Allowance for Credit Losses

9 Months Ended

Sep. 30, 2022

Allowance for Credit Losses

Allowance for Credit Losses

6. Allowance for Credit Losses

Available for Sale Securities and Held to Maturity Securities

The Company has evaluated available for sale debt securities that are in an unrealized loss position and has determined that any decline in value is unrelated to credit loss and related to changes in market interest rates since purchase. None of the available for sale debt securities held were past due at September 30, 2022. In addition, as of September 30, 2022, the Company had not made a decision to sell any of its debt securities held, nor did the Company consider it more likely than not that it would be required to sell such securities before recovery of their amortized cost basis. The Company does not expect to have credit losses associated with the debt securities and no allowance was recognized on the debt securities portfolio.

Loans Held for Investment

The allowance for credit losses for loans held for investment represents management’s best estimate of all expected credit losses over the expected contractual life of our existing portfolio. Management’s methodology for determining the allowance for credit losses uses the current expected credit losses (“CECL”) standard. Management considers the level of allowance for credit losses to be a reasonable and supportable estimate of expected credit losses inherent within the loans held for investment portfolio as of September 30, 2022. While the Company believes it has an appropriate allowance for the existing loan portfolio at September 30, 2022, additional provision for losses on existing loans may be necessary in the future. Future changes in the allowance for credit losses are expected to be volatile given dependence upon, among other things, the portfolio composition and quality, as well as the impact of significant drivers, including prepayment assumptions and macroeconomic conditions and forecasts. In addition to the allowance for credit losses, the Company maintains a separate allowance for credit losses related to off-balance sheet credit exposures, including unfunded loan commitments, and this amount is included in other liabilities within the consolidated balance sheets. For further information on the policies that govern the estimation of the allowances for credit losses levels, see Note 1 to the consolidated financial statements in the Company’s 2021 Form 10-K.

One of the most significant judgments involved in estimating the Company’s allowance for credit losses relates to the macroeconomic forecasts used to estimate credit losses over the reasonable and supportable forecast period. To determine our best estimate of expected credit losses as of September 30, 2022, the Company utilized a single macroeconomic alternative scenario, or S7, published by Moody’s Analytics in September 2022 that was updated to reflect the U.S. economic outlook. This alternative economic scenario expects inflation to rise more than the baseline scenario as the military conflict between Russia and Ukraine persists longer than anticipated. Inflation continues to trend higher than expectation as supply-chain issues and reductions in disposable income persist during the reasonable and supportable period. Federal Reserve monetary policy raises interest rates faster and higher than the baseline scenario where the federal funds rate increases to 3.9% by the third quarter of 2023. Other significant variables that impact the modeled losses across our loan portfolios are the U.S. Real Gross Domestic Product, or GDP, growth rates and unemployment rate assumptions. Changes in these assumptions and forecasts of economic conditions could significantly affect the estimate of expected credit losses at the balance sheet date or between reporting periods.

The COVID-19 pandemic has adversely impacted financial markets and overall economic conditions, and may continue to have implications on borrowers across our lending portfolios. Significant judgment is required to estimate the severity and duration of the current economic uncertainties, as well as its potential impact on borrower defaults and loss severity. In particular, macroeconomic conditions and forecasts are rapidly changing and remain highly uncertain.

During the three and nine months ended September 30, 2021, the decreases in the allowance reflect improvement in both realized economic results and the macroeconomic outlook and were significantly comprised of net reversals of credit losses on expected losses of collectively evaluated loans of $11.0 million and $45.2 million, respectively. Such reversals were primarily due to improvements in both macroeconomic forecast assumptions and credit quality metrics on COVID-19 impacted industry sector exposures. The net impact to the allowance from changes associated with individually evaluated loans during the three and nine months ended September 30, 2021 included a provision for credit losses of $5.2 million and $5.6 million, respectively. The changes in the allowance for credit losses during the noted periods were primarily attributable to the Bank and also reflected other factors including, but not limited to, loan mix, and changes in

loan balances and qualitative factors from the prior quarter. The changes in the allowance during both the three and nine months ended September 30, 2021 were also impacted by net recoveries of $0.1 million.

During the three months ended September 30, 2022, the reversal of credit losses reflected modest improvements in the U.S. economic outlook compared to assumptions in the prior quarter outlook, and in specific reserves and credit metrics since the prior quarter, while the increase in provision for credit losses during the nine months ended September 30, 2022 was driven by a deteriorating U.S. economic outlook since December 31, 2021. The net impact to the allowance of changes associated with individually evaluated loans during the three and nine months ended September 30, 2022 included reversals of credit losses of $0.2 million and $1.2 million, respectively, while collectively evaluated loans included a reversal of credit losses of $0.5 million, compared to a provision for credit losses of $5.9 million, respectively. The changes in the allowance for credit losses during the noted periods were primarily attributable to the Bank and also reflected other factors including, but not limited to, loan mix, and changes in loan balances and qualitative factors from the prior quarter. The changes in the allowance during the three and nine months ended September 30, 2022 were also impacted by net charge-offs of $2.7 million and $4.2 million, respectively.

Changes in the allowance for credit losses for loans held for investment, distributed by portfolio segment, are shown below (in thousands).

	Balance,		Provision for				Recoveries on		Balance,
	Beginning of		(Reversal of)		Loans		Charged Off		End of
Three Months Ended September 30, 2022	Period		Credit Losses		Charged Off		Loans		Period
Commercial real estate	$	63,719	$	(560)	$	—	$	41	$	63,200
Commercial and industrial		19,836		(1,002)		(3,096)		370		16,108
Construction and land development		4,996		(228)		—		—		4,768
1-4 family residential		5,554		1,049		(14)		23		6,612
Consumer		542		91		(149)		90		574
Broker-dealer		651		(130)		—		—		521
Total	$	95,298	$	(780)	$	(3,259)	$	524	$	91,783

	Balance,		Provision for				Recoveries on		Balance,
	Beginning of		(Reversal of)		Loans		Charged Off		End of
Nine Months Ended September 30, 2022	Period		Credit Losses		Charged Off		Loans		Period
Commercial real estate	$	59,354	$	3,762	$	—	$	84	$	63,200
Commercial and industrial		21,982		(1,681)		(6,197)		2,004		16,108
Construction and land development		4,674		94		—		—		4,768
1-4 family residential		4,589		2,014		(62)		71		6,612
Consumer		578		136		(361)		221		574
Broker-dealer		175		346		—		—		521
Total	$	91,352	$	4,671	$	(6,620)	$	2,380	$	91,783

	Balance,		Provision for				Recoveries on		Balance,
	Beginning of		(Reversal of)		Loans		Charged Off		End of
Three Months Ended September 30, 2021	Period		Credit Losses		Charged Off		Loans		Period
Commercial real estate	$	77,633	$	(8,993)	$	(124)	$	19	$	68,535
Commercial and industrial		27,866		2,398		(317)		598		30,545
Construction and land development		5,185		(85)		—		—		5,100
1-4 family residential		3,659		946		(87)		20		4,538
Consumer		592		(41)		(73)		26		504
Broker-dealer		334		(44)		—		—		290
Total	$	115,269	$	(5,819)	$	(601)	$	663	$	109,512

	Balance,		Provision for				Recoveries on		Balance,
	Beginning of		(Reversal of)		Loans		Charged Off		End of
Nine Months Ended September 30, 2021	Period		Credit Losses		Charged Off		Loans		Period
Commercial real estate	$	109,629	$	(41,037)	$	(310)	$	253	$	68,535
Commercial and industrial		27,703		2,848		(1,738)		1,732		30,545
Construction and land development		6,677		(1,577)		—		—		5,100
1-4 family residential		3,946		358		(248)		482		4,538
Consumer		876		(317)		(226)		171		504
Broker-dealer		213		77		—		—		290
Total	$	149,044	$	(39,648)	$	(2,522)	$	2,638	$	109,512

Unfunded Loan Commitments

The Bank uses a process similar to that used in estimating the allowance for credit losses on the funded portion to estimate the allowance for credit loss on unfunded loan commitments. The allowance is based on the estimated exposure at default, multiplied by the lifetime Probability of Default grade and Loss Given Default grade for that particular loan segment. The Bank estimates expected losses by calculating a commitment usage factor based on industry usage factors. The commitment usage factor is applied over the relevant contractual period. Loss factors from the underlying loans to which commitments are related are applied to the results of the usage calculation to estimate any liability for credit losses related for each loan type. The expected losses on unfunded commitments align with statistically calculated parameters used to calculate the allowance for credit losses on the funded portion. There is no reserve calculated for letters of credit as they are issued primarily as credit enhancements and the likelihood of funding is low.

Changes in the allowance for credit losses for loans with off-balance sheet credit exposures are shown below (in thousands).

	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Balance, beginning of period	$	6,931	$	7,981	$	5,880	$	8,388
Other noninterest expense		87		(1,183)		1,138		(1,590)
Balance, end of period	$	7,018	$	6,798	$	7,018	$	6,798

During the three and nine months ended September 30, 2021, the decreases in the reserve for unfunded commitments were primarily due to improvements in loan expected loss rates. During the three months ended September 30, 2022, the increase in the reserve for unfunded commitments was primarily due to an increase in available commitment balances, while the increase in the reserve for unfunded commitments during the nine months ended September 30, 2022 was due to increases in both loan expected loss rates and available commitment balances.