related Allowance Recorded	(in thousands)
Commercial real estate	$	2,093	$	2,542		$	—
Total	$	2,093	$	2,542		$	—


With An Allowance Recorded
Commercial real estate	$	4,180		$		4,180			$	531
Residential mortgage		4,046				4,046				340
Total	$	8,226		$		8,226			$	871
Total
Commercial real estate	$	6,273		$		6,722			$	531
Residential mortgage		4,046				4,046				340
Total (including related allowance)	$	10,319		$		10,768			$	871



	Year Ended December 31, 2011
	Recorded Investment				Unpaid Principal Balance			Related Allowance
No Related Allowance Recorded	(in thousands)
Commercial real estate			2,121				2,570				—
Total	$		2,121		$		2,570		$		—


With An Allowance Recorded
Commercial real estate	$	4,180	$	4,180	$	567
Construction		3,044		3,584		200
Residential mortgage		4,601		4,601		318
Total	$	11,825	$	12,365	$	1,085
Total
Commercial real estate		6,301		6,750		567
Construction		3,044		3,584		200
Residential mortgage		4,601		4,601		318
Total (including related allowance)	$	13,946	$	14,935	$	1,085


	Three Months Ended June 30, 2012				Six Months Ended June 30, 2012				Year Ended December 31, 2011
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(in thousands)
Impaired loans with no related allowance recorded:

Commercial and industrial	$	—	$	—	$	—	$	—	$	292	$	11
Commercial real estate		2,250		28		2,250		58		3,390		149
Construction		—		—		—		—		3,156		—
Residential mortgage		—		—		—		—		—		—
Total	$	2,250	$	28	$	2,250	$	58	$	6,838	$	160

Impaired loans with an allowance recorded:

Commercial real estate	$	4,180	$	34	$	4,180	$	69	$	4,583	$	258
Construction		2,873		16		3,093		16		3,048		18
Residential mortgage		4,016		33		4,217		59		4,572		102
Total	$	11,069	$	83	$	11,490	$	144	$	12,203	$	378

Total impaired loans:

Commercial and industrial	$	—	$	—	$	—	$	—	$	292	$	11
Commercial real estate		6,430		62		6,430		127		7,973		407
Construction		2,873		16		3,093		16		6,204		18
Residential mortgage		4,016		33		4,217		59		4,572		102
Total	$	13,319	$	111	$	13,740	$	202	$	19,041	$	538

Loans are considered to have been modified in a troubled debt restructuring when due to a borrower's financial difficulties, the Corporation makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a troubled debt restructuring remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status. Included in impaired loans at June 30, 2012 are loans that are deemed troubled debt restructurings. Of these loans, $8.7 million, 84.9 percent of which are included in the tables above, are performing under the restructured terms and are accruing interest.

The following table provides an analysis of the aging of loans, excluding deferred fees and costs that are past due at June 30, 2012 and December 31, 2011:


Aging Analysis
	June 30, 2012
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Loans Receivable > 90 Days And Accruing
	(in thousands)
Commercial and Industrial	$	155	$	—	$	233	$	388	$	167,749	$	168,137	$	—
Commercial Real Estate		543		—		1,434		1,977		446,647		448,624		1,026
Construction		—		—		—		—		33,521		33,521		—
Residential Mortgage		279		312		3,302		3,893		152,771		156,664		—
Installment		5		—		—		5		340		345		—
Total	$	982	$	312	$	4,969	$	6,263	$	801,028	$	807,291	$	1,026


	December 31, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Loans Receivable > 90 Days And Accruing
	(in thousands)
Commercial and Industrial	$	137	$	1,544	$	125	$	1,806	$	144,905	$	146,711	$	—
Commercial Real Estate		1,331		5,335		1,254		7,920		400,244		408,164		1,029
Construction		—		—		3,044		3,044		36,344		39,388		—
Residential Mortgage		2,174		99		3,477		5,750		155,021		160,771		—
Installment		16		—		—		16		943		959		—
Total	$	3,658	$	6,978	$	7,900	$	18,536	$	737,457	$	755,993	$	1,029

