Allowance For Loan Losses

Management systematically monitors the loan portfolio and the adequacy of the allowance for loan losses on a quarterly basis to provide for probable losses inherent in the portfolio. Management assesses the risk in each loan type based on historical trends, the general economic environment of its local markets, individual loan performance and other relevant factors.

Individual credits are selected throughout the year for detailed loan reviews, which are utilized by management to assess the risk in the portfolio and the adequacy of the allowance. Due to the nature of commercial lending, evaluation of the adequacy of the allowance as it relates to these loan types is often based more upon specific credit reviews, with consideration given to the potential impairment of certain credits and historical loss rates, adjusted for economic conditions and other inherent risk factors.

The following table summarizes the activity in the allowance for loan losses, by portfolio loan classification, for the nine months ended September 30, 2018 and 2017 (in thousands). The allocation of a portion of the allowance in one portfolio segment does not preclude its availability to absorb losses in other portfolio segments. The following table also presents the balance in the allowance for loan loss disaggregated on the basis of the Company’s impairment measurement method and the related recorded investment in loans, by portfolio segment, as of September 30, 2018 and December 31, 2017 (in thousands).



	Commercial and			Commercial			Residential									DDA
	Industrial			Real Estate			Real Estate			Home Equity			Consumer			Overdrafts			Total
Nine months ended September 30, 2018
Allowance for loan losses
Beginning balance	$	4,571		$	6,183		$	5,212		$	1,138		$	62		$	1,670		$	18,836
Charge-offs	(724		)	(349		)	(464		)	(219		)	(560		)	(1,976		)	(4,292		)
Recoveries	1,625			538			275			—			130			1,109			3,677
(Recovery of) provision	(1,583		)	(1,775		)	(557		)	385			709			911			(1,910		)
Ending balance	$	3,889		$	4,597		$	4,466		$	1,304		$	341		$	1,714		$	16,311

Nine months ended September 30, 2017
Allowance for loan losses
Beginning balance	$	4,206		$	6,573		$	6,680		$	1,417		$	82		$	772		$	19,730
Charge-offs	(150		)	(564		)	(1,295		)	(256		)	(47		)	(1,989		)	(4,301		)
Recoveries	57			92			286			45			46			1,015			1,541
(Recovery of) provision	946			205			218			68			(25		)	1,172			2,584
Ending balance	$	5,059		$	6,306		$	5,889		$	1,274		$	56		$	970		$	19,554

As of September 30, 2018
Allowance for loan losses
Evaluated for impairment:
Individually	$	—		$	355		$	—		$	—		$	—		$	—		$	355
Collectively	3,885			4,189			4,466			1,304			334			1,714			15,892
Acquired with deteriorated credit quality	4			53			—			—			7			—			64
Total	$	3,889		$	4,597		$	4,466		$	1,304		$	341		$	1,714		$	16,311

Loans
Evaluated for impairment:
Individually	$	656		$	9,894		$	—		$	—		$	—		$	—		$	10,550
Collectively	212,959			1,252,989			1,483,829			143,540			31,754			3,598			3,128,669
Acquired with deteriorated credit quality	200			5,169			1,994			—			115			—			7,478
Total	$	213,815		$	1,268,052		$	1,485,823		$	143,540		$	31,869		$	3,598		$	3,146,697

As of December 31, 2017
Allowance for loan losses
Evaluated for impairment:
Individually	$	—		$	647		$	—		$	—		$	—		$	—		$	647
Collectively	4,567			5,313			5,112			1,138			58			1,670			17,858
Acquired with deteriorated credit quality	4			223			100			—			4			—			331
Total	$	4,571		$	6,183		$	5,212		$	1,138		$	62		$	1,670		$	18,836

Loans
Evaluated for impairment:
Individually	$	849		$	8,818		$	—		$	—		$	—		$	—		$	9,667
Collectively	207,429			1,263,076			1,465,685			139,499			29,046			4,411			3,109,146
Acquired with deteriorated credit quality	206			5,682			2,593			—			116			—			8,597
Total	$	208,484		$	1,277,576		$	1,468,278		$	139,499		$	29,162		$	4,411		$	3,127,410

Credit Quality Indicators

All commercial loans within the portfolio are subject to internal risk rating. All non-commercial loans are evaluated based on payment history. The Company’s internal risk ratings for commercial loans are: Pass, Special Mention, Substandard and Doubtful. Each internal risk rating is defined in the loan policy using the following criteria: balance sheet yields; ratios and leverage; cash flow spread and coverage; prior history; capability of management; market position/industry; potential impact of changing economic, legal, regulatory or environmental conditions; purpose; structure; collateral support; and guarantor support. Risk grades are generally assigned by the primary lending officer and are periodically evaluated by the Company’s internal loan review process. Based on an individual loan’s risk grade, estimated loss percentages are applied to the outstanding balance of the loan to determine the amount of probable loss.

The Company categorizes loans into risk categories based on relevant information regarding the customer’s debt service ability, capacity, overall collateral position along with other economic trends, and historical payment performance. The risk rating for each credit is updated when the Company receives current financial information, the loan is reviewed by the Company’s internal loan review and credit administration departments, or the loan becomes delinquent or impaired. The risk grades are updated a minimum of annually for loans rated exceptional, good, acceptable, or pass/watch. Loans rated special mention, substandard or doubtful are reviewed at least quarterly. The Company uses the following definitions for its risk ratings:



Risk Rating	Description
Pass ratings:
(a) Exceptional	Loans classified as exceptional are secured with liquid collateral conforming to the internal loan policy. Loans rated within this category pose minimal risk of loss to the bank.
(b) Good	Loans classified as good have similar characteristics that include a strong balance sheet, satisfactory debt service coverage ratios, strong management and/or guarantors, and little exposure to economic cycles. Loans in this category generally have a low chance of loss to the bank.
(c) Acceptable	Loans classified as acceptable have acceptable liquidity levels, adequate debt service coverage ratios, experienced management, and have average exposure to economic cycles. Loans within this category generally have a low risk of loss to the bank.
(d) Pass/watch	Loans classified as pass/watch have erratic levels of leverage and/or liquidity, cash flow is volatile and the borrower is subject to moderate economic risk. A borrower in this category poses a low to moderate risk of loss to the bank.
Special mention	Loans classified as special mention have a potential weakness(es) that deserves management’s close attention. The potential weakness could result in deterioration of the loan repayment or the bank’s credit position at some future date. A loan rated in this category poses a moderate loss risk to the bank.
Substandard	Loans classified as substandard reflect a customer with a well defined weakness that jeopardizes the liquidation of the debt. Loans in this category have the possibility that the bank will sustain some loss if the deficiencies are not corrected and the bank’s collateral value is weakened by the financial deterioration of the borrower.
Doubtful	Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristics that make collection of the full contract amount highly improbable. Loans rated in this category are most likely to cause the bank to have a loss due to a collateral shortfall or a negative capital position.

The following table presents the Company’s commercial loans by credit quality indicators, by portfolio loan classification (in thousands):



	Commercial and Industrial		Commercial Real Estate		Total
September 30, 2018
Pass	$	182,275	$	1,228,716	$	1,410,991
Special mention	26,345		7,421		33,766
Substandard	5,195		31,915		37,110
Doubtful	—		—		—
Total	$	213,815	$	1,268,052	$	1,481,867

December 31, 2017
Pass	$	175,951	$	1,231,256	$	1,407,207
Special mention	25,872		8,068		33,940
Substandard	6,661		38,252		44,913
Doubtful	—		—		—
Total	$	208,484	$	1,277,576	$	1,486,060

The following table presents the Company's non-commercial loans by payment performance, by portfolio loan classification (in thousands):



	Performing		Non-Performing		Total
September 30, 2018
Residential real estate	$	1,482,771	$	3,052	$	1,485,823
Home equity	143,531		9		143,540
Consumer	31,869		—		31,869
DDA overdrafts	3,598		—		3,598
Total	$	1,661,769	$	3,061	$	1,664,830

December 31, 2017
Residential real estate	$	1,465,445	$	2,833	$	1,468,278
Home equity	139,239		260		139,499
Consumer	29,162		—		29,162
DDA overdrafts	4,411		—		4,411
Total	$	1,638,257	$	3,093	$	1,641,350

Aging Analysis of Accruing and Non-Accruing Loans

Interest income on loans is accrued and credited to operations based upon the principal amount outstanding, using methods that generally result in level rates of return. Loan origination fees, and certain direct costs, are deferred and amortized as an adjustment to the yield over the term of the loan. The accrual of interest generally is discontinued when a loan becomes 90 days past due as to principal or interest for all loan types. However, any loan may be placed on non-accrual status if the Company receives information that indicates a borrower is unable to meet the contractual terms of its respective loan agreement. Other indicators considered for placing a loan on non-accrual status include the borrower’s involvement in bankruptcies, foreclosures, repossessions, litigation and any other situation resulting in doubt as to whether full collection of contractual principal and interest is attainable. When interest accruals are discontinued, unpaid interest recognized in income in the current year is reversed, and interest accrued in prior years is charged to the allowance for loan losses. Management may elect to continue the accrual of interest when the net realizable value of collateral exceeds the principal balance and related accrued interest, and the loan is in the process of collection.

Generally for all loan classes, interest income during the period the loan is non-performing is recorded on a cash basis after recovery of principal is reasonably assured. Cash payments received on nonperforming loans are typically applied directly against the outstanding principal balance until the loan is fully repaid. Generally, loans are restored to accrual status when the obligation is brought current, the borrower has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

Generally, all loan types are considered past due when the contractual terms of a loan are not met and the borrower is 30 days or more past due on a payment. Furthermore, residential and home equity loans are generally subject to charge-off when the loan becomes 120 days past due, depending on the estimated fair value of the collateral less cost to dispose, versus the outstanding loan balance. Commercial loans are generally charged off when the loan becomes 120 days past due. Open-end consumer loans are generally charged off when the loan becomes 180 days past due.

The following table presents an aging analysis of the Company’s accruing and non-accrual loans, by portfolio loan classification (in thousands):



	September 30, 2018
	Accruing
	Current		30-59 days		60-89 days		Over 90 days		Non-accrual		Total
Residential real estate	$	1,478,137	$	3,841	$	793	$	23	$	3,029	$	1,485,823
Home equity	143,072		407		52		9		—		143,540
Commercial and industrial	212,810		187		—		—		818		213,815
Commercial real estate	1,259,519		934		—		—		7,599		1,268,052
Consumer	31,829		38		1		—		1		31,869
DDA overdrafts	3,016		570		9		3		—		3,598
Total	$	3,128,383	$	5,977	$	855	$	35	$	11,447	$	3,146,697

	December 31, 2017
	Accruing
	Current		30-59 days		60-89 days		Over 90 days		Non-accrual		Total
Residential real estate	$	1,458,746	$	5,990	$	709	$	19	$	2,814	$	1,468,278
Home equity	138,480		671		88		92		168		139,499
Commercial and industrial	206,447		549		1		142		1,345		208,484
Commercial real estate	1,269,520		1,841		245		—		5,970		1,277,576
Consumer	29,108		39		13		2		—		29,162
DDA overdrafts	3,849		541		14		7		—		4,411
Total	$	3,106,150	$	9,631	$	1,070	$	262	$	10,297	$	3,127,410

The following table presents the Company’s impaired loans, by class (in thousands). The difference between the unpaid principal balance and the recorded investment generally reflects amounts that have been previously charged-off. There are no impaired residential, home equity, or consumer loans.



	September 30, 2018						December 31, 2017
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
	Investment		Balance		Allowance		Investment		Balance		Allowance
With no related allowance recorded:
Commercial and industrial	$	656	$	656	$	—	$	849	$	3,013	$	—
Commercial real estate	4,185		4,210		—		3,036		4,861		—
Total	$	4,841	$	4,866	$	—	$	3,885	$	7,874	$	—

With an allowance recorded:
Commercial and industrial	$	—	$	—	$	—	$	—	$	—	$	—
Commercial real estate	5,709		5,709		356		5,782		5,782		647
Total	$	5,709	$	5,709	$	356	$	5,782	$	5,782	$	647

The following table presents information related to the average recorded investment and interest income recognized on the Company’s impaired loans, by class (in thousands):



	Nine months ended September 30,
	2018				2017
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
With no related allowance recorded:
Commercial and industrial	$	910	—		$	1,165	$	—
Commercial real estate	3,873		7		5,035		64
Total	$	4,783	$	7	$	6,200	$	64

With an allowance recorded:
Commercial and industrial	$	—	$	—	$	—	$	—
Commercial real estate	5,730		179		3,821		83
Total	$	5,730	$	179	$	3,821	$	83

Approximately $0.2 million of interest income would have been recognized during the nine months ended September 30, 2018 and 2017, respectively, if such loans had been current in accordance with their original terms. There were no commitments to provide additional funds on non-accrual, impaired or other potential problem loans at September 30, 2018.

Loan Modifications

The Company’s policy on loan modifications typically does not allow for modifications that would be considered a concession from the Company. However, when there is a modification, the Company evaluates each modification to determine if the modification constitutes a troubled debt restructuring (“TDR”) in accordance with ASU 2011-02, whereby a modification of a loan would be considered a TDR when both of the following conditions are met: (1) a borrower is experiencing financial difficulty and (2) the modification constitutes a concession. When determining whether the borrower is experiencing financial difficulties, the Company reviews whether the borrower is currently in payment default on any of its debt or whether it is probable that the borrower would be in payment default in the foreseeable future without the modification. Other indicators of financial difficulty include whether the borrower has declared or is in the process of declaring bankruptcy, the borrower’s ability to continue as a going concern, and the borrower’s projected cash flow to service its debt (including principal and interest) in accordance with the contractual terms for the foreseeable future, without a modification.

Regulatory guidance requires loans to be accounted for as collateral-dependent loans when borrowers have filed Chapter 7 bankruptcy, the debt has been discharged by the bankruptcy court, and the borrower has not reaffirmed the debt. The filing of bankruptcy is deemed to be evidence that the borrower is in financial difficulty and the discharge of the debt by the bankruptcy court is deemed to be a concession granted to the borrower.

The following tables set forth the Company’s TDRs (in thousands):



	September 30, 2018						December 31, 2017
			Non-						Non-
	Accruing		Accruing		Total		Accruing		Accruing		Total
Commercial and industrial	$	108	$	—	$	108	$	135	$	—	$	135
Commercial real estate	8,231		—		8,231		8,381		—		8,381
Residential real estate	20,414		175		20,589		21,005		84		21,089
Home equity	2,941		—		2,941		3,047		50		3,097
Consumer	—		—		—		—		—		—
Total	$	31,694	$	175	$	31,869	$	32,568	$	134	$	32,702



	New TDRs
	Nine months ended September 30,
	2018					2017
		Pre		Post			Pre		Post
		Modification		Modification			Modification		Modification
		Outstanding		Outstanding			Outstanding		Outstanding
	Number of	Recorded		Recorded		Number of	Recorded		Recorded
	Contracts	Investment		Investment		Contracts	Investment		Investment
Commercial and industrial	—	$	—	$	—	—	$	—	$	—
Commercial real estate	—	—		—		—	—		—
Residential real estate	22	1,465		1,465		27	3,009		3,009
Home equity	9	200		200		7	145		145
Consumer	—	—		—		—	—		—
Total	31	$	1,665	$	1,665	34	$	3,154	$	3,154