CATY 10-Q Quarter ended June 30, 2016

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(In thousands, except share and per share data)		June 30, 2016				December 31, 2015
Assets
Cash and due from banks		$	229,411			$	180,130
Short-term investments and interest bearing deposits			706,927				536,880
Securities available-for-sale (amortized cost of $1,227,169 in 2016 and $1,595,723 in 2015			1,241,904				1,586,352
Loans held for sale			2,925				6,676
Loans			10,523,100				10,163,452
Less: Allowance for loan losses			(122,948	)			(138,963	)
Unamortized deferred loan fees, net			(6,679	)			(8,262	)
Loans, net			10,393,473				10,016,227
Federal Home Loan Bank stock			17,250				17,250
Other real estate owned, net			26,417				24,701
Affordable housing investments and alternative energy partnerships, net			199,210				182,943
Premises and equipment, net			107,236				108,924
Customers’ liability on acceptances			26,096				40,335
Accrued interest receivable			30,941				30,558
Goodwill			372,189				372,189
Other intangible assets, net			3,310				3,677
Other assets			135,888				147,284
Total assets		$	13,493,177			$	13,254,126
Liabilities and Stockholders’ Equity
Deposits
Non-interest-bearing demand deposits		$	2,188,072			$	2,033,048
Interest-bearing deposits:
Demand deposits			1,018,388				966,404
Money market deposits			2,066,349				1,905,719
Savings deposits			620,094				618,164
Time deposits			4,578,200				4,985,752
Total deposits			10,471,103				10,509,087
Securities sold under agreements to repurchase			400,000				400,000
Advances from the Federal Home Loan Bank			555,000				275,000
Other borrowings for affordable housing investments			17,748				18,593
Long-term debt			119,136				119,136
Acceptances outstanding			26,096				40,335
Other liabilities			145,039				144,197
Total liabilities			11,734,122				11,506,348
Commitments and contingencies			-				-
Stockholders’ Equity
Common stock, $0.01 par value, 100,000,000 shares authorized, 87,072,749 issued and 78,862,106 outstanding at June 30, 2016, and 87,002,931 issued and 80,806,116 outstanding at December 31, 2015			871				870
Additional paid-in-capital			884,352				880,822
Accumulated other comprehensive income/(loss), net			1,142				(8,426	)
Retained earnings			1,112,279				1,059,660
Treasury stock, at cost (8,210,643 shares at June 30, 2016, and 6,196,815 shares at December 31, 2015)			(239,589	)			(185,148	)
Total equity			1,759,055				1,747,778
Total liabilities and equity		$	13,493,177			$	13,254,126

