ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is maintained at a level considered adequate to provide for our estimate of probable credit losses inherent in the loan portfolio. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. Loans are charged against the allowance for loan losses when we believe that collectability is unlikely. While we use the best information available to make our evaluation, future adjustments may be necessary if there are significant changes in conditions.

The allowance is comprised of three distinct reserve components: (1) specific reserves related to loans individually evaluated, (2) quantitative reserves related to loans collectively evaluated, and (3) qualitative reserves related to loans collectively evaluated. A summary of the methodology we employ on a quarterly basis with respect to each of these components in order to evaluate the overall adequacy of our allowance for loan losses is as follows.

Specific Reserve for Loans Individually Evaluated

First, we identify loan relationships having aggregate balances in excess of $500,000 and that may also have credit weaknesses. Such loan relationships are identified primarily through our analysis of internal loan evaluations, past due loan reports, and loans adversely classified by regulatory authorities. Each loan so identified is then individually evaluated to determine whether it is impaired – that is, based on current information and events, it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the underlying loan agreement. Substantially all of our impaired loans historically have been collateral dependent, meaning repayment of the loan is expected or is considered to be provided solely from the sale of the loan’s underlying collateral. For such loans, we measure impairment based on the fair value of the loan’s collateral, which is generally determined utilizing current appraisals. A specific reserve is established in an amount equal to the excess, if any, of the recorded investment in each impaired loan over the fair value of its underlying collateral, less estimated costs to sell. Our policy is to re-evaluate the fair value of collateral dependent loans at least every twelve months unless there is a known deterioration in the collateral’s value, in which case a new appraisal is obtained. Beginning in 2014, for purposes of loans that have been modified in a troubled debt restructuring and not internally graded as substandard, doubtful, or loss("performing TDRs") we began measuring impairment using the discounted cash flows method. Under this method, a specific reserve is established in an amount equal to the excess, if any, of the recorded investment in each impaired loan over its discounted cash flows.

Quantitative Reserve for Loans Collectively Evaluated

Second, we stratify the loan portfolio into the following ten loan pools: land and land development, construction, commercial, commercial real estate -- owner-occupied, commercial real estate -- non-owner occupied, conventional residential mortgage, jumbo residential mortgage, home equity, consumer, and other. Quantitative reserves relative to each loan pool are established as follows: for all loan segments detailed above an allocation equaling 100% of the respective pool’s average 12 month historical net loan charge-off rate (determined based upon the most recent twelve quarters) is applied to the aggregate recorded investment in the pool of loans.

Qualitative Reserve for Loans Collectively Evaluated

Third, we consider the necessity to adjust our average historical net loan charge-off rates relative to each of the above ten loan pools for potential risks factors that could result in actual losses deviating from prior loss experience. For example, if we observe a significant increase in delinquencies within the conventional mortgage loan pool above historical trends, an additional allocation to the average historical loan charge-off rate is applied. Such qualitative risk factors considered are: (1) levels of and trends in delinquencies and impaired loans, (2) levels of and trends in charge-offs and recoveries, (3)trends in volume and term of loans, (4) effects of any changes in risk selection and underwriting standards, and other changes in lending policies, procedures, and practice, (5) experience, ability, and depth of lending management and other relevant staff, (6) national and local economic trends and conditions, (7) industry conditions, and (8) effects of changes in credit concentrations.

An analysis of the allowance for loan losses for the years ended December 31, 2014, 2013, and 2012 is as follows:



Dollars in thousands	2014		2013		2012

Balance, beginning of year	$	12,659	$	17,933	$	17,712
Losses:
Commercial	390		723		1,273
Commercial real estate
Owner occupied	11		1,031		636
Non-owner occupied	—		9		806
Construction and development
Land and land development	3,535		3,596		3,390
Construction	—		—		367
Residential real estate
Non-jumbo	435		541		1,372
Jumbo	65		4,741		737
Home equity	14		77		5
Consumer	265		79		136
Other	118		162		95
Total	4,833		10,959		8,817
Recoveries:
Commercial	34		12		13
Commercial real estate
Owner occupied	40		8		33
Non-owner occupied	318		674		31
Construction and development
Land and land development	298		187		61
Construction	—		—		—
Real estate - mortgage
Non-jumbo	87		127		81
Jumbo	163		6		86
Home equity	4		5		61
Consumer	74		79		95
Other	73		87		77
Total	1,091		1,185		538
Net losses	3,742		9,774		8,279
Provision for loan losses	2,250		4,500		8,500
Balance, end of year	$	11,167	$	12,659	$	17,933

