CENTRAL VALLEY COMMUNITY BANCORP - Annual Report: 2017 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission file number: 000-31977
CENTRAL VALLEY COMMUNITY BANCORP
(Exact name of registrant as specified in its charter)
CALIFORNIA | 77-0539125 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
7100 N. Financial Dr., Suite 101, Fresno, CA | 93720 | |
(Address of principal executive offices) | (Zip Code) | |
559-298-1775
(Registrant’s telephone number, including area code)
[None]
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on which Registered | |
Common Stock, no par value | NASDAQ Capital Market | |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer x |
Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Emerging reporting company o | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of June 30, 2017, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $222,959,000 based on the price at which the stock was last sold on June 30, 2017.
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, Par Value | Outstanding at March 8, 2018 | |||
13,751,287 | shares | |||
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with the 2018 Annual Meeting of Shareholders to be held on May 16, 2018 are incorporated by reference into Part III of this Report. The proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the Registrant’s fiscal year ended December 31, 2017.
TABLE OF CONTENTS
PART I
ITEM 1 - | DESCRIPTION OF BUSINESS |
General
Central Valley Community Bancorp is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the “Company”). The Company was incorporated on February 7, 2000 as a California corporation, for the purpose of becoming the holding company for Central Valley Community Bank (the “Bank”), formerly known as Clovis Community Bank, a California state chartered bank, through a corporate reorganization. In the reorganization, the Bank became the wholly-owned subsidiary of the Company, and the shareholders of the Bank became the shareholders of the Company. The Company made a decision in the first half of 2002 to change the name of its one subsidiary, Clovis Community Bank, to Central Valley Community Bank.
At December 31, 2017, the Bank was our only banking subsidiary. The Bank is a multi-community bank that offers a full range of commercial banking services to small and medium size businesses, and their owners, managers and employees in the central valley area of California. We serve nine contiguous counties in California’s central valley including Fresno County, El Dorado County, Madera County, Merced County, Placer County, Sacramento County, San Joaquin County, Stanislaus County, and Tulare County, and their surrounding areas. We do not currently conduct any operations other than through the Bank. Unless the context otherwise requires, references to “us,” “we,” or “our” refer to the Company and the Bank on a consolidated basis. At December 31, 2017, we had consolidated total assets of approximately $1,661,655,000. See Items 7 and 8, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Financial Statements.
Effective October 1, 2017, the Company and Folsom Lake Bank (FLB) completed a merger under which Folsom Lake Bank, with two full-service offices, located in Folsom and Rancho Cordova (Sacramento County), merged with and into the Bank. Effective October 1, 2016, the Company and Sierra Vista Bank (SVB) completed a merger under which Sierra Vista Bank, with three full-service offices, located in Folsom and Fair Oaks (Sacramento County) and Cameron Park (El Dorado County), merged with and into the Bank.
The Company is regulated by the Board of Governors of the Federal Reserve. The Bank is regulated by the California Department of Business Oversight and its primary Federal regulator is the Federal Deposit Insurance Corporation (“FDIC”).
As of March 1, 2018, we had a total of 343 employees and 316 full time equivalent employees, including the employees of the Bank.
The Bank
The Bank was organized in 1979 and commenced business as a California state chartered bank in 1980. The deposits of the Bank are insured by the FDIC up to applicable limits. The Bank is not a member of the Federal Reserve System.
The Bank operates 24 full-service banking offices in Cameron Park, Clovis, Exeter, Fair Oaks, Folsom, Fresno, Kerman, Lodi, Madera, Merced, Modesto, Oakhurst, Prather, Rancho Cordova, Roseville, Sacramento, Stockton, Tracy, and Visalia. The Bank conducts a commercial banking business, which includes accepting demand, savings and time deposits and making commercial, real estate and consumer loans. It also provides domestic and international wire transfer services and provides safe deposit boxes and other customary banking services. The Bank also offers Internet banking. Internet banking consists of inquiry, account status, bill paying, account transfers, and cash management. The Bank does not offer trust services or international banking services and does not currently plan to do so in the near future. The Bank has a Real Estate Division, an Agribusiness Center, and an SBA Lending Division in Fresno. All real estate related transactions are conducted and processed through the Real Estate Division, including interim construction loans for single family residences and commercial buildings. We offer permanent single family residential loans through our mortgage broker services. Our total market share of deposits in Fresno, Madera, and Tulare counties was 4.88% in 2017 compared to 4.82% in 2016 based on FDIC deposit market share information published as of June 30, 2017. Our total market share in the other counties we operate in (El Dorado, Merced, San Joaquin, Sacramento, and Stanislaus), was less than 1.00% in 2017. We have a diversified loan portfolio. At December 31, 2017, we had total loans of $900,679,000. Total commercial and industrial loans outstanding were $100,856,000, total agricultural land and production loans outstanding were $14,956,000, total real estate construction and other land loans outstanding were $96,460,000; total other real estate loans outstanding were $581,007,000, total equity loans and lines of credit were $76,404,000 and total consumer installment loans outstanding were $29,637,000. Our loans are collateralized by real estate, listed securities, savings and time deposits, automobiles, inventory, accounts receivable, machinery and equipment.
In addition to acquisitions, we have experienced organic growth by expanding our branch network. Opening new branches provides us with opportunities to expand our loan and deposit base; however, based on past experience, management expects these new offices may initially have a negative impact on earnings until the volume of business grows to cover fixed overhead expenses. The Bank anticipates opening new branches in the future. In February 2017, the Bank established the Real Estate and Agribusiness Center Branch in Fresno, California. The Bank’s private banking office in Gold River, California was
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closed in late April 2017. The Bank opened a full-service branch in Roseville, California the same weekend in April 2017. After extensive analysis combined with the rising popularity of online and mobile banking trends, we chose to consolidate the Sunnyside office into our Fresno Downtown office in April 2016. In 2018, we will consolidate two banking offices into branches currently serving the same communities - one in Visalia and one in Folsom.
Since August of 1995 the Bank has been a party to an agreement with Investment Centers of America, pursuant to which Investment Centers of America provides Bank customers with access to investment services. In November 2017, the Bank ended its relationship with Investment Centers of America and entered into an agreement with Raymond James Financial Services, Inc. to provide Bank customers with access to investment services.
No individual or single group of related accounts is considered material in relation to the Bank’s assets or deposits, or in relation to our overall business. Our deposits are attracted from individual and commercial customers. A material portion of our deposits have not been obtained from a single person or a few persons, the loss of any one or more of which would not have a material adverse effect on our business. However, at December 31, 2017 approximately 83.7% of our loan portfolio held for investment consisted of loans secured by real estate, including construction loans, equity loans and lines of credit and commercial loans secured by real estate and 12.9% consisted of commercial loans. See Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations. Currently, our business activities are primarily concentrated in Fresno, El Dorado, Madera, Merced, Sacramento, San Joaquin, Stanislaus, and Tulare Counties in California. Consequently, our results of operations and financial condition are dependent upon the general economic trends in our market area and, in particular, the residential and commercial real estate markets. Further, our concentration of operations in this area of California exposes us to greater risk than other banking companies with a wider geographic base.
Competition
The banking business in California generally, and our primary service area specifically, is highly competitive with respect to both loans and deposits, and is dominated by a relatively small number of major banks with many offices operating over a wide geographic area. Among the advantages such major banks have over us is their ability to finance wide-ranging advertising campaigns and to allocate their investment assets, including loans, to regions of higher yield and demand. Major banks offer certain services such as international banking and trust services which we do not offer directly but which we usually can offer indirectly through correspondent institutions. To compete effectively, we rely substantially on local promotional activity, personal contacts by our officers, directors and employees, referrals by our shareholders, extended hours, personalized service and our reputation in the communities we serve.
In Fresno and Madera Counties, in addition to our 10 full-service branch locations serving the Bank’s primary service areas, as of June 30, 2017 there were 141 operating banking and credit union offices in our primary service area, which consists of the cities of Clovis, Fresno, Kerman, Oakhurst, Madera, and Prather, California. Prather does not contain any banking offices other than our office. The June 2017 FDIC Summary of Deposits report indicated the Company had 4.99% of the total deposits held by all depositories in Fresno County and 7.74% in Madera County. In San Joaquin County, in addition to our three full service branch locations, as of June 30, 2017 there were 98 operating banking and credit union offices. The FDIC Summary of Deposits as of June 2017 report indicated the Company had 1.39% of total deposits held by all depositories in San Joaquin County. In Merced County, in addition to our one branch, as of June 30, 2017 there were 28 operating banking and credit union offices in our primary service area. In Sacramento County, in addition to our five branches, as of June 30, 2017 there were 217 operating banking and credit union offices in our primary service area. In Stanislaus County, in addition to our one branch, there were 87 operating banking and credit union offices in our primary service area. In Tulare County, in addition to our four branches there were 54 operating banking and credit union offices in our primary service area. In El Dorado County, in addition to our one branch, there were 39 operating banking and credit union offices in our primary service area. Business activity in our primary service area is oriented toward light industry, small business and agriculture.
By virtue of their greater total capitalization, larger banks have substantially higher lending limits than we do. Legal lending limits to an individual customer are limited to a percentage of our total capital. As of December 31, 2017, the Bank’s legal lending limits to individual customers were $23,783,000 for unsecured loans and $39,639,000 for unsecured and secured loans combined.
For borrowers desiring loans in excess of the Bank’s lending limits, the Bank seeks to make such loans on a participation basis with other financial institutions. Banks also compete with money market funds and other money market instruments, which are not subject to interest rate ceilings. In recent years, increased competition has also developed from specialized finance and non-finance companies that offer wholesale finance, credit card, and other consumer finance services, including on-line banking services and personal finance software. Competition for deposit and loan products remains strong, from both banking and non-banking firms, and affects the rates of those products as well as the terms on which they are offered to customers.
Technological innovation continues to contribute to greater competition in domestic and international financial services markets. Technological innovation has, for example, made it possible for non-depository institutions to offer customers automated transfer payment services that previously have been traditional banking products. In addition, customers
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now expect a choice of several delivery systems and channels, including telephone, mail, home computer, ATMs, remote deposit, mobile banking applications, self-service branches, and in-store branches.
Mergers between financial institutions have placed additional pressure on banks to streamline their operations, reduce expenses, and increase revenues to remain competitive. In addition, competition has intensified due to federal and state interstate banking laws, which permit banking organizations to expand geographically with fewer restrictions than in the past. Such laws allow banks to merge with other banks across state lines, thereby enabling banks to establish or expand banking operations in our market. The competitive environment also is significantly impacted by federal and state legislation, which may make it easier for non-bank financial institutions to compete with us.
Supervision and Regulation
GENERAL
Banking is a complex, highly regulated industry. Regulation and supervision by federal and state banking agencies are intended to maintain a safe and sound banking system, protect depositors and the FDIC’s insurance fund, and to facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress and the states have created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the financial services industry. Consequently, the growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions, but also by the requirements of applicable state and federal statues, regulations and the policies of various governmental regulatory authorities, including the Federal Reserve, FDIC, the Calirfornia Department of Business Oversight (DBO) and the Consumer Financial Protection Bureau (CFPB). Furthermore, tax laws administered by the Internal Revenue Service and state taxing authorities, accounting rules developed by the FASB, securities laws administered by the SEC and state securities authorities, anti-money laundering laws enforced by the U.S. Department of the Treasury, or Treasury, and mortgage related rules, including with respect to loan securitization and servicing by the U.S. Department of Housing and Urban Development and agencies such as Fannie Mae and Freddie Mac, also impact our business. The effect of these statutes, regulations, regulatory policies and rules are significant to our financial condition and results of operations. Further, the nature and extent of future legislative, regulatory or other changes affecting financial institutions are impossible to predict with any certainty.
Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of banks, their holding companies and their affiliates. These laws are intended primarily for the protection of the FDIC’s Deposit Insurance Fund and bank customers rather than shareholders. Federal and state laws, and the related regulations of the bank regulatory agencies, affect, among other things, the scope of business, the kinds and amounts of investments banks may make, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, the ability to merge, consolidate and acquire, dealings with insiders and affiliates and the payment of dividends.
This supervisory and regulatory framework subjects banks and bank holding companies to regular examination by their respective regulatory agencies, which results in examination reports and ratings that, while not publicly available, can affect the conduct and growth of their businesses. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. The regulatory agencies have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.
The following is a summary of the material elements of the supervisory and regulatory framework applicable to the Company and its bank subsidiary. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. The descriptions are qualified in their entirety by reference to the particular statutory and regulatory provision.
BANK HOLDING COMPANY REGULATION
The Company, as a bank holding company, is subject to regulation under the Bank Holding Company Act of 1956, as amended (“BHC Act”), and is subject to the supervision and examination of the Board of Governors. Pursuant to the BHC Act, we are required to obtain the prior approval of the Board of Governors before we may acquire all or substantially all of the assets of any bank, or ownership or control of voting shares of any bank if, after giving effect to such acquisition, we would own or control, directly or indirectly, more than five percent of such bank.
Under the BHC Act, we may not engage in any business other than managing or controlling banks or furnishing services to our subsidiaries that the Board of Governors deems to be so closely related to banking as to be a proper incident to banking. Bank holding companies that qualify and elect to be treated as “financial holding companies” may engage in a broad range of additional activities that are (i) financial in nature or incidental to such financial activities or (ii) complementary to a
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financial activity and do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. These activities include securities underwriting and dealing, insurance underwriting and making merchant banking investments. We have not elected to be treated as a financial holding company and currently have no plans to make a financial holding company election.
We are also prohibited, with certain exceptions, from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company unless the company is engaged in banking activities or the Board of Governors determines that the activity is so closely related to banking to be a proper incident to banking. The Board of Governors’ approval must be obtained before the shares of any such company can be acquired and, in certain cases, before any approved company can open new offices.
The BHC Act and regulations of the Board of Governors also impose certain constraints on the redemption or purchase by a bank holding company of its own shares of stock.
Our earnings and activities are affected by legislation, by actions of regulators, and by local legislative and administrative bodies and decisions of courts in the jurisdictions in which both the Company and the Bank conduct business. For example, these include limitations on the ability of the Bank to pay dividends to the Company and the ability of the Company to pay dividends to its shareholders. It is the policy of the Board of Governors that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries. Various federal and state statutory provisions limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval. In addition to these explicit limitations, the federal regulatory agencies are authorized to prohibit a banking subsidiary or bank holding company from engaging in an unsafe or unsound banking practice. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.
In addition, banking subsidiaries of bank holding companies are subject to certain restrictions imposed by federal law in dealings with their holding companies and other affiliates. Transactions between affiliates are subject to Sections 23A and 23B of the Federal Reserve Act. Regulation W codifies interpretive guidance with respect to affiliate transactions. Subject to certain exceptions set forth in the Federal Reserve Act and Regulation W, a bank can make a loan or extend credit to an affiliate, purchase or invest in the securities of an affiliate, purchase assets from an affiliate, accept securities of an affiliate as collateral security for a loan or extension of credit to any person or company, issue a guarantee, or accept letters of credit on behalf of an affiliate only if the aggregate amount of the above transactions of such subsidiary does not exceed 10 percent of such subsidiary’s capital stock and surplus on a per affiliate basis or 20 percent of such subsidiary’s capital stock and surplus on an aggregate affiliate basis. Such transactions must be on terms and conditions that are consistent with safe and sound banking practices and on terms that are not more favorable than those provided to a non-affiliate. A bank and its subsidiaries generally may not purchase a “low-quality asset,” as that term is defined in the Federal Reserve Act, from an affiliate. Such restrictions also generally prevent a holding company and its other affiliates from borrowing from a banking subsidiary of the holding company unless the loans are secured by collateral.
A holding company and its banking subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or provision of services. For example, with certain exceptions a bank may not condition an extension of credit on a customer obtaining other services provided by it, a holding company or any of its other bank affiliates, or on a promise by the customer not to obtain other services from a competitor.
The Board of Governors has cease and desist powers over parent bank holding companies and non-banking subsidiaries where actions of a parent bank holding company or its non-financial institution subsidiaries represent an unsafe or unsound practice or violation of law. The Board of Governors has the authority to regulate debt obligations (other than commercial paper) issued by bank holding companies by imposing interest ceilings and reserve requirements on such debt obligations.
We are also a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, we and our subsidiaries are subject to examination by the California Department of Business Oversight (DBO).
Further, we are required by the Board of Governors to maintain certain capital levels. See “Capital Standards.”
REGULATION OF THE BANK
Banks are extensively regulated under both federal and state law. The Bank, as a California state-chartered bank, is subject to primary supervision, regulation and periodic examination by the DBO and the FDIC. The Bank is not a member of the Federal Reserve System, but is nevertheless subject to certain regulations of the Board of Governors.
If, as a result of an examination of a bank, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in
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capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate the Bank’s deposit insurance, which for a California chartered bank would result in a revocation of the Bank’s charter. The DBO has many of the same remedial powers.
The Bank is a member of the FDIC, which currently insures customer deposits in each member bank to a maximum of $250,000 per depositor. For this protection, the Bank is subject to the rules and regulations of the FDIC, and, as is the case with all insured banks, may be required to pay a semi-annual statutory assessment. All of a depositors’ accounts at an insured depository institution, including all non-interest bearing transactions accounts, will be insured by the FDIC up to the standard maximum deposit insurance amount of ($250,000) for each deposit insurance ownership category.
Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statutes and regulations relate to many aspects of the Bank’s operations, including standards for safety and soundness, reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, fair lending requirements, Community Reinvestment Act activities, and loans to affiliates.
Depositor Preference. In the event of the “liquidation or other resolution” of an insured depository institution, the claims of depositors of the institution, including the claims of the FDIC as subrogee of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors including the parent bank holding company with respect to any extensions of credit they have made to such insured depository institution.
Brokered Deposit Restrictions. Well-capitalized institutions are not subject to limitations on brokered deposits, while an adequately capitalized institution is able to accept, renew or roll over brokered deposits only with a waiver from the FDIC and subject to certain restrictions on the yield paid on such deposits. Undercapitalized institutions are generally not permitted to accept, renew, or roll over brokered deposits. The Bank is eligible to accept brokered deposits without limitations.
Loans to Directors, Executive Officers and Principal Shareholders. The authority of the Bank to extend credit to its directors, executive officers and principal shareholders, including their immediate family members and corporations and other entities that they control, is subject to substantial restrictions and requirements under Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O promulgated thereunder, as well as the Sarbanes- Oxley Act of 2002. These statutes and regulations impose specific limits on the amount of loans the Bank may make to directors and other insiders, and specified approval procedures must be followed in making loans that exceed certain amounts. In addition, all loans the Bank makes to directors and other insiders must satisfy the following requirements:
• | the loans must be made on substantially the same terms, including interest rates and collateral, as prevailing at the time for comparable transactions with persons not affiliated with the Bank; |
• | the Bank must follow credit underwriting procedures at least as stringent as those applicable to comparable transactions with persons who are not affiliated with the Bank; and |
• | the loans must not involve a greater than normal risk of non-payment or include other features not favorable to the Bank. |
Furthermore, the Bank must periodically report all loans made to directors and other insiders to the bank regulators, and these loans are closely scrutinized by the regulators for compliance with Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O. Each loan to directors or other insiders must be pre-approved by the Bank’s board of directors with the interested director abstaining from voting.
PAYMENT OF DIVIDENDS
THE COMPANY
Our shareholders are entitled to receive dividends when and as declared by our Board of Directors, out of funds legally available, subject to the dividends preference, if any, on preferred shares that may be outstanding, and also subject to the restrictions of the California Corporations Code.
The principal source of cash revenue to the Company is dividends received from the Bank. The Bank’s ability to make dividend payments to the Company is subject to state and federal regulatory restrictions.
THE BANK
Dividends payable by the Bank to the Company are restricted under California law to the lesser of the Bank’s retained earnings, or the Bank’s net income for the latest three fiscal years, less dividends paid during that period, or, with the approval of the DBO, to the greater of the retained earnings of the Bank, the net income of the Bank for its last fiscal year or the net income of the Bank for its current fiscal year.
In addition to the regulations concerning minimum uniform capital adequacy requirements described below, the FDIC has established guidelines regarding the maintenance of an adequate allowance for credit losses. Therefore, the future payment
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of cash dividends by the Bank will generally depend, in addition to regulatory constraints, upon the Bank’s earnings during any fiscal period, the assessment of the Board of Directors of the capital requirements of the Bank and other factors, including the maintenance of an adequate allowance for credit losses.
REGULATORY CAPITAL REQUIREMENTS
The federal banking agencies have risk-based capital adequacy requirements intended to provide a measure of capital adequacy that reflects the perceived degree of risk associated with a banking organization’s operations, both for transactions reported on the balance sheet as assets and for transactions, such as letters of credit and recourse arrangements, that are recorded as off-balance sheet items. In 2013, the bank regulatory agencies issued final rules (the “Basel III Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations. The Basel III Capital Rules implement the Basel Committee’s December 2010 framework for strengthening international capital standards and certain provisions of the Dodd-Frank Act. The Basel III Capital Rules became effective on January 1, 2015.
The Basel III Capital Rules require the Bank to comply with several minimum capital standards. The Bank must maintain a Tier 1 leverage ratio of at least 4.0%; a common equity Tier 1, which we refer to as CET1, to risk-weighted assets of 4.5%; a Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets of at least 6.0% and a total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets of at least 8.0%. CET1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as CET1 and Additional Tier 1 capital. Additional Tier 1 capital generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (CET1 capital plus Additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan loss limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into CET1 capital (including unrealized gains and losses on available-for-sale-securities). We exercised the opt-out election regarding the treatment of AOCI in part to avoid significant variations in our capital levels resulting from changes in the fair value of our available-for-sale investment securities portfolio as interest rates fluctuate. The calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.
The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that (i) mortgage servicing rights, (ii) deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks, and (iii) significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and would be phased-in over a four-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter).
In addition to establishing the minimum regulatory capital requirements, the Basel III Capital Rules limit capital distributions and certain discretionary bonus payments to management if an institution does not hold a “capital conservation buffer” consisting of an additional 2.5% of CET1, on top of the minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. The capital conservation buffer requirement is being phased in over a four-year period beginning on January 1, 2016 at 0.625%, increasing by 0.625% each January 1 until it reaches 2.5% on January 1, 2019.
In 2018, banking organizations, including the Company and the Bank, are required to maintain a CET1 capital ratio of at least 6.375%, a Tier 1 capital ratio of at least 7.875%, and a total capital ratio of at least 9.875% to avoid limitations on capital distributions and certain discretionary incentive compensation payments. When fully phased-in on January 1, 2019, The Company and the Bank will be required to meet minimum Tier 1 leverage ratio of 4.0%, a minimum CET1 to risk-weighted assets of 4.5% (7% with the capital conservation buffer), a Tier 1 capital to risk-weighted assets of 6.0% (8.5% including the capital conservation buffer) and a minimum total capital to risk-weighted assets of 8.0% (10.5% including the capital conservation buffer).
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, a bank’s assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests), are multiplied by a risk weight factor assigned by the regulations based on perceived risks inherent in the type of asset. As a result, higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien 1- 4 family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors. The Basel III Capital Rules increased the risk weights for a variety of asset classes,
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including certain commercial real estate mortgages. Additional aspects of the Basel III Capital Rules’ risk weighting requirements that are relevant to the Company and the Bank include:
• | assigning exposures secured by single-family residential properties to either a 50% risk weight for first-lien mortgages that meet prudent underwriting standards or a 100% risk weight category for all other mortgages; |
• | providing for a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (increased from 0% under the previous risk-based capital rules); |
• | assigning a 150% risk weight to all exposures that are nonaccrual or 90 days or more past due (increased from 100% under the previous risk-based capital rules), except for those secured by single-family residential properties, which will be assigned a 100% risk weight, consistent with the Basel I risk-based capital rules; |
• | applying a 150% risk weight instead of a 100% risk weight for certain high volatility CRE acquisition, development and construction loans; and |
• | applying a 250% risk weight to the portion of mortgage servicing rights and deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks that are not deducted from CET1 capital (increased from 100% under the previous Basel I risk-based capital rules). |
As of December 31, 2017, the Company’s and the Bank’s capital ratios exceeded the minimum capital adequacy guideline percentage requirements of the federal banking agencies for “well capitalized” institutions under the Basel III Capital Rules on a fully phased-in basis.
USA PATRIOT ACT
On October 26, 2001, President Bush signed the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001. The USA PATRIOT Act also made significant changes to the Bank Secrecy Act. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and of identifying customers when establishing new relationships and standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps:
* To conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;
* To ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;
* To ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and
* To ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.
Under the USA PATRIOT Act, financial institutions are to establish anti-money laundering programs to enhance their Bank Secrecy Act program. The USA PATRIOT Act sets forth minimum standards for these programs, including:
* The development of internal policies, procedures, and controls;
* The designation of a compliance officer;
* An ongoing employee training program; and
* An independent audit function to test the programs.
Bank management believes that the Bank is currently in compliance with the US PATRIOT Act.
OFFICE OF FOREIGN ASSETS CONTROL REGULATION
The U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”), administers and enforces economic and trade sanctions against targeted foreign countries and regimes under authority of various laws, including designated foreign countries, nationals and others. OFAC publishes lists of specially designated targets and countries. The Company and the Bank are responsible for, among other things, blocking accounts of and transactions with such targets and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Failure to comply with these sanctions could have serious legal and reputational consequences, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
SAFEGUARDING OF CUSTOMER INFORMATION AND PRIVACY
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The Federal Reserve and other bank regulatory agencies have adopted guidelines for safeguarding confidential, personal customer information. These guidelines require financial institutions to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The Bank has adopted a customer information security program to comply with such requirements.
Financial institutions are also required to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, financial institutions must provide explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information and, except as otherwise required by law, prohibits disclosing such information. The Bank has implemented privacy policies addressing these restrictions which are distributed regularly to all existing and new customers of the Bank.
COMMUNITY REINVESTMENT ACT
The Community Reinvestment Act (CRA) is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. The CRA specifically directs the federal bank regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs of their entire community, including low-and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA further requires the agencies to take a financial institution’s record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions or holding company formations. The federal banking agencies have adopted regulations which measure a bank’s compliance with its CRA obligations on a performance based evaluation system. This system bases CRA ratings on an institution’s actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. The ratings range from “outstanding” to a low of “substantial noncompliance.” The Bank had a CRA rating of “satisfactory” as of its most recent regulatory examination.
CONSUMER PROTECTION LAWS AND REGULATIONS
The bank regulatory agencies are focusing greater attention on compliance with consumer protection laws and their implementing regulations. Examination and enforcement have become more intense in nature, and insured institutions have been advised to monitor carefully compliance with such laws and regulations. The Bank is subject to many federal consumer protection statutes and regulations, some of which are discussed below.
The Equal Credit Opportunity Act (ECOA) generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age, receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.
The Truth in Lending Act (TILA) is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology to express rates and payments, including the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule, among other things.
The Fair Housing Act (FH Act) regulates many practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status. A number of lending practices have been found by the courts to be, or may be considered, illegal under the FH Act, including some that are not specifically mentioned in the FH Act itself.
The Home Mortgage Disclosure Act (HMDA) grew out of public concern over credit shortages in certain urban neighborhoods and provides public information that will help show whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The HMDA also includes a “fair lending” aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes.
Finally, the Real Estate Settlement Procedures Act (RESPA) requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts. Penalties under the above laws may include fines, reimbursements and other civil money penalties.
Due to heightened regulatory concern related to compliance with the CRA, TILA, FH Act, ECOA, HMDA and RESPA generally, the Bank may incur additional compliance costs or be required to expend additional funds for investments in its local community.
CONSUMER FINANCIAL PROTECTION BUREAU
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Dodd-Frank created a new, independent federal agency, the Consumer Financial Protection Bureau (CFPB), which was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws. The CFPB is also authorized to engage in consumer financial education, track consumer complaints, request data and promote the availability of financial services to underserved consumers and communities. Although all institutions are subject to rules adopted by the CFPB and examination by the CFPB in conjunction with examinations by the institution’s primary federal regulator, the CFPB has primary examination and enforcement authority over institutions with assets of $10 billion or more. The FDIC has primary responsibility for examination of the Bank and enforcement with respect to federal consumer protection laws so long as the Bank has total consolidated assets of less than $10 billion, and state authorities are responsible for monitoring our compliance with all state consumer laws. The CFPB also has the authority to require reports from institutions with less than $10 billion in assets, such as the Bank, to support the CFPB in implementing federal consumer protection laws, supporting examination activities, and assessing and detecting risks to consumers and financial markets.
The consumer protection provisions of Dodd-Frank and the examination, supervision and enforcement of those laws and implementing regulations by the CFPB have created a more intense and complex environment for consumer finance regulation. The CFPB has significant authority to implement and enforce federal consumer finance laws, including the Truth in Lending Act, the Equal Credit Opportunity Act and new requirements for financial services products provided for in Dodd-Frank, as well as the authority to identify and prohibit unfair, deceptive or abusive acts and practices. The review of products and practices to prevent such acts and practices is a continuing focus of the CFPB, and of banking regulators more broadly. The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination, additional remediation efforts and possible penalties. In addition, Dodd-Frank provides the CFPB with broad supervisory, examination and enforcement authority over various consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged legal violations and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. Dodd-Frank does not prevent states from adopting stricter consumer protection standards. State regulation of financial products and potential enforcement actions could also adversely affect our business, financial condition or results of operations.
DEPOSIT INSURANCE
The FDIC is an independent federal agency that insures deposits up to prescribed statutory limits of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC insures the Bank’s customer deposits through the Deposit Insurance Fund (the “DIF”) up to prescribed limits for each depositor. Pursuant to Dodd-Frank, the maximum deposit insurance amount was increased to $250,000. The amount of FDIC assessments paid by each DIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other supervisory factors.
The Bank is subject to deposit insurance assessments to maintain the DIF. In October 2010, the FDIC adopted a revised restoration plan to ensure that the DIF’s designated reserve ratio (“DRR”) reaches 1.35% of insured deposits by September 30, 2020, the deadline mandated by Dodd-Frank. However, financial institutions like the Bank with assets of less than $10 billion are exempted from the cost of this increase. The restoration plan proposed an increase in the DRR to 2% of estimated insured deposits as a long-term goal for the fund. The FDIC also proposed future assessment rate reductions in lieu of dividends when the DRR reaches 1.5% or greater.
We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures or if the FDIC otherwise determines, we may be required to pay even higher FDIC premiums than the recently increased levels. These announced increases and any future increases in FDIC insurance premiums may have a material and adverse effect on our earnings and could have a material adverse effect on the value of or market for our common stock.
In addition to DIF assessments, banks must pay quarterly assessments that are applied to the retirement of Financing Corporation (“FICO”) bonds issued in the 1980’s to assist in the recovery of the savings and loan industry. The FICO assessment amount fluctuates quarterly, but was 0.00115% of average total assets less average tangible equity for the third quarter of 2017. As of the date of this report, the Company had not received the FICO assessment for the fourth quarter of 2017. Those assessments will continue until the Financing Corporation bonds mature in 2019.
The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF or that may prejudice the interest of the bank’s depositors. The termination of deposit insurance for a bank would also result in the revocation of the bank’s charter by the DBO.
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CALIFORNIA FINANCIAL INFORMATION PRIVACY ACT/FAIR CREDIT REPORTING ACT
In 1970, the Federal Fair Credit Reporting Act (the FCRA) was enacted to insure the confidentiality, accuracy, relevancy and proper utilization of consumer credit report information. Under the framework of the FCRA, the United States has developed a highly advanced and efficient credit reporting system. The information contained in that broad system is used by financial institutions, retailers and other creditors of every size in making a wide variety of decisions regarding financial transactions. Employers and law enforcement agencies have also made wide use of the information collected and maintained in databases made possible by the FCRA. The FCRA affirmatively preempts state law in a number of areas, including the ability of entities affiliated by common ownership to share and exchange information freely, and the requirements on credit bureaus to reinvestigate the contents of reports in response to consumer complaints, among others.
The California Financial Information Privacy Act, which was enacted in 2003, requires a financial institution to provide specific information to a consumer related to the sharing of that consumer’s nonpublic personal information. The Act allows a consumer to direct the financial institution not to share his or her nonpublic personal information with affiliated or nonaffiliated companies with which a financial institution has contracted to provide financial products and services, and requires that permission from each such consumer be acquired by a financial institution prior to sharing such information.
The FACT Act, (Fair and Accurate Credit Transaction Act) became law in 2003, effectively extending and amending provisions of the Fair Credit Reporting Act (FCRA). The FACT Act created many new responsibilities for consumer reporting agencies and users of consumer reports. It contains many new consumer disclosure requirements as well as provisions to address identity theft.
OTHER PENDING AND PROPOSED LEGISLATION
Other legislative and regulatory initiatives which could affect the Company and the Bank and the banking industry in general may be proposed or introduced before the United States Congress, the California legislature and other governmental bodies in the future. Such proposals, if enacted, may further alter the structure, regulation and competitive relationship among financial institutions, and may subject the Company or the Bank to increased regulation, disclosure and reporting requirements. In addition, the various banking regulatory agencies often adopt new rules and regulations to implement and enforce existing legislation. It cannot be predicted whether, or in what form, any such legislation or regulations may be enacted or the extent to which the business of the Company or the Bank would be affected thereby.
Many aspects of the Dodd-Frank Act are subject to continued rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on us. Although the reforms primarily target systemically important financial service providers, the Dodd-Frank Act’s influence has and is expected to continue to filter down in varying degrees to smaller institutions over time. We will continue to evaluate the effect of the Dodd-Frank Act; however, in many respects, the ultimate impact of the Dodd-Frank Act will not be fully known for years, and no current assurance may be given that the Dodd-Frank Act, or any other new legislative changes, will not have a negative impact on the results of operations and financial condition of the Company and the Bank.
ADDITIONAL INFORMATION
Copies of the annual report on Form 10-K for the year ended December 31, 2017 may be obtained without charge upon written request to Dave Kinross, Chief Financial Officer, at the Company’s administrative offices, 7100 N. Financial Dr., Suite 101, Fresno, CA 93720. The Form 10-K is available on our website: www.cvcb.com.
Inquiries regarding Central Valley Community Bancorp’s accounting, internal controls or auditing concerns should be directed to Steven D. McDonald, chairman of the Board of Directors’ Audit Committee, at steve.mcdonald@cvcb.com or anonymously at www.ethicspoint.com or EthicsPoint, Inc. at 1-866-294-9588.
General inquiries about Central Valley Community Bancorp or Central Valley Community Bank should be directed to LeAnn Ruiz, Assistant Corporate Secretary at 1-800-298-1775.
ITEM 1A - | RISK FACTORS |
An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that management believes may affect our business are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this Annual Report. The risks and uncertainties described below are not the only ones facing our business. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This Annual Report is qualified in its entirety by these risk factors.
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If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.
Worsening economic conditions could adversely affect our business.
The Bank conducts banking operations principally in California’s Central Valley. As a result, our financial condition, results of operations and cash flows are subject to changes in the economic conditions in California’s Central Valley. Our business results are dependent in large part upon the business activity, population, income levels, deposits and real estate activity in the Central Valley, and adverse economic conditions could have a material adverse effect upon us. In addition, the Central Valley remains largely dependent on agriculture. A downturn in agriculture and agricultural related business could indirectly and adversely affect our results of operations and financial condition.
We can provide no assurance that economic conditions in the United States in general and in the State of California and within our operating markets will not further deteriorate or that such deterioration will not materially and adversely affect us. A further deterioration in economic conditions locally, regionally or nationally could result in a further economic downturn in the Central Valley with the following consequences, any of which could further adversely affect our business:
• | loan delinquencies and defaults may increase; |
• | problem assets and foreclosures may increase; |
• | demand for our products and services may decline; |
• | low cost or noninterest bearing deposits may decrease; |
• | collateral for loans may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral as sources of repayment of existing loans; |
• | foreclosed assets may not be able to be sold; |
• | volatile securities market conditions could adversely affect valuations of investment portfolio assets; and |
• | reputational risk may increase due to public sentiment regarding the banking industry. |
Governmental monetary policies and intervention to stabilize the U.S. financial system may affect our business and are beyond our control.
The business of banking is affected significantly by the fiscal and monetary policies of the Federal government and its agencies. Such policies are beyond our control. We are particularly affected by the policies established by the Federal Reserve Board in relation to the supply of money and credit in the United States. The instruments of monetary policy available to the Federal Reserve Board can be used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits, and this can and does have a material effect on our business.
Tightening of credit markets and liquidity risk could adversely affect our business, financial condition and results of operations.
A tightening of the credit markets or any inability to obtain adequate funds for continued loan growth at an acceptable cost could adversely affect our asset growth and liquidity position and, therefore, our earnings capability. In addition to core deposit growth, maturity of investment securities and loan and lease payments, we also rely on alternative funding sources including unsecured borrowing lines with correspondent banks, secured borrowing lines with the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank of San Francisco, and public time certificates of deposits. Our ability to access these sources could be impaired by deterioration in our financial condition as well as factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations for the financial services industry or serious dislocation in the general credit markets. In the event such a disruption should occur, our ability to access these sources could be adversely affected, both as to price and availability, which would limit or potentially raise the cost of the funds available to us.
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Because a significant portion of our loan portfolio is comprised of real estate loans, negative changes in the economy affecting real estate values and liquidity could impair the value of collateral securing our real estate loans and result in loan and other losses.
At December 31, 2017, $754 million, or 83.70% of our total loan and lease portfolio, consisted of real estate related loans. The real estate securing our loan portfolio is concentrated in California. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. As a result, adverse developments affecting real estate values in our market areas could increase the credit risk associated with our real estate loan portfolio. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, the rate of unemployment, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies and acts of nature, such as earthquakes and natural disasters. Adverse changes affecting real estate values and the liquidity of real estate in one or more of our markets could increase the credit risk associated with our loan portfolio, significantly impair the value of property pledged as collateral on loans and affect our ability to sell the collateral upon foreclosure without a loss or additional losses, which could result in losses that would adversely affect profitability. Such declines and losses would have a material adverse impact on our business, results of operations and growth prospects. In addition, if hazardous or toxic substances are found on properties pledged as collateral, the value of the real estate could be impaired. If we foreclose on and take title to such properties, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materially reduce the affected property’s value or limit our ability to use or sell the affected property.
Supervisory guidance on commercial real estate concentrations could restrict our activities and impose financial requirements or limits on the conduct of our business.
As a part of their regulatory oversight, the federal regulators have issued the CRE Concentration Guidance on sound risk management practices with respect to a financial institution’s concentrations in commercial real estate lending activities. These guidelines were issued in response to the agencies’ concerns that rising commercial real estate, or CRE, concentrations might expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in the commercial real estate market. Existing guidance reinforces and enhances existing regulations and guidelines for safe and sound real estate lending by providing supervisory criteria, including numerical indicators to assist in identifying institutions with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny. The guidance does not limit banks’ commercial real estate lending, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. The CRE Concentration Guidance identifies certain concentration levels that, if exceeded, will expose the institution to additional supervisory analysis with regard to the institution’s CRE concentration risk. The CRE Concentration Guidance is designed to promote appropriate levels of capital and sound loan and risk management practices for institutions with a concentration of CRE loans. In general, the CRE Concentration Guidance establishes the following supervisory criteria as preliminary indications of possible CRE concentration risk: (i) the institution’s total construction, land development and other land loans represent 100% or more of total risk-based capital; or (ii) total CRE loans as defined in the regulatory guidelines represent 300% or more of total risk-based capital, and the institution’s CRE loan portfolio has increased by 50% or more during the prior 36-month period. Pursuant to the CRE Concentration Guidelines, loans secured by owner occupied commercial real estate are not included for purposes of CRE Concentration calculation. We believe that our underwriting policies, management information systems, independent credit administration process, and monitoring of real estate loan concentrations are currently sufficient to address the CRE Concentration Guidance.
If our allowance for credit losses is not sufficient to cover actual loan losses, our earnings could decrease.
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. We may experience significant credit losses that could have a material adverse effect on our operating results. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses for probable incurred losses in our loan portfolio. The allowance is established through a provision for loan losses based on management’s evaluation of the risks inherent in the loan portfolio and the general economy. The allowance is also appropriately increased for new loan growth. The allowance is based upon a number of factors, including the size of the loan portfolio, asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, management’s assessment of the credit risk inherent in the portfolio, historical loan loss experience and loan underwriting policies. The allowance is only an estimate of the probable incurred losses in the loan portfolio and may not represent actual losses realized over time, either of losses in excess of the allowance or of losses less than the allowance. If our assumptions prove to be incorrect, our current allowance my not be sufficient to cover future loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio.
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Our bank regulatory agencies will periodically review our allowance for loan losses and the value attributed to nonaccrual loans or to real estate acquired through foreclosure and may require us to adjust our determination of the value for these items. These adjustments may adversely affect our business, financial condition and results of operations.
Non-performing assets take significant time to resolve and adversely affect our results of operations and financial condition.
At December 31, 2017, our non-performing loans and leases were 0.32% of total loans and leases compared to 0.29% at December 31, 2016, and 0.40% at December 31, 2015, and our non-performing assets (which include foreclosed real estate) were 0.18% of total assets compared to 0.18% at December 31, 2016. The allowance for credit losses as a percentage of non-performing loans and leases was 305.32% as of December 31, 2017 compared to 427.80% at December 31, 2016. Non-performing assets adversely affect our net income in various ways. We generally do not record interest income on non-performing loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair value of the collateral, which may ultimately result in a loss. An increase in the level of non-performing assets increases our risk profile and may impact the capital levels our regulators believe are appropriate in light of the ensuing risk profile, which could result in a request to reduce our level of non-performing assets. When we reduce problem assets through loan sales, workouts, restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. In addition, the resolution of non-performing assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. There can be no assurance that we will not experience future increases in non-performing assets or that the disposition of such non-performing assets will not adversely affect our profitability.
Our focus on lending to small to mid-sized community-based businesses may increase our credit risk.
Commercial real estate and commercial business loans generally are considered riskier than single-family residential loans because they have larger balances to a single borrower or group of related borrowers. Commercial real estate and commercial business loans involve risks because the borrowers’ ability to repay the loans typically depends primarily on the successful operation of the businesses or the properties securing the loans. Most of the Bank’s commercial real estate and commercial business loans are made to small to medium sized businesses who may have a heightened vulnerability to economic conditions. Moreover, a portion of these loans have been made by us in recent years and the borrowers may not have experienced a complete business or economic cycle. Furthermore, the deterioration of our borrowers’ businesses may hinder their ability to repay their loans with us, which could adversely affect our results of operations.
Fluctuations in interest rates could reduce our profitability.
We realize income primarily from the difference between interest earned on loans and securities and the interest paid on deposits and borrowings. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” will work against us, and our earnings may be negatively affected.
We are unable to predict fluctuations of market interest rates, which are affected by the following factors outside our control:
• | inflation; |
• | recession; |
• | competition; |
• | a rise in unemployment; |
• | tightening money supply; |
• | international disorder; and |
• | instability in domestic and foreign financial markets. |
Our asset/liability management strategy, which is designed to address the risk from changes in market interest rates and the shape of the yield curve, may not prevent changes in interest rates from having a material adverse effect on our results of operations and financial condition. In recent years, we have shifted our mix of assets from consisting primarily of loans to a more balanced mix of loans and securities. The value of these securities is subject to interest rate risk, which we must monitor and manage successfully in order to prevent declines in value of these assets if interest rates rise in the future.
Additionally, increasing levels of competition in the banking and financial services business may decrease our net interest spread as well as net interest margin by forcing us to offer lower lending interest rates and pay higher deposit interest rates. Although we believe our current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates (such as a sudden and substantial increase in Prime and Overnight Fed Funds rates) as well as increasing competition may require us to increase rates on deposits at a faster pace than the yield we receive on interest earning assets increases. The impact of any sudden and substantial move in interest rates and/or increased competition may have an adverse effect on our
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business, results of operations and financial condition as our net interest income (including the net interest spread and margin) may be negatively impacted.
