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Loans and Allowance for Loan Losses

6 Months Ended

Jun. 30, 2021

Note 5: Loans and Allowance for Loan Losses

The Company’s loan portfolio is its largest class of earning assets and typically provides higher yields than other types of earning assets. Associated with the higher yields is an inherent amount of credit risk which the Company attempts to mitigate with strong underwriting. As of June 30, 2021 and December 31, 2020, the carrying value of total loans held for investment amounted to $1.6 billion and $1.5 billion, respectively. The following table presents the balance of each major product type within the Company’s portfolio as of the dates indicated.

Schedule of Loan Portfolio

(in thousands)	June 30, 2021		December 31, 2020
Real estate:
Commercial	$	1,153,600	$	1,002,497
Commercial land and development		10,472		10,600
Commercial construction		67,984		91,760
Residential construction		6,362		11,914
Residential		26,447		30,431
Farmland		48,888		50,164
Commercial:
Secured		127,237		138,676
Unsecured		20,772		17,526
Paycheck Protection Program (“PPP”)		120,936		147,965
Consumer and other		6,902		4,921
Subtotal		1,589,600		1,506,454
Less: Net deferred loan fees		4,138		3,295
Less: Allowance for loan losses		22,153		22,189
Total loans, net	$	1,563,309	$	1,480,970

Underwriting

Commercial loans: Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay its obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Real estate loans: Real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography, and risk grade criteria.

Construction loans: With respect to construction loans that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the ultimate success of the project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property, or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are generally considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.

Residential real estate loans: Residential real estate loans are underwritten based upon the borrower’s income, credit history, and collateral. To monitor and manage residential loan risk, policies and procedures are developed and modified, as needed. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Underwriting standards for home loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage, collection remedies, the number of such loans a borrower can have at one time, and documentation requirements.

Farmland loans: Farmland loans are generally made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or service. Farmland loans are secured by real property and are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions, and changes in business cycles, as well as adverse weather conditions.

Consumer loans: The Company purchased consumer loans underwritten utilizing credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage, collection remedies, the number of such loans a borrower can have at one time, and documentation requirements.

Credit Quality Indicators

The Company has established a loan risk rating system to measure and monitor the quality of the loan portfolio. All loans are assigned a risk rating from the inception of the loan until the loan is paid off. The primary loan grades are as follows:

Loans Rated Pass: These are loans to borrowers with satisfactory financial support, repayment capacity, and credit strength. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history, and management expertise. Loans in this category must have an identifiable and stable source of repayment and meet the Company’s policy regarding debt service coverage ratios. These borrowers are capable of sustaining normal economic, market, or operational setbacks without significant financial impacts. Financial ratios and trends are acceptable. Negative external industry factors are generally not present. The loan may be secured, unsecured, or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain.

Loans Rated Watch: These are loans which have deficient loan quality and potentially significant issues, but losses do not appear to be imminent, and the issues are expected to be temporary in nature. The significant issues are typically: (a) a history of losses or events that threaten the borrower’s viability, (b) a property with significant depreciation and/or marketability concerns, or (c) poor or deteriorating credit, occasional late payments, and/or limited reserves but loan is generally kept current. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date.

Loans Rated Substandard: These are loans which are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged (if any). Loans so classified exhibit a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans are characterized by the distinct possibility that the Company may sustain some loss if the deficiencies are not corrected. The substandard loan category includes loans that management has determined not to be impaired, as well as loans that are impaired.

Loans Rated Doubtful: These are loans for which the collection or liquidation of the entire debt is highly questionable or improbable. Typically, the possibility of loss is extremely high. The losses on these loans are deferred until all pending factors have been addressed.

The following table summarizes the credit quality indicators related to the Company’s loans by class as of June 30, 2021:

Schedule of Loan by credit quality

(in thousands)	Pass		Watch		Substandard		Doubtful		Total
Real estate loans:
Commercial	$	1,102,858	$	15,223	$	35,519	$	—	$	1,153,600
Commercial land and development		10,472		—		—		—		10,472
Commercial construction		62,084		5,900		—		—		67,984
Residential construction		6,362		—		—		—		6,362
Residential		26,266		—		181		—		26,447
Farmland		48,888		—		—		—		48,888

Commercial:
Secured		126,211		—		1,026		—		127,237
Unsecured		20,772		—		—		—		20,772
PPP		120,936		—		—		—		120,936

Consumer		6,902		—		—		—		6,902

Loans and Leases Receivable, Gross	$	1,531,751	$	21,123	$	36,726	$	—	$	1,589,600

The following table summarizes the credit quality indicators related to the Company’s loans by class as of December 31, 2020:

(in thousands)	Pass		Watch		Substandard		Doubtful		Total
Real estate loans:
Commercial	$	950,118	$	16,836	$	35,543	$	—	$	1,002,497
Commercial land and development		10,600		—		—		—		10,600
Commercial construction		85,860		5,900		—		—		91,760
Residential construction		11,914		—		—		—		11,914
Residential		30,248		—		183		—		30,431
Farmland		50,164		—		—		—		50,164

Commercial:
Secured		136,992		1,552		132		—		138,676
Unsecured		17,526		—		—		—		17,526
PPP		147,965		—		—		—		147,965

Consumer		4,921		—		—		—		4,921

	$	1,446,308	$	24,288	$	35,858	$	—	$	1,506,454

Management regularly reviews the Company’s loans for accuracy of risk grades whenever new information is received. Borrowers are generally required to submit financial information at regular intervals. Typically, commercial borrowers with lines of credit are required to submit financial information with reporting intervals ranging from monthly to annually depending on credit size, risk, and complexity. In addition, investor commercial real estate borrowers with loans exceeding a certain dollar threshold are usually required to submit rent rolls or property income statements annually. Management monitors construction loans monthly. Management reviews other consumer loans based on delinquency. Management also reviews loans graded “Watch” or worse, regardless of loan type, no less than quarterly.

The age analysis of past due loans by class as of June 30, 2021 consisted of the following:


	Past Due
(in thousands)	30-89 Days		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable
Real estate loans:
Commercial	$	—	$	—	$	—	$	1,153,600	$	1,153,600
Commercial land and development		—		—		—		10,472		10,472
Commercial construction		—		—		—		67,984		67,984
Residential construction		—		—		—		6,362		6,362
Residential		—		—		—		26,447		26,447
Farmland		—		—		—		48,888		48,888

Commercial loans:
Secured		—		—		—		127,237		127,237
Unsecured		—		—		—		20,772		20,772
PPP		—		—		—		120,936		120,936

Consumer and other		—		—		—		6,902		6,902

Total Loans	$	—	$	—	$	—	$	1,589,600	$	1,589,600

There were no loans between 30-89 days past due nor any loans greater than 90 days past due and still accruing as of June 30, 2021.

The age analysis of past due loans by class as of December 31, 2020 consisted of the following:


	Past Due
(in thousands)	30-89 Days		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable
Real estate loans:
Commercial	$	—	$	—	$	—	$	1,002,497	$	1,002,497
Commercial land and development		—		—		—		10,600		10,600
Commercial construction		—		—		—		91,760		91,760
Residential construction		—		—		—		11,914		11,914
Residential		—		—		—		30,431		30,431
Farmland		—		—		—		50,164		50,164

Commercial loans:
Secured		—		—		—		138,676		138,676
Unsecured		—		—		—		17,526		17,526
PPP		—		—		—		147,965		147,965

Consumer and other		137		—		137		4,784		4,921

Total Loans	$	137	$	—	$	137	$	1,506,317	$	1,506,454

There were no loans between 60-89 days past due nor any loans greater than 90 days past due and still accruing as of December 31, 2020.

Impaired Loans

Information related to impaired loans as of June 30, 2021 and December 31, 2020 consisted of the following:

(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
June 30, 2021
Commercial real estate	$	130	$	130	$	—	$	134	$	—
Residential real estate		181		181		—		182		—
Commercial secured		120		120		—		126		—
Consumer and other		—		—		—		—		—
Total impaired loans	$	431	$	431	$	—	$	442	$	—
December 31, 2020
Commercial real estate	$	137	$	137	$	—	$	69	$	—
Residential real estate		183		183		—		92		—
Commercial secured		132		132		—		65		—
Total impaired loans	$	452	$	452	$	—	$	226	$	—

No collateral dependent loans were in process of foreclosure at June 30, 2021 or December 31, 2020. In addition, the weighted average loan-to-value of impaired, collateral dependent loans was approximately 44.76% at June 30, 2021 and 50.51% at December 31, 2020.

