Reserve for loan losses

The Company has processes in place which require periodic reviews of individual loans within the loan portfolio. These processes assess, among other criteria, adherence to certain lending policies and procedures designed to maintain an acceptable level of risk in the portfolio. A portfolio reporting system supplements individual loan reviews by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions. Management reviews and approves all loan related policies and procedures on a regular basis (generally, at least annually).

At June 30, 2011, the reserve for credit losses (reserve for loan losses and reserve for unfunded commitments) was approximately $41.7 million or 3.7% of outstanding loans compared to $43.4 million or 3.7% at March 31, 2011. The unallocated reserve at June 30, 2011 was $2.7 million compared to $0.9 million at March 31, 2011. The primary reason for the increase in the unallocated reserve was uncertainty related to the potential effects of planned enhancements to the Company’s model for calculating the reserve for loan losses with respect to creating historical loss rates to be applied against loan risk-ratings.

Commercial real estate (“CRE”) loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operations of the real property securing the loan or the business conducted on the property securing the loan. CRE loans may be more adversely affected by conditions in the real estate markets or in the general economy than other loan types.

With respect to loans to developers and builders that are secured by CRE, the Company generally requires the borrower to have an existing relationship with the Company and a historical record of successful projects. Construction loans are underwritten considering the feasibility of the project, independent “as-completed” appraisals, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and final property values associated with the completed project, and actual results may differ from these estimates. Construction loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved third-party long-term lenders, sales of the developed property, or else may be dependent on an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.

Residential real estate loans are generally secured by first mortgages, and are exposed to the risk that the collateral securing these loans may fluctuate in value due to economic or individual performance factors.

Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as forecasted and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Consumer loans are loans made to purchase personal property such as automobiles, boats, and recreational vehicles. The terms and rates are established periodically by management. Consumer loans tend to be relatively small and the amounts are spread across many individual borrowers, thereby minimizing the risk of loss.

For purposes of analyzing loan portfolio credit quality and determining the reserve for loan losses, the Company determines loan portfolio segments and classes based on the nature of the underlying loan collateral.

Transactions in the reserve for loan losses and unfunded loan commitments, by portfolio segment, for the six months ended June 30, 2011 were as follows (dollars in thousands):

	Commerical real estate			Construction			Residential real estate			Commercial and industrial			Consumer			Unallocated		Total

Balance at beginning of year	$	14,338		$	12,652		$	4,115		$	12,220		$	2,966		$	377	$	46,668
Loan loss provision		508			2,087			387			1,763			552			2,203		7,500
Recoveries		96			261			102			1,002			180			-		1,641
Loans charged off		(2,060	)		(4,064	)		(908	)		(6,937	)		(1,050	)		-		(15,019	)
Balance at end of period	$	12,882		$	10,936		$	3,696		$	8,048		$	2,648		$	2,580	$	40,790

Reserve for unfunded loan commitments
Balance at beginning of year	$	40		$	-		$	101		$	523		$	241		$	36	$	941
Provision for unfunded loan commitments		-			-			-			-			-			-		-
Balance at end of period	$	40		$	-		$	101		$	523		$	241		$	36	$	941

Reserve for credit losses
Reserve for loan losses	$	12,882		$	10,936		$	3,696		$	8,048		$	2,648		$	2,580	$	40,790
Reserve for unfunded loan commitments		40			-			101			523			241			36		941
Total reserve for credit losses	$	12,922		$	10,936		$	3,797		$	8,571		$	2,889		$	2,616	$	41,731

Summary transactions in the reserve for loan losses and unfunded loan commitments for the six months ended June 30, 2010 were as follows (dollars in thousands):

	Total

Balance at beginning of year	$	58,586
Loan loss provision		16,000
Recoveries		7,259
Loans charged off		(24,115	)
Balance at end of period	$	57,730

Reserve for unfunded loan commitments
Balance at beginning of year	$	704
Provision for unfunded loan commitments		237
Balance at end of period	$	941

Reserve for credit losses
Reserve for loan losses	$	57,730
Reserve for unfunded loan commitments		941
Total reserve for credit losses	$	58,671

An individual loan is impaired when, based on current information and events, management believes that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. The following table presents information, by portfolio segment, on the loans evaluated individually for impairment and collectively evaluated for impairment in the reserve for loan losses at June 30, 2011 and December 31, 2010 (dollars in thousands):

