LOANS AND ALLOWANCE FOR PROBABLE LOAN LOSSES | LOANS AND ALLOWANCE FOR PROBABLE LOAN LOSSES Loans in the accompanying consolidated balance sheets are classified as follows (in thousands): December 31, 2018 December 31, 2017 Real Estate Loans: Construction $ 507,732 $ 475,867 1-4 Family Residential 794,499 805,341 Commercial 1,194,118 1,265,159 Commercial Loans 356,649 266,422 Municipal Loans 353,370 345,798 Loans to Individuals 106,431 135,769 Total Loans 3,312,799 3,294,356 Less: Allowance for Loan Losses (1) 27,019 20,781 Net Loans $ 3,285,780 $ 3,273,575 (1) Loans acquired with the Diboll acquisition were measured at fair value on November 30, 2017 , with no carryover of allowance for loan loss. The allowance for loan loss recorded on PCI loans totaled $302,000 as of December 31, 2018 . There was no allowance for loan loss recorded on PCI loans as of December 31, 2017 . Loans to Affiliated Parties In the normal course of business, we make loans to certain of our executive officers and directors and their related interests. As of December 31, 2018 and 2017 , these loans totaled $4.0 million and $5.5 million , respectively. These loans represented 0.6% and 0.7% of shareholders’ equity as of December 31, 2018 and 2017 , respectively. Construction Real Estate Loans Our construction loans are collateralized by property located primarily in or near the market areas we serve. A number of our construction loans will be owner occupied upon completion. Construction loans for non-owner occupied projects are financed, but these typically have cash flows from leases with tenants, secondary sources of repayment and in some cases, additional collateral. Our construction loans have both adjustable and fixed interest rates during the construction period. Construction loans to individuals are typically priced and made with the intention of granting the permanent loan on the property. Speculative and commercial construction loans are subject to underwriting standards similar to that of the commercial portfolio. Owner occupied 1-4 family residential construction loans are subject to the underwriting standards of the permanent loan. 1-4 Family Residential Real Estate Loans Residential loan originations are generated by our loan officers, in-house origination staff, marketing efforts, present customers, walk-in customers and referrals from real estate agents and builders. We focus our lending efforts primarily on the origination of loans secured by first mortgages on owner occupied 1-4 family residences. Substantially all of our 1-4 family residential originations are secured by properties located in or near our market areas. Our 1-4 family residential loans generally have maturities ranging from five to 30 years. These loans are typically fully amortizing with monthly payments sufficient to repay the total amount of the loan. Our 1-4 family residential loans are made at both fixed and adjustable interest rates. Underwriting for 1-4 family residential loans includes debt-to-income analysis, credit history analysis, appraised value and down payment considerations. Changes in the market value of real estate can affect the potential losses in the portfolio. Commercial Real Estate Loans Commercial real estate loans as of December 31, 2018 consisted of $1.13 billion of owner and non-owner occupied real estate, $49.2 million of loans secured by multi-family properties and $15.8 million of loans secured by farmland. Commercial real estate loans primarily include loans collateralized by retail, commercial office buildings, multi-family residential buildings, medical facilities and offices, senior living, assisted living and skilled nursing facilities, warehouse facilities, hotels and churches. Management does not consider there to be a risk in any one industry type. In determining whether to originate commercial real estate loans, we generally consider such factors as the financial condition of the borrower and the debt service coverage of the property. Commercial real estate loans are made at both fixed and adjustable interest rates for terms generally up to 20 years. Commercial Loans Our commercial loans are diversified loan types including short-term working capital loans for inventory and accounts receivable and short- and medium-term loans for equipment or other business capital expansion. Management does not consider there to be a concentration of risk in any one