The Company provides for loan losses through the establishment of an allowance for loan losses, which represents an estimated reserve for existing losses in the loan portfolio. A systematic methodology is used for determining the allowance that includes a quarterly review process, risk rating changes, and adjustments to the allowance. Major risk characteristics relevant to each portfolio segment are as follows:

Commercial Real Estate - Commercial real estate loans are impacted by factors such as competitive market forces, vacancy rates, cap rates, net operating incomes, lease renewals and overall economic demand. In addition, loans in the recreational and tourism sector can be affected by weather conditions, such as unseasonably low winter snowfalls. Commercial real estate lending also carries a higher degree of environmental risk than other real estate lending.

Residential Real Estate Construction - The overall health of the economy, including unemployment rates and housing prices, has an impact on the credit quality of this segment. Residential construction loans are impacted by factors similar to those for residential real estate term loans in addition to risks related to contractor financial capacity and ability to complete a project within acceptable time frames and within budget.

Consumer -The overall health of the economy, including unemployment rates, has an impact on the credit quality of this segment. The appropriate level of the allowance is evaluated continually based on a review of significant loans, with a particular emphasis on nonaccruing, past due, and other loans that may require special attention. Other factors include general conditions in local and national economies; loan portfolio composition and asset quality indicators; and internal factors such as changes in underwriting policies, credit administration practices, experience, ability and depth of lending management, among others.



As of December 31,	2018		2017
Allowance for Loans Evaluated Individually for Impairment
Commercial
Real estate	$	260,000	$	224,000
Construction	—		—
Other	1,696,000		1,309,000
Municipal	—		—
Residential
Term	335,000		255,000
Construction	—		—
Home equity line of credit	17,000		24,000
Consumer	—		—
Total	$	2,308,000	$	1,812,000
Allowance for Loans Evaluated Collectively for Impairment
Commercial
Real estate	$	3,307,000	$	3,648,000
Construction	255,000		434,000
Other	1,845,000		2,049,000
Municipal	24,000		20,000
Residential
Term	900,000		875,000
Construction	34,000		36,000
Home equity line of credit	713,000		668,000
Consumer	630,000		545,000
Unallocated	1,216,000		642,000
Total	$	8,924,000	$	8,917,000
Total Allowance for Loan Losses
Commercial
Real estate	$	3,567,000	$	3,872,000
Construction	255,000		434,000
Other	3,541,000		3,358,000
Municipal	24,000		20,000
Residential
Term	1,235,000		1,130,000
Construction	34,000		36,000
Home equity line of credit	730,000		692,000
Consumer	630,000		545,000
Unallocated	1,216,000		642,000
Total	$	11,232,000	$	10,729,000

The allowance consists of four elements: (1) specific reserves for loans evaluated individually for impairment; (2) general reserves for each portfolio segment based on historical loan loss experience; (3) qualitative reserves judgmentally adjusted for local and national economic conditions, concentrations, portfolio composition, volume and severity of delinquencies and nonaccrual loans, trends of criticized and classified loans, changes in credit policies, and underwriting standards, credit administration practices, and other factors as applicable for each portfolio segment; and (4) unallocated reserves. All outstanding loans are considered in evaluating the appropriateness of the allowance.



As of December 31, 2018	Specific Reserves on Loans Evaluated Individually for Impairment		General Reserves on Loans Based on Historical Loss Experience		Reserves for Qualitative Factors		Unallocated Reserves		Total Reserves
Commercial
Real estate	$	260,000	$	742,000	$	2,565,000	$	—	$	3,567,000
Construction	—		57,000		198,000		—		255,000
Other	1,696,000		414,000		1,431,000		—		3,541,000
Municipal	—		—		24,000		—		24,000
Residential
Term	335,000		326,000		574,000		—		1,235,000
Construction	—		12,000		22,000		—		34,000
Home equity line of credit	17,000		263,000		450,000		—		730,000
Consumer	—		271,000		359,000		—		630,000
Unallocated	—		—		—		1,216,000		1,216,000
	$	2,308,000	$	2,085,000	$	5,623,000	$	1,216,000	$	11,232,000



