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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the fiscal year ended December 31, 2017

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from                      to                     

Commission file number: 1-10140

 

 

CVB FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

California   95-3629339

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

701 N. Haven Avenue, Suite 350

Ontario, California

  91764
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (909) 980-4030

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Class

 

Name of Each Exchange on Which Registered

Common Stock, no par value   NASDAQ Stock Market, LLC

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☒    No  ☐

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No  ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer   ☐ (Do not check if a smaller reporting company)    Smaller reporting company  
Emerging growth company       

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☒

As of June 30, 2017, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $2,303,271,765.

Number of shares of common stock of the registrant outstanding as of February 15, 2018: 110,159,857.

 

 

 

DOCUMENTS INCORPORATED BY REFERENCE

     PART OF  

Definitive Proxy Statement for the Annual Meeting of Stockholders which will be filed

within 120 days of the fiscal year ended December 31, 2017

     Part III of Form 10-K  

 

 

 


Table of Contents

CVB FINANCIAL CORP.

2017 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

PART I   
ITEM 1.   BUSINESS      4  
ITEM 1A.   RISK FACTORS      18  
ITEM 1B.   UNRESOLVED STAFF COMMENTS      32  
ITEM 2.   PROPERTIES      32  
ITEM 3.   LEGAL PROCEEDINGS      32  
ITEM 4.   MINE SAFETY DISCLOSURES      33  
PART II   
ITEM 5.   MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES      34  
ITEM 6.   SELECTED FINANCIAL DATA      36  
ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      37  
  CRITICAL ACCOUNTING POLICIES      37  
  OVERVIEW      38  
  ANALYSIS OF THE RESULTS OF OPERATIONS      39  
  RESULTS BY BUSINESS SEGMENTS      49  
  ANALYSIS OF FINANCIAL CONDITION      52  
  RISK MANAGEMENT      76  
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK      86  
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA      87  
ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE      87  
ITEM 9A.   CONTROLS AND PROCEDURES      87  
ITEM 9B.   OTHER INFORMATION      89  
PART III   
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE      90  
ITEM 11.   EXECUTIVE COMPENSATION      90  
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS      90  
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE      91  
ITEM 14.   PRINCIPAL ACCOUNTING FEES AND SERVICES      91  
PART IV   
ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES      92  
ITEM 16.   FORM 10-K SUMMARY      92  
SIGNATURES        96  

 

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INTRODUCTION

Cautionary Note Regarding Forward-Looking Statements

Certain statements in this report constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, Rule 175 promulgated thereunder, Section 21E of the Securities and Exchange Act of 1934, as amended, Rule 3b-6 promulgated thereunder, or Exchange Act, and as such involve risk and uncertainties. All statements in this Form 10-K other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws. Words such as “will likely result, “aims”, “anticipates”, “believes”, “could”, “estimates”, “expects”, “hopes”, “intends”, “may”, “plans”, “projects”, “seeks”, “should”, “will” and variations of these words and similar expressions help to identify these forward looking statements, which involve risks and uncertainties.

These forward-looking statements relate to, among other things, anticipated future operating and financial performance, the allowance for loan losses, our financial position and liquidity, business strategies, regulatory and competitive outlook, investment and expenditure plans, capital and financing needs and availability, plans and objectives of management for future operations, expectations of the environment in which we operate, projections of future performance, perceived opportunities in the market and strategies regarding our mission and vision and statements relating to any of the foregoing. Factors that could cause actual results to differ from those discussed in the forward-looking statements include but are not limited to:

 

    local, regional, national and international economic and market conditions and events and the impact they may have on us, our customers and our assets and liabilities;
    our ability to attract deposits and other sources of funding or liquidity;
    supply and demand for real estate and periodic deterioration in real estate prices and/or values in California or other states where we lend, including both residential and commercial real estate;
    a prolonged slowdown or decline in real estate construction, sales or leasing activities;
    changes in the financial performance and/or condition of our borrowers or key vendors or counterparties;
    changes in our levels of delinquent loans, nonperforming assets, allowance for loan losses and charge-offs;
    the costs or effects of mergers, acquisitions or dispositions we may make, including the pending merger of Community Bank with and into Citizens Business Bank, whether we are able to obtain any required governmental approvals in connection with any such mergers, acquisitions or dispositions, and/or our ability to realize the contemplated financial or business benefits associated with any such mergers, acquisitions or dispositions;
    our ability to realize cost savings or synergies in connection with any acquisitions we may make;
    the effect of changes in laws, regulations and applicable judicial decisions (including laws, regulations and judicial decisions concerning financial reforms, taxes, bank capital levels, consumer, commercial or secured lending, securities and securities trading and hedging, compliance, fair lending, employment, executive compensation, insurance, vendor management and information security) with which we and our subsidiaries must comply or believe we should comply, including additional legal and regulatory requirements to which we may become subject in the event our total assets exceed $10 billion;
    changes in estimates of future reserve requirements and minimum capital requirements based upon the periodic review thereof under relevant regulatory and accounting requirements, including changes in the Basel Committee framework establishing capital standards for credit, operations and market risk;
    the accuracy of the assumptions and estimates and the absence of technical error in implementation or calibration of models used to estimate the fair value of financial instruments;
    inflation, interest rate, securities market and monetary fluctuations;
    changes in government interest rates or monetary policies;
    changes in the amount and availability of deposit insurance;

 

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    political developments, uncertainties or instability;
    disruptions in the infrastructure that supports our business and the communities where we are located, which are concentrated in California, involving or related to physical site access, cyber incidents, terrorist and political activities, disease pandemics, catastrophic events, natural disasters such as earthquakes, extreme weather events, electrical, environmental, computer servers, and communications or other services we use, or that affect our employees or third parties with whom we conduct business;
    our timely development and acceptance of new banking products and services and the perceived overall value of these products and services by customers and potential customers;
    the Company’s relationships with and reliance upon vendors with respect to certain of the Company’s key internal and external systems and applications;
    changes in commercial or consumer spending, borrowing and savings preferences or behaviors;
    technological changes and the expanding use of technology in banking (including the adoption of mobile banking, funds transfer applications and electronic marketplaces for loans and other banking products or services);
    our ability to retain and increase market share, retain and grow customers and control expenses;
    changes in the competitive environment among financial and bank holding companies, banks and other financial service providers;
    competition and innovation with respect to financial products and services by banks, financial institutions and non-traditional providers including retail businesses and technology companies;
    volatility in the credit and equity markets and its effect on the general economy or local or regional business conditions;
    fluctuations in the price of the Company’s common stock or other securities, and the resulting impact on the Company’s ability to raise capital or make acquisitions;
    the effect of changes in accounting policies and practices, as may be adopted from time-to-time by the regulatory agencies, as well as by the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard-setters;
    changes in our organization, management, compensation and benefit plans, and our ability to retain or expand our workforce, management team and/or board of directors;
    the costs and effects of legal, compliance and regulatory actions, changes and developments, including the initiation and resolution of legal proceedings (such as securities, bank operations, consumer or employee class action litigation),
    the possibility that any settlement of any of the putative class action lawsuits may not be approved by the relevant court or that significant numbers of putative class members may opt out of any settlement;
    regulatory or other governmental inquiries or investigations, and/or the results of regulatory examinations or reviews;
    our ongoing relations with our various federal and state regulators, including the SEC, Federal Reserve Board, FDIC and California DBO; and
    our success at managing the risks involved in the foregoing items.

For additional information concerning risks we face, see “Item 1A. Risk Factors” and any additional information we set forth in our periodic reports filed pursuant to the Exchange Act, including our Annual Report on Form 10-K. We do not undertake any obligation to update our forward-looking statements to reflect occurrences or unanticipated events or circumstances arising after the date of such statements, except as required by law.

 

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PART I

 

ITEM 1. BUSINESS

CVB Financial Corp.

CVB Financial Corp. (referred to herein on an unconsolidated basis as “CVB” and on a consolidated basis as “we”, “our” or the “Company”) is a bank holding company incorporated in California on April 27, 1981 and registered with the Board of Governors of the Federal Reserve System (“Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”). The Company commenced business on December 30, 1981 when, pursuant to a reorganization, it acquired all of the voting stock of Chino Valley Bank. On March 29, 1996, Chino Valley Bank changed its name to Citizens Business Bank (“CBB” or the “Bank”). The Bank is our principal asset. The Company also has one inactive subsidiary, Chino Valley Bancorp. The Company is also the common stockholder of CVB Statutory Trust III. CVB Statutory Trust III was created in January 2006 to issue trust preferred securities in order to raise capital for the Company.

CVB’s principal business is to serve as a holding company for the Bank and for other banking or banking related subsidiaries, which the Company may establish or acquire. CVB has not engaged in any other material activities to date. As a legal entity separate and distinct from its subsidiaries, CVB’s principal source of funds is, and will continue to be, dividends paid by and other funds advanced from the Bank and capital raised directly by CVB. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to CVB. See “Item 1. Business — Regulation and Supervision — Dividends.” As of December 31, 2017, the Company had $8.27 billion in total consolidated assets, $4.77 billion in net loans, $6.55 billion in deposits, and $553.8 million in customer repurchase agreements.

On March 10, 2017, we completed the acquisition of Valley Commerce Bancorp (“VCBP”), the holding company for Valley Business Bank (“VBB”), headquartered in the Central Valley area of California with four branch locations and total assets of approximately $400 million. This acquisition strengthens our market share in the Central Valley area of California. Our consolidated financial statements for 2017 include VBB operations, post-merger. See Note 4 — Business Combinations, included herein.

On February 26, 2018, we entered into a definitive agreement to merge Community Bank with and into Citizens Business Bank. As of December 31, 2017, Community Bank had approximately $3.75 billion in total assets, $2.74 billion in gross loans and $2.86 billion in total deposits. Under the terms of the merger, Community Bank shareholders will have the right to receive, in respect of each share of common stock of Community Bank, 9.4595 shares of CVB common stock and $56.00 per share in cash, subject to any adjustments set forth in the Merger Agreement. The merger transaction is valued at approximately $878.3 million based on CVB’s closing stock price of $23.37 on February 23, 2018. Consummation of the merger is subject to customary closing conditions, including, among others, shareholder and regulatory approval. The merger is expected to close in the third quarter of 2018.

The principal executive offices of CVB and the Bank are located at 701 North Haven Avenue, Suite 350, Ontario, California. Our phone number is (909) 980-4030.

Citizens Business Bank

The Bank commenced operations as a California state-chartered bank on August 9, 1974. The Bank’s deposit accounts are insured under the Federal Deposit Insurance Act up to applicable limits. The Bank is not a member of the Federal Reserve System. At December 31, 2017, the Bank had $8.26 billion in assets, $4.77 billion in net loans, $6.57 billion in deposits, and $553.8 million in customer repurchase agreements.

As of December 31, 2017, there were 50 Banking Centers (“Centers”) located in the Inland Empire, Los Angeles County, Orange County, San Diego County, Ventura County, Santa Barbara County, and the Central Valley area of California.

 

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We also have three trust offices located in Ontario, Newport Beach and Pasadena. These offices serve as sales offices for the Bank’s wealth management, trust and investment products.

Through our network of Centers, we emphasize personalized service combined with a wide range of banking and trust services for businesses, professionals and individuals located in the service areas of our Centers. Although we focus the marketing of our services to small-and medium-sized businesses, a wide range of banking, investment and trust services are made available to the local consumer market.

We offer a standard range of bank deposit instruments. These include checking, savings, money market and time certificates of deposit for both business and personal accounts. We also serve as a federal tax depository for our business customers.

We also provide a full complement of lending products, including commercial, agribusiness, consumer, real estate loans and equipment and vehicle leasing. Commercial products include lines of credit and other working capital financing, accounts receivable lending and letters of credit. Agribusiness products are loans to finance the operating needs of wholesale dairy farm operations, cattle feeders, livestock raisers, and farmers. We provide bank qualified lease financing for municipal governments. Commercial real estate and construction loans are secured by a range of property types and include both owner-occupied and investor owned properties. Financing products for consumers include automobile leasing and financing, lines of credit, credit cards, home mortgages, and home equity loans and lines of credit.

We also offer a wide range of specialized services designed for the needs of our commercial customers. These services include cash management systems for monitoring cash flow, a credit card program for merchants, courier pick-up and delivery, payroll services, remote deposit capture, electronic funds transfers by way of domestic and international wires and automated clearinghouse, and on-line account access. We make available investment products offered by other providers to our customers, including mutual funds, a full array of fixed income vehicles and a program to diversify our customers’ funds in federally insured time certificates of deposit of other institutions.

In addition, we offer a wide range of financial services and trust services through our CitizensTrust division. These services include fiduciary services, mutual funds, annuities, 401(k) plans and individual investment accounts.

Business Segments

We are a community bank with two reportable operating segments: (i) Banking Centers (“Centers”) and (ii) Dairy & Livestock and Agribusiness. These operating segments are the focal points for customer sales and services and the primary focus of management of the Company. See the sections captioned “Results by Segment Operations” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 21 — Business Segments of the notes to consolidated financial statements.

Competition

The banking and financial services business is highly competitive. The competitive environment faced by banks is a result primarily of changes in laws and regulations, changes in technology and product delivery systems, and the ongoing consolidation among insured financial institutions. We compete for loans, deposits, and customers with other commercial banks, savings and loan associations, savings banks, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers, including online banks and “peer-to-peer” or “marketplace” lenders and other small business and consumer lenders. Many competitors are much larger in total assets and capitalization, have greater access to capital markets and/or offer a broader range of financial products and services, including technology-based services.

 

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Economic Conditions/Government Policies

Our profitability, like most financial institutions, is primarily dependent on interest rate spreads and noninterest income. In general, the difference between the interest rates paid by the Bank on interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by the Bank on interest-earning assets, such as loans extended to customers and securities held in the investment portfolio, will comprise the major portion of our earnings. These rates are highly sensitive to many factors that are beyond our control, such as inflation, recession and unemployment, government monetary and other policies, and the impact which future changes in domestic and foreign economic conditions might have on us cannot be predicted.

Opportunity for banks to earn fees and other noninterest income have also been limited by restrictions imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) and other government regulations. As the following sections indicate, the impact of current and future changes in government laws and regulations on our ability to maintain current levels of fees and other noninterest income could be material and cannot be predicted.

Our business is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Federal Reserve. The Federal Reserve implements national monetary policies (with objectives such as curbing inflation, increasing employment and combating recession) through its open-market operations in U.S. Government securities by buying and selling treasury and mortgage-backed securities, by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve in these areas influence the growth and performance of bank loans, investments, and deposits and also affect interest earned on interest-earning assets and paid on interest-bearing liabilities. Government fiscal and budgetary policies, including deficit spending, can also have a significant impact on the capital markets and interest rates. The nature and impact of any future changes in monetary and fiscal policies on us cannot be predicted.

Regulation and Supervision

General

The Company and the Bank are subject to significant regulation and restrictions by federal and state laws and regulatory agencies. These regulations and restrictions are intended primarily for the protection of depositors and the Federal Deposit Insurance Corporation (“FDIC”) Deposit Insurance Fund (“DIF”) and for the protection of borrowers, and secondarily for the stability of the U.S. banking system. The following discussion of statutes and regulations is a summary and does not purport to be complete nor does it address all applicable statutes and regulations. This discussion is qualified in its entirety by reference to the statutes and regulations referred to in this discussion. From time to time, federal and state legislation is enacted and implemented by regulations which may have the effect of materially increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive balance between banks and other financial services providers.

We cannot predict whether or when other legislation or new regulations may be enacted, and if enacted, the effect that new legislation or any implemented regulations and supervisory policies would have on our financial condition and results of operations. Such developments may further alter the structure, regulation, and competitive relationship among financial institutions, may limit the types or pricing of the products and services we offer, and may subject us to increased regulation, disclosure, and reporting requirements.

Legislation and Regulatory Developments

The federal banking agencies continue to implement the remaining requirements in the Dodd-Frank Act as well as promulgating other regulations and guidelines intended to assure the financial strength and safety and

 

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soundness of banks and the stability of the U.S. banking system. On February 3, 2017 the President of the United States issued an executive order identifying certain “core principles” for the administration’s financial services regulatory policy and directing the Secretary of the Treasury, in consultation with the heads of other financial regulatory agencies, to evaluate how the current regulatory framework promotes or inhibits the principles and what actions have been, and are being, taken to promote the principles. In response to the executive order, on June 12, 2017, October 6, 2017 and October 26, 2017, respectively, the United States Department of the Treasury issued the first three of four reports recommending a number of comprehensive changes in the current regulatory system for U.S. depository institutions, the U.S. capital markets and the U.S. asset management and insurance industries, around the following principles.

 

    Improving regulatory efficiency and effectiveness by critically evaluating mandates and regulatory fragmentation, overlap, and duplication across regulatory agencies;
    Aligning the financial system to help support the U.S. economy;
    Reducing regulatory burden by decreasing unnecessary complexity;
    Tailoring the regulatory approach based on size and complexity of regulated firms and requiring greater regulatory cooperation and coordination among financial regulators; and
    Aligning regulations to support market liquidity, investment, and lending in the U.S. economy. The scope and breadth of regulatory changes that will be implemented in response to the President’s executive order have not yet been determined.

Capital Adequacy Requirements

Bank holding companies and banks are subject to similar regulatory capital requirements administered by state and federal banking agencies. The basic capital rule changes in the new capital rules (the “New Capital Rules”) adopted by the federal bank regulatory agencies were fully effective on January 1, 2015, but many elements are being phased in over multiple future years. The risk-based capital guidelines for bank holding companies, and additionally for banks, require capital ratios that vary based on the perceived degree of risk associated with a banking organization’s operations, both for transactions reported on the balance sheet as assets, such as loans, and for those recorded as off-balance sheet items, such as commitments, letters of credit and recourse arrangements. The risk-based capital ratio is determined by classifying assets and certain off-balance sheet financial instruments into weighted categories, with higher levels of capital being required for those categories perceived as representing greater risks, and with the applicable ratios calculated by dividing qualifying capital by total risk-adjusted assets and off-balance sheet items. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors. Bank holding companies and banks engaged in significant trading activity may also be subject to the market risk capital guidelines and be required to incorporate additional market and interest rate risk components into their risk-based capital standards. To the extent that the new rules are not fully phased in, the prior capital rules will continue to apply.

The New Capital Rules revised the previous risk-based and leverage capital requirements for banking organizations to meet the requirements of the Dodd-Frank Act and to implement the international Basel Committee on Banking Supervision Basel III agreements. Many of the requirements in the New Capital Rules and other regulations and rules are applicable only to larger or internationally active institutions and not to all banking organizations, including institutions currently with less than $10 billion of assets, which currently include CVB and the Bank. These include required annual stress tests for institutions with $10 billion or more assets (which CVB and the Bank would be if we are able to successfully consummate the acquisition of Community Bank) and Enhanced Prudential Standards, Comprehensive Capital Analysis and Review requirements, Capital Plan and Resolution Plan or living will submissions. These also include an additional countercyclical capital buffer, a supplementary leverage ratio and the Liquidity Coverage Ratio rule requiring sufficient high-quality liquid assets, which may in turn apply to institutions with $50 billion or more in assets, $250 billion or more in assets, or institutions which may be identified as Global Systematically Important Banking Institutions (G-SIBs). If CVB were to cross the $10 billion or more asset threshold, its compliance costs

 

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and regulatory requirements, including the requirement to conduct an annual company-run stress test, would increase. Under the risk-based capital guidelines in place prior to the effectiveness of the New Capital Rules, which trace back to the 1988 Basel I accord, there were three fundamental capital ratios: a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio. To be deemed “well capitalized,” a bank must have a total risk-based capital ratio, a Tier 1 risk-based capital ratio and a Tier 1 leverage ratio of at least ten percent, six percent and five percent, respectively.

The following are the New Capital Rules applicable to the Company and the Bank which began January 1, 2015:

 

    an increase in the minimum Tier 1 capital ratio from 4.00% to 6.00% of risk-weighted assets;
    a new category and a required 4.50% of risk-weighted assets ratio is established for “common equity Tier 1” as a subset of Tier 1 capital limited to common equity;
    a minimum non-risk-based leverage ratio is set at 4.00%;
    changes in the permitted composition of Tier 1 capital to exclude trust preferred securities subject to certain grandfathering exceptions for organizations like CVB which were under $15 billion in assets as of December 31, 2009, mortgage servicing rights and certain deferred tax assets and include unrealized gains and losses on available for sale debt and equity securities unless the organization opts out of including such unrealized gains and losses, which election the Company made in 2015;
    the risk-weights of certain assets for purposes of calculating the risk-based capital ratios are changed for high volatility commercial real estate acquisition, development and construction loans, certain past due non-residential mortgage loans and certain mortgage-backed and other securities exposures; and
    an additional capital conservation buffer of 2.5% of risk weighted assets above the regulatory minimum capital ratios, which will be phased in over four years beginning at the rate of 0.625% of risk-weighted assets per year beginning 2016 and which must be met to avoid limitations on the ability of the Bank to pay dividends, repurchase shares or pay discretionary bonuses.

Management believes that, as of December 31, 2017, the Company and the Bank would meet all requirements under the New Capital Rules applicable to them on a fully phased-in basis if such requirements were currently in effect.

Including the capital conservation buffer of 2.5%, the New Capital Rules would result in the following minimum ratios to be considered well capitalized: (i) a Tier 1 capital ratio of 8.5%, (ii) a common equity Tier 1 capital ratio of 7.0%, and (iii) a total capital ratio of 10.5%. At December 31, 2017, the respective capital ratios of the Company and the Bank exceeded the minimum percentage requirements to be deemed “well-capitalized” for regulatory purposes. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources.”

While the New Capital Rules set higher regulatory capital standards for the Company and the Bank, bank regulators may also continue their past policies of expecting banks to maintain additional capital beyond the new minimum requirements. The implementation of the New Capital Rules or more stringent requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Company’s net income and return on equity, restrict the ability to pay dividends or executive bonuses and require the raising of additional capital. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources.”

