Effective January 1, 2020, the Company adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments using the open pool methodology for all financial assets measured at amortized cost, which as of the adoption date consisted of the Company’s held for investment loan portfolio, excluding loans held for investment measured at fair value.

ASU 2016-13 replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables held for investment. Under the CECL methodology, the allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. The Company has identified the following portfolio segments based on risk characteristics of the loans in its loan portfolio (pool):

The Company determines the collectability of its loans by evaluating certain risk characteristics. The segmentation of its loan portfolio was determined based on analyses of the Company’s loan portfolio performance over the past seven years. Based on analyses of the loan portfolio’s historical performance, the Company concluded that loan purpose and product types are the most significant risk factors in determining its expectation of future loan losses. Loan purpose considers whether a borrower is acquiring the property or refinancing an existing property. The Company’s historical experience shows that refinance loans have higher loss rates than acquisitions. Product type includes residential 1-4 unit property and traditional commercial property. The Company’s historical experience shows that traditional commercial property loans have higher loss rates than residential 1-4 unit property.

To determine the loss rates used for the open pool methodology, the Company starts with its historical database of losses, segments the loans by loan purpose and product type, and then adjusts the loss rates based upon macroeconomic forecasts over a reasonable and supportable period. The reasonable and supportable period is meant to represent the period in which the Company believes the forecasted macroeconomic variables can be reasonably estimated.

In determining the January 1, 2020 CECL transition impact, the Company used a third-party model with a four-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. Management determined that a four-quarter forecast period and four-quarter straight-line reversion period were appropriate for the January 1, 2020 initial CECL estimate because, as of the beginning of the year, the economy was strong, unemployment and interest rates were low, and GDP was expected to have a modest increase during 2020. Management concluded that using a 1-year forecast trending steadily back to the Company’s historical loss levels best fit the strong, stable economy at that time.

For the March 31, 2020 CECL estimate, the Company used a COVID-19 stress scenario with a six-quarter reasonable and supportable forecast period followed by a three-quarter straight-line reversion period. Management concluded that using a six-quarter forecast and a three-quarter straight-line reversion best coincided with management and analysts’ sentiments that the impact of the COVID crisis would linger into 2021, with expectation of a quick recovery. This forecast period and reversion to historical loss is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.

For the June 30, 2020 CECL estimate, the Company used a COVID-19 stress scenario with a five-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. Management concluded that the original six-quarter COVID-19 stress forecast was still appropriate and, therefore, used five remaining forecasted quarters as of June 30. Given the second wave of the COVID pandemic, management decided to extend its reversion period by a quarter and used a four-quarter reversion period as of June 30. This forecast period and reversion to historical loss is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.

Loans 90 days or more delinquent, in bankruptcy, or in foreclosure, are evaluated individually for determination of allowance for credit losses. Loans individually evaluated are excluded from loans evaluated collectively by segment. The Company primarily relies on the value of the underlying real estate, coupled with low loan-to-value ratios, to satisfy the loan obligation, either through successful loss mitigation efforts or foreclosure and sale of the underlying real estate. Expected loan losses are based on the fair value of the collateral underlying the loans at the reporting date, adjusted for estimated selling costs as appropriate.

The allowance for credit losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when the Company believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.

The Company estimates the allowance using relevant available information, from internal and external sources, relating to historical performance, current conditions, and reasonable and supportable macroeconomic forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are considered for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency levels, or term, as well as for changes in environmental conditions, such as unemployment rates, property values and changes in the competitive or regulatory environment.

The allowance for credit losses is maintained at a level deemed adequate by management to provide for expected losses in the portfolio at the balance sheet date. While management uses available information to estimate its required allowance for credit losses, future additions to the allowance for credit losses may be necessary based on changes in estimates resulting from economic and other conditions.

Interest income on loans held for investment is accrued on the unpaid principal balance (UPB) at their respective stated interest rates. Generally, loans are placed on nonaccrual status when they become 90 days past due. Loans are considered past due when contractually required principal or interest payments have not been made on the due dates. Management has concluded that ASC 310-20-35-18(a) on interest income recognition does not apply to the forbearances granted under the Company’s COVID-19 forbearance program. The Company will continue to accrue interest on the COVID-19 forbearance granted loans for all such loans that were less than 90 days past due at the forbearance grant date. The Company will continue to evaluate the COVID-19 forbearance-granted loans on an individual basis to determine if a reserve should be established on the collectability of the accrued interest and whether any loans should be placed on nonaccrual status at a future date.

The Company has made the accounting policy election not to measure an allowance for credit losses for accrued interest receivables. When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction of interest income and accrued interest receivable. Accrued interest receivable is excluded from the amortized cost of loans and it is presented as accrued interest receivable in the Consolidated Balance Sheets.

The Company adopted ASU 2016-13, or ASU 326 using the modified-retrospective transition approach. Upon adoption, the Company recognized a cumulative effect adjustment to decrease retained earnings by $96,000, net of taxes. Results for reporting periods after January 1, 2020 are presented under ASC 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP.

The following table illustrates the impact of ASC 326 on the Company’s allowance for credit losses (in thousands):

	January 1, 2020
	As Reported				Impact of
	Under		Pre-ASC 326		ASC 326
Allowance for credit losses	ASC 326		Adoption		Adoption
Commercial - Purchase	$	323	$	304	$	19
Commercial - Refinance		1,078		1,016		62
Residential 1-4 Unit - Purchase		157		148		9
Residential 1-4 Unit - Refinance		819		772		47
Total	$	2,377	$	2,240	$	137

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which, among other things, allows the Company to (i) elect to suspend the requirements under GAAP for loan modifications related to COVID-19 that would otherwise be categorized as troubled debt restructurings (TDRs), and (ii) suspend any determination of a loan modified as a result of the effects of COVID-19 as being a TDR, including impairment for accounting purposes.

On March 22, 2020, the federal banking agencies issued an interagency statement to provide additional guidance to financial institutions who are working with borrowers affected by COVID-19. The agencies have confirmed with staff of the Financial Accounting Standards Board that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented

In response to the COVID-19 pandemic, the Company has implemented a COVID-19 forbearance program allowing customers to primarily defer payments for up to 90 days. Deferrals under the CARES Act or interagency guidance are not considered troubled debt restructurings. Interest on loans in the COVID-19 forbearance program that were less than 90 days past due at forbearance grant date will continue to accrue.