Note 4: Loans and Allowance for Loan Losses

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.

For loans at amortized cost, interest income is accrued based on the unpaid principal balance.

The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past-due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is applied to the principal balance until the loan can be returned to an accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

For all loan portfolio segments, the Company promptly charges off loans, or portions thereof, when available information confirms that specific loans are uncollectable based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

When cash payments are received on impaired loans in each loan class, the Company records the payment as interest income unless collection of the remaining recorded principal amount is doubtful, at which time payments are used to reduce the principal balance of the loan. Troubled debt restructured loans recognize interest income on an accrual basis at the renegotiated rate if the loan is in compliance with the modified terms.

Loans receivable at March 31, 2020 and December 31, 2019 include:


	March 31,		December 31,
	2020		2019
	(In thousands)

Mortgage warehouse lines of credit	$	1,083,776	$	765,151
Residential real estate		421,978		413,835
Multi-family and healthcare financing		1,435,206		1,347,125
Commercial and commercial real estate		468,668		398,601
Agricultural production and real estate		92,498		85,210
Consumer and margin loans		18,527		18,388
		3,520,653		3,028,310
Less
Allowance for loan losses		18,883		15,842

Loans Receivable	$	3,501,770	$	3,012,468

Risk characteristics applicable to each segment of the loan portfolio are described as follows.

Mortgage Warehouse Lines of Credit (MTG WHLOC): Under its warehouse program, the Company provides warehouse financing arrangements to approved mortgage companies for the origination and sale of residential mortgage loans and to a lesser extent multi-family loans. Agency eligible, governmental and jumbo residential mortgage loans that are secured by mortgages placed on existing one-to-four family dwellings may be originated or purchased and placed on each mortgage warehouse line.

As a secured line of credit, collateral pledged to the Company secures each individual mortgage until the lender sells the loan in the secondary market. A traditional secured warehouse line of credit typically carries a base interest rate of 30-day LIBOR, plus a margin, or mortgage note rate, less a margin.

Risk is evident if there is a change in the fair value of mortgage loans originated by mortgage bankers in warehouse, the sale of which is the expected source of repayment of the borrowings under a warehouse line of credit.

Residential Real Estate Loans (RES RE): Real estate loans are secured by owner-occupied 1‑4 family residences. Repayment of residential real estate loans is primarily dependent on the personal income and credit rating of the borrowers. All-in-One mortgages included in this segment typically carry a base rate of 30-day LIBOR, plus a margin.

Multi-Family and Healthcare Financing (MF RE): The Company engages in multi-family and healthcare financing, including construction loans, specializing in originating and servicing loans for multi-family rental and senior living properties. In addition, the Company originates loans secured by an assignment of federal income tax credits by partnerships invested in multi-family real estate projects. Construction and land loans are generally based upon estimates of costs and estimated value of the completed project and include independent appraisal reviews and a financial analysis of the developers and property owners. Sources of repayment of these loans may include permanent loans, sales of developed property or an interim loan commitment from the Company until permanent agency-eligible financing is obtained. These loans are considered to be higher risk than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions and the availability of long-term financing. Credit risk in these loans may be impacted by the creditworthiness of a borrower, property values and the local economy in the Company’s market area. Repayment of these loans depends on the successful operation of a business or property and the borrower’s cash flows.

Commercial Lending and Commercial Real Estate Loans (CML & CRE): The commercial lending and commercial real estate portfolio includes loans to commercial customers for use in financing working capital needs, equipment purchases and expansions, as well as loans to commercial customers to finance land and improvements. It also includes loans collateralized by mortgage servicing rights and loan sale proceeds of mortgage warehouse customers. The loans in this category are repaid primarily from the cash flow of a borrower’s principal business operation. Credit risk in these loans is driven by creditworthiness of a borrower and the economic conditions that impact the cash flow stability from business operations.

