Note 10 – Credit Quality and Nonperforming Assets

Credit Quality Classifications

The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention, substandard and impaired to characterize the associated credit risk. Balances classified as “loss” are immediately charged off. The Company conforms to the following definitions for its risk classifications:

Pass: Larger non-homogeneous loans not meeting the risk rating definitions below, and smaller homogeneous loans that are not assessed on an individual basis.

Special mention: Loans which have potential issues that deserve the close attention of Management. If left uncorrected, those potential weaknesses could eventually diminish the prospects for full repayment of principal and interest according to the contractual terms of the loan agreement, or could result in deterioration of the Company’s credit position at some future date.

Substandard: Loans that have at least one clear and well-defined weakness that could jeopardize the ultimate recoverability of all principal and interest, such as a borrower displaying a highly leveraged position, unfavorable financial operating results and/or trends, uncertain repayment sources or an otherwise deteriorated financial condition.

Impaired: A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include all nonperforming loans and restructured troubled debt (“TDRs”). A TDR may be nonperforming or performing, depending on its accrual status and the demonstrated ability of the borrower to comply with restructured terms (see “Troubled Debt Restructurings” section below for additional information on TDRs).

Credit quality classifications for the Company’s loan balances were as follows, as of the dates indicated:

Credit Quality Classifications

(dollars in thousands, unaudited)


	March 31, 2020
	Pass		Special Mention		Substandard		Impaired		Total
Real estate:
1-4 family residential construction	$	94,114	$	464	$	—	$	—	$	94,578
Other construction/land		87,861		2,219		—		522		90,602
1-4 family - closed end		182,832		3,523		169		3,110		189,634
Equity lines		42,010		2,084		61		4,381		48,536
Multi-family residential		57,891		—		—		347		58,238
Commercial real estate - owner occupied		293,360		3,936		3,109		2,529		302,934
Commercial real estate - non-owner occupied		471,003		747		568		2,608		474,926
Farmland		140,307		1,047		130		256		141,740
Total real estate		1,369,378		14,020		4,037		13,753		1,401,188

Agricultural		49,030		164		—		5		49,199
Commercial and industrial		97,081		12,994		510		1,405		111,990
Mortgage warehouse		228,608		—		—		—		228,608
Consumer loans		6,579		70		15		376		7,040
Total gross loans and leases	$	1,750,676	$	27,248	$	4,562	$	15,539	$	1,798,025


	December 31, 2019
	Pass		Special Mention		Substandard		Impaired		Total
Real estate:
1-4 family residential construction	$	105,979	$	—	$	—	$	—	$	105,979
Other construction/land		90,761		98		—		554		91,413
1-4 family - closed end		194,572		2,425		164		3,020		200,181
Equity lines		43,111		1,995		72		4,421		49,599
Multi-family residential		54,104		—		—		353		54,457
Commercial real estate - owner occupied		334,460		4,005		3,384		2,034		343,883
Commercial real estate - non-owner occupied		409,289		1,164		11		2,105		412,569
Farmland		142,594		1,048		132		259		144,033
Total real estate		1,374,870		10,735		3,763		12,746		1,402,114

Agricultural		47,814		217		—		5		48,036
Commercial and industrial		100,584		13,415		556		977		115,532
Mortgage warehouse		189,103		—		—		—		189,103
Consumer loans		7,245		85		25		425		7,780
Total gross loans and leases	$	1,719,616	$	24,452	$	4,344	$	14,153	$	1,762,565

Past Due and Nonperforming Assets

Nonperforming assets are comprised of loans for which the Company is no longer accruing interest, and foreclosed assets. The Company’s foreclosed assets can include mobile homes and/or OREO, which consists of commercial and/or residential real estate properties acquired by foreclosure or similar means that the Company is offering or will offer for sale. Foreclosed assets totaled $.8 million at March 31, 2020, and December 31, 2019. Gross nonperforming loans totaled $7.4 million at March 31, 2020 and $5.7 million at December 31, 2019. Loans and leases are classified as nonperforming when reasonable doubt surfaces with regard to the ability of the Company to collect all principal and interest. At that point, we stop accruing interest on the loan or lease in question and reverse any previously-recognized interest to the extent that it is uncollected or associated with interest-reserve loans. Any asset for which principal or interest has been in default for 90 days or more is also placed on non-accrual status even if interest is still being received, unless the asset is both well secured and in the process of collection.

