Note 4 – Loans

Major classifications of loans, net of unearned income, deferred loan origination costs, and net premiums on acquired loans, are summarized as follows:

(in thousands)	March 31 2014		December 31 2013
Commercial construction	$	111,272	$	110,779
Commercial secured by real estate		874,437		872,542
Equipment lease financing		8,122		8,840
Commercial other		351,648		374,881
Real estate construction		59,730		56,075
Real estate mortgage		695,514		697,601
Home equity		84,694		84,880
Consumer direct		117,497		122,215
Consumer indirect		282,594		287,541
Total loans	$	2,585,508	$	2,615,354

CTBI has segregated and evaluates its loan portfolio through nine portfolio segments. CTBI serves customers in small and mid-sized communities in eastern, northeastern, central, and south central Kentucky, southern West Virginia, and northeastern Tennessee. Therefore, CTBI’s exposure to credit risk is significantly affected by changes in these communities.

Commercial construction loans are for the purpose of erecting or rehabilitating buildings or other structures for commercial purposes, including any infrastructure necessary for development. Included in this category are improved property, land development, and tract development loans. The terms of these loans are generally short-term with permanent financing upon completion.

Commercial real estate loans include loans secured by nonfarm, nonresidential properties, 1-4 family/ multi-family properties, farmland, and other commercial real estate. These loans are originated based on the borrower’s ability to service the debt and secondarily based on the fair value of the underlying collateral.

Equipment lease financing loans are fixed, variable, and tax exempt leases for commercial purposes.

Commercial other loans consist of commercial check loans, agricultural loans, receivable financing, floorplans, loans to financial institutions, loans for purchasing or carrying securities, and other commercial purpose loans. Commercial loans are underwritten based on the borrower’s ability to service debt from the business’s underlying cash flows. As a general practice, we obtain collateral such as real estate, equipment, or other assets, although such loans may be uncollateralized but guaranteed.

Real estate construction loans are typically for owner-occupied properties. The terms of these loans are generally short-term with permanent financing upon completion.

Residential real estate loans are a mixture of fixed rate and adjustable rate first and second lien residential mortgage loans. As a policy, CTBI holds adjustable rate loans and sells the majority of its fixed rate first lien mortgage loans into the secondary market. Changes in interest rates or market conditions may impact a borrower’s ability to meet contractual principal and interest payments. Residential real estate loans are secured by real property.

Home equity lines are revolving adjustable rate credit lines secured by real property.

Consumer direct loans are fixed rate products comprised of unsecured loans, consumer revolving credit lines, deposit secured loans, and all other consumer purpose loans.

Consumer indirect loans are fixed rate loans secured by automobiles, trucks, vans, and recreational vehicles originated at the selling dealership underwritten and purchased by CTBI’s indirect lending department. Both new and used products are financed. Only dealers who have executed dealer agreements with CTBI participate in the indirect lending program.

Not included in the loan balances above were loans held for sale in the amount of $1.6 million at March 31, 2014 and $0.8 million at December 31, 2013, respectively. The amount of capitalized fees and costs under ASC 310-20, included in the above loan totals were ($6) thousand and $3 thousand at March 31, 2014 and December 31, 2013, respectively.

Refer to note 1 to the condensed consolidated financial statements for further information regarding our nonaccrual policy. Nonaccrual loans segregated by class of loans were as follows:

(in thousands)	March 31 2014		December 31 2013
Commercial:
Commercial construction	$	4,767	$	4,519
Commercial secured by real estate		13,252		6,576
Commercial other		2,629		2,801

Residential:
Real estate construction		481		481
Real estate mortgage		5,406		5,152
Home equity		349		429
Total nonaccrual loans	$	26,884	$	19,958

The following tables present CTBI’s loan portfolio aging analysis, segregated by class, as of March 31, 2014 and December 31, 2013:

	March 31, 2014
(in thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days Past Due		Total Past Due		Current		Total Loans		90+ and Accruing*
Commercial:
Commercial construction	$	386	$	52	$	6,209	$	6,647	$	104,625	$	111,272	$	1,456
Commercial secured by real estate		4,975		1,900		15,937		22,812		851,625		874,437		4,728
Equipment lease financing		0		0		0		0		8,122		8,122		0
Commercial other		578		8,182		5,595		14,355		337,293		351,648		3,323
Residential:
Real estate construction		439		31		752		1,222		58,508		59,730		271
Real estate mortgage		1,510		3,846		9,929		15,285		680,229		695,514		5,189
Home equity		843		240		648		1,731		82,963		84,694		319
Consumer:
Consumer direct		803		168		58		1,029		116,468		117,497		202
Consumer indirect		1,525		531		202		2,258		280,336		282,594		58
Total	$	11,059	$	14,950	$	39,330	$	65,339	$	2,520,169	$	2,585,508	$	15,546

