NOTE 5: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES

The composition of our loan portfolio at June 30, 2015 and December 31, 2014 was as follows:


(In thousands)		June 30, 2015		December 31, 2014
Commercial, financial and agricultural	$	210,458	$	177,597
Municipal loans		59,035		94,366
Residential		454,114		469,529
Commercial Real Estate		438,622		412,447
Construction		38,435		23,858
Installment loans		2,950		4,504
All other loans		41		33
Total loans	$	1,203,655	$	1,182,334

We primarily originate residential real estate, commercial, commercial real estate, and municipal obligations to customers throughout the state of Vermont. There are no significant industry concentrations in the loan portfolio. Total loans in the table above included $748 thousand and $734 thousand of net deferred loan origination costs at June 30, 2015 and December 31, 2014, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $662 thousand and $235 thousand at June 30, 2015 and December 31, 2014, respectively.

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the three months ended June 30, 2015:


		Commercial,
		financial and				Real estate-		Real estate-		Real estate-
(In thousands)		agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for credit losses:
Beginning balance	$	3,375	$	543	$	3,110	$	5,217	$	438	$	81	$	-	$	12,764
Charge-offs		(6)		-		-		-		-		(17)		-		(23)
Recoveries		14		-		26		-		-		10		-		50
Provision (credit)		67		(174)		(10)		137		95		(15)		-		100
Ending balance	$	3,450	$	369	$	3,126	$	5,354	$	533	$	59	$	-	$	12,891

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the three months ended June 30, 2014:


		Commercial,
		financial and				Real estate-		Real estate-		Real estate-
(In thousands)		agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for credit losses:
Beginning balance	$	3,378	$	693	$	3,352	$	5,119	$	360	$	18	$	9	$	12,929
Charge-offs		(34)		-		(16)		-		-		-		(31)		(81)
Recoveries		1		-		2		-		-		1		4		8
Provision (credit)		311		(307)		(92)		(30)		134		(1)		35		50
Ending balance	$	3,656	$	386	$	3,246	$	5,089	$	494	$	18	$	17	$	12,906

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the six months ended June 30, 2015:


	Commercial,
	financial and		Real estate-	Real estate-	Real estate-
(In thousands)	agricultural	Municipal	residential	commercial	construction	Installment	All Other	Total
Allowance for credit losses:
Beginning balance	$ 3,331	$ 636	$ 3,127	$ 5,251	$ 415	$ 13	$ 42	$ 12,815
Charge-offs	(17)		(55)			(43)		(115)
Recoveries	28		29	1		33		91
Provision (credit)	108	(267)	25	102	118	56	(42)	100
Ending balance	$ 3,450	$ 369	$ 3,126	$ 5,354	$ 533	$ 59	$ -	$ 12,891

The following table reflects our loan loss experience and activity in the allowance for credit losses by portfolio segment for the six months ended June 30, 2014:


		Commercial,
		financial and				Real estate-		Real estate-		Real estate-
(In thousands)		agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for credit losses:
Beginning balance	$	3,354	$	768	$	3,081	$	5,085	$	512	$	18	$	10	$	12,828
Charge-offs		(34)		-		(18)		-		-		-		(51)		(103)
Recoveries		3		-		20		-		-		1		7		31
Provision (credit)		333		(382)		163		4		(18)		(1)		51		150
Ending balance	$	3,656	$	386	$	3,246	$	5,089	$	494	$	18	$	17	$	12,906

The allowance for credit losses consists of the allowance for loan losses and the reserve for undisbursed lines and letters of credit. The reserve for undisbursed lines and letters 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 June 30, 2015:


		Commercial,
		financial and				Real estate-		Real estate-		Real estate-
(In thousands)		agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for credit losses:
Ending balance individually evaluated for impairment	$	-	$	-	$	143	$	-	$	-	$	-	$	-	$	143
Ending balance collectively evaluated for impairment		3,450		369		2,983		5,354		533		59		-		12,748
Totals	$	3,450	$	369	$	3,126	$	5,354	$	533	$	59	$	-	$	12,891
Financing receivables:
Ending balance individually evaluated for impairment	$	512	$	-	$	875	$	-	$	-	$	-	$	-	$	1,387
Ending balance collectively evaluated for impairment		209,946		59,035		453,239		438,622		38,435		2,950		41		1,202,268
Totals	$	210,458	$	59,035	$	454,114	$	438,622	$	38,435	$	2,950	$	41	$	1,203,655
Components:
Allowance for loan losses	$	2,925	$	359	$	3,043	$	5,299	$	477	$	59	$	-	$	12,162
Reserve for undisbursed lines of credit		525		10		83		55		56		-		-		729
Total allowance for credit losses	$	3,450	$	369	$	3,126	$	5,354	$	533	$	59	$	-	$	12,891

