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borrowers and secondarily on any underlying collateral provided by the borrowers. A borrower’s cash flows may be
unpredictable, and collateral securing those loans may fluctuate in value. Although commercial loans are often
collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in
the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible
and inventories may be obsolete or of limited use, among other things.
Nonperforming assets adversely affect our results of operations and financial condition, and can take
significant time to resolve.
Our nonperforming loans may remain at current elevated levels or could increase, which
will negatively impact earnings and could have a substantial adverse impact if conditions deteriorate. We do not
record interest income on non-accrual loans, thereby adversely affecting our level of interest income. Furthermore,
when we receive collateral through foreclosures and similar proceedings, we are required to record the collateral at its
fair market value less estimated selling costs, which may result in write-downs or losses. Additionally, while 2014
was favorably impacted by significant gains on the sale of OREO, our non-interest expense was relatively high in
prior years due to the costs of reappraising adversely classified assets, write-downs on foreclosed assets incidental to
declining property values, operating costs related to foreclosed assets, legal and other costs associated with loan
collections, and various other expenses that would not typically be incurred in a more normal operating environment.
A relatively high level of nonperforming assets also increases our risk profile and may impact the capital levels our
regulators believe is appropriate in light of such risks. We utilize various techniques such as loan sales, workouts
and restructurings to manage our problem assets. Deterioration in the value of these problem assets, the underlying
collateral, or in the borrowers’ performance or financial condition, could adversely affect our business, results of
operations and financial condition. In addition, the resolution of nonperforming assets requires a significant
commitment of time from management and staff, which can be detrimental to their performance of other
responsibilities. There can be no assurance that we will avoid further increases in nonperforming loans in the future.
We may experience loan and lease losses in excess of our allowance for such losses.
We endeavor to limit the
risk that borrowers might fail to repay; nevertheless, losses can and do occur. We have established an allowance for
estimated loan and lease losses in our accounting records based on estimates of:
•
historical experience with our loans;
•
evaluation of economic conditions;
•
regular reviews of the quality, mix and size of the overall loan portfolio;
•
a detailed cash flow analysis for nonperforming loans;
•
regular reviews of delinquencies; and
•
the quality of the collateral underlying our loans.
We maintain our allowance for loan and lease losses at a level that we believe is adequate to absorb specifically
identified probable losses as well as any other losses inherent in our loan portfolio at a given date. While we strive to
carefully monitor credit quality and to identify loans that may become nonperforming, at any given time there are
loans in the portfolio that could result in losses but have not been identified as nonperforming or potential problem
loans. We cannot be sure that we will identify deteriorating loans before they become nonperforming assets, or that
we will be able to limit losses on those loans that have been so identified. Changes in economic, operating and other
conditions which are beyond our control, including interest rate fluctuations, deteriorating values in underlying
collateral, and changes in the financial condition of borrowers, may lead to an increase in our estimate of probable
losses or cause actual loan losses to exceed our current allowance. In addition, the FDIC and the DBO, as part of
their supervisory functions, periodically review our allowance for loan and lease losses. Such agencies may require
us to increase our provision for loan and lease losses or to recognize further losses based on their judgment, which
may be different from that of our management. Any such increase in the allowance required by the FDIC or the DBO
could also hurt our business.
Our use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the
value of the collateral.
In considering whether to make a loan secured by real property, we generally require an
appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the
appraisal is made, and an error in fact or judgment could adversely affect the reliability of an appraisal. In addition,
events occurring after the initial appraisal may cause the value of the real estate to decrease. As a result of any of
these factors the value of collateral backing a loan may be less than supposed, and if a default occurs we may not
recover the entire outstanding balance of the loan.