In September 2017, the federal bank regulators proposed to revise and simplify the capital treatment for certain deferred tax assets, mortgage servicing assets, investments in non-consolidated financial entities and minority interests for banking organizations, such as the Company and the Bank, that are not subject to the advanced approaches requirements. In November 2017, the federal banking regulators revised the Basel III

 

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Capital Rules to extend the current transitional treatment of these items for non-advanced approaches banking organizations until the September 2017 proposal is finalized. The September 2017 proposal would also change the capital treatment of certain commercial real estate loans under the standardized approach, which we use to calculate our capital ratios.

In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provides a new standardized approach for operational risk capital. Under the Basel framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing in through January 1, 2027. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company and the Bank. The impact of Basel IV on us will depend on the manner in which it is implemented by the federal bank regulators.

Prompt Corrective Action Provisions

The Federal Deposit Insurance Act requires the federal bank regulatory agencies to take “prompt corrective action” with respect to a depository institution if that institution does not meet certain capital adequacy standards, including requiring the prompt submission of an acceptable capital restoration plan. Depending on the bank’s capital ratios, the agencies’ regulations define five categories in which an insured depository institution will be placed: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. At each successive lower capital category, an insured bank is subject to more restrictions, including restrictions on the bank’s activities, operational practices or the ability to pay dividends or executive bonuses. Based upon its capital levels, a bank that is classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment.

The prompt corrective action standards were changed to conform with the New Capital Rules. Under the new standards, in order to be considered well-capitalized, the bank will be required to meet the new common equity Tier 1 ratio of 6.5%, an increased Tier 1 ratio of 8% (increased from 6%), a total capital ratio of 10% (unchanged) and a leverage ratio of 5% (unchanged).

The federal banking agencies also may require banks and bank holding companies subject to enforcement actions to maintain capital ratios in excess of the minimum ratios otherwise required to be deemed well capitalized, in which case institutions may no longer be deemed to be well capitalized and may therefore be subject to certain restrictions such as taking brokered deposits.

Volcker Rule

In December 2013, the federal bank regulatory agencies adopted final rules that implement a part of the Dodd-Frank Act commonly referred to as the “Volcker Rule.” Under these rules and subject to certain exceptions, banking entities are restricted from engaging in activities that are considered proprietary trading and from sponsoring or investing in certain entities, including hedge or private equity funds that are considered “covered funds.” These rules became effective on April 1, 2014, although certain provisions are subject to delayed effectiveness under rules promulgated by the FRB. The Company and the Bank held no investment positions at December 31, 2017 which were subject to the final rule. Therefore, while these new rules may require us to conduct certain internal analysis and reporting to ensure continued compliance, they did not require any material changes in our operations or business.

 

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Bank Holding Company Regulation

Bank holding companies and their subsidiaries are subject to significant regulation and restrictions by Federal and State laws and regulatory agencies, which may affect the cost of doing business, and may limit permissible activities and expansion or impact the competitive balance between banks and other financial services providers.

A wide range of requirements and restrictions are contained in both federal and state banking laws, which together with implementing regulatory authority:

 

    Require periodic reports and such additional reports of information as the Federal Reserve may require;
    Require bank holding companies to meet or exceed increased levels of capital (See “Capital Adequacy Requirements”);
    Require that bank holding companies serve as a source of financial and managerial strength to subsidiary banks and commit resources as necessary to support each subsidiary bank;
    Limit of dividends payable to shareholders and restrict the ability of bank holding companies to obtain dividends or other distributions from their subsidiary banks. The Company’s ability to pay dividends on both its common and preferred stock is subject to legal and regulatory restrictions. Substantially all of the Company’s funds to pay dividends or to pay principal and interest on our debt obligations are derived from dividends paid by the Bank;
    Require a bank holding company to terminate an activity or terminate control of or liquidate or divest certain subsidiaries, affiliates or investments if the Federal Reserve believes the activity or the control of the subsidiary or affiliate constitutes a significant risk to the financial safety, soundness or stability of any bank subsidiary;
    Require the prior approval of senior executive officer or director changes and prohibit golden parachute payments, including change in control agreements, or new employment agreements with such payment terms, which are contingent upon termination if an institution is in “troubled condition”;
    Regulate provisions of certain bank holding company debt, including the authority to impose interest ceilings and reserve requirements on such debt and require prior approval to purchase or redeem securities in certain situations;
    Require prior approval for the acquisition of 5% or more of the voting stock of a bank or bank holding company by bank holding companies or other acquisitions and mergers with banks and consider certain competitive, management, financial, anti-money-laundering compliance, potential impact on U.S. financial stability or other factors in granting these approvals, in addition to similar California or other state banking agency approvals which may also be required; and
    Require prior notice and/or prior approval of the acquisition of control of a bank or a bank holding company by a shareholder or individuals acting in concert with ownership or control of 10% of the voting stock being a presumption of control.

Other Restrictions on the Company’s Activities

Subject to prior notice or Federal Reserve approval, bank holding companies may generally engage in, or acquire shares of companies engaged in, activities determined by the Federal Reserve to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Bank holding companies which elect and retain “financial holding company” status pursuant to the Gramm-Leach-Bliley Act of 1999 (“GLBA”) may engage in these nonbanking activities and broader securities, insurance, merchant banking and other activities that are determined to be “financial in nature” or are incidental or complementary to activities that are financial in nature without prior Federal Reserve approval. Pursuant to GLBA and Dodd-Frank, in order to elect and retain financial holding company status, a bank holding company and all depository institution subsidiaries of a bank holding company must be considered well capitalized and well managed, and, except in limited circumstances,

 

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depository subsidiaries must be in satisfactory compliance with the Community Reinvestment Act (“CRA”), which requires banks to help meet the credit needs of the communities in which they operate. Failure to sustain compliance with these requirements or correct any non-compliance within a fixed time period could lead to divestiture of subsidiary banks or require all activities to conform to those permissible for a bank holding company. CVB has not elected financial holding company status and neither CVB nor the Bank has engaged in any activities determined by the Federal Reserve to be financial in nature or incidental or complementary to activities that are financial in nature.

CVB is also a bank holding company within the meaning of Section 3700 of the California Financial Code. Therefore, CVB and any of its subsidiaries are subject to examination by, and may be required to file reports with, the California Department of Business Oversight (“DBO”). DBO approvals may also be required for certain mergers and acquisitions.

Securities Exchange Act of 1934

CVB’s common stock is publicly held and listed on the NASDAQ Stock Market (“NASDAQ”), and CVB is subject to the periodic reporting, information, proxy solicitation, insider trading, corporate governance and other requirements and restrictions of the Securities Exchange Act of 1934 and the regulations of the Securities and Exchange Commission (“SEC”) promulgated thereunder as well as listing requirements of NASDAQ.

Sarbanes-Oxley Act

The Company is subject to the accounting oversight and corporate governance requirements of the Sarbanes-Oxley Act of 2002, including, among other things, required executive certification of financial presentations, requirements for board audit committees and their members, and disclosure of controls and procedures and internal control over financial reporting.

Bank Regulation

As a California commercial bank whose deposits are insured by the FDIC, the Bank is subject to regulation, supervision, and regular examination by the DBO and by the FDIC, as the Bank’s primary Federal regulator, and must additionally comply with certain applicable regulations of the Federal Reserve. Specific federal and state laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds, their activities relating to dividends, investments, loans, the nature and amount of and collateral for certain loans, servicing and foreclosing on loans, borrowings, capital requirements, certain check-clearing activities, branching, and mergers and acquisitions. California banks are also subject to statutes and regulations including Federal Reserve Regulation O and Federal Reserve Act Sections 23A and 23B and Regulation W, which restrict or limit loans or extensions of credit to “insiders”, including officers, directors, and principal shareholders, and loans or extension of credit by banks to affiliates or purchases of assets from affiliates, including parent bank holding companies, except pursuant to certain exceptions and only on terms and conditions at least as favorable to those prevailing for comparable transactions with unaffiliated parties. Failure to comply with applicable bank regulation or adverse results from any examinations of the Bank could affect the cost of doing business, and may limit or impede otherwise permissible activities and expansion activities by the Bank.

Pursuant to the Federal Deposit Insurance Act (“FDI Act”) and the California Financial Code, California state chartered commercial banks may generally engage in any activity permissible for national banks. Therefore, the Bank may form subsidiaries to engage in the many so-called “closely related to banking” or “nonbanking” activities commonly conducted by national banks in operating subsidiaries or in subsidiaries of bank holding companies. Further, California banks may conduct certain “financial” activities permitted under GLBA in a “financial subsidiary” to the same extent as may a national bank, provided the bank is and remains “well-capitalized,” “well-managed” and in satisfactory compliance with the CRA. The Bank currently has no financial subsidiaries.

 

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FDIC and DBO Enforcement Authority

The federal and California regulatory structure gives the bank regulatory agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of appropriate loan loss reserves for regulatory purposes. The regulatory agencies have adopted guidelines to assist in identifying and addressing potential safety and soundness concerns before an institution’s capital becomes impaired. The guidelines establish operational and managerial standards generally relating to: (1) internal controls, information systems, and internal audit systems; (2) loan documentation; (3) credit underwriting; (4) interest-rate exposure; (5) asset growth and asset quality; and (6) compensation, fees, and benefits. Further, the regulatory agencies have adopted safety and soundness guidelines for asset quality and for evaluating and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves. If, as a result of an examination, the DBO or the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, the DBO and the FDIC, and separately the FDIC as insurer of the Bank’s deposits, have residual authority to:

 

    Require affirmative action to correct any conditions resulting from any violation or practice;
    Direct an increase in capital and the maintenance of higher specific minimum capital ratios, which could preclude the Bank from being deemed well capitalized and restrict its ability to accept certain brokered deposits;
    Restrict the Bank’s growth geographically, by products and services, or by mergers and acquisitions, including bidding in FDIC receiverships for failed banks;
    Enter into or issue informal or formal enforcement actions, including required Board resolutions, Matters Requiring Board Attention (MRBA), written agreements and consent or cease and desist orders or prompt corrective action orders to take corrective action and cease unsafe and unsound practices;
    Require prior approval of senior executive officer or director changes; remove officers and directors and assess civil monetary penalties; and
    Terminate FDIC insurance, revoke the charter and/or take possession of and close and liquidate the Bank or appoint the FDIC as receiver.

Deposit Insurance

The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC insures our customer deposits through the DIF up to prescribed limits for each depositor. The Dodd-Frank Act revised the FDIC’s DIF management authority by setting requirements for the Designated Reserve Ratio (the DIF balance divided by estimated insured deposits) and redefining the assessment base, which is used to calculate banks’ quarterly assessments. The amount of FDIC assessments paid by each DIF member institution is based on its asset size and relative risk of default as measured by regulatory capital ratios and other supervisory factors. The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices that pose a risk to the DIF or that may prejudice the interest of the bank’s depositors. The termination of deposit insurance for a bank would also result in the revocation of the bank’s charter by the DBO.

We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance, which can be affected by the cost of bank failures to the FDIC among other factors.

In October 2010, the FDIC adopted a restoration plan to ensure that the fund reserve ratio reaches 1.35%. In March 2016, the FDIC approved a final rule requiring banks with more than $10 billion in total assets to pay “surcharge assessments” at an annual rate of 0.045% to bring the fund’s reserve ratio to 1.35% by the end of 2018. If the fund’s reserve ratio does not reach 1.35% by the end of 2018, the FDIC will impose a one-time

 

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special assessment in the first quarter of 2019 for banks with more than $10 billion in assets. For banks with less than $10 billion in total assets, in April 2016, the board of directors of the FDIC approved a final rule to amend the risk-based assessment methodology for banks with less than $10.0 billion in assets that have been FDIC-insured for at least five years, such as the Bank. The final rule replaces the four risk categories for determining such a bank’s assessment rate with a financial ratios method based on a statistical model estimating the bank’s probability of failure over three years. The final rule also eliminates the then existing brokered deposit downward adjustment factor for such banks’ assessment rates; lowers the range of assessment rates authorized to 0.015% per annum for an institution posing the least risk, to 0.40% per annum for an institution posing the most risk; and will further lower the range of assessment rates if the reserve ratio of the Deposit Insurance Fund increases to 2% or more.

The FDIC will, at least semi-annually, update its income and loss projections for the Deposit Insurance Fund and, if necessary, propose rules to further increase assessment rates. Any future increases in FDIC insurance premiums may have a material and adverse effect on our earnings and could have a material adverse effect on the value of, or market for, our common stock.

Dividends

It is the Federal Reserve’s policy that bank holding companies should generally pay dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. It is also the Federal Reserve’s policy that bank holding companies should not maintain dividend levels that undermine their ability to be a source of strength to its banking subsidiaries. The Federal Reserve also discourages dividend payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong. In addition, a bank holding company may be unable to pay dividends on its common stock if it fails to maintain an adequate capital conservation buffer under the New Capital Rules.

The Bank is a legal entity that is separate and distinct from its holding company. The Company relies on dividends received from the Bank for use in the operation of the Company and the ability of the Company to pay dividends to shareholders. Future cash dividends by the Bank will also depend upon management’s assessment of future capital requirements, contractual restrictions, and other factors. The new Capital Rules may restrict dividends by the Bank if the additional capital conservation buffer is not achieved. See “Capital Adequacy Requirements”.

The ability of the Bank to declare a cash dividend to CVB is subject to California law, which restricts the amount available for cash dividends to the lesser of a bank’s retained earnings or net income for its last three fiscal years (less any distributions to shareholders made during such period). Where the above test is not met, cash dividends may still be paid, with the prior approval of the DBO, in an amount not exceeding the greatest of (1) retained earnings of the bank; (2) the net income of the bank for its last fiscal year; or (3) the net income of the bank for its current fiscal year.

Compensation

The Dodd-Frank Act requires the federal bank regulators and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities, including the Company and the Bank, having at least $1 billion in total assets that encourage inappropriate risks by providing an executive officer, employee, director or principal stockholder with excessive compensation, fees or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations initially in April 2011 and in April 2016, the Federal Reserve and other federal financial agencies re-proposed restrictions on incentive-based compensation. For institutions with at least $1 billion but less than $50 billion in total consolidated assets, such as the Company and the Bank, the proposal

 

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would impose principles-based restrictions that are broadly consistent with existing interagency guidance on incentive-based compensation. Such institutions would be prohibited from entering into incentive compensation arrangements that encourage inappropriate risks by the institution (1) by providing an executive officer, employee, director, or principal shareholder with excessive compensation, fees, or benefits, or (2) that could lead to material financial loss to the institution. The proposal would also impose certain governance and recordkeeping requirements on institutions of the Company’s and the Bank’s size. The regulatory organizations would reserve the authority to impose more stringent requirements on institutions of the Company’s and the Bank’s size. We are evaluating the expected impact of the proposal on our business.

Operations and Consumer Compliance Laws

The Bank must comply with numerous federal and state anti-money laundering and consumer protection statutes and implementing regulations, including the USA PATRIOT Act of 2001, the Bank Secrecy Act, the Foreign Account Tax Compliance Act, the CRA, the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act, the California Homeowner Bill of Rights and various federal and state privacy protection laws, including the Telephone Consumer Protection Act , CAN-SPAM Act. Noncompliance with any of these laws could subject the Bank to compliance enforcement actions as well as lawsuits and could also result in administrative penalties, including, fines and reimbursements. The Bank and the Company are also subject to federal and state laws prohibiting unfair or fraudulent business practices, untrue or misleading advertising and unfair competition.

These laws and regulations mandate certain disclosure and reporting requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, servicing, collecting and foreclosure of loans, and providing other services. Failure to comply with these laws and regulations can subject the Bank and the Company to various penalties, including but not limited to enforcement actions, injunctions, fines or criminal penalties, punitive damages to consumers, and the loss of certain contractual rights.

The Bank received a “Satisfactory” rating in its most recent FDIC CRA performance evaluation, which measures how financial institutions support their communities in the areas of lending, investment and service.

The Dodd-Frank Act provided for the creation of the Bureau of Consumer Finance Protection (“CFPB”) as an independent entity within the Federal Reserve with broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards. The CFPB’s functions include investigating consumer complaints, conducting market research, rulemaking, and enforcing rules related to consumer financial products and services. CFPB regulations and guidance apply to all covered persons and banks with $10 billion or more in assets are subject to supervision including examination by the CFPB. Banks with less than $10 billion in assets will continue to be examined for compliance by their primary federal banking agency.

The CFPB has finalized a number of significant rules which impact nearly every aspect of the lifecycle of a residential mortgage loan. These rules implement the Dodd-Frank Act amendments to the Equal Credit Opportunity Act, the Truth in Lending Act and the Real Estate Settlement Procedures Act. Among other things, the rules adopted by the CFPB require covered persons including banks making residential mortgage loans to: (i) develop and implement procedures to ensure compliance with an “ability-to-repay” test and identify whether a loan meets a new definition for a “qualified mortgage”, in which case a rebuttable presumption exists that the creditor extending the loan has satisfied the ability-to-repay test; (ii) implement new or revised disclosures, policies and procedures for originating and servicing mortgages including, but not limited to, pre-loan counseling, early intervention with delinquent borrowers and specific loss mitigation procedures for loans secured by a borrower’s principal residence; (iii) comply with additional restrictions on mortgage loan originator hiring and compensation; (iv) comply with new disclosure requirements and standards for appraisals and certain

 

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financial products; and (v) maintain escrow accounts for higher-priced mortgage loans for a longer period of time.

The review of products and practices to prevent unfair, deceptive or abusive acts or practices (“UDAAP”) is a continuing focus of the CFPB, and of banking regulators more broadly. The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination, additional remediation efforts and possible penalties. In addition, the Dodd-Frank Act provides the CFPB with broad supervisory, examination and enforcement authority over various consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged violations of UDAAP and other legal requirements and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. The Dodd-Frank Act does not prevent states from adopting stricter consumer protection standards. State regulation of financial products and potential enforcement actions could also adversely affect the Bank’s business, financial condition or results of operations.

The federal bank regulators have adopted rules limiting the ability of banks and other financial institutions to disclose non-public information about consumers to unaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. These regulations affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. In addition, consumers may also prevent disclosure of certain information among affiliated companies that is assembled or used to determine eligibility for a product or service, such as that shown on consumer credit reports and asset and income information from applications. Consumers also have the option to direct banks and other financial institutions not to share information about transactions and experiences with affiliated companies for the purpose of marketing products or services.

Under the Durbin Amendment to the Dodd-Frank Act, the Federal Reserve adopted rules establishing standards for assessing whether the interchange fees that may be charged with respect to certain electronic debit transactions are “reasonable and proportional” to the costs incurred by issuers for processing such transactions.

Interchange fees, or “swipe” fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Under the final rules, the maximum permissible interchange fee is equal to no more than 21 cents plus 5 basis points of the transaction value for many types of debit interchange transactions. The Federal Reserve also adopted a rule to allow a debit card issuer to recover one cent per transaction for fraud prevention purposes if the issuer complies with certain fraud-related requirements required by the Federal Reserve. The Federal Reserve also has rules governing routing and exclusivity that require issuers to offer two unaffiliated networks for routing transactions on each debit or prepaid product.

Currently, we qualify for the small issuer exemption from the interchange fee cap, which applies to any debit card issuer that, together with its affiliates, has total assets of less than $10 billion as of the end of the previous calendar year. We will become subject to the interchange fee cap beginning July 1 of the year following the time when our total assets reaches or exceeds $10 billion. Reliance on the small issuer exemption does not exempt us from federal regulations prohibiting network exclusivity arrangements or from routing restrictions, however.

Commercial Real Estate Concentration Limits

In December 2006, the federal banking regulators issued guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” to address increased concentrations in commercial real estate, or CRE, loans. In addition, in December 2015, the federal bank agencies issued additional guidance entitled “Statement on Prudent Risk Management for Commercial Real Estate Lending.” Together, these

 

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guidelines describe the criteria the agencies will use as indicators to identify institutions potentially exposed to CRE concentration risk. An institution that has (i) experienced rapid growth in CRE lending, (ii) notable exposure to a specific type of CRE, (iii) total reported loans for construction, land development, and other land representing 100% or more of the institution’s capital, or (iv) total CRE loans representing 300% or more of the institution’s capital, and the outstanding balance of the institutions CRE portfolio has increased by 50% or more in the prior 36 months, may be identified for further supervisory analysis of the level and nature of its CRE concentration risk. As of December 31, 2017, the Bank’s total CRE loans and unfunded loan commitments represented 251% of its capital.

Future Legislation and Regulation

Congress may enact, modify or repeal legislation from time to time that affects the regulation of the financial services industry, and state legislatures may enact, modify or repeal legislation from time to time affecting the regulation of financial institutions chartered by or operating in those states. Federal and state regulatory agencies also periodically propose and adopt changes to their regulations or change the manner in which existing regulations are applied. The substance or impact of pending or future legislation or regulation, or the application thereof, cannot be predicted, although enactment of proposed legislation (or modification or repeal of existing legislation) could impact the regulatory structure under which the Company and Bank operate and may significantly increase its costs, impede the efficiency of its internal business processes, require the Bank to increase its regulatory capital and modify its business strategy, and limit its ability to pursue business opportunities in an efficient manner. The Company’s business, financial condition, results of operations or prospects may be adversely affected, perhaps materially.

