As a result of the adverse financial and economic conditions in recent years, many lending institutions, including our Company, experienced significant declines in the performance of their loans, particularly construction, development and land loans, and unsecured commercial and consumer loans.  Our nonperforming assets and credit costs (primarily our loan loss provision, net OREO costs, legal expense, and appraisal costs) have been at elevated levels since the beginning of the recession in 2007.  While we experienced significant improvement in nonperforming assets during 2013, they still totaled $45.6 million, or 5.62% of total loans plus foreclosed assets at the end of 2013, relative to only $689,000, or 0.08% of total loans and foreclosed assets at the end of 2006.  California’s San Joaquin Valley, where the Company is headquartered and has most of its branch locations, was particularly hard hit by the recession.  Unemployment levels have always been relatively high in the San Joaquin Valley, including Tulare County which is our geographic center, but recessionary conditions pushed unemployment rates to exceptionally high levels.  The unemployment rate for Tulare County reached a high of 19.2% during the most recent economic cycle, in March 2010.  It was 13.4% for December 2013, reflecting a downward trend relative to 15.9% in December 2012, 17.2% in December 2011 and 18.0% in December 2010, but it is still well above the 8.3% aggregate unemployment rate reported for California in December 2013.  In addition, as discussed below in connection with challenges to the agricultural industry, if the current drought in California continues it could have a significant negative impact on unemployment rates in our market areas.

Challenges in the agricultural industry could have an adverse effect on our customers and their ability to make payments to us, particularly in view of the current drought in California.  While the Company’s nonperforming assets are currently comprised mainly of other real estate owned and loans secured by land, lots, and commercial/residential real estate, the drivers behind high levels of nonperforming assets in previous economic cycles include difficulties experienced by the agricultural industry in our market areas.  This is due to the fact that a considerable portion of our borrowers are involved in, or are impacted to some extent by, the agricultural industry.  While a great number of our borrowers are not directly involved in agriculture, they would likely be impacted by difficulties in the agricultural industry since many jobs in the San Joaquin Valley are ancillary to the regular production, processing, marketing and sales of agricultural commodities.

 

The markets for agricultural products can be adversely impacted by increased supply from overseas competition, a drop in consumer demand, and numerous other factors.  The ripple effect of any resulting drop in commodity prices could lower borrower income and depress collateral values.  Weather patterns are also of critical importance to row crop, tree fruit, and citrus production.  A degenerative cycle of weather has the potential to adversely affect agricultural industries as well as consumer purchasing power, and could lead to further unemployment throughout the San Joaquin Valley.  Another looming issue that could have a major impact on the agricultural industry involves water availability and distribution rights.  The state of California is currently experiencing the worst drought in recorded history.   While recent storms have mitigated the potential adverse impact to a slight extent, it is impossible to predict at present how long the drought may last.  If the amount of water available to agriculture becomes increasingly scarce due to drought and/or diversion to other uses, farmers may not be able to continue to produce agricultural products at a reasonable profit, which has the potential to force many out of business.  Such conditions have affected and may continue to adversely affect our borrowers and, by extension, our business, and if general agricultural conditions decline our level of nonperforming assets could increase.

 

Concentrations of real estate loans have negatively impacted our performance in the past, and could subject us further risks in the event of another real estate recession or natural disaster.  Our loan portfolio is heavily concentrated in real estate loans, particularly commercial real estate.  At December 31, 2013, 72% of our loan portfolio consisted of real estate loans, and a sizeable portion of the remaining loan portfolio has real estate collateral as a secondary source of repayment or as an abundance of caution.  Real estate loans on commercial buildings represented approximately 51% of all real estate loans, while construction/development and land loans were 5%, loans secured by residential properties accounted for 26%, and loans secured by farmland were 19% of real estate loans.  The Company’s $45.6 million balance of nonperforming assets at December 31, 2013 also includes nonperforming real estate loans totaling $33.3 million, and $8.2 million in foreclosed assets comprised primarily of other real estate owned (OREO). 

We may not be able to continue to attract and retain banking customers, and our efforts to compete may reduce our profitability.  The banking business in our current and intended future market areas is highly competitive with respect to virtually all products and services, which may limit our ability to attract and retain banking customers.  In California generally, and in our service areas specifically, branches of major banks dominate the commercial banking industry.  Such banks have substantially greater lending limits than we have, offer certain services we cannot offer directly, and often operate with economies of scale that result in relatively low operating costs.  We also compete with numerous financial and quasi-financial institutions for deposits and loans, including providers of financial services over the internet.  Recent technology advances and other changes have allowed parties to effectuate financial transactions that previously required the involvement of banks.  For example, consumers can maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits.  Consumers can also complete transactions such as paying bills and transferring funds directly without the assistance of banks.  The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits.  The loss of these revenue streams and access to lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

Confidential customer information transmitted through our online banking service is vulnerable to security breaches and computer viruses, which could expose us to litigation and adversely affect our reputation and ability to generate deposits.  We provide our customers the ability to bank online.  The secure transmission of confidential information over the Internet is a critical element of online banking.  Our network or those of our customers could be vulnerable to unauthorized access, computer viruses, phishing schemes and other security problems.  We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses.  To the extent that our activities or those of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, litigation and other possible liabilities.  Any inability to prevent security breaches or computer viruses could also cause existing customers to lose confidence in our systems, and could adversely affect our reputation and our ability to generate deposits.

 

If our information systems were to experience a system failure, our business and reputation could suffer.  We rely heavily on communications and information systems to conduct our business.  The computer systems and network infrastructure we use could be vulnerable to unforeseen problems.  Our operations are dependent upon our ability to minimize service disruptions by protecting our computer equipment, systems, and network infrastructure from physical damage due to fire, power loss, telecommunications failure or a similar catastrophic event.  We have protective measures in place to prevent or limit the effect of the failure or interruption of our information systems, and will continue to upgrade our security technology and update procedures to help prevent such damage.  However, if such failures or interruptions were to occur, they could result in damage to our reputation, a loss of customers, increased regulatory scrutiny, or possible exposure to financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

 

You may not be able to sell your shares at the times and in the amounts you want if the price of our stock fluctuated significantly or the trading market for our stock is not active.  The trading price of our common stock could be impacted by a number of factors, many of which are outside our control.  Although our stock has been listed on NASDAQ for many years, trading in our stock does not consistently occur in high volumes and cannot always be characterized as an active trading market.  A limited trading market for our common stock may exaggerate fluctuations in the value of our common stock, leading to price volatility in excess of that which would occur in a more active trading market.  In addition, the stock market in general is subject to fluctuations that affect the share prices and trading volumes of many companies, and these broad market fluctuations could adversely affect the market price of our common stock.  Factors that could affect our common stock price in the future include but are not necessarily limited to the following: 

 

The following table provides information as of December 31, 2013 with respect to options outstanding and available under our 2007 Stock Incentive Plan and the now-terminated 1998 Stock Option Plan, which are our only equity compensation plans other than an employee benefit plan meeting the qualification requirements of Section 401(a) of the Internal Revenue Code: