Note 6. Loans

The composition of net loans (in thousands) at March 31, 2014 and December 31, 2013 is as follows:


	March 31, 2014			December 31, 2013
Real Estate:
Land Development and Construction	$	31,062		$	27,224
Farmland		30,097			29,634
1-4 Family Mortgages		102,413			105,489
Commercial Real Estate		158,224			145,369
Total Real Estate Loans		321,796			307,716
Business Loans:
Commercial and Industrial Loans		40,971			55,813
Farm Production and Other Farm Loans		1,140			1,308
Total Business Loans		42,111			57,121
Consumer Loans:
Credit Cards		988			1,087
Other Consumer Loans		25,500			26,744
Total Consumer Loans		26,488			27,831
Total Gross Loans		390,395			392,668
Unearned income		(561	)		(485	)
Allowance for loan losses		(8,362	)		(8,078	)
Loans, net	$	381,472		$	384,105

Loans are considered to be past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status, when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether such loans are considered past due. When interest accruals are discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Period-end, non-accrual loans (in thousands), segregated by class, were as follows:


	March 31, 2014		December 31, 2013
Real Estate:
Land Development and Construction	$	130	$	136
Farmland		281		352
1-4 Family Mortgages		1,672		1,866
Commercial Real Estate		10,561		8,894

Total Real Estate Loans		12,644		11,248
Business Loans:
Commercial and Industrial Loans		2,131		2,224

Total Business Loans		2,131		2,224
Consumer Loans:
Other Consumer Loans		80		120

Total Consumer Loans		80		120

Total Non-Accrual Loans	$	14,855	$	13,592

An aging analysis of past due loans (in thousands), segregated by class, as of March 31, 2014, was as follows:


											Accruing
			Loans								Loans
	Loans		90 or more								90 or more
	30-89 Days		Days		Total Past		Current		Total		Days
	Past Due		Past Due		Due Loans		Loans		Loans		Past Due
Real Estate:
Land Development and Construction	$	639	$	—	$	639	$	30,423	$	31,062	$	—
Farmland		366		71		437		29,660		30,097		—
1-4 Family Mortgages		4,827		342		5,169		97,244		102,413		90
Commercial Real Estate		2,348		5,630		4,978		153,246		158,224		—

Total Real Estate Loans		8,180		6,043		14,223		310,573		321,796		90
Business Loans:
Commercial and Industrial Loans		192		—		192		40,779		40,971		—
Farm Production and Other Farm Loans		3		—		3		1,137		1,140		—

Total Business Loans		195		3		195		41,916		42,111		—
Consumer Loans:
Credit Cards		26		17		43		945		988		17
Other Consumer Loans		993		49		1,042		24,458		25,500		12

Total Consumer Loans		1,019		66		1,085		25,403		26,488		29

Total Loans	$	9,394	$	6,109	$	15,503	$	377,892	$	390,395	$	119

An aging analysis of past due loans (in thousands), segregated by class, as of December 31, 2013 was as follows:


											Accruing
			Loans								Loans
	Loans		90 or more								90 or more
	30-89 Days		Days		Total Past		Current		Total		Days
	Past Due		Past Due		Due Loans		Loans		Loans		Past Due
Real Estate:
Land Development and Construction	$	170	$	—	$	170	$	27,054	$	27,224	$	—
Farmland		419		69		488		29,146		29,634		—
1-4 Family Mortgages		4,234		1,088		5,322		100,167		105,489		335
Commercial Real Estate		3,308		9,316		12,624		132,745		145,369		1,750

Total Real Estate Loans		8,131		10,473		18,604		289,112		307,716		2,085

Business Loans:
Commercial and Industrial Loans		248		23		271		55,542		55,813		—
Farm Production and other Farm Loans		5		—		5		1,303		1,308		—

Total Business Loans		253		23		276		56,845		57,121		—

Consumer Loans:
Credit Cards		39		10		49		1,038		1,087		10
Other Consumer Loans		1,105		41		1,146		25,598		26,744		—

Total Consumer Loans		1,144		51		1,195		26,636		27,831		10

Total Loans	$	9,528	$	10,547	$	20,075	$	372,593	$	392,668	$	2,095

Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. In determining which loans to evaluate for impairment, management looks at past due loans, bankruptcy filings and any situation that might lend itself to cause a borrower to be unable to repay the loan according to the original agreement terms. If a loan is determined to be impaired and the collateral is deemed to be insufficient to fully repay the loan, a specific reserve will be established. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans or portions thereof, are charged-off when deemed uncollectible.

