4. Allowance for Loan Losses and Credit Quality of Loans

Allowance for Loan Losses

The allowance for loan losses is maintained at a level estimated by management to provide adequately for probable incurred losses inherent in the current loan portfolio. The appropriateness of the allowance for loan losses is continuously monitored. It is assessed for appropriateness using a methodology designed to ensure the level of the allowance reasonably reflects the loan portfolio’s risk profile. It is evaluated to ensure that it is sufficient to absorb all reasonably estimable credit losses inherent in the current loan portfolio.

To develop and document a systematic methodology for determining the allowance for loan losses, the Company has divided the loan portfolio into three segments, each with different risk characteristics and methodologies for assessing risk. Those segments are further segregated between our loans accounted for under the amortized cost method (referred to as “originated” loans) and loans acquired in a business combination (referred to as “acquired” loans). Each portfolio segment is broken down into class segments where appropriate. Class segments contain unique measurement attributes, risk characteristics and methods for monitoring and assessing risk that are necessary to develop the allowance for loan losses. Unique characteristics such as borrower type, loan type, collateral type and risk characteristics define each class segment.

During the first quarter of 2018, the Company made adjustments to the class segments within the portfolios to better align risk characteristics and reflect the monitoring and assessment of risks as the portfolios continue to evolve. Agricultural and Agricultural Real Estate were consolidated with Commercial and Industrial and Commercial Real Estate, respectively. Agricultural loans are a type of Commercial loan with some specific underwriting guidelines; however, as of March 31, 2018, the portfolio had decreased to less than 3% of the Commercial portfolio and separation was no longer warranted. The Indirect class segment was further separated into Dealer Finance and Specialty Lending class segments. The growth in our Specialty Lending portfolio to 21% of Consumer Loans as of March 31, 2018 warranted evaluation of this class separately due to different risk characteristics from Dealer Finance class segments. The Direct and Home Equity class segments were consolidated into Direct to reflect common management, similar underwriting and in-market focus. The change to the class segments in the allowance methodology did not have a significant impact on the allowance for loan losses. The following table illustrates the portfolio and class segments for the loan portfolio in 2018 compared to 2017:

Portfolio	Class - 2018	Class - 2017
Commercial Loans	Commercial and Industrial	Commercial
	Commercial Real Estate	Commercial Real Estate
	Business Banking	Agricultural
		Agricultural Real Estate
		Business Banking
Consumer Loans	Dealer Finance	Indirect
	Specialty Lending	Home Equity
	Direct	Direct
Residential Real Estate

Commercial Loans

The Company offers a variety of Commercial loan products including Commercial and Industrial, Commercial Real Estate and Business Banking loans. The Company’s underwriting analysis for Commercial loans typically includes credit verification, independent appraisals, a review of the borrower’s financial condition and a detailed analysis of the borrower’s underlying cash flows.

Commercial and Industrial (“C&I”) – The Company offers a variety of loan options to meet the specific needs of our C&I customers including term loans, time notes and lines of credit. Such loans are made available to businesses for working capital needs such as inventory and receivables, business expansion, equipment purchases, livestock purchases and finance seasonal crop expenses. Generally, a collateral lien is placed on equipment or other assets owned by the borrower. These loans typically carry a higher risk than Commercial Real Estate loans due to the nature of the underlying collateral, which can be business assets such as equipment, accounts receivable and perishable agricultural products, which are generally less liquid than real estate and exposed to industry price volatility. To reduce these risks, management also attempts to obtain personal guarantees of the owners or obtain government loan guarantees to provide further support. In 2018, the Commercial and Agricultural class segments were combined to create the C&I class segment.

Commercial Real Estate (“CRE”) – The Company offers CRE loans to finance real estate purchases, refinancings, expansions and improvements to commercial and agricultural properties. CRE loans are made to finance the purchases and improvements of real property, which generally consists of real estate with completed structures. These CRE loans are secured by liens on the real estate, which may include both owner occupied and non-owner-occupied properties, such as apartments, commercial structures, health care facilities and other facilities. These loans are typically less risky than C&I loans, since they are secured by real estate. The Company’s underwriting analysis includes credit verification, independent appraisals, a review of the borrower’s financial condition and a detailed analysis of the borrower’s underlying cash flows. These loans are typically originated in amounts of no more than 80% of the appraised value of the property and no more than 75% of the appraised value of the agricultural property. Government loan guarantees may be obtained to provide further support for agricultural property. In 2018, the Commercial Real Estate and Agricultural Real Estate class segments were combined to create the CRE segment.

