Loans | Loans Management segments the Banks' loan portfolio to a level that enables risk and performance monitoring according to similar risk characteristics. Loans are segmented based on the underlying collateral characteristics. Categories include commercial, financial, and agricultural, real estate, and installment loans to individuals. Real estate loans are further segmented into three categories: residential, commercial, and construction. The following table presents the related aging categories of loans, by segment, as of June 30, 2016 and December 31, 2015 : June 30, 2016 Past Due Past Due 90 30 To 89 Days Or More Non- (In Thousands) Current Days & Still Accruing Accrual Total Commercial, financial, and agricultural $ 154,569 $ 244 $ 152 $ 140 $ 155,105 Real estate mortgage: Residential 540,130 2,837 123 1,970 545,060 Commercial 293,174 1,198 235 8,929 303,536 Construction 24,494 — — 67 24,561 Installment loans to individuals 26,795 516 — 8 27,319 1,039,162 $ 4,795 $ 510 $ 11,114 1,055,581 Net deferred loan fees and discounts (1,462 ) (1,462 ) Allowance for loan losses (12,517 ) (12,517 ) Loans, net $ 1,025,183 $ 1,041,602 December 31, 2015 Past Due Past Due 90 30 To 89 Days Or More Non- (In Thousands) Current Days & Still Accruing Accrual Total Commercial, financial, and agricultural $ 162,312 $ 164 $ — $ 1,596 $ 164,072 Real estate mortgage: Residential 517,753 6,827 714 889 526,183 Commercial 295,784 720 265 5,770 302,539 Construction 26,545 67 — 212 26,824 Installment loans to individuals 26,572 429 — — 27,001 1,028,966 $ 8,207 $ 979 $ 8,467 1,046,619 Net deferred loan fees and discounts (1,412 ) (1,412 ) Allowance for loan losses (12,044 ) (12,044 ) Loans, net $ 1,015,510 $ 1,033,163 Purchased loans acquired are recorded at fair value on their purchase date without a carryover of the related allowance for loan losses. Upon the acquisition of Luzerne Bank on June 1, 2013, the Company evaluated whether each acquired loan (regardless of size) was within the scope of ASC 310-30, Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality . Purchased credit-impaired loans are loans that have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. There were no material increases or decreases in the expected cash flows of these loans between June 1, 2013 (the “acquisition date”) and June 30, 2016 . The fair value of purchased credit-impaired loans, on the acquisition date, was determined, primarily based on the fair value of loan collateral. The carrying value of purchased loans acquired with deteriorated credit quality was $333,000 at June 30, 2016 . On the acquisition date, the preliminary estimate of the unpaid principal balance for all loans evidencing credit impairment acquired in the Luzerne Bank acquisition was $1,211,000 and the estimated fair value of the loans was $878,000 . Total contractually required payments on these loans, including interest, at the acquisition date was $1,783,000 . However, the Company’s preliminary estimate of expected cash flows was $941,000 . At such date, the Company established a credit risk related non-accretable discount (a discount representing amounts which are not expected to be collected from either the customer or liquidation of collateral) of $842,000 relating to these impaired loans, reflected in the recorded net fair value. Such amount is reflected as a non-accretable fair value adjustment to loans. The Company further estimated the timing and amount of expected cash flows in excess of the estimated fair value and established an accretable discount of $63,000 on the acquisition date relating to these impaired loans. The following table presents additional information regarding loans acquired in the Luzerne Bank transaction with specific evidence of deterioration in credit quality: (In Thousands) June 30, 2016 December 31, 2015 Outstanding balance $ 433 $ 441 Carrying amount 333 341 There were no material increases or decreases in the expected cash flows of these loans between June 1, 2013 (the “acquisition date”) and June 30, 2016 . There has been no allowance for loan losses recorded for acquired loans with specific evidence of deterioration in credit quality as of June 30, 2016 . The following table presents interest income the Banks would have recorded if interest had been recorded based on the original loan agreement terms and rate of interest for non-accrual loans and interest income recognized on a cash basis for non-accrual loans for the three and six months ended June 30, 2016 and 2015 : Three Months Ended June 30, 2016 2015 (In Thousands) Interest Income That Would Have Been Recorded Based on Original Term and Rate Interest Income Recorded on a Cash Basis Interest Income That Would Have Been Recorded Based on Original Term and Rate Interest Income Recorded on a Cash Basis Commercial, financial, and agricultural $ 1 $ — $ 2 $ — Real estate mortgage: Residential 24 13 16 10 Commercial 110 16 66 10 Construction 2 — 15 29 $ 137 $ 29 $ 99 $ 49 Six Months Ended June 