Note 4 - Loans

9 Months Ended

Sep. 30, 2011

Loans, Notes, Trade and Other Receivables Disclosure [Text Block]

NOTE 4 - LOANS

The following information provides a description of how loan grades are determined for our Commercial and Industrial and Commercial Real Estate Segments. In general, for Commercial and Industrial, and Commercial Real Estate Segments, the probability of loss increases with each rate change from the Grade 1 Excellent down through the Grade 9 Doubtful classes. For Consumer and Residential Mortgage segments, the probability of loss increases as loans move down from current to greater than 60 days past due, nonaccrual.

Grade 1 Excellent – Characteristics of loans in this category include: the loan is generally secured by cash or readily marketable securities; the borrower provides annual audited financials with interim financials reviewed quarterly; the loan has no delinquencies over ten days in the past year; the company’s management is considered to have a high degree of integrity; management of the company has over 15 years of experience; lines of credit have not and are not expected to be utilized; financial statements demonstrate consistently strong profits; and the company has little competition and excellent growth prospects.

Grade 2 Quality – Characteristics of loans in this category include: high net worth borrowers with excellent cash flow and a high degree of liquidity; the borrower generally has annual audited financial statements; there has been one or fewer delinquencies over ten days in the past year; the company’s management is considered to have a high degree of integrity; the company’s management has over ten years of experience; lines of credit have had nominal use over the preceding 12 months; financial statements demonstrate consistent profitability; and the company is in an excellent competitive position.

Grade 3 Good – Loans in this category are very strong, but may lack some of the net worth and/or cash flow characteristics of the previous rating. Characteristics of loans in this category include: annual reviewed financial statements and compiled quarterly financial statements, there has only been one or fewer delinquencies over 15 days in the past year, the company’s management has solid integrity, the company’s management is capable and has over five years of experience, lines of credit have regular usage with no balance in the last 60 days, financial statements demonstrate consistent but nominal profits, and the company has good a solid market share.

Grade 4 Acceptable – Characteristics of loans in this category include: annual compiled financial statements with quarterly information available or CPA prepared tax returns, there are only two or fewer delinquencies over 15 days of which only one is over 30 days in the past year, the company’s management has average business experience of over three years, lines of credit have regular use but have no current balance or a significant reduction in balance in the last 30 days, the company has been profitable in two of the preceding three years, and the company is competitive in its market and is maintaining its market share.

Loans graded as one through four are considered as Pass loans and are shown as one class of loans in our credit quality table.

Grade 5 Watch - This rating is used for loans which have shown some sign of weakness, but have not degraded to the point of requiring an impairment review. Characteristics of loans in this rating include: annual management prepared financial statements; delinquencies not exceeding three times over 30 days or one time over 60 days in the past year; weakening financial statements but profitable in two of the last three years; and a declining market share in a competitive market. These loans merit monitoring by management to assure that if circumstances deteriorate further actions are taken to protect the bank’s position.

Grade 6 Special Mention - This rating is used for loans which are included on a watch list and have degraded to a point where additional supervision is required; however, the bank remains confident in the full collection of all principal and interest. These loans are reviewed for impairment on a quarterly basis. Characteristics of loans in this rating may include: repeat delinquency; longer term negative trends in financial results; continuing deterioration of cash flows; concerns regarding the liquidity of guarantors; and other negative business trends.

Grade 7 Substandard - This rating is for loans for which a lender is actively working with the borrower to resolve issues and the full repayment of the loan is questionable. The loan is inadequately protected by current sound worth of the borrower, paying capacity of the guarantor, or pledged collateral. Loans in this grade have well defined weaknesses that jeopardize the full collectability of the loan and a distinct possibility of loss exits.  These loans are reviewed for impairment on a quarterly basis. Characteristics of loans in this rating may include: persistent delinquency; poor financial results of the business; negative cash flow; the ability of guarantor(s) to provide support for the loan is questionable.

Grade 8 Impaired Nonaccrual - This rating is for loans which are considered impaired and classified as nonaccrual. Loans in this grade have all the weaknesses of those classified as substandard grade 7 above, with the added characteristic that, based upon currently known facts, the weaknesses make collection of all principal and interest due according to contractual terms unlikely. These loans are reviewed for impairment on a quarterly basis. Loans in this grade may be assigned an allocated reserve in the loan loss allowance analysis if a determination is made that the future cash flows or the value of the collateral do not support the current carrying value of the loan.

