NOTE 3: LOANS AND ALLOWANCE FOR LOAN LOSSES

We extend commercial and consumer credit primarily to customers in the states of Oklahoma, Texas, and Kansas. Our commercial lending operations are concentrated in Oklahoma City, Tulsa, Dallas, Wichita, and other metropolitan markets in Oklahoma, Texas, and Kansas. As a result, the collectability of our loan portfolio can be affected by changes in the economic conditions in those states and markets. Please see Note 8: Operating Segments for more detail regarding loans by market. At March 31, 2014 and December 31, 2013, substantially all of our loans were collateralized with real estate, inventory, accounts receivable, and/or other assets or were guaranteed by agencies of the United States government.

Our loan classifications were as follows:



	At March 31, 2014				At December 31, 2013
(Dollars in thousands)	Noncovered		Covered		Noncovered		Covered
Real estate mortgage:
Commercial	$	755,680	$	10,498	$	740,997	$	11,282
One-to-four family residential		81,199		3,420		80,058		3,930
Real estate construction:
Commercial		165,820		187		143,650		198
One-to-four family residential		6,629		-		4,646		-
Commercial		265,394		917		254,087		971
Installment and consumer:
Guaranteed student loans		4,318		-		4,394		-
Other		26,029		31		26,644		46
		1,305,069		15,053		1,254,476		16,427
Less: Allowance for loan losses		(34,918)		(7)		(36,607)		(56)
Total loans, net	$	1,270,151	$	15,046	$	1,217,869	$	16,371

Concentrations of Credit. At March 31, 2014, $433.2 million, or 33% and $420.3 million, or 32%, of our noncovered loans consisted of loans to individuals and businesses in the real estate and healthcare industry, respectively. We do not have any other concentrations of loans to individuals or businesses involved in a single industry totaling 10% or more of total loans.

Loans Held for Sale. We had loans which were held for sale of $5.7 million and $3.1 million at March 31, 2014 and December 31, 2013, respectively. The loans currently classified as held for sale, primarily residential mortgage loans, are carried at the lower of cost or market value. A substantial portion of our one-to-four family residential loans and loan servicing rights are primarily sold to one buyer. These mortgage loans are generally sold within a one-month period from loan closing at amounts determined by the investor commitment based upon the pricing of the loan. These loans are available for sale in the secondary market.

Loan Servicing. We earn fees for servicing real estate mortgages and other loans owned by others. The fees are generally calculated on the outstanding principal balance of the loans serviced and are recorded as noninterest income when earned. The unpaid principal balance of real estate mortgage loans serviced for others totaled $391.3 million and $390.7 million at March 31, 2014 and December 31, 2013, respectively. Loan servicing rights are capitalized based on estimated fair value at the point of origination. The servicing rights are amortized over the period of estimated net servicing income.

Acquired Loans. On June 19, 2009, Bank SNB entered into a purchase and assumption agreement with the Federal Deposit Insurance Corporation (“FDIC”) to acquire substantially all loans as well as certain other related assets of First National Bank of Anthony, Anthony, Kansas in an FDIC-assisted transaction. Bank SNB and the FDIC entered into loss sharing agreements that provide Bank SNB with significant protection against credit losses from loans and related assets acquired in the transaction. Under these agreements, the FDIC will reimburse Bank SNB for 80% of net losses up to $35.0 million on covered assets, primarily acquired loans and other real estate, and for 95% of any net losses above $35.0 million. Bank SNB services the covered assets.

Loans covered under the loss sharing agreements with the FDIC, including the amounts of expected reimbursements from the FDIC under these agreements, are reported in loans and are referred to as “covered” loans. Covered loans were initially recorded at fair value (as determined by the present value of expected future cash flows) with no allowance for loan losses. Subsequent decreases in expected cash flows are recognized as impairments. Valuation allowances on these covered loans reflect only losses incurred after the acquisition.

The expected payments from the FDIC under the loss sharing agreements are recorded as part of the covered loans in the Unaudited Consolidated Statements of Financial Condition.

