NOTE 4 – LOANS AND LEASES

Major classifications of LHFI are as follows:

	As of December 31,
(In thousands)	2013		2012
Commercial real estate	$	148,293	$	167,115
Construction and land development		45,261		37,215
Commercial and industrial		79,589		40,560
Multi-family		11,737		11,756
Residential real estate		25,535		24,981
Leases		42,524		37,347
Tax certificates		12,716		24,569
Consumer		826		1,139
		366,481		344,682
Less: Deferred loan fees, net*		-		(517	)
Total LHFI, net of unearned income	$	366,481	$	344,165

*For the 2013 period net deferred fees were allocated among the various loan types.

The Company originates commercial and real estate loans, including construction and land development loans primarily in the greater Philadelphia metropolitan area as well as selected locations throughout the mid-Atlantic region. The Company also has participated with other financial institutions in selected construction and land development loans outside our geographic area. The Company has a concentration of credit risk in commercial real estate, construction and land development loans at December 31, 2013. A substantial portion of its debtors’ ability to honor their contracts is dependent upon the housing sector specifically and the economy in general.

The Company has originated loans to the officers and directors of the Company and to their associates. In accordance with Regulation O, related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectability. The aggregate dollar amount of these loans and commitments was $234,000 and $1.4 million at December 31, 2013 and 2012. During 2013 there were no new related party loans. Total payments received on related party loans in 2013 were $1.2 million.

The Company uses a nine point grading risk classification system commonly used in the financial services industry as the credit quality indicator. The first four classifications are rated Pass. The riskier classifications include Pass-Watch, Special Mention, Substandard, Doubtful and Loss. The risk rating is related to the underlying credit quality and probability of default. These risk ratings are used to calculate the historical loss component of the allowance.

Pass: includes credits that demonstrate a low probability of default;

Pass-Watch: a warning classification which includes credits that are beginning to demonstrate above average risk through declining earnings, strained cash flows, increased leverage and/or weakening market fundamentals;

Special mention: includes credits that have potential weaknesses that if left uncorrected could weaken the credit or result in inadequate protection of the Company’s position at some future date. While potentially weak, credits in this classification are marginally acceptable and loss of principal or interest is not anticipated;

Substandard accrual: includes credits that exhibit a well-defined weakness which currently jeopardizes the repayment of debt and liquidation of collateral even though they are currently performing. These credits are characterized by the distinct possibility that the Company may incur a loss in the future if these weaknesses are not corrected;

Non-accrual: (substandard non-accrual, doubtful, loss): includes credits that demonstrate serious problems to the point that it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement.

All loans, at the time of presentation to the appropriate loan committee, are given an initial loan risk rating by the Chief Credit Officer (“CCO”). From time to time, and at the general direction of any of the various loan committees, the ratings may be changed based on the findings of that committee. Items considered in assigning ratings include the financial strength of the borrower and/or guarantors, the type of collateral, the collateral lien position, the type of loan and loan structure, any potential risk inherent in the specific loan type, higher than normal monitoring of the loan or any other factor deemed appropriate by any of the various committees for changing the rating of the loan. Any such change in rating is reflected in the minutes of that committee.

The following tables present risk ratings for each loan portfolio segment at December 31, 2013 and 2012, excluding LHFS.

As of December 31, 2013					Special
(In thousands)	Pass		Pass-Watch		Mention		Substandard		Non-accrual		Total
Commercial real estate	$	99,525	$	32,267	$	11,572	$	2,604	$	2,325	$	148,293
Construction and land development		14,677		16,270		11,095		569		2,650		45,261
Commercial & industrial		50,478		10,508		5,735		9,239		3,629		79,589
Multi-family		10,792		410		535		-		-		11,737
Residential real estate		24,903		-		-		-		632		25,535
Leases		41,325		485		247		-		467		42,524
Tax certificates		12,262		-		-		-		454		12,716
Consumer		750		76		-		-		-		826
Total LHFI	$	254,712	$	60,016	$	29,184	$	12,412	$	10,157	$	366,481

