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. December 31, 2017 2016 (Dollars in thousands) Commercial and industrial $ 513,325 $ 485,078 SBA 122,055 97,184 Real estate: Commercial real estate 3,376,713 2,930,141 Construction 77,982 85,879 SFR mortgage 236,202 250,605 Dairy & livestock and agribusiness 347,289 338,631 Municipal lease finance receivables 70,243 64,639 Consumer and other loans 64,229 78,274 Gross loans, excluding PCI loans 4,808,038 4,330,431 Less: Deferred loan fees, net (6,289) (6,952) Gross loans, excluding PCI loans, net of deferred loan fees 4,801,749 4,323,479 Less: Allowance for loan losses (59,218) (60,321) Net loans, excluding PCI loans 4,742,531 4,263,158 PCI Loans 30,908 73,093 Discount on PCI loans (2,026) (1,508) Less: Allowance for loan losses (367) (1,219) PCI loans, net 28,515 70,366 Total loans and lease finance receivables $ 4,771,046 $ 4,333,524 As of December 31, 2017, 76.77% of the total gross loan portfolio (excluding PCI loans) consisted of real estate loans, 70.23% 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 December 31, 2017, $206.1 million, or 6.10% 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 $118.2 million for loans secured by dairy & livestock land and $87.9 million for loans secured by agricultural land at December 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 December 31, 2017, dairy & livestock and agribusiness loans of $347.3 million were comprised of $310.6 million for dairy & livestock loans and $36.7 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 December 31, 2017, the Company held approximately $2.17 billion of total fixed rate loans, including PCI loans. At December 31, 2017 and 2016, loans totaling $3.68 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 affected in the future. The following table summarizes loans by type, excluding PCI loans, according to our internal risk ratings for the periods presented. December 31, 2017 Pass Special Mention Substandard Doubtful & Total (Dollars in thousands) Commercial and industrial $ 483,641 $ 19,566 $ 10,118 $ - $ 513,325 SBA 112,835 5,358 3,862 - 122,055 Real estate: Commercial real estate Owner occupied 1,009,199 76,111 10,970 - 1,096,280 Non-owner 2,257,130 16,434 6,869 - 2,280,433 Construction Speculative 60,042 - - - 60,042 Non-speculative 17,940 - - - 17,940 SFR mortgage 229,032 3,124 4,046 - 236,202 Dairy & livestock and agribusiness 321,413 9,047 16,829 - 347,289 Municipal lease finance receivables 69,644 599 - - 70,243 Consumer and other loans 61,715 1,255 1,259 - 64,229 Total gross loans, excluding PCI loans $ 4,622,591 $ 131,494 $ 53,953 $ - $ 4,808,038 December 31, 2016 Pass Special Mention 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 Audit and Director Loan Committee provide 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 Management believes that the ALLL was appropriate at December 31, 2017 and 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 Year Ended December 31, 2017 Ending Balance Charge-offs Recoveries (Recapture of) Ending Balance (Dollars in thousands) Commercial and industrial $ 8,154 $ (138) $ 118 $ (854) $ 7,280 SBA 871 - 78 (80) 869 Real estate: Commercial real estate 37,443 - 154 4,125 41,722 Construction 1,096 - 6,036 (6,148) 984 SFR mortgage 2,287 - 212 (387) 2,112 Dairy & livestock and agribusiness 8,541 - 19 (3,913) 4,647 Municipal lease finance receivables 941 - - (90) 851 Consumer and other loans 988 (13) 79 (301) 753 PCI loans 1,219 - - (852) 367 Total allowance for loan losses $ 61,540 $ (151) $ 6,696 $ (8,500) $ 59,585 For the Year Ended December 31, 2016 Ending Balance Charge-offs Recoveries (Recapture of) Ending Balance (Dollars in thousands) Commercial and industrial $ 8,588 $ (120) $ 630 $ (944) $ 8,154 SBA 993 - 40 (162) 871 Real estate: Commercial real estate 36,995 - 792 (344) 37,443 Construction 2,389 - 7,174 (8,467) 1,096 SFR mortgage 2,103 (102) - 286 2,287 Dairy & livestock and agribusiness 6,029 - 216 2,296 8,541 Municipal lease finance receivables 1,153 - - (212) 941 Consumer and other loans 906 (16) 170 (72) 988 PCI loans - - - 1,219 1,219 Total allowance for loan losses $ 59,156 $ (238) $ 9,022 $ (6,400) $ 61,540 For the Year Ended December 31, 2015 Ending Balance Charge-offs Recoveries (Recapture of) Ending Balance (Dollars in thousands) Commercial and industrial $ 7,074 $ (411) $ 319 $ 1,606 $ 8,588 SBA 2,557 (37) 41 (1,568) 993 Real estate: Commercial real estate 33,373 (117) 4,330 (591) 36,995 Construction 988 - 581 820 2,389 SFR mortgage 2,344 (215) 186 (212) 2,103 Dairy & livestock and agribusiness 5,479 - 407 143 6,029 Municipal lease finance receivables 1,412 - - (259) 1,153 Consumer and other loans 1,262 (229) 76 (203) 906 Unallocated (1) 5,336 - - (5,336) - Total allowance for loan losses $ 59,825 $ (1,009) $ 5,940 $ (5,600) $ 59,156 (1) Based upon changes to our ALLL methodology, as described earlier in this document, beginning with the fourth quarter of 2015 and coinciding with the implementation of the new ALLL methodology, the Bank’s previous “unallocated reserve” was absorbed into the qualitative component of the allowance. The following tables present the recorded investment in loans held-for-investment December 31, 2017 Recorded Investment in Loans Allowance for Loan Losses Individually Collectively Acquired with Individually Collectively Acquired with (Dollars in thousands) Commercial and industrial $ 440 $ 512,885 $ - $ - $ 7,280 $ - SBA 1,531 120,524 - 1 868 - Real estate: Commercial real estate 8,133 3,368,580 - - 41,722 - Construction - 77,982 - - 984 - SFR mortgage 4,040 232,162 - - 2,112 - Dairy & livestock and agribusiness 829 346,460 - - 4,647 - Municipal lease finance receivables - 70,243 - - 851 - Consumer and other loans 552 63,677 - 74 679 - PCI loans - - 28,882 - - 367 Total $ 15,525 $ 4,792,513 $ 28,882 $ 75 $ 59,143 $ 367 December 31, 2016 Recorded Investment in Loans Allowance for Loan Losses Individually Collectively Acquired with Individually Collectively Acquired (Dollars in thousands) Commercial and industrial $ 901 $ 484,177 $ - $ 114 $ 8,040 $ - SBA 3,582 93,602 - 27 844 - Real estate: Commercial real estate 15,128 2,915,013 - - 37,443 - Construction - 85,879 - - 1,096 - SFR mortgage 5,174 245,431 - - 2,287 - Dairy & livestock and agribusiness 747 337,884 - - 8,541 - Municipal lease finance receivables - 64,639 - - 941 - Consumer and other loans 853 77,421 - - 988 - PCI loans - - 71,585 - - 1,219 Total $ 26,385 $ 4,304,046 $ 71,585 $ 141 $ 60,180 $ 1,219 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 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. December 31, 2017 30-59 60-89 Total Past Due and Nonaccrual (1) Current Total Loans (Dollars in thousands) Commercial and industrial $ 768 $ - $ 768 $ 250 $ 512,307 $ 513,325 SBA 403 - 403 906 120,746 122,055 Real estate: Commercial real estate Owner occupied - - - 4,365 1,091,915 1,096,280 Non-owner - - - 2,477 2,277,956 2,280,433 Construction Speculative (2) - - - - 60,042 60,042 Non-speculative - - - - 17,940 17,940 SFR mortgage - - - 1,337 234,865 236,202 Dairy & livestock and agribusiness - - - 829 346,460 347,289 Municipal lease finance receivables - - - - 70,243 70,243 Consumer and other loans 1 - 1 552 63,676 64,229 Total gross loans, excluding PCI loans $ 1,172 $ - $ 1,172 $ 10,716 $ 4,796,150 $ 4,808,038 (1) As of December 31, 2017, $3.6 million of nonaccruing loans were current, $376,000 were 60-89 (2) Speculative construction loans are generally for properties where there is no identified buyer or renter. December 31, 2016 30-59 60-89 Total Past Due Nonaccrual (1) Current Total Loans (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 December 31, 2017, the Company had impaired loans, excluding PCI loans, of $15.5 million and included $3.7 million of loans acquired from VBB in the first quarter of 2017. Impaired loans included $6.8 million of nonaccrual commercial real estate loans, $1.3 million of nonaccrual SFR mortgage loans, $906,000 million of nonaccrual SBA loans, $829,000 of nonaccrual dairy & livestock and agribusiness loans, $552,000 of nonaccrual consumer and other loans, and $250,000 of nonaccrual commercial and industrial loans. These impaired loans included $9.0 million of loans whose terms were modified in a troubled debt restructuring, of which $4.2 million are classified as nonaccrual. The remaining balance of $4.8 million consisted of 16 loans performing according to the restructured terms. The impaired loans had a specific allowance of $75,000 at December 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 Year Ended December 31, 2017 Recorded Unpaid Related Average Interest (Dollars in thousands) With no related allowance recorded: Commercial and industrial $ 440 $ 980 $ - $ 548 $ 10 SBA 1,530 1,699 - 1,598 47 Real estate: Commercial real estate Owner occupied 4,365 4,763 - 4,414 36 Non-owner 3,768 5,107 - 3,951 94 Construction Speculative - - - - - Non-speculative - - - - - SFR mortgage 4,040 4,692 - 4,119 118 Dairy & livestock and agribusiness 829 1,091 - 988 1 Municipal lease finance receivables - - - - - Consumer and other loans 174 370 - 202 - Total 15,146 18,702 - 15,820 306 With a related allowance recorded: Commercial and industrial - - - - - SBA 1 18 1 6 - 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 378 391 74 385 - Total 379 409 75 391 - Total impaired loans $ 15,525 $ 19,111 $ 75 $ 16,211 $ 306 As of and For the Year Ended December 31, 2016 Recorded Unpaid Related Average Interest (Dollars in thousands) With no related allowance recorded: Commercial and industrial $ 730 $ 1,646 $ - $ 832 $ 26 SBA 3,386 4,189 - 3,709 50 Real estate: Commercial real estate Owner occupied 1,797 2,276 - 1,410 70 Non-owner 13,331 15,842 - 13,517 592 Construction Speculative - - - - - Non-speculative - - - - - SFR mortgage 5,174 6,075 - 5,327 135 Dairy & livestock and agribusiness 747 747 - 692 47 Municipal lease finance receivables - - - - - Consumer and other loans 853 1,423 - 919 18 Total 26,018 32,198 - 26,406 938 With a related allowance recorded: Commercial and industrial 171 171 114 233 9 SBA 196 212 27 206 14 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 367 383 141 439 23 Total impaired loans $ 26,385 $ 32,581 $ 141 $ 26,845 $ 961 As of and For the Year Ended December 31, 2015 Recorded Investment Unpaid Principal Related Allowance Average Recorded Investment Interest Income Recognized (Dollars in thousands) With no related allowance recorded: Commercial and industrial $ 1,017 $ 1,894 $ - $ 1,122 $ 38 SBA 3,207 3,877 - 3,333 51 Real estate: Commercial real estate Owner occupied 6,252 7,445 - 6,718 97 Non-owner 34,041 37,177 - 34,639 1,787 Construction Speculative - - - - - Non-speculative - - - - - SFR mortgage 5,665 6,453 - 5,771 109 Dairy & livestock and agribusiness 3,685 3,684 - 3,687 177 Municipal lease finance receivables - - - - - Consumer and other loans 890 1,454 - 922 17 Total 54,757 61,984 - 56,192 2,276 With a related allowance recorded: Commercial and industrial 626 695 626 637 - SBA 41 47 10 45 - Real estate: Commercial real estate Owner occupied - - - - - Non-owner - - - - - Construction Speculative 7,651 7,651 13 7,651 388 Non-speculative - - - - - SFR mortgage 588 640 20 607 12 Dairy & livestock and agribusiness - - - - - Municipal lease finance receivables - - - - - Consumer and other loans 43 45 - 45 - Total 8,949 9,078 669 8,985 400 Total impaired loans $ 63,706 $ 71,062 $ 669 $ 65,177 $ 2,676 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 Loans that are reported as TDRs are considered impaired and charge-off Summary of Significant Accounting Policies, Troubled Debt Restructurings As of December 31, 2017, there were $9.0 million of loans classified as a TDR, of which $4.2 million were nonperforming and $4.8 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 December 31, 2017, performing TDRs were comprised of 10 SFR mortgage loans of $2.7 million, two commercial real estate loans of $1.3 million, one SBA loan of $625,000, and three commercial and industrial loans of $190,000. 