Credit Quality of Loans and Allowance for Loan Losses

The loan portfolio consisted of the following (in thousands):



	March 31, 2017			December 31, 2016
Commercial, financial and agricultural	$	469,815		$	459,574
Real estate – construction	100,248			100,959
Real estate – commercial	464,859			481,155
Real estate – residential	159,426			157,872
Installment loans to individuals	75,258			82,660
Lease financing receivable	969			1,095
Other	1,425			767
	1,272,000			1,284,082
Less allowance for loan losses	(24,578		)	(24,372		)
	$	1,247,422		$	1,259,710

The Company monitors loan concentrations and evaluates individual customer and aggregate industry leverage, profitability, risk rating distributions, and liquidity for each major standard industry classification segment. At March 31, 2017, one industry segment concentration, the oil and gas industry, constituted more than 10% of the loan portfolio. The Company’s exposure in the oil and gas industry, including related service and manufacturing industries, totaled approximately $231.8 million, or 18.2% of total loans. Additionally, the Company’s exposure to loans secured by commercial real estate is monitored. At March 31, 2017, loans secured by commercial real estate (including commercial construction, farmland and multifamily loans) totaled approximately $539.9 million, 48% of which are secured by owner-occupied commercial properties. Of the $539.9 million in loans secured by commercial real estate, $20.6 million, or 3.8%, were on nonaccrual status at March 31, 2017.

Allowance for Loan Losses

The allowance for loan losses is a valuation account available to absorb probable losses on loans. All losses are charged to the allowance for loan losses when the loss actually occurs or when a determination is made that a loss is likely to occur. Recoveries are credited to the allowance for loan losses at the time of recovery. Quarterly, the probable level of losses in the existing portfolio is estimated through consideration of various factors. Based on these estimates, the allowance for loan losses is increased by charges to earnings and decreased by charge‑offs (net of recoveries).

The allowance is composed of general reserves and specific reserves. General reserves are determined by applying loss percentages to segments of the portfolio. The loss percentages are based on each segment’s historical loss experience, generally over the past twelve to eighteen months, and adjustment factors derived from conditions in the Company’s internal and external environment. All loans considered to be impaired are evaluated on an individual basis to determine specific reserve allocations in accordance with GAAP. Loans for which specific reserves are provided are excluded from the calculation of general reserves.

Loans acquired in business combinations are initially recorded at fair value, which includes an estimate of credit losses expected to be realized over the remaining lives of the loans, and therefore no corresponding allowance for loan losses is recorded for these loans at acquisition. Methods utilized to estimate any subsequently required allowance for loan losses for acquired loans not deemed credit-impaired at acquisition are similar to originated loans; however, the estimate of loss is based on the unpaid principal balance and then compared to any remaining unaccreted purchase discount. To the extent that the calculated loss is greater than the remaining unaccreted purchase discount, an allowance is recorded for such difference.

The Company has an internal loan review department that is independent of the lending function to challenge and corroborate the loan grade assigned by the lender and to provide additional analysis in determining the adequacy of the allowance for loan losses.

A rollforward of the activity within the allowance for loan losses by loan type and recorded investment in loans for the three months ended March 31, 2017 and 2016 is as follows (in thousands):



	March 31, 2017
				Real Estate
	Coml, Fin, and Agric			Construction			Commercial			Residential			Installment loans to individuals			Lease financing receivable			Other		Total
Allowance for loan losses:
Beginning balance	$	16,057		$	585		$	5,384		$	940		$	1,395		$	5		$	6	$	24,372
Charge-offs	(1,705		)	—			(823		)	(117		)	(261		)	—			—		(2,906		)
Recoveries	154			—			10			90			58			—			—		312
Provision	3,832			(321		)	(238		)	(249		)	(222		)	(2		)	—		2,800
Ending balance	$	18,338		$	264		$	4,333		$	664		$	970		$	3		$	6	$	24,578
Ending balance: individually evaluated for impairment	$	4,173		$	9		$	1,656		$	217		$	160		$	—		$	—	$	6,215
Ending balance: collectively evaluated for impairment	$	14,165		$	255		$	2,677		$	447		$	810		$	3		$	6	$	18,363

Loans:
Ending balance	$	469,815		$	100,248		$	464,859		$	159,426		$	75,258		$	969		$	1,425	$	1,272,000
Ending balance: individually evaluated for impairment	$	35,346		$	26		$	20,623		$	1,956		$	487		$	—		$	—	$	58,438
Ending balance: collectively evaluated for impairment	$	434,469		$	100,222		$	443,802		$	157,401		$	74,771		$	969		$	1,425	$	1,213,059
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	434		$	69		$	—		$	—		$	—	$	503



