Allowance for Credit Losses

6 Months Ended

Jun. 30, 2024

Allowance for Credit Losses

Allowance for Credit Losses

6. Allowance for Credit Losses

Available for Sale Securities and Held to Maturity Securities

The Company has evaluated available for sale debt securities that are in an unrealized loss position and has determined that any decline in value is unrelated to credit loss and related to changes in market interest rates since purchase. None of the available for sale debt securities held were past due at June 30, 2024. In addition, as of June 30, 2024, the Company had not made a decision to sell any of its debt securities held, nor did the Company consider it more likely than not that it would be required to sell such securities before recovery of their amortized cost basis. The Company does not expect to have credit losses associated with the debt securities, and no allowance was recognized on the debt securities portfolio.

Loans Held for Investment

The allowance for credit losses for loans held for investment represents management’s best estimate of all expected credit losses over the expected contractual life of the Company’s existing portfolio. Management’s methodology for determining the allowance for credit losses uses the current expected credit losses (“CECL”) standard. Management considers the level of allowance for credit losses to be a reasonable and supportable estimate of expected credit losses inherent within the loans held for investment portfolio as of June 30, 2024. While the Company believes it has an appropriate allowance for the existing loan portfolio at June 30, 2024, additional provision for losses on existing loans may be necessary in the future. Future changes in the allowance for credit losses are expected to be volatile given dependence upon, among other things, the portfolio composition and quality, as well as changes in macroeconomic forecasts and loan cash flow assumptions. In addition to the allowance for credit losses, the Company maintains a separate allowance for credit losses related to off-balance sheet credit exposures, including unfunded loan commitments, and this amount is included in other liabilities within the consolidated balance sheets. For further information on the policies that govern the estimation of the allowances for credit losses levels, see Note 1 to the consolidated financial statements in the Company’s 2023 Form 10-K.

One of the most significant judgments involved in estimating the Company’s allowance for credit losses relates to the macroeconomic forecasts used to estimate credit losses over the reasonable and supportable forecast period. To determine the Company’s best estimate of expected credit losses as of June 30, 2024, the Company utilized a single macroeconomic alternative scenario, or S7, published by Moody’s Analytics in June 2024 that was updated to reflect the U.S. economic outlook. This alternative economic scenario expects inflation to accelerate back to more than 3% annualized. In response to rising inflation, Federal Reserve monetary policy raises the federal funds rate in 2024 to a terminal range of 5.75 to 6%. The combination of the persistent inflation, the Federal Reserve rate increases, and declining confidence causes economic growth to decelerate during the remainder of 2024 and early 2025 and to fall into recession in the second quarter of 2025. Significant variables that impact the modeled losses across the Company’s loan portfolios are the U.S. Real Gross Domestic Product, or GDP, growth rates and unemployment rate assumptions. Changes in these assumptions and forecasts of economic conditions could significantly affect the estimate of expected credit losses at the balance sheet date or between reporting periods.

During the three and six months ended June 30, 2023, the provision for credit losses reflected a significant build in the allowance related to loan portfolio changes since the prior quarter and a deteriorating outlook for commercial real estate markets. The net impact to the allowance of changes associated with collectively evaluated loans during the three and six months ended June 30, 2023 included a provision for credit losses on collectively evaluated loans at the Bank of $12.9 million and $14.5 million, respectively, while the net impact to the allowance of changes associated with individually evaluated loans during the three and six months ended June 30, 2023 included a provision for credit losses of $1.9 million and $2.7 million, respectively. The changes in the allowance for credit losses during the noted periods were primarily attributable to the Bank and also reflected other factors including, but not limited to, loan mix, and changes in loan balances and qualitative factors from the prior quarter. The changes in the allowance during the three and six months ended June 30, 2023 were also impacted by net charge-offs of $2.9 million and $3.3 million, respectively.

During the three and six months ended June 30, 2024, the provision for credit losses reflected a build in the allowance related to specific reserves and loan portfolio changes within the banking segment since the prior quarter, slightly offset by improvements to the U.S. economic outlook. Specific to the Bank, the net impact to the allowance of changes associated with individually evaluated loans during the three and six months ended June 30, 2024 included a provision for

credit losses of $8.0 million and $12.1 million, respectively, while the net impact to the allowance of changes associated with collectively evaluated loans during the three and six months ended June 30, 2024 included a provision for credit losses of $3.0 million and a reversal of credit losses of $4.0 million, respectively. The changes in the allowance for credit losses during the noted periods were primarily attributable to the Bank and also reflected other factors including, but not limited to, loan mix, and changes in loan balances and qualitative factors from the prior quarter. The changes in the allowance during the three and six months ended June 30, 2024 were also impacted by net charge-offs of $0.1 million and $4.4 million, respectively.

