The composition of net loans is summarized as follows:



	Year Ended December 31,
(Dollars In Thousands)	2017		Percentage of Total		2016		Percentage of Total
Commercial real estate - owner occupied	$	467,082	23.60	%	$	250,440	23.87	%
Commercial real estate - non-owner occupied	436,083		22.04		184,688		17.59
Residential real estate	489,669		24.74		204,413		19.47
Commercial	463,652		23.43		311,486		29.67
Real estate construction	97,481		4.93		91,822		8.75
Consumer	24,942		1.26		6,849		0.65
Total loans	$	1,978,909	100.00	%	$	1,049,698	100.00	%
Less allowance for loan losses	15,805				16,008
Net loans	$	1,963,104			$	1,033,690

Unearned income and net deferred loan fees and costs totaled $3.1 million and $2.4 million at December 31, 2017 and 2016, respectively. Loans pledged to secure borrowings at the FHLB totaled $492.2 million and $266.6 million at December 31, 2017 and 2016, respectively.

Allowance for Loan Losses

The allowance for loan losses totaled $15.8 million and $16.0 million at year end December 31, 2017 and 2016, respectively. The allowance for loan losses was equivalent to 0.80% and 1.53% of total loans held for investment at December 31, 2017 and 2016, respectively. Adequacy of the allowance is assessed and the allowance is increased by provisions for loan losses charged to expense no less than quarterly. Charge-offs are taken when a loan is identified as uncollectible.

The methodology by which the Corporation systematically determines the amount of its allowance is set forth by the Board of Directors in its Loan Policy and implemented by management. The results of the analysis are documented, reviewed, and approved by the Board of Directors no less than quarterly.

The level of the allowance for loan losses is determined by management through an ongoing, detailed analysis of historical loss rates and risk characteristics. During each quarter, management evaluates the collectability of all loans in the portfolio and ensures an accurate risk rating is assigned to each loan. The risk rating scale and definitions commonly adopted by the Federal Banking Agencies is contained within the framework prescribed by the Bank’s Loan Policy. Any loan that is deemed to have potential or well defined weaknesses that may jeopardize collection in full is then analyzed to ascertain its level of weakness. If appropriate, the loan may be charged-off or a specific reserve may be assigned if the loan is deemed to be impaired.

During the risk rating verification process, each loan identified as inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged is considered impaired and is placed on non-accrual status. On these loans, management analyzes the potential impairment of the individual loan and may set aside a specific reserve. Any amounts deemed uncollectible during that analysis are charged-off.

For the remaining loans in each segment, the Bank calculates the probability of loss as a group using the risk rating for each of the following loan types: Commercial Real Estate - Owner Occupied, Commercial Real Estate - Non-Owner Occupied, Residential Real Estate, Commercial, Real Estate Construction, and Consumer. Management calculates the historical loss rate in each group by risk rating using a period of at least six years. This historical loss rate may then be adjusted based on management’s assessment of internal and external environmental factors. While management may consider other factors, the analysis generally includes factors such as unemployment, office vacancy rates, and any concentrations that exist within the portfolio. This adjustment is meant to account for changes between the historical economic environment and current conditions and for changes in the ongoing management of the portfolio which affects the loans’ potential losses.

Once complete, management compares the condition of the portfolio using several different characteristics, as well as its experience, to the experience of other banks in its peer group in order to determine if it is directionally consistent with others’ experience in our area and line of business. Based on that analysis, management aggregates the probabilities of loss of the remaining portfolio based on the specific and general allowances and may provide additional amounts to the allowance for loan losses as needed. Since this process involves estimates, the allowance for loan losses may also contain an amount that is non-material which is not allocated to a specific loan or to a group of loans but is deemed necessary to absorb additional losses in the portfolio.

Management and the Board of Directors subject the reserve adequacy and methodology to a review on a regular basis by internal auditors and bank regulators, and such reviews have not resulted in any material adjustment to the allowance.

The following provides detailed information about the changes in the allowance for loan losses for the years ended December 31, 2017, 2016 and 2015 as well as the recorded investment in loans at December 31, 2017 and 2016.