	March 31, 2016
				Real Estate
	Coml, Fin, and Agric			Construction			Commercial		Residential			Installment loans to individuals			Lease financing receivable			Other		Total
Allowance for loan losses:
Beginning balance	$	11,268		$	819		$	4,614	$	816		$	1,468		$	14		$	12	$	19,011
Charge-offs	(1,307		)	—			—		(4		)	(283		)	—			—		(1,594		)
Recoveries	26			—			76		3			25			—			—		130
Provision	2,194			(420		)	861		(170		)	336			(3		)	2		2,800
Ending balance	$	12,181		$	399		$	5,551	$	645		$	1,546		$	11		$	14	$	20,347
Ending balance: individually evaluated for impairment	$	1,021		$	—		$	2,586	$	267		$	278		$	—		$	—	$	4,152
Ending balance: collectively evaluated for impairment	$	11,160		$	399		$	2,965	$	378		$	1,268		$	11		$	14	$	16,195

Loans:
Ending balance	$	441,160		$	84,790		$	467,648	$	149,961		$	103,181		$	1,590		$	1,719	$	1,250,049
Ending balance: individually evaluated for impairment	$	29,097		$	35		$	27,511	$	2,230		$	506		$	—		$	—	$	59,379
Ending balance: collectively evaluated for impairment	$	412,063		$	84,755		$	439,530	$	147,653		$	102,675		$	1,590		$	1,719	$	1,189,985
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	607	$	78		$	—		$	—		$	—	$	685

Non-Accrual and Past Due Loans

Loans are considered past due if the required principal and interest payment have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the probability of collection of interest is deemed insufficient to warrant further accrual. For loans placed on non-accrual status, the accrual of interest is discontinued and subsequent payments received are applied to the principal balance. Interest income is recorded after principal has been satisfied and as payments are received. Non-accrual loans may be returned to accrual status if all principal and interest amounts contractually owed are reasonably assured of repayment within a reasonable period and there is a period of at least six months to one year of repayment performance by the borrower depending on the contractual payment terms.

An age analysis of past due loans (including both accruing and non-accruing loans) is as follows (in thousands):



	March 31, 2017
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 days and Accruing
Commercial, financial, and agricultural	$	1,849	$	1,022	$	28,154	$	31,025	$	438,790	$	469,815	$	546
Real estate - construction	709		—		125		834		99,414		100,248		99
Real estate - commercial	9,326		1,389		18,542		29,257		435,602		464,859		—
Real estate - residential	2,237		136		1,620		3,993		155,433		159,426		130
Installment loans to individuals	302		190		487		979		74,279		75,258		—
Lease financing receivable	—		—		—		—		969		969		—
Other loans	41		6		—		47		1,378		1,425		—
	$	14,464	$	2,743	$	48,928	$	66,135	$	1,205,865	$	1,272,000	$	775

	December 31, 2016
	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 days and Accruing
Commercial, financial, and agricultural	$	2,297	$	902	$	31,425	$	34,624	$	424,950	$	459,574	$	96
Real estate - construction	2,613		399		9		3,021		97,938		100,959		—
Real estate - commercial	5,159		1,931		25,408		32,498		448,657		481,155		140
Real estate - residential	1,956		207		1,553		3,716		154,156		157,872		16
Installment loans to individuals	756		36		538		1,330		81,330		82,660		16
Lease financing receivable	—		—		—		—		1,095		1,095		—
Other loans	89		5		—		94		673		767		—
	$	12,870	$	3,480	$	58,933	$	75,283	$	1,208,799	$	1,284,082	$	268

Non-accrual loans are as follows (in thousands):



	March 31, 2017		December 31, 2016
Commercial, financial, and agricultural	$	33,351	$	31,461
Real estate - construction	26		9
Real estate - commercial	20,623		28,688
Real estate - residential	1,956		1,881
Installment loans to individuals	487		541
Lease financing receivable	—		—
Other	—		—
	$	56,443	$	62,580

The amount of interest that would have been recorded on non-accrual loans, had the loans not been classified as non-accrual, totaled approximately $931,000 and $757,000 for the three months ended March 31, 2017 and 2016, respectively. Interest actually received on non-accrual loans subsequent to their transfer to non-accrual status totaled at March 31, 2017 and 2016 was $244,000 and $59,000, respectively.

