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Allowance for Loan Losses | 3 Months Ended
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Jun. 30, 2012
Notes |
Allowance for Loan Losses |
8. | ALLOWANCE FOR LOAN LOSSES
Allowance for loan loss: The allowance for loan losses is maintained at a level sufficient to provide for probable loan losses based on evaluating known and inherent risks in the loan portfolio. The allowance is provided based upon the Company’s ongoing quarterly assessment of the pertinent factors underlying the quality of the loan portfolio. These factors include changes in the size and composition of the loan portfolio, delinquency levels, actual loan loss experience, current economic conditions and detailed analysis of individual loans for which full collectability may not be assured. The detailed analysis includes techniques to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment. The allowance consists of specific, general and unallocated components. The specific component relates to loans that are considered impaired. For loans that are classified as impaired, an allowance is established when the discounted cash flows, or 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 based on the Company’s risk rating system and historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that the Company believes have resulted in losses that have not yet been allocated to specific elements of the general component. Such factors include uncertainties in economic conditions and in identifying triggering events that directly correlate to subsequent loss rates, changes in appraised value of underlying collateral, risk factors that have not yet manifested themselves in loss allocation factors and historical loss experience data that may not precisely correspond to the current portfolio or economic conditions. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The appropriate allowance level is estimated based upon factors and trends identified by the Company at the time the consolidated financial statements are prepared. Commercial business, commercial real estate, multi-family, construction and land acquisition and development loans are considered to have a higher degree of credit risk than one-to-four family residential loans, and tend to be more vulnerable to adverse conditions in the real estate market and deteriorating economic conditions. While the Company believes the estimates and assumptions used in its determination of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, that the actual amount of future provisions will not exceed the amount of past provisions, or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. In addition, bank regulators periodically review the Company’s allowance and may require the Company to increase its provision for loan losses or recognize additional loan charge-offs. An increase in the Company’s allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on the Company’s financial condition and results of operations. Management’s evaluation of the allowance for loan losses is based on ongoing, quarterly assessments of the known and inherent risks in the loan portfolio. Loss factors are based on the Company’s historical loss experience with additional consideration and adjustments made for changes in economic conditions, changes in the amount and composition of the loan portfolio, delinquency rates, changes in collateral values, seasoning of the loan portfolio, duration of current business cycle, a detailed analysis of impaired loans and other factors as deemed appropriate. These factors are evaluated on a quarterly basis. Loss rates used by the Company are affected as changes in these factors increase or decrease from quarter to quarter. The Company also considers bank regulatory examination results and findings of internal credit examiners in its quarterly evaluation of the allowance for loan losses. Management’s recent analysis of the allowance has placed greater emphasis on the Company’s construction and land development loan portfolios and the effect of various factors such as geographic and loan type concentrations. The Company has focused on managing these portfolios in an attempt to minimize the effects of declining home values and slower home sales in its market areas. The following tables present a reconciliation of the allowance for loan losses (in thousands):
