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EX-32.2 - EX-32.2 - TRICO BANCSHARES /d504131dex322.htm
EX-32.1 - EX-32.1 - TRICO BANCSHARES /d504131dex321.htm
EX-31.2 - EX-31.2 - TRICO BANCSHARES /d504131dex312.htm
EX-31.1 - EX-31.1 - TRICO BANCSHARES /d504131dex311.htm
EX-23.1 - EX-23.1 - TRICO BANCSHARES /d504131dex231.htm
EX-21.1 - EX-21.1 - TRICO BANCSHARES /d504131dex211.htm
EX-10.19 - EX-10.19 - TRICO BANCSHARES /d504131dex1019.htm

 

 

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    

Commission File Number 0-10661

 

 

TriCo Bancshares

(Exact name of Registrant as specified in its charter)

 

 

 

California   94-2792841

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

63 Constitution Drive, Chico, California   95973
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code:(530) 898-0300

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

 

Common Stock, without par value

 

Nasdaq Global Select Market

(Title of Class)   (Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act: None.

 

 

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

Indicate by check mark whether 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 periods 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 (§ 232.405 of this chapter) 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 the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the 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, non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “accelerated filer”, “large accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      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 Exchange Act).    ☐  Yes    ☒  No

The aggregate market value of the voting common stock held by non-affiliates of the Registrant, as of June 30, 2017, was approximately $712,127,000 (based on the closing sales price of the Registrant’s common stock on the date). This computation excludes a total of 2,665,409 shares that are beneficially owned by the officers and directors of Registrant who may be deemed to be the affiliates of Registrant under applicable rules of the Securities and Exchange Commission.

The number of shares outstanding of Registrant’s common stock, as of February 23, 2018, was 22,956,323.

DOCUMENTS INCORPORATED BY REFERENCE

The information required to be disclosed pursuant to Part III of this report either shall be (i) deemed to be incorporated by reference from selected portions of the Registrant’s definitive proxy statement for the 2018 annual meeting of shareholders, if such proxy statement is filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the Registrants’s most recently completed fiscal year, or (ii) included in an amendment to this report filed with the Commission on Form 10-K/A not later than the end of such 120 day period.

 

 

 

 


TABLE OF CONTENTS

 

          Page
Number
 

PART I

  

Item 1

   Business      2  

Item 1A

   Risk Factors      9  

Item 1B

   Unresolved Staff Comments      19  

Item 2

   Properties      19  

Item 3

   Legal Proceedings      20  

Item 4

   Mine Safety Disclosures      20  

PART II

  

Item 5

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      21  

Item 6

   Selected Financial Data      23  

Item 7

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      24  

Item 7A

   Quantitative and Qualitative Disclosures About Market Risk      54  

Item 8

   Financial Statements and Supplementary Data      54  

Item 9

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      105  

Item 9A

   Controls and Procedures      105  

Item 9B

   Other Information      105  

PART III

  

Item 10

   Directors, Executive Officers and Corporate Governance      106  

Item 11

   Executive Compensation      106  

Item 12

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      106  

Item 13

   Certain Relationships and Related Transactions, and Director Independence      106  

Item 14

   Principal Accountant Fees and Services      106  

PART IV

  

Item 15

   Exhibits and Financial Statement Schedules      106  

Signatures

     109  

FORWARD-LOOKING STATEMENTS

In addition to historical information, this Annual Report on Form 10-K contains forward-looking statements about TriCo Bancshares (the “Company,” “TriCo” or “we”) and its subsidiaries for which it claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the current knowledge and belief of the Company’s management (“Management”) and include information concerning the Company’s possible or assumed future financial condition and results of operations. When you see any of the words “believes”, “expects”, “anticipates”, “estimates”, or similar expressions, these generally indicate that we are making forward-looking statements. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. These factors include those listed at Item 1A Risk Factors, in this report.

Forward-looking statements speak only as of the date they are made, and the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made, whether as a result of new information, future developments or otherwise.


PART I

ITEM 1. BUSINESS

Information about TriCo Bancshares’ Business

TriCo Bancshares is a bank holding company incorporated in California in 1981 and registered under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company’s principal subsidiary is Tri Counties Bank, a California-chartered commercial bank (the “Bank”). The Bank offers banking services to retail customers and small to medium-sized businesses through 57 traditional branches, 9 in-store branches and 2 loan production offices in northern and central California and had total assets of approximately $4.76 billion at December 31, 2017. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to applicable limits. See “Business of Tri Counties Bank”. The Company and the Bank are headquartered in Chico, California.

As a bank holding company, TriCo is subject to the supervision of the Board of Governors of the Federal Reserve System (the “FRB”) under the BHC Act. The Bank is subject to the supervision of the California Department of Business Oversight (the “DBO”) and the FDIC. See “Regulation and Supervision.”

TriCo has five capital trusts, which are all wholly-owned trust subsidiaries formed for the purpose of issuing trust preferred securities (“Trust Preferred Securities”) and lending the proceeds to TriCo.    For more information regarding the trust preferred securities please refer to Note 17, “Junior Subordinated Debt” to the financial statements at Item 8 of this report.

Additional information concerning the Company can be found on our website at www.tcbk.com. Copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports are available free of charge through the investors relations page of our website, www.tcbk.com, as soon as reasonably practicable after the Company files these reports with the U.S. Securities and Exchange Commission (“SEC”). The information on our website is not part this annual report.

Business of Tri Counties Bank

The Bank was incorporated as a California banking corporation on June 26, 1974, and received its certificate of authority to conduct banking operations on March 11, 1975. The Bank engages in the general commercial banking business in 26 counties in Northern and Central California.

The Bank conducts a commercial banking business including accepting demand, savings and time deposits and making commercial, real estate, and consumer loans. It also offers installment note collection, issues cashier’s checks, sells travelers checks and provides safe deposit boxes and other customary banking services. Brokerage services are provided at the Bank’s offices by the Bank’s arrangement with Raymond James Financial Services, Inc., an independent financial services provider and broker-dealer. The Bank does not offer trust services or international banking services.

The Bank has emphasized retail banking since it opened. Most of the Bank’s customers are retail customers and small to medium-sized businesses. The Bank emphasizes serving the needs of local businesses, farmers and ranchers, retired individuals and wage earners. The majority of the Bank’s loans are direct loans made to individuals and businesses in Northern and Central California where its branches are located. At December 31, 2017, the total of the Bank’s consumer loans net of deferred fees outstanding was $356,874,000 (11.8%), the total of commercial loans outstanding was $220,412,000 (7.3%), and the total of real estate loans including construction loans of $137,557,000 was $2,437,879,000 (80.9%). The Bank takes real estate, listed and unlisted securities, savings and time deposits, automobiles, machinery, equipment, inventory, accounts receivable and notes receivable secured by property as collateral for loans.

Most of the Bank’s deposits are attracted from individuals and business-related sources. No single person or group of persons provides a material portion of the Bank’s deposits, the loss of any one or more of which would have a materially adverse effect on the business of the Bank, nor is a material portion of the Bank’s loans concentrated within a single industry or group of related industries.

Proposed Merger with FNB Bancorp

On December 11, 2017, the Company and FNB Bancorp (“FNBB”), entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) pursuant to which FNBB will be merged with and into TriCo, with TriCo as the surviving corporation (the “Merger”). The Merger Agreement provides that immediately after the Merger, FNBB’s bank subsidiary, First National Bank of Northern California (“First National Bank”), will merge with and into TriCo’s bank subsidiary, Tri Counties Bank, with Tri Counties Bank as the surviving bank (the “Bank Merger”). The Merger and Bank Merger are collectively referred to as the “Proposed Transaction.”

 

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The Merger Agreement provides that each share of FNBB common stock issued and outstanding immediately prior to the effective time of the Merger will be canceled and converted into the right to receive 0.98 shares of TriCo common stock (the “Exchange Ratio”), with cash paid in lieu of fractional shares of TriCo common stock.

Based on the closing price of TriCo common stock of $41.64 on December 8, 2017, the consideration value was $40.81 per share of FNBB common stock or approximately $315.3 million in aggregate. The value of the merger consideration will fluctuate until closing based on the value of TriCo’s stock and subject to a trading collar in certain circumstances. Upon consummation of the Merger, the shareholders of FNBB will own approximately 24% of the combined company.

The consummation of the Merger is subject to a number of conditions, which include: (i) the approval of the Merger Agreement by FNBB’s shareholders and the approval of the Merger Agreement and the issuance of shares of TriCo common stock by TriCo’s shareholders; (ii) as of the closing of the Merger, FNBB shall have tangible common equity of not less than $119.0 million, subject to credit for certain merger-related expenses and certain assumptions and adjustments that are set forth in the Merger Agreement; (iii) the receipt of all necessary regulatory approvals for the Proposed Transaction, without the imposition of conditions or requirements that the TriCo Board of Directors reasonably determines in good faith would, individually or in the aggregate, materially reduce the economic benefits of the Proposed Transaction; (iv) the absence of any regulation, judgment, decree, injunction or other order of a governmental authority which prohibits the consummation of the Proposed Transaction or which prohibits or makes illegal the consummation of the Proposed Transaction; (v) the effective registration of the shares of TriCo Common Stock to be issued to FNBB’s shareholders with the Securities and Exchange Commission (the “SEC”) and the approval of such shares for listing on the Nasdaq Global Select Market; (vi) all representations and warranties made by TriCo and FNBB in the Merger Agreement must remain true and correct, except for certain inaccuracies that would not have, or would not reasonably be expected to have, a material adverse effect; and (vii) TriCo and FNBB must have performed their respective obligations under the Merger Agreement in all material respects.

Acquisition of Three Branch Offices and Deposits from Bank of America

On March 18, 2016, the Bank completed its acquisition of three branch banking offices from Bank of America originally announced October 28, 2015. The acquired branches are located in Arcata, Eureka and Fortuna in Humboldt County on the North Coast of California, and have significant overlap compared to the Company’s then-existing Northern California customer base and branch locations. As a result, these branch acquisitions create potential cost savings and future growth potential. With the levels of capital at the time, the acquisitions fit well into the Company’s growth strategy. Also on March 18, 2016, the electronic customer service and other data processing systems of the acquired branches were converted into the Bank’s systems, and the effect of revenue and expenses from the operations of the acquired branches are included in the results of the Company. The Bank paid a premium of $3,204,000 for deposit relationships with balances of $161,231,000 and loans with balances of $289,000, and received cash of $159,520,000 from Bank of America.

The assets acquired and liabilities assumed in the acquisition of these branches were accounted for in accordance with ASC 805 “Business Combinations,” using the acquisition method of accounting and were recorded at their estimated fair values on the March 18, 2016 acquisition date, and the results of operations of the acquired branches are included in the Company’s consolidated statements of income since that date. The excess of the fair value of consideration transferred over total identifiable net assets was recorded as goodwill. The goodwill arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of the Company and the acquired branches. $849,000 of the goodwill is deductible for income tax purposes because the acquisition was accounted for as a purchase of assets and assumption of liabilities for tax purposes.

See Note 2 in the financial statements at Item 8 of this report for a discussion about this transaction.

Other Activities

The Bank may in the future engage in other businesses either directly or indirectly through subsidiaries acquired or formed by the Bank subject to regulatory constraints. See “Regulation and Supervision.”

Employees

At December 31, 2017, the Company employed 1,023 persons, including six executive officers. Full time equivalent employees were 985. No employees of the Company are presently represented by a union or covered under a collective bargaining agreement. Management believes that its employee relations are good.

 

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Competition

The banking business in California generally, and in the Bank’s primary service area of Northern and Central California specifically, is highly competitive with respect to both loans and deposits. It is dominated by a relatively small number of national and regional banks with many offices operating over a wide geographic area. Among the advantages such major banks have over the Bank is their ability to finance wide ranging advertising campaigns and to allocate their investment assets to regions of high yield and demand. By virtue of their greater total capitalization such institutions have substantially higher lending limits than does the Bank.

In addition to competing with other banks, the Bank competes with savings institutions, credit unions and the financial markets for funds. Yields on corporate and government debt securities and other commercial paper may be higher than on deposits, and therefore affect the ability of commercial banks to attract and hold deposits. Commercial banks also compete for available funds with money market instruments and mutual funds. During past periods of high interest rates, money market funds have provided substantial competition to banks for deposits and they may continue to do so in the future. Mutual funds are also a major source of competition for savings dollars.

The Bank relies substantially on local promotional activity, personal contacts by its officers, directors, employees and shareholders, extended hours, personalized service and its reputation in the communities it services to compete effectively.

Regulation and Supervision

General

The Company and the Bank are subject to extensive regulation under both federal and state law. This regulation is intended primarily for the protection of depositors, the FDIC deposit insurance fund and the banking system as a whole, and not for the protection of shareholders of the Company. Set forth below is a summary description of the significant laws and regulations applicable to the Company and the Bank. The description is qualified in its entirety by reference to the applicable laws and regulations.

Regulatory Agencies

The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. As a bank holding company, the Company is regulated under the BHC Act, and is subject to supervision, regulation and examination by the FRB. The Company is also under the jurisdiction of the SEC and is subject to the disclosure and regulatory requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934, each administered by the SEC. The Company’s common stock is listed on the Nasdaq Global Select market (“Nasdaq”) under the trading symbol “TCBK” and the Company is, therefore, subject to the rules of Nasdaq for listed companies.

The Bank, as a state chartered bank, is subject to broad federal regulation and oversight extending to all its operations by the FDIC and to state regulation by the DBO.

The Dodd-Frank Act created the Consumer Financial Protection Bureau (the “CFPB”) as an independent entity with broad rulemaking, supervisory and enforcement authority over consumer financial products and services. The CFPB’s functions include investigating consumer complaints, rulemaking, supervising and examining bank consumer transactions, and enforcing rules related to consumer financial products and services. CFPB regulations and guidance apply to all financial institutions, including the Bank. Banks with $10 billion or more in assets are subject to examination by the CFPB. Banks with less than $10 billion in assets, including the Bank, continue to be examined for compliance with federal consumer laws by their primary federal banking agency.

The Bank Holding Company Act

The Company is registered as a bank holding company under the BHC Act. In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the FRB has determined to be so closely related to banking as to be a proper incident thereto. As a bank holding company, TriCo is required to file reports with the FRB and the FRB periodically examines the Company. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary bank and, under appropriate circumstances, to commit resources to support the subsidiary bank. Qualified bank holding companies that elect to be financial holding companies may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity or (ii) complementary to a financial activity, and that does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as determined solely by the FRB). Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and agency, and making merchant banking investments. The Company has not elected to become a financial holding company.

 

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The BHC Act, the Bank Merger Act, and other federal and state statutes regulate acquisitions of commercial banks. The BHC Act requires the prior approval of the FRB for the direct or indirect acquisition of more than 5 percent of the voting shares of a commercial bank or its parent holding company. Under the Bank Merger Act, the prior approval of an acquiring bank’s primary federal regulator is required before it may merge with another bank or purchase the assets or assume the deposits of another bank. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the applicant’s performance record under the Community Reinvestment Act, consumer compliance, fair housing laws and the effectiveness of the subject organizations in combating money laundering activities.

Safety and Soundness Standards

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) implemented certain specific restrictions on transactions and required the regulators to adopt overall safety and soundness standards for depository institutions related to internal control, loan underwriting and documentation, and asset growth. Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, the use of brokered deposits and the aggregate extension of credit by a depository institution to an executive officer, director, principal stockholder or related interest, and reduces deposit insurance coverage for deposits offered by undercapitalized institutions for deposits by certain employee benefits accounts.

Section 39 to the Federal Deposit Insurance Act requires the agencies to establish safety and soundness standards for insured financial institutions covering:

 

    internal controls, information systems and internal audit systems;

 

    loan documentation;

 

    credit underwriting;

 

    interest rate exposure;

 

    asset growth;

 

    compensation, fees and benefits;

 

    asset quality, earnings and stock valuation; and

 

    excessive compensation for executive officers, directors or principal shareholders which could lead to material financial loss.

If an agency determines that an institution fails to meet any standard established by the guidelines, the agency may require the financial institution to submit to the agency an acceptable plan to achieve compliance with the standard. If the agency requires submission of a compliance plan and the institution fails to timely submit an acceptable plan or to implement an accepted plan, the agency must require the institution to correct the deficiency. An institution must file a compliance plan within 30 days of a request to do so from the institution’s primary federal regulatory agency. The agencies may elect to initiate enforcement action in certain cases rather than rely on an existing plan particularly where failure to meet one or more of the standards could threaten the safe and sound operation of the institution.

Restrictions on Dividends and Distributions

A California corporation such as TriCo may make a distribution to its shareholders to the extent that either the corporation’s retained earnings meet or exceed the amount of the proposed distribution or the value of the corporation’s assets exceed the amount of its liabilities plus the amount of shareholders preferences, if any, and certain other conditions are met. It is the FRB’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.

The primary source of funds for payment of dividends by TriCo to its shareholders has been and will be the receipt of dividends and management fees from the Bank. TriCo’s ability to receive dividends from the Bank is limited by applicable state and federal law. Under the California Financial Code, funds available for cash dividend payments by a bank are restricted to the lesser of: (i) retained earnings or (ii) the bank’s net income for its last three fiscal years (less any distributions to shareholders made during such period). However, with the prior approval of the Commissioner of the DBO, a bank may pay cash dividends in an amount not to exceed the greatest of the: (1) retained earnings of the bank; (2) net income of the bank for its last fiscal year; or (3) net income of the bank for its current fiscal year. However, if the DBO finds that the shareholders’ equity of the bank is not adequate or that the payment of a dividend would be unsafe or unsound, the Commissioner may order the bank not to pay a dividend to shareholders.

Additionally, under FDICIA, a bank may not make any capital distribution, including the payment of dividends, if after making such distribution the bank would be in any of the “undercapitalized” categories under the FDIC’s Prompt Corrective Action regulations. A bank is undercapitalized for this purpose if its leverage ratios, Tier 1 risk-based capital level and total risk-based capital ratio are not at least four percent, four percent and eight percent, respectively.

 

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The FRB, FDIC and the DBO have authority to prohibit a bank holding company or a bank from engaging in practices which are considered to be unsafe and unsound. Depending on the financial condition of TriCo and the Bank and other factors, the FRB, FDIC or the DBO could determine that payment of dividends or other payments by TriCo or the Bank might constitute an unsafe or unsound practice.

The Community Reinvestment Act

The Community Reinvestment Act of 1977 (“CRA”) requires the federal banking regulatory agencies to periodically assess a bank’s record of helping meet the credit needs of its entire community, including low- and moderate-income neighborhoods. The CRA also requires the agencies to consider a financial institution’s record of meeting its community credit when evaluating applications for, among other things, domestic branches and mergers or acquisitions. The federal banking agencies rate depository institutions’ compliance with the CRA. The ratings range from a high of “outstanding” to a low of “substantial noncompliance.” A less than “satisfactory” rating could result in the suspension of any growth of the Bank through acquisitions or opening de novo branches until the rating is improved. As of its most recent CRA examination, the Bank’s CRA rating was “Satisfactory.”

Consumer Protection Laws

The Bank is subject to many federal consumer protection statues and regulations, some of which are discussed below.

 

    The Equal Credit Opportunity Act generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.

 

    The Truth-in-Lending Act is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably.

 

    The Fair Housing Act regulates many practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status.

 

    The Home Mortgage Disclosure Act, which includes a “fair lending” aspect, requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes.

 

    The Real Estate Settlement Procedures Act requires lenders to provide borrowers with disclosures regarding the nature and cost of real estate settlements and prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts.

