ITEM 7 -MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
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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. Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluating the business prospects of the Company.
When the Company uses in this Annual Report the words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar expressions, the Company intends to identify forward-looking statements. Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Annual Report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. The future results and shareholder values of the Company may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. See also the discussion of risk factors in Item 1A, “Risk Factors.”
We are not able to predict all the factors that may affect future results. You should not place undue reliance on any forward looking statement, which speaks only as of the date of this Report on Form 10-K. Except as required by applicable laws or regulations, we do not undertake any obligation to update or revise any forward looking statement, whether as a result of new information, future events or otherwise.
INTRODUCTION
Central Valley Community Bancorp (NASDAQ: CVCY) (the Company) was incorporated on February 7, 2000. The formation of the holding company offered the Company more flexibility in meeting the long-term needs of customers, shareholders, and the communities it serves. The Company currently has one bank subsidiary, Central Valley Community Bank (the Bank) and one business trust subsidiary, Service 1st Capital Trust 1. The Company’s market area includes the Central Valley area from Sacramento, California to Bakersfield, California.
During 2022, we focused on asset quality, loan growth, and capital adequacy. 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, 2022, the Bank operated 19 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
Recent economics within California, the Central Valley, and Greater Sacramento Region, including unemployment rates and housing prices are showing moderate and steady improvement. We only conduct business in the state of California.
Agriculture and agricultural-related businesses remain a critical part of the Central Valley’s economy. The Valley’s agricultural production is widely diversified, producing nuts, vegetables, fruit, cattle, dairy products, and cotton. The continued future success of agriculture related businesses is highly dependent on the availability of water and is subject to fluctuation in
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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. Despite a good start to the current rainy season, California has been experiencing significant drought conditions for many years which impacts surface water deliveries to customers. In reaction to these conditions, we closely monitor the surface water availability with customer specific budgeting and third party information and surveys. There are also certain regulatory impacts that limit the water than can be pumped from underground sources. Both sources are closely considered and monitored in the granting and monitoring of our loan exposures, along with related issues affecting our customers. We closely monitor the water resources and the related issues affecting our customers, and we will remain vigilant for identifying signs of deterioration within the loan portfolio in an effort to manage credit quality and work with borrowers where possible to mitigate any losses.
As a whole, the loan portfolio may be subject to the impact of changes in interest rates, a decline in economic conditions in the Central Valley and the Greater Sacramento Region, and inflation.
OVERVIEW
Diluted earnings per share (EPS) for the year ended December 31, 2022 was $2.27 compared to $2.31 and $1.62 for the years ended December 31, 2021 and 2020, respectively. Net income for 2022 was $26,645,000 compared to $28,401,000 and $20,347,000 for the years ended December 31, 2021 and 2020, respectively. The decrease in net income for 2022 compared to 2021 was driven by a reversal of provision for credit losses in 2021 compared to a provision in 2022, an increase in net realized losses on sales and calls of investment securities, compared to net gains in 2021, a decrease in loan placement fees, and an increase in non-interest expense. This was offset by an increase in net interest income, an increase in interchange fees, a decrease in the provision for income taxes, and an increase in service charge income. Total assets at December 31, 2022 were $2,422,519,000 compared to $2,450,139,000 at December 31, 2021.
Return on average equity (“ROE”) for 2022 was 14.25% compared to 11.50% and 8.85% for 2021 and 2020, respectively. Return on average assets (“ROA”) for 2022 was 1.09% compared to 1.25% and 1.11% for 2021 and 2020, respectively. Total equity was $174,660,000 at December 31, 2022 compared to $247,845,000 at December 31, 2021. The decrease in shareholders’ equity is the result of a decrease in accumulated other comprehensive income (AOCI) of $88,859,000, the payment of common stock cash dividends of $5,638,000 and the repurchase and retirement of common stock of $6,814,000, offset primarily by an increase in retained earnings from our net income of $26,645,000. The decrease in AOCI was the result of an increase in the unrealized loss on the Company’s investment portfolio.
Average total loans (including nonaccrual) increased $64,266,000 or 6.01% to $1,133,919,000 in 2022 compared to $1,069,653,000 in 2021. In 2022 we recorded a provision for credit losses of $1,000,000, compared to a reversal of provision of $4,300,000 in 2021, and a provision of $3,275,000 in 2020. The Company had no nonperforming assets at December 31, 2022. At December 31, 2021, nonperforming assets totaled $946,000. Net loan loss recoveries for 2022 were $248,000 compared to net loan loss recoveries in the amount of $985,000 for 2021 and net loan loss recoveries in the amount of $510,000 for 2020. Refer to “Asset Quality” below for further information.
Dividend Declared
The Company declared a $0.12 per common share cash dividend, payable on February 24, 2023 to shareholders of record on February 10, 2023.
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 14.25% for the year ended 2022 compared to 11.50% and 8.85% for the years ended 2021 and 2020, respectively.
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Our net income for the year ended December 31, 2022 decreased $1,756,000 compared to 2021 and increased $8,054,000 in 2021 compared to 2020. Contributing to the decrease during 2022, compared to 2021, was a provision for credit losses, compared to a reversal in 2021, an increase in net realized losses on sales and calls of investment securities, compared to net gains in 2021, a decrease in loan placement fees, and an increase in non-interest expense. These were partially offset by an increase in net interest income, an increase in interchange fees, a decrease in the provision for income taxes, and an increase in service charge income. During 2021, net income compared to 2020 was impacted by a reversal in the provision for credit losses and an increase in net interest income.
Net interest income increased because of increases in loan and fee income and increases in interest income on investments, offset by an increase in interest expense. For 2022, our net interest margin (NIM) decreased 2 basis points to 3.52% compared to 2021 as a result of yield changes and asset mix changes. Net interest income was positively impacted by the accretion of the loan marks on acquired loans in the amount of $521,000 and $802,000 for the year ended December 31, 2022 and 2021, respectively. In addition, net interest income before the provision for credit losses for the year ended December 31, 2022 benefited by approximately $649,000 in nonrecurring income from prepayment penalties and payoff of loans, as compared to $676,000 for the year ended December 31, 2021. Excluding these reversals and benefits, net interest income for the year ended December 31, 2022 increased by $7,320,000 compared to the year ended December 31, 2021.
Non-interest income decreased 43.88% in 2022 compared to 2021 primarily due to a $2,231,000 increase in net realized losses on sales and calls of investment securities, a decrease of $1,012,000 in other income, and a decrease in loan placement fees of $1,075,000, partially offset by an increase in service charge income of $113,000, an increase in interchange fees of $63,000, and an increase in appreciation in cash surrender value of bank-owned life insurance of $145,000.
Non-interest expenses increased $637,000 or 1.33% to $48,479,000 in 2022 compared to $47,842,000 in 2021. The net increase year over year resulted from increases in information technology of $476,000, salaries and employee benefits of $197,000, regulatory assessments of $20,000, occupancy and equipment expenses of $249,000, donations of $28,000, general insurance of $35,000, telephone of $152,000, armored courier of $2,000, travel and mileage of $67,000, risk management expenses of $5,000, operating losses of $113,000, and advertising expenses of $30,000, partially offset by decreases in alarm expenses of $10,000, postage of $46,000, personnel of $51,000, professional services of $146,000, loan related expenses of $16,000, Internet banking expenses of $186,000, directors’ expenses of $140,000, stationary and supplies of $5,000, amortization of software of $15,000, and amortization of core deposit intangible of $207,000, in 2022 compared to 2021.
The Company recorded an income tax provision of $8,496,000 for the year ended December 31, 2022, compared to $9,616,000 for the year ended December 31, 2021, and $6,914,000 for the year ended December 31, 2020. Basic EPS was $2.27 for 2022 compared to $2.32 and $1.62 for 2021 and 2020, respectively. Diluted EPS was $2.27 for 2022 compared to $2.31 and $1.62 for 2021 and 2020, 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 2022 was 1.09% compared to 1.25% and 1.11% for the years ended December 31, 2021 and 2020, respectively. The 2022 decrease in ROA is primarily due to the decrease in net income, and the increase in average assets. Annualized ROA for our peer group was 1.10% at December 31, 2022. 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 3.52% for the year ended December 31, 2022, compared to 3.54% and 3.87% for the years ended December 31, 2021 and 2020, respectively. The decrease in 2022 net interest margin compared to 2021, resulted from the decrease in the yield on the Company’s loan portfolio, and an increase in the balance of average interest earning assets. The effective tax equivalent yield on total earning assets increased 5 basis points, while the cost of total interest-bearing liabilities increased 16 basis points to 0.28% for the year ended December 31, 2022. Our cost of total deposits in 2022 and 2021 was 0.06% and 0.05%, respectively, compared to 0.09% for the same period in 2020. Our net interest income before provision for credit losses increased $7,012,000 or 9.66% to $79,566,000 for the year ended 2022 compared to $72,554,000 and $64,423,000 for the years ended 2021 and 2020, 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 or losses from sales and calls of investment securities. Non-interest income in 2022 decreased $3,951,000 or 43.88% to $5,054,000 compared to $9,005,000 in 2021 and $13,797,000 in 2020. The decrease resulted primarily from an increase in net realized losses on sales and calls of
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investment securities, compared to a gain in 2021, a decrease in loan placement fees, and a decrease in other income, partially offset by an increase in service charge income, an increase in interchange fees, an increase in FHLB dividends, and an increase in appreciation in cash surrender value of bank-owned life insurance compared to 2021. 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. There were no nonperforming assets or nonperforming loans at December 31, 2022, compared to $946,000 in nonperforming assets, which were nonperforming loans, at December 31, 2021. Nonperforming assets totaled 0.09% of gross loans as of December 31, 2021. The ratio of nonperforming loans to total loans was 0.09% as of December 31, 2021.
The Company had no other real estate owned at December 31, 2022, or December 31, 2021. No foreclosed assets were recorded at December 31, 2022 or December 31, 2021. 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 allowance for credit losses as a percentage of outstanding loan balance was 0.86% as of December 31, 2022 and 0.92% as of December 31, 2021. The ratio of net recoveries to average loans was 0.02% as of December 31, 2022 and 0.09% as of December 31, 2021.
