LOANS AND ALLOWANCE FOR LOAN LOSSES

The composition of the loan portfolio, net of deferred origination fees and cost, and unearned income is summarized as follows (in thousands):



	September 30, 2015		December 31, 2014
Commercial and agricultural:
Commercial and industrial	$	175,098	$	165,385
Agricultural	1,043		1,021
Commercial mortgages:
Construction	45,579		54,831
Commercial mortgages, other	442,785		397,762
Residential mortgages	197,506		196,809
Consumer loans:
Credit cards	1,423		1,654
Home equity lines and loans	102,085		99,354
Indirect consumer loans	157,059		184,763
Direct consumer loans	19,359		19,995
Total loans, net of deferred loan fees	$	1,141,937	$	1,121,574
Interest receivable on loans	2,694		2,780
Total recorded investment in loans	$	1,144,631	$	1,124,354

The Corporation's concentrations of credit risk by loan type are reflected in the preceding table. The concentrations of credit risk with standby letters of credit, committed lines of credit and commitments to originate new loans generally follow the loan classifications in the table above.

The following tables present the activity in the allowance for loan losses by portfolio segment for the three and nine month periods ended September 30, 2015 and 2014 (in thousands):



	Three Months Ended September 30, 2015
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages		Consumer Loans			Total
Beginning balance:	$	1,825		$	6,625		$	1,545	$	4,033		$	14,028
Charge-offs:	(113		)	(1		)	—		(304		)	(418		)
Recoveries:	26			17			—		62			105
Net recoveries (charge-offs)	(87		)	16			—		(242		)	(313		)
Provision	(162		)	326			7		136			307
Ending balance	$	1,576		$	6,967		$	1,552	$	3,927		$	14,022



	Three Months Ended September 30, 2014
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Beginning balance:	$	1,749		$	6,912		$	1,498		$	3,473		$	13,632
Charge-offs:	(60		)	(878		)	(90		)	(415		)	(1,443		)
Recoveries:	138			35			—			200			373
Net recoveries (charge-offs)	78			(843		)	(90		)	(215		)	(1,070		)
Provision	(115		)	256			24			424			589
Ending balance	$	1,712		$	6,325		$	1,432		$	3,682		$	13,151



	Nine Months Ended September 30, 2015
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Beginning balance:	$	1,460		$	6,326		$	1,572		$	4,328		$	13,686
Charge-offs:	(113		)	(29		)	(32		)	(917		)	(1,091		)
Recoveries:	64			101			—			306			471
Net recoveries (charge-offs)	(49		)	72			(32		)	(611		)	(620		)
Provision	165			569			12			210			956
Ending balance	$	1,576		$	6,967		$	1,552		$	3,927		$	14,022



	Nine Months Ended September 30, 2014
Allowance for loan losses	Commercial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Total
Beginning balance:	$	1,979		$	6,243		$	1,517		$	3,037		$	12,776
Charge-offs:	(415		)	(1,236		)	(97		)	(1,191		)	(2,939		)
Recoveries:	331			118			28			507			984
Net recoveries (charge-offs)	(84		)	(1,118		)	(69		)	(684		)	(1,955		)
Provision	(183		)	1,200			(16		)	1,329			2,330
Ending balance	$	1,712		$	6,325		$	1,432		$	3,682		$	13,151

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of September 30, 2015 and December 31, 2014 (in thousands):



	September 30, 2015
Allowance for loan losses:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	85	$	1,525	$	—	$	—	$	1,610
Collectively evaluated for impairment	1,491		5,383		1,521		3,927		12,322
Loans acquired with deteriorated credit quality	—		59		31		—		90
Total ending allowance balance	$	1,576	$	6,967	$	1,552	$	3,927	$	14,022



	December 31, 2014
Allowance for loan losses:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	89	$	1,145	$	—	$	1	$	1,235
Collectively evaluated for impairment	1,335		5,145		1,550		4,327		12,357
Loans acquired with deteriorated credit quality	36		36		22		—		94
Total ending allowance balance	$	1,460	$	6,326	$	1,572	$	4,328	$	13,686



	September 30, 2015
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	1,088	$	12,796	$	239	$	477	$	14,600
Loans collectively evaluated for impairment	175,461		474,848		197,504		280,104		1,127,917
Loans acquired with deteriorated credit quality	—		1,849		265		—		2,114
Total ending loans balance	$	176,549	$	489,493	$	198,008	$	280,581	$	1,144,631



	December 31, 2014
Loans:	Commercial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	1,452	$	13,712	$	254	$	486	$	15,904
Loans collectively evaluated for impairment	164,748		438,246		196,783		306,042		1,105,819
Loans acquired with deteriorated credit quality	620		1,761		250		—		2,631
Total ending loans balance	$	166,820	$	453,719	$	197,287	$	306,528	$	1,124,354