The following table details the amount of loans receivable that are evaluated individually, and collectively, for impairment, and the related portion of the allowance for loan loss that is allocated to each loan portfolio segment:


Allowance for loan and lease losses
	June 30, 2012
	C & I		Comm R/E		Construction		Res Mtge		Installment		Unallocated		Total
	(in thousands)
Allowance for loan and lease losses:
Individually evaluated for impairment	$	—	$	531	$	—	$	340	$	—	$	—	$	871
Collectively evaluated for impairment		1,747		5,642		449		960		59		493		9,350

Total	$	1,747	$	6,173	$	449	$	1,300	$	59	$	493	$	10,221

Loans Receivable
Individually evaluated for impairment	$	841	$	11,250	$	3,600	$	4,487	$	—	$	—	$	20,178
Collectively evaluated for impairment		167,296		437,374		29,921		152,177		345		—		787,113
Total	$	168,137	$	448,624	$	33,521	$	156,664	$	345	$	—	$	807,291


Allowance for loan and lease losses
	December 31, 2011
	C & I		Comm R/E		Construction		Res Mtge		Installment		Unallocated		Total
	(in thousands)
Allowance for loan and lease losses:
Individually evaluated for impairment	$	—	$	567	$	200	$	318	$	—	$	—	$	1,085
Collectively evaluated for impairment		1,527		5,405		507		945		51		82		8,517
Total	$	1,527	$	5,972	$	707	$	1,263	$	51	$	82	$	9,602

Loans Receivable
Individually evaluated for impairment	$	953	$	12,769	$	3,044	$	5,050	$	—	$	—	$	21,816
Collectively evaluated for impairment		145,758		395,395		36,344		155,721		959		—		734,177
Total	$	146,711	$	408,164	$	39,388	$	160,771	$	959	$	—	$	755,993

The Corporation's allowance for loan losses is analyzed quarterly. Many factors are considered, including growth in the portfolio, delinquencies, nonaccrual loan levels, and other factors inherent in the extension of credit. There have been no material changes to the allowance for loan loss methodology as disclosed in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2011.

A summary of the activity in the allowance for loan losses is as follows:


	Three Months Ended June 30, 2012
	C & I			Comm R/E		Construction			Res Mtge		Installment			Unallocated		Total
	(in thousands)
Balance at April 1,	$	1,784		$	5,876	$	637		$	1,234	$	54		$	169	$	9,754

Charge offs		—			—		—			—		(5	)		—		(5	)

Recoveries		—			—		540			38		1			—		579

Provision		(37	)		297		(728	)		28		9			324		(107	)

Balance at June 30,	$	1,747		$	6,173	$	449		$	1,300	$	59		$	493	$	10,221


	Six Months Ended June 30, 2012
	C & I		Comm R/E		Construction			Res Mtge			Installment			Unallocated		Total
	(in thousands)
Balance at January 1,	$	1,527	$	5,972	$	707		$	1,263		$	51		$	82	$	9,602

Charge offs		—		—		—			—			(8	)		—		(8	)

Recoveries		—		—		540			85			2			—		627

Provision		220		201		(798	)		(48	)		14			411		—

Balance at June 30,	$	1,747	$	6,173	$	449		$	1,300		$	59		$	493	$	10,221


	Three Months Ended June 30, 2011
	C & I			Comm R/E			Construction		Res Mtge		Installment			Unallocated			Total
	(in thousands)
Balance at April 1,	$	1,378		$	6,183		$	900	$	952	$	51		$	127		$	9,591

Charge offs		(20	)		—			—		—		(4	)		—			(24	)

