Allowance for Probable Loan Losses | Note 4 — Allowance for Probable Loan Losses The allowance for probable loan losses primarily consists of the aggregate loan loss allowances of the Subsidiary Banks. The allowances are established through charges to operations in the form of provisions for probable loan losses. Loan losses or recoveries are charged or credited directly to the allowances. The allowance for probable loan losses of each Subsidiary Bank is maintained at a level considered appropriate by management, based on estimated probable losses in the loan portfolio. The allowance for probable loan losses is derived from the following elements: (i) allowances established on specific impaired loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry in which the customer operates; (ii) allowances based on actual historical loss experience for similar types of loans in our loan portfolio; and (iii) allowances based on general economic conditions, changes in the mix of loans, company resources, border risk and credit quality indicators, among other things. All segments of the loan portfolio continue to be impacted by economic uncertainty as the economy recovers from the recent prolonged downturn. Our management continually reviews the allowance for loan losses of the Subsidiary Banks using the amounts determined from the allowances established on specific impaired loans, the allowance established on quantitative historical loss percentages, and the allowance based on qualitative data to establish an appropriate amount to maintain in our allowance for loan losses. Should any of the factors considered by management in evaluating the adequacy of the allowance for probable loan losses change, our estimate of probable loan losses could also change, which could affect the level of future provisions for probable loan losses. While the calculation of the allowance for probable loan losses utilizes management’s best judgment and all information reasonably available, the adequacy of the allowance is dependent on a variety of factors beyond our control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications. The loan loss provision is determined using the following methods. On a weekly basis, loan past due reports are reviewed by the credit quality committee to determine if a loan has any potential problems and if a loan should be placed on the internal classified report of the Subsidiary Banks. Additionally, the credit department of each Subsidiary Bank reviews the majority of our loans for proper internal classification purposes, regardless of whether they are past due, and segregates any loans with potential problems for further review. The credit department will discuss the potential problem loans with the servicing loan officers to determine any relevant issues that were not discovered in the evaluation. Also, an analysis of loans that is provided through examinations by regulatory authorities is considered in the review process. After the above analysis is completed, we determine if a loan should be placed on an internal classified report because of issues related to the analysis of the credit, credit documents, collateral and/or payment history. A summary of the transactions in the allowance for probable loan losses by loan class is as follows: Three Months Ended September 30, 2019 Domestic Foreign Commercial Real Estate: Other Commercial Construction & Real Estate: Commercial Land Farmland & Real Estate: Residential: Residential: Commercial Development Commercial Multifamily First Lien Junior Lien Consumer Foreign Total (Dollars in Thousands) Balance at June 30, $ 11,780 $ 15,273 $ 17,029 $ 1,849 $ 3,627 $ 7,312 $ 488 $ 845 $ 58,203 Losses charged to allowance (3,231) — (468) — (164) (214) (216) — (4,293) Recoveries credited to allowance 585 4 10 — 3 65 5 — 672 Net (losses) recoveries charged to allowance (2,646) 4 (458) — (161) (149) (211) — (3,621) Provision charged to operations 1,837 1,573 230 350 263 852 199 (26) 5,278 Balance at September 30, $ 10,971 $ 16,850 $ 16,801 $ 2,199 $ 3,729 $ 8,015 $ 476 $ 819 $ 59,860 Three Months Ended September 30, 2018 Domestic Foreign Commercial Real Estate: Other Commercial Construction & Real Estate: Commercial