NOTE 3 - 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)
	December 31,
	2013				2012
	Balance		%		Balance		%
Commercial	$	73,643		21.2	$	62,312		19.6
Commercial real estate		206,744		59.6		193,417		61.1
Residential real estate		42,288		12.2		39,091		12.3
Consumer - home equity		19,510		5.6		17,910		5.6
Consumer - other		4,648		1.4		4,552		1.4
Total loans	$	346,833			$	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: home equity loans and other consumer 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		Increasing
Changes in lending policies and procedures		Stable
Experience, depth and ability of management		Stable
Economic trends		Decreasing
Concentrations of credit		Stable

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

Factor Considered:		Risk Trend:
Levels and trends in classification		Decreasing
Declining trends in financial performance		Increasing
Structure and lack of performance measures		Increasing
Migration between risk categories		Decreasing

The provision charged to operations can be allocated to a loan segment either as a positive or negative value as a result of any material changes to: net charge-offs or recovery, risk factors or loan balances.

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

	(Amounts in thousands)
December 31, 2013	Commercial			Commercial real estate			Residential real estate			Consumer - home equity			Consumer - other			Total
Balance at beginning of period	$	639		$	2,616		$	343		$	123		$	104		$	3,825
Loan charge-offs		(1	)		(782	)		(81	)		(12	)		(146	)		(1,022	)
Recoveries		167			11			26			18			89			311
Net loan charge-offs		166			(771	)		(55	)		6			(57	)		(711	)
Provision charged to operations		(212	)		793			68			(41	)		42			650
Balance at end of period	$	593		$	2,638		$	356		$	88		$	89		$	3,764

December 31, 2012	Commercial			Commercial real estate			Residential real estate			Consumer - home equity			Consumer - other			Total
Balance at beginning of period	$	565		$	1,803		$	470		$	128		$	92		$	3,058
Loan charge-offs		(1,937	)		(36	)		(231	)		(59	)		(152	)		(2,415	)
Recoveries		9			37			46			13			57			162
Net loan charge-offs		(1,928	)		1			(185	)		(46	)		(95	)		(2,253	)
Provision charged to operations		2,002			812			58			41			107			3,020
Balance at end of period	$	639		$	2,616		$	343		$	123		$	104		$	3,825

December 31, 2011	Commercial		Commercial real estate			Residential real estate			Consumer - home equity			Consumer - other			Total
Balance at beginning of period	$	249	$	1,611		$	418		$	111		$	112		$	2,501
Loan charge-offs		—		(211	)		(362	)		(91	)		(168	)		(832	)
Recoveries		3		118			6			6			60			193
Net loan charge-offs		3		(93	)		(356	)		(85	)		(108	)		(639	)
Provision charged to operations		313		285			408			102			88			1,196
Balance at end of period	$	565	$	1,803		$	470		$	128		$	92		$	3,058

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 December 31, 2013 and 2012:

	(Amounts in thousands)
December 31, 2013	Commercial		Commercial real estate		Residential real estate		Consumer - home equity		Consumer - other		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	50	$	251	$	—	$	—	$	—	$	301
Collectively evaluated for impairment		543		2,387		356		88		89		3,463
Total ending allowance balance	$	593	$	2,638	$	356	$	88	$	89	$	3,764
Loan Portfolio:
Individually evaluated for impairment	$	418	$	5,134	$	—	$	—	$	—	$	5,552
Collectively evaluated for impairment		73,225		201,610		42,288		19,510		4,648		341,281
Total ending loans balance	$	73,643	$	206,744	$	42,288	$	19,510	$	4,648	$	346,833

December 31, 2012	Commercial		Commercial real estate		Residential real estate		Consumer - home equity		Consumer - other		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		343		123		104		3,353
Total ending allowance balance	$	639	$	2,616	$	343	$	123	$	104	$	3,825
Loan Portfolio:
Individually evaluated for impairment	$	49	$	5,031	$	—	$	—	$	—	$	5,080
Collectively evaluated for impairment		62,263		188,386		39,091		17,910		4,552		312,202
Total ending loans balance	$	62,312	$	193,417	$	39,091	$	17,910	$	4,552	$	317,282

The following tables represent credit exposures by internally assigned grades for years ended December 31, 2013 and 2012, respectively. 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 is a summary of credit quality indicators by internally assigned grade as of December 31, 2013 and 2012.

	(Amounts in thousands)
December 31, 2013	Commercial		Commercial real estate
Pass	$	72,562	$	192,604
Special Mention		626		9,158
Substandard		455		4,982
Doubtful		—		—
Ending Balance	$	73,643	$	206,744

December 31, 2012	Commercial		Commercial real estate
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 is a summary of consumer credit exposure as of December 31, 2013 and 2012.

