Credit Quality of Loans and Allowance for Loan Losses

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



	September 30, 2017			December 31, 2016
Commercial, financial and agricultural	$	447,482		$	459,574
Real estate – construction	90,088			100,959
Real estate – commercial	473,046			481,155
Real estate – residential	155,676			157,872
Installment loans to individuals	63,148			82,660
Lease financing receivable	760			1,095
Other	5,769			767
	1,235,969			1,284,082
Less allowance for loan losses	(25,053		)	(24,372		)
	$	1,210,916		$	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 September 30, 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 $197.8 million, or 16.0% of total loans. Additionally, the Company’s exposure to loans secured by commercial real estate is monitored. At September 30, 2017, loans secured by commercial real estate (including commercial construction, farmland and multifamily loans) totaled approximately $537.9 million, 56% of which are secured by owner-occupied commercial properties. Of the $537.9 million in loans secured by commercial real estate, $20.5 million, or 3.8%, were on nonaccrual status at September 30, 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 three to five years, 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. Additionally, the Company utilizes the services of a third party to supplement its loan review efforts.

A rollforward of the activity within the allowance for loan losses by loan type and recorded investment in loans for the nine months ended September 30, 2017 and 2016 is as follows (in thousands):



	September 30, 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	(15,106		)	(70		)	(3,618		)	(293		)	(860		)	—			—		(19,947		)
Recoveries	537			—			158			97			235			—			—		1,027
Provision	17,413			28			2,024			(40		)	159			(1		)	18		19,601
Ending balance	$	18,901		$	543		$	3,948		$	704		$	929		$	4		$	24	$	25,053
Ending balance: individually evaluated for impairment	$	3,254		$	17		$	904		$	7		$	69		$	1		$	—	$	4,252
Ending balance: collectively evaluated for impairment	$	15,647		$	526		$	3,044		$	697		$	860		$	3		$	24	$	20,801

Loans:
Ending balance	$	447,482		$	90,088		$	473,046		$	155,676		$	63,148		$	760		$	5,769	$	1,235,969
Ending balance: individually evaluated for impairment	$	30,892		$	2,416		$	18,132		$	1,031		$	338		$	34		$	—	$	52,843
Ending balance: collectively evaluated for impairment	$	416,590		$	87,672		$	454,488		$	154,582		$	62,810		$	726		$	5,769	$	1,182,637
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	426		$	63		$	—		$	—		$	—	$	489



	September 30, 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	(2,957		)	—			(208		)	(24		)	(991		)	—			—		(4,180		)
Recoveries	193			—			115			4			125			—			—		437
Provision	6,747			(478		)	1,042			(97		)	781			(5		)	10		8,000
Ending balance	$	15,251		$	341		$	5,563		$	699		$	1,383		$	9		$	22	$	23,268
Ending balance: individually evaluated for impairment	$	1,105		$	—		$	2,270		$	194		$	268		$	—		$	—	$	3,837
Ending balance: collectively evaluated for impairment	$	14,146		$	341		$	3,293		$	505		$	1,115		$	9		$	22	$	19,431

Loans:
Ending balance	$	463,031		$	96,365		$	464,853		$	155,653		$	88,537		$	1,449		$	2,912	$	1,272,800
Ending balance: individually evaluated for impairment	$	29,887		$	10		$	28,285		$	1,831		$	464		$	—		$	—	$	60,477
Ending balance: collectively evaluated for impairment	$	433,144		$	96,355		$	435,985		$	153,747		$	88,073		$	1,449		$	2,912	$	1,211,665
Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	583		$	75		$	—		$	—		$	—	$	658

Non-Accrual and Past Due Loans

Loans are considered past due if the required principal and interest payments 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):



	September 30, 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	$	2,144	$	512	$	27,161	$	29,817	$	417,665	$	447,482	$	384
Real estate - construction	335		350		2,416		3,101		86,987		90,088		—
Real estate - commercial	1,804		—		9,749		11,553		461,493		473,046		—
Real estate - residential	2,467		28		898		3,393		152,283		155,676		—
Installment loans to individuals	408		173		215		796		62,352		63,148		18
Lease financing receivable	33		—		—		33		727		760		—
Other loans	79		12		—		91		5,678		5,769		—
	$	7,270	$	1,075	$	40,439	$	48,784	$	1,187,185	$	1,235,969	$	402

	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):



	September 30, 2017		December 31, 2016
Commercial, financial, and agricultural	$	29,337	$	31,461
Real estate - construction	2,416		9
Real estate - commercial	18,132		28,688
Real estate - residential	1,032		1,881
Installment loans to individuals	339		541
Lease financing receivable	33		—
Other	—		—
	$	51,289	$	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 $2.6 million and $2.5 million for the nine months ended September 30, 2017 and 2016, respectively. Interest actually received on non-accrual loans subsequent to their transfer to non-accrual status totaled $201,000 and $128,000 for the nine months ended September 30, 2017 and 2016, 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.

