Note 7. Loans

The composition of net loans (in thousands) at June 30, 2018 and December 31, 2017 was as follows:


	June 30, 2018			December 31, 2017
Real Estate:
Land Development and Construction	$	37,360		$	25,923
Farmland		15,889			16,905
1-4 Family Mortgages		88,627			95,925
Commercial Real Estate		196,715			191,736

Total Real Estate Loans		338,591			330,489
Business Loans:
Commercial and Industrial Loans		66,382			58,204
Farm Production and Other Farm Loans		999			922

Total Business Loans		67,381			59,126
Consumer Loans:
Credit Cards		1,342			1,310
Other Consumer Loans		13,408			14,680

Total Consumer Loans		14,750			15,990

Total Gross Loans		420,722			405,605
Unearned Income		(105	)		(195	)
Allowance for Loan Losses		(3,028	)		(3,019	)

Loans, net	$	417,589		$	402,391

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:


	June 30, 2018		December 31, 2017
Real Estate:
Land Development and Construction	$	420	$	—
Farmland		272		366
1-4 Family Mortgages		1,927		2,131
Commercial Real Estate		4,279		4,891

Total Real Estate Loans		6,898		7,388
Business Loans:
Commercial and Industrial Loans		83		78
Farm Production and Other Farm Loans		31		32

Total Business Loans		114		110
Consumer Loans:
Other Consumer Loans		71		84

Total Consumer Loans		71		84

Total Nonaccrual Loans	$	7,083	$	7,582

An aging analysis of past due loans (in thousands), segregated by class, as of June 30, 2018, was as follows:


	Loans 30-89 Days Past Due		Loans 90 or more Days Past Due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or more Days Past Due
Real Estate:
Land Development and Construction	$	16	$	420	$	436	$	36,924	$	37,360	$	—
Farmland		294		32		326		15,563		15,889		—
1-4 Family Mortgages		1,978		255		2,233		86,394		88,627		—
Commercial Real Estate		2,635		1,150		3,785		192,930		196,715		—

Total Real Estate Loans		4,923		1,857		6,780		331,811		338,591		—
Business Loans:
Commercial and Industrial Loans		154		—		154		66,228		66,382		—
Farm Production and Other Farm Loans		—		—		—		999		999		—

Total Business Loans		154		—		154		67,227		67,381		—
Consumer Loans:
Credit Cards		40		10		50		1,292		1,342		10
Other Consumer Loans		311		58		369		13,039		13,408		8

Total Consumer Loans		351		68		419		14,331		14,750		18

Total Loans	$	5,428	$	1,925	$	7,353	$	413,369	$	420,722	$	18

An aging analysis of past due loans (in thousands), segregated by class, as of December 31, 2017 was as follows:


	Loans 30-89 Days Past Due		Loans 90 or more Days Past Due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or more Days Past Due
Real Estate:
Land Development and Construction	$	281	$	—	$	281	$	25,642	$	25,923	$	—
Farmland		93		—		93		16,812		16,905		—
1-4 Family Mortgages		2,657		—		2,657		93,268		95,925		—
Commercial Real Estate		2,585		862		3,447		188,289		191,736		807

Total Real Estate Loans		5,616		862		6,478		324,011		330,489		807
Business Loans:
Commercial and Industrial Loans		32		—		32		58,172		58,204		—
Farm Production and Other Farm Loans		19		—		19		903		922		—

Total Business Loans		51		—		51		59,075		59,126		—
Consumer Loans:
Credit Cards		25		6		31		1,279		1,310		6
Other Consumer Loans		422		—		422		14,258		14,680		—

Total Consumer Loans		447		6		453		15,537		15,990		6

Total Loans	$	6,114	$	868	$	6,982	$	398,623	$	405,605	$	813

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 all loans over $100,000 that are 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 June 30, 2018, segregated by class, were as follows:


	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment
Real Estate:
Land Development and Construction	$	420	$	—	$	420	$	420	$	112	$	321
Farmland		272		272		—		272		—		262
1-4 Family Mortgages		1,232		1,034		198		1,232		33		1,288
Commercial Real Estate		5,686		1,739		3,947		5,686		384		5,744

Total Real Estate Loans		7,610		3,045		4,565		7,610		529		7,615
Business Loans:
Farm Production and Other Farm Loans		—		—		—		—		—		25

Total Business Loans		—		—		—		—		—		25

Total Loans	$	7,610	$	3,045	$	4,565	$	7,610	$	529	$	7,640

Impaired loans (in thousands) as of December 31, 2017, segregated by class, were as follows:


	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment
Real Estate:
Land Development and Construction	$	222	$	—	$	222	$	222	$	—	$	111
Farmland		252		252		—		252		—		126
1-4 Family Mortgages		1,344		1,141		203		1,344		46		906
Commercial Real Estate		5,801		1,763		4,038		5,801		397		4,994

Total Real Estate Loans		7,619		3,156		4,463		7,619		443		6,137
Business Loans:
Farm Production and Other Farm Loans		50		50		—		50		—		25

Total Business Loans		50		50		—		50		—		25

Total Loans	$	7,669	$	3,206	$	4,463	$	7,669	$	443	$	6,162

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


June 30, 2018	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial real estate		3	$	4,871	$	2,998

Total		3	$	4,871	$	2,998


December 31, 2017	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial real estate		3	$	4,871	$	3,047

Total		3	$	4,871	$	3,047

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, 2018		3	$	3,047
Reductions due to:
Principal paydowns				(49	)

Total at June 30, 2018		3	$	2,998

The allocated allowance for loan losses attributable to restructured loans was $174,274 at June 30, 2018 and December 31, 2017. The Corporation had no remaining availability under commitments to lend additional funds on these troubled debt restructurings as of June 30, 2018.

