ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS
The following discussion addresses information pertaining to the financial condition and results of operations of Westamerica Bancorporation and subsidiaries (the “Company”) that may not be otherwise apparent from a review of the consolidated financial statements and related footnotes. It should be read in conjunction with those statements and notes found on pages 50 through 92, as well as with the other information presented throughout this Report.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the banking industry. Application of these principles requires the Company to make certain estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain accounting policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment writedown or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.
The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, Management has identified the allowance for credit losses accounting to be the accounting area requiring the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available. A discussion of the factors affecting accounting for the allowance for credit losses and purchased loans is included in the “Loan Portfolio Credit Risk” discussion below.
Financial Overview
Westamerica Bancorporation and subsidiaries’ (collectively, the “Company”) reported net income of $80.4 million or $2.98 diluted earnings per common share in 2020. The COVID-19 coronavirus pandemic began in the United States and California in the first quarter 2020 and continued to cause escalating infections in the United States through the fourth quarter 2020. In response to the pandemic, the Company’s primary and wholly-owned subsidiary bank, Westamerica Bank (the “Bank”), funded $249 million Paycheck Protection Program (“PPP”) loans for the Bank’s customers during the second quarter 2020. PPP loans meaningfully increased interest-earning assets and related interest and fee income. The Bank continues to work with loan customers requesting deferral of loan payments due to economic weakness caused by the pandemic. At December 31, 2020, consumer loans granted loan deferrals totaled $2.5 million, commercial real estate loans with deferred payments totaled $7.8 million, primarily for hospitality and retail properties, and commercial loans with deferred payments totaled $33 thousand. The results for 2020 included a provision for credit losses of $4.3 million, which reduced EPS $0.11, representing Management’s estimate of additional reserves needed over the remaining life of its loans due to increased credit-risk from deteriorating economic conditions caused by the COVID-19 pandemic. Results for 2020 include a $3.5 million gain on sales of a closed branch building which increased EPS $0.13. These results compare to net income of $80.4 million or $2.98 diluted earnings per common share for 2019. Results for 2019 include a tax-exempt life insurance gain of $433 thousand and $553 thousand in loss contingencies. The loss contingencies include a $301 thousand increase in estimated customer refunds of revenue recognized prior to 2018 and a $252 thousand settlement to dismiss a lawsuit. During the year ended December 31, 2020, the Company paid $4,410 thousand of obligations accrued in prior years to customers eligible for refunds. The remaining obligations at December 31, 2020 was $1,433 thousand, included in other liabilities. The tax-exempt life insurance gain and loss contingencies did not have a significant impact on the EPS for 2019.
Regions and states of the United States of America, including California implemented varying degrees of “stay at home” directives in an effort to prevent the spread of the virus in the first quarter of 2020. These directives have significantly reduced economic activity in the United States and the State of California. In the second and third quarters 2020 the “stay at home” directives were gradually lifted in varying stages in counties of the State of California. Counties with high infection rates delayed reopening and restrictions on certain economic activity remained. When infections increased in the fourth quarter restrictions were re-imposed to some degree. California-based claims for unemployment rose and remained elevated during 2020. The California “stay at home” directive excludes essential businesses including banks. The Bank remains open and fully operational.
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In response to the pandemic, the Federal Reserve has engaged significant levels of monetary policy to provide liquidity and credit facilities to the financial markets. On March 15, 2020, the Federal Open Market Committee (“FOMC”) reduced the target range for the federal funds rate to 0 to 0.25 percent; relatedly, the FOMC reduced the interest rate paid on deposit balances to 0.10 percent effective March 16, 2020. The Bank maintains deposit balances at the Federal Reserve Bank; the amount that earns interest is identified in the Company’s financial statements as “interest-bearing cash”.
The extent of the spread of the coronavirus and its ultimate containment are uncertain at this time. The effectiveness of the Federal Reserve Bank’s monetary policies and the federal government’s fiscal policies in stimulating the United States economy is uncertain at this time. Management expects the Company’s net interest margin and non-interest income to decline and credit-related losses to increase for an uncertain period given the decline in economic activity occurring due to the coronavirus. The amount of impact on the Company’s financial results is uncertain. Please refer to Part II, Item 1A “Risk factors” in this report on Form 10-K.
The Company presents its net interest margin and net interest income on a fully taxable equivalent (“FTE”) basis using the current statutory federal tax rate. Management believes the FTE basis is valuable to the reader because the Company’s loan and investment securities portfolios contain a relatively large portion of municipal loans and securities that are federally tax exempt. The Company’s tax exempt loans and securities composition may not be similar to that of other banks, therefore in order to reflect the impact of the federally tax exempt loans and securities on the net interest margin and net interest income for comparability with other banks, the Company presents its net interest margin and net interest income on an FTE basis.
The Company’s significant accounting policies (see Note 1 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements below) are fundamental to understanding the Company’s results of operations and financial condition. The Company adopted the following new accounting guidance:
FASB ASU 2016-13,Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was issued on June 16, 2016. The ASU significantly changed estimates for credit losses related to financial assets measured at amortized cost and certain other contracts. For estimating credit losses, the FASB replaced the incurred loss model with the current expected credit loss (CECL) model, which accelerated recognition of credit losses. Additionally, credit losses relating to debt securities available-for-sale are recorded through an allowance for credit losses under the new standard. The Company is also required to provide additional disclosures related to the financial assets within the scope of the new standard.
The Company adopted the ASU provisions on January 1, 2020. Management evaluated available data, defined portfolio segments of loans with similar attributes, and selected loss estimate models for each identified loan portfolio segment. Management measured historical loss rates for each portfolio segment. Management also segmented debt securities held to maturity, selected methods to estimate losses for each segment, and measured a loss estimate. Agency mortgage-backed securities were assigned no credit loss allowance due to the perceived backing of government sponsored entities. Municipal securities were evaluated for risk of default based on credit rating and remaining term to maturity using Moody’s risk of default factors; Moody’s loss upon default factors were applied to the assumed defaulted principal amounts to estimate the amount for credit loss allowance. The adjustment to the allowance for credit losses was recorded through an offsetting after-tax adjustment to shareholders’ equity. The implementing entry increased allowance for credit losses on loans by $2,017 thousand, reduced allowance for unfunded credit commitments by $2,107 thousand and increased retained earnings by $52 thousand.
FASB ASU 2018-13, Fair Value Measurements (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, was issued August 2018. The ASU is part of the disclosure framework project, where the primary focus is to improve the effectiveness of disclosures in the financial statements. The ASU removes, modifies and adds disclosure requirements related to Fair Value Measurements.
The provisions of the ASU were effective January 1, 2020 with the option to early adopt any removed or modified disclosures upon issuance of the ASU. The Company early adopted the provisions to remove and/or modify relevant disclosures in the “Fair Value Measurements” note to the unaudited consolidated financial statements. The requirement to include additional disclosures was adopted by the Company January 1, 2020. The additional disclosures did not affect the financial results upon adoption.
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Net Income
Following is a summary of the components of net income for the periods indicated:
For the Years Ended December 31,
($ in thousands, except per share data)
Provision for credit losses (4,300 ) - -
Net income per average fully-diluted common share $ 2.98 $ 2.98 $ 2.67
Net income as a percentage of average total assets 1.30 % 1.44 % 1.27 %
Net income remained at the same level in 2020 and 2019. Net interest and loan fee (FTE) income increased $6.3 million due to higher average balances of investments and average balances of $151 million of PPP loans, partially offset by lower yield on interest-bearing earning assets and lower average balances of other loans.
Results for 2020 include a provision of credit losses of $4.3 million, representing Management estimate of additional reserves needed over the remaining life of its loans due to credit-risk from economic weakness caused by the COVID-19 pandemic. Noninterest income decreased $1.8 million compared with 2019 due to lower income from activity based fees due to reduced economic activity related to the COVID-19 pandemic. Additionally, the results for 2019 included a life insurance gain of $433 thousand. The decrease in noninterest income from 2019 to 2020 was partially offset by $3.5 million in gains on sales of a closed branch building in 2020. In 2020 noninterest expense decreased $420 thousand compared with lower salaries, occupancy and equipment expenses, and lower amortization of intangible assets, and because the results for 2019 included $553 thousand of loss contingency. The decrease was partially offset by higher FDIC assessments (included in “other noninterest expense”) in 2020 because FDIC assessments in 2019 were reduced by application of the Bank’s FDIC assessment credit described in Part 1, Item 1, “Premiums for Deposit Insurance”. The effective tax rates (FTE) was 27.2% for 2020 compared with 26.8% for 2019.
Comparing 2019 with 2018, net income increased $8.8 million. Net interest and loan fee (FTE) income increased $6.0 million due to a higher net yield on earning assets and higher average balances of investments, partially offset by lower average balances of interest-bearing cash and loans. The provision for loan losses remained zero, reflecting Management's evaluation of losses inherent in the loan portfolio. In 2019, noninterest income decreased $741 thousand compared with 2018 due to lower income from service charges on deposit accounts, other service charges and debit card fees, offset in part by an increase in merchant processing services and securities gains in 2019. In 2019 noninterest expense decreased $7.9 million compared with 2018 primarily due to decreases in loss contingencies, salaries and related benefits, FDIC insurance assessments, and intangible amortization. The effective tax rates (FTE) was 26.8% for 2019 compared with 26.0% for 2018.
