NOTE 4: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES

Loans

The composition of our loan portfolio at December 31, 2014 and 2013 was as follows:



(In thousands)	December 31, 2014		December 31, 2013
Commercial, financial and agricultural	$	177,597	$	172,810
Municipal loans		94,366		94,007
Real estate loans – residential		469,529		489,706
Real estate loans – commercial		412,447		371,319
Real estate loans – construction		23,858		31,841
Installment loans		4,504		5,655
All other loans		33		895
Total loans	$	1,182,334	$	1,166,233

We primarily originate residential real estate, commercial, commercial real estate, municipal obligations and installment loans to customers throughout the state of Vermont. There are no significant industry concentrations in the loan portfolio. Loans totaled $1.18 billion and $1.17 billion at December 31, 2014 and 2013, respectively. Total loans included $734 thousand and $618 thousand of net deferred loan origination costs at December 31, 2014 and December 31, 2013, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $235 thousand and $895 thousand at December 31, 2014 and 2013, respectively.

The following table reflects our loan loss experience and activity in the allowance for credit losses for the twelve months ended December 31, 2014:



(In thousands)	Commercial, financial and agricultural		Municipal		Real estate- residential		Real estate- commercial		Real estate-construction		Installment		All other		Totals
Allowance for credit losses:
Beginning balance	$	3,354		768		3,081		5,085		512		18		10	$	12,828
Charge-offs		(34)		0		(25)		0		0		(2)		(170)		(231)
Recoveries		10		0		24		1		0		2		31		68
Provision (credit)		1		(132)		47		165		(97)		(5)		171		150
Ending balance	$	3,331	$	636	$	3,127	$	5,251	$	415	$	13	$	42	$	12,815

The following table reflects our loan loss experience and activity in the allowance for credit losses for the twelve months ended December 31, 2013:



(In thousands)	Commercial, financial and agricultural		Municipal		Real estate- residential		Real estate- commercial		Real estate-construction		Installment		All other		Totals
Allowance for credit losses:
Beginning balance	$	3,447	$	522	$	3,421	$	4,660	$	234	$	17	$	11	$	12,312
Charge-offs		(20)		0		(289)		(1)		0		(9)		(93)		(412)
Recoveries		62		0		6		40		1		6		13		128
Provision (credit)		(135)		246		(57)		386		277		4		79		800
Ending balance	$	3,354	$	768	$	3,081	$	5,085	$	512	$	18	$	10	$	12,828

The following table reflects our loan loss experience and activity in the allowance for credit losses for the twelve months ended December 31, 2012:



(In thousands)	Commercial, financial and agricultural		Municipal		Real estate- residential		Real estate- commercial		Real estate-construction		Installment		All other		Totals
Allowance for credit losses:
Beginning balance	$	2,905	$	309	$	3,017	$	4,605	$	477	$	23	$	17	$	11,353
Charge-offs		(9)		0		(20)		(32)		0		0		0		(61)
Recoveries		30		0		14		1		25		0		0		70
Provision (credit)		521		213		410		86		(268)		(6)		(6)		950
Ending balance	$	3,447	$	522	$	3,421	$	4,660	$	234	$	17	$	11	$	12,312

The allowance for credit losses consists of the allowance for loan losses and the reserve for undisbursed lines of credit. The reserve for undisbursed lines of credit is included in other liabilities on the balance sheet. The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at December 31, 2014:



(In thousands)	Commercial, financial and agricultural		Municipal		Real estate- residential		Real estate- commercial		Real estate-construction		Installment		All other		Totals
Allowance for credit losses:
Ending balance individually evaluated for impairment	$	0		0		63		0		0		0		0	$	63
Ending balance collectively evaluated for impairment		3,331		636		3,064		5,251		415		13		42		12,752
Totals	$	3,331	$	636	$	3,127	$	5,251	$	415	$	13	$	42	$	12,815
Financing receivables:
Ending balance individually evaluated for impairment	$	134		0		657		0		0		0		0	$	791
Ending balance collectively evaluated for impairment		177,463		94,366		468,872		412,447		23,858		4,504		33		1,181,543
Totals	$	177,597	$	94,366	$	469,529	$	412,447	$	23,858	$	4,504	$	33	$	1,182,334
Components:
Allowance for loan losses	$	2,583		623		3,038		5,209		325		13		42	$	11,833
Reserve for undisbursed lines of credit		748		13		89		42		90		0		0		982
Total allowance for credit losses	$	3,331	$	636	$	3,127	$	5,251	$	415	$	13	$	42	$	12,815

