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Loans And The Allowance For Credit Losses

9 Months Ended

Sep. 30, 2011

Loans And The Allowance For Credit Losses [Abstract]

Loans And The Allowance For Credit Losses

Note 3: Loans and the Allowance for Credit Losses

Loans

The composition of the loan portfolio at September 30, 2011 and December 31, 2010 is as follows:

(In thousands)	September 30, 2011	December 31, 2010
Commercial, financial and agricultural	$156,043	$ 112,514
Municipal loans	97,015	67,861
Real estate loans – residential	425,620	422,981
Real estate loans – commercial	310,863	284,296
Real estate loans – construction	12,238	16,420
Installment loans	5,858	6,284
All other loans	439	438
Total loans	$1,008,076	$ 910,794

At September 30, 2011 and December 31, 2010, total loans included $(12) thousand and $80 thousand of net deferred loan origination fees. The aggregate amount of overdrawn deposit balances classified as loan balances was $439 thousand and $437 thousand at September 30, 2011 and December 31, 2010, respectively.

Residential and commercial loans serviced for others at September 30, 2011 and December 31, 2010 amounted to approximately $21.00 million and $19.41 million, respectively.

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. Economic conditions have improved somewhat during 2011, but remain difficult. While continuing to adhere to prudent underwriting standards, we are not immune to some negative consequences arising from overall economic weakness and, in particular, a sharp downturn in the real estate market or business conditions in Vermont.

Allowance for Credit Losses

We have divided the loan portfolio into portfolio segments, each with different risk characteristics and methodologies for assessing risk. Each portfolio segment is broken down into classes where appropriate. Portfolio classes contain unique measurement attributes, risk characteristics and methods for monitoring and assessing risk that are necessary to develop the allowance for loan and lease losses. Unique characteristics such as borrower type, loan type, collateral type, and risk characteristics define each portfolio class. A description of each portfolio segment follows:

Commercial, financial and agricultural: We offer a variety of loan options to meet the specific needs of commercial customers, including term loans and lines of credit. Such loans are made available to businesses for working capital such as inventory and receivables, business expansion and equipment purchases. Generally, a collateral lien is placed on equipment, receivables, inventory or other assets owned by the borrower. These loans carry a higher risk than commercial real estate loans by the nature of the underlying collateral, and the collateral value may change daily. To reduce the risk, Management generally employs enhanced monitoring requirements, obtains personal guarantees and, where appropriate, may also attempt to secure real estate as collateral.

Municipal: Municipal loans primarily consist of shorter term loans issued on a tax-exempt basis which are considered general obligations of the municipality. These loans are generally viewed as lower risk and self-liquidating, as Vermont statutes mandate that a municipality utilize its taxing power to meet its financial obligations. To a lesser extent, we make longer term municipal loans, which are also considered general obligations of the municipality. Most of the longer term loans were originated under the federal Qualified School Construction Bond program. Proceeds are used for the construction, rehabilitation or repair of public school properties, and we receive a federal tax credit in lieu of interest income on these loans.

Real Estate – Residential: Residential real estate loans consist primarily of loans secured by first or second mortgages on primary residences. We originate adjustable-rate and fixed-rate, one- to four-family residential real estate loans for the construction or purchase of a home or refinancing of a mortgage. These loans are collateralized by owner-occupied properties located in our market area. Loans on one- to four-family residential real estate are generally originated in amounts of no more than 80% of the purchase price or appraised value (whichever is lower). Mortgage title insurance and hazard insurance are required.

Real Estate – Commercial: We offer commercial real estate loans to finance real estate purchases and refinancing of existing commercial properties. These commercial real estate loans are secured by first liens on the real estate, which may include both owner-occupied and non-owner occupied facilities. The types of facilities financed include apartments, hotels, warehouses, retail facilities, manufacturing facilities and office buildings. These loans may be less risky than commercial loans, since they are secured by real estate and buildings. Our underwriting analysis includes credit verification, independent appraisals, a review of the borrower's financial condition, and a detailed analysis of the borrower's underlying cash flows. These loans are typically originated in amounts of no more than 75% of the appraised value of the property.