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 $1,000 and $141,000 of specific allowance to TDRs as of December 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 Year Ended December 31, 2017 2016 (Dollars in thousands) Performing TDRs: Beginning balance $ 19,233 $ 42,687 New modifications 3,143 1,996 Payoffs/payments, net and other (14,752) (34,001) TDRs returned to accrual status 329 8,551 TDRs placed on nonaccrual status (3,144) - Ending balance $ 4,809 $ 19,233 Nonperforming TDRs: Beginning balance $ 1,626 $ 12,622 New modifications 2,066 102 Charge-offs - (38) Payoffs/payments, net and other (2,307) (2,509) TDRs returned to accrual status (329) (8,551) TDRs placed on nonaccrual status 3,144 - Ending balance $ 4,200 $ 1,626 Total TDRs $ 9,009 $ 20,859 The following tables summarize loans modified as troubled debt restructurings for the periods presented. Modifications (1) For the Year Ended December 31, 2017 Number of Pre-Modification Post-Modification Outstanding Financial Effect (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 - - - - - Total loans 2 $ 5,127 $ 5,127 $ 3,221 $ - For the Year Ended December 31, 2016 Number of Pre-Modification Post-Modification Outstanding Financial Effect (Dollars in thousands) Commercial and industrial: Interest rate reduction 1 $ 112 $ 112 $ 103 $ - Change in amortization period or maturity - - - - - SBA: Interest rate reduction - - - - - Change in amortization period or maturity 2 214 214 196 28 Real estate: Commercial real estate: Owner occupied Interest rate reduction - - - - - Change in amortization period or maturity - - - - - Non-owner Interest rate reduction 1 759 759 756 - Change in amortization period or maturity - - - - - Dairy & livestock and agribusiness: Interest rate reduction - - - - - Change in amortization period or maturity - - - - - Consumer: Interest rate reduction - - - - - Change in amortization period or maturity 3 201 201 185 - Total loans 7 $ 1,286 $ 1,286 $ 1,240 $ 28 For the Year Ended December 31, 2015 Number of Pre-Modification Post-Modification Outstanding Financial Effect (Dollars in thousands) Commercial and industrial: Interest rate reduction - $ - $ - $ - $ - Change in amortization period or maturity 1 203 203 203 203 SBA: Interest rate reduction - - - - - Change in amortization period or maturity 1 330 330 320 - Real estate: Commercial real estate: Owner occupied Interest rate reduction - - - - - Change in amortization period or maturity 2 823 823 821 - Non-owner Interest rate reduction 1 2,376 2,376 2,316 - Change in amortization period or maturity 1 280 280 280 - Dairy & livestock and agribusiness: Interest rate reduction - - - - - Change in amortization period or maturity - - - - - SFR mortgage: Interest rate reduction 1 322 322 326 - Change in amortization period or maturity - - - - - Total loans 7 $ 4,334 $ 4,334 $ 4,266 $ 203 (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 December 31, 2017, there was one commercial real estate loan with an outstanding balance of $3.1 million that was modified as a TDR within the previous 12 months that subsequently defaulted. As of December 31, 2016 and 2015, there were no loans that were previously modified as a troubled debt restructuring within the previous 12 months that subsequently defaulted during each of the years ended December 31, 2016 and 2015, respectively. |