	December 31, 2013
(in thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days Past Due		Total Past Due		Current		Total Loans		90+ and Accruing*
Commercial:
Commercial construction	$	250	$	166	$	6,012	$	6,428	$	104,351	$	110,779	$	1,673
Commercial secured by real estate		3,703		1,982		16,660		22,345		850,197		872,542		12,403
Equipment lease financing		0		0		0		0		8,840		8,840		0
Commercial other		344		422		6,156		6,922		367,959		374,881		3,723
Residential:
Real estate construction		81		383		694		1,158		54,917		56,075		213
Real estate mortgage		1,274		4,419		9,346		15,039		682,562		697,601		4,847
Home equity		786		330		737		1,853		83,027		84,880		324
Consumer:
Consumer direct		1,063		291		119		1,473		120,742		122,215		119
Consumer indirect		2,750		668		297		3,715		283,826		287,541		297
Total	$	10,251	$	8,661	$	40,021	$	58,933	$	2,556,421	$	2,615,354	$	23,599

*90+ and Accruing are also included in 90+ Days Past Due column.

The risk characteristics of CTBI’s material portfolio segments are as follows:

Commercial construction loans generally are made to customers for the purpose of building income-producing properties. Personal guarantees of the principals are generally required. Such loans are made on a projected cash flow basis and are secured by the project being constructed. Construction loan draw procedures are included in each specific loan agreement, including required documentation items and inspection requirements. Construction loans may convert to term loans at the end of the construction period, or may be repaid by the take-out commitment from another financing source. If the loan is to convert to a term loan, the repayment ability is based on the borrower’s projected cash flow. Risk is mitigated during the construction phase by requiring proper documentation and inspections whenever a draw is requested. Loans in amounts greater than $500,000 generally require a performance bond to be posted by the general contractor to assure completion of the project.

Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria.

Equipment lease financing is underwritten by our commercial lenders using the same underwriting standards as would be applied to a secured commercial loan requesting 100% financing. The pricing for equipment lease financing is comparable to that of borrowers with similar quality commercial credits with similar collateral. Maximum terms of equipment leasing are determined by the type and expected life of the equipment to be leased. Residual values are determined by appraisals or opinion letters from industry experts. Leases must be in conformity with our consolidated annual tax plan. As we underwrite our equipment lease financing in a manner similar to our commercial loan portfolio described below, the risk characteristics for this portfolio mirror that of the commercial loan portfolio.

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, CTBI generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences. Residential construction loans are handled through the home mortgage area of the bank. The repayment ability of the borrower and the maximum loan-to-value ratio are calculated using the normal mortgage lending criteria. Draws are processed based on percentage of completion stages including normal inspection procedures. Such loans generally convert to term loans after the completion of construction.

Consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Our determination of a borrower’s ability to repay these loans is primarily dependent on the personal income and credit rating of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

The indirect lending area of the bank generally deals with purchasing/funding consumer contracts with new and used automobile dealers. The dealers generate consumer loan applications which are forwarded to the indirect loan processing area for approval or denial. Loan approvals or denials are based on the creditworthiness and repayment ability of the borrower, and on the collateral value. The dealers may have recourse agreements with the Bank.

Credit Quality Indicators:

CTBI categorizes loans into risk categories 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. CTBI also considers the fair value of the underlying collateral and the strength and willingness of the guarantor(s). CTBI analyzes commercial loans individually by classifying the loans as to credit risk. Loans classified as loss, doubtful, substandard, or special mention are reviewed quarterly by CTBI for further deterioration or improvement to determine if appropriately classified and valued if deemed impaired. All other commercial loan reviews are completed every 12 to 18 months. In addition, during the renewal process of any loan, as well as if a loan becomes past due or if other information becomes available, CTBI will evaluate the loan grade. CTBI uses the following definitions for risk ratings:

Pass grades include investment grade, low risk, moderate risk, and acceptable risk loans. The loans range from loans that have no chance of resulting in a loss to loans that have a limited chance of resulting in a loss. Customers in this grade have excellent to fair credit ratings. The cash flows are adequate to meet required debt repayments.

Watch graded loans are loans that warrant extra management attention but are not currently criticized. Loans on the watch list may be potential troubled credits or may warrant “watch” status for a reason not directly related to the asset quality of the credit. The watch grade is a management tool to identify credits which may be candidates for future classification or may temporarily warrant extra management monitoring.

Other assets especially mentioned (OAEM) reflects loans that are currently protected but are potentially weak. These loans constitute an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of circumstances surrounding a specific asset. Loans in this grade display potential weaknesses which may, if unchecked or uncorrected, inadequately protect CTBI’s credit position at some future date. The loans may be adversely affected by economic or market conditions.

