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 three months ended March 31, 2019 and 2018 (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 March 31, 2019 and December 31, 2018 (in thousands).



	Commercial and			Commercial			Residential									DDA
	Industrial			Real Estate			Real Estate			Home Equity			Consumer			Overdrafts			Total
Three months ended March 31, 2019
Allowance for loan losses
Beginning balance	$	4,060		$	4,495		$	4,116		$	1,268		$	319		$	1,708		$	15,966
Charge-offs	—			(45		)	(328		)	(46		)	(185		)	(625		)	(1,229		)
Recoveries	135			32			75			—			97			419			758
(Recovery of) provision	(1,225		)	158			(43		)	26			237			(2		)	(849		)
Ending balance	$	2,970		$	4,640		$	3,820		$	1,248		$	468		$	1,500		$	14,646

Three months ended March 31, 2018
Allowance for loan losses
Beginning balance	$	4,571		$	6,183		$	5,212		$	1,138		$	62		$	1,670		$	18,836
Charge-offs	(339		)	(157		)	(131		)	(71		)	(99		)	(636		)	(1,433		)
Recoveries	2			223			106			—			46			420			797
(Recovery of) provision	529			(480		)	(244		)	133			203			40			181
Ending balance	$	4,763		$	5,769		$	4,943		$	1,200		$	212		$	1,494		$	18,381

As of March 31, 2019
Allowance for loan losses
Evaluated for impairment:
Individually	$	—		$	503		$	—		$	—		$	—		$	—		$	503
Collectively	2,969			4,085			3,820			1,248			461			1,500			14,083
Acquired with deteriorated credit quality	1			52			—			—			7			—			60
Total	$	2,970		$	4,640		$	3,820		$	1,248		$	468		$	1,500		$	14,646

Loans
Evaluated for impairment:
Individually	$	617		$	9,354		$	—		$	—		$	—		$	—		$	9,971
Collectively	287,172			1,415,938			1,623,550			152,251			52,370			3,424			3,534,705
Acquired with deteriorated credit quality	1,538			10,898			2,097			—			113			—			14,646
Total	$	289,327		$	1,436,190		$	1,625,647		$	152,251		$	52,483		$	3,424		$	3,559,322

As of December 31, 2018
Allowance for loan losses
Evaluated for impairment:
Individually	$	—		$	428		$	—		$	—		$	—		$	—		$	428
Collectively	4,059			4,015			4,116			1,268			312			1,708			15,478
Acquired with deteriorated credit quality	1			52			—			—			7			—			60
Total	$	4,060		$	4,495		$	4,116		$	1,268		$	319		$	1,708		$	15,966

Loans
Evaluated for impairment:
Individually	$	651		$	9,855		$	—		$	—		$	—		$	—		$	10,506
Collectively	284,018			1,433,674			1,633,241			153,496			51,077			6,328			3,561,834
Acquired with deteriorated credit quality	1,645			11,413			2,097			—			113			—			15,268
Total	$	286,314		$	1,454,942		$	1,635,338		$	153,496		$	51,190		$	6,328		$	3,587,608

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: Exceptional, Good, Acceptable, Pass/Watch, 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
March 31, 2019
Pass	$	258,096	$	1,380,744	$	1,638,840
Special mention	25,457		10,242		35,699
Substandard	5,774		45,204		50,978
Doubtful	—		—		—
Total	$	289,327	$	1,436,190	$	1,725,517

December 31, 2018
Pass	$	250,856	$	1,402,821	$	1,653,677
Special mention	27,886		5,696		33,582
Substandard	7,572		46,425		53,997
Doubtful	—		—		—
Total	$	286,314	$	1,454,942	$	1,741,256

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



	Performing		Non-Performing		Total
March 31, 2019
Residential real estate	$	1,622,370	$	3,277	$	1,625,647
Home equity	152,208		43		152,251
Consumer	52,429		54		52,483
DDA overdrafts	3,424		—		3,424
Total	$	1,830,431	$	3,374	$	1,833,805

December 31, 2018
Residential real estate	$	1,630,892	$	4,446	$	1,635,338
Home equity	153,334		162		153,496
Consumer	51,188		2		51,190
DDA overdrafts	6,322		6		6,328
Total	$	1,841,736	$	4,616	$	1,846,352

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):



	March 31, 2019
	Accruing
	Current		30-59 days		60-89 days		Over 90 days		Non-accrual		Total
Residential real estate	$	1,614,413	$	7,245	$	713	$	13	$	3,263	$	1,625,647
Home equity	151,489		551		167		3		41		152,251
Commercial and industrial	287,700		101		—		—		1,526		289,327
Commercial real estate	1,427,494		1,377		—		37		7,282		1,436,190
Consumer	52,218		129		82		53		1		52,483
DDA overdrafts	2,889		533		2		—		—		3,424
Total	$	3,536,203	$	9,936	$	964	$	106	$	12,113	$	3,559,322

	December 31, 2018
	Accruing
	Current		30-59 days		60-89 days		Over 90 days		Non-accrual		Total
Residential real estate	$	1,621,073	$	8,607	$	1,213	$	170	$	4,275	$	1,635,338
Home equity	152,083		1,240		11		24		138		153,496
Commercial and industrial	284,140		397		49		52		1,676		286,314
Commercial real estate	1,445,896		487		94		4		8,461		1,454,942
Consumer	50,894		253		41		1		1		51,190
DDA overdrafts	5,840		467		15		6		—		6,328
Total	$	3,559,926	$	11,451	$	1,423	$	257	$	14,551	$	3,587,608

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.



	March 31, 2019						December 31, 2018
			Unpaid						Unpaid
	Recorded		Principal		Related		Recorded		Principal		Related
	Investment		Balance		Allowance		Investment		Balance		Allowance
With no related allowance recorded:
Commercial and industrial	$	617	$	617	$	—	$	651	$	651	$	—
Commercial real estate	6,369		6,394		—		6,870		6,895		—
Total	$	6,986	$	7,011	$	—	$	7,521	$	7,546	$	—

With an allowance recorded:
Commercial and industrial	$	—	$	—	$	—	$	—	$	—	$	—
Commercial real estate	2,985		2,985		503		2,985		2,985		428
Total	$	2,985	$	2,985	$	503	$	2,985	$	2,985	$	428

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):



	Three months ended March 31,
	2019				2018
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized
With no related allowance recorded:
Commercial and industrial	$	618	—		$	774	$	—
Commercial real estate	6,521		36		3,008		3
Total	$	7,139	$	36	$	3,782	$	3

With an allowance recorded:
Commercial and industrial	$	—	$	—	$	—	$	—
Commercial real estate	2,985		30		5,750		52
Total	$	2,985	$	30	$	5,750	$	52

Approximately $0.1 million of interest income would have been recognized during the three months ended March 31, 2019 and 2018, 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 March 31, 2019.

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):



	March 31, 2019						December 31, 2018
			Non-						Non-
	Accruing		Accruing		Total		Accruing		Accruing		Total
Commercial and industrial	$	89	$	—	$	89	$	98	$	—	$	98
Commercial real estate	8,164		—		8,164		8,205		—		8,205
Residential real estate	23,017		464		23,481		22,863		658		23,521
Home equity	3,013		5		3,018		3,025		5		3,030
Consumer	—		—		—		—		—		—
Total	$	34,283	$	469	$	34,752	$	34,191	$	663	$	34,854



	New TDRs
	Three months ended March 31,
	2019					2018
		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	23	1,729		1,729		7	412		412
Home equity	5	69		69		4	77		77
Consumer	—	—		—		—	—		—
Total	28	$	1,798	$	1,798	11	$	489	$	489