Other Regulatory Authorities

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“Tax Reform Act”) was signed into law. The Tax Reform Act includes a number of provisions that impact us, including the following:

 

    Tax Rate. The Tax Reform Act replaces the corporate tax rates applicable under prior law, which imposed a maximum tax rate of 35%, with a reduced 21% tax rate. Although the reduced tax rate generally should be favorable to us by resulting in lower tax expense in future periods, it will decrease the value of our existing deferred tax assets. Generally accepted accounting principles (“GAAP”) requires that the impact of the provisions of the Tax Reform Act be accounted for in the period of enactment. Accordingly, the incremental income tax expense recorded by the Corporation in the fourth quarter of 2017 related to the Tax Reform Act was $13.2 million, resulting primarily from a re-measurement of deferred tax assets.
    FDIC Insurance Premiums. The Tax Reform Act prohibits taxpayers with consolidated assets over $50 billion from deducting any FDIC insurance premiums and prohibits taxpayers with consolidated assets between $10 and $50 billion from deducting the portion of their FDIC premiums equal to the ratio, expressed as a percentage, that (i) the taxpayer’s total consolidated assets over $10 billion, as of the close of the taxable year, bears to (ii) $40 billion.
    Employee Compensation. A “publicly held company” is not permitted to deduct compensation in excess of $1 million per year paid to certain employees. The Tax Reform Act eliminates certain exceptions to the $1 million limit applicable under prior law related to performance-based compensation, such as equity grants and cash bonuses that are paid only on the attainment of performance goals. As a result, our ability to deduct certain compensation paid to our most highly compensated employees may be limited in the future.
    Business Asset Expensing. The Tax Reform Act allows taxpayers immediately to expense the entire cost (instead of only 50%, as under prior law) of certain depreciable tangible property and real property improvements acquired and placed in service after September 27, 2017 and before January 1, 2023 (with an additional year for certain property). This 100% “bonus” depreciation is phased out proportionately for property placed in service on or after January 1, 2023 and before January 1, 2027 (with an additional year for certain property).

 

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The foregoing description of the impact of the Tax Reform Act on us should be read in conjunction with Note 12 —Income Taxes of the notes to consolidated financial statements for more information.

Available Information

Reports filed with the SEC include our proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. These reports and other information on file can be inspected and copied on official business days between 10:00 a.m. and 3:00 p.m. at the public reference facilities of the SEC on file at 100 F Street, N.E., Washington D.C., 20549. The public may obtain information on the operation of the public reference rooms by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains the reports, proxy and information statements and other information we file with them. The address of the site is http://www.sec.gov. The Company also maintains an Internet website at http://www.cbbank.com. We make available, free of charge through our website, our Proxy Statement, Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, and any amendments thereto, as soon as reasonably practicable after we file such reports with the SEC. None of the information contained in or hyperlinked from our website is incorporated into this Form 10-K.

Executive Officers of the Company

The following sets forth certain information regarding our executive officers, their positions and their ages.

 

   Executive Officers:   

            Name

  

Position

  

Age

Christopher D. Myers

   President and Chief Executive Officer of the Company and the Bank    55

E. Allen Nicholson

   Chief Financial Officer of the Company and Executive Vice President and Chief Financial Officer of the Bank    50

David F. Farnsworth

   Executive Vice President and Chief Credit Officer of the Bank    61

David A. Brager

   Executive Vice President and Sales Division Manager of the Bank    50

David C. Harvey

   Executive Vice President and Chief Operations Officer of the Bank    50

Richard H. Wohl

   Executive Vice President and General Counsel    59

Yamynn DeAngelis

   Executive Vice President and Chief Risk Officer    61

Mr. Myers assumed the position of President and Chief Executive Officer of the Company and the Bank on August 1, 2006. Prior to that, Mr. Myers served as Chairman of the Board and Chief Executive Officer of Mellon First Business Bank from 2004 to 2006. From 1996 to 2003, Mr. Myers held several management positions with Mellon First Business Bank, including Executive Vice President, Regional Vice President, and Vice President/Group Manager.

Mr. Nicholson was appointed Chief Financial Officer of the Company and Executive Vice President and Chief Financial Officer of the Bank on May 4, 2016. Previously, Mr. Nicholson served as Executive Vice President and Chief Financial Officer of Pacific Premier Bank and its holding company, Pacific Premier Bancorp Inc. from June of 2015 to May of 2016, and from 2008 to 2014, Mr. Nicholson was Chief Financial Officer of 1st Enterprise Bank. From 2005 to 2008, he was the Chief Financial Officer of Mellon First Business Bank.

Mr. Farnsworth was appointed Executive Vice President and Chief Credit Officer of the Bank on July 18, 2016. Prior to his appointment, Mr. Farnsworth was Executive Vice President, Global Risk Management, and National CRE Risk Executive at BBVA Compass. Previously, Mr. Farnsworth held senior credit management positions with US Bank and AmSouth.

 

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Mr. Brager assumed the position of Executive Vice President and Sales Division Manager of the Bank on November 22, 2010. From 2007 to 2010, he served as Senior Vice President and Regional Manager of the Central Valley Region for the Bank. From 2003 to 2007, he served as Senior Vice President and Manager of the Fresno Business Financial Center for the Bank. From 1997 to 2003, Mr. Brager held management positions with Westamerica Bank.

Mr. Harvey assumed the position of Executive Vice President and Chief Operations Officer of the Bank on December 31, 2009. From 2000 to 2008, he served as Senior Vice President and Operations Manager at Bank of the West. From 2008 to 2009 he served as Executive Vice President and Commercial and Treasury Services Manager at Bank of the West.

Mr. Wohl was initially appointed Executive Vice President and General Counsel of the Company and the Bank on October 11, 2011, and he rejoined the Company and the Bank in the same position on July 10, 2017 after a one-year hiatus at another financial institution. Prior to his initial appointment in 2011, Mr. Wohl served in senior business and legal roles at Indymac Bank, the law firm of Morrison & Foerster, and the U.S. Department of State.

Ms. DeAngelis assumed the position of Executive Vice President and Chief Risk Officer of the Bank on January 5, 2009. From 2006 to 2008, she served as Executive Vice President and Service Division Manager for the Bank. From 1995 to 2005, she served as Senior Vice President and Division Service Manager for the Bank.

 

ITEM 1A.     RISK FACTORS

Risk Factors That May Affect Future Results — Together with the other information on the risks we face and our management of risk contained in this Annual Report or in our other SEC filings, the following presents significant risks which may affect us. Events or circumstances arising from one or more of these risks could adversely affect our business, financial condition, operating results and prospects and the value and price of our common stock could decline. The risks identified below are not intended to be a comprehensive list of all risks we face, and additional risks that we may currently view as not material may also impair our business operations and results.

Strategic and External Risks

Changes in economic, market and political conditions can adversely affect our liquidity, results of operations and financial condition.

Our success depends, to a certain extent, upon local, national and global economic and political conditions, as well as governmental monetary policies. Conditions such as an economic recession, rising unemployment, changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore, our earnings. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which could have an adverse impact on our earnings. In addition, we may face the following risks in connection with any downward turn in the economy:

 

    The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The level of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates which may, in turn, impact the reliability of the process.
    The Company’s commercial, residential and consumer borrowers may be unable to make timely repayments of their loans, or the decrease in value of real estate collateral securing the payment of such loans could result in significant credit losses, increasing delinquencies, foreclosures and customer bankruptcies, any of which could have a material adverse effect on the Company’s operating results.

 

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    A sustained environment of low interest rates would continue to cause lending margins to stay compressed, which in turn may limit our revenues and profitability.
    The value of the portfolio of investment securities that we hold may be adversely affected by increasing interest rates and defaults by debtors.
    Further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations, may result in changes in applicable rates of interest, difficulty in accessing capital or an inability to borrow on favorable terms or at all from other financial institutions.
    Increased competition among financial services companies due to expected further consolidation in the industry may adversely affect the Company’s ability to market its products and services.

Although the Company and the Bank exceed the minimum capital ratio requirements to be deemed well capitalized and have not suffered any significant liquidity issues as a result of these types of events, the cost and availability of funds may be adversely affected by illiquid credit markets and the demand for our products and services may decline as our borrowers and customers continue to realize the impact of slower than customary economic growth, after-effects of the previous recession and ongoing underemployment of the workforce. In view of the concentration of our operations and the collateral securing our loan portfolio in Central and Southern California, we may be particularly susceptible to adverse economic conditions in the state of California, where our business is concentrated. In addition, adverse economic conditions may exacerbate our exposure to credit risk and adversely affect the ability of borrowers to perform, and thereby, adversely affect our liquidity, financial condition, results or operations and profitability.

Our earnings are significantly affected by the fiscal and monetary policies of the federal government and its agencies.

The policies of the Federal Reserve impact us significantly. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments we hold. Changes in those policies are beyond our control and are difficult to predict. Federal Reserve policies can also affect our borrowers, potentially increasing the risk that they may fail to repay their loans. As an example, monetary tightening by the Federal Reserve could adversely affect our borrowers’ earnings and ability to repay their loans, which could have a material adverse effect on our financial condition and results of operations.

Future legislation, regulatory reform or policy changes under the current U.S. administration could have a material effect on our business and results of operations.

New legislation, regulatory reform or policy changes under the current U.S. administration, including financial services regulatory reform, U.S. oil deregulation, tax reform, government-sponsored enterprise (GSE) reform and increased infrastructure spending, could impact our business. At this time, we cannot predict the scope or nature of these changes or assess what the overall effect of such potential changes could be on our results of operations or cash flows.

We face strong competition from financial services companies and other companies that offer banking services

We conduct most of our operations in the state of California. The banking and financial services businesses in the state of California are highly competitive and increased competition in our primary market area may adversely impact the level of our loans and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. These competitors include national banks, regional banks and other community banks. We also face competition from many other types of financial institutions, including savings and loan associations, finance companies, brokerage firms, insurance companies, credit unions, mortgage companies and other financial intermediaries. In particular, our competitors include major financial companies

 

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whose greater resources may afford them a marketplace advantage by enabling them to offer products at lower costs, maintain numerous locations, and mount extensive promotional and advertising campaigns. Areas of competition include interest rates for loans and deposits, efforts to obtain loan and deposit customers and a range in quality of products and services provided, including new technology driven products and services. If we are unable to attract and retain banking customers, we may be unable to continue our loan growth and level of deposits.

Potential acquisitions may disrupt our business and dilute shareholder value

We generally seek merger or acquisition partners that are culturally similar and have experienced management and possess either significant market presence or have potential for improved profitability through financial management, economies of scale or expanded services. Acquiring other banks, businesses, or branches including our pending acquisition of Community Bank, involves various risks commonly associated with acquisitions, including, among other things:

 

    Potential exposure to unknown or contingent liabilities of the target company.
    Exposure to potential asset quality issues of the target company.
    Potential disruption to our business.
    Potential diversion of our management’s time and attention.
    The possible loss of key employees and customers of the target company.
    Difficulty in estimating the value of the target company.
    Potential changes in banking or tax laws or regulations that may affect the target company.

Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction. Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on our business, financial condition and results of operations.

Consumers may decide not to use banks to complete their financial transactions.

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions, such as paying bills and / or transferring funds directly without the assistance of banks. In December 2016, the OCC announced that it would begin considering applications from financial technology companies to become special purpose national banks, and requested comments about how it can foster responsible innovation in the chartering process while continuing to provide robust oversight. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

Credit Risks

Our allowance for loan losses may not be sufficient to cover actual losses

A significant source of risk arises from the possibility that we could sustain losses because borrowers, guarantors, and related parties may fail to perform in accordance with the terms of their loans and leases. The underwriting and credit monitoring policies and procedures that we have adopted to address this risk may not prevent unexpected losses that could have a material adverse effect on our business, financial condition, results of operations and cash flows. We maintain an allowance for loan losses to provide for loan and lease defaults and

 

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non-performance, which also includes increases for new loan growth. While we believe that our allowance for loan losses is appropriate to cover inherent losses, we cannot assure you that we will not increase the allowance for loan losses further or that regulators will not require us to increase this allowance.

We may be required to make additional provisions for credit losses and charge-off additional loans in the future, which could adversely affect our results of operations

For the year ended December 31, 2017, we recorded an $8.5 million loan loss provision recapture. During 2017 we experienced charge-offs of $151,000, and recoveries of $6.7 million. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral. As of December 31, 2017, we had $3.40 billion in commercial real estate loans, $78.0 million in construction loans, $348.1 million in dairy & livestock and agribusiness loans, and $236.4 million in single-family residential mortgages. Although the U.S. economy has emerged from a prior period of severe recession followed by slower than normal growth, business activity and real estate values continue to grow more slowly than in past economic recoveries, and may not recover fully or could again decline from current levels, and this in turn could affect the ability of our loan customers to service their debts, including those customers whose loans are secured by commercial or residential real estate. This, in turn, could result in loan charge-offs and provisions for credit losses in the future, which could have a material adverse effect on our financial condition, net income and capital. In addition, the Federal Reserve Board and other government officials have expressed concerns about banks’ concentration in commercial real estate lending and the ability of commercial real estate borrowers to perform pursuant to the terms of their loans.

Dairy & livestock and agribusiness lending presents unique credit risks.

As of December 31, 2017, approximately 7.2% of our total gross loan portfolio was comprised of dairy & livestock and agribusiness loans. As of December 31, 2017, we had $348.1 million in dairy & livestock and agribusiness loans, including $310.6 in dairy & livestock loans, $37.5 million in agribusiness loans. Repayment of dairy & livestock and agribusiness loans depends primarily on the successful raising and feeding of livestock or planting and harvest of crops and marketing the harvested commodity (including milk production). Collateral securing these loans may be illiquid. In addition, the limited purpose of some agricultural -related collateral affects credit risk because such collateral may have limited or no other uses to support values when loan repayment problems emerge. Our dairy & livestock and agribusiness lending staff have specific technical expertise that we depend on to mitigate our lending risks for these loans and we may have difficulty retaining or replacing such individuals. Many external factors can impact our agricultural borrowers’ ability to repay their loans, including adverse weather conditions, water issues, commodity price volatility (i.e. milk prices), diseases, land values, production costs, changing government regulations and subsidy programs, changing tax treatment, technological changes, labor market shortages/increased wages, and changes in consumers’ preferences, over which our borrowers may have no control. These factors, as well as recent volatility in certain commodity prices, including milk prices, could adversely impact the ability of those to whom we have made dairy & livestock and agribusiness loans to perform under the terms of their borrowing arrangements with us, which in turn could result in credit losses and adversely affect our business, financial condition and results of operations.

The FASB has recently issued an accounting standard update that will result in a significant change in how we recognize credit losses and may have a material impact on our financial condition or results of operations.

In June 2016, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update, “Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments,” which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the Current Expected Credit Loss (“CECL”) model. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be

 

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based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current generally accepted accounting principles (“GAAP”), which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of our allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.

The new CECL standard will become effective for us for fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years. We are currently evaluating the impact the CECL model will have on our accounting, but we expect to recognize a one-time cumulative-effect adjustment to our allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, consistent with regulatory expectations set forth in interagency guidance issued at the end of 2016. We cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our financial condition or results of operations.

Our loan portfolio is predominantly secured by real estate and thus we have a higher degree of risk from a downturn in our real estate markets

A renewed downturn in our real estate markets could hurt our business because many of our loans are secured by real estate. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies, and acts of nature, such as earthquakes, prolonged drought and disasters particular to California. Substantially all of our real estate collateral is located in the state of California. If real estate values, including values of land held for development, should again start to decline, the value of real estate collateral securing our loans could be significantly reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans. Commercial real estate loans typically involve large balances to single borrowers or a group of related borrowers. Since payments on these loans are often dependent on the successful operation or management of the properties, as well as the business and financial condition of the borrower(s), repayment of such loans may be subject to adverse conditions in the real estate market, adverse economic conditions or changes in applicable government regulations.

Additional risks associated with our real estate construction loan portfolio include failure of developers and/or contractors to complete construction on a timely basis or at all, market deterioration during construction, cost overruns and failure to sell or lease the security underlying the construction loans so as to generate the cash flow anticipated by our borrower.

A decline in the economy may cause renewed declines in real estate values and increases in unemployment, which may result in higher than expected loan delinquencies or problem assets, a decline in demand for our products and services, or a lack of growth or decrease in deposits, which may cause us to incur losses, adversely affect our capital or hurt our business.

Our commercial real estate loan portfolio exposes us to risks that may be greater than the risks related to our other loans

Federal and state banking regulators are examining commercial real estate lending activity with heightened scrutiny and may require banks with higher levels of commercial real estate loans to implement more stringent underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and

 

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exposures. Because a significant portion of our loan portfolio is comprised of commercial real estate loans, the banking regulators may require us to maintain higher levels of capital than we would otherwise be expected to maintain, which could limit our ability to leverage our capital and have a material adverse effect on our business, financial condition, results of operations and prospects.

We are exposed to risk of environmental liabilities with respect to properties to which we take title

In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. While we will take steps to mitigate this risk, we may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean-up hazardous or toxic substances, or chemical releases at one or more properties. The costs associated with investigation or remediation activities could be substantial. In addition, while there are certain statutory protections afforded lenders who take title to property through foreclosure on a loan, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we become subject to significant environmental liabilities, our business, financial condition, results of operations and prospects could be adversely affected.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. Many if not all of these same factors could also significantly raise the cost of deposits to our Company and/or to the banking industry in general. This in turn could negatively affect the amount of interest we pay on our interest-bearing liabilities, which could have an adverse impact on our interest rate spread and profitability.

The actions and commercial soundness of other financial institutions could affect our ability to engage in routine funding transactions

Financial service institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to different industries and counterparties, and execute transactions with various counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual funds, and other institutional clients. Defaults by financial services institutions, even rumors or questions about one or more financial institutions or the financial services industry in general, could lead to market wide liquidity problems and further, could lead to losses or defaults by the Company or other institutions. Many of these transactions expose us to credit risk in the event of default of the applicable counterparty or client. In addition, our credit risk may increase when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due to us. Any such losses could materially and adversely affect our consolidated financial statements.

Changes in interest rates could reduce the value of our investment securities holdings.

The Bank maintains an investment portfolio consisting of various high quality liquid fixed-income securities. The total book value of the securities portfolio as of December 31, 2017 was $2.91 billion, of which $2.08 billion is available for sale. The nature of fixed-income securities is such that changes in market interest rates impact the value of these assets.

 

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Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance

A substantial portion of our income is derived from the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and the interest paid on deposits, borrowings and other interest-bearing liabilities. Because of the differences in the maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. At December 31, 2017 our balance sheet was positioned with a slightly asset sensitive bias over both a one and two-year horizon assuming no balance sheet growth, and as a result, our net interest margin tends to expand in a rising interest rate environment and decrease in a declining interest rate environment. Accordingly, fluctuations in interest rates could adversely affect our interest rate spread and, in turn, our profitability. In addition, loan origination volumes are affected by market interest rates. Rising interest rates, generally, are associated with a lower volume of loan originations while lower interest rates are usually associated with higher loan originations. Conversely, in rising interest rate environments, loan repayment rates may decline and in falling interest rate environments, loan repayment rates may increase. In addition, in a rising interest rate environment, we may need to accelerate the pace of rate increases on our deposit accounts as compared to the pace of future increases in short-term market rates. Accordingly, changes in levels of market interest rates could materially and adversely affect our net interest spread, asset quality, as well as loan origination and prepayment volume.

We may be subject to additional regulatory scrutiny if and when the Company or the Bank’s total assets exceed $10.0 billion.

The Company’s total assets were $8.27 billion at December 31, 2017. If the Company’s or the Bank’s total assets equal or exceed $10 billion (which would occur if we successfully consummate the acquisition of Community Bank), we will become subject to a number of additional requirements (such as annual stress testing requirements, an enterprise risk management committee comprised of independent directors, including one risk management expert, and general oversight by the CFPB) that will impose additional compliance costs on our business. The $10 billion threshold is calculated in different ways for the various requirements (from simply reaching the $10 billion as of a certain date, to reaching it for four consecutive quarters or to reaching it by averaging total consolidated assets for four consecutive quarters) and the dates the new requirements are triggered also vary (from immediate application to a period of over two years to achieve compliance). Being subject to these additional requirements may also result in higher expectations from regulators. The CFPB has near exclusive supervision authority, including examination authority, over institutions of that size and their affiliates to assess compliance with federal consumer financial laws, to obtain information about the institutions’ activities and compliance systems and procedures, and to detect and assess risks to consumers and markets.

Under the Dodd-Frank Act, the minimum ratio of net worth to insured deposits of the Deposit Insurance Fund was increased from 1.15% to 1.35% and the FDIC is required, in setting deposit insurance assessments, to offset the effect of the increase on institutions with assets of less than $10 billion, which results in institutions with assets greater than $10 billion paying a surcharge during a temporary period expected to last through 2018. In addition, if the Bank exceeds $10 billion in assets, its assessment base for federal deposit insurance will change from the amount of insured deposits to consolidated average assets less tangible capital to a scorecard method. The scorecard method uses a performance score and a loss severity score, which are combined and converted into an initial base assessment rate. The performance score is based on measures of the bank’s ability to withstand asset-related stress and funding-related stress and weighted CAMELS ratings, which are ratings ascribed under the CAMELS supervisory rating system and assigned based on a supervisory authority’s analysis of a bank’s financial statements and on-site examinations. The loss severity score is a measure of potential losses to the FDIC in the event of the bank’s failure. Under a formula, the performance score and loss severity score are combined and converted to a total score that determines the bank’s initial base assessment rate. The FDIC has the discretion to alter the total score based on factors not captured by the scorecard. The resulting initial base assessment rate is also subject to adjustments downward based on long term unsecured debt issued by the bank,

 

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to adjustment upward based on long term unsecured debt held by the bank that is issued by other FDIC-insured institutions, and to further adjustment upward if the bank’s brokered deposits exceed 10% of its domestic deposits.

Further, we may be affected by the Durbin Amendment to the Dodd-Frank Act regarding limits on debit card interchange fees. The Durbin Amendment gave the FRB the authority to establish rules regarding interchange fees charged for electronic debit transactions by a payment card issuer that, together with its affiliates, has assets of $10 billion or more and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. The FRB has adopted rules under this provision that limit the swipe fees that a debit card issuer can charge a merchant for a transaction to the sum of 21 cents and five basis points times the value of the transaction, plus up to one cent for fraud prevention costs.

As a result of the above, if and when our total assets exceed $10 billion, deposit insurance assessments, expenses related to regulatory compliance are likely to increase, and interchange fee income will decrease, the cumulative effect of which may be material to our results of operations.

We may experience goodwill impairment

If our estimates of segment fair value change due to changes in our businesses or other factors, we may determine that impairment charges on goodwill recorded as a result of acquisitions are necessary. Estimates of fair value are determined based on a complex model using cash flows, the fair value of our Company as determined by our stock price, and company comparisons. If management’s estimates of future cash flows are inaccurate, fair value determined could be inaccurate and impairment may not be recognized in a timely manner. If the fair value of the Company declines, we may need to recognize goodwill impairment in the future which would have a material adverse effect on our results of operations and capital levels.

Our accounting estimates and risk management processes rely on analytical and forecasting models

The processes we use to estimate our inherent loan losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and results of operations, depends upon the use of analytical and forecasting models. These models reflect assumptions that may not be accurate, particularly in times of market stress or other unforeseen circumstances. Even if these assumptions are adequate, the models may prove to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models we use for interest rate risk and asset-liability management are inadequate, we may incur increased or unexpected losses upon changes in market interest rates or other market measures. If the models we use for determining our probable loan losses are inadequate, the allowance for loan losses may not be sufficient to support future charge-offs. If the models we use to measure the fair value of financial instruments are inadequate, the fair value of such financial instruments may fluctuate unexpectedly or may not accurately reflect what we could realize upon sale or settlement of such financial instruments. Any such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition and results of operations.

Our decisions regarding the fair value of assets acquired could be different than initially estimated, which could materially and adversely affect our business, financial condition, results of operations, and future prospects

In business combinations, we acquire significant portfolios of loans that are marked to their estimated fair value. There is no assurance that the acquired loans will not suffer deterioration in value. The fluctuations in national, regional and local economic conditions, including those related to local residential, commercial real estate and construction markets, may increase the level of charge-offs in the loan portfolio that we acquire and correspondingly reduce our net income. These fluctuations are not predictable, cannot be controlled and may have a material adverse impact on our operations and financial condition, even if other favorable events occur.

 

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Operational Risks

Failure to manage our growth may adversely affect our performance

Our financial performance and profitability depend on our ability to manage past and possible future growth, including the significant growth we anticipate experiencing if we successfully close the acquisition of Community Bank. Future acquisitions and our continued growth may present operating, integration, regulatory, management and other issues that could have a material adverse effect on our business, financial condition, results of operations and cash flows.

The occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents could have a material adverse effect on our business, financial condition and results of operations

As a financial institution, we are susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against us or our clients, which may result in financial losses or increased costs to us or our clients, disclosure or misuse of our information or our client information, misappropriation of assets, privacy breaches against our clients, litigation, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, on-line banking, takeover, phishing, social engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by us or our clients, denial or degradation of service attacks, and malware or other cyber-attacks. There continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. In recent periods, several large corporations, including financial institutions and retail companies, have suffered major data breaches, in some cases exposing not only confidential and proprietary corporate information, but also sensitive financial and other personal information of their customers and employees and subjecting them to potential fraudulent activity. Some of our clients may have been affected by these breaches, which increase their risks of identity theft, credit card fraud and other fraudulent activity that could involve their accounts with us.

Information pertaining to us and our clients is maintained, and transactions are executed, such as our online banking or core systems on the networks and systems of ours, our clients and certain of our third party providers. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect us and our clients against fraud and security breaches and to maintain our clients’ confidence. In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third-party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our clients and underlying transactions, as well as the technology used by our clients to access our systems. Although we have developed, and continue to invest in, systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, our inability to anticipate, or failure to adequately mitigate, breaches of security could result in: losses to us or our clients; our loss of business and/or clients; damage to our reputation; the incurrence of additional expenses; disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability — any of which could have a material adverse effect on our business, financial condition and results of operations.

More generally, publicized information concerning security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions for us and other financial institutions. Such publicity may also cause damage to our reputation as a financial institution. As a result, our business, financial condition and results of operations could be adversely affected.

 

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Our business is exposed to the risk of changes in technology

The rapid pace of technology changes and the impact of such changes on financial services generally and on our Company specifically could impact our cost structure and our competitive position with our customers. Such developments include the rapid movement by customers and some competitor financial institutions to web-based services, mobile banking and cloud computing. Our failure or inability to anticipate, plan for or implement technology change could adversely affect our competitive position, financial condition and profitability.

Our controls and procedures could fail or be circumvented

Management regularly reviews and updates our internal controls, disclosure controls and procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and on the conduct of individuals, and can provide only reasonable, but not absolute, assurances of the effectiveness of these systems and controls, and that the objectives of these controls have been met. Any failure or circumvention of our controls and procedures, and any failure to comply with regulations related to controls and procedures could adversely affect our business, results of operations and financial condition.

Failure to maintain effective internal control over financial reporting or disclosure controls and procedures could adversely affect our ability to report our financial condition and results of operations accurately and on a timely basis

A failure to maintain effective internal control over financial reporting or disclosure controls and procedures could adversely affect our ability to report our financial results accurately and on a timely basis, which could result in a loss of investor confidence in our financial reporting or adversely affect our access to sources of liquidity. Furthermore, because of the inherent limitations of any system of internal control over financial reporting, including the possibility of human error, the circumvention or overriding of controls and fraud, even effective internal controls may not prevent or detect all misstatements.

We rely on communications, information, operating and financial control systems technology from third-party service providers, and we may suffer an interruption in those systems

We rely heavily on third-party service providers for much of our communications, information, operating and financial control systems technology, including our internet banking services and data processing systems. Any failure or interruption of these services or systems or breaches in the security of these systems could result in failures or interruptions to serve our customers, including deposit, servicing and/or loan origination systems. The occurrence of any failures or interruptions may require us to identify alternative sources of such services, which may result in increased costs or other consequences that in turn could have an adverse effect on our business, including damage to the Bank’s reputation.

We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects

Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the California community banking industry. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. In addition, legislation and regulations which impose restrictions on executive compensation may make it more difficult for us to retain and recruit key personnel. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, risk management, marketing and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our President and Chief Executive Officer, and certain other employees.

 

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Legal, Regulatory, Compliance and Reputational Risks

We are subject to extensive government regulation that could limit or restrict our activities, which, in turn, may hamper our ability to increase our assets and earnings

Our operations are subject to extensive regulation by federal, state and local governmental authorities and we are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Similarly, the lending, credit and deposit products we offer are subject to broad oversight and regulation. Because our business is highly regulated, the laws, rules, regulations and supervisory guidance and policies applicable to us are subject to regular modification and change. Perennially, various laws, rules and regulations are proposed, which, if adopted, could impact our operations by making compliance much more difficult or expensive, restricting our ability to originate or sell loans or further restricting the amount of interest or other charges or fees earned on loans or other products. Current and future legal and regulatory requirements, restrictions and regulations, including those imposed under Dodd-Frank, may adversely impact our profitability and may have a material and adverse effect on our business, financial condition, and results of operations, may require us to invest significant management attention and resources to evaluate and make any changes required by the legislation and accompanying rules, and may make it more difficult for us to attract and retain qualified executive officers and employees. The implementation of certain final Dodd-Frank rules is delayed or phased in over several years; therefore, as yet we cannot definitively assess what may be the short or longer term specific or aggregate effect of the full implementation of Dodd-Frank on us.

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations

The Bank Secrecy Act, the USA PATRIOT Act of 2001, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration, and Internal Revenue Service. We are also subject to scrutiny of compliance with the rules enforced by the Office of Foreign Assets Control and compliance with the Foreign Corrupt Practices Act. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could materially and adversely affect our business, financial condition and results of operations.

Mortgage regulations may adversely impact our business

Revisions made pursuant to Dodd-Frank to Regulation Z, which implements the Truth in Lending Act (TILA), effective in January 2014, apply to all consumer mortgages (except home equity lines of credit, timeshare plans, reverse mortgages, or temporary loans), and mandate specific underwriting criteria and “ability to repay” requirements for home loans. This may impact our offering and underwriting of single family residential loans in our residential mortgage lending operation and could have a resulting unknown effect on potential delinquencies. In addition, the relatively uniform requirements may make it difficult for regional and community banks to compete against the larger national banks for single family residential loan originations.

The impact of new capital rules will impose enhanced capital adequacy requirements on us and may materially affect our operations

We are subject to more stringent capital requirements. Pursuant to Dodd-Frank and to implement for U.S. banking institutions the principles of the international “Basel III” standards, the federal banking agencies have

 

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adopted a set of rules on minimum leverage and risk-based capital that will apply to both insured banks and their holding companies. These regulations were issued in July 2013, and have been phased in for the Bank and the Company beginning in 2016. The new capital rules, among other things:

 

    impose more restrictive eligibility requirements for Tier 1 and Tier 2 capital;
    introduce a new category of capital, called Common Equity Tier 1 capital, which must be at least 4.5% of risk-based assets, net of regulatory deductions, and a capital conservation buffer of an additional 2.5% of common equity to risk-weighted assets, raising the target minimum common equity ratio to 7%;
    increase the minimum Tier 1 capital ratio to 8.5% inclusive of the capital conservation buffer;
    increase the minimum total capital ratio to 10.5% inclusive of the capital conservation buffer; and
    introduce a non-risk adjusted Tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity standards.

The full implementation of the new capital rule may adversely affect our ability to pay dividends, or require us to reduce business levels or raise capital, including in ways that may adversely affect our business, liquidity, financial condition and results of operations.

The new Basel III-based capital standards could limit our ability to pay dividends or make stock repurchases and our ability to compensate our executives with discretionary bonuses. Under the new capital standards, if our Common Equity Tier 1 Capital does not include a newly required “capital conservation buffer,” we will be prohibited from making distributions to our stockholders. The capital conservation buffer requirement, which is measured in addition to the minimum Common Equity Tier 1 capital of 4.5%, will be phased in over four years, starting at 0.625% for 2016, and rising to 2.5% for 2019 and subsequent years. Additionally, under the new capital standards, if our Common Equity Tier 1 Capital does not include the newly required “capital conservation buffer,” we will also be prohibited from paying discretionary bonuses to our executive employees. This may affect our ability to attract or retain employees, or alter the nature of the compensation arrangements that we may enter into with them.

Managing reputational risk is important to attracting and maintaining customers, investors and employees

Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee mistakes, misconduct or fraud, failure to deliver minimum standards of service or quality, failure of any product or service offered by us to meet our customers’ expectations, compliance deficiencies, government investigations, litigation, and questionable or fraudulent activities of our customers. We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental scrutiny and regulation.

We are subject to legal and litigation risk which could adversely affect us

Because our Company is extensively regulated by a variety of federal and state agencies, and because we are subject to a wide range of business, consumer and employment laws and regulations at the federal, state and local levels, we are at risk of governmental investigations and lawsuits as well as claims and litigation from private parties. We are from time to time involved in disputes with and claims from investors, customers, government agencies, vendors, employees and other business parties, and such disputes and claims may result in litigation or settlements, any one of which or in the aggregate could have an adverse impact on the Company’s operating flexibility, employee relations, financial condition or results of operations, as a result of the costs of any judgment, the terms of any settlement and/or the expenses incurred in defending the applicable claim.

 

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We are unable, at this time, to estimate our potential liability in these matters, but we may be required to pay judgments, settlements or other penalties and incur other costs and expenses in connection with any one or more of these lawsuits, which in turn could have a material adverse effect on our business, results of operations and financial condition. In addition, responding to requests for information in connection with discovery demanded by the plaintiffs in any of these lawsuits may be costly and divert internal resources away from managing our business. See Item 3 — Legal Proceedings below.

We may be subject to customer claims and legal actions pertaining to the performance of our fiduciary responsibilities. Whether or not such customer claims and legal actions are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services, as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Federal and state laws and regulations may restrict our ability to pay dividends

The ability of the Bank to pay dividends to the Company and of the Company to pay dividends to its shareholders is limited by applicable federal and California law and regulations. See “Business — Regulation and Supervision” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Cash Flow.”

Risks Associated with our Common Stock

The price of our common stock may be volatile or may decline

The trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in its share prices and trading volumes that affect the market prices of the shares of many companies. These specific and broad market fluctuations could adversely affect the market price of our common stock. Among the factors that could affect our stock price are:

 

    actual or anticipated fluctuations in our operating results and financial condition;
    changes in revenue or earnings estimates or publication of research reports and recommendations by financial analysts;
    credit events or losses;
    failure to meet analysts’ revenue or earnings estimates;
    speculation in the press or investment community;
    strategic actions by us or our competitors, such as acquisitions or restructurings;
    actions or trades by institutional shareholders or other large shareholders;
    our capital position;
    fluctuations in the stock price and operating results of our competitors;
    actions by hedge funds, short term investors, activist shareholders or shareholder representative organizations;
    general market conditions and, in particular, developments related to market conditions for the financial services industry;
    proposed or adopted regulatory changes or developments;
    anticipated or pending investigations, proceedings or litigation that involve or affect the Company and/or the Bank; or
    domestic and international economic factors, whether related or unrelated to the Company’s performance.

The stock market and, in particular, the market for financial institution stocks, has experienced significant volatility in recent years. The market price of our common stock and the trading volume in our common stock

 

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may fluctuate and cause significant price variations to occur. The trading price of the shares of our common stock and the value of our other securities will depend on many factors, which may change from time to time, including, without limitation, our financial condition, performance, creditworthiness and prospects, future sales of our equity or equity related securities, and other factors identified above in “Cautionary Note Regarding Forward-Looking Statement”. The capital and credit markets have been experiencing volatility and disruption for more than five years. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation. Extensive sales by large shareholders could also exert sustained downward pressure on our stock price.

An investment in our common stock is not an insured deposit

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you could lose some or all of your investment.

Anti-takeover provisions and federal law may limit the ability of another party to acquire us, which could cause our stock price to decline

Various provisions of our articles of incorporation and by-laws and certain other actions we have taken could delay or prevent a third-party from acquiring us, even if doing so might be beneficial to our shareholders. The Bank Holding Company Act of 1956, as amended, and the Change in Bank Control Act of 1978, as amended, together with federal regulations, require that, depending on the particular circumstances, regulatory approval and/or appropriate regulatory filings may be required from either or all the Federal Reserve, the FDIC, the DBO prior to any person or entity acquiring “control” (as defined in the applicable regulations) of a state non-member bank, such as the Bank. These provisions may prevent a merger or acquisition that would be attractive to shareholders and could limit the price investors would be willing to pay in the future for our common stock.

Changes in stock market prices could reduce fee income from our brokerage, asset management and investment advisory businesses

We earn substantial wealth management fee income for managing assets for our clients and also providing brokerage and investment advisory services. Because investment management and advisory fees are often based on the value of assets under management, a fall in the market prices of those assets could reduce our fee income. Changes in stock market prices could affect the trading activity of investors, reducing commissions and other fees we earn from our brokerage business.

CVB is a holding company and depends on the Bank for dividends, distributions and other payments

CVB is a legal entity separate and distinct from the Bank. Our principal source of cash flow, including cash flow to pay dividends to our shareholders is dividends from the Bank. CVB’s ability to pay dividends to our stockholders is substantially dependent upon the Bank’s ability to pay dividends to CVB. Federal and state law imposes limits on the ability of the Bank to pay dividends and make other distributions and payments. If the Bank is unable to meet regulatory requirements to pay dividends or make other distributions to CVB, CVB will be unable to pay dividends to its shareholders.

We may face other risks

From time to time, we detail other risks with respect to our business and/or financial results in our filings with the SEC. For further discussion on additional areas of risk, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

None

 

ITEM 2. PROPERTIES

The principal executive offices of the Company and the Bank are located in Ontario, California, and are owned by the Company.

As of December 31, 2017, the Bank occupied a total of 53 premises consisting of (i) 50 Banking Centers (“Centers”) of which one Center is located at our Corporate Headquarters in Ontario California, (ii) an operation and technology center, and (iii) two loan production offices, in San Diego and Stockton California. We own 16 of these locations and the remaining properties are leased under various agreements with expiration dates ranging from 2018 through 2026, some with lease renewal options that could extend certain leases through 2036. All properties are located in Southern and Central California.

For additional information concerning properties, see Note 10 — Premises and Equipment of the Notes to the consolidated financial statements included in this report. See “Item 8 — Financial Statements and Supplemental Data.”

 

ITEM 3. LEGAL PROCEEDINGS

The Company and its subsidiaries are parties to various lawsuits and threatened lawsuits in the ordinary and non-ordinary course of business. From time to time, such lawsuits and threatened lawsuits may include, but are not limited to actions involving employment, wage-hour and labor law claims, consumer, lender liability claims and negligence claims, some of which may be styled as “class action” or representative cases. Some of these lawsuits may be similar in nature to other lawsuits pending against the Company’s competitors.

The Company has been involved in several related actions entitled Glenda Morgan v. Citizens Business Bank, et al., Case No. BC568004, in the Superior Court for Los Angeles County, and Jessica Osuna v. Citizens Business Bank, et al., Case No. CIVDS1501781, in the Superior Court for San Bernardino County, alleging wage and hour claims on behalf of the Company’s “exempt” and “non-exempt” hourly employees. These cases, which were consolidated in Los Angeles County Superior Court in April 2015, are styled as putative class action lawsuits and allege, among other things, that (i) the Company misclassified certain employees and managers as “exempt” employees, (ii) the Company violated California’s wage and hour, overtime, meal break and rest break rules and regulations, (iii) certain employees did not receive proper expense reimbursements, (iv) the Company did not maintain accurate and complete payroll records, and (v) the Company engaged in unfair business practices. Subsequently, related cases were filed by the same law firm representing Morgan and Osuna in the Superior Court for San Bernardino County, alleging (1) violations of the California Labor Code and seeking penalties under the California Private Attorney General Act of 2004 and (2) seeking a declaratory judgment that certain releases and arbitration agreements previously signed by CBB employees were invalid.

On November 28, 2016, the parties reached an agreement in principle to settle all of the related wage and hour class action lawsuits (“Wage-Hour Settlement”). Plaintiffs will dismiss all their lawsuits with prejudice in exchange for the payment of $1.5 million to the putative class members, including attorneys’ fees and costs, but not including credit for monies previously paid to certain employees in exchange for releases and arbitration agreements. The Wage-Hour Settlement received preliminary Court approval at a hearing on September 28, 2017, and the hearing for final Court approval is presently scheduled to take place on March 6, 2018. In the interim, a settlement administrator is handling certain administrative matters related to the settlement, including notification to eligible class members, the filing of claims and any objections, and the reconciliation of amounts to be paid to individual claimants. We anticipate that the Wage-Hour Settlement will be finally concluded sometime in the second or third quarter of 2018. As of December 31, 2017, the Company maintained a litigation accrual of $1.5 million for the Wage-Hour Settlement, and at this time no further accrual is expected to be necessary.

 

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For lawsuits where the Company has determined that a loss is both probable and reasonably estimable, a liability representing the best estimate of the Company’s financial exposure based on known facts has been recorded in accordance with FASB guidance over loss contingencies (ASC 450). However, as a result of ambiguities and inconsistencies in the myriad laws applicable to the Company’s business, and the unique, complex factual issues presented in any given lawsuit, the Company often cannot determine the probability of loss or estimate the amount of damages which a plaintiff might successfully prove if the Company were found to be liable. For lawsuits or threatened lawsuits where a claim has been asserted or the Company has determined that it is probable that a claim will be asserted, and there is a reasonable possibility that the outcome will be unfavorable, the Company will disclose the existence of the loss contingency, even if the Company is not able to make an estimate of the possible loss or range of possible loss with respect to the action or potential action in question, unless the Company believes that the nature, potential magnitude or potential timing (if known) of the loss contingency is not reasonably likely to be material to the Company’s liquidity, consolidated financial position, and/or results of operations.

Our accruals and disclosures for loss contingencies are reviewed quarterly and adjusted as additional information becomes available. We disclose the loss contingency and/or the amount accrued if we believe it is reasonably likely to be material or if we believe such disclosure is necessary for our financial statements to not be misleading. If we determine that an exposure to loss exists in excess of an amount previously accrued or disclosed, we assess whether there is at least a reasonable possibility that a loss, or additional loss, may have been incurred, and we adjust our accruals and disclosures accordingly.

We do not presently believe that the ultimate resolution of the foregoing matters will have a material adverse effect on the Company’s results of operations, financial condition, or cash flows. The outcome of litigation and other legal and regulatory matters is inherently uncertain, however, and it is possible that one or more of the legal matters currently pending or threatened could have a material adverse effect on our liquidity, consolidated financial position, and/or results of operations.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the NASDAQ Global Select National Market under the symbol “CVBF.” The following table presents the high and low sales prices and dividend information for our common stock during each quarter for the past two years. The Company had approximately 110,159,857 shares of common stock outstanding with 1,765 registered shareholders of record as of February 15, 2018. Refer to the section entitled “Information about the Annual Meeting and Voting” of our definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the last fiscal year.

 

Quarter

Ended

 

High

 

Low

 

Cash Dividends
Declared

12/31/2017

  $25.49   $22.25   $0.14

9/30/2017

  $24.29   $19.58   $0.14

6/30/2017

  $22.85   $19.90   $0.14

3/31/2017

  $24.63   $20.58   $0.12

12/31/2016

  $23.23   $16.32   $0.12

9/30/2016

  $17.88   $15.39   $0.12

6/30/2016

  $17.92   $15.25   $0.12

3/31/2016

  $17.70   $14.02   $0.12

For information on the statutory and regulatory limitations on the ability of the Company to pay dividends to its shareholders and on the Bank to pay dividends to the Company, see “Item 1. Business-Regulation and Supervision — Dividends” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Cash Flow.”