Substandard grading indicates that the loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged. These loans have a well-defined weakness or weaknesses that jeopardize the orderly liquidation of the debt with the distinct possibility that CTBI will sustain some loss if the deficiencies are not corrected.

Doubtful graded loans have the weaknesses inherent in the substandard grading 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. The probability of loss is extremely high, but because of certain important and reasonably specific pending factors which may work to CTBI’s advantage or strengthen the asset(s), its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans.

The following tables present the credit risk profile of CTBI’s commercial loan portfolio based on rating category and payment activity, segregated by class of loans, as of March 31, 2014 and December 31, 2013:

(in thousands)	Commercial Construction		Commercial Secured by Real Estate		Equipment Leases		Commercial Other		Total
March 31, 2014
Pass	$	90,787	$	747,805	$	8,122	$	299,605	$	1,146,319
Watch		9,141		75,684		0		32,277		117,102
OAEM		1,094		9,611		0		6,005		16,710
Substandard		5,649		28,986		0		11,552		46,187
Doubtful		4,601		12,351		0		2,209		19,161
Total	$	111,272	$	874,437	$	8,122	$	351,648	$	1,345,479

December 31, 2013
Pass	$	85,699	$	746,202	$	8,840	$	321,819	$	1,162,559
Watch		13,519		77,561		0		32,800		123,880
OAEM		0		6,639		0		6,200		12,839
Substandard		7,208		37,334		0		11,772		56,314
Doubtful		4,353		4,806		0		2,291		11,450
Total	$	110,779	$	872,542	$	8,840	$	374,881	$	1,367,042

The following tables present the credit risk profile of the CTBI’s residential real estate and consumer loan portfolios based on performing or nonperforming status, segregated by class, as of March 31, 2014 and December 31, 2013:

(in thousands)	Real Estate Construction		Real Estate Mortgage		Home Equity		Consumer Direct		Consumer Indirect		Total
March 31, 2014
Performing	$	58,978	$	684,919	$	84,026	$	117,295	$	282,536	$	1,227,754
Nonperforming (1)		752		10,595		668		202		58		12,275
Total	$	59,730	$	695,514	$	84,694	$	117,497	$	282,594	$	1,240,029

December 31, 2013
Performing	$	55,381	$	687,602	$	84,127	$	122,096	$	287,244	$	1,236,450
Nonperforming (1)		694		9,999		753		119		297		11,862
Total	$	56,075	$	697,601	$	84,880	$	122,215	$	287,541	$	1,248,312

(1) A loan is considered nonperforming if it is 90 days or more past due and/or on nonaccrual.

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable CTBI will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection.

The following table presents impaired loans, the average investment in impaired loans, and interest income recognized on impaired loans for the periods ended March 31, 2014, December 31, 2013, and March 31, 2013:

	March 31, 2014
(in thousands)	Recorded Balance		Unpaid Contractual Principal Balance		Specific Allowance		Average Investment in Impaired Loans		*Interest Income Recognized
Loans without a specific valuation allowance:
Commercial construction	$	5,430	$	5,431	$	0	$	5,441	$	50
Commercial secured by real estate		35,719		36,618		0		36,416		265
Commercial other		14,191		15,726		0		14,324		114
Real estate mortgage		1,021		1,021		0		1,022		10

Loans with a specific valuation allowance:
Commercial construction		4,278		4,284		939		4,312		0
Commercial secured by real estate		4,234		4,611		1,084		4,686		4
Commercial other		413		536		112		439		0

Totals:
Commercial construction		9,708		9,715		939		9,753		50
Commercial secured by real estate		39,953		41,229		1,084		41,102		269
Commercial other		14,604		16,262		112		14,763		114
Real estate mortgage		1,021		1,021		0		1,022		10
Total	$	65,286	$	68,227	$	2,135	$	66,640	$	443

	December 31, 2013
(in thousands)	Recorded Balance		Unpaid Contractual Principal Balance		Specific Allowance		Average Investment in Impaired Loans		*Interest Income Recognized
Loans without a specific valuation allowance:
Commercial construction	$	5,457	$	5,458	$	0	$	5,595	$	240
Commercial secured by real estate		35,258		36,173		0		32,472		1,231
Commercial other		14,839		16,435		0		15,396		568
Real estate mortgage		1,024		1,024		0		934		43

Loans with a specific valuation allowance:
Commercial construction		4,353		4,359		1,189		4,935		0
Commercial secured by real estate		4,039		4,326		1,005		5,033		1
Commercial other		330		453		102		525		0

