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Summary of Significant Accounting Policies

3 Months Ended

Mar. 31, 2023

Summary of Significant Accounting Policies

3. Summary of Significant Accounting Policies

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), commonly referred to as “CECL.” The provisions of the update eliminate the probable initial recognition threshold under previous GAAP which requires reserves to be based on an incurred loss methodology. Under CECL, reserves required for financial assets measured at amortized cost will reflect an organization’s estimate of all expected credit losses over the expected term of the financial asset and thereby require the use of reasonable and supportable forecasts to estimate future credit losses. Because CECL encompasses all financial assets carried at amortized cost, the requirement that reserves be established based on an organization’s reasonable and supportable estimate of expected credit losses extends to held to maturity debt securities. Under the provisions of the update, credit losses recognized on available for sale debt securities will be presented as an allowance as opposed to a write-down. In addition, CECL will modify the accounting for purchased loans. Under prior GAAP, a purchased loan’s contractual balance was adjusted to fair value through a credit discount, and no reserve was recorded on the purchased loan upon acquisition. Under CECL loans determined to be purchased credit deteriorated will have an allowance for credit losses established through purchase accounting. Finally, increased disclosure requirements under CECL oblige organizations to present credit quality disclosures disaggregated by the year of origination or vintage. FASB expects that the evaluation of underwriting standards and credit quality trends by financial statement users will be enhanced with the additional vintage disclosures. In October 2019, the FASB approved a change in the effective dates for CECL which delayed the effective date to fiscal years beginning after December 15, 2022 for smaller reporting companies.

On January 1, 2023, the Company adopted CECL. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to-maturity investment securities. It also applies to off-balance credit exposures not accounted for as insurance (loan commitments and standby letters of credit). In addition, ASC 326 made changes to the accounting for available-for-sale investment securities management does not intend to sell or believes that it is more likely than not they will be required to sell.

The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for the 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 requirements. The adoption of CECL resulted in an increase in the allowance for credit losses on loans of $1.5 million, an initial allowance for credit losses on held-to-maturity investment securities of $72,000, an increase in deferred tax assets of $391,000 and a decrease in retained earnings of $1.2 million. The increases in allowance for credit losses is primarily due to moving to a weighted average remaining maturity allowance methodology and the transition of purchase accounting discounts on loans from an adjustment to amortized cost in the allowance calculation.

The following table illustrates the impact of ASC 326:


	January 1, 2023
(Dollars in thousands)	As reported under ASC 326		Pre-ASC 326 adoption		Impact of ASC 326 adoption

Allowance for credit losses:
Held-to-maturity investment securities	$	72	$	-	$	72

One-to-four family residential real estate loans	$	1,677	$	655	$	1,022
Construction and land loans		166		117		49
Commercial real estate loans		4,221		3,158		1,063
Commercial loans		2,898		2,753		145
Paycheck protection program loans		-		-		-
Agriculture loans		1,142		1,966		(824	)
Municipal loans		16		5		11
Consumer loans		194		137		57
Total allowance for credit losses for loans	$	10,314	$	8,791	$	1,523

Unfunded loan commitments	$	170	$	170	$	-

Investment Securities. Investment securities are classified as held-to-maturity when management has the positive intent and ability to hold them to maturity. Securities are classified as available-for-sale when they might be sold before maturity. Held-to-maturity securities are carried at amortized cost while available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Realized gains and losses on sales of available-for-sale securities are recorded on a trade date basis and are calculated using the specific identification method.

Allowance for Credit Losses – Held-to-Maturity Investment Securities. Management measures expected credit losses on held-to-maturity investment securities on a collective basis by major security type. Accrued interest is excluded from the estimate of credit losses. The estimate of expected credit losses considers historical loss information adjusted for current conditions and reasonable and supportable forecasts.

Allowance for Credit Losses – Available-for-Sale Investment Securities. For available-for-sale investment securities in an unrealized loss position, the Company first assesses whether it intends to sell, or is more likely than not will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Company considers the extent to which fair value is less than amortized cost, the current interest rate environment, changes to rating of the security or security issuer, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected was less than the amortized cost basis, a credit loss existed and an allowance for credit losses would be recorded for the credit loss, which is limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. Changes in the allowance for credit losses are recorded as provision for or reversal of credit loss expense. Losses are charged against the allowance for credit losses when the Company determines the available-for-sale security is uncollectible or when either of the criteria regarding intent or requirement to sell is met. The Company does not estimate credit losses on available-for-sale security accrued interest receivable.