In addition, the CFPB has taken a number of actions that may affect the Bank’s operations and compliance costs, including the following:

 

    The issuance of final rules for residential mortgage lending, which became effective January 10, 2013, including definitions for “qualified mortgages” and detailed standards by which lenders must satisfy themselves of the borrower’s ability to repay the loan and revised forms of disclosure under the Truth in Lending Act and the Real Estate Settlement Procedures Act

 

    The issuance of a policy report on arbitration clauses which could result in the restriction or prohibition of lenders including arbitration clauses in consumer financial services contracts.

 

    Actions taken to regulate and supervise credit bureaus and debt collections.

 

    Positions taken by CFPB on fair lending, including applying the disparate impact theory in auto financing, which could make it harder for lenders, such as the Bank, to charge different rates or apply different terms to loans to different customers.

Penalties for violations of the above laws may include fines, reimbursements, injunctive relief and other penalties.

Data Privacy and Cyber Security Regulation

The Company is subject to many U.S. federal, state and international laws and regulations governing requirements for maintaining policies and procedures to protect the non-public confidential information of customers and employees. The privacy provisions of the Gramm-Leach-Bliley Act generally prohibit financial institutions, including the Company, from disclosing nonpublic personal financial information of consumer customers to third parties for certain purposes (primarily marketing) unless customers have the opportunity to “opt out” of the disclosure. Other laws and regulations, at the international, federal and state level, limit the Company’s ability to share certain information with affiliates and non-affiliates for marketing and/or non-marketing purposes, or to contact customers with marketing offers. The Gramm-Leach-Bliley Act

 

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also requires banks to implement a comprehensive information security program that includes administrative, technical and physical safeguards to ensure the security and confidentiality of customer records and information.

Regulatory Capital Requirements

The Company and the Bank are subject to the minimum capital requirements of the FDIC and the FRB, respectively. Capital requirements may have an effect on the Company’s and the Bank’s profitability and ability to pay dividends. If the Company or the Bank lacks adequate capital to increase its assets without violating the minimum capital requirements or if it forced to reduce the level of its assets in order to satisfy regulatory capital requirements, its ability to generate earnings would be reduced.

The Company’s and the Bank’s primary federal regulators, the FRB and the FDIC, have adopted guidelines utilizing a risk-based capital structure. Under the risk-based capital rules applicable through December 31, 2014, banking organizations were required to maintain minimum ratios of Tier 1 capital and total capital to total risk- weighted assets (including certain off- balance sheet items, such as letters of credit). Qualifying capital is divided into two tiers. Tier 1 capital consists generally of common stockholders’ equity, retained earnings, qualifying noncumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual preferred stock (at the holding company level) and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and certain other intangible assets. Tier 2 capital consists of, among other things, allowance for loan and lease losses up to 1.25% of weighted risk assets, other perpetual preferred stock, hybrid capital instruments, perpetual debt, mandatory convertible debt, subordinated debt and intermediate-term preferred stock, subject to limitations. Tier 2 capital qualifies as part of total capital up to a maximum of 100% of Tier 1 capital. Under these risk-based capital guidelines, the Company is required to maintain total capital equal to at least 8% of its assets, of which at least 4% must be in the form of Tier 1 capital. In addition, the Bank is subject to minimum capital ratios under the regulatory framework for prompt corrective action discussed below under “— Prompt Corrective Action.”

The Company and the Bank are also required to maintain a minimum leverage ratio of 4% of Tier 1 capital to total assets (the “leverage ratio”). The leverage ratio is determined by dividing an institution’s Tier 1 capital by its quarterly average total assets, less goodwill and certain other intangible assets. The minimum leverage ratio constitutes a minimum requirement for the most well-run banking organizations. See Note 29 in the financial statements at Item 8 of this report for a discussion about the Company’s risk-based capital and leverage ratios.

In July, 2013, the federal banking agencies approved new capital rules implementing the “Basel III” regulatory capital reforms and other changes required by the Dodd-Frank Act. “Basel III” refers to capital guidelines adopted by the Basel Committee on Banking Supervision, which is a committee of central banks and bank supervisors/regulators from the major industrialized countries. The new capital rules include new risk-based capital and leverage ratios, which are being phased in from 2015 to 2019, and which refine the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Company and the Bank as of January 1, 2015 under the new capital rules included: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from previous rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The new capital rules also establish a “capital conservation buffer” above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The capital conservation buffer is to be phased-in over four years beginning on January 1, 2016, as follows: The buffer will be 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. This will result in the following minimum ratios beginning in 2019 (inclusive of the buffer): (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. Under the new capital rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its common equity capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

The new capital rules provide regulators discretion to impose an additional capital buffer, the “countercyclical buffer,” of up to 2.5% of common equity Tier 1 capital to take into account the macro-financial environment and periods of excessive credit growth. However, the countercyclical buffer only applies to larger banks with $250 billion or more in total assets or $10 billion or more in total foreign exposures and is not expected to have an impact on the Company or the Bank.

The new capital rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments including trust preferred securities that will no longer qualify as Tier 1 capital, some of which will be phased out over time. However, the new capital rules provide that depository institution holding companies with less than $15 billion in total assets as of December 31, 2009, such as the Company, will be able to continue to include non-qualifying instruments that were issued and included in Tier 1 capital prior to May 19, 2010, such as the Company’s Trust Preferred Securities, as Tier 1. This treatment is grandfathered and will apply even if the Company exceeds $15 billion assets due to organic growth. However, if the Company exceeds $15 billion in assets as the result of a merger or acquisition, then the Tier 1 treatment of its outstanding trust preferred securities will be phased out but may still be treated as Tier 2 capital.

 

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The new capital rules also include changes for the calculation of risk-weighted assets, which are being phased in beginning January 1, 2015. The new capital rules utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets.

We believe that we were in compliance with the requirements applicable to us as set forth in the new capital rules as of December 31, 2017.

Prompt Corrective Action

Prompt Corrective Action regulations of the federal bank regulatory agencies establish five capital categories in descending order (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized), assignment to which depends upon the institution’s total risk-based capital ratio, Tier 1 risk-based capital ratio, and leverage ratio. The new capital rules revised the prompt corrective action framework. Under the new prompt corrective action framework, which implements the new capital rules, insured depository institutions will be required to meet the following increased capital level requirements in order to qualify as “well capitalized:” (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8% (increased from 6%); (iii) a total capital ratio of 10% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 5% (increased from 4%). Institutions classified in one of the three undercapitalized categories are subject to certain mandatory and discretionary supervisory actions, which include increased monitoring and review, implementation of capital restoration plans, asset growth restrictions, limitations upon expansion and new business activities, requirements to augment capital, restrictions upon deposit gathering and interest rates, replacement of senior executive officers and directors, and requiring divestiture or sale of the institution. The Bank’s capital levels have exceeded the amounts necessary to be considered well capitalized under the current regulatory framework for prompt corrective action since its adoption.

Deposit Insurance

Deposit accounts in the Bank are insured by the FDIC, generally up to a maximum of $250,000 per separately insured depositor. The Bank pays deposit insurance assessments based on its consolidated total assets less tangible equity capital. The assessment rate is based on the risk category of the institution. To determine the total base assessment rate, the FDIC first establishes an institution’s initial base assessment rate and then adjusts the initial base assessment based upon an institution’s levels of unsecured debt, secured liabilities, and brokered deposits. The total base assessment rate ranges from 2.5 to 45 basis points of the institution’s average consolidated total assets less tangible equity capital.

The Bank is generally unable to control the amount of premiums that it is required to pay for FDIC insurance. If there are additional bank or financial institution failures or if the FDIC otherwise determines, the Bank may be required to pay even higher FDIC premiums than the recently increased levels. Increases in FDIC insurance premiums may have a material and adverse effect on the Company’s earnings and could have a material adverse effect on the value of, or market for, the Company’s common stock.

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 the Bank would also result in the revocation of the Bank’s charter by the DBO.

Interstate Branching

The Dodd-Frank Act authorized national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely.

Anti-Money Laundering Laws

A series of banking laws and regulations beginning with the bank Secrecy Act in 1970 requires banks to prevent, detect, and report illicit or illegal financial activities to the federal government to prevent money laundering, international drug trafficking, and terrorism. Under the USA Patriot Act of 2001, financial institutions are subject to prohibitions against specified financial transactions and account relationships, requirements regarding the Customer Identification Program, as

 

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well as enhanced due diligence and “know your customer” standards in their dealings with high risk customers, foreign financial institutions, and foreign individuals and entities.

Transactions with Affiliates

Banks are also subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to executive officers, directors, principal shareholders (including the Company) or any related interest of such persons. Extensions of credit must be made on substantially the same terms, including interest rates and collateral as, and follow credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with persons not affiliated with the bank, and must not involve more than the normal risk of repayment or present other unfavorable features. Banks are also subject to certain lending limits and restrictions on overdrafts to such persons. Regulation W requires that certain transactions between the Bank and its affiliates, including its holding company, be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving nonaffiliated companies or, in the absence of comparable transactions, on terms and under circumstances, including credit standards, that in good faith would be offered to or would apply to nonaffiliated companies.

 

Impact of Monetary Policies

Banking is a business that depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and other borrowings, and the interest rate earned by banks on loans, securities and other interest-earning assets comprises the major source of banks’ earnings. Thus, the earnings and growth of banks are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the FRB. The FRB implements national monetary policy, such as seeking to curb inflation and combat recession, by its open-market dealings in United States government securities, by adjusting the required level of reserves for financial institutions subject to reserve requirements and through adjustments to the discount rate applicable to borrowings by banks which are members of the FRB. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits and also affect interest rates. The nature and timing of any future changes in such policies and their impact on the Company cannot be predicted. In addition, adverse economic conditions could make a higher provision for loan losses a prudent course and could cause higher loan loss charge-offs, thus adversely affecting the Company’s net earnings.

ITEM 1A. RISK FACTORS

There are a number of factors that may adversely affect the Company’s business, financial results, or stock price. Information concerning additional risk factors related to the proposed merger of the Company and FNB Bancorp is available in the Company’s registration statement on Form S-4 SEC to be filed with the SEC. In analyzing whether to make or continue holding an investment in the Company, investors should consider, among other factors, the following:

Risks Related to the Nature and Geographic Area of Our Business

We are exposed to risks in connection with the loans we make.

As a lender, we face a significant risk that we will sustain losses because borrowers, guarantors and related parties may fail to perform in accordance with the terms of the loans we make or acquire. Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. We have underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that we believe appropriately address this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our respective loan portfolios. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect our results of operations. We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner.

Our allowance for loan losses may not be adequate to cover actual losses.

Like other financial institutions, we maintain an allowance for loan losses to provide for loan defaults and non-performance. Our allowance for loan losses may not be adequate to cover actual loan losses, and future provisions for loan losses would reduce our earnings and could materially and adversely affect our business, financial condition, results of operations and cash flows. The allowance for loan losses reflects our estimate of the probable incurred losses in our loan portfolio at the relevant balance sheet date. Our allowance for loan losses is based on prior experience, as well as an evaluation of the known risks in the current portfolio, composition and growth of the loan portfolio and economic factors. Determining an appropriate level of loan loss allowance is an inherently difficult process and is based on numerous assumptions. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, that may be beyond our control and these losses may exceed current estimates. Federal and state regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses. While we believe that our allowance for loan losses is

 

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adequate to cover current losses, we cannot assure you that we will not increase the allowance for loan losses further or that the allowance will be adequate to absorb loan losses we actually incur. Either of these occurrences could have a material adverse effect on our business, financial condition and results of operations.

 

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Our business may be adversely affected by business conditions in northern and central California.

We conduct most of our business in northern and central California. As a result of this geographic concentration, our financial results may be impacted by economic conditions in California. Deterioration in the economic conditions in California could result in the following consequences, any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows:

 

    problem assets and foreclosures may increase,

 

    demand for our products and services may decline,

 

    low cost or non-interest bearing deposits may decrease, and

 

    collateral for loans made by us, especially real estate, may decline in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with our existing loans.

In view of the concentration of our operations and the collateral securing our loan portfolio in both northern and central California, we may be particularly susceptible to the adverse effects of any of these consequences, any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

A significant majority of the loans in our portfolio are secured by real estate and a downturn in our real estate markets could hurt our business.

A downturn in our real estate markets in which we conduct our business in California could hurt our business because most 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. As real estate prices decline, the value of real estate collateral securing our loans is reduced. As a result, our ability to recover on defaulted loans by foreclosing and selling the real estate collateral could then be diminished and we would be more likely to suffer losses on defaulted loans. As of December 31, 2017, approximately 91.9% of the book value of our loan portfolio consisted of loans collateralized by various types of real estate. Substantially all of our real estate collateral is located in California. So if there is a significant adverse decline in real estate values in California, the collateral for our loans will provide less security. Real estate values could also be affected by, among other things, earthquakes, drought and national disasters in our markets. Any such downturn could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We depend 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. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, 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 our senior management team of Messrs. Smith, Bailey, Carney, Fleshood, O’Sullivan and Reddish, who have expertise in banking and collective experience in the California markets we serve and have targeted for future expansion. We also depend upon a number of other key executives who are California natives or are long-time residents and who are integral to implementing our business plan. The loss of the services of any one of our senior executive management team or other key executives could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We are exposed to the 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. 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 may be required to investigate or clean-up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, 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 cash flows could be materially adversely affected.

Strong competition in California could hurt our profits.

Competition in the banking and financial services industry is intense. Our profitability depends upon our continued ability to successfully compete. We primarily compete in northern and central California for loans, deposits and

 

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customers with commercial banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage firms and Internet-based marketplace lending platforms. In particular, our competitors include major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous locations and mount extensive promotional and advertising campaigns. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions may have larger lending limits which would allow them to serve the credit needs of larger customers. 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. Technological innovation continues to contribute to greater competition in domestic and international financial services markets as technological advances enable more companies, such as Internet-based marketplace lenders, to provide financial services, often without many of regulatory and capital restrictions that we face. We also face competition from out-of-state financial intermediaries that have opened loan production offices or that solicit deposits in our market areas. If we are unable to attract and retain banking customers, we may be unable to continue our loan growth and level of deposits and our business, financial condition, results of operations and cash flows may be adversely affected.

Our previous results may not be indicative of our future results.

We may not be able to sustain our historical rate of growth and level of profitability or may not even be able to grow our business or continue to be profitable at all. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit our ability to expand our market presence and financial performance. If we experience a significant decrease in our historical rate of growth, our results of operations and financial condition may be adversely affected due to a high percentage of our operating costs being fixed expenses.

We may be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral that we hold cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to us. Any such losses could have a material adverse effect on our financial condition and results of operations.

Severe weather, natural disasters and other external events could adversely affect our business.

Our operations and our customer base are primarily located in northern and central California where natural and other disasters may occur. These regions are known for being vulnerable to natural disasters and other risks, such as earthquakes, fires, droughts and floods, the nature and severity of which may be impacted by climate change. These types of natural catastrophic events have at times disrupted the local economies, our business and customers in these regions. Such events could also affect the stability of the Bank’s deposit base; impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans and cause significant property damage, result in losses of revenue and/or cause us to incur additional expenses. In addition, catastrophic events occurring in other regions of the world may have an impact on our customers and in turn, on us. Our business continuity and disaster recovery plans may not be successful upon the occurrence of one of these scenarios, and a significant catastrophic event anywhere in the world could materially adversely affect our operating results.

The impacts of recent tax reform are not yet fully known, and these and other tax regulations could be subject to potential legislative, administrative or judicial changes or interpretations.

The tax reform bill enacted on December 22, 2017 has had, and is expected to continue to have, far-reaching and significant effects on us, our customers and the U.S. economy. The tax reform bill lowered the corporate federal statutory tax rate and eliminated or limited certain federal corporate deductions. It is too early to evaluate all of the potential consequences of the tax reform bill, but such consequences could include lower commercial customer borrowings, either due to the increase in cash flows as a result of the reduction in the corporate statutory tax rate or the utilization by businesses in certain sectors of alternative non-debt financing and/or early retirement of existing debt. Further, there can be no assurance that any benefits realized by us as a result of the reduction in the corporate federal statutory tax rate will ultimately result in increased net income, whether due to decreased loan yields as a result of competition or to other factors. Uncertainty also exists related to state and other taxing jurisdictions’ response to federal tax reform, which will continue to be monitored and evaluated.

Federal income tax treatment of corporations may be further clarified and modified by other legislative, administrative or judicial changes or interpretations at any time. Any such changes could adversely affect us.

 

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Market and Interest Rate Risk

Fluctuations in interest rates could reduce our profitability and affect the value of our assets.

Like other financial institutions, we are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and leases and investments, and interest paid on deposits and borrowings. We expect that we will periodically experience imbalances in the interest rate sensitivities of our assets and liabilities and the relationships of various interest rates to each other. Over any defined period of time, our interest-earning assets may be more sensitive to changes in market interest rates than our interest-bearing liabilities, or vice-versa. In addition, the individual market interest rates underlying our loan and lease and deposit products may not change to the same degree over a given time period. If market interest rates should move contrary to our position, earnings may be negatively affected. In addition, loan and lease volume and quality and deposit volume and mix can be affected by market interest rates as can the businesses of our clients. Changes in levels of market interest rates could have a material adverse effect on our net interest spread, asset quality, origination volume, and overall profitability.

Market interest rates are beyond our control, and they fluctuate in response to general economic conditions and the policies of various governmental and regulatory agencies, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, may negatively affect our ability to originate loans and leases, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately could affect our earnings.

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

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. 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. Although we were successful in generating new loans during 2017, the continuation of historically low long-term interest rate levels may cause additional refinancing of commercial real estate and 1-4 family residence loans, which may depress our loan volumes or cause rates on loans to decline. In addition, an increase in the general level of short-term interest rates on variable rate loans may adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations or reduce the amount they wish to borrow. Additionally, if short-term market rates rise, in order to retain existing deposit customers and attract new deposit customers we may need to increase rates we pay on deposit accounts. Accordingly, changes in levels of market interest rates could materially and adversely affect our net interest spread, asset quality, loan origination volume, business, financial condition, results of operations and cash flows.

Regulatory Risks

Recently enacted financial reform legislation has, among other things, created a new Consumer Financial Protection Bureau, tightened capital standards and resulted in new laws and regulations that are expected to increase our costs of operations.

The Dodd-Frank Act, which was enacted in 2010, significantly changed the current bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. Among other things, the Dodd-Frank Act created a new Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks with $10 billion or less in assets, such as the Bank, are subject to the CFPB’s rules but continue to be examined for compliance with the consumer laws by their primary bank regulators. In addition, the Dodd-Frank Act required the FDIC and FRB to adopt new, more stringent capital rules that apply to us. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.

It is difficult to predict the continuing impact that the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.

 

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We operate in a highly regulated environment and we may be adversely affected by new laws and regulations or changes in existing laws and regulations. Regulations may prevent or impair our ability to pay dividends, engage in acquisitions or operate in other ways.

We are subject to extensive regulation, supervision and examination by the DBO, FDIC, and the FRB. See Item 1 - Regulation and Supervision of this report for information on the regulation and supervision which governs our activities. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Banking regulations, designed primarily for the protection of depositors, may limit our growth and the return to our shareholders by restricting certain of our activities, such as:

 

    the payment of dividends to our shareholders,

 

    possible mergers with or acquisitions of or by other institutions,

 

    desired investments,

 

    loans and interest rates on loans,

 

    interest rates paid on deposits,

 

    service charges on deposit account transactions,

 

    the possible expansion of branch offices, and

 

    the ability to provide securities or trust services.

We also are subject to regulatory capital requirements. We could be subject to regulatory enforcement actions if, any of our regulators determines for example, that we have violated a law of regulation, engaged in unsafe or unsound banking practice or lack adequate capital. Federal and state governments and regulators could pass legislation and adopt policies responsive to current credit conditions that would have an adverse effect on the Company and its financial performance. We cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our future business and earnings prospects. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material adverse impact on our operations.

