Credit Quality of Loans and Allowance for Loan Losses

The loan portfolio consisted of the following (in thousands):



	June 30, 2015			December 31, 2014
Commercial, financial and agricultural	$	471,397		$	467,147
Real estate - construction	79,176			68,577
Real estate – commercial	469,022			467,172
Real estate – residential	153,820			154,602
Installment loans to individuals	113,626			119,328
Lease financing receivable	5,561			4,857
Other	1,790			2,748
	1,294,392			1,284,431
Less allowance for loan losses	(16,048		)	(11,226		)
	$	1,278,344		$	1,273,205

The Company monitors loan concentrations and evaluates individual customer and aggregate industry leverage, profitability, risk rating distributions, and liquidity for each major standard industry classification segment. At June 30, 2015, one industry segment concentration, the oil and gas industry, constituted more than 10% of the loan portfolio. The Company’s exposure in the oil and gas industry, including related service and manufacturing industries, totaled approximately $266.4 million, or 20.6% of total loans. Additionally, the Company’s exposure to loans secured by commercial real estate is monitored. At June 30, 2015, loans secured by commercial real estate (including commercial construction, farmland and multifamily loans) totaled approximately $526.6 million. Of the $526.6 million, $469.0 million represent CRE loans, 53% of which are secured by owner-occupied commercial properties. Of the $526.6 million in loans secured by commercial real estate, $18.5 million, or 3.5%, were on nonaccrual status at June 30, 2015.

Allowance for Loan Losses

The allowance for loan losses is a valuation account available to absorb probable losses on loans. All losses are charged to the allowance for loan losses when the loss actually occurs or when a determination is made that a loss is likely to occur. Recoveries are credited to the allowance for loan losses at the time of recovery. Quarterly, the probable level of losses in the existing portfolio is estimated through consideration of various factors. Based on these estimates, the allowance for loan losses is increased by charges to earnings and decreased by charge‑offs (net of recoveries).

The allowance is composed of general reserves and specific reserves. General reserves are determined by applying loss percentages to segments of the portfolio. The loss percentages are based on each segment’s historical loss experience, generally over the past twelve to eighteen months, and adjustment factors derived from conditions in the Company’s internal and external environment. All loans considered to be impaired are evaluated on an individual basis to determine specific reserve allocations in accordance with GAAP. Loans for which specific reserves are provided are excluded from the calculation of general reserves.

Loans acquired in business combinations are initially recorded at fair value, which includes an estimate of credit losses expected to be realized over the remaining lives of the loans, and therefore no corresponding allowance for loan losses is recorded for these loans at acquisition. Methods utilized to estimate any subsequently required allowance for loan losses for acquired loans not deemed credit-impaired at acquisition are similar to originated loans; however, the estimate of loss is based on the unpaid principal balance and then compared to any remaining unaccreted purchase discount. To the extent that the calculated loss is greater than the remaining unaccreted purchase discount, an allowance is recorded for such difference.

The Company has an internal loan review department that is independent of the lending function to challenge and corroborate the loan grade assigned by the lender and to provide additional analysis in determining the adequacy of the allowance for loan losses.

A rollforward of the activity within the allowance for loan losses by loan type and recorded investment in loans for the six months ended June 30, 2015 and 2014 is as follows (in thousands):



	June 30, 2015
				Real Estate
	Coml, Fin, and Agric			Constru-ction			Commercial			Residential			Installment loans to individuals			Lease financing receivable		Other		Total
Allowance for loan losses:
Beginning balance	$	5,729		$	954		$	2,402		$	810		$	1,311		$	16	$	4	$	11,226
Charge-offs	(1,855		)	(6		)	(48		)	(37		)	(537		)	—		—		(2,483		)
Recoveries	144			—			14			5			42			—		—		205
Provision	5,074			20			1,560			608			(173		)	9		2		7,100
Ending balance	$	9,092		$	968		$	3,928		$	1,386		$	643		$	25	$	6	$	16,048
Ending balance: individually evaluated for impairment	$	889		$	—		$	1,123		$	107		$	156		$	—	$	—	$	2,275
Ending balance: collectively evaluated for impairment	$	8,203		$	968		$	2,805		$	1,279		$	487		$	25	$	6	$	13,773

Loans:
Ending balance	$	471,397		$	79,176		$	469,022		$	153,820		$	113,626		$	5,561	$	1,790	$	1,294,392
Ending balance: individually evaluated for impairment	$	23,750		$	531		$	18,423		$	1,823		$	324		$	—	$	—	$	44,851
Ending balance: collectively evaluated for impairment	$	447,647		$	78,645		$	449,957		$	151,912		$	113,302		$	5,561	$	1,790	$	1,248,814
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	642		$	85		$	—		$	—	$	—	$	727



