The Company adopted ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, effective January 1, 2021. The guidance replaces the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables. It also applies to off-balance sheet credit exposures not accounted for as insurance, including loan commitments, standby letters of credits, financial guarantees, and similar instruments. The Company adopted ASC 326 using the modified retrospective method for loans and off-balance sheet credit exposures. The Company recorded a one-time cumulative-effect adjustment to the allowance for credit losses of $11.6 million. This adjustment brought the balance of the allowance for credit losses to $67.3 million as of January 1, 2021. In addition, the Company recorded an $8.7 million liability for unfunded commitments as of January 1, 2021. The after-tax effect decreased retained earnings by $14.2 million. The adjustment was based upon the Company’s analysis of then-current conditions, assumptions and economic forecasts at January 1, 2021.

The Company adopted ASC 326 using the prospective transition approach for financial assets purchased with credit deterioration (PCD) that were previously classified as purchased credit impaired (PCI) and accounted for under ASC 310-30. In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. On January 1, 2021, the amortized cost basis of the PCD assets were adjusted to reflect the addition of $1.9 million to allowance for credit losses.

The allowance for credit losses is measured using an average historical loss model that incorporates relevant information about past events (including historical credit loss experience on loans with similar risk characteristics), current conditions, and reasonable and supportable forecasts that affect the collectability of the remaining cash flows over the contractual term of the loans. The allowance for credit losses is measured on a collective (pool) basis. Loans are aggregated into pools based on similar risk characteristics, including borrower type, collateral and repayment types and expected credit loss patterns. Loans that do not share similar risk characteristics, primarily classified and/or TDR loans with a balance greater than or equal to $100,000, are evaluated on an individual basis.

For loans evaluated for credit losses on a collective basis, average historical loss rates are calculated for each pool using the Company’s historical net charge-offs (combined charge-offs and recoveries by observable historical reporting period) and outstanding loan balances during a lookback period. Lookback periods can be different based on the individual pool and represent management’s credit expectations for the pool of loans over the remaining contractual life. In certain loan pools, if the Company’s own historical loss rate is not reflective of the loss expectations, the historical loss rate is augmented by industry and peer data. The calculated average net charge-off rate is then adjusted for current conditions and reasonable and supportable forecasts. These adjustments increase or decrease the average historical loss rate to reflect expectations of future losses given economic forecasts of key macroeconomic variables including, but not limited to, unemployment rate, gross domestic product (“GDP”), commercial real estate price index, consumer sentiment and construction spending. The adjustments are based on results from various regression models projecting the impact of the macroeconomic variables to loss rates. The forecast is used for a reasonable and supportable period before reverting to historical averages. The forecast-adjusted loss rate is applied to the amortized cost of loans over the remaining contractual lives, adjusted for expected prepayments. The contractual term excludes expected extensions, renewals and modifications unless there is a reasonable expectation that a troubled debt restructuring (“TDR”) will be executed. Additionally, the allowance for credit losses considers other qualitative factors not included in historical loss rates or macroeconomic forecasts such as changes in portfolio composition, underwriting practices, or significant unique events or conditions.

ASU 2016-13 requires an allowance for off balance sheet credit exposures: unfunded lines of credit, undisbursed portions of loans, written residential and commercial commitments, and letters of credit. To determine the amount needed for allowance purposes, a utilization rate is determined either by the model or internally for each pool. Our loss model calculates the reserve on unfunded commitments based upon the utilization rate multiplied by the average loss rate factors in each pool with unfunded and committed balances. The liability for unfunded lending commitments utilizes the same model as the allowance for credit losses on loans; however, the liability for unfunded lending commitments incorporates assumptions for the portion of unfunded commitments that are expected to be funded.

Loans are placed on nonaccrual status at 90 days past due and interest is considered a loss unless the loan is well secured and in the process of collection. Payments received on nonaccrual loans are applied to principal until the loans are returned to accrual status. Loans are returned to accrual status when all payments contractually due are brought current, payment performance is sustained for a period of time, generally six months, and future payments are reasonably assured. With the exception of consumer loans, charge-offs on loans are recorded when available information indicates a loan is not fully collectible and the loss is reasonably quantifiable. Consumer loans are charged-off at specified delinquency dates consistent with regulatory guidelines.

No interest income was recorded on these loans for the three and nine months ended September 30, 2022 and 2021, respectively.

Nonaccrual loans for which there is no related allowance for credit losses as of September 30, 2022 had an amortized cost of $2.4 million. These loans are individually assessed and do not require an allowance due to being adequately collateralized under the collateral-dependent valuation method. A collateral-dependent loan is a financial asset for which the repayment is expected to be provided substantially through the operation or sale of the collateral when the borrower is experiencing financial difficulty based on the Company’s assessment as of the reporting date. Collateral-dependent loans are identified by either a classified risk rating or TDR status and a loan balance equal to or greater than $100,000, including, but not limited to, any loan in process of foreclosure or repossession.