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		Three months ended June 30,								Six months ended June 30,
		2016				2015				2016				2015
		(In thousands, except share and per share data)
Interest and Dividend Income
Loans receivable, including loan fees		$	115,822			$	104,995			$	230,712			$	205,095
Investment securities			5,265				5,346				12,124				9,120
Federal Home Loan Bank stock			382				1,677				729				2,258
Deposits with banks			433				368				682				847
Total interest and dividend income			121,902				112,386				244,247				217,320
Interest Expense
Time deposits			10,619				9,122				21,476				17,914
Other deposits			3,931				3,019				7,571				5,793
Securities sold under agreements to repurchase			3,934				3,934				7,868				7,859
Advances from Federal Home Loan Bank			202				117				308				210
Long-term debt			1,440				1,440				2,880				2,864
Total interest expense			20,126				17,632				40,103				34,640
Net interest income before reversal for credit losses			101,776				94,754				204,144				182,680
Reversal for loan losses			(5,150	)			(2,150	)			(15,650	)			(7,150	)
Net interest income after reversal for credit losses			106,926				96,904				219,794				189,830
Non-Interest Income
Securities gains/(losses), net			1,655				(3,332	)			1,449				(3,353	)
Letters of credit commissions			1,205				1,391				2,486				2,659
Depository service fees			1,385				1,293				2,708				2,594
Other operating income			4,812				6,267				9,955				12,268
Total non-interest income			9,057				5,619				16,598				14,168
Non-Interest Expense
Salaries and employee benefits			21,501				24,463				48,432				47,079
Occupancy expense			4,484				3,986				8,853				8,007
Computer and equipment expense			2,443				2,292				5,023				4,794
Professional services expense			4,614				4,342				8,982				7,712
Data processing service expense			2,027				1,945				4,277				3,927
FDIC and State assessments			2,763				2,244				5,352				4,504
Marketing expense			1,002				1,321				1,798				2,141
Other real estate owned expense/(income)			493				(1,786	)			788				(1,303	)
Amortization of investments in low income housing and alternative energy partnerships			27,400				5,467				30,194				7,850
Amortization of core deposit intangibles			173				147				345				324
Other operating expense			1,979				3,164				6,406				6,681
Total non-interest expense			68,879				47,585				120,450				91,716
Income before income tax expense			47,104				54,938				115,942				112,282
Income tax expense			12,273				9,738				34,948				31,102
Net income		$	34,831			$	45,200			$	80,994			$	81,180
Other comprehensive income/(loss), net of tax
Unrealized holding gain/(loss) on securities available-for-sale			4,456				(6,395	)			14,810				104
Less: reclassification adjustments included in net income			959				(1,931	)			840				(1,943	)
Unrealized holding (loss)/gain on cash flow hedge derivatives			(1,282	)			2,328				(4,402	)			740
Total other comprehensive gain/(loss), net of tax			2,215				(2,136	)			9,568				2,787
Total comprehensive income		$	37,046			$	43,064			$	90,562			$	83,967
Net income per common share:
Basic		$	0.44			$	0.57			$	1.02			$	1.02
Diluted		$	0.44			$	0.56			$	1.01			$	1.01
Cash dividends paid per common share		$	0.18			$	0.14			$	0.36			$	0.24
Average common shares outstanding
Basic			78,846,237				79,939,197				79,290,378				79,887,699
Diluted			79,619,883				80,698,994				80,006,866				80,505,265

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		Six months ended June 30
		2016				2015
		(In thousands)
Cash Flows from Operating Activities
Net income		$	80,994			$	81,180
Adjustments to reconcile net income to net cash provided by/(used in) operating activities:
Credit for loan losses			(15,650	)			(7,150	)
Provision for losses on other real estate owned			383				368
Deferred tax liability			7,098				8,797
Depreciation and amortization			3,861				6,864
Net gains on sale and transfer of other real estate owned			(228	)			(2,003	)
Net gains on sale of loans			(201	)			(763	)
Proceeds from sales of loans			6,065				19,170
Originations of loans held-for-sale			(8,789	)			(17,433	)
Amortization on alternative energy partnerships, venture capital and other investments			25,264				327
Net gain on sales and calls of securities			(1,655	)			(522	)
Amortization/accretion of security premiums/discounts, net			3,404				1,770
Write-down on impaired securities			206				3,875
Excess tax short-fall from share-based payment arrangements			-				5,619
Stock based compensation and stock issued to officers as compensation			2,623				2,738
Net change in accrued interest receivable and other assets			(4,690	)			(15,041	)
Net change in other liabilities			(7,212	)			(1,423	)
Net cash provided by operating activities			91,473				86,373
Cash Flows from Investing Activities
Decrease/(increase) in short-term investments			(170,047	)			440,903
Purchase of investment securities available-for-sale			(290,901	)			(1,223,504	)
Proceeds from sale of investment securities available-for-sale			241,844				958,656
Proceeds from repayments, maturities and calls of investment securities available-for-sale			415,656				36,512
Redemptions of Federal Home Loan Bank stock			-				13,535
Net increase in loans			(350,810	)			(581,379	)
Purchase of premises and equipment			(1,857	)			(1,383	)
Proceeds from sales of other real estate owned			828				10,139
Investment in affordable housing and alternative energy partnerships			(47,420	)			(19,590	)
Net cash used in investing activities			(202,707	)			(366,111	)
Cash Flows from Financing Activities
Net (decrease)/increase in deposits			(37,711	)			555,369
Net decrease in federal funds purchased and securities sold under agreements to repurchase			-				(50,000	)
Advances from Federal Home Loan Bank			1,755,000				4,632,000
Repayment of Federal Home Loan Bank borrowings			(1,475,000	)			(4,847,000	)
Cash dividends paid			(28,375	)			(19,170	)
Purchases of treasury stock			(54,441	)			-
Proceeds from shares issued under Dividend Reinvestment Plan			1,096				2,752
Proceeds from exercise of stock options			49				1,713
Taxes paid related to net share settlement of RSUs			(103	)			(204	)
Excess tax short-fall from share-based payment arrangements			-				(5,619	)
Net cash provided by financing activities			160,515				269,841
Increase/(decrease) in cash and cash equivalents			49,281				(9,897	)
Cash and cash equivalents, beginning of the period			180,130				176,830
Cash and cash equivalents, end of the period		$	229,411			$	166,933
Supplemental disclosure of cash flow information
Cash paid during the period:
Interest		$	40,740			$	34,505
Income taxes paid		$	30,698			$	43,534
Non-cash investing and financing activities:
Net change in unrealized holding gain on securities available-for-sale, net of tax		$	13,970			$	2,046
Net change in unrealized holding loss on cash flow hedge derivatives		$	4,402			$	740
Transfers to other real estate owned from loans held for investment		$	2,698			$	866
Loans transferred from held for sale to held for investment, net		$	3,751			$	-