As of December 31, 2017	Specific Reserves on Loans Evaluated Individually for Impairment		General Reserves on Loans Based on Historical Loss Experience		Reserves for Qualitative Factors		Unallocated Reserves		Total Reserves
Commercial
Real estate	$	224,000	$	1,285,000	$	2,363,000	$	—	$	3,872,000
Construction	—		153,000		281,000		—		434,000
Other	1,309,000		723,000		1,326,000		—		3,358,000
Municipal	—		—		20,000		—		20,000
Residential
Term	255,000		311,000		564,000		—		1,130,000
Construction	—		13,000		23,000		—		36,000
Home equity line of credit	24,000		297,000		371,000		—		692,000
Consumer	—		251,000		294,000		—		545,000
Unallocated	—		—		—		642,000		642,000
	$	1,812,000	$	3,033,000	$	5,242,000	$	642,000	$	10,729,000

The unallocated component totaled $1,216,000 at December 31, 2018, or 10.8% of the total reserve. This compares to $642,000 or 6.0% as of December 31, 2017. The change supported general imprecision related to portfolio growth and includes considerations of general economic and business conditions affecting our lending area, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, duration of the current business cycle, bank regulatory examination results, findings of external loan review examiners, and Management's judgment with respect to various other conditions including loan administration and management and the quality of risk identification systems. Consequently, there maybe underlying credit risks that have not yet surfaced in the loan specific or qualitative metrics the Company uses to estimate its allowance for loan losses that are reflected in the unallocated component.

Commercial real estate loans consist of mortgage loans to finance investments in real property, such as multi-family residential, commercial/retail, office, industrial, hotels, educational and other specific or mixed use properties. Commercial real estate loans are typically written with amortizing payment structures. Collateral values are determined based on appraisals and evaluations in accordance with established policy and regulatory guidelines. Commercial real estate loans typically have a loan-to-value ratio of up to 80% based upon current valuation information at the time the loan is made. Commercial real estate loans are primarily paid by the cash flow generated from the real property, such as operating leases, rents, or other operating cash flows from the borrower.

Commercial construction loans consist of loans to finance construction in a mix of owner- and non-owner occupied commercial real estate properties. Commercial construction loans typically have maturities of less than two years. Payment structures during the construction period are typically on an interest only basis, although principal payments may be established depending on the type of construction project being financed. During the construction phase, commercial construction loans are primarily paid by cash flow generated from the construction project or other operating cash flows from the borrower or guarantors, if applicable. At the end of the construction period, loan repayment typically comes from a third party source in the event that the Bank will not be providing permanent term financing. Collateral valuation and loan-to-value guidelines follow those for commercial real estate loans.

Other commercial loans consist of revolving and term loan obligations extended to business and corporate enterprises for the purpose of financing working capital or capital investment. Collateral generally consists of pledges of business assets including, but not limited to, accounts receivable, inventory, plant and equipment, and/or real estate, if applicable. Commercial loans are primarily paid by the operating cash flow of the borrower. Commercial loans may be secured or unsecured.

Residential term loans consist of residential real estate loans held in the Bank's loan portfolio made to borrowers who demonstrate the ability to make scheduled payments with full consideration of underwriting factors. Borrower qualifications include favorable credit history combined with supportive income requirements and loan-to-value ratios within established policy and regulatory guidelines. Collateral values are determined based on appraisals and evaluations in accordance with established policy and regulatory guidelines. Residential loans typically have a loan-to-value ratio of up to 80% based on appraisal information at the time the loan is made. Collateral consists of mortgage liens on one- to four-family residential properties. Loans are offered with fixed or adjustable rates with amortization terms of up to thirty years.

Residential construction loans typically consist of loans for the purpose of constructing single family residences to be owned and occupied by the borrower. Borrower qualifications include favorable credit history combined with supportive income requirements and loan-to-value ratios within established policy and regulatory guidelines. Residential construction loans normally have terms of one year or less and payment during the construction term is typically on an interest only basis from sources including interest reserves, borrower liquidity and/or income. Residential construction loans will typically convert to permanent financing from the Bank or have another financing commitment in place from an acceptable mortgage lender. Collateral valuation and loan-to-value guidelines are consistent with those for residential term loans.

Home equity lines of credit are made to qualified individuals and are secured by senior or junior mortgage liens on owner-occupied one- to four-family homes, condominiums, or vacation homes. The home equity line of credit typically has a variable interest rate and is billed as interest-only payments during the draw period. At the end of the draw period, the home equity line of credit payments are billed as a percentage of the principal balance plus all accrued interest. Loan maturities are normally 300 months. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to- value ratios usually not exceeding 80% inclusive of priority liens. Collateral valuation guidelines follow those for residential real estate loans.

Consumer loan products including personal lines of credit and amortizing loans made to qualified individuals for various purposes such as auto, recreational vehicles, debt consolidation, personal expenses or overdraft protection. Borrower qualifications include favorable credit history combined with supportive income and collateral requirements within established policy guidelines. Consumer loans may be secured or unsecured.

Construction, land and land development loans, both commercial and residential, comprise a small portion of the portfolio, and at 25.7% of capital are below the regulatory guidance of 100.0% of capital at December 31, 2018. Construction loans and non- owner-occupied commercial real estate loans are at 126.4% of total capital at December 31, 2018, below the regulatory limit of 300.0% of capital.

The process of establishing the allowance with respect to the commercial loan portfolio begins when a Loan Officer or Senior Officer (or designate) initially assigns each loan a risk rating, using established credit criteria, which is reviewed and updated if necessary at least annually or when conditions may warrant a change in the assigned risk rating. Approximately 60% of the outstanding loans and commitments are subject to review and validation annually by an independent consulting firm. Additionally, commercial loan relationships with exposure greater than or equal to $500,000 and lines of credit greater than $250,000 are subject to review annually by the Bank's internal credit review function. The methodology employs Management's judgment as to the level of losses on existing loans based on internal review of the loan portfolio, including an analysis of a borrower's current financial position, and the consideration of current and anticipated economic conditions and their potential effects on specific borrowers or lines of business.

Loans classified "Doubtful" have the same weaknesses as those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is high, but because of certain important and reasonably specific pending factors which may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined.



	Commercial Real Estate		Commercial Construction		Commercial Other		Municipal Loans		All Risk- Rated Loans
1 Strong	$	—	$	—	$	3,444,000	$	—	$	3,444,000
2 Above average	10,484,000		37,000		4,564,000		48,800,000		63,885,000
3 Satisfactory	80,266,000		2,231,000		46,090,000		518,000		129,105,000
4 Average	172,597,000		18,780,000		82,081,000		1,810,000		275,268,000
5 Watch	66,325,000		5,970,000		45,546,000		—		117,841,000
6 OAEM	6,890,000		—		1,805,000		—		8,695,000
7 Substandard	16,558,000		286,000		12,861,000		—		29,705,000
8 Doubtful	123,000		—		—		—		123,000
Total	$	353,243,000	$	27,304,000	$	196,391,000	$	51,128,000	$	628,066,000



	Commercial Real Estate		Commercial Construction		Commercial Other		Municipal Loans		All Risk- Rated Loans
1 Strong	$	—	$	—	$	1,586,000	$	—	$	1,586,000
2 Above average	12,534,000		40,000		5,776,000		32,673,000		51,023,000
3 Satisfactory	73,899,000		2,856,000		38,151,000		718,000		115,624,000
4 Average	173,956,000		22,446,000		84,360,000		—		280,762,000
5 Watch	41,652,000		12,714,000		33,934,000		—		88,300,000
6 OAEM	3,442,000		—		2,765,000		—		6,207,000
7 Substandard	18,203,000		—		14,956,000		—		33,159,000
8 Doubtful	123,000		—		—		—		123,000
Total	$	323,809,000	$	38,056,000	$	181,528,000	$	33,391,000	$	576,784,000