Compliance with changing regulation of corporate governance and public disclosure may result in additional risks and expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Dodd-Frank Act, the Sarbanes-Oxley Act of 2002 and new SEC regulations, are creating additional expense for publicly-traded companies such as the Company. The application of these laws, regulations and standards may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased expenses and a diversion of management time and attention. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding management’s required assessment of its internal control over financial reporting and its external auditors’ audit of our internal control over financial reporting requires, and will continue to require, the commitment of significant financial and managerial resources. Further, the members of our board of directors, members of our audit or compensation and management succession committees, our chief executive officer, our chief financial officer and certain other executive officers could face an increased risk of personal liability in connection with the performance of their duties. It may also become more difficult and more expensive to obtain director and officer liability insurance. As a result, our ability to attract and retain executive officers and qualified board and committee members could be more difficult.

We may be adversely affected by recent changes in U.S. tax laws.

The enactment of the Tax Cuts and Jobs Act (the “TCJA”) on December 22, 2017 made significant changes to the Internal Revenue Code, many of which are highly complex and may require interpretations and implementing regulations. As a result of the TCJA’s reduction of the corporate income tax rate from 35% to 21%, we were required to re-measure our net deferred tax assets and to record a charge to income tax expense in the quarter ended December 31, 2017 of approximately $7.4 million, which amount is subject to refinement in future periods as further information becomes available. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Income Taxes”. Furthermore, we may incur additional meaningful expenses (including professional fees) as the TCJA is implemented, and the expected impact of certain aspects of the statute remains unclear and subject to change.

The TCJA includes a number of provisions that will have an impact on the banking industry, borrowers and the market for residential real estate. These changes include: (i) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans, (ii) the elimination of interest deductions for home equity loans, (iii) a limitation on the deductibility of business interest expense, and (iv) a limitation on the deductibility of property taxes and state and local

 

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income taxes. The TCJA may have an adverse effect on the market for and the valuation of residential properties, as well as on the demand for such loans in the future, and could make it harder for borrowers to make their loan payments. The value of the properties securing loans in our loan portfolio may be adversely impacted as a result of the changing economics of home ownership. Such an impact could require an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations.

Risks Related to Growth and Expansion

Goodwill resulting from acquisitions may adversely affect our results of operations.

Goodwill and other intangible assets have increased substantially as a result of our acquisition of North Valley Bancorp in 2014 and will further increase following our acquisition of FNBB. Potential impairment of goodwill and amortization of other intangible assets could adversely affect our financial condition and results of operations. We assess our goodwill and other intangible assets and long-lived assets for impairment annually and more frequently when required by U.S. GAAP. We are required to record an impairment charge if circumstances indicate that the asset carrying values exceed their fair values. Our assessment of goodwill, other intangible assets, or long-lived assets could indicate that an impairment of the carrying value of such assets may have occurred that could result in a material, non-cash write-down of such assets, which could have a material adverse effect on our results of operations and future earnings.

If we cannot attract deposits, our growth may be inhibited.

We plan to increase the level of our assets, including our loan portfolio. Our ability to increase our assets depends in large part on our ability to attract additional deposits at favorable rates. We intend to seek additional deposits by offering deposit products that are competitive with those offered by other financial institutions in our markets and by establishing personal relationships with our customers. We cannot assure that these efforts will be successful. Our inability to attract additional deposits at competitive rates could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Existing and potential acquisitions may disrupt our business and dilute stockholder value.

On December 11, 2017, we entered into the Merger Agreement providing for our acquisition of FNBB and its wholly-owned subsidiary, First National Bank of Northern California. The Merger is expected to close in the second quarter of 2018, subject to the satisfaction of customary closing conditions, including the receipt of regulatory and shareholder approvals.

The success of the merger will depend on, among other things, our ability to realize the anticipated revenue enhancements and efficiencies and to combine the businesses of the Company and FNBB in a manner that does not materially disrupt the existing customer relationships of FNBB or result in decreased revenues resulting from any loss of customers and that permits growth opportunities to occur. If we are not able to successfully achieve these objectives, the anticipated benefits of the Merger may not be realized fully or at all or may take longer to realize than expected.

The Company and FNBB have operated and, until the completion of the Merger, will continue to operate, independently. It is possible that the integration process could result in the loss of key employees, the disruption of each company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the Merger. Integration efforts between the two companies could also divert management attention and resources.

These integration matters could have an adverse effect on each of the Company and FNBB the transition period and on the combined company following completion of the Merger.

We intend to continue to explore expanding our branch system through opening new bank branches and in-store branches in existing or new markets in northern and central California. In the ordinary course of business, we evaluate potential branch locations that would bolster our ability to cater to the small business, individual and residential lending markets in California. Any given new branch, if and when opened, will have expenses in excess of revenues for varying periods after opening that may adversely affect our results of operations or overall financial condition. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity

 

15


securities may occur at any time. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of our stock’s 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 recent or future acquisitions could have a material adverse effect on our financial condition and results of operations.

We cannot say with any certainty that we will be able to consummate, or if consummated, successfully integrate future acquisitions or that we will not incur disruptions or unexpected expenses in integrating such acquisitions. In attempting to make such future acquisitions, we anticipate competing with other financial institutions, many of which have greater financial and operational resources. Acquiring other banks, businesses, or branches involves various risks commonly associated with acquisitions, including, among other things:

 

    incurring substantial expenses in pursuing potential acquisitions without completing such acquisitions,

 

    exposure to potential asset quality issues of the target company,

 

    losing key clients as a result of the change of ownership,

 

    the acquired business not performing in accordance with our expectations,

 

    difficulties and expenses arising in connection with the integration of the operations of the acquired business with our operations,

 

    difficulty in estimating the value of the target company,

 

    needing to make significant investments and infrastructure, controls, staff, emergency backup facilities or other critical business functions that become strained by our growth,

 

    management needing to divert attention from other aspects of our business,

 

    potentially losing key employees of the acquired business,

 

    incurring unanticipated costs which could reduce our earnings per share,

 

    assuming potential liabilities of the acquired company as a result of the acquisition,

 

    potential changes in banking or tax laws or regulations that may affect the target company,

 

    potential disruption to our business, and

 

    an acquisition may dilute our earnings per share, in both the short and long term, or it may reduce our tangible capital ratios.

Our growth and expansion may strain our ability to manage our operations and our financial resources.

Our financial performance and profitability depend on our ability to execute our corporate growth strategy. In addition to seeking deposit and loan and lease growth in our existing markets, we may pursue expansion opportunities in new markets. Continued growth, however, may present operating and other problems that could adversely affect our business, financial condition, results of operations and cash flows. Accordingly, there can be no assurance that we will be able to execute our growth strategy or maintain the level of profitability that we have recently experienced.

Our growth may place a strain on our administrative, operational and financial resources and increase demands on our systems and controls. This business growth may require continued enhancements to and expansion of our operating and financial systems and controls and may strain or significantly challenge them. In addition, our existing operating and financial control systems and infrastructure may not be adequate to maintain and effectively monitor future growth. Our continued growth may also increase our need for qualified personnel. We cannot assure you that we will be successful in attracting, integrating and retaining such personnel.

Risks Relating to Dividends and Our Common Stock

Our future ability to pay dividends is subject to restrictions.

As a holding company with no significant assets other than the Bank, we depend on dividends from the Bank to fund our operations and for a substantial portion of our revenues. Our ability to continue to pay dividends depends in large part upon our receipt of dividends or other capital distributions from the Bank. The ability of the Bank to pay dividends or make other capital distributions to us is subject to the restrictions in the California Financial Code. As of December 31, 2017, the Bank could have paid approximately $85,254,000 in dividends to TriCo without the prior approval of the DBO. The amount that the Bank may pay in dividends is further restricted due to the fact that the Bank must maintain a certain minimum amount of capital to be considered a “well capitalized” institution as well as a separate capital conservation buffer, as further described under “Item 1 – Supervision and Regulation — Regulatory Capital Requirements” in this report.

 

16


From time to time, we may become a party to financing agreements or other contractual arrangements that have the effect of limiting or prohibiting us or the Bank from declaring or paying dividends. Our holding company expenses and obligations with respect to our trust preferred securities and corresponding junior subordinated deferrable interest debentures issued by us may limit or impair our ability to declare or pay dividends. Finally, our ability to pay dividends is also subject to the restrictions of the California Corporations Code. See “Regulation and Supervision – Restrictions on Dividends and Distributions.”

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 bylaws could delay or prevent a third party from acquiring us, even if doing so might be beneficial to our shareholders. These provisions provide for, among other things, specified actions that the Board of Directors shall or may take when an offer to merge, an offer to acquire all assets or a tender offer is received and the authority to issue preferred stock by action of the board of directors acting alone, without obtaining shareholder approval.

The BHC Act and the Change in Bank Control Act of 1978, as amended, together with federal regulations, require that, depending on the particular circumstances, either FRB approval must be obtained or notice must be furnished to the FRB and not disapproved prior to any person or entity acquiring “control” of a bank holding company such as TriCo. These provisions may prevent a merger or acquisition that would be attractive to shareholders and could limit the price investors would be willing to pay in the future for our common stock.

The amount of common stock owned by, and other compensation arrangements with, our officers and directors may make it more difficult to obtain shareholder approval of potential takeovers that they oppose.

As of December 31, 2017, directors and executive officers beneficially owned approximately 8.9% of our common stock and our Employee Stock Ownership Plan (“ESOP”) owned approximately 5.1%. Agreements with our senior management also provide for significant payments under certain circumstances following a change in control. These compensation arrangements, together with the common stock beneficially owned by our board of directors, management, and the ESOP could make it difficult or expensive to obtain majority support for shareholder proposals or potential acquisition proposals of us that our directors and officers oppose.

We may issue additional common stock or other equity securities in the future which could dilute the ownership interest of existing shareholders.

In order to maintain our capital at desired or regulatory-required levels, or to fund future growth, our board of directors may decide from time to time to issue additional shares of common stock, or securities convertible into, exchangeable for or representing rights to acquire shares of our common stock. The sale of these shares may significantly dilute your ownership interest as a shareholder. New investors in the future may also have rights, preferences and privileges senior to our current shareholders which may adversely impact our current shareholders.

Holders of our junior subordinated debentures have rights that are senior to those of our common stockholders.

We have supported our continued growth through the issuance of trust preferred securities from special purpose trusts and accompanying junior subordinated debentures. At December 31, 2017, we had outstanding trust preferred securities and accompanying junior subordinated debentures with face value of $62,889,000. Payments of the principal and interest on the trust preferred securities are conditionally guaranteed by us. Further, the accompanying junior subordinated debentures we issued to the trusts are senior to our shares of common stock. As a result, we must make payments on the junior subordinated debentures before we can pay any dividends on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the junior subordinated debentures must be satisfied before any distributions can be made on our common stock.

Risks Relating to Systems, Accounting and Internal Controls

If we fail to maintain an effective system of internal and disclosure controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business and the trading price of our securities.

Effective internal control over financial reporting and disclosure controls and procedures are necessary for us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. We continually review and analyze our internal control over financial reporting for Sarbanes-Oxley Section 404 compliance. As part of that process we may discover material weaknesses or significant deficiencies in our internal control as defined under standards adopted by the Public Company Accounting Oversight Board that require remediation. A material weakness is a deficiency, or combination

 

17


of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected in a timely basis. A significant deficiency is a deficiency or combination of deficiencies, in internal control over financial reporting that is less severe than material weakness, yet important enough to merit attention by those responsible for the oversight of the Company’s financial reporting.

As a result of weaknesses that may be identified in our internal controls, we may also identify certain deficiencies in some of our disclosure controls and procedures that we believe require remediation. If we discover weaknesses, we will make efforts to improve our internal and disclosure controls. However, there is no assurance that we will be successful. Any failure to maintain effective controls or timely effect any necessary improvement of our internal and disclosure controls could harm operating results or cause us to fail to meet our reporting obligations, which could affect our ability to remain listed with Nasdaq. Ineffective internal and disclosure controls could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our securities.

We rely on communications, information, operating and financial control systems technology and we may suffer an interruption in or breach of the security of those systems.

We rely heavily on our communications, information, operating and financial control systems technology to conduct our business. We rely on third party services providers to provide many of these systems. Any failure, interruption or breach in security of these systems could result in failures or interruptions in our customer relationship management, general ledger, deposit, servicing and loan origination systems. We cannot assure you that such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed by us or the third parties service providers on which we rely. The occurrence of any failures, interruptions or security breaches could damage our reputation, result in a loss of customers, expose us to possible financial liability, lead to additional regulatory scrutiny or require that we make expenditures for remediation or prevention. Any of these circumstances could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

18


We rely on certain third-party vendors.

We are reliant upon certain third-party vendors to provide products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with applicable contractual arrangements or service level agreements. We maintain a system of policies and procedures designed to monitor vendor risks including, among other things, (i) changes in the vendor’s organizational structure, (ii) changes in the vendor’s financial condition, (iii) changes in existing products and services or the introduction of new products and services, and (iv) changes in the vendor’s support for existing products and services. While we believe these policies and procedures help to mitigate risk, the failure of an external vendor to perform in accordance with applicable contractual arrangements or the service level agreements could be disruptive to our operations, which could have a material adverse effect on our business and our financial condition and results of operations.

Our business is highly reliant on technology and our ability and our third party service providers to manage the operational risks associated with technology.

Our business involves storing and processing sensitive consumer and business customer data. We depend on internal systems, third party service providers, and outsourced technology to support these data storage and processing operations. Despite our efforts to ensure the security and integrity of our systems, we may not be able to anticipate, detect or recognize threats to our systems or those of third party service providers or to implement effective preventive measures against all cyber security breaches. Cyberattack techniques change regularly and can originate from a wide variety of sources, including third parties who are or may be involved in organized crime or linked to terrorist organizations or hostile foreign governments, and such third parties may seek to gain access to systems directly or using equipment or security passwords belonging to employees, customers, third-party service providers or other users of our systems. These risks may increase in the future as we continue to increase our mobile and other internet-based product offerings and expands our internal usage of web-based products and applications. A cyber security breach or cyberattack could persist for a long time before being detected and could result in theft of sensitive data or disruption of our transaction processing systems.

Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operations. A material breach of customer data security may negatively impact our business reputation and cause a loss of customers, result in increased expense to contain the event and/or require that we provide credit monitoring services for affected customers, result in regulatory fines and sanctions and/or result in litigation. Cyber security risk management programs are expensive to maintain and will not protect us from all risks associated with maintaining the security of customer data and our proprietary data from external and internal intrusions, disaster recovery and failures in the controls used by our vendors. In addition, Congress and the legislatures of states in which we operate regularly consider legislation that would impose more stringent data privacy requirements, resulting in increased compliance costs.

A failure to implement technological advances could negatively impact our business.

The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources than we do to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or successfully market such products and services to our customers.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

The Company is engaged in the banking business through 57 traditional branches, 9 in-store branches and 2 loan production offices in 26 counties in northern and central California including twelve offices in Shasta County, eight in Butte County, six in Humboldt County, five in Nevada County, four in Sacramento and Stanislaus Counties, three in Placer and Siskiyou Counties, two each in Fresno, Glenn, Mendocino, Sutter and Trinity Counties, and one each in Colusa, Contra Costa, Del Norte, Kern, Lake, Lassen, Madera, Merced, Sonoma, Tehama, Tulare, Yolo and Yuba Counties. All offices are constructed and equipped to meet prescribed security requirements.

The Company owns twenty-nine branch office locations, one administrative building with a branch location, five administrative buildings, and one other building that it leases out. The Company leases thirty-six branch office locations, two loan production offices, and three administrative locations. Most of the leases contain multiple renewal options and provisions for rental increases, principally for changes in the cost of living index, property taxes and maintenance.

 

19


ITEM 3. LEGAL PROCEEDINGS

On September 15, 2014, a former Personal Banker at one of the Bank’s in-store branches filed a Class Action Complaint against the Bank in Butte County Superior Court, alleging causes of action related to the observance of meal and rest periods and seeking to represent a class of current and former branch employees with the same or similar job duties, employed by the Bank within the State of California during the preceding four years. On or about June 25, 2015, Plaintiff filed an Amended Complaint expanding the class definition to include all current and former non-exempt branch employees employed by the Bank within the State of California at any time during the period of September 15, 2010 to the entry of judgment. The Bank responded to the First Amended Complaint by denying the charges and the parties engaged in written discovery. The parties then engaged in non-binding mediation during the third quarter of 2016.

In addition to this, on January 20, 2015, a then-current Personal Banker at one of the Bank’s in-store branches filed a First Amended Complaint against the Bank and the Company in Sacramento County Superior Court, alleging causes of action related to wage statement violations. As part of the Complaint Plaintiff is seeking to represent a class of current and former exempt and non-exempt employees who worked for the Company and/or the Bank during the time period of December 12, 2013 to the date of filing the action. The Company and the Bank responded to the First Amended Complaint by denying the charges and engaging in written discovery with Plaintiff. The parties then engaged in non-binding mediation of the action during the third quarter of 2016 as well. This matter was transferred to the Butte County Superior Court and consolidated with the case above, effective August 25, 2017.

As part of the mediations, which took place concurrently, the Bank agreed in principal to settle the two matters in a consolidated settlement proceeding. The agreement was preliminarily approved by the court and notices were sent to the members of the purported classes. After reviewing the received claims, on January 12, 2018, the court approved the final settlement agreement on both matters. The total cost to the Bank was $1,469,000, of which $1,450,000 was previously accrued as of December 31, 2017 and 2016. These matters will not be discussed in future filings.

Neither the Company nor its subsidiaries are a party to any other pending legal proceedings that are material, nor is their property the subject of any other material pending legal proceeding at this time. All other legal proceedings are routine and arise out of the ordinary course of the Bank’s business. None of those proceedings are currently expected to have a material adverse impact upon the Company’s and the Bank’s business, their consolidated financial position nor their operations in any material amount not already accrued, after taking into consideration any applicable insurance.

ITEM 4. MINE SAFETY DISCLOSURES

Inapplicable.

 

20


PART II

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

Common Stock Market Prices and Dividends

The Company’s common stock is traded on the Nasdaq under the symbol “TCBK.” The following table shows the high and the low closing sale prices for the common stock for each quarter in the past two years, as reported by Nasdaq:

 

2017:

   High      Low  

Fourth quarter

   $ 43.42      $ 37.86  

Third quarter

   $ 40.75      $ 33.60  

Second quarter

   $ 36.77      $ 33.05  

First quarter

   $ 37.38      $ 32.84  

2016:

     

Fourth quarter

   $ 34.46      $ 25.49  

Third quarter

   $ 28.40      $ 25.40  

Second quarter

   $ 28.90      $ 24.60  

First quarter

   $ 27.44      $ 23.80  

As of February 23, 2018 there were approximately 1,583 shareholders of record of the Company’s common stock. On February 23, 2018, the closing sales price was $38.29.

The Company has paid cash dividends on its common stock in every quarter since March 1990, and it is currently the intention of the Board of Directors of the Company to continue payment of cash dividends on a quarterly basis. There is no assurance, however, that any dividends will be paid since they are dependent upon earnings, financial condition and capital requirements of the Company and the Bank. As of December 31, 2017 $85,254,000 was available for payment of dividends by the Bank to the Company, under applicable laws and regulations. The Company paid cash dividends of $0.17 per common share in each of the quarters ended December 31, 2017, September 30, 2017, June 30, 2017, and $0.15 per common share in each of the quarters ended March 31, 2017, December 31, 2016, September 30, 2016, June 30, 2016, March 31, 2016.