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Net Interest and Loan Fee Income (FTE)
The Company's primary source of revenue is net interest income, or the difference between interest income earned on loans and investment securities and interest expense paid on interest-bearing deposits and other borrowings.
Components of Net Interest and Loan Fee Income (FTE)
For the Years Ended December 31,
($ in thousands)
Net interest margin (FTE) 2.91 % 3.11 % 2.98 %
Net interest and loan fee income (FTE) increased $6.3 million in 2020 compared with 2019 due to higher average balances of investments (up $445 million) and average balances of $151 million of PPP loans, partially offset by lower yield on interest-bearing earning assets (down 0.20%) and lower average balances of other loans (down $74 million).
Comparing 2019 with 2018, net interest and loan fee income (FTE) increased $6.0 million due to a higher net yield on earning assets (up 0.12%) and higher average balances of investments (up $127 million), partially offset by lower average balances of interest-bearing cash (down $101 million) and loans (down $47 million).
The net interest margin (FTE) was 2.91% in 2020, 3.11% in 2019 and 2.98% in 2018. The yield on earning assets (FTE) was 2.94% in 2020, 3.14% in 2019 and 3.02% in 2018. Market interest rates declined in 2020 compared with 2019. Additionally, investments, which generally carry lower yield than loans, made up a higher percentage of total earning assets in 2020 than in prior periods. (72.0% in 2020 compared with 71.4% in 2019 and 68.6% in 2018).
The Company’s funding costs were 0.03% in 2020 and 2019 compared with 0.04% in 2018. Average balances of time deposits in 2020 declined $18 million from 2019. Average balances of lower-cost checking and savings deposits grew 11% from 2019 to 2020. Average balances of checking and saving deposits accounted for 96.9% of average total deposits in 2020 compared with 96.2% in 2019 and 95.6% in 2018.
Net Interest Margin (FTE)
The following summarizes the components of the Company's net interest margin (FTE) for the periods indicated.
For the Years Ended December 31,
Yield on earning assets (FTE) 2.94 % 3.14 % 3.02 %
Rate paid on interest-bearing liabilities 0.06 % 0.07 % 0.07 %
Net interest spread (FTE) 2.88 % 3.07 % 2.95 %
Impact of noninterest-bearing demand deposits 0.03 % 0.04 % 0.03 %
Net interest margin (FTE) 2.91 % 3.11 % 2.98 %
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Summary of Average Balances, Yields/Rates and Interest Differential
The following tables present information regarding the consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income earned from average interest earning assets and the resulting yields, and the amounts of interest expense incurred on average interest-bearing liabilities and the resulting rates. Average loan balances include nonperforming loans. Interest income includes reversal of previously accrued interest on loans placed on non-accrual status during the period and proceeds from loans on nonaccrual status only to the extent cash payments have been received and applied as interest income and accretion of purchased loan discounts. Yields on tax-exempt securities and loans have been adjusted upward to reflect the effect of income exempt from federal income taxation at the federal statutory tax rate of 21 percent.
Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin
For the Year Ended December 31, 2020
Interest
Average Income/ Yields/
Balance Expense Rates
($ in thousands)
Assets
Investment securities:
Loans:
Taxable:
Liabilities and shareholders' equity
Noninterest-bearing demand $ 2,538,819 $ - - %
Total liabilities and shareholders' equity $ 6,174,470
Net interest spread (1) (2) 2.88 %
Net interest and fee income and interest margin (1) (3) $ 167,682 2.91 %
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Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin
For the Year Ended December 31, 2019
Interest
Average Income/ Yields/
Balance Expense Rates
($ in thousands)
Assets
Investment securities:
Loans:
Liabilities and shareholders' equity
Noninterest-bearing demand $ 2,222,876 $ - - %
Total liabilities and shareholders' equity $ 5,597,109
Net interest spread (1) (2) 3.07 %
Net interest and fee income and interest margin (1) (3) $ 161,406 3.11 %
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Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin
For the Year Ended December 31, 2018
Interest
Average Income/ Yields/
Balance Expense Rates
($ in thousands)
Assets
Investment securities:
Loans:
Liabilities and shareholders' equity
Noninterest-bearing demand $ 2,209,924 $ - - %
Total liabilities and shareholders' equity $ 5,620,618
Net interest spread (1) (2) 2.95 %
Net interest and fee income and interest margin (1) (3) $ 155,410 2.98 %
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Summary of Changes in Interest Income and Expense due to Changes in Average Asset & Liability Balances and Yields Earned & Rates Paid
The following tables set forth a summary of the changes in interest income and interest expense due to changes in average assets and liability balances (volume) and changes in average interest yields/rates for the periods indicated. Changes not solely attributable to volume or yields/rates have been allocated in proportion to the respective volume and yield/rate components.
Summary of Changes in Interest Income and Expense
For the Year Ended December 31, 2020
Compared with
For the Year Ended December 31, 2019
Volume Yield/Rate Total
(In thousands)
Increase (decrease) in interest and loan fee income:
Investment securities:
Loans:
Taxable:
Increase (decrease) in interest expense:
Deposits:
Savings and interest-bearing transaction 110 (126 ) (16 )
Total interest-bearing deposits 54 (138 ) (84 )
Short-term borrowed funds 19 - 19
Other borrowed funds 1 - 1
Total increase (decrease) in interest expense 74 (138 ) (64 )
(1) Amounts calculated on an FTE basis using the current statutory federal tax rate.
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Summary of Changes in Interest Income and Expense
For the Year Ended December 31, 2019
Compared with
For the Year Ended December 31, 2018
Volume Yield/Rate Total
(In thousands)
Increase (decrease) in interest and loan fee income:
Investment securities:
Loans:
Total (decrease) in interest and loan fee income (1) (2,541 ) 8,466 5,925
Increase (decrease) in interest expense:
Deposits:
Savings and interest-bearing transaction (27 ) 26 (1 )
Total interest-bearing deposits (127 ) 59 (68 )
Short-term borrowed funds (7 ) 4 (3 )
Total (decrease) increase in interest expense (134 ) 63 (71 )
(1) Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate.
Provision for Credit Losses
The Company manages credit costs by consistently enforcing conservative underwriting and administration procedures and aggressively pursuing collection efforts with debtors experiencing financial difficulties. The provision for credit losses reflects Management's assessment of credit risk in the loan portfolio and debt securities held to maturity during each of the periods presented.
The Company’s provided a provision of credit losses of $4.3 million recorded in 2020. The provision represents Management’s estimate of additional reserves needed over the remaining life of its loans due to credit-risk from weakened economic conditions caused by the COVID-19 pandemic. The Company provided no provision for loan losses in 2019 and 2018. Classified loans declined $3.8 million in 2019. Nonaccrual loans were $4 million at December 31, 2019 compared with $5 million at December 31, 2018. These factors were reflected in Management’s evaluation of credit quality, the level of the provision for loan losses in 2019, and the adequacy of the allowance for loan losses at December 31, 2019. For further information regarding credit risk, net credit losses and the allowance for credit losses, see the “Loan Portfolio Credit Risk” and “Allowance for Credit Losses” sections of this Report.
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Noninterest Income
Components of Noninterest Income
For the Years Ended December 31,
(In thousands)
Gains on sales of real property 3,536 - -
Securities gains (losses) 71 217 (52 )
In 2020, noninterest income decreased $1.8 million compared with 2019 due to lower income from activity based fees due to reduced economic activity related to the COVID-19 pandemic. Additionally, the results for 2019 included a life insurance gain of $433 thousand. The decrease was partially offset by $3.5 million in gains on sale of a closed branch building in 2020.
In 2019, noninterest income decreased $741 thousand compared with 2018. Income from service charges on deposit accounts decreased due to lower overdraft fees in 2019. Other service charges decreased due to lower income from internet banking. Debit card fees and financial services commissions decreased in 2019. Merchant processing services increased due to successful sales efforts and higher transaction volumes and partially offset the decrease in noninterest income in 2019 compared with 2018.
Noninterest Expense
Components of Noninterest Expense
For the Years Ended December 31,
(In thousands)
Amortization of identifiable intangibles 287 538 1,921
In 2020, noninterest expense decreased $420 thousand compared with 2019 due to lower salaries, occupancy and equipment expenses, and lower amortization of intangible assets, and because the results for 2019 included $553 thousand of loss contingency. The decrease was partially offset by higher FDIC assessments (included in “other noninterest expense”) in 2020 because FDIC assessments in 2019 were reduced by application of the Bank’s FDIC assessment credit described in Part 1, Item 1, “Premiums for Deposit Insurance”.
In 2019, noninterest expense decreased $7.9 million compared with 2018 primarily due to decreases in loss contingencies, salaries and related benefits, FDIC insurance assessments, and intangible amortization. The 2019 loss contingencies include a $301 thousand increase in estimated customer refunds of revenue recognized prior to 2018 and a $252 thousand settlement to dismiss a lawsuit. Although loss contingencies represent estimated liabilities, which are subject to revision, the Company does not anticipate additional losses for either of these matters. Salaries and related benefits decreased $1.9 million primarily due to employee attrition and lower incentives and employee benefit costs. Amortization of intangibles decreased $1.4 million as assets are amortized on a declining balance method. FDIC insurance assessments (included in “other noninterest expense”) decreased primarily due to application of the Bank’s assessment credit described in Part 1, Item 1, “Premiums for Deposit Insurance”.
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Provision for Income Tax
The Company’s income tax provision (FTE) was $30.0 million in 2020 compared with $29.4 million in 2019 and $25.1 million in 2018. The effective tax rates (FTE) were 27.2% in 2020 compared with 26.8% in 2019 and 26.0% in 2018.
