The structure of federal consumer protection regulation applicable to all providers of consumer financial products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise and enforce federal consumer protection laws. The consumer protection provisions of the Dodd-Frank Act and the examination, supervision and enforcement of those laws and implementing regulations by the CFPB have created a more intense and complex environment for consumer finance regulation. The CFPB has significant authority to implement and enforce federal consumer protection laws and new requirements for financial services products provided for in the Dodd-Frank Act, as well as the authority to identify and prohibit unfair, deceptive or abusive acts and practices. The review of products and practices to prevent such acts and practices is a continuing focus of the CFPB, and of banking regulators more broadly. The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination, additional remediation efforts and possible penalties. In addition, the Dodd-Frank Act provides the CFPB with broad supervisory, examination and enforcement authority over various consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged legal violations and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. The Dodd-Frank Act does not prevent states from adopting stricter consumer protection standards. State regulation of financial products and potential enforcement actions could also adversely affect our business, financial condition or results of operations.
Banking laws impose notice, approval and ongoing regulatory requirements on any stockholder or other party that seeks to acquire direct or indirect "control" of an FDIC-insured depository institution. These laws include the BHCA and the Change in Bank Control Act. Among other things, these laws require regulatory filings by a stockholder or other party that seeks to acquire direct or indirect "control" of an FDIC-insured depository institution or bank holding company. The determination whether an investor "controls" a depository institution is based on all of the facts and circumstances surrounding the investment. As a general matter, a party is deemed to control a depository institution or other company if the party owns or controls 25% or more of any class of voting stock. Subject to rebuttal, a party may be presumed to control a depository institution or other company if the investor owns or controls 10% or more of any class of voting stock. Ownership by family members, affiliated parties, or parties acting in concert, is typically aggregated for these purposes. If a party's ownership of the Company were to exceed certain thresholds, the investor could be deemed to "control" the Company for regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences.
In addition, except under limited circumstances, bank holding companies are prohibited from acquiring, without prior approval:
For institutions with at least $1 billion but less than $50 billion in total consolidated assets, the proposal would impose principles-based restrictions that are broadly consistent with existing interagency guidance on incentive-based compensation. Such institutions would be prohibited from entering into incentive compensation arrangements that encourage inappropriate risks by the institution: (i) by providing an executive officer, employee, director, or principal shareholder with excessive compensation, fees, or benefits; or (ii) that could lead to material financial loss to the institution. The comment period for these proposed regulations has closed, but a final rule has not been published. Depending upon the outcome of the rule making process, the application of this rule to us could require us to revise our compensation strategy, increase our administrative costs and adversely affect our ability to recruit and retain qualified employees. Further, as discussed above, the Basel III Capital Rules limit discretionary bonus payments to bank executives if the institution’s regulatory capital ratios fail to exceed certain thresholds that started being phased in on January 1, 2016.
Available Information
Company reports filed with the SEC including the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and ownership reports filed by directors, executive officers and principal stockholders can be accessed through the Company’s website at http://www.fmbonline.com. The link to the SEC is on the About Us page. The Company’s reports may also be accessed at the SEC’s Internet website (http://www.sec.gov).
An investment in our common stock is subject to risks inherent in our business. The material risks and uncertainties that management believes may affect our business are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this 10-K Report. The risks and uncertainties described below are not the only ones facing our business. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This 10-K Report is qualified in its entirety by these risk factors.
If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.
Risks Associated With Our BusinessRelated to COVID-19 Pandemic
Economic Conditions Nationally And The outbreak of the COVID-19 pandemic in early 2020 caused a significant global economic downturn which adversely affected our business and results of operations.
In Our Service Areas Could Adversely Affect Our Operations And/Or Cause Us To Sustain Losses- Thelate 2021 and early 2022, as vaccination rates increased across the markets we serve and governmental restrictions were eased, economic activity began to improve, and at the current time COVID-19 is not having any material adverse impact on our business activities and financial results. However, the COVID-19 virus continues to develop new strains and no assurances can be given that these or other variants of the virus will not lead to future governmental restrictions on economic activity or have other materially adverse effects on the local and national economy and the economy of other portions of California had, for the most part, experienced solid improvements since the recession of 2007-2012, but in 2020 the spread of COVID-19 has placed many sectors of the economy under stress. The economy of the Central Valley of California, which remains the Company’s primary market area, has remained fairly resilient because of its strong agricultural base. However, this could changeour business.
Even if the COVID-19 outbreak continues to subside locally and nationally, we may experience material adverse impacts of COVID-19 continue for an extended period of time.
Although we have initiated efforts to broaden our geographic footprint to include Contra Costa, Solano and Napa counties, our retail and commercial banking operations remain primarily concentrated in Sacramento, San Joaquin, Stanislaus and Merced counties. See “Item 1. Business – Service Area.” Asbusiness as a result of the continuing global economic impact of the virus.
For additional information regarding the COVID-19 pandemic and its consequences for our business, see “COVID-19 (Coronavirus) Disclosure” above in this geographic concentration,Annual Report on Form 10-K.
Risks Relating to the Industry and Geographic Area in Which We Operate and the U.S. Economy
As a financial services company, our resultsbusiness and operations may be adversely affected by weak economic conditions. Our business operations, which primarily consist of operations depend largely uponlending money to clients in the form of loans, borrowing money from clients in the form of deposits and investing in securities, are sensitive to general business and economic conditions in these areas. Whereas much of this area has improved, real estate values remain below peak pricesthe United States. If the U.S. economy weakens, our growth and unemployment remains above most other areasprofitability from our lending, deposit and investment operations could be constrained. In addition, economic conditions in the state and country. As a result, risk still remains from the possibility that losses will be sustained if a significant number of our borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans or leases. We have adopted underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for credit losses, that management believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan & lease performance and diversifying our credit portfolio. These policies and procedures; however, may not prevent unexpected losses thatforeign countries could materially and adversely affect our results of operations in general and the market value of our stock. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview - Looking Forward: 2021 and Beyond.”
Additionally, despite the stability of our earnings over the last several years,global financial markets, which could hinder U.S. economic uncertainties could returngrowth. Our business is also significantly affected by monetary and the full extentrelated policies of the repercussions onU.S. federal government and its agencies. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our local economies in generalcontrol. Adverse economic conditions and our business in particular are still not fully known at this time. Such events may have a negative effect on: (i) our abilitygovernment policy responses to service our existing customers and attract new customers; (ii) the ability of our borrowers to operate their business as successfully as in the past; (iii) the financial security and net worth of our customers; and (iv) the ability of our customers to repay their loans or leases with us in accordance with the terms thereof.
Our Allowance For Credit Losses May Not Be Adequate To Cover Actual Losses - A significant source of risk arises from the possibility that losses could be sustained because borrowers, guarantors, and related parties may fail to perform in accordance with the terms of their loans & leases. The underwriting and credit monitoring policies and procedures that we have adopted to address this risk may not prevent unexpected losses thatsuch conditions could have a material adverse effect on our business, financial condition results of operations and cash flows. Unexpected losses may arise from a wide variety of specific or systemic factors, many of which are beyond our ability to predict, influence, or control.operations.
Like all financial institutions, we maintain an allowance for credit losses to provide for loan & lease defaults and non-performance. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Provision and Allowance for Credit Losses.” The allowance is funded from a provision for credit losses, which is a charge to our income statement. Our allowance for credit losses may not be adequate to cover actual loan & lease losses, and future provisions for credit losses could materially and adversely affect our business, financial condition, results of operations and cash flows. The allowance for credit losses reflects our estimate of the probable losses in our loan & lease portfolio at the relevant balance sheet date. Our allowance for credit 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 & lease portfolio and other economic factors. The determination of an appropriate level of credit 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.
The process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments.
While we believe that our allowance for credit losses is adequate to cover our estimate of the current probable losses, we cannot assure you that we will not increase the allowance for credit losses further or that regulators will not require us to increase this allowance. Either of these occurrences could materially adversely affect our business, financial condition, results of operations and cash flows.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update, Financial Instruments: Credit Losses (“CECL”), which establishes a new impairment framework also known as the "current expected credit loss model." In contrast to the incurred loss model currently used by financial entities like us, the current expected credit loss model requires an allowance be recognized based on the expected credit losses (i.e. all contractual cash flows that the entity does not expect to collect from financial assets or commitments to extend credit). It requires the consideration of more forward-looking information than is permitted under current U.S. generally accepted accounting principles. In addition to relevant information about past events and current conditions, such as borrowers’ current creditworthiness, quantitative and qualitative factors specific to borrowers, and the economic environment in which the entity operates, the new model requires consideration of reasonable and supportable forecasts that affect the expected collectability of the financial assets’ remaining contractual cash flows, and evaluation of the forecasted direction of the economic cycle, as well as time value of money. This proposed impairment framework is expected to have wide reaching implications to financial institutions such as us. The CECL model will become effective for the Bank for fiscal year 2022. See Note 21, located in “Item 8. Financial Statements and Supplementary Data.”
We Are Dependent On Real Estate And Downturns In The Real Estate Market Could Hurt Our Business - A significantlarge portion of our loan portfolio is dependent ontied to the real estate market where we operate and we may be negatively impacted by downturns in that market. A significant percentage of our loans are real estate related, consisting of loans for construction and land development projects, and for the purchase, improvement or refinancing of residential and commercial real estate. See “Item 1. Business – SupervisionA downturn in the real estate market could increase loan delinquencies, defaults and Regulation - Prompt Corrective Action.” Atforeclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. Real estate collateral provides an alternate source of repayment in the event of default by the client and may deteriorate in value during the time the credit is extended. If values decline, it is also more likely that we would be required to increase our allowance for credit losses. If during a period of reduced real estate values we are required to liquidate the property collateralizing a loan to satisfy the debt or to increase our allowance for credit losses, it could materially reduce our profitability and adversely affect our financial condition.
Although only 4.7% of our loan portfolio consisted of real estate construction, and acquisition and land development loans as of December 31, 2020, real estate served as2022, such loans generally have a higher degree of risk than long-term financing of existing properties because repayment depends on the principal sourcecompletion of collateralthe project and usually on the sale or long term financing of the property. The COVID-19 pandemic has had, and may continue to have, an impact on the ability of our clients to complete these projects on time and within budget, particularly with respect to approximately 69%access to materials and labor and costs of ourthe same. In addition, these loans outstanding. Stresses in economic conditions in our local markets orare often “interest-only loans,” which normally require only the payment of interest accrued prior to maturity. Interest-only loans carry greater risk than other loans because no principal is paid prior to maturity. This risk is particularly apparent during periods of rising interest rates and declining real estate values. If there is a significant decline in the real estate market due to a material increase in interest rates or for other reasons, many of these loans could havedefault and result in foreclosure. If we are forced to foreclose on a project prior to completion, we may not be able to recover the entire unpaid portion of the loan or we may be required to fund additional money to complete the project or hold the property for an adverse effect onindeterminate period. In addition, real estate exposes us to incurring costs and liabilities for environmental contamination and remediation. Any of these outcomes may result in losses and reduce our earnings.
The FDIC has given guidance recommending that if the sum of (i) certain categories of CRE loans and (ii) acquisition, development and construction loans (“ADC loans”) exceeds 300% of total risk-based capital, or if ADC loans exceed 100% of total risk- based capital, heightened risk management practices should be employed to mitigate risk. As of December 31, 2022, our ratio for the sum of CRE and ADC loans was 190% and our ratio for ADC loans was 32.27%. Our concentration in ADC loans is cyclical and tends to increase in the second and third quarters of each year as demand for newADC loans increases. An increase in ADC loan concentration could cause our ratio for ADC loans to increase and even exceed the abilityFDIC’s guideline. We have exceeded these guidance ratios at times in the past and may do so in the future. We actively monitor and believe that we effectively manage our CRE and ADC loan concentrations. If we exceed the FDIC’s guidelines and do not effectively manage the risk of borrowersour CRE and ADC loans, we may be subject to repay outstanding loans,regulatory scrutiny, including a requirement to raise additional capital, reduce our loan concentrations, or undertake other remedial actions.
We could suffer material credit losses if we do not appropriately manage our credit risk. There are risks inherent in making any loan, including risks in dealing with individual clients, risks of non-payment, risks resulting from uncertainties as to the future value of real estatecollateral and other collateral securing loansrisks resulting from changes in economic and industry conditions. Changes in the value of real estate owned by us, as well aseconomy may cause the assumptions that we made at origination to change and may cause clients to be unable to make payments on their loans. There is no assurance that our credit risk monitoring and loan approval procedures are or will be adequate to address the inherent risks associated with lending. Any failure to manage such risks may materially adversely affect our financial condition and results of operations.
The small to medium-sized businesses that we lend to may have fewer resources to weather adverse business and economic developments, which may impair their ability to repay a loan, and such impairment could adversely affect our operations and financial condition.Our business strategy targets primarily small to medium-sized businesses, which frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete, and may experience substantial volatility in generaloperating results, any of which may impair a client’s ability to repay a loan.
The success of a small to medium-sized business often depends on the management skills, talents and efforts of one or a small number of people, and the market valuedeath, disability or resignation of one or more of these people could have a material adverse impact on the business and its ability to repay its loan. If general economic conditions negatively affect California and small to medium-sized businesses are adversely affected or our common stock. Additionally we have credit exposure to the Hospitality and Entertainment industries (See “Covid-19 Disclosure”) that have been significantly impactedclients are otherwise affected by COVID-19 and the primary collateral for those borrowers is real estate.
Acts of nature, including earthquakes, floods and fires, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.
Our Real Estate Lending Also Exposes Us To The Risk Of Environmental Liabilities - In the course of ouradverse 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 entityconditions or to third persons 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, as 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 ever become subject to significant environmental liabilities,developments, our business, financial condition liquidity and results of operations could be materially and adversely affected.
Our Business Is Subject To Interest Rate Risk And Changes In Interest Rates May Adversely Affect Our Performance And Financial Condition - Our earnings are impactedprofitability depends on interest rates generally, and we may be adversely affected by changingchanges in market interest rates. ChangesOur profitability depends in substantial part on our net interest income. Our net interest income depends on many factors that are partly or completely outside of our control, including competition, monetary and fiscal policies, and economic conditions generally. Our net interest income will be adversely affected if market interest rates impactchange so that the demand for new loans & leases, the credit profile of our borrowers, the rates received on loans & leases and securities and rates paid on deposits and borrowings. The difference between the rates received on loans & leases and securities and the rates paidinterest we pay on deposits and borrowings is known asincreases faster than the net interest margin. The FRB decreased short-term interest rates by 1.5% during 2020,we earn on loans and that has already impacted the Company’s net interest margin. Looking forward, if short-term rates remain low, when combined with aggressive competitor pricing strategies, our net interest margin could be adversely impactedinvestments. In addition, an increase in 2021.
Future levels of market interest rates could adversely affect clients’ ability to pay the principal or interest on existing loans or reduce their borrowings. This may lead to an increase in our earnings. Our CRE and commercial loans carry interest rates that,non-performing assets, a decrease in general, adjust in accordance with changesloan originations, or a reduction in the prime rate. We are also significantly affected by the levelvalue of loan & lease demand available inand income from our market. The inability to make sufficient loans, & leases directly affects the interest income we earn. Lower loan & lease demand will generally result in lower interest income realized as we place funds in lower yielding investments. See “Item 7. Management’s Discussionany of which could have a material and Analysis of Financial Condition and Results of Operations – Overview - Looking Forward: 2021 and Beyond.”
Although we believe our current level of interest rate sensitivity is reasonable, significant fluctuations in interest rates and increasing competition may have an adversenegative effect on our business,operations. Fluctuations in market rates and other market disruptions are neither predictable nor controllable and may adversely affect our financial condition and earnings.
During 2022, inflationary pressures began to affect many aspects of the U.S. economy, including gasoline and fuel prices, and global and domestic supply-chain issues have also had a disruptive effect on many industries, including the agricultural industry. In response, the FRB increased short-term interest rates by 4.25% in 2022, and further increases are generally expected in 2023. The impact of these developments on the business of our clients and on our business cannot be predicted with certainty but could present challenges in 2023 and beyond.
Beginning in 2021, the U.S. economy began to reflect relatively rapid rates of increase in the consumer price index and other economic indices; a prolonged elevated rate of inflation could present risks for the U.S. banking industry and our business. During the latter part of 2021 and into 2022, the U.S. economy exhibited relatively rapid rates of increase in the consumer price index and other economic indices. Pandemic-related supply chain disruptions may be contributing to this development. If the U.S. economy encounters a significant, prolonged rate of inflation, this could pose higher relative risks to the banking industry and our business. Such inflationary periods have historically corresponded with relatively weaker earnings and higher loan losses for banks.
In the past, inflationary environments have caused financing conditions to tighten and have increased borrowing costs for some marginal borrowers, which, in turn, has impacted bank credit quality and loan growth.
Additionally, a sustained period of inflation could prompt broad-based selling of longer-duration, fixed-rate debt, which could have negative implications for equity and real estate markets. Small businesses and leveraged loan borrowers can be challenged in a materially higher-rate environment. Higher interest rates can also present challenges for commercial real estate projects, pressuring valuations and loan-to-value ratios.
In addition, the outbreak of hostilities between Russia and Ukraine and global reactions thereto have increased U.S. domestic and global energy prices. Oil supply disruptions related to the Russia-Ukraine conflict, and sanctions and other measures taken by the U.S. or its allies, have led to higher costs for gas, food and goods in the U.S. and exacerbated the inflationary pressures on the economy, with potentially adverse impacts on our customers and on our business, results of operations. See “Item 7. Management’s Discussionoperations and Analysisfinancial condition.
We face strong competition from banks, credit unions and other financial services providers that offer banking services, which may limit our ability to attract and retain banking clients. Competition in the banking industry generally, and in our geographic market specifically, is strong. Competitors include banks, as well as other financial services providers, such as savings and loan institutions, consumer finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. Our competitors include several larger national and regional financial institutions whose greater resources may afford them a marketplace advantage inasmuch as they may offer a wider array of Financial Conditionbanking services at better rates and Resultsbe able to target a broader client base through more extensive promotional and advertising campaigns. Moreover, larger competitors may not be as vulnerable as we are to downturns in the local economy and real estate market since they have a broader geographic area and their loan portfolio is more diversified. While our deposit base has increased, several banks have grown their deposit market share in our markets faster than we have resulting in a declining relative deposit market share for us in our existing markets. We believe our declining relative market share in deposits has resulted primarily from aggressive marketing and advertising, in-migration of Operations – Net Interest Income/Net Interest Margin”more competitors, expanded delivery channels and “Item 7A. Quantitativemore attractive rates offered by larger bank competitors. We also compete against community banks, credit unions and Qualitative Disclosures About Market Risk - Interest Rate Risk.”non-bank financial services companies that have strong local ties. These smaller institutions are likely to cater to the same small to medium-sized businesses that we target. Additionally, financial technology companies allow clients to obtain loans via the Internet in an expeditious manner and have become competitors. If we are unable to attract and retain customers, we may be unable to continue to grow our loan and deposit portfolios and our operations and financial condition may otherwise be adversely affected. Ultimately, we may be unable to compete successfully against current and future competitors.
Our financial results may be impacted by the cyclicality and seasonality of our agricultural lending business. The Company has provided financing to agricultural customers in the mid Central Valley of California throughout its history. We recognize the cyclical nature of the industry, often caused by fluctuating commodity prices, changing climatic conditions and the availability of seasonal labor, and manage these risks accordingly. The Company remains committed to providing credit to agricultural customers and will always have a material exposure to this industry. Although the Company’s loan portfolio is believed to be well diversified, at various times during 2022 a significant portion of the Company’s loans (as much as 29.8%) were outstanding to agricultural borrowers. Commitments are well diversified across various commodities, including dairy, grapes, walnuts, almonds, cherries, apples, pears, and various row crops. Additionally, many individual borrowers are themselves diversified across commodity types, reducing their exposure, and therefore the Company’s, to cyclical downturns in any one commodity.
The Company’s service areas can also be significantly impacted by the seasonal operations of the agricultural industry. As a result, the Company’s financial results can be influenced by the banking needs of its agricultural customers. Generally speaking, during the spring and summer customers draw down their deposit balances and increase loan borrowings to fund the purchase of equipment and the planting of crops. Deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold. Disruptions in the global supply chain arising from the COVID-19 pandemic may adversely affect the ability of some of our agricultural customers to efficiently export their agricultural products and in turn may adversely affect their results of operations or financial condition and their ability to repay loans we have made to them.
The impact of climate change and governmental and societal responses to climate change, including on the availability of water and the transition to a low-carbon economy, could adversely affect our business and our clients’ businesses. Despite the fact that 2023 began with significant levels of precipitation in California, the State has experienced severe drought conditions at times over the past several years. These weather patterns reinforce the fact that the long-term risks associated with the availability of water are significant. The farming belt of the Central Valley is often cited as an example of an area that experienced extreme drought. However, not all areas of the state are impacted equally, and this is particularly true in the Central Valley, which stretches some 450 miles from Bakersfield in the south to Redding in the north. The vast majority of the Company’s agricultural customers are located in the mid Central Valley, an area that benefits from the drainage of the Sacramento, American, Mokelumne and Stanislaus rivers.
In addition to the impact of climate has on the availability of water, State and Federal regulators ultimately manage this resource, which may also impact that access of our customers’ water. For example, in 2014, the State of California passed the Sustainable Groundwater Management Act. All Water Districts must develop plans to comply with the Act, including groundwater recharge programs. Although the exact impact of compliance is not currently known, and even prior to 2014 most of the water districts in the Bank’s service area had been developing and implementing management plans, it is possible that some water districts will have to ultimately fallow some ground to achieve compliance with the Act.
Additional legislation and regulatory requirements and changes in consumer preferences, including those associated with the transition to a low-carbon economy, could increase expenses of, or otherwise adversely impact, the Company, its businesses or its customers. We and our customers may face cost increases, asset value reductions, operating process changes, reduced availability of insurance, and the like, as a result of governmental actions or societal responses to climate change. New and/or more stringent regulatory requirements relating to climate change or environmental sustainability could materially affect the Company’s results of operations by increasing our compliance costs. Regulatory changes or market shifts to low-carbon products could also impact the creditworthiness of some of our customers or reduce the value of assets securing loans, which may require the Company to adjust our lending portfolios and business strategies.
Changes Toto LIBOR May Adversely Impact The Value Of,may adversely affect the value of, and The Return On, Our Financial Instruments That Are Indexed Tothe return on, our financial instruments that are indexed to LIBOR - . OnIn July 27, 2017, the United Kingdom’s Financial Conduct Authority (the authority that“FCA”) which regulates the London Interbank Funding Rate (“LIBOR”)LIBOR announced that it intends towould stop compelling banks to submit rates for the calculation of LIBOR after 2021 (although it may now. In March 2021, the FCA and LIBOR’s administrator, ICE Benchmarks Administration, announced that LIBOR would no longer be postponed untilprovided (i) for the one-week and two-month U.S. dollar settings and for various foreign currency settings after December 31, 2021, and (ii) for the remaining U.S. dollar settings after June 30, 2023).2023. In addition, the FRB issued guidance urging market participants in the U.S. to cease using LIBOR as a reference rate for new contracts entered into after December 31, 2021. There are on-going efforts to establish an alternative reference rate to LIBOR. The U.S.Secured Overnight Financing Rate (or SOFR) published by the Federal Reserve in conjunction withBank of New York (the “FRBNY”) is considered a likely alternative reference rate suitable for replacing LIBOR. SOFR is a broad measure of the cost of overnight borrowings collateralized by U.S. Treasury securities. The Alternative Reference Rates Committee, (“AARC”), is considering replacinga group of private-market participants convened by the FRBNY to help ensure a successful transition from U.S. dollar LIBOR withto a newly created index called the Secured Overnight Financing Rate (“SOFR”) calculated based on repurchase agreements backed by treasury securities. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administratornew reference rate, has recommended adoption of LIBOR, whether LIBOR rates will cease to be published before December 31, 2021 or June 30, 2023, as applicable, or whether any additional reforms to LIBOR may be enacted. Although the ARRC has announced SOFR as its recommendedthe alternative to LIBOR,reference rate. The scope of the acceptance of SOFR may not gain market acceptance or be widely used as a benchmark. Uncertainty as toand the natureconsequent impact on rates, pricing, the value and liquidity of our financial instruments and liquidity of such potential changes,instruments and the ability to manage risk, including through derivatives, remain uncertain at this time. While some of our existing products or contracts include fallback provisions to alternative reference rates, the eliminationother products or replacementcontracts may not include adequate fallback provisions and may require consent of all parties to any modification. The market transition from LIBOR or other reforms mayand similar benchmarks could adversely affect the return on and pricing, liquidity and value of our outstanding products and contracts, cause market dislocations, increase the cost of and access to capital and increase the risk of disputes and litigation in connection with the interpretation and enforceability of our outstanding products and contracts.
Failure of the U.S. Congress to increase the federal government’s debt limit could have material and adverse impacts on the U.S. and global economies and our business. Discussions are occurring between the Administration and the returnRepublican-controlled House of Representatives regarding the increase in the federal government’s statutory debt limit that is expected to be required later in 2023 in order to allow the U.S. to meet its outstanding obligations, including on its borrowings. If the debt limit were not raised and the U.S. were to default on its obligations, there could be material and adverse impacts on the U.S. and global economies with consequent impacts on the business of our financial instrumentscustomers and our business. Reductions of the ratings on U.S. sovereign debt as a result of issues over the debt ceiling could also have material and adverse impacts on the U.S. economy.
Risks Related to Our Growth
If we are not able to maintain our past levels of growth, our future prospects and competitive position could be diminished and our profitability could be reduced. We may not be able to sustain our deposit, loan, and asset growth at the rate we have attained during the past several years, including the significant deposit growth experienced since the onset of the COVID-19 pandemic. Our Accounting Estimates And Risk Management Processes Rely On Analytical And Forecasting Models - The processesgrowth over the past several years has been driven primarily by agricultural and commercial real estate growth in our market areas, growth in non-real estate agricultural and commercial loans, commercial leasing, and residential real estate. A failure to attract and retain high performing employees, heightened competition from other financial services providers, and an inability to attract additional core deposits and lending clients, among other factors, could limit our ability to grow as rapidly as we use to measurehave in the fair value of financial instruments,past and as well as the processes used to estimate the effects of changing interest rates and other market measuressuch could have a negative effect on our financial condition and resultsoperations.
If we are adequate, the models may proveunable to be inadequate or inaccurate because of other flaws in their design or their implementation. If the models we use for interest rate risk and asset-liability management are inadequate,manage our growth effectively, we may incur higher than anticipated costs, and our ability to execute our growth strategy could be impaired. It is our objective to continue to grow our assets and deposits by increasing our product and service offerings and expanding our operations organically. Our ability to manage growth successfully will depend on our ability to (i) identify suitable markets for expansion; (ii) attract and retain qualified management; (iii) attract funding to support additional growth; (iv) maintain asset quality and cost controls; (v) maintain adequate regulatory capital and profitability to support our lending activities; and (vi) may include finding attractive acquisition targets and successfully acquire and integrate the acquisitions in an efficient manner. If we do not manage our growth effectively, we may be unable to realize the benefit from our investments in technology, infrastructure, and personnel that we have made to support our expansion. In addition, we may incur higher costs and realize less revenue growth, which would reduce our earnings and diminish our future prospects. Failing to maintain effective financial and operational controls, as we grow, such as appropriate loan underwriting procedures, adequate allowances for credit losses and compliance with regulatory requirements could have a negative effect on our financial condition and operations, such as increased credit losses, reduced earnings and potential regulatory restrictions on growth.
Entering new market areas, new lines of business, or unexpected losses upon changes in market interest rates or other market measures. If the models we usenew products and services may subject us to measure the fair value of financial instruments are inadequate, the fair value of such financial instrumentsadditional risks. A failure to successfully manage these risks may fluctuate unexpectedly or may not accurately reflect what we could realize upon sale or settlement of such financial instruments. Any such failure in our analytical or forecasting models could have a material adverse effect on our business, financial condition and results of operations.
Failure To Successfully Execute Our Strategy Could Adversely Affect Our Performance - Our financial performance and profitability depends on our ability to execute our corporate growth strategy. Continued growth however, may present operating and other problems that could adversely affect our business, financial condition and results of operations. 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. Factors that may adversely affect our ability to attain our long-term financial performance goals include those stated elsewhere in this section, as well as the:
inability to maintain or increase net interest margin;
inability to control non-interest expense, including, but not limited to, rising employee and healthcare costs and the costs of regulatory compliance;
inability to maintain or increase non-interest income;
the need to raise additional capital to support growth and regulatory requirements; and
continuing ability to expand through de novo branching or otherwise.
Growth May Produce Unfavorable Outcomes - We seek to expand our franchise safely and consistently. A successful growth strategy requires us to manage multiple aspects of the business simultaneously, such as following adequate loan underwriting standards, balancing loan and deposit growth without increasing interest rate risk or compressing our net interest margin, maintaining sufficient capital, and recruiting, training and retaining qualified professionals.
Our growth strategy also includes acquisition possibilities (such as Delta National Bancorp & Bank of Rio Vista) that either enhance our market presence or have potential for improved profitability through financial management, economies of scale or expanded services. We may be exposed to difficulties in combining the operations of acquired institutions into our own operations, which may prevent us from achieving the expected benefits from our acquisition activities. Inherent uncertainties exist in integrating the operations of an acquired institution and there is no assurance that we will be able to do so successfully. Among the issues that we could face are:
unexpected problems with operations, personnel, technology or credit;
loss of customers and employees of the acquiree;
difficulty in working with the acquiree's employees and customers;
the assimilation of the acquiree's operations, culture and personnel;
instituting and maintaining uniform standards, controls, procedures and policies; and
litigation risk not discovered during the due diligence period.
Undiscovered factors as a result of an acquisition could bring liabilities against us, our management and the management of the institutions we acquire. These factors could contribute to our not achieving the expected benefits from our acquisitions within desired time frames, if at all. Further, although we anticipate cost savings as a result of mergers, we may not be able to fully realize those savings. Any cost savings that are realized may be offset by losses in revenues or other charges to earnings.
New Market Areas And New Lines Of Business Or New Products And Services May Subject Us To Additional Risks. A Failure To Successfully Manage These Risks May Have A Material Adverse Effect On Our Business -business. As part of our growth strategy, we have implemented and may continue to implemententer new market areas and new lines of business. We recently have begun to: (i) expandexpanded into the East Bay area of San Francisco and Napa, which are relatively new market areas for us; and (ii) introduceus. We introduced commercial equipment leasing as a new product line.line a few years ago. There are risks and uncertainties associated with these efforts, particularly in instances where such product lines are not fully mature. In developing and marketing new lines of business and/or new products and services and/or shifting the focus of our asset mix and/or expanding into new markets, we may invest significant time and resources. Initial timetables may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives in these markets and shifting market preferences, may also impactaffect the successful implementation. Failure to successfully manage these risks could have an adverse effect on our business, financial condition and results of operations.
Our Financial Results Can Be Impacted By The Cyclicality and Seasonality Of Our Agricultural Business And The Risks Related Thereto -to Our Personnel
We may have difficulty attracting additional necessary personnel, which may divert resources and limit our ability to successfully expand our operations. The Company has provided financingOur business plan includes, and is dependent upon, our hiring and retaining highly qualified and motivated associates at every level. We have experienced, and expect to agricultural customerscontinue to experience, substantial competition in the Central Valley throughout its history. We recognize the cyclical nature of the industry, often caused by fluctuating commodity prices, changing climatic conditionsidentifying, hiring and the availability of seasonal labor,retaining top-quality associates due to low unemployment rate and new financial institutions entering our markets. If we are unable to hire and retain qualified personnel, we may be unable to successfully execute our business strategy and manage these risks accordingly. The Company remains committed to providing credit to agricultural customers and will always have a material exposure to this industry. Although the Company’s loan portfolio is believed to be well diversified, at various times during 2020 approximately 29% of the Company’s loan balances were outstanding to agricultural borrowers. Commitments are well diversified across various commodities, including dairy, grapes, walnuts, almonds, cherries, apples, pears, and various row crops. Additionally, many individual borrowers are themselves diversified across commodity types, reducing their exposure, and therefore the Company’s, to cyclical downturns in any one commodity. Agriculture has been deemed an “essential” industry during the COVID-19 pandemic, helping mitigate economic stress in the industry.
The Company’s service areas can also be significantly impacted by the seasonal operations of the agricultural industry. As a result, the Company’s financial results can be influenced by the banking needs of its agricultural customers (e.g., generally speaking during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and the planting of crops. Correspondingly, deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold).our growth.
The Impactunexpected loss of Climatekey officers would materially and Governmentadversely affect our ability to execute our business strategy, and diminish our future prospects. Our success to date and our prospects for success in the future depend substantially on our senior management team. The Availabilityloss of Water is a Long Term Risk That Could Affect Our Customers’ Businesses - The Statekey members of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rainour senior management team could materially and snow have alleviated drought conditions in California. Asadversely affect our ability to successfully implement our business plan and, as a result, current reservoir levels are adequate and the availabilityour future prospects. The loss of water insenior management without qualified successors who can execute our primary service area should not bestrategy would also have an issue. However, the weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.adverse impact on us.
As a community bank, our ability to maintain our positive reputation is critical to the success of our business. The farming beltfailure to maintain that reputation may materially and adversely affect our financial performance. Our reputation is one of the Central Valley was often cited asmost valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an example of an area that experienced extreme drought during 2013 - 2016. However, it is important to understand that not all areasintegral part of the state were impacted equally, and thiscommunities we serve, delivering superior service to our clients. If our reputation is particularly true innegatively affected by the Central Valley, which stretches some 450 miles from Bakersfield in the south to Redding in the north. The vast majority of the Company’s agricultural customers are located in the more northern portion of the Central Valley, an area that benefits from the drainage of the Sacramento, American, Mokelumne and Stanislaus rivers. As a result, even during the worst of the drought farmers in this area still had access to reasonable ground water sources that were economical to pump.
Importantly, the Company has minimal credit exposure in the more southern portion of the Central Valley, defined broadly as an area south of Highway 152, but more importantly the Fresno area and south (including the Westlands Water District). In most of these areas ground water levels were depleted, making farmers increasingly dependent on the delivery of surface water from the Central Valley Project, which cut back deliveries to many farmers during the worst of the drought.
In addition to the impact of climate on the availability of water, the “politics” of water, and how the state and federal governments ultimately manage this resource, could also impact how much water our customers have access to. For example, in 2014, the State of California passed the Sustainable Groundwater Management Act. All Water Districts must develop plans to comply with the Act, including groundwater recharge programs. Although the exact impact of compliance is not currently known, and even prior to 2014 most of the Water Districts in the Bank’s service area had been developing and implementing management plans, it is possible that some Water Districts will have to ultimately fallow some ground to achieve compliance with the Act.
This example points out how the “politics” of water can also affect the availability of water.
The Company monitors the water situation through: (i) regularly reviewing ground water level reports provided by California’s Department of Water Resources; (ii) requiring water budgets and plans from allactions of our agricultural borrowers that detail the sources of their irrigation wateremployees or otherwise, our business and, the irrigation requirements to achieve their crop plan;therefore, our operating results may be materially and (iii) in the case of new permanent crop development projects, requiring well tests.adversely affected.
Risks Related to Our Financial Practices
Our allowance for credit losses may not be adequate to cover actual losses. A significant source of risk arises from the possibility that we could sustain losses due to loan defaults and non-performance on loans. We Face Strong Competition From Financial Service Companies And Other Companies That Offer Banking Services That Could Adversely Impact Our Business -maintain an allowance for credit losses in accordance with U.S. generally accepted accounting principles to provide for such defaults and other non-performance. The financial services business in our market areasdetermination of the appropriate level of this allowance is highly competitive. Itan inherently difficult process and is becoming increasingly competitive duebased on numerous assumptions. The amount of future losses is susceptible to changes in regulation, technological advances,economic, operating and the accelerating pace of consolidation among financial services providers. We face competition bothother conditions, including changes in attracting deposits and in making loans & leases. We compete for loans & leases principally through the interest rates, which may be beyond our control. In addition, our underwriting policies, adherence to credit monitoring processes, and loan & lease fees we chargerisk management systems and controls may not prevent unexpected losses. Our allowance for credit losses may not be adequate to cover actual credit losses. Moreover, any increase in our allowance for credit losses will adversely affect our earnings.
In June 2016, the efficiencyFinancial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 became effective January 1, 2020, and qualitysubstantially changed the accounting for credit losses on loans and other financial assets held by banks, financial institutions and other organizations. The standard replaced existing incurred loss impairment guidance and established a single allowance framework for financial assets carried at amortized cost. Upon adoption of services we provide. Increasing levelsASU 2016-13, companies must recognize credit losses on these assets equal to management’s estimate of competition incredit losses over the full remaining expected life. Companies must consider all relevant information when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts. We adopted and implemented this accounting standard fully effective January 1, 2022. The adoption of ASU 2016-13 did not have a material negative effect on the level of allowance for credit loss held by us or on our reported earnings. The potential negative effect that the adoption of this new accounting pronouncement may have on future lending by us or the banking and financial services business may reduceindustry in general is still not well known. We believe that our market share, decreaseallowance for credit losses as of December 31, 2022 was adequate to absorb expected credit losses inherent in our loan & lease demand, cause the pricesportfolio; however, we charge for our servicescannot assure that such levels will be sufficient to fall,cover actual or decrease our net interest margin by forcing us to offer lower lending interest rates and pay higher deposit interest rates. Therefore, our results may differ in future periods depending upon the nature or level of competition.losses.
TechnologyOur financial and other changes are allowing partiesaccounting estimates and risk management framework rely on analytical forecasting and models. The processes we use to completeestimate our inherent credit losses and to measure the fair value of financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income,instruments, as well as the lossprocesses used to estimate the effects of customer depositschanging interest rates and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effectother market measures on our financial condition and resultsoperations, depend upon the use of operations.analytical and forecasting models. Some of our tools and metrics for managing risk are based upon our use of observed historical market behavior. We rely on quantitative models to measure risks and to estimate certain financial values. Models may be used in such processes as determining the pricing of various products, grading loans and extending credit, measuring interest rate and other market risks, predicting losses, assessing capital adequacy and calculating regulatory capital levels, as well as estimating the value of financial instruments and balance sheet items.
ManyPoorly designed or implemented models present the risk that our business decisions based on information incorporating such models will be adversely affected due to the inadequacy of that information. Moreover, our competitors offer productsmodels may fail to predict future risk exposures if the information used in the model is incorrect, obsolete or not sufficiently comparable to actual events as they occur.
We seek to incorporate appropriate historical data in our models, but the range of market values and services thatbehaviors reflected in any period of historical data is not at all times predictive of future developments in any particular period and the period of data we do not offer,incorporate into our models may prove to be inappropriate for the period being modeled. In such case, our ability to manage risk would be limited and many have substantiallyour risk exposure and losses could be significantly greater resources, suchthan our models indicated. This could harm our reputation as greater capital resourceswell as our revenues and more accessprofits. Finally, information we provide to longer term, lower cost funding sources. Manyour regulators based on poorly designed or implemented models could also have greater name recognition and market presence that benefit them in attracting business. In addition, larger competitors may be able to price loans & lease and deposits more aggressively than we do. Our larger competitors generally have easier access to capital, and often on better terms.inaccurate or misleading. Some of the financial services organizations with which we compete are not subjectdecisions that our regulators make, including those related to capital distributions to our stockholders, could be affected adversely due to their perception that the same degree of regulation as is imposed on bank holding companies and federally insured state-chartered banks, national banks and federal savings institutions. As a result, these non-bank competitors have certain advantages over us in accessing funding and in providing various services. Other competitors are subject to similar regulation but have the advantages of larger established customer bases, higher lending limits, extensive branch networks, numerous automated teller machines, greater advertising and marketing budgets or other factors. Some of our competitors have other advantages, such as tax exemption in the case of credit unions, and lesser regulation in the case of mortgage companies and specialty finance companies.
