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.

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 eleven loan pools. Quantitative reserves relative to each loan pool are established as follows: for all loan segments 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, 2017, 2016 and 2015 is as follows:



Dollars in thousands	2017		2016		2015

Balance, beginning of year	$	11,674	$	11,472	$	11,167
Losses:
Commercial	23		489		77
Commercial real estate
Owner occupied	5		179		559
Non-owner occupied	65		124		178
Construction and development
Land and land development	3		127		457
Construction	33		9		—
Residential real estate
Non-jumbo	359		169		417
Jumbo	2		—		208
Home equity	158		175		76
Mortgage warehouse lines	—		—		—
Consumer	389		98		69
Other	251		185		110
Total	1,288		1,555		2,151
Recoveries:
Commercial	124		73		10
Commercial real estate
Owner occupied	89		31		290
Non-owner occupied	91		17		13
Construction and development
Land and land development	278		840		456
Construction	—		—		—
Real estate - mortgage
Non-jumbo	134		136		107
Jumbo	—		6		96
Home equity	30		3		3
Mortgage warehouse lines	—		—		—
Consumer	82		76		105
Other	101		75		126
Total	929		1,257		1,206
Net losses	359		298		945
Provision for loan losses	1,250		500		1,250
Balance, end of year	$	12,565	$	11,674	$	11,472

The following tables present the activity in the allowance for loan losses, balance in allowance for loan losses and recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2017 and 2016.



	For the Year Ended December 31, 2017												At December 31, 2017								At December 31, 2017
	Allowance for loan losses												Allowance related to:								Loans
Dollars in thousands	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 (PCI)		Total		Loans individua- lly evaluated for impairm- ent		Loans collectively evaluated for impairment		Loans acquired with deteriora- ted credit quality (PCI)		Total
Commercial	$	934	$	(23	)	$	124	$	268		$	1,303	$	252	$	1,051	$	—	$	1,303	$	495	$	189,477	$	9	$	189,981
Commercial real estate
Owner occupied	2,109		(5		)	89		231			2,424		125		2,299		—		2,424		9,545		239,968		689		250,202
Non-owner occupied	3,438		(65		)	91		1,486			4,950		517		4,432		1		4,950		10,443		472,622		1,837		484,902
Construction and development
Land and land development	2,263		(3		)	278		(1,897		)	641		524		117		—		641		6,482		60,737		—		67,219
Construction	24		(33		)	—		162			153		—		153		—		153		—		33,412		—		33,412
Residential real estate
Non-jumbo	2,174		(359		)	134		(38		)	1,911		158		1,747		6		1,911		5,907		346,709		1,485		354,101
Jumbo	95		(2		)	—		(21		)	72		14		58		—		72		4,393		56,875		999		62,267
Home equity	413		(158		)	30		353			638		—		638		—		638		523		83,505		—		84,028
Mortgage warehouse lines	—		—			—		—			—		—		—		—		—		—		30,757		—		30,757
Consumer	121		(389		)	82		396			210		—		210		—		210		17		36,185		—		36,202
Other	103		(251		)	101		310			263		—		263		—		263		—		13,238		—		13,238
Total	$	11,674	$	(1,288	)	$	929	$	1,250		$	12,565	$	1,590	$	10,968	$	7	$	12,565	$	37,805	$	1,563,485	$	5,019	$	1,606,309



	For the Year Ended December 31, 2016												At December 31, 2016								At December 31, 2016
	Allowance for loan losses												Allowance related to:								Loans
Dollars in thousands	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 (PCI)		Total		Loans individua- lly evaluated for impairm- ent		Loans collectively evaluated for impairment		Loans acquired with deteriora- ted credit quality (PCI)		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		395		72,042
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		790		265,641
Jumbo	1,593		—			6		(1,504		)	95		24		71		—		95		4,493		60,119		1,016		65,628
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
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