The higher effective tax rate (FTE) in 2020 compared with 2019 and 2018 is due to lower levels of tax-exempt interest income and stock compensation tax deductions in 2020. The tax provisions (FTE) for 2020, 2019 and 2018 include tax benefits of $87 thousand, $435 thousand and $737 thousand, respectively, for tax deductions from the exercise of employee stock options which exceed related compensation expenses recognized in the financial statements. In 2019, the Company decreased unrecognized tax benefits by $909 thousand related to settlements with taxing authorities. The settlements incorporated amended tax returns for which the Company had recognized a deferred tax asset in the amount of $1,003 thousand.
Investment Securities Portfolio
The Company maintains an investment securities portfolio consisting of securities issued by U.S. Government sponsored entities, agency and non-agency mortgage backed securities, state and political subdivisions, corporations, collateralized loan obligations, commercial paper and other securities.
Management managed the investment securities portfolio in response to changes in deposit and loan volumes. The carrying value of the Company’s investment securities portfolio was $4.6 billion at December 31, 2020 and $3.8 billion at December 31, 2019. The following table indicates the carrying values of investment securities in the Company’s portfolio by type as of the indicated dates. The Company adopted ASU 2016-13 effective January 1, 2020. Debt securities held to maturity of $515,598 thousand at December 31, 2020, is amortized cost before related reserve for expected credit losses of $9 thousand.
($ in thousands)
Commercial paper 24,990 1 % - - %
Management continually evaluates the Company’s investment securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability, liquidity, and the level of interest rate risk to which the Company is exposed. These evaluations may cause Management to change the level of funds the Company deploys into investment securities and change the composition of the Company’s investment securities portfolio.
At December 31, 2020, substantially all of the Company’s investment securities continue to be investment grade rated by one or more major rating agencies. In addition to monitoring credit rating agency evaluations, Management performs its own evaluations regarding the credit worthiness of the issuer or the securitized assets underlying asset-backed securities. The Company’s procedures for evaluating investments in securities are in accordance with guidance issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Agencies” (SR 12-15) and other regulatory guidance. There have been no significant differences in the Company’s internal analyses compared with the ratings assigned by the third party credit rating agencies.
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The Company had no marketable equity securities at December 31, 2020 and December 31, 2019. All of the marketable equity securities were sold with no gains or losses from the sale during the third quarter 2019. The market value of the marketable equity securities was $1,747 thousand at December 31, 2018. The Company recognized gross unrealized holding gains of $50 thousand in earnings in 2019.
The following table shows the fair value carrying amount of the Company’s equity securities and debt securities available for sale as of the dates indicated:
At December 31,
(In thousands)
Equity securities:
Mutual funds $ - $ - $ 1,747
Total equity securities - - 1,747
Debt securities available for sale:
Securities of U.S. Government sponsored entities - 111,167 164,018
Non-agency residential MBS - - 114
Securities of U.S. Government entities 154 544 1,119
Commercial paper 24,990 - -
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The following table sets forth the relative maturities and contractual yields of the Company’s debt securities available for sale (stated at fair value) at December 31, 2020. Yields on state and political subdivision securities have been calculated on a fully taxable equivalent basis using the current federal statutory rate. Mortgage-backed securities are shown separately because they are typically paid in monthly installments over a number of years.
Debt Securities Available for Sale Maturity Distribution
($ in thousands)
Securities of U.S. Government entities $ - $ 154 $ - $ - $ - $ 154
Interest rate - % 2.60 % - % - % - % 2.60 %
Interest rate 0.47 % - % - % - % - % 0.47 %
Interest rate - % - % 1.76 % 1.86 % - % 1.76 %
Interest rate - % - % - % - % 1.47 % 1.47 %
The following table shows the amortized cost carrying amount and fair value of the Company’s debt securities held to maturity as of the dates indicated:
At December 31,
(In thousands)
The following table sets forth the relative maturities and contractual yields of the Company’s debt securities held to maturity at December 31, 2020. Yields on state and political subdivision securities have been calculated on a fully taxable equivalent basis using the current federal statutory rate. Mortgage-backed securities are shown separately because they are typically paid in monthly installments over a number of years.
Debt Securities Held to Maturity Maturity Distribution
($ in thousands)
Interest rate - % - % - % - % 1.46 % 1.46 %
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The following table summarizes total corporate securities by credit rating:
($ in thousands)
The Company’s $14.96 million corporate bond rated BB- at December 31, 2020 and $14.53 million corporate bond rated BB at December 31, 2019, represents a bond of one pharmaceutical company which develops, manufactures and markets generic and branded human pharmaceuticals, as well as active pharmaceutical ingredients, to customers worldwide. The bond matures in July 2021.
The following table summarizes total corporate securities by the industry sector in which the issuing companies operate:
($ in thousands)
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The following table summarizes total consumer, cyclical by sub-sector:
Market value
($ in thousands)
Hotels $ -
Department Stores -
Casinos -
Airlines -
Total Consumer, Cyclical $ 93,330
The Company’s $21.1 million in corporate bonds to issuers operating in the consumer cyclical – restaurant subsector represent bonds of one company which retails, roasts and provides its own brand of specialty coffee and other complementary products through retail locations worldwide and sells coffee through several distribution channels. The bonds mature in 2023. At December 31, 2020, the bonds were rated BBB and priced with an unrealized gain of $1.1 million.
Amortized Fair
Cost Value
(In thousands)
The $103.0 million (fair value) in corporate bonds in the energy sector are issued by 4 issuers at December 31, 2020. The $188.8 million (fair value) in corporate bonds in the industrial sector are issued by 10 issuers at December 31, 2020.
The Company’s $1.2 billion (fair value) in collateralized loan obligations at December 31, 2020, include investments in 141 issues that are within the senior tranches of their respective fund securitization structures. All of the Company’s collateralized loan obligation investments are rated AAA or AA at December 31, 2020.
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The following tables summarize the total general obligation and revenue bonds issued by states and political subdivisions held in the Company’s investment securities portfolios as of the dates indicated, identifying the state in which the issuing government municipality or agency operates.
At December 31, 2020, the Company’s investment securities portfolios included securities issued by 317 state and local government municipalities and agencies located within 40 states. The largest exposure to any one municipality or agency was $8.2 million (fair value) represented by six general obligation bonds.
Amortized Fair
Cost Value
(In thousands)
Obligations of states and political subdivisions:
General obligation bonds:
Revenue bonds:
Total obligations of states and political subdivisions $ 379,601 $ 392,175
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At December 31, 2019, the Company’s investment securities portfolios included securities issued by 451 state and local government municipalities and agencies located within 42 states. The largest exposure to any one municipality or agency was $9.0 million (fair value) represented by one general obligation bond.
Amortized Fair
Cost Value
(In thousands)
Obligations of states and political subdivisions:
General obligation bonds:
Revenue bonds:
Total obligations of states and political subdivisions $ 541,308 $ 552,591
At December 31, 2020 and December 31, 2019, the revenue bonds in the Company’s investment securities portfolios were issued by state and local government municipalities and agencies to fund public services such as water utility, sewer utility, recreational and school facilities, and general public and economic improvements. The revenue bonds were payable from 19 revenue sources at December 31, 2020 and 20 revenue sources at December 31, 2019. The revenue sources that represent 5% or more individually of the total revenue bonds are summarized in the following tables.
Amortized Fair
Cost Value
(In thousands)
Revenue bonds by revenue source:
Total revenue bonds by revenue source $ 98,923 $ 101,424
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Amortized Fair
Cost Value
(In thousands)
Revenue bonds by revenue source:
See Note 2 to the consolidated financial statements for additional information related to the investment securities.
Loan Portfolio
The Company originates loans with the intent to hold such assets until principal is repaid. Management follows written loan underwriting policies and procedures which are approved by the Bank’s Board of Directors. Loans are underwritten following approved underwriting standards and lending authorities within a formalized organizational structure. The Board of Directors also approves independent real estate appraisers to be used in obtaining estimated values for real property serving as loan collateral. Prevailing economic trends and conditions are also taken into consideration in loan underwriting practices.
All loan applications must be for clearly defined legitimate purposes with a determinable primary source of repayment, and as appropriate, secondary sources of repayment. All loans are supported by appropriate documentation such as current financial statements, tax returns, credit reports, collateral information, guarantor asset verification, title reports, appraisals, and other relevant documentation.
The Bank processed customer PPP loan applications as established by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The United States Small Business Administration guarantees PPP loans; given this guarantee, the PPP loans are not considered to have default risk. The Company funded $249 million PPP loans in the second quarter 2020. PPP loans, net of deferred fees and costs, were $187 million at December 31, 2020.
Commercial loans represent term loans used to acquire durable business assets or revolving lines of credit used to finance working capital. Underwriting practices evaluate each borrower’s cash flow as the principal source of loan repayment. Commercial loans are generally secured by the borrower’s business assets as a secondary source of repayment. Commercial loans are evaluated for credit-worthiness based on prior loan performance and borrower financial information including cash flow, borrower net worth and aggregate debt. PPP loans are included in commercial loans.
Commercial real estate loans represent term loans used to acquire or refinance real estate to be operated by the borrower in a commercial capacity. Underwriting practices evaluate each borrower’s global cash flow as the principal source of loan repayment, independent appraisal of value of the property, and other relevant factors. Commercial real estate loans are generally secured by a first lien on the property as a secondary source of repayment.