Deposit Insurance Assessments Could Increase At Any Time, Which Will Adversely Affect Profits - FDIC deposit insurance expense for the years 2020, 2019, and 2018 was $517,000, $624,000, and $912,000, respectively. During 2016 the FDIC changed its methodology for calculating deposit premiums, See “Item 1. Business – Supervision and Regulation – Deposit Insurance.” Any increases could have adverse effects on the operating expenses and results of operationsquality of the Company.
We May Not Be Able To Attract And Retain Skilled People - Our success depends, in large part, on our abilitymodels used to attract and retain key people. Competition forgenerate the best people in most of our activities can be intense and we may not be able to hire people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
Our Internal Operations Are Subject To A Number Of Risks - We are subject to certain operations risks, including, but not limited to,relevant information system failures and errors, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. We maintain a system of internal controls to mitigate against such occurrences and maintain insurance coverage for such risks that are insurable, but should such an event occur that is not prevented or detected by our internal controls, uninsured or in excess of applicable insurance limits, it could have a significant adverse impact on our business, financial condition or results of operations.insufficient.
Impairment of investment securities could require charges to earnings, which would negatively affect our operations. We rely heavilymaintain a significant amount of our assets in investment securities, and must periodically evaluate investment securities for impairment under previously adopted accounting guidance during 2021 or for current expected credit losses after the adoption of ASU 2016-13. We evaluate our investment securities portfolio for impairment as of each reporting date. At December 31, 2022, we had no investment securities that were impaired.
Changes in accounting standards could materially affect our financial statements. The Company’s consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America, called GAAP. The financial information contained within our consolidated financial statements is, to a significant extent, financial information that is based on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan & leases and other systems. While we have policies and procedures designed to prevent or limit the effectapproximate measures of the failure, interruption or security breachfinancial effects of our information systems, there can be no assurancetransactions and events that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrencehave already occurred. A variety of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
Natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. Such eventsfactors could affect the stabilityultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. Other estimates that we use are fair value of our deposit base, impair the ability of borrowers to repay outstanding loanssecurities and lessees to make lease payments, impair the value of collateral securing loans & leases, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Operations in severalexpected useful lives of our markets could be disrupted by bothdepreciable assets. From time to time, the evacuationFASB and the SEC change the financial accounting and reporting standards that govern the preparation of large portions of the population as well as damage and or lack of access to our banking and operation facilities. While we have not experienced such an occurrence to date, other natural disasters, acts of war or terrorism or other adverse external events may occur in the future. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial conditionstatements or new interpretations of existing standards emerge. These changes can be difficult to predict and results of operations.
The Value of Goodwilloperationally complex to implement and Other Intangible Assets May Decline in the Future - As of December 31, 2020,can materially affect how we had goodwill totaling $11.2 millionrecord and a core deposit intangible asset totaling $4.0 million from business acquisitions. A significant decline in expected future cash flows, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock could necessitate taking charges in the future related to the impairment of goodwill or other intangible assets. If we were to conclude that a future write-down of goodwill or other intangible assets is necessary, we would record the appropriate charge, which could have a material adverse effect on our business, financial condition and results of operations.
We Depend On Cash Dividends From The Bank To Meet Our Cash Obligations - As a holding company, dividends from the Bank provide a substantial portion of our cash flow used to service the interest payments on our subordinated debentures issued in 2003 and our other obligations, including cash dividends. See “Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.” Various statutory provisions restrict the amount of dividends our subsidiary bank can pay to us without regulatory approval.
A Lack Of Liquidity Could Adversely Affect Our Operations And Jeopardize Our Business, Financial Condition And Results Of Operations - Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, the sale of our investment securities, Federal Home Loan Bank advances, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our most important source of funds consists of deposits. Deposit balances can decrease when customers perceive alternative investments as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments, we would lose a relatively low-cost source of funds, increasing our funding costs and reducing our net interest income and net income.
Other primary sources of funds consist of cash flows from operations, investment maturities and sales of investment securities and proceeds from the issuance and sale of any equity and debt securities to investors. Additional liquidity is provided by the ability to borrow from the Federal Reserve Bank and the Federal Home Loan Bank and our ability to raise brokered deposits. We also may borrow funds from third-party lenders, such as other financial institutions. Our access to funding sources in amounts adequate to finance or capitalize our activities, or on terms that are acceptable to us, could be impaired by factors that affect us directly or the bank or non-bank financial services industries or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the bank or non-bank financial services industries.
As of December 31, 2020, approximately $2.2 billion, or 53.3%, of our deposits consisted of interest-bearing demand deposits, savings and money market accounts. Based on past experience, we believe that our deposit accounts are relatively stable sources of funds. If we increase interest rates paid to retain deposits, our earnings may be adversely affected, which could have an adverse effect on our business, financial condition and results of operations. Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to our stockholders or to fulfill obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, financial condition and results of operations.
System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities - The computer systems and network infrastructure we use could be vulnerable to hardware and cyber-security issues. Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. We could also experience a breach by intentional or negligent conduct on the part of employees or other internal or external sources, including our third-party vendors. Any damage or failure that causes an interruption in our operations could have an adverse effect onreport our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure utilized by us, including our internet banking activities, against damage from physical break-ins, cyber-security breaches and other disruptive problems caused by the internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability, damage our reputation and inhibit the use of our internet banking services by current and potential customers.
We rely heavily on communications, information systems (both internal and provided by third-parties) and the internet to conduct our business. Our business is dependent on our ability to process and monitor large numbers of daily transactions in compliance with legal, regulatory and internal standards and specifications. In addition, a significant portion of our operations relies heavily on the secure processing, storage and transmission of personal and confidential information, such as the personal information of our customers and clients. In recent periods, several governmental agencies and large corporations, including financial service organizations and retail companies, have suffered major data breaches, in some cases, exposing not only their confidential and proprietary corporate information, but also sensitive financial and other personal information of their clients and their employees or other third-parties, and subjecting those agencies and corporations to potential fraudulent activity and their clients and other third-parties to identity theft and fraudulent activity in their credit card and banking accounts. Therefore, security breaches and cyber-attacks can cause significant increases in operating costs, including the costs of compensating clients and customers for any resulting losses they may incur and the costs and capital expenditures required to correct the deficiencies in and strengthen the security of data processing and storage systems. These risks may increase in the future as we continue to increase mobile payments and other internet-based product offerings and expand our internal usage of web-based products and applications.
In addition to well-known risks related to fraudulent activity, which take many forms, such as check “kiting” or fraud, wire fraud, and other dishonest acts, information security breaches and cyber-security related incidents have become a material risk in the financial services industry. For example, U.S. financial institutions have experienced significant distributed denial-of-service attacks, some of which involve sophisticated and targeted attacks intended to disable or degrade service, or sabotage systems. Other potential attacks attempt to obtain unauthorized access to confidential information, steal money, or manipulate or destroy data, often through the introduction of computer viruses or malware, cyber-attacks and other means. Other threats of this type may include fraudulent or unauthorized access to data processing or data storage systems used by us or by our clients, electronic identity theft, “phishing,” account takeover, and malware or other cyber-attacks. To date, none of these types of attacks have had a material effect on our business or operations. Such security attacks can originate from a wide variety of sources, including persons who are involved with organized crime or who may be linked to terrorist organizations or hostile foreign governments. Those same parties may also attempt to fraudulently induce employees, customers or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers or clients.
We are also subject to the risk that our employees may intercept and transmit unauthorized confidential or proprietary information. An interception, misuse or mishandling of personal, confidential or proprietary information being sent to or received from a customer or third-party could result in legal liabilities, remediation costs, regulatory actions and reputational harm.
Unfortunately, it is not always possible to anticipate, detect, or recognize these threats to our systems, or to implement effective preventative measures against all breaches, whether those breaches are malicious or accidental. Cyber-security risks for banking organizations have significantly increased in recent years and have been difficult to detect before they occur because of the following, among other reasons:
the proliferation of new technologies, and the use of the Internet and telecommunications technologies to conduct financial transactions;
these threats arise from numerous sources, not all of which are in our control, including among others human error, fraud or malice on the part of employees or third-parties, accidental technological failure, electrical or telecommunication outages, failures of computer servers or other damage to our property or assets, natural disasters or severe weather conditions, or terrorist acts;
the techniques used in cyber-attacks change frequently and may not be recognized until launched or until well after the breach has occurred;
the increased sophistication and activities of organized crime groups, hackers, terrorist organizations, hostile foreign governments, disgruntled employees or vendors, activists and other external parties, including those involved in corporate espionage;
the vulnerability of systems to third-parties seeking to gain access to such systems either directly or using equipment or security passwords belonging to employees, customers, third-party service providers or other users of our systems; and
our frequent transmission of sensitive information to, and storage of such information by, third-parties, including our vendors and regulators, and possible weaknesses that go undetected in our data systems notwithstanding the testing we conduct of those systems.
Our investments in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and our conduct of periodic tests of our security systems and processes, may not succeed in anticipating or adequately protecting against or preventing all security breaches and cyber-attacks from occurring.Even the most advanced internal control environment may be vulnerable to compromise. Targeted social engineering attacks are becoming more sophisticated and are extremely difficult to prevent. Additionally, the existence of cyber-attacks or security breaches at third-parties with access to our data, such as vendors, may not be disclosed to us in a timely manner. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modifyapply a new or enhancerevised standard retrospectively, resulting in our protective measures or to investigate and remediate any information security vulnerabilities or incidents.We maintain a system of internal controls and insurance coverage to mitigate against operational risks, including data processing system failures and errors and customer or employee fraud. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business,restating prior period financial condition and results of operations.statements.
As is the case with non-electronic fraudulent activity, cyber-attacks or other information or security breaches, whether directed at us or third-parties, may result in a material loss or have material consequences. Furthermore, the public perception that a cyber-attack on our systems has been successful, whether or not this perception is correct, may damage our reputation with customers and third-parties with whom we do business. A successful penetration or circumvention of system security could cause us negative consequences, including loss of customers and business opportunities, disruptionRisks Related to our operations and business, misappropriation or destruction of our confidential information and/or that of our customers, or damageOur Access to our customers’ and/or third-parties’ computers or systems, and could expose us to additional regulatory scrutiny and result in a violation of applicable privacy laws and other laws, litigation exposure, regulatory fines, penalties or intervention, loss of confidence in our security measures, reputational damage, reimbursement or other compensatory costs, additional compliance costs, and could adversely impact our results of operations, liquidity and financial condition.
We Rely On Third-Party Vendors For Important Aspects Of Our Operation - We depend on the accuracy and completeness of information and systems provided by certain key vendors, including but not limited to data processing, payroll processing, technology support, investment safekeeping and accounting. Our ability to operate, as well as our financial condition and results of operations, could be negatively affected in the event of an interruption of an information system, an undetected error, a cyber breach, or in the event of a natural disaster whereby certain vendors are unable to maintain business continuity.Capital
We May Be Adversely Affected By The Soundness Of Other Financial Institutions -may be unable to, or choose not to, pay dividends on our common shares. Financial services institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We have exposureconsistently declared an annual cash dividend for over 87 years. Our ability to many different industriescontinue to pay dividends depends on various factors. FMCB is a legal entity separate and counterparties,distinct from the Bank, and routinely execute transactionsdoes not conduct stand-alone operations, which means that the Bank must first pay dividend(s) to the Company. The FDIC, the DFPI and California corporate and banking laws may, under certain circumstances, prohibit the Bank’s payment of dividends to FMCB. FRB policy requires bank holding companies to pay cash dividends on common shares only out of net income available over the past year and only if prospective earnings retention is consistent with counterpartiesthe organization’s expected future needs and financial condition. FMCB’s Board of Directors may determine that, even though funds are available for dividend payments, retaining the funds for other internal uses, such as expansion of our operations, is necessary or appropriate in the financial services industry, including commercial banks, broker-dealers, investment banks and other institutional clients. Manylight 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 if our collateral cannot be foreclosed upon or is liquidated at prices not sufficient to recover the full amount of the credit or cover the derivative exposure due. Any such losses could have a material adverse effect on our business financial conditionplan and results of operations.objectives. A failure to pay dividends may negatively affect your investment.
Deterioration Of Credit Quality Or Insolvency Of Insurance Companies May Impede Our Ability To Recover Losses - The financial crisis led certain major insurance companies to be downgraded by rating agencies. We have property, casualty and financial institution risk coverage underwritten by several insurance companies. In addition, someprice of our investments in obligations of statecommon shares may fluctuate significantly and political subdivisions are insured by insurance companies. While we closely monitor credit ratings of our insurers and insurers of our municipality securities, and we are poised to make quick changes if needed, we cannot predict an unexpected inability to honor commitments. We also invest in bank-owned life insurance policies on certain members of senior Management,stock may have low trading volumes, which may lose value in the event of the carriers' insolvency. In the event that our bank-owned life insurance policy carriers' credit ratings fall below investment grade, we may exchange policies underwritten by them to another carrier at a cost charged by the original carrier, or we may terminate the policies that may result in adverse tax consequences.
Our loan portfolio is also primarily secured by properties located in earthquake or fire-prone zones. In the event of a disaster that causes pervasive damage to the region in which we operate, not only the Bank, but also the loan collateral may suffer losses not recovered by insurance.
Risks Associated With Our Industry
We Are Subject To Government Regulation That Could Limit Or Restrict Our Activities, Which In Turn Could Adversely Impact Our Financial Performance - The financial services industry is regulated extensively and we are subject to examination, supervision and comprehensive regulations by various regulatory agencies. Federal and state regulations are designed primarily to protect the deposit insurance funds and consumers, and not to benefit our stockholders. These regulations can sometimes impose significant limitations on our operations and increase our cost of doing business.
Further, federal monetary policy, particularly as implemented by the FRB, significantly affects economic conditions for us.
Proposals to change the laws and regulations governing the operations and taxation of, and federal insurance premiums paid by, banks and other financial institutions and companies that control such institutions are frequently raised in the U.S. Congress, the California legislature and before bank regulatory authorities. The likelihood of any major changes in the future and the impact such changes, including the Dodd-Frank Act, might have on us or the Bank are impossible to determine. Similarly, proposals to change the accounting treatment applicable to banks and other depository institutions are frequently raised by the SEC, the federal banking agencies, the IRS and other appropriate authorities. The likelihood and impact of any additional future changes in law or regulation and the impact such changes might have on us or the Bank are impossible to determine at this time.
Risks Associated With Our Stock
Our Stock Trades Less Frequently Than Others - The Company’s common stock is not widely held or listed on any exchange. However, trades are reported on the OTCQX under the symbol "FMCB". The limited trading market for the Company’s common stock may make it difficult for stockholdersyou to dispose of their shares.
Our Stock Price Is Affected By A Variety Of Factorsresell common shares owned by you at times or prices you find attractive. - StockThe stock market and, in particular, the market for financial institution stocks, has experienced significant volatility. The markets may produce downward pressure on stock prices for certain issuers without regard to those issuers’ underlying financial strength. As a result, the trading volume in our common shares may fluctuate and cause significant price volatilityvariations to occur. This may make it more difficult for you to resell your common stock whenshares owned by you want andat times or at prices you find attractive.
The low trading volume in our common shares on the OTCQX means that our shares may have less liquidity than other companies, who shares are more broadly traded. We cannot ensure that the volume of trading in our common shares or the price of our common shares will be maintained or will increase in the future. Our stock price can fluctuate significantly in response to a variety of factors discussed in this section, including, among other things:
actual or anticipated variations in quarterly results of operations;
operating and stock price performance of other companies that investors deem comparable to our Company;
news reports relating to trends, concerns and other issues in the financial services industry;
available investment liquidity in our market area since our stock is not listed on any exchange; and
perceptions in the marketplace regarding our Company and/or its competitors.
If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable. We may need to raise additional capital in the future to support our continued growth and to maintain our capital levels. Our ability to raise capital through the sale of additional securities will depend primarily upon our financial condition and the condition of financial markets at that time. Accordingly, we may not be able to obtain additional capital in the amounts or on terms satisfactory to us. Our growth may be constrained if we are unable to generate or raise additional capital as needed.
Our Common Stock Is Not An Insured Depositfunding sources may prove insufficient to provide liquidity, replace deposits and support our future growth. We rely on customer deposits, advances from the Federal Home Loan Bank of San Francisco (“FHLB”), lines of credit at other financial institutions and the Federal Reserve Bank to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, we may not be able to replace such funds in the future if our financial condition, the financial condition of the FHLB or market conditions were to change. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our profitability would be adversely affected. FHLB borrowings and other current sources of liquidity may not be available or, if available, not sufficient to provide adequate funding for operations. Furthermore, our own actions could result in a loss of adequate funding. For example, our borrowing capacity at the FHLB could be reduced if we are deemed to have poor documentation or processes. Accordingly, we may be required to seek additional higher-cost debt in the future to achieve our long-term business objectives. Additional borrowings, if sought, may not be available to us or, if available, may not be available on favorable terms. If additional financing sources are unavailable or are not available on reasonable terms, our growth and future prospects could be adversely affected.
-We may be adversely affected by the lack of soundness of other financial institutions or financial market utilities. Our ability to engage in routine funding and other transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial institutions are interrelated because of trading, clearing, counterparty or other relationships. Defaults by, or even rumors or questions about, one or more financial institutions or financial market utilities, or the financial services industry generally, may lead to market-wide liquidity problems and losses of client, creditor and counterparty confidence and could lead to losses or defaults by us or by other financial institutions.
Risks Related to Cyber-security and Information Technology
Cyber-attacks or other security breaches could have a material adverse effect on our business. In the normal course of business, we collect, process, and retain sensitive and confidential information regarding our clients. We also have arrangements in place with other third parties through which we share and receive information about their clients who are or may become our clients. Although we devote significant resources and management focus to ensuring the integrity of our systems through information security and business continuity programs, our facilities and systems, and those of third-party service providers, are vulnerable to external or internal security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming or human errors or other similar events.
Information security risks for financial institutions have increased recently in part because of new technologies, the use of the Internet and telecommunications technologies (including mobile devices) to conduct financial and other business transactions, and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, terrorists and others. In addition to cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers recently have engaged in attacks against large financial institutions, particularly denial of service attacks that are designed to disrupt key business services, such as client-facing websites. We are not able to anticipate or implement effective preventive measures against all potential security breaches, because the techniques used change frequently and because attacks can originate from a wide variety of sources. We employ detection and response mechanisms designed to contain and mitigate security incidents, but early detection may be thwarted by sophisticated attacks and malware designed to avoid detection.
We also face risks related to cyber-attacks and other security breaches in connection with credit and debit card transactions that typically involve the transmission of sensitive information regarding our clients through various third parties, including merchant acquiring banks, payment processors, payment card networks and our core processors. Some of these parties have in the past been the target of security breaches and cyber-attacks, and because the transactions involve third parties and environments such as the point of sale that we do not control or secure, future security breaches or cyber-attacks affecting any of these third parties could impact us through no fault of our own, and in some cases we may have exposure and suffer losses for breaches or attacks relating to them. We also rely on numerous other third-party service providers to conduct other aspects of our business operations and face similar risks relating to them. While we regularly conduct security assessments on these third parties, we cannot be sure that their information security protocols are sufficient at all times to withstand a cyber-attack or other security breach.
The access by unauthorized persons to, or the improper disclosure by us of, confidential information regarding our clients or our own proprietary information, software, methodologies, and business secrets could result in significant legal and financial exposure, supervisory liability, damage to our reputation or a loss of confidence in the security of our systems, products and services, which could have a material adverse effect on our financial condition or operations. In the past several years, there have been a number of well-publicized attacks or breaches affecting others in our industry that have heightened concern by consumers and have resulted in increased regulatory focus. Furthermore, cyber-attacks or other breaches in the future, whether affecting others or us, could intensify consumer concern and regulatory focus and result in reduced use of our cards and increased costs, all of which could have a material adverse effect on our business. To the extent we are involved in any future cyber-attacks or other breaches, our brand and reputation could be affected, and this could have a material adverse effect on our financial condition and operations. If we experience a cyber-attack, our insurance coverage may not cover all losses, and furthermore, we may experience a loss of reputation.
