NOTE 6. LOANS

Loans are generally stated at the amount of unpaid principal, reduced by unearned discount and allowance for loan losses. Interest on loans is accrued daily on the outstanding balances. Loan origination fees and certain direct loan origination costs are deferred and amortized as adjustments of the related loan yield over its contractual life.

Generally, loans are placed on nonaccrual status when principal or interest is greater than 90 days past due based upon the loan's contractual terms. Interest is accrued daily on impaired loans unless the loan is placed on nonaccrual status. Impaired loans are placed on nonaccrual status when the payments of principal and interest are in default for a period of 90 days, unless the loan is both well-secured and in the process of collection. Interest on nonaccrual loans is recognized primarily using the cost-recovery method. Loans may be returned to accrual status when repayment is reasonably assured and there has been demonstrated performance under the terms of the loan or, if applicable, the terms of the restructured loans.

Commercial-related loans or portions thereof (which are risk-rated) are charged off to the allowance for loan losses when the loss has been confirmed. This determination is made on a case by case basis considering many factors, including the prioritization of our claim in bankruptcy, expectations of the workout/restructuring of the loan and valuation of the borrower's equity. We deem a loss confirmed when a loan or a portion of a loan is classified "loss" in accordance with bank regulatory classification guidelines, which state, "Assets classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted".

Consumer-related loans are generally charged off to the allowance for loan losses upon reaching specified stages of delinquency, in accordance with the Federal Financial Institutions Examination Council policy. For example, credit card loans are charged off by the end of the month in which the account becomes 180 days past due or within 60 days from receiving notification about a specified event (e.g., bankruptcy of the borrower), which ever is earlier. Residential mortgage loans are generally charged off to net realizable value no later than when the account becomes 180 days past due. Other consumer loans, if collateralized, are generally charged off to net realizable value at 120 days past due.

Loans are summarized as follows:


		September 30,		December 31,		September 30,
Dollars in thousands		2012		2011		2011
Commercial	$	88,997	$	99,024	$	90,422
Commercial real estate
Owner-occupied		150,090		158,754		171,192
Non-owner occupied		279,132		270,226		253,538
Construction and development
Land and land development		82,857		93,035		94,023
Construction		2,087		2,936		9,445
Residential real estate
Non-jumbo		215,584		221,733		224,499
Jumbo		62,748		61,535		62,255
Home equity		53,455		50,898		51,025
Consumer		21,290		22,325		22,988
Other		2,513		2,762		2,911
Total loans, net of unearned fees		958,753		983,228		982,298
Less allowance for loan losses		17,820		17,712		17,949
Loans, net	$	940,933	$	965,516	$	964,349

The following table presents the contractual aging of the recorded investment in past due loans by class as of September 30, 2012 and 2011 and December 31, 2011.


	At September 30, 2012
											Recorded
											Investment
	Past Due										> 90 days
Dollars in thousands		30-59 days		60-89 days	> 90 days			Total		Current	and Accruing
Commercial	$	273	$	634	$	1,594	$	2,501	$	86,496	$	-
Commercial real estate
Owner-occupied		216		581		400		1,197		148,893		-
Non-ow ner occupied		513		-		1,882		2,395		276,737		-
Construction and development
Land and land development		17		39		13,412		13,468		69,389		-
Construction		50		-		153		203		1,884		-
Residential mortgage
Non-jumbo		2,681		2,029		2,544		7,254		208,330		-
Jumbo		-		-		15,273		15,273		47,475		-
Home equity		280		5		149		434		53,021		-
Consumer		319		36		46		401		20,889		-
Other		-		-		-		-		2,513		-
Total	$	4,349	$	3,324	$	35,453	$	43,126	$	915,627	$	-


