Note 4 — Allowance for Probable Loan Losses

The allowance for probable loan losses primarily consists of the aggregate loan loss allowances of the Subsidiary Banks. The allowances are established through charges to operations in the form of provisions for probable loan losses. Loan losses or recoveries are charged or credited directly to the allowances. The allowance for probable loan losses of each Subsidiary Bank is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance for probable loan losses is derived from the following elements: (i) allowances established on specific impaired loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry in which the customer operates; (ii) allowances based on actual historical loss experience for similar types of loans in our loan portfolio; and (iii) allowances based on general economic conditions, changes in the mix of loans, company resources, border risk and credit quality indicators, among other things. All segments of the loan portfolio continue to be impacted by economic uncertainty as the economy recovers from the recent prolonged downturn.

Our management continually reviews the allowance for loan losses of the Subsidiary Banks using the amounts determined from the allowances established on specific impaired loans, the allowance established on quantitative historical loss percentages, and the allowance based on qualitative data to establish an appropriate amount to maintain in our allowance for loan losses. Should any of the factors considered by management in evaluating the adequacy of the allowance for probable loan losses change, our estimate of probable loan losses could also change, which could affect the level of future provisions for probable loan losses. While the calculation of the allowance for probable loan losses utilizes management’s best judgment and all information reasonably available, the adequacy of the allowance is dependent on a variety of factors beyond our control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications.

The loan loss provision is determined using the following methods. On a weekly basis, loan past due reports are reviewed by the credit quality committee to determine if a loan has any potential problems and if a loan should be placed on the internal classified report of the Subsidiary Banks. Additionally, the credit department of each Subsidiary Bank reviews the majority of our loans for proper internal classification purposes, regardless of whether they are past due, and segregates any loans with potential problems for further review. The credit department will discuss the potential problem loans with the servicing loan officers to determine any relevant issues that were not discovered in the evaluation. Also, an analysis of loans that is provided through examinations by regulatory authorities is considered in the review process. After the above analysis is completed, we determine if a loan should be placed on an internal classified report because of issues related to the analysis of the credit, credit documents, collateral and/or payment history.

A summary of the transactions in the allowance for probable loan losses by loan class is as follows:


	Three Months Ended March 31, 2019
	Domestic														Foreign
			Commercial
			Real Estate:
			Other		Commercial
			Construction &		Real Estate:		Commercial
			Land		Farmland &		Real Estate:		Residential:		Residential:
	Commercial		Development		Commercial		Multifamily		First Lien		Junior Lien		Consumer		Foreign		Total
	(Dollars in Thousands)

Balance at December 31,	$	12,596	$	15,123	$	19,353	$	1,808	$	3,467	$	7,719	$	447	$	871	$	61,384
Losses charged to allowance		(2,764)		—		(1)		—		(1)		(6)		(63)		—		(2,835)
Recoveries credited to allowance		638		20		283		—		1		102		17		—		1,061
Net (losses) recoveries charged to allowance		(2,126)		20		282		—		—		96		(46)		—		(1,774)

Provision charged to operations		942		(354)		6,245		537		79		(70)		61		(20)		7,420

Balance at March 31,	$	11,412	$	14,789	$	25,880	$	2,345	$	3,546	$	7,745	$	462	$	851	$	67,030


	Three Months Ended March 31, 2018
	Domestic														Foreign
			Commercial
			Real Estate:
			Other		Commercial
			Construction &		Real Estate:		Commercial
			Land		Farmland &		Real Estate:		Residential:		Residential:
	Commercial		Development		Commercial		Multifamily		First Lien		Junior Lien		Consumer		Foreign		Total
	(Dollars in Thousands)

Balance at December 31,	$	27,905	$	11,675	$	16,663	$	1,109	$	2,950	$	6,103	$	440	$	842	$	67,687
Losses charged to allowance		(2,715)		(1)		—		—		(14)		(30)		(117)		—		(2,877)
Recoveries credited to allowance		583		2		18		—		1		66		12		—		682
Net (losses) recoveries charged to allowance		(2,132)		1		18		—		(13)		36		(105)		—		(2,195)

Provision charged to operations		(5,082)		122		8,122		(162)		69		(1,450)		102		(59)		1,662

