Allowance for Loan Losses

The allowance for loan losses is management’s best estimate of inherent risk of loss in the loan portfolio as of the balance sheet date. The allowance is increased by provisions charged to earnings and by recoveries of amounts previously charged off, and is reduced by charge-offs on loans. The Corporation uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the loan portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: (1) identification of loss allocations for individual loans deemed to be impaired, (2) loss allocation factors for non-impaired loans based on credit grade, historical loss experience, delinquency factors and other similar credit quality indicators, and (3) an unallocated allowance maintained for measurement imprecision and to reflect management’s consideration of other environmental factors.

Periodic assessments and revisions to the loss allocation factors used in the assignment of loss exposure are made to appropriately reflect the analysis of migrational loss experience. The Corporation analyzes historical loss experience in the various portfolios over periods deemed to be relevant to the inherent risk of loss in the respective portfolios as of the balance sheet date. The Corporation adjusts the loss allocations for various factors it believes are not adequately presented in historical loss experience, including trends in real estate values, trends in rental rates on commercial real estate, trends in unemployment rates in primary markets, consideration of general economic conditions, and our assessments of credit risk associated with certain industries and an ongoing trend toward larger credit relationships. These factors are also evaluated taking into account the geographic location of the underlying loans. Revisions to loss allocation factors are not retroactively applied.

Loss allocations for loans deemed to be impaired are measured on a discounted cash flow method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or, if the loan is collateral dependent, at the fair value of the collateral. For collateral dependent loans for which repayment is dependent on the sale of the collateral, management adjusts the fair value for estimated costs to sell. For collateral dependent loans for which repayment is dependent on the operation of the collateral, such as accruing troubled debt restructured loans, estimated costs to sell are not incorporated into the measurement. Management may also adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values for unobservable factors resulting from its knowledge of circumstances associated with the property.

Loss allocation factors are used for non-impaired loans based on credit grade, historical loss experience, delinquency factors and other similar credit quality indicators. Individual commercial loans and commercial mortgage loans not deemed to be impaired are evaluated using the internal rating system described in Note 5 under the caption “Credit Quality Indicators” and the application of loss allocation factors. The loan rating system and the related loss allocation factors take into consideration parameters including the borrower’s financial condition, the borrower’s performance with respect to loan terms, and the adequacy of collateral. Portfolios of more homogeneous populations of loans, including the various categories of residential mortgages and consumer loans, are analyzed as groups, taking into account delinquency status and historical loss experience and other qualitative environmental factors for each type of credit product.

An unallocated allowance is maintained to allow for measurement imprecision attributable to uncertainty in the economic environment and ever changing conditions and to reflect management’s consideration of qualitative and quantitative assessments of other environmental factors, including, but not limited to, conditions that may affect the collateral position such as environmental matters, regulatory changes affecting the foreclosure process, as well as conditions that may affect the ability of borrowers to meet debt service requirements.

Because the methodology is based upon historical experience and trends, current economic data as well as management’s judgment, factors may arise that result in different estimations. Significant factors that could give rise to changes in these estimates may include, but are not limited to, changes in economic conditions in our market area, concentration of risk and declines in local property values. Adversely different conditions or assumptions could lead to increases in the allowance. In addition, various regulatory agencies periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination.

The following tables present the activity in the allowance for loan losses for the three months ended June 30, 2014 and 2013, respectively:



	Commercial
(Dollars in thousands)	Mortgages			Construction		Other			Total Commercial			Residential			Consumer			Un-allocated			Total
Beginning Balance		$6,547			$269		$5,201			$12,017			$5,087			$2,565			$7,374			$27,043
Charge-offs	(32		)	—		(115		)	(147		)	(30		)	(90		)				(267		)
Recoveries	6			—		20			26			—			17						43
Provision	452			225		348			1,025			(217		)	77			(435		)	450
Ending Balance		$6,973			$494		$5,454			$12,921			$4,840			$2,569			$6,939			$27,269



	Commercial
(Dollars in thousands)	Mortgages			Construction		Other			Total Commercial			Residential			Consumer			Un-allocated			Total
Beginning Balance		$9,607			$246		$5,966			$15,819			$4,533			$2,489			$8,298			$31,139
Charge-offs	(4,000		)	—		(85		)	(4,085		)	(39		)	(51		)				(4,175		)
Recoveries	186			—		22			208			3			9						220
Provision	955			31		(461		)	525			194			8			(27		)	700
Ending Balance		$6,748			$277		$5,442			$12,467			$4,691			$2,455			$8,271			$27,884

The following tables present the activity in the allowance for loan losses for six months ended June 30, 2014 and 2013, respectively:



(Dollars in thousands)	Commercial
	Mortgages			Construction		Other			Total Commercial			Residential			Consumer			Un-allocated			Total
Beginning Balance		$6,969			$362		$5,433			$12,764			$4,700			$2,511			$7,911			$27,886
Charge-offs	(977		)	—		(311		)	(1,288		)	(72		)	(130		)				(1,490		)
Recoveries	12			—		46			58			35			30						123
Provision	969			132		286			1,387			177			158			(972		)	750
Ending Balance		$6,973			$494		$5,454			$12,921			$4,840			$2,569			$6,939			$27,269



(Dollars in thousands)	Commercial
	Mortgages			Construction		Other			Total Commercial			Residential			Consumer			Un-allocated			Total
Beginning Balance		$9,407			$224		$5,996			$15,627			$4,269			$2,684			$8,293			$30,873
Charge-offs	(4,114		)	—		(178		)	(4,292		)	(48		)	(209		)				(4,549		)
Recoveries	192			—		44			236			3			21						260
Provision	1,263			53		(420		)	896			467			(41		)	(22		)	1,300
Ending Balance		$6,748			$277		$5,442			$12,467			$4,691			$2,455			$8,271			$27,884

The following table presents the Corporation’s loan portfolio and associated allowance for loan loss by portfolio segment and by impairment methodology:



(Dollars in thousands)	June 30, 2014				December 31, 2013
	Loans		Related Allowance		Loans		Related Allowance
Loans Individually Evaluated for Impairment:
Commercial:
Mortgages		$24,893		$747		$30,292		$552
Construction & development	—		—		—		—
Other	2,585		324		2,556		463
Residential real estate	4,456		390		4,290		463
Consumer	291		64		355		3
Subtotal		$32,225		$1,525		$37,493		$1,481
Loans Collectively Evaluated for Impairment:
Commercial:
Mortgages		$747,879		$6,226		$765,957		$6,417
Construction & development	38,574		494		36,289		362
Other	552,239		5,130		528,241		4,970
Residential real estate	872,183		4,450		768,384		4,237
Consumer	338,024		2,505		326,520		2,508
Subtotal		$2,548,899		$18,805		$2,425,391		$18,494
Unallocated	—		6,939		—		7,911
Total		$2,581,124		$27,269		$2,462,884		$27,886