Note 6 - Allowance for Loan and Lease Losses and Credit Disclosures

The allowance for loan and lease losses ("ALLL") is a valuation allowance for probable incurred credit losses, increased by the provision for loan and lease losses and decreased by charge-offs net of recoveries. The ALLL represents one of the most significant estimates in the Bank's financial condition. Accordingly, the Bank endeavors to provide a comprehensive and systematic approach for determining management's current judgment about the credit quality of the loan portfolio.

At the end of each quarter, or more frequently if warranted, the Bank analyzes its loan portfolio to determine the level of ALLL needed to be maintained. Management believes this analysis results in a prudent, conservative ALLL that falls within an acceptable range of estimated credit losses. The ALLL covers estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated credit losses inherent in the remainder of the loan portfolio.

Senior management and other lenders review all Watch and Substandard credits to determine if a loan is impaired. A loan is considered impaired if it is probable that full principal and interest will not be collected within the contractual terms of the original note. For loans that are individually evaluated and determined to be impaired, the Bank calculates the amount of impairment based on whether repayment of the loan is dependent on operating cash flow or on the underlying collateral. The decision of which method to use is determined by looking at a number of factors, including the size of the loan and other available information. If the loan is to be repaid primarily from the operating cash flow from the borrower, the impairment analysis calculates the present value of the expected future cash flows discounted at the loan's effective interest rate and compares the result to the recorded investment. Collateral-dependent loans are measured against the fair value of the collateral less the costs to sell.

As of December 31, 2011, management further refined its methodology for calculating the amount in the ALLL by segregating a component of loans considered to be "high risk" but lack sufficient weakness to be considered impaired. These loans are assigned a specific percentage allocation, adjusted by environmental and qualitative factors management believes may affect the repayment of these loans. The impact to the ALLL for the creation of this additional pool of loans was not significant at December 31, 2011 and March 31, 2012.

The remaining unimpaired loan portfolio is segmented into groups based on loan types having similar risk characteristics. Estimated loan losses for these groups are determined using historical loss experience and adjusted for other environmental and qualitative factors the Bank deems significant that would likely cause estimated credit losses to differ from the group's historical loss experience.

Allocations of the ALLL may be made for specific loans and leases, but the entire allowance is available for any loan or lease that, in management's judgment, should be charged-off. Loan and lease losses are charged against the allowance when management believes the uncollectibility of a loan or lease balance is confirmed.

It is the Company's policy to administer and pursue charged-off borrowers with the same diligence as other loans. Charging off an exposure is an accounting entry and does not affect the borrower's obligation to repay the indebtedness. Administration of charged-off exposure is governed by maximization of recoveries, and borrowers will be pursued until, in the opinion of management, future costs of collection exceed probable future recoveries.

Activity in the allowance for loan and lease losses for the three months ended March 31, 2012 and 2011 is set forth below:


For the Three Months Ended	Beginning										Ending
March 31, 2012 ($000's)	Balance					Recoveries		Provision			Balance
	Allowance					to Loans		Charges to			Allowance
	for Loan		Loans			Previously		Operating			for Loan
	Losses		Charged Off			Charged Off		Expense			Losses

Commercial	$	792	$	(6	)	$	0	$	326		$	1,112
Real estate-construction		3,149		(1,228	)		0		(68	)		1,853
Real estate-mortgage 1-4 family		865		(76	)		1		63			853
Real estate-mortgage 5+ family		1,646		0			0		68			1,714
Real estate-mortgage commercial		12,018		0			0		689			12,707
Home equity		500		(48	)		0		321			773
Leases		0		0			0		0			0
Installment		14		(1	)		0		1			14

Total	$	18,984	$	(1,359	)	$	1	$	1,400		$	19,026

For the Three Months Ended	Beginning										Ending
March 31, 2011 ($000's)	Balance					Recoveries		Provision			Balance
	Allowance					to Loans		Charges to			Allowance
	for Loan		Loans			Previously		Operating			for Loan
	Losses		Charged Off			Charged Off		Expense			Losses

Commercial	$	1,013	$	0		$	4	$	182		$	1,199
Real estate-construction		2,842		(1	)		0		(567	)		2,274
Real estate-mortgage 1-4 family		988		(254	)		0		(18	)		716
Real estate-mortgage 5+ family		1,025		0			0		884			1,909
Real estate-mortgage commercial		11,977		(750	)		0		721			11,948
Home equity		468		0			0		(3	)		465
Leases		0		0			0		0			0
Installment		23		(4	)		1		1			21

Total	$	18,336	$	(1,009	)	$	5	$	1,200		$	18,532

Nonaccrual Loans: Accrual of uncollectible income on problem loans inflates income and, if recognized in an untimely fashion, can have a dramatic negative impact on earnings. Any loan meeting one of the following criteria is placed in a nonaccrual status and all related interest earned but not collected is reversed:

The loan is maintained on a cash basis because of deterioration in the financial condition of the borrower.