Furthermore, a sustained decrease in market interest rates could adversely affect our earnings. When interest rates decline borrowers tend to refinance higher-rate, fixed-rate loans to lower rates, prepaying their existing loans. Under those circumstances we would not be able to reinvest those prepayments in assets earning interest rates as high as the rates on the prepaid loans. In addition, our commercial real estate and commercial loans, which carry interest rates that, in general, adjust in accordance with changes in the prime rate, will adjust to lower rates. We are also significantly affected by the level of loan demand available in our market. The inability to make sufficient loans directly affects the interest income we earn. Lower loan demand will generally result in lower interest income realized as we place funds in lower yielding investments.
As a result of the Dodd-Frank Act and recent rulemaking, we are subject to more stringent capital requirements.
In July 2013, the U.S. federal banking authorities approved the implementation of the Basel III regulatory capital reforms, or Basel III, and issued rules effecting certain changes required by the Dodd-Frank Act. Basel III is applicable to all U.S. banks that are subject to minimum capital requirements as well as to bank and saving and loan holding companies, other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $1.0 billion). Basel III not only increases most of the required minimum regulatory capital ratios, it introduces a new common equity Tier 1 capital ratio and the concept of a capital conservation buffer. Basel III also expands the current definition of capital by establishing additional criteria that capital instruments must meet to be considered additional Tier 1 and Tier 2 capital. In order to be a “well-capitalized” depository institution under the new regime, an institution must maintain a common equity Tier 1 capital ratio of 6.5% or more; a Tier 1 capital ratio of 8% or more; a total capital ratio of 10% or more; and a Tier 1 leverage ratio of 5% or more. The Basel III capital rules became effective as applied to the Company and the Bank on January 1, 2015 with a phase-in period that generally extends through January 1, 2019 for many of the changes.
The failure to meet applicable regulatory capital requirements could result in one or more of our regulators placing limitations or conditions on our activities, including our growth initiatives, or restricting the commencement of new activities, and could affect customer and investor confidence, our costs of funds and FDIC insurance costs, our ability to pay dividends on our common stock, our ability to make acquisitions, and our business, results of operations and financial conditions, generally.
Competition with other financial institutions could adversely affect our profitability.
We face vigorous competition from banks and other financial institutions, including savings institutions, finance companies and credit unions. A number of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies. This competition may reduce or limit our margins on banking services, reduce our market share and adversely affect our results of operations and financial condition. Additionally, we face competition primarily from other banks in attracting, developing and retaining qualified banking professionals.
Recently, several new banks have opened in our service areas. We are seeing price competition from these new banks, as they work to establish their markets. The existence of competitors, large and small, is a normal and expected part of our operations, but in responding to the particular short-term impact on business of new entrants to the marketplace, we could see a negative impact on revenue and income. Moreover, these near term impacts could be accentuated by the seasonal impact on revenue and income generated by the borrowing and deposit habits of the agricultural community that comprises a significant component of our customer base.
Technology is continually changing and we must effectively implement new technologies.
Our future growth prospects will be highly dependent on our ability to implement changes in technology that affect the delivery of banking services such as the increased demand for computer access to bank accounts and the availability to perform banking transactions electronically. Our ability to compete will depend upon our ability to continue to adapt technology on a timely and cost-effective basis to meet such demands. In addition, our business and operations could be susceptible to adverse effects from computer failures, communication and energy disruption, and activities such as fraud of unethical individuals with the technological ability to cause disruptions or failures of our data processing system.
If our information systems were to experience a system failure, our business and reputation could suffer.
We rely heavily on communications and information systems to conduct our business. The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to minimize service disruptions by protecting our computer equipment, systems, and network infrastructure from physical damage due to fire, power loss, telecommunications failure or a similar catastrophic event. We have protective measures in place to prevent or limit the effect of the failure or interruption of our information systems, and will continue to upgrade our security technology and update procedures to help prevent such events. However, if such failures or interruptions were to occur, they could result in damage to our reputation, a loss of customers, increased regulatory scrutiny, or possible exposure to financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.
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The occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents could have a material adverse effect on our business, financial condition and results of operations.
As a financial institution we are susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customer information, misappropriation of assets, privacy breaches against our customers, litigation, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, on-line banking, phishing, social engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by us or our customers, denial or degradation of service attacks, and malware or other cyber-attacks. In recent periods, there continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. Consistent with industry trends we have also experienced an increase in attempted electronic fraudulent activity, security breaches and cybersecurity-related incidents in recent periods. Moreover, in recent periods, several large corporations, including financial institutions and retail companies, have suffered major data breaches, in some cases exposing not only confidential and proprietary corporate information, but also sensitive financial and other personal information of their customers and employees and subjecting them to potential fraudulent activity. Some of our customers may have been affected by these breaches which increase their risks of identity theft, credit card fraud and other fraudulent activity that could involve their accounts with us.
Information pertaining to us and our customers is maintained and transactions are executed on the networks and systems of ours, our customers and certain of our third party partners, such as our online banking or core systems. The secure maintenance and transmission of confidential information as well as execution of transactions over these systems are essential to protect us and our customers against fraud and security breaches and to maintain our customers’ confidence. Breaches of information security also may occur, and in infrequent, incidental, cases have occurred, through intentional or unintentional acts by those having access to our systems or our customers’ or counterparties’ confidential information, including employees. In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions as well as the technology used by our customers to access our systems. Although we have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, our inability to anticipate, or failure to adequately mitigate, breaches of security could result in: losses to us or our customers; our loss of business and/or customers; damage to our reputation; the incurrence of additional expenses; disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability - any of which could have a material adverse effect on our business, financial condition and results of operations.
More generally, publicized information concerning security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions. Such publicity may also cause damage to our reputation as a financial institution. As a result, our business, financial condition and results of operations could be adversely affected.
Our controls over financial reporting and related governance procedures may fail or be circumvented.
Management regularly reviews and updates our internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. We maintain controls and procedures to mitigate risks such as processing system failures or errors and customer or employee fraud, and we maintain insurance coverage for certain of these risks. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and provides only reasonable, not absolute, assurances that the objectives of the system are met. Events could occur which are not prevented or detected by our internal controls, are not insured against, or are in excess of our insurance limits. Any failure or circumvention of our controls and procedures, or failure to comply with regulations related to controls and procedures, could have an adverse effect on our business.
The current expected credit loss standard established by the Financial Accounting Standards Board will require significant data requirements and changes to methodologies.
In the aftermath of the 2007-2008 financial crises, the Financial Accounting Standards Board, or FASB, decided to review how banks estimate losses in the allowance for loan loss calculation, and it issued the final Current Expected Credit Loss, or CECL, standard on June 16, 2016. Currently, the impairment model used by financial institutions is based on incurred losses, and loans are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. This model will be replaced by the CECL model that will become effective for the fiscal year beginning after December 15, 2019 in which financial institutions will be required to use historical information, current conditions and reasonable forecasts to estimate the expected loss over the life of the loan. The transition to the CECL model will necessitate significantly greater data requirements and changes to methodologies to accurately account for expected
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losses over the life of a loan. There can be no assurance that we will not be required to increase out reserves and allowance for loan loss as a result of the implementation of CECL.
We have a significant deferred tax asset and cannot assure that it will be fully realized.
Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the carrying amounts and tax basis of assets and liabilities computed using enacted tax rates. We regularly assess available positive and negative evidence to determine whether it is more likely than not that our net deferred tax asset will be realized. Realization of a deferred tax asset requires us to apply significant judgment and is inherently speculative because it requires estimates that cannot be made with certainty. At December 31, 2017, we had a net deferred tax asset of $8.024 million. If we were to determine at some point in the future that we will not achieve sufficient future taxable income to realize our net deferred tax asset, we would be required, under generally accepted accounting principles, to establish a full or partial valuation allowance which would require us to incur a charge to operations for the period in which the determination was made.
We may not be successful in raising additional capital needed in the future.
We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business strategies. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time which are outside of our control, and our financial performance. We cannot be assured that such capital will be available to us on acceptable terms or at all. Any occurrence that may limit our access to the capital markets may adversely affect our capital costs and our ability to raise capital. Moreover, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse effect on our business, results of operations and financial condition.
The effects of changes to FDIC insurance coverage limits are uncertain and increased premiums may adversely affect us.
The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. All of a depositors’ accounts at an insured depository institution, including all non-interest bearing transactions accounts, will be insured by the FDIC up to the standard maximum deposit insurance amount of ($250,000) for each deposit insurance ownership category.
Increases in FDIC insurance premiums will add to our cost of operations and could have a significant impact on the Bank. Depending on any future losses that the FDIC insurance fund may suffer due to failed institutions, there can be no assurance that there will not be additional significant premium increases in order to replenish the fund.
On February 7, 2011, the FDIC Board of Directors adopted the final rule, which redefined the deposit insurance assessment base as required by Dodd-Frank, and makes changes to assessment rates, implements Dodd-Frank’s Deposit Insurance Fund (DIF) dividend provisions, and revises the risk based assessment system for all large institutions. The final rule redefined the deposit insurance assessment base as average consolidated total assets minus average tangible equity, defined as Tier 1 capital. The rule lowered overall assessment rates in order to generate the same approximate amount of revenue under the new larger base as was raised under the old base. In 2016, the FDIC board of directors approved a final rule revising DIF assessment formulas for community banks with less than $10 billion in assets that have been FDIC-insured for at least five years. The revised method better reflects risks and helps ensure that banks that take on greater risks pay more for deposit insurance than their less risk counterparts. The method change is revenue-neutral meaning aggregate assessment revenue collected from established small banks is expected to be approximately the same as it would have been using the prior method. Assessments were expected to drop by an average of approximately one-third. The range of initial assessment rates for all institutions declines to between 3 cents and 30 cents per $100 of the assessment base from between 5 cents and 35 cents.
We have and in the future we may be required to recognize impairment with respect to investment securities, including the FHLB stock we hold.
Our securities portfolio contains whole loan private mortgage-backed securities and currently includes securities with unrecognized losses and securities that have been downgraded to below investment grade by national rating agencies. We may continue to observe declines in the fair market value of these securities. We evaluate the securities portfolio for any other-than-temporary impairment each reporting period, as required by generally accepted accounting principles. Numerous factors, including the lack of liquidity for re-sales of certain securities, the absence of reliable pricing information for securities, adverse changes in the business climate, adverse regulatory actions or unanticipated changes in the competitive environment, could have a negative effect on our securities portfolio and results of operations in future periods. There can be no assurance, however, that future evaluations of the securities portfolio will not require us to recognize further impairment charges with respect to these and other holdings.
In addition, as a condition to membership in the Federal Home Loan Bank of San Francisco (the FHLB), we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB. At December 31, 2017, we held stock in the FHLB totaling
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$6,843,000 as compared to our minimum required stock holding of $6,335,000. The FHLB stock held by us is carried at cost and is subject to recoverability testing under applicable accounting standards. To date, the FHLB has not discontinued the distribution of dividends on its shares. However, there can be no assurance the FHLB’s dividend paying practices will continue. As of December 31, 2017, we did not recognize an impairment charge related to our FHLB stock holdings. There can be no assurance, however, that future negative changes to the financial condition of the FHLB may not require us to recognize an impairment charge with respect to such holdings.
If the goodwill we have recorded in connection with our acquisitions becomes impaired, it could have an adverse impact on our earnings and capital.
At December 31, 2017, we had approximately $53,777,000 of goodwill on our balance sheet attributable to our acquisitions of the Bank of Madera County in January 2005, Service 1st Bancorp in November 2008, Visalia Community Bank in July 2013, Sierra Vista Bank in October 2016, and Folsom Lake Bank in October 2017. In accordance with generally accepted accounting principles, our goodwill is not amortized but rather evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists. Such evaluation is based on a variety of factors, including the quoted price of our common stock, market prices of the common stock of other banking organizations, common stock trading multiples, discounted cash flows, and data from comparable acquisitions. There can be no assurance that future evaluations of goodwill will not result in findings of impairment and write-downs, which could be material.
We may raise additional capital, which could have a dilutive effect on the existing holders of our common stock and adversely affect the market price of our common stock.
We are not restricted from issuing additional shares of common stock or securities that are convertible into or exchangeable for, or that represent the right to receive, common stock. We frequently evaluate opportunities to access the capital markets taking into account our regulatory capital ratios, financial condition and other relevant considerations, and subject to market conditions, we may take further capital actions. Such actions could include, among other things, the issuance of additional shares of common stock in public or private transactions in order to further increase our capital levels above the requirements for a well-capitalized institution established by the Federal bank regulatory agencies as well as other regulatory targets.
The issuance of any additional shares of common stock or securities convertible into or exchangeable for common stock or that represent the right to receive common stock, or the exercise of such securities including, without limitation, securities issued upon exercise of outstanding stock options under our stock option plans, could be substantially dilutive to shareholders of our common stock. With the exception of one major shareholder, holders of our shares of common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, such sales or offerings could result in increased dilution to our shareholders. The market price of our common stock could decline as a result of sales of shares of our common stock or the perception that such sales could occur.
We may not be able to maintain our historical growth rate which may adversely impact our results of operations and financial condition.
We have initiated internal asset growth programs, completed various acquisitions and opened additional offices in the past few years. We may not be able to sustain our historical rate of asset growth or may not even be able to grow at all. We may not be able to obtain the financing necessary to fund additional asset growth and may not be able to find suitable candidates for acquisition. Various factors, such as economic conditions and competition, may impede or prohibit the opening of new branch offices. Further, our inability to attract and retain experienced bankers may adversely affect our internal asset growth. A significant decrease in our historical rate of asset growth may adversely impact our results of operations and financial condition.
We may be unable to complete future acquisitions, and once complete, may not be able to integrate our acquisitions successfully.
Our growth strategy includes our desire to acquire other financial institutions. We may not be able to complete any future acquisitions and, for completed acquisitions, we may not be able to successfully integrate the operations, management, products and services of the entities we acquire. We may not realize expected cost savings or make revenue enhancements. Following each acquisition, we must expend substantial managerial, operating, financial and other resources to integrate these entities. In particular, we may be required to install and standardize adequate operational and control systems, deploy or modify equipment, implement marketing efforts in new as well as existing locations and employ and maintain qualified personnel. Our failure to successfully integrate the entities we acquire into our existing operations may adversely affect our financial condition and results of operations.
We operate in a highly regulated environment and may be adversely affected by changes in federal and local laws and regulations.
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We are subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or federal or state legislation could have a substantial impact on us and our operations. Additional legislation and regulations may be enacted or adopted in the future that could significantly affect our powers, authority and operations, which could have a material adverse effect on our financial condition and results of operations. Further, regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of this regulatory discretion and power may have a negative impact on us.
The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell shares of common stock owned by you at times or at prices you find attractive.
The stock market and, in particular, the market for financial institution stocks, has experienced significant volatility, which, in recent quarters, has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices for certain issuers without regard to those issuers’ underlying financial strength. As a result, the trading volume in our common stock may fluctuate more than usual and cause significant price variations to occur. This may make it difficult for you to resell shares of common stock owned by you at times or at prices you find attractive. The low trading volume in our common shares on the NASDAQ Capital Market means that our shares may have less liquidity than other publicly traded companies. We cannot ensure that the volume of trading in our common shares will be maintained or will increase in the future.
The trading price of the shares of our common stock will depend on many factors, which may change from time to time and which may be beyond our control, including, without limitation, our financial condition, performance, creditworthiness and prospects, future sales or offerings of our equity or equity related securities, and other factors identified above in the forward-looking statement discussion under the section titled “Cautionary Statements Regarding Forward-Looking Statements” and below. These broad market fluctuations have adversely affected and may continue to adversely affect the market price of our common stock. Among the factors that could affect our stock price are:
• | actual or anticipated quarterly fluctuations in our operating results and financial condition; |
• | changes in financial estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to our common stock or those of other financial institutions; |
• | failure to meet analysts’ revenue or earnings estimates; |
• | speculation in the press or investment community generally or relating to our reputation, our market area, our competitors or the financial services industry in general; |
• | strategic actions by us or our competitors, such as acquisitions, restructurings, dispositions or financings; |
• | actions by our current shareholders, including sales of common stock by existing shareholders and/or directors and executive officers; |
• | fluctuations in the stock price and operating results of our competitors; |
• | future sales of our equity, equity-related or debt securities; |
• | changes in the frequency or amount of dividends or share repurchases; |
• | proposed or adopted regulatory changes or developments; |
• | anticipated or pending investigations, proceedings, or litigation that involves or affects us; |
• | trading activities in our common stock, including short-selling; |
• | domestic and international economic factors unrelated to our performance; and |
• | general market conditions and, in particular, developments related to market conditions for the financial services industry. |
A significant decline in our stock price could result in substantial losses for individual shareholders.
ITEM 1B - | UNRESOLVED STAFF COMMENTS |
Not applicable.
ITEM 2 - | DESCRIPTION OF PROPERTY |
The Company owns the property on which full-service branch offices are situated at the following California locations: the Clovis Main office in Clovis, the Foothill office in Prather, the Modesto office, the Kerman office, the Floral office in Visalia, and the Exeter office.
All other property is leased by the Company, including the principal executive offices in Fresno. This facility houses the Company’s corporate offices, comprised of various departments, including accounting, information services, human resources, real estate department, loan servicing, credit administration, branch support operations, and compliance.
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The Company continually evaluates the suitability and adequacy of the Company’s offices and has a program of relocating or remodeling them as necessary to be efficient and attractive facilities. Management believes that its existing facilities are adequate for its present purposes.
Properties owned by the Bank are held without loans or encumbrances. All of the property leased is leased directly from independent parties. Management considers the terms and conditions of each of the existing leases to be in the aggregate favorable to the Company. See Note 12 of the Company’s audited Consolidated Financial Statements in Item 8 of this Annual Report.
ITEM 3 - | LEGAL PROCEEDINGS |
The Company is subject to legal proceedings and claims which arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to such actions will not materially affect the consolidated financial position or consolidated results of operations of the Company.
None of our directors, officers, affiliates, more than 5% shareholders or any associates of these persons is a party adverse to the Company or the Bank or has a material interest adverse to the Company or the Bank in any material legal proceeding.
ITEM 4 - | MINE SAFETY DISCLOSURES |
Not Applicable.
PART II
ITEM 5 - | MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Our common stock is listed for trading on the Nasdaq Capital Market under the ticker symbol CVCY. As of March 8, 2018, we had approximately 1,072 shareholders of record.
The following table shows the high and low sales prices for the common stock for each quarter as reported by The NASDAQ Stock Market and cash dividend payment for each quarter presented.
Common Stock Prices and Dividends
Quarter 1 2016 | Quarter 2 2016 | Quarter 3 2016 | Quarter 4 2016 | Quarter 1 2017 | Quarter 2 2017 | Quarter 3 2017 | Quarter 4 2017 | ||||||||||||||||||||||||
High | $ | 12.49 | $ | 14.64 | $ | 16.42 | $ | 20.00 | $ | 22.44 | $ | 23.94 | $ | 23.28 | $ | 22.75 | |||||||||||||||
Low | $ | 9.45 | $ | 10.78 | $ | 13.30 | $ | 13.75 | $ | 18.42 | $ | 17.62 | $ | 18.57 | $ | 19.06 | |||||||||||||||
Dividends per share | $ | 0.06 | $ | 0.06 | $ | 0.06 | $ | 0.06 | $ | 0.06 | $ | 0.06 | $ | 0.06 | $ | 0.06 | |||||||||||||||
We paid common share cash dividends of $0.24 per share in 2017 and 2016. The Company’s primary source of income with which to pay cash dividends is dividends from the Bank. The Bank would not pay any dividend that would cause it to be deemed not “well capitalized” under applicable banking laws and regulations. See Note 13 in the audited Consolidated Financial Statements in Item 8 of this Annual Report.
The amount of future dividends will depend upon our earnings, financial condition, capital requirements and other factors, and will be determined by our board of directors on a quarterly basis. It is Federal Reserve policy that bank holding companies generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also Federal Reserve policy that bank holding companies not maintain dividend levels that undermine the holding company’s ability to be a source of strength to its banking subsidiaries. Additionally, in consideration of the current financial and economic environment, the Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong. Under the federal Prompt Corrective Action regulations, the Federal Reserve or the FDIC may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as undercapitalized.
As a holding company, our ability to pay cash dividends is affected by the ability of our bank subsidiary, to pay cash dividends. The ability of the Bank (and our ability) to pay cash dividends in the future and the amount of any such cash dividends is and could be in the future further influenced by bank regulatory requirements and approvals and capital guidelines.
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The decision whether to pay dividends will be made by our board of directors in light of conditions then existing, including factors such as our results of operations, financial condition, business conditions, regulatory capital requirements and covenants under any applicable contractual arrangements, including agreements with regulatory authorities.
The Company has outstanding trust preferred securities from special purpose trust and accompanying subordinated debt. The subordinated debt is senior to our shares of common stock. As a result, we must make payments on the subordinated debt before any dividends can be paid on our common stock. Under the terms of the subordinated debt, we may defer interest payments for up to five years. If the Company should ever defer such interest payments, we would be prohibited from declaring or paying any cash dividends on any shares of our common stock.
For information on the statutory and regulatory limitations on the ability of the Company to pay dividends and on the Bank to pay dividends to Company see “Item 1 - Business - Supervision and Regulation - Dividends.”
EQUITY COMPENSATION PLAN INFORMATION
The following chart sets forth information for the year ended December 31, 2017, regarding equity based compensation plans of the Company.
Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted- average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||||||
Plan Category | (a) | (b) | (c) | ||||||||
Equity compensation plans approved by security holders | 232,870 | (1) | $ | 9.13 | 830,760 | (2) | |||||
Equity compensation plans not approved by security holders | N/A | N/A | N/A | ||||||||
Total | 232,870 | $ | 9.13 | 830,760 | |||||||
(1) Under the Central Valley Community Bancorp 2015 Omnibus Incentive Plan (2015 Plan) and the Central Valley Community Bancorp 2005 Omnibus Incentive Plan (2005 Plan), the Company is authorized to issue restricted stock awards. Restricted stock awards are not included in the total in column (a). See Note 14 in the audited Consolidated Financial Statements in Item 8 of this Annual Report.
(2) Includes securities available for issuance of stock options and restricted stock.
At December 31, 2017, there were 63,768 shares of restricted stock issued and outstanding. No options to purchase shares of the Company’s common stock were issued during the years ended December 31, 2017 and 2016 from any of the Company’s stock based compensation plans. During the years ended December 31, 2017 and 2016, zero and 54,650 shares of restricted common stock were granted from outstanding grants under the 2015 and 2005 Plans.
ITEM 6 - | SELECTED CONSOLIDATED FINANCIAL DATA |
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Years Ended December 31, | ||||||||||||||||||||
(In thousands, except per-share amounts) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Statements of Income | ||||||||||||||||||||
Total interest income | $ | 57,376 | $ | 46,676 | $ | 41,822 | $ | 41,039 | $ | 34,836 | ||||||||||
Total interest expense | 1,137 | 1,096 | 1,047 | 1,156 | 1,385 | |||||||||||||||
Net interest income before provision for credit losses | 56,239 | 45,580 | 40,775 | 39,883 | 33,451 | |||||||||||||||
(Reversal of) Provision for credit losses | (1,150 | ) | (5,850 | ) | 600 | 7,985 | — | |||||||||||||
Net interest income after provision for credit losses | 57,389 | 51,430 | 40,175 | 31,898 | 33,451 | |||||||||||||||
Non-interest income | 10,836 | 9,591 | 9,387 | 8,164 | 7,831 | |||||||||||||||
Non-interest expenses | 44,406 | 38,922 | 36,016 | 35,338 | 31,685 | |||||||||||||||
Income before provision for (benefit from) income taxes | 23,819 | 22,099 | 13,546 | 4,724 | 9,597 | |||||||||||||||
Provision for (benefit from) income taxes | 9,793 | 6,917 | 2,582 | (570 | ) | 1,347 | ||||||||||||||
Net income | 14,026 | 15,182 | 10,964 | 5,294 | 8,250 | |||||||||||||||
Preferred stock dividends and accretion of discount | — | — | — | — | 350 | |||||||||||||||
Net income available to common shareholders | $ | 14,026 | $ | 15,182 | $ | 10,964 | $ | 5,294 | $ | 7,900 | ||||||||||
Basic earnings per share | $ | 1.12 | $ | 1.34 | $ | 1.00 | $ | 0.48 | $ | 0.77 | ||||||||||
Diluted earnings per share | $ | 1.10 | $ | 1.33 | $ | 1.00 | $ | 0.48 | $ | 0.77 | ||||||||||
Cash dividends declared per common share | $ | 0.24 | $ | 0.24 | $ | 0.18 | $ | 0.20 | $ | 0.20 | ||||||||||
December 31, | ||||||||||||||||||||
(In thousands) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Balances at end of year: | ||||||||||||||||||||
Investment securities, Federal funds sold and deposits in other banks | $ | 604,801 | $ | 558,132 | $ | 580,544 | $ | 520,511 | $ | 529,398 | ||||||||||
Net loans | 891,901 | 747,302 | 588,501 | 564,280 | 503,149 | |||||||||||||||
Total deposits | 1,425,687 | 1,255,979 | 1,116,267 | 1,039,152 | 1,004,143 | |||||||||||||||
Total assets | 1,661,655 | 1,443,323 | 1,276,736 | 1,192,183 | 1,145,635 | |||||||||||||||
Shareholders’ equity | 209,559 | 164,033 | 139,323 | 131,045 | 120,043 | |||||||||||||||
Earning assets | 1,505,436 | 1,319,065 | 1,173,591 | 1,074,942 | 1,042,552 | |||||||||||||||
Average balances: | ||||||||||||||||||||
Investment securities, Federal funds sold and deposits in other banks | $ | 568,426 | $ | 560,860 | $ | 529,046 | $ | 513,866 | $ | 445,859 | ||||||||||
Net loans | 784,085 | 636,475 | 577,784 | 531,382 | 444,770 | |||||||||||||||
Total deposits | 1,284,305 | 1,144,231 | 1,065,798 | 1,006,560 | 848,493 | |||||||||||||||
Total assets | 1,491,696 | 1,321,007 | 1,222,526 | 1,157,483 | 986,924 | |||||||||||||||
Shareholders’ equity | 182,507 | 154,325 | 135,062 | 130,414 | 119,746 | |||||||||||||||
Earning assets | 1,364,839 | 1,210,082 | 1,112,758 | 1,052,097 | 895,330 | |||||||||||||||
Data from 2017 reflects the partial year impact of the acquisition of Folsom Lake Bank on October 1, 2017. Data from 2016 reflects the partial year impact of the acquisition of Sierra Vista Bank on October 1, 2016. Data from 2013 reflects the partial year impact of the acquisition of Visalia Community Bank on July 1, 2013.
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ITEM 7 - | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
Management’s discussion and analysis should be read in conjunction with the Company’s audited Consolidated Financial Statements, including the Notes thereto, in Item 8 of this Annual Report.
Certain matters discussed in this report constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained herein that are not historical facts, such as statements regarding the Company’s current business strategy and the Company’s plans for future development and operations, are based upon current expectations. These statements are forward-looking in nature and involve a number of risks and uncertainties. Such risks and uncertainties include, but are not limited to (1) significant increases in competitive pressure in the banking industry; (2) the impact of changes in interest rates; (3) a decline in economic conditions in the Central Valley; (4) the Company’s ability to continue its internal growth at historical rates; (5) the Company’s ability to maintain its net interest margin; (6) the decline quality of the Company’s earning assets; (7) decline in credit quality; (8) changes in the regulatory environment; (9) fluctuations in the real estate market; (10) changes in business conditions and inflation; (11) changes in securities markets (12) risks associated with acquisitions, relating to difficulty in integrating combined operations and related negative impact on earnings, and incurrence of substantial expenses. Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluating the business prospects of the Company.
When the Company uses in this Annual Report the words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar expressions, the Company intends to identify forward-looking statements. Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Annual Report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. The future results and shareholder values of the Company may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. See also the discussion of risk factors in Item 1A, “Risk Factors.”
We are not able to predict all the factors that may affect future results. You should not place undue reliance on any forward looking statement, which speaks only as of the date of this Report on Form 10-K. Except as required by applicable laws or regulations, we do not undertake any obligation to update or revise any forward looking statement, whether as a result of new information, future events or otherwise.
INTRODUCTION
Central Valley Community Bancorp (NASDAQ: CVCY) (the Company) was incorporated on February 7, 2000. The formation of the holding company offered the Company more flexibility in meeting the long-term needs of customers, shareholders, and the communities it serves. The Company currently has one bank subsidiary, Central Valley Community Bank (the Bank) and one business trust subsidiary, Service 1st Capital Trust 1. The Company and Folsom Lake Bank (FLB) completed a merger under which FLB was merged with and into the Bank on October 1, 2017. With the FLB acquisition, the Company added two full service branches, located in Folsom, and Rancho Cordova, California which continue to be operated by the Bank. The Company’s market area includes the central valley area from Sacramento, California to Bakersfield, California.
During 2017, we focused on asset quality and capital adequacy due to the uncertainty created by the economy. We also focused on assuring that competitive products and services were made available to our clients while adjusting to the many new laws and regulations that affect the banking industry.
As of December 31, 2017, the Bank operated 24 full-service offices. The Bank has a Real Estate Division, an Agribusiness Center and an SBA Lending Division in Fresno. All real estate related transactions are conducted and processed through the Real Estate Division, including interim construction loans for single family residences and commercial buildings. We offer permanent single family residential loans through our mortgage broker services. The FLB acquisition added total assets, at fair value, of approximately $196.15 million, $117.82 million in loans, at fair value, and $171.95 million in deposits, at fair value, at October 1, 2017. FLB’s results of operations have been included in the Company’s results of operations beginning October 1, 2017. The one-time pre-tax severance, retention, acquisition and integration costs totaled $1.83 million for the year ended December 31, 2017.
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ECONOMIC CONDITIONS
The economy in California’s Central Valley was negatively impacted by the economic conditions in California and in our operating markets during the economic downturn of 2007 through 2010. The recession impacted most industries in our market area. Initially, housing values throughout the nation and especially in the Central Valley decreased dramatically, which in turn negatively affected the personal net worth of much of the population in our service area. Over the last several years the economy, as evidenced by the California and Central Valley unemployment rates, and housing prices have shown slow but steady improvement. Housing in the Central Valley continues to be relatively more affordable than the major metropolitan areas in California.
Agriculture and agricultural related businesses remain a critical part of the Central Valley’s economy. The Valley’s agricultural production is widely diversified, producing nuts, vegetables, fruit, cattle, dairy products, and cotton. The continued future success of agriculture related businesses is highly dependent on the availability of water and is subject to fluctuation in worldwide commodity prices, currency exchanges, and demand. From time to time, California experiences severe droughts, which could significantly harm the business of our customers and the credit quality of the loans to those customers. We closely monitor the water resources and the related issues affecting our customers, and will remain vigilant for signs of deterioration within the loan portfolio in an effort to manage credit quality and work with borrowers where possible to mitigate any losses.
OVERVIEW
Diluted earnings per share (EPS) for the year ended December 31, 2017 was $1.10 compared to $1.33 and $1.00 for the years ended December 31, 2016 and 2015, respectively. Net income for 2017 was $14,026,000 compared to $15,182,000 and $10,964,000 for the years ended December 31, 2016 and 2015, respectively. The decrease in net income and EPS was primarily driven by the increase in provision for income taxes and increase in non-interest expense, and an increase in provision for credit losses, offset by an increase in net interest income, and an increase in non-interest income in 2017 compared to 2016. Total assets at December 31, 2017 were $1,661,655,000 compared to $1,443,323,000 at December 31, 2016.
Return on average equity for 2017 was 7.69% compared to 9.84% and 8.12% for 2016 and 2015, respectively. Return on average assets for 2017 was 0.94% compared to 1.15% and 0.90% for 2016 and 2015, respectively. Total equity was $209,559,000 at December 31, 2017 compared to $164,033,000 at December 31, 2016. The increase in equity in 2017 compared to 2016 was primarily driven by the issuance of common stock in connection with the Folsom Lake Bank acquisition, as well as the retention of earnings, net of dividends paid, and an increase in unrealized gains on available-for-sale securities, net of tax, recorded in accumulated other comprehensive income (AOCI).
Average total loans increased $146,770,000 or 22.70% to $793,343,000 in 2017 compared to $646,573,000 in 2016. In 2017, we recorded a reverse provision for credit losses of $1,150,000 compared to a reverse provision of $5,850,000 in 2016 and a provision of $600,000 in 2015. The Company had nonperforming assets consisting of $2,875,000 in nonaccrual loans and $70,000 in repossessed assets, totaling $2,945,000 at December 31, 2017. At December 31, 2016, nonperforming assets totaled $2,542,000. Net loan loss recoveries for 2017 were $602,000 compared to $5,566,000 for 2016 and $702,000 for 2015. Refer to “Asset Quality” below for further information.
Key Factors in Evaluating Financial Condition and Operating Performance
In evaluating our financial condition and operating performance, we focus on several key factors including:
•Return to our shareholders;
•Return on average assets;
•Development of revenue streams, including net interest income and non-interest income;
•Asset quality;
•Asset growth;
•Capital adequacy;
•Operating efficiency; and
•Liquidity.
Return to Our Shareholders
One measure of our return to our shareholders is the return on average equity (ROE). ROE is a ratio that measures net income divided by average shareholders’ equity. Our ROE was 7.69% for the year ended 2017 compared to 9.84% and 8.12% for the years ended 2016 and 2015, respectively.
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Our net income for the year ended December 31, 2017 decreased $1,156,000 compared to 2016 and increased $4,218,000 in 2016 compared to 2015. During 2017, net income compared to 2016 was negatively impacted by the re-measurement of our deferred tax asset and corresponding increase in tax expense. Also contributing to the decrease was the increase in non-interest expenses, and an increase in the provision for credit losses. These were partially offset by increases in net interest income and increases in non-interest income.
Net interest income increased primarily because of increases in loan and investment income, offset by increases in interest expense on deposits. For 2017, our net interest margin (NIM) increased 32 basis points to 4.41% compared to 2016. Our net interest margin increased as a result of yield changes, asset mix changes, and an increase in average earning assets, partially offset by an increase in interest-bearing liabilities. Net interest income during 2017 was positively impacted by the collection of nonaccrual loans which resulted in a recovery of interest income of approximately $1,325,000. The recovery was partially offset by reversal of approximately $12,000 in interest income on loans placed on nonaccrual during the year. Net interest income during 2016 was positively impacted by the collection of nonaccrual loan which resulted in a recovery of interest income of approximately $657,000. The recovery in 2016 was partially offset by reversal of approximately $71,000 in interest income on loans put on nonaccrual during the year.
Non-interest income increased 12.98% in 2017 compared to 2016 primarily due to a $882,000 increase in net realized gains on sales and calls of investment securities, a $230,000 increase in interchange fees, a $204,000 increase in service charge income, and a $294,000 increase in other income, partially offset by a decrease in loan placement fees of $377,000, and a $187,000 decrease in Federal Home Loan Bank dividends. The Company also realized $190,000 tax-free gains related to the collection of life insurance proceeds in 2016, which are included in other non-interest income. In addition, the Company recorded an other-than-temporary impairment loss of $136,000 during the period ended December 31, 2016.
Non-interest expenses increased in 2017 compared to 2016 primarily due to the SVB and FLB acquisitions. The net increase year over year was a result of increases in salary and employee benefit expenses of $2,857,000, increase in acquisition and integration expenses of $46,000, data processing expenses of $33,000, occupancy and equipment expenses of $432,000, ATM/Debit card expenses of $117,000, Internet banking expenses of $27,000, regulatory assessments of $10,000, advertising fees of $62,000, professional services of $251,000, and amortization of core deposit intangibles of $85,000. The Company also recognized additional tax expense of $3,535,000 related to a tax law change enacted in 2017. Basic EPS was $1.12 for 2017 compared to $1.34 and $1.00 for 2016 and 2015, respectively. Diluted EPS was $1.10 for 2017 compared to $1.33 and $1.00 for 2016 and 2015, respectively. The decrease in EPS for 2017 is primarily due to the decrease in net income.
We experienced an increase in capital due to the issuance of common stock as a result of the Folsom Lake Bank acquisition, as well as the retention of earnings, net of dividends paid, and an increase in accumulated other comprehensive income.
Return on Average Assets
Our return on average assets (ROA) is a ratio that measures our performance compared with other banks and bank holding companies. Our ROA for the year ended 2017 was 0.94% compared to 1.15% and 0.90% for the years ended December 31, 2016 and 2015, respectively. The 2017 decrease in ROA is primarily due to the decrease in net income. Annualized ROA for our peer group was 1.13% at December 31, 2017. Peer group information from SNL Financial data includes bank holding companies in central California with assets from $600 million to $3.5 billion.
Development of Revenue Streams
Over the past several years, we have focused on not only our net income, but improving the consistency of our revenue streams in order to create more predictable future earnings and reduce the effect of changes in our operating environment on our net income. Specifically, we have focused on net interest income through a variety of strategies, including increases in average interest earning assets, and minimizing the effects of the recent interest rate decline on our net interest margin by focusing on core deposits and managing the cost of funds. Our net interest margin (fully tax equivalent basis) was 4.41% for the year ended December 31, 2017, compared to 4.09% and 4.01% for the years ended December 31, 2016 and 2015, respectively. We experienced an increase in 2017 net interest margin compared to 2016, resulting from the increase in loan and investment yields. The effective tax equivalent yield on total earning assets increased 32 basis points, while the cost of total interest-bearing liabilities decreased slightly to 0.14% for the year ended December 31, 2017. Our cost of total deposits in 2017 and 2016 was 0.08% and 0.09%, respectively, compared to 0.09% for the same period in 2015. Our net interest income before provision for credit losses increased $10,659,000 or 23.39% to $56,239,000 for the year ended 2017 compared to $45,580,000 and $40,775,000 for the years ended 2016 and 2015, respectively.
Our non-interest income is generally made up of service charges and fees on deposit accounts, fee income from loan placements, appreciation in cash surrender value of bank owned life insurance, and net gains from sales and calls of investment securities. Non-interest income in 2017 increased $1,245,000 or 12.98% to $10,836,000 compared to $9,591,000 in 2016 and $9,387,000 in 2015. The increase resulted primarily from increases in net realized gains on sales and calls of investment securities, interchange fees, service charge income, and appreciation in cash surrender value of bank owned life insurance,
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partially offset by a decrease in loan placement fees and Federal Home Loan Bank dividends compared to 2016. Customer service charges increased $204,000 or 7.16% to $3,053,000 in 2017 compared to $2,849,000 and $2,970,000 in 2016 and 2015, respectively. Further detail on non-interest income is provided below.
Asset Quality
For all banks and bank holding companies, asset quality has a significant impact on the overall financial condition and results of operations. Asset quality is measured in terms of classified and nonperforming loans, and is a key element in estimating the future earnings of a company. Total nonperforming assets were $2,945,000 and $2,542,000 at December 31, 2017 and 2016, respectively. Nonperforming assets totaled 0.33% of gross loans as of December 31, 2017 and 0.34% of gross loans as of December 31, 2016. The nonperforming assets for 2017 includes repossessed assets of $70,000 compared to $362,000 repossessed assets at December 31, 2016. The Company had no other real estate owned (OREO) at December 31, 2017 or December 31, 2016. Management maintains certain loans that have been brought current by the borrower (less than 30 days delinquent) on nonaccrual status until such time as management has determined that the loans are likely to remain current in future periods.
The ratio of nonperforming loans to total loans was 0.32% as of December 31, 2017 and 0.29% as of December 31, 2016. The allowance for credit losses as a percentage of outstanding loan balance was 0.98% as of December 31, 2017 and 1.23% as of December 31, 2016. The ratio of net recoveries to average loans was 0.08% as of December 31, 2017 and 0.86% as of December 31, 2016.
Asset Growth
As revenues from both net interest income and non-interest income are a function of asset size, the continued growth in assets has a direct impact in increasing net income and therefore ROE and ROA. The majority of our assets are loans and investment securities, and the majority of our liabilities are deposits, and therefore the ability to generate deposits as a funding source for loans and investments is fundamental to our asset growth. Total assets increased 15.13% during 2017 to $1,661,655,000 as of December 31, 2017 from $1,443,323,000 as of December 31, 2016. Total gross loans increased 19.04% to $900,679,000 as of December 31, 2017, compared to $756,628,000 at December 31, 2016. Total investment securities and Federal funds sold decreased 0.92% to $542,721,000 as of December 31, 2017 compared to $547,764,000 as of December 31, 2016. Total deposits increased 13.51% to $1,425,687,000 as of December 31, 2017 compared to $1,255,979,000 as of December 31, 2016. Our loan to deposit ratio at December 31, 2017 was 63.18% compared to 60.24% at December 31, 2016. The loan to deposit ratio of our peers was 77.65% at December 31, 2017. The growth information above includes the results of our acquisition of Folsom Bank which added approximately $117,815,000 in net loans and $171,948,000 in deposits during 2017.
Capital Adequacy
At December 31, 2017, we had a total capital to risk-weighted assets ratio of 14.07%, a Tier 1 risk-based capital ratio of 13.28%, common equity Tier 1 ratio of 12.90%, and a leverage ratio of 9.71%. At December 31, 2016, we had a total capital to risk-weighted assets ratio of 13.72%, a Tier 1 risk-based capital ratio of 12.74%, common equity Tier 1 ratio of 12.48%, and a leverage ratio of 8.75%. At December 31, 2017, on a stand-alone basis, the Bank had a total risk-based capital ratio of 13.74%, a Tier 1 risk based capital ratio of 12.96%, common equity Tier 1 ratio of 12.96%, and a leverage ratio of 9.46%. At December 31, 2016, the Bank had a total risk-based capital ratio of 13.57%, Tier 1 risk-based capital of 12.59% and a leverage ratio of 8.64%. Note 13 of the audited Consolidated Financial Statements provides more detailed information concerning the Company’s capital amounts and ratios. As of January 1, 2015, along with other community banking organizations, the Company and the Bank became subject to new capital requirements, and certain provisions of the new rules are being phased in through 2019 under the Dodd-Frank Act and Basel III. As of December 31, 2017, the Company and the Bank met or exceeded all of their capital requirements inclusive of the capital buffer. The Company and the Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at December 31, 2017.
Operating Efficiency
Operating efficiency is the measure of how efficiently earnings before taxes are generated as a percentage of revenue. A lower ratio represents greater efficiency. The Company’s efficiency ratio (operating expenses, excluding amortization of intangibles and foreclosed property expense, divided by net interest income plus non-interest income, excluding net gains and losses from sale of securities) was 62.03% for 2017 compared to 64.72% for 2016 and 68.46% for 2015. The improvement in the efficiency ratio in 2017 was due to the growth in revenues outpacing the growth in non-interest expense. The increase in the efficiency ratio in 2016 compared to 2015 was due to the growth in revenues outpacing the growth in non-interest expense.
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The Company’s net interest income before provision for credit losses plus non-interest income increased 21.58% to $67,075,000 in 2017 compared to $55,171,000 in 2016 and $50,162,000 in 2015, while operating expenses increased 14.09% in 2017, 8.07% in 2016, and 1.92% in 2015.
Liquidity
Liquidity management involves our ability to meet cash flow requirements arising from fluctuations in deposit levels and demands of daily operations, which include providing for customers’ credit needs, funding of securities purchases, and ongoing repayment of borrowings. Our liquidity is actively managed on a daily basis and reviewed periodically by our management and Directors’ Asset/Liability Committee. This process is intended to ensure the maintenance of sufficient funds to meet our needs, including adequate cash flows for off-balance sheet commitments. Our primary sources of liquidity are derived from financing activities which include the acceptance of customer and, to a lesser extent, broker deposits, Federal funds facilities and advances from the Federal Home Loan Bank of San Francisco. We have available unsecured lines of credit with correspondent banks totaling approximately $40,000,000 and secured borrowing lines of approximately $234,689,000 with the Federal Home Loan Bank. These funding sources are augmented by collection of principal and interest on loans, the routine maturities and pay downs of securities from our investment securities portfolio, the stability of our core deposits, and the ability to sell investment securities. Primary uses of funds include origination and purchases of loans, withdrawals of and interest payments on deposits, purchases of investment securities, and payment of operating expenses.
We had liquid assets (cash and due from banks, interest-earning deposits in other banks, Federal funds sold and available-for-sale securities) totaling $643,087,000 or 38.70% of total assets at December 31, 2017 and $586,317,000 or 40.62% of total assets as of December 31, 2016.
RESULTS OF OPERATIONS
Net Income
Net income was $14,026,000 in 2017 compared to $15,182,000 and $10,964,000 in 2016 and 2015, respectively. Basic earnings per share was $1.12, $1.34, and $1.00 for 2017, 2016, and 2015, respectively. Diluted earnings per share was $1.10, $1.33, and $1.00 for 2017, 2016, and 2015, respectively. ROE was 7.69% for 2017 compared to 9.84% for 2016 and 8.12% for 2015. ROA for 2017 was 0.94% compared to 1.15% for 2016 and 0.90% for 2015.
The decrease in net income for 2017 compared to 2016 can be attributed to an increase in provision for income taxes and an increase in non-interest expense, partially offset by an increase in the provision for credit losses, an increase in net interest income, and an increase in non-interest income. The increase in net income for 2016 compared to 2015 was primarily attributed to a decrease in the provision for credit losses, an increase in net interest income, and an increase in non-interest income, partially offset by an increase in provision for income taxes and an increase in non-interest expense.
Interest Income and Expense
Net interest income is the most significant component of our income from operations. Net interest income (the interest rate spread) is the difference between the gross interest and fees earned on the loan and investment portfolios and the interest paid on deposits and other borrowings. Net interest income depends on the volume of and interest rate earned on interest-earning assets and the volume of and interest rate paid on interest-bearing liabilities.
The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield and cost information for the periods presented. Average balances are derived from daily balances, and nonaccrual loans are not included as interest-earning assets for purposes of this table.
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SCHEDULE OF AVERAGE BALANCES, AVERAGE YIELDS AND RATES
Year Ended December 31, 2017 | Year Ended December 31, 2016 | Year Ended December 31, 2015 | |||||||||||||||||||||||||||||||
(Dollars in thousands) | Average Balance | Interest Income/ Expense | Average Interest Rate | Average Balance | Interest Income/ Expense | Average Interest Rate | Average Balance | Interest Income/ Expense | Average Interest Rate | ||||||||||||||||||||||||
ASSETS | |||||||||||||||||||||||||||||||||
Interest-earning deposits in other banks | $ | 36,709 | $ | 424 | 1.16 | % | $ | 53,514 | $ | 289 | 0.54 | % | $ | 64,963 | $ | 209 | 0.32 | % | |||||||||||||||
Securities | |||||||||||||||||||||||||||||||||
Taxable securities | 310,876 | 6,526 | 2.10 | % | 313,006 | 5,876 | 1.88 | % | 285,585 | 4,793 | 1.68 | % | |||||||||||||||||||||
Non-taxable securities (1) | 220,806 | 10,443 | 4.73 | % | 194,224 | 9,787 | 5.04 | % | 178,247 | 9,569 | 5.37 | % | |||||||||||||||||||||
Total investment securities | 531,682 | 16,969 | 3.19 | % | 507,230 | 15,663 | 3.09 | % | 463,832 | 14,362 | 3.10 | % | |||||||||||||||||||||
Federal funds sold | 35 | — | 1.50 | % | 116 | — | 0.51 | % | 251 | 1 | 0.25 | % | |||||||||||||||||||||
Total securities and interest-earning deposits | 568,426 | 17,393 | 3.06 | % | 560,860 | 15,952 | 2.84 | % | 529,046 | 14,572 | 2.75 | % | |||||||||||||||||||||
Loans (2) (3) | 790,504 | 43,534 | 5.51 | % | 644,282 | 34,051 | 5.29 | % | 578,899 | 30,504 | 5.27 | % | |||||||||||||||||||||
Federal Home Loan Bank stock | 5,909 | 443 | 7.50 | % | 4,940 | 630 | 12.75 | % | 4,813 | 580 | 12.05 | % | |||||||||||||||||||||
Total interest-earning assets | 1,364,839 | $ | 61,370 | 4.50 | % | 1,210,082 | $ | 50,633 | 4.18 | % | 1,112,758 | $ | 45,656 | 4.10 | % | ||||||||||||||||||
Allowance for credit losses | (9,258 | ) | (10,098 | ) | (8,978 | ) | |||||||||||||||||||||||||||
Nonaccrual loans | 2,839 | 2,291 | 7,863 | ||||||||||||||||||||||||||||||
Cash and due from banks | 24,989 | 23,840 | 25,019 | ||||||||||||||||||||||||||||||
Bank premises and equipment | 9,310 | 9,053 | 9,664 | ||||||||||||||||||||||||||||||
Other non-earning assets | 98,977 | 85,839 | 76,200 | ||||||||||||||||||||||||||||||
Total average assets | $ | 1,491,696 | $ | 1,321,007 | $ | 1,222,526 | |||||||||||||||||||||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||||||||||||||||||||||||||||
Interest-bearing liabilities: | |||||||||||||||||||||||||||||||||
Savings and NOW accounts | $ | 382,071 | $ | 350 | 0.09 | % | $ | 337,804 | $ | 317 | 0.09 | % | $ | 300,741 | $ | 261 | 0.09 | % | |||||||||||||||
Money market accounts | 264,581 | 211 | 0.08 | % | 249,620 | 133 | 0.05 | % | 227,743 | 141 | 0.06 | % | |||||||||||||||||||||
Time certificates of deposit | 137,666 | 408 | 0.30 | % | 139,656 | 525 | 0.38 | % | 149,383 | 546 | 0.37 | % | |||||||||||||||||||||
Total interest-bearing deposits | 784,318 | 969 | 0.12 | % | 727,080 | 975 | 0.13 | % | 677,867 | 948 | 0.14 | % | |||||||||||||||||||||
Other borrowed funds | 6,930 | 168 | 2.42 | % | 5,157 | 121 | 2.35 | % | 5,156 | 99 | 1.89 | % | |||||||||||||||||||||
Total interest-bearing liabilities | 791,248 | $ | 1,137 | 0.14 | % | 732,237 | $ | 1,096 | 0.15 | % | 683,023 | $ | 1,047 | 0.15 | % | ||||||||||||||||||
Non-interest bearing demand deposits | 499,987 | 417,151 | 387,931 | ||||||||||||||||||||||||||||||
Other liabilities | 17,954 | 17,294 | 16,510 | ||||||||||||||||||||||||||||||
Shareholders’ equity | 182,507 | 154,325 | 135,062 | ||||||||||||||||||||||||||||||
Total average liabilities and shareholders’ equity | $ | 1,491,696 | $ | 1,321,007 | $ | 1,222,526 | |||||||||||||||||||||||||||
Interest income and rate earned on average earning assets | $ | 61,370 | 4.50 | % | $ | 50,633 | 4.18 | % | $ | 45,656 | 4.10 | % | |||||||||||||||||||||
Interest expense and interest cost related to average interest-bearing liabilities | 1,137 | 0.14 | % | 1,096 | 0.15 | % | 1,047 | 0.15 | % | ||||||||||||||||||||||||
Net interest income and net interest margin (4) | $ | 60,233 | 4.41 | % | $ | 49,537 | 4.09 | % | $ | 44,609 | 4.01 | % | |||||||||||||||||||||
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(1) | Interest income is calculated on a fully tax equivalent basis, which includes Federal tax benefits (at a 35% tax rate) relating to income earned on municipal bonds totaling $3,551, $3,327, and $3,254 in 2017, 2016, and 2015, respectively. |
(2) | Loan interest income includes loan fees of $684 in 2017, $134 in 2016, and $255 in 2015. |
(3) | Average loans do not include nonaccrual loans. |
(4) | Net interest margin is computed by dividing net interest income by total average interest-earning assets. |
The following table sets forth a summary of the changes in interest income and interest expense due to changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. The change in interest due to both rate and volume has been allocated to the change in rate.
Changes in Volume/Rate | For the Years Ended December 31, 2017 Compared to 2016 | For the Years Ended December 31, 2016 Compared to 2015 | ||||||||||||||||||||||
(In thousands) | Volume | Rate | Net | Volume | Rate | Net | ||||||||||||||||||
Increase (decrease) due to changes in: | ||||||||||||||||||||||||
Interest income: | ||||||||||||||||||||||||
Interest-earning deposits in other banks | $ | (90 | ) | $ | 225 | $ | 135 | $ | (36 | ) | $ | 116 | $ | 80 | ||||||||||
Investment securities: | ||||||||||||||||||||||||
Taxable | (39 | ) | 689 | 650 | 460 | 623 | 1,083 | |||||||||||||||||
Non-taxable (1) | 1,339 | (683 | ) | 656 | 857 | (639 | ) | 218 | ||||||||||||||||
Total investment securities | 1,300 | 6 | 1,306 | 1,317 | (16 | ) | 1,301 | |||||||||||||||||
Federal funds sold | — | — | — | (1 | ) | — | (1 | ) | ||||||||||||||||
Loans | 7,728 | 1,755 | 9,483 | 3,446 | 101 | 3,547 | ||||||||||||||||||
FHLB Stock | 123 | (310 | ) | (187 | ) | 16 | 34 | 50 | ||||||||||||||||
Total earning assets (1) | 9,061 | 1,676 | 10,737 | 4,742 | 235 | 4,977 | ||||||||||||||||||
Interest expense: | ||||||||||||||||||||||||
Deposits: | ||||||||||||||||||||||||
Savings, NOW and MMA | 49 | 62 | 111 | 46 | 2 | 48 | ||||||||||||||||||
Time certificate of deposits | (7 | ) | (110 | ) | (117 | ) | (36 | ) | 14 | (22 | ) | |||||||||||||
Total interest-bearing deposits | 42 | (48 | ) | (6 | ) | 10 | 16 | 26 | ||||||||||||||||
Other borrowed funds | 41 | 6 | 47 | — | 22 | 22 | ||||||||||||||||||
Total interest bearing liabilities | 83 | (42 | ) | 41 | 10 | 38 | 48 | |||||||||||||||||
Net interest income (1) | $ | 8,978 | $ | 1,718 | $ | 10,696 | $ | 4,732 | $ | 197 | $ | 4,929 | ||||||||||||
(1) Computed on a tax equivalent basis for securities exempt from federal income taxes.
Interest and fee income from loans increased $9,483,000 or 27.85% in 2017 compared to 2016. Interest and fee income from loans increased $3,547,000 or 11.63% in 2016 compared to 2015. The increase in 2017 is primarily attributable to an increase in average total loans outstanding, as well as an increase in the yield on loans by 22 basis points. The net interest income during 2017 was positively impacted by the FLB and SVB acquisitions in addition to the collection of nonaccrual loans which resulted in a recovery of interest income of approximately $1,325,000. The recovery was partially offset by reversal of approximately $12,000 in interest income on loans placed on nonaccrual status during the year. Interest income during 2016 was positively impacted by the collection of nonaccrual loans which resulted in a recovery of interest income of approximately $657,000. The recovery was partially offset by reversal of approximately $71,000 in interest income on loans placed on nonaccrual status during the year.
Average total loans for 2017 increased $146,770,000 to $793,343,000 compared to $646,573,000 for 2016 and $586,762,000 for 2015. Of the increase in 2017, approximately $116.7 million was attributed to organic growth and approximately $30.1 million from the acquisition of FLB. The yield on loans for 2017 was 5.51% compared to 5.29% and 5.27% for 2016 and 2015, respectively. The impact to interest income from the accretion of the loan marks on acquired loans was an increase of $1,048,000 and $1,143,000 for the years ended December 31, 2017 and 2016, respectively.
Interest income from total investments on a non tax-equivalent basis, (total investments include investment securities, Federal funds sold, interest-bearing deposits in other banks, and other securities), increased $1,217,000 or 9.64% in 2017 compared to 2016. The yield on average investments increased 22 basis points to 3.06% for the year ended December 31, 2017 from 2.84% for the year ended December 31, 2016. Average total investments increased $7,566,000 to $568,426,000 in 2017 compared to $560,860,000 in 2016. In 2016, total investment income on a non tax-equivalent basis increased $1,307,000 or 11.55% compared to 2015.
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Our investment portfolio consists primarily of securities issued by U.S. Government sponsored entities and agencies collateralized by mortgage backed obligations and obligations of states and political subdivision securities. However, a significant portion of the investment portfolio is mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs). At December 31, 2017, we held $325,589,000 or 59.99% of the total market value of the investment portfolio in MBS and CMOs with an average yield of 2.89%. We invest in CMOs and MBS as part of our overall strategy to increase our net interest margin. CMOs and MBS by their nature are affected by prepayments which are impacted by changes in interest rates. In a normal declining rate environment, prepayments from MBS and CMOs would be expected to increase and the expected life of the investment would be expected to shorten. Conversely, if interest rates increase, prepayments normally would be expected to decline and the average life of the MBS and CMOs would be expected to extend. Premium amortization and discount accretion of these investments affects our net interest income. Our management monitors the prepayment trends of these investments and adjusts premium amortization and discount accretion based on several factors. These factors include the type of investment, the investment structure, interest rates, interest rates on new mortgage loans, expectation of interest rate changes, current economic conditions, the level of principal remaining on the bond, the bond coupon rate, the bond origination date, and volume of available bonds in market. The calculation of premium amortization and discount accretion is by nature inexact, and represents management’s best estimate of principal pay downs inherent in the total investment portfolio.
The cumulative net of tax effect of the change in market value of the available-for-sale investment portfolio as of December 31, 2017 was an unrealized gain of $2,826,000 and is reflected in the Company’s equity. At December 31, 2017, the average life of the investment portfolio was 5.69 years and the market value reflected a pre-tax unrealized gain of $4,012,000. Management reviews market value declines on individual investment securities to determine whether they represent other-than-temporary impairment (OTTI). For the years ended December 31, 2017 and 2015, no OTTI was recorded. For the year ended December 31, 2016, OTTI was recorded in the amount of $136,000. Future deterioration in the market values of our investment securities may require the Company to recognize additional OTTI losses.
A component of the Company’s strategic plan has been to use its investment portfolio to offset, in part, its interest rate risk relating to variable rate loans. Measured at December 31, 2017, an immediate rate increase of 200 basis points would result in an estimated decrease in the market value of the investment portfolio by approximately $36,360,000. Conversely, with an immediate rate decrease of 200 basis points, the estimated increase in the market value of the investment portfolio would be $36,325,000. The modeling environment assumes management would take no action during an immediate shock of 200 basis points. However, the Company uses those increments to measure its interest rate risk in accordance with regulatory requirements and to measure the possible future risk in the investment portfolio. For further discussion of the Company’s market risk, refer to Quantitative and Qualitative Disclosures about Market Risk.
Management’s review of all investments before purchase includes an analysis of how the security will perform under several interest rate scenarios to monitor whether investments are consistent with our investment policy. The policy addresses issues of average life, duration, and concentration guidelines, prohibited investments, impairment, and prohibited practices.
Total interest income in 2017 increased $10,700,000 to $57,376,000 compared to $46,676,000 in 2016 and $41,822,000 in 2015. The increase was the result of yield changes, asset mix changes, and an increase in average earning assets. The tax equivalent yield on interest earning assets increased to 4.50% for the year ended December 31, 2017 from 4.18% for the year ended December 31, 2016. Average interest earning assets increased to $1,364,839,000 for the year ended December 31, 2017 compared to $1,210,082,000 for the year ended December 31, 2016. Average interest-earning deposits in other banks decreased $16,805,000 comparing 2017 to 2016. Average yield on these deposits was 1.16% compared to 0.54% on December 31, 2017 and December 31, 2016 respectively. Average investments and interest-earning deposits increased $7,566,000 but the tax equivalent yield on those assets increased 22 basis points. Average total loans increased $146,770,000 and the yield on average loans increased 22 basis points.
The increase in total interest income for 2016 was the result of yield changes, asset mix changes, and an increase in average earning assets. The yield on interest-earning assets increased to 4.18% for the year ended December 31, 2016 from 4.10% for the year ended December 31, 2015. Average interest-earning assets increased to $1,210,082,000 for the year ended December 31, 2016 compared to $1,112,758,000 for the year ended December 31, 2015.
Interest expense on deposits in 2017 decreased $6,000 or 0.62% to $969,000 compared to $975,000 in 2016 and increased as compared to $948,000 in 2015. The yield on interest-bearing deposits decreased 1 basis point to 0.12% in 2017 from 0.13% in 2016. The increase in interest expense in 2016 compared to 2015 was the result of the deposits acquired. The yield on interest-bearing deposits decreased 1 basis point to 0.13% in 2016 from 0.14% in 2015. Average interest-bearing deposits were $784,318,000 for 2017 compared to $727,080,000 and $677,867,000 for 2016 and 2015, respectively. The increases in average interest-bearing deposits in 2017 and 2016 was the result of organic growth and the FLB and SVB acquisitions in 2017 and 2016.
Average other borrowings were $6,930,000 with an effective rate of 2.42% for 2017 compared to $5,157,000 with an effective rate of 2.35% for 2016. In 2015, the average other borrowings were $5,156,000 with an effective rate of 1.89%. Included in other borrowings are the junior subordinated deferrable interest debentures acquired from Service 1st, advances on lines of credit, advances from the Federal Home Loan Bank (FHLB), and overnight borrowings. The debentures carry a floating rate based on the three month LIBOR plus a margin of 1.60%. The rate was 2.96% for 2017, 2.48% for 2016, and 1.92% for 2015.
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The cost of all interest-bearing liabilities was 0.14% and 0.15% basis points for 2017 and 2016, respectively, compared to 0.15% for 2015. The cost of total deposits decreased to 0.08% for the year ended December 31, 2017, compared to 0.09% for the years ended December 31, 2016 and 2015. Average demand deposits increased 19.86% to $499,987,000 in 2017 compared to $417,151,000 for 2016 and $387,931,000 for 2015. The ratio of average non-interest demand deposits to average total deposits increased to 38.93% for 2017 compared to 36.46% and 36.40% for 2016 and 2015, respectively.
Net Interest Income before Provision for Credit Losses
Net interest income before provision for credit losses for 2017 increased $10,659,000 or 23.39% to $56,239,000 compared to $45,580,000 for 2016 and $40,775,000 for 2015. The increase in 2017 was due to the increase in average earning assets while the yield on interest bearing liabilities decreased 1 basis point. Our net interest margin (NIM) increased 32 basis points. Yield on interest earning assets increased 32 basis points. The change in the mix of average interest earning assets also affected NIM. Interest-earning deposits in other banks and investment securities, which tend to have lower effective yields, increased reflective of the Federal Reserve rate increase. Net interest income before provision for credit losses increased $4,805,000 in 2016 compared to 2015, primarily due to the increase in average earning assets. Average interest-earning assets were $1,364,839,000 for the year ended December 31, 2017 with a NIM of 4.41% compared to $1,210,082,000 with a NIM of 4.09% in 2016, and $1,112,758,000 with a NIM of 4.01% in 2015. For a discussion of the repricing of our assets and liabilities, refer to Quantitative and Qualitative Disclosure about Market Risk.
Provision for Credit Losses
We provide for probable incurred credit losses through a charge to operating income based upon the change in balance and composition of the loan portfolio, delinquency levels, historical losses and nonperforming assets, economic and environmental conditions and other factors which, in management’s judgment, deserve recognition in estimating credit losses. Loans are charged off when they are considered uncollectible or when continuance as an active earning bank asset is not warranted.
The establishment of an adequate credit allowance is based on both an accurate risk rating system and loan portfolio management tools. The Board has established initial responsibility for the accuracy of credit risk grades with the individual credit officer. The grading is then submitted to the Chief Credit Officer (CCO), who reviews the grades for accuracy and gives final approval. The CCO is not involved in loan originations. The risk grading and reserve allocation is analyzed quarterly by the Senior Risk Manager, CCO, Chief Financial Officer, and Board; and at least annually by a third party credit reviewer and by various regulatory agencies.
Quarterly, the Senior Risk Manager and the CCO set the specific reserve for all adversely risk-graded credits. This process includes the utilization of loan delinquency reports, classified asset reports, collateral analysis, and portfolio concentration reports to assist in accurately assessing credit risk and establishing appropriate reserves. Reserves are also allocated to credits that are not impaired based on inherent risk in those loans.
The allowance for credit losses is reviewed at least quarterly by the Board’s Audit/Compliance Committee and by the Board of Directors. Reserves are allocated to loan portfolio categories using percentages which are based on both historical risk elements such as delinquencies and losses and predictive risk elements such as economic, competitive and environmental factors. We have adopted the specific reserve approach to allocate reserves to each impaired credit for the purpose of estimating potential loss exposure. Although the allowance for credit losses is allocated to various portfolio categories, it is general in nature and available for the loan portfolio in its entirety. Changes in the allowance for credit losses may be required based on the results of independent loan portfolio examinations, regulatory agency examinations, or our own internal review process. Additions are also required when, in management’s judgment, the allowance does not properly reflect the portfolio’s probable loss exposure. Management believes that all adjustments, if any, to the allowance for credit losses are supported by the timely and consistent application of methodologies and processes resulting in detailed documentation of the allowance of the allowance calculation and other portfolio trending analysis.
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The allocation of the allowance for credit losses is set forth below (in thousands):
Loan Type | December 31, 2017 | December 31, 2016 | ||||||
Commercial: | ||||||||
Commercial and industrial | $ | 1,784 | $ | 1,884 | ||||
Agricultural land and production | 287 | 296 | ||||||
Real estate: | ||||||||
Owner occupied | 1,252 | 1,408 | ||||||
Real estate construction and other land loans | 1,004 | 698 | ||||||
Commercial real estate | 1,958 | 1,969 | ||||||
Agricultural real estate | 1,441 | 1,969 | ||||||
Other real estate | 140 | 156 | ||||||
Consumer: | ||||||||
Equity loans and lines of credit | 464 | 483 | ||||||
Consumer and installment | 361 | 369 | ||||||
Unallocated reserves | 87 | 94 | ||||||
Total allowance for credit losses | $ | 8,778 | $ | 9,326 | ||||
Loans are charged to the allowance for credit losses when the loans are deemed uncollectible. It is the policy of management to make additions to the allowance so that it remains adequate to cover all probable incurred credit losses that exist in the portfolio at that time. We assign qualitative and environmental factors (Q factors) to each loan category. Q factors include reserves held for the effects of lending policies, economic trends, and portfolio trends along with other dynamics which may cause additional stress to the portfolio.
Managing high-risk credits identified through the risk evaluation methodology includes developing a business strategy with the customer to mitigate our potential losses. Management continues to monitor these credits with a view to identifying as early as possible when, and to what extent, additional provisions may be necessary. Management believes that the level of allowance for loan losses allocated to commercial and real estate loans has been adjusted accordingly.
During the year ended December 31, 2017, the Company recorded a reverse provision for credit losses of $1,150,000 compared to a reverse provision of $5,850,000 and a provision of $600,000 for the same periods in 2016 and 2015, respectively. The reversal from the allowance for credit losses is primarily the result of $602,000 in net loan loss recoveries and our assessment of the overall adequacy of the allowance for credit losses considering a number of factors as discussed in the “Allowance for Credit Losses” section.
During the years ended December 31, 2017, 2016 and 2015 the Company had net recoveries totaling $602,000, $5,566,000, and $702,000, respectively. The net charge-off (recovery) ratio, which reflects net charge-offs (recoveries) to average loans, was (0.08)%, (0.86)% and (0.12)% for 2017, 2016, and 2015, respectively.
Nonperforming loans were $2,875,000 and $2,180,000 at December 31, 2017 and 2016, respectively. Nonperforming loans as a percentage of total loans were 0.32% at December 31, 2017 compared to 0.29% at December 31, 2016. The Company had no other real estate owned at December 31, 2017, December 31, 2016, and December 31, 2015. The carrying value of foreclosed assets was $70,000 at December 31, 2017 and $362,000 at December 31, 2016, and is included in other assets on the consolidated balance sheets. No foreclosed assets were recorded at December 31, 2015. We had $1,281,000 loans past due, not including nonaccrual loans at December 31, 2017 compared to none at December 31, 2016.
Economic pressures may negatively impact the financial condition of borrowers to whom the Company has extended credit and as a result when negative economic conditions are anticipated, we may be required to make significant provisions to the allowance for credit losses. For example, many farmers and ranchers have instituted improved farming practices including planting less acreage, as part of the mitigation for the cost of water delivery and the expense of pumping. However, we continue to closely monitor the water and the related issues affecting our customers. We have been and will continue to be proactive in looking for signs of deterioration within the loan portfolio in an effort to manage credit quality and work with borrowers where possible to mitigate losses. As of December 31, 2017, there were $50.0 million in classified loans of which $26.5 million related to agricultural real estate, $7.9 million to commercial and industrial loans, $2.8 million to real estate owner occupied, $3.9 million to real estate construction, and $3.4 million to commercial real estate. This compares to $49.5 million in classified loans as of December 31, 2016 of which $27.1 million related to agricultural real estate, $1.4 million to real estate construction, $12.5 million to commercial and industrial, $0.3 million to agricultural production, and $2.7 million to commercial real estate.
As of December 31, 2017, we believe, based on all current and available information, the allowance for credit losses is adequate to absorb probable incurred losses within the loan portfolio; however, no assurance can be given that we may not
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sustain charge-offs which are in excess of the allowance in any given period. Refer to “Allowance for Credit Losses” below for further information.
Net Interest Income after Provision for Credit Losses
Net interest income, after the provision for credit losses was $57,389,000 for 2017 compared to $51,430,000 and $40,175,000 for 2016 and 2015, respectively.
Non-Interest Income
Non-interest income is comprised of customer service charges, gains on sales and calls of investment securities, income from appreciation in cash surrender value of bank owned life insurance, loan placement fees, Federal Home Loan Bank dividends, and other income. Non-interest income was $10,836,000 in 2017 compared to $9,591,000 and $9,387,000 in 2016 and 2015, respectively. The $1,245,000 or 12.98% increase in non-interest income in 2017 was due to increases in net realized gains on sales and calls of investment securities, service charge income, interchange fees, and other income compared to 2016, partially offset by a decrease in Federal Home Loan Bank dividends and loan placement fees. The $204,000 or 2.17% increases in non-interest income in 2016 compared to 2015 was due to increases in net realized gains on sales and calls of investment securities, loan placement fees, Federal Home Loan Bank dividends, and interchange fees, partially offset by a decrease in service charge income, gain on other real estate owned, appreciation in cash surrender value of bank owned life insurance, and other income.
Customer service charges increased $204,000 to $3,053,000 in 2017 compared to $2,849,000 in 2016 and $2,970,000 in 2015. The increase in 2017 from 2016 resulted from increase in customer base from the SVB and FLB acquisitions. The decrease in 2016 from 2015 was the result of lower NSF fees and lower analyzed service charge fee income.
During the year ended December 31, 2017, we realized net gains on sales and calls of investment securities of $2,802,000. In 2016, we realized a net gain of $1,920,000 compared to a net gain of $1,495,000 in 2015 from sales and calls of investment securities. In 2016, we recorded an other-than-temporary impairment loss of $136,000 as compared to none during the year ended December 31, 2017, and 2015. The net gains in 2017, 2016, and 2015 were the results of partial restructuring of the investment portfolio designed to improve the future performance of the portfolio. See Note 4 to the audited Consolidated Financial Statements for more detail.
Income from the appreciation in cash surrender value of bank owned life insurance (BOLI) totaled $621,000 in 2017 compared to $558,000 and $596,000 in 2016 and 2015, respectively. The Bank’s salary continuation and deferred compensation plans and the related BOLI are used as a retention tool for directors and key executives of the Bank.
Interchange fees totaled $1,458,000 in 2017 compared to $1,228,000 and $1,197,000 in 2016 and 2015, respectively. Part of the increases in 2017 and 2016 was attributable to the FLB and SVB acquisitions.
We earn loan placement fees from the brokerage of single-family residential mortgage loans provided for the convenience of our customers. Loan placement fees decreased $377,000 in 2017 to $706,000 compared to $1,083,000 in 2016 and $1,042,000 in 2015.
The Bank holds stock from the Federal Home Loan Bank in relationship with its borrowing capacity and generally receives quarterly dividends. As of December 31, 2017, we held $6,843,000 in FHLB stock compared to $5,594,000 at December 31, 2016. Dividends in 2017 decreased to $443,000 compared to $630,000 in 2016 and $580,000 in 2015.
Other income increased to $1,753,000 in 2017 compared to $1,459,000 and $1,507,000 in 2016 and 2015, respectively. The period-to-period increase in 2017 compared to 2016 was a result of recoveries on favorable legal settlements.
Non-Interest Expenses
Salaries and employee benefits, occupancy and equipment, regulatory assessments, acquisition and integration-related expenses, data processing expenses, ATM/Debit card expenses, license and maintenance contract expenses, and professional services (consisting of audit, accounting, consulting and legal fees) are the major categories of non-interest expenses. Non-interest expenses increased $5,484,000 or 14.09% to $44,406,000 in 2017 compared to $38,922,000 in 2016, and $36,016,000 in 2015. The net increase period-over-period is primarily due to the FLB and SVB acquisitions. Various items are discussed below.
Our efficiency ratio, measured as the percentage of non-interest expenses (exclusive of amortization of core deposit intangibles, other real estate owned, and repossessed asset expenses) to net interest income before provision for credit losses plus non-interest income (exclusive of realized gains or losses on sale and calls of investments) was 62.03% for 2017 compared to 64.72% for 2016 and 68.46% for 2015. The improvement in the efficiency ratio in 2017 and 2016 is due to the growth in revenues outpacing the growth in non-interest expense.
Salaries and employee benefits increased $2,857,000 or 13.06% to $24,738,000 in 2017 compared to $21,881,000 in 2016 and $20,836,000 in 2015. Full time equivalents were 334 for the year ended December 31, 2017 compared to 277 for the year ended December 31, 2016. The increase in salaries and employee benefits in 2017 compared to 2016 is a result of higher
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overall salary and benefit expenses; however, direct loan origination costs including salaries and employee benefits, which are capitalized and expensed as an adjustment to interest and fees on loans increased during 2017 compared to 2016. The FLB acquisition attributed to approximately $413,000 of the increase in 2017.
For the years ended December 31, 2017, 2016, and 2015, the compensation cost recognized for share based compensation was $384,000, $284,000 and $238,000, respectively. As of December 31, 2017, there was $696,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under all plans. The cost is expected to be recognized over a weighted average period of 2.90 years. See Notes 1 and 14 to the audited Consolidated Financial Statements for more detail. No options to purchase shares of the Company’s common stock were issued during the years ending December 31, 2016 and 2015. No restricted stock shares were awarded in 2017. Restricted stock awards of 54,650 shares were awarded in 2016.
Occupancy and equipment expense increased $432,000 or 9.09% to $5,186,000 in 2017 compared to $4,754,000 in 2016 and $4,669,000 in 2015. The addition of five new branches from the FLB and SVB acquisitions resulted in an approximately $338,000 increase in rent expense in 2017 as compared to 2016. The Company made no changes in its depreciation expense methodology.
Regulatory assessments were $652,000 in 2017 compared to $642,000 and $1,059,000 in 2016 and 2015, respectively. The assessment base for calculating the amount owed is average assets minus average tangible equity. Beginning in the third quarter of 2016, the FDIC approved a final rule revising DIF assessment formulas which resulted in lower assessments for the Company.
Data processing expenses were $1,740,000 in 2017 compared to $1,707,000 in 2016 and $1,139,000 in 2015. The $33,000 or 1.93% increase in 2017 is from the addition of additional branches from the acquisition. Acquisition and integration expenses related to the FLB and SVB mergers were $1,828,000 in 2017 compared to $1,782,000 in 2016. Professional services increased $251,000 in 2017 compared to 2016.
Amortization of core deposit intangibles was $234,000 for 2017, $149,000 for 2016, and $320,000 for 2015. During 2017, amortization expense related to FLB core deposit intangible (CDI) was $47,000, amortization expense related to SVB core deposit intangible (CDI) was $50,000, and amortization expense related to VCB CDI was $137,000. During 2016, amortization expense related to SVB CDI was $12,000 and amortization expense related to VCB CDI was $137,000. During 2015, amortization expense related to Service 1st Bank CDI was $183,000, and amortization expense related to VCB CDI was $137,000.
ATM/Debit card expenses increased $117,000 to $750,000 for the year ended December 31, 2017 compared to $633,000 in 2016 and $548,000 in 2015. License and maintenance contracts increased $287,000 to $818,000 for the year ended December 31, 2017 compared to $531,000 and $520,000 in 2016 and 2015, respectively. Other non-interest expenses increased $1,210,000 or 31.83% to $5,011,000 in 2017 compared to $3,801,000 in 2016 and $3,665,000 in 2015.
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The following table describes significant components of other non-interest expense as a percentage of average assets.
For the years ended December 31, (Dollars in thousands) | Other Expense 2017 | % Average Assets | Other Expense 2016 | % Average Assets | Other Expense 2015 | % Average Assets | |||||||||||||||
Stationery/supplies | $ | 292 | 0.02 | % | $ | 247 | 0.02 | % | $ | 269 | 0.02 | % | |||||||||
Amortization of software | 289 | 0.02 | % | 257 | 0.02 | % | 240 | 0.02 | % | ||||||||||||
Telephone | 265 | 0.02 | % | 357 | 0.03 | % | 292 | 0.02 | % | ||||||||||||
Alarm | 130 | 0.01 | % | 103 | 0.01 | % | 108 | 0.01 | % | ||||||||||||
Postage | 205 | 0.01 | % | 200 | 0.02 | % | 212 | 0.01 | % | ||||||||||||
Armored courier fees | 266 | 0.02 | % | 227 | 0.02 | % | 218 | 0.01 | % | ||||||||||||
Risk management expense | 207 | 0.01 | % | 150 | 0.01 | % | 163 | 0.01 | % | ||||||||||||
Loss on sale or write-down of assets | 187 | 0.01 | % | 4 | — | % | 6 | — | % | ||||||||||||
Donations | 249 | 0.02 | % | 171 | 0.01 | % | 185 | 0.01 | % | ||||||||||||
Personnel other | 259 | 0.02 | % | 161 | 0.01 | % | 173 | 0.01 | % | ||||||||||||
Credit card expense | 245 | 0.02 | % | 196 | 0.02 | % | 124 | 0.01 | % | ||||||||||||
Education/training | 174 | 0.01 | % | 154 | 0.01 | % | 148 | 0.01 | % | ||||||||||||
Loan related expenses | 132 | 0.01 | % | 35 | — | % | 41 | — | % | ||||||||||||
General insurance | 159 | 0.01 | % | 159 | 0.01 | % | 150 | 0.01 | % | ||||||||||||
Mileage Expense | 138 | 0.01 | % | 88 | 0.01 | % | 114 | 0.01 | % | ||||||||||||
Operating losses | 187 | 0.01 | % | 175 | 0.01 | % | 56 | — | % | ||||||||||||
Other | 1,627 | 0.11 | % | 1,117 | 0.09 | % | 1,166 | 0.08 | % | ||||||||||||
Total other non-interest expense | $ | 5,011 | 0.34 | % | $ | 3,801 | 0.30 | % | $ | 3,665 | 0.25 | % | |||||||||
Provision for Income Taxes
Our effective income tax rate was 41.1% for 2017 compared to 31.3% for 2016 and 19.1% for 2015. The Company reported an income tax provision of $9,793,000, $6,917,000, and $2,582,000 for the years ended December 31, 2017, 2016, and 2015, respectively. As a result of the enactment of the Tax Cuts and Jobs Act (the “Act”) on December 22, 2017, the federal tax rate applied to the Company’s deferred taxes was adjusted to reflect the 2018 tax rates (the rates at which the deferred tax items are expected to reverse). The change to the tax rates (including the rate change applied to deferred taxes reflected in other comprehensive income and certain tax-advantaged investments as reflected in other assets) resulted in an increase to the Company’s tax provision of $3,535,000. As part of the Act for tax years beginning after December 31, 2017, alternative minimum tax credit carryforwards are refundable and are expected to be fully refunded by 2022. As such, they are not dependent on future taxable income to be realized and have been classified as an other receivable. During the year ended December 31, 2017, the Company adopted ASU 2016-09 “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” which due to the exercise of stock options in the current period, resulted in the recognition of $853,000 in excess tax benefits. The effective tax rate in 2016 was affected by the large negative provision for credit losses which resulted in higher pretax and taxable income and also diluted the impact of the Company’s tax exempt municipal bonds and other tax planning strategies.
FINANCIAL CONDITION
Summary of Changes in Consolidated Balance Sheets
Total assets were $1,661,655,000 as of December 31, 2017, compared to $1,443,323,000 as of December 31, 2016, an increase of 15.13% or $218,332,000. Total gross loans were $900,679,000 as of December 31, 2017, compared to $756,628,000 as of December 31, 2016, an increase of $144,051,000 or 19.04%. The total investment portfolio (including Federal funds sold and interest-earning deposits in other banks) increased 8.36% or $46,669,000 to $604,801,000. Total deposits increased 13.51% or $169,708,000 to $1,425,687,000 as of December 31, 2017, compared to $1,255,979,000 as of December 31, 2016. Shareholders’ equity increased $45,526,000 or 27.75% to $209,559,000 as of December 31, 2017, compared to $164,033,000 as of December 31, 2016. The increase in shareholders’ equity was due to the issuance of common stock in connection with the Folsom Lake Bank acquisition, as well as the retention of earnings, net of dividends paid, and an increase in unrealized gains on available-for-sale securities recorded, net of taxes, in accumulated other
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comprehensive income (AOCI). Accrued interest payable and other liabilities were $21,254,000 as of December 31, 2017, compared to $17,756,000 as of December 31, 2016, an increase of $3,498,000.
Fair Value
The Company measures the fair value of its financial instruments utilizing a hierarchical framework associated with the level of observable pricing scenarios utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of the observable pricing scenario. Financial instruments with readily available actively quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of observable pricing and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no observable pricing and a higher degree of judgment utilized in measuring fair value. Observable pricing scenarios are impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.
See Note 3 of the Notes to Consolidated Financial Statements for additional information about the level of pricing transparency associated with financial instruments carried at fair value.
Investments
The following table reflects the balances for each category of securities at year end:
Available-for-Sale Securities | Amortized Cost at December 31, | |||||||||||
(In thousands) | 2017 | 2016 | 2015 | |||||||||
U.S. Government agencies | $ | 65,994 | $ | 69,005 | $ | 52,803 | ||||||
Obligations of states and political subdivisions | 136,955 | 288,543 | 181,785 | |||||||||
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations | 237,210 | 181,785 | 225,636 | |||||||||
Private label mortgage and asset backed securities | 91,033 | 1,807 | 2,356 | |||||||||
Other equity securities | 7,500 | 7,500 | 7,500 | |||||||||
Total Available-for-Sale Securities | $ | 538,692 | $ | 548,640 | $ | 470,080 | ||||||
Held-to-Maturity Securities | ||||||||||||
(In thousands) | 2017 | 2016 | 2015 | |||||||||
Obligations of states and political subdivisions | $ | — | $ | — | $ | 31,712 | ||||||
Our investment portfolio consists primarily of U.S. Government sponsored entities and agencies collateralized by mortgage backed obligations and obligations of states and political subdivision securities and are classified at the date of acquisition as available-for-sale or held-to-maturity. As of December 31, 2017, investment securities with a fair value of $90,541,000, or 16.68% of our investment securities portfolio, were held as collateral for public funds, short and long-term borrowings, treasury, tax, and for other purposes. Our investment policies are established by the Board of Directors and implemented by our Investment/Asset Liability Committee. They are designed primarily to provide and maintain liquidity, to enable us to meet our pledging requirements for public money and borrowing arrangements, to generate a favorable return on investments without incurring undue interest rate and credit risk, and to complement our lending activities.
Our investment portfolio as a percentage of total assets is generally higher than our peers due primarily to our comparatively low loan-to-deposit ratio. Our loan-to-deposit ratio at December 31, 2017 was 63.18% compared to 60.24% at December 31, 2016. The loan to deposit ratio of our peers was 77.65% at December 31, 2017. Peer group information from SNL Financial data includes bank holding companies in central California with assets from $600 million to $3.5 billion. The total investment portfolio, including Federal funds sold and interest-earning deposits in other banks, increased 8.36% or $46,669,000 to $604,801,000 at December 31, 2017, from $558,132,000 at December 31, 2016. The market value of the portfolio reflected an unrealized gain of $4,012,000 at December 31, 2017, compared to an unrealized loss of $891,000 at December 31, 2016.
Losses recognized in 2017, 2016, and 2015 were incurred in order to reposition the investment securities portfolio based on the current rate environment. The securities which were sold at a loss were acquired when the rate environment was not as volatile. The securities which were sold were primarily purchased strategically several years ago in view of the rate environment at that time. The Company is addressing risks in the security portfolio by selling these securities and using proceeds to purchase securities that meet the Company’s current risk profile.
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During 2014, to better manage our interest rate risk, the Company transferred from available-for-sale to held-to-maturity selected municipal securities in our portfolio having a book value of approximately $31 million, a market value of approximately $32 million, and a net unrecognized gain of approximately $163,000. This transfer was completed after careful consideration of our intent and ability to hold these securities to maturity. During the first quarter of 2016, management sold certain investment securities of which management identified that five of the 13 securities sold were previously designated as held-to-maturity (HTM). Through an oversight during the portfolio restructuring analysis related to this transaction, management unintentionally sold these five HTM securities. The book value of the HTM securities sold was $8.5 million. The gain realized on the sale of the HTM securities was $696,000. As such, management was required to reclassify the remaining HTM securities with a fair value of $23.1 million to the AFS designation.
We periodically evaluate each investment security for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. The portion of the impairment that is attributable to a shortage in the present value of expected future cash flows relative to the amortized cost should be recorded as a current period charge to earnings. The discount rate in this analysis is the original yield expected at time of purchase.
As of December 31, 2017, the Company performed an analysis of the investment portfolio to determine whether any of the investments held in the portfolio had an other-than-temporary impairment (OTTI). Management evaluated all investment securities with an unrealized loss at December 31, 2017, and identified those that had an unrealized loss for at least a consecutive 12 month period, which had an unrealized loss at December 31, 2017 greater than 10% of the recorded book value on that date, or which had an unrealized loss of more than $10,000. Management also analyzed any securities that may have been downgraded by credit rating agencies.
For those securities that met the evaluation criteria, management obtained and reviewed the most recently published national credit ratings for those securities. For those securities that were obligations of states and political subdivisions with an investment grade rating by the rating agencies, management also evaluated the financial condition of the municipality and any applicable municipal bond insurance provider and concluded during March 2016 that a $136,000 credit related impairment related to one security with a fair value of $2,995,000 and a pre-impairment amortized cost of $3,131,000 existed. The Company recorded an other-than-temporary impairment loss of $136,000 during the twelve months ended December 31, 2016. There were no OTTI losses recorded during the twelve months ended December 31, 2017.
At December 31, 2017, the Company had a total of 30 private label mortgage backed securities (PLMBS) with a remaining principal balance of $91,033,000 and a net unrealized loss of approximately $352,000. Ten of these PLMBS with a remaining principal balance of $1,359,000 had credit ratings below investment grade. The Company continues to monitor these securities for changes in credit ratings or other indications of credit deterioration. No credit related OTTI charges related to PLMBS were recorded during the year ended December 31, 2017.
The amortized cost, maturities and weighted average yield of investment securities at December 31, 2017 are summarized in the following table.
(Dollars in thousands) | In one year or less | After one through five years | After five through ten years | After ten years | Total | ||||||||||||||||||||||||||||||
Available-for-Sale Securities | Amount | Yield(1) | Amount | Yield(1) | Amount | Yield(1) | Amount | Yield(1) | Amount | Yield(1) | |||||||||||||||||||||||||
Debt securities(1) | |||||||||||||||||||||||||||||||||||
U.S. Government agencies | $ | — | — | $ | — | — | $ | 8,492 | 5.18 | % | $ | 57,502 | 5.05 | % | $ | 65,994 | 5.07 | % | |||||||||||||||||
Obligations of states and political subdivisions (2) | 1,893 | 2.06 | % | 7,149 | 4.71 | % | 22,043 | 4.11 | % | 105,870 | 4.83 | % | 136,955 | 4.67 | % | ||||||||||||||||||||
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations | 7 | 4.65 | % | 887 | 4.80 | % | 421 | 4.99 | % | 235,895 | 3.80 | % | 237,210 | 3.81 | % | ||||||||||||||||||||
Private label residential mortgage backed securities | 5 | 1.00 | % | 79 | 4.75 | % | — | — | 90,949 | 3.68 | % | 91,033 | 3.68 | % | |||||||||||||||||||||
Other equity securities | 7,500 | 2.13 | % | — | — | — | — | — | — | 7,500 | 2.13 | % | |||||||||||||||||||||||
$ | 9,405 | 2.12 | % | $ | 8,115 | 4.72 | % | $ | 30,956 | 4.41 | % | $ | 490,216 | 4.15 | % | $ | 538,692 | 4.16 | % | ||||||||||||||||
(1) | Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties. Expected maturities will also differ from contractual maturities due to unscheduled principal pay downs. |
(2) | Not computed on a tax equivalent basis. |
Loans
Total gross loans increased $144,051,000 or 19.04% to $900,679,000 as of December 31, 2017, compared to $756,628,000 as of December 31, 2016.
