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## NOTES TO THE CONSOLIDATED FEVANCIAL STATEMENTS 

December 31,2012 

## Note 4. Loans Receivable and Related Allowance for Loan Losses (Continued) 

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Management uses a nine point intemal risk rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized, and are aggregated as "Pass" rated. The criticized rating categories utilized by management generally follow Bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the orderly liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Loans in the Doubtful category have all the weaknesses found in Substandard loans, with the added provision that the weaknesses make collection of debt in fiill highly questionable and improbable. Any portion of a loan that has been charged off is placed in the Loss category. 

To help ensure that risk ratings are accurate and reflect the present and fiiture capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with both intemal and external oversight. The Bank’s loan officers are responsible for the timely and accurate risk rating ofthe loans in their portfolios at origination and on an ongoing basis. The loan processing department confirms the appropriate risk grade at origination and monitors all subsequent changes to risk ratings. The Bank’s Loan Committee reviews risk grades when approvmg a loan and approves all risk rating changes, except those made within the pass risk ratings. The Bank engages an extemal consultant to conduct loan reviews on a semi-aimual basis. Generally, the external consultant reviews relationships greater than $650,000 and all loans over $50,000 that are either in nonaccrual status, over 90 days past due, or that are adversely classified. The extemal consultant also reviews a sample of new loans during the year. The Bank’s process requires the review and evaluation of an impaired loan to be updated at least quarterly. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance. 