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:


		Commercial,
		financial and				Real estate-		Real estate-		Real estate-
(In thousands)		agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for credit losses:
Ending balance individually evaluated for impairment	$	-	$	-	$	63	$	-	$	-	$	-	$	-	$	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	$	-	$	657	$	-	$	-	$	-	$	-	$	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		-		-		982
Total allowance for credit losses	$	3,331	$	636	$	3,127	$	5,251	$	415	$	13	$	42	$	12,815

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by us over the most recent 5 years. This actual loss experience is supplemented with other factors based on the risks present for each portfolio segment. These factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. Due to the added risks associated with loans which are graded as pass-watch, special mention, and substandard that are not classified as impaired, an additional analysis is performed to determine whether an allowance is needed that is not fully captured by the historical loss experience. While historical loss experience by loan segment and migration of loans into higher risk classifications are considered, the following factors are also considered in determining the level of needed allowance on such loans: the historical loss rates of loans specifically classified as pass-watch, special mention, or substandard; and the trends in the collateral on the loans included within these classifications. This analysis created an additional $694 thousand at June 30, 2015 compared to $1.23 million at December 31, 2014 in needed allowance for loan loss.

The table below presents the recorded investment of loans, including nonaccrual and restructured loans, segregated by class, with delinquency aging as of June 30, 2015:


														91 Days or
		31-60		61-90		91 Days		Total						More past
		Days		Days		or More		Past						Due and
(In thousands)		Past Due		Past Due		Past Due		Due		Current		Total		Accruing
Commercial, financial and agricultural	$	50	$	94	$	-	$	144	$	210,314	$	210,458	$	-
Municipal		-		-		-		-		59,035		59,035		-
Residential:
First mortgage		274		148		392		814		418,393		419,207		-
Second mortgage		-		-		79		79		34,828		34,907		-
Commercial Real Estate:
Owner occupied		-		-		-		-		183,472		183,472		-
Non-owner occupied		47		-		-		47		255,103		255,150		-
Construction:
Residential		-		-		-		-		2,750		2,750		-
Commercial		-		-		-		-		35,685		35,685		-
Installment		-		-		-		-		2,950		2,950		-
Other		-		-		-		-		41		41		-
Total	$	371	$	242	$	471	$	1,084	$	1,202,571	$	1,203,655	$	-

Of the total past due loans in the aging table above, $619 thousand are non-performing of which $0 are restructured loans and $0 were greater than 91 days past due and accruing. There was $465 thousand past due performing loan at June 30, 2015.

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


														91 Days or
		31-60		61-90		91 Days		Total						more past
		Days		Days		or More		Past						due and
(In thousands)		Past Due		Past Due		Past Due		Due		Current		Total		Accruing
Commercial, financial and agricultural	$	49	$	-	$	-	$	49	$	177,548	$	177,597	$	-
Municipal		-		-		-		-		94,366		94,366		-
Residential:
First mortgage		157		-		391		549		431,191		431,739		-
Second mortgage		33		-		79		112		36,678		37,790		-
Commercial Real Estate:
Owner occupied		-		22		-		22		260,075		260,097		-
Non-owner occupied		202		-		-		202		152,148		152,350		-
Construction:
Residential		-		-		-		-		4,131		4,131		-
Commercial		-		-		-		-		19,727		19,727		-
Installment		-		-		-		-		4,504		4,504		-
Other		-		-		-		-		33		33		-
Total	$	441	$	22	$	470	$	933	$	1,181,401	$	1,182,334	$	-

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

Impaired loans by class at June 30, 2015 and for the three and six months ended June 30, 2015 are as follows:


							Three Months Ended				Six Months Ended
							June 30, 2015				June 30, 2015
			Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
(In thousands)	Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
With no related allowance recorded
Commercial, financial and agricultural	$	512	$	517	$	-	$	229	$	-	$	169	$	-
Residential:
First mortgage		174		230		-		159		-		153		-
Second mortgage		79		79		-		79		-		79		-
Commercial Real Estate:
Owner occupied		-		-		-		-		-		-		-
Non-owner occupied		-		-		-		10		-		5		-
Construction:
Residential		-		-		-		-		-		-		-
Commercial		-		-		-		-		-		-		-
Installment		-		-		-		-		-		-		-
With related allowance recorded
Commercial, financial and agricultural		-		-		-		331		-		248		-
Residential:
First mortgage		622		623		143		512		-		475		-
Second mortgage		-		-		-		11		-		9		-
Commercial Real Estate:
Owner occupied		-		-		-		-		-		-		-
Total
Commercial, financial and agricultural		512		517		-		560		-		417		-
Residential:		875		932		143		761		-		716		-
Commercial Real Estate:		-		-		-		10		-		5		-
Construction		-		-		-		-		-		-		-
Installment		-		-		-		-		-		-		-
Total	$	1,387	$	1,449	$	143	$	1,331	$	-	$	1,138	$	-

Impaired loans by class at December 31, 2014 and for the three and six months ended June 30, 2014 are as follows:


							Three Months Ended				Six Months Ended
							June 30, 2014				June 30, 2014
			Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
(In thousands)	Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
With no related allowance recorded
Commercial, financial and agricultural	$	134	$	136	$	-	$	95	$	1	$	65	$	1
Residential:
First mortgage		147		257		-		306		2		285		4
Second mortgage		79		79		-		162		1		168		1
Commercial Real Estate:
Owner occupied		-		-		-		51		1		25		1
Installment		-		-		-		-		-		-		-
With related allowance recorded
Commercial, financial and agricultural		-		-		-		29		-		24		-
Residential:
First mortgage		431		432		63		214		-		189		-
Second mortgage		-		-		-		-		-		-		-
Commercial Real Estate:
Owner occupied		-		-		-		158		-		160		-
Installment		-		-		-		-		-		-		-
Total
Commercial, financial and agricultural		134		136		-		124		1		89		1
Residential:		657		768		63		682		3		642		5
Commercial Real Estate:		-		-		-		209		1		185		1
Installment		-		-		-		-		-		-		-
Total	$	791	$	904	$	63	$	1,015	$	5	$	916	$	7

Residential and commercial loans serviced for others at June 30, 2015 and December 31, 2014 amounted to approximately $14.42 million and $13.53 million, respectively.

Nonperforming loans at June 30, 2015 and December 31, 2014 are as follows:


(In thousands)		June 30, 2015		December 31, 2014
Nonaccrual loans	$	748	$	598
Loans greater than 90 days and accruing		-		-
Troubled debt restructurings ("TDRs")		639		193
Total nonperforming loans	$	1,387	$	791

Of the total TDRs in the table above, $53 thousand at June 30, 2015 and $63 thousand at December 31, 2014 are nonaccruing. We have reviewed all restructurings that occurred on or after January 1, 2015 for identification as TDRs. One TDR with a balance of $471 thousand was restructured during the three and six months ended June 30, 2015. We did not identify as a TDR any loan 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. All TDRs at June 30, 2015 continue to pay as agreed according to the modified terms and five of the seven TDRs are considered well-secured. At June 30, 2015, there were no commitments to lend additional funds to borrowers whose loans have been modified in a TDR. 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 June 30, 2015. Interest income on restructured loans during the three and six months ended June 30, 2015 and 2014 was insignificant.

Nonaccrual loans by class as of June 30, 2015 and December 31, 2014 are as follows:


(In thousands)		June 30, 2015		December 31, 2014
Commercial, financial and agricultural	$	7	$	88
Residential:
First mortgage		645		431
Second mortgage		96		79
Total nonaccruing non-TDR loans		748		598
Nonaccruing TDR’s
Commercial, financial and agricultural		3		5
Residential:
First mortgage		50		58
Commercial Real Estate:
Owner occupied		-		-
Total nonaccrual loans including TDRs	$	801	$	661

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 the loan 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 June 30, 2015:


						Pass-		Special		Sub-
(In thousands)		Unrated		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	753	$	172,398	$	21,711	$	4,323	$	11,273	$	210,458
Municipal		609		48,349		9,363		714		-		59,035
Residential:
First mortgage		414,985		3,341		167		-		714		419,207
Second mortgage		34,907		-		-		-		-		34,907
Commercial Real Estate:
Owner occupied		133		150,973		14,328		3,330		14,708		183,472
Non-owner occupied		208		230,357		22,213		652		1,720		255,150
Construction:
Residential		129		2,621		-		-		-		2,750
Commercial		181		33,607		34		-		1,863		35,685
Installment		2,950		-		-		-		-		2,950
All other loans		41		-		-		-		-		41
Total	$	454,896	$	641,646	$	67,816	$	9,019	$	30,278	$	1,203,655

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


						Pass-		Special		Sub-
(In thousands)		Unrated Residential and		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		-		94,366
Residential:
First mortgage		428,073		3,046		170		-		450		431,739
Second mortgage		37,790		-		-		-		-		37,790
Commercial Real Estate:
Owner occupied		187		220,651		18,708		1,378		19,173		260,097
Non-owner occupied		189		130,218		20,773		-		1,170		152,350
Construction:
Residential		288		3,843		-		-		-		4,131
Commercial		170		17,588		40		-		1,929		19,727
Installment		4,504		-		-		-		-		4,504
All other loans		33		-		-		-		-		33
Total	$	471,626	$	594,496	$	78,355	$	7,208	$	30,649	$	1,182,334