Real Estate – Construction: We offer construction loans for the construction, expansion and improvement of residential and commercial properties which are secured by the real estate being developed. A review of all plans and budgets is performed prior to approval, third party progress documents are required during construction, and an independent approval process for all draw and release requests is maintained to ensure that funding is prudently administered and that funds are sufficient to complete the project.

Installment: We offer traditional direct consumer installment loans for various personal needs, including vehicle and boat financing. The vast majority of these loans are secured by a lien on the purchased vehicle and are underwritten using credit scores and income verification. The Bank does not engage in any indirect consumer lending activities.

For purposes of evaluating the adequacy of the allowance for credit losses, we consider a number of significant factors that affect the collectability of the portfolio. For individually evaluated loans, these include estimates of loss exposure, which reflect the facts and circumstances that affect the likelihood of repayment of such loans as of the evaluation date. For homogeneous pools of loans, estimates of our exposure to credit loss reflect a current assessment of a number of factors, which could affect collectability. These factors include: past loss experience, size, trend, composition and nature of loans; changes in lending policies and procedures, including underwriting standards and collection, charge-offs and recoveries; trends experienced in nonperforming and delinquent loans; current economic conditions in our market; the effect of external factors such as competition, legal and regulatory requirements; and the experience, ability, and depth of lending management and staff. In addition, an external loan review firm and various regulatory agencies periodically review our allowance for credit losses.

After a thorough consideration of the factors discussed above, any required additions to the allowance for credit losses are made periodically by charges to the provision for credit losses. These charges are necessary to maintain the allowance for credit losses at a level which Management believes is reasonably reflective of overall inherent risk of probable loss in the portfolio. While Management uses available information to recognize losses on loans, additions may fluctuate from one reporting period to another. These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in Management's assessment of any or all of the determining factors discussed above.

The following table reflects our loan loss experience and activity in the allowance for credit losses for the three months ended September 30, 2011:

(In thousands)	Commercial, financial and agricultural	Municipal	Real estate- residential	Real estate- commercial	Real estate-construction	Installment	All other	Totals
Allowance for credit losses:
Beginning balance	$3,122	$115	$2,563	$4,856	$193	$25	$27	$10,901
Chargeoffs	(2)	0	(14)	0	(85)	(2)	0	(103)
Recoveries	32	0	2	0	7	0	0	41
Provision	(274)	182	678	(507)	175	0	(4)	250
Ending balance	$2,878	$297	$3,229	$4,349	$290	$23	$23	$11,089

The following table reflects our loan loss experience and activity in the allowance for credit losses for the nine months ended September 30, 2011:

(In thousands)	Commercial, financial and agricultural	Municipal	Real estate- residential	Real estate- commercial	Real estate-construction	Installment	All other	Totals
Allowance for credit losses:
Beginning balance	$2,617	$236	$2,428	$5,143	$283	$24	$23	$10,754
Chargeoffs	(79)	0	(63)	(60)	(96)	(10)	0	(308)
Recoveries	76	0	3	43	18	3	0	143
Provision	264	61	861	(777)	85	6	0	500
Ending balance	$2,878	$297	$3,229	$4,349	$290	$23	$23	$11,089

Ending balance individually evaluated for impairment	$39	$0	$215	$0	$0	$0	$0	$254
Ending balance collectively evaluated for impairment	2,839	297	3,014	4,349	290	23	23	10,835
Totals	$2,878	$297	$3,229	$4,349	$290	$23	$23	$11,089

Financing receivables:
Ending balance individually evaluated for impairment	$178	$0	$2,380	$294	$0	$1	$0	$2,853
Ending balance collectively evaluated for impairment	155,865	97,015	423,240	310,569	12,238	5,857	439	1,005,223
Totals	$156,043	$97,015	$425,620	$310,863	$12,238	$5,858	$439	$1,008,076

