| 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. Similar to practice under legacy GAAP, the ACL on the loan portfolio is a valuation allowance deducted from the recorded balance in loans. However, under CECL the ACL represents principal which is not expected to be collected over the contractual life of the loans, adjusted for expected prepayment, whereas under legacy GAAP the allowance represented only losses already incurred as of the balance sheet date. The ACL is increased by a provision for credit losses charged to expense, and by principal recovered on charged-off balances. It is reduced by principal charge-offs. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, using information from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Adjustments are also made for changes in risk profile, credit concentrations, historical trends, and other economic conditions. The Company elected the practical expedient available under CECL to exclude accrued interest receivable from the amortized cost basis of all categorizations of loans, and resultingly did not estimate reserves on accrued interest receivable balances, as any past due interest income is reversed on a timely basis. Accrued interest receivable on loans of $5.3 million and $6.4 million at September 30, 2023 and December 31, 2022, respectively is included in other assets on the Company’s balance sheet. The following table presents loans by class as of September 30, 2023 and December 31, 2022. The December 31, 2022 balance in residential real estate 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) September 30, 2023 December 31, 2022 Real estate: Residential real estate $ 418,734 $ 437,446 Commercial real estate 1,334,663 1,311,158 Other construction/land 7,368 18,412 Farmland 90,993 113,394 Total real estate 1,851,758 1,880,410 Other commercial 137,407 102,967 Mortgage warehouse lines 107,584 65,439 Consumer loans 4,061 4,124 Subtotal 2,100,810 2,052,940 Net deferred loan fees and costs 163 (123) Loans, amortized cost basis 2,100,973 2,052,817 Allowance for credit losses (23,060) (23,060) Net Loans $ 2,077,913 $ 2,029,757 The Company places loans on nonaccrual status when management has determined that the full repayment of principal and collection of contractually agreed upon interest is unlikely or when the loan in question has become delinquent more than 90 days. The Company may decide that it is appropriate to continue to accrue interest on certain loans more than 90 days delinquent if they are well-secured by collateral and collection is in process. When a loan is placed on nonaccrual status, any accrued but uncollected interest for the loan is reversed out of interest income in the period in which the loan’s status changed. For loans with an interest reserve, i.e., where loan proceeds are advanced to the borrower to make interest payments, all interest recognized from the inception of the loan is reversed when the loan is placed on nonaccrual. Once a loan is on nonaccrual status subsequent payments received from the customer are applied to principal, and no further interest income is recognized until the principal has been paid in full or until circumstances have changed such that payments are again consistently received as contractually required. Generally, loans are not restored to accrual status until the obligation is brought current and has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The following tables present the amortized cost basis of nonaccrual loans, according to loan class, with and without individually evaluated reserves as of September 30, 2023 and December 31, 2022: Nonaccrual Loans (dollars in thousands, unaudited) September 30, 2023 Nonaccrual Loans With no allowance for credit loss With an allowance for credit loss Total Loans Past Due 90+ Accruing Real estate: Residential real estate $ 446 $ — $ 446 $ — Total real estate 446 — 446 — Other commercial 335 — 335 1,115 Consumer loans — — — — Total $ 781 $ — $ 781 $ 1,115 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: Residential real estate $ 688 $ — $ 688 $ — Farmland 15,812 — 15,812 — Total real estate 16,500 — 16,500 — Other commercial 2,909 163 3,072 940 Consumer loans — 7 7 — Total $ 19,409 $ 170 $ 19,579 $ 940 The Company did not recognize any interest on nonaccrual loans during the three and nine months ended September 30, 2023, and would have recognized an additional $0.004 million and $0.06 million, respectively, in interest income on nonaccrual loans had those loans not been designated as nonaccrual. Due to loans being placed on nonaccrual status, during the third