NOTE 6: LOANS AND THE ALLOWANCE FOR CREDIT LOSSES

Loans

The composition of our loan portfolio at March 31, 2017 and December 31, 2016 was as follows:


(In thousands)	March 31, 2017		December 31, 2016
Commercial, financial and agricultural	$	276,915	$	257,078
Municipal loans		113,875		114,509
Real estate loans – residential		438,424		447,527
Real estate loans – commercial		672,712		636,755
Real estate loans – construction		35,964		52,533
Installment loans		4,813		5,790
All other loans		15		17
Total loans	$	1,542,718	$	1,514,209

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 $1.13 million and $1.19 million of net deferred loan origination costs at March 31, 2017 and December 31, 2016, respectively. The aggregate amount of overdrawn deposit balances classified as loan balances was $254 thousand and $297 thousand at March 31, 2017 and December 31, 2016, respectively.

Additionally, residential and commercial loans serviced for others at March 31, 2017 and December 31, 2016 amounted to approximately $35.61 million and $34.63 million, respectively.

The following table reflects our loan loss experience and activity in the allowance for loan losses for the three months ended March 31, 2017:


	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	$	2,946	$	593	$	2,575	$	5,922	$	534	$	89	$	—	$	12,659
Charge-offs		(3)		—		—		—		—		(69)		—		(72)
Recoveries		2		—		9		—		—		23		—		34
Provision (credit)		250		(19)		(32)		434		(183)		116		—		566
Ending balance	$	3,195	$	574	$	2,552	$	6,356	$	351	$	159	$	—	$	13,187

The following table reflects our loan loss experience and activity in the allowance for loan losses for the three months ended March 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		(3)		—		(73)		—		—		(42)		—		(118)
Recoveries		2		—		11		4		—		19		—		36
Provision (credit)		161		32		37		(109)		45		49		—		215
Ending balance	$	2,856	$	622	$	2,857	$	5,281	$	465	$	92	$	—	$	12,173

In addition to the provision for loan losses included above, there was a provision (credit) for the reserve for undisbursed lines of $(66) thousand and $(10) thousand for the three months ended March 31, 2017 and March 31, 2016 included in the provision for credit losses in the consolidated statement of income.

The following presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based upon the impairment method at March 31, 2017:


	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	$	—	$	—	$	227	$	18	$	—	$	—	$	—	$	245
Ending balance collectively evaluated for impairment		3,195		574		2,325		6,331		351		159		—		12,935
Ending balance acquired with deteriorated credit quality		—		—		—		7		—		—		—		7
Totals	$	3,195	$	574	$	2,552	$	6,356	$	351	$	159	$	—	$	13,187
Financing receivables:
Ending balance individually evaluated for impairment	$	77	$	—	$	1,447	$	2,066	$	—	$	—	$	—	$	3,590
Ending balance collectively evaluated for impairment		276,144		113,875		436,977		668,775		35,964		4,813		15		1,536,563
Ending balance acquired with deteriorated credit quality		694		—		—		1,871		—		—		—		2,565
Totals	$	276,915	$	113,875	$	438,424	$	672,712	$	35,964	$	4,813	$	15	$	1,542,718

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 table below presents the recorded investment of loans segregated by class, with delinquency aging as of March 31, 2017:


	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	$	623	$	—	$	—	$	623	$	276,137	$	155	$	276,915
Municipal		—		—		—		—		113,875		—		113,875
Real estate-residential:
First mortgage		121		—		—		121		400,689		1,343		402,153
Second mortgage		—		—		—		—		36,271		—		36,271
Real estate-commercial:
Owner occupied		501		—		—		501		241,895		2,714		245,110
Non-owner occupied		—		—		—		—		427,602		—		427,602
Real estate-construction:
Residential		—		—		—		—		2,388		—		2,388
Commercial		—		—		—		—		33,576		—		33,576
Installment		87		14		—		101		4,712		—		4,813
Other		—		—		—		—		15		—		15
Total	$	1,332	$	14	$	—	$	1,346	$	1,537,160	$	4,212	$	1,542,718

Of the total nonperforming loans in the aging table above, $4.08 million were past due of which $0 were restructured loans, $804 thousand were purchase credit impaired, 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, 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.