An aging of the Company’s loan balances is presented in the following tables, by number of days past due as of the indicated dates:

Loan Portfolio Aging

(dollars in thousands, unaudited)


	March 31, 2020
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or More Past Due(1)		Total Past Due		Current		Total Financing Receivables		Non-Accrual Loans(2)
Real estate:
1-4 family residential construction	$	464	$	—	$	—	$	464	$	94,114	$	94,578	$	—
Other construction/land		—		—		—		—		90,602		90,602		10
1-4 family - closed end		2,349		14		783		3,146		186,488		189,634		866
Equity lines		122		—		141		263		48,273		48,536		535
Multi-family residential		—		—		—		—		58,238		58,238		—
Commercial real estate - owner occupied		196		—		837		1,033		301,901		302,934		1,941
Commercial real estate - non-owner occupied		633		—		2,127		2,760		472,166		474,926		2,608
Farmland		213		—		—		213		141,527		141,740		257
Total real estate		3,977		14		3,888		7,879		1,393,309		1,401,188		6,217

Agricultural		—		—		—		—		49,199		49,199		—
Commercial and industrial		617		358		195		1,170		110,820		111,990		1,116
Mortgage warehouse lines		—		—		—		—		228,608		228,608		—
Consumer		42		8		—		50		6,990		7,040		18
Total gross loans and leases	$	4,636	$	380	$	4,083	$	9,099	$	1,788,926	$	1,798,025	$	7,351

(1)

As of March 31, 2020 there were no loans over 90 days past due and still accruing.

(2)

Included in total financing receivables

Loan Portfolio Aging

(dollars in thousands, unaudited)


	December 31, 2019
	30-59 Days Past Due		60-89 Days Past Due		90 Days Or More Past Due(1)		Total Past Due		Current		Total Financing Receivables		Non-Accrual Loans(2)
Real estate:
1-4 family residential construction	$	—	$	—	$	—	$	—	$	105,979	$	105,979	$	—
Other construction/land		16		—		—		16		91,397		91,413		31
1-4 family - closed end		485		380		659		1,524		198,657		200,181		741
Equity lines		177		10		78		265		49,334		49,599		480
Multi-family residential		—		—		—		—		54,457		54,457		—
Commercial real estate - owner occupied		1,552		—		88		1,640		342,243		343,883		1,440
Commercial real estate - non-owner occupied		500		—		1,605		2,105		410,464		412,569		2,105
Farmland		—		—		—		—		144,033		144,033		258
Total real estate		2,730		390		2,430		5,550		1,396,564		1,402,114		5,055

Agricultural		—		—		—		—		48,036		48,036		—
Commercial and industrial		160		215		—		375		115,157		115,532		651
Mortgage warehouse lines		—		—		—		—		189,103		189,103		—
Consumer		55		12		2		69		7,711		7,780		31
Total gross loans and leases	$	2,945	$	617	$	2,432	$	5,994	$	1,756,571	$	1,762,565	$	5,737

(1)

As of December 31, 2019 there were no loans over 90 days past due and still accruing.

(2)

Included in total financing receivables

Troubled Debt Restructurings

A loan that is modified for a borrower who is experiencing financial difficulty is classified as a troubled debt restructuring (TDR) if the modification constitutes a concession, excluding loan modifications that are COVID-19 related and made in accordance with the interagency guidance and the CARES Act as described in Note 3, above. At March 31, 2020, the Company had a total of $9.2 million in TDRs, including $1.0 million in TDRs that were on non-accrual status. Generally, a non-accrual loan that has been modified as a TDR remains on non-accrual status for a period of at least six months to demonstrate the borrower’s ability to comply with the modified terms. However, performance prior to the modification, or significant events that coincide with the modification, could result in a loan’s return to accrual status after a shorter performance period or even at the time of loan modification. Regardless of the period of time that has elapsed, if the borrower’s ability to meet the revised payment schedule is uncertain then the loan will be kept on non-accrual status. Moreover, a TDR is generally considered to be in default when it appears that the customer will not likely be able to repay all principal and interest pursuant to restructured terms.

