5. 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, 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 and land loans – 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, 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 September 30, 2017 and December 31, 2016 were as follows:


(in thousands)	At September 30, 2017		At December 31, 2016
Commercial	$	1,250,257	$	1,217,001
Real estate - mortgage		1,259,648		1,171,596
Construction & land		216,737		175,738
Consumer		287,245		266,947
Other		108,437		103,616
Loans held for investment		3,122,324		2,934,898

Allowance for loan losses		(36,850)		(33,293)
Unearned net loan fees		(626)		(793)
Total net loans	$	3,084,848	$	2,900,812

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 September 30, 2017 and December 31, 2016 is summarized below:


	At September 30, 2017
(in thousands)	Non-classified		Classified		Total
Commercial
Manufacturing	$	88,605	$	1,369	$	89,974
Finance and insurance		39,481		475		39,956
Healthcare		150,731		1,954		152,685
Real estate services		117,358		3,456		120,814
Construction		66,868		539		67,407
Public administration		248,957		913		249,870
Other		493,891		35,660		529,551
		1,205,891		44,366		1,250,257
Real estate - mortgage
Residential & commercial owner-occupied		467,876		6,470		474,346
Residential & commercial investor		784,663		639		785,302
		1,252,539		7,109		1,259,648

Construction & land		216,737		-		216,737

Consumer		285,859		1,386		287,245
Other		106,943		1,494		108,437
Total loans held for investment	$	3,067,969	$	54,355	$	3,122,324
Unearned net loan fees						(626)
Net loans held for investment					$	3,121,698


	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
Healthcare		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

Transactions in the allowance for loan losses by segment for the three and nine months ended September 30, 2017 and 2016 are summarized below:


	Three months ended September 30,				Nine months ended September 30,
(in thousands)	2017		2016		2017		2016
Allowance for loan losses, beginning of period
Commercial	$	15,749	$	17,349	$	15,398	$	24,215
Real estate - mortgage		12,804		10,281		11,475		10,372
Construction & land		2,484		2,335		1,997		2,111
Consumer		2,561		2,660		2,803		2,592
Other		1,021		786		945		643
Unallocated		1,006		933		675		753
Total		35,625		34,344		33,293		40,686

Provision
Commercial	$	437	$	(1,247)	$	829	$	(2,306)
Real estate - mortgage		(167)		247		998		138
Construction & land		958		(250)		437		(765)
Consumer		(9)		109		(172)		187
Other		(40)		119		36		262
Unallocated		(119)		(146)		212		34
Total		1,060		(1,168)		2,340		(2,450)

Charge-offs
Commercial	$	-	$	(227)	$	(222)	$	(6,630)
Consumer		(11)		-		(97)		(20)
Other		-		(4)		-		(4)
Total		(11)		(231)		(319)		(6,654)

Recoveries
Commercial	$	165	$	460	$	346	$	1,056
Real estate - mortgage		3		9		167		27
Construction & land		4		101		1,012		840
Consumer		4		14		11		24
Total		176		584		1,536		1,947

Allowance for loan losses, end of period
Commercial	$	16,351	$	16,335	$	16,351	$	16,335
Real estate - mortgage		12,640		10,537		12,640		10,537
Construction & land		3,446		2,186		3,446		2,186
Consumer		2,545		2,783		2,545		2,783
Other		981		901		981		901
Unallocated		887		787		887		787
Total	$	36,850	$	33,529	$	36,850	$	33,529

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 reasonableness based on recent sales transactions that may have occurred subsequent to or 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 ALL. The Company uses a comprehensive loan grading process for its 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 ALL 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 substantial percentage of probable incurred losses within the portfolio.

