ITEM 1A -RISK FACTORS
An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that management believes may affect our business are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this Annual Report. The risks and uncertainties described below are not the only ones facing our business. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This Annual Report is qualified in its entirety by these risk factors.
General Business and Industry Risks
Economic conditions could adversely affect our business, financial condition and results of operations.
Our financial performance generally, and in particular the ability of our borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services that we offer, is highly dependent upon the business environment in the markets in which we operate and in the United States as a whole. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; terrorist attacks; disruptions in global or national supply chains; or a combination of these or other factors.
The Bank conducts banking operation principally in California’s Central Valley. The Central Valley is largely dependent on agriculture. The agricultural economy in the Central Valley is therefore important to our financial performance, results of operations and cash flows. We are also dependent in a large part upon the business activity, population growth, income levels and real estate activity in this market area. A downturn in agriculture and the agricultural related businesses could have a material adverse effect on our business, results of operations and financial condition. The agricultural industry has been affected by declines in prices and changes in yields of various crops and other agricultural commodities. Weaker prices could reduce the cash flows generated by farms and the value of agricultural land in our local markets and thereby increase the risk of default by our borrowers or reduce the foreclosure value of agricultural land and equipment that serve as collateral of our loans. Moreover, weaker prices might threaten farming operations in the Central Valley, reducing market demand for agricultural lending. In particular, farm income has seen recent declines, and in line with the downturn in farm income, farmland prices are coming under pressure.
Risks relating to the impact of COVID-19 could have a material adverse effect on our business, financial condition and results of operations.
The COVID-19 pandemic has created economic and financial disruptions that could adversely affect our business, financial condition, liquidity, capital, and results of operations. Even as efforts to contain the pandemic, including vaccinations, have made progress and some restrictions have relaxed, new variants of the virus are causing additional outbreaks. The impact of the Delta variant, or other variants that may emerge, cannot be predicted at this time, and could depend on numerous factors, including the availability of vaccines in different parts of the world, vaccination rates among the population, the effectiveness of COVID-19 vaccines against the Delta variant and other variants, and the response by governmental bodies to reinstate restrictive measures.
As the result of the COVID-19 pandemic and the related adverse local and national economic consequences,we could be subject to any of the following risks, any of which could have a material adverse effect on our business, financial condition, or results of operations:
•supply chain issues remain unresolved for longer than anticipated and decreased consumer and business confidence and economic activity, leading to certain lower loan demand and an increased risk of loan delinquencies, defaults, and foreclosures;
•high levels of unemployment may continue for an extended period of time, and loan delinquencies, problem assets and foreclosures may increase, resulting in increased charges and reduced income;
•collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;
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•our allowance for credit losses on loans may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect our net income;
•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;
•as the result of the decline in the Federal Reserve Board’s target federal funds rate, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;
•a material decrease in net income or a net loss over several quarters could result in a decrease in the rate of our quarterly cash dividend;
•a prolonged weakness in economic conditions resulting in a reduction of future projected earnings could result in our recording a valuation allowance against our current outstanding deferred tax assets; and
•cybersecurity, information security and operational risks could result from work-from-home arrangements, and the unavailability of critical services provided by third party vendors.
As a participating lender in the SBA Paycheck Protection Program (“PPP”), we aresubject to additional risks of litigation from our customers or other parties regarding our processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.
Federal and state governments have enacted laws intending to stimulate the economy in light of the business and market disruptions related to COVID-19, including the Small Business Administration Paycheck Protection Program. Our Bank participated as a lender in both rounds of the PPP. We understand that PPP loans are fully guaranteed by the SBA and believe the majority of these loans will be forgiven. However, there can be no assurance that the borrowers will use or have used the funds appropriately or will have satisfied the staffing or payment requirements to qualify for forgiveness in whole or in part. Any portion of the loan that is not forgiven must be repaid by the borrower. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded or serviced by the Bank, which may or may not be related to an ambiguity in the laws, rules or guidance regarding operation of the PPP, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if we have already been paid under the guaranty, seek recovery from us of any loss related to the deficiency. Several other large banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. We and the Bank may be exposed to the risk of litigation, from both customers and non-customers that approached the Bank regarding PPP loans and our PPP process. If any such litigation is filed against the Bank and is not resolved in a manner favorable to the Bank, it may result in significant financial liability or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.
Liquidity risks could affect operations and jeopardize our business, financial condition, and results of operations.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and/or investment securities and from other sources could have a substantial negative effect on our liquidity. Our most important source of funds consists of our customer deposits. Such deposit balances can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments, we could lose a relatively low cost source of funds, which would require us to seek wholesale funding alternatives in order to continue to grow, thereby increasing our funding costs and reducing our net interest income and net income. We also rely on alternative funding sources including unsecured borrowing lines with correspondent banks, secured borrowing lines with the Federal Home Loan Bank of San Francisco and the Federal Reserve Bank of San Francisco, and public time certificates of deposits. Our ability to access these sources could be impaired by deterioration in our financial condition as well as factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations for the financial services industry or serious dislocation in the general credit markets. In the event such a disruption should occur, our ability to access these sources could be adversely affected, both as to price and availability, which would limit or potentially raise the cost of the funds available to us. Any decline in available funding could adversely impact our ability to continue to implement our strategic plan, including our ability to originate loans, invest in securities, meet our expenses, or to fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our business, financial condition and results of operations.
Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of operations.
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In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve. An important function of the Federal Reserve is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, adjustments of the discount rate and changes in reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits. The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. The effects of such policies upon our business, financial condition and results of operations cannot be predicted.
We are subject to interest rate risk which, among other things, could affect our earnings and the value of certain of our assets.
Our earnings and cash flows are largely dependent on net interest income. Interest rates are sensitive to many factors that are beyond our control, such as economic conditions, competition and policies of various governmental and regulatory agencies, and, in particular, the fiscal and monetary policies of the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but these changes could also affect our ability to originate loans and obtain deposits; the fair value of our financial assets and liabilities, including our securities portfolio; and the average duration of our interest-earning assets. This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa, the risk that the individual interest rates or rate indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period, and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities, including a prolonged flat or inverted yield curve environment. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our business, financial condition and results of operations.
Uncertainty relating to the London Interbank Offered Rate ("LIBOR") calculation process and potential phasing out of LIBOR may adversely affect our results of operations.
The Financial Conduct Authority in the United Kingdom, which regulates LIBOR, will not guarantee the continuation of LIBOR on the current basis after 2021. The Federal Reserve selected a new index calculated by short-term repurchase agreements, backed by Treasury securities ("SOFR") to replace LIBOR. SOFR differs in its methodology from LIBOR in that it is backward looking and is likely to be lower than LIBOR and less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains market acceptance as a LIBOR replacement tool remains in question. In 2020 the Company began transitioning our instruments indexed to LIBOR to either a US Treasury index or a Wall Street Journal Prime Rate index. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and to a lesser extent, securities in our portfolio, and may impact the availability and cost of hedging instruments and borrowings, including the rates we pay on our subordinated debentures and trust preferred securities. In addition, there is a risk that we may not complete our full transition to alternative indices or reference rates by the time LIBOR is no longer available. Once LIBOR rates are no longer available, we may be subject to disputes or litigation with customers and creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our financial condition, results of operations and capital position.
The effects of changes to FDIC insurance coverage limits are uncertain and may adversely affect us.
The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. All of depositors’ accounts at an insured depository institution, including all non-interest bearing transactions accounts, will be insured by the FDIC up to the standard maximum deposit insurance amount of ($250,000) for each deposit insurance ownership category. Increases in FDIC insurance premiums will add to our cost of operations and could have a significant impact on the Bank.Depending on any future losses that the FDIC insurance fund may suffer due to failed institutions, there can be no assurance that there will not be additional significant premium increases in order to replenish the fund.
Competition with other financial institutions could adversely affect our profitability.
We face vigorous competition from banks and other financial institutions, including finance companies and credit unions. A number of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services.To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies, and fintech companies.This competition may reduce or limit our margins on banking services, reduce our market share and adversely affect our results of operations and financial condition.Additionally, we face competition primarily from other banks in attracting, developing and retaining qualified banking professionals.
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Whenever new banks open in our service areas, we see price competition from these new banks, as they work to establish their markets.The existence of competitors, large and small, is a normal and expected part of our operations, but in responding to the particular short-term impact on business of new entrants to the marketplace, we could see a negative impact on revenue and income.Moreover, these near term impacts could be accentuated by the seasonal impact on revenue and income generated by the borrowing and deposit habits of the agricultural community that comprises a significant component of our customer base.
The current expected credit loss standard established by the Financial Accounting Standards Board will require significant data requirements and changes to methodologies.
In the aftermath of the 2007-2008 financial crisis, the Financial Accounting Standards Board, or FASB, decided to review how banks estimate losses in the allowance for credit loss calculation, and it issued the final Current Expected Credit Loss, or CECL, standard on June 16, 2016. Currently, the impairment model used by financial institutions is based on incurred losses, and loans are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. This model will be replaced by the CECL model in which financial institutions will be required to use historical information, current conditions, and reasonable forecasts to estimate the expected loss over the life of the loan. The CECL model that will become effective for the Bank for the fiscal year beginning after December 15, 2022. Management established a task force to begin the implementation process. The transition to the CECL model will require significantly greater data requirements and changes to methodologies to accurately account for expected losses. The Bank will likely be required to increase its allowance for credit losses as a result of the implementation of CECL. An increase in the allowance would increase the provision for credit losses, decreasing net income and retained earnings.
We may incur losses as a result of unforeseen or catastrophic events, including the emergence of a pandemic, terrorist attacks, extreme weather events or other natural disasters.
The occurrence of unforeseen or catastrophic events, including the emergence of additional pandemics, or other widespread health emergency (or concerns over the possibility of such an emergency), terrorist attacks, extreme terrestrial or solar weather events or other natural disasters, could create economic and financial disruptions, and could lead to operational difficulties (including travel limitations) that could impair our ability to manage our businesses.
Risks Related to our Lending Activities
Agribusiness lending presents unique credit risks.
As of December 31, 2021, approximately 3.9% of our total gross loan portfolio was comprised of agribusiness loans. Repayment of agribusiness loans depends primarily on the successful planting and harvest of crops and marketing the harvested commodity or raising and feeding of livestock (including milk production). Collateral securing these loans may be illiquid. In addition, the limited purpose of some agricultural-related collateral affects credit risk because such collateral may have limited or no other uses to support values when loan repayment problems emerge. Many external factors can impact our agricultural borrowers’ ability to repay their loans, including adverse weather conditions, water issues, commodity price volatility, diseases, land values, production costs, changing government regulations and subsidy programs, changing tax treatment, technological changes, labor market shortages/increased wages, and changes in consumers’ preferences, over which our borrowers may have no control. These factors, as well as recent volatility in certain commodity prices, could adversely impact the ability of those to whom we have made agribusiness loans to perform under the terms of their borrowing arrangements with us, which in turn could result in credit losses and materially and adversely affect our business, financial condition and results of operations.
Because a significant portion of our loan portfolio is comprised of real estate loans, negative changes in the economy affecting real estate values and liquidity could impair the value of collateral securing our real estate loans and result in loan and other losses.
At December 31, 2021, $824 million, or 79.3% of our total loan and lease portfolio, consisted of real estate related loans. The real estate securing our loan portfolio is concentrated in California. The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, the rate of unemployment, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies and acts of nature, such as earthquakes and natural disasters. Adverse changes affecting real estate values and the liquidity of real estate in one or more of our markets could increase the credit risk associated with our loan portfolio, significantly impair the value of property pledged as collateral on loans and affect our ability
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to sell the collateral upon foreclosure without a loss or additional losses. Such declines and losses would have a material adverse impact on our business, financial condition and results of operations.
Small Business Administration lending is an important part of our business. Our SBA lending program is dependent upon the U.S. federal government, and we face specific risks associated with originating SBA loans.
