NOTE 4: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES

The composition of our loan portfolio at September 30, 2014 and December 31, 2013 was as follows:


(In thousands)		September 30, 2014		December 31, 2013
Commercial, financial and agricultural	$	183,069	$	172,810
Municipal loans		96,258		94,007
Real estate loans – residential		472,986		489,706
Real estate loans – commercial		381,301		371,319
Real estate loans – construction		17,970		31,841
Installment loans		4,793		5,655
All other loans		286		895
Total loans	$	1,156,663	$	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 $646 thousand and $618 thousand of net deferred loan origination costs at September 30, 2014 and December 31, 2013, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $286 thousand and $895 thousand at September 30, 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 September 30, 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	$	3,656	$	386	$	3,246	$	5,089	$	494	$	18	$	17	$	12,906
Charge-offs		-		-		(7)		-		-		-		(48)		(55)
Recoveries		-		-		-		-		-		-		7		7
Provision (credit)		(253)		316		42		(45)		(94)		(2)		36		-
Ending balance	$	3,403	$	702	$	3,281	$	5,044	$	400	$	16	$	12	$	12,858

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the nine months ended September 30, 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		(34)		-		(25)		-		-		-		(99)		(158)
Recoveries		3		-		20		-		-		1		14		38
Provision (credit)		80		(66)		205		(41)		(112)		(3)		87		150
Ending balance	$	3,403	$	702	$	3,281	$	5,044	$	400	$	16	$	12	$	12,858

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the three months ended September 30, 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	$	3,274	$	400	$	3,385	$	5,018	$	551	$	21	$	9	$	12,658
Charge-offs		-		-		(49)		-		-		(9)		(27)		(85)
Recoveries		13		-		-		-		1		-		4		18
Provision (credit)		137		346		(192)		100		(19)		6		22		400
Ending balance	$	3,424	$	746	$	3,144	$	5,118	$	533	$	18	$	8	$	12,991

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the nine months ended September 30, 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		3,421		4,660		234		17		11	$	12,312
Charge-offs		-		-		(152)		(1)		-		(9)		(75)		(237)
Recoveries		62		-		4		40		2		-		8		116
Provision (credit)		(85)		224		(129)		419		297		10		64		800
Ending balance	$	3,424	$	746	$	3,144	$	5,118	$	533	$	18	$	8	$	12,991

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 September 30, 2014:


	Commercial,
	financial and				Real estate-		Real estate-		Real estate-				All
(In thousands)	agricultural		Municipal		residential		commercial		construction		Installment		Other		Total
Allowance for credit losses:
Ending balance individually evaluated for impairment	$	-	$	-	$	34	$	66	$	-	$	-	$	-	$	100
Ending balance collectively evaluated for impairment		3,403		702		3,247		4,978		400		16		12		12,758
Totals	$	3,403	$	702	$	3,281	$	5,044	$	400	$	16	$	12	$	12,858
Financing receivables:
Ending balance individually evaluated for impairment	$	64	$	-	$	514	$	154	$	-	$	-	$	-	$	732
Ending balance collectively evaluated for impairment		183,005		96,258		472,472		381,147		17,970		4,793		286		1,155,931
Totals	$	183,069	$	96,258	$	472,986	$	381,301	$	17,970	$	4,793	$	286	$	1,156,663
Components:
Allowance for loan losses	$	2,798	$	688	$	3,195	$	5,005	$	305	$	16	$	12	$	12,019
Reserve for undisbursed lines of credit		605		14		86		39		95		-		-		839
Total allowance for credit losses	$	3,403	$	702	$	3,281	$	5,044	$	400	$	16	$	12	$	12,858

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-				All
(In thousands)	agricultural		Municipal		residential		commercial		construction		Installment		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 September 30, 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	$	43	$	95	$	-	$	138	$	182,931	$	183,069	$	-
Municipal		-		-		-		-		96,258		96,258		-
Real estate-residential:
First mortgage		-		9		176		185		434,722		434,907		-
Second mortgage		28		-		79		107		37,972		38,079		-
Real estate-commercial:
Owner occupied		-		-		-		-		241,480		241,480		-
Non-owner occupied		-		-		-		-		139,821		139,821		-
Real estate-construction:
Residential		-		-		-		-		3,374		3,374		-
Commercial		-		-		-		-		14,596		14,596		-
Installment		-		-		-		-		4,793		4,793		-
All other loans		-		-		-		-		286		286		-
Total	$	71	$	104	$	255	$	430	$	1,156,233	$	1,156,663	$	-

Of the total past due loans in the aging table above, $255 thousand are non-performing, none of which are restructured or greater than 90 days past due and accruing. There were $175 thousand past due performing loans at September 30, 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		-
All other loans		-		-		-		-		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 are 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 September 30, 2014 and for the three and nine months ended September 30, 2014 are as follows:


