NOTE 6: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES

Loans

The composition of our loan portfolio was as follows:


(In thousands)	December 31, 2016		December 31, 2015
Commercial, financial and agricultural	$	257,078	$	237,451
Municipal loans		114,509		105,421
Real estate loans – residential		447,527		468,443
Real estate loans – commercial		636,755		558,004
Real estate loans – construction		52,533		34,802
Installment loans		5,790		10,115
All other loans		17		44
Total loans	$	1,514,209	$	1,414,280

We primarily originate commercial, commercial real estate, municipal obligations 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 $1.19 million and $1.20 million of net deferred loan origination costs at December 31, 2016 and 2015, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $297 thousand and $308 thousand at December 31, 2016 and 2015, respectively.

Additionally, residential and commercial loans serviced for others at December 31, 2016 and 2015 amounted to approximately $34.63 million and $27.87 million, respectively.

The following table reflects our loan loss experience and activity in the allowance for loan losses for the year ended December 31, 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		(125)		—		(215)		—		—		(168)		—		(508)
Recoveries		5		—		35		4		—		83		—		127
Provision (credit)		370		3		(127)		532		114		108		—		1,000
Ending balance	$	2,946	$	593	$	2,575	$	5,922	$	534	$	89	$	—	$	12,659

The following table reflects our loan loss experience and activity in the allowance for loan losses for the year ended December 31, 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	$	2,583	$	623	$	3,038	$	5,209	$	325	$	13	$	42	$	11,833
Charge-offs		(29)		—		(112)		—		—		(108)		—		(249)
Recoveries		34		—		52		2		—		52		—		140
Provision (credit)		108		(33)		(96)		175		95		109		(42)		316
Ending balance	$	2,696	$	590	$	2,882	$	5,386	$	420	$	66	$	—	$	12,040

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


	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	$	2,740	$	758	$	2,995	$	5,040	$	481	$	18	$	10	$	12,042
Charge-offs		(34)		—		(25)		—		—		(2)		(170)		(231)
Recoveries		10		—		24		1		—		2		31		68
Provision (credit)		(133)		(135)		44		168		(156)		(5)		171		(46)
Ending balance	$	2,583	$	623	$	3,038	$	5,209	$	325	$	13	$	42	$	11,833

In addition to the provision for loan losses include above, there was a provision (credit) for the reserve for undisbursed lines of $105 thousand, $(66) thousand and $196 thousand for 2016, 2015 and 2014, respectively, included in the provision for credit losses in the consolidated statements of income.

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, 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	$	—	$	—	$	184	$	—	$	—	$	—	$	—	$	184
Ending balance collectively evaluated for impairment		2,946		593		2,391		5,922		534		89		—		12,475
Ending balance acquired with deteriorated credit quality		—		—		—		—		—		—		—		—
Totals	$	2,946	$	593	$	2,575	$	5,922	$	534	$	89	$	—	$	12,659
Financing receivables:
Ending balance individually evaluated for impairment	$	97	$	—	$	1,213	$	1,634	$	—	$	12	$	—	$	2,956
Ending balance collectively evaluated for impairment		256,239		114,509		446,314		633,217		52,533		5,778		17		1,508,607
Ending balance acquired with deteriorated credit quality		742		—		—		1,904		—		—		—		2,646
Totals	$	257,078	$	114,509	$	447,527	$	636,755	$	52,533	$	5,790	$	17	$	1,514,209

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 December 31, 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	$	—	$	—	$	—	$	—	$	256,894	$	184	$	257,078
Municipal		—		—		—		—		114,509		—		114,509
Real estate-residential:
First mortgage		164		71		—		235		408,597		1,104		409,936
Second mortgage		32		—		—		32		37,559		—		37,591
Real estate-commercial:
Owner occupied		—		—		—		—		224,691		1,882		226,573
Non-owner occupied		—		—		—		—		410,182		—		410,182
Real estate-construction:
Residential		—		—		—		—		2,530		—		2,530
Commercial		—		—		—		—		50,003		—		50,003
Installment		123		—		—		123		5,655		12		5,790
Other		—		—		—		—		17		—		17
Total	$	319	$	71	$	—	$	390	$	1,510,637	$	3,182	$	1,514,209