Recoveries		—			15			—		2		2			—			19

Provision		18			(43	)		230		51		7			(13	)		250

Balance at June 30,	$	1,376		$	6,155		$	1,130	$	1,005	$	56		$	114		$	9,836


	Six Months Ended June 30, 2011
	C & I			Comm R/E		Construction		Res Mtge			Installment			Unallocated			Total
	(in thousands)
Balance at January 1,	$	1,272		$	5,715	$	551	$	1,038		$	52		$	239		$	8,867

Charge offs		(185	)		—		—		(23	)		(7	)		—			(215	)

Recoveries		35			15		—		2			4			—			56

Provision		254			425		579		(12	)		7			(125	)		1,128

Balance at June 30,	$	1,376		$	6,155	$	1,130	$	1,005		$	56		$	114		$	9,836

At June 30, 2012, there were no commitments to lend additional funds to borrowers whose loans were on non-accrual status or were contractually past due in excess of 90 days and still accruing interest.

The policy of the Corporation is to generally grant commercial, mortgage and installment loans to New Jersey residents and businesses within its market area. The borrowers' abilities to repay their obligations are dependent upon various factors, including the borrowers' income and net worth, cash flows generated by the borrowers' underlying collateral, value of the underlying collateral, and priority of the lender's lien on the property. Such factors are dependent upon various economic conditions and individual circumstances beyond the control of the Corporation. The Corporation is therefore subject to risk of loss. The Corporation believes its lending policies and procedures adequately minimize the potential exposure to such risks and that adequate provisions for loan losses are provided for all known and inherent risks. Collateral and/or personal guarantees are required for virtually all loans.

The following table presents information about the troubled debt restructurings (TDRs) by class for the period indicated:


	Three Months Ended June 30, 2012						Six Months Ended June 30, 2012
	Number of Loans		Pre-restructuring Outstanding Recorded Investment		Post-restructuring Outstanding Recorded Investment		Number of Loans		Pre-restructuring Outstanding Recorded Investment			Post-restructuring Outstanding Recorded Investment
	(dollars in thousands)
Troubled debt restructurings:
Commercial Real Estate		—	$	—	$	—		1		$	225		$	225
Residential Mortgage		1		1,354		1,354		2			2,068			2,059
Total		1	$	1,354	$	1,354		3		$	2,293		$	2,284

The Corporation had no loan charged off in connection with loan modifications at the time of the modification during the six months ended June 30, 2012.

The Corporation had one loan modified as a TDR within the previous twelve months that subsequently defaulted during the three and six months ended June 30, 2012.

The Corporation adopted ASU No. 2011-02 on July 1, 2011 which provides additional guidance to creditors for evaluating whether a modification or restructuring of a receivable is a troubled debt restructuring. In general, a modification or restructuring of a loan constitutes a TDR if the Corporation grants a concession to a borrower experiencing financial difficulty. Loans modified in TDRs are placed on non-accrual status until the Corporation determines that future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrate performance according to the restructured terms for a period of at least six months. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status.

Loans modified in a troubled debt restructuring totaled $9.7 million at June 30, 2012 of which $900,000 were on non-accrual status. The remaining loans modified were current at the time of the restructuring and have complied with the terms of their restructure agreement. At December 31, 2011, loans modified in a troubled debt restructuring totaled $11.1 million of which $3.7 million were on non-accrual status. The remaining loans modified were current at the time of the restructuring and have complied with the terms of their restructure agreement.

In an effort to proactively manage delinquent loans, the Corporation has selectively extended to certain borrowers concessions such as rate reductions, extension of maturity dates, principal or interest forgiveness, adjusted repayment terms, forbearance agreements, or combinations of two or more of these concessions. As of June 30, 2012, loans on which concessions were made with respect to adjusted repayment terms amounted to $1.6 million. Loans on which combinations of two or more concessions were made amounted to $8.0 million. The concessions granted included principal concessions, rate reduction, adjusted repayment, extended maturity and payment deferral.