industry type. In our commercial loan underwriting, we assess the creditworthiness, ability to repay and the value and liquidity of the collateral being offered. Terms of commercial loans are generally commensurate with the useful life of the collateral offered. Municipal Loans We have a specific lending department that makes loans to municipalities and school districts primarily throughout the state of Texas, with a small percentage originating outside of the state. The majority of the loans to municipalities and school districts have tax or revenue pledges and in some cases are additionally supported by collateral. Municipal loans made without a direct pledge of taxes or revenues are usually made based on some type of collateral that represents an essential service. Loans to Individuals Substantially all originations of our loans to individuals are made to consumers in our market areas. The majority of loans to individuals are collateralized by titled equipment, which are primarily automobiles. Loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The underwriting standards we employ for consumer loans include an application, a determination of the applicant’s payment history on other debts, with the greatest weight being given to payment history with us and an assessment of the borrower’s ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, in relation to the proposed loan amount. Most of our loans to individuals are collateralized, which management believes assists in limiting our exposure. Allowance for Loan Losses The allowance for loan losses is based on the most current review of the loan portfolio and is a result of multiple processes. First, we utilize historical net charge-off data to establish general reserve amounts for each class of loans. The historical charge-off figure is further adjusted through qualitative factors that include general trends in past dues, nonaccruals and classified loans to more effectively and promptly react to both positive and negative movements not reflected in the historical data. Second, our lenders have the primary responsibility for identifying problem loans based on customer financial stress and underlying collateral. These recommendations are reviewed by senior loan administration, the special assets department and the loan review department on a monthly basis. Third, the loan review department independently reviews the portfolio on an annual basis. The loan review department follows a board-approved annual loan review scope. The loan review scope encompasses a number of considerations including the size of the loan, the type of credit extended, the seasoning of the loan and the performance of the loan. The loan review scope, as it relates to size, focuses more on larger dollar loan relationships, typically aggregate debt of $500,000 or greater. The loan review officer also reviews specific reserves compared to general reserves to determine trends in comparative reserves as well as losses not reserved for prior to charge-off to determine the effectiveness of the specific reserve process. At each review, a subjective analysis methodology is used to grade the respective loan. Categories of grading vary in severity from loans that do not appear to have a significant probability of loss at the time of review to loans that indicate a probability that the entire balance of the loan will be uncollectible. If at the time of review we determine it is probable that we will not collect the principal and interest cash flows contractually due on the loan, estimates of future expected cash flows or appraisals of the collateral securing the debt are used to determine the necessary allowance. The internal loan review department maintains a list (“Watch List”) of all loans or loan relationships that are graded as having more than the normal degree of risk associated with them. In addition, a list of specifically reserved loans or loan relationships of $150,000 or more is updated on a quarterly basis in order to properly determine necessary allowances and keep management informed on the status of attempts to correct the deficiencies noted with respect to the loans. We calculate historical loss ratios for pools of loans with similar characteristics based on the proportion of actual charge-offs experienced, consistent with the characteristics of remaining loans, to the total population of loans in the pool. The historical