Real estate construction loans represent the financing of real estate development. Loan principal disbursements are controlled through the use of project budgets, and disbursements are approved based on construction progress, which is validated by project site inspections. A first lien on the real estate serves as collateral to secure the loan.
Residential real estate loans generally represent first lien mortgages used by the borrower to purchase or refinance a principal residence. For interest-rate risk purposes, the Company offers only fully-amortizing, adjustable-rate mortgages. In underwriting first lien mortgages, the Company evaluates each borrower’s ability to repay the loan, an independent appraisal of the value of the property, and other relevant factors. The Company does not offer riskier mortgage products, such as non-amortizing “interest-only” mortgages and “negative amortization” mortgages.
For loans secured by real estate, the Bank requires title insurance to insure the status of its lien and each borrower is obligated to insure the real estate collateral, naming the Company as loss payee, in an amount sufficient to repay the principal amount outstanding in the event of a property casualty loss.
Consumer installment and other loans are predominantly comprised of indirect automobile loans with underwriting based on credit history and scores, personal income, debt service capacity, and collateral values.
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Excluding PPP, loan volumes have declined due to payoffs and problem loan workout activities, particularly with purchased loans, and reduced volumes of loan originations. The Company did not take an aggressive posture relative to loan portfolio growth during the post-recession period of historically low interest rates. Management increased investment securities as loan volumes declined.
The following table shows the composition of the loan portfolio of the Company by type of loan and type of borrower, on the dates indicated:
Loan Portfolio
At December 31,
(In thousands)
PPP loans $ 186,945 $ - $ - $ - $ -
The following table shows the maturity distribution and interest rate sensitivity of commercial, commercial real estate, and construction loans at December 31, 2020. Balances exclude residential real estate loans and consumer installment and other loans totaling $297.0 million. These types of loans are typically paid in monthly installments over a number of years.
Loan Maturity Distribution
Within One Year One to Five Years After Five Years Total
(In thousands)
Commitments and Letters of Credit
The Company issues formal commitments on lines of credit to well-established and financially responsible commercial enterprises. Such commitments can be either secured or unsecured and are typically in the form of revolving lines of credit for seasonal working capital needs. Occasionally, such commitments are in the form of letters of credit to facilitate the customers’ particular business transactions. Commitment fees are generally charged for commitments and letters of credit. Commitments on lines of credit and letters of credit typically mature within one year. For further information, see the accompanying notes to the consolidated financial statements.
Loan Portfolio Credit Risk
The Company extends loans to commercial and consumer customers which expose the Company to the risk borrowers will default, causing loan losses. The Company’s lending activities are exposed to various qualitative risks. All loan segments are exposed to risks inherent in the economy and market conditions. Significant risk characteristics related to the commercial loan segment include the borrowers’ business performance and financial condition, and the value of collateral for secured loans. Significant risk characteristics related to the commercial real estate segment include the borrowers’ business performance and the value of properties collateralizing the loans. Significant risk characteristics related to the construction loan segment include the borrowers’ performance in successfully developing the real estate into the intended purpose and the value of the property collateralizing the loans. Significant risk characteristics related to the residential real estate segment include the borrowers’ financial wherewithal to service the mortgages and the value of the property collateralizing the loans. Significant risk characteristics related to the consumer loan segment include the financial condition of the borrowers and the value of collateral securing the loans.
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The Bank processed customer PPP loan applications as established by the CARES Act. The United States Small Business Administration guarantees PPP loans; given this guarantee, the PPP loans are not considered to have default risk. The Company funded $249 million PPP loans in the second quarter 2020. PPP loans, net of deferred fees and costs, were $187 million at December 31, 2020.
On April 7, 2020, the U.S. banking agencies issued an Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised). The statement describes accounting for COVID-19-related loan modifications, including clarifying the interaction between current accounting rules and the temporary relief provided by the CARES Act. The Bank has been actively working with consumer and commercial borrowers requesting deferral of loan payments, granting deferrals of principal and interest payments for 90 days. At December 31, 2020, consumer loans granted loan deferrals totaled $2.5 million, commercial real estate loans with deferred payments totaled $7.8 million, primarily for hospitality and retail properties, and five commercial loans with deferred payments totaled $33 thousand.
The preparation of the financial statements requires Management to estimate the amount of expected losses in the loan portfolio and establish an allowance for credit losses. The allowance for credit losses is maintained by assessing or reversing a provision for credit losses through the Company’s earnings. In estimating credit losses, Management must exercise judgment in evaluating information deemed relevant, such as financial information regarding individual borrowers, overall loan loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other information. The amount of ultimate losses on the loan portfolio can vary from the estimated amounts. Management follows a systematic methodology to estimate loss potential in an effort to reduce the differences between estimated and actual losses.
The Company closely monitors the markets in which it conducts its lending operations and follows a strategy to control exposure to loans with high credit risk. The Bank’s organization structure separates the functions of business development and loan underwriting; Management believes this segregation of duties avoids inherent conflicts of combining business development and loan approval functions. In measuring and managing credit risk, the Company adheres to the following practices.
Classified loans with higher levels of credit risk are further designated as “nonaccrual loans.” Management places classified loans on nonaccrual status when full collection of contractual interest and principal payments is in doubt. Uncollected interest previously accrued on loans placed on nonaccrual status is reversed as a charge against interest income. The Company does not accrue interest income on loans following placement on nonaccrual status. Interest payments received on nonaccrual loans are applied to reduce the carrying amount of the loan unless the carrying amount is well secured by loan collateral. “Nonperforming assets” include nonaccrual loans, loans 90 or more days past due and still accruing, and repossessed loan collateral (commonly referred to as “Other Real Estate Owned”).
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Nonperforming Assets
At December 31,
(In thousands)
At December 31, 2020, one loan secured by commercial real estate with a balance of $3.4 million was on nonaccrual status. The remaining seven nonaccrual loans held at December 31, 2020 had an average carrying value of $130 thousand.
Management believes the overall credit quality of the loan portfolio is reasonably stable; however, classified and nonperforming assets could fluctuate from period to period. The performance of any individual loan can be affected by external factors such as the interest rate environment, economic conditions, pandemics, and collateral values or factors particular to the borrower. No assurance can be given that additional increases in nonaccrual and delinquent loans will not occur in the future.
Allowance for Credit Losses
Effective January 1, 2020, the Company adopted Accounting Standards Update (ASU) 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments (“CECL”). The following table summarizes allowance for credit losses at the dates indicated:
At December 31,
(In thousands)
Allowance for Credit Losses on Loans $ 23,854 $ 19,484
Allowance for Credit Losses on Held to Maturity Debt Securities 9 -
Total Allowance for Credit Losses $ 23,863 $ 19,484
Allowance for unfunded credit commitments 101 2,160
Allowance for Credit Losses on Debt Securities Held to Maturity
Management segmented debt securities held to maturity, selected methods to estimate losses for each segment, and measured a loss estimate. Agency mortgage-backed securities were assigned no credit loss allowance due to the perceived backing of government sponsored entities. Municipal securities were evaluated for risk of default based on credit rating and remaining term to maturity using Moody’s risk of default factors; Moody’s loss upon default factors were applied to the assumed defaulted principal amounts to estimate the amount for credit loss allowance. The adoption of the ASU resulted in establishment of allowance for credit losses related to debt securities held to maturity of $16 thousand. It was reduced to $9 thousand at December 31, 2020 to reflect the expected credit losses on debt securities held to maturity.
Allowance for Credit Losses on Loans
The Company’s allowance for credit losses on loans represents Management’s estimate of forecasted credit losses in the loan portfolio based on the current expected credit loss (CECL) model. In evaluating credit risk for loans, Management measures loss potential of the carrying value of loans. As described above, payments received on nonaccrual loans may be applied against the principal balance of the loans until such time as full collection of the remaining recorded balance is expected.
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The following table summarizes the allowance for credit losses, chargeoffs and recoveries for the periods indicated:
For the Years Ended December 31,
($ in thousands)
Analysis of the Allowance for Credit Losses
Provision for (reversal of) credit losses on loans 4,307 - - (1,900 ) (3,200 )
Loans charged off:
Commercial real estate - - (240 ) - -
Construction - - - - -
Residential real estate - - - - -
Recoveries of loans previously charged off:
Construction - - - 1,899 -
The Company's allowance for credit losses on loans is maintained at a level considered adequate to provide for expected losses based on historical loss rates adjusted for current and expected conditions over a forecast period. These include conditions unique to individual borrowers, as well as overall loan loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing and forecasted economic conditions, or credit protection agreements and other factors. Loans that share common risk characteristics are segregated into pools based on common characteristics, which is primarily determined by loan, borrower, or collateral type. Historical loss rates are determined for each pool. Loans that do not share risk characteristics with other loans in the pools are evaluated individually. See Note 1 to the consolidated financial statements for additional information.
The following table presents the allocation of the allowance for credit losses as of December 31 for the years indicated:
At December 31,
($ in thousands)
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Allowance for Credit Losses
For the Year Ended December 31, 2020
Consumer
Commercial Residential Installment
Commercial Real Estate Construction Real Estate and Other Unallocated Total
(In thousands)
Allowance for credit losses:
Management considers the $23.9 million allowance for credit losses on loans to be adequate as a reserve against current expected credit losses in the loan portfolio as of December 31, 2020.
See Note 3 to the consolidated financial statements for additional information related to the loan portfolio, loan portfolio credit risk, and allowance for credit losses.