We rely on our information technology and telecommunications systems and third-party servicers, and the failure of these systems could adversely affect our business. Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. We rely on these systems to process new and renewal loans, provide client service, facilitate collections and share data across our organization. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans and provide client service or compromise our ability to collect loan payments in a timely manner. Our ability to adopt new information technology and technological products needed to meet our clients’ banking needs may be limited if our third-party servicers are slow to adopt or choose not to adopt such new technology and products. Such a failure to provide this technology and products to our clients could result in a loss of clients, which would negatively affect our financial condition and operations.
Other Operational Risks
Our risk management framework may not be effective in mitigating risks and losses to us. Our risk management framework is comprised of various processes, systems and strategies, and is designed to manage the types of risk to which we are subject, including, among others, credit, market, liquidity, interest rate and compliance. Our framework also includes financial or other modeling methodologies that involve management assumptions and judgment. Our risk management framework may not be effective under all circumstances and may not adequately mitigate any risk of loss to us. If our framework is not effective, we could suffer unexpected losses and our financial condition, operations or business prospects could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.
We are subject to certain operating risks, related to client or employee fraud, which could harm our reputation and business. Employee error, or employee or client misconduct, could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our clients or improper use of confidential information. It is not always possible to prevent employee error and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee error could also subject us to financial claims for negligence. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured, excess insurance coverage is denied or not available, it could have a material adverse effect on our financial condition and operations.
We depend on the accuracy and completeness of information about clients and counterparties. In deciding whether to extend credit or enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. In deciding whether to extend credit, we may rely upon our clients’ representations that their financial statements conform to U.S. generally accepted accounting principles, or GAAP, and present fairly, in all material respects, the financial condition, operations and cash flows of the client. We also may rely on client representations and certifications, or other auditors’ reports, with respect to the business and financial condition of our clients. Our financial condition, operations, financial reporting and reputation could be negatively affected if we rely on materially misleading, false, inaccurate or fraudulent information provided by or about clients and counterparties.
Catastrophic events including, but not limited to, hurricanes, tornadoes, earthquakes, fires, floods, prolonged drought, and pandemics may adversely affect the general economy, financial and capital markets, specific industries, and the Bank. The Bank has significant operations and a significant customer base in regions where natural and other disasters may occur. These regions are known for being vulnerable to natural disasters and other risks, such as earthquakes, fires, floods, and prolonged drought. These types of natural catastrophic events at times have disrupted the local economy, the Bank’s business and clients, and could pose physical risks to the Bank’s property. In addition, catastrophic events, such as natural disasters or global pandemics, occurring in other regions of the world may have an impact on the Bank’s clients and in turn on the Bank. Although we have business continuity and disaster recovery programs in place, a significant catastrophic event could materially adversely affect the Bank’s operating results.
The physical effects of climate change, as well as governmental and societal responses to climate change could materially adversely affect our operations, businesses and customers. There is increasing concern over the risks of climate change and related environmental sustainability matters. The physical effects of climate change include rising average global temperatures, rising sea levels and an increase in the frequency and severity of extreme weather events and natural disasters, including droughts, wildfires, floods, hurricanes and tornados. Most of the Company’s operations and customers are located in California, which could be adversely impacted by severe weather events. Agriculture is especially dependent on climate, and climate impacts could include shifting average growing conditions, increased climate and weather variability, decreases in available water sources, and more uncertainty in predicting climate and weather conditions, any or all of which could have a particularly adverse impact on our agricultural customers.
Additional legislation and regulatory requirements and changes in consumer preferences, including those associated with the transition to a low-carbon economy, could increase expenses of, or otherwise adversely affect, the Company, its businesses or its customers. Our customers and we may face cost increases, asset value reductions, operating process changes, reduced availability of insurance, and the like, because of governmental actions or societal responses to climate change.
New and/or more stringent regulatory requirements relating to climate change or environmental sustainability could materially affect the Company’s results of operations by increasing our compliance costs. Regulatory changes or market shifts to low-carbon products could also affect the creditworthiness of some of our customers or reduce the value of assets securing loans, which may require the Company to adjust our lending portfolios and business strategies.
Risks Related to Our Regulatory Environment
We are subject to regulation, which increases the cost and expense of regulatory compliance, and may restrict our growth and our ability to acquire other financial institutions. Supervision, regulation, and examination of the Company and the Bank by the bank regulatory agencies are intended primarily for the protection of consumers, bank clients and the Deposit Insurance Fund of the FDIC, rather than holders of our common stockshares. As a bank holding company under federal law, we are subject to regulation under the BHCA, and the examination and reporting requirements of the FRB. In addition to supervising and examining us, the FRB, through its adoption of regulations implementing the BHCA, places certain restrictions on the permissible activities for bank holding companies. Changes in the number or scope of permissible activities could have an adverse effect on our ability to realize our strategic goals. As a California state-chartered bank that is not a member of the Federal Reserve System, the Bank is separately subject to regulation by both the FDIC and the DFPI. The FDIC and DFPI regulate numerous aspects of the Bank’s operations, including adequate capital and financial condition, permissible types and amounts of extensions of credit and investments, permissible non-banking activities and restrictions on dividend payments. We may be required to invest significant management attention and resources to evaluate and make any changes necessary to comply with applicable laws and regulations. This allocation of resources, as well as any failure to comply with applicable requirements, may negatively affect our operations and financial condition.
Banking agencies periodically conduct examinations of our business, including compliance with laws and regulations, and our failure to comply with any regulatory actions to which we become subject because such examinations could materially and adversely affect us. The DFPI, the FDIC, and the FRB periodically conduct examinations of our business, including compliance with laws and regulations. Accommodating such examinations may require management to reallocate resources that would otherwise be used in the day-to-day operation of other aspects of our business. If, as a result of an examination, the DFPI or a federal banking agency were to determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of our operations had become unsatisfactory, or that we or our management were in violation of any law or regulation, it may take a number of different remedial actions as it deems appropriate. These actions could include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to assess civil monetary penalties against us, our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to clients, to terminate our deposit insurance. FDIC deposit insurance is critical to the continued operation of the Bank. If we become subject to such regulatory actions, our business operations could be materially and adversely affected.
Changes in laws, government regulation and monetary policy may have a material adverse effect on our operations. Financial institutions have been the subject of significant legislative and regulatory changes (including the Dodd-Frank Act) and may be the subject of further significant legislation or regulation in the future, none of which is within our control. This may result in repeals of or amendments to, existing laws, treaties, regulations, guidance, reporting, recordkeeping requirements, and other government policies. Significant new laws or regulations or changes in, or repeals of, existing laws or regulations, including those with respect to federal and state taxation, may cause our results of operations to differ materially. In addition, the costs and burden of compliance could adversely affect our ability to operate profitably. Further, federal monetary policy significantly affects the Bank’s credit conditions, as well as the Bank’s clients, particularly as implemented through the FRB, primarily through open market operations in U.S. government securities, the discount rate for bank depositborrowings and reserve requirements. A material change in any of these conditions could have a material impact on us, the Bank and the Bank’s clients, and therefore is not insured against losson our financial condition and operations.
New and future rulemaking by the FDIC, anyCFPB and other deposit insurance fundregulators, as well as enforcement of existing consumer protection laws, may have a material effect on our operations and operating costs. The CFPB has the authority to implement and enforce a variety of existing federal consumer protection statutes and to issue new regulations. However, with respect to institutions of our size, it does not have primary examination and enforcement authority. The authority to examine depository institutions with $10 billion or less in assets, such as the Bank, for compliance with federal consumer laws remains largely with our primary federal regulator, the FDIC. However, the CFPB may participate in examinations of smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. In some cases, regulators such as the Federal Trade Commission, or FTC, and the Department of Justice also retain certain rulemaking or enforcement authority, and we remain subject to certain state consumer protection laws. The CFPB has placed significant emphasis on consumer complaint management and has established a public consumer complaint database to encourage consumers to file complaints they may have against financial institutions. We are expected to monitor and respond to these complaints, including those that we deem frivolous, and doing so may require management to reallocate resources away from more profitable endeavors.
The CFPB has adopted a number of significant rules that affect nearly every aspect of the lifecycle of a residential mortgage. These rules implement the Dodd-Frank Act amendments to the Equal Credit Opportunity Act, the Truth in Lending Act and the Real Estate Settlement Procedures Act. The rules require banks to, among other things: (i) develop and implement procedures to ensure compliance with a new “reasonable ability to repay” test and identify whether a loan meets a new definition for a “qualified mortgage”; (ii) implement new or revised disclosures, policies and procedures for servicing mortgages including, but not limited to, early intervention with delinquent clients and specific loss mitigation procedures for loans secured by any other publica client’s principal residence; (iii) comply with additional restrictions on mortgage loan originator compensation; and (iv) comply with new disclosure requirements and standards for appraisals and escrow accounts maintained for “higher priced mortgage loans.” These rules create operational and strategic challenges for us, as we are both a mortgage originator and a servicer.
We are subject to stringent capital requirements.
Pursuant to the Dodd-Frank Act, the federal banking agencies adopted final rules, or private entity. Investmentthe U.S. Basel III Capital Rules, to update their general risk-based capital and leverage capital requirements to incorporate agreements reflected in our common stock is inherently risky for the reasonsThird Basel Accord adopted by the Basel Committee on Banking Supervision, or Basel III Capital Standards, as well as the requirements of the Dodd-Frank Act. The U.S. Basel III Capital Rules are described in this “Risk Factors” sectionmore detail in “Supervision and elsewhereRegulation — Capital Standards” in this report and ison Form 10-K.
The failure to meet the established capital requirements could result in one or more of our regulators placing limitations or conditions on our activities or restricting the commencement of new activities. Such failure could subject us to a variety of enforcement remedies available to the same market forcesfederal regulatory authorities, including limiting our ability to pay dividends, issuing a directive to increase our capital and terminating our FDIC deposit insurance. FDIC deposit insurance is critical to the continued operation of the Bank. Our failure to meet applicable regulatory capital requirements, or to maintain appropriate capital levels in general, could affect client and investor confidence, our ability to grow, our costs of funds and FDIC insurance costs, our ability to pay dividends on common shares, our ability to make acquisitions, and our operations and financial condition, generally.
We may be required to contribute capital or assets to the Bank that affectcould otherwise be invested or deployed more profitably elsewhere. Federal law and regulatory policy impose a number of obligations on bank holding companies designed to reduce potential loss exposure to the clients of insured depository subsidiaries and to the FDIC’s DIF. For example, a bank holding company is required to serve as a source of financial strength to its FDIC-insured depository subsidiaries and to commit financial resources to support such institutions where it might not do so otherwise. These situations include guaranteeing the compliance of an “undercapitalized” bank with its obligations under a capital restoration plan.
A capital injection into the Bank may be required at times when we do not have the resources to provide it at the holding company level; therefore, we may be required to issue common shares or debt to obtain the required capital. Issuing additional common shares would dilute our current stockholders’ percentage of ownership and could cause the price of common stock in any company. As a result, if you acquire our common stock, youshares to decline. Any debt would be entitled to a priority of payment over the claims of the Company’s general unsecured creditors or equity holdings. Thus, any Company borrowing to make the required capital injection may lose some or all of your investment.be expensive and adversely affect our cash flows, financial condition, operations, and business prospects.
We face a risk of non-compliance and enforcement actions with respect to the Bank Secrecy Act (“BSA”) and other anti-money laundering statutes and regulations. Like all U.S. financial institutions, we are subject to monitoring requirements under federal law, including anti-money laundering, or AML, and BSA matters. Since September 11, 2001, banking regulators have intensified their focus on AML and BSA compliance requirements, particularly the AML provisions of the USA PATRIOT Act. There is also increased scrutiny of compliance with the rules enforced by the U.S. Treasury Department’s OFAC, which involve sanctions for dealing with certain persons or countries. While the Bank has adopted policies, procedures and controls to comply with the BSA, other AML statutes and regulations and OFAC regulations, this aggressive supervision and examination and increased likelihood of enforcement actions may increase our operating costs, which could negatively affect our operations and reputation.
We are subject to federal and state fair lending laws, and failure to comply with these laws could lead to material penalties. Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose non-discrimination lending requirements on financial institutions. The FDIC, the Department of Justice, the CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the fair lending laws and regulations could adversely impact our rating under the CRA, and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, financial condition and operations.
Regulations relating to privacy, information security and data protection could increase our costs, affect or limit how we collect and use personal information and adversely affect our business opportunities. We are subject to various privacy, information security and data protection laws, including requirements concerning security breach notification, and these laws could negatively affect us. Federal law imposes requirements for the safeguarding of certain client information. Various state and federal banking regulators and states have also enacted data security breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in certain circumstances in the event of a security breach. Moreover, legislators and regulators in the United States are increasingly adopting or revising privacy, information security and data protection laws that potentially could have a significant impact on our current and planned privacy, data protection and information security-related practices, our collection, use, sharing, retention and safeguarding of consumer or employee information, and some of our current or planned business activities. This could also increase our costs of compliance and business operations and could reduce income from certain business initiatives.
Compliance with current or future privacy, data protection and information security laws (including those regarding security breach notification) affecting client or employee data to which we are subject could result in higher compliance and technology costs and could restrict our ability to provide certain products and services, which could have a material adverse effect on our financial conditions or operations.
Our failure to comply with privacy, data protection and information security laws could result in potentially significant regulatory or governmental investigations or actions, litigation, fines, sanctions and damage to our reputation, which could have a material adverse effect on our financial condition or operations.
Possible changes in the U.S. tax laws could adversely affect our business and result of operations in a variety of ways.
The Company has no unresolved comments receivedTax Cuts and Jobs Act (“TCJA”), signed into law on December 22, 2017, enacted sweeping changes to the U.S. federal tax laws generally, effective January 1, 2018. The TCJA reduced the corporate tax rate to 21% from staff at35%, which resulted in a net reduction in our annual income tax expense and which benefitted many of our corporate and other small business borrowers. However, our ability to utilize tax credits, such as those arising from low-income housing and alternative energy investments, was constrained by the SEC.lower tax rate. There are presently ongoing discussions in the U.S. Congress and the White House which could result in changes in the tax laws that would substantially increase the U.S. corporate tax rate. If enacted, such measures could adversely affect our profitability and that of our customers.
Item 1B. | Unresolved Staff Comments |
Item 2. Properties
None.
Farmers & Merchants Bancorp and its subsidiaries are headquartered in Lodi, California. Executive offices are located at 111 W. Pine Street. Banking services are provided in twenty-eight branches29 branch locations in the Company's service area. Of the twenty-eight29 branches, nineteen20 are owned and nine9 are leased. The expiration of these leases occurs between the years 20212023 and 2028.2030. See Note 20,14, located in “Item 8. Financial Statements and Supplementary Data.”Data” in this Annual Report on Form 10-K.
Item 3. Legal Proceedings
Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against the Company or its subsidiaries. Based upon information available to the Company, its review of such lawsuits and claims and consultation with its counsel, the Company believes the liability relating to these actions, if any, would not have a material adverse effect on its consolidated financial statements.
There are no material proceedings adverse to the Company to which any director, officer or affiliate of the Company is a party.
Item 4. Mine Safety DisclosuresItem 4. | Mine Safety Disclosures |
Not Applicable
PART II
Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
The common stock of Farmers & Merchants Bancorp is not widely held or listed on any exchange. However, trades are reported on the OTCQX under the symbol “FMCB”.“FMCB.”
The following tables summarize the actual high, low, and close sale prices for the Company's common stock since the first quarter of
2019. 2021. These figures are based on activity posted on the
OTCQX.OTCQX:
| Calendar Quarter | | High | | | Low | | | Close | | | Cash Dividends Declared (Per Share) | |
| | | | | | | | | | | | | |
2020 | Fourth quarter | | $ | 770 | | | $ | 701 | | | $ | 760 | | | $ | 7.50 | |
| Third quarter | | | 770 | | | | 695 | | | | 725 | | | | - | |
| Second quarter | | | 800 | | | | 626 | | | | 706 | | | | 7.25 | |
| First quarter | | | 800 | | | | 650 | | | | 685 | | | | - | |
| | Year Ended December 31, 2022 | |
| | High | | | Low | | | Close | | | Dividend Declared | |
First quarter | | $ | 960 | | | $ | 913 | | | $ | 950 | | | $ | - | |
Second quarter | | | 960 | | | | 914 | | | | 927 | | | | 7.85 | |
Third quarter | | | 975 | | | | 922 | | | | 956 | | | | - | |
Fourth quarter | | | 1,088 | | | | 952 | | | | 1,050 | | | | 8.30 | |
| Calendar Quarter | | High | | | Low | | | Close | | | Cash Dividends Declared (Per Share) | |
| | | | | | | | | | | | | |
2019 | Fourth quarter | | $ | 804 | | | $ | 755 | | | $ | 768 | | | $ | 7.15 | |
| Third quarter | | | 850 | | | | 757 | | | | 780 | | | | - | |
| Second quarter | | | 950 | | | | 700 | | | | 795 | | | | 7.05 | |
| First quarter | | | 788 | | | | 695 | | | | 725 | | | | - | |
| | Year Ended December 31, 2021 | |
| | High | | | Low | | | Close | | | Dividend Declared | |
First quarter | | $ | 788 | | | $ | 731 | | | $ | 778 | | | $ | - | |
Second quarter | | | 925 | | | | 773 | | | | 862 | | | | 7.50 | |
Third quarter | | | 920 | | | | 862 | | | | 897 | | | | - | |
Fourth quarter | | | 1,156 | | | | 897 | | | | 960 | | | | 7.80 | |
As of January 31, 2021,February 28, 2023, there were approximately 1,6501,315 stockholders of record of the Company’s common stock. However, since approximately 30% of our common stock shares are held by brokers on behalf of stockholders, we are unable to determine the exact total number of stockholders.
The Company and, before the Company was formed, the Bank, has paid cash dividends for the past 8687 consecutive years. There are limitations under Delaware corporate law as to the amounts of cash dividends that may be paid by the Company. Additionally, if we decided to defer interest on our 2003 subordinated debentures, we would be prohibited from paying cash dividends on the Company’s common stock. The Company is dependent on cash dividends paid by the Bank to fund its cash dividend payments to its stockholders. There are regulatory limitations on cash dividends that may be paid by the Bank. See “Item 1. Business – Supervision and Regulation.”
In 1998, the Board approved the Company’s first common stock repurchase program. This program has been extended and expanded several times since then, and most recently, onOn November 6, 2018,8, 2022, the Board of Directors approvedauthorized an extension to its share repurchase program through December 31, 2024 for an additional $20.0 million of the $20 millionCompany’s common stock repurchase program over(“Repurchase Plan”), which represents approximately 3% of outstanding shareholders’ equity. Repurchases by the three-year period ending December 31, 2021.
RepurchasesCompany under the programRepurchase Plan may be made from time to time on thethrough open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or through private transactions. by other means. Beginning in 2023 under the Inflation Reduction Act of 2022 (IRA), a 1% excise tax will be imposed on certain public company stock repurchases.
The repurchase program also requires that no purchasesactual means and timing of any repurchases, the quantity of purchased shares and prices will be subject to certain limitations, including, without limitation, market prices of the Company’s common shares, general market and economic conditions, the Company’s financial performance, capital position, and applicable legal and regulatory requirements, and at the discretion of the Chief Executive Officer and Chief Financial Officer.
Repurchases under the Repurchase Plan may be made ifinitiated, discontinued, suspended, or restarted at any time in the Bank wouldCompany’s discretion. The Company is not remain “well-capitalized” after the repurchase.
There were no stock repurchases in 2020 or 2019obligated to repurchase any shares under the Common Stock Repurchase Plan. The remaining dollar value ofNo shares that may yet be purchased underrepurchased pursuant to the authority granted in the Repurchase Plan after December 31, 2024. Repurchased shares are to be used to fund the Company’s Common Stock Repurchase Plan is approximately $20 million.non-qualified retirement plans or may be returned to the status of authorized but unissued common shares of the Company.