gross loss ratios are updated quarterly based on actual charge-off experience and adjusted for qualitative factors. All loans are subject to individual analysis if determined to be impaired with the exception of consumer loans and loans secured by 1-4 family residential loans. Industry and our own experience indicates that a portion of our loans will become delinquent and a portion of our loans will require partial or full charge-off. Regardless of the underwriting criteria utilized, losses may occur as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of properties used as collateral for loans and problems affecting the credit worthiness of the borrower and the ability of the borrower to make payments on the loan. Our determination of the appropriateness of the allowance for loan losses is based on various considerations, including an analysis of the risk characteristics of various classifications of loans, previous loan loss experience, specific loans which have loan loss potential, delinquency trends, estimated fair value of the underlying collateral, current economic conditions and geographic and industry loan concentration. Credit Quality Indicators We categorize loans into risk categories on an ongoing basis based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. We use the following definitions for risk ratings: • Pass (Rating 1 – 4) – This rating is assigned to all satisfactory loans. This category, by definition, consists of acceptable credit. Credit and collateral exceptions should not be present, although their presence would not necessarily prohibit a loan from being rated Pass, if deficiencies are in the process of correction. These loans are not included in the Watch List. • Pass Watch (Rating 5) – These loans require some degree of special treatment but not due to credit quality. This category does not include loans specially mentioned or adversely classified; however, particular attention is warranted to characteristics such as: ◦ A lack of, or abnormally extended payment program; ◦ A heavy degree of concentration of collateral without sufficient margin; ◦ A vulnerability to competition through lesser or extensive financial leverage; and ◦ A dependence on a single or few customers or sources of supply and materials without suitable substitutes or alternatives. • Special Mention (Rating 6) – A Special Mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in our credit position at some future date. Special Mention loans are not adversely classified and do not expose us to sufficient risk to warrant adverse classification. • Substandard (Rating 7) – Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. • Doubtful (Rating 8) – Loans classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation, in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. All accruing loans are reserved for as a group of similar type credits and included in the general portion of the allowance for loan losses. Loans to individuals and 1-4 family residential loans, including loans not accruing, are collectively evaluated and included in the general portion of the allowance for loan losses. All loans considered troubled debt restructurings (“TDR”) are evaluated individually for impairment. The general portion of the loan loss allowance is reflective of historical charge-off levels for similar loans adjusted for changes in current conditions and other relevant factors. These factors are likely to cause estimated losses to differ from historical loss experience and include: • Changes in lending policies or procedures, including underwriting, collection, charge-off and recovery procedures; • Changes in local, regional and national economic and business conditions, including entry into new markets; • Changes in the volume or type of credit extended; • Changes in the experience, ability and depth of lending management; • Changes in the volume and severity of past due, nonaccrual, restructured or classified loans; • Changes in charge-off trends; • Changes in loan review or Board oversight; • Changes in the level of concentrations of credit; and • Changes in external factors, such as competition and legal and regulatory requirements. These factors are also considered for the non-PCI purchased loan portfolio specifically in regards to changes in credit quality, past due, nonaccrual and charge-off trends. The following tables detail activity in the allowance