Loans and Allowance for Loan Losses |
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Loans and Allowance for Loan Losses | Note 4. Loans and Allowance for Loan Losses
The following table presents loans held for investment, including Paycheck Protection Program ("PPP") loans, as of the dates stated.
The Company has pledged certain commercial and residential mortgages as collateral for borrowings with the FHLB. Loans totaling $436.0 million and $478.3 million were pledged as of December 31, 2022 and 2021, respectively. Additionally, PPP loans were pledged as collateral for Paycheck Protection Program Liquidity Facility ("PPPLF") advances in the amount of $51 thousand and $17.9 million as of December 31, 2022 and 2021, respectively.
As a result of the Bay Banks Merger and the 2019 acquisition of Virginia Community Bankshares, Inc., the acquired loan portfolios were initially measured at fair value as of the respective acquisition dates and subsequently accounted for as either purchased performing loans or PCI loans. The following table presents the outstanding principal balance and related recorded investment of these acquired loans included in the consolidated balance sheets as of the dates stated.
The following table presents the changes in the accretable yield for PCI loans for the periods stated.
The following tables present the aging of the recorded investment of loans held for investment as of the dates stated.
The following tables present the aging of the recorded investment of PCI loans as of the dates stated.
The following tables present the allowance for loan losses and the amount of loans evaluated for impairment, individually and collectively, by loan type as of the dates stated.
The tables above exclude PPP loans of $12.0 million and $30.7 million as of December 31, 2022 and 2021, respectively. PPP loans are fully guaranteed by the U.S. government; therefore, the Company recorded no allowance for loan losses for these loans. In future periods, the Company may be required to establish an ALL for these loans, which would result in a provision for loan losses charged to earnings.
The following tables present information related to impaired loans by loan type as of the dates presented.
The $35.4 million increase in impaired loans from December 31, 2021 to December 31, 2022 was primarily attributable to one loan to a commercial and industrial borrower totaling $37.3 million as of December 31, 2022. This loan was risk graded as substandard as of the same date, and as a result, was deemed impaired per Company policy and individually evaluated for impairment. This impairment analysis resulted in a $2.9 million allowance for loan loss as of December 31, 2022, which is included in the table above.
Impaired loans also include TDRs. As of December 31, 2022, there were 11 TDRs totaling $1.1 million as compared to eight TDRs totaling $688 thousand as of December 31, 2021.
The following table presents an analysis of the change in the allowance for loans losses by loan type as of the dates and for the periods stated.
The Company categorizes loans into risk categories based on relevant information about the expected ability of borrowers to service their debt, such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. The Company uses the following definitions for loan risk ratings and periodically evaluates the appropriateness of these ratings across its loan portfolio:
Risk Grade 1 – Strong: This grade is reserved for loans to the strongest of borrowers. These loans are to individuals or corporations that are well known to the Bank and are always secured with an almost guaranteed source of repayment such as a lien on a bank deposit account. Character, credit history, and ability of individuals or company principals are excellent and unquestioned. Source of income and industry of borrower appears stable. High liquidity, minimum risk, good ratios, and low handling cost are present.
Risk Grade 2 – Minimal: This grade is reserved for loans to borrowers who are deemed exceptionally strong. These loans are within guidelines and where the borrowers have documented significant overall financial strength. These loans have excellent sources of repayment, significant balance sheet liquidity, no significant identifiable risk of collection, and conform in all respects to policy, guidelines, underwriting standards, and federal and state regulations (no exceptions of any kind).
Risk Grade 3 – Acceptable: This grade is reserved for loans to borrowers who are deemed strong. These loans have adequate sources of repayment, with little identifiable risk of collection. Generally, loans assigned this risk grade will demonstrate the following characteristics: (1) conformity in all respects with policy, guidelines, underwriting standards, and federal and state regulations (no exceptions of any kind), (2) documented historical cash flow that meets or exceeds required minimum guidelines, or that can be supplemented with verifiable cash flow from other sources, and (3) adequate secondary sources to liquidate the debt.
Risk Grade 4 – Satisfactory: This grade is given to satisfactory loans containing more risk than Risk Grade 3 loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this risk grade will demonstrate the following characteristics: (1) general conformity to the Bank's underwriting requirements, with limited exceptions to policy, product, or underwriting guidelines. All exceptions noted have documented mitigating factors that offset any additional risk associated with the exceptions noted, (2) documented historical cash flow that meets or exceeds required minimum guidelines, or that can be supplemented with verifiable cash flow from other sources, and (3) adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.
Risk Grade 5 – Watch: This grade is for satisfactory loans containing acceptable but elevated risk. These loans are characterized by borrowers who have a marginal cash flow, marginal profitability, or have experienced an unprofitable year and declining financial condition. The borrower's management may be deemed to be satisfactory, the collateral securing the loan may create a loan-to-value ratio in excess of 90%, the debt service coverage ratio and global debt service coverage are unstable but mostly positive, and/or guarantor support, if any, is inadequate. Loans classified as Watch warrant additional monitoring by management.
Risk Grade 6 – Special Mention: This grade is for loans that have potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the Bank's credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. Special mention credits typically exhibit underwriting guideline tolerances and/or exceptions with no mitigating factors, or emerging weaknesses that may or may not be cured as time passes.
Risk Grade 7 – Substandard: A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans consistently not meeting the repayment schedule should be downgraded further to substandard. Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action. The weaknesses may include, but are not limited to: (1) high debt to worth ratios, (2) declining or negative earnings trends, (3) declining or inadequate liquidity, (4) improper loan structure, (5) questionable repayment sources, (6) lack of well-defined secondary repayment source, and (7) unfavorable competitive comparisons. Such loans are no longer considered to be adequately protected due to the borrower's declining net worth, lack of earnings capacity, declining collateral margins, and/or unperfected collateral positions. A possibility of loss of a portion of the loan balance cannot be ruled out. The repayment ability of the borrower is marginal or weak and the loan may have exhibited excessive overdue status or extensions and/or renewals.
Risk Grade 8 – Doubtful: Loans classified doubtful have all the weaknesses inherent in loans classified substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. However, these loans are not yet rated as loss because certain events may occur which would salvage the Bank's position, which can include, but not limited to (1) an injection of capital, (2) alternative financing, and (3) liquidation of assets or the pledging of additional collateral. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off against the allowance for loan losses.
Risk Grade 9 – Loss: Loans classified loss are considered uncollectable and of such little value that their continuance as assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer charging off the worthless loan, even though partial recovery may be effected in the future. Probable loss portions of doubtful loans are charged off promptly against the allowance for loan losses. There were no loans classified as doubtful or loss as of December 31, 2022 and December 31, 2021.
The following tables present the Company's loan portfolio (PCI and originated and purchased performing) by internal loan grades as of the dates stated. PPP loans are risk graded strong because they are fully guaranteed by the U.S. government.
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