	(Amounts in thousands)
	Residential real estate		Consumer - home equity		Consumer-other
December 31, 2013
Performing	$	41,807	$	19,438	$	4,632
Nonperforming		481		72		16
Total	$	42,288	$	19,510	$	4,648

	Residential real estate		Consumer - home equity		Consumer-other
December 31, 2012
Performing	$	38,602	$	17,838	$	4,525
Nonperforming		489		72		27
Total	$	39,091	$	17,910	$	4,552

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 six months.

The following presents, by class, information related to loans modified in a TDR during the periods ended:

	(Amounts in thousands)
	December 31, 2013
	Number of contracts		Pre-modification recorded investment		Post-modification recorded investment		Increase in the allowance
Commercial		5	$	438	$	438	$	20
Commercial real estate		7		2,348		2,348		—
Total restructured loans		12	$	2,786	$	2,786	$	20
Subsequently defaulted		—	$	—

	December 31, 2012
	Number of contracts		Pre-modification recorded investment		Post-modification recorded investment		Increase in the allowance
Commercial real estate		4	$	1,734	$	1,734	$	148
Total restructured loans		4	$	1,734	$	1,734	$	148
Subsequently defaulted		—	$	—

December 31, 2011

Number of
contracts

Pre-modification
recorded
investment

Post-modification
recorded
investment

Increase in the
allowance

Commercial real estate

—

Total restructured loans

—

Subsequently defaulted

—

The seven new commercial real estate loans had either the rate unchanged or blended with no rate impact. All the loans had loan term changes. Five of the commercial real estate loans were to the same customer. Two of the five commercial loans were to the same company. The commercial loans had loan term changes with no rate concessions made. One commercial loan had multiple changes including rate change, shortened maturity and additional collateral and one commercial loan had an extended loan term and interest only for 6 months.

The following is an aging analysis of the recorded investment of past due loans as of the periods ended December 31, 2013 and 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
December 31, 2013
Commercial	$	—	$	—	$	30	$	30	$	73,613	$	73,643	$	—
Commercial real estate		—		—		1,136		1,136		205,608		206,744		—
Residential real estate		—		201		380		581		41,707		42,288		—
Consumer:
Consumer - home equity		—		7		65		72		19,438		19,510		—
Consumer - other		29		—		16		45		4,603		4,648		—
Total	$	29	$	208	$	1,627	$	1,864	$	344,969	$	346,833	$	—

	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	$	—	$	—	$	49	$	49	$	62,263	$	62,312	$	—
Commercial real estate		32		—		2,182		2,214		191,203		193,417		—
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 December 31, 2013 and 2012. Also presented are the average recorded investments in the impaired balances and interest income recognized after impairment for the years ended December 31, 2013, 2012 and 2011.

	(Amounts in thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance
December 31, 2013
With no related allowance recorded:
Commercial	$	320	$	320	$	—
Commercial real estate		3,554		3,554		—
With an allowance recorded:
Commercial		98		98		50
Commercial real estate		1,580		1,580		251
Total:
Commercial	$	418	$	418	$	50
Commercial real estate	$	5,134	$	5,134	$	251

	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		49		49		49
Commercial real estate		4,242		4,242		423
Total:
Commercial	$	49	$	49	$	49
Commercial real estate	$	5,031	$	5,031	$	423

	(Amounts in thousands)
	Average Recorded Investment		Interest Income Recognized
December 31, 2013
With no related allowance recorded:
Commercial	$	123	$	6
Commercial real estate		1,638		117
With an allowance recorded:
Commercial		73		—
Commercial real estate		3,015		95
Total:
Commercial	$	196	$	6
Commercial real estate	$	4,653	$	212

	(Amounts in thousands)
	Average Recorded Investment		Interest Income Recognized
December 31, 2012
With no related allowance recorded:
Commercial	$	17	$	—
Commercial real estate		1,196		3
With an allowance recorded:
Commercial		58		—
Commercial real estate		3,177		117
Total:
Commercial	$	75	$	—
Commercial real estate	$	4,373	$	120

	Average Recorded Investment		Interest Income Recognized
December 31, 2011
With no related allowance recorded:
Commercial	$	42	$	—
Commercial real estate		951		66
With an allowance recorded:
Commercial		83		—
Commercial real estate		1,320		74
Total:
Commercial	$	125	$	—
Commercial real estate	$	2,271	$	140

The following is a summary of classes of loans on non-accrual status as of:

	(Amounts in thousands) December 31,
	2013		2012
Commercial	$	98	$	49
Commercial real estate		1,279		2,336
Residential real estate		481		489
Consumer:
Consumer - home equity		72		72
Consumer - other		16		27
Total	$	1,946	$	2,973

Gross income that should have been recorded in income on nonaccrual loans was $147,000, $207,000 and $305,000 for the years ended December 31, 2013, 2012 and 2011, respectively. Actual interest included in income on these nonaccrual loans amounts to $38,000, $55,000 and $191,000 in 2013, 2012 and 2011, respectively.