Loans and Allowance for Credit Losses | Note 10 – Loans and Allowance for Credit Losses We adopted the new current expected credit loss accounting guidance, CECL, and all related amendments as of January 1, 2022. The following table presents loans by class as of March 31, 2023 and December 31, 2022. Accrued interest receivable on loans of $5.2 million and $6.4 million at March 31, 2023 and December 31, 2022 respectively is not included in the loans included in the table below but is included in other assets on the Company’s balance sheet. The December 31, 2022 balance in 1-4 family closed end loans reflects year-to-date 2022 loan purchases of $173.1 million. The majority of the disclosures in this footnote are prepared at the class level which is equivalent to the call report or call code classification. The final table in this section separates a roll forward of the Allowance for Credit Losses at the portfolio segment level. Loan Distribution (dollars in thousands, unaudited) March 31, 2023 December 31, 2022 Real estate: Other construction/land $ 15,653 $ 18,412 1-4 family - closed-end 414,232 416,116 Equity lines 18,953 21,330 Multi-family residential 92,220 91,691 Commercial real estate - owner occupied 313,863 323,873 Commercial real estate - non-owner occupied 912,544 893,846 Farmland 92,906 113,394 Total real estate 1,860,371 1,878,662 Agricultural 26,392 27,936 Commercial and industrial 74,726 76,779 Mortgage warehouse lines 68,472 65,439 Consumer loans 4,007 4,124 Subtotal 2,033,968 2,052,940 Net deferred loan fees and costs 24 (123) Loans, amortized cost basis 2,033,992 2,052,817 Allowance for credit losses (23,090) (23,060) Net Loans $ 2,010,902 $ 2,029,757 The following tables present the amortized cost basis of nonaccrual loans, according to loan class, with and without individually evaluated reserves as of March 31, 2023 and December 31, 2022 : Nonaccrual Loans (dollars in thousands, unaudited) March 31, 2023 Nonaccrual Loans With no allowance for credit loss With an allowance for credit loss Total Loans Past Due 90+ Accruing Real estate: 1-4 family residential construction $ — $ — $ — $ — Other construction/land — — — — 1-4 family - closed-end 485 — 485 — Equity lines 93 — 93 — Multi-family residential — — — — Commercial real estate - owner occupied — — — — Commercial real estate - non-owner occupied — — — — Farmland 78 — 78 — Total real estate 656 — 656 — Agricultural 71 — 71 — Commercial and industrial 75 134 209 88 Mortgage warehouse lines — — — — Consumer loans 1 1 2 — Total $ 803 $ 135 $ 938 $ 88 December 31, 2022 Nonaccrual Loans With no allowance for credit loss With an allowance for credit loss Total Loans Past Due 90+ Accruing Real estate: 1-4 family residential construction $ — $ — $ — $ — Other construction/land — — — — 1-4 family - closed-end 629 — 629 — Equity lines 59 — 59 — Multi-family residential — — — — Commercial real estate - owner occupied — — — — Commercial real estate - non-owner occupied — — — — Farmland 15,812 — 15,812 — Total real estate 16,500 — 16,500 — Agricultural 2,826 29 2,855 — Commercial and industrial 83 134 217 940 Mortgage warehouse lines — — — — Consumer loans — 7 7 — Total $ 19,409 $ 170 $ 19,579 $ 940 The Company did not recognize any interest on nonaccrual loans during 2022 and would have recognized an additional $0.04 million in interest income on nonaccrual loans had those loans not been designated as nonaccrual. The following table presents the amortized cost basis of collateral-dependent loans by class as of March 31, 2023 and December 31, 2022: Collateral Dependent Loans (dollars in thousands, unaudited) March 31, 2023 December 31, 2022 Amortized Cost Individual Reserves Amortized Cost Individual Reserves Real estate: 1-4 family residential construction $ — $ — $ — $ — Other construction/land — — — — 1-4 family - closed-end 485 — 629 — Equity lines 93 — 59 — Multi-family residential — — — — Commercial real estate - owner occupied — — — — Commercial real estate - non-owner occupied — — — — Farmland 78 — 15,812 — Total real estate 656 — 16,500 — Agricultural 71 — 2,826 — Commercial and industrial 210 39 217 39 Mortgage warehouse lines — — — — Consumer loans — — — — Total Loans $ 937 $ 39 $ 19,543 $ 39 During the first quarter of 2023 the