	Reserve for loan losses						Recorded investment in loans
	Individually evaluated for impairment		Collectively evaluated for impairment		Total		Individually evaluated for impairment		Collectively evaluated for impairment		Total
June 30, 2011
Commercial real estate:
Owner occupied	$	1,670	$	2,312	$	3,982	$	28,533	$	270,087	$	298,620
Non-owner occupied		1,158		7,742		8,900		35,957		331,428		367,385
Total commercial real estate loans		2,828		10,054		12,882		64,490		601,515		666,005
Construction:
1-4 Family		-		187		187		1,640		3,702		5,342
Other		2,561		8,188		10,749		60,064		64,256		124,320
Total construction loans		2,561		8,375		10,936		61,704		67,958		129,662
Residential real estate:
Term		200		1,260		1,460		8,278		36,237		44,515
Line of credit and other		416		1,820		2,236		1,475		52,383		53,858
Total residential real estate loans		616		3,080		3,696		9,753		88,620		98,373
Commerical and industrial		1,006		7,042		8,048		22,451		168,335		190,786
Consumer		-		2,648		2,648		732		43,174		43,906
	$	7,011	$	31,199		38,210	$	159,130	$	969,602	$	1,128,732
Unallocated						2,580
					$	40,790

December 31, 2010
Commercial real estate:
Owner occupied	$	1,422	$	2,275	$	3,697	$	24,684	$	291,039	$	315,723
Non-owner occupied		1,242		9,399		10,641		33,184		363,125		396,309
Total commercial real estate loans		2,664		11,674		14,338		57,868		654,164		712,032
Construction:
1-4 Family		-		339		339		1,337		6,186		7,523
Other		10		12,303		12,313		43,913		107,027		150,940
Total construction loans		10		12,642		12,652		45,250		113,213		158,463
Residential real estate:
Term		110		1,728		1,838		2,164		43,041		45,205
Line of credit and other		-		2,278		2,278		544		56,737		57,281
Total residential real estate loans		110		4,006		4,116		2,708		99,778		102,486
Commerical and industrial		4,091		8,129		12,220		24,998		180,694		205,692
Consumer		-		2,966		2,966		-		47,687		47,687
	$	6,875	$	39,417		46,292	$	130,824	$	1,095,536	$	1,226,360
Unallocated						376
					$	46,668

The Company uses credit risk ratings which reflect the Bank’s assessment of a loan’s risk or loss potential. The Bank’s credit risk rating definitions along with applicable borrower characteristics for each credit risk rating are as follows:

Acceptable

The borrower is a reasonable credit risk and demonstrates the ability to repay the loan from normal business operations. Loans are generally made to companies operating in sound industries and markets with a normal competitive environment. The borrower tends to be involved in regional or local markets with adequate market share. Financial performance has been consistent in normal economic times and has been average or better than average for its industry.

The borrower may have some vulnerability to downturns in the economy due to marginally satisfactory working capital and debt service cushion. Availability of alternate financing sources may be limited or nonexistent. In certain cases, management, although less experienced, is considered capable. Also, in some cases, management may have limited depth or continuity. An adequate primary source of repayment is identified while secondary sources may be illiquid, more speculative, less readily identified, or reliant upon collateral liquidation. Loan agreements will be well defined, including several financial performance covenants and detailed operating covenants. This category also includes commercial loans to individuals with average or better capacity to repay.

Watch

Loans are graded Watch when they have temporary situations which cause the level of risk to be increased until the situation has been corrected. These situations may involve one or more weaknesses that could, if not corrected within a short period of time, jeopardize the full repayment of the debt. In general, loans in this category remain adequately protected by current sound net worth, paying capacity of the borrower, or pledged collateral.

Special Mention

A Special Mention credit has potential weaknesses that may, if not checked or corrected, weaken the loan or inadequately protect the Bank’s position at some future date. Loans in this category are currently deemed by management of the Bank to be protected but reflect potential problems that warrant more than the usual management attention but do not justify a Substandard classification.

Substandard

Substandard loans are those inadequately protected by the current sound net worth and paying capacity of the obligor and/or by the value of the pledged collateral, if any. Substandard loans have a high probability of payment default or they have other well defined weaknesses. They require more intensive supervision and are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity, or marginal capitalization. Repayment may depend on collateral or other credit risk mitigants.

Commercial real estate loans are classified Substandard when well-defined weaknesses are present which jeopardize the orderly liquidation of the loan. Well-defined weaknesses include a project’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time, and/or the project’s failure to fulfill economic expectations. These loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

In addition, Substandard loans also include impaired loans. Such loans bear all of the characteristics of Substandard loans as described above, but with the added characteristic that the likelihood of full collection of interest and principal may be uncertain. Impaired loans include loans that may be adequately secured by collateral but the borrower is unable to maintain regularly scheduled interest payments.

