Loans and Lease Finance Receivables and Allowance for Loan Losses | 7. LOANS AND LEASE FINANCE RECEIVABLES AND ALLOWANCE FOR LOAN LOSSES The following table provides a summary of total loans and lease finance receivables, excluding PCI loans, by type. March 31, 2017 December 31, 2016 (Dollars in thousands) Commercial and industrial $ 528,945 $ 485,078 SBA 112,690 97,184 Real estate: Commercial real estate 3,219,299 2,930,141 Construction 72,782 85,879 SFR mortgage 245,362 250,605 Dairy & livestock and agribusiness 244,264 338,631 Municipal lease finance receivables 62,416 64,639 Consumer and other loans 80,163 78,274 Gross loans, excluding PCI loans 4,565,921 4,330,431 Less: Deferred loan fees, net (6,951 ) (6,952 ) Gross loans, excluding PCI loans, net of deferred loan fees 4,558,970 4,323,479 Less: Allowance for loan losses (58,487 ) (60,321 ) Net loans, excluding PCI loans 4,500,483 4,263,158 PCI Loans 57,785 73,093 Discount on PCI loans (1,258 ) (1,508 ) Less: Allowance for loan losses (725 ) (1,219 ) PCI loans, net 55,802 70,366 Total loans and lease finance receivables $ 4,556,285 $ 4,333,524 As of March 31, 2017, 77.47% of the total gross loan portfolio (excluding PCI loans) consisted of real estate loans, 70.51% of which consisted of commercial real estate loans. Substantially all of the Company’s real estate loans and construction loans are secured by real properties located in California. As of March 31, 2017, $164.9 million, or 5.12% of the total commercial real estate loans included loans secured by farmland, compared to $180.6 million, or 6.16%, at December 31, 2016. The loans secured by farmland included $111.6 million for loans secured by dairy & livestock land and $53.3 million for loans secured by agricultural land at March 31, 2017, compared to $127.1 million for loans secured by dairy & livestock land and $53.6 million for loans secured by agricultural land at December 31, 2016. As of March 31, 2017, dairy & livestock and agribusiness loans of $244.3 million were comprised of $216.3 million for dairy & livestock loans and $28.0 million for agribusiness loans, compared to $317.9 million for dairy & livestock loans and $20.7 million for agribusiness loans at December 31, 2016. At March 31, 2017, the Company held approximately $2.07 billion of total fixed rate loans, including PCI loans. At March 31, 2017 and December 31, 2016, loans totaling $3.12 billion and $3.11 billion, respectively, were pledged to secure the borrowings and available lines of credit from the FHLB and the Federal Reserve Bank. There were no outstanding loans held-for-sale Credit Quality Indicators Central to our credit risk management is our loan risk rating system. The originating officer assigns each loan an initial risk rating, which is reviewed and confirmed or changed, as appropriate, by credit management. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit management personnel. Credits are monitored by line and credit management personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary. Loans are risk rated into the following categories (Credit Quality Indicators): Pass, Special Mention, Substandard, Doubtful and Loss. Each of these groups is assessed for the proper amount to be used in determining the adequacy of our allowance for losses. These categories can be described as follows: Pass – These loans, including loans on the Bank’s internal watch list, range from minimal credit risk to lower than average, but still acceptable, credit risk. Watch list loans usually require more than normal management attention. Loans on the watch list may involve borrowers with adverse financial trends, higher debt/equity ratios, or weaker liquidity positions, but not to the degree of being considered a defined weakness or problem loan where risk of loss may be apparent. Special Mention — Loans assigned to this category have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or the Company’s credit position at some future date. Special mention assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification. Substandard – Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. Substandard loans are characterized by the distinct possibility that the Company will sustain some loss if deficiencies are not corrected. Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or the liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loss — Loans classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this asset with insignificant value even though partial recovery may be effected in the future. The following table summarizes loans by type, excluding PCI loans, according to our internal risk ratings for the periods presented. March 31, 2017 Pass Special Substandard Doubtful & Total (Dollars in thousands) Commercial and industrial $ 491,534 $ 25,393 $ 12,018 $ - $ 528,945 SBA 97,795 10,098 4,788 9 112,690 Real estate: Commercial real estate Owner occupied 939,031 85,700 22,700 - 1,047,431 Non-owner 2,132,104 22,541 17,223 - 2,171,868 Construction Speculative 53,305 - 384 - 53,689 Non-speculative 19,093 - - - 19,093 SFR mortgage 239,390 4,989 983 - 245,362 Dairy & livestock and agribusiness 137,440 75,054 31,770 - 244,264 Municipal lease finance receivables 58,088 4,328 - - 62,416 Consumer and other loans 75,864 2,198 2,098 3 80,163 Total gross loans, excluding PCI loans $ 4,243,644 $ 230,301 $ 91,964 $ 12 $ 4,565,921 December 31, 2016 Pass Special Substandard Doubtful & Total (Dollars in thousands) Commercial and industrial $ 449,658 $ 21,610 $ 13,809 $ 1 $ 485,078 SBA 80,138 10,553 6,482 11 97,184 Real estate: Commercial real estate Owner occupied 842,992 87,781 19,046 - 949,819 Non-owner 1,941,203 23,534 15,585 - 1,980,322 Construction Speculative 48,841 - - - 48,841 Non-speculative 37,038 - - - 37,038 SFR mortgage 243,374 4,930 2,301 - 250,605 Dairy & livestock and agribusiness 187,819 114,106 36,706 - 338,631 Municipal lease finance receivables 60,102 4,537 - - 64,639 Consumer and other loans 74,328 2,123 1,819 4 78,274 Total gross loans, excluding PCI loans $ 3,965,493 $ 269,174 $ 95,748 $ 16 $ 4,330,431 Allowance for Loan Losses The Bank’s Director Loan Committee provides Board oversight of the ALLL process and approves the ALLL methodology on a quarterly basis. Our methodology for assessing the appropriateness of the allowance is conducted on a regular basis and considers the Bank’s overall loan portfolio. Refer to Note 3 – Summary of Significant Accounting Policies 10-K Management believes that the ALLL was appropriate at March 31, 2017 and December 31, 2016. No assurance can be given that economic conditions which adversely affect the Company’s service areas or other circumstances will not be reflected in increased provisions for loan losses in the future. The following tables present the balance and activity related to the allowance for loan losses for held-for-investment For the Three Months Ended March 31, 2017 Ending Balance December 31, Charge-offs Recoveries (Recapture of) Provision for Loan Losses Ending Balance March 31, 2017 (Dollars in thousands) Commercial and industrial $ 8,154 $ - $ 52 $ (250 ) $ 7,956 SBA 871 - 4 (4 ) 871 Real estate: Commercial real estate 37,443 - - 1,543 38,986 Construction 1,096 - 2,025 (2,301 ) 820 SFR mortgage 2,287 - 64 (165 ) 2,186 Dairy & livestock and agribusiness 8,541 - - (2,699 ) 5,842 Municipal lease finance receivables 941 - - (52 ) 889 Consumer and other loans 988 (2 ) 29 (78 ) 937 PCI loans 1,219 - - (494 ) 725 Total allowance for loan losses $ 61,540 $ (2 ) $ 2,174 $ (4,500 ) $ 59,212 For the Three Months Ended March 31, 2016 Ending Balance December 31, Charge-offs Recoveries (Recapture of) Provision for Loan Losses Ending Balance March 31, 2016 (Dollars in thousands) Commercial and industrial $ 8,588 $ (61 ) $ 63 $ 141 $ 8,731 SBA 993 - 1 242 1,236 Real estate: Commercial real estate 36,995 - 139 1,152 38,286 Construction 2,389 - 9 (1,247 ) 1,151 SFR mortgage 2,103 (102 ) - 201 2,202 Dairy & livestock and agribusiness 6,029 - 99 (952 ) 5,176 Municipal lease finance receivables 1,153 - - 12 1,165 Consumer and other loans 906 - 32 451 1,389 PCI loans - - - - - Total allowance for loan losses $ 59,156 $ (163 ) $ 343 $ - $ 59,336 The following tables present the recorded investment in loans held-for-investment March 31, 2017 Recorded Investment in Loans Allowance for Loan Losses Individually Collectively Acquired with Deterioriated Credit Quality Individually Evaluated for Impairment Collectively Evaluated for Impairment Acquired with Deterioriated Credit Quality (Dollars in thousands) Commercial and industrial $ 1,150 $ 527,795 $ - $ 88 $ 7,868 $ - SBA 1,926 110,764 - 9 862 - Real estate: Commercial real estate 20,216 3,199,083 - - 38,986 - Construction 384 72,398 - - 820 - SFR mortgage 4,248 241,114 - - 2,186 - Dairy & livestock and agribusiness 1,324 242,940 - - 5,842 - Municipal lease finance receivables - 62,416 - - 889 - Consumer and other loans 801 79,362 - - 937 - PCI loans - - 56,527 - - 725 Total $ 30,049 $ 4,535,872 $ 56,527 $ 97 $ 58,390 $ 725 March 31, 2016 Recorded Investment in Loans Allowance for Loan Losses Individually Collectively Acquired with Deterioriated Credit Quality Individually Evaluated for Impairment Collectively Evaluated for Impairment Acquired with Deterioriated Credit Quality (Dollars in thousands) Commercial and industrial $ 1,477 $ 465,484 $ - $ 575 $ 8,156 $ - SBA 3,304 110,399 - 55 1,181 - Real estate: Commercial real estate 35,577 2,783,542 - - 38,286 - Construction 7,651 81,997 - 48 1,103 - SFR mortgage 5,874 227,091 - 16 2,186 - Dairy & livestock and agribusiness 714 226,996 - - 5,176 - Municipal lease finance receivables - 73,098 - - 1,165 - Consumer and other loans 868 75,235 - - 1,389 - PCI loans - - 81,850 - - - Total $ 55,465 $ 4,043,842 $ 81,850 $ 694 $ 58,642 $ - Past Due and Nonperforming Loans We seek to manage asset quality and control credit risk through diversification of the loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. The Bank’s Credit Management Division is in charge of monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. Reviews of nonperforming, past due loans and larger credits, designed to identify potential charges to the allowance for loan losses, and to determine the adequacy of the allowance, are conducted on an ongoing basis. These reviews consider such factors as the financial strength of borrowers and any guarantors, the value of the applicable collateral, loan loss experience, estimated loan losses, growth in the loan portfolio, prevailing economic conditions and other factors. Refer to Note 3 – Summary of Significant Accounting Policies, included in our Annual Report on Form 10-K A loan is reported as a TDR when the Bank grants a concession(s) to a borrower experiencing financial difficulties that the Bank would not otherwise consider. Examples of such concessions include a reduction in the interest rate, deferral of principal or accrued interest, extending the payment due dates or loan maturity date(s), or providing a lower interest rate than would be normally available for new debt of similar risk. As a result of these concessions, restructured loans are classified as impaired. Impairment reserves on non-collateral Generally, when loans are identified as impaired they are moved to our Special Assets Department. When we identify a loan as impaired, we measure the loan for potential impairment using discounted cash flows, unless the loan is determined to be collateral dependent. In these cases, we use the current fair value of collateral, less selling costs. Generally, the determination of fair value is established through obtaining external appraisals of the collateral. The following tables present the recorded investment in, and the aging of, past due and nonaccrual loans, excluding PCI loans, by type of loans for the periods presented. March 31, 2017 30-59 Days Past Due 60-89 Days Past Due Total Past Due and Accruing Nonaccrual (1) Current Total Loans and Financing Receivables (Dollars in thousands) Commercial and industrial $ 42 $ 177 $ 219 $ 506 $ 528,220 $ 528,945 SBA 328 1 329 1,089 111,272 112,690 Real estate: Commercial real estate Owner occupied - - - 2,374 1,045,057 1,047,431 Non-owner - - - 3,249 2,168,619 2,171,868 Construction Speculative (2) - - - 384 53,305 53,689 Non-speculative - - - - 19,093 19,093 SFR mortgage 403 - 403 983 243,976 245,362 Dairy & livestock and agribusiness - - - 1,324 242,940 244,264 Municipal lease finance receivables - - - - 62,416 62,416 Consumer and other loans 30 399 429 438 79,296 80,163 Total gross loans, excluding PCI Loans $ 803 $ 577 $ 1,380 $ 10,347 $ 4,554,194 $ 4,565,921 (1) As of March 31, 2017, $6.2 million of nonaccruing loans were current, $2.2 million were 30-59 60-89 (2) Speculative construction loans are generally for properties where there is no identified buyer or renter. December 31, 2016 30-59 Days Past Due 60-89 Days Past Due Total Past Due and Accruing Nonaccrual (1) Current Total Loans and Financing Receivables (Dollars in thousands) Commercial and industrial $ - $ - $ - $ 156 $ 484,922 $ 485,078 SBA 352 - 352 2,737 94,095 97,184 Real estate: Commercial real estate Owner occupied - - - 635 949,184 949,819 Non-owner - - - 1,048 1,979,274 1,980,322 Construction Speculative (2) - - - - 48,841 48,841 Non-speculative - - - - 37,038 37,038 SFR mortgage - - - 2,207 248,398 250,605 Dairy & livestock and agribusiness - - - - 338,631 338,631 Municipal lease finance receivables - - - - 64,639 64,639 Consumer