As of December 31, 2012					Special
(In thousands)	Pass		Pass-Watch		Mention		Substandard		Non-accrual		Total
Commercial real estate	$	64,308	$	69,510	$	19,529	$	3,423	$	10,345	$	167,115
Construction and land development		2,139		13,872		16,343		581		4,280		37,215
Commercial & industrial		14,764		10,774		92		9,969		4,961		40,560
Multi-family		9,019		2,034		703		-		-		11,756
Residential real estate		15,125		6,634		602		1,626		994		24,981
Leases		36,755		325		16		-		251		37,347
Tax certificates		23,968		-		-		-		601		24,569
Consumer		926		213		-		-		-		1,139
Subtotal LHFI		167,004		103,362		37,285		15,599		21,432		344,682
Less: Deferred loan fees												(517	)
Total LHFI											$	344,165

The following tables are an aging analysis of past due payments for each loan portfolio segment at December 31, 2013 and 2012, excluding LHFS.

As of December 31, 2013	30-59 Days		60-89 Days		Accruing		Total
(In thousands)	Past Due		Past Due		90+ Days		Non-accrual		Current		Total
Commercial real estate	$	996	$	-	$	-	$	2,325	$	144,972	$	148,293
Construction and land development		-		-		-		2,650		42,611		45,261
Commercial & industrial		115		49		-		3,629		75,796		79,589
Multi-family		-		-		-		-		11,737		11,737
Residential real estate		458		262		-		632		24,183		25,535
Leases		485		247		-		467		41,325		42,524
Tax certificates		-		-		-		454		12,262		12,716
Consumer		-		-		-		-		826		826
Total LHFI	$	2,054	$	558	$	-	$	10,157	$	353,712	$	366,481

As of December 31, 2012	30-59 Days		60-89 Days		Accruing		Total
(In thousands)	Past Due		Past Due		90+ Days		Non-accrual		Current		Total
Commercial real estate	$	1,548	$	1,486	$	-	$	10,345	$	153,736	$	167,115
Construction and land development		-		-		-		4,280		32,935		37,215
Commercial & industrial		200		-		-		4,961		35,399		40,560
Multi-family		-		-		-		-		11,756		11,756
Residential real estate		562		486		-		994		22,939		24,981
Leases		325		16		-		251		36,755		37,347
Tax certificates		-		-		-		601		23,968		24,569
Consumer		-		-		-		-		1,139		1,139
Subtotal LHFI		2,635		1,988		-		21,432		318,627		344,682
Less: Deferred loan fees												(517	)
Total LHFI											$	344,165

The following table details the composition of the non-accrual loans.

	As of December 31, 2013				As of December 31, 2012
(In thousands)	Loan balance		Specific reserves		Loan balance		Specific reserves
Non-accrual loans held for investment
Commercial real estate	$	2,325	$	331	$	10,345	$	835
Construction and land development		2,650		-		4,280		820
Commercial & industrial		3,629		452		4,961		255
Residential real estate		632		19		994		14
Leases		467		60		251		55
Tax certificates		454		24		601		47
Total non-accrual LHFI	$	10,157	$	886	$	21,432	$	2,026
Non-accrual loans held for sale
Commercial real estate	$	-	$	-	$	1,572	$	-
Total non-accrual LHFS	$	-	$	-	$	1,572	$	-
Total non-accrual loans	$	10,157	$	886	$	23,004	$	2,026

Total non-accrual loans at December 31, 2013 were $10.2 million in LHFI. Total non-accrual loans at December 31, 2012 were $23.0 million and were comprised of $21.4 million in LHFI and $1.6 million in LHFS. The $12.8 million decline in total non-accrual loans was the result of a $13.2 million reduction in existing non-accrual loan balances through payments or payoffs, $4.0 million in charge-offs and write downs related to impairment, and transfers to OREO of $9.1 million, which collectively were offset by $13.5 million in additions. The majority of the new non-accrual activity and transfers to OREO originated from the tax certificate portfolio. Commercial, construction and land development, and commercial real estate loans represent 36%, 26%, and 23%, respectively, of the total $10.2 million in non-accrual loans at December 31, 2013. If interest had been accrued, such income would have been approximately $1.7 million and $3.1 million for the years ended December 31, 2013 and 2012, respectively. At December 31, 2013, the Company had no loans past due 90 days or more on which interest continues to accrue.

