Credit Quality of Loans and Allowance for Loan Losses

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



	September 30, 2016			December 31, 2015
Commercial, financial and agricultural	$	463,031		$	454,028
Real estate – construction	96,365			74,952
Real estate – commercial	464,853			471,141
Real estate – residential	155,653			149,064
Installment loans to individuals	88,537			111,009
Lease financing receivable	1,449			1,968
Other	2,912			1,483
	1,272,800			1,263,645
Less allowance for loan losses	(23,268		)	(19,011		)
	$	1,249,532		$	1,244,634

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 September 30, 2016, 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 $243.3 million, or 19.1% of total loans. Additionally, the Company’s exposure to loans secured by commercial real estate is monitored. At September 30, 2016, loans secured by commercial real estate (including commercial construction, farmland and multifamily loans) totaled approximately $542.2 million. Of the $542.2 million, $464.9 million represent CRE loans, 54% of which are secured by owner-occupied commercial properties. Of the $542.2 million in loans secured by commercial real estate, $28.3 million, or 5.2%, were on nonaccrual status at September 30, 2016.

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 nine months ended September 30, 2016 and 2015 is as follows (in thousands):



	September 30, 2016
				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	$	11,268		$	819		$	4,614		$	816		$	1,468		$	14		$	12	$	19,011
Charge-offs	(2,957		)	—			(208		)	(24		)	(991		)	—			—		(4,180		)
Recoveries	193			—			115			4			125			—			—		437
Provision	6,747			(478		)	1,042			(97		)	781			(5		)	10		8,000
Ending balance	$	15,251		$	341		$	5,563		$	699		$	1,383		$	9		$	22	$	23,268
Ending balance: individually evaluated for impairment	$	1,105		$	—		$	2,270		$	194		$	268		$	—		$	—	$	3,837
Ending balance: collectively evaluated for impairment	$	14,146		$	341		$	3,293		$	505		$	1,115		$	9		$	22	$	19,431

Loans:
Ending balance	$	463,031		$	96,365		$	464,853		$	155,653		$	88,537		$	1,449		$	2,912	$	1,272,800
Ending balance: individually evaluated for impairment	$	29,887		$	10		$	28,285		$	1,831		$	464		$	—		$	—	$	60,477
Ending balance: collectively evaluated for impairment	$	433,144		$	96,355		$	435,985		$	153,747		$	88,073		$	1,449		$	2,912	$	1,211,665
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	583		$	75		$	—		$	—		$	—	$	658



	September 30, 2015
				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	$	5,729		$	954		$	2,402		$	810		$	1,311		$	16	$	4	$	11,226
Charge-offs	(2,310		)	(76		)	(169		)	(45		)	(883		)	—		—		(3,483		)
Recoveries	185			1			20			10			80			—		—		296
Provision	8,016			(62		)	2,107			(104		)	923			13		7		10,900
Ending balance	$	11,620		$	817		$	4,360		$	671		$	1,431		$	29	$	11	$	18,939
Ending balance: individually evaluated for impairment	$	2,569		$	26		$	1,739		$	147		$	216		$	—	$	—	$	4,697
Ending balance: collectively evaluated for impairment	$	9,051		$	791		$	2,621		$	524		$	1,215		$	29	$	11	$	14,242

Loans:
Ending balance	$	482,452		$	74,279		$	473,319		$	151,667		$	113,199		$	4,790	$	1,746	$	1,301,452
Ending balance: individually evaluated for impairment	$	29,185		$	212		$	19,928		$	1,796		$	386		$	—	$	—	$	51,507
Ending balance: collectively evaluated for impairment	$	453,267		$	74,067		$	452,758		$	149,788		$	112,813		$	4,790	$	1,746	$	1,249,229
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	633		$	83		$	—		$	—	$	—	$	716

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):