The borrower is in bankruptcy and the exposure is not fully secured and in the process of collection.

Full payment of principal or interest is not expected.

The loan has been in default for a period of ninety (90) days or more unless the asset is both well secured and in the process of collection.

Loans meeting any of the criteria above may be exempted from this policy if unanimously agreed upon and duly documented by the Directors Loan Committee. In general, all accrued and earned but not collected interest on an exposure placed on nonaccrual status is charged-off to income. A loan may be returned to accrual status when at least six (6) consecutive months of timely payments have been received and there is evidence to support the payments will continue.

The Company is attempting to work with nonaccrual borrowers to resolve the issues, but in many cases the Company may have to foreclose on the properties securing these loans if the loans are secured by real estate.

Troubled Debt Restructuring: Restructuring of loans is undertaken to improve the likelihood that the loan will be repaid in full under the modified terms in accordance with a reasonable repayment schedule. All restructured loans are evaluated to determine whether the loans should be reported as a TDR. A loan is a TDR when the Company, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower by modifying or renewing a loan that the Company would not otherwise consider. To make this determination the Bank must determine whether (a) the borrower is experiencing financial difficulties and (b) the Company granted the borrower a concession. This determination requires consideration of all of the facts and circumstances surrounding the modification. An overall general decline in the economy or some deterioration in a borrower's financial condition does not automatically mean the borrower is experiencing financial difficulties.

Some of the factors reviewed to determine whether the borrower is experiencing financial difficulties are: 1) is the borrower currently in default on any of its debts; 2) has the borrower declared or in the process of declaring bankruptcy; or 3) absent the current modification, would the borrower more than likely default. Factors to consider in determining whether the Company has granted a concession include: lowering the interest rate, extending the maturity date, forgiving debt, reducing accrued interest or changing the payment to interest only for an extended period of time.

For regulatory purposes, a restructured loan classified as a TDR need not continue to be reported as such in calendar years after the year in which the restructuring took place if the loan yields a market rate and is in compliance with the loan's modified terms. In determining whether the rate is a market rate the Company considers the riskiness of the transaction, the structure of the loan, the borrower's financial condition, financial support of the guarantor and protection provided by the collateral. The Company also considers rates given to other borrowers for similar loans as well as what competitors are offering. To be in compliance with the modified loan terms the borrower should demonstrate the ability to repay under the modified terms for a period of at least six months and provide evidence to support that payments will continue.

Loan Rating System: Senior management and the Bank's lenders use a loan rating system to determine the credit risks of the Bank's loan and leases with the following loan ratings:

Pass: A Pass loan has no apparent weaknesses.

Watch: A Watch loan has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank's credit position at some future date. Loan collection is not in jeopardy yet, but continued adverse trends may cause it to be. Typical characteristics of Watch assets include: increasing debt; liquidity problems; negative trends in operating cash flow; collateral dependent with advances outside policy guidelines; and/or sporadic payment performance.

Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the borrower or of the collateral pledged, if any. These loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that the Company may sustain some loss if the deficiencies are not corrected.

Nonaccrual: Loans in this category have the same characteristics as those classified Substandard with the added characteristic that further erosion in the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The likelihood of loss is yet to be fully determined due to the borrower's inability or refusal to provide updated financial information, appraisals or additional collateral.

Doubtful: Loans in this category have the weaknesses of those classified Substandard where collection and/or liquidation in full, on the basis of currently existing conditions, is highly questionable or improbable. Treatment as "loss" is deferred until exact status can be determined.

Loss: Loans classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless loan even though partial recovery may be affected in the future.