Changes in the carrying amounts and accretable yields for ASC 310.30, Receivables: Loans and Debt Securities Acquired with Deteriorated Credit Quality, loans were as follows for the three months ended March 31, 2014 and March 31, 2013.



	For the three months ended March 31,
	2014					2013
			Carrying				Carrying
	Accretable		amount		Accretable		amount
(Dollars in thousands)	Yield		of loans		Yield		of loans
Balance at beginning of period	$	1,597	$	16,427	$	1,904	$	25,707
Payments received		-		(1,333)		-		(1,889)
Transfers to other real estate / repossessed assets		-		-		(33)		(375)
Net charge-offs		(4)		(41)		(1)		-
Net reclassifications to / from nonaccretable amount		-		-		-		-
Accretion		(90)		-		(163)		158
Balance at end of period	$	1,503	$	15,053	$	1,707	$	23,601

Nonperforming / Past Due Loans. We identify past due loans based on contractual terms on a loan by loan basis and generally place loans, except for consumer loans, on nonaccrual when any portion of the principal or interest is ninety days past due and collateral is insufficient to discharge the debt in full. Interest accrual may also be discontinued earlier if, in management’s opinion, collection is unlikely. Generally, consumer installment loans are not placed on nonaccrual but are charged-off when they are four months past due. Accrued interest is written off when a loan is placed on nonaccrual status. Subsequent interest income is recorded when cash receipts are received from the borrower and collectability of the principal amount is reasonably assured.

Under generally accepted accounting principles and instructions to reports of condition and income of federal banking regulators, a nonaccrual loan may be returned to accrual status: (i) when none of its principal and interest is due and unpaid, repayment is expected, and there has been a sustained period (at least six months) of repayment performance; (ii) when the loan is not brought current, but there is a sustained period of performance and repayment within a reasonable period is reasonably assured; or (iii) when the loan otherwise becomes well-secured and in the process of collection. Purchased nonperforming loans also may be returned to accrual status without becoming fully current. Loans that have been restructured because of weakened financial positions of the borrowers also may be returned to accrual status if repayment is reasonably assured under the revised terms and there has been a sustained period of repayment performance.

Management strives to carefully monitor credit quality and to identify loans that may become nonperforming. At any time, however, there are loans included in the portfolio that will result in losses to us that have not been identified as nonperforming or potential problem loans. Because the loan portfolio contains a significant number of commercial and commercial real estate loans with relatively large balances, the unexpected deterioration of one or a few such loans may cause a significant increase in nonperforming assets and may lead to a material increase in charge-offs and the provision for loan losses in future periods.

The following table shows the recorded investment in loans on nonaccrual status.



	At March 31, 2014				At December 31, 2013
(Dollars in thousands)	Noncovered		Covered		Noncovered		Covered
Real estate mortgage:
Commercial	$	6,571	$	970	$	6,564	$	1,202
One-to-four family residential		417		53		456		57
Real estate construction:
Commercial		80		-		2,721		-
Commercial		7,992		-		8,769		-
Other consumer		2		-		50		-
Total nonaccrual loans	$	15,062	$	1,023	$	18,560	$	1,259

During the first three months of 2014, an immaterial amount of interest income was received on nonaccruing loans. If interest on all nonaccrual loans had been accrued for the three months ended March 31, 2014, additional interest income of $0.2 million would have been recorded.

Net cumulative charge-offs against noncovered nonaccrual loans at March 31, 2014 and December 31, 2013 were $5.5 million and $8.2 million, respectively.

Included in noncovered nonaccrual loans are seven and five collateral dependent lending relationships with aggregate principal balances of approximately $12.4 million and $14.6 million as of March 31, 2014 and December 31, 2013, respectively. Related impairment reserves as of March 31, 2014 and December 31, 2013 were $2.8 million and $2.9 million, respectively. These impairment reserves were established either based on recent appraisal values obtained for the respective properties or the discounted present value of expected cash flows using the loan’s initial effective interest rate. At March 31, 2014, four of the seven lending relationships were secured by commercial real estate.