Land Farmland & Real Estate: Residential: Residential: Commercial Development Commercial Multifamily First Lien Junior Lien Consumer Foreign Total (Dollars in Thousands) Balance at June 30, $ 16,596 $ 14,703 $ 18,296 $ 1,574 $ 3,591 $ 6,793 $ 450 $ 850 $ 62,853 Losses charged to allowance (6,798) — — — (74) (133) (80) (3) (7,088) Recoveries credited to allowance 489 4 19 — 23 53 12 9 609 Net (losses) recoveries charged to allowance (6,309) 4 19 — (51) (80) (68) 6 (6,479) Provision charged to operations 3,039 397 1,050 (138) (354) 194 57 35 4,280 Balance at September 30, $ 13,326 $ 15,104 $ 19,365 $ 1,436 $ 3,186 $ 6,907 $ 439 $ 891 $ 60,654 Nine Months Ended September 30, 2019 Domestic Foreign Commercial Real Estate: Other Commercial Construction & Real Estate: Commercial Land Farmland & Real Estate: Residential: Residential: Commercial Development Commercial Multifamily First Lien Junior Lien Consumer Foreign Total (Dollars in Thousands) Balance at December 31, $ 12,596 $ 15,123 $ 19,353 $ 1,808 $ 3,467 $ 7,719 $ 447 $ 871 $ 61,384 Losses charged to allowance (11,011) — (7,347) — (166) (314) (334) — (19,172) Recoveries credited to allowance 1,631 80 308 — 14 222 30 — 2,285 Net (losses) recoveries charged to allowance (9,380) 80 (7,039) — (152) (92) (304) — (16,887) Provision charged to operations 7,755 1,647 4,487 391 414 388 333 (52) 15,363 Balance at September 30, $ 10,971 $ 16,850 $ 16,801 $ 2,199 $ 3,729 $ 8,015 $ 476 $ 819 $ 59,860 Nine Months Ended September 30, 2018 Domestic Foreign Commercial Real Estate: Other Commercial Construction & Real Estate: Commercial Land Farmland & Real Estate: Residential: Residential: Commercial Development Commercial Multifamily First Lien Junior Lien Consumer Foreign Total (Dollars in Thousands) Balance at December 31, $ 27,905 $ 11,675 $ 16,663 $ 1,109 $ 2,950 $ 6,103 $ 440 $ 842 $ 67,687 Losses charged to allowance (11,798) (1) (70) — (118) (172) (262) (3) (12,424) Recoveries credited to allowance 1,520 8 229 — 25 348 39 10 2,179 Net (losses) recoveries charged to allowance (10,278) 7 159 — (93) 176 (223) 7 (10,245) Provision charged to operations (4,301) 3,422 2,543 327 329 628 222 42 3,212 Balance at September 30, $ 13,326 $ 15,104 $ 19,365 $ 1,436 $ 3,186 $ 6,907 $ 439 $ 891 $ 60,654 The allowance for probable loan losses is a reserve established through a provision for probable loan losses charged to expense, which represents management’s best estimate of probable loan losses when evaluating loans individually or collectively. The increase in provision for probable loan losses charged to expense and charge offs charged to the allowance for probable loan losses for the nine months ended September 30, 2019 can be primarily attributed to a relationship that is secured by multiple pieces of real property on which car dealerships are operated. The relationship began deteriorating in the fourth quarter of 2018, triggered by significant fraud by a high level insider of the car dealership resulting in the dealerships unexpectedly filing for bankruptcy and creating an exposure for potential loss since the operations of the dealerships were the source of repayment from the borrower. The relationship further deteriorated in the first quarter of 2019 after the sponsor of the court approved debtor in possession plan discontinued its role in the process and thus did not fulfill its obligation to assume full responsibility of the accrued and unpaid interest. Although the relationship is secured by real property (the dealerships’ real estate), the real property has specialized use, contributing to the potential exposure for probable loss. During the first quarter of 2019, in light of the circumstances and management’s evaluation of the relationship, the decision was made to place the relationship on impaired, non-accrual status and place a specific reserve on the relationship in the amount of $9.5 million. During the second quarter of 2019, management continued to evaluate the relationship and decided to foreclose on the underlying real estate collateral, resulting in a charge off of approximately $9,500,000 , reflected in the tables above as part of the Commercial and Commercial Real Estate: Farmland and Commercial