30, 2016 2015 (In Thousands) Interest Income That Would Have Been Recorded Based on Original Term and Rate Interest Income Recorded on a Cash Basis Interest Income That Would Have Been Recorded Based on Original Term and Rate Interest Income Recorded on a Cash Basis Commercial, financial, and agricultural $ 4 $ 1 $ 14 $ 8 Real estate mortgage: Residential 56 27 21 19 Commercial 279 80 171 35 Construction 2 30 36 $ 341 $ 108 $ 236 $ 98 Impaired Loans Impaired loans are loans for which it is probable the Banks will not be able to collect all amounts due according to the contractual terms of the loan agreement. The Banks evaluate such loans for impairment individually and does not aggregate loans by major risk classifications. The definition of “impaired loans” is not the same as the definition of “non-accrual loans,” although the two categories overlap. The Banks may choose to place a loan on non-accrual status due to payment delinquency or uncertain collectability, while not classifying the loan as impaired. Factors considered by management in determining impairment include payment status and collateral value. The amount of impairment for these types of loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original interest rate, and its recorded value, or as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loan. When foreclosure is probable, impairment is measured based on the fair value of the collateral. Management evaluates individual loans in all of the commercial segments for possible impairment if the loan is greater than $100,000 and if the loan is either on non-accrual status or has a risk rating of substandard. Management may also elect to measure an individual loan for impairment if less than $100,000 on a case-by-case basis. Mortgage loans on one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis taking into consideration all circumstances surrounding the loan and the borrower including the length of the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed. Interest income for impaired loans is recorded consistent with the Banks' policy on non-accrual loans. The following table presents the recorded investment, unpaid principal balance, and related allowance of impaired loans by segment as of June 30, 2016 and December 31, 2015 : June 30, 2016 Recorded Unpaid Principal Related (In Thousands) Investment Balance Allowance With no related allowance recorded: Commercial, financial, and agricultural $ 289 $ 289 $ — Real estate mortgage: Residential 1,417 1,417 — Commercial 2,175 2,225 — Construction 278 278 — 4,159 4,209 — With an allowance recorded: Commercial, financial, and agricultural 140 140 70 Real estate mortgage: Residential 2,260 2,360 1,038 Commercial 9,369 9,369 1,517 Construction — — — 11,769 11,869 2,625 Total: Commercial, financial, and agricultural 429 429 70 Real estate mortgage: Residential 3,677 3,777 1,038 Commercial 11,544 11,594 1,517 Construction 278 278 — $ 15,928 $ 16,078 $ 2,625 December 31, 2015 Recorded Unpaid Principal Related (In Thousands) Investment Balance Allowance With no related allowance recorded: Commercial, financial, and agricultural $ 319 $ 319 $ — Real estate mortgage: Residential 1,142 1,142 — Commercial 1,735 1,785 — Construction 212 212 — 3,408 3,458 — With an allowance recorded: Commercial, financial, and agricultural 150 150 75 Real estate mortgage: Residential 1,573 1,703 376 Commercial 10,752 10,752 1,653 Construction — — — 12,475 12,605 2,104 Total: Commercial, financial, and agricultural 469 469 75 Real estate mortgage: Residential 2,715 2,845 376 Commercial 12,487 12,537 1,653 Construction 212 212 — $ 15,883 $ 16,063 $ 2,104 The following table presents the average recorded investment in impaired loans and related interest income recognized for the three and six months ended for June 30, 2016 and 2015 : Three Months Ended June 30, 2016 2015 (In Thousands) Average Investment in Impaired Loans Interest Income Recognized on an Accrual Basis on Impaired Loans Interest Income Recognized on a Cash Basis on Impaired Loans Average Investment in Impaired Loans Interest Income Recognized on an Accrual Basis on Impaired Loans Interest Income Recognized on a Cash Basis on Impaired Loans Commercial, financial, and agricultural $ 513 $ 4 $ — $ 1,064 $ 5 $ 3 Real estate mortgage: Residential 2,985 22 13 1,922 16 12 Commercial 11,724 82 16 14,271 77 11 Construction 173 — 910 — 29 $ 15,395 $ 108 $ 29 $ 18,167 $ 98 $ 55 Six Months Ended June 30, 2016 2015 (In Thousands) Average Investment in Impaired Loans Interest Income Recognized on an Accrual Basis on Impaired Loans Interest Income Recognized on a Cash Basis on Impaired Loans Average Investment in Impaired Loans Interest Income Recognized on an Accrual Basis on Impaired Loans Interest Income Recognized on a Cash Basis on Impaired Loans Commercial, financial, and agricultural $ 498 $ 8 $ 4 $ 1,080 $ 10 $ 10 Real estate mortgage: Residential 3,208 44 22 1,741 28 17 Commercial 12,410 164 82 14,486 148 36 Construction 186 — 780 — 36 $ 16,302 $ 216 $ 108 $ 18,087 $ 186 $ 99 Currently, there is $23,000 committed to be advanced in connection with impaired loans. Troubled Debt Restructurings The loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. 