Business Banking – The Company offers a variety of loan options to meet the specific needs of our Business Banking customers including term loans, Business Banking mortgages and lines of credit. Such loans are generally less than $750 thousand and are made available to businesses for working capital such as inventory and receivables, business expansion, equipment purchases and agricultural needs. Generally, a collateral lien is placed on assets owned by the borrower and can include real estate, equipment, inventory, receivables or other business assets. These loans carry a higher risk than C&I and CRE loans due to the smaller size of the borrower and lower levels of capital. To reduce these risks, the Company obtains personal guarantees of the owners for a majority of the loans.

Consumer Loans

The Company offers a variety of Consumer loan products including Dealer Finance, Specialty Lending and Direct loans.

Dealer Finance – The Company maintains relationships with many dealers primarily in the communities that we serve. Through these relationships, the Company primarily finances the purchases of automobiles and recreational vehicles (such as campers, boats, etc.) indirectly through dealer relationships. Approximately 95% of the Dealer Finance relationships represent automobile financing. Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from three to six years, based upon the nature of the collateral and the size of the loan. The majority of Dealer Finance Consumer loans are underwritten on a secured basis using the underlying collateral being financed. In 2018, the Indirect class segment was further separated into Dealer Finance and Specialty Lending class segments (see above and below).

Specialty Lending – The Company offers unsecured Consumer loans across a national footprint originated through our relationships with national technology-driven consumer lending companies to finance such things as dental and medical procedures, K-12 tuition, solar energy installations and other consumer purpose loans. Advances of credit through this specialty lending business line are subject to the Company’s underwriting standards including criteria such as FICO score and debt to income thresholds. In 2018, the Indirect class segment has been further separated into Dealer Finance (see above) and Specialty Lending class segments.

Direct – The Company offers a variety of consumer installment loans to finance vehicle purchases, mobile home purchases and personal expenditures. In addition to installment loans, the Company also offers personal lines of credit, overdraft protection, home equity lines of credit and second mortgage loans (loans secured by a lien position on one-to-four family residential real estate) to finance home improvements, debt consolidation, education and other uses. Most of the consumer installment loans carry a fixed rate of interest with principal repayment terms typically ranging from one to ten years, based upon the nature of the collateral and the size of the loan. For home equity loans, consumers are able to borrow up to 85% of the equity in their homes. These loans carry a higher risk than first mortgage residential loans as they are often in a second position with respect to collateral. Consumer installment loans are often secured with collateral consisting of a perfected lien on the asset being purchased or a perfected lien on a consumer’s deposit account. A minimal amount of consumer installment loans are unsecured, which carry a higher risk of loss. Risk is reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower’s financial condition and personal cash flows. A security interest, with title insurance when necessary, is taken in the underlying real estate. In 2018, the Home Equity segment was consolidated into the Direct class segment.

Residential Real Estate

Residential real estate loans consist primarily of loans secured by a first or second mortgage on primary residences. We originate adjustable-rate and fixed-rate, one-to-four-family residential real estate loans for the construction, purchase or refinancing of a mortgage. These loans are collateralized by owner-occupied properties located in the Company’s market area. When market conditions are favorable, for longer term, fixed-rate residential real estate mortgages without escrow, the Company retains the servicing, but sells the right to receive principal and interest to Freddie Mac. This practice allows the Company to manage interest rate risk, liquidity risk and credit risk. Loans on one-to-four-family residential real estate are generally originated in amounts of no more than 85% of the purchase price or appraised value (whichever is lower) or have private mortgage insurance. Mortgage title insurance and hazard insurance are normally required. Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through periodic site inspections, including one at each loan draw period.

Allowance for Loan Loss Calculation

For purposes of evaluating the adequacy of the allowance, the Company considers a number of significant factors that affect the collectability of the portfolio. For individually impaired loans, these include estimates of impairment, if any, which reflect the facts and circumstances that affect the likelihood of repayment of such loans as of the evaluation date. For homogeneous pools of loans, estimates of the Company’s exposure to credit loss reflect a current assessment of a number of factors, which could affect collectability. These factors include: past loss experience, size, trend, composition and nature of loans; changes in lending policies and procedures, including underwriting standards and collection, charge-offs and recoveries; trends experienced in nonperforming and delinquent loans; current economic conditions in the Company’s market; portfolio concentrations that may affect loss experienced across one or more components of the portfolio; the effect of external factors such as competition, legal and regulatory requirements; and the experience, ability and depth of lending management and staff. In addition, various regulatory agencies, as an integral component of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to make loan grade changes as well as recognize additions to the allowance based on their examinations.