Totals:
Commercial construction		9,810		9,817		1,189		10,530		240
Commercial secured by real estate		39,297		40,499		1,005		37,505		1,232
Commercial other		15,169		16,888		102		15,921		568
Real estate mortgage		1,024		1,024		0		934		43
Total	$	65,300	$	68,228	$	2,296	$	64,890	$	2,083

	March 31, 2013
(in thousands)	Recorded Balance		Unpaid Contractual Principal Balance		Specific Allowance		Average Investment in Impaired Loans		*Interest Income Recognized
Loans without a specific valuation allowance:
Commercial construction	$	5,155	$	5,609	$	0	$	5,225	$	74
Commercial secured by real estate		33,765		34,586		0		33,908		297
Commercial other		15,779		17,920		0		15,435		154
Real estate mortgage		657		657		0		658		7

Loans with a specific valuation allowance:
Commercial construction		6,073		7,303		1,911		6,075		0
Commercial secured by real estate		4,158		4,276		1,192		4,166		0
Commercial other		867		2,188		322		868		0

Totals:
Commercial construction		11,228		12,912		1,911		11,300		74
Commercial secured by real estate		37,923		38,862		1,192		38,074		297
Commercial other		16,646		20,108		322		16,303		154
Real estate mortgage		657		657		0		658		7
Total	$	66,454	$	72,539	$	3,425	$	66,335	$	532

*Cash basis interest is substantially the same as interest income recognized.

Included in certain loan categories of impaired loans are certain loans and leases that have been modified in a troubled debt restructuring, where economic concessions have been granted to borrowers who have experienced financial difficulties. These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances. Loan modifications that are included as troubled debt restructurings may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral of principal and/or interest payments, regardless of the period of the modification. All of the loans identified as troubled debt restructuring were modified due to financial stress of the borrower. In order to determine if a borrower is experiencing financial difficulty, an evaluation is performed to determine the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under CTBI’s internal underwriting policy.

When we modify loans and leases in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan or lease agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determined that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. In periods subsequent to modification, we evaluate all troubled debt restructuring, including those that have payment defaults, for possible impairment and recognize impairment through the allowance.

During 2014, certain loans were modified in troubled debt restructurings, where economic concessions were granted to borrowers consisting of reductions in the interest rates, payment extensions, forgiveness of principal, and forbearances. Presented below, segregated by class of loans, are troubled debt restructurings that occurred during the three months ended March 31, 2014 and 2013 and the year ended December 31, 2013:

	Three Months Ended March 31, 2014
(in thousands)	Number of Loans		Term Modification		Rate Modification		Combination		Post-Modification Outstanding Balance
Commercial:
Commercial secured by real estate		2	$	126	$	0	$	0	$	126
Commercial other		2		41		0		0		41
Total troubled debt restructurings		4	$	167	$	0	$	0	$	167

	Year Ended December 31, 2013
(in thousands)	Number of Loans		Term Modification		Rate Modification		Combination		Post-Modification Outstanding Balance
Commercial:
Commercial construction		6	$	2,603	$	0	$	0	$	2,603
Commercial secured by real estate		27		2,568		0		2,920		5,488
Commercial other		30		6,471		0		152		6,623
Residential:
Real estate mortgage		1		373		0		0		373
Total troubled debt restructurings		64	$	12,015	$	0	$	3,072	$	15,087

	Three Months Ended March 31, 2013
(in thousands)	Number of Loans		Term Modification		Rate Modification		Combination		Post-Modification Outstanding Balance
Commercial:
Commercial construction		3	$	2,110	$	0	$	0	$	2,110
Commercial secured by real estate		5		605		0		0		605
Commercial other		9		5,493		0		92		5,585
Total troubled debt restructurings		17	$	8,208	$	0	$	92	$	8,300

No charge-offs have resulted from modifications for any of the presented periods.

Loans retain their accrual status at the time of their modification. As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual, and if a loan is on accrual at the time of the modification, it generally stays on accrual. Commercial and consumer loans modified in a troubled debt restructuring are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a troubled debt restructuring subsequently default, CTBI evaluates the loan for possible further impairment. The allowance for loan losses may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan. Presented below, segregated by class of loans, are loans that were modified as troubled debt restructurings within the past twelve months which have subsequently defaulted. CTBI generally considers a loan in default when it is 90 days or more past due or transferred to nonaccrual.

(in thousands)	Three Months Ended March 31, 2014
	Number of Loans		Recorded Balance
Commercial:
Commercial construction		0	$	0
Commercial secured by real estate		0		0
Commercial other		2		34
Total defaulted restructured loans		2	$	34

(in thousands)	Three Months Ended March 31, 2013
	Number of Loans		Recorded Balance
Commercial:
Commercial construction		2	$	328
Commercial secured by real estate		2		662
Commercial other		1		12
Total defaulted restructured loans		5	$	1,002