The following table presents, by portfolio class, credit risk profile by internally assigned grades at June 30, 2011 and December 31, 2010 (dollars in thousands):

	Loan Grades
	Acceptable		Watch		Special Mention		Substandard		Total
June 30, 2011
Commercial real estate:
Owner occupied	$	222,092	$	11,637	$	27,086	$	37,805	$	298,620
Non-owner occupied		268,570		20,078		35,977		42,760		367,385
Total commercial real estate loans		490,662		31,715		63,063		80,565		666,005
Construction:
1-4 Family		681		-		437		4,224		5,342
Other		36,134		19,641		3,389		65,156		124,320
Total construction loans		36,815		19,641		3,826		69,380		129,662
Residential real estate:
Term		33,048		1,610		3,180		6,677		44,515
Line of credit and other		49,289		408		980		3,181		53,858
Total residential real estate loans		82,337		2,018		4,160		9,858		98,373
Commerical and industrial		136,937		5,536		11,575		36,738		190,786
Consumer		42,824		1		620		461		43,906
	$	789,575	$	58,911	$	83,244	$	197,002	$	1,128,732

December 31, 2010
Commercial real estate:
Owner occupied	$	245,775	$	12,741	$	22,213	$	34,994	$	315,723
Non-owner occupied		289,670		41,105		21,318		44,216		396,309
Total commercial real estate loans		535,445		53,846		43,531		79,210		712,032
Construction:
1-4 Family		4,826		467		500		1,730		7,523
Other		65,165		20,942		6,362		58,471		150,940
Total construction loans		69,991		21,409		6,862		60,201		158,463
Residential real estate:
Term		36,752		1,761		3,218		3,474		45,205
Line of credit and other		52,848		408		1,073		2,952		57,281
Total residential real estate loans		89,600		2,169		4,291		6,426		102,486
Commerical and industrial		144,055		7,350		12,158		42,129		205,692
Consumer		46,465		116		637		469		47,687
	$	885,556	$	84,890	$	67,479	$	188,435	$	1,226,360

The following table presents, by portfolio class, an age analysis of past due loans, including loans placed on non-accrual at June 30, 2011 and December 31, 2010 (dollars in thousands):

	30-89 days past due		90 days or more past due		Total past due		Current		Total loans
June 30, 2011
Commercial real estate:
Owner occupied	$	2,097	$	4,958	$	7,055	$	291,565	$	298,620
Non-owner occupied		2,042		3,887		5,929		361,456		367,385
Total commercial real estate loans		4,139		8,845		12,984		653,021		666,005
Construction:
1-4 Family		244		1,397		1,641		3,701		5,342
Other		7,042		21,780		28,822		95,498		124,320
Total construction loans		7,286		23,177		30,463		99,199		129,662
Residential real estate:
Term		3,452		1,270		4,722		39,793		44,515
Line of credit and other		101		247		348		53,510		53,858
Total residential real estate loans		3,553		1,517		5,070		93,303		98,373
Commerical and industrial		2,316		9,211		11,527		179,259		190,786
Consumer		95		43		138		43,768		43,906
	$	17,389	$	42,793	$	60,182	$	1,068,550	$	1,128,732

December 31, 2010
Commercial real estate:
Owner occupied	$	5,313	$	5,405	$	10,718	$	305,005	$	315,723
Non-owner occupied		16,706		10,263		26,969		369,340		396,309
Total commercial real estate loans		22,019		15,668		37,687		674,345		712,032
Construction:
1-4 Family		754		976		1,730		5,793		7,523
Other		1,857		28,695		30,552		120,388		150,940
Total construction loans		2,611		29,671		32,282		126,181		158,463
Residential real estate:
Term		617		1,092		1,709		43,496		45,205
Line of credit and other		453		404		857		56,424		57,281
Total residential real estate loans		1,070		1,496		2,566		99,920		102,486
Commerical and industrial		2,129		14,126		16,255		189,437		205,692
Consumer		157		7		164		47,523		47,687
	$	27,986	$	60,968	$	88,954	$	1,137,406	$	1,226,360

Loans contractually past due 90 days or more on which the Company continued to accrue interest were insignificant at June 30, 2011 and December 31, 2010.

