4. Loans

The following disclosure reports the Company’s loan portfolio segments and classes. Segments are groupings of similar loans at a level which the Company has adopted systematic methods of documentation for determining its allowance for loan and credit losses. Classes are a disaggregation of the portfolio segments. The Company’s loan portfolio segments are:

Commercial loans – Commercial loans consist of loans to small and medium-sized businesses in a wide variety of industries. The Bank’s areas of emphasis in commercial lending include, but are not limited to, loans to wholesalers, manufacturers, municipalities, and construction and business services companies. Commercial loans are generally collateralized by inventory, accounts receivable, equipment, real estate and other commercial assets, and may be supported by other credit enhancements such as personal guarantees. Risk arises primarily due to a difference between expected and actual cash flows of the borrowers. However, the recoverability of the Company’s investment in these loans is also dependent on other factors primarily dictated by the type of collateral securing these loans. The fair value of the collateral securing these loans may fluctuate as market conditions change. In the case of loans secured by accounts receivable, the recovery of the Company’s investment is dependent upon the borrowers’ ability to collect amounts due from its customers.

Real estate - mortgage loans – Real estate mortgage loans include various types of loans for which the Company holds real property as collateral. Commercial real estate lending activity is typically restricted to owner-occupied properties or to investor properties that are owned by customers with a current banking relationship. The primary risks of real estate mortgage loans include the borrower’s inability to pay, material decreases in the value of the real estate that is being held as collateral and significant increases in interest rates, which may make the real estate mortgage loan unprofitable. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy.

Construction & land – The Company originates loans to finance construction projects including one- to four-family residences, multifamily residences, commercial office, senior housing, and industrial projects. Residential construction loans are due upon the sale of the completed project and are generally collateralized by first liens on the real estate and have floating interest rates. Construction loans are considered to have higher risks due to construction completion and timing risk, and the ultimate repayment being sensitive to interest rate changes, governmental regulation of real property and the availability of long-term financing. Additionally, economic conditions may impact the Company’s ability to recover its investment in construction loans. Adverse economic conditions may negatively impact the real estate market which could affect the borrowers’ ability to complete and sell the project. Additionally, the fair value of the underlying collateral may fluctuate as market conditions change. The Company also originates loans for the acquisition and future development of land for residential building projects, as well as finished lots prepared to enter the construction phase. The primary risks include the borrower’s inability to pay and the inability of the Company to recover its investment due to a decline in the fair value of the underlying collateral.

Consumer loans – The Company provides a broad range of consumer loans to customers, including personal lines of credit, home equity loans, residential mortgage loans and automobile loans. Repayment of these loans is dependent on the borrowers’ ability to pay and the fair value of the underlying collateral.

Other loans – Other loans include lending products, such as taxable and tax-exempt leasing, not defined as commercial, real estate, acquisition and development, construction, or consumer loans.

The loan portfolio segments at December 31, 2016 and 2015 were as follows:


	December 31,
(in thousands)	2016		2015
Commercial	$	1,217,001	$	1,174,570
Real estate - mortgage		1,171,596		1,017,072
Construction & land		175,738		202,011
Consumer		266,947		253,240
Other		103,616		52,616
Loans held for investment		2,934,898		2,699,509

Allowance for loan losses		(33,293)		(40,686)
Unearned net loan fees		(793)		(304)
Total net loans	$	2,900,812	$	2,658,519

The Company routinely acquires participating interests in loans originated by other banks.

At December 31, 2016 and 2015, overdraft demand deposits totaling $0.6 million and $0.2 million, respectively, were reclassified from deposits to loans.

