FIRST NORTHERN COMMUNITY BANCORP - Quarter Report: 2020 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, 2020

☐

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 1, 2020 was 12,968,567.

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	46

ITEM 4. – CONTROLS AND PROCEDURES	46

PART II – OTHER INFORMATION	46

ITEM 1. – LEGAL PROCEEDINGS	46

ITEM 1A. – RISK FACTORS	46

ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	53

ITEM 3. – DEFAULTS UPON SENIOR SECURITIES	53

ITEM 4. – MINE SAFETY DISCLOSURES	53

ITEM 5. – OTHER INFORMATION	53

ITEM 6. – EXHIBITS	53

SIGNATURES	54

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, 2020		December 31, 2019

Assets

Cash and cash equivalents	$	143,861	$	111,493
Certificates of deposit		24,745		14,700
Investment securities – available-for-sale		354,950		342,897
Loans, net of allowance for loan losses of $12,869 at March 31, 2020 and $12,356 at December 31, 2019		758,258		768,873
Loans held-for-sale		6,464		4,130
Stock in Federal Home Loan Bank and other equity securities, at cost		6,574		6,574
Premises and equipment, net		6,404		6,594
Interest receivable and other assets		39,940		37,330

Total Assets	$	1,341,196	$	1,292,591

Liabilities and Stockholders’ Equity

Liabilities:

Demand deposits	$	452,662	$	423,095
Interest-bearing transaction deposits		327,649		317,681
Savings and MMDA's		351,172		344,415
Time, $250,000 or less		36,978		37,564
Time, over $250,000		13,569		15,877
Total deposits		1,182,030		1,138,632

Interest payable and other liabilities		18,373		21,044

Total Liabilities		1,200,403		1,159,676
Commitments and contingencies
Stockholders' Equity:
Common stock, no par value; 16,000,000 shares authorized; 12,968,567 shares issued and outstanding at March 31, 2020 and 12,919,132 shares issued and outstanding at December 31, 2019		100,673		100,187
Additional paid-in capital		977		977
Retained earnings		33,940		31,617
Accumulated other comprehensive income, net		5,203		134
Total Stockholders’ Equity		140,793		132,915

Total Liabilities and Stockholders’ Equity	$	1,341,196	$	1,292,591

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, 2020		Three months ended March 31, 2019
Interest and dividend income:
Loans	$	9,235	$	9,612
Due from banks interest bearing accounts		533		641
Investment securities
Taxable		1,757		1,633
Non-taxable		100		50
Other earning assets		124		115
Total interest and dividend income		11,749		12,051
Interest expense:
Deposits		518		371
Total interest expense		518		371
Net interest income		11,231		11,680
Provision for loan losses		650		—
Net interest income after provision for loan losses		10,581		11,680
Non-interest income:
Service charges on deposit accounts		436		480
Gains on sales of loans held-for-sale		164		115
Investment and brokerage services income		158		149
Mortgage brokerage income		35		59
Loan servicing income		123		90
Debit card income		500		491
Gains on sales/calls of available-for-sale securities		38		—
Other income		195		475
Total non-interest income		1,649		1,859
Non-interest expenses:
Salaries and employee benefits		5,752		5,372
Occupancy and equipment		895		654
Data processing		615		603
Stationery and supplies		79		62
Advertising		70		68
Directors’ fees		44		45
Other real estate owned expense		—		56
Other expense		1,115		1,158
Total non-interest expenses		8,570		8,018
Income before provision for income taxes		3,660		5,521
Provision for income taxes		981		1,536

Net income	$	2,679	$	3,985

Basic earnings per common share	$	0.21	$	0.31
Diluted earnings per common share	$	0.21	$	0.31

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, 2020			Three months ended March 31, 2019
Net income	$	2,679		$	3,985
Other comprehensive income, net of tax:
Unrealized holding gains on securities:
Unrealized holding gains arising during the period, net of tax effect of $2,055 and $595 for the three-month periods ended March 31, 2020 and March 31, 2019, respectively		5,096			1,478
Less: reclassification adjustment due to gains realized on sales of securities, net of tax effect of $(11) and $0 for the three-month periods ended March 31, 2020 and March 31, 2019, respectively		(27	)		—
Other comprehensive income	$	5,069		$	1,478
Comprehensive income	$	7,748		$	5,463

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 Income (Loss)			Total

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

Balance at December 31, 2019		12,919,132		$	100,187	$	977	$	31,617		$	134		$	132,915
Net income									2,679						2,679
Other comprehensive income, net of tax												5,069			5,069
Stock dividend adjustment		1,310			348				(348	)					—
Cash in lieu of fractional shares		(166	)						(8	)					(8	)
Stock-based compensation					134										134
Common shares issued related to restricted stock grants, net of reversals		38,224			—										—
Stock options exercised, net		10,067			4										4
Balance at March 31, 2020		12,968,567		$	100,673	$	977	$	33,940		$	5,203		$	140,793

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, 2020			Three months ended March 31, 2019
Cash Flows From Operating Activities
Net income	$	2,679		$	3,985
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		239			168
Accretion and amortization of investment securities premiums and discounts, net		404			425
Increase (decrease) in deferred loan origination fees and costs, net		22			(23	)
Provision for loan losses		650			—
Stock-based compensation		134			111
Gain on sale of fixed assets		—			(281	)
Gains on sales/calls of available-for-sale securities		(38	)		—
Amortization of operating lease right-of-use asset		254			192
Gain on sales of loans held-for-sale		(164	)		(115	)
Proceeds from sales of loans held-for-sale		7,870			6,173
Originations of loans held-for-sale		(10,040	)		(6,170	)
Changes in assets and liabilities:
(Increase) decrease in interest receivable and other assets		(4,908	)		789
Net decrease in interest payable and other liabilities		(2,671	)		(2,259	)
Net cash (used in) provided by operating activities		(5,569	)		2,995

Cash Flows From Investing Activities
Proceeds from calls or maturities of available-for-sale securities		9,700			17,000
Proceeds from sales of available-for-sale securities		10,344			—
Principal repayments on available-for-sale securities		14,333			11,564
Purchase of available-for-sale securities		(39,683	)		(10,928	)
Net increase in certificates of deposit		(10,045	)		(2,450	)
Net decrease in loans		9,943			31,811
Net (purchases) sales/disposals of premises and equipment		(49	)		462
Net cash (used in) provided by investing activities		(5,457	)		47,459

Cash Flows From Financing Activities
Net increase (decrease) in deposits		43,398			(38,384	)
Cash dividends paid in lieu of fractional shares		(8	)		(8	)
Stock options exercised		4			—
Net cash provided by (used in) financing activities		43,394			(38,392	)

Net increase in Cash and Cash Equivalents		32,368			12,062
Cash and Cash Equivalents, beginning of period		111,493			116,032
Cash and Cash Equivalents, end of period	$	143,861		$	128,094

Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest	$	517		$	355
Supplemental disclosures of non-cash investing and financing activities:
Stock dividend distributed	$	7,016		$	6,610
Unrealized holding gains on available for sale securities, net of taxes	$	5,069		$	1,478

See notes to unaudited condensed consolidated financial statements.

FIRST NORTHERN COMMUNITY BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2020 and 2019 and December 31, 2019

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, 2019 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, 2019. 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 Issued Accounting Pronouncements:

In March 2020, the FASB issued ASU 2020-02, Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842). This ASU adds an SEC paragraph pursuant to the issuance of SEC Staff Accounting Bulletin No. 119 on loan losses to the FASB Codification Topic 326. This ASU also updates the SEC section of the Codification for the change in the effective date of Topic 842. This ASU is effective upon addition to the FASB Codification. The Company adopted ASU 2016-02, Leases (Topic 842) on January 1, 2019. ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) is effective on January 1, 2023 for smaller reporting companies with less than $250 million in public float as defined in the SEC's rules. While the Company is currently unable to reasonably estimate the impact of adopting ASU 2016-13, it expects that the impact of adoption will be significantly influenced by the composition, characteristics and quality of the Company’s loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.

In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. The amendments in ASU 2020-03, make narrow-scope improvements to various aspects of the financial instruments guidance, including the current expected credit losses (CECL) standard issued in 2016. The ASU is part of the FASB’s ongoing Codification improvement project aimed at clarifying specific areas of accounting guidance to help avoid unintended application. The items addressed in that project generally are not expected to have a significant effect on current accounting practice or create a significant administrative cost for most entities. Effective dates for each amendment vary. The Company does not expect the adoption of this update to have a significant impact on its financial statements.

3. INVESTMENT SECURITIES

The amortized cost, unrealized gains and losses and estimated fair values of investments in debt and other securities at March 31, 2020 are summarized as follows:

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

Investment securities available-for-sale:
U.S. Treasury Securities	$	37,702	$	1,422	$	—		$	39,124
Securities of U.S. government agencies and corporations		50,410		1,364		(3	)		51,771
Obligations of states and political subdivisions		26,713		934		(2	)		27,645
Collateralized mortgage obligations		88,390		2,402		—			90,792
Mortgage-backed securities		142,431		3,206		(19	)		145,618
Total debt securities	$	345,646	$	9,328	$	(24	)	$	354,950

The amortized cost, unrealized gains and losses and estimated fair values of investments in debt and other securities at December 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	$	42,667	$	601	$	(13	)	$	43,255
Securities of U.S. government agencies and corporations		53,525		433		(46	)		53,912
Obligations of states and political subdivisions		26,311		749		(29	)		27,031
Collateralized mortgage obligations		79,470		349		(399	)		79,420
Mortgage-backed securities		138,733		999		(453	)		139,279
Total debt securities	$	340,706	$	3,131	$	(940	)	$	342,897

The Company had $20,529,000 and $17,000,000 proceeds from sales, calls and maturities of available-for-sale securities for the three months ended March 31, 2020 and March 31, 2019, respectively. Gross realized gains on sales/calls of available-for-sale securities were $84,000 and $0 the three months ended March 31, 2020 and March 31, 2019, respectively. Gross realized losses on sales of available-for-sale securities were $46,000 and $0 for the three months ended March 31, 2020 and March 31, 2019, respectively.