Total impaired loans at June 30, 2011 and December 31, 2010 were as follows (dollars in thousands):

	June 30, 2011		December 31, 2010
Impaired loans with an associated allowance	$	86,222	$	52,004
Impaired loans without an associated allowance		72,908		78,820
Total recorded investment in impaired loans	$	159,130	$	130,824
Amount of the reserve for loan losses allocated to impaired loans	$	7,011	$	6,875

The following table presents information related to impaired loans, by portfolio class, at June 30, 2011 and December 31, 2010 (dollars in thousands):

	Impaired loans
	With a related allowance		Without a related allowance		Total recorded balance		Unpaid principal balance		Related allowance
June 30, 2011
Commercial real estate:
Owner occupied	$	21,110	$	7,423	$	28,533	$	28,560	$	1,670
Non-owner occupied		31,035		4,922		35,957		42,039		1,158
Total commercial real estate loans		52,145		12,345		64,490		70,599		2,828
Construction:
1-4 Family		-		1,640		1,640		1,702		-
Other		20,174		39,890		60,064		82,079		2,561
Total construction loans		20,174		41,530		61,704		83,781		2,561
Residential:
Term		3,295		4,983		8,278		10,766		200
Line of credit and other		949		526		1,475		1,475		416
Total residential loans		4,244		5,509		9,753		12,241		616
Commerical and industrial loans		9,659		12,792		22,451		23,709		1,006
Consumer loans		-		732		732		732		-
	$	86,222	$	72,908	$	159,130	$	191,062	$	7,011

December 31, 2010
Commercial real estate:
Owner occupied	$	18,051	$	6,633	$	24,684	$	25,493	$	1,422
Non-owner occupied		22,167		11,017		33,184		39,105		1,242
Total commercial real estate loans		40,218		17,650		57,868		64,598		2,664
Construction:
1-4 Family		-		1,337		1,337		1,541		-
Other		273		43,640		43,913		66,324		10
Total construction loans		273		44,977		45,250		67,865		10
Residential:
Term		756		1,408		2,164		4,600		110
Line of credit and other		-		544		544		544		-
Total residential loans		756		1,952		2,708		5,144		110
Commerical and industrial loans		10,757		14,241		24,998		26,529		4,091
	$	52,004	$	78,820	$	130,824	$	164,136	$	6,875

The average recorded investment in impaired loans was approximately $133.7 million and $140.2 million for the six months ended June 30, 2011 and 2010, respectively. Interest income recognized for cash payments received on impaired loans for the six and three months ended June 30, 2011 and 2010 was insignificant.

At June 30, 2011 and December 31, 2010, the remaining commitments to lend on loans accounted for as troubled debt restructurings (“TDRs”) were insignificant.

The following table presents information with respect to non-performing assets at June 30, 2011 and December 31, 2010 (dollars in thousands):

	June 30, 2011		December 31, 2010
Loans on nonaccrual status	$	60,827	$	80,997
Loans past due 90 days or more but not on nonaccrual status		274		7
OREO, net		37,112		39,536
Total non-performing assets	$	98,213	$	120,540

The following table presents information with respect to the Company’s non-performing assets, by portfolio class, at June 30, 2011 and December 31, 2010 (dollars in thousands):

	June 30, 2011			December 31, 2010
Loans on nonaccrual status:
Commercial real estate:
Owner occupied	$	5,779		$	6,510
Non-owner occupied		3,928			10,883
Total commercial real estate loans		9,707			17,393
Construction:
1-4 Family		1,640			1,337
Other		36,347			43,493
Total construction loans		37,987			44,830
Residential real estate:
Term		1,497			1,408
Line of credit and other		1,458			544
Total residential real estate loans		2,955			1,952
Commerical and industrial		10,158			16,822
Consumer		20			-
Total non-accrual loans		60,827			80,997

Accruing loans which are contractually past due 90 days or more		274			7
Total of nonaccrual and 90 days past due loans		61,101			81,004

OREO, net		37,112			39,536
Total non-performing assets (1)	$	98,213		$	120,540
TDR loans on accrual status (2)	$	92,491		$	43,283

Nonaccrual and 90 days or more past due on loans as a percentage of loans		5.41	%		6.61	%

Nonaccrual and 90 days or more past due loans as a percentage of total assets		3.91	%		4.72	%

Non-performing assets as a percentage of total assets		6.29	%		7.02	%
Total loans (3)	$	1,128,732		$	1,226,360
Total assets	$	1,562,559		$	1,716,458

(1)

Does not include TDR loans on accrual status.

(2)

Does not include TDR loans reported as nonaccrual totaling $17,917 and $19,539, respectively, as of June 30, 2011 and December 2010.

(3)

Includes loans held for sale and is before deferred loan fees and the reserve for loan losses.

At June 30, 2011, the Bank had approximately $186.1 million in outstanding commitments to extend credit, compared to approximately $191.2 million at December 31, 2010.