quarter and first nine months of 2023, $0.001 million and $0.3 million respectively, of interest receivable on loans was reversed against interest income . The following table presents the amortized cost basis of collateral-dependent loans by class as of September 30, 2023, and December 31, 2022: Collateral Dependent Loans (dollars in thousands, unaudited) September 30, 2023 December 31, 2022 Amortized Cost Individual Reserves Amortized Cost Individual Reserves Real estate: Residential real estate $ 152 $ — $ 688 $ — Farmland 67 — 15,812 — Total real estate 219 — 16,500 — Other commercial — — 3,043 39 Total Loans $ 219 $ — $ 19,543 $ 39 During the first nine months of 2023 the amortized cost balance of collateral-dependent loans declined by $19.3 million due to the foreclosure and subsequent sale of Farmland and other Commercial collateral related to a single borrower during the first quarter of 2023, as well as declines resulting from upgrades and payoffs. The weighted average loan-to-value ratio of collateral dependent loans was 12% at September 30, 2023. There were no collateral dependent loans in the process of foreclosure as of September 30, 2023. The following tables presents the aging of the amortized cost basis in past-due loans, according to class, as of September 30, 2023 and December 31, 2022: Past Due Loans (dollars in thousands, unaudited) September 30, 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: Residential real estate $ 51 $ — $ 98 $ 149 $ 419,791 $ 419,940 Commercial real estate 208 — — 208 1,331,686 1,331,894 Other construction/land — — — — 7,376 7,376 Farmland — — — — 91,217 91,217 Total real estate 259 — 98 357 1,850,070 1,850,427 Other commercial 469 43 1,325 1,837 136,949 138,786 Mortgage warehouse lines — — — — 107,584 107,584 Consumer loans 35 2 — 37 4,139 4,176 Total Loans $ 763 $ 45 $ 1,423 $ 2,231 $ 2,098,742 $ 2,100,973 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: Residential real estate $ 1,294 $ 87 $ 179 $ 1,560 $ 437,171 $ 438,731 Commercial real estate — — — — 1,308,328 1,308,328 Other construction/land — — — — 18,358 18,358 Farmland 522 97 15,393 16,012 97,582 113,594 Total real estate 1,816 184 15,572 17,572 1,861,439 1,879,011 Other commercial 19 134 3,718 3,871 100,264 104,135 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 or nine months ended September 30, 2023. There were no payment defaults on loans previously modified in the preceding 12 months for either of the periods ending September 30, 2023 and 2022. The Company had no additional funds committed on loans which have been modified to borrowers experiencing financial difficulty. For the three and nine months ended September 30, 2022, there were no new Troubled Debt Restructures (TDR) 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 September 30, 2023 and December 31, 2022: Loan Credit Quality by Vintage (dollars in thousands, unaudited) September 30, 2023 Term Loans Amortized Cost Basis by Origination Year 2023 2022 2021 2020 2019 Prior Revolving Loans Amortized Cost Revolving Loans Converted to Term Loans Total Loans Residential real estate Pass $ — $ 106,878 $ 232,300 $ 7,662 $ 1,998 $ 51,555 $ 13,455 $ 2,244 $ 416,092 Special mention — — — — — 2,617 51 340 3,008 Substandard — — — — — 548 124 168 840 Subtotal — 106,878 232,300 7,662 1,998 54,720 13,630 2,752 419,940 Commercial real estate Pass 94,660 276,945 58,990 486,033 51,884 256,619 23,366 — 1,248,497 Special mention 3,368 — — 42,759 3,026 6,606 — — 55,759 Substandard — — — 15,856 — 11,782 — — 27,638 Subtotal 98,028 276,945 58,990 544,648 54,910 275,007 23,366 — 1,331,894 Other construction/land Pass — — — 3,702 648 1,715 1,311 — 7,376 Substandard — — — — — — — — — Subtotal — — — 3,702 648 1,715 1,311 — 7,376 Farmland Pass 2,743 29,650 11,908 3,531 1,683 25,537 3,753 400 79,205 Special mention — — — — — 2,927 — 2,927 Substandard — — — — — 9,085 — 9,085 Subtotal 2,743 29,650 11,908 3,531 1,683 37,549 3,753 400 91,217 Other commercial Pass 29,405 11,894 3,121 6,872 4,768 10,347 62,711 3,888 133,006 Special mention — — 80 2,841 1 39 144 437 3,542 Substandard — — 60 — 33 — 1,809 336 2,238 Subtotal 29,405 11,894 3,261 9,713 4,802 10,386 64,664 4,661 138,786 Mortgage warehouse lines Pass — — — — — — 107,584 — 107,584 Subtotal — — — — — — 107,584 — 107,584 Consumer loans Pass 1,457 271 134 102 77 199 1,831 — 4,071 Special mention — — — 17 7 35 1 — 60 Substandard 43 2 — — — — — — 45 Subtotal 1,500 273 134 119 84 234 1,832 — 4,176 Total $ 131,676 $ 425,640 $ 306,593 $ 569,375 $ 64,125 $ 379,611 $ 216,139 $ 7,813 $ 2,100,973 Gross Charge-Offs 1,376 38 250 — 50 