Agricultural Production and Real Estate Loans (AG & AGRE): Agricultural production loans are generally comprised of seasonal operating lines of credit to grain farmers to plant and harvest corn and soybeans and term loans to fund the purchase of equipment. The Company also offers long term financing to purchase agricultural real estate. Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry-developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop and other farm assets as considered necessary. The Company is approved to sell agricultural loans in the secondary market through the Federal Agricultural Mortgage Corporation and uses this relationship to manage interest rate risk within the portfolio.

Consumer and Margin Loans (CON & MAR): Consumer loans are those loans secured by household assets. Margin loans are those loans secured by marketable securities. The term and maximum amount for these loans are determined by considering the purpose of the loan, the margin (advance percentage against value) in all collateral, the primary source of repayment, and the borrower’s other related cash flow.

Allowance for Loan Losses: The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to net interest income. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows (collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by the fair value of the collateral if the loan is collateral dependent, the loan’s obtainable market price, or either the present value of expected future cash flows discounted at the loan’s effective interest rate. For impaired loans where the Company utilizes discounted cash flows to determine the level of impairment, the Company includes the entire change in the present value of cash flows as bad debt expense.

Groups of loans with similar risk characteristics are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

In the course of working with borrowers, the Company may choose to restructure the contractual terms of certain loans. In restructuring the loan, the Company attempts to work out an alternative payment schedule with the borrower in order to optimize collectability of the loan. A troubled debt restructuring (“TDR)” occurs when, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status, and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two.

Nonaccrual loans, including TDRs that have not met the six-month minimum performance criterion, are reported as nonperforming loans. For all loan classes, it is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being restructured remain on nonaccrual status until three months of satisfactory borrower performance, at which time management would consider its return to accrual status. A loan is generally classified as nonaccrual when the Company believes that receipt of principal and interest is doubtful under the terms of the loan agreement. Most generally, this is at 90 or more days past due.

With regard to determination of the amount of the allowance for credit losses, restructured loans are considered to be impaired. As a result, the determination of the amount of impaired loans for each loan portfolio segment within troubled debt restructurings is the same as detailed previously above.

The following tables present, by loan portfolio segment, the activity in the allowance for loan losses for the three months ended March 31, 2020 and 2019 and the recorded investment in loans and impairment method as of March 31, 2020:


	At or For the Three Months Ended March 31, 2020
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	1,913	$	2,042	$	7,018	$	4,173	$	523	$	173	$	15,842
Provision (credit) for loan losses		796		20		676		1,445		38		23		2,998
Loans charged to the allowance		—		—		—		—		—		(1)		(1)
Recoveries of loans previously charged off		—		—		—		44		—		—		44
Balance, end of period	$	2,709	$	2,062	$	7,694	$	5,662	$	561	$	195	$	18,883
Ending balance: individually evaluated for impairment	$	—		29		—		1,167		—		6	$	1,202
Ending balance: collectively evaluated for impairment	$	2,709	$	2,033	$	7,694	$	4,495	$	561	$	189	$	17,681
Loans
Ending balance	$	1,083,776	$	421,978	$	1,435,206	$	468,668	$	92,498	$	18,527	$	3,520,653
Ending balance individually evaluated for impairment	$	230	$	2,410	$	—	$	9,425	$	2,043	$	16	$	14,124
Ending balance collectively evaluated for impairment	$	1,083,546	$	419,568	$	1,435,206	$	459,243	$	90,455	$	18,511	$	3,506,529


	For the Three Months Ended March 31, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, beginning of period	$	1,068	$	1,986	$	6,030	$	3,051	$	429	$	140	$	12,704
Provision (credit) for loan losses		186		4		347		71		34		7		649
Loans charged to the allowance		—		—		—		—		—		—		—
Recoveries of loans previously charged off		—		—		—		—		3		—		3
Balance, end of period	$	1,254	$	1,990	$	6,377	$	3,122	$	466	$	147	$	13,356

The following table presents the allowance for loan losses and the recorded investment in loans and impairment method as of December 31, 2019:


	December 31, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Allowance for loan losses
Balance, December 31, 2019	$	1,913	$	2,042	$	7,018	$	4,173	$	523	$	173	$	15,842
Ending balance: individually evaluated for impairment	$	—	$	23	$	—	$	650	$	—	$	8	$	681
Ending balance: collectively evaluated for impairment	$	1,913	$	2,019	$	7,018	$	3,523	$	523	$	165	$	15,161
Loans
Balance, December 31, 2019	$	765,151	$	413,835	$	1,347,125	$	398,601	$	85,210	$	18,388	$	3,028,310
Ending balance individually evaluated for impairment	$	233	$	3,109	$	—	$	9,152	$	—	$	23	$	12,517
Ending balance collectively evaluated for impairment	$	764,918	$	410,726	$	1,347,125	$	389,449	$	85,210	$	18,365	$	3,015,793

Internal Risk Categories

In adherence with policy, the Company uses the following internal risk grading categories and definitions for loans:

Average or above – Loans to borrowers of satisfactory financial strength or better. Earnings performance is consistent with primary and secondary sources of repayment that are well defined and adequate to retire the debt in a timely and orderly fashion. These businesses would generally exhibit satisfactory asset quality and liquidity with moderate leverage, average performance to their peer group and experienced management in key positions. These loans are disclosed as “Acceptable and Above” in the following table.

Acceptable – Loans to borrowers involving more than average risk and which contain certain characteristics that require some supervision and attention by the lender. Asset quality is acceptable, but debt capacity is modest and little excess liquidity is available. The borrower may be fully leveraged and unable to sustain major setbacks. Covenants are structured to ensure adequate protection. Borrower’s management may have limited experience and depth. This category includes loans which are highly leveraged due to regulatory constraints, as well as loans involving reasonable exceptions to policy. These loans are disclosed as “Acceptable and Above” in the following table.

Special Mention (Watch) – This is a loan that is sound and collectable but contains considerable risk. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard - Loans 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 have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

The following tables present the credit risk profile of the Company’s loan portfolio based on internal rating category and payment activity as of March 31, 2020 and December 31, 2019:


	March 31, 2020
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)

Special Mention (Watch)	$	—	$	2,413	$	30,930	$	12,961	$	2,006	$	30	$	48,340
Substandard		230		2,410		—		9,425		2,043		16		14,124
Doubtful		—		—		—		—		—		—		—
Acceptable and Above		1,083,546		417,155		1,404,276		446,282		88,449		18,481		3,458,189
Total	$	1,083,776	$	421,978	$	1,435,206	$	468,668	$	92,498	$	18,527	$	3,520,653


	December 31, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)

Special Mention (Watch)	$	—	$	2,472	$	41,882	$	13,806	$	2,114	$	31	$	60,305
Substandard		233		3,109		—		9,152		—		23		12,517
Doubtful		—		—		—		—		—		—		—
Acceptable and Above		764,918		408,254		1,305,243		375,643		83,096		18,334		2,955,488
Total	$	765,151	$	413,835	$	1,347,125	$	398,601	$	85,210	$	18,388	$	3,028,310

The Company evaluates the loan risk grading system definitions and allowance for loan loss methodology on an ongoing basis. No significant changes were made to either during the past year.

The following tables present the Company’s loan portfolio aging analysis of the recorded investment in loans as of March 31, 2020 and December 31, 2019:


	March 31, 2020
	30-59 Days		60-89 Days		Greater Than		Total				Total
	Past Due		Past Due		90 Days		Past Due		Current		Loans
	(In thousands)
MTG WHLOC	$	—	$	—	$	—	$	—	$	1,083,776	$	1,083,776
RES RE		1,002		289		1,972		3,263		418,715		421,978
MF RE		—		—		—		—		1,435,206		1,435,206
CML & CRE		274		622		2,180		3,076		465,592		468,668
AG & AGRE		429		152		1,908		2,489		90,009		92,498
CON & MAR		610		36		42		688		17,839		18,527
	$	2,315	$	1,099	$	6,102	$	9,516	$	3,511,137	$	3,520,653


	December 31, 2019
	30-59 Days		60-89 Days		Greater Than		Total				Total
	Past Due		Past Due		90 Days		Past Due		Current		Loans
	(In thousands)
MTG WHLOC	$	—	$	—	$	—	$	—	$	765,151	$	765,151
RES RE		3,089		562		2,324		5,975		407,860		413,835
MF RE		—		—		—		—		1,347,125		1,347,125
CML & CRE		2,293		335		1,663		4,291		394,310		398,601
AG & AGRE		2,047		—		195		2,242		82,968		85,210
CON & MAR		50		31		19		100		18,288		18,388
	$	7,479	$	928	$	4,201	$	12,608	$	3,015,702	$	3,028,310

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in TDRs.

The following tables present impaired loans and specific valuation allowance information based on class level as of March 31, 2020 and December 31, 2019:


	March 31, 2020
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Impaired loans without a specific allowance:
Recorded investment	$	230	$	2,179	$	—	$	7,028	$	2,043	$	7	$	11,487
Unpaid principal balance		230		2,179		—		7,028		2,043		7		11,487
Impaired loans with a specific allowance:
Recorded investment		—		231		—		2,397		—		9		2,637
Unpaid principal balance		—		231		—		2,397		—		9		2,637
Specific allowance		—		29		—		1,167		—		6		1,202
Total impaired loans:
Recorded investment		230		2,410		—		9,425		2,043		16		14,124
Unpaid principal balance		230		2,410		—		9,425		2,043		16		14,124
Specific allowance		—		29		—		1,167		—		6		1,202


	December 31, 2019
	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Impaired loans without a specific allowance:
Recorded investment	$	233	$	2,899	$	—	$	6,662	$	—	$	12	$	9,806
Unpaid principal balance		233		2,899		—		6,662		—		12		9,806
Impaired loans with a specific allowance:
Recorded investment		—		210		—		2,490		—		11		2,711
Unpaid principal balance		—		210		—		2,490		—		11		2,711
Specific allowance		—		23		—		650		—		8		681
Total impaired loans:
Recorded investment		233		3,109		—		9,152		—		23		12,517
Unpaid principal balance		233		3,109		—		9,152		—		23		12,517
Specific allowance		—		23		—		650		—		8		681

The following tables present by portfolio class, information related to the average recorded investment and interest income recognized on impaired loans for the three months ended March 31, 2020 and 2019:


	MTG WHLOC		RES RE		MF RE		CML & CRE		AG & AGRE		CON & MAR		TOTAL
	(In thousands)
Three Months Ended March 31, 2020
Average recorded investment in impaired loans	$	231	$	3,088	$	—	$	9,502	$	2,043	$	20	$	14,884
Interest income recognized		—		16		—		131		—		—		147

Three Months Ended March 31, 2019
Average recorded investment in impaired loans	$	574	$	2,806	$	—	$	8,468	$	364	$	48	$	12,260
Interest income recognized		—		15		—		140		—		—		155

The following table presents the Company’s nonaccrual loans and loans past due 90 days or more and still accruing at March 31, 2020 and December 31, 2019.


	March 31,				December 31,
	2020				2019
			Total Loans >				Total Loans >
			90 Days &				90 Days &
	Nonaccrual		Accruing		Nonaccrual		Accruing
	(In thousands)
MTG WHLOC	$	230	$	—	$	233	$	—
RES RE		664		1,551		740		1,851
MF RE		—		—		—		—
CML & CRE		1,766		396		1,118		486
AG & AGRE		—		1,908		—		231
CON & MAR		16		26		18		1

	$	2,676	$	3,881	$	2,109	$	2,569

No troubled loans were restructured during the three months ended March 31, 2020 or 2019. No restructured loans defaulted during the three months ended March 31, 2020 or 2019. Loan modifications or forbearances related to the COVID-19 pandemic will generally not be considered TDRs.

There was one customer with a residential loan balance of $725,000 in the process of foreclosure at December 31, 2019 that was paid in full at March 31, 2020 and there were no residential loans in process of foreclosure as of March 31, 2020.