NOTE 7: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES

Loans

The composition of our loan portfolio at June 30, 2016 and December 31, 2015 was as follows:


(In thousands)	June 30, 2016		December 31, 2015
Commercial, financial and agricultural	$	260,167	$	237,451
Municipal loans		60,590		105,421
Real estate loans – residential		456,132		468,443
Real estate loans – commercial		560,056		558,004
Real estate loans – construction		50,788		34,802
Installment loans		7,629		10,115
All other loans		31		44
Total loans	$	1,395,393	$	1,414,280

We primarily originate commercial, commercial real estate, municipal, and residential real estate loans to customers throughout the states of Vermont and Massachusetts. There are no significant industry concentrations in the loan portfolio. Total loans included $1.14 million and $1.20 million of net deferred loan origination costs at June 30, 2016 and December 31, 2015, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $344 thousand and $308 thousand at June 30, 2016 and December 31, 2015, respectively.

The following table reflects our loan loss experience and activity in the allowance for loan losses for the three months ended June 30, 2016:


	Commercial,
	financial				Real		Real		Real
	and				estate-		estate-		estate-
(In thousands)	agricultural		Municipal		residential		commercial		construction		Installment		All other		Totals
Allowance for loan losses:
Beginning balance	$	2,856	$	622	$	2,857	$	5,281	$	465	$	92	$	—	$	12,173
Charge-offs		(4)		—		—		—		—		(36)		—		(40)
Recoveries		2		—		11		—		—		20		—		33
Provision (credit)		344		(270)		(59)		142		84		13		—		254
Ending balance	$	3,198	$	352	$	2,809	$	5,423	$	549	$	89	$	—	$	12,420

The $254 thousand provision for loan losses includes a $200 thousand provision for credit losses plus $54 thousand of excess reserves from the reserve for undisbursed lines and letters.

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


	Commercial,
	financial				Real		Real		Real
	and				estate-		estate-		estate-
(In thousands)	agricultural		Municipal		residential		commercial		construction		Installment		All other		Totals
Allowance for loan losses:
Beginning balance	$	2,866	$	530	$	3,024	$	5,149	$	364	$	81	$	—	$	12,014
Charge-offs		(6)		—		—		—		—		(17)		—		(23)
Recoveries		14		—		26		—		—		10		—		50
Provision (credit)		51		(171)		(7)		150		113		(15)		—		121
Ending balance	$	2,925	$	359	$	3,043	$	5,299	$	477	$	59	$	—	$	12,162

The $121 thousand provision for loan losses includes a $100 thousand provision for credit losses plus $21 thousand of excess reserves to the reserve for undisbursed lines and letters.

The following table reflects our loan loss experience and activity in the allowance for loan losses for the six months ended June 30, 2016:


	Commercial,
	financial				Real		Real		Real
	and				estate-		estate-		estate-
(In thousands)	agricultural		Municipal		residential		commercial		construction		Installment		All other		Totals
Allowance for loan losses:
Beginning balance	$	2,696	$	590	$	2,882	$	5,386	$	420	$	66	$	—	$	12,040
Charge-offs		(7)		—		(73)		—		—		(78)		—		(158)
Recoveries		4		—		22		4		—		39		—		69
Provision (credit)		505		(238)		(22)		33		129		62		—		469
Ending balance	$	3,198	$	352	$	2,809	$	5,423	$	549	$	89	$	—	$	12,420

The $469 thousand provision for loan losses consists of a $405 thousand provision for credit losses outstanding plus $64 thousand of excess reserves from the reserve for undisbursed lines and letters.

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


	Commercial,
	financial				Real		Real		Real
	and				estate-		estate-		estate-
(In thousands)	agricultural		Municipal		residential		commercial		construction		Installment		All Other		Total
Allowance for loan losses:
Beginning balance	$	2,583	$	623	$	3,038	$	5,209	$	325	$	13	$	42	$	11,833
Charge-offs		(17)		—		(55)		—		—		(43)		—		(115)
Recoveries		28		—		29		1		—		33		—		91
Provision (credit)		331		(264)		31		89		152		56		(42)		353
Ending balance	$	2,925	$	359	$	3,043	$	5,299	$	477	$	59	$	—	$	12,162

The $353 thousand provision for loan losses a consists of a $100 thousand provision for credit losses plus $253 thousand of excess reserves from the reserve for undisbursed lines and letters.

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, 2016:


	Commercial,
	financial and				Real estate-		Real estate-		Real estate-
(In thousands)	agricultural		Municipal		residential		commercial		construction		Installment		All other		Totals
Allowance for loan losses:
Ending balance individually evaluated for impairment	$	195	$	—	$	116	$	52	$	—	$	—	$	—	$	363
Ending balance collectively evaluated for impairment		3,003		352		2,693		5,371		549		89		—		12,057
Ending balance acquired with deteriorated credit quality		—		—		—		—		—		—		—		—
Totals	$	3,198	$	352	$	2,809	$	5,423	$	549	$	89	$	—	$	12,420
Financing receivables:
Ending balance individually evaluated for impairment	$	668	$	—	$	701	$	1,339	$	—	$	27	$	—	$	2,735
Ending balance collectively evaluated for impairment		258,824		60,590		455,431		556,742		50,788		7,602		31		1,390,008
Ending balance acquired with deteriorated credit quality		675		—		—		1,975		—		—		—		2,650
Totals	$	260,167	$	60,590	$	456,132	$	560,056	$	50,788	$	7,629	$	31	$	1,395,393

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, 2015:


	Commercial,
	financial and				Real estate-		Real estate-		Real estate-
(In thousands)	agricultural		Municipal		residential		commercial		construction		Installment		All other		Totals
Allowance for loan losses:
Ending balance individually evaluated for impairment	$	—	$	—	$	137	$	—	$	—	$	—	$	—	$	137
Ending balance collectively evaluated for impairment		2,696		590		2,745		5,386		420		66		—		11,903
Ending balance acquired with deteriorated credit quality		—		—				—		—		—		—		—
Totals	$	2,696	$	590	$	2,882	$	5,386	$	420	$	66	$	—	$	12,040
Financing receivables:
Ending balance individually evaluated for impairment	$	595	$	—	$	706	$	647	$	—	$	22	$	—	$	1,970
Ending balance collectively evaluated for impairment		235,652		105,421		467,737		555,323		34,802		10,093		44		1,409,072
Ending balance acquired with deteriorated credit quality		1,204		—		—		2,034		—		—		—		3,238
Totals	$	237,451	$	105,421	$	468,443	$	558,004	$	34,802	$	10,115	$	44	$	1,414,280

The table below presents the recorded investment of loans segregated by class, with delinquency aging as of June 30, 2016:


	31-60		61-90		91 Days		Total
	Days		Days		or More		Past
(In thousands)	Past Due		Past Due		Past Due		Due		Current			Nonperforming	Total
Commercial, financial and agricultural	$	—	$	—	$	—	$	—	$	258,942	$	1,225	$	260,167
Municipal		—		—		—		—		60,590		—		60,590
Real estate-residential:
First mortgage		702		—		—		702		414,053		701		415,456
Second mortgage		—		—		—		—		40,676		—		40,676
Real estate-commercial:
Owner occupied		—		—		—		—		214,080		2,155		216,235
Non-owner occupied		—		—		—		—		343,240		581		343,821
Real estate-construction:
Residential		—		—		—		—		2,446		—		2,446
Commercial		—		—		—		—		48,342		—		48,342
Installment		72		—		—		72		7,530		27		7,629
Other		—		—		—		—		31		—		31
Total	$	774	$	—	$	—	$	774	$	1,389,930	$	4,689	$	1,395,393

Of the total nonperforming loans in the aging table above, $2.31 million are past due of which $386 thousand are restructured loans and $0 were 91 days or more past due and accruing.

The table below presents the recorded investment of loans segregated by class, with delinquency aging as of December 31, 2015:


	31-60		61-90		91 Days		Total
	Days		Days		or More		Past
(In thousands)	Past Due		Past Due		Past Due		Due		Current			Nonperforming	Total
Commercial, financial and agricultural	$	—	$	251	$	—	$	251	$	235,820	$	1,380	$	237,451
Municipal		—		—		—		—		105,421		—		105,421
Real estate-residential:
First mortgage		50		—		—		50		425,520		706		426,276
Second mortgage		—		8		—		8		42,159		—		42,167
Real estate-commercial:
Owner occupied		323		—		—		323		219,080		1,605		221,008
Non-owner occupied		—		—		—		—		336,514		482		336,996
Real estate-construction:
Residential		—		—		—		—		2,422		—		2,422
Commercial		—		—		—		—		32,380		—		32,380
Installment		61		9		—		70		10,023		22		10,115
Other		—		—		—		—		44		—		44
Total	$	434	$	268	$	—	$	702	$	1,409,383	$	4,195	$	1,414,280

Of the total nonperforming loans in the aging table above, $2.65 million are past due of which $471 thousand are restructured loans and $0 were 91 days or more past due and accruing.

Impaired loans by class at June 30, 2016 and for the three and six months ended June 30, 2016 are as follows:


	Period Ended						Three Months Ended				Six Months Ended
	June 30, 2016						June 30, 2016				June 30, 2016
			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	$	97	$	97	$	—	$	99	$	1	$	245	$	2
Residential:
First mortgage		220		282		—		213		1		227		3
Second mortgage		—		—		—		—		—		1		—
Commercial Real Estate:
Owner occupied		698		691		—		623		—		512		—
Non-owner occupied		581		595		—		587		—		529		—
Construction:
Residential		—		—		—		—		—		—		—
Commercial		—		—		—		—		—		—		—
Installment		27		27		—		10		—		9		—
With related allowance recorded
Commercial, financial and agricultural		571		576		195		508		—		381		—
Residential:
First mortgage		481		496		116		421		—		423		—
Second mortgage		—		—		—		—		—		—		—
Commercial Real Estate:
Owner occupied		60		59		52		40		—		20		—
Total
Commercial, financial and agricultural		668		673		195		607		1		626		2
Residential		701		778		116		634		1		651		3
Commercial Real Estate		1,339		1,345		52		1,250		—		1,061		—
Construction		—		—		—		—		—		—		—
Installment		27		27		—		10		—		9		—
Total	$	2,735	$	2,823	$	363	$	2,501	$	2	$	2,347	$	5

Impaired loans by class at December 31, 2015 and for the three and six months ended June 30, 2015 are as follows:


	Period Ended						Three Months Ended				Six Months Ended
	December 31, 2015						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	$	595	$	599	$	—	$	229	$	2	$	169	$	2
Residential:
First mortgage		264		322		—		159		1		153		2
Second mortgage		—		—		—		79		—		79		—
Commercial Real Estate:
Owner occupied		165		165		—		10		—		5		—
Non-owner occupied		482		482		—		—		—		—		—
Installment		22		22		—		—		—		—		—
With related allowance recorded
Commercial, financial and agricultural		—		—		—		331		—		248		—
Residential:
First mortgage		442		442		137		512		—		475		—
Second mortgage		—		—		—		11		—		9		—
Commercial Real Estate:
Owner occupied		—		—		—		—		—		—		—
Installment		—		—		—		—		—		—		—
Total
Commercial, financial and agricultural		595		599		—		560		2		417		2
Residential		706		764		137		761		1		716		2
Commercial Real Estate		647		647		—		10		—		5		—
Installment		22		22		—		—		—		—		—
Total	$	1,970	$	2,032	$	137	$	1,331	$	3	$	1,138	$	4

Residential and commercial loans serviced for others at June 30, 2016 and December 31, 2015 amounted to approximately $25.15 million and $27.87 million, respectively.

Nonperforming loans at June 30, 2016 and December 31, 2015 are as follows:


(In thousands)	June 30, 2016		December 31, 2015
Nonaccrual loans	$	3,659	$	3,513
Loans greater than 90 days and accruing		—		—
Troubled debt restructurings ("TDRs")		1,030		682
Total nonperforming loans	$	4,689	$	4,195

Of the total TDRs in the table above, $830 thousand at June 30, 2016 and $472 thousand at December 31, 2015, are non-accruing. There were no loans restructured in the three months ending June 30, 2016 and one loan restructured in the six months ending June 30, 2016 with a balance of $444 thousand. One TDR with a balance of $471 thousand was restructured in the three and six months ending June 30, 2015. The loan modified in 2016 was individually evaluated for impairment and it was determined that no reserve was required.

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 three restructured residential mortgages at June 30, 2016 with balances totaling $117 thousand. There were two restructured commercial loans at June 30, 2016 with a balance of $469 thousand. There was one commercial real estate loan at June 30, 2016 with a balance of $444 thousand. Five of the six TDRs at June 30, 2016 continue to pay as agreed according to the modified terms. The one TDR that was delinquent at June 30, 2016 totaled $386 thousand. At June 30, 2016, 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 June 30, 2016. Interest income on restructured loans during the three months ending June 30, 2016 and 2015 was insignificant.

Nonaccrual loans by class as of June 30, 2016 and December 31, 2015 are as follows:


(In thousands)	June 30, 2016		December 31, 2015
Commercial, financial and agricultural	$	757	$	823
Real estate - residential:
First mortgage		584		581
Second mortgage		—		—
Real estate - commercial:
Owner occupied		2,154		1,605
Non owner occupied		137		482
Installment		27		22
Total nonaccruing non-TDR loans	$	3,659	$	3,513
Nonaccruing TDR’s
Commercial, financial and agricultural		386		472
Real estate – residential:
First mortgage		—		—
Real estate - commercial:
Non owner occupied		444		—
Total nonaccrual loans including TDRs	$	4,489	$	3,985

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 June 30, 2016:


					Pass-		Special		Sub-
(In thousands)	Unrated		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	530	$	205,435	$	35,778	$	304	$	18,120	$	260,167
Municipal		37		51,809		8,629		115		—		60,590
Real estate – residential:
First mortgage		406,892		6,293		1,590		—		681		415,456
Second mortgage		40,449		—		227		—		—		40,676
Real estate – commercial:
Owner occupied		227		169,987		29,684		1,867		14,470		216,235
Non-owner occupied		470		293,266		45,271		451		4,363		343,821
Real estate – construction:
Residential		3		2,108		335		—		—		2,446
Commercial		255		42,342		4,018		—		1,727		48,342
Installment		7,602		—		—		—		27		7,629
All other loans		31		—		—		—		—		31
Total	$	456,496	$	771,240	$	125,532	$	2,737	$	39,388	$	1,395,393

Below is a summary of loans by credit quality indicator as of December 31, 2015:


					Pass-		Special		Sub-
(In thousands)	Unrated		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	597	$	179,451	$	45,977	$	4,177	$	7,249	$	237,451
Municipal		58		92,011		13,352		—		—		105,421
Real estate – residential:
First mortgage		420,798		4,733		164		—		581		426,276
Second mortgage		42,167		—		—		—		—		42,167
Real estate – commercial:
Owner occupied		296		161,810		41,477		5,959		11,466		221,008
Non-owner occupied		166		290,337		44,485		444		1,564		336,996
Real estate – construction:
Residential		478		1,944		—		—		—		2,422
Commercial		145		27,299		3,136		—		1,800		32,380
Installment		10,093		—		—		—		22		10,115
All other loans		44		—		—		—		—		44
Total	$	474,842	$	757,585	$	148,591	$	10,580	$	22,682	$	1,414,280

The carrying amount of loans purchased with evidence of credit deterioration accounted for under ASC 310-30 acquired in the acquisition totaled $2.65 million and $3.24 million at June 30, 2016 and December 31, 2015, respectively. There was no transfer of nonaccretable yield to accretable.