(5) Allowance for Loan Losses

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Company has segmented certain loans in the portfolio by product type. Historical loss percentages for each risk category are calculated and used as the basis for calculating loan loss allowance allocations. These historical loss percentages are calculated over a two-year period for all portfolio segments. Certain economic factors are also considered for trends which management uses to establish the directionality of changes to the unallocated portion of the reserve. The following economic factors are analyzed:

•

Changes in lending policies and procedures

•

Changes in experience and depth of lending and management staff

•

Changes in quality of Citizens’ credit review system

•

Changes in nature and volume of the loan portfolio

•

Changes in past due, classified and nonaccrual loans and TDRs

•

Changes in economic and business conditions

•

Changes in competition or legal and regulatory requirements

•

Changes in concentrations within the loan portfolio

•

Changes in the underlying collateral for collateral dependent loans

The total allowance reflects management’s estimate of loan losses inherent in the loan portfolio at the balance sheet date. The Company considers the allowance for loan losses of $15,395 adequate to cover loan losses inherent in the loan portfolio, at June 30, 2014. The following tables present, by portfolio segment, the changes in the allowance for loan losses and the loan balances outstanding for the six months ended June 30, 2014 and 2013.


	Commercial & Agriculture			Commercial Real Estate			Residential Real Estate			Real Estate Construction		Consumer and Other			Unallocated			Total
For the six months ended June 30, 2014
Allowance for loan losses:
Beginning balance	$	2,841		$	7,559		$	5,224		$	184	$	214		$	506		$	16,528
Charge-offs		(313	)		(1,574	)		(1,054	)		—		(43	)		—			(2,984	)
Recoveries		95			99			121			3		33			—			351
Provision		(556	)		1,904			148			100		(8	)		(88	)		1,500

Ending Balance	$	2,067		$	7,988		$	4,439		$	287	$	196		$	418		$	15,395

For the six months ended June 30, 2014, the allowance for Commercial & Agriculture loans was reduced not only by charge-offs, but also due to a decrease in both the loan balances outstanding and the specific reserve required for this type. The net result of these changes was represented as a decrease in the provision. The increase in the allowance for Commercial Real Estate loans was the result of large charge offs, which led to increased general reserves due to an increase in loss rate. The net result of these changes was represented as an increase in the provision. The allowance for Residential Real Estate loans decreased during the period due to charge-offs of loans that had a specific reserve previously applied, a reduction in total loans past due and a reduction in nonaccrual loans. The net result of these changes was represented as a decrease in the provision. The loss rate on Consumer loans decreased for the six months ended June 30, 2014 and is reflected in a negative provision. Overall, we have seen continued improvement in asset quality, leading to a small decrease in unallocated reserves.


	Commercial & Agriculture			Commercial Real Estate			Residential Real Estate			Real Estate Construction			Consumer and Other			Unallocated		Total
For the six months ended June 30, 2013
Allowance for loan losses:
Beginning balance	$	2,811		$	10,139		$	5,780		$	349		$	246		$	417	$	19,742
Charge-offs		(92	)		(631	)		(1,021	)		—			(122	)		—		(1,866	)
Recoveries		62			223			301			106			37			—		729
Provision		994			(575	)		109			(271	)		(12	)		555		800

Ending Balance	$	3,775		$	9,156		$	5,169		$	184		$	149		$	972	$	19,405

For the six months ended June 30, 2013, the allowance for Commercial and Agriculture loans increased primarily as a result of reserves on specific loans. There was also an increase related to increased loan balances. The allowance for Commercial Real Estate loans was reduced not only by charge-offs, but also due to a decrease in both the loan balances outstanding and the specific reserve required for this type. The net result of these changes was represented as a decrease in the provision. The allowance for Residential Real Estate loans decreased as a result of charged-off loans for which there had previously been a specific reserve. The allowance for Real Estate Construction loans was reduced as a result of changes to specific reserves required and the historical charge-offs for this type. The result of these changes was represented as a decrease in the provision. The allowance for Consumer loans was reduced as a result of changes to the historical charge-offs for this type. While we saw improvement in asset quality during the period, given the uncertainty in the economy, management determined that it was appropriate to maintain unallocated reserves at a higher level.


