LOANS AND ALLOWANCE FOR LOAN LOSSES

9 Months Ended

Sep. 30, 2011

NOTE 3. LOANS AND ALLOWANCE FOR LOAN LOSSES

Major classifications of loans are as follows:	September 30,
	2011			December 31,
	(unaudited)				2010
Loans
Commercial	$	102,028			$	107,388
Commercial real estate		183,611				173,898
Residential real estate		56,088				55,406
Consumer		19,460				20,308
		361,187				357,000
Less deferred loan fees		(68	)			(94	)
		361,119				356,906

Less allowance for loan losses		(5,880	)			(5,005	)

Loans, net of allowance	$	355,239			$	351,901

The allowance for loan losses is management’s estimate of probable credit losses inherent in the loan portfolio. Management’s evaluation of the adequacy of the allowance for loan losses and the appropriate provision for credit losses is based upon a quarterly evaluation of the loan portfolio. This evaluation is inherently subjective and requires significant estimates, including the amounts and timing of the estimated future cash flows, estimated losses on pools of loans based on historical loss experience, and consideration of current economic trends, all of which are susceptible to constant and significant change. Allocations are made for specific loans based upon management’s estimate of the borrowers’ ability to repay and other factors impacting collectability. Other loans not specifically reviewed are segregated by class and allocations are made based upon historical loss percentages adjusted for current environmental factors. The environmental factors considered for each of the portfolios includes estimated probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet fully manifested themselves in loss allocation factors. For purposes of determining the general allowance, the loan portfolio is segregated by product type to recognize differing risk profiles among categories. It is further segregated by credit grade for risk-related loan pools and delinquency for homogeneous loan pools. The outstanding principal balance within each pool is multiplied by historical loss data and certain qualitative factors to derive the general loss allocation per pool. Loans deemed to be uncollectible are charged against the allowance for loan losses, while recoveries of previously charged-off amounts are credited to the allowance for loan losses.

Changes in the allowance for loan losses for the nine months ended September 30, 2011 and 2010 (unaudited) are as follows:

	September 30,		September 30,
	2011		2010

Balance at beginning of the period	$	5,005	$	4,785

Loan charge-offs:
Commercial		508		3,340
Commercial real estate		858		6
Residential real estate		171		24
Consumer		88		36
Total charge-offs		1,625		3,406

Loan recoveries:
Commercial		30		36
Commercial real estate		18		2
Residential real estate		-		21
Consumer		19		11
Total recoveries		67		70

Provision for loan losses		2,433		3,511

Balance at end of the period	$	5,880	$	4,960

The following presents the balance in the allowance for loan losses disaggregated on the basis of the Bank’s impairment measurement method, by portfolio segment, as of September 30, 2011 (unaudited) and December 31, 2010:

	Individually Evaluated for		Collectively Evaluated for
	Impairment		Impairment		Total
September 30, 2011 (unaudited):
Commercial	$	2,226	$	1,979	$	4,205
Commercial real estate		570		559		1,129
Residential real estate		362		80		442
Consumer		40		33		73
Unallocated		-		31		31

	$	3,198	$	2,682	$	5,880

December 31, 2010:
Commercial	$	1,866	$	1,386	$	3,252
Commercial real estate		213		1,002		1,215
Residential real estate		285		46		331
Consumer		-		135		135
Unallocated		-		72		72

	$	2,364	$	2,641	$	5,005

The following presents the balance of loans disaggregated on the basis of the Bank’s impairment measurement method, by portfolio segment, as of September 30, 2011 (unaudited) and December 31, 2010:

	Individually Evaluated for		Collectively Evaluated for
	Impairment		Impairment		Total
September 30, 2011 (unaudited):
Commercial	$	5,162	$	96,866	$	102,028
Commercial real estate		7,721		175,890		183,611
Residential real estate		2,076		54,012		56,088
Consumer		333		19,127		19,460

	$	15,292	$	345,895	$	361,187

December 31, 2010:
Commercial	$	2,500	$	104,888	$	107,388
Commercial real estate		5,840		168,058		173,898
Residential real estate		1,094		54,312		55,406
Consumer		7		20,301		20,308