Issuer Purchases of Equity Securities

On July 16, 2008, our Board of Directors approved a program to repurchase up to 10,000,000 shares of our common stock (such number will not be adjusted for stock splits, stock dividends, and the like) in the open market or in privately negotiated transactions, at times and at prices considered appropriate by us, depending upon prevailing market conditions and other corporate and legal considerations. As a result of various repurchases made under the 2008 repurchase program, on August 11, 2016, our Board of Directors authorized an increase in the Company’s common stock repurchase program back to 10,000,000 shares, or approximately 9.3% of the Company’s currently outstanding shares at the time of authorization, and adopted a 10b5-1 plan. There is no expiration date for this repurchase program. During the fourth quarter and for the year ended December 31, 2017, the Company did not repurchase any shares of common stock under this program. The Company terminated its 10b5-1 plan in January 2017 in order to comply with Regulation M. A new 10b5-1 plan was approved by the Board of Directors effective as of May 2, 2017. As of December 31, 2017, we have 9,918,200 shares of our common stock remaining that are eligible for repurchase under the common stock repurchase program.

Performance Graph

The following Performance Graph and related information shall not be deemed “soliciting material” or be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that the Company specifically incorporates it by reference into such filing.

The following graph compares the yearly percentage change in CVB Financial Corp.’s cumulative total shareholder return (stock price appreciation plus reinvested dividends) on common stock (i) the cumulative total

 

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return of the Nasdaq Composite Index; and (ii) a published index comprised by Morningstar (formerly Hemscott, Inc.) of banks and bank holding companies in the Pacific region (the peer group line depicted below). The graph assumes an initial investment of $100 on December 31, 2012, and reinvestment of dividends through December 31, 2017. Points on the graph represent the performance as of the last business day of each of the years indicated. The graph is not necessarily indicative of future price performance.

 

 

LOGO

ASSUMES $100 INVESTED ON DECEMBER 31, 2012

ASSUMES DIVIDEND REINVESTED

FISCAL YEAR ENDING DECEMBER 31, 2017

 

Company/Market/Peer Group

  

12/31/2012

    

12/31/2013

    

12/31/2014

    

12/31/2015

    

12/31/2016

    

12/31/2017

 

CVB Financial Corp.

     100.00        169.00        162.69        176.76        244.75        257.22  

NASDAQ Composite

     100.00        141.63        162.09        173.33        187.19        242.29  

Peer Group Index

     100.00        157.14        162.52        172.49        238.15        273.23  

Source: Research Data Group, Inc., www.researchdatagroup.com

 

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ITEM 6. SELECTED FINANCIAL DATA

The following table reflects selected financial information at and for the five years ended December 31. Throughout the past five years, the Company has acquired other banks. This may affect the comparability of the data.

 

     At or For the Year Ended December 31,  
     2017     2016     2015     2014     2013  
     (Dollars in thousands, except per share amounts)  

Interest income

   $ 287,226     $ 265,050     $ 261,513     $ 252,903     $ 232,773  

Interest expense

     8,296       7,976       8,571       16,389       16,507  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     278,930       257,074       252,942       236,514       216,266  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recapture of provision for loan losses

     (8,500     (6,400     (5,600     (16,100     (16,750

Noninterest income

     42,118       35,552       33,483       36,412       25,287  

Noninterest expense

     140,753       136,740       140,659       126,229       114,028  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings before income taxes

     188,795       162,286       151,366       162,797       144,275  

Income taxes

     84,384       60,857       52,221       58,776       48,667  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET EARNINGS

   $ 104,411     $ 101,429     $ 99,145     $ 104,021     $ 95,608  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings per common share

   $ 0.95     $ 0.94     $ 0.93     $ 0.98     $ 0.91  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.95     $ 0.94     $ 0.93     $ 0.98     $ 0.91  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared per common share

   $ 0.540     $ 0.480     $ 0.480     $ 0.400     $ 0.385  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared on common shares

   $ 59,483     $ 51,849     $ 51,040     $ 42,356     $ 40,469  

Dividend pay-out ratio (1)

     56.97     51.12     51.48     40.72     42.33

Weighted average common shares:

          

Basic

     109,409,301       107,282,332       105,715,247       105,239,421       104,729,184  

Diluted

     109,806,710       107,686,955       106,192,472       105,759,523       105,126,303  

Common Stock Data:

          

Common shares outstanding at year end

     110,184,922       108,251,981       106,384,982       105,893,216       105,370,170  

Book value per share

   $ 9.70     $ 9.15     $ 8.68     $ 8.29     $ 7.33  

Financial Position:

          

Assets

   $ 8,270,586     $ 8,073,707     $ 7,671,200     $ 7,377,920     $ 6,664,967  

Investment securities available-for-sale

     2,080,985       2,270,466       2,368,646       3,137,158       2,663,642  

Investment securities held-to-maturity

     829,890       911,676       850,989       1,528       1,777  

Net loans, excluding PCI loans (2)

     4,742,531       4,263,158       3,867,941       3,630,875       3,310,681  

Net PCI loans (3)

     28,515       70,366       89,840       126,367       160,315  

Deposits

     6,546,853       6,309,680       5,917,260       5,604,658       4,890,631  

Borrowings

     553,773       656,028       736,704       809,106       911,457  

Junior subordinated debentures

     25,774       25,774       25,774       25,774       25,774  

Stockholders’ equity

     1,069,266       990,862       923,399       878,109       771,887  

Equity-to-assets ratio (4)

     12.93     12.27     12.04     11.90     11.58

Financial Performance:

          

Return on beginning equity

     10.54     10.98     11.29     13.48     12.53

Return on average equity (ROAE)

     9.84     10.26     10.87     12.50     12.34

Return on average assets (ROAA)

     1.26     1.26     1.31     1.45     1.48

Net interest margin, tax-equivalent (TE) (5)

     3.63     3.46     3.62     3.62     3.71

Efficiency ratio (6)

     43.84     46.73     49.11     46.25     47.21

Noninterest expense to average assets

     1.70     1.70     1.86     1.77     1.77

Credit Quality:

          

Allowance for loan losses

   $ 59,585     $ 61,540     $ 59,156     $ 59,825     $ 75,235  

Allowance/gross loans

     1.23     1.40     1.47     1.57     2.12

Total nonaccrual loans

   $ 10,716     $ 7,152     $ 21,019     $ 32,186     $ 39,954  

Nonaccrual loans/gross loans, net of deferred loan fees

     0.22     0.16     0.52     0.84     1.13

Allowance/nonaccrual loans

     556.04     860.46     281.44     185.87     188.30

Net recoveries, (charge offs)

   $ 6,545     $ 8,784     $ 4,931     $ 690     $ (456

Net recoveries, (charge offs)/average loans

     0.14     0.21     0.13     0.02     -0.01

Regulatory Capital Ratios:

          

Company:

          

Tier 1 leverage ratio

     11.88     11.49     11.22     10.86     11.30

Common equity Tier 1 risk-based capital ratio

     16.43     16.48     16.49     N/A       N/A  

Tier 1 risk-based capital ratio

     16.87     16.94     16.98     16.99     17.83

Total risk-based capital ratio

     18.01     18.19     18.23     18.24     19.09

Bank:

          

Tier 1 leverage ratio

     11.77     11.36     11.11     10.77     11.20

Common equity Tier 1 risk-based capital ratio

     16.71     16.76     16.81     N/A       N/A  

Tier 1 risk-based capital ratio

     16.71     16.76     16.81     16.85     17.67

Total risk-based capital ratio

     17.86     18.01     18.06     18.11     18.93

 

  (1) Dividends declared on common stock divided by net earnings.
  (2) Net loans, excluding Purchase Credit Impaired (“PCI”) loans.
  (3) Excludes loans held-for-sale. PCI loans are those loans acquired from SJB and previously covered by a loss sharing agreement with the FDIC.
  (4) Stockholders’ equity divided by total assets.
  (5) Net interest income (TE) divided by average interest-earning assets.
  (6) Noninterest expense divided by net interest income before provision for loan losses plus noninterest income. Also refer to “Noninterest Expense and Efficiency Ratio Reconciliation (non-GAAP)” under Analysis of the Results of Operations of Item 7 of this Form 10-K.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information about the results of operations, financial condition, liquidity, and capital resources of CVB Financial Corp. and its wholly owned subsidiary. This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of our operations. This discussion and analysis should be read in conjunction with this Annual Report on Form 10-K, and the audited consolidated financial statements and accompanying notes presented elsewhere in this report.

CRITICAL ACCOUNTING POLICIES

The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and are essential to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following is a summary of the more judgmental and complex accounting estimates and principles. In each area, we have identified the variables most important in the estimation process. We have used the best information available to make the necessary estimates to value the related assets and liabilities. Actual performance that differs from our estimates and future changes in the key variables could change future valuations and impact the results of operations.

Allowance for Loan Losses (“ALLL”) — Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. Our allowance for loan losses provides for probable losses based upon evaluations of known and inherent risks in the loan and lease portfolio. The determination of the balance in the allowance for loan losses is based on an analysis of the loan and lease finance receivables portfolio using a systematic methodology and reflects an amount that, in our judgment, is appropriate to provide for probable credit losses inherent in the portfolio, after giving consideration to the character of the loan portfolio, current economic conditions, past credit loss experience, and such other factors as deserve current recognition in estimating inherent credit losses. The provision for loan losses is charged to expense. For a full discussion of our methodology of assessing the adequacy of the allowance for loan losses, see “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation — Risk Management” and Note 3 — Summary of Significant Accounting Policies and Note 7 — Loans and Lease Finance Receivables and Allowance for Loan Losses of our consolidated financial statements presented elsewhere in this report.

Income Taxes — Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback or carryforward periods available under the tax law. Based on historical and future expected taxable earnings and available strategies, the Company considers the future realization of these deferred tax assets more likely than not.

The tax effects from an uncertain tax position are recognized in the financial statements only if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. Interest and penalties related to uncertain tax positions are recorded as part of other operating expense.

 

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For complete discussion and disclosure of other accounting policies see Note 3 — Summary of Significant Accounting Policies of the Company’s consolidated financial statements presented elsewhere in this report.

OVERVIEW

For the year ended December 31, 2017, we reported net earnings of $104.4 million, compared with $101.4 million for 2016. This represented an increase of $3.0 million, or 2.94%. Diluted earnings per share were $0.95 for the year ended December 31, 2017, compared to $0.94 for 2016. Earnings for 2017 included $8.5 million in loan loss provision recapture, compared to $6.4 million in 2016. 2017 also included a $2.9 million net gain from an eminent domain condemnation of one of our banking center buildings, a $906,000 net gain on the sale of a branch acquired from Valley Business Bank (“VBB”), and a $542,000 net gain on the sale of our former operations and technology center. Income tax expense for 2017 included a one-time charge of $13.2 million due to the re-measurement of the Company’s net deferred tax asset (“DTA”) resulting from the enactment of the Tax Reform Act on December 22, 2017. Excluding the impact of the $13.2 million DTA revaluation, net income increased by $16.2 million, or 15.96%, to $117.6 million, or $1.07 per share, for the year ended December 31, 2017.

Total assets of $8.27 billion at December 31, 2017 increased $196.9 million, or 2.44%, from total assets of $8.07 billion at December 31, 2016. Interest-earning assets totaled $7.80 billion at December 31, 2017, an increase of $156.8 million, or 2.05%, when compared with earning assets of $7.64 billion at December 31, 2016. The increase in interest-earning assets was primarily due to a $435.6 million increase in total loans, which was partially offset by a $271.3 million decrease in investment securities.

Total investment securities were $2.91 billion at December 31, 2017, a decrease of $271.3 million, or 8.52%, from $3.18 billion at December 31, 2016. At December 31, 2017, investment securities HTM totaled $829.9 million. At December 31, 2017, investment securities AFS totaled $2.08 billion, inclusive of a pre-tax unrealized gain of $2.9 million. HTM securities declined by $81.8 million, or 8.97%, and AFS securities declined by $189.5 million, or 8.35%, from December 31, 2016.

Total loans and leases, net of deferred fees and discount, of $4.83 billion at December 31, 2017, increased by $435.6 million, or 9.91%, from $4.40 billion at December 31, 2016. The increase in total loans included $309.7 million of loans acquired from VBB in the first quarter of 2017. Excluding the acquired VBB loans, the $125.9 million, or 2.86% increase in total loans was principally due to growth of $182.8 million in commercial real estate loans and $12.8 million in Small Business Administration (“SBA”) loans. This growth was partially offset by decreases of $21.4 million in consumer and other loans, $17.2 million in commercial and industrial loans, $16.3 million in construction loans, and $14.7 million in single-family residential (“SFR”) mortgage loans.

Noninterest-bearing deposits were $3.85 billion at December 31, 2017, an increase of $172.9 million, or 4.71%, compared to $3.67 billion at December 31, 2016. The increase in total deposits from the end of 2016 included $172.5 million of noninterest-bearing deposits and $361.8 million of total deposits acquired from VBB during the first quarter of 2017. In the fourth quarter of 2017, we sold a branch acquired from VBB, which included approximately $27 million in total deposits. At December 31, 2017, noninterest-bearing deposits were 58.75% of total deposits, compared to 58.22% at December 31, 2016. Our average cost of total deposits was 0.09% for 2017 and 2016.

Customer repurchase agreements totaled $553.8 million at December 31, 2017, compared to $603.0 million at December 31, 2016. Our average cost of total deposits including customer repurchase agreements was 0.10% for 2017, compared to 0.11% for 2016.

There were no short-term borrowings at December 31, 2017, compared to $53.0 million at December 31, 2016. At December 31, 2017, we had $25.8 million of junior subordinated debentures, unchanged from December 31, 2016. These debentures bear interest at three-month LIBOR plus 1.38% and mature in 2036.

 

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The allowance for loan losses totaled $59.6 million at December 31, 2017, compared to $61.5 million at December 31, 2016. The allowance for loan losses was increased by net recoveries on loans of $6.5 million for 2017 and was reduced by an $8.5 million loan loss provision recapture for 2017. The allowance for loan losses was 1.23% and 1.40% of total loans and leases outstanding at December 31, 2017 and December 31, 2016, respectively.

Our capital ratios under the revised capital framework referred to as Basel III remain well-above regulatory standards. As of December 31, 2017, the Company’s Tier 1 leverage capital ratio totaled 11.88%, our common equity Tier 1 ratio totaled 16.43%, our Tier 1 risk-based capital ratio totaled 16.87%, and our total risk-based capital ratio totaled 18.01%. Refer to our Analysis of Financial Condition-Capital Resources for discussion of the new capital rules which were effective beginning with the first quarter ended March 31, 2015.

Recent Acquisitions

On March 10, 2017, we completed the acquisition of VCBP, the holding company for VBB. Our financial statements for the year ended December 31, 2017 included 296 days of VBB operations, post-merger. At close, Citizens Business Bank acquired $309.7 million of loans and assumed $361.8 million of total deposits, including $172.5 million of noninterest-bearing deposits.

At close, VBB had four branches located in Visalia, Tulare, Fresno, and Woodlake. The consolidation of three of these branches occurred in the third quarter of 2017. The sale of the Woodlake branch occurred in the fourth quarter of 2017.

ANALYSIS OF THE RESULTS OF OPERATIONS

Financial Performance

 

                       Variance  
     For the Year Ended December 31,     2017     2016  
     2017     2016     2015     $     %     $     %  
     (Dollars in thousands, except per share amounts)  

Net interest income

   $ 278,930     $ 257,074     $ 252,942     $ 21,856       8.50   $ 4,132       1.63

Recapture of provision for loan losses

     8,500       6,400       5,600       2,100       32.81     800       14.29

Noninterest income

     42,118       35,552       33,483       6,566       18.47     2,069       6.18

Noninterest expense

     (140,753     (136,740     (140,659 ) (2)      (4,013     -2.93     3,919       2.79

Income taxes

     (84,384 (1)      (60,857     (52,221     (23,527     -38.66     (8,636     -16.54
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

   $ 104,411     $ 101,429     $ 99,145     $ 2,982       2.94   $ 2,284       2.30
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per common share:

              

Basic

   $ 0.95     $ 0.94     $ 0.93     $ 0.01       $ 0.01    

Diluted

   $ 0.95     $ 0.94     $ 0.93     $ 0.01       $ 0.01    

Return on average assets

     1.26 % (1)      1.26     1.31 (2)      -         -0.05  

Return on average shareholders’ equity

     9.84 % (1)      10.26     10.87 (2)      -0.42       -0.61  

Efficiency ratio

     43.84     46.73     49.11 (2)      -2.89       -2.38  

Noninterest expense to average assets

     1.70     1.70     1.86 (2)      -         -0.16  

(1) Includes $13.2 million DTA revaluation resulting from the Tax Reform Act.

(2) Includes $13.9 million debt termination expense.

 

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Tax Reform and Effect of Tax Rate Change Reconciliations (Non-GAAP)

The year ended December 31, 2017 includes a one-time charge of $13.2 million as a result of the December 22, 2017 enactment of the Tax Reform Act of 2017. We believe that presenting the effective tax rate, earnings, ROAA, ROAE, earnings per common share, and dividend payout ratio, excluding the impact of the re-measurement of our net deferred tax asset, provides additional clarity to the users of financial statements regarding core financial performance.

 

     For the Year Ended December 31,  
     2017     2016     2015  
     (Dollars in thousands, except per share amounts)  

Income tax expense

   $ 84,384     $ 60,857     $ 52,221  

Less: Effect of income tax rate change-DTA revaluation

     (13,208     -       -  
  

 

 

   

 

 

   

 

 

 

Adjusted income tax expense

   $ 71,176     $ 60,857     $ 52,221  

Effective Tax Rate

     44.70     37.50     34.50

Adjusted effective tax rate

     37.70     37.50     34.50

Net earnings

   $ 104,411     $ 101,429     $ 99,145  

Effect of income tax rate change-DTA revaluation

     13,208       -       -  
  

 

 

   

 

 

   

 

 

 

Adjusted net earnings

   $ 117,619     $ 101,429     $ 99,145  

Average assets

   $ 8,301,721     $ 8,022,994     $ 7,565,056  

Return on average assets

     1.26     1.26     1.31

Adjusted return on average assets

     1.42     1.26     1.31

Average equity

   $ 1,061,557     $ 988,732     $ 878,526  

Return on average equity

     9.84     10.26     10.87

Adjusted return on average equity

     11.08     10.26     10.87

Weighted average shares outstanding

      

Basic

         109,409,301           107,282,332           105,715,247  

Diluted

     109,806,710       107,686,955       106,192,472  

Earnings per common share:

      

Basic

   $ 0.95     $ 0.94     $ 0.93  

Diluted

   $ 0.95     $ 0.94     $ 0.93  

Adjusted earnings per common share:

      

Basic

   $ 1.07     $ 0.94     $ 0.93  

Diluted

   $ 1.07     $ 0.94     $ 0.93  

Dividends declared

   $ 59,483     $ 51,849     $ 51,040  

Dividend payout ratio (1)

     56.97     51.12     51.48

Adjusted dividend payout ratio (1)

     50.57     51.12     51.48

(1) Dividends declared on common stock divided by net earnings.

 

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Noninterest Expense and Efficiency Ratio Reconciliation (Non-GAAP)

We use certain non-GAAP financial measures to provide supplemental information regarding our performance. Noninterest expense for the years ended December 31, 2016 and 2015 included debt termination expense of $16,000 and $13.9 million, respectively. We believe that presenting the efficiency ratio, and the ratio of noninterest expense to average assets, excluding the impact of debt termination expense, provides additional clarity to the users of financial statements regarding core financial performance. The Company did not incur debt termination expense during the year ended December 31, 2017.

 

     For the Year Ended December 31,  
     2017     2016     2015  
     (Dollars in thousands)  

Net interest income

   $ 278,930     $ 257,074     $ 252,942  

Noninterest income

     42,118       35,552       33,483  

Noninterest expense

     140,753       136,740       140,659  

Less: debt termination expense

     -       (16     (13,870
  

 

 

   

 

 

   

 

 

 

Adjusted noninterest expense

   $ 140,753     $ 136,724     $ 126,789  

Efficiency ratio

     43.84     46.73     49.11

Adjusted efficiency ratio

     43.84     46.72     44.27

Adjusted noninterest expense

   $ 140,753     $ 136,724     $ 126,789  

Average assets

         8,301,721           8,022,994           7,565,056  

Noninterest expense to average assets

     1.70     1.70     1.86

Adjusted noninterest expense to average assets

     1.70     1.70     1.68

Net Interest Income

The principal component of our earnings is net interest income, which is the difference between the interest and fees earned on loans and investments (interest-earning assets) and the interest paid on deposits and borrowed funds (interest-bearing liabilities). Net interest margin is net interest income as a percentage of average interest-earning assets for the period. The level of interest rates and the volume and mix of interest-earning assets and interest-bearing liabilities impact net interest income and net interest margin. The net interest spread is the yield on average interest earning assets minus the cost of average interest-bearing liabilities. Net interest margin and net interest spread are included on a tax equivalent (TE) basis by adjusting interest income utilizing the federal statutory tax rate of 35% in effect for the years presented. Our net interest income, interest spread, and net interest margin are sensitive to general business and economic conditions. These conditions include short-term and long-term interest rates, inflation, monetary supply, and the strength of the international, national and state economies, in general, and more specifically, the local economies in which we conduct business. Our ability to manage net interest income during changing interest rate environments will have a significant impact on our overall performance. We manage net interest income through affecting changes in the mix of interest-earning assets as well as the mix of interest-bearing liabilities, changes in the level of interest-bearing liabilities in proportion to interest-earning assets, and in the growth and maturity of earning assets. See Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability and Market Risk Management – Interest Rate Sensitivity Management included herein.

