Note 11 – Allowance for Loan and Lease Losses

The Company’s allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses. The allowance is maintained at a level that is considered adequate to absorb probable losses on certain specifically identified impaired loans, as well as probable incurred losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are received subsequent to the charge off. We employ a systematic methodology, consistent with FASB guidelines on loss contingencies and impaired loans, for determining the appropriate level of the allowance for loan and lease losses and adjusting it to that level at least quarterly. Pursuant to our methodology, impaired loans and leases are individually analyzed and a criticized asset action plan is completed specifying the financial status of the borrower and, if applicable, the characteristics and condition of collateral and any associated liquidation plan. A specific loss allowance is created for each impaired loan, if necessary.

The following tables disclose the unpaid principal balance, recorded investment, average recorded investment, and interest income recognized for impaired loans on our books as of the dates indicated. Balances are shown by loan type, and are further broken out by those that required an allowance and those that did not, with the associated allowance disclosed for those that required such. Included in the valuation allowance for impaired loans shown in the tables below are specific reserves allocated to TDRs, totaling $.6 million at March 31, 2020 and December 31, 2019.

Impaired Loans

(dollars in thousands, unaudited)


	March 31, 2020
	Unpaid Principal Balance(1)		Recorded Investment(2)		Related Allowance		Average Recorded Investment		Interest Income Recognized(3)
With an allowance recorded
Real estate:
Other construction/land	$	641	$	522	$	154	$	527	$	12
1-4 family - closed-end		2,266		2,266		62		2,279		33
Equity lines		4,129		4,076		252		4,090		37
Multi-family residential		347		347		17		349		6
Commercial real estate- owner occupied		586		586		2		589		9
Commercial real estate- non-owner occupied		—		—		—		—		—
Farmland		237		237		3		237		—
Total real estate		8,206		8,034		490		8,071		97
Agricultural		5		5		—		5		—
Commercial and industrial		1,156		1,137		520		1,157		6
Consumer loans		414		376		98		385		8
Subtotal		9,781		9,552		1,108		9,618		111
With no related allowance recorded
Real estate:
Other construction/land		—		—		—		—		—
1-4 family - closed-end		844		844		—		845		—
Equity lines		305		305		—		307		1
Commercial real estate- owner occupied		2,062		1,942		—		1,950		—
Commercial real estate- non-owner occupied		3,798		2,608		—		2,440		—
Farmland		20		20		—		21		—
Total real estate		7,029		5,719		—		5,563		1
Agricultural		—		—		—		—		—
Commercial and industrial		289		268		—		271		—
Consumer loans		—		—		—		—		—
Subtotal		7,318		5,987		—		5,834		1
Total	$	17,099	$	15,539	$	1,108	$	15,452	$	112

(1)

Contractual principal balance due from customer.

(2)

Principal balance on Company’s books, less any direct charge offs.

(3)

Interest income is recognized on performing balances on a regular accrual basis.

Impaired Loans

(dollars in thousands, unaudited)


	December 31, 2019
	Unpaid Principal Balance(1)		Recorded Investment(2)		Related Allowance		Average Recorded Investment		Interest Income Recognized(3)
With an allowance recorded
Real estate:
1-4 family residential construction	$	—	$	—	$	—	$	—	$	—
Other construction/land		656		537		157		563		32
1-4 family - closed-end		2,298		2,298		58		2,365		146
Equity lines		4,173		4,120		252		4,185		200
Multi-family residential		353		353		17		361		23
Commercial real estate- owner occupied		593		593		6		606		38
Commercial real estate- non-owner occupied		—		—		—		—		—
Farmland		237		237		3		256		—
Total real estate		8,310		8,138		493		8,336		439
Agricultural		5		5		1		6		—
Commercial and industrial		915		896		219		1,140		29
Consumer loans		464		425		114		469		35
Subtotal		9,694		9,464		827		9,951		503
With no related allowance recorded
Real estate:
1-4 family residential construction	$	—	$	—	$	—	$	—	$	—
Other construction/land		52		17		—		577		4
1-4 family - closed-end		755		722		—		726		—
Equity lines		326		301		—		310		5
Multi-family residential		—		—		—		—		—
Commercial real estate- owner occupied		1,560		1,440		—		1,477		—
Commercial real estate- non-owner occupied		3,295		2,105		—		3,267		—
Farmland		22		22		—		25		—
Total real estate		6,010		4,607		—		6,382		9
Agricultural		—		—		—		—		—
Commercial and industrial		102		81		—		162		—
Consumer loans		9		—		—		140		15
Subtotal		6,121		4,688		—		6,684		24
Total	$	15,815	$	14,152	$	827	$	16,635	$	527

(1)

Contractual principal balance due from customer.