Grade 9 Doubtful Nonaccrual- This rating is for loans which are considered impaired and are classified as nonaccrual. Loans in this grade have all the weaknesses of those classified as impaired nonaccrual grade 8 above, with the added characteristic that the weaknesses make full collection through payment or liquidation of the collateral, based on currently known facts, highly questionable or improbable. These loans are reviewed for impairment on a quarterly basis. Loans in this grade may be assigned an allocated reserve in the loan loss allowance analysis if a determination is made that the future cash flows or the value of the collateral do not support the current carrying value of the loan.

Restructured Loans

Impaired Restructured and Accruing - Loans where the borrower is experiencing financial difficulty and the bank has granted a concession to the borrower. A concession may be: a reduction in the contractual interest rate below current market rates for loans of similar quality, a lengthening of the accrual time frame beyond normal market terms, a forgiveness of a portion of the outstanding principal, or acceptance of collateral in lieu of payment for a portion of the loan balance. If the loan is in accrual status at the time of the restructuring, the borrower has the ability to make the payments under the restructured terms, and the restructuring does not forgive principal, the loan remains on an accrual status under the new terms. However, if there is a forgiveness of debt or partial charge off, the loan will generally be graded as impaired nonaccrual (Grade 8) with any accrued interest reversed against interest income. If a loan is in nonaccrual status at the time of a restructuring, it will remain in nonaccrual status (Grade 8) at the time of restructuring. All non-accruing restructured loans remain in nonaccrual status until the borrower has demonstrated the ability to make the payments under the restructured terms by making a minimum of six months of payments. If the borrower makes the six months of payments without becoming past due 30 days or more, the loan may be returned to accrual status. The determination of the need for an allowance for loan loss adjustment is based on a factor relating to historical losses multiplied times the balance of the loan for residential mortgages, or a collateral impairment review for commercial loans, and a net present value adjustment relating to a change in interest rate and other terms, if applicable.

Impaired Restructured and Accruing loans are graded seven or better based on the above definitions. If  restructured loan is graded as eight or nine, it is reported as Impaired Nonaccrual, or Doubtful Nonaccrual, respectively.

For commercial loans graded eight and nine and consumer and residential mortgage loans reported in nonaccrual, interest income is generally not recognized until the loan improves and is returned to accrual status. In some cases, if the loan is well secured and the borrower’s ability to support the loan payments has improved, such as in the case of a restructured nonaccrual loan, interest income may be recognized on a cash basis while the loan is in nonaccrual status.

For Consumer and Residential Mortgage Loan Segments, loans are classified by risk based on current delinquency and nonaccrual status. These segments of loans will contain a separate class for restructured loans, if they exist.

The following credit quality indicators provide a system for distribution of our loan portfolio in a manner consistent with the previously described loan grading system and for use in the determination of our loan loss allowance. This presentation differs somewhat by loan category from classification of loans presented elsewhere in our regulatory reports and within this report. These variations primarily relate to how real estate loans are analyzed internally to determine the adequacy of the loan loss allowance, versus how we are required to report real estate loans for regulatory purposes.

Credit Quality Indicators:

Loans at period end were as follows:
(In Thousands of Dollars)	September 30, 2011		December 31, 2010
Commercial & Industrial
Pass loans	$	123,335	$	143,805
Watch loans		19,559		12,727
Special mention loans		8,093		4,267
Substandard loans		3,907		1,561
Impaired restructured and accruing loans		2,081		182
Impaired nonaccrual loans		2,365		1,649
Doubtful nonaccrual loans		0		141
Total Commercial & Industrial		159,340		164,332
Commercial Real Estate
Pass loans	$	369,786	$	394,674
Watch loans		54,437		50,590
Special mention loans		23,240		31,310
Substandard loans		6,143		8,320
Impaired restructured and accruing loans		11,643		5,780
Impaired nonaccrual loans		14,763		17,729
Doubtful nonaccrual loans		0		882
Total Commercial Real Estate		480,012		509,285
First lien residential mortgage loans
Performing loans	$	191,463	$	192,298
Loans > 60 days past due		1,877		2,102
Impaired restructured and accruing loans		4,725		4,205
Nonaccrual loans		4,208		5,160
Total First lien residential mortgage loans		202,273		203,765
Junior lien residential mortgage loans
Performing loans	$	69,541	$	75,590
Loans > 60 days past due		301		148
Nonaccrual loans		562		555
Total Junior lien residential mortgage loans		70,404		76,293
Consumer Loans
Performing loans	$	76,612	$	77,472
Loans > 60 days past due		175		289
Nonaccrual loans		237		184
Total Consumer Loans		77,024		77,945
Total Loans	$	989,053	$	1,031,620

