Allowance for Loan Losses

The allowance for loan losses is management’s best estimate of the 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.

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 three months ended March 31, 2015:



(Dollars in thousands)	Commercial
	Mortgages			Construction			C&I (1)			Total Commercial			Residential			Consumer			Un-allocated			Total
Beginning Balance		$8,202			$1,300			$7,987			$17,489			$5,430			$2,713			$2,391			$28,023
Charge-offs	(200		)	—			(7		)	(207		)	(48		)	(66		)	—			(321		)
Recoveries	80			—			14			94			2			12			—			108
Provision	249			(71		)	(191		)	(13		)	(29		)	72			(30		)	—
Ending Balance		$8,331			$1,229			$7,803			$17,363			$5,355			$2,731			$2,361			$27,810

(1) Commercial & industrial loans.

The following table presents the activity in the allowance for loan losses for three months ended March 31, 2014. Prior to December 31, 2014, the unallocated allowance included amounts for management’s qualitative and quantitative assessment of certain other loan portfolio risks not captured in other components of the allowance. The 2014 presentation of the allowance for loan losses by portfolio segment, set forth below, has been revised to conform to the December 31, 2014 presentation format. The reclassification resulted in a reduction of $5.3 million in the unallocated allowance previously reported as of March 31, 2014, with a corresponding increase to the allowance by portfolio segment. The reclassification resulted in no change in the total allowance.



(Dollars in thousands)	Commercial
	Mortgages			Construction			C&I (1)			Total Commercial			Residential			Consumer			Un-allocated			Total
Beginning Balance		$8,022			$383			$7,835			$16,240			$6,450			$2,511			$2,685			$27,886
Charge-offs	(945		)	—			(196		)	(1,141		)	(42		)	(40		)	—			(1,223		)
Recoveries	6			—			26			32			35			13			—			80
Provision	(536		)	(114		)	805			155			705			93			(653		)	300
Ending Balance		$6,547			$269			$8,470			$15,286			$7,148			$2,577			$2,032			$27,043

(1) Commercial & industrial loans.

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)	March 31, 2015				December 31, 2014
	Loans		Related Allowance		Loans		Related Allowance
Loans Individually Evaluated for Impairment:
Commercial:
Mortgages		$14,563		$1,173		$14,991		$927
Construction & development	—		—		—		—
Commercial & industrial	3,074		185		2,921		177
Residential real estate	2,912		222		3,698		326
Consumer	467		77		409		153
Subtotal		$21,016		$1,657		$22,019		$1,583
Loans Collectively Evaluated for Impairment:
Commercial:
Mortgages		$850,479		$7,158		$828,987		$7,275
Construction & development	89,851		1,229		79,592		1,300
Commercial & industrial	601,556		7,618		608,997		7,810
Residential real estate	984,652		5,133		981,717		5,104
Consumer	333,038		2,654		337,964		2,560
Subtotal		$2,859,576		$23,792		$2,837,257		$24,049
Unallocated	—		2,361		—		2,391
Total		$2,880,592		$27,810		$2,859,276		$28,023