Our SBA lending program is dependent upon the U.S. federal government. As an approved participant in the SBA Preferred Lender’s Program (an “SBA Preferred Lender”), we enable our clients to obtain SBA loans without being subject to the potentially lengthy SBA approval process necessary for lenders that are not SBA Preferred Lenders. The SBA periodically reviews the lending operations of participating lenders to assess, among other things, whether the lender exhibits prudent risk management. When weaknesses are identified, the SBA may request corrective actions or impose enforcement actions, including revocation of the lender’s SBA Preferred Lender status. If we lose our status as an SBA Preferred Lender, we may lose some or all of our customers to lenders who are SBA Preferred Lenders, and as a result we could experience a material adverse effect to our financial results. Any changes to the SBA program, including but not limited to changes to the level of guarantee provided by the federal government on SBA loans, changes to program specific rules impacting volume eligibility under the guaranty program, as well as changes to the program amounts authorized by Congress may also have a material adverse effect on our business. In addition, any default by the U.S. government on its obligations or any prolonged government shutdown could, among other things, impede our ability to originate SBA loans or sell such loans in the secondary market, which could adversely affect our business, results of operations and financial condition.
Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies and especially our organization, changes in the laws, regulations and procedures applicable to SBA loans could adversely affect our business, financial condition and results of operation.
If our allowance for credit losses is not sufficient to cover actual loan losses, our earnings could decrease.
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. We may experience significant credit losses that could have a material adverse effect on our operating results. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses for probable incurred losses in our loan portfolio. The allowance is established through a provision for loan losses based on management’s evaluation of the risks inherent in the loan portfolio and the general economy. The allowance is also appropriately increased for new loan growth. The allowance is based upon a number of factors, including the size of the loan portfolio, asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, management’s assessment of the credit risk inherent in the portfolio, historical loan loss experience and loan underwriting policies. The allowance is only an estimate of the probable incurred losses in the loan portfolio and may not represent actual losses realized over time, either of losses in excess of the allowance or of losses less than the allowance. If our assumptions prove to be incorrect, our current allowance my not be sufficient to cover future loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. Our bank regulatory agencies will periodically review our allowance for loan losses and the value attributed to nonaccrual loans or to real estate acquired through foreclosure and may require us to adjust our determination of the value for these items. These adjustments may adversely affect our business, financial condition and results of operation.
Non-performing assets adversely affect our results of operations and financial condition and take significant management time to resolve.
At December 31, 2021, our non-performing loans and leases were 0.09% of total loans and leases compared to 0.30% at December 31, 2020, and 0.18% at December 31, 2019, and our non-performing assets (which include foreclosed real estate) were 0.04% of total assets compared to 0.16% at December 31, 2020. The allowance for credit losses as a percentage of non-performing loans and leases was 1,014.80% as of December 31, 2021 compared to 393.99% at December 31, 2020. Non-performing assets adversely affect our net income in various ways. We generally do not record interest income on non-performing loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair value of the collateral, which may ultimately result in a loss. An increase in the level of non-performing assets increases our risk profile and may impact the capital levels our regulators believe are appropriate in light of the ensuing risk profile, which could result in a request to reduce our level of non-performing assets. When we reduce problem assets through loan sales, workouts, restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. In addition, the resolution of non-performing assets requires significant
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commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. There can be no assurance that we will not experience future increases in non-performing assets or that the disposition of such non-performing assets will not have a material adverse effect on our business, financial condition and results of operations.
Our focus on lending to small to mid-sized community-based businesses may increase our credit risk.
Commercial real estate and commercial business loans generally are considered riskier than single-family residential loans because they have larger balances to a single borrower or group of related borrowers. Commercial real estate and commercial business loans involve risks because the borrowers’ ability to repay the loans typically depends primarily on the successful operation of the businesses or the properties securing the loans. Most of the Bank’s commercial real estate and commercial business loans are made to small to medium sized businesses who may have a heightened vulnerability to economic conditions. Moreover, a portion of these loans have been made by us in recent years and the borrowers may not have experienced a complete business or economic cycle. Furthermore, the deterioration of our borrowers’ businesses may hinder their ability to repay their loans with us, which could have a material adverse effect on our business, financial condition and results of operations.
We are exposed to risk of environmental liabilities with respect to properties to which we take title.
In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. While we will take steps to mitigate this risk, we may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean-up hazardous or toxic substances, or chemical releases at one or more properties. The costs associated with investigation or remediation activities could be substantial. In addition, while there are certain statutory protections afforded lenders who take title to property through foreclosure on a loan, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected.
We may suffer losses in our loan portfolio despite our underwriting practices.
We mitigate the risks inherent in our loan portfolio by adhering to sound and proven underwriting practices, managed by experienced and knowledgeable credit professionals. These practices include analysis of a borrower’s prior credit history, financial statements, tax returns, and cash flow projections, valuations of collateral based on reports of independent appraisers and verifications of liquid assets. Nonetheless, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for loan loss.
Risks Related to Our Securities Portfolio
We have and in the future we may be required to recognize impairment with respect to investment securities.
Our securities portfolio contains whole loan private mortgage-backed securities and currently includes securities with unrecognized losses and securities that have been downgraded to below investment grade by national rating agencies. We may continue to observe declines in the fair market value of these securities.We evaluate the securities portfolio for any other-than-temporary impairment each reporting period, as required by generally accepted accounting principles. Numerous factors, including the lack of liquidity for re-sales of certain securities, the absence of reliable pricing information for securities, adverse changes in the business climate, adverse regulatory actions or unanticipated changes in the competitive environment, could have a negative effect on our securities portfolio and results of operations in future periods. There can be no assurance, however, that future evaluations of the securities portfolio will not require us to recognize further impairment charges with respect to these and other holdings.
Risks Related to our Management
We are highly dependent on our management team, and the loss of our senior executive officers or other key employees could harm our ability to implement our strategic plan, impair our relationships with customers and adversely affect our business, financial condition and results of operations.
Our success depends, in large degree, on the skills of our management team and our ability to retain, recruit and motivate key officers and employees. Our senior management team has significant industry experience, and their knowledge
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and relationships would be difficult to replace. Leadership changes will occur from time to time, and we cannot predict whether significant resignations will occur or whether we will be able to recruit additional qualified personnel. Competition for senior executives and skilled personnel in the financial services and banking industry is intense, which means the cost of hiring, paying incentives and retaining skilled personnel may continue to increase. We need to continue to attract and retain key personnel and to recruit qualified individuals to succeed existing key personnel to ensure the continued growth and successful operation of our business. In addition, as a provider of relationship-based commercial banking services, we must attract and retain qualified banking personnel to continue to grow our business, and competition for such personnel can be intense. In addition, to attract and retain personnel with appropriate skills and knowledge to support our business, we may offer a variety of benefits, which could reduce our earnings or have a material adverse effect on our business, financial condition and results of operations. The loss of the services of any senior executive or other key personnel, the inability to recruit and retain qualified personnel in the future, or an increase in compensation benefits could have a material adverse effect on our business, financial condition and results of operations. .
Risks Related to Our Capital
We may be subject to more stringent capital requirements in the future.
We are subject to current and changing regulatory requirements specifying minimum amounts and types of capital that we must maintain. Our failure to comply with capital requirements may restrict the types of activities we or our subsidiaries may conduct, and we may be prohibited from taking certain capital actions, such as paying dividends and repurchasing or redeeming capital securities. In particular, the capital requirements applicable to us under the recently adopted Capital Rules implementing the Basel III capital framework in the United States started to be phased-in on January 1, 2015. While we expect to meet the requirements of the Basel III-based Capital Rules, we may fail to do so. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial condition and results of operations. In addition, these requirements could have a negative impact on our ability to lend, grow deposit balances, make acquisitions or make capital distributions in the form of dividends or share repurchases. Higher capital levels could also lower our return on equity..
We may not be successful in raising additional capital needed in the future.
We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business strategies. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time which are outside of our control, and our financial performance. We cannot be assured that such capital will be available to us on acceptable terms or at all. Any occurrence that may limit our access to the capital markets may adversely affect our capital costs and our ability to raise capital. Moreover, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to Our Growth
We may not be able to maintain our historical growth rate which may adversely impact our business, financial condition and results of operations and financial condition.
We have initiated internal asset growth programs, completed various acquisitions and opened additional offices in prior years. We may not be able to sustain our historical rate of asset growth or may not even be able to grow at all. We may not be able to obtain the financing necessary to fund additional asset growth and may not be able to find suitable candidates for acquisition. Various factors, such as economic conditions and competition, may impede or prohibit the opening of new branch offices. Further, our inability to attract and retain experienced bankers may adversely affect our internal asset growth. A significant decrease in our historical rate of asset growth could have a material adverse impact on our business, financial condition and results of operations.
We may be unable to complete future acquisitions, and once complete, may not be able to integrate our acquisitions successfully.
Our growth strategy includes our desire to acquire other financial institutions. We may not be able to complete any future acquisitions and, for completed acquisitions, we may not be able to successfully integrate the operations, management, products and services of the entities we acquire. We may not realize expected cost savings or make revenue enhancements. Following each acquisition, we must expend substantial managerial, operating, financial and other resources to integrate these entities. In particular, we may be required to install and standardize adequate operational and control systems, deploy or modify equipment, implement marketing efforts in new as well as existing locations and employ and maintain qualified
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personnel. Our failure to successfully integrate the entities we acquire into our existing operations could have a material and adverse affect on our business, financial condition and results of operations.
If the goodwill we have recorded in connection with our acquisitions becomes impaired, it could have an adverse impact on our earnings and capital.
At December 31, 2021, we had approximately $53,777,000 of goodwill on our balance sheet attributable to our acquisitions of the Bank of Madera County in January 2005, Service 1st Bancorp in November 2008, Visalia Community Bank in July 2013, Sierra Vista Bank in October 2016, and Folsom Lake Bank in October 2017.In accordance with generally accepted accounting principles, our goodwill is not amortized but rather evaluated for impairment on an annual basis or more frequently if events or circumstances indicate that a potential impairment exists.Such evaluation is based on a variety of factors, including the quoted price of our common stock, market prices of the common stock of other banking organizations, common stock trading multiples, discounted cash flows, and data from comparable acquisitions.There can be no assurance that future evaluations of goodwill will not result in findings of impairment and write-downs, which could be material.
Risks Related to Our Reputation and Operations
Our ability to maintain our reputation is critical to the success of our business, and the failure to do so may materially and adversely affect our business and the value of our common stock.
We are a community bank, and our reputation is one of the most valuable components of our business. Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable or fraudulent activities of our customers. Negative publicity regarding our industry, the Bank, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results and the value of our common stock may be adversely affected.
Our risk management framework may not be effective in mitigating risks and/or losses to us.
Our risk management framework is comprised of various processes, systems and strategies, and is designed to manage the types of risk to which we are subject, including, among others, credit, market, liquidity, interest rate and compliance. Our framework also includes financial or other modeling methodologies that involve management assumptions and judgment. Our risk management framework may not be effective under all circumstances and may not adequately mitigate any risk or loss to us. If our risk management framework is not effective, we could suffer unexpected losses and our business, financial condition and results of operations could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.
Our business is exposed to the risk of changes in technology.
The rapid pace of technology changes and the impact of such changes on financial services generally and on our business specifically could impact our cost structure and our competitive position with our customers. Such developments include the rapid movement by customers and some competitor financial institutions to web-based services, mobile banking and cloud computing. Our failure or inability to anticipate, plan for or implement technology change could adversely affect our business, financial condition and results of operations.
If our information systems were to experience a system failure, our business and reputation could suffer.
We rely heavily on communications and information systems to conduct our business. The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to minimize service disruptions by protecting our computer equipment, systems, and network infrastructure from physical damage due to fire, power loss, telecommunications failure, or a similar catastrophic event. We have protective measures in place to prevent or limit the effect of the failure or interruption of our information systems, and will continue to upgrade our security technology and update procedures to help prevent such events. However, if such failures or interruptions were to occur, they could result in damage to our reputation, a loss of customers, increased regulatory scrutiny, or possible exposure to financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.
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The occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents could have a material adverse effect on our business, financial condition and results of operations.
As a financial institution we are susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customer information, misappropriation of assets, privacy breaches against our customers, litigation, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, online banking, phishing, social engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by us or our customers, denial or degradation of service attacks, and malware or other cyber-attacks. There continues to be a rise in electronic fraudulent activity, security breaches, and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. Consistent with industry trends, we have also experienced an increase in attempted electronic fraudulent activity, security breaches and cybersecurity-related incidents in recent periods. Moreover, in recent periods, several large corporations, including financial institutions and retail companies, have suffered major data breaches, in some cases exposing not only confidential and proprietary corporate information, but also sensitive financial and other personal information of their customers and employees and subjecting them to potential fraudulent activity. Some of our customers may have been affected by these breaches which increase their risks of identity theft, credit card fraud, and other fraudulent activity that could involve their accounts with us.
