Loans and Allowance for Loan Losses

Portfolio Segmentation:

At March 31, 2018 and December 31, 2017, loans are summarized as follows (in thousands):



	March 31, 2018								December 31, 2017
	PCI Loans¹		All Other Loans			Total			PCI Loans¹			All Other Loans			Total
Commercial real estate	$	16,236	$	647,458		$	663,694		$	17,903		$	625,085		$	642,988
Consumer real estate	6,985		292,162			299,147			7,450			286,007			293,457
Construction and land development	5,003		137,701			142,704			5,120			130,289			135,409
Commercial and industrial	649		255,684			256,333			858			237,229			238,087
Consumer and other	963		11,416			12,379			1,463			11,854			13,317
Total loans	29,836		1,344,421			1,374,257			32,794			1,290,464			1,323,258
Less: Allowance for loan losses	—		(6,477		)	(6,477		)	(16		)	(5,844		)	(5,860		)
Loans, net	$	29,836	$	1,337,944		$	1,367,780		$	32,778		$	1,284,620		$	1,317,398

¹ Purchased Credit Impaired loans (“PCI loans”) are loans with evidence of credit deterioration at purchase.

For purposes of the disclosures required pursuant to the adoption of ASC 310, the loan portfolio was disaggregated into segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. There are five loan portfolio segments that include commercial real estate, consumer real estate, construction and land development, commercial and industrial, and consumer and other.

The following describe risk characteristics relevant to each of the portfolio segments:

Commercial Real Estate: Commercial real estate loans include owner-occupied commercial real estate loans and loans secured by income-producing properties. Owner-occupied commercial real estate loans to operating businesses are long-term financing of land and buildings. These loans are repaid by cash flow generated from the business operation. Real estate loans for income-producing properties such as apartment buildings, office and industrial buildings, and retail shopping centers are repaid from rent income derived from the properties. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.

Consumer Real Estate: Consumer real estate loans include real estate loans secured by first liens, second liens, or open end real estate loans, such as home equity lines. These are repaid by various means such as a borrower's income, sale of the property, or rental income derived from the property. One to four family first mortgage loans are repaid by various means such as a borrower's income, sale of the property, or rental income derived from the property. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.

Construction and Land Development: Loans for real estate construction and development are repaid through cash flow related to the operations, sale or refinance of the underlying property. This portfolio segment includes extensions of credit to real estate developers or investors where repayment is dependent on the sale of the real estate or income generated from the real estate collateral. Loans within this portfolio segment are particularly sensitive to the valuation of real estate.

Commercial and Industrial: The commercial and industrial loan portfolio segment includes commercial, financial, and agricultural loans. These loans include those loans to commercial customers for use in normal business operations to finance working capital needs, equipment purchases, or expansion projects. Loans are repaid by business cash flows. Collection risk in this portfolio is driven by the creditworthiness of the underlying borrower, particularly cash flows from the customers' business operations.

Consumer and Other: The consumer loan portfolio segment includes direct consumer installment loans, overdrafts and other revolving credit loans, and educational loans. Loans in this portfolio are sensitive to unemployment and other key consumer economic measures.

Note 4. Loans and Allowance for Loan Losses, Continued

Credit Risk Management:

The Company employs a credit risk management process with defined policies, accountability and routine reporting to manage credit risk in the loan portfolio segments. Credit risk management is guided by credit policies that provide for a consistent and prudent approach to underwriting and approvals of credits. Within the Credit Policy, procedures exist that elevate the approval requirements as credits become larger and more complex. All loans are individually underwritten, risk-rated, approved, and monitored.

Responsibility and accountability for adherence to underwriting policies and accurate risk ratings lies in each portfolio segment. For the consumer real estate and consumer and other portfolio segments, the risk management process focuses on managing customers who become delinquent in their payments. For the other portfolio segments, the risk management process focuses on underwriting new business and, on an ongoing basis, monitoring the credit of the portfolios, including a third party review of the largest credits on an annual basis or more frequently as needed. To ensure problem credits are identified on a timely basis, several specific portfolio reviews occur periodically to assess the larger adversely rated credits for proper risk rating and accrual status.

