LOANS AND LEASES

BancShares' accounting methods for loans and leases differ depending on whether they are purchased credit-impaired (PCI) or non-PCI. Non-PCI loans and leases include originated commercial, originated noncommercial, purchased non-impaired loans, purchased leases and certain purchased revolving credit. For purchased non-impaired loans to be included as non-PCI, it must be determined that the loans do not have any credit deterioration at the time of acquisition. Conversely, loans for which it is probable at acquisition that all required payments will not be collected in accordance with contractual terms are considered impaired and, therefore, classified as PCI loans. PCI loans are accounted for under the guidance in ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. PCI loans and leases are recorded at fair value at the date of acquisition. No allowance for loan and lease losses is recorded on the acquisition date as the fair value of the acquired assets incorporates assumptions regarding credit risk over the life of the loans. An allowance is recorded if there is additional credit deterioration after the acquisition date.

BancShares reports PCI and non-PCI loan portfolios separately, and each portfolio is further divided into commercial and non-commercial based on the type of borrower, purpose, collateral, and/or our underlying credit management processes. Additionally, loans are assigned to loan classes, which further disaggregate loans based upon common risk characteristics.

Commercial – Commercial loans include construction and land development, commercial mortgage, other commercial real estate, commercial and industrial, lease financing and other.

Construction and land development – Construction and land development consists of loans to finance land for development, investment, and use in a commercial business enterprise; multifamily apartments; and other commercial buildings that may be owner-occupied or income generating investments for the owner.

Commercial mortgage – Commercial mortgage consists of loans to purchase or refinance owner-occupied nonresidential and investment properties. Investment properties include office buildings and other facilities that are rented or leased to unrelated parties.

Other commercial real estate – Other commercial real estate consists of loans secured by farmland (including residential farms and other improvements) and multifamily (5 or more) residential properties.

Commercial and industrial – Commercial and industrial consists of loans or lines of credit to finance corporate credit cards, accounts receivable, inventory and other general business purposes.

Lease financing – Lease financing consists solely of lease financing agreements for business equipment, vehicles and other assets.

Other – Other consists of all other commercial loans not classified in one of the preceding classes. These typically include loans to non-profit organizations such as churches, hospitals, educational and charitable organizations, and certain loans repurchased with government guarantees.

Noncommercial – Noncommercial consist of residential and revolving mortgage, construction and land development, and consumer loans.

Residential mortgage – Residential real estate consists of loans to purchase, construct or refinance the borrower's primary dwelling, second residence or vacation home.

Revolving mortgage – Revolving mortgage consists of home equity lines of credit that are secured by first or second liens on the borrower's primary residence.

Construction and land development – Construction and land development consists of loans to construct the borrower's primary or secondary residence or vacant land upon which the owner intends to construct a dwelling at a future date.

Consumer – Consumer loans consist of installment loans to finance purchases of vehicles, unsecured home improvements, student loans and revolving lines of credit that can be secured or unsecured, including personal credit cards.

Loans and leases outstanding included the following at June 30, 2017 and December 31, 2016:



(Dollars in thousands)	June 30, 2017		December 31, 2016
Non-PCI loans and leases:
Commercial:
Construction and land development	$	740,291	$	649,157
Commercial mortgage	9,301,154		9,026,220
Other commercial real estate	363,339		351,291
Commercial and industrial	2,553,612		2,567,501
Lease financing	853,943		826,270
Other	486,573		340,264
Total commercial loans	14,298,912		13,760,703
Noncommercial:
Residential mortgage	3,305,361		2,889,124
Revolving mortgage	2,678,686		2,601,344
Construction and land development	218,233		231,400
Consumer	1,475,410		1,446,138
Total noncommercial loans	7,677,690		7,168,006
Total non-PCI loans and leases	21,976,602		20,928,709
PCI loans:
Commercial:
Construction and land development	18,660		20,766
Commercial mortgage	426,778		453,013
Other commercial real estate	21,409		12,645
Commercial and industrial	9,307		11,844
Other	903		1,702
Total commercial loans	477,057		499,970
Noncommercial:
Residential mortgage	350,038		268,777
Revolving mortgage	65,949		38,650
Consumer	1,819		1,772
Total noncommercial loans	417,806		309,199
Total PCI loans	894,863		809,169
Total loans and leases	$	22,871,465	$	21,737,878

At June 30, 2017, $73.2 million of total residential loans and leases were covered under shared-loss agreements with the FDIC, compared to $84.8 million at December 31, 2016. The shared-loss agreements, for their terms, protect BancShares from a substantial portion of the credit and asset quality risk that would otherwise be incurred.