Information pertaining to us and our customers is maintained and transactions are executed on the networks and systems of ours, our customers, and certain of our third party partners, such as our online banking or core systems. The secure maintenance and transmission of confidential information as well as execution of transactions over these systems are essential to protect us and our customers against fraud and security breaches and to maintain our customers’ confidence. Breaches of information security also may occur, and in infrequent, incidental, cases have occurred, through intentional or unintentional acts by those having access to our systems or our customers’ or counterparties’ confidential information, including employees. In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions as well as the technology used by our customers to access our systems. Although we have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, our inability to anticipate, or failure to adequately mitigate, breaches of security could result in: losses to us or our customers; our loss of business and/or customers; damage to our reputation; the incurrence of additional expenses; disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability any of which could have a material adverse effect on our business, financial condition and results of operations.
Finance and Accounting Risks
Our controls over financial reporting and related governance procedures may fail or be circumvented.
Management regularly reviews and updates our internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. We maintain controls and procedures to mitigate risks such as processing system failures or errors and customer or employee fraud, and we maintain insurance coverage for certain of these risks. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and provides only reasonable, not absolute, assurances that the objectives of the system are met. Events could occur which are not prevented or detected by our internal controls, are not insured against, or are in excess of our insurance limits. Any failure or circumvention of our controls and procedures, or failure to comply with regulations related to controls and procedures, could have a material adverse effect on our business.
Our accounting estimates and risk management processes rely on analytical and forecasting models.
The processes we use to estimate our inherent loan losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and results of operations, depends upon the use of analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models we use for interest rate risk and asset-liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models we use for determining our probable loan losses are inadequate, the allowance for loan losses may not be sufficient to support future charge-offs. If the models we use to measure the fair value of financial instruments are inadequate, the fair value of such
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financial instruments may fluctuate unexpectedly or may not accurately reflect what we could realize upon sale or settlement of such financial instruments. Any such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition, and results of operations.
We have a significant deferred tax asset and cannot assure that it will be fully realized.
Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between the carrying amounts and tax basis of assets and liabilities computed using enacted tax rates. We regularly assess available positive and negative evidence to determine whether it is more likely than not that our net deferred tax asset will be realized. Realization of a deferred tax asset requires us to apply significant judgment and is inherently speculative because it requires estimates that cannot be made with certainty. At December 31, 2021, we had a net deferred tax asset of $6.31 million. If we were to determine at some point in the future that we will not achieve sufficient future taxable income to realize our net deferred tax asset, we would be required, under generally accepted accounting principles, to establish a full or partial valuation allowance which would require us to incur a charge to operations for the period in which the determination was made.
Risks Related to Legislative and Regulatory Developments
We are subject to extensive government regulation that could limit or restrict our activities, which, in turn, may hamper our ability to increase our assets and earnings.
Our operations are subject to extensive regulation by federal, state and local governmental authorities and we are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Similarly, the lending, credit and deposit products we offer are subject to broad oversight and regulation. Because our business is highly regulated, the laws, rules, regulations and supervisory guidance and policies applicable to us are subject to regular modification and change. Perennially, various laws, rules and regulations are proposed, which, if adopted, could impact our operations by making compliance much more difficult or expensive, restricting our ability to originate or sell loans or further restricting the amount of interest or other charges or fees earned on loans or other products. Current and future legal and regulatory requirements, restrictions and regulations, including those imposed under Dodd-Frank, may adversely impact our profitability and may have a material and adverse effect on our business, financial condition, and results of operations. While the banking regulators continue to refine existing regulations implemented after the 2007-2008 financial crisis, currently they are also focusing their attention on certain policy areas, such as climate risk, digital currencies, and technological innovation. This new focus may require us to invest significant management attention and resources to evaluate and make any changes required by the legislation and accompanying rules, and may make it more difficult for us to attract and retain qualified executive officers and employees.
Regulations relating to privacy, information security and data protection could increase our costs, affect or limit how we collect and use personal information.
We are subject to an increasing number of federal and state privacy, information security and data protection laws, and we could be negatively impacted by these laws. Various state and federal banking regulators and states have also enacted data security breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification. Moreover, legislators and regulators in the United States are increasingly adopting or revising privacy, information security and data protection laws that potentially could have a significant impact on our current and planned privacy, data protection and information security-related practices, as well as on our collection, use, sharing, retention and safeguarding of consumer or employee information.
The effects of these privacy and data protection laws, including the cost of compliance and required changes in the manner in which we conduct our business, are not fully known and are potentially significant, and the failure to comply could adversely affect the Company. Compliance with current or future privacy, data protection and information security laws (including those regarding security breach notification) affecting customer or employee data to which we are subject could result in higher compliance and technology costs and could restrict our ability to provide certain products and services. Our failure to comply with privacy, data protection and information security laws could result in potentially significant regulatory or governmental investigations or actions, litigation, fines, sanctions and damage to our reputation, which could have a material adverse effect on our business, financial condition and results of operations.
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We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.
The Bank Secrecy Act, the USA PATRIOT Act of 2001, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration, and Internal Revenue Service. We are also subject to scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control and compliance with the Foreign Corrupt Practices Act. If our policies, procedures, and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could materially and adversely affect our business, financial condition and results of operations.
Risks Related to Our Common Stock
We may raise additional capital, which could have a dilutive effect on the existing holders of our common stock and adversely affect the market price of our common stock.
We are not restricted from issuing additional shares of common stock or securities that are convertible into or exchangeable for, or that represent the right to receive, common stock.We frequently evaluate opportunities to access the capital markets taking into account our regulatory capital ratios, financial condition and other relevant considerations, and subject to market conditions, we may take further capital actions.Such actions could include, among other things, the issuance of additional shares of common stock in public or private transactions in order to further increase our capital levels above the requirements for a well-capitalized institution established by the federal bank regulatory agencies as well as other regulatory targets.
The issuance of any additional shares of common stock or securities convertible into or exchangeable for common stock or that represent the right to receive common stock, or the exercise of such securities including, without limitation, securities issued upon exercise of outstanding stock options under our stock option plans, could be substantially dilutive to shareholders of our common stock. Holders of our shares of common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, such sales or offerings could result in increased dilution to our shareholders. The market price of our common stock could decline as a result of sales of shares of our common stock or the perception that such sales could occur.
The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell shares of common stock owned by you at times or at prices you find attractive.
At times, the stock market and, in particular, the market for financial institution stocks, has experienced significant volatility, which has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices for certain issuers without regard to those issuers’ underlying financial strength. As a result, the trading volume in our common stock may fluctuate more than usual and cause significant price variations to occur. This may make it difficult for shareholders to resell shares of common stock at times or at prices they find attractive. The low trading volume in our common shares on the NASDAQ Capital Market means that our shares may have less liquidity than other publicly traded companies. We cannot ensure that the volume of trading in our common shares will be maintained or will increase in the future.
The trading price of the shares of our common stock will depend on many factors, which may change from time to time and which may be beyond our control. Broad market fluctuations have adversely affected and may continue to adversely affect the market price of our common stock. Among the factors that could affect our stock price are:
•actual or anticipated quarterly fluctuations in our operating results and financial condition;
•changes in financial estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to our common stock or those of other financial institutions;
•failure to meet analysts’ revenue or earnings estimates;
•speculation in the press or investment community generally or relating to our reputation, our market area, our competitors or the financial services industry in general;
•strategic actions by us or our competitors, such as acquisitions;
•actions by our institutional shareholders;
•fluctuations in the stock price and operating results of our competitors;
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•future sales of our equity, equity-related or debt securities;
•changes in the frequency or amount of dividends or share repurchases;
•trading activities in our common stock, including short-selling;
•domestic and international economic factors unrelated to our performance; and
•general market conditions and, in particular, developments related to market conditions for the financial services industry.
An investment in our common stock is not an insured deposit.
Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund, or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you could lose some or all of your investment.
Anti-takeover provisions and federal law may limit the ability of another party to acquire us, which could cause our stock price to decline.
Various provisions of our articles of incorporation and by-laws and certain other actions we have taken could delay or prevent a third party from acquiring us, even if doing so might be beneficial to our shareholders. The Bank Holding Company Act of 1956, as amended, and the Change in Bank Control Act of 1978, as amended, together with federal regulations, require that, depending on the particular circumstances, regulatory approval and/or appropriate regulatory filings may be required from either or all the Federal Reserve, the FDIC, and the DFPI prior to any person or entity acquiring “control” (as defined in the applicable regulations) of a state non-member bank, such as the Bank. These provisions may prevent a merger or acquisition that would be attractive to shareholders and could limit the price investors would be willing to pay in the future for our common stock.
The Company is a holding company and depends on the Bank for dividends, distributions, and other payments.
The Company is a legal entity separate and distinct from the Bank. The Company’s principal source of cash flow, including cash flow to pay dividends to our shareholders, is dividends from the Bank. The Company’s ability to pay dividends to its stockholders is substantially dependent upon the Bank’s ability to pay dividends to the Company. Federal and state law imposes limits on the ability of the Bank to pay dividends and make other distributions and payments. If the Bank is unable to meet regulatory requirements to pay dividends or make other distributions to the Company, the Company will be unable to pay dividends to its shareholders.
The holders of our debt obligations will have priority over our common stock with respect to payment in the event of liquidation, dissolution or winding up and with respect to the payment of interest and dividends.
The holders of our debt obligations if any, will have priority over our common stock with respect to payment in the event of liquidation, dissolution or winding up and with respect to the payment of interest and dividends. In any liquidation, dissolution or winding up of the Company, our common stock would rank below all claims of the holders of outstanding debt issued by the Company. As of December 31, 2021, we had $35.0 million principal amount of subordinated notes outstanding due 2031. In addition, as of December 31, 2021, we had $5.15 million of trust preferred securities outstanding due 2036. In such event, holders of our common stock would not be entitled to receive any payment or other distribution of assets upon the liquidation, dissolution or winding up of the Company until after all of the Company’s obligations to the debt holders were satisfied and holders of the subordinated debt and trust preferred securities subordinate debentures had received any payment or distribution due to them. In addition, we are required to pay interest on the subordinated notes and trust preferred securities and if we are in default in the payment of interest we would not be able to pay any dividends on our common stock.
ITEM 1B - UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2 -DESCRIPTION OF PROPERTY
The Company owns the property on which full-service branch offices are situated at the following California locations: the Clovis Office, the Prather Office, the Modesto office, the Kerman office, the Visalia Floral Office, and the Exeter office.
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All other property is leased by the Company, including the principal executive offices in Fresno, which houses the Company’s corporate offices, comprised of various departments, including accounting and finance, business lending for real estate, SBA, and agribusiness, information services, human resources, loan operations, credit review administration, banking services administration, risk management, and compliance.
The Company continually evaluates the suitability and adequacy of the Company’s offices and has a program of relocating or remodeling them as necessary to be efficient and attractive facilities. Management believes that its existing facilities are adequate for its present purposes.
Properties owned by the Bank are held without loans or encumbrances. All of the property leased is leased directly from independent parties. Management considers the terms and conditions of each of the existing leases to be in the aggregate favorable to the Company. SeeNote 9 of the Company’s audited Consolidated Financial Statements in Item 8 of this Annual Report.
ITEM 3 -LEGAL PROCEEDINGS
The Company is subject to legal proceedings and claims which arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to such actions will not materially affect the consolidated financial position or consolidated results of operations of the Company.
ITEM 4 -MINE SAFETY DISCLOSURES
None to report.
PART II
ITEM 5 -MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed for trading on the Nasdaq Capital Market under the ticker symbol CVCY. As of March 4, 2022, we had approximately 918 shareholders of record.
The following table shows the high and low sales prices for the common stock for each quarter as reported by The NASDAQ Stock Market and cash dividend payment for each quarter presented.
Common Stock Prices and Dividends
We paid common share cash dividends of $0.47 and $0.44 per share in 2021 and 2020, respectively. The Company’s primary source of income with which to pay cash dividends is dividends from the Bank. See Note 13in the audited Consolidated Financial Statements in Item 8 of this Annual Report.
The amount of future dividends will depend upon our earnings, financial condition, capital requirements and other factors, and will be determined by our board of directors on a quarterly basis. It is Federal Reserve policy that bank holding companies generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also Federal Reserve policy that bank holding companies not maintain dividend levels that undermine the holding company’s ability to be a source of strength to its banking subsidiaries. Additionally, the Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong. Under the federal Prompt Corrective Action regulations, the Federal Reserve or the FDIC may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as undercapitalized.
