Note 6. Allowance for Loan Losses

The Company maintains an allowance for loan losses in an amount determined by management on the basis of the character of the loans, loan performance, the financial condition of borrowers, the value of collateral securing loans and other relevant factors.

The following table summarizes the changes in the Company’s allowance for loan losses for the periods indicated.


	Three months ended September 30,						Nine months ended September 30,
	2013			2012			2013			2012
	(in thousands)
Allowance for loan losses, beginning of period	$	20,500		$	17,979		$	19,197		$	16,574
Loans charged off		(149	)		(728	)		(682	)		(1,787	)
Recoveries on loans previously charged-off		149			157			485			621

Net charge-offs		—			(571	)		(197	)		(1,166	)
Provision charged to expense		750			1,250			2,250			3,250

Allowance for loan losses, end of period	$	21,250		$	18,658		$	21,250		$	18,658

Further information pertaining to the allowance for loan losses for the three months ending September 30, 2013 follows:


	Construction and Land Development			Commercial and Industrial			Commercial Real Estate		Residential Real Estate		Consumer			Home Equity		Unallocated			Total
	(Dollars in thousands)
Allowance for loan losses:

Balance at June 30, 2013	$	3,241		$	3,215		$	9,424	$	2,030	$	363		$	932	$	1,295		$	20,500
Charge-offs		—			—			—		—		(149	)		—		—			(149	)
Recoveries		—			42			2		4		101			—		—			149
Provision		(114	)		(534	)		1,162		176		76			17		(33	)		750

Ending balance at September 30, 2013	$	3,127		$	2,723		$	10,588	$	2,210	$	391		$	949	$	1,262		$	21,250

Amount of allowance for loan losses for loans deemed to be impaired	$	1,000		$	90		$	445	$	139	$	—		$	95	$	—			1,769

Amount of allowance for loan losses for loans not deemed to be impaired	$	2,127		$	2,633		$	10,143	$	2,071	$	391		$	854	$	1,262		$	19,481


Loans:
Ending balance	$	32,750		$	87,468		$	666,166	$	309,291	$	8,728		$	126,645	$	—		$	1,231,048

Loans deemed to be impaired	$	1,500		$	1,132		$	4,688	$	1,151	$	—		$	95	$	—		$	8,566

Loans not deemed to be impaired	$	31,250		$	86,336		$	661,478	$	308,140	$	8,728		$	126,550	$	—		$	1,222,482

Further information pertaining to the allowance for loan losses for the nine months ending September 30, 2013 follows:


	Construction and Land Development		Commercial and Industrial			Commercial Real Estate		Residential Real Estate		Consumer			Home Equity		Unallocated		Total
	(Dollars in thousands)
Allowance for loan losses:

Balance at December 31, 2012	$	3,041	$	3,118		$	9,065	$	1,994	$	333		$	886	$	760	$	19,197
Charge-offs		—		(234	)		—		—		(448	)		—		—		(682	)
Recoveries		—		163			5		9		307			1		—		485
Provision		86		(324	)		1,518		207		199			62		502		2,250

Ending balance at September 30, 2013	$	3,127	$	2,723		$	10,588	$	2,210	$	391		$	949	$	1,262	$	21,250

Amount of allowance for loan losses for loans deemed to be impaired	$	1,000	$	90		$	445	$	139	$	—		$	95	$	—		1,769

Amount of allowance for loan losses for loans not deemed to be impaired	$	2,127	$	2,633		$	10,143	$	2,071	$	391		$	854	$	1,262	$	19,481


Loans:
Ending balance	$	32,750	$	87,468		$	666,166	$	309,291	$	8,728		$	126,645	$	—	$	1,231,048

Loans deemed to be impaired	$	1,500	$	1,132		$	4,688	$	1,151	$	—		$	95	$	—	$	8,566

Loans not deemed to be impaired	$	31,250	$	86,336		$	661,478	$	308,140	$	8,728		$	126,550	$	—	$	1,222,482

Further information pertaining to the allowance for loan losses for three months ending September 30, 2012 follows:


	Construction and Land Development		Commercial and Industrial			Commercial Real Estate		Residential Real Estate			Consumer			Home Equity		Unallocated			Total
	(Dollars in thousands)
Allowance for loan losses:

Balance at June 30, 2012	$	2,889	$	3,466		$	7,754	$	1,793		$	293		$	681	$	1,103		$	17,979
Charge-offs		—		(532	)		—		(49	)		(147	)		—		—			(728	)
Recoveries		—		38			2		2			99			16		—			157
Provision		140		133			967		240			52			176		(458	)		1,250

Ending balance at September 30, 2012	$	3,029	$	3,105		$	8,723	$	1,986		$	297		$	873	$	645		$	18,658

Amount of allowance for loan losses for loans deemed to be impaired	$	1,000	$	455		$	434	$	127		$	—		$	97	$	—			2,113

Amount of allowance for loan losses for loans not deemed to be impaired	$	2,029	$	2,650		$	8,289	$	1,859		$	297		$	776	$	645		$	16,545


Loans:
Ending balance	$	38,318	$	78,567		$	562,252	$	262,426		$	6,661		$	116,699	$	—		$	1,064,923

Loans deemed to be impaired	$	1,500	$	1,882		$	2,302	$	777		$	—		$	97	$	—		$	6,558

Loans not deemed to be impaired	$	36,818	$	76,685		$	559,950	$	261,649		$	6,661		$	116,602	$	—		$	1 058,365

Further information pertaining to the allowance for loan losses for nine months ending September 30, 2012 follows:


	Construction and Land Development		Commercial and Industrial			Commercial Real Estate		Residential Real Estate			Consumer			Home Equity			Unallocated			Total
	(Dollars in thousands)
Allowance for loan losses:
Balance at December 31, 2011	$	2,893	$	3,139		$	6,566	$	1,886		$	356		$	704		$	1,030		$	16,574
Charge-offs		—		(931	)		—		(110	)		(587	)		(159	)		—			(1,787	)
Recoveries		—		243			5		11			346			16			—			621
Provision		136		654			2,152		199			182			312			(385	)		3,250

Ending balance at September 30, 2012	$	3,029	$	3,105		$	8,723	$	1,986		$	297		$	873		$	645		$	18,658

Amount of allowance for loan losses for loans deemed to be impaired	$	1,000	$	455		$	434	$	127		$	—		$	97		$	—		$	2,113

Amount of allowance for loan losses for loans not deemed to be impaired	$	2,029	$	2,649		$	8,289	$	1,859		$	297		$	776		$	645		$	16,545


Loans:
Ending balance	$	38,318	$	78,567		$	562,252	$	262,426		$	6,661		$	116,699		$	—		$	1,064,923

Loans deemed to be impaired	$	1,500	$	1,882		$	2,302	$	777		$	—		$	97		$	—		$	6,558

Loans not deemed to be impaired	$	36,818	$	76,685		$	559,950	$	261,649		$	6,661		$	116,602		$	—		$	1 058,365

The Company utilizes a six grade internal loan rating system for commercial real estate, construction and commercial loans as follows:

Loans rated 1-3 (Pass):

Loans in this category are considered “pass” rated loans with low to average risk.

Loans rated 4 (Monitor):

These loans represent classified loans that management is closely monitoring for credit quality. These loans have had or may have minor credit quality deterioration as of September 30, 2013 and December 31, 2012.

Loans rated 5 (Substandard):

Substandard loans represent classified loans that management is closely monitoring for credit quality. These loans have had more significant credit quality deterioration as of September 30, 2013 and December 31, 2012.

Loans rated 6 (Doubtful):

Doubtful loans represent classified loans that management is closely monitoring for credit quality. These loans had more significant credit quality deterioration as of September 30, 2013 and December 31, 2012 and are doubtful for full collection.

Impaired:

Impaired loans represent classified loans that management is closely monitoring for credit quality. A loan is classified as impaired when it is probable that the Company will be unable to collect all amounts due.

The following table presents the Company’s loans by risk rating at September 30, 2013.