Of the total nonperforming loans in the aging table above, $1.75 million were past due of which $0 were restructured loans, $819 thousand were purchase credit impaired, and $19 thousand were 91 days or more past due and accruing. In the third quarter of 2016, the Company’s policy was updated to classify accruing TDRs as performing loans to more accurately represent the characteristics of the loans. Prior period amounts have been reclassified to be consistent with the current period presentation. Nonperforming loans as of December 31, 2015 were reduced $210 thousand for accruing TDRs.

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	$	235,905	$	1,295	$	237,451
Municipal		—		—		—		—		105,421		—		105,421
Real estate-residential:
First mortgage		50		—		—		50		425,645		581		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	$	1,409,593	$	3,985	$	1,414,280

Of the total nonperforming loans in the aging table above, $2.65 million were past due of which $472 thousand were restructured loans, $1.05 million were purchased credit impaired, and $0 were 91 days or more past due and accruing.

Impaired loans by class at December 31, 2016 are as follows:


									Interest
	Recorded		Unpaid Principal		Related		Average Recorded		Income
(In thousands)	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial, financial and agricultural	$	97	$	97	$	—	$	243	$	4
Real estate – residential:
First mortgage		208		266		—		253		6
Second mortgage		—		—		—		1		—
Real estate – commercial:
Owner occupied		1,229		1,229		—		525		—
Non-owner occupied		405		432		—		508		—
Installment		12		12		—		7		—
With related allowance recorded
Commercial, financial and agricultural		—		—		—		298		—
Real estate – residential:
First mortgage		1,005		1,026		184		514		—
Second mortgage		—		—		—		—		—
Real estate – commercial:
Owner occupied		—		—		—		10		—
Installment		—		—		—		—		—
Total
Commercial, financial and agricultural		97		97		—		541		4
Real estate – residential		1,213		1,292		184		768		6
Real estate – commercial		1,634		1,661		—		1,043		—
Installment		12		12		—		7		—
Total	$	2,956	$	3,062	$	184	$	2,359	$	10

Impaired loans by class at December 31, 2015 are as follows:


									Interest
	Recorded		Unpaid Principal		Related		Average Recorded		Income
(In thousands)	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial, financial and agricultural	$	595	$	599	$	—	$	374	$	11
Real estate – residential:
First mortgage		264		322		—		227		5
Second mortgage		—		—		—		52		—
Real estate – commercial:
Owner occupied		165		165		—		13		—
Non-owner occupied		482		482		—		43		—
Installment		22		22		—		2		—
With related allowance recorded
Commercial, financial and agricultural		—		—		—		124		—
Real estate – residential:
First mortgage		442		442		137		484		—
Second mortgage		—		—		—		4		—
Real estate – commercial:
Owner occupied		—		—		—		—		—
Installment		—		—		—		—		—
Total
Commercial, financial and agricultural		595		599		—		498		11
Real estate – residential		706		764		137		767		5
Real estate – commercial		647		647		—		56		—
Installment		22		22		—		2		—
Total	$	1,970	$	2,032	$	137	$	1,323	$	16

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


									Interest
	Recorded		Unpaid Principal		Related		Average Recorded		Income
(In thousands)	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial, financial and agricultural	$	134	$	136	$	—	$	86	$	3
Real estate – residential:
First mortgage		147		257		—		256		8
Second mortgage		79		79		—		136		1
Real estate – commercial:
Owner occupied		—		—		—		12		1
Non-owner occupied		—		—		—		—		—
Installment		—		—		—		—		—
With related allowance recorded
Commercial, financial and agricultural		—		—		—		12		—
Real estate – residential:
First mortgage		431		432		63		204		—
Second mortgage		—		—		—		—		—
Real estate – commercial:
Non-owner occupied		—		—		—		119		—
Installment		—		—		—		—		—
Total
Commercial, financial and agricultural		134		136		—		98		3
Real estate – residential		657		768		63		596		9
Real estate – commercial		—		—		—		131		1
Installment and other		—		—		—		—		—
Total	$	791	$	904	$	63	$	825	$	13

