Loans, Allowance for Loan Losses, and Credit Quality Indicators | NOTE 5 – LOANS, ALLOWANCE FOR LOAN LOSSES, AND CREDIT QUALITY INDICATORS Loans are stated at the amount of unpaid principal net of loan premiums or discounts for purchased loans, net deferred loan origination fees, discounts associated with retained portions of loans sold, and an allowance for loan losses. Interest on loans is calculated using the simple-interest method on daily balances of the principal amount outstanding. Loan origination fees, net of origination costs and discounts, are amortized over the lives of the loans as adjustments to yield. Major classifications of loans at December 31, 2016 and 2015 are as follows: December 31, % of gross December 31, % of gross 2016 loans 2015 loans Real estate secured loans: Multi-family residential $ 74,340 4.00 % $ 66,445 4.73 % Residential 1-4 family 61,548 3.31 % 53,776 3.82 % Owner-occupied commercial 461,557 24.82 % 364,742 25.94 % Nonowner-occupied commercial 451,893 24.30 % 300,774 21.39 % Total permanent real estate loans 1,049,338 56.43 % 785,737 55.88 % Construction loans: Multi-family residential 22,252 1.20 % 7,027 0.50 % Residential 1-4 family 43,532 2.34 % 30,856 2.19 % Commercial real estate 76,301 4.10 % 42,680 3.04 % Commercial bare land and acquisition & development 15,081 0.81 % 20,537 1.46 % Residential bare land and acquisition & development 10,645 0.57 % 7,268 0.52 % Total construction real estate loans 167,811 9.02 % 108,368 7.71 % Total real estate loans 1,217,149 65.45 % 894,105 63.59 % Commercial loans 630,491 33.89 % 501,976 35.70 % Consumer loans 2,922 0.16 % 3,351 0.24 % Other loans 9,225 0.50 % 6,580 0.47 % Gross loans 1,859,787 100.00 % 1,406,012 100.00 % Deferred loan origination fees (2,020 ) (1,530 ) 1,857,767 1,404,482 Allowance for loan losses (22,454 ) (17,301 ) Total loans, net of allowance for loan losses and net deferred fees $ 1,835,313 $ 1,387,181 At December 31, 2016, outstanding loans to dental professionals totaled $377,478 and represented 20.30% of total outstanding loans compared to dental professional loans of $340,162 or 24.19% of total loans at December 31, 2015. Additional information about the Company’s dental portfolio can be found in Note 6. There are no other industry concentrations in excess of 10.00% of the total loan portfolio. However, as of December 31, 2016, 65.45% of the Company’s loan portfolio was collateralized by real estate and is, therefore, susceptible to changes in local market conditions. While appropriate action is taken to manage identified concentration risks, management believes that the loan portfolio is well diversified by geographic location and among industry groups. Acquired Loans The following table represents the contractually required principal payments, net of any previous charge offs, and the carrying balance of loans acquired in the Century Bank, Capital Pacific Bank and Foundation Bank acquisitions, at December 31, 2016, 2015 and 2014, respectively. December 31, 2016 2015 2014 Contractually required principal payments, net of charge offs $ 373,674 $ 183,347 $ 28,187 Purchase adjustment for credit and interest rate (11,297 ) (3,958 ) (881 ) Balance of acquired loans $ 362,377 $ 179,389 $ 27,306 Purchased Credit Impaired Loans On September 6, 2016, the Bank acquired purchased credit impaired loans with a fair value of $19,510, associated with the Foundation Bank Acquisition. The contractually required principal and interest payments at acquisition totaled $21,575, of which $919 were not expected to be collected. The following table represents the contractually required principal balance of purchased credit impaired loans and the carrying balance at December 31, 2016, 2015 and 2014: December 31, 2016 2015 2014 Contractually required principal payments for purchased credit impaired loans $ 22,941 $ 11,528 $ 2,753 Accretable yield (1,453 ) (1,070 ) (151 ) Nonaccretable yield (809 ) (378 ) (321 ) Balance of purchased credit impaired loans $ 20,679 $ 10,080 $ 2,281 The following tables summarize the changes in the accretable yield for purchased credit impaired loans for the year ended December 31, 2016 and 2015: Year ended December 