for loan losses by portfolio segment for the periods presented (in thousands): Year Ended December 31, 2018 Real Estate Construction 1-4 Family Residential Commercial Commercial Loans Municipal Loans Loans to Individuals Total Balance at beginning of period (1) $ 3,676 $ 2,445 $ 10,821 $ 2,094 $ 860 $ 885 $ 20,781 Provision (reversal) for loan losses (2) (72 ) 1,134 3,894 2,392 (335 ) 1,424 8,437 Loans charged off (14 ) (91 ) (783 ) (756 ) — (2,602 ) (4,246 ) Recoveries of loans charged off 7 356 36 244 — 1,404 2,047 Balance at end of period $ 3,597 $ 3,844 $ 13,968 $ 3,974 $ 525 $ 1,111 $ 27,019 Year Ended December 31, 2017 Real Estate Construction 1-4 Family Residential Commercial Commercial Loans Municipal Loans Loans to Individuals Total Balance at beginning of period $ 4,147 $ 2,665 $ 7,204 $ 2,263 $ 750 $ 882 $ 17,911 Provision (reversal) for loan losses (2) (437 ) 65 3,604 242 110 1,091 4,675 Loans charged off (35 ) (304 ) — (723 ) — (2,391 ) (3,453 ) Recoveries of loans charged off 1 19 13 312 — 1,303 1,648 Balance at end of period (1) $ 3,676 $ 2,445 $ 10,821 $ 2,094 $ 860 $ 885 $ 20,781 Year Ended December 31, 2016 Real Estate Construction 1-4 Family Residential Commercial Commercial Loans (3) Municipal Loans Loans to Individuals Total Balance at beginning of period $ 4,350 $ 2,595 $ 4,577 $ 6,596 $ 725 $ 893 $ 19,736 Provision (reversal) for loan losses (2) (472 ) (28 ) 2,604 6,397 (224 ) 1,503 9,780 Loans charged off (3) — (43 ) — (11,396 ) — (2,948 ) (14,387 ) Recoveries of loans charged off 269 141 23 666 249 1,434 2,782 Balance at end of period $ 4,147 $ 2,665 $ 7,204 $ 2,263 $ 750 $ 882 $ 17,911 (1) Loans acquired with the Diboll acquisition were measured at fair value on November 30, 2017 with no carryover of allowance for loan loss. (2) Of the $8.4 million in provision for loan losses for the year ended December 31, 2018 , $302,000 related to provision expense on PCI loans. Of the $4.7 million and $9.8 million recorded in provision for loan losses for the year ended December 31, 2017 and 2016 , respectively, none related to provision expense on PCI loans. (3) Of the $11.4 million in commercial charge-offs recorded for the year ended December 31, 2016 , $10.9 million relates to the charge-off of two large commercial borrowing relationships. The following tables present the balance in the allowance for loan losses by portfolio segment based on impairment method (in thousands): December 31, 2018 Real Estate Construction 1-4 Family Residential Commercial Commercial Loans Municipal Loans Loans to Individuals Total Ending balance – individually evaluated for impairment (1) $ 13 $ 40 $ 5,337 $ 368 $ 1 $ 149 $ 5,908 Ending balance – collectively evaluated for impairment 3,584 3,804 8,631 3,606 524 962 21,111 Balance at end of period $ 3,597 $ 3,844 $ 13,968 $ 3,974 $ 525 $ 1,111 $ 27,019 December 31, 2017 Real Estate Construction 1-4 Family Residential Commercial Commercial Loans Municipal Loans Loans to Individuals Total Ending balance – individually evaluated for impairment (1) $ 12 $ 14 $ 14 $ 252 $ 10 $ 51 $ 353 Ending balance – collectively evaluated for impairment 3,664 2,431 10,807 1,842 850 834 20,428 Balance at end of period $ 3,676 $ 2,445 $ 10,821 $ 2,094 $ 860 $ 885 $ 20,781 (1) The allowance for loan loss on PCI loans totaled $302,000 as of December 31, 2018 . There was no allowance for loan losses associated with PCI loans as of December 31, 2017 . The following tables present the recorded investment in loans by portfolio segment based on impairment method (in thousands): December 31, 2018 Real Estate Construction 1-4 Family Residential Commercial Commercial Loans Municipal Loans Loans to Individuals Total Loans individually evaluated for impairment $ 12 $ 1,215 $ 33,013 $ 1,394 $ 429 $ 184 $ 36,247 Loans collectively evaluated for impairment 507,564 782,614 1,128,220 353,036 352,941 105,775 3,230,150 Purchased credit impaired loans (1) 156 10,670 32,885 2,219 — 472 46,402 Total ending loan balance $ 507,732 $ 794,499 $ 1,194,118 $ 356,649 $ 353,370 $ 106,431 $ 3,312,799 December 31, 2017 Real Estate Construction 1-4 Family Residential Commercial Commercial Loans Municipal Loans Loans to Individuals Total Loans individually evaluated for impairment $ 86 $ 1,581 $ 895 $ 1,429 $ 502 $ 205 $ 4,698 Loans collectively evaluated for impairment 475,505 797,111 1,232,327 259,745 345,296 134,441 3,244,425 Purchased credit impaired