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 decreased 1.13% during 2022 to $2,422,519,000 as of December 31, 2022 from $2,450,139,000 as of December 31, 2021. Total gross loans increased 20.90% to $1,256,304,000 as of December 31, 2022, compared to $1,039,111,000 at December 31, 2021. Total investment securities decreased 13.98% to $960,490,000 as of December 31, 2022 compared to $1,116,624,000 as of December 31, 2021. Total deposits decreased 1.09% to $2,099,649,000 as of December 31, 2022 compared to $2,122,797,000 as of December 31, 2021. Our loan to deposit ratio at December 31, 2022 was 59.83% compared to 48.95% at December 31, 2021. The loan to deposit ratio of our peers was 77.00% at December 31, 2022. 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, 2022, we had a total capital to risk-weighted assets ratio of 14.92%, a Tier 1 risk-based capital ratio of 12.22%, common equity Tier 1 ratio of 11.92%, and a leverage ratio of 8.37%. 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, 2022, on a stand-alone basis, the Bank had a total risk-based capital ratio of 16.53%, a Tier 1 risk based capital ratio of 15.87%, common equity Tier 1 ratio of 15.87%, and a leverage ratio of 10.86%. At December 31, 2021, the Bank had a total risk-based capital ratio of 14.18%, Tier 1 risk-based capital of 13.52% and a leverage ratio of 8.47%. Note 13 of the audited Consolidated Financial Statements provides more detailed information concerning the Company’s capital amounts and ratios. As of December 31, 2022, 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, 2022.
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 54.51% for 2022 compared to 57.16% for 2021 and 64.08% for 2020. The improvement in the efficiency ratio in 2022 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 3.75% to $84,620,000 in 2022 compared to $81,559,000 in 2021 and $78,220,000 in 2020, while operating expenses increased 1.33% in 2022, 0.33% in 2021, and 3.44% in 2020.
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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 $319,309,000 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 $686,553,000 or 28.34% of total assets at December 31, 2022 and $1,280,091,000 or 52.25% of total assets as of December 31, 2021.
RESULTS OF OPERATIONS
Net Income
Net income was $26,645,000 in 2022 compared to $28,401,000 and $20,347,000 in 2021 and 2020, respectively. Basic earnings per share was $2.27, $2.32, and $1.62 for 2022, 2021, and 2020, respectively. Diluted earnings per share was $2.27, $2.31, and $1.62 for 2022, 2021, and 2020, respectively. ROE was 14.25% for 2022 compared to 11.50% for 2021 and 8.85% for 2020. ROA for 2022 was 1.09% compared to 1.25% for 2021 and 1.11% for 2020.
The decrease in net income for 2022 compared to 2021 was driven by a provision for credit losses compared to a reversal of provision for credit losses in 2021, an increase in non-interest expense, an increase in net realized losses on sales and calls of investment securities, compared to a gain in 2021, an increase in non-interest expense, and a decrease in loan placement fees, partially offset by an increase in net interest income, an increase in interchange fees, a decrease in the provision for income taxes, and an increase in service charge income. The increase in net income for 2021 compared to 2020 was primarily due to 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.
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 $1,775, $1,490, and $523 in 2022, 2021, and 2020, respectively.
(2)Loan interest income includes loan fees of $274 in 2022, $6,474 in 2021, and $2,234 in 2020.
(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 $1,830,000 or 3.38% in 2022 compared to 2021. Interest and fee income from loans increased $2,011,000 or 3.86% in 2021 compared to 2020. The increase in 2022 is primarily attributable to an increase in average total loans outstanding.
Average total loans, including nonaccrual loans, for 2022 increased $64,266,000 to $1,133,919,000 compared to $1,069,653,000 for 2021 and $1,055,712,000 for 2020. The yield on loans for 2022 was 4.93% compared to 5.07% and 4.94% for 2021 and 2020, respectively. The impact to interest income from the accretion of the loan marks on acquired loans was an decrease to $521,000 from $802,000 for the years ended December 31, 2022 and 2021, respectively. Additionally, 2021 included $6,205,000 in commercial loan fees from PPP activity compared to $120,000 in 2022.
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 $7,302,000 or 36.92% in 2022 compared to 2021. The yield on average investments increased 37 basis points to 2.45% for the year ended December 31, 2022 from 2.08% for the year ended December 31, 2021. Average total investments increased $158,452,000 to $1,180,125,000 in 2022 compared to $1,021,673,000 in 2021. In 2021, total investment income on a non tax-equivalent basis increased $5,827,000 or 41.76% compared to 2020.
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, 2022, we held $465,035,000 or 48.75% of the total market value of the investment portfolio in MBS and CMOs with an average yield of 4.42%. We invested 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. However, as interest rates have increased, prepayments likely have decline and therefore the average life of the MBS and CMOs are 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. 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
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available bonds in market. The calculation of premium amortization and discount accretion is by its nature inexact, and represents management’s best estimate of principal pay downs inherent in the total investment portfolio.
The cumulative net-of-tax effect of the change in market value of the available-for-sale investment portfolio as of December 31, 2022 was an unrealized loss of $81,227,000 and is reflected in the Company’s equity. At December 31, 2022, the effective duration of the investment portfolio was 4.85 years and the market value reflected a pre-tax unrealized loss of $91,643,000. 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, 2022, 2021, and 2020, no OTTI was recorded. Future deterioration in the market values of our investment securities may require the Company to recognize 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, 2022, an immediate rate increase of 200 basis points would result in an estimated decrease in the market value of the investment portfolio by approximately $61,000. Conversely, with an immediate rate decrease of 200 basis points, the estimated increase in the market value of the investment portfolio would be $60,000. 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 2022 increased $9,132,000 to $82,988,000 compared to $73,856,000 in 2021 and $66,018,000 in 2020, respectively. The increase in 2022 was the result of yield changes and asset mix changes. The tax-equivalent yield on interest earning assets increased to 3.66% for the year ended December 31, 2022 from 3.61% for the year ended December 31, 2021. Average interest earning assets increased to $2,313,766,000 for the year ended December 31, 2022 compared to $2,088,989,000 for the year ended December 31, 2021. Average interest-earning deposits in other banks decreased $56,678,000 in 2022 compared to 2021. Average yield on these deposits was 0.81% compared to 0.12% on December 31, 2022 and December 31, 2021 respectively. Average investments and interest-earning deposits increased $158,452,000 and the tax equivalent yield on those assets increased 37 basis points. Average total loans increased $64,266,000 but the yield on average loans decreased 14 basis points.
The increase in total interest income for 2021 was the result of yield changes, the decrease in interest rates being offset by 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 total loans increased and the yield on average loans increased 13 basis points.
Interest expense on deposits in 2022 increased $161,000 or 15.54% to $1,197,000 compared to $1,036,000 in 2021 and decreased $268,000 as compared to 2020. The yield on interest-bearing deposits remained unchanged at 0.10% in 2022 and 2021. The yield on interest-bearing deposits decreased 8 basis points to 0.10% in 2021 from 0.18% in 2020. Average interest-bearing deposits were $1,149,581,000 for 2022 compared to $1,074,493,000 and $823,955,000 for 2021 and 2020, respectively.
Average other borrowings were $63,752,000 with an effective rate of 3.49% for 2022 compared to $9,864,000 with an effective rate of 2.70% for 2021. In 2020, the average other borrowings were $5,155,000 with an effective rate of 2.52%. Included in other borrowings are the junior subordinated deferrable interest debentures acquired from Service 1st, subordinated debt, senior debit, 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 5.68% for 2022, 1.73% for 2021, and 1.84% for 2020. The subordinated debt, issued in 2021, bears a fixed interest rate of 3.125% per year. The senior debt secured from Bell Bank has an interest rate cap of 6.75% which was reached in 2022.
The cost of all interest-bearing liabilities was 0.28% and 0.12% basis points for 2022 and 2021, respectively, compared to 0.19% for 2020. The cost of total deposits was 0.06% for the year ended December 31, 2022, compared to 0.05% and 0.09% for the years ended December 31, 2021 and 2020, respectively. Average demand deposits increased 11.82% to $1,006,511,000 in 2022 compared to $900,083,000 for 2021 and $744,239,000 for 2020. The ratio of average non-interest demand deposits to average total deposits increased to 46.68% for 2022 compared to 45.58% and 47.46% for 2021 and 2020, respectively.
Net Interest Income before Provision for Credit Losses
Net interest income before provision for credit losses for 2022 increased $7,012,000 or 9.66% to $79,566,000 compared to $72,554,000 for 2021 and $64,423,000 for 2020. The increase in 2022 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 2 basis points. Yield on interest earning assets increased 5 basis points. The decrease in net interest
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margin in the period-to-period comparison resulted primarily from the increase in interest expense. Net interest income before provision for credit losses increased $8,131,000 in 2021 compared to 2020, primarily due yield changes and asset mix changes. Average interest-earning assets were $2,313,766,000 for the year ended December 31, 2022 with a NIM of 3.52% compared to $2,088,989,000 with a NIM of 3.54% in 2021, and $1,676,567,000 with a NIM of 3.87% in 2020. 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, 2022, the Company recorded a provision for credit losses of $1,000,000 compared to a reversal of provision of $4,300,000 in 2021. A provision of $3,275,000 was recorded for 2020. 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, 2022, 2021 and 2020 the Company had net recoveries totaling $248,000, $985,000, and $510,000, respectively. The net recovery ratio, which reflects net recoveries to average loans, was 0.02%, 0.09% and 0.05% for 2022, 2021, and 2020, 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, 2022, there were $27.8 million in classified loans of which $1.7 million related to commercial and industrial loans, $2.2 million to real estate owner occupied, and $5.4 million to agricultural production. This compares to $8.5 million in classified loans as of December 31, 2021 of which $2.6 million related to commercial and industrial, $2.4 million to agricultural production, and $3.6 million to real estate owner occupied.
As of December 31, 2022, we believe, based on all current and available information, the allowance for credit losses is adequate to absorb probable incurred losses within the loan portfolio; however, no assurance can be given that we may not
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sustain charge-offs which are in excess of the allowance in any given period. Refer to “Allowance for Credit Losses” below for further information.
Net Interest Income after Provision for Credit Losses
Net interest income, after the provision for credit losses was $78,566,000 for 2022 compared to $76,854,000 and $61,148,000 for 2021 and 2020, 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 $5,054,000 in 2022 compared to $9,005,000 and $13,797,000 in 2021 and 2020, respectively. The $3,951,000 or 43.88% decrease in non-interest income in 2022 was driven by an increase of $2,231,000 in net realized losses on sales and calls of investment securities, a decrease of $1,012,000 in other income, and a decrease in loan placement fees of $1,075,000, partially offset by an increase in service charge income of $113,000, an increase in interchange fees of $63,000 and an increase in appreciation in cash surrender value of bank-owned life insurance of $145,000. 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.