Asset/Liability and Market Risk Management
Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk, liquidity and funding. The fundamental objective of the Company's management of assets and liabilities is to maximize its economic value while maintaining adequate liquidity and a conservative level of interest rate risk.
Interest Rate Risk
Interest rate risk is a significant market risk affecting the Company. Many factors affect the Company’s exposure to interest rates, such as general economic and financial conditions, customer preferences, historical pricing relationships, and re-pricing characteristics of financial instruments. Financial instruments may mature or re-price at different times. Financial instruments may re-price at the same time but by different amounts. Short-term and long-term market interest rates may change by different amounts. The timing and amount of cash flows of various financial instruments may change as interest rates change. In addition, the changing levels of interest rates may have an impact on loan demand and demand for various deposit products.
The Company’s earnings are affected not only by general economic conditions, but also by the monetary and fiscal policies of the United States government and its agencies, particularly the FOMC. The monetary policies of the FOMC can influence the overall growth of loans, investment securities, and deposits and the level of interest rates earned on loans and investment securities and paid for deposits and other borrowings. The nature and impact of future changes in monetary policies are generally not predictable.
Management attempts to manage interest rate risk while enhancing the net interest margin and net interest income. At times, depending on expected increases or decreases in market interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, Management may adjust the Company's interest rate risk position. The Company's results of operations and net portfolio values remain subject to changes in interest rates and to fluctuations in the difference between long and short-term interest rates.
Management monitors the Company’s interest rate risk using a purchased simulation model, which is periodically validated using supervisory guidance issued by the Board of Governors of the Federal Reserve System, SR 11-7 “Guidance on Model Risk Management.” Management measures its exposure to interest rate risk using both a static and dynamic composition of financial instruments. Within the static composition simulation, cash flows are assumed redeployed into like financial instruments at prevailing rates and yields, except cash flows from PPP loans are reinvested into interest-bearing cash. Within the dynamic composition simulation, Management makes assumptions regarding the expected change in the volume of financial instruments given the assumed change in market interest rates. Both simulations are used to measure expected changes in net interest income assuming various levels of change in market interest rates.
The Company’s asset and liability position was slightly “asset sensitive” at December 31, 2020, depending on the interest rate assumptions applied to each simulation model. An “asset sensitive” position results in a slightly larger change in interest income than in interest expense resulting from application of assumed interest rate changes.
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At December 31, 2020, Management’s most recent measurements of estimated changes in net interest income were:
Static Simulation (balance sheet composition unchanged):
Assumed Immediate Parallel Shift in Interest Rates +1.00%
First Year Change in Net Interest Income +12.96%
Dynamic Simulation (balance sheet composition changes):
Assumed Change in Interest Rates Over 1 Year +1.00%
First Year Change in Net Interest Income +6.90%
Simulation estimates depend on, and will change with, the size and mix of the actual and projected composition of financial instruments at the time of each simulation.
The Company does not currently engage in trading activities or use derivative instruments to manage interest rate risk, even though such activities may be permitted with the approval of the Company's Board of Directors.
Market Risk - Equity Markets
Equity price risk can affect the Company. Preferred or common stock holdings, as permitted by banking regulations, can fluctuate in value. Changes in value of preferred or common stock holdings are recognized in the Company's income statement.
Fluctuations in the Company's common stock price can impact the Company's financial results in several ways. First, the Company has at times repurchased and retired its common stock; the market price paid to retire the Company's common stock affects the level of the Company's shareholders' equity, cash flows and shares outstanding. Second, the Company's common stock price impacts the number of dilutive equivalent shares used to compute diluted earnings per share. Third, fluctuations in the Company's common stock price can motivate holders of options to purchase Company common stock through the exercise of such options thereby increasing the number of shares outstanding and potentially adding volatility to the book tax provision. Finally, the amount of compensation expense and tax deductions associated with share based compensation fluctuates with changes in and the volatility of the Company's common stock price.
Market Risk - Other
Market values of loan collateral can directly impact the level of loan chargeoffs and the provision for credit losses. The financial condition and liquidity of debtors issuing bonds and debtors whose mortgages or other obligations are securitized can directly impact the credit quality of the Company’s investment securities portfolio requiring the Company to establish or increase reserves for credit losses. Other types of market risk, such as foreign currency exchange risk, are not significant in the normal course of the Company's business activities.
Liquidity and Funding
The objective of liquidity management is to manage cash flow and liquidity reserves so that they are adequate to fund the Company's operations and meet obligations and other commitments on a timely basis and at a reasonable cost. The Company achieves this objective through the selection of asset and liability maturity mixes that it believes best meet its needs. The Company's liquidity position is enhanced by its ability to raise additional funds as needed by selling debt securities available-for-sale or borrowing in the wholesale markets.
In recent years, the Company's deposit base has provided the majority of the Company's funding requirements. This relatively stable and low-cost source of funds, along with shareholders' equity, provided 97% of funding for average total assets in the year ended December 31, 2020 and 98% in the year ended December 31, 2019. The stability of the Company’s funding from customer deposits is in part reliant on the confidence clients have in the Company. The Company places a very high priority in maintaining this confidence through conservative credit and capital management practices and by maintaining an appropriate level of liquidity.
Liquidity is further provided by assets such as balances held at the Federal Reserve Bank, investment securities, and amortizing loans. The Company's investment securities portfolio provides a substantial secondary source of liquidity. The Company held $4.6 billion in total investment securities at December 31, 2020. Under certain deposit, borrowing and other arrangements, the Company must hold and pledge investment securities as collateral. At December 31, 2020, such collateral requirements totaled approximately $889 million.
The Bank funded $249 million in PPP loans by crediting loan proceeds to the borrower’s deposit accounts. PPP loans, net of deferred fees and costs, were $187 million at December 31, 2020. The Federal Reserve Bank established the Paycheck Protection Program Liquidity Facility (“PPPLF”) to provide funding for eligible firms extending PPP loans. Under the PPPLF, the Bank must pledge PPP loans as collateral for PPPLF borrowings. Principal reductions on the pledged PPP loans must immediately result in principal reduction of the PPPLF borrowing.
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Liquidity risk can result from the mismatching of asset and liability cash flows, or from disruptions in the financial markets. The Company performs liquidity stress tests on a periodic basis to evaluate the sustainability of its liquidity. Under the stress testing, the Company assumes outflows of funds increase beyond expected levels. Measurement of such heightened outflows considers the composition of the Company’s deposit base, including any concentration of deposits, non-deposit funding such as short-term borrowings, and unfunded lending commitments. The Company evaluates its stock of highly liquid assets to meet the assumed higher levels of outflows. Highly liquid assets include cash and amounts due from other banks from daily transaction settlements, reduced by branch cash needs and Federal Reserve Bank reserve requirements, and investment securities based on regulatory risk-weighting guidelines. Based on the results of the most recent liquidity stress test, Management is satisfied with the liquidity condition of the Bank and the Company. However, no assurance can be given the Bank or Company will not experience a period of reduced liquidity.
Management continually monitors the Company’s cash levels. Loan demand from credit worthy borrowers will be dictated by economic and competitive conditions. The Company aggressively solicits non-interest bearing demand deposits and money market checking deposits, which are the least sensitive to changes in interest rates. The growth of these deposit balances is subject to heightened competition, the success of the Company's sales efforts, delivery of superior customer service, new regulations and market conditions. The Company does not aggressively solicit higher-costing time deposits. Changes in interest rates, most notably rising interest rates, could impact deposit volumes. Depending on economic conditions, interest rate levels, liquidity management and a variety of other conditions, deposit growth may be used to fund loans or purchase investment securities. However, due to possible volatility in economic conditions, competition and political uncertainty, loan demand and levels of customer deposits are not certain. Shareholder dividends are expected to continue subject to the Board's discretion and continuing evaluation of capital levels, earnings, asset quality and other factors.
Westamerica Bancorporation ("Parent Company") is a separate entity apart from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Parent Company is responsible for the payment of dividends declared for its shareholders, and interest and principal on any outstanding debt. The Parent Company currently has no debt. Substantially all of the Parent Company's revenues are obtained from subsidiary dividends and service fees.
The Bank’s dividends paid to the Parent Company, proceeds from the exercise of stock options, and Parent Company cash balances provided adequate cash for the Parent Company to pay shareholder dividends of $44 million each in the year ended December 31, 2020 and December 31, 2019 and retire common stock in the amount of $16 million and $488 thousand, respectively. Payment of dividends to the Parent Company by the Bank is limited under California and Federal laws. The Company believes these regulatory dividend restrictions will not have an impact on the Parent Company's ability to meet its ongoing cash obligations.
Capital Resources
The Company has historically generated high levels of earnings, which provide a means of accumulating capital. The Company's net income as a percentage of average shareholders' equity (“return on equity” or “ROE”) has been 11.3% in the year ended December 31, 2020 and 11.9% in the year ended December 31, 2019. The Company also raises capital as employees exercise stock options. Capital raised through the exercise of stock options was $2.8 million in year ended December 31, 2020 and $14 million in the year ended December 31, 2019.
The Company paid common dividends totaling $44 million each in the year ended December 31, 2020 and December 31, 2019, which represent dividends per common share of $1.64 and $1.63, respectively. The Company's earnings have historically exceeded dividends paid to shareholders. The amount of earnings in excess of dividends provides the Company resources to finance growth and maintain appropriate levels of shareholders' equity. In the absence of profitable growth opportunities, the Company has at times repurchased and retired its common stock as another means to return earnings to shareholders. The Company repurchased and retired 319 thousand shares valued at $16 million in the year ended December 31, 2020 and 8 thousand shares valued at $488 thousand in the year ended December 31, 2019.