Three months ended June 30, 2012 |  | Commercial Business |  |  | Commercial Real Estate |  |  | Land |  |  | Multi-Family |  |  | Real Estate Construction |  |  | Consumer |  |  | Unallocated |  |  | Total |
Beginning balance | $ | 2,688 |  | $ | 5,599 |  | $ | 4,906 |  | $ | 1,121 |  | $ | 412 |  | $ | 3,274 |  | $ | 1,921 |  | $ | 19,921 |
Provision for loan losses |  | 480 |  |  | 2,957 |  |  | (105 | ) |  | 208 |  |  | 142 |  |  | 201 |  |  | 117 |  |  | 4,000 |
Charge-offs |  | (624 | ) |  | (934 | ) |  | (874 | ) |  | (384 | ) |  | (75 | ) |  | (156 | ) |  | - |  |  | (3,047 | )
Recoveries |  | 32 |  |  | - |  |  | 31 |  |  | - |  |  | 1 |  |  | 34 |  |  | - |  |  | 98 |
Ending balance | $ | 2,576 |  | $ | 7,622 |  | $ | 3,958 |  | $ | 945 |  | $ | 480 |  | $ | 3,353 |  | $ | 2,038 |  | $ | 20,972 |
Three months ended June 30, 2011 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning balance | $ | 1,822 |  | $ | 4,744 |  | $ | 2,003 |  | $ | 2,172 |  | $ | 820 |  | $ | 1,339 |  | $ | 2,068 |  | $ | 14,968 |
Provision for loan losses |  | 464 |  |  | (172 | ) |  | 1,804 |  |  | (9 | ) |  | (21 | ) |  | 222 |  |  | (738 | ) |  | 1,550 |
Charge-offs |  | (453 | ) |  | - |  |  | - |  |  | - |  |  | - |  |  | (15 | ) |  | - |  |  | (468 | )
Recoveries |  | 8 |  |  | - |  |  | - |  |  | - |  |  | - |  |  | 1 |  |  | - |  |  | 9 |
Ending balance | $ | 1,841 |  | $ | 4,572 |  | $ | 3,807 |  | $ | 2,163 |  | $ | 799 |  | $ | 1,547 |  | $ | 1,330 |  | $ | 16,059 |
The following tables present an analysis of loans receivable and allowance for loan losses, which were evaluated individually and collectively for impairment at the dates indicated (in thousands):
| Allowance for loan losses |  | Recorded investment in loans |
June 30, 2012 |  | Individually Evaluated for Impairment |  |  | Collectively Evaluated for Impairment |  |  | Total |  |  | Individually Evaluated for Impairment |  |  | Collectively Evaluated for Impairment |  |  | Total |
Commercial business | $ | 127 |  | $ | 2,449 |  | $ | 2,576 |  | $ | 5,017 |  | $ | 74,778 |  | $ | 79,795 |
Commercial real estate |  | 681 |  |  | 6,941 |  |  | 7,622 |  |  | 23,163 |  |  | 323,077 |  |  | 346,240 |
Land |  | 76 |  |  | 3,882 |  |  | 3,958 |  |  | 6,059 |  |  | 23,072 |  |  | 29,131 |
Multi-family |  | 20 |  |  | 925 |  |  | 945 |  |  | 10,437 |  |  | 29,512 |  |  | 39,949 |
Real estate construction |  | 25 |  |  | 455 |  |  | 480 |  |  | 1,871 |  |  | 13,576 |  |  | 15,447 |
Consumer |  | 475 |  |  | 2,878 |  |  | 3,353 |  |  | 5,143 |  |  | 102,405 |  |  | 107,548 |
Unallocated |  | - |  |  | 2,038 |  |  | 2,038 |  |  | - |  |  | - |  |  | - |
Total | $ | 1,404 |  | $ | 19,568 |  | $ | 20,972 |  | $ | 51,690 |  | $ | 566,420 |  | $ | 618,110 |
| Allowance for loan losses |  | Recorded investment in loans |
March 31, 2012 |  | Individually Evaluated for Impairment |  |  | Collectively Evaluated for Impairment |  |  | Total |  |  | Individually Evaluated for Impairment |  |  | Collectively Evaluated for Impairment |  |  | Total |
Commercial business | $ | 73 |  | $ | 2,615 |  | $ | 2,688 |  | $ | 7,818 |  | $ | 79,420 |  | $ | 87,238 |
Commercial real estate |  | 686 |  |  | 4,913 |  |  | 5,599 |  |  | 22,824 |  |  | 330,256 |  |  | 353,080 |
Land |  | 624 |  |  | 4,282 |  |  | 4,906 |  |  | 14,226 |  |  | 24,662 |  |  | 38,888 |
Multi-family |  | 4 |  |  | 1,117 |  |  | 1,121 |  |  | 8,265 |  |  | 34,530 |  |  | 42,795 |
Real estate construction |  | 18 |  |  | 394 |  |  | 412 |  |  | 7,613 |  |  | 18,178 |  |  | 25,791 |
Consumer |  | 197 |  |  | 3,077 |  |  | 3,274 |  |  | 4,967 |  |  | 132,050 |  |  | 137,017 |
Unallocated |  | - |  |  | 1,921 |  |  | 1,921 |  |  | - |  |  | - |  |  | - |
Total | $ | 1,602 |  | $ | 18,319 |  | $ | 19,921 |  | $ | 65,713 |  | $ | 619,096 |  | $ | 684,809 |
Non-accrual loans: Loans are reviewed regularly and it is the Company’s general policy that a loan is past due when it is 30 days to 89 days delinquent. In general, when a loan is 90 days delinquent or when collection of principal or interest appears doubtful, it is placed on non-accrual status, at which time the accrual of interest ceases and a reserve for unrecoverable accrued interest is established and charged against operations. Payments received on non-accrual loans are applied to reduce the outstanding principal balance on a cash-basis method. As a general practice, a loan is not removed from non-accrual status until all delinquent principal, interest and late fees have been brought current and the borrower has demonstrated a history of performance based upon the contractual terms of the note. Interest income foregone on non-accrual loans was $470,000 and $281,000 during the three months ended June 30, 2012 and 2011, respectively. The following tables present an analysis of past due loans at the dates indicated (in thousands):
June 30, 2012 |  | 30-89 Days Past Due |  |  | 90 Days and Greater (Non- Accrual) |  |  | Total Past Due |  |  | Current |  |  | Total Loans Receivable |  |  | Recorded Investment > 90 Days and Accruing
Commercial business | $ | 482 |  | $ | 2,136 |  | $ | 2,618 |  | $ | 77,177 |  | $ | 79,795 |  | $ | -
Commercial real estate |  | 5,468 |  |  | 16,701 |  |  | 22,169 |  |  | 324,071 |  |  | 346,240 |  |  | -
Land |  | - |  |  | 4,184 |  |  | 4,184 |  |  | 24,947 |  |  | 29,131 |  |  | -
Multi-family |  | - |  |  | 7,207 |  |  | 7,207 |  |  | 32,742 |  |  | 39,949 |  |  | -
Real estate construction |  | - |  |  | 2,014 |  |  | 2,014 |  |  | 13,433 |  |  | 15,447 |  |  | -
Consumer |  | 2,037 |  |  | 4,540 |  |  | 6,577 |  |  | 100,971 |  |  | 107,548 |  |  | -
Total | $ | 7,987 |  | $ | 36,782 |  | $ | 44,769 |  | $ | 573,341 |  | $ | 618,110 |  | $ | -
March 31, 2012 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial business | $ | 535 |  | $ | 3,930 |  | $ | 4,465 |  | $ | 82,773 |  | $ | 87,238 |  | $ | -
Commercial real estate |  | 5,733 |  |  | 13,950 |  |  | 19,683 |  |  | 333,397 |  |  | 353,080 |  |  | -
Land |  | 128 |  |  | 12,985 |  |  | 13,113 |  |  | 25,775 |  |  | 38,888 |  |  | -
Multi-family |  | - |  |  | 1,627 |  |  | 1,627 |  |  | 41,168 |  |  | 42,795 |  |  | -
Real estate construction |  | - |  |  | 7,756 |  |  | 7,756 |  |  | 18,035 |  |  | 25,791 |  |  | -
Consumer |  | 2,453 |  |  | 3,915 |  |  | 6,368 |  |  | 130,649 |  |  | 137,017 |  |  | -
Total | $ | 8,849 |  | $ | 44,163 |  | $ | 53,012 |  | $ | 631,797 |  | $ | 684,809 |  | $ | -
Credit quality indicators: The Company monitors credit risk in its loan portfolio using a risk rating system for all commercial (non-consumer) loans. The risk rating system is a measure of the credit risk of the borrower based on their historical, current and anticipated financial characteristics. The Company assigns a risk rating to each commercial loan at origination and subsequently updates these ratings, as necessary, so the risk rating continues to reflect the appropriate risk characteristics of the loan. Application of appropriate risk ratings is key to management of the loan portfolio risk. In arriving at the rating, the Company considers the following factors: delinquency, payment history, quality of management, liquidity, leverage, earning trends, alternative funding sources, geographic risk, industry risk, cash flow adequacy, account practices, asset protection and extraordinary risks. Consumer loans, including custom construction loans, are not assigned a risk rating but rather are grouped into homogeneous pools with similar risk characteristics. When a consumer loan is delinquent 90 days it is placed on non-accrual status and assigned a substandard risk rating. Loss factors are assigned to each risk rating and homogeneous pool based on historical loss experience for similar loans. This