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1. Business

Cathay General Bancorp (“Bancorp”) is the holding company for Cathay Bank (the “Bank” and, together, the “Company”), six limited partnerships investing in affordable housing investments in which the Bank is the sole limited partner, GBC Venture Capital, Inc., and Asia Realty Corp. Bancorp also owns 100% of the common stock of five statutory business trusts created for the purpose of issuing capital securities. The Bank was founded in 1962 and offers a wide range of financial services. As of June 30, 2016, the Bank operated 22 branches in Southern California, 12 branches in Northern California, 12 branches in New York State, three branches in Illinois, three branches in Washington State, two branches in Texas, one branch in Massachusetts, one branch in New Jersey, one branch in Maryland, one branch in Nevada, one branch in Hong Kong, and a representative office in Shanghai and in Taipei. Deposit accounts at the Hong Kong branch are not insured by the Federal Deposit Insurance Corporation (the “FDIC”).

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. For further information, refer to the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

The preparation of the condensed consolidated financial statements in accordance with GAAP requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The most significant estimates subject to change are the allowance for loan losses, goodwill impairment, and other-than-temporary impairment.

3 . Recent Accounting Pronouncements

In January 2016, the FASB issued ASU 2016-01, “ Financial Instruments Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities .” This update requires an entity to measure equity investments with readily determinable fair values at fair value with changes in fair value recognized in net income. Equity investment without readily determinable fair values will be measured at fair value either upon the occurrence of an observable price change or upon identification of an impairment and any amount by which the carrying value exceeding the fair value will be recognized as an impairment in net income. This update also requires an entity to disclose fair value of financial instruments measured at amortized cost on the balance sheet to measure that fair value using the exit price option. In addition, this update requires separate presentation in comprehensive income for changes in the fair value of a liability and in the balance sheet by measurement category and form of financial asset. ASU 2016-01 becomes effective for interim and annual periods beginning after December 15, 2017.  Adoption of ASU 2016-01 is not expected to have a significant impact on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU 2016-06, “ Derivatives and Hedging ( T opic 8 15 ): Contingent Put and Call Options in Debt Instruments .” This update requires an entity to perform a four-step decision sequence when assessing whether contingent call or put options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. The four-step decision sequence is: the payoff is adjusted based on changes in an index; the payoff is indexed to an underlying other than interest rates or credit risk; the debt involves a substantial premium or discount; and the call or put option is contingently exercisable. ASU 2016-06 becomes effective for interim and annual periods beginning after December 15, 2016.  Adoption of ASU 2016-06 is not expected to have a significant impact on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU 2016-07, “ Investments Equity Method and Joint Ventures ( T opic 323 ): Simplifying the Transition to the Equity Method of Accounting .” This update eliminates the requirement to retroactively adopt the equity method of accounting. It requires that an equity method investor add the cost of acquiring the additional interest to the current basis of the previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The retroactive adjustment of the investment is no longer required. ASU 2016-07 becomes effective for interim and annual periods beginning after December 15, 2016.  Adoption of ASU 2016-07 is not expected to have a significant impact on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, “ Compensation Stock Compensation ( T opic 718 ): I m provements to Employee Share-Based Payment Accounting .” This update simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 becomes effective for interim and annual periods beginning after December 15, 2016.  Adoption of ASU 2016-09 is not expected to have a significant impact on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, “ Financial Instruments - Credit Losses ( T opic 326 ): Measurement of Credit Losses on Financial Instruments.” This update requires an entity to use a broader range of reasonable and supportable forecasts, in addition to historical experience and current conditions, to develop an expected credit loss estimate for financial assets and net investments that are not accounted for at fair value through net income. Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses to the amount by which fair value is below amortized cost. ASU 2016-13 becomes effective for interim and annual periods beginning after December 15, 2019.  The Company is currently evaluating the impact on the Company’s consolidated financial statements.

