| LOANS | 2. LOANS The composition of the Company's loan portfolio, by loan class, is as follows: ($ in thousands) September 30, 2015 December 31, 2014 Commercial $ 129,614 $ 120,751 Commercial Real Estate 296,421 256,955 Agriculture 74,138 61,144 Residential Mortgage 42,666 50,511 Residential Construction 11,313 5,963 Consumer 45,679 49,911 599,831 545,235 Allowance for loan losses (9,360 ) (8,583 ) Net deferred origination costs 1,032 1,327 Loans, net $ 591,503 $ 537,979 The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk rating standards and criteria similar to those employed by state and federal banking regulatory agencies. Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses. These loans are generally secured by the receivables, equipment, and real property of the business and are susceptible to the related risks described above. Problem commercial loans are generally identified by periodic review of financial information that may include financial statements, tax returns, and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate means. Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner-occupied real estate are primarily susceptible to changes in the market conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles. These same risks apply to commercial loans whether secured by equipment, receivables or other personal property or unsecured. Losses on loans secured by owner-occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resulting over-supply of space. Losses are dependent on the value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means. Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or payments for services. Agricultural loans are generally secured by inventory, receivables, equipment, and real property. Agricultural loans are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as adverse weather conditions, including drought conditions such as those affecting California. Problem agricultural loans are generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections. Based on this information, the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Residential mortgage loans, which are secured by real estate, are primarily susceptible to four risks: non-payment due to diminished or lost income; over-extension of credit; a lack of borrower's cash flow to sustain payments; and shortfalls in collateral value. In general, non-payment is usually due to loss of employment and follows general economic trends in the economy, particularly the upward movement in the unemployment rate, loss of collateral value, and demand shifts. Residential construction loans, whether owner-occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction, including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion. Losses are primarily related to underlying collateral value and changes therein as described above. Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower. Based on this information the Company may decide to take any of several courses of action including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, or repossession or foreclosure of the underlying collateral. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate means. Consumer loans, whether unsecured or secured are primarily susceptible to four risks: non-payment due to diminished or lost income; over-extension of credit; a lack of borrower's cash flow to sustain payments; and shortfall in the collateral value. In general, non-payment is usually due to loss of employment and will follow general economic trends in the economy, particularly upward movements in the unemployment rate, loss of collateral value, and demand shifts. As of September 30, 2015, approximately 49% in principal amount of the Company's loans were secured by commercial real estate, consisting primarily of loans secured by commercial properties and construction and land development loans. Approximately 7% in principal amount of the Company's loans were residential mortgage loans. Approximately 2% in principal amount of the Company's loans were residential construction loans. Approximately 12% in principal