| LOANS | 4. LOANS The composition of the Company's loan portfolio, by loan class, as of June 30, 2017 and December 31, 2015 was as follows: ($ in thousands) June 30, 2017 December 31, 2016 Commercial $ 122,803 $ 126,311 Commercial Real Estate 355,060 344,210 Agriculture 101,340 101,905 Residential Mortgage 41,347 40,237 Residential Construction 24,802 23,650 Consumer 40,412 43,250 685,764 679,563 Allowance for loan losses (11,720 ) (10,899 ) Net deferred origination fees and costs 973 1,106 Loans, net $ 675,017 $ 669,770 The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk rating standards and criteria similar to those employed by state and federal banking regulatory agencies. Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses. These loans are generally secured by the receivables, equipment, and other real property of the business and are susceptible to the related risks described above. Problem commercial loans are generally identified by periodic review of financial information that may include financial statements, tax returns, and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner-occupied real estate are primarily susceptible to changes in the market conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles. These same risks apply to Commercial loans whether secured by equipment, receivables or other personal property or unsecured. Losses on loans secured by owner occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resulting over-supply of space. Losses are dependent on the value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means. Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or service. Agricultural loans are generally secured by inventory, receivables, equipment, and other real property. Agricultural loans primarily are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as adverse weather conditions such as drought or floods. Problem agricultural loans are generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Residential mortgage loans, which are secured by real estate, are primarily susceptible to four risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfalls in collateral value. In general, non-payment is usually due to loss of employment and follows general economic trends in the economy, particularly the upward movement in the unemployment rate, loss of collateral value, and demand shifts. Construction loans, whether owner-occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction, including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion. Losses are primarily related to underlying collateral value and changes therein as described above. Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower. Based on this information the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, or repossession or foreclosure of the underlying collateral. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Consumer loans, whether unsecured or secured, are primarily susceptible to four risks: non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfall in collateral value. In general, non-payment is usually due to loss of employment and will follow general economic trends in the economy, particularly the upward movements in the unemployment rate, loss of collateral value, and demand shifts. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Collateral valuations are obtained at origination of the credit and periodically thereafter (generally annually but may be more frequent depending on the collateral type), once repayment is questionable, and the loan has been deemed classified. As of June 30, 2017, approximately 51% in principal amount of the Company's loans were secured by commercial real estate, consisting primarily of loans secured by commercial properties and construction and land development loans. Approximately 6% in principal amount of the Company's loans were residential mortgage loans. Approximately 4% in principal amount of the Company's loans were residential construction loans. Approximately 15% in principal amount of the Company's loans were for agriculture and 18% in principal amount of the Company's loans were for general commercial uses including professional, retail and small businesses. Approximately 6% in principal amount of the Company's loans were consumer loans. Once a loan becomes delinquent and repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal payment. If this is not forthcoming and payment of principal and interest in accordance with the contractual terms of the loan agreement becomes unlikely, the Company will consider the loan to be impaired and will estimate its probable loss, using the present value of future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. For collateral dependent loans, the Company will obtain an updated valuation of