4.) Loans and Allowance for Loan Losses:

The Company, through the Bank, grants residential, consumer and commercial loans to customers located primarily in Northeastern Ohio and Western Pennsylvania.

The following represents the composition of the loan portfolio for the period ending:


	(Amounts in thousands)
	March 31, 2013			December 31, 2012

	Balance	%	Balance		%

Commercial real estate	$ 197,547	66.5	$ 193,417		61.1
Commercial	39,671	13.3	62,312		19.6
Residential real estate	38,437	12.9	39,091		12.3
Consumer - other	4,225	1.4	4,552		1.4
Consumer - home equity	17,583	5.9	17,910		5.6

Total loans	$ 297,463		$ 317,282

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Company has segmented loans in the portfolio by product type. Loans are segmented into the following pools: commercial loans, commercial real estate loans, residential real estate loans and consumer loans. The Company also sub-segments the consumer loan portfolio into the following two classes: other consumer loans and home equity loans. Historical loss percentages for each risk category are calculated and used as the basis for calculating allowance allocations. These historical loss percentages are calculated over multiple periods for all portfolio segments. Management evaluates these results and utilizes the most reflective period in the calculation. Certain qualitative factors are then added to the historical allocation percentage to get the adjusted factor.

These factors include, but are not limited to, the following:


Factor Considered:	Risk Trend:

Levels of and trends in charge-offs, classifications and non-accruals	Increasing
Trends in volume and terms	Stable
Changes in lending policies and procedures	Stable
Experience, depth and ability of management	Stable
Economic trends	Stable
Concentrations of credit	Stable

The following factors are analyzed and applied to loans internally graded with higher credit risk in addition to the above factors for non-classified loans:


Factor Considered:	Risk Trend:

Levels and trends in classification	Stable
Declining trends in financial performance – Commercial real estate and Commercial	Increasing
Structure and lack of performance measures – Commercial real estate and Commercial	Increasing
Migration between risk categories	Stable

The following is an analysis of changes in the allowance for loan losses for the three months ended:


	(Amounts in thousands)
March 31, 2013	Commercial	Commercial real estate	Consumer - other	Consumer - home equity	Residential real estate	Total

Balance at beginning of period	$ 639	$ 2,616	$ 104	$ 123	$ 343	$ 3,825
Loan charge-offs	(1 )	(72 )	(29 )	-	(74 )	(176 )
Recoveries	4	-	32	5	1	42

Net loan charge-offs	3	(72 )	3	5	(73 )	(134 )
Provision charged to operations	(23 )	194	(14 )	(21 )	64	200

Balance at end of period	$ 619	$ 2,738	$ 93	$ 107	$ 334	$ 3,891


March 31, 2012	Commercial	Commercial real estate	Consumer - other	Consumer - home equity	Residential real estate	Total

Balance at beginning of period	$ 565	$ 1,803	$ 92	$ 128	$ 470	$ 3,058
Loan charge-offs	(17 )	-	(46 )	(51 )	(100 )	(214 )
Recoveries	2	-	15	2	6	25

Net loan charge-offs	(15 )	-	(31 )	(49 )	(94 )	(189 )
Provision charged to operations	(16 )	(148 )	60	112	262	270

Balance at end of period	$ 534	$ 1,655	$ 121	$ 191	$ 638	$ 3,139

The total allowance reflects management’s estimate of loan losses inherent in the loan portfolio at the consolidated balance sheet date.

The following tables present a full breakdown by portfolio segment, the changes in the allowance for loan losses and the recorded investment in loans for the periods ended March 31, 2013 and December 31, 2012:


	(Amounts in thousands)
March 31, 2013	Commercial	Commercial real estate	Consumer - other	Consumer - home equity	Residential real estate	Total

Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$ 45	$ 391	$ -	$ -	$ -	$ 436
Collectively evaluated for impairment	574	2,347	93	107	334	3,455

Total ending allowance balance	$ 619	$ 2,738	$ 93	$ 107	$ 334	$ 3,891

Loan Portfolio:
Individually evaluated for impairment	$ 57	$ 4,824	$ -	$ -	$ -	$ 4,881
Collectively evaluated for impairment	39,614	192,723	4,225	17,583	38,437	292,582

Total ending loans balance	$ 39,671	$ 197,547	$ 4,225	$ 17,583	$ 38,437	$ 297,463


December 31, 2012	Commercial	Commercial real estate	Consumer - other	Consumer - home equity	Residential real estate	Total

Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$ 49	$ 423	$ -	$ -	$ -	$ 472
Collectively evaluated for impairment	590	2,193	104	123	343	3,353

Total ending allowance balance	$ 639	$ 2,616	$ 104	$ 123	$ 343	$ 3,825

Loan Portfolio:
Individually evaluated for impairment	$ 49	$ 5,031	$ -	$ -	$ -	$ 5,080
Collectively evaluated for impairment	62,263	188,386	4,552	17,910	39,091	312,202

Total ending loans balance	$ 62,312	$ 193,417	$ 4,552	$ 17,910	$ 39,091	$ 317,282

The following tables represent credit exposures by internally assigned grades for March 31, 2013 and December 31, 2012. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The Company’s internal credit risk grading system is based on experiences with similarly graded loans.

The Company’s internally assigned grades are as follows:

• Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. Within this category, there are grades of exceptional, quality, acceptable and pass monitor.

• Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.

• Substandard – loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

• Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset but with the severity which make collection in full highly questionable and improbable, based on existing circumstances.

• Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted. This rating does not mean that the assets have no recovery or salvage value but rather that the assets should be charged off now, even though partial or full recovery may be possible in the future.

The following table is a summary of credit quality indicators by internally assigned grade as of March 31, 2013 and December 31, 2012:


	(Amounts in thousands)
	Commercial	Commercial real estate

March 31, 2013
Pass	$ 37,991	$ 181,005
Special Mention	951	8,513
Substandard	729	8,029
Doubtful	-	-

Ending Balance	$ 39,671	$ 197,547


	Commercial	Commercial real estate

December 31, 2012
Pass	$ 60,387	$ 175,367
Special Mention	1,182	11,135
Substandard	743	6,915
Doubtful	-	-

Ending Balance	$ 62,312	$ 193,417

The Company evaluates the classification of consumer, home equity and residential loans primarily on a pooled basis. If the Company becomes aware that adverse or distressed conditions exist that may affect a particular loan, the loan is downgraded following the above definitions of special mention and substandard.

The following table is a summary of consumer credit exposure as of March 31, 2013 and December 31, 2012:


	(Amounts in thousands)
	Consumer- other	Consumer - home equity	Residential real estate

March 31, 2013
Performing	$ 4,201	$ 17,512	$ 37,960
Nonperforming	24	71	477

Total	$ 4,225	$ 17,583	$ 38,437


	Consumer- other	Consumer - home equity	Residential real estate

December 31, 2012
Performing	$ 4,525	$ 17,838	$ 38,602
Nonperforming	27	72	489

Total	$ 4,552	$ 17,910	$ 39,091

Loans are considered to be nonperforming when they become 90 days past due or on nonaccrual status, though the Company may be receiving partial payments of interest and partial repayments of principal on such loans. When a loan is placed in non-accrual status, previously accrued but unpaid interest is deducted from interest income. Loans in foreclosure are considered nonperforming.

Troubled Debt Restructuring

Nonperforming loans also include certain loans that have been modified in trouble debt restructurings (TDRs) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally nine months.

The following table shows the amounts of contractual interest income and interest income actually reflected in income on TDRs for the periods indicated.


	(Amounts in thousands)
	Three Months Ended	Twelve Months Ended	Three Months Ended
	March 31, 2013	December 31, 2012	March 31, 2012

Principal balance of TDRs at period end	$ 2,875	$ 2,926	$ 1,473
Gross interest income that would have been recorded if loans had not been restructured	32	165	21
Interest income actually included in income on TDRs	30	165	21

There were no loans modified in a TDR for the three months ended March 31, 2013. The following table presents, by class, information related to loans modified in a TDR during the three months ended March 31, 2012 (1):


	March 31, 2012

	Number of contracts	Pre-modification recorded investment	Post-modification recorded investment	Increase in the allowance

Commercial Real Estate	1	$ 269	$ 269	$ -

Total restructured loans	1	$ 269	$ 269	$ -

Subsequently defaulted	-	$ -

(1) The period end balances are inclusive of all partial paydowns and charge-offs since the modification date. Loans modified in a TDR that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

The following table is an aging analysis of the recorded investment of past due loans as of March 31, 2013 and December 31, 2012:


	(Amounts in thousands)
	30-59 Days Past Due	60-89 Days Past Due	90 Days Or Greater	Total Past Due	Current	Total Loans	Recorded Investment > 90 Days and Accruing