On November 23, 2020, the Board of Directors of Farmers & Merchants Bancorp approved, and all applicable regulators provided statements of non-objection regarding, the Company’s repurchase and retirement of up to $8.5 million of its outstanding common stock during the fourth quarter of 2020 and the first half of 2021. These repurchases will be done outside of the Company’s current repurchase plan. All repurchases will be made at the then prevailing market prices. In the fourth quarter of 2020, the Company repurchased $2.8 million of shares from shareholders.
On May 24, 2018, stockholders approved a proposal to increase our authorized shares of common stock from 7,500,000 to 40,000,000. In approving this proposal the stockholders also granted the Board discretionary authority (i.e., without further stockholder action) to determine whether to delay the proposed amendment. The Company has no immediate plans to effect the increase in the authorized shares of common stock.
On August 5, 2008, the Board of Directors approved a Share Purchase Rights Plan (the “Rights Plan”), pursuant to which the Company entered into a Rights Agreement dated August 5, 2008, with Computershare as Rights Agent, and the Company declared a dividend of a right to acquire one preferred share purchase right (a “Right”) for each outstanding share of the Company’s common stock, $0.01 par value per share, to stockholders of record at the close of business on August 15, 2008. Generally, the Rights are only triggered and become exercisable if a person or group (the “Acquiring Person”) acquires beneficial ownership of 10 percent or more of the Company’s common stock or announces a tender offer for 10 percent or more of the Company’s common stock.
The Rights Plan is similar to plans adopted by many other publicly traded companies. The effect of the Rights Plan is to discourage any potential acquirer from triggering the Rights without first convincing the Company’s Board of Directors that the proposed acquisition is fair to, and in the best interest of, all of the stockholders of the Company. The provisions of the Plan, if triggered by the Acquiring Person, will substantially dilute the equity and voting interest of any potential acquirer unless the Board of Directors approves of the proposed acquisition (under Article XV of the Company’s Certificate of Incorporation, the Board of Directors has the authority to consider any and all factors in determining whether an acquisition is in the best interests of the Company and its stockholders). Each Right, if and when exercisable, will entitle the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, no par value, at a purchase price of $1,600 for each one one-hundredth of a share, subject to adjustment.
Each holder of a Right (except for the Acquiring Person, whose Rights will be null and void upon such event) shall thereafter have the right to receive, upon exercise, that number of Common Shares of the Company having a market value of two times the exercise price of the Right. At any time before a person becomes an Acquiring Person, the Rights can be redeemed, in whole, but not in part, by Farmers and Merchants Bancorp’sthe Company’s Board of Directors at a price of $0.001 per Right.
The Rights Plan was set to expire on August 5, 2018. On November 19, 2015, the Board of Directors approved a seven-year extension of the term of the Rights Plan. Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025. The extension of the term of the Rights Plan was intended as a means to continue to guard against abusive takeover tactics and was not in response to any particular proposal. The Board also increased the purchase price under the Rights Plan to $1,600 per one one-hundredth of a preferred share from $1,200, to reflect the increase in the market price of the Company’s common stock over the past several years.
During 2020,2022, the Company issuedrepurchased 21,309 shares under the Repurchase Plan, for a combined total 523of $20.31 million. All of these shares were purchased at prices ranging from $925.00 to $990.00 per share, based upon the then current price on the OTCQX. The Company did not issue any shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at a price of $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital. See Note 14, located in “Item 8. Financial Statements and Supplementary Data.”2022.
The following table reports information regarding repurchases of our common stock during the year ended December 31, 2022:
Period | | Total number of shares purchased | | | Average price paid per share | | | Total number of shares purchased as part of publicly announced plans or programs | | | Maximum number (or approximate dollar value) of shares that may yet purchased under the plans or programs (In thousands) (1) | |
Total 1st Quarter 2022 | | | 4,500 | | | $ | 945.00 | | | | 4,500 | | | $ | 15,748 | |
Total 2nd Quarter 2022 | | | 7,956 | | | | 954.32 | | | | 7,956 | | | | 8,155 | |
Total 3rd Quarter 2022 | | | 6,368 | | | | 951.68 | | | | 6,368 | | | | 2,095 | |
| | | | | | | | | | | | | | | | |
October 1, 2022 to October 31, 2022 | | | 1,465 | | | $ | 962.22 | | | | 1,465 | | | $ | 685 | |
November 1, 2022 to November 30, 2022 | | | 709 | | | | 973.47 | | | | 709 | | | | 19,995 | |
December 1, 2022 to December 31, 2022 | | | 311 | | | | 979.84 | | | | 311 | | | | 19,690 | |
Total 4th Quarter 2022 | | | 2,485 | | | $ | 967.64 | | | | 2,485 | | | $ | 19,690 | |
| | | | | | �� | | | | | | | | | | |
Total 2022 | | | 21,309 | | | $ | 953.12 | | | | 21,309 | | | $ | 19,690 | |
| | | | | | | | | | | | | | | | |
(1)As of November 8, 2022 the Board approved an extension to the repurchase program through December 31, 2024 and for an additional $20 million of the Company's common stock.
The Company issued a combined total 9,312did not issue or purchase any shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at prices ranging from $715.00 to $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital. See Note 14, located in “Item 8. Financial Statements and Supplementary Data.”2021.
Performance Graphs
The following graph compares the Company’s cumulative total stockholder return on common stock from December 31, 20152017 to December 31, 20202022 to that of: (i) the S&P 600 Regional Banks (Sub Ind) (TR) Index (which replaces the Morningstar Banks Index - Regional (US) Industry Group;Group going forward through 2020, since the data is no longer accessible); and (ii) the cumulative total return of the New York Stock Exchange market index. The graph assumes an initial investment of $100 on December 31, 20152017 and reinvestment of dividends. The stock price performance set forth in the following graph is not necessarily indicative of future price performance. The Company’s stock price data is based on activity posted on the OTCQX and on private transactions between individual stockholders that are reported to the Company. This data was furnished by Zacks SEC Compliance Services Group.
![graphic](https://capedge.com/proxy/10-K/0001140361-21-008518/image00002.jpg)
![graphic](https://capedge.com/proxy/10-K/0001140361-23-011796/image00002.jpg)
This graph shall not be deemed filed or incorporated by reference into any filing under the Securities Act of 1933.Act.
Item 6. | Selected Financial DataReserved |
Farmers & Merchants Bancorp
Five Year Financial Summary of Operations
(in thousands except per share data)
Summary of Income: | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Total Interest Income | | $ | 158,652 | | | $ | 153,708 | | | $ | 133,453 | | | $ | 114,612 | | | $ | 99,266 | |
Total Interest Expense | | | 9,491 | | | | 13,194 | | | | 7,950 | | | | 6,289 | | | | 4,196 | |
Net Interest Income | | | 149,161 | | | | 140,514 | | | | 125,503 | | | | 108,323 | | | | 95,070 | |
Provision for Credit Losses | | | 4,500 | | | | 200 | | | | 5,533 | | | | 2,850 | | | | 6,335 | |
Net Interest Income After Provision for Credit Losses | | | 144,661 | | | | 140,314 | | | | 119,970 | | | | 105,473 | | | | 88,735 | |
Total Non-Interest Income | | | 15,696 | | | | 17,241 | | | | 15,219 | | | | 16,762 | | | | 15,257 | |
Total Non-Interest Expense | | | 82,406 | | | | 82,242 | | | | 75,459 | | | | 67,754 | | | | 58,172 | |
Income Before Income Taxes | | | 77,951 | | | | 75,313 | | | | 59,730 | | | | 54,481 | | | | 45,820 | |
Provision for Income Taxes | | | 19,217 | | | | 19,277 | | | | 14,203 | | | | 26,111 | | | | 16,097 | |
Net Income | | $ | 58,734 | | | $ | 56,036 | | | $ | 45,527 | | | $ | 28,370 | | | $ | 29,723 | |
Balance Sheet Data: | | | | | | | | | | | | | | | | | | | | |
Total Assets | | $ | 4,550,453 | | | $ | 3,721,830 | | | $ | 3,434,243 | | | $ | 3,075,452 | | | $ | 2,922,121 | |
Loans & Leases | | | 3,099,592 | | | | 2,673,027 | | | | 2,571,241 | | | | 2,215,295 | | | | 2,177,601 | |
Allowance for Credit Losses | | | 58,862 | | | | 55,012 | | | | 55,266 | | | | 50,342 | | | | 47,919 | |
Investment Securities | | | 876,665 | | | | 567,615 | | | | 548,962 | | | | 536,056 | | | | 506,372 | |
Goodwill | | | 11,183 | | | | 11,183 | | | | 11,183 | | | | - | | | | - | |
Core Deposit Intangible | | | 4,013 | | | | 4,640 | | | | 5,278 | | | | 836 | | | | 946 | |
Deposits | | | 4,060,267 | | | | 3,278,019 | | | | 3,062,832 | | | | 2,723,228 | | | | 2,581,711 | |
Shareholders' Equity | | | 423,665 | | | | 369,296 | | | | 311,215 | | | | 299,660 | | | | 279,981 | |
| | | | | | | | | | | | | | | | | | | | |
Selected Ratios: | | | | | | | | | | | | | | | | | | | | |
Return on Average Assets | | | 1.43 | % | | | 1.61 | % | | | 1.45 | % | | | 0.94 | % | | | 1.12 | % |
Return on Average Equity | | | 14.60 | % | | | 16.77 | % | | | 14.80 | % | | | 9.66 | % | | | 11.17 | % |
Dividend Payout Ratio | | | 19.92 | % | | | 20.02 | % | | | 24.49 | % | | | 38.71 | % | | | 35.25 | % |
Average Loans & Leases to Average Deposits | | | 80.77 | % | | | 84.38 | % | | | 84.36 | % | | | 82.18 | % | | | 88.63 | % |
Average Equity to Average Assets | | | 9.78 | % | | | 9.61 | % | | | 9.66 | % | | | 9.77 | % | | | 10.05 | % |
Period-end Shareholders' Equity to Total Assets | | | 9.31 | % | | | 9.92 | % | | | 9.06 | % | | | 9.74 | % | | | 9.58 | % |
| | | | | | | | | | | | | | | | | | | | |
Basic and Diluted Per Share Data: | | | | | | | | | | | | | | | | | | | | |
Earnings (1) | | $ | 74.03 | | | $ | 71.18 | | | $ | 56.82 | | | $ | 35.03 | | | $ | 37.44 | |
Cash Dividends Per Share | | $ | 14.75 | | | $ | 14.20 | | | $ | 13.90 | | | $ | 13.55 | | | $ | 13.10 | |
Book Value Per Share at Year End (2) | | $ | 536.53 | | | $ | 465.68 | | | $ | 397.10 | | | $ | 368.90 | | | $ | 346.80 | |
(1) | Based on the weighted average number of shares outstanding of 793,337, 787,227, 801,229, 809,834, and 793,970 for the years ended December 31, 2020, 2019, 2018, 2017, and 2016, respectively. |
(2) | Based on the year-end number of shares outstanding of 789,646, 793,033, 783,721, 812,304, and 807,329 for the years ended December 31, 2020, 2019, 2018, 2017, and 2016, respectively. |
Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
Overview
Although the Company has initiated effortsThe following discussion and analysis is intended to expand its geographic footprint into the East Bay areaprovide a comprehensive review of San Francisco and Napa, California (see “Item 1. Business – Service Area”), the Company’s primary service area remainsoperating results and financial condition. The information contained in this section should be read in conjunction with the mid Central Valley of California, a region that can be significantly impacted byAudited Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements in this Annual Report on Form 10-K. Information related to the seasonal needscomparison of the agricultural industry. Accordingly, discussionresults of operations for the Company’syears December 31, 2021 to 2020 is found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations is influenced by the seasonal banking needs of its agricultural customers (e.g., during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and planting of crops. Correspondingly, deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold).
The Five-Year Period: 2016 through 2020
By early 2020 the Company’s primary service area had significantly recovered from the recession that began in late 2007. Then, lateOperations” in the first quarter2021 Annual Report on Form 10-K filed with the SEC on March 15, 2022.
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K may contain certain forward-looking statements within the meaning of 2020Section 27A of the COVID-19 pandemic began, an eventSecurities Act, as amended, and Section 21E of the Exchange Act. These forward-looking statements reflect our current views and are not historical facts. These statements may include statements regarding projected performance for periods following the date of this report. These statements can generally be identified by use of phrases such as “believe,” “expect,” “will,” “seek,” “should,” “anticipate,” “estimate,” “intend,” “plan,” “target,” “project,” “commit” or other words of similar import. Similarly, statements that would impact economies everywhere. Importantly, agriculture has been designated as an “essential” industry duringdescribe our future financial condition, results of operations, objectives, strategies, plans, goals or future performance and business are also forward-looking statements. Statements that project future financial conditions, results of operations and shareholder value are not guarantees of performance and many of the pandemic, helpingfactors that will determine these results and values are beyond our ability to mitigate economic stresscontrol or predict. For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the Company’s primary service area.
Despite this challenging economic environment, in management’s opinion, the Company’s operating performance over the past five years has been exceptionally strong.
We used certain non-GAAP financial measures1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors, including, but not limited to, provide supplemental information regarding our performance in 2017. Income Tax Expense for the year ended 2017 included a one-time, non-cash $6.3 million charge related to the re-measurement of the Company’s Deferred Tax Asset (“DTA”) as a result of the passage of the Tax Cuts and Jobs Act in 2017. We believed that presenting Adjusted Net Income, excluding the impact of the DTA re-measurement charge, provides additional clarity to the users of financial statements regarding core financial performance and allows for a better year-over-year comparison of trends in core profitability.
(in thousands, except per share data)
Financial Performance Indicator | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
| | | | | | | | | | | | | | | |
Pre Tax Income | | $ | 77,951 | | | $ | 75,313 | | | $ | 59,730 | | | $ | 54,481 | | | $ | 45,820 | |
Income Tax Expense | | | 19,217 | | | | 19,277 | | | | 14,203 | | | | 26,111 | | | | 16,097 | |
Effect of Income Tax Rate Change | | | | | | | | | | | | | | | | | | | | |
DTA Re-measurement | | | - | | | | - | | | | - | | | | (6,300 | ) | | | - | |
Adjusted Income Tax Expense | | | 19,217 | | | | 19,277 | | | | 14,203 | | | | 19,811 | | | | 16,097 | |
Non-GAAP Adjusted Net Income | | | 58,734 | | | | 56,036 | | | | 45,527 | | | | 34,670 | | | | 29,723 | |
Effect of Income Tax Rate Change | | | | | | | | | | | | | | | | | | | | |
DTA Re-measurement | | | - | | | | - | | | | - | | | | (6,300 | ) | | | - | |
Net Income (See Note 1) | | $ | 58,734 | | | $ | 56,036 | | | $ | 45,527 | | | $ | 28,370 | | | $ | 29,723 | |
Total Assets | | | 4,550,453 | | | | 3,721,830 | | | | 3,434,243 | | | | 3,075,452 | | | | 2,922,121 | |
Total Loans & Leases | | | 3,099,592 | | | | 2,673,027 | | | | 2,571,241 | | | | 2,215,295 | | | | 2,177,601 | |
Total Deposits | | | 4,060,267 | | | | 3,278,019 | | | | 3,062,832 | | | | 2,723,228 | | | | 2,581,711 | |
Total Shareholders’ Equity | | | 423,665 | | | | 369,296 | | | | 311,215 | | | | 299,660 | | | | 279,981 | |
Total Risk-Based Capital Ratio | | | 12.60 | % | | | 12.40 | % | | | 11.40 | % | | | 13.07 | % | | | 12.80 | % |
Non-Performing Loans as a % of Total Loans | | | 0.02 | % | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % | | | 0.14 | % |
Substandard Loans as a % of Total Loans | | | 0.60 | % | | | 0.61 | % | | | 0.57 | % | | | 0.40 | % | | | 0.29 | % |
Net Charge-Offs (Recoveries) to Average Loans | | | 0.02 | % | | | 0.02 | % | | | 0.03 | % | | | 0.02 | % | | | 0.00 | % |
Loan Loss Allowance as a % of Total Loans | | | 1.89 | % | | | 2.05 | % | | | 2.14 | % | | | 2.27 | % | | | 2.19 | % |
Return on Average Assets | | | 1.43 | % | | | 1.61 | % | | | 1.45 | % | | | 0.94 | % | | | 1.12 | % |
Adjusted Return on Average Assets | | | 1.43 | % | | | 1.61 | % | | | 1.45 | % | | | 1.15 | % | | | 1.12 | % |
Return on Average Equity | | | 14.60 | % | | | 16.77 | % | | | 14.80 | % | | | 9.66 | % | | | 11.17 | % |
Adjusted Return on Average Equity | | | 14.60 | % | | | 16.77 | % | | | 14.80 | % | | | 11.79 | % | | | 11.17 | % |
Earnings Per Share | | | 74.03 | | | | 71.18 | | | | 56.82 | | | | 35.03 | | | | 37.44 | |
Adjusted Earnings Per Share | | | 74.03 | | | | 71.18 | | | | 56.82 | | | | 42.81 | | | | 37.44 | |
Cash Dividends Per Share | | | 14.75 | | | | 14.20 | | | | 13.90 | | | | 13.55 | | | | 13.10 | |
Cash Dividends Declared | | | 11,700 | | | | 11,221 | | | | 11,151 | | | | 10,982 | | | | 10,478 | |
Note 1 – On December 22, 2017, the Tax Cuts and Jobs Act was signed into law by the President. Among other things, this legislation reduced the corporate tax rate from 35% to 21% beginning January 1, 2018. Although the Company believes that this reductionthose described in the corporate tax rate will continue“Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections and other parts of this Annual Report on Form 10-K that could cause our actual results to havediffer materially from those anticipated in these forward-looking statements. The following is a significant positive impactnon-exclusive list of factors, that could cause our actual results to differ materially from our forward-looking statements in this Annual Report on future financial performance, U.S. generally accepted accounting principles requireForm 10-K:
◾ | changes in general economic conditions, either nationally, in California, or in our local markets; |
◾ | inflation, changes in interest rates, securities market volatility and monetary fluctuations; |
◾ | increases in competitive pressures among financial institutions and businesses offering similar products and services; |
◾ | the future impact of the COVID-19 virus; |
◾ | higher defaults in our loan portfolio than we expect; |
◾ | changes in management’s estimate of the adequacy of the allowance for credit losses; |
◾ | risks associated with our growth and expansion strategy and related costs; |
◾ | increased lending risks associated with our high concentration of real estate loans; |
◾ | legislative or regulatory changes or changes in accounting principles, policies or guidelines; |
◾ | failure to raise the debt limit on U.S. debt; |
◾ | regulatory or judicial proceedings; and |
◾ | other factors and risks including those described under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K. |
Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. Additional factors that all companies re-measure their DTA’s usingcould cause actual results to differ materially from those expressed in the new lower tax rateforward-looking statements are discussed in “Item 1A. Risk Factors” in this Annual Report on Form 10-K. Please take into account that forward-looking statements speak only as of the date of enactmentthis Annual Report on Form 10-K (or documents incorporated by reference, if applicable).
The Company does not undertake any obligation to publicly correct or update any forward-looking statement if it later becomes aware that actual results are likely to differ materially from those expressed in such forward-looking statement, except as required by law.
Overview
Farmers & Merchants Bancorp (the “Company”, “FMCB”, or “we”) is the holding company for Farmers & Merchants Bank of Central California (the “Bank” or “FMB). The Bank is a full-service community bank providing loans, deposit and cash management services to individuals and businesses. Our primary clients are small to medium-sized businesses that require highly personalized commercial banking products and services. The Bank has 29 branch locations and 3 ATMs that have been serving communities in the mid-Central Valley and East Bay of California for over 100 years.
The primary source of funding for our asset growth has been the generation of core deposits, which we raise through our existing branch locations, newly opened branch locations, or through acquisitions. Our recent loan growth is primarily the result of organic growth generated by our seasoned relationship managers and supporting associates who provide outstanding service and responsiveness to our clients or through acquisitions.