	June 30, 2014
				Real Estate
	Coml, Fin, and Agric			Constr-uction			Commercial			Residential			Installment loans to individuals			Lease financing receivable			Other		Total
Allowance for loan losses:
Beginning balance	$	3,906		$	1,046		$	1,389		$	1,141		$	1,273		$	21		$	3	$	8,779
Charge-offs	(1,135		)	—			(17		)	(176		)	(350		)	—			—		(1,678		)
Recoveries	42			—			42			39			101			—			—		224
Provision	1,970			(53		)	(23		)	(325		)	184			(4		)	1		1,750
Ending balance	$	4,783		$	993		$	1,391		$	679		$	1,208		$	17		$	4	$	9,075
Ending balance: individually evaluated for impairment	$	208		$	3		$	55		$	152		$	145		$	—		$	—	$	563
Ending balance: collectively evaluated for impairment	$	4,575		$	990		$	1,336		$	527		$	1,063		$	17		$	4	$	8,512

Loans:
Ending balance	$	454,310		$	86,238		$	413,565		$	153,082		$	108,581		$	4,750		$	3,656	$	1,224,182
Ending balance: individually evaluated for impairment	$	1,793		$	152		$	3,234		$	1,214		$	340		$	—		$	—	$	6,733
Ending balance: collectively evaluated for impairment	$	452,517		$	86,086		$	409,631		$	151,763		$	108,241		$	4,750		$	3,656	$	1,216,644
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	700		$	105		$	—		$	—		$	—	$	805

Non-Accrual and Past Due Loans

Loans are considered past due if the required principal and interest payment have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the probability of collection of interest is deemed insufficient to warrant further accrual. For loans placed on non-accrual status, the accrual of interest is discontinued and subsequent payments received are applied to the principal balance. Interest income is recorded after principal has been satisfied and as payments are received. Non-accrual loans may be returned to accrual status if all principal and interest amounts contractually owed are reasonably assured of repayment within a reasonable period and there is a period of at least six months to one year of repayment performance by the borrower depending on the contractual payment terms.

An age analysis of past due loans (including both accruing and non-accruing loans) is as follows (in thousands):



			June 30, 2015
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 days and Accruing
Commercial, financial, and agricultural	$	1,710	$	592	$	2,999	$	5,301	$	466,096	$	471,397	$	501
Commercial real estate - construction	364		—		13		377		57,151		57,528		—
Commercial real estate - other	13,681		361		4,994		19,036		449,986		469,022		—
Residential - construction	—		—		490		490		21,158		21,648		—
Residential - prime	523		449		1,378		2,350		151,470		153,820		—
Consumer - credit card	29		29		13		71		5,749		5,820		13
Consumer - other	1,065		264		324		1,653		106,153		107,806		95
Lease financing receivable	—		—		—		—		5,561		5,561		—
Other loans	100		—		—		100		1,690		1,790		—
	$	17,472	$	1,695	$	10,211	$	29,378	$	1,265,014	$	1,294,392	$	609

	December 31, 2014
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 days and Accruing
Commercial, financial, and agricultural	$	2,179	$	654	$	2,556	$	5,389	$	461,758	$	467,147	$	26
Commercial real estate - construction	15		—		105		120		43,390		43,510		97
Commercial real estate - other	4,989		270		2,464		7,723		459,449		467,172		—
Residential - construction	431		—		—		431		24,636		25,067		—
Residential - prime	1,843		523		704		3,070		151,532		154,602		—
Consumer - credit card	5		19		18		42		5,970		6,012		18
Consumer - other	671		392		107		1,170		112,146		113,316		46
Lease financing receivable	—		—		—		—		4,857		4,857		—
Other loans	134		—		—		134		2,614		2,748		—
	$	10,267	$	1,858	$	5,954	$	18,079	$	1,266,352	$	1,284,431	$	187

Non-accrual loans are as follows (in thousands):



	June 30, 2015		December 31, 2014
Commercial, financial, and agricultural	$	2,636	$	2,642
Commercial real estate – construction	41		54
Commercial real estate - other	18,452		6,429
Residential - construction	490		—
Residential - prime	1,930		1,194
Consumer - credit card	—		—
Consumer - other	324		382
Lease financing receivable	—		—
Other	—		—
	$	23,873	$	10,701

The amount of interest that would have been recorded on non-accrual loans, had the loans not been classified as non-accrual, totaled approximately $851,000 and $275,000 for the six months ended June 30, 2015 and 2014, respectively. Interest actually received on non-accrual loans at June 30, 2015 and 2014 was $13,000 and $91,000, respectively.