Nonperforming loans were as follows:


(In thousands)	December 31, 2016		December 31, 2015
Nonaccrual loans	$	3,163	$	3,513
Loans greater than 90 days and accruing		19		—
Troubled debt restructurings		—		472
Total nonperforming loans	$	3,182	$	3,985

There was one commercial real estate loan restructured with a balance of $405 thousand in 2016 and is considered to be a TDR. This loan was individually evaluated for impairment and it was determined that no reserve was required. In 2015, there were two commercial loans restructured with a total balance of $556 thousand and were considered to be TDRs.

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. At December 31, 2016, there were three restructured residential mortgages with balances totaling $110 thousand, one restructured commercial loan with a balance of $78 thousand and one restructured commercial real estate loan with a balance of $405 thousand. All of the five of the TDRs at December 31, 2016 continue to pay as agreed according to the modified terms, are accruing, and are considered performing loans. At December 31, 2015, there were three restructured residential mortgages with balances totaling $125 thousand and three restructured commercial loans with balances totaling $557 thousand.

At December 31, 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 December 31, 2016. Interest income on restructured loans during years ended December 31, 2016 and 2015 was insignificant.

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


(In thousands)	December 31, 2016		December 31, 2015
Commercial, financial and agricultural	$	165	$	823
Real estate - residential:
First mortgage		1,104		581
Second mortgage		—		—
Real estate - commercial:
Owner occupied		1,882		1,605
Non owner occupied		—		482
Installment		12		22
Total nonaccruing non-TDR loans	$	3,163	$	3,513
Nonaccruing TDR’s
Commercial, financial and agricultural		—		472
Real estate – residential:
First mortgage		—		—
Real estate - commercial:
Non owner occupied		—		—
Total nonaccrual loans including TDRs	$	3,163	$	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 ongoing 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, 2016:


					Pass-		Special		Sub-
(In thousands)	Unrated		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	102	$	215,891	$	24,215	$	322	$	16,548	$	257,078
Municipal		—		110,864		2,824		821		—		114,509
Real estate – residential:
First mortgage		400,961		7,392		481		—		1,102		409,936
Second mortgage		37,367		—		224		—		—		37,591
Real estate – commercial:
Owner occupied		—		186,494		25,492		—		14,587		226,573
Non-owner occupied		—		369,566		38,706		—		1,910		410,182
Real estate – construction:
Residential		412		2,118		—		—		—		2,530
Commercial		152		41,373		7,476		—		1,002		50,003
Installment		5,778		—		—		—		12		5,790
All other loans		17		—		—		—		—		17
Total	$	444,789	$	933,698	$	99,418	$	1,143	$	35,161	$	1,514,209

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	$	116	$	179,932	$	45,977	$	4,177	$	7,249	$	237,451
Municipal		—		92,069		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		—		162,106		41,477		5,959		11,466		221,008
Non-owner occupied		—		290,503		44,485		444		1,564		336,996
Real estate – construction:
Residential		477		1,945		—		—		—		2,422
Commercial		134		27,310		3,136		—		1,800		32,380
Installment		10,093		—		—		—		22		10,115
All other loans		44		—		—		—		—		44
Total	$	473,829	$	758,598	$	148,591	$	10,580	$	22,682	$	1,414,280

The carrying amount of loans purchased with evidence of credit deterioration accounted for under FASB ASC 310-30 acquired in the NUVO acquisition totaled $2.65 million and $3.24 million at December 31, 2016 and 2015, respectively.