1,305 25 3,044 Loan Credit Quality by Vintage (dollars in thousands, unaudited) December 31, 2022 Term Loans Amortized Cost Basis by Origination Year 2022 2021 2020 2019 2018 Prior Revolving Loans Amortized Cost Revolving Loans Converted to Term Loans Total Loans Residential real estate Pass $ 107,744 $ 239,044 $ 7,814 $ 2,066 $ 10,723 $ 49,282 $ 15,970 $ 1,825 $ 434,468 Special mention — — — — 89 1,584 36 970 2,679 Substandard — — — — 31 1,201 — 352 1,584 Subtotal 107,744 239,044 7,814 2,066 10,843 52,067 16,006 3,147 438,731 Commercial real estate Pass 276,728 62,764 474,494 56,419 82,595 221,447 22,158 — 1,196,605 Special mention 296 — 73,002 3,068 — 7,299 — — 83,665 Substandard — — 14,733 — 7,144 6,181 — — 28,058 Subtotal 277,024 62,764 562,229 59,487 89,739 234,927 22,158 — 1,308,328 Other construction/land Pass — — 14,896 734 955 1,010 693 — 18,288 Substandard — — 70 — — — — — 70 Subtotal — — 14,966 734 955 1,010 693 — 18,358 Farmland Pass 30,346 12,941 4,504 1,819 9,418 24,175 3,976 420 87,599 Special mention — — — — 7,045 3,042 — — 10,087 Substandard — — — — 3,417 12,491 — — 15,908 Subtotal 30,346 12,941 4,504 1,819 19,880 39,708 3,976 420 113,594 Other commercial Pass 7,478 6,350 7,913 6,028 5,178 10,579 47,998 167 91,691 Special mention — 129 3,067 44 — 1,616 3,773 660 9,289 Substandard 1 2,798 28 — 28 133 — 167 3,155 Subtotal 7,479 9,277 11,008 6,072 5,206 12,328 51,771 994 104,135 Mortgage warehouse lines Pass — — — — — — 65,439 — 65,439 Subtotal — — — — — — 65,439 — 65,439 Consumer loans Pass 1,162 203 138 127 4 375 2,148 — 4,157 Special mention 5 — 35 16 — — 11 — 67 Substandard 8 — — — — — — — 8 Subtotal 1,175 203 173 143 4 375 2,159 — 4,232 Total $ 731,138 $ 399,934 $ 1,182,393 $ 132,361 $ 237,201 $ 616,060 $ 189,029 $ 4,981 $ 2,052,817 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 September 30, 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. 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. 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. 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 September 30, 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, nonaccruals 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: Residential Real Estate, Commercial Real Estate, Farmland & Agricultural Production, Commercial & Industrial, Mortgage Warehouse and Consumer loans. Loans secured by Residential Real Estate have a different profile from loans secured by Commercial Real Estate. Generally, the borrowers for Residential Real Estate 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 September 30, 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 September 30, 2023 and 2022: Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands, unaudited) Residential Real Estate Commercial Real Estate Farmland & Agricultural Production Commercial & Industrial Mortgage Warehouse Consumer Total Allowance for credit losses: Balance, June 30, 2023 $ 3,037 $ 17,373 $ 497 $ 1,676 $ 144 $ 283 $ 23,010 Charge-offs — — — (116) — (425) (541) Recoveries — — 54 170 — 250 474 Provision for credit losses (115) 501 40 (481) (36) 208 117 Ending allowance balance: $ 2,922 $ 17,874 $ 591 $ 1,249 $ 108 $ 316 $ 23,060 Residential Real Estate Commercial Real Estate Farmland & Agricultural Production Commercial & Industrial Mortgage Warehouse Consumer Total Allowance for credit losses: Balance, June 30, 2022 $ 3,593 $ 17,319 $ 376 $ 1,133 $ 41 $ 340 $ 22,802 Charge-offs — — — (85) — (371) (456) Recoveries — — — 36 — 196 232 Provision for credit losses (262) 249 1,034 67 6 118 1,212 Ending allowance balance: $ 3,331 $ 17,568 $ 1,410 $ 1,151 $ 47 $ 283 $ 23,790 There were no significant changes in the Company’s loan portfolio ACL in the third quarter of 2023. The following tables present the activity in the allowance for credit losses by portfolio segment for the nine months ended September 30, 2023 and 2022: Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands, unaudited) Residential 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) (476) — (1,292) (3,045) Recoveries 205 17 1,370 239 — 770 2,601 Provision for credit losses (534) 125 40 253 36 524 444 Ending allowance balance: $ 2,922 $ 17,874 $ 591 $ 1,249 $ 108 $ 316 $ 23,060 Residential 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 — (1,911) (2,170) (244) — (984) (5,309) Recoveries 99 259 — 118 — 553 1,029 Provision for credit losses 712 539 2,858 (141) (44) 436 4,360 Ending allowance balance: $ 3,331 $ 17,567 $ 1,410 $ 1,151 $ 47 $ 284 $ 23,790 There were no significant changes in the Company’s loan portfolio ACL in the first nine months of 2023. |
