Loans Receivable and Related Allowance for Loan Losses

The Corporation’s loans receivable as of the respective dates are summarized as follows:

(Dollar amounts in thousands)	June 30,		December 31,
	2013		2012

Mortgage loans on real estate:
Residential first mortgages	$	93,338	$	97,246
Home equity loans and lines of credit		86,774		85,615
Commercial real estate		97,168		98,823
		277,280		281,684
Other loans:
Commercial business		51,337		45,581
Consumer		10,344		11,886
		61,681		57,467

Total loans, gross		338,961		339,151
Less allowance for loan losses		4,670		5,350
Total loans, net	$	334,291	$	333,801

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of June 30, 2013:

(Dollar amounts in thousands)
	Impaired Loans with Specific Allowance
							For the three months
	As of June 30, 2013						ended June 30, 2013
											Cash Basis
	Unpaid						Average		Interest Income		Interest
	Principal		Recorded		Related		Recorded		Recognized		Recognized
	Balance		Investment		Allowance		Investment		in Period		in Period

Residential first mortgages	$	81	$	81	$	20	$	40	$	2	$	2
Home equity and lines of credit		-		-		-		-		-		-
Commercial real estate		3,665		2,724		214		3,364		5		5
Commercial business		-		-		-		-		-		-
Consumer		-		-		-		-		-		-
Total	$	3,746	$	2,805	$	234	$	3,404	$	7	$	7

	For the six months
	ended June 30, 2013
					Cash Basis
	Average		Interest Income		Interest
	Recorded		Recognized		Recognized
	Investment		in Period		in Period

Residential first mortgages	$	27	$	2	$	2
Home equity and lines of credit		-		-		-
Commercial real estate		3,599		9		9
Commercial business		-		-		-
Consumer		-		-		-
Total	$	3,626	$	11	$	11

	Impaired Loans with No Specific Allowance
					For the three months
	As of June 30, 2013				ended June 30, 2013
									Cash Basis
	Unpaid				Average		Interest Income		Interest
	Principal		Recorded		Recorded		Recognized		Recognized
	Balance		Investment		Investment		in Period		in Period

Residential first mortgages	$	-	$	-	$	-	$	-	$	-
Home equity and lines of credit		-		-		-		-		-
Commercial real estate		1,061		662		563		2		2
Commercial business		356		356		360		-		-
Consumer		1,348		1,348		1,469		-		-
Total	$	2,765	$	2,366	$	2,392	$	2	$	2

	For the six months
	ended June 30, 2013
					Cash Basis
	Average		Interest Income		Interest
	Recorded		Recognized		Recognized
	Investment		in Period		in Period

Residential first mortgages	$	-	$	-	$	-
Home equity and lines of credit		-		-		-
Commercial real estate		544		3		3
Commercial business		363		-		-
Consumer		1,529		-		-
Total	$	2,436	$	3	$	3

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of December 31, 2012:

(Dollar amounts in thousands)
	Impaired Loans with Specific Allowance
							For the year ended
	As of December 31, 2012						December 31, 2012
											Cash Basis
	Unpaid						Average		Interest Income		Interest
	Principal		Recorded		Related		Recorded		Recognized		Recognized
	Balance		Investment		Allowance		Investment		in Period		in Period

Residential first mortgages	$	-	$	-	$	-	$	-	$	-	$	-
Home equity and lines of credit		-		-		-		-		-		-
Commercial real estate		4,242		4,068		1,448		2,075		186		16
Commercial business		-		-		-		-		-		-
Consumer		-		-		-		-		-		-
Total	$	4,242	$	4,068	$	1,448	$	2,075	$	186	$	16

	Impaired Loans with No Specific Allowance
					For the year ended
	As of December 31, 2012				December 31, 2012
									Cash Basis
	Unpaid				Average		Interest Income		Interest
	Principal		Recorded		Recorded		Recognized		Recognized
	Balance		Investment		Investment		in Period		in Period

Residential first mortgages	$	-	$	-	$	-	$	-	$	-
Home equity and lines of credit		-		-		-		-		-
Commercial real estate		730		505		690		12		12
Commercial business		394		369		368		5		5
Consumer		1,650		1,650		1,774		-		-
Total	$	2,774	$	2,524	$	2,832	$	17	$	17

Unpaid principal balance includes any loans that have been partially charged off but not forgiven. Accrued interest is not included in the recorded investment in loans based on the amounts not being material.

Troubled debt restructurings (TDR). The Corporation has certain loans that have been modified in order to maximize collection of loan balances. If, for economic or legal reasons related to the customer’s financial difficulties, management grants a concession compared to the original terms and conditions of the loan that it would not have otherwise considered, the modified loan is classified as a TDR. Concessions related to TDRs generally do not include forgiveness of principal balances. The Corporation generally does not extend additional credit to borrowers with loans classified as TDRs.