	Commercial & Agriculture			Commercial Real Estate			Residential Real Estate			Real Estate Construction			Consumer and Other			Unallocated			Total
For the three months ended June 30, 2014
Allowance for loan losses:
Beginning balance	$	2,607		$	7,997		$	5,050		$	295		$	239		$	579		$	16,767
Charge-offs		(84	)		(1,500	)		(737	)		—			(11	)		—			(2,332	)
Recoveries		37			82			72			2			17			—			210
Provision		(493	)		1,409			54			(10	)		(49	)		(161	)		750

Ending Balance	$	2,067		$	7,988		$	4,439		$	287		$	196		$	418		$	15,395

For the three months ended June 30, 2014, the allowance for Commercial and Agriculture loans decreased both as a result of decreased reserves on specific loans and a decrease in the loss rate. The result of these changes was represented as a decrease in the provision. The allowance for Commercial Real Estate loans was reduced by charge-offs, which was partially offset by an increase in the loss rate. The impact of these two changes was nearly equal and offsetting. The allowance for Residential Real Estate loans was reduced as a result of charge offs, a reduction in total loans past due and a reduction in nonaccrual loans, partially offset by changes related to increased volume. The net result of these changes was represented as a decrease in the provision. We have seen continued improvement in asset quality, leading to a small decrease in unallocated reserves.


	Commercial & Agriculture			Commercial Real Estate			Residential Real Estate			Real Estate Construction			Consumer and Other			Unallocated		Total
For the three months ended June 30, 2013
Allowance for loan losses:
Beginning balance	$	2,937		$	9,924		$	5,414		$	314		$	225		$	896	$	19,710
Charge-offs		(92	)		(319	)		(534	)		—			(40	)		—		(985	)
Recoveries		21			133			145			54			27			—		380
Provision		909			(582	)		144			(184	)		(63	)		76		300

Ending Balance	$	3,775		$	9,156		$	5,169		$	184		$	149		$	972	$	19,405

For the three months ended June 30, 2013, the allowance for Commercial and Agriculture loans increased both as a result of increased reserves on specific loans and reserves related to increased loan balances. The allowance for Commercial Real Estate loans was reduced not only by charge-offs, but also due to a decrease in both the loan balances outstanding and the specific reserve required for this type. The allowance for Real Estate Construction loans was reduced as a result of changes to specific reserves required and the historical charge-offs for this type. The allowance for Consumer loans was reduced as a result of changes to the historical charge-offs for this type. The result of these changes for each loan type was represented as a decrease in the provision. While we saw improvement in asset quality during the period, given the uncertainty in the economy, management determined that it was appropriate to maintain unallocated reserves at a higher level.


	Commercial & Agriculture		Commercial Real Estate		Residential Real Estate		Real Estate Construction		Consumer and Other		Unallocated		Total
June 30, 2014
Allowance for loan losses:
Ending balance:
Individually evaluated for impairment	$	769	$	175	$	377	$	—	$	—	$	—	$	1,321
Ending balance:
Collectively evaluated for impairment	$	1,298	$	7,813	$	4,062	$	287	$	196	$	418	$	14,074

Ending Balance	$	2,067	$	7,988	$	4,439	$	287	$	196	$	418	$	15,395

Loan balances outstanding:
Ending balance:
Individually evaluated for impairment	$	3,339	$	8,840	$	3,445	$	—	$	6			$	15,630
Ending balance:
Collectively evaluated for impairment	$	104,430	$	432,423	$	251,227	$	51,243	$	13,025			$	852,348

Ending Balance	$	107,769	$	441,263	$	254,672	$	51,243	$	13,031			$	867,978


	Commercial & Agriculture		Commercial Real Estate		Residential Real Estate		Real Estate Construction		Consumer and Other		Unallocated		Total
December 31, 2013
Allowance for loan losses:
Ending balance:
Individually evaluated for impairment	$	1,262	$	445	$	802	$	—	$	—	$	—	$	2,509
Ending balance:
Collectively evaluated for impairment	$	1,579	$	7,114	$	4,422	$	184	$	214	$	506	$	14,019

Ending Balance	$	2,841	$	7,559	$	5,224	$	184	$	214	$	506	$	16,528

Loan balances outstanding:
Ending balance:
Individually evaluated for impairment	$	3,869	$	10,175	$	4,005	$	—	$	8			$	18,057
Ending balance:
Collectively evaluated for impairment	$	112,006	$	433,671	$	246,686	$	39,964	$	10,857			$	843,184

Ending Balance	$	115,875	$	443,846	$	250,691	$	39,964	$	10,865			$	861,241

The following tables present credit exposures by internally assigned grades for the periods ended June 30, 2014 and December 31, 2013. The remaining loans in Residential Real Estate, Real Estate Construction and Consumer and Other loans that are not assigned a risk grade are presented in a separate table below. The risk rating analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The Company’s internal credit risk grading system is based on experiences with similarly graded loans.

The Company’s internally assigned grades are as follows:

•

Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.

•

Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.