Components:

Allowance for loan losses

$2,448

$295

$3,131

$4,306

$254

$23

$10,480

Reserve for undisbursed

lines of credit

430

609

Total allowance for credit

losses

$2,878

$297

$3,229

$4,349

$290

$23

$11,089

Presented below is an aging of past due loans, including nonaccrual loans, by class as of September 30, 2011:

(In thousands)	30-59 Days Past Due	60-89 Days Past Due	Over 90 Days Past Due	Total Past Due	Current	Total	Greater Than 90 Days and Accruing

Commercial, financial and agricultural	$0	$0	$8	$8	$156,035	$156,043	$0
Municipal	0	0	0	0	97,015	97,015	0
Real estate-residential:
First mortgage	29	418	1,139	1,586	385,548	387,134	0
Second mortgage	176	0	237	413	38,073	38,486	0
Real estate-commercial:
Owner occupied	52	0	120	172	198,712	198,884	0
Non-owner occupied	0	0	0	0	111,979	111,979	0
Real estate-construction:
Residential	0	0	0	0	1,819	1,819	0
Commercial	0	0	0	0	10,419	10,419	0
Installment	7	0	0	7	5,851	5,858	0
Other	0	0	0	0	439	439	0
Total	$264	$418	$1,504	$2,186	$1,005,890	$1,008,076	$0

Presented below is an aging of past due loans, including nonaccrual loans, by class as of December 31, 2010:

(In thousands)	30-59 Days Past Due	60-89 Days Past Due	Over 90 Days Past Due	Total Past Due	Current	Total	Greater Than 90 Days and Accruing

Commercial, financial and agricultural	$38	$88	$169	$295	$112,219	$112,514	$0
Municipal	0	0	0	0	67,861	67,861	0
Real estate - residential:
First mortgage	0	743	1,461	2,204	378,508	380,712	216
Second mortgage	128	118	491	737	41,532	42,269	168
Real estate - commercial:
Owner occupied	186	0	445	631	125,325	125,956	0
Non-owner occupied	0	21	400	421	157,919	158,340	0
Real estate - construction:
Residential	0	0	0	0	6,287	6,287	0
Commercial	0	167	0	167	9,966	10,133	0
Installment	20	6	0	26	6,258	6,284	0
Other	5	0	0	5	433	438	0
Total	$377	$1,143	$2,966	$4,486	$906,308	$910,794	$384

Impaired loans by class at September 30, 2011 were as follows:

(In thousands)	Recorded Investment	Unpaid Principal Balance	Related Allowance
With no related allowance recorded
Commercial, financial and agricultural	$168	$1,185	$0
Real estate – residential:
First mortgage	1,164	1,438	0
Second mortgage	178	178	0
Real estate – commercial:
Owner occupied	588	588	0
Non-owner occupied	0	70	0
Real estate – construction:
Commercial	0	94	0
Installment	1	22	0
With related allowance recorded
Commercial, financial and agricultural	55	55	39
Real estate – residential:
First mortgage	979	979	212
Second mortgage	59	59	3
Total
Commercial, financial and agricultural	223	1,240	39
Real estate – residential	2,380	2,654	215
Real estate – commercial	588	658	0
Real estate – construction	0	94	0
Installment and other	1	22	0
Total	$3,192	$4,668	$254

Impaired loans by class at December 31, 2010 were as follows:

(In thousands)	Recorded Investment	Unpaid Principal Balance	Related Allowance
With no related allowance recorded:
Commercial, financial and agricultural	$112	$1,077	$0
Real estate - residential:
First mortgage	1,318	1,636	0
Second mortgage	644	644	0
Real estate - commercial:
Owner occupied	483	490	0
Non-owner occupied	400	640	0
Installment	0	17	0
With related allowance recorded:
Commercial, financial and agricultural	483	483	275
Real estate - residential:
First mortgage	664	664	58
Total:
Commercial, financial and agricultural	595	1,560	275
Real estate - residential	2,626	2,944	58
Real estate - commercial	883	1,130	0
Installment	0	17	0
Total	$4,104	$5,651	$333