The following table shows an age analysis of past due loans at March 31, 2014 and December 31, 2013.



			90 days and								Recorded loans
	30-89 days		greater		Total past				Total		> 90 days and
(Dollars in thousands)	past due		past due		due		Current		loans		accruing
At March 31, 2014
Noncovered:
Real estate mortgage:
Commercial	$	4,005	$	6,571	$	10,576	$	745,104	$	755,680	$	-
One-to-four family residential		109		417		526		80,673		81,199		-
Real estate construction:
Commercial		847		80		927		164,893		165,820		-
One-to-four family residential		-		-		-		6,629		6,629		-
Commercial		1,166		7,992		9,158		256,236		265,394		-
Other		391		2		393		29,954		30,347		-
Total - noncovered		6,518		15,062		21,580		1,283,489		1,305,069		-

Covered:
Real estate mortgage:
Commercial		911		970		1,881		8,617		10,498		-
One-to-four family residential		34		53		87		3,333		3,420		-
Real estate construction:
Commercial		-		-		-		187		187		-
Commercial		-		-		-		917		917		-
Other		1		-		1		30		31		-
Total - covered		946		1,023		1,969		13,084		15,053		-
Total	$	7,464	$	16,085	$	23,549	$	1,296,573	$	1,320,122	$	-

At December 31, 2013
Noncovered:
Real estate mortgage:
Commercial	$	3,843	$	6,564	$	10,407	$	730,590	$	740,997	$	-
One-to-four family residential		284		456		740		79,318		80,058		-
Real estate construction:
Commercial		569		2,721		3,290		140,360		143,650		-
One-to-four family residential		-		-		-		4,646		4,646		-
Commercial		1,998		8,819		10,817		243,270		254,087		50
Other		128		53		181		30,857		31,038		3
Total - noncovered		6,822		18,613		25,435		1,229,041		1,254,476		53

Covered:
Real estate mortgage:
Commercial real estate		8		1,202		1,210		10,072		11,282		-
One-to-four family residential		18		57		75		3,855		3,930		-
Real estate construction:
Commercial		-		-		-		198		198		-
Commercial		-		-		-		971		971		-
Other		-		-		-		46		46		-
Total - covered		26		1,259		1,285		15,142		16,427		-
Total	$	6,848	$	19,872	$	26,720	$	1,244,183	$	1,270,903	$	53

Impaired Loans. A loan is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Each loan deemed to be impaired (loans on nonaccrual status and greater than one-hundred thousand, and all troubled debt restructurings) is evaluated on an individual basis using the discounted present value of expected cash flows based on the loan’s initial effective interest rate, the fair value of collateral, or the market value of the loan. Smaller balance, homogeneous loans, including mortgage, student, and consumer, are collectively evaluated for impairment.

Interest payments on impaired loans are applied to principal until collectability of the principal amount is reasonably assured, and at that time interest is recognized on a cash basis. Impaired loans or portions thereof, are charged-off when deemed uncollectible.

Impaired loans are shown in the following table:



	With No Specific Allowance				With A Specific Allowance
			Unpaid				Unpaid
	Recorded		Principal		Recorded		Principal		Related
(Dollars in thousands)	Investment		Balance		Investment		Balance		Allowance
At March 31, 2014
Noncovered:
Commercial real estate	$	23,213	$	23,559	$	16,827	$	17,105	$	4,748
One-to-four family residential		417		549		-		-		-
Real estate construction		81		105		-		-		-
Commercial		2,459		5,524		7,003		10,270		2,164
Other		2		4		-		-		-
Total noncovered	$	26,172	$	29,741	$	23,830	$	27,375	$	6,912

Covered:
Commercial real estate	$	5,535	$	6,552	$	453	$	453	$	6
One-to-four family residential		54		54		41		74		1
Total covered	$	5,589	$	6,606	$	494	$	527	$	7