Impaired Loans

Loans are considered impaired when, based upon current information, it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans classified as special mention, substandard, or doubtful, based on credit risk rating factors, are reviewed to determine whether impairment testing is appropriate. An allowance for each impaired loan is calculated based on the present value of expected future cash flows discounted at the loan’s effective interest rate or at the loan’s observable market price or the fair value of the collateral if the loan is collaterally dependent. All impaired loans are reviewed, at a minimum, on a quarterly basis. Existing valuations are reviewed to determine if additional discounts or new appraisals are required. After this review, when comparing the resulting collateral valuation to the outstanding loan balance, if the discounted collateral value exceeds the loan balance no specific allocation is reserved. Acquired impaired loans are generally not subject to individual evaluation for impairment and are not reported with impaired loans or troubled debt restructurings, even if they would otherwise qualify for such treatment.

Loans that are individually evaluated for impairment are as follows (in thousands):



	June 30, 2015
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial, and agricultural	$	21,578	$	21,842	$	—	$	10,993	$	507
Commercial real estate – construction	41		41		—		42		—
Commercial real estate – other	7,048		7,048		—		5,450		33
Residential – prime	1,278		1,298		—		1,167		9
Residential – construction	490		490		—		462		1
Consumer – other	36		36		—		46		—
Subtotal:	30,471		30,755		—		18,160		550
With an allowance recorded:
Commercial, financial, and agricultural	2,172		2,172		889		2,096		18
Commercial real estate – other	11,375		11,375		1,123		7,750		—
Residential – prime	545		545		107		480		6
Consumer – other	288		302		156		318		1
Subtotal:	14,380		14,394		2,275		10,644		25
Totals:
Commercial	42,214		42,478		2,012		26,331		558
Residential	2,313		2,333		107		2,109		16
Consumer	324		338		156		364		1
Grand total:	$	44,851	$	45,149	$	2,275	$	28,804	$	575

	December 31, 2014
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial, and agricultural	$	438	$	521	$	—	$	554	$	—
Commercial real estate – construction	54		54		—		58		—
Commercial real estate – other	1,921		1,921		—		1,885		17
Residential – prime	543		543		—		534		15
Consumer – other	78		78		—		72		—
Subtotal:	3,034		3,117		—		3,103		32
With an allowance recorded:
Commercial, financial, and agricultural	2,218		2,333		1,010		1,394		35
Commercial real estate – construction	—		—		—		19		—
Commercial real estate – other	4,467		4,467		1,484		2,416		220
Residential – prime	529		548		68		452		3
Consumer – other	299		313		179		252		4
Subtotal:	7,513		7,661		2,741		4,533		262
Totals:
Commercial	9,098		9,296		2,494		6,326		272
Residential	1,072		1,091		68		986		18
Consumer	377		391		179		324		4
Grand total:	$	10,547	$	10,778	$	2,741	$	7,636	$	294

Credit Quality

The Company manages credit risk by observing written underwriting standards and lending policy established by the Board of Directors and management to govern all lending activities. The risk management program requires that each individual loan officer review his or her portfolio on a quarterly basis and assign recommended credit ratings on each loan. These efforts are supplemented by independent reviews performed by a loan review officer and other validations performed by the internal audit department. The results of the reviews are reported directly to the Audit Committee of the Board of Directors.

Loans can be classified into the following three risk rating grades: pass, special mention, and substandard/doubtful. Factors considered in determining a risk rating grade include debt service capacity, capital structure/liquidity, management, collateral quality, industry risk, company trends/operating performance, repayment source, revenue diversification/customer concentration, quality of financial information, and financing alternatives. Pass grade signifies the highest quality of loans to loans with reasonable credit risk, which may include borrowers with marginally adequate financial performance, but have the ability to repay the debt. Special mention loans have potential weaknesses that warrant extra attention from the loan officer and other management personnel, but still have the ability to repay the debt. Substandard classification includes loans with well-defined weaknesses with risk of potential loss. Loans classified as doubtful are considered to have little recovery value and are charged off.