After a thorough consideration of the factors discussed above, any required additions or reductions to the allowance for loan losses are made periodically by charges or credits to the provision for loan losses. These charges are necessary to maintain the allowance at a level that management believes is reflective of overall level of incurred loss in the portfolio. While management uses available information to recognize losses on loans, additions and reductions of the allowance may fluctuate from one reporting period to another. These fluctuations are reflective of changes in risk associated with portfolio content or changes in management’s assessment of any or all of the determining factors discussed above.

The following tables illustrate the changes in the allowance for loan losses by our portfolio segments:

(In thousands)	Commercial Loans			Consumer Loans			Residential Real Estate			Total
Balance as of June 30, 2018	$	31,059		$	36,479		$	4,912		$	72,450
Charge-offs		(823	)		(6,818	)		(123	)		(7,764	)
Recoveries		410			1,602			81			2,093
Provision		1,086			6,044			(1,104	)		6,026
Ending Balance as of September 30, 2018	$	31,732		$	37,307		$	3,766		$	72,805

Balance as of June 30, 2017	$	24,428		$	35,523		$	6,649		$	66,600
Charge-offs		(574	)		(6,979	)		(421	)		(7,974	)
Recoveries		266			1,446			123			1,835
Provision		1,434			6,197			258			7,889
Ending Balance as of September 30, 2017	$	25,554		$	36,187		$	6,609		$	68,350

(In thousands)	Commercial Loans			Consumer Loans			Residential Real Estate			Total
Balance as of December 31, 2017	$	27,606		$	36,830		$	5,064		$	69,500
Charge-offs		(2,535	)		(21,947	)		(513	)		(24,995	)
Recoveries		780			4,946			274			6,000
Provision		5,881			17,478			(1,059	)		22,300
Ending Balance as of September 30, 2018	$	31,732		$	37,307		$	3,766		$	72,805

Balance as of December 31, 2016	$	25,444		$	33,375		$	6,381		$	65,200
Charge-offs		(2,991	)		(19,742	)		(1,717	)		(24,450	)
Recoveries		919			3,680			166			4,765
Provision		2,182			18,874			1,779			22,835
Ending Balance as of September 30, 2017	$	25,554		$	36,187		$	6,609		$	68,350

For acquired loans, to the extent that we experience deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses is established based on our estimate of incurred losses at the balance sheet date. There was no allowance for loan losses for the acquired loan portfolio as of September 30, 2018 and December 31, 2017. There were no charge-offs of acquired loans for the three months ended September 30, 2018 and 2017, and approximately $0.1 million and $0.7 million during the nine months ended September 30, 2018 and 2017 of net charge-offs of acquired loans, respectively, which are included in the table above.

The following tables illustrate the allowance for loan losses and the recorded investment by portfolio segments:

(In thousands)	Commercial Loans		Consumer Loans		Residential Real Estate		Total
As of September 30, 2018
Allowance for loan losses	$	31,732	$	37,307	$	3,766	$	72,805
Allowance for loans individually evaluated for impairment		25		-		-		25
Allowance for loans collectively evaluated for impairment	$	31,707	$	37,307	$	3,766	$	72,780
Ending balance of loans	$	3,212,577	$	2,301,198	$	1,373,487	$	6,887,262
Ending balance of originated loans individually evaluated for impairment		5,077		7,760		6,445		19,282
Ending balance of acquired loans collectively evaluated for impairment		153,808		33,994		153,073		340,875
Ending balance of originated loans collectively evaluated for impairment	$	3,053,692	$	2,259,444	$	1,213,969	$	6,527,105

As of December 31, 2017
Allowance for loan losses	$	27,606	$	36,830	$	5,064	$	69,500
Allowance for loans individually evaluated for impairment		57		-		-		57
Allowance for loans collectively evaluated for impairment	$	27,549	$	36,830	$	5,064	$	69,443
Ending balance of loans	$	3,028,269	$	2,234,349	$	1,321,021	$	6,583,639
Ending balance of originated loans individually evaluated for impairment		5,876		8,432		6,830		21,138
Ending balance of acquired loans collectively evaluated for impairment		187,313		43,906		170,472		401,691
Ending balance of originated loans collectively evaluated for impairment	$	2,835,080	$	2,182,011	$	1,143,719	$	6,160,810

Credit Quality of Loans

For all loan classes within the Company’s loan portfolio, loans are placed on nonaccrual status when timely collection of principal and/or interest in accordance with contractual terms is in doubt. Loans are transferred to nonaccrual status generally when principal or interest payments become ninety days delinquent, unless the loan is well secured and in the process of collection or sooner when management concludes circumstances indicate that borrowers may be unable to meet contractual principal or interest payments. When a loan is transferred to a nonaccrual status, all interest previously accrued in the current period but not collected is reversed against interest income in that period. Interest accrued in a prior period and not collected is charged-off against the allowance for loan losses.

