Allowance for Loan Losses & Unfunded Loan Commitments

6 Months Ended

Jun. 30, 2011

Allowance for Loan Losses & Unfunded Loan Commitments

Allowance for Loan Losses & Unfunded Loan Commitments

Note 8.Allowance for Loan Losses & Unfunded Loan Commitments

    Management reviews the level of the allowance for loan losses on a quarterly basis.  The standardized methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves.  The same standard methodology is used, regardless of loan type.  Specific reserves are made to individual impaired loans and troubled debt restructurings, (see Note 1 for additional information on this term).  The general reserve is set based upon a representative average historical net charge-off rate adjusted for certain environmental factors such as: delinquency and impairment trends, charge-off and recovery trends, volume and loan term trends, risk and underwriting policy trends, staffing and experience changes, national and local economic trends, industry conditions and credit concentration changes.

 Beginning in the third quarter of 2009, when calculating the five-year historical net charge-off rate, the Company weights the past three years more heavily due to the higher amount of charge-offs experienced during those years.  All of the environmental factors are ranked and assigned a basis points value based on the following scale: low, low moderate, moderate, high moderate, and high risk.  The factors are evaluated separately for each type of loan.  For example, commercial loans are broken down further into commercial loans, commercial real estate loans, and commercial construction loans.  Each type of loan is risk weighted for each environmental factor based on its individual characteristics. 

 For SBA 7(a), SBA 504 and commercial loans, the estimate of loss based on pools of loans with similar characteristics is made through the use of a standardized loan grading system that is applied on an individual loan level and updated on a continuous basis.  The loan grading system incorporates  reviews of the financial performance of the borrower, including cash flow, debt-service coverage ratio, earnings power, debt level and equity position, in conjunction with an assessment of the borrower's industry and future prospects.  It also incorporates analysis of the type of collateral and the relative loan to value ratio. 

 For residential mortgage and consumer loans,  the estimate of loss is based on pools of loans with similar characteristics.  Factors such as credit score, delinquency status and type of collateral are evaluated.  Factors are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in loss mitigation or credit origination strategies, and adjustments to the reserve factors are made as needed. 

 According to the Company's policy, a loss ("charge-off") is to be recognized and charged to the allowance for loan losses as soon as a loan is recognized as uncollectable.  All credits which are 90 days past due must be analyzed for the Company's ability to collect on the credit.  Once a loss is known to exist, the charge-off approval process is immediately expedited.  This charge-off policy is followed for all loan types.

 An analysis of the change in the allowance for loan losses for the three and six months ended June 30, 2011 and 2010 is presented in the table below.  The allocated allowance is the total of identified specific and general reserves by loan category.  The allocation is not necessarily indicative of the categories in which future losses may occur.  The total allowance is available to absorb losses from any segment of the portfolio.

For the six months ended June 30, 2011
(In thousands)	SBA			SBA 504			Commercial			Residential			Consumer			Unallocated			Total
Allowance for credit losses:
Beginning balance	$	4,198		$	1,551		$	6,011		$	1,679		$	586		$	339		$	14,364
Charge-offs		(1,303	)		-			(1,494	)		(142	)		(131	)		-			(3,070	)
Recoveries		79			-			389			4			2			-			474
Net charge-offs		(1,224	)		-			(1,105	)		(138	)		(129	)		-			(2,596	)
Provision for loan losses charged to expense		1,323			(141	)		2,763			221			112			(28	)		4,250
Ending balance	$	4,297		$	1,410		$	7,669		$	1,762		$	569		$	311		$	16,018
Ending balance:
Individually evaluated for impairment	$	1,627		$	83		$	2,187		$	-		$	-		$	-		$	3,897
Collectively evaluated for impairment		2,670			1,327			5,482			1,762			569			311			12,121
Totals	$	4,297		$	1,410		$	7,669		$	1,762		$	569		$	311		$	16,018
Loan ending balances:
Individually evaluated for impairment	$	6,487		$	8,355		$	20,592		$	-		$	-		$	-		$	35,434
Collectively evaluated for impairment		78,695			47,455			267,193			134,782			51,546			-			579,671
Total ending balance	$	85,182		$	55,810		$	287,785		$	134,782		$	51,546		$	-		$	615,105