Residential loans are comprised of two classes: term loans, which include traditional amortizing home mortgages, and construction loans, which include loans for owner-occupied residential construction. Residential loans typically have a 75% to 80% loan to value ratio based upon current appraisal information at the time the loan is made. Home equity loans and lines of credit are typically written to the same underwriting standards. Consumer loans are primarily amortizing loans to individuals collateralized by automobiles, pleasure craft and recreation vehicles, typically with a maximum loan to value ratio of 80% to 90% of the purchase price of the collateral. Consumer loans also include a small amount of unsecured short-term time notes to individuals.

Residential loans, consumer loans and home equity lines of credit are segregated into homogeneous pools with similar risk characteristics. Trends and current conditions are analyzed and historical loss experience is adjusted accordingly. Quantitative and qualitative adjustment factors for these segments are consistent with those for the commercial and municipal classes. Certain loans in the residential, home equity lines of credit and consumer classes identified as having the potential for further deterioration are analyzed individually to confirm impairment status, and to determine the need for a specific reserve; however, there is no formal rating system used for these classes. Consumer loans greater than 120 days past due are generally charged off. Residential loans 90 days or more past due are placed on non-accrual status unless the loans are both well secured and in the process of collection. One-to four-family residential real estate loans and home equity loans are written down or charged-off no later than 180 days past due, or for residential real estate secured loans having a borrower in bankruptcy, within 60 days of receipt of notification of filing from the bankruptcy court, whichever is sooner. This is subject to completion of a current assessment of the value of the collateral with any outstanding loan balance in excess of the fair value of the property, less costs to sell, written down or charged-off.

The following tables present allowance for loan losses activity by class, allowance for loan loss balances by class and related loan balances by class for the years ended December 31, 2018, 2017 and 2016:



For the year ended December 31, 2018	Commercial										Residential					Home Equity Line of Credit
For the year ended December 31, 2018	Real Estate			Construction			Other		Municipal		Term		Construction			Home Equity Line of Credit		Consumer		Unallocated		Total
Allowance for loan losses:
Beginning balance	$	3,872,000		$	434,000		$	3,358,000	$	20,000	$	1,130,000	$	36,000		$	692,000	$	545,000	$	642,000	$	10,729,000
Chargeoffs	168,000			—			423,000		—		213,000		—			121,000		348,000		—		1,273,000
Recoveries	52,000			—			40,000		—		64,000		—			24,000		96,000		—		276,000
Provision (credit)	(189,000		)	(179,000		)	566,000		4,000		254,000		(2,000		)	135,000		337,000		574,000		1,500,000
Ending balance	$	3,567,000		$	255,000		$	3,541,000	$	24,000	$	1,235,000	$	34,000		$	730,000	$	630,000	$	1,216,000	$	11,232,000
Ending balance specifically evaluated for impairment	$	260,000		$	—		$	1,696,000	$	—	$	335,000	$	—		$	17,000	$	—	$	—	$	2,308,000
Ending balance collectively evaluated for impairment	$	3,307,000		$	255,000		$	1,845,000	$	24,000	$	900,000	$	34,000		$	713,000	$	630,000	$	1,216,000	$	8,924,000
Related loan balances:
Ending balance	$	353,243,000		$	27,304,000		$	196,391,000	$	51,128,000	$	469,145,000	$	17,743,000		$	98,469,000	$	24,860,000	$	—	$	1,238,283,000
Ending balance specifically evaluated for impairment	$	9,760,000		$	721,000		$	9,259,000	$	—	$	10,904,000	$	—		$	1,092,000	$	15,000	$	—	$	31,751,000
Ending balance collectively evaluated for impairment	$	343,483,000		$	26,583,000		$	187,132,000	$	51,128,000	$	458,241,000	$	17,743,000		$	97,377,000	$	24,845,000	$	—	$	1,206,532,000



