3. Loans, Allowance for Loan Losses and Credit Quality

12 Months Ended

Dec. 31, 2012

Notes to Financial Statements

3. Loans, Allowance for Loan Losses and Credit Quality

The composition of net loans at December 31 was as follows:

		2012			2011
Commercial & industrial	$	49,283,948		$	39,514,607
Commercial real estate		139,807,517			132,269,368
Residential real estate - 1st lien		171,114,515			159,535,958
Residential real estate – Jr lien		47,029,023			45,886,967
Consumer		10,642,151			11,465,139
		417,877,154			388,672,039
Deduct (add):
Allowance for loan losses		4,312,080			3,886,502
Deferred net loan costs		(169,501	)		(7,251	)
Loans held-for-sale		1,501,706			2,285,567
		5,644,285			6,164,818
Net Loans	$	412,232,869		$	382,507,221

The following is an age analysis of past due loans (including non-accrual) by class:

				90 Days		Total						Non-Accrual		Over 90 Days
December 31, 2012		30-89 Days		or More		Past Due		Current		Total Loans		Loans		and Accruing
Commercial & industrial	$	782,937	$	377,145	$	1,160,082	$	48,123,866	$	49,283,948	$	596,777	$	0
Commercial real estate		785,890		888,179		1,674,069		138,133,448		139,807,517		1,892,195		53,937
Residential real estate - 1st lien		4,654,077		844,803		5,498,880		164,113,929		169,612,809		1,928,097		281,845
Residential real estate - Jr lien		379,363		57,128		436,491		46,592,532		47,029,023		338,383		41,434
Consumer		132,624		844		133,468		10,508,683		10,642,151		0		844
Total	$	6,734,891	$	2,168,099	$	8,902,990	$	407,472,458	$	416,375,448	$	4,755,452	$	378,060

				90 Days		Total						Non-Accrual		Over 90 Days
December 31, 2011		30-89 Days		or More		Past Due		Current		Total Loans		Loans		and Accruing
Commercial & industrial	$	655,168	$	265,668	$	920,836	$	38,593,771	$	39,514,607	$	1,066,945	$	59,618
Commercial real estate		2,266,412		1,288,616		3,555,028		128,714,340		132,269,368		3,714,146		98,554
Residential real estate - 1st lien		5,614,513		2,517,282		8,131,795		149,118,596		157,250,391		2,703,920		969,078
Residential real estate - Jr lien		431,885		2,754,129		3,186,014		42,700,953		45,886,967		464,308		111,061
Consumer		152,151		1,498		153,649		11,311,490		11,465,139		0		1,498
Total	$	9,120,129	$	6,827,193	$	15,947,322	$	370,439,150	$	386,386,472	$	7,949,319	$	1,239,809

The following summarizes changes in the allowance for loan losses and select loan information, by portfolio segment.

For the year ended December 31, 2012
							Residential			Residential
	Commercial			Commercial			Real Estate			Real Estate
	& Industrial			Real Estate			1st Lien			Jr Lien			Consumer			Unallocated		Total
Allowance for loan losses
Beginning balance	$	342,314		$	1,385,939		$	1,578,493		$	331,684		$	124,779		$	123,293	$	3,886,502
Charge-offs		(159,309	)		(57,923	)		(246,237	)		(135,622	)		(96,491	)		0		(695,582	)
Recoveries		29,769			51,863			5,538			1,538			32,452			0		121,160
Provision		215,607			156,561			225,782			134,956			77,959			189,135		1,000,000
Ending balance	$	428,381		$	1,536,440		$	1,563,576		$	332,556		$	138,699		$	312,428	$	4,312,080
Allowance for loan losses
Evaluated for impairment
Individually	$	0		$	0		$	134,800		$	39,200		$	0		$	0	$	174,000
Collectively		428,381			1,536,440			1,428,776			293,356			138,699			312,428		4,138,080
Total	$	428,381		$	1,536,440		$	1,563,576		$	332,556		$	138,699		$	312,428	$	4,312,080
Loans evaluated for impairment
Individually	$	435,165		$	1,762,615		$	1,641,960		$	309,606		$	0				$	4,149,346
Collectively		48,848,783			138,044,902			167,970,849			46,719,417			10,642,151					412,226,102
Total	$	49,283,948		$	139,807,517		$	169,612,809		$	47,029,023		$	10,642,151				$	416,375,448