loans 276 6,649 31,937 5,248 — 1,123 45,233 Total ending loan balance $ 475,867 $ 805,341 $ 1,265,159 $ 266,422 $ 345,798 $ 135,769 $ 3,294,356 (1) At December 31, 2018 , PCI totals include approximately $14.0 million in new funds to a borrower that has since been upgraded to a Pass credit. The following tables set forth credit quality indicators by class of loans for the periods presented (in thousands): December 31, 2018 Pass Pass Watch (1) Special Mention (1) Substandard (1) Doubtful (1) Total Real Estate Loans: Construction $ 507,529 $ 163 $ — $ 28 $ 12 $ 507,732 1-4 Family Residential 787,516 37 100 5,489 1,357 794,499 Commercial 1,067,874 11,479 26,490 87,767 508 1,194,118 Commercial Loans 349,495 520 3,189 2,988 457 356,649 Municipal Loans 353,370 — — — — 353,370 Loans to Individuals 105,536 4 4 678 209 106,431 Total $ 3,171,320 $ 12,203 $ 29,783 $ 96,950 $ 2,543 $ 3,312,799 December 31, 2017 Pass Pass Watch (1) Special Mention (1) Substandard (1) Doubtful (1) Total Real Estate Loans: Construction $ 471,446 $ 3,329 $ 77 $ 982 $ 33 $ 475,867 1-4 Family Residential 796,639 559 857 6,610 676 805,341 Commercial 1,136,576 26,275 25,301 76,625 382 1,265,159 Commercial Loans 247,430 9,625 3,956 5,203 208 266,422 Municipal Loans 344,366 — 930 502 — 345,798 Loans to Individuals 134,694 20 102 707 246 135,769 Total $ 3,131,151 $ 39,808 $ 31,223 $ 90,629 $ 1,545 $ 3,294,356 (1) Includes PCI loans comprised of $22,000 pass watch, $859,000 special mention, $3.9 million substandard and $1.2 million doubtful as of December 31, 2018 . Includes PCI loans comprised of $362,000 pass watch, $6.0 million special mention, $10.5 million substandard and $925,000 doubtful as of December 31, 2017 . Nonperforming Assets and Past Due Loans Nonaccrual loans are loans 90 days or more delinquent and collection in full of both the principal and interest is not expected. Additionally, some loans that are not delinquent or that are delinquent less than 90 days may be placed on nonaccrual status if it is probable that we will not receive contractual principal and interest payments in accordance with the terms of the respective loan agreement. When a loan is categorized as nonaccrual, the accrual of interest is discontinued and any accrued balance is reversed for financial statement purposes. Payments received on nonaccrual loans are applied to the outstanding principal balance. Payments of contractual interest are recognized as income only to the extent that full recovery of the principal balance of the loan is reasonably certain. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Other factors, such as the value of collateral securing the loan and the financial condition of the borrower, are considered in judgments as to potential loan loss. Nonaccrual loans and accruing loans past due more than 90 days include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. PCI loans are recorded at fair value at acquisition date. Although the PCI loans may be contractually delinquent, we do not classify these loans as past due or nonperforming when the timing and amount of expected cash flows can be reasonably estimated, as the loans were written down to fair value at the acquisition date and the accretable yield is recognized in interest income over the remaining life of the loan. However, subsequent to acquisition, we reassess PCI loans for additional impairment and record additional impairment in the event we conclude it is probable that we will be unable to collect all cash flows originally expected to be collected at acquisition plus any additional cash flows expected to be collected due to changes in estimates after acquisition. All such PCI loans for which we recognize subsequent impairment are reported as impaired loans in the financial statements. The following table sets forth nonperforming assets for the periods presented (in thousands): December 31, 2018 December 31, 2017 Nonaccrual loans (1) (2) $ 35,770 $ 2,937 Accruing loans past due more than 90 days (1) — 1 Restructured loans (3) 5,930 5,767 Other real estate owned 1,206 1,613 Repossessed assets — 154 Total Nonperforming Assets $ 42,906 $ 10,472 (1) Excludes PCI loans measured at fair value at acquisition if the timing and amount of cash flows expected to be collected from those sales can be reasonably estimated. The increase in nonaccrual loans was primarily due to the addition of four commercial real estate