Below shows the allocation of the allowance for loan and lease losses by segment to loans and leases individually and collectively evaluated for impairment:

					Allowance				Allowance
					for Loan				for Loan
					Losses				Losses
	Ending				Allocated to				Allocated to
	Balance		Loans		Loans		Loans		Loans
`	Total		Individually		Individually		Collectively		Collectively
	Loans		Evaluated		Evaluated		Evaluated		Evaluated
	and		for		for		for		for
At March 31, 2012 ($000's)	Leases		Impairment		Impairment		Impairment		Impairment

Commercial	$	15,523	$	647	$	612	$	14,876	$	500
Real estate-construction		27,811		14,262		956		13,549		897
Real estate-mortgage 1-4 family		34,155		4,264		368		29,891		485
Real estate-mortgage 5+ family		35,621		3,983		0		31,638		1,714
Real estate-mortgage commercial		181,610		53,766		9,394		127,844		3,313
Home equity		20,740		761		345		19,979		428
Leases		259		0		0		259		0
Installment		1,355		0		0		1,355		14

Balance at March 31, 2012	$	317,074	$	77,683	$	11,675	$	239,391	$	7,351

					Allowance				Allowance
					for Loan				for Loan
					Losses				Losses
	Ending				Allocated to				Allocated to
	Balance		Loans		Loans		Loans		Loans
	Total		Individually		Individually		Collectively		Collectively
	Loans		Evaluated		Evaluated		Evaluated		Evaluated
	and		for		for		for		for
At December 31, 2011 ($000's)	Leases		Impairment		Impairment		Impairment		Impairment

Commercial	$	15,827	$	655	$	273	$	15,172	$	519
Real estate-construction		28,504		6,876		2,044		21,628		1,105
Real estate-mortgage 1-4 family		35,758		5,163		396		30,595		469
Real estate-mortgage 5+ family		35,977		3,987		0		31,990		1,646
Real estate-mortgage commercial		183,881		54,074		8,561		129,807		3,457
Home equity		21,266		443		141		20,823		359
Leases		295		0		0		295		0
Installment		1,476		0		0		1,476		14

Balance at December 31, 2011	$	322,984	$	71,198	$	11,415	$	251,786	$	7,569

Below shows the age analysis of the past due loans and leases by segment and class at March 31, 2012 and December 31, 2011:

													Greater
													Than
													90 Days Past
At March 31, 2012 ($000's)							Greater				Total		Due and
			30-59 Days		60-89 Days		Than 90 Days		Total		Loans and		Still
	Current		Past Due		Past Due		Past Due		Past Due		Leases		Accruing

Commercial	$	14,889	$	92	$	0	$	542	$	634	$	15,523	$	0
Real estate-construction
1-4 family		9,824		60		0		5,953		6,013		15,837		4,230
Other		10,022		68		0		1,884		1,952		11,974		0
Real estate-mortgage
1-4 family		32,070		548		108		1,429		2,085		34,155		474
Real estate-mortgage
5+ family		30,445		1,193		0		3,983		5,176		35,621		0
Real estate-mortgage commercial
Owner occupied		52,887		603		0		7,901		8,504		61,391		50
Non-owner occupied		70,388		951		0		2,081		3,032		73,420		1,057
Hotel industry		46,799		0		0		0		0		46,799		0
Home equity		19,552		431		58		699		1,188		20,740		0
Leases		259		0		0		0		0		259		0
Installment		1,319		21		0		15		36		1,355		15

Balance at March 31, 2012	$	288,454	$	3,967	$	166	$	24,487	$	28,620	$	317,074	$	5,826

													Greater
													Than
													90 Days Past
At December 31, 2011 ($000's)							Greater				Total		Due and
			30-59 Days		60-89 Days		Than 90 Days		Total		Loans and		Still
	Current		Past Due		Past Due		Past Due		Past Due		Leases		Accruing

Commercial	$	15,273	$	6	$	0	$	548	$	554	$	15,827	$	0
Real estate-construction
1-4 family		14,084		0		0		2,716		2,716		16,800		152
Other		9,820		0		0		1,884		1,884		11,704		0
Real estate-mortgage
1-4 family		32,539		1,672		284		1,263		3,219		35,758		0
Real estate-mortgage
5+ family		32,227		0		0		3,750		3,750		35,977		0
Real estate-mortgage commercial
Owner occupied		53,911		265		471		7,850		8,586		62,497		0
Non-owner occupied		73,162		575		227		450		1,252		74,414		0
Hotel industry		46,970		0		0		0		0		46,970		0
Home equity		20,288		206		71		701		978		21,266		322
Leases		295		0		0		0		0		295		0
Installment		1,442		15		3		16		34		1,476		16