As a holding company, our ability to pay cash dividends is affected by the ability of our bank subsidiary, to pay cash dividends. The ability of the Bank (and our ability) to pay cash dividends in the future and the amount of any such cash dividends is and could be in the future further influenced by bank regulatory requirements and approvals and capital guidelines.
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The decision whether to pay dividends will be made by our board of directors in light of conditions then existing, including factors such as our results of operations, financial condition, business conditions, regulatory capital requirements and covenants under any applicable contractual arrangements, including agreements with regulatory authorities.
As of December 31, 2021, we had $35.0 million principal amount of subordinated notes outstanding due 2031. If we fail to make interest payments required by the terms of the subordinated debt we would be prohibited from paying dividends on any shares of common stock. In addition, as of December 31, 2021, we had $5.15 million of trust preferred securities outstanding due 2036. Under the terms of the trust preferred securities, we may defer interest payments for up to five years. But, if the Company should ever defer such interest payments, we would be prohibited from declaring or paying any cash dividends on any shares of our common stock.
For information on the statutory and regulatory limitations on the ability of the Company to pay dividends and on the Bank to pay dividends to Company see “Item 1 - Business - Supervision and Regulation - Dividends.”
ISSUER PURCHASES OF EQUITY SECURITIES
A summary of the repurchase activity of the Company’s common stock for the year ended December 31, 2021 follows.
(1) The Company approved a stock repurchase program effective March 17, 2021 with the intent to purchase up to $12,000,000 of the Company’s outstanding common stock, or approximately 636,934 shares. During the year ended December 31, 2021, the Company repurchased and retired 584,619 shares at an approximate cost of $20.50 per share, completing the March 17, 2021 approved stock repurchase program.
(2) The Company approved a stock repurchase program effective November 17, 2021 with the intent to purchase an additional $15,000,000 of the Company’s outstanding common stock, or approximately 702,576 shares. During the year ended December 31, 2021, the Company repurchased and retired 76,613 shares under the November 17, 2021 approved stock repurchase program at an approximate cost of $21.10 per share.
(3) All share repurchases were effected in accordance with the safe harbor provisions of Rule 10b-18 of the Securities Exchange Act.
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EQUITY COMPENSATION PLAN INFORMATION
The following chart sets forth information for the year ended December 31, 2021, regarding equity-based compensation plans of the Company.
Plan Category (a) (b) (c)
Equity compensation plans not approved by security holders N/A N/A N/A
(1) Under the Central Valley Community Bancorp 2015 Omnibus Incentive Plan (2015 Plan) and the Central Valley Community Bancorp 2005 Omnibus Incentive Plan (2005 Plan), the Company is authorized to issue restricted stock awards. Restricted stock awards are not included in the total in column (a). See Note 14in the audited Consolidated Financial Statements in Item 8 of this Annual Report.
(2) Includes securities available for issuance of stock options and restricted stock.
At December 31, 2021, there were 24,177 shares of restricted common stock issued and outstanding. No options to purchase shares of the Company’s common stock were issued during the years ended December 31, 2021 and 2020 from any of the Company’s equity-based compensation plans. During the year ended December 31, 2021, 31,496 shares of restricted common stock were granted under the 2015 Plan, and 21,397 shares of restricted common stock were granted during the year ended December 31, 2020.
ITEM 6 -[Reserved]
ITEM 7 -MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Management’s discussion and analysis should be read in conjunction with the Company’s audited Consolidated Financial Statements, including the Notes thereto, in Item 8 of this Annual Report.
Certain matters discussed in this report constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained herein that are not historical facts, such as statements regarding the Company’s current business strategy and the Company’s plans for future development and operations, are based upon current expectations. These statements are forward-looking in nature and involve a number of risks and uncertainties. Such risks and uncertainties include, but are not limited to (1) significant increases in competitive pressure in the banking industry; (2) the impact of changes in interest rates; (3) a decline in economic conditions in the Central Valley and the Greater Sacramento Region; (4) the Company’s ability to continue its internal growth at historical rates; (5) the Company’s ability to maintain its net interest margin; (6) the decline in quality of the Company’s earning assets; (7) a decline in credit quality; (8) changes in the regulatory environment; (9) fluctuations in the real estate market; (10) changes in business conditions and inflation; (11) changes in securities markets (12) risks associated with acquisitions, relating to difficulty in integrating combined operations and related negative impact on earnings, and incurrence of substantial expenses; (13) political developments, uncertainties or instability, catastrophic events, acts of war or terrorism, or natural disasters, such as earthquakes, drought, pandemic diseases or extreme weather events, any of which may affect services we use or affect our customers, employees or third parties with which we conduct business; (14) the uncertainties related to the Covid-19 pandemic including, but not limited to, the potential adverse effect of the pandemic on the economy, our employees and customers, and our financial performance; and (15) the impact of the federal CARES Act and the significant additional lending activities undertaken by the Company in connection with the Small Business Administration’s Paycheck Protection Program enacted thereunder, including risks to the Company with respect to the uncertain application by the Small Business Administration of new borrower and loan eligibility, forgiveness and audit criteria. Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluating the business prospects of the Company.
When the Company uses in this Annual Report the words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar expressions, the Company intends to identify forward-looking statements.
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Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Annual Report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. The future results and shareholder values of the Company may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. See also the discussion of risk factors in Item 1A, “Risk Factors.”
We are not able to predict all the factors that may affect future results. You should not place undue reliance on any forward looking statement, which speaks only as of the date of this Report on Form 10-K. Except as required by applicable laws or regulations, we do not undertake any obligation to update or revise any forward looking statement, whether as a result of new information, future events or otherwise.
INTRODUCTION
Central Valley Community Bancorp (NASDAQ: CVCY) (the Company) was incorporated on February 7, 2000. The formation of the holding company offered the Company more flexibility in meeting the long-term needs of customers, shareholders, and the communities it serves. The Company currently has one bank subsidiary, Central Valley Community Bank (the Bank) and one business trust subsidiary, Service 1st Capital Trust 1. The Company’s market area includes the central valley area from Sacramento, California to Bakersfield, California.
During 2021, we focused on asset quality and capital adequacy as well as managing the COVID-19 affects on businesses, customers and employees. We also focused on assuring that competitive products and services were made available to our clients while adjusting to the many new laws and regulations that affect the banking industry.
As of December 31, 2021, the Bank operated 20 full-service offices. Additionally, the Bank maintains a Commercial Real Estate Division, an Agribusiness Center and a SBA Lending Division. The Real Estate Division processes or assists in processing the majority of the Bank’s real estate related transactions, including interim construction loans for single family residences and commercial buildings. We offer permanent single family residential loans through our mortgage broker services.
ECONOMIC CONDITIONS
For the years leading up to 2021, the economy, as evidenced by the California, Central Valley, and Greater Sacramento Region unemployment rates, and housing prices, were showing moderate and steady improvement.
During 2020 and to a lesser extent in 2021, our business has been, and continues to be, impacted by the ongoing outbreak of COVID-19. During 2021 and 2020, the outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company. The World Health Organization has declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. As a result, the demand for our products and services has been and may continue to be significantly impacted. The spread of the outbreak has caused significant disruptions in the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates.
We only conduct business in the state of California. California placed significant restrictions on businesses and individuals at the outset of the COVID-19 pandemic. While many of these initial restrictions have been lifted, there is still the possibility that certain restrictions could be re-imposed or extended to contain further spread if the rate of infection were to surge again in any of these states, including as a result of the Delta and Omicron variants that have recently caused an uptick in infections particularly among non-vaccinated individuals. As a financial institution, we are considered an essential business and we have therefore continued to operate on a modified basis throughout the pandemic to comply with governmental restrictions and public health authority guidelines.
We remain focused on keeping our employees safe and our bank running effectively to serve our customers and continue to monitor the continued spread of COVID-19 and its variants. Our branches have been reopened across our footprint.
The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. While there has been no material impact to the Company’s employees to date, COVID-19 could also potentially create widespread business continuity issues for the Company. If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience an adverse effect on its business, financial condition and results of operations.
Agriculture and agricultural-related businesses remain a critical part of the Central Valley’s economy. The Valley’s agricultural production is widely diversified, producing nuts, vegetables, fruit, cattle, dairy products, and cotton. The continued future success of agriculture related businesses is highly dependent on the availability of water and is subject to fluctuation in
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worldwide commodity prices, currency exchanges, and demand. From time to time, California experiences severe droughts or adverse weather issues, which could significantly harm the business of our customers and the credit quality of the loans to those customers. We closely monitor the water resources and the related issues affecting our customers, and will remain vigilant for signs of deterioration within the loan portfolio in an effort to manage credit quality and work with borrowers where possible to mitigate any losses.
OVERVIEW
Diluted earnings per share (EPS) for the year ended December 31, 2021 was $2.31 compared to $1.62 and $1.59 for the years ended December 31, 2020 and 2019, respectively. Net income for 2021 was $28,401,000 compared to $20,347,000 and $21,443,000 for the years ended December 31, 2020 and 2019, respectively. The increase in net income for 2021 compared to 2020 was driven by a reversal of provision for credit losses, an increase in net interest income, and an increase in interchange fees, partially offset by an increase in the provision for income taxes, an increase in non-interest expense, a decrease in net realized gains on sales and calls of investment securities, a decrease in loan placement fees, and a decrease in service charge income. Total assets at December 31, 2021 were $2,450,139,000 compared to $2,004,096,000 at December 31, 2020.
Return on average equity (“ROE”) for 2021 was 11.50% compared to 8.85% and 9.39% for 2020 and 2019, respectively. Return on average assets (“ROA”) for 2021 was 1.25% compared to 1.11% and 1.36% for 2020 and 2019, respectively. Total equity was $247,845,000 at December 31, 2021 compared to $245,021,000 at December 31, 2020. The increase in shareholders’ equity is the result of an increase in retained earnings from our net income of $28,401,000, the exercise of stock options in the amount of $256,000, the effect of share-based compensation expense of $405,000, and stock issued under our employee stock purchase plan of $204,000, partially offset by a decrease in accumulated other comprehensive income (AOCI) of $7,224,000, the payment of common stock cash dividends of $5,757,000 and the repurchase and retirement of common stock of $13,619,000.
Average total loans (including nonaccrual) increased $13,941,000 or 1.32% to $1,069,653,000 in 2021 compared to $1,055,712,000 in 2020. In 2021, we recorded a reversal of provision for credit losses of $4,300,000 compared to a provision of $3,275,000 in 2020 and a provision of $1,025,000 in 2019. The Company had nonperforming assets consisting of $946,000 in nonaccrual loans at December 31, 2021. At December 31, 2020, nonperforming assets totaled $3,278,000. Net loan loss recoveries for 2021 were $985,000 compared to net loan loss recoveries in the amount of $510,000 for 2020 and net loan loss charge-offs in the amount of $999,000 for 2019. Refer to “Asset Quality” below for further information.
Dividend Declared
The Company declared a $0.12 per common share cash dividend, payable on February 25, 2022 to shareholders of record on February 11, 2022.
Key Factors in Evaluating Financial Condition and Operating Performance
In evaluating our financial condition and operating performance, we focus on several key factors including:
•Return to our shareholders;
•Return on average assets;
•Development of revenue streams, including net interest income and non-interest income;
•Asset quality;
•Asset growth;
•Capital adequacy;
•Operating efficiency; and
•Liquidity.
Return to Our Shareholders
One measure of our return to our shareholders is the return on average equity (ROE), which is a ratio that measures net income divided by average shareholders’ equity. Our ROE was 11.50% for the year ended 2021 compared to 8.85% and 9.39% for the years ended 2020 and 2019, respectively.
Our net income for the year ended December 31, 2021 increased $8,054,000 compared to 2020 and decreased $1,096,000 in 2020 compared to 2019. Contributing to the increase during 2021 compared to 2020 was a reversal of provision for credit losses, an increase in net interest income, and an increase in interchange fees, partially offset by a decrease in net realized gains on sales and calls of investment securities, a decrease in service charge income, an increase in non-interest expense, a decrease in loan placement fees, and an increase in the provision for income taxes. During 2020, net income
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compared to 2019 was negatively impacted by an increase in the provision for credit losses and higher non-interest expenses. During 2019 net income was positively impacted by an increase in net interest income and an increase in net realized gains on sales and calls of investment securities.
