Loans, Allowance for Loan Losses, and Credit Quality Indicators | NOTE 3 - 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 of 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 period-end loans are as follows: March 31, % of Gross December 31, % of Gross 2017 Loans 2016 Loans Real estate loans Multi-family residential $ 80,333 4.20 % $ 74,340 4.00 % Residential 1-4 family 61,516 3.21 % 61,548 3.31 % Owner-occupied commercial 468,296 24.46 % 461,557 24.82 % Nonowner-occupied commercial 462,555 24.16 % 451,893 24.30 % Total permanent real estate loans 1,072,700 56.03 % 1,049,338 56.43 % Construction loans Multi-family residential 29,473 1.54 % 22,252 1.20 % Residential 1-4 family 48,449 2.53 % 43,532 2.34 % Commercial real estate 90,389 4.72 % 76,301 4.10 % Commercial bare land and acquisition & development 10,398 0.54 % 15,081 0.81 % Residential bare land and acquisition & development 9,682 0.51 % 10,645 0.57 % Total construction real estate loans 188,391 9.84 % 167,811 9.02 % Total real estate loans 1,261,091 65.87 % 1,217,149 65.45 % Commercial loans 640,520 33.45 % 630,491 33.89 % Consumer loans 3,000 0.16 % 2,922 0.16 % Other loans 10,037 0.52 % 9,225 0.50 % Gross loans 1,914,648 100.00 % 1,859,787 100.00 % Deferred loan origination fees (2,040 ) (2,020 ) 1,912,608 1,857,767 Allowance for loan losses (22,612 ) (22,454 ) Total loans, net of allowance for $ 1,889,996 $ 1,835,313 At March 31, 2017, outstanding loans to dental professionals totaled $382,867 and represented 20.00% of total outstanding loan principal balances compared to dental professional loans of $377,478, or 20.30% of total outstanding loan principal balance at December 31, 2016. Additional information about the Company’s dental portfolio can be found in Note 4 to theses consolidated financial statements. There are no other industry concentrations in excess of 10% of the total loan portfolio. However, as of March 31, 2017, 65.87% 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. Purchased Credit Impaired Loans The following table represents the contractually required principal balance of purchased credit impaired loans and the carrying balance at March 31, 2017 and December 31, 2016: March 31, December 31, 2017 2016 Contractually required principal payments for purchased credit impaired loans $ 21,053 $ 22,941 Accretable yield (1,359 ) (1,453 ) Nonaccretable yield (669 ) (809 ) Balance of purchased credit impaired loans $ 19,025 $ 20,679 The following tables summarize the changes in the accretable yield for purchased credit impaired loans for the periods ended March 31, 2017 and 2016: Three months ended March 31, 2017 2016 Capital Foundation Total Century Capital Total Balance, beginning of period $ 765 $ 688 $ 1,453 $ 40 $ 1,030 $ 1,070 Additions — — — — — — Accretion to interest income (38 ) (56 ) (94 ) (29 ) (91 ) (120 ) Balance, end of period $ 727 $ 632 $ 1,359 $ 11 $ 939 $ 950 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 provide 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 U.S. political environment, including debt ceiling negotiations, government shutdown and healthcare 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. A summary of the activity in the allowance for loan losses by major loan classification follows: For the three months ended March 31, 2017 Commercial and Other Real Estate Construction Consumer Unallocated Total Beginning balance $ 8,614 $ 10,872 $ 1,781 $ 41 $ 1,146 $ 22,454 Charge-offs (641 ) (150 ) — — — (791 ) Recoveries 36 12 1 — — 49 Provision (reclassification) (292 ) 565 269 (1 ) 359 900 Ending balance $ 7,717 $ 11,299 $ 2,051 $ 40 $ 1,505 $ 22,612 At March 31, 2017, the allowance for loan losses on dental loans was $4,171, compared to $4,713 at December 31, 2016. See Note 4 for additional information on the dental loan portfolio. The following table presents the allowance and recorded investment in loans by major loan classification at March 31, 