The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon impairment method at December 31, 2013:



(In thousands)	Commercial, financial and agricultural		Municipal		Real estate- residential		Real estate- commercial		Real estate-construction		Installment		All other		Totals
Allowance for credit losses:
Ending balance individually evaluated for impairment	$	2	$	0	$	41	$	69	$	0	$	0	$	0	$	112
Ending balance collectively evaluated for impairment		3,352		768		3,040		5,016		512		18		10		12,716
Totals	$	3,354	$	768	$	3,081	$	5,085	$	512	$	18	$	10	$	12,828
Financing receivables:
Ending balance individually evaluated for impairment	$	20	$	0	$	722	$	164	$	0	$	0	$	0	$	906
Ending balance collectively evaluated for impairment		172,790		94,007		488,984		371,155		31,841		5,655		895		1,165,327
Totals	$	172,810	$	94,007	$	489,706	$	371,319	$	31,841	$	5,655	$	895	$	1,166,233
Components:
Allowance for loan losses	$	2,740	$	758	$	2,995	$	5,040	$	481	$	18	$	10	$	12,042
Reserve for undisbursed lines of credit		614		10		86		45		31		0		0		786
Total allowance for credit losses	$	3,354	$	768	$	3,081	$	5,085	$	512	$	18	$	10	$	12,828

The table below presents the recorded investment of loans, including nonperforming and restructured loans, segregated by class, with delinquency aging as of December 31, 2014:



	31-60 Days		61-90 Days		91 Days or More		Total Past						91 Days or more past due and
(In thousands)	Past Due		Past Due		Past Due		Due		Current		Total		Accruing
Commercial, financial and agricultural	$	49		0		0	$	49	$	177,548	$	177,597	$	0
Municipal		0		0		0		0		94,366		94,366		0
Real estate-residential:
First mortgage		157		0		391		548		431,191		431,739		0
Second mortgage		33		0		79		112		37,678		37,790		0
Real estate-commercial:
Owner occupied		0		22		0		22		260,075		260,097		0
Non-owner occupied		202		0		0		202		152,148		152,350		0
Real estate-construction:
Residential		0		0		0		0		4,131		4,131		0
Commercial		0		0		0		0		19,727		19,727		0
Installment		0		0		0		0		4,504		4,504		0
Other		0		0		0		0		33		33		0
Total	$	441	$	22	$	470	$	933	$	1,181,401	$	1,182,334	$	0

Of the total past due loans in the aging table above, $519 thousand are non-performing of which $0 are restructured loans and $0 were 91 days or more past due and accruing. There were $414 thousand past due performing loans at December 31, 2014.

The table below presents the recorded investment of loans, including nonaccrual and restructured loans, segregated by class, with delinquency aging as of December 31, 2013:



	31-60 Days		61-90 Days		91 Days or More		Total Past						91 Days or more past due and
(In thousands)	Past Due		Past Due		Past Due		Due		Current		Total		Accruing
Commercial, financial and agricultural	$	0	$	0	$	20	$	20	$	172,790	$	172,810	$	0
Municipal		0		0		0		0		94,007		94,007		0
Real estate-residential:
First mortgage		4		294		341		639		452,440		453,079		0
Second mortgage		0		4		181		185		36,442		36,627		75
Real estate-commercial:
Owner occupied		0		0		0		0		224,416		224,416		0
Non-owner occupied		72		0		0		72		146,831		146,903		0
Real estate-construction:
Residential		0		0		0		0		2,495		2,495		0
Commercial		0		0		0		0		29,346		29,346		0
Installment		0		0		0		0		5,655		5,655		0
Other		0		0		0		0		895		895		0
Total	$	76	$	298	$	542	$	916	$	1,165,317	$	1,166,233	$	75

Of the total past due loans in the aging table above, $542 thousand are non-performing of which $42 thousand are restructured loans and $75 thousand were greater than 90 days past due and accruing. There were $374 thousand past due performing loans at December 31, 2013.