amortized cost balance of collateral-dependent loans declined by 18.6 million due to the foreclosure and subsequent sale of Farmland and other Agricultural collateral related to a single borrower, as well as declines resulting from upgrades and payoffs. The weighted average loan-to-value ratio of collateral dependent loans was 17% at March 31, 2023. There were no collateral dependent loans in the process of foreclosure as of March 31, 2023. The following tables presents the aging of the amortized cost basis in past-due loans, according to class, as of March 31, 2023 and December 31, 2022: Past Due Loans (dollars in thousands, unaudited) March 31, 2023 30-59 Days Past Due 60-89 Days Past Due Loans Past Due 90+ Days Total Past Due Loans not Past Due Total Loans Real estate: Other construction/land $ — $ — $ — $ — $ 15,596 $ 15,596 1-4 family - closed-end 1,158 — 31 1,189 413,998 415,187 Equity lines 1 88 35 124 19,139 19,263 Multi-family residential — — — — 92,040 92,040 Commercial real estate - owner occupied — — — — 313,860 313,860 Commercial real estate - non-owner occupied — — — — 909,884 909,884 Farmland — — — — 93,141 93,141 Total real estate 1,159 88 66 1,313 1,857,658 1,858,971 Agricultural — — — — 26,672 26,672 Commercial and industrial 322 — 222 544 75,218 75,762 Mortgage warehouse lines — — — — 68,472 68,472 Consumer loans 30 — — 30 4,085 4,115 Total Loans $ 1,511 $ 88 $ 288 $ 1,887 $ 2,032,105 $ 2,033,992 December 31, 2022 30-59 Days Past Due 60-89 Days Past Due Loans Past Due 90+ Days Total Past Due Loans not Past Due Total Loans Real estate: Other construction/land $ — $ — $ — $ — $ 18,358 $ 18,358 1-4 family - closed-end 1,259 87 179 1,525 415,568 417,093 Equity lines 35 — — 35 21,603 21,638 Multi-family residential — — — — 91,485 91,485 Commercial real estate - owner occupied — — — — 323,895 323,895 Commercial real estate - non-owner occupied — — — — 891,195 891,195 Farmland 522 97 15,393 16,012 97,582 113,594 Total real estate 1,816 184 15,572 17,572 1,859,686 1,877,258 Agricultural — — 2,778 2,778 25,416 28,194 Commercial and industrial 19 134 940 1,093 76,601 77,694 Mortgage warehouse lines — — — — 65,439 65,439 Consumer loans 15 — — 15 4,217 4,232 Total Loans $ 1,850 $ 318 $ 19,290 $ 21,458 $ 2,031,359 $ 2,052,817 Loan Modifications The Company may agree to different types of concessions when modifying a loan. There were no modifications to borrowers experiencing financial difficulty, including principal forgiveness, rate reductions, payment deferral, or term extension, during the three months ended March 31, 2023. For the three months ended March 31, 2022, there were no new TDRs and no modifications of existing TDRs. The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention and substandard to characterize and qualify the associated credit risk. Loans classified as “loss” are immediately charged-off. The Company uses the following definitions of risk classifications: Pass – Loans listed as pass include larger non-homogeneous loans not meeting the risk rating definitions below and smaller, homogeneous loans not assessed on an individual basis. Special Mention – Loans classified as special mention have the potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. Substandard – Loans classified as substandard are those loans with clear and well-defined weaknesses such as a highly leveraged position, unfavorable financial operating results and/or trends, or uncertain repayment sources or poor financial condition, which may jeopardize ultimate recoverability of the debt. The following tables present the amortized cost of loans by credit quality classification in addition to loan vintage as of March 31, 2023: Loan Credit Quality by Vintage (dollars in thousands, unaudited) Term Loans Amortized Cost Basis by Origination Year 2023 2022 2021 2020 2019 Prior Revolving Loans Amortized Cost Total Loans Other construction/land Pass $ — $ — $ — $ 3,792 $ 712 $ 1,892 $ 9,132 $ 15,528 Substandard — — — 68 — — — 68 Subtotal — — — 3,860 712 1,892 9,132 15,596 1-4 family - closed-end Pass — 109,728 237,151 7,761 2,038 55,919 — 412,597 Special mention — — — — — 1,603 — 1,603 Substandard — — — — — 987 — 987 Subtotal — 109,728 237,151 7,761 2,038 58,509 — 415,187 Equity lines Pass — 46 332 400 322 363 16,856 18,319 Special mention — — — 20 — — 454 474 Substandard — — 114 — — — 356 470 Subtotal — 46 446 420 322 363 17,666 19,263 Multi-family residential Pass 1,892 23,696 511 11,348 655 23,368 27,341 88,811 Special mention — — — — — 3,229 — 3,229 Subtotal 1,892 23,696 511 11,348 655 26,597 27,341 92,040 Commercial real estate - OO Pass 3,275 38,637 24,015 63,603 36,273 138,028 5,839 309,670 Special mention — 279 — 203 341 1,329 — 2,152 Substandard — — — — — 1,571 467 2,038 Subtotal 3,275 38,916 24,015 63,806 36,614 140,928 6,306 313,860 Commercial real estate - NOO Pass 31,278 84,417 19,416 375,899 24,797 207,388 69,399 812,594 Special mention — — — 68,559 — 4,165 — 72,724 Substandard — — — 14,653 — 9,913 — 24,566 Subtotal 31,278 84,417 19,416 459,111 24,797 221,466 69,399 909,884 Farmland Pass — 27,996 1,350 3,993 1,746 32,519 15,428 83,032 Special mention — — — — — 3,023 — 3,023 Substandard — — — — — 7,086 — 7,086 Subtotal — 27,996 1,350 3,993 1,746 42,628 15,428 93,141 Agricultural Pass 3,475 7,509 425 438 18 2,667 11,619 26,151 Special mention — — — — — — 450 450 Substandard — — 71 — — — — 71 Subtotal 3,475 7,509 496 438 18 2,667 12,069 26,672 Commercial and industrial Pass 2,089 4,302 3,893 7,024 5,857 10,590 33,439 67,194 Special mention — 184 119 3,006 41 1,097 3,772 8,219 Substandard — — — — 72 208 69 349 Subtotal 2,089 4,486 4,012 10,030 5,970 11,895 37,280 75,762 Mortgage warehouse lines Pass — — — — — — 68,472 68,472 Subtotal — — — — — — 68,472 68,472 Consumer loans Pass 885 397 181 133 101 303 2,049 4,049 Special mention — — — 19 12 17 14 62 Substandard 2 — — — — — 2 4 Subtotal 887 397 181 152 113 320 2,065 4,115 Total $ 42,896 $ 297,191 $ 287,578 $ 560,919 $ 72,985 $ 507,265 $ 265,158 $ 2,033,992 Gross charge-offs $ 437 $ 13 $ 250 $ — $ — $ 1,280 CECL replaces the legacy accounting for loans designated as purchased credit impaired (“PCI”) with loans designated as purchased credit deteriorated (“PCD”). PCD loans are loans acquired or purchased, which as of acquisition, had evidence of more than insignificant credit deterioration since origination. Due to the immaterial balance in the Company’s PCI loans as of December 31, 2021 management elected not to transition these loans into the PCD designation. As of March 31, 2023 the Company had loans categorized as PCD. As noted in footnote 3, on January 1, 2022 the Company implemented CECL and increased our ACL, previously the allowance for loan losses, with a $9.5 million cumulative adjustment. The Company’s ACL is calculated quarterly, with any difference in the calculated ACL and the recorded ACL trued-up through an entry to the provision for credit losses. Management calculates the quantitative portion of collectively evaluated reserves for all loan categories, with the exception of Farmland, Agricultural Production and Consumer loans, using a discounted cash flow (“DCF”) methodology. For purposes of calculating the quantitative portion of collectively evaluated reserves on Farmland, Agricultural Production, and Consumer categories a Remaining Life methodology is utilized. For purposes of estimating the Company’s ACL, Management generally evaluates collectively evaluated loans by Federal Call code in order to group loans with similar risk characteristics together, however management has grouped loans in selected call codes together in determining portfolio segments, due to similar risk characteristics and reserve methodologies used for certain call code classifications. The DCF quantitative reserve methodology incorporates the consideration of probability of default (“PD”) and loss given default (“LGD”) estimates to estimate periodic losses. The PD estimates are derived through the application of reasonable and supportable economic forecasts to call code specific regression models, derived from the consideration of historical bank-specific and peer loss-rate data. The loss rate data has been regressed against benchmark economic indicators, for which reasonable and supportable forecasts exist, in the development of the call-code specific regression models. Regression models are generally refreshed on an annual basis, in order to pull in more recent loss rate data. Reasonable and supportable forecasts of the selected economic metric