Loans. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost. The amortized cost is the principal balance outstanding net of previous charge-offs, and for purchased loans, net of unamortized purchase premiums and discounts. Interest income is accrued on the unpaid principal balance. Origination fees received on loans held in portfolio and the estimated direct costs of origination are deferred and amortized to interest income using the level yield method without anticipating prepayments.

The accrual of interest on non-performing loans is discontinued at the time the loan is ninety days delinquent, unless the credit is well secured and in process of collection. Loans are placed on non-accrual or are charged off at an earlier date if collection of the principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost recovery method, until qualifying for return to accrual. Loans are evaluated individually and are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Credit Losses - Loans. 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 loans. The analysis is updated on a quarterly basis based on historical loss information adjusted for current conditions and reasonable and supportable forecasts. Additionally, the Company considers asset quality trends, composition and trends in the loan portfolio, underlying collateral values, industry trends and other pertinent factors, including regulatory recommendations. The level of the allowance for credit losses maintained by management is believed adequate to absorb all expected future losses expected in the loan portfolio at the balance sheet date. The allowance is adjusted through provision for credit losses and charge-offs, net of recoveries of amounts previously charged off.

The allowance for credit losses is measured on a collective basis for pools of loans with similar risk characteristics. The Company has identified the following pools of financial assets with similar risk characteristics for measuring expected credit losses.

One-to-Four Family Residential Real Estate. One-to-four family residential real estate loans consists primarily of loans secured by 1-4 family residential properties. Repayment is primarily dependent on the personal cash flow of the borrower.

Construction and Land. Construction and land loans consist primarily of loans to facilitate the development of both residential and commercial real estate. Repayment is primarily dependent on the completion of the development and refinancing to longer term financing.

Commercial Real Estate. Commercial real estate loans consist primarily of loans secured by office buildings, industrial buildings, warehouses, retail buildings and multi-family housing and are primarily owner-occupied. For such loans, repayment is largely dependent upon the operation of the borrower’s business.

Commercial. Commercial loans include loans to business enterprises issued for commercial, industrial and/or other professional purposes. These loans are generally secured by equipment, inventory and accounts receivable of the borrower and repayment is primarily dependent on business cash flows.

Agriculture. Agriculture loans include operating and real estate loans to agriculture enterprises. Generally, the borrower’s ability to repay is based on the cash flows from farming operations.

Municipal. Municipal loans are generally related to equipment leasing or general fund loans. Repayment is primarily dependent on the tax revenue of the municipal entity.

Consumer. Consumer loans include automobile, boat, home improvement and home equity loans. Repayment is primarily dependent on the personal cash flow of the borrower.

The Company utilized a weighted average remaining maturity allowance methodology to calculate the allowance for credit losses. Historical loss rates are adjusted for current conditions and reasonable and supportable forecasts. Following the economic forecast period loss rates revert back to historical loss rates over a reasonable period of time. Additional adjustments for qualitative factors are included to quantify the risks within each of the loan categories that are not included in the historical loss rates or economic projections. The data for the allowance calculation may be obtained from internal or external sources.

Loans that do not share similar risk characteristics with the collectively evaluated pools are evaluated on an individual basis and are excluded from the collectively evaluated loan pools. Such loans are evaluated for credit losses based on either discounted cash flows or the fair value of collateral.

The Company estimates expected credit losses over the contractual term of obligations to extend credit, unless the obligation is unconditionally cancellable. The allowance for off-balance-sheet exposures is adjusted through the provision for credit losses. The estimates are determined based on the likelihood of funding during the contractual term and an estimate of credit losses subsequent to funding. Estimated credit losses on subsequently funded balances are based on the same assumptions used to estimated credit losses on loans.

In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures which eliminated the recognition and measurement guidance for troubled debt restructurings (“TDRs”) by creditors in ASC 310-40. The update also enhanced disclosure required for loan restructurings by creditors when a borrower is experiencing financial difficulty. Specifically, rather than applying the recognition and measurement guidance for TDRs, an entity will apply the loan refinancing and restructuring guidance to determine whether a modification or other form of restructuring results in a new loan or a continuation of an existing loan. Additionally, the amendments to this ASU require a public business entity to disclose current period gross charge-offs by year of origination for loans in the vintage disclosures.

On January 1, 2023, the Company adopted ASU 2022-02, electing the prospective approach. The adoption did not have a material effect on the Company’s operating results or financial condition. The disclosures in this document have been updated to reflect the new guidance.

Loans Modifications. Loan modifications, including modifications to borrowers experiencing financial difficulty, are treated as a new loan if two conditions are met. The terms of the new loan are at least as favorable to the Company as the terms for comparable loans to other customers with similar collection risks and modifications to the terms of the original loan are more than minor.