Critical Accounting Policy

Allowance for Credit Losses:

The allowance for credit losses represents management’s best estimate of probable losses inherent in the company’s loan portfolios, excluding those loans accounted for under fair value. The allowance is determined using a methodology with two main components:

1. Evaluation of expected credit losses for certain groups of homogeneous loans that share similar risk characteristics.
2. Evaluation of loans that do not share risk characteristics with other loans.

The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. The company uses the call report classification as its segment breakout and measures the allowance using the Weighted Average Remaining Maturity method for all loan segments.

Historical credit loss experience is the basis for the estimation of expected credit losses. The company applies historical loss rates to pools of loans with similar risk characteristics. After considering the historic loss calculation, management applies qualitative adjustments to reflect the current conditions and reasonable and supportable forecasts not already reflected in the historical loss information at the balance sheet date.

The reasonable and supportable forecast adjustment is based on a 2-year unemployment forecast provided by Bloomberg and management judgment. For periods beyond the reasonable and supportable forecast, the company reverts back to historical annual loss rates for the remainder of the life of each pool after the forecast period.

The qualitative adjustments for current conditions are based on the current level of inflation, the rapid increase in interest rates, changes in lending policies and practices, experience and ability of lending staff, quality of the company’s loan review system, value of underlying collateral, the existence of and changes in concentrations, and other external factors.

These modified historical loss rates are multiplied by the outstanding principal balance of each loan to calculate a required reserve. The process of determining the level of the allowance for credit losses requires a high degree of judgment. To the extent actual outcomes differ from the company’s estimates, additional provision for loan and lease losses may be required, which would reduce future earnings.