If ultimate repayment of a nonaccrual loan is expected, any payments received are applied in accordance with contractual terms. If ultimate repayment of principal is not expected, any payment received on a nonaccrual loan is applied to principal until ultimate repayment becomes expected. For all loan classes within the Company’s loan portfolio, nonaccrual loans are returned to accrual status when they become current as to principal and interest and demonstrate a period of performance under the contractual terms and, in the opinion of management, are fully collectible as to principal and interest. For loans in all portfolios, the principal amount is charged off in full or in part as soon as management determines, based on available facts, that the collection of principal in full or in part is improbable. For Commercial loans, management considers specific facts and circumstances relative to individual credits in making such a determination. For Consumer and Residential Real Estate loans, management uses specific guidance and thresholds from the Federal Financial Institutions Examination Council’s Uniform Retail Credit Classification and Account Management Policy.

The following tables set forth information with regard to past due and nonperforming loans by loan class:

(In thousands)	31-60 Days Past Due Accruing		61-90 Days Past Due Accruing		Greater Than 90 Days Past Due Accruing		Total Past Due Accruing		Nonaccrual		Current		Recorded Total Loans
As of September 30, 2018
Originated
Commercial Loans:
C&I	$	209	$	41	$	-	$	250	$	908	$	857,782	$	858,940
CRE		1,133		-		-		1,133		3,637		1,708,369		1,713,139
Business Banking		1,318		98		-		1,416		5,754		479,520		486,690
Total Commercial Loans	$	2,660	$	139	$	-	$	2,799	$	10,299	$	3,045,671	$	3,058,769
Consumer Loans:
Dealer Finance	$	14,364	$	2,039	$	1,252	$	17,655	$	2,062	$	1,209,880	$	1,229,597
Specialty Lending		3,037		2,155		1,544		6,736		-		514,660		521,396
Direct		3,313		949		434		4,696		2,541		508,974		516,211
Total Consumer Loans	$	20,714	$	5,143	$	3,230	$	29,087	$	4,603	$	2,233,514	$	2,267,204
Residential Real Estate	$	1,366	$	219	$	1,231	$	2,816	$	6,106	$	1,211,492	$	1,220,414
Total Originated Loans	$	24,740	$	5,501	$	4,461	$	34,702	$	21,008	$	6,490,677	$	6,546,387

Acquired
Commercial Loans:
C&I	$	-	$	-	$	-	$	-	$	-	$	30,871	$	30,871
CRE		-		-		-		-		2		87,827		87,829
Business Banking		425		-		240		665		611		33,832		35,108
Total Commercial Loans	$	425	$	-	$	240	$	665	$	613	$	152,530	$	153,808
Consumer Loans:
Dealer Finance	$	4	$	-	$	-	$	4	$	-	$	99	$	103
Direct		223		14		-		237		275		33,379		33,891
Total Consumer Loans	$	227	$	14	$	-	$	241	$	275	$	33,478	$	33,994
Residential Real Estate	$	839	$	39	$	33	$	911	$	1,405	$	150,757	$	153,073
Total Acquired Loans	$	1,491	$	53	$	273	$	1,817	$	2,293	$	336,765	$	340,875

Total Loans	$	26,231	$	5,554	$	4,734	$	36,519	$	23,301	$	6,827,442	$	6,887,262

(In thousands)	31-60 Days Past Due Accruing		61-90 Days Past Due Accruing		Greater Than 90 Days Past Due Accruing		Total Past Due Accruing		Nonaccrual		Current		Recorded Total Loans
As of December 31, 2017
Originated
Commercial Loans:
Commercial	$	-	$	-	$	-	$	-	$	202	$	753,577	$	753,779
Commercial Real Estate		161		138		-		299		3,178		1,533,065		1,536,542
Agricultural		117		-		-		117		1,043		34,386		35,546
Agricultural Real Estate		493		-		-		493		2,736		30,905		34,134
Business Banking		1,907		597		-		2,504		5,304		473,147		480,955
Total Commercial Loans	$	2,678	$	735	$	-	$	3,413	$	12,463	$	2,825,080	$	2,840,956
Consumer Loans:
Indirect	$	18,747	$	4,033	$	3,492	$	26,272	$	2,115	$	1,642,204	$	1,670,591
Home Equity		2,887		854		341		4,082		2,736		448,081		454,899
Direct		341		108		70		519		35		64,399		64,953
Total Consumer Loans	$	21,975	$	4,995	$	3,903	$	30,873	$	4,886	$	2,154,684	$	2,190,443
Residential Real Estate	$	3,730	$	667	$	1,262	$	5,659	$	5,987	$	1,138,903	$	1,150,549
Total Originated Loans	$	28,383	$	6,397	$	5,165	$	39,945	$	23,336	$	6,118,667	$	6,181,948