historical loss experience is adjusted for qualitative factors that are likely to cause the estimated credit losses to differ from the Company’s historical loss experience. The Company uses these loss factors to estimate the general component of its allowance for loan losses. Pass - These loans have risk rating between 1 and 4 and are to borrowers that meet normal credit standards. Any deficiencies in satisfactory asset quality, liquidity, debt servicing capacity and coverage are offset by strengths in other areas. The borrower currently has the capacity to perform according to the loan terms. Any concerns about risk factors such as stability of margins, stability of cash flows, liquidity, dependence on a single product/supplier/customer, depth of management, etc., are offset by strength in other areas. Typically, the operating assets of the company and/or real estate will secure these loans. Management of borrowers of loans with this rating is considered competent. The borrower has the ability to repay the debt in the normal course of business. Watch – These loans have a risk rating of 5 and would typically have many of the attributes of loans in the pass rating. However, there would typically be some reason for additional management oversight, such as recent financial setbacks, deteriorating financial position, industry concerns and failure to perform on other borrowing obligations. Loans with this rating are to be monitored closely in an effort to correct deficiencies. Special mention – These loans have a risk rating of 6 and are currently protected but have the potential to deteriorate to a “Substandard” rating. The borrower’s financial performance may be inconsistent or below forecast, creating the possibility of liquidity problems and shrinking debt service coverage. The borrower may have a short track record and little depth of management. Other typical characteristics include inadequate current financial information, marginal capitalization, and susceptibility to negative industry trends. The primary source of repayment is still viable but there is increasing reliance on collateral or guarantor support. Substandard – These loans have a risk rating of 7 and are rated in accordance with regulatory guidelines, for which the accrual of interest may or may not be discontinued. By definition under regulatory guidelines, a “Substandard” loan has defined weaknesses which make payment default or principal exposure likely, but not yet certain. Such loans are apt to be dependent upon collateral liquidation, a secondary source of repayment, or an event outside of the normal course of business. Doubtful - These loans have a risk rating of 8 and are rated in accordance with regulatory guidelines. Such loans are placed on non-accrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Loss - These loans have a risk rating of 9 and are rated in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt. The following tables present an analysis of credit quality indicators at the dates indicated (dollars in thousands):
| June 30, 2012 |  |  | March 31, 2012
|  | Weighted- Average Risk Grade |  |  | Classified Loans (2) |  |  |  | Weighted- Average Risk Grade |  |  | Classified Loans (2)
Commercial business |  | 3.90 |  | $ | 10,132 |  |  |  | 3.97 |  | $ | 13,456
Commercial real estate |  | 4.05 |  |  | 50,771 |  |  |  | 3.88 |  |  | 35,077
Land |  | 4.89 |  |  | 6,370 |  |  |  | 5.60 |  |  | 17,560
Multi-family |  | 4.22 |  |  | 10,436 |  |  |  | 4.06 |  |  | 8,265
Real estate construction |  | 3.80 |  |  | 2,014 |  |  |  | 4.51 |  |  | 7,756
Consumer (1) |  | 7.00 |  |  | 4,540 |  |  |  | 7.00 |  |  | 3,915
Total |  | 4.10 |  | $ | 84,263 |  |  |  | 4.08 |  | $ | 86,029
Total loans risk rated | $ | 514,879 |  |  |  |  |  | $ | 550,174 |  |  |
(1) Consumer loans are primarily evaluated on a homogenous pool level and generally not individually risk rated unless certain factors are met. (2) Classified loans include loans under the credit quality indicator categories of substandard, doubtful and loss.