	$	9,441	$	347,559	$	357,000

Management monitors the credit quality of its loans on an ongoing basis. Measurement of the delinquency and past due status are based on the contractual terms of each loan. For all loan classes, past due loans are reviewed on a monthly basis to identify loans for nonaccrual status. Generally, when collection in full of the principal and interest is jeopardized, the loan is placed on non-accrual. The following presents an aging analysis of the Bank’s accruing and non-accruing loans as of September 30, 2011 (unaudited) and December 31, 2010:

	30-89		90 Days
	Days		Or More
	Past Due		Past Due		Non-accrual		Current		Total
September 30, 2011 (unaudited):
Commercial	$	1,664	$	-	$	986	$	99,378	$	102,028
Commercial real estate		579		-		4,165		178,867		183,611
Residential real estate		1,704		-		688		53,696		56,088
Consumer		429		-		158		18,873		19,460

	$	4,376	$	-	$	5,997	$	350,814	$	361,187

December 31, 2010:
Commercial	$	199	$	136	$	1,190	$	105,863	$	107,388
Commercial real estate		1,123		1,059		1,500		170,216		173,898
Residential real estate		1,314		401		1		53,690		55,406
Consumer		410		164		4		19,730		20,308

	$	3,046	$	1,760	$	2,695	$	349,499	$	357,000

The Bank assigns credit quality indicators of pass, special mention, substandard and doubtful to its loans. Special mention loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loans or in the Bank’s credit position at some future date. A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt by the borrower. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. They require more intensive supervision by management. For some substandard loans, the likelihood of full collection of interest and principal may be in doubt and thus, placed on nonaccrual. A loan is classified as doubtful if it has all the weaknesses inherent in one classified as substandard with the added characteristic that the weaknesses make collection in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. A doubtful loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the loan, its classification as loss is deferred. Doubtful borrowers are usually in default, lack adequate liquidity or capital, and lack the resources necessary to remain an operating entity. At September 30, 2011 (unaudited) and December 31, 2010, the Bank had no loans classified as doubtful.

The following is a summary of credit exposure using a credit risk profile utilizing internal assigned grades as of September 30, 2011 (unaudited) and December 31, 2010:

September 30, 2011 (unaudited):	Pass		Special Mention		Substandard
Loans
Commercial	$	97,203	$	1,395	$	3,430
Commercial real estate		167,842		6,010		9,759
Residential real estate		53,537		864		1,687
Consumer		19,157		40		263

	$	337,739	$	8,309	$	15,139

December 31, 2010:
Loans
Commercial	$	103,532	$	1,356	$	2,500
Commercial real estate		160,166		7,892		5,840
Residential real estate		53,651		661		1,094
Consumer		20,246		55		7

	$	337,595	$	9,964	$	9,441

Loans are designated as impaired when, in the opinion of management, based on current information and events, the collection of principal and interest in accordance with the loan contract is doubtful. Typically, the Bank does not consider loans for impairment unless a sustained period of delinquency (i.e. 90-plus days) is noted or there are subsequent events that impact repayment probability (i.e. negative financial trends, bankruptcy filings, eminent foreclosure proceedings, etc.). Impaired loans, or portions thereof, are charged-off when deemed uncollectible. The Company considers nonaccrual loans and loans past-due ninety days or more to be impaired. At September 30, 2011 (unaudited), there were no commitments to lend additional funds to customers whose loans are classified as nonaccrual. The average recorded investment in impaired loans at September 30, 2011 (unaudited) and December 31, 2010 was $3,981 and $5,050, respectively. The following is a summary of loans considered impaired:

	September 30, 2011 (unaudited)		December 31, 2010
Gross impaired loans	$	5,997	$	4,455
Less valuation allowance for impaired loans		1,468		1,299
Recorded investment in impaired loans	$	4,529	$	3,156

- Definition

The entire disclosure for claims held for amounts due a company. Examples include trade accounts receivables, notes receivables, loans receivables.

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Reference 4: http://www.xbrl.org/2003/role/presentationRef

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Reference 7: http://www.xbrl.org/2003/role/presentationRef

-Publisher FASB

-Name Accounting Standards Codification

-Topic 210

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-Subparagraph (SX 210.5-02.3,4)

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Reference 8: http://www.xbrl.org/2003/role/presentationRef

-Publisher SEC

-Name Regulation S-X (SX)

-Number 210

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Reference 9: http://www.xbrl.org/2003/role/presentationRef

-Publisher FASB

-Name Accounting Standards Codification

-Topic 310

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First Sentry Bancshares, Inc. 10-Q