the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount. Depending on the length of time until final collection, the Company may periodically revalue the estimated loss and take additional charge-offs or specific reserves as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when the collateral is liquidated and the actual loss is confirmed. Unpaid balances on loans after or during collection and liquidation may also be pursued through legal action and attachment of wages or judgment liens on the borrower's other assets. At June 30, 2017 and December 31, 2016, all loans were pledged under a blanket collateral lien to secure actual and potential borrowings from the Federal Home Loan Bank ("FHLB") and the Federal Reserve Bank. Non-accrual and Past Due Loans The Company's loans by delinquency and non-accrual status, as of June 30, 2017 and December 31, 2016, were as follows: ($ in thousands) Current & Accruing 30-59 Days Past Due & Accruing 60-89 Days Past Due & Accruing 90 Days or more Past Due & Accruing Nonaccrual Total Loans June 30, 2017 Commercial $ 119,766 $ 535 $ 102 $ — $ 2,400 $ 122,803 Commercial Real Estate 353,805 — 755 — 500 355,060 Agriculture 101,340 — — — — 101,340 Residential Mortgage 41,220 — — — 127 41,347 Residential Construction 24,387 415 — — — 24,802 Consumer 39,512 899 1 — — 40,412 Total $ 680,030 $ 1,849 $ 858 $ — $ 3,027 $ 685,764 December 31, 2016 Commercial $ 121,311 $ — $ — $ — $ 5,000 $ 126,311 Commercial Real Estate 343,186 484 — — 540 344,210 Agriculture 101,905 — — — — 101,905 Residential Mortgage 39,463 — 120 — 654 40,237 Residential Construction 23,650 — — — — 23,650 Consumer 43,106 — 41 — 103 43,250 Total $ 672,621 $ 484 $ 161 $ — $ 6,297 $ 679,563 Non-accrual loans amounted to $3,027,000 at June 30, 2017 and were comprised of one commercial loan totaling $2,400,000, two commercial real estate loans totaling $500,000 and two residential mortgage loans totaling $127,000. Non-accrual loans amounted to $6,297,000 at December 31, 2016 and were comprised of one commercial loan totaling $5,000,000, two commercial real estate loans totaling $540,000, three residential mortgage loans totaling $654,000, and one consumer loan totaling $103,000. All non-accrual loans are measured for impairment based upon the present value of future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of collateral, if the loan is collateral dependent. If the measurement of the non-accrual loan is less than the recorded investment in the loan, an impairment is recognized through the establishment of a specific reserve sufficient to cover expected losses and/or a charge-off against the allowance for loan losses. If the loan is considered to be collateral dependent, it is generally the Company's policy to charge-off the portion of any non-accrual loan that the Company does not expect to collect by writing the loan down to the estimated net realizable value of the underlying collateral. There were no commitments to lend additional funds to borrowers whose loans were on non-accrual status at June 30, 2017. Impaired Loans A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. Loans to be considered for impairment include non-accrual loans, troubled debt restructurings and loans with a risk rating of 6 (substandard) or worse. Once identified, impaired loans are measured individually for impairment using one of three methods: present value of expected cash flows discounted at the loan's effective interest rate; the loan's observable market price; or fair value of collateral if the loan is collateral dependent. In general, any portion of the recorded investment in a collateral dependent loan in excess of the fair value of the collateral that can be identified as uncollectible, and is, therefore, deemed a confirmed loss, and is promptly charged-off against the allowance for loan losses. Impaired loans, segregated by loan class, as of June 30, 2017 and December 31, 2016 were as follows: ($ in thousands) Unpaid Contractual Principal Balance Recorded Investment with no Allowance Recorded Investment with Allowance Total Recorded Investment Related Allowance June 30, 2017 Commercial $ 4,003 $ — $ 3,541 $ 3,541 $ 827 Commercial Real Estate 1,614 500 1,033 1,533 48 Agriculture — — — — — Residential Mortgage 2,676 127 2,323 2,450 571 Residential Construction 805 — 805 805 87 Consumer 591 — 591 591 25 Total $ 9,689 $ 627 $ 8,293 $ 8,920 $ 1,558 December 31, 2016 Commercial $ 5,578 $ — $ 5,578 $ 5,578 $ 898 Commercial Real Estate 885 540 283 823 39 Agriculture — — — — — Residential Mortgage 3,392 654 2,380 3,034 584 Residential Construction 820 — 820 820 98 Consumer 708 103 601 704 25 Total $ 11,383 $ 1,297 $ 9,662 $ 10,959 $ 1,644 The average recorded investment in impaired loans and the amount of interest income recognized on impaired loans during the three months ended June 