and other loans 84 - 84 369 77,821 78,274 Total gross loans, excluding PCI Loans $ 436 $ - $ 436 $ 7,152 $ 4,322,843 $ 4,330,431 (1) As of December 31, 2016, $4.7 million of nonaccruing loans were current, $514,000 were 30-59 60-89 (2) Speculative construction loans are generally for properties where there is no identified buyer or renter. Impaired Loans At March 31, 2017, the Company had impaired loans, excluding PCI loans, of $30.0 million and included $6.4 million of loans acquired from VBB in the first quarter of 2017. Of this amount, there was $5.6 million of nonaccrual commercial real estate loans, $1.3 million of nonaccrual dairy & livestock and agribusiness loans, $1.1 million of nonaccrual Small Business Administration (“SBA”) loans, $983,000 of nonaccrual single-family residential (“SFR”) mortgage loans, $506,000 of nonaccrual commercial and industrial loans, $438,000 of nonaccrual consumer and other loans, and $384,000 of nonaccrual construction loans. These impaired loans included $21.1 million of loans whose terms were modified in a troubled debt restructuring, of which $1.4 million were classified as nonaccrual. The remaining balance of $19.7 million consisted of 25 loans performing according to the restructured terms. The impaired loans had a specific allowance of $97,000 at March 31, 2017. At December 31, 2016, the Company had classified as impaired, loans, excluding PCI loans, with a balance of $26.4 million with a related allowance of $141,000. The following tables present information for held-for-investment As of and For the Three Months Ended Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Income Recognized (Dollars in thousands) With no related allowance recorded: Commercial and industrial $ 1,015 $ 1,985 $ - $ 1,045 $ 6 SBA 1,917 2,272 - 1,960 16 Real estate: Commercial real estate Owner occupied 6,669 7,081 - 6,434 32 Non-owner 13,547 16,198 - 13,479 401 Construction Speculative 384 402 - 384 - Non-speculative - - - - - SFR mortgage 4,248 5,024 - 4,259 34 Dairy & livestock and agribusiness 1,324 1,610 - 1,839 1 Municipal lease finance receivables - - - - - Consumer and other loans 801 1,379 - 809 5 Total 29,905 35,951 - 30,209 495 With a related allowance recorded: Commercial and industrial 135 136 88 152 2 SBA 9 25 9 10 - Real estate: Commercial real estate Owner occupied - - - - - Non-owner - - - - - Construction Speculative - - - - - Non-speculative - - - - - SFR mortgage - - - - - Dairy & livestock and agribusiness - - - - - Municipal lease finance receivables - - - - - Consumer and other loans - - - - - Total 144 161 97 162 2 Total impaired loans $ 30,049 $ 36,112 $ 97 $ 30,371 $ 497 As of and For the Three Months Ended Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Income Recognized (Dollars in thousands) With no related allowance recorded Commercial and industrial $ 805 $ 1,677 $ - $ 831 $ 7 SBA 3,050 3,765 - 3,089 13 Real estate: Commercial real estate Owner occupied 5,315 6,507 - 5,095 51 Non-owner 30,262 33,368 - 30,400 343 Construction Speculative - - - - - Non-speculative - - - - - SFR mortgage 5,499 6,406 - 5,512 27 Dairy & livestock and agribusiness 714 714 - 710 8 Municipal lease finance receivables - - - - - Consumer and other loans 868 1,420 - 888 4 Total 46,513 53,857 - 46,525 453 With a related allowance recorded Commercial and industrial 672 741 575 687 3 SBA 254 274 55 254 2 Real estate: Commercial real estate Owner occupied - - - - - Non-owner - - - - - Construction Speculative 7,651 7,651 48 7,651 97 Non-speculative - - - - - SFR mortgage 375 426 16 515 2 Dairy & livestock and agribusiness - - - - - Municipal lease finance receivables - - - - - Consumer and other loans - - - - - Total 8,952 9,092 694 9,107 104 Total impaired loans $ 55,465 $ 62,949 $ 694 $ 55,632 $ 557 As of December 31, 2016 Recorded Investment Unpaid Principal Balance Related Allowance (Dollars in thousands) With no related allowance recorded Commercial and industrial $ 730 $ 1,646 $ - SBA 3,386 4,189 - Real estate: Commercial real estate Owner occupied 1,797 2,276 - Non-owner 13,331 15,842 - Construction Speculative - - - Non-speculative - - - SFR mortgage 5,174 6,075 - Dairy & livestock and agribusiness 747 747 - Municipal lease finance receivables - - - Consumer and other loans 853 1,423 - Total 26,018 32,198 - With a related allowance recorded Commercial and industrial 171 171 114 SBA 196 212 27 Real estate: Commercial real estate Owner occupied - - - Non-owner - - - Construction Speculative - - - Non-speculative - - - SFR mortgage - - - Dairy & livestock and agribusiness - - - Municipal lease finance receivables - - - Consumer and other loans - - - Total 367 383 141 Total impaired loans $ 26,385 $ 32,581 $ 141 The Company recognizes the charge-off charge-off non-collateral Reserve for Unfunded Loan Commitments The allowance for off-balance off-balance Troubled Debt Restructurings (“TDRs”) Loans that are reported as TDRs are considered impaired and charge-off Summary of Significant Accounting Policies 10-K As of March 31, 2017, there were $21.1 million of loans classified as a TDR, of which $1.4 million were nonperforming and $19.7 million were performing. TDRs on accrual status are comprised of loans that were accruing interest at the time of restructuring or have demonstrated repayment performance in compliance with the restructured terms for a sustained period and for which the Company anticipates full repayment of both principal and interest. At March 31, 2017, performing TDRs were comprised of six commercial real estate loans of $14.6 million, 11 SFR mortgage loans of $3.3 million, two SBA loans of $837,000, five commercial and industrial loans of $644,000, and one consumer loan of $363,000. The majority of TDRs have no specific allowance allocated as any impairment amount is normally charged off at the time a probable loss is determined. We have allocated $97,000 and $141,000 of specific allowance to TDRs as of March 31, 2017 and December 31, 2016, respectively. The following table provides a summary of the activity related to TDRs for the periods presented. For the Three Months Ended March 31, 2017 2016 (Dollars in thousands) Performing TDRs: Beginning balance $ 19,233 $ 42,687 New modifications 3,143 1,006 Payoffs and payments, net (3,003 ) (6,372 ) TDRs returned to accrual status 329 - TDRs placed on nonaccrual status - - Ending balance $ 19,702 $ 37,321 Nonperforming TDRs: Beginning balance $ 1,626 $ 12,622 New modifications 2,066 82 Charge-offs - (38 ) Payoffs and payments, net (1,956 ) (306 ) TDRs returned to accrual status (329 ) - TDRs placed on nonaccrual status - - Ending balance $ 1,407 $ 12,360 Total TDRs $ 21,109 $ 49,681 The following tables summarize loans modified as troubled debt restructurings for the periods presented. Modifications (1) For the Three Months Ended March 31, 2017 Number of Loans Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Outstanding Recorded Investment at March 31, 2017 Financial Effect Resulting From Modifications (2) (Dollars in thousands) Commercial and industrial: Interest rate reduction - $ - $ - $ - $ - Change in amortization period or maturity - - - - - SBA: Interest rate reduction - - - - - Change in amortization period or maturity - - - - - Real estate: Commercial real estate: Owner occupied Interest rate reduction - - - - - Change in amortization period or maturity 1 3,143 3,143 3,143 - Non-owner Interest rate reduction - - - - - Change in amortization period or maturity - - - - - Dairy & livestock and agribusiness: Interest rate reduction - - - - - Change in amortization period or maturity 1 1,984 1,984 78 - Consumer: Interest rate reduction - - - - - Change in amortization period or maturity 1 82 82 80 - Total loans 3 $ 5,209 $ 5,209 $ 3,301 $ - For the Three Months Ended March 31, 2016 Number of Loans Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Outstanding Recorded Investment at March 31, 2016 Financial Effect Resulting From Modifications (2) (Dollars in thousands) Commercial and industrial: Interest rate reduction - $ - $ - $ - $ - Change in amortization period or maturity - - - - - SBA: Interest rate reduction - - - - - Change in amortization period or maturity 1 194 194 193 28 Real estate: Commercial real estate: Owner occupied Interest rate reduction - - - - - Change in amortization period or maturity 2 812 812 778 - Non-owner Interest rate reduction - - - - - Change in amortization period or maturity - - - - - Consumer: Interest rate reduction - - - - - Change in amortization period or maturity 2 82 82 75 - Total loans 5 $ 1,088 $ 1,088 $ 1,046 $ 28 (1) The tables above exclude modified loans that were paid off prior to the end of the period. (2) Financial effects resulting from modifications represent charge-offs and specific allowance recorded at modification date. As of March 31, 2017, there were no loans that were previously modified as a TDR within the previous 12 months that subsequently defaulted during the three months ended March 31, 2017. |