(4) Allowance for Probable Loan Losses

The allowance for probable loan losses primarily consists of the aggregate loan loss allowances of the Subsidiary Banks. The allowances are established through charges to operations in the form of provisions for probable loan losses. Loan losses or recoveries are charged or credited directly to the allowances. The allowance for probable loan losses of each Subsidiary Bank is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance for probable loan losses is derived from the following elements: (i) allowances established on specific impaired loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry in which the customer operates, (ii) allowances based on actual historical loss experience for similar types of loans in our loan portfolio, and (iii) allowances based on general economic conditions, changes in the mix of loans, company resources, border risk and credit quality indicators, among other things.

Our management continually reviews the allowance for loan losses of the Subsidiary Banks using the amounts determined from the allowances established on specific impaired loans, the allowance established on quantitative historical loss percentages, and the allowance based on qualitative data to establish an appropriate amount to maintain in our allowance for probable loan losses. Should any of the factors considered by management in evaluating the adequacy of the allowance for probable loan losses change, our estimate of probable loan losses could also change, which could affect the level of future provisions for probable loan losses. While the calculation of the allowance for probable loan losses utilizes management’s best judgment and all information available, the adequacy of the allowance is dependent on a variety of factors beyond our control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications.

The loan loss provision is determined using the following methods. On a weekly basis, loan past due reports are reviewed by the credit quality committee to determine if a loan has any potential problems and if a loan should be placed on our internal classified report. Additionally, our credit department reviews the majority of our loans for proper internal classification purposes regardless of whether they are past due and segregates any loans with potential problems for further review. The credit department will discuss the potential problem loans with the servicing loan officers to determine any relevant issues that were not discovered in the evaluation. Also, an analysis of loans that is provided through examinations by regulatory authorities is considered in the review process. After the above analysis is completed, we will determine if a loan should be placed on an internal classified report because of issues related to the analysis of the credit, credit documents, collateral and/or payment history.

World and U.S. economic conditions have continued to improve; however, there remains some uncertainty created by continued issues with negative demographic trends, weak labor participation rates, enormous government debt, excessive regulations, and unfunded entitlement programs that could create a financial crisis. The impact to the world and U.S. economy from these issues is being magnified by a lack of appropriate government action to find solutions to the problems. Economic risk factors are minimized by the underwriting standards of the Subsidiary Banks. The general underwriting standards encompass the following principles: (i) the financial strength of the borrower including strong earnings, a high net worth, significant liquidity and an acceptable debt to worth ratio, (ii) managerial and business competence, (iii) the ability to repay, (iv) for a new business, projected cash flows, (v) loan to value, (vi) in the case of a secondary guarantor, a guarantor financial statement, and (vii) financial and/or other character references. Although the underwriting standards reduce the risk of loss, unique risk factors exist in each type of loan in which the Subsidiary Banks invest.

Commercial and industrial loans are mostly secured by the collateral pledged by the borrower that is directly related to the business activities of the company such as accounts receivable and inventory. The ability of the borrower to collect accounts receivable, and to turn inventory into sales are risk factors in the repayment of the loan.

Construction and land development loans can carry risk of repayment when projects incur cost overruns, have an increase in the price of building materials, encounter zoning and environmental issues, or encounter other factors that may affect the completion of a project on time and on budget. Additionally, repayment risk may be negatively impacted when the market experiences a deterioration in the value of real estate. Risks specifically related to 1‑4 family development loans also include the practice by the mortgage industry of more restrictive underwriting standards, which inhibits the buyer from obtaining long term financing and excessive housing and lot inventory in the market.

Commercial real estate loans demonstrate a risk of repayment when market values deteriorate, the business experiences turnover in key management, the business has an inability to attract or keep occupancy levels stable, or when the market experiences an exit of a specific business industry that is significant to the local economy, such as a manufacturing plant.

First and second lien residential 1-4 family mortgage and consumer loan repayments may be affected by unemployment or underemployment and deteriorating market values of real estate.

A summary of the changes in the allowance for probable loan losses by loan class is as follows:


	December 31, 2018
	Domestic														Foreign
			Commercial
			real estate:
			other		Commercial
			construction &		real estate:		Commercial
			land		farmland &		real estate:		Residential:		Residential:
	Commercial		development		commercial		multifamily		first lien		junior lien		Consumer		Foreign		Total
	(Dollars in Thousands)
Balance at December 31,	$	27,905	$	11,675	$	16,663	$	1,109	$	2,950	$	6,103	$	440	$	842	$	67,687
Losses charge to allowance		(14,220)		(1)		(70)		—		(122)		(347)		(362)		(3)		(15,125)
Recoveries credited to allowance		1,981		25		246		—		36		369		43		10		2,710
Net losses charged to allowance		(12,239)		24		176		—		(86)		22		(319)		7		(12,415)
Provision (credit) charged to operations		(3,070)		3,424		2,514		699		603		1,594		326		22		6,112
Balance at December 31,	$	12,596	$	15,123	$	19,353	$	1,808	$	3,467	$	7,719	$	447	$	871	$	61,384


	December 31, 2017
	Domestic																	Foreign
			Commercial
			real estate:
			other			Commercial
			construction &			real estate:		Commercial
			land			farmland &		real estate:		Residential:			Residential:
	Commercial			development		commercial		multifamily		first lien			junior lien			Consumer			Foreign			Total
	(Dollars in Thousands)
Balance at December 31,	$	25,649	$		13,889	$	16,731	$	806	$	2,455	$		3,716	$		531	$		884	$		64,661
Losses charge to allowance		(12,094)			(213)		(40)		—		(101)			(340)			(309)			(1)			(13,098)
Recoveries credited to allowance		4,020			21		527		—		11			258			45			21			4,903
Net losses charged to allowance		(8,074)			(192)		487		—		(90)			(82)			(264)			20			(8,195)
Provision (credit) charged to operations		10,330			(2,022)		(555)		303		585			2,469			173			(62)			11,221
Balance at December 31,	$	27,905	$		11,675	$	16,663	$	1,109	$	2,950	$		6,103	$		440	$		842	$		67,687


	December 31, 2016
	Domestic																	Foreign
			Commercial
			real estate:
			other		Commercial
			construction &		real estate:		Commercial
			land		farmland &		real estate:		Residential:		Residential:
	Commercial		development		commercial		multifamily		first lien		junior lien		Consumer		Foreign		Total
	(Dollars in Thousands)
Balance at December 31,	$	21,431	$	13,920	$	19,769	$	1,248	$	3,509	$	5,321	$	638	$	1,152	$	66,988
Losses charge to allowance		(32,959)		(16)		(1,890)		(180)		(70)		(331)		(414)		(41)		(35,901)
Recoveries credited to allowance		7,110		6,099		119		—		21		278		69		19		13,715
Net losses charged to allowance		(25,849)		6,083		(1,771)		(180)		(49)		(53)		(345)		(22)		(22,186)
Provision (credit) charged to operations		30,067		(6,114)		(1,267)		(262)		(1,005)		(1,552)		238		(246)		19,859
Balance at December 31,	$	25,649	$	13,889	$	16,731	$	806	$	2,455	$	3,716	$	531	$	884	$	64,661

The allowance for probable loan losses is a reserve established through a provision for probable loan losses charged to expense, which represents management’s best estimate of probable loan losses when evaluating loans (i) individually or (ii) collectively. The decrease in the provision for probable loan losses charged to expense for the years ended December 31, 2018 and December 31, 2017 can be attributed to a decrease in the historical loss experience in the commercial category of the calculation. As discussed in prior periods, charge-offs increased from historical levels due to the deterioration of one relationship that was secured by multiple pieces of transportation equipment beginning in the fourth quarter of 2014. We use a three-year historical charge-off experience in the calculation, therefore, as those charge-offs are eliminated from the calculation, the allowance for probable loan losses is impacted. As fluctuations occur in historical loss factors, management evaluates the need to adjust the qualitative factors used in the calculation to properly reflect probable loan losses. The increase in losses charged to the allowance for probable loan losses for the year ended December 31, 2016 can be attributed to further deterioration in the previously identified and charged down relationship primarily secured by multiple pieces of transportation equipment. In March 2016, litigation against the management of the borrower was filed in the State of Nevada, resulting in a going concern issue with the borrower’s operations and the future use of the transportation equipment pledged as collateral on the relationship. As a result, management, in accordance with its credit review procedures, re-evaluated the collateral values on the equipment in light of the new circumstances and reduced the collateral values accordingly, resulting in a further charge-down of the relationship of approximately $19.4 million, which is included in the losses charged to the allowance in the commercial category in the table detailing the year ended December 31, 2016 activity.

The table below provides additional information on the balance of loans individually or collectively evaluated for impairment and their related allowance, by loan class:


	December 31, 2018
	Loans Individually				Loans Collectively
	Evaluated For				Evaluated For
	Impairment				Impairment
	Recorded				Recorded
	Investment		Allowance		Investment		Allowance
	(Dollars in Thousands)
Domestic
Commercial	$	9,179	$	656	$	1,119,790	$	11,940
Commercial real estate: other construction & land development		2,092		116		1,884,139		15,007
Commercial real estate: farmland & commercial		3,509		—		1,946,389		19,353
Commercial real estate: multifamily		507		—		225,750		1,808
Residential: first lien		6,244		—		439,556		3,467
Residential: junior lien		901		—		726,400		7,719
Consumer		1,175		—		45,141		447
Foreign		293		—		150,224		871

Total	$	23,900	$	772	$	6,537,389	$	60,612


	December 31, 2017
	Loans Individually				Loans Collectively
	Evaluated For				Evaluated For
	Impairment				Impairment
	Recorded				Recorded
	Investment		Allowance		Investment		Allowance
	(Dollars in Thousands)
Domestic
Commercial	$	17,947	$	300	$	1,068,520	$	27,605
Commercial real estate: other construction & land development		2,455		116		1,681,095		11,559
Commercial real estate: farmland & commercial		33,123		18		2,010,162		16,645
Commercial real estate: multifamily		476		—		192,440		1,109
Residential: first lien		6,852		—		425,925		2,950
Residential: junior lien		723		—		700,025		6,103
Consumer		1,281		—		48,262		440
Foreign		347		—		158,539		842

Total	$	63,204	$	434	$	6,284,968	$	67,253

The decrease in loans individually evaluated for impairment at December 31, 2018 compared to December 31, 2017, can be attributed to the foreclosure on a relationship primarily secured by a water park and the foreclosure of the collateral on a relationship secured by multiple pieces of transportation equipment. The foreclosure of the collateral securing the two relationships is also impacting the balances reported as impaired loans in the following tables. Loans accounted for on a non‑accrual basis at December 31, 2018, 2017 and 2016 amounted to $15,791,000, $54,730,000 and $37,245,000, respectively. The effect of such non‑accrual loans reduced interest income by approximately $1,119,000, $977,000 and $2,461,000 for the years ended December 31, 2018, 2017 and 2016, respectively. Amounts received on non‑accruals are applied, for financial accounting purposes, first to principal and then to interest after all principal has been collected. Accruing loans contractually past due 90 days or more as to principal or interest payments at December 31, 2018, 2017 and 2016 amounted to approximately $40,674,000, $7,257,000 and $5,226,000, respectively and can be attributed to a relationship that is secured by multiple pieces of real property on which car dealerships are operated.

The table below provides additional information on loans accounted for on a non‑accrual basis by loan class:


	December 31, 2018		December 31, 2017
	(Dollars in Thousands)
Domestic
Commercial	$	9,143	$	17,909
Commercial real estate: other construction & land development		2,092		2,455
Commercial real estate: farmland & commercial		3,509		33,123
Commercial real estate: multifamily		507		476
Residential: first lien		347		712
Residential: junior lien		171		11
Consumer		22		44
Total non-accrual loans	$	15,791	$	54,730

Impaired loans are those loans where it is probable that all amounts due according to contractual terms of the loan agreement will not be collected. We have identified these loans through our normal loan review procedures. Impaired loans are measured based on (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the loan’s observable market price; or (iii) the fair value of the collateral if the loan is collateral dependent. Substantially all of our impaired loans are measured at the fair value of the collateral. In limited cases, we may use other methods to determine the level of impairment of a loan if such loan is not collateral dependent.

The following tables detail key information regarding our impaired loans by loan class for the year ended December 31, 2018:


	December 31, 2018
			Unpaid				Average
	Recorded		Principal		Related		Recorded		Interest
	Investment		Balance		Allowance		Investment		Recognized
	(Dollars in Thousands)
Loans with Related Allowance
Domestic
Commercial	$	1,563	$	2,161	$	656	$	1,741	$	—
Commercial real estate: other construction & land development		135		169		116		141		—
Total impaired loans with related allowance	$	1,698	$	2,330	$	772	$	1,882	$	—


	December 31, 2018
			Unpaid		Average
	Recorded		Principal		Recorded		Interest
	Investment		Balance		Investment		Recognized
	(Dollars in Thousands)
Loans with No Related Allowance
Domestic
Commercial	$	7,616	$	7,730	$	16,194	$	3
Commercial real estate: other construction & land development		1,957		2,205		2,151		—
Commercial real estate: farmland & commercial		3,509		4,031		36,632		—
Commercial real estate: multifamily		507		538		565		—
Residential: first lien		6,244		6,386		7,136		305
Residential: junior lien		901		911		976		44
Consumer		1,175		1,190		1,211		2
Foreign		293		293		327		14
Total impaired loans with no related allowance	$	22,202	$	23,284	$	65,192	$	368

The following tables detail key information regarding our impaired loans by loan class for the year ended December 31, 2017:


	December 31, 2017
			Unpaid				Average
	Recorded		Principal		Related		Recorded		Interest
	Investment		Balance		Allowance		Investment		Recognized
	(Dollars in Thousands)
Loans with Related Allowance
Domestic
Commercial real estate: other construction & land development	$	1,300	$	1,577	$	300		1,346		—
Commercial real estate: farmland & commercial		145		169		116		150		—
Commercial real estate: multifamily		449		590		18		489		—
Total impaired loans with related allowance	$	1,894	$	2,336	$	434	$	1,985	$	—


	December 31, 2017
			Unpaid		Average
	Recorded		Principal		Recorded		Interest
	Investment		Balance		Investment		Recognized
	(Dollars in Thousands)
Loans with No Related Allowance
Domestic
Commercial	$	16,646	$	44,095	$	19,615	$	3
Commercial real estate: other construction & land development		2,310		2,455		3,493		—
Commercial real estate: farmland & commercial		32,675		33,275		38,536		—
Commercial real estate: multifamily		476		505		511		—
Residential: first lien		6,852		6,968		7,249		324
Residential: junior lien		723		736		970		45
Consumer		1,281		1,283		1,293		3
Foreign		347		347		750		16
Total impaired loans with no related allowance	$	61,310	$	89,664	$	72,417	$	391

A portion of the impaired loans have adequate collateral and credit enhancements not requiring a related allowance for loan loss. Management is confident our loss exposure regarding these credits will be significantly reduced due to our long‑standing practices that emphasize secured lending with strong collateral positions and guarantor support. Management is likewise confident the reserve for probable loan losses is adequate.

Management recognizes the risks associated with these impaired loans. However, management's decision to place loans in this category does not necessarily mean that losses will occur. In the current environment, troubled loan management can be protracted because of the legal and process problems that delay the collection of an otherwise collectible loan. Additionally, management believes that the collateral related to these impaired loans and/or the secondary support from guarantors mitigates the potential for losses from impaired loans.

The following table details loans accounted for as “troubled debt restructuring,” segregated by loan class. Loans accounted for as troubled debt restructuring are included in impaired loans.


	December 31, 2018		December 31, 2017
		(Dollars in Thousands)
Domestic
Commercial	$	35	$	6,910
Commercial real estate: farmland & commercial		—		—
Residential: first lien		5,947		6,140
Residential: junior lien		730		712
Consumer		1,153		1,237
Foreign		293		347

Total troubled debt restructuring	$	8,158	$	15,346

The Subsidiary Banks charge-off that portion of any loan which management considers to represent a loss, as well as that portion of any other loan which is classified as a “loss” by bank examiners. Commercial and industrial or real estate loans are generally considered by management to represent a loss, in whole or part, when an exposure beyond any collateral coverage is apparent and when no further collection of the loss portion is anticipated based on the borrower’s financial condition and general economic conditions in the borrower’s industry. Generally, unsecured consumer loans are charged‑off when 90 days past due.

While management considers that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers carefully, there is no precise method of predicting loan losses. The determination that a loan is likely to be uncollectible and that it should be wholly or partially charged‑off as a loss is an exercise of judgment. Similarly, the determination of the adequacy of the allowance for probable loan losses can be made only on a subjective basis. It is the judgment of our management that the allowance for probable loan losses at December 31, 2018 and December 31, 2017, was adequate to absorb probable losses from loans in the portfolio at that date.

The following table presents information regarding the aging of past due loans by loan class:


	December 31, 2018
							90 Days or		Total
	30 - 59		60 - 89		90 Days or		greater &		Past				Total
	Days		Days		Greater		still accruing		Due		Current		Portfolio
	(Dollars in Thousands)
Domestic
Commercial	$	4,651	$	1,089	$	19,851	$	10,890	$	25,591	$	1,103,378	$	1,128,969
Commercial real estate: other construction & land development		727		1,707		922		16		3,356		1,882,875		1,886,231
Commercial real estate: farmland & commercial		2,928		784		27,239		24,910		30,951		1,918,947		1,949,898
Commercial real estate: multifamily		927		—		578		71		1,505		224,752		226,257
Residential: first lien		3,998		1,677		3,362		3,079		9,037		436,763		445,800
Residential: junior lien		1,155		618		1,108		937		2,881		724,420		727,301
Consumer		486		19		45		32		550		45,766		46,316
Foreign		1,106		117		739		739		1,962		148,555		150,517
Total past due loans	$	15,978	$	6,011	$	53,844	$	40,674	$	75,833	$	6,485,456	$	6,561,289


	December 31, 2017
							90 Days or		Total
	30 - 59		60 - 89		90 Days or		greater &		Past				Total
	Days		Days		Greater		still accruing		Due		Current		Portfolio
		(Dollars in Thousands)
Domestic
Commercial	$	3,790	$	398	$	18,308	$	537	$	22,496	$	1,063,971	$	1,086,467
Commercial real estate: other construction & land development		354		308		820		6		1,482		1,682,068		1,683,550
Commercial real estate: farmland & commercial		3,925		518		31,133		954		35,576		2,007,709		2,043,285
Commercial real estate: multifamily		84		—		476		—		560		192,356		192,916
Residential: first lien		4,295		2,458		4,095		3,861		10,848		421,929		432,777
Residential: junior lien		1,310		580		1,110		1,099		3,000		697,748		700,748
Consumer		868		98		160		133		1,126		48,417		49,543
Foreign		1,229		69		667		667		1,965		156,921		158,886
Total past due loans	$	15,855	$	4,429	$	56,769	$	7,257	$	77,053	$	6,271,119	$	6,348,172

The increase in the commercial real estate: farmland and commercial in the 90 days and greater category at December 31, 2018 compared to December 31, 2017 can be attributed to a relationship that is secured by multiple pieces of real property on which car dealerships are operated. The relationship remained on accrual since we had a court approved debtor in possession plan that provided that the sponsors of the plan would assume full responsibility for the plan, including accrued and unpaid interest. Our internal classified report is segregated into the following categories: (i) “Special Review Credits,” (ii) “Watch List—Pass Credits,” or (iii) “Watch List—Substandard Credits.” The loans placed in the “Special Review Credits” category reflect our opinion that the loans reflect potential weakness which require monitoring on a more frequent basis. The “Special Review Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List—Pass Credits” category reflect our opinion that the credit contains weaknesses which represent a greater degree of risk, which warrant “extra attention.” The “Watch List—Pass Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List—Substandard Credits” classification are considered to be potentially inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These credit obligations, even if apparently protected by collateral value, have shown defined weaknesses related to adverse financial, managerial, economic, market or political conditions which may jeopardize repayment of principal and interest. Furthermore, there is the possibility that we could sustain some future loss if such weaknesses are not corrected. For loans that are classified as impaired, management evaluates these credits in accordance with the provision of. ASC 310‑10, “Receivables,” and, if deemed necessary, a specific reserve is allocated to the credit. The specific reserve allocated under ASC 310‑10, is based on (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the loan’s observable market price; or (iii) the fair value of the collateral if the loan is collateral dependent. Substantially all of our loans evaluated as impaired under ASC 310‑10 are measured using the fair value of collateral method. In limited cases, we may use other methods to determine the specific reserve of a loan under ASC 310‑10 if such loan is not collateral dependent.

The allowance based on historical loss experience on our remaining loan portfolio, which includes the “Special Review Credits,” “Watch List—Pass Credits,” and “Watch List—Substandard Credits” is determined by segregating the remaining loan portfolio into certain categories such as commercial loans, installment loans, international loans, loan concentrations and overdrafts. Installment loans are then further segregated by number of days past due. A historical loss percentage, adjusted for (i) management’s evaluation of changes in lending policies and procedures, (ii) current economic conditions in the market area served, (iii) other risk factors, (iv) the effectiveness of the internal loan review function, (v) changes in loan portfolios, and (vi) the composition and concentration of credit volume is applied to each category. Each category is then added together to determine the allowance allocated under ASC 450‑20.

A summary of the loan portfolio by credit quality indicator by loan class is as follows:


			December 31, 2018
			Special		Watch		Watch List—		Watch List—
	Pass		Review		List—Pass		Substandard		Impaired
			(Dollars in Thousands)
Domestic
Commercial	$	998,625	$	441	$	44,544	$	76,180	$	9,179
Commercial real estate: other construction & land development		1,817,098		1,648		9,055		56,338		2,092
Commercial real estate: farmland & commercial		1,726,711		62,046		38,373		119,259		3,509
Commercial real estate: multifamily		224,823		—		—		927		507
Residential: first lien		438,773		—		142		641		6,244
Residential: junior lien		725,538		—		862		—		901
Consumer		45,141		—		—		—		1,175
Foreign		150,224		—		—		—		293
Total	$	6,126,933	$	64,135	$	92,976	$	253,345	$	23,900


			December 31, 2017
			Special		Watch		Watch List—		Watch List—
	Pass		Review		List—Pass		Substandard		Impaired
			(Dollars in Thousands)
Domestic
Commercial	$	905,707	$	—	$	3,170	$	159,643	$	17,947
Commercial real estate: other construction & land development		1,616,604		1,288		672		62,531		2,455
Commercial real estate: farmland & commercial		1,863,763		5,134		41,820		99,445		33,123
Commercial real estate: multifamily		192,440		—		—		—		476
Residential: first lien		425,811		40		—		74		6,852
Residential: junior lien		699,875		150		—		—		723
Consumer		48,262		—		—		—		1,281
Foreign		158,539		—		—		—		347
Total	$	5,911,001	$	6,612	$	45,662	$	321,693	$	63,204

The increase in special review credits in the commercial real estate: farmland and commercial for December 31, 2018 compared to December 31, 2017 can be attributed to a relationship secured by children’s learning centers reclassified from the Pass category. The increase in Watch-List Pass commercial credits can be attributed to the reclassification of a relationship in the oil and gas production business from Watch-List Substandard. The decrease in Watch-List Substandard for December 31, 2018 can be attributed to the payoff of a relationship secured by barges used in the transportation of petroleum products, the reclassification of a relationship secured by accounts receivable to Pass and the previously mentioned reclassification of the relationship in the oil and gas production business to Watch-List Pass. The increase in Watch-List Substandard commercial credits for December 31, 2018 can be attributed to a relationship secured by real property on which car dealerships are operated from the Pass category. The decrease in Watch-List Impaired credits in the commercial real estate: farmland and commercial at December 31, 2018 can be attributed to the foreclosure of a loan relationship primarily secured by a water park.