At December 31, 2013
Noncovered:
Commercial real estate	$	32,284	$	32,784	$	15,446	$	15,729	$	4,012
One-to-four family residential		456		576		-		-		-
Real estate construction		84		106		2,636		2,762		18
Commercial		1,120		1,254		9,177		14,608		3,863
Other		4		6		46		72		46
Total noncovered	$	33,948	$	34,726	$	27,305		33,171	$	7,939

Covered:
Commercial real estate	$	5,793	$	6,760	$	457	$	457	$	3
One-to-four family residential		54		54		42		94		4
Total covered	$	5,847	$	6,814	$	499	$	551	$	7

The average recorded investment and interest income recognized on impaired loans as of and for the three months ended March 31, 2014 and March 31, 2013 is shown in the following table:



	As of and for the three months ended March 31,
	2014				2013
	Average				Average
	Recorded		Interest		Recorded		Interest
(Dollars in thousands)	Investment		Income		Investment		Income
Noncovered:
Commercial real estate	$	38,631	$	348	$	47,880	$	410
One-to-four family residential		427		-		578		-
Real estate construction		82		-		5,117		12
Commercial		8,942		24		13,254		34
Other		3		-		77		-
Total noncovered	$	48,085	$	372	$	66,906	$	456

Covered:
Commercial real estate	$	10,958	$	91	$	17,803	$	82
One-to-four family residential		3,682		-		4,724		-
Real estate construction		193		-		373		-
Commercial		863		-		1,873		-
Other		32		-		95		-
Total covered	$	15,728	$	91	$	24,868	$	82

Troubled Debt Restructurings. Our loan portfolio also includes certain loans that have been modified in a troubled debt restructuring, where economic concessions have been granted to borrowers who have experienced financial difficulties. These concessions typically result from loss mitigation activities and can include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Troubled debt restructurings are classified as impaired at the time of restructuring and classified as nonperforming, potential problem, or performing restructured, as applicable. Loans modified in troubled debt restructurings may be returned to performing status after considering the borrowers’ sustained repayment for a reasonable period of at least six months.

When we modify loans in a troubled debt restructuring, an evaluation of any possible impairment is performed similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or use of the current fair value of the collateral, less selling costs for collateral dependent loans. If it is determined that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs, and unamortized premium or discount), an impairment is recognized through an allowance estimate or a charge-off to the allowance. In periods subsequent to modification, all loans modified in troubled debt restructurings are evaluated, including those that have payment defaults, for possible impairment.

Troubled debt restructured loans outstanding as of March 31, 2014 and December 31, 2013 were as follows:



	At March 31, 2014				At December 31, 2013
(Dollars in thousands)	Accruing		Nonaccrual		Accruing		Nonaccrual
Commercial real estate	$	36,435	$	4,318	$	44,442	$	4,456
One-to-four family residential		17		151		18		162
Commercial		1,471		292		1,527		648
Consumer		-		-		-		46
Total	$	37,923	$	4,761	$	45,987	$	5,312

At March 31, 2014 and December 31, 2013, we had no significant commitments to lend additional funds to debtors whose loan terms have been modified in a troubled debt restructuring.

Loans modified as troubled debt restructurings that occurred during the three months ended March 31, 2014 and March 31, 2013 are shown in the following table:



	For the three months ended March 31,
	2014				2013
	Number of		Recorded		Number of		Recorded
(Dollars in thousands)	Modifications		Investment		Modifications		Investment
Commercial real estate		-	$	-		6	$	10,882
Commercial		3		244		3		576
Total		3	$	244		9	$	11,458

The modifications of loans identified as troubled debt restructurings primarily related to payment extensions and/or reductions in the interest rate. The financial impact of troubled debt restructurings is not significant.

The following table presents the recorded investment and the number of loans modified as a troubled debt restructuring that subsequently defaulted during the three months ended March 31, 2014 and March 31, 2013. Default, for this purpose, is deemed to occur when a loan is 90 days or more past due or transferred to nonaccrual and is within twelve months of restructuring.



	For the three months ended March 31,
	2014				2013
	Number of		Recorded		Number of		Recorded
(Dollars in thousands)	Contracts		Investment		Contracts		Investment
Commercial		-	$	-		1	$	563
Total		-	$	-		1	$	563

Credit Quality Indicators. To assess the credit quality of loans, we categorize loans into risk categories based on relevant information about the ability of the borrowers to service their debts such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. This analysis is performed on a quarterly basis. We use the following definitions for risk ratings:

Special mention – Loans classified as special mention have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for these loans or of the institution’s credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligors or of the collateral pledged, if any. Loans so classified have one or more well-defined weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. These loans are considered potential problem or nonperforming loans depending on the accrual status of the loans.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. These loans are considered nonperforming.

Loans not meeting the criteria above that are analyzed as part of the above described process are considered to be pass rated loans. As of March 31, 2014 and December 31, 2013, based on the most recent analysis performed as of those dates, the risk category of loans by class was as follows:



	Commercial		1-4 Family		Real Estate
(Dollars in thousands)	Real Estate		Residential		Construction		Commercial		Other		Total
At March 31, 2014
Grade:
Pass	$	633,694	$	82,679	$	128,465	$	247,156	$	30,250	$	1,122,244
Special Mention		58,080		895		21,876		6,437		123		87,411
Substandard		73,974		897		22,295		7,271		3		104,440
Doubtful		430		148		-		5,447		2		6,027
Total	$	766,178	$	84,619	$	172,636	$	266,311	$	30,378	$	1,320,122

At December 31, 2013
Grade:
Pass	$	610,929	$	81,534	$	101,715	$	233,132	$	30,893	$	1,058,203
Special Mention		62,932		1,452		22,576		6,130		141		93,231
Substandard		77,453		944		24,203		11,329		50		113,979
Doubtful		965		58		-		4,467		-		5,490
Total	$	752,279	$	83,988	$	148,494	$	255,058	$	31,084	$	1,270,903

Allowance for Loan Losses. The allowance for loan losses is a reserve established through the provision for loan losses charged to operations. Loan amounts which are determined to be uncollectible are charged against this allowance, and recoveries, if any, are added to the allowance. The appropriate amount of the allowance is based on periodic review and evaluation of the loan portfolio and quarterly assessments of the probable losses inherent in the loan portfolio. The amount of the loan loss provision for a period is based solely upon the amount needed to cause the allowance to reach the level deemed appropriate after the effects of net charge-offs for the period.

Management believes the level of the allowance is appropriate to absorb probable losses inherent in the loan portfolio. The allowance for loan losses is determined in accordance with regulatory guidelines and generally accepted accounting principles and is comprised of two primary components, specific and general. There is no one factor, or group of factors, that produces the amount of an appropriate allowance for loan losses, as the methodology for assessing the allowance for loan losses makes use of evaluations of individual impaired loans along with other factors and analysis of loan categories. This assessment is highly qualitative and relies upon judgments and estimates by management.

The specific allowance is recorded based on the result of an evaluation consistent with ASC 310.10.35, Receivables: Subsequent Measurement, for each impaired loan. Collateral dependent loans are evaluated for impairment based upon the fair value of the collateral. The amount and level of the impairment allowance is ultimately determined by management’s estimate of the amount of expected future cash flows or, if the loan is collateral dependent, on the value of collateral, which may vary from period to period depending on changes in the financial condition of the borrower or changes in the estimated value of the collateral. Charge-offs against the allowance for impaired loans are made when and to the extent loans are deemed uncollectible. Any portion of a collateral dependent impaired loan in excess of the fair value of the collateral that is determined to be uncollectible is charged off.

