WILSON BANK HOLDING CO

Allowance for Credit Losses

On January 1, 2022, we adopted FASB ASU 2016-13, which introduces the current expected credit losses (CECL) methodology and requires us to estimate all expected credit losses over the remaining life of our financial instrument portfolios. The provision for credit losses represents a charge to earnings necessary to establish an allowance for credit losses that, in management’s evaluation, is adequate to provide coverage for all expected credit losses.

The allowance for credit losses for loans represents the portion of the loan's amortized cost basis that we do not expect to collect due to credit losses over the loan's life, considering past events, current conditions, and reasonable and supportable forecasts of future economic conditions considering macroeconomic forecasts. Loan losses are charged against the allowance when we believe the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for credit losses for loans is based on the loan's amortized cost basis, excluding accrued interest receivable, as we promptly charge off accrued interest receivable determined to be uncollectible. We determine the appropriateness of the allowance through quarterly discounted cash flow modeling of the loan portfolio which considers lending-related commitments and other relevant factors, including macroeconomic forecasts and historical loss rates. In future quarters, we may update information and forecasts that may cause significant changes in the estimate in those future quarters.

Our allowance for credit losses for loans at December 31, 2023 reflects an amount deemed appropriate to adequately cover all expected future losses as of the date the allowance is determined based on our allowance for credit losses for loans assessment methodology. Provision for credit losses for loans in 2023 resulted in an increase of the allowance for credit losses for loans (net of charge-offs and recoveries) to $44,848,000 at December 31, 2023 from $39,813,000 at December 31, 2022 and $39,632,000 at December 31, 2021. The allowance for credit losses for loans increased 12.65% from December 31, 2022 to December 31, 2023 as compared to the 14.01% increase in total loans over the same period. The allowance for credit losses for loans was 1.25% of total loans outstanding at December 31, 2023 compared to 1.26% at December 31, 2022. The allowance for loan losses was 1.60% at December 31, 2021. The internally classified loans as a percentage of the allowance for credit losses for loans were 13.2% and 16.0%, respectively, at December 31, 2023 and 2022.

The following schedule provides an allocation of the year-end allowance for credit losses for loans by portfolio segment for the Company as of and for the fiscal years ended December 31, 2023 and 2022:

The allowance for credit losses for loans is an amount that management believes will be adequate to absorb expected losses on existing loans that may become uncollectible. The allowance for credit losses for loans as a percentage of total loans outstanding at December 31, 2023, net of deferred fees, decreased slightly from the year ended December 31, 2022. This decrease was due to the movement of loans out of the construction and land development pools, which had higher reserve rates, and into various other loan pools within the portfolio that had lower reserve rates, and a reduced provision expense due to slowing loan growth. This was offset in part by the increase in our historical modeled loss rates during the twelve months ended December 31, 2023 due to changes in our macroeconomic forecasts, which are discussed below in more detail, capturing the potential for a recession, that was not captured in our forecast at December 31, 2022.

We measure expected credit losses over the life of each loan utilizing two models. For residential 1-4 family, commercial and multi-family real estate, construction and land development, commercial and industrial, 1-4 family equity lines of credit, municipal, and certain other loan types, we use discounted cash flow models which measure probability of default and loss given default. For farmland, agricultural, credit cards, auto, and other consumer loans we use the remaining life method to estimate credit losses. The measurement of expected credit losses for loan segments utilizing discounted cash flow is impacted by certain macroeconomic variables. Models are adjusted to reflect the current impact of certain macroeconomic variables as well as their expected changes over a reasonable and supportable forecast period.

In estimating expected credit losses as of December 31, 2023, we utilized the Moody’s Analytics December 2023 Next-Cycle Recession Scenario (the “December N-CR Scenario”) to forecast the macroeconomic variables used in our models. The December NC-R Scenario was based on the review of a variety of surveys of forecasts of the U.S. economy. The December NC-R Scenario projections included, among other things, (i) U.S. Gross Domestic Product (“GDP”) annualized quarterly growth rates in the range of approximately (1.07)% to 1.64% during 2024 and 0.03% to 3.15% through the end of the forecast period in the fourth quarter of 2025; (ii) a U.S. unemployment rate in the range of approximately 4.78% to 6.11% during 2024 and 4.47% to 5.21% through the end of the forecast period in the fourth quarter of 2025; and (iii) a Home Price Index annualized quarterly growth rates in the range of approximately (6.50)% to 2.76% during 2024 and (4.55)% to 0.90% through the end of the forecast period in the fourth quarter of 2025.

We adjust model results using qualitative factor ("Q-factor") adjustments. Q-Factor adjustments are based upon management judgment and current assessment as to the impact of risks related to changes in lending policies and procedures; economic and business conditions; loan portfolio attributes and credit concentrations; and external factors, among other things, that are not already captured within the modeling inputs, assumptions and other processes. Management assesses the potential impact of such items within a range of major risk to improvement and adjusts the modeled expected credit loss by an aggregate adjustment percentage based upon the assessment.

Our charge-off policy for collateral dependent loans is similar to our charge-off policy for all loans in that loans are charged-off in the month when a determination is made that the loan is uncollectible. Net charge-offs increased to $1,265,000 in 2023 from net charge-offs of $911,000 in 2022 and net charge-offs of $50,000 in 2021. The ratio of net charge-offs to average total outstanding loans was 0.04% in 2023, 0.03% in 2022 and 0.00% in 2021. Overall, the Bank experienced minimal charge-offs during 2023. It is expected that charge-offs will be modest for 2024; however, a deterioration in local economic conditions more severe than currently expected may negatively impact charge-offs in the future.

We also maintain an allowance for credit losses on off-balance sheet exposures, which decreased $2,989,000 from December 31, 2022 to $3,147,000 at December 31, 2023 as a result of a decrease in our off-balance sheet commitments and an increase in our unconditionally cancellable commitments as a percentage of our off-balance sheet commitments, which are excluded from the calculation of the allowance for credit losses on off-balance credit exposure under ASC 326.

The level of the allowance and the amount of the provision for credit losses involve evaluation of uncertainties and matters of judgment. The Company maintains an allowance for credit losses - loans which management believes is adequate to absorb losses in the loan portfolio. A formal calculation is prepared quarterly by the Company's Chief Financial Officer and provided to the Board of Directors to determine the adequacy of the allowance for credit losses. The calculation includes an evaluation of historical default and loss experience, current and forecasted economic conditions, an evaluation of qualitative factors, industry and peer bank loan quality indicators and other factors. See the discussion above under “Application of Critical Accounting Policies and Accounting Estimates” for more information. Management believes the allowance for credit losses at December 31, 2023 to be adequate, but if forecasted economic conditions do not meet management’s current expectations, the allowance for credit losses may require an increase through additional provision for credit loss expense which would negatively impact earnings.

For a detailed discussion regarding our allowance for credit losses, see"Provision for Credit Losses and Allowance for Credit Losses" elsewhere in this document.