Activity in the allowance for loan losses by loan class during 2014 and 2013 is as follows:



	2014
	Construction & Land Development						Commercial Real Estate					Residential Real Estate
Dollars in thousands	Land & Land Develop- ment		Construc- tion		Commer- cial		Owner Occupied			Non- Owner Occupied		Non- jumbo			Jumbo		Home Equity		Con- sumer		Other		Total
Allowance for loan losses
Beginning balance	$	5,455	$	269	$	1,324	$	969		$	641	$	1,842		$	1,888	$	173	$	47	$	51	$	12,659
Charge-offs	3,535		—		390		11			—		435			65		14		265		118		4,833
Recoveries	298		—		34		40			318		87			163		4		74		73		1,091
Provision	1,199		158		236		(71		)	357		(214		)	95		24		241		225		2,250
Ending balance	$	3,417	$	427	$	1,204	$	927		$	1,316	$	1,280		$	2,081	$	187	$	97	$	231	$	11,167

Allowance related to:
Loans individually evaluated for impairment	$	46	$	—	$	81	$	286		$	74	$	282		$	46	$	—	$	—	$	—	$	815
Loans collectively evaluated for impairment	3,371		427		1,123		641			1,242		998			2,035		187		97		231		10,352
Total	$	3,417	$	427	$	1,204	$	927		$	1,316	$	1,280		$	2,081	$	187	$	97	$	231	$	11,167

Loans
Loans individually evaluated for impairment	$	14,308	$	—	$	495	$	10,807		$	6,507	$	6,927		$	8,480	$	808	$	84	$	—	$	48,416
Loans collectively evaluated for impairment	53,573		28,591		88,095		146,976			310,629		213,144			44,399		66,307		19,372		11,507		$	982,593
Total	$	67,881	$	28,591	$	88,590	$	157,783		$	317,136	$	220,071		$	52,879	$	67,115	$	19,456	$	11,507	$	1,031,009



	2013
	Construction & Land Development						Commercial Real Estate					Residential Real Estate
Dollars in thousands	Land & Land Develop- ment		Construc- tion		Commer- cial		Owner Occupied		Non- Owner Occupied			Non- jumbo			Jumbo		Home Equity			Con- sumer			Other		Total
Allowance for loan losses
Beginning balance	$	5,220	$	138	$	783	$	1,387	$	3,269		$	2,616		$	3,942	$	425		$	131		$	22	$	17,933
Charge-offs	3,596		—		723		1,031		9			541			4,741		77			79			162		10,959
Recoveries	187		—		12		8		674			127			6		5			79			87		1,185
Provision	3,644		131		1,252		605		(3,293		)	(360		)	2,681		(180		)	(84		)	104		4,500
Ending balance	$	5,455	$	269	$	1,324	$	969	$	641		$	1,842		$	1,888	$	173		$	47		$	51	$	12,659

Allowance related to:
Loans individually evaluated for impairment	$	3,186	$	—	$	406	$	306	$	175		$	256		$	37	$	22		$	12		$	—	$	4,400
Loans collectively evaluated for impairment	2,269		269		918		663		466			1,586			1,851		151			35			51		8,259
Total	$	5,455	$	269	$	1,324	$	969	$	641		$	1,842		$	1,888	$	173		$	47		$	51	$	12,659

Loans
Loans individually evaluated for impairment	$	25,269	$	—	$	2,023	$	12,550	$	5,832		$	6,082		$	8,768	$	212		$	47		$	—	$	60,783
Loans collectively evaluated for impairment	46,184		15,155		86,329		137,068		274,958			206,864			44,638		54,632			19,842			3,276		$	888,946
Total	$	71,453	$	15,155	$	88,352	$	149,618	$	280,790		$	212,946		$	53,406	$	54,844		$	19,889		$	3,276	$	949,729