Balance at December 31, 2011	$	300,011	$	2,739	$	1,056	$	19,178	$	22,973	$	322,984	$	490

The Company utilizes a loan rating system as a means of identifying problem and potential loans. Below shows the loan ratings of loans and leases by segment and class at March 31, 2012 and December 31, 2011:

At March 31, 2012 ($000's)	Pass		Watch		Substandard		Nonaccrual		Total

Commercial	$	12,247	$	2,622	$	112	$	542	$	15,523
Real estate-construction
1-4 Family		2,222		168		11,724		1,723		15,837
Other		490		2,647		6,953		1,884		11,974
Real estate-mortgage 1-4 family		25,007		5,020		3,174		954		34,155
Real estate-mortgage 5+ family		24,783		6,855		0		3,983		35,621
Real estate-mortgage commercial
Owner occupied		30,827		12,838		9,876		7,850		61,391
Non-owner occupied		40,545		17,984		13,866		1,025		73,420
Hotel industry		3,754		9,219		33,826		0		46,799
Home equity		18,556		793		628		763		20,740
Leases		259		0		0		0		259
Installment		1,355		0		0		0		1,355
Balance at March 31, 2012	$	160,045	$	58,146	$	80,159	$	18,724	$	317,074

At December 31, 2011 ($000's)	Pass		Watch		Substandard		Nonaccrual		Total

Commercial	$	12,587	$	2,247	$	445	$	548	$	15,827
Real estate-construction
1-4 Family		2,345		4,230		7,662		2,563		16,800
Other		277		6,602		2,941		1,884		11,704
Real estate-mortgage 1-4 family		25,430		4,968		4,097		1,263		35,758
Real estate-mortgage 5+ family		25,105		6,885		0		3,987		35,977
Real estate-mortgage commercial
Owner occupied		31,778		12,211		10,186		8,322		62,497
Non-owner occupied		41,096		20,031		12,837		450		74,414
Hotel industry		3,784		9,358		33,828		0		46,970
Home equity		19,527		792		504		443		21,266
Leases		247		48		0		0		295
Installment		1,476		0		0		0		1,476
Balance at December 31, 2011	$	163,652	$	67,372	$	72,500	$	19,460	$	322,984

The following tables present loans and leases by segment and class individually evaluated for impairment at March 31, 2012 and December 31, 2011 and the average recorded investment and investment income recognized for the three months ended March 31, 2012 and for the year ended December 31, 2011:

($000's)							For the Three Months
	At March 31. 2012						Ended March 31, 2012
			Unpaid				Average		Investment
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized

With no related allowance recorded:
Commercial	$	0	$	0	$	0	$	0	$	0
Real estate-construction
1-4 family		5,953		7,181		0		3,693		0
Other		4,746		6,479		0		2,071		0
Real estate-mortgage 1-4 family		2,072		2,072		0		1,897		13
Real estate-mortgage 5+ family		3,983		3,983		0		3,984		0
Real estate-mortgage commercial
Owner occupied		3,879		3,879		0		4,193		41
Non-owner occupied		4,403		4,403		0		4,085		33
Hotel industry		6,151		6,151		0		6,153		74
Home equity		30		30		0		63		0
Leases		0		0		0		0		0
Installment		0		0		0		0		0
With an allowance recorded:
Commercial		647		1,408		612		652		0
Real estate-construction
1-4 family		2,413		2,413		873		2,413		27
Other		1,150		1,150		83		1,150		0
Real estate-mortgage 1-4 family		2,192		2,192		368		2,326		14
Real estate-mortgage 5+ family		0		0		0		0		0
Real estate-mortgage commercial
Owner occupied		10,916		10,916		3,135		10,919		39
Non-owner occupied		8,661		8,661		585		8,662		93
Hotel industry		19,756		23,355		5,674		19,756		193
Home equity		731		731		345		561		0
Leases		0		0		0		0		0
Installment		0		0		0		0		0

