Allowance for Credit Losses

The allowance for credit losses (the “allowance”) is an estimate of probable credit losses inherent in the Company’s loan portfolio that have been incurred as of the balance-sheet date. The allowance is established through a provision for credit losses which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The allowance consists of two primary components, specific reserves related to impaired loans and general reserves for inherent losses related to loans that are not impaired.

For all portfolio segments, the determination of the general reserve for loans that are not impaired is based on estimates made by management, including but not limited to, consideration of historical losses by portfolio segment over the most recent 20 quarters, and qualitative factors including economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan portfolio, and probable losses inherent in the portfolio taken as a whole. During the nine months ended September 30, 2013, management determined that the most recent 20 quarters was an appropriate look back period based on several factors including the current global economic uncertainty and various national and local economic indicators. Moving from a 16 quarter rolling average used at December 31, 2012 to a 20 quarter rolling average during the first quarter of 2013 did not have a material impact on the level of allowance required, but it did ensure that the significant historical loss years for the bank would continue to be factored into the general reserve analysis. Management determined that it was necessary to expand the look back period to capture enough data due to the size of the portfolio to produce statistically accurate historical loss calculations. We believe this period is an appropriate look back period.

The following table shows the summary of activities for the allowance for credit losses as of and for the three months ended September 30, 2013 and 2012 by portfolio segment (in thousands):



	Commercial			Real Estate			Consumer			Unallocated			Total
Allowance for credit losses:
Beginning balance, July 1, 2013	$	2,792		$	5,057		$	1,252		$	500		$	9,601
Provision charged to operations	(52		)	(331		)	48			335			—
Losses charged to allowance	(5		)	—			(51		)	—			(56		)
Recoveries	111			8			68			—			187
Ending balance, September 30, 2013	$	2,846		$	4,734		$	1,317		$	835		$	9,732
Allowance for credit losses:
Beginning balance, July 1. 2012	$	2,799		$	5,474		$	1,494		$	373		$	10,140
Provision charged to operations	(329		)	532			151			(354		)	—
Losses charged to allowance	(1		)	—			(219		)	—			(220		)
Recoveries	209			—			85			—			294
Ending balance, September 30, 2012	$	2,678		$	6,006		$	1,511		$	19		$	10,214

The following table shows the summary of activities for the allowance for credit losses as of and for the nine months ended September 30, 2013 and 2012 by portfolio segment of loans (in thousands):



	Commercial			Real Estate			Consumer			Unallocated			Total
Allowance for credit losses:
Beginning balance, January 1, 2013	$	2,676		$	5,877		$	1,541		$	39		$	10,133
Provision charged to operations	622			(1,151		)	(267		)	796			—
Losses charged to allowance	(706		)	—			(86		)	—			(792		)
Recoveries	254			8			129			—			391
Ending balance, September 30, 2013	$	2,846		$	4,734		$	1,317		$	835		$	9,732

Allowance for credit losses:
Beginning balance, January 1, 2012	$	2,266		$	7,155		$	1,836		$	139		$	11,396
Provision charged to operations	33			643			(56		)	(120		)	500
Losses charged to allowance	(123		)	(1,792		)	(486		)	—			(2,401		)
Recoveries	502			—			217			—			719
Ending balance, September 30, 2012	$	2,678		$	6,006		$	1,511		$	19		$	10,214

The following is a summary of the allowance for credit losses by impairment methodology and portfolio segment as of September 30, 2013 and December 31, 2012 (in thousands).



	Commercial		Real Estate		Consumer		Unallocated		Total
Allowance for credit losses:
Ending balance, September 30, 2013	$	2,846	$	4,734	1,317		$	835	$	9,732
Ending balance: individually evaluated for impairment	$	632	$	214	235		$	—	$	1,081
Ending balance: collectively evaluated for impairment	$	2,214	$	4,520	1,082		$	835	$	8,651

Ending balance, December 31, 2012	$	2,676	$	5,877	$	1,541	$	39	$	10,133
Ending balance: individually evaluated for impairment	$	40	$	465	$	5	$	—	$	510
Ending balance: collectively evaluated for impairment	$	2,636	$	5,412	$	1,536	$	39	$	9,623

The table above excludes ending balance of loans acquired with deteriorated quality of $2,489,000 with no allowance at September 30, 2013.

The following table shows the ending balances of loans as of September 30, 2013 and December 31, 2012 by portfolio segment and by impairment methodology. These include loans acquired at fair value at July 1, 2013 with outstanding balances of $108 million as of September 30, 2013 (in thousands):



	Commercial		Real Estate		Consumer		Total
Loans:
Ending balance, September 30, 2013	$	133,661	$	319,738	$	62,070	$	515,469
Ending balance: individually evaluated for impairment	$	1,649	$	9,858	$	2,510	$	14,017
Ending balance: collectively evaluated for impairment	$	132,012	$	309,880	$	59,560	$	501,452

Loans:
Ending balance, December 31, 2012	$	104,555	$	237,938	$	53,278	$	395,771
Ending balance: individually evaluated for impairment	$	2,405	$	12,868	$	1,832	$	17,105
Ending balance: collectively evaluated for impairment	$	102,150	$	225,070	$	51,446	$	378,666

The following table shows the loan portfolio by class allocated by management’s internal risk ratings at September 30, 2013 (in thousands):



	Pass		Special Mention		Sub-Standard		Doubtful		Total
Commercial:
Commercial and industrial	$	83,958	$	2,626	$	3,407	$	—	$	89,991
Agricultural land and production	43,670		—		—		—		43,670
Real Estate:
Owner occupied	142,344		5,294		7,533		—		155,171
Real estate construction and other land loans	25,642		2,405		7,280		—		35,327
Commercial real estate	76,661		3,745		5,051		—		85,457
Agricultural real estate	37,856		2,001		—		—		39,857
Other real estate	3,926		—		—		—		3,926
Consumer:
Equity loans and lines of credit	44,508		2,465		4,320		—		51,293
Consumer and installment	10,698		52		27		—		10,777
Total	$	469,263	$	18,588	$	27,618	$	—	$	515,469

The following table shows the loan portfolio by class allocated by management’s internally assigned risk grade ratings at December 31, 2012 (in thousands):



	Pass		Special Mention		Sub-Standard		Doubtful		Total
Commercial:
Commercial and industrial	$	71,125	$	824	$	6,007	$	—	$	77,956
Agricultural land and production	26,599		—		—		—		26,599
Real Estate:
Owner occupied	107,281		1,831		5,332		—		114,444
Real estate construction and other land loans	18,517		3,377		11,305		—		33,199
Commercial real estate	44,880		3,952		4,965		—		53,797
Agricultural real estate	26,883		1,517		—		—		28,400
Other real estate	8,098		—		—		—		8,098
Consumer:
Equity loans and lines of credit	40,527		258		2,147		—		42,932
Consumer and installment	10,259		77		10		—		10,346
Total	$	354,169	$	11,836	$	29,766	$	—	$	395,771

The following table shows an aging analysis of the loan portfolio by class and the time past due at September 30, 2013 (in thousands):



	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days Accruing		Non-accrual
Commercial:
Commercial and industrial	$	1,497	$	—	$	78	$	1,575	$	88,416	$	89,991	$	—	$	1,649
Agricultural land and production	—		—		—		—		43,670		43,670		—		—
Real estate:	—						—		—		—
Owner occupied	555		—		229		784		154,387		155,171		—		2,198
Real estate construction and other land loans	—		—		—		—		35,327		35,327		—		1,499
Commercial real estate	—		—		—		—		85,457		85,457		—		167
Agricultural real estate	—		—		—		—		39,857		39,857		—		—
Other real estate	—		—		—		—		3,926		3,926		—		—
Consumer:							—		—		—
Equity loans and lines of credit	424		59		505		988		50,305		51,293		—		2,497
Consumer and installment	57		—		—		57		10,720		10,777		—		12
Total	$	2,533	$	59	$	812	$	3,404	$	512,065	$	515,469	$	—	$	8,022

The following table shows an aging analysis of the loan portfolio by class and the time past due at December 31, 2012 (in thousands):



	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days Accruing		Non- accrual
Commercial:
Commercial and industrial	$	—	$	—	$	—	$	—	$	77,956	$	77,956	$	—	$	—
Agricultural land and production	—		—		—		—		26,599		26,599		—		—
Real estate:	—
Owner occupied	—		213		—		213		114,231		114,444		—		1,575
Real estate construction and other land loans	—		—		—		—		33,199		33,199		—		6,288
Commercial real estate	—		—		—		—		53,797		53,797		—		—
Agricultural real estate	—		—		—		—		28,400		28,400		—		—
Other real estate	—		—		—		—		8,098		8,098		—		—
Consumer:
Equity loans and lines of credit	—		—		—		—		42,932		42,932		—		1,832
Consumer and installment	27		—		—		27		10,319		10,346		—		—
Total	$	27	$	213	$	—	$	240	$	395,531	$	395,771	$	—	$	9,695

The following table shows information related to impaired loans by class at September 30, 2013 (in thousands):



	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial:
Commercial and industrial	$	393	$	423	$	—
Agricultural land and production	—		—		—
Total commercial	393		423		—
Real estate:
Owner occupied	1,804		2,643		—
Real estate construction and other land loans	5,227		5,431		—
Commercial real estate	167		549		—
Agricultural real estate	—		—		—
Other real estate	—		—		—
Total real estate	7,198		8,623		—
Consumer:
Equity loans and lines of credit	1,926		2,691		—
Consumer and installment	12		15		—
Total consumer	1,938		2,706		—
Total with no related allowance recorded	9,529		11,752		—

With an allowance recorded:
Commercial:
Commercial and industrial	1,256		1,284		632
Agricultural land and production	—		—		—
Total commercial	1,256		1,284		632
Real estate:
Owner occupied	1,790		1,963		49
Real estate construction and other land loans	870		1,315		165
Commercial real estate	—		—		—
Agricultural real estate	—		—		—
Other real estate	—		—		—
Total real estate	2,660		3,278		214
Consumer:
Equity loans and lines of credit	572		578		235
Consumer and installment	—		—		—
Total consumer	572		578		235
Total with an allowance recorded	4,488		5,140		1,081
Total	$	14,017	$	16,892	$	1,081

The recorded investment in loans excludes accrued interest receivable and net loan origination fees, due to immateriality.

The following table shows information related to impaired loans by class at December 31, 2012 (in thousands):



	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial:
Commercial and industrial	$	—	$	—	$	—
Agricultural land and production	—		—		—
Total commercial	—		—		—
Real estate:
Owner occupied	—		—		—
Real estate construction and other land loans	1,352		1,888		—
Commercial real estate	—		—		—
Agricultural real estate	—		—		—
Other real estate	—		—		—
Total real estate	1,352		1,888		—
Consumer:
Equity loans and lines of credit	1,523		1,834		—
Consumer and installment	—		—		—
Total consumer	1,523		1,834		—
Total with no related allowance recorded	2,875		3,722		—

With an allowance recorded:
Commercial:
Commercial and industrial	2,405		2,405		40
Agricultural land and production	—		—		—
Total commercial	2,405		2,405		40
Real estate:
Owner occupied	1,575		1,733		165
Real estate construction and other land loans	9,941		10,875		300
Commercial real estate	—		—		—
Agricultural real estate	—		—		—
Other real estate	—		—		—
Total real estate	11,516		12,608		465
Consumer:
Equity loans and lines of credit	309		323		5
Consumer and installment	—		—		—
Total consumer	309		323		5
Total with an allowance recorded	14,230		15,336		510
Total	$	17,105	$	19,058	$	510

The recorded investment in loans excludes accrued interest receivable and net loan origination fees, due to immateriality.

The following presents by class, information related to the average recorded investment and interest income recognized on impaired loans for the three months ended September 30, 2013 and 2012.



	Three Months Ended September 30, 2013				Three Months Ended September 30, 2012
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial:
Commercial and industrial	$	412	$	—	$	600	$	—
Agricultural land and production	—		—		—		—
Total commercial	412		—		600		—
Real estate:
Owner occupied	2,196		—		992		—
Real estate construction and other land loans	2,172		—		4,778		—
Commercial real estate	332		—		—		—
Agricultural real estate	—		—		—		—
Other real estate	—		—		—		—
Total real estate	4,700		—		5,770		—
Consumer:
Equity loans and lines of credit	2,057		—		1,615		—
Consumer and installment	14		—		—		—
Total consumer	2,071		—		1,615		—
Total with no related allowance recorded	7,183		—		7,985		—

With an allowance recorded:
Commercial:
Commercial and industrial	1,271		15		1,849		50
Agricultural land and production	—		—		—		—
Total commercial	1,271		15		1,849		50
Real estate:
Owner occupied	1,471		35		646		—
Real estate construction and other land loans	4,049		85		6,833		92
Commercial real estate	—		—		—		—
Agricultural real estate	—		—		—		—
Other real estate	—		—		—		—
Total real estate	5,520		120		7,479		92
Consumer:
Equity loans and lines of credit	571		—		289		—
Consumer and installment	—		—		23		—
Total consumer	571		—		312		—
Total with an allowance recorded	7,362		135		9,640		142
Total	$	14,545	$	135	$	17,625	$	142

The following presents by class, information related to the average recorded investment and interest income recognized on impaired loans for the nine months ended September 30, 2013 and 2012 (in thousands):



	Nine Months Ended September 30, 2013				Nine Months Ended September 30, 2012
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial:
Commercial and industrial	$	309	$	—	$	1,235	$	—
Agricultural land and production	—		—		—		—
Total commercial	309		—		1,235		—
Real estate:
Owner occupied	1,681		—		747		—
Real estate construction and other land loans	3,001		—		5,551		—
Commercial real estate	282		—		200		—
Agricultural real estate	—		—		—		—
Other real estate	—		—		—		—
Total real estate	4,964		—		6,498		—
Consumer:
Equity loans and lines of credit	1,966		—		1,566		—
Consumer and installment	10		—		—		—
Total consumer	1,976		—		1,566		—
Total with no related allowance recorded	7,249		—		9,299		—

With an allowance recorded:
Commercial:
Commercial and industrial	1,404		80		1,624		178
Agricultural land and production	—		—		—		—
Total commercial	1,404		80		1,624		178
Real estate:
Owner occupied	1,454		65		662		—
Real estate construction and other land loans	4,440		255		6,387		285
Commercial real estate	—		—		193		—
Agricultural real estate	—		—		—		—
Other real estate	—		—		—		—
Total real estate	5,894		320		7,242		285
Consumer:
Equity loans and lines of credit	465		—		543		—
Consumer and installment	—		—		48		—
Total consumer	465		—		591		—
Total with an allowance recorded	7,763		400		9,457		463
Total	$	15,012	$	400	$	18,756	$	463

Foregone interest on nonaccrual loans totaled $523,000 and $525,000 for the nine month periods ended September 30, 2013 and 2012, respectively. For the three month periods ended September 30, 2013 and 2012, foregone interest on nonaccrual loans totaled $145,000 and $181,000 respectively.

Troubled Debt Restructurings:

As of September 30, 2013 and 2012, the Company has a recorded investment in troubled debt restructurings of $10,766,000 and $17,036,000, respectively. The Company has allocated $865,000 of specific reserves to loans whose terms have been modified in troubled debt restructurings as of September 30, 2013. The Company has committed to lend no additional amounts as of September 30, 2013 to customers with outstanding loans that are classified as troubled debt restructurings.

During the three month periods ended September 30, 2013 and 2012 no loans were modified as troubled debt restructurings.

During the nine month period ended September 30, 2013 no loans were modified as troubled debt restructurings. The following table presents loans by class modified as troubled debt restructurings that occurred during the nine months ended September 30, 2012 (dollars in thousands):



Troubled Debt Restructurings:	Number of Loans	Pre-Modification Outstanding Recorded Investment (1)		Principal Modification (2)		Post Modification Outstanding Recorded Investment (3)		Outstanding Recorded Investment
Real Estate - Owner occupied	2	$	500	$	—	$	500	$	493


(1)	Amounts represent the recorded investment in loans before recognizing effects of the TDR, if any.


(2)	Principal Modification includes principal forgiveness at the time of modification, contingent principal forgiveness granted over the life of the loan based on borrower performance, and principal that has been legally separated and deferred to the end of the loan, with zero percent contractual interest rate.


(3)	Balance outstanding after principal modification, if any borrower reduction to recorded investment.

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There were no defaults on troubled debt restructurings, within twelve months following the modification, during the three and nine months ended September 30, 2013 and September 30, 2012.