FIRST NORTHERN COMMUNITY BANCORP - Quarter Report: 2019 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

☒

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2019

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 000-30707

FIRST NORTHERN COMMUNITY BANCORP

(Exact name of registrant as specified in its charter)

California		68-0450397
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

195 N. First Street, Dixon, California		95620
(Address of principal executive offices)		(Zip Code)

707-678-3041

(Registrant’s telephone number including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or Section 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 ☒

No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes ☒

No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☒
Non-accelerated filer ☐	Smaller reporting company ☒

Emerging growth company ☐

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. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐

No ☒

The number of shares of Common Stock outstanding as of May 3, 2019 was 12,295,355.

FIRST NORTHERN COMMUNITY BANCORP

INDEX

	Page
PART I – Financial Information

ITEM I. – Financial Statements (Unaudited)	3

Condensed Consolidated Balance Sheets (Unaudited)	3

Condensed Consolidated Statements of Income (Unaudited)	4

Condensed Consolidated Statements of Comprehensive Income (Unaudited)	5

Condensed Consolidated Statement of Stockholders’ Equity (Unaudited)	6

Condensed Consolidated Statements of Cash Flows (Unaudited)	7

Notes to Condensed Consolidated Financial Statements	8

ITEM 2. – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	30

ITEM 3. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	45

ITEM 4. – CONTROLS AND PROCEDURES	45

PART II – OTHER INFORMATION	45

ITEM 1. – LEGAL PROCEEDINGS	45

ITEM 1A. – RISK FACTORS	45

ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	47

ITEM 3. – DEFAULTS UPON SENIOR SECURITIES	47

ITEM 4. – MINE SAFETY DISCLOSURES	47

ITEM 5. – OTHER INFORMATION	47

ITEM 6. – EXHIBITS	47

SIGNATURES	48

PART I – FINANCIAL INFORMATION

FIRST NORTHERN COMMUNITY BANCORP

ITEM I. – FINANCIAL STATEMENTS (UNAUDITED)

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands, except share amounts)	March 31, 2019			December 31, 2018

Assets

Cash and cash equivalents	$	128,094		$	116,032
Certificates of deposit		10,045			7,595
Investment securities – available-for-sale		298,649			314,637
Loans, net of allowance for loan losses of $12,746 at March 31, 2019 and $12,822 at December 31, 2018		731,605			763,393
Loans held-for-sale		2,407			2,295
Stock in Federal Home Loan Bank and other equity securities, at cost		6,019			6,019
Premises and equipment, net		6,297			6,646
Other real estate owned		1,092			1,092
Interest receivable and other assets		34,760			32,136

Total Assets	$	1,218,968		$	1,249,845

Liabilities and Stockholders’ Equity

Liabilities:

Demand deposits	$	388,381		$	416,493
Interest-bearing transaction deposits		307,875			312,697
Savings and MMDA's		330,030			332,514
Time, $250,000 or less		43,730			46,905
Time, over $250,000		16,212			16,003
Total deposits		1,086,228			1,124,612

Interest payable and other liabilities		14,713			12,772

Total Liabilities		1,100,941			1,137,384

Stockholders' Equity:
Common stock, no par value; 16,000,000 shares authorized; 12,295,355 shares issued and outstanding at March 31, 2019 and 12,253,812 shares issued and outstanding at December 31, 2018		93,059			92,618
Additional paid-in capital		977			977
Retained earnings		27,549			23,902
Accumulated other comprehensive loss, net		(3,558	)		(5,036	)
Total Stockholders’ Equity		118,027			112,461

Total Liabilities and Stockholders’ Equity	$	1,218,968		$	1,249,845

See notes to unaudited condensed consolidated financial statements.

FIRST NORTHERN COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(in thousands, except per share amounts)	Three months ended March 31, 2019		Three months ended March 31, 2018
Interest and dividend income:
Loans	$	9,612	$	8,806
Due from banks interest bearing accounts		641		517
Investment securities
Taxable		1,633		1,308
Non-taxable		50		39
Other earning assets		115		105
Total interest and dividend income		12,051		10,775
Interest expense:
Deposits		371		263
Total interest expense		371		263
Net interest income		11,680		10,512
Provision for loan losses		—		525
Net interest income after provision for loan losses		11,680		9,987
Non-interest income:
Service charges on deposit accounts		480		488
Gains on sales of loans held-for-sale		115		69
Investment and brokerage services income		149		161
Mortgage brokerage income		59		6
Loan servicing income		90		106
Debit card income		491		502
Other income		475		472
Total non-interest income		1,859		1,804
Non-interest expenses:
Salaries and employee benefits		5,372		5,317
Occupancy and equipment		654		715
Data processing		603		530
Stationery and supplies		62		99
Advertising		68		88
Directors’ fees		45		65
Other real estate owned expense		56		—
Other expense		1,158		1,180
Total non-interest expenses		8,018		7,994
Income before provision for income taxes		5,521		3,797
Provision for income taxes		1,536		1,064

Net income	$	3,985	$	2,733

Basic earnings per common share	$	0.33	$	0.23
Diluted earnings per common share	$	0.32	$	0.22

See notes to unaudited condensed consolidated financial statements.

FIRST NORTHERN COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(in thousands)	Three months ended March 31, 2019		Three months ended March 31, 2018
Net income	$	3,985	$	2,733
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) on securities:
Unrealized holding gains (losses) arising during the period, net of tax effect of $595 and $(731) for the three-month periods ended March 31, 2019 and March 31, 2018, respectively		1,478		(1,811	)
Other comprehensive income (loss)	$	1,478	$	(1,811	)
Comprehensive income	$	5,463	$	922

See notes to unaudited condensed consolidated financial statements.

FIRST NORTHERN COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(in thousands, except share data)

	Common Stock
	Shares			Amounts		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Loss			Total

Balance at December 31, 2017		11,630,129		$	85,583	$	977	$	17,881		$	(4,397	)	$	100,044
Net income									2,733						2,733
Other comprehensive loss, net of tax												(1,811	)		(1,811	)
Stock dividend adjustment		628			240				(240	)					—
Cash in lieu of fractional shares		(159	)						(10	)					(10	)
Stock-based compensation					108										108
Common shares issued related to restricted stock grants		25,281			—										—
Stock options exercised, net		5,978			—										—
Balance at March 31, 2018		11,661,857		$	85,931	$	977	$	20,364		$	(6,208	)	$	101,064

Balance at December 31, 2018		12,253,812			92,618		977		23,902			(5,036	)		112,461
Net income									3,985						3,985
Other comprehensive income, net of tax												1,478			1,478
Stock dividend adjustment		1,401			330				(330	)					—
Cash in lieu of fractional shares		(116	)						(8	)					(8	)
Stock-based compensation					111										111
Common shares issued related to restricted stock grants		40,258			—										—
Balance at March 31, 2019		12,295,355		$	93,059	$	977	$	27,549		$	(3,558	)	$	118,027

See notes to unaudited condensed consolidated financial statements.

FIRST NORTHERN COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	(in thousands)
	Three months ended March 31, 2019			Three months ended March 31, 2018
Cash Flows From Operating Activities
Net income	$	3,985		$	2,733
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		168			144
Accretion and amortization of investment securities premiums and discounts, net		425			722
(Decrease) increase in deferred loan origination fees and costs, net		(23	)		10
Provision for loan losses		—			525
Stock-based compensation		111			108
Gain on sale of fixed assets		(281	)		—
Operating lease payments		(217	)		(209	)
Gain on sales of loans held-for-sale		(115	)		(69	)
Proceeds from sales of loans held-for-sale		6,173			5,148
Originations of loans held-for-sale		(6,170	)		(4,469	)
Changes in assets and liabilities:
(Increase) decrease in interest receivable and other assets		(3,219	)		830
Net increase (decrease) in interest payable and other liabilities		2,158			(2,254	)
Net cash provided by operating activities		2,995			3,219

Cash Flows From Investing Activities
Proceeds from calls or maturities of available-for-sale securities		17,000			11,115
Principal repayments on available-for-sale securities		11,564			12,193
Purchase of available-for-sale securities		(10,928	)		(36,997	)
Net increase in certificates of deposit		(2,450	)		—
Net decrease in loans		31,811			18,018
Sales/disposals of premises and equipment, net		462			27
Net cash used in investing activities		47,459			4,356

Cash Flows From Financing Activities
Net decrease in deposits		(38,384	)		(11,946	)
Cash dividends paid in lieu of fractional shares		(8	)		(10	)
Net cash provided by financing activities		(38,392	)		(11,956	)

Net increase (decrease) in Cash and Cash Equivalents		12,062			(4,381	)
Cash and Cash Equivalents, beginning of period		116,032			152,892
Cash and Cash Equivalents, end of period	$	128,094		$	148,511

Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest	$	355		$	261
Supplemental disclosures of non-cash investing and financing activities:
Stock dividend distributed	$	6,610		$	6,046
Unrealized holding gains (losses) on available for sale securities, net of taxes	$	1,478		$	(1,811	)

See notes to unaudited condensed consolidated financial statements.

FIRST NORTHERN COMMUNITY BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2019 and 2018 and December 31, 2018

1.	BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of First Northern Community Bancorp (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Articles 9 and 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The results of operations for any interim period are not necessarily indicative of results expected for the full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 as filed with the Securities and Exchange Commission. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates. All material intercompany balances and transactions have been eliminated in consolidation.

2.	ACCOUNTING POLICIES

The most significant accounting policies followed by the Company are presented in Note 1 to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, Management has identified the allowance for loan losses accounting to be the accounting area requiring the most subjective or complex judgments, and as such the accounting area that could be most subject to revision as new information becomes available. A discussion of the factors affecting accounting for the allowance for loan losses is included in the “Asset Quality” and “Allowance for Loan Losses” discussions below. Certain amounts in prior periods have been reclassified to conform to the current presentation.

Application of these principles requires the Company to make certain estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain accounting policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment writedown or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.

Recently Adopted Accounting Standards:

In February 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-02, Leases (Topic 842). The Company adopted ASU 2016-02 on January 1, 2019. The Company adopted the new guidance using the optional transition method provided in ASU 2018-11, Leases (Topic 842): Targeted Improvements. This modified transition method allowed the Company to initially apply the new leases standard at the adoption date and allowed the Company to continue reporting comparative periods presented in the financial statements in accordance with legacy guidance in ASC 840. See FN (11), Leases.

Recently Issued Accounting Pronouncements:

In June 2016, FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in ASU 2016-13, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments are effective for public companies for annual periods beginning after December 15, 2019. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. We are currently evaluating the potential impact of ASU 2016-13 on our financial statements. In that regard, we have formed a cross-functional working group, under the direction of our Chief Financial Officer and our Chief Credit Officer. The working group is comprised of individuals from various functional areas including credit risk, finance and information technology, among others. We are currently working through our implementation plan which includes assessment and documentation of processes, internal controls and data sources; model development and documentation; and system configuration, among other things. We are also in the process of implementing a third-party vendor solution to assist us in the application of ASU 2016-13. The adoption of ASU 2016-13 could result in an increase in the allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. Furthermore, ASU 2016-13 will necessitate that we establish an allowance for expected credit losses for certain debt securities and other financial assets. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.

In November 2018, FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments – Credit Losses. The guidance clarifies that receivables arising from operating leases are not within the scope of the credit losses standard, but rather should be accounted for in accordance with the leases standard. The effective date and transition requirements are the same as the effective dates and transition requirements in the credit losses standard, ASU 2016-13. The Company does not expect the adoption of this update to have a significant impact on its consolidated financial statements.