At June 30, 2017, $8.80 billion in noncovered loans with a lendable collateral value of $5.56 billion were used to secure $835.2 million in Federal Home Loan Bank (FHLB) of Atlanta advances, resulting in additional borrowing capacity of $4.72 billion. At December 31, 2016, $8.26 billion in noncovered loans with a lendable collateral value of $5.50 billion were used to secure $660.2 million in FHLB of Atlanta advances, resulting in additional borrowing capacity of $4.84 billion. At June 30, 2017, $2.89 billion in noncovered loans with a lendable collateral value of $1.99 billion were used to secure additional borrowing capacity at the Federal Reserve Bank (FRB). There were no loans used to secure additional borrowing capacity at the FRB at December 31, 2016.

Net deferred fees on originated non-PCI loans and leases, including unearned income and unamortized costs, fees, premiums and discounts, were $3.8 million and $6.7 million at June 30, 2017 and December 31, 2016, respectively. The unamortized discount related to purchased non-PCI loans and leases in the Guaranty, Cordia Bancorp Inc. (Cordia) and First Citizens Bancorporation, Inc. (Bancorporation) acquisitions was $17.3 million, $3.3 million and $22.3 million at June 30, 2017, respectively. At December 31, 2016, the unamortized discount related to purchased non-PCI loans and leases from the Cordia and Bancorporation acquisitions was $4.2 million and $27.4 million, respectively. During the three months ended June 30, 2017 and June 30, 2016, accretion income on non-PCI loans and leases was $3.0 million and $2.9 million, respectively. During the six months ended June 30, 2017 and June 30, 2016, accretion income on non-PCI loans and leases was $6.0 million and $6.1 million, respectively.

Certain residential real estate loans are originated to be sold to investors and are recorded in loans held for sale at fair value. In addition, we may change our strategy for certain portfolio loans and sell them in the secondary market. At that time, portfolio loans are transferred to loans held for sale at the lower of amortized cost or market. Loans held for sale totaled $154.5 million at June 30, 2017, which included $70.0 million of originated loans held for sale at fair value and $84.5 million of portfolio loans transferred to loans held for sale during the second quarter of 2017. In the first quarter of 2017, certain residential mortgage portfolio loans of $32.5 million were sold, resulting in a gain of $164 thousand.

Credit quality indicators

Loans and leases are monitored for credit quality on a recurring basis. The credit quality indicators used are dependent on the portfolio segment to which the loan relates. Commercial and noncommercial loans and leases have different credit quality indicators as a result of the unique characteristics of the loan segment being evaluated. The credit quality indicators for non-PCI and PCI commercial loans and leases are developed through a review of individual borrowers on an ongoing basis. Each commercial loan is evaluated annually with more frequent evaluation of more severely criticized loans or leases. The credit quality indicators for non-PCI and PCI noncommercial loans are based on the delinquency status of the borrower. As the borrower becomes more delinquent, the likelihood of loss increases. The indicators represent the rating for loans or leases as of the date presented based on the most recent assessment performed. These credit quality indicators are defined as follows:

Pass – A pass rated asset is not adversely classified because it does not display any of the characteristics for adverse classification.

Special mention – A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, such potential weaknesses may result in deterioration of the repayment prospects or collateral position at some future date. Special mention assets are not adversely classified and do not warrant adverse classification.

Substandard – A substandard asset is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Assets classified as substandard generally have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. These assets are characterized by the distinct possibility of loss if the deficiencies are not corrected.

Doubtful – An asset classified as doubtful has all the weaknesses inherent in an asset classified substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable on the basis of currently existing facts, conditions and values.

Loss – Assets classified as loss are considered uncollectible and of such little value that it is inappropriate to be carried as an asset. This classification is not necessarily equivalent to no potential for recovery or salvage value, but rather that it is not appropriate to defer a full charge-off even though partial recovery may be affected in the future.