Allowance for Loan Losses

The allowance for loan losses is determined based on management’s estimate of probable losses incurred within the loan portfolio as of the balance sheet date. We determine the amount of the allowance for loan losses based on periodic evaluation of the loan portfolios and other relevant factors. This evaluation is inherently subjective and requires material estimates, which are subject to change. Factors that are considered in the evaluation of individual, and pools of loans, include: historical loss experience; likelihood of default; liquidation value of a loan’s underlying collateral; timing and amounts of expected future cash flows; and our exposure to loss in the event of default. We further estimate the impact of qualitative factors that may cause future losses to differ from historical experience. Such factors include: changes in credit quality, macro economic impacts on our customers, and changes in underwriting standards.

Our historical loss experience is determined based on actual losses incurred over the previous twelve quarters. We utilize a method of averaging these losses whereby we place a heavier emphasis on more recent experience. Our model provides  a 50% weighting on the most recent four quarters, 30% weighting on the middle four quarters, and 20% weighting on the oldest four quarters.

The loan portfolio is segmented into five loan types: commercial and industrial loans; commercial real estate loans; consumer loans; residential mortgages – first liens; and residential mortgage – junior liens. These segments are further grouped by credit quality classifications.

The segments comprising commercial and industrial loans and commercial real estate loans are classified based on the loan grading system described above. We group loans rated as one through four together into one class of Pass loans. Commercial and industrial and commercial real estate loans graded as Pass and Watch are assigned a unique pooled loss rate based on historical losses incurred over the prior three years as described above. We adjust the calculated historical loss rate up or down based on current developments, that in management’s judgment are not reflected in the historical losses of the company. The current outstanding balance for each of these classes of loans is then multiplied by the adjusted historical loss rate to determine the amount of allowance for loan losses to reserve on that pool of loans.

Loans graded special mention use a shorter 12 month loss history to determine the loss rate. Losses over the preceding 12 month period are divided by the average balance outstanding of substandard and impaired loans to determine a historical loss rate. That calculated historical loss rate is multiplied by a probability factor to determine a loss rate to be applied to this class of loans. The probability factor is determined from an analysis of the migration of special mention loans to more severe risk classes over the preceding 12 month period.

Loans graded as substandard use the shorter 12 month loss history to determine the loss rate. Losses over the preceding 12 month period are divided by the average balance outstanding of substandard and impaired loans to determine a historical loss rate. The calculated historical loss rate, without adjustment for migration, is then multiplied times the outstanding balance of substandard loans to determine the amount of allowance for loan losses to provide for this class of loans.

Loans graded as impaired nonaccrual, impaired doubtful, and impaired restructured and accruing are individually analyzed for loan losses. An allocated reserve is established within the allowance for loan losses for the difference between the carrying value of the loan and its determined collectable value. To determine the collectable value of the loan, the present value of expected cash flows, the collateral value, or some combination of the two is used. The allocated reserve is established as the difference between the carrying value of the loan and the collectable value.

For consumer and residential loan segments, loans that are current, or less than 60 days past due are assigned a unique historical loss rate as described above for commercial Pass and Watch loans. For loans that are more than 60 days past due including nonaccrual loans, a loss rate is determined based on charge offs within the last 12 months, divided by the sum of the average balance of loans 60 days or more past due and nonaccrual loans. These loss rates are multiplied by the outstanding balances in each unique loan segment at the end of the reporting period to determine the amount of allowance for loan loss.

