Credit Quality of Loans and Allowance for Loan Losses

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



	March 31, 2018			December 31, 2017
Commercial, financial and agricultural	$	401,048		$	435,207
Real estate – construction	94,679			90,287
Real estate – commercial	438,779			448,406
Real estate – residential	145,671			146,751
Installment loans to individuals	50,888			56,398
Lease financing receivable	692			732
Other	5,498			5,645
	1,137,255			1,183,426
Less allowance for loan losses	(25,371		)	(26,888		)
	$	1,111,884		$	1,156,538

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, 2018, 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 $172.8 million, or 15.2% of total loans. Additionally, the Company’s exposure to loans secured by commercial real estate is monitored. At March 31, 2018, loans secured by commercial real estate (including commercial construction, farmland and multifamily loans) totaled approximately $502.5 million, 54% of which are secured by owner-occupied commercial properties. Of the $502.5 million in loans secured by commercial real estate, $26.2 million, or 5.2%, were on nonaccrual status at March 31, 2018.

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 three months ended March 31, 2018 and 2017 is as follows (in thousands):



	March 31, 2018
				Real Estate
	Coml, Fin, and Agric			Construction			Commercial			Residential			Installment loans to individuals			Lease financing receivable		Other		Total
Allowance for loan losses:
Beginning balance	$	20,577		$	596		$	3,893		$	837		$	957		$	3	$	25	$	26,888
Charge-offs	(1,524		)	(2		)	(86		)	(3		)	(221		)	—		—		(1,836		)
Recoveries	276			—			6			1			36			—		—		319
Provision	(264		)	159			(106		)	64			146			—		1		—
Ending balance	$	19,065		$	753		$	3,707		$	899		$	918		$	3	$	26	$	25,371
Ending balance: individually evaluated for impairment	$	5,968		$	94		$	76		$	20		$	6		$	—	$	—	$	6,164
Ending balance: collectively evaluated for impairment	$	13,097		$	659		$	3,631		$	879		$	912		$	3	$	26	$	19,207

Loans:
Ending balance	$	401,048		$	94,679		$	438,779		$	145,671		$	50,888		$	692	$	5,498	$	1,137,255
Ending balance: individually evaluated for impairment	$	55,092		$	192		$	26,005		$	2,088		$	50		$	—	$	—	$	83,427
Ending balance: collectively evaluated for impairment	$	345,956		$	94,487		$	412,774		$	143,583		$	50,838		$	692	$	5,498	$	1,053,828



	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

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):



	March 31, 2018
	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	$	2,235	$	3,156	$	12,816	$	18,207	$	382,841	$	401,048	$	1
Real estate - construction	927		1,179		192		2,298		92,381		94,679		—
Real estate - commercial	5,681		6,079		11,330		23,090		415,689		438,779		—
Real estate - residential	657		1,137		1,187		2,981		142,690		145,671		—
Installment loans to individuals	202		125		50		377		50,511		50,888		—
Lease financing receivable	—		—		—		—		692		692		—
Other loans	65		16		—		81		5,417		5,498		—
	$	9,767	$	11,692	$	25,575	$	47,034	$	1,090,221	$	1,137,255	$	1

	December 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	$	1,195	$	1,893	$	14,847	$	17,935	$	417,272	$	435,207	$	545
Real estate - construction	616		—		190		806		89,481		90,287		125
Real estate - commercial	5,889		6,402		4,163		16,454		431,952		448,406		58
Real estate - residential	1,065		235		559		1,859		144,892		146,751		—
Installment loans to individuals	276		32		34		342		56,056		56,398		—
Lease financing receivable	—		—		—		—		732		732		—
Other loans	—		—		—		—		5,645		5,645		—
	$	9,041	$	8,562	$	19,793	$	37,396	$	1,146,030	$	1,183,426	$	728

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



	March 31, 2018		December 31, 2017
Commercial, financial, and agricultural	$	53,939	$	37,418
Real estate - construction	192		66
Real estate - commercial	26,006		11,128
Real estate - residential	2,088		618
Installment loans to individuals	50		48
Lease financing receivable	—		—
Other	—		—
	$	82,275	$	49,278

The amount of interest that would have been recorded on non-accrual loans, had the loans not been classified as non-accrual, totaled approximately $1.5 million and $931,000 for the three months ended March 31, 2018 and 2017, respectively. Interest actually received on non-accrual loans subsequent to their transfer to non-accrual status totaled $68,000 and $244,000 for the three months ended March 31, 2018 and 2017, 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.