The following tables present loans individually evaluated for impairment recognized by class of loans as of September 30, 2015 and December 31, 2014, the average recorded investment and interest income recognized by class of loans as of the three and nine month periods ended September 30, 2015 and 2014 (in thousands):



	September 30, 2015						December 31, 2014
With no related allowance recorded:	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
Commercial and agricultural:
Commercial and industrial	$	1,001	$	1,003	$	—	$	1,359	$	1,364	$	—
Commercial mortgages:
Construction	357		358		—		1,927		1,910		—
Commercial mortgages, other	7,520		7,433		—		7,803		7,708		—
Residential mortgages	238		239		—		253		253		—
Consumer loans:
Home equity lines and loans	474		477		—		429		432		—
With an allowance recorded:
Commercial and agricultural:
Commercial and industrial	85		85		85		89		89		89
Commercial mortgages:
Commercial mortgages, other	5,055		5,005		1,525		4,210		4,094		1,145
Consumer loans:
Home equity lines and loans	—		—		—		54		54		1
Total	$	14,730	$	14,600	$	1,610	$	16,124	$	15,904	$	1,235



	Three Months Ended September 30, 2015				Three Months Ended September 30, 2014				Nine Months Ended September 30, 2015				Nine Months Ended September 30, 2014
With no related allowance recorded:	Average Recorded Investment		Interest Income Recognized (1)		Average Recorded Investment		Interest Income Recognized (1)		Average Recorded Investment		Interest Income Recognized (1)		Average Recorded Investment		Interest Income Recognized (1)
Commercial and agricultural:
Commercial and industrial	$	1,133	$	15	$	1,309	$	11	$	1,325	$	47	$	1,566	$	26
Commercial mortgages:
Construction	402		4		1,924		26		1,153		33		2,231		76
Commercial mortgages, other	7,556		70		7,909		82		7,765		196		6,806		211
Residential mortgages	241		1		110		—		246		3		114		—
Consumer loans:
Home equity lines & loans	479		6		69		1		468		18		72		2
With an allowance recorded:
Commercial and agricultural:
Commercial and industrial	165		—		144		—		180		3		784		—
Commercial mortgages:
Commercial mortgages, other	4,975		1		1,233		—		4,418		48		912		—
Consumer loans:
Home equity lines and loans	—		—		56		1		13		—		58		3
Total	$	14,951	$	97	$	12,754	$	121	$	15,568	$	348	$	12,543	$	318

(1)Cash basis interest income approximates interest income recognized.

The following tables present the recorded investment in past due and non-accrual status by class of loans as of September 30, 2015 and December 31, 2014 (in thousands):



September 30, 2015	Current		30-89 Days Past Due		90 Days or more Past Due and accruing		Loans acquired with deteriorated credit quality		Non-Accrual (1)		Total
Commercial and agricultural:
Commercial and industrial	$	175,397	$	11	$	1	$	—	$	94	$	175,503
Agricultural	1,046		—		—		—		—		1,046
Commercial mortgages:
Construction	45,620		—		—		—		64		45,684
Commercial mortgages, other	434,476		272		—		1,849		7,212		443,809
Residential mortgages	192,719		1,124		—		265		3,900		198,008
Consumer loans:
Credit cards	1,383		27		13		—		—		1,423
Home equity lines and loans	101,188		335		—		—		811		102,334
Indirect consumer loans	155,327		1,804		—		—		269		157,400
Direct consumer loans	19,325		81		—		—		18		19,424
Total	$	1,126,481	$	3,654	$	14	$	2,114	$	12,368	$	1,144,631

(1) Includes all loans on non-accrual status regardless of the number of days such loans were past due as of September 30, 2015. The past due status of non-accrual loans as of September 30, 2015 were as follows: $3.0 million in current, $3.5 million in 30-89 days past due, and $5.9 million in 90 days or more past due.



December 31, 2014	Current		30-89 Days Past Due		90 Days or more Past Due and accruing		Loans acquired with deteriorated credit quality		Non-Accrual (1)		Total
Commercial and agricultural:
Commercial and industrial	$	164,109	$	756	$	—	$	620	$	312	$	165,797
Agricultural	1,023		—		—		—		—		1,023
Commercial mortgages:
Construction	53,371		—		1,446		—		150		54,967
Commercial mortgages, other	391,096		3,064		—		1,761		2,831		398,752
Residential mortgages	191,089		2,333		—		250		3,615		197,287
Consumer loans:
Credit cards	1,641		5		8		—		—		1,654
Home equity lines and loans	98,340		736		—		—		515		99,591
Indirect consumer loans	183,103		1,789		—		—		325		185,217
Direct consumer loans	19,988		48		—		—		30		20,066
Total	$	1,103,760	$	8,731	$	1,454	$	2,631	$	7,778	$	1,124,354

(1) Includes all loans on non-accrual status regardless of the number of days such loans were past due as of December 31, 2014. The past due status of non-accrual loans as of December 31, 2014 were as follows: $2.9 million in current, $1.7 million in 30-89 days past due, and $3.2 million in 90 days or more past due.