For restructured loans where the bank has granted a rate concession, an additional amount is added to the loan loss reserve that represents the difference in the present value of the cash flows between the original terms and the new terms of the modified loan, using the original interest rate of the loan as a discount rate. Any change in the present value of the loan due to passage of time is reflected as an adjustment to provision for loan loss expense.

After each of the steps outlined above is completed, the results are aggregated and compared with the existing balance of the allowance for loan losses. If the aggregation is greater than the balance, the allowance for loan losses is increased through a charge to earnings on the provision for loan losses line. If the resulting aggregation is below the current balance of the allowance for loan losses, management will determine, based upon the number, potential impact, and uncertainty of the estimates contained within the process whether the unallocated reserve is excessive. If in management’s judgment the unallocated reserve exceeds a level deemed prudent given the inherent uncertainty of these issues, a reversal of the provision for loan losses may be recorded.

The following table provides a breakdown of our loan portfolio by the primary credit quality indicators we use in the determination of our allowance for loan losses.

Allowance for credit losses and recorded investment in financing receivables:

(In Thousands of Dollars)
Nine months ending September 30, 2011	Commercial and Industrial			Commercial Real Estate			First Lien Residential Mortgages			Junior Lien Residential Mortgages			Consumer Loans			Unallocated			Total
Allowance for Credit Losses:
Beginning balance	$	3,024		$	12,375		$	3,960		$	774		$	1,162		$	136		$	21,431
Provision for loan losses		1,855			4,379			3,544			(72	)		504			516			10,726
Loans charged off		(1,468	)		(6,903	)		(2,470	)		(148	)		(730	)		(0	)		(11,719	)
Recoveries		158			453			112			0			222			0			945
Ending balance	$	3,569		$	10,304		$	5,146		$	554		$	1,158		$	652		$	21,383
Ending balance: individually evaluated for impairment		1,311			2,382			0			0			0			-			3,693
Ending balance: collectively evaluated for impairment		2,258			7,922			5,146			554			1,158			652			17,690
Financing Receivables:
Ending balance		159,340			480,012			202,273			70,404			77,024			-			989,053
Ending balance: individually evaluated for impairment		4,445			26,405			0			0			0			-			30,850
Ending balance: collectively evaluated for impairment		154,895			453,607			202,273			70,404			77,024			-			958,203
Nine months ending September 30, 2010
Allowance for Credit Losses:
Beginning balance	$	3,640		$	10,473		$	2,502		$	967		$	1,525		$	7		$	19,114
Provision for loan losses		410			4,414			2,525			88			95			1,091			8,623
Loans charged off		(1,132	)		(4,215	)		(1,419	)		(175	)		(802	)		(0	)		(7,743	)
Recoveries		265			26			119			0			322			0			732
Ending balance	$	3,183		$	10,698		$	3,727		$	880		$	1,140		$	1,098		$	20,726
Ending balance: individually evaluated for impairment		172			3,044			0			0			0			-			3,216
Ending balance: collectively evaluated for impairment		3,011			7,654			3,727			880			1,140			1,098			17,510
Financing Receivables:
Ending balance		167,056			514,222			206,169			79,255			83,174			-			1,049,876
Ending balance: individually evaluated for impairment		1,214			21,564			0			0			0			-			22,778
Ending balance: collectively evaluated for impairment		165,842			492,658			206,169			79,255			83,174			-			1,027,098

Age Analysis of Past Due Loans excluding nonaccrual loans:

(In thousands of dollars)
At September 30, 2011	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 days and accruing
Commercial and Industrial	$	1,020	$	1,686	$	0	$	2,706	$	153,002	$	159,340	$	0
Commercial Real Estate		1,230		1,702		799		3,731		464,074		480,012		799
Residential Mortgages 1st Liens		556		1,186		584		2,326		195,739		202,273		584
Residential Mortgages Junior Liens		358		301		0		659		69,183		70,404		0
Consumer		734		103		72		909		75,878		77,024		72
Total	$	3,898	$	4,978	$	1,455	$	10,331	$	957,876	$	989,053	$	1,455
At December 31, 2010
Commercial and Industrial	$	916	$	400	$	0	$	1,316	$	159,532	$	164,413	$	0
Commercial Real Estate		3,514		981		18		4,513		352,615		373,996		18
Residential Mortgages 1st Liens		1,025		1,529		573		3,127		349,086		357,402		573
Residential Mortgages Junior Liens		628		148		0		776		74,934		76,266		0
Consumer		703		273		15		991		58,368		59,543		15
Total	$	6,786	$	3,331	$	606	$	10,723	$	994,535	$	1,031,620	$	606