Impaired loans by class at December 31, 2014 are as follows:


(In thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment
With no related allowance recorded
Commercial, financial and agricultural	$	134	$	136	$	0	$	86
Real estate – residential:
First mortgage		147		257		0		256
Second mortgage		79		79		0		136
Real estate – commercial:
Owner occupied		0		0		0		12
Non-owner occupied		0		0		0		0
Installment		0		0		0		0
With related allowance recorded
Commercial, financial and agricultural		0		0		0		12
Real estate – residential:
First mortgage		431		432		63		204
Second mortgage		0		0		0		0
Real estate – commercial:
Owner occupied		0		0		0		119
Installment		0		0		0		0
Total
Commercial, financial and agricultural		134		136		0		98
Real estate – residential		657		768		63		596
Real estate – commercial		0		0		0		131
Installment		0		0		0		0
Total	$	791	$	904	$	63	$	825

Impaired loans by class at December 31, 2013 are as follows:


(In thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment
With no related allowance recorded
Commercial, financial and agricultural	$	0	$	0	$	0	$	211
Real estate – residential:
First mortgage		410		629		0		541
Second mortgage		181		218		0		145
Real estate – commercial:
Owner occupied		0		0		0		93
Non-owner occupied		0		0		0		0
Installment		0		0		0		1
With related allowance recorded
Commercial, financial and agricultural		20		21		2		343
Real estate – residential:
First mortgage		131		135		41		512
Second mortgage		0		0		0		246
Real estate – commercial:
Owner occupied		164		175		69		170
Installment		0		0		0		5
Total
Commercial, financial and agricultural		20		21		2		554
Real estate – residential		722		982		41		1,444
Real estate – commercial		164		175		69		263
Installment		0		0		0		6
Total	$	906	$	1,178	$	112	$	2,267

Impaired loans by class at December 31, 2012 are as follows:


(In thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment
With no related allowance recorded
Commercial, financial and agricultural	$	7	$	22	$	0	$	39
Real estate – residential:
First mortgage		853		1,010		0		807
Second mortgage		16		17		0		247
Real estate – commercial:
Owner occupied		295		367		0		380
Non-owner occupied		0		0		0		0
Installment		0		0		0		1
With related allowance recorded
Commercial, financial and agricultural		226		228		149		37
Real estate – residential:
First mortgage		748		766		173		662
Second mortgage		700		700		188		320
Real estate – commercial:
Non-owner occupied		177		179		59		136
Total
Commercial, financial and agricultural		233		250		149		76
Real estate – residential		2,317		2,493		361		2,036
Real estate – commercial		472		546		59		516
Installment and other		0		0		0		1
Total	$	3,022	$	3,289	$	569	$	2,629

Interest income recorded on impaired loans was immaterial for the years ended December 31, 2014, 2013, and 2012.

Residential and commercial loans serviced for others at December 31, 2014 and 2013 amounted to approximately $13.53 million and $13.83 million, respectively.

Nonperforming loans at December 31, 2014 and 2013 are as follows:



(In thousands)	December 31, 2014		December 31, 2013
Nonaccrual loans	$	598	$	425
Loans greater than 90 days and accruing		0		75
Troubled debt restructurings ("TDRs")		193		406
Total nonperforming loans	$	791	$	906

Of the total TDRs in the table above, $63 thousand at December 31, 2014 and $235 thousand at December 31, 2013, are non-accruing. There were three commercial loans restructured with a balance of $46 thousand and one residential loan restructured with a balance of $55 thousand in 2014. We have reviewed all restructurings that occurred on or after January 1, 2014 for identification as TDRs. We did not identify as a TDR any loans for which the allowance for credit losses had been measured under a general allowance for credit losses methodology.

TDRs represent balances where the existing loan was modified involving a concession in rate, term or payment amount due to the distressed financial condition of the borrower. There were four restructured residential mortgages at December 31, 2014 with balances totaling $147 thousand. There were three restructured commercial loans at December 31, 2014 with a balance of $46 thousand. No loans were restructured in 2013. All of the TDRs at December 31, 2014 continue to pay as agreed according to the modified terms. At December 31, 2014, there were no commitments to lend additional funds to borrowers whose loans have been modified in a troubled debt restructuring. We had no commitments to lend additional funds to borrowers whose loans were in nonaccrual status or to borrowers whose loans were 91 days past due and still accruing at December 31, 2014. Interest income on restructured loans during years ended December 31, 2014 and 2013 was insignificant.