•

Substandard – loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that Citizens will sustain some loss if the deficiencies are not corrected.

•

Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.

•

Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.

Generally, Residential Real Estate, Real Estate Construction and Consumer and Other loans are not risk-graded, except when collateral is used for a business purpose.


	Commercial & Agriculture		Commercial Real Estate		Residential Real Estate		Real Estate Construction		Consumer and Other		Total
June 30, 2014
Pass	$	98,393	$	409,690	$	93,980	$	47,389	$	4,081	$	653,533
Special Mention		3,747		15,509		899		20		—		20,175
Substandard		5,629		16,064		9,843		8		75		31,619
Doubtful		—		—		—		—		—		—

Ending Balance	$	107,769	$	441,263	$	104,722	$	47,417	$	4,156	$	705,327


	Commercial & Agriculture		Commercial Real Estate		Residential Real Estate		Real Estate Construction		Consumer and Other		Total
December 31, 2013
Pass	$	107,923	$	415,938	$	98,700	$	35,495	$	2,252	$	660,308
Special Mention		2,038		9,145		986		21		—		12,190
Substandard		5,914		18,763		8,175		—		70		32,922
Doubtful		—		—		2,349		—		—		2,349

Ending Balance	$	115,875	$	443,846	$	110,210	$	35,516	$	2,322	$	707,769

The following tables present performing and nonperforming loans based solely on payment activity for the periods ended June 30, 2014 and December 31, 2013 that have not been assigned an internal risk grade. The types of loans presented here are not assigned a risk grade unless there is evidence of a problem. Payment activity is reviewed by management on a monthly basis to evaluate performance. Loans are considered to be nonperforming when they become 90 days past due or if management thinks that we may not collect all of our principal and interest. Nonperforming loans may also include certain loans that have been modified in Troubled Debt Restructurings (TDRs) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions due to economic status. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.


	Residential Real Estate		Real Estate Construction		Consumer and Other		Total
June 30, 2014
Performing	$	149,950	$	3,826	$	8,875	$	162,651
Nonperforming		—		—		—		—

Total	$	149,950	$	3,826	$	8,875	$	162,651


	Residential Real Estate		Real Estate Construction		Consumer and Other		Total
December 31, 2013
Performing	$	140,481	$	4,448	$	8,543	$	153,472
Nonperforming		—		—		—		—

Total	$	140,481	$	4,448	$	8,543	$	153,472

The following tables include an aging analysis of the recorded investment of past due loans outstanding as of June 30, 2014 and December 31, 2013.


	30-59 Days Past Due		60-89 Days Past Due		90 Days or Greater		Total Past Due		Current		Total Loans		Past Due 90 Days and Accruing
June 30, 2014
Commercial & Agriculture	$	74	$	—	$	220	$	294	$	107,475	$	107,769	$	—
Commercial Real Estate		977		53		1,570		2,600		438,663		441,263		—
Residential Real Estate		680		1,405		4,107		6,192		248,480		254,672		—
Real Estate Construction		620		8		—		628		50,615		51,243		—
Consumer and Other		31		21		28		80		12,951		13,031		—

Total	$	2,382	$	1,487	$	5,925	$	9,794	$	858,184	$	867,978	$	—


	30-59 Days Past Due		60-89 Days Past Due		90 Days or Greater		Total Past Due		Current		Total Loans		Past Due 90 Days and Accruing
December 31, 2013
Commercial & Agriculture	$	105	$	—	$	443	$	548	$	115,327	$	115,875	$	—
Commercial Real Estate		655		201		2,098		2,954		440,892		443,846		—
Residential Real Estate		3,140		1,084		5,531		9,755		240,936		250,691		—
Real Estate Construction		—		—		—		—		39,964		39,964		—
Consumer and Other		170		20		—		190		10,675		10,865		—

Total	$	4,070	$	1,305	$	8,072	$	13,447	$	847,794	$	861,241	$	—

Nonaccrual Loans: Loans are considered for nonaccrual status upon reaching 90 days delinquency, unless the loan is well secured and in the process of collection, although the Company may be receiving partial payments of interest and partial repayments of principal on such loans. Loans that are not delinquent 90 days or more may still be considered for nonaccrual status if management has recognized one or more weaknesses in a loan that indicate the Company may not be assured of collecting all principal and interest contractually due under terms of the loan. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is deducted from interest income.

The following table presents loans on nonaccrual status as of June 30, 2014 and December 31, 2013.