In March 2019, FASB issued ASU 2019-01, Leases (Topic 842): Codification Improvements. These amendments align the guidance for fair value of the underlying asset by lessors that are not manufacturers or dealers in Topic 842 with that of existing guidance (Issue 1). This ASU also requires lessors within the scope of Topic 942, Financial Services - Depository and Lending, to present all "principal payments received under leases" within investing activities (Issue 2). Finally, this ASU exempts both lessees and lessors from having to provide certain interim disclosures in the fiscal year in which a company adopts the new leases standard (Issue 3). Issue 1 and Issue 2 are effective for public companies for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Issue 3 is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company adopted Issue 3 of ASU 2019-01 on January 1, 2019, which did not have a significant impact on its consolidated financial statements. See FN (11), Leases.

3. INVESTMENT SECURITIES

The amortized cost, unrealized gains and losses and estimated fair values of investments in debt and other securities at March 31, 2019 are summarized as follows:

(in thousands)	Amortized cost		Unrealized gains		Unrealized losses			Estimated fair value

Investment securities available-for-sale:
U.S. Treasury Securities	$	43,402	$	258	$	(100	)	$	43,560
Securities of U.S. government agencies and corporations		33,670		109		(154	)		33,625
Obligations of states and political subdivisions		22,663		272		(72	)		22,863
Collateralized mortgage obligations		66,511		67		(1,447	)		65,131
Mortgage-backed securities		135,755		295		(2,580	)		133,470
Total debt securities	$	302,001	$	1,001	$	(4,353	)	$	298,649

The amortized cost, unrealized gains and losses and estimated fair values of investments in debt and other securities at December 31, 2018 are summarized as follows:

(in thousands)	Amortized cost		Unrealized gains		Unrealized losses			Estimated fair value

Investment securities available-for-sale:
U.S. Treasury Securities	$	50,825	$	14	$	(157	)	$	50,682
Securities of U.S. government agencies and corporations		42,215		89		(228	)		42,076
Obligations of states and political subdivisions		19,110		181		(123	)		19,168
Collateralized mortgage obligations		65,615		34		(1,850	)		63,799
Mortgage-backed securities		142,297		147		(3,532	)		138,912
Total debt securities	$	320,062	$	465	$	(5,890	)	$	314,637

The Company had $17,000,000 and $11,115,000 proceeds from calls and maturities of available-for-sale securities for the three months ended March 31, 2019 and March 31, 2018, respectively. There were no gross realized gains from sales/calls of available-for-sale securities for each of the three months ended March 31, 2019 and March 31, 2018. There were no gross realized losses from sales/calls of available-for-sale securities for each of the three months ended March 31, 2019 and March 31, 2018.

The amortized cost and estimated market value of debt and other securities at March 31, 2019, by contractual and expected maturity, are shown in the following table:

(in thousands)	Amortized cost		Estimated fair value

Maturity in years:
Due in one year or less	$	37,748	$	37,645
Due after one year through five years		51,955		52,120
Due after five years through ten years		5,097		5,303
Due after ten years		4,935		4,980
Subtotal		99,735		100,048
MBS & CMO		202,266		198,601
Total	$	302,001	$	298,649

Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. In addition, factors such as prepayments and interest rates may affect the yield on the carrying value of mortgage-related securities.

An analysis of gross unrealized losses of the available-for-sale investment securities portfolio as of March 31, 2019, follows:

	Less than 12 months					12 months or more					Total
(in thousands)	Fair Value		Unrealized losses			Fair Value		Unrealized losses			Fair Value		Unrealized losses

U.S. Treasury securities	$	4,996	$	(2	)	$	15,407	$	(98	)	$	20,403	$	(100	)
Securities of U.S. government agencies and corporations		998		(1	)		20,576		(153	)		21,574		(154	)
Obligations of states and political subdivisions		698		(1	)		8,591		(71	)		9,289		(72	)
Collateralized Mortgage obligations		2,048		(2	)		51,133		(1,445	)		53,181		(1,447	)
Mortgage-backed securities		1,929		(14	)		106,343		(2,566	)		108,272		(2,580	)
Total	$	10,669	$	(20	)	$	202,050	$	(4,333	)	$	212,719	$	(4,353	)

No decline in value was considered “other-than-temporary” during the first three months of 2019. Twenty securities, all considered investment grade, which had a fair value of $10,669,000 and a total unrealized loss of $20,000 have been in an unrealized loss position for less than twelve months as of March 31, 2019. Two hundred five securities, all considered investment grade, which had a fair value of $202,050,000 and a total unrealized loss of $4,333,000 have been in an unrealized loss position for more than twelve months as of March 31, 2019. The unrealized losses on the Company's investment securities were caused by market conditions for these types of investments, particularly changes in risk-free interest rates. The Company does not intend to sell the securities and has concluded it is not more likely than not that we will be required to sell these securities prior to recovery of their anticipated cost basis. Therefore, the Company does not consider these investments to be other than temporarily impaired as of March 31, 2019.

The fair value of investment securities could decline in the future if the general economy deteriorates, inflation increases, credit ratings decline, the issuer's financial condition deteriorates, or the liquidity for securities declines. As a result, other than temporary impairments may occur in the future.

An analysis of gross unrealized losses of the available-for-sale investment securities portfolio as of December 31, 2018, follows:

	Less than 12 months					12 months or more					Total
(in thousands)	Fair Value		Unrealized losses			Fair Value		Unrealized losses			Fair Value		Unrealized losses

U.S. Treasury Securities	$	37,805	$	(67	)	$	5,951	$	(90	)	$	43,756	$	(157	)
Securities of U.S. government agencies and corporations		16,959		(39	)		13,540		(189	)		30,499		(228	)
Obligations of states and political subdivisions		847		(2	)		9,134		(121	)		9,981		(123	)
Collateralized Mortgage obligations		2,217		(6	)		53,217		(1,844	)		55,434		(1,850	)
Mortgage-backed securities		16,358		(123	)		105,361		(3,409	)		121,719		(3,532	)
Total	$	74,186	$	(237	)	$	187,203	$	(5,653	)	$	261,389	$	(5,890	)

Investment securities carried at $34,363,000 and $36,781,000 at March 31, 2019 and December 31, 2018, respectively, were pledged to secure public deposits or for other purposes as required or permitted by law.

4. LOANS

The composition of the Company’s loan portfolio, by loan class, as of March 31, 2019 and December 31, 2018 was as follows:

($ in thousands)	March 31, 2019			December 31, 2018

Commercial	$	113,575		$	125,177
Commercial Real Estate		419,540			420,106
Agriculture		109,749			123,626
Residential Mortgage		51,682			51,064
Residential Construction		17,626			20,124
Consumer		31,435			35,397
		743,607			775,494
Allowance for loan losses		(12,746	)		(12,822	)
Net deferred origination fees and costs		744			721
Loans, net	$	731,605		$	763,393

The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk rating standards and criteria similar to those employed by state and federal banking regulatory agencies.

Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses. These loans are generally secured by the receivables, equipment, and other real property of the business and are susceptible to the related risks described above. Problem commercial loans are generally identified by periodic review of financial information that may include financial statements, tax returns, and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation.

Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner-occupied real estate are primarily susceptible to changes in the market conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles. These same risks apply to Commercial loans whether secured by equipment, receivables or other personal property or unsecured. Problem commercial real estate loans are generally identified by periodic review of financial information that may include financial statements, tax returns, payment history of the borrower, and site inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Losses on loans secured by owner occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resulting over-supply of space. Losses are dependent on the value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means.

Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or service. Agricultural loans are generally secured by inventory, receivables, equipment, and other real property. Agricultural loans primarily are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as adverse weather conditions such as drought or floods. Problem agricultural loans are generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary.

Residential mortgage loans, which are secured by real estate, are primarily susceptible to four risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfalls in collateral value. In general, non-payment is usually due to loss of employment and follows general economic trends in the economy, particularly the upward movement in the unemployment rate, loss of collateral value, and demand shifts.

Construction loans, whether owner-occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction, including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion. Losses are primarily related to underlying collateral value and changes therein as described above. Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, or repossession or foreclosure of the underlying collateral. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation.

Consumer loans, whether unsecured or secured, are primarily susceptible to four risks: non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfall in collateral value. In general, non-payment is usually due to loss of employment and will follow general economic trends in the economy, particularly the upward movements in the unemployment rate, loss of collateral value, and demand shifts.

Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Collateral valuations are obtained at origination of the credit and periodically thereafter (generally annually but may be more frequent depending on the collateral type), once repayment is questionable, and the loan has been deemed classified.

As of March 31, 2019, approximately 15% in principal amount of the Company's loans were for general commercial uses, including professional, retail and small businesses. Approximately 57% in principal amount of the Company’s loans were secured by commercial real estate, consisting primarily of loans secured by commercial properties and construction and land development loans. Approximately 15% in principal amount of the Company's loans were for agriculture, approximately 7% in principal amount of the Company’s loans were residential mortgage loans, approximately 2% in principal amount of the Company’s loans were residential construction loans and approximately 4% in principal amount of the Company’s loans were consumer loans.

Once a loan becomes delinquent or repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal payment. If this is not forthcoming and payment of principal and interest in accordance with the contractual terms of the loan agreement becomes unlikely, the Company will consider the loan to be impaired and will estimate its probable loss, using the present value of future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. For collateral dependent loans, the Company will utilize a recent valuation of the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount. Depending on the length of time until final collection, the Company may periodically revalue the estimated loss and take additional charge-offs or specific reserves as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when the collateral is liquidated and the actual loss is confirmed. Unpaid balances on loans after or during collection and liquidation may also be pursued through legal action and attachment of wages or judgment liens on the borrower's other assets.

At March 31, 2019 and December 31, 2018, all loans were pledged under a blanket collateral lien to secure actual and potential borrowings from the Federal Home Loan Bank (“FHLB”).

Non-accrual and Past Due Loans

The Company’s loans by delinquency and non-accrual status, as of March 31, 2019 and December 31, 2018, were as follows:

($ in thousands)	Current & Accruing		30-59 Days Past Due & Accruing		60-89 Days Past Due & Accruing		90 Days or more Past Due & Accruing		Nonaccrual		Total Loans
March 31, 2019
Commercial	$	111,929	$	771	$	—	$	662	$	213	$	113,575
Commercial Real Estate		419,173		—		—		—		367		419,540
Agriculture		104,791		180		—		—		4,778		109,749
Residential Mortgage		51,408		177		—		—		97		51,682
Residential Construction		17,626		—		—		—		—		17,626
Consumer		30,983		150		110		—		192		31,435
Total	$	735,910	$	1,278	$	110	$	662	$	5,647	$	743,607

December 31, 2018
Commercial	$	123,765	$	662	$	—	$	—	$	750	$	125,177
Commercial Real Estate		419,725		—		—		—		381		420,106
Agriculture		118,639		157		—		—		4,830		123,626
Residential Mortgage		50,964		—		—		—		100		51,064
Residential Construction		20,124		—		—		—		—		20,124
Consumer		35,054		114		38		—		191		35,397
Total	$	768,271	$	933	$	38	$	—	$	6,252	$	775,494

Non-accrual loans amounted to $5,647,000 at March 31, 2019 and were comprised of one commercial loan totaling $213,000, two commercial real estate loans totaling $367,000, five agriculture loans totaling $4,778,000, two residential mortgage loans totaling $97,000 and two consumer loans totaling $192,000. The Company had one commercial loan totaling $662,000 that was 90 days or more past due and still accruing at March 31, 2019. Non-accrual loans amounted to $6,252,000 at December 31, 2018 and were comprised of two commercial loans totaling $750,000, two commercial real estate loans totaling $381,000, five agriculture loans totaling $4,830,000, two residential mortgage loans totaling $100,000, and one consumer loan totaling $191,000. All non-accrual loans are measured for impairment based upon the present value of future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of collateral, if the loan is collateral dependent. If the measurement of the non-accrual loan is less than the recorded investment in the loan, an impairment is recognized through the establishment of a specific reserve sufficient to cover expected losses and/or a charge-off against the allowance for loan losses. If the loan is considered to be collateral dependent, it is generally the Company's policy to charge-off the portion of any non-accrual loan that the Company does not expect to collect by writing the loan down to the estimated net realizable value of the underlying collateral. There were no commitments to lend additional funds to borrowers whose loans were on non-accrual status at March 31, 2019.