Credit quality and trends in the loan portfolio segments are measured and monitored regularly. Detailed reports, by product, collateral, accrual status, etc., are reviewed by the Senior Credit Officer and the Directors Loan Committee.

The allowance for loan losses is a valuation reserve allowance established through provisions for loan losses charged against income. The allowance for loan losses, which is evaluated quarterly, is maintained at a level that management deems sufficient to absorb probable losses inherent in the loan portfolio. Loans deemed to be uncollectible are charged against the allowance for loan losses, while recoveries of previously charged-off amounts are credited to the allowance for loan losses. The allowance for loan losses is comprised of specific valuation allowances for loans evaluated individually for impairment and general allocations for pools of homogeneous loans with similar risk characteristics and trends.

The allowance for loan losses related to specific loans is based on management's estimate of potential losses on impaired loans as determined by (1) the present value of expected future cash flows; (2) the fair value of collateral if the loan is determined to be collateral dependent or (3) the loan's observable market price. The Company's homogeneous loan pools include commercial real estate loans, consumer real estate loans, construction and land development loans, commercial and industrial loans, and consumer and other loans. The general allocations to these loan pools are based on the historical loss rates for specific loan types and the internal risk grade, if applicable, adjusted for both internal and external qualitative risk factors.

The qualitative factors considered by management include, among other factors, (1) changes in local and national economic conditions; (2) changes in asset quality; (3) changes in loan portfolio volume; (4) the composition and concentrations of credit; (5) the impact of competition on loan structuring and pricing; (6) the impact of interest rate changes on portfolio risk and (7) effectiveness of the Company's loan policies, procedures and internal controls. The total allowance established for each homogeneous loan pool represents the product of the historical loss ratio adjusted for qualitative factors and the total dollar amount of the loans in the pool.

Note 4. Loans and Allowance for Loan Losses, Continued

Credit Risk Management (continued):

The composition of loans by loan classification for impaired and performing loan status at March 31, 2018 and December 31, 2017, is summarized in the tables below (in thousands):



	March 31, 2018
	Commercial Real Estate		Consumer Real Estate		Construction and Land Development		Commercial and Industrial		Consumer and Other		Total
Performing loans	$	646,908	$	290,556	$	137,154	$	255,472	$	11,304	$	1,341,394
Impaired loans	550		1,606		547		212		112		3,027
	647,458		292,162		137,701		255,684		11,416		1,344,421
PCI loans	16,236		6,985		5,003		649		963		29,836
Total	$	663,694	$	299,147	$	142,704	$	256,333	$	12,379	$	1,374,257



	December 31, 2017
	Commercial Real Estate		Consumer Real Estate		Construction and Land Development		Commercial and Industrial		Consumer and Other		Total
Performing loans	$	624,638	$	284,585	$	129,742	$	237,016	$	11,842	$	1,287,823
Impaired loans	447		1,422		547		213		12		2,641
	625,085		286,007		130,289		237,229		11,854		1,290,464
PCI loans	17,903		7,450		5,120		858		1,463		32,794
Total loans	$	642,988	$	293,457	$	135,409	$	238,087	$	13,317	$	1,323,258

The following tables show the allowance for loan losses allocation by loan classification for impaired, PCI, and performing loans as of March 31, 2018 and December 31, 2017 (in thousands):



	March 31, 2018
	Commercial Real Estate		Consumer Real Estate		Construction and Land Development		Commercial and Industrial		Consumer and Other		Total
Performing loans	$	2,925	$	1,327	$	627	$	1,111	$	118	$	6,108
Impaired loans	—		192		—		99		78		369
Total	$	2,925	$	1,519	$	627	$	1,210	$	196	$	6,477



	December 31, 2017
	Commercial Real Estate		Consumer Real Estate		Construction and Land Development		Commercial and Industrial		Consumer and Other		Total
Performing loans	$	2,444	$	1,340	$	521	$	890	$	204	$	5,399
PCI loans	16		—		—		—		—		16
Impaired loans	5		256		—		172		12		445
Total	$	2,465	$	1,596	$	521	$	1,062	$	216	$	5,860

There was no allowance for PCI loans at March 31, 2018 .