	June 30, 2014		December 31, 2013
Commercial & Agriculture	$	1,187	$	1,590
Commercial Real Estate		8,468		9,609
Residential Real Estate		7,898		9,210
Real Estate Construction		—		—
Consumer and Other		59		50

Total	$	17,612	$	20,459

Loan modifications that are considered TDRs completed during the six-month periods ended June 30, 2014 and June 30, 2013 were as follows:


	For the Six-Month Period Ended June 30, 2014						For the Six-Month Period Ended June 30, 2013
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Commercial & Agriculture		—	$	—	$	—		—	$	—	$	—
Commercial Real Estate		—		—		—		1		125		125
Residential Real Estate		2		149		149		—		—		—
Real Estate Construction		—		—		—		—		—		—
Consumer and Other		—		—		—		—		—		—

Total Loan Modifications		2	$	149	$	149		1	$	125	$	125

There were no loan modifications that are considered TDRs completed during the quarters ended June 30, 2014 and June 30, 2013.

Recidivism, or the borrower defaulting on its obligation pursuant to a modified loan, results in the loan once again becoming a non-accrual loan. Recidivism occurs at a notably higher rate than defaults on new origination loans, so modified loans present a higher risk of loss than do new origination loans. At June 30, 2014, TDRs accounted for $465 of the allowance for loan losses.

During the six-month period ended June 30, 2014, there were no defaults, on loans which were modified and considered TDRs during the twelve months previous to the six-month period ended June 30, 2014.

During the six-month period ended June 30, 2013, there were two defaults, totaling $66, on loans which were modified and considered TDRs during the twelve months previous to the six-month period ended June 30, 2013.

During the three-month period ended June 30, 2014, there were no defaults, on loans which were modified and considered TDRs during the twelve months previous to the three-month period ended June 30, 2014.

During the three-month period ended June 30, 2013, there were two defaults, totaling $66, on loans which were modified and considered TDRs during the twelve months previous to the three-month period ended June 30, 2013.

Impaired Loans: Larger Commercial loans and Commercial Real Estate loans or lending relationships at or above $350,000, many of which are 60 days or more past due, are tested for impairment. These loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. Additionally, if a Residential Real Estate loan or Consumer loan is part of a relationship with a Commercial loan or Commercial Real Estate loan that is impaired, then the Residential Real Estate loan or Consumer loan is considered impaired as well.

The following table includes the recorded investment and unpaid principal balances for impaired financing receivables with the associated allowance amount, if applicable, as of June 30, 2014 and December 31, 2013.


	June 30, 2014						December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial & Agriculture	$	1,380	$	1,504	$	—	$	1,525	$	1,657	$	—
Commercial Real Estate		6,419		7,784		—		5,983		6,214		—
Residential Real Estate		1,579		2,752		—		1,202		2,263		—
Real Estate Construction		—		—		—		—		—		—
Consumer and Other		6		6		—		8		8		—

Total		9,384		12,046		—		8,718		10,142		—

With an allowance recorded:
Commercial & Agriculture		1,959		2,062		769		2,344		2,437		1,262
Commercial Real Estate		2,421		2,722		175		4,192		4,496		445
Residential Real Estate		1,866		3,808		377		2,803		4,021		802
Real Estate Construction		—		—		—		—		—		—
Consumer and Other		—		—		—		—		—		—

Total		6,246		8,592		1,321		9,339		10,954		2,509

Total:
Commercial & Agriculture		3,339		3,566		769		3,869		4,094		1,262
Commercial Real Estate		8,840		10,506		175		10,175		10,710		445
Residential Real Estate		3,445		6,560		377		4,005		6,284		802
Real Estate Construction		—		—		—		—		—		—
Consumer and Other		6		6		—		8		8		—

Total	$	15,630	$	20,638	$	1,321	$	18,057	$	21,096	$	2,509

The following tables include the average recorded investment and interest income recognized for impaired financing receivables for the three and six-month periods ended June 30, 2014 and 2013.


	June 30, 2014				June 30, 2013
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
For the six months ended:
Commercial & Agriculture	$	3,986	$	79	$	5,178	$	131
Commercial Real Estate		10,034		222		13,292		409
Residential Real Estate		3,628		146		5,794		269
Real Estate Construction		—		—		503		11
Consumer and Other		7		—		40		—

Total	$	17,655	$	447	$	24,807	$	820


	June 30, 2014				June 30, 2013
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
For the three months ended:
Commercial & Agriculture	$	4,045	$	14	$	5,125	$	63
Commercial Real Estate		9,907		75		12,855		204
Residential Real Estate		3,495		54		5,671		126
Real Estate Construction		—		—		483		6
Consumer and Other		7		—		31		—

Total	$	17,454	$	143	$	24,165	$	399