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considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and
liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of
borrower default. Our commercial loans are primarily made based on the cash flows of the 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 return to elevated levels, which would 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 income levels. 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, our non-interest expense has been inflated 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:
•
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 regulators 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