The average recorded investment and interest income recognized for the three and nine months ended September 30, 2011 were as follows:

(In thousands)	Three Months		Nine Months
(In thousands)	Average Recorded Investment	Interest Income Recognized	Average Recorded Investment	Interest Income Recognized
With no related allowance recorded
Commercial, financial and agricultural	$138	$0	$170	$0
Real estate – residential:
First mortgage	1,412	3	1,257	9
Second mortgage	221	0	369	1
Real estate – commercial:
Owner occupied	510	0	486	0
Non-owner occupied	120	0	86	0
Real estate – construction:
Commercial	105	0	142	0
Installment	1	0	3	0
With related allowance recorded
Commercial, financial and agricultural	138	0	306	0
Real estate – residential:
First mortgage	997	0	751	0
Second mortgage	59	0	26	0
Real estate – commercial:
Non-owner occupied	0	0	61	0
Total
Commercial, financial and agricultural	276	0	476	0
Real estate – residential	2,689	3	2,403	10
Real estate – commercial	630	0	633	0
Real estate – construction	105	0	142	0
Installment and other	1	0	3	0
Total	$3,701	$3	$3,657	$10

Impaired loans at September 30, 2011 consist primarily of residential real estate loans. Total impaired loans totaled $3.19 million and $4.10 million at September 30, 2011 and December 31, 2010, respectively. At September 30, 2011, $1.09 million of the impaired loans had a specific reserve allocation of $254 thousand, and $2.10 million of the impaired loans had no specific reserve allocation. At December 31, 2010, $1.15 million of the impaired loans had a specific reserve allocation of $333 thousand, and $2.96 million of the impaired loans had no specific reserve allocation. We recorded interest income on impaired loans of approximately $3 thousand and $10 thousand during the three and nine months ended September 30, 2011, respectively. No interest was recorded on a cash basis during the period the loans were impaired. The average balance of impaired loans was $3.70 million and $3.66 million during the three and nine months ended September 30, 2011, respectively.

Nonperforming loans at September 30, 2011 and December 31, 2010 were as follows:

(In thousands)	September 30, 2011	December 31, 2010
Nonaccrual loans	$2,687	$3,171
Troubled debt restructured loans ("TDRs")	505	549
Loans greater than 90 days and accruing	0	384
Total nonperforming loans	$3,192	$4,104

Of the total TDRs in the table above, $218 thousand at September 30, 2011 and $146 thousand at December 31, 2010, are nonaccruing.

As a result of adopting the amendments in Accounting Standards Update ("ASU") 2011-02, we have reassessed all restructurings that occurred on or after January 1, 2011 for identification as troubled debt restructurings. We did not identify as TDR any loans for which the allowance for credit losses had been measured under a general allowance for credit losses methodology. The loans in the table below are considered impaired under the guidance in Section 310-10-35. Included in the total TDR's of $505 thousand at September 30, 2011 are $349 thousand which were restructured prior to January 1, 2011.

Presented below is a summary of our restructurings during the periods indicated:

	Three months ended September 30, 2011			Nine months ended September 30, 2011
(Dollars in thousands)	Number of loans	Pre-modification Outstanding Recorded Investment	Post-modification Outstanding Recorded Investment	Number of loans	Pre-modification Outstanding Recorded Investment	Post-modification Outstanding Recorded Investment
Real estate – residential:
First mortgage	1	$105	$104	2	$158	$156

The loans in the table above were classified as TDRs because the borrowers demonstrated cash flow insufficient to service their debt, as well as an inability to obtain funds at market rates from other sources. Modifications consisted of lower interest rates and more favorable payment terms. There were no TDR's restructured within the past twelve months that have defaulted.