Total:
Commercial	$	647	$	1,408	$	612	$	652	$	0
Real estate-construction		14,262		17,223		956		9,327		27
Real estate-mortgage 1-4 family		4,264		4,264		368		4,223		27
Real estate-mortgage 5+ family		3,983		3,983		0		3,984		0
Real estate-mortgage commercial		53,766		57,365		9,394		53,768		473
Home equity		761		761		345		624		0
Leases		0		0		0		0		0
Installment		0		0		0		0		0
Total	$	77,683	$	85,004	$	11,675	$	72,578	$	527

($000's)							For the Year
	At December 31. 2011						Ended December 31, 2011
			Unpaid				Average		Investment
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized

With no related allowance recorded:
Commercial	$	0	$	0	$	0	$	152	$	0
Real estate-construction
1-4 family		34		34		0		4,607		176
Other		734		2,468		0		1,109		0
Real estate-mortgage 1-4 family		2,039		2,039		0		3,391		96
Real estate-mortgage 5+ family		3,987		3,987		0		8,856		38
Real estate-mortgage commercial
Owner occupied		5,254		5,254		0		6,333		185
Non-owner occupied		3,927		3,927		0		10,281		408
Hotel industry		3,034		3,034		0		2,758		132
Home equity		30		30		0		67		20
Leases		0		0		0		0		0
Installment		0		0		0		0		0
With an allowance recorded:
Commercial		655		1,416		273		1,026		1
Real estate-construction
1-4 family		4,958		4,958		1,960		4,861		103
Other		1,150		1,150		84		1,150		22
Real estate-mortgage 1-4 family		3,124		3,124		396		2,899		131
Real estate-mortgage 5+ family		0		0		0		0		0
Real estate-mortgage commercial
Owner occupied		10,319		10,319		2,974		9,549		97
Non-owner occupied		746		746		458		746		2
Hotel industry		30,794		34,393		5,129		31,523		1,139
Home equity		413		413		141		1,621		2
Leases		0		0		0		0		0
Installment		0		0		0		6		1

Total:
Commercial	$	655	$	1,416	$	273	$	1,178	$	1
Real estate-construction		6,876		8,610		2,044		11,727		301
Real estate-mortgage 1-4 family		5,163		5,163		396		6,290		227
Real estate-mortgage 5+ family		3,987		3,987		0		8,856		38
Real estate-mortgage commercial		54,074		57,673		8,561		61,190		1,963
Home equity		443		443		141		1,688		22
Leases		0		0		0		0		0
Installment		0		0		0		6		1
Total	$	71,198	$	77,292	$	11,415	$	90,935	$	2,553

The following table presents the number of loans and leases modified as TDRs by segment and class during the three month period ended March 31, 2012, the outstanding recorded balances at the time modified and the outstanding recorded investment balances at March 31, 2012:

At March 31, 2012 ($000's)	Troubled Debt Restructurings
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
Troubled Debt Restructurings	Loans		Investment		Investment

Commercial		1	$	109	$	106
Real estate-construction
1-4 family		2		4,230		4,230
Other		1		4,012		4,012
Real estate-mortgage 1-4 family		13		1,777		1,770
Real estate-mortgage 5+ family		0		0		0
Real estate-mortgage commercial
Owner occupied		5		4,909		4,895
Non-owner occupied		2		2,755		2,753
Hotel industry		1		5,433		5,500
Home equity		0		0		0
Leases		0		0		0
Installment		0		0		0

Total		25	$	23,225	$	23,266

The following table presents the number of loans and leases modified as TDRs by segment and class during the twelve month period ended March 31, 2012 that subsequently defaulted during the three month period ended March 31, 2012 and the outstanding recorded investment balance at March 31, 2012. For disclosure in this table, defaulted TDRs are those TDR loans greater than 90 days or more past due and still accruing or on nonaccrual status.

March 31, 2012 ($000s)	Troubled Debt Restructurings that Subsequently Defaulted
Troubled Debt Restructurings	Number of Loans		Recorded Investment

Commercial		0	$	0
Real estate-construction
1-4 Family		2		4,230
Other		0		0
Real estate-mortgage 1-4 family		0		0
Real estate-mortgage 5+ family		0		0
Real estate-mortgage commercial
Owner occupied		1		412
Non-owner occupied		0		0
Hotel industry		0		0
Home equity		0		0
Leases		0		0
Installment		0		0

Total at March 31, 2012		3	$	4,642