(5.) LOANS

The Company's loan portfolio consisted of the following at December 31 (in thousands):


		Principal		Net Deferred
		Amount		Loan (Fees)
		Outstanding		Costs			Loans, Net
2017
Commercial business	$	449,763	$	563		$	450,326
Commercial mortgage		810,851		(1,943	)		808,908
Residential real estate loans		457,761		7,522			465,283
Residential real estate lines		113,422		2,887			116,309
Consumer indirect		845,682		30,888			876,570
Other consumer		17,443		178			17,621
Total	$	2,694,922	$	40,095			2,735,017
Allowance for loan losses							(34,672	)
Total loans, net						$	2,700,345

2016
Commercial business	$	349,079	$	468		$	349,547
Commercial mortgage		671,552		(1,494	)		670,058
Residential real estate loans		421,476		6,461			427,937
Residential real estate lines		119,745		2,810			122,555
Consumer indirect		725,754		26,667			752,421
Other consumer		17,465		178			17,643
Total	$	2,305,071	$	35,090			2,340,161
Allowance for loan losses							(30,934	)
Total loans, net						$	2,309,227

The Company's significant concentrations of credit risk in the loan portfolio relate to a geographic concentration in the communities that the Company serves.

Certain executive officers, directors and their business interests are customers of the Company. Transactions with these parties are based on the same terms as similar transactions with unrelated third parties and do not carry more than normal credit risk. Borrowings by these related parties amounted to $6.6 million and $3.5 million at December 31, 2017 and 2016, respectively. During 2017, new borrowings amounted to $5.7 million (including borrowings of executive officers and directors that were outstanding at the time of their appointment), and repayments and other reductions were $2.6 million.

Past Due Loans Aging

The Company's recorded investment, by loan class, in current and nonaccrual loans, as well as an analysis of accruing delinquent loans is set forth as of December 31 (in thousands):


						Greater
		30-59 Days		60-89 Days		Than 90		Total Past
		Past Due		Past Due		Days		Due		Nonaccrual		Current		Total Loans
2017
Commercial business	$	64	$	36	$	-	$	100	$	5,344	$	444,319	$	449,763
Commercial mortgage		56		375		-		431		2,623		807,797		810,851
Residential real estate loans		1,908		56		-		1,964		2,252		453,545		457,761
Residential real estate lines		349		-		-		349		404		112,669		113,422
Consumer indirect		2,806		672		-		3,478		1,895		840,309		845,682
Other consumer		174		15		11		200		2		17,241		17,443
Total loans, gross	$	5,357	$	1,154	$	11	$	6,522	$	12,520	$	2,675,880	$	2,694,922

2016
Commercial business	$	1,337	$	-	$	-	$	1,337	$	2,151	$	345,591	$	349,079
Commercial mortgage		48		-		-		48		1,025		670,479		671,552
Residential real estate loans		1,073		253		-		1,326		1,236		418,914		421,476
Residential real estate lines		216		-		-		216		372		119,157		119,745
Consumer indirect		2,320		488		-		2,808		1,526		721,420		725,754
Other consumer		134		15		9		158		7		17,300		17,465
Total loans, gross	$	5,128	$	756	$	9	$	5,893	$	6,317	$	2,292,861	$	2,305,071

There were no loans past due greater than 90 days and still accruing interest as of December 31, 2017 and 2016. There were $11 thousand and $9 thousand in consumer overdrafts which were past due greater than 90 days as of December 31, 2017 and 2016, respectively. Consumer overdrafts are overdrawn deposit accounts which have been reclassified as loans but by their terms do not accrue interest.

Interest income on nonaccrual loans, if recognized, is recorded using the cash basis method of accounting. There was no interest income recognized on nonaccrual loans during the years ended December 31, 2017, 2016 and 2015. For the years ended December 31, 2017, 2016 and 2015, estimated interest income of $481 thousand, $234 thousand, and $432 thousand, respectively, would have been recorded if all such loans had been accruing interest according to their original contractual terms.

Troubled Debt Restructurings

A modification of a loan constitutes a troubled debt restructuring ("TDR") when a borrower is experiencing financial difficulty and the modification constitutes a concession. Commercial loans modified in a TDR may involve temporary interest-only payments, term extensions, reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, collateral concessions, forgiveness of principal, forbearance agreements, or substituting or adding a new borrower or guarantor.

The following presents, by loan class, information related to loans modified in a TDR during the years ended December 31 (in thousands).