The Company's primary capital resource is shareholders' equity, which was $845 million at December 31, 2020 compared with $731 million at December 31, 2019. The Company's ratio of equity to total assets was 12.5% at December 31, 2020 and 13.0% at December 31, 2019.
The Company performs capital stress tests on a periodic basis to evaluate the sustainability of its capital. Under the stress testing, the Company assumes various scenarios such as deteriorating economic and operating conditions, unanticipated asset devaluations, and significant operational lapses. The Company measures the impact of these scenarios on its earnings and capital. Based on the results of the most recent stress tests, Management is satisfied with the capital condition of the Bank and the Company. However, no assurance can be given the Bank or Company will not experience a period of reduced earnings or a reduction in capital from unanticipated events and circumstances.
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Capital to Risk-Adjusted Assets
The capital ratios for the Company and the Bank under current regulatory capital standards are presented in the tables below, on the dates indicated. For Common Equity Tier I Capital, Tier 1 Capital and Total Capital, the minimum percentage required for regulatory capital adequacy purposes include a 2.5% “capital conservation buffer.”
To Be
Well-capitalized
Required for Under Prompt
At December 31, 2020 Capital Adequacy Corrective Action
Company Bank Purposes Regulations (Bank)
To Be
Well-capitalized
Required for Under Prompt
At December 31, 2019 Capital Adequacy Corrective Action
Company Bank Purposes Regulations (Bank)
In June 2016, the Financial Accounting Standards Board issued an update to the accounting standards for credit losses known as the "Current Expected Credit Losses" (CECL) methodology, which replaced the existing incurred loss methodology for certain financial assets. The Company adopted the CECL methodology effective January 1, 2020, which involved an implementing accounting entry to retained earnings on a net-of-tax basis. The adoption of the CECL methodology did not have a material adverse day-one impact to capital ratios and the Company did not adopt the phase in regulatory capital relief. See Note 1 to consolidated financial statements, “Recently Adopted Accounting Standards” for more information on the CECL methodology.
PPP loans are zero percent risk weighted for regulatory capital purposes; average PPP loans of $228 million did not affect regulatory capital ratios. The Leverage ratio would have been approximately 0.3% higher for both the Company and the Bank without PPP loans. To the extent funding of PPP loans is through excess cash balances or PPPLF borrowings, the Leverage ratio is unaffected. However, PPP loans funded by increased non-PPPLF borrowings reduces the leverage ratio.
The Company and the Bank routinely project capital levels by analyzing forecasted earnings, credit quality, shareholder dividends, asset volumes, share repurchase activity, stock option exercise proceeds, and other factors. Based on current capital projections, the Company and the Bank expect to maintain regulatory capital levels in excess of the minimum required to be considered well-capitalized under the prompt corrective action framework while continuing to pay quarterly dividends to shareholders. No assurance can be given that changes in capital management plans will not occur.
Deposit Categories
The Company primarily attracts deposits from local businesses and professionals, as well as through retail savings and checking accounts, and, to a more limited extent, certificates of deposit.
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The following table summarizes the Company’s average daily amount of deposits and the rates paid for the periods indicated:
Deposit Distribution and Average Rates Paid
For the Years Ended December 31,
($ In thousands)
Interest bearing:
(1) The rates for total deposits reflect the value of noninterest-bearing deposits.
The Company’s strategy includes building the value of its deposit base by building balances of lower-costing deposits and avoiding reliance on higher-costing time deposits. Average balances of higher costing time deposits declined 24% to $164 million from 2018 to 2020. The Company’s average balances of checking and savings accounts represented 97% of average balances of total deposits in 2020 compared with 96% in 2019 and 2018.
Total time deposits were $156 million and $169 million at December 31, 2020 and 2019, respectively. The following table sets forth, by time remaining to maturity, the Company’s total domestic time deposits. The Company has no foreign time deposits.
Time Deposits Maturity Distribution
(In thousands)
Thereafter 26
The following sets forth, by time remaining to maturity, the Company’s domestic time deposits in amounts of $100 thousand or more:
Time Deposits $100,000 or more Maturity Distribution
(In thousands)
Three months or less $ 24,323
Over three through six months 11,882
Over six through twelve months 20,222
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Short-term Borrowings
The following table sets forth the short-term borrowings of the Company:
Short-Term Borrowings Distribution
At December 31,
(In thousands)
Further detail of federal funds purchased and other borrowed funds is as follows:
For the Years Ended December 31,
($ in thousands)
Federal funds purchased balances and rates paid on outstanding amount:
Average balance for the year $ 1 $ 1 $ 1
Maximum month-end balance during the year - - -
Average interest rate for the year 0.88 % 1.98 % 2.56 %
Average interest rate at period end - % - % - %
Average interest rate for the year 0.07 % 0.07 % 0.06 %
Average interest rate at period end 0.07 % 0.06 % 0.06 %
PPPLF balances and rates paid on outstanding amount:
Average balance for the year $ 1 $ - $ -
Maximum month-end balance during the year - - -
Average interest rate for the year 0.35 % - % - %
Average interest rate at period end - % - % - %
Financial Ratios
The following table shows key financial ratios for the periods indicated:
At and For the Years Ended December 31,
Return on average total assets 1.30 % 1.44 % 1.27 %
Return on average common shareholders' equity 11.30 % 11.90 % 11.35 %
Average shareholders' equity as a percentage of:
Common dividend payout ratio 55 % 55 % 60 %
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company’s Board of Directors.
Credit risk and interest rate risk are the most significant market risks affecting the Company, and equity price risk can also affect the Company’s financial results. These risks are described in the preceding sections regarding “Loan Portfolio Credit Risk,” and “Asset/Liability and Market Risk Management.” Other types of market risk, such as foreign currency exchange risk and commodity price risk, are not significant in the normal course of the Company’s business activities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Page
Management’s Report on Internal Control Over Financial Reporting 49
Consolidated Balance Sheets as of December 31, 2020 and 2019 50
Notes to the Consolidated Financial Statements 55
Report of Independent Registered Public Accounting Firm 93
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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Westamerica Bancorporation and subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2020. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of Management and Directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020 based upon criteria in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, Management determined that the Company’s internal control over financial reporting was effective as of December 31, 2020 based on the criteria in Internal Control - Integrated Framework (2013) issued by COSO.
The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. Their opinion and attestation on internal control over financial reporting appear on page 93.
Dated: February 25, 2021
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WESTAMERICA BANCORPORATION
CONSOLIDATED BALANCE SHEETS
At December 31,
(In thousands)
Assets:
Allowance for credit losses on loans (23,854 ) (19,484 )
Other real estate owned - 43
Identifiable intangibles, net 1,104 1,391
Liabilities:
Contingencies (Note 10)
Shareholders' Equity:
Deferred compensation 35 771
See accompanying notes to consolidated financial statements.
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WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31,
(In thousands, except per share data)
Interest and Loan Fee Income:
Interest Expense:
Short-term borrowed funds 53 34 37
Other borrowed funds 1 - -
Provision for Credit Losses 4,300 - -
Noninterest Income:
Gains on sales of real property 3,536 - -
Securities gains (losses) 71 217 (52 )
Noninterest Expense:
Amortization of identifiable intangibles 287 538 1,921
Per Common Share Data:
See accompanying notes to consolidated financial statements.
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WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Years Ended December 31,
(In thousands)
Other comprehensive income (loss):
Reclassification of gains included in net income (71 ) (167 ) -
Deferred tax expense on gains included in net income 21 49 -
See accompanying notes to consolidated financial statements.
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WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Accumulated
Common Other
Shares Common Deferred Comprehensive Retained
Outstanding Stock Compensation Income (Loss) Earnings Total
(In thousands, except per share data)
Cumulative effect of equity securities losses reclassified 142 (142 ) -
Stock awarded to employees 2 124 124
Retirement of common stock (9 ) (149 ) (375 ) (524 )
Shares issued from stock warrant exercise, net of repurchase 51 - -
Stock awarded to employees 2 105 105
Retirement of common stock (8 ) (136 ) (352 ) (488 )
Stock awarded to employees 2 100 100
See accompanying notes to consolidated financial statements.
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WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
Operating Activities: (In thousands)
Provision for credit losses 4,300 - -
Net amortization of deferred loan fees (4,442 ) (260 ) (203 )
Increase in interest income receivable (4,225 ) (2,963 ) (2,277 )
(Increase) decrease in net deferred tax asset (246 ) 3,662 (943 )
Increase (decrease) in income taxes payable 353 (1,733 ) 7,554
Decrease in interest expense payable (5 ) (9 ) (27 )
Increase (decrease) in other liabilities 14,280 (5,298 ) (580 )
Life insurance gains - (433 ) (585 )
Securities (gains) losses (71 ) (217 ) 52
Gains on sales of premises and equipment (3,536 ) - -
Gain on disposal of premises and equipment (71 ) - (216 )
Net gain on sale of or write-down of foreclosed assets - - (83 )
Investing Activities:
Proceeds from life insurance policies - 1,273 1,169
Proceeds from sale of equity securities - 1,797 -
Purchases of premises and equipment (2,200 ) (3,994 ) (3,123 )
Proceeds from sale of premises and equipment 3,819 - 446
Proceeds from sale of foreclosed assets 114 307 1,159
Financing Activities:
Supplemental Cash Flow Disclosures:
Supplemental disclosure of noncash activities:
Amount recognized upon initial adoption of ASU 2016-02 - 15,325 -
Securities purchases pending settlement 29,000 - -
Supplemental disclosure of cash flow activities:
Cash paid for amounts included in operating lease liabilities 6,516 5,123 -
See accompanying notes to consolidated financial statements.
