CHFC 2018 Annual Report

Allowance for Loan Losses We maintain the allowance for loan losses (the "allowance") at a level we believe is sufficient to absorb probable, incurred losses in our portfolio given the conditions at the time. Management determines the adequacy of the allowance based on quarterly evaluations of the loan portfolio and other factors. These evaluations are inherently subjective as they require management to make material estimates, all of which may be susceptible to significant change. The originated allowance is comprised of specific valuation allowances (assessed for originated loans that have known credit weaknesses and are considered impaired), pooled allowances, based on assigned risk ratings and historical loan loss experience for each loan type, and a qualitative allowance based on environmental factors that take into consideration risks inherent in the originated loan portfolio that differ from historical loan loss experience. Our methodology for measuring the adequacy of the originated allowance is comprised of several key elements, which include a review of the loan portfolio, both individually and by category, and consideration of changes in the mix and volume of the loan portfolio, actual delinquency and loan loss experience, review of collateral values, the size and financial condition of the borrowers, industry and geographical exposures within the portfolio, economic conditions and employment levels of our local markets and other factors affecting business sectors. The allowance for each acquired loan portfolio was not carried over on the date of each respective acquisition. Instead, the acquired loans were recorded at their estimated fair values at each acquisition date, with the estimated fair values including a component for expected credit losses. Acquired loans are subsequently evaluated for further credit deterioration in loan pools, which consist of loans with similar credit risk characteristics. If an acquired loan pool experiences a decrease in expected cash flows, as compared to those expected at the acquisition date, an allowance is established and allocated to acquired loans. The allowance is evaluated utilizing the key assumptions and estimates, similar to the initial estimate of fair value. Management must use judgment to develop its estimates of cash flows for acquired loans, which are impacted by many factors, including changes in property values, default rates, loss severities and prepayment speeds. As a result of the significant amount of judgment involved in estimating future cash flows expected to be collected for acquired loans, the adequacy of the allowance could be significantly impacted by changes in expected cash flows resulting from changes in credit quality of acquired loans. The results of our quarterly re-estimations of cash flows on our acquired loan portfolio resulted in $420 thousand of allowance established for our acquired loan portfolios at December 31, 2018, compared to no allowance at December 31, 2017. We evaluate the originated and acquired allowances on a quarterly basis in an effort to ensure the level is adequate to absorb probable losses inherent in the loan portfolios. This evaluation process is inherently subjective as it requires estimates that may be susceptible to significant change and has the potential to affect net income materially. We believe that the allowances are currently maintained at an appropriate level, considering the inherent risk in the loan portfolios. Future significant adjustments to the allowances may be necessary due to changes in economic conditions, delinquencies or the level of loan losses incurred. The following schedule summarizes information related to the allowance for loan losses: December 31, (Dollars in thousands) 2018 2017 2016 2015 2014 Allowance for loan losses: Originated loans $ 109,564 $ 91,887 $ 78,268 $ 73,328 $ 75,183 Acquired loans 420 — — — 500 Total $ 109,984 $ 91,887 $ 78,268 $ 73,328 $ 75,683 Originated loans $11,844,756 $ 9,747,429 $ 7,458,401 $ 5,807,934 $ 4,990,067 Acquired loans 3,425,023 4,407,838 5,532,378 1,463,213 698,163 Total loans $15,269,779 $14,155,267 $12,990,779 $ 7,271,147 $ 5,688,230 Nonperforming loans $ 85,433 $ 63,095 $ 44,334 $ 62,225 $ 50,644 Allowance for originated loan losses as a percent of: Total originated loans 0.93% 0.94% 1.05% 1.26% 1.51% Nonperforming loans 128% 146% 177% 118% 148% Nonperforming loans, less impaired originated loans for which the expected loss has been charged-off 144% 157% 194% 169% 216% Credit mark as a percent of unpaid principal balance on acquired loans 1.7% 2.4% 3.1% 4.4% 5.4% 63