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 internally or 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.

PCI loans are individually evaluated. The evaluation of the PCI loans requires continued quarterly assessment of key assumptions and estimates similar to the initial fair value estimate, including changes in the severity of loss, timing and speed of payments, collateral value changes, expected cash flows and other relevant factors. The quarterly assessment is compared to the initial fair value estimate and a determination is made if an adjustment to the allowance for loan loss is deemed necessary.

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. Purchased performing loans are collectively evaluated as their own separate category within each loan pool. The reserve on each pool is compared to the estimated fair value credit discount to determine if this discount remains adequate. If any credit discount is not adequate, additional reserves will be recognized.

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 years ended December 31, 2016, 2015 and 2014 is as follows:



Dollars in thousands	2016		2015		2014

Balance, beginning of year	$	11,472	$	11,167	$	12,659
Losses:
Commercial	489		77		390
Commercial real estate
Owner occupied	179		559		11
Non-owner occupied	124		178		—
Construction and development
Land and land development	127		457		3,535
Construction	9		—		—
Residential real estate
Non-jumbo	169		417		435
Jumbo	—		208		65
Home equity	175		76		14
Mortgage warehouse lines	—		—		—
Consumer	98		69		265
Other	185		110		118
Total	1,555		2,151		4,833
Recoveries:
Commercial	73		10		34
Commercial real estate
Owner occupied	31		290		40
Non-owner occupied	17		13		318
Construction and development
Land and land development	840		456		298
Construction	—		—		—
Real estate - mortgage
Non-jumbo	136		107		87
Jumbo	6		96		163
Home equity	3		3		4
Mortgage warehouse lines	—		—		—
Consumer	76		105		74
Other	75		126		73
Total	1,257		1,206		1,091
Net losses	298		945		3,742
Provision for loan losses	500		1,250		2,250
Balance, end of year	$	11,674	$	11,472	$	11,167

Activity in the allowance for loan losses by loan class during 2016 and 2015 is as follows:



	2016
	Allowance for loan losses												Allowance related to:								Loans
	Beginning Balance		Charge- offs			Recoveries		Provision			Ending Balance		Loans individua- lly evaluated for impairm- ent		Loans collective- ly evaluated for impairm- ent		Loans acquired with deteriora- ted credit quality		Total		Loans individua- lly evaluated for impairm- ent		Loans collectively evaluated for impairment		Loans acquired with deteriora- ted credit quality		Total
Commercial	$	781	$	(489	)	$	73	$	569		$	934	$	—	$	934	$	—	$	934	$	285	$	118,803	$	—	$	119,088
Commercial real estate
Owner occupied	1,589		(179		)	31		668			2,109		347		1,762		—		2,109		7,384		195,663		—		203,047
Non-owner occupied	2,977		(124		)	17		568			3,438		197		3,241		—		3,438		11,514		370,407		—		381,921
Construction and development
Land and land development	2,852		(127		)	840		(1,302		)	2,263		585		1,678		—		2,263		7,293		64,354		—		71,647
Construction	15		(9		)	—		18			24		—		24		—		24		—		16,584		—		16,584
Residential real estate
Non-jumbo	1,253		(169		)	136		954			2,174		251		1,923		—		2,174		6,110		258,741		—		264,851
Jumbo	1,593		—			6		(1,504		)	95		24		71		—		95		4,493		60,119		—		64,612
Home equity	253		(175		)	3		332			413		—		413		—		413		524		74,072		—		74,596
Mortgage warehouse lines	—		—			—		—			—		—		—		—		—		—		85,966		—		85,966
Consumer	59		(98		)	76		84			121		—		121		—		121		44		25,490		—		25,534
Other	100		(185		)	75		113			103		—		103		—		103		—		9,489		—		9,489
PCI	—		—			—		—			—		—		—		—		—		—		—		2,201		2,201
Total	$	11,472	$	(1,555	)	$	1,257	$	500		$	11,674	$	1,404	$	10,270	$	—	$	11,674	$	37,647	$	1,279,688	$	2,201	$	1,319,536



	2015
	Allowance for loan losses												Allowance related to:						Loans
	Beginning Balance		Charge- offs			Recoveries		Provision			Ending Balance		Loans individually evaluated for impairment		Loans collectively evaluated for impairment		Total		Loans individually evaluated for impairment		Loans collectively evaluated for impairment		Total
Commercial	$	1,204	$	(77	)	$	10	$	(356	)	$	781	$	—	$	781	$	781	$	242	$	96,959	$	97,201
Commercial real estate
Owner occupied	927		(559		)	290		931			1,589		45		1,544		1,589		8,399		195,156		203,555
Non-owner occupied	1,316		(178		)	13		1,826			2,977		386		2,591		2,977		13,450		323,844		337,294
Construction and development
Land and land development	3,417		(457		)	456		(564		)	2,852		85		2,767		2,852		8,774		56,726		65,500
Construction	427		—			—		(412		)	15		—		15		15		—		9,970		9,970
Residential real estate
Non-jumbo	1,280		(417		)	107		283			1,253		225		1,028		1,253		6,131		215,619		221,750
Jumbo	2,081		(208		)	96		(376		)	1,593		35		1,558		1,593		4,740		45,573		50,313
Home equity	187		(76		)	3		139			253		—		253		253		709		73,591		74,300
Consumer	97		(69		)	105		(74		)	59		—		59		59		68		19,183		19,251
Other	231		(110		)	126		(147		)	100		—		100		100		—		11,669		11,669
Total	$	11,167	$	(2,151	)	$	1,206	$	1,250		$	11,472	$	776	$	10,696	$	11,472	$	42,513	$	1,048,290	$	1,090,803