	Allowance for Loan Losses
Twelve months ended December 31, 2017	Commercial real estate - owner occupied		Commercial real estate - non-owner occupied		Residential real estate			Commercial			Real estate construction			Consumer			Total
	(In Thousands)
Allowance for loan losses:
Beginning Balance	$	2,943	$	2,145	$	2,510		$	7,053		$	1,277		$	80		$	16,008
Charge-offs	—		—		—			(7,457		)	—			(27		)	(7,484		)
Recoveries	17		—		131			209			—			5			362
Provisions	1,320		959		(460		)	5,645			(571		)	26			6,919
Ending Balance	$	4,280	$	3,104	$	2,181		$	5,450		$	706		$	84		$	15,805



Twelve months ended December 31, 2016	Commercial real estate - owner occupied			Commercial real estate - non-owner occupied		Residential real estate			Commercial		Real estate construction		Consumer			Total
	(In Thousands)
Allowance for loan losses:
Beginning Balance	$	3,042		$	1,862	$	2,862		$	4,612	$	1,056	$	129		$	13,563
Charge-offs	—			—		—			—		—		—			—
Recoveries	—			—		40			285		—		—			325
Provisions	(99		)	283		(392		)	2,156		221		(49		)	2,120
Ending Balance	$	2,943		$	2,145	$	2,510		$	7,053	$	1,277	$	80		$	16,008



Twelve months ended December 31, 2015	Commercial real estate - owner occupied			Commercial real estate - non-owner occupied			Residential real estate			Commercial			Real estate construction		Consumer		Total
	(In Thousands)
Allowance for loan losses:
Beginning Balance	$	3,229		$	1,894		$	3,308		$	4,284		$	596	$	88	$	13,399
Charge-offs	—			—			—			(186		)	—		—		(186		)
Recoveries	—			—			61			102			37		—		200
Provisions	(187		)	(32		)	(507		)	412			423		41		150
Ending Balance	$	3,042		$	1,862		$	2,862		$	4,612		$	1,056	$	129	$	13,563

Loans acquired in a transfer, including in business combinations, where there is evidence of credit deterioration since origination and it is probable at the date of acquisition that the Corporation will not collect all contractually required principal and interest payments, are accounted for as purchased credit impaired loans. Purchased credit impaired loans are initially recorded at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, the historical allowance for loan losses related to these loans is not carried over.

Accounting for purchased credit impaired loans involves estimating fair value, at acquisition, using the principal and interest cash flows expected to be collected discounted at the prevailing market rate of interest. The excess of cash flows expected to be collected over the estimated fair value at the acquisition date is referred to as the accretable yield and is recognized in interest income using an effective yield method over the remaining life of the loans. The difference between contractually required payments and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference and is not recorded. Any decreases in cash flows expected to be collected (other than due to decreases in interest rate indices and changes in prepayment and assumptions) will be charged to the provision for loan losses, resulting in an increase to the allowance for loan losses.

The following table present the changes in the accretable yield for purchased credit impaired loans for the year ended December 31, 2017:



(In Thousands)	2017
Accretable yield, beginning of period	$	—
Additions	557
Accretion	(313		)
Reclassification from (to) nonaccretable difference	—
Other changes, net	—
Accretable yield, end of period	$	244



	Recorded Investment in Loans
December 31, 2017	Commercial real estate - owner occupied		Commercial real estate - non-owner occupied		Residential real estate		Commercial		Real estate construction		Consumer		Total
	(In Thousands)
Allowance
Ending balance:	$	4,280	$	3,104	$	2,181	$	5,450	$	706	$	84	$	15,805
Ending balance: individually evaluated for impairment	$	—	$	—	$	—	$	234	$	186	$	—	$	420
Ending balance: collectively evaluated for impairment	$	4,280	$	3,104	$	2,181	$	5,216	$	520	$	84	$	15,385
Ending balance: loans acquired with deteriorated credit quality	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Loans
Ending balance:	$	467,082	$	436,083	$	489,669	$	463,652	$	97,481	$	24,942	$	1,978,909
Ending balance: individually evaluated for impairment	$	1,393	$	—	$	166	$	3,107	$	865	$	182	$	5,713
Ending balance: collectively evaluated for impairment	$	464,030	$	435,109	$	487,390	$	460,369	$	96,616	$	24,713	$	1,968,227
Ending balance: loans acquired with deteriorated credit quality	$	1,659	$	974	$	2,113	$	176	$	—	$	47	$	4,969