are then input into the regression model to calculate an expected default rate. The expected default rates are then applied to expected monthly loan balances estimated through the consideration of contractual repayment terms and expected prepayments. The Company utilizes a four-quarter forecast period, after which the expected default rates revert to the historical average for each call code, over a four-quarter reversion period, on a straight-line basis. The prepayment assumptions applied to expected cash flow over the contractual life of the loans are estimated based on historical, bank-specific experience, peer data and the consideration of current and expected conditions and circumstances including the level of interest rates. The prepayment assumptions may be updated by Management in the event that changing conditions impact Management’s estimate or additional historical data gathered has resulted in the need for a reevaluation. LGD utilized in the DCF is derived from the application of the Frye-Jacobs theory which relates LGD to PD based on historical peer data, as calculated by a third-party. Economic forecasts are considered over a four-quarter forecast period, with reversion to mean occurring on a straight-line basis over four quarters. The call code regression models utilized upon implementation of CECL on January 1, 2022, and as of March 31, 2023, were identical, and relied upon reasonable and supportable forecasts of the National Unemployment Rate. Management selected the National Unemployment Rate as the driver of quantitative portion of collectively reserves on loan classes reliant upon the DCF methodology, primarily as a result of high correlation coefficients identified in regression modeling, the availability of forecasts including the quarterly FOMC forecast, and given the widespread familiarity of stakeholders with this economic metric. The quantitative reserves for Farmland, Agricultural Production and Consumer loans are calculated using a Remaining Life methodology where average historical bank specific and peer loss rates are applied to expected loan balances over an estimated remaining life of loans in calculation of the quantitative portion of collectively evaluated loans in these classes. The estimated remaining life is calculated using historical bank-specific loan attrition data. For the Farmland, Agricultural Production and Consumer classes of loans, reasonable and supportable forecasts of the National Unemployment rate, real GDP and the housing price index are considered through estimation of qualitative reserves. Management recognizes that there are additional factors impacting risk of loss in the loan portfolio beyond what is captured in the quantitative portion of reserves on collectively evaluated loans. As current and expected conditions, may vary compared with conditions over the historical lookback period, which is utilized in the calculation of quantitative reserves, management considers whether additional or reduced reserve levels on collectively evaluated loans may be warranted given the consideration of a variety of qualitative factors. Several of the following qualitative factors (“Q- factors”) considered by management reflect the legacy regulatory guidance on Q-factors, whereas several others represent factors unique to the Company or unique to the current time period. ● Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices ● Changes in international, regional and local economic and business conditions, and developments that affect the collectability of the portfolio, as reflected in forecasts of the Housing Price Index, Real GDP and the National Unemployment Rate (Farmland & Agricultural Production and Consumer segments only) ● Changes in the nature and volume of the loan portfolio ● Changes in the experience, ability, and depth of lending management and other relevant staff ● Changes in the volume and severity of past due, non-accruals loans, and adversely classified loans, as reflected in changes of the relative level of loans classified as substandard and special mention ● Changes in the quality of the Bank’s loan review processes ● Changes in the value of underlying collateral for loans not identified as collateral dependent ● Changes in loan