The general component of the allowance is calculated based on ASC 450, Contingencies. Loans not evaluated for specific allowance are segmented into loan pools by type of loan. The commercial real estate and real estate construction pools are further segmented by the market in which the loan collateral is located. Our primary markets are Oklahoma, Texas, and Kansas, and loans secured by real estate in those states are included in the “in-market” pool, with the remaining loans defaulting to the “out-of-market” pool. Estimated allowances are based on historical loss trends with adjustments factored in based on qualitative risk factors both internal and external to us. The historical loss trend is determined by loan pool and segmentation and is based on the actual loss history experienced by us over the most recent three years. The qualitative risk factors include, but are not limited to, economic and business conditions, changes in lending staff, lending policies and procedures, quality of loan review, changes in the nature and volume of the portfolios, loss and recovery trends, asset quality trends, and legal and regulatory considerations.

Independent appraisals on real estate collateral securing loans are obtained at origination. New appraisals are obtained periodically and following discovery of factors that may significantly affect the value of the collateral. Appraisals typically are received within 30 days of request. Results of appraisals on nonperforming and potential problem loans are reviewed promptly upon receipt and considered in the determination of the allowance for loan losses. We are not aware of any significant time lapses in the process that have resulted, or would result in, a significant delay in determination of a credit weakness, the identification of a loan as nonperforming, or the measurement of an impairment.

The following tables show the balance in the allowance for loan losses and the recorded investment in covered and noncovered loans for the dates indicated by portfolio classification disaggregated on the basis of impairment evaluation method.



	Commercial		1-4 Family		Real Estate
(Dollars in thousands)	Real Estate		Residential		Construction		Commercial		Other		Total
At March 31, 2014
Balance at beginning of period	$	18,854	$	850	$	5,523	$	10,985	$	451	$	36,663
Loans charged-off		(41)		-		(655)		(2,575)		(121)		(3,392)
Recoveries		2,284		18		-		308		30		2,640
Provision for loan losses		(2,238)		(152)		706		682		16		(986)
Balance at end of period	$	18,859	$	716	$	5,574	$	9,400	$	376	$	34,925

Allowance for loan losses ending balance:
Individually evaluated for impairment	$	4,748	$	-	$	-	$	2,164	$	-	$	6,912
Collectively evaluated for impairment		14,105		715		5,574		7,236		376		28,006
Acquired with deteriorated credit quality		6		1		-		-		-		7
Total ending allowance balance	$	18,859	$	716	$	5,574	$	9,400	$	376	$	34,925

Loans receivable ending balance:
Individually evaluated for impairment	$	40,040	$	417	$	81	$	9,462	$	2	$	50,002
Collectively evaluated for impairment		715,640		80,782		172,368		255,932		30,345		1,255,067
Acquired with deteriorated credit quality		10,498		3,420		187		917		31		15,053
Total ending loans balance	$	766,178	$	84,619	$	172,636	$	266,311	$	30,378	$	1,320,122



	Commercial		1-4 Family		Real Estate
(Dollars in thousands)	Real Estate		Residential		Construction		Commercial		Other		Total
At March 31, 2013
Balance at beginning of period	$	27,223	$	861	$	5,271	$	12,604	$	759	$	46,718
Loans charged-off		(458)		(186)		-		(3,926)		(81)		(4,651)
Recoveries		42		19		19		175		33		288
Provision for loan losses		(1,520)		161		669		1,260		(72)		498
Balance at end of period	$	25,287	$	855	$	5,959	$	10,113	$	639	$	42,853

Allowance for loan losses ending balances:
Individually evaluated for impairment	$	5,146		-		249		3,431		68		8,894
Collectively evaluated for impairment		19,996		786		5,710		6,682		571		33,745
Acquired with deteriorated credit quality		145		69		-		-		-		214
Total ending allowance balance	$	25,287	$	855	$	5,959	$	10,113	$	639	$	42,853

Loans receivable ending balance:
Individually evaluated for impairment	$	47,494		651		7,238		13,539		73		68,995
Collectively evaluated for impairment		772,379		73,260		137,239		218,685		33,056		1,234,619
Acquired with deteriorated credit quality		16,970		4,458		367		1,715		91		23,601
Total ending loans balance	$	836,843	$	78,369	$	144,844	$	233,939	$	33,220	$	1,327,215