Note 4.

Loans and Leases

Major classifications of LHFI are as follows:

	March 31,		December 31,
(In thousands)	2014		2013
Commercial real estate	$	150,111	$	148,293
Construction and land development		45,751		45,261
Commercial and industrial		68,664		79,589
Multi-family		11,876		11,737
Residential real estate		26,465		25,535
Leases		43,644		42,524
Tax certificates		11,182		12,716
Consumer		965		826
Total LHFI, net of unearned income	$	358,658		366,481

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 March 31, 2014. A substantial portion of its debtors’ ability to honor their contracts is dependent upon the housing sector specifically and the economy in general.

Loans and leases are classified as LHFI when management has the intent and ability to hold the loan or lease for the foreseeable future or until maturity or payoff. LHFI are stated at their outstanding unpaid principal balances, net of an allowance for loan and leases losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan.

At March 31, 2014 and December 31, 2013, the Company’s loans held for sale (“LHFS”) were $0 and $1.4 million, respectively. The three loans that comprised the balance at December 31, 2013 were sold during the first quarter of 2014. These loans were transferred from LHFI at fair market value using expected net sales proceeds.

The Company classifies its leases as finance leases, in accordance with FASB ASC Topic 840, “Leases”. The difference between the Company’s gross investment in the lease and the cost or carrying amount of the leased property, if different, is recorded as unearned income, which is amortized to income over the lease term by the interest method.

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 March 31, 2014 and December 31, 2013, excluding LHFS.

As of March 31, 2014	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
(In thousands)	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
Commercial real estate	$	105,285	$	29,212	$	11,459	$	2,575	$	1,580	$	150,111
Construction and land development		16,967		15,739		10,160		567		2,318		45,751
Commercial & industrial		47,842		9,190		573		8,122		2,937		68,664
Multi-family		11,086		260		530		-		-		11,876
Residential real estate		25,719		-		-		-		746		26,465
Leases		42,812		115		90		-		627		43,644
Tax certificates		10,045		-		-		-		1,137		11,182
Consumer		892		73		-		-		-		965
Total LHFI, net of unearned income	$	260,648	$	54,589	$	22,812	$	11,264	$	9,345	$	358,658

As of December 31, 2013	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
(In thousands)	Pass		Pass-Watch		Special 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, net of unearned income	$	254,712	$	60,016	$	29,184	$	12,412	$	10,157	$	366,481

The following tables present an aging analysis of past due payments for each loan portfolio segment at March 31, 2014 and December 31, 2013, excluding LHFS.

As of March 31, 2014	30-59 Days Past Due		60-89 Days Past Due		Accruing 90+ Days		Non-accrual		Current		Total
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		Accruing 90+ Days		Non-accrual		Current		Total
Commercial real estate	$	977	$	50	$	-	$	1,580	$	147,504	$	150,111
Construction and land development		567		-		-		2,318		42,866		45,751
Commercial & industrial		161		-		-		2,937		65,566		68,664
Multi-family		-		-		-		-		11,876		11,876
Residential real estate		184		346		-		746		25,189		26,465
Leases		115		90		-		627		42,812		43,644
Tax certificates		-		-		-		1,137		10,045		11,182
Consumer		-		23		-		-		942		965
Total LHFI, net of unearned income	$	2,004	$	509	$	-	$	9,345	$	346,800	$	358,658

As of December 31, 2013	30-59 Days Past Due		60-89 Days Past Due		Accruing 90+ Days		Non-accrual		Current		Total
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		Accruing 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, net of unearned income	$	2,054	$	558	$	-	$	10,157	$	353,712	$	366,481

The following tables detail the composition of the non-accrual loans at March 31, 2014 and December 31, 2013.

	As of March 31, 2014				As of December 31, 2013
(In thousands)	Loan balance		Specific reserves		Loan balance		Specific reserves
Non-accrual loans
Commercial real estate	$	1,580	$	-	$	2,325	$	331
Construction and land development		2,318		-		2,650		-
Commercial & industrial		2,937		-		3,629		452
Residential real estate		746		22		632		19
Leases		627		116		467		60
Tax certificates		1,137		-		454		24
Total non-accrual loans	$	9,345	$	138	$	10,157	$	886

Total non-accrual loans at March 31, 2014 were $9.3 million compared to $10.2 million at December 31, 2013. The slight decrease of $812,000 was the result of $1.2 million in charge-offs mostly related to specific reserves, $1.0 million reduction in existing non-accrual loan balances through payments and payoffs, and $672,000 in transfers to OREO, which were partially offset by additions of $2.1 million. The tax certificate portfolio accounted for the majority of the new non-accrual activity and transfers to OREO. If interest had been accrued, such income would have been approximately $275,000 for the three months ended March 31, 2014. The Company had no loans past due 90 days or more on which it has continued to accrue interest during the quarter. Typically, loans are restored to accrual status when the loan is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual principal and interest is no longer in doubt.

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 troubled debt restructurings (“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 non-accrual and impaired loans during the three months ended March 31, 2014 and 2013 was $2.0 million and $4.4 million respectively, of which $1.7 million and $4.2 million was credited to the principal balance outstanding on such loans, respectively.

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

	March 31,		December 31,
(In thousands)	2014		2013
Impaired loans with a valuation allowance	$	885	$	3,835
Impaired loans without a valuation allowance		16,013		14,671
Total impaired loans and leases	$	16,898	$	18,506
Valuation allowance related to impaired loans	$	138	$	886

Troubled Debt Restructurings

A loan modification is deemed a TDR when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made by the Company that would not otherwise be considered for a borrower or collateral with similar credit risk characteristics. All loans classified as TDRs are considered to be impaired. TDRs are returned to an accrual status when the loan is brought current, has performed in accordance with the contractual restructured terms for a reasonable period of time (generally six months) and the ultimate collectibility of the total contractual restructured principal and interest is no longer in doubt. At March 31 2014, the Company had twelve TDRs, with a total carrying value of $10.3 million. At the time of the modifications, four of the loans were already classified as impaired non-accrual loans. At December 31, 2013, the Company had twelve TDRs with a total carrying value of $12.1 million. The Company’s policy for TDRs is to recognize income on currently performing restructured loans under the accrual method.

The following table details the Company’s TDRs that are on an accrual status and non-accrual status at March 31, 2014 and December 31, 2013.

	As of March 31, 2014
(In thousands)	Number of loans		Accrual Status		Non-Accrual Status		Total TDRs
Commercial real estate		2	$	2,957	$	-	$	2,957
Construction and land development		3		1,128		260		1,388
Commercial & industrial		5		4,129		1,669		5,798
Residential real estate		2		-		116		116
Total		12	$	8,214	$	2,045	$	10,259

	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

At March 31, 2014, all of the TDRs were in compliance with their restructured terms.

The following table presents newly restructured loans that occurred during the three months ended March 31, 2014.

	Modifications by type for the three months ended March 31, 2014
(Dollars in thousands)	Number of loans		Rate		Term		Payment		Combination of types		Total		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial & industrial		2	$	-	$	45	$	-	$	28	$	73	$	73	$	73
Total		2	$	-	$	45	$	-	$	28	$	73	$	73	$	73