categories. The table below provides additional information on the balance of loans individually or collectively evaluated for impairment and their related allowance, by loan class as of September 30, 2019 and December 31, 2018: September 30, 2019 Loans Individually Loans Collectively Evaluated For Evaluated For Impairment Impairment Recorded Recorded Investment Allowance Investment Allowance (Dollars in Thousands) Domestic Commercial $ 7,412 $ 395 $ 1,288,324 $ 10,576 Commercial real estate: other construction & land development 1,794 116 2,042,616 16,734 Commercial real estate: farmland & commercial 1,740 — 1,965,371 16,801 Commercial real estate: multifamily 649 — 241,440 2,199 Residential: first lien 6,286 — 432,186 3,729 Residential: junior lien 704 — 712,588 8,015 Consumer 1,131 — 45,941 476 Foreign 273 — 146,687 819 Total $ 19,989 $ 511 $ 6,875,153 $ 59,349 December 31, 2018 Loans Individually Loans Collectively Evaluated For Evaluated For Impairment Impairment Recorded Recorded Investment Allowance Investment Allowance (Dollars in Thousands) Domestic Commercial $ 9,179 $ 656 $ 1,119,790 $ 11,940 Commercial real estate: other construction & land development 2,092 116 1,884,139 15,007 Commercial real estate: farmland & commercial 3,509 — 1,946,389 19,353 Commercial real estate: multifamily 507 — 225,750 1,808 Residential: first lien 6,244 — 439,556 3,467 Residential: junior lien 901 — 726,400 7,719 Consumer 1,175 — 45,141 447 Foreign 293 — 150,224 871 Total $ 23,900 $ 772 $ 6,537,389 $ 60,612 The table below provides additional information on loans accounted for on a non-accrual basis by loan class at September 30, 2019 and December 31, 2018: September 30, 2019 December 31, 2018 (Dollars in Thousands) Domestic Commercial $ 7,379 $ 9,143 Commercial real estate: other construction & land development 1,794 2,092 Commercial real estate: farmland & commercial 1,740 3,509 Commercial real estate: multifamily 649 507 Residential: first lien 583 347 Residential: junior lien — 171 Consumer 5 22 Total non-accrual loans $ 12,150 $ 15,791 Impaired loans are those loans where it is probable that all amounts due according to contractual terms of the loan agreement will not be collected. We have identified these loans through our normal loan review procedures. Impaired loans are measured based on (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the loan’s observable market price; or (iii) the fair value of the collateral if the loan is collateral dependent. Substantially all of our impaired loans are measured at the fair value of the collateral. In limited cases, we may use other methods to determine the level of impairment of a loan if such loan is not collateral dependent. The following tables detail key information regarding our impaired loans by loan class at September 30, 2019 and December 31, 2018: September 30, 2019 Quarter to Date Year to Date Unpaid Average Average Recorded Principal Related Recorded Interest Recorded Interest Investment Balance Allowance Investment Recognized Investment Recognized (Dollars in Thousands) Loans with Related Allowance Domestic Commercial $ 598 $ 621 $ 395 $ 602 $ — $ 616 $ — Commercial real estate: other construction & land development 128 169 116 129 — 132 — Total impaired loans with related allowance $ 726 $ 790 $ 511 $ 731 $ — $ 748 $ — September 30, 2019 Quarter to Date Year to Date Unpaid Average Average Recorded Principal Recorded Interest Recorded Interest Investment Balance Investment Recognized Investment Recognized (Dollars in Thousands) Loans with No Related Allowance Domestic Commercial $ 6,814 $ 6,963 $ 8,002 $ 1 $ 17,945 $ 2 Commercial real estate: other construction & land development 1,666 1,953 1,674 — 1,767 — Commercial real estate: farmland & commercial 1,740 2,368 3,222 — 22,389 — Commercial real estate: multifamily 649 684 653 — 656 — Residential: first lien 6,286 6,400 6,427 78 6,698 231 Residential: junior lien 704 708 914 10 1,028 32 Consumer 1,131 1,131 1,131 — 1,088 — Foreign 273 273 274 3 281 9 Total impaired loans with no related allowance $ 19,263 $ 20,480 $ 22,297 $ 92 $ 51,852 $ 274 December 31, 2018 Unpaid Average Recorded Principal Related Recorded Interest Investment Balance Allowance Investment Recognized (Dollars in Thousands) Loans with Related Allowance Domestic Commercial $ 1,563 $ 2,161 $ 656 $ 1,741 $ — Commercial real estate: other construction & land development 135 169 116 141 — Total impaired loans with related allowance $ 1,698 $ 2,330 $ 772 $ 1,882 $ — December 31, 2018 Unpaid Average Recorded Principal Recorded Interest Investment Balance Investment Recognized (Dollars in Thousands) Loans with No Related Allowance Domestic Commercial $ 7,616 $ 7,730 $ 16,194 $ 3 Commercial real estate: other construction & land development 1,957 2,205 2,151 — Commercial real estate: farmland & commercial 3,509 4,031 36,632 — Commercial real estate: multifamily 507 538 565 — Residential: first lien 6,244 6,386 7,136 305 Residential: junior lien 901 911 976 44 Consumer 1,175 1,190 1,211 2 Foreign 293 293 327 14 Total impaired loans with no related allowance $ 22,202 $ 23,284 $ 65,192 $ 368 The following table details key information regarding our impaired loans by loan class at September 30, 2018: September 30, 2018 Quarter to Date Year to Date Average Average Recorded Interest Recorded Interest Investment Recognized Investment Recognized (Dollars in Thousands) Loans with Related Allowance Domestic Commercial $ 1,620 $ — $ 1,794 $ — Commercial real estate: other construction & land development 139 — 142 — Total impaired loans with related allowance $ 1,759 $ — $ 1,936 $ — September 30, 2018 Quarter to Date Year to Date Average Average Recorded Interest Recorded Interest Investment Recognized Investment Recognized (Dollars in Thousands) Loans with No Related Allowance Domestic Commercial $ 15,758 $ — $ 16,464 $ 2 Commercial real estate: other construction & land development 1,994 — 2,203 — Commercial real estate: farmland & commercial 5,986 — 36,633 — Commercial real estate: multifamily 590 — 575 — Residential: first lien 6,362 76 6,929 228 Residential: junior lien 743 11 807 33 Consumer 1,187 1 1,192 2 Foreign 318 4 331 11 Total impaired loans with no related allowance $ 32,938 $ 92 $ 65,134 $ 276 A portion of the impaired loans have adequate collateral and credit enhancements not requiring a related allowance for loan loss. Management recognizes the risks associated with these impaired loans, however, management is confident our loss exposure regarding these credits will be significantly reduced due to our long-standing practices that encompass the following principles: (i) the financial strength of the borrower, including strong earnings, a high net worth, significant liquidity and an acceptable debt to worth ratio, (ii) managerial and business competence, (iii) the ability to repay, (iv) for a new business, projected cash flows, (v) loan to value, (vi) in the case of a secondary guarantor, a guarantor financial statement, and (vii) financial and/or other character references. Management’s decision to place loans in this category does not necessarily mean that we will experience significant losses from these loans or significant increases in impaired loans from these levels. The following table details loans accounted for as “troubled debt restructuring,” segregated by loan class. Loans accounted for as troubled debt restructuring are included in impaired loans. September 30, 2019 December 31, 2018 (Dollars in Thousands) Domestic Commercial $ 33 $ 35 Residential: first lien 5,703 5,947 Residential: junior lien 704 730 Consumer 1,126 1,153 Foreign 273 293 Total troubled debt restructuring $ 7,839 $ 8,158 The Subsidiary Banks charge-off that portion of any loan which management considers to represent a loss as well as that portion of any other loan which is classified as a “loss” by bank examiners. Commercial and industrial or real estate loans are generally considered by management to represent a loss, in whole or part, when an exposure beyond any collateral coverage is apparent and when no further collection of the loss portion is anticipated based on the borrower’s financial condition and general economic conditions in the borrower’s industry. Generally, unsecured consumer loans are charged-off when 90 days past due. While our management believes that it is generally able to identify borrowers with financial problems reasonably early and to monitor credit extended to such borrowers carefully, there is no precise method of predicting loan losses. The determination that a loan is likely to be uncollectible and that it should be wholly or partially charged-off as a loss is an exercise of judgment. Similarly, the determination of the adequacy of the allowance for probable loan losses can be made only on a subjective basis. It is the judgment of our management that the allowance for probable loan losses at September 30, 2019 was adequate to absorb probable losses from loans in the portfolio at that date. The following tables present information regarding the aging of past due loans by loan class at September 30, 2019 and December 31, 2018: September 30, 2019 90 Days or Total 30 - 59 60 - 89 90 Days or greater & Past Total Days Days Greater still accruing Due Current Portfolio (Dollars in Thousands) Domestic Commercial $ 3,493 $ 902 $ 7,408 $ 1,477 $ 11,803 $ 1,283,933 $ 1,295,736 Commercial real estate: other construction & land development 8,977 18,504 1,100 286 28,581 2,015,829 2,044,410 Commercial real estate: farmland & commercial 3,210 56,125 1,270 737 60,605 1,906,506 1,967,111 Commercial real estate: multifamily 24 290 1,265 764 1,579 240,510 242,089 Residential: first lien 2,961 1,169 3,303 2,930 7,433 431,039 438,472 Residential: junior lien 1,316 305 1,216 1,216 2,837 710,455 713,292 Consumer 770 128 69 69 967 46,105 47,072 Foreign 2,119 490 147 147 2,756 144,204 146,960 Total past due loans $ 22,870 $ 77,913 $ 15,778 $ 7,626 $ 116,561 $ 6,778,581 $ 6,895,142 December 31, 2018 90 Days or Total 30 - 59 60 - 89 90 Days or greater & Past Total Days Days Greater still accruing Due Current Portfolio (Dollars in Thousands) Domestic Commercial $ 4,651 $ 1,089 $ 19,851 $ 10,890 $ 25,591 $ 1,103,378 $ 1,128,969 Commercial real estate: other construction & land development 727 1,707 922 16 3,356 1,882,875 1,886,231 Commercial real estate: farmland & commercial 2,928 784 27,239 24,910 30,951 1,918,947 1,949,898 Commercial real estate: multifamily 927 — 578 71 1,505 224,752 226,257 Residential: first lien 3,998 1,677 3,362 3,079 9,037 436,763 445,800 Residential: junior lien 1,155 618 1,108 937 2,881 724,420 727,301 Consumer 486 19 45 32 550 45,766 46,316 Foreign 1,106 117 739 739 1,962 148,555 150,517 Total past due loans $ 15,978 $ 6,011 $ 53,844 $ 40,674 $ 75,833 $ 6,485,456 $ 6,561,289 The increase in loans past due 60 – 89 days at September 30, 2019 compared to December 31, 2018 can be primarily attributed to a loan relationship secured by real property on which a commercial office building is being constructed and a relationship secured by real estate on which private education centers are operated. The decrease in the 90 days or greater and still accruing loans at September 30, 2019 compared to December 31, 2018 can be primarily attributed to the previously discussed relationship secured by real property on which car dealerships are operated and the foreclosure of the underlying real estate assets securing the relationship in the second quarter of 2019. Our internal classified report is segregated into the following categories: (i) “Special Review Credits,” (ii) “Watch List-Pass Credits,” and (iii) “Watch List-Substandard Credits.” The loans placed in the “Special Review Credits” category reflect management’s opinion that the loans reflect potential weakness which requires monitoring on a more frequent basis. The “Special Review Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List-Pass Credits” category reflect our opinion that the credit contains weaknesses which represent a greater degree of risk, which warrant “extra attention.” The “Watch List-Pass Credits” are reviewed and discussed on a regular basis with the credit department and the lending staff to determine if a change in category is warranted. The loans placed in the “Watch List-Substandard Credits” classification are considered to be potentially inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These credit obligations, even if apparently protected by collateral value, have shown defined weaknesses related to adverse financial, managerial, economic, market or political conditions which may jeopardize