NOTE 4: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES

The composition of our loan portfolio at March 31, 2014 and December 31, 2013 was as follows:


(In thousands)		March 31, 2014		December 31, 2013
Commercial, financial and agricultural	$	190,840	$	172,810
Municipal loans		93,176		94,007
Real estate loans – residential		482,775		489,706
Real estate loans – commercial		372,155		371,319
Real estate loans – construction		27,567		31,841
Installment loans		4,993		5,655
All other loans		231		895
Total loans	$	1,171,737	$	1,166,233

We primarily originate residential real estate, commercial, commercial real estate, municipal obligations and installment loans to customers throughout the state of Vermont. There are no significant industry concentrations in the loan portfolio. Total loans in the table above included $587 thousand and $618 thousand of net deferred loan origination cost at March 31, 2014 and December 31, 2013, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $231 thousand and $895 thousand at March 31, 2014 and December 31, 2013, respectively.

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2014:


		Commercial,
		financial and				Real estate-		Real estate-		Real estate-
(In thousands)		agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for credit losses:
Beginning balance	$	3,354	$	768	$	3,081	$	5,085	$	512	$	18	$	10	$	12,828
Charge-offs		-		-		(2)		-		-		-		(20)		(22)
Recoveries		2		-		18		-		-		-		3		23
Provision (credit)		22		(75)		255		34		(152)		-		16		100
Ending balance	$	3,378	$	693	$	3,352	$	5,119	$	360	$	18	$	9	$	12,929

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2013:


		Commercial,
		financial and				Real estate-		Real estate-		Real estate-
(In thousands)		agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for credit losses:
Beginning balance	$	3,447	$	522	$	3,582	$	4,499	$	234	$	17	$	11	$	12,312
Charge-offs		-		-		(7)		(1)		-		-		(20)		(28)
Recoveries		9		-		3		40		1		-		1		54
Provision (credit)		(45)		133		130		(27)		40		(1)		20		250
Ending balance	$	3,411	$	655	$	3,708	$	4,511	$	275	$	16	$	12	$	12,588

The allowance for credit losses consists of the allowance for loan losses and the reserve for undisbursed lines of credit. The reserve for undisbursed lines of credit is included in other liabilities on the balance sheet. The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at March 31, 2014:


		Commercial,
		financial and				Real estate-		Real estate-		Real estate-
(In thousands)		agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for credit losses:
Ending balance individually evaluated for impairment	$	1	$	-	$	63	$	68	$	-	$	-	$	-	$	132
Ending balance collectively evaluated for impairment		3,377		693		3,289		5,051		360		18		9		12,797
Totals	$	3,378	$	693	$	3,352	$	5,119	$	360	$	18	$	9	$	12,929
Financing receivables:
Ending balance individually evaluated for impairment	$	120	$	-	$	724	$	162	$	-	$	-	$	-	$	1,006
Ending balance collectively evaluated for impairment		190,720		93,176		482,051		371,993		27,567		4,993		231		1,170,731
Totals	$	190,840	$	93,176	$	482,775	$	372,155	$	27,567	$	4,993	$	231	$	1,171,737
Components:
Allowance for loan losses	$	2,792	$	681	$	3,260	$	5,077	$	340	$	15	$	9	$	12,174
Reserve for undisbursed lines of credit		586		12		92		42		20		3		-		755
Total allowance for credit losses	$	3,378	$	693	$	3,352	$	5,119	$	360	$	18	$	9	$	12,929

The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at December 31, 2013:


		Commercial,
		financial and				Real estate-		Real estate-		Real estate-
(In thousands)		agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for credit losses:
Ending balance individually evaluated for impairment	$	2	$	-	$	41	$	69	$	-	$	-	$	-	$	112
Ending balance collectively evaluated for impairment		3,352		768		3,040		5,016		512		18		10		12,716
Totals	$	3,354	$	768	$	3,081	$	5,085	$	512	$	18	$	10	$	12,828
Financing receivables:
Ending balance individually evaluated for impairment	$	20	$	-	$	722	$	164	$	-	$	-	$	-	$	906
Ending balance collectively evaluated for impairment		172,790		94,007		488,984		371,155		31,841		5,655		895		1,165,327
Totals	$	172,810	$	94,007	$	489,706	$	371,319	$	31,841	$	5,655	$	895	$	1,166,233
Components:
Allowance for loan losses	$	2,740	$	758	$	2,995	$	5,040	$	481	$	18	$	10	$	12,042
Reserve for undisbursed lines of credit		614		10		86		45		31		-		-		786
Total allowance for credit losses	$	3,354	$	768	$	3,081	$	5,085	$	512	$	18	$	10	$	12,828

The table below presents the recorded investment of loans, including nonaccrual and restructured loans, segregated by class, with delinquency aging as of March 31, 2014:


														Greater
		30-59		60-89		90 Days								Than 90
		Days		Days		or More		Total Past						Days and
(In thousands)		Past Due		Past Due		Past Due		Due		Current		Total		Accruing
Commercial, financial and agricultural	$	146	$	-	$	19	$	165	$	190,675	$	190,840	$	-
Municipal		-		-		-		-		93,176		93,176		-
Real estate-residential:
First mortgage		511		133		233		877		445,029		445,906		-
Second mortgage		72		-		168		240		36,629		36,869		79
Real estate-commercial:
Owner occupied		734		231		-		965		224,967		225,932		-
Non-owner occupied		522		-		-		522		145,701		146,223		-
Real estate-construction:
Residential		-		-		-		-		2,603		2,603		-
Commercial		-		-		-		-		24,964		24,964		-
Installment		-		-		-		-		4,993		4,993		-
Other		-		-		-		-		231		231		-
Total	$	1,985	$	364	$	420	$	2,769	$	1,168,968	$	1,171,737	$	79

Of the total past due loans in the aging table above, $709 thousand are non-performing of which $162 thousand are restructured loans and $79 thousand were greater than 90 days past due and accruing. There were $2.06 million past due performing loans at March 31, 2014.

The table below presents the recorded investment of loans, including nonaccrual and restructured loans, segregated by class, with delinquency aging as of December 31, 2013:


														Greater
		30-59		60-89		90 Days								Than 90
		Days		Days		or More		Total Past						Days and
(In thousands)		Past Due		Past Due		Past Due		Due		Current		Total		Accruing
Commercial, financial and agricultural	$	-	$	-	$	20	$	20	$	172,790	$	172,810	$	-
Municipal		-		-		-		-		94,007		94,007		-
Real estate-residential:
First mortgage		4		294		341		639		452,440		453,079		-
Second mortgage		-		4		181		185		36,442		36,627		75
Real estate-commercial:
Owner occupied		-		-		-		-		224,416		224,416		-
Non-owner occupied		72		-		-		72		146,831		146,903		-
Real estate-construction:
Residential		-		-		-		-		2,495		2,495		-
Commercial		-		-		-		-		29,346		29,346		-
Installment		-		-		-		-		5,655		5,655		-
Other		-		-		-		-		895		895		-
Total	$	76	$	298	$	542	$	916	$	1,165,317	$	1,166,233	$	75

Of the total past due loans in the aging table above, $542 thousand are non-performing of which $42 thousand are restructured loans and $75 thousand were greater than 90 days past due and accruing. There were $374 thousand past due performing loans at December 31, 2013.