Acquired
Commercial Loans:
Commercial	$	-	$	-	$	-	$	-	$	-	$	39,575	$	39,575
Commercial Real Estate		-		-		-		-		2		106,632		106,634
Business Banking		354		-		-		354		669		40,081		41,104
Total Commercial Loans	$	354	$	-	$	-	$	354	$	671	$	186,288	$	187,313
Consumer Loans:
Indirect	$	38	$	-	$	1	$	39	$	22	$	1,157	$	1,218
Home Equity		254		34		103		391		225		39,256		39,872
Direct		6		1		1		8		23		2,785		2,816
Total Consumer Loans	$	298	$	35	$	105	$	438	$	270	$	43,198	$	43,906
Residential Real Estate	$	627	$	226	$	140	$	993	$	1,431	$	168,048	$	170,472
Total Acquired Loans	$	1,279	$	261	$	245	$	1,785	$	2,372	$	397,534	$	401,691

Total Loans	$	29,662	$	6,658	$	5,410	$	41,730	$	25,708	$	6,516,201	$	6,583,639

There were no material commitments to extend further credit to borrowers with nonperforming loans as of September 30, 2018 and December 31, 2017.

Impaired Loans

The methodology used to establish the allowance for loan losses on impaired loans incorporates specific allocations on loans analyzed individually. Classified loans, including all troubled debt restructured loans (“TDRs”) and nonaccrual Commercial loans that are graded Substandard, Doubtful or Loss, with outstanding balances of $750 thousand or more are evaluated for impairment through the Company’s quarterly status review process. The Company considers Commercial loans less than $750 thousand to be homogeneous loans. In determining that we will be unable to collect all principal and/or interest payments due in accordance with the contractual terms of the loan agreements, we consider factors such as payment history and changes in the financial condition of individual borrowers, local economic conditions, historical loss experience and the conditions of the various markets in which the collateral may be liquidated. For loans that are identified as impaired, impairment is measured by one of three methods: 1) the fair value of collateral less cost to sell, 2) present value of expected future cash flows or 3) the loan’s observable market price. These impaired loans are reviewed on a quarterly basis for changes in the level of impairment. Impaired amounts are charged off immediately if such amounts are determined by management to be uncollectable. Any change to the previously recognized impairment loss is recognized as a component of the provision for loan losses.

The following table provides information on loans specifically evaluated for impairment:

	September 30, 2018						December 31, 2017
(In thousands)	Recorded Investment Balance (Book)		Unpaid Principal Balance (Legal)		Related Allowance		Recorded Investment Balance (Book)		Unpaid Principal Balance (Legal)		Related Allowance
Originated
With no related allowance recorded:
Commercial Loans:
C&I	$	404	$	676			$	-	$	-
CRE		3,629		5,616				-		-
Commercial		-		-				-		251
Commercial Real Estate		-		-				2,211		3,979
Agricultural		-		-				452		465
Agricultural Real Estate		-		-				2,250		2,423
Business Banking		1,019		2,099				860		1,730
Total Commercial Loans	$	5,052	$	8,391			$	5,773	$	8,848
Consumer Loans:
Dealer Finance	$	160	$	254			$	-	$	-
Direct		7,600		9,600				-		-
Indirect		-		-				131		143
Home Equity		-		-				8,027		9,966
Direct		-		-				274		274
Total Consumer Loans	$	7,760	$	9,854			$	8,432	$	10,383
Residential Real Estate	$	6,445	$	8,721			$	6,830	$	8,780
Total	$	19,257	$	26,966			$	21,035	$	28,011

With an allowance recorded:
Commercial Loans:
C&I	$	25	$	25	$	25	$	-	$	-	$	-
Commercial Real Estate		-		-		-		76		82		30
Agricultural		-		-		-		27		27		27
Total Commercial Loans	$	25	$	25	$	25	$	103	$	109	$	57

Total Loans	$	19,282	$	26,991	$	25	$	21,138	$	28,120	$	57

There were no acquired impaired loans specifically evaluated for impairment as of September 30, 2018 or December 31, 2017.

The following tables summarize the average recorded investments on loans specifically evaluated for impairment and the interest income recognized:

	For the three months ended
	September 30, 2018				September 30, 2017
(In thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Originated
Commercial Loans:
C&I	$	433	$	-	$	-	$	-
CRE		3,645		32		-		-
Commercial		-		-		1,000		-
Commercial Real Estate		-		-		2,415		48
Agricultural		-		-		115		-
Agricultural Real Estate		-		-		1,505		11
Business Banking		1,024		4		955		2
Total Commercial Loans	$	5,102	$	36	$	5,990	$	61
Consumer Loans:
Dealer Finance	$	177	$	4	$	-	$	-
Direct		7,730		102		-		-
Indirect		-		-		35		1
Home Equity		-		-		8,159		111
Direct		-		-		119		2
Total Consumer Loans	$	7,907	$	106	$	8,313	$	114
Residential Real Estate	$	6,519	$	68	$	6,633	$	82
Total Originated Loans	$	19,528	$	210	$	20,936	$	257

Total Loans	$	19,528	$	210	$	20,936	$	257

	For the nine months ended
	September 30, 2018				September 30, 2017
(In thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Originated
Commercial Loans:
C&I	$	449	$	1	$	-	$	-
CRE		3,999		96		-		-
Commercial		-		-		2,393		-
Commercial Real Estate		-		-		3,906		93
Agricultural		-		-		147		1
Agricultural Real Estate		-		-		1,545		32
Business Banking		998		12		837		7
Total Commercial Loans	$	5,446	$	109	$	8,828	$	133
Consumer Loans:
Dealer Finance	$	187	$	8	$	-	$	-
Direct		7,953		317		-		-
Indirect		-		-		22		2
Home Equity		-		-		8,274		331
Direct		-		-		119		2
Total Consumer Loans	$	8,140	$	325	$	8,415	$	335
Residential Real Estate	$	6,719	$	212	$	6,425	$	211
Total Originated Loans	$	20,305	$	646	$	23,668	$	679

Acquired
Commercial Loans:
Commercial Real Estate	$	-	$	-	$	121	$	-
Total Commercial Loans	$	-	$	-	$	121	$	-
Total Acquired Loans	$	-	$	-	$	121	$	-

Total Loans	$	20,305	$	646	$	23,789	$	679

Credit Quality Indicators

The Company has developed an internal loan grading system to evaluate and quantify the Company’s loan portfolio with respect to quality and risk. The system focuses on, among other things, financial strength of borrowers, experience and depth of borrower’s management, primary and secondary sources of repayment, payment history, nature of the business and outlook on particular industries. The internal grading system enables the Company to monitor the quality of the entire loan portfolio on a consistent basis and provide management with an early warning system, enabling recognition and response to problem loans and potential problem loans.

Commercial Grading System

For C&I and CRE loans, the Company uses a grading system that relies on quantifiable and measurable characteristics when available. This would include comparison of financial strength to available industry averages, comparison of transaction factors (loan terms and conditions) to loan policy and comparison of credit history to stated repayment terms and industry averages. Some grading factors are necessarily more subjective such as economic and industry factors, regulatory environment and management. C&I and CRE loans are graded Doubtful, Substandard, Special Mention and Pass.

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Doubtful

A Doubtful loan has a high probability of total or substantial loss, but because of specific pending events that may strengthen the asset, its classification as a loss is deferred. Doubtful borrowers are usually in default, lack adequate liquidity or capital and lack the resources necessary to remain an operating entity. Pending events can include mergers, acquisitions, liquidations, capital injections, the perfection of liens on additional collateral, the valuation of collateral and refinancing. Generally, pending events should be resolved within a relatively short period and the ratings will be adjusted based on the new information. Nonaccrual treatment is required for Doubtful assets because of the high probability of loss.

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Substandard

Substandard loans have a high probability of payment default or they have other well-defined weaknesses. They require more intensive supervision by bank management. Substandard loans are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity or marginal capitalization. Repayment may depend on collateral or other credit risk mitigants. For some Substandard loans, the likelihood of full collection of interest and principal may be in doubt and those loans should be placed on nonaccrual. Although Substandard assets in the aggregate will have a distinct potential for loss, an individual asset’s loss potential does not have to be distinct for the asset to be rated Substandard.

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Special Mention

Special Mention loans have potential weaknesses that may, if not checked or corrected, weaken the asset or inadequately protect the Company’s position at some future date. These loans pose elevated risk, but their weakness does not yet justify a Substandard classification. Borrowers may be experiencing adverse operating trends (i.e., declining revenues or margins) or may be struggling with an ill-proportioned balance sheet (i.e., increasing inventory without an increase in sales, high leverage, tight liquidity). Adverse economic or market conditions, such as interest rate increases or the entry of a new competitor, may also support a Special Mention rating. Although a Special Mention loan has a higher probability of default than a Pass asset, its default is not imminent.