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4. Earnings per Share

Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock that then shared in earnings. Outstanding stock options with anti-dilutive effect were not included in the computation of diluted earnings per share. The following table sets forth earnings per common share calculations:

5. Stock-Based Compensation

Under the Company’s equity incentive plans, directors and eligible employees may be granted incentive or non-statutory stock options and/or restricted stock units, or awarded non-vested stock. As of June 30, 2016, the only options granted by the Company were non-statutory stock options to selected Bank officers and non-employee directors at exercise prices equal to the fair market value of a share of the Company’s common stock on the date of grant. Such options have a maximum ten-year term and vest in 20% annual increments (subject to early termination in certain events) except certain options granted to the Chief Executive Officer of the Company in 2005 and 2008. There were no options granted during the first six months of 2016 or 2015.

Option compensation expense was zero for the three months and for the six months ended June 30, 2016, and June 30, 2015. Stock-based compensation was fully recognized over the requisite service period for all awards. There were 2,110 and 73,350 stock option shares exercised in the six months ended June 30, 2016 and 2015, respectively. The Company received $49,000 with an aggregate intrinsic value of $9,000 from the exercise of stock options during the six months ended June 30, 2016 compared to $1.7 million with an aggregate intrinsic value of $556,000 during the six months ended June 30, 2015. The table below summarizes stock option activity for the periods indicated:

In addition to stock options, the Company also grants restricted stock units to eligible employees that vest subject to continued employment at the vesting dates.

The Company granted restricted stock units for 88,693 shares at an average closing price of $30.37 per share in the first six months of 2016. The Company granted restricted stock units for 72,900 shares at an average closing price for $28.11 per share in the first six months of 2015 .

In December 2013, the Company granted performance share unit awards in which the number of units earned is calculated based on the relative total shareholder return (TSR) of the Company’s common stock as compared to the TSR of the KBW Regional Banking Index. In addition, the Company granted performance share unit awards in which the number of units earned is determined by comparison to the targeted EPS as defined in the award for the 2014 to 2016 period. Performance TSR restricted stock units for 119,840 shares and performance EPS restricted stock units for 116,186 shares were granted to eight executive officers in 2013. In December 2014, the Company granted additional performance TSR restricted stock units for 60,456 shares and performance EPS restricted stock units for 57,642 shares to seven executive officers. In December 2015, the Company granted additional performance TSR restricted stock units for 61,209 shares and performance EPS restricted stock units for 57,409 shares to seven executive officers. Both the performance TSR and performance EPS units awarded are scheduled to vest three years from grant date.

The following table presents restricted stock unit activity during the six months ended June 30, 2016:

The compensation expense recorded for restricted stock units was $1.0 million for the three months ended June 30, 2016 , compared to $1.2 million in the same period a year ago. For the six months ended June 30, 2016 and 2015, compensation expense recorded related to the restricted stock units was $2.1 million and $2.2 million, respectively. Unrecognized stock-based compensation expense related to restricted stock units was $8.2 million as of June 30, 2016, and is expected to be recognized over the next 2.3 years.

As of June 30, 2016, 3,713,089 shares were available under the Company’s 2005 Incentive Plan (as Amended and Restated) for future grants.

The following table summarizes the tax benefit (short-fall) from share-based payment arrangements:

The short-fall amount from share-based payment arrangements was charged against income tax expense. In addition, As of June 30, 2016, $140,000 was offset against additional paid-in capital that resulted from previously realized excess tax benefits.

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6. Investment Securities

Investment securities were $1.24 billion as of June 30, 2016, compared to $1.59 billion as of December 31, 2015. The following tables reflect the amortized cost, gross unrealized gains, gross unrealized losses, and fair value of investment securities as of June 30, 2016, and December 31, 2015:

The amortized cost and fair value of investment securities as of June 30, 2016, by contractual maturities, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or repayment penalties.

⁽¹⁾ Equity securities are reported in this category

Proceeds of $241.8 million were received from the sales transactions of mortgage-backed securities during the first six months of 2016. Proceeds of $573.5 million were received from the sale of mortgage-backed securities during the first six months of 2015. Proceeds from repayments, maturities and calls of mortgage-backed securities were $80.7 million and $36.5 million for the six months ended June 30, 2016 and 2015, respectively. There were no sales transactions of other investment securities during the six months ended June 30, 2016. Proceeds of $385.2 million were received from the sale of other investment securities during the six months ended June 30, 2015. Proceeds from maturities and calls of other investment securities were $335.0 million during the six months ended June 30, 2016 compared to zero during the same period a year ago. Gains of $1.7 million and zero losses were realized on sales of investment securities in addition to a permanent impairment write-down of $206,000 that was recorded during the six months ended June 30, 2016 compared to gains of $2.3 million and losses of $1.8 million realized during the same period a year ago.

The tables below show the fair value and unrealized losses of the temporarily impaired securities in our investment securities portfolio as of June 30, 2016, and December 31, 2015:

As of June 30, 2016, the Company had unrealized losses of $1.9 million. The unrealized losses on these securities were primarily attributed to yield curve movement, together with the widened liquidity spread and credit spread. The issuers have not, to the Company’s knowledge, established any cause for default on these securities. Management believes the impairment was temporary and, accordingly, no impairment loss on these securities has been recognized in our condensed consolidated statements of operations. The Company expects to recover the amortized cost basis of its debt securities, and has no intent to sell and will not be required to sell available-for-sale debt securities that have declined below their cost before their anticipated recovery.

Investment securities having a carrying value of $471.6 million as of June 30, 2016, and $449.6 million as of December 31, 2015, were pledged to secure public deposits, other borrowings, treasury tax and loan, and securities sold under agreements to repurchase.

7 . Loans

Most of the Company’s business activity is with Asian customers located in Southern and Northern California; New York City, New York; Houston and Dallas, Texas; Seattle, Washington; Boston, Massachusetts; Chicago, Illinois; Edison, New Jersey; Rockville, Maryland; Las Vegas, Nevada, and Hong Kong. The Company has no specific industry concentration, and generally its loans are secured by real property or other collateral of the borrowers. Loans are generally expected to be paid off from the operating profits of the borrowers, from refinancing by other lenders, or through sale by the borrowers of the secured collateral.

The types of loans in the condensed consolidated balance sheets as of June 30, 2016, and December 31, 2015, were as follows:

As of June 30, 2016, recorded investment in impaired loans totaled $127.8 million and was comprised of non-accrual loans of $53.1 million and accruing troubled debt restructured loans (TDRs) of $74.7 million. As of December 31, 2015, recorded investment in impaired loans totaled $133.8 million and was comprised of non-accrual loans of $52.1 million and accruing TDRs of $81.7 million. For impaired loans, the amounts previously charged off represent 17.2% as of June 30, 2016, and 22.4% as of December 31, 2015, of the contractual balances for impaired loans.

The following table presents the average balance and interest income recognized related to impaired loans for the periods indicated:

The following table presents impaired loans and the related allowance for loan losses as of the dates indicated:

The following tables present the aging of the loan portfolio by type as of June 30, 2016, and as of December 31, 2015:

The determination of the amount of the allowance for loan losses for impaired loans is based on management’s current judgment about the credit quality of the loan portfolio and takes into consideration known relevant internal and external factors that affect collectability when determining the appropriate level for the allowance for loan losses. The nature of the process by which the Bank determines the appropriate allowance for loan losses requires the exercise of considerable judgment. This allowance evaluation process is also applied to troubled debt restructurings since they are considered to be impaired loans.