Nonaccrual loans, segregated by class, are as follows as of June 30, 2021 and December 31, 2020:

(in thousands)	June 30, 2021		December 31, 2020
Real estate loans:
Commercial	$	130	$	137
Residential		181		183
Commercial Secured		120		132
Consumer and other		—		—
Total nonaccrual loans	$	431	$	452

The amount of foregone interest income related to nonaccrual loans was $6,776 for the three months ended June 30, 2021 and $13,583 for the six months ended June 30, 2021, compared to $6,108 and $17,864 for the three and six months ended June 30, 2020, respectively.

Troubled Debt Restructuring

The Company’s loan portfolio includes certain loans that have been modified in a troubled debt restructuring (“TDR”), which are loans for which concessions in terms have been granted because of the borrowers’ financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are placed on non-accrual status at the time of restructure and may only be returned to accruing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.

When a loan is modified, it is measured based upon the present value of future cash flows discounted at the contractual interest rate of the original loan agreement, or the fair value of collateral less selling costs if the loan is collateral dependent. If the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through a specific allowance or a charge-off of the loan.

There were no loans outstanding with a TDR designation at June 30, 2021, December 31, 2020, and June 30, 2020.

Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), as subsequently amended by the Consolidated Appropriations Act, 2021, provided TDR relief for borrowers affected by the COVID-19 pandemic. Specifically, the CARES Act, as amended, specified that to be eligible not to be considered a TDR, a loan modification must be (1) related to the COVID-19 pandemic; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (a) 60 days after the date of termination of the federal national emergency, or (b) January 1, 2022. In accordance with section 4013 of the CARES Act, the Company elected to apply the temporary accounting relief provisions for loan modifications that met certain criteria, which would otherwise be designated TDRs under existing GAAP. As of June 30, 2021, eight borrowing relationships with ten loans totaling $12.9 million were continuing to benefit from payment relief. The Company accrues and recognizes interest income on loans under payment relief based on the original contractual interest rates. When payments resume at the end of the relief period, the payments will generally be applied to accrued interest due until accrued interest is fully paid.

The following table discloses activity in the allowance for loan losses for the periods presented.


Allowance for Loan Losses Rollforward
	Real Estate																		Commercial
(in thousands)	Comml			Comml Land and Devel			Comml Const			Resid Const			Resid			Farm- land			Secured			Unsec		PPP		Consu			Unal			Total
Three months ended June 30, 2021
Beginning balance	$	10,219		$	80		$	504		$	57		$	188		$	578		$	8,918		$	195	$	—	$	600		$	932		$	22,271
Charge-offs		—			—			—			—			—			—			(183	)		—		—		(72	)		—			(255	)
Recoveries		—			—			—			—			—			—			47			—		—		90			—			137
Provision (recapture)		(111	)		(5	)		(13	)		(11	)		—			16			412			14		—		(134	)		(168	)		—
Ending balance	$	10,108		$	75		$	491		$	46		$	188		$	594		$	9,194		$	209	$	—	$	484		$	764		$	22,153
Three months ended June 30, 2020
Beginning balance	$	7,752		$	128		$	919		$	156		$	241		$	1,533		$	4,720		$	114	$	—	$	710		$	218		$	16,491
Charge-offs		—			—			—			—			—			—			(103	)		—		—		(262	)		—			(365	)
Recoveries		—			—			—			—			90			—			108			—		—		31			—			229
Provision (recapture)		(251	)		(17	)		42			(41	)		(113	)		(652	)		2,361			5		—		397			(181	)		1,550
Ending balance	$	7,501		$	111		$	961		$	115		$	218		$	881		$	7,086		$	119	$	—	$	876		$	37		$	17,905

Six months ended June 30, 2021
Beginning balance	$	9,358		$	77		$	821		$	87		$	220		$	615		$	9,476		$	179	$	—	$	632		$	724		$	22,189
Charge-offs		—			—			—			—			—			—			(440	)		—		—		(72	)		—			(512)
Recoveries		—			—			—			—			—			—			134			—		—		142			—			276
Provision (recapture)		750			(2	)		(330	)		(41	)		(32	)		(21	)		24			30		—		(218	)		40			200
Ending balance	$	10,108		$	75		$	491		$	46		$	188		$	594		$	9,194		$	209	$	—	$	484		$	764		$	22,153
Six months ended June 30, 2020
Beginning balance	$	6,331		$	109		$	661		$	116		$	224		$	1,382		$	4,976		$	88	$	—	$	601		$	427		$	14,915
Charge-offs		—			—			—			—			—			—			(936	)		—		—		(487	)		—			(1,423)
Recoveries		—			—			—			—			90			—			116			—		—		58			(1	)		263
Provision (recapture)		1,170			2			300			(1	)		(96	)		(501	)		2,930			31		—		704			(389	)		4,150
Ending balance	$	7,501		$	111		$	961		$	115		$	218		$	881		$	7,086		$	119	$	—	$	876		$	37		$	17,905

The following table summarizes the allocation of the allowance for loan losses by impairment methodology for the periods presented.


	Real Estate												Commercial
(in thousands)	Comml		Comml Land and Devel		Comml Const		Resid Const		Resid		Farm- land		Secured		Unsec		PPP		Consu		Unal		Total
As of June 30, 2021:
Ending allowance balance allocated to:
Loans individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Loans collectively evaluated for impairment		10,108		75		491		46		188		594		9,194		209		—		484		764		22,153
Ending balance	$	10,108	$	75	$	491	$	46	$	188	$	594	$	9,194	$	209	$	—	$	484	$	764	$	22,153
Loans:
Ending balance individually evaluated for impairment	$	130	$	—	$	—	$	—	$	181	$	—	$	120	$	—	$	—	$	—	$	—	$	431
Ending balance collectively evaluated for impairment		1,153,470		10,472		67,984		6,362		26,266		48,888		127,117		20,772		120,936		6,902		—		1,589,169
Ending balance	$	1,153,600	$	10,472	$	67,984	$	6,362	$	26,447	$	48,888	$	127,237	$	20,772	$	120,936	$	6,902	$	—	$	1,589,600

As of December 31, 2020:
Ending allowance balance allocated to:
Loans individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Loans collectively evaluated for impairment		9,358		77		821		87		220		615		9,476		179		—		632		724		22,189
Ending balance	$	9,358	$	77	$	821	$	87	$	220	$	615	$	9,476	$	179	$	—	$	632	$	724	$	22,189
Loans:
Ending balance individually evaluated for impairment	$	137	$	—	$	—	$	—	$	183	$	—	$	132	$	—	$	—	$	—	$	—	$	452
Ending balance collectively evaluated for impairment		1,002,360		10,600		91,760		11,914		30,248		50,164		138,544		17,526		147,965		4,921		—		1,506,002
Ending balance	$	1,002,497	$	10,600	$	91,760	$	11,914	$	30,431	$	50,164	$	138,676	$	17,526	$	147,965	$	4,921	$	—	$	1,506,454

As of June 30, 2020:
Ending allowance balance allocated to:
Loans individually evaluated for impairment	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	49	$	—	$	49
Loans collectively evaluated for impairment		7,501		111		961		115		218		881		7,086		119		—		827		37		17,856
Ending balance	$	7,501	$	111	$	961	$	115	$	218	$	881	$	7,086	$	119	$	—	$	876	$	37	$	17,905
Loans:
Ending balance: individually evaluated for impairment	$	145	$	—	$	—	$	—	$	186	$	—	$	—	$	—	$	—	$	49	$	—	$	380
Ending balance: collectively evaluated for impairment		881,876		15,573		131,284		16,194		30,515		51,451		127,386		11,878		253,286		6,501		—		1,525,944
Ending balance	$	882,021	$	15,573	$	131,284	$	16,194	$	30,701	$	51,451	$	127,386	$	11,878	$	253,286	$	6,550	$	—	$	1,526,324

Pledged Loans

The Company’s FHLB line of credit is secured under terms of a collateral agreement by a pledge of certain qualifying loans with unpaid principal balances of $702.2 million and $1.1 billion at June 30, 2021 and December 31, 2020, respectively. In addition, the Company pledges eligible Tenants in Common loans, which totaled $42.4 million and $61.6 million at June 30, 2021 and December 31, 2020, respectively, to secure its borrowing capacity with the Federal Reserve Bank of San Francisco. See Note 7, Long Term Debt and Other Borrowings, for further discussion of these borrowings.

Related Party Loans

The Company has, and expects to have in the future, banking transactions in the ordinary course of its business with directors, officers, principal shareholders, and their businesses or associates. In accordance with applicable regulations and Bank policies, these loans are granted on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to us. Likewise, these transactions do not involve more than the normal risk of collectability or present other unfavorable features. Loan commitment to insiders and affiliates, net of cash collateral, totaled $5.5 million at June 30, 2021 and $1.6 million at December 31, 2020.