ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is maintained at a level considered adequate to provide for our estimate of probable credit losses inherent in the loan portfolio. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. Loans are charged against the allowance for loan losses when we believe that collectability is unlikely. While we use the best information available to make our evaluation, future adjustments may be necessary if there are significant changes in conditions.

The allowance is comprised of three distinct components: (1) specific allowances related to loans individually evaluated, (2) quantitative allowances related to loans collectively evaluated and (3) qualitative allowances related to loans collectively evaluated. A summary of the methodology we employ on a quarterly basis with respect to each of these components in order to evaluate the overall adequacy of our allowance for loan losses is as follows.

Specific Allowance for Loans Individually Evaluated

First, we identify loan relationships having aggregate balances in excess of $500,000 and that may also have credit weaknesses. Such loan relationships are identified primarily through our analysis of internal loan evaluations, past due loan reports and loans adversely classified internally or by regulatory authorities. Each loan so identified is then individually evaluated to determine whether it is impaired – that is, based on current information and events, it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the underlying loan agreement. Substantially all of our impaired loans historically have been collateral dependent, meaning repayment of the loan is expected or is considered to be provided solely from the sale of the loan’s underlying collateral. For such loans, we measure impairment based on the fair value of the loan’s collateral, which is generally determined utilizing current appraisals. A specific allowance is established in an amount equal to the excess, if any, of the recorded investment in each impaired loan over the fair value of its underlying collateral, less estimated costs to sell. Our policy is to re-evaluate the fair value of collateral dependent loans at least every twelve months unless there is a known deterioration in the collateral’s value, in which case a new appraisal is obtained.

PCI loans are individually evaluated. The evaluation of the PCI loans requires continued quarterly assessment of key assumptions and estimates similar to the initial fair value estimate, including changes in the severity of loss, timing and speed of payments, collateral value changes, expected cash flows and other relevant factors. The quarterly assessment is compared to the recorded investment and a determination is made if an adjustment to the allowance for loan loss is deemed necessary.

Quantitative Allowance for Loans Collectively Evaluated

Second, we stratify the loan portfolio into eleven loan pools. Quantitative allowances relative to each loan pool are established as follows: we calculate a historical loss rate utilizing the net loan charge-offs experienced for the most recent twelve quarters for each loan pool. This historical loss rate is applied to the aggregate recorded investment as of the financial statement date for each pool. We believe that the most recent twelve quarter historical loss rate to be the most indicative of the losses that can be expected. Purchased performing loans are collectively evaluated as their own separate category within each loan pool. The historical loss rate, as calculated above for each pool, is applied to the principal balance of purchased performing loans by pool. The calculated allowance is then compared to the estimated fair value discount remaining to determine if the discount remains adequate. If the discount remaining is not adequate, additional allowances will be recognized.

Qualitative Allowance for Loans Collectively Evaluated

Third, we consider the necessity to adjust our average historical net loan charge-off rates relative to each of the above eleven loan pools for potential risks factors that could result in actual losses deviating from prior loss experience. For example, if we observe a significant increase in delinquencies within the conventional mortgage loan pool above historical trends, an additional allocation to the average historical loan charge-off rate is applied. Such qualitative risk factors considered are: (1) levels of and trends in delinquencies and impaired loans, (2) levels of and trends in charge-offs and recoveries, (3) trends in volume and term of loans, (4) effects of any changes in risk selection and underwriting standards and other changes in lending policies, procedures and practice, (5) experience, ability and depth of lending management and other relevant staff, (6) national and local economic trends and conditions, (7) industry conditions and (8) effects of changes in credit concentrations.

An analysis of the allowance for loan losses for the years ended December 31, 2019, 2018 and 2017 is as follows:



Dollars in thousands	2019		2018		2017

Balance, beginning of year	$	13,047	$	12,565	$	11,674
Losses:
Commercial	281		248		23
Commercial real estate
Owner occupied	2		38		5
Non-owner occupied	170		619		65
Construction and development
Land and land development	2		259		3
Construction	—		—		33
Residential real estate
Non-jumbo	979		887		359
Jumbo	—		—		2
Home equity	24		26		158
Mortgage warehouse lines	—		—		—
Consumer	285		244		389
Other	360		282		251
Total	2,103		2,603		1,288
Recoveries:
Commercial	17		16		124
Commercial real estate
Owner occupied	21		23		89
Non-owner occupied	1		—		91
Construction and development
Land and land development	108		270		278
Construction	—		—		—
Real estate - mortgage
Non-jumbo	125		228		134
Jumbo	—		25		—
Home equity	19		10		30
Mortgage warehouse lines	—		—		—
Consumer	168		141		82
Other	121		122		101
Total	580		835		929
Net losses	1,523		1,768		359
Provision for loan losses	1,550		2,250		1,250
Balance, end of year	$	13,074	$	13,047	$	12,565

The following tables present the activity in the allowance for loan losses, balance in allowance for loan losses and recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2019 and 2018.