Balance at March 31,	$	20,691	$	11,798	$	24,803	$	947	$	3,006	$	4,689	$	437	$	783	$	67,154

The allowance for probable loan losses is a reserve established through a provision for probable loan losses charged to expense, which represents management’s best estimate of probable loan losses when evaluating loans individually or collectively. The increase in provision for probable loan losses charged to expense for the three months ended March 31, 2019 can be attributed to a specific reserve on a relationship that is secured by multiple pieces of real property on which car dealerships are operated. The deterioration was triggered by significant fraud by a high level insider of the car dealership resulting in the dealerships unexpectedly filing for bankruptcy and creating a potential exposure since the source of repayment from the borrower were the operations of the car dealerships. The relationship further deteriorated in the first quarter of 2019 after the sponsor of the court approved debtor in possession plan discontinued its role in the process and thus did not fulfill its obligation to assume full responsibility of the accrued and unpaid interest. Although the relationship is secured by real property (the dealerships’ real estate), the real property has specialized use, contributing to a potential exposure for probable loss. In light of the new circumstances and management’s evaluation of the relationship, the decision was made to place the relationship on impaired, non-accrual status and place a specific reserve on the relationship in the amount of $9.5 million. The impact of the specific reserve on the provision for probable loan loss charged to expense is not fully demonstrated in the charge for the quarter because we use a three year historical charge-off experience in the calculation, and, as large charge-offs in prior periods are eliminated from the calculation, the allowance for probable loan losses is impacted. As fluctuations occur in historical loss factors, management evaluates the need to adjust the qualitative factors used in the calculation to properly reflect probable loan losses.

The table below provides additional information on the balance of loans individually or collectively evaluated for impairment and their related allowance, by loan class as of March 31, 2019 and December 31, 2018:


	March 31, 2019
	Loans Individually				Loans Collectively
	Evaluated For				Evaluated For
	Impairment				Impairment
	Recorded				Recorded
	Investment		Allowance		Investment		Allowance
	(Dollars in Thousands)
Domestic
Commercial	$	18,608	$	666	$	1,194,931	$	10,746
Commercial real estate: other construction & land development		2,059		116		1,932,287		14,673
Commercial real estate: farmland & commercial		26,391		9,500		1,870,267		16,380
Commercial real estate: multifamily		507		—		293,605		2,345
Residential: first lien		6,216		—		450,698		3,546
Residential: junior lien		908		—		720,204		7,745
Consumer		1,074		—		44,999		462
Foreign		286		—		144,303		851

Total	$	56,049	$	10,282	$	6,651,294	$	56,748


	December 31, 2018
	Loans Individually				Loans Collectively
	Evaluated For				Evaluated For
	Impairment				Impairment
	Recorded				Recorded
	Investment		Allowance		Investment		Allowance
	(Dollars in Thousands)
Domestic
Commercial	$	9,179	$	656	$	1,119,790	$	11,940
Commercial real estate: other construction & land development		2,092		116		1,884,139		15,007
Commercial real estate: farmland & commercial		3,509		—		1,946,389		19,353
Commercial real estate: multifamily		507		—		225,750		1,808
Residential: first lien		6,244		—		439,556		3,467
Residential: junior lien		901		—		726,400		7,719
Consumer		1,175		—		45,141		447
Foreign		293		—		150,224		871

Total	$	23,900	$	772	$	6,537,389	$	60,612

The table below provides additional information on loans accounted for on a non-accrual basis by loan class at March 31, 2019 and December 31, 2018:


	March 31, 2019		December 31, 2018
	(Dollars in Thousands)
Domestic
Commercial	$	18,573	$	9,143
Commercial real estate: other construction & land development		2,059		2,092
Commercial real estate: farmland & commercial		26,391		3,509
Commercial real estate: multifamily		507		507
Residential: first lien		319		347
Residential: junior lien		165		171
Consumer		14		22
Total non-accrual loans	$	48,028	$	15,791

Impaired loans are those loans where it is probable that all amounts due according to contractual terms of the loan agreement will not be collected. We have identified these loans through our normal loan review procedures. Impaired loans are measured based on (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the loan’s observable market price; or (iii) the fair value of the collateral if the loan is collateral dependent. Substantially all of our impaired loans are measured at the fair value of the collateral. In limited cases, we may use other methods to determine the level of impairment of a loan if such loan is not collateral dependent.

