LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio, net of deferred origination fees and costs, is summarized as follows (in thousands):



	March 31, 2018		December 31, 2017
Commercial and agricultural:
Commercial and industrial	$	199,947	$	198,463
Agricultural	529		544
Commercial mortgages:
Construction	55,404		45,558
Commercial mortgages, other	592,195		598,772
Residential mortgages	194,600		194,440
Consumer loans:
Credit cards	1,418		1,517
Home equity lines and loans	100,611		100,591
Indirect consumer loans	156,958		153,060
Direct consumer loans	18,249		18,879
Total loans, net of deferred origination fees and costs	$	1,319,911	$	1,311,824
Interest receivable on loans	3,618		3,758
Total recorded investment in loans	$	1,323,529	$	1,315,582

The Corporation's concentrations of credit risk by loan type are reflected in the preceding table. The concentrations of credit risk with standby letters of credit, committed lines of credit and commitments to originate new loans generally follow the loan classifications in the table above.

The following tables present the activity in the allowance for loan losses by portfolio segment for the three-month periods ended March 31, 2018 and 2017 (in thousands):



	Three Months Ended March 31, 2018
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages		Residential Mortgages			Consumer Loans			Total
Beginning balance	$	6,976		$	8,514	$	1,316		$	4,355		$	21,161
Charge-offs	(19		)	—		(94		)	(458		)	(571		)
Recoveries	9			1		5			76			91
Net recoveries (charge-offs)	(10		)	1		(89		)	(382		)	(480		)
Provision	37			125		180			367			709
Ending balance	$	7,003		$	8,640	$	1,407		$	4,340		$	21,390



	Three Months Ended March 31, 2017
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages		Residential Mortgages			Consumer Loans			Total
Beginning balance	$	1,589		$	7,270	$	1,523		$	3,871		$	14,253
Charge-offs	(5		)	—		(12		)	(427		)	(444		)
Recoveries	24			1		17			69			111
Net recoveries (charge-offs)	19			1		5			(358		)	(333		)
Provision	42			478		(16		)	536			1,040
Ending balance	$	1,650		$	7,749	$	1,512		$	4,049		$	14,960

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2018 and December 31, 2017 (in thousands):



	March 31, 2018
Allowance for loan losses:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	4,910	$	771	$	—	$	—	$	5,681
Collectively evaluated for impairment	2,093		7,869		1,407		4,340		15,709
Total ending allowance balance	$	7,003	$	8,640	$	1,407	$	4,340	$	21,390



	December 31, 2017
Allowance for loan losses:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	5,135	$	802	$	—	$	—	$	5,937
Collectively evaluated for impairment	1,841		7,683		1,316		4,355		15,195
Loans acquired with deteriorated credit quality	—		29		—		—		29
Total ending allowance balance	$	6,976	$	8,514	$	1,316	$	4,355	$	21,161



	March 31, 2018
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	5,795	$	7,359	$	425	$	61	$	13,640
Loans collectively evaluated for impairment	195,242		642,054		194,671		277,922		1,309,889
Total ending loans balance	$	201,037	$	649,413	$	195,096	$	277,983	$	1,323,529



	December 31, 2017
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	6,133	$	7,302	$	427	$	64	$	13,926
Loans collectively evaluated for impairment	193,443		638,080		194,510		274,831		1,300,864
Loans acquired with deteriorated credit quality	—		792		—		—		792
Total ending loans balance	$	199,576	$	646,174	$	194,937	$	274,895	$	1,315,582

The following table presents loans individually evaluated for impairment recognized by class of loans as of March 31, 2018 and December 31, 2017 (in thousands):



	March 31, 2018						December 31, 2017
With no related allowance recorded:	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
Commercial and agricultural:
Commercial and industrial	$	770	$	773	$	—	$	861	$	867	$	—
Commercial mortgages:
Construction	351		352		—		364		365		—
Commercial mortgages, other	4,210		4,212		—		4,135		4,138		—
Residential mortgages	447		425		—		450		427		—
Consumer loans:
Home equity lines and loans	61		61		—		64		64		—
With an allowance recorded:
Commercial and agricultural:
Commercial and industrial	5,019		5,022		4,910		5,231		5,266		5,135
Commercial mortgages:
Commercial mortgages, other	2,984		2,795		771		2,989		2,799		802
Total	$	13,842	$	13,640	$	5,681	$	14,094	$	13,926	$	5,937

The following table presents the average recorded investment and interest income of loans individually evaluated for impairment recognized by class of loans as of the three-month periods ended March 31, 2018 and 2017 (in thousands):



	Three Months Ended March 31, 2018				Three Months Ended March 31, 2017
With no related allowance recorded:	Average Recorded Investment		Interest Income Recognized (1)		Average Recorded Investment		Interest Income Recognized (1)
Commercial and agricultural:
Commercial and industrial	$	820	$	9	$	671	$	9
Commercial mortgages:
Construction	359		3		919		3
Commercial mortgages, other	4,175		5		7,000		59
Residential mortgages	426		2		393		2
Consumer loans:
Home equity lines & loans	63		1		84		1
With an allowance recorded:
Commercial and agricultural:
Commercial and industrial	5,144		—		—		—
Commercial mortgages:
Commercial mortgages, other	2,797		1		3,257		1
Consumer loans:
Home equity lines and loans	—		—		360		—
Total	$	13,784	$	21	$	12,684	$	75

(1)Cash basis interest income approximates interest income recognized.

