LOANS | 4 . LOANS AND ALLOWANCE FOR LOAN LOSSES Loans, net of unearned income, consist of the following at year end (in thousands): December 31, 2017 December 31, 2016 Loans secured by real estate: Commercial real estate - owner occupied $ 401,847 $ 154,807 Commercial real estate - non-owner occupied 440,700 279,634 Secured by farmland 23,038 541 Construction and land development 197,972 91,067 Residential 1-4 family (1) 483,006 230,810 Multi- family residential 70,892 30,021 Home equity lines of credit (1) 152,829 29,203 Total real estate loans 1,770,284 816,083 Commercial loans 253,258 115,365 Consumer loans 39,374 856 Gross loans 2,062,916 932,304 Less deferred fees on loans (588) (1,889) Loans, net of deferred fees $ 2,062,328 $ 930,415 (1) Includes $23.3 million and $28.2 million of loans as of December 31, 2017 and 2016, respectively, acquired in the GAB transaction covered under an FDIC loss-share agreement. The agreement covering single family loans expires in December 2019. Accounting policy related to the allowance for loan losses is considered a critical policy given the level of estimation, judgment, and uncertainty in the levels of the allowance required to account for the inherent probable losses in the loan portfolio and the material effect such estimation, judgment, and uncertainty can have on the consolidated financial results. On June 23, 2017, in connection with the merger with EVBS, Southern National acquired loans held for sale with a fair value of $19.7 million and loans held for investment with an unpaid principal balance of $1.05 billion and an est imated fair value of $1.03 billion, which created a fair value adjustment of $13.6 million at acquisition. Accretion of $2.8 million associated with these acquired loans held for investment was recognized in the twelve months ended December 31 , 2017. As part of the GAB acquisition, the Bank and the FDIC entered into loss sharing agreement s on approximately $143.4 million ( contractual basis) of GAB’s assets. There were two agreements with the FDIC, one for single family loans which is a 10 -year agreement expiring in December 2019, and one for non-single family (commercial) assets which was a 5 -year agreement which expired in December 2014. The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement s ; we refer to these assets collectively as “covered assets.” Loans that are not covered in the loss sharing agreement are referred to as “non-covered loans”. As of December 31, 2017, n on-covered loans included $3.9 million of loans acquired in the GAB acquisition , $19.2 million of loans acquired in the HarVest acquisition , $36.3 million acquired in the Prince Georges Federal Savings Bank (“PGFSB”) acquisition, and $942.8 million acquired in the EVBS acquisition. Covered loans are now considered an immaterial part of our overall loan portfolio and have been blended together with our non-covered loans for presentation purposes. Accretable discount on the acquired performing loans in the EVBS, GAB, HarVest, and PGFSB acquisitions totaled $17.5 million and $6.5 million at December 31, 2017 and 2016, respectively. For the three acquisitions subsequent to the GAB acquisition noted above, management sold the majority of the PCI loans immediately after closing of the acquisition. Impaired loans for the portfolio were as follows (in thousands): December 31, 2017 Total Loans Unpaid Recorded Principal Related Investment (1) Balance Allowance With no related allowance recorded: Commercial real estate - owner occupied $ 767 $ 781 $ - Commercial real estate - non-owner occupied (2) 766 830 - Construction and land development 9,969 9,984 - Commercial loans 6,035 12,847 - Residential 1-4 family (3) 3,160 3,430 - Other consumer loans - - - Total $ 20,697 $ 27,872 $ - With an allowance recorded: Commercial real estate - owner occupied $ - $ - $ - Commercial real estate - non-owner occupied (2) - - - Construction and land development - - - Commercial loans - - - Residential 1-4 family (3) - - - Other consumer loans - - - Total $ - $ - $ - Grand total $ 20,697 $ 27,872 $ - (1) Recorded investment is after cumulative prior charge offs of $6.8 million. These loans also have aggregate SBA guarantees of $5.0 million. (2) Includes loans secured by farmland and multi-family residential loans. (3) Includes home equity lines of credit. December 31, 2016 Total Loans Unpaid Recorded Principal Related Investment (1) Balance Allowance With no related allowance recorded: Commercial real estate - owner occupied $ 5,583 $ 5,592 $ - Commercial real estate - non-owner occupied (2) - - - Construction and land development - - - Commercial loans 3,002 3,603 - Residential 1-4 family (3) 963 1,113 - Other consumer loans - - - Total $ 9,548 $ 10,308 $ - With an allowance recorded: Commercial real estate - owner occupied $ 688 $ 688 $ 150 Commercial real estate - non-owner occupied (2) - - - Construction and land development - - - Commercial loans 3,378 5,798 750 Residential 1-4 family (3) - - - Other consumer loans - - - Total $ 4,066 $ 6,486 $ 900 Grand total $ 13,614 $ 16,794 $ 900 (1) Recorded investment is after cumulative prior charge offs of $3.0 million. These loans also have aggregate SBA guarantees of $2.2 million. (2) Includes loans secured by farmland and multi-family residential loans. (3) Includes home equity lines of credit. The following tables present the average recorded investment and interest income for impaired loans recognized by class of loans for the years ended December 31, 2017, 2016 and 2015 (in thousands): For the Year Ended December 31, 2017 Total Loans Average Interest Recorded Income Investment Recognized With no related allowance recorded: Commercial real estate - owner occupied $ 875 $ 34 Commercial real estate - non-owner occupied (1) 890 56 Construction and land development 9,942 139 Commercial loans 12,655 485 Residential 1-4 family (2) 3,398 91 Other consumer loans - - Total $ 27,760 $ 805 With an allowance recorded: Commercial real estate - owner occupied $ - $ - Commercial real estate - non-owner occupied (1) - - Construction and land development - - Commercial loans - - Residential 1-4 family (2) - - Other consumer loans - - Total $ - $ - Grand total $ 27,760 $ 805 (1) Includes loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. For the Year Ended December 31, 2016 Total Loans Average Interest Recorded Income Investment Recognized With no related allowance recorded: Commercial real estate - owner occupied $ 6,454 $ 292 Commercial real estate - non-owner occupied (1) 103 3 Construction and land development - - Commercial loans 2,888 54 Residential 1-4 family (2) 988 32 Other consumer loans - - Total $ 10,433 $ 381 With an allowance recorded: Commercial real estate - owner occupied $ 694 $ 31 Commercial real estate - non-owner occupied (1) - - Construction and land development - - Commercial loans 3,402 155 Residential 1-4 family (2) - - Other consumer loans - - Total $ 4,096 $ 186 Grand total $ 14,529 $ 567 (1) Includes loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. For the Year Ended December 31, 2015 Total Loans Average Interest Recorded Income Investment Recognized With no related allowance recorded: Commercial real estate - owner occupied $ 7,156 $ 297 Commercial real estate - non-owner occupied (1) 822 11 Construction and land development 89 - Commercial loans 3,428 - Residential 1-4 family (2) 1,501 26 Other consumer loans - - Total $ 12,996 $ 334 With an allowance recorded: Commercial real estate - owner occupied $ 2,259 $ 42 Commercial real estate - non-owner occupied (1) - - Construction and land development 93 - Commercial loans 3,488 213 Residential 1-4 family (2) 416 - Other consumer loans - - Total $ 6,256 $ 255 Grand total $ 19,252 $ 589 (1) Includes loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. The following tables present the aging of the recorded investment in past due loans by class of loans as of December 31, 2017 and 2016 (in thousands): December 31, 2017 30 - 59 60 - 89 Days Days 90 Days Total Nonaccrual Loans Not Total Past Due Past Due or More Past Due Loans Past Due Loans Total loans: Commercial real estate - owner occupied $ 687 $ - $ - $ 687 $ - $ 401,160 $ 401,847 Commercial real estate - non-owner occupied (1) 138 50 - 188 - 534,442 534,630 Construction and land development 1,134 149 - 1,283 9,969 186,720 197,972 Commercial loans 496 - - 496 5,664 247,098 253,258 Residential 1-4 family (2) 2,926 361 - 3,287 2,392 630,156 635,835 Other consumer loans 57 1 - 58 - 39,316 39,374 Total $ 5,438 $ 561 $ - $ 5,999 $ 18,025 $ 2,038,892 $ 2,062,916 December 31, 2016 30 - 59 60 - 89 Days Days 90 Days Total Nonaccrual Loans Not Total Past Due Past Due or More Past Due Loans Past Due Loans Total loans: Commercial real estate - owner occupied $ - $ - $ - $ - $ 637 $ 154,170 $ 154,807 Commercial real estate - non-owner occupied (1) - - - - - 310,196 310,196 Construction and land development - - - - - 91,067 91,067 Commercial loans 1,349 - - 1,349 3,158 110,858 115,365 Residential 1-4 family (2) 1,232 95 - 1,327 850 257,836 