Impaired Loans

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 according to the contractual terms of the loan agreement, including scheduled interest payments. Loans to be considered for impairment include non-accrual loans, troubled debt restructurings and loans with a risk rating of 5 (special mention) or worse and an aggregate exposure of $500,000 or more. Once identified, impaired loans are measured individually for impairment using one of three methods: present value of expected cash flows discounted at the loan's effective interest rate; the loan's observable market price; or fair value of collateral if the loan is collateral dependent. In general, any portion of the recorded investment in a collateral dependent loan in excess of the fair value of the collateral that can be identified as uncollectible, and is, therefore, deemed a confirmed loss, is promptly charged-off against the allowance for loan losses.

Impaired loans, segregated by loan class, as of March 31, 2019 and December 31, 2018 were as follows:

($ in thousands)	Unpaid Contractual Principal Balance		Recorded Investment with no Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance
March 31, 2019
Commercial	$	2,930	$	213	$	1,961	$	2,174	$	37
Commercial Real Estate		767		367		258		625		21
Agriculture		4,779		4,779		—		4,779		—
Residential Mortgage		1,471		96		1,255		1,351		267
Residential Construction		743		—		743		743		48
Consumer		400		192		191		383		2
Total	$	11,090	$	5,647	$	4,408	$	10,055	$	375

December 31, 2018
Commercial	$	3,591	$	300	$	2,602	$	2,902	$	496
Commercial Real Estate		780		381		261		642		21
Agriculture		4,830		4,830		—		4,830		—
Residential Mortgage		1,669		100		1,451		1,551		287
Residential Construction		560		—		560		560		49
Consumer		403		191		198		389		2
Total	$	11,833	$	5,802	$	5,072	$	10,874	$	855

The average recorded investment in impaired loans and the amount of interest income recognized on impaired loans during the three months ended March 31, 2019 and March 31, 2018 was as follows:

($ in thousands)	Three Months Ended March 31, 2019				Three Months Ended March 31, 2018
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Commercial	$	2,538	$	42	$	3,425	$	46
Commercial Real Estate		634		4		1,971		4
Agriculture		4,804		—		—		—
Residential Mortgage		1,451		12		2,234		15
Residential Construction		652		9		647		9
Consumer		386		3		470		3
Total	$	10,465	$	70	$	8,747	$	77

Troubled Debt Restructurings

The Company's loan portfolio includes certain loans that have been modified in a Troubled Debt Restructuring ("TDR"), which are loans on which concessions in terms have been granted because of the borrowers' financial difficulties and, as a result, the Company receives less than the current market-based compensation for the loan. These concessions may include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are placed on non-accrual status at the time of restructure and may be returned to accruing status after considering the borrower's sustained repayment performance for a reasonable period, generally six months.

When a loan is modified, it is measured based upon the present value of future cash flows discounted at the contractual interest rate of the original loan agreement, or the fair value of collateral less selling costs if the loan is collateral dependent. If the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through a specific allowance or a charge-off of the loan.

The Company had $4,591,000 and $4,813,000 in TDR loans as of March 31, 2019 and December 31, 2018, respectively. Specific reserves for TDR loans totaled $375,000 and $405,000 as of March 31, 2019 and December 31, 2018, respectively. TDR loans performing in compliance with modified terms totaled $4,408,000 and $4,622,000 as of March 31, 2019 and December 31, 2018, respectively. There were no commitments to advance additional funds on existing TDR loans as of March 31, 2019.

Loans modified as TDRs during the three months ended March 31, 2019 were as follows:

	Three Months Ended March 31, 2019
	Number of Contracts		Pre-modification outstanding recorded investment		Post-modification outstanding recorded investment
Residential Construction		2	$	189	$	189
Total		2	$	189	$	189

There were no loans modified as TDRs during the three months ended March 31, 2018.

Loan modifications generally involve reductions in the interest rate, payment extensions, forgiveness of principal, or forbearance. There were no loans modified as a TDR within the previous twelve months and for which there was a payment default during the three months ended March 31, 2019 and March 31, 2018.

Credit Quality Indicators

All loans are rated using the credit risk ratings and criteria adopted by the Company. Risk ratings are adjusted as future circumstances warrant. All credits risk rated 1, 2, 3 or 4 equate to a Pass as indicated by Federal and State bank regulatory agencies; a 5 equates to a Special Mention; a 6 equates to Substandard; a 7 equates to Doubtful; and an 8 equates to a Loss. For the definitions of each risk rating, see Note 4 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2018.

The following table presents the risk ratings by loan class as of March 31, 2019 and December 31, 2018:

($ in thousands)	Pass		Special Mention		Substandard		Doubtful		Loss		Total
March 31, 2019
Commercial	$	110,899	$	510	$	2,166	$	—	$	—	$	113,575
Commercial Real Estate		396,130		14,753		8,657		—		—		419,540
Agriculture		89,670		13,139		6,940		—		—		109,749
Residential Mortgage		51,121		—		561		—		—		51,682
Residential Construction		17,626		—		—		—		—		17,626
Consumer		30,595		538		302		—		—		31,435
Total	$	696,041	$	28,940	$	18,626	$	—	$	—	$	743,607

December 31, 2018
Commercial	$	121,848	$	66	$	2,813	$	450	$	—	$	125,177
Commercial Real Estate		395,436		14,272		10,398		—		—		420,106
Agriculture		104,809		11,750		7,067		—		—		123,626
Residential Mortgage		50,149		—		915		—		—		51,064
Residential Construction		19,372		752		—		—		—		20,124
Consumer		34,272		590		535		—		—		35,397
Total	$	725,886	$	27,430	$	21,728	$	450	$	—	$	775,494

Allowance for Loan Losses

The following tables detail activity in the allowance for loan losses and the amount allocated to individually and collectively evaluated for impairment by loan class for the three months ended March 31, 2019 and March 31, 2018:

Three months ended March 31, 2019
($ in thousands)	Commercial			Commercial Real Estate		Agriculture		Residential Mortgage			Residential Construction			Consumer			Unallocated		Total
Balance as of December 31, 2018	$	3,198		$	5,890	$	1,632	$	643		$	318		$	279		$	862	$	12,822
Provision for (reversal of) loan losses		(568	)		496		202		(197	)		(102	)		—			169		—

Charge-offs		(150	)		—		—		—			—			(7	)		—		(157	)
Recoveries		19			—		—		56			1			5			—		81
Net charge-offs		(131	)		—		—		56			1			(2	)		—		(76	)
Balance as of March 31, 2019	$	2,499		$	6,386	$	1,834	$	502		$	217		$	277		$	1,031	$	12,746
Period-end amount allocated to:
Loans individually evaluated for impairment		37			21		—		267			48			2			—		375
Loans collectively evaluated for impairment		2,462			6,365		1,834		235			169			275			1,031		12,371
Balance as of March 31, 2019	$	2,499		$	6,386	$	1,834	$	502		$	217		$	277		$	1,031	$	12,746

Three months ended March 31, 2018
($ in thousands)	Commercial			Commercial Real Estate			Agriculture			Residential Mortgage			Residential Construction			Consumer			Unallocated		Total
Balance as of December 31, 2017	$	2,625		$	5,460		$	1,547		$	628		$	360		$	342		$	171	$	11,133
Provision for (reversal of) loan losses		(85	)		(46	)		(124	)		(1	)		(13	)		(68	)		862		525

Charge-offs		—			—			—			—			—			(6	)		—		(6	)
Recoveries		9			—			—			16			1			37			—		63
Net recoveries		9			—			—			16			1			31			—		57
Balance as of March 31, 2018	$	2,549		$	5,414		$	1,423		$	643		$	348		$	305		$	1,033	$	11,715
Period-end amount allocated to:
Loans individually evaluated for impairment		47			36			—			309			71			4			—		467
Loans collectively evaluated for impairment		2,502			5,378			1,423			334			277			301			1,033		11,248
Balance as of March 31, 2018	$	2,549		$	5,414		$	1,423		$	643		$	348		$	305		$	1,033	$	11,715

The following table details activity in the allowance for loan losses and the amount allocated to loans individually and collectively evaluated for impairment by loan class as of and for the period ended December 31, 2018.

Year ended December 31, 2018
($ in thousands)	Commercial			Commercial Real Estate			Agriculture		Residential Mortgage			Residential Construction			Consumer			Unallocated		Total
Balance as of December 31, 2017	$	2,625		$	5,460		$	1,547	$	628		$	360		$	342		$	171	$	11,133
Provision for (reversal of) loan losses		1,036			572			85		(19	)		(173	)		(92	)		691		2,100

Charge-offs		(509	)		(142	)		—		—			—			(34	)		—		(685	)
Recoveries		46			—			—		34			131			63			—		274
Net charge-offs		(463	)		(142	)		—		34			131			29			—		(411	)
Ending Balance		3,198			5,890			1,632		643			318			279			862		12,822
Period-end amount allocated to:
Loans individually evaluated for impairment		496			21			—		287			49			2			—		855
Loans collectively evaluated for impairment		2,702			5,869			1,632		356			269			277			862		11,967
Balance as of December 31, 2018	$	3,198		$	5,890		$	1,632	$	643		$	318		$	279		$	862	$	12,822

The Company’s investment in loans as of March 31, 2019, March 31, 2018, and December 31, 2018 related to each balance in the allowance for loan losses by loan class and disaggregated on the basis of the Company’s impairment methodology was as follows:

($ in thousands)	Commercial		Commercial Real Estate		Agriculture		Residential Mortgage		Residential Construction		Consumer		Total
March 31, 2019
Loans individually evaluated for impairment	$	2,174	$	625	$	4,779	$	1,351	$	743	$	383	$	10,055
Loans collectively evaluated for impairment		111,401		418,915		104,970		50,331		16,883		31,052		733,552
Ending Balance	$	113,575	$	419,540	$	109,749	$	51,682	$	17,626	$	31,435	$	743,607

March 31, 2018
Loans individually evaluated for impairment	$	3,191	$	1,946	$	—	$	2,192	$	644	$	523	$	8,496
Loans collectively evaluated for impairment		127,558		391,964		104,104		42,596		20,110		36,407		722,739
Ending Balance	$	130,749	$	393,910	$	104,104	$	44,788	$	20,754	$	36,930	$	731,235

December 31, 2018
Loans individually evaluated for impairment	$	2,902	$	642	$	4,830	$	1,551	$	560	$	389	$	10,874
Loans collectively evaluated for impairment		122,275		419,464		118,796		49,513		19,564		35,008		764,620
Ending Balance	$	125,177	$	420,106	$	123,626	$	51,064	$	20,124	$	35,397	$	775,494

5. MORTGAGE OPERATIONS

Transfers and servicing of financial assets and extinguishments of liabilities are accounted for and reported based on consistent application of a financial-components approach that focuses on control. Transfers of financial assets that are sales are distinguished from transfers that are secured borrowings. Retained interests (mortgage servicing rights) in loans sold are measured by allocating the previous carrying amount of the transferred assets between the loans sold and retained interests, if any, based on their relative fair value at the date of transfer. Fair values are estimated using discounted cash flows based on a current market interest rate.