The amortized cost and estimated market value of debt and other securities at March 31, 2020, 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	$	31,232	$	31,461
Due after one year through five years		57,494		59,843
Due after five years through ten years		14,087		14,868
Due after ten years		12,012		12,368
Subtotal		114,825		118,540
MBS & CMO		230,821		236,410
Total	$	345,646	$	354,950

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, 2020, follows:

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

Securities of U.S. government agencies and corporations		$	1,498		$	(3	)		$	—		$	—			$	1,498		$	(3	)
Obligations of states and political subdivisions			1,068			(2	)			—			—				1,068			(2	)
Mortgage-backed securities			—			—				4,230			(19	)			4,230			(19	)
Total		$	2,566		$	(5	)		$	4,230		$	(19	)		$	6,796		$	(24	)

No decline in value was considered “other-than-temporary” during the first three months of 2020. Five securities, all considered investment grade, which had a fair value of $2,566,000 and a total unrealized loss of $5,000 have been in an unrealized loss position for less than twelve months as of March 31, 2020. Five securities, all considered investment grade, which had a fair value of $4,230,000 and a total unrealized loss of $19,000 have been in an unrealized loss position for more than twelve months as of March 31, 2020. 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, 2020.

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. The coronavirus pandemic and the impact of governmental health measures in response thereto may increase the likelihood of such other than temporary impairments.

An analysis of gross unrealized losses of the available-for-sale investment securities portfolio as of December 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	$	10,113	$	(8	)	$	2,015	$	(5	)	$	12,128	$	(13	)
Securities of U.S. government agencies and corporations		13,187		(44	)		1,998		(2	)		15,185		(46	)
Obligations of states and political subdivisions		4,645		(29	)		—		—			4,645		(29	)
Collateralized Mortgage obligations		21,763		(129	)		21,132		(270	)		42,895		(399	)
Mortgage-backed securities		11,970		(28	)		44,433		(425	)		56,403		(453	)
Total	$	61,678	$	(238	)	$	69,578	$	(702	)	$	131,256	$	(940	)

Investment securities carried at $39,091,000 and $37,943,000 at March 31, 2020 and December 31, 2019, 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, 2020 and December 31, 2019 was as follows:

($ in thousands)	March 31, 2020			December 31, 2019

Commercial	$	113,346		$	106,140
Commercial Real Estate		452,611			451,774
Agriculture		94,303			115,751
Residential Mortgage		66,184			64,943
Residential Construction		19,086			15,212
Consumer		25,035			26,825
		770,565			780,645
Allowance for loan losses		(12,869	)		(12,356	)
Net deferred origination fees and costs		562			584
Loans, net	$	758,258		$	768,873

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, 2020, approximately 15% in principal amount of the Company's loans were for general commercial uses, including professional, retail and small businesses. Approximately 59% 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 12% in principal amount of the Company's loans were for agriculture, approximately 9% 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 3% 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, 2020 and December 31, 2019, 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, 2020 and December 31, 2019, 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, 2020
Commercial	$	112,774	$	274	$	—	$	40	$	258	$	113,346
Commercial Real Estate		451,868		—		234		—		509		452,611
Agriculture		91,503		—		2,800		—		—		94,303
Residential Mortgage		65,536		477		—		—		171		66,184
Residential Construction		19,086		—		—		—		—		19,086
Consumer		24,637		47		—		100		251		25,035
Total	$	765,404	$	798	$	3,034	$	140	$	1,189	$	770,565

December 31, 2019
Commercial	$	105,741	$	—	$	133	$	—	$	266	$	106,140
Commercial Real Estate		451,215		—		93		—		466		451,774
Agriculture		115,751		—		—		—		—		115,751
Residential Mortgage		64,771		—		—		—		172		64,943
Residential Construction		15,212		—		—		—		—		15,212
Consumer		26,472		100		—		—		253		26,825
Total	$	779,162	$	100	$	226	$	—	$	1,157	$	780,645

Non-accrual loans amounted to $1,189,000 at March 31, 2020 and were comprised of three commercial loans totaling $258,000, three commercial real estate loans totaling $509,000, one residential mortgage loan totaling $171,000 and four consumer loans totaling $251,000. The Company had one commercial loan totaling $40,000 and one consumer loan totaling $100,000 that were 90 days or more past due and still accruing at March 31, 2020. Non-accrual loans amounted to $1,157,000 at December 31, 2019 and were comprised of three commercial loans totaling $266,000, two commercial real estate loans totaling $466,000, one residential mortgage loan totaling $172,000 and four consumer loans totaling $253,000. 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, 2020.

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, 2020 and December 31, 2019 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, 2020
Commercial	$	1,524	$	258	$	1,204	$	1,462	$	21
Commercial Real Estate		783		509		247		756		19
Agriculture		–		—		—		—		—
Residential Mortgage		1,144		171		904		1,075		168
Residential Construction		713		—		681		681		49
Consumer		336		251		79		330		2
Total	$	4,500	$	1,189	$	3,115	$	4,304	$	259

December 31, 2019
Commercial	$	1,694	$	266	$	1,385	$	1,651	$	26
Commercial Real Estate		715		466		250		716		19
Agriculture		—		—		—		—		—
Residential Mortgage		1,152		172		912		1,084		171
Residential Construction		724		—		691		691		56
Consumer		340		253		80		333		1
Total	$	4,625	$	1,157	$	3,318	$	4,475	$	273

The average recorded investment in impaired loans and the amount of interest income recognized on impaired loans during the three months ended March 31, 2020 and March 31, 2019 was as follows:

($ in thousands)	Three Months Ended March 31, 2020				Three Months Ended March 31, 2019
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Commercial	$	1,557	$	21	$	2,538	$	42
Commercial Real Estate		735		4		634		4
Agriculture		—		—		4,804		—
Residential Mortgage		1,079		9		1,451		12
Residential Construction		686		9		652		9
Consumer		332		1		386		3
Total	$	4,389	$	44	$	10,465	$	70

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 $3,202,000 and $3,413,000 in TDR loans as of March 31, 2020 and December 31, 2019, respectively. Specific reserves for TDR loans totaled $259,000 and $273,000 as of March 31, 2020 and December 31, 2019, respectively. TDR loans performing in compliance with modified terms totaled $3,115,000 and $3,318,000 as of March 31, 2020 and December 31, 2019, respectively. There were no commitments to advance additional funds on existing TDR loans as of March 31, 2020.

There were no loans modified as TDRs during the three months ended March 31, 2020.

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

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, 2020 and March 31, 2019.

On March 22, 2020, the federal bank regulatory agencies issued joint guidance advising that the agencies have confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to relief, are not TDRs.

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, 2019.

The following table presents the risk ratings by loan class as of March 31, 2020 and December 31, 2019:

($ in thousands)	Pass		Special Mention		Substandard		Doubtful		Loss		Total
March 31, 2020
Commercial	$	109,462	$	3,298	$	586	$	—	$	—	$	113,346
Commercial Real Estate		429,125		19,101		4,385		—		—		452,611
Agriculture		82,755		—		11,548		—		—		94,303
Residential Mortgage		65,847		—		337		—		—		66,184
Residential Construction		19,086		—		—		—		—		19,086
Consumer		24,147		—		888		—		—		25,035
Total	$	730,422	$	22,399	$	17,744	$	—	$	—	$	770,565

December 31, 2019
Commercial	$	104,944	$	428	$	768	$	—	$	—	$	106,140
Commercial Real Estate		427,991		17,739		6,044		—		—		451,774
Agriculture		105,573		7,823		2,355		—		—		115,751
Residential Mortgage		64,596		—		347		—		—		64,943
Residential Construction		15,212		—		—		—		—		15,212
Consumer		25,933		500		392		—		—		26,825
Total	$	744,249	$	26,490	$	9,906	$	—	$	—	$	780,645

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, 2020 and March 31, 2019:

Three months ended March 31, 2020
($ in thousands)	Commercial			Commercial Real Estate		Agriculture			Residential Mortgage		Residential Construction		Consumer			Unallocated			Total
Balance as of December 31, 2019	$	2,354		$	6,846	$	2,054		$	466	$	201	$	236		$	199		$	12,356
Provision for (reversal of) loan losses		386			560		(266	)		70		59		18			(177	)		650

Charge-offs		(145	)		—		—			—		—		(9	)		—			(154	)
Recoveries		11			—		—			—		—		6			—			17
Net charge-offs		(134	)		—		—			—		—		(3	)		—			(137	)
Balance as of March 31, 2020	$	2,606		$	7,406	$	1,788		$	536	$	260	$	251		$	22		$	12,869
Period-end amount allocated to:
Loans individually evaluated for impairment		21			19		—			168		49		2			—			259
Loans collectively evaluated for impairment		2,585			7,387		1,788			368		211		249			22			12,610
Balance as of March 31, 2020	$	2,606		$	7,406	$	1,788		$	536	$	260	$	251		$	22		$	12,869

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

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, 2019.