Net interest income increased primarily because of increases in loan and fee income, increases in interest income on investments, and decreases in interest expense. For 2021, our net interest margin (NIM) decreased 33 basis points to 3.54% compared to 2020 as a result of yield changes and asset mix changes. The decrease in net interest margin in the period-to-period comparison resulted from the decrease in the effective yield on interest earning deposits in other banks and Federal Funds sold and the decrease in the effective yield on average investment securities, offset by the increase in the yield on the Company’s loan portfolio. Net interest income during 2021 was positively impacted by from the accretion of the loan marks on acquired loans in the amount of $802,000 and $1,321,000 for the year ended December 31, 2021 and 2020, respectively. In addition, net interest income before the provision for credit losses for the year ended December 31, 2021 benefited by approximately $676,000 in nonrecurring income from prepayment penalties and payoff of loans, as compared to $805,000 for the year ended December 31, 2020. Excluding these reversals and benefits, net interest income for the year ended December 31, 2021 increased by $8,779,000 compared to the year ended December 31, 2020.
Non-interest income decreased 34.73% in 2021 compared to 2020 primarily due to a $3,751,000 decrease in net realized gains on sales and calls of investment securities, a decrease of $1,118,000 in other income, a decrease in loan placement fees of $317,000, and a decrease in service charge income of $170,000, partially offset by an increase in interchange fees of $437,000 and an increase in appreciation in cash surrender value of bank-owned life insurance of $129,000. Other income for the year ended December 31, 2020 included a $1,167,000 gain related to the collection of tax-exempt life insurance proceeds.
Non-interest expenses increased $158,000 or 0.33% to $47,842,000 in 2021 compared to $47,684,000 in 2020. The net increase year over year resulted from increases in data processing of $348,000, information technology of $477,000, regulatory assessments of $341,000, occupancy and equipment expenses of $256,000, personnel of $213,000, salaries and employee benefits of $117,000, loan related expenses of $75,000, donations of $45,000, education and training of $42,000 general insurance of $31,000, telephone of $31,000, alarm of $16,000, and postage of $11,000, partially offset by decreases in professional services of $733,000, Internet banking expenses of $330,000, directors’ expenses of $193,000, advertising expenses of $136,000, stationary and supplies of $78,000, risk management expenses of $55,000, amortization of software of $41,000, amortization of core deposit intangible of $34,000, armored courier of $25,000, travel and mileage of $24,000, and operating losses of $5,000 in 2021 compared to 2020. The Company recorded an income tax provision of $9,616,000 for the year ended December 31, 2021, compared to $6,914,000 for the year ended December 31, 2020, and $8,509,000 for the year ended December 31, 2019. Basic EPS was $2.32 for 2021 compared to $1.62 and $1.60 for 2020 and 2019, respectively. Diluted EPS was $2.31 for 2021 compared to $1.62 and $1.59 for 2020 and 2019, respectively.
Return on Average Assets
Our ROA is a ratio that measures our performance compared with other banks and bank holding companies. Our ROA for the year ended 2021 was 1.25% compared to 1.11% and 1.36% for the years ended December 31, 2020 and 2019, respectively. The 2021 increase in ROA is primarily due to the increase in net income, notwithstanding the increase in average assets. Annualized ROA for our peer group was 0.93% at December 31, 2021. Peer group information from S&P Global Market Intelligence data includes bank holding companies in central California with assets from $1 billion to $3.5 billion.
Development of Revenue Streams
Over the past several years, we have focused on not only our net income, but improving the consistency of our revenue streams in order to create more predictable future earnings and reduce the effect of changes in our operating environment on our net income. Specifically, we have focused on net interest income through a variety of strategies, including increases in average interest earning assets, and minimizing the effects of the recent interest rate changes on our net interest margin by focusing on core deposits and managing our cost of funds. Our net interest margin (fully tax equivalent basis) was 3.54% for the year ended December 31, 2021, compared to 3.87% and 4.51% for the years ended December 31, 2020 and 2019, respectively. The decrease in 2021 net interest margin compared to 2020, resulted from the decrease in the effective yield on interest earning deposits in other banks and Federal Funds sold, the decrease in the effective yield on average investment securities, offset by the increase in the yield on the Company’s loan portfolio. The effective tax equivalent yield on total earning assets decreased 36 basis points, while the cost of total interest-bearing liabilities decreased 7 basis points to 0.12% for the year ended December 31, 2021. Our cost of total deposits in 2021 and 2020 was 0.05% and 0.09%, respectively, compared to 0.15% for the same period in 2019. Our net interest income before provision for credit losses increased $8,131,000 or 12.62% to $72,554,000 for the year ended 2021 compared to $64,423,000 and $63,772,000 for the years ended 2020 and 2019, respectively.
Our non-interest income is generally made up of service charges and fees on deposit accounts, fee income from loan placements, appreciation in cash surrender value of bank-owned life insurance, and net gains from sales and calls of investment
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securities. Non-interest income in 2021 decreased $4,792,000 or 34.73% to $9,005,000 compared to $13,797,000 in 2020 and $13,305,000 in 2019. The decrease resulted primarily from a decrease in net realized gains on sales and calls of investment securities, a decrease in service charge income, a decrease in loan placement fees, a decrease in FHLB dividends, and a decrease in other income, partially offset by an increase in interchange fees and an increase in appreciation in cash surrender value of bank-owned life insurance compared to 2020. Further detail on non-interest income is provided below.
Asset Quality
For all banks and bank holding companies, asset quality has a significant impact on the overall financial condition and results of operations. Asset quality is measured in terms of classified and nonperforming loans, and is a key element in estimating the future earnings of a company. Total nonperforming assets were $946,000 and $3,278,000 at December 31, 2021 and 2020, respectively. Nonperforming assets totaled 0.09% of gross loans as of December 31, 2021 and 0.30% of gross loans as of December 31, 2020. Nonperforming loans were $946,000 and $3,278,000 at December 31, 2021 and 2020, respectively. The Company had no other real estate owned at December 31, 2021, or December 31, 2020. No foreclosed assets were recorded at December 31, 2021 or December 31, 2020. Management maintains certain loans that have been brought current by the borrower (less than 30 days delinquent) on nonaccrual status until such time as management has determined that the loans are likely to remain current in future periods.
The ratio of nonperforming loans to total loans was 0.09% as of December 31, 2021 and 0.30% as of December 31, 2020. The allowance for credit losses as a percentage of outstanding loan balance was 0.92% as of December 31, 2021 and 1.17% as of December 31, 2020. The ratio of net recoveries (charge-offs) to average loans was 0.09% as of December 31, 2021 and 0.05% as of December 31, 2020.
Asset Growth
As revenues from both net interest income and non-interest income are a function of asset size, the continued growth in assets has a direct impact in increasing net income and therefore ROE and ROA. The majority of our assets are loans and investment securities, and the majority of our liabilities are deposits, and therefore the ability to generate deposits as a funding source for loans and investments is fundamental to our asset growth. Total assets increased 22.26% during 2021 to $2,450,139,000 as of December 31, 2021 from $2,004,096,000 as of December 31, 2020. Total gross loans decreased 5.74% to $1,039,111,000 as of December 31, 2021, compared to $1,102,347,000 at December 31, 2020. Total investment securities increased 55.58% to $1,116,624,000 as of December 31, 2021 compared to $717,726,000 as of December 31, 2020. Total deposits increased 23.22% to $2,122,797,000 as of December 31, 2021 compared to $1,722,710,000 as of December 31, 2020. Our loan to deposit ratio at December 31, 2021 was 48.95% compared to 63.99% at December 31, 2020. The loan to deposit ratio of our peers was 71.00% at December 31, 2021. Peer group information from S&P Global Market Intelligence data includes bank holding companies in central California with assets from $1 billion to $3.5 billion.
Capital Adequacy
At December 31, 2021, we had a total capital to risk-weighted assets ratio of 15.80%, a Tier 1 risk-based capital ratio of 12.82%, common equity Tier 1 ratio of 12.48%, and a leverage ratio of 8.03%. At December 31, 2020, we had a total capital to risk-weighted assets ratio of 15.58%, a Tier 1 risk-based capital ratio of 14.50%, common equity Tier 1 ratio of 14.10%, and a leverage ratio of 9.28%. At December 31, 2021, on a stand-alone basis, the Bank had a total risk-based capital ratio of 14.18%, a Tier 1 risk based capital ratio of 13.52%, common equity Tier 1 ratio of 13.52%, and a leverage ratio of 8.47%. At December 31, 2020, the Bank had a total risk-based capital ratio of 15.48%, Tier 1 risk-based capital of 14.41% and a leverage ratio of 9.23%. Note 13 of the audited Consolidated Financial Statements provides more detailed information concerning the Company’s capital amounts and ratios. As of December 31, 2021, the Bank met or exceeded all of their capital requirements inclusive of the capital buffer. The Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized financial institution under the Basel III regulatory requirements at December 31, 2021.
Operating Efficiency
Operating efficiency is the measure of how efficiently earnings before taxes are generated as a percentage of revenue. A lower ratio represents greater efficiency. The Company’s efficiency ratio (operating expenses, excluding amortization of intangibles and foreclosed property expense, divided by net interest income plus non-interest income, excluding net gains and losses from sale of securities) was 57.16% for 2021 compared to 64.08% for 2020 and 62.77% for 2019. The improvement in the efficiency ratio in 2021 was due to the growth in non-interest income outpacing the increase in non-interest expense. The Company’s net interest income before provision for credit losses plus non-interest income increased 4.27% to $81,559,000 in 2021 compared to $78,220,000 in 2020 and $77,077,000 in 2019, while operating expenses increased 0.33% in 2021, 3.44% in 2020, and 2.29% in 2019.
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Liquidity
Liquidity management involves our ability to meet cash flow requirements arising from fluctuations in deposit levels and demands of daily operations, which include providing for customers’ credit needs, funding of securities purchases, and ongoing repayment of borrowings. Our liquidity is actively managed on a daily basis and reviewed periodically by our management and Directors’ Asset/Liability Committee. This process is intended to ensure the maintenance of sufficient funds to meet our needs, including adequate cash flows for off-balance sheet commitments. Our primary sources of liquidity are derived from financing activities which include the acceptance of customer and, to a lesser extent, broker deposits, Federal funds facilities and advances from the Federal Home Loan Bank of San Francisco. We have available unsecured lines of credit with correspondent banks totaling approximately $110,000,000 and secured borrowing lines of approximately $277,130,000 with the Federal Home Loan Bank. These funding sources are augmented by collection of principal and interest on loans, the routine maturities and pay downs of securities from our investment securities portfolio, the stability of our core deposits, and the ability to sell investment securities. Primary uses of funds include origination and purchases of loans, withdrawals of and interest payments on deposits, purchases of investment securities, and payment of operating expenses.
We had liquid assets (cash and due from banks, interest-earning deposits in other banks, Federal funds sold, equity securities, and available-for-sale securities) totaling $1,280,091,000 or 52.25% of total assets at December 31, 2021 and $788,004,000 or 39.32% of total assets as of December 31, 2020.
RESULTS OF OPERATIONS
Net Income
Net income was $28,401,000 in 2021 compared to $20,347,000 and $21,443,000 in 2020 and 2019, respectively. Basic earnings per share was $2.32, $1.62, and $1.60 for 2021, 2020, and 2019, respectively. Diluted earnings per share was $2.31, $1.62, and $1.59 for 2021, 2020, and 2019, respectively. ROE was 11.50% for 2021 compared to 8.85% for 2020 and 9.39% for 2019. ROA for 2021 was 1.25% compared to 1.11% for 2020 and 1.36% for 2019.
The increase in net income for 2021 compared to 2020 was driven by a reversal of provision for credit losses, an increase in net interest income, and an increase in interchange fees, partially offset by an increase in the provision for income taxes, an increase in non-interest expense, a decrease in net realized gains on sales and calls of investment securities, a decrease in loan placement fees, and a decrease in service charge income. The decrease in net income for 2020 compared to 2019 was primarily due to an increase in provision for credit losses, a decrease in net realized gains on sales and calls of investment securities, a decrease in service charge income, and an increase in non-interest expense, partially offset by an increase in net interest income, an increase in loan placement fees, and a decrease in the provision for income taxes.
Interest Income and Expense
Net interest income is the most significant component of our income from operations. Net interest income (the interest rate spread) is the difference between the gross interest and fees earned on the loan and investment portfolios and the interest paid on deposits and other borrowings. Net interest income depends on the volume of and interest rate earned on interest-earning assets and the volume of and interest rate paid on interest-bearing liabilities.
The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield and cost information for the periods presented. Average balances are derived from daily balances, and nonaccrual loans are not included as interest-earning assets for purposes of this table.
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SCHEDULE OF AVERAGE BALANCES, AVERAGE YIELDS AND RATES
ASSETS
Securities
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
(1)Interest income is calculated on a fully tax equivalent basis, which includes Federal tax benefits relating to income earned on municipal bonds totaling $1,490, $523, and $344 in 2021, 2020, and 2019, respectively.
(2)Loan interest income includes loan fees of $6,474 in 2021, $2,234 in 2020, and $164 in 2019.
(3)Average loans do not include nonaccrual loans.
(4)Net interest margin is computed by dividing net interest income by total average interest-earning assets.
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The following table sets forth a summary of the changes in interest income and interest expense due to changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. The change in interest due to both rate and volume has been allocated to the change in rate.
(In thousands) Volume Rate Net Volume Rate Net
Increase (decrease) due to changes in:
Interest income:
Investment securities:
Interest expense:
Deposits:
(1) Computed on a tax equivalent basis for securities exempt from federal income taxes.
Interest and fee income from loans increased $2,011,000 or 3.86% in 2021 compared to 2020. Interest and fee income from loans increased $602,000 or 1.17% in 2020 compared to 2019. The increase in 2021 is primarily attributable to an increase in average total loans outstanding as well as an increase in the yield on loans of 13 basis points.
Average total loans for 2021 increased $13,941,000 to $1,069,653,000 compared to $1,055,712,000 for 2020 and $930,883,000 for 2019. The yield on loans for 2021 was 5.07% compared to 4.94% and 5.54% for 2020 and 2019, respectively. The impact to interest income from the accretion of the loan marks on acquired loans was an increase of $802,000 and $1,321,000 for the years ended December 31, 2021 and 2020, respectively.
Interest income from total investments on a non tax-equivalent basis, (total investments include investment securities, Federal funds sold, interest-bearing deposits in other banks, and other securities), increased $5,827,000 or 41.76% in 2021 compared to 2020. The yield on average investments decreased 24 basis points to 2.08% for the year ended December 31, 2021 from 2.32% for the year ended December 31, 2020. Average total investments increased $398,556,000 to $1,021,673,000 in 2021 compared to $623,117,000 in 2020. In 2020, total investment income on a non tax-equivalent basis decreased $915,000 or 6.15% compared to 2019.
Our investment portfolio consists primarily of securities issued by U.S. Government sponsored entities and agencies collateralized by mortgage backed obligations and obligations of states and political subdivision securities. However, a significant portion of the investment portfolio is mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs). At December 31, 2021, we held $527,659,000 or 47.57% of the total market value of the investment portfolio in MBS and CMOs with an average yield of 2.08%. We invest in CMOs and MBS as part of our overall strategy to increase our net interest margin. CMOs and MBS by their nature are affected by prepayments which are impacted by changes in interest rates. In a normal declining rate environment, prepayments from MBS and CMOs would be expected to increase and the expected life of the investment would be expected to shorten. Conversely, if interest rates increase, prepayments normally would be expected to decline and the average life of the MBS and CMOs would be expected to extend. However, in the current economic environment, prepayments may not behave according to historical norms. Premium amortization and discount accretion of these investments affects our net interest income. Our management monitors the prepayment trends of these investments and adjusts premium amortization and discount accretion based on several factors. These factors include the type of investment, the investment structure, interest rates, interest rates on new mortgage loans, expectation of interest rate changes, current economic conditions, the level of principal remaining on the bond, the bond coupon rate, the bond origination date, and volume of available bonds in market. The calculation of premium amortization and discount accretion is by nature inexact, and represents management’s best estimate of principal pay downs inherent in the total investment portfolio.
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The cumulative net-of-tax effect of the change in market value of the available-for-sale investment portfolio as of December 31, 2021 was an unrealized gain of $7,632,000 and is reflected in the Company’s equity. At December 31, 2021, the effective duration of the investment portfolio was 4.86 years and the market value reflected a pre-tax unrealized gain of $10,835,000. Management reviews market value declines on individual investment securities to determine whether they represent other-than-temporary impairment (OTTI). For the years ended December 31, 2021, 2020, and 2019, no OTTI was recorded. Future deterioration in the market values of our investment securities may require the Company to recognize additional OTTI losses.
A component of the Company’s strategic plan has been to use its investment portfolio to offset, in part, its interest rate risk relating to variable rate loans. Measured at December 31, 2021, an immediate rate increase of 200 basis points would result in an estimated decrease in the market value of the investment portfolio by approximately $117,000,000. Conversely, with an immediate rate decrease of 200 basis points, the estimated increase in the market value of the investment portfolio would be $123,000,000. The modeling environment assumes management would take no action during an immediate shock of 200 basis points. However, the Company uses those increments to measure its interest rate risk in accordance with regulatory requirements and to measure the possible future risk in the investment portfolio. For further discussion of the Company’s market risk, refer to Quantitative and Qualitative Disclosures about Market Risk.
Management’s review of all investments before purchase includes an analysis of how the security will perform under several interest rate scenarios to monitor whether investments are consistent with our investment policy. The policy addresses issues of average life, duration, and concentration guidelines, prohibited investments, impairment, and prohibited practices.
Total interest income in 2021 increased $7,838,000 to $73,856,000 compared to $66,018,000 in 2020 and $66,331,000 in 2019, respectively. The increase in 2021 was the result of yield changes and asset mix changes. The tax-equivalent yield on interest earning assets decreased to 3.61% for the year ended December 31, 2021 from 3.97% for the year ended December 31, 2020. Average interest earning assets increased to $2,088,989,000 for the year ended December 31, 2021 compared to $1,676,567,000 for the year ended December 31, 2020. Average interest-earning deposits in other banks increased $27,786,000 in 2021 compared to 2020. Average yield on these deposits was 0.12% compared to 0.32% on December 31, 2021 and December 31, 2020 respectively. Average investments and interest-earning deposits increased $398,556,000 but the tax equivalent yield on those assets decreased 24 basis points. Average total loans increased $13,941,000 and the yield on average loans increased 13 basis points.
The decrease in total interest income for 2020 was the result of yield changes, decrease in interest rates, and asset mix changes. The tax-equivalent yield on interest-earning assets increased to 3.97% for the year ended December 31, 2020 from 4.69% for the year ended December 31, 2019. Average interest-earning assets increased to $1,676,567,000 for the year ended December 31, 2020 compared to $1,423,015,000 for the year ended December 31, 2019. Average total loans increased and the yield on average loans decreased 60 basis points.
Interest expense on deposits in 2021 decreased $429,000 or 29.28% to $1,036,000 compared to $1,465,000 in 2020 and decreased $892,000 as compared to 2019. The yield on interest-bearing deposits decreased 8 basis points to 0.10% in 2021 from 0.18% in 2020. The yield on interest-bearing deposits decreased 8 basis points to 0.18% in 2020 from 0.26% in 2019. Average interest-bearing deposits were $1,074,493,000 for 2021 compared to $823,955,000 and $738,432,000 for 2020 and 2019, respectively.
Average other borrowings were $9,864,000 with an effective rate of 2.70% for 2021 compared to $5,155,000 with an effective rate of 2.52% for 2020. In 2019, the average other borrowings were $21,943,000 with an effective rate of 2.88%. Included in other borrowings are the junior subordinated deferrable interest debentures acquired from Service 1st, subordinated debt, advances on lines of credit, advances from the Federal Home Loan Bank (FHLB), and overnight borrowings. The junior subordinated debentures carry a floating rate based on the three month LIBOR plus a margin of 1.60%. The rate was 1.73% for 2021, 1.84% for 2020, and 3.59% for 2019. The subordinated debt, issued in 2021, bears a fixed interest rate of 3.125% per year.
The cost of all interest-bearing liabilities was 0.12% and 0.19% basis points for 2021 and 2020, respectively, compared to 0.34% for 2019. The cost of total deposits decreased to 0.05% for the year ended December 31, 2021, compared to 0.09% and 0.15% for the years ended December 31, 2020 and 2019, respectively. Average demand deposits increased 20.94% to $900,083,000 in 2021 compared to $744,239,000 for 2020 and $557,348,000 for 2019. The ratio of average non-interest demand deposits to average total deposits increased to 45.58% for 2021 compared to 47.46% and 43.01% for 2020 and 2019, respectively.
Net Interest Income before Provision for Credit Losses
Net interest income before provision for credit losses for 2021 increased $8,131,000 or 12.62% to $72,554,000 compared to $64,423,000 for 2020 and $63,772,000 for 2019. The increase in 2021 was a result of yield changes, asset mix changes, and an increase in average earning assets, offset by an increase in average interest bearing liabilities. Our net interest margin (NIM) decreased 33 basis points. Yield on interest earning assets decreased 36 basis points. The decrease in net interest margin in the period-to-period comparison resulted primarily from the decrease in the effective yield on interest earning deposits in other banks and Federal Funds sold, the decrease in the effective yield on average investment securities, offset by
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the increase in the yield on the Company’s loan portfolio. Net interest income before provision for credit losses increased $651,000 in 2020 compared to 2019, primarily due to the increase in average earning assets, yield changes, asset mix changes, offset by an increase in average interest bearing liabilities. Average interest-earning assets were $2,088,989,000 for the year ended December 31, 2021 with a NIM of 3.54% compared to $1,676,567,000 with a NIM of 3.87% in 2020, and $1,423,015,000 with a NIM of 4.51% in 2019. For a discussion of the repricing of our assets and liabilities, refer to Quantitative and Qualitative Disclosure about Market Risk.
Provision for Credit Losses
We provide for probable incurred credit losses through a charge to operating income based upon the composition of the loan portfolio, delinquency levels, historical losses, and nonperforming assets, economic and environmental conditions and other factors which, in management’s judgment, deserve recognition in estimating credit losses. Credit risk is inherent in the business of making loans. Credit risk is inherent in the business of making loans. The Company establishes an allowance for credit losses on loans through charges to earnings, which are presented in the statements of income as the provision for credit losses on loans. Specifically identifiable and quantifiable known losses are promptly charged off against the allowance. Loans are charged off when they are considered uncollectible or when continuance as an active earning bank asset is not warranted.
The provision for credit losses on loans is determined by conducting a quarterly evaluation of the adequacy of the Company’s allowance for credit losses on loans and charging the shortfall or excess, if any, to the current quarter’s expense. This has the effect of creating variability in the amount and frequency of charges to the Company’s earnings. The provision for credit losses on loans and level of allowance for each period are dependent upon many factors, including loan growth, net charge offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of the quality of the loan portfolio, the valuation of problem loans and the general economic conditions in the Company’s market area.
The establishment of an adequate credit allowance is based on an allowance model that utilizes qualitative and quantitative factors, historical losses, loan level risk ratings and portfolio management tools. The Board of Directors has established initial responsibility for the accuracy of credit risk ratings with the individual credit officer and oversight from Credit Administration who ensures the accuracy of the risk ratings. Quarterly, the credit officers must certify the current risk ratings of the loans in their portfolio. Credit Administration reviews the certifications and reports to the Board of Directors Audit/Compliance Committee. At least annually the loan portfolio, including risk ratings, is reviewed by a third party credit reviewer. Regulatory agencies also review the loan portfolio on a periodic basis. See “Allowance for Credit Losses” for more information on the Company’s Allowance for Loan Loss.
During the year ended December 31, 2021, the Company recorded a reversal of provision for credit losses of $4,300,000 compared to a provision of $3,275,000 and $1,025,000 for the same periods in 2020 and 2019, respectively. The recorded provisions to the allowance for credit losses are primarily the result of our assessment of the overall adequacy of the allowance for credit losses considering a number of factors as discussed in the “Allowance for Credit Losses” section.
During the years ended December 31, 2021, 2020 and 2019 the Company had net charge-offs (recoveries) totaling $(985,000), $(510,000), and $999,000, respectively. The net charge-off (recovery) ratio, which reflects net charge-offs (recoveries) to average loans, was (0.09)%, (0.05)% and 0.11% for 2021, 2020, and 2019, respectively.