The following table present the recorded investment in non-accrual and loans past due 90 days or more and still accruing by class of loans as of March 31, 2018 and December 31, 2017 (in thousands):



	Non-accrual				Loans Past Due 90 Days or More and Still Accruing
	March 31, 2018		December 31, 2017		March 31, 2018		December 31, 2017
Commercial and agricultural:
Commercial and industrial	$	5,164	$	5,250	$	2	$	5
Commercial mortgages:
Construction	130		135		—		—
Commercial mortgages, other	6,597		6,520		—		—
Residential mortgages	3,155		3,160		—		—
Consumer loans:
Credit cards	—		—		26		24
Home equity lines and loans	1,302		1,310		—		—
Indirect consumer loans	886		935		—		—
Direct consumer loans	46		14		—		—
Total	$	17,280	$	17,324	$	28	$	29

The following tables present the aging of the recorded investment in loans as of March 31, 2018 and December 31, 2017 (in thousands):



	March 31, 2018
	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Loans Acquired with Deteriorated Credit Quality		Loans Not Past Due		Total
Commercial and agricultural:
Commercial and industrial	$	1,397	$	—	$	3,642	$	5,039	$	—	$	195,468	$	200,507
Agricultural	—		—		—		—		—		530		530
Commercial mortgages:
Construction	—		—		—		—		—		55,560		55,560
Commercial mortgages, other	442		—		928		1,370		—		592,483		593,853
Residential mortgages	1,719		308		1,263		3,290		—		191,806		195,096
Consumer loans:
Credit cards	3		9		26		38		—		1,380		1,418
Home equity lines and loans	283		231		856		1,370		—		99,532		100,902
Indirect consumer loans	1,332		216		489		2,037		—		155,303		157,340
Direct consumer loans	38		4		35		77		—		18,246		18,323
Total	$	5,214	$	768	$	7,239	$	13,221	$	—	$	1,310,308	$	1,323,529



	December 31, 2017
	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Loans Acquired with Deteriorated Credit Quality		Loans Not Past Due		Total
Commercial and agricultural:
Commercial and industrial	$	1,689	$	999	$	20	$	2,708	$	—	$	196,322	$	199,030
Agricultural	—		—		—		—		—		546		546
Commercial mortgages:
Construction	—		—		—		—		—		45,688		45,688
Commercial mortgages, other	2,399		115		748		3,262		792		596,432		600,486
Residential mortgages	1,399		939		1,474		3,812		—		191,125		194,937
Consumer loans:
Credit cards	17		9		24		50		—		1,466		1,516
Home equity lines and loans	265		31		983		1,279		—		99,599		100,878
Indirect consumer loans	1,822		484		581		2,887		—		150,645		153,532
Direct consumer loans	48		28		2		78		—		18,891		18,969
Total	$	7,639	$	2,605	$	3,832	$	14,076	$	792	$	1,300,714	$	1,315,582

Troubled Debt Restructurings:

A modification of a loan may result in classification as a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of modifications which may involve a change in the schedule of payments, a reduction in the interest rate, an extension of the maturity date, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, requesting additional collateral, releasing collateral for consideration, substituting or adding a new borrower or guarantor, a permanent reduction of the recorded investment in the loan or a permanent reduction of the interest on the loan.

As of March 31, 2018 and December 31, 2017, the Corporation has a recorded investment in TDRs of $7.3 million and $7.7 million, respectively. There were specific reserves of $0.5 million and $0.7 million allocated for TDRs at March 31, 2018 and December 31, 2017, respectively. As of March 31, 2018, TDRs totaling $1.5 million were accruing interest under the modified terms and $5.8 million were on non-accrual status. As of December 31, 2017, TDRs totaling $1.7 million were accruing interest under the modified terms and $6.0 million were on non-accrual status. The Corporation had committed no additional amounts as of both March 31, 2018 and December 31, 2017, to customers with outstanding loans that are classified as TDRs.

During the three-month periods ended March 31, 2018 and 2017, the terms of certain loans were modified as TDRs. The modification of the terms of one commercial & industrial term loan during the three months ended March 31, 2018 included an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk. The modification of the terms of one commercial mortgage loan during the three months ended March 31, 2017 included a reduction of the scheduled amortized payments of the loan for greater than a three month period.

The following table presents loans by class modified as TDRs that occurred during the three month periods ended March 31, 2018 and 2017 (dollars in thousands):



March 31, 2018	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial and agricultural:
Commercial and industrial	1	$	100	$	100
Total	1	$	100	$	100



March 31, 2017	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial mortgages:
Commercial mortgages	1	$	166	$	166
Total	1	$	166	$	166

The TDRs described above did not increase the allowance for loan losses and resulted in no charge-offs during the three month periods ended March 31, 2018 and 2017.