Year ended December 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		(415	)		956		520			(251	)		(138	)		(9	)		(663	)		—

Charge-offs		(638	)		—		(98	)		—			—			(43	)		—			(779	)
Recoveries		209			—		—			74			21			9			—			313
Net charge-offs		(429	)		—		(98	)		74			21			(34	)		—			(466	)
Ending Balance		2,354			6,846		2,054			466			201			236			199			12,356
Period-end amount allocated to:
Loans individually evaluated for impairment		26			19		—			171			56			1			—			273
Loans collectively evaluated for impairment		2,328			6,827		2,054			295			145			235			199			12,083
Balance as of December 31, 2019	$	2,354		$	6,846	$	2,054		$	466		$	201		$	236		$	199		$	12,356

The Company’s investment in loans as of March 31, 2020, March 31, 2019, and December 31, 2019 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, 2020
Loans individually evaluated for impairment	$	1,462	$	756	$	—	$	1,075	$	681	$	330	$	4,304
Loans collectively evaluated for impairment		111,884		451,855		94,303		65,109		18,405		24,705		766,261
Ending Balance	$	113,346	$	452,611	$	94,303	$	66,184	$	19,086	$	25,035	$	770,565

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

December 31, 2019
Loans individually evaluated for impairment	$	1,651	$	716	$	—	$	1,084	$	691	$	333	$	4,475
Loans collectively evaluated for impairment		104,489		451,058		115,751		63,859		14,521		26,492		776,170
Ending Balance	$	106,140	$	451,774	$	115,751	$	64,943	$	15,212	$	26,825	$	780,645

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, 2020 for cash proceeds equal to the fair value of the loans. At March 31, 2020, and December 31, 2019, the Company serviced real estate mortgage loans for others totaling $205,130,000 and $208,862,000, 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, 2020 and December 31, 2019 were as follows:

	March 31, 2020			December 31, 2019

Constant prepayment rate		15.60	%		12.10	%
Discount rate		10.01	%		10.01	%
Weighted average life (years)		4.60			5.50

The following table summarizes the Company’s mortgage servicing rights assets as of March 31, 2020 and December 31, 2019. Mortgage servicing rights are included in Interest Receivable and Other Assets on the condensed consolidated balance sheets:

	(in thousands)
	December 31, 2019			Additions			Reductions				March 31, 2020

Mortgage servicing rights		$	1,481		$	81		$	(89	)		$	1,473
Valuation allowance			—			—			—				—
Mortgage servicing rights, net of valuation allowance		$	1,481		$	81		$	(89	)		$	1,473

At March 31, 2020 and December 31, 2019, the estimated fair market value of the Company’s mortgage servicing rights asset was $1,496,000 and $1,631,000, respectively.

The Company received contractually specified servicing fees of $131,000 and $133,000 for the three months ended March 31, 2020 and March 31, 2019, 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, 2020:

	(in thousands)
March 31, 2020	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	$	39,124	$	39,124	$	—	$	—
Securities of U.S. government agencies and corporations		51,771		—		51,771		—
Obligations of states and political subdivisions		27,645		—		27,645		—
Collateralized mortgage obligations		90,792		—		90,792		—
Mortgage-backed securities		145,618		—		145,618		—
Total investments at fair value	$	354,950	$	39,124	$	315,826	$	—

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, 2019:

	(in thousands)
December 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	$	43,255	$	43,255	$	—	$	—
Securities of U.S. government agencies and corporations		53,912		—		53,912		—
Obligations of states and political subdivisions		27,031		—		27,031		—
Collateralized mortgage obligations		79,420		—		79,420		—
Mortgage-backed securities		139,279		—		139,279		—
Total investments at fair value	$	342,897	$	43,255	$	299,642	$	—

Assets Recorded at Fair Value on a Non-Recurring Basis

There were no assets measured at fair value on a non-recurring basis as of March 31, 2020.

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 December 31, 2019:

	(in thousands)
December 31, 2019	Carrying Value			Level 1			Level 2			Level 3
Impaired loans		$	170		$	—		$	—		$	170
Total assets at fair value		$	170		$	—		$	—		$	170

There were no liabilities measured at fair value on a recurring or non-recurring basis as of March 31, 2020 and December 31, 2019.

Key methods and assumptions used in measuring the fair value of impaired loans as of December 31, 2019 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.

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, 2019, 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.

Disclosures about Fair Value of Financial Instruments

The estimated fair values of the Company’s financial instruments for the periods ended March 31, 2020 and December 31, 2019 were approximately as follows:

			March 31, 2020				December 31, 2019
	Level		Carrying amount		Fair value		Carrying amount		Fair value

Financial assets:
Cash and cash equivalents		1	$	143,861	$	143,861	$	111,493	$	111,493
Certificates of deposit		2		24,745		25,109		14,700		14,984
Stock in Federal Home Loan Bank and other equity securities		3		6,574		6,574		6,574		6,574
Loans receivable:
Net loans		3		758,258		712,382		768,873		723,507
Loans held-for-sale		2		6,464		6,683		4,130		4,213
Interest receivable		2		4,393		4,393		4,295		4,295
Mortgage servicing rights		3		1,473		1,496		1,481		1,631
Financial liabilities:
Deposits		3		1,182,030		1,150,166		1,138,632		1,035,644
Interest payable		2		93		93		92		92

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, 2020		December 31, 2019

Undisbursed loan commitments	$	208,260	$	198,534
Standby letters of credit		2,082		2,455
Commitments to sell loans		17,316		1,240
	$	227,658	$	202,229

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, 2020 and December 31, 2019, 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 $2,082,000 and $2,455,000 at March 31, 2020 and December 31, 2019, 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 $940,000 and $840,000 at March 31, 2020 and December 31, 2019, 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, 2020 and December 31, 2019, 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 23, 2020, the Board of Directors of the Company declared a 5% stock dividend paid on March 25, 2020 to shareholders of record as of February 28, 2020. 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, 2020:

	Number of Shares			Weighted Average Exercise Price		Aggregate Intrinsic Value		Weighted Average Remaining Contractual Term (in years)
Options outstanding at Beginning of Period		425,373		$	8.30
Granted		178,087		$	11.19
Expired		—		$	—
Cancelled / Forfeited		—			—
Exercised		(15,040	)	$	3.11
Options outstanding at End of Period		588,420		$	9.31	$	510,098		7.44
Exercisable (vested) at End of Period		293,924		$	7.59	$	510,098		5.64

The weighted average grant date fair value per share of options granted during the three months ended March 31, 2020 was $1.41 per share.

The intrinsic value of options exercised was $96,000 and $0 during the three months ended March 31, 2020 and March 31, 2019, respectively. The fair value of awards vested was $149,000 and $141,000 during the three months ended March 31, 2020 and March 31, 2019, respectively.

As of March 31, 2020, there was $460,000 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 2.86 years.

There was $42,000 of recognized compensation cost related to stock options granted for the three months ended March 31, 2020.

A summary of the weighted average assumptions used in valuing stock options during the three months ended March 31, 2020 is presented below:

	Three Months Ended March 31, 2020
Risk Free Interest Rate		1.42	%

Expected Dividend Yield		0.00	%

Expected Life in Years		5

Expected Price Volatility		10.18	%

The following table presents the activity related to non-vested restricted stock for the three months ended March 31, 2020:

	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		131,661		$	9.72
Granted		40,985		$	11.19
Cancelled/Forfeited		(858	)	$	10.74
Exercised/Released/Vested		(30,817	)		6.56
Non-vested restricted stock outstanding at End of Period		140,971		$	10.84		$	1,196,844		3.07

The weighted average fair value of restricted stock granted during the three months ended March 31, 2020 was $11.19 per share.

As of March 31, 2020, there was $1,002,000 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 3.07 years.

There was $87,000 of recognized compensation cost related to restricted stock awards for the three months ended March 31, 2020.

The Company has an Employee Stock Purchase Plan (“ESPP”). There are 310,041 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 23, 2020, payable March 25, 2020 to shareholders of record as of February 28, 2020. 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, 2019 to November 23, 2020. 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, 2020, 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, 2020.

The weighted average fair value at issuance date during the three months ended March 31, 2020 was $2.37.

A summary of the weighted average assumptions used in valuing ESPP issuances during the three months ended March 31, 2020 is presented below:

	Three Months Ended March 31, 2020
Risk Free Interest Rate		1.56	%

Expected Dividend Yield		0.00	%

Expected Life in Years		1.00

Expected Price Volatility		13.09	%

9. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table details activity in accumulated other comprehensive income (loss) for the three months ended March 31, 2020:

($ in thousands)	Unrealized Gains (losses) on Securities		Officers’ retirement plan			Directors’ retirement plan			Accumulated Other Comprehensive Income (loss)
Balance as of December 31, 2019	$	1,561	$	(1,411	)	$	(16	)	$	134
Current period other comprehensive income		5,069		—			—			5,069
Balance as of March 31, 2020	$	6,630	$	(1,411	)	$	(16	)	$	5,203

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 Income (loss)
Balance as of December 31, 2018	$	(3,867	)	$	(1,198	)	$	29	$	(5,036	)
Current period other comprehensive income		1,478			—			—		1,478
Balance as of March 31, 2019	$	(2,389	)	$	(1,198	)	$	29	$	(3,558	)

10. OUTSTANDING SHARES AND EARNINGS PER SHARE

On January 23, 2020, the Board of Directors of the Company declared a 5% stock dividend payable on March 25, 2020 to shareholders of record as of February 28, 2020. 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, 2020 and 2019 (dollars in thousands except per share amounts):

	Three months ended March 31,
	2020		2019
Basic earnings per share:
Net income	$	2,679	$	3,985

Weighted average common shares outstanding		12,795,402		12,752,221
Basic EPS	$	0.21	$	0.31

Diluted earnings per share:
Net income	$	2,679	$	3,985

Weighted average common shares outstanding		12,795,402		12,752,221
Effect of dilutive shares		148,036		150,473
Adjusted weighted average common shares outstanding		12,943,438		12,902,694
Diluted EPS	$	0.21	$	0.31

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 404,262 shares and 226,186 shares for the three months ended March 31, 2020 and March 31, 2019, respectively. Restricted stock which were not included in the computation of diluted earnings per share because they would have had an anti-dilutive effect amounted to 40,985 and 0 for the three months ended March 31, 2020 and March 31, 2019, respectively.

11. LEASES

The Bank leases ten branch and administrative locations under operating leases expiring on various dates through 2030. 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. The Bank had no financing leases as of March 31, 2020.

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.

The Company had right-of-use assets totaling $6,708,000 and $6,962,000 as of March 31, 2020 and December 31, 2019, respectively. The Company had lease liabilities totaling $7,281,000 and $7,483,000 as of March 31, 2020 and December 31, 2019, respectively. The Company recognized lease expenses totaling $309,000 and $223,000 for the three months ended March 31, 2020 and March 31, 2019, respectively, which included expenses related to short-term leases and 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, 2020
2020	$	867
2021		1,118
2022		1,065
2023		1,006
2024		899
2025 and thereafter		3,080
Total lease payments		8,035
Less: interest		(754	)
Present value of lease liabilities	$	7,281

The following table presents supplemental cash flow information related to leases for the three months ended March 31, 2020 and March 31, 2019:

(in thousands)	Three Months Ended March 31, 2020		Three Months Ended March 31, 2019
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	249	$	217
Right-of-use assets obtained in exchange for new operating lease liabilities	$	—	$	4,417

The following table presents the weighted average operating lease term and discount rate as of March 31, 2020 and December 31, 2019:

(in thousands)	March 31, 2020			December 31, 2019

Weighted-average remaining lease term – operating leases, in years	$	7.85		$	8.01
Weighted-average discount rate – operating leases	$	2.52	%	$	2.52	%

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 2019 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”), the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”), and other legislation and governmental measures introduced in response to the financial crisis which began in 2008 and the ensuing recession affecting the banking system, financial markets and the U.S. economy, as well as the effect of the federal Coronavirus Aid, Relief, and. Economic Security Act (“CARES Act”), enacted in April 2020, in an effort to mitigate the consequences of the coronavirus pandemic and the governmental actions in response thereto

●

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 established after the financial crisis by the U.S. federal banking agencies and our current intention not to elect to use the recently enacted community bank leverage framework

●

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 changes 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 strategies and beliefs concerning the adequacy of 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, including related electrical power outages, 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

●

Our expectations regarding the adoption of the expected loss model for determining the allowance for loan losses

●

The effects of the coronavirus pandemic on the U.S., California and global economies and the actions of government to reduce the spread of the virus and to mitigate the resulting economic consequences

●

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 2019 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, 2019.

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 2020 included:

●

Net income of $2.7 million for the three months ended March 31, 2020, down 32.8% from $4.0 million earned for the same period last year.

●

Diluted earnings per share of $0.21 for the three months ended March 31, 2020, down 32.3% from diluted earnings per share of $0.31 in the same period last year.

●

Net interest income of $11.2 million for the three months ended March 31, 2020, down 3.8% from $11.7 million in the same period last year.

●

Net interest margin of 3.63% for the three months ended March 31, 2020, down 11.2% from 4.09% for the same period last year.

●

Provision for loan losses of $0.7 million for the three months ended March 31, 2020, compared to no provision for the same period last year - the increase being largely driven by the coronavirus pandemic.

●

Total assets of $1.34 billion as of March 31, 2020, up 3.8% from $1.29 billion as of December 31, 2019.

●

Total net loans (including loans held-for-sale) of $764.7 million as of March 31, 2020, down 1.1% from $773.0 million as of December 31, 2019.

●

Total investment securities of $355.0 million as of March 31, 2020, up 3.5% from $342.9 million as of December 31, 2019.

●

Total deposits of $1.18 billion as of March 31, 2020, up 3.8% from $1.14 billion as of December 31, 2019.

Since March 13, 2020, the United States has been operating under a state of emergency declared by President Trump in response to the spread of the coronavirus and the COVID-19 disease which it causes. On March 4, 2020, California Governor Gavin Newsom declared a similar state-wide emergency. Also, early in March, a number of county and other local health agencies in California declared emergencies and issued “stay at home” ordinances for all persons other than workers at “essential businesses”. During March 2020 and continuing thereafter, the pandemic and governmental responses have resulted in recessionary economic, labor and financial market conditions across the United States and in our markets in California, including dramatic increases in unemployment. In response, the FRB reduced its federal funds rate by 1.5 percentage points to .00 to .25 percent. In addition, in early April 2020, the U.S. government enacted the CARES Act, a $2.2 trillion economic stimulus package, the largest in U.S. history, in an effort to lessen the impact of the pandemic on consumers and businesses.

These developments have had an impact on our business. Our commercial real estate loan portfolio exposure to industries most affected by the stay-at-home order includes 7.6% to retail properties and business; 1.9% to restaurants and 1.2% to the hospitality/hotel sector. Loans to these customers are generally secured by real estate with relatively low loan-to-value ratios and strong guarantors. There is concern that borrowers will draw on their credit lines to support cashflow disruptions caused by the stay at home ordinances. Most of the Bank’s optional advance lines of credit are “controlled” with advances supported by certain assets pledged to the bank for repayment or specific budgeted expense. Therefor advances on our lines have not been unusual. The Bank monitors credit line advances daily and has not noted any significant, unusual loan advances. We have also granted customer relief in a variety of ways, including extended grace periods on residential and commercial mortgages, commercial loans, and automobile loan and lease payments, refraining from reporting payment deferrals to credit bureaus and waiving or refunding certain fees. The increase in our provision for loan and lease losses to $650,000 for the first quarter 2020, compared to no provision for the first quarter 2019, was largely driven by our perception of the impact of the pandemic on our borrowers. The Bank, in the first part of April 2020, commenced participation the Paycheck Protection Program (PPP) of the Small Business Administration (SBA) which is aimed at providing relief from the pandemic to small businesses through loans by banks guaranteed by the SBA. In the initial phase of the program, the Bank approved approximately 650 applications for loans under the PPP covering approximately $184 million in funding. The program was suspended after the initial Congressional appropriation of $349 billion was exhausted. A second phase of the program, involving a Congressional appropriation of some $310 billion was initiated on April 27, 2020. As of April 30, 2020, the Bank approved approximately 520 applications in this second phase, covering approximately $42 million in funding. These loans will be booked in the second quarter of 2020.

Although banks in California are defined as “essential businesses” under the California governmental actions and thus are allowed to remain open, in order to protect the health of our employees, approximately 40% of our employees are now working remotely, a majority of whom would normally be working in our branches or offices. We have reduced branch hours and erected plexiglass protectors on teller stations in branches.

For additional information on the possible effects of the pandemic on our business, see Item 1.A., “Risk Factors”, in this Report on Form 10-Q.

SUMMARY

The Company recorded net income of $2,679,000 for the three months ended March 31, 2020, representing a decrease of $1,306,000 from net income of $3,985,000 for the same period in 2019.

The following tables present a summary of the results for the three months ended March 31, 2020 and 2019, and a summary of our financial condition at March 31, 2020 and December 31, 2019:

	Three months ended March 31, 2020				Three months ended March 31, 2019

(in thousands except for per share amounts and ratios)
For the Period:
Net Income		$	2,679			$	3,985
Basic Earnings Per Common Share		$	0.21			$	0.31
Diluted Earnings Per Common Share		$	0.21			$	0.31
Net Income to Average Assets (annualized)			0.81	%			1.30	%
Net Income to Average Equity (annualized)			7.89	%			13.84	%
Average Equity to Average Assets			10.32	%			9.41	%

	March 31, 2020				December 31, 2019

(in thousands except for ratios)
At Period End:
Total Assets		$	1,341,196			$	1,292,591
Total Investment Securities		$	354,950			$	342,897
Total Loans, Net (including loans held-for-sale)		$	764,722			$	773,003
Total Deposits		$	1,182,030			$	1,138,632
Loan-To-Deposit Ratio			64.7	%			67.9	%

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, 2020							Three months ended March 31, 2019
	Average Balance		Interest		Yield/ Rate (4)			Average Balance		Interest		Yield/ Rate (4)
Assets
Interest-earning assets:
Loans (1)	$	754,296	$	9,235		4.91	%	$	744,045	$	9,612		5.24	%
Certificates of deposit		18,159		114		2.52	%		8,994		66		2.98	%
Interest bearing due from banks		115,507		419		1.45	%		87,772		575		2.66	%
Investment securities, taxable		329,293		1,757		2.14	%		299,866		1,633		2.21	%
Investment securities, non-taxable (2)		16,287		100		2.46	%		10,621		50		1.91	%
Other interest earning assets		6,574		124		7.57	%		6,019		115		7.75	%
Total average interest-earning assets		1,240,116		11,749		3.80	%		1,157,317		12,051		4.22	%
Non-interest-earning assets:
Cash and due from banks		33,271							26,606
Premises and equipment, net		6,529							6,557
Other real estate owned		—							1,092
Interest receivable and other assets		36,089							32,587
Total average assets		1,316,005							1,224,159

Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing transaction deposits		331,663		158		0.19	%		309,859		127		0.17	%
Savings and MMDA’s		345,082		268		0.31	%		329,563		162		0.20	%
Time, $250,000 and under		38,418		56		0.58	%		44,759		56		0.51	%
Time, over $250,000		14,097		36		1.02	%		16,594		26		0.64	%
Total average interest-bearing liabilities		729,260		518		0.28	%		700,775		371		0.21	%
Non-interest-bearing liabilities:
Non-interest-bearing demand deposits		431,675							395,329
Interest payable and other liabilities		19,236							12,920
Total liabilities		1,180,171							1,109,024
Total average stockholders’ equity		135,834							115,135
Total average liabilities and stockholders’ equity	$	1,316,005						$	1,224,159
Net interest income and net interest margin (3)			$	11,231		3.63	%			$	11,680		4.09	%

(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 $(2) and $(9) for the three months ended March 31, 2020 and 2019, 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, 2020							Three months ended December 31, 2019
	Average Balance		Interest		Yield/ Rate (4)			Average Balance		Interest		Yield/ Rate (4)
Assets
Interest-earning assets:
Loans (1)	$	754,296	$	9,235		4.91	%	$	753,814	$	9,987		5.26	%
Certificates of deposit		18,159		114		2.52	%		14,894		103		2.74	%
Interest bearing due from banks		115,507		419		1.45	%		105,674		421		1.58	%
Investment securities, taxable		329,293		1,757		2.14	%		325,496		1,747		2.13	%
Investment securities, non-taxable (2)		16,287		100		2.46	%		15,999		98		2.43	%
Other interest earning assets		6,574		124		7.57	%		6,574		119		7.18	%
Total average interest-earning assets		1,240,116		11,749		3.80	%		1,222,451		12,475		4.05	%
Non-interest-earning assets:
Cash and due from banks		33,271							33,943
Premises and equipment, net		6,529							6,447
Other real estate owned		—							409
Interest receivable and other assets		36,089							37,467
Total average assets		1,316,005							1,300,717

Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Interest-bearing transaction deposits		331,663		158		0.19	%		315,989		144		0.18	%
Savings and MMDA’s		345,082		268		0.31	%		347,076		308		0.35	%
Time, $250,000 and under		38,418		56		0.58	%		38,836		59		0.60	%
Time, over $250,000		14,097		36		1.02	%		16,415		38		0.92	%
Total average interest-bearing liabilities		729,260		518		0.28	%		718,316		549		0.30	%
Non-interest-bearing liabilities:
Non-interest-bearing demand deposits		431,675							430,530
Interest payable and other liabilities		19,236							20,156
Total liabilities		1,180,171							1,169,002
Total average stockholders’ equity		135,834							131,715
Total average liabilities and stockholders’ equity	$	1,316,005						$	1,300,717
Net interest income and net interest margin (3)			$	11,231		3.63	%			$	11,926		3.87	%

(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 $(2) and $84 for the three months ended March 31, 2020 and December 31, 2019, 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, 2020 over the three months ended March 31, 2019 and the three months ended March 31, 2020 over the three months ended December 31, 2019. Changes not solely due to interest rate or volume have been allocated proportionately to interest rate and volume.

	Three Months Ended March 31, 2020 Over Three Months Ended March 31, 2019									Three Months Ended March 31, 2020 Over Three Months Ended December 31, 2019
	Volume			Interest Rate			Change			Volume			Interest Rate			Change

Increase (Decrease) in Interest Income:

Loans	$	153		$	(530	)	$	(377	)	$	4		$	(756	)	$	(752	)
Certificates of Deposit		59			(11	)		48			20			(9	)		11
Due From Banks		154			(310	)		(156	)		35			(37	)		(2	)
Investment Securities - Taxable		174			(50	)		124			7			3			10
Investment Securities - Non-taxable		32			18			50			1			1			2
Other Assets		12			(3	)		9			—			5			5

	$	584		$	(886	)	$	(302	)	$	67		$	(793	)	$	(726	)

Increase (Decrease) in Interest Expense:

Deposits:
Interest-Bearing Transaction Deposits	$	12		$	19		$	31		$	7		$	7		$	14
Savings & MMDAs		8			98			106			(2	)		(38	)		(40	)
Time Certificates		(35	)		45			10			(13	)		8			(5	)

	$	(15	)	$	162		$	147		$	(8	)	$	(23	)	$	(31	)

Decrease in Net Interest Income:	$	599		$	(1,048	)	$	(449	)	$	75		$	(770	)	$	(695	)

CHANGES IN FINANCIAL CONDITION

The assets of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect a $32,368,000 or 29.0% increase in cash and cash equivalents, a $10,045,000 or 68.3% increase in certificates of deposit, a $12,053,000 or 3.5% increase in investment securities available-for-sale, a $10,615,000 or 1.4% decrease in net loans held-for-investment, and a $2,334,000 or 56.5% increase in loans held-for-sale from December 31, 2019 to March 31, 2020. The increase in cash and cash equivalents was primarily due to an increase in retained earnings and deposit balances, net of a decrease in net loans. The increase in certificates of deposit and investment securities was due to allocating the cash flows from payments on and maturities of available-for-sale securities and loans, coupled with deposit inflows, towards additional purchases of certificates of deposit and investment 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 an increase in refinancing activity as a result of the decrease in interest rates and the timing of funding and sale of the loans held-for-sale pipeline.

The liabilities of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect an increase in total deposits of $43,398,000 or 3.8% from December 31, 2019 to March 31, 2020. The overall increase in total deposits was primarily attributable to new customers coupled with seasonal fluctuations.

CHANGES IN RESULTS OF OPERATIONS

Interest Income

The Federal Open Market Committee decreased the Federal Funds rate by 150 basis points to 0.00% to 0.25% during the three months ended March 31, 2020.

Interest income on loans for the three months ended March 31, 2020 was down 3.9% from the same period in 2019, decreasing from $9,612,000 to $9,235,000. The decrease was primarily due to a 33 basis point decrease in loan yields, which was partially offset by an increase in average loans. The decrease in loan yields was primarily due to the origination of new loans and the repricing of existing loans at lower rates.

Interest income on investment securities available-for-sale for the three months ended March 31, 2020 was up 10.3% from the same period in 2019, increasing from $1,683,000 to $1,857,000. The increase was primarily due to an increase in average investment securities, which was partially offset by a 4 basis point decrease in yields on investment securities.

Interest income on certificates of deposit for the three months ended March 31, 2020 was up 72.7% from the same period in 2019, increasing from $66,000 to $114,000. The increase was primarily due to an increase in average balance of certificates of deposit, which was partially offset by a 46 basis point decrease in certificates of deposit yields.

Interest income on interest-bearing due from banks for the three months ended March 31, 2020 was down 27.1% from the same period in 2019, decreasing from $575,000 to $419,000. The decrease was due to a 121 basis point decrease in interest-bearing due from yields, which was partially offset by an increase in average interest-bearing due from banks balance.

The Company had no Federal Funds sold balances during the three months ended March 31, 2020 and March 31, 2019.

Interest Expense

Interest expense on deposits for the three months ended March 31, 2020 was up 39.6% from the same period in 2019, increasing from $371,000 to $518,000. The increase in interest expense was primarily due to a 7 basis point increase in average interest-bearing deposits yield and an increase in average deposits.

The Company had no FHLB advances or other borrowing balances during the three months ended March 31, 2020 and March 31, 2019.

Provision for Loan Losses

Provision for loan losses was $0.7 million for the three months ended March 31, 2020 compared to no provision for loan losses for the same period in 2019. The allowance for loan losses was approximately $12,869,000, or 1.67% of total loans, at March 31, 2020, compared to $12,356,000, or 1.58% of total loans, at December 31, 2019. 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. The increase in the ratio of allowance to total loans from December 31, 2019 to March 31, 2020 was primarily due to an increase in qualitative factors resulting from the downturn in economic conditions associated with the COVID-19 pandemic.

The increase in the provision for loan losses during the three months ended March 31, 2020 compared to the same period in 2019 was due to an increase in net charge-offs and an increase in loan balances, coupled with an increase in qualitative factors resulting from the downturn in economic conditions associated with the COVID-19 pandemic.

Provision for Unfunded Lending Commitment Losses

There was a provision for unfunded lending commitment losses of $100,000 and $80,000 for the three months ended March 31, 2020 and March 31, 2019, respectively. The increase in the provision for unfunded lending commitments waas primarily due to an increase in qualitative factors resulting from the downturn in economic conditions associated with the COVID-19 pandemic.

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 down 11.3% for the three months ended March 31, 2020 from the same period in 2019, decreasing from $1,859,000 to $1,649,000.

The decrease was primarily due to decreases in service charges on deposit accounts, mortgage brokerage income, and other income, which were partially offset by increases in gains on sales of loans held-for-sale, loan servicing income, and gains on sales/calls of available-for-sale securities. The decrease in service charges on deposit accounts was primarily a result of COVID-19 and the Bank's decision to waive overdraft/NSF fees for all business and consumer customers for an initial period of 60 days which began in March. This assistance has resulted in increased fee waiver activity, reducing reported service charge income for the quarter. The decrease in mortgage brokerage income was primarily a result of decreased mortgage brokerage volume. The decrease in other income was primarily due to a gain on sale of land recognized during the three months ended March 31, 2019 that was not repeated during the same period in 2020. The increase in gains on sales of loans held-for-sale was primarily due to an increase in volume of sales. The increase in loan servicing income was primarily due to an increase in mortgage servicing assets booked. The increase in gains on sales/calls of available-for-sale securities was primarily due to sales/calls of investment securities during the three months ended March 31, 2020, compared to no sales of investment securities during the same period in 2019.

Non-Interest Expenses

Total non-interest expenses were up 6.9% for the three months ended March 31, 2020 from the same period in 2019, increasing from $8,018,000 to $8,570,000.

The increase was primarily due to increases in salaries and employee benefits and occupancy and equipment, which was partially offset by decreases in other real estate owned expense and other expenses. The increase in salaries and employee benefits was primarily due to an increase in the number of full-time equivalent employees. The increase in occupancy and equipment expense was primarily due to rent expense and other expenses associated with the opening of an administrative office space and branch during the second half of 2019. The decrease in other real estate owned expense was due to a decrease in other real estate owned properties. The decrease in other expenses was primarily due to a decrease in FDIC assessments, contributions, and computer software depreciation, which was partially offset by increases in loan collection expense and minibank interchange fees.

The following table sets forth other non-interest expenses by category for the three months ended March 31, 2020 and 2019.

	(in thousands)
	Three months ended March 31, 2020		Three months ended March 31, 2019
Other non-interest expenses
Allowance for unfunded commitments expense	$	100	$	80
FDIC assessments		—		90
Contributions		49		66
Legal fees		84		73
Accounting and audit fees		114		110
Consulting fees		74		78
Postage expense		22		28
Telephone expense		28		33
Public relations		62		48
Training expense		26		33
Loan origination expense		44		51
Computer software depreciation		17		32
Operational losses		64		54
Loan collection expense (recovery)		34		(52	)
Minibank interchange fees		135		109
Other non-interest expense		262		325
Total other non-interest expenses	$	1,115	$	1,158

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 decreased 36.1% for the three months ended March 31, 2020 from the same period in 2019, decreasing from $1,536,000 to $981,000 primarily due to a decrease 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, 2020			December 31, 2019

Undisbursed loan commitments		$	208,260		$	198,534
Standby letters of credit			2,082			2,455
Commitments to sell loans			17,316			1,240
		$	227,658		$	202,229

The reserve for unfunded lending commitments amounted to $940,000 and $840,000 as of March 31, 2020 and December 31, 2019, 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, 2020 and December 31, 2019:

	At March 31, 2020									At December 31, 2019
	Gross			Guaranteed			Net			Gross			Guaranteed			Net
(dollars in thousands)

Commercial		$	258		$	170		$	88		$	266		$	170		$	96
Commercial real estate			509			42			467			466			45			421
Agriculture			—			—			—			—			—			—
Residential mortgage			171			—			171			172			—			172
Residential construction			—			—			—			—			—			—
Consumer			251			—			251			253			—			253
Total non-accrual loans		$	1,189		$	212		$	977		$	1,157		$	215		$	942

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 $1,189,000 and $1,157,000 as of March 31, 2020 and December 31, 2019, 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 $3,115,000 and $3,318,000 at March 31, 2020 and December 31, 2019, 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. On March 22, 2020, the federal bank regulatory agencies issued joint guidance advising that the agencies have confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to relief, are not TDRs.

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 $175,000 or 18.6% to $1,117,000 during the first three months of 2020. Non-performing assets, net of guarantees, represented 0.1% of total assets at March 31, 2020.

	At March 31, 2020							At December 31, 2019
	Gross		Guaranteed		Net			Gross		Guaranteed		Net
(dollars in thousands)
Non-accrual loans	$	1,189	$	212	$	977		$	1,157	$	215	$	942
Loans 90 days past due and still accruing		140		—		140			—		—		—

Total non-performing loans		1,329		212		1,117			1,157		215		942
Other real estate owned		—		—		—			—		—		—
Total non-performing assets		1,329		212		1,117			1,157		215		942

Non-performing loans (net of guarantees) to total loans						0.1	%						0.1	%
Non-performing assets (net of guarantees) to total assets						0.1	%						0.1	%
Allowance for loan and lease losses to non-performing loans (net of guarantees)						1,152.1	%						1,311.7	%

The Company had one commercial loan totaling $40,000 and one consumer loan totaling $100,000 that were 90 days or more past due and still accruing at March 31, 2020. The Company had no loans 90 days or more past due and still accruing at December 31, 2019.

Excluding the non-performing loans cited previously, loans totaling $16,415,000 and $8,749,000 were classified as substandard or doubtful loans, representing potential problem loans at March 31, 2020 and December 31, 2019, 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, 2020 and December 31, 2019. The ratio of the Allowance for Loan Losses to total loans at March 31, 2020 and December 31, 2019 was 1.67% and 1.58%, 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 no OREO as of March 31, 2020 and December 31, 2019.

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, 2020 and 2019, and for the year ended December 31, 2019:

Analysis of the Allowance for Loan Losses

(Amounts in thousands, except percentage amounts)

	Three months ended March 31,						Year ended December 31,
	2020			2019			2019

Balance at beginning of period	$	12,356		$	12,822		$	12,822
Provision for loan losses		650			-			-
Loans charged-off:
Commercial		(145	)		(150	)		(638	)
Commercial Real Estate		—			—			—
Agriculture		—			—			(98	)
Residential Mortgage		—			—			—
Residential Construction		—			—			—
Consumer		(9	)		(7	)		(43	)
Total charged-off		(154	)		(157	)		(779	)

Recoveries:
Commercial		11			19			209
Commercial Real Estate		—			—			—
Agriculture		—			—			—
Residential Mortgage		—			56			74
Residential Construction		—			1			21
Consumer		6			5			9
Total recoveries		17			81			313

Net charge-offs		(137	)		(76	)		(466	)

Balance at end of period	$	12,869		$	12,746		$	12,356

Ratio of net charge-offs to average loans outstanding during the period (annualized)		(0.07	%)		(0.04	%)		(0.06	%)
Allowance for loan losses
To total loans at the end of the period		1.67	%		1.71	%		1.58	%
To non-performing loans, net of guarantees at the end of the period		1,152.1	%		230.9	%		1,311.7	%

Deposits

Deposits are one of the Company’s primary sources of funds. At March 31, 2020, the Company had the following deposit mix: 29.7% in savings and MMDA deposits, 4.3% in time deposits, 27.7% in interest-bearing transaction deposits and 38.3% in non-interest-bearing transaction deposits. At December 31, 2019, the Company had the following deposit mix: 30.2% in savings and MMDA deposits, 4.7% in time deposits, 27.9% in interest-bearing transaction deposits and 37.2% 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, 2020 and December 31, 2019 are summarized as follows:

	(in thousands)
	March 31, 2020		December 31, 2019
Three months or less	$	2,860	$	4,738
Over three to twelve months		3,800		5,104
Over twelve months		6,909		6,035
Total	$	13,569	$	15,877

Liquidity and Capital Resources

In order to serve our market area and comply with banking regulations, 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 64.7% on March 31, 2020. In addition, on March 31, 2020, the Company had the following short-term investments (based on remaining maturity and/or next repricing date): $20,665,000 in securities due within one year or less; and $70,254,000 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 $82,000,000 at March 31, 2020. Additionally, the Company has a line of credit with the FHLB, with a borrowing capacity at March 31, 2020 of $323,148,000; credit availability is subject to certain collateral requirements. The Company had no borrowings outstanding as of March 31, 2020.

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 FRB 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. The Basel Committee is a committee of banking supervisory authorities from major countries in the global financial system which formulates broad supervisory standards and guidelines relating to financial institutions for implementation on a country-by-country basis. 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.

Banks, such as First Northern, 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. The final rules provide for increased minimum capital ratios as follows: (a) a common equity Tier1 capital ratio of 4.5%; (b) a Tier 1 capital ratio of 6%; (c) a total capital ratio of 8%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4%. Under these 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). The capital conservation buffer is designed to absorb losses during periods of economic stress.

Pursuant to the Economic Growth Regulatory Relief and Consumer Protection Act (the "EGRRCPA"), the FRB adopted a final rule, effective August 31, 2018, amending the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (the “policy statement”) to increase the consolidated assets threshold to qualify to utilize the provisions of the policy statement from $1 billion to $3 billion. Bank holding companies, such as the Company, are subject to capital adequacy requirements of the FRB; however, bank holding companies which are subject to the policy statement are not subject to compliance with the regulatory capital requirements until they hold $3 billion or more in consolidated total assets. As a consequence, as of December 31, 2018, the Company was not required to comply with the FRB’s regulatory capital requirements until such time that its consolidated total assets equal $3 billion or more or if the FRB determines that the Company is no longer deemed to be a small bank holding company. However, if the Company had been subject to these regulatory capital requirements, it would have exceeded all regulatory requirements.

In November 2019, the bank regulatory agencies jointly adopted a final rule, that became effective January 1, 2020, that provided for a simple measure of capital adequacy for certain community banking organizations, consistent with the EGRRCPA. Under the rule, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets, such as the Company and the Bank, and that meet other qualifying criteria, including a leverage ratio (equal to tier 1 capital divided by average total consolidated assets) of greater than 9 percent, will be eligible to opt into the community bank leverage ratio framework. In April 2020, the federal bank regulatory agencies issued an interim final rule that made temporary changes to the community bank leverage ratio framework, pursuant to the CARES Act. As of the second quarter 2020, a banking organization with a leverage ratio of 8 percent or greater (and that meets other qualifying criteria) may elect to use the community bank leverage ratio framework. The temporary changes to the community bank leverage ratio framework implemented by this interim final rule will cease to be effective as of the earlier of the termination date of the national emergency concerning the coronavirus disease declared by the President on March 13, 2020, or December 31, 2020. Concurrently, the federal bank regulatory agencies issued an interim final rule that provides for a transition from the temporary 8 percent community bank leverage ratio requirement to the 9 percent community bank leverage ratio requirement under the final rule. Under the transition rule, the community bank leverage ratio will be 8 percent in the second quarter through fourth quarter of calendar year 2020, 8.5 percent in calendar year 2021, and 9 percent thereafter. Qualifying community banking organizations that elect to use the community bank leverage ratio framework and that maintain a leverage ratio of greater than 8 percent (subject to transition to 9 percent beginning in calendar year 2021) will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the agencies’ capital rules and, if applicable, will be considered to have met the well-capitalized ratio requirements for purposes of the FDIA. At the present time, the Company does not intend to elect to use the community bank leverage framework.

As of March 31, 2020, 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, 2020.

	(amounts in thousands except percentage amounts)
	Actual						Well Capitalized Ratio Requirement
	Capital			Ratio			Well Capitalized Ratio Requirement
Leverage		$	131,954		10.06	%		5.0	%
Common Equity Tier 1		$	131,954		14.93	%		6.5	%
Tier 1 Risk-Based		$	131,954		14.93	%		8.0	%
Total Risk-Based		$	143,038		16.18	%		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, 2020, from those presented in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019, 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, 2020. This conclusion is based on an evaluation conducted under the supervision and with the participation of management.

(b) During the quarter ended March 31, 2020, 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 2019 Form 10-K, which is incorporated by reference herein, and to the following:

The COVID-19 Pandemic Has Adversely Impacted our Business and Results of Operations, and the Ultimate Impact of the Pandemic on the U.S., California and Global Economies, and on our Business, Results of Operations and Financial Condition, Will Depend on Future Developments, Which Are Highly Uncertain and Cannot be Predicted; However, the Effects of the Pandemic Can Be Reasonably Expected to Have an Adverse Impact, Which Could Be Material

The COVID-19 pandemic has adversely impacted our business and results of operation, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and responsive actions taken by governmental and regulatory authorities. The pandemic and related governmental actions have negatively impacted the U.S., California and global economies, disrupted supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, and increased unemployment levels. In addition, the pandemic has significantly increased economic uncertainty, reduced economic activity, and resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities, including the markets where we have operations. Governments in the U.S. and globally have taken steps to mitigate some of the more severe anticipated economic effects of the virus. During March 2020, the U.S. Congress adopted and the President signed into law the CARES Act, which provided for some $2.2 trillion in federal funding for a variety of programs designed to stimulate the U.S. economy and to soften the economic consequences of the pandemic. Also, during March 2020, in response to the pandemic, the FRB reduced the federal funds rate 1.5 percentage points to .00 to .25 percent, and provided other monetary support to the financial markets and financial institutions in the U.S. There can be no assurance that these and other governmental measures will be effective or achieve their desired results in a timely fashion.

In response to the pandemic, the Bank proactively developed a COVID-19 Customer Support Plan designed to provide relief to those business and consumer customers financially impacted by the pandemic. Among other actions, the Bank has offered loan assistance for those impacted by COVID-19, including waiver of late fees for qualifying consumer, small business, commercial and agricultural loan customers for a period of 60 days (subject to extension if economic circumstances dictate); payment relief options; delinquencies resulting from impacts of COVID-19 will not be reported to the credit reporting bureaus; access to loan programs, including the Paycheck Protection Program (PPP) of the Small Business Administration (SBA) and the Bank’s strong partnership with the State of California’s I-Bank; deposit account assistance, including waiver of overdraft/non-sufficient funds fees for all business and consumer customers for a period of 60 days (subject to extension if economic circumstances dictate); increased debit card limits on a case by case basis for consumer clients; deposit customer access to surcharge-free ATMs at over 50 locations within the Bank’s local footprint and hundreds more throughout the state through the Bank’s membership in the MoneyPass ATM Network; and waiver of early withdrawal charges for customers wishing to withdraw funds from their Certificates of Deposit. We expect that the overall impact of these measures on our results of operations will be material and adverse to a degree which cannot be quantified at this time. Future governmental and regulatory actions may require us to provide these and additional types of customer-related responses.

The pandemic, the early economic effects of which began to be felt late in the first quarter 2020, will adversely affect our revenue, and continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed, the impact on the national economy worsens, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. We provide financing to businesses in a number of industries that may be particularly vulnerable to industry-specific economic factors that can adversely impact the performance of our commercial business, construction, commercial and multi-family real estate loan portfolios. Certain industries, such as the home building, commercial real estate, retail, agricultural, industrial, and commercial industries, among others, have been, and can expected to continue to be, adversely impacted by the disruptive and recessionary market conditions caused by the pandemic, which could result in higher nonperforming assets and elevated levels of charge-offs. Because of changing economic and market conditions affecting issuers, we also may be required to recognize impairments on the securities we hold.

Our business operations may also be disrupted if significant portions of our workforce, including employees of our third-party service providers, are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. We have shortened branch hours but not cut employee hours and approximately 40 percent of our employees are now working remotely rather than in our offices and branches, the majority of whom would not have been remote workers before the pandemic. Remote work arrangements may exacerbate certain risks to our business, including an increased demand for information technology resources, increased risk of phishing and other cybersecurity attacks, and increased information security risk involving, among other risks, the unauthorized dissemination of sensitive personal information or proprietary or confidential information about us, our customers or other third-parties. The pandemic could also disrupt our operations due to absenteeism by infected or ill members of management or other employees, or members of our Board of Directors, making it more difficult to conduct meetings for the management of our affairs. The operations of our clients, customers, suppliers, and third party service providers have also been, and are likely to be further, adversely impacted.

We may also experience financial losses due to a number of operational factors, including, among others: challenges to the availability and reliability of our network due to changes to normal operations or third party disruptions, including potential outages at network providers, call centers and other suppliers; increased cyber fraud risk related to COVID-19, as cybercriminals attempt to profit from the disruption, given increased online banking, e-commerce and other online activity; and new or additional regulatory requirements, which could require additional resources and costs to address. Various banks who participated in the SBA’s PPP have become the subject of purported class-action litigation regarding their activities under the program; there can be no assurance that such litigation will not be brought against other banks who participate in this program, including the Bank.

These factors may remain prevalent for a significant period of time and may continue to adversely affect our business, results of operations and financial condition even after the COVID-19 outbreak has subsided. The extent to which the COVID-19 outbreak impacts our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 outbreak has subsided, we may continue to experience materially adverse impacts to our business as a result of the national and global economic impact of the virus, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future. A substantial majority of our assets, deposits and interest and fee income are generated in Northern California, particularly in the Sacramento Valley region. As of this time, the California state government, as well as the county health departments in our market areas, continue to require residents to shelter in place and to keep non-essential businesses closed in response to COVID-19. A prolonged reduction in economic activity in this region could have an adverse impact, which could be material, on our business, results of operations and financial condition.

There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. We do not yet know the full extent of the impacts on our business, results of operations and financial condition, or on the U.S., California or global economies or our market areas in particular. Given the many challenges and uncertainties resulting from the coronavirus pandemic, there is a risk that conditions will be substantially different than we are currently expecting. However, the effects of the pandemic can be reasonably expected to have an adverse impact, which could be material, on our business, results of operations and financial condition, and heighten many of our known risks described in the “Risk Factors” section in Item 1A of Part I our 2019 Form 10-K and in this Report.

The COVID-19 Pandemic and Related Governmental and Regulatory Actions have Negatively Impacted the U.S., California and Global Economies, Significantly Increased Economic Uncertainty and Reduced Economic Activity, Resulting in Recessionary Economic and Financial Market Conditions, Which Are Likely to Have Resultant Adverse Consequences for the U.S. Financial Services Industry and for the Bank

Following the financial crisis of 2008, adverse financial and economic developments impacted U.S. and global economies and financial markets and presented challenges for the banking and financial services industry and for us. These developments included a general recession both globally and in the U.S. accompanied by substantial volatility in the financial markets.

In response, various significant economic and monetary stimulus measures were implemented by the U.S. government. The FRB also pursued a highly accommodative monetary policy aimed at keeping interest rates at historically low levels although the FRB more recently modified certain aspects of this policy by gradually increasing short-term interest rates and reducing its balance sheet.

While the U.S. economy experienced a period of significant expansion in recent years, the COVID-19 pandemic and related governmental and regulatory actions, the early economic effects of which began to be felt late in the first quarter 2020, have negatively impacted the U.S. and global economies, disrupted supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, and increased unemployment levels. In addition, the pandemic has significantly increased economic uncertainty, reduced economic activity, and resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities, including the markets where we have operations. We, and other financial services companies, are impacted to a significant degree by current economic conditions.

Governments in the U.S. and globally have taken steps to mitigate some of the more severe anticipated economic effects of the virus. During March 2020, the U.S. Congress adopted and the President signed into law the CARES Act, which provided for some $2.2 trillion in federal funding for a variety of programs designed to stimulate the U.S. economy and to soften the economic consequences of the pandemic. Also, during March 2020, in response to the pandemic, the FRB reduced the federal funds rate 1.5 percentage points to .00 to .25 percent, and provided other monetary support to the financial markets and financial institutions in the U.S. There can be no assurance that these and other governmental measures will be effective or achieve their desired results in a timely fashion.

The various governmental stimulus measures introduced in response to the COVID-19 pandemic have increased, and can be expected to continue to increase, federal budget deficits and the national debt level, while tax revenue can be expected to decline along with economic activity. These events can be expected to adversely affect the long-term sovereign credit rating of United States debt, and downgrades by the credit rating agencies with respect to the obligations of the U.S. federal government could occur. Any such downgrades could increase over time the U.S. federal government’s cost of borrowing, which may worsen its fiscal challenges, as well as generate upward pressure on interest rates generally in the U.S., which could, in turn, have adverse consequences for borrowers and the level of business activity.

The extent to which the COVID-19 outbreak ultimately impacts the national and global economies will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 outbreak has subsided, the U.S., California and global economies may continue to experience materially adverse impacts and continuing or worsening recessionary conditions. We do not yet know the full extent of the impacts of the COVID-19 pandemic on the U.S. or global economies or our market areas in particular; however, the pandemic can reasonably be expected to result in prolonged continuing or worsening recessionary economic and financial market conditions, which are likely to have adverse consequences, which could be material, for the U.S. financial services industry and for the Bank.

The Bank is Subject to Lending Risks of Loss and Repayment Associated with Commercial Banking Activities Which are Likely to be Adversely Impacted by the COVID-19 Pandemic

The Bank’s business strategy is to focus on commercial business loans (which includes agricultural loans), construction loans, and commercial and multi-family real estate loans. The principal factors affecting the Bank’s risk of loss in connection with commercial business loans include the borrower’s ability to manage its business affairs and cash flows, general economic conditions, and, with respect to agricultural loans, weather and climate conditions.

In response to the COVID-19 pandemic, following a declaration of a state of emergency in early March, the California state government issued a strict shelter in place order on March 19, 2020, instituting social distancing requirements and closing all non-essential businesses. The shelter in place order does not have a specific termination date. Given the many uncertainties and challenges resulting from the coronavirus pandemic, it is difficult to predict when this shelter in place order will be lifted, and the timing of when, and the extent to which, normal economic and operating conditions can resume in the state.

In the U.S. generally, and in California in particular, the pandemic has significantly increased economic uncertainty, reduced economic activity and increased unemployment levels. While many financial institutions, including the Bank, have offered loan assistance and payment relief to qualifying consumer, small business, commercial and agricultural loan customers impacted by the COVID-19 outbreak, the pandemic can reasonably be expected to have significant economic consequences on many of our commercial loan customers, with commercial lending customers increasing line of credit balances or seeking additional loans to help finance their businesses, and increased risk of delinquencies and defaults, particularly as shelter in place orders remain in effect for a prolonged period and many businesses remain closed. These events, in turn, could result in the recognition of credit losses in our loan portfolios and increases in our allowance for loan losses, which could have an adverse effect, which could be material, on the Bank’s financial condition and results of operations,

For a number of years in the past decade, California has also experienced severe drought, wildfires or other natural disasters. It can be expected that these events will continue to occur from time to time in the areas served by the Bank, and that the consequences of these natural disasters, including programs of public utility public safety power outages when weather conditions and fire danger warrant, may adversely affect the Bank’s business and that of its commercial loan customers, particularly in the agricultural sector.

Loans secured by commercial real estate are generally larger and involve a greater degree of credit and transaction risk than residential mortgage (one to four family) loans. Because payments on loans secured by commercial and multi-family real estate properties are often dependent on successful operation or management of the underlying properties, repayment of such loans may be dependent on factors other than the prevailing conditions in the real estate market or the economy. Real estate construction financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development compared to the estimated cost (including interest) of construction. If the estimate of value proves to be inaccurate, the Bank may be confronted with a project which, when completed, has a value which is insufficient to assure full repayment of the construction loan. For additional information, see “The Bank’s Dependence on Real Estate Lending Increases Our Risk of Losses, Particularly Given the Continuing or Worsening Economic and Financial Market Conditions Caused by the COVID-19 Pandemic”, below in these “Risk Factors” in this Report on Form 10-Q.

Although the Bank manages lending risks through its underwriting and credit administration policies, no assurance can be given that such risks will not materialize, in which event, the Company’s financial condition, results of operations, cash flows, and business prospects could be materially adversely affected.

Increases in the Allowance for Loan Losses Would Adversely Affect the Bank’s Financial Condition and Results of Operations

The Bank’s allowance for estimated losses on loans was approximately $12.9 million, or 1.67% of total loans, at March 31, 2020, compared to $12.4 million, or 1.58% of total loans, at December 31, 2019, and 1,152.1% of total non-performing loans net of guaranteed portions at March 31, 2020, compared to 1,311.7% of total non-performing loans, net of guaranteed portions at December 31, 2019. The increase in the ratio of allowance to total loans from December 31, 2019 to March 31, 2020, was primarily due to an increase in qualitative factors resulting from the downturn in economic conditions associated with the COVID-19 pandemic. Provision for loan losses increased $0.7 million for the three months ended March 31, 2020, compared to first quarter 2019, due to an increase in net charge-offs and an increase in loan balances, coupled with an increase in qualitative factors resulting from the downturn in economic conditions associated with the COVID-19 pandemic.

The COVID-19 pandemic and related governmental actions have negatively impacted the U.S., California and global economies, significantly increased economic uncertainty, reduced economic activity, increased unemployment levels, and resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities, including many markets where we have operations. The pandemic, the early economic effects of which began to be felt late in the first quarter 2020, can reasonably be expected to continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed, the impact on the national economy worsens, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Material future additions to the allowance for estimated losses on loans may be necessary if such material adverse changes in economic conditions continue to occur and the performance of the Bank’s loan portfolio deteriorates.

In addition, the pandemic may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular, decreasing property values, increasing the risk of defaults and reducing the value of real estate collateral. An allowance for losses on other real estate owned may also be required in order to reflect changes in the markets for real estate in which the Bank’s other real estate owned is located and other factors which may result in adjustments which are necessary to ensure that the Bank’s foreclosed assets are carried at the lower of cost or fair value, less estimated costs to dispose of the properties. Moreover, the FDIC and the DBO, as an integral part of their examination process, periodically review the Bank’s allowance for estimated losses on loans and the carrying value of its assets. Increases in the provisions for estimated losses on loans and foreclosed assets would adversely affect the Bank’s financial condition and results of operations.

The Bank’s Dependence on Real Estate Lending Increases Our Risk of Losses, Particularly Given the Continuing or Worsening Economic and Financial Market Conditions Caused by the COVID-19 Pandemic

At March 31, 2020, approximately 82% of the Bank’s loans in principal amount (excluding loans held-for-sale) were secured by real estate. We do not yet know the full extent of the impacts of the COVID-19 pandemic on the U.S., California or global economies or our market areas in particular; however, the pandemic can reasonably be expected to result in prolonged continuing or worsening recessionary economic and financial market conditions. At this time, the California state government, as well as the county health departments in our market areas, continue to require residents to shelter in place and to keep non-essential businesses closed in response to COVID-19. The value of the Bank’s real estate collateral has been, and could in the future continue to be, adversely affected by this prolonged reduction in economic activity and the economic recession in California, with has had resulting adverse impacts, which could be material, 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, 2020, real estate mortgage (excluding loans held-for-sale) and construction loans (residential and other) comprised approximately 79% and 3%, respectively, of the total loans in the Bank’s portfolio. At March 31, 2020, 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 further deteriorate. 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.

Adverse Economic Factors Affecting Certain Industries the Bank Serves Could Adversely Affect Our Business

The Bank is subject to certain industry specific economic factors. For example, a portion of the Bank’s total loan portfolio is related to residential and commercial real estate, especially in California. The COVID-19 pandemic, and its resulting recessionary economic and market conditions, may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular, decreasing property values, increasing the risk of defaults and reducing the value of real estate collateral. Increases in residential mortgage loan interest rates could also have an adverse effect on the Bank’s operations by depressing new mortgage loan originations, which in turn could negatively impact the Bank’s title and escrow deposit levels. Additionally, a downturn in the residential real estate and housing industries in California could have an adverse effect on the Bank’s operations and the quality of its real estate and construction loan portfolio. Although the Bank does not engage in subprime or negative amortization lending, we are not immune to volatility in the real estate market. Real estate valuations are influenced by demand, and demand is driven by economic factors such as employment rates and interest rates, which have been, and can be expected to continue to be, affected by the pandemic. These factors could adversely impact the quality of the Bank’s residential construction, residential mortgage and construction related commercial portfolios in various ways, including by decreasing the value of the collateral for our loans, and thereby negatively affecting the Bank’s overall loan portfolio.

The Bank provides financing to, and receives deposits from, businesses in a number of other industries that may be particularly vulnerable to industry-specific economic factors, including the home building, commercial real estate, retail, agricultural, industrial, and commercial industries. Certain of these industries have been, and can expected to continue to be, adversely impacted by the disruptive and recessionary market conditions caused by the pandemic, which could result in higher nonperforming assets and elevated levels of charge-offs.

Following the financial crisis of 2008, the home building industry in California was especially adversely impacted by the deterioration in residential real estate markets, which lead the Bank to take additional provisions and charge-offs against credit losses in this portfolio. The recessionary economic and market conditions resulting from the COVID-19 pandemic may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular, decreasing property values, increasing the risk of defaults and reducing the value of real estate collateral. Continued volatility in fuel prices and energy costs and the return of the drought in California could also adversely affect businesses in several of these industries. Industry specific risks are beyond the Bank’s control and could adversely affect the Bank’s portfolio of loans, potentially resulting in an increase in non-performing loans or charge-offs and a slowing of growth or reduction in our loan portfolio.

Recent wildfires across California and in our market area resulted in significant damage and destruction of property and equipment. The fire damage caused resulted in adverse economic impacts to those affected markets and beyond and on the Bank's customers. In addition, the major electric utility company in our region has adopted programs of electrical power shut-offs, often for multiple days, in wide areas of Northern California during periods of high winds and high fire danger. In 2019, shut-offs of power by this utility have adversely impacted the business of some of our customers and also have resulted in some of our branches being temporarily closed. It can be expected that these events will continue to occur from time to time in the areas served by the Bank, and that the consequences of these natural disasters, including programs of public utility public safety power outages when weather conditions and fire danger warrant, may adversely affect the Bank’s business and that of its customers. It is also possible that climate change may be increasing the severity or frequency of adverse weather conditions, thus increasing the impact of these types of natural disasters on our business and that of our customers.

The long-term impact of these developments on the markets we serve cannot be predicted at this time.

California Economic Conditions, Have Been, and Can Reasonably be Expected to Continue to be, Adversely Affected by the COVID-19 Pandemic, Which 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, 2020, the majority 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, particularly as a result of the COVID-19 pandemic.

In response to the pandemic, following a declaration of a state of emergency in early March, the California state government issued a strict shelter in place order on March 19, 2020, instituting social distancing requirements and closing all non-essential businesses. The shelter in place order does not have a specific termination date. Given the many uncertainties and challenges resulting from the coronavirus pandemic, it is difficult to predict when this shelter in place order will be lifted, and the timing of when, and the extent to which, normal economic and operating conditions can resume in the state.

In the U.S. generally, and in California in particular, the pandemic has significantly increased economic uncertainty, reduced economic activity and increased unemployment levels. While many financial institutions, including the Bank, have offered payment relief to mortgage and home equity line of credit customers impacted by the COVID-19 outbreak, among other customer-related responses, the pandemic may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular. There can be no assurance that home prices and the value of real estate collateral in California will not decline, and that the risk of defaults will not increase, as a result of the recessionary financial and market conditions created by the COVID-19 pandemic.

In addition, although the State of California has historically experienced budget shortfalls or deficits, during the past several years, California’s budgetary situation improved considerably. However, the various economic and health measures introduced by the legislature and the governor of the State of California in response to the COVID-19 pandemic have increased state spending at a time when the current economic slowdown can be expected to result in reduced state tax revenues, perhaps for a prolonged period.

Also, municipalities and other governmental units within California have experienced budgetary difficulties and several California municipalities filed for protection under the Bankruptcy Code. As a result, concerns have arisen regarding the outlook for the governmental obligations of California municipalities and other governmental units. If the budgetary and fiscal difficulties of the California state government and California municipalities and other governmental units recur or economic conditions in California decline, we expect that our level of problem assets could increase and our prospects for growth could be impaired.

For a number of years in the past decade, California has also experienced severe drought, wildfires or other natural disasters. It can be expected that these events will continue to occur from time to time in the areas served by the Bank, and that the consequences of these natural disasters, including programs of public utility public safety power outages when weather conditions and fire danger warrant, may adversely affect the Bank’s business and that of its customers. It is also possible that climate change may be increasing the severity or frequency of adverse weather conditions, thus increasing the impact of these types of natural disasters on our business and that of our customers.

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, 2020, 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 6, 2020	By:	/s/ Kevin Spink

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