30, 2017 and June 30, 2016 was as follows: ($ in thousands) Three Months Ended June 30, 2017 Three Months Ended June 30, 2016 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Commercial $ 4,542 $ 8 $ 940 $ 10 Commercial Real Estate 1,164 4 880 4 Agriculture — — — — Residential Mortgage 2,736 23 3,265 23 Residential Construction 808 10 992 11 Consumer 592 9 739 9 Total $ 9,842 $ 54 $ 6,816 $ 57 The average recorded investment in impaired loans and the amount of interest income recognized on impaired loans during the six months ended June 30, 2017 and June 30, 2016 was as follows: ($ in thousands) Six Months Ended June 30, 2017 Six Months Ended June 30, 2016 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Commercial $ 4,887 $ 17 $ 933 $ 22 Commercial Real Estate 1,050 8 1,006 8 Agriculture — — — — Residential Mortgage 2,835 54 3,369 47 Residential Construction 812 19 996 23 Consumer 630 17 933 53 Total $ 10,214 $ 115 $ 7,237 $ 153 Troubled Debt Restructurings The Company's loan portfolio includes certain loans that have been modified in a Troubled Debt Restructuring ("TDR"), which are loans on which concessions in terms have been granted because of the borrowers' financial difficulties and, as a result, the Company receives less than the current market-based compensation for the loan. These concessions may include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are placed on non-accrual status at the time of restructure and may only be returned to accruing status after considering the borrower's sustained repayment performance for a reasonable period, generally six months. When a loan is modified, it is measured based upon the present value of future cash flows discounted at the contractual interest rate of the original loan agreement, or the fair value of collateral less selling costs if the loan is collateral dependent. If the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through a specific allowance or a charge-off of the loan. The Company had $6,900,529 and $9,663,000 in TDR loans as of June 30, 2017 and December 31, 2016, respectively. Specific reserves for TDR loans totaled $1,543,141 and $1,644,000 as of June 30, 2017 and December 31, 2016, respectively. TDR loans performing in compliance with modified terms totaled $4,500,529 and $4,662,000 as of June 30, 2017 and December 31, 2016, respectively. There were no commitments to advance additional funds on existing TDR loans as of June 30, 2017. There were no loans modified as TDRs during the three and six months ended June 30, 2017. There were no loans modified as TDRs during the three months ended June 30, 2016. Loans modified as TDRs during the six months ended June 30, 2016 were as follows: ($ in thousands) Six Months Ended June 30, 2016 Number of Contracts Pre-modification outstanding recorded investment Post- modification outstanding recorded investment Commercial 1 $ 180 $ 180 Total 1 $ 180 $ 180 Loan modifications generally involve reductions in the interest rate, payment extensions, forgiveness of principal, or forbearance. There were no loans modified as a TDR within the previous 12 months and for which there was a payment default during the three and six months ended June 30, 2017 and June 30, 2016. Credit Quality Indicators All loans are rated using the credit risk ratings and criteria adopted by the Company. Risk ratings are adjusted as future circumstances warrant. All credits risk rated 1, 2, 3 or 4 equate to a Pass as indicated by Federal and State bank regulatory agencies; a 5 equates to a Special Mention; a 6 equates to Substandard; a 7 equates to Doubtful; and an 8 equates to a Loss. For the definitions of each risk rating, see Note 4 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016. The following table presents the risk ratings by loan class as of June 30, 2017 and December 31, 2016: ($ in thousands) Pass Special Mention Substandard Doubtful Loss Total June 30, 2017 Commercial $ 111,835 $ 7,690 $ 3,278 $ — $ — $ 122,803 Commercial Real Estate 341,999 11,806 1,255 — — 355,060 Agriculture 101,295 — 45 — — 101,340 Residential Mortgage 40,111 1,107 129 — — 41,347 Residential Construction 24,802 — — — — 24,802 Consumer 39,393 500 519 — — 40,412 Total $ 659,435 $ 21,103 $ 5,226 $ — $ — $ 685,764 December 31, 2016 Commercial $ 112,656 $ 7,294 $ 6,361 $ — $ — $ 126,311 Commercial Real Estate 331,653 11,058 1,499 — — 344,210 Agriculture 101,820 — 85 — — 101,905 Residential Mortgage 37,831 1,751 655 — — 40,237 Residential Construction 23,070 436 144 — — 23,650 Consumer 41,826 547 877 — — 43,250 Total $ 648,856 $ 21,086 $ 9,621 $ — $ — $ 679,563 Allowance for Loan Losses The following tables detail activity in the allowance for loan losses by loan class for the three and six months ended June 30, 2017. Three months ended June 30, 2017 