NOTE 4: 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 10: Operating Segments for more detail regarding loans by market. At September 30, 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:




(Dollars in thousands)	At September 30, 2014		At December 31, 2013
Real estate mortgage:
Commercial	$	757,878	$	752,279
One-to-four family residential		78,985		83,988
Real estate construction:
Commercial		166,379		143,848
One-to-four family residential		11,030		4,646
Commercial		330,738		255,058
Installment and consumer:
Guaranteed student loans		127		4,394
Other		22,251		26,690
		1,367,388		1,270,903
Less: Allowance for loan losses		(30,917)		(36,663)
Total loans, net	$	1,336,471	$	1,234,240

Concentrations of Credit. At September 30, 2014, $474.3 million, or 35%, and $403.8 million, or 30%, of our 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 $4.4 million and $3.1 million at September 30, 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 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 $401.8 million and $390.7 million at September 30, 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, for a period of ten years for 1-4 family real estate loans and for a period of five years for other loans, 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. The five-year period for other loans expired June 30, 2014.

Due to the immateriality of the remaining balance of loans covered under the loss sharing agreement with the FDIC, covered and noncovered loans have been combined for reporting purposes. Prior period numbers have also been adjusted to reflect this change. This adjustment has no financial statement impact.

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. The acquired 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 loans reflect only losses incurred after the acquisition.

The expected payments from the FDIC under the loss sharing agreements are recorded as part of loans in the unaudited consolidated statements of financial condition.

Changes in the carrying amounts and accretable yields for loans acquired under the loss sharing agreement with the FDIC were as follows for the three and nine months ended September 30, 2014 and September 30, 2013.



	For the three months ended September 30,
	2014					2013
			Carrying				Carrying
	Accretable		amount		Accretable		amount
(Dollars in thousands)	Yield		of loans		Yield		of loans
Balance at beginning of period	$	860	$	7,920	$	1,580	$	21,646
Payments received		-		(1,301)		-		(2,697)
Net charge-offs		-		-		-		-
Accretion		(68)		-		(137)		31
Balance at end of period	$	792	$	6,619	$	1,443	$	18,980



	For the nine months ended September 30,
	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		-		(9,401)		-		(6,527)
Transfers to other real estate / repossessed assets		-		-		(33)		(375)
Net charge-offs		(9)		(407)		(1)		(70)
Accretion		(796)		-		(427)		245
Balance at end of period	$	792	$	6,619	$	1,443	$	18,980

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, past due 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 well-secured, 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. 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.




(Dollars in thousands)	At September 30, 2014		At December 31, 2013
Real estate mortgage:
Commercial	$	7,504	$	7,766
One-to-four family residential		1,274		513
Real estate construction:
Commercial		77		2,721
Commercial		6,149		8,769
Other consumer		55		50
Total nonaccrual loans	$	15,059	$	19,819

During the first nine 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 nine months ended September 30, 2014, additional interest income of $0.7 million would have been recorded.

Net cumulative charge-offs against nonaccrual loans at September 30, 2014 and December 31, 2013 were $6.2 million and $8.2 million, respectively.

The following table shows an age analysis of past due loans at September 30, 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 September 30, 2014
Real estate mortgage:
Commercial	$	3,758	$	7,504	$	11,262	$	746,616	$	757,878	$	-
One-to-four family residential		18		1,274		1,292		77,693		78,985		-
Real estate construction:
Commercial		-		77		77		166,302		166,379		-
One-to-four family residential		-		-		-		11,030		11,030		-
Commercial		356		6,149		6,505		324,233		330,738		-
Other		109		55		164		22,214		22,378		-
Total	$	4,241	$	15,059	$	19,300	$	1,348,088		1,367,388	$	-

At December 31, 2013
Real estate mortgage:
Commercial	$	3,851	$	7,766	$	11,617	$	740,662	$	752,279	$	-
One-to-four family residential		302		513		815		83,173		83,988		-
Real estate construction:
Commercial		569		2,721		3,290		140,558		143,848		-
One-to-four family residential		-		-		-		4,646		4,646		-
Commercial		1,998		8,819		10,817		244,241		255,058		50
Other		128		53		181		30,903		31,084		3
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 loans, 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 September 30, 2014
Commercial real estate	$	13,970	$	17,510	$	13,782	$	13,910	$	3,234
One-to-four family residential		1,289		1,987		-		-		-
Real estate construction		77		106		-		-		-
Commercial		2,844		3,548		4,494		10,607		2,063
Other		54		56		-		-		-
Total	$	18,234	$	23,207	$	18,276	$	24,517	$	5,297

At December 31, 2013
Commercial real estate	$	38,077	$	39,544	$	15,903	$	16,186	$	4,015
One-to-four family residential		510		630		42		94		4
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	$	39,795	$	41,540	$	27,804		33,722	$	7,946

The average recorded investment and interest income recognized on impaired loans as of the nine months ended September 30, 2014 and September 30, 2013 are shown in the following table:



	As of and for the nine months ended September 30,
	2014				2013
	Average				Average
	Recorded		Interest		Recorded		Interest
(Dollars in thousands)	Investment		Income		Investment		Income
Commercial real estate	$	33,304	$	724	$	62,407	$	1,528
One-to-four family residential		3,106		1		4,757		1
Real estate construction		234		-		5,706		-
Commercial		8,760		58		13,939		74
Other		39		-		142		-
Total	$	45,442	$	783	$	86,951	$	1,603