For the six months ended June 30, 2010
(In thousands)
Allowance for credit losses:
Beginning balance	$	13,842
Charge-offs		(3,003	)
Recoveries		107
Net charge-offs		(2,896	)
Provision for loan losses charged to expense		3,000
Ending balance	$	13,946

 In addition to the allowance for loan losses, the Company maintains an allowance for unfunded loan commitments that is maintained at a level that management believes is adequate to absorb estimated probable losses.  Adjustments to the allowance are made through other expense and applied to the allowance which is maintained in other liabilities.  At June 30, 2011 and December 31, 2010, a $65 thousand commitment reserve was reported on the balance sheet as an "other liability". 

Credit Risk:

 Loans are made to individuals as well as commercial entities.  Specific loan terms vary as to interest rate, repayment, and collateral requirements based on the type of loan requested and the credit worthiness of the prospective borrower.  Credit risk, excluding SBA loans, tends to be geographically concentrated in that a majority of the loan customers are located in the markets serviced by the Bank.  As a preferred SBA lender, a portion of the SBA portfolio is to borrowers outside the Company's lending area.  However, during late 2008, the Company withdrew from SBA lending outside of its primary trade area, but continues to offer SBA loan products as an additional credit product within its primary trade area.

 The Company's extension of credit is governed the Credit Risk Policy which was established to control the quality of the Company's loans.  These policies and procedures are reviewed and approved by the Board of Directors on a regular basis.

 SBA Loans .  SBA loans, on which the SBA provides guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products.  The Company's SBA loans are generally sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment.  SBA loans are for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans are guaranteed by the businesses' major owners. SBA loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.

 SBA 504 Loans.  The SBA 504 program consists of real estate backed commercial mortgages where the Company has the first mortgage and the SBA has the second mortgage on the property. SBA 504  loans, are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided.  Generally, the Company has a 50 percent loan to value ratio on SBA 504 program loans. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type.

 Commercial Loans.  Commercial credit is extended primarily to middle market and small business customers.  Commercial loans are generally made in the Company's market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. Loans will generally be guaranteed in full or for a meaningful amount by the businesses' major owners. Commercial loans are made based primarily on the historical and projected cash flow of the business and secondarily on the underlying collateral provided. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type.

 Mortgage and Consumer Loans.  The Company originates mortgage and consumer loans including principally residential real estate and home equity lines and loans.  Each loan type is evaluated on debt to income, type of collateral and loan to collateral value, credit history and Company relationship with the borrower. 

 Inherent in the lending function is credit risk, which is the possibility a borrower may not perform in accordance with the contractual terms of their loan.  A borrower's inability to pay their obligations according to the contractual terms can create the risk of past due loans and, ultimately, credit losses, especially on collateral deficient loans.  The Company minimizes its credit risk by loan diversification and adhering to credit administration policies and procedures.  Due diligence on loans begins when we initiate contact regarding a loan with a borrower.  Documentation, including a borrower's credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval.  The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.

For SBA 7(a), SBA 504 and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality.  A loan's internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating.  The Company uses a 1 through 10 loan grading system that follows regulatory accepted definitions.

·   Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments.  These performing loans are termed "Pass".

·   Criticized loans are assigned a risk rating of 7 and termed "Special Mention", as the borrowers exhibit potential credit weaknesses or downward trends deserving management's close attention.  If not checked or corrected, these trends will weaken the Bank's collateral and position.  While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated.  As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification.  Included in "Special Mention" could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in start up or deteriorating industries, or borrowers with a poor market share in an average industry.  "Special Mention" loans may include an element of asset quality, financial flexibility, or management below average.  Management and ownership may have limited depth or experience.  Regulatory agencies have agreed on a consistent definition of "Special Mention" as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank's credit position at some future date.  This definition is intended to ensure that the "Special Mention" category is not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.