Issuer Repurchases of Common Stock

The Company adopted a stock repurchase plan on August 21, 2007 for the repurchase of up to 500,000 shares of the Company’s common stock from time to time as market conditions allow. The 500,000 shares authorized for repurchase under this plan represented approximately 3.2% of the Company’s approximately 15,815,000 common shares outstanding as of August 21, 2007. This plan has no stated expiration date for the repurchases. As of December 31, 2017, the Company had purchased 166,600 shares under this plan.

The following table shows the repurchases made by the Company or any affiliated purchaser (as defined in Rule 10b-18(a)(3) under the Exchange Act) during the fourth quarter of 2017:

 

Period

   (a) Total number
of shares purchased(1)
   (b) Average price
paid per share
   (c) Total number of
shares purchased as of
part of publicly
announced plans or
programs
   (d) Maximum number
shares that may yet be
purchased under the
plans or programs(2)

Oct. 1-31, 2017

   —      —      —      333,400

Nov. 1-30, 2017

   —      —      —      333,400

Dec. 1-31, 2017

   —      —      —      333,400
  

 

  

 

  

 

  

 

Total

   —      —      —      333,400

 

(1) Includes shares purchased by the Company’s Employee Stock Ownership Plan and pursuant to various other equity incentive plans. See Note 19 to the consolidated financial statements at Item 8 of Part II of this report, for a discussion of the Company’s stock repurchased under equity compensation plans.
(2) Does not include shares that may be purchased by the Company’s Employee Stock Ownership Plan and pursuant to various other equity incentive plans.

 

21


The following graph presents the cumulative total yearly shareholder return from investing $100 on December 31, 2012, in each of TriCo common stock, the Russell 3000 Index, and the SNL Western Bank Index. The SNL Western Bank Index compiled by SNL Financial includes banks located in California, Oregon, Washington, Montana, Hawaii and Alaska with market capitalization similar to that of TriCo’s. The amounts shown assume that any dividends were reinvested.

 

LOGO

 

     Period Ending  

Index

   12/31/12      12/31/13      12/31/14      12/31/15      12/31/16      12/31/17  

TriCo Bancshares

     100.00        172.66        153.12        173.61        220.88        249.10  

Russell 3000 Index

     100.00        133.55        150.32        151.04        170.28        206.26  

SNL Western Bank Index

     100.00        140.70        168.86        174.96        193.96        216.26  

Equity Compensation Plans

The following table shows shares reserved for issuance for outstanding options, stock appreciation rights and warrants granted under our equity compensation plans as of December 31, 2017. All of our equity compensation plans have been approved by shareholders.

 

Plan category

   (a)
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
     (b)
Weighted average
exercise price of
outstanding options,
warrants and rights
     (c) Number of securities
remaining available for
issuance under equity
compensation plans
(excluding securities
reflected in column (a))
 

Equity compensation plans not approved by shareholders

     —          —          —    

Equity compensation plans approved by shareholders

     567,686      $ 16.84        527,039  
  

 

 

    

 

 

    

 

 

 

Total

     567,686      $ 16.84        527,039  

 

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ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data are derived from our consolidated financial statements. This data should be read in connection with our consolidated financial statements and the related notes located at Item 8 of this report.

TRICO BANCSHARES

Financial Summary

(in thousands, except per share amounts)

 

Year ended December 31,

   2017     2016     2015     2014     2013  

Interest income

   $ 181,402     $ 173,708     $ 161,414     $ 121,115     $ 106,560  

Interest expense

     6,798       5,721       5,416       4,681       4,696  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     174,604       167,987       155,998       116,434       101,864  

Provision for (benefit from) loan losses

     89       (5,970     (2,210     (4,045     (715

Noninterest income

     50,021       44,563       45,347       34,516       36,829  

Noninterest expense

     147,024       145,997       130,841       110,379       93,604  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     77,512       72,523       72,714       44,616       45,804  

Provision for income taxes

     36,958       27,712       28,896       18,508       18,405  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 40,554     $ 44,811     $ 43,818     $ 26,108     $ 27,399  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

          

Basic

   $ 1.77     $ 1.96     $ 1.93     $ 1.47     $ 1.71  

Diluted

   $ 1.74     $ 1.94     $ 1.91     $ 1.46     $ 1.69  

Per share:

          

Dividends paid

   $ 0.66     $ 0.60     $ 0.52     $ 0.44     $ 0.42  

Book value at December 31

   $ 22.03     $ 20.87     $ 19.85     $ 18.41     $ 15.61  

Tangible book value at December 31

   $ 19.01     $ 17.77     $ 16.81     $ 15.31     $ 14.59  

Average common shares outstanding

     22,912       22,814       22,750       17,716       16,045  

Average diluted common shares outstanding

     23,250       23,087       22,998       17,923       16,197  

Shares outstanding at December 31

     22,956       22,868       22,775       22,715       16,077  

At December 31:

          

Loans, net of allowance

   $ 2,984,842     $ 2,727,090     $ 2,486,926     $ 2,245,939     $ 1,633,762  

Total assets

     4,761,315       4,517,968       4,220,722       3,916,458       2,744,066  

Total deposits

     4,009,131       3,895,560       3,631,266       3,380,423       2,410,483  

Other borrowings

     122,166       17,493       12,328       9,276       6,335  

Junior subordinated debt

     56,858       56,667       56,470       56,272       41,238  

Shareholders’ equity

     505,808       477,347       452,116       418,172       250,946  

Financial Ratios:

          

For the year:

          

Return on average assets

     0.89     1.02     1.11     0.87     1.04

Return on average equity

     8.10     9.46     10.04     8.67     11.34

Net interest margin1

     4.22     4.23     4.32     4.17     4.18

Net loan losses (recoveries) to average loans

     0.08     (0.09 )%      (0.07 )%      (0.13 )%      0.23

Efficiency ratio2

     64.7     67.9     64.7     72.9     67.3

Average equity to average assets

     10.99     10.84     11.01     10.00     9.21

Dividend payout ratio

     37.3     30.6     27.2     30.1     24.9

At December 31:

          

Equity to assets

     10.62     10.57     10.71     10.68     9.15

Total capital to risk-adjusted assets

     14.07     14.65     15.09     15.63     14.77

 

1  Fully taxable equivalent.
2  Noninterest expense divided by the sum of fully taxable equivalent net interest income and noninterest income.

 

23


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

General

As TriCo Bancshares has not commenced any business operations independent of the Bank, the following discussion pertains primarily to the Bank. Average balances, including such balances used in calculating certain financial ratios, are generally comprised of average daily balances for the Company. Within Management’s Discussion and Analysis of Financial Condition and Results of Operations, interest income and net interest income are generally presented on a fully tax-equivalent (FTE) basis. The presentation of interest income and net interest income on a FTE basis is a common practice within the banking industry. Interest income and net interest income are shown on a non-FTE basis in this Item 7 this report, and a reconciliation of the FTE and non-FTE presentations is provided below in the discussion of net interest income.

Critical Accounting Policies and Estimates

The Company’s discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America (GAAP). The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those that materially affect the financial statements and are related to the adequacy of the allowance for loan losses, investments, mortgage servicing rights, fair value measurements, retirement plans, intangible assets and the fair value of acquired assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company’s policies related to estimates on the allowance for loan losses, other than temporary impairment of investments and impairment of intangible assets, can be found in Note 1 in the financial statements at Item 8 of this report.

Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances for the Company. Within Management’s Discussion and Analysis of Financial Condition and Results of Operations, certain performance measures including interest income, net interest income, net interest yield, and efficiency ratio are generally presented on a fully tax-equivalent (FTE) basis. The Company believes the use of these non-generally accepted accounting principles (non-GAAP) measures provides additional clarity in assessing its results.

On March 18, 2016, the Bank completed its acquisition of three branch banking offices from Bank of America originally announced October 28, 2015. The acquired branches are located in Arcata, Eureka and Fortuna in Humboldt County on the North Coast of California, and have significant overlap compared to the Company’s then-existing Northern California customer base and branch locations. As a result, these branch acquisitions create potential cost savings and future growth potential. With the levels of capital at the time, the acquisitions fit well into the Company’s growth strategy. Also on March 18, 2016, the electronic customer service and other data processing systems of the acquired branches were converted into the Bank’s systems, and the effect of revenue and expenses from the operations of the acquired branches are included in the results of the Company. The Bank paid a premium of $3,204,000 for deposit relationships with balances of $161,231,000 and loans with balances of $289,000, and received cash of $159,520,000 from Bank of America.

The Company refers to loans and foreclosed assets that are covered by loss sharing agreements as “covered loans” and “covered foreclosed assets”, respectively. In addition, the Company refers to loans purchased or obtained in a business combination as “purchased credit impaired” (PCI) loans, or “purchased not credit impaired” (PNCI) loans. The Company refers to loans that it originates as “originated” loans. Additional information regarding the North Valley Bancorp acquisition can be found in Note 2 in the financial statements at Item 8 of this report. Additional information regarding the definitions and accounting for originated, PNCI and PCI loans can be found in Notes 1, 2, 4 and 5 in the financial statements at Item 8 of this report, and under the heading Asset Quality and Non-Performing Assets below.

Geographical Descriptions

For the purpose of describing the geographical location of the Company’s loans, the Company has defined northern California as that area of California north of, and including, Stockton; central California as that area of the State south of Stockton, to and including, Bakersfield; and southern California as that area of the State south of Bakersfield.

 

24


Results of Operations

Overview

The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to the Company and the Bank’s financial condition, operating results, asset and liability management, liquidity and capital resources and should be read in conjunction with the consolidated financial statements of the Company and the related notes at Item 8 of this report. Following is a summary of the components of net income for the periods indicated (dollars in thousands):

 

     Year ended December 31,  
     2017     2016     2015  

Net interest income

   $ 174,604     $ 167,987     $ 155,998  

(Provision for) benefit from reversal of provision for loan losses

     (89     5,970       2,210  

Noninterest income

     50,021       44,563       45,347  

Noninterest expense

     (147,024     (145,997     (130,841

Taxes

     (36,958     (27,712     (28,896
  

 

 

   

 

 

   

 

 

 

Net income

   $ 40,554     $ 44,811     $ 43,818  
  

 

 

   

 

 

   

 

 

 

Net income per average fully-diluted share

   $ 1.77     $ 1.94     $ 1.91  

Net income as a percentage of average shareholders’ equity (ROAE)

     8.10     9.46     10.04

Net income as a percentage of average total assets (ROAA)

     0.89     1.02     1.11
  

 

 

   

 

 

   

 

 

 

The Company uses certain non-GAAP measures to provide supplemental information regarding performance. The Company believes that presenting net income, effective tax rate, return on average assets (ROAA), return on average equity (ROAE), and earnings per common share, excluding the impact of merger & acquisition expenses and the effect of changes in tax rates, provides additional clarity to the users of the financial statements regarding core financial performance. The following table presents a comparison of net income, effective tax rate, ROAA, ROAE, and earnings per common share as reported, and as adjusted for the impact of merger & acquisition expenses and changes in tax rates, for the periods indicated:

 

     Year ended December 31,  
(amounts in thousands, except per share amounts)    2017     2016     2015  

Net income

   $ 40,554     $ 44,811     $ 43,818  

Effect of merger & acquisition expenses

     491       454       340  

Effect of income tax rate change

     7,416       —         —    
  

 

 

   

 

 

   

 

 

 

Adjusted net income

   $ 48,462     $ 45,266     $ 44,158  
  

 

 

   

 

 

   

 

 

 

Income tax expense

   $ 36,958     $ 27,712     $ 28,896  

Effect of non-deductible merger & acquisition expenses

     (184     —         —    

Effect of income tax rate change

     (7,416     —         —    
  

 

 

   

 

 

   

 

 

 

Adjusted income tax expense

   $ 29,358     $ 27,712     $ 28,896  
  

 

 

   

 

 

   

 

 

 

Effective tax rate

     47.7     38.2     39.7

Adjusted effective tax rate

     37.9     38.2     39.7

ROAA

     0.89     1.02     1.11

Adjusted ROAA

     1.06     1.04     1.11

ROAE

     8.10     9.46     10.04

Adjusted ROAE

     9.68     9.55     10.12

Earnings per common share:

      

Basic

   $ 1.77     $ 1.96     $ 1.93  

Diluted

   $ 1.74     $ 1.94     $ 1.91  

Adjusted earnings per common share:

      

Basic

   $ 2.12     $ 1.98     $ 1.94  

Diluted

   $ 2.08     $ 1.96     $ 1.92  

Merger & acquisition expenses

   $ 530     $ 784     $ 586  

Non-deductible merger & acquisition expenses

   $ 438       —         —    

Average assets

   $ 4,554,505     $ 4,373,022     $ 3,963,998  

Average equity

   $ 500,653     $ 473,829     $ 436,301  

Weighted average shares

     22,912       22,814       22,750  

Weighted average diluted shares

     23,250       23,086       22,998  

 

25


Net Interest Income

The Company’s primary source of revenue is net interest income, which is the difference between interest income on earning assets and interest expense on interest-bearing liabilities.

Following is a summary of the Company’s net interest income for the periods indicated (dollars in thousands):

 

     Year ended December 31,  
     2017     2016     2015  

Components of Net Interest Income

      

Interest income

   $ 181,402     $ 173,708     $ 161,414  

Interest expense

     (6,798     (5,721     (5,416
  

 

 

   

 

 

   

 

 

 

Net interest income

     174,604       167,987       155,998  

FTE adjustment

     2,499       2,329       905  
  

 

 

   

 

 

   

 

 

 

Net interest income (FTE)

   $ 177,103     $ 170,316     $ 156,903  
  

 

 

   

 

 

   

 

 

 

Net interest margin (FTE)

     4.22     4.23     4.32
  

 

 

   

 

 

   

 

 

 

Net interest income (FTE) for the year ended December 31, 2017 increased $6,787,000 (4.0%) to $177,103,000 from $170,316,000 during the year ended December 31, 2016. The increase in net interest income (FTE) was due primarily to a $212,930,000 (8.1%) increase in the average balance of loans to $2,842,659,000, and a 9 basis point increase in the average yield on investments–taxable that were partially offset by a 21 basis point decrease in the average yield on loans, and a 3 basis point increase in the average rate paid on interest bearing liabilities. The $212,930,000 increase in average loan balances compared to the prior year was due primarily to net organic (i.e., not purchased) loan growth that was funded by deposit growth and the use of interest bearing cash at banks and other borrowings. The 9 basis point increase in the average yield on investments-taxable was due to increased market rates on investment purchased, and slower prepay speeds on the Company’s mortgage backed securities (“MBS”) investments in 2017 compared to 2016. Slower prepay speeds for MBS investments with net purchase premiums result in higher yields, as was the case for the Company’s MBS investments during 2017 compared to 2016. Accounting for 12 basis points of the 21 point decrease in the average yield on loans from 2016 to 2017 was the recovery of $2,311,000 of loan interest income from the sale of loans in 2016. A decrease in purchased loan discounts accretion accounted for 5 basis points of the 21 point decrease in average loan yield, and the remaining 4 basis point decrease in average loan yield was due primarily to lower average yields on new loans compared to existing loans, primarily during the first half of 2017 that was somewhat alleviated in the second half of 2017 and included the effects of 25 basis point increases in the Federal Funds Rate and the Prime Lending Rate during each of December 2016, and March, June, and December 2017. The 3 basis point increase in the average rate paid on interest-bearing liabilities was due primarily to increased rates paid on time deposits, other borrowings, and junior subordinated debt.

Net interest income (FTE) for the year ended December 31, 2016 increased $13,413,000 (8.6%) to $170,316,000 from $156,903,000 during the year ended December 31, 2015. The increase in net interest income (FTE) was due primarily to a $240,292,000 (10.1%) increase in the average balance of loans to $2,629,729,000, a $140,526,000 (13.4%) increase in the average balance of investments to $1,190,509,000, and a seven basis point increase in the average yield of nontaxable investments from 4.85% during the year ended December 31, 2015 to 4.92% during the year ended December 31, 2016 , that were partially offset by a 15 basis point decrease in the average yield on loans from 5.52% during the year ended December 31, 2015 to 5.37% during the year ended December 31, 2016, and a 15 basis point decrease in the average yield on investments taxable from 2.74% during the year ended December 31, 2015 to 2.59% during the year ended December 31, 2016. The $240,292,000 increase in average loan balances during 2016 compared to 2015 was due primarily to organic loan growth. The $140,526,000 increase in average investment balances during 2016 compared to 2015 was due primarily to investment purchases in excess of investment maturities. The increases in average loan and investment balances during 2016 were funded primarily by a $350,461,000 increase in the average balance of deposits, and a $37,528,000 increase in the average balance of shareholders’ equity during 2016. The $350,461,000 increase in the average balance of deposits during 2016 compared to 2015 included the effect of the purchase of three branches and $161,231,000 of deposits from Bank of America on March 18, 2016. The seven basis point increase in the average yield of investments nontaxable was due to purchases of investments nontaxable with higher average tax-equivalent yields during 2016 compared to the yields on investments nontaxable that the Company owned during 2015. The 15 basis point decrease in average loan yields was due primarily to declines in market yields on new and renewed loans compared to yields on repricing, maturing, and paid off loans. The 15 basis point decrease in the average yield of investments taxable was due to purchases of investments taxable with lower average tax-equivalent yields during 2016 compared to the yields on investments taxable that the Company owned during 2015, and increased amortization of purchase premiums on mortgage backed securities during 2016 compared to 2015. The increased amortization of purchase premiums on mortgage backed securities during 2016 was due primarily to faster prepayment of existing mortgages caused by higher mortgage refinance activity that was caused by reduced mortgage rates during most of 2016 compared to 2015. The increases in average loan and investment balances added $13,264,000 and $5,461,000, respectively, to net interest income (FTE) while the decreases in average loan and investments taxable yields reduced net interest income (FTE) during 2016 by $4,104,000 and $1,602,000, respectively, compared to 2015. The increase in average investments nontaxable yield increased net interest income (FTE) during 2016 by $94,000 compared to 2015. Included in investment interest income during the years ended December 31, 2016 and 2015 were special cash dividend of $578,000 and $626,000, respectively, from the Company’s investment in Federal Home Loan Bank of San Francisco stock.

 

26


Included in loan interest income during the year ended December 31, 2016 was discount accretion from purchased loans of $7,399,000 compared to $10,056,000 during the year ended December 31, 2015. Also included in loan interest income during the year ended December 31, 2016 was interest income of $2,311,000 from the recovery of interest payments previously applied to principal balances of nonperforming loans sold during 2016. Included in loan interest income during the year ended December 31, 2015 was the recovery of $728,000 of loan interest income from the payoff of a single originated loan that was in interest nonaccrual status; and while recoveries of loan interest income from paid off nonaccrual loans occur from time to time, a single recovery of this magnitude is unusual.

For more information related to loan interest income, including loan purchase discount accretion, see the Summary of Average Balances, Yields/Rates and Interest Differential and Note 30 to the consolidated financial statements at Part II, Item 8 of this report. The “Yield” and “Volume/Rate” tables shown below are useful in illustrating and quantifying the developments that affected net interest income during 2017 and 2016.

Summary of Average Balances, Yields/Rates and Interest Differential – Yield Tables

The following tables present, for the periods indicated, information regarding the Company’s consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income from average earning assets and resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual loans only to the extent cash payments have been received and applied to interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income thereon exempt from federal income taxation at the current statutory tax rate (dollars in thousands):

 

     Year ended December 31, 2017  
     Average
balance
     Interest
income/expense
     Rates
earned/paid
 

Assets

        

Loans

   $ 2,842,659      $ 146,794        5.16

Investment securities - taxable

     1,087,302        29,096        2.68

Investment securities - nontaxable

     136,240        6,664        4.89

Cash at Federal Reserve and other banks

     126,432        1,347        1.07
  

 

 

    

 

 

    

Total earning assets

     4,192,633        183,901        4.39
     

 

 

    

Other assets

     361,872        
  

 

 

       

Total assets

   $ 4,554,505        
  

 

 

       

Liabilities and shareholders’ equity

        

Interest-bearing demand deposits

   $ 939,516        744        0.08

Savings deposits

     1,368,705        1,683        0.12

Time deposits

     317,724        1,531        0.48

Other borrowings

     41,252        305        0.74

Junior subordinated debt

     56,762        2,535        4.47
  

 

 

    

 

 

    

Total interest-bearing liabilities

     2,723,959        6,798        0.25
     

 

 

    

Noninterest-bearing demand

     1,262,592        

Other liabilities

     67,301        

Shareholders’ equity

     500,653        
  

 

 

       

Total liabilities and shareholders’ equity

   $ 4,554,505        
  

 

 

       

Net interest spread (1)

           4.14

Net interest income and interest margin (2)

      $ 177,103        4.22
     

 

 

    

 

 

 

 

(1) Net interest spread represents the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by dividing net interest income by total average earning assets.

 

27


Summary of Average Balances, Yields/Rates and Interest Differential – Yield Tables (continued)

 

     Year ended December 31, 2016  
     Average
balance
     Interest
income/expense
     Rates
earned/paid
 

Assets

        

Loans

   $ 2,629,729      $ 141,086        5.37

Investment securities - taxable

     1,064,410        27,578        2.59

Investment securities - nontaxable

     126,099        6,210        4.92

Cash at Federal Reserve and other banks

     205,263        1,163        0.57
  

 

 

    

 

 

    

Total earning assets

     4,025,501        176,037        4.37
     

 

 

    

Other assets

     347,521        
  

 

 

       

Total assets

   $ 4,373,022        
  

 

 

       

Liabilities and shareholders’ equity

        

Interest-bearing demand deposits

   $ 878,436        441        0.05

Savings deposits

     1,344,304        1,685        0.13

Time deposits

     342,511        1,357        0.40

Other borrowings

     18,873        9        0.05

Junior subordinated debt

     56,566        2,229        3.94
  

 

 

    

 

 

    

Total interest-bearing liabilities

     2,640,690        5,721        0.22
     

 

 

    

Noninterest-bearing demand

     1,193,297        

Other liabilities

     65,206        

Shareholders’ equity

     473,829        
  

 

 

       

Total liabilities and shareholders’ equity

   $ 4,373,022        
  

 

 

       

Net interest spread (1)

           4.15

Net interest income and interest margin (2)

      $ 170,316        4.23
     

 

 

    

 

 

 

 

     Year ended December 31, 2015  
     Average
balance
     Interest
income/expense
     Rates
earned/paid
 

Assets

        

Loans

   $ 2,389,437      $ 131,836        5.52

Investment securities - taxable

     1,000,221        27,421        2.74

Investment securities - nontaxable

     49,762        2,414        4.85

Cash at Federal Reserve and other banks

     189,506        648        0.34
  

 

 

    

 

 

    

Total earning assets

     3,628,926        162,319        4.47
     

 

 

    

Other assets

     335,072        
  

 

 

       

Total assets

   $ 3,963,998        
  

 

 

       

Liabilities and shareholders’ equity

        

Interest-bearing demand deposits

   $ 808,281        476        0.06

Savings deposits

     1,183,201        1,475        0.12

Time deposits

     340,443        1,482        0.44

Other borrowings

     8,668        4        0.05

Junior subordinated debt

     56,345        1,979        3.51
  

 

 

    

 

 

    

Total interest-bearing liabilities

     2,396,938        5,416        0.23
     

 

 

    

Noninterest-bearing demand

     1,076,162        

Other liabilities

     54,597        

Shareholders’ equity

     436,301        
  

 

 

       

Total liabilities and shareholders’ equity

   $ 3,963,998        
  

 

 

       

Net interest spread (1)

           4.24

Net interest income and interest margin (2)

      $ 156,903        4.32
     

 

 

    

 

 

 

 

(1) Net interest spread represents the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities.
(2) Net interest margin is computed by dividing net interest income by total average earning assets.

 

28


Summary of Changes in Interest Income and Expense due to Changes in Average Asset and Liability Balances and Yields Earned and Rates Paid – Volume/Rate Tables

The following table sets forth a summary of the changes in the Company’s interest income and interest expense from changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. The rate/volume variance has been included in the rate variance. Amounts are calculated on a fully taxable equivalent basis:

 

     2017 over 2016     2016 over 2015  
     Volume     Yield/
Rate
    Total     Volume      Yield/
Rate
    Total  
     (dollars in thousands)  

Increase (decrease) in interest income:

             

Loans

   $ 11,434     $ (5,726   $ 5,708     $ 13,264      $ (4,014   $ 9,250  

Investments - taxable

     593       925       1,518       1,759        (1,602     157  

Investments - nontaxable

     499       (45     454       3,702        94       3,796  

Cash at Federal Reserve and other banks

     (449     633       184       54        461       515  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total

     12,077       (4,213     7,864       18,779        (5,061     13,718  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Increase (decrease) in interest expense:

             

Demand deposits (interest-bearing)

     31       272       303       42        (77     (35

Savings deposits

     32       (34     (2     193        17       210  

Time deposits

     (99     273       174       9        (135     (126

Other borrowings

     11       285       296       5        —         5  

Junior subordinated debt

     8       298       306       8        243       251  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total

     (17     1,094       1,077       257        48       305  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Increase (decrease) in net interest income

   $ 12,094     $ (5,307   $ 6,787     $ 18,522      $ (5,109   $ 13,413  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Provision for Loan Losses

The provision for loan losses during any period is the sum of the allowance for loan losses required at the end of the period and any loan charge offs during the period, less the allowance for loan losses required at the beginning of the period, and less any loan recoveries during the period. See the Tables labeled “Allowance for loan losses – year ended December 31, 2017 and 2016” at Note 5 in Item 8 of Part II of this report for the components that make up the provision for loan losses for the years ended December 31, 2017 and 2016.

The Company provided $89,000 for loan losses during the year ended December 31, 2017 versus a $5,970,000 reversal of provision for loan losses during the year ended December 31, 2016. The increase in provision for loan losses for the year ended December 31, 2017 compared to the year ended December 31, 2016 was due primarily to an increase of $4,266,000 (21.2%) in nonperforming loans during 2017 compared to a $16,991,000 (45.8%) decrease in nonperforming loans during 2016, and net charge-offs of $2,269,000 during 2017 compared to net recoveries of $2,462,000 during 2016. As shown in the Table labeled Allowance for Loan Losses - year ended December 31, 2017 at Note 5 in Item 8 of Part II of this report residential and commercial real estate loans, home equity lines of credit, home equity loans, and commercial construction loans experienced a reversal of provision for loan losses during the year ended December 31, 2017. The level of provision, or reversal of provision, for loan losses of each loan category during the year ended December 31, 2017 was due primarily to a decrease in the required allowance for loan losses as of December 31, 2017 when compared to the required allowance for loan losses as of December 31, 2016 less net charge-offs during the year ended December 31, 2017. All categories of loans except C & I loans experienced a decrease in the required allowance for loan losses during the year ended December 31, 2017. These decreases in required allowance for loan losses were due primarily to improvements in estimated cash flows and collateral values for impaired loans, and reductions in historical loss factors that were offset by increases in loan balances and nonperforming loans in some loan categories. For details of the change in nonperforming loans during the year ended December 31, 2017 see the Tables, and associated narratives, labeled Changes in nonperforming assets during the year ended December 31, 2017 and Changes in nonperforming assets during the three months ended December 31, September 30, June 30, and March 31, 2017 under the heading Asset Quality and Non-Performing Assets” below.

The Company benefited from a $5,970,000 reversal of provision for loan losses during the year ended December 31, 2016 versus a $2,210,000 reversal of provision for loan losses during the year ended December 31, 2015. The increase in the reversal of provision for loan losses for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily the result of an increase in net loan recoveries from 0.07% of average loans during 2015 to 0.09% of average loans during 2016, a decrease in nonperforming loans from $37,119,000 at December 31, 2015 to $20,128,000 at December 31, 2016, continued improvement in loan portfolio loss history, and improvements in collateral values and estimated cash flows related to nonperforming loans and purchased credit impaired loans. As shown in the Table labeled “Allowance for

 

29


Loan Losses - year ended December 31, 2016” at Note 5 in Item 8 of Part II of this report, residential real estate loans, home equity lines of credit, home equity loans, and commercial construction loans experienced a reversal of provision for loan losses during the year ended December 31, 2016. The level of provision, or reversal of provision, for loan losses of each loan category during the year ended December 31, 2016 was due primarily to a decrease in the required allowance for loan losses as of December 31, 2016 when compared to the required allowance for loan losses as of December 31, 2015 less net charge-offs during the year ended December 31, 2016. All categories of loans except commercial real estate mortgage loans, C & I loans, and residential construction loans experienced a decrease in the required allowance for loan losses during the year ended December 31, 2016. These decreases in required allowance for loan losses were due primarily to reduced impaired loans, improvements in estimated cash flows and collateral values for the remaining and newly impaired loans, and reductions in historical loss factors that, in part, determine the required loan loss allowance for performing loans in accordance with the Company’s allowance for loan losses methodology as described under the heading “Loans and Allowance for Loan Losses” at Note 1 in Item 8 of Part II of this report. These same factors were also present, to some extent, for commercial real estate mortgage loans, C & I loans, and residential construction loans, but were more than offset by the effect of increased loan balances in these loan categories resulting in net provisions for loan losses in these categories during the year ended December 31, 2016.

The provision for loan losses related to Originated and PNCI loans is based on management’s evaluation of inherent risks in these loan portfolios and a corresponding analysis of the allowance for loan losses. The provision for loan losses related to PCI loan portfolio is based on changes in estimated cash flows expected to be collected on PCI loans. Additional discussion on loan quality, our procedures to measure loan impairment, and the allowance for loan losses is provided under the heading “Asset Quality and Non-Performing Assets” below.

Management re-evaluates the loss ratios and other assumptions used in its calculation of the allowance for loan losses for its Originated and PNCI loan portfolios on a quarterly basis and makes changes as appropriate based upon, among other things, changes in loss rates experienced, collateral support for underlying loans, changes and trends in the economy, and changes in the loan mix. Management also re-evaluates expected cash flows used in its accounting for its PCI loan portfolio, including any required allowance for loan losses, on a quarterly basis and makes changes as appropriate based upon, among other things, changes in loan repayment experience, changes in loss rates experienced, and collateral support for underlying loans.

Noninterest Income

The following table summarizes the Company’s noninterest income for the periods indicated (dollars in thousands):

 

     Years Ended December 31,  
     2017      2016      2015  

Service charges on deposit accounts

   $ 16,056      $ 14,365      $ 14,276  

ATM and interchange fees

     16,727        15,859        13,364  

Other service fees

     3,282        3,121        2,977  

Mortgage banking service fees

     2,076        2,065        2,164  

Change in value of mortgage servicing rights

     (718      (2,184      (701
  

 

 

    

 

 

    

 

 

 

Total service charges and fees

     37,423        33,226        32,080  
  

 

 

    

 

 

    

 

 

 

Gain on sale of loans

     3,109        4,037        3,064  

Commissions on sale of non-deposit investment products

     2,729        2,329        3,349  

Increase in cash value of life insurance

     2,685        2,717        2,786  

Gain on sale of investments

     961        —          —    

Lease brokerage income

     782        711        712  

Gain on sale of foreclosed assets

     711        262        991  

Change in indemnification asset

     490        (493      (207

Sale of customer checks

     372        408        492  

Life insurance benefit in excess of cash value

     108        238        155  

Loss on disposal of fixed assets

     (142      (147      (129

Other

     793        1,275        2,054  
  

 

 

    

 

 

    

 

 

 

Total other noninterest income

     12,598        11,337        13,267  
  

 

 

    

 

 

    

 

 

 

Total noninterest income

   $ 50,021      $ 44,563      $ 45,347  
  

 

 

    

 

 

    

 

 

 

Noninterest income increased $5,458,000 (12.2%) to $50,021,000 in 2017 compared to 2016. The increase in noninterest income was due primarily to an increase in service charges on deposit accounts of $1,691,000 (11.8%) to $16,056,000, an increase in ATM fees and interchange revenue of $868,000 (5.5%) to $16,727,000, an increase of $1,466,000 in change in value of mortgage servicing rights, a $961,000 increase in gain on sale of investments, which were partially offset by a $928,000 (23.0%) decrease in gain on sale of loans, and a $482,000 (37.8%) decrease in other noninterest income. The $1,691,000 increase in service charges on deposit accounts was due primarily to increased fee generation from both consumer and business checking customers. The $868,000 increase in ATM fees and interchange revenue was due primarily to the Company’s continued focus in this area, and growth in electronic payments volume. The $1,466,000 improvement in change in value of mortgage servicing rights (MSRs) was due primarily to a decrease in the market rate of return for such servicing

 

30


rights thus increasing their value at December 31, 2017 compared to December 31, 2016. The $961,000 gain on sale of investment securities was due to the Company’s decision to sell $24,796,000 of investment securities during the three months ended September 30, 2017 while no investment sales were made during 2016. The $983,000 increase in change in indemnification agreement was the result of the termination of its indemnification agreements with the FDIC during 2017. The $928,000 decrease in gain on sale of loans was due primarily to reduced residential mortgage refinance activity in 2017 compared to 2016.

Noninterest income decreased $784,000 (1.7%) to $44,563,000 in 2016 compared to 2015. The decrease in noninterest income was due primarily to $870,000 of recoveries of loans from acquired institutions that were charged off prior to acquisition of those institutions by the Company that were recorded in other noninterest income during the year ended December 31, 2015, a $1,483,000 decrease in change in value of mortgage servicing rights, a $1,020,000 decrease in commissions on sale of nondeposit investment products, and a $729,000 decrease in gain on sale of foreclosed assets that were partially offset by a $2,495,000 increase in ATM fees and interchange income and a $973,000 increase in gain on sale of loans. The decrease in change in value of mortgage servicing rights (MSRs) is primarily due to a change in the required rate of return on MSRs by market participants and a decrease in estimated future MSR cash flows as a result of reduced mortgage rates and higher rates of early mortgage payoffs from mortgage refinancing, both of which reduced the value of such MSRs during the year ended December 31, 2016 compared to a smaller decrease in the value of MSRs during the year ended December 31, 2015 that was primarily due to a decrease in estimated future MSR cash flows as a result of reduced mortgage rates and higher rates of early mortgage payoffs from mortgage refinancing. The decrease in gain on sale of foreclosed assets was due to decreased foreclosed asset sales during the year ended December 31, 2016, and the uniqueness of individual foreclosed asset sales when compared to the year-ago period. The $2,495,000 increase in ATM fees and interchange revenue was primarily due to the Company’s increased focus in this area, including the introduction of new services in this area during the quarter ended March 31, 2016. The $973,000 increase in gain on sale of loans was due to continued high levels of refinance and home purchase activity, and increased focus in this area by the Company. The $4,037,000 of gain on sale of loans during 2016 included $3,729,000 of gain on sale of residential real estate loans originated for sale, and $308,000 of gain on sale of loans not originated for sale. The changes in noninterest income include the effects from the operation of three branches, including $161,231,000 of deposits, acquired from Bank of America on March 18, 2016.

Noninterest Expense

The following table summarizes the Company’s other noninterest expense for the periods indicated (dollars in thousands):

 

The components of noninterest expense were as follows (in thousands):    Years Ended December 31,  
     2017      2016      2015  

Base salaries, net of deferred loan origination costs

   $ 54,589      $ 53,169      $ 46,822  

Incentive compensation

     9,227        8,872        6,964  

Benefits and other compensation costs

     19,114        18,683        17,619  
  

 

 

    

 

 

    

 

 

 

Total salaries and benefits expense

     82,930        80,724        71,405  
  

 

 

    

 

 

    

 

 

 

Occupancy

     10,894        10,139        10,126  

Data processing and software

     10,448        8,846        7,670  

Equipment

     7,141        6,597        5,997  

ATM & POS network charges

     4,752        4,999        4,190  

Advertising

     4,101        3,829        3,992  

Professional fees

     3,745        5,409        4,545  

Telecommunications

     2,713        2,749        3,007  

Assessments

     1,676        2,105        2,572  

Operational losses

     1,394        1,564        737  

Intangible amortization

     1,389        1,377        1,157  

Postage

     1,296        1,603        1,296  

Courier service

     1,035        998        1,154  

Change in reserve for unfunded commitments

     445        244        330  

Foreclosed assets expense

     231        266        490  

Provision for foreclosed asset losses

     162        140        502  

Legal settlement

     —          1,450        —    

Merger & acquisition expense

     530        784        586  

Miscellaneous other

     12,142        12,174        11,085  
  

 

 

    

 

 

    

 

 

 

Total other noninterest expense

     64,094        65,273        59,436  
  

 

 

    

 

 

    

 

 

 

Total noninterest expense

   $ 147,024      $ 145,997      $ 130,841  
  

 

 

    

 

 

    

 

 

 

 

31


Merger and acquisition expense:

      

Base salaries, net of loan origination costs

     —       $ 187       —    

Data processing and software

     —         —       $ 108  

Professional fees

   $ 513       342       120  

Other

     17       255       358  
  

 

 

   

 

 

   

 

 

 

Total merger expense

   $ 530     $ 784     $ 586  
  

 

 

   

 

 

   

 

 

 

Average full time equivalent staff

     1,000       999       949  

Noninterest expense to revenue (FTE)

     64.7     67.9     64.7

Salary and benefit expenses increased $2,206,000 (2.7%) to $82,930,000 during the year ended December 31, 2017 compared to the year ended December 31, 2016. Base salaries, incentive compensation and benefits & other compensation expense increased $1,420,000 (2.7%), 355,000 (4.0%), and 431,000 (2.3%), respectively, to $54,589,000, $9,227,000 and $19,114,000, respectively, during the year ended December 31, 2017. The increases in these categories of salary and benefits expense are primarily due to annual merit increases. The average number of full-time equivalent staff increased 1 (0.1%) from 999 during the year ended December 31, 2016 to 1,000 for the year ended December 31, 2017.

Salary and benefit expenses increased $9,319,000 (13.1%) to $80,724,000 during the year ended December 31, 2016 compared to the year ended December 31, 2015. Base salaries, incentive compensation and benefits & other compensation expense increased $6,347,000 (13.6%), 1,908,000 (27.4%), and 1,064,000 (6.0%), respectively, to $53,169,000, $8,872,000 and $18,683,000, respectively, during the year ended December 31, 2016. The average number of full-time equivalent staff increased 50 (5.3%) from 949 during the year ended December 31, 2015 to 999 for the year ended December 31, 2016. The increase in base salaries was due primarily to annual pay raises, an increase in average full-time equivalent staff, and a $1,409,000 increase in temporary help expense from $63,000 during 2015 to $1,472,000 during 2016. The increase in temporary help expense was due primarily to an expansion of the Bank’s customer call center capacity during 2016. All categories of incentive compensation expense increased during 2016 compared to 2015 due to related production and profitability measures, and the general increase in staff, except for commissions on sale of nondeposit investment products for which production was down compared to 2015. The increase in benefits and other compensation expense was due primarily to the increase in full-time equivalent staff during 2016.