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There were no payment defaults on any loans previously modified as TDRs within twelve months following the modification during the three month periods ended March 31, 2018 and 2017.

Credit Quality Indicators

The Corporation establishes a risk rating at origination for all commercial loans. The main factors considered in assigning risk ratings include, but are not limited to: historic and future debt service coverage, collateral position, operating performance, liquidity, leverage, payment history, management ability, and the customer’s industry. Commercial relationship managers monitor all loans in their respective portfolios for any changes in the borrower’s ability to service its debt and affirm the risk ratings for the loans at least annually.

For the retail loans, which include residential mortgages, indirect and direct consumer loans, home equity lines and loans, and credit cards, once a loan is properly approved and closed, the Corporation evaluates credit quality based upon loan repayment.

The Corporation uses the risk rating system to identify criticized and classified loans. Commercial relationships within the criticized and classified risk ratings are analyzed quarterly. The Corporation uses the following definitions for criticized and classified loans (which are consistent with regulatory guidelines):

Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capability of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Commercial loans not meeting the criteria above to be considered criticized or classified are considered to be pass rated loans. Loans listed as not rated are included in groups of homogeneous loans performing under terms of the loan notes. Based on the analyses performed as of March 31, 2018 and December 31, 2017, the risk category of the recorded investment of loans by class of loans is as follows (in thousands):



	March 31, 2018
	Not Rated		Pass		Special Mention		Substandard		Doubtful		Loans acquired with deteriorated credit quality		Total
Commercial and agricultural:
Commercial and industrial	$	—	$	183,869	$	8,719	$	2,911	$	5,008	$	—	$	200,507
Agricultural	—		530		—		—		—		—		530
Commercial mortgages:
Construction	—		55,430		—		130		—		—		55,560
Commercial mortgages	—		567,624		11,570		13,307		1,352		—		593,853
Residential mortgages	191,941		—		—		3,155		—		—		195,096
Consumer loans:
Credit cards	1,418		—		—		—		—		—		1,418
Home equity lines and loans	99,600		—		—		1,302		—		—		100,902
Indirect consumer loans	156,454		—		—		886		—		—		157,340
Direct consumer loans	18,277		—		—		46		—		—		18,323
Total	$	467,690	$	807,453	$	20,289	$	21,737	$	6,360	$	—	$	1,323,529



	December 31, 2017
	Not Rated		Pass		Special Mention		Substandard		Doubtful		Loans acquired with deteriorated credit quality		Total
Commercial and agricultural:
Commercial and industrial	$	—	$	186,556	$	4,447	$	6,605	$	1,422	$	—	$	199,030
Agricultural	—		546		—		—		—		—		546
Commercial mortgages:
Construction	—		45,553		—		135		—		—		45,688
Commercial mortgages	—		575,321		9,665		13,331		1,377		792		600,486
Residential mortgages	191,777		—		—		3,160		—		—		194,937
Consumer loans:
Credit cards	1,516		—		—		—		—		—		1,516
Home equity lines and loans	99,568		—		—		1,310		—		—		100,878
Indirect consumer loans	152,598		—		—		934		—		—		153,532
Direct consumer loans	18,955		—		—		14		—		—		18,969
Total	$	464,414	$	807,976	$	14,112	$	25,489	$	2,799	$	792	$	1,315,582

The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential and consumer loans based on payment activity as of March 31, 2018 and December 31, 2017 (in thousands):



	March 31, 2018
			Consumer Loans
	Residential Mortgages		Credit Card		Home Equity Lines and Loans		Indirect Consumer Loans		Other Direct Consumer Loans
Performing	$	191,941	$	1,418	$	99,600	$	156,454	$	18,277
Non-Performing	3,155		—		1,302		886		46
	$	195,096	$	1,418	$	100,902	$	157,340	$	18,323



	December 31, 2017
			Consumer Loans
	Residential Mortgages		Credit Card		Home Equity Lines and Loans		Indirect Consumer Loans		Other Direct Consumer Loans
Performing	$	191,777	$	1,516	$	99,568	$	152,598	$	18,955
Non-Performing	3,160		—		1,310		934		14
	$	194,937	$	1,516	$	100,878	$	153,532	$	18,969

At the time of the merger with Fort Orange Financial Corp., the Corporation identified certain loans with evidence of deteriorated credit quality, and the probability that the Corporation would be unable to collect all contractually required payments from the borrower. These loans were classified as PCI loans. The Corporation previously adjusted its estimates of future expected losses, cash flows, and renewal assumptions on the PCI loans. These adjustments were made for changes in expected cash flows due to loans refinanced beyond original maturity dates, impairments recognized subsequent to the acquisition, advances made for taxes or insurance to protect collateral held and payments received in excess of amounts originally expected. During the first quarter of 2018, management determined that the disclosure of PCI loans was no longer material and will analyze these loans as part of the overall impairment process going forward.