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The following table sets forth information concerning the composition of our loan portfolio as of December 31, 2017, 2016, 2015, 2014, and 2013.
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||||||||||||||||||
Loan Type (Dollars in thousands) | Amount | % of Total Loans | Amount | % of Total Loans | Amount | % of Total Loans | Amount | % of Total Loans | Amount | % of Total Loans | |||||||||||||||||||||||||
Commercial: | |||||||||||||||||||||||||||||||||||
Commercial and industrial | $ | 100,856 | 11.2 | % | $ | 88,652 | 11.7 | % | $ | 102,197 | 17.1 | % | $ | 89,007 | 15.5 | % | $ | 87,082 | 17.0 | % | |||||||||||||||
Agricultural land and production | 14,956 | 1.7 | % | 25,509 | 3.4 | % | 30,472 | 5.1 | % | 39,140 | 6.8 | % | 31,649 | 6.1 | % | ||||||||||||||||||||
Total commercial | 115,812 | 12.9 | % | 114,161 | 15.1 | % | 132,669 | 22.2 | % | 128,147 | 22.3 | % | 118,731 | 23.1 | % | ||||||||||||||||||||
Real estate: | |||||||||||||||||||||||||||||||||||
Owner occupied | 204,452 | 22.7 | % | 191,665 | 25.3 | % | 168,910 | 28.2 | % | 176,804 | 30.9 | % | 156,781 | 30.6 | % | ||||||||||||||||||||
Real estate-construction and other land loans | 96,460 | 10.7 | % | 69,200 | 9.1 | % | 38,685 | 6.5 | % | 38,923 | 6.8 | % | 42,329 | 8.3 | % | ||||||||||||||||||||
Commercial real estate | 269,254 | 29.9 | % | 184,225 | 24.3 | % | 117,244 | 19.6 | % | 106,788 | 18.7 | % | 86,117 | 16.8 | % | ||||||||||||||||||||
Agricultural real estate | 76,081 | 8.4 | % | 86,761 | 11.5 | % | 74,867 | 12.5 | % | 57,501 | 10.0 | % | 44,164 | 8.6 | % | ||||||||||||||||||||
Other real estate | 31,220 | 3.5 | % | 18,945 | 2.7 | % | 10,520 | 1.8 | % | 6,611 | 1.2 | % | 4,548 | 0.9 | % | ||||||||||||||||||||
Total real estate | 677,467 | 75.2 | % | 550,796 | 72.9 | % | 410,226 | 68.6 | % | 386,627 | 67.6 | % | 333,939 | 65.2 | % | ||||||||||||||||||||
Consumer: | |||||||||||||||||||||||||||||||||||
Equity loans and lines of credit | 76,404 | 8.5 | % | 64,494 | 8.5 | % | 42,296 | 7.1 | % | 47,575 | 8.3 | % | 48,594 | 9.5 | % | ||||||||||||||||||||
Consumer and installment | 29,637 | 3.4 | % | 25,910 | 3.5 | % | 12,503 | 2.1 | % | 10,093 | 1.8 | % | 11,252 | 2.2 | % | ||||||||||||||||||||
Total consumer | 106,041 | 11.9 | % | 90,404 | 12.0 | % | 54,799 | 9.2 | % | 57,668 | 10.1 | % | 59,846 | 11.7 | % | ||||||||||||||||||||
Deferred loan fees, net | 1,359 | 1,267 | 417 | 146 | (159 | ) | |||||||||||||||||||||||||||||
Total gross loans (1) | 900,679 | 100.0 | % | 756,628 | 100.0 | % | 598,111 | 100.0 | % | 572,588 | 100.0 | % | 512,357 | 100.0 | % | ||||||||||||||||||||
Allowance for credit losses | (8,778 | ) | (9,326 | ) | (9,610 | ) | (8,308 | ) | (9,208 | ) | |||||||||||||||||||||||||
Total loans (1) | $ | 891,901 | $ | 747,302 | $ | 588,501 | $ | 564,280 | $ | 503,149 | |||||||||||||||||||||||||
(1) Includes nonaccrual loans of: | $ | 2,875 | $ | 2,180 | $ | 2,413 | $ | 14,052 | $ | 7,586 | |||||||||||||||||||||||||
The FLB acquisition added approximately $117,815,000 in net loans on the acquisition date, of which $114,275,000 in net loans remained as of December 31, 2017 due to payoffs and pay down of principal in the normal course of operations. At December 31, 2017, loans acquired in the FLB, SVB and VCB acquisitions had a balance of $243,712,000, of which $12,554,000 were commercial loans, $197,004,000 were real estate loans, and $34,154,000 were consumer loans. At December 31, 2016, loans acquired in the SVB and VCB acquisition had a balance of $168,296,000, of which $7,239,000 were commercial loans, $129,520,000 were real estate loans, and $31,537,000 were consumer loans.
At December 31, 2017, in management’s judgment, a concentration of loans existed in commercial loans and real-estate-related loans, representing approximately 96.6% of total loans of which 12.9% were commercial and 83.7% were real-estate-related. This level of concentration is consistent with 96.5% at December 31, 2016. Although we believe the loans within this concentration have no more than the normal risk of collectability, a substantial decline in the performance of the economy in general or a decline in real estate values in our primary market areas, in particular, could have an adverse impact on collectability, increase the level of real estate-related nonperforming loans, or have other adverse effects which alone or in the aggregate could have a material adverse effect on our business, financial condition, results of operations and cash flows. The Company was not involved in any sub-prime mortgage lending activities at December 31, 2017 and 2016.
We believe that our commercial real estate loan underwriting policies and practices result in prudent extensions of credit, but recognize that our lending activities result in relatively high reported commercial real estate lending levels. Commercial real estate loans include certain loans which represent low to moderate risk and certain loans with higher risks.
The Board of Directors review and approve concentration limits and exceptions to limitations of concentration are reported to the Board of Directors at least quarterly.
Loan Maturities
The following table presents information concerning loan maturities and sensitivity to changes in interest rates of the indicated categories of our loan portfolio, as well as loans in those categories maturing after one year that have fixed or floating interest rates at December 31, 2017.
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(In thousands) (net of deferred costs) | One Year or Less | After One Through Five Years | After Five Years | Total | ||||||||||||
Loan Maturities: | ||||||||||||||||
Commercial and agricultural | $ | 62,919 | $ | 23,060 | $ | 29,833 | $ | 115,812 | ||||||||
Real estate construction and other land loans | 87,124 | 5,347 | 3,989 | 96,460 | ||||||||||||
Other real estate | 45,190 | 86,795 | 449,022 | 581,007 | ||||||||||||
Consumer and installment | 9,822 | 12,023 | 84,196 | 106,041 | ||||||||||||
$ | 205,055 | $ | 127,225 | $ | 567,040 | $ | 899,320 | |||||||||
Sensitivity to Changes in Interest Rates: | ||||||||||||||||
Loans with fixed interest rates | $ | 79,586 | $ | 79,802 | $ | 105,032 | $ | 264,420 | ||||||||
Loans with floating interest rates (1) | 125,469 | 47,423 | 462,008 | 634,900 | ||||||||||||
$ | 205,055 | $ | 127,225 | $ | 567,040 | $ | 899,320 | |||||||||
(1) Includes floating rate loans which are currently at their floor rate in accordance with their respective loan agreement | $ | 9,838 | $ | 13,768 | $ | 276,408 | $ | 300,014 | ||||||||
Nonperforming Assets
Nonperforming assets consist of nonperforming loans, other real estate owned (OREO), and repossessed assets. Nonperforming loans are those loans which have (i) been placed on nonaccrual status; (ii) been classified as doubtful under our asset classification system; or (iii) become contractually past due 90 days or more with respect to principal or interest and have not been restructured or otherwise placed on nonaccrual status. A loan is classified as nonaccrual when 1) it is maintained on a cash basis because of deterioration in the financial condition of the borrower; 2) payment in full of principal or interest under the original contractual terms is not expected; or 3) principal or interest has been in default for a period of 90 days or more unless the loan is both well secured and in the process of collection. We measure all loans placed on nonaccrual status for impairment based on the fair value of the underlying collateral or the net present value of the expected cash flows.
Our consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans. Interest income from nonaccrual loans is recorded only if collection of principal in full is not in doubt and when cash payments, if any, are received.
Loans are placed on nonaccrual status and any accrued but unpaid interest income is reversed and charged against income when the payment of interest or principal is 90 days or more past due. Loans in the nonaccrual category are treated as nonaccrual loans even though we may ultimately recover all or a portion of the interest due. These loans return to accrual status when the loan becomes contractually current, future collectability of amounts due is reasonably assured, and a minimum of six months of satisfactory principal repayment performance has occurred. See Note 5 of the Company’s audited Consolidated Financial Statements in Item 8 of this Annual Report.
At December 31, 2017, total nonperforming assets totaled $2,945,000, or 0.18% of total assets, compared to $2,542,000, or 0.18% of total assets at December 31, 2016. Total nonperforming assets at December 31, 2017, included nonaccrual loans totaling $2,875,000, no OREO, and $70,000 in repossessed assets. Nonperforming assets at December 31, 2016 consisted of $2,180,000 in nonaccrual loans, no OREO, and $362,000 in repossessed assets. At December 31, 2017, we had one loan considered a troubled debt restructuring (“TDR”) totaling $59,000 which is included in nonaccrual loans compared to one TDR totaling $20,000 at December 31, 2016. We have no outstanding commitments to lend additional funds to any of these borrowers. See Note 5 of the Company’s audited Consolidated Financial Statements in Item 8 of this Annual Report concerning our recorded investment in loans for which impairment has been recognized.
A summary of nonaccrual, restructured, and past due loans at December 31, 2017, 2016, 2015, 2014, and 2013 is set forth below. The Company had no loans past due more than 90 days and still accruing interest at December 31, 2017 and 2016. Management is not aware of any potential problem loans, which were current and accruing at December 31, 2017, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms. Management can give no assurance that nonaccrual and other nonperforming loans will not increase in the future.
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Composition of Nonaccrual, Past Due and Restructured Loans
(As of December 31, Dollars in thousands) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Nonaccrual Loans: | ||||||||||||||||||||
Commercial and industrial | $ | 356 | $ | 447 | $ | — | $ | 7,265 | $ | 335 | ||||||||||
Owner occupied real estate | — | 87 | 324 | 1,363 | 1,777 | |||||||||||||||
Real estate construction and other land loans | 1,397 | — | — | — | — | |||||||||||||||
Agricultural real estate | — | — | — | 360 | — | |||||||||||||||
Commercial real estate | 976 | 1,082 | 567 | 1,468 | 158 | |||||||||||||||
Equity loans and line of credit | 87 | 526 | 172 | 1,751 | 721 | |||||||||||||||
Consumer and installment | — | 18 | 13 | 19 | — | |||||||||||||||
Restructured loans (non-accruing): | ||||||||||||||||||||
Commercial and industrial | — | — | 29 | — | 1,192 | |||||||||||||||
Owner occupied | — | 20 | 23 | — | 384 | |||||||||||||||
Real estate construction and other land loans | — | — | — | 547 | 1,450 | |||||||||||||||
Equity loans and line of credit | 59 | — | 1,285 | 1,279 | 1,565 | |||||||||||||||
Consumer and Installment | — | — | — | — | 4 | |||||||||||||||
Total nonaccrual | 2,875 | 2,180 | 2,413 | 14,052 | 7,586 | |||||||||||||||
Accruing loans past due 90 days or more | — | — | — | — | — | |||||||||||||||
Total nonperforming loans | $ | 2,875 | $ | 2,180 | $ | 2,413 | $ | 14,052 | $ | 7,586 | ||||||||||
Interest foregone | $ | 210 | $ | 245 | $ | 340 | $ | 716 | $ | 661 | ||||||||||
Nonperforming loans to total loans | 0.32 | % | 0.29 | % | 0.40 | % | 2.45 | % | 1.48 | % | ||||||||||
Accruing loans past due 90 days or more | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Accruing troubled debt restructurings | $ | 3,491 | $ | 3,089 | $ | 4,286 | $ | 4,774 | $ | 5,771 | ||||||||||
Ratio of nonperforming loans to allowance for credit losses | 32.75 | % | 23.38 | % | 25.11 | % | 169.14 | % | 82.38 | % | ||||||||||
Loans considered to be impaired | $ | 6,366 | $ | 5,269 | $ | 6,699 | $ | 18,826 | $ | 13,357 | ||||||||||
Related allowance for credit losses on impaired loans | $ | 36 | $ | 307 | $ | 164 | $ | 612 | $ | 1,007 | ||||||||||
As of December 31, 2017 and 2016, we had impaired loans totaling $6,366,000 and $5,269,000, respectively. We measure our impaired loans by using the fair value of the collateral if the loan is collateral dependent and the present value of the expected future cash flows discounted at the loan’s original contractual interest rate if the loan is not collateral dependent. Impaired loans are identified from internal credit review reports, past due reports, overdraft listings, and third party reports of examination. Borrowers experiencing problems such as operating losses, marginal working capital, inadequate cash flow or business interruptions which jeopardize collection of the loan are also reviewed for possible impairment classification. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans determined to be impaired are individually evaluated for impairment. When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For collateral dependent loans secured by real estate, we obtain external appraisals which are updated at least annually to determine the fair
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value of the collateral, and we record an immediate charge off for the difference between the book value of the loan and the appraised value less selling costs of the collateral. We perform quarterly internal reviews on substandard loans.
We place loans on nonaccrual status and classify them as impaired when it becomes probable that we will not receive interest and principal under the original contractual terms, or when loans are delinquent 90 days or more, unless the loan is both well secured and in the process of collection. Management maintains certain loans that have been brought current by the borrower (less than 30 days delinquent) on nonaccrual status until such time as management has determined that the loans are likely to remain current in future periods. Foregone interest on nonaccrual loans totaled $210,000 for the year ended December 31, 2017 of which $17,000 was attributable to troubled debt restructurings. Foregone interest on nonaccrual loans totaled $245,000 and $340,000 for the years ended December 31, 2016 and 2015, respectively of which $2,000 and $104,000 was attributable to troubled debt restructurings, respectively.
The following table provides a reconciliation of the change in non-accrual loans for the year ended December 31, 2017.
(In thousands) | Balances December 31, 2016 | Additions to Nonaccrual Loans | Net Pay Downs | Transfer to Foreclosed Collateral | Returns to Accrual Status | Charge Offs | Balances December 31, 2017 | |||||||||||||||||||||
Non-accrual loans: | ||||||||||||||||||||||||||||
Commercial and industrial | $ | 447 | $ | 17 | $ | (98 | ) | $ | — | $ | — | $ | (10 | ) | $ | 356 | ||||||||||||
Real estate | 1,169 | — | (193 | ) | — | — | — | 976 | ||||||||||||||||||||
Real estate construction and land development | — | 1,494 | (97 | ) | — | — | — | 1,397 | ||||||||||||||||||||
Equity loans and lines of credit | 526 | 50 | (102 | ) | — | (240 | ) | (147 | ) | 87 | ||||||||||||||||||
Consumer | 18 | — | (13 | ) | — | — | (5 | ) | — | |||||||||||||||||||
Restructured loans (non-accruing): | ||||||||||||||||||||||||||||
Real estate | 20 | — | (1 | ) | — | — | (19 | ) | — | |||||||||||||||||||
Equity loans and lines of credit | — | 65 | (6 | ) | — | — | — | 59 | ||||||||||||||||||||
Total non-accrual | $ | 2,180 | $ | 1,626 | $ | (510 | ) | $ | — | $ | (240 | ) | $ | (181 | ) | $ | 2,875 | |||||||||||
OREO represents real property taken either through foreclosure or through a deed in lieu thereof from the borrower. OREO is carried at the lesser of cost or fair market value less selling costs. As of December 31, 2017 and December 31, 2016, the Bank had no OREO properties. The carrying value of foreclosed assets was $70,000 at December 31, 2017 and $362,000 at December 31, 2016, and is included in other assets on the consolidated balance sheets.
As of December 31, 2015 the Bank had no OREO properties. In 2015, the Bank foreclosed on one property collateralized by real estate. Proceeds from OREO sales totaled $359,000 during 2015. The Company realized $11,000 in net gains from the sale of all properties.
Allowance for Credit Losses
We have established a methodology for determining the adequacy of the allowance for credit losses made up of general and specific allocations. The methodology is set forth in a formal policy and takes into consideration the need for an overall allowance for credit losses as well as specific allowances that are tied to individual loans. The allowance for credit losses is an estimate of probable incurred credit losses in the Company’s loan portfolio. The allowance consists of two primary components, specific reserves related to impaired loans and general reserves for probable incurred losses related to loans that are not impaired.
For all portfolio segments, the determination of the general reserve for loans that are not impaired is based on estimates made by management including, but not limited to, consideration of historical losses by portfolio segment (and in certain cases peer loss data) over the most recent 20 quarters, and qualitative factors including economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan portfolio, and probable losses incurred in the portfolio taken as a whole. Management has determined that the most recent 20 quarters was an appropriate look-back period based on several factors including the current global economic uncertainty and various national and local economic indicators, and a time period sufficient to capture enough data due to the size of the portfolio to produce statistically accurate historical loss calculations. We believe this period is an appropriate look-back period.
In originating loans, we recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral securing the loan. The allowance is increased by
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provisions charged against earnings and recoveries, and reduced by net loan charge offs. Loans are charged off when they are deemed to be uncollectible, or partially charged off when portions of a loan are deemed to be uncollectible. Recoveries are generally recorded only when cash payments are received.
The allowance for credit losses is maintained to cover probable incurred credit losses in the loan portfolio. The responsibility for the review of our assets and the determination of the adequacy lies with management and our Audit/Compliance Committee. They delegate the authority to the Senior Risk Manager and the Chief Credit Officer (CCO) to determine the loss reserve ratio for each type of asset and to review, at least quarterly, the adequacy of the allowance based on an evaluation of the portfolio, past experience, prevailing market conditions, amount of government guarantees, concentration in loan types and other relevant factors.
The allowance for credit losses is an estimate of the probable incurred credit losses in our loan and lease portfolio. The allowance is based on principles of accounting: (1) losses accrued for on loans when they are probable of occurring and can be reasonably estimated and (2) losses accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
Management adheres to an internal asset review system and loss allowance methodology designed to provide for timely recognition of problem assets and adequate valuation allowances to cover probable incurred losses. The Bank’s asset monitoring process includes the use of asset classifications to segregate the assets, largely loans and real estate, into various risk categories. The Bank uses the various asset classifications as a means of measuring risk and determining the adequacy of valuation allowances by using a nine-grade system to classify assets. In general, all credit facilities exceeding 90 days of delinquency require classification and are placed on nonaccrual.
The following table summarizes the Company’s loan loss experience, as well as provisions and recoveries (charge-offs) to the allowance and certain pertinent ratios for the periods indicated:
(Dollars in thousands) | 2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
Loans outstanding at December 31, | $ | 899,320 | $ | 755,361 | $ | 597,694 | $ | 572,442 | $ | 512,516 | ||||||||||
Average loans outstanding during the year | $ | 793,343 | $ | 646,573 | $ | 586,762 | $ | 539,529 | $ | 454,483 | ||||||||||
Allowance for credit losses: | ||||||||||||||||||||
Balance at beginning of year | $ | 9,326 | $ | 9,610 | $ | 8,308 | $ | 9,208 | $ | 10,133 | ||||||||||
Deduct loans charged off: | ||||||||||||||||||||
Commercial and industrial | (197 | ) | (621 | ) | (802 | ) | (7,423 | ) | (713 | ) | ||||||||||
Agricultural production | (10 | ) | — | — | (1,722 | ) | — | |||||||||||||
Owner occupied | (22 | ) | — | — | (183 | ) | (281 | ) | ||||||||||||
Commercial real estate | — | — | — | — | (4 | ) | ||||||||||||||
Consumer loans | (235 | ) | (262 | ) | (159 | ) | (506 | ) | (448 | ) | ||||||||||
Total loans charged off | (464 | ) | (883 | ) | (961 | ) | (9,834 | ) | (1,446 | ) | ||||||||||
Add recoveries of loans previously charged off: | ||||||||||||||||||||
Commercial and industrial | 850 | 3,656 | 954 | 171 | 315 | |||||||||||||||
Agricultural production | 10 | 1,631 | 90 | — | — | |||||||||||||||
Owner occupied | 49 | — | — | 150 | — | |||||||||||||||
Real estate construction and other land loans | — | 702 | 32 | 364 | 16 | |||||||||||||||
Commercial real estate | 17 | 283 | — | — | — | |||||||||||||||
Consumer loans | 140 | 177 | 587 | 264 | 190 | |||||||||||||||
Total recoveries | 1,066 | 6,449 | 1,663 | 949 | 521 | |||||||||||||||
Net recoveries (charge offs) | 602 | 5,566 | 702 | (8,885 | ) | (925 | ) | |||||||||||||
(Reversal) Provision charged to credit losses | (1,150 | ) | (5,850 | ) | 600 | 7,985 | — | |||||||||||||
Balance at end of year | $ | 8,778 | $ | 9,326 | $ | 9,610 | $ | 8,308 | $ | 9,208 | ||||||||||
Allowance for credit losses as a percentage of outstanding loan balance | 0.98 | % | 1.23 | % | 1.61 | % | 1.45 | % | 1.80 | % | ||||||||||
Net recoveries (charge offs) to average loans outstanding | 0.08 | % | 0.86 | % | 0.12 | % | (1.65 | )% | (0.20 | )% | ||||||||||
Managing credits identified through the risk evaluation methodology includes developing a business strategy with the customer to mitigate our losses. Our management continues to monitor these credits with a view to identifying as early as possible when, and to what extent, additional provisions may be necessary.
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The allowance for credit losses is reviewed at least quarterly by the Bank’s and our Board of Directors’ Audit/Compliance Committee. Reserves are allocated to loan portfolio segments using percentages which are based on both historical risk elements such as delinquencies and losses and predictive risk elements such as economic, competitive and environmental factors. We have adopted the specific reserve approach to allocate reserves to each impaired asset for the purpose of estimating potential loss exposure. Although the allowance for credit losses is allocated to various portfolio categories, it is general in nature and available for the loan portfolio in its entirety. Additions may be required based on the results of independent loan portfolio examinations, regulatory agency examinations, or our own internal review process. Additions are also required when, in management’s judgment, the reserve does not properly reflect the potential loss exposure.
The allocation of the allowance for credit losses is set forth below:
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||||||||||||||||||
Loan Type (Dollars in thousands) | Amount | Percent of Loans in Each Category to Total Loans | Amount | Percent of Loans in Each Category to Total Loans | Amount | Percent of Loans in Each Category to Total Loans | Amount | Percent of Loans in Each Category to Total Loans | Amount | Percent of Loans in Each Category to Total Loans | |||||||||||||||||||||||||
Commercial: | |||||||||||||||||||||||||||||||||||
Commercial and industrial | $ | 1,784 | 11.2 | % | $ | 1,884 | 11.7 | % | $ | 3,143 | 17.1 | % | $ | 2,753 | 15.5 | % | $ | 1,928 | 17.0 | % | |||||||||||||||
Agricultural land and production | 287 | 1.7 | % | 296 | 3.4 | % | 419 | 5.1 | % | 377 | 6.8 | % | 516 | 6.1 | % | ||||||||||||||||||||
Real estate: | |||||||||||||||||||||||||||||||||||
Owner occupied | 1,252 | 22.7 | % | 1,408 | 25.3 | % | 1,556 | 28.2 | % | 1,380 | 30.9 | % | 1,697 | 30.6 | % | ||||||||||||||||||||
Real estate construction and other land loans | 1,004 | 10.7 | % | 698 | 9.1 | % | 694 | 6.5 | % | 837 | 6.8 | % | 1,289 | 8.3 | % | ||||||||||||||||||||
Commercial real estate | 1,958 | 29.9 | % | 1,969 | 24.3 | % | 1,686 | 19.6 | % | 1,201 | 18.7 | % | 1,406 | 16.8 | % | ||||||||||||||||||||
Agricultural real estate | 1,441 | 8.4 | % | 1,969 | 11.5 | % | 1,149 | 12.5 | % | 564 | 10.0 | % | 672 | 8.6 | % | ||||||||||||||||||||
Other real estate | 140 | 3.5 | % | 156 | 2.7 | % | 119 | 1.8 | % | 76 | 1.2 | % | 110 | 0.9 | % | ||||||||||||||||||||
Consumer: | |||||||||||||||||||||||||||||||||||
Equity loans and lines of credit | 464 | 8.5 | % | 483 | 8.5 | % | 500 | 7.1 | % | 811 | 8.3 | % | 874 | 9.5 | % | ||||||||||||||||||||
Consumer and installment | 361 | 3.4 | % | 369 | 3.5 | % | 234 | 2.1 | % | 267 | 1.8 | % | 294 | 2.2 | % | ||||||||||||||||||||
Unallocated reserves | 87 | 94 | 110 | 42 | 422 | ||||||||||||||||||||||||||||||
Total allowance for credit losses | $ | 8,778 | 100 | % | $ | 9,326 | 100 | % | $ | 9,610 | 100 | % | $ | 8,308 | 100 | % | $ | 9,208 | 100 | % | |||||||||||||||
Loans are charged to the allowance for credit losses when the loans are deemed uncollectible. It is the policy of management to make additions to the allowance so that it remains adequate to cover all probable loan charge offs that exist in the portfolio at that time. We assign qualitative and environmental factors (Q factors) to each loan category. Q factors include reserves held for the effects of lending policies, economic trends, and portfolio trends along with other dynamics which may cause additional stress to the portfolio.
As of December 31, 2017, the allowance for credit losses (ALLL) stood at $8,778,000, compared to $9,326,000 at December 31, 2016, a net decrease of $548,000. The decrease in the ALLL was due to net recoveries and a reverse provision for credit losses during the year ended December 31, 2017 which was necessitated by management’s observations and assumptions about the existing credit quality of the loan portfolio. Net recoveries totaled $602,000 while the reversal of provision for credit losses was $1,150,000. The balance of classified loans and loans graded special mention, totaled $49,998,000 and $21,908,000 at December 31, 2017 and $49,464,000 and $29,911,000 at December 31, 2016. This increase in classified loans necessitated additional allocation within the ALLL; however it was offset by improvements in qualitative factors (moderating drought conditions), as well as relative improvements in loss trends, past dues, and other credit variables, causing the allowance level to decrease. The balance of undisbursed commitments to extend credit on construction and other loans and letters of credit was $350,141,000 as of December 31, 2017, compared to $259,415,000 as of December 31, 2016. At December 31, 2017 and 2016, the balance of a contingent allocation for probable loan loss experience on unfunded obligations was $326,000 and $125,000, respectively. The contingent allocation for probable loan loss experience on unfunded obligations is calculated by management using an appropriate, systematic, and consistently applied process. While related to credit losses, this allocation is not a part of ALLL and is considered separately as a liability for accounting and regulatory reporting purposes. Risks and uncertainties exist in all lending transactions and our management and Directors’ Loan Committee have established reserve levels based on economic uncertainties and other risks that exist as of each reporting period.
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The ALLL as a percentage of total loans was 0.97% at December 31, 2017, and 1.23% at December 31, 2016. Total loans include FLB, SVB and VCB loans that were recorded at fair value in connection with the acquisitions of $243,712,000 at December 31, 2017 and $168,296,000 at December 31, 2016. Excluding these acquired loans from the calculation, the ALLL to total gross loans was 1.34% and 1.59% as of December 31, 2017 and 2016, respectively, and general reserves associated with non-impaired loans to total non-impaired loans was 1.34% and 1.55%, respectively. The loan portfolio acquired in the mergers was booked at fair value with no associated allocation in the ALLL. The size of the fair value discount remains adequate for all non-impaired acquired loans; therefore, there is no associated allocation in the ALLL.
The Company’s loan portfolio balances in 2017 increased through organic growth and the acquisition of FLB. Management believes that the change in the allowance for credit losses to total loans ratios is directionally consistent with the composition of loans and the level of nonperforming and classified loans, partially offset by the general economic conditions experienced in the central California communities serviced by the Company and recent improvements in real estate collateral values.
The determination of the general reserve for loans that are not impaired is based on estimates made by management including, but not limited to, consideration of historical losses (or peer data) by portfolio segment over the most recent 20 quarters, and qualitative factors. Assumptions regarding the collateral value of various under-performing loans may affect the level and allocation of the allowance for credit losses in future periods. The allowance may also be affected by trends in the amount of charge offs experienced or expected trends within different loan portfolios. However, the total reserve rates on non-impaired loans include qualitative factors which are systematically derived and consistently applied to reflect conservatively estimated losses from loss contingencies at the date of the financial statements. Based on the above considerations and given recent changes in historical charge-off rates included in the ALLL modeling and the changes in other factors, management determined that the ALLL was appropriate as of December 31, 2017.
Non-performing loans totaled $2,875,000 as of December 31, 2017, and $2,180,000 as of December 31, 2016. The allowance for credit losses as a percentage of nonperforming loans was 305.32% and 427.80% as of December 31, 2017 and December 31, 2016, respectively. In addition, management believes that the likelihood of recoveries on previously charged-off loans continues to improve based on the collection efforts of management combined with improvements in the value of real estate which serves as the primary source of collateral for loans. Management believes the allowance at December 31, 2017 is adequate based upon its ongoing analysis of the loan portfolio, historical loss trends and other factors. However, no assurance can be given that the Company may not sustain charge-offs which are in excess of the allowance in any given period.
Goodwill and Intangible Assets
Business combinations involving the Bank’s acquisition of the equity interests or net assets of another enterprise give rise to goodwill. Total goodwill at December 31, 2017 was $53,777,000 consisting of $13,466,000, $10,394,000, $6,340,000, $14,643,000 and $8,934,000 representing the excess of the cost of Folsom Lake Bank, Sierra Vista Bank, Visalia Community Bank, Service 1st Bancorp, and Bank of Madera County, respectively, over the net amounts assigned to assets acquired and liabilities assumed in the transactions accounted for under the purchase method of accounting. The value of goodwill is ultimately derived from the Bank’s ability to generate net earnings after the acquisitions and is not deductible for tax purposes. A significant decline in net earnings could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill is assessed at least annually for impairment.
The Company has selected September 30 as the date to perform the annual impairment test. Management assessed qualitative factors including performance trends and noted no factors indicating goodwill impairment.
Goodwill is also tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the Company below its carrying amount. No such events or circumstances arose during the fourth quarter of 2017; therefore, goodwill was not required to be retested.
The intangible assets at December 31, 2017 represent the estimated fair value of the core deposit relationships acquired in the 2017 acquisition of Folsom Lake Bank of $1,879,000, the 2016 acquisition of Sierra Vista Bank of $508,000 and the 2013 acquisition of Visalia Community Bank of $1,365,000. Core deposit intangibles are being amortized using the straight-line method over an estimated life of ten years from the date of acquisition. The carrying value of intangible assets at December 31, 2017 was $3,027,000, net of $725,000 in accumulated amortization expense. The carrying value at December 31, 2016 was $1,383,000, net of $490,000 in accumulated amortization expense. Management evaluates the remaining useful lives quarterly to determine whether events or circumstances warrant a revision to the remaining periods of amortization. Based on the evaluation, no changes to the remaining useful lives was required. Management performed an annual impairment test on core deposit intangibles as of September 30, 2017 and determined no impairment was necessary. In addition, management determined that no events had occurred between the annual evaluation date and December 31, 2017 which would necessitate further analysis. Amortization expense recognized was $234,000 for 2017, $149,000 for 2016 and $320,000 for 2015.
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The following table summarizes the Company’s estimated core deposit intangible amortization expense for each of the next five years (in thousands):
Years Ending December 31, | Estimated Core Deposit Intangible Amortization | |||
2018 | $ | 376 | ||
2019 | 376 | |||
2020 | 376 | |||
2021 | 376 | |||
2022 | 376 | |||
Thereafter | 1,147 | |||
Total | $ | 3,027 | ||
Deposits and Borrowings
The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. All of a depositor’s accounts at an insured depository institution, including all non-interest bearing transactions accounts, will be insured by the FDIC up to the standard maximum deposit insurance amount of $250,000 for each deposit insurance ownership category.
Total deposits increased $169,708,000 or 13.51% to $1,425,687,000 as of December 31, 2017, compared to $1,255,979,000 as of December 31, 2016. Interest-bearing deposits increased $80,484,000 or 10.59% to $840,648,000 as of December 31, 2017, compared to $760,164,000 as of December 31, 2016. Non-interest bearing deposits increased $89,224,000 or 18.00% to $585,039,000 as of December 31, 2017, compared to $495,815,000 as of December 31, 2016. In conjunction with the acquisition of Folsom Lake Bank the Company acquired total interest bearing deposits of $101,029,000, consisting of $5,432,000, $73,477,000, $19,288,000 and $2,832,000 in NOW, MMA, Time and Savings deposits, respectively, and $70,919,000 in non-interest bearing deposits. Average non-interest bearing deposits to average total deposits was 38.93% for the year ended December 31, 2017 compared to 36.46% for the same period in 2016. Our total market share of deposits in Fresno, Madera, San Joaquin, and Tulare counties was 3.69% in 2017 compared to 3.76% in 2016 based on FDIC deposit market share information published as of June 2017.
The composition of the deposits and average interest rates paid at December 31, 2017 and December 31, 2016 is summarized in the table below.
(Dollars in thousands) | December 31, 2017 | % of Total Deposits | Effective Rate | December 31, 2016 | % of Total Deposits | Effective Rate | ||||||||||||||
NOW accounts | $ | 296,406 | 20.8 | % | 0.12 | % | $ | 247,623 | 19.7 | % | 0.12 | % | ||||||||
MMA accounts | 299,638 | 21.0 | % | 0.08 | % | 250,749 | 19.9 | % | 0.05 | % | ||||||||||
Time deposits | 128,070 | 9.0 | % | 0.30 | % | 156,694 | 12.5 | % | 0.38 | % | ||||||||||
Savings deposits | 116,534 | 8.2 | % | 0.03 | % | 105,098 | 8.4 | % | 0.03 | % | ||||||||||
Total interest-bearing | 840,648 | 59.0 | % | 0.12 | % | 760,164 | 60.5 | % | 0.13 | % | ||||||||||
Non-interest bearing | 585,039 | 41.0 | % | 495,815 | 39.5 | % | ||||||||||||||
Total deposits | $ | 1,425,687 | 100.0 | % | $ | 1,255,979 | 100.0 | % | ||||||||||||
We have no known foreign deposits. The following table sets forth the average amount of and the average rate paid on certain deposit categories which were in excess of 10% of average total deposits for the years ended December 31, 2017, 2016, and 2015.
2017 | 2016 | 2015 | |||||||||||||||||||
(Dollars in thousands) | Balance | Rate | Balance | Rate | Balance | Rate | |||||||||||||||
NOW accounts | $ | 271,456 | 0.12 | % | $ | 246,770 | 0.12 | % | $ | 222,839 | 0.10 | % | |||||||||
Money market accounts | $ | 264,581 | 0.08 | % | $ | 249,620 | 0.05 | % | $ | 227,743 | 0.06 | % | |||||||||
Time certificates of deposit | $ | 137,666 | 0.30 | % | $ | 139,656 | 0.38 | % | $ | 149,383 | 0.37 | % | |||||||||
Non-interest bearing demand | $ | 499,987 | — | $ | 417,151 | — | $ | 387,931 | — | ||||||||||||
Total deposits | $ | 1,284,305 | 0.08 | % | $ | 1,144,231 | 0.09 | % | $ | 1,065,798 | 0.09 | % | |||||||||
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The following table sets forth the maturity of time certificates of deposit and other time deposits of $100,000 or more at December 31, 2017.
(In thousands) | |||
Three months or less | $ | 30,844 | |
Over 3 through 6 months | 19,024 | ||
Over 6 through 12 months | 24,593 | ||
Over 12 months | 12,699 | ||
$ | 87,160 | ||
There were no short-term or long-term FHLB borrowings as of December 31, 2017 or December 31, 2016. We maintain a line of credit with the FHLB collateralized by government securities and loans. Refer to Liquidity section below for further discussion of FHLB advances. The Bank had unsecured lines of credit with its correspondent banks which, in the aggregate, amounted to $40,000,000 at December 31, 2017 and 2016, at interest rates which vary with market conditions. As of December 31, 2017, the Company had no overnight borrowings outstanding under these credit facilities. The Company had $400,000 in Federal funds purchased at December 31, 2016.
Capital Resources
Capital serves as a source of funds and helps protect depositors and shareholders against potential losses. Historically, the primary sources of capital for the Company have been internally generated capital through retained earnings and the issuance of common and preferred stock.
The Company has historically maintained substantial levels of capital. The assessment of capital adequacy is dependent on several factors including asset quality, earnings trends, liquidity and economic conditions. Maintenance of adequate capital levels is integral to providing stability to the Company. The Company needs to maintain substantial levels of regulatory capital to give it maximum flexibility in the changing regulatory environment and to respond to changes in the market and economic conditions.
Our shareholders’ equity was $209,559,000 as of December 31, 2017, compared to $164,033,000 as of December 31, 2016. The increase in shareholders’ equity is the result of an increase in retained earnings from our net income of $14,026,000, the issuance of stock in connection with the Folsom Lake Bank acquisition in the amount of $28,405,000, the exercise of stock options, including the related tax benefit of $2,835,000, the effect of share-based compensation expense of $384,000, and an increase in accumulated other comprehensive income (AOCI) of $3,342,000 partially offset by common stock cash dividends of $3,010,000.
During 2017, the Bank declared and paid cash dividends to the Company in the amount of $3,133,000 in connection with the cash dividends to the Company’s shareholders approved by the Company’s Board of Directors. The Company declared and paid a total of $3,010,000 or $0.24 per common share cash dividend to shareholders of record during the year ended December 31, 2017.
During 2016, the Bank declared and paid cash dividends to the Company in the amount of $13,010,000 in connection with the cash dividends to the Company’s shareholders approved by the Company’s Board of Directors and the cash portion of the SVB transaction. The Company declared and paid a total of $2,715,000 or $0.24 per common share cash dividend to shareholders of record during the year ended December 31, 2016.
During 2015, the Bank declared and paid cash dividends to the Company in the amount of $2,260,000 in connection with the cash dividends to the Company’s shareholders approved by the Company’s Board of Directors. The Company declared and paid a total of $1,979,000 or $0.18 per common share cash dividend to shareholders of record during the year ended December 31, 2015.
The following table sets forth certain financial ratios for the years ended December 31, 2017, 2016, and 2015.
2017 | 2016 | 2015 | ||||||
Net income: | ||||||||
To average assets | 0.94 | % | 1.15 | % | 0.90 | % | ||
To average shareholders’ equity | 7.69 | % | 9.84 | % | 8.12 | % | ||
Dividends declared per share to net income per share | 23.53 | % | 19.20 | % | 18.00 | % | ||
Average shareholders’ equity to average assets | 12.23 | % | 11.68 | % | 11.05 | % | ||
Management considers capital requirements as part of its strategic planning process. The strategic plan calls for continuing increases in assets and liabilities, and the capital required may therefore be in excess of retained earnings. The
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ability to obtain capital is dependent upon the capital markets as well as our performance. Management regularly evaluates sources of capital and the timing required to meet its strategic objectives.
The Board of Governors, the FDIC and other federal banking agencies have issued risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets, and transactions, such as letters of credit and recourse arrangements, which are reported as off-balance-sheet items.
The following table presents the Company’s regulatory capital ratios as of December 31, 2017 and December 31, 2016.
(Dollars in thousands) | Actual Ratio | Minimum regulatory requirement (1) | ||||||||||||
December 31, 2017 | Amount | Ratio | Amount | Ratio | ||||||||||
Tier 1 Leverage Ratio | $ | 153,676 | 9.71 | % | $ | 63,338 | 4.00 | % | ||||||
Common Equity Tier 1 Ratio (CET 1) | $ | 149,186 | 12.90 | % | $ | 52,081 | 5.75 | % | ||||||
Tier 1 Risk-Based Capital Ratio | $ | 153,676 | 13.28 | % | $ | 69,441 | 7.25 | % | ||||||
Total Risk-Based Capital Ratio | $ | 162,780 | 14.07 | % | $ | 92,588 | 9.25 | % | ||||||
December 31, 2016 | ||||||||||||||
Tier 1 Leverage Ratio | $ | 122,601 | 8.75 | % | $ | 56,057 | 4.00 | % | ||||||
Common Equity Tier 1 Ratio (CET 1) | $ | 120,080 | 12.48 | % | $ | 43,426 | 5.13 | % | ||||||
Tier 1 Risk-Based Capital Ratio | $ | 122,601 | 12.74 | % | $ | 57,901 | 6.63 | % | ||||||
Total Risk-Based Capital Ratio | $ | 132,052 | 13.72 | % | $ | 77,202 | 8.63 | % | ||||||
(1) The 2017 and 2016 minimum regulatory requirement threshold includes the capital conservation buffer of 1.250% and 0.625%, respectively. These ratios are not reflected on a fully phased-in basis, which will occur in January 2019. | ||||||||||||||
The following table presents the Bank’s regulatory capital ratios as of December 31, 2017 and December 31, 2016
(Dollars in thousands) | Actual Ratio | Minimum regulatory requirement (1) | ||||||||||||
December 31, 2017 | Amount | Ratio | Amount | Ratio | ||||||||||
Tier 1 Leverage Ratio | $ | 149,779 | 9.46 | % | $ | 63,332 | 4.00 | % | ||||||
Common Equity Tier 1 Ratio (CET 1) | $ | 149,779 | 12.96 | % | $ | 52,040 | 5.75 | % | ||||||
Tier 1 Risk-Based Capital Ratio | $ | 149,779 | 12.96 | % | $ | 69,387 | 7.25 | % | ||||||
Total Risk-Based Capital Ratio | $ | 158,882 | 13.74 | % | $ | 92,516 | 9.25 | % | ||||||
December 31, 2016 | ||||||||||||||
Tier 1 Leverage Ratio | $ | 121,079 | 8.64 | % | $ | 56,064 | 4.00 | % | ||||||
Common Equity Tier 1 Ratio (CET 1) | $ | 121,079 | 12.59 | % | $ | 43,383 | 5.13 | % | ||||||
Tier 1 Risk-Based Capital Ratio | $ | 121,079 | 12.59 | % | $ | 57,845 | 6.63 | % | ||||||
Total Risk-Based Capital Ratio | $ | 130,530 | 13.57 | % | $ | 77,126 | 8.63 | % | ||||||
(1) The 2017 and 2016 minimum regulatory requirement threshold includes the capital conservation buffer of 1.250% and 0.625%, respectively. These ratios are not reflected on a fully phased-in basis, which will occur in January 2019. | ||||||||||||||
The Company succeeded to all of the rights and obligations of the Service 1st Capital Trust I, a Delaware business trust, in connection with the acquisition of Service 1st as of November 12, 2008. The Trust was formed on August 17, 2006 for the sole purpose of issuing trust preferred securities fully and unconditionally guaranteed by Service 1st. Under applicable regulatory guidance, the amount of trust preferred securities that is eligible as Tier 1 capital is limited to 25% of the Company’s Tier 1 capital on a pro forma basis. At December 31, 2017, all of the trust preferred securities that have been issued qualify as Tier 1 capital. The trust preferred securities mature on October 7, 2036, are redeemable at the Company’s option beginning five years after issuance, and require quarterly distributions by the Trust to the holder of the trust preferred securities at a variable interest rate which will adjust quarterly to equal the three month LIBOR plus 1.60%.