Impaired Loans

Loans are considered impaired when, based upon current information, it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans classified as special mention, substandard, or doubtful, based on credit risk rating factors, are reviewed to determine whether impairment testing is appropriate. All loan relationships with an outstanding commitment balance above a specified threshold are evaluated for potential impairment. All loan relationships with an outstanding commitment balance below the specified threshold are assigned an allowance allocation percentage that is determined by management and adjusted periodically based on certain factors. An allowance for each impaired loan is calculated based on the present value of expected future cash flows discounted at the loan’s effective interest rate or at the loan’s observable market price or the fair value of the collateral if the loan is collaterally dependent. All impaired loans are reviewed, at a minimum, on a quarterly basis. Existing valuations are reviewed to determine if additional discounts or new appraisals are required. After this review, when comparing the resulting collateral valuation to the outstanding loan balance, if the discounted collateral value exceeds the loan balance no specific allocation is reserved. Acquired impaired loans are generally not subject to individual evaluation for impairment and are not reported with impaired loans or troubled debt restructurings, even if they would otherwise qualify for such treatment.

Loans that are individually evaluated for impairment are as follows (in thousands):



	March 31, 2017
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial, and agricultural	$	19,185	$	19,688	$	—	$	17,143	$	26
Real estate - construction	—		—		—		5		—
Real estate - commercial	6,320		6,320		—		9,515		3
Real estate - residential	389		389		—		646		1
Installment loans to individuals	—		—		—		37		—
Subtotal:	25,894		26,397		—		27,346		30
With an allowance recorded:
Commercial, financial, and agricultural	16,161		16,344		4,173		16,267		1
Real estate - construction	26		26		9		13		—
Real estate - commercial	14,303		14,503		1,656		15,141		—
Real estate - residential	1,567		1,567		217		1,245		—
Installment loans to individuals	487		524		160		477		—
Subtotal:	32,544		32,964		6,215		33,143		1
Totals:
Commercial	55,969		56,855		5,829		58,066		30
Construction	26		26		9		18		—
Residential	1,956		1,956		217		1,891		1
Consumer	487		524		160		514		—
Grand total:	$	58,438	$	59,361	$	6,215	$	60,489	$	31

	December 31, 2016
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial, and agricultural	$	15,101	$	15,428	$	—	$	18,815	$	191
Real estate - construction	9		9		—		23		—
Real estate - commercial	12,710		12,710		—		9,297		64
Real estate - residential	903		903		—		1,134		—
Installment loans to individuals	73		87		—		54		1
Subtotal:	28,796		29,137		—		29,323		256
With an allowance recorded:
Commercial, financial, and agricultural	16,372		16,470		4,369		10,781		42
Real estate - commercial	15,979		15,979		2,216		14,992		28
Real estate - residential	923		923		260		730		—
Installment loans to individuals	468		478		308		419		11
Subtotal:	33,742		33,850		7,153		26,922		81
Totals:
Commercial	60,162		60,587		6,585		53,885		325
Construction	9		9		—		23		—
Residential	1,826		1,826		260		1,864		—
Consumer	541		565		308		473		12
Grand total:	$	62,538	$	62,987	$	7,153	$	56,245	$	337

Credit Quality

The Company manages credit risk by observing written underwriting standards and lending policy established by the Board of Directors and management to govern all lending activities. The risk management program requires that each individual loan officer review his or her portfolio on a quarterly basis and assign recommended credit ratings on each loan. These efforts are supplemented by independent reviews performed by a loan review officer and other validations performed by the internal audit department. The results of the reviews are reported directly to the Audit Committee of the Board of Directors.

Loans are categorized into risk categories based on relevant information about the ability of borrowers to serve their debt, such as: current financial information, historical payment experience, credit documentation, public information, current economic trends, and other factors. Loans are analyzed individually and classified according to their credit risk. This analysis is performed on a continuous basis. The following definitions are used for risk ratings:

Special Mention: Weakness exists that could cause future impairment, including the deterioration of financial ratios, past due status, and questionable management capabilities. Collateral values generally afford adequate coverage but may not be immediately marketable.

Substandard: Specific and well-defined weaknesses exist that may include poor liquidity and deterioration of financial ratios. Currently the borrower maintains the capacity to service the debt. The loan may be past due and related deposit accounts experiencing overdrafts. Immediate corrective action is necessary.

Doubtful: Specific weaknesses characterized as Substandard exist that are severe enough to make collection in full unlikely. There is no reliable secondary source of full repayment. Loans classified as Doubtful will usually be placed on non-accrual status. The probability of some loss is extremely high but because of certain important and reasonably specific factors, the amount of loss cannot be determined.