Customer service charges increased $113,000 to $2,014,000 in 2022 compared to $1,901,000 in 2021. Service charges were $2,071,000 in 2020. The decrease in 2021 resulted from decreases in our NSF fees and lower analysis service charge income.
During the year ended December 31, 2022, we realized net losses on sales and calls of investment securities of $1,730,000, compared to net gains of $501,000 in 2021 and $4,252,000 in 2020. The net gains in 2021, and 2020 were the results of partial restructuring of the investment portfolio designed to improve the future performance of the portfolio. Realized loss recorded in 2022 was the result of strategic decisions to reduce the overall impact of the Company’s investment 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 $985,000 in 2022 compared to $840,000 and $711,000 in 2021 and 2020, 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 $1,847,000 in 2022 compared to $1,784,000 and $1,347,000 in 2021 and 2020, 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 $1,075,000 in 2022 to $899,000 compared to $1,974,000 in 2021 and $2,291,000 in 2020.
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, 2022 and 2021, we held FHLB stock totaling $6,169,000 and $5,595,000, respectively. Dividends in 2022 increased to $367,000 compared to $321,000 in 2021 and $323,000 in 2020.
Other income decreased to $672,000 in 2022 compared to $1,684,000 and $2,802,000 in 2021 and 2020, 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 $637,000 or 1.33% to $48,479,000 in 2022 compared to $47,842,000 in 2021, and $47,684,000 in 2020.
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 54.51% for 2022 compared to 57.16% for 2021 and 64.08% for 2020. The improvement in the efficiency ratio in 2022 and 2021 was due to the growth in non-interest income outpacing the increase in non-interest expense.
Salaries and employee benefits increased $197,000 or 0.69% to $28,917,000 in 2022 compared to $28,720,000 in 2021 and $28,603,000 in 2020. Full time equivalents were 248 for the year ended December 31, 2022 compared to 256 for the year
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ended December 31, 2021. The increase in salaries and employee benefits in 2022 compared to 2021 was the result of an increase in salaries and benefits and lower loan origination costs.
For the years ended December 31, 2022, 2021, and 2020, the compensation cost recognized for equity-based compensation was $497,000, $405,000 and $470,000, respectively. As of December 31, 2022, there was $505,000 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 2.01 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, 2022 and 2021. Restricted common stock awards of 56,089 and 31,496 shares were awarded in 2022 and 2021, respectively.
Occupancy and equipment expense increased $249,000 or 5.10% to $5,131,000 in 2022 compared to $4,882,000 in 2021 and $4,626,000 in 2020. The Company made no changes in its depreciation expense methodology. The Company operated 19 full-service offices at December 31, 2022 and 20 full-service offices at December 31, 2020.
Regulatory assessments were $851,000 in 2022 compared to $831,000 and $490,000 in 2021 and 2020, respectively. The assessment base for calculating the amount owed is based on the formula of average assets minus average tangible equity.
Information technology expense increased $476,000 to $3,344,000 for the year ended December 31, 2022 compared to $2,868,000 and $2,391,000 in 2021 and 2020, respectively. Data processing expenses were $2,245,000 in 2022 compared to $2,394,000 in 2021 and $2,046,000 in 2020. Professional services decreased $146,000 in 2022 compared to 2021 due to lower legal expenses and consulting fees.
Amortization of core deposit intangibles was $454,000 for 2022, $661,000 for 2021, and $695,000 for 2020. During 2022, amortization expense related to FLB core deposit intangibles (“CDI”) was $317,000, and amortization expense related to Visalia Community Bank (“VCB”) CDI was $137,000. During 2021, amortization expense related to FLB CDI was $423,000, amortization expense related to SVB CDI was $101,000, and amortization expense related to 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.
ATM/Debit card expenses decreased $9,000 to $809,000 for the year ended December 31, 2022 compared to $818,000 in 2021 and $819,000 in 2020. Other non-interest expenses decreased $502,000 or 13.44% to $4,236,000 in 2022 compared to $3,734,000 in 2021 and $3,688,000 in 2020.
The following table describes significant components of other non-interest expense as a percentage of average assets.
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Provision for Income Taxes
Our effective income tax rate was 24.2% for 2022 compared to 25.3% for 2021 and 25.4% for 2020. The Company reported an income tax provision of $8,496,000, $9,616,000, and $6,914,000 for the years ended December 31, 2022, 2021, and 2020, 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 $43.38 million and $6.31 million at December 31, 2022 and 2021, 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, 2022 and 2021 will be fully realized in future years.
FINANCIAL CONDITION
Summary of Changes in Consolidated Balance Sheets
Total assets were $2,422,519,000 as of December 31, 2022, compared to $2,450,139,000 as of December 31, 2021, a decrease of 1.13% or $27,620,000. Total gross loans were $1,256,304,000 as of December 31, 2022, compared to $1,039,111,000 as of December 31, 2021, an increase of $217,193,000 or 20.90%. The total investment portfolio (including Federal funds sold and interest-earning deposits in other banks) decreased 22.75% or $284,504,000 to $966,175,000. Total deposits decreased 1.09% or $23,148,000 to $2,099,649,000 as of December 31, 2022, compared to $2,122,797,000 as of December 31, 2021. Shareholders’ equity decreased $73,185,000 or 29.53% to $174,660,000 as of December 31, 2022, compared to $247,845,000 as of December 31, 2021. The decrease in shareholders’ equity was driven by the increase in net unrealized losses on the investment portfolio, net of estimated taxes, in accumulated other comprehensive income (AOCI), and share repurchases, partially offset by the retention of earnings, net of dividends paid. Accrued interest payable and other liabilities were $32,611,000 as of December 31, 2022, compared to $40,043,000 as of December 31, 2021, a decrease of $7,432,000.
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 (in thousands):
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Amortized Cost at December 31,
U.S. Treasury securities $ 9,990 $ 9,988 $ —
Amortized Cost at December 31,
Obligations of states and political subdivisions $ 192,004 $ — $ —
Private label mortgage and asset backed securities 56,691 — —
Corporate debt securities 45,982 — —
Total Held-to-Maturity Securities $ 305,107 $ — $ —
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, 2022, investment securities with a fair value of $201,261,000, or 21.10% 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, 2022 was 59.83% compared to 48.95% at December 31, 2021. The loan to deposit ratio of our peers was 77.00% 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, decreased 22.75% or $284,504,000 to $966,175,000 at December 31, 2022, from $1,250,679,000 at December 31, 2021. The market value of the portfolio reflected an unrealized loss of $91,643,000 at December 31, 2022, compared to an unrealized gain of $10,835,000 at December 31, 2021.
Losses recognized in 2022, 2021, and 2020 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 as interest rates 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.
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
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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, 2022, 2021, or 2020.
The amortized cost, maturities and weighted average yield of investment securities at December 31, 2022 are summarized in the following table.
Debt securities(1)
U.S. Treasury securities $ — — % $ — — % $ 9,990 1.25 % $ — — % $ 9,990 1.25 %
Debt securities(1)
(1)Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties. Expected maturities will also differ from contractual maturities due to unscheduled principal pay downs.
(2)Not computed on a tax equivalent basis.
Loans
Total gross loans increased $217,193,000 or 20.90% to $1,256,304,000 as of December 31, 2022, compared to $1,039,111,000 as of December 31, 2021.
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The following table sets forth information concerning the composition of our loan portfolio as of December 31, 2022, 2021, 2020, 2019, and 2018.
Commercial:
Real estate:
Consumer:
At December 31, 2022, loans acquired in the FLB, SVB and VCB acquisitions had a balance of $73,456,000, of which $2,049,000 were commercial loans, $66,583,000 were real estate loans, and $4,824,000 were consumer loans, and at December 31, 2021, the acquired loans 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.
At December 31, 2022, in management’s judgment, a concentration of loans existed in commercial loans and real-estate-related loans, representing approximately 96.8% of total loans of which 14.3% were commercial and 82.5% were real-estate-related. This level of concentration is consistent with 96.4% at December 31, 2021. Although we believe the loans within this concentration have no more than the normal risk of collectability, a substantial decline in the performance of the economy in general or a decline in real estate values in our primary market areas, in particular, could have an adverse impact on collectability, increase the level of real estate-related nonperforming loans, or have other adverse effects which alone or in the aggregate could have a material adverse effect on our business, financial condition, results of operations and cash flows. The Company was not involved in any sub-prime mortgage lending activities during the years ended December 31, 2022 and 2021.
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, 2022, gross loans included $333,000 in PPP loans which are fully guaranteed by the SBA as compared to $18,553,000 as of December 31, 2021.
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
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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, 2022.
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.
At December 31, 2022, there were no nonperforming assets, compared to $946,000, or 0.04% of total assets at December 31, 2021. Nonperforming assets totaled 0.09% of gross loans as of December 31, 2021. Total nonperforming assets at December 31, 2022, included no nonaccrual loans, no OREO, and no repossessed assets. Nonperforming assets at December 31, 2021 consisted of $946,000 in nonaccrual loans, no OREO, and no repossessed assets. At December 31, 2022 and December 31, 2021, 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, 2022, 2021, 2020, 2019, and 2018 is set forth below. The Company had no loans past due more than 90 days and still accruing interest at December 31, 2022 and 2021. Management is not aware of any potential problem loans, which were current and accruing at December 31, 2022, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms. Management can give no assurance that nonaccrual and other nonperforming loans will not increase in the future.
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Composition of Nonaccrual, Past Due and Restructured Loans
Nonaccrual Loans:
Agricultural production — 634 — — — —
Real estate construction and other land loans — — 1,556 — 1,439
Agricultural real estate — — — 321 —
Equity loans and line of credit — — — 66 320
Consumer and installment — — 88 — —
Restructured loans (non-accruing):
Equity loans and line of credit — — — 322 50
Accruing loans past due 90 days or more — — — — —
Nonperforming loans to total loans — % 0.09 % 0.30 % 0.18 % 0.30 %
Accruing loans past due 90 days or more $ — $ — $ — $ — $ —
As of December 31, 2022 and 2021, we had impaired loans totaling $2,372,000 and $8,586,000, respectively. We measure our impaired loans by using the fair value of the collateral if the loan is collateral dependent and the present value of the expected future cash flows discounted at the loan’s original contractual interest rate if the loan is not collateral dependent. Impaired loans are identified from internal credit review reports, past due reports, overdraft listings, and third party reports of examination. Borrowers experiencing problems such as operating losses, marginal working capital, inadequate cash flow or business interruptions which jeopardize collection of the loan are also reviewed for possible impairment classification. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans determined to be impaired are individually evaluated for impairment. When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. For collateral dependent loans secured by real estate, we obtain external appraisals which are updated 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,
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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 $132,000 for the year ended December 31, 2022 of which none was attributable to troubled debt restructurings. 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.
The following table provides a reconciliation of the change in non-accrual loans for the year ended December 31, 2022.
Non-accrual loans:
Commercial and industrial $ 312 $ — $ (80) $ — $ (232) $ — $ —
Agricultural real estate 634 — (634) — — — —
Total non-accrual $ 946 $ — $ (714) $ — $ (232) $ — $ —
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, 2022, 2021, and 2020, the Bank had no OREO properties. The Company held no repossessed assets at December 31, 2022, 2021, and 2020, 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.
For all portfolio segments, the determination of the general reserve for loans that are not impaired is based on estimates made by management including, but not limited to, consideration of historical losses by portfolio segment (and in certain cases peer loss data) over the most recent 56 quarters, and qualitative and quantitative factors including economic trends in the Company’s service areas, industry experience and trends, industry and geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan portfolio, and probable losses incurred in the portfolio taken as a whole. Management has determined that the most recent 56 quarters was an appropriate look-back period based on several factors including the current global economic uncertainty and various national and local economic indicators, and a time period sufficient to capture enough data due to the size of the portfolio to produce statistically accurate historical loss calculations. We believe this period is an appropriate look-back period.
In originating loans, we recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the collateral securing the loan. The allowance is increased by provisions charged against earnings and recoveries, and reduced by net loan charge-offs. Loans are charged off when they are deemed to be uncollectible, or partially charged off when portions of a loan are deemed to be uncollectible. Recoveries are generally recorded only when cash payments are received.
The allowance for credit losses is maintained to cover probable incurred credit losses in the loan portfolio. The responsibility for the review of our assets and the determination of the adequacy lies with management and our Audit/Compliance Committee. They delegate the authority to the Chief Credit Officer (CCO) to determine the loss reserve ratio for each type of asset and to review, at least quarterly, the adequacy of the allowance based on an evaluation of the portfolio, past experience, prevailing market conditions, amount of government guarantees, concentration in loan types and other relevant factors.
The allowance for credit losses is an estimate of the probable incurred credit losses in our loan and lease portfolio. The allowance is based on principles of accounting: (i) losses accrued for on loans when they are probable of occurring and can be reasonably estimated and (ii) losses accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
Management adheres to an internal asset review system and loss allowance methodology designed to provide for timely recognition of problem assets and adequate valuation allowances to cover probable incurred losses. The Bank’s asset
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monitoring process includes the use of asset classifications to segregate the assets, largely loans and real estate, into various risk categories. The Bank uses the various asset classifications as a means of measuring risk and determining the adequacy of valuation allowances by using a nine-grade system to classify assets. In general, all credit facilities exceeding 90 days of delinquency require classification and are placed on nonaccrual.
The following table summarizes the Company’s loan loss experience, as well as provisions and recoveries (charge-offs) to the allowance and certain pertinent ratios for the periods indicated:
Allowance for credit losses:
Deduct loans charged off:
Add recoveries of loans previously charged off:
Owner occupied — — — — 21
Real estate construction and other land loans — 319 — — —
Commercial real estate — — — — 81
Managing credits identified through the risk evaluation methodology includes developing a business strategy with the customer to mitigate our losses. Our management continues to monitor these credits with a view to identifying as early as possible when, and to what extent, additional provisions may be necessary.
The allowance for credit losses is reviewed at least quarterly by the Bank’s and our Board of Directors’ Audit/Compliance Committee. Reserves are allocated to loan portfolio segments using percentages which are based on both historical risk elements such as delinquencies and losses and predictive risk elements such as economic, competitive and environmental factors. We have adopted the specific reserve approach to allocate reserves to each impaired asset for the purpose of estimating potential loss exposure. Although the allowance for credit losses is allocated to various portfolio categories, it is general in nature and available for the loan portfolio in its entirety. Additions may be required based on the results of independent loan portfolio examinations, regulatory agency examinations, or our own internal review process. Additions are also required when, in management’s judgment, the reserve does not properly reflect the potential loss exposure.
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The allocation of the allowance for credit losses is set forth below:
Commercial:
Real estate:
Consumer:
Loans are charged to the allowance for credit losses when the loans are deemed uncollectible. It is the policy of management to make additions to the allowance so that it remains adequate to cover all probable loan charge-offs that exist in the portfolio at that time. We assign qualitative and quantitative factors (Q factors) to each loan category. Q factors include reserves held for the effects of lending policies, experience, economic trends, and portfolio trends along with other dynamics which may cause additional stress to the portfolio.
As of December 31, 2022, the allowance for credit losses (ACL) was $10,848,000, compared to $9,600,000 at December 31, 2021, a net increase of $1,248,000. The net increase in the ACL was primarily attributed to loan growth, with additional consideration reflected in the net recoveries during the year ended December 31, 2022. Net recoveries totaled $248,000 while the provision for credit losses was $1,000,000 for the year ended December 31, 2022. The balance of classified loans and loans graded special mention, totaled $27,785,000 and $31,023,000 at December 31, 2022 and $8,540,000 and $40,845,000 at December 31, 2021, respectively. The balance of undisbursed commitments to extend credit on construction and other loans and letters of credit was $288,141,000 as of December 31, 2022, compared to $326,108,000 as of December 31, 2021. At December 31, 2022 and 2021, the balance of a contingent allocation for probable loan loss experience on unfunded obligations was $110,000 and $115,000, respectively. The contingent allocation for probable loan loss experience on unfunded obligations is calculated by management using appropriate, systematic, and consistently applied processes. While related to credit losses, this allocation is not a part of ACL and is considered separately as a liability for accounting and regulatory reporting purposes. Risks and uncertainties exist in all lending transactions and our management and Directors’ Loan Committee have established reserve levels based on economic uncertainties and other risks that exist as of each reporting period.
The ACL as a percentage of total loans was 0.86% at December 31, 2022, and 0.92% at December 31, 2021. Total loans include FLB, SVB and VCB loans that were recorded at fair value in connection with the acquisitions of $73,456,000 at December 31, 2022 and $93,201,000 at December 31, 2021. Excluding these acquired loans from the calculation, the ACL to total gross loans was 0.92% and 1.01% as of December 31, 2022 and 2021, respectively, and general reserves associated with non-impaired loans to total non-impaired loans was 0.89% and 0.98%, respectively. The loan portfolio acquired in the mergers was booked at fair value with no associated allocation in the ACL. As of December 31, 2022 and 2021 gross loans included loans related to PPP loans which are fully guaranteed by the SBA in the amount of $333,000 and $18,553,000.00, respectively. Excluding PPP loans and the acquired loans from the calculation, the allowance for credit losses to total gross loans was 0.92% and 1.04% as of December 31, 2022 and 2021, respectively.
The Company’s loan portfolio balances in 2022 increased from 2021. Net loans increased $215.9 million or 20.98%, at December 31, 2022 compared to December 31, 2021. The net loan increase consisted of a decrease of $18.2 million in SBA Paycheck Protection Program (PPP) loans, offset by an increase of $234.2 million in non-PPP loan growth. Management believes that the change in the allowance for credit losses to total loans ratios is directionally consistent with the composition of loans and the level of nonperforming and classified loans, and by the general economic conditions experienced in the central California communities serviced by the Company, partially offset by recent improvements in real estate collateral values.
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Assumptions regarding the collateral value of various under-performing loans may affect the level and allocation of the allowance for credit losses in future periods. The allowance may also be affected by trends in the amount of charge-offs experienced or expected trends within different loan portfolios. However, the total reserve rates on non-impaired loans include qualitative and quantitative factors which are systematically derived and consistently applied to reflect conservatively estimated losses from loss contingencies at the date of the financial statements. Based on the above considerations and given recent changes in historical charge-off rates included in the ACL modeling and the changes in other factors, management determined that the ACL was appropriate as of December 31, 2022.
There were no non-performing loans as of December 31, 2022, compared to $946,000 as of December 31, 2021. Nonperforming loans as a percentage of total loans were 0.09% at December 31, 2021. The Company had no other real estate owned at December 31, 2022, December 31, 2021, and December 31, 2020. No foreclosed assets were recorded at December 31, 2022, December 31, 2021, and December 31, 2020. The allowance for credit losses as a percentage of nonperforming loans was 10,848.00% and 1,014.80% as of December 31, 2022 and December 31, 2021, respectively. In addition, management believes that the likelihood of recoveries on previously charged-off loans continues to improve based on the collection efforts of management combined with improvements in the value of real estate which serves as the primary source of collateral for loans. Management believes the allowance at December 31, 2022 is adequate based upon its ongoing analysis of the loan portfolio, historical loss trends and other factors. However, no assurance can be given that the Company may not sustain charge-offs which are in excess of the allowance in any given period.
Goodwill and Intangible Assets
Business combinations involving the Bank’s acquisition of the equity interests or net assets of another enterprise give rise to goodwill. Total goodwill at December 31, 2022 was $53,777,000 consisting of $13,466,000, $10,394,000, $6,340,000, $14,643,000 and $8,934,000 representing the excess of the cost of FLB, SVB, VCB, Service 1st Bancorp, and Bank of Madera County, respectively, over the net amounts assigned to assets acquired and liabilities assumed in the transactions accounted for under the purchase method of accounting. The value of goodwill is ultimately derived from the Company’s ability to generate net earnings after the acquisitions and is not deductible for tax purposes. The fair values of assets acquired and liabilities assumed are subject to adjustment during the first twelve months after the acquisition date if additional information becomes available to indicate a more accurate or appropriate value for an asset or liability. A significant decline in net earnings, among other factors, could be indicative of a decline in the fair value of goodwill and result in impairment. For that reason, goodwill is assessed at least annually for impairment.
Management performed an annual impairment test in the third quarter of 2022 utilizing various qualitative factors. Management believes these factors are sufficient and comprehensive and as such, no further factors need to be assessed at this time. Based on management’s analysis performed, no impairment was required.