March 31, 2013
Commercial real estate	$ 414	$ -	$ 1,916	$ 2,330	$ 195,217	$ 197,547	$ -
Commercial	29	-	45	74	39,597	39,671	-
Residential real estate	323	-	373	696	37,741	38,437	-
Consumer:
Consumer - home equity	-	56	62	118	17,465	17,583	-
Consumer - other	2	-	24	26	4,199	4,225	-

Total	$ 768	$ 56	$ 2,420	$ 3,244	$ 294,219	$ 297,463	$ -


	30-59 Days Past Due	60-89 Days Past Due	90 Days Or Greater	Total Past Due	Current	Total Loans	Recorded Investment > 90 Days and Accruing

December 31, 2012
Commercial real estate	$ 32	$ -	$ 2,182	$ 2,214	$ 191,203	$ 193,417	$ -
Commercial	-	-	49	49	62,263	62,312	-
Residential real estate	72	158	384	614	38,477	39,091	-
Consumer:
Consumer - home equity	-	-	62	62	17,848	17,910	-
Consumer - other	14	-	27	41	4,511	4,552	-

Total	$ 118	$ 158	$ 2,704	$ 2,980	$ 314,302	$ 317,282	$ -

An impaired loan is a loan on which, based on current information and events, it is probable that a creditor will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the loan agreement. However, an insignificant delay or insignificant shortfall in amount of payments on a loan does not indicate that the loan is impaired.

When a loan is determined to be impaired, impairment should be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate. However, as a practical expedient, the Company will measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

The following are the criteria for selecting individual loans / relationships for impairment analysis. Non-homogenous loans which meet the criteria below are evaluated quarterly.

• All borrowers whose loans are classified doubtful by examiners and internal loan review

• All loans on non-accrual status

• Any loan in foreclosure

• Any loan with a specific reserve

• Any loan determined to be collateral dependent for repayment

• Loans classified as troubled debt restructuring

Any loan evaluated for impairment is excluded from the general pool of loans in the ALLL calculation regardless if a specific reserve was determined. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance.

The following table presents the recorded investment and unpaid principal balances for impaired loans, excluding homogenous loans for which impaired analyses are not necessarily performed, with the associated allowance amount, if applicable, at March 31, 2013 and December 31, 2012. Also presented are the average recorded investments in the impaired balances and interest income recognized after impairment for the three months ended March 31, 2013 and March 31, 2012.


	(Amounts in thousands)
	Recorded Investment	Unpaid Principal Balance	Related Allowance

March 31, 2013
With no related allowance recorded:
Commercial real estate	$ 848	$ 848	$ -
Commercial	$ 12	$ 12	-
With an allowance recorded:
Commercial real estate	$ 3,976	$ 3,976	$ 391
Commercial	45	45	45

Total:
Commercial real estate	$ 4,824	$ 4,824	$ 391
Commercial	57	57	45

	Recorded Investment	Unpaid Principal Balance	Related Allowance

December 31, 2012
With no related allowance recorded:
Commercial real estate	$ 789	$ 789	$ -
With an allowance recorded:
Commercial real estate	$ 4,242	$ 4,242	$ 423
Commercial	49	49	49

Total:
Commercial real estate	$ 5,031	$ 5,031	$ 423
Commercial	49	49	49


	(Amounts in thousands)
	March 31, 2013		March 31, 2012
	Average Recorded Investment	Interest Income Recognized	Average Recorded Investment	Interest Income Recognized

With no related allowance recorded:
Commercial real estate	$ 855	$ 4	$ 978	$ 1
Commercial	4	-	-	-
With an allowance recorded:
Commercial real estate	$ 3,980	$ 27	$ 1,382	$ 17
Commercial	46	-	66	-

Total:
Commercial real estate	$ 4,835	$ 31	$ 2,360	$ 18
Commercial	50	-	66	-

The following table is a summary of classes of loans on non-accrual status as of March 31, 2013 and December 31, 2012:


	(Amounts in thousands)
	March 31, 2013	December 31, 2012

Commercial real estate	$ 2,145	$ 2,336
Commercial	57	49
Residential real estate	477	489
Consumer:
Consumer - other	24	27
Consumer - home equity	71	72

Total	$ 2,774	$ 2,973

As of March 31, 2013 and December 31, 2012, there were $3.9 million and $2.7 million, respectively, in loans that were neither classified as non-accrual nor considered impaired, but which can be considered potential problem loans.