	At December 31, 2011
												Recorded
												Investment
	Past Due											> 90 days
Dollars in thousands		30-59 days		60-89 days	> 90 days			Total		Current		and Accruing
Commercial	$	904	$	324	$	2,544	$	3,772	$	95,252	$	-
Commercial real estate
Ow ner-occupied		4,241		197		664		5,102		153,652		-
Non-ow ner occupied		1,566		1,752		1,705		5,023		265,203		-
Construction and dev elopment
Land and land development		1,539		116		16,392		18,047		74,988		344
Construction		106		-		979		1,085		1,851		-
Residential mortgage
Non-jumbo		4,730		1,624		2,336		8,690		213,043		-
Jumbo		699		-		13,965		14,664		46,871		-
Home equity		-		223		91		314		50,584		-
Consumer		381		144		85		610		21,715		-
Other		-		-		-		-		2,762		-
Total	$	14,166	$	4,380	$	38,761	$	57,307	$	925,921	$	344


					At September 30, 2011
											Recorded
											Investment
	Past Due										> 90 days
Dollars in thousands		30-59 days		60-89 days	> 90 days			Total		Current	and Accruing
Commercial	$	194	$	178	$	2,606	$	2,978	$	87,444	$	-
Commercial real estate
Ow ner-occupied		510		-		1,403		1,913		169,279		-
Non-ow ner occupied		1,926		667		1,308		3,901		249,637		-
Construction and dev elopment
Land and land dev elopment		814		438		4,635		5,887		88,136		-
Construction		-		-		152		152		9,293		-
Residential mortgage
Non-jumbo		3,973		835		3,493		8,301		216,198		-
Jumbo		-		-		1,345		1,345		60,910		-
Home equity		28		132		120		280		50,745		-
Consumer		178		141		77		396		22,592		-
Other		-		-		-		-		2,911		-
Total	$	7,623	$	2,391	$	15,139	$	25,153	$	957,145	$	-

Nonaccrual loans: The following table presents the nonaccrual loans included in the net balance of loans at September 30, 2012, December 31, 2011 and September 30, 2011.


Dollars in thousands		9/30/2012		12/31/2011		9/30/2011
Commercial	$	5,343	$	3,260	$	3,473
Commercial real estate
Owner-occupied		921		2,815		3,451
Non-owner occupied		1,882		4,348		4,948
Construction and development
Land & land development		16,558		22,362		17,354
Construction		203		979		152
Residential mortgage
Non-jumbo		3,122		3,683		3,949
Jumbo		15,272		13,966		2,273
Home equity		415		538		595
Consumer		87		145		87
Other		-		-		-
Total	$	43,803	$	52,096	$	36,282

Impaired loans: Impaired loans include the following:

§ Loans which we risk-rate (consisting of loan relationships having aggregate balances in excess of $2,000,000, or loans exceeding $500,000 and exhibiting credit weakness) through our normal loan review procedures and which, based on current information and events, it is probable that we will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement. Risk-rated loans with insignificant delays or insignificant short falls in the amount of payments expected to be collected are not considered to be impaired.

§ Loans that have been modified in a troubled debt restructuring.

Both commercial and consumer loans are deemed impaired upon being contractually modified in a troubled debt restructuring. Troubled debt restructurings typically result from our loss mitigation activities and occur when we grant a concession to a borrower who is experiencing financial difficulty in order to minimize our economic loss and to avoid foreclosure or repossession of collateral. Once restructured in a troubled debt restructuring, a loan is generally considered impaired until its maturity, regardless of whether the borrower performs under the modified terms. Although such a loan may be returned to accrual status if the criteria set forth in our accounting policy are met, the loan would continue to be evaluated for an asset-specific allowance for loan losses and we would continue to report the loan in the impaired loan table below.

The table below sets forth information about our impaired loans.

