Allowance for Loan Losses (Policies)

6 Months Ended

Jun. 30, 2020

Text Block [Abstract]

Credit Loss, Financial Instrument

Allowance for Loan Losses

On January 1, 2020, the Company adopted ASU 2016-13 that establishes a single allowance framework for all financial assets measured at amortized cost and certain off-balance sheet credit exposures. It requires the measurement of the allowance for loan losses to be based on management’s best estimate of lifetime expected credit losses inherent in the Company’s relevant financial assets. Balance sheet information and results for reporting periods beginning with January 1, 2020 are presented under ASC 326, while prior period comparisons continue to be presented under legacy GAAP.

The process of the allowance for loan losses involves procedures to consider the unique risk characteristics of the portfolio segments. For each loan portfolio segment, the expected credit losses are estimated collectively for groups of loans with similar risk characteristics. For loans that do not share similar risk characteristics, the expected credit losses are estimated individually, which includes impaired loans.

Allowance for Collectively Evaluated Loans

Quantitative Component — The allowance for loan losses is estimated using quantitative methods that consider a variety of factors such as historical loss experience, the current credit quality of the portfolio as well as an economic outlook over the life of the loan. The Company incorporates forward-looking information through the use of macroeconomic scenarios applied over the forecasted life of the loans. These macroeconomic scenarios include variables that are considered key drivers of increases and decreases in credit losses. The Company utilizes a probability-weighted multiple scenario forecast approach. These scenarios may consist of a base forecast representing management's view of the most likely outcome, combined with and downside and upside scenarios reflecting possible worsening or improving economic conditions, respectively. A weighted average of these macroeconomic scenarios over a reasonable and supportable forecast period is incorporated into the quantitative models. If the loan’s life extends beyond the reasonable and supportable forecast period, then historical experience is considered over the remaining life of the loans in the allowance for loan losses.

Qualitative Component — The Company also considers the following qualitative factors in the determination of collectively evaluated allowance if they have not already been captured by the quantitative model. Such qualitative factors may include, but not limited to:

•Loan growth trends.

•The volume and severity of past due financial assets and the volume and severity of adversely classified or rated financial assets.

•The Company’s lending policies and procedures, including changes in lending strategies, underwriting standards, collection, write-off and recovery practices, as well as knowledge of the borrower’s operations or the borrower’s standing in the community.

•The quality of the Company’s credit review system.

•The experience, ability and depth of the Company’s management, lending staff and relevant staff.

•The effect of other external factors such as the regulatory, legal and technological environments.

•Actual and expected changes in international, national, regional, and local economic and business conditions and developments in which the Company operates, including the actual and expected condition of various market segments.

The following table provides key credit risk characteristics and macroeconomic variables that the Company uses to estimate the expected credit losses by portfolio segments and methodologies:

Portfolio Segment	Risk Characteristics	Macroeconomic Variables
C&I	Internal risk rating, size and credit spread at origination and time to maturity	Unemployment rate and two and ten year treasury spread
CRE, Multifamily residential, and Construction and land	Delinquency status, maturity date, collateral value, property type and geographic location	Unemployment rate, GDP and U.S. Treasury rates
Single-family residential and HELOCs	FICO, delinquency status, maturity date, collateral value and geographic location	Unemployment rate, GDP and home price index
Other consumer	Historical loss experience	Immaterial (1)

(1)Macroeconomic variables were measured in the qualitative estimate.

In light of the recessionary economic conditions and forecasts during the quarter, management updated its macroeconomic forecast used in the credit loss estimation process to reflect the sudden sharp and continued recession caused by the COVID-19 global pandemic, U.S. monetary and fiscal responses to the outbreak, oil price declines and other assumptions. The macroeconomic forecast used in the credit loss estimation for the quarter ended June 30, 2020 was more adverse compared to the prior quarter, as expectations for the unemployment rate and real GDP growth deteriorated and a slower recovery was expected. For the three and six months ended June 30, 2020, there were no changes to the reasonable and supportable forecast period, and reversion to historical loss experience method.

Allowance for Loan Losses for the Commercial Loan Portfolio — The Company’s C&I lifetime loss rate model estimates credit losses by estimating a loss rate expected over the life of a loan. This loss rate is applied to the amortized cost basis, excluding accrued interest receivables, to determine expected credit losses. The lifetime loss rate model’s reasonable and supportable period spans eight quarters, thereafter immediately reverting to the historical average loss rate, expressed implicitly through the loan-level lifetime loss rate.

The Company’s CRE probability of default (“PD”)/loss given default (“LGD”) models estimate the probability that a loan will default and, in the event of default, estimate the expected credit losses upon default. The product of the PD/LGD determines the Company’s CECL. The PD/LGD model assumptions and variable inputs span the entire contractual life of the loans, adjusted for expected prepayments. After a reasonable and supportable period, the forecast of future economic conditions reverts to long-run historical economic trends. The loan-specific variables apply over the lifetime of a loan.

In order to estimate the life of a loan under both models, the contractual term of the loan is adjusted for estimated prepayments, which are based on historical prepayment experience.

Allowance for Loan Losses for the Consumer Loan Portfolio — For single-family residential and HELOC loans, PD/LGD model assumptions and variable inputs span the entire contractual life of the loans, adjusted for expected prepayments. After a reasonable and supportable period, the forecast of future economic conditions reverts to long-run historical economic trends. The loan-specific variables apply over the lifetime of a loan.

For other consumer loans, the Company uses a loss rate approach. In order to estimate the life of a loan, the contractual term of the loan is adjusted for estimated prepayments, which are based on historical prepayment experience.

While the Company’s allowance methodologies strive to reflect all relevant credit risk factors, there continues to be uncertainty associated with, but not limited to, potential imprecision in the estimation process due to the inherent time lag of obtaining information and normal variations between expected and actual outcomes. The Company may hold additional reserves that are designed to provide coverage for losses attributable to such risk. The allowance for loan losses as of June 30, 2020 also included qualitative adjustments for certain industry sectors, such as oil & gas, which are included as part of the C&I loan portfolio, that the Company views as higher risk, where quantitative models may not have captured the additional exposure related to such industry sectors.

Allowance for Individually Assessed Loans When a loan no longer shares similar risk characteristics with other loans, such as in the case for certain nonaccrual or TDR loans, the Company estimates the allowance for loan losses on an individual loan basis. The allowance for loan losses for individually evaluated loans is measured as the difference between the recorded value of the loans and their fair value. For loans evaluated individually, the Company uses one of three different asset valuation measurement methods: (1) the present value of expected future cash flows; (2) the fair value of collateral less costs to sell; and (3) the loan's observable market price. If an individually evaluated loan is determined to be collateral dependent, the Company applies the fair value of the collateral less costs to sell method. If an individually evaluated loan is determined to not be collateral dependent, the Company uses the present value of future cash flows or the observable market value of the loan.

Collateral-Dependent Loans — When a loan is collateral dependent, the allowance is measured on an individual loan basis and is limited to the difference between the recorded value and fair value of the collateral less cost of disposal or sale.