For the year ended December 31, 2011
							Residential			Residential
	Commercial			Commercial			Real Estate			Real Estate
	& Industrial			Real Estate			1st Lien			Jr Lien			Consumer			Unallocated		Total
Allowance for loan losses
Beginning balance	$	302,421		$	1,391,898		$	1,830,816		$	0		$	151,948		$	50,852	$	3,727,935
Charge-offs		(22,050	)		(197,367	)		(521,608	)		(96,961	)		(103,687	)		0		(941,673	)
Recoveries		13,225			8,479			42,593			20			35,923			0		100,240
Provision		48,718			182,929			226,692			428,625			40,595			72,441		1,000,000
Ending balance	$	342,314		$	1,385,939		$	1,578,493		$	331,684		$	124,779		$	123,293	$	3,886,502
Allowance for loan losses
Evaluated for impairment
Individually	$	70,600		$	57,500		$	283,200		$	47,200		$	0		$	0	$	458,500
Collectively		271,714			1,328,439			1,295,293			284,484			124,779			123,293		3,428,002
Total	$	342,314		$	1,385,939		$	1,578,493		$	331,684		$	124,779		$	123,293	$	3,886,502
Loans evaluated for impairment
Individually	$	1,000,120		$	3,669,260		$	2,366,326		$	434,664		$	0				$	7,470,370
Collectively		38,514,487			128,600,108			154,884,065			45,452,303			11,465,139					378,916,102
Total	$	39,514,607		$	132,269,368		$	157,250,391		$	45,886,967		$	11,465,139				$	386,386,472

Impaired loans by segment were as follows:

For the year ended December 31, 2012
			Unpaid				Average
		Recorded		Principal		Related		Recorded
		Investment		Balance		Allowance		Investment
With no related allowance recorded
Commercial & industrial	$	435,165	$	473,664	$	0	$	536,973
Commercial real estate		1,762,615		2,123,371		0		2,019,449
Residential real estate - 1st lien		1,024,598		1,250,224		0		893,629
Residential real estate - Jr lien		15,694		76,680		0		34,602
With an allowance recorded
Commercial & industrial		0		0		0		232,743
Commercial real estate		0		0		0		920,842
Residential real estate - 1st lien		617,362		669,288		134,800		892,339
Residential real estate - Jr lien		293,912		319,020		39,200		295,372
Total
Commercial & industrial	$	435,165	$	473,664	$	0	$	769,716
Commercial real estate	$	1,762,615	$	2,123,371	$	0	$	2,940,291
Residential real estate - 1st lien	$	1,641,960	$	1,919,512	$	134,800	$	1,785,968
Residential real estate - Jr lien	$	309,606	$	395,700	$	39,200	$	329,974
Total	$	4,149,346	$	4,912,247	$	174,000	$	5,825,949

For the year ended December 31, 2011
			Unpaid				Average
		Recorded		Principal		Related		Recorded
		Investment		Balance		Allowance		Investment
With no related allowance recorded
Commercial & industrial	$	380,624	$	391,800	$	0	$	332,523
Commercial real estate		2,041,101		2,246,905		0		960,407
Residential real estate - 1st lien		1,000,819		1,191,437		0		1,210,137
Residential real estate - Jr lien		125,786		185,142		0		25,157
With an allowance recorded
Commercial & industrial		619,496		637,729		70,600		237,724
Commercial real estate		1,628,159		1,653,646		57,500		1,128,795
Residential real estate - 1st lien		1,365,507		1,869,338		283,200		1,629,151
Residential real estate - Jr lien		308,878		321,475		47,200		61,776
Total
Commercial & industrial	$	1,000,120	$	1,029,529	$	70,600	$	570,247
Commercial real estate	$	3,669,260	$	3,900,551	$	57,500	$	2,089,202
Residential real estate - 1st lien	$	2,366,326	$	3,060,775	$	283,200	$	2,839,288
Residential real estate - Jr lien	$	434,664	$	506,617	$	47,200	$	86,933
Total	$	7,470,370	$	8,497,472	$	458,500	$	5,585,670

Interest income recognized on impaired loans is immaterial for all periods presented.

Interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The Company is not contractually committed to lend additional funds to debtors with impaired, non-accrual or restructured loans.

Credit Quality Grouping

In developing the allowance for loan losses, management uses credit quality grouping to help evaluate trends in credit quality. The Company groups credit risk into Groups A, B and C. The manner the Company utilizes to assign risk grouping is driven by loan purpose. Commercial purpose loans are individually risk graded while the retail portion of the portfolio is generally grouped by delinquency pool.

Group A loans - Acceptable Risk – are loans that are expected to perform as agreed under their respective terms. Such loans carry a normal level of risk that does not require management attention beyond that warranted by the loan or loan relationship characteristics, such as loan size or relationship size. Group A loans include commercial purpose loans that are individually risk rated and retail loans that are rated by pool. Group A retail loans include both performing consumer and residential real estate loans. Residential real estate loans are loans to individuals secured by 1-4 family homes, including first mortgages, home equity and home improvement loans. Loan balances fully secured by deposit accounts or that are fully guaranteed by the Federal Government are considered acceptable risk.

Group B loans – Management Involved - are loans that require greater attention than the acceptable loans in Group A. Characteristics of such loans may include, but are not limited to, borrowers that are experiencing negative operating trends such as reduced sales or margins, borrowers that have exposure to adverse market conditions such as increased competition or regulatory burden, or borrowers that have had unexpected or adverse changes in management. These loans have a greater likelihood of migrating to an unacceptable risk level if these characteristics are left unchecked. Group B is limited to commercial purpose loans that are individually risk rated.

Group C loans – Unacceptable Risk – are loans that have distinct shortcomings that require a greater degree of management attention. Examples of these shortcomings include a borrower's inadequate capacity to service debt, poor operating performance, or insolvency. These loans are more likely to result in repayment through collateral liquidation. Group C loans range from those that are likely to sustain some loss if the shortcomings are not corrected, to those for which loss is imminent and non-accrual treatment is warranted. Group C loans include individually rated commercial purpose loans, and retail loans adversely rated in accordance with the Federal Financial Institutions Examination Council’s Uniform Retail Credit Classification Policy. Group C retail loans include 1-4 family residential real estate loans and home equity loans past due 90 days or more with loan-to-value ratios greater than 60%, home equity loans 90 days or more past due where the bank does not hold first mortgage, irrespective of loan-to-value, loans in bankruptcy where repayment is likely but not yet established, and lastly consumer loans that are 90 days or more past due.

Commercial purpose loan ratings are assigned by the commercial account officer; for larger and more complex commercial loans, the credit rating is a collaborative assignment by the lender and the credit analyst. The credit risk rating is based on the borrower's expected performance, i.e., the likelihood that the borrower will be able to service its obligations in accordance with the loan terms. Credit risk ratings are meant to measure risk versus simply record history. Assessment of expected future payment performance requires consideration of numerous factors. While past performance is part of the overall evaluation, expected performance is based on an analysis of the borrower's financial strength, and historical and projected factors such as size and financing alternatives, capacity and cash flow, balance sheet and income statement trends, the quality and timeliness of financial reporting, and the quality of the borrower’s management. Other factors influencing the credit risk rating to a lesser degree include collateral coverage and control, guarantor strength and commitment, documentation, structure and covenants and industry conditions. There are uncertainties inherent in this process.

Credit risk ratings are dynamic and require updating whenever relevant information is received. The risk ratings of larger or more complex loans, and Group B and C rated loans, are assessed at the time of their respective annual reviews, during quarterly updates, in action plans or at any other time that relevant information warrants update. Lenders are required to make immediate disclosure to the Chief Credit Officer of any known increase in loan risk, even if considered temporary in nature.