·   Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed "Substandard".  A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt.  The loan is inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any.  Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned.  There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected.  Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified "Substandard".  A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.  Serious problems exist to the point where partial loss of principal is likely.  The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans' classification as estimated losses is deferred until a more exact status may be determined.   Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans.  Partial charge-offs are likely.

·   Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a "Loss", and charged-off immediately.  Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted.  This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.

 For residential mortgage and consumer loans,management uses performing versus nonperforming as the best indicator of credit quality.  Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt.   These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.

The tables below detail the Company's loans by class according to their credit quality indicators discussed in the paragraphs above as of June 30, 2011 and December 31, 2010:

	June 30, 2011
	SBA, SBA 504 & Commercial Loans - Internal Risk Ratings
(In thousands)	Pass		Special Mention		Substandard		Total
SBA loans	$	57,446	$	12,431	$	15,305	$	85,182
SBA 504 loans		37,722		4,579		13,509		55,810
Commercial loans
Commercial other		17,803		5,610		2,710		26,123
Commercial real estate		190,422		50,941		12,195		253,558
Commercial real estate construction		5,315		2,005		784		8,104
Total commercial loans		213,540		58,556		15,689		287,785
Total SBA, SBA 504 and Commercial loans	$	308,708	$	75,566	$	44,503	$	428,777

	June 30, 2011
	Residential Mortgage & Consumer Loans - Performing/Nonperforming
(In thousands)	Performing		Nonperforming		Total
Residential mortgage loans
Residential mortgages	$	122,279	$	1,973	$	124,252
Residential construction		2,243		-		2,243
Purchased residential mortgages		6,220		2,067		8,287
Total residential mortgage loans	$	130,742		4,040	$	134,782
Consumer loans
Home equity	$	49,789	$	261	$	50,050
Consumer other		1,487		9		1,496
Total consumer loans	$	51,276	$	270	$	51,546
Total loans					$	615,105

	December 31, 2010
	SBA, SBA 504 & Commercial Loans - Internal Risk Ratings
(In thousands)	Pass		Special Mention		Substandard		Total
SBA loans	$	48,500	$	25,668	$	11,970	$	86,138
SBA 504 loans		30,235		15,366		18,675		64,276
Commercial loans
Commercial other		17,402		4,764		2,102		24,268
Commercial real estate		169,093		67,305		10,493		246,891
Commercial real estate construction		6,197		2,715		1,134		10,046
Total commercial loans		192,692		74,784		13,729		281,205
Total SBA, SBA 504 and Commercial loans	$	271,427	$	115,818	$	44,374	$	431,619

	December 31, 2010
	Residential Mortgage & Consumer Loans - Performing/Nonperforming
(In thousands)	Performing		Nonperforming		Total
Residential mortgage loans
Residential mortgages	$	114,716	$	2,453	$	117,169
Residential construction		2,711		-		2,711
Purchased residential mortgages		5,888		2,632		8,520
Total residential mortgage loans	$	123,315	$	5,085	$	128,400
Consumer loans
Home equity	$	54,024	$	249	$	54,273
Consumer other		1,644		-		1,644
Total consumer loans	$	55,668	$	249	$	55,917
Total loans					$	615,936

 Nonperforming and past due loans: Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt.  When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest previously recognized as income is reversed and charged against current period income.  Generally, until the loan becomes current, any payments received from the borrower are applied to outstanding principal, until such time as management determines that the financial condition of the borrower and other factors merit recognition of a portion of such payments as interest income.  Loans past due 90 days or more and still accruing interest are not included in nonperforming loans.  Loans past due 90 days or more generally represent loans that are well collateralized and in a continuing process that is expected to result in repayment or restoration to current status.

 The risk of loss is difficult to quantify and is subject to fluctuations in collateral values, general economic conditions and other factors. The current state of the economy and the downturn in the real estate market have resulted in increased loan delinquencies and defaults.  In some cases, these factors have also resulted in significant impairment to the value of loan collateral.  The Company values its collateral through the use of appraisals, broker price opinions, and knowledge of its local market.  In response to the credit risk in its portfolio, the Company has increased staffing in its credit monitoring department and increased efforts in the collection and analysis of borrowers' financial statements and tax returns. 