Troubled Debt Restructurings:

A modification of a loan may result in classification as a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of modifications which may involve a change in the schedule of payments, a reduction in the interest rate, an extension of the maturity date, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, requesting additional collateral, releasing collateral for consideration, substituting or adding a new borrower or guarantor, a permanent reduction of the recorded investment in the loan or a permanent reduction of the interest on the loan.

As of September 30, 2015 and December 31, 2014, the Corporation has a recorded investment in TDRs of $9.4 million and $9.7 million, respectively. There were specific reserves of $0.5 million and $0.3 million allocated for TDRs at September 30, 2015 and December 31, 2014, respectively. As of September 30, 2015, TDRs totaling $7.1 million were accruing interest under the modified terms and $2.3 million were on non-accrual status. As of December 31, 2014, TDRs totaling $8.7 million were accruing interest under the modified terms and $1.0 million were on non-accrual status. The Corporation had committed additional amounts up to $0.6 million as of September 30, 2015 and less than $0.1 million as of December 31, 2014, to customers with outstanding loans that are classified as TDRs.

During the three and nine months ended September 30, 2015 and 2014, the terms of certain loans were modified as TDRs. The modification of the terms of such loans included one or a combination of the following: reduced scheduled payments for greater than three months or an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk.

The following table presents loans by class modified as TDRs that occurred during the three months ended September 30, 2015 and 2014 (in thousands):



September 30, 2015	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial mortgages:
Commercial mortgages	1	$	432	$	432
Total	1	$	432	$	432



September 30, 2014	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial and agricultural:
Commercial and industrial	2	$	405	$	405
Commercial mortgages:
Commercial mortgages	1	1,869		1,869
Total	3	$	2,274	$	2,274

The TDRs described above did not increase the allowance for loan losses and resulted in no charge-offs during the three months ended September 30, 2015 and 2014, respectively.

The following table presents loans by class modified as TDRs that occurred during the nine months ended September 30, 2015 and 2014 (in thousands):



September 30, 2015	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial and agricultural:
Commercial and industrial	1	$	477	$	477
Commercial mortgages:
Commercial mortgages	2	542		542
Total	3	$	1,019	$	1,019



September 30, 2014	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled debt restructurings:
Commercial and agricultural:
Commercial and industrial	3	$	908	$	908
Commercial mortgages:
Commercial mortgages	3	2,236		2,192
Total	6	$	3,144	$	3,100

The TDRs described above increased the allowance for loan losses by less than $0.1 million and resulted in no charge-offs during the nine months ended September 30, 2015. The TDRs described above did not increase the allowance for loan losses and resulted in less than $0.1 million in charge-offs during the nine months ended September 30, 2014.

There were no payment defaults on any loans previously modified as TDRs during the three and nine months ended September 30, 2015 or 2014, within twelve months following the modification. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

Credit Quality Indicators

The Corporation establishes a risk rating at origination for all commercial loans. The main factors considered in assigning risk ratings include, but are not limited to: historic and future debt service coverage, collateral position, operating performance, liquidity, leverage, payment history, management ability, and the customer’s industry. Commercial relationship managers monitor all loans in their respective portfolios for any changes in the borrower’s ability to service their debt and affirm the risk ratings for the loans at least annually.

For the retail loans, which include residential mortgages, indirect and direct consumer loans, home equity lines and loans, and credit cards, once a loan is properly approved and closed, the Corporation evaluates credit quality based upon loan repayment.