Other noninterest expense decreased $1,179,000 (1.8%) to $64,094,000 during the year ended December 31, 2017 compared to the year ended December 31, 2016. The decrease in other noninterest expense was due primarily to a $1,664,000 (30.8%) decrease in professional fees, and a $1,450,000 decrease in litigation contingent liability expense, that were partially offset by a $1,602,000 (18.1%) increase in data processing and software expense, a $755,000 (7.4%) increase in occupancy expense, and a $544,000 (8.2%) increase in equipment expense. The $1,664,000 decrease in professional fees was due primarily to consulting fees related to system conversions during 2016. The $1,450,000 decrease in litigation contingent liability expense was due to a single specific liability incurred during 2016. The $1,602,000 increase in data processing and software expense was due primarily to data system outsourcing and enhancements that occurred throughout 2016, and early 2017. The $755,000 increase in occupancy expense was due primarily to increases in building maintenance and remodel, and lease expense. The $544,000 increase in equipment expense was due primarily to increased depreciation expense related to technology and other equipment, and furniture.

Other noninterest expense increased $5,837,000 (9.8%) to $65,273,000 during the year ended December 31, 2016 compared to the year ended December 31, 2015. The increase in other noninterest expense was primarily due to system conversion and capacity expansion expenses during 2016. Expense categories including equipment, data processing and software, ATM & POS network charges and professional (consulting) experienced significant increases due primarily to system conversion and capacity expansion during 2016. The Company recorded a litigation contingency expense of $1,450,000 during 2016. The details of this contingency can be found at Note 18 in Item 8 of Part II of this report. Assessments expense decrease $467,000 (18.2%) to $2,105,000 during 2016 compared to $2,572,000 during 2015 due to a decrease in FDIC insurance premiums during the three months ended September 30, 2016. Nonrecurring expenses related to the acquisition of three branches from Bank of America in March 2016 totaling $784,000 and the acquisition of North Valley Bancorp in October 2014 are included in other noninterest expense for the years ended December 31, 2016 and 2015, respectively. Included in miscellaneous other noninterest expense during 2016 were $782,000 valuation allowance expenses on fixed assets transferred to held for sale including a $716,000 valuation allowance expense related to a closed branch building held for sale, the value of which was written down to current market value, and subsequently sold during the three months ended September 30, 2016. Net proceeds from the sale of this building were $1,218,000, and resulted in no gain or additional loss being recorded upon the sale of this building.

 

32


Income Taxes

On December 22, 2017, President Donald Trump signed into law “H.R.1”, commonly known as the “Tax Cuts and Jobs Act”, which among other items reduces the Federal corporate tax rate from 35% to 21% effective January 1, 2018. While this decrease in the Federal corporate tax rate is expected to have a positive impact on the Company’s net income beginning January 1, 2018, the enactment of the law during 2017 required the Company to re-measure its deferred tax assets and liabilities. The Company concluded that this caused the Company’s net deferred tax asset to be reduced, and Federal income tax expense to be increased by $7,416,000 during the fourth quarter of 2017. Additionally, amortization expense of the low income housing tax credit investments was accelerated by $226,000.

The provisions for income taxes applicable to income before taxes for the years ended December 31, 2017, 2016 and 2015 differ from amounts computed by applying the statutory Federal income tax rates to income before taxes. The effective tax rate and the statutory federal income tax rate are reconciled as follows:

 

     Years Ended December 31,  
     2017     2016     2015  

Federal statutory income tax rate

     35.0     35.0     35.0

State income taxes, net of federal tax benefit

     6.9       6.8       6.6  

Tax Cuts and Jobs Act impact on deferred measurement

     9.6       —         —    

Tax-exempt interest on municipal obligations

     (1.9     (1.8     (0.7

Tax-exempt life insurance related income

     (1.3     (1.3     (1.3

Equity compensation

     (1.2     —         —    

Low income housing tax credit benefits

     (2.3     (1.3     (0.4

Low income housing tax credit amortization

     2.1       0.8       —    

Non-deductible joint beneficiary agreement expense

     0.1       0.1       0.1  

Non-deductible merger expense

     0.2       —         —    

Other

     0.5       (0.1     0.4  
  

 

 

   

 

 

   

 

 

 

Effective Tax Rate

     47.7     38.2     39.7
  

 

 

   

 

 

   

 

 

 

The effective tax rate on income was 47.7%, 38.2%, and 39.7% in 2017, 2016, and 2015, respectively. The effective tax rate was greater than the Federal statutory tax rate due to State tax expense of $8,178,000, $7,576,000, and $7,412,000, respectively, in these years, and a $7,416,000 Federal tax expense in 2017 due to the re-measurement of the Company’s net deferred tax asset resulting from the Federal tax law change that occurred in December; and were partially offset by Federal tax-exempt investment income of $4,165,000, $3,881,000, and $1,509,000, respectively, Federal and State tax-exempt income of $2,792,000, $2,955,000, and $2,786,000, respectively, from increase in cash value and gain on death benefit of life insurance, low income housing tax credits of $142,000, $197,000, and $0, respectively, and equity compensation excess tax benefits of $906,000, $0, and $0, respectively. The low income housing tax credits and the equity compensation excess tax benefits represent direct reductions in tax expense. The items noted above resulted in an effective combined Federal and State income tax rate that differed from the combined Federal and State statutory income tax rate of approximately 42.0% during 2017, 2016, and 2015. Based on the Tax Cuts and Jobs Act, the Company expects its combined statutory income tax rate to be 29.6%.

Financial Condition

Investment Securities

The following table presents the available for sale investment securities portfolio by major type as of the dates indicated:

 

     Year ended December 31,  
(In thousands)    2017      2016      2015      2014      2013  

Investment securities available for sale (at fair value):

              

Obligations of US government corporations and agencies

   $ 604,789      $ 429,678      $ 313,682      $ 75,120      $ 97,143  

Obligations of states and political subdivisions

     123,156        117,617        88,218        3,175        5,589  

Corporate bonds

     —          —          —          1,908        1,915  

Marketable equity securities

     2,938        2,938        2,985        3,002        —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities available for sale

   $ 730,883      $ 550,233      $ 404,885      $ 83,205      $ 104,647  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Investment securities available for sale increased $180,650,000 to $730,883,000 as of December 31, 2017, compared to December 31, 2016. This increase is attributable to purchases of $265,806,000, maturities and principal repayments of $63,942,000, sales of investments with a cost basis of $24,796,000, a net increase in the fair value of investments securities available for sale of $5,461,000, and amortization of net purchase price premiums of $1,879,000.

 

33


The following table presents the held to maturity investment securities portfolio by major type as of the dates indicated:

 

     Year ended December 31,  
(In thousands)    2017      2016      2015      2014      2013  

Investment securities held to maturity (at cost):

              

Obligations of US government corporations and agencies

   $ 500,271      $ 597,982      $ 711,994      $ 660,836      $ 227,864  

Obligations of states and political subdivisions

     14,573        14,554        14,536        15,590        12,640  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities held to maturity

   $ 514,844      $ 602,536      $ 726,530      $ 676,426      $ 240,504  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Investment securities held to maturity decreased $87,692,000 to $514,844,000 as of December 31, 2017, compared to December 31, 2016. This decrease is attributable to principal repayments of $86,371,000 and amortization of net purchase price discounts/premiums of $1,321,000.

Additional information about the investment portfolio is provided in Note 3 in the financial statements at Item 8 of Part II of this report.

Restricted Equity Securities

Restricted equity securities were $16,956,000 at December 31, 2017 and December 31, 2016. The entire balance of restricted equity securities at December 31, 2017 and December 31, 2016 represents the Bank’s investment in the Federal Home Loan Bank of San Francisco (“FHLB”).

FHLB stock is carried at par and does not have a readily determinable fair value. While technically these are considered equity securities, there is no market for the FHLB stock. Therefore, the shares are considered as restricted investment securities. Management periodically evaluates FHLB stock for other-than-temporary impairment. Management’s determination of whether these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (4) the liquidity position of the FHLB.

As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets, or FHLB advances. The Bank may request redemption at par value of any stock in excess of the minimum required investment. Stock redemptions are at the discretion of the FHLB.

Loans

The Bank concentrates its lending activities in four principal areas: real estate mortgage loans (residential and commercial loans), consumer loans, commercial loans (including agricultural loans), and real estate construction loans. The interest rates charged for the loans made by the Bank vary with the degree of risk, the size and maturity of the loans, the borrower’s relationship with the Bank and prevailing money market rates indicative of the Bank’s cost of funds.

The majority of the Bank’s loans are direct loans made to individuals, farmers and local businesses. The Bank relies substantially on local promotional activity and personal contacts by bank officers, directors and employees to compete with other financial institutions. The Bank makes loans to borrowers whose applications include a sound purpose, a viable repayment source and a plan of repayment established at inception and generally backed by a secondary source of repayment.

Loan Portfolio Composite

The following table shows the Company’s loan balances, including net deferred loan fees, at the dates indicated:

 

     Year ended December 31,  
(dollars in thousands)    2017      2016      2015      2014      2013  

Real estate mortgage

   $ 2,300,322      $ 2,057,824      $ 1,811,832      $ 1,615,359      $ 1,107,863  

Consumer

     356,874        362,303        395,283        417,084        383,163  

Commercial

     220,412        217,047        194,913        174,945        131,878  

Real estate construction

     137,557        122,419        120,909        75,136        49,103  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans, net of fees

   $ 3,015,165      $ 2,759,593      $ 2,522,937      $ 2,282,524      $ 1,672,007  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

34


The following table shows the Company’s loan balances, including net deferred loan fees, as a percentage of total loans at the dates indicated:

 

     Year ended December 31,  
     2017     2016     2015     2014     2013  

Real estate mortgage

     76.3     74.6     71.8     70.7     66.3

Consumer

     11.8     13.1     15.7     18.3     22.9

Commercial

     7.3     7.9     7.7     7.7     7.9

Real estate construction

     4.6     4.4     4.8     3.3     2.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, net of fees

     100.0     100.0     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

At December 31, 2017 loans, including net deferred loan costs, totaled $3,015,165,000 which was a 9.3% ($255,572,000) increase over the balances at the end of 2016. Demand for all categories of loans was strong to moderate during 2017.

At December 31, 2016 loans, including net deferred loan costs, totaled $2,759,593,000 which was a 9.4% ($236,656,000) increase over the balances at the end of 2015. Demand for commercial real estate (real estate mortgage) loans was strong during 2016. Demand for residential mortgage loans was strong during 2016. Demand for home equity loans and lines of credit was moderate during 2016.

At December 31, 2015 loans, including net deferred loan costs, totaled $2,522,937,000 which was a 10.5% ($240,413,000) increase over the balances at the end of 2014. Demand for commercial real estate (real estate mortgage) loans was strong during 2015. Demand for home equity loans and lines of credit was weak during 2015.

Asset Quality and Nonperforming Assets

Nonperforming Assets

Loans originated by the Company, i.e., not purchased or acquired in a business combination, are referred to as originated loans. Originated loans are reported at the principal amount outstanding, net of deferred loan fees and costs. Loan origination and commitment fees and certain direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loan’s yield over the actual life of the loan. Originated loans on which the accrual of interest has been discontinued are designated as nonaccrual loans.

Originated loans are placed in nonaccrual status when reasonable doubt exists as to the full, timely collection of interest or principal, or a loan becomes contractually past due by 90 days or more with respect to interest or principal and is not well secured and in the process of collection. When an originated loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loan is estimated to be fully collectible as to both principal and interest.

An allowance for loan losses for originated loans is established through a provision for loan losses charged to expense. Originated loans and deposit related overdrafts are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely or, with respect to consumer installment loans, according to an established delinquency schedule. The allowance is an amount that management believes will be adequate to absorb probable losses inherent in existing loans and leases, based on evaluations of the collectability, impairment and prior loss experience of loans and leases. The evaluations take into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. The Company defines an originated loan as impaired when it is probable the Company will be unable to collect all amounts due according to the original contractual terms of the loan agreement. Impaired originated loans are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. As a practical expedient, impairment may be measured based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance.

In situations related to originated loans where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). The Company strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where the Company grants the borrower new terms that result in the loan being classified as a TDR, the Company measures any impairment on the restructuring as noted above for impaired loans. TDR loans are classified as impaired until they are fully paid off or charged off. Loans that are in nonaccrual status at the time they become TDR loans, remain in nonaccrual status

 

35


until the borrower demonstrates a sustained period of performance which the Company generally believes to be six consecutive months of payments, or equivalent. Otherwise, TDR loans are subject to the same nonaccrual and charge-off policies as noted above with respect to their restructured principal balance.

Credit risk is inherent in the business of lending. As a result, the Company maintains an allowance for loan losses to absorb losses inherent in the Company’s originated loan portfolio. This is maintained through periodic charges to earnings. These charges are included in the Consolidated Statements of Income as provision for loan losses. All specifically identifiable and quantifiable losses are immediately charged off against the allowance. However, for a variety of reasons, not all losses are immediately known to the Company and, of those that are known, the full extent of the loss may not be quantifiable at that point in time. The balance of the Company’s allowance for originated loan losses is meant to be an estimate of these unknown but probable losses inherent in the portfolio.

The Company formally assesses the adequacy of the allowance for originated loan losses on a quarterly basis. Determination of the adequacy is based on ongoing assessments of the probable risk in the outstanding originated loan portfolio, and to a lesser extent the Company’s originated loan commitments. These assessments include the periodic re-grading of credits based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment, growth of the portfolio as a whole or by segment, and other factors as warranted. Loans are initially graded when originated. They are re-graded as they are renewed, when there is a new loan to the same borrower, when identified facts demonstrate heightened risk of nonpayment, or if they become delinquent. Re-grading of larger problem loans occurs at least quarterly. Confirmation of the quality of the grading process is obtained by independent credit reviews conducted by consultants specifically hired for this purpose and by various bank regulatory agencies.

The Company’s method for assessing the appropriateness of the allowance for originated loan losses includes specific allowances for impaired originated loans and leases, formula allowance factors for pools of credits, and allowances for changing environmental factors (e.g., interest rates, growth, economic conditions, etc.). Allowance factors for loan pools were based on historical loss experience by product type and prior risk rating.

Loans purchased or acquired in a business combination are referred to as acquired loans. Acquired loans are valued as of acquisition date in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Topic 805, Business Combinations. Loans acquired with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are referred to as purchased credit impaired (PCI) loans. PCI loans are accounted for under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. Under FASB ASC Topic 805 and FASB ASC Topic 310-30, PCI loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. Fair value is defined as the present value of the future estimated principal and interest payments of the loan, with the discount rate used in the present value calculation representing the estimated effective yield of the loan. Default rates, loss severity, and prepayment speed assumptions are periodically reassessed and our estimate of future payments is adjusted accordingly. The difference between contractual future payments and estimated future payments is referred to as the nonaccretable difference. The difference between estimated future payments and the present value of the estimated future payments is referred to as the accretable yield. The accretable yield represents the amount that is expected to be recorded as interest income over the remaining life of the loan. If after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be more than the originally estimated, an increase in the discount rate (effective yield) would be made such that the newly increased accretable yield would be recognized, on a level yield basis, over the remaining estimated life of the loan. If, after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be less than the previously estimated, the discount rate would first be reduced until the present value of the reduced cash flow estimate equals the previous present value however, the discount rate may not be lowered below its original level at acquisition. If the discount rate has been lowered to its original level and the present value has not been sufficiently lowered, an allowance for loan loss would be established through a provision for loan losses charged to expense to decrease the present value to the required level. If the estimated cash flows improve after an allowance has been established for a loan, the allowance may be partially or fully reversed depending on the improvement in the estimated cash flows. Only after the allowance has been fully reversed may the discount rate be increased. PCI loans are put on nonaccrual status when cash flows cannot be reasonably estimated. PCI loans on nonaccrual status are accounted for using the cost recovery method or cash basis method of income recognition. PCI loans are charged off when evidence suggests cash flows are not recoverable. Foreclosed assets from PCI loans are recorded in foreclosed assets at fair value with the fair value at time of foreclosure representing cash flow from the loan. ASC 310-30 allows PCI loans with similar risk characteristics and acquisition time frame to be “pooled” and have their cash flows aggregated as if they were one loan. The Company elected to use the “pooled” method of ASC 310-30 for PCI – other loans in the acquisition of certain assets and liabilities of Granite Community Bank, N.A. (“Granite”) in 2010 and Citizens Bank of Northern California (“Citizens”) in 2011.

Acquired loans that are not PCI loans are referred to as purchased not credit impaired (PNCI) loans. PNCI loans are accounted for under FASB ASC Topic 310-20, Receivables – Nonrefundable Fees and Other Costs, in which interest income is accrued on a level-yield basis for performing loans. For income recognition purposes, this method assumes that all

 

36


contractual cash flows will be collected, and no allowance for loan losses is established at the time of acquisition. Post-acquisition date, an allowance for loan losses may need to be established for acquired loans through a provision charged to earnings for credit losses incurred subsequent to acquisition. Under ASC 310-20, the loss would be measured based on the probable shortfall in relation to the contractual note requirements, consistent with our allowance for loan loss policy for similar loans.

When referring to PNCI and PCI loans we use the terms “nonaccretable difference”, “accretable yield”, or “purchase discount”. Nonaccretable difference is the difference between undiscounted contractual cash flows due and undiscounted cash flows we expect to collect, or put another way, it is the undiscounted contractual cash flows we do not expect to collect. Accretable yield is the difference between undiscounted cash flows we expect to collect and the value at which we have recorded the loan on our financial statements. On the date of acquisition, all purchased loans are recorded on our consolidated financial statements at estimated fair value. Purchase discount is the difference between the estimated fair value of loans on the date of acquisition and the principal amount owed by the borrower, net of charge offs, on the date of acquisition. We may also refer to “discounts to principal balance of loans owed, net of charge-offs”. Discounts to principal balance of loans owed, net of charge-offs is the difference between principal balance of loans owed, net of charge-offs, and loans as recorded on our financial statements. Discounts to principal balance of loans owed, net of charge-offs arise from purchase discounts, and equal the purchase discount on the acquisition date.

Loans are also categorized as “covered” or “noncovered”. Covered loans refer to loans covered by a FDIC loss sharing agreement. Noncovered loans refer to loans not covered by a FDIC loss sharing agreement.

Originated loans and PNCI loans are reviewed on an individual basis for reclassification to nonaccrual status when any one of the following occurs: the loan becomes 90 days past due as to interest or principal, the full and timely collection of additional interest or principal becomes uncertain, the loan is classified as doubtful by internal credit review or bank regulatory agencies, a portion of the principal balance has been charged off, or the Company takes possession of the collateral. Loans that are placed on nonaccrual even though the borrowers continue to repay the loans as scheduled are classified as “performing nonaccrual” and are included in total nonperforming loans. The reclassification of loans as nonaccrual does not necessarily reflect management’s judgment as to whether they are collectible.

Interest income on originated nonaccrual loans that would have been recognized during the years ended December 31, 2017, 2016, and 2015, if all such loans had been current in accordance with their original terms, totaled $1,067,000, $783,000, and $1,840,000, respectively. Interest income actually recognized on these originated loans during the years ended December 31, 2017, 2016, and 2015 was $530,000, $377,000, and $170,000, respectively. Interest income on PNCI nonaccrual loans that would have been recognized during the years ended December 31, 2017, 2016, and 2015, if all such loans had been current in accordance with their original terms, totaled $73,000, $178,000, and $386,000, respectively. Interest income actually recognized on these PNCI loans during the years ended December 31, 2017, 2016, and 2015 was $18,000, $11,000, and $205,000, respectively.

The Company’s policy is to place originated loans and PNCI loans 90 days or more past due on nonaccrual status. In some instances when an originated loan is 90 days past due Management does not place it on nonaccrual status because the loan is well secured and in the process of collection. A loan is considered to be in the process of collection if, based on a probable specific event, it is expected that the loan will be repaid or brought current. Generally, this collection period would not exceed 30 days. Loans where the collateral has been repossessed are classified as foreclosed assets. Management considers both the adequacy of the collateral and the other resources of the borrower in determining the steps to be taken to collect nonaccrual loans. Alternatives that are considered are foreclosure, collecting on guarantees, restructuring the loan or collection lawsuits.

 

37


The following table set forth the amount of the Bank’s nonperforming assets as of the dates indicated. For purposes of the following table, “PCI – other” loans that are 90 days past due and still accruing are not considered nonperforming loans. “Performing nonaccrual loans” are loans that may be current for both principal and interest payments, or are less than 90 days past due, but for which payment in full of both principal and interest is not expected, and are not well secured and in the process of collection:

 

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

Performing nonaccrual loans

   $ 20,937     $ 17,677     $ 31,033     $ 45,072     $ 48,112  

Nonperforming nonaccrual loans

     3,176       2,451       6,086       2,517       5,104  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonaccrual loans

     24,113       20,128       37,119       47,589       53,216  

Originated and PNCI loans 90 days past due and still accruing

     281       —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     24,394       20,128       37,119       47,589       53,216  

Noncovered foreclosed assets

     3,226       3,763       5,369       4,449       5,588  

Covered foreclosed assets

     —         223       —         445       674  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 27,620     $ 24,114     $ 42,488     $ 52,483     $ 59,478  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

U.S. government, including its agencies and its government-sponsored agencies, guaranteed portion of nonperforming loans

   $ 358     $ 911     $ 28     $ 123     $ 101  

Indemnified portion of covered foreclosed assets

     —       $ 218       —       $ 356     $ 539  

Nonperforming assets to total assets

     0.58     0.53     1.01     1.88     2.30

Nonperforming loans to total loans

     0.81     0.73     1.47     2.08     3.18

Allowance for loan losses to nonperforming loans

     124     161     97     77     72

Allowance for loan losses, unamortized loan fees, and discounts to loan principal balances owed

     0.77     2.09     2.69     3.31     4.09

The following tables set forth the amount of the Bank’s nonperforming assets as of the dates indicated. For purposes of the following tables, “PCI – other” loans that are 90 days past due and still accruing are not considered nonperforming loans. “Performing nonaccrual loans” are loans that may be current for both principal and interest payments, or are less than 90 days past due, but for which payment in full of both principal and interest is not expected, and are not well secured and in the process of collection:

 

     December 31, 2017  
(dollars in thousands)    Originated     PNCI     PCI – cash basis     PCI - other     Total  

Performing nonaccrual loans

   $ 12,942     $ 1,305     $ 2,056     $ 4,634     $ 20,937  

Nonperforming nonaccrual loans

     2,520       158       13       485       3,176  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonaccrual loans

     15,462       1,463       2,069       5,119       24,113  

Originated loans 90 days past due and still accruing

     —         281       —         —         281  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     15,462       1,744       2,069       5,119       24,394  

Noncovered foreclosed assets

     1,836       —         —         1,390       3,226  

Covered foreclosed assets

     —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 17,298     $ 1,744     $ 2,069     $ 6,509     $ 27,620  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

U.S. government, including its agencies and its government-sponsored agencies, guaranteed portion of nonperforming loans

   $ 358       —         —         —       $ 358  

Indemnified portion of covered foreclosed assets

     —         —         —         —         —    

Nonperforming assets to total assets

     0.36     0.04     0.04     0.14     0.58

Nonperforming loans to total loans

     0.57     0.56     100.0     37.94     0.81

Allowance for loan losses to nonperforming loans

     188     53     1     5     124

Allowance for loan losses, unamortized loan fees, and discounts to loan principal balances owed

     0.32     2.22     64.71     22.10     0.77

 

38


The following tables set forth the amount of the Bank’s nonperforming assets as of the dates indicated. For purposes of the following tables, “PCI – other” loans that are 90 days past due and still accruing are not considered nonperforming loans. “Performing nonaccrual loans” are loans that may be current for both principal and interest payments, or are less than 90 days past due, but for which payment in full of both principal and interest is not expected, and are not well secured and in the process of collection:

 

     December 31, 2016  
(dollars in thousands)    Originated     PNCI     PCI – cash basis     PCI - other     Total  

Performing nonaccrual loans

   $ 11,146     $ 2,131     $ 2,983     $ 1,417     $ 17,677  

Nonperforming nonaccrual loans

     1,748       703       —         —         2,451  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonaccrual loans

     12,894       2,834     $ 2,983     $ 1,417       20,128  

Originated loans 90 days past due and still accruing

     —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     12,894       2,834     $ 2,983     $ 1,417       20,128  

Noncovered foreclosed assets

     2,277       —         —         1,486       3,763  

Covered foreclosed assets

     —         —         —         223       223  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 15,171     $ 2,834     $ 2,983     $ 3,126     $ 24,114  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

U.S. government, including its agencies and its government-sponsored agencies, guaranteed portion of nonperforming loans

   $ 911       —         —         —       $ 911  

Indemnified portion of covered foreclosed assets

     —         —         —       $ 218     $ 218  

Nonperforming assets to total assets

     0.34     0.06     0.07     0.07     0.53

Nonperforming loans to total loans

     0.55     0.75     100.00     6.42     0.73

Allowance for loan losses to nonperforming loans

     218     59     1     189     161

Allowance for loan losses, unamortized loan fees, and discounts to loan principal balances owed

     1.48     2.98     64.18     24.44     2.09

The following table shows the activity in the balance of nonperforming assets for the year ended December 31, 2017:

 

(dollars in thousands):    Balance at
December 31,
2017
     New
NPA
     Advances/
Capitalized
Costs
     Pay-downs
/Sales
/Upgrades
    Charge-offs/
Write-downs
    Transfers to
Foreclosed
Assets
    Category
Changes
    Balance at
December 31,
2016
 

Real estate mortgage:

                   

Residential

   $ 3,739      $ 3,416      $ 1      $ (123   $ (60   $ (127   $ 183     $ 449  

Commercial

     11,820        11,715        45        (10,439     (186     (466     258       10,893  

Consumer

                   

Home equity lines

     3,482        1,234        424        (2,139     (98     (550     (326     4,937  

Home equity loans

     1,636        1,701        54        (660     (332     (140     143       870  

Other consumer

     11        653        —          (43     (637     —         —         38  

Commercial

     3,706        5,292        42        (2,712     (1,444     (144     (258     2,930  

Construction:

                   

Residential

     —          1,118        —          (25     (1,104     —         —         11  

Commercial

     —          —          —          —         —         —         —         —    
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     24,394        25,129        566        (16,141     (3,861     (1,427     —         20,128  

Noncovered foreclosed assets

     3,226        —          —          (1,938     (26     1,427       —         3,763  

Covered foreclosed assets

     —          —          —          (223     —         —         —         223  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 27,620      $ 25,129      $ 566      $ (18,301   $ (3,886     —         —       $ 24,114  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The table above does not include deposit overdraft charge-offs.

 

39


The following tables and narratives describe the activity in the balance of nonperforming assets during each of the three-month periods ending March 31, June 30, September 30, and December 31, 2017. These tables and narratives are presented in chronological order:

Changes in nonperforming assets during the three months ended December 31, 2017

 

(dollars in thousands):    Balance at
December 31,
2017
     New
NPA
     Advances/
Capitalized
Costs
    

Pay-downs
/Sales

/Upgrades

    Charge-offs/
Write-downs
    Transfers to
Foreclosed
Assets
    Category
Changes
    Balance at
September 30,
2017
 

Real estate mortgage:

                   

Residential

   $ 3,739      $ 830      $ 1      $ (31     —       $ (127     —       $ 3,066  

Commercial

     11,820        6,318        38        (6,488   $ (16     (381     —         12,349  

Consumer

                   

Home equity lines

     3,482        701        64        (157     —         (88   $ (57     3,019  

Home equity loans

     1,636        510        54        (386     (1     (98     57       1,500  

Other consumer

     11        198        —          (4     (202     —         —         19  

Commercial (C&I)

     3,706        2,290        39        (224     (256     (144     —         2,001  

Construction:

                   

Residential

     —          —          —          —         —         —         —         —    

Commercial

     —          —          —          —         —         —         —         —    
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     24,394        10,847        196        (7,290     (475     (838     —         21,954  

Noncovered foreclosed assets

     3,226        —          —          (683     —         838       —         3,071  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 27,620      $ 10,847      $ 196      $ (7,973   $ (475     —         —       $ 25,025  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The table above does not include deposit overdraft charge-offs.

Nonperforming assets increased during the fourth quarter of 2017 by $2,595,000 (10.4%) to $27,620,000 at December 31, 2017 compared to $25,025,000 at September 30, 2017. The increase in nonperforming assets during the fourth quarter of 2017 was primarily the result of new nonperforming loans of $10,847,000, and advances on nonperforming loans of $196,000, that were partially offset by sales or upgrades of nonperforming loans to performing status totaling $7,290,000, dispositions of foreclosed assets totaling $683,000, and loan charge-offs of $475,000.

The $10,847,000 in new nonperforming loans during the fourth quarter of 2017 was comprised of increases of $830,000 on four residential real estate loans, $6,318,000 on four commercial real estate loans, $1,211,000 on nine home equity lines and loans, $198,000 on 30 consumer loans, and $2,290,000 on 11 C&I loans.

The $830,000 in new nonperforming residential real estate loans was primarily made up of one loan in the amount of $345,000 secured by a single family property in northern California. The $6,318,000 in new nonperforming CRE loans was primarily comprised of two loans in the amount of $5,178,000 secured by commercial office properties in northern California, one loan in the amount of $793,000 secured by a medical office building in northern California, one loan in the amount of $381,000 secured by residential development land in northern California, and one loan in the amount of $347,000 secured by commercial retail real estate in northern California. The $2,290,000 in new nonperforming C&I loans was primarily comprised of two loans totaling $1,865,000 within a single relationship secured by general business assets in central California, and one loan in the amount of $290,000 secured by general business assets in northern California. Related charge-offs are discussed below.

Loan charge-offs during the three months ended December 31, 2017

In the fourth quarter of 2017, the Company recorded $475,000 in loan charge-offs and $153,000 in deposit overdraft charge-offs less $461,000 in loan recoveries and $66,000 in deposit overdraft recoveries resulting in $101,000 of net charge-offs. Primary causes of the loan charges taken in the fourth quarter of 2017 were gross charge-offs of $16,000 on a single commercial real estate loan, $1,000 on one equity loan, $202,000 on 33 other consumer loans, and $256,000 on twelve C&I loans.

Total charge-offs were comprised of individual charges of less than $250,000 each. Generally losses are triggered by non-performance by the borrower and calculated based on any difference between the current loan amount and the current value of the underlying collateral less any estimated costs associated with the disposition of the collateral.

 

40


Changes in nonperforming assets during the three months ended September 30, 2017

 

(dollars in thousands):    Balance at
September 30,
2017
     New
NPA
     Advances/
Capitalized
Costs
    

Pay-downs
/Sales

/Upgrades

    Charge-offs/
Write-downs
    Transfers to
Foreclosed
Assets
    Category
Changes
    Balance at
June 30,
2017
 

Real estate mortgage:

                   

Residential

   $ 3,066      $ 1,144        —        $ (43   $ (60     —         183     $ 1,842  

Commercial

     12,349        3,323      $ 7        (486     (20     —         123       9,402  

Consumer

                   

Home equity lines

     3,019        137        —          (448     (13     —         (210     3,553  

Home equity loans

     1,500        709        —          (103     (94   $ (42     27       1,003  

Other consumer

     19        143        —          (24     (174     —         —         74  

Commercial (C&I)

     2,001        1,189        3        (332     (291     —         (123     1,555  

Construction:

                   

Residential

     —          33           —         (33     —         —         —    

Commercial

     —                —         —         —         —         —    
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     21,954        6,678        10        (1,436     (685     (42     —         17,429  

Noncovered foreclosed assets

     3,071        —          —          (325     (135     42       —         3,489  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 25,025      $ 6,678      $ 10      $ (1,761   $ (820     —         —       $ 20,918  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The table above does not include deposit overdraft charge-offs.

Nonperforming assets increased during the third quarter of 2017 by $4,107,000 (19.6%) to $25,025,000 at September 30, 2017 compared to $20,918,000 at June 30, 2017. The increase in nonperforming assets during the third quarter of 2017 was primarily the result of new nonperforming loans of $6,678,000, and advances on nonperforming loans of $10,000, that were partially offset by sales or upgrades of nonperforming loans to performing status totaling $1,436,000, dispositions of foreclosed assets totaling $325,000, loan charge-offs of $685,000, and write-downs on foreclosed assets of $135,000.

The $6,678,000 in new nonperforming loans during the third quarter of 2017 was comprised of increases of $1,144,000 on three residential real estate loans, $3,323,000 on five commercial real estate loans, $846,000 on 10 home equity lines and loans, $143,000 on 21 consumer loans, $1,189,000 on 15 C&I loans, and $33,000 on one residential construction loan.

The $1,144,000 in new nonperforming residential real estate loans was primarily made up of one loan in the amount of $939,000 secured by a single family property in northern California. The $3,323,000 in new nonperforming CRE loans was primarily comprised of two loans secured by commercial office properties in northern California. The $1,189,000 in new nonperforming C&I loans was primarily comprised of four loans within a single relationship secured by general business assets in northern California. Related charge-offs are discussed below.

Loan charge-offs during the three months ended September 30, 2017

In the third quarter of 2017, the Company recorded $685,000 in loan charge-offs and $176,000 in deposit overdraft charge-offs less $646,000 in loan recoveries and $55,000 in deposit overdraft recoveries resulting in $161,000 of net charge-offs. Primary causes of the loan charges taken in the third quarter of 2017 were gross charge-offs of $60,000 on two residential real estate loans, $20,000 on a single commercial real estate loan, $107,000 on six home equity lines and loans, $174,000 on 19 other consumer loans, $291,000 on four C&I loans and $33,000 on a single pool of Purchased Credit Impaired residential construction loans.

Total charge-offs were comprised of individual charges of less than $250,000 each. Generally losses are triggered by non-performance by the borrower and calculated based on any difference between the current loan amount and the current value of the underlying collateral less any estimated costs associated with the disposition of the collateral.

 

41


Changes in nonperforming assets during the three months ended June 30, 2017

 

(dollars in thousands):    Balance at
June 30,
2017
     New
NPA
     Advances/
Capitalized
Costs
    

Pay-downs
/Sales

/Upgrades

    Charge-offs/
Write-downs
    Transfers to
Foreclosed
Assets
    Category
Changes
    Balance at
March 31,
2017
 

Real estate mortgage:

                   

Residential

   $ 1,842      $ 1,097        —        $ (16     —         —         —       $ 761  

Commercial

     9,402        362        —          (3,085   $ (150     —       $ 135       12,140  

Consumer

                   

Home equity lines

     3,553        396      $ 360        (428     (13   $ (462     —         3,700  

Home equity loans

     1,003        283        —          (35     (206     —         —         961  

Other consumer

     74        255        —          (6     (190     —         —         15  

Commercial (C&I)

     1,555        1,684        —          (1,139     (764     —       $ (135     1,909  

Construction:

                   

Residential

     —          1,071        —          (25     (1,071     —         —         25  

Commercial

     —          —          —          —         —         —         —         —    
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     17,429        5,148        360        (4,734     (2,394     (462     —         19,511  

Noncovered foreclosed assets

     3,489        —          —          (545     43     $ 462       —         3,529  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 20,918      $ 5,148      $ 360      $ (5,279   $ (2,351     —         —       $ 23,040  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The table above does not include deposit overdraft charge-offs.

Nonperforming assets decreased during the second quarter of 2017 by $2,122,000 (9.2%) to $20,918,000 at June 30, 2017 compared to $23,040,000 at March 31, 2017. The decrease in nonperforming assets during the second quarter of 2017 was primarily the result of sales or upgrades of nonperforming loans to performing status totaling $4,734,000, dispositions of foreclosed assets totaling $545,000, and loan charge-offs of $2,394,000, that were partially offset by new nonperforming loans of $5,148,000, advances on nonperforming loans of $360,000, and an increase in foreclosed asset valuation of $43,000, the net result of $6,000 of write-downs and $49,000 of positive adjustments to foreclosed asset valuations.

The $5,148,000 in new nonperforming loans during the second quarter of 2017 was comprised of increases of $1,097,000 on two residential real estate loans, $362,000 on two commercial real estate loans, $679,000 on 11 home equity lines and loans, $255,000 on 27 consumer loans, $1,684,000 on 12 C&I loans, and $1,071,000 residential construction loans.

The $1,097,000 in new nonperforming residential real estate loans was primarily made up of one loan in the amount of $959,000 secured by a single family property in southern California. The $1,684,000 in new nonperforming C&I loans was primarily comprised of one loan in the amount of $361,000 secured by crop proceeds in northern California, and one loan in the amount of $363,000 secured by general business assets in northern California. Also, included in these new nonperforming assets during the three months ended June 30, 2017 were residential construction loans of $1,071,000, commercial loans of $424,000, and commercial real estate loans of $150,000; all of which were classified as PCI – other loans and accounted for using the pool method of accounting under ASC Topic 310-30; and for which the related pools were resolved during the three months ended June 30, 2017 resulting in these fully reserved loan balances to be deemed uncollectable and simultaneously charged off. Related charge-offs are discussed below.

Loan charge-offs during the three months ended June 30, 2017

In the second quarter of 2017, the Company recorded $2,394,000 in loan charge-offs and $118,000 in deposit overdraft charge-offs less $377,000 in loan recoveries and $56,000 in deposit overdraft recoveries resulting in $2,079,000 of net charge-offs. Primary causes of the loan charges taken in the first quarter of 2017 were gross charge-offs of $150,000 on a single pool of PCI - other commercial real estate loans, $219,000 on five home equity lines and loans, $190,000 on 24 other consumer loans, $764,000 on five C&I loans and $1,071,000 on a single pool of Purchased Credit Impaired residential construction loans.

Total charge-offs were generally comprised of individual charges of less than $250,000 each with the exception of two during the quarter. Each of these charges was related to the resolution of a pool of Purchased Credit Impaired loans. One charge in the amount of $424,000 was related to C&I loans secured by general business assets in northern California, and the second in the amount of $1,071,000 was related to a pool of residential construction loans in northern California. Generally losses are triggered by non-performance by the borrower and calculated based on any difference between the current loan amount and the current value of the underlying collateral less any estimated costs associated with the disposition of the collateral.

 

42


Changes in nonperforming assets during the three months ended March 31, 2017

 

(dollars in thousands):    Balance at
March 31,
2017
     New
NPA
     Advances/
Capitalized
Costs
    

Pay-downs
/Sales

/Upgrades

    Charge-offs/
Write-downs
    Transfers to
Foreclosed
Assets
    Category
Changes
    Balance at
December 31,
2016
 

Real estate mortgage:

                   

Residential

   $ 761      $ 345        —        $ (33     —         —         $ 449  

Commercial

     12,140        1,712        —          (380     —       $ (85     —         10,893  

Consumer

                   

Home equity lines

     3,700        —          —          (1,107   $ (71     —       $ (59     4,937  

Home equity loans

     961        199        —          (136     (31     —         59       870  

Other consumer

     15        57        —          (9     (71     —         —         38  

Commercial (C&I)

     1,909        129        —          (1,017     (133     —         —         2,930  

Construction:

                   

Residential

     25        14        —          —         —         —         —         11  

Commercial

     —          —          —          —         —         —         —         —    
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     19,511        2,456        —          (2,682     (306     (85     —         20,128  

Noncovered foreclosed assets

     3,529        —          —          (385     66       85       —         3,763  

Covered foreclosed assets

     —          —          —          (223     —         —         —         223  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 23,040      $ 2,456        —        $ (3,290   $ 240       —         —       $ 24,114  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The table above does not include deposit overdraft charge-offs.

Nonperforming assets decreased during the first quarter of 2017 by $1,074,000 (4.5%) to $23,040,000 at March 31, 2017 compared to $24,114,000 at December 31, 2016. The decrease in nonperforming assets during the first quarter of 2017 was primarily the result of sales or upgrades of nonperforming loans to performing status totaling $2,682,000, dispositions of foreclosed assets totaling $608,000, loan charge-offs of $306,000, and write-downs on foreclosed assets totaling $22,000, that were partially offset by new nonperforming loans of $2,456,000, and an increase in foreclosed asset valuation of $66,000, the net result of $22,000 of write-downs and $88,000 of positive adjustments to foreclosed asset valuations.

The $2,456,000 in new nonperforming loans during the first quarter of 2017 was comprised of increases of $345,000 on three residential real estate loans, $1,712,000 on one commercial real estate loan, $199,000 on three home equity lines and loans, $57,000 on 10 consumer loans, $129,000 on two C&I loans, and $14,000 on a single residential construction loan.

The $1,712,000 in new nonperforming commercial real estate loans was entirely comprised of one loan secured by a commercial mini storage facility in central California. Related charge-offs are discussed below.

Loan charge-offs during the three months ended March 31, 2017

In the first quarter of 2017, the Company recorded $306,000 in loan charge-offs and $103,000 in deposit overdraft charge-offs less $406,000 in loan recoveries and $74,000 in deposit overdraft recoveries resulting in $71,000 of net recoveries. Primary causes of the loan charges taken in the first quarter of 2017 were gross charge-offs of $102,000 on five home equity lines and loans, $71,000 on 12 other consumer loans, and $133,000 on five C&I loans.

Total charge-offs were generally comprised of individual charges of less than $250,000 each. Generally losses are triggered by non-performance by the borrower and calculated based on any difference between the current loan amount and the current value of the underlying collateral less any estimated costs associated with the disposition of the collateral.

Allowance for Loan Losses

The Company’s allowance for loan losses is comprised of allowances for originated, PNCI and PCI loans. All such allowances are established through a provision for loan losses charged to expense.

Originated and PNCI loans, and deposit related overdrafts are charged against the allowance for originated loan losses when Management believes that the collectability of the principal is unlikely or, with respect to consumer installment loans, according to an established delinquency schedule. The allowances for originated and PNCI loan losses are amounts that Management believes will be adequate to absorb probable losses inherent in existing originated loans, based on evaluations of the collectability, impairment and prior loss experience of those loans and leases. The evaluations take into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. The Company defines an originated or PNCI loan as impaired when it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired originated and PNCI loans are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. As a practical expedient, impairment may be measured based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance.

 

43


In situations related to originated and PNCI loans where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). The Company strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where the Company grants the borrower new terms that provide for a reduction of either interest or principal, the Company measures any impairment on the restructuring as noted above for impaired loans. TDR loans are classified as impaired until they are fully paid off or charged off. Loans that are in nonaccrual status at the time they become TDR loans, remain in nonaccrual status until the borrower demonstrates a sustained period of performance which the Company generally believes to be six consecutive months of payments, or equivalent. Otherwise, TDR loans are subject to the same nonaccrual and charge-off policies as noted above with respect to their restructured principal balance.

Credit risk is inherent in the business of lending. As a result, the Company maintains an allowance for loan losses to absorb incurred losses inherent in the Company’s originated and PNCI loan portfolios. These are maintained through periodic charges to earnings. These charges are included in the Consolidated Income Statements as provision for loan losses. All specifically identifiable and quantifiable losses are immediately charged off against the allowance. However, for a variety of reasons, not all losses are immediately known to the Company and, of those that are known, the full extent of the loss may not be quantifiable at that point in time. The balance of the Company’s allowances for originated and PNCI loan losses are meant to be an estimate of these unknown but probable losses inherent in these portfolios.

The Company formally assesses the adequacy of the allowance for originated and PNCI loan losses on a quarterly basis. Determination of the adequacy is based on ongoing assessments of the probable risk in the outstanding originated and PNCI loan portfolios, and to a lesser extent the Company’s originated and PNCI loan commitments. These assessments include the periodic re-grading of credits based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment, growth of the portfolio as a whole or by segment, and other factors as warranted. Loans are initially graded when originated or acquired. They are re-graded as they are renewed, when there is a new loan to the same borrower, when identified facts demonstrate heightened risk of nonpayment, or if they become delinquent. Re-grading of larger problem loans occurs at least quarterly. Confirmation of the quality of the grading process is obtained by independent credit reviews conducted by consultants specifically hired for this purpose and by various bank regulatory agencies.

The Company’s method for assessing the appropriateness of the allowance for originated and PNCI loan losses includes specific allowances for impaired loans and leases, formula allowance factors for pools of credits, and allowances for changing environmental factors (e.g., interest rates, growth, economic conditions, etc.). Allowance factors for loan pools are based on historical loss experience by product type and prior risk rating. Allowances for impaired loans are based on analysis of individual credits. Allowances for changing environmental factors are Management’s best estimate of the probable impact these changes have had on the originated or PNCI loan portfolio as a whole. The allowances for originated and PNCI loans are included in the allowance for loan losses.

As noted above, the allowances for originated and PNCI loan losses consists of a specific allowance, a formula allowance, and an allowance for environmental factors. The first component, the specific allowance, results from the analysis of identified credits that meet management’s criteria for specific evaluation. These loans are reviewed individually to determine if such loans are considered impaired. Impaired loans are those where management has concluded that it is probable that the borrower will be unable to pay all amounts due under the original contractual terms. Impaired loans are specifically reviewed and evaluated individually by management for loss potential by evaluating sources of repayment, including collateral as applicable, and a specified allowance for loan losses is established where necessary.

The second component of the allowance for originated and PNCI loan losses, the formula allowance, is an estimate of the probable losses that have occurred across the major loan categories in the Company’s originated and PNCI loan portfolios. This analysis is based on loan grades by pool and the loss history of these pools. This analysis covers the Company’s entire originated and PNCI loan portfolios including unused commitments but excludes any loans that were analyzed individually and assigned a specific allowance as discussed above. The total amount allocated for this component is determined by applying loss estimation factors to outstanding loans and loan commitments. The loss factors were previously based primarily on the Company’s historical loss experience tracked over a five-year period and adjusted as appropriate for the input of current trends and events. Because historical loss experience varies for the different categories of originated loans, the loss factors applied to each category also differed. In addition, there is a greater chance that the Company would suffer a loss from a loan that was risk rated less than satisfactory than if the loan was last graded satisfactory. Therefore, for any given category, a larger loss estimation factor was applied to less than satisfactory loans than to those that the Company last graded as satisfactory. The resulting formula allowance was the sum of the allocations determined in this manner.

 

44


The third component of the allowances for originated and PNCI loan losses, the environmental factor allowance, is a component that is not allocated to specific loans or groups of loans, but rather is intended to absorb losses that may not be provided for by the other components.

There are several primary reasons that the other components discussed above might not be sufficient to absorb the losses present in the originated and PNCI loan portfolios, and the environmental factor allowance is used to provide for the losses that have occurred because of them.

The first reason is that there are limitations to any credit risk grading process. The volume of originated and PNCI loans makes it impractical to re-grade every loan every quarter. Therefore, it is possible that some currently performing originated or PNCI loans not recently graded will not be as strong as their last grading and an insufficient portion of the allowance will have been allocated to them. Grading and loan review often must be done without knowing whether all relevant facts are at hand. Troubled borrowers may deliberately or inadvertently omit important information from reports or conversations with lending officers regarding their financial condition and the diminished strength of repayment sources.

The second reason is that the loss estimation factors are based primarily on historical loss totals. As such, the factors may not give sufficient weight to such considerations as the current general economic and business conditions that affect the Company’s borrowers and specific industry conditions that affect borrowers in that industry. The factors might also not give sufficient weight to other environmental factors such as changing economic conditions and interest rates, portfolio growth, entrance into new markets or products, and other characteristics as may be determined by Management.

Specifically, in assessing how much environmental factor allowance needed to be provided, management considered the following:

 

    with respect to the economy, management considered the effects of changes in GDP, unemployment, CPI, debt statistics, housing starts, home affordability, and other economic factors which serve as indicators of economic health and trends and which may have an impact on the performance of our borrowers, and

 

    with respect to changes in the interest rate environment, management considered the recent changes in interest rates and the resultant economic impact it may have had on borrowers with high leverage and/or low profitability; and

 

    with respect to changes in energy prices, management considered the effect that increases, decreases or volatility may have on the performance of our borrowers, and

 

    with respect to loans to borrowers in new markets and growth in general, management considered the relatively short seasoning of such loans and the lack of experience with such borrowers, and

 

    with respect to loans that have not yet been identified as impaired, management considered the volume and severity of past due loans, and

 

    with respect to concentrations within the portfolio, management considered the risk introduced by concentrations among specific segments of the portfolio, underlying collateral types, borrowers or group of borrowers, and geographic areas.

Each of these considerations was assigned a factor and applied to a portion or the entire originated and PNCI loan portfolios. Since these factors are not derived from experience and are applied to large non-homogeneous groups of loans, they are available for use across the portfolio as a whole.

Acquired loans are valued as of their acquisition date in accordance with FASB ASC Topic 805, Business Combinations. Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are referred to as purchased credit impaired (PCI) loans. PCI loans are accounted for under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. In addition, because of the significant credit discounts associated with the loans acquired in the Granite acquisition, the Company elected to account for all loans acquired in the Granite acquisition under FASB ASC Topic 310-30, and classify them all as PCI loans. Under FASB ASC Topic 805 and FASB ASC Topic 310-30, PCI loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. Fair value is defined as the present value of the future estimated principal and interest payments of the loan, with the discount rate used in the present value calculation representing the estimated effective yield of the loan. The difference between contractual future payments and estimated future payments is referred to as the nonaccretable difference. The difference between estimated future payments and the present value of the estimated future payments is referred to as the accretable yield. The accretable yield represents the amount that is expected to be recorded as interest income over the remaining life of the loan. If after acquisition, the Company determines that the future cash flows of a PCI loan are expected to be more than the originally estimated, an increase in the discount rate (effective yield) would be made such that the newly increased accretable yield would be recognized, on a level yield basis, over the remaining estimated life of the loan. If after acquisition, the Company determines that the future cash flows of a PCI loan are expected to be less than the previously estimated, the discount rate would first be reduced until the present value of the reduced cash flow estimate equals the previous present value however, the discount rate may not be lowered below its original level. If the discount rate has been lowered to its original level and the present value has not been sufficiently lowered, an allowance for

 

45


loan loss would be established through a provision for loan losses charged to expense to decrease the present value to the required level. If the estimated cash flows improve after an allowance has been established for a loan, the allowance may be partially or fully reversed depending on the improvement in the estimated cash flows. Only after the allowance has been fully reversed may the discount rate be increased. PCI loans are put on nonaccrual status when cash flows cannot be reasonably estimated. PCI loans are charged off when evidence suggests cash flows are not recoverable. Foreclosed assets from PCI loans are recorded in foreclosed assets at fair value with the fair value at time of foreclosure representing cash flow from the loan. ASC 310-30 allows PCI loans with similar risk characteristics and acquisition time frame to be “pooled” and have their cash flows aggregated as if they were one loan.

The Components of the Allowance for Loan Losses

The following table sets forth the Bank’s allowance for loan losses as of the dates indicated (dollars in thousands):

 

     December 31,  
     2017     2016     2015     2014     2013  

Allowance for originated and PNCI loan losses:

          

Specific allowance

   $ 2,699     $ 2,046     $ 2,890     $ 4,267     $ 3,975  

Formula allowance

     17,100       17,485       20,603       22,076       24,611  

Environmental factors allowance

     10,252       10,275       9,625       6,815       5,619  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for originated and PNCI loan losses

     30,051       29,806       33,118       33,158       34,205  

Allowance for PCI loan losses

     272       2,697       2,893       3,427       4,040  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses

   $ 30,323     $ 32,503     $ 36,011     $ 36,585     $ 38,245  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses to loans

     1.01     1.18     1.43     1.60     2.29

Based on the current conditions of the loan portfolio, management believes that the $30,323,000 allowance for loan losses at December 31, 2017 is adequate to absorb probable losses inherent in the Bank’s loan portfolio. No assurance can be given, however, that adverse economic conditions or other circumstances will not result in increased losses in the portfolio.

The following table summarizes the allocation of the allowance for loan losses between loan types:

 

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

Real estate mortgage

   $ 13,758      $ 14,292      $ 13,950      $ 12,313      $ 12,854  

Consumer

     8,227        10,284        15,079        18,201        18,238  

Commercial

     6,512        5,831        5,271        4,226        4,331  

Real estate construction

     1,826        2,096        1,711        1,845        2,822  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 30,323      $ 32,503      $ 36,011      $ 36,585      $ 38,245  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table summarizes the allocation of the allowance for loan losses between loan types as a percentage of the total allowance for loan losses:

 

     December 31,  
     2017     2016     2015     2014     2013  

Real estate mortgage

     45.4     44.0     38.7     33.7     33.6

Consumer

     27.1     31.6     41.9     49.7     47.7

Commercial

     21.5     17.9     14.6     11.6     11.3

Real estate construction

     6.0     6.5     4.8     5.0     7.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan losses

     100.0     100.0     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table summarizes the allocation of the allowance for loan losses between loan types as a percentage of total loans and as a percentage of total loans in each of the loan categories listed:

 

     December 31,  
     2017     2016     2015     2014     2013  

Real estate mortgage

     0.60     0.69     0.77     0.76     1.16

Consumer

     2.31     2.84     3.81     4.36     4.76

Commercial

     2.95     2.69     2.70     2.42     3.28

Real estate construction

     1.33     1.71     1.42     2.46     5.75
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan losses

     1.01     1.18     1.43     1.60     2.29
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

46


The following tables summarize the activity in the allowance for loan losses, reserve for unfunded commitments, and allowance for losses (which is comprised of the allowance for loan losses and the reserve for unfunded commitments) for the years indicated (dollars in thousands):

 

     Year ended December 31,  
     2017     2016     2015     2014     2013  

Allowance for loan losses:

          

Balance at beginning of period

   $ 32,503     $ 36,011     $ 36,585     $ 38,245     $ 42,648  

(Benefit from) provision for loan losses

     89       (5,970     (2,210     (4,045     (715

Loans charged off:

          

Real estate mortgage:

          

Residential

     (60     (321     (224     (171     (46

Commercial

     (186     (827     —         (110     (2,038

Consumer:

          

Home equity lines

     (98     (585     (694     (1,094     (2,651

Home equity loans

     (332     (219     (242     (29     (94

Auto indirect

     —         —         (4     (3     (68

Other consumer

     (1,186     (823     (972     (599     (887

Commercial

     (1,444     (455     (680     (479     (1,599

Construction:

          

Residential

     (1,104     —         —         (4     (20

Commercial

       —         —         (69     (140
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged off

     (4,410     (3,230     (2,816     (2,558     (7,543

Recoveries of previously charged-off loans:

          

Real estate mortgage:

          

Residential

     —         880       204       2       345  

Commercial

     397       920       243       540       994  

Consumer:

          

Home equity lines

     698       2,317       666       960       1,053  

Home equity loans

     242       590       252       34       41  

Auto indirect

     —         —         42       86       195  

Other consumer

     375       449       500       495       759  

Commercial

     428       404       677       1,268       340  

Construction:

          

Residential

     —         54       1,728       1,377       63  

Commercial

     1       78       140       181       65  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries of previously charged off loans

     2,141       5,692       4,452       4,943       3,855  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     (2,269     2,462       1,636       2,385       (3,688
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 30,323     $ 32,503     $ 36,011     $ 36,585     $ 38,245  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Year ended December 31,  
     2017     2016     2015     2014     2013  

Reserve for unfunded commitments:

          

Balance at beginning of period

   $ 2,719     $ 2,475     $ 2,145     $ 2,415     $ 3,615  

Provision for losses – unfunded commitments

     445       244       330       (270     (1,200
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 3,164     $ 2,719     $ 2,475     $ 2,145     $ 2,415  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period:

          

Allowance for loan losses

   $ 30,323     $ 32,503     $ 36,011     $ 36,585     $ 38,245  

Reserve for unfunded commitments

     3,164       2,719       2,475       2,145       2,415  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses and reserve for unfunded commitments

   $ 33,487       35,222     $ 38,486     $ 38,730     $ 40,660  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As a percentage of total loans at end of period:

          

Allowance for loan losses

     1.01     1.18     1.43     1.60     2.29

Reserve for unfunded commitments

     0.10     0.10     0.10     0.10     0.14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses and reserve for unfunded commitments

     1.11     1.28     1.53     1.70     2.43
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average total loans

   $ 2,842,659     $ 2,629,729     $ 2,389,437     $ 1,847,749     $ 1,610,725  

Ratios:

          

Net charge-offs during period to average loans outstanding during period

     0.08     (0.09 )%      (0.07 )%      (0.13 )%      0.23

Provision for loan losses to average loans outstanding

     0.00     (0.21 )%      (0.09 )%      (0.22 )%      (0.04 )% 

Allowance for loan losses to loans at year end

     1.01     1.18     1.43     1.60     2.29

 

47


Foreclosed Assets, Net of Allowance for Losses

The following tables detail the components and summarize the activity in foreclosed assets, net of allowances for losses for the years indicated (dollars in thousands):

 

(dollars in thousands):   

Balance at
December 31,

2017

    

New

NPA

    

Advances/
Capitalized

Costs

     Sales     Valuation
Adjustments
    Transfers
from Loans
     Category
Changes
     Balance at
December 31,
2016
 

Noncovered:

                     

Land & Construction

   $ 1,786        —          —        $ (15   $ (92   $ 381        —        $ 1,512  

Residential real estate

     1,186        —          —          (1,071     (49     865        —          1,441  

Commercial real estate

     254        —          —          (852     (21     317        —          810  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total noncovered

     3,226        —          —          (1,938     (162     1,563        —          3,763  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Covered:

                     

Land & Construction

     —          —          —          —         —         —          —          —    

Residential real estate

     —          —          —        $ (223     —         —          —          223  

Commercial real estate

     —          —          —          —         —         —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total covered

     —                (223             223  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total foreclosed assets

   $ 3,226        —          —        $ (2,161   $ (162   $ 1,563        —        $ 3,986  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

 

(dollars in thousands):    Balance at
December 31,
2016
     New
NPA
     Advances/
Capitalized
Costs
     Sales     Valuation
Adjustments
    Transfers
from Loans
     Category
Changes
     Balance at
December 31,
2015
 

Noncovered:

                     

Land & Construction

   $ 1,512        —          —        $ (979     —         —          —        $ 2,491  

Residential real estate

     1,441        —          —          (2,380   $ (56   $ 2,090        —          1,787  

Commercial real estate

     810        —          —          (389     (84     192        —          1,091  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total noncovered

     3,763        —          —          (3,748     (140     2,282        —          5,369  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Covered:

                     

Land & Construction

     —          —          —          —         —         —          —          —    

Residential real estate

     223        —          —          —         —         223        —          —    

Commercial real estate

     —          —          —          —         —         —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total covered

     223        —          —          —         —         223        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total foreclosed assets

   $ 3,986        —          —        $ (3,748   $ (140   $ 2,505        —        $ 5,369  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Premises and Equipment

Premises and equipment were comprised of:

 

     December 31,
2017
     December 31,
2016
 
       
     (In thousands)  

Land & land improvements

   $ 9,959      $ 9,522  

Buildings

     50,340        42,345  

Furniture and equipment

     35,939        31,428  
  

 

 

    

 

 

 
     96,238        83,295  

Less: Accumulated depreciation

     (40,644      (37,412
  

 

 

    

 

 

 
     55,594        45,883  

Construction in progress

     2,148        2,523  
  

 

 

    

 

 

 

Total premises and equipment

   $ 57,742      $ 48,406