amount of the Company's loans were for agriculture and 22% in principal amount of the Company's loans were for general commercial uses including professional, retail and small businesses. Approximately 8% in principal amount of the Company's loans were consumer loans. Once a loan becomes delinquent and repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal payment. If this is not forthcoming and payment in full is unlikely, the Company will consider the loan to be collateral dependent and will estimate its probable loss, using a recent valuation as appropriate to the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount. Depending on the length of time until final collection, the Company may periodically revalue the underlying collateral and take additional charge-offs as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when collateral is liquidated and actual loss is known. Unpaid balances on loans after or during collection and liquidation may also be pursued through legal action and attachment of wages or judgment liens on the borrower's other assets. At September 30, 2015 and December 31, 2014, all loans were pledged under a blanket collateral lien to secure actual and potential borrowings from the Federal Home Loan Bank ("FHLB") and the Federal Reserve Bank. Non-accrual and Past Due Loans The Company's non-accrual loans by loan class, as of September 30, 2015 and December 31, 2014 were as follows: ($ in thousands) September 30, 2015 December 31, 2014 Commercial $ 129 $ 2,151 Commercial Real Estate 1,281 672 Agriculture — — Residential Mortgage 575 1,691 Residential Construction 58 71 Consumer 563 652 $ 2,606 $ 5,237 Non-accrual loans amounted to $2,606,000 at September 30, 2015 and were comprised of four commercial loans totaling $129,000, five commercial real estate loans totaling $1,281,000, three residential mortgage loans totaling $575,000, one residential construction loan totaling $58,000 and four consumer loans totaling $563,000. Non-accrual loans amounted to $5,237,000 at December 31, 2014 and were comprised of six residential mortgage loans totaling $1,691,000, two residential construction loans totaling $71,000, five commercial real estate loans totaling $672,000, seven commercial loans totaling $2,151,000, and five consumer loans totaling $652,000. It is generally the Company's policy to charge-off the portion of any non-accrual loan that the Company does not expect to collect by writing the loan down to the estimated net realizable value of the underlying collateral. An age analysis of past due loans, segregated by loan class, as of September 30, 2015 and December 31, 2014, is as follows: ($ in thousands) 30-59 Days Past Due 60-89 Days Past Due 90 Days or more Past Due Total Past Due Current Total Loans September 30, 2015 Commercial $ 245 $ — $ 57 $ 302 $ 129,312 $ 129,614 Commercial Real Estate — 136 774 910 295,511 296,421 Agriculture — — — — 74,138 74,138 Residential Mortgage 320 434 125 879 41,787 42,666 Residential Construction 464 65 — 529 10,784 11,313 Consumer 8 — 428 436 45,243 45,679 Total $ 1,037 $ 635 $ 1,384 $ 3,056 $ 596,775 $ 599,831 December 31, 2014 Commercial $ — $ — $ 82 $ 82 $ 120,669 $ 120,751 Commercial Real Estate — — 239 239 256,716 256,955 Agriculture — — — — 61,144 61,144 Residential Mortgage 1,172 — 457 1,629 48,882 50,511 Residential Construction — — — — 5,963 5,963 Consumer 2 1 472 475 49,436 49,911 Total $ 1,174 $ 1 $ 1,250 $ 2,425 $ 542,810 $ 545,235 The Company had no loans that were 90 days or more past due and still accruing at September 30, 2015 and December 31, 2014. Included in the aging loan category labeled "current" are non-accrual loans that were not delinquent with respect to contractual principal and interest payments as of September 30, 2015 and December 31, 2014. These loans are categorized as non-accrual loans and are not accruing interest as of September 30, 2015 and December 31, 2014. Non-accrual loans outstanding at September 30, 2015 and December 31, 2014 are disclosed in the table above. Impaired Loans A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. Loans considered for impairment include non-accrual loans, troubled debt restructurings and loans with a risk rating of 6 (substandard) or worse. Once identified, impaired loans are measured individually for impairment using one of three methods: present value of expected cash flows discounted at the loan's effective interest rate; the loan's observable market price; and the fair value of collateral if the loan is collateral dependent. In general, any portion of the recorded investment in a collateral dependent loan in excess of the fair value of the collateral that can be identified as uncollectible, and is, therefore, deemed a confirmed loss, is promptly charged-off against the allowance for loan losses. Impaired loans, segregated by loan class, as of September 30, 2015 and December 31, 2014 were as follows: ($ in thousands) Unpaid Contractual Principal Balance Recorded Investment with no Allowance Recorded Investment with Allowance Total Recorded Investment Related Allowance September 30, 2015 Commercial $ 973 $ 113 $ 846 $ 959 $ 51 Commercial Real Estate 1,578 1,281 297 1,578 42 Agriculture — — — — — Residential Mortgage 3,593 576 2,784 3,360 619 Residential Construction 987 58 802 860 114 Consumer 1,634 634 695 1,329 26 Total $ 8,765 $ 2,662 $ 5,424 $ 8,086 $ 852 December 31, 2014 Commercial $ 2,803 $ 2,147 $ 531 $ 2,678 $ 39 Commercial Real Estate 990 672 304 976 45 Agriculture — — — — — Residential Mortgage 5,666 1,691 2,956 4,647 646 Residential Construction 1,065 71 826 897 107 Consumer 1,506 780 726 1,506 23 Total $ 12,030 $ 5,361 $ 5,343 $ 10,704 $ 860 The average recorded investment in impaired loans and the amount of interest income recognized on impaired loans during the three months ended September 30, 2015 and September 30, 2014 was as follows: ($ in thousands) Three Months Ended September 30, 2015 Three Months Ended September 30, 2014 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Commercial $ 1,840 $ 13 $ 2,993 $ 9 Commercial Real Estate 1,392 30 2,930 20 Agriculture — — — — Residential Mortgage 3,587 38 5,293 32 Residential Construction 866 8 914 9 Consumer 1,351 10 1,500 11 Total $ 9,036 $ 99 $ 13,630 $ 81 The average recorded investment in impaired loans and the amount of interest income recognized on impaired loans during the nine months ended September 30, 2015 and September 30, 2014 was as follows: ($ in thousands) Nine Months Ended September 30, 2015 Nine Months Ended September 30, 2014 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized Commercial $ 2,234 $ 33 $ 4,039 $ 19 Commercial Real Estate 1,180 38 3,320 58 Agriculture — — 655 — Residential Mortgage 4,104 96 5,389 96 Residential Construction 879 27 925 29 Consumer 1,423 29 1,482 40 Total $ 9,820 $ 223 $ 15,810 $ 242 None of the interest on impaired loans was recognized using a cash basis of accounting for the three and nine months ended September 30, 2015 and September 30, 2014. Troubled Debt Restructurings The Company's loan portfolio includes certain loans that have been modified in a Troubled Debt Restructuring ("TDR"), which are loans on which concessions in terms have been granted because of the borrowers' financial difficulties and, as a result, the Company receives less than the current market based compensation for the loan. These concessions may include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are placed on non-accrual status at the time of restructure and may only be returned to accruing status after considering the borrower's sustained repayment performance for a reasonable period, generally six months. When a loan is modified, it is measured based upon the present value of future cash flows discounted at the contractual interest rate of the original loan agreement, or the fair value of collateral less selling costs if the loan is collateral dependent. If the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through a specific allowance or a charge-off of the loan. The Company had $5,621,000 and $6,712,000 in TDR loans as of September 30, 2015 and December 31, 2014, respectively. Specific reserves for TDR loans totaled $852,000 and $860,000 as of September 30, 2015 and December 31, 2014, respectively. TDR loans performing in compliance with modified terms totaled $5,480,000 and $5,467,000 as of September 30, 2015 and December 31, 2014, respectively. There were no commitments to advance more funds on existing TDR loans as of September 30, 2015. There were no loans modified as troubled debt restructurings during the three-month periods ended September 30, 2015 and September 30, 2014. Loans modified as TDRs during the nine months ended September 30, 2015 and September 30, 2014 were as follows: ($ in thousands) Nine Months Ended September 30, 2015 Number of Contracts Pre-modification outstanding recorded investment Post- modification outstanding recorded investment Commercial 1 $ 419 $ 419 Consumer 1 109 109 Total 2 $ 528 $ 528 ($ in thousands) Nine Months Ended September 30, 2014 Number of Contracts Pre-modification outstanding recorded investment Post- modification outstanding recorded investment Commercial 1 $ 49 $ 49 Consumer 2 498 498 Total 3 $ 547 $ 547 The loan modifications generally involved reductions in the interest rate, payment extensions, forgiveness of principal, and forbearance. There were no loans modified as a TDR within the previous 12 months and for which there was a payment default during the three and nine months ended September 30, 2015. There was one consumer loan with a recorded investment of $49,000 that was modified as a troubled debt restructuring within the previous 12 months and for which there was a payment default during the three-month and nine-month periods ended September 30, 2014. Credit Quality Indicators All loans are rated using the credit risk ratings and criteria adopted by the Company. Risk ratings are adjusted as future circumstances warrant. All credits risk-rated 1, 2, 3 or 4 equate to a Pass as indicated by Federal and State regulatory agencies; a 5 equates to a Special Mention; a 6 equates to Substandard; a 7 equates to Doubtful; and an 8 equates to a Loss. For the definitions of each risk rating, see Note 4 to our condensed consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2014. The following table presents the risk ratings by loan class as of September 30, 2015 and December 31, 2014: ($ in thousands) Pass Special Mention Substandard Doubtful Loss Total September 30, 2015 Commercial $ 116,571 $ 11,547 $ 1,496 $ — $ — $ 129,614 Commercial Real Estate 275,822 16,618 3,981 — — 296,421 Agriculture 74,138 — — — — 74,138 Residential Mortgage 41,511 376 779 — — 42,666 Residential Construction 10,732 458 123 — — 11,313 Consumer 43,570 348 1,761 — — 45,679 Total $ 562,344 $ 29,347 $ 8,140 $ — $ — $ 599,831 December 31, 2014 Commercial $ 112,751 $ 3,255 $ 4,745 $ — $ — $ 120,751 Commercial Real Estate 240,808 10,607 5,540 — — 256,955 Agriculture 61,144 — — — — 61,144 Residential Mortgage 46,043 997 3,471 — — 50,511 Residential Construction 5,386 467 110 — — 5,963 Consumer 46,234 944 2,733 — — 49,911 Total $ 512,366 $ 16,270 $ 16,599 $ — $ — $ 545,235 Allowance for Loan Losses The following table details activity in the allowance for loan losses by loan class for the three and nine months ended September 30, 2015. Three months ended September 30, 2015 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of June 30, 2015 $ 3,259 $ 2,888 $ 852 $ 833 $ 144 $ 647 $ 483 $ 9,106 Provision for loan losses (128 ) 454 75 (98 ) 171 57 (231 ) 300 Charge-offs (14 ) — — — — (67 ) — (81 ) Recoveries 3 13 — 1 1 17 — 35 Net charge-offs (11 ) 13 — 1 1 (50 ) — (46 ) Balance as of September 30, 2015 $ 3,120 $ 3,355 $ 927 $ 736 $ 316 $ 654 $ 252 $ 9,360 Nine months ended September 30, 2015 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of December 31, 2014 $ 3,581 $ 1,825 $ 580 $ 1,181 $ 161 $ 886 $ 369 $ 8,583 Provision for loan losses (537 ) 1,513 347 (529 ) 97 (124 ) (117 ) 650 Charge-offs (14 ) — — (132 ) — (152 ) — (298 ) Recoveries 90 17 — 216 58 44 — 425 Net recoveries 76 17 — 84 58 (108 ) — 127 Balance as of September 30, 2015 $ 3,120 $ 3,355 $ 927 $ 736 $ 316 $ 654 $ 252 $ 9,360 The following table details the allowance for loan losses allocated to loans individually and collectively evaluated for impairment by loan class as of September 30, 2015. ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Period-end amount allocated to: Loans individually evaluated for impairment $ 51 $ 42 $ — $ 619 $ 114 $ 26 $ — $ 852 Loans collectively evaluated for impairment 3,069 3,313 927 117 202 628 252 8,508 Ending Balance $ 3,120 $ 3,355 $ 927 $ 736 $ 316 $ 654 $ 252 $ 9,360 The following table details activity in the allowance for loan losses by loan class for the three and nine months ended September 30, 2014. Three months ended September 30, 2014 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of June 30, 2014 $ 3,471 $ 1,691 $ 439 $ 1,126 $ 196 $ 1,013 $ 238 $ 8,174 Provision for loan losses 314 (66 ) 108 53 (77 ) (58 ) 126 400 Charge-offs (203 ) — — — — (50 ) — (253 ) Recoveries 12 — — — 42 27 — 81 Net charge-offs (191 ) — — — 42 (23 ) — (172 ) Balance as of September 30, 2014 $ 3,594 $ 1,625 $ 547 $ 1,179 $ 161 $ 932 $ 364 $ 8,402 Nine months ended September 30, 2014 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of December 31, 2013 $ 3,199 $ 2,290 $ 557 $ 1,216 $ 441 $ 1,023 $ 627 $ 9,353 Provision for loan losses 2,637 (596 ) (10 ) (37 ) (325 ) 194 (263 ) 1,600 Charge-offs (2,288 ) (69 ) — — — (378 ) — (2,735 ) Recoveries 46 — — — 45 93 — 184 Net charge-offs (2,242 ) (69 ) — — 45 (285 ) — (2,551 ) Balance as of September 30, 2014 $ 3,594 $ 1,625 $ 547 $ 1,179 $ 161 $ 932 $ 364 $ 8,402 The following table details the allowance for loan losses allocated to loans individually and collectively evaluated for impairment by loan class as of September 30, 2014. ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Period-end amount allocated to: Loans individually evaluated for impairment $ 36 $ 56 $ — $ 645 $ 111 $ 22 $ — $ 870 Loans collectively evaluated for impairment 3,558 1,569 547 534 50 910 364 7,532 Ending Balance $ 3,594 $ 1,625 $ 547 $ 1,179 $ 161 $ 932 $ 364 $ 8,402 The following table details activity in the allowance for loan losses and the amount allocated to loans individually and collectively evaluated for impairment as of and for the year ended December 31, 2014. Year ended December 31, 2014 ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Unallocated Total Balance as of December 31, 2013 $ 3,199 $ 2,290 $ 557 $ 1,216 $ 441 $ 1,023 $ 627 $ 9,353 Provision for (reversal of) loan losses 2,612 (396 ) 23 36 (366 ) 149 (258 ) 1,800 Charge-offs (2,288 ) (69 ) — (71 ) — (393 ) — (2,821 ) Recoveries 58 — — — 86 107 — 251 Net charge-offs (2,230 ) (69 ) — (71 ) 86 (286 ) — (2,570 ) Ending Balance $ 3,581 $ 1,825 $ 580 $ 1,181 $ 161 $ 886 $ 369 $ 8,583 Period-end amount allocated to: Loans individually evaluated for impairment $ 39 $ 45 $ — $ 646 $ 107 $ 23 $ — $ 860 Loans collectively evaluated for impairment 3,542 1,780 580 535 54 863 369 7,723 Balance as of December 31, 2014 $ 3,581 $ 1,825 $ 580 $ 1,181 $ 161 $ 886 $ 369 $ 8,583 The Company's investment in loans as of September 30, 2015, September 30, 2014, and December 31, 2014 related to each balance in the allowance for loan losses by loan class and disaggregated on the basis of the Company's impairment methodology was as follows: ($ in thousands) Commercial Commercial Real Estate Agriculture Residential Mortgage Residential Construction Consumer Total September 30, 2015 Loans individually evaluated for impairment $ 959 $ 1,578 $ — $ 3,360 $ 860 $ 1,329 $ 8,086 Loans collectively evaluated for impairment 128,655 294,843 74,138 39,306 10,453 44,350 591,745 Ending Balance $ 129,614 $ 296,421 $ 74,138 $ 42,666 $ 11,313 $ 45,679 $ 599,831 September 30, 2014 Loans individually evaluated for impairment $ 2,738 $ 2,740 $ — $ 5,267 $ 908 $ 1,686 $ 13,339 Loans collectively evaluated for impairment 114,503 251,220 55,293 44,204 4,487 48,812 518,519 Ending Balance $ 117,241 $ 253,960 $ 55,293 $ 49,471 $ 5,395 $ 50,498 $ 531,858 December 31, 2014 Loans individually evaluated for impairment $ 2,678 $ 976 $ — $ 4,647 $ 897 $ 1,506 $ 10,704 Loans collectively evaluated for impairment 118,073 255,979 61,144 45,864 5,066 48,405 534,531 Ending Balance $ 120,751 $ 256,955 $ 61,144 $ 50,511 $ 5,963 $ 49,911 $ 545,235 |