At June 30, 2013 and December 31, 2012, the Corporation had $2.1 million and $2.3 million, respectively, of loans classified as TDRs, which are included in impaired loans above. At June 30, 2013 and December 31, 2012, the Corporation had $55,000 and $36,000, respectively, of the allowance for loan losses allocated to these specific loans. At June 30, 2012, the Corporation had $796,000 of loans classified as TDRs with $36,000 of the allowance for loan losses allocated to these specific loans.

During the six month period ended June 30, 2013, the Corporation modified a residential mortgage loan with a pre- and post-modification recorded investment of $83,000 as a TDR due to financial difficulties experienced by the borrower. The modification included a reduction in the interest rate from 6.75% to 4.00% and a 65 month extension of the original term. At June 30, 2013, the Corporation had $20,000 of the allowance for loan losses allocated to this specific loan. During the six month period ended June 30, 2012, the Corporation did not modify any additional loans as TDRs.

During the six month periods ended June 30, 2013 and 2012, the Corporation did not have any loans which were modified as TDRs for which there was a payment default within twelve months following the modification.

Credit Quality Indicators. Management categorizes 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.

Commercial real estate and commercial business loans not identified as impaired are evaluated as risk rated pools of loans utilizing a risk rating practice that is supported by a quarterly special asset review. In this review process, strengths and weaknesses are identified, evaluated and documented for each criticized and classified loan and borrower, strategic action plans are developed, risk ratings are confirmed and the loan’s performance status is reviewed.

Management has determined certain portions of the loan portfolio to be homogeneous in nature and assigns like reserve factors for the following loan pool types: residential real estate, home equity loans and lines of credit, and consumer installment and personal lines of credit.

The reserve allocation for risk rated loan pools is developed by applying the following factors:

Historic: Management utilizes a computer model to develop the historical net charge-off experience which is used to formulate the assumptions employed in the migration analysis applied to estimate future losses in the portfolio. Outstanding balance and charge-off information are input into the model and historical loss migration rate assumptions are developed to apply to pass, special mention, substandard and doubtful risk rated loans. A twelve-quarter rolling weighted-average is utilized to anticipate probable incurred losses in the portfolios.

Qualitative: Qualitative adjustment factors for pass, special mention, substandard and doubtful ratings are developed and applied to risk rated loans to allow for: quality of lending policies and procedures; national and local economic and business conditions; changes in the nature and volume of the portfolio; experiences, ability and depth of lending management; changes in trends, volume and severity of past due, nonaccrual and classified loans and loss and recovery trends; quality of loan review systems; concentrations of credit and other external factors.

Management uses the following definitions for risk ratings:

Pass: Loans classified as pass typically exhibit good payment performance and have underlying borrowers with acceptable financial trends where repayment capacity is evident. These borrowers typically would have a sufficient cash flow that would allow them to weather an economic downturn and the value of any underlying collateral could withstand a moderate degree of depreciation due to economic conditions.

Special Mention: Loans classified as special mention are characterized by potential weaknesses that could jeopardize repayment as contractually agreed. These loans may exhibit adverse trends such as increasing leverage, shrinking profit margins and/or deteriorating cash flows. These borrowers would inherently be more vulnerable to the application of economic pressures.

Substandard: Loans classified as substandard exhibit weaknesses that are well-defined to the point that repayment is jeopardized. Typically, the Corporation is no longer adequately protected by both the apparent net worth and repayment capacity of the borrower.

Doubtful: Loans classified as doubtful have advanced to the point that collection or liquidation in full, on the basis of currently ascertainable facts, conditions and value, is highly questionable or improbable.

The following table presents the classes of the loan portfolio summarized by the aggregate pass and the criticized categories of special mention, substandard and doubtful within the Corporation’s internal risk rating system as of June 30, 2013 and December 31, 2012:

(Dollar amounts in thousands)
					Special
	Not Rated		Pass		Mention		Substandard		Doubtful		Total

June 30, 2013:
Residential first mortgages	$	93,068	$	-	$	-	$	270	$	-	$	93,338
Home equity and lines of credit		86,570		-		-		204		-		86,774
Commercial real estate		-		89,049		508		7,611		-		97,168
Commercial business		-		48,076		723		2,538		-		51,337
Consumer		8,996		-		-		1,348		-		10,344
Total	$	188,634	$	137,125	$	1,231	$	11,971	$	-	$	338,961

December 31, 2012:
Residential first mortgages	$	96,713	$	-	$	-	$	533	$	-	$	97,246
Home equity and lines of credit		85,443		-		-		172		-		85,615
Commercial real estate		-		88,944		1,658		6,870		1,351		98,823
Commercial business		-		42,417		2,157		1,007		-		45,581
Consumer		10,236		-		-		1,650		-		11,886
Total	$	192,392	$	131,361	$	3,815	$	10,232	$	1,351	$	339,151

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and nonperforming loans as of June 30, 2013 and December 31, 2012:

(Dollar amounts in thousands)
	Performing						Nonperforming
	Accruing		Accruing		Accruing		Accruing
	Loans Not		30-59 Days		60-89 Days		90 Days +				Total
	Past Due		Past Due		Past Due		Past Due		Nonaccrual		Loans

June 30, 2013:
Residential first mortgages	$	90,251	$	2,530	$	197	$	41	$	319	$	93,338
Home equity and lines of credit		85,968		530		73		61		142		86,774
Commercial real estate		93,974		132		-		-		3,062		97,168
Commercial business		50,618		363		-		-		356		51,337
Consumer		8,990		4		2		-		1,348		10,344
Total loans	$	329,801	$	3,559	$	272	$	102	$	5,227	$	338,961

December 31, 2012:
Residential first mortgages	$	95,001	$	1,272	$	440	$	-	$	533	$	97,246
Home equity and lines of credit		84,592		669		157		-		197		85,615
Commercial real estate		94,485		50		49		21		4,218		98,823
Commercial business		44,915		297		-		-		369		45,581
Consumer		10,172		41		23		-		1,650		11,886
Total loans	$	329,165	$	2,329	$	669	$	21	$	6,967	$	339,151

The following table presents the Corporation’s nonaccrual loans by aging category as of June 30, 2013 and December 31, 2012:

(Dollar amounts in thousands)

	Not		30-59 Days		60-89 Days		90 Days +		Total
	Past Due		Past Due		Past Due		Past Due		Loans

June 30, 2013:
Residential first mortgages	$	89	$	-	$	-	$	230	$	319
Home equity and lines of credit		-		-		-		142		142
Commercial real estate		440		2,283		-		339		3,062
Commercial business		70		-		-		286		356
Consumer		1,348		-		-		-		1,348
Total loans	$	1,947	$	2,283	$	-	$	997	$	5,227

December 31, 2012:
Residential first mortgages	$	-	$	-	$	-	$	533	$	533
Home equity and lines of credit		-		25		-		172		197
Commercial real estate		469		3,386		10		353		4,218
Commercial business		78		-		-		291		369
Consumer		1,650		-		-		-		1,650
Total loans	$	2,197	$	3,411	$	10	$	1,349	$	6,967

An allowance for loan losses (ALL) is maintained to absorb probable incurred losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience and the amount of nonperforming loans.

Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL.

The following table details activity in the ALL and the recorded investment by portfolio segment based on impairment method:

(Dollar amounts in thousands)
			Home Equity
	Residential		& Lines		Commercial		Commercial
	Mortgages		of Credit		Real Estate		Business		Consumer		Total
Three months ended June 30, 2013:
Allowance for loan losses:
Beginning Balance	$	807	$	727	$	3,189	$	702	$	63	$	5,488
Charge-offs		(12)		-		(941)		-		(25)		(978)
Recoveries		-		-		2		-		5		7
Provision		(23)		(106)		297		(25)		10		153
Ending Balance	$	772	$	621	$	2,547	$	677	$	53	$	4,670

Six months ended June 30, 2013:
Allowance for loan losses:
Beginning Balance	$	828	$	730	$	3,090	$	636	$	66	$	5,350
Charge-offs		(17)		-		(941)		-		(56)		(1,014)
Recoveries		1		-		4		-		34		39
Provision		(40)		(109)		394		41		9		295
Ending Balance	$	772	$	621	$	2,547	$	677	$	53	$	4,670

At June 30, 2013:
Ending ALL balance attributable to loans:
Individually evaluated for impairment		20		-		214		-		-		234
Collectively evaluated for impairment		752		621		2,333		677		53		4,436

Total loans:
Individually evaluated for impairment		81		-		3,386		356		1,348		5,171
Collectively evaluated for impairment		93,257		86,774		93,782		50,981		8,996		333,790

At December 31, 2012:
Ending ALL balance attributable to loans:
Individually evaluated for impairment		-		-		1,448		-		-		1,448
Collectively evaluated for impairment		828		730		1,642		636		66		3,902

Total loans:
Individually evaluated for impairment		-		-		4,573		369		1,650		6,592
Collectively evaluated for impairment		97,246		85,615		94,250		45,212		10,236		332,559

Three months ended June 30, 2012:
Allowance for loan losses:
Beginning Balance	$	856	$	413	$	1,723	$	586	$	64	$	3,642
Charge-offs		(15)		(4)		(36)		(10)		(11)		(76)
Recoveries		7		20		2		-		5		34
Provision		4		39		146		(80)		6		115
Ending Balance	$	852	$	468	$	1,835	$	496	$	64	$	3,715

Six months ended June 30, 2012:
Allowance for loan losses:
Beginning Balance	$	832	$	320	$	1,737	$	590	$	57	$	3,536
Charge-offs		(65)		(40)		(36)		(10)		(37)		(188)
Recoveries		83		27		4		15		10		139
Provision		2		161		130		(99)		34		228

Ending Balance	$	852	$	468	$	1,835	$	496	$	64	$	3,715

The allowance for loan losses is based on estimates and actual losses will vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.