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of March 31, 2017 $ 3,808 $ 4,723 $ 1,287 $ 701 $ 454 $ 381 $ 145 $ 11,499 Provision for loan losses (869 ) 160 88 (114 ) 22 (12 ) 725 — Charge-offs — — — — — (5 ) — (5 ) Recoveries 121 — — 90 1 14 — 226 Net recoveries 121 — — 90 1 9 — 221 Balance as of June 30, 2017 $ 3,060 $ 4,883 $ 1,375 $ 677 $ 477 $ 378 $ 870 $ 11,720 Six months ended June 30, 2017 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of December 31, 2016 $ 3,571 $ 3,910 $ 1,262 $ 660 $ 440 $ 498 $ 558 $ 10,899 Provision for loan losses (634 ) 973 113 (73 ) 35 (126 ) 312 600 Charge-offs — — — — — (16 ) — (16 ) Recoveries 123 — — 90 2 22 — 237 Net recoveries 123 — — 90 2 6 — 221 Balance as of June 30, 2017 $ 3,060 $ 4,883 $ 1,375 $ 677 $ 477 $ 378 $ 870 $ 11,720 The following table details the allowance for loan losses allocated to loans individually and collectively evaluated for impairment by loan class as of June 30, 2017. ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Period-end amount allocated to: Loans individually evaluated for impairment $ 827 $ 48 $ — $ 571 $ 87 $ 25 $ — $ 1,558 Loans collectively evaluated for impairment 2,233 4,835 1,375 106 390 353 870 10,162 Ending Balance $ 3,060 $ 4,883 $ 1,375 $ 677 $ 477 $ 378 $ 870 $ 11,720 The following table details activity in the allowance for loan losses by loan class for the three and six months ended June 30, 2016. Three months ended June 30, 2016 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of March 31, 2016 $ 2,980 $ 3,636 $ 965 $ 702 $ 401 $ 589 $ 334 $ 9,607 Provision for loan losses 315 (52 ) 104 (12 ) (12 ) (45 ) 152 450 Charge-offs (130 ) — — — — (15 ) — (145 ) Recoveries 10 — 81 — 1 26 — 118 Net charge-offs (120 ) — 81 — 1 11 — (27 ) Balance as of June 30, 2016 $ 3,175 $ 3,584 $ 1,150 $ 690 $ 390 $ 555 $ 486 $ 10,030 Six months ended June 30, 2016 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of December 31, 2015 $ 3,097 $ 3,343 $ 1,060 $ 739 $ 334 $ 641 $ 37 $ 9,251 Provision for loan losses 280 256 9 (50 ) 54 (98 ) 449 900 Charge-offs (230 ) (15 ) — — — (35 ) — (280 ) Recoveries 28 — 81 1 2 47 — 159 Net charge-offs (202 ) (15 ) 81 1 2 12 — (121 ) Balance as of June 30, 2016 $ 3,175 $ 3,584 $ 1,150 $ 690 $ 390 $ 555 $ 486 $ 10,030 The following table details the allowance for loan losses allocated to loans individually and collectively evaluated for impairment by loan class as of June 30, 2016. ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Period-end amount allocated to: Loans individually evaluated for impairment $ 36 $ 40 $ — $ 598 $ 109 $ 36 $ — $ 819 Loans collectively evaluated for impairment 3,139 3,544 1,150 92 281 519 486 9,211 Ending Balance $ 3,175 $ 3,584 $ 1,150 $ 690 $ 390 $ 555 $ 486 $ 10,030 The following table details activity in the allowance for loan losses and the amount allocated to loans individually and collectively evaluated for impairment as of and for the year ended December 31, 2016. Year ended December 31, 2016 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of December 31, 2015 $ 3,097 $ 3,343 $ 1,060 $ 739 $ 334 $ 641 $ 37 $ 9,251 Provision for loan losses 883 582 121 (67 ) 101 (341 ) 521 1,800 Charge-offs (446 ) (15 ) — (13 ) — (65 ) — (539 ) Recoveries 37 — 81 1 5 263 — 387 Net charge-offs (409 ) (15 ) 81 (12 ) 5 198 — (152 ) Ending Balance $ 3,571 $ 3,910 $ 1,262 $ 660 $ 440 $ 498 $ 558 $ 10,899 Period-end amount allocated to: Loans individually evaluated for impairment $ 898 $ 39 $ — $ 584 $ 98 $ 25 $ — $ 1,644 Loans collectively evaluated for impairment 2,673 3,871 1,262 76 342 473 558 9,255 Balance as of December 31, 2016 $ 3,571 $ 3,910 $ 1,262 $ 660 $ 440 $ 498 $ 558 $ 10,899 The Company's investment in loans as of June 30, 2017, June 30, 2016, and December 31, 2016 related to each balance in the allowance for loan losses by loan class and disaggregated on the basis of the Company's impairment methodology was as follows: ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Total June 30, 2017 Loans individually evaluated for impairment $ 3,541 $ 1,533 $ — $ 2,450 $ 805 $ 591 $ 8,920 Loans collectively evaluated for impairment 119,262 353,527 101,340 38,897 23,997 39,821 676,844 Ending Balance $ 122,803 $ 355,060 $ 101,340 $ 41,347 $ 24,802 $ 40,412 $ 685,764 June 30, 2016 Loans individually evaluated for impairment $ 818 $ 869 $ — $ 2,986 $ 987 $ 773 $ 6,433 Loans collectively evaluated for impairment 131,529 312,664 92,766 40,684 16,567 42,046 636,256 Ending Balance $ 132,347 $ 313,533 $ 92,766 $ 43,670 $ 17,554 $ 42,819 $ 642,689 December 31, 2016 Loans individually evaluated for impairment $ 5,578 $ 823 $ — $ 3,034 $ 820 $ 704 $ 10,959 Loans collectively evaluated for impairment 120,733 343,387 101,905 37,203 22,830 42,546 668,604 Ending Balance $ 126,311 $ 344,210 $ 101,905 $ 40,237 $ 23,650 $ 43,250 $ 679,563 |
