ALLOWANCE FOR LOAN LOSSES

We maintain the allowance for loan losses at a level considered adequate to provide for estimated probable credit losses inherent in the loan portfolio. 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 six month periods ended June 30, 2015 and 2014, and for the year ended December 31, 2014 is as follows:



	Six Months Ended June 30,				Year Ended December 31,
Dollars in thousands	2015		2014		2014
Balance, beginning of year	$	11,167	$	12,659	$	12,659
Losses:
Commercial	77		390		390
Commercial real estate
Owner occupied	269		11		11
Non-owner occupied	—		—		—
Construction and development
Land and land development	434		3,533		3,535
Construction	—		—		—
Residential real estate
Non-jumbo	284		46		435
Jumbo	—		63		65
Home equity	76		—		14
Consumer	48		80		265
Other	56		51		118
Total	1,244		4,174		4,833
Recoveries:
Commercial	4		17		34
Commercial real estate
Owner occupied	5		31		40
Non-owner occupied	4		4		318
Construction and development
Land and land development	322		165		298
Construction	—		—		—
Real estate - mortgage
Non-jumbo	63		53		87
Jumbo	96		163		163
Home equity	2		3		4
Consumer	68		41		74
Other	35		44		73
Total	599		521		1,091
Net losses	645		3,653		3,742
Provision for loan losses	750		2,000		2,250
Balance, end of period	$	11,272	$	11,006	$	11,167

Activity in the allowance for loan losses by loan class during the first six months of 2015 is as follows:



	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	$	3,417		$	427		$	1,204	$	927	$	1,316	$	1,280	$	2,081		$	187	$	97		$	231		$	11,167
Charge-offs	434			—			77		269		—		284		—			76		48			56			1,244
Recoveries	322			—			4		5		4		63		96			2		68			35			599
Provision	(435		)	(355		)	40		795		522		548		(430		)	149		(59		)	(25		)	750
Ending balance	$	2,870		$	72		$	1,171	$	1,458	$	1,842	$	1,607	$	1,747		$	262	$	58		$	185		$	11,272

Allowance related to:
Loans individually evaluated for impairment	$	133		$	—		$	—	$	232	$	64	$	331	$	71		$	—	$	—		$	—		$	831
Loans collectively evaluated for impairment	2,737			72			1,171		1,226		1,778		1,276		1,676			262		58			185			10,441
Total	$	2,870		$	72		$	1,171	$	1,458	$	1,842	$	1,607	$	1,747		$	262	$	58		$	185		$	11,272

Loans
Loans individually evaluated for impairment	$	11,272		$	—		$	343	$	14,669	$	7,747	$	6,266	$	6,535		$	709	$	75		$	—		$	47,616
Loans collectively evaluated for impairment	53,163			18,214			96,941		177,074		323,309		213,933		42,668			71,795		18,608			12,423			$	1,028,128
Total	$	64,435		$	18,214		$	97,284	$	191,743	$	331,056	$	220,199	$	49,203		$	72,504	$	18,683		$	12,423		$	1,075,744