Our results of operations are largely dependent on net interest income. Net interest income is the difference between interest income we earn on interest earning assets, which are comprised of loans, investment securities and short-term investments, and the interest we pay on our interest bearing liabilities, which are primarily deposits, and, to a lesser extent, other borrowings. Management strives to match the re-pricing characteristics of the legislation. Asinterest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve.
We measure our performance by calculating our net interest margin, return on average assets, and return on average equity. Net interest margin is calculated by dividing net interest income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities, by average interest earning assets. Net interest income is our largest source of revenue. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income. We also measure our performance by our efficiency ratio, which is calculated by dividing non-interest expense by the sum of net interest income and non-interest income.
Selected Financial Data
The following condensed consolidated statements of financial condition and operations and selected performance ratios as of December 31, 2022, 2021, and 2020 and for the years then ended have been derived from our audited consolidated financial statements. The information below is qualified in its entirety by the detailed information included elsewhere herein and should be read along with this “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8, Financial Statement and Supplementary Data.”
| | Years Ended December 31 | |
(Dollars in thousands, except per share data) | | 2022 | | | 2021 | | | 2020 | |
Selected Income Statement Information: | | | | | | | | | |
Interest income | | $ | 198,413 | | | $ | 165,268 | | | $ | 159,294 | |
Interest expense | | | 4,840 | | | | 4,332 | | | | 9,491 | |
Net interest income | | | 193,573 | | | | 160,936 | | | | 149,803 | |
Provision for credit losses | | | 6,450 | | | | 1,910 | | | | 4,500 | |
Net interest income after provision for credit losses | | | 187,123 | | | | 159,026 | | | | 145,303 | |
Non-interest income | | | 6,178 | | | | 21,056 | | | | 15,054 | |
Non-interest expense | | | 93,560 | | | | 91,761 | | | | 82,406 | |
Income before income tax expense | | | 99,741 | | | | 88,321 | | | | 77,951 | |
Income tax expense | | | 24,651 | | | | 21,985 | | | | 19,217 | |
Net income | | $ | 75,090 | | | $ | 66,336 | | | $ | 58,734 | |
| | | | | | | | | | | | |
Selected financial ratios: | | | | | | | | | | | | |
Basic and diluted earnings per share | | $ | 96.55 | | | $ | 84.01 | | | $ | 74.03 | |
Cash dividends per common share | | | 16.15 | | | | 15.30 | | | | 14.75 | |
Dividend ratio | | | 16.73 | % | | | 18.21 | % | | | 19.92 | % |
Net interest margin | | | 3.80 | % | | | 3.46 | % | | | 3.88 | % |
Non-interest income to average assets | | | 0.12 | % | | | 0.43 | % | | | 0.37 | % |
Non-interest expense to average assets | | | 1.75 | % | | | 1.87 | % | | | 2.00 | % |
Efficiency ratio | | | 46.84 | % | | | 50.42 | % | | | 49.99 | % |
Return on average assets | | | 1.41 | % | | | 1.35 | % | | | 1.43 | % |
Return on average equity | | | 16.04 | % | | | 15.00 | % | | | 14.60 | % |
Net charge-offs (recoveries) to average loans | | | 0.01 | % | | | (0.01 | %) | | | 0.02 | % |
| | As of December 31, | |
(Dollars in thousands, except per share data) | | 2022 | | | 2021 | | | 2020 | |
Selected Balance Sheet Information: | |
Cash and cash equivalents | | $ | 588,257 | | | $ | 715,460 | | | $ | 383,837 | |
Investment securities | | | 997,817 | | | | 1,007,506 | | | | 876,665 | |
Gross loans held for investment | | | 3,512,361 | | | | 3,237,177 | | | | 3,099,592 | |
Total assets | | | 5,327,399 | | | | 5,177,720 | | | | 4,550,453 | |
Total deposits | | | 4,759,269 | | | | 4,640,152 | | | | 4,060,267 | |
Shareholders' equity | | | 485,308 | | | | 463,136 | | | | 423,665 | |
| | | | | | | | | | | | |
Average Balances: | | | | | | | | | | | | |
Average earning assets | | | 5,091,684 | | | | 4,656,337 | | | | 3,861,070 | |
Average assets | | | 5,341,901 | | | | 4,913,999 | | | | 4,112,537 | |
Average shareholders' equity | | | 468,001 | | | | 442,246 | | | | 402,329 | |
| | | | | | | | | | | | |
Selected financial ratios: | | | | | | | | | |
Book value per share | | $ | 631.63 | | | $ | 586.51 | | | $ | 536.53 | |
Tangible book value per share | | $ | 613.42 | | | $ | 568.04 | | | $ | 517.28 | |
Allowance for credit losses to total loans | | | 1.90 | % | | | 1.88 | % | | | 1.89 | % |
Non-performing assets to total assets | | | 0.03 | % | | | 0.03 | % | | | 0.03 | % |
Loans held for investment to deposits | | | 73.80 | % | | | 69.76 | % | | | 76.34 | % |
| | | | | | | | | | | | |
Capital ratios: | | | | | | | | | | | | |
Tier 1 leverage capital | | | 9.36 | % | | | 8.92 | % | | | 9.13 | % |
Total risk-based capital | | | 13.06 | % | | | 13.19 | % | | | 12.59 | % |
Average equity to average assets | | | 8.76 | % | | | 9.00 | % | | | 9.78 | % |
Tangible common equity to tangible assets | | | 8.87 | % | | | 8.69 | % | | | 9.01 | % |
Summary of Critical Accounting Policies and Estimates
In the opinion of management, the accompanying Consolidated Statements of Financial Condition and related Consolidated Statements of Operations, Comprehensive Income, Changes in Shareholders’ Equity and Cash Flows reflect all adjustments (which include reclassification and normal recurring adjustments) that are necessary for a fair presentation in conformity with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements.
Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. In particular, management has identified certain accounting policies that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of our financial statements. Management believes the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the factual circumstances at the time. However, given the sensitivity of the financial statements to these critical accounting policies, the use of other judgments, estimates and assumptions could result in material differences in our results of operations or financial condition. Further, subsequent changes in economic or market conditions could have a material impact on these estimates and our financial condition and operating results in future periods. For additional information concerning critical accounting policies, see the Selected Notes to the Consolidated Financial Statements and the following:
Use of Estimates — The preparation of our financial statements requires management to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. On an ongoing basis, management evaluates the estimates used. Estimates are based upon historical experience, current economic conditions and other factors that management considers reasonable under the circumstances and the actual results may differ from these estimates under different assumptions. The allowance for credit losses, deferred income taxes, and fair values of financial instruments are estimates, which are particularly subject to change.
Allowance for Credit Losses — The Company recognizes there is risk of credit losses with financial instruments, to include loans, and unfunded loan commitments, where the Company advances funds to a counterparty. The risk of credit losses varies with, among other things, the type of financial instrument, the creditworthiness and cash flows of the counterparty, any guarantees from government agencies, and the collateral, if any, used to secure the financial instrument. The Company maintains an allowance for credit losses on loans and unfunded commitments held in accordance with GAAP. The allowance for credit losses represents our estimate of probable losses inherent in our existing loan portfolio. The allowance for credit losses is increased by charging a provision for credit losses against income and reduced by charge-offs, net of recoveries.
Under the guidance of Financial Accounting Standards Board Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“CECL”), we evaluate our allowance for credit losses quarterly based on a number of quantitative and qualitative factors, including levels and trends of past due and non-accrual loans, asset classifications, loan grades and internal loan reviews, change in volume and mix of loans, collateral value, historical loss experience, size and complexity of individual credits, loan concentrations and economic conditions. Allowance for credit losses is provided on both a specific and general basis. Specific allowances are provided for impaired credits for which the expected/anticipated loss is measurable. General valuation allowances are based on a portfolio segmentation based on risk grading, with a further evaluation of various quantitative and qualitative factors.
The Company begins its determination of credit losses by evaluating historical credit loss experience by loan segment. Historical loss information may be adjusted based on specific risk characteristics by loan segment. Such risk characteristics may include, but are not necessarily limited to, changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses; changes in national and local economic conditions and forecasts; changes in the nature and volume of the loans and in the terms of such instruments; changes in the experience, ability, and depth of lending management and other relevant staff; changes in the volume and severity of past due status, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans; changes in the quality of the institution’s loan review system; changes in the value of underlying collateral for collateral-dependent loans; the existence and effect of any concentrations of credit, and changes in the level of such concentrations; and the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses.
While the Company utilizes a systematic methodology in determining its allowance, the allowance is based on estimates, and ultimate losses may vary from current estimates. The estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known. For additional information, see Note 4, located in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.
The allowance for credit losses on unfunded loan commitments is classified in other liabilities on the Consolidated Statements of Financial Condition. The allowance for credit losses on unfunded loan commitments is increased by charging a provision for credit losses on unfunded commitments, which was reported in other non-interest expenses for 2022 and prior.
We believe that our allowance for credit losses was adequate to absorb probable losses inherent in the loan portfolio as of December 31, 2022 and 2021.
Investment Securities — Investment securities are classified as held-to-maturity (“HTM”) when the Company has the positive intent and ability to hold the securities to maturity. Investment securities are classified as available-for-sale (“AFS”) when the Company has the intent of holding the security for an indefinite period of time, but not necessarily to maturity. The Company determines the appropriate classification at the time of purchase, and periodically thereafter. Investment securities classified at HTM are carried at amortized cost. Investment securities classified at AFS are reported at fair value. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Debt securities classified as held-to-maturity are carried at cost, net of the allowance for credit losses - securities, adjusted for amortization of premiums and discounts to the earliest callable date. Debt securities classified as available-for-sale are measured at fair value. Unrealized holding gains and losses on debt securities classified as available-for-sale are excluded from earnings and are reported net of tax as accumulated other comprehensive income (AOCI), a component of shareholders’ equity, until realized. When AFS securities, specifically identified, are sold, the unrealized gain or loss is reclassified from AOCI to non-interest income.
Management measures expected credit losses on held-to-maturity debt securities on a collective basis by major security type. The Company’s HTM portfolio contains securities issued by U.S. government entities and agencies and municipalities. The Company uses industry historical credit loss information adjusted for current conditions to establish the allowance for credit losses on its HTM municipal bond portfolio.
For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings. If the Company does not intend to sell the security, and it is not more likely than not that the Company will be required to sell the security, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized costs, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. Projected cash flows are discounted by the current effective interest rate. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to AOCI.
Changes in the allowance for credit losses-securities are recorded as provision for (or reversal of) credit losses. Losses are charged against the allowance when management believes the non-collectability of an available-for-sale security is confirmed or when either criteria regarding intent of requirement to sell is met.
At December 31, 2022, we had no investment securities that were impaired.
Goodwill — Goodwill represents the excess of the purchase considerations paid over the fair value of the assets acquired, net of the fair values of liabilities assumed in a business combination it is not amortized but is reviewed annually, or more frequently as current circumstances and conditions warrant, for impairment. An assessment of qualitative factors is completed to determine if it is more likely than not that, the fair value of a reporting unit is less than its carrying amount. If the qualitative analysis concludes that further analysis is required, then a quantitative impairment test would be completed. The quantitative goodwill impairment compares the reporting unit's estimated fair values, including goodwill, to its carrying amount. If the carrying amount exceeds its reporting unit’s fair value, then an impairment loss would be recognized as a charge to earnings, but is limited by the amount of goodwill allocated to that reporting unit.
Other Intangible Assets — Other intangible assets consists primarily of core deposit intangibles (“CDI”), which are amounts recorded in business combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the client relationships associated with the deposits. Core deposit intangibles are amortized over the estimated useful lives of such deposits. These assets are reviewed at least annually for events or circumstances that could affect their recoverability. These events could include loss of the underlying core deposits, increased competition or adverse changes in the economy. The amortization of our CDI is recorded in other non-interest expense. To the extent other identifiable intangible assets are deemed unrecoverable; impairment losses are recorded in other non-interest expense to reduce the carrying amount of the assets.
Fair Value Measurements — The Company discloses the fair value of financial instruments and the methods and significant assumptions used to estimate those fair values. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period between origination of the instrument and its expected realization.
For additional information, see “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” and Note 12 located in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.
Income Taxes — Income taxes are filed on a consolidated basis with our subsidiaries and allocate income tax expense (benefit) based on each entity’s proportionate share of the consolidated provision for 2017 includedincome taxes. Deferred income tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amounts of assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The determination of the amount of deferred income tax assets, that are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a $6.3 million re-measurementvaluation allowance is recorded if it is “more likely than not” that all or a portion of the deferred income tax asset will not be realized. “More likely than not” is defined as greater than a 50% probability. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed.
Only tax positions that meet the more likely than not recognition threshold are recognized. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a one-time, non-cash increaseliability for unrecognized tax benefits in the accompanying consolidated statements of financial condition along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest expense and penalties associated with unrecognized tax benefits are classified as income tax expense in the 4th quarter. Our situation is not unique in that the majorityconsolidated statements of all financial institutions reported significant DTA re-measurements in the 4th quarter of 2017. Excluding the impact of the $6.3 million DTA re-measurement, non-GAAP adjusted net income for the year totaled $34.6 million, an increase of $5.0 million or 16.8% over the prior year, which would have resulted in an adjusted return on average assets of 1.15% and adjusted return on average equity of 11.79%.income.
Management believes that the Company’s performance compared very favorably to its peer banks during the five-year period ended December 31, 2020:Impact of Recently Issued Accounting Standards
Net income overSee Note 1. “Summary of Significant Accounting Policies” to the five-year period totaled $218 million.Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.
Return on Average Assets averaged 1.31% over the five-year period.
Total assets increased 74% from $2.6 billion at December 31, 2015 to $4.6 billion at December 31, 2020.
Total loans & leases increased 55.3% from $2.0 billion at December 31, 2015 to $3.1 billion at December 31, 2020.
Total deposits increased 78.3% from $2.3 billion at December 31, 2015 to $4.1 billion at December 31, 2020.
More recently:
In 2020, the Company earned $58.7 million for a return on average assets of 1.43%.
In 2020, the Company increased its cash dividend per share by 3.9% over 2019 levels, and our strong financial performance has allowed us to increase dividends every year during this five-year period.
The Company’s total risk based capital ratio was 12.60% at December 31, 2020, and the Bank achieved the highest regulatory classification of “well capitalized” in each of the previous five years. See “Financial Condition – Capital.”
The Company’s asset quality remains very strong at the present time, when measured by: (1) net charge-offs at 0.02% of average loans & leases during 2020; (2) non-accrual loans of $495,000 at December 31, 2020; and (3) substandard loans & leases totaling 0.60% of total loans & leases at December 31, 2020. See “Results of Operations – Provision and Allowance for Credit Losses” and “Financial Condition – Classified Loans & Leases and Non-Performing Assets.”
Because of our strong earnings performance, capital position, and asset quality, stockholders have benefited from the fact that cash dividends per share have increased 14.34% since 2015, and totaled $69.50 per share over the five-year period. The 2020 dividend of $14.75 per share represents a 1.94% yield based upon the December 31, 2020 closing stock price of $760 per share (See “Part II, Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities”).
Looking Forward: 2021 and Beyond
In management’s opinion, the following key issues will continue to influence the financial results of the Company in 2021 and future years:
The continuing impact of COVID-19.
The Company’s earnings are heavily dependent on its net interest margin, which is sensitive to such factors as: (1) market interest rates; (2) the mix of our earning assets and interest-bearing liabilities; and (3) competitor pricing strategies. Since early 2020 market interest rates have declined and remain at very low levels. This has adversely impacted the Company’s NIM, and will, in all probability, continue to place pressure on NIM in 2021.
The Company’s results are impacted by changes in the credit quality of its borrowers. Substandard loans & leases totaled $18.6 million or 0.60% of total loans & leases at December 31, 2020 vs. $16.2 million or 0.61% of total loans & leases at December 31, 2019. Management believes, based on information currently available, that these levels are adequately covered by the Company’s $58.9 million allowance for credit losses as of December 31, 2020. See “Results of Operations - Provision and Allowance for Credit Losses” and “Financial Condition – Classified Loans & Leases and Non-Performing Assets.” The Company’s provision for credit losses was $4.5 million in 2020, compared to $200,000 in 2019 and $5.5 million in 2018. See “Item 1A. Risk Factors.”
Since the passage of the Dodd-Frank Act in 2010, Congress has implemented broad changes to the regulation of consumer financial products and the financial services industry as a whole. These changes have, and will continue to have, a significant effect on the Company’s product offerings, pricing and profitability in areas such as debit and credit cards, home mortgages and deposit service charges.
The Company has: (i) expanded its geographic footprint through de novo branch expansion in Walnut Creek, Napa, Lockeford and Concord, CA and through acquisition in Manteca, Riverbank, Rio Vista, and Walnut Grove, CA; and (ii) established equipment leasing as a new line of business. Although Management believes that these initiatives will result in increased asset growth and earnings, along with reduced concentration risks, the start-up costs related to staff and facilities are significant and will take time to recoup.
The Company benefited significantly in 2018 and 2019, and should continue to benefit in future years, from the reduction of the federal corporate tax rate from 35% to 21% pursuant to the recently enacted Tax Cuts and Jobs Act. However, if the new Biden administration increases federal corporate tax rates it will negatively impact the Company’s future financial results.
Results of Operations
The following discussion and analysis is intended to provide a better understanding of Farmers & Merchants Bancorp and its subsidiaries’ performance during each of the years in the three-yeartwo-year period ended December 31, 20202022 and the material changes in financial condition, operating income, and expense of the Company and its subsidiaries as shown in the accompanying consolidated financial statements.
Impact Information related to the comparison of Bankthe results of Rio Vista Acquisition on Results of Operations
On October 10, 2018, Farmers & Merchants Bancorp completed the acquisition of Bank of Rio Vista. Since the acquisition took place late in the year, and Bank of Rio Vista had only $217.5 million in assets (less than 6% of Farmers & Merchants Bancorp’s total assets), the impact on the Company’s 2018 Results of Operations was limited with the exception of legal fees, contract termination costs and systems conversion costs that were booked as non-interest expense by the Company in 2018. The gross amount of such expenses were $2.93 million.
Net Interest Income/Net Interest Margin
The tables on the following pages reflect the Company's average balance sheets and volume and rate analysisoperations for the years endedDecember 31, 2021 and 2020 2019can be found in “Management’s Discussion and 2018. Average balance amounts for assetsAnalysis of Financial Condition and liabilities areResults of Operations” in the computed average of daily balances.2021 Annual Report on Form 10-K filed with the SEC on March 15, 2022.
Net interest income isFactors that determine the amount by which the interest and fees on loans & leases and other interest-earning assets exceed the interest paid on interest-bearing sources of funds. For the purpose of analysis, the interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes. This adjustment is referred to as “tax equivalent” adjustment and is noted wherever applicable. The presentationlevel of net interest income and net interest margin on a tax equivalent basis is a common practice withininclude the banking industry.
The Volume and Rate Analysisvolume of Net Interest Income summarizes the changes in interest income and interest expense based on changes in average asset and liability balances (volume) and changes in average rates (rate). For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to: (1) changes in volume (change in volume multiplied by initial rate); (2) changes in rate (change in rate multiplied by initial volume); and (3) changes in rate/volume, also called “changes in mix” (allocated in proportion to the respective volume and rate components).
The Company’s earning assets and interest bearing liabilities, are subject to repricing at different times, which exposesyields earned and rates paid, fee income, non-interest expense, the Company tolevel of non-performing loans and other non-earning assets, and the amount of non-interest bearing liabilities supporting earning assets. Non-interest income fluctuations when interest rates change. In order to minimizeincludes card processing fees, service charges on deposit accounts, bank-owned life insurance income, fluctuations,gains/losses on the Company attempts to match assetsale of investment securities, and liability maturities. However, some maturity mismatch is inherent in the assetgains/losses on deferred compensation investments. Non-interest expense consists primarily of salaries and liability mix. See “Item 7A. Quantitativeemployee benefits, cost of deferred compensation benefits, occupancy, data processing, FDIC insurance, marketing, legal and Qualitative Disclosures About Market Risk - Interest Rate Risk.”other expenses.
Farmers & Merchants Bancorp
Year-to-Date Average BalancesBalance and Interest Rates
(Interest and Rates onYields. The following table sets forth a Taxable Equivalent Basis)
(in thousands)
| | Year Ended December 31, 2020 | |
Assets | | Balance | | | Interest | | | Rate | |
Interest Bearing Deposits with Banks | | $ | 326,247 | | | $ | 1,207 | | | | 0.37 | % |
Investment Securities: | | | | | | | | | | | | |
U.S. Treasuries | | | 21,249 | | | | 356 | | | | 1.68 | % |
U.S. Govt SBA | | | 9,450 | | | | 116 | | | | 1.23 | % |
Government Agency & Government-Sponsored Entities | | | - | | | | - | | | | - | |
Municipals - Taxable | | | 12,582 | | | | 513 | | | | 4.08 | % |
Obligations of States and Political Subdivisions - Non-Taxable (1) | | | 52,736 | | | | 2,109 | | | | 4.00 | % |
Mortgage Backed Securities | | | 468,306 | | | | 11,193 | | | | 2.39 | % |
Other | | | 19,323 | | | | 213 | | | | 1.10 | % |
Total Investment Securities | | | 583,646 | | | | 14,500 | | | | 2.48 | % |
| | | | | | | | | | | | |
Loans & Leases: (2) | | | | | | | | | | | | |
Real Estate | | | 1,921,485 | | | | 95,194 | | | | 4.95 | % |
Home Equity Lines and Loans | | | 37,952 | | | | 1,828 | | | | 4.82 | % |
Agricultural | | | 259,132 | | | | 13,049 | | | | 5.04 | % |
Commercial | | | 372,344 | | | | 17,941 | | | | 4.82 | % |
Consumer (3) | | | 12,748 | | | | 784 | | | | 6.15 | % |
Other | | | 228,530 | | | | 8,837 | | | | 3.87 | % |
Leases | | | 106,293 | | | | 5,750 | | | | 5.41 | % |
Total Loans & Leases | | | 2,938,484 | | | | 143,383 | | | | 4.88 | % |
Total Earning Assets | | | 3,848,377 | | | $ | 159,090 | | | | 4.13 | % |
| | | | | | | | | | | | |
Unrealized Gain on Securities Available-for-Sale | | | 16,289 | | | | | | | | | |
Allowance for Credit Losses | | | (55,804 | ) | | | | | | | | |
Cash and Due From Banks | | | 62,089 | | | | | | | | | |
All Other Assets | | | 241,586 | | | | | | | | | |
Total Assets | | $ | 4,112,537 | | | | | | | | | |
| | | | | | | | | | | | |
Liabilities & Shareholders' Equity | | | | | | | | | | | | |
Interest Bearing Deposits: | | | | | | | | | | | | |
Interest Bearing DDA | | $ | 787,306 | | | $ | 1,618 | | | | 0.21 | % |
Savings and Money Market | | | 1,128,623 | | | | 2,724 | | | | 0.24 | % |
Time Deposits | | | 489,246 | | | | 4,771 | | | | 0.98 | % |
Total Interest Bearing Deposits | | | 2,405,175 | | | | 9,113 | | | | 0.38 | % |
Federal Home Loan Bank Advances | | | 1 | | | | - | | | | 0.00 | % |
Subordinated Debt | | | 10,310 | | | | 378 | | | | 3.67 | % |
Total Interest Bearing Liabilities | | | 2,415,486 | | | $ | 9,491 | | | | 0.39 | % |
Interest Rate Spread (4) | | | | | | | | | | | 3.74 | % |
Demand Deposits (Non-Interest Bearing) | | | 1,232,874 | | | | | | | | | |
All Other Liabilities | | | 61,848 | | | | | | | | | |
Total Liabilities | | | 3,710,208 | | | | | | | | | |
Shareholders' Equity | | | 402,329 | | | | | | | | | |
Total Liabilities & Shareholders' Equity | | $ | 4,112,537 | | | | | | | | | |
Impact of Non-Interest Bearing Deposits and Other Liabilities | | | | | | | | | | | 0.15 | % |
Net Interest Income and Margin on Total Earning Assets (5) | | | | | | | 149,599 | | | | 3.89 | % |
Tax Equivalent Adjustment | | | | | | | (438 | ) | | | | |
Net Interest Income | | | | | | $ | 149,161 | | | | 3.88 | % |
(1) Yields and interest income are calculated on an fully taxable equivalent basis using the current statutory federal tax rate.
(2) Averagesummary of average balances on loans & leases outstanding include non-performing loans, if any. The amortized portion of net loan origination fees is included in interest income on loans & leases, representing an adjustment to the yield.
(3) Includes CARES Act Small Business Administration Paycheck Protection Program loans.
(4) Interest rate spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
(5) Net interest margin is computed by calculating the difference betweenwith corresponding interest income and interest expense divided byas well as average yield, cost and net interest margin information for the average balance of interest-earningperiods presented. Average balances are derived from daily balances.
| | Year ended December 31, |
| | 2022 | | | 2021 | |
(Dollars in thousands) | | Average Balance | | | Interest Income / Expense | | | Average Yield / Rate | | | Average Balance | | | Interest Income / Expense | | | Average Yield / Rate | |
ASSETS | | | | | | | | | | | | | | | | | | |
Interest earnings deposits in other banks and federal funds sold | | $ | 704,082 | | | $ | 12,102 | | | | 1.72 | % | | $ | 666,167 | | | $ | 902 | | | | 0.14 | % |
Investment securities:(1) | | | | | | | | | | | | | | | | | | | | | | | | |
Taxable securities | | | 1,044,954 | | | | 19,678 | | | | 1.88 | % | | | 838,710 | | | | 14,646 | | | | 1.75 | % |
Non-taxable securities(2) | | | 48,168 | | | | 1,569 | | | | 3.26 | % | | | 52,384 | | | | 1,648 | | | | 3.15 | % |
Total investment securities | | | 1,093,122 | | | | 21,247 | | | | 1.94 | % | | | 891,094 | | | | 16,294 | | | | 1.83 | % |
Loans:(3) | | | | | | | | | | | | | | | | | | | | | | | | |
Real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial | | | 1,202,548 | | | | 58,966 | | | | 4.90 | % | | | 1,037,554 | | | | 53,298 | | | | 5.14 | % |
Agricultural | | | 705,222 | | | | 35,010 | | | | 4.96 | % | | | 641,086 | | | | 29,544 | | | | 4.61 | % |
Residential and home equity | | | 369,619 | | | | 14,551 | | | | 3.94 | % | | | 339,345 | | | | 12,717 | | | | 3.75 | % |
Construction | | | 182,523 | | | | 9,788 | | | | 5.36 | % | | | 182,722 | | | | 7,965 | | | | 4.36 | % |
Total real estate | | | 2,459,912 | | | | 118,315 | | | | 4.81 | % | | | 2,200,707 | | | | 103,524 | | | | 4.70 | % |
Commercial & industrial | | | 440,510 | | | | 22,452 | | | | 5.10 | % | | | 373,497 | | | | 16,935 | | | | 4.53 | % |
Agricultural | | | 262,461 | | | | 14,084 | | | | 5.37 | % | | | 233,544 | | | | 10,385 | | | | 4.45 | % |
Commercial leases | | | 94,040 | | | | 5,702 | | | | 6.06 | % | | | 98,056 | | | | 5,485 | | | | 5.59 | % |
Consumer and other | | | 22,008 | | | | 3,469 | | | | 15.76 | % | | | 178,535 | | | | 10,879 | | | | 6.09 | % |
Total loans and leases | | | 3,278,931 | | | | 164,022 | | | | 5.00 | % | | | 3,084,339 | | | | 147,208 | | | | 4.77 | % |
Non-marketable securities | | | 15,549 | | | | 1,042 | | | | 6.70 | % | | | 14,737 | | | | 864 | | | | 5.86 | % |
Total interest earning assets | | | 5,091,684 | | | | 198,413 | | | | 3.90 | % | | | 4,656,337 | | | | 165,268 | | | | 3.55 | % |
Allowance for credit losses | | | (62,588 | ) | | | | | | | | | | | (60,059 | ) | | | | | | | | |
Non-interest earning assets | | | 312,805 | | | | | | | | | | | | 317,721 | | | | | | | | | |
Total average assets | | $ | 5,341,901 | | | | | | | | | | | $ | 4,913,999 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | |
Interest bearing deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
Demand | | $ | 1,120,198 | | | | 1,497 | | | | 0.13 | % | | $ | 1,024,009 | | | | 1,128 | | | | 0.11 | % |
Savings and money market accounts | | | 1,542,310 | | | | 1,981 | | | | 0.13 | % | | | 1,352,258 | | | | 1,458 | | | | 0.11 | % |
Certificates of deposit greater than $250,000 | | | 157,623 | | | | 460 | | | | 0.29 | % | | | 170,040 | | | | 701 | | | | 0.41 | % |
Certificates of deposit less than $250,000 | | | 215,044 | | | | 411 | | | | 0.19 | % | | | 235,746 | | | | 730 | | | | 0.31 | % |
Total interest bearing deposits | | | 3,035,175 | | | | 4,349 | | | | 0.14 | % | | | 2,782,053 | | | | 4,017 | | | | 0.14 | % |
Short-term borrowings | | | 1 | | | | - | | | | 0.00 | % | | | 1 | | | | - | | | | 0.00 | % |
Subordinated debentures | | | 10,310 | | | | 491 | | | | 4.76 | % | | | 10,310 | | | | 315 | | | | 3.06 | % |
Total interest bearing liabilities | | | 3,045,486 | | | | 4,840 | | | | 0.16 | % | | | 2,792,364 | | | | 4,332 | | | | 0.16 | % |
Non-interest bearing deposits | | | 1,751,797 | | | | | | | | | | | | 1,610,611 | | | | | | | | | |
Total funding | | | 4,797,283 | | | | 4,840 | | | | 0.10 | % | | | 4,402,975 | | | | 4,332 | | | | 0.10 | % |
Other non-interest bearing liabilities | | | 76,617 | | | | | | | | | | | | 68,778 | | | | | | | | | |
Shareholders' equity | | | 468,001 | | | | | | | | | | | | 442,246 | | | | | | | | | |
Total average liabilities and shareholders' equity | | $ | 5,341,901 | | | | | | | | | | | $ | 4,913,999 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income | | | | | | $ | 193,573 | | | | | | | | | | | $ | 160,936 | | | | | |
Interest rate spread | | | | | | | | | | | 3.74 | % | | | | | | | | | | | 3.39 | % |
Net interest margin(4) | | | | | | | | | | | 3.80 | % | | | | | | | | | | | 3.46 | % |
| | | | | | | | | | | | | | | | | | | | | | | | |
(1) | Excludes average unrealized (losses) gains of ($24.5) million and $3.4 million for the years ended December 31, 2022, and 2021, respectively, which are included in non-interest earning assets. |
(2) | The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $415,000 and $436,000 for the years ended December 31, 2022, and 2021, respectively. |
(3) | Loan interest income includes loan fees of $11.6 million and $17.0 million for the years ended December 31, 2022 and 2021, respectively. |
(4) | Net interest margin is computed by dividing net interest income by average interest earning assets. |
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
| | Year Ended December 31, 2019 | |
Assets | | Balance | | | Interest | | | Rate | |
Interest Bearing Deposits with Banks | | $ | 232,623 | | | $ | 4,909 | | | | 2.11 | % |
Investment Securities: | | | | | | | | | | | | |
U.S. Treasuries | | | 27,096 | | | | 537 | | | | 1.98 | % |
U.S. Govt SBA | | | 13,372 | | | | 329 | | | | 2.46 | % |
Government Agency & Government-Sponsored Entities | | | 2,108 | | | | 62 | | | | 2.94 | % |
Municipals - Taxable | | | 6,545 | | | | 344 | | | | 5.26 | % |
Obligations of States and Political Subdivisions - Non-Taxable | | | 51,872 | | | | 2,079 | | | | 4.01 | % |
Mortgage Backed Securities | | | 321,240 | | | | 8,466 | | | | 2.64 | % |
Other | | | 4,850 | | | | 173 | | | | 3.57 | % |
Total Investment Securities | | | 427,083 | | | | 11,990 | | | | 2.81 | % |
| | | | | | | | | | | | |
Loans & Leases: | | | | | | | | | | | | |
Real Estate | | | 1,736,406 | | | | 93,227 | | | | 5.37 | % |
Home Equity Lines and Loans | | | 90,423 | | | | 2,316 | | | | 2.56 | % |
Agricultural | | | 275,472 | | | | 15,423 | | | | 5.60 | % |
Commercial | | | 364,676 | | | | 19,335 | | | | 5.30 | % |
Consumer | | | 16,634 | | | | 1,194 | | | | 7.18 | % |
Other | | | 1,051 | | | | 24 | | | | 2.28 | % |
Leases | | | 104,896 | | | | 5,718 | | | | 5.45 | % |
Total Loans & Leases | | | 2,589,558 | | | | 137,237 | | | | 5.30 | % |
Total Earning Assets | | | 3,249,264 | | | $ | 154,136 | | | | 4.74 | % |
| | | | | | | | | | | | |
Unrealized Gain on Securities Available-for-Sale | | | 938 | | | | | | | | | |
Allowance for Credit Losses | | | (55,165 | ) | | | | | | | | |
Cash and Due From Banks | | | 56,855 | | | | | | | | | |
All Other Assets | | | 225,565 | | | | | | | | | |
Total Assets | | $ | 3,477,457 | | | | | | | | | |
| | | | | | | | | | | | |
Liabilities & Shareholders' Equity | | | | | | | | | | | | |
Interest Bearing Deposits: | | | | | | | | | | | | |
Interest Bearing DDA | | $ | 668,818 | | | $ | 2,360 | | | | 0.35 | % |
Savings and Money Market | | | 930,390 | | | | 3,340 | | | | 0.36 | % |
Time Deposits | | | 519,848 | | | | 6,940 | | | | 1.34 | % |
Total Interest Bearing Deposits | | | 2,119,056 | | | | 12,640 | | | | 0.60 | % |
Federal Home Loan Bank Advances | | | 1 | | | | - | | | | 0.00 | % |
Subordinated Debt | | | 10,310 | | | | 554 | | | | 5.37 | % |
Total Interest Bearing Liabilities | | | 2,129,367 | | | $ | 13,194 | | | | 0.62 | % |
Interest Rate Spread | | | | | | | | | | | 4.12 | % |
Demand Deposits | | | 949,695 | | | | | | | | | |
All Other Liabilities | | | 64,274 | | | | | | | | | |
Total Liabilities | | | 3,143,336 | | | | | | | | | |
Shareholders' Equity | | | 334,121 | | | | | | | | | |
Total Liabilities & Shareholders' Equity | | $ | 3,477,457 | | | | | | | | | |
Impact of Non-Interest Bearing Deposits and Other Liabilities | | | | | | | | | | | 0.21 | % |
Net Interest Income and Margin on Total Earning Assets | | | | | | | 140,942 | | | | 4.34 | % |
Tax Equivalent Adjustment | | | | | | | (428 | ) | | | | |
Net Interest Income | | | | | | $ | 140,514 | | | | 4.32 | % |
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis. Loan interest income includes fee income and unearned discount in the amount of $5.8 million for the year ended December 31, 2019. Non-accrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost.
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
| | Year Ended December 31, 2018 | |
Assets | | Balance | | | Interest | | | Rate | |
Interest Bearing Deposits with Banks | | $ | 147,700 | | | $ | 2,755 | | | | 1.87 | % |
Investment Securities: | | | | | | | | | | | | |
U.S. Treasuries | | | 64,630 | | | | 939 | | | | 1.45 | % |
U.S. Govt SBA | | | 22,537 | | | | 445 | | | | 1.97 | % |
Government Agency & Government-Sponsored Entities | | | 3,057 | | | | 88 | | | | 2.88 | % |
Municipals - Taxable | | | 665 | | | | 5 | | | | 0.75 | % |
Obligations of States and Political Subdivisions - Non-Taxable | | | 53,143 | | | | 2,024 | | | | 3.81 | % |
Mortgage Backed Securities | | | 314,937 | | | | 7,682 | | | | 2.44 | % |
Other | | | 3,707 | | | | 98 | | | | 2.64 | % |
Total Investment Securities | | | 462,676 | | | | 11,281 | | | | 2.44 | % |
| | | | | | | | | | | | |
Loans & Leases | | | | | | | | | | | | |
Real Estate | | | 1,642,005 | | | | 83,131 | | | | 5.06 | % |
Home Equity Lines and Loans | | | 37,086 | | | | 2,041 | | | | 5.50 | % |
Agricultural | | | 273,178 | | | | 14,067 | | | | 5.15 | % |
Commercial | | | 291,209 | | | | 15,158 | | | | 5.21 | % |
Consumer | | | 9,014 | | | | 503 | | | | 5.58 | % |
Other | | | 1,356 | | | | 31 | | | | 2.29 | % |
Leases | | | 95,968 | | | | 4,906 | | | | 5.11 | % |
Total Loans & Leases | | | 2,349,816 | | | | 119,837 | | | | 5.10 | % |
Total Earning Assets | | | 2,960,192 | | | $ | 133,873 | | | | 4.52 | % |
| | | | | | | | | | | | |
Unrealized Loss on Securities Available-for-Sale | | | (8,151 | ) | | | | | | | | |
Allowance for Credit Losses | | | (52,012 | ) | | | | | | | | |
Cash and Due From Banks | | | 49,292 | | | | | | | | | |
All Other Assets | | | 199,526 | | | | | | | | | |
Total Assets | | $ | 3,148,847 | | | | | | | | | |
| | | | | | | | | | | | |
Liabilities & Shareholders' Equity | | | | | | | | | | | | |
Interest Bearing Deposits | | | | | | | | | | | | |
Interest Bearing DDA | | $ | 618,674 | | | $ | 1,683 | | | | 0.27 | % |
Savings and Money Market | | | 844,729 | | | | 1,798 | | | | 0.21 | % |
Time Deposits | | | 476,756 | | | | 3,944 | | | | 0.83 | % |
Total Interest Bearing Deposits | | | 1,940,159 | | | | 7,425 | | | | 0.38 | % |
Federal Home Loan Bank Advances | | | 36 | | | | 1 | | | | 2.78 | % |
Subordinated Debt | | | 10,310 | | | | 524 | | | | 5.08 | % |
Total Interest Bearing Liabilities | | | 1,950,505 | | | $ | 7,950 | | | | 0.41 | % |
Interest Rate Spread | | | | | | | | | | | 4.11 | % |
Demand Deposits | | | 845,165 | | | | | | | | | |
All Other Liabilities | | | 45,516 | | | | | | | | | |
Total Liabilities | | | 2,841,186 | | | | | | | | | |
Shareholders' Equity | | | 307,661 | | | | | | | | | |
Total Liabilities & Shareholders' Equity | | $ | 3,148,847 | | | | | | | | | |
Impact of Non-Interest Bearing Deposits and Other Liabilities | | | | | | | | | | | 0.14 | % |
Net Interest Income and Margin on Total Earning Assets | | | | | | | 125,923 | | | | 4.25 | % |
Tax Equivalent Adjustment | | | | | | | (420 | ) | | | | |
Net Interest Income | | | | | | $ | 125,503 | | | | 4.24 | % |
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis. Loan interest income includes fee income and unearned discount in the amount of $5.5 million for the year ended December 31, 2018. Non-accrual loans and lease financing receivables have been included in the average balances. Yields on securities available-for-sale are based on historical cost.