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 . There were three loan modifications that were considered TDRs completed during the three months ended June 30, 2016. Loan modifications that are considered TDRs completed during the three and six months ended June 30, 2016 and 2015 and were as follows: Three Months Ended June 30, 2016 2015 (In Thousands, Except Number of Contracts) Number of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Number Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Commercial, financial, and agricultural — $ — $ — Real estate mortgage: Residential 2 342 342 1 88 88 Commercial 1 838 838 1 247 247 Construction — — — 1 398 398 3 $ 1,180 $ 1,180 3 $ 733 $ 733 Six Months Ended June 30, 2016 2015 (In Thousands, Except Number of Contracts) 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, financial, and agricultural — $ — $ — 2 $ 97 $ 97 Real estate mortgage: Residential 2 342 342 6 322 322 Commercial 1 838 838 2 517 517 Construction — — — 1 398 398 3 $ 1,180 $ 1,180 11 $ 1,334 $ 1,334 There were five loan modifications considered to be TDRs made during the twelve months previous to June 30, 2016 that defaulted during the six months ended June 30, 2016 . The defaulted loan types and recorded investments at March 31, 2016 are as follows: one commercial loan with a recorded investment of $103,000 , one commercial real estate loan with a recorded investment of $239,000 , and three residential real estate loan with a recorded investment of $173,000 . There was one loan modifications considered TDRs made during the twelve months previous to June 30, 2015 that defaulted during the six months ended June 30, 2015 . The loan that defaulted is a commercial real estate loans with a recorded investment of $48,000 at June 30, 2015 . Troubled debt restructurings amounted to $10,245,000 and $9,647,000 as of June 30, 2016 and December 31, 2015 . The amount of foreclosed residential real estate held at June 30, 2016 and December 31, 2015 , totaled $126,000 and $102,000 , respectively. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process at June 30, 2016 and December 31, 2015 , totaled $938,000 and $448,000 , respectively. Internal Risk Ratings Management uses a ten point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The special mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a substandard classification. Loans in the substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are evaluated for substandard classification. Loans in the doubtful category exhibit the same weaknesses found in the substandard loans, however, the weaknesses are more pronounced. Such loans are static and collection in full is improbable. However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Loans classified loss are considered uncollectible and charge-off is imminent. To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Banks have a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the pass category unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. An external annual loan review of large commercial relationships is performed, as well as a sample of smaller transactions. Confirmation of the appropriate risk category is included in the review. Detailed reviews, including plans for resolution, are performed on loans classified as substandard, doubtful, or loss on a quarterly basis. The following table presents the credit quality categories identified above as of June 30, 2016 and December 31, 2015 : June 30, 2016 Commercial, Financial, and Agricultural Real Estate Mortgages Installment Loans to Individuals (In Thousands) Residential Commercial Construction Totals Pass $ 151,930 $ 542,212 $ 293,881 $ 24,494 $ 27,311 $ 1,039,828 Special Mention 3,035 878 726 — — 4,639 Substandard 140 1,970 8,929 67 8 11,114 $ 155,105 $ 545,060 $ 303,536 $ 24,561 $ 27,319 $ 1,055,581 December 31, 2015 Commercial, Financial, and Agricultural Real Estate Mortgages Installment Loans to Individuals (In Thousands) Residential Commercial Construction Totals Pass $ 160,734 $ 522,853 $ 277,248 $ 26,612 $ 27,001 $ 1,014,448 Special Mention 1,669 823 8,625 — — 11,117 Substandard 1,669 2,507 16,666 212 — 21,054 $ 164,072 $ 526,183 $ 302,539 $ 26,824 $ 27,001 $ 1,046,619 Allowance for Loan Losses An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated future loss experience, and the amount of non-performing loans. The Banks' methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (previously discussed) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Banks' ALL. Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. Allowances are segmented based on collateral characteristics previously disclosed, and consistent with credit quality monitoring. Loans that are collectively evaluated for impairment are grouped into two classes for evaluation. A general allowance is determined for “Pass” rated credits, while a separate pool allowance is provided for “Criticized” rated credits that are not individually evaluated for impairment. For the general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative factors. A historical charge-off factor is calculated utilizing a twelve quarter moving average. However, management may adjust the moving average time frame by up to four quarters to adjust for variances in the economic cycle. Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint. Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors. Management also monitors industry loss factors by loan segment for applicable adjustments to actual loss experience. Management reviews the loan portfolio on a quarterly basis in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL. Activity in the allowance is presented for the three and six months ended June 30, 2016 and 2015 : Three Months Ended June 30, 2016 Commercial, Financial, and Agricultural Real Estate Mortgages Installment Loans to Individuals (In Thousands) Residential Commercial Construction Unallocated Totals Beginning Balance $ 1,254 $ 5,123 $ 4,472 $ 147 $ 264 $ 1,122 $ 12,382 Charge-offs (149 ) (7 ) — — (53 ) — (209 ) Recoveries 52 3 — 2 29 — 86 Provision 116 732 (471 ) (6 ) 37 (150 ) 258 Ending Balance $ 1,273 $ 5,851 $ 4,001 $ 143 $ 277 $ 972 $ 12,517 Three Months Ended June 30, 2015 Commercial, Financial, and Agricultural Real Estate Mortgages Installment Loans to Individuals (In Thousands) Residential Commercial Construction Unallocated Totals Beginning Balance $ 1,478 $ 4,227 $ 3,873 $ 752 $ 193 $ 303 $ 10,826 Charge-offs (263 ) — — (46 ) (58 ) — (367 ) Recoveries 2 13 169 5 17 — 206 Provision 69 94 (173 ) (163 ) 85 688 600 Ending Balance $ 1,286 $ 4,334 $ 3,869 $ 548 $ 237 $ 991 $ 11,265 Six Months Ended June 30, 2016 Commercial, Financial, and Agricultural Real Estate Mortgages Installment Loans to Individuals (In Thousands) Residential Commercial Construction Unallocated Totals Beginning Balance $ 1,532 $ 5,116 $ 4,217 $ 160 $ 243 $ 776 $ 12,044 Charge-offs (149 ) (7 ) — — (104 ) — (260 ) Recoveries 52 6 5 5 57 — 125 Provision (162 ) 736 (221 ) (22 ) 81 196 608 Ending Balance $ 1,273 $ 5,851 $ 4,001 $ 143 $ 277 $ 972 $ 12,517 Six Months Ended June 30, 2015 Commercial, Financial, and Agricultural Real Estate Mortgages Installment Loans to Individuals (In Thousands) Residential Commercial Construction Unallocated Totals Beginning Balance $ 1,124 $ 3,755 $ 4,205 $ 786 $ 245 $ 464 $ 10,579 Charge-offs (283 ) (1 ) (449 ) (46 ) (114 ) — (893 ) Recoveries 28 37 169 16 29 — 279 Provision 417 543 (56 ) (208 ) 77 527 1,300 Ending Balance $ 1,286 $ 4,334 $ 3,869 $ 548 $ 237 $ 991 $ 11,265 The Company grants commercial, industrial, residential, and installment loans to customers primarily throughout north-east and central Pennsylvania. Although the Company has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on the economic conditions within this region. The Company has a concentration of the following to gross loans at June 30, 2016 and 2015 : June 30, 2016 2015 Owners of residential rental properties 16.74 % 16.32 % Owners of commercial rental properties 14.14 % 14.18 % The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of June 30, 2016 and December 31, 2015 : June 30, 2016 Commercial, Financial, and Agricultural Real Estate Mortgages Installment Loans to Individuals Unallocated (In Thousands) Residential Commercial Construction Totals Allowance for Loan Losses: Ending allowance balance attributable to loans: Individually evaluated for impairment $ 70 $ 1,038 $ 1,517 $ — $ — $ — $ 2,625 Collectively evaluated for impairment 1,203 4,813 2,484 143 277 972 9,892 Total ending allowance balance $ 1,273 $ 5,851 $ 4,001 $ 143 $ 277 $ 972 $ 12,517 Loans: Individually evaluated for impairment $ 429 $ 3,344 $ 11,544 $ 278 $ — $ 15,595 Loans acquired with deteriorated credit quality — 333 — — — 333 Collectively evaluated for impairment 154,676 541,383 291,992 24,283 27,319 1,039,653 Total ending loans balance $ 155,105 $ 545,060 $ 303,536 $ 24,561 $ 27,319 $ 1,055,581 December 31, 2015 Commercial, Financial, and Agricultural Real Estate Mortgages Installment Loans to Individuals Unallocated (In Thousands) Residential Commercial Construction Totals Allowance for Loan Losses: Ending allowance balance attributable to loans: Individually evaluated for impairment $ 75 $ 376 $ 1,653 $ — $ — $ — $ 2,104 Collectively evaluated for impairment 1,457 4,740 2,564 160 243 776 9,940 Total ending allowance balance $ 1,532 $ 5,116 $ 4,217 $ 160 $ 243 $ 776 $ 12,044 Loans: Individually evaluated for impairment $ 469 $ 2,374 $ 12,487 $ 212 $ — $ 15,542 Loans acquired with deteriorated credit quality — 341 — — — 341 Collectively evaluated for impairment 163,603 523,468 290,052 26,612 27,001 1,030,736 Total ending loans balance $ 164,072 $ 526,183 $ 302,539 $ 26,824 $ 27,001 $ 1,046,619 |