The Corporation uses the risk rating system to identify criticized and classified loans. Commercial relationships within the criticized and classified risk ratings are analyzed quarterly. The Corporation uses the following definitions for criticized and classified loans (which are consistent with regulatory guidelines):

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 the institution’s credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capability 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 institution 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 above described process are considered to be pass rated loans. Loans listed as not rated are included in groups of homogeneous loans. Based on the analyses performed as of September 30, 2015 and December 31, 2014, the risk category of the recorded investment of loans by class of loans is as follows (in thousands):



	September 30, 2015
	Not Rated		Pass		Loans acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful		Total
Commercial and agricultural:
Commercial and industrial	$	—	$	170,179	$	—	$	3,718	$	1,521	$	85	$	175,503
Agricultural	—		1,046		—		—		—		—		1,046
Commercial mortgages:
Construction	—		45,326		—		293		65		—		45,684
Commercial mortgages	—		412,811		1,849		12,200		12,798		4,151		443,809
Residential mortgages	193,843		—		265		—		3,900		—		198,008
Consumer loans:
Credit cards	1,423		—		—		—		—		—		1,423
Home equity lines and loans	101,515		—		—		—		819		—		102,334
Indirect consumer loans	157,087		—		—		—		313		—		157,400
Direct consumer loans	19,406		—		—		—		18		—		19,424
Total	$	473,274	$	629,362	$	2,114	$	16,211	$	19,434	$	4,236	$	1,144,631



	December 31, 2014
	Not Rated		Pass		Loans acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful		Total
Commercial and agricultural:
Commercial and industrial	$	—	$	158,140	$	620	$	3,695	$	3,306	$	36	$	165,797
Agricultural	—		1,023		—		—		—		—		1,023
Commercial mortgages:
Construction	—		51,525		—		3,292		150		—		54,967
Commercial mortgages	—		365,448		1,761		20,871		10,266		406		398,752
Residential mortgages	193,422		—		250		—		3,615		—		197,287
Consumer loans:
Credit cards	1,654		—		—		—		—		—		1,654
Home equity lines and loans	99,076		—		—		—		515		—		99,591
Indirect consumer loans	184,940		—		—		—		277		—		185,217
Direct consumer loans	20,045		—		—		—		21		—		20,066
Total	$	499,137	$	576,136	$	2,631	$	27,858	$	18,150	$	442	$	1,124,354

The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential and consumer loans based on payment activity as of September 30, 2015 and December 31, 2014 (in thousands):



	September 30, 2015
			Consumer Loans
	Residential Mortgages		Credit Card		Home Equity Lines and Loans		Indirect Consumer Loans		Other Direct Consumer Loans
Performing	$	194,108	$	1,423	$	101,523	$	157,131	$	19,406
Non-Performing	3,900		—		811		269		18
	$	198,008	$	1,423	$	102,334	$	157,400	$	19,424



	December 31, 2014
			Consumer Loans
	Residential Mortgages		Credit Card		Home Equity Lines and Loans		Indirect Consumer Loans		Other Direct Consumer Loans
Performing	$	193,672	$	1,654	$	99,076	$	184,892	$	20,036
Non-Performing	3,615		—		515		325		30
	$	197,287	$	1,654	$	99,591	$	185,217	$	20,066

At the time of the merger with Fort Orange Financial Corp., the Corporation identified certain loans with evidence of deteriorated credit quality, and the probability that the Corporation would be unable to collect all contractually required payments from the borrower. These loans are classified as PCI loans. The Corporation adjusted its estimates of future expected losses, cash flows, and renewal assumptions on the PCI loans during the current year. These adjustments were made for changes in expected cash flows due to loans refinanced beyond original maturity dates, impairments recognized subsequent to the acquisition, advances made for taxes or insurance to protect collateral held and payments received in excess of amounts originally expected.

The table below summarizes the changes in total contractually required principal and interest cash payments, management’s estimate of expected total cash payments and carrying value of the PCI loans from July 1, 2015 to September 30, 2015 and January 1, 2015 to September 30, 2015 (in thousands):



Three Months Ended September 30, 2015	Balance at June 30, 2015			Income Accretion		All Other Adjustments			Balance at September 30, 2015
Contractually required principal and interest	$	3,036		$	—	$	(69	)	$	2,967
Contractual cash flows not expected to be collected (nonaccretable discount)	(568		)	—		19			(549		)
Cash flows expected to be collected	2,468			—		(50		)	2,418
Interest component of expected cash flows (accretable yield)	(324		)	39		(19		)	(304		)
Fair value of loans acquired with deteriorating credit quality	$	2,144		$	39	$	(69	)	$	2,114



Nine Months Ended September 30, 2015	Balance at December 31, 2014			Income Accretion		All Other Adjustments			Balance at September 30, 2015
Contractually required principal and interest	$	3,621		$	—	$	(654	)	$	2,967
Contractual cash flows not expected to be collected (nonaccretable discount)	(570		)	—		21			(549		)
Cash flows expected to be collected	3,051			—		(633		)	2,418
Interest component of expected cash flows (accretable yield)	(420		)	138		(22		)	(304		)
Fair value of loans acquired with deteriorating credit quality	$	2,631		$	138	$	(655	)	$	2,114