In addition to the allocated reserve for graded loans, a portion of the ALL 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 the loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The following table summarizes loans held for investment and the allowance for loan losses on the basis of the impairment method:


	At September 30, 2017								At December 31, 2016
	Individually evaluated for impairment				Collectively evaluated for impairment				Individually evaluated for impairment				Collectively evaluated for impairment
(in thousands)	Loans held for investment		Allowance for loan losses		Loans held for investment		Allowance for loan losses		Loans held for investment		Allowance for loan losses		Loans held for investment		Allowance for loan losses
Commercial	$	33,585	$	3,362	$	1,218,230	$	12,989	$	20,279	$	2,220	$	1,197,453	$	13,178
Real estate - mortgage		2,453		77		1,256,453		12,563		3,758		147		1,167,365		11,328
Construction & land		1,792		122		213,380		3,324		1,919		109		172,532		1,888
Consumer		238		81		287,062		2,464		294		98		266,719		2,705
Other		-		-		108,505		981		-		-		103,786		945
Unallocated		-		-		-		887		-		-		-		675
Total	$	38,068	$	3,642	$	3,083,630	$	33,208	$	26,250	$	2,574	$	2,907,855	$	30,719

Information on impaired loans at September 30, 2017 and December 31, 2016 is reported in the following tables:


	At September 30, 2017
					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	$	3,342	$	3,342	$	3,342	$	-	$	192
Finance and insurance		475		475		475		-		50
Healthcare		528		528		437		91		201
Real estate services		5,123		5,123		5,123		-		287
Construction		1,864		1,864		1,710		154		278
Public administration		320		320		320		-		22
Other		22,273		21,933		20,709		1,224		2,332
		33,925		33,585		32,116		1,469		3,362
Real estate - mortgage
Residential & commercial owner-occupied		1,172		1,172		869		303		59
Residential & commercial investor		1,281		1,281		1,281		-		18
		2,453		2,453		2,150		303		77

Construction & land		1,792		1,792		1,792		-		122
Consumer		238		238		81		157		81
Total	$	38,408	$	38,068	$	36,139	$	1,929	$	3,642


	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


	Impaired loans
	Three months ended September 30,								Nine months ended September 30,
	2017				2016				2017				2016
(in thousands)	Average recorded		Interest income		Average recorded		Interest income		Average recorded		Interest income		Average recorded		Interest income
Commercial
Manufacturing	$	2,444	$	30	$	3,100	$	31	$	2,173	$	89	$	3,815	$	122
Finance and insurance		476		6		28		-		349		16		31		-
Healthcare		500		15		205		3		432		29		194		9
Real estate services		5,475		45		7,046		78		5,812		147		7,240		206
Construction		1,524		39		1,998		59		1,591		79		1,694		98
Public administration		106		1		-		-		36		1		-		-
Other		19,998		467		11,598		150		16,421		869		12,861		407
		30,523		603		23,975		321		26,814		1,230		25,835		842
Real estate - mortgage
Residential & commercial owner-occupied		1,158		8		1,680		18		1,236		26		1,877		43
Residential & commercial investor		1,285		14		3,141		30		2,005		54		4,171		107
		2,443		22		4,821		48		3,241		80		6,048		150

Construction & land		1,807		15		2,309		34		1,850		46		2,470		76

Consumer		242		5		243		4		244		7		504		18
Total	$	35,015	$	645	$	31,348	$	407	$	32,149	$	1,363	$	34,857	$	1,086

Interest income recognized on impaired loans presented 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 required under ASU 310-10-50-15.

The table below summarizes transactions related to troubled debt restructurings during the nine months ended September 30, 2017.


(in thousands)	Performing		Nonperforming		Total
Beginning balance at December 31, 2016	$	23,612	$	2,541	$	26,153
New restructurings		16,031		1,435		17,466
Change in accrual status		(98)		98		-
Net paydowns		(6,340)		(956)		(7,296)
Charge-offs		-		(41)		(41)
Ending balance at September 30, 2017	$	33,205	$	3,077	$	36,282

The below table provides information regarding troubled debt restructurings that occurred during the three and nine months ended September 30, 2017 and 2016. 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 table below does not include loans restructured and paid-off during the periods presented.