Impaired loans were as follows:

(In Thousands of Dollars)
September 30, 2011	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Period end loans with no allocated allowance for loan losses
Commercial and Industrial	$	3,588	$	4,269		0	$	1,502	$	37
Commercial Real Estate		16,709		21,078		0		12,571		306
Residential Mortgages 1st Liens		8,933		9,731		0		9,009		234
Residential Mortgages Junior Liens		562		562		0		505		0
Consumer		237		254		0		188		4
Total	$	30,029	$	35,894	$	0	$	23,773	$	581
Period end loans with allocated allowance for loan losses
Commercial and Industrial	$	527	$	879	$	331	$	723	$	0
Commercial Real Estate		7,622		11,097		2,075		8,648		0
Residential Mortgages 1st Liens		0		0		0		0		0
Residential Mortgages Junior Liens		0		0		0		0		0
Consumer		0		0		0		0		0
Total	$	8,149	$	11,976	$	2,406	$	9,371	$	0
Total
Commercial and Industrial	$	4,115	$	5,148	$	331	$	2,225	$	37
Commercial Real Estate		24.331		32,175		2,075		21,219		306
Residential Mortgages 1st Liens		8,933		9,731		0		9,009		234
Residential Mortgages Junior Liens		562		562		0		505		0
Consumer		237		237		0		188		4
Total	$	38,178	$	47,870	$	2,406	$	33,144	$	581
December 31, 2010
Period end loans with no allocated allowance for loan losses
Commercial and Industrial	$	476	$	564		0	$	1,121	$	0
Commercial Real Estate		10,142		11,718		0		12,432		158
Residential Mortgages 1st Liens		9,365		9,959		0		7,721		253
Residential Mortgages Junior Liens		555		555		0		295		1
Consumer		134		165		0		200		5
Total	$	20,672	$	22,961		0	$	21,769	$	417
Period end loans with allocated allowance for loan losses
Commercial and Industrial	$	693	$	1,978	$	804	$	438	$	0
Commercial Real Estate		9,725		16,614		4,532		8,724		125
Residential Mortgages 1st Liens		0		0		0		0		0
Residential Mortgages Junior Liens		0		0		0		0		0
Consumer		0		0		0		0		0
Total	$	10,418	$	18.592	$	5,336	$	9,162	$	125
Total
Commercial and Industrial	$	1,169	$	2,544	$	804	$	1,559	$	0
Commercial Real Estate		19,867		28,332		4,532		21,156		283
Residential Mortgages 1st Liens		9,365		9,959		0		7,721		253
Residential Mortgages Junior Liens		555		555		0		295		1
Consumer		134		165		0		200		5
Total	$	31,090	$	41,553	$	5,336	$	30,931	$	542

Loan Modifications as of the period ending:

(In thousands of dollars)	Troubled Debt Restructurings						Troubled Debt Restructurings that Subsequently Defaulted
	Number of contracts		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment		Number of contracts		Recorded investment
September 30, 2011
Commercial and industrial		4	$	2,045	$	2,035		3	$	652
Commercial real estate		25		11,639		10,623		11		1,768
Residential 1st liens		56		5,414		5,315		13		775
Residential junior liens		1		10		9		0		0
Consumer		0		0		0		0		0
December 31, 2010
Commercial and industrial		3	$	1,962	$	1,413		1	$	709
Commercial real estate		4		1,341		922		3		602
Residential 1st liens		26		2,933		2,608		7		493
Residential junior liens		0		0		0		0		0
Consumer		0		0		0		0		0

Financing Receivables on Nonaccrual Status were as follows:

(In Thousands of Dollars)	September 30, 2011		December 31, 2010
Nonaccrual loans at period end
Commercial and Industrial	$	3,632	$	3,565
Commercial Real Estate		12,207		16,868
Residential Mortgages 1st Liens		4,208		5.189
Residential Mortgages Junior Liens		562		556
Consumer		237		184
Total nonaccrual loans	$	20,846	$	26,362