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 eleven 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, mortgage warehouse lines, 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 eleven 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 nine month periods ended September 30, 2016 and 2015, and for the year ended December 31, 2015 is as follows:



	Nine Months Ended September 30,				Year Ended December 31,
Dollars in thousands	2016		2015		2015
Balance, beginning of year	$	11,472	$	11,167	$	11,167
Losses:
Commercial	379		77		77
Commercial real estate
Owner occupied	179		559		559
Non-owner occupied	122		178		178
Construction and development
Land and land development	50		457		457
Construction	—		—		—
Residential real estate
Non-jumbo	119		316		417
Jumbo	—		206		208
Home equity	117		76		76
Mortgage warehouse lines	—		—		—
Consumer	61		62		69
Other	128		88		110
Total	1,155		2,019		2,151
Recoveries:
Commercial	69		6		10
Commercial real estate
Owner occupied	25		282		290
Non-owner occupied	13		6		13
Construction and development
Land and land development	514		454		456
Construction	—		—		—
Real estate - mortgage
Non-jumbo	58		90		107
Jumbo	6		96		96
Home equity	3		3		3
Mortgage warehouse lines	—		—		—
Consumer	55		88		105
Other	59		55		126
Total	802		1,080		1,206
Net losses	353		939		945
Provision for loan losses	500		1,000		1,250
Balance, end of period	$	11,619	$	11,228	$	11,472

Activity in the allowance for loan losses by loan class during the first nine months of 2016 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		Mortgage Warehouse Lines		Con- sumer		Other		Total
Allowance for loan losses
Beginning balance	$	2,852		$	15	$	780	$	1,589	$	2,977	$	1,253	$	1,593		$	253	$	—	$	60	$	100	$	11,472
Charge-offs	50			—		379		179		122		119		—			117		—		61		128		1,155
Recoveries	514			—		69		25		13		58		6			3		—		55		59		802
Provision	(1,814		)	9		734		543		1,097		694		(1,157		)	267		—		37		90		500
Ending balance	$	1,502		$	24	$	1,204	$	1,978	$	3,965	$	1,886	$	442		$	406	$	—	$	91	$	121	$	11,619

Allowance related to:
Loans individually evaluated for impairment	$	493		$	—	$	19	$	12	$	132	$	216	$	25		$	—	$	—	$	—	$	—	$	897
Loans collectively evaluated for impairment	1,009			24		1,185		1,966		3,833		1,670		417			406		—		91		121		10,722
Total	$	1,502		$	24	$	1,204	$	1,978	$	3,965	$	1,886	$	442		$	406	$	—	$	91	$	121	$	11,619

Loans
Loans individually evaluated for impairment	$	7,322		$	—	$	809	$	7,413	$	11,717	$	6,480	$	4,541		$	713	$	—	$	48	$	—	$	39,043
Loans collectively evaluated for impairment	58,108			11,276		109,657		184,841		355,479		222,297		52,735			74,448		108,983		19,708		9,649		1,207,181
Total	$	65,430		$	11,276	$	110,466	$	192,254	$	367,196	$	228,777	$	57,276		$	75,161	$	108,983	$	19,756	$	9,649	$	1,246,224