Loans not meeting the criteria above that are analyzed individually as part of the above-described process are considered to be Pass rated loans.

The following tables present the classes of loans by risk rating (in thousands):



	March 31, 2017
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
			Commercial, financial, and agricultural		Real estate - commercial		Total		% of Total
Pass			$	354,424	$	412,694	$	767,118	82.07	%
Special mention			10,916		14,188		25,104		2.69	%
Substandard			104,261		37,977		142,238		15.22	%
Doubtful			214		—		214		0.02	%
			$	469,815	$	464,859	$	934,674	100.00	%

Construction Credit Exposure
Credit Risk Profile by Creditworthiness Category
							Real estate - construction		% of Total
Pass							$	100,050	99.80	%
Special mention							—		—	%
Substandard							198		0.20	%
							$	100,248	100.00	%

Residential Credit Exposure
Credit Risk Profile by Creditworthiness Category
							Real estate - residential		% of Total
Pass							$	154,943	97.19	%
Special mention							1,131		0.71	%
Substandard							3,352		2.10	%
							$	159,426	100.00	%

Consumer and Commercial Credit Exposure
Credit Risk Profile Based on Payment Activity
	Installment loans to individuals		Lease financing receivable		Other		Total		% of Total
Performing	$	74,753	$	969	$	1,425	$	77,147	99.35	%
Nonperforming	505		—		—		505		0.65	%
	$	75,258	$	969	$	1,425	$	77,652	100.00	%



	December 31, 2016
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
				Commercial, financial, and agricultural		Real estate - commercial		Total		% of Total
Pass				$	346,246	$	420,970	$	767,216	81.56	%
Special mention				22,611		23,085		45,696		4.86	%
Substandard				90,300		37,100		127,400		13.54	%
Doubtful				417		—		417		0.04	%
				$	459,574	$	481,155	$	940,729	100.00	%

Construction Credit Exposure
Credit Risk Profile by Creditworthiness Category
								Real estate - construction		% of Total
Pass								$	100,775	99.82	%
Special mention								—		—	%
Substandard								184		0.18	%
								$	100,959	100.00	%

Residential Credit Exposure
Credit Risk Profile by Creditworthiness Category
								Real estate - residential		% of Total
Pass								$	153,403	97.17	%
Special mention								1,181		0.75	%
Substandard								3,288		2.08	%
								$	157,872	100.00	%

Consumer and Commercial Credit Exposure
Credit Risk Profile Based on Payment Activity
		Installment loans to individuals		Lease financing receivable		Other		Total		% of Total
Performing		$	82,103	$	1,095	$	767	$	83,965	99.34	%
Nonperforming		557		—		—		557		0.66	%
		$	82,660	$	1,095	$	767	$	84,522	100.00	%

Troubled Debt Restructurings

A troubled debt restructuring (“TDR”) is a restructuring of a debt made by the Company to a debtor for economic or legal reasons related to the debtor’s financial difficulties that it would not otherwise consider. The Company grants the concession in an attempt to protect as much of its investment as possible.

Information about the Company’s TDRs is as follows (in thousands):



	March 31, 2017
	Current		Past Due Greater Than 30 Days		Nonaccrual TDRs		Total TDRs
Commercial, financial and agricultural	$	1,995	$	—	$	21,864	$	23,859
Real estate – commercial	—		—		808		808
	$	1,995	$	—	$	22,672	$	24,667

	December 31, 2016
	Current		Past Due Greater Than 30 Days		Nonaccrual TDRs		Total TDRs
Commercial, financial and agricultural	$	12	$	—	$	24,331	$	24,343
Real estate – commercial	—		140		808		948
	$	12	$	140	$	25,139	$	25,291

During the three months ended March 31, 2017, there was one loan relationship with a pre-modification balance of $2.0 million identified as a TDR after a reduction in payments. There were no defaults on any loans that were modified as TDRs during the preceding twelve months. During the three months ended March 31, 2016, there was one loan relationship with a pre-modification balance of $5.5 million identified as a TDR after conversion of the loans to interest only for a limited amount of time. This one TDR subsequently defaulted on the modified terms and totaled $5.5 million at March 31, 2016. For purposes of the determination of an allowance for loan losses on these TDRs, as an identified TDR, the Company considers a loss probable on the loan and, as a result is reviewed for specific impairment in accordance with the Company’s allowance for loan loss methodology. If it is determined losses are probable on such TDRs, either because of delinquency or other credit quality indicator, the Company establishes specific reserves for these loans. As of March 31, 2017, there were no commitments to lend additional funds to debtors owing sums to the Company whose terms have been modified in TDRs.