Economic pressures may negatively impact the financial condition of borrowers to whom the Company has extended credit and as a result, when negative economic conditions are anticipated, we may be required to make significant provisions to the allowance for credit losses. The Bank conducts banking operations principally in California’s Central Valley. The Central Valley is largely dependent on agriculture. The agricultural economy in the Central Valley is therefore important to our business, financial performance and results of operations. We are also dependent in a large part upon the business activity, population growth, income levels and real estate activity in this market area. A downturn in agriculture and the agricultural related businesses could have a material adverse effect our business, results of operations and financial condition. The agricultural industry has been affected by declines in prices and the changes in yields on various crops and other agricultural commodities. Similarly, weaker prices could reduce the cash flows generated by farms and the value of agricultural land in our local markets and thereby increase the risk of default by our borrowers or reduce the foreclosure value of agricultural land and equipment that serve as collateral for our loans. Further declines in commodity prices or collateral values may increase the incidence of default by our borrowers. Moreover, weaker prices might threaten farming operations in the Central Valley, reducing market demand for agricultural lending. In particular, farm income has seen recent declines, and in line with the downturn in farm income, farmland prices are coming under pressure.
We have been and will continue to be proactive in looking for signs of deterioration within the loan portfolio in an effort to manage credit quality and work with borrowers where possible to mitigate losses. As of December 31, 2021, there were $8.5 million in classified loans of which $2.6 million related to commercial and industrial loans, $3.6 million to real estate owner occupied, and $2.4 million to agricultural production. This compares to $36.1 million in classified loans as of December 31, 2020 of which $1.2 million related to agricultural real estate, $3.2 million to real estate construction, $10.4 million to commercial and industrial, $3.3 million to agricultural production, $9.6 million to commercial real estate, and $7.3 million to real estate owner occupied.
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As of December 31, 2021, we believe, based on all current and available information, the allowance for credit losses is adequate to absorb probable incurred losses within the loan portfolio; however, no assurance can be given that we may not sustain charge-offs which are in excess of the allowance in any given period. Refer to “Allowance for Credit Losses” below for further information.
Net Interest Income after Provision for Credit Losses
Net interest income, after the provision for credit losses was $76,854,000 for 2021 compared to $61,148,000 and $62,747,000 for 2020 and 2019, respectively.
Non-Interest Income
Non-interest income is comprised of customer service charges, gains on sales and calls of investment securities, income from appreciation in cash surrender value of bank owned life insurance, loan placement fees, Federal Home Loan Bank dividends, and other income. Non-interest income was $9,005,000 in 2021 compared to $13,797,000 and $13,305,000 in 2020 and 2019, respectively. The $4,792,000 or 34.73% decrease in non-interest income in 2021 was driven by a decrease of $3,751,000 in net realized gains on sales and calls of investment securities, a decrease of $1,118,000 in other income, a decrease in service charge income of $170,000, and a decrease in loan placement fees of $317,000, partially offset by an increase in interchange fees of $437,000 and an increase in appreciation in cash surrender value of bank-owned life insurance of $129,000. Other income for the year ended December 31, 2020 included a $1,167,000 gain related to the collection of tax-exempt life insurance proceeds. The 492,000 or 3.70% increase in non-interest income in 2020 resulted primarily from an increase in loan placement fees, and an increase in other income, partially offset by a decrease in net realized gains on sales and calls of investment securities, a decrease in service charge income, and a decrease in FHLB dividends compared to 2019.
Customer service charges decreased $170,000 to $1,901,000 in 2021 compared to $2,071,000 in 2020 and $2,756,000 in 2019. The decreases in 2021 and 2020 resulted from decreases in our NSF fees and lower analysis service charge income.
During the year ended December 31, 2021, we realized net gains on sales and calls of investment securities of $501,000, compared to $4,252,000 in 2020 and $5,199,000 in 2019. The net gains in 2021, 2020, and 2019 were the results of partial restructuring of the investment portfolio designed to improve the future performance of the portfolio. See Note 3 to the audited Consolidated Financial Statements for more detail.
Income from the appreciation in cash surrender value of bank owned life insurance (BOLI) totaled $840,000 in 2021 compared to $711,000 and $728,000 in 2020 and 2019, respectively. The Bank’s salary continuation and deferred compensation plans and the related BOLI are used as retention tools for directors and key executives of the Bank.
Interchange fees totaled $1,784,000 in 2021 compared to $1,347,000 and $1,446,000 in 2020 and 2019, respectively.
We earn loan placement fees from the brokerage of single-family residential mortgage loans provided for the convenience of our customers. Loan placement fees decreased $317,000 in 2021 to $1,974,000 compared to $2,291,000 in 2020 and $978,000 in 2019.
The Bank holds stock from the Federal Home Loan Bank in relationship with its borrowing capacity and generally receives quarterly dividends. As of December 31, 2021 and 2020, we held FHLB stock totaling $5,595,000. Dividends in 2021 decreased to $321,000 compared to $323,000 in 2020 and $455,000 in 2019.
Other income decreased to $1,684,000 in 2021 compared to $2,802,000 and $1,743,000 in 2020 and 2019, respectively. Other income for the year ended December 31, 2020 included a $1,167,000 gain related to the collection of tax-exempt life insurance proceeds.
Non-Interest Expenses
Salaries and employee benefits, occupancy and equipment, regulatory assessments, acquisition and integration-related expenses, data processing expenses, ATM/Debit card expenses, license and maintenance contract expenses, information technology, and professional services (consisting of audit, accounting, consulting and legal fees) are the major categories of non-interest expenses. Non-interest expenses increased $158,000 or 0.33% to $47,842,000 in 2021 compared to $47,684,000 in 2020, and $46,100,000 in 2019.
Our efficiency ratio, measured as the percentage of non-interest expenses (exclusive of amortization of core deposit intangibles, other real estate owned, and repossessed asset expenses) to net interest income before provision for credit losses plus non-interest income (exclusive of realized gains or losses on sale and calls of investments) was 57.16% for 2021 compared to 64.08% for 2020 and 62.77% for 2019. The improvement in the efficiency ratio in 2021 and 2020 was due to the growth in non-interest income outpacing the increase in non-interest expense.
Salaries and employee benefits increased $117,000 or 0.41% to $28,720,000 in 2021 compared to $28,603,000 in 2020 and $26,654,000 in 2019. Full time equivalents were 256 for the year ended December 31, 2021 compared to 273 for the year ended December 31, 2020. The increase in salaries and employee benefits in 2021 compared to 2020 was the result of an increase of approximately $535,000 in salaries and benefits and lower loan origination costs of approximately $878,000, offset
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by a decrease of $1,296,000 for directors’ and officers’ expenses related to the change in the discount rate used to calculate the liability for salary continuation, deferred compensation, and split-dollar plans.
For the years ended December 31, 2021, 2020, and 2019, the compensation cost recognized for equity-based compensation was $405,000, $470,000 and $555,000, respectively. As of December 31, 2021, there was $273,000 of total unrecognized compensation cost related to non-vested equity-based compensation arrangements granted under all plans. The cost is expected to be recognized over a weighted average period of 1.55 years. See Notes 1and 14 to the audited Consolidated Financial Statements for more detail. No options to purchase shares of the Company’s common stock were issued during the years ending December 31, 2021 and 2020. Restricted common stock awards of 31,496 and 21,397 shares were awarded in 2021 and 2020, respectively.
Occupancy and equipment expense increased $256,000 or 5.53% to $4,882,000 in 2021 compared to $4,626,000 in 2020 and $5,439,000 in 2019. The Company made no changes in its depreciation expense methodology. The Company operated 20 full-service offices at December 31,2021 and at December 31, 2020.
Regulatory assessments were $831,000 in 2021 compared to $490,000 and $251,000 in 2020 and 2019, respectively. The assessment base for calculating the amount owed is based on the formula of average assets minus average tangible equity. The 2019 lower assessments were the result of the Company receiving its small business bank credit.
Information technology expense increased $477,000 to $2,868,000 for the year ended December 31, 2021 compared to $2,391,000 and $2,611,000 in 2020 and 2019, respectively. Data processing expenses were $2,394,000 in 2021 compared to $2,046,000 in 2020 and $1,557,000 in 2019. Professional services decreased $733,000 in 2021 compared to 2020 due to lower legal expenses and consulting fees.
Amortization of core deposit intangibles was $661,000 for 2021, $695,000 for 2020, and $695,000 for 2019. During 2021, amortization expense related to FLB core deposit intangibles (“CDI”) was $423,000, amortization expense related to SVB CDI was $101,000, and amortization expense related to Visalia Community Bank (“VCB”) CDI was $137,000. During 2020, amortization expense related to FLB CDI was $423,000, amortization expense related to SVB CDI was $135,000, and amortization expense related to VCB CDI was $137,000. During 2019, amortization expense related to FLB CDI was $423,000, amortization expense related to SVB CDI was $135,000, and amortization expense related to VCB CDI was $137,00.
ATM/Debit card expenses decreased $1,000 to $818,000 for the year ended December 31, 2021 compared to $819,000 in 2020 and $920,000 in 2019. Other non-interest expenses decreased $46,000 or 1.25% to $3,734,000 in 2021 compared to $3,688,000 in 2020 and $4,386,000 in 2019.
The following table describes significant components of other non-interest expense as a percentage of average assets.
Credit card expense — — % — — % 114 0.01 %
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Provision for Income Taxes
Our effective income tax rate was 25.3% for 2021 compared to 25.4% for 2020 and 28.4% for 2019. The Company reported an income tax provision of $9,616,000, $6,914,000, and $8,509,000 for the years ended December 31, 2021, 2020, and 2019, respectively.
Some items of income and expense are recognized in different years for tax purposes than when applying generally accepted accounting principles leading to timing differences between the Company’s actual tax liability, and the amount accrued for this liability based on book income. These temporary differences comprise the “deferred” portion of the Company’s tax expense or benefit, which is accumulated on the Company’s books as a deferred tax asset or deferred tax liability until such time as they reverse.
Realization of the Company’s deferred tax assets is primarily dependent upon the Company generating sufficient future taxable income to obtain benefit from the reversal of net deductible temporary differences and the utilization of tax credit carryforwards and the net operating loss carryforwards for Federal and California state income tax purposes. The amount of deferred tax assets considered realizable is subject to adjustment in future periods based on estimates of future taxable income. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax assets will not be realized. The determination of the realization of the deferred tax assets is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, including forecasts of future income, cumulative losses, applicable tax-planning strategies, and assessments of current and future economic and business conditions.
The Company had the net deferred tax assets of $6.31 million and $4.74 million at December 31, 2021 and 2020, respectively. After consideration of the matters in the preceding paragraph, the Company determined that it is more likely than not that the net deferred tax assets at December 31, 2021 and 2020 will be fully realized in future years.
FINANCIAL CONDITION
Summary of Changes in Consolidated Balance Sheets
Total assets were $2,450,139,000 as of December 31, 2021, compared to $2,004,096,000 as of December 31, 2020, an increase of 22.26% or $446,043,000. Total gross loans were $1,039,111,000 as of December 31, 2021, compared to $1,102,347,000 as of December 31, 2020, a decrease of $63,236,000 or 5.74%. The total investment portfolio (including Federal funds sold and interest-earning deposits in other banks) increased 65.91% or $496,850,000 to $1,250,679,000. Total deposits increased 23.22% or $400,087,000 to $2,122,797,000 as of December 31, 2021, compared to $1,722,710,000 as of December 31, 2020. Shareholders’ equity increased $2,824,000 or 1.15% to $247,845,000 as of December 31, 2021, compared to $245,021,000 as of December 31, 2020. The increase in shareholders’ equity was driven by the retention of earnings, net of dividends paid, the decrease in net unrealized gains on available-for-sale (AFS) securities recorded, net of estimated taxes, in accumulated other comprehensive income (AOCI), and share repurchases. Accrued interest payable and other liabilities were $40,043,000 as of December 31, 2021, compared to $31,210,000 as of December 31, 2020, an increase of $8,833,000.
Fair Value
The Company measures the fair value of its financial instruments utilizing a hierarchical framework associated with the level of observable pricing scenarios utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of the observable pricing scenario. Financial instruments with readily available actively quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of observable pricing and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no observable pricing and a higher degree of judgment utilized in measuring fair value. Observable pricing scenarios are impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction.