December 31, 2016	Commercial real estate - owner occupied		Commercial real estate - non-owner occupied		Residential real estate		Commercial		Real estate construction		Consumer		Total
	(In Thousands)
Allowance
Ending balance:	$	2,943	$	2,145	$	2,510	$	7,053	$	1,277	$	80	$	16,008
Ending balance: individually evaluated for impairment	$	—	$	—	$	—	$	2,805	$	221	$	—	$	3,026
Ending balance: collectively evaluated for impairment	$	2,943	$	2,145	$	2,510	$	4,248	$	1,056	$	80	$	12,982
Ending balance: loans acquired with deteriorated credit quality	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Loans
Ending balance:	$	250,440	$	184,688	$	204,413	$	311,486	$	91,822	$	6,849	$	1,049,698
Ending balance: individually evaluated for impairment	$	335	$	—	$	606	$	6,182	$	940	$	—	$	8,063
Ending balance: collectively evaluated for impairment	$	250,105	$	184,688	$	203,807	$	305,304	$	90,882	$	6,849	$	1,041,635
Ending balance: loans acquired with deteriorated credit quality	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Identifying and Classifying Portfolio Risks by Risk Rating

At origination, loans are categorized into risk categories based upon original underwriting. Subsequent to origination, management evaluates the collectability of all loans in the portfolio and assigns a proprietary risk rating on a quarterly basis as of the 15th of the last month in the quarter. Ratings range from the highest to lowest quality based on factors including measurements of ability to pay, collateral type and value, borrower stability, management experience, and credit enhancements. These ratings are consistent with the bank regulatory rating system.

A loan may have portions of its balance in one rating and other portions in a different rating. The Bank may use these “split ratings” when factors cause loan loss risk to exist for part but not all of the principal balance. Split ratings may also be used where cash collateral or a government agency has provided a guaranty that partially covers a loan.

For clarity of presentation, the Corporation’s loan portfolio is profiled below in accordance with the risk rating framework that has been commonly adopted by the federal banking agencies. The definitions of the various risk rating categories are as follows:

Pass - The condition of the borrower and the performance of the loan are satisfactory or better.

Special mention - A special mention asset has one or more potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.

Substandard - A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful - An asset classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss - Assets classified loss are considered uncollectible and their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, and a partial recovery may be effected in the future.

The Bank did not have any loans classified as loss or doubtful at December 31, 2017 and 2016. It is the Bank’s policy to charge-off any loan once the risk rating is classified as loss.

The profile of the loan portfolio, as indicated by risk rating, as of December 31, 2017 and 2016 is shown below.



	December 31, 2017
Credit Risk Profile by Risk Rating	Pass		Special Mention		Substandard		Doubtful		Loss		Unearned Income			Total Loans
	(In Thousands)
Commercial real estate - owner occupied	$	465,464	$	1,639	$	758	$	—	$	—	$	(779	)	$	467,082
Commercial real estate - non-owner occupied	437,087		—		—		—		—		(1,004		)	436,083
Residential real estate	487,800		189		1,835		—		—		(155		)	489,669
Commercial	461,091		1,615		1,750		—		—		(804		)	463,652
Real estate construction	92,522		5,349		—		—		—		(390		)	97,481
Consumer	24,928		—		10		—		—		4			24,942
Total	$	1,968,892	$	8,792	$	4,353	$	—	$	—	$	(3,128	)	$	1,978,909



	December 31, 2016
Credit Risk Profile by Risk Rating	Pass		Special Mention		Substandard		Doubtful		Loss		Unearned Income			Total Loans
	(In Thousands)
Commercial real estate - owner occupied	$	247,001	$	1,213	$	2,807	$	—	$	—	$	(581	)	$	250,440
Commercial real estate - non-owner occupied	185,020		300		—		—		—		(632		)	184,688
Residential real estate	202,762		932		878		—		—		(159		)	204,413
Commercial	287,978		4,544		19,561		—		—		(597		)	311,486
Real estate construction	91,296		—		940		—		—		(414		)	91,822
Consumer	6,848		—		—		—		—		1			6,849
Total	$	1,020,905	$	6,989	$	24,186	$	—	$	—	$	(2,382	)	$	1,049,698

Loans listed as non-performing are also placed on non-accrual status. The accrual of interest is discontinued at the time a loan is 90 days delinquent or when the credit deteriorates and there is doubt that the credit will be paid as agreed, unless the credit is well-secured and in process of collection. Once the loan is on non-accrual status, all accrued but unpaid interest is also charged-off, and all payments are used to reduce the principal balance. Once the principal balance is repaid in full, additional payments are taken into income. A loan may be returned to accrual status if the borrower shows renewed willingness and ability to repay under the term of the loan agreement. The risk profile based upon payment activity is shown below.