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Pass

Loans graded as Pass encompass all loans not graded as Doubtful, Substandard or Special Mention. Pass loans are in compliance with loan covenants and payments are generally made as agreed. Pass loans range from superior quality to fair quality.

Business Banking Grading System

Business Banking loans are graded as either Classified or Non-classified:

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Classified

Classified loans are inadequately protected by the current worth and paying capacity of the obligor or, if applicable, the collateral pledged. These loans have a well-defined weakness or weaknesses, that jeopardize the liquidation of the debt or in some cases make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Classified loans have a high probability of payment default or a high probability of total or substantial loss. These loans require more intensive supervision by management and are generally characterized by current or expected unprofitable operations, inadequate debt service coverage, inadequate liquidity or marginal capitalization. Repayment may depend on collateral or other credit risk mitigants. When the likelihood of full collection of interest and principal may be in doubt, Classified loans are considered to have a nonaccrual status. In some cases, Classified loans are considered uncollectable and of such little value that their continuance as assets is not warranted.

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Non-classified

Loans graded as Non-classified encompass all loans not graded as Classified. Non-classified loans are in compliance with loan covenants and payments are generally made as agreed.

Consumer and Residential Real Estate Grading System

Consumer and Residential Real Estate loans are graded as either Nonperforming or Performing.

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Nonperforming

Nonperforming loans are loans that are 1) over 90 days past due and interest is still accruing or 2) on nonaccrual status.

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Performing

All loans not meeting any of these criteria are considered Performing.

The following tables illustrate the Company’s credit quality by loan class:

(In thousands)	As of September 30, 2018
Originated
Commercial Credit Exposure By Internally Assigned Grade:			C&I		CRE		Total
Pass			$	805,333	$	1,660,900	$	2,466,233
Special Mention				33,557		16,762		50,319
Substandard				20,050		35,477		55,527
Total			$	858,940	$	1,713,139	$	2,572,079

Business Banking Credit Exposure By Internally Assigned Grade:					Business Banking		Total
Non-classified					$	474,252	$	474,252
Classified						12,438		12,438
Total					$	486,690	$	486,690

Consumer Credit Exposure By Payment Activity:	Dealer Finance		Specialty Lending		Direct		Total
Performing	$	1,226,283	$	519,852	$	513,236	$	2,259,371
Nonperforming		3,314		1,544		2,975		7,833
Total	$	1,229,597	$	521,396	$	516,211	$	2,267,204

Residential Real Estate Credit Exposure By Payment Activity:					Residential Real Estate		Total
Performing					$	1,213,077	$	1,213,077
Nonperforming						7,337		7,337
Total					$	1,220,414	$	1,220,414

Acquired
Commercial Credit Exposure By Internally Assigned Grade:	C&I		CRE		Total
Pass	$	27,046	$	87,091	$	114,137
Special Mention		3,825		93		3,918
Substandard		-		645		645
Total	$	30,871	$	87,829	$	118,700

Business Banking Credit Exposure By Internally Assigned Grade:			Business Banking		Total
Non-classified			$	32,098	$	32,098
Classified				3,010		3,010
Total			$	35,108	$	35,108

Consumer Credit Exposure By Payment Activity:	Dealer Finance		Direct		Total
Performing	$	103	$	33,616	$	33,719
Nonperforming		-		275		275
Total	$	103	$	33,891	$	33,994

Residential Real Estate Credit Exposure By Payment Activity:			Residential Real Estate		Total
Performing			$	151,635	$	151,635
Nonperforming				1,438		1,438
Total			$	153,073	$	153,073

(In thousands)	As of December 31, 2017
Originated
Commercial Credit Exposure By Internally Assigned Grade:	Commercial		Commercial Real Estate		Agricultural		Agricultural Real Estate		Total
Pass	$	708,567	$	1,481,926	$	31,142	$	23,381	$	2,245,016
Special Mention		30,337		28,264		2,294		2,441		63,336
Substandard		14,875		26,352		2,110		8,312		51,649
Total	$	753,779	$	1,536,542	$	35,546	$	34,134	$	2,360,001

Business Banking Credit Exposure By Internally Assigned Grade:							Business Banking		Total
Non-classified							$	468,898	$	468,898
Classified								12,057		12,057
Total							$	480,955	$	480,955

Consumer Credit Exposure By Payment Activity:			Indirect		Home Equity		Direct		Total
Performing			$	1,664,984	$	451,822	$	64,848	$	2,181,654
Nonperforming				5,607		3,077		105		8,789
Total			$	1,670,591	$	454,899	$	64,953	$	2,190,443