(2)

Principal balance on Company’s books, less any direct charge offs.

(3)

Interest income is recognized on performing balances on a regular accrual basis.

The specific loss allowance for an impaired loan generally represents the difference between the book value of the loan and either the fair value of underlying collateral less estimated disposition costs, or the loan’s net present value as determined by a discounted cash flow analysis. The discounted cash flow approach is typically used to measure impairment on loans for which it is anticipated that repayment will be provided from cash flows other than those generated solely by the disposition or operation of underlying collateral. However, historical loss rates may be used by the Company to determine a specific loss allowance if those rates indicate a higher potential reserve need than the discounted cash flow analysis. Any change in impairment attributable to the passage of time is accommodated by adjusting the loss allowance accordingly.

For loans where repayment is expected to be provided by the disposition or operation of the underlying collateral, impairment is measured using the fair value of the collateral. If the collateral value, net of the expected costs of disposition, is less than the loan balance, then a specific loss reserve is established for the shortfall in collateral coverage. If the discounted collateral value is greater than or equal to the loan balance, no specific loss reserve is required. At the time a collateral-dependent loan is designated as nonperforming, a new appraisal is ordered and typically received within 30 to 60 days if a recent appraisal is not already available. We generally use external appraisals to determine the fair value of the underlying collateral for nonperforming real estate loans, although the Company’s licensed staff appraisers may update older appraisals based on current market conditions and property value trends. Until an updated appraisal is received, the Company uses the existing appraisal to determine the amount of the specific loss allowance that may be required. The specific loss allowance is adjusted, as necessary, once a new appraisal is received. Updated appraisals are generally ordered at least annually for collateral-dependent loans that remain impaired, and current appraisals were available or in process for 55% of the Company’s impaired real estate loan balances at March 31, 2020. Furthermore, the Company analyzes collateral-dependent loans on at least a quarterly basis, to determine if any portion of the recorded investment in such loans can be identified as uncollectible and would therefore constitute a confirmed loss. All amounts deemed to be uncollectible are promptly charged off against the Company’s allowance for loan and lease losses, with the loan then carried at the fair value of the collateral, as appraised, less estimated costs of disposition if applicable. Once a charge-off or write-down is recorded, it will not be restored to the loan balance on the Company’s accounting books.

Our methodology also provides for the establishment of a “general” allowance for probable incurred losses inherent in loans and leases that are not impaired. Unimpaired loan balances are segregated by credit quality, and are then evaluated in pools with common characteristics. At the present time, pools are based on the same segmentation of loan types presented in our regulatory filings. While this methodology utilizes historical loss data and other measurable information, the credit classification of loans and the establishment of the allowance for loan and lease losses are both to some extent based on Management’s judgment and experience. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that Management believes is appropriate at each reporting date. Quantitative information includes our historical loss experience, delinquency and charge-off trends, and current collateral values. Qualitative factors include the general economic environment in our markets and, in particular, the condition of the agricultural industry and other key industries. Lending policies and procedures (including underwriting standards), the experience and abilities of lending staff, the quality of loan review, credit concentrations (by geography, loan type, industry and collateral type), the rate of loan portfolio growth, and changes in legal or regulatory requirements are additional factors that are considered. The total general reserve established for probable incurred losses on unimpaired loans was $10.3 million at March 31, 2020.

There were no material changes to the methodology used to determine our allowance for loan and lease losses during the three months ended March 31, 2020, although as outlined in Note 3 to the consolidated financial statements we will substantially update our methodology upon the implementation of the CECL accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update ASU 2016‑13 and related amendments, Financial Instruments – Credit Losses (Topic 326) when the earlier of the national emergency related to the outbreak of COVID-19 ends or December 31, 2020. Moreover, we will continue to enhance our methodology as needed in order to comply with regulatory and accounting requirements, keep pace with the size and complexity of our loan and lease portfolio, and respond to pressures created by external forces. We engage outside firms on a regular basis to assess our methodology and perform independent credit reviews of our loan and lease portfolio. In addition, the FDIC and the California DBO review the allowance for loan and lease losses as an integral part of their audit and examination processes. Management believes deferring the implementation of “CECL” and continuing with the current incurred loss methodology is appropriate given the impact of the economic uncertainty surrounding COVID-19 and related governmental and regulatory actions taken in response thereto, such as the stimulus provisions of the CARES Act.

The tables that follow detail the activity in the allowance for loan and lease losses for the periods noted:

Allowance for Credit Losses and Recorded Investment in Financing Receivables

(dollars in thousands, unaudited)


	Three months ended March 31, 2020
	Real Estate		Agricultural Products		Commercial and Industrial (1)		Consumer		Unallocated		Total
Allowance for credit losses:
Beginning balance	$	5,635	$	193	$	2,685	$	1,278	$	132	$	9,923
Charge-offs		—		—		(25)		(617)		—		(642)
Recoveries		72		—		28		272		—		372
Provision		1,608		42		66		204		(120)		1,800
Ending balance	$	7,315	$	235	$	2,754	$	1,137	$	12	$	11,453
Reserves:
Specific	$	490	$	—	$	520	$	98	$	—	$	1,108
General		6,825		235		2,234		1,039		12		10,345
Ending balance	$	7,315	$	235	$	2,754	$	1,137	$	12	$	11,453
Loans evaluated for impairment:
Individually	$	13,753	$	5	$	1,405	$	376	$	—	$	15,539
Collectively		1,387,435		49,194		339,193		6,664		—		1,782,486
Ending balance	$	1,401,188	$	49,199	$	340,598	$	7,040	$	—	$	1,798,025

		Year ended December 31, 2019
	Real Estate		Agricultural Products		Commercial and Industrial (1)		Consumer		Unallocated		Total
Allowance for credit losses:
Beginning balance	$	5,831	$	256	$	2,394	$	1,239	$	30	$	9,750
Charge-offs		(1,190)		—		(1,274)		(2,409)		—		(4,873)
Recoveries		647		—		690		1,159		—		2,496
Provision		347		(63)		875		1,289		102		2,550
Ending balance	$	5,635	$	193	$	2,685	$	1,278	$	132	$	9,923
Reserves:
Specific	$	493	$	1	$	219	$	114	$	—	$	827
General		5,142		192		2,466		1,164		132		9,096
Ending balance	$	5,635	$	193	$	2,685	$	1,278	$	132	$	9,923
Loans evaluated for impairment:
Individually	$	12,746	$	5	$	977	$	425	$	—	$	14,153
Collectively		1,389,368		48,031		303,658		7,355		—		1,748,412
Ending balance	$	1,402,114	$	48,036	$	304,635	$	7,780	$	—	$	1,762,565

		Three months ended March 31, 2019
	Real Estate		Agricultural Products		Commercial and Industrial (1)		Consumer		Unallocated		Total
Allowance for credit losses:
Beginning balance	$	5,831	$	256	$	2,394	$	1,239	$	30	$	9,750
Charge-offs		—		—		(579)		(551)		—		(1,130)
Recoveries		175		—		41		302		—		518
Provision		88		(37)		58		139		52		300
Ending balance	$	6,094	$	219	$	1,914	$	1,129	$	82	$	9,438
Reserves:
Specific	$	915	$	1	$	333	$	180	$	—	$	1,429
General		5,179		218		1,581		949		82		8,009
Ending balance	$	6,094	$	219	$	1,914	$	1,129	$	82	$	9,438
Loans evaluated for impairment:
Individually	$	13,348	$	6	$	1,099	$	789	$	—	$	15,242
Collectively		1,460,502		52,080		215,698		7,467		—		1,735,747
Ending balance	$	1,473,850	$	52,086	$	216,797	$	8,256	$	—	$	1,750,989

(1)

Includes mortgage warehouse lines.