Impaired loans: A loan is considered impaired when it is probable that the Company will be unable to collect all amounts (principal and interest) due according to the contractual terms of the loan agreement. Typically, factors used in determining if a loan is impaired are, but not limited to, whether the loan is 90 days or more delinquent, internally designated as substandard, on non-accrual status or trouble debt restructures (“TDRs”). The majority of the Company’s impaired loans are considered collateral dependent. When a loan is considered collateral dependent impairment is measured using the estimated value of the underlying collateral, less any prior liens, and when applicable, less estimated selling costs. For impaired loans that are not collateral dependent impairment is measured using the present value of expected future cash flows, discounted at the loan’s original effective interest rate. When the net realizable value of the impaired loan is less than the recorded investment in the loan (including accrued interest, net deferred loan fees or costs, and unamortized premium or discount), an impairment is recognized by adjusting an allocation of the allowance for loan losses. Subsequent to the initial allocation of allowance to the individual loan, the Company may conclude that it is appropriate to record a charge-off of the impaired portion of the loan. When a charge-off is recorded the loan balance is reduced and the specific allowance is eliminated. Generally, when a collateral dependent loan is initially measured for impairment and has not had an appraisal performed in the last three months, the Company obtains an updated market valuation. Thereafter, the Company obtains an updated market valuation of the impaired loan on an annual basis. The valuation may occur more frequently if the Company determines that there is an indication that the market value of impaired loan smay have declined. The following tables present an analysis of impaired loans at the dates indicated (in thousands):
June 30, 2012 |  | Recorded Investment with No Specific Valuation Allowance |  |  | Recorded Investment with Specific Valuation Allowance |  |  | Total Recorded Investment |  |  | Unpaid Principal Balance |  |  | Related Specific Valuation Allowance |  |  | Average Recorded Investment
Commercial business | $ | 4,033 |  | $ | 984 |  | $ | 5,017 |  | $ | 5,586 |  | $ | 127 |  | $ | 6,417
Commercial real estate |  | 11,005 |  |  | 12,158 |  |  | 23,163 |  |  | 25,929 |  |  | 681 |  |  | 22,994
Land |  | 3,900 |  |  | 2,159 |  |  | 6,059 |  |  | 6,480 |  |  | 76 |  |  | 10,143
Multi-family |  | 9,999 |  |  | 438 |  |  | 10,437 |  |  | 11,408 |  |  | 20 |  |  | 9,351
Real estate construction |  | 1,267 |  |  | 604 |  |  | 1,871 |  |  | 5,220 |  |  | 25 |  |  | 4,742
Consumer |  | 1,740 |  |  | 3,403 |  |  | 5,143 |  |  | 5,741 |  |  | 475 |  |  | 5,055
Total | $ | 31,944 |  | $ | 19,746 |  | $ | 51,690 |  | $ | 60,364 |  | $ | 1,404 |  | $ | 58,702
March 31, 2012 |  | Recorded Investment with No Specific Valuation Allowance |  |  | Recorded Investment with Specific Valuation Allowance |  |  | Total Recorded Investment |  |  | Unpaid Principal Balance |  |  | Related Specific Valuation Allowance |  |  | Average Recorded Investment
Commercial business | $ | 4,790 |  | $ | 3,028 |  | $ | 7,818 |  | $ | 10,477 |  | $ | 73 |  | $ | 6,400
Commercial real estate |  | 12,704 |  |  | 10,120 |  |  | 22,824 |  |  | 25,359 |  |  | 686 |  |  | 17,102
Land |  | 10,365 |  |  | 3,861 |  |  | 14,226 |  |  | 17,989 |  |  | 624 |  |  | 13,339
Multi-family |  | 7,825 |  |  | 440 |  |  | 8,265 |  |  | 9,189 |  |  | 4 |  |  | 8,254
Real estate construction |  | 7,009 |  |  | 604 |  |  | 7,613 |  |  | 13,796 |  |  | 18 |  |  | 6,700
Consumer |  | 2,842 |  |  | 2,125 |  |  | 4,967 |  |  | 6,880 |  |  | 197 |  |  | 1,584