The following tables set forth an aging analysis of past due and nonaccrual loans as of June 30, 2011 and December 31, 2010:

	June 30, 2011
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days and Still Accruing		Nonaccrual		Total Past Due		Current		Total Loans
SBA loans	$	1,693	$	1,083	$	207	$	7,941	$	10,924	$	74,258	$	85,182
SBA 504 loans		1,797		-		-		3,952		5,749		50,061		55,810
Commercial loans
Commercial other		66		128		771		1,043		2,008		24,115		26,123
Commercial real estate		664		621		1,154		7,253		9,692		243,866		253,558
Commercial real estate construction		-		-		-		600		600		7,504		8,104
Residential mortgage loans
Residential mortgages		3,614		489		299		1,973		6,375		117,877		124,252
Residential construction		43		-		-		-		43		2,200		2,243
Purchased residential mortgages		160		107		427		2,067		2,761		5,526		8,287
Consumer loans
Home equity		452		-		-		261		713		49,337		50,050
Consumer other		26		-		-		9		35		1,461		1,496
Total loans	$	8,515	$	2,428	$	2,858	$	25,099	$	38,900	$	576,205	$	615,105

 

	December 31, 2010
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days and Still Accruing		Nonaccrual		Total Past Due		Current		Total Loans
SBA loans	$	1,297	$	1,181	$	374	$	8,162	$	11,014	$	75,124	$	86,138
SBA 504 loans		-		1,339		-		2,714		4,053		60,223		64,276
Commercial loans
Commercial other		693		86		-		179		958		23,310		24,268
Commercial real estate		3,051		176		-		4,139		7,366		239,525		246,891
Commercial real estate contruction		-		-		-		1,134		1,134		8,912		10,046
Residential mortgage loans
Residential mortgages		2,123		144		-		2,453		4,720		112,449		117,169
Residential construction		-		-		-		-		-		2,711		2,711
Purchased residential mortgages		117		-		-		2,632		2,749		5,771		8,520
Cosumer loans
Home equity		175		325		-		249		749		53,524		54,273
Consumer other		5		-		-		-		5		1,639		1,644
Total loans	$	7,461	$	3,251	$	374	$	21,662	$	32,748	$	583,188	$	615,936

 Impaired Loans: The Company has defined impaired loans to be all nonperforming loans and troubled debt restructurings.  Impairment is evaluated in total for smaller-balance loans of a similar nature, (consumer and residential mortgage loans), and on an individual basis for other loans.  Troubled debt restructurings ("TDRs") occur when a creditor, for economic or legal reasons related to a debtor's financial condition, grants a concession to the debtor that it would not otherwise consider, such as a below market interest rate, extending the maturity of a loan, or a combination of both.  At June 30, 2011, there were sixteen loans totaling $17.5 million that were classified as TDRs by the Company and are deemed impaired, compared to fifteen such loans totaling $14.1 million at December 31, 2010.  During the six months ended June 30, 2011, there were seven loans totaling $9.0 million classified as TDRs, six loans totaling $3.1 million which were transferred to nonaccrual status and one decrease of $2.5 million due to a loan which was bought at sheriffs sale.  TDRs are not included in the nonperforming or potential problem loan figures listed above, as they continue to perform under their modified terms.

 The following tables provide detail on the Company's impaired loans as of June 30, 2011 and December 31, 2010:

	June 30, 2011
(In thousands)	Recorded Investment (Balance less specific reserves)			Outstanding Principal Balance		Related Allowance		Average Recorded Investment		Year to Date  Lost Interest on Impaired Loans		Year to Date  Interest Income Collected on Impaired Loans
With no related allowance:
SBA loans(1)		$	1,800	$	1,800	$	-
SBA 504 loans			5,882		5,882		-
Commercial loans
Commercial other			1,920		1,920		-
Commercial real estate			8,249		8,249		-
Commercial real estate construction			600		600
Total commercial loans			10,769		10,769		-
Total impaired loans with no related allowance		$	18,451	$	18,451	$	-
With an allowance:
SBA loans(1)		$	3,060	$	4,687	$	1,627
SBA 504 loans			2,390		2,473		83
Commercial loans
Commercial other			-		108		108
Commercial real estate			7,636		9,715		2,079
Commercial real estate construction			-		-		-
Total commercial loans			7,636		9,823		2,187
Total impaired loans with a related allowance		$	13,086	$	16,983	$	3,897
Total individually evaluated impaired loans:
SBA loans(1)		$	4,860	$	6,487	$	1,627	$	6,607	$	225	$	68
SBA 504 loans			8,272		8,355		83		9,693		197		14
Commercial loans
Commercial other			1,920		2,028		108		983		11		10
Commercial real estate			15,885		17,964		2,079		13,125		205		104
Commercial real estate construction			600		600		-		920		64		-
Total commercial loans			18,405		20,592		2,187		15,028		280		114
Total individually evaluated impaired loans		$	31,537	$	35,434	$	3,897	$	31,328	$	702	$	196
Homogeneous loans collectively evaluated for impairment:
Residential mortgage loans
Residential mortgages		$	1,973	$	1,973	$	-	$	2,148	$	180	$	-
Purchased mortgages			2,067		2,067		-		2,122		157		-
Total residential mortgage loans			4,040		4,040		-		4,270		337		-
Consumer loans
Home equity			261		261		-		288		6		4
Consumer Other			9		9		-		2		-		-
Total consumer loans			270		270				290		6		4
Total other homogeneous loans evaluated for impairment			4,310		4,310		-		4,560		343		4
Total impaired loans		$	35,847	$	39,744	$	3,897	$	35,888	$	1,045	$	200
(1) Balances are reduced by amount guaranteed by the Small Business Administration

	December 31, 2010
(In thousands)	Recorded Investment (Balance less specific reserves)			Outstanding Principal Balance		Related Allowance		Average Recorded Investment		Year to Date  Lost Interest on Impaired Loans		Year to Date  Interest Income Collected on Impaired Loans
With no related allowance:
SBA loans(1)		$	2,362	$	2,362	$	-
SBA 504 loans			8,145		8,145		-
Commercial loans
Commercial other			179		179		-
Commercial real estate			7,891		7,891		-
Total commercial loans			8,070		8,070		-
Total impaired loans with no related allowance		$	18,577	$	18,577	$	-
With an allowance:
SBA loans(1)		$	2,765	$	4,526	$	1,761
SBA 504 loans			2,390		2,477		87
Commercial loans
Commercial real estate			764		990		226
Commercial real estate construction			751		1,134		383
Total commercial loans			1,515		2,124		609
Total impaired loans with a related allowance		$	6,670	$	9,127	$	2,457
Total individually evaluated impaired loans:
SBA loans(1)		$	5,127	$	6,888	$	1,761	$	6,792	$	317	$	234
SBA 504 loans			10,535		10,622		87		6,454		133		69
Commercial loans
Commercial other			179		179		-		425		16		1
Commercial real estate			8,655		8,881		226		10,964		367		143
Commercial real estate construction			751		1,134		383		813		84		47
Total commercial loans			9,585		10,194		609		12,202		467		191
Total individually evaluated impaired loans		$	25,247	$	27,704	$	2,457	$	25,448	$	917	$	494
Homogeneous loans collectively evaluated for impairment:
Residential mortgage loans
Residential mortgages		$	2,453	$	2,453	$	-	$	4,632	$	147	$	-
Purchased mortgages			2,632		2,632		-		1,897		136		-
Total residential mortgage loans			5,085		5,085		-		6,529		283		-
Consumer loans
Home equity			249		249		-		341		2		9
Total other homogeneous loans evaluated for impairment			5,334		5,334		-		6,870		285		9
Total impaired loans		$	30,581	$	33,038	$	2,457	$	32,318	$	1,202	$	503
(1) Balances are reduced by amount guaranteed by the Small Business Administration