							Three Months Ended				Nine Months Ended
							September 30, 2014				September 30, 2014
			Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
(In thousands)	Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
With no related allowance recorded
Commercial, financial and agricultural	$	64	$	65	$	-	$	66	$	1	$	65	$	2
Real estate – residential:
First mortgage		280		418		-		283		1		284		7
Second mortgage		78		78		-		131		-		156		1
Real estate – commercial:
Owner occupied		-		-		-		-		-		17		1
With related allowance recorded
Commercial, financial and agricultural		-		-		-		-		-		16		-
Real estate – residential:
First mortgage		155		155		34		190		-		189		-
Real estate – commercial:
Owner occupied		155		173		66		156		-		159		-
Total
Commercial, financial and agricultural		64		65		-		66		1		81		2
Real estate – residential		513		651		34		604		1		629		8
Real estate – commercial		155		173		66		156		-		176		1
Total	$	732	$	889	$	100	$	826	$	2	$	886	$	11

Impaired loans by class at December 31, 2013 and for the three and nine months ended September 30, 2013 are as follows:


							Three Months Ended				Nine Months Ended
							September 30, 2013				September 30, 2013
			Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
(In thousands)	Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
With no related allowance recorded
Commercial, financial and agricultural	$	-	$	-	$	-	$	272	$	15	$	223	$	42
Real estate – residential:
First mortgage		410		629		-		463		24		622		68
Second mortgage		181		218		-		188		1		133		2
Real estate – commercial:
Owner occupied		-		-		-		107		-		83		15
Installment		-		-		-		-		-		1		-
With related allowance recorded
Commercial, financial and agricultural		20		21		2		333		-		342		-
Real estate – residential:
First mortgage		131		135		41		399		-		523		-
Second mortgage		-		-		-		18		-		317		-
Real estate – commercial:
Owner occupied		164		175		69		168		-		171		-
Installment		-		-		-		6		-		6		-
Total
Commercial, financial and agricultural		20		21		2		605		15		565		42
Real estate – residential		722		982		41		1,068		25		1,595		70
Real estate – commercial		164		175		69		275		-		254		15
Installment		-		-		-		6		-		7		-
Total	$	906	$	1,178	$	112	$	1,954	$	40	$	2,421	$	127

Residential and commercial loans serviced for others at September 30, 2014 and December 31, 2013 amounted to approximately $13.33 million and $13.83 million, respectively.

Nonperforming loans at September 30, 2014 and December 31, 2013 are as follows:


(In thousands)		September 30, 2014		December 31, 2013
Nonaccrual loans	$	308	$	425
Loans greater than 90 days and accruing		-		75
Troubled debt restructurings ("TDRs")		424		406
Total nonperforming loans	$	732	$	906

Of the total TDRs in the table above, $222 thousand at September 30, 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 were four TDRs that were 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. All TDRs at September 30, 2014 continue to pay as agreed according to the modified terms and all but one of these loans are considered well-secured. At September 30, 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 September 30, 2014. Interest income on restructured loans during the three and nine months ended September 30, 2014 and 2013 was insignificant.

Nonaccrual loans by class as of September 30, 2014 and December 31, 2013 are as follows:


(In thousands)		September 30, 2014		December 31, 2013
Commercial, financial and agricultural	$	11	$	20
Real estate - residential:
First mortgage		218		299
Second mortgage		79		106
Total nonaccruing non-TDR loans		308		425
Nonaccruing TDR’s
Commercial, financial and agricultural		5		-
Real estate – residential:
First mortgage		62		71
Real estate - commercial:
Owner occupied		155		164
Total nonaccrual loans including TDRs	$	530	$	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 the loan 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 September 30, 2014:


						Pass-		Special		Sub-
(In thousands)		Unrated		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	247	$	153,403	$	10,772	$	13,043	$	5,604	$	183,069
Municipal		55		73,502		20,804		1,897		-		96,258
Real estate – residential:
First mortgage		431,494		3,004		172		-		237		434,907
Second mortgage		38,079		-		-		-		-		38,079
Real estate – commercial:
Owner occupied		166		200,491		20,668		4,308		15,847		241,480
Non-owner occupied		130		119,757		18,095		258		1,581		139,821
Real estate – construction:
Residential		149		2,022		1,203		-		-		3,374
Commercial		190		11,999		444		-		1,963		14,596
Installment		4,756		37		-		-		-		4,793
All other loans		286		-		-		-		-		286
Total	$	475,552	$	564,215	$	72,158	$	19,506	$	25,232	$	1,156,663

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


						Pass-		Special		Sub-
(In thousands)		Unrated		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 $11 thousand and $32 thousand for the three months ended September 30, 2014 and 2013, respectively; and $29 thousand and $108 thousand for the nine months ended September 30, 2014 and 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.