			Pre-		Post-
			Modification		Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
	Contracts		Investment		Investment
2017
Commercial business	1	$	3,081	$	565
Commercial mortgage	-		-		-
Total	1	$	3,081	$	565

2016
Commercial business	3	$	526	$	526
Commercial mortgage	1		550		550
Total	4	$	1,076	$	1,076

The loans identified as TDRs by the Company during the years ended December 31, 2017 and 2016 were previously reported as impaired loans prior to restructuring. The modifications during the year ended December 31, 2017 primarily related to collateral concessions. For the year ended December 31, 2016, the restructured loan modifications primarily related to collateral concessions and forbearance. All loans restructured during the years ended December 31, 2017 and 2016 were on nonaccrual status at the end of those respective years. Nonaccrual loans that are restructured remain on nonaccrual status, but may move to accrual status after they have performed according to the restructured terms for a period of time. The TDR classification did not have a material impact on the Company's determination of the allowance for loan losses because the modified loans were either classified as substandard, with an increased risk allowance allocation, or impaired and evaluated for a specific reserve both before and after restructuring.

There were no loans modified as a TDR during the years ended December 31, 2017 and 2016 that defaulted during the year ended December 31, 2017. For purposes of this disclosure, a loan modified as a TDR is considered to have defaulted when the borrower becomes 90 days past due.

Impaired Loans

Management has determined that specific commercial loans on nonaccrual status and all loans that have had their terms restructured in a troubled debt restructuring are impaired loans. The following table presents data on impaired loans at December 31 (in thousands):


				Unpaid				Average		Interest
		Recorded		Principal		Related		Recorded		Income
		Investment ⁽¹⁾		Balance ⁽¹⁾		Allowance		Investment		Recognized
2017
With no related allowance recorded:
Commercial business	$	1,635	$	2,370	$	-	$	853	$	-
Commercial mortgage		584		584		-		621		-
		2,219		2,954		-		1,474		-
With an allowance recorded:
Commercial business		3,853		3,853		2,056		4,468		-
Commercial mortgage		2,528		2,528		115		1,516		-
		6,381		6,381		2,171		5,984		-
	$	8,600	$	9,335	$	2,171	$	7,458	$	-

2016
With no related allowance recorded:
Commercial business	$	645	$	1,044	$	-	$	1,032	$	-
Commercial mortgage		673		882		-		725		-
		1,318		1,926		-		1,757		-
With an allowance recorded:
Commercial business		1,506		1,506		694		1,141		-
Commercial mortgage		352		352		124		486		-
		1,858		1,858		818		1,627		-
	$	3,176	$	3,784	$	818	$	3,384	$	-

(1) Difference between recorded investment and unpaid principal balance represents partial charge-offs.

Credit Quality Indicators

The Company 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 such as the fair value of collateral. The Company analyzes commercial business and commercial mortgage loans individually by classifying the loans as to credit risk. Risk ratings are updated any time the situation warrants. The Company uses the following definitions for risk ratings: Special Mention: Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the Company's credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the process described above are considered "uncriticized" or pass-rated loans and are included in groups of homogeneous loans with similar risk and loss characteristics.

The following table sets forth the Company's commercial loan portfolio, categorized by internally assigned asset classification, as of December 31 (in thousands):


		Commercial		Commercial
		Business		Mortgage
2017
Uncriticized	$	429,692	$	791,127
Special mention		7,120		12,185
Substandard		12,951		7,539
Doubtful		-		-
Total	$	449,763	$	810,851

2016
Uncriticized	$	326,254	$	652,550
Special mention		10,377		12,690
Substandard		12,448		6,312
Doubtful		-		-
Total	$	349,079	$	671,552

The Company utilizes payment status as a means of identifying and reporting problem and potential problem retail loans. The Company considers nonaccrual loans and loans past due greater than 90 days and still accruing interest to be non-performing. The following table sets forth the Company's retail loan portfolio, categorized by payment status, as of December 31 (in thousands):


		Residential		Residential
		Real Estate		Real Estate		Consumer		Other
		Loans		Lines		Indirect		Consumer
2017
Performing	$	455,509	$	113,018	$	843,787	$	17,430
Non-performing		2,252		404		1,895		13
Total	$	457,761	$	113,422	$	845,682	$	17,443

2016
Performing	$	420,240	$	119,373	$	724,228	$	17,449
Non-performing		1,236		372		1,526		16
Total	$	421,476	$	119,745	$	725,754	$	17,465

Allowance for Loan Losses

The following tables set forth the changes in the allowance for loan losses for the years ended December 31 (in thousands):


								Residential			Residential
		Commercial			Commercial			Real Estate			Real Estate			Consumer			Other
		Business			Mortgage			Loans			Lines			Indirect			Consumer			Total
2017
Allowance for loan losses:
Beginning balance	$	7,225		$	10,315		$	1,478		$	303		$	11,311		$	302		$	30,934
Charge-offs		(3,614	)		(10	)		(431	)		(106	)		(10,164	)		(926	)		(15,251	)
Recoveries		416			262			130			60			4,444			316			5,628
Provision (credit)		11,641			(6,871	)		145			(77	)		7,824			699			13,361
Ending balance	$	15,668		$	3,696		$	1,322		$	180		$	13,415		$	391		$	34,672
Evaluated for impairment:
Individually	$	2,001		$	107		$	-		$	-		$	-		$	-		$	2,108
Collectively	$	13,667		$	3,589		$	1,322		$	180		$	13,415		$	391		$	32,564

Loans:
Ending balance	$	449,763		$	810,851		$	457,761		$	113,422		$	845,682		$	17,443		$	2,694,922
Evaluated for impairment:
Individually	$	5,322		$	2,852		$	-		$	-		$	-		$	-		$	8,174
Collectively	$	444,441		$	807,999		$	457,761		$	113,422		$	845,682		$	17,443		$	2,686,748

2016
Allowance for loan losses:
Beginning balance	$	5,540		$	9,027		$	1,347		$	345		$	10,458		$	368		$	27,085
Charge-offs		(943	)		(385	)		(289	)		(104	)		(8,748	)		(607	)		(11,076	)
Recoveries		447			45			174			15			4,259			347			5,287
Provision		2,181			1,628			246			47			5,342			194			9,638
Ending balance	$	7,225		$	10,315		$	1,478		$	303		$	11,311		$	302		$	30,934
Evaluated for impairment:
Individually	$	663		$	105		$	-		$	-		$	-		$	-		$	768
Collectively	$	6,562		$	10,210		$	1,478		$	303		$	11,311		$	302		$	30,166

Loans:
Ending balance	$	349,079		$	671,552		$	421,476		$	119,745		$	725,754		$	17,465		$	2,305,071
Evaluated for impairment:
Individually	$	2,052		$	935		$	-		$	-		$	-		$	-		$	2,987
Collectively	$	347,027		$	670,617		$	421,476		$	119,745		$	725,754		$	17,465		$	2,302,084


		Commercial			Commercial			Residential			Home			Consumer			Other
		Business			Mortgage			Mortgage			Equity			Indirect			Consumer			Total
2015
Allowance for loan losses:
Beginning balance	$	5,621		$	8,122		$	1,620		$	435		$	11,383		$	456		$	27,637
Charge-offs		(1,433	)		(895	)		(397	)		(199	)		(9,156	)		(878	)		(12,958	)
Recoveries		212			146			114			31			4,200			322			5,025
Provision		1,140			1,654			10			78			4,031			468			7,381
Ending balance	$	5,540		$	9,027		$	1,347		$	345		$	10,458		$	368		$	27,085
Evaluated for impairment:
Individually	$	996		$	10		$	-		$	-		$	-		$	-		$	1,006
Collectively	$	4,544		$	9,017		$	1,347		$	345		$	10,458		$	368		$	26,079

Loans:
Ending balance	$	313,475		$	567,481		$	376,023		$	124,766		$	652,494		$	18,361		$	2,052,600
Evaluated for impairment:
Individually	$	3,922		$	947		$	-		$	-		$	-		$	-		$	4,869
Collectively	$	309,553		$	566,534		$	376,023		$	124,766		$	652,494		$	18,361		$	2,047,731

Risk Characteristics

Commercial business loans primarily consist of loans to small to mid-sized businesses in our market area in a diverse range of industries. These loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower's operations or on the value of underlying collateral, if any.

Commercial mortgage loans generally have larger balances and involve a greater degree of risk than residential mortgage loans, potentially resulting in higher potential losses on an individual customer basis. Loan repayment is often dependent on the successful operation and management of the properties, as well as on the collateral securing the loan. Economic events or conditions in the real estate market could have an adverse impact on the cash flows generated by properties securing the Company's commercial real estate loans and on the value of such properties.

Residential real estate loans (comprised of conventional mortgages and home equity loans) and residential real estate lines (comprised of home equity lines) are generally made on the basis of the borrower's ability to make repayment from his or her employment and other income, but are secured by real property whose value tends to be more easily ascertainable. Credit risk for these types of loans is generally influenced by general economic conditions, the characteristics of individual borrowers, and the nature of the loan collateral.

Consumer indirect and other consumer loans may entail greater credit risk than residential mortgage loans and home equities, particularly in the case of other consumer loans which are unsecured or, in the case of indirect consumer loans, secured by depreciable assets, such as automobiles or boats. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances such as job loss, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.