The following table presents loans that are individually evaluated for impairment (in thousands). Interest income recognized represents interest on accruing loans modified in a TDR.



	September 30, 2017
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial, and agricultural	$	19,853	$	22,105	$	—	$	17,477	$	61
Real estate - construction	2,366		2,366		—		1,188		—
Real estate - commercial	15,371		17,820		—		14,040		—
Real estate - residential	587		587		—		745		—
Installment loans to individuals	91		91		—		82		—
Finance leases	—		—		—		—		—
Subtotal:	38,268		42,969		—		33,532		61
With an allowance recorded:
Commercial, financial, and agricultural	11,039		12,071		3,254		13,706		1
Real estate - construction	50		120		17		25		—
Real estate - commercial	2,761		2,761		904		9,370		—
Real estate - residential	445		445		7		684		—
Installment loans to individuals	247		278		69		357		—
Finance leases	33		33		1		17		—
Subtotal:	14,575		15,708		4,252		24,159		1
Totals:
Commercial	49,057		54,790		4,159		54,610		62
Construction	2,416		2,486		17		1,213		—
Residential	1,032		1,032		7		1,429		—
Consumer	338		369		69		439		—
Grand total:	$	52,843	$	58,677	$	4,252	$	57,691	$	62



	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	$	90
Real estate - construction	9		9		—		23		—
Real estate - commercial	12,710		12,710		—		9,297		14
Real estate - residential	903		903		—		1,134		—
Installment loans to individuals	73		87		—		54		—
Subtotal:	28,796		29,137		—		29,323		104
With an allowance recorded:
Commercial, financial, and agricultural	16,372		16,470		4,369		10,781		1
Real estate - commercial	15,979		15,979		2,216		14,992		—
Real estate - residential	923		923		260		730		—
Installment loans to individuals	468		478		308		419		—
Subtotal:	33,742		33,850		7,153		26,922		1
Totals:
Commercial	60,162		60,587		6,585		53,885		105
Construction	9		9		—		23		—
Residential	1,826		1,826		260		1,864		—
Consumer	541		565		308		473		—
Grand total:	$	62,538	$	62,987	$	7,153	$	56,245	$	105

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):



	September 30, 2017
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
			Commercial, financial, and agricultural		Real estate - commercial		Total		% of Total
Pass			$	345,629	$	421,071	$	766,700	83.29	%
Special mention			15,321		8,654		23,975		2.60	%
Substandard			86,523		43,321		129,844		14.11	%
Doubtful			9		—		9		—	%
			$	447,482	$	473,046	$	920,528	100.00	%

Construction Credit Exposure
Credit Risk Profile by Creditworthiness Category
							Real estate - construction		% of Total
Pass							$	85,295	94.68	%
Special mention							1,834		2.04	%
Substandard							2,959		3.28	%
							$	90,088	100.00	%

Residential Credit Exposure
Credit Risk Profile by Creditworthiness Category
							Real estate - residential		% of Total
Pass							$	149,548	96.06	%
Special mention							1,839		1.18	%
Substandard							4,289		2.76	%
							$	155,676	100.00	%

Consumer and Other Credit Exposure
Credit Risk Profile Based on Payment Activity
	Installment loans to individuals		Lease financing receivable		Other		Total		% of Total
Performing	$	62,791	$	727	$	5,769	$	69,287	99.44	%
Nonperforming	357		33		—		390		0.56	%
	$	63,148	$	760	$	5,769	$	69,677	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 Other 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.

The following tables present information about TDRs that were modified during the periods presented by portfolio segment:



	Three months ended
	September 30, 2017			September 30, 2016
	Number of loans	Pre-modification recorded investment		Number of loans	Pre-modification recorded investment
Commercial, financial and agricultural	1	$	18	—	$	—

	Nine months ended
	September 30, 2017			September 30, 2016
	Number of loans	Pre-modification recorded investment		Number of loans	Pre-modification recorded investment
Commercial, financial and agricultural	6	$	2,002	2	$	3,943
Real estate – commercial	—	—		2	1,572
	6	$	2,002	4	$	5,515

The following table presents TDRs that had a payment default during the three and nine-month periods ending September 30, 2017 and 2016, and that were modified within the previous 12 months. The Company defines a payment default as any loan that is greater than 30 days past due or was past due greater than 30 days at any point during the reporting period, or since the date of modification, whichever is shorter.



	Three Months Ended September 30,				Nine Months Ended September 30,
	2017		2016		2017		2016
	Recorded Investment		Recorded Investment		Recorded Investment		Recorded Investment
Commercial, financial and agricultural	$	18	$	—	$	18	$	3,943
Real estate – commercial	—		—		—		1,572
	$	18	$	—	$	18	$	5,515

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 September 30, 2017, there were no commitments to lend additional funds to debtors owing sums to the Company whose terms have been modified in TDRs.