260,013 Other consumer loans - - - - - 856 856 Total $ 2,581 $ 95 $ - $ 2,676 $ 4,645 $ 924,983 $ 932,304 (1) Includes loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. Nonaccrual loans include SBA guaranteed amounts totaling $4.7 million and $2.2 million at December 31, 2017 and 2016, respectively. Activity in the allowance for loan and lease losses by class of loan for the years ended December 31, 2017, 2016 and 2015 is summarized below (in thousands): Commercial Commercial Real Estate Real Estate Construction Other Owner Non-owner and Land Commercial 1-4 Family Consumer Year ended December 31, 2017 Occupied Occupied (1) Development Loans Residential (2) Loans Unallocated Total Allowance for loan losses: Beginning balance $ 905 $ 1,484 $ 752 $ 3,366 $ 1,279 $ 78 $ 746 $ 8,610 Charge offs - (100) - (8,250) (369) (110) - (8,829) Recoveries 132 299 1 538 17 4 - 991 Provision (347) (362) (61) 8,842 659 640 (746) 8,625 Ending balance $ 690 $ 1,321 $ 692 $ 4,496 $ 1,586 $ 612 $ - $ 9,397 Year ended December 31, 2016 Allowance for loan losses: Beginning balance $ 1,185 $ 1,222 $ 865 $ 3,041 $ 1,408 $ 48 $ 652 $ 8,421 Charge offs (799) - (449) (3,370) (22) (322) - (4,962) Recoveries 8 - 121 96 10 4 - 239 Provision 511 262 215 3,599 (117) 348 94 4,912 Ending balance $ 905 $ 1,484 $ 752 $ 3,366 $ 1,279 $ 78 $ 746 $ 8,610 Year ended December 31, 2015 Allowance for loan losses: Beginning balance $ 855 $ 1,123 $ 1,644 $ 2,063 $ 1,339 $ 53 $ 337 $ 7,414 Adjustments (3) - - - - (17) - - (17) Charge offs (1,067) - - (1,174) (413) (19) - (2,673) Recoveries 18 18 139 91 259 1 - 526 Provision 1,379 81 (918) 2,061 240 13 315 3,171 Ending balance $ 1,185 $ 1,222 $ 865 $ 3,041 $ 1,408 $ 48 $ 652 $ 8,421 (1) Includes loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. (3) Represents the portion of increased expected losses which is covered by the loss sharing agreement with the FDIC. The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2017 and 2016 (in thousands): Commercial Commercial Real Estate Real Estate Construction Other Owner Non-owner and Land Commercial 1-4 Family Consumer Occupied Occupied (1) Development Loans Residential (2) Loans Unallocated Total December 31, 2017 Ending allowance balance attributable to loans: Individually evaluated for impairment $ - $ - $ - $ - $ - $ - $ - $ - Collectively evaluated for impairment 690 1,321 692 4,496 1,586 612 - 9,397 Total ending allowance $ 690 $ 1,321 $ 692 $ 4,496 $ 1,586 $ 612 $ - $ 9,397 Loans: Individually evaluated for impairment $ 767 $ 766 $ 9,969 $ 6,035 $ 3,160 $ - $ - $ 20,697 Collectively evaluated for impairment 401,080 533,864 188,003 247,223 632,675 39,374 - 2,042,219 Total ending loan balances $ 401,847 $ 534,630 $ 197,972 $ 253,258 $ 635,835 $ 39,374 $ - $ 2,062,916 December 31, 2016 Ending allowance balance attributable to loans: Individually evaluated for impairment $ 150 $ - $ - $ 750 $ - $ - $ - $ 900 Collectively evaluated for impairment 755 1,484 752 2,616 1,279 78 746 7,710 Total ending allowance $ 905 $ 1,484 $ 752 $ 3,366 $ 1,279 $ 78 $ 746 $ 8,610 Loans: Individually evaluated for impairment $ 6,271 $ - $ - $ 6,380 $ 963 $ - $ - $ 13,614 Collectively evaluated for impairment 148,536 310,196 91,067 108,985 259,050 856 - 918,690 Total ending loan balances $ 154,807 $ 310,196 $ 91,067 $ 115,365 $ 260,013 $ 856 $ - $ 932,304 (1) Includes loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. Troubled Debt Restructurings A modification is classified as a troubled debt restructuring (“TDR”) if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Bank has granted a concession to the borrower. The Bank determines that a borrower may be experiencing financial difficulty if the borrower is currently delinquent on any of its debt, or if the Bank is concerned that the borrower may not be able to perform in accordance with the current terms of the loan agreement in the foreseeable future. Many aspects of the borrower’s financial situation are assessed when determining whether they are experiencing financial difficulty, particularly as it relates to commercial borrowers due to the complex nature of the loan structure, business/industry risk and borrower/guarantor structures. Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness. When evaluating whether a concession has been granted, the Bank also considers whether the borrower has provided additional collateral or guarantors and whether such additions adequately compensate the Bank for the restructured terms, or if the revised terms are consistent with those currently being offered to new loan customers. The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management’s judgment is required when determining whether a modification is a TDR. Although each occurrence is unique to the borrower and is evaluated separately, for all portfolio segments, TDRs are typically modified through reduction in interest rates, reductions in payments, changing the payment terms from principal and interest to interest only, and/or extensions in term maturity. During the years ending December 31, 2017 and 2016, there were no loans modified in TDRs. One TDR which had been modified in 2013 defaulted during the second quarter of 2015. This loan, in the amount of $672 thousand, was current as of December 31, 2017. Credit Quality Indicators Through its system of internal controls, Southern National evaluates and segments loan portfolio credit quality on a quarterly basis using regulatory definitions for Special Mention, Substandard and Doubtful. Special Mention loans are considered to be criticized. Substandard and Doubtful loans are considered to be classified. Southern National had no loans classified Doubtful at December 31, 2017 or 2016. Special Mention loans are loans that have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position. Substandard loans may be inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful loans have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. As of December 31, 2017 and 2016, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands): December 31, 2017 Total Loans Special Mention Substandard (3) Pass Total Commercial real estate - owner occupied $ 4,178 $ 1,678 $ 395,991 $ 401,847 Commercial real estate - non-owner occupied (1) 5,705 830 528,095 534,630 Construction and land development 128 9,969 187,875 197,972 Commercial loans 5,936 6,035 241,287 253,258 Residential 1-4 family (2) 1,323 3,935 630,577 635,835 Other consumer loans 162 - 39,212 39,374 Total $ 17,432 $ 22,447 $ 2,023,037 $ 2,062,916 December 31, 2016 Total Loans Special Mention Substandard (3) Pass Total Commercial real estate - owner occupied $ - $ 6,271 $ 148,536 $ 154,807 Commercial real estate - non-owner occupied (1) - - 310,196 310,196 Construction and land development - - 91,067 91,067 Commercial loans 28 6,380 108,957 115,365 Residential 1-4 family (2) - 963 259,050 260,013 Other consumer loans - - 856 856 Total $ 28 $ 13,614 $ 918,662 $ 932,304 (1) Includes loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. (3) Includes SBA guarantees of $5.0 million and $2.2 million as of December 31, 2017 and 2016, respectively. The amount of foreclosed residential real estate property held at December 31, 2017 and 2016 wa s $3.3 million and $3.4 million, respectively. The recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure was $939 thousand and $1.8 million at December 31, 2017 and 2016, respectively. Purchased Loans The following table presents the carrying amount of purchased impaired and non-impaired loans from the EVBS acquisition as of December 31, 2017 (in thousands): December 31, 2017 Purchased Purchased Impaired Non-impaired Loans Loans Total Commercial real estate (1) $ 5,788 $ 418,170 $ 423,958 Construction and land development - 85,036 85,036 Commercial loans 3,598 112,693 116,291 Residential 1-4 family (2) 1,255 282,702 283,957 Other consumer loans - 33,539 33,539 Total $ 10,641 $ 932,140 $ 942,781 (1) Includes owner occupied and non-owner occupied as well as loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. Changes in the carrying amount and accretable yield for purchased impaired and non-impaired loans from the EVBS acquisition were as follows for the year ended December 31, 2017 (in thousands): December 31, 2017 Purchased Impaired Purchased Non-impaired Carrying Carrying Accretable Amount Accretable Amount Yield of Loans Discount of Loans Balance at beginning of period $ - $ - $ - $ - Additions 398 11,329 14,783 1,020,653 Accretion (83) 83 (2,669) 2,669 Adjustment-transfer to OREO - - - (43) Payments received - (771) - (91,139) Balance at end of the period $ 315 $ 10,641 $ 12,114 $ 932,140 The following table presents the carrying amount of purchased impaired and non-impaired loans from the GAB acquisition as of December 31, 2017 and 2016 (in thousands): December 31, 2017 December 31, 2016 Purchased Purchased Purchased Purchased Impaired Non-impaired Impaired Non-impaired Loans Loans Total Loans Loans Total Commercial real estate (1) $ 1,050 $ 2,257 $ 3,307 $ 1,080 $ 3,630 $ 4,710 Construction