Ungraded – Ungraded loans represent loans that are not included in the individual credit grading process due to their relatively small balances or borrower type. The majority of ungraded loans at June 30, 2017 and December 31, 2016 relate to business credit cards. Business credit card loans are subject to automatic charge-off when they become 120 days past due in the same manner as unsecured consumer lines of credit. The remaining balance is comprised of a small amount of commercial mortgage, lease financing and other commercial real estate loans.

Non-PCI loans and leases outstanding at June 30, 2017 and December 31, 2016 by credit quality indicator are provided below:



	June 30, 2017
(Dollars in thousands)	Non-PCI commercial loans and leases
Grade:	Construction and land development		Commercial mortgage		Other commercial real estate		Commercial and industrial		Lease financing		Other		Total non-PCI commercial loans and leases
Pass	$	733,587	$	9,107,385	$	358,889	$	2,371,181	$	842,476	$	480,223	$	13,893,741
Special mention	960		69,690		1,366		30,180		5,056		992		108,244
Substandard	5,699		123,629		3,084		16,655		6,411		5,358		160,836
Doubtful	45		291		—		6		—		—		342
Ungraded	—		159		—		135,590		—		—		135,749
Total	$	740,291	$	9,301,154	$	363,339	$	2,553,612	$	853,943	$	486,573	$	14,298,912

	December 31, 2016
	Non-PCI commercial loans and leases
	Construction and land development		Commercial mortgage		Other commercial real estate		Commercial and industrial		Lease financing		Other		Total non-PCI commercial loans and leases
Pass	$	645,232	$	8,821,439	$	347,509	$	2,402,659	$	818,008	$	335,831	$	13,370,678
Special mention	2,236		76,084		1,433		22,804		2,675		1,020		106,252
Substandard	1,683		126,863		2,349		17,870		5,415		3,413		157,593
Doubtful	6		334		—		8		—		—		348
Ungraded	—		1,500		—		124,160		172		—		125,832
Total	$	649,157	$	9,026,220	$	351,291	$	2,567,501	$	826,270	$	340,264	$	13,760,703



	June 30, 2017
	Non-PCI noncommercial loans and leases
(Dollars in thousands)	Residential mortgage		Revolving mortgage		Construction and land development		Consumer		Total non-PCI noncommercial loans and leases
Current	$	3,259,647	$	2,656,372	$	215,354	$	1,462,603	$	7,593,976
30-59 days past due	21,478		10,819		1,252		8,179		41,728
60-89 days past due	7,412		3,176		111		2,310		13,009
90 days or greater past due	16,824		8,319		1,516		2,318		28,977
Total	$	3,305,361	$	2,678,686	$	218,233	$	1,475,410	$	7,677,690

	December 31, 2016
	Non-PCI noncommercial loans and leases
	Residential mortgage		Revolving mortgage		Construction and land development		Consumer		Total non-PCI noncommercial loans and leases
Current	$	2,839,045	$	2,576,942	$	229,106	$	1,434,658	$	7,079,751
30-59 days past due	27,760		14,290		1,139		6,775		49,964
60-89 days past due	7,039		2,698		598		2,779		13,114
90 days or greater past due	15,280		7,414		557		1,926		25,177
Total	$	2,889,124	$	2,601,344	$	231,400	$	1,446,138	$	7,168,006

PCI loans outstanding at June 30, 2017 and December 31, 2016 by credit quality indicator are provided below:



	June 30, 2017
(Dollars in thousands)	PCI commercial loans
Grade:	Construction and land development		Commercial mortgage		Other commercial real estate		Commercial and industrial		Other		Total PCI commercial loans
Pass	$	8,004	$	228,746	$	16,998	$	6,605	$	306	$	260,659
Special mention	1,608		58,942		688		646		331		62,215
Substandard	6,511		125,348		3,029		1,764		266		136,918
Doubtful	2,537		13,742		694		264		—		17,237
Ungraded	—		—		—		28		—		28
Total	$	18,660	$	426,778	$	21,409	$	9,307	$	903	$	477,057

	December 31, 2016
	PCI commercial loans
	Construction and land development		Commercial mortgage		Other commercial real estate		Commercial and industrial		Other		Total PCI commercial loans
Pass	$	8,103	$	234,023	$	8,744	$	7,253	$	696	$	258,819
Special mention	950		67,848		102		620		—		69,520
Substandard	7,850		138,312		3,462		3,648		1,006		154,278
Doubtful	3,863		12,830		337		303		—		17,333
Ungraded	—		—		—		20		—		20
Total	$	20,766	$	453,013	$	12,645	$	11,844	$	1,702	$	499,970