The Trust used the proceeds from the sale of the trust preferred securities to purchase approximately $5,155,000 in aggregate principal amount of Service 1st’s junior subordinated notes (the Notes). The Notes bear interest at the same
48
variable interest rate during the same quarterly periods as the trust preferred securities. The Notes are redeemable by the Company on any January 7, April 7, July 7, or October 7 on or after October 7, 2012 or at any time within 90 days following the occurrence of certain events, such as: (i) a change in the regulatory capital treatment of the Notes (ii) in the event the Trust is deemed an investment company or (iii) upon the occurrence of certain adverse tax events. In each such case, the Company may redeem the Notes for their aggregate principal amount, plus any accrued but unpaid interest.
The Notes may be declared immediately due and payable at the election of the trustee or holders of 25% of the aggregate principal amount of outstanding Notes in the event that the Company defaults in the payment of any interest following the nonpayment of any such interest for 20 or more consecutive quarterly periods. Holders of the trust preferred securities are entitled to a cumulative cash distribution on the liquidation amount of $1,000 per security. For each January 7, April 7, July 7 or October 7 of each year, the rate will be adjusted to equal the three month LIBOR plus 1.60%. As of December 31, 2017, the rate was 2.96%. Interest expense recognized by the Company for the years ended December 31, 2017, 2016, and 2015 was $147,000, $121,000 and $99,000, respectively.
LIQUIDITY
Liquidity management involves our ability to meet cash flow requirements arising from fluctuations in deposit levels and demands of daily operations, which include funding of securities purchases, providing for customers’ credit needs and ongoing repayment of borrowings. Our liquidity is actively managed on a daily basis and reviewed periodically by our management and Director’s Asset/Liability Committees. This process is intended to ensure the maintenance of sufficient funds to meet our needs, including adequate cash flows for off-balance sheet commitments.
Our primary sources of liquidity are derived from financing activities which include the acceptance of customer and, to a lesser extent, broker deposits, Federal funds facilities and advances from the Federal Home Loan Bank of San Francisco (FHLB). These funding sources are augmented by payments of principal and interest on loans, the routine maturities and pay downs of securities from the securities portfolio, the stability of our core deposits and the ability to sell investment securities. As of December 31, 2017, the Company had unpledged securities totaling $452,163,000 available as a secondary source of liquidity and total cash and cash equivalents of $100,383,000. Cash and cash equivalents at December 31, 2017 increased 160.28% compared to December 31, 2016. Primary uses of funds include withdrawal of and interest payments on deposits, origination and purchases of loans, purchases of investment securities, and payment of operating expenses.
To augment our liquidity, we have established Federal funds lines with various correspondent banks. At December 31, 2017, our available borrowing capacity includes approximately $40,000,000 in Federal funds lines with our correspondent banks and $234,689,000 in unused FHLB advances. At December 31, 2017, we were not aware of any information that was reasonably likely to have a material effect on our liquidity position.
The following table reflects the Company’s credit lines, balances outstanding, and pledged collateral at December 31, 2017 and 2016:
Credit Lines (In thousands) | December 31, 2017 | December 31, 2016 | ||||||
Unsecured Credit Lines (interest rate varies with market): | ||||||||
Credit limit | $ | 40,000 | $ | 40,000 | ||||
Balance outstanding | $ | — | $ | 400 | ||||
Federal Home Loan Bank (interest rate at prevailing interest rate): | ||||||||
Credit limit | 234,689 | 174,576 | ||||||
Balance outstanding | $ | — | $ | — | ||||
Collateral pledged | $ | 357,393 | $ | 271,123 | ||||
Fair value of collateral | $ | 316,160 | $ | 237,879 | ||||
Federal Reserve Bank (interest rate at prevailing discount interest rate): | ||||||||
Credit limit | $ | 6,740 | $ | 9,102 | ||||
Balance outstanding | $ | — | $ | — | ||||
Collateral pledged | $ | 7,431 | $ | 9,315 | ||||
Fair value of collateral | $ | 7,437 | $ | 9,277 | ||||
The liquidity of our parent company, Central Valley Community Bancorp, is primarily dependent on the payment of cash dividends by its subsidiary, Central Valley Community Bank, subject to limitations imposed by state and federal regulations.
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OFF-BALANCE SHEET ITEMS
In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. The balance of commitments to extend credit on undisbursed construction and other loans and letters of credit was $350,141,000 as of December 31, 2017 compared to $259,415,000 as of December 31, 2016. For a more detailed discussion of these financial instruments, see Note 12 to the audited Consolidated Financial Statements in this Annual Report.
Contractual Obligations
The contractual obligations of the Company, summarized by type of obligation and contractual maturity, at December 31, 2017, are as follows:
(In thousands) | Less Than One Year | One to Three Years | Three to Five Years | After Five Years | Total | ||||||||||||||
Deposits | $ | 1,404,965 | $ | 16,315 | $ | 3,288 | $ | 1,119 | $ | 1,425,687 | |||||||||
Subordinated debentures | — | — | — | 5,155 | 5,155 | ||||||||||||||
Operating leases | 2,511 | 3,442 | 2,452 | 4,316 | 12,721 | ||||||||||||||
Total | $ | 1,407,476 | $ | 19,757 | $ | 5,740 | $ | 10,590 | $ | 1,443,563 | |||||||||
Deposits represent both non-interest bearing and interest bearing deposits. Interest bearing deposits include interest bearing transaction accounts, money market and savings deposits and certificates of deposit. Deposits with indeterminate maturities, such as demand, savings and money market accounts are reflected as obligations due in less than one year.
Subordinated debentures represent notes issued to a capital trust which was formed solely for the purpose of issuing trust preferred securities. These subordinated debentures were acquired as a part of the merger with Service 1st. The aggregate amount indicated above represents the full amount of the contractual obligation. All of these securities are variable rate instruments. The trust preferred securities mature on October 7, 2036, and are redeemable quarterly at the Company’s option.
In the ordinary course of business, the Company is party to various operating leases. For operating leases, the dollar balances reflected in the table above are categorized by the due date of the lease payments. Operating leases represent the total minimum lease payments under non-cancelable operating leases.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission (SEC) has issued disclosure guidance for “critical accounting policies.” The SEC defines “critical accounting policies” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods.
Our accounting policies are integral to understanding the results reported. Our significant accounting policies are described in detail in Note 1 in the audited Consolidated Financial Statements. Not all of the significant accounting policies presented in Note 1 of the audited Consolidated Financial Statements in this Annual Report require management to make difficult, subjective or complex judgments or estimates.
Use of Estimates
The preparation of these financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates the estimates used. Estimates are based upon historical experience, current economic conditions and other factors that management considers reasonable under the circumstances.
These estimates result in judgments regarding the carrying values of assets and liabilities when these values are not readily available from other sources, as well as assessing and identifying the accounting treatments of contingencies and commitments. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions.
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Accounting Principles Generally Accepted in the United States of America
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).
We follow accounting policies typical to the commercial banking industry and in compliance with various regulation and guidelines as established by the Public Company Accounting Oversight Board (PCAOB), Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA), and the Bank’s primary federal regulator, the FDIC. The following is a brief description of our current accounting policies involving significant management judgments.
Allowance for Credit Losses
Our most significant management accounting estimate is the appropriate level for the allowance for credit losses. The allowance for credit losses is an estimate of probable incurred credit losses in the Company’s loan portfolio. The adequacy of the allowance is monitored on an on-going basis and is based on our management’s evaluation of numerous factors. These factors include the quality of the current loan portfolio, the trend in the loan portfolio’s risk ratings, current economic conditions, loan concentrations, loan growth rates, past-due and nonperforming trends, evaluation of specific loss estimates for all significant problem loans, historical charge-off and recovery experience and other pertinent information. See Note 1 to the audited Consolidated Financial Statements in this Annual Report for more detail regarding our allowance for credit losses.
The calculation of the allowance for credit losses is by nature inexact, as the allowance represents our management’s best estimate of the probable losses inherent in our credit portfolios at the reporting date. These credit losses will occur in the future, and as such cannot be determined with absolute certainty at the reporting date.
Impairment of Investment Securities
Investment securities are impaired when the amortized cost exceeds fair value. Investment securities are evaluated for impairment on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the securities for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary and we do not intend to sell the security or it is more likely than not that we will not be required to sell the security before recovery, only the portion of the impairment loss representing credit exposure is recognized as a charge to earnings, with the balance recognized as a charge to other comprehensive income. If management intends to sell the security or it is more likely than not that we will be required to sell the security before recovering its forecasted cost, the entire impairment loss is recognized as a charge to earnings.
Goodwill
Business combinations involving the Company’s acquisition of the equity interests or net assets of another enterprise or the assumption of net liabilities in an acquisition of branches constituting a business may give rise to goodwill. Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed in transactions accounted for under the purchase method of accounting. The value of goodwill is ultimately derived from the Company’s ability to generate net earnings after the acquisition. A decline in net earnings could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill is assessed for impairment at a reporting unit level at least annually or more often if an event occurs or circumstances change that would more likely than not reduce the fair value of the Company below its carrying amount. While the Company believes all assumptions utilized in its assessment of goodwill for impairment are reasonable and appropriate, changes could cause the Company to record impairment in the future.
Accounting for Income Taxes
The Company files its income taxes on a consolidated basis with its subsidiary. The allocation of income tax expense (benefit) represents each entity’s proportionate share of the consolidated provision for income taxes.
Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. On the balance sheet, net deferred tax assets are included in accrued interest receivable and other assets.
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The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed.
Only tax positions that meet the more-likely-than-not recognition threshold are recognized. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest expense and penalties associated with unrecognized tax benefits are classified as income tax expense in the consolidated statement of income.
INFLATION
The impact of inflation on a financial institution differs significantly from that exerted on other industries primarily because the assets and liabilities of financial institutions consist largely of monetary items. However, financial institutions are affected by inflation in part through non-interest expenses, such as salaries and occupancy expenses, and to some extent by changes in interest rates.
At December 31, 2017, we do not believe that inflation will have a material impact on our consolidated financial position or results of operations. However, if inflation concerns cause short term rates to rise in the near future, we may benefit by immediate repricing of a portion of our loan portfolio. Refer to Quantitative and Qualitative Disclosures About Market Risk for further discussion.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate risk (IRR) and credit risk constitute the two greatest sources of financial exposure for insured financial institutions that operate like we do. IRR represents the impact that changes in absolute and relative levels of market interest rates may have upon our net interest income (NII). Changes in the NII are the result of changes in the net interest spread between interest-earning assets and interest-bearing liabilities (timing risk), the relationship between various rates (basis risk), and changes in the shape of the yield curve.
We realize income principally from the differential or spread between the interest earned on loans, investments, other interest-earning assets and the interest incurred on deposits and borrowings. The volumes and yields on loans, deposits and borrowings are affected by market interest rates. As of December 31, 2017, 70.60% of our loan portfolio was tied to adjustable-rate indices. The majority of our adjustable rate loans are tied to prime and reprice within 90 days. However, in the current low rate environment, several of our loans, tied to prime, are at their floors and will not reprice until prime plus the factor is greater than the floor. The majority of our time deposits have a fixed rate of interest. As of December 31, 2017, 78.25% of our time deposits mature within one year or less.
Changes in the market level of interest rates directly and immediately affect our interest spread, and therefore profitability. Sharp and significant changes to market rates can cause the interest spread to shrink or expand significantly in the near term, principally because of the timing differences between the adjustable rate loans and the maturities (and therefore repricing) of the deposits and borrowings.
Our management and Board of Directors’ Asset/Liability Committees (ALCO) are responsible for managing our assets and liabilities in a manner that balances profitability, IRR and various other risks including liquidity. The ALCO operates under policies and within risk limits prescribed, reviewed, and approved by the Board of Directors.
The ALCO seeks to stabilize our NII by matching rate-sensitive assets and liabilities through maintaining the maturity and repricing of these assets and liabilities at appropriate levels given the interest rate environment. When the amount of rate-sensitive liabilities exceeds rate-sensitive assets within specified time periods, NII generally will be negatively impacted by an increasing interest rate environment and positively impacted by a decreasing interest rate environment. Conversely, when the amount of rate-sensitive assets exceeds the amount of rate-sensitive liabilities within specified time periods, net interest income will generally be positively impacted by an increasing interest rate environment and negatively impacted by a decreasing interest rate environment. Our mix of assets consists primarily of loans and securities, none of which are held for trading purposes. The value of these securities is subject to interest rate risk, which we must monitor and manage successfully in order to prevent declines in value of these assets if interest rates rise in the future. The speed and velocity of the repricing of assets
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and liabilities will also contribute to the effects on our NII, as will the presence or absence of periodic and lifetime interest rate caps and floors.
Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Earnings simulations are produced using a software model that is based on actual cash flows and repricing characteristics for all of our financial instruments and incorporates market-based assumptions regarding the impact of changing interest rates on current volumes of applicable financial instruments.
Interest rate simulations provide us with an estimate of both the dollar amount and percentage change in NII under various rate scenarios. All assets and liabilities are normally subjected to up to 400 basis point increases and decreases in interest rates in 100 basis point increments. Under each interest rate scenario, we project our net interest income. From these results, we can then develop alternatives in dealing with the tolerance thresholds.
The assets and liabilities of a financial institution are primarily monetary in nature. As such they represent obligations to pay or receive fixed and determinable amounts of money that are not affected by future changes in prices. Generally, the impact of inflation on a financial institution is reflected by fluctuations in interest rates, the ability of customers to repay their obligations and upward pressure on operating expenses. Although inflationary pressures are not considered to be of any particular hindrance in the current economic environment, they may have an impact on the company’s future earnings in the event those pressures become more prevalent.
As a financial institution, the Company’s primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of interest income and interest expense recorded on a large portion of the Company’s assets and liabilities, and the market value of all interest earning assets and interest bearing liabilities, other than those which possess a short term to maturity. Virtually all of the Company’s interest earning assets and interest bearing liabilities are located at the Bank level. Thus, virtually all of the Company’s interest rate risk exposure lies at the Bank level other than $5.2 million in subordinated debentures issued by the Company’s subsidiary Service 1st Capital Trust I. As a result, all significant interest rate risk procedures are performed at the Bank level.
The fundamental objective of the Company’s management of its assets and liabilities is to maximize the Company’s economic value while maintaining adequate liquidity and an exposure to interest rate risk deemed by management to be acceptable. Management believes an acceptable degree of exposure to interest rate risk results from the management of assets and liabilities through maturities, pricing and mix to attempt to neutralize the potential impact of changes in market interest rates. The Company’s profitability is dependent to a large extent upon its net interest income, which is the difference between its interest income on interest earning assets, such as loans and investments, and its interest expense on interest bearing liabilities, such as deposits and borrowings. The Company is subject to interest rate risk to the degree that its interest earning assets re-price differently than its interest bearing liabilities. The Company manages its mix of assets and liabilities with the goals of limiting its exposure to interest rate risk, ensuring adequate liquidity, and coordinating its sources and uses of funds.
The Company seeks to control interest rate risk exposure in a manner that will allow for adequate levels of earnings and capital over a range of possible interest rate environments. The Company has adopted formal policies and practices to monitor and manage interest rate risk exposure. Management believes historically it has effectively managed the effect of changes in interest rates on its operating results and believes that it can continue to manage the short-term effects of interest rate changes under various interest rate scenarios.
Management employs asset and liability management software and engages consultants to measure the Company’s exposure to future changes in interest rates. The software measures the expected cash flows and re-pricing of each financial asset/liability separately in measuring the Company’s interest rate sensitivity. Based on the results of the software’s output, management believes the Company’s balance sheet is evenly matched over the short term and slightly asset sensitive over the longer term as of December 31, 2017. This means that the Company would expect (all other things being equal) to experience a limited change in its net interest income if rates rise or fall. The level of potential or expected change indicated by the tables below is considered acceptable by management and is compliant with the Company’s ALCO policies. Management will continue to perform this analysis each quarter.
The hypothetical impacts of sudden interest rate movements applied to the Company’s asset and liability balances are modeled quarterly. The results of these models indicate how much of the Company’s net interest income is “at risk” from various rate changes over a one year horizon. This exercise is valuable in identifying risk exposures. Management believes the results for the Company’s December 31, 2017 balances indicate that the net interest income at risk over a one year time horizon for a 100 basis points (“bps”), 200 bps, 300 bps, and 400 bps rate increase and a 100 bps decrease is acceptable to management and within policy guidelines at this time. Given the low interest rate environment, 200 bps, 300 bps, and 400 bps decreases are not considered a realistic possibility and are therefore not modeled.
The results in the table below indicate the change in net interest income the Company would expect to see as of December 31, 2017, if interest rates were to change in the amounts set forth:
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Sensitivity Analysis of Impact of Rate Changes on Interest Income
Hypothetical Change in Rates (Dollars in thousands) | Projected Net Interest Income | $ Change from Rates at December 31, 2017 | % Change from Rates at December 31, 2017 | ||||||||
Up 400 bps | $ | 71,988 | $ | 7,809 | 12.17 | % | |||||
Up 300 bps | 69,499 | 5,320 | 8.29 | % | |||||||
Up 200 bps | 67,711 | 3,532 | 5.50 | % | |||||||
Up 100 bps | 66,229 | 2,050 | 3.19 | % | |||||||
Unchanged | 64,179 | — | — | ||||||||
Down 100 bps | 61,173 | (3,006 | ) | (4.68 | )% | ||||||
It is important to note that the above table is a summary of several forecasts and actual results may vary from any of the forecasted amounts and such difference may be material and adverse. The forecasts are based on estimates and assumptions made by management, and that may turn out to be different, and may change over time. Factors affecting these estimates and assumptions include, but are not limited to: 1) competitor behavior, 2) economic conditions both locally and nationally, 3) actions taken by the Federal Reserve Board, 4) customer behavior and 5) management’s responses to each of the foregoing. Factors that vary significantly from the assumptions and estimates may have material and adverse effects on the Company’s net interest income; therefore, the results of this analysis should not be relied upon as indicative of actual future results.
The following table shows management’s estimates of how the loan portfolio is segregated between variable-daily, variable other than daily and fixed rate loans, and estimates of re-pricing opportunities for the entire loan portfolio at December 31, 2017 and 2016:
December 31, 2017 | December 31, 2016 | |||||||||||||
Rate Type (Dollars in thousands) | Balance | Percent of Total | Balance | Percent of Total | ||||||||||
Variable rate | $ | 634,900 | 70.60 | % | $ | 571,325 | 75.64 | % | ||||||
Fixed rate | 264,420 | 29.40 | % | 184,036 | 24.36 | % | ||||||||
Total gross loans | $ | 899,320 | 100.00 | % | $ | 755,361 | 100.00 | % | ||||||
Approximately 70.60% of our loan portfolio is tied to adjustable rate indices and 28.97% of our loan portfolio reprices within 90 days. As of December 31, 2017, we had 2,232 commercial and real estate loans totaling $579,652,000 with floors ranging from 3.25% to 7.50% and ceilings ranging from 6.00% to 30.00%.
The following table shows the repricing categories of the Company’s loan portfolio at December 31, 2017 and 2016:
December 31, 2017 | December 31, 2016 | |||||||||||||
Repricing (Dollars in thousands) | Balance | Percent of Total | Balance | Percent of Total | ||||||||||
< 1 Year | $ | 318,985 | 35.47 | % | $ | 309,397 | 40.95 | % | ||||||
1-3 Years | 177,545 | 19.74 | % | 153,680 | 20.35 | % | ||||||||
3-5 Years | 200,471 | 22.29 | % | 183,834 | 24.34 | % | ||||||||
> 5 Years | 202,319 | 22.50 | % | 108,450 | 14.36 | % | ||||||||
Total gross loans | $ | 899,320 | 100.00 | % | $ | 755,361 | 100.00 | % | ||||||
Assumptions are inherently uncertain, and, consequently, the model cannot precisely measure net interest income or precisely predict the impact of changes in interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and management strategies which might moderate the negative consequences of interest rate deviations.
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ITEM 8 - | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Shareholders and Board of Directors
Central Valley Community Bancorp and Subsidiary
Fresno, California
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Central Valley Community Bancorp and Subsidiary (the “Company”) as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes (collectively referred to as the “financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 20117, based on criteria established in Internal Control - Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework: (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. As permitted, the Company has excluded the operations of Folsom Lake Bank acquired during 2017, which is described in Note 2 of the consolidated financial statements, from the scope of management’s report on internal control over financial reporting. As such, it has also been excluded from the scope of our audit of internal control over financial reporting. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions
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and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Crowe Horwath LLP | |
We have served as the Company’s auditor since 2011. | |
Sacramento, California | |
March 14, 2018 | |
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2017 and 2016
(In thousands, except share amounts) | 2017 | 2016 | ||||||
ASSETS | ||||||||
Cash and due from banks | $ | 38,286 | $ | 28,185 | ||||
Interest-earning deposits in other banks | 62,080 | 10,368 | ||||||
Federal funds sold | 17 | 15 | ||||||
Total cash and cash equivalents | 100,383 | 38,568 | ||||||
Available-for-sale investment securities (Amortized cost of $538,692 at December 31, 2017 and $548,640 at December 31, 2016) | 542,704 | 547,749 | ||||||
Loans, less allowance for credit losses of $8,778 at December 31, 2017 and $9,326 at December 31, 2016 | 891,901 | 747,302 | ||||||
Bank premises and equipment, net | 9,398 | 9,407 | ||||||
Bank owned life insurance | 27,807 | 23,189 | ||||||
Federal Home Loan Bank stock | 6,843 | 5,594 | ||||||
Goodwill | 53,777 | 40,231 | ||||||
Core deposit intangibles | 3,027 | 1,383 | ||||||
Accrued interest receivable and other assets | 25,815 | 29,900 | ||||||
Total assets | $ | 1,661,655 | $ | 1,443,323 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Deposits: | ||||||||
Non-interest bearing | $ | 585,039 | $ | 495,815 | ||||
Interest bearing | 840,648 | 760,164 | ||||||
Total deposits | 1,425,687 | 1,255,979 | ||||||
Short-term borrowings | — | 400 | ||||||
Junior subordinated deferrable interest debentures | 5,155 | 5,155 | ||||||
Accrued interest payable and other liabilities | 21,254 | 17,756 | ||||||
Total liabilities | 1,452,096 | 1,279,290 | ||||||
Commitments and contingencies (Note 12) | ||||||||
Shareholders’ equity: | ||||||||
Preferred stock, no par value, $1,000 per share liquidation preference; 10,000,000 shares authorized, none issued and outstanding | — | — | ||||||
Common stock, no par value; 80,000,000 shares authorized; issued and outstanding: 13,696,722 at December 31, 2017 and 12,143,815 at December 31, 2016 | 103,314 | 71,645 | ||||||
Retained earnings | 103,419 | 92,904 | ||||||
Accumulated other comprehensive (loss) income, net of tax | 2,826 | (516 | ) | |||||
Total shareholders’ equity | 209,559 | 164,033 | ||||||
Total liabilities and shareholders’ equity | $ | 1,661,655 | $ | 1,443,323 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2017, 2016, and 2015
(In thousands, except per share amounts) | 2017 | 2016 | 2015 | |||||||||
Interest income: | ||||||||||||
Interest and fees on loans | $ | 43,534 | $ | 34,051 | $ | 30,504 | ||||||
Interest on deposits in other banks | 424 | 289 | 210 | |||||||||
Interest and dividends on investment securities: | ||||||||||||
Taxable | 6,526 | 5,876 | 4,793 | |||||||||
Exempt from Federal income taxes | 6,892 | 6,460 | 6,315 | |||||||||
Total interest income | 57,376 | 46,676 | 41,822 | |||||||||
Interest expense: | ||||||||||||
Interest on deposits | 969 | 975 | 948 | |||||||||
Interest on junior subordinated deferrable interest debentures | 147 | 121 | 99 | |||||||||
Other | 21 | — | — | |||||||||
Total interest expense | 1,137 | 1,096 | 1,047 | |||||||||
Net interest income before provision for credit losses | 56,239 | 45,580 | 40,775 | |||||||||
(Reversal of) Provision for credit losses | (1,150 | ) | (5,850 | ) | 600 | |||||||
Net interest income after provision for credit losses | 57,389 | 51,430 | 40,175 | |||||||||
Non-interest income: | ||||||||||||
Service charges | 3,053 | 2,849 | 2,970 | |||||||||
Appreciation in cash surrender value of bank owned life insurance | 621 | 558 | 596 | |||||||||
Interchange fees | 1,458 | 1,228 | 1,197 | |||||||||
Loan placement fees | 706 | 1,083 | 1,042 | |||||||||
Net realized gains on sales and calls of investment securities | 2,802 | 1,920 | 1,495 | |||||||||
Other-than-temporary impairment loss on investment securities | — | (136 | ) | — | ||||||||
Federal Home Loan Bank dividends | 443 | 630 | 580 | |||||||||
Other income | 1,753 | 1,459 | 1,507 | |||||||||
Total non-interest income | 10,836 | 9,591 | 9,387 | |||||||||
Non-interest expenses: | ||||||||||||
Salaries and employee benefits | 24,738 | 21,881 | 20,836 | |||||||||
Occupancy and equipment | 5,186 | 4,754 | 4,669 | |||||||||
Regulatory assessments | 652 | 642 | 1,059 | |||||||||
Data processing expense | 1,740 | 1,707 | 1,139 | |||||||||
Professional services | 1,509 | 1,258 | 1,504 | |||||||||
ATM/Debit card expenses | 750 | 633 | 548 | |||||||||
License & maintenance contracts | 818 | 531 | 520 | |||||||||
Directors’ expenses | 597 | 530 | 439 | |||||||||
Advertising | 638 | 576 | 608 | |||||||||
Internet banking expenses | 705 | 678 | 709 | |||||||||
Acquisition and integration expenses | 1,828 | 1,782 | — | |||||||||
Amortization of core deposit intangibles | 234 | 149 | 320 | |||||||||
Other expense | 5,011 | 3,801 | 3,665 | |||||||||
Total non-interest expenses | 44,406 | 38,922 | 36,016 | |||||||||
Income before provision for income taxes | 23,819 | 22,099 | 13,546 | |||||||||
Provision for income taxes | 9,793 | 6,917 | 2,582 | |||||||||
Net income available to common shareholders | $ | 14,026 | $ | 15,182 | $ | 10,964 | ||||||
Basic earnings per common share | $ | 1.12 | $ | 1.34 | $ | 1.00 | ||||||
Diluted earnings per common share | $ | 1.10 | $ | 1.33 | $ | 1.00 | ||||||
Cash dividends per common share | $ | 0.24 | $ | 0.24 | $ | 0.18 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Years Ended December 31, 2017, 2016, and 2015
(In thousands) | 2017 | 2016 | 2015 | |||||||||
Net income | $ | 14,026 | $ | 15,182 | $ | 10,964 | ||||||
Other Comprehensive Income (Loss): | ||||||||||||
Unrealized gains (losses) on securities: | ||||||||||||
Unrealized holdings gains (losses) arising during the period | 7,705 | (9,924 | ) | 59 | ||||||||
Less: reclassification for net gains included in net income | 2,802 | 1,224 | 1,481 | |||||||||
Less: reclassification for other-than-temporary impairment loss included in net income | — | (136 | ) | — | ||||||||
Transfer of investment securities from held-to-maturity to available-for-sale | — | 2,647 | — | |||||||||
Amortization of net unrealized gains transferred | — | (64 | ) | (78 | ) | |||||||
Other comprehensive income (loss), before tax | 4,903 | (8,429 | ) | (1,500 | ) | |||||||
Tax (expense) benefit related to items of other comprehensive income | (2,062 | ) | 3,451 | 585 | ||||||||
Total other comprehensive income (loss) | 2,841 | (4,978 | ) | (915 | ) | |||||||
Comprehensive income | $ | 16,867 | $ | 10,204 | $ | 10,049 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Years Ended December 31, 2017, 2016, and 2015
Common Stock | Accumulated Other Comprehensive Income (Loss) (Net of Taxes) | Total Shareholders’ Equity | |||||||||||||||||
Retained Earnings | |||||||||||||||||||
(In thousands, except share amounts) | Shares | Amount | |||||||||||||||||
Balance, January 1, 2015 | 10,980,440 | $ | 54,216 | $ | 71,452 | $ | 5,377 | $ | 131,045 | ||||||||||
Net income | — | — | 10,964 | — | 10,964 | ||||||||||||||
Other comprehensive loss | — | — | — | (915 | ) | (915 | ) | ||||||||||||
Restricted stock granted, forfeited and related tax benefit | 7,263 | (96 | ) | — | — | (96 | ) | ||||||||||||
Cash dividend ($0.18 per common share) | — | — | (1,979 | ) | — | (1,979 | ) | ||||||||||||
Stock-based compensation expense | — | 238 | — | — | 238 | ||||||||||||||
Stock options exercised and related tax benefit | 9,070 | 66 | — | — | 66 | ||||||||||||||
Balance, December 31, 2015 | 10,996,773 | 54,424 | 80,437 | 4,462 | 139,323 | ||||||||||||||
Net income | — | — | 15,182 | — | 15,182 | ||||||||||||||
Other comprehensive loss | — | — | — | (4,978 | ) | (4,978 | ) | ||||||||||||
Restricted stock granted, forfeited and related tax benefit | 52,911 | (2 | ) | — | — | (2 | ) | ||||||||||||
Stock issued for acquisition | 1,058,851 | 16,678 | — | — | 16,678 | ||||||||||||||
Stock-based compensation expense | — | 284 | — | — | 284 | ||||||||||||||
Cash dividend ($0.24 per common share) | — | — | (2,715 | ) | — | (2,715 | ) | ||||||||||||
Stock options exercised and related tax benefit | 35,280 | 261 | — | — | 261 | ||||||||||||||
Balance, December 31, 2016 | 12,143,815 | 71,645 | 92,904 | (516 | ) | 164,033 | |||||||||||||
Net income | — | — | 14,026 | — | 14,026 | ||||||||||||||
Other comprehensive income | — | — | — | 2,841 | 2,841 | ||||||||||||||
Reclassification associated with the adoption of ASU 2018-02 | — | — | (501 | ) | 501 | — | |||||||||||||
Stock issued for acquisition | 1,276,888 | 28,405 | — | — | 28,405 | ||||||||||||||
Restricted stock granted, (forfeited) and related tax benefit | (2,360 | ) | — | — | — | — | |||||||||||||
Stock issued under employee stock purchase plan | 2,441 | 45 | — | — | 45 | ||||||||||||||
Stock-based compensation expense | — | 384 | — | — | 384 | ||||||||||||||
Cash dividend ($0.24 per common share) | — | — | (3,010 | ) | — | (3,010 | ) | ||||||||||||
Stock options exercised and related tax benefit | 275,938 | 2,835 | — | — | 2,835 | ||||||||||||||
Balance, December 31, 2017 | 13,696,722 | $ | 103,314 | $ | 103,419 | $ | 2,826 | $ | 209,559 | ||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2017, 2016, and 2015 | ||||||||||||
(In thousands) | 2017 | 2016 | 2015 | |||||||||
Cash flows from operating activities: | ||||||||||||
Net income | $ | 14,026 | $ | 15,182 | $ | 10,964 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Net increase in deferred loan costs | (92 | ) | (851 | ) | (270 | ) | ||||||
Depreciation | 1,429 | 1,320 | 1,392 | |||||||||
Accretion | (766 | ) | (1,142 | ) | (1,196 | ) | ||||||
Amortization | 8,519 | 7,912 | 8,024 | |||||||||
Stock-based compensation | 384 | 284 | 238 | |||||||||
Excess tax benefit from exercise of stock options | — | (30 | ) | (6 | ) | |||||||
(Reversal of) provision for credit losses | (1,150 | ) | (5,850 | ) | 600 | |||||||
Other than temporary impairment losses on investment securities | — | 136 | — | |||||||||
Net realized gains on sales and calls of available-for-sale investment securities | (2,802 | ) | (1,224 | ) | (1,481 | ) | ||||||
Net realized gains on sales or calls of held-to-maturity investment securities | — | (696 | ) | (14 | ) | |||||||
Net loss on sale and disposal of equipment | — | 4 | 6 | |||||||||
Net gain on sale of other real estate owned | — | — | (11 | ) | ||||||||
Increase in bank owned life insurance, net of expenses | (621 | ) | (558 | ) | (596 | ) | ||||||
Net gain on bank owned life insurance | — | (190 | ) | (345 | ) | |||||||
Net (increase) decrease in accrued interest receivable and other assets | (2,263 | ) | (4,711 | ) | 2,109 | |||||||
Net increase (decrease) in accrued interest payable and other liabilities | 1,370 | 821 | (963 | ) | ||||||||
Benefit (provision) for deferred income taxes | 7,184 | 2,592 | (933 | ) | ||||||||
Net cash provided by operating activities | 25,218 | 12,999 | 17,518 | |||||||||
Cash Flows From Investing Activities: | ||||||||||||
Net cash and cash equivalents acquired in acquisition | 26,279 | 13,241 | — | |||||||||
Purchases of available-for-sale investment securities | (226,740 | ) | (278,664 | ) | (198,851 | ) | ||||||
Proceeds from sales or calls of available-for-sale investment securities | 228,405 | 167,163 | 93,167 | |||||||||
Proceeds from sales or calls of held-to-maturity investment securities | — | 9,257 | 810 | |||||||||
Proceeds from maturity and principal repayment of available-for-sale investment securities | 44,956 | 50,531 | 53,593 | |||||||||
Net increase in loans | (25,542 | ) | (29,930 | ) | (24,776 | ) | ||||||
Proceeds from sale of other real estate owned | — | — | 359 | |||||||||
Purchases of premises and equipment | (859 | ) | (861 | ) | (741 | ) | ||||||
Purchases of bank owned life insurance | — | — | (325 | ) | ||||||||
FHLB stock purchased | — | — | (32 | ) | ||||||||
Proceeds from bank owned life insurance | — | 928 | 1,365 | |||||||||
Proceeds from sale of premises and equipment | — | 7 | — | |||||||||
Net cash provided by (used in) investing activities | 46,499 | (68,328 | ) | (75,431 | ) | |||||||
Cash Flows From Financing Activities: | ||||||||||||
Net increase in demand, interest-bearing and savings deposits | 45,672 | 26,372 | 90,732 | |||||||||
Net decrease in time deposits | (48,044 | ) | (25,038 | ) | (13,617 | ) | ||||||
Repayments of short-term borrowings to Federal Home Loan Bank | (7,000 | ) | — | — | ||||||||
Proceeds of borrowings from other financial institutions | — | 400 | — | |||||||||
Repayments of borrowings from other financial institutions | (400 | ) | — | — | ||||||||
Proceeds from stock issued under employee stock purchase plan | 45 | — | — | |||||||||
Proceeds from exercise of stock options | 2,835 | 231 | 60 | |||||||||
Excess tax benefit from exercise of stock options | — | 30 | 6 | |||||||||
Cash dividend payments on common stock | (3,010 | ) | (2,715 | ) | (1,979 | ) | ||||||
Net cash (used in) provided by financing activities | (9,902 | ) | (720 | ) | 75,202 | |||||||
Increase (decrease) in cash and cash equivalents | 61,815 | (56,049 | ) | 17,289 | ||||||||
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR | 38,568 | 94,617 | 77,328 | |||||||||
CASH AND CASH EQUIVALENTS AT END OF YEAR | $ | 100,383 | $ | 38,568 | $ | 94,617 | ||||||
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) For the Years Ended December 31, 2017, 2016, and 2015 | ||||||||||||
(In thousands) | 2017 | 2016 | 2015 | |||||||||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | ||||||||||||
Cash paid during the year for: | ||||||||||||
Interest | $ | 1,171 | $ | 1,053 | $ | 1,059 | ||||||
Income taxes | $ | 4,720 | $ | 5,840 | $ | 1,865 | ||||||
Non-cash investing and financing activities: | ||||||||||||
Transfer of securities from held-to-maturity to available-for-sale | $ | — | $ | 23,131 | $ | — | ||||||
Unrealized gain on transfer of securities from held-to-maturity to available-for-sale | $ | — | $ | 526 | $ | — | ||||||
Foreclosure of loan collateral and recognition of other real estate owned | $ | — | $ | — | $ | 227 | ||||||
Transfer of loans to other assets | $ | — | $ | 363 | $ | — | ||||||
Assumption of debt related to foreclosure of other real estate owned | $ | — | $ | — | $ | 121 | ||||||
Common stock issued in acquisitions | $ | 28,405 | $ | 16,678 | $ | — | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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Central Valley Community Bancorp and Subsidiary
Notes to Consolidated Financial Statements
1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
General - Central Valley Community Bancorp (the “Company”) was incorporated on February 7, 2000 and subsequently obtained approval from the Board of Governors of the Federal Reserve System to be a bank holding company in connection with its acquisition of Central Valley Community Bank (the “Bank”). The Company became the sole shareholder of the Bank on November 15, 2000 in a statutory merger, pursuant to which each outstanding share of the Bank’s common stock was exchanged for one share of common stock of the Company.
Service 1st Capital Trust I (the Trust) is a business trust formed by Service 1st for the sole purpose of issuing trust preferred securities. The Company succeeded to all the rights and obligations of Service 1st in connection with the acquisition of Service 1st. The Trust is a wholly-owned subsidiary of the Company.
The Bank operates 24 full service offices throughout California’s San Joaquin Valley and Greater Sacramento Region. The Bank’s primary source of revenue is providing loans to customers who are predominately small and middle-market businesses and individuals.
The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. Depositors’ accounts at an insured depository institution, including all non-interest bearing transactions accounts, will be insured by the FDIC up to the standard maximum deposit insurance amount of $250,000 for each deposit insurance ownership category.
The accounting and reporting policies of the Company and the Bank conform with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry.
Management has determined that because all of the banking products and services offered by the Company are available in each branch of the Bank, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank branches and report them as a single operating segment. No customer accounts for more than 10 percent of revenues for the Company or the Bank.
Principles of Consolidation - The consolidated financial statements include the accounts of the Company and the consolidated accounts of its wholly-owned subsidiary, the Bank. Intercompany transactions and balances are eliminated in consolidation.
For financial reporting purposes, Service 1st Capital Trust I, is a wholly-owned subsidiary acquired in the merger of Service 1st Bancorp and formed for the exclusive purpose of issuing trust preferred securities. The Company is not considered the primary beneficiary of this trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability on the Company’s consolidated financial statements. The Company’s investment in the common stock of the Trust is included in accrued interest receivable and other assets on the consolidated balance sheet.
Use of Estimates - The preparation of these financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates the estimates used. Estimates are based upon historical experience, current economic conditions and other factors that management considers reasonable under the circumstances.
These estimates result in judgments regarding the carrying values of assets and liabilities when these values are not readily available from other sources, as well as assessing and identifying the accounting treatments of contingencies and commitments. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions.
Cash and Cash Equivalents - For the purpose of the statement of cash flows, cash, due from banks with maturities less than 90 days, interest-earning deposits in other banks, and Federal funds sold are considered to be cash equivalents. Generally, Federal funds are sold and purchased for one-day periods. Net cash flows are reported for customer loan and deposit transactions, interest-bearing deposits in other banks, and Federal funds purchased.
Investment Securities - Investments are classified into the following categories:
• | Available-for-sale securities, reported at fair value, with unrealized gains and losses excluded from earnings and reported, net of taxes, as accumulated other comprehensive income (loss) within shareholders’ equity. |
• | Held-to-maturity securities, which management has the positive intent and ability to hold to maturity, reported at amortized cost, adjusted for the accretion of discounts and amortization of premiums. |
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Management determines the appropriate classification of its investments at the time of purchase and may only change the classification in certain limited circumstances. All transfers between categories are accounted for at fair value in the period which the transfer occurs. During the year ended December 31, 2017, there were no transfers between categories. For the year ended December 31, 2016 management transferred $23.1 million of securities from held-to-maturity to available-for-sale. Due to the 2016 transfer, management is precluded from utilizing the held-to-maturity designation until the second quarter of 2018.
Gains or losses on the sale of investment securities are computed on the specific identification method. Interest earned on investment securities is reported in interest income, net of applicable adjustments for accretion of discounts and amortization of premiums. Premiums and discounts on securities are amortized or accreted on the level yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated.
An investment security is impaired when its carrying value is greater than its fair value. Investment securities that are impaired are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether such a decline in their fair value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the securities for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other than temporary, and management does not intend to sell the security or it is more likely than not that the Company will not be required to sell the security before recovery, for debt securities, only the portion of the impairment loss representing credit exposure is recognized as a charge to earnings, with the balance recognized as a charge to other comprehensive income. If management intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its forecasted cost, the entire impairment loss is recognized as a charge to earnings.
Loans - All loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at principal balances outstanding net of deferred loan fees and costs, and the allowance for credit losses. Interest is accrued daily based upon outstanding loan principal balances. However, when a loan becomes impaired and the future collectability of interest and principal is in serious doubt, the loan is placed on nonaccrual status and the accrual of interest income is suspended. Any loan delinquent 90 days or more is automatically placed on nonaccrual status. Any interest accrued but unpaid is charged against income. Subsequent payments on these loans, or payments received on nonaccrual loans for which the ultimate collectability of principal is not in doubt, are applied first to principal until fully collected and then to interest.
Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically charged off no later than 90 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. A loan placed on non-accrual status may be restored to accrual status when principal and interest are no longer past due and unpaid, or the loan otherwise becomes both well secured and in the process of collection. When a loan is brought current, the Company must also have reasonable assurance that the obligor has the ability to meet all contractual obligations in the future, that the loan will be repaid within a reasonable period of time, and that a minimum of six months of satisfactory repayment performance has occurred.
Substantially all loan origination fees, commitment fees, direct loan origination costs and purchase premiums and discounts on loans are deferred and recognized as an adjustment of yield, and amortized to interest income over the contractual term of the loan. The unamortized balance of deferred fees and costs is reported as a component of net loans.
Acquired loans and Leases - Loans and leases acquired through purchase or through a business combination are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan and lease losses is not recorded at the acquisition date. Should the Company’s allowance for credit losses methodology indicate that the credit discount associated with acquired, non-purchased credit impaired loans, is no longer sufficient to cover probable losses inherent in those loans, the Company will establish an allowance for those loans through a charge to provision for credit losses. At the time of an acquisition, we evaluate loans to determine if they are purchase credit impaired loans. Purchased credit impaired loans are those acquired loans with evidence of credit deterioration for which collection of all contractual payments was not considered probable at the date of acquisition. This determination is made by considering past due and/or nonaccrual status, prior designation of a troubled debt restructuring, or other factors that may suggest we will not be able to collect all contractual payments. Purchased credit impaired loans are initially recorded at fair value with the difference between fair value and estimated future cash flows accreted over the expected cash flow period as income only to the extent we can reasonably estimate the timing and amount of future cash flows. In this case, these loans would be classified as accruing. In the event we are unable to reasonably estimate the timing and amount of future cash flows, or if the loan is acquired primarily for the rewards of ownership of the underlying collateral, the loan is classified as non-accrual. An acquired loan
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previously classified by the seller as a troubled debt restructuring is no longer classified as such at the date of acquisition. Past due status is reported based on contractual payment status.
All loans not otherwise classified as purchase credit impaired are recorded at fair value with the discount to contractual value accreted over the life of the loan.
Allowance for Credit Losses - The allowance for credit losses (the “allowance”) is a valuation allowance for probable incurred credit losses in the Company’s loan portfolio. The allowance is established through a provision for credit losses which is charged to expense. Additions to the allowance are made to maintain the adequacy of the total allowance after credit losses and loan growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of two primary components, specific reserves related to impaired loans and general reserves for inherent losses related to loans that are not impaired.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans determined to be impaired are individually evaluated for impairment. When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to come solely from the sale or operation of underlying collateral.
A restructuring of a debt constitutes a troubled debt restructuring (TDR) if the Company for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider. Restructured workout loans typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. Loans that are reported as TDRs are considered impaired and measured for impairment as described above.
When determining the allowance for loan losses on acquired loans, we bifurcate the allowance between legacy loans and acquired loans. Loans remain designated as acquired until either (i) loan is renewed or (ii) loan is substantially modified whereby modification results in a new loan. When determining the allowance on acquired loans, the Company estimates probable incurred credit losses as compared to the Company’s recorded investment, with the recorded investment being net of any unaccreted discounts from the acquisition.