Construction
and land
development

Commercial
and
industrial

Commercial
real
estate

(Dollars in thousands)

Grade:

1-3 (Pass)

23,789

85,797

660,114

4 (Monitor)

7,461

539

1,364

5 (Substandard)

—

6 (Doubtful)

—

Impaired

1,500

1,132

4,688

Total

32,750

87,468

666,166

The following table presents the Company’s loans by risk rating at December 31, 2012.


	Construction and land development		Commercial and industrial		Commercial real estate
	(Dollars in thousands)
Grade:
1-3(Pass)	$	29,719	$	86,587	$	569,760
4 (Monitor)		7,399		606		4,424
5 (Substandard)		—		—		—
6 (Doubtful)		—		—		—
Impaired		1,500		1,282		2,281

Total	$	38,618	$	88,475	$	576,465

The Company utilized payment performance as credit quality indicators for residential real estate, consumer and overdrafts, and the home equity portfolio. The indicators are depicted in the table “aging of past due loans,” below.

Further information pertaining to the allowance for loan losses at September 30, 2013 follows:

Accruing
30-89 Days
Past Due

Non Accrual

Accrual
Greater
Than
90 Days

Total
Past Due

Current Loans

Total

(Dollars in thousands)

Construction and land development

—

1,500

—

1,500

31,250

32,750

Commercial and industrial

392

501

—

893

86,575

87,468

Commercial real estate

3,174

448

—

3,622

662,544

666,166

Residential real estate

1,907

1,270

—

3,177

306,114

309,291

Consumer and overdrafts

—

8,719

8,728

Home equity

1,147

—

1,171

125,474

126,645

Total

6,627

3,745

—

10,372

1,220,676

1,231,048

Further information pertaining to the allowance for loan losses at December 31, 2012 follows:


	Accruing 30-89 Days Past Due		Non Accrual		Accrual Greater Than 90 Days		Total Past Due		Current Loans		Total
	(Dollars in thousands)

Construction and land development	$	—	$	1,500	$	—	$	1,500	$	37,118	$	38,618
Commercial and industrial		1,256		676				1,932		86,543		88,475
Commercial real estate		3,450		674		—		4,124		572,341		576,465
Residential real estate		864		1,597		—		2,461		279,396		281,857
Consumer and overdrafts		32		24		—		56		7,394		7,450
Home equity		1,088		—		—		1,088		117,835		118,923

Total	$	6,690	$	4,471	$	—	$	11,161	$	1,100,627	$	1,111,788

A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company measures impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Loans are charged-off when management believes that the collectability of the loan’s principal is not probable. The specific factors that management considers in making the determination that the collectability of the loan’s principal is not probable include; the delinquency status of the loan, the fair value of the collateral, if secured, and the financial strength of the borrower and/or guarantors. For collateral dependent loans, the amount of the recorded investment in a loan that exceeds the fair value of the collateral is charged-off against the allowance for loan losses in lieu of an allocation of a specific allowance amount when such an amount has been identified definitively as uncollectible. The Company’s policy for recognizing interest income on impaired loans is contained within Note 1 of the consolidated financial statements contained in the Company’s Annual Report for the fiscal year ended December 31, 2012.

The following is information pertaining to impaired loans for September 30, 2013:


	Carrying Value		Unpaid Principal Balance		Required Reserve		Average Carrying Value for 3 Months Ending 9/30/13		Average Carrying Value for 9 Months Ending 9/30/13		Interest Income Recognized For 3 Months Ending 9/30/13		Interest Income Recognized For 9 months Ending 9/30/13
	(Dollars in thousands)
With no required reserve recorded:
Construction and land development	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Commercial and industrial		264		294		—		239		390		—		1
Commercial real estate		218		218		—		126		133		—		—
Residential real estate		254		263		—		260		145		—		—
Consumer		—		—		—		—		—		—		—
Home equity		—		—		—		—		—		—		—

Total	$	736	$	775	$	—	$	625	$	668	$	—	$	1

With required reserve recorded:
Construction and land development	$	1,500	$	3,292	$	1,000	$	1,500	$	1,500	$	—	$	—
Commercial and industrial		868		1,101		90		885		864		12		29
Commercial real estate		4,470		4,558		445		2,796		2,394		26		72
Residential real estate		897		979		139		901		853		—		—
Consumer		—		—		—		—		—		—		—
Home equity		95		95		95		95		96		—		—