loans to nonaccrual status during the year, one of which was added during the fourth quarter . (2) Includes $10.9 million and $1.3 million of restructured loans as of December 31, 2018 and 2017 , respectively. (3) Includes $3.1 million and $2.9 million in PCI loans restructured as of December 31, 2018 and 2017 , respectively. Foreclosed assets include other real estate owned and repossessed assets. For 1-4 family residential real estate properties, a loan is recognized as a foreclosed property once legal title to the real estate property has been received upon completion of foreclosure or the borrower has conveyed all interest in the residential property through a deed in lieu of foreclosure. There were $147,000 and $154,000 in loans secured by 1-4 family residential properties for which formal foreclosure proceedings were in process as of December 31, 2018 and December 31, 2017 , respectively. The following table sets forth the recorded investment in nonaccrual loans by class of loans for the periods presented (in thousands). The table excludes PCI loans measured at fair value at acquisition: Nonaccrual Loans December 31, 2018 December 31, 2017 Real Estate Loans: Construction $ 12 $ 86 1-4 Family Residential 2,202 1,098 Commercial 32,599 595 Commercial Loans 639 903 Loans to Individuals 318 255 Total $ 35,770 $ 2,937 Loans are considered impaired if, based on current information and events, it is probable we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for larger loans. The measurement of loss on impaired loans is generally based on the fair value of the collateral less selling costs if repayment is expected solely from the collateral or the present value of the expected future cash flows discounted at the historical effective interest rate stipulated in the loan agreement. In measuring the fair value of the collateral, in addition to relying on third party appraisals, we use assumptions, such as discount rates, and methodologies, such as comparison to the recent selling price of similar assets, consistent with those that would be utilized by unrelated third parties performing a valuation. Loans that are evaluated and determined not to meet the definition of an impaired loan are reserved for at the general reserve rate for its appropriate class. At the time a loss is probable in the collection of contractual amounts, specific reserves are allocated. Loans are charged off to the liquidation value of the collateral net of liquidation costs, if any, when deemed uncollectible or as soon as collection by liquidation is evident. The following tables set forth impaired loans by class of loans, including the unpaid contractual principal balance, the recorded investment and the allowance for loan losses for the periods presented (in thousands). Impaired loans include restructured and nonaccrual loans for which the allowance was measured in accordance with section 310-10 of ASC Topic 310, “Receivables.” There were no impaired loans recorded without an allowance for the years ended December 31, 2018 or 2017 . December 31, 2018 Unpaid Contractual Principal Balance Recorded Investment Related Allowance for Loan Losses Real Estate Loans: Construction $ 182 $ 148 $ 13 1-4 Family Residential 6,507 5,923 40 Commercial 36,457 34,744 5,337 Commercial Loans 2,874 2,366 368 Municipal Loans 429 429 1 Loans to Individuals 825 657 149 Total (1) $ 47,274 $ 44,267 $ 5,908 December 31, 2017 Unpaid Contractual Principal Balance Recorded Related Allowance for Loan Losses Real Estate Loans: Construction $ 91 $ 86 $ 12 1-4 Family Residential 4,141 3,952 14 Commercial 1,353 1,199 14 Commercial Loans 1,665 1,605 252 Municipal Loans 502 502 10 Loans to Individuals 237 205 51 Total (1) $ 7,989 $ 7,549 $ 353 (1) Includes $8.0 million and $2.9 million of PCI loans that experienced deterioration in credit quality subsequent to the acquisition date as of December 31, 2018 and December 31, 2017 , respectively. The following tables present the aging of the recorded investment in past due loans by class of loans (in thousands): December 31, 2018 30-59 Days Past Due 60-89 Days Past Due Greater than 90 Days Past Due Total Past Due Current (1) Total Real Estate Loans: Construction $ 627 $ 307 $ — $ 934 $ 506,798 $ 507,732 1-4 Family Residential 7,441 1,258 1,335 10,034 784,465 794,499 Commercial 10,663 7,655 — 18,318 1,175,800 1,194,118 Commercial Loans 1,946 705 591 3,242 353,407 