Method Used to Measure Impairment of Impaired Loans

Dollars in thousands


							Method used to
Loan Category		9/30/2012		12/31/2011		9/30/2011	measure impairment
Commerical	$	12,411	$	2,969	$	3,043	Fair value of collateral
		-		-		-	Discounted cash flow
Commerical real estate
Owner-occupied		13,248		9,698		10,613	Fair value of collateral
		2,698		2,580		2,591	Discounted cash flow
Non-owner occupied		12,057		9,790		11,397	Fair value of collateral
		-		-		1,791	Discounted cash flow
Construction and development
Land & land development		30,482		29,862		26,360	Fair value of collateral
		656		-		1,525	Discounted cash flow
Construction		-		735		-	Fair value of collateral
Residential mortgage
Non-jumbo		5,461		4,488		5,157	Fair value of collateral
		959		372		1,179	Discounted cash flow
Jumbo		23,094		18,147		14,894	Fair value of collateral
Home equity		219		407		409	Fair value of collateral
Consumer		42		8		-	Fair value of collateral
Total	$	101,327	$	79,056	$	78,959

The following tables present loans individually evaluated for impairment at September 30, 2012, December 31, 2011 and September 30, 2011.


	September 30, 2012
								Average		Interest Income
		Recorded		Unpaid	Related			Impaired		Recognized
Dollars in thousands		Investment		Principal Balance	Allowance			Balance		while impaired

Without a related allowance
Commercial	$	12,059	$	12,075	$	-	$	3,148	$	54
Commercial real estate
Owner-occupied		11,370		11,373		-		8,058		346
Non-owner occupied		8,537		8,540		-		6,349		304
Construction and development
Land & land development		15,624		15,624		-		14,060		524
Construction		-		-		-		-		-
Residential real estate
Non-jumbo		3,987		3,996		-		3,545		135
Jumbo		8,902		8,905		-		6,497		257
Home equity		191		191		-		192		12
Consumer		39		38		-		30		1
Total without a related allowance	$	60,709	$	60,742	$	-	$	41,879	$	1,633

With a related allowance
Commercial	$	336	$	336	$	86	$	299	$	6
Commercial real estate
Owner-occupied		4,573		4,573		241		4,409		209
Non-owner occupied		3,516		3,517		475		3,361		115
Construction and development
Land & land development		15,514		15,514		2,762		15,026		182
Construction		-		-		-		-		-
Residential real estate
Non-jumbo		2,422		2,424		502		1,787		101
Jumbo		14,183		14,189		3,211		13,193		32
Home equity		28		28		28		29		-
Consumer		4		4		4		1		-
Total with a related allowance	$	40,576	$	40,585	$	7,309	$	38,105	$	645

Total
Commercial	$	71,529	$	71,552	$	3,564	$	54,710	$	1,740
Residential real estate		29,713		29,733		3,741		25,243		537
Consumer		43		42		4		31		1
Total	$	101,285	$	101,327	$	7,309	$	79,984	$	2,278


				December 31, 2011
								Average		Interest Income
		Recorded		Unpaid	Related			Impaired		Recognized
Dollars in thousands		Investment		Principal Balance	Allowance			Balance		while impaired

Without a related allowance
Commercial	$	2,074	$	2,076	$	-	$	874	$	10
Commercial real estate
Owner-occupied		9,013		9,034		-		8,132		253
Non-owner occupied		5,599		5,600		-		2,891		116
Construction and development
Land & land development		12,128		12,128		-		9,509		346
Construction		-		-		-		-		-
Residential real estate
Non-jumbo		3,697		3,708		-		2,843		68
Jumbo		15,203		15,204		-		12,626		-
Home equity		194		194		-		99		6
Total without a related allowance	$	47,908	$	47,944	$	-	$	36,974	$	799

With a related allowance
Commercial	$	893	$	893	$	247	$	661	$	1
Commercial real estate
Owner-occupied		3,244		3,244		465		3,588		143
Non-owner occupied		4,190		4,190		456		3,357		87
Construction and development
Land & land development		17,719		17,734		2,901		8,726		40
Construction		735		735		29		2		-
Residential real estate
Non-jumbo		1,150		1,152		209		706		31
Jumbo		2,943		2,943		275		1,349		-
Home equity		213		213		162		125		2
Consumer		8		8		1		-		-
Total with a related allowance	$	31,095	$	31,112	$	4,745	$	18,514	$	304