and land development - - - - - - Commercial loans 189 280 469 193 347 540 Residential 1-4 family (2) - 23,339 23,339 - 28,180 28,180 Other consumer loans - 67 67 - 14 14 Total $ 1,239 $ 25,943 $ 27,182 $ 1,273 $ 32,171 $ 33,444 (1) Includes owner occupied and non-owner occupied as well as loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. The FDIC indemnification on the GAB residential mortgages and home equity lines of credit expires in December 2019 . Changes in the carrying amount and accretable yield for purchased impaired and non-impaired loans from the GAB acquisition were as follows for the years ended December 31, 2017 and 2016 (in thousands): December 31, 2017 December 31, 2016 Purchased Impaired Purchased Non-impaired Purchased Impaired Purchased Non-impaired Carrying Carrying Carrying Carrying Accretable Amount Accretable Amount Accretable Amount Accretable Amount Yield of Loans Discount of Loans Yield of Loans Discount of Loans Balance at beginning of the period $ - $ 1,273 $ 3,761 $ 32,171 $ - $ 1,444 $ 4,597 $ 38,758 Additions - - - - - - - - Accretion - - (886) 892 - - (1,085) 1,085 Reclassifications from nonaccretable balance - - 230 - - - 269 - Adjustment-transfer to OREO - - - - - - (20) (169) Payments received - (34) - (7,120) - (171) - (7,503) Balance at end of the period $ - $ 1,239 $ 3,105 $ 25,943 $ - $ 1,273 $ 3,761 $ 32,171 The following table presents the carrying amount of purchased impaired and non-impaired loans from the HarVest acquisition as of December 31, 2017 and 2016 (in thousands): December 31, 2017 December 31, 2016 Purchased Purchased Purchased Purchased Impaired Non-impaired Impaired Non-impaired Loans Loans Total Loans Loans Total Commercial real estate (1) $ - $ 9,162 $ 9,162 $ 258 $ 10,150 $ 10,408 Construction and land development 396 2,869 3,265 488 2,996 3,484 Commercial loans - 1,688 1,688 - 2,062 2,062 Residential 1-4 family (2) 792 4,290 5,082 818 6,221 7,039 Other consumer loans - - - - 2 2 Total $ 1,188 $ 18,009 $ 19,197 $ 1,564 $ 21,431 $ 22,995 (1) Includes owner occupied and non-owner occupied as well as loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. Changes in the carrying amount and accretable yield for purchased impaired and non-impaired loans from the HarVest acquisition were as follows for the years ended December 31, 2017 and 2016 (in thousands): December 31, 2017 December 31, 2016 Purchased Impaired Purchased Non-impaired Purchased Impaired Purchased Non-impaired Carrying Carrying Carrying Carrying Accretable Amount Accretable Amount Accretable Amount Accretable Amount Yield of Loans Discount of Loans Yield of Loans Discount of Loans Balance at beginning of the period $ - $ 1,564 $ 662 $ 21,431 $ - $ 1,688 $ 858 $ 27,878 Additions - - - - - - - - Accretion - - (184) 184 - - (196) 139 Payments received - (376) - (3,606) - (124) - (6,586) Balance at end of the period $ - $ 1,188 $ 478 $ 18,009 $ - $ 1,564 $ 662 $ 21,431 The following table presents the carrying amount of purchased impaired and non-impaired loans from the PGFSB acquisition as of December 31, 2017 and 2016 (in thousands): December 31, 2017 December 31, 2016 Purchased Purchased Purchased Purchased Impaired Non-impaired Impaired Non-impaired Loans Loans Total Loans Loans Total Commercial real estate (1) $ 198 $ 1,997 $ 2,195 $ 225 $ 2,638 $ 2,863 Construction and land development - 1,216 1,216 355 860 1,215 Commercial loans - 39 39 - 116 116 Residential 1-4 family (2) 348 32,357 32,705 - 38,018 38,018 Other consumer loans - 100 100 - 142 142 Total $ 546 $ 35,709 $ 36,255 $ 580 $ 41,774 $ 42,354 (1) Includes owner occupied and non-owner occupied as well as loans secured by farmland and multi-family residential loans. (2) Includes home equity lines of credit. Changes in the carrying amount and accretable yield for purchased impaired and non-impaired loans from the PGFSB acquisition were as follows for the year ended December 31, 2017 and 2016 (in thousands): December 31, 2017 December 31, 2016 Purchased Impaired Purchased Non-impaired Purchased Impaired Purchased Non-impaired Carrying Carrying Carrying Carrying Accretable Amount Accretable Amount Accretable Amount Accretable Amount Yield of Loans Discount of Loans Yield of Loans Discount of Loans Balance at beginning of the period $ - $ 580 $ 2,096 $ 41,774 $ - $ 703 $ 2,462 $ 51,263 Additions - - - - - - - - Accretion - - (333) 333 - - (366) 365 Payments received - (34) - (6,398) - (123) - (9,854) Balance at end of the period $ - $ 546 $ 1,763 $ 35,709 $ - $ 580 $ 2,096 $ 41,774 |