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 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 majority 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. This classification does not mean that the loan will incur a total or partial loss. Substandard loans may or may not be impaired.

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 as 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 June 30, 2018.

The following table details the amount of gross loans (in thousands), segregated by loan grade and class, as of June 30, 2018:


	Satisfactory 1,2,3,4		Special Mention 5,6		Substandard 7		Doubtful 8		Loss 9		Total Loans
Real Estate:
Land Development and Construction	$	35,479	$	881	$	1,000	$	—	$	—	$	37,360
Farmland		14,488		367		1,034		—		—		15,889
1-4 Family Mortgages		78,362		2,482		7,783		—		—		88,627
Commercial Real Estate		157,962		28,584		10,169		—		—		196,715

Total Real Estate Loans		286,291		32,314		19,986		—		—		338,591
Business Loans:
Commercial and Industrial Loans		63,280		995		2,107		—		—		66,382
Farm Production and Other Farm Loans		958		5		36		—		—		999

Total Business Loans		64,238		1,000		2,143		—		—		67,381
Consumer Loans:
Credit Cards		1,332		—		10		—		—		1,342
Other Consumer Loans		13,167		84		99		58		—		13,408

Total Consumer Loans		14,499		84		109		58		—		14,750

Total Loans	$	365,028	$	33,398	$	22,238	$	58	$	—	$	420,722

The following table details the amount of gross loans (in thousands) segregated by loan grade and class, as of December 31, 2017:


	Satisfactory 1,2,3,4		Special Mention 5,6		Substandard 7		Doubtful 8		Loss 9		Total Loans
Real Estate:
Land Development and Construction	$	23,720	$	2,116	$	87	$	—	$	—	$	25,923
Farmland		15,496		377		1,032		—		—		16,905
1-4 Family Mortgages		82,227		5,615		8,083		—		—		95,925
Commercial Real Estate		143,271		41,833		6,632		—		—		191,736

Total Real Estate Loans		264,714		49,941		15,834		—		—		330,489
Business Loans:
Commercial and Industrial Loans		55,081		2,990		133		—		—		58,204
Farm Production and Other Farm Loans		853		9		60		—		—		922

Total Business Loans		55,934		2,999		193		—		—		59,126
Consumer Loans:
Credit Cards		1,304		—		6		—		—		1,310
Other Consumer Loans		14,414		71		137		58		—		14,680

Total Consumer Loans		15,718		71		143		58		—		15,990

Total Loans	$	336,366	$	53,011	$	16,170	$	58	$	—	$	405,605

The allowance for loan losses is 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 twenty 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 are adjusted when necessary.

The following table details activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2018:


June 30, 2018	Real Estate		Business Loans			Consumer			Total
Beginning Balance, January 1, 2018	$	2,151,715	$	346,781		$	520,732		$	3,019,228
Provision for (reversal of) loan losses		481,714		(410,727	)		(218,798	)		(147,811	)
Chargeoffs		98,644		15,347			59,355			173,346
Recoveries		82,114		197,321			50,444			329,879

Net chargeoffs (recoveries)		16,530		(181,974	)		8,911			(156,533	)

Ending Balance	$	2,616,899	$	118,028		$	293,023		$	3,027,950

Period end allowance allocated to:
Loans individually evaluated for impairment	$	528,937	$	—		$	—		$	528,937
Loans collectively evaluated for impairment		2,087,962		118,028			293,023			2,499,013

Ending Balance, June 30, 2018	$	2,616,899	$	118,028		$	293,023		$	3,027,950

The following table details activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2017:


June 30, 2017	Real Estate			Business Loans		Consumer			Total
Beginning Balance, January 1, 2017	$	3,117,134		$	257,554	$	528,108		$	3,902,796
(Reversal of) provision for loan losses		(271,448	)		153,428		(62,786	)		(180,806	)
Chargeoffs		117,157			128,207		21,536			266,900
Recoveries		19,397			273		31,246			50,916

Net chargeoffs (recoveries)		97,760			127,934		(9,710	)		215,984

Ending Balance	$	2,747,926		$	283,048	$	475,032		$	3,506,006

Period end allowance allocated to:
Loans individually evaluated for impairment	$	547,621		$	—	$	—		$	547,621
Loans collectively evaluated for impairment		2,200,305			283,048		475,032			2,958,385

Ending Balance, June 30, 2017	$	2,747,926		$	283,048	$	475,032		$	3,506,006

The Corporation’s recorded investment in loans as of June 30, 2018 and December 31, 2017 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):


June 30, 2018	Real Estate		Business Loans		Consumer		Total
Loans individually evaluated for specific impairment	$	7,610	$	—	$	—	$	7,610
Loans collectively evaluated for general impairment		330,981		67,381		14,750		413,112

	$	338,591	$	67,381	$	14,750	$	420,722


December 31, 2017	Real Estate		Business Loans		Consumer		Total
Loans individually evaluated for specific impairment	$	4,396	$	—	$	—	$	4,396
Loans collectively evaluated for general impairment		326,093		59,126		15,990		401,209

	$	330,489	$	59,126	$	15,990	$	405,605