Impaired loans (in thousands) as of March 31, 2014 and December 31, 2013, segregated by class, are as follows:


			Recorded		Recorded
	Unpaid		Investment		Investment		Total				Average
	Principal		With No		With		Recorded		Related		Recorded
March 31, 2014	Balance		Allowance		Allowance		Investment		Allowance		Investment
Real Estate:
Land Development and Construction	$	130	$	24	$	106	$	130	$	103	$	130
Farmland		281		153		128		281		24		339
1-4 Family Mortgages		1,672		1,328		344		1,672		53		1,653
Commercial Real Estate		10,561		2,797		7,764		10,561		896		9,922

Total Real Estate Loans		12,644		4,302		8,342		12,644		1,076		12,044
Business Loans:
Commercial and Industrial Loans		2,131		47		2,084		2,131		1,560		2,136

Total Business Loans		2,131		47		2,084		2,131		1,560		2,136
Consumer Loans:
Other Consumer Loans		80		80		—		80		—		100

Total Consumer Loans		80		80		—		80		—		100

Total Loans	$	14,855	$	4,429	$	10,426	$	14,855	$	2,636	$	14,281


			Recorded		Recorded
	Unpaid		Investment		Investment		Total				Average
	Principal		With No		With		Recorded		Related		Recorded
December 31, 2013	Balance		Allowance		Allowance		Investment		Allowance		Investment
Real Estate:
Land Development and Construction	$	136	$	25	$	111	$	136	$	103	$	278
Farmland		352		220		132		352		24		720
1-4 Family Mortgages		1,866		1,054		812		1,866		202		2,111
Commercial Real Estate		8,894		976		7,918		8,894		896		9,535

Total Real Estate Loans		11,248		2,275		8,973		11,248		1,225		12,644

Business Loans:
Commercial and Industrial Loans		2,224		118		2,106		2,224		1,072		1,195
Farm Production and other Farm Loans		—		—		—		—		—		2

Total Business Loans		2,224		118		2,106		2,224		1,072		1,197

Consumer Loans:
Other Consumer Loans		120		120		—		120		—		166

Total Consumer Loans		120		120		—		120		—		166

Total Loans	$	13,592	$	2,513	$	11,079	$	13,592	$	2,297	$	14,007

The following table presents troubled debt restructurings (in thousands, except for number of loans), segregated by class:


			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
March 31, 2014	Loans		Investment		Investment
Commercial real estate		5	$	9,261	$	7,024

Total		5	$	9,261	$	7,024


			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
December 31, 2013	Loans		Investment		Investment
Commercial real estate		5	$	9,261	$	7,119

Total		5	$	9,261	$	7,119

Changes in the Corporation’s troubled debt restructurings (in thousands, except for number of loans) are set forth in the table below:


	Number of Loans		Recorded Investment
Totals at January 1, 2014		5	$	7,119
Reductions due to:
Principal paydowns				(95	)

Total at March 31, 2014		5	$	7,024

The allocated allowance for loan losses attributable to restructured loans was $1,694,274 at March 31, 2014 and $1,196,274 at December 31, 2013. The Corporation had no remaining availability under commitments to lend additional funds on these troubled debt restructuring as of March 31, 2014.

The Corporation utilizes a risk grading matrix to assign a risk grade to each of its loans when originated and is updated as factors related to the strength of the loan changes. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 risk grades is as follows.

Grade 1. MINIMAL RISK—These loans are without loss exposure to the Corporation. This classification is reserved for only the best, well secured loans to borrowers with significant capital strength, low leverage, stable earnings and growth and other readily available financing alternatives. This type of loan would also include loans secured by a program of the government.

Grade 2. MODEST RISK—These loans include borrowers with solid credit quality and moderate risk of loss. These loans may be fully secured by certificates of deposit with another reputable financial institution, or secured by readily marketable securities with acceptable margins.

Grade 3. AVERAGE RISK—This is the rating assigned to the majoprity of the loans held by the Corporation. This includes loans with average loss exposure and average overall quality. These loans should liquidate through possessing adequate collateral and adequate earnings of the borrower. In addition, these loans are properly documented and are in accordance with all aspects of the current loan policy.

Grade 4. ACCEPTABLE RISK—Borrower generates sufficient cash flow to fund debt service but most working asset and capital expansion needs are provided from external sources. Profitability and key balance sheet ratios are usually close to peers but one or more may be higher than peers.

Grade 5. MANAGEMENT ATTENTION—Borrower has significant weaknesses resulting from performance trends or management concerns. The financial condition of the borrower has taken a negative turn and may be temporarily strained. Cash flow is weak but cash reserves remain adequate to meet debt service. Management weakness is evident.

Grade 6. OTHER LOANS ESPECIALLY MENTIONED (OLEM)—Loans in this category are fundamentally sound but possess some weaknesses. OLEM loans have potential weaknesses which may, if not checked or corrected, weaken the asset or inadequately protect the bank’s credit position at some future date. These loans have an identifiable weakness in credit, collateral, or repayment ability but there is no expectation of loss.

Grade 7. SUBSTANDARD ASSETS—Assets classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets classified as substandard must have a well-defined weakness based upon objective evidence. Assets classified as substandard are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. The possibility that liquidation would not be timely requires a substandard classification even if there is little likelihood of total loss.

Grade 8. DOUBTFUL—A loan classified as doubtful has all the weaknesses of a substandard classification and the added characteristic that the weakness makes collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable or improbable. The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors which may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. A doubtful classification could reflect the fact that the primary source of repayment is gone and serious doubt exists as to the quality of a secondary source of repayment.

Grade 9. LOSS—Loans classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may occur in the future. Also included in this classification is the defined loss portion of loans rated substandard assets and doubtful assets.

These internally assigned grades are updated on a continual basis throughout the course of the year and represent management’s most updated judgment regarding grades at March 31, 2014.

The following table details the amount of gross loans (in thousands), segregated by loan grade and class, as of March 31, 2014:


			Special
	Satisfactory		Mention		Substandard		Doubtful		Loss		Total
Grades	1, 2, 3, 4		5, 6		7		8		9		Loans
Real Estate:
Land Development and Construction	$	29,024	$	176	$	1,862	$	—	$	—	$	31,062
Farmland		25,603		805		3,689		—		—		30,097
1-4 Family Mortgages		84,462		4,910		13,041		—		—		102,413
Commercial Real Estate		138,337		5,702		14,185		—		—		158,224

Total Real Estate Loans		277,426		11,593		32,777		—		—		321,796
Business Loans:
Commercial and Industrial Loans		38,179		430		284		2,078		—		40,971
Farm Production and Other Farm Loans		1,133		6		1		—		—		1,140

Total Business Loans		39,312		436		285		2,078		—		42,111
Consumer Loans:
Credit Cards		971		—		17		—		—		988
Other Consumer Loans		24,759		233		464		44		—		25,500

Total Consumer Loans		25,730		233		481		44		—		26,488

Total Loans	$	342,468	$	12,262	$	33,543	$	2,122	$	—	$	390,395

The following table details the amount of gross loans (in thousands) segregated by loan grade and class, as of December 31, 2013:


			Special
	Satisfactory		Mention		Substandard		Doubtful		Loss		Total
Grades	1, 2, 3, 4		5, 6		7		8		9		Loans
Real Estate:
Land Development and Construction	$	25,165	$	192	$	1,867	$	—	$	—	$	27,224
Farmland		25,160		744		3,730		—		—		29,634
1-4 Family Mortgages		87,108		4,671		13,710		—		—		105,489
Commercial Real Estate		125,339		5,915		14,115		—		—		145,369

Total Real Estate Loans		262,772		11,522		33,422		—		—		307,716

Business Loans:
Commercial and Industrial Loans		52,871		426		416		2,100		—		55,813
Farm Production and other Farm Loans		1,298		8		2		—		—		1,308

Total Business Loans		54,169		434		418		2,100		—		57,121

Consumer Loans:
Credit Cards		1,077		—		10		—		—		1,087
Other Consumer Loans		25,942		193		564		42		3		26,744

Total Consumer Loans		27,019		193		574		42		3		27,831

Total Loans	$	343,960	$	21,295	$	34,414	$	2,142	$	3	$	392,668

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio.

The allowance on the majority of the loan portfolio is calculated using a historical chargeoff percentage applied to the current loan balances by loan segment. This historical period is the average of the previous 20 quarters with the most current quarters weighted more heavily to show the effect of the most recent chargeoff activity. This percentage is also adjusted for economic factors such as local unemployment and general business conditions, both local and nationwide.

The group of loans that are considered to be impaired are individually evaluated for possible loss and a specific reserve is established to cover any loss contingency. Loans that are determined to be a loss with no benefit of remaining in the portfolio are charged off to the allowance. These specific reserves are reviewed periodically for continued impairment and adequacy of the specific reserve and adjusted when necessary.

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2014:


	Real		Business
March 31, 2014	Estate		Loans		Consumer			Total
Beginning Balance, January 1, 2014	$	4,705,753	$	2,767,409	$	604,337		$	8,077,499
Provision for possible loan losses		239,280		139,578		(17,490	)		361,368
Chargeoffs		61,040		22,760		35,540			119,340
Recoveries		15,155		2,283		24,607			42,045

Net Chargeoffs		45,885		20,477		10,933			77,295

Ending Balance	$	4,899,148	$	2,886,510	$	575,914		$	8,361,572

Period end allowance allocated to:
Loans individually evaluated for impairment	$	1,075,733	$	1,560,619	$	—		$	2,636,352
Loans collectively evaluated for impairment		3,823,415		1,325,891		575,914			5,725,220

Ending Balance, March 31, 2014	$	4,899,148	$	2,886,510	$	575,914		$	8,361,572

The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2013:


	Real		Business
March 31, 2013	Estate		Loans			Consumer			Total
Beginning Balance, January 1, 2013	$	4,629,559	$	1,554,698		$	770,012		$	6,954,269
Provision for possible loan losses		742,220		(537,313	)		(30,398	)		174,509
Chargeoffs		276,473		1,404			60,136			338,013
Recoveries		14,520		7,126			22,164			43,810

Net Chargeoffs		261,953		(5,722	)		37,972			294,203

Ending Balance, March 31, 2013	$	5,109,826	$	1,023,107		$	701,642		$	6,834,575

Period end allowance allocated to:
Loans individually evaluated for impairment	$	1,321,099	$	54,706		$	—		$	1,375,805
Loans collectively evaluated for impairment		3,788,727		968,401			701,642			5,458,770

Ending Balance, March 31, 2013	$	5,109,826	$	1,023,107		$	701,642		$	6,834,575

The Corporation’s recorded investment in loans as of March 31, 2014 and December 31, 2013 related to each balance in the allowance for possible loan losses by portfolio segment and disaggregated on the basis of the Corporation’s impairment methodology was as follows (in thousands):


	Real		Business
March 31, 2014	Estate		Loans		Consumer		Total
Loans individually evaluated for specific impairment	$	12,644	$	2,131	$	80	$	14,855
Loans collectively evaluated for general impairment		309,152		39,980		26,408		375,540

	$	321,796	$	42,111	$	26,488	$	390,395


	Real		Business
December 31, 2013	Estate		Loans		Consumer		Total
Loans individually evaluated for specific impairment	$	11,248	$	2,224	$	120	$	13,592
Loans collectively evaluated for general impairment		296,468		54,897		27,711		379,076

	$	307,716	$	57,121	$	27,831	$	392,668