LOANS AND ALLOWANCE FOR CREDIT LOSSES

9 Months Ended

Sep. 30, 2020

NOTE 3 - LOANS AND ALLOWANCE FOR CREDIT LOSSES

The following table summarizes the Company’s loan portfolio by type of loan as of:

	September 30, 2020			December 31, 2019
Commercial and industrial	$	531,152		$	279,583
Real estate:
Construction and development		269,101			280,498
Commercial real estate		602,664			567,360
Farmland		80,197			57,476
1-4 family residential		385,783			412,166
Multi-family residential		19,499			37,379
Consumer		52,855			53,245
Agricultural		17,004			18,359
Overdrafts		379			329
Total loans⁽¹⁾		1,958,634			1,706,395
Net of:
Deferred loan (fees) costs, net		(3,643	)		601
Allowance for credit losses		(33,757	)		(16,202	)
Total net loans⁽¹⁾	$	1,921,234		$	1,690,794

(1) Excludes accrued interest receivable on loans of $6.7 million and $6.4 million as of September 30, 2020 and December 31, 2019, respectively, which is presented separately on the consolidated balance sheets.

The Company’s estimate of the allowance for credit losses (“ACL”) reflects losses expected over the remaining contractual life of the assets. The contractual term does not consider extensions, renewals or modifications unless the Company has identified an expected troubled debt restructuring. The following tables present the activity in the ACL by class of loans for the nine months ended September 30, 2020, and the activity in the allowance for loan loss by portfolio segment for the year ended December 31, 2019 and for the nine months ended September 30, 2019:

For the Nine Months Ended September 30, 2020	Commercial and industrial			Construction and development		Commercial real estate		Farmland		1-4 family residential			Multi-family residential			Consumer			Agricultural			Overdrafts			Total
Allowance for credit losses:
Beginning balance, prior to adoption of ASC 326	$	2,056		$	2,378	$	6,853	$	570	$	3,125		$	409		$	602		$	197		$	12		$	16,202
Impact of adopting ASC 326		546			323		2,228		26		1,339			(50	)		72			73			(9	)		4,548
Provision for credit losses		1,366			2,228		6,613		694		1,778			(34	)		407			59			89			13,200
Loans charged-off		(43	)		—		—		—		(59	)		—			(136	)		(18	)		(128	)		(384	)
Recoveries		93			—		1		—		2			—			30			20			45			191
Ending balance	$	4,018		$	4,929	$	15,695	$	1,290	$	6,185		$	325		$	975		$	331		$	9		$	33,757

For the Year Ended December 31, 2019	Commercial and industrial			Construction and development		Commercial real estate		Farmland			1-4 family residential			Multi-family residential			Consumer			Agricultural			Overdrafts			Total
Allowance for loan losses:
Beginning balance	$	1,751		$	1,920	$	6,025	$	643		$	2,868		$	631		$	565		$	238		$	10		$	14,651
Provision for loan losses		(117	)		458		827		(73	)		268			(222	)		(2	)		(41	)		152			1,250
Loans charged-off		(86	)		—		—		—			(14	)		—			(72	)		(89	)		(192	)		(453	)
Recoveries		508			—		1		—			3			—			111			89			42			754
Ending balance	$	2,056		$	2,378	$	6,853	$	570		$	3,125		$	409		$	602		$	197		$	12		$	16,202

For the Nine Months Ended September 30, 2019	Commercial and industrial			Construction and development		Commercial real estate		Farmland			1-4 family residential			Multi-family residential		Consumer			Agricultural			Overdrafts			Total
Allowance for loan losses:
Beginning balance	$	1,751		$	1,920	$	6,025	$	643		$	2,868		$	631	$	565		$	238		$	10		$	14,651
Provision for loan losses		(152	)		215		863		(49	)		220			199		(28	)		(126	)		108			1,250
Loans charged-off		(49	)		—		—		—			(14	)		—		(32	)		—			(137	)		(232	)
Recoveries		507			—		1		—			3			—		95			89			30			725
Ending balance	$	2,057		$	2,135	$	6,889	$	594		$	3,077		$	830	$	600		$	201		$	11		$	16,394

The ACL as of September 30, 2020 was estimated using the current expected credit loss model. The $300,000 provision reversal during the current quarter resulted primarily from lower loan balances in loan segments with higher general allocation factors as of September 30, 2020, compared to prior quarters. Additionally, in the second quarter of 2020, qualitative factor adjustments were made in our Current Expected Credit Losses (“CECL”) model, primarily derived from changes in national GDP, Texas unemployment rates and national industry-related CRE trends, all of which are impacted by the effects of COVID-19 and resulted in the $12.1 million provision expense during second quarter. Qualitative factor adjustments made in the second quarter remained consistent in the third quarter because our CECL model assumes a six-to-nine month lag in estimated losses as a result of economic factors present during the second quarter, as well as continued uncertainty surrounding the virus and timing of economic recovery.

The Company uses the weighted-average remaining maturity (WARM) method as the basis for the estimation of expected credit losses. The WARM method uses a historical average annual charge-off rate containing loss content over a historical lookback period and is used as a foundation for estimating the credit loss reserve for the remaining outstanding balances of loans in a segment at the balance sheet date. The average annual charge-off rate is applied to the contractual term, further adjusted for estimated prepayments, to determine the unadjusted historical charge-off rate. The calculation of the unadjusted historical charge-off rate is then adjusted, using qualitative factors, for current conditions and for reasonable and supportable forecast periods. Qualitative loss factors are based on the Company’s judgement of company, market, industry or business specific data, differences in loan-specific risk characteristics such as underwriting standards, portfolio mix, risk grades, delinquency level, or term. These qualitative factors serve to compensate for additional areas of uncertainty inherent in the portfolio that are not reflected in our historic loss factors. Additionally, we have adjusted for changes in expected environmental and economic conditions, such as changes in unemployment rates, property values, and other relevant factors over the next 12 to 24 months. Management adjusted the historical loss experience for these expectations. No reversion adjustments were necessary, as the starting point for the Company’s estimate was a cumulative loss rate covering the expected contractual term of the portfolio.

The ACL is measured on a collective segment basis when similar risk characteristics exist. Our loan portfolio is segmented first by regulatory call report code, and second, by internally identified risk grades for our commercial loan segments and by delinquency status for our consumer loan segments. We also have separate segments for our warehouse lines of credit, for our internally originated SBA loans and for our SBA loans acquired from Westbound Bank. Consistent forecasts of the loss drivers are used across the loan segments. For loans that do not share general risk characteristics with segments, we estimate a specific reserve on an individual basis. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan's initial effective interest rate or the fair value of collateral for collateral-dependent loans.

Assets are graded “pass” when the relationship exhibits acceptable credit risk and indicates repayment ability, tolerable collateral coverage and reasonable performance history. Lending relationships exhibiting potentially significant credit risk and marginal repayment ability and/or asset protection are graded “special mention.” Assets classified as “substandard” are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness that jeopardizes the liquidation of the debt. Substandard graded loans are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Assets graded “doubtful” are substandard graded loans that have added characteristics that make collection or liquidation in full improbable. Loans that are on nonaccrual status are generally classified as substandard.

In general, the loans in our portfolio have low historical credit losses. The Company closely monitors economic conditions and loan performance trends to manage and evaluate the exposure to credit risk. Key factors tracked by the Company and utilized in evaluating the credit quality of the loan portfolio include trends in delinquency ratios, the level of nonperforming assets, borrower’s repayment capacity, and collateral coverage.

The following table summarizes the credit exposure in the Company’s loan portfolio, by year of origination, as of September 30, 2020:

September 30, 2020	2020		2019		2018			2017		2016		Prior		Revolving Loans Amortized Cost		Total
Commercial and industrial:
Risk rating
Pass	$	361,379	$	35,265	$	16,564		$	7,252	$	7,194	$	17,740	$	80,480	$	525,874
Special mention		—		—		—			3,523		1,324		—		150		4,997
Substandard		—		—		210			—		56		—		—		266
Nonaccrual		—		10		5			—		—		—		—		15
Total commercial and industrial loans	$	361,379	$	35,275	$	16,779		$	10,775	$	8,574	$	17,740	$	80,630	$	531,152

Charge-offs	$	—	$	—	$	(43	)	$	—	$	—	$	—	$	—	$	(43	)
Recoveries		—		—		43			—		—		14		36		93
Current period net	$	—	$	—	$	—		$	—	$	—	$	14	$	36	$	50

Construction and development:
Risk rating
Pass	$	90,694	$	92,719	$	29,841		$	25,992	$	8,753	$	10,585	$	4,539	$	263,123
Special mention		262		164		—			1,001		—		—		—		1,427
Substandard		2,907		609		5			—		680		—		—		4,201
Nonaccrual		—		50		300			—		—		—		—		350
Total construction and development loans	$	93,863	$	93,542	$	30,146		$	26,993	$	9,433	$	10,585	$	4,539	$	269,101

Charge-offs	$	—	$	—	$	—		$	—	$	—	$	—	$	—	$	—
Recoveries		—		—		—			—		—		—		—		—
Current period net	$	—	$	—	$	—		$	—	$	—	$	—	$	—	$	—

Commercial real estate:
Risk rating
Pass	$	59,513	$	98,704	$	99,042		$	75,436	$	94,333	$	128,363	$	6,349	$	561,740
Special mention		—		4,979		3,570			5,335		2,495		914		—		17,293
Substandard		—		—		2,014			437		2,038		8,293		—		12,782
Nonaccrual		—		1,140		153			4,124		4,751		681		—		10,849
Total commercial real estate loans	$	59,513	$	104,823	$	104,779		$	85,332	$	103,617	$	138,251	$	6,349	$	602,664

Charge-offs	$	—	$	—	$	—		$	—	$	—	$	—	$	—	$	—
Recoveries		—		—		—			—		—		1		—		1
Current period net	$	—	$	—	$	—		$	—	$	—	$	1	$	—	$	1

Farmland:
Risk rating
Pass	$	13,842	$	12,939	$	11,854		$	7,382	$	11,014	$	17,591	$	5,283	$	79,905
Special mention		—		—		—			—		—		37		—		37
Substandard		—		—		—			—		—		135		—		135
Nonaccrual		—		—		—			—		—		120		—		120
Total farmland loans	$	13,842	$	12,939	$	11,854		$	7,382	$	11,014	$	17,883	$	5,283	$	80,197

Charge-offs	$	—	$	—	$	—		$	—	$	—	$	—	$	—	$	—
Recoveries		—		—		—			—		—		—		—		—
Current period net	$	—	$	—	$	—		$	—	$	—	$	—	$	—	$	—

September 30, 2020	2020			2019			2018			2017			2016			Prior			Revolving Loans Amortized Cost		Total
1-4 family residential:
Risk rating
Pass	$	63,466		$	64,012		$	54,716		$	39,389		$	46,163		$	105,068		$	10,780	$	383,594
Special mention		—			—			—			—			—			—			—		—
Substandard		—			—			—			—			—			—			—		—
Nonaccrual		—			—			332			435			207			1,215			—		2,189
Total 1-4 family residential loans	$	63,466		$	64,012		$	55,048		$	39,824		$	46,370		$	106,283		$	10,780	$	385,783

Charge-offs	$	—		$	—		$	—		$	—		$	—		$	(59	)	$	—	$	(59	)
Recoveries		—			—			—			—			—			2			—		2
Current period net	$	—		$	—		$	—		$	—		$	—		$	(57	)	$	—	$	(57	)

Multi-family residential:
Risk rating
Pass	$	4,180		$	4,528		$	2,913		$	1,408		$	1,758		$	4,503		$	209	$	19,499
Special mention		—			—			—			—			—			—			—		—
Substandard		—			—			—			—			—			—			—		—
Nonaccrual		—			—			—			—			—			—			—		—
Total multi-family residential loans	$	4,180		$	4,528		$	2,913		$	1,408		$	1,758		$	4,503		$	209	$	19,499

Charge-offs	$	—		$	—		$	—		$	—		$	—		$	—		$	—	$	—
Recoveries		—			—			—			—			—			—			—		—
Current period net	$	—		$	—		$	—		$	—		$	—		$	—		$	—	$	—

Consumer and overdrafts:
Risk rating
Pass	$	19,940		$	14,466		$	11,420		$	2,297		$	937		$	617		$	3,292	$	52,969
Special mention		5			1			23			7			—			11			—		47
Substandard		—			—			—			—			—			—			—		—
Nonaccrual		9			45			140			20			4			—			—		218
Total consumer loans and overdrafts	$	19,954		$	14,512		$	11,583		$	2,324		$	941		$	628		$	3,292	$	53,234

Charge-offs	$	(128	)	$	(61	)	$	(27	)	$	(41	)	$	(3	)	$	(4	)	$	—	$	(264	)
Recoveries		41			2			12			8			3			9			—		75
Current period net	$	(87	)	$	(59	)	$	(15	)	$	(33	)	$	—		$	5		$	—	$	(189	)

Agricultural:
Risk rating
Pass	$	2,776		$	1,978		$	2,534		$	774		$	336		$	223		$	8,209	$	16,830
Special mention		—			—			—			51			—			—			—		51
Substandard		—			—			10			—			74			—			—		84
Nonaccrual		—			—			30			—			—			2			7		39
Total agricultural loans	$	2,776		$	1,978		$	2,574		$	825		$	410		$	225		$	8,216	$	17,004

Charge-offs	$	—		$	—		$	(18	)	$	—		$	—		$	—		$	—	$	(18	)
Recoveries		—			—			—			—			20			—			—		20
Current period net	$	—		$	—		$	(18	)	$	—		$	20		$	—		$	—	$	2

Total loans:
Risk rating
Pass	$	615,790		$	324,611		$	228,884		$	159,930		$	170,488		$	284,690		$	119,141	$	1,903,534
Special mention		267			5,144			3,593			9,917			3,819			962			150		23,852
Substandard		2,907			609			2,239			437			2,848			8,428			—		17,468
Nonaccrual		9			1,245			960			4,579			4,962			2,018			7		13,780
Total loans	$	618,973		$	331,609		$	235,676		$	174,863		$	182,117		$	296,098		$	119,298	$	1,958,634

Charge-offs	$	(128	)	$	(61	)	$	(88	)	$	(41	)	$	(3	)	$	(63	)	$	—	$	(384	)
Recoveries		41			2			55			8			23			26			36		191
Total current period net (charge-offs) recoveries	$	(87	)	$	(59	)	$	(33	)	$	(33	)	$	20		$	(37	)	$	36	$	(193	)

The following table summarizes the credit exposure in the Company’s loan portfolio by class as of December 31, 2019:

December 31, 2019	Commercial and industrial		Construction and development		Commercial real estate		Farmland		1-4 family residential		Multi-family residential		Consumer and Overdrafts		Agricultural		Total
Grade:
Pass	$	279,217	$	278,679	$	548,662	$	57,152	$	409,896	$	37,379	$	53,327	$	18,101	$	1,682,413
Special mention		153		600		1,071		91		1,425		—		192		126		3,658
Substandard		213		1,219		17,627		233		845		—		55		132		20,324
Total	$	279,583	$	280,498	$	567,360	$	57,476	$	412,166	$	37,379	$	53,574	$	18,359	$	1,706,395

There were no loans classified in the “doubtful” or “loss” risk rating categories as of September 30, 2020 and December 31, 2019.

The following table presents the amortized cost basis of individually evaluated collateral-dependent loans by class of loans, and their impact on ACL, as of September 30, 2020:

	Real Estate		Non-RE		Total		Allowance for Credit Losses Allocation
Commercial and industrial	$	129	$	—	$	129	$	37
Real estate:
Construction and development		609		—		609		174
Commercial real estate		9,987		—		9,987		1,990
Farmland		—		—		—		—
1-4 family residential		—		—		—		—
Multi-family residential		—		—		—		—
Consumer		—		—		—		—
Agricultural		—		—		—		—
Overdrafts		—		—		—		—
Total	$	10,725	$	—	$	10,725	$	2,201

The following tables summarize the payment status of loans in the Company’s total loan portfolio, including an aging of delinquent loans and loans 90 days or more past due continuing to accrue interest as of:

September 30, 2020	30 to 59 Days Past Due		60 to 89 Days Past Due		90 Days and Greater Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Commercial and industrial	$	78	$	35	$	—	$	113	$	531,039	$	531,152	$	—
Real estate:
Construction and development		—		164		350		514		268,587		269,101		—
Commercial real estate		448		525		8,698		9,671		592,993		602,664		—
Farmland		3		—		—		3		80,194		80,197		—
1-4 family residential		1,481		88		177		1,746		384,037		385,783		—
Multi-family residential		—		—		—		—		19,499		19,499		—
Consumer		274		93		23		390		52,465		52,855		—
Agricultural		95		18		—		113		16,891		17,004		—
Overdrafts		—		—		—		—		379		379		—
Total	$	2,379	$	923	$	9,248	$	12,550	$	1,946,084	$	1,958,634	$	—