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WESTAMERICA BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Business and Accounting Policies
Westamerica Bancorporation, a registered bank holding company (the “Company”), provides a full range of banking services to corporate and individual customers in Northern and Central California through its wholly-owned subsidiary bank, Westamerica Bank (the “Bank”). The Bank is subject to competition from both financial and nonfinancial institutions and to the regulations of certain agencies and undergoes periodic examinations by those regulatory authorities. All of the financial service operations are considered by management to be aggregated in one reportable operating segment.
The Company has evaluated events and transactions subsequent to the balance sheet date. Based on this evaluation, the Company is not aware of any events or transactions that occurred subsequent to the balance sheet date but prior to filing that would require recognition or disclosure in its consolidated financial statements. Certain amounts in prior periods have been reclassified to conform to the current presentation.
Summary of Significant Accounting Policies
The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. The following is a summary of significant policies used in the preparation of the accompanying financial statements.
Accounting Estimates. Certain accounting policies underlying the preparation of these financial statements require Management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in fair value of an asset not carried on the financial statements at fair value warrants an impairment writedown or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. The allowance for credit losses accounting is an area requiring the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available. A discussion of the factors affecting the accounting for the allowance for credit losses on loans is included in the following “Loans” and “Allowance for Credit Losses” sections. Carrying assets and liabilities at fair value inherently results in financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third party sources, when available. The “Securities” section discusses the factors that may affect the valuation of the Company’s securities. Although the estimates contemplate current conditions actual results can change.
Principles of Consolidation. The consolidated financial statements include the accounts of the Company and all the Company’s subsidiaries. Significant intercompany transactions have been eliminated in consolidation. The Company does not maintain or conduct transactions with any unconsolidated special purpose entities.
Cash. Cash includes Due From Banks balances which are readily convertible to known amounts of cash and are generally 90 days or less from maturity at the time of initiation, presenting insignificant risk of changes in value due to interest rate changes.
Equity Securities. Equity securities consist of marketable equity securities and mutual funds which are recorded at fair value. Unrealized gains and losses are included in net income.
Debt Securities. Debt securities consist of the U.S. Treasury, securities of government sponsored entities, states, counties, municipalities, corporations, agency and non-agency mortgage-backed securities, collateralized loan obligations and commercial paper. Securities transactions are recorded on a trade date basis. The Company classifies its debt securities in one of three categories: trading, available for sale or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Trading securities are recorded at fair value with unrealized gains and losses included in net income. Held to maturity debt securities are those securities which the Company has the ability and intent to hold until maturity. Held to maturity debt securities are recorded at cost, adjusted for the amortization of premiums or accretion of discounts. Securities not included in trading or held to maturity are classified as available for sale debt securities. Available for sale debt securities are recorded at fair value. Unrealized gains and losses, net of the related tax effect, on available for sale debt securities are included in accumulated other comprehensive income. Accrued interest is recorded within other assets and reversed against interest income if it is not received.
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The Company utilizes third-party sources to value its investment securities; securities individually valued using quoted prices in active markets are classified as Level 1 assets in the fair value hierarchy, and securities valued using quoted prices in active markets for similar securities (commonly referred to as “matrix” pricing) are classified as Level 2 assets in the fair value hierarchy. The Company validates the reliability of third-party provided values by comparing individual security pricing for securities between more than onethird-party source. When third-party information is not available, valuation adjustments are estimated in good faith by Management and classified as Level 3 in the fair value hierarchy.
The Company follows the guidance issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Agencies” (SR 12-15) and other regulatory guidance when performing investment security pre-purchase analysis or evaluating investment securities for credit loss. Credit ratings issued by recognized rating agencies are considered in the Company’s analysis only as a guide to the historical default rate associated with similarly-rated bonds.
To the extent that debt securities in the held-to-maturity portfolio share common risk characteristics, estimated expected credit losses are calculated in a manner like that used for loans held for investment. That is, for pools of such securities with common risk characteristics, the historical lifetime probability of default and severity of loss in the event of default is derived or obtained from external sources and adjusted for the expected effects of reasonable and supportable forecasts over the expected lives of the securities on those historical credit losses. Expected credit loss on each security in the held-to-maturity portfolio that do not share common risk characteristics with any of the pools of debt securities is individually evaluated and a reserve for credit losses is established at the difference between the discounted value of the expected future cash flows, based on the original effective interest rate, and the recorded amortized cost basis of the security. For certain classes of debt securities, the bank considers the history of credit losses, current conditions and reasonable and supportable forecasts, which may indicate that the expectation that nonpayment of the amortized cost basis is or continues to be zero. Therefore, for those securities, the bank does not record expected credit losses.
Available for sale debt securities in unrealized loss positions are evaluated for credit related loss at least quarterly. For available for sale debt securities, a decline in fair value due to credit loss results in recording an allowance for credit losses to the extent the fair value is less than the amortized cost basis. Declines in fair value that have not been recorded through an allowance for credit losses, such as declines due to changes in market interest rates, are recorded through other comprehensive income, net of applicable taxes. Although these evaluations involve significant judgment, an unrealized loss in the fair value of a debt security is generally considered to not be related to credit when the fair value of the security is below the carrying value primarily due to changes in risk-free interest rates, there has not been significant deterioration in the financial condition of the issuer, and the Company does not intend to sell nor does it believe it will be required to sell the security before the recovery of its cost basis.
If the Company intends to sell a debt security or more likely than not will be required to sell the security before recovery of its amortized cost basis, the debt security is written down to its fair value and the write down is charged against the allowance for credit losses with any incremental loss reported in earnings.
Purchase premiums are amortized to the earliest call date and purchase discounts are amortized to maturity as an adjustment to yield using the effective interest method. Unamortized premiums, unaccreted discounts, and early payment premiums are recognized as a component of gain or loss on sale upon disposition of the related security. Interest and dividend income are recognized when earned. Realized gains and losses from the sale of available for sale debt securities are included in earnings using the specific identification method.
Nonmarketable Equity Securities. Nonmarketable equity securities include securities that are not publicly traded, such as Visa Class B common stock, and securities acquired to meet regulatory requirements, such as Federal Reserve Bank stock, which are restricted. These restricted securities are accounted for under the cost method and are included in other assets. The Company reviews those assets accounted for under the cost method at least quarterly. The Company’s review typically includes an analysis of the facts and circumstances of each investment, the expectations for the investment’s cash flows and capital needs, the viability of its business model and any exit strategy. When the review indicates that impairment exists the asset value is reduced to fair value. The Company recognizes the estimated loss in noninterest income.
Loans. Loans are stated at the principal amount outstanding, net of unearned discount and unamortized deferred fees and costs. Interest is accrued daily on the outstanding principal balances and included in other assets. Loans which are more than 90 days delinquent with respect to interest or principal, unless they are well secured and in the process of collection, and other loans on which full recovery of principal or interest is in doubt, are placed on nonaccrual status. Interest previously accrued on loans placed on nonaccrual status is charged against interest income. In addition, some loans secured by real estate and commercial loans to borrowers experiencing financial difficulties are placed on nonaccrual status even though the borrowers continue to repay the loans as scheduled. When the ability to fully collect nonaccrual loan principal is in doubt, payments received are applied against the principal balance of the loans on a cost-recovery method until such time as full collection of the remaining recorded balance is expected. Any additional interest payments received after that time are recorded as interest income on a cash basis. Nonaccrual loans are reinstated to accrual status when none of the loan’s principal and interest is past due and improvements in credit quality eliminate doubt as to the full collectability of both principal and interest, or the loan otherwise becomes well secured and in the process of collection. Certain consumer loans or auto receivables are charged off against the allowance for credit losses when they become 120 days past due.
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A troubled debt restructuring (“TDR”) occurs when the Company, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower it would not otherwise consider. The Company follows its general nonaccrual policy for TDRs. Performing TDRs are reinstated to accrual status when improvements in credit quality eliminate the doubt as to full collectability of both principal and interest. Under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), banks may elect to deem that loan modifications do not result in TDRs if they are (1) related to the novel coronavirus disease; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency or (B) December 31, 2020.The Consolidated Appropriations Act, 2021, extended the period during which banks may elect to deem that qualified loan modifications do not result in TDR classification through January 1, 2022.
Allowance for Credit Losses. The Company extends loans to commercial and consumer customers primarily in Northern and Central California. These lending activities expose the Company to the risk borrowers will default, causing loan losses. The Company’s lending activities are exposed to various qualitative risks. All loan segments are exposed to risks inherent in the economy and market conditions. Significant risk characteristics related to the commercial loan segment include the borrowers’ business performance and financial condition, and the value of collateral for secured loans. Significant risk characteristics related to the commercial real estate segment include the borrowers’ business performance and the value of properties collateralizing the loans. Significant risk characteristics related to the construction loan segment include the borrowers’ performance in successfully developing the real estate into the intended purpose and the value of the property collateralizing the loans. Significant risk characteristics related to the residential real estate segment include the borrowers’ financial wherewithal to service the mortgages and the value of the property collateralizing the loans. Significant risk characteristics related to the consumer loan segment include the financial condition of the borrowers and the value of collateral securing the loans.