The following tables detail key information regarding our impaired loans by loan class at March 31, 2019 and December 31, 2018:


	March 31, 2019
							Quarter to Date
			Unpaid				Average
	Recorded		Principal		Related		Recorded		Interest
	Investment		Balance		Allowance		Investment		Recognized
	(Dollars in Thousands)
Loans with Related Allowance
Domestic
Commercial	$	1,325	$	1,908	$	666	$	1,327	$	—
Commercial real estate: other construction & land development		134		169		116		135		—
Commercial real estate: farmland & commercial		24,463		24,774		9,500		24,480
Total impaired loans with related allowance	$	25,922	$	26,851	$	10,282	$	25,942	$	—


	March 31, 2019
					Quarter to Date
			Unpaid		Average
	Recorded		Principal		Recorded		Interest
	Investment		Balance		Investment		Recognized
	(Dollars in Thousands)
Loans with No Related Allowance
Domestic
Commercial	$	17,283	$	17,420	$	17,370	$	1
Commercial real estate: other construction & land development		1,925		2,167		1,924		—
Commercial real estate: farmland & commercial		1,928		2,493		2,305		—
Commercial real estate: multifamily		507		539		506		—
Residential: first lien		6,216		6,268		6,239		75
Residential: junior lien		908		918		912		11
Consumer		1,074		1,075		1,075		—
Foreign		286		286		288		3
Total impaired loans with no related allowance	$	30,127	$	31,166	$	30,619	$	90


	December 31, 2018
			Unpaid				Average
	Recorded		Principal		Related		Recorded		Interest
	Investment		Balance		Allowance		Investment		Recognized
	(Dollars in Thousands)
Loans with Related Allowance
Domestic
Commercial	$	1,563	$	2,161	$	656	$	1,741	$	—
Commercial real estate: other construction & land development		135		169		116		141		—
Total impaired loans with related allowance	$	1,698	$	2,330	$	772	$	1,882	$	—


	December 31, 2018
			Unpaid		Average
	Recorded		Principal		Recorded		Interest
	Investment		Balance		Investment		Recognized
	(Dollars in Thousands)
Loans with No Related Allowance
Domestic
Commercial	$	7,616	$	7,730	$	16,194	$	3
Commercial real estate: other construction & land development		1,957		2,205		2,151		—
Commercial real estate: farmland & commercial		3,509		4,031		36,632		—
Commercial real estate: multifamily		507		538		565		—
Residential: first lien		6,244		6,386		7,136		305
Residential: junior lien		901		911		976		44
Consumer		1,175		1,190		1,211		2
Foreign		293		293		327		14
Total impaired loans with no related allowance	$	22,202	$	23,284	$	65,192	$	368

The following table details key information regarding our impaired loans by loan class at March 31, 2018:


	March 31, 2018
	Quarter to Date
	Average
	Recorded		Interest
	Investment		Recognized
	(Dollars in Thousands)
Loans with Related Allowance
Domestic
Commercial	$	1,717	$	—
Commercial real estate: other construction & land development		144		—
Commercial real estate: farmland & commercial		15,103		—
Total impaired loans with related allowance	$	16,964	$	—


	March 31, 2018
	Quarter to Date
	Average
	Recorded		Interest
	Investment		Recognized
	(Dollars in Thousands)
Loans with No Related Allowance
Domestic
Commercial	$	16,820	$	1
Commercial real estate: other construction & land development		2,284		—
Commercial real estate: farmland & commercial		21,488		—
Commercial real estate: multifamily		471		—
Residential: first lien		6,960		77
Residential: junior lien		708		10
Consumer		1,208		1
Foreign		341		4
Total impaired loans with no related allowance	$	50,280	$	93

A portion of the impaired loans have adequate collateral and credit enhancements not requiring a related allowance for loan loss. Management recognizes the risks associated with these impaired loans, however, management is confident our loss exposure regarding these credits will be significantly reduced due to our long-standing practices that encompass the following principles: (i) the financial strength of the borrower, including strong earnings, a high net worth, significant liquidity and an acceptable debt to worth ratio, (ii) managerial and business competence, (iii) the ability to repay, (iv) for a new business, projected cash flows, (v) loan to value, (vi) in the case of a secondary guarantor, a guarantor financial statement, and (vii) financial and/or other character references. Management’s decision to place loans in this category does not necessarily mean that we will experience significant losses from these loans or significant increases in impaired loans from these levels.

The following table details loans accounted for as “troubled debt restructuring,” segregated by loan class. Loans accounted for as troubled debt restructuring are included in impaired loans.


	March 31, 2019		December 31, 2018
		(Dollars in Thousands)
Domestic
Commercial	$	34	$	35
Residential: first lien		5,951		5,947
Residential: junior lien		743		730
Consumer		1,060		1,153
Foreign		286		293

Total troubled debt restructuring	$	8,074	$	8,158

The Subsidiary Banks charge-off that portion of any loan which management considers to represent a loss as well as that portion of any other loan which is classified as a “loss” by bank examiners. Commercial and industrial or real estate loans are generally considered by management to represent a loss, in whole or part, when an exposure beyond any collateral coverage is apparent and when no further collection of the loss portion is anticipated based on the borrower’s financial condition and general economic conditions in the borrower’s industry. Generally, unsecured consumer loans are charged-off when 90 days past due.

While our management believes that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers carefully, there is no precise method of predicting loan losses. The determination that a loan is likely to be uncollectible and that it should be wholly or partially charged-off as a loss is an exercise of judgment. Similarly, the determination of the adequacy of the allowance for probable loan losses can be made only on a subjective basis. It is the judgment of our management that the allowance for probable loan losses at March 31, 2019 was adequate to absorb probable losses from loans in the portfolio at that date.

The following tables present information regarding the aging of past due loans by loan class at March 31, 2019 and December 31, 2018:


	March 31, 2019
							90 Days or		Total
	30 - 59		60 - 89		90 Days or		greater &		Past				Total
	Days		Days		Greater		still accruing		Due		Current		Portfolio
	(Dollars in Thousands)
Domestic
Commercial	$	7,139	$	1,412	$	18,727	$	844	$	27,278	$	1,186,261	$	1,213,539
Commercial real estate: other construction & land development		7,451		1,111		1,865		1,041		10,427		1,923,919		1,934,346
Commercial real estate: farmland & commercial		6,486		5,292		25,328		401		37,106		1,859,552		1,896,658
Commercial real estate: multifamily		1,122		938		507		—		2,567		291,545		294,112
Residential: first lien		3,610		1,516		4,512		4,272		9,638		447,276		456,914
Residential: junior lien		982		815		1,739		1,574		3,536		717,576		721,112
Consumer		351		73		25		16		449		45,624		46,073
Foreign		3,018		726		144		144		3,888		140,701		144,589
Total past due loans	$	30,159	$	11,883	$	52,847	$	8,292	$	94,889	$	6,612,454	$	6,707,343


	December 31, 2018
							90 Days or		Total
	30 - 59		60 - 89		90 Days or		greater &		Past				Total
	Days		Days		Greater		still accruing		Due		Current		Portfolio
		(Dollars in Thousands)
Domestic
Commercial	$	4,651	$	1,089	$	19,851	$	10,890	$	25,591	$	1,103,378	$	1,128,969
Commercial real estate: other construction & land development		727		1,707		922		16		3,356		1,882,875		1,886,231
Commercial real estate: farmland & commercial		2,928		784		27,239		24,910		30,951		1,918,947		1,949,898
Commercial real estate: multifamily		927		—		578		71		1,505		224,752		226,257
Residential: first lien		3,998		1,677		3,362		3,079		9,037		436,763		445,800
Residential: junior lien		1,155		618		1,108		937		2,881		724,420		727,301
Consumer		486		19		45		32		550		45,766		46,316
Foreign		1,106		117		739		739		1,962		148,555		150,517
Total past due loans	$	15,978	$	6,011	$	53,844	$	40,674	$	75,833	$	6,485,456	$	6,561,289

The decrease in the 90 days or greater and still accruing at March 31, 2019 compared to December 31, 2018 can be attributed to the previously discussed relationship secured by real property on which car dealerships are operated and the placement of the relationship on non-accrual impaired status.

Our internal classified report is segregated into the following categories: (i) “Special Review Credits,” (ii) “Watch List-Pass Credits,” and (iii) “Watch List-Substandard Credits.” The loans placed in the “Special Review Credits” category reflect management’s opinion that the loans reflect potential weakness which requires monitoring on a more frequent basis. The “Special Review Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List-Pass Credits” category reflect our opinion that the credit contains weaknesses which represent a greater degree of risk, which warrant “extra attention.” The “Watch List-Pass Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List-Substandard Credits” classification are considered to be potentially inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These credit obligations, even if apparently protected by collateral value, have shown defined weaknesses related to adverse financial, managerial, economic, market or political conditions which may jeopardize repayment of principal and interest. Furthermore, there is the possibility that we could sustain some future loss if such weaknesses are not corrected. For loans that are classified as impaired, management evaluates these credits in accordance with the provisions of ASC 310-10, “Receivables,” and, if deemed necessary, a specific reserve is allocated to the credit. The specific reserve allocated under ASC 310-10 is based on (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the loan’s observable market price; or (iii) the fair value of the collateral if the loan is collateral dependent. Substantially all of our loans evaluated as impaired under ASC 310-10 are measured using the fair value of collateral method. In limited cases, we may use other methods to determine the specific reserve of a loan under ASC 310-10 if such loan is not collateral dependent.

The allowance based on historical loss experience on our remaining loan portfolio, which includes the “Special Review Credits,” “Watch List - Pass Credits,” and “Watch List - Substandard Credits” is determined by segregating the remaining loan portfolio into certain categories such as commercial loans, installment loans, international loans, loan concentrations and overdrafts. Installment loans are then further segregated by number of days past due. A historical loss percentage, adjusted for (i) management’s evaluation of changes in lending policies and procedures, (ii) current economic conditions in the market area we serve, (iii) other risk factors, (iv) the effectiveness of the internal loan review function, (v) changes in loan portfolios, and (vi) the composition and concentration of credit volume is applied to each category. Each category is then added together to determine the allowance allocated under ASC 450-20.

A summary of the loan portfolio by credit quality indicator by loan class at March 31, 2019 and December 31, 2018 is as follows:


			March 31, 2019
			Special		Watch		Watch List—		Watch List—
	Pass		Review		List—Pass		Substandard		Impaired
			(Dollars in Thousands)
Domestic
Commercial	$	1,130,988	$	19	$	3,061	$	60,863	$	18,608
Commercial real estate: other construction & land development		1,865,359		1,640		9,284		56,004		2,059
Commercial real estate: farmland & commercial		1,669,873		62,012		39,269		99,113		26,391
Commercial real estate: multifamily		292,687		—		—		918		507
Residential: first lien		449,291		—		142		1,265		6,216
Residential: junior lien		719,334		—		870		—		908
Consumer		44,999		—		—		—		1,074
Foreign		144,303		—		—		—		286
Total	$	6,316,834	$	63,671	$	52,626	$	218,163	$	56,049


			December 31, 2018
			Special		Watch		Watch List—		Watch List—
	Pass		Review		List—Pass		Substandard		Impaired
			(Dollars in Thousands)
Domestic
Commercial	$	998,625	$	441	$	44,544	$	76,180	$	9,179
Commercial real estate: other construction & land development		1,817,098		1,648		9,055		56,338		2,092
Commercial real estate: farmland & commercial		1,726,711		62,046		38,373		119,259		3,509
Commercial real estate: multifamily		224,823		—		—		927		507
Residential: first lien		438,773		—		142		641		6,244
Residential: junior lien		725,538		—		862		—		901
Consumer		45,141		—		—		—		1,175
Foreign		150,224		—		—		—		293
Total	$	6,126,933	$	64,135	$	92,976	$	253,345	$	23,900

The decrease in Watch List – Pass credits at March 31, 2019 from Decmeber 31, 2018 can be attirubuted to the reclassification of a relationship secured by oil and gas properties to Pass. The decrease in Watch List- Substandard and increase in Watch List – Impaired can be attributed to the reclassification of the previously discussed relationship secured by commercial real estate leased by car dealerships.