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, 2015, 2014, and 2013 is as follows:



Dollars in thousands	2015		2014		2013

Balance, beginning of year	$	11,167	$	12,659	$	17,933
Losses:
Commercial	77		390		723
Commercial real estate
Owner occupied	559		11		1,031
Non-owner occupied	178		—		9
Construction and development
Land and land development	457		3,535		3,596
Construction	—		—		—
Residential real estate
Non-jumbo	417		435		541
Jumbo	208		65		4,741
Home equity	76		14		77
Consumer	69		265		79
Other	110		118		162
Total	2,151		4,833		10,959
Recoveries:
Commercial	10		34		12
Commercial real estate
Owner occupied	290		40		8
Non-owner occupied	13		318		674
Construction and development
Land and land development	456		298		187
Construction	—		—		—
Real estate - mortgage
Non-jumbo	107		87		127
Jumbo	96		163		6
Home equity	3		4		5
Consumer	105		74		79
Other	126		73		87
Total	1,206		1,091		1,185
Net losses	945		3,742		9,774
Provision for loan losses	1,250		2,250		4,500
Balance, end of year	$	11,472	$	11,167	$	12,659

Activity in the allowance for loan losses by loan class during 2015 and 2014 is as follows:



	2015
	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	457			—			77			559		178		417		208			76		69			110			2,151
Recoveries	456			—			10			290		13		107		96			3		105			126			1,206
Provision	(564		)	(412		)	(356		)	931		1,826		283		(376		)	139		(74		)	(147		)	1,250
Ending balance	$	2,852		$	15		$	781		$	1,589	$	2,977	$	1,253	$	1,593		$	253	$	59		$	100		$	11,472

Allowance related to:
Loans individually evaluated for impairment	$	85		$	—		$	—		$	45	$	386	$	225	$	35		$	—	$	—		$	—		$	776
Loans collectively evaluated for impairment	2,767			15			781			1,544		2,591		1,028		1,558			253		59			100			10,696
Total	$	2,852		$	15		$	781		$	1,589	$	2,977	$	1,253	$	1,593		$	253	$	59		$	100		$	11,472

Loans
Loans individually evaluated for impairment	$	8,774		$	—		$	242		$	8,399	$	13,450	$	6,131	$	4,740		$	709	$	68		$	—		$	42,513
Loans collectively evaluated for impairment	56,726			9,970			96,959			195,156		323,844		215,619		45,573			73,591		19,183			11,669			$	1,048,290
Total	$	65,500		$	9,970		$	97,201		$	203,555	$	337,294	$	221,750	$	50,313		$	74,300	$	19,251		$	11,669		$	1,090,803



	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