Note 4.Loans and Leases

Major classifications of LHFI are as follows:


	June 30,		December 31,
(In thousands)	2014		2013
Commercial real estate	$	154,510	$	148,293
Construction and land development		41,180		45,261
Commercial and industrial		71,759		79,589
Multi-family		13,336		11,737
Residential real estate		40,223		25,535
Leases		45,925		42,524
Tax certificates		9,631		12,716
Consumer		1,227		826
Total LHFI, net of unearned income	$	377,791		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 June 30, 2014. The Company has shifted its lending focus to diversifying the loan portfolio through the origination of small business loans, owner occupied commercial real estate and middle market business lending. Additionally, after thorough due diligence, the Company has purchased small residential loan pools. 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 June 30, 2014 and December 31, 2013, the Company’s loans held for sale (“LHFS”) were $1.4 million. 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. During the second quarter of 2014, the Company transferred a $1.4 million non-accrual LHFI to LHFS.

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 June 30, 2014 and December 31, 2013, excluding LHFS.


As of June 30, 2014
(In thousands)	Pass		Pass-Watch		Special Mention		Substandard		Non-accrual		Total
Commercial real estate	$	110,089	$	32,113	$	8,418	$	2,555	$	1,335	$	154,510
Construction and land development		13,813		21,025		4,877		563		902		41,180
Commercial & industrial		56,240		8,405		567		3,662		2,885		71,759
Multi-family		12,478		331		527		—		—		13,336
Residential real estate		39,219		—		—		—		1,004		40,223
Leases		45,144		146		237		—		398		45,925
Tax certificates		8,491		—		—		—		1,140		9,631
Consumer		1,101		126		—		—		—		1,227
Total LHFI, net of unearned income	$	286,575	$	62,146	$	14,626	$	6,780	$	7,664	$	377,791


As of December 31, 2013
(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 June 30, 2014 and December 31, 2013, excluding LHFS.


As of June 30, 2014	30-59 Days		60-89 Days		Accruing
(In thousands)	Past Due		Past Due		90+ Days		Non-accrual		Current		Total
Commercial real estate	$	2,563	$	2,440	$	—	$	1,335	$	148,172	$	154,510
Construction and land development		563		—		—		902		39,715		41,180
Commercial & industrial		56		239		—		2,885		68,579		71,759
Multi-family		—		—		—		—		13,336		13,336
Residential real estate		107		117		—		1,004		38,995		40,223
Leases		146		238		—		398		45,143		45,925
Tax certificates		—		—		—		1,140		8,491		9,631
Consumer		—		—		—		—		1,227		1,227
Total LHFI, net of unearned income	$	3,435	$	3,034	$	—	$	7,664	$	363,658	$	377,791


As of December 31, 2013	30-59 Days		60-89 Days		Accruing
(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, 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 June 30, 2014 and December 31, 2013.


	As of June 30, 2014				As of December 31, 2013
	Loan		Specific		Loan		Specific
(In thousands)	balance		reserves		balance		reserves
Non-accrual loans held for investment
Commercial real estate	$	1,335	$	—	$	2,325	$	331
Construction and land development		902		—		2,650		—
Commercial & industrial		2,885		—		3,629		452
Residential real estate		1,004		30		632		19
Leases		398		71		467		60
Tax certificates		1,140		—		454		24
Total non-accrual LHFI	$	7,664	$	101	$	10,157	$	886
Non-accrual loans held for sale
Construction and land development	$	1,396	$	—	$	—	$	—
Total non-accrual LHFS	$	1,396	$	—	$	—	$	—
Total non-accrual loans	$	9,060	$	101	$	10,157	$	886

Total non-accrual loans at June 30, 2014 were $9.1 million compared to $10.2 million at December 31, 2013. The decrease of $1.1 million was the result of $1.4 million in charge-offs mostly related to specific reserves, $1.4 million reduction in existing non-accrual loan balances through payments and payoffs, and $882,000 in transfers to OREO, which were partially offset by additions of $2.6 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 $213,000 and $488,000 for the three and six months ended June 30, 2014, respectively. 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 collectability 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 six months ended June 30, 2014 and 2013 was $3.0 million and $5.9 million respectively, of which $2.6 million and $5.6 million was credited to the principal balance outstanding on such loans, respectively.

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



	June 30,		December 31,
(In thousands)	2014		2013
Impaired LHFI with a valuation allowance	$	1,083	$	3,835
Impaired LHFI without a valuation allowance		13,828		14,671
Impaired LHFS		1,396		—
Total impaired loans and leases	$	16,307	$	18,506
Valuation allowance related to impaired LHFI	$	101	$	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 June 30 2014, the Company had eleven TDRs, with a total carrying value of $9.6 million. At the time of the modifications, three 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 June 30, 2014 and December 31, 2013.


	As of June 30, 2014
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		Status		Total TDRs
Commercial real estate	2	$	2,913	$	—	$	2,913
Construction and land development	3		941		256		1,197
Commercial & industrial	5		3,810		1,620		5,430
Residential real estate	1		—		109		109
Total	11	$	7,664	$	1,985	$	9,649


	As of December 31, 2013
				Non-
	Number of	Accrual		Accrual
(In thousands)	loans	Status		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 June 30, 2014, all of the TDRs were in compliance with their restructured terms.

The following table presents newly restructured loans that occurred during the six months ended June 30, 2014. There were no TDRs during the second quarter of 2014.


	Modifications by type for the six months ended June 30, 2014
												Pre-		Post-
												Modification		Modification
												Outstanding		Outstanding
	Number of							Combination				Recorded		Recorded
(Dollars in thousands)	loans	Rate		Term		Payment		of types		Total		Investment		Investment
Commercial & industrial	2	$	—	$	45	$	—	$	28	$	73	$	73	$	73
Total	2	$	—	$	45	$	—	$	28	$	73	$	73	$	73