Total	$	7,830	$	10,025	$	1,769	$	6,177	$	5,707	$	38	$	101


Total:

Construction and land development	$	1,500	$	3,292	$	1,000	$	1,500	$	1,500	$	—	$	—
Commercial and industrial		1,132		1,395		90		1,124		1,254		12		30
Commercial real estate		4,688		4,776		445		2,922		2,527		26		72
Residential real estate		1,151		1,242		139		1,161		998		—		—
Consumer		—		—		—		—		—		—		—
Home equity		95		95		95		95		96		—		—

Total	$	8,566	$	10,800	$	1,769	$	6,802	$	6,375	$	38	$	102

The following is information pertaining to impaired loans for September 30, 2012:


	Carrying Value		Unpaid Principal Balance		Required Reserve		Average Carrying Value for 3 Months Ending 9/30/12		Average Carrying Value for 9 Months Ending 9/30/12		Interest Income Recognized For 3 Months Ending 9/30/12		Interest Income Recognized For 9 months Ending 9/30/12
			(Dollars in thousands)

With no required reserve recorded:
Construction and land development	$	—	$	—	$	—	$	—	$	450	$	—	$	—
Commercial and industrial		635		1,346		—		473		382		—		—
Commercial real estate		172		200		—		174		178		—		—
Residential real estate		31		31		—		218		152		—		—
Consumer		—		—		—		—		—		—		—
Home equity		—		—		—		—		—		—		—

Total	$	838	$	1,577	$	—	$	865	$	1,162	$	—	$	—

With required reserve recorded:
Construction and land development	$	1,500	$	3,292	$	1,000	$	1,500	$	1,050	$	—	$	—
Commercial and industrial		1,247		1,295		455		1,745		1,492		12		35
Commercial real estate		2,130		2,170		434		2,138		3,027		40		84
Residential real estate		746		746		127		494		610		1		1
Consumer		—		—		—		—		—		—		—
Home equity		97		97		97		73		29		—		—

Total	$	5,720	$	7,600	$	2,113	$	5,950	$	6,208	$	53	$	120

Total

Construction and land development	$	1,500	$	3,292	$	1,000	$	1,500	$	1,500	$	—	$	—
Commercial and industrial		1,882		2,641		455		2,218		1,874		12		35
Commercial real estate		2,302		2,370		434		2,312		3,205		40		84
Residential real estate		777		777		127		712		762		1		1
Consumer		—		—		—		—		—		—		—
Home equity		97		97		97		73		29		—		—

Total	$	6,558	$	9,177	$	2,113	$	6,815	$	7,370	$	53	$	120

There were no troubled debt restructurings occurring during the nine month period ended September 30, 2012.

Troubled Debt Restructurings occurring during the three and nine month periods ended September 30, 2013:


	Number of Contracts		Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment
	(Dollars in thousands)
Construction and land development		1	$	108	$	108
Commercial and industrial		1		41		41
Commercial real estate		1		2,247		2,242

Total		3	$	2,396	$	2,391

Troubled Debt Restructurings were identified as a modification in which a concession was granted to a customer who is having financial difficulties. This concession may be below market rate, longer amortization/term, and a lower payment amount. The present value calculation of the modification did not result in an increase in the allowance for these loans beyond any previously established allocations. There were no troubled debt restructurings that subsequently defaulted. The loans were modified, for the loans, by reducing interest rates as well as extending term for the commercial and industrial loan. The financial impact of the modifications for performing commercial and industrial loans were $366 reduction in principal and $217 reduction in interest payments for the quarter and year-to-date ended September 30, 2013 The financial impact of the modifications for performing commercial real estate loans were $1,786 increase in principal and $7,907 reduction in interest payments for the quarter and year-to-date ended September 30, 2013. The financial impact of the modifications for performing construction and land development loans were $530 reduction in principal and $415 reduction in interest payments for the quarter and year-to-date ended September 30, 2013.