The preparation of these financial statements requires Management to estimate the amount of expected losses over the expected contractual life of our existing loan portfolio and establish an allowance for credit losses. Loan agreements generally include a maturity date, and the Company considers the contractual life of a loan agreement to extend from the date of origination to the contractual maturity date. In estimating credit losses, Management must exercise significant judgment in evaluating information deemed relevant. The amount of ultimate losses on the loan portfolio can vary from the estimated amounts. Management follows a systematic methodology to estimate loss potential in an effort to reduce the differences between estimated and actual losses.
The allowance for credit losses is established through provisions for credit losses charged to income. Losses on loans are charged to the allowance for credit losses when all or a portion of the recorded amount of a loan is deemed to be uncollectible. Recoveries of loans previously charged off are credited to the allowance when realized. The Company’s allowance for credit losses is maintained at a level considered adequate to provide for expected losses based on historical loss rates adjusted for current and expected conditions over a forecast period. These include conditions unique to individual borrowers, as well as overall credit loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions, or credit protection agreements and other factors.
Loans that share common risk characteristics are segregated into pools based on common characteristics, which is primarily determined by loan, borrower, or collateral type. Historical loss rates are determined for each pool. For consumer installment loans, primarily secured by automobiles, historical loss rates are determined using a vintage methodology, which tracks losses based on period of origination. For commercial, construction, and commercial real estate, historical loss rates are determined using an open pool methodology where losses are tracked over time for all loans included in the pool at the historical measurement date. Historical loss rates are adjusted for factors that are not reflected in the historical loss rates that are attributable to national or local economic or industry trends which have occurred but have not yet been recognized in past loan charge-off history, estimated losses based on management’s reasonable and supportable expectation of economic trends over a forecast horizon of up to two years, and other factors that impact credit loss expectations that are not reflected in the historical loss rates. Other factors include, but are not limited to, the effectiveness of the Company’s loan review system, adequacy of lending Management and staff, loan policies and procedures, problem loan trends, and concentrations of credit. At the end of the two-year forecast period loss rates revert immediately to the historical loss rates. The results of this analysis are applied to the amortized cost of the loans included within each pool.
Loans that do not share risk characteristics with other loans in the pools are evaluated individually. A loan is considered ‘collateral-dependent’ when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. A credit loss reserve for collateral-dependent loans is established at the difference between the amortized cost basis in the loan and the fair value of the underlying collateral adjusted for costs to sell. For other individually evaluated loans that are not collateral dependent, a credit loss reserve is established at the difference between the amortized cost basis in the loan and the present value of expected future cash flows discounted at the loan’s effective interest rate. The impact of an expected TDR modification is included in the allowance for credit losses when management determines a TDR modification is likely.
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Accrued interest is recorded in other assets and is excluded from the estimation of expected credit loss. Accrued interest is reversed through interest income when amounts are determined to be uncollectible, which generally occurs when the underlying receivable is placed on nonaccrual status or charged off.
Liability for Off-Balance Sheet Credit Exposures. Off-balance sheet credit exposures relate to letters of credit and unfunded loan commitments for commercial, construction and consumer loans. The Company maintains a separate allowance for credit losses from off-balance-sheet credit exposures, which is included within other liabilities on the consolidated statements of financial condition. Increases or reductions to the Company’s allowance for credit losses from off-balance sheet credit exposures are recorded in other expenses. Management estimates the amount of expected losses by estimating expected usage exposures that are not unconditionally cancellable by the Company and applying the loss factors used in the allowance for credit loss methodology to estimate the liability for credit losses related to unfunded commitments. No credit loss estimate is reported for off-balance-sheet credit exposures that are unconditionally cancellable by the Company or for undrawn amounts under such arrangements that may be drawn prior to the cancellation of the arrangement.
Nonrefundable fees and certain costs associated with originating or acquiring loans are deferred and amortized as an adjustment to interest income over the contractual loan lives. Upon prepayment, unamortized loan fees, net of costs, are immediately recognized in interest income. Other fees, including those collected upon principal prepayments, are included in interest income when received. Loans held for sale are identified upon origination and are reported at the lower of cost or market value on an aggregate loan basis.
Other Real Estate Owned. Other real estate owned is comprised of property acquired through foreclosure proceedings, acceptances of deeds-in-lieu of foreclosure and, if applicable, vacated bank properties. Losses recognized at the time of acquiring property in full or partial satisfaction of debt are charged against the allowance for credit losses. Other real estate owned is recorded at the fair value of the collateral, generally based upon an independent property appraisal, less estimated disposition costs. Losses incurred subsequent to acquisition due to any decline in annual independent property appraisals are recognized as noninterest expense. Routine holding costs, such as property taxes, insurance and maintenance, and losses from sales and dispositions, are recognized as noninterest expense.
Premises and Equipment. Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed substantially on the straight-line method over the estimated useful life of each type of asset. Estimated useful lives of premises and equipment range from 20 to 50 years and from 3 to 20 years, respectively. Leasehold improvements are amortized over the terms of the lease or their estimated useful life, whichever is shorter.
Revenue Recognition. The Company recognizes revenue as it is earned based on contractual terms, as transactions occur, or as services are provided and collectability is reasonably assured. In certain circumstances, noninterest income is reported net of associated expenses that are directly related to variable volume-based sales or revenue sharing arrangements or when the Company acts on an agency basis for others.
Life Insurance Cash Surrender Value. The Company has purchased life insurance policies on certain directors and officers as well as acquired such assets as part of the acquisition of other banks. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. These assets are included in other assets on the consolidated balance sheets.
Intangible Assets. Intangible assets are comprised of goodwill, core deposit intangibles and other identifiable intangibles acquired in business combinations. Intangible assets with finite useful lives are amortized on an accelerated basis over their respective estimated useful lives not exceeding 15 years. Intangible assets with a finite useful life are reviewed at least annually for impairment. Any goodwill and any intangible asset acquired in a business combination determined to have an indefinite useful life is not amortized and is reviewed at least annually for impairment. If management determines, based on a qualitative review of events and circumstances, that it is more likely than not that the carrying value of the intangible asset will not be realized, an impairment test is performed to determine whether the asset’s fair value is less than the carrying amount of the asset.
Impairment of Long-Lived Assets. The Company reviews its long-lived and certain intangible assets for impairment whenever events or changes indicate that the carrying amount of an asset may not be recoverable. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
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Income Taxes. The Company and its subsidiaries file consolidated tax returns. The Company accounts for income taxes in accordance with FASB ASC 740, Income Taxes, resulting in two components of income tax expense: current and deferred. Current income tax expense approximates taxes to be paid or refunded for the current period. The Company determines deferred income taxes using the balance sheet method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and recognizes enacted changes in tax rates and laws in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized subject to Management’s judgment that realization is more likely than not. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize. The tax position is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement. Interest and penalties are recognized as a component of income tax expense.
Stock-based Compensation. The Company applies FASB ASC 718 – Compensation – Stock Compensation, to account for stock based awards granted to employees using the fair value method. The Company recognizes compensation expense for restricted performance share grants over the relevant attribution period. Restricted performance share grants have no exercise price, therefore, the intrinsic value is measured using an estimated per share price at the vesting date for each restricted performance share. The estimated per share price is adjusted during the attribution period to reflect actual stock price performance. The Company’s obligation for unvested outstanding restricted performance share grants is classified as a liability until the vesting date due to a cash settlement feature, at which time the issued shares become classified as shareholders’ equity.
Other. Securities and other property held by the Bank in a fiduciary or agency capacity are not included in the financial statements since such items are not assets of the Company or its subsidiaries.
Recently Adopted Accounting Standards
In 2020, the Company adopted the following new accounting guidance:
FASB ASU 2016-13,Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was issued on June 16, 2016. The ASU significantly changed estimates for credit losses related to financial assets measured at amortized cost and certain other contracts. For estimating credit losses, the FASB replaced the incurred loss model with the current expected credit loss (CECL) model, which accelerated recognition of credit losses. Additionally, credit losses relating to debt securities available-for-sale are recorded through an allowance for credit losses under the new standard. The Company is also required to provide additional disclosures related to the financial assets within the scope of the new standard.
The Company adopted the ASU provisions on a modified retrospective basis on January 1, 2020. Management evaluated available data, defined portfolio segments of loans with similar attributes, and selected loss estimate models for each identified loan portfolio segment. Management measured historical loss rates for each portfolio segment. Management also segmented debt securities held to maturity, selected methods to estimate losses for each segment, and measured a loss estimate. Agency mortgage-backed securities were assigned no credit loss allowance due to the perceived backing of government sponsored entities. Municipal securities were evaluated for risk of default based on credit rating and remaining term to maturity using Moody’s risk of default factors; Moody’s loss upon default factors were applied to the assumed defaulted principal amounts to estimate the amount for credit loss allowance. The adjustment to the allowance for credit losses was recorded through an offsetting after-tax adjustment to shareholders’ equity. The implementing entry increased allowance for credit losses by $2,017 thousand, reduced allowance for credit losses for unfunded credit commitments by $2,107 thousand and increased retained earnings by $52 thousand.
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The following table summarizes the impact of adoption of ASU 2016-13.
Balance, Impact of As reported
prior to adoption adoption of under
(In thousands)
Assets:
Allowance for credit losses on loans: