Note 4: Loans and Allowance for Loan Losses

Categories of loans at December 31 include:

	Total Loans						Non-Accrual Loans
($ in thousands)	Dec. 2016			Dec. 2015			Dec. 2016		Dec. 2015

Commercial & Industrial	$	108,752		$	86,542			190		188
Commercial RE & Construction		284,084			242,208			1,194		5,670
Agricultural & Farmland		52,475			43,835			4		7
Residential Real Estate		142,452			130,806			1,162		749
Consumer & Other		56,335			54,224			187		32

Total Loans	$	644,098		$	557,615		$	2,737	$	6,646

Unearned Income	$	335		$	44

Total Loans, net of unearned income	$	644,433		$	557,659

Allowance for loan losses	$	(7,725	)	$	(6,990	)

State Bank makes commercial, agri-business, consumer and residential loans to customers throughout its defined market area. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.

Standby letters of credit are conditional commitments issued by State Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

Forward sale commitments are commitments to sell groups of residential mortgage loans that the Company originates or purchases as part of its mortgage banking activities. The Company commits to sell the loans at specified prices in a future period, typically within forty-five days. These commitments are acquired to reduce market risk on mortgage loans in the process of origination and mortgage loans held for sales since the Company is exposed to interest rate risk during the period between issuing a loan commitment and the sales of the loan into the secondary market.

Listed below is a summary of loan commitments, unused lines of credit and standby letters of credit as of December 31, 2016 and 2015.

($ in thousands)	2016		2015

Loan commitments and unused lines of credit	$	143,553	$	126,902
Standby letters of credit		708		1,026

Total	$	144,261	$	127,928

There are various contingent liabilities that are not reflected in the consolidated financial statements, including claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material effect on the Company’s consolidated financial condition or results of operations.

The risk characteristics of each loan portfolio segment are as follows:

Commercial and Agricultural

Commercial and agricultural 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 include a personal guarantee. 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.

Commercial Real Estate including Construction

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. The characteristics of properties securing the Company’s commercial real estate portfolio are diverse, but with geographic location almost entirely in the Company’s market area. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In general, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate versus nonowner-occupied loans.

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Residential and Consumer

Residential and consumer loans consist of two segments – residential mortgage loans and personal loans. Residential mortgage loans are secured by 1-4 family residences and are generally owner-occupied, and the Company 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, and consumer personal loans are secured by consumer personal assets, such as automobiles or recreational vehicles. Some consumer personal loans are unsecured, such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income 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 these loans are of smaller individual amounts and spread over a large number of borrowers.

The following tables present the balance of the allowance for loan and lease losses (“ALLL”) and the recorded investment in loans based on portfolio segment and impairment method as of December 31, 2016 and 2015:

	Commercial			Commercial RE			Agricultural		Residential			Consumer
($'s in thousands)	& Industrial			& Construction			& Farmland		Real Estate			& Other			Total

ALLOWANCE FOR LOAN AND LEASE LOSSES
For the Twelve Months Ended
December 31, 2016
Beginning balance	$	914		$	3,886		$	204	$	1,312		$	674		$	6,990
Charge Offs		(135	)		(241	)		-		(20	)		(105	)	$	(501	)
Recoveries		408			5			12		2			59			486
Provision		17			(329	)		131		669			262			750
Ending Balance	$	1,204		$	3,321		$	347	$	1,963		$	890		$	7,725

Loans Receivable at December 31, 2016
Allowance:
Ending balance:
individually evaluated for impairment	$	50		$	119		$	-	$	124		$	7		$	300
Ending balance:
collectively evaluated for impairment	$	1,154		$	3,202		$	347	$	1,839		$	883		$	7,425
Loans:
Ending balance:
individually evaluated for impairment	$	50		$	1,578		$	-	$	1,919		$	248		$	3,795
Ending balance:
collectively evaluated for impairment	$	108,702		$	282,506		$	52,475	$	140,533		$	56,087		$	640,303

	Commercial			Commercial RE			Agricultural			Residential			Consumer
($'s in thousands)	& Industrial			& Construction			& Farmland			Real Estate			& Other			Total

ALLOWANCE FOR LOAN AND LEASE LOSSES
For the Twelve Months Ended
December 31, 2015
Beginning balance	$	1,630		$	2,857		$	208		$	1,308		$	768		$	6,771
Charge Offs		(497	)		(303	)		-			(56	)		(96	)	$	(952	)
Recoveries		26			3			3			29			10			71
Provision		(245	)		1,329			(7	)		31			(8	)		1,100
Ending Balance	$	914		$	3,886		$	204		$	1,312		$	674		$	6,990

Loans Receivable at December 31, 2015.
Allowance:
Ending balance:
individually evaluated for impairment	$	-		$	1,759		$	-		$	167		$	37		$	1,963
Ending balance:
collectively evaluated for impairment	$	914		$	2,127		$	204		$	1,145		$	637		$	5,027
Loans:
Ending balance:
individually evaluated for impairment	$	126		$	5,754		$	-		$	1,713		$	464		$	8,057
Ending balance:
collectively evaluated for impairment	$	86,416		$	236,454		$	43,835		$	129,093		$	53,760		$	549,558

Credit Risk Profile

The Company categorizes loans into risk categories (loan grades) 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. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes loans with an outstanding balance greater than $100,000 and non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings:

Pass (grades 1 – 4): Loans which management has determined to be performing as expected and in agreement with the terms established at the time of loan origination.