31, 2016 Century Capital Pacific Foundation Total Balance, beginning of period $ 40 $ 1,030 $ — $ 1,070 Additions — — 908 908 Accretion to interest income (40 ) (265 ) (220 ) (525 ) Balance, end of period $ — $ 765 $ 688 $ 1,453 Year ended December 31, 2015 Century Capital Pacific Total Balance, beginning of period $ 151 $ — $ 151 Additions — 1,569 1,569 Accretion to interest income (111 ) (539 ) (650 ) Balance, end of period $ 40 $ 1,030 $ 1,070 Allowance for Loan Losses The allowance for loan losses is established as an amount that management considers adequate to absorb possible losses on existing loans within the portfolio. The allowance consists of general, specific, and unallocated components. The general component is based upon all loans collectively evaluated for impairment. The specific component is based upon all loans individually evaluated for impairment. The unallocated component represents credit losses inherent in the loan portfolio that may not have been contemplated in the general risk factors or the specific allowance analysis. Loans are charged against the allowance when management believes the collection of principal and interest is unlikely. The Company performs regular credit reviews of the loan portfolio to determine the credit quality and adherence to underwriting standards. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process. The Company’s internal risk rating methodology assigns risk ratings ranging from one to ten, where a higher rating represents higher risk. The ten-point risk rating categories are a primary factor in determining an appropriate amount for the allowance for loan losses. Estimated credit losses reflect consideration of all significant factors that affect the collectability of the loan portfolio. The historical loss rate for each group of loans with similar risk characteristics is determined based on the Company’s own loss experience in that group. Historical loss experience and recent trends in losses provides a reasonable starting point for analysis, however they do not by themselves form a sufficient basis to determine the appropriate level for the allowance for loan losses. Qualitative or environmental factors that are likely to cause estimated credit losses to differ from historical losses are also considered including but not limited to: • Changes in international, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments, • Changes in the nature and volume of the portfolio and in the terms of loans, • Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans, • Changes in the quality of the institution’s loan review system, • Changes in the value of underlying collateral for collateral-dependent loans, • The existence and effect of any concentrations of credit, and changes in the level of such concentrations, • The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio, • Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses, and • Changes in the current and future US political environment, including healthcare reform, federal tax structure, and immigration reform that may affect national, regional and local economic conditions, taxation, or disruption of national or global financial markets. The adequacy of the allowance for loan losses and the reserve for unfunded commitments is determined using a consistent, systematic methodology and is monitored regularly based on management’s evaluation of numerous factors. For each portfolio segment, these factors include: • The quality of the current loan portfolio, • The trend in the migration of the loan portfolio’s risk ratings, • The velocity of migration of losses and potential losses, • Current economic conditions, • Loan concentrations, • Loan growth rates, • Past-due and nonperforming trends, • Evaluation of specific loss estimates for all significant problem loans, • Recovery experience, and • Peer comparison loss rates. The following tables present a summary of the activity in the allowance for loan losses by major loan classification for the periods ended December 31, 2016, 2015 and 2014: For the year ended December 31, 2016 Commercial Real Construction Consumer Unallocated Total Beginning balance $ 6,349 $ 8,297 $ 1,258 $ 46 $ 1,351 $ 17,301 Charge-offs (716 ) — — (9 ) — (725 ) Recoveries 207 55 163 3 — 428 Provision (reclassification) 2,774 2,520 360 1 (205 ) 5,450 Ending balance $ 8,614 $ 10,872 $ 1,781 $ 41 $ 1,146 $ 22,454 For the year ended December 31, 2015 Commercial Real Construction Consumer Unallocated Total Beginning balance $ 5,733 $ 7,494 $ 1,077 $ 54 $ 1,279 $ 15,637 Charge-offs (630 ) (61 ) — (9 ) — (700 ) Recoveries 562 76 16 15 — 669 Provision (reclassification) 684 788 165 (14 ) 72 1,695 Ending balance $ 6,349 $ 8,297 $ 1,258 $ 46 $ 1,351 $ 17,301 For the year ended December 31, 2014 Commercial Real Construction Consumer Unallocated Total Beginning balance $ 5,113 $ 7,668 $ 1,493 $ 68 $ 1,575 $ 15,917 Charge-offs (610 ) (58 ) (155 ) (12 ) — (835 ) Recoveries 348 186 16 5 — 555 Provision (reclassification) 882 (302 ) (277 ) (7 ) (296 ) — Ending balance $ 5,733 $ 7,494 $ 1,077 $ 54 $ 1,279 $ 15,637 The following table presents the allowance and recorded investment in loans by major loan classification at December 31, 2016, and 2015: December 31, 2016 Commercial Real Estate Construction Consumer Unallocated Total Ending allowance: collectively evaluated for impairment $ 7,881 $ 10,869 $ 1,781 $ 41 $ 1,146 $ 21,718 Ending allowance: individually evaluated for impairment 733 3 — — — 736 Ending allowance: loans acquired with deteriorated credit quality — — — — — — Total ending allowance $ 8,614 $ 10,872 $ 1,781 $ 41 $ 1,146 $ 22,454 Ending loan balance: collectively evaluated for impairment $ 628,773 $ 1,027,354 $ 167,491 $ 2,922 $ — $ 1,826,540 Ending loan balance: individually evaluated for impairment 4,396 7,852 320 — — 12,568 Ending loan balance: loans acquired with deteriorated credit quality 6,547 14,132 — — — 20,679 Total ending loan balance $ 639,716 $ 1,049,338 $ 167,811 $ 2,922 $ — $ 1,859,787 December 31, 2015 Commercial Real Estate Construction Consumer Unallocated Total Ending allowance: collectively evaluated for impairment $ 6,303 $ 8,267 $ 1,159 $ 46 $ 1,351 $ 17,126 Ending allowance: individually evaluated for impairment 46 30 99 — — 175 Ending allowance: loans acquired with deteriorated credit quality — — — — — — Total ending allowance $ 6,349 $ 8,297 $ 1,258 $ 46 $ 1,351 $ 17,301 Ending loan balance: collectively evaluated for impairment $ 504,261 $ 771,915 $ 107,605 $ 3,351 $ — $ 1,387,132 Ending loan balance: individually evaluated for impairment 2,627 5,782 391 — — 8,800 Ending loan balance: loans acquired with deteriorated credit quality 1,668 8,040 372 — — 10,080 Total ending loan balance $ 508,556 $ 785,737 $ 108,368 $ 3,351 $ — $ 1,406,012 The 2016 ending allowance includes $736 in specific allowance for $12,568 of impaired loans ($10,567 net of government guarantees). At December 31, 2015, the Company had $8,800 of impaired loans ($7,527 net of government guarantees) with a specific allowance of $175 assigned. Management believes that the allowance for loan losses was adequate as of December 31, 2016. However, future loan losses may exceed the levels provided for in the allowance for loan losses and could possibly result in additional charges to the provision for loan losses. Credit Quality Indicators The Company uses the following loan grades, which are also often used by regulators when assessing the credit quality of a loan portfolio. Pass Special Mention Substandard Doubtful Management strives to consistently apply these definitions when allocating its loans by loan grade. The loan portfolio is continuously monitored for changes in credit quality and management takes appropriate action to update the loan risk ratings accordingly. Management has not changed the Company’s policy towards its use of credit quality indicators during the periods reported. The following tables present the Company’s loan portfolio information by loan type and credit grade at December 31, 2016, and 2015: Credit Quality Indicators As of December 31, 2016 Loan Grade Pass Special Mention Substandard Doubtful Totals Real estate loans Multi-family residential $ 74,340 $ — $ — $ — $ 74,340 Residential 1-4 family 58,286 — 3,262 — 61,548 Owner-occupied commercial 443,737 — 17,820 — 461,557 Nonowner-occupied commercial 445,283 — 6,610 — 451,893 Total real estate loans 1,021,646 — 27,692 — 1,049,338 Construction Multi-family residential 22,252 — — — 22,252 Residential 1-4 family 43,532 — — — 43,532 Commercial real estate 76,301 — — — 76,301 Commercial bare land and acquisition & development 15,081 — — — 15,081 Residential bare land and acquisition & development 9,852 — 793 — 10,645 Total construction loans 167,018 — 793 — 167,811 Commercial and other 621,165 — 16,890 1,661 639,716 Consumer 2,922 — — — 2,922 Totals $ 1,812,751 $ — $ 45,375 $ 1,661 $ 1,859,787 Percentage of total portfolio 97.47 % 0.00 % 2.44 % 0.09 % 100.00 % Credit Quality Indicators As of December 31, 2015 Loan Grade Pass Special Mention Substandard Doubtful Totals Real estate loans Multi-family residential $ 66,208 $ — $ 237 $ — $ 66,445 Residential 1-4 family 49,077 — 4,699 — 53,776 Owner-occupied commercial 353,249 — 11,493 — 364,742 Nonowner-occupied commercial 296,528 — 4,246 — 300,774 Total real estate loans 765,062 — 20,675 — 785,737 Construction Multi-family residential 7,027 — — — 7,027 Residential 1-4 family 30,803 — 53 — 30,856 Commercial real estate 42,580 — 100 — 42,680 Commercial bare land and acquisition & development 20,265 — 272 — 20,537 Residential bare land and acquisition & development 4,969 — 2,299 — 7,268 Total construction loans 105,644 — 2,724 — 108,368 Commercial and other 494,267 — 14,289 — 508,556 Consumer 3,350 — 1 — 3,351 Totals $ 1,368,323 $ — $ 37,689 $ — $ 1,406,012 Percentage of total portfolio 97.32 % 0.00 % 2.68 % 0.00 % 100.00 % Past Due and Nonaccrual Loans The Company uses the terms “past due” and “delinquent” interchangeably. Amortizing loans are considered past due or delinquent based upon the number of contractually required payments not made. Delinquency status for all contractually matured loans, commercial and commercial real estate loans with non-monthly amortization, and all other extensions of credit is determined based upon the number of calendar months past due. The following tables present an aged analysis of past due and nonaccrual loans at December 31, 2016, and 2015: Aged Analysis of Loans Receivable As of December 31, 2016 Greater 30-59 Days 60-89 Days Than Total Past Past Due Past Due 90 Days Due and Total Total Loans Still Accruing Still Accruing Still Accruing Nonaccrual Nonaccrual Current Receivable Real estate loans Multi-family residential $ — $ — $ — $ — $ — $ 74,340 $ 74,340 Residential 1-4 family — — — 158 158 59,241 59,399 Owner-occupied commercial — — — — — 452,748 452,748 Nonowner-occupied commercial — — — 601 601 448,118 448,719 Total real estate loans — — — 759 759 1,034,447 1,035,206 Construction Multi-family residential — — — — — 22,252 22,252 Residential 1-4 family — — — — — 43,532 43,532 Commercial real estate — — — — — 76,301 76,301 Commercial bare land and acquisition & development — — — — — 15,081 15,081 Residential bare land and acquisition & development — — — — — 10,645 10,645 Total construction loans — — — — — 167,811 167,811 Commercial and other 363 366 — 2,794 3,523 629,646 633,169 Consumer — — — — — 2,922 2,922 Total $ 363 $ 366 $ — $ 3,553 $ 4,282 $ 1,834,826 $ 1,839,108 Percentage of total portfolio 0.02 % 0.02 % 0.00 % 0.19 % 0.23 % 99.77 % 100.00 % Aged Analysis of Loans Receivable As of December 31, 2015 Greater 30-59 Days 60-89 Days Than Total Past Past Due Past Due 90 Days Due and Total Total Loans Still Accruing Still Accruing Still Accruing Nonaccrual Nonaccrual Current Receivable Real estate loans Multi-family residential $ — $ — $ — $ — $ — $ 66,445 $ 66,445 Residential 1-4 family — — — 374 374 51,578 51,952 Owner-occupied commercial — — — — — 359,065 359,065 Nonowner-occupied commercial — — — 750 750 299,485 300,235 Total real estate loans — — — 1,124 1,124 776,573 777,697 Construction Multi-family residential — — — — — 7,027 7,027 Residential 1-4 family 480 — — 53 533 30,323 30,856 Commercial real estate — — — — — 42,580 42,580 Commercial bare land and acquisition & development — — — — — 20,265 20,265 Residential bare land and acquisition & development — — — — — 7,268 7,268 Total construction loans 480 — — 53 533 107,463 107,996 Commercial and other — — — 1,495 1,495 505,393 506,888 Consumer 1 3 — — 4 3,347 3,351 Total $ 481 $ 3 $ — $ 2,672 $ 3,156 $ 1,392,776 $ 1,395,932 Percentage of total portfolio 0.03 % 0.00 % 0.00 % 0.19 % 0.23 % 99.77 % 100.00 % Impaired Loans Regular credit reviews of the portfolio are performed to identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALCO for review and are included in the specific calculation of allowance for loan losses. A loan is considered impaired when, based on current information and events, the Company is unlikely to collect all principal and interest due according to the terms of the loan agreement. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. Impaired loans are often reported net of government guarantees to the extent that the guarantees are expected to be collected. Impaired loans generally include all loans classified as nonaccrual and troubled debt restructurings. Accrual of interest is discontinued on impaired loans when management believes that, after considering economic and business conditions and collection efforts, the borrower’s financial condition is such that collection of principal or interest is doubtful. Accrued, but uncollected interest is generally reversed when loans are placed on nonaccrual status. Interest income is subsequently recognized only to the extent cash payments are received satisfying all delinquent principal and interest amounts, and the prospects for future payments in accordance with the loan agreement appear relatively certain. In accordance with GAAP, payments received on nonaccrual loans are applied to the principal balance and no interest income is recognized. Interest income may be recognized on impaired loans that are not on nonaccrual status. The following tables display an analysis of the Company’s impaired loans at December 31, 2016, and 2015: Impaired Loan Analysis As of December 31, 2016 Recorded Recorded With Specific Recorded Unpaid Average Related Real estate Multi-family residential $ — $ — $ — $ — $ — $ — Residential 1-4 family 454 300 754 775 644 1 Owner-occupied commercial 4,106 865 4,971 4,971 1,804 2 Nonowner-occupied commercial 2,127 — 2,127 2,189 2,228 — Total real estate loans 6,687 1,165 7,852 7,935 4,676 3 Construction Multi-family residential — — — — — — Residential 1-4 family — — — — 37 — Commercial real estate — — — — — — Commercial bare land and acquisition & development — — — — — — Residential bare land and acquisition & development 320 — 320 320 1,556 — Total construction loans 320 — 320 320 1,593 — Commercial and other 2,255 2,141 4,396 4,767 3,518 733 Consumer — — — — — — Total impaired loans $ 9,262 $ 3,306 $ 12,568 $ 13,022 $ 9,787 $ 736 Impaired Loan Analysis As of December 31, 2015 Recorded Recorded With Specific Recorded Unpaid Average Related Real estate Multi-family residential $ — $ — $ — $ — $ — $ — Residential 1-4 family 374 308 682 911 766 5 Owner-occupied commercial 2,788 — 2,788 2,788 1,177 — Nonowner-occupied commercial 2,287 25 2,312 2,374 2,395 25 Total real estate loans 5,449 333 5,782 6,073 4,338 30 Construction Multi-family residential — — — — — — Residential 1-4 family 53 — 53 72 32 — Commercial real estate — — — — — — Commercial bare land and acquisition & development — — — — — — Residential bare land and acquisition & development — 338 338 338 347 99 Total construction loans 53 338 391 410 379 99 Commercial and other 2,091 536 2,627 3,018 2,404 46 Consumer — — — — — — Total impaired loans $ 7,593 $ 1,207 $ 8,800 $ 9,501 $ 7,121 $ 175 The impaired balances reported above are not adjusted for government guarantees of $2,001 and $1,273 at December 31, 2016, and 2015, respectively. The recorded investment in impaired loans, net of government guarantees, totaled $10,567 and $7,527 at December 31, 2016, and 2015, respectively. Troubled Debt Restructurings In the normal course of business, the Company may modify the terms of certain loans, attempting to protect as much of its investment as possible. Management evaluates the circumstances surrounding each modification to determine whether it is a troubled debt restructuring (“TDR”). TDRs exist when 1) the restructuring constitutes a concession, and 2) the debtor is experiencing financial difficulties. The