The Company recognizes a gain and a related asset for the fair value of the rights to service loans for others when loans are sold. The Company sold substantially its entire portfolio of conforming long-term residential mortgage loans originated during the three months ended March 31, 2019 for cash proceeds equal to the fair value of the loans. At March 31, 2019, and December 31, 2018, the Company serviced real estate mortgage loans for others totaling $211,229,000 and $211,845,000, respectively.

The recorded value of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues. The Company assesses capitalized mortgage servicing rights for impairment based upon the fair value of those rights at each reporting date. For purposes of measuring impairment, the rights are stratified based upon the product type, term and interest rates. Fair value is determined by discounting estimated net future cash flows from mortgage servicing activities using discount rates that approximate current market rates and estimated prepayment rates, among other assumptions. The amount of impairment recognized, if any, is the amount by which the capitalized mortgage servicing rights for a stratum exceeds their fair value. Impairment, if any, is recognized through a valuation allowance for each individual stratum. Changes in the carrying amount of mortgage servicing rights are reported in earnings under other operating income on the condensed consolidated statements of income.

Key assumptions used in measuring the fair value of mortgage servicing rights as of March 31, 2019 and December 31, 2018 were as follows:

	March 31, 2019		December 31, 2018

Constant prepayment rate		9.00%		8.58%
Discount rate		10.01%		10.01%
Weighted average life (years)		6.60		6.79

The following table summarizes the Company’s mortgage servicing rights assets as of March 31, 2019 and December 31, 2018. Mortgage servicing rights are included in Interest Receivable and Other Assets on the condensed consolidated balance sheets:

	(in thousands)
	December 31, 2018		Additions		Reductions			March 31, 2019

Mortgage servicing rights	$	1,579	$	25	$	(68	)	$	1,536
Valuation allowance		—		—		—			—
Mortgage servicing rights, net of valuation allowance	$	1,579	$	25	$	(68	)	$	1,536

At March 31, 2019 and December 31, 2018, the estimated fair market value of the Company’s mortgage servicing rights asset was $1,953,000 and $2,091,000, respectively.

The Company received contractually specified servicing fees of $133,000 and $139,000 for the three months ended March 31, 2019 and March 31, 2018, respectively. Contractually specified servicing fees are included in non-interest income on the condensed consolidated statements of income, net of the amortization of the mortgage servicing rights asset.

6. FAIR VALUE MEASUREMENTS

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale and trading securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a non-recurring basis, such as loans held-for-sale, loans held-for-investment and certain other assets. These non-recurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally corresponds with the Company’s quarterly valuation process.

Assets Recorded at Fair Value on a Recurring Basis

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis as of March 31, 2019:

	(in thousands)
March 31, 2019	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Treasury securities	$	43,560	$	43,560	$	—	$	—
Securities of U.S. government agencies and corporations		33,625		—		33,625		—
Obligations of states and political subdivisions		22,863		—		22,863		—
Collateralized mortgage obligations		65,131		—		65,131		—
Mortgage-backed securities		133,470		—		133,470		—
Total investments at fair value	$	298,649	$	43,560	$	255,089	$	—

There were no transfers of assets measured at fair value on a recurring basis between level 1 and level 2 of the fair value hierarchy.

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis as of December 31, 2018:

	(in thousands)
December 31, 2018	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Treasury securities	$	50,682	$	50,682	$	—	$	—
Securities of U.S. government agencies and corporations		42,076		—		42,076		—
Obligations of states and political subdivisions		19,168		—		19,168		—
Collateralized mortgage obligations		63,799		—		63,799		—
Mortgage-backed securities		138,912		—		138,912		—
Total investments at fair value	$	314,637	$	50,682	$	263,955	$	—

Assets Recorded at Fair Value on a Non-Recurring Basis

Assets measured at fair value on a non-recurring basis are included in the table below by level within the fair value hierarchy as of March 31, 2019 and December 31, 2018:

	(in thousands)
March 31, 2019	Carrying Value		Level 1		Level 2		Level 3
Other real estate owned	$	1,092	$	—	$	—	$	1,092
Total assets at fair value	$	1,092	$	—	$	—	$	1,092

	(in thousands)
December 31, 2018	Carrying Value		Level 1		Level 2		Level 3
Impaired loans	$	300	$	—	$	—	$	300
Other real estate owned		1,092		—		—		1,092
Total assets at fair value	$	1,392	$	—	$	—	$	1,392

There were no liabilities measured at fair value on a recurring or non-recurring basis as of March 31, 2019 and December 31, 2018.

Key methods and assumptions used in measuring the fair value of impaired loans and other real estate owned as of December 31, 2018 were as follows:

	Method	Assumption Inputs

Impaired loans	Collateral, market, income, enterprise, liquidation and discounted Cash Flows	External appraised values, management assumptions regarding market trends or other relevant factors, selling costs generally ranging from 6% to 10%, or the amount and timing of cash flows based on the loan's effective interest rate.
Other real estate owned	Collateral	External appraised values, management assumptions regarding market trends or other relevant factors, selling costs generally ranging from 6% to 10%.

The following section describes the valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, if available. If quoted market prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions, and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets where valuations include significant unobservable assumptions.

Impaired Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, the Company measures impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. Those impaired loans not requiring charge-off or specific allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.

At December 31, 2018, certain impaired loans were considered collateral dependent and were evaluated based on the fair value of the underlying collateral securing the loan. Impaired loans where a charge-off is recorded based on the fair value of collateral require classification in the fair value hierarchy. When a loan is evaluated based on the fair value of the underlying collateral securing the loan, the Company records the impaired loan as non-recurring Level 3 given the valuation includes significant unobservable assumptions.

Other Real Estate Owned

Other real estate assets (“OREO”) acquired through, or in lieu of, foreclosure are held-for-sale and are initially recorded at the lower of cost or fair value, less selling costs. Any write-downs to fair value at the time of transfer to OREO are charged to the allowance for loan losses. Appraisals or evaluations are then done periodically thereafter charging any additional write-downs or valuation allowances to the appropriate expense accounts. Values are derived from appraisals of underlying collateral and discounted cash flow analysis. OREO is classified within Level 3 of the hierarchy given the valuation includes significant unobservable assumptions.

Disclosures about Fair Value of Financial Instruments

The estimated fair values of the Company’s financial instruments for the periods ended March 31, 2019 and December 31, 2018 were approximately as follows:

			March 31, 2019				December 31, 2018
	Level		Carrying amount		Fair value		Carrying amount		Fair value

Financial assets:
Cash and cash equivalents		1	$	128,094	$	128,094	$	116,032	$	116,032
Certificates of deposit		2		10,045		10,118		7,595		7,573
Stock in Federal Home Loan Bank and other equity securities		3		6,019		6,019		6,019		6,019
Loans receivable:
Net loans		3		731,605		692,053		763,393		726,179
Loans held-for-sale		2		2,407		2,462		2,295		2,345
Interest receivable		2		4,410		4,410		4,158		4,158
Mortgage servicing rights		3		1,536		1,953		1,579		2,091
Financial liabilities:
Deposits		3		1,086,228		947,551		1,124,612		966,464
Interest payable		2		90		90		74		74

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument and expected exit prices. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, 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 estimates.

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include deferred tax liabilities and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in many of the estimates.

7. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Financial instruments, whose contract amounts represent credit risk at the indicated periods, were as follows:

(in thousands)	March 31, 2019		December 31, 2018

Undisbursed loan commitments	$	204,184	$	201,983
Standby letters of credit		2,447		2,974
Commitments to sell loans		1,078		570
	$	207,709	$	205,527

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. 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. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank issues both financial and performance standby letters of credit. The financial standby letters of credit are primarily to guarantee payment to third parties. At March 31, 2019 and December 31, 2018, there were no financial standby letters of credit outstanding. The performance standby letters of credit are typically issued to municipalities as specific performance bonds. Performance standby letters of credit totaled $2,447,000 and $2,974,000 at March 31, 2019 and December 31, 2018, respectively. The Bank has experienced no draws on these letters of credit, resulting in no related liability included on its balance sheet; however, should a triggering event occur, the Bank either has collateral in excess of the letter of credit or imbedded agreements of recourse from the customer. The Bank has set aside a reserve for unfunded commitments in the amount of $880,000 and $800,000 at March 31, 2019 and December 31, 2018, respectively, which is recorded in “interest payable and other liabilities” on the Condensed Consolidated Balance Sheets.

Commitments to extend credit and standby letters of credit bear similar credit risk characteristics as outstanding loans. As of March 31, 2019 and December 31, 2018, the Company had no off-balance sheet derivatives requiring additional disclosure.

Mortgage loans sold to investors may be sold with servicing rights retained, for which the Company makes only standard legal representations and warranties as to meeting certain underwriting and collateral documentation standards. In the past two years, the Company has not had to repurchase any loans due to deficiencies in underwriting or loan documentation. Management believes that any liabilities that may result from such recourse provisions are not significant.

8. STOCK PLANS

On January 24, 2019, the Board of Directors of the Company declared a 5% stock dividend payable on March 29, 2019 to shareholders of record as of February 28, 2019. All stock options and restricted stock outstanding have been adjusted to give retroactive effect to stock dividends.

The following table presents the activity related to stock options for the three months ended March 31, 2019:

	Number of Shares			Weighted Average Exercise Price		Aggregate Intrinsic Value		Weighted Average Remaining Contractual Term (in years)
Options outstanding at Beginning of Period		329,160		$	8.23
Granted		77,666		$	10.86
Expired		—		$	—
Cancelled / Forfeited		(1,689	)		12.41
Exercised		—		$	—
Options outstanding at End of Period		405,137		$	8.72	$	1,192,539		7.16
Exercisable (vested) at End of Period		224,595		$	6.95	$	1,038,576		5.71

The weighted average grant date fair value per share of options granted during the three months ended March 31, 2019 was $1.82 per share.

The intrinsic value of options exercised was $0 and $88,000 during the three months ended March 31, 2019 and March 31, 2018, respectively. The fair value of awards vested was $141,000 and $114,000 during the three months ended March 31, 2019 and March 31, 2018, respectively.

As of March 31, 2019, there was $365,000 of total unrecognized compensation cost related to non-vested stock options. This cost is expected to be recognized over a weighted average period of approximately 2.74 years.

There was $35,000 of recognized compensation cost related to stock options granted for the three months ended March 31, 2019.

A summary of the weighted average assumptions used in valuing stock options during the three months ended March 31, 2019 is presented below:

	Three Months Ended March 31, 2019
Risk Free Interest Rate		2.47 %

Expected Dividend Yield		0.00 %

Expected Life in Years		5

Expected Price Volatility		11.86 %

The following table presents the activity related to non-vested restricted stock for the three months ended March 31, 2019:

	Number of Shares			Weighted Average Grant - Date Fair Value		Aggregate Intrinsic Value		Weighted Average Remaining Contractual Term (in years)
Non-vested Restricted stock outstanding at Beginning of Period		118,391		$	8.94
Granted		42,262		$	10.86
Cancelled / Forfeited		—			—
Exercised/Released/Vested		(33,922	)	$	6.64
Non-vested restricted stock outstanding at End of Period		126,731		$	10.19	$	1,457,407		3.13

The weighted average fair value of restricted stock granted during the three months ended March 31, 2019 was $10.86 per share.