The Company maintains a loan review program independent of the lending function that is designed to reduce and control risk in lending. It includes the continuous monitoring of lending activities with respect to underwriting and processing new loans, preventing insider abuse and timely follow-up and corrective action for loans showing signs of deterioration in quality. The Company also has a systematic process to evaluate individual loans and pools of loans within our loan portfolio. The Company maintains a loan grading system whereby each loan is assigned a grade between 1 and 8, with 1 representing the highest quality credit, 7 representing a nonaccrual loan where collection or liquidation in full is highly questionable and improbable, and 8 representing a loss that has been or will be charged-off. Grades are assigned based upon the degree of risk associated with repayment of a loan in the normal course of business pursuant to the original terms. Loans that are graded 5 or lower are categorized as non-classified credits while loans graded 6 and higher are categorized as classified credits. Loan grade changes are evaluated on a monthly basis. Loans above a certain dollar amount that are adversely graded are reported to the Special Assets Group manager and the Chief Credit Officer along with current financial information, a collateral analysis and an action plan.

The loan portfolio showing total non-classified and classified balances by loan class at December 31, 2016 and 2015 is summarized below:


	At December 31, 2016
(in thousands)	Non-classified		Classified		Total
Commercial
Manufacturing	$	96,465	$	153	$	96,618
Finance and insurance		49,764		587		50,351
Health care		153,468		555		154,023
Real estate services		125,531		513		126,044
Construction		55,471		3,247		58,718
Public administration		254,861		1,136		255,997
Other		437,219		38,031		475,250
		1,172,779		44,222		1,217,001
Real estate - mortgage
Residential & commercial owner-occupied		469,027		6,496		475,523
Residential & commercial investor		695,170		903		696,073
		1,164,197		7,399		1,171,596

Construction & land		172,816		2,922		175,738

Consumer		265,307		1,640		266,947
Other		101,894		1,722		103,616
Total loans held for investment	$	2,876,993	$	57,905	$	2,934,898
Unearned net loan fees						(793)
Net loans held for investment					$	2,934,105


	At December 31, 2015
(in thousands)	Non-classified		Classified		Total
Commercial
Manufacturing	$	132,083	$	2,967	$	135,050
Finance and insurance		64,243		36		64,279
Health care		126,049		462		126,511
Real estate services		117,283		1,580		118,863
Construction		56,581		1,325		57,906
Public administration		211,373		9,739		221,112
Other		425,233		25,616		450,849
		1,132,845		41,725		1,174,570
Real estate - mortgage
Residential & commercial owner-occupied		431,805		5,050		436,855
Residential & commercial investor		577,835		1,057		578,892
Other		1,325		-		1,325
		1,010,965		6,107		1,017,072

Construction & land		201,984		27		202,011

Consumer		252,869		371		253,240
Other		49,768		2,848		52,616
Total loans held for investment	$	2,648,431	$	51,078	$	2,699,509
Unearned net loan fees						(304)
Net loans held for investment					$	2,699,205

Transactions in the ALL by segment for the years ended December 31, 2016 and 2015 are summarized below:


	For the year ended
	December 31,
(in thousands)	2016		2015
Allowance for loan losses, beginning of period
Commercial	$	24,215	$	14,614
Real estate - mortgage		10,372		12,463
Construction & land		2,111		2,316
Consumer		2,592		2,329
Other		643		488
Unallocated		753		555
Total		40,686		32,765

Provision
Commercial	$	(2,334)	$	9,950
Real estate - mortgage		1,072		(3,017)
Construction & land		(1,279)		(1,253)
Consumer		216		374
Other		302		168
Unallocated		(78)		198
Total		(2,101)		6,420

Charge-offs
Commercial	$	(7,767)	$	(588)
Real estate - mortgage		-		(186)
Construction & land		-		(107)
Consumer		(37)		(130)
Other		-		(285)
Total		(7,804)		(1,296)

Recoveries
Commercial	$	1,284	$	239
Real estate - mortgage		31		1,112
Construction & land		1,165		1,155
Consumer		32		19
Other		-		272
Total		2,512		2,797

Allowance for loan losses, end of period
Commercial	$	15,398	$	24,215
Real estate - mortgage		11,475		10,372
Construction & land		1,997		2,111
Consumer		2,803		2,592
Other		945		643
Unallocated		675		753
Total	$	33,293	$	40,686

The Company estimates the ALL in accordance with ASC 310 for purposes of evaluating loan impairment on a loan-by-loan basis and ASC 450 for purposes of collectively evaluating loan impairment by grouping loans with common risk characteristics (i.e. risk classification, past-due status, type of loan, and collateral). The ALL is comprised of the following components:

Specific Reserves – The Company continuously evaluates its reserve for loan losses to maintain an adequate level to absorb loan losses incurred in the loan portfolio. Reserves on loans identified as impaired, including troubled debt restructurings, are based on discounted expected cash flows using the loan’s initial effective interest rate, the observable market value of the loan or the fair value of the collateral for certain collateral-dependent loans. The fair value of the collateral is determined in accordance with ASC 820. Loans are considered to be impaired in accordance with the provisions of ASC 310, when it is probable that all amounts due in accordance with the contractual terms will not be collected. Factors contributing to the determination of specific reserves include the financial condition of the borrower, changes in the value of pledged collateral and general economic conditions. Troubled debt restructurings meet the definition of an impaired loan under ASC 310 and therefore, troubled debt restructurings are subject to impairment evaluation on a loan-by-loan basis.

For collateral dependent loans that have been specifically identified as impaired, the Company measures fair value based on third-party appraisals, adjusted for estimated costs to sell the property. Upon impairment, the Company will obtain a new appraisal if one had not been previously obtained in the last 12 months. For credits over $2.0 million, the Company engages an additional third-party appraiser to review the appraisal. For credits under $2.0 million, the Company’s internal appraisal department reviews the appraisal. All appraisals are reviewed for adherence to regulations and mathematical accuracy reasonableness based on recent sales transactions that may have occurred subsequent to or right at the time of the appraisal. Based on this analysis the appraised value may be adjusted downward if there is evidence that the appraised value may not be indicative of fair value. Each appraisal is updated on an annual basis, either through a new appraisal or through the Company’s comprehensive internal review process.

Values are reviewed and monitored internally and fair value is re-assessed at least quarterly or more frequently when events or circumstances occur that indicate a change in fair value.

General Reserves – General reserves are considered part of the allocated portion of the allowance. The Company uses a comprehensive loan grading process for our loan portfolios. Based on this process, a loss factor is assigned to each pool of graded loans. A combination of loss experience and external loss data is used in determining the appropriate loss factor. This estimate represents the probable incurred losses within the portfolio. In evaluating the adequacy of the ALL, management considers historical losses (Migration), as well as other factors including changes in:

Lending policies and procedures

National and local economic and business conditions and developments

Nature and volume of portfolio

Trends of the volume and severity of past-due and classified loans

Trends in the volume of nonaccrual loans, troubled debt restructurings, and other loan modifications

Credit concentrations

Troubled debt restructurings have a direct impact on the allowance to the extent a loss has been recognized in relation to the loan modified. This is consistent with the Company’s consideration of Migration in determining general reserves.

The aforementioned factors enable management to recognize environmental conditions contributing to incurred losses in the portfolio, which have not yet manifested in Migration. Management believes Migration history adequately captures a great percentage of probable incurred losses within the portfolio.

In addition to the allocated reserve for graded loans, a portion of the allowance is determined by segmenting the portfolio into product groupings with similar risk characteristics. Part of the segmentation involves assigning increased reserve factors to those lending activities deemed higher-risk such as leverage-financings, unsecured loans, certain loans lacking personal guarantees, senior housing, speculative residential construction and multifamily loans.

Unallocated Reserves – The unallocated reserve, which is judgmentally determined, is maintained to recognize the imprecision in estimating and measuring loss when evaluating reserves for individual loans or pools of loans. The unallocated reserve consists of a missed grade component that is intended to capture the inherent risk that certain loans may be assigned an incorrect loan grade.

In assessing the reasonableness of management’s assumptions, consideration is given to select peer ratios, industry standards and directional consistency of the ALL. Ratio analysis highlights divergent trends in the relationship of the ALL to nonaccrual loans, to total loans and to historical charge-offs. Although these comparisons can be helpful as a supplement to assess reasonableness of management assumptions, they are not, by themselves, sufficient basis for determining the adequacy of the ALL. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including the performance of our loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The following tables summarize loans held for investment and the ALL on the basis of the impairment method at December 31, 2016 and 2015:


	At December 31, 2016								At December 31, 2015
	Individually								Individually
	evaluated for				Collectively evaluated for				evaluated for				Collectively evaluated for
	impairment				impairment				impairment				impairment
	Loans		Allowance		Loans		Allowance		Loans		Allowance		Loans		Allowance
	held for		for loan		held for		for loan		held for		for loan		held for		for loan
(in thousands)	investment		losses		investment		losses		investment		losses		investment		losses
Commercial	$	20,279	$	2,220	$	1,197,453	$	13,178	$	33,927	$	10,975	$	1,141,452	$	13,240
Real estate - mortgage		3,758		147		1,167,365		11,328		6,521		320		1,009,747		10,052
Construction & land		1,919		109		172,532		1,888		2,610		192		198,671		1,919
Consumer		294		98		266,719		2,705		855		56		252,462		2,536
Other		-		-		103,786		945		-		-		52,960		643
Unallocated		-		-		-		675		-		-		-		753
Total	$	26,250	$	2,574	$	2,907,855	$	30,719	$	43,913	$	11,543	$	2,655,292	$	29,143

Information on impaired loans at December 31, 2016 and 2015 is reported in the following tables:


	At December 31, 2016
					Recorded		Recorded
			Recorded		investment		investment
	Unpaid		investment		with a		with no
	principal		in impaired		related		related		Related
(in thousands)	balance		loans		allowance		allowance		allowance
Commercial
Manufacturing	$	2,095	$	2,072	$	2,071	$	1	$	114
Finance and insurance		25		25		25		-		25
Healthcare		189		189		189		-		11
Real estate services		6,268		6,268		6,268		-		350
Construction		2,166		2,166		1,932		234		149
Other		10,716		9,559		9,066		493		1,571
		21,459		20,279		19,551		728		2,220
Real estate - mortgage
Residential & commercial owner-occupied		1,391		1,391		1,122		269		64
Residential & commercial investor		2,367		2,367		2,367		-		83
		3,758		3,758		3,489		269		147

Construction & land		1,919		1,919		1,919		-		109

Consumer		294		294		195		99		98
Total	$	27,430	$	26,250	$	25,154	$	1,096	$	2,574


	At December 31, 2015
					Recorded		Recorded
			Recorded		investment		investment
	Unpaid		investment		with a		with no
	principal		in impaired		related		related		Related
(in thousands)	balance		loans		allowance		allowance		allowance
Commercial
Manufacturing	$	5,002	$	4,795	$	4,795	$	-	$	476
Finance and insurance		36		36		36		-		36
Healthcare		125		125		125		-		9
Real estate services		7,638		7,638		7,638		-		559
Construction		1,906		1,874		1,874		-		309
Other		20,847		19,459		19,451		8		9,586
		35,554		33,927		33,919		8		10,975
Real estate - mortgage
Residential & commercial owner-occupied		1,790		1,790		1,479		311		185
Residential & commercial investor		4,731		4,731		4,731		-		135
		6,521		6,521		6,210		311		320

Construction & land		2,643		2,610		2,583		27		192

Consumer		855		855		746		109		56
Total	$	45,573	$	43,913	$	43,458	$	455	$	11,543


	For the year ended December 31,
	2016				2015				2014
	Average				Average				Average
	recorded				recorded				recorded
	investment		Interest		investment		Interest		investment		Interest
	in impaired		income		in impaired		income		in impaired		income
(in thousands)	loans		recognized		loans		recognized		loans		recognized
Commercial
Manufacturing	$	3,383	$	234	$	5,643	$	306	$	4,244	$	299
Finance and insurance		30		-		164		24		307		13
Healthcare		194		12		33		11		205		13
Real estate services		6,996		261		8,006		283		6,416		281
Construction		1,873		140		1,666		106		1,604		158
Other		12,804		619		7,507		1,034		3,807		349
		25,280		1,266		23,019		1,764		16,583		1,113
Real estate - mortgage
Residential & commercial owner-occupied		1,777		114		1,762		130		4,102		176
Residential & commercial investor		3,722		127		5,104		182		7,062		247
		5,499		241		6,866		312		11,164		423