Impaired loans by class at March 31, 2017 and for the three months ended March 31, 2017 are as follows:


	Period Ended						Three Months Ended
	March 31, 2017						March 31, 2017
			Unpaid					Average	Interest
	Recorded		Principal		Related			Recorded	Income
(In thousands)	Investment		Balance		Allowance			Investment	Recognized
With no related allowance recorded
Commercial, financial and agricultural	$	77	$	77	$	—	$	78	$	1
Residential:
First mortgage		130		190		—		180		1
Second mortgage		—		—		—		—		—
Commercial Real Estate:
Owner occupied		1,751		1,760		—		1,687		—
Non-owner occupied		—		—		—		134		2
Construction:
Residential		—		—		—		—		—
Commercial		—		—		—		—		—
Installment		—		—		—		—		—
With related allowance recorded
Commercial, financial and agricultural		—		—		—		—		—
Residential:
First mortgage		1,317		1,330		227		1,114		—
Second mortgage		—		—		—		—		—
Commercial Real Estate:
Owner occupied		315		315		18		105		—
Total
Commercial, financial and agricultural		77		77		—		78		1
Residential		1,447		1,520		227		1,294		1
Commercial Real Estate		2,066		2,075		18		1,926		2
Construction		—		—		—		—		—
Installment		—		—		—		—		—
Total	$	3,590	$	3,672	$	245	$	3,298	$	4

Impaired loans by class at December 31, 2016 and for the three months ended March 31, 2016 are as follows:


	Period Ended						Three Months Ended
	December 31, 2016						March 31, 2016
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
(In thousands)	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded
Commercial, financial and agricultural	$	97	$	97	$	—	$	390	$	1
Residential:
First mortgage		208		266		—		241		2
Second mortgage		—		—		—		3		—
Commercial Real Estate:
Owner occupied		1,229		1,229		—		401		—
Non-owner occupied		405		432		—		470		—
Installment		12		12		—		8		—
With related allowance recorded
Commercial, financial and agricultural		—		—		—		254		—
Residential:
First mortgage		1,005		1,026		184		425		—
Second mortgage		—		—		—		—		—
Commercial Real Estate:
Owner occupied		—		—		—		—		—
Installment		—		—		—		—		—
Total
Commercial, financial and agricultural		97		97		—		644		1
Residential		1,213		1,292		184		669		2
Commercial Real Estate		1,634		1,661		—		871		—
Installment		12		12		—		8		—
Total	$	2,956	$	3,062	$	184	$	2,192	$	3

Nonperforming loans at March 31, 2017 and December 31, 2016 are as follows:


(In thousands)	March 31, 2017		December 31, 2016
Nonaccrual loans	$	4,212	$	3,163
Loans greater than 90 days and accruing		—		19
Troubled debt restructurings ("TDRs")		—		—
Total nonperforming loans	$	4,212	$	3,182

There were no loans restructured in the three months ended March 31, 2017. One commercial real estate loan with a balance of $464 thousand was restructured during the three months ended March 31, 2016 and was considered to be a TDR.

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 March 31, 2017 with balances totaling $104 thousand. There was one restructured commercial loan at March 31, 2017 with a balance of $77 thousand. All of the four TDRs at March 31, 2017 continue to pay as agreed according to the modified terms, are accruing, and are considered performing. At December 31, 2016, there were three restructured residential mortgages with balances totaling $110 thousand, one restructured commercial loans with a balance totaling $78 thousand, and one restructured commercial real estate loan with a balance of $405 thousand.

At March 31, 2017, 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 March 31, 2017. Interest income on restructured loans during the three months ended March 31, 2017 and 2016 was insignificant.

Nonaccrual loans by class as of March 31, 2017 and December 31, 2016 are as follows:


(In thousands)	March 31, 2017		December 31, 2016
Commercial, financial and agricultural	$	155	$	165
Real estate - residential:
First mortgage		1,343		1,104
Second mortgage		—		—
Real estate - commercial:
Owner occupied		2,714		1,882
Non owner occupied		—		—
Installment		—		12
Total nonaccruing non-TDR loans	$	4,212	$	3,163
Nonaccruing TDR’s
Commercial, financial and agricultural		—		—
Real estate – residential:
First mortgage		—		—
Real estate - commercial:
Non owner occupied		—		—
Total nonaccrual loans including TDRs	$	4,212	$	3,163

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 March 31, 2017:


					Pass-		Special		Sub-
(In thousands)	Unrated		Pass		Watch		Mention		Standard		Total
Commercial, financial and agricultural	$	99		233,838	$	25,422	$	317	$	17,239	$	276,915
Municipal		—		110,222		3,653		—		—		113,875
Real estate – residential:
First mortgage		393,208		7,060		542		—		1,343		402,153
Second mortgage		36,049		—		222		—		—		36,271
Real estate – commercial:
Owner occupied		—		205,107		25,561		—		14,442		245,110
Non-owner occupied		—		385,105		41,426		—		1,071		427,602
Real estate – construction:
Residential		605		1,783		—		—		—		2,388
Commercial		116		31,948		1,512		—		—		33,576
Installment		4,813		—		—		—		—		4,813
All other loans		15		—		—		—		—		15
Total	$	434,905	$	975,063	$	98,338	$	317	$	34,095	$	1,542,718

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

The carrying amount of loans purchased with evidence of credit deterioration accounted for under FASB Accounting Standards Codification (“ASC”) 310-30 acquired in the NUVO acquisition totaled $2.57 million and $2.65 million at March 31, 2017 and December 31, 2016, respectively.