Impaired loans by class at March 31, 2014 and for the three months ended March 31, 2014 are as follows:


				Three Months Ended
				March 31, 2014
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
(In thousands)	Investment	Balance	Allowance	Investment	Recognized
With no related allowance recorded
Commercial, financial and agricultural	$ 101	$ 101	$ -	$ 34	$ -
Real estate – residential:
First mortgage	325	440	-	264	2
Second mortgage	168	169	-	174	-
With related allowance recorded
Commercial, financial and agricultural	19	19	1	19	-
Real estate – residential:
First mortgage	231	236	63	164	-
Real estate – commercial:
Owner occupied	162	175	68	162	-
Total
Commercial, financial and agricultural	120	120	1	53	-
Real estate – residential	724	845	63	602	2
Real estate – commercial	162	175	68	162	-
Total	$ 1,006	$ 1,140	$ 132	$ 817	$ 2

Impaired loans by class at December 31, 2013 and for the three months ended March 31, 2013 are as follows:


				Three Months Ended
				March 31, 2013
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
(In thousands)	Investment	Balance	Allowance	Investment	Recognized
With no related allowance recorded
Commercial, financial and agricultural	$ -	$ -	$ -	$ 107	$ 8
Real estate – residential:
First mortgage	410	629	-	841	33
Second mortgage	181	218	-	67	-
Real estate – commercial:
Owner occupied	-	-	-	36	15
Installment	-	-	-	3	-
With related allowance recorded
Commercial, financial and agricultural	20	21	2	414	-
Real estate – residential:
First mortgage	131	135	41	677	-
Second mortgage	-	-	-	700	-
Real estate – commercial:
Owner occupied	164	175	69	174	-
Installment	-	-	-	3	-
Total
Commercial, financial and agricultural	20	21	2	521	8
Real estate – residential	722	982	41	2,285	33
Real estate – commercial	164	175	69	210	15
Installment	-	-	-	6	-
Total	$ 906	$ 1,178	$ 112	$ 3,022	$ 56

Residential and commercial loans serviced for others at March 31, 2014 and December 31, 2013 amounted to approximately $13.21 million and $13.83 million, respectively.

Nonperforming loans at March 31, 2014 and December 31, 2013 are as follows:


(In thousands)		March 31, 2014		December 31, 2013
Nonaccrual loans	$	473	$	425
Loans greater than 90 days and accruing		79		75
Troubled debt restructurings ("TDRs")		454	$	406
Total nonperforming loans	$	1,006		906

Of the total TDRs in the table above, $187 thousand at March 31, 2014 and $235 thousand at December 31, 2013, are nonaccruing. We have reviewed all restructurings that occurred on or after January 1, 2014 for identification as TDRs. There was one TDR that was restructured during 2014. We did not identify as a TDR any loan for which the allowance for credit losses had been measured under a general allowance for credit losses methodology.

TDRs represent balances where the existing loan was modified involving a concession in rate, term or payment amount due to the distressed financial condition of the borrower. There were six restructured residential mortgages at March 31, 2014 with balances totaling $191 thousand. There were two restructured commercial loans at March 31, 2014 with balances totaling $263 thousand. With the exception of one TDR showing delinquency related to a renewal, all TDRs at March 31, 2014 continue to pay as agreed according to the modified terms and all but two of these loans are considered well-secured. At March 31, 2014, there were no commitments to lend additional funds to borrowers whose loans have been modified in a TDR. We had no commitments to lend additional funds to borrowers whose loans were in nonaccrual status or to borrowers whose loans were 90 days past due and still accruing at March 31, 2014. Interest income on restructured loans during the three months ended March 31, 2014 and 2013 was insignificant.

Nonaccrual loans by class as of March 31, 2014 and December 31, 2013 are as follows:


(In thousands)		March 31, 2014		December 31, 2013
Commercial, financial and agricultural	$	19	$	20
Real estate - residential:
First mortgage		365		299
Second mortgage		89		106
Total nonaccruing non-TDR loans		473		425
Nonaccruing TDR’s
Real estate – residential:
First mortgage		26		71
Real estate - commercial:
Owner occupied		162		164
Total nonaccrual loans including TDRs	$	661	$	660

Commercial Grading System

We use risk rating definitions for our commercial loan portfolios and certain residential loans which are generally consistent with regulatory and banking industry norms. Loans are assigned a credit quality grade which is based upon management’s on-going assessment of risk based upon an evaluation of the quantitative and qualitative aspects of each credit. This assessment is a dynamic process and risk ratings are adjusted as each borrower’s financial situation changes. This process is designed to provide timely recognition of a borrower’s financial condition and appropriately focus management resources.