As of March 31, 2019, there was $871,000 of total unrecognized compensation cost related to non-vested restricted stock. This cost is expected to be recognized over a weighted average period of approximately 3.13 years.

There was $69,000 of recognized compensation cost related to restricted stock awards for the three months ended March 31, 2019.

The Company has an Employee Stock Purchase Plan (“ESPP”). There are 295,277 shares authorized under the ESPP. The total number of shares authorized has been adjusted to give retroactive effect to stock dividends and stock splits, including the 5% stock dividend declared on January 24, 2019, payable March 29, 2019 to shareholders of record as of February 28, 2019. The ESPP will expire on March 16, 2026.

The ESPP is implemented by participation periods of not more than twenty-seven months each. The Board of Directors determines the commencement date and duration of each participation period. The Board of Directors approved the current participation period of November 24, 2018 to November 23, 2019. An eligible employee is one who has been continually employed for at least 90 days prior to commencement of a participation period. Under the terms of the ESPP, employees can choose to have up to 10 percent of their compensation withheld to purchase the Company’s common stock each participation period. The purchase price of the stock is 85 percent of the lower of the fair value on the last trading day before the date of participation or the fair value on the last trading day during the participation period.

As of March 31, 2019, there was $19,000 of unrecognized compensation cost related to ESPP issuances. This cost is expected to be recognized over a weighted average period of approximately 0.75 years.

There was $6,000 of recognized compensation cost related to ESPP issuances for the three months ended March 31, 2019.

The weighted average fair value at issuance date during the three months ended March 31, 2019 was $2.57.

A summary of the weighted average assumptions used in valuing ESPP issuances during the three months ended March 31, 2019 is presented below:

	Three Months Ended March 31, 2019
Risk Free Interest Rate		2.67%

Expected Dividend Yield		0.00%

Expected Life in Years		1.00

Expected Price Volatility		8.47%

9. ACCUMULATED OTHER COMPREHENSIVE LOSS

The following table details activity in accumulated other comprehensive income (loss) for the three months ended March 31, 2019:

($ in thousands)	Unrealized Gains (losses) on Securities			Officers’ retirement plan			Directors’ retirement plan		Accumulated Other Comprehensive Loss
Balance as of December 31, 2018	$	(3,867	)	$	(1,198	)	$	29	$	(5,036	)
Current period other comprehensive income/(loss)		1,478			—			—		1,478
Balance as of March 31, 2019	$	(2,389	)	$	(1,198	)	$	29	$	(3,558	)

The following table details activity in accumulated other comprehensive income (loss) for the three months ended March 31, 2018:

($ in thousands)	Unrealized Gains (losses) on Securities			Officers’ retirement plan			Directors’ retirement plan		Accumulated Other Comprehensive Loss
Balance as of December 31, 2017	$	(2,997	)	$	(1,403	)	$	3	$	(4,397	)
Current period other comprehensive income/(loss)		(1,811	)		—			—		(1,811	)
Balance as of March 31, 2018	$	(4,808	)	$	(1,403	)	$	3	$	(6,208	)

10. OUTSTANDING SHARES AND EARNINGS PER SHARE

On January 24, 2019, the Board of Directors of the Company declared a 5% stock dividend payable on March 29, 2019 to shareholders of record as of February 28, 2019. All income per share amounts have been adjusted to give retroactive effect to stock dividends.

Earnings Per Share (EPS)

Basic EPS includes no dilution and is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the respective period. Diluted EPS is computed by dividing net income available to common shareholders by the weighted average number of shares outstanding plus dilutive shares for the quarter. Diluted shares include all common stock equivalents (“in-the-money” stock options, unvested restricted stock, stock units, warrants and rights, convertible bonds and preferred stock), which reflects the potential dilution of securities that could share in the earnings of the Company.

The following table presents a reconciliation of basic and diluted EPS for the three months ended March 31, 2019 and 2018 (dollars in thousands except per share amounts):

	Three months ended March 31,
	2019		2018
Basic earnings per share:
Net income	$	3,985	$	2,733

Weighted average common shares outstanding		12,141,752		12,111,999
Basic EPS	$	0.33	$	0.23

Diluted earnings per share:
Net income	$	3,985	$	2,733

Weighted average common shares outstanding		12,141,752		12,111,999
Effect of dilutive shares		143,308		170,787
Adjusted weighted average common shares outstanding		12,285,060		12,282,786
Diluted EPS	$	0.32	$	0.22

Stock options which were not included in the computation of diluted earnings per share because they would have had an anti-dilutive effect amounted to 215,415 shares and 139,445 shares for the three months ended March 31, 2019 and March 31, 2018, respectively.

11. LEASES

The Company adopted ASU 2016-02, Leases (Topic 842) on January 1, 2019. As a result, the Company recognized a right-of-use asset of $4,417,000 included in Interest receivable and other assets and lease liabilities of $4,812,000 included in Interest payable and other liabilities on the Balance Sheet. The recognition of a cumulative-effect adjustment to the opening balance of retained earnings was not necessary as prior to the adoption of this ASU, the Company recognized lease expense on a straight-line basis over the life of the lease term. As such, the difference between the right-of-use asset and lease liabilities was offset by accrued rent and tenant improvement receivables as of January 1, 2019.

The Bank leases nine branch and administrative locations. Leases with an initial term of 12 months or less are not recorded on the balance sheet and lease expense is recognized on a straight-line basis over the lease term. For lease agreements entered into or reassessed after the adoption of Topic 842, the Bank combines lease and nonlease components. As of March 31, 2019, all of the Bank’s leases are operating leases.

Most leases include options to renew, with renewal terms that can extend the lease term from 3 to 10 years. The exercise of lease renewal options is at the Bank’s sole discretion. Most leases are currently in the extension period. For the remaining leases with options to renew, the Bank has not included the extended lease terms in the calculation of lease liabilities as the options are not reasonably certain of being exercised. Certain lease agreements include rental payments that are adjusted periodically for inflation. The Bank's lease agreements do not contain any residual value guarantees or restrictive covenants.

The Bank uses its FHLB advance fixed rates, which are the Bank’s incremental borrowing rates for secured borrowings, as the discount rates to calculate lease liabilities.

As of March 31, 2019, the Company had right-of use assets and lease liabilities totaling $4,225,000 and $4,618,000, respectively. For the three months ended March 31, 2019, the Company recognized lease expense totaling $223,000, which includes expenses related to short-term leases totaling $29,000 and a reduction of $21,000 for the recognition of deferred gain on sale-leaseback. Lease expense is included in Occupancy and equipment expense on the Income Statement.

The table below summarizes the maturity of remaining lease liabilities:

(in thousands)	March 31, 2019
2019	$	656
2020		858
2021		802
2022		738
2023		669
After 2023		1,387
Total lease payments		5,110
Less: interest		(492	)
Present value of lease liabilities	$	4,618

The table below summarizes other information related to our operating leases:

(in thousands except for percent and period data)	Three Months Ended March 31, 2019
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	217
Right-of-use assets obtained in exchange for new operating lease liabilities		4,417
Weighted-average remaining lease term - operating leases, in years		6.41
Weighted-average discount rate - operating leases		3.03	%

FIRST NORTHERN COMMUNITY BANCORP

ITEM 2. – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

This report may include forward-looking statements, which may include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly compared to our forecasts and expectations. See Part I, Item 1A. “Risk Factors,” and the other risks described in our 2018 Annual Report on Form 10-K and Part II, Item 1A "Risk Factors" in this Quarterly Report on Form 10-Q and the other risks described in our Quarterly Reports on Form 10-Q for factors to be considered when reading any forward-looking statements in this filing.

This report and other reports or statements which we may release may include forward-looking statements, which are subject to the “safe harbor” created by section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended. We may make forward-looking statements in our Securities and Exchange Commission (SEC) filings, press releases, news articles and when we are speaking on behalf of the Company. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include the words “believe,” “expect,” “target,” “anticipate,” “intend,” “plan,” “seek,” “strive,” “estimate,” “potential,” “project,” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” or “may.” These forward-looking statements are intended to provide investors with additional information with which they may assess our future potential. All of these forward-looking statements are based on assumptions about an uncertain future and are based on information available to us at the date of these statements. We do not undertake to update forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date any forward-looking statements are made.

In this document and in other SEC filings or other public statements, for example, we make forward-looking statements relating to the following topics, among others:

●

Our business objectives, strategies and initiatives, our organizational structure, the growth of our business and our competitive position and prospects, and the effect of competition on our business and strategies

●

Our assessment of significant factors and developments that have affected or may affect our results

●

Pending and recent legal and regulatory actions, and future legislative and regulatory developments, including the effects of the Dodd-Frank Wall Street Reform and Protection Act (the “Dodd-Frank Act”) and other legislation and governmental measures introduced in response to the financial crisis which began in 2008 affecting the banking system, financial markets and the U.S. economy

●

Regulatory and compliance controls, processes and requirements and their impact on our business

●

The costs and effects of legal or regulatory actions

●

Expectations regarding draws on performance letters of credit and liabilities that may result from recourse provisions in standby letters of credit

●

Our intent to sell or hold, and the likelihood that we would be required to sell, various investment securities

●

Our regulatory capital requirements, including the capital rules after the financial crisis by the U.S. federal banking agencies

●

Expectations regarding our non-payment of a cash dividend on our common stock in the foreseeable future

●

Credit quality and provision for credit losses and management of asset quality and credit risk, and expectations regarding collections

●

Our allowances for credit losses, including the conditions we consider in determining the unallocated allowance and our portfolio credit quality, the adequacy of the allowance for loan losses, underwriting standards, and risk grading

●

Our assessment of economic conditions and trends and credit cycles and their impact on our business

●

The seasonal nature of our business

●

The impact of changes in interest rates and our strategy to manage our interest rate risk profile and the possible effect of increases in residential mortgage interest rates on new originations and refinancing of existing residential mortgage loans

●

Loan portfolio composition and risk grade trends, expected charge-offs, portfolio credit quality, our strategy regarding troubled debt restructurings (“TDRs”), delinquency rates and our underwriting standards

●

Our deposit base including renewal of time deposits

●

The impact on our net interest income and net interest margin from the current interest rate environment

●

Possible changes in the initiatives and policies of the federal bank regulatory agencies

●

Tax rates and the impact of changes in the U.S. tax laws, including the Tax Cuts and Jobs Act

●

Our pension and retirement plan costs

●

Our liquidity position

●

Critical accounting policies and estimates, the impact or anticipated impact of recent accounting pronouncements or changes in accounting principles

●

Expected rates of return, maturities, loss exposure, growth rates, yields and projected results

●

The possible impact of weather related conditions, including drought, fire or flooding, seismic events, and related governmental responses, on economic conditions, especially in the agricultural sector

●

Maintenance of insurance coverages appropriate for our operations

●

Threats to the banking sector and our business due to cybersecurity issues and attacks and regulatory expectations related to cybersecurity

●

Descriptions of assumptions underlying or relating to any of the foregoing

Readers of this document should not rely on any forward-looking statements, which reflect only our management’s belief as of the date of this report. There are numerous risks and uncertainties that could and will cause actual results to differ materially from those discussed in our forward-looking statements. Many of these factors are beyond our ability to control or predict and could have a material adverse effect on our financial condition and results of operations or prospects. Such risks and uncertainties include, but are not limited to those listed in Item 1A “Risk Factors” of Part II of this Form 10-Q, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of Part I of this Form 10-Q and "Risk Factors" and “Supervision and Regulation” in our 2018 Annual Report on Form 10-K, and in our other reports to the SEC.