Special Mention (grade 5): Assets have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification. Ordinarily, special mention credits have characteristics which corrective management action would remedy.

Substandard (grade 6): Loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardized 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 (grade 7): Loans classified as doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of current known facts, conditions and values, highly questionable and improbable.

Loss (grade 8): Loans are considered uncollectable and of such little value that continuing to carry them as assets on the Company’s financial statement is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

The following tables present the credit risk profile of the Company’s loan portfolio based on rating category as of December 31, 2016 and 2015:

December 31, 2016	Commercial		Commercial RE		Agricultural		Residential		Consumer
($ in thousands)	& Industrial		& Construction		& Farmland		Real Estate		& Other		Total

1-2	$	1,149	$	33	$	9	$	234	$	3	$	1,428
3		28,461		89,406		9,985		113,403		53,386		294,641
4		78,517		188,007		42,481		26,510		2,625		338,140
Total Pass (1 - 4)		108,127		277,446		52,475		140,147		56,014		634,209

Special Mention (5)		-		5,030		-		518		123		5,671
Substandard (6)		150		1,291		-		625		61		2,127
Doubtful (7)		475		317		-		1,162		137		2,091
Loss (8)		-		-		-		-		-		-
Total Loans	$	108,752	$	284,084	$	52,475	$	142,452	$	56,335	$	644,098

December 31, 2015	Commercial		Commercial RE		Agricultural		Residential		Consumer
($ in thousands)	& Industrial		& Construction		& Farmland		Real Estate		& Other		Total

1-2	$	709	$	767	$	47	$	-	$	15	$	1,538
3		23,362		79,915		8,195		118,463		50,745		280,680
4		61,799		149,473		35,593		10,418		3,223		260,506
Total Pass (1 - 4)		85,870		230,155		43,835		128,881		53,983		542,724

Special Mention (5)		330		5,260		-		756		70		6,416
Substandard (6)		110		1,072		-		420		139		1,741
Doubtful (7)		232		5,721		-		749		32		6,734
Loss (8)		-		-		-		-		-		-
Total Loans	$	86,542	$	242,208	$	43,835	$	130,806	$	54,224	$	557,615

The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. The Company uses a three-year average of historical losses for the general component of the allowance for loan loss calculation. No significant changes were made to the loan risk grading system definitions and allowance for loan loss methodology during the periods presented.

The following tables present the Company’s loan portfolio aging analysis as of December 31, 2016 and 2015:

($ in thousands)	30-59 Days		60-89 Days		Greater Than		Total Past				Total Loans
December 31, 2016	Past Due		Past Due		90 Days		Due		Current		Receivable

Commercial & Industrial	$	35	$	50	$	104	$	189	$	108,563	$108,752
Commercial RE & Construction		254		883		59		1,196		282,888	284,084
Agricultural & Farmland		-		-		-		-		52,475	52,475
Residential Real Estate		123		201		115		439		142,013	142,452
Consumer & Other		185		45		148		378		55,957	56,335
Total Loans	$	597	$	1,179	$	426	$	2,202	$	641,896	$644,098

($ in thousands)	30-59 Days		60-89 Days		Greater Than		Total Past				Total Loans
December 31, 2015	Past Due		Past Due		90 Days		Due		Current		Receivable

Commercial & Industrial	$	-	$	60	$	188	$	248	$	86,294	$	86,542
Commercial RE & Construction		99		-		5,280		5,379		236,829		242,208
Agricultural & Farmland		-		-		-		-		43,835		43,835
Residential Real Estate		98		198		156		452		130,354		130,806
Consumer & Other		64		-		2		66		54,158		54,224
Total Loans	$	261	$	258	$	5,626	$	6,145	$	551,470	$	557,615

All loans past due 90 days are systematically placed on nonaccrual status.

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 State Bank will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include non-performing 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 tables present impaired loan activity for the twelve months ended December 31, 2016 and 2015:

Twelve Months Ended December 31, 2016	Recorded		Unpaid Principal		Related		Average Recorded		Interest Income
($'s in thousands)	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial & Industrial	$	-	$	-	$	-	$	-	$	-
Commercial RE & Construction		637		637		-		655		24
Agricultural & Farmland		-		-		-		-		-
Residential Real Estate		1,248		1,290		-		1,470		70
Consumer & Other		129		129		-		151		11
All Impaired Loans < $100,000		452		452		-		452		-
With a specific allowance recorded:
Commercial & Industrial		50		50		50		50		3
Commercial RE & Construction		941		941		119		1,010		45
Agricultural & Farmland		-		-		-		-		-
Residential Real Estate		671		672		124		751		30
Consumer & Other		119		118		7		123		7
Totals:
Commercial & Industrial	$	50	$	50	$	50	$	50	$	3
Commercial RE & Construction	$	1,578	$	1,578	$	119	$	1,665	$	69
Agricultural & Farmland	$	-	$	-	$	-	$	-	$	-
Residential Real Estate	$	1,919	$	1,962	$	124	$	2,221	$	100
Consumer & Other	$	248	$	247	$	7	$	274	$	18
All Impaired Loans < $100,000	$	452	$	452	$	-	$	452	$	-

Twelve Months Ended December 31, 2015	Recorded		Unpaid Principal		Related		Average Recorded		Interest Income
($'s in thousands)	Investment		Balance		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial & Industrial	$	126	$	1,214	$	-	$	1,388	$	-
Commercial RE & Construction		1,110		1,110		-		1,206		27
Agricultural & Farmland		-		-		-		-		-
Residential Real Estate		657		657		-		862		52
Consumer & Other		90		90		-		107		9
All Impaired Loans < $100,000		131		131		-		131		-
With a specific allowance recorded:
Commercial & Industrial		-		-		-		-		-
Commercial RE & Construction		4,643		4,893		1,759		5,006		90
Agricultural & Farmland		-		-		-		-		-
Residential Real Estate		1,013		1,013		167		1,084		45
Consumer & Other		374		374		37		385		22
Totals:
Commercial & Industrial	$	126	$	1,214	$	-	$	1,388	$	-
Commercial RE & Construction	$	5,753	$	6,003	$	1,759	$	6,212	$	117
Agricultural & Farmland	$	-	$	-	$	-	$	-	$	-
Residential Real Estate	$	1,670	$	1,670	$	167	$	1,946	$	97
Consumer & Other	$	464	$	464	$	37	$	492	$	31
All Impaired Loans < $100,000	$	131	$	131	$	-	$	131	$	-

Impaired loans less than $100,000 are included in groups of homogenous loans. These loans are evaluated based on delinquency status.

Interest income recognized on a cash basis does not materially differ from interest income recognized on an accrual basis.

Troubled Debt Restructured (TDR) Loans

TDRs are modified loans where a concession was provided to a borrower experiencing financial difficulties. Loan modifications are considered TDRs when the concessions provided are not available to the borrower through either normal channels or other sources. However, not all loan modifications are TDRs.

TDR Concession Types

The Company’s standards relating to loan modifications consider, among other factors, minimum verified income requirements, cash flow analysis, and collateral valuations. Each potential loan modification is reviewed individually and the terms of the loan are modified to meet a borrower’s specific circumstances at a point in time. All loan modifications, including those classified as TDRs, are reviewed and approved. The types of concessions provided to borrowers include:

●

Interest rate reduction: A reduction of the stated interest rate to a nonmarket rate for the remaining original life of the debt. The Company also may grant interest rate concessions for a limited timeframe on a case by case basis.

●

Amortization or maturity date change beyond what the collateral supports, including a change that does any of the following:

(1)

Lengthens the amortization period of the amortized principal beyond market terms. This concession reduces the minimum monthly payment and increases the amount of the balloon payment at the end of the term of the loan. Principal is generally not forgiven.

(2)

Reduces the amount of loan principal to be amortized. This concession also reduces the minimum monthly payment and increases the amount of the balloon payment at the end of the term of the loan. Principal is generally not forgiven.

(3)

Extends the maturity date or dates of the debt beyond what the collateral supports. This concession generally applies to loans without a balloon payment at the end of the term of the loan. In addition, there may be instances where renewing loans potentially require non-market terms and would then be reclassified as TDRs.

●

Other: A concession that is not categorized as one of the concessions described above. These concessions include, but are not limited to: principal forgiveness, collateral concessions, covenant concessions, and reduction of accrued interest. Principal forgiveness may result from any TDR modification of any concession type.

The tables below present the activity of TDRs during the years ended December 31, 2016 and 2015:

	December 31, 2016

($ in thousands)	Number of Loans		Pre-Modification Recorded Balance		Post Modification Recorded Balance

Residential Real Estate		1	$	220	$	220
Commercial		1		307		307

Total Modifications		2	$	527	$	527

($ in thousands)	Interest						Total
	Only		Term		Combination		Modification

Residential Real Estate	$	-	$	220	$	-	$	220
Commercial		-		307		-		307

Total Modifications	$	-	$	527	$	-	$	527

There was no increase in the allowance for loan losses due to TDRs in the twelve-month period ended December 31, 2016.

	December 31, 2015
($ in thousands)	Number of Loans		Pre-Modification Recorded Balance		Post Modification Recorded Balance

Residential Real Estate		1	$	22	$	22
Commercial		1		314		314
Consumer & Other		1		39		39

Total Modifications		3	$	375	$	375

($ in thousands)	Interest						Total
	Only		Term		Combination		Modification

Residential Real Estate	$	-	$	22	$	-	$	22
Commercial		-		314		-		314
Consumer & Other		-		39		-		39

Total Modifications	$	-	$	375	$	-	$	375

There was no increase in the allowance for loan losses due to TDRs in the twelve-month period ended December 31, 2015.

There were no TDRs modified during 2016 or 2015 that have subsequently defaulted.