The determination of the general reserve for loans that are not impaired is based on estimates made by management, including but not limited to, consideration of a simple average of historical losses by portfolio segment (and in certain cases peer loss data) over the most recent 20 quarters, and qualitative factors including economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan portfolio, and probable losses inherent in the portfolio taken as a whole.
The Company segregates the allowance by portfolio segment. These portfolio segments include commercial, real estate, and consumer loans. The relative significance of risk considerations vary by portfolio segment. For commercial and real estate loans, the primary risk consideration is a borrower’s ability to generate sufficient cash flows to repay their loan. Secondary considerations include the creditworthiness of guarantors and the valuation of collateral. In addition to the creditworthiness of a borrower, the type and location of real estate collateral is an important risk factor for real estate loans. The primary risk considerations for consumer loans are a borrower’s personal cash flow and liquidity, as well as collateral value. The allowance for credit losses attributable to each portfolio segment, which includes both impaired loans and loans that are not impaired, is combined to determine the Company’s overall allowance, which is included on the consolidated balance sheet.
Commercial:
Commercial and industrial - Commercial and industrial loans are generally underwritten to existing cash flows of operating businesses. Additionally, economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Past due payments may indicate the borrower’s capacity to repay their obligations may be deteriorating.
Agricultural land and production - Loans secured by crop production and livestock are especially vulnerable to two risk factors that are largely outside the control of Company and borrowers: commodity prices and weather conditions.
Real Estate:
Owner-occupied commercial real estate - Real estate collateral secured by commercial or professional properties with repayment arising from the owner’s business cash flows. To meet this classification, the owner’s operation must occupy no less
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than 50% of the real estate held. Financial profitability and capacity to meet the cyclical nature of the industry and related real estate market over a significant timeframe is essential.
Real estate construction and other land loans - Land and construction loans generally possess a higher inherent risk of loss than other real estate portfolio segments. A major risk arises from the necessity to complete projects within specified costs and time lines. Trends in the construction industry significantly impact the credit quality of these loans, as demand drives construction activity. In addition, trends in real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of construction projects.
Agricultural real estate - Agricultural loans secured by real estate generally possess a higher inherent risk of loss caused by changes in concentration of permanent plantings, government subsidies, and the value of the U.S. dollar affecting the export of commodities.
Investor commercial real estate - Investor commercial real estate loans generally possess a higher inherent risk of loss than other real estate portfolio segments, except land and construction loans. Adverse economic developments or an overbuilt market impact commercial real estate projects and may result in troubled loans. Trends in vacancy rates of commercial properties impact the credit quality of these loans. High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flows to service debt obligations.
Other real estate - Primarily loans secured by agricultural real estate for development and production of permanent plantings that have not reached maximum yields. Also real estate loans where agricultural vertical integration exists in packing and shipping of commodities. Risk is primarily based on the liquidity of the borrower to sustain payment during the development period.
Consumer:
Equity loans and lines of credit - The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower’s ability to repay in an orderly fashion. These loans generally possess a lower inherent risk of loss than other real estate portfolio segments. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends may indicate that the borrowers’ capacity to repay their obligations may be deteriorating.
Installment and other consumer loans - An installment loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period. Most installment loans are made directly for consumer purchases. Other consumer loans include credit card and other open ended unsecured consumer loans. Credit cards and open ended unsecured loans generally have a higher rate of default than all other portfolio segments and are also impacted by weak economic conditions and trends. Credit cards and open ended unsecured loans in homogeneous loan portfolio segments are not evaluated for specific impairment.
Although management believes the allowance to be adequate, ultimate losses may vary from its estimates. At least quarterly, the Board of Directors reviews the adequacy of the allowance, including consideration of the relative risks in the portfolio, current economic conditions and other factors. If the Board of Directors and management determine that changes are warranted based on those reviews, the allowance is adjusted. In addition, the Company’s primary regulators, the FDIC and California Department of Business Oversight, as an integral part of their examination process, review the adequacy of the allowance. These regulatory agencies may require additions to the allowance based on their judgment about information available at the time of their examinations.
Risk Rating - The Company assigns a risk rating to all loans, and periodically performs detailed reviews of all such loans over a certain threshold to identify credit risks and to assess the overall collectability of the portfolio. The most recent review of risk rating was completed in December 2017. These risk ratings are also subject to examination by independent specialists engaged by the Company, and the Company’s regulators. During these internal reviews, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans. These credit quality indicators are used to assign a risk rating to each individual loan. The risk ratings can be grouped into five major categories, defined as follows:
Pass - A pass loan is a strong credit with no existing or known potential weaknesses deserving of management’s close attention.
Special Mention - A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Company’s credit position at some future date. Special Mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Substandard - A substandard loan is not adequately protected by the current sound worth and paying capacity of the borrower or the value of the collateral pledged, if any. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Well-defined weaknesses include a project’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time, or the project’s failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
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Doubtful - Loans classified doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans. Doubtful classification is considered temporary and short term.
Loss - Loans classified as loss are considered uncollectible and charged off immediately.
The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management’s assessment of the following for each portfolio segment: (1) inherent credit risk, (2) historical losses and (3) other qualitative factors including economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan portfolio, and probable losses inherent in the portfolio taken as a whole. Inherent credit risk and qualitative reserve factors are inherently subjective and are driven by the repayment risk associated with each class of loans.
Bank Premises and Equipment - Land is carried at cost. Bank premises and equipment are carried at cost less accumulated depreciation. Depreciation is determined using the straight-line method over the estimated useful lives of the related assets. The useful lives of Bank premises are estimated to be between twenty and forty years. The useful lives of improvements to Bank premises, furniture, fixtures and equipment are estimated to be three to ten years. Leasehold improvements are amortized over the life of the asset or the term of the related lease, whichever is shorter. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in income for the period. The cost of maintenance and repairs is charged to expense as incurred.
The Bank evaluates premises and equipment for financial impairment as events or changes in circumstances indicate that the carrying amount of such assets may not be fully recoverable.
Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.
Investments in Low Income Housing Tax Credit Funds - The Bank has invested in limited partnerships that were formed to develop and operate affordable housing projects for low or moderate income tenants throughout California. Our ownership in each limited partnership is less than two percent. In accordance with ASU No. 2014-01, Investments - Equity Method and Joint Ventures (Topic 323), we elected to account for the investments in qualified affordable housing tax credit funds using the proportional amortization method. Under the proportional amortization method, the initial cost of the investment is amortized in proportion to the tax credits and other tax benefits received and the net investment performance is recognized as part of income tax expense (benefit). Each of the partnerships must meet the regulatory minimum requirements for affordable housing for a minimum 15-year compliance period to fully utilize the tax credits. If the partnerships cease to qualify during the compliance period, the credit may be denied for any period in which the project is not in compliance and a portion of the credit previously taken is subject to recapture with interest. The Company’s investment in Low Income Housing Tax Credit Funds is reported in other assets on the consolidated balance sheet.
Other Real Estate Owned - Other real estate owned (OREO) is comprised of property acquired through foreclosure proceedings or acceptance of deeds-in-lieu of foreclosure. Losses recognized at the time of acquiring property in full or partial satisfaction of debt are charged against the allowance for credit losses. OREO, when acquired, is initially recorded at fair value less estimated disposition costs, establishing a new cost basis. Fair value of OREO is generally based on an independent appraisal of the property. Subsequent to initial measurement, OREO is carried at the lower of the recorded investment or fair value less disposition costs. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Revenues and expenses associated with OREO are reported as a component of noninterest expense when incurred.
Foreclosed Assets - Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through operations. Operating costs after acquisition are expensed. Gains and losses on disposition are included in noninterest expense. The carrying value of foreclosed assets was $70,000 at December 31, 2017 and $362,000 at December 31, 2016, and is included in other assets on the consolidated balance sheets.
Bank Owned Life Insurance - The Company has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
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Business Combinations - The Company accounts for acquisitions of businesses using the acquisition method of accounting. Under the acquisition method, assets and liabilities assumed are recorded at their estimated fair values at the date of acquisition. Management utilizes various valuation techniques included discounted cash flow analyses to determine these fair values. Any excess of the purchase price over amounts allocated to the acquired assets, including identifiable intangible assets, and liabilities assumed is recorded as goodwill.
Goodwill - Business combinations involving the Bank’s acquisition of the equity interests or net assets of another enterprise give rise to goodwill. Total goodwill at December 31, 2017 and 2016 represents the excess of the purchase price of acquired businesses over the net fair value of assets, including identified intangible assets, acquired and liabilities assumed in the transactions accounted for under the purchase method of accounting. The value of goodwill is ultimately derived from the Bank’s ability to generate net earnings after the acquisitions. A decline in net earnings could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill is assessed at least annually for impairment.
The Company has selected September 30 as the date to perform the annual impairment test. Management assessed qualitative factors including performance trends and noted no factors indicating goodwill impairment. Goodwill is also tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the Company below its carrying amount. No such events or circumstances arose during the fourth quarter of 2017, so goodwill was not required to be retested. Goodwill is the only intangible asset with an indefinite life on our balance sheet.
Intangible Assets - The intangible assets at December 31, 2017 represent the estimated fair value of the core deposit relationships acquired in business combinations. Core deposit intangibles are being amortized using the straight-line method over an estimated life of ten years from the date of acquisition. Management evaluates the remaining useful lives quarterly to determine whether events or circumstances warrant a revision to the remaining periods of amortization. Based on the evaluation, no changes to the remaining useful lives was required. Management performed an annual impairment test on core deposit intangibles as of September 30, 2017 and determined no impairment was necessary. Core deposit intangibles are also tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value below its carrying amount. No such events or circumstances arose during the fourth quarter of 2017, so core deposit intangibles were not required to be retested.
Loan Commitments and Related Financial Instruments - Financial instruments include off‑balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount of these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Income Taxes - The Company files its income taxes on a consolidated basis with the Bank. The allocation of income tax expense represents each entity’s proportionate share of the consolidated provision for income taxes.
Income tax expense represents the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. On the balance sheet, net deferred tax assets are included in accrued interest receivable and other assets.
The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax assets will not be realized. “More likely than not” is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed.
Accounting for Uncertainty in Income Taxes - The Company uses a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return. A tax position is recognized as a benefit only if it is more likely than not that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the more likely than not test, no tax benefit is recorded.
Interest expense and penalties associated with unrecognized tax benefits, if any, are classified as income tax expense in the consolidated statement of income.
Retirement Plans - Employee 401(k) plan expense is the amount of employer matching contributions. Profit sharing plan expense is the amount of employer contributions. Contributions to the profit sharing plan are determined at the discretion of the Board of Directors. Deferred compensation and supplemental retirement plan expense is allocated over years of service.
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Earnings Per Common Share - Basic earnings per common share (EPS), which excludes dilution, is computed by dividing income available to common shareholders (net income after deducting dividends, if any, on preferred stock and accretion of discount) by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options or warrants, result in the issuance of common stock which shares in the earnings of the Company. All data with respect to computing earnings per share is retroactively adjusted to reflect stock dividends and splits and the treasury stock method is applied to determine the dilutive effect of stock options in computing diluted EPS.
Comprehensive Income - Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity.
Loss Contingencies - Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements.
Restrictions on Cash - Cash on hand or on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements.
Share-Based Compensation - Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes-Merton model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. Additionally, the compensation expense for the Company’s employee stock ownership plan is based on the market price of the shares as they are committed to be released to participant accounts. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
Dividend Restriction - Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the Company to shareholders.
Fair Value of Financial Instruments - Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 3. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.
Recently Issued Accounting Standards:
FASB Accounting Standards Update (ASU) 2014-09 - Revenue from Contracts with Customers (Topic 606): Revenue from Contracts with Customers was issued in May 2014. This ASU is the result of a joint project initiated by the FASB and the International Accounting Standards Board (IASB) to clarify the principles for recognizing revenue, and to develop common revenue standards and disclosure requirements that would: (1) remove inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosures; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. The guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required with regard to contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This ASU is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The amendments will be applied through the election of one of two retrospective methods. Substantially all of the Company’s revenue is generated from interest income related to loans and investment securities, which are not within the scope of this guidance. The contracts that are within the scope of this guidance include service charges and fees on deposit accounts interchange fees, and merchant income. The Company has substantially completed its overall assessment of revenue streams and review of related contracts and other agreements that are within the scope of this guidance and did not identify any material changes to the timing of revenue recognition. The Company adopted ASU 2014-09 on its required effective date of January 1, 2018 utilizing
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the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. The Company is completing its evaluation of the ASU’s expanded disclosure requirement effective for the March 31, 2018 Form 10-Q. The Company expects the expanded disclosures to be primarily qualitative in nature. The Company does not expect material additions or revisions to our quantitative disclosures.
FASB Accounting Standards Update (ASU) 2016-01 - Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, was issued January 2016. The main provisions of the update are to eliminate the available-for-sale classification of accounting for equity securities and to adjust the fair value disclosures for financial instruments carried at amortized costs such that the disclosed fair values represent an exit price as opposed to an entry price. The provisions of this update will require that equity securities be carried at fair market value on the balance sheet and any periodic changes in value will be adjustments to the income statement. A practical expedient is provided for equity securities without a readily determinable fair value, such that these securities can be carried at cost less any impairment. ASU No. 2016-01 is effective for interim and annual reporting periods beginning after December 15, 2017. The Company has performed an evaluation of the provisions of ASU No. 2016-01 and based on this evaluation, has determined that ASU No. 2016-01 will not have a material impact on the Company’s financial position, results of operations or its cash flows.
FASB Accounting Standards Update (ASU) 2016-02 - Leases - Overall (Subtopic 845), was issued February 2016. The update requires all leases, with the exception of short-term leases that have contractual terms of no greater than one year, to be recorded on the balance sheet. Under the provisions of the update, leases classified as operating will be reflected on the balance sheet with the recognition of both a right-of-use asset and a lease liability. Under the update, a distinction will exist between finance and operating type leases and the rules for determining which classification a lease will fall into are similar to existing rules. For public business entities, the amendments of this update are effective for interim and annual periods beginning after December 15, 2018. The update requires a modified retrospective transition under which comparative balance sheets from the earliest historical period presented will be revised to reflect what the financials would have looked like were the provisions of the update applied consistently in all prior periods. The Company is currently evaluating the provisions of ASU No. 2016-02 and has determined that the provisions of ASU No. 2016-02 will result in an increase in assets to recognize the present value of the lease obligations with a corresponding increase in liabilities; however, the Company does not expect this to have a material impact on the Company’s results of operations or cash flows.
FASB Accounting Standards Update (ASU) 2016-09 - Compensation - Stock Compensation (Subtopic 718): Improvements to Employee Share-Based Payment Accounting, was issued March 2016. This ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. Some of the key provisions of this new ASU include: (1) companies will no longer record excess tax benefits and certain tax deficiencies in additional paid-in capital (“APIC”). Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement, and APIC pools will be eliminated. The guidance also eliminates the requirement that excess tax benefits be realized before companies can recognize them. In addition, the guidance requires companies to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity; (2) increase the amount an employer can withhold to cover income taxes on awards and still qualify for the exception to liability classification for shares used to satisfy the employer’s statutory income tax withholding obligation. The new guidance will also require an employer to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding obligation as a financing activity on its statement of cash flows (current guidance did not specify how these cash flows should be classified); and (3) permit companies to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures can be estimated, as required today, or recognized when they occur. ASU No. 2016-09 is effective for interim and annual reporting periods beginning after December 15, 2016. Early adoption was permitted, but all of the guidance must be adopted in the same period. Effective January 1, 2017, the Company adopted ASU 2016-09 “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” including the election to continue to treat option forfeitures on an expected basis and to provide cash flow disclosures on a prospective basis. During the year ended December 31, 2017 the adoption of this standard resulted in the recognition of $853,000 in tax benefits related to the exercise of stock options and vesting of restricted shares during the period.
FASB Accounting Standards Update (ASU) 2016-13 - Measurement of Credit Losses on Financial Instruments (Subtopic 326): Financial Instruments - Credit Losses, commonly referred to as “CECL,” was issued June 2016. The provisions of the update eliminate the probable initial recognition threshold under current GAAP which requires reserves to be based on an incurred loss methodology. Under CECL, reserves required for financial assets measured at amortized cost will reflect an organization’s estimate of all expected credit losses over the contractual term of the financial asset and thereby require the use of reasonable and supportable forecasts to estimate future credit losses. Because CECL encompasses all financial assets carried at amortized cost, the requirement that reserves be established based on an organization’s reasonable and supportable estimate of expected credit losses extends to held to maturity (“HTM”) debt securities. Under the provisions of the update, credit losses recognized
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on available for sale (“AFS”) debt securities will be presented as an allowance as opposed to a write-down. In addition, CECL will modify the accounting for purchased loans, with credit deterioration since origination, so that reserves are established at the date of acquisition for purchased loans. Under current GAAP a purchased loan’s contractual balance is adjusted to fair value through a credit discount and no reserve is recorded on the purchased loan upon acquisition. Since under CECL reserves will be established for purchased loans at the time of acquisition, the accounting for purchased loans is made more comparable to the accounting for originated loans. Finally, increased disclosure requirements under CECL require organizations to present the currently required credit quality disclosures disaggregated by the year of origination or vintage. The FASB expects that the evaluation of underwriting standards and credit quality trends by financial statement users will be enhanced with the additional vintage disclosures. For public business entities that are SEC filers, the amendments of the update will become effective beginning January 1, 2020. While the Company is currently evaluating the provisions of ASU No. 2016-13 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements, it has taken steps to prepare for the implementation when it becomes effective, such as forming an internal task force, gathering pertinent data, consulting with outside professionals, and evaluating its current IT systems. Management expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the first reporting period in which the new standard is effective, but cannot yet estimate the magnitude of the one-time adjustment or the overall impact of the new guidance on the Company’s financial position, results of operations or cash flows.
FASB Accounting Standards Update (ASU) 2017-04 - Intangibles Goodwill and Other (Subtopic 350): Simplifying the Test for Goodwill Impairment, was issued January 2017. The provisions of the update eliminate the existing second step of the goodwill impairment test which provides for the allocation of reporting unit fair value among existing assets and liabilities, with the net leftover amount representing the implied fair value of goodwill. In replacement of the existing goodwill impairment rule, the update will provide that impairment should be recognized as the excess of any of the reporting unit’s goodwill over the fair value of the reporting unit. Under the provisions of this update, the amount of the impairment is limited to the carrying value of the reporting unit’s goodwill. For public business entities that are SEC filers, the amendments of the update will become effective in fiscal years beginning after December 15, 2019.
FASB Accounting Standards Update (ASU) 2017-08 - Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities, was issued March 2017. The provisions of the update require premiums recognized upon the purchase of callable debt securities to be amortized to the earliest call date in order to avoid losses recognized upon call. For public business entities that are SEC filers, the amendments of the update will become effective in fiscal years beginning after December 15, 2018. Management does not expect the requirements of this update to have a material impact on the Company’s financial position, results of operations or cash flows.
FASB Accounting Standards Update (ASU) 2017-09 - Compensation - Stock Compensation (Subtopic 718): Scope of Modification Accounting, was issued May 2017. The amendments in ASU 2017-09 provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. An entity should account for the effects of a modification unless all of the following conditions are met: the fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified; the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The amendments in this Update should be applied prospectively to an award modified on or after the adoption date. The amendments in this Update are effective for annual periods, and interim periods within those annual periods, beginning after December 31, 2017. Early adoption is permitted, including adoption in any interim period. The adoption of this guidance is not expected to have a material impact on the Company’s Consolidated Financial Statements.
FASB Accounting Standards Update (ASU) 2017-12 - Derivatives and Hedging (Topic 815); Targeted Improvements to Accounting for Hedging Activities, was issued August 2017. This ASU’s objectives are to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities; and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. ASU No. 2017-12 is effective for interim and annual reporting periods beginning after December 15, 2018; early adoption is permitted. The Company currently does not designate any derivative financial instruments as formal hedging relationships, and therefore, does not utilize hedge accounting. However, the Company is currently evaluating this ASU to determine whether its provisions will enhance the Company’s ability to employ risk management strategies, while improving the transparency and understanding of those strategies for financial statement users.
FASB Accounting Standards Update (ASU) 2018-02 - Income Statement — Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” ASU 2018-02, was issued to address
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the income tax accounting treatment of the stranded tax effects within other comprehensive income due to the prohibition of backward tracing due to an income tax rate change that was initially recorded in other comprehensive income. This issue came about from the enactment of the Tax Cuts and Jobs Act on December 22, 2017 that changed the Company’s income tax rate from 35% to 21%. The ASU changed current accounting whereby an entity may elect to reclassify the stranded tax effect from accumulated other comprehensive income to retained earnings. The ASU is effective for periods beginning after December 15, 2018 although early adoption is permitted. The Company adopted ASU 2018-02 in the fourth quarter of 2017 and reclassified its stranded tax debit of $501,000 within accumulated other comprehensive income to retained earnings at December 31, 2017.
2. ACQUISITIONS
On October 1, 2017, the Company completed the acquisition of Folsom Lake Bank (“FLB”) for an aggregate transaction value of $28,475,000. FLB was merged into the Bank, and the Company issued 1,276,888 shares of common stock to the former shareholders of FLB. The Company also assumed the outstanding FLB stock options. With the FLB acquisition, the Company added two full service branches, located in Folsom, and Rancho Cordova, California. The FLB Roseville branch was consolidated with the Company’s Roseville branch in October 2017. FLB’s assets as of October 1, 2017 totaled approximately $196,148,000.
In accordance with GAAP guidance for business combinations, the Company recorded $13,466,000 of goodwill and $1,879,000 of other intangible assets on the acquisition date. The other intangible assets are primarily related to core deposits and are being amortized using a straight-line method over a period of ten years with no significant residual value. For tax purposes, purchase accounting adjustments including goodwill are all non-taxable and/or non-deductible. Acquisition related costs of $1,828,000 are included in the income statement for the year ended December 31, 2017.
The acquisition was consistent with the Company’s strategy to build a regional presence in Central California. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded region. Goodwill arising from the acquisition consisted largely of synergies and the expected cost savings resulting from the combined operations.
The following table summarizes the consideration paid for FLB and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date (in thousands):
Merger consideration: | |||
Common stock issued | $ | 28,475 | |
Fair Value of Total Consideration Transferred | $ | 28,475 | |
Recognized amounts of identifiable assets acquired and liabilities assumed: | |||
Cash and cash equivalents | $ | 26,279 | |
Loans, net | 117,815 | ||
Investments | 41,280 | ||
Core deposit intangible | 1,879 | ||
Premises and equipment | 561 | ||
Federal Home Loan Bank stock | 1,559 | ||
Deferred taxes and taxes receivable | 2,186 | ||
Bank owned life insurance | 3,997 | ||
Other assets | 592 | ||
Total assets acquired | 196,148 | ||
Deposits | 171,948 | ||
Deposit premium | 132 | ||
Short-term borrowings - Federal Home Loan Bank | 7,000 | ||
Other liabilities | 2,059 | ||
Total liabilities assumed | 181,139 | ||
Total identifiable net assets | 15,009 | ||
Goodwill | $ | 13,466 | |
The fair value of net assets acquired includes fair value adjustments to certain loans that were not considered impaired as of the acquisition date. The fair value adjustments were determined using discounted contractual cash flows. As such, these loans were not considered impaired at the acquisition date and were not subject to the guidance relating to purchased credit
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impaired loans, which have shown evidence of credit deterioration since origination. Loans acquired that were not subject to these requirements include non-impaired loans and customer receivables with a fair value and gross contractual amounts receivable of $117,815,000 and $121,872,000, respectively, on the date of acquisition. See Note 5 for discussion of purchased credit impaired loans.
On October 1, 2016, the Company acquired Sierra Vista Bank, headquartered in Folsom, California, wherein Sierra Vista Bank, with one branch in Folsom, one branch in Fair Oaks, and one branch in Cameron Park, merged with and into Central Valley Community Bancorp’s subsidiary, Central Valley Community Bank, in a combined cash and stock transaction. Sierra Vista Bank’s assets as of October 1, 2016 totaled approximately $155,154,000. The acquired assets and liabilities were recorded at fair value at the date of acquisition. Under the terms of the merger agreement, the Company issued an aggregate of approximately 1,058,851 shares of its common stock and cash totaling approximately $9,468,000 to the former shareholders of Sierra Vista Bank.
In accordance with GAAP guidance for business combinations, the Company recorded $10,314,000 of goodwill and $508,000 of other intangible assets on the acquisition date. The other intangible assets are primarily related to core deposits and are being amortized using a straight-line method over a period of ten years with no significant residual value. For tax purposes, purchase accounting adjustments including goodwill are all non-taxable and/or non-deductible. Acquisition related costs of $1,782,000 are included in the income statement for the year ended December 31, 2016.
The acquisition was consistent with the Company’s strategy to build a regional presence in Central California. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded region. Goodwill arising from the acquisition consisted largely of synergies and the cost savings resulting from the combined operations.
The following table summarizes the consideration paid for Sierra Vista Bank and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date (in thousands):
Merger consideration: | |||
Cash | $ | 9,468 | |
Common stock issued | 16,793 | ||
Fair Value of Total Consideration Transferred | $ | 26,261 | |
Recognized amounts of identifiable assets acquired and liabilities assumed: | |||
Cash and cash equivalents | $ | 22,709 | |
Loans, net | 122,533 | ||
Core deposit intangible | 508 | ||
Premises and equipment | 586 | ||
Federal Home Loan Bank stock | 771 | ||
Deferred taxes and taxes receivable | 4,417 | ||
Bank owned life insurance | 2,664 | ||
Other assets | 966 | ||
Total assets acquired | 155,154 | ||
Deposits | 138,236 | ||
Deposit premium | 142 | ||
Other liabilities | 829 | ||
Total liabilities assumed | 139,207 | ||
Total identifiable net assets | 15,947 | ||
Goodwill | $ | 10,314 | |
The fair value of net assets acquired includes fair value adjustments to certain loans that were not considered impaired as of the acquisition date. The fair value adjustments were determined using discounted contractual cash flows. As such, these loans were not considered impaired at the acquisition date and were not subject to the guidance relating to purchased credit impaired loans, which have shown evidence of credit deterioration since origination. Loans acquired that were not subject to these requirements include non-impaired loans and customer receivables with a fair value and gross contractual amounts receivable of $121,902,000 and $124,396,000, respectively, on the date of acquisition. See Note 5 for discussion of purchased credit impaired loans.
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Pro Forma Results of Operations
The accompanying consolidated financial statements include the accounts of Sierra Vista Bank since October 1, 2016 and Folsom Lake Bank since October 1, 2017. The following table presents pro forma results of operations information for the periods presented as if the acquisitions had occurred on January 1, 2015 after giving effect to certain adjustments. The unaudited pro forma results of operations for the years ended December 31, 2017, 2016, and 2015 include the historical accounts of the Company, Folsom Lake Bank, and Sierra Vista Bank and pro forma adjustments as may be required, including the amortization of intangibles with definite lives and the amortization or accretion of any premiums or discounts arising from fair value adjustments for assets acquired and liabilities assumed. The pro forma information is intended for informational purposes only and is not necessarily indicative of the Company’s future operating results or operating results that would have occurred had the acquisitions been completed at the beginning of each respective year. No assumptions have been applied to the pro forma results of operations regarding possible revenue enhancements, expense efficiencies or asset dispositions. (In thousands, except per-share amounts):
For the Years Ended December 31, | ||||||||||||
2017 | 2016 | 2015 | ||||||||||
Net interest income | $ | 61,059 | $ | 56,531 | $ | 52,413 | ||||||
Provision for (reversal of) credit losses | (1,150 | ) | (5,800 | ) | 570 | |||||||
Non-interest income | 11,240 | 10,205 | 10,063 | |||||||||
Non-interest expense | 51,415 | 52,131 | 45,692 | |||||||||
Income before provision for income taxes | 22,034 | 20,405 | 16,214 | |||||||||
Provision for income taxes | 9,168 | 6,381 | 3,669 | |||||||||
Net income | $ | 12,866 | $ | 14,024 | $ | 12,545 | ||||||
Net income available to common shareholders | $ | 12,866 | $ | 14,024 | $ | 12,545 | ||||||
Basic earnings per common share | $ | 1.03 | $ | 1.24 | $ | 1.15 | ||||||
Diluted earnings per common share | $ | 1.01 | $ | 1.23 | $ | 1.14 | ||||||
3. | FAIR VALUE MEASUREMENTS |
Fair Value Hierarchy
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In accordance with applicable guidance, the Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. Valuations within these levels are based upon:
Level 1 — Quoted market prices (unadjusted) for identical instruments traded in active exchange markets that the Company has the ability to access as of the measurement date.
Level 2 — Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable or can be corroborated by observable market data.
Level 3 — Model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use on pricing the asset or liability. Valuation techniques include management judgment and estimation which may be significant.
Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, we report the transfer at the beginning of the reporting period.
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The estimated carrying and fair values of the Company’s financial instruments are as follows (in thousands):
December 31, 2017 | ||||||||||||||||||||
Carrying Amount | Fair Value | |||||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||
Financial assets: | ||||||||||||||||||||
Cash and due from banks | $ | 38,286 | $ | 38,286 | $ | — | $ | — | $ | 38,286 | ||||||||||
Interest-earning deposits in other banks | 62,080 | 62,080 | — | — | 62,080 | |||||||||||||||
Federal funds sold | 17 | 17 | — | — | 17 | |||||||||||||||
Available-for-sale investment securities | 542,704 | 7,423 | 535,281 | — | 542,704 | |||||||||||||||
Loans, net | 891,901 | — | — | 899,191 | 899,191 | |||||||||||||||
Federal Home Loan Bank stock | 6,843 | N/A | N/A | N/A | N/A | |||||||||||||||
Accrued interest receivable | 7,168 | 57 | 3,256 | 3,855 | 7,168 | |||||||||||||||
Financial liabilities: | ||||||||||||||||||||
Deposits | 1,425,687 | 1,296,048 | 127,966 | — | 1,424,014 | |||||||||||||||
Short-term borrowings | — | — | — | — | — | |||||||||||||||
Junior subordinated deferrable interest debentures | 5,155 | — | — | 3,550 | 3,550 | |||||||||||||||
Accrued interest payable | 110 | — | 72 | 38 | 110 | |||||||||||||||
December 31, 2016 | ||||||||||||||||||||
Carrying Amount | Fair Value | |||||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||
Financial assets: | ||||||||||||||||||||
Cash and due from banks | $ | 28,185 | $ | 28,185 | $ | — | $ | — | $ | 28,185 | ||||||||||
Interest-earning deposits in other banks | 10,368 | 10,368 | — | — | 10,368 | |||||||||||||||
Federal funds sold | 15 | 15 | — | — | 15 | |||||||||||||||
Available-for-sale investment securities | 547,749 | 7,416 | 540,333 | — | 547,749 | |||||||||||||||
Held-to-maturity investment securities | — | — | — | — | — | |||||||||||||||
Loans, net | 747,302 | — | — | 761,023 | 761,023 | |||||||||||||||
Federal Home Loan Bank stock | 5,594 | N/A | N/A | N/A | N/A | |||||||||||||||
Accrued interest receivable | 7,885 | 26 | 4,517 | 3,342 | 7,885 | |||||||||||||||
Financial liabilities: | ||||||||||||||||||||
Deposits | 1,255,979 | 1,099,200 | 156,711 | — | 1,255,911 | |||||||||||||||
Short-term borrowings | 400 | — | 400 | — | 400 | |||||||||||||||
Junior subordinated deferrable interest debentures | 5,155 | — | — | 3,235 | 3,235 | |||||||||||||||
Accrued interest payable | 144 | — | 111 | 33 | 144 | |||||||||||||||
These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.
These estimates are made at a specific point in time based on relevant market data and information about the financial instruments. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented.
The methods and assumptions used to estimate fair values are described as follows:
(a) Cash and Cash Equivalents — The carrying amounts of cash and due from banks, interest-earning deposits in other banks, and Federal funds sold approximate fair values and are classified as Level 1.
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(b) Investment Securities — Investment securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets. Fair values for investment securities classified in Level 2 are based on quoted market prices for similar securities in active markets. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators.
(c) Loans — Fair values of loans are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Purchased credit impaired (PCI) loans are measured at estimated fair value on the date of acquisition. Carrying value is calculated as the present value of expected cash flows and approximates fair value. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are initially valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for credit losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.
(d) FHLB Stock — It is not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.
(e) Deposits — Fair value of demand deposit, savings, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. Fair value for fixed and variable rate certificates of deposit are estimated using discounted cash flow analyses using interest rates offered at each reporting date by the Company for certificates with similar remaining maturities resulting in a Level 2 classification.
(f) Short-Term Borrowings — The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.
The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.
(g) Accrued Interest Receivable/Payable — The fair value of accrued interest receivable and payable is based on the fair value hierarchy of the related asset or liability.
(h) Off-Balance Sheet Instruments — Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.
Assets Recorded at Fair Value
The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2017:
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Recurring Basis
The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements (in thousands):
Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||
Available-for-sale investment securities | ||||||||||||||||
Debt Securities: | ||||||||||||||||
U.S. Government agencies | $ | 66,587 | $ | — | $ | 66,587 | $ | — | ||||||||
Obligations of states and political subdivisions | 143,105 | — | 143,105 | — | ||||||||||||
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations | 234,908 | — | 234,908 | — | ||||||||||||
Private label residential mortgage and asset backed securities | 90,681 | — | 90,681 | — | ||||||||||||
Other equity securities | 7,423 | 7,423 | — | — | ||||||||||||
Total assets measured at fair value on a recurring basis | $ | 542,704 | $ | 7,423 | $ | 535,281 | $ | — | ||||||||
Securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets. Fair values for available-for-sale investment securities in Level 2 are based on quoted market prices for similar securities in active markets. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators.
Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings. During the year ended December 31, 2017, no transfers between levels occurred.
There were no Level 3 assets measured at fair value on a recurring basis at December 31, 2017. Also there were no liabilities measured at fair value on a recurring basis at December 31, 2017.
Non-recurring Basis
The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis. These include the following assets and liabilities that are measured at the lower of cost or fair value that were recognized at fair value which was below cost at December 31, 2017 (in thousands):
Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||
Other repossessed assets | $ | 70 | $ | — | $ | — | $ | 70 | ||||||||
Total assets measured at fair value on a non-recurring basis | $ | 70 | $ | — | $ | — | $ | 70 | ||||||||
At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for credit losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. The fair value of impaired loans is based on the fair value of the collateral. Impaired loans were determined to be collateral dependent and categorized as Level 3 due to ongoing real estate market conditions resulting in inactive market data, which in turn required the use of unobservable inputs and assumptions in fair value measurements. Impaired loans evaluated under the discounted cash flow method are excluded from the table above. The discounted cash flow method as prescribed by ASC 310 is not a fair value measurement since the discount rate utilized is the loan’s effective interest rate which is not a market rate. There were no changes in valuation techniques used during the year ended December 31, 2017.
Appraisals for collateral-dependent impaired loans are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value is compared with independent data sources such as recent market data or industry-wide statistics.
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As of December 31, 2017, there were no loans measured using the fair value of the collateral for collateral dependent loans.
During the year ended December 31, 2017 specific allocation for the allowance for credit losses related to loans carried at fair value was none, compared to $15,000 during the year ended December 31, 2016. There were no net charge-offs related to loans carried at fair value at December 31, 2017 and 2016.
There were no liabilities measured at fair value on a non-recurring basis at December 31, 2017.
The following two tables present information about the Company’s assets and liabilities measured at fair value on a recurring and nonrecurring basis as of December 31, 2016:
Recurring Basis
The Company is required or permitted to record the following assets at fair value on a recurring basis under other accounting pronouncements (in thousands):
Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||
Available-for-sale securities | ||||||||||||||||
Debt Securities: | ||||||||||||||||
U.S. Government agencies | $ | 68,970 | $ | — | $ | 68,970 | $ | — | ||||||||
Obligations of states and political subdivisions | 290,299 | — | 290,299 | — | ||||||||||||
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations | 178,221 | — | 178,221 | — | ||||||||||||
Private label residential mortgage and asset backed securities | 2,843 | — | 2,843 | — | ||||||||||||
Other equity securities | 7,416 | 7,416 | — | — | ||||||||||||
Total assets measured at fair value on a recurring basis | $ | 547,749 | $ | 7,416 | $ | 540,333 | $ | — | ||||||||
Securities in Level 1 are mutual funds and fair values are based on quoted market prices for identical instruments traded in active markets. Fair values for available-for-sale investment securities in Level 2 are based on quoted market prices for similar securities in active markets. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators.
There were no Level 3 assets measured at fair value on a recurring basis at December 31, 2016. Also there were no liabilities measured at fair value on a recurring basis at December 31, 2016.
Non-recurring Basis
The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a non-recurring basis. These include the following assets and liabilities that are measured at the lower of cost or fair value that were recognized at fair value which was below cost at December 31, 2016 (in thousands):
Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||
Impaired loans: | ||||||||||||||||
Consumer: | ||||||||||||||||
Equity loans and lines of credit | $ | 47 | $ | — | $ | — | $ | 47 | ||||||||
Total consumer | 47 | — | — | 47 | ||||||||||||
Total impaired loans | $ | 47 | $ | — | $ | — | $ | 47 | ||||||||
Other repossessed assets | $ | 362 | $ | — | $ | — | $ | 362 | ||||||||
Total assets measured at fair value on a non-recurring basis | $ | 409 | $ | — | $ | — | $ | 409 | ||||||||
At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for credit losses. For collateral dependent real estate loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. The fair
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value of impaired loans is based on the fair value of the collateral. Impaired loans were determined to be collateral dependent and categorized as Level 3 due to ongoing real estate market conditions resulting in inactive market data, which in turn required the use of unobservable inputs and assumptions in fair value measurements. Impaired loans evaluated under the discounted cash flow method are excluded from the table above. The discounted cash flow method as prescribed by ASC Topic 310 is not a fair value measurement since the discount rate utilized is the loan’s effective interest rate which is not a market rate. There were no changes in valuation techniques used during the year ended December 31, 2016.
Appraisals for collateral-dependent impaired loans are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value is compared with independent data sources such as recent market data or industry-wide statistics.
Impaired loans that are measured for impairment using the fair value of the collateral for collateral dependent loans had a principal balance of $62,000 with a valuation allowance of $15,000 at December 31, 2016, and a resulting fair value of $47,000. The valuation allowance represents specific allocations for the allowance for credit losses for impaired loans. Fair value of other repossessed assets is based on observable market data for other similar property as adjusted by management for depreciation and other asset conditions impacting value.
During the year ended December 31, 2016, there was no provision for credit losses related to loans carried at fair value. During the year ended December 31, 2016, there was no net charge-offs related to loans carried at fair value.
There were no liabilities measured at fair value on a non-recurring basis at December 31, 2016.
4. | INVESTMENT SECURITIES |
The fair value of the available-for-sale investment portfolio reflected an unrealized gain of $4,012,000 at December 31, 2017 compared to an unrealized loss of $891,000 at December 31, 2016. The unrealized gain/(loss) recorded is net of $1,186,000 and $(375,000) in tax liabilities (benefits) as accumulated other comprehensive income within shareholders’ equity at December 31, 2017 and 2016, respectively.
The following tables set forth the carrying values and estimated fair values of our investment securities portfolio at the dates indicated (in thousands):
December 31, 2017 | |||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | ||||||||||||
Available-for-Sale Securities | |||||||||||||||
Debt Securities: | |||||||||||||||
U.S. Government agencies | $ | 65,994 | $ | 667 | $ | (74 | ) | $ | 66,587 | ||||||
Obligations of states and political subdivisions | 136,955 | 6,240 | (90 | ) | 143,105 | ||||||||||
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations | 237,210 | 601 | (2,903 | ) | 234,908 | ||||||||||
Private label mortgage and asset backed securities | 91,033 | 924 | (1,276 | ) | 90,681 | ||||||||||
Other equity securities | 7,500 | — | (77 | ) | 7,423 | ||||||||||
$ | 538,692 | $ | 8,432 | $ | (4,420 | ) | $ | 542,704 | |||||||
December 31, 2016 | |||||||||||||||
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | ||||||||||||
Available-for-Sale Securities | |||||||||||||||
Debt Securities: | |||||||||||||||
U.S. Government agencies | $ | 69,005 | $ | 242 | $ | (277 | ) | $ | 68,970 | ||||||
Obligations of states and political subdivisions | 288,543 | 6,109 | (4,353 | ) | 290,299 | ||||||||||
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations | 181,785 | 484 | (4,048 | ) | 178,221 | ||||||||||
Private label mortgage and asset backed securities | 1,807 | 1,036 | — | 2,843 | |||||||||||
Other equity securities | 7,500 | — | (84 | ) | 7,416 | ||||||||||
` | $ | 548,640 | $ | 7,871 | $ | (8,762 | ) | $ | 547,749 | ||||||
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During 2014, to better manage our interest rate risk, the Company transferred from available-for-sale to held-to-maturity selected municipal securities in our portfolio having a book value of approximately $31 million, a market value of approximately $32 million, and a net unrecognized gain of approximately $163,000. This transfer was completed after careful consideration of our intent and ability to hold these securities to maturity. During the first quarter of 2016, management sold certain investment securities of which management identified that five of the 13 securities sold were previously designated as held-to-maturity (HTM). Through an oversight during the portfolio restructuring analysis related to this transaction, management unintentionally sold these five HTM securities. The book value of the HTM securities sold was $8.5 million. The gain realized on the sale of the HTM securities was $696,000. As such, management was required to reclassify the remaining HTM securities with a fair value of $23.1 million to the AFS designation.
Proceeds and gross realized gains (losses) on investment securities for the years ended December 31, 2017, 2016, and 2015 are shown below (in thousands):
Years Ended December 31, | ||||||||||||
2017 | 2016 | 2015 | ||||||||||
Available-for-Sale Securities | ||||||||||||
Proceeds from sales or calls | $ | 228,405 | $ | 167,163 | $ | 93,167 | ||||||
Gross realized gains from sales or calls | $ | 4,701 | $ | 2,223 | $ | 1,715 | ||||||
Gross realized losses from sales or calls | $ | (1,899 | ) | $ | (999 | ) | $ | (234 | ) | |||
Held-to-Maturity Securities | ||||||||||||
Proceeds from sales and calls | $ | — | $ | 9,257 | $ | 810 | ||||||
Gross realized gains from sales or calls | $ | — | $ | 696 | $ | 14 | ||||||
Losses recognized in 2017, 2016, and 2015 were incurred in order to reposition the investment securities portfolio based on the current rate environment. The securities which were sold at a loss were acquired when the rate environment was not as volatile. The securities which were sold were primarily purchased several years ago to serve a purpose in the rate environment in which the securities were purchased. The Company addressed risks in the security portfolio by selling these securities and using the proceeds to purchase securities that fit with the Company’s current risk profile.
The provision (benefit) for income taxes includes $1,178,000, $515,000, and $615,000 income tax impact from the reclassification of unrealized net gains on available-for-sale securities to realized net gains on available-for-sale securities for the years ended December 31, 2017, 2016, and 2015, respectively.