	March 31, 2018
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial, and agricultural	$	44,445	$	50,416	$	—	$	34,552	$	18
Real estate - construction	—		—		—		—		—
Real estate - commercial	25,250		27,514		—		17,861		—
Real estate - residential	1,400		1,400		—		851		—
Installment loans to individuals	24		24		—		12		—
Finance leases	—		—		—		—		—
Subtotal:	71,119		79,354		—		53,276		18
With an allowance recorded:
Commercial, financial, and agricultural	10,647		10,802		5,968		12,383		—
Real estate - construction	192		192		94		129		—
Real estate - commercial	755		755		76		706		—
Real estate - residential	688		688		20		502		—
Installment loans to individuals	26		26		6		37		—
Finance leases	—		—		—		—		—
Subtotal:	12,308		12,463		6,164		13,757		—
Totals:
Commercial	81,097		89,487		6,044		65,502		18
Construction	192		192		94		129		—
Residential	2,088		2,088		20		1,353		—
Consumer	50		50		6		49		—
Grand total:	$	83,427	$	91,817	$	6,164	$	67,033	$	18



	December 31, 2017
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial, and agricultural	$	24,659	$	30,630	$	—	$	19,880	$	90
Real estate - construction	—		—		—		5		—
Real estate - commercial	10,471		11,965		—		11,590		—
Real estate - residential	302		302		—		602		—
Installment loans to individuals	—		—		—		37		—
Subtotal:	35,432		42,897		—		32,114		90
With an allowance recorded:
Commercial, financial, and agricultural	14,119		14,150		7,197		15,245		1
Real estate - construction	66		136		23		33		—
Real estate - commercial	657		657		131		8,318		—
Real estate - residential	316		316		5		620		—
Installment loans to individuals	48		50		14		258		—
Subtotal:	15,206		15,309		7,370		24,474		1
Totals:
Commercial	49,906		57,402		7,328		55,033		91
Construction	66		136		23		38		—
Residential	618		618		5		1,222		—
Consumer	48		50		14		295		—
Grand total:	$	50,638	$	58,206	$	7,370	$	56,588	$	91

Credit Quality

The Company manages credit risk by observing written underwriting standards and the 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, 2018
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
			Commercial, financial, and agricultural		Real estate - commercial		Total		% of Total
Pass			$	326,697	$	393,327	$	720,024	85.73	%
Special mention			8,718		5,798		14,516		1.73	%
Substandard			65,633		39,654		105,287		12.54	%
			$	401,048	$	438,779	$	839,827	100.00	%

Construction Credit Exposure
Credit Risk Profile by Creditworthiness Category
							Real estate - construction		% of Total
Pass							$	92,978	98.20	%
Special mention							167		0.18	%
Substandard							1,534		1.62	%
							$	94,679	100.00	%

Residential Credit Exposure
Credit Risk Profile by Creditworthiness Category
							Real estate - residential		% of Total
Pass							$	140,883	96.71	%
Special mention							854		0.59	%
Substandard							3,934		2.70	%
							$	145,671	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	$	50,837	$	692	$	5,498	$	57,027	99.91	%
Nonperforming	51		—		—		51		0.09	%
	$	50,888	$	692	$	5,498	$	57,078	100.00	%



	December 31, 2017
Commercial Credit Exposure
Credit Risk Profile by Creditworthiness Category
				Commercial, financial, and agricultural		Real estate - commercial		Total		% of Total
Pass				$	358,373	$	411,280	$	769,653	87.10	%
Special mention				9,687		3,823		13,510		1.53	%
Substandard				67,147		33,303		100,450		11.37	%
				$	435,207	$	448,406	$	883,613	100.00	%

Construction Credit Exposure
Credit Risk Profile by Creditworthiness Category
								Real estate - construction		% of Total
Pass								$	89,323	98.93	%
Special mention								600		0.66	%
Substandard								364		0.40	%
								$	90,287	100.00	%

Residential Credit Exposure
Credit Risk Profile by Creditworthiness Category
								Real estate - residential		% of Total
Pass								$	144,250	98.30	%
Special mention								1,233		0.84	%
Substandard								1,268		0.86	%
								$	146,751	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		$	56,041	$	699	$	5,645	$	62,385	99.38	%
Nonperforming		357		33		—		390		0.62	%
		$	56,398	$	732	$	5,645	$	62,775	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 (in thousands):



	Three months ended
	March 31, 2018			March 31, 2017
	Number of loans	Pre-modification recorded investment		Number of loans	Pre-modification recorded investment
Commercial, financial and agricultural	—	$	—	1	$	1,984

During the three month periods ending March 31, 2018 and 2017, there were no defaults on any loans that were modified as TDRs during the preceding twelve 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.

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, 2018, there were no commitments to lend additional funds to debtors owing sums to the Company whose terms have been modified in TDRs.