repayment of principal and interest. Furthermore, there is the possibility that we could sustain some future loss if such weaknesses are not corrected. For loans that are classified as impaired, management evaluates these credits in accordance with the provisions of ASC 310-10, “Receivables,” and, if deemed necessary, a specific reserve is allocated to the credit. The specific reserve allocated under ASC 310-10 is based on (i) the present value of expected future cash flows discounted at the loan’s effective interest rate; (ii) the loan’s observable market price; or (iii) the fair value of the collateral if the loan is collateral dependent. Substantially all of our loans evaluated as impaired under ASC 310-10 are measured using the fair value of collateral method. In limited cases, we may use other methods to determine the specific reserve of a loan under ASC 310-10 if such loan is not collateral dependent. The allowance based on historical loss experience on our remaining loan portfolio, which includes the “Special Review Credits,” “Watch List - Pass Credits,” and “Watch List - Substandard Credits” is determined by segregating the remaining loan portfolio into certain categories such as commercial loans, installment loans, international loans, loan concentrations and overdrafts. Installment loans are then further segregated by number of days past due. A historical loss percentage, adjusted for (i) management’s evaluation of changes in lending policies and procedures, (ii) current economic conditions in the market area we serve, (iii) other risk factors, (iv) the effectiveness of the internal loan review function, (v) changes in loan portfolios, and (vi) the composition and concentration of credit volume is applied to each category. Each category is then added together to determine the allowance allocated under ASC 450-20. A summary of the loan portfolio by credit quality indicator by loan class at September 30, 2019 and December 31, 2018 is as follows: September 30, 2019 Special Watch Watch List— Watch List— Pass Review List—Pass Substandard Impaired (Dollars in Thousands) Domestic Commercial $ 1,228,895 $ 19 $ 957 $ 58,453 $ 7,412 Commercial real estate: other construction & land development 1,948,752 — 37,566 56,298 1,794 Commercial real estate: farmland & commercial 1,771,180 7,975 34,067 152,149 1,740 Commercial real estate: multifamily 240,535 — — 905 649 Residential: first lien 430,825 — 143 1,218 6,286 Residential: junior lien 711,747 — 841 — 704 Consumer 45,941 — — — 1,131 Foreign 146,550 — — 137 273 Total $ 6,524,425 $ 7,994 $ 73,574 $ 269,160 $ 19,989 December 31, 2018 Special Watch Watch List— Watch List— Pass Review List—Pass Substandard Impaired (Dollars in Thousands) Domestic Commercial $ 998,625 $ 441 $ 44,544 $ 76,180 $ 9,179 Commercial real estate: other construction & land development 1,817,098 1,648 9,055 56,338 2,092 Commercial real estate: farmland & commercial 1,726,711 62,046 38,373 119,259 3,509 Commercial real estate: multifamily 224,823 — — 927 507 Residential: first lien 438,773 — 142 641 6,244 Residential: junior lien 725,538 — 862 — 901 Consumer 45,141 — — — 1,175 Foreign 150,224 — — — 293 Total $ 6,126,933 $ 64,135 $ 92,976 $ 253,345 $ 23,900 The decrease in Special Review credits at September 30, 2019 compared to December 31, 2018 can be primarily attributed to a relationship secured by real property on which education centers are operated being downgraded to Watch-List Substandard. The decrease in Watch List – Pass credits at September 30, 2019 from December 31, 2018 can be primarily attributed to the reclassification of a relationship secured by oil and gas properties to Pass offset by the addition of relationships secured by real estate on which commercial buildings are being constructed. The increase in Watch List- Substandard credits at September 30, 2019 compared to December 31, 2018 can be primarily attributed to the previously mentioned relationship secured by real estate on which education centers are operated offset by the foreclosure of the underlying real estate assets in the previously discussed relationship on which car dealerships were operated and a pay down on a relationship secured primarily by aircraft. |