Investment securities with unrealized losses at December 31, 2017 and 2016 are summarized and classified according to the duration of the loss period as follows (in thousands):
December 31, 2017 | |||||||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||||
Available-for-Sale Securities | |||||||||||||||||||||||
Debt Securities: | |||||||||||||||||||||||
U.S. Government agencies | $ | 8,201 | $ | (47 | ) | $ | 6,741 | $ | (27 | ) | $ | 14,942 | $ | (74 | ) | ||||||||
Obligations of states and political subdivisions | 1,627 | (3 | ) | 3,357 | (87 | ) | 4,984 | (90 | ) | ||||||||||||||
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations | 82,604 | (822 | ) | 64,488 | (2,081 | ) | 147,092 | (2,903 | ) | ||||||||||||||
Private label residential mortgage and asset backed securities | 88,312 | (1,276 | ) | — | — | 88,312 | (1,276 | ) | |||||||||||||||
Other equity securities | 7,423 | (77 | ) | — | — | 7,423 | (77 | ) | |||||||||||||||
$ | 188,167 | $ | (2,225 | ) | $ | 74,586 | $ | (2,195 | ) | $ | 262,753 | $ | (4,420 | ) | |||||||||
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December 31, 2016 | |||||||||||||||||||||||
Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||||
Available-for-Sale Securities | |||||||||||||||||||||||
Debt Securities: | |||||||||||||||||||||||
U.S. Government agencies | $ | 34,586 | $ | (198 | ) | $ | 10,438 | $ | (79 | ) | $ | 45,024 | $ | (277 | ) | ||||||||
Obligations of states and political subdivisions | 122,522 | (4,353 | ) | — | — | 122,522 | (4,353 | ) | |||||||||||||||
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations | 118,719 | (3,866 | ) | 7,666 | (182 | ) | 126,385 | (4,048 | ) | ||||||||||||||
Other equity securities | 7,416 | (84 | ) | — | — | 7,416 | (84 | ) | |||||||||||||||
$ | 283,243 | $ | (8,501 | ) | $ | 18,104 | $ | (261 | ) | $ | 301,347 | $ | (8,762 | ) | |||||||||
We periodically evaluate each investment security for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. The portion of the impairment that is attributable to a shortage in the present value of expected future cash flows relative to the amortized cost should be recorded as a current period charge to earnings. The discount rate in this analysis is the original yield expected at time of purchase.
As of December 31, 2017, the Company performed an analysis of the investment portfolio to determine whether any of the investments held in the portfolio had an other-than-temporary impairment (OTTI). Management evaluated all investment securities with an unrealized loss at December 31, 2017, and identified those that had an unrealized loss for at least a consecutive 12 month period, which had an unrealized loss at December 31, 2017 greater than 10% of the recorded book value on that date, or which had an unrealized loss of more than $10,000. Management also analyzed any securities that may have been downgraded by credit rating agencies.
For those bonds that met the evaluation criteria, management obtained and reviewed the most recently published national credit ratings for those bonds. For those bonds that were obligations of states and political subdivisions with an investment grade rating by the rating agencies, management also evaluated the financial condition of the municipality and any applicable municipal bond insurance provider and concluded during March 2016 that a $136,000 credit related impairment related to one security with a fair value of $2,995,000 and a pre-impairment amortized cost of $3,131,000 existed. The Company recorded an other-than-temporary impairment loss of $136,000 during the twelve months ended December 31, 2016. There were no OTTI losses recorded during the twelve months ended December 31, 2017.
U.S. Government Agencies - At December 31, 2017, the Company held 22 U.S. Government agency securities of which two were in a loss position for less than 12 months and two were in a loss position and had been in a loss position for 12 months or more. The unrealized losses on the Company’s investments in U.S. Government Agencies were caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized costs of the investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell, and it is more likely than not that it will not be required to sell those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2017.
Obligations of States and Political Subdivisions - At December 31, 2017, the Company held 91 obligations of states and political subdivision securities of which one was in a loss position for less than 12 months and one was in a loss position or had been in a loss position for 12 months or more. The unrealized losses on the Company’s investments in obligations of states and political subdivision securities were caused by interest rate changes. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell, and it is more likely than not that it will not be required to sell those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2017.
U.S. Government Sponsored Entities and Agencies Collateralized by Residential Mortgage Obligations - At December 31, 2017, the Company held 150 U.S. Government sponsored entity and agency securities collateralized by residential mortgage obligation securities of which 42 were in a loss position for less than 12 months and 27 in a loss position for more than 12 months. The unrealized losses on the Company’s investments in U.S. Government sponsored entity and agencies collateralized by residential mortgage obligations were caused by interest rate changes. The contractual cash flows of those investments are guaranteed or supported by an agency or sponsored entity of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell,
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and it is more likely than not that it will not be required to sell those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2017.
Private Label Mortgage and Asset Backed Securities - At December 31, 2017, the Company had a total of 30 PLMBS with a remaining principal balance of $91,033,000 and a gross and net unrealized loss of approximately $352,000. 17 of these securities had an unrealized loss at December 31, 2017. Ten of these PLMBS with a remaining principal balance of $1,359,000 had credit ratings below investment grade. The Company continues to monitor these securities for changes in credit ratings or other indications of credit deterioration.
The following table provides a rollforward for the years ended December 31, 2017 and 2016 of investment securities credit losses recorded in earnings (in thousands). The beginning balance represents the credit loss component for which OTTI occurred on debt securities in prior periods. Additions represent the first time a debt security was credit impaired or when subsequent credit impairments have occurred on securities for which OTTI credit losses have been previously recognized.
Years ended December 31, | ||||||||
2017 | 2016 | |||||||
Beginning balance of credit losses recognized | $ | 874 | $ | 747 | ||||
Amounts related to credit loss for which an OTTI charge was not previously recognized | — | 136 | ||||||
Realized losses for securities sold | — | (9 | ) | |||||
Ending balance of credit losses recognized | $ | 874 | $ | 874 | ||||
The amortized cost and estimated fair value of available-for-sale investment securities at December 31, 2017 and 2016 by contractual maturity are shown in the two tables below (in thousands). Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.
December 31, 2017 | December 31, 2016 | |||||||||||||||
Amortized Cost | Estimated Fair Value | Amortized Cost | Estimated Fair Value | |||||||||||||
Within one year | $ | 1,893 | $ | 1,914 | $ | — | $ | — | ||||||||
After one year through five years | 7,149 | 7,316 | 15,145 | 15,484 | ||||||||||||
After five years through ten years | 22,043 | 22,696 | 35,667 | 35,614 | ||||||||||||
After ten years | 105,870 | 111,179 | 237,731 | 239,201 | ||||||||||||
136,955 | 143,105 | 288,543 | 290,299 | |||||||||||||
Investment securities not due at a single maturity date: | ||||||||||||||||
U.S. Government agencies | 65,994 | 66,587 | 69,005 | 68,970 | ||||||||||||
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations | 237,210 | 234,908 | 181,785 | 178,221 | ||||||||||||
Private label mortgage and asset backed securities | 91,033 | 90,681 | 1,807 | 2,843 | ||||||||||||
Other equity securities | 7,500 | 7,423 | 7,500 | 7,416 | ||||||||||||
$ | 538,692 | $ | 542,704 | $ | 548,640 | $ | 547,749 | |||||||||
Investment securities with amortized costs totaling $88,930,000 and $86,418,000 and fair values totaling $90,541,000 and $88,903,000 were pledged as collateral for borrowing arrangements, public funds and for other purposes at December 31, 2017 and 2016, respectively.
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5. LOANS AND ALLOWANCE FOR CREDIT LOSSES
Outstanding loans are summarized as follows (in thousands):
Loan Type | December 31, 2017 | % of Total loans | December 31, 2016 | % of Total loans | ||||||||||
Commercial: | ||||||||||||||
Commercial and industrial | $ | 100,856 | 11.2 | % | $ | 88,652 | 11.7 | % | ||||||
Agricultural land and production | 14,956 | 1.7 | % | 25,509 | 3.4 | % | ||||||||
Total commercial | 115,812 | 12.9 | % | 114,161 | 15.1 | % | ||||||||
Real estate: | ||||||||||||||
Owner occupied | 204,452 | 22.7 | % | 191,665 | 25.3 | % | ||||||||
Real estate construction and other land loans | 96,460 | 10.7 | % | 69,200 | 9.1 | % | ||||||||
Commercial real estate | 269,254 | 29.9 | % | 184,225 | 24.3 | % | ||||||||
Agricultural real estate | 76,081 | 8.4 | % | 86,761 | 11.5 | % | ||||||||
Other real estate | 31,220 | 3.5 | % | 18,945 | 2.7 | % | ||||||||
677,467 | 75.2 | % | 550,796 | 72.9 | % | |||||||||
Consumer: | ||||||||||||||
Equity loans and lines of credit | 76,404 | 8.5 | % | 64,494 | 8.5 | % | ||||||||
Consumer and installment | 29,637 | 3.4 | % | 25,910 | 3.5 | % | ||||||||
Total consumer | 106,041 | 11.9 | % | 90,404 | 12.0 | % | ||||||||
Net deferred origination costs | 1,359 | 1,267 | ||||||||||||
Total gross loans | 900,679 | 100.0 | % | 756,628 | 100.0 | % | ||||||||
Allowance for credit losses | (8,778 | ) | (9,326 | ) | ||||||||||
Total loans | $ | 891,901 | $ | 747,302 | ||||||||||
At December 31, 2017 and 2016, loans originated under Small Business Administration (SBA) programs totaling $25,925,000 and $16,590,000, respectively, were included in the real estate and commercial categories. Approximately $356,977,000 in loans were pledged under a blanket lien as collateral to the FHLB for the Bank’s remaining borrowing capacity of $234,689,000 as of December 31, 2017. The Bank’s credit limit varies according to the amount and composition of the investment and loan portfolios pledged as collateral.
Salaries and employee benefits totaling $2,593,000, $2,344,000, and $2,056,000 have been deferred as loan origination costs for the years ended December 31, 2017, 2016, and 2015, respectively.
Purchased Credit Impaired Loans
The Company has loans that were acquired in acquisitions for which there was at acquisition evidence of deterioration of credit quality since origination, and for which it was probable at acquisition that all contractually required payments would not be collected.
The carrying amount of those loans is included in the balance sheet amounts of loans receivable at December 31. The amounts of loans at December 31 are as follows (in thousands):
December 31, | ||||||||
2017 | 2016 | |||||||
Commercial | $ | 383 | $ | 612 | ||||
Outstanding balance | $ | 383 | $ | 612 | ||||
Carrying amount, net of allowance of $0 | $ | 383 | $ | 612 | ||||
Purchased credit impaired (PCI) loans are recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. The Company estimates the amount and timing of expected cash flows for each loan and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan (accretable yield). The excess of the loan’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference). Over the life of the loan, expected cash flows continue to be estimated. If the present value of expected cash flows
83
is less than the carrying amount, a loss is recorded. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.
Loans acquired during each year for which it was probable at acquisition that all contractually required payments would not be collected are as follows (in thousands):
December 31, | ||||||||
2017 | 2016 | |||||||
Contractually required payments receivable on PCI loans at acquisition: | ||||||||
Commercial | $ | — | $ | 982 | ||||
Total | $ | — | $ | 982 | ||||
Cash flows expected to be collected at acquisition | $ | — | $ | 693 | ||||
Fair value of acquired loans at acquisition | $ | — | $ | 631 | ||||
Certain of the loans acquired by the Company that are within the scope of Topic ASC 310-30 are not accounted for using the income recognition model of the Topic because the Company cannot reliably estimate cash flows expected to be collected. The carrying amounts of such loans (which are included in the carrying amount, net of allowance, described above) are as follows.
December 31, | ||||||||
2017 | 2016 | |||||||
Loans acquired during the year | $ | — | $ | 631 | ||||
Loans at the end of the year | $ | 383 | $ | 612 | ||||
Allowance for Credit Losses
The allowance for credit losses (the “allowance”) is a valuation allowance for probable incurred credit losses in the Company’s loan portfolio. The allowance is established through a provision for credit losses which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged-off credits is recorded as a recovery to the allowance. The overall allowance consists of two primary components, specific reserves related to impaired loans and general reserves for probable incurred losses related to loans that are not impaired.
For all portfolio segments, the determination of the general reserve for loans that are not impaired is based on estimates made by management, including but not limited to, consideration of historical losses by portfolio segment (and in certain cases peer loss data) over the most recent 20 quarters, and qualitative factors including economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan portfolio, and probable losses inherent in the portfolio taken as a whole.
Changes in the allowance for credit losses were as follows (in thousands):
Years Ended December 31, | ||||||||||||
2017 | 2016 | 2015 | ||||||||||
Balance, beginning of year | $ | 9,326 | $ | 9,610 | $ | 8,308 | ||||||
(Reversal of) Provision charged to operations | (1,150 | ) | (5,850 | ) | 600 | |||||||
Losses charged to allowance | (464 | ) | (883 | ) | (961 | ) | ||||||
Recoveries | 1,066 | 6,449 | 1,663 | |||||||||
Balance, end of year | $ | 8,778 | $ | 9,326 | $ | 9,610 | ||||||
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The following table shows the summary of activities for the allowance for credit losses as of and for the years ended December 31, 2017, 2016, and 2015 by portfolio segment (in thousands):
Commercial | Real Estate | Consumer | Unallocated | Total | ||||||||||||||||
Allowance for credit losses: | ||||||||||||||||||||
Beginning balance, January 1, 2017 | $ | 2,180 | $ | 6,200 | $ | 852 | $ | 94 | $ | 9,326 | ||||||||||
(Reversal of ) Provision charged to operations | (762 | ) | (449 | ) | 68 | (7 | ) | (1,150 | ) | |||||||||||
Losses charged to allowance | (207 | ) | (22 | ) | (235 | ) | — | (464 | ) | |||||||||||
Recoveries | 860 | 66 | 140 | — | 1,066 | |||||||||||||||
Ending balance, December 31, 2017 | $ | 2,071 | $ | 5,795 | $ | 825 | $ | 87 | $ | 8,778 | ||||||||||
Allowance for credit losses: | ||||||||||||||||||||
Beginning balance, January 1, 2016 | $ | 3,562 | $ | 5,204 | $ | 734 | $ | 110 | $ | 9,610 | ||||||||||
Provision charged to operations | (6,048 | ) | 11 | 203 | (16 | ) | (5,850 | ) | ||||||||||||
Losses charged to allowance | (621 | ) | — | (262 | ) | — | (883 | ) | ||||||||||||
Recoveries | 5,287 | 985 | 177 | — | 6,449 | |||||||||||||||
Ending balance, December 31, 2016 | $ | 2,180 | $ | 6,200 | $ | 852 | $ | 94 | $ | 9,326 | ||||||||||
Allowance for credit losses: | ||||||||||||||||||||
Beginning balance, January 1, 2015 | $ | 3,130 | $ | 4,058 | $ | 1,078 | $ | 42 | $ | 8,308 | ||||||||||
Provision charged to operations | 190 | 1,114 | (772 | ) | 68 | 600 | ||||||||||||||
Losses charged to allowance | (802 | ) | — | (159 | ) | — | (961 | ) | ||||||||||||
Recoveries | 1,044 | 32 | 587 | — | 1,663 | |||||||||||||||
Ending balance, December 31, 2015 | $ | 3,562 | $ | 5,204 | $ | 734 | $ | 110 | $ | 9,610 | ||||||||||
The following is a summary of the allowance for credit losses by impairment methodology and portfolio segment as of December 31, 2017 and December 31, 2016 (in thousands):
Commercial | Real Estate | Consumer | Unallocated | Total | ||||||||||||||||
Allowance for credit losses: | ||||||||||||||||||||
Ending balance, December 31, 2017 | $ | 2,071 | $ | 5,795 | $ | 825 | $ | 87 | $ | 8,778 | ||||||||||
Ending balance: individually evaluated for impairment | $ | 1 | $ | 1 | $ | 34 | $ | — | $ | 36 | ||||||||||
Ending balance: collectively evaluated for impairment | $ | 2,070 | $ | 5,794 | $ | 791 | $ | 87 | $ | 8,742 | ||||||||||
Ending balance, December 31, 2016 | $ | 2,180 | $ | 6,200 | $ | 852 | $ | 94 | $ | 9,326 | ||||||||||
Ending balance: individually evaluated for impairment | $ | 3 | $ | 241 | $ | 63 | $ | — | $ | 307 | ||||||||||
Ending balance: collectively evaluated for impairment | $ | 2,177 | $ | 5,959 | $ | 789 | $ | 94 | $ | 9,019 | ||||||||||
The following table shows the ending balances of loans as of December 31, 2017 and December 31, 2016 by portfolio segment and by impairment methodology (in thousands):
Commercial | Real Estate | Consumer | Total | |||||||||||||
Loans: | ||||||||||||||||
Ending balance, December 31, 2017 | $ | 115,812 | $ | 677,467 | $ | 106,041 | $ | 899,320 | ||||||||
Ending balance: individually evaluated for impairment | $ | 377 | $ | 4,846 | $ | 1,143 | $ | 6,366 | ||||||||
Ending balance: collectively evaluated for impairment | $ | 115,435 | $ | 672,621 | $ | 104,898 | $ | 892,954 | ||||||||
Loans: | ||||||||||||||||
Ending balance, December 31, 2016 | $ | 114,161 | $ | 550,796 | $ | 90,404 | $ | 755,361 | ||||||||
Ending balance: individually evaluated for impairment | $ | 487 | $ | 4,238 | $ | 544 | $ | 5,269 | ||||||||
Ending balance: collectively evaluated for impairment | $ | 113,674 | $ | 546,558 | $ | 89,860 | $ | 750,092 | ||||||||
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The following table shows the loan portfolio by class allocated by management’s internal risk ratings at December 31, 2017 (in thousands):
Pass | Special Mention | Substandard | Doubtful | Total | ||||||||||||||||
Commercial: | ||||||||||||||||||||
Commercial and industrial | $ | 84,745 | $ | 8,217 | $ | 7,894 | $ | — | $ | 100,856 | ||||||||||
Agricultural land and production | 10,848 | 206 | 3,902 | — | 14,956 | |||||||||||||||
Real Estate: | ||||||||||||||||||||
Owner occupied | 196,838 | 4,795 | 2,819 | — | 204,452 | |||||||||||||||
Real estate construction and other land loans | 90,927 | 1,625 | 3,908 | — | 96,460 | |||||||||||||||
Commercial real estate | 261,746 | 4,147 | 3,361 | — | 269,254 | |||||||||||||||
Agricultural real estate | 48,274 | 1,270 | 26,537 | — | 76,081 | |||||||||||||||
Other real estate | 29,867 | 1,165 | 188 | — | 31,220 | |||||||||||||||
Consumer: | ||||||||||||||||||||
Equity loans and lines of credit | 74,535 | 483 | 1,386 | — | 76,404 | |||||||||||||||
Consumer and installment | 29,634 | — | 3 | — | 29,637 | |||||||||||||||
Total | $ | 827,414 | $ | 21,908 | $ | 49,998 | $ | — | $ | 899,320 | ||||||||||
The following table shows the loan portfolio by class allocated by management’s internally assigned risk grade ratings at December 31, 2016 (in thousands):
Pass | Special Mention | Substandard | Doubtful | Total | ||||||||||||||||
Commercial: | ||||||||||||||||||||
Commercial and industrial | $ | 75,212 | $ | 907 | $ | 12,533 | $ | — | $ | 88,652 | ||||||||||
Agricultural land and production | 16,562 | 8,681 | 266 | — | 25,509 | |||||||||||||||
Real Estate: | ||||||||||||||||||||
Owner occupied | 184,987 | 2,865 | 3,813 | — | 191,665 | |||||||||||||||
Real estate construction and other land loans | 62,538 | 5,259 | 1,403 | — | 69,200 | |||||||||||||||
Commercial real estate | 179,966 | 1,548 | 2,711 | — | 184,225 | |||||||||||||||
Agricultural real estate | 49,270 | 10,390 | 27,101 | — | 86,761 | |||||||||||||||
Other real estate | 18,779 | 166 | — | — | 18,945 | |||||||||||||||
Consumer: | ||||||||||||||||||||
Equity loans and lines of credit | 62,782 | 95 | 1,617 | — | 64,494 | |||||||||||||||
Consumer and installment | 25,890 | — | 20 | — | 25,910 | |||||||||||||||
Total | $ | 675,986 | $ | 29,911 | $ | 49,464 | $ | — | $ | 755,361 | ||||||||||
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The following table shows an aging analysis of the loan portfolio by class and the time past due at December 31, 2017 (in thousands):
30-59 Days Past Due | 60-89 Days Past Due | Greater Than 90 Days Past Due | Total Past Due | Current | Total Loans | Recorded Investment > 90 Days Accruing | Non-accrual | |||||||||||||||||||||||||
Commercial: | ||||||||||||||||||||||||||||||||
Commercial and industrial | $ | — | $ | — | $ | — | $ | — | $ | 100,856 | $ | 100,856 | $ | — | $ | 356 | ||||||||||||||||
Agricultural land and production | — | — | — | — | 14,956 | 14,956 | — | — | ||||||||||||||||||||||||
Real estate: | — | — | — | |||||||||||||||||||||||||||||
Owner occupied | — | — | — | — | 204,452 | 204,452 | — | — | ||||||||||||||||||||||||
Real estate construction and other land loans | — | — | 1,397 | 1,397 | 95,063 | 96,460 | — | 1,397 | ||||||||||||||||||||||||
Commercial real estate | — | — | — | — | 269,254 | 269,254 | — | 976 | ||||||||||||||||||||||||
Agricultural real estate | — | — | — | — | 76,081 | 76,081 | — | — | ||||||||||||||||||||||||
Other real estate | — | 1,165 | — | 1,165 | 30,055 | 31,220 | — | — | ||||||||||||||||||||||||
Consumer: | — | — | ||||||||||||||||||||||||||||||
Equity loans and lines of credit | 149 | — | — | 149 | 76,255 | 76,404 | — | 146 | ||||||||||||||||||||||||
Consumer and installment | 26 | — | — | 26 | 29,611 | 29,637 | — | — | ||||||||||||||||||||||||
Total | $ | 175 | $ | 1,165 | $ | 1,397 | $ | 2,737 | $ | 896,583 | $ | 899,320 | $ | — | $ | 2,875 | ||||||||||||||||
The following table shows an aging analysis of the loan portfolio by class and the time past due at December 31, 2016 (in thousands):
30-59 Days Past Due | 60-89 Days Past Due | Greater Than 90 Days Past Due | Total Past Due | Current | Total Loans | Recorded Investment > 90 Days Accruing | Non- accrual | |||||||||||||||||||||||||
Commercial: | ||||||||||||||||||||||||||||||||
Commercial and industrial | $ | — | $ | — | $ | — | $ | — | $ | 88,652 | $ | 88,652 | $ | — | $ | 447 | ||||||||||||||||
Agricultural land and production | — | — | — | — | 25,509 | 25,509 | — | — | ||||||||||||||||||||||||
Real estate: | — | — | ||||||||||||||||||||||||||||||
Owner occupied | 87 | — | — | 87 | 191,578 | 191,665 | — | 107 | ||||||||||||||||||||||||
Real estate construction and other land loans | — | — | — | — | 69,200 | 69,200 | — | — | ||||||||||||||||||||||||
Commercial real estate | 565 | — | — | 565 | 183,660 | 184,225 | — | 1,082 | ||||||||||||||||||||||||
Agricultural real estate | — | — | — | — | 86,761 | 86,761 | — | — | ||||||||||||||||||||||||
Other real estate | — | — | — | — | 18,945 | 18,945 | — | — | ||||||||||||||||||||||||
Consumer: | — | |||||||||||||||||||||||||||||||
Equity loans and lines of credit | 62 | 48 | — | 110 | 64,384 | 64,494 | — | 526 | ||||||||||||||||||||||||
Consumer and installment | 38 | — | — | 38 | 25,872 | 25,910 | — | 18 | ||||||||||||||||||||||||
Total | $ | 752 | $ | 48 | $ | — | $ | 800 | $ | 754,561 | $ | 755,361 | $ | — | $ | 2,180 | ||||||||||||||||
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The following table shows information related to impaired loans by class at December 31, 2017 (in thousands):
Recorded Investment | Unpaid Principal Balance | Related Allowance | ||||||||||
With no related allowance recorded: | ||||||||||||
Commercial: | ||||||||||||
Commercial and industrial | $ | 355 | $ | 553 | $ | — | ||||||
Real estate: | ||||||||||||
Real estate construction and other land loans | 3,023 | 3,085 | — | |||||||||
Commercial real estate | 1,772 | 2,040 | — | |||||||||
Total real estate | 4,795 | 5,125 | — | |||||||||
Consumer: | ||||||||||||
Equity loans and lines of credit | 146 | 206 | — | |||||||||
Total with no related allowance recorded | 5,296 | 5,884 | — | |||||||||
With an allowance recorded: | ||||||||||||
Commercial: | ||||||||||||
Commercial and industrial | 22 | 22 | 1 | |||||||||
Real estate: | ||||||||||||
Agricultural real estate | 51 | 51 | 1 | |||||||||
Consumer: | ||||||||||||
Equity loans and lines of credit | 997 | 997 | 34 | |||||||||
Total with an allowance recorded | 1,070 | 1,070 | 36 | |||||||||
Total | $ | 6,366 | $ | 6,954 | $ | 36 | ||||||
The recorded investment in loans excludes accrued interest receivable and net loan origination fees, due to immateriality.
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The following table shows information related to impaired loans by class at December 31, 2016 (in thousands):
Recorded Investment | Unpaid Principal Balance | Related Allowance | ||||||||||
With no related allowance recorded: | ||||||||||||
Commercial: | ||||||||||||
Commercial and industrial | $ | 447 | $ | 612 | $ | — | ||||||
Real estate: | ||||||||||||
Owner occupied | 107 | 111 | — | |||||||||
Commercial real estate | 827 | 967 | — | |||||||||
Total real estate | 934 | 1,078 | — | |||||||||
Consumer: | ||||||||||||
Equity loans and lines of credit | 167 | 234 | — | |||||||||
Consumer and installment | 6 | 9 | — | |||||||||
Total consumer | 173 | 243 | — | |||||||||
Total with no related allowance recorded | 1,554 | 1,933 | — | |||||||||
With an allowance recorded: | ||||||||||||
Commercial: | ||||||||||||
Commercial and industrial | 40 | 40 | 3 | |||||||||
Real estate: | ||||||||||||
Real estate construction and other land loans | 2,222 | 2,222 | 79 | |||||||||
Commercial real estate | 1,082 | 1,146 | 162 | |||||||||
Total real estate | 3,304 | 3,368 | 241 | |||||||||
Consumer: | ||||||||||||
Equity loans and lines of credit | 359 | 364 | 61 | |||||||||
Consumer and installment | 12 | 12 | 2 | |||||||||
Total consumer | 371 | 376 | 63 | |||||||||
Total with an allowance recorded | 3,715 | 3,784 | 307 | |||||||||
Total | $ | 5,269 | $ | 5,717 | $ | 307 | ||||||
The recorded investment in loans excludes accrued interest receivable and net loan origination fees, due to immateriality.
89
The following presents by class, information related to the average recorded investment and interest income recognized on impaired loans for the years ended December 31, 2017, 2016, and 2015 (in thousands):
Year Ended December 31, 2017 | Year Ended December 31, 2016 | Year Ended December 31, 2015 | ||||||||||||||||||||||
Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | |||||||||||||||||||
With no related allowance recorded: | ||||||||||||||||||||||||
Commercial: | ||||||||||||||||||||||||
Commercial and industrial | $ | 404 | $ | — | $ | 115 | $ | — | $ | 2,921 | $ | — | ||||||||||||
Agricultural land and production | — | — | 42 | — | — | — | ||||||||||||||||||
Total commercial | 404 | — | 157 | — | 2,921 | — | ||||||||||||||||||
Real estate: | ||||||||||||||||||||||||
Owner occupied | 24 | — | 162 | — | 770 | 231 | ||||||||||||||||||
Real estate construction and other land loans | 1,228 | 114 | 2,393 | 196 | 1,266 | 79 | ||||||||||||||||||
Commercial real estate | 1,370 | 53 | 903 | 55 | 1,939 | — | ||||||||||||||||||
Agricultural real estate | — | — | 173 | — | 211 | — | ||||||||||||||||||
Total real estate | 2,622 | 167 | 3,631 | 251 | 4,186 | 310 | ||||||||||||||||||
Consumer: | ||||||||||||||||||||||||
Equity loans and lines of credit | 132 | — | 598 | — | 1,858 | — | ||||||||||||||||||
Consumer and installment | 6 | — | 41 | — | — | — | ||||||||||||||||||
Total consumer | 138 | — | 639 | — | 1,858 | — | ||||||||||||||||||
Total with no related allowance recorded | 3,164 | 167 | 4,427 | 251 | 8,965 | 310 | ||||||||||||||||||
— | ||||||||||||||||||||||||
With an allowance recorded: | — | |||||||||||||||||||||||
Commercial: | — | |||||||||||||||||||||||
Commercial and industrial | 38 | 1 | 441 | 3 | 243 | — | ||||||||||||||||||
Agricultural land and production | — | — | 104 | — | — | — | ||||||||||||||||||
Total commercial | 38 | 1 | 545 | 3 | 243 | — | ||||||||||||||||||
Real estate: | — | — | — | |||||||||||||||||||||
Owner occupied | — | — | 120 | — | 190 | — | ||||||||||||||||||
Real estate construction and other land loans | 1,827 | — | 171 | — | 2,297 | — | ||||||||||||||||||
Commercial real estate | 470 | — | 548 | — | 753 | — | ||||||||||||||||||
Agricultural real estate | 43 | 3 | — | — | — | — | ||||||||||||||||||
Total real estate | 2,340 | 3 | 839 | — | 3,240 | — | ||||||||||||||||||
Consumer: | ||||||||||||||||||||||||
Equity loans and lines of credit | 239 | 32 | 203 | — | 328 | — | ||||||||||||||||||
Consumer and installment | 1 | — | 19 | — | 16 | — | ||||||||||||||||||
Total consumer | 240 | 32 | 222 | — | 344 | — | ||||||||||||||||||
Total with an allowance recorded | 2,618 | 36 | 1,606 | 3 | 3,827 | — | ||||||||||||||||||
Total | $ | 5,782 | $ | 203 | $ | 6,033 | $ | 254 | $ | 12,792 | $ | 310 | ||||||||||||
Foregone interest on nonaccrual loans totaled $210,000, $245,000, and $340,000 for the years ended December 31, 2017, 2016, and 2015, respectively. Interest income recognized on cash basis during the years presented above was not considered significant for financial reporting purposes.
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Troubled Debt Restructurings:
As of December 31, 2017 and 2016, the Company has a recorded investment in troubled debt restructurings of $3,551,000 and, $3,109,000, respectively. The Company has allocated $36,000 and $82,000 of specific reserves for those loans at December 31, 2017 and 2016, respectively. The Company has committed to lend no additional amounts as of December 31, 2017 to customers with outstanding loans that are classified as troubled debt restructurings.
For the years ended December 31, 2017, 2016, and 2015 the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan or an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk. During the same periods, there were no troubled debt restructurings in which the amount of principal or accrued interest owed from the borrower were forgiven.
The following table presents loans by class modified as troubled debt restructurings that occurred during the year ended December 31, 2017 (dollars in thousands):
Troubled Debt Restructurings: | Number of Loans | Pre-Modification Outstanding Recorded Investment (1) | Principal Modification | Post Modification Outstanding Recorded Investment (2) | Outstanding Recorded Investment | ||||||||||||||
Real Estate: | |||||||||||||||||||
Agricultural real estate | 1 | $ | 59 | — | $ | 59 | $ | 51 | |||||||||||
Consumer: | |||||||||||||||||||
Equity loans and line of credit | 2 | 490 | — | 1,066 | 1,059 | ||||||||||||||
Total | 3 | $ | 549 | $ | — | $ | 1,125 | $ | 1,110 | ||||||||||
(1) | Amounts represent the recorded investment in loans before recognizing effects of the TDR, if any. |
(2) | Balance outstanding after principal modification, if any borrower reduction to recorded investment. |
The following table presents loans by class modified as troubled debt restructurings that occurred during the year ended December 31, 2016 (dollars in thousands):
Troubled Debt Restructurings: | Number of Loans | Pre-Modification Outstanding Recorded Investment (1) | Principal Modification | Post Modification Outstanding Recorded Investment (2) | Outstanding Recorded Investment | ||||||||||||||
Commercial: | |||||||||||||||||||
Commercial and Industrial | 2 | $ | 45 | $ | — | $ | 45 | $ | 40 | ||||||||||
(1) | Amounts represent the recorded investment in loans before recognizing effects of the TDR, if any. |
(2) | Balance outstanding after principal modification, if any borrower reduction to recorded investment. |
The following table presents loans by class modified as troubled debt restructurings that occurred during the year ended December 31, 2015 (dollars in thousands):
Troubled Debt Restructurings: | Number of Loans | Pre-Modification Outstanding Recorded Investment (1) | Principal Modification | Post Modification Outstanding Recorded Investment (2) | Outstanding Recorded Investment | ||||||||||||||
Commercial: | |||||||||||||||||||
Commercial and Industrial | 2 | $ | 42 | $ | — | $ | 42 | $ | 30 | ||||||||||
(1) | Amounts represent the recorded investment in loans before recognizing effects of the TDR, if any. |
(2) | Balance outstanding after principal modification, if any borrower reduction to recorded investment. |
A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There were no defaults on troubled debt restructurings within 12 months following the modification during the years ended December 31, 2017, 2016, and 2015.
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6. | BANK PREMISES AND EQUIPMENT |
Bank premises and equipment consisted of the following (in thousands):
December 31, | ||||||||
2017 | 2016 | |||||||
Land | $ | 1,131 | $ | 1,131 | ||||
Buildings and improvements | 6,754 | 6,680 | ||||||
Furniture, fixtures and equipment | 12,345 | 11,521 | ||||||
Leasehold improvements | 4,594 | 4,100 | ||||||
24,824 | 23,432 | |||||||
Less accumulated depreciation and amortization | (15,426 | ) | (14,025 | ) | ||||
$ | 9,398 | $ | 9,407 | |||||
Depreciation and amortization included in occupancy and equipment expense totaled $1,429,000, $1,320,000 and $1,392,000 for the years ended December 31, 2017, 2016, and 2015, respectively.
7. GOODWILL AND INTANGIBLE ASSETS
The change in goodwill during the years ended December 31, 2017, 2016, and 2015 is as follows (in thousands):
2017 | 2016 | 2015 | |||||||||
Balance, beginning of year | $ | 40,231 | $ | 29,917 | $ | 29,917 | |||||
Acquired goodwill | 13,546 | 10,314 | — | ||||||||
Impairment | — | — | — | ||||||||
Balance, end of year | $ | 53,777 | $ | 40,231 | $ | 29,917 | |||||
Business combinations involving the Company’s acquisition of the equity interests or net assets of another enterprise give rise to goodwill. Total goodwill at December 31, 2017 and 2016 was $53,777,000 and $40,231,000, respectively. Total goodwill at December 31, 2017 consisted of $13,466,000, $10,394,000, $6,340,000, $14,643,000, and $8,934,000 representing the excess of the cost of Folsom Lake Bank, Sierra Vista Bank, Visalia Community Bank, Service 1st Bancorp, and Bank of Madera County, respectively, over the net of the amounts assigned to assets acquired and liabilities assumed in the transactions accounted for under the purchase method of accounting. During the year ended December 31, 2017, the Company determined that a measurement adjustment was appropriate to the goodwill recorded as part of the Sierra Vista Bank acquisitions which resulted in an $80,000 increase to goodwill. The value of goodwill is ultimately derived from the Company’s ability to generate net earnings after the acquisitions and is not deductible for tax purposes. A decline in net earnings could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill is assessed at least annually for impairment.
The Company has selected September 30 as the date to perform the annual impairment test. Management assessed qualitative factors including performance trends and noted no factors indicating goodwill impairment.
Goodwill is also tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the Company below its carrying amount. No such events or circumstances arose during the fourth quarter of 2017, so goodwill was not required to be retested.
The intangible assets at December 31, 2017 represent the estimated fair value of the core deposit relationships acquired in the acquisition of Folsom Lake Bank in 2017 of $1,879,000, Sierra Vista Bank in 2016 of $508,000 and the 2013 acquisition of Visalia Community Bank of $1,365,000. Core deposit intangibles are being amortized using the straight-line method over an estimated life of ten years from the date of acquisition. At December 31, 2017, the weighted average remaining amortization period is eight years. The carrying value of intangible assets at December 31, 2017 was $3,027,000, net of $725,000 in accumulated amortization expense. The carrying value at December 31, 2016 was $1,383,000, net of $490,000 in accumulated amortization expense. Management evaluates the remaining useful lives quarterly to determine whether events or circumstances warrant a revision to the remaining periods of amortization. Based on the evaluation, no changes to the remaining useful lives was required. Management performed an annual impairment test on core deposit intangibles as of September 30, 2017 and determined no impairment was necessary. Amortization expense recognized was $234,000 for 2017, $149,000 for 2016, and $320,000 for 2015.
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The following table summarizes the Company’s estimated core deposit intangible amortization expense for each of the next five years (in thousands):
Years Ending December 31, | Estimated Core Deposit Intangible Amortization | |||
2018 | $ | 376 | ||
2019 | 376 | |||
2020 | 376 | |||
2021 | 376 | |||
2022 | 376 | |||
Thereafter | 1,147 | |||
Total | $ | 3,027 | ||
8. DEPOSITS
Interest-bearing deposits consisted of the following (in thousands):
December 31, | ||||||||
2017 | 2016 | |||||||
Savings | $ | 116,534 | $ | 105,098 | ||||
Money market | 299,638 | 250,749 | ||||||
NOW accounts | 296,406 | 247,623 | ||||||
Time, $250,000 or more | 34,441 | 39,284 | ||||||
Time, under $250,000 | 93,629 | 117,410 | ||||||
$ | 840,648 | $ | 760,164 | |||||
Aggregate annual maturities of time deposits are as follows (in thousands):
Years Ending December 31, | ||||
2018 | $ | 107,348 | ||
2019 | 13,229 | |||
2020 | 3,086 | |||
2021 | 1,519 | |||
2022 | 1,769 | |||
Thereafter | 1,119 | |||
$ | 128,070 | |||
Interest expense recognized on interest-bearing deposits consisted of the following (in thousands):
Years Ended December 31, | ||||||||||||
2017 | 2016 | 2015 | ||||||||||
Savings | $ | 33 | $ | 27 | $ | 30 | ||||||
Money market | 211 | 133 | 141 | |||||||||
NOW accounts | 317 | 290 | 231 | |||||||||
Time certificates of deposit | 408 | 525 | 546 | |||||||||
$ | 969 | $ | 975 | $ | 948 | |||||||
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9. BORROWING ARRANGEMENTS
Federal Home Loan Bank Advances - As of December 31, 2017 and 2016, the Company had no Federal Home Loan Bank (FHLB) of San Francisco advances.
Approximately $356,977,000 in loans were pledged under a blanket lien as collateral to the FHLB for the Bank’s remaining borrowing capacity of $234,689,000 as of December 31, 2017. FHLB advances are also secured by investment securities with amortized costs totaling $416,000 and $584,000 and market values totaling $440,000 and $637,000 at December 31, 2017 and 2016, respectively. The Bank’s credit limit varies according to the amount and composition of the investment and loan portfolios pledged as collateral.
Lines of Credit - The Bank had unsecured lines of credit with its correspondent banks which, in the aggregate, amounted to $40,000,000 at December 31, 2017 and 2016, at interest rates which vary with market conditions. As of December 31, 2017, the Company had no in Federal funds purchased. The Company had $400,000 overnight borrowings outstanding under these credit facilities at December 31, 2016.
Federal Reserve Line of Credit - The Bank has a line of credit in the amount of $6,740,000 and $9,102,000 with the Federal Reserve Bank of San Francisco (FRB) at December 31, 2017 and 2016, respectively, which bears interest at the prevailing discount rate collateralized by investment securities with amortized costs totaling $7,431,000 and $9,315,000 and market values totaling $7,437,000 and $9,277,000, respectively. At December 31, 2017 and 2016, the Bank had no outstanding borrowings with the FRB.
10. JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES
Service 1st Capital Trust I is a Delaware business trust formed by Service 1st. The Company succeeded to all of the rights and obligations of Service 1st in connection with the merger with Service 1st as of November 12, 2008. The Trust was formed on August 17, 2006 for the sole purpose of issuing trust preferred securities fully and unconditionally guaranteed by Service 1st. Under applicable regulatory guidance, the amount of trust preferred securities that is eligible as Tier 1 capital is limited to 25% of the Company’s Tier 1 capital on a pro forma basis. At December 31, 2017, all of the trust preferred securities that have been issued qualify as Tier 1 capital. The trust preferred securities mature on October 7, 2036, are redeemable at the Company’s option, and require quarterly distributions by the Trust to the holder of the trust preferred securities at a variable interest rate which will adjust quarterly to equal the three month LIBOR plus 1.60%.
The Trust used the proceeds from the sale of the trust preferred securities to purchase approximately $5,155,000 in aggregate principal amount of Service 1st’s junior subordinated notes (the Notes). The Notes bear interest at the same variable interest rate during the same quarterly periods as the trust preferred securities. The Notes are redeemable by the Company on any January 7, April 7, July 7, or October 7 or at any time within 90 days following the occurrence of certain events, such as: (i) a change in the regulatory capital treatment of the Notes (ii) in the event the Trust is deemed an investment company or (iii) upon the occurrence of certain adverse tax events. In each such case, the Company may redeem the Notes for their aggregate principal amount, plus any accrued but unpaid interest.
The Notes may be declared immediately due and payable at the election of the trustee or holders of 25% of the aggregate principal amount of outstanding Notes in the event that the Company defaults in the payment of any interest following the nonpayment of any such interest for 20 or more consecutive quarterly periods.
Holders of the trust preferred securities are entitled to a cumulative cash distribution on the liquidation amount of $1,000 per security. For each January 7, April 7, July 7 or October 7 of each year, the rate will be adjusted to equal the three month LIBOR plus 1.60%. As of December 31, 2017, the rate was 2.96%. Interest expense recognized by the Company for the years ended December 31, 2017, 2016, and 2015 was $147,000, $121,000 and $99,000, respectively.
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11. INCOME TAXES
The provision for income taxes for the years ended December 31, 2017, 2016, and 2015 consisted of the following (in thousands):
Federal | State | Total | ||||||||||
2017 | ||||||||||||
Current | $ | 1,188 | $ | 1,224 | $ | 2,412 | ||||||
Deferred | 3,328 | 518 | 3,846 | |||||||||
Re-measurement resulting from Tax Act | 3,535 | — | 3,535 | |||||||||
Provision for income taxes | $ | 8,051 | $ | 1,742 | $ | 9,793 | ||||||
2016 | ||||||||||||
Current | $ | 3,720 | $ | 605 | $ | 4,325 | ||||||
Deferred | 1,100 | 1,492 | 2,592 | |||||||||
Provision for income taxes | $ | 4,820 | $ | 2,097 | $ | 6,917 | ||||||
2015 | ||||||||||||
Current | $ | 2,945 | $ | 570 | $ | 3,515 | ||||||
Deferred | (1,208 | ) | 275 | (933 | ) | |||||||
Provision for income taxes | $ | 1,737 | $ | 845 | $ | 2,582 | ||||||
The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is more likely than not that all or a portion of the deferred tax asset will not be realized. More likely than not is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of the evidence, a valuation allowance is needed. Thus, Management concludes no valuation allowance is necessary against deferred tax assets.
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Deferred tax assets (liabilities) consisted of the following (in thousands):
December 31, | ||||||||
2017 | 2016 | |||||||
Deferred tax assets: | ||||||||
Allowance for credit losses | $ | 2,100 | $ | 3,267 | ||||
Deferred compensation | 4,415 | 5,304 | ||||||
Unrealized loss on available-for-sale investment securities | — | 375 | ||||||
Net operating loss carryovers | 2,549 | 3,816 | ||||||
Mark-to-market adjustment | 87 | 167 | ||||||
Other deferred | 386 | 338 | ||||||
Other-than-temporary impairment | 192 | 273 | ||||||
Loan and investment impairment | 1,793 | 1,285 | ||||||
State Enterprise Zone credit carry-forward | — | 209 | ||||||
Alternative minimum tax credit | — | 2,438 | ||||||
Partnership income | 68 | 114 | ||||||
State taxes | 375 | 297 | ||||||
Total deferred tax assets | 11,965 | 17,883 | ||||||
Deferred tax liabilities: | ||||||||
Finance leases | (365 | ) | (474 | ) | ||||
Unrealized gain on available-for-sale investment securities | (1,186 | ) | — | |||||
Core deposit intangible | (895 | ) | (582 | ) | ||||
FHLB stock | (234 | ) | (327 | ) | ||||
Loan origination costs | (783 | ) | (918 | ) | ||||
Bank premises and equipment | (478 | ) | (71 | ) | ||||
Total deferred tax liabilities | (3,941 | ) | (2,372 | ) | ||||
Net deferred tax assets | $ | 8,024 | $ | 15,511 | ||||
The provision for income taxes differs from amounts computed by applying the statutory Federal income tax rates to operating income before income taxes. The significant items comprising these differences for the years ended December 31, 2017, 2016, and 2015 consisted of the following:
2017 | 2016 | 2015 | ||||||
Federal income tax, at statutory rate | 35.0 | % | 35.0 | % | 34.0 | % | ||
State taxes, net of Federal tax benefit | 4.8 | % | 6.2 | % | 4.1 | % | ||
Tax exempt investment security income, net | (10.1 | )% | (10.3 | )% | (15.9 | )% | ||
Bank owned life insurance, net | (0.8 | )% | (1.1 | )% | (2.5 | )% | ||
Compensation - Stock Compensation | (2.8 | )% | — | % | — | % | ||
Re-measurement resulting from Tax Act | 14.8 | % | — | % | — | % | ||
Change in uncertain tax positions | (0.9 | )% | 0.1 | % | 0.8 | % | ||
Other | 1.1 | % | 1.4 | % | (1.4 | )% | ||
Effective tax rate | 41.1 | % | 31.3 | % | 19.1 | % | ||
As of December 31, 2017, the Company had Federal and California net operating loss (“NOL”) carry-forwards of $8,527,000 and $8,850,000, respectively. These NOLs were acquired through business combinations and are subject to IRC 382 and begin expiring in 2028, for federal and California purposes. While they are subject to IRC Section 382, management has determined that all of the NOLs are more than likely than not to be utilized.