Residential Real Estate Credit Exposure By Payment Activity:							Residential Real Estate		Total
Performing							$	1,143,300	$	1,143,300
Nonperforming								7,249		7,249
Total							$	1,150,549	$	1,150,549

Acquired
Commercial Credit Exposure By Internally Assigned Grade:			Commercial		Commercial Real Estate		Total
Pass			$	37,825	$	103,248	$	141,073
Special Mention				425		498		923
Substandard				1,325		2,888		4,213
Total			$	39,575	$	106,634	$	146,209

Business Banking Credit Exposure By Internally Assigned Grade:					Business Banking		Total
Non-classified					$	38,236	$	38,236
Classified						2,868		2,868
Total					$	41,104	$	41,104

Consumer Credit Exposure By Payment Activity:	Indirect		Home Equity		Direct		Total
Performing	$	1,195	$	39,544	$	2,792	$	43,531
Nonperforming		23		328		24		375
Total	$	1,218	$	39,872	$	2,816	$	43,906

Residential Real Estate Credit Exposure By Payment Activity:					Residential Real Estate		Total
Performing					$	168,901	$	168,901
Nonperforming						1,571		1,571
Total					$	170,472	$	170,472

Troubled Debt Restructured Loans

When the Company modifies a loan in a troubled debt restructuring, such modifications include one or a combination of the following: an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; temporary reduction in the interest rate or change in scheduled payment amount. Residential Real Estate and Consumer TDRs occurring during 2018 and 2017 were due to the reduction in the interest rate or extension of the term. Commercial TDRs during 2018 and 2017 were both a reduction of the interest rate and change in terms.

When the Company modifies a loan in a troubled debt restructuring, management measures for impairment, if any, based on the present value of the expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs. If management determines that the value of the modified loan is less than the recorded investment in the loan an impairment charge would be recognized.

The following tables illustrate the recorded investment and number of modifications for modified loans, including the recorded investment in the loans prior to a modification and the recorded investment in the loans after restructuring:

	Three months ended September 30, 2018
(Dollars in thousands)	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Consumer Loans:
Dealer Finance		8	$	90	$	89
Total Consumer Loans		8	$	90	$	89
Total Troubled Debt Restructurings		8	$	90	$	89

	Three months ended September 30, 2017
(Dollars in thousands)	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Consumer Loans:
Indirect		1	$	7	$	7
Home Equity		4		189		222
Total Consumer Loans		5	$	196	$	229
Residential Real Estate		1	$	518	$	518
Total Troubled Debt Restructurings		6	$	714	$	747

	Nine months ended September 30, 2018
(Dollars in thousands)	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial Loans:
Business Banking		3	$	369	$	371
Total Commercial Loans		3	$	369	$	371
Consumer Loans:
Dealer Finance		15	$	185	$	183
Direct		2		41		41
Total Consumer Loans		17	$	226	$	224
Residential Real Estate		5	$	323	$	323
Total Troubled Debt Restructurings		25	$	918	$	918

	Nine months ended September 30, 2017
(Dollars in thousands)	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial Loans:
Commercial		1	$	3,300	$	3,239
Business Banking		1		337		333
Total Commercial Loans		2	$	3,637	$	3,572
Consumer Loans:
Indirect		4	$	39	$	37
Home Equity		8		373		414
Direct		1		120		120
Total Consumer Loans		13	$	532	$	571
Residential Real Estate		8	$	1,066	$	1,068
Total Troubled Debt Restructurings		23	$	5,235	$	5,211

The following tables illustrate the recorded investment and number of modifications for TDRs where a concession has been made and subsequently defaulted during the period:

	Three months ended September 30, 2018				Three months ended September 30, 2017
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
Consumer Loans:
Indirect		-	$	-		1	$	13
Home Equity		-		-		12		622
Direct		17		816		-		-
Total Consumer Loans		17	$	816		13	$	635
Residential Real Estate		5	$	398		6	$	546
Total Troubled Debt Restructurings		22	$	1,214		19	$	1,181

	Nine months ended September 30, 2018				Nine months ended September 30, 2017
(Dollars in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
Commercial Loans:
Commercial		-	$	-		1	$	145
Business Banking		2		258		1		329
Total Commercial Loans		2	$	258		2	$	474
Consumer Loans:
Indirect		-	$	-		2	$	19
Home Equity		-		-		30		1,381
Direct		35		1,740		-		-
Total Consumer Loans		35	$	1,740		32	$	1,400
Residential Real Estate		17	$	1,239		12	$	817
Total Troubled Debt Restructurings		54	$	3,237		46	$	2,691