	For the Year Ended December 31, 2019												At December 31, 2019								At December 31, 2019
	Allowance for loan losses												Allowance related to:								Loans
Dollars in thousands	Beginning Balance		Charge- offs			Recoveries		Provision			Ending Balance		Loans individua- lly evaluated for impairm- ent		Loans collective- ly evaluated for impairm- ent		Loans acquired with deteriora- ted credit quality (PCI)		Total		Loans individua- lly evaluated for impairm- ent		Loans collectively evaluated for impairment		Loans acquired with deteriora- ted credit quality (PCI)		Total
Commercial	$	1,705	$	(281	)	$	17	$	(295	)	$	1,146	$	51	$	1,095	$	—	$	1,146	$	5,285	$	201,853	$	—	$	207,138
Commercial real estate
Owner occupied	2,214		(2		)	21		467			2,700		409		2,291		—		2,700		11,085		265,133		—		276,218
Non-owner occupied	5,742		(170		)	1		366			5,939		113		5,821		5		5,939		9,054		619,499		653		629,206
Construction and development
Land and land development	339		(2		)	108		155			600		589		11		—		600		1,960		82,152		—		84,112
Construction	64		—			—		178			242		—		242		—		242		—		37,523		—		37,523
Residential real estate
Non-jumbo	2,090		(979		)	125		576			1,812		173		1,624		15		1,812		5,263		348,453		1,247		354,963
Jumbo	379		—			—		(368		)	11		—		11		—		11		3,980		66,023		944		70,947
Home equity	167		(24		)	19		(24		)	138		—		138		—		138		523		76,045		—		76,568
Mortgage warehouse lines	—		—			—		—			—		—		—		—		—		—		126,237		—		126,237
Consumer	79		(285		)	168		173			135		—		135		—		135		13		36,457		—		36,470
Other	268		(360		)	121		322			351		—		351		—		351		—		14,117		—		14,117
Total	$	13,047	$	(2,103	)	$	580	$	1,550		$	13,074	$	1,335	$	11,719	$	20	$	13,074	$	37,163	$	1,873,492	$	2,844	$	1,913,499



	For the Year Ended December 31, 2018												At December 31, 2018								At December 31, 2018
	Allowance for loan losses												Allowance related to:								Loans
Dollars in thousands	Beginning Balance		Charge- offs			Recoveries		Provision			Ending Balance		Loans individua- lly evaluated for impairm- ent		Loans collective- ly evaluated for impairm- ent		Loans acquired with deteriora- ted credit quality (PCI)		Total		Loans individua- lly evaluated for impairm- ent		Loans collectively evaluated for impairment		Loans acquired with deteriora- ted credit quality (PCI)		Total
Commercial	$	1,303	$	(248	)	$	16	$	634		$	1,705	$	682	$	1,023	$	—	$	1,705	$	4,362	$	189,953	$	—	$	194,315
Commercial real estate
Owner occupied	2,424		(38		)	23		(195		)	2,214		462		1,752		—		2,214		11,569		254,793		—		266,362
Non-owner occupied	4,950		(619		)	—		1,411			5,742		9		5,729		4		5,742		9,855		553,809		1,162		564,826
Construction and development
Land and land development	641		(259		)	270		(313		)	339		298		41		—		339		5,824		63,009		—		68,833
Construction	153		—			—		(89		)	64		—		64		—		64		—		24,731		—		24,731
Residential real estate
Non-jumbo	1,911		(887		)	228		838			2,090		585		1,495		10		2,090		6,261		329,342		1,374		336,977
Jumbo	72		—			25		282			379		106		273		—		379		4,953		67,671		975		73,599
Home equity	638		(26		)	10		(455		)	167		—		167		—		167		523		80,387		—		80,910
Mortgage warehouse lines	—		—			—		—			—		—		—		—		—		—		39,140		—		39,140
Consumer	210		(244		)	141		(28		)	79		—		79		—		79		9		32,451		—		32,460
Other	263		(282		)	122		165			268		—		268		—		268		—		12,899		—		12,899
Total	$	12,565	$	(2,603	)	$	835	$	2,250		$	13,047	$	2,142	$	10,891	$	14	$	13,047	$	43,356	$	1,648,185	$	3,511	$	1,695,052