For the year ended December 31, 2017	Commercial								Residential					Home Equity Line of Credit
For the year ended December 31, 2017	Real Estate		Construction		Other		Municipal		Term		Construction			Home Equity Line of Credit			Consumer		Unallocated			Total
Allowance for loan losses:
Beginning balance	$	3,988,000	$	396,000	$	1,780,000	$	18,000	$	1,288,000	$	44,000		$	807,000		$	559,000	$	1,258,000		$	10,138,000
Chargeoffs	587,000		—		212,000		—		456,000		—			28,000			335,000		—			1,618,000
Recoveries	—		—		49,000		—		40,000		—			11,000			109,000		—			209,000
Provision (credit)	471,000		38,000		1,741,000		2,000		258,000		(8,000		)	(98,000		)	212,000		(616,000		)	2,000,000
Ending balance	$	3,872,000	$	434,000	$	3,358,000	$	20,000	$	1,130,000	$	36,000		$	692,000		$	545,000	$	642,000		$	10,729,000
Ending balance specifically evaluated for impairment	$	224,000	$	—	$	1,309,000	$	—	$	255,000	$	—		$	24,000		$	—	$	—		$	1,812,000
Ending balance collectively evaluated for impairment	$	3,648,000	$	434,000	$	2,049,000	$	20,000	$	875,000	$	36,000		$	668,000		$	545,000	$	642,000		$	8,917,000
Related loan balances:
Ending balance	$	323,809,000	$	38,056,000	$	181,528,000	$	33,391,000	$	432,661,000	$	17,868,000		$	111,302,000		$	25,524,000	$	—		$	1,164,139,000
Ending balance specifically evaluated for impairment	$	7,790,000	$	741,000	$	9,918,000	$	—	$	11,748,000	$	—		$	1,179,000		$	16,000	$	—		$	31,392,000
Ending balance collectively evaluated for impairment	$	316,019,000	$	37,315,000	$	171,610,000	$	33,391,000	$	420,913,000	$	17,868,000		$	110,123,000		$	25,508,000	$	—		$	1,132,747,000



For the year ended December 31, 2016	Commercial									Residential				Home Equity Line of Credit
For the year ended December 31, 2016	Real Estate		Construction			Other		Municipal		Term		Construction		Home Equity Line of Credit		Consumer		Unallocated			Total
Allowance for loan losses:
Beginning balance	$	3,120,000	$	580,000		$	1,452,000	$	17,000	$	1,391,000	$	24,000	$	893,000	$	566,000	$	1,873,000		$	9,916,000
Chargeoffs	294,000		75,000			376,000		—		379,000		—		147,000		450,000		—			1,721,000
Recoveries	—		8,000			129,000		—		93,000		—		5,000		108,000		—			343,000
Provision (credit)	1,162,000		(117,000		)	575,000		1,000		183,000		20,000		56,000		335,000		(615,000		)	1,600,000
Ending balance	$	3,988,000	$	396,000		$	1,780,000	$	18,000	$	1,288,000	$	44,000	$	807,000	$	559,000	$	1,258,000		$	10,138,000
Ending balance specifically evaluated for impairment	$	505,000	$	100,000		$	39,000	$	—	$	304,000	$	—	$	26,000	$	—	$	—		$	974,000
Ending balance collectively evaluated for impairment	$	3,483,000	$	296,000		$	1,741,000	$	18,000	$	984,000	$	44,000	$	781,000	$	559,000	$	1,258,000		$	9,164,000
Related loan balances:
Ending balance	$	302,506,000	$	25,406,000		$	150,769,000	$	27,056,000	$	411,469,000	$	18,303,000	$	110,907,000	$	25,110,000	$	—		$	1,071,526,000
Ending balance specifically evaluated for impairment	$	10,021,000	$	763,000		$	1,743,000	$	—	$	13,669,000	$	—	$	1,387,000	$	—	$	—		$	27,583,000
Ending balance collectively evaluated for impairment	$	292,485,000	$	24,643,000		$	149,026,000	$	27,056,000	$	397,800,000	$	18,303,000	$	109,520,000	$	25,110,000	$	—		$	1,043,943,000