Total
Commercial	$	55,595	$	55,634	$	4,098	$	37,740	$	996
Residential real estate		23,400		23,414		646		17,748		107
Consumer		8		8		1		-		-
Total	$	79,003	$	79,056	$	4,745	$	55,488	$	1,103


				September 30, 2011
								Average		Interest Income
		Recorded		Unpaid	Related			Impaired		Recognized
Dollars in thousands		Investment		Principal Balance	Allowance			Balance		while impaired

Without a related allowance
Commercial	$	2,739	$	2,741	$	-	$	1,060	$	12
Commercial real estate
Owner-occupied		9,932		9,948		-		7,298		160
Non-owner occupied		8,958		8,961		-		3,489		104
Construction and development
Land & land development		18,266		18,266		-		15,915		257
Construction		-		-		-		-		-
Residential real estate
Non-jumbo		3,976		3,983		-		4,502		123
Jumbo		12,621		12,621		-		12,618		687
Home equity		195		194		-		173		8
Total without a related allowance	$	56,687	$	56,714	$	-	$	45,055	$	1,351

With a related allowance
Commercial	$	302	$	302	$	103	$	73	$	-
Commercial real estate
Owner-occupied		3,255		3,256		465		3,703		107
Non-owner occupied		4,227		4,227		493		3,073		65
Construction and development
Land & land development		9,619		9,619		1,933		3,774		77
Construction		-		-		-		-		-
Residential real estate
Non-jumbo		2,351		2,353		823		1,621		39
Jumbo		2,270		2,273		513		1,666		-
Home equity		215		215		166		95		2
Consumer		-		-		-		-		-
Total with a related allowance	$	22,239	$	22,245	$	4,496	$	14,005	$	290

Total
Commercial	$	57,298	$	57,320	$	2,994	$	38,385	$	782
Consumer		-		-		-		-		-
Residential real estate		21,628		21,639		1,502		20,675		859
Total	$	78,926	$	78,959	$	4,496	$	59,060	$	1,641

A modification of a loan is considered a troubled debt restructuring ("TDR") when a borrower is experiencing financial difficulty and the modification constitutes a concession that we would not otherwise consider. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of both. A loan continues to qualify as a TDR until a consistent payment history or change in the borrower's financial condition has been evidenced, generally no less than twelve months. Included in impaired loans are TDRs of $55,242,000 and $47,770,000 at September 30, 2012 and December 31, 2011, respectively, with no commitments to lend additional funds under these restructurings at either balance sheet date.

The following table presents by class the TDRs that were restructured during the three and nine months ended September 30, 2012. Generally, the modifications were extensions of term, modifying the payment terms from principal and interest to interest only for an extended period, or reduction in interest rate. All TDRs are evaluated individually for allowance for loan loss purposes.


	For the Three Months Ended					For the Nine Months Ended
		September 30, 2012					September 30, 2012
		Pre-modification			Post-modification			Pre-modification		Post-modification
	Number of		Recorded		Recorded	Number of		Recorded		Recorded
dollars in thousands	Modifications		Investment		Investment	Modifications		Investment		Investment
Commercial	-	$	- $		-	3	$	1,109	$	1,117
Commercial real estate
Owner-occupied	-		-		-	-		-		-
Non-owner occupied	1		1,929		1,929	3		4,063		3,685
Construction and development
Land & land development	2		1,927		1,927	3		3,715		2,927
Construction	-		-		-	-		-		-
Residential real estate
Non-jumbo	3		688		688	7		1,245		1,256
Jumbo	-		-		-	3		2,301		2,701
Home equity	-		-		-	-		-		-
Consumer	-		-		-	2		42		42
Total	6	$	4,544	$	4,544	21	$	12,475	$	11,728

The following table presents defaults during the stated period of TDRs that were restructured during the past twelve months. For purposes of these tables, a default is considered as either the loan was past due 30 days or more at any time during the period, or the loan was fully or partially charged off during the period.


	For the Three Months Ended			For the Nine Months Ended
	September 30, 2012			September 30, 2012
	Number		Recorded	Number		Recorded
	of		Investment	of		Investment
dollars in thousands	Defaults		at Default Date	Defaults		at Default Date
Commercial	-	$	-	- $		-
Commercial real estate
Owner-occupied	1		581	1		580
Non-owner occupied	-		-	-		-
Construction and development
Land & land development	-		-	-		-
Construction	-		-	-		-
Residential real estate
Non-jumbo	2		233	2		233
Jumbo	2		4,218	3		4,727
Home equity	-		-	-		-
Consumer	1		34	1		36
Total	6	$	5,066	7	$	5,576

We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. We internally grade all commercial loans at the time of loan origination. In addition, we perform an annual loan review on all non-homogenous commercial loan relationships with an aggregate exposure of $2 million, at which time these loans are re-graded. We use the following definitions for our risk grades:

Pass: Loans graded as Pass are loans to borrowers of acceptable credit quality and risk. They are higher quality loans that do not fit any of the other categories described below.

OLEM (Special Mention): Commercial loans categorized as OLEM are potentially weak. The credit risk may be relatively minor yet represent a risk given certain specific circumstances. If the potential weaknesses are not monitored or mitigated, the asset may weaken or inadequately protect our position in the future.

Substandard: Commercial loans categorized as Substandard are inadequately protected by the borrower's ability to repay, equity, and/or the collateral pledged to secure the loan. These loans have identified weaknesses that could hinder normal repayment or collection of the debt. These loans are characterized by the distinct possibility that we will sustain some loss if the identified weaknesses are not mitigated.

Doubtful: Commercial loans categorized as Doubtful have all the weaknesses inherent in those loans classified as Substandard, with the added elements that the full collection of the loan is improbable and the possibility of loss is high.

Loss: Loans classified as loss are considered to be non-collectible and of such little value that their continuance as a bankable asset is not warranted. This does not mean that the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future.

Loan Risk Profile by Internal Risk Rating


	Construction and Development												Commercial Real Estate
		Land and land
		development				Construction				Commercial				Owner Occupied				Non-Owner Occupied
Dollars in thousands		9/30/2012	12/31/2011			9/30/2012		12/31/2011		9/30/2012		12/31/2011		9/30/2012		12/31/2011		9/30/2012		12/31/2011
Pass	$	44,279	$	47,521	$	1,934	$	1,886	$	75,249	$	84,225	$	149,266	$	143,845	$	262,349	$	253,319
OLEM (Special Mention)		9,137		18,615		-		-		986		6,889		824		5,474		11,719		10,421
Substandard		29,441		26,899		153		1,049		12,762		7,910		-		9,435		5,064		6,486
Doubtful		-		-		-		-		-		-		-		-		-		-
Loss		-		-		-		-		-		-		-		-		-		-
Total	$	82,857	$	93,035	$	2,087	$	2,935	$	88,997	$	99,024	$	150,090	$	158,754	$	279,132	$	270,226

The following table presents the recorded investment in consumer, residential real estate, and home equity loans, which are generally evaluated based on the aging status of the loans, which was previously presented, and payment activity.


				Performing						Nonperforming
Dollars in thousands		9/30/2012		12/31/2011		9/30/2011		9/30/2012		12/31/2011		9/30/2011
Residential real estate
Non-jumbo	$	212,529	$	218,050	$	220,550	$	3,055	$	3,683	$	3,949
Jumbo		47,476		47,570		59,982		15,272		13,965		2,273
Home Equity		53,040		50,360		50,430		415		538		595
Consumer		21,202		22,180		22,901		88		145		87
Other		2,513		2,762		2,911		-		-		-
Total	$	336,760	$	340,922	$	356,774	$	18,830	$	18,331	$	6,904

Loan commitments: ASC Topic 815, Derivatives and Hedging, requires that commitments to make mortgage loans should be accounted for as derivatives if the loans are to be held for sale, because the commitment represents a written option and accordingly is recorded at the fair value of the option liability.