 

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The table below presents the interest rate spread, net interest margin and the composition of average interest-earning assets and average interest-bearing liabilities by category for the periods indicated, including the changes in average balance, composition, and average yield/rate between these respective periods.

Interest-Earning Assets and Interest-Bearing Liabilities

 

     For the Year Ended December 31,  
     2017     2016     2015  
     Average             Yield/     Average            Yield/     Average            Yield/  
     Balance      Interest      Rate     Balance      Interest     Rate     Balance      Interest     Rate  
     (Dollars in thousands)  

INTEREST-EARNING ASSETS

                      

Investment securities (1)

                      

Available-for-sale securities:

                      

Taxable

   $ 2,137,332      $ 47,596        2.24   $ 2,126,733      $ 43,538       2.07   $ 2,339,849      $ 48,854       2.08

Tax-advantaged

     68,522        2,182        4.73     123,844        4,164       4.90     397,440        14,336       4.95

Held-to-maturity securities:

                      

Taxable

     586,673        12,558        2.14     500,557        10,183       2.03     223,780        4,451       1.97

Tax-advantaged

     278,109        8,457        4.11     300,484        10,044       4.51     135,419        4,567       4.55

Investment in FHLB stock

     18,046        1,375        7.62     17,873        2,224 (4)      12.24     20,497        2,774 (5)      13.35

Interest-earning deposits with other institutions

     86,537        932        1.08     320,289        1,905       0.59     276,459        868       0.31

Loans (2)

     4,623,244        214,126        4.63     4,195,129        192,992       4.60     3,782,133        185,663       4.91
  

 

 

    

 

 

      

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-earning assets

     7,798,463        287,226        3.74     7,584,909        265,050       3.57     7,175,577        261,513       3.74

Total noninterest-earning assets

     503,258             438,085            389,479       
  

 

 

         

 

 

        

 

 

      

Total assets

   $ 8,301,721           $ 8,022,994          $ 7,565,056       
  

 

 

         

 

 

        

 

 

      

INTEREST-BEARING LIABILITIES

                      

Savings deposits (3)

   $ 2,337,142        4,903        0.21   $ 2,185,493        4,354       0.20   $ 1,998,601        3,849       0.19

Time deposits

     401,033        1,141        0.28     584,149        1,603       0.27     735,045        1,417       0.19
  

 

 

    

 

 

      

 

 

    

 

 

     

 

 

    

 

 

   

Total interest-bearing deposits

     2,738,175        6,044        0.22     2,769,642        5,957       0.21     2,733,646        5,266       0.19

FHLB advances, other borrowings, and customer repurchase agreements

     571,991        2,252        0.39     637,585        2,019       0.32     684,386        3,305       0.48
  

 

 

    

 

 

      

 

 

    

 

 

     

 

 

    

 

 

   

Interest-bearing liabilities

     3,310,166        8,296        0.25     3,407,227        7,976       0.23     3,418,032        8,571       0.25
  

 

 

    

 

 

      

 

 

    

 

 

     

 

 

    

 

 

   

Noninterest-bearing deposits

     3,856,987             3,539,707            3,159,989       

Other liabilities

     73,011             87,328            74,997       

Stockholders’ equity

     1,061,557             988,732            912,038       
  

 

 

         

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 8,301,721           $ 8,022,994          $ 7,565,056       
  

 

 

         

 

 

        

 

 

      

Net interest income

      $ 278,930           $ 257,074          $ 252,942    
     

 

 

         

 

 

        

 

 

   

Net interest spread - tax equivalent

           3.49          3.34          3.49

Net interest margin

           3.58          3.39          3.52

Net interest margin - tax equivalent

           3.63          3.46          3.62

 

 

 

  (1) Includes tax equivalent (TE) adjustments utilizing a federal statutory rate of 35% in effect for the year presented. Non tax-equivalent (TE) rate was 2.31%, 2.24% and 2.38% for the years ended December 31, 2017, 2016 and 2015, respectively. The Company expects that as a result of the Tax Reform Act, the fully tax-equivalent adjustment will be somewhat reduced in future periods.
  (2) Includes loan fees of $3,617, $3,953 and $3,922 for the years ended December 31, 2017, 2016 and 2015, respectively. Prepayment penalty fees of $2,663, $3,479 and $4,920 are included in interest income for the years ended December 31, 2017, 2016 and 2015, respectively.
  (3) Includes interest-bearing demand and money market accounts.
  (4) Includes a special dividend from the FHLB of $588,000.
  (5) Includes a special dividend from the FHLB of $923,000.

The following tables present a comparison of interest income and interest expense resulting from changes in the volumes and rates on average interest-earning assets and average interest-bearing liabilities for the periods indicated. Changes in interest income or expense attributable to volume changes are calculated by multiplying the change in volume by the initial average interest rate. The change in interest income or expense attributable to

 

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changes in interest rates is calculated by multiplying the change in interest rate by the initial volume. The changes attributable to interest rate and volume changes are calculated by multiplying the change in rate times the change in volume.

Rate and Volume Analysis for Changes in Interest Income, Interest Expense and Net Interest Income

 

    Comparison of Year Ended December 31,  
    2017 Compared to 2016
Increase (Decrease) Due to
    2016 Compared to 2015
Increase (Decrease) Due to
 
    Volume     Rate     Rate/
Volume
    Total     Volume     Rate     Rate/
Volume
    Total  
                      (Dollars in thousands)              

Interest income:

               

Available-for-sale securities:

               

Taxable investment securities

  $ 468     $ 3,552     $ 38     $ 4,058     $ (5,121   $ (214   $ 19     $ (5,316

Tax-advantaged investment securities

    (1,824     (281     123       (1,982     (9,930     (786     544       (10,172

Held-to-maturity securities:

               

Taxable investment securities

    1,753       531       91       2,375       5,408       145       179       5,732  

Tax-advantaged investment securities

    (766     (889     68       (1,587     5,564       (39     (48     5,477  

Investment in FHLB stock

    21       (862     (8     (849     (351     (228     29       (550

Interest-earning deposits with other institutions

    (1,390     1,544       (1,127     (973     138       776       123       1,037  

Loans

    19,620       1,373       141       21,134       18,606       (9,328     (1,949     7,329  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

    17,882       4,968       (674     22,176       14,314       (9,674     (1,103     3,537  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

               

Savings deposits

    295       237       17       549       368       126       11       505  

Time deposits

    (506     64       (20     (462     (297     608       (125     186  

FHLB advances, other borrowings, and
customer repurchase agreements

    (203     486       (50     233       (225     (1,139     78       (1,286
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

    (414     787       (53     320       (154     (405     (36     (595
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

  $   18,296     $   4,181     $ (621   $   21,856     $   14,468     $ (9,269   $ (1,067   $ 4,132  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

2017 Compared to 2016

Net interest income, before recapture of provision for loan losses, was $278.9 million for 2017, an increase of $21.9 million, or 8.50%, compared to $257.1 million for 2016. Interest-earning assets grew on average by $213.6 million, or 2.82%, from $7.58 billion for 2016 to $7.80 billion for 2017. Our net interest margin (TE) was 3.63% for 2017, compared to 3.46% for 2016.

Interest income for 2017 was $287.2 million, which represented a $22.2 million, or 8.37%, increase when compared to 2016. Compared to 2016, average interest-earning assets increased by $213.6 million and the yield on interest-earning assets increased by 17 basis points. The 17 basis point increase in the interest-earning asset yield over 2016 resulted from the combination of a seven basis point increase in investment yields, a three basis point increase in loan yields and the change in mix of earning assets represented by an increase in loans as a percentage of earning assets growing from 55.3% in 2016 to 59.3% in 2017. Excluding interest recaptured on nonaccrual loans and additional discount accretion on a PCI loan, interest income grew by about $23.3 million, or 8.91%, year-over-year. When the impact of the recaptured interest and additional discount accretion is excluded, the yield on interest-earning assets increased from 3.52% for 2016 to 3.71% for 2017.

Interest income and fees on loans for 2017 totaled $214.1 million which represented a $21.1 million, or 10.95%, increase when compared to 2016. Average loans increased $428.1 million for 2017 when compared with 2016, and included approximately $238 million of acquired VBB loans.

For the year ended December 31, 2017, there were three nonperforming, troubled debt restructuring (“TDR”) loans that were paid in full resulting in the recognition of $1.4 million of interest income and additional discount accretion of $762,000 resulted from the payoff of a PCI loan. This compares to four nonperforming loans paid in

 

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full resulting in a $3.3 million increase in interest income in 2016. Excluding the impact of recaptured interest and additional discount accretion, the net interest margin (TE) was 3.60% for 2017, compared to 3.42% for 2016.

In general, we stop accruing interest on a loan after its principal or interest becomes 90 days or more past due. When a loan is placed on nonaccrual, all interest previously accrued but not collected is charged against earnings. There was no interest income that was accrued and not reversed on nonaccrual loans at December 31, 2017 and 2016. As of December 31, 2017 and 2016, we had $10.7 million and $7.2 million of nonaccrual loans (excluding PCI loans), respectively. Had these nonaccrual loans for which interest was no longer accruing complied with the original terms and conditions, interest income would have been approximately $889,000 and $493,000 greater for 2017 and 2016, respectively.

Interest income from investment securities was $70.8 million for 2017, a $2.9 million, or 4.22%, increase from $67.9 million for 2016. This increase was the result of a $19.0 million increase in the average investment securities for 2017, compared to 2016 and a seven basis point increase in the non-TE yield on securities. Dividend income from FHLB stock decreased by $849,000 from 2016, due to a special dividend of $588,000 from the FHLB in 2016.

Interest expense of $8.3 million for 2017 increased $320,000, or 4.01%, compared to $8.0 million for 2016. The average rate paid on interest-bearing liabilities increased two basis points, to 0.25% for 2017, from 0.23% for 2016. Average interest-bearing liabilities were $97.1 million lower in 2017, compared to 2016, as repurchase agreements and other borrowings declined by $65.6 million. Excluding a $183.1 million decline in average time deposits primarily due to the Bank’s decision in 2016 to not renew certificates of deposit with the State of California, interest-bearing liabilities increased by $86.1 million. Our total cost of funds in 2017 was 0.12%, compared to 0.11% in 2016.

2016 Compared to 2015

Net interest income, before recapture of provision for loan losses, of $257.1 million for 2016 increased $4.1 million, or 1.63%, compared to $252.9 million for 2015. Average interest-earning assets of $7.58 billion grew by $409.3 million, or 5.70%, from $7.18 billion for 2015. Our net interest margin tax equivalent (TE) was 3.46% for 2016, compared to 3.62% for 2015. Total cost of funds decreased to 0.11% for 2016 from 0.13% for 2015.

Interest income for 2016 was $265.1 million, which represented a $3.5 million, or 1.35%, increase when compared to 2015. Interest income grew by $14.3 million as a result of the $409.3 million growth in earning assets, but the decline in the earning asset yield reduced interest income by $11.0 million. The tax equivalent yield on earning assets declined from 3.74% in 2015 to 3.57% in 2016, primarily due to the 0.26% decrease in loan yields.

Interest income and fees on loans for 2016 totaled $193.0 million which represented a $7.3 million, or 3.95%, increase when compared to 2015. The low interest rate environment and competitive pricing pressures continued to impact both loan retention and loan yields during 2016. Our average loan yield on loans (excluding discount on PCI loans) was 4.53% for 2016, compared to 4.79% for 2015.

For the year ended December 31, 2016, there were four nonperforming, TDR loans that were paid in full resulting in the recognition of $3.3 million of interest income. This compares to five nonperforming loans paid in full resulting in a $4.9 million increase in interest income in 2015. When this recaptured nonaccrued interest is excluded, the net interest margin (TE) was 3.42% for 2016, compared to 3.55% for 2015. Interest income from prepayment penalties declined by $1.4 million from $4.9 million in 2015 to $3.5 million for 2016. The impact of loan repricing and lower prepayment penalties combined for an approximate 13 basis point decline in the net interest margin.

There was no interest income that was accrued and not reversed on nonaccrual loans at December 31, 2016 and 2015. As of December 31, 2016 and 2015, we had $7.2 million and $21.0 million of nonaccrual loans (excluding PCI loans), respectively. Had these nonaccrual loans for which interest was no longer accruing complied with the original terms and conditions, interest income would have been approximately $493,000 and $1.2 million greater for 2016 and 2015, respectively.

 

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Interest income from total investment securities of $67.9 million for 2016 decreased $4.3 million, or 5.93%, from $72.2 million for 2015. This decrease was the result of both a $44.9 million decline in average investment securities and a 0.14% decline in the average non-TE yield on securities for 2016. Dividend income from FHLB stock decreased by $550,000 from 2015, due to a special dividend of $588,000 for 2016, compared to $923,000 from the FHLB for 2015.

Interest expense of $8.0 million for 2016 decreased $595,000, or 6.94%, compared to $8.6 million for 2015. The average rate paid on interest-bearing liabilities decreased two basis points, to 0.23% for 2016, from 0.25% for 2015. Average interest-bearing liabilities were $10.8 million lower in 2016, compared to 2015, as repurchase agreements and other borrowings declined by $46.8 million. The combination of a lower cost of interest bearing liabilities and the $379.7 million increase in non-interest bearing deposits resulted in a reduction in cost of funds from 0.13% in 2015 to 0.11% in 2016.

Provision for Loan Losses

The allowance for loan losses is increased by the provision for loan losses and recoveries of prior losses, and is decreased by recapture of provisions and by charge-offs taken when management believes the uncollectability of any loan is confirmed. The provision for loan losses is determined by management as the amount to be added to (subtracted from) the allowance for loan losses after net charge-offs have been deducted to bring the allowance to an appropriate level which, in management’s best estimate, is necessary to absorb probable loan losses within the existing loan portfolio.

The allowance for loan losses totaled $59.6 million at December 31, 2017, compared to $61.5 million at December 31, 2016. The allowance for loan losses was reduced by an $8.5 million loan loss provision recapture for 2017, offset by net recoveries of $6.5 million. This compares to a $6.4 million loan loss provision recapture and net recoveries of $8.8 million for 2016 and a $5.6 million loan loss provision recapture and net recoveries of $5.0 million for 2015. We periodically assess the credit quality of our portfolio to determine whether additional provisions for loan losses are necessary. The ratio of the allowance for loan losses to total loans and leases outstanding, net of deferred fees and discount, as of December 31, 2017, 2016 and 2015 was 1.23%, 1.40% and 1.47%, respectively. Refer to the discussion of Allowance for Loan Losses in Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations contained herein for discussion concerning observed changes in the credit quality of various components of our loan portfolio as well as changes and refinements to our methodology.

No assurance can be given that economic conditions which adversely affect the Company’s service areas or other circumstances will not be reflected in increased provisions for loan losses in the future, as the nature of this process requires considerable judgment. See “Allowance for Loan Losses” under Analysis of Financial Condition herein.

PCI loans acquired in the FDIC-assisted transaction were initially recorded at their fair value and were covered by a loss sharing agreement with the FDIC, which expired in October 2014 for commercial loans. Refer to Note 3 — Summary of Significant Accounting Policies of the consolidated financial statements. During the year ended December 31, 2017 and 2016, there were no charge-offs or recoveries, compared to $92,000 in net charge-offs for 2015, for loans in excess of the amount originally expected in the fair value of the loans at acquisition.

Noninterest Income

Noninterest income includes income derived from financial services offered, such as CitizensTrust, BankCard services, international banking, and other business services. Also included in noninterest income are service charges and fees, primarily from deposit accounts, gains (net of losses) from the disposition of investment securities, loans, other real estate owned, and fixed assets, and other revenues not included as interest on earning assets.

 

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The following table sets forth the various components of noninterest income for the periods presented.

 

                        Variance  
     For the Year Ended December 31,     2017     2016  
     2017      2016     2015     $     %     $     %  
     (Dollars in thousands)  

Noninterest income:

               

Service charges on deposit accounts

   $ 15,809      $ 15,066     $ 15,567     $ 743       4.93   $ (501     -3.22

Trust and investment services

     9,845        9,595       8,642       250       2.61     953       11.03

Bankcard services

     3,406        2,921       3,094       485       16.60     (173     -5.59

BOLI income

     3,420        2,612       2,561       808       30.93     51       1.99

Gain (loss) on sale of investment securities, net

     402        548       (22     (146     -26.64     570       2590.91

Change in FDIC loss sharing asset, net

     -        (5     (902     5       100.00     897       99.45

Gain (loss) on OREO, net

     6        (20     416       26       130.00     (436     -104.81

Gain on sale of loans

     -        1,101       732       (1,101     -100.00     369       50.41

Gain on sale of asset held-for-sale, net

     542        -       -       542       -       -       -  

Gain on sale of branches, net

     906        272       -       634       233.09     272       -  

Gain on eminent domain condemnation, net

     2,894        -       -       2,894       -       -       -  

Other

     4,888        3,462       3,395       1,426       41.19     67       1.97
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

   $   42,118      $   35,552     $   33,483     $   6,566       18.47   $   2,069       6.18
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

2017 Compared to 2016

The $6.6 million increase in noninterest income was primarily due to a $2.9 million net gain from an eminent domain condemnation of one of our banking center buildings, a $906,000 net gain on the sale of a branch acquired from VBB, and a $542,000 net gain on the sale of our operations and technology center that was classified as an asset held-for-sale at December 31, 2016. Service charges on deposit accounts and Bankcard services increased $743,000 and $485,000, respectively. Noninterest income for 2016 included a $1.1 million net gain on the sale of loans during the first quarter of 2016 and a $272,000 net gain on the sale of our Porterville branch in the second quarter of 2016.

CitizensTrust consists of Wealth Management and Investment Services income. The Wealth Management group provides a variety of services, which include asset management, financial planning, estate planning, retirement planning, private and corporate trustee services, and probate services. Investment Services provides self-directed brokerage, 401(k) plans, mutual funds, insurance and other non-insured investment products. At December 31, 2017, CitizensTrust had approximately $2.88 billion in assets under management and administration, including $2.15 billion in assets under management. CitizensTrust generated fees of $9.8 million for 2017, an increase of $250,000 compared to $9.6 million for 2016.

The Bank’s investment in Bank-Owned Life Insurance (“BOLI”) includes life insurance policies acquired through acquisitions and the purchase of life insurance by the Bank on a selected group of employees. The Bank is the owner and beneficiary of these policies. BOLI is recorded as an asset at its cash surrender value. Increases in the cash value of these policies, as well as insurance proceeds received, are recorded in noninterest income and are not subject to income tax, as long as they are held for the life of the covered parties. The $808,000 increase in BOLI income was due to $775,000 in tax free income on the death benefit of a former director.

2016 Compared to 2015

The $2.1 million increase in noninterest income was primarily due to a $953,000 increase in trust and investment service fees, an $897,000 positive impact from the change in the FDIC loss sharing asset, and a $548,000 net gain on the sale of investment securities in the third quarter of 2016. Gain on sale of loans increased

 

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by $369,000 due to a $1.1 million net gain on sale of loans in the first quarter of 2016. These gains were offset by a decrease of $501,000 in service charges on deposit accounts and a decrease of $436,000 in gain on sale of OREO during 2016 compared to 2015. Other income included a $358,000 increase in swap fee income for 2016 and a $272,000 net gain on the sale of our Porterville branch in the second quarter of 2016.

At December 31, 2016, CitizensTrust had approximately $2.69 billion in assets under management and administration, including $2.08 billion in assets under management. CitizensTrust generated fees of $9.6 million for 2016, compared to $8.6 million for 2015.

BOLI income was $2.6 million for both 2016 and 2015.

Noninterest Expense

The following table summarizes the various components of noninterest expense for the periods presented.

 

                      Variance  
    For the Year Ended December 31,     2017     2016  
    2017     2016     2015     $     %     $     %  
    (Dollars in thousands)  

Noninterest expense:

             

Salaries and employee benefits

    $87,065     $ 82,630     $ 78,618     $ 4,435       5.37   $ 4,012       5.10

Occupancy

    13,188       12,138       11,141       1,050       8.65     997       8.95

Equipment

    3,568       3,503       3,751       65       1.86     (248     -6.61

Professional services

    5,940       5,054       5,757       886       17.53     (703     -12.21

Software licenses and maintenance

    6,385       5,465       5,368       920       16.83     97       1.81

Stationery and supplies

    1,246       1,178       1,295       68       5.77     (117     -9.03

Telecommunications expense

    2,352       2,222       1,649       130       5.85     573       34.75

Marketing and promotion

    4,839       5,027       5,015       (188     -3.74     12       0.24

Amortization of intangible assets

    1,329       1,106       949       223       20.16     157       16.54

Regulatory assessments

    3,119       3,785       4,168       (666     -17.60     (383     -9.19

Insurance

    1,780       1,719       1,771       61       3.55     (52     -2.94

Loan expense

    752       991       904       (239     -24.12     87       9.62

OREO expense

    128       500       443       (372     -74.40     57       12.87

Recapture of provision for unfunded loan
commitments

    (400     (450     (500     50       11.11     50       10.00

Directors’ expenses

    954       797       691       157       19.70     106       15.34

Acquisition related expenses

    2,251       1,897       475       354       18.66     1,422       299.37

Impairment loss on asset held-for-sale

    -       2,558       -       (2,558     -100.00     2,558       -  

Legal settlement

    -       1,500       -       (1,500     -100.00     1,500       -  

Debt termination expense

    -       16       13,870       (16     -100.00     (13,854     -99.88

Other

    6,257       5,104       5,294       1,153       22.59     (190     -3.59
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

    $140,753     $ 136,740     $ 140,659     $ 4,013       2.93   $ (3,919     -2.79
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest expense to average assets,
excluding debt termination expense

    1.70%       1.70     1.68        

Efficiency ratio, excluding debt termination
expense (1)

    43.84%       46.72     44.27        

 

  (1) Noninterest expense divided by net interest income before provision for loan losses plus noninterest income.