December 31, 2019	30 to 59 Days Past Due		60 to 89 Days Past Due		90 Days and Greater Past Due		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Commercial and industrial	$	321	$	53	$	15	$	389	$	279,194	$	279,583	$	—
Real estate:
Construction and development		161		—		—		161		280,337		280,498		—
Commercial real estate		1,181		49		882		2,112		565,248		567,360		—
Farmland		103		—		—		103		57,373		57,476		—
1-4 family residential		2,514		1,433		845		4,792		407,374		412,166		—
Multi-family residential		—		—		—		—		37,379		37,379		—
Consumer		373		152		96		621		52,624		53,245		—
Agricultural		51		67		—		118		18,241		18,359		—
Overdrafts		—		—		—		—		329		329		—
Total	$	4,704	$	1,754	$	1,838	$	8,296	$	1,698,099	$	1,706,395	$	—

Troubled Debt Restructurings

A troubled debt restructuring (“TDR”) is a restructuring in which a bank, for economic or legal reasons related to a borrower's financial difficulties, grants a concession to the borrower that it would not otherwise consider.

The outstanding balances of TDRs are shown below:

	September 30, 2020		December 31, 2019
Nonaccrual TDRs	$	92	$	101
Performing TDRs		7,891		7,240
Total	$	7,983	$	7,341
Specific reserves on TDRs	$	—	$	164

There was one loan modified as a TDR that occurred during the nine months ended September 30, 2020.

The following table presents the loan by class, modified as a TDR that occurred during the nine months ended September 30, 2020:

Nine Months Ended September 30, 2020	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings:
Construction and development		1	$	680	$	680
Total		1	$	680	$	680

The following table presents loans by class, modified as TDRs that occurred during the year ended December 31, 2019:

Year Ended December 31, 2019	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings:
Commercial real estate		4	$	1,680	$	1,515
Total		4	$	1,680	$	1,515

There were two TDRs that subsequently defaulted during 2019 and remained on nonaccrual status as of December 31, 2019. The TDRs described above did not increase the allowance for loan losses and resulted in no charge-offs during the year ended December 31, 2019.

The following table presents loans by class, modified as TDRs that occurred during the nine months ended September 30, 2019:

Nine Months Ended September 30, 2019	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings:
Commercial real estate		4	$	1,680	$	1,515
Total		4	$	1,680	$	1,515

There were no TDRs that subsequently defaulted through September 30, 2019.

The following table presents loans individually and collectively evaluated for impairment, and the respective allowance for loan losses as of December 31, 2019, as determined in accordance with ASC 310 prior to the adoption of ASC 326. A loan was considered impaired when, based on current information and events, it was probable that the Company would be unable to collect all amounts due from the borrower in accordance with original contractual terms of the loan. Loans with insignificant delays or insignificant short falls in the amount payments expected to be collected were not considered to be impaired. Loans defined as individually impaired included larger balance non-performing loans and TDRs.

December 31, 2019	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment
With no related allowance recorded:
Commercial and industrial	$	289	$	289	$	—	$	312
Real estate:
Construction and development		1,212		1,212		—		1,259
Commercial real estate		4,612		4,612		—		4,244
Farmland		—		—		—		—
1-4 family residential		2,498		2,498		—		1,798
Multi-family residential		—		—		—		—
Consumer		—		—		—		—
Agricultural		62		62		—		190
Subtotal		8,673		8,673		—		7,803
With allowance recorded:
Commercial and industrial		—		—		—		61
Real estate:
Construction and development		—		—		—		—
Commercial real estate		12,871		12,871		1,587		9,111
Farmland		133		133		62		135
1-4 family residential		—		—		—		78
Multi-family residential		—		—		—		—
Consumer		—		—		—		—
Agricultural		—		—		—		—
Subtotal		13,004		13,004		1,649		9,385
Total	$	21,677	$	21,677	$	1,649	$	17,188