Total | $ | 45,535 |  | $ | 20,178 |  | $ | 65,713 |  | $ | 83,690 |  | $ | 1,602 |  | $ | 53,379
The related amount of interest income recognized on loans that were impaired was $243,000 and $291,000 during the three months ended June 30, 2012 and 2011, respectively. The following table presents newly restructured loans that occurred during the three months ended June 30, 2012 and 2011:
| June 30, 2012 |  | June 30, 2011
(Dollars in Thousands) |  | Number of Contracts |  |  | Pre- Modification Outstanding Recorded Investment |  |  | Post- Modification Outstanding Recorded Investment |  | Number of Contracts |  |  | Pre- Modification Outstanding Recorded Investment |  |  | Post- Modification Outstanding Recorded Investment |
Commercial business |  | 1 |  | $ | 301 |  | $ | 301 |  | 1 |  | $ | 501 |  | $ | 500 |
Commercial real estate (1) |  | 2 |  |  | 1,973 |  |  | 1,649 |  | - |  |  | - |  |  | - |
Land (1) |  | 3 |  |  | 2,340 |  |  | 1,964 |  | - |  |  | - |  |  | - |
Multi-family (1) |  | 1 |  |  | 3,278 |  |  | 3,201 |  | - |  |  | - |  |  | - |
Consumer |  | 2 |  |  | 1,971 |  |  | 1,945 |  | - |  |  | - |  |  | - |
Total |  | 9 |  | $ | 9,863 |  | $ | 9,060 |  | 1 |  | $ | 501 |  | $ | 500 |
(1) Original loan was a $5.0 million real estate construction loan restructured into one $3.3 million multi-family, one $875,000 commercial real estate and one $800,000 land loan based upon collateral securing the restricted loans.
Trouble debt restructures (“TDRs”) are loans where the Company, for economic or legal reasons related to the borrower's financial condition, has granted a concession to the borrower that it would otherwise not consider. A TDR typically involves a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, or an extension of the maturity date(s) at a stated interest rate lower than the current market rate for a new loan with similar risk. TDRs are considered impaired loans and as such, when a loan is deemed to be impaired, the amount of the impairment is measured using discounted cash flows using the original note rate, except when the loan is collateral dependent. In these cases, the current fair value of the collateral, less selling costs is used. Impairment is recognized as a specific component within the allowance for loan losses if the value of the impaired loan is less than the recorded investment in the loan. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. There were no TDRs that were recorded in the twelve months prior to June 30, 2012 or 2011 that subsequently defaulted in the three months ended June 30, 2012 or 2011. In accordance with the Company’s policy guidelines, unsecured loans are generally charged-off when no payments have been received for three consecutive months unless an alternative action plan is in effect. Consumer installment loans delinquent six months or more that have not received at least 75% of their required monthly payment in the last 90 days are charged-off. In addition, loans discharged in bankruptcy proceedings are charged-off. Loans under bankruptcy protection with no payments received for four consecutive months will be charged-off. The outstanding balance of a secured loan that is in excess of the net realizable value is generally charged-off if no payments are received for four to five consecutive months. However, charge-offs are postponed if alternative proposals to restructure, obtain additional guarantors, obtain additional assets as collateral or a potential sale would result in full repayment of the outstanding loan balance. Once any of these or other repayment potentials are considered exhausted the impaired portion of the loan is charged-off, unless an updated valuation of the collateral reveals no impairment. Regardless of whether a loan is unsecured or collateralized, once an amount is determined to be a confirmed loan loss it is promptly charged off.

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