	Three months ended September 30, 2017						Three months ended September 30, 2016
			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	$	1,366	$	1,366		-	$	-	$	-
Construction		-		-		-		2		1,500		1,444
Other		8		4,617		3,763		4		3,122		2,757
Total		9	$	5,983	$	5,129		6	$	4,622	$	4,201


	Nine months ended September 30, 2017						Nine months ended September 30, 2016
			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	$	1,366	$	1,366		1	$	50	$	23
Finance and insurance		1		456		456		-		-		-
Healthcare		3		465		304		1		100		100
Construction		-		-		-		3		1,825		1,769
Public administration		1		320		320		-		-		-
Other		13		14,472		13,230		8		6,640		5,726
		19		17,079		15,676		13		8,615		7,618
Consumer		1		83		75		1		77		73
Total		20	$	17,162	$	15,751		14	$	8,692	$	7,691

Troubled debt restructurings during the three and nine months ended September 30, 2017 and 2016 resulted primarily from the extension of repayment terms and interest rate concessions. The Company had no charge-offs in conjunction with loans restructured during the three and nine months ended September 30, 2017 and 2016.

At September 30, 2017 and December 31, 2016, there were $2.5 million and $1.6 million in outstanding commitments on restructured loans, respectively.

There were no loans restructured within the past 12 months that had a payment default during the nine months ended September 30, 2017. The table below presents troubled loans restructured within the past 12 months that had a payment default during the nine months ended September 30, 2016.

The Company’s nonaccrual loans by class at September 30, 2017 and December 31, 2016 are reported in the following table:


(in thousands)	At September 30, 2017		At December 31, 2016
Commercial
Manufacturing	$	-	$	2
Finance and insurance		19		25
Healthcare		304		-
Construction		1,006		234
Other		3,089		1,941
Total commercial		4,418		2,202
Real estate-mortgage
Residential & commercial owner-occupied		303		269
Total real estate - mortgage		303		269
Consumer		142		167
Total nonaccrual loans	$	4,863	$	2,638

The tables below summarize the aging of the Company’s loan portfolio at September 30, 2017 and December 31, 2016.


	At September 30, 2017
	30 - 59		60 - 89										90 days or more
	Days		Days		90+ Days		Total						past due and
(in thousands)	past due		past due		past due		past due		Current		Total loans		accruing
Commercial
Manufacturing	$	200	$	-	$	-	$	200	$	89,774	$	89,974	$	-
Finance and insurance		1,451		-		-		1,451		38,505		39,956		-
Healthcare		459		459		133		1,051		151,634		152,685		-
Real estate services		250		-		-		250		120,564		120,814		-
Construction		438		-		375		813		66,594		67,407		-
Public administration		-		-		-		-		249,870		249,870		-
Other		1,096		3,122		1,024		5,242		524,309		529,551		20
		3,894		3,581		1,532		9,007		1,241,250		1,250,257		20
Real estate - mortgage
Residential & commercial owner-occupied		5		122		-		127		474,219		474,346		-
Residential & commercial investor		892		233		-		1,125		784,177		785,302		-
		897		355		-		1,252		1,258,396		1,259,648		-

Construction & land		-		-		-		-		216,737		216,737		-

Consumer		15		1,087		61		1,163		286,082		287,245		-
Other		-		-		-		-		108,437		108,437		-
Total loans held for investment	$	4,806	$	5,023	$	1,593	$	11,422	$	3,110,902	$	3,122,324	$	20
Unearned net loan fees												(626)
Net loans held for investment											$	3,121,698


	At December 31, 2016
													Recorded
													investment
													in loans
	30 - 59		60 - 89										90 days or more
	Days		Days		90+ Days		Total						past due and
(in thousands)	past due		past due		past due		past due		Current		Total loans		accruing
Commercial
Manufacturing	$	-	$	-	$	-	$	-	$	96,618	$	96,618	$	-
Finance and insurance		456		-		25		481		49,870		50,351		-
Healthcare		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

Nine months ended September 30,

Troubled debt restructurings that subsequently defaulted
($ in thousands)

Number of contracts

Recorded investment

Commercial