	September 30, 2016
	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	$	3,213	$	1,255	$	29,710	$	34,178	$	428,853	$	463,031	$	42
Real estate - construction	206		—		829		1,035		95,330		96,365		819
Real estate - commercial	3,539		—		26,219		29,758		435,095		464,853		—
Real estate - residential	853		457		1,587		2,897		152,756		155,653		82
Installment loans to individuals	397		370		489		1,256		87,281		88,537		25
Lease financing receivable	—		—		—		—		1,449		1,449		—
Other loans	83		11		—		94		2,818		2,912		—
	$	8,291	$	2,093	$	58,834	$	69,218	$	1,203,582	$	1,272,800	$	968

	December 31, 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	$	1,362	$	2,317	$	25,696	$	29,375	$	424,653	$	454,028	$	59
Real estate - construction	1,047		—		12		1,059		73,893		74,952		—
Real estate - commercial	1,164		514		19,512		21,190		449,951		471,141		—
Real estate - residential	1,703		367		1,563		3,633		145,431		149,064		19
Installment loans to individuals	1,022		244		409		1,675		109,334		111,009		69
Lease financing receivable	—		—		—		—		1,968		1,968		—
Other loans	101		4		—		105		1,378		1,483		—
	$	6,399	$	3,446	$	47,192	$	57,037	$	1,206,608	$	1,263,645	$	147

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



	September 30, 2016		December 31, 2015
Commercial, financial, and agricultural	$	29,874	$	27,705
Real estate - construction	10		37
Real estate - commercial	28,285		19,907
Real estate - residential	1,889		1,998
Installment loans to individuals	464		404
Lease financing receivable	—		—
Other	—		—
	$	60,522	$	50,051

The amount of interest that would have been recorded on non-accrual loans, had the loans not been classified as non-accrual, totaled approximately $2.5 million and $1.3 million for the nine months ended September 30, 2016 and 2015, respectively. Interest actually received on non-accrual loans subsequent to their transfer to non-accrual status totaled at September 30, 2016 and 2015 was $128,000 and $19,000, 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):



	September 30, 2016
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial, and agricultural	$	26,802	$	27,383	$	—	$	13,401	$	131
Real estate - construction	10		10		—		23		—
Real estate - commercial	13,254		13,254		—		9,341		56
Real estate - residential	1,062		1,062		—		1,115		3
Installment loans to individuals	20		20		—		10		—
Subtotal:	41,148		41,729		—		23,890		190
With an allowance recorded:
Commercial, financial, and agricultural	3,085		3,182		1,105		4,137		25
Real estate - commercial	15,031		15,031		2,270		14,518		28
Real estate - residential	769		769		194		653		—
Installment loans to individuals	444		469		268		407		8
Subtotal:	19,329		19,451		3,837		19,715		61
Totals:
Commercial	58,172		58,850		3,375		41,397		240
Construction	10		10		—		23		—
Residential	1,831		1,831		194		1,768		3
Consumer	464		489		268		417		8
Grand total:	$	60,477	$	61,180	$	3,837	$	43,605	$	251

	December 31, 2015
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial, and agricultural	$	22,529	$	22,793	$	—	$	11,484	$	745
Real estate - construction	37		37		—		45		—
Real estate - commercial	5,886		5,886		—		3,903		97
Real estate - residential	1,365		1,385		—		954		17
Installment loans to individuals	34		34		—		56		—
Subtotal:	29,851		30,135		—		16,442		859
With an allowance recorded:
Commercial, financial, and agricultural	5,189		6,373		961		3,704		138
Real estate - commercial	14,004		14,004		1,585		9,236		161
Real estate - residential	538		538		160		533		7
Installment loans to individuals	370		384		221		334		8
Subtotal:	20,101		21,299		2,927		13,807		314
Totals:
Commercial	47,608		49,056		2,546		28,327		1,141
Construction	37		37		—		45		—
Residential	1,903		1,923		160		1,487		24
Consumer	404		418		221		390		8
Grand total:	$	49,952	$	51,434	$	2,927	$	30,249	$	1,173

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):



	September 30, 2016
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
			Commercial, financial, and agricultural		Real estate - commercial		Total		% of Total
Pass			$	358,670	$	403,961	$	762,631	82.20	%
Special mention			28,270		25,173		53,443		5.76	%
Substandard			75,923		35,719		111,642		12.03	%
Doubtful			168		—		168		0.02	%
			$	463,031	$	464,853	$	927,884	100.00	%

Construction Credit Exposure
Credit Risk Profile by Creditworthiness Category
							Real estate - construction		% of Total
Pass							$	96,178	99.81	%
Special mention							—		—	%
Substandard							187		0.19	%
							$	96,365	100.00	%

Residential Credit Exposure
Credit Risk Profile by Creditworthiness Category
							Real estate - residential		% of Total
Pass							$	151,053	97.04	%
Special mention							1,227		0.79	%
Substandard							3,373		2.17	%
							$	155,653	100.00	%

Consumer and Commercial Credit Exposure
Credit Risk Profile Based on Payment Activity
	Installment loans to individuals		Lease financing receivable		Other		Total		% of Total
Performing	$	88,048	$	1,449	$	2,912	$	92,409	99.47	%
Nonperforming	489		—		—		489		0.53	%
	$	88,537	$	1,449	$	2,912	$	92,898	100.00	%



	December 31, 2015
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
				Commercial, financial, and agricultural		Real estate - commercial		Total		% of Total
Pass				$	383,897	$	412,141	$	796,038	86.04	%
Special mention				32,506		28,217		60,723		6.55	%
Substandard				37,353		30,783		68,136		7.36	%
Doubtful				272		—		272		0.03	%
				$	454,028	$	471,141	$	925,169	100.00	%

Construction Credit Exposure
Credit Risk Profile by Creditworthiness Category
								Real estate - construction		% of Total
Pass								$	74,794	99.79	%
Special mention								34		0.04	%
Substandard								124		0.17	%
								$	74,952	100.00	%

Residential Credit Exposure
Credit Risk Profile by Creditworthiness Category
								Real estate - residential		% of Total
Pass								$	144,704	97.08	%
Special mention								1,225		0.82	%
Substandard								3,135		2.10	%
								$	149,064	100.00	%

Consumer and Commercial Credit Exposure
Credit Risk Profile Based on Payment Activity
		Installment loans to individuals		Lease financing receivable		Other		Total		% of Total
Performing		$	110,536	$	1,968	$	1,483	$	113,987	99.59	%
Nonperforming		473		—		—		473		0.41	%
		$	111,009	$	1,968	$	1,483	$	114,460	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):



	September 30, 2016
	Current		Past Due Greater Than 30 Days		Nonaccrual TDRs		Total TDRs
Commercial, financial and agricultural	$	13	$	—	$	24,568	$	24,581
Real estate – commercial	—		140		1,573		1,713
	$	13	$	140	$	26,141	$	26,294

	December 31, 2015
	Current		Past Due Greater Than 30 Days		Nonaccrual TDRs		Total TDRs
Commercial, financial and agricultural	$	16	$	—	$	20,865	$	20,881
Real estate – commercial	—		148		—		148
	$	16	$	148	$	20,865	$	21,029

During the three months ended September 30, 2016, 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 three months ended September 30, 2015, there were no loans identified as a TDR. There was one TDR totaling $21.1 million that defaulted on the modified terms of its agreement during the three months ended September 30, 2015. During the nine months ended September 30, 2016, there was one loan relationship with a pre-modification balance of $5.5 million identified as a TDR after conversion of the loans to interest only for a limited amount of time. Subsequent to its conversion to TDR status, this one TDR totaling $5.5 million defaulted on the modified terms during the nine months ended September 30, 2016. During the nine months ended September 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. This one TDR subsequently defaulted on the modified terms and totaled $21.1 million at September 30, 2015. 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 September 30, 2016, there were no commitments to lend additional funds to debtors owing sums to the Company whose terms have been modified in TDRs.