Note 4. Loans and Allowance for Loan Losses, Continued

Credit Risk Management (continued):

The following tables detail the changes in the allowance for loan losses for the three month period ending March 31, 2018 and year ending December 31, 2017, by loan classification (in thousands):



	March 31, 2018
	Commercial Real Estate			Consumer Real Estate			Construction and Land Development		Commercial and Industrial			Consumer and Other			Total
Beginning balance	$	2,465		$	1,596		$	521	$	1,062		$	216		$	5,860
Loans charged off	(38		)	—			—		(78		)	(42		)	(158		)
Recoveries of loans charged off	—			23			2		40			21			86
Provision (reallocation) charged to expense	498			(100		)	104		186			1			689
Ending balance	$	2,925		$	1,519		$	627	$	1,210		$	196		$	6,477



	December 31, 2017
	Commercial Real Estate		Consumer Real Estate			Construction and Land Development			Commercial and Industrial			Consumer and Other			Total
Beginning balance	$	2,369	$	1,382		$	717		$	520		$	117		$	5,105
Loans charged off	—		(111		)	—			(24		)	(141		)	(276		)
Recoveries of charge-offs	8		99			13			67			61			248
Provision (reallocation) charged to expense	88		226			(209		)	499			179			783
Ending balance	$	2,465	$	1,596		$	521		$	1,062		$	216		$	5,860

A description of the general characteristics of the risk grades used by the Company is as follows:

Pass: Loans in this risk category involve borrowers of acceptable-to-strong credit quality and risk who have the apparent ability to satisfy their loan obligations. Loans in this risk grade would possess sufficient mitigating factors, such as adequate collateral or strong guarantors possessing the capacity to repay the debt if required, for any weakness that may exist.

Special Mention: Loans in this risk grade are the equivalent of the regulatory definition of "Other Assets Especially Mentioned" classification. Loans in this category possess some credit deficiency or potential weakness, which requires a high level of management attention. Potential weaknesses include declining trends in operating earnings and cash flows and /or reliance on the secondary source of repayment. If left uncorrected, these potential weaknesses may result in noticeable deterioration of the repayment prospects for the asset or in the Company's credit position.

Substandard: Loans in this risk grade are inadequately protected by the borrower's current financial condition and payment capability or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the orderly repayment of debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans in this risk grade have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or orderly repayment in full, on the basis of current existing facts, conditions and values, highly questionable and improbable. Possibility of loss is extremely high, but because of certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure, its classification as an estimated loss is deferred until its more exact status may be determined.

Note 4. Loans and Allowance for Loan Losses, Continued

Credit Risk Management (continued):

Uncollectible: Loans in this risk grade are considered to be non-collectible and of such little value that their continuance as bankable assets is not warranted. This does not mean the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future. Charge-offs against the allowance for loan losses are taken in the period in which the loan becomes uncollectible. Consequently, the Company typically does not maintain a recorded investment in loans within this category.

The following tables outline the amount of each loan classification and the amount categorized into each risk rating as of March 31, 2018 and December 31, 2017 (in thousands):



	March 31, 2018
Non PCI Loans	Commercial Real Estate		Consumer Real Estate		Construction and Land Development		Commercial and Industrial		Consumer and Other		Total
Pass	$	645,238	$	287,350	$	137,154	$	254,341	$	11,150	$	1,335,233
Watch	1,660		3,227		—		1,154		127		6,168
Special mention	—		12		—		—		—		12
Substandard	560		1,573		547		169		114		2,963
Doubtful	—		—		—		20		25		45
Total	$	647,458	$	292,162	$	137,701	$	255,684	$	11,416	$	1,344,421



PCI Loans
Pass	$	13,474	$	4,257	$	4,008	$	99	$	843	$	22,681
Watch	1,590		1,281		651		3		21		3,546
Special mention	—		—		—		59		—		59
Substandard	1,172		1,447		344		475		99		3,537
Doubtful	—		—		—		13		—		13
Total	$	16,236	$	6,985	$	5,003	$	649	$	963	$	29,836
Total loans	$	663,694	$	299,147	$	142,704	$	256,333	$	12,379	$	1,374,257