Construction & land		2,336		93		2,935		104		5,957		166

Consumer		448		19		1,444		202		1,362		93
Other		-		-		26		11		51		1
Total	$	33,563	$	1,619	$	34,290	$	2,393	$	35,117	$	1,796

Interest income recognized on impaired loans noted in the table above, primarily represents interest earned on troubled debt restructurings that meet the definition of an impaired loan and are subject to disclosure. Interest income disclosed represents income recognized during the year ended December 31, 2016, 2015, and 2014 on impaired loans, regardless of when the loans became impaired. Interest income recognized on impaired loans using the cash-basis method of accounting during the years ended December 31, 2016, 2015 and 2014 was immaterial.

Interest income that would have been recorded had nonaccrual loans performed in accordance with their original contract terms during 2016, 2015, and 2014 was $0.1 million, $0.2 million, and $0.3 million, respectively.

The table below summarizes transactions as it relates to troubled debt restructurings for the year ended December 31, 2016:


(in thousands)	Performing		Nonperforming		Total
Beginning balance at December 31, 2015	$	28,196	$	13,837	$	42,033
New restructurings		8,563		3,266		11,829
Change in accrual status		(912)		912		-
Paydowns		(12,235)		(7,883)		(20,118)
Net charge-offs		-		(7,591)		(7,591)
Ending balance at December 31, 2016	$	23,612	$	2,541	$	26,153

The below table provides information regarding troubled debt restructurings that occurred during years ended December 31, 2016, 2015 and 2014. Pre-modification outstanding recorded investment reflects the Company’s recorded investment immediately before the modification. Post-modification outstanding recorded investment represents the Company’s recorded investment at the end of the reporting period. The tables below do not include loans restructured and paid-off during the periods presented.


	For the year ended December 31, 2016						For the year ended December 31, 2015
			Pre-modification		Post-modification				Pre-modification		Post-modification
			outstanding		outstanding				outstanding		outstanding
	Number of		recorded		recorded		Number of		recorded		recorded
($ in thousands)	contracts		investment		investment		contracts		investment		investment
Commercial
Manufacturing		1	$	50	$	22		2	$	491	$	437
Health care		1		100		100		1		200		125
Construction		4		1,995		1,844		3		1,738		1,029
Other		9		7,388		5,275		15		19,809		15,975
		15		9,533		7,241		21		22,238		17,566

Real estate - mortgage
Residential & commercial owner-occupied		-		-		-		1		1,000		1,000

Consumer		1		77		72		1		148		130
Total		16	$	9,610	$	7,313		23	$	23,386	$	18,696


	For the year ended December 31, 2014
			Pre-modification		Post-modification
			outstanding		outstanding
	Number of		recorded		recorded
($ in thousands)	contracts		investment		investment
Commercial
Manufacturing		3	$	1,611	$	1,318
Real estate services		4		1,171		1,024
Construction		5		2,784		1,478
Other		8		2,092		1,454
		20		7,658		5,274

Real estate - mortgage
Residential & commercial owner-occupied		1		29		28

Construction & land		1		121		95

Consumer		1		93		89
Other		1		91		84
Total		24	$	7,992	$	5,570

Troubled debt restructurings during the years ended December 31, 2016, 2015 and 2014, resulted primarily from the extension of repayment terms and interest rate reductions. For the year ended December 31, 2016, the Company charged-off $1.1 million in loans restructured during the year. For the year ended December 31, 2015, the Company did not charge-off any troubled debt restructurings modified during 2015. For the year ended December 31, 2014, the Company charged-off $0.4 million in troubled debt restructurings modified during 2014.

Loans modified as troubled debt restructurings within the previous 12 months having a payment default during the years ended December 31, 2016 and 2015 were immaterial.