categorization concentrations ● Other external factors, which include, the influence of peer data on estimated quantitative reserves, residual COVID-19 related risk, expected impact of current and expected inflationary environment, reliance on the National Unemployment rate as opposed to the California unemployment rate in the calculation of quantitative reserves, the expected impact of current and expected geo-political conditions The qualitative portion of the Company’s reserves on collectively evaluated loans are calculated using a combination of numeric frameworks and management judgement, to determine risk categorizations in each of the Q-factors presented above. The amount of qualitative reserves is also contingent upon the historical peer, life-of-loan-equivalent, loss rate ranges and the relative weighting of Q-factors according to management’s judgement. Although collectively evaluated reserves are generally calculated separately at the call code or loan class level, management has grouped loan classes with similar risk characteristics into the following portfolio segments: 1-4 Family Real Estate, Commercial Real Estate, Farmland & Agricultural Production, Commercial & Industrial, Mortgage Warehouse and Consumer loans. Loans secured by 1-4 family residences have a different profile from loans secured by Commercial Real Estate. Generally, the borrowers for 1-4 Family loans are consumers whereas borrowers for Commercial Real Estate are often businesses. The COVID-19 pandemic illustrated how these different categories of real estate loans were subject to different risks, which was exacerbated by the widespread work-from-home model adopted by many companies during and since the pandemic. Farmland and Agricultural Production loans are included in a single segment as these loans are often times to the same borrowers, facing the same risks relating to commodity prices, water supply and drought conditions in addition to other environmental concerns. Commercial & Industrial loans are separated into a unique segment given the uniqueness of these loans, which are often revolving and secured by other business assets as opposed to real estate. Mortgage warehouse loans are also unique in the Company’s portfolio and warrant separate presentation as an individual portfolio segment, given the specific nature of these constantly revolving lines to mortgage originators and also attributable to a very limited loss history, even after consideration of peer data. Finally, the Company splits out Consumer loans as a separate segment as a result of the small balance, homogeneous terms that characterize these loans. Management individually evaluates loans that do not share risk characteristics with other loans when estimating reserves. As of March 31, 2023, the only loans that Management considered to have different risk characteristics from other loans sharing the same Federal Call Report code were loans designated nonaccrual. The following tables present the activity in the allowance for credit losses by portfolio segment for the quarters ended March 31, 2023 and 2022: Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands, unaudited) 1-4 Family Real Estate Commercial Real Estate Farmland & Agricultural Production Commercial & Industrial Mortgage Warehouse Consumer Total Allowance for credit losses: Balance, December 31, 2022 $ 3,251 $ 17,732 $ 458 $ 1,233 $ 72 $ 314 $ 23,060 Charge-offs — — (1,277) (308) — (395) (1,980) Recoveries 205 — 1,282 23 — 250 1,760 Provision for credit losses (213) 67 38 258 10 90 250 Ending allowance balance: $ 3,243 $ 17,799 $ 501 $ 1,206 $ 82 $ 259 $ 23,090 1-4 Family Real Estate Commercial Real Estate Farmland & Agricultural Production Commercial & Industrial Mortgage Warehouse Consumer Total Allowance for credit losses: Balance, December 31, 2021 $ 1,909 $ 9,052 $ 1,202 $ 1,060 $ 512 $ 521 $ 14,256 Impact of adopting ASC 326 611 9,628 (480) 358 (421) (242) 9,454 Charge-offs — — (1,958) (74) — (299) (2,331) Recoveries 87 260 — 20 — 184 551 Provision for credit losses 722 (1,897) 1,842 (133) (40) 106 600 Ending allowance balance: $ 3,329 $ 17,043 $ 606 $ 1,231 $ 51 $ 270 $ 22,530 There were no significant changes in the Company’s loan portfolio ACL in the first quarter of 2023. |