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) application of loss allocation factors for non-impaired loans based on credit grade, historical loss experience, estimated loss emergence period and delinquency status, with adjustments for various exposures not adequately presented in historical loss experience, and (3) an unallocated allowance maintained for measurement imprecision associated with impaired and nonaccrual loans. Prior to December 31, 2014, the unallocated allowance also included amounts for management’s qualitative and quantitative assessment of certain other loan portfolio risks not captured in other components of the allowance. The presentation of the allowance for loan losses and related activity by portfolio segment, set forth below, has been revised to conform to the 2014 presentation of the unallocated allowance. This reclassification to the appropriate loan portfolios resulted in reductions of $5.2 million and $5.5 million, respectively, in the unallocated allowance previously reported as of December 31, 2013 and 2012.

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.

Individual commercial loans not deemed to be impaired are evaluated using an internal rating system and the application of loss allocation factors. The loan rating system is described under the caption “Credit Quality Indicators” in Note 5. 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, the adequacy of collateral and the adequacy of guarantees. We periodically reassess and revise the loss allocation factors used in the assignment of loss exposure to appropriately reflect our analysis of migrational loss experience. Revisions to loss allocation factors are not retroactively applied. We analyze historical loss experience over periods deemed to be relevant to the inherent risk of loss in the commercial loan portfolio and the related estimate of the loss emergence period as of the balance sheet date. We also adjust loss factor allocations for various exposures we believe are not adequately presented in historical loss experience, including our assessments of credit risk associated with certain industries, an ongoing trend toward larger credit relationships, recent changes in portfolio composition, conditions that may affect the ability of borrowers to meet debt service requirements, trends in rental rates on commercial real estate and conditions that may affect the collateral position, such as environmental matters.

Portfolios of more homogeneous populations of loans, including the various categories of residential mortgages and consumer loans are analyzed as groups, with loss allocation factors assigned to each group based on account delinquency status. We periodically reassess and revise the loss allocation factors. Revisions to loss allocation factors are not retroactively applied. We analyze historical loss experience over periods deemed to be relevant to the inherent risk of loss in residential mortgage and consumer loan portfolios and the related estimate of the loss emergence period as of the balance sheet date. We also adjust loss factor allocations for various exposures we believe are not adequately presented in historical loss experience including trends in real estate values, consideration of general economic conditions, increases in delinquency levels and regulatory changes affecting the foreclosure process. These matters are also evaluated taking into account the geographic location of the underlying loans.

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 table presents the activity in the allowance for loan losses for the year ended December 31, 2014:



(Dollars in thousands)	Commercial
	Mortgages			Construction		C&I (1)			Total Commercial			Residential			Consumer			Unallocated			Total
Beginning Balance		$8,022			$383		$7,835			$16,240			$6,450			$2,511			$2,685			$27,886
Charge-offs	(977		)	—		(558		)	(1,535		)	(132		)	(282		)	—			(1,949		)
Recoveries	24			—		86			110			51			75			—			236
Provision	1,133			917		624			2,674			(939		)	409			(294		)	1,850
Ending Balance		$8,202			$1,300		$7,987			$17,489			$5,430			$2,713			$2,391			$28,023


(1)	Commercial & industrial loans.

The following table presents the activity in the allowance for loan losses for the year ended December 31, 2013:



(Dollars in thousands)	Commercial
	Mortgages			Construction		C&I (1)			Total Commercial			Residential			Consumer			Unallocated			Total
Beginning Balance		$9,817			$224		$8,934			$18,975			$6,428			$2,684			$2,786			$30,873
Charge-offs	(5,213		)	—		(358		)	(5,571		)	(128		)	(323		)	—			(6,022		)
Recoveries	380			—		153			533			3			99			—			635
Provision	3,038			159		(894		)	2,303			147			51			(101		)	2,400
Ending Balance		$8,022			$383		$7,835			$16,240			$6,450			$2,511			$2,685			$27,886


(1)	Commercial & industrial loans.

The following table presents the activity in the allowance for loan losses for the year ended December 31, 2012:



(Dollars in thousands)	Commercial
	Mortgages			Construction		C&I (1)			Total Commercial			Residential			Consumer			Unallocated			Total
Beginning Balance		$8,580			$95		$8,709			$17,384			$6,867			$2,452			$3,099			$29,802
Charge-offs	(485		)	—		(1,179		)	(1,664		)	(367		)	(304		)	—			(2,335		)
Recoveries	442			—		103			545			110			51			—			706
Provision	1,280			129		1,301			2,710			(182		)	485			(313		)	2,700
Ending Balance		$9,817			$224		$8,934			$18,975			$6,428			$2,684			$2,786			$30,873


(1)	Commercial & industrial loans.

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



(Dollars in thousands)	December 31, 2014				December 31, 2013
			Related Allowance				Related Allowance
	Loans				Loans
Loans Individually Evaluated For Impairment:
Commercial:
Mortgages		$14,991		$927		$30,292		$552
Construction & development	—		—		—		—
Commercial & industrial	2,921		177		2,556		463
Residential Real Estate	3,698		326		4,290		463
Consumer	409		153		355		3
Subtotal	22,019		1,583		37,493		1,481
Loans Collectively Evaluated For Impairment:
Commercial:
Mortgages	828,987		7,275		765,957		7,470
Construction & development	79,592		1,300		36,289		383
Commercial & industrial	608,997		7,810		528,241		7,372
Residential Real Estate	981,717		5,104		768,384		5,987
Consumer	337,964		2,560		326,520		2,508
Subtotal	2,837,257		24,049		2,425,391		23,720
Unallocated	—		2,391		—		2,685
Total		$2,859,276		$28,023		$2,462,884		$27,886