	June 30, 2017
	PCI noncommercial loans
(Dollars in thousands)	Residential mortgage		Revolving mortgage		Consumer		Total PCI noncommercial loans
Current	$	305,156	$	60,006	$	1,685	$	366,847
30-59 days past due	10,089		2,033		58		12,180
60-89 days past due	5,420		405		22		5,847
90 days or greater past due	29,373		3,505		54		32,932
Total	$	350,038	$	65,949	$	1,819	$	417,806

	December 31, 2016
	PCI noncommercial loans
	Residential mortgage		Revolving mortgage		Consumer		Total PCI noncommercial loans
Current	$	230,065	$	33,827	$	1,637	$	265,529
30-59 days past due	9,595		618		68		10,281
60-89 days past due	6,528		268		4		6,800
90 days or greater past due	22,589		3,937		63		26,589
Total	$	268,777	$	38,650	$	1,772	$	309,199

The aging of the outstanding non-PCI loans and leases, by class, at June 30, 2017 and December 31, 2016 is provided in the table below.

The calculation of days past due begins on the day after payment is due and includes all days through which all required interest or principal has not been paid. Loans and leases 30 days or less past due are considered current as various grace periods allow borrowers to make payments within a stated period after the due date and still remain in compliance with the loan agreement.



	June 30, 2017
(Dollars in thousands)	30-59 days past due		60-89 days past due		90 days or greater		Total past due		Current		Total loans and leases
Non-PCI loans and leases:
Construction and land development - commercial	$	954	$	18	$	119	$	1,091	$	739,200	$	740,291
Commercial mortgage	7,696		2,480		11,108		21,284		9,279,870		9,301,154
Other commercial real estate	132		—		642		774		362,565		363,339
Commercial and industrial	7,702		1,808		2,399		11,909		2,541,703		2,553,612
Lease financing	1,879		416		339		2,634		851,309		853,943
Residential mortgage	21,478		7,412		16,824		45,714		3,259,647		3,305,361
Revolving mortgage	10,819		3,176		8,319		22,314		2,656,372		2,678,686
Construction and land development - noncommercial	1,252		111		1,516		2,879		215,354		218,233
Consumer	8,179		2,310		2,318		12,807		1,462,603		1,475,410
Other	441		—		158		599		485,974		486,573
Total non-PCI loans and leases	$	60,532	$	17,731	$	43,742	$	122,005	$	21,854,597	$	21,976,602

	December 31, 2016
	30-59 days past due		60-89 days past due		90 days or greater		Total past due		Current		Total loans and leases
Non-PCI loans and leases:
Construction and land development - commercial	$	1,845	$	39	$	286	$	2,170	$	646,987	$	649,157
Commercial mortgage	11,592		2,773		10,329		24,694		9,001,526		9,026,220
Other commercial real estate	310		—		—		310		350,981		351,291
Commercial and industrial	7,918		2,102		1,051		11,071		2,556,430		2,567,501
Lease financing	1,175		444		863		2,482		823,788		826,270
Residential mortgage	27,760		7,039		15,280		50,079		2,839,045		2,889,124
Revolving mortgage	14,290		2,698		7,414		24,402		2,576,942		2,601,344
Construction and land development - noncommercial	1,139		598		557		2,294		229,106		231,400
Consumer	6,775		2,779		1,926		11,480		1,434,658		1,446,138
Other	72		—		198		270		339,994		340,264
Total non-PCI loans and leases	$	72,876	$	18,472	$	37,904	$	129,252	$	20,799,457	$	20,928,709

The recorded investment, by class, in loans and leases on nonaccrual status, and loans and leases greater than 90 days past due and still accruing at June 30, 2017 and December 31, 2016 for non-PCI loans and leases, were as follows:



	June 30, 2017				December 31, 2016
(Dollars in thousands)	Nonaccrual loans and leases		Loans and leases > 90 days and accruing		Nonaccrual loans and leases		Loans and leases > 90 days and accruing
Non-PCI loans and leases:
Construction and land development - commercial	$	706	$	18	$	606	$	—
Commercial mortgage	26,416		1,072		26,527		482
Other commercial real estate	738		—		86		—
Commercial and industrial	2,474		1,238		4,275		440
Lease financing	900		165		359		683
Residential mortgage	36,712		138		32,470		37
Revolving mortgage	15,844		—		14,308		—
Construction and land development - noncommercial	2,163		—		1,121		—
Consumer	1,919		1,561		2,236		1,076
Other	195		—		319		—
Total non-PCI loans and leases	$	88,067	$	4,192	$	82,307	$	2,718

The recorded investment of PCI loans on nonaccrual status was $1.3 million and $3.5 million at June 30, 2017 and December 31, 2016, respectively.

Purchased non-PCI loans and leases

The following table relates to purchased non-PCI loans and leases acquired in the Guaranty transaction and provides the contractually required payments, estimate of contractual cash flows not expected to be collected and fair value of the acquired loans at the acquisition date.



(Dollars in thousands)
Contractually required payments	$	703,916
Cash flows not expected to be collected	16,073
Fair value of loans at acquisition	574,553

The recorded fair values of purchased non-PCI loans and leases acquired in the Guaranty transaction as of the acquisition date are as follows:



(Dollars in thousands)
Commercial:
Commercial mortgage	$	850
Commercial and industrial	583
Other	183,816
Total commercial loans	185,249
Noncommercial:
Residential mortgage	309,612
Revolving mortgage	54,780
Consumer	24,912
Total noncommercial loans	389,304
Total non-PCI loans and leases	$	574,553

Purchased credit-impaired loans (PCI) loans

The following table relates to PCI loans acquired in the HCB and Guaranty acquisitions and summarizes the contractually required payments, which include principal and interest, expected cash flows to be collected, and the fair value of PCI loans at the acquisition dates.



(Dollars in thousands)	HCB		Guaranty
Contractually required payments	$	111,250	$	158,456
Cash flows expected to be collected	101,802		142,000
Fair value of loans at acquisition	85,149		114,533

The recorded fair values of PCI loans acquired in the HCB and Guaranty acquisitions as of the acquisition dates were as follows:



(Dollars in thousands)	HCB		Guaranty
Commercial:
Construction and land development	$	7,061	$	55
Commercial mortgage	21,836		644
Other commercial real estate	6,404		—
Commercial and industrial	19,675		2
Total commercial loans	54,976		701
Noncommercial:
Residential mortgage	25,857		80,475
Revolving mortgage	3,434		33,319
Construction and land development	—		26
Consumer	882		12
Total noncommercial loans	30,173		113,832
Total PCI loans	$	85,149	$	114,533

The following table provides changes in the carrying value of all purchased credit-impaired loans during the six months ended June 30, 2017 and June 30, 2016:



(Dollars in thousands)	2017			2016
Balance at January 1	$	809,169		$	950,516
Fair value of acquired loans	199,682			80,084
Accretion	39,798			41,821
Payments received and other changes, net	(153,786		)	(150,954		)
Balance at June 30	$	894,863		$	921,467
Unpaid principal balance at June 30	$	1,199,358		$	1,614,998

The carrying value of loans on the cost recovery method was $454 thousand at June 30, 2017 and $498 thousand at December 31, 2016. The cost recovery method is applied to loans when the timing of future cash flows is not reasonably estimable due to borrower nonperformance or uncertainty in the ultimate disposition of the asset. Cash payments from cost recovery loans are 100 percent applied to principal. After all the principal has been recovered, cash payments are then recorded to interest income.

During the three months ended June 30, 2017 and June 30, 2016, accretion income on PCI loans was $20.4 million for both periods.

The following table documents changes to the amount of accretable yield for the first six months of 2017 and 2016.



(Dollars in thousands)	2017			2016
Balance at January 1	$	335,074		$	343,856
Additions from acquisitions	44,120			12,279
Accretion	(39,798		)	(41,821		)
Reclassifications from nonaccretable difference	12,328			18,384
Changes in expected cash flows that do not affect nonaccretable difference	(1,405		)	30,239
Balance at June 30	$	350,319		$	362,937

For PCI loans, improved credit loss expectations generally result in the reclassification of nonaccretable difference to accretable yield. Changes in expected cash flows not related to credit improvements or deterioration do not affect the nonaccretable difference.