	December 31, 2017
Credit Risk Profile Based on Payment Activity	Performing		Non-Performing		Total Loans
	(In Thousands)
Commercial real estate - owner occupied	$	466,016	$	1,066	$	467,082
Commercial real estate - non-owner occupied	436,083		—		436,083
Residential real estate	489,669		—		489,669
Commercial	461,139		2,513		463,652
Real estate construction	96,616		865		97,481
Consumer	24,760		182		24,942
Total	$	1,974,283	$	4,626	$	1,978,909



	December 31, 2016
Credit Risk Profile Based on Payment Activity	Performing		Non-Performing		Total Loans
	(In Thousands)
Commercial real estate - owner occupied	$	250,440	$	—	$	250,440
Commercial real estate - non-owner occupied	184,688		—		184,688
Residential real estate	203,982		431		204,413
Commercial	305,935		5,551		311,486
Real estate construction	90,882		940		91,822
Consumer	6,849		—		6,849
Total	$	1,042,776	$	6,922	$	1,049,698

Loans are considered past due if a contractual payment is not made by the calendar day after the payment is due. For reporting purposes, however, loans past due 1 to 29 days are excluded. The delinquency status of the loans in the portfolio is shown below as of December 31, 2017 and 2016. Loans that were on non-accrual status are not included in any past due amounts.



	Age Analysis of Past Due Loans December 31, 2017
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Non-accrual Loans		Current Loans		Total Loans
	(In Thousands)
Commercial real estate - owner occupied	$	—	$	—	$	—	$	—	$	1,066	$	466,016	$	467,082
Commercial real estate - non-owner occupied	—		—		—		—		—		436,083		436,083
Residential real estate	655		140		213		1,008		—		488,661		489,669
Commercial	138		19		—		157		2,513		460,982		463,652
Real estate construction	—		—		—		—		865		96,616		97,481
Consumer	81		2		—		83		182		24,677		24,942
Total	$	874	$	161	$	213	$	1,248	$	4,626	$	1,973,035	$	1,978,909



	12/31/2016
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Non-accrual Loans		Current Loans		Total Loans
	(In Thousands)
Commercial real estate - owner occupied	$	—	$	—	$	—	$	—	$	—	$	250,440	$	250,440
Commercial real estate - non-owner occupied	—		—		—		—		—		184,688		184,688
Residential real estate	—		97		—		97		431		203,885		204,413
Commercial	438		—		—		438		5,551		305,497		311,486
Real estate construction	—		—		—		—		940		90,882		91,822
Consumer	—		—		—		—		—		6,849		6,849
Total	$	438	$	97	$	—	$	535	$	6,922	$	1,042,241	$	1,049,698

Impaired Loans

A loan is classified as impaired when it is deemed probable by management’s analysis that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement, or the recorded investment in the impaired loan is greater than the present value of expected future cash flows, discounted at the loan's effective interest rate. In the case of an impaired loan, management conducts an analysis which identifies if a quantifiable potential loss exists, and takes the necessary steps to record that loss when it has been identified as uncollectible.

As the ultimate collectability of the total principal of an impaired loan is in doubt, the loan is placed on nonaccrual status with all payments applied to principal under the cost-recovery method. As such, the Bank did not recognize any interest income on its impaired loans for the years ended December 31, 2017, 2016 and 2015.

The table below shows the results of management’s analysis of impaired loans as of December 31, 2017 and 2016.