356,649 Municipal Loans — — — — 353,370 353,370 Loans to Individuals 1,289 351 146 1,786 104,645 106,431 Total $ 21,966 $ 10,276 $ 2,072 $ 34,314 $ 3,278,485 $ 3,312,799 December 31, 2017 30-59 Days Past Due 60-89 Days Past Due Greater than 90 Days Past Due Total Past Due Current (1) Total Real Estate Loans: Construction $ 1,302 $ 1,530 $ 68 $ 2,900 $ 472,967 $ 475,867 1-4 Family Residential 8,508 1,574 862 10,944 794,397 805,341 Commercial 1,357 24 5 1,386 1,263,773 1,265,159 Commercial Loans 662 400 333 1,395 265,027 266,422 Municipal Loans 422 — — 422 345,376 345,798 Loans to Individuals 1,526 373 93 1,992 133,777 135,769 Total $ 13,777 $ 3,901 $ 1,361 $ 19,039 $ 3,275,317 $ 3,294,356 (1) Includes PCI loans measured at fair value at acquisition if the timing and amount of cash flows expected to be collected from those sales can be reasonably estimated. The following table sets forth average recorded investment and interest income recognized on impaired loans by class of loans for the periods presented (in thousands). The table excludes PCI loans measured at fair value at acquisition that have not experienced further deterioration in credit quality subsequent to the acquisition date: Years Ended December 31, 2018 2017 2016 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Real Estate Loans: Construction $ 149 $ 7 $ 251 $ — $ 510 $ 22 1-4 Family Residential 4,193 208 4,264 197 3,247 169 Commercial 26,186 65 1,338 30 4,490 63 Commercial Loans 2,131 102 2,862 59 13,481 48 Municipal Loans 474 26 545 30 612 33 Loans to Individuals 250 9 244 9 257 9 Total $ 33,383 $ 417 $ 9,504 $ 325 $ 22,597 $ 344 Troubled Debt Restructurings The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, restructuring amortization schedules and other actions intended to minimize potential losses. We may provide a combination of concessions which may include an extension of the amortization period, interest rate reduction and/or converting the loan to interest-only for a limited period of time. The following tables set forth the recorded balance of loans considered to be TDRs that were restructured and the type of concession during the periods presented (dollars in thousands): December 31, 2018 Extend Amortization Period Interest Rate Reductions Combination Total Modifications Number of Contracts Real Estate Loans: 1-4 Family Residential $ — $ 79 $ — $ 79 1 Commercial 10,398 — 274 10,672 3 Commercial Loans 211 — 215 426 13 Loans to Individuals 8 33 51 92 5 Total $ 10,617 $ 112 $ 540 $ 11,269 22 December 31, 2017 Extend Amortization Period Interest Rate Reductions Combination Total Modifications Number of Contracts Commercial Loans $ 778 $ — $ 241 $ 1,019 4 Loans to Individuals 23 — 52 75 6 Total $ 801 $ — $ 293 $ 1,094 10 The majority of loans restructured as TDRs during the year ended December 31, 2018 were modified with maturity extensions. Interest continues to be charged on principal balances outstanding during the extended term. Therefore, the financial effects of the recorded investment of loans restructured as TDRs during the year ended December 31, 2018 and 2017 were not significant. Generally, the loans identified as TDRs were previously reported as impaired loans prior to restructuring, and therefore, the modification did not impact our determination of the allowance for loan losses. On an ongoing basis, the performance of the TDRs is monitored for subsequent payment default. Payment default for TDRs is recognized when the borrower is 90 days or more past due. For the years ended December 31, 2018 and 2017 , there were $216,000 and $138,000 , respectively, of TDRs in default. Payment defaults for TDRs did not significantly impact the determination of the allowance for loan loss in either period presented. At December 31, 2018 and 2017 , there were no commitments to lend additional funds to borrowers whose terms had been modified in TDRs. Purchased Credit Impaired Loans The following table presents the outstanding principal balance and carrying value for PCI loans for the periods presented (in thousands): December 31, 2018 December 31, 2017 Outstanding principal balance (1) $ 51,388 $ 52,426 Carrying amount (1) $ 46,402 $ 45,233 (1) At December 31, 2018 , PCI totals include approximately $14.0 million in new funds to a borrower that has since been upgraded to a Pass credit. The following table presents the changes in the accretable yield during the periods fo |