Impaired Loans

The Company identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. Impaired loans include TDRs. The Company does not accrue interest income on impaired non-accrual loans. Excess proceeds received over the principal amounts due on impaired non-accrual loans are recognized as income on a cash basis. The Company recognizes income under the accrual basis when the principal payments on the loans become current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company does not recognize income.

Total cash collected on impaired loans and leases during 2013 and 2012 was $16.1 million and $23.4 million, respectively, of which $15.3 million and $21.1 million was credited to the principal balance outstanding on such loans, respectively.

The following is a summary of information pertaining to impaired loans:

	As of December 31,
(In thousands)	2013		2012
Impaired LHFI with a valuation allowance	$	3,835	$	9,405
Impaired LHFI without a valuation allowance		14,671		19,423
Impaired LHFS		-		1,572
Total impaired loans and leases	$	18,506	$	30,400
Valuation allowance related to impaired LHFI	$	886	$	2,026

	For the years ended December 31,
(In thousands)		2013		2012
Average investment in impaired loans and leases	$	24,714	$	39,412
Interest income recognized on impaired loans and leases	$	559	$	366
Interest income recognized on a cash basis on impaired loans and leases	$	27	$	66

Troubled Debt Restructurings

At December 31, 2013, the Company had twelve TDRs, of which five are on non-accrual status, with a total carrying value of $12.1 million. At the time of the modifications, five of the loans were already classified as impaired loans. At December 31, 2012, the Company had twelve TDRs, of which eight were on non-accrual status, with a total carrying value of $21.1 million. At the time of the modifications, eight of the loans were already classified as impaired loans. The Company’s policy for TDRs is to recognize interest income on currently performing restructured loans under the accrual method. The TDR balances are included in the impaired loan totals presented above.

The following table details the Company’s TDRs that are on an accrual status and a non-accrual status at December 31, 2013 and 2012.

	As of December 31, 2013
(In thousands)	Number of loans		Accrual Status		Non-Accrual Status		Total TDRs
Commercial real estate		3	$	3,847	$	-	$	3,847
Construction and land development		4		1,257		479		1,736
Commercial & industrial		3		4,420		1,960		6,380
Residential real estate		2		-		121		121
Total		12	$	9,524	$	2,560	$	12,084

	As of December 31, 2012
(In thousands)	Number of loans		Accrual Status		Non-Accrual Status		Total TDRs
Commercial real estate		4	$	1,664	$	854	$	2,518
Construction and land development		4		613		10,063		10,676
Commercial & industrial		2		5,290		2,457		7,747
Residential real estate		2		-		149		149
Total		12	$	7,567	$	13,523	$	21,090

At December 31, 2013, all of the TDRs were in compliance with their restructured terms.

The following table presents newly restructured loans that occurred during the years ended December 31, 2013 and 2012.

	Modifications by type for the year ended December 31, 2013
(Dollars in thousands)	Number of loans		Rate		Term		Payment		Combination of types		Total		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Commercial real estate		2	$	-	$	-	$	-	$	3,705	$	3,705	$	3,761	$	3,761
Commercial & industrial		1		-		-		-		82		82		87		87
Total		3	$	-	$	-	$	-	$	3,787	$	3,787	$	3,848	$	3,848

	Modifications by type for the year ended December 31, 2012
(Dollars in thousands)	Number of loans		Rate		Term		Payment		Combination of types		Total		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Commercial real estate		2	$	-	$	-	$	-	$	7,624	$	7,624	$	9,426	$	9,426
Construction and land development		1		-		-		-		282		282		290		290
Commercial & industrial		1		-		-		5,290		-		5,290		5,290		5,290
Total		4	$	-	$	-	$	5,290	$	7,906	$	13,196	$	15,006	$	15,006