	Impaired Loans
	December 31, 2017						December 31, 2016
	Recorded investment		Unpaid principal balance		Related allowance		Recorded investment		Unpaid principal balance		Related allowance
	(In Thousands)
With no specific related allowance recorded:
Commercial real estate - owner occupied	$	1,066	$	1,092	$	—	$	—	$	—	$	—
Commercial real estate - non-owner occupied	—		—		—		—		—		—
Residential real estate	—		—		—		431		431		—
Commercial	747		1,080		—		2,748		3,771		—
Real estate construction	—		—		—		—		—		—
Consumer	145		155		—		—		—		—
With a specific related allowance recorded:
Commercial real estate - owner occupied	$	—	$	—	$	—	$	—	$	—	$	—
Commercial real estate - non-owner occupied	—		—		—		—		—		—
Residential real estate	—		—		—		—		—		—
Commercial	1,766		1,817		234		2,803		1,400		2,805
Real estate construction	865		952		186		940		994		221
Consumer	37		38		—		—		—		—
Total:
Commercial real estate - owner occupied	$	1,066	$	1,092	$	—	$	—	$	—	$	—
Commercial real estate - non-owner occupied	—		—		—		—		—		—
Residential real estate	—		—		—		431		431		—
Commercial	2,513		2,897		234		5,551		5,171		2,805
Real estate construction	865		952		186		940		994		221
Consumer	182		193		—		—		—		—
	$	4,626	$	5,134	$	420	$	6,922	$	6,596	$	3,026

The table below shows the average recorded investment in impaired loans for the years ended December 31, 2017, 2016 and 2015.



	Twelve Months Ended
	December 31, 2017		December 31, 2016		December 31, 2015
	Average Recorded Investment		Average Recorded Investment		Average Recorded Investment
	(In Thousands)
Commercial real estate - owner occupied	$	1,075	$	59	$	—
Commercial real estate - non-owner occupied	—		2,099		5,572
Residential real estate	—		120		163
Commercial	3,395		4,885		917
Real estate construction	923		1,009		1,086
Consumer	179		—		—
	$	5,572	$	8,172	$	7,738

Troubled Debt Restructurings

A troubled debt restructuring ("TDR") is a formal restructure of a loan when the Bank, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to a borrower. The Bank classifies these transactions as a TDR if the transaction meets the following conditions: an existing credit agreement must be formally renewed, extended and/or modified; the borrower must be experiencing financial difficulty; and the Bank has granted a concession that it would not otherwise consider.

Once identified as a TDR, a loan is considered to be impaired, and an impairment analysis is performed for the loan individually, rather than under a general loss allowance based on the loan type and risk rating. Any resulting shortfall is charged off. This method is used consistently for all segments of the portfolio.

Normally, loans identified as TDRs would be placed on non-accrual status and considered non-performing until sufficient history of timely collection or payment has occurred that allows them to return to performing status, generally 6 months.

During 2017, one commercial loan totaling $91 thousand at December 31, 2017 was modified in connection with a troubled debt restructuring. The modification granted the borrower an extension of the maturity date and was deemed to have no material financial effects as a direct result of this modification. Two construction loan totaling $2.0 million at the time of restructure were modified in connection with a troubled debt restructuring during the year ended December 31, 2016. The modification granted the borrower reduced payments for a period of two years as well as a reduction in the interest rate. There were no material financial effects as a direct result of this modification.

No payment defaults occurred during the year ended December 31, 2017 or December 31, 2016 for loans restructured during the preceding 12 month period.

The table below shows the results of management’s analysis of troubled debt restructurings as of December 31, 2017 and 2016.



	Troubled Debt Restructurings
	December 31, 2017					December 31, 2016
	Number of loans	Outstanding balance		Recorded investment		Number of loans	Outstanding balance		Recorded investment
	(Dollars in Thousands)
Performing
Commercial real estate - owner occupied	—	$	—	$	—	—	$	—	$	—
Commercial real estate - non-owner occupied	—	—		—		—	—		—
Residential real estate	1	208		166		1	217		175
Commercial	2	921		921		2	967		967
Real estate construction	—	—		—		—	—		—
Consumer	—	—		—		—	—		—

Non-Performing
Commercial real estate - owner occupied	—	$	—	$	—	—	$	—	$	—
Commercial real estate - non-owner occupied	—	—		—		—	—		—
Residential real estate	—	—		—		—	—		—
Commercial	2	956		956		2	2,000		2,000
Real estate construction	—	—		—		1	994		940
Consumer	—	—		—		—	—		—

Total	5	$	2,085	$	2,043	6	$	4,178	$	4,082