INTRODUCTION

This overview of Management’s Discussion and Analysis highlights selected information in this report and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting estimates, you should carefully read this entire report and any other reports to the Securities and Exchange Commission (“SEC”), together with our Consolidated Financial Statements and the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2018.

Our subsidiary, First Northern Bank of Dixon (the “Bank”), is a California state-chartered bank that derives most of its revenues from lending and deposit taking in the Sacramento Valley region of Northern California. Interest rates, business conditions and customer confidence all affect our ability to generate revenues. In addition, the regulatory and compliance environment and competition can present challenges to our ability to generate those revenues.

Significant results and developments during the first quarter and year-to-date 2019 included:

●

Net income of $4.0 million for the three months ended March 31, 2019, up 45.8% from $2.7 million earned for the same period last year.

●

Diluted earnings per share of $0.32 for the three months ended March 31, 2019, up 45.5% from diluted earnings per share of $0.22 in the same period last year.

●

Net interest income of $11.7 million for the three months ended March 31, 2019, up 11.1% from $10.5 million in the same period last year.

●

Net interest margin of 4.09% for the three months ended March 31, 2019, up 9.4% from 3.74% for the same period last year.

●

No provision for loan losses for the three months ended March 31, 2019, compared to $0.5 million provision for the same period last year.

●

Total assets of $1.22 billion as of March 31, 2019, down 2.5% from $1.25 billion as of December 31, 2018.

●

Total net loans (including loans held-for-sale) of $734.0 million as of March 31, 2019, down 4.1% from $765.7 million as of December 31, 2018.

●

Total investment securities of $298.6 million as of March 31, 2019, down 5.1% from $314.6 million as of December 31, 2018.

●

Total deposits of $1.09 billion as of March 31, 2019, down 3.4% from $1.12 billion as of December 31, 2018.

SUMMARY

The Company recorded net income of $3,985,000 for the three months ended March 31, 2019, representing an increase of $1,252,000 from net income of $2,733,000 for the same period in 2018.

The following tables present a summary of the results for the three months ended March 31, 2019 and 2018, and a summary of our financial condition at March 31, 2019 and December 31, 2018:

	Three months ended March 31, 2019			Three months ended March 31, 2018

(in thousands except for per share amounts)
For the Period:
Net Income	$	3,985		$	2,733
Basic Earnings Per Common Share	$	0.33		$	0.23
Diluted Earnings Per Common Share	$	0.32		$	0.22
Net Income to Average Assets (annualized)		1.30	%		0.91	%
Net Income to Average Equity (annualized)		13.84	%		10.85	%
Average Equity to Average Assets		9.41	%		8.39	%

	March 31, 2019			December 31, 2018

(in thousands except for ratios)
At Period End:
Total Assets	$	1,218,968		$	1,249,845
Total Investment Securities	$	298,649		$	314,637
Total Loans, Net (including loans held-for-sale)	$	734,012		$	765,688
Total Deposits	$	1,086,228		$	1,124,612
Loan-To-Deposit Ratio		67.6	%		68.1	%

FIRST NORTHERN COMMUNITY BANCORP

Distribution of Average Statements of Condition and Analysis of Net Interest Income

(in thousands, except percentage amounts)

	Three months ended March 31, 2019							Three months ended March 31, 2018
	Average Balance		Interest		Yield/ Rate (4)			Average Balance		Interest		Yield/ Rate (4)
Assets
Interest-earning assets:
Loans (1)	$	744,045	$	9,612		5.24	%	$	717,675	$	8,806		4.98	%
Certificates of deposit		8,994		66		2.98	%		1,984		6		1.23	%
Interest bearing due from banks		87,772		575		2.66	%		123,235		511		1.68	%
Investment securities, taxable		299,866		1,633		2.21	%		280,552		1,308		1.89	%
Investment securities, non-taxable (2)		10,621		50		1.91	%		12,259		39		1.29	%
Other interest earning assets		6,019		115		7.75	%		5,567		105		7.65	%
Total average interest-earning assets		1,157,317		12,051		4.22	%		1,141,272		10,775		3.83	%
Non-interest-earning assets:
Cash and due from banks		26,606							24,267
Premises and equipment, net		6,557							6,154
Other real estate owned		1,092							—
Interest receivable and other assets		32,587							29,683
Total average assets		1,224,159							1,201,376

Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing transaction deposits		309,859		127		0.17	%		303,755		67		0.09	%
Savings and MMDA’s		329,563		162		0.20	%		337,901		129		0.15	%
Time, $250,000 and under		44,759		56		0.51	%		52,184		47		0.37	%
Time, over $250,000		16,594		26		0.64	%		18,841		20		0.43	%
Total average interest-bearing liabilities		700,775		371		0.21	%		712,681		263		0.15	%
Non-interest-bearing liabilities:
Non-interest-bearing demand deposits		395,329							376,428
Interest payable and other liabilities		12,920							11,486
Total liabilities		1,109,024							1,100,595
Total average stockholders’ equity		115,135							100,781
Total average liabilities and stockholders’ equity	$	1,224,159						$	1,201,376
Net interest income and net interest margin (3)			$	11,680		4.09	%			$	10,512		3.74	%

(1) Average balances for loans include loans held-for-sale and non-accrual loans and are net of the allowance for loan losses, but non-accrued interest is excluded. Loan interest income includes loan fees of approximately $(9) and $28 for the three months ended March 31, 2019 and 2018, respectively.

(2) Interest income and yields on tax-exempt securities are not presented on a taxable equivalent basis.

(3) Net interest margin is computed by dividing net interest income by total average interest-earning assets.

(4) For disclosure purposes, yield/rates are annualized by dividing the number of days in the reported period by 365.

FIRST NORTHERN COMMUNITY BANCORP

Distribution of Average Statements of Condition and Analysis of Net Interest Income

(in thousands, except percentage amounts)

	Three months ended March 31, 2019							Three months ended December 31, 2018
	Average Balance		Interest		Yield/ Rate (4)			Average Balance		Interest		Yield/ Rate (4)
Assets
Interest-earning assets:
Loans (1)	$	744,045	$	9,612		5.24	%	$	764,464	$	9,589		4.98	%
Certificates of deposit		8,994		66		2.98	%		6,192		44		2.82	%
Interest bearing due from banks		87,772		575		2.66	%		118,042		629		2.11	%
Investment securities, taxable		299,866		1,633		2.21	%		291,535		1,518		2.07	%
Investment securities, non-taxable (2)		10,621		50		1.91	%		8,932		38		1.69	%
Other interest earning assets		6,019		115		7.75	%		6,019		205		13.51	%
Total average interest-earning assets		1,157,317		12,051		4.22	%		1,195,184		12,023		3.99	%
Non-interest-earning assets:
Cash and due from banks		26,606							26,581
Premises and equipment, net		6,557							5,995
Other real estate owned		1,092							736
Interest receivable and other assets		32,587							31,292
Total average assets		1,224,159							1,259,788

Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing transaction deposits		309,859		127		0.17	%		315,644		144		0.18	%
Savings and MMDA’s		329,563		162		0.20	%		341,631		162		0.19	%
Time, $250,000 and under		44,759		56		0.51	%		47,281		57		0.48	%
Time, over $250,000		16,594		26		0.64	%		16,131		20		0.49	%
Total average interest-bearing liabilities		700,775		371		0.21	%		720,687		383		0.21	%
Non-interest-bearing liabilities:
Non-interest-bearing demand deposits		395,329							417,473
Interest payable and other liabilities		12,920							12,883
Total liabilities		1,109,024							1,151,043
Total average stockholders’ equity		115,135							108,745
Total average liabilities and stockholders’ equity	$	1,224,159						$	1,259,788
Net interest income and net interest margin (3)			$	11,680		4.09	%			$	11,640		3.86	%

(1) Average balances for loans include loans held-for-sale and non-accrual loans and are net of the allowance for loan losses, but non-accrued interest is excluded. Loan interest income includes loan fees of approximately $(9) and $(173) for the three months ended March 31, 2019 and December 31, 2018, respectively.

(2) Interest income and yields on tax-exempt securities are not presented on a taxable equivalent basis.

(3) Net interest margin is computed by dividing net interest income by total average interest-earning assets.

(4) For disclosure purposes, yield/rates are annualized by dividing the number of days in the reported period by 365.

Analysis of Changes

in Interest Income and Interest Expense

(Dollars in thousands)

Following is an analysis of changes in interest income and expense (dollars in thousands) for the three months ended March 31, 2019 over the three months ended March 31, 2018 and the three months ended March 31, 2019 over the three months ended December 31, 2018. Changes not solely due to interest rate or volume have been allocated proportionately to interest rate and volume.

	Three Months Ended March 31, 2019 Over Three Months Ended March 31, 2018							Three Months Ended March 31, 2019 Over Three Months Ended December 31, 2018
	Volume			Interest Rate		Change		Volume			Interest Rate			Change

Increase (Decrease) in Interest Income:

Loans	$	318		$	488	$	806	$	(278	)	$	301		$	23
Certificates of Deposit		42			18		60		20			2			22
Due From Banks		(178	)		242		64		(188	)		134			(54	)
Investment Securities - Taxable		93			232		325		43			72			115
Investment Securities - Non-taxable		(6	)		17		11		8			4			12
Other Assets		8			2		10		—			(90	)		(90	)

	$	277		$	999	$	1,276	$	(395	)	$	423		$	28

Increase (Decrease) in Interest Expense:

Deposits:
Interest-Bearing Transaction Deposits	$	1		$	59	$	60	$	(4	)	$	(13	)	$	(17	)
Savings & MMDAs		(3	)		36		33		(7	)		7			—
Time Certificates		(26	)		41		15		(8	)		13			5

	$	(28	)	$	136	$	108	$	(19	)	$	7		$	(12	)

Increase in Net Interest Income:	$	305		$	863	$	1,168	$	(376	)	$	416		$	40

CHANGES IN FINANCIAL CONDITION

The assets of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect a $12,062,000 or 10.4% increase in cash and cash equivalents, a $15,988,000 or 5.1% decrease in investment securities available-for-sale, a $31,788,000 or 4.2% decrease in net loans held-for-investment, a $112,000 or 4.9% increase in loans held-for-sale, and a $349,000 or 5.3% decrease in premises & equipment from December 31, 2018 to March 31, 2019. The increase in cash and cash equivalents was due to an increase in non-interest bearing accounts, which was partially offset by a decrease in interest bearing due from Federal Reserve Bank accounts. The decrease in investment securities available-for-sale was primarily the result of maturities of agency, mortgage-backed, U.S. Treasury and municipal securities, which was partially offset by purchases of agency, municipal, collateralized mortgage obligations, and mortgage-backed securities. The decrease in net loans held-for-investment was primarily due to principal paydowns and maturities of loans. The increase in loans held-for-sale was due to timing of sales of loans held-for-sale. The decrease in premises & equipment was primarily due the sale of land during the three months ended March 31, 2019.

The liabilities of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect a decrease in total deposits of $38,384,000 or 3.4% from December 31, 2018 to March 31, 2019. The decrease in deposits was largely due to increased competition for low cost funding as short term rates rose during the period, coupled with seasonal fluctuations.