Pass rated loans exhibit acceptable risk to the bank in terms of financial capacity to repay their loans as well as possessing acceptable fallback repayment sources, typically collateral and personal guarantees. Pass rated commercial loan relationships with a total exposure of $1 million or greater are subject to a formal annual review process; additionally, management reviews the risk rating at the time of any late payments, overdrafts or other sign of deterioration in the interim.

Loans rated Pass-Watch require more than usual attention and monitoring by the account officer, though not to the extent that a formal remediation plan is warranted. Borrowers can be rated Pass-Watch based upon a weakened capital structure, marginally adequate cash flow and/or collateral coverage or early-stage declining trends in operations or financial condition.

Loans rated Special Mention possess potential weakness that may expose the bank to some risk of loss in the future. These loans require more frequent monitoring and formal reporting to Management.

Substandard loans reflect well-defined weaknesses in the current repayment capacity, collateral or net worth of the borrower with the possibility of some loss to the bank if these weaknesses are not corrected. Action plans are required for these loans to address the inherent weakness in the credit and are formally reviewed.

Residential real estate and consumer loans

We do not use a grading system for our performing residential real estate and consumer loans. Credit quality for these loans is based on performance and payment status.

Below is a summary of loans by credit quality indicator as of March 31, 2014:


						Pass-		Special		Sub-
(In thousands)		Unrated		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	229	$	169,830	$	12,200	$	7,136	$	1,445	$	190,840
Municipal		18		64,667		26,534		1,957		-		93,176
Real estate – residential:
First mortgage		443,059		2,417		-		64		366		445,906
Second mortgage		36,859		-		-		-		10		36,869
Real estate – commercial:
Owner occupied		177		187,602		15,469		5,592		17,092		225,932
Non-owner occupied		143		132,489		10,887		240		2,464		146,223
Real estate – construction:
Residential		790		473		1,340		-		-		2,603
Commercial		201		24,296		467		-		-		24,964
Installment		4,953		40		-		-		-		4,993
All other loans		231		-		-		-		-		231
Total	$	486,660	$	581,814	$	66,897	$	14,989	$	21,377	$	1,171,737

Below is a summary of loans by credit quality indicator as of December 31, 2013:


						Pass-		Special		Sub-
(In thousands)		Unrated Residential and		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	242	$	152,466	$	14,092	$	96	$	5,914	$	172,810
Municipal		28		65,474		26,548		1,957		-		94,007
Real estate – residential:
First mortgage		449,951		2,520		-		65		543		453,079
Second mortgage		36,599		-		-		-		28		36,627
Real estate – commercial:
Owner occupied		165		187,779		17,236		2,342		16,894		224,416
Non-owner occupied		171		134,222		9,841		270		2,399		146,903
Real estate – construction:
Residential		904		1,591		-		-		-		2,495
Commercial		738		28,127		481		-		-		29,346
Installment		5,655		-		-		-		-		5,655
All other loans		895		-		-		-		-		895
Total	$	495,348	$	572,179	$	68,198	$	4,730	$	25,778	$	1,166,233

The amount of interest which was not earned, but which would have been earned had our nonaccrual and restructured loans performed in accordance with their original terms and conditions, was approximately $7 thousand and $38 thousand for the three months ended March 31, 2014 and March 31, 2013, respectively.

It is our policy to make loans to directors, executive officers, and associates of such persons on substantially the same terms, including interest rates and collateral, as those prevailing for comparable lending transactions with other persons.