Our ability to control noninterest expenses in relation to asset growth can be measured in terms of total noninterest expenses as a percentage of average assets. Excluding the impact of the debt termination expense, noninterest expense measured as a percentage of average assets was 1.70% for 2017, compared to 1.70% and 1.68% for 2016 and 2015, respectively.

Our ability to control noninterest expenses in relation to the level of total revenue (net interest income before provision for loan losses plus noninterest income) is measured by the efficiency ratio and indicates the

 

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percentage of net revenue that is used to cover expenses. For 2017, the efficiency ratio, excluding debt termination expense, was 43.84%, compared to 46.72% for 2016 and 44.27% for 2015.

2017 Compared to 2016

Noninterest expense of $140.8 million for the year ended December 31, 2017 was $4.0 million higher than 2016. The $4.4 million, or 5.37%, increase in compensation and benefit expense includes additional staff from the acquisition of VBB and normal year-over-year escalation in wages. The $1.1 million year-over-year increase in occupancy and equipment expense included both temporary and permanent expenses related to the acquisition of VBB and the build-out and relocation to our new operations and technology building. Acquisition related expenses were $2.3 million, up $354,000 from the prior year. Software licenses and maintenance and professional service expense increased $920,000 and $886,000, respectively. Increases in professional services included $300,000 in higher legal expenses. Partially offsetting these expense increases were $4.1 million in nonrecurring expenses in the fourth quarter of 2016 resulting from a fair value adjustment of $2.6 million for our operations and technology center and a $1.5 million accrual for the settlement of a wage-hour class action lawsuit.

2016 Compared to 2015

Noninterest expense for 2016 was $3.9 million lower than 2015, as $13.9 million in debt termination expense was incurred in 2015. Excluding the impact of debt termination expense, noninterest expense of $136.7 million increased $9.9 million, or 7.84%. This increase was primarily due to $4.1 million in nonrecurring expenses resulting from a fair value adjustment of $2.6 million for our operations and technology center, which was classified as an asset held-for-sale at December 31, 2016, and a $1.5 million accrual for the settlement of a wage-hour class action lawsuit. Salaries and employee benefits increased $4.0 million, principally due to additional compensation related costs resulting from the acquisition of County Commerce Bank (“CCB”), the opening of our Santa Barbara banking center in January 2016, and other strategic new hires. Acquisition expenses of $1.9 million in 2016 were due to the CCB acquisition and pending VBB acquisition.

Income Taxes

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was enacted into law. Beginning in 2018, this Tax Reform Act reduces the federal tax rate for corporations from 35% to 21% and changes or limits certain tax deductions. During the fourth quarter of 2017, we recorded a $13.2 million one-time charge to income tax expense due to the tax rate reduction and re-measurement of our DTA. The effects of the law’s impacts have been reflected in our financial statements for the period ended December 31, 2017. Refer to Note 12 — Income Taxes of the notes to consolidated financial statements for more information.

Our effective tax rate for the quarter and year ended December 31, 2017 was 64.51% and 44.70%, respectively, compared with 37.50% for both the quarter and year ended December 31, 2016. Excluding the DTA revaluation adjustment, our effective tax rate for 2017 was 38.25% and 37.70% for the quarter and year ended December, 2017, respectively. The effective tax rate for 2017 was also impacted by the tax effects related to the adoption of Accounting Standards Update (“ASU”) No. 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which resulted in the recognition of excess tax benefits of approximately $1.6 million in our provision for income taxes, rather than as an adjustment of paid-in capital. Our estimated annual effective tax rate also varies depending upon the level of tax-advantaged income as well as available tax credits.

The effective tax rates are below the nominal combined Federal and State tax rate as a result of tax-advantaged income from certain municipal security investments and municipal loans and leases as a percentage of total income as well as available tax credits for each period.

 

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RESULTS BY BUSINESS SEGMENTS

We have two reportable business segments: (i) Banking Centers (“Centers”) and (ii) Dairy & Livestock and Agribusiness. All other operations have been aggregated in “Other”. Our Centers and Dairy & Livestock and Agribusiness are the focal points for customer sales and services and the primary focus of management of the Company. All other operating departments have been aggregated and included in the “Other” category for reporting purposes. Recapture of provision for loan losses was allocated by segment based on loan type. In addition, the Company allocates internal funds to the segments using a methodology that charges users of funds interest expense and credits providers of funds interest income with the net effect of this allocation being recorded in the “Other” category. Taxes are not included in the segments as this is accounted for at the corporate level. The results of these two segments are included in the reconciliation between business segment totals and our consolidated total. Refer to Note 3 — Summary of Significant Accounting Policies and Note 21 — Business Segments of the consolidated financial statements.

Key measures we use to evaluate the segments’ performance are included in the following table for the years ended December 31, 2017, 2016 and 2015. These tables also provide additional significant segment measures useful to understanding the performance of these segments.

Banking Centers

 

     For the Year Ended December 31,  
     2017     2016     2015  
Key Measures:    (Dollars in thousands)  

Statement of Operations

      

Net interest income

   $ 195,377     $ 178,183     $ 167,633  

(Recapture of) provision for loan losses

     1,712       (172     (6,711

Noninterest income

     21,674       20,179       20,677  

Noninterest expense

     51,337       50,110       48,568  
  

 

 

   

 

 

   

 

 

 

Segment pre-tax profit

   $ 164,002     $ 148,424     $ 146,453  
  

 

 

   

 

 

   

 

 

 

Balance Sheet

      

Average loans

   $     3,837,945     $     3,377,639     $     3,001,503  

Average interest-bearing deposits and customer repurchase agreements

   $ 3,228,134     $ 3,203,070     $ 3,080,142  

Yield on loans (1)

     4.54     4.55     4.78

Rate paid on interest-bearing deposits and customer repurchases

     0.23     0.22     0.21

 

  (1) Yield on loans excludes PCI discount accretion, and is accounted for at the corporate level.

For the year ended December 31, 2017, the Centers’ segment pre-tax profit increased primarily due to a $20.7 million, or 10.89%, increase in interest income when compared with 2016. Average loans increased $460.3 million and included approximately $237.7 million of acquired VBB loans. The year-over-year increase in interest income was offset by an increase in interest expense for 2017 compared to $3.6 million for 2016, principally due to a $25.1 million increase in average interest-bearing deposits and customer repurchase agreements, including about $138.2 million of VBB interest-bearing deposits, and a 0.01% increase the average rate paid on interest-bearing deposits and customer repurchase agreements. In addition, 2017 included a loan loss provision of $1.7 million, compared to a recapture of loan loss provision of $172,000 for 2016. The $1.5 million increase in noninterest income included and an increase of $743,000 in service charges on deposit accounts and a $485,000 increase in fees from Bankcard services. The $1.2 million, or 2.45%, year-over-year increase in noninterest expense includes additional staff from the acquisition of VBB and normal year-over-year escalation in wages.

 

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For the year ended December 31, 2016, the Centers’ segment pre-tax profit increased by $2.0 million, or 1.35%, primarily due to an increase in interest income of $12.0 million, or 6.73%, compared to 2015. The $12.0 million increase in interest income for 2016 was principally due to a $376.1 million increase in average loans offset by a 23 basis point drop in the loan yield to 4.55% for 2016, compared to 4.78% for 2015. The increase in interest income was offset by a $1.5 million increase in noninterest expense for 2016 compared to 2015, principally due to additional compensation related costs resulting from the acquisition of CCB, the opening of our Santa Barbara commercial banking center in January 2016, and normal year-over-year escalation in wages. In addition, 2016 included a loan loss provision recapture of $172,000 for 2016, compared to a $6.7 million loan loss provision recapture for 2015.

Dairy & Livestock and Agribusiness

 

     For the Year Ended December 31,  
     2017     2016     2015  
Key Measures:    (Dollars in thousands)  

Statement of Operations

      

Net interest income

   $ 10,798     $ 7,973     $ 7,558  

(Recapture of) provision for loan losses

     (3,913     2,296       143  

Noninterest income

     232       223       261  

Noninterest expense

     1,963       1,958       1,844  
  

 

 

   

 

 

   

 

 

 

Segment pre-tax profit

   $ 12,980     $ 3,942     $ 5,832  
  

 

 

   

 

 

   

 

 

 

Balance Sheet

      

Average loans

   $ 441,451     $ 428,864     $ 370,582  

Average interest-bearing deposits and customer repurchase agreements

   $ 39,489     $ 23,606     $ 25,895  

Yield on loans (1)

     3.94     3.46     3.53

Rate paid on interest-bearing deposits and customer repurchases

     0.28     0.15     0.18

 

  (1) Yield on loans excludes PCI discount accretion, and is accounted for at the corporate level.

For year ended December 31, 2017, the dairy & livestock and agribusiness segment pre-tax profit increased by $9.0 million, primarily due to a $3.9 million loan loss provision recapture for 2017, compared to a $2.3 million loan loss provision for 2016. Higher interest income of $2.6 million resulted from a 48 basis point increase in the loan yield for 2017 compared to 2016, principally due to an increase in the Bank’s Prime rate.

For the year ended December 31, 2016, the dairy & livestock and agribusiness segment pre-tax profit decreased by $1.9 million, or 32.41%, primarily due to an increase in the loan loss provision of $2.2 million for 2016, compared to 2015.

 

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Other

 

     For the Year Ended December 31,  
     2017     2016     2015  

Key Measures:

     (Dollars in thousands)  

Statement of Operations

      

Net interest income (1)

   $ 72,755     $ 70,918     $ 77,751  

(Recapture of) provision for loan losses

     (6,299     (8,524     968  

Noninterest income

     20,212       15,150       12,545  

Noninterest expense

     87,453       84,656       76,377  

Debt termination expense

     -       16       13,870  
  

 

 

   

 

 

   

 

 

 

Segment pre-tax profit (loss)

   $ 11,813     $ 9,920     $ (919
  

 

 

   

 

 

   

 

 

 

Balance Sheet

      

Average investment securities

   $ 3,070,636     $ 3,051,618     $ 3,096,488  

Average loans

   $ 343,848     $ 388,626     $ 410,048  

Average interest-bearing deposits

   $ -     $ 174,986     $ 279,918  

Average borrowings

   $ 42,544     $ 28,806     $ 55,565  

Yield on investment securities -TE

     2.44     2.42     2.55

Non-tax equivalent yield on investment securities

     2.31     2.24     2.38

Yield on loans

     6.53     6.26     7.07

Average cost of borrowings

     1.95     1.91     3.27

 

  (1) Includes the elimination of certain items that are included in more than one department, most of which represents products and services for Centers’ customers.

For year ended December 31, 2017, the Company’s other operating departments, including treasury and administration, reported a pre-tax profit that increased by $1.9 million compared to 2016. Net interest income increased by $1.8 million as interest expense declined by $3.0 million as a result of not renewing the time deposits with the State of California. Recapture of loan loss provision of $6.3 million decreased by $2.2 million for 2017, compared to 2016. The $5.1 million increase in noninterest income for 2017, was primarily due to a $2.9 million net gain from an eminent domain condemnation of one of our banking center buildings, a $906,000 net gain on the sale of a branch acquired from VBB, $775,000 in tax free income on the death benefit of a former director included in our BOLI policies, $443,000 of recoveries on ASB loans that were charged off prior to the acquisition, and a $542,000 net gain on the sale of our former operations and technology center. 2016 included a $1.1 million net gain on the sale of loans during the first quarter of 2016 and a $272,000 net gain on the sale of our Porterville branch in the second quarter of 2016. The $2.8 million increase in noninterest expense for 2017 was primarily due to increases in salaries and employee benefits, increased occupancy costs, higher levels of professional service expense, and increased acquisition related costs. The year-over-year increase in occupancy and equipment expense included both temporary and permanent expenses primarily related to the build-out and relocation to our new operations and technology building. Increases in professional services included $300,000 in higher legal expenses. Acquisition related expenses were $2.3 million, up $354,000 from the prior year. Partially offsetting these expense increases were $4.1 million in nonrecurring expenses in the fourth quarter of 2016 resulting from a fair value adjustment of $2.6 million for our operations and technology center and a $1.5 million accrual for the settlement of a wage-hour class action lawsuit.

The decline in average interest-bearing deposits was primarily due to maturing time deposits from the State of California that were not renewed in the latter half of 2016.

For the year ended December 31, 2016, the Company’s other operating departments reported a pre-tax profit of $9.9 million, compared to a pre-tax loss of $919,000 for 2015. This $10.8 million increase in pre-tax profit was primarily due to $13.9 million in debt termination expense as a result of the redemption of $200.0 million of fixed rate debt from the FHLB on February 23, 2015. In addition, 2016 included a loan loss provision recapture

 

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of $8.5 million for 2016, compared to a $968,000 loan loss provision for 2015. Net interest income decreased $6.8 million as a result of a $44.9 million decrease in average investments and a 14 basis point drop in non-tax equivalent yield on investments. The yield on loans also decreased 81 basis points from 2015. The overall decrease in net interest income was partially offset by a decrease of $1.4 million in interest expense due to the redemption of fixed rate debt from the FHLB in the first quarter of 2015. The $8.3 million increase in noninterest expense in 2016 included $4.1 million in nonrecurring expenses resulting from a fair value adjustment of $2.6 million for our operations center, and a $1.5 million accrual for the settlement of a wage-hour class action lawsuit. Acquisition expenses of $1.9 million in 2016 were due to the CCB acquisition and pending Valley Business Bank acquisition.

ANALYSIS OF FINANCIAL CONDITION

The Company reported total assets of $8.27 billion at December 31, 2017. This represented an increase of $196.9 million, or 2.44%, from total assets of $8.07 billion at December 31, 2016. Interest-earning assets totaled $7.80 billion at December 31, 2017, an increase of $156.8 million, or 2.05%, when compared with interest-earning assets of $7.64 billion at December 31, 2016. The increase in interest-earning assets was primarily due to a $435.6 million increase in total loans, which was partially offset by a $271.3 million decrease in investment securities. The increase in total assets at December 31, 2017 included $405.9 million of acquired assets, including $309.7 million of acquired loans, from VBB in the first quarter of 2017. Total liabilities were $7.20 billion at December 31, 2017, an increase of $118.5 million, or 1.67%, from total liabilities of $7.08 billion at December 31, 2016. The $237.2 million increase in deposits at December 31, 2017 included $361.8 million of total deposits assumed from VBB during the first quarter of 2017, of which $172.5 million were noninterest-bearing deposits. Total equity increased $78.4 million, or 7.91%, to $1.07 billion at December 31, 2017, compared to total equity of $990.9 million at December 31, 2016. The $78.4 million increase in equity was due to $104.4 million in net earnings, $37.6 million for the issuance of common stock for the acquisition of VCBP, and $4.6 million for various stock-based compensation items. This was offset by $59.5 million for cash dividends declared for the year ended December 31, 2017, and an $8.7 million decrease in other comprehensive income, net of tax, resulting from the net change in fair value of our investment securities portfolio.

Investment Securities

The Company maintains a portfolio of investment securities to provide interest income and to serve as a source of liquidity for its ongoing operations. At December 31, 2017, we reported total investment securities of $2.91 billion. This represented a decrease of $271.3 million, or 8.52%, from total investment securities of $3.18 billion at December 31, 2016. At December 31, 2017, investment securities HTM totaled $829.9 million. At December 31, 2017, our investment securities AFS totaled $2.08 billion, inclusive of a pre-tax unrealized gain of $2.9 million. The after-tax unrealized gain reported in AOCI on investment securities AFS was $1.7 million.

As of December 31, 2017, the Company had a pre-tax net unrealized holding gain on total investment securities of $2.7 million, compared to a pre-tax net unrealized holding gain of $16.3 million at December 31, 2016. The changes in the net unrealized holding gain resulted primarily from fluctuations in market interest rates. For 2017, total repayments/maturities and proceeds from sales of investment securities totaled $572.8 million, compared to $827.6 million for 2016. The Company purchased additional investment securities totaling $362.0 million and $808.0 million for 2017 and 2016, respectively. We sold one investment security with a recognized gain of $402,000 in 2017. This compares to two investment securities sold in 2016 with a recognized gain of $548,000 and one investment security sold in 2015 with a recognized loss of approximately $22,000.

 

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The tables below summarize the fair value of AFS and HTM investment securities for the periods presented.

 

    December 31,  
    2017     2016     2015  
    Fair Value     Percent     Fair Value     Percent     Fair Value     Percent  
    (Dollars in thousands)  

Investment securities available-for-sale

           

Government agency/GSE

  $ -       0.00   $ 2,752       0.12   $ 5,745       0.24

Residential mortgage-backed securities

    1,750,909       84.14     1,834,748       80.81     1,813,097       76.55

CMO/REMIC - residential

    273,829       13.16     347,189       15.29     383,781       16.20

Municipal bonds

    55,496       2.66     80,071       3.53     160,973       6.80

Other securities

    751       0.04     5,706       0.25     5,050       0.21
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale securities

  $   2,080,985       100.00   $   2,270,466       100.00   $   2,368,646       100.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     December 31,  
     2017     2016     2015  
     Amortized
Cost
     Percent     Amortized
Cost
     Percent     Amortized
Cost
     Percent  
     (Dollars in thousands)  

Investment securities held-to-maturity

               

Government agency/GSE

   $ 159,716        19.25   $ 182,648        20.03   $ 293,338        34.47

Residential mortgage-backed securities

     176,427        21.26     193,699        21.25     232,053        27.27

CMO

     225,072        27.12     244,419        26.81     1,284        0.15

Municipal bonds

     268,675        32.37     290,910        31.91     324,314        38.11
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total held-to-maturity securities

   $ 829,890        100.00   $ 911,676        100.00   $ 850,989        100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Fair Value

   $ 819,215        $ 897,374        $ 853,039     
  

 

 

      

 

 

      

 

 

    

The maturity distribution of the AFS and HTM portfolios consist of the following for the period presented.

 

    December 31, 2017  
    One Year or
Less
    After One
Year
Through
Five Years
    After Five
Years
Through
Ten Years
    After Ten
Years
    Total     Percent to
Total
 
    (Dollars in thousands)  

Investment securities available-for-sale:

           

Residential mortgage-backed securities

  $ 4,470     $ 1,651,561     $ 89,434     $ 5,444     $ 1,750,909       84.14

CMO/REMIC - residential

    4,696       269,133       -       -       273,829       13.16

Municipal bonds (1)

    8,172       11,908       6,766       28,650       55,496       2.66

Other securities

    751       -       -       -       751       0.04
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 18,089     $ 1,932,602     $ 96,200     $ 34,094     $ 2,080,985       100.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average yield:

           

Residential mortgage-backed securities

    4.15     2.50     2.31     4.45     2.50  

CMO/REMIC - residential

    3.39     2.42     -       -       2.44  

Municipal bonds (1)

    4.07     2.52     4.04     2.60     2.97  

Total

    3.74     2.49     2.43     2.88     2.50  

 

  (1) The weighted average yield for the portfolio is based on projected duration and is not tax-equivalent. The tax-equivalent yield at December 31, 2017 was 4.56%.

 

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     December 31, 2017  
     One Year or
Less
    After One
Year
Through
Five Years
    After Five
Years
Through
Ten Years
    After Ten
Years
    Total     Percent to
Total
 
     (Dollars in thousands)  

Investment securities held-to-maturity:

            

Government agency/GSE

   $ 425     $ -     $ -     $ 159,291     $ 159,716       19.25

Residential mortgage-backed securities

     -       84,682       88,744       3,001       176,427       21.26

CMO

     -       76,930       77,462       70,680       225,072       27.12

Municipal bonds (1)

     460       14,287       105,373       148,555       268,675       32.37
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 885     $ 175,899     $ 271,579     $ 381,527     $ 829,890       100.00
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average yield:

            

Government agency/GSE

     1.36     -       -       1.90     1.90  

Residential mortgage-backed securities

     -       2.49     2.49     2.93     2.50  

CMO

     -       2.02     2.05     2.47     2.17  

Municipal bonds (1)

     2.59     3.54     3.23     2.84     3.03  

Total

     2.00     2.37     2.65     2.38     2.47  

 

  (1) The weighted average yield for the portfolio is not tax-equivalent. The tax equivalent yield at December 31, 2017 was 4.66%.

The maturity of each security category is defined as the contractual maturity except for the categories of mortgage-backed securities and CMO/REMIC whose maturities are defined as the estimated average life. The final maturity of mortgage-backed securities and CMO/REMIC will differ from their contractual maturities because the underlying mortgages have the right to repay such obligations without penalty. The speed at which the underlying mortgages repay is influenced by many factors, one of which is interest rates. Mortgages tend to repay faster as interest rates fall and slower as interest rate rise. This will either shorten or extend the estimated average life. Also, the yield on mortgage-backed securities and CMO/REMIC are affected by the speed at which the underlying mortgages repay. This is caused by the change in the amount of amortization of premiums or accretion of discounts of each security as repayments increase or decrease. The Company obtains the estimated average life of each security from independent third parties.

The weighted-average yield on the total investment portfolio at December 31, 2017 was 2.50% with a weighted-average life of 4.3 years. This compares to a weighted-average yield of 2.38% at December 31, 2016 with a weighted-average life of 4.5 years. The weighted average life is the average number of years that each dollar of unpaid principal due remains outstanding. Average life is computed as the weighted-average time to the receipt of all future cash flows, using as the weights the dollar amounts of the principal pay-downs.

Approximately 89% of the securities in the total investment portfolio, at December 31, 2017, are issued by the U.S. government or U.S. government-sponsored agencies and enterprises, which have the implied guarantee of payment of principal and interest. As of December 31, 2017, approximately $101.3 million in U.S. government agency bonds are callable. The Agency CMO/REMIC are backed by agency-pooled collateral. Municipal bonds, which represented approximately 11% of the total investment portfolio are predominately AA or higher rated securities.