At December 31, 2016 and 2015 there were $1.6 million and $1.7 million in outstanding commitments on restructured loans, respectively.

The Company’s recorded investment on nonaccrual loans by class at December 31, 2016 and 2015 is reported in the following table:


	At December 31,
(in thousands)	2016		2015
Commercial
Manufacturing	$	2	$	1,045
Finance and insurance		25		36
Real estate services		-		91
Construction		234		451
Other		1,941		13,486
Total commercial		2,202		15,109
Real estate - mortgage
Residential & commercial owner-occupied		269		499
Total real estate - mortgage		269		499
Construction & land		-		27
Consumer		167		82
Total nonaccrual loans	$	2,638	$	15,717

The following tables summarize the aging of the Company’s loan portfolio at December 31, 2016 and 2015:


	At December 31, 2016
													Recorded
													investment
													in loans
	30 - 59		60 - 89										90 days or more
	Days past		Days past		90+ Days		Total past						past due and
(in thousands)	due		due		past due		due		Current		Total loans		accruing
Commercial
Manufacturing	$	-	$	-	$	-	$	-	$	96,618	$	96,618	$	-
Finance and insurance		456		-		25		481		49,870		50,351		-
Health care		500		-		-		500		153,523		154,023		-
Real estate services		-		-		-		-		126,044		126,044		-
Construction		260		-		-		260		58,458		58,718		-
Public administration		-		-		-		-		255,997		255,997		-
Other		2,941		200		-		3,141		472,109		475,250		-
		4,157		200		25		4,382		1,212,619		1,217,001		-
Real estate - mortgage
Residential & commercial owner-occupied		204		161		-		365		475,158		475,523		-
Residential & commercial investor		-		225		-		225		695,848		696,073		-
		204		386		-		590		1,171,006		1,171,596		-

Construction & land		-		-		657		657		175,081		175,738		657

Consumer		4		63		75		142		266,805		266,947		-
Other		-		-		-		-		103,616		103,616		-
Total loans held for investment	$	4,365	$	649	$	757	$	5,771	$	2,929,127	$	2,934,898	$	657
Unearned net loan fees												(793)
Net loans held for investment											$	2,934,105


	At December 31, 2015
													Recorded
													investment
													in loans
	30 - 59		60 - 89										90 days or more
	Days past		Days past		90+ Days		Total past						past due and
(in thousands)	due		due		past due		due		Current		Total loans		accruing
Commercial
Manufacturing	$	24	$	-	$	-	$	24	$	135,026	$	135,050	$	-
Finance and insurance		-		-		-		-		64,279		64,279		-
Health care		323		-		-		323		126,188		126,511		-
Real estate services		183		-		-		183		118,680		118,863		-
Construction		-		-		-		-		57,906		57,906		-
Public administration		-		-		-		-		221,112		221,112		-
Other		173		185		2,125		2,483		448,366		450,849		-
		703		185		2,125		3,013		1,171,557		1,174,570		-
Real estate - mortgage
Residential & commercial owner-occupied		-		317		-		317		436,538		436,855		-
Residential & commercial investor		-		-		-		-		578,892		578,892		-
Other		-		-		-		-		1,325		1,325		-
		-		317		-		317		1,016,755		1,017,072		-

Construction & land		156		-		-		156		201,855		202,011		-

Consumer		-		89		505		594		252,646		253,240		505
Other		-		-		-		-		52,616		52,616		-
Total loans held for investment	$	859	$	591	$	2,630	$	4,080	$	2,695,429	$	2,699,509	$	505
Unearned net loan fees												(304)
Net loans held for investment											$	2,699,205

In the ordinary course of business, the Company makes various direct and indirect loans to officers and directors of the Company. Activity with respect to officer and director loans is as follows for the years ended December 31, 2016 and 2015.


(in thousands)	2016		2015
Balance - beginning of year	$	34,301	$	25,522
New loan and advances		48,110		35,916
Principal paydowns and payoffs		(47,416)		(27,137)
Balance - end of year	$	34,995	$	34,301