Note 4. Loans and Allowance for Loan Losses, Continued

Credit Risk Management (continued):



	December 31, 2017
Non PCI Loans	Commercial Real Estate		Consumer Real Estate		Construction and Land Development		Commercial and Industrial		Consumer and Other		Total
Pass	$	616,028	$	279,464	$	129,359	$	233,942	$	11,624	$	1,270,417
Watch	7,673		2,543		383		3,007		62		13,668
Special mention	1,006		2,627		—		64		155		3,852
Substandard	378		1,159		547		157		—		2,241
Doubtful	—		214		—		59		13		286
Total	$	625,085	$	286,007	$	130,289	$	237,229	$	11,854	$	1,290,464



PCI Loans
Pass	$	14,386	$	4,151	$	4,134	$	68	$	819	$	23,558
Watch	261		1,345		649		120		262		2,637
Special mention	—		456		—		58		24		538
Substandard	3,084		1,192		337		588		107		5,308
Doubtful	172		306		—		24		251		753
Total	$	17,903	$	7,450	$	5,120	$	858	$	1,463	$	32,794
Total loans	$	642,988	$	293,457	$	135,409	$	238,087	$	13,317	$	1,323,258

Past Due Loans:

A loan is considered past due if any required principal and interest payments have not been received as of the date such payments were required to be made under the terms of the loan agreement. Generally, management places a loan on nonaccrual when there is a clear indicator that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due.

The following tables present the aging of the recorded investment in loans as of March 31, 2018 and December 31, 2017 (in thousands):



	March 31, 2018
	30-89 Days Past Due and Accruing		Past Due 90 Days or More and Accruing		Nonaccrual		Total Past Due and NonAccrual		PCI Loans		Current Loans		Total Loans
Commercial real estate	$	1,039	$	165	$	6	$	1,210	$	16,236	$	646,248	$	663,694
Consumer real estate	458		130		1,085		1,673		6,985		290,489		299,147
Construction and land development	238		334		547		1,119		5,003		136,582		142,704
Commercial and industrial	315		138		83		536		649		255,148		256,333
Consumer and other	103		31		90		224		963		11,192		12,379
Total	$	2,153	$	798	$	1,811	$	4,762	$	29,836	$	1,339,659	$	1,374,257

Note 4. Loans and Allowance for Loan Losses, Continued

Past Due Loans (continued):



	December 31, 2017
	30-89 Days Past Due and Accruing		Past Due 90 Days or More and Accruing		Nonaccrual		Total Past Due and NonAccrual		PCI Loans		Current Loans		Total Loans
Commercial real estate	$	517	$	728	$	128	$	1,373	$	17,903	$	623,712	$	642,988
Consumer real estate	963		33		991		1,987		7,450		284,020		293,457
Construction and land development	65		326		547		938		5,120		129,351		135,409
Commercial and industrial	286		131		85		502		858		236,727		238,087
Consumer and other	165		291		13		469		1,463		11,385		13,317
Total	$	1,996	$	1,509	$	1,764	$	5,269	$	32,794	$	1,285,195	$	1,323,258

Impaired Loans:

The following is an analysis of the impaired loan portfolio, excluding PCI loans, detailing the related allowance recorded as of March 31, 2018 and December 31, 2017 (in thousands):



							For the three months ended
	At March 31, 2018						March 31, 2018
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans without a valuation allowance:
Commercial real estate	$	550	$	565	$	—	$	487	$	10
Consumer real estate	889		929		—		652		5
Construction and land development	547		547		—		547		—
Commercial and industrial	52		51		—		47		1
Consumer and other	—		—		—		—		—
	2,038		2,092		—		1,733		16

Impaired loans with a valuation allowance:
Commercial real estate	—		—		—		12		—
Consumer real estate	716		729		192		862		11
Construction and land development	—		—		—		—		—
Commercial and industrial	161		162		99		167		1
Consumer and other	112		113		78		62		1
	989		1,004		369		1,103		13
Total impaired loans	$	3,027	$	3,096	$	369	$	2,836	$	29

Note 4. Loans and Allowance for Loan Losses, Continued

Impaired Loans (continued):



							For the year ended
	At December 31, 2017						December 31, 2017
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans without a valuation allowance:
Commercial real estate	$	424	$	454	$	—	$	204	$	44
Consumer real estate	415		420		—		401		16
Construction and land development	547		547		—		628		—
Commercial and industrial	41		41		—		44		3
Consumer and other	—		—		—		—		—
	1,427		1,462		—		1,277		63

Impaired loans with a valuation allowance:
Commercial real estate	23		23		5		5		1
Consumer real estate	1,007		1,033		256		601		38
Construction and land development	—		—		—		—		—
Commercial and industrial	172		172		172		117		10
Consumer and other	12		13		12		2		1
	1,214		1,241		445		725		50

PCI loans:
Commercial real estate	16		123		16		3		16

Total impaired loans	$	2,657	$	2,826	$	461	$	2,005	$	129

Troubled Debt Restructurings:

At March 31, 2018 and December 31, 2017, impaired loans included loans that were classified as Troubled Debt Restructurings ("TDRs"). The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.

In assessing whether or not a borrower is experiencing financial difficulties, the Company considers information currently available regarding the financial condition of the borrower. This information includes, but is not limited to, whether (i) the debtor is currently in payment default on any of its debt; (ii) a payment default is probable in the foreseeable future without the modification; (iii) the debtor has declared or is in the process of declaring bankruptcy; and (iv) the debtor's projected cash flow is sufficient to satisfy contractual payments due under the original terms of the loan without a modification.

The Company considers all aspects of the modification to loan terms to determine whether or not a concession has been granted to the borrower. Key factors considered by the Company include the debtor's ability to access funds at a market rate for debt with similar risk characteristics, the significance of the modification relative to unpaid principal balance or collateral value of the debt, and the significance of a delay in the timing of payments relative to the original contractual terms of the loan.

Note 4. Loans and Allowance for Loan Losses, Continued

Troubled Debt Restructurings (continued):

The most common concessions granted by the Company generally include one or more modifications to the terms of the debt, such as (i) a reduction in the interest rate for the remaining life of the debt; (ii) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk; (iii) a temporary period of interest-only payments; and (iv) a reduction in the contractual payment amount for either a short period or remaining term of the loan. As of March 31, 2018 and December 31, 2017, management had approximately, $40 thousand and $41 thousand, respectively, in loans that met the criteria for restructured, none of which were on nonaccrual. A loan is placed back on accrual status when both principal and interest are current and it is probable that management will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.

There were no loans that were modified as troubled debt restructurings during the three month period ended March 31, 2018 or during the twelve month period ended December 31, 2017. There were no loans that were modified as troubled debt restructurings during the past three months and for which there was a subsequent payment default.

Foreclosure Proceedings and Balances:

As of March 31, 2018 the company had $681 thousand in residential real estate included in foreclosed assets and consumer mortgage loans collateralized by residential real estate property that were in the process of foreclosure totaled $201 thousand .

Purchased Credit Impaired Loans:

The Company has acquired loans which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans as of is as follows (in thousands):



	March 31, 2018			December 31, 2017
Commercial real estate	$	21,866		$	23,366
Consumer real estate	9,849			10,764
Construction and land development	6,109			6,285
Commercial and industrial	1,191			1,452
Consumer and other	1,277			1,710
Total loans	40,292			43,577
Less remaining purchase discount	(10,456		)	(10,783		)
Total loans, net of purchase discount	29,836			32,794
Less: Allowance for loan losses	—			(16		)
Carrying amount, net of allowance	$	29,836		$	32,778

Activity related to the accretable yield on loans acquired with deteriorated credit quality is as follows for the three months period ended March 31, 2018 and 2017 (in thousands):



	Three Months Ended March 31, 2018			Three Months Ended March 31, 2017
Accretable yield, beginning of period	$	9,287		$	8,950
Additions	—			—
Accretion income	(1,101		)	(697		)
Reclassification to accretable	262			244
Other changes, net	(668		)	(15		)
Accretable yield	$	7,780		$	8,482