See Note 2 of the Notes to Consolidated Financial Statements for additional information about the level of pricing transparency associated with financial instruments carried at fair value.
Investments
The following table reflects the balances for each category of securities at year end:
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Available-for-Sale Securities Amortized Cost at December 31,
Treasuries $ 9,988 $ — $ —
Our investment portfolio consists primarily of U.S. Government sponsored entities and agencies collateralized by mortgage backed obligations and obligations of states and political subdivision securities and are classified at the date of acquisition as available-for-sale or held-to-maturity. As of December 31, 2021, investment securities with a fair value of $260,325,000, or 23.47% of our investment securities portfolio, were held as collateral for public funds, short and long-term borrowings, treasury, tax, and for other purposes. Our investment policies are established by the Board of Directors and implemented by our Investment/Asset Liability Committee. They are designed primarily to provide and maintain liquidity, to enable us to meet our pledging requirements for public money and borrowing arrangements, to generate a favorable return on investments without incurring undue interest rate and credit risk, and to complement our lending activities.
Our investment portfolio as a percentage of total assets is generally higher than our peers due primarily to our comparatively low loan-to-deposit ratio. Our loan-to-deposit ratio at December 31, 2021 was 48.95% compared to 63.99% at December 31, 2020. The loan to deposit ratio of our peers was 71.00% at December 31, 2021. Peer group information from S&P Global Market Intelligence data includes bank holding companies in central California with assets from $1 billion to $3.5 billion. The total investment portfolio, including Federal funds sold and interest-earning deposits in other banks, increased 65.91% or $496,850,000 to $1,250,679,000 at December 31, 2021, from $753,829,000 at December 31, 2020. The market value of the portfolio reflected an unrealized gain of $10,835,000 at December 31, 2021, compared to an unrealized gain of $21,091,000 at December 31, 2020.
Losses recognized in 2021, 2020, and 2019 were incurred in order to reposition the investment securities portfolio based on the current rate environment. As market interest rates or risks associated with a security’s issuer continue to change and impact the actual or perceived values of investment securities, the Company may determine that selling these securities and using proceeds to purchase securities that fit with the Company’s current risk profile is appropriate and beneficial to the Company.
The Board and management have had periodic discussions about our strategy for risk management in dealing with potential losses should interest rates begin to rise. We have been managing the portfolio with an objective of optimizing risk and return in various interest rate scenarios. We do not attempt to predict future interest rates, but we analyze the cash flows of our investment portfolio in different interest rate scenarios in connection with the rest of our balance sheet to design an investment portfolio that optimizes performance.
The Company periodically evaluates each investment security for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. The portion of the impairment that is attributable to a shortage in the present value of expected future cash flows relative to the amortized cost should be recorded as a current period charge to earnings. The discount rate in this analysis is the original yield expected at time of purchase.
As of December 31, 2021, the Company performed an analysis of the investment portfolio to determine whether any of the investments held in the portfolio had an other-than-temporary impairment (OTTI). The Company evaluated all individual available-for-sale investment securities with an unrealized loss at December 31, 2021 and identified those that had an unrealized loss for at least a consecutive 12 month period, which had an unrealized loss at December 31, 2021 greater than 10% of the recorded book value on that date, or which had an unrealized loss of more than $75,000. The Company also analyzed any securities that may have been downgraded by credit rating agencies.
For those bonds that met the evaluation criteria, management obtained and reviewed the most recently published national credit ratings for those bonds. For those bonds that were obligations of states and political subdivisions with an investment grade rating by the rating agencies, management also evaluated the financial condition of the municipality and any applicable municipal bond insurance provider and concluded that no credit related impairment existed. There were no OTTI losses recorded during the twelve months ended December 31, 2021, 2020, or 2019.
The amortized cost, maturities and weighted average yield of investment securities at December 31, 2021 are summarized in the following table.
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Debt securities(1)
U.S. Treasury securities $ — — $ — — $ 9,988 1.25 % $ — — $ 9,988 1.25 %
(1)Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties. Expected maturities will also differ from contractual maturities due to unscheduled principal pay downs.
(2)Not computed on a tax equivalent basis.
Loans
Total gross loans decreased $63,236,000 or 5.74% to $1,039,111,000 as of December 31, 2021, compared to $1,102,347,000 as of December 31, 2020.
The following table sets forth information concerning the composition of our loan portfolio as of December 31, 2021, 2020, 2019, 2018, and 2017.
Commercial:
Real estate:
Consumer:
At December 31, 2021, loans acquired in the FLB, SVB and VCB acquisitions had a balance of $93,201,000, of which $2,111,000 were commercial loans, $83,128,000 were real estate loans, and $7,962,000 were consumer loans, and at December 31, 2020, the acquired loans had a balance of $127,186,000, of which $2,529,000 were commercial loans, $110,616,000 were real estate loans, and $14,041,000 were consumer loans.
At December 31, 2021, in management’s judgment, a concentration of loans existed in commercial loans and real-estate-related loans, representing approximately 96.4% of total loans of which 17.1% were commercial and 79.3% were real-estate-related. This level of concentration is consistent with 96.7% at December 31, 2020. Although we believe the loans
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within this concentration have no more than the normal risk of collectability, a substantial decline in the performance of the economy in general or a decline in real estate values in our primary market areas, in particular, could have an adverse impact on collectability, increase the level of real estate-related nonperforming loans, or have other adverse effects which alone or in the aggregate could have a material adverse effect on our business, financial condition, results of operations and cash flows. The Company was not involved in any sub-prime mortgage lending activities during the years ended December 31, 2021 and 2020.
We believe that our commercial real estate loan underwriting policies and practices result in prudent extensions of credit, but recognize that our lending activities result in relatively high reported commercial real estate lending levels. Commercial real estate loans include certain loans which represent low to moderate risk and certain loans with higher risks. Contributing to the commercial and industrial loan growth in 2020 was the issuance of PPP loans. As of December 31, 2021, gross loans included $18,553,000 in PPP loans which are fully guaranteed by the SBA as compared to $192,916,000.00 as of December 31, 2020.
The Board of Directors review and approve concentration limits and exceptions to limitations of concentration are reported to the Board of Directors at least quarterly.
Loan Maturities
The following table presents information concerning loan maturities and sensitivity to changes in interest rates of the indicated categories of our loan portfolio, as well as loans in those categories maturing after one year that have fixed or floating interest rates at December 31, 2021.
Loan Maturities:
Sensitivity to Changes in Interest Rates:
Nonperforming Assets
Nonperforming assets consist of nonperforming loans, other real estate owned (OREO), and repossessed assets. Nonperforming loans are those loans which have (i) been placed on nonaccrual status; (ii) been classified as doubtful under our asset classification system; or (iii) become contractually past due 90 days or more with respect to principal or interest and have not been restructured or otherwise placed on nonaccrual status. A loan is classified as nonaccrual when 1) it is maintained on a cost recovery method because of deterioration in the financial condition of the borrower; 2) payment in full of principal or interest under the original contractual terms is not expected; or 3) principal or interest has been in default for a period of 90 days or more unless the loan is both well secured and in the process of collection. We measure all loans placed on nonaccrual status for impairment based on the fair value of the underlying collateral or the net present value of the expected cash flows.
Our consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans. Interest income from nonaccrual loans is recorded only if collection of principal in full is not in doubt and when cash payments, if any, are received.
Loans are placed on nonaccrual status and any accrued but unpaid interest income is reversed and charged against income when the payment of interest or principal is 90 days or more past due. Loans in the nonaccrual category are treated as nonaccrual loans even though we may ultimately recover all or a portion of the interest due. These loans return to accrual status when the loan becomes contractually current, future collectability of amounts due is reasonably assured, and a minimum of six months of satisfactory principal repayment performance has occurred. See Note 4 of the Company’s audited Consolidated Financial Statements in Item 8 of this Annual Report.
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At December 31, 2021, total nonperforming assets totaled $946,000, or 0.04% of total assets, compared to $3,278,000, or 0.16% of total assets at December 31, 2020. Nonperforming assets totaled 0.09% of gross loans as of December 31, 2021 and 0.30% of gross loans as of December 31, 2020. Total nonperforming assets at December 31, 2021, included nonaccrual loans totaling $946,000, no OREO, and no repossessed assets. Nonperforming assets at December 31, 2020 consisted of $3,278,000 in nonaccrual loans, no OREO, and no repossessed assets. At December 31, 2021 and December 31, 2020, we had no loans considered a troubled debt restructuring (“TDR”) included in nonaccrual loans. See Note 4 of the Company’s audited Consolidated Financial Statements in Item 8 of this Annual Report concerning our recorded investment in loans for which impairment has been recognized.
A summary of nonaccrual, restructured, and past due loans at December 31, 2021, 2020, 2019, 2018, and 2017 is set forth below. The Company had no loans past due more than 90 days and still accruing interest at December 31, 2021 and 2020. Management is not aware of any potential problem loans, which were current and accruing at December 31, 2021, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms. Management can give no assurance that nonaccrual and other nonperforming loans will not increase in the future.
Composition of Nonaccrual, Past Due and Restructured Loans
Nonaccrual Loans:
Agricultural production 634 — — — — —
Real estate construction and other land loans — 1,556 — 1,439 1,397
Agricultural real estate — — 321 — —
Equity loans and line of credit — — 66 320 87
Consumer and installment — 88 — — —
Restructured loans (non-accruing):
Equity loans and line of credit — — 322 50 59
Accruing loans past due 90 days or more — — — — —
Accruing loans past due 90 days or more $ — $ — $ — $ — $ —
Related allowance for credit losses on impaired loans $ 649 $ 631 $ 40 $ 90 $ 36
As of December 31, 2021 and 2020, we had impaired loans totaling $8,586,000 and $11,186,000, respectively. We measure our impaired loans by using the fair value of the collateral if the loan is collateral dependent and the present value of the expected future cash flows discounted at the loan’s original contractual interest rate if the loan is not collateral dependent. Impaired loans are identified from internal credit review reports, past due reports, overdraft listings, and third party reports of examination. Borrowers experiencing problems such as operating losses, marginal working capital, inadequate cash flow or business interruptions which jeopardize collection of the loan are also reviewed for possible impairment classification. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment
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shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans determined to be impaired are individually evaluated for impairment. When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For collateral dependent loans secured by real estate, we obtain external appraisals which are updated periodically, but generally no less than annually to determine the fair value of the collateral, and we record an immediate charge-off for the difference between the book value of the loan and the net realizable value, which is generally defined as appraised value less costs to dispose of the collateral. We perform quarterly internal reviews on all criticized and classified loans.
We place loans on nonaccrual status and classify them as impaired when it becomes probable that we will not receive the full amount of interest and principal under the original contractual terms, or when loans are delinquent 90 days or more, unless the loan is both well secured and in the process of collection. Management maintains certain loans that have been brought current by the borrower (less than 30 days delinquent) on nonaccrual status until such time as management has determined that the loans are likely to remain current in future periods. Foregone interest on nonaccrual loans totaled $99,000 for the year ended December 31, 2021 of which none was attributable to troubled debt restructurings. Foregone interest on nonaccrual loans totaled $177,000 for the year ended December 31, 2020 of which none was attributable to troubled debt restructurings. Foregone interest on nonaccrual loans totaled $85,000 for the year ended December 31, 2019, of which none was attributable to troubled debt restructurings.
The following table provides a reconciliation of the change in non-accrual loans for the year ended December 31, 2021.
Non-accrual loans:
Commercial and industrial $ 752 $ — $ (385) $ — $ (55) $ — $ 312
Real estate construction and other land loans 1,556 — (1,531) — (25) — —
Consumer 88 — (2) — (86) — —
OREO represents real property taken either through foreclosure or through a deed in lieu thereof from the borrower. OREO is carried at the lesser of cost or fair market value less selling costs. As of December 31, 2021, 2020, and 2019, the Bank had no OREO properties. The Company held no repossessed assets at December 31, 2021, 2020, and 2019, which is included in other assets on the consolidated balance sheets.
Allowance for Credit Losses
We have established a methodology for determining the adequacy of the allowance for credit losses made up of general and specific allocations. The methodology is set forth in a formal policy and takes into consideration the need for an overall allowance for credit losses as well as specific allowances that are tied to individual loans. The allowance for credit losses is an estimate of probable incurred credit losses in the Company’s loan portfolio. The allowance consists of two primary components, specific reserves related to impaired loans and general reserves for probable incurred losses related to loans that are not impaired.