Goodwill is also assessed for impairment between annual tests if a triggering event occurs or circumstances change that may cause the fair value of a reporting unit to decline below its carrying amount. Management considers the entire Company to be one reporting unit. No such events or circumstances arose during for the year ended December 31, 2022. Changes in the economic environment, operations of the reporting unit or other adverse events could result in future impairment charges which could have a material adverse impact on the Company’s operating results.
The intangible assets at December 31, 2022 represent the estimated fair value of the core deposit relationships acquired in the 2013 acquisition of VCB of $1,365,000. Core deposit intangibles are being amortized using the straight-line method over an estimated life of five to ten years from the date of acquisition. The carrying value of intangible assets at December 31, 2022 was $68,000, net of $1,297,000 in accumulated amortization expense. The carrying value at December 31, 2021 was $522,000, net of $3,230,000 in accumulated amortization expense. Management evaluates the remaining useful lives quarterly to determine whether events or circumstances warrant a revision to the remaining periods of amortization. Based on the evaluation, no changes to the remaining useful life was required. Amortization expense recognized was $454,000 for 2022, $661,000 for 2021 and $695,000 for 2020. The remaining $68,000 core deposit intangible will be amortized during 2023.
Deposits and Borrowings
The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. All of a depositor’s accounts at an insured depository institution, including all non-interest bearing transactions accounts, will be insured by the FDIC up to the standard maximum deposit insurance amount of $250,000 for each deposit insurance ownership category.
Total deposits decreased $23,148,000 or 1.09% to $2,099,649,000 as of December 31, 2022, compared to $2,122,797,000 as of December 31, 2021. Interest-bearing deposits decreased $116,131,000 or 10.02% to $1,043,082,000 as of December 31, 2022, compared to $1,159,213,000 as of December 31, 2021. Non-interest bearing deposits increased $92,983,000 or 9.65% to $1,056,567,000 as of December 31, 2022, compared to $963,584,000 as of December 31, 2021. The Company’s deposit balances for the year ended December 31, 2022 decreased through normal customer deposit related activity. Average non-interest bearing deposits to average total deposits was 46.68% for the year ended December 31, 2022 compared to
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45.58% for the same period in 2021. Based on FDIC deposit market share information published as of June 2022, our total market share of deposits in Fresno, Madera, San Joaquin, and Tulare counties was 3.66% in 2022 compared to 3.83% in 2021. Our total market share in the other counties as of June 2022 and 2021 we operate in (Merced, Placer, Sacramento, and Stanislaus), was less than 1.00%.
The composition of the deposits and average interest rates paid at December 31, 2022 and December 31, 2021 is summarized in the table below.
We have no known foreign deposits. The following table sets forth the average amount of and the average rate paid on certain deposit categories which were in excess of 10% of average total deposits for the years ended December 31, 2022, 2021, and 2020.
(Dollars in thousands) Balance Rate Balance Rate Balance Rate
The following table sets forth the maturity of time certificates of deposit and other time deposits of $100,000 or more at December 31, 2022.
(In thousands)
Three months or less $ 20,931
As of December 31, 2022, the Company had $46,000,000 in short-term Federal Home Loan Bank (FHLB) of San Francisco advances. There was no short-term FHLB advances as of December 31, 2021. We maintain a line of credit with the FHLB collateralized by government securities and loans. Refer to Liquidity section below for further discussion of FHLB advances. The Bank had unsecured lines of credit with its correspondent banks which, in the aggregate, amounted to $110,000,000 at December 31, 2022 and 2021, at interest rates which vary with market conditions. As of December 31, 2022 and 2021, the Company had no overnight borrowings outstanding under these credit facilities.
Capital Resources
Capital serves as a source of funds and helps protect depositors and shareholders against potential losses. Historically, the primary sources of capital for the Company have been internally generated capital through retained earnings and the issuance of common and preferred stock.
The Company has historically maintained substantial levels of capital. The assessment of capital adequacy is dependent on several factors including asset quality, earnings trends, liquidity and economic conditions. Maintenance of adequate capital levels is integral to providing stability to the Company. The Company needs to maintain substantial levels of regulatory capital to give it maximum flexibility in the changing regulatory environment and to respond to changes in the market and economic conditions.
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Our shareholders’ equity was $174,660,000 as of December 31, 2022, compared to $247,845,000 as of December 31, 2021. The decrease in shareholders’ equity is the result of decrease in accumulated other comprehensive income (AOCI) of $88,859,000, an increase in the unrealized loss recorded on the Company’s investment portfolio, the payment of common stock cash dividends of $5,638,000, and the repurchase and retirement of common stock of $6,814,000. These decreases were partially offset by an increase in retained earnings from our net income of $26,645,000, the exercise of stock options in the amount of $489,000, the effect of share-based compensation expense of $497,000, and stock issued under our employee stock purchase plan of $216,000.
During 2022, the Company made a capital contribution to the Bank in the amount of $38,000,000 in connection with the senior and subordinated debt proceeds approved by the Company’s Board of Directors. The Company declared and paid a total of $5,638,000 or $0.48 per common share cash dividend to shareholders of record during the year ended December 31, 2022. During the year ended December 31, 2022, the Company repurchased and retired common stock in the amount of $6,814,000.
During 2021, the Bank declared and paid cash dividends to the Company in the amount of $7,679,000 in connection with the cash dividends to the Company’s shareholders approved by the Company’s Board of Directors. The Company declared and paid a total of $5,757,000 or $0.47 per common share cash dividend to shareholders of record during the year ended December 31, 2021. During the year ended December 31, 2021, the Company repurchased and retired common stock in the amount of $13,619,000.
During 2020 the Bank declared and paid cash dividends to the Company in the amount of $15,622,000 in connection with the cash dividends to the Company’s shareholders approved by the Company’s Board of Directors. The Company declared and paid a total of $5,530,000 or $0.44 per common share cash dividend to shareholders of record during the year ended December 31, 2020. During the year ended December 31, 2020, the Company repurchased and retired common stock in the amount of $11,052,000.
The following table sets forth certain financial ratios for the years ended December 31, 2022, 2021, and 2020.
Net income:
Dividends declared per share to net income per share 21.14 % 19.75 % 26.99 %
Average shareholders’ equity to average assets 7.67 % 10.89 % 12.54 %
Management considers capital requirements as part of its strategic planning process. The strategic plan calls for continuing increases in assets and liabilities, and the capital required may therefore be in excess of retained earnings. The ability to obtain capital is dependent upon the capital markets as well as our performance. Management regularly evaluates sources of capital and the timing required to meet its strategic objectives.
The Board of Governors, the FDIC and other federal banking agencies have issued risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets, and transactions, such as letters of credit and recourse arrangements, which are reported as off-balance-sheet items.
The following table presents the Company’s regulatory capital ratios as of December 31, 2022 and December 31, 2021.
(Dollars in thousands) Actual Ratio
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The following table presents the Bank’s regulatory capital ratios as of December 31, 2022 and December 31, 2021
December 31, 2022 Amount Ratio Amount Ratio Amount Ratio
The Company succeeded to all of the rights and obligations of the Service 1st Capital Trust I, a Delaware business trust, in connection with the acquisition of Service 1st as of November 12, 2008. The Trust was formed on August 17, 2006 for the sole purpose of issuing trust preferred securities fully and unconditionally guaranteed by Service 1st. Under applicable regulatory guidance, the amount of trust preferred securities that is eligible as Tier 1 capital is limited to 25% of the Company’s Tier 1 capital on a pro forma basis. At December 31, 2022, all of the trust preferred securities that have been issued qualify as Tier 1 capital. The trust preferred securities mature on October 7, 2036, are redeemable at the Company’s option beginning five years after issuance, and require quarterly distributions by the Trust to the holder of the trust preferred securities at a variable interest rate which will adjust quarterly to equal the three-month LIBOR plus 1.60%.
The Trust used the proceeds from the sale of the trust preferred securities to purchase approximately $5,155,000 in aggregate principal amount of Service 1st’s junior subordinated notes (the Notes). The Notes bear interest at the same variable interest rate during the same quarterly periods as the trust preferred securities. The Notes are redeemable by the Company on any January 7, April 7, July 7, or October 7 on or after October 7, 2012 or at any time within 90 days following the occurrence of certain events, such as: (i) a change in the regulatory capital treatment of the Notes (ii) in the event the Trust is deemed an investment company or (iii) upon the occurrence of certain adverse tax events. In each such case, the Company may redeem the Notes for their aggregate principal amount, plus any accrued but unpaid interest.
The Notes may be declared immediately due and payable at the election of the trustee or holders of 25% of the aggregate principal amount of outstanding Notes in the event that the Company defaults in the payment of any interest following the nonpayment of any such interest for 20 or more consecutive quarterly periods. Holders of the trust preferred securities are entitled to a cumulative cash distribution on the liquidation amount of $1,000 per security. For each January 7, April 7, July 7 or October 7 of each year, the rate will be adjusted to equal the three month LIBOR plus 1.60%. As of December 31, 2022, the rate was 5.68%. Interest expense recognized by the Company for the years ended December 31, 2022, 2021, and 2020 was $188,000, $93,000 and $130,000, respectively.
On November 12, 2021, the Company completed a private placement of $35.0 million aggregate principal amount of its fixed-to-floating rate subordinated notes (“Subordinated Debt”) due December 1, 2031. The Subordinated Debt initially bears a fixed interest rate of 3.125% per year. Commencing on December 1, 2026, the interest rate on the Subordinated Debt will reset each quarter at a floating interest rate equal to the then-current three month term SOFR plus 210 basis points. The Company may at its option redeem in whole or in part the Subordinated Debt on or after November 12, 2026 without a premium. The Subordinated Debt is treated as Tier 2 Capital for regulatory purposes.
On September 15, 2022, the Company entered into a $30 million loan agreement with Bell Bank. Initially, payments of interest only are payable in 12 quarterly payments commencing December 31, 2022. As of December 31, 2022 the rate had reached its interest rate cap of 6.75%. Commencing December 31, 2025, 27 equal quarterly principal and interest payments are payable based on the outstanding balance of the loan on August 30, 2025 and an amortization of 48 quarters. A final payment of outstanding principal and accrued interest is due at maturity on September 30, 2032. Variable interest is payable at the Prime Rate (published by the Wall Street Journal) less 50 basis points. The loan is secured by the assets of the Company and a pledge of the outstanding common stock of Central Valley Community Bank, the Company’s banking subsidiary. The Company may prepay the loan without penalty with one exception. If the loan is prepaid prior to August 30, 2025 with funds received from a financing source other than Bell Bank, the Company will incur a 2% prepayment penalty. The loan contains customary representations, covenants, and events of default.
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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 funding of securities purchases, providing for customers’ credit needs and ongoing repayment of borrowings. Our liquidity is actively managed on a daily basis and reviewed periodically by our management and Directors’ Asset/Liability Committees. This process is intended to ensure the maintenance of sufficient funds to meet our needs, including adequate cash flows for off-balance sheet commitments.
Our primary sources of liquidity are derived from financing activities which include the acceptance of customer and, to a lesser extent, broker deposits, Federal funds facilities and advances from the Federal Home Loan Bank of San Francisco (FHLB). These funding sources are augmented by payments of principal and interest on loans, the routine maturities and pay downs of securities from the securities portfolio, the stability of our core deposits and the ability to sell investment securities. As of December 31, 2022, the Company had unpledged securities totaling $759,229,000 available as a secondary source of liquidity and total cash and cash equivalents of $31,170,000. Cash and cash equivalents at December 31, 2022 decreased 80.93% compared to December 31, 2021. Primary uses of funds include withdrawal of and interest payments on deposits, origination and purchases of loans, purchases of investment securities, and payment of operating expenses.
To augment our liquidity, we have established Federal funds lines with various correspondent banks. At December 31, 2022, our available borrowing capacity includes approximately $110,000,000 in Federal funds lines with our correspondent banks and $319,309,000 in unused FHLB advances. At December 31, 2022, we were not aware of any information that was reasonably likely to have a material effect on our liquidity position.
The following table reflects the Company’s credit lines, balances outstanding, and pledged collateral at December 31, 2022 and 2021:
Credit Lines (In thousands) December 31, 2022 December 31, 2021
Unsecured Credit Lines (interest rate varies with market):
Balance outstanding $ — $ —
Federal Home Loan Bank (interest rate at prevailing interest rate):
Balance outstanding $ 46,000 $ —
Federal Reserve Bank (interest rate at prevailing discount interest rate):
Balance outstanding $ — $ —
The liquidity of our parent company, Central Valley Community Bancorp, is primarily dependent on the payment of cash dividends by its subsidiary, Central Valley Community Bank, subject to limitations imposed by state and federal regulations.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with the accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expense in the financial statements. Various elements of our accounting policies, by their nature, involve the application of highly sensitive and judgmental estimates and assumptions. Some of these policies and estimates relate to matters that are highly complex and contain inherent uncertainties. It is possible that, in some instances, different estimates and assumptions could reasonably have been made and used by management, instead of those we applied, which might have produced different results that could have had a material effect on the financial statements.
We have identified the following accounting policies and estimates that, due to the inherent judgments and assumptions and the potential sensitivity of the financial statements to those judgments and assumptions, are critical to an understanding of our financial statements. We believe that the judgments, estimates and assumptions used in the preparation of the Company’s financial statements are appropriate. For a further description of our accounting policies, see Note 1 - Summary of Significant Accounting Policies in the financial statements included in this Form 10‐K.
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Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Allowance for Credit Losses
Our allowance for credit losses is an estimate of probable incurred losses in the loan portfolio. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance for credit losses. Management’s methodology for estimating the allowance balance consists of several key elements, which include specific allowances on individual impaired loans and the formula driven allowances on pools of loans with similar risks. The allowance is only an estimate of the inherent loss 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. Our accounting for estimated loan losses is discussed and disclosed primarily in Note 1 and 4 to the consolidated financial statements under the heading “Allowance for Credit Losses”.
INFLATION
The impact of inflation on a financial institution differs significantly from that exerted on other industries primarily because the assets and liabilities of financial institutions consist largely of monetary items. However, financial institutions are affected by inflation in part through non-interest expenses, such as salaries and occupancy expenses, and to some extent by changes in interest rates.
At December 31, 2022, we do not believe that inflation will have a material impact on our consolidated financial position or results of operations. However, if inflation concerns cause short term rates to rise in the near future, we may benefit by immediate repricing of a portion of our loan portfolio. Higher inflation rates may increase operating expenses or have other adverse effects on our borrowers, making collection on extensions of credit more difficult for us. Refer to Quantitative and Qualitative Disclosures About Market Risk for further discussion.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate risk (IRR) and credit risk constitute the two greatest sources of financial exposure for insured financial institutions that operate like we do. IRR represents the impact that changes in absolute and relative levels of market interest rates may have upon our net interest income (NII). Changes in the NII are the result of changes in the net interest spread between interest-earning assets and interest-bearing liabilities (timing risk), the relationship between various rates (basis risk), and changes in the shape of the yield curve.
We realize income principally from the differential or spread between the interest earned on loans, investments, other interest-earning assets and the interest incurred on deposits and borrowings. The volumes and yields on loans, deposits and borrowings are affected by market interest rates. As of December 31, 2022, 61.42% of our loan portfolio was tied to adjustable-rate indices. The majority of our adjustable rate loans are tied to prime and reprice within 90 days. Several of our loans, tied to prime, are at their floors and will not reprice until prime plus the factor is greater than the floor. The majority of our time deposits have a fixed rate of interest. As of December 31, 2022, 84.77% of our time deposits mature within one year or less.
Changes in the market level of interest rates directly and immediately affect our interest spread, and therefore profitability. Sharp and significant changes to market rates can cause the interest spread to shrink or expand significantly in the near term, principally because of the timing differences between the adjustable rate loans and the maturities (and therefore repricing) of the deposits and borrowings.
Our management and Board of Directors’ Asset/Liability Committees (ALCO) are responsible for managing our assets and liabilities in a manner that balances profitability, IRR and various other risks including liquidity. The ALCO operates under policies and within risk limits prescribed, reviewed, and approved by the Board of Directors.
The ALCO seeks to stabilize our NII by matching rate-sensitive assets and liabilities through maintaining the maturity and repricing of these assets and liabilities at appropriate levels given the interest rate environment. When the amount of rate-sensitive liabilities exceeds rate-sensitive assets within specified time periods, NII generally will be negatively impacted by an increasing interest rate environment and positively impacted by a decreasing interest rate environment. Conversely, when the amount of rate-sensitive assets exceeds the amount of rate-sensitive liabilities within specified time periods, net interest income will generally be positively impacted by an increasing interest rate environment and negatively impacted by a decreasing interest rate environment. Our mix of assets consists primarily of loans and securities, none of which are held for trading
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purposes. The value of these securities is subject to interest rate risk, which we must monitor and manage successfully in order to prevent declines in value of these assets if interest rates rise in the future. The speed and velocity of the repricing of assets and liabilities will also contribute to the effects on our NII, as will the presence or absence of periodic and lifetime interest rate caps and floors.
Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Earnings simulations are produced using a software model that is based on actual cash flows and repricing characteristics for all of our financial instruments and incorporates market-based assumptions regarding the impact of changing interest rates on current volumes of applicable financial instruments.
Interest rate simulations provide us with an estimate of both the dollar amount and percentage change in NII under various rate scenarios. All assets and liabilities are normally subjected to up to 400 basis point increases and decreases in interest rates in 100 basis point increments. Under each interest rate scenario, we project our net interest income. From these results, we can then develop alternatives in dealing with the tolerance thresholds.
The assets and liabilities of a financial institution are primarily monetary in nature. As such they represent obligations to pay or receive fixed and determinable amounts of money that are not affected by future changes in prices. Generally, the impact of inflation on a financial institution is reflected by fluctuations in interest rates, the ability of customers to repay their obligations and upward pressure on operating expenses. Although inflationary pressures are not considered to be of any particular hindrance in the current economic environment, they may have an impact on the company’s future earnings in the event those pressures become more prevalent.
As a financial institution, the Company’s primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of interest income and interest expense recorded on a large portion of the Company’s assets and liabilities, and the market value of all interest earning assets and interest bearing liabilities, other than those which possess a short term to maturity. Virtually all of the Company’s interest earning assets and interest bearing liabilities are located at the Bank level. Thus, virtually all of the Company’s interest rate risk exposure lies at the Bank level other than $5.2 million in subordinated notes issued by the Company’s subsidiary, Service 1st Capital Trust I. As a result, all significant interest rate risk procedures are performed at the Bank level.
The fundamental objective of the Company’s management of its assets and liabilities is to maximize the Company’s economic value while maintaining adequate liquidity and an exposure to interest rate risk deemed by management to be acceptable. Management believes an acceptable degree of exposure to interest rate risk results from the management of assets and liabilities through maturities, pricing and mix to attempt to neutralize the potential impact of changes in market interest rates. The Company’s profitability is dependent to a large extent upon its net interest income, which is the difference between its interest income on interest earning assets, such as loans and investments, and its interest expense on interest bearing liabilities, such as deposits and borrowings. The Company is subject to interest rate risk to the degree that its interest earning assets re-price differently than its interest bearing liabilities. The Company manages its mix of assets and liabilities with the goals of limiting its exposure to interest rate risk, ensuring adequate liquidity, and coordinating its sources and uses of funds.
The Company seeks to control interest rate risk exposure in a manner that will allow for adequate levels of earnings and capital over a range of possible interest rate environments. The Company has adopted formal policies and practices to monitor and manage interest rate risk exposure. Management believes historically it has effectively managed the effect of changes in interest rates on its operating results and believes that it can continue to manage the short-term effects of interest rate changes under various interest rate scenarios.
Management employs asset and liability management software and engages consultants to measure the Company’s exposure to future changes in interest rates. The software measures the expected cash flows and re-pricing of each financial asset/liability separately in measuring the Company’s interest rate sensitivity. Based on the results of the software’s output, management believes the Company’s balance sheet is evenly matched over the short term and slightly asset sensitive over the longer term as of December 31, 2022. This means that the Company would expect (all other things being equal) to experience a limited change in its net interest income if rates rise or fall. The level of potential or expected change indicated by the tables below is considered acceptable by management and is compliant with the Company’s ALCO policies. Management will continue to perform this analysis each quarter.
The hypothetical impacts of sudden interest rate movements applied to the Company’s asset and liability balances are modeled quarterly. The results of these models indicate how much of the Company’s net interest income is “at risk” from various rate changes over a one year horizon. This exercise is valuable in identifying risk exposures. Management believes the results for the Company’s December 31, 2022 balances indicate that the net interest income at risk over a one year time horizon for a 100 basis points (“bps”), 200 bps, 300 bps, and 400 bps rate increase and a 100 bps decrease is acceptable to management and within policy guidelines at this time. Given the low interest rate environment, 200 bps, 300 bps, and 400 bps decreases are not considered a realistic possibility and are therefore not modeled.
The results in the table below indicate the change in net interest income the Company would expect to see as of December 31, 2022, if interest rates were to change in the amounts set forth:
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Sensitivity Analysis of Impact of Rate Changes on Interest Income
It is important to note that the above table is a summary of several forecasts and actual results may vary from any of the forecasted amounts and such difference may be material and adverse. The forecasts are based on estimates and assumptions made by management, and that may turn out to be different, and may change over time. Factors affecting these estimates and assumptions include, but are not limited to: 1) competitor behavior, 2) economic conditions both locally and nationally, 3) actions taken by the Federal Reserve Board, 4) customer behavior and 5) management’s responses to each of the foregoing. Factors that vary significantly from the assumptions and estimates may have material and adverse effects on the Company’s net interest income; therefore, the results of this analysis should not be relied upon as indicative of actual future results.
The following table shows management’s estimates of how the loan portfolio is segregated between variable-daily, variable other than daily, and fixed rate loans, and estimates of re-pricing opportunities for the entire loan portfolio at December 31, 2022 and 2021:
Approximately 61.42% of our loan portfolio is tied to adjustable rate indices and 18.42% of our loan portfolio reprices within 90 days. As of December 31, 2022, we had 1,146 commercial and real estate loans totaling $578,407,341 with floors ranging from 0.50% to 9.00% and ceilings ranging from 4.50% to 25.00%.
The following table shows the repricing categories of the Company’s loan portfolio at December 31, 2022 and 2021:
Assumptions are inherently uncertain, and, consequently, the model cannot precisely measure net interest income or precisely predict the impact of changes in interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes, as well as changes in market conditions and management strategies which might moderate the negative consequences of interest rate deviations.
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ITEM 8 -FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors of
Central Valley Community Bancorp and Subsidiary
Fresno, California
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Central Valley Community Bancorp and Subsidiary (the "Company") as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive (loss) income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2022, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Credit Losses (ACL) – Qualitative Factors
As described in Notes 1 – Summary of Significant Accounting Policies and 4 – Loans and Allowance for Credit Losses to the consolidated financial statements, the ACL is a valuation allowance for probable incurred credit losses in the Company’s loan portfolio. The ACL consists of two primary components, specific reserves related to impaired loans and general reserves for inherent losses related to loans that are not impaired. The general reserve consists of a simple average of historical losses by portfolio segment and qualitative factors. The qualitative factors include consideration of economic trends in the Company’s service areas, industry experience and trends, industry and geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan portfolio, and probable losses inherent in the portfolio taken as a whole.
Given the significance of the qualitative factors to the overall allowance for credit losses, that management’s determination of the qualitative factors is subjective and involves significant management judgments, we have identified auditing the qualitative factors used in the ACL as a critical audit matter. Our audit procedures involved a high degree of auditor judgment and required significant audit effort, including the need to involve more experienced audit personnel.
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The primary procedures we performed to address this critical audit matter included:
•Evaluation of the relevance and reliability of the internal and external data used and its appropriateness and sensitivity as a basis for the adjustments relating to the qualitative factors.
•Evaluation of the reasonableness of management’s significant judgments and assumptions used in the determination of the qualitative factors.
•Analytically evaluating the directional consistency and magnitude of the change of the qualitative factors to trends in the loan portfolio and other economic data for reasonableness, which included a comparison to the prior period end and evaluating the reasonableness of the qualitative factors as of period end.
•Testing the mathematical accuracy of the qualitative factors.
/s/ Crowe LLP
We have served as the Company’s auditor since 2011.
Sacramento, California
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2022 and 2021
(In thousands, except share amounts) 2022 2021
ASSETS
Interest-earning deposits in other banks 5,685 134,055
Held-to-maturity investment securities 305,107 —
Bank premises and equipment, net 7,987 8,380
Core deposit intangibles 68 522
Accrued interest receivable and other assets 76,865 32,710
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Short-term borrowings 46,000 —
Senior debt and subordinated debentures 69,599 39,454
Accrued interest payable and other liabilities 32,611 40,043
Commitments and contingencies (Note 12)
Shareholders’ equity:
Accumulated other comprehensive (loss) income, net of tax (81,227) 7,632
The accompanying notes are an integral part of these consolidated financial statements.
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2022, 2021, and 2020
Interest income:
Interest on deposits in other banks 391 129 246
Interest and dividends on investment securities:
Interest expense:
Interest on subordinated debentures and borrowings 2,225 266 130
Provision for (reversal of) credit losses 1,000 (4,300) 3,275
Non-interest income:
Appreciation in cash surrender value of bank owned life insurance 985 840 711
Non-interest expenses:
Amortization of core deposit intangibles 454 661 695
Basic earnings per common share $ 2.27 $ 2.32 $ 1.62
Diluted earnings per common share $ 2.27 $ 2.31 $ 1.62
Cash dividends per common share $ 0.48 $ 0.47 $ 0.44
The accompanying notes are an integral part of these consolidated financial statements.
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
For the Years Ended December 31, 2022, 2021, and 2020
Other Comprehensive (Loss) Income:
Unrealized (losses) gains on securities:
Amortization of net unrealized losses transferred 1,651 — —
The accompanying notes are an integral part of these consolidated financial statements.
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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Years Ended December 31, 2022, 2021, and 2020
Common Stock Retained Earnings
(In thousands, except share amounts) Shares Amount
Restricted stock granted, net of forfeitures 13,008 — — — —
Stock issued under employee stock purchase plan 15,764 199 — — 199
Stock-based compensation expense — 470 — — 470
Cash dividend ($0.44 per common share) — — (5,530) — (5,530)
Other comprehensive loss — — — (7,224) (7,224)
Restricted stock granted, net of forfeitures 20,720 — — — —
Stock issued under employee stock purchase plan 12,521 204 — — 204
Stock-based compensation expense — 405 — — 405
Cash dividend ($0.47 per common share) — — (5,757) — (5,757)
Restricted stock granted, net of forfeitures 42,399 — — — —
Stock issued under employee stock purchase plan 13,351 216 — — 216
Stock-based compensation expense — 497 — — 497
Cash dividend ($0.48 per common share) — — (5,638) — (5,638)
Repurchase and retirement of common stock (300,761) (6,814) — — (6,814)
The accompanying notes are an integral part of these consolidated financial statements.
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Cash flows from operating activities:
Net (increase) decrease in deferred loan costs (422) 3,483 (4,127)
Net gain on sale and disposal of equipment (15) (8) (6)
Net change in equity investments 858 218 (162)
Increase in bank owned life insurance, net of expenses (985) (840) (551)
Net gain on bank owned life insurance — — (1,167)
Benefit (provision) for deferred income taxes 224 1,465 (1,051)
Cash Flows From Investing Activities:
Purchases of premises and equipment (362) (1,049) (1,492)
Purchases of bank owned life insurance — (10,000) (250)
FHLB stock (purchased) redeemed (574) — 467
Proceeds from bank owned life insurance — — 3,485
Proceeds from sale of premises and equipment 15 9 6
Cash Flows From Financing Activities:
Net (decrease) increase in time deposits (22,107) 184 (3,883)
Proceeds from issuance of subordinated debt — 34,299 —
Proceeds from short-term borrowings from Federal Home Loan Bank 2,452,826 — —
Repayments of short-term borrowings to Federal Home Loan Bank (2,406,826) — —
Proceeds of issuance of senior debt 30,000 — —
Proceeds from stock issued under employee stock purchase plan 216 204 199
Proceeds from exercise of stock options 489 257 279
Cash dividend payments on common stock (5,638) (5,757) (5,530)
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Operating cash flows from operating leases $ 2,221 $ 2,259 $ 2,240
Non-cash investing and financing activities:
The accompanying notes are an integral part of these consolidated financial statements.
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Central Valley Community Bancorp and Subsidiary
Notes to Consolidated Financial Statements
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General - Central Valley Community Bancorp (the “Company”) was incorporated on February 7, 2000 and subsequently obtained approval from the Board of Governors of the Federal Reserve System to be a bank holding company in connection with its acquisition of Central Valley Community Bank (the “Bank”). The Company became the sole shareholder of the Bank on November 15, 2000 in a statutory merger, pursuant to which each outstanding share of the Bank’s common stock was exchanged for one share of common stock of the Company.
Service 1st Capital Trust I (the Trust) is a business trust formed by Service 1st for the sole purpose of issuing trust preferred securities. The Company succeeded to all the rights and obligations of Service 1st in connection with the acquisition of Service 1st. The Trust is a wholly-owned subsidiary of the Company.
The Bank operates 19 full service offices throughout California’s San Joaquin Valley and Greater Sacramento Region. The Bank’s primary source of revenue is providing loans to customers who are predominately small and middle-market businesses and individuals.
The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. Depositors’ accounts at an insured depository institution, including all non-interest bearing transactions accounts, will be insured by the FDIC up to the standard maximum deposit insurance amount of $250,000 for each deposit insurance ownership category.
The accounting and reporting policies of the Company and the Bank conform with accounting principles generally accepted in the United States of America and prevailing practices within the banking industry.
Management has determined that because all of the banking products and services offered by the Company are available in each branch of the Bank, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank branches and report them as a single operating segment. No customer accounts for more than 10 percent of revenues for the Company or the Bank.
Principles of Consolidation - The consolidated financial statements include the accounts of the Company and the consolidated accounts of its wholly-owned subsidiary, the Bank. Intercompany transactions and balances are eliminated in consolidation.
For financial reporting purposes, Service 1st Capital Trust I, is a wholly-owned subsidiary acquired in the merger of Service 1st Bancorp and formed for the exclusive purpose of issuing trust preferred securities. The Company is not considered the primary beneficiary of this trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability on the Company’s consolidated financial statements. The Company’s investment in the common stock of the Trust is included in accrued interest receivable and other assets on the consolidated balance sheet.
Use of Estimates - The preparation of these financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates the estimates used. Estimates are based upon historical experience, current economic conditions and other factors that management considers reasonable under the circumstances.
These estimates result in judgments regarding the carrying values of assets and liabilities when these values are not readily available from other sources, as well as assessing and identifying the accounting treatments of contingencies and commitments. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions.
Cash and Cash Equivalents - For the purpose of the statement of cash flows, cash, due from banks with maturities less than 90 days, interest-earning deposits in other banks, and Federal funds sold are considered to be cash equivalents. Generally, Federal funds are sold and purchased for one-day periods. Net cash flows are reported for customer loan and deposit transactions, interest-bearing deposits in other banks, and Federal funds purchased.
Investment Securities - Investments are classified into the following categories:
•Available-for-sale securities, reported at fair value, with unrealized gains and losses excluded from earnings and reported, net of taxes, as accumulated other comprehensive income (loss) within shareholders’ equity.
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•Held-to-maturity securities, which management has the positive intent and ability to hold to maturity, reported at amortized cost, adjusted for the accretion of discounts and amortization of premiums.
Management determines the appropriate classification of its investments at the time of purchase and may only change the classification in certain limited circumstances. All transfers between categories are accounted for at fair value in the period which the transfer occurs.
Gains or losses on the sale of investment securities are computed on the specific identification method. Interest earned on investment securities is reported in interest income, net of applicable adjustments for accretion of discounts and amortization of premiums. Premiums and discounts on securities are amortized or accreted on the level yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated.
An investment security is impaired when its carrying value is greater than its fair value. Investment securities that are impaired are evaluated on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation to determine whether such a decline in their fair value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline and the intent and ability of the Company to retain its investment in the securities for a period of time sufficient to allow for an anticipated recovery in fair value, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other than temporary, and management does not intend to sell the security or it is more likely than not that the Company will not be required to sell the security before recovery, for debt securities, only the portion of the impairment loss representing credit exposure is recognized as a charge to earnings, with the balance recognized as a charge to other comprehensive income. If management intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its forecasted cost, the entire impairment loss is recognized as a charge to earnings.
Loans - All loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at principal balances outstanding net of deferred loan fees and costs, and the allowance for credit losses. Interest is accrued daily based upon outstanding loan principal balances. However, when a loan becomes impaired and the future collectability of interest and principal is in serious doubt, the loan is placed on nonaccrual status and the accrual of interest income is suspended. Any loan delinquent 90 days or more is automatically placed on nonaccrual status. Any interest accrued but unpaid is charged against income. Subsequent payments on these loans, or payments received on nonaccrual loans for which the ultimate collectability of principal is not in doubt, are applied first to principal until fully collected and then to interest.
Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer and credit card loans are typically charged off no later than 90 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. A loan placed on non-accrual status may be restored to accrual status when principal and interest are no longer past due and unpaid, or the loan otherwise becomes both well secured and in the process of collection. When a loan is brought current, the Company must also have reasonable assurance that the obligor has the ability to meet all contractual obligations in the future, that the loan will be repaid within a reasonable period of time, and that a minimum of six months of satisfactory repayment performance has occurred.
Substantially all loan origination fees, commitment fees, direct loan origination costs and purchase premiums and discounts on loans are deferred and recognized as an adjustment of yield, and amortized to interest income over the contractual term of the loan. The unamortized balance of deferred fees and costs is reported as a component of net loans.
Acquired loans and Leases - Loans and leases acquired through purchase or through a business combination are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan and lease losses is not recorded at the acquisition date. Should the Company’s allowance for credit losses methodology indicate that the credit discount associated with acquired, non-purchased credit impaired loans, is no longer sufficient to cover probable losses inherent in those loans, the Company will establish an allowance for those loans through a charge to provision for credit losses. At the time of an acquisition, we evaluate loans to determine if they are purchase credit impaired loans. Purchased credit impaired loans are those acquired loans with evidence of credit deterioration for which collection of all contractual payments was not considered probable at the date of acquisition. This determination is made by considering past due and/or nonaccrual status, prior designation of a troubled debt restructuring, or other factors that may suggest we will not be able to collect all contractual payments. Purchased credit impaired loans are initially recorded at fair value with the difference between fair value and estimated future cash flows accreted over the expected cash flow period as income only to the extent we can reasonably estimate the timing and amount of future cash flows. In this case, these loans would be classified as accruing. In the event we are unable to reasonably estimate the timing and amount of future cash flows, or if the loan is acquired primarily for the rewards of ownership of the underlying collateral, the loan is classified as non-accrual. An acquired loan
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previously classified by the seller as a troubled debt restructuring is no longer classified as such at the date of acquisition. Past due status is reported based on contractual payment status.
All loans not otherwise classified as purchase credit impaired are recorded at fair value with the discount to contractual value accreted over the life of the loan.
Allowance for Credit Losses - The allowance for credit losses (the “allowance”) is a valuation allowance for probable incurred credit losses in the Company’s loan portfolio. The allowance is established through a provision for credit losses which is charged to expense. Additions to the allowance are made to maintain the adequacy of the total allowance after credit losses and loan growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of two primary components, specific reserves related to impaired loans and general reserves for inherent losses related to loans that are not impaired.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans determined to be impaired are individually evaluated for impairment. When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. A loan is collateral dependent if the repayment of the loan is expected to come solely from the sale or operation of underlying collateral.
A restructuring of a debt constitutes a troubled debt restructuring (TDR) if the Company for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider. Restructured workout loans typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. Loans that are reported as TDRs are considered impaired and measured for impairment as described above.
When determining the allowance for loan losses on acquired loans, we bifurcate the allowance between legacy loans and acquired loans. Loans remain designated as acquired until either (i) loan is renewed or (ii) loan is substantially modified whereby modification results in a new loan. When determining the allowance on acquired loans, the Company estimates probable incurred credit losses as compared to the Company’s recorded investment, with the recorded investment being net of any unaccreted discounts from the acquisition.
The determination of the general reserve for loans that are not impaired is based on estimates made by management, including but not limited to, consideration of a simple average of historical losses by portfolio segment (and in certain cases peer loss data) over the most recent 56 quarters, and qualitative factors including economic trends in the Company’s service areas, industry experience and trends, industry and geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan portfolio, and probable losses inherent in the portfolio taken as a whole.
The Company segregates the allowance by portfolio segment. These portfolio segments include commercial, real estate, and consumer loans. The relative significance of risk considerations vary by portfolio segment. For commercial and real estate loans, the primary risk consideration is a borrower’s ability to generate sufficient cash flows to repay their loan. Secondary considerations include the creditworthiness of guarantors and the valuation of collateral. In addition to the creditworthiness of a borrower, the type and location of real estate collateral is an important risk factor for real estate loans. The primary risk considerations for consumer loans are a borrower’s personal cash flow and liquidity, as well as collateral value. The allowance for credit losses attributable to each portfolio segment, which includes both impaired loans and loans that are not impaired, is combined to determine the Company’s overall allowance, which is included on the consolidated balance sheet.
Commercial:
Commercial and industrial - Commercial and industrial loans are generally underwritten to existing cash flows of operating businesses. Additionally, economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Past due payments may indicate the borrower’s capacity to repay their obligations may be deteriorating.
Agricultural production - Loans secured by crop production and livestock are especially vulnerable to two risk factors that are largely outside the control of Company and borrowers: commodity prices and weather conditions.
Real Estate:
Owner-occupied commercial real estate - Real estate collateral secured by commercial or professional properties with repayment arising from the owner’s business cash flows. To meet this classification, the owner’s operation must occupy no less
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than 50% of the real estate held. Financial profitability and capacity to meet the cyclical nature of the industry and related real estate market over a significant timeframe is essential.
Real estate construction and other land loans - Land and construction loans generally possess a higher inherent risk of loss than other real estate portfolio segments. A major risk arises from the necessity to complete projects within specified costs and time lines. Trends in the construction industry significantly impact the credit quality of these loans, as demand drives construction activity. In addition, trends in real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of construction projects.
Agricultural real estate - Agricultural loans secured by real estate generally possess a higher inherent risk of loss caused by changes in concentration of permanent plantings, government subsidies, and the value of the U.S. dollar affecting the export of commodities.
Investor commercial real estate - Investor commercial real estate loans generally possess a higher inherent risk of loss than other real estate portfolio segments, except land and construction loans. Adverse economic developments or an overbuilt market impact commercial real estate projects and may result in troubled loans. Trends in vacancy rates of commercial properties impact the credit quality of these loans. High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flows to service debt obligations.
Other real estate - Primarily loans secured by agricultural real estate for development and production of permanent plantings that have not reached maximum yields. Real estate loans where agricultural vertical integration exists in packing and shipping of commodities and risk is primarily based on the liquidity of the borrower to sustain payment during the development period.
Consumer:
Equity loans and lines of credit - The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower’s ability to repay in an orderly fashion. These loans generally possess a lower inherent risk of loss than other real estate portfolio segments. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends may indicate that the borrowers’ capacity to repay their obligations may be deteriorating.
Installment and other consumer loans - An installment loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period. Most installment loans are made directly for consumer purchases. Other consumer loans include other open ended unsecured consumer loans. Open ended unsecured loans generally have a higher rate of default than all other portfolio segments and are also impacted by weak economic conditions and trends. Open ended unsecured loans in homogeneous loan portfolio segments are not evaluated for specific impairment.
Although management believes the allowance to be adequate, ultimate losses may vary from its estimates. At least quarterly, the Board of Directors reviews the adequacy of the allowance, including consideration of the relative risks in the portfolio, current economic conditions and other factors. If the Board of Directors and management determine that changes are warranted based on those reviews, the allowance is adjusted. In addition, the Company’s primary regulators, the FDIC and California Department of Business Oversight, as an integral part of their examination process, review the adequacy of the allowance. These regulatory agencies may require additions to the allowance based on their judgment about information available at the time of their examinations.
Risk Rating - The Company assigns a risk rating to all loans, and periodically performs detailed reviews of all such loans over a certain threshold to identify credit risks and to assess the overall collectability of the portfolio. The most recent review of risk rating was completed in December 2022. These risk ratings are also subject to examination by independent specialists engaged by the Company, and the Company’s regulators. During these internal reviews, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans. These credit quality indicators are used to assign a risk rating to each individual loan. The risk ratings can be grouped into five major categories, defined as follows:
Pass - A pass loan is a strong credit with no existing or known potential weaknesses deserving of management’s close attention.
Special Mention - A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Company’s credit position at some future date. Special Mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.