CHANGES IN RESULTS OF OPERATIONS

Interest Income

The Federal Open Market Committee made no changes to the Federal Funds rate during the three months ended March 31, 2019.

Interest income on loans for the three months ended March 31, 2019 was up 9.2% from the same period in 2018, increasing from $8,806,000 to $9,612,000. The increase in interest income on loans for the three months ended March 31, 2019 as compared to the same period a year ago was primarily due to an increase in average loans and a 26 basis point increase in loan yields. The increase in loan yields was primarily due to the origination of new loans and the repricing of existing loans at higher rates.

Interest income on investment securities available-for-sale for the three months ended March 31, 2019 was up 24.9% from the same period in 2018, increasing from $1,347,000 to $1,683,000. The increase in interest income on investment securities for the three months ended March 31, 2019 as compared to the same period a year ago was primarily due to an increase in average investment securities and a 33 basis point increase in yields on investment securities. The increase in yields on investment securities is primarily due to the reinvestment of cash flows into higher yielding investment securities.

Interest income on certificates of deposit for the three months ended March 31, 2019 was up 1000.0% from the same period in 2018, increasing from $6,000 to $66,000. The increase in interest income on certificates of deposit for the three months ended March 31, 2019 as compared to the same period a year ago was primarily due to an increase in average balance of certificates of deposit and a 175 basis point increase in certificates of deposit yields.

Interest income on interest-bearing due from banks for the three months ended March 31, 2019 was up 12.5% from the same period in 2018, increasing from $511,000 to $575,000. The increase in interest income on interest-bearing due from banks for the three months ended March 31, 2019 as compared to the same period a year ago was due to a 98 basis point increase in interest-bearing due from yields, which was partially offset by a decrease in average interest-bearing due from banks balance.

The Company had no Federal Funds sold balances during the three months ended March 31, 2019 and March 31, 2018.

Interest Expense

Interest expense on deposits for the three months ended March 31, 2019 was up 41.4% from the same period in 2018, increasing from $263,000 to $371,000. The increase in interest expense is primarily due to a 6 basis point increase in average interest-bearing deposits, which was partially offset by a decrease in average deposits.

The Company had no FHLB advances or other borrowing balances during the three months ended March 31, 2019 and March 31, 2018.

Provision for Loan Losses

There was no provision for loan losses for the three months ended March 31, 2019 compared to a provision for loan losses of $525,000 for the same period in 2018. The allowance for loan losses was approximately $12,746,000, or 1.71% of total loans, at March 31, 2019, compared to $12,822,000, or 1.65% of total loans, at December 31, 2018. The allowance for loan losses is maintained at a level considered adequate by management to provide for probable loan losses inherent in the loan portfolio.

Provision for Unfunded Lending Commitment Losses

There was a provision for unfunded lending commitment losses of $80,000 and $0 for the three months ended March 31, 2019 and March 31, 2018, respectively.

Provisions for unfunded lending commitment losses are included in non-interest expense in the Condensed Consolidated Statements of Income.

Non-Interest Income

Non-interest income was up 3.1% for the three months ended March 31, 2019 from the same period in 2018, increasing from $1,804,000 to $1,859,000.

The increase was primarily due to increases on gains on sales of loans held-for-sale, mortgage brokerage income, and gain on sale of land, which were partially offset by decreases in investment and brokerage income, loan servicing income, debit card income and trust income. The increase in gains on sales of loans held-for-sale was primarily due to an increase in originations of loans held-for-sale. The increase in mortgage brokerage income was primarily due to an increase in demand for those services. The Company recognized a gain on sale of land totaling $281,000 during the three months ended March 31, 2019. The decrease in investment and brokerage income was primarily due to a decrease in demand for those services. The decrease in loan servicing income was primarily due to a decrease in mortgage servicing assets recorded. The decrease in debit card income was primarily due to a decrease in volume of transactions. The decrease in trust income was due to the sale of the Company's Trust Department during the fourth quarter of 2018.

Non-Interest Expenses

Total non-interest expenses were up 0.3% for the three months ended March 31, 2019 from the same period in 2018, increasing from $7,994,000 to $8,018,000.

The increase was primarily due to increases in salaries and employee benefits, data processing, and other real estate owned expense, which was partially offset by decreases in occupancy and equipment expense, stationery and supplies, advertising and directors' fees. The increase in salaries and employee benefits was primarily due to an increase in the number of full-time equivalent employees. The increase in data processing expense was primarily due to enhanced IT infrastructure costs. The increase in other real estate owned expense was primarily due to an increase in other real estate owned properties. The decrease in occupancy and equipment expense was primarily due to a decrease in service contracts. The decrease in directors' fees was partially due to a decrease in the number of directors and number of meetings.

The following table sets forth other non-interest expenses by category for the three months ended March 31, 2019 and 2018.

	(in thousands)
	Three months ended March 31, 2019			Three months ended March 31, 2018
Other non-interest expenses
Allowance for unfunded commitments expense	$	80		$	—
FDIC assessments		90			110
Contributions		66			49
Legal fees		73			54
Accounting and audit fees		110			105
Consulting fees		78			96
Postage expense		28			26
Telephone expense		33			30
Public relations		48			61
Training expense		33			27
Loan origination expense		51			51
Computer software depreciation		32			36
Operational losses		54			40
Loan collection (recovery) expense		(52	)		12
Other non-interest expense		434			483
Total other non-interest expenses	$	1,158		$	1,180

Income Taxes

The Company’s tax rate, the Company’s income before taxes and the amount of tax relief provided by non-taxable earnings affect the Company’s provision for income taxes. Provision for income taxes increased 44.4% for the three months ended March 31, 2019 from the same period in 2018, increasing from $1,064,000 to $1,536,000 due to an increase in pre-tax income.

Off-Balance Sheet Commitments

The following table shows the distribution of the Company’s undisbursed loan commitments at the dates indicated.

	(in thousands)
	March 31, 2019		December 31, 2018

Undisbursed loan commitments	$	204,184	$	201,983
Standby letters of credit		2,447		2,974
Commitments to sell loans		1,078		570
	$	207,709	$	205,527

The reserve for unfunded lending commitments amounted to $880,000 and $800,000 as of March 31, 2019 and December 31, 2018, respectively. The reserve for unfunded lending commitments is included in other liabilities on the Condensed Consolidated Balance Sheets. See Note 7 of the Notes to Condensed Consolidated Financial Statements of this Form 10-Q, "Financial Instruments with Off-Balance Sheet Risk," for additional information.

Asset Quality

The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk-rating standards and criteria similar to those employed by state and federal banking regulatory agencies. The federal bank regulatory agencies utilize the following definitions for assets adversely classified for supervisory purposes:

●

Substandard Assets – A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

●

Doubtful Assets – An asset classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable or improbable.

Other Real Estate Owned and loans rated Substandard and Doubtful are deemed "classified assets". This category, which includes both performing and non-performing assets, receives an elevated level of attention regarding collection.

The following tables summarize the Company’s non-accrual loans net of guarantees of the State of California and U.S. Government by loan category at March 31, 2019 and December 31, 2018:

	At March 31, 2019						At December 31, 2018
	Gross		Guaranteed		Net		Gross		Guaranteed		Net
(dollars in thousands)

Commercial	$	213	$	—	$	213	$	750	$	300	$	450
Commercial real estate		367		53		314		381		56		325
Agriculture		4,778		735		4,043		4,830		776		4,054
Residential mortgage		97		—		97		100		—		100
Residential construction		—		—		—		—		—		—
Consumer		192		—		192		191		—		191
Total non-accrual loans	$	5,647	$	788	$	4,859	$	6,252	$	1,132	$	5,120

It is generally the Company’s policy to discontinue interest accruals once a loan is past due for a period of 90 days as to interest or principal payments unless the loan is well secured and in process of collection. When a loan is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected or there is an extended period of positive performance and a high probability that the loan will continue to pay according to original terms.

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Nonaccrual loans are non-performing impaired loans totaling $5,647,000 and $6,252,000 as of March 31, 2019 and December 31, 2018, respectively. A restructuring of a loan can constitute a TDR if the Company for economic or legal reasons related to the borrower’s financial difficulties grants a concession to the borrower that it would not otherwise consider. A loan that is restructured as a TDR is considered an impaired loan. Performing impaired loans, which consisted of loans modified as TDRs, totaled $4,408,000 and $4,622,000 at March 31, 2019 and December 31, 2018, respectively. The Company expects to collect all principal and interest due from performing impaired loans. These loans are not on non-accrual status. The majority of the non-performing impaired loans, in management's opinion, were adequately collateralized based on recently obtained appraised property values or were guaranteed by a governmental entity. See “Allowance for Loan Losses” below for additional information. No assurance can be given that the existing or any additional collateral will be sufficient to secure full recovery of the obligations owed under these loans.

As the following table illustrates, total non-performing assets, net of guarantees of the State of California and U.S. Government, including its agencies and its government-sponsored agencies, increased $401,000 or 6.5% to $6,613,000 during the first three months of 2019. Non-performing assets, net of guarantees, represented 0.5% of total assets at March 31, 2019.

	At March 31, 2019							At December 31, 2018
	Gross		Guaranteed		Net			Gross		Guaranteed		Net
(dollars in thousands)
Non-accrual loans	$	5,647	$	788	$	4,859		$	6,252	$	1,132	$	5,120
Loans 90 days past due and still accruing		662		—		662			—		—		—

Total non-performing loans		6,309		788		5,521			6,252		1,132		5,120
Other real estate owned		1,092		—		1,092			1,092		—		1,092
Total non-performing assets		7,401		788		6,613			7,344		1,132		6,212

Non-performing loans (net of guarantees) to total loans						0.7	%						0.7	%
Non-performing assets (net of guarantees) to total assets						0.5	%						0.5	%
Allowance for loan and lease losses to non-performing loans (net of guarantees)						230.9	%						250.4	%

The Company had one commercial loan totaling $662,000 that was 90 days or more past due and still accruing at March 31, 2019. The Company had no loans 90 days or more past due and still accruing at December 31, 2018.

Excluding the non-performing loans cited previously, loans totaling $12,317,000 and $15,926,000 were classified as substandard or doubtful loans, representing potential problem loans at March 31, 2019 and December 31, 2018, respectively. In Management’s opinion, the potential loss related to these problem loans was sufficiently covered by the Bank’s existing loan loss reserve (Allowance for Loan Losses) at March 31, 2019 and December 31, 2018. The ratio of the Allowance for Loan Losses to total loans at March 31, 2019 and December 31, 2018 was 1.71% and 1.65%, respectively.

Other real estate owned (“OREO”) consists of property that the Company has acquired by deed in lieu of foreclosure or through foreclosure proceedings, and property that the Company does not hold title to but is in actual control of, known as in-substance foreclosure. The estimated fair value of the property is determined prior to transferring the balance to OREO. The balance transferred to OREO is the estimated fair value of the property less estimated cost to sell. Impairment may be deemed necessary to bring the book value of the loan equal to the appraised value. Appraisals or loan officer evaluations are then conducted periodically thereafter charging any additional impairment to the appropriate expense account. The Company had one commercial property classified as OREO totaling $1,092,000 as of March 31, 2019 and December 31, 2018.

Allowance for Loan Losses

The Company's Allowance for Loan Losses is maintained at a level believed by management to be adequate to provide for loan and other credit losses that can be reasonably anticipated. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. The Company contracts with vendors for credit reviews of the loan portfolio as well as considers current economic conditions, loan loss experience, and other factors in determining the adequacy of the reserve balance. The allowance for loan losses is based on estimates, and actual losses may vary from current estimates.

The following table summarizes the Allowance for Loan Losses of the Company during the three months ended March 31, 2019 and 2018, and for the year ended December 31, 2018:

Analysis of the Allowance for Loan Losses

(Amounts in thousands, except percentage amounts)

	Three months ended March 31,						Year ended December 31,
	2019			2018			2018

Balance at beginning of period	$	12,822		$	11,133		$	11,133
Provision for loan losses		—			525			2,100
Loans charged-off:
Commercial		(150	)		—			(509	)
Commercial Real Estate		—			—			(142	)
Agriculture		—			—			—
Residential Mortgage		—			—			—
Residential Construction		—			—			—
Consumer		(7	)		(6	)		(34	)
Total charged-off		(157	)		(6	)		(685	)

Recoveries:
Commercial		19			9			46
Commercial Real Estate		—			—			—
Agriculture		—			—			—
Residential Mortgage		56			16			34
Residential Construction		1			1			131
Consumer		5			37			63
Total recoveries		81			63			274

Net charge-offs		(76	)		57			(411	)

Balance at end of period	$	12,746		$	11,715		$	12,822

Ratio of net charge-offs (recoveries) to average loans outstanding during the period (annualized)		(0.04	%)		0.03	%		(0.05	%)
Allowance for loan losses
To total loans at the end of the period		1.71	%		1.60	%		1.65	%
To non-performing loans, net of guarantees at the end of the period		230.9	%		374.3	%		250.4	%

The allowance for loan losses to non-performing loans, net of guarantees was 230.9% and 374.3% as of March 31, 2019 and March 31, 2018, respectively, and 250.4% as of December 31, 2018. The decrease in the ratio of allowance for loan losses to non-performing loans, net of guarantees from December 31, 2018 to March 31, 2019 was due to various factors which include the payoff of a $450,000 commercial loan that was fully reserved as of December 31, 2018, an increase in unallocated reserves driven by a decrease in loans outstanding primarily driven by seasonal fluctuations associated with agricultural production loans and reductions in commercial loans outstanding.

Deposits

Deposits are one of the Company’s primary sources of funds. At March 31, 2019, the Company had the following deposit mix: 30.4% in savings and MMDA deposits, 5.5% in time deposits, 28.3% in interest-bearing transaction deposits and 35.8% in non-interest-bearing transaction deposits. At December 31, 2018, the Company had the following deposit mix: 29.6% in savings and MMDA deposits, 5.6% in time deposits, 27.8% in interest-bearing transaction deposits and 37.0% in non-interest-bearing transaction deposits. Non-interest-bearing transaction deposits increase the Company’s net interest income by lowering its cost of funds.

The Company obtains deposits primarily from the communities it serves. The Company believes that no material portion of its deposits has been obtained from or is dependent on any one person or industry. The Company accepts deposits in excess of $250,000 from customers. These deposits are priced to remain competitive.

Maturities of time certificates of deposits of over $250,000 or more outstanding at March 31, 2019 and December 31, 2018 are summarized as follows:

	(in thousands)
	March 31, 2019		December 31, 2018
Three months or less	$	3,492	$	3,848
Over three to twelve months		6,603		6,414
Over twelve months		6,117		5,741
Total	$	16,212	$	16,003

Liquidity and Capital Resources

In order to serve our market area, the Company must maintain adequate liquidity and adequate capital. Liquidity is measured by various ratios, in management’s opinion, the most common being the ratio of net loans to deposits (including loans held-for-sale). This ratio was 67.6% on March 31, 2019. In addition, on March 31, 2019, the Company had the following short-term investments (based on remaining maturity and/or next repricing date): $32,725,000 in securities due within one year or less; and $63,605,000 in securities due in one to five years.

To meet unanticipated funding requirements, the Company maintains short-term unsecured lines of credit with other banks which totaled $67,000,000 at March 31, 2019. Additionally, the Company has a line of credit with the FHLB, with a borrowing capacity at March 31, 2019 of $330,553,000; credit availability is subject to certain collateral requirements. The Company had no borrowings outstanding as of March 31, 2019.

The Company’s primary source of liquidity on a stand-alone basis is dividends from the Bank. Dividends from the Bank are subject to regulatory restrictions.

In July 2013, the Federal Reserve Board and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the guidelines published by the Basel Committee on Banking Supervision (Basel Committee) known as the Basel III Global Regulatory Framework for Capital and Liquidity. These rules adopted by the FRB and the other federal banking agencies (the U.S. Basel III Capital Rules) replaced the federal banking agencies' general risk-based capital rules, advanced approaches rule, market-risk rule, and leverage rules, in accordance with certain transition provisions. The Bank became subject to the new rules on January 1, 2015. The new rules implement higher minimum capital requirements, include a new common equity Tier 1 capital requirement, and establish criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. When fully phased in by January 1, 2019, the final rules will provide for increased minimum capital ratios as follows: (a) a common equity Tier 1 capital ratio of 4.5%; (b) a Tier 1 capital ratio of 6% (which is an increase from 4.0%); (c) a total capital ratio of 8%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4%. Under the new rules, in order to avoid certain limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk based capital requirements (equal to 2.5% of total risk-weighted assets when fully phased in). The phase-in of the capital conservation buffer began on January 1, 2016, and must be completed by January 1, 2019. The U.S. Basel III Capital Rules also provide for various adjustments and deductions to the definitions of regulatory capital that phased in from January 1, 2014 through December 31, 2017.

As of March 31, 2019, the Bank’s capital ratios exceeded applicable regulatory requirements. The following table presents the capital ratios for the Bank, compared to the regulatory standards for well-capitalized depository institutions, as of March 31, 2019.

	(amounts in thousands except percentage amounts)
	Actual					Well Capitalized Ratio Requirement
	Capital		Ratio			Well Capitalized Ratio Requirement
Leverage	$	118,367		9.65	%		5.0	%
Common Equity Tier 1	$	118,367		13.81	%		6.5	%
Tier 1 Risk-Based	$	118,367		13.81	%		8.0	%
Total Risk-Based	$	129,114		15.07	%		10.0	%

ITEM 3. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company believes that there have been no material changes in the quantitative and qualitative disclosures about market risk as of March 31, 2019, from those presented in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, which are incorporated by reference herein.

ITEM 4. – CONTROLS AND PROCEDURES

(a) We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us 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 disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is 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. Our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) have concluded that the design and operation of our disclosure controls and procedures are effective as of March 31, 2019. This conclusion is based on an evaluation conducted under the supervision and with the participation of management.

(b) During the quarter ended March 31, 2019, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II – OTHER INFORMATION

ITEM 1. – LEGAL PROCEEDINGS

Neither the Company nor the Bank is a party to any material pending legal proceeding, nor is any of their property the subject of any material pending legal proceeding, except ordinary routine litigation arising in the ordinary course of the Bank’s business and incidental to its business, none of which is expected to have a material adverse impact upon the Company’s or the Bank’s business, financial position or results of operations.

ITEM 1A. – RISK FACTORS

For a discussion of risk factors relating to our business, please refer to Part I, Item 1A of our 2018 Form 10-K, which is incorporated by reference herein, and to the following:

The Bank’s Dependence on Real Estate Lending Increases Our Risk of Losses

At March 31, 2019, approximately 80% of the Bank’s loans in principal amount (excluding loans held-for-sale) were secured by real estate. The value of the Bank’s real estate collateral has been, and could in the future continue to be, adversely affected by the economic recession and resulting adverse impact on the real estate market in Northern California.

The Bank’s primary lending focus has historically been commercial (including agricultural), construction, and real estate mortgage. At March 31, 2019, real estate mortgage (excluding loans held-for-sale) and construction loans (residential and other) comprised approximately 77% and 3%, respectively, of the total loans in the Bank’s portfolio. At March 31, 2019, all of the Bank’s real estate mortgage and construction loans and approximately 1% of its commercial loans were secured fully or in part by deeds of trust on underlying real estate. The Company’s dependence on real estate increases the risk of loss in both the Bank’s loan portfolio and its holdings of other real estate owned if economic conditions in Northern California deteriorate in the future. Deterioration of the real estate market in Northern California would have a material adverse effect on the Company’s business, financial condition, and results of operations.

The CFPB has adopted various regulations which have impacted, and will continue to impact, our residential mortgage lending business. For additional information, see “Business – Certain CFPB Rules” in Item 1 of our Annual Report on Form 10-K for the year ended December 31, 2018.

Adverse California Economic Conditions Could Adversely Affect the Bank’s Business

The Bank’s operations and a substantial majority of the Bank’s assets and deposits are generated and concentrated primarily in Northern California, particularly the counties of Placer, Sacramento, Solano and Yolo, and are likely to remain so for the foreseeable future. At March 31, 2019, approximately 80% of the Bank’s loan portfolio in principal amount (excluding loans held-for-sale) consisted of real estate-related loans, all of which were secured by collateral located in Northern California. As a result, a downturn in the economic conditions in Northern California may cause the Bank to incur losses associated with high default rates and decreased collateral values in its loan portfolio. Economic conditions in California are subject to various uncertainties including deterioration in the California real estate market and housing industry.

At times, economic conditions in California, and especially the regional markets we serve, have been subject to various challenges, including significant deterioration in the residential real estate sector and the California state government’s budgetary and fiscal difficulties. While California home prices and the California economy in general have experienced a recovery in recent years, there can be no assurance that the recovery will continue. Recent growth in home prices in some California markets may be unsustainable relative to market fundamentals, and home price declines may occur.

In addition, until 2013, the State government of California experienced budget shortfalls or deficits that led to protracted negotiations between the Governor and the State Legislature over how to address the budget gap. The California electorate approved, in the 2012 general elections, certain increases in the rate of income taxation in California. However, there can be no assurance that the state’s fiscal and budgetary challenges will not recur. In addition, the impact of increased rates of income taxation on the level of economic activity in California cannot be predicted at this time.

Also, municipalities and other governmental units within California have been experiencing budgetary difficulties, and several California municipalities have filed for protection under the Bankruptcy Code. As a result, concerns also have arisen regarding the outlook for the State of California’s governmental obligations, as well as those of California municipalities and other governmental units.

Poor economic conditions in California, and especially the regional markets we serve, will cause us to incur losses associated with higher default rates and decreased collateral values in our loan portfolio. If the budgetary and fiscal difficulties of the California State government and California municipalities and other governmental units were to recur or economic conditions in California decline, we expect that our level of problem assets will increase and our prospects for growth will be impaired.

ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. – DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. – MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. – OTHER INFORMATION

None.

ITEM 6. – EXHIBITS

Exhibit Number		Description of Document

31.1		Rule 13a — 14(a) Certification of Chief Executive Officer

31.2		Rule 13a — 14(a) Certification of Chief Financial Officer

32.1*		Statement of the Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)

32.2*		Statement of the Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)

101		Pursuant to Rule 405 of Regulation S-T, the following financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2019, is formatted in XBRL interactive data files: (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Income; (iii) Condensed Consolidated Statements of Comprehensive (Loss) Income (iv) Condensed Consolidated Statement of Stockholders’ Equity; (v) Condensed Consolidated Statements of Cash Flows; and (vi) Notes to Condensed Consolidated Financial Statements.

* In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 34-47986, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed “filed” for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

			FIRST NORTHERN COMMUNITY BANCORP

Date:	May 8, 2019	By:	/s/ Kevin Spink

			Kevin Spink, Executive Vice President / Chief Financial Officer
			(Principal Financial Officer and Duly Authorized Officer)