2017 and December 31, 2016: Balances as of March 31, 2017 Commercial and Other Real Estate Construction Consumer Unallocated Total Ending allowance: collectively evaluated for impairment $ 7,709 $ 11,298 $ 2,051 $ 40 $ 1,505 $ 22,603 Ending allowance: individually evaluated for impairment 8 1 — — — 9 Ending allowance: loans acquired with deteriorated credit quality — — — — — — Total ending allowance $ 7,717 $ 11,299 $ 2,051 $ 40 $ 1,505 $ 22,612 Ending loan balance: collectively evaluated for impairment $ 641,689 $ 1,052,250 $ 188,391 $ 3,000 $ — $ 1,885,330 Ending loan balance: individually evaluated for impairment 2,793 7,500 — — — 10,293 Ending loan balance: loans acquired with deteriorated credit quality 6,075 12,950 — — — 19,025 Total ending loan balance $ 650,557 $ 1,072,700 $ 188,391 $ 3,000 $ — $ 1,914,648 Balances as of 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 The March 31, 2017, ending allowance includes $9 in specific allowance for $10,293 of impaired loans ($9,377 net of government guarantees). At December 31, 2016, the Company had $12,568 of impaired loans ($10,567 net of government guarantees) with a specific allowance of $736 assigned. Management believes that the allowance for loan losses was adequate as of March 31, 2017. 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 March 31, 2017 and December 31, 2016: Credit Quality Indicators As of March 31, 2017 Loan Grade Pass Special Mention Substandard Doubtful Totals Real estate loans Multi-family residential $ 80,333 $ — $ — $ — $ 80,333 Residential 1-4 family 59,881 — 1,635 — 61,516 Owner-occupied commercial 450,629 — 17,667 — 468,296 Nonowner-occupied commercial 456,054 — 6,501 — 462,555 Total real estate loans 1,046,897 — 25,803 — 1,072,700 Construction Multi-family residential 29,473 — — — 29,473 Residential 1-4 family 48,449 — — — 48,449 Commercial real estate 90,389 — — — 90,389 Commercial bare land and acquisition & development 10,398 — — — 10,398 Residential bare land and acquisition & development 9,069 — 613 — 9,682 Total construction loans 187,778 — 613 — 188,391 Commercial and other 635,775 — 14,782 — 650,557 Consumer 3,000 — — — 3,000 Totals $ 1,873,450 $ — $ 41,198 $ — $ 1,914,648 Percentage of portfolio 97.85 % 0.00 % 2.15 % 0.00 % 100.00 % 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 portfolio 97.47 % 0.00 % 2.44 % 0.09 % 100.00 % At March 31, 2017 and December 31, 2016, the Company had $474, and $1,026, respectively, in unfunded commitments on its classified loans, which amounts are included in the calculation of our classified asset ratio. 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 aging analysis of past due and nonaccrual loans at March 31, 2017 and December 31, 2016: Age Analysis of Loans Receivable As of March 31, 2017 30-59 Days 60-89 Days Greater Nonaccrual Total Past Total Total Loans Real estate loans Multi-family residential $ — $ — $ — $ — $ — $ 80,333 $ 80,333 Residential 1-4 family 59 — — 153 212 60,254 60,466 Owner-occupied commercial — — — — — 459,535 459,535 Nonowner-occupied commercial 536 — — 575 1,111 458,311 459,422 Total real estate loans 595 — — 728 1,323 1,058,433 1,059,756 Construction Multi-family residential — — — — — 29,473 29,473 Residential 1-4 family — — — — — 48,449 48,449 Commercial real estate — — — — — 90,389 90,389 Commercial bare land and acquisition & development — — — — — 10,398 10,398 Residential bare land and acquisition & development — — — — — 9,682 9,682 Total construction loans — — — — — 188,391 188,391 Commercial and other 585 — — 1,684 2,269 642,207 644,476 Consumer 3 — — — 3 2,997 3,000 Total $ 1,183 $ — $ — $ 2,412 $ 3,595 $ 1,892,028 $ 1,895,623 Age Analysis of Loans Receivable As of December 31, 2016 30-59 Days 60-89 Days Greater Nonaccrual Total Past Total Total Loans 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 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 Asset-Liability Committee (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 March 31, 2017, and December 31, 2016: Impaired Loan Analysis As of March 31, 2017 Recorded Recorded Total Unpaid Average Related Real estate Multi-family residential $ — $ — $ — $ — $ — $ — Residential 1-4 family 153 298 451 472 646 1 Owner-occupied commercial 4,103 855 4,958 4,958 4,963 — Nonowner-occupied commercial 2,091 — 2,091 2,153 2,100 — Total real estate loans 6,347 1,153 7,500 7,583 7,709 1 Construction Multi-family 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 2,281 512 2,793 3,274 3,692 8 Consumer — — — — — — Total impaired loans $ 8,628 $ 1,665 $ 10,293 $ 10,857 $ 11,401 $ 9 Impaired Loan Analysis As of December 31, 2016 Recorded Recorded Total 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 The impaired balances reported above are not adjusted for government guarantees of $916, and $2,001 at March 31, 2017 and December 31, 2016, respectively. The recorded investment in impaired loans, net of government guarantees, totaled $9,377 and $10,567 at March 31, 2017, and December 31, 2016, 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 March 31, 2017 and December 31, 2016: Troubled Debt Restructurings as of March 31, 2017 December 31, 2016 Number of Post-Modification Number of Post-Modification Real estate Multifamily residential — $ — — $ — Residential 1-4 family 4 501 4 754 Owner-occupied commercial 4 5,418 4 5,447 Non owner-occupied commercial 6 2,091 6 2,127 Total real estate loans 14 8,010 14 8,328 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 15 2,352 16 2,901 Consumer — — — — Total 29 $ 10,362 30 $ 11,229 The recorded investment in TDRs on nonaccrual status totaled $2,210, and $2,250 at March 31, 2017 and December 31, 2016, respectively. The Company’s policy is that loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain. The Company’s policy generally refers to a minimum of six months of payment performance as sufficient to warrant a return to accrual status. For the three months ended March 31, 2017, the Company restructured one loan into a TDR for which impairment was previously measured under the Company’s general loan loss allowance methodology. The types of modifications offered can generally be described in the following categories: • Rate Modification • Term Modification • Interest-only Modification • Combination Modification Below is a table of the newly restructured loans identified in the three months ended March 31, 2017 and 2016. Troubled Debt Restructurings Identified During the three months ended March 31, 2017 Rate Term Interest-only Combination Real estate Multi-family residential $ — $ — $ — $ — Residential 1-4 family — — — 50 Owner-occupied commercial — — — — Nonowner-occupied commercial — — — — Total real estate loans — — — 50 Construction Multi-family 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 — — Total $ — $ — $ — $ 50 Troubled Debt Restructurings Identified During the three months ended March 31, 2016 Rate Term Interest-only Combination Real estate Multi-family residential $ — $ — $ — $ — Residential 1-4 family — — — — Owner-occupied commercial — — — — Nonowner-occupied commercial — — — — Total real estate loans — — — — Construction Multi-family residential — — — — Residential 1-4 family — — — — Commercial real estate — — — — Commercial bare land and acquisition & development — — — — Residential bare land and acquisition & development — — — 1,838 Total construction loans — — — 1,838 Commercial and other — — 397 701 Consumer — — — — Total $ — $ — $ 397 $ 2,539 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 recover principal and interest payments including the use of foreclosure proceedings. There were no TDRs that subsequently defaulted within the first twelve months of restructure during the periods ended March 31, 2017 and 2016. At March 31, 2017 and December 31, 2016, the Company had no commitments to lend additional funds on loans restructured as TDRs. |