A troubled debt restructuring is a formal modification of the terms of a loan when the lender, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower it would not otherwise consider. The concessions may be granted in various forms, including a change in the stated interest rate, a reduction in the loan balance or accrued interest, or an extension of the maturity date that causes significant delay in payment.

TDRs on accrual status are comprised of the loans that have, pursuant to the Bank’s policy, performed under the restructured terms and have demonstrated sustained performance under the modified terms for six months before being returned to accrual status. The sustained performance considered by management pursuant to its policy includes the periods prior to the modification if the prior performance met or exceeded the modified terms. This would include cash paid by the borrower prior to the restructure to set up interest reserves.

As of June 30, 2016, accruing TDRs were $74.7 million and non-accrual TDRs were $25.4 million compared to accruing TDRs of $81.7 million and non-accrual TDRs of $39.9 million as of December 31, 2015. The Company allocated specific reserves of $1.6 million to accruing TDRs and $4.4 million to non-accrual TDRs as of June 30, 2016, and $2.0 million to accruing TDRs and $5.4 million to non-accrual TDRs as of December 31, 2015. The following tables present TDRs that were modified during the first six months of 2016 and of 2015, their specific reserve s at June 30, 2016, and 2015, and charge-off s during the first six months of 2016 and of 2015:

Modifications of the loan terms during the first six months of 2016 were in the form of changes in the stated interest rate, extensions of maturity dates, and/or reductions in monthly payment amounts. The length of time for which modifications involving a reduction of the stated interest rate or changes in payment terms that were documented ranged from three to ten months from the modification date.

We expect that the TDRs on accruing status as of June 30, 2016, which were all performing in accordance with their restructured terms, will continue to comply with the restructured terms because of the reduced principal or interest payments on these loans.  A summary of TDRs by type of concession and by type of loan, as of June 30, 2016, and December 31, 2015, is shown below:

`

The activity within our TDRs for the periods indicated are shown below:

A loan is considered to be in payment default once it is 60 to 90 days contractually past due under the modified terms.  The Company did not have any loans that were modified as a TDR during the previous twelve months and which subsequently defaulted as of June 30, 2016.

Under the Company’s internal underwriting policy, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification in order to determine whether a borrower is experiencing financial difficulty.

As of June 30, 2016, there were no commitments to lend additional funds to those borrowers whose loans had been restructured, were considered impaired, or were on non-accrual status.

As part of the on-going monitoring of the credit quality of our loan portfolio, the Company utilizes a risk grading matrix to assign a risk grade to each loan. The risk rating categories can be generally described by the following grouping for non-homogeneous loans:

	●	Pass/Watch – These loans range from minimal credit risk to lower than average, but still acceptable, credit risk.
	●	Special Mention – Borrower is fundamentally sound and loan is currently protected but adverse trends are apparent that, if not corrected, may affect ability to repay. Primary source of loan repayment remains viable but there is increasing reliance on collateral or guarantor support.
	●	Substandard – These loans are inadequately protected by current sound net worth, paying capacity, or collateral. Well-defined weaknesses exist that could jeopardize repayment of debt. Loss may not be imminent, but if weaknesses are not corrected, there is a good possibility of some loss.
	●	Doubtful – The possibility of loss is extremely high, but due to identifiable and important pending events (which may strengthen the loan), a loss classification is deferred until the situation is better defined.
	●	Loss – These loans are considered uncollectible and of such little value that to continue to carry the loan as an active asset is no longer warranted.

The following tables present the loan portfolio by risk rating as of June 30, 2016, and as of December 31, 2015:

The allowance for loan losses and the reserve for off-balance sheet credit commitments are significant estimates that can and do change based on management’s process in analyzing the loan portfolio and on management’s assumptions about specific borrowers, underlying collateral, and applicable economic and environmental conditions, among other factors.

The following table presents the balance in the allowance for loan losses by portfolio segment and based on impairment method as of June 30, 2016, and as of December 31, 2015:

The following tables detail activity in the allowance for loan losses by portfolio segment for the three months and six months ended June 30, 2016, and June 30, 2015. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.