Changes in the allowance for credit losses for loans held for investment, distributed by portfolio segment, are shown below (in thousands).

	Balance,		Provision for				Recoveries on		Balance,
	Beginning of		(Reversal of)		Loans		Charged Off		End of
Three Months Ended June 30, 2024	Period		Credit Losses		Charged Off		Loans		Period
Commercial real estate:
Non-owner occupied	$	39,563	$	(2,242)	$	—	$	—	$	37,321
Owner occupied		28,737		4,029		—		6		32,772
Commercial and industrial		16,552		12,480		(615)		452		28,869
Construction and land development		10,008		(2,415)		—		1		7,594
1-4 family residential		8,744		(924)		(1)		93		7,912
Consumer		544		22		(65)		46		547
Broker-dealer		83		(16)		—		—		67
Total	$	104,231	$	10,934	$	(681)	$	598	$	115,082

	Balance,		Provision for				Recoveries on		Balance,
	Beginning of		(Reversal of)		Loans		Charged Off		End of
Six Months Ended June 30, 2024	Period		Credit Losses		Charged Off		Loans		Period
Commercial real estate:
Non-owner occupied	$	40,061	$	(1,093)	$	(1,647)	$	—	$	37,321
Owner occupied		28,114		4,643		—		15		32,772
Commercial and industrial		20,926		10,747		(3,598)		794		28,869
Construction and land development		12,102		(4,510)		—		2		7,594
1-4 family residential		9,461		(1,652)		(1)		104		7,912
Consumer		648		(38)		(146)		83		547
Broker-dealer		101		(34)		—		—		67
Total	$	111,413	$	8,063	$	(5,392)	$	998	$	115,082

	Balance,		Provision for				Recoveries on		Balance,
	Beginning of		(Reversal of)		Loans		Charged Off		End of
Three Months Ended June 30, 2023	Period		Credit Losses		Charged Off		Loans		Period
Commercial real estate:
Non-owner occupied	$	38,667	$	4,906	$	—	$	9	$	43,582
Owner occupied		22,854		5,015		—		11		27,880
Commercial and industrial		16,615		3,632		(3,020)		88		17,315
Construction and land development		5,999		1,396		—		—		7,395
1-4 family residential		11,691		(108)		—		35		11,618
Consumer		563		59		(53)		46		615
Broker-dealer		965		(64)		—		—		901
Total	$	97,354	$	14,836	$	(3,073)	$	189	$	109,306

	Balance,		Provision for				Recoveries on		Balance,
	Beginning of		(Reversal of)		Loans		Charged Off		End of
Six Months Ended June 30, 2023	Period		Credit Losses		Charged Off		Loans		Period
Commercial real estate:
Non-owner occupied	$	39,247	$	4,326	$	—	$	9	$	43,582
Owner occupied		24,008		4,827		(977)		22		27,880
Commercial and industrial		16,035		3,579		(3,079)		780		17,315
Construction and land development		6,051		1,344		—		—		7,395
1-4 family residential		9,313		2,326		(73)		52		11,618
Consumer		554		98		(122)		85		615
Broker-dealer		234		667		—		—		901
Total	$	95,442	$	17,167	$	(4,251)	$	948	$	109,306

Unfunded Loan Commitments

The Bank uses a process similar to that used in estimating the allowance for credit losses on the funded portion to estimate the allowance for credit loss on unfunded loan commitments. The allowance is based on the estimated exposure at default, multiplied by the lifetime Probability of Default grade and Loss Given Default grade for that particular loan segment. The Bank estimates expected losses by calculating a commitment usage factor based on industry usage factors. The commitment usage factor is applied over the relevant contractual period. Loss factors from the underlying loans to which commitments are related are applied to the results of the usage calculation to estimate any liability for credit losses related for each loan type. The expected losses on unfunded commitments align with statistically calculated parameters used to calculate the allowance for credit losses on the funded portion. There is no reserve calculated for letters of credit as they are issued primarily as credit enhancements and the likelihood of funding is low.

Changes in the allowance for credit losses for loans with off-balance sheet credit exposures are shown below (in thousands).

	Three Months Ended June 30,				Six Months Ended June 30,
	2024		2023		2024		2023
Balance, beginning of period	$	8,296	$	6,805	$	8,876	$	7,784
Other noninterest expense		289		1,187		(291)		208
Balance, end of period	$	8,585	$	7,992	$	8,585	$	7,992

The increases in the reserve for unfunded commitments during the three and six months ended June 30, 2023 were primarily due to increases in expected loss rates. During the three months ended June 30, 2024, the increase in the reserve for unfunded commitments was primarily due to an increase in expected loss rates, while the decrease in the reserve for unfunded commitments during the six months ended June 30, 2024 was primarily due to decreases in commitment balances.