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 September 30, 2014 and December 31, 2013 were as follows:



	At September 30, 2014				At December 31, 2013
(Dollars in thousands)	Accruing		Nonaccrual		Accruing		Nonaccrual
Commercial real estate	$	20,248	$	3,747	$	44,442	$	4,456
One-to-four family residential		15		70		18		162
Commercial		1,190		603		1,527		648
Consumer		-		-		-		46
Total	$	21,453	$	4,420	$	45,987	$	5,312

At September 30, 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 and nine months ended September 30, 2014 and September 30, 2013 are shown in the following table:



	For the three months ended September 30,
	2014				2013
	Number of		Recorded		Number of		Recorded
(Dollars in thousands)	Modifications		Investment		Modifications		Investment
Commercial real estate		1	$	26		-	$	-
Commercial		3		434		-		-
Total		4	$	460		-	$	-


	For the nine months ended September 30,
	2014				2013
	Number of		Recorded		Number of		Recorded
(Dollars in thousands)	Modifications		Investment		Modifications		Investment
Commercial real estate		1	$	26		7	$	2,881
Commercial		4		448		5		1,820
Total		5	$	474		12	$	4,701

The modifications of loans identified as troubled debt restructurings primarily related to payment reductions, 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 and nine months ended September 30, 2014 and September 30, 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 September 30,
	2014				2013
	Number of		Recorded		Number of		Recorded
(Dollars in thousands)	Contracts		Investment		Contracts		Investment
Commercial		1	$	18		-	$	-
Total		1	$	18		-	$	-


	For the nine months ended September 30,
	2014				2013
	Number of		Recorded		Number of		Recorded
(Dollars in thousands)	Contracts		Investment		Contracts		Investment
Commercial real estate		-	$	-		1	$	535
Commercial		1		18		1		1,033
Total		1	$	18		2	$	1,568

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 September 30, 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 September 30, 2014
Grade:
Pass	$	672,510	$	77,058	$	157,838	$	317,458	$	22,194	$	1,247,058
Special Mention		37,653		93		233		3,115		130		41,224
Substandard		47,390		1,800		19,338		4,998		54		73,580
Doubtful		325		34		-		5,167		-		5,526
Total	$	757,878	$	78,985	$	177,409	$	330,738	$	22,378	$	1,367,388

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 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 September 30, 2014
Balance at beginning of period	$	18,854	$	850	$	5,523	$	10,985	$	451	$	36,663
Loans charged-off		(1,400)		(187)		(655)		(3,857)		(441)		(6,540)
Recoveries		3,700		195		-		917		220		5,032
Provision for loan losses		(5,519)		(174)		(697)		2,102		50		(4,238)
Balance at end of period	$	15,635	$	684	$	4,171	$	10,147	$	280	$	30,917

Allowance for loan losses ending balance:
Individually evaluated for impairment	$	3,234	$	-	$	-	$	2,063	$	-	$	5,297
Collectively evaluated for impairment		12,401		684		4,171		8,084		280		25,620
Acquired with deteriorated credit quality		-		-		-		-		-		-
Total ending allowance balance	$	15,635	$	684	$	4,171	$	10,147	$	280	$	30,917

Loans receivable ending balance:
Individually evaluated for impairment	$	25,932	$	598	$	77	$	7,338	$	54	$	33,999
Collectively evaluated for impairment		726,991		76,877		177,217		323,362		22,323		1,326,770
Acquired with deteriorated credit quality		4,955		1,510		115		38		1		6,619
Total ending loans balance	$	757,878	$	78,985	$	177,409	$	330,738	$	22,378	$	1,367,388



	Commercial		1-4 Family		Real Estate
(Dollars in thousands)	Real Estate		Residential		Construction		Commercial		Other		Total
At September 30, 2013
Balance at beginning of period	$	27,223	$	861	$	5,271	$	12,604	$	759	$	46,718
Loans charged-off		(806)		(577)		(131)		(5,583)		(226)		(7,323)
Recoveries		109		212		59		916		97		1,393
Provision for loan losses		(6,770)		411		2,236		3,536		(120)		(707)
Balance at end of period	$	19,756	$	907	$	7,435	$	11,473	$	510	$	40,081

Allowance for loan losses ending balances:
Individually evaluated for impairment	$	4,343		-		-		4,295		49		8,687
Collectively evaluated for impairment		15,403		849		7,435		7,178		461		31,326
Acquired with deteriorated credit quality		10		58		-		-		-		68
Total ending allowance balance	$	19,756	$	907	$	7,435	$	11,473	$	510	$	40,081

Loans receivable ending balance:
Individually evaluated for impairment	$	45,920		396		5,659		12,663		54		64,692
Collectively evaluated for impairment		697,938		80,165		161,800		250,935		32,115		1,222,953
Acquired with deteriorated credit quality		13,578		4,084		311		967		40		18,980
Total ending loans balance	$	757,436	$	84,645	$	167,770	$	264,565	$	32,209	$	1,306,625