The following tables present the classes of loans by risk rating (in thousands):



			June 30, 2015
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
			Commercial, financial, and agricultural		Commercial real estate - construction		Commercial real estate - other		Total		% of Total
Pass			$	418,761	$	57,361	$	421,359	$	897,481	89.93	%
Special mention			19,477		126		14,039		33,642		3.37	%
Substandard			32,812		41		33,624		66,477		6.66	%
Doubtful			347		—		—		347		0.04	%
			$	471,397	$	57,528	$	469,022	$	997,947	100.00	%

Residential Credit Exposure
Credit Risk Profile by Creditworthiness Category
					Residential - construction		Residential - prime		Total		% of Total
Pass					$	20,666	$	149,209	$	169,875	96.81	%
Special mention					492		1,320		1,812		1.03	%
Substandard					490		3,291		3,781		2.16	%
					$	21,648	$	153,820	$	175,468	100.00	%

Consumer and Commercial Credit Exposure
Credit Risk Profile Based on Payment Activity
	Consumer - credit card		Consumer - other		Lease financing receivable		Other		Total		% of Total
Performing	$	5,817	$	107,809	$	5,561	$	1,790	$	120,977	100.00	%
Nonperforming	—		—		—		—		—		—	%
	$	5,817	$	107,809	$	5,561	$	1,790	$	120,977	100.00	%



	December 31, 2014
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
			Commercial, financial, and agricultural		Commercial real estate - construction		Commercial real estate - other		Total		% of Total
Pass			$	456,221	$	43,320	$	440,281	$	939,822	96.11	%
Special mention			4,861		132		7,120		12,113		1.24	%
Substandard			5,541		58		19,771		25,370		2.60	%
Doubtful			524		—		—		524		0.05	%
			$	467,147	$	43,510	$	467,172	$	977,829	100.00	%

Residential Credit Exposure
Credit Risk Profile by Creditworthiness Category
					Residential - construction		Residential - prime		Total		% of Total
Pass					$	25,067	$	150,664	$	175,731	97.81	%
Special mention					—		1,184		1,184		0.66	%
Substandard					—		2,754		2,754		1.53	%
					$	25,067	$	154,602	$	179,669	100.00	%

Consumer and Commercial Credit Exposure
Credit Risk Profile Based on Payment Activity
	Consumer - credit card		Consumer - other		Lease financing receivable		Other		Total		% of Total
Performing	$	5,995	$	112,893	$	4,857	$	2,748	$	126,493	99.65	%
Nonperforming	17		423		—		—		440		0.35	%
	$	6,012	$	113,316	$	4,857	$	2,748	$	126,933	100.00	%

Troubled Debt Restructurings

A troubled debt restructuring (“TDR”) is a restructuring of a debt made by the Company to a debtor for economic or legal reasons related to the debtor’s financial difficulties that it would not otherwise consider. The Company grants the concession in an attempt to protect as much of its investment as possible.

Information about the Company’s TDRs is as follows (in thousands):



	June 30, 2015
	Current		Past Due Greater Than 30 Days		Nonaccrual TDRs		Total TDRs
Commercial, financial and agricultural	$	21,377	$	—	$	234	$	21,611
Real estate - commercial	152		—		—		152
	$	21,529	$	—	$	234	$	21,763

	December 31, 2014
	Current		Past Due Greater Than 30 Days		Nonaccrual TDRs		Total TDRs
Commercial, financial and agricultural	$	21	$	—	$	234	$	255
Real estate - commercial	155		—		—		155
	$	176	$	—	$	234	$	410

During the three months ended June 30, 2015, there was one loan relationship with a pre-modification balance of $21.4 million identified as a TDR after conversion of the loans to interest only for a limited amount of time, and there were no defaults on any loans that were modified as TDRs during the preceding twelve months. During the three months ended June 30, 2014, there were no loans identified as a TDR, and there were no defaults on any loans that were modified as TDRs during the preceding twelve months. During the six months ended June 30, 2015, there was one loan relationship with a pre-modification balance of $21.4 million identified as a TDR after conversion of the loans to interest only for a limited amount of time, and there were no defaults on any loans that were modified as TDRs during the preceding twelve months. During the six months ended June 30, 2014, there was one loan relationship with a pre-modification balance of $1.2 million identified as a TDR through a modification of the original loan terms, and there were no defaults on any loans that were modified as TDRs during the preceding twelve months. For purposes of the determination of an allowance for loan losses on these TDRs, as an identified TDR, the Company considers a loss probable on the loan and, as a result is reviewed for specific impairment in accordance with the Company’s allowance for loan loss methodology. If it is determined losses are probable on such TDRs, either because of delinquency or other credit quality indicator, the Company establishes specific reserves for these loans. As of June 30, 2015, there were no commitments to lend additional funds to debtors owing sums to the Company whose terms have been modified in TDRs.