following table displays the Company’s TDRs by class at December 31, 2016, and 2015: Troubled Debt Restructurings as of December 31, 2016 December 31, 2015 Number of Outstanding Number of Outstanding Real estate Multifamily residential — $ — — $ — Residential 1-4 family 4 754 6 682 Owner-occupied commercial 4 5,447 3 2,788 Non owner-occupied commercial 6 2,127 7 2,312 Total real estate loans 14 8,328 16 5,782 Construction Multifamily residential — — — — Residential 1-4 family — — — — Commercial real estate — — — — Commercial bare land and acquisition & development — — — — Residential bare land and acquisition & development — — — — Total construction loans — — — — Commercial and other 16 2,901 11 2,170 Consumer — — — — 30 $ 11,229 27 $ 7,952 The recorded investment on TDRs in nonaccrual status totaled $2,250 and $1,807 at December 31, 2016, and December 31, 2015, respectively. The Bank’s policy is that loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appear relatively certain. The Bank’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status. For the twelve months ended December 31, 2016, the Company restructured 10 loans into troubled debt restructurings for which impairment was previously measured under the Company’s general loan loss allowance methodology. The total recorded investment in such receivables was $5,870, and the associated allowance for loan losses was $11 at December 31, 2016. The types of modifications offered can generally be described in the following categories: Rate Modification Term Modification Interest Only Modification Combination Modification The following tables present newly restructured loans that occurred during the twelve months ended December 31, 2016, and 2015, respectively: Troubled Debt Restructurings Restructured during the twelve months ended December 31, 2016 Rate Term Interest Only Combination Real estate Multifamily residential $ — $ — $ — $ — Residential 1-4 family — — — 296 Owner-occupied commercial — — 4,478 — Non owner-occupied commercial — — — — Total real estate loans — — 4,478 296 Construction Multifamily residential — — — — Residential 1-4 family — — — — Commercial real estate — — — — Commercial bare land and acquisition & development — — — — Residential bare land and acquisition & development — — — — Total construction loans — — — — Commercial and other — — 445 651 Consumer — — — — $ — $ — $ 4,923 $ 947 Troubled Debt Restructurings Restructured during the twelve months ended December 31, 2015 Rate Term Interest Only Combination Real estate Multifamily residential $ — $ — $ — $ — Residential 1-4 family — — — — Owner-occupied commercial — 1,780 — — Non owner-occupied commercial — — — — Total real estate loans — 1,780 — — Construction Multifamily residential — — — — Residential 1-4 family — — — — Commercial real estate — — — — Commercial bare land and acquisition & development — — — — Residential bare land and acquisition & development — — — — Total construction loans — — — — Commercial and other 297 — — — Consumer — — — — $ 297 $ 1,780 $ — $ — Subsequent to a loan being classified as a TDR, a borrower may become unwilling or unable to abide by the terms of the modified agreement. In such cases of default, the Company takes appropriate action to secure additional payments including the use of foreclosure proceedings. The following table presents loans receivable modified as troubled debt restructurings that subsequently defaulted within twelve months during the period: Troubled Debt Restructurings 2016 2015 Number of Recorded Number of Recorded Real estate Multifamily residential — $ — — $ — Residential 1-4 family — — — — Owner-occupied commercial 1 475 — — Non owner-occupied commercial — — — — Total real estate loans 1 475 — — Construction Multifamily residential — — — — Residential 1-4 family — — — — Commercial real estate — — — — Commercial bare land and acquisition & development — — — — Residential bare land and acquisition & development — — — — Total construction loans — — — — Commercial and other — — — — Consumer — — — — 1 $ 475 — $ — At December 31, 2016, and December 31, 2015, the Company had no commitments to lend additional funds on loans restructured as TDRs. |