The following tables present the activity in the allowance for credit losses by portfolio segment for the three and nine months ended September 30, 2022 and 2021. During the three months ended September 30, 2022, the Company recorded provision expense of $2.0 million on its portfolio of outstanding loans, compared to a negative provision expense of $3.0 million during the three months ended September 30, 2021. During the nine months ended September 30, 2022, the Company recorded provision expense of $2.0 million on its portfolio of outstanding loans, compared to a negative provision expense of $3.7 million during the nine months ended September 30, 2021.

The following tables present the activity in the allowance for unfunded commitments by portfolio segment for the three and nine months ended September 30, 2022 and 2021. The provision for losses on unfunded commitments for the three months ended September 30, 2022 was $1.3 million, compared to $643,000 for the three months ended September 30, 2021. The provision for losses on unfunded commitments for the nine months ended September 30, 2022 was $3.3 million, compared to a credit (negative expense) of $338,000 for the nine months ended September 30, 2021. In the 2022 periods, the Company experienced increases in its unfunded commitments, resulting in an increase in its required reserves for such potential losses. The level and mix of unfunded commitments resulted in a decrease in the required reserve for such potential losses in the 2021 nine month period presented.

The portfolio segments used in the preceding tables correspond to the loan classes used in all other tables in Note 6 as follows:

The following table presents the amortized cost basis of collateral-dependent loans by class of loans:


	September 30, 2022				December 31, 2021
	Principal		Specific		Principal		Specific
	Balance		Allowance		Balance		Allowance

	(In Thousands)
One- to four-family residential construction	$	—	$	—	$	—	$	—
Subdivision construction		—		—		—		—
Land development		468		—		468		—
Commercial construction		—		—		—		—
Owner occupied one- to four- family residential		1,695		35		1,980		18
Non-owner occupied one- to four-family residential		—		—		—		—
Commercial real estate		1,805		112		2,217		397
Other residential		—		—		—		—
Commercial business		—		—		—		—
Industrial revenue bonds		—		—		—		—
Consumer auto		—		—		—		—
Consumer other		159		80		160		80
Home equity lines of credit		138		—		377		—

Total	$	4,265	$	227	$	5,202	$	495

TDRs by class are presented below as of September 30, 2022 and December 31, 2021.


	September 30, 2022
	Accruing TDR Loans			Non-accruing TDR Loans			Total TDR Loans
	Number	Balance		Number	Balance		Number	Balance

	(In Thousands)
Construction and land development	—	$	—	—	$	—	—	$	—
One- to four-family residential	12		1,005	3		103	15		1,108
Other residential	—		—	—		—	—		—
Commercial real estate	—		—	2		1,609	2		1,609
Commercial business	—		—	—		—	—		—
Consumer	14		220	7		49	21		269
	26	$	1,225	12	$	1,761	38	$	2,986


	December 31, 2021
	Accruing TDR Loans			Non-accruing TDR Loans			Total TDR Loans
	Number	Balance		Number	Balance		Number	Balance

	(In Thousands)
Construction and land development	1	$	15	—	$	—	1	$	15
One- to four-family residential	10		579	12		1,059	22		1,638
Other residential	—		—	—		—	—		—
Commercial real estate	1		85	1		1,726	2		1,811
Commercial business	—		—	—		—	—		—
Consumer	26		323	13		64	39		387
	38	$	1,002	26	$	2,849	64	$	3,851

The following tables present newly restructured loans, which were considered TDRs, during the three and nine months ended September 30, 2022 and 2021, respectively, by type of modification:

Three Months Ended September 30, 2022

Total

Interest Only

Term

Combination

Modification

(In Thousands)

Commercial real estate

—

Consumer

—


	Three Months Ended September 30, 2021
							Total
	Interest Only		Term		Combination		Modification

	(In Thousands)
One- to four-family residential	$	—	$	—	$	134	$	134
Consumer		—		—		10		10
	$	—	$	—	$	144	$	144


	Nine Months Ended September 30, 2022
							Total
	Interest Only		Term		Combination		Modification

	(In Thousands)
Commercial real estate	$	—	$	—	$	247	$	247
Consumer		—		4		3		7
	$	—	$	4	$	250	$	254


	Nine Months Ended September 30, 2021
							Total
	Interest Only		Term		Combination		Modification

	(In Thousands)
Commercial real estate	$	1,768	$	—	$	—	$	1,768
One- to four-family residential		—		157		134		291
Consumer		—		100		10		110
	$	1,768	$	257	$	144	$	2,169

At September 30, 2022, of the $3.0 million in TDRs, $1.8 million were classified as substandard using the Company’s internal grading system, which is described below. The Company had no TDRs that were modified in the previous 12 months and subsequently defaulted during the three months ended September 30, 2022.

At December 31, 2021, of the $3.9 million in TDRs, $2.9 million were classified as substandard using the Company’s internal grading system. The Company had no TDRs that were modified in the previous 12 months and subsequently defaulted during the year ended December 31, 2021.

During the three and nine months ended September 30, 2022, $66,000 and $578,000 of loans, respectively, met the criteria for placement back on accrual status. During the three and nine months ended September 30, 2021, $96,000 and $433,000 of loans, respectively, met the criteria for placement back on accrual status. The criteria is generally a minimum of six months of consistent and timely payment performance under original or modified terms.

The Company utilizes an internal risk rating system comprised of a series of grades to categorize loans according to perceived risk associated with the expectation of debt repayment. The analysis of the borrower’s ability to repay considers specific information, including but not limited to current financial information, historical payment experience, industry information, collateral levels and collateral types. A risk rating is assigned at loan origination and then monitored throughout the contractual term for possible risk rating changes.

Satisfactory loans range from Excellent to Moderate Risk, but generally are loans supported by strong recent financial statements. The character and capacity of the borrower are strong, including reasonable project performance, good industry experience, liquidity and/or net worth. The probability of financial deterioration seems unlikely. Repayment is expected from approved sources over a reasonable period of time.

Watch loans are identified when the borrower has capacity to perform according to terms; however, elements of uncertainty exist. Margins of debt service coverage may be narrow, historical patterns of financial performance may be erratic, collateral margins may be diminished and the borrower may be a new and/or thinly capitalized company. Some management weakness may also exist, the borrower may have somewhat limited access to other financial institutions, and that access may diminish in difficult economic times.

Special Mention loans have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of repayment prospects or the Bank’s credit position at some future date. It is a transitional grade that is closely monitored for improvement or deterioration.

The Substandard rating is applied to loans where the borrower exhibits well-defined weaknesses that jeopardize its continued performance and are of a severity that the distinct possibility of default exists. Loans are placed on “non-accrual” when management does not expect to collect payments consistent with acceptable and agreed upon terms of repayment.

Doubtful loans have all the weaknesses inherent to those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable. Loans considered loss are uncollectable and no longer included as an asset.

All loans are analyzed for risk rating updates regularly. For larger loans, rating assessments may be more frequent if relevant information is obtained earlier through debt covenant monitoring or overall relationship management. Smaller loans are monitored as identified by the loan officer based on the risk profile of the individual borrower or if the loan becomes past due related to credit issues. Loans rated Watch, Special Mention, Substandard or Doubtful are subject to quarterly review and monitoring processes. In addition to the regular monitoring performed by the lending personnel and credit committees, loans are subject to review by the credit review department, which verifies the appropriateness of the risk ratings for the loans chosen as part of its risk-based review plan.

The following table present a summary of loans by category and risk rating separated by origination and loan class as of September 30, 2022.


	Term Loans by Origination Year
													Revolving
	2022 YTD		2021		2020		2019		2018		Prior		Loans		Total

	(In Thousands)
One- to four-family residential construction
Satisfactory (1-4)	$	18,381	$	10,834	$	2,551	$	—	$	—	$	216	$	—	$	31,982
Watch (5)		—		—		—		—		—		—		—		—
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		—		—
Total		18,381		10,834		2,551		—		—		216		—		31,982

Subdivision construction
Satisfactory (1-4)		4,240		26,362		757		204		142		608		664		32,977
Watch (5)		—		—		—		—		—		—		—		—
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		—		—
Total		4,240		26,362		757		204		142		608		664		32,977

Construction and land development
Satisfactory (1-4)		15,441		6,579		5,451		8,280		771		5,285		596		42,403
Watch (5)		—		—		—		—		—		—		—		—
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		468		468
Total		15,441		6,579		5,451		8,280		771		5,285		1,064		42,871

Other construction
Satisfactory (1-4)		83,318		318,197		161,223		20,336		—		—		—		583,074
Watch (5)		—		—		—		—		—		—		—		—
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		—		—
Total		83,318		318,197		161,223		20,336		—		—		—		583,074

One- to four-family residential
Satisfactory (1-4)		309,787		220,044		131,304		74,776		41,077		101,610		803		879,401
Watch (5)		—		—		—		181		89		1,301		60		1,631
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		2,108		84		2,192
Total		309,787		220,044		131,304		74,957		41,166		105,019		947		883,224

Other residential
Satisfactory (1-4)		77,919		137,890		236,600		171,455		134,426		127,677		25,366		911,333
Watch (5)		—		—		—		—		—		3,360		—		3,360
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		—		—
Total		77,919		137,890		236,600		171,455		134,426		131,037		25,366		914,693

Commercial real estate
Satisfactory (1-4)		204,359		174,769		112,680		214,892		201,908		610,957		31,602		1,551,167
Watch (5)		—		—		—		—		—		23,548		—		23,548
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		1,814		—		1,814
Total		204,359		174,769		112,680		214,892		201,908		636,319		31,602		1,576,529

Commercial business
Satisfactory (1-4)		30,491		66,722		40,232		15,906		9,853		65,411		79,849		308,464
Watch (5)		—		—		—		—		—		48		—		48
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		—		—
Total		30,491		66,722		40,232		15,906		9,853		65,459		79,849		308,512

Consumer
Satisfactory (1-4)		18,712		12,761		6,700		3,526		4,146		18,424		132,025		196,294
Watch (5)		—		30		—		8		—		161		100		299
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		5		13		—		5		233		388		644
Total		18,712		12,796		6,713		3,534		4,151		18,818		132,513		197,237

Combined
Satisfactory (1-4)		762,648		974,158		697,498		509,375		392,323		930,188		270,905		4,537,095
Watch (5)		—		30		—		189		89		28,418		160		28,886
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		5		13		—		5		4,155		940		5,118
Total	$	762,648	$	974,193	$	697,511	$	509,564	$	392,417	$	962,761	$	272,005	$	4,571,099

The following table presents a summary of loans by category and risk rating separated by origination and loan class as of December 31, 2021. The remaining accretable discount of $429,000 has not been included in this table.


	Term Loans by Origination Year
														Revolving
	2021		2020		2019		2018		2017			Prior		Loans	Total

	(In Thousands)
One- to four-family residential construction
Satisfactory (1-4)	$	23,081	$	4,453	$	763	$	—	$	—	$	5	$	—	$	28,302
Watch (5)		—		—		—		—		—		—		—		—
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		—		—
Total		23,081		4,453		763		—		—		5		—		28,302

Subdivision construction
Satisfactory (1-4)		24,129		949		224		160		252		965		—		26,679
Watch (5)		—		—		—		—		—		—		—		—
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		15		—		15
Total		24,129		949		224		160		252		980		—		26,694

Construction and land development
Satisfactory (1-4)		9,968		15,965		11,115		2,591		3,013		4,184		527		47,363
Watch (5)		—		—		—		—		—		—		—		—
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		468		468
Total		9,968		15,965		11,115		2,591		3,013		4,184		995		47,831

Other construction
Satisfactory (1-4)		145,991		298,710		130,502		42,302		—		—		—		617,505
Watch (5)		—		—		—		—		—		—		—		—
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		—		—
Total		145,991		298,710		130,502		42,302		—		—		—		617,505

One- to four-family residential
Satisfactory (1-4)		237,498		169,765		93,648		49,618		14,707		113,059		1,662		679,957
Watch (5)		—		—		—		132		—		267		69		468
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		144		—		50		1,223		83		1,500
Total		237,498		169,765		93,792		49,750		14,757		114,549		1,814		681,925

Other residential
Satisfactory (1-4)		117,029		96,551		115,418		179,441		104,053		70,438		11,605		694,535
Watch (5)		—		—		—		—		—		3,417		—		3,417
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		—		—
Total		117,029		96,551		115,418		179,441		104,053		73,855		11,605		697,952

Commercial real estate
Satisfactory (1-4)		141,868		113,226		220,580		231,321		196,166		521,545		22,785		1,447,491
Watch (5)		—		410		582		—		—		25,742		—		26,734
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		2,006		—		2,006
Total		141,868		113,636		221,162		231,321		196,166		549,293		22,785		1,476,231

Commercial business
Satisfactory (1-4)		67,049		28,743		23,947		16,513		24,126		58,116		76,187		294,681
Watch (5)		—		—		—		—		—		58		—		58
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		—		—		—		—		—		—		—
Total		67,049		28,743		23,947		16,513		24,126		58,174		76,187		294,739

Consumer
Satisfactory (1-4)		20,140		11,138		7,154		9,065		4,175		24,280		130,111		206,063
Watch (5)		—		—		—		20		4		10		29		63
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		2		—		16		32		280		347		677
Total		20,140		11,140		7,154		9,101		4,211		24,570		130,487		206,803

Combined
Satisfactory (1-4)		786,753		739,500		603,351		531,011		346,492		792,592		242,877		4,042,576
Watch (5)		—		410		582		152		4		29,494		98		30,740
Special Mention (6)		—		—		—		—		—		—		—		—
Classified (7-9)		—		2		144		16		82		3,524		898		4,666
Total		786,753	$	739,912	$	604,077	$	531,179	$	346,578	$	825,610	$	243,873	$	4,077,982