As a result of the enactment of the Tax Cuts and Jobs Act (the “ Tax Act”) on December 22, 2017, the federal tax rate applied to the Company’s net deferred tax assets were re-measured to reflect the 2018 tax rates (the rates at which the deferred tax items are expected to reverse). The change to the tax rates (including the rate change applied to deferred taxes reflected in other comprehensive income and certain tax-advantaged investments as reflected in other assets) resulted in an increase to the
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Company’s tax provision of $3,535,000. As part of the Tax Act for tax years beginning after December 31, 2017, alternative minimum tax credit carryforwards are refundable and are expected to be fully refunded by 2022. As such, they are not dependent on future taxable income to be realized and have been classified as a current tax receivable. During the year ended December 31, 2017, the Company adopted ASU 2016-09 “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” which due to the exercise of stock options in the current period, resulted in the recognition of $853,000 in tax benefits.
The Company and its subsidiary file income tax returns in the U.S. federal and California jurisdictions. The Company conducts all of its business activities in the State of California. There are no pending U.S. federal or California Franchise Tax Board income tax examinations by those taxing authorities. The Company is no longer subject to the examination by U.S. federal taxing authorities for the years ended before December 31, 2014 and by the state and local taxing authorities for the years ended before December 31, 2013.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
December 31, | |||||||
2017 | 2016 | ||||||
Balance, beginning of year | $ | 298 | $ | 286 | |||
Additions based on tax positions related to prior years | — | 44 | |||||
Reductions for tax positions of prior years | (215 | ) | (32 | ) | |||
Balance, end of year | $ | 83 | $ | 298 | |||
This represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods. The Company does expect the amount of unrecognized tax benefits to decrease in the next 12 months due to closure of statues of limitations in the taxing jurisdictions.
During the years ended December 31, 2017 and 2016, the Company recorded $0 and $44,000, respectively, in interest or penalties related to uncertain tax positions.
12. COMMITMENTS AND CONTINGENCIES
Leases - The Bank leases certain of its branch facilities and administrative offices under noncancelable operating leases. Rental expense included in occupancy and equipment and other expenses totaled $2,533,000, $2,300,000 and $2,273,000 for the years ended December 31, 2017, 2016, and 2015, respectively.
Future minimum lease payments on noncancelable operating leases are as follows (in thousands):
Years Ending December 31, | |||
2018 | $ | 2,511 | |
2019 | 1,804 | ||
2020 | 1,638 | ||
2021 | 1,357 | ||
2022 | 1,095 | ||
Thereafter | 4,316 | ||
$ | 12,721 | ||
Federal Reserve Requirements - Banks are required to maintain reserves with the Federal Reserve Bank equal to a percentage of their reservable deposits. The amount of such reserve balances required at December 31, 2017 was $13,823,000.
Correspondent Banking Agreements - The Bank maintains funds on deposit with other federally insured financial institutions under correspondent banking agreements. Uninsured deposits totaled $306,000 at December 31, 2017.
Financial Instruments With Off-Balance-Sheet Risk - The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business in order to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments consist of commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the balance sheet.
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The Bank’s exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and standby letters of credit as it does for loans included on the balance sheet.
The following financial instruments represent off-balance-sheet credit risk (in thousands):
December 31, | ||||||||
2017 | 2016 | |||||||
Commitments to extend credit | $ | 347,001 | $ | 257,557 | ||||
Standby letters of credit | $ | 3,140 | $ | 1,858 | ||||
Commitments to extend credit consist primarily of unfunded commercial loan commitments and revolving lines of credit, single-family residential equity lines of credit and commercial real estate construction loans. Construction loans are established under standard underwriting guidelines and policies and are secured by deeds of trust, with disbursements made over the course of construction. Commercial revolving lines of credit have a high degree of industry diversification. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are generally secured and are issued by the Bank to guarantee the financial obligation or performance of a customer to a third party. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at December 31, 2017 and 2016. The Company recognizes these fees as revenue over the term of the commitment or when the commitment is used.
At December 31, 2017, commercial loan commitments represent 50% of total commitments and are generally secured by collateral other than real estate or unsecured. Real estate loan commitments represent 39% of total commitments and are generally secured by property with a loan-to-value ratio not to exceed 80%. Consumer loan commitments represent the remaining 10% of total commitments and are generally unsecured. In addition, the majority of the Bank’s loan commitments have variable interest rates.
At December 31, 2017 and 2016, the balance of a contingent allocation for probable loan loss experience on unfunded obligations was $326,000 and $125,000, respectively. The contingent allocation for probable loan loss experience on unfunded obligations is calculated by management using an appropriate, systematic, and consistently applied process. While related to credit losses, this allocation is not a part of the ALLL and is considered separately as a liability for accounting and regulatory reporting purposes. Changes in this contingent allocation are recorded in other non-interest expense.
Concentrations of Credit Risk - At December 31, 2017, in management’s judgment, a concentration of loans existed in commercial loans and real-estate-related loans, representing approximately 96.6% of total loans of which 12.9% were commercial and 83.7% were real-estate-related.
At December 31, 2016, in management’s judgment, a concentration of loans existed in commercial loans and real-estate-related loans, representing approximately 96.5% of total loans of which 15.1% were commercial and 81.4% were real-estate-related.
Management believes the loans within these concentrations have no more than the typical risks of collectability. However, in light of the current economic environment, additional declines in the performance of the economy in general, or a continued decline in real estate values or drought-related decline in agricultural business in the Company’s primary market area could have an adverse impact on collectability, increase the level of real-estate-related nonperforming loans, or have other adverse effects which alone or in the aggregate could have a material adverse effect on the financial condition, results of operations and cash flows of the Company.
Contingencies - The Company is subject to legal proceedings and claims which arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to such actions will not materially affect the consolidated financial position or consolidated results of operations of the Company.
13. SHAREHOLDERS’ EQUITY
Regulatory Capital - The Company and the Bank are subject to certain regulatory capital requirements administered by the Board of Governors of the Federal Reserve System and the FDIC. Failure to meet these minimum capital requirements could result in mandatory or, discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.
The Company and the Bank each meet specific capital guidelines that involve quantitative measures of their respective assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. These quantitative
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measures are established by regulation and require that the Company and the Bank maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
The Bank is also subject to additional capital guidelines under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. The most recent notification from the FDIC categorized the Bank as well capitalized under these guidelines. Management knows of no conditions or events since that notification that would change the Bank’s category.
Capital ratios are reviewed by Management on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs. For all periods presented, the Bank’s ratios exceed the regulatory definition of well capitalized under the regulatory framework for prompt correct action and the Company’s ratios exceed the required minimum ratios for capital adequacy purposes.
Effective January 1, 2015, bank holding companies with consolidated assets of $1 billion or more and banks like Central Valley Community Bank must comply with new minimum capital ratio requirements to be phased-in between January 1, 2015 and January 1, 2019, which consist of the following: (i) a new common equity Tier 1 capital to total risk weighted assets ratio of 4.5%; (ii) a Tier 1 capital to total risk weighted assets ratio of 6% (increased from 4%); (iii) a total capital to total risk weighted assets ratio of 8% (unchanged from current rules); and (iv) a Tier 1 capital to adjusted average total assets (“leverage”) ratio of 4%.
In addition, a “capital conversation buffer” is established which, when fully phased-in, will require maintenance of a minimum of 2.5% of common equity Tier 1 capital to total risk weighted assets in excess of the regulatory minimum capital ratio requirements described above. The 2.5% buffer will increase the minimum capital ratios to (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new buffer requirement is being phased-in between January 1, 2016 and January 1, 2019. The capital conservation buffer as of December 31, 2017 was 1.250% and 0.625% as of December 31, 2016. If the capital ratio levels of a banking organization fall below the capital conservation buffer amount, the organization will be subject to limitations on (i) the payment of dividends; (ii) discretionary bonus payments; (iii) discretionary payments under Tier 1 instruments; and (iv) engaging in share repurchases.
Management believes that the Company and the Bank met all their capital adequacy requirements as of December 31, 2017 and 2016. There are no conditions or events since those notifications that management believes have changed those categories. The capital ratios for the Company and the Bank are presented in the table below (exclusive of the capital conservation buffer).
The following table presents the Company’s regulatory capital ratios as of December 31, 2017 and December 31, 2016.
(Dollars in thousands) | Actual Ratio | Minimum regulatory requirement (1) | ||||||||||||
December 31, 2017 | Amount | Ratio | Amount | Ratio | ||||||||||
Tier 1 Leverage Ratio | $ | 153,676 | 9.71 | % | $ | 63,338 | 4.00 | % | ||||||
Common Equity Tier 1 Ratio (CET 1) | $ | 149,186 | 12.90 | % | $ | 52,081 | 5.75 | % | ||||||
Tier 1 Risk-Based Capital Ratio | $ | 153,676 | 13.28 | % | $ | 69,441 | 7.25 | % | ||||||
Total Risk-Based Capital Ratio | $ | 162,780 | 14.07 | % | $ | 92,588 | 9.25 | % | ||||||
December 31, 2016 | ||||||||||||||
Tier 1 Leverage Ratio | $ | 122,601 | 8.75 | % | $ | 56,057 | 4.00 | % | ||||||
Common Equity Tier 1 Ratio (CET 1) | $ | 120,080 | 12.48 | % | $ | 43,426 | 5.13 | % | ||||||
Tier 1 Risk-Based Capital Ratio | $ | 122,601 | 12.74 | % | $ | 57,901 | 6.63 | % | ||||||
Total Risk-Based Capital Ratio | $ | 132,052 | 13.72 | % | $ | 77,202 | 8.63 | % | ||||||
(1) The 2017 and 2016 minimum regulatory requirement threshold includes the capital conservation buffer of 1.250% and 0.625%, respectively. These ratios are not reflected on a fully phased-in basis, which will occur in January 2019. | ||||||||||||||
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The following table presents the Bank’s regulatory capital ratios as of December 31, 2017 and December 31, 2016.
(Dollars in thousands) | Actual Ratio | Minimum regulatory requirement (1) | ||||||||||||
December 31, 2017 | Amount | Ratio | Amount | Ratio | ||||||||||
Tier 1 Leverage Ratio | $ | 149,779 | 9.46 | % | $ | 63,332 | 4.00 | % | ||||||
Common Equity Tier 1 Ratio (CET 1) | $ | 149,779 | 12.96 | % | $ | 52,040 | 5.75 | % | ||||||
Tier 1 Risk-Based Capital Ratio | $ | 149,779 | 12.96 | % | $ | 69,387 | 7.25 | % | ||||||
Total Risk-Based Capital Ratio | $ | 158,882 | 13.74 | % | $ | 92,516 | 9.25 | % | ||||||
December 31, 2016 | ||||||||||||||
Tier 1 Leverage Ratio | $ | 121,079 | 8.64 | % | $ | 56,064 | 4.00 | % | ||||||
Common Equity Tier 1 Ratio (CET 1) | $ | 121,079 | 12.59 | % | $ | 43,383 | 5.13 | % | ||||||
Tier 1 Risk-Based Capital Ratio | $ | 121,079 | 12.59 | % | $ | 57,845 | 6.63 | % | ||||||
Total Risk-Based Capital Ratio | $ | 130,530 | 13.57 | % | $ | 77,126 | 8.63 | % | ||||||
(1) The 2017 and 2016 minimum regulatory requirement threshold includes the capital conservation buffer of 1.250% and 0.625%, respectively. These ratios are not reflected on a fully phased-in basis, which will occur in January 2019. | ||||||||||||||
Dividends - During 2017, the Bank declared and paid cash dividends to the Company in the amount of $3,133,000 in connection with the cash dividends to the Company’s shareholders approved by the Company’s Board of Directors. The Bank may not pay any dividend that would cause it to be deemed not “well capitalized” under applicable banking laws and regulations. The Company declared and paid a total of $3,010,000 or $0.24 per common share cash dividend to shareholders of record during the year ended December 31, 2017.
During 2016, the Bank declared and paid cash dividends to the Company in the amount of $13,010,000, in connection with the SVB acquisition, and cash dividends to the Company’s shareholders approved by the Company’s Board of Directors. The Company declared and paid a total of $2,715,000 or $0.24 per common share cash dividend to shareholders of record during the year ended December 31, 2016.
During 2015, the Bank declared and paid cash dividends to the Company in the amount of $2,260,000, in connection with the cash dividends approved by the Company’s Board of Directors. The Company declared and paid a total of $1,979,000 or $0.18 per common share cash dividend to shareholders of record during the year ended December 31, 2015.
The Company’s primary source of income with which to pay cash dividends is dividends from the Bank. The California Financial Code restricts the total amount of dividends payable by a bank at any time without obtaining the prior approval of the California Department of Business Oversight to the lesser of (1) the Bank’s retained earnings or (2) the Bank’s net income for its last three fiscal years, less distributions made to shareholders during the same three-year period. At December 31, 2017, $23,185,000 of the Bank’s retained earnings were free of these restrictions.
A reconciliation of the numerators and denominators of the basic and diluted earnings per common share computations is as follows (in thousands, except share and per share amounts):
For the Years Ended December 31, | ||||||||||||
2017 | 2016 | 2015 | ||||||||||
Basic Earnings Per Common Share: | ||||||||||||
Net income | $ | 14,026 | $ | 15,182 | $ | 10,964 | ||||||
Weighted average shares outstanding | 12,472,095 | 11,331,166 | 10,931,927 | |||||||||
Net income per common share | $ | 1.12 | $ | 1.34 | $ | 1.00 | ||||||
Diluted Earnings Per Common Share: | ||||||||||||
Net income | $ | 14,026 | $ | 15,182 | $ | 10,964 | ||||||
Weighted average shares outstanding | 12,472,095 | 11,331,166 | 10,931,927 | |||||||||
Effect of dilutive stock options and warrants | 250,255 | 104,283 | 83,836 | |||||||||
Weighted average shares of common stock and common stock equivalents | 12,722,350 | 11,435,449 | 11,015,763 | |||||||||
Net income per diluted common share | $ | 1.10 | $ | 1.33 | $ | 1.00 | ||||||
No outstanding options and restricted stock awards were anti-dilutive at December 31, 2017 and 2016. Outstanding options and restricted stock of 26,704 were not factored into the calculation of dilutive stock options at December 31, 2015, because they were anti-dilutive.
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14. SHARED-BASED COMPENSATION
On December 31, 2017, the Company had five share-based compensation plans, which are described below. The Plans do not provide for the settlement of awards in cash and new shares are issued upon option exercise or restricted share grants.
The Central Valley Community Bancorp 2000 Stock Option Plan (2000 Plan) expired on November 15, 2010. The Central Valley Community Bancorp 2005 Omnibus Incentive Plan (2005 Plan) was adopted in May 2005 and expired March 16, 2015. While outstanding arrangements to issue shares under these plans, including options, continue in force until their expiration, no new options will be granted under these plans. The plans require that the exercise price may not be less than the fair market value of the stock at the date the option is granted, and that the option price must be paid in full at the time it is exercised. The options and awards under the plans expire on dates determined by the Board of Directors, but not later than ten years from the date of grant. The vesting period for the options, restricted common stock awards and option related stock appreciation rights is determined by the Board of Directors and is generally over five years.
In May 2015, the Company adopted the Central Valley Community Bancorp 2015 Omnibus Incentive Plan (2015 Plan). The plan provides for awards in the form of incentive stock options, non-statutory stock options, stock appreciation rights, and restricted stock. The plan also allows for performance awards that may be in the form of cash or shares of the Company, including restricted stock. The 2015 plan requires that the exercise price may not be less than the fair market value of the stock at the date the option is granted, and that the option price must be paid in full at the time it is exercised. The options and awards under the plan expire on dates determined by the Board of Directors, but not later than ten years from the date of grant. The vesting period for the options, restricted common stock awards and option related stock appreciation rights is determined by the Board of Directors and is generally over five years. The maximum number of shares that can be issued with respect to all awards under the plan is 875,000. Currently under the 2015 Plan, there are 830,760 shares remain reserved for future grants as of December 31, 2017.
Effective June 2, 2017, the Company adopted an Employee Stock Purchase Plan whereby our employees may purchase Company common shares through payroll deductions of between one percent and 15 percent of pay in each pay period. Shares are purchased at the end of an offering period at a discount of 10 percent from the closing market price on the last day of each offering period. The plan calls for 500,000 common shares to be set aside for employee purchases, and there were 497,559 shares available for future purchase under the plan as of December 31, 2017.
In October 2017, the Company adopted the Folsom Lake Bank 2007 Equity Incentive Plan (2007 Plan). The plan provides for awards in the form of incentive stock options, non-statutory stock options, stock appreciation rights, and restricted stock. While outstanding arrangements to issue shares under this plan, including options, continue in force until their expiration, no new options will be granted under this plan. The options and awards under the plan expire on dates determined by the Board of Directors, but not later than ten years from the date of grant. The vesting period for the options, restricted common stock awards and option related stock appreciation rights is determined by the Board of Directors and is generally over five years. The maximum number of shares that can be issued with respect to all awards under the plan is 313,360.
For the years ended December 31, 2017, 2016, and 2015, the compensation cost recognized for share-based compensation was $384,000, $284,000, and $238,000, respectively. The recognized tax benefit for share-based compensation expense was $805,000, $44,000, and $14,000 for 2017, 2016, and 2015, respectively.
Stock Options - The Company bases the fair value of the options granted on the date of grant using a Black-Scholes Merton option pricing model that uses assumptions based on expected option life and the level of estimated forfeitures, expected stock volatility, risk free interest rate, and dividend yield. The expected term and level of estimated forfeitures of the Company’s options are based on the Company’s own historical experience. Stock volatility is based on the historical volatility of the Company’s stock. The risk-free rate is based on the U. S. Treasury yield curve for the periods within the contractual life of the options in effect at the time of grant. The compensation cost for options granted is based on the weighted average grant date fair value per share.
No options to purchase shares of the Company’s common stock were granted during the years ending December 31, 2017, 2016 and 2015 from any of the Company’s stock based compensation plans.
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A summary of the combined activity of the Plans during the years then ended is presented below (dollars in thousands, except per share amounts):
Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term (Years) | Aggregate Intrinsic Value | ||||||||||
Options outstanding at December 31, 2014 | 368,360 | $ | 8.89 | ||||||||||
Options exercised | (9,070 | ) | $ | 6.64 | |||||||||
Options forfeited | (118,595 | ) | $ | 13.25 | 4.06 | $ | 1,251 | ||||||
Options outstanding at December 31, 2015 | 240,695 | $ | 6.83 | ||||||||||
Options exercised | (35,280 | ) | $ | 6.55 | |||||||||
Options forfeited | (3,200 | ) | $ | 8.77 | |||||||||
Options outstanding at December 31, 2016 | 202,215 | $ | 6.87 | 3.26 | $ | 2,647 | |||||||
Options assumed in acquisition | 313,360 | $ | 11.79 | ||||||||||
Options exercised | (281,125 | ) | $ | 10.47 | |||||||||
Options forfeited | (1,580 | ) | $ | 8.11 | |||||||||
Options outstanding at December 31, 2017 | 232,870 | $ | 9.13 | 2.87 | $ | 2,574 | |||||||
Options vested or expected to vest at December 31, 2017 | 232,870 | $ | 9.13 | 2.87 | $ | 2,574 | |||||||
Options exercisable at December 31, 2017 | 232,870 | $ | 9.13 | 2.87 | $ | 2,574 | |||||||
Information related to the stock option plan during each year follows (in thousands):
2017 | 2016 | 2015 | ||||||||||
Intrinsic value of options exercised | $ | 2,807 | $ | 235 | $ | 42 | ||||||
Cash received from options exercised | $ | 2,835 | $ | 231 | $ | 60 | ||||||
Excess tax benefit realized for option exercises | $ | 805 | $ | 30 | $ | 6 | ||||||
As of December 31, 2017, there is no unrecognized compensation cost related to stock options granted under all Plans. All options are fully vested. The total fair value of options vested was $170,000 and $15,220 for the years ended December 31, 2017 and 2016, respectively.
Restricted Common Stock Awards - The 2005 Plan and 2015 Plan provide for the issuance of shares to directors and officers. Restricted common stock grants typically vest over a five-year period. Restricted common stock (all of which are shares of our common stock) is subject to forfeiture if employment terminates prior to vesting. The cost of these awards is recognized over the vesting period of the awards based on the fair value of our common stock on the date of the grant.
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The following table presents the activity for restricted stock during the years then ended:
Shares | Weighted Average Grant Date Fair Value | ||||||
Nonvested outstanding shares at December 31, 2014 | 56,850 | $ | 12.68 | ||||
Granted | 9,268 | $ | 10.79 | ||||
Vested | (11,085 | ) | $ | 12.67 | |||
Forfeited | (2,005 | ) | $ | 12.95 | |||
Nonvested outstanding shares at December 31, 2015 | 53,028 | $ | 12.34 | ||||
Granted | 54,650 | $ | 14.10 | ||||
Vested | (12,438 | ) | $ | 12.38 | |||
Forfeited | (1,739 | ) | $ | 12.95 | |||
Nonvested outstanding shares at December 31, 2016 | 93,501 | $ | 13.35 | ||||
Vested | (27,373 | ) | $ | 13.34 | |||
Forfeited | (2,360 | ) | $ | 14.07 | |||
Nonvested outstanding shares at December 31, 2017 | 63,768 | $ | 13.33 | ||||
During the years ended December 31, 2017, 2016, and 2015, 0, 54,650, and 9,268 shares of restricted common stock were granted from outstanding grants under the 2005 and 2015 Plans. The restricted common stock had a weighted average fair value of $14.10, and $10.79 per share on the date of grant during the years ended December 31, 2016 and 2015, respectively. These restricted common stock awards vest 20% after the first year. Thereafter, 20% of the remaining restricted stock will vest on each anniversary of the initial award commencement date and will be fully vested on the fifth such anniversary.
As of December 31, 2017, there were 63,768 shares of restricted stock that are nonvested and expected to vest. Share-based compensation cost charged against income for restricted stock awards was $349,000 for the year ended December 31, 2017, $235,000 for the year ended December 31, 2016, and $161,000 for the year ended December 31, 2015.
As of December 31, 2017, there was $696,000 of total unrecognized compensation cost related to nonvested restricted common stock. Restricted stock compensation expense is recognized on a straight-line basis over the vesting period. This cost is expected to be recognized over a weighted average remaining period of 2.90 years and will be adjusted for subsequent changes in estimated forfeitures. Restricted common stock awards had an intrinsic value of $1,598,000 at December 31, 2017.
15. EMPLOYEE BENEFITS
401(k) and Profit Sharing Plan - The Bank has established a 401(k) and profit sharing plan. The 401(k) plan covers substantially all employees who have completed a one-month employment period. Participants in the profit sharing plan are eligible to receive employer contributions after completion of 2 years of service. Bank contributions to the profit sharing plan are determined at the discretion of the Board of Directors. Participants are automatically vested 100% in all employer contributions. The Bank contributed $600,000 and $380,000 to the profit sharing plan in 2017 and 2016, respectively. There was $270,000 contribution by the Bank to the profit sharing plan in 2015.
Additionally, the Bank may elect to make a matching contribution to the participants’ 401(k) plan accounts. The amount to be contributed is announced by the Bank at the beginning of the plan year. For the years ended December 31, 2017, 2016, and 2015, the Bank made a 100% matching contribution on all deferred amounts up to 3% of eligible compensation and a 50% matching contribution on all deferred amounts above 3% to a maximum of 5%. For the years ended December 31, 2017, 2016, and 2015, the Bank made matching contributions totaling $686,000, $604,000, and $585,000, respectively.
Deferred Compensation Plans - The Bank has a nonqualified Deferred Compensation Plan which provides directors with an unfunded, deferred compensation program. Under the plan, eligible participants may elect to defer some or all of their current compensation or director fees. Deferred amounts earn interest at an annual rate determined by the Board of Directors (2.68% at December 31, 2017). At December 31, 2017 and 2016, the total net deferrals included in accrued interest payable and other liabilities were $3,713,000 and $3,440,000, respectively.
In connection with the implementation of the above plan, single premium universal life insurance policies on the life of each participant were purchased by the Bank, which is the beneficiary and owner of the policies. The cash surrender value of the policies totaled $3,375,000 and $3,297,000 and at December 31, 2017 and 2016, respectively. Income recognized on
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these policies, net of related expenses, for the years ended December 31, 2017, 2016, and 2015, was $78,000, $83,000, and $105,000, respectively.
In October 2015, the Board of Directors of the Company and the Bank adopted a board resolution to create the Central Valley Community Bank Executive Deferred Compensation Plan (the Executive Plan). Pursuant to the Executive Plan, all eligible executives of the Bank may elect to defer up to 50 percent of their compensation for each deferral year. Deferred amounts earn interest at an annual rate determined by the Board of Directors (2.68% at December 31, 2017). At December 31, 2017 and 2016, the total net deferrals included in accrued interest payable and other liabilities were $86,000 and $52,000, respectively.
Salary Continuation Plans - The Board of Directors approved salary continuation plans for certain key executives during 2002 and subsequently amended the plans in 2006. Under these plans, the Bank is obligated to provide the executives with annual benefits for 15 years after retirement. These benefits are substantially equivalent to those available under split-dollar life insurance policies purchased by the Bank on the life of the executives. The expense recognized under these plans for the years ended December 31, 2017, 2016, and 2015, totaled $561,000, $489,000, and $447,000, respectively. Accrued compensation payable under the salary continuation plans totaled $5,786,000 and $5,572,000 at December 31, 2017 and 2016, respectively.
In connection with these plans, the Bank purchased single premium life insurance policies with cash surrender values totaling $6,355,000 and $6,196,000 at December 31, 2017 and 2016, respectively. Income recognized on these policies, net of related expense, for the years ended December 31, 2017, 2016, and 2015 totaled $159,000, $159,000, and $167,000, respectively.
In connection with the acquisitions of Folsom Lake Bank (FLB), Service 1st Bank, and Visalia Community Bank (VCB), the Bank assumed a liability for the estimated present value of future benefits payable to former key executives of FLB, Service 1st, and VCB . The liability relates to change in control benefits associated with their salary continuation plans. The benefits are payable to the individuals when they reach retirement age. At December 31, 2017 and 2016, the total amount of the liability was $4,557,000 and $2,788,000, respectively. Expense recognized by the Bank in 2017, 2016 and 2015 associated with these plans was $163,000, $120,000, and $78,000, respectively. These benefits are substantially equivalent to those available under split-dollar life insurance policies acquired. These single premium life insurance policies had cash surrender values totaling $15,326,000, and $11,014,000 at December 31, 2017 and 2016, respectively. Income recognized on these policies, net of related expenses, for the years ended December 31, 2017, 2016, and 2015, was $315,000, $298,000, and $194,000, respectively.
The current annual tax-free interest rate on all life insurance policies is 3.97%.
Employee Stock Purchase Plan - During 2017, the Company adopted an Employee Stock Purchase Plan which allows employees to purchase the Company’s stock at a discount to fair market value as of the date of purchase. The Company bears all costs of administering the plan, including broker’s fees, commissions, postage and other costs actually incurred.
16. LOANS TO RELATED PARTIES
During the normal course of business, the Bank enters into loans with related parties, including executive officers and directors. The following is a summary of the aggregate activity involving related-party borrowers (in thousands):
Balance, January 1, 2017 | $ | 6,482 | |
Disbursements | 6,654 | ||
Amounts repaid | (1,251 | ) | |
Balance, December 31, 2017 | $ | 11,885 | |
Undisbursed commitments to related parties, December 31, 2017 | $ | 1,298 | |
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17. PARENT ONLY CONDENSED FINANCIAL STATEMENTS
CONDENSED BALANCE SHEETS
December 31, 2017 and 2016
(In thousands) | 2017 | 2016 | ||||||
ASSETS | ||||||||
Cash and cash equivalents | $ | 3,296 | $ | 887 | ||||
Investment in Bank subsidiary | 210,816 | 167,666 | ||||||
Other assets | 750 | 790 | ||||||
Total assets | $ | 214,862 | $ | 169,343 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Liabilities: | ||||||||
Junior subordinated debentures due to subsidiary grantor trust | $ | 5,155 | $ | 5,155 | ||||
Other liabilities | 148 | 155 | ||||||
Total liabilities | 5,303 | 5,310 | ||||||
Shareholders’ equity: | ||||||||
Common stock | 103,314 | 71,645 | ||||||
Retained earnings | 103,419 | 92,904 | ||||||
Accumulated other comprehensive (loss) income, net of tax | 2,826 | (516 | ) | |||||
Total shareholders’ equity | 209,559 | 164,033 | ||||||
Total liabilities and shareholders’ equity | $ | 214,862 | $ | 169,343 | ||||
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CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the Years Ended December 31, 2017, 2016, and 2015
(In thousands) | 2017 | 2016 | 2015 | |||||||||
Income: | ||||||||||||
Dividends declared by Subsidiary - eliminated in consolidation | $ | 3,133 | $ | 13,010 | $ | 2,260 | ||||||
Other income | 4 | 4 | 3 | |||||||||
Total income | 3,137 | 13,014 | 2,263 | |||||||||
Expenses: | ||||||||||||
Interest on junior subordinated deferrable interest debentures | 147 | 121 | 99 | |||||||||
Professional fees | 231 | 133 | 156 | |||||||||
Other expenses | 1,019 | 779 | 411 | |||||||||
Total expenses | 1,397 | 1,033 | 666 | |||||||||
Income before equity in undistributed net income of Subsidiary | 1,740 | 11,981 | 1,597 | |||||||||
Equity in undistributed net income of Subsidiary, net of distributions | 11,754 | 2,852 | 9,080 | |||||||||
Income before income tax benefit | 13,494 | 14,833 | 10,677 | |||||||||
Benefit from income taxes | 532 | 349 | 287 | |||||||||
Income available to common shareholders | $ | 14,026 | $ | 15,182 | $ | 10,964 | ||||||
Comprehensive income | $ | 16,867 | $ | 10,204 | $ | 10,049 | ||||||
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CONDENSED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2017, 2016, and 2015
(In thousands) | 2017 | 2016 | 2015 | |||||||||
Cash flows from operating activities: | ||||||||||||
Net income | $ | 14,026 | $ | 15,182 | $ | 10,964 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Undistributed net income of subsidiary, net of distributions | (11,754 | ) | (2,852 | ) | (9,080 | ) | ||||||
Stock-based compensation | 384 | 284 | 238 | |||||||||
Tax benefit from exercise of stock options | — | (30 | ) | (6 | ) | |||||||
Net (increase) decrease in other assets | (114 | ) | (405 | ) | 50 | |||||||
Net (decrease) increase in other liabilities | (7 | ) | 64 | (32 | ) | |||||||
Benefit from deferred income taxes | 155 | 98 | (5 | ) | ||||||||
Net cash provided by operating activities | 2,690 | 12,341 | 2,129 | |||||||||
Cash flows used in investing activities: | ||||||||||||
Investment in subsidiary | (151 | ) | (9,584 | ) | — | |||||||
Cash flows from financing activities: | ||||||||||||
Cash dividend payments on common stock | (3,010 | ) | (2,715 | ) | (1,979 | ) | ||||||
Proceeds from exercise of stock options | 2,880 | 231 | 60 | |||||||||
Tax benefit from exercise of stock options | — | 30 | 6 | |||||||||
Net cash used in financing activities | (130 | ) | (2,454 | ) | (1,913 | ) | ||||||
Increase in cash and cash equivalents | 2,409 | 303 | 216 | |||||||||
Cash and cash equivalents at beginning of year | 887 | 584 | 368 | |||||||||
Cash and cash equivalents at end of year | $ | 3,296 | $ | 887 | $ | 584 | ||||||
Supplemental Disclosure of Cash Flow Information: | ||||||||||||
Cash paid during the year for interest | $ | 142 | $ | 112 | $ | 97 | ||||||
Non-cash investing and financing activities: | ||||||||||||
Common stock issued in acquisitions | $ | 28,405 | $ | 16,678 | $ | — | ||||||
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SUPPLEMENTARY FINANCIAL INFORMATION
The following supplementary financial information is not a part of the Company’s financial statements.
Unaudited Quarterly Statement of Operations Data
(In thousands, except per share amounts)
Q4 2017 | Q3 2017 | Q2 2017 | Q1 2017 | Q4 2016 | Q3 2016 | Q2 2016 | Q1 2016 | ||||||||||||||||||||||||
Net interest income | $ | 15,567 | $ | 13,578 | $ | 13,786 | $ | 13,308 | $ | 12,773 | $ | 10,995 | $ | 11,208 | $ | 10,604 | |||||||||||||||
Reversal of credit losses | — | (900 | ) | (150 | ) | (100 | ) | — | (1,000 | ) | (4,600 | ) | (250 | ) | |||||||||||||||||
Net interest income after provision for credit losses | 15,567 | 14,478 | 13,936 | 13,408 | 12,773 | 11,995 | 15,808 | 10,854 | |||||||||||||||||||||||
Other non-interest income | 1,947 | 2,385 | 1,939 | 1,764 | 2,154 | 1,849 | 2,094 | 1,574 | |||||||||||||||||||||||
Net realized (losses) gains on investment securities | (6 | ) | 169 | 2,157 | 482 | 84 | 286 | 420 | 1,130 | ||||||||||||||||||||||
Total non-interest expense | 13,109 | 10,394 | 10,789 | 10,113 | 10,913 | 9,655 | 9,377 | 8,977 | |||||||||||||||||||||||
Provision for income taxes | 4,064 | 2,144 | 2,295 | 1,291 | 1,492 | 1,361 | 2,887 | 1,177 | |||||||||||||||||||||||
Net income | $ | 335 | $ | 4,494 | $ | 4,948 | $ | 4,250 | $ | 2,606 | $ | 3,114 | $ | 6,058 | $ | 3,404 | |||||||||||||||
Net income available to common shareholders | $ | 335 | $ | 4,494 | $ | 4,948 | $ | 4,250 | $ | 2,606 | $ | 3,114 | $ | 6,058 | $ | 3,403 | |||||||||||||||
Basic earnings per share | $ | 0.02 | $ | 0.37 | $ | 0.41 | $ | 0.35 | $ | 0.21 | $ | 0.28 | $ | 0.55 | $ | 0.31 | |||||||||||||||
Diluted earnings per share | $ | 0.02 | $ | 0.36 | $ | 0.40 | $ | 0.35 | $ | 0.21 | $ | 0.28 | $ | 0.55 | $ | 0.31 | |||||||||||||||
The results for the fourth quarter 2017 include the results of the assets and liabilities acquired from Folsom Lake Bank in addition to the continued organic growth of the Company. The Company recorded additional tax expense of $3.54 million in the fourth quarter of 2017 related to the Tax Cuts and Jobs Act, which required the Company to re-measure its net deferred tax assets and resulted in a reduction in diluted earnings per share of $0.26 in the quarter and $0.28 for the year. The results for the fourth quarter 2016 include the results of the assets and liabilities acquired from Sierra Vista Bank in addition to the continued organic growth of the Company.
ITEM 9 - | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. |
Not Applicable.
ITEM 9A - | CONTROLS AND PROCEDURES |
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), as of the end of the period covered by this report.
In designing and evaluating our disclosure controls and procedures, management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Based on management’s evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are designed to, and are effective to, provide assurance at a reasonable level that the information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosures.
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(b) Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as
such term is defined in Exchange Act Rules 13a- l 5(f) and 15d-15(f). Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2017 based on the guidelines established in the Internal Control--Integrated Framework (2013 framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our internal control over financial reporting includes policies and procedures that provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. As permitted management has excluded the operations of Folsom Lake Bank acquired during 2017, from the scope of management’s report on internal control over financial reporting.
Based on the results of our evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2017. We reviewed the results of management’s assessment with our Audit Committee.
The effectiveness of our internal control over financial reporting as of December 31, 2017 has been audited by Crowe Horwath LLP, an independent registered public accounting firm, as stated in its report which is included in Item 8 of this Annual Report on Form 10-K.
(c) Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 2017, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
(d) Inherent Limitations on Effectiveness of Controls
Our management, including our chief executive officer and chief financial officer, do not expect that our disclosure controls or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
ITEM 9B - | OTHER INFORMATION |
Not Applicable.
PART III
ITEM 10 - | DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. |
For information concerning directors and executive officers of the Company, see “ELECTION OF DIRECTORS OF THE COMPANY” in the definitive Proxy Statement for the Company’s 2018 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A (the Proxy Statement), which section of the Proxy Statement is incorporated herein by reference.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s officers and directors, and persons who own more than 10% of a registered class of the Company’s equity securities, to file reports of ownership and changes in ownership with the FDIC. Officers, directors and greater than 10% shareholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file.
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Based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no Forms 4 and 5 were required for those persons, the Company believes that for the 2017 fiscal year the officers and directors of the Company complied with all applicable filing requirements.
ITEM 11 - | EXECUTIVE COMPENSATION. |
The information required by this Item can be found in the Company’s Definitive Proxy Statement under the captions “Executive Compensation” which section of the Proxy Statement is incorporated herein by reference.
ITEM 12 - | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. |
For information concerning security ownership of certain beneficial owners and management, see “PRINCIPAL SHAREHOLDERS” and “ELECTION OF DIRECTORS OF THE COMPANY” in the Company’s Definitive Proxy Statement, which sections of the Proxy Statement are incorporated herein by reference.
ITEM 13 - | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. |
For information concerning certain relationships and related transactions, see “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” and “INDEBTEDNESS OF MANAGEMENT” in the Company’s Definitive Proxy Statement, which sections of the Proxy Statement are incorporated herein by reference.
ITEM 14 - | PRINCIPAL ACCOUNTING FEES AND SERVICES |
For information concerning principal accounting fees and services, see “PRINCIPAL ACCOUNTING FEES AND SERVICES” in the Company’s Definitive Proxy Statement, which section of the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) FINANCIAL STATEMENTS
The Financial Statements of the Company and the Report of Independent Registered Public Accounting Firm are set forth in Part II, Item 8 and incorporated by reference herein.
(a)(2) FINANCIAL STATEMENT SCHEDULES
All schedules to the Financial Statements are omitted because of the absence of the conditions under which they are required or because the required information is included in the Financial Statements or accompanying notes.
(a)(3) EXHIBITS
See “Index to Exhibits”
(b) EXHIBITS
The exhibit list required by this Item is incorporated by reference to the Exhibit Index included in this report.
ITEM 16 FORM 10-K SUMMARY
Omitted at registrant's option
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INDEX TO EXHIBITS
Exhibit | ||
Number | Exhibit | |
2.1 | ||
2.2 | ||
2.3 | ||
2.4 | ||
2.5 | ||
3.1 | ||
3.2 | ||
3.2 | ||
3.3 | ||
3.5 | ||
3.6 | ||
4.1 | ||
111
4.2 | ||
10.1 | ||
10.2 | ||
10.3 | ||
10.4 | ||
10.5 | ||
10.6 | ||
10.7 | ||
10.8 | ||
10.9 | ||
10.10 | ||
10.11 | ||
10.12 | ||
10.13 | ||
10.14 | ||
112
10.15 | ||
10.16 | ||
10.17 | ||
10.18 | ||
10.19 | ||
10.20 | ||
10.21 | ||
10.22 | ||
10.23 | ||
10.24 | ||
10.25 | ||
10.26 | ||
113
10.27 | ||
10.28 | ||
10.29 | ||
10.30 | ||
10.31 | ||
10.32 | ||
10.33 | ||
10.34 | ||
10.35 | ||
10.36 | ||
10.37 | ||
114
10.38 | ||
10.39 | ||
10.40 | ||
10.41 | ||
10.42 | ||
10.43 | ||
10.44 | ||
10.45 | ||
10.46 | ||
10.47 | ||
10.48 | ||
10.49 | ||
10.50 | ||
115
10.51 | ||
10.52 | ||
10.53 | ||
10.54 | ||
10.55 | ||
10.56 | ||
10.57 | ||
10.58 | ||
10.59 | ||
10.60 | ||
10.61 | ||
10.62 | ||
10.63 | ||
116
10.64 | ||
10.65 | ||
10.66 | ||
10.67 | ||
10.68 | ||
10.69 | ||
10.70 | ||
10.71 | ||
10.72 | ||
10.73 | ||
10.74 | ||
10.75 | ||
10.76 | ||
117
10.77 | ||
10.78 | ||
10.79 | ||
10.80 | ||
10.81 | ||
10.82 | ||
21 | ||
22 | N/A | |
23 | ||
24 | ||
31.1 | ||
31.2 | ||
32.1 | ||
32.2 | ||
101.INS | XBRL Instance Document | |
101.SCH | XBRL Taxonomy Extension Schema Document | |
101.CAL | XBRL Taxonomy Extension Calculation Document | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase | |
101.LAB | XBRL Taxonomy Extension Labels Linkbase Document | |
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101.PRE | XBRL Taxonomy Extension Presentation Link Document | |
* Management contract and compensatory plans.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CENTRAL VALLEY COMMUNITY BANCORP | ||||
Date: | March 14, 2018 | By: | /s/ James M. Ford | |
James M. Ford | ||||
President and Chief Executive Officer | ||||
(principal executive officer) | ||||
Date: | March 14, 2018 | By: | /s/ David A. Kinross | |
David A. Kinross | ||||
Executive Vice President and Chief Financial Officer | ||||
(principal accounting officer and principal financial officer) | ||||
POWER OF ATTORNEY AND SIGNATURES
KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears below constitutes and appoints James M. Ford, his or her attorney-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his or her substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
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/s/ James M. Ford | Date: March 14, 2018 | ||
James M. Ford, | |||
President and Chief Executive Officer and Director (principal executive officer) | |||
/s/ David A. Kinross | Date: March 14, 2018 | ||
David A. Kinross, | |||
Executive Vice President and Chief Financial Officer | |||
(principal accounting officer and principal financial officer) | |||
/s/ Daniel J. Doyle | Date: March 14, 2018 | ||
Daniel J. Doyle, | |||
Chairman of the Board and Director | |||
/s/ Daniel N. Cunningham | Date: March 14, 2018 | ||
Daniel N. Cunningham, Lead Independent Director | |||
/s/ Edwin S. Darden | Date: March 14, 2018 | ||
Edwin S. Darden, Director | |||
/s/ F.T. “Tommy” Elliott, IV | Date: March 14, 2018 | ||
F.T. “Tommy” Elliott, IV, Director | |||
/s/ Robert J. Flautt | Date: March 14, 2018 | ||
Robert J. Flautt, Director | |||
/s/ Gary D. Gall | Date: March 14, 2018 | ||
Gary D. Gall, Director | |||
/s/ Steven D. McDonald | Date: March 14, 2018 | ||
Steven D. McDonald, Director | |||
/s/ Louis McMurray | Date: March 14, 2018 | ||
Louis McMurray, Director | |||
/s/ Karen Musson | Date: March 14, 2018 | ||
Karen Musson, Director | |||
/s/ William S. Smittcamp | Date: March 14, 2018 | ||
William S. Smittcamp, Director | |||
120