The Company may agree to different types of concessions when modifying a loan or lease. The tables below summarize TDRs which were modified during the noted periods, by type of concession:

Troubled Debt Restructurings, by Type of Loan Modification

(dollars in thousands, unaudited)


	Three months ended March 31, 2020
	Rate Modification		Term Modification		Interest Only Modification		Rate & Term Modification		Term & Interest Modification		Total
Real estate:
Other construction/land	$	—	$	—	$	—	$	—	$	—	$	—
1-4 family - closed-end		—		—		—		—		—		—
Equity lines		—		—		—		—		—		—
Multi-family residential		—		—		—		—		—		—
Commercial real estate - owner occupied		—		—		—		—		86		86
Farmland		—		—		—		—		—		—
Total real estate loans		—		—		—		—		86		86
Agricultural		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—
Consumer loans		—		—		—		—		—		—
Total	$	—	$	—	$	—	$	—	$	86	$	86


	Three months ended March 31, 2019
	Rate Modification		Term Modification		Interest Only Modification		Rate & Term Modification		Term & Interest Modification		Total
Real estate:
Other construction/land	$	—	$	—	$	—	$	—	$	—	$	—
1-4 family - closed-end		—		—		—		—		—		—
Equity lines		—		100		—		—		—		100
Multi-family residential		—		—		—		—		—		—
Commercial real estate - owner occupied		—		—		—		—		—		—
Farmland		—		—		—		—		—		—
Total real estate loans		—		100		—		—		—		100
Agricultural		—		—		—		—		—		—
Commercial and industrial		94		—		—		—		—		94
Consumer loans		—		9		—		—		—		9
Total	$	94	$	109	$	—	$	—	$	—		203

Troubled Debt Restructurings

(dollars in thousands, unaudited)


	Three months ended March 31, 2020
		Pre- Modification		Post- Modification
	Number of Loans	Outstanding Recorded Investment		Outstanding Recorded Investment		Reserve Difference⁽¹⁾		Reserve
Real estate:
Other construction/land	0	$	—	$	—	$	—	$	—
1-4 family - closed-end	0		—		—		—		—
Equity lines	0		—		—		—		—
Multi-family residential	0		—		—		—		—
Commercial real estate - owner occupied	1		86		86		—		—
Farmland	0		—		—		—		—
Total real estate loans			86		86		—		—

Agricultural	0		—		—		—		—
Commercial and industrial	0		—		—		—		—
Consumer loans	0		—		—		—		—
Total		$	86	$	86	$	—	$	—

(1)

This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.


	Three months ended March 31, 2019
		Pre- Modification		Post- Modification
	Number of Loans	Outstanding Recorded Investment		Outstanding Recorded Investment		Reserve Difference⁽¹⁾		Reserve
Real estate:
Other construction/land	0	$	—	$	—	$	—	$	—
1-4 family - closed-end	0		—		—		—		—
Equity lines	1		100		100		—		—
Multi-family residential	0		—		—		—		—
Commercial real estate - owner occupied	0		—		—		—		—
Farmland	0		—		—		—		—
Total real estate loans			100		100		—		—

Agricultural	0		—		—		—		—
Commercial and industrial	2		94		94		(20)		1
Consumer loans	1		9		9		(2)		—
Total		$	203	$	203	$	$(22)	$	1

(1)

The Company had no finance receivables modified as TDRs within the previous twelve months that defaulted or were charged off during the nine-month periods ended March 31, 2020 and 2019.

Purchased Credit Impaired Loans

The Company may acquire loans which show evidence of credit deterioration since origination. These purchased credit impaired (“PCI”) loans are recorded at the amount paid, since there is no carryover of the seller’s allowance for loan losses. Potential losses on PCI loans subsequent to acquisition are recognized by an increase in the allowance for loan losses. PCI loans are accounted for individually or are aggregated into pools of loans based on common risk characteristics. The Company projects the amount and timing of expected cash flows, and expected cash receipts in excess of the amount paid for any such loans are recorded as interest income over the remaining life of the loan or pool of loans (accretable yield). The excess of contractual principal and interest over expected cash flows is not recorded (nonaccretable difference). Expected cash flows are periodically re-evaluated throughout the life of the loan or pool of loans. If the present value of the expected cash flows is determined at any time to be less than the carrying amount, a reserve is recorded. If the present value of the expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.

Our acquisition of Santa Clara Valley Bank in 2014 included certain loans which have shown evidence of credit deterioration since origination, and for which it was probable at acquisition that all contractually required payments would not be collected. The carrying amount and unpaid principal balance of those PCI loans was as follows, as of the dates indicated:

Purchased Credit Impaired Loans:

(dollars in thousands, unaudited)


	December 31, 2019
	Unpaid Principal Balance		Carrying Value
Real estate secured	$	88	$	—
Total purchased credit impaired loans	$	—	$	—

There was no allowance for loan losses allocated for PCI loans as of March 31, 2020 and, December 31, 2019. There was no discount accretion recorded on PCI loans during the three months ended March 31, 2020.

March 31, 2020

Unpaid Principal Balance

Carrying Value

Real estate secured

Total purchased credit impaired loans