The risk ratings within the loan portfolio by class were as follows:

Total Loans
						Residential		Residential
		Commercial		Commercial		Real Estate		Real Estate
December 31, 2012		&Industrial		Real Estate		1st Lien		Jr Lien		Consumer		Total
Group A	$	47,689,238	$	131,643,756	$	167,876,199	$	46,162,420	$	10,632,404	$	404,004,017
Group B		593,838		4,139,367		404,752		318,248		0		5,456,205
Group C		1,000,872		4,024,394		2,833,564		548,355		9,747		8,416,932
Total	$	49,283,948	$	139,807,517	$	171,114,515	$	47,029,023	$	10,642,151	$	417,877,154

Total Loans
			Residential	Residential
	Commercial	Commercial	Real Estate	Real Estate
December 31, 2011	& Industrial	Real Estate	1st Lien	Jr Lien	Consumer	Total
Group A	$36,971,880	$119,410,381	$153,954,604	$44,943,200	$11,459,371	$366,739,436
Group B	530,523	4,037,860	98,603	322,022	0	4,989,008
Group C	2,012,204	8,821,127	5,482,751	621,745	5,768	16,943,595
Total	$39,514,607	$132,269,368	$159,535,958	$45,886,967	$11,465,139	$388,672,039

Modifications of Loans and TDRs

A loan is classified as a TDR if, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider.

The Company is deemed to have granted such a concession if it has modified a troubled loan in any of the following ways:

· Reduced accrued interest;

· Reduced the original contractual interest rate to a rate that is below the current market rate for the borrower;

· Converted a variable-rate loan to a fixed-rate loan;

· Extended the term of the loan beyond an insignificant delay;

· Deferred or forgiven principal in an amount greater than three months of payments; or

· Performed a refinancing and deferred or forgiven principal on the original loan.

An insignificant delay or insignificant shortfall in the amount of payments typically would not require the loan to be accounted for as a TDR. However, pursuant to regulatory guidance, any delay longer than three months is generally not considered insignificant. The assessment of whether a concession has been granted also takes into account payments expected to be received from third parties, including third-party guarantors, provided that the third party has the ability to perform on the guarantee.

The Company’s TDRs are principally a result of extending loan repayment terms to relieve cash flow difficulties. The Company has only, on a limited basis, reduced interest rates for borrowers below the current market rate for the borrower. The Company has not forgiven principal or reduced accrued interest within the terms of original restructurings, nor has it converted variable rate terms to fixed rate terms. However, the Company evaluates each TDR situation on its own merits and does not foreclose the granting of any particular type of concession.

TDRs by segment for the year ended December 31, 2012 were as follows:

			Pre-		Post-
			Modification		Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
	Contracts		Investment		Investment
Commercial real estate	2	$	1,030,645	$	997,645
Residential real estate - 1st lien	3		197,127		192,478
Total	5	$	1,227,772	$	1,190,123

TDRs by segment for the year ended December 31, 2011 were as follows:

			Pre-		Post-
			Modification		Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
	Contracts		Investment		Investment
Commercial & industrial	10	$	985,666	$	985,666
Commercial real estate	6		1,202,546		1,202,546
Residential real estate - 1st lien	4		299,505		299,505
Residential real estate - Jr lien	2		71,928		71,928
Total	22	$	2,559,645	$	2,559,645

There were no TDRs for which there was a payment default under the restructured terms during the twelve month period ended December 31, 2012. The TDRs for which there was a payment default during the year ended December 31, 2011 were as follows:

	Number of		Recorded
	Contracts		Investment
Commercial & industrial	8	$	741,090
Commercial real estate	1		401,002
Residential real estate - 1st lien	2		178,492
Residential real estate - Jr lien	1		34,687
Total	12	$	1,355,271

TDRs are treated as other impaired loans and carry individual specific reserves with respect to the calculation of the allowance for loan losses. These loans are categorized as non-performing, may be past due, and are generally adversely risk rated. The TDRs that have defaulted under their restructured terms are generally in collection status and their reserve is typically calculated using the fair value of collateral method. At December 31, 2012 and 2011, the allowance related to TDRs was approximately $23,000 and $203,000, respectively.

At December 31, 2012, the Company did not have any commitments to lend additional funds to borrowers with loans classified as TDRs.