Nonaccrual loans by class as of December 31, 2014 and 2013 are as follows:



(In thousands)	December 31, 2014		December 31, 2013
Commercial, financial and agricultural	$	88	$	20
Real estate - residential:
First mortgage		431		299
Second mortgage		79		106
Real estate - commercial:
Owner occupied		0		0
Non owner occupied		0		0
Installment		0		0
Total nonaccruing non-TDR loans	$	598	$	425
Nonaccruing TDR’s
Commercial, financial and agricultural		5		0
Real estate – residential:
First mortgage		58		71
Real estate - commercial:
Owner occupied		0		164
Total nonaccrual loans including TDRs	$	661	$	660

Commercial Grading System

We use risk rating definitions for our commercial loan portfolios and certain residential loans which are generally consistent with regulatory and banking industry norms. Loans are assigned a credit quality grade which is based upon management’s on-going assessment of risk based upon an evaluation of the quantitative and qualitative aspects of each credit. This assessment is a dynamic process and risk ratings are adjusted as each borrower’s financial situation changes. This process is designed to provide timely recognition of a borrower’s financial condition and appropriately focus management resources.

Pass rated loans exhibit acceptable risk to the bank in terms of financial capacity to repay their loans as well as possessing acceptable fallback repayment sources, typically collateral and personal guarantees. Pass rated commercial loan relationships with a total exposure of $1 million or greater are subject to a formal annual review process; additionally, management reviews the risk rating at the time of any late payments, overdrafts or other sign of deterioration in the interim.

Loans rated Pass-Watch require more than usual attention and monitoring by the account officer, though not to the extent that a formal remediation plan is warranted. Borrowers can be rated Pass-Watch based upon a weakened capital structure, marginally adequate cash flow and/or collateral coverage or early-stage declining trends in operations or financial condition.

Loans rated Special Mention possess potential weakness that may expose the bank to some risk of loss in the future. These loans require more frequent monitoring and formal reporting to Management.

Substandard loans reflect well-defined weaknesses in the current repayment capacity, collateral or net worth of the borrower with the possibility of some loss to the bank if these weaknesses are not corrected. Action plans are required for these loans to address the inherent weakness in the credit and are formally reviewed.

Residential real estate and consumer loans

We do not use a grading system for our performing residential real estate and consumer loans. Credit quality for these loans is based on performance and payment status.

Below is a summary of loans by credit quality indicator as of December 31, 2014:


					Pass-		Special		Sub-
(In thousands)	Unrated		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	352		143,813		21,563		3,942		7,927	$	177,597
Municipal		40		75,337		17,101		1,888		0		94,366
Real estate – residential:
First mortgage		428,073		3,046		170		0		450		431,739
Second mortgage		37,790		0		0		0		0		37,790
Real estate – commercial:
Owner occupied		187		220,651		18,708		1,378		19,173		260,097
Non-owner occupied		189		130,218		20,773		0		1,170		152,350
Real estate – construction:
Residential		288		3,843		0		0		0		4,131
Commercial		170		17,588		40		0		1,929		19,727
Installment		4,504		0		0		0		0		4,504
All other loans		33		0		0		0		0		33
Total	$	471,626	$	594,496	$	78,355	$	7,208	$	30,649	$	1,182,334

Below is a summary of loans by credit quality indicator as of December 31, 2013:


					Pass-		Special		Sub-
(In thousands)	Unrated		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	242	$	152,466	$	14,092	$	96	$	5,914	$	172,810
Municipal		28		65,474		26,548		1,957		0		94,007
Real estate – residential:
First mortgage		449,951		2,520		0		65		543		453,079
Second mortgage		36,599		0		0		0		28		36,627
Real estate – commercial:
Owner occupied		165		187,779		17,236		2,342		16,894		224,416
Non-owner occupied		171		134,222		9,841		270		2,399		146,903
Real estate – construction:
Residential		904		1,591		0		0		0		2,495
Commercial		738		28,127		481		0		0		29,346
Installment		5,655		0		0		0		0		5,655
All other loans		895		0		0		0		0		895
Total	$	495,348	$	572,179	$	68,198	$	4,730	$	25,778	$	1,166,233