TDRs consist of six residential real estate loans at September 30, 2011. All six borrowers experienced financial difficulties that led to the restructure. At the time of restructure five were in payment default and all six demonstrated cash flow insufficient to service their debt as well as an inability to obtain funds at market rates from other sources. At September 30, 2011, four of the restructured loans were performing in accordance with modified agreements, while two loans totaling $63 thousand were in default and had been placed in nonaccruing with foreclosure proceedings in process. At September 30, 2011, $287 thousand of the TDRs was accruing and $218 was in nonaccrual. There were no commitments to lend additional funds to borrowers whose loans have been modified in a troubled debt restructuring at September 30, 2011. 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.

We had $340 thousand in OREO at September 30, 2011, compared with $191 thousand at December 31, 2010 and zero at June 30, 2011. Loans associated with three borrowers were put into OREO during the third quarter of 2011. Two are residential borrowers and one is a commercial borrower.

Nonaccrual loans by class as of September 30, 2011 and December 31, 2010 were as follows:

(In thousands)	September 30, 2011	December 31, 2010
Commercial, financial and agricultural	$223	$ 595
Real estate - residential:
First mortgage	1,639	1,340
Second mortgage	237	391
Real estate - commercial:
Owner occupied	587	445
Non owner occupied	0	400
Installment	1	0
Nonaccrual non-TDR loans	$2,687	$3,171
Nonaccruing TDR's
Real estate – residential:
First mortgage	218	146
Total nonaccrual loans	$2,905	$3,317

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 and possess acceptable fallback repayment sources, typically collateral and personal guarantees. These loans 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, but not to the extent that a formal remediation plan is warranted. Borrowers can be rated Pass-Watch based upon a weakened capital structure, adequate but low 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 inherent weakness in the credit and are formally reviewed periodically.

Below is a summary of loans by credit quality indicator as of September 30, 2011:

(In thousands)	Unrated Residential and Consumer	Pass	Pass-Watch	Special Mention	Sub-Standard	Total
Commercial, financial and agricultural	$3	$139,225	$15,334	$588	$893	$156,043
Municipal	0	97,015	0	0	0	97,015
Real estate – residential:
First mortgage	365,351	17,841	1,538	696	1,708	387,134
Second mortgage	38,209	40	0	0	237	38,486
Real estate – commercial:
Owner occupied	0	164,385	20,306	5,281	8,912	198,884
Non-owner occupied	0	99,758	8,345	1,879	1,997	111,979
Real estate – construction:
Residential	24	1,795	0	0	0	1,819
Commercial	87	9,139	577	0	616	10,419
Installment	5,858	0	0	0	0	5,858
All other loans	439	0	0	0	0	439
Total	$409,971	$529,198	$46,100	$8,444	$14,363	$1,008,076

Below is a summary of loans by credit quality indicator as of December 31, 2010:

(In thousands)	Unrated Residential and Consumer	Pass	Pass-Watch	Special Mention	Sub-Standard	Total
Commercial, financial and agricultural	$ 0	$103,384	$5,271	$2,038	$1,821	$112,514
Municipal	0	67,861	0	0	0	67,861
Real estate – residential:
First mortgage	380,712	0	0	0	0	380,712
Second mortgage	42,269	0	0	0	0	42,269
Real estate – commercial:
Owner occupied	0	95,705	14,732	4,601	10,918	125,956
Non-owner occupied	0	120,491	26,735	4,604	6,510	158,340
Real estate – construction:
Residential	0	3,568	1,562	1,157	0	6,287
Commercial	0	9,015	186	629	303	10,133
Installment	6,284	0	0	0	0	6,284
All other loans	270	0	0	168	0	438
Total	$429,535	$400,024	$48,486	$13,197	$19,552	$910,794

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 $49 thousand and $157 thousand for the three and nine months ended September 30, 2011.

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.