 

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The Company held investment securities in excess of 10% of shareholders’ equity from the following issuers for the periods presented.

 

     December 31, 2017      December 31, 2016  
     Book Value      Market Value      Book Value      Market Value  
Major issuer:    (Dollars in thousands)  

Federal National Mortgage Association

   $ 1,164,683      $ 1,170,306      $ 1,282,274      $ 1,291,769  

Federal Home Loan Mortgage Corporation

     991,287        988,480        1,036,363        1,039,163  

Government National Mortgage Association

     268,369        259,521        289,054        282,516  

Small Business Administration

     159,291        158,011        182,224        180,613  

Municipal securities held by the Company are issued by various states and their various local municipalities. The following tables present municipal securities by the top holdings by state for the periods presented.

 

     December 31, 2017  
     Amortized
Cost
     Percent of
Total
    Fair Value      Percent of
Total
 
     (Dollars in thousands)  

Municipal Securities available-for-sale:

          

Minnesota

   $ 11,089        20.2   $ 10,992        19.8

Iowa

     8,618        15.7     8,865        16.0

Connecticut

     6,639        12.1     6,672        12.0

California

     5,609        10.2     5,751        10.4

Massachusetts

     5,061        9.2     5,040        9.1

Arizona

     2,698        4.9     2,733        4.9

All other states (9 states)

     15,252        27.7     15,443        27.8
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 54,966        100.0   $ 55,496        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Municipal Securities held-to-maturity:

          

Minnesota

   $ 59,813        22.3   $ 59,213        22.1

Texas

     32,025        11.9     31,929        11.9

Massachusetts

     27,281        10.2     27,217        10.2

New York

     14,718        5.5     14,727        5.5

Wisconsin

     12,675        4.7     12,472        4.7

Louisiana

     12,906        4.8     12,652        4.7

All other states (21 states)

     109,257        40.6     109,426        40.9
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 268,675        100.0   $ 267,636        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

 

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Table of Contents
     December 31, 2016  
     Amortized
Cost
     Percent of
Total
    Fair Value      Percent of
Total
 
     (Dollars in thousands)  

Municipal Securities available-for-sale:

          

California

   $ 13,449        16.8   $ 13,681        17.1

Minnesota

     11,100        13.9     10,690        13.4

Iowa

     8,620        10.8     8,800        11.0

Arizona

     7,033        8.8     7,132        8.9

Connecticut

     6,979        8.7     6,896        8.6

Massachusetts

     5,979        7.5     5,770        7.2

All other states (10 states)

     26,977        33.5     27,102        33.8
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 80,137        100.0   $ 80,071        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

Municipal Securities held-to-maturity:

          

Minnesota

   $ 68,913        23.7   $ 67,651        23.6

Texas

     32,607        11.2     32,051        11.2

Massachusetts

     18,645        6.4     18,247        6.4

Pennsylvania

     17,506        6.0     17,576        6.1

New York

     16,811        5.8     16,738        5.8

Ohio

     16,400        5.6     16,325        5.7

All other states (21 states)

     120,028        41.3     118,330        41.2
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 290,910        100.0   $ 286,918        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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The tables below show the Company’s investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2017 and 2016. The unrealized losses on these securities were primarily attributed to changes in interest rates. The issuers of these securities have not, to our knowledge, evidenced any cause for default on these securities. These securities have fluctuated in value since their purchase dates as market rates have fluctuated. However, we have the ability and the intention to hold these securities until their fair values recover to cost or maturity. As such, management does not deem these securities to be other-than-temporarily-impaired (“OTTI”). A summary of our analysis of these securities and the unrealized losses is described more fully in Note 5 — Investment Securities of the notes to the consolidated financial statements. Economic trends may adversely affect the value of the portfolio of investment securities that we hold.

 

     December 31, 2017  
     Less Than 12 Months     12 Months or Longer     Total  
     Fair Value      Gross
Unrealized
Holding
Losses
    Fair Value      Gross
Unrealized
Holding
Losses
    Fair Value      Gross
Unrealized
Holding
Losses
 
     (Dollars in thousands)  

Investment securities available-for-sale:

               

Residential mortgage-backed securities

   $ 414,091      $ (1,828   $ 303,746      $ (6,274   $ 717,837      $ (8,102

CMO/REMIC - residential

     95,137        (487     71,223        (1,595     166,360        (2,082

Municipal bonds

     946        (4     13,956        (240     14,902        (244
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available-for-sale securities

   $ 510,174      $ (2,319   $ 388,925      $ (8,109   $ 899,099      $ (10,428
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Investment securities held-to-maturity:

               

Government agency/GSE

   $ 18,950      $ (27   $ 43,495      $ (2,107   $ 62,445      $ (2,134

Residential mortgage-backed securities

     51,297        (188     55,306        (194     106,603        (382

CMO

     -        -       216,431        (8,641     216,431        (8,641

Municipal bonds

     32,069        (492     66,217        (3,298     98,286        (3,790
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total held-to-maturity securities

   $   102,316      $   (707)     $   381,449      $   (14,240)     $   483,765      $   (14,947)  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     December 31, 2016  
     Less Than 12 Months     12 Months or Longer     Total  
     Fair Value      Gross
Unrealized
Holding
Losses
    Fair Value      Gross
Unrealized
Holding
Losses
    Fair Value      Gross
Unrealized
Holding
Losses
 
     (Dollars in thousands)  

Investment securities available-for-sale:

               

Residential mortgage-backed securities

   $ 583,143      $ (6,232   $ -      $ -     $ 583,143      $ (6,232

CMO/REMIC - residential

     128,595        (1,485     -        -       128,595        (1,485

Municipal bonds

     23,255        (954     5,981        (1     29,236        (955
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total available-for-sale securities

   $ 734,993      $ (8,671   $ 5,981      $ (1   $ 740,974      $ (8,672
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Investment securities held-to-maturity:

               

Government agency/GSE

   $ 76,854      $ (1,972   $ -      $ -     $ 76,854      $ (1,972

Residential mortgage-backed securities

     191,807        (1,892     -        -       191,807        (1,892

CMO

     237,611        (6,808     -        -       237,611        (6,808

Municipal bonds

     145,804        (3,711     36,971        (1,057     182,775        (4,768
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total held-to-maturity securities

   $   652,076      $   (14,383)     $   36,971      $   (1,057)     $   689,047      $   (15,440)  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The Company did not record any charges for other-than-temporary impairment losses for the years ended December 31, 2017 and 2016.

Loans

Total loans and leases, net of deferred fees and discounts, of $4.83 billion at December 31, 2017, increased by $435.6 million, or 9.91%, from $4.40 billion at December 31, 2016. The increase in total loans included $309.7 million of loans acquired from VBB in the first quarter of 2017. Excluding the acquired VBB loans, the $125.9 million, or 2.86%, increase in total loans was principally due to growth of $182.8 million in commercial real estate loans and $12.8 million in SBA loans. This growth was partially offset by decreases of $21.4 million in consumer and other loans, $17.2 million in commercial and industrial loans, $16.3 million in construction loans, and $14.7 million in SFR mortgage loans.

 

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Total loans, net of deferred loan fees, comprise 62.02% of our total earning assets as of December 31, 2017. The following table presents our loan portfolio, excluding PCI and held-for-sale loans, by type for the periods presented.

Distribution of Loan Portfolio by Type

 

     December 31,  
     2017      2016      2015      2014      2013  
     (Dollars in thousands)  

Commercial and industrial

   $ 513,325      $ 485,078      $ 434,099      $ 390,011      $ 376,800  

SBA

     122,055        97,184        106,867        134,265        135,992  

Real estate:

              

Commercial real estate

     3,376,713        2,930,141        2,643,184        2,487,803        2,207,515  

Construction

     77,982        85,879        68,563        55,173        47,109  

SFR mortgage

     236,202        250,605        233,754        205,124        189,233  

Dairy & livestock and agribusiness

     347,289        338,631        305,509        279,173        294,292  

Municipal lease finance receivables

     70,243        64,639        74,135        77,834        89,106  

Consumer and other loans

     64,229        78,274        69,278        69,884        55,103  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross loans, excluding PCI loans

     4,808,038        4,330,431        3,935,389        3,699,267        3,395,150  

Less: Deferred loan fees, net

     (6,289      (6,952      (8,292      (8,567      (9,234
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross loans, excluding PCI loans, net of deferred loan fees

     4,801,749        4,323,479        3,927,097        3,690,700        3,385,916  

Less: Allowance for loan losses

     (59,218      (60,321      (59,156      (59,825      (75,235
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net loans, excluding PCI loans

     4,742,531        4,263,158        3,867,941        3,630,875        3,310,681  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

PCI Loans

     30,908        73,093        93,712        133,496        173,104  

Discount on PCI loans

     (2,026      (1,508      (3,872      (7,129      (12,789

Less: Allowance for loan losses

     (367      (1,219      -        -        -  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

PCI loans, net

     28,515        70,366        89,840        126,367        160,315  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans and lease finance receivables

   $ 4,771,046      $ 4,333,524      $ 3,957,781      $ 3,757,242      $ 3,470,996  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

As of December 31, 2017, $206.1 million, or 6.10% of the total commercial real estate loans included loans secured by farmland, compared to $180.6 million, or 6.16%, at December 31, 2016. The loans secured by farmland included $118.2 million for loans secured by dairy & livestock land and $87.9 million for loans secured by agricultural land at December 31, 2017, compared to $127.1 million for loans secured by dairy & livestock land and $53.6 million for loans secured by agricultural land at December 31, 2016. As of December 31, 2017, dairy & livestock and agribusiness loans of $347.3 million were comprised of $310.6 million for dairy & livestock loans and $36.7 million for agribusiness loans, compared to $317.9 million for dairy & livestock loans and $20.7 million for agribusiness loans at December 31, 2016.

Real estate loans are loans secured by conforming trust deeds on real property, including property under construction, land development, commercial property and single-family and multi-family residences. Our real estate loans are comprised of industrial, office, retail, medical, single-family residences, multi-family residences, and farmland. Consumer loans include auto and equipment leases, installment loans to consumers as well as home equity loans and other loans secured by junior liens on real property. Municipal lease finance receivables are leases to municipalities. Dairy & livestock and agribusiness loans are loans to finance the operating needs of wholesale dairy farm operations, cattle feeders, livestock raisers, and farmers.

As of December 31, 2017, the Company had $109.0 million of total SBA 504 loans. SBA 504 loans include term loans to finance capital expenditures and for the purchase of commercial real estate. Initially the Bank provides two separate loans to the Borrower representing a first and second lien on the collateral. The loan with the first lien is typically at a 50% advance to the acquisition costs and the second lien loan provides the financing for 40% of the acquisition costs with the Borrower’s down payment of 10%. When the loans are funded the Bank retains the first lien loan for its term and sells the second lien loan to the SBA subordinated debenture program. A majority of the Bank’s 504 loans are granted for the purpose of commercial real estate acquisition. As of December 31, 2017, the Company had $14.4 million of total SBA 7(a) loans. The SBA 7(a) loans include

 

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revolving lines of credit (SBA Express) and term loans to finance long term working capital requirements, capital expenditures, and/or for the purchase or refinance of commercial real estate.

As of December 31, 2017, the Company had $78.0 million in construction loans. This represents 1.61% of total gross loans held-for-investment. There were no PCI construction loans at December 31, 2017. Although our construction loans are located throughout our market footprint, the majority of construction loans consist of commercial land development and construction projects in Los Angeles County, Orange County, and the Inland Empire region of Southern California. At December 31, 2017, construction loans consisted of $41.1 million in SFR construction loans and $36.9 million in commercial construction loans. There were no nonperforming construction loans at December 31, 2017.

PCI Loans from the SJB Acquisition

These PCI loans were acquired from SJB on October 16, 2009 and were subject to a loss sharing agreement with the FDIC. Under the terms of such loss sharing agreement, the FDIC absorbs 80% of losses and shares in 80% of loss recoveries up to $144.0 million in losses with respect to covered assets, after a first loss amount of $26.7 million. The loss sharing agreement covered 5 years for commercial loans and covers 10 years for single-family residential loans from the October 16, 2009 acquisition date and the loss recovery provisions are in effect for 8 and 10 years, respectively, for commercial and single-family residential loans from the acquisition date. The loss sharing agreement for commercial loans expired on October 16, 2014 and will expire for single family residential loans on October 16, 2019.

The PCI loan portfolio included unfunded commitments for commercial lines of credit, construction draws and other lending activity. The total commitment outstanding as of the acquisition date is included under the shared-loss agreement. As such, any additional advances up to the total commitment outstanding at the time of acquisition were covered under the loss share agreement.

The following table presents PCI loans by type for the periods presented.

Distribution of Loan Portfolio by Type

 

     December 31,  
     2017      2016      2015      2014      2013  
     (Dollars in thousands)  

Commercial and industrial

   $ 934      $ 2,309      $ 7,473      $ 14,605      $ 19,047  

SBA

     1,383        327        393        1,110        1,414  

Real estate:

              

Commercial real estate

     27,431        67,594        81,786        109,350        141,141  

Construction

     -        -        -        -        644  

SFR mortgage

     162        178        193        205        313  

Dairy & livestock and agribusiness

     770        1,216        1,429        4,890        6,000  

Municipal lease finance receivables

     -        -        -        -        -  

Consumer and other loans

     228        1,469        2,438        3,336        4,545  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross PCI loans

     30,908        73,093        93,712        133,496        173,104  

Less: Purchase accounting discount

     (2,026      (1,508      (3,872      (7,129      (12,789
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross PCI loans, net of discount

     28,882        71,585        89,840        126,367        160,315  

Less: Allowance for PCI loan losses

     (367      (1,219      -        -        -  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net PCI loans

   $     28,515      $     70,366      $     89,840      $     126,367      $     160,315  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The excess of cash flows expected to be collected over the initial fair value of acquired loans is referred to as the accretable yield and is accreted into interest income over the estimated life of the acquired loans using the effective yield method. The accretable yield will change due to:

 

    estimate of the remaining life of acquired loans which may change the amount of future interest income;

 

    estimate of the amount of contractually required principal and interest payments over the estimated life that will not be collected (the nonaccretable difference); and

 

    changes in indices for acquired loans with variable rates of interest.

Our loan portfolio is geographically disbursed throughout our marketplace, with less than 5% located outside of California. The following is the breakdown of our total held-for-investment commercial real estate loans, excluding PCI loans, by region as of December 31, 2017.

 

     December 31, 2017  
     Total Loans     Commercial Real
Estate Loans
 
     (Dollars in thousands)  

Los Angeles County

   $ 1,648,944        34.3   $ 1,155,739        34.2

Central Valley

     1,024,636        21.3     685,325        20.3

Inland Empire

     745,323        15.5     621,449        18.4

Orange County

     593,080        12.3     366,271        10.9

Central Coast

     350,585        7.3     287,319        8.5

San Diego

     111,927        2.3     78,549        2.3

Other California

     110,407        2.3     59,773        1.8

Out of State

     223,136        4.7     122,288        3.6
  

 

 

    

 

 

   

 

 

    

 

 

 
   $     4,808,038        100.0   $     3,376,713        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

The following is the breakdown of total PCI held-for-investment commercial real estate loans by region as of December 31, 2017.

 

     December 31, 2017  
     Total PCI Loans     Commercial Real
Estate Loans
 
     (Dollars in thousands)  

Central Valley

   $     29,470        95.3   $     27,303        99.5

Los Angeles County

     1,329        4.3     128        0.5

Central Coast

     109        0.4     -        -  

Other California

     -        -       -        -  
  

 

 

    

 

 

   

 

 

    

 

 

 
   $     30,908        100.0   $     27,431        100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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The table below breaks down our real estate portfolio, excluding PCI loans.

 

     December 31, 2017  
     Loan
Balance
     Percent     Percent
Owner-
Occupied (1)
    Average
Loan Balance
 
     (Dollars in thousands)  

SFR mortgage:

         

SFR mortgage - Direct

   $ 208,283        5.7     100.0   $ 540  

SFR mortgage - Mortgage pools

     27,919        0.8     100.0     150  
  

 

 

    

 

 

     

Total SFR mortgage

     236,202        6.5    
  

 

 

    

 

 

     

Commercial real estate:

         

Multi-family

     308,189        8.5     -                     1,295  

Industrial

     986,159        27.3     39.6     1,222  

Office

     607,333        16.8     25.9     1,295  

Retail

     533,457        14.8     7.9     1,511  

Medical

     252,100        7.0     37.1     1,970  

Secured by farmland (2)

     206,110        5.7     100.0     2,021  

Other (3)

     483,365        13.4     42.8     1,299  
  

 

 

    

 

 

     

Total commercial real estate

     3,376,713        93.5    
  

 

 

    

 

 

     

Total SFR mortgage and commercial real estate loans

   $     3,612,915        100.0     36.9     1,188  
  

 

 

    

 

 

     

 

  (1) Represents percentage of reported owner-occupied at origination in each real estate loan category.
  (2) The loans secured by farmland included $118.2 million for loans secured by dairy & livestock land and $87.9 million for loans secured by agricultural land at December 31, 2017.
  (3) Other loans consist of a variety of loan types, none of which exceeds 2.0% of total commercial real estate loans.

In the table above, SFR mortgage — Direct loans include SFR mortgage loans which are currently generated through an internal program in our Centers. This program is focused on owner-occupied SFR’s with defined loan-to-value, debt-to-income and other credit criteria, such as FICO credit scores, that we believe are appropriate for loans which are primarily intended for retention in our Bank’s loan portfolio. We originated loan volume in the aggregate principal amount of $10.9 million under this program during 2017.

In addition, we previously purchased pools of owner-occupied single-family loans from real estate lenders, SFR mortgage — Mortgage Pools, with a remaining balance totaling $27.9 million at December 31, 2017. These loans were purchased with average FICO scores predominantly ranging from 700 to over 800 and overall original loan-to-value ratios of 60% to 80%. These pools were purchased to diversify our loan portfolio. We have not purchased any mortgage pools since August 2007.

 

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The table below breaks down our PCI real estate portfolio.

 

     December 31, 2017  
     Loan
Balance
     Percent     Percent
Owner-
Occupied (1)
    Average
Loan Balance
 
     (Dollars in thousands)  

SFR mortgage

         

SFR mortgage - Direct

   $ 162        0.6     100.0   $ 162  

SFR mortgage - Mortgage pools

     -          -         -         -    
  

 

 

    

 

 

     

Total SFR mortgage

     162        0.6    

Commercial real estate:

         

Multi-family

     583        2.1     -         583  

Industrial

     3,956        14.3     99.0     283  

Office

     413        1.5     100.0     207  

Retail

     5,096        18.5     32.9     463  

Medical

     5,499        19.9     100.0     1,100  

Secured by farmland

     1,425        5.2     100.0     285  

Other (2)

     10,459        37.9     64.9     418  
  

 

 

    

 

 

     

Total commercial real estate

     27,431        99.4    
  

 

 

    

 

 

     

Total SFR mortgage and commercial real estate loans

   $ 27,593        100.0     72.0     431  
  

 

 

    

 

 

     

 

  (1) Represents percentage of reported owner-occupied at origination in each real estate loan category.
  (2) Includes loans associated with hospitality, churches and gas stations, which represents approximately 78% of other loans.

The table below provides the maturity distribution for held-for-investment total gross loans, including PCI loans, as of December 31, 2017. The loan amounts are based on contractual maturities although the borrowers have the ability to prepay the loans. Amounts are also classified according to repricing opportunities or rate sensitivity.

Loan Maturities and Interest Rate Category at December 31, 2017

 

     Within
One Year
     After One
But Within
Five Years
     After Five
Years
     Total  
     (Dollars in thousands)  

Types of Loans:

           

Commercial and industrial

   $ 185,936      $ 184,171      $ 144,152      $ 514,259  

SBA

     3,922        17,050        102,466        123,438  

Real estate:

           

Commercial real estate

     127,319        762,216        2,514,609        3,404,144  

Construction

     76,014        1,263        705        77,982  

SFR mortgage

     300        3,937        232,127        236,364  

Dairy & livestock and agribusiness

     242,517        96,609        8,933        348,059  

Municipal lease finance receivables

     442        8,982        60,819        70,243  

Consumer and other loans

     10,986        23,355        30,116        64,457  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total gross loans

   $ 647,436      $ 1,097,583      $ 3,093,927      $ 4,838,946  
  

 

 

    

 

 

    

 

 

    

 

 

 

Amount of Loans based upon:

           

Fixed Rates

   $ 116,013      $ 643,936      $ 1,405,075      $ 2,165,024  

Floating or adjustable rates

     531,423        453,647        1,688,852        2,673,922  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total gross loans

   $ 647,436      $ 1,097,583      $ 3,093,927      $ 4,838,946  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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As a normal practice in extending credit for commercial and industrial purposes, we may accept trust deeds on real property as collateral. In some cases, when the primary source of repayment for the loan is anticipated to come from the cash flow from normal operations of the borrower, and real property has been taken as collateral, the real property is considered a secondary source of repayment for the loan. Since we lend primarily in Southern and Central California, our real estate loan collateral is concentrated in this region. At December 31, 2017, substantially all of our loans secured by real estate were collateralized by properties located in California. This concentration is considered when determining the adequacy of our allowance for loan losses.

Nonperforming Assets

The following table provides information on nonperforming assets, excluding PCI loans, as of December 31 for each of the last five years.

 

    December 31,  
    2017     2016     2015     2014     2013  
    (Dollars in thousands)  

Nonaccrual loans

  $ 6,516     $ 5,526     $ 8,397     $ 11,901     $ 14,835  

Troubled debt restructured loans (nonperforming)

    4,200       1,626       12,622       20,285       25,119  

OREO, net

    4,527       4,527       6,993       5,637       6,475  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

  $     15,243     $     11,679     $     28,012     $     37,823     $     46,429  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Troubled debt restructured performing loans

  $ 4,809