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Summary of Significant Accounting Policies (Policies)

9 Months Ended

Sep. 30, 2023

Summary of Significant Accounting Policies

Recent Accounting Pronouncements

The following table provides a summary of Accounting Standards Updates (“ASU”) issued by the Financial Accounting Standards Board (“FASB”) that the Company has recently adopted.

ASU	Description	Effective Date	Effect on Financial Statements or Other Significant Matters
ASU 2019-10: Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates	Guidance to defer the effective dates for private companies, not-for-profit organizations, and certain smaller reporting companies applying standards on current expected credit losses (CECL), leases and hedging.	January 1, 2023	The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position but did impact disclosure requirements.
ASU 2019-11: Codification Improvements to Topic 326, Financial Instruments—Credit Losses	Guidance that addresses issues raised by stakeholders during the implementation of ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments affect a variety of Topics in the ASC.	January 1, 2023	The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position but did impact disclosure requirements.
ASU 2020-03: Codification Improvements to Financial Instruments	Guidance to clarify that the contractual term of a net investment in a lease, determined in accordance with the leases standard, should be the contractual term used to measure expected credit losses under ASC 326.	January 1, 2023	The adoption of this guidance did not have a material impact on the Company’s results of operations, financial position or disclosures.
ASU 2022-02: Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures	Eliminates the guidance on troubled debt restructurings (TDRs) for creditors in ASC 310-40 2 and amends the guidance on “vintage disclosures” to require disclosure of current-period gross write-offs by year of origination.	January 1, 2023	The adoption of this guidance did not have a material impact on the Company’s results of operations or financial position but did impact disclosure requirements.

Other accounting standards that have been issued or proposed by FASB or other standards-setting bodies are not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

On January 1, 2023, the Company adopted ASC 326, which replaced the incurred loss impairment framework in prior GAAP with a current expected credit loss (“CECL”) framework, which requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts and generally applies to financial assets measured at amortized cost, including loan receivables and some off-balance sheet credit exposures such as unfunded commitments to extend credit. Financial assets measured at amortized cost are presented at the net amount expected to be collected by using an allowance for credit losses (“ACL”).

In addition, the adoption of CECL resulted in changes to the Company’s accounting for available for sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available for sale debt securities if management does not intend to sell and does not believe that it is more likely than not, they will be required to sell.

The Company adopted ASC 326 and all related subsequent amendments thereto effective January 1, 2023 using the modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit exposures. Adoption of ASC 326 resulted in an initial reduction to retained earnings of $838,000, net of tax, due to a $1.1 million increase in the allowance for credit losses, comprised of a $2.3 million increase in the allowance for credit losses on unfunded commitments and a $1.2 million decrease in the allowance for credit losses on loans. There was no impact to the available-for-sale securities portfolio or other financial instruments. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP (referred to as the “Incurred Loss” methodology).

The Company adopted ASC 326 using the prospective transition approach for debt securities for which other-than-temporary impairment had been recognized prior to January 1, 2023. As of December 31, 2022, the Company did not have any other than-temporarily impaired investment securities. Therefore, upon adoption of ASC 326, the Company determined that an allowance for credit losses on available for sale securities was not deemed material.

The Company elected not to measure an allowance for credit losses for accrued interest receivable and instead elected to reverse interest income on loans or securities that are placed on nonaccrual status, which is generally when the instrument is 90 days past due, or earlier if the Company believes the collection of interest is doubtful. The Company has concluded that this policy results in the timely reversal of uncollectible interest.

The allowance for credit losses on loans 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 management 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. Accrued interest receivable is excluded from the estimate of credit losses. The allowance for credit losses represents management’s estimate of lifetime credit losses inherent in loans as of September 30, 2023. The allowance for credit losses is estimated by management using relevant available information, from both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The Company measures expected credit losses for loans on a pooled basis when similar risk characteristics exist. No loans were individually evaluated as of September 30, 2023. The Company has identified the following portfolio segments and calculates the allowance for credit losses for each using a Weighted Average Remaining Maturity (“WARM”) methodology:

- 1-4 family residential construction loans

- Other construction loans and all land development and other land loans

- Secured by farmland (including farm residential and other improvements)

- Home equity loans

- 1-4 family residential loans secured by first liens

- 1-4 family residential loans secured by junior liens

- Secured by multifamily residential properties

- Loans secured by owner-occupied, nonfarm nonresidential properties

- Loans secured by other nonfarm nonresidential properties

- Loans to finance agricultural production and other loans to farmers

- Commercial and industrial loans

- Other revolving credit plans

- Other consumer loans

- Obligations (other than securities and leases) of states and political subdivisions in the US

- Other loans

Under the WARM methodology, lifetime losses are calculated by determining the remaining life of the loan pool and then applying a loss rate which includes a forecast component over this remaining life of the loan pool. The methodology considers historical loss experience and a loss forecast expectation to estimate credit losses for the remaining balance of the loan pool. The calculated loss rate is applied to the contractual term (adjusted for prepayments) to determine the loan pool’s current expected credit losses. The Company’s forecast component projects the next four quarters to have similar loss rates to the period between November 1, 2015 and September 30, 2019, and then with a reversion back to the long-term average over four quarters. This period is intended to reflect the environment that began when the Federal Reserve started its last series of rate hikes beginning in November of 2015, and reflects the overall loan loss rates of the Company during this time of no higher than 0.4%. This period has been extended from the prior quarter by three months, and had minor impacts on the loss rates. The Company expects to adjust these time frames for affecting the forecast periods as the rate environment changes to reflect either increasing or decreasing loan loss rates that will adjust the historical loss rates.

Additionally, the allowance for credit losses calculation includes subjective adjustments for qualitative risk factors that are likely to cause estimated credit losses to differ from historical experience. These qualitative adjustments may increase or reduce reserve levels and include adjustments for: local, state and national economic outlook; levels and trends of delinquencies; trends in volume, mix and size of loans; seasoning of the loan portfolio; experience of staff; concentrations of credit; and interest rate risk.

Loans that do not share risk characteristics are evaluated on an individual basis. When management determines that foreclosure is probable and the borrower is experiencing financial difficulty, the expected credit losses are based on the fair value of collateral at the reporting date unadjusted for selling costs as appropriate. The Company did not have any loans evaluated on an individual basis at September 30, 2023.

Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.

The Company records an allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable. The allowance for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit loss model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for unfunded commitments is included in other liabilities on the Company’s consolidated balance sheets.

Reclassification

Certain amounts in the 2022 consolidated financial statements have been reclassified to conform to the 2023 presentation. These reclassifications did not have any impact on shareholders’ equity or net earnings.