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Income
(Rates on a Taxable Equivalent Basis)
(in thousands)
| | 2020 versus 2019 Amount of Increase (Decrease) Due to Change in: | |
Interest Earning Assets | | Volume | | | Rate | | | Net Chg. | |
Interest Bearing Deposits with Banks | | $ | 3,529 | | | $ | (7,230 | ) | | $ | (3,702 | ) |
Investment Securities: | | | | | | | | | | | | |
U.S. Treasuries | | | (105 | ) | | | (76 | ) | | | (181 | ) |
U.S. Govt SBA | | | (78 | ) | | | (135 | ) | | | (213 | ) |
Government Agency & Government-Sponsored Entities | | | (31 | ) | | | (31 | ) | | | (62 | ) |
Municipals - Taxable | | | 223 | | | | (54 | ) | | | 169 | |
Obligations of States and Political Subdivisions - Non-Taxable | | | 35 | | | | (5 | ) | | | 29 | |
Mortgage Backed Securities | | | 3,423 | | | | (696 | ) | | | 2,727 | |
Other | | | 52 | | | | (13 | ) | | | 40 | |
Total Investment Securities | | | 3,519 | | | | (1,010 | ) | | | 2,509 | |
| | | | | | | | | | | | |
Loans: | | | | | | | | | | | | |
Real Estate | | | 7,147 | | | | (5,180 | ) | | | 1,967 | |
Home Equity | | | 943 | | | | (1,431 | ) | | | (488 | ) |
Agricultural | | | (881 | ) | | | (1,493 | ) | | | (2,374 | ) |
Commercial | | | 418 | | | | (1,811 | ) | | | (1,394 | ) |
Consumer (1) | | | (254 | ) | | | (156 | ) | | | (410 | ) |
Other | | | 8,785 | | | | 29 | | | | 8,813 | |
Leases | | | 72 | | | | (41 | ) | | | 32 | |
Total Loans | | | 16,229 | | | | (10,083 | ) | | | 6,146 | |
Total Earning Assets | | | 23,277 | | | | (18,324 | ) | | | 4,953 | |
| | | | | | | | | | | | |
Interest Bearing Liabilities | | | | | | | | | | | | |
Interest Bearing Deposits: | | | | | | | | | | | | |
Transaction | | | 547 | | | | (1,290 | ) | | | (742 | ) |
Savings | | | 1,147 | | | | (1,762 | ) | | | (616 | ) |
Time Deposits | | | (390 | ) | | | (1,779 | ) | | | (2,169 | ) |
Total Interest Bearing Deposits | | | 1,304 | | | | (4,831 | ) | | | (3,527 | ) |
Other Borrowed Funds | | | - | | | | - | | | | - | |
Subordinated Debt | | | - | | | | (176 | ) | | | (176 | ) |
Total Interest Bearing Liabilities | | | 1,304 | | | | (5,007 | ) | | | (3,703 | ) |
Total Change | | $ | 21,973 | | | $ | (13,317 | ) | | $ | 8,656 | |
(1) Includes CARES Act Small Business Administration Paycheck Protection Program loans.
Notes: Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total "net change." The above figures have been rounded to the nearest whole number.
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Income
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
| | 2019 versus 2018 Amount of Increase (Decrease) Due to Change in: | |
Interest Earning Assets | | Volume | | | Rate | | | Net Chg. | |
Interest Bearing Deposits with Banks | | $ | 1,753 | | | $ | 401 | | | $ | 2,154 | |
Investment Securities: | | | | | | | | | | | | |
U.S. Treasuries | | | (1,078 | ) | | | 676 | | | | (402 | ) |
U.S. Govt SBA | | | (294 | ) | | | 178 | | | | (116 | ) |
Government Agency & Government-Sponsored Entities | | | (28 | ) | | | 2 | | | | (26 | ) |
Municipals - Taxable | | | 306 | | | | 33 | | | | 339 | |
Obligations of States and Political Subdivisions - Non-Taxable | | | (66 | ) | | | 121 | | | | 55 | |
Mortgage Backed Securities | | | 156 | | | | 628 | | | | 784 | |
Other | | | 35 | | | | 41 | | | | 76 | |
Total Investment Securities | | | (969 | ) | | | 1,679 | | | | 710 | |
| | | | | | | | | | | | |
Loans & Leases: | | | | | | | | | | | | |
Real Estate | | | 4,920 | | | | 5,176 | | | | 10,096 | |
Home Equity Lines and Loans | | | 438 | | | | (163 | ) | | | 275 | |
Agricultural | | | 119 | | | | 1,237 | | | | 1,356 | |
Commercial | | | 3,890 | | | | 287 | | | | 4,177 | |
Consumer | | | 516 | | | | 175 | | | | 691 | |
Other | | | (7 | ) | | | - | | | | (7 | ) |
Leases | | | 474 | | | | 337 | | | | 811 | |
Total Loans & Leases | | | 10,350 | | | | 7,049 | | | | 17,399 | |
Total Earning Assets | | | 11,134 | | | | 9,129 | | | | 20,263 | |
| | | | | | | | | | | | |
Interest Bearing Liabilities | | | | | | | | | | | | |
Interest Bearing Deposits: | | | | | | | | | | | | |
Interest Bearing DDA | | | 145 | | | | 532 | | | | 677 | |
Savings and Money Market | | | 198 | | | | 1,344 | | | | 1,542 | |
Time Deposits | | | 384 | | | | 2,612 | | | | 2,996 | |
Total Interest Bearing Deposits | | | 727 | | | | 4,488 | | | | 5,215 | |
Other Borrowed Funds | | | (1 | ) | | | - | | | | (1 | ) |
Subordinated Debt | | | - | | | | 30 | | | | 30 | |
Total Interest Bearing Liabilities | | | 726 | | | | 4,518 | | | | 5,244 | |
Total Change | | $ | 10,408 | | | $ | 4,611 | | | $ | 15,019 | |
Notes: Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total "net change." The above figures have been rounded to the nearest whole number.
2020 Compared to 2019
Net interest income increased 6.15% to $149.2 million during 2020. On a fully tax equivalent (TE) basis, net interest income increased 6.14% and totaled $149.6 million during 2020 compared to $141.0 million for 2019. As more fully discussed below, the increase in net interest income was due primarily to a $599.1 million increase in average earning assets offset by a 45 basis point decrease in the net interest margin.
Net interest income on a tax equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin. For 2020, the Company’s net interest margin was 3.89% compared to 4.34% in 2019. This decrease in net interest margin was due primarily to a decrease of 0.61% in the yield received on earning assets, offset somewhat by a 0.23% decrease in the cost of interest bearing liabilities.
Average loans & leases totaled $2.9 billion for the year ended December 31, 2020; an increase of $349.0 million compared to the year ended December 31, 2019. A significant portion of this increase was due to loans funded under the SBA PPP. Since April 2020, we have funded $347.4 million of loans for 1,540 of our small business customers. (See “Introduction - COVID-19 (Coronavirus) Disclosure” for additional information). Loans & leases decreased from 79.7% of average earning assets during 2019 to 76.4% in 2020. The year-to-date yield on the loan & lease portfolio decreased to 4.88% for the year ended December 31, 2020, compared to 5.30% for the year ended December 31, 2019. Some of this decrease was due to $347.4 million of PPP loans funded at a rate of 1.00% (plus accreted loan fees) with the remaining decrease due to an overall drop in market interest rates. This lower yield was offset by the positive impact of increased average loan & lease balances resulting in interest revenue from loans & leases to increase by 4.48% to $143.4 million. The Company continues to experience aggressive competitor pricing for loans & leases to which it may need to respond in order to retain key customers. This could place negative pressure on future loan & lease yields and net interest margin.
The investment portfolio is the other main component of the Company’s earning assets. Historically, the Company invested primarily in: (1) mortgage-backed securities issued by government-sponsored entities; (2) debt securities issued by the U.S. Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 7 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity. Since the risk factor for these types of investments is generally lower than that of loans & leases, the yield earned on investments is generally less than that of loans & leases.
Average investment securities increased $156.6 million in 2020 compared to the average balance during 2019. The average yield, on a tax equivalent basis, in the investment portfolio was 2.48% in 2020 compared to 2.81% in 2019. This overall decrease in yield was caused primarily by a decrease in market interest rates. As a result, of the combined impact of mix, balance and yield changes, tax equivalent interest income on securities increased $2.5 million to $14.5 million for the year ended December 31, 2020, compared to $12.0 million for the year ended December 31, 2019. See “Financial Condition – Investment Securities” for a discussion of the Company’s investment strategy in 2020. Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates, is shown on a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statements of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.
Interest-bearing deposits with banks and overnight investments in Federal Funds SoldReserve balances are additional earning assets available to the Company. Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earnearned an average interest atrate of 1.72% and 0.14% for the Fed Funds rate, which decreased to .10% inyears ended December 2020 compared to 1.55% in December 2019.31, 2022 and 2021, respectively. The increase was primarily the result of the FRB increasing rates by 425 basis points during 2022. Average interest-bearing deposits with bankswas $704 million and $666 million for the yearyears ended December 31, 2020, was $326.2 million, an increase of $93.6 million compared to the average balance for the year ended December 31, 2019.2022 and 2021, respectively. Interest income on interest-bearing deposits with banks was $12.1 million and $902,000 for the yearyears ended December 31, 2020, decreased $3.7 million to $1.2 million from the year ended December 31, 2019.
Average interest-bearing liabilities increased $286.1 million or 13.4% during the year ended December 31, 2020 compared to the average balance during 2019. Of that increase: (1) interest-bearing transaction deposits increased $118.5 million; (2) savings2022 and money market deposits increased $198.2 million; and (3) time deposits decreased $30.6 million (see “Financial Condition – Deposits”); (4) FHLB advances remained unchanged (see “Financial Condition – Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings”); and (5) subordinated debt remained unchanged (see “Financial Condition – Subordinated Debentures”). A significant portion of this deposit growth was a result of funds from the SBA PPP being deposited into borrower accounts until those funds will be used for their operating expenses.
Total interest expense on deposits was $9.1 million for 2020 and $12.6 million for 2019. As a result of the overall drop in market interest rates during 2020, and the decrease in higher yielding CD’s as a percentage of total deposits, the average rate paid on interest-bearing deposits was 0.38% in 2020 as compared to 0.60% in 2019. See “Overview – Looking Forward: 2021, and Beyond” for a discussion of factors influencing the Company’s future deposit rates and their impact on net interest margin.
2019 Compared to 2018
Net interest income increased 12.0% to $140.5 million during 2019. On a fully tax equivalent basis, net interest income increased 12.0% and totaled $141.0 million during 2019 compared to $125.9 million for 2018. As more fully discussed below, the increase in net interest income was due primarily to a $289.1 million increase in average earning assets, and a 9 basis point increase in the net interest margin.
Net interest income on a tax equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin. For 2019, the Company’s net interest margin was 4.34% compared to 4.25% in 2018 This increase in net interest margin was due primarily to an increase of 0.22% in the yield received on earning assets, offset somewhat by a 0.21% increase in the rates paid on interest bearing liabilities.
Average loans & leases totaled $2.6 billion for the year ended December 31, 2019; an increase of $239.7 million compared to the year ended December 31, 2018. Loans & leases increased from 79.4% of average earning assets during 2018 to 79.7% in 2019. The year-to-date yield on the loan & lease portfolio increased to 5.30% for the year ended December 31, 2019, compared to 5.10% for the year ended December 31, 2018. This higher yield combined with the impact of increased average loan & lease balances resulted in interest revenue from loans & leases increasing 14.5% to $137.2 million for 2019. The Company continues to experience aggressive competitor pricing for loans & leases to which it may need to respond in order to retain key customers. This could place negative pressure on future loan & lease yields and net interest margin.respectively.
The investment portfolio is the otheranother main component of the Company’s earning assets. Historically, the Company invested primarily in: (1) mortgage-backed securities issued by government-sponsored entities; (2) debt securities issued by the U.S. Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times the Company selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity. Since the risk factor for these types of investments is generally lower than that of loans &and leases, the yield earned on investments is generally less than that of loans &and leases.
Average total investment securities decreased $35.6were $1.1 billion and $891 million in 2019 compared tofor the average balance during 2018.years ended December 31, 2022 and 2021, respectively. The average yield on a tax equivalent basis, in thetotal investment portfolio was 2.81% in 2019 compared to 2.44% in 2018. This overall increase in yield was caused primarily by an increase in the mix of mortgage-backed securities as a percentage of total securitieswere 1.94% and an increase in market interest rates. As a result of the combined impact of these mix, balance and yield changes, tax equivalent interest income on securities increased slightly by $710,000 to $12.0 million1.83 % for the yearyears ended December 31, 2019, compared to $11.3 million for the year ended December 31, 2018.2022 and 2021, respectively. See “Financial Condition – Investment Securities”“Investment Securities and Federal Reserve balances” for a discussion of the Company’s investment strategy in 2019. Net interest income2022.
Average loans and leases held for investment were $3.3 billion and $3.1 billion for the years ended December 31, 2022 and 2021, respectively. The yield on the Schedule of Year-to-Date Average Balancesloan & lease portfolio was 5.00% and Interest Rates is shown4.77% for the years ended December 31, 2022 and 2021, respectively. The Company continues to experience aggressive competitor pricing for loans and leases to which it may need to respond in order to retain key customers. This could continue to place negative pressure on a tax equivalent basis, which is higher thanfuture loan & lease yields and net interest income as reflectedmargin.
Average interest-bearing liabilities was $3.0 billion and $2.8 billion for the years ended December 31, 2022 and 2021, respectively. Total interest expense on interest-bearing liabilities was $4.8 million, $4.3 million for the Consolidated Statements of Income because of adjustments that relate to incomeyears ended December 31, 2022 and 2021, respectively. The average rate paid on securities that are exempt from federal income taxes.interest-bearing liabilities was 0.16% and 0.16% for the years ended December 31, 2022 and 2021, respectively.
Interest-bearingRate/Volume Analysis. The following table shows the change in interest income and interest expense and the amount of change attributable to variances in volume, rates and the combination of volume and rates based on the relative changes of volume and rates. For purposes of this table, the change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of absolute dollar amounts of change in each.
| | Year Ended December 31, 2022 compared with 2021 |
|
| | | Increase (Decrease) Due to: | | | | |
(Dollars in thousands) | | Volume | | | Rate | | | Net | |
Interest income: | | | | | | | | | |
Interest earnings deposits in other banks and federal funds sold | | $ | 54 | | | $ | 11,146 | | | $ | 11,200 | |
Investment securities: | | | | | | | | | | | | |
Taxable securities | | | 3,816 | | | | 1,216 | | | | 5,032 | |
Non-taxable securities | | | (136 | ) | | | 57 | | | | (79 | ) |
Total investment securities | | | 3,680 | | | | 1,273 | | | | 4,953 | |
Loans: | | | | | | | | | | | | |
Real estate: | | | | | | | | | | | | |
Commercial | | | 7,805 | | | | (2,137 | ) | | | 5,668 | |
Agricultural | | | 3,081 | | | | 2,385 | | | | 5,466 | |
Residential and home equity | | | 1,168 | | | | 666 | | | | 1,834 | |
Construction | | | (9 | ) | | | 1,832 | | | | 1,823 | |
Total real estate | | | 12,045 | | | | 2,746 | | | | 14,791 | |
Commercial & industrial | | | 3,261 | | | | 2,256 | | | | 5,517 | |
Agricultural | | | 1,385 | | | | 2,314 | | | | 3,699 | |
Commercial leases | | | (231 | ) | | | 448 | | | | 217 | |
Consumer and other(1) | | | (14,475 | ) | | | 7,065 | | | | (7,410 | ) |
Total loans and leases | | | 1,986 | | | | 14,828 | | | | 16,814 | |
Non-marketable securities | | | 49 | | | | 129 | | | | 178 | |
Total interest income | | | 5,769 | | | | 27,376 | | | | 33,145 | |
| | | | | | | | | | | | |
Interest expense: | | | | | | | | | | | | |
Interest bearing deposits: | | | | | | | | | | | | |
Demand | | | 113 | | | | 256 | | | | 369 | |
Savings and money market accounts | | | 222 | | | | 301 | | | | 523 | |
Certificates of deposit greater than $250,000 | | | (48 | ) | | | (193 | ) | | | (241 | ) |
Certificates of deposit less than $250,000 | | | (60 | ) | | | (259 | ) | | | (319 | ) |
Total interest bearing deposits | | | 227 | | | | 105 | | | | 332 | |
Subordinated debentures | | | 8 | | | | 168 | | | | 176 | |
Total interest expense | | | 235 | | | | 273 | | | | 508 | |
Net interest income | | $ | 5,534 | | | $ | 27,103 | | | $ | 32,637 | |
(1) Consumer and other - These decreases respresent the end of the PPP loans which were $0 and $70,765 as of December 31, 2022 and 2021 respectively.
Net interest income was $193.6 million and $160.9 million for the two years ended December 31, 2022 and 2021, respectively. The increase in net interest income was driven primarily by increased interest rates and deposit growth, which we were able to partially deploy into growing our loan portfolio. The remaining increase in interest was held in interest earning deposits and investment securities.
Comparison of Results of Operations for the Years Ended December 31, 2022 and 2021
| | Years Ended December 31 | | | | | | | |
(Dollars in thousands) | | 2022 | | | 2021 | | | $ Better / (Worse) | | | % Better / (Worse) | |
Selected Income Statement Information: | | | | | | | | | | | | |
Interest income | | $ | 198,413 | | | $ | 165,268 | | | $ | 33,145 | | | | 20.06 | % |
Interest expense | | | 4,840 | | | | 4,332 | | | | (508 | ) | | | -11.73 | % |
Net interest income | | | 193,573 | | | | 160,936 | | | | 32,637 | | | | 20.28 | % |
Provision for credit losses | | | 6,450 | | | | 1,910 | | | | (4,540 | ) | | | -237.70 | % |
Net interest income after provision for credit losses | | | 187,123 | | | | 159,026 | | | | 28,097 | | | | 17.67 | % |
Non-interest income | | | 6,178 | | | | 21,056 | | | | (14,878 | ) | | | -70.66 | % |
Non-interest expense | | | 93,560 | | | | 91,761 | | | | (1,799 | ) | | | -1.96 | % |
Income before income tax expense | | | 99,741 | | | | 88,321 | | | | 11,420 | | | | 12.93 | % |
Income tax expense | | | 24,651 | | | | 21,985 | | | | (2,666 | ) | | | -12.13 | % |
Net income | | $ | 75,090 | | | $ | 66,336 | | | $ | 8,754 | | | | 13.20 | % |
Net Income. For the years ended December 31, 2022 and 2021, net income was $75.1 million compared with banks$66.3 million, respectively. The increase in net income was primarily the result of higher net interest income of $32.6 million. This increase was offset by a decrease in non-interest income of $14.9 million, higher provision for credit losses of $4.5 million, higher income tax expense of $2.7 million and overnight investmentsan increase in Federal Funds Sold are additionalnon-interest expense of $1.8 million.
Net Interest Income and Net Interest Margin. For the year ended December 31, 2022, net interest income increased $32.6 million, or 20.28%, to $193.6 million compared with $160.9 million for the same period a year earlier. The increase is the result of: (1) average interest earning assets availableincreasing $435.4 million, or 9.35%, to $5.1 billion compared with $4.7 billion for the Company. Average interest-bearing depositssame period a year earlier; and (2) the net interest margin increasing 34 basis points to 3.80% for all of 2022 compared with banks consisted3.46% for the same period a year earlier. The increase in the net interest margin was primarily the result of FRB deposits. Balances with the FRB increasing the federal funds rate over the past year.
earn interestProvision for Credit Losses. The provision for credit losses in each period is a charge against earnings in that period. The provision is the amount required to maintain the allowance for credit losses at a level that, in management’s judgment, is adequate to absorb expected losses over the Fed Funds rate, which decreased to 1.55% in December 2019. Average interest-bearing deposits with bankslife of the loan and HTM securities portfolios.
The provision for credit losses for the year ended December 31, 2019,2022, was $232.6 million, an increase of $84.9$6.5 million compared towith $1.9 million for the average balance forsame period a year ago. For the year ended December 31, 2018. Interest income on interest-bearing deposits2022, the Company incurred net charge-offs of $0.2 million compared with banksnet recoveries of $0.2 million for the same period a year ended December 31, 2019, increased $2.2 million to $4.9 million from the year ended December 31, 2018.
Average interest-bearing liabilities increased $178.9 million or 9.2% during the year ended December 31, 2019 compared to the average balance during 2018. Of that increase: (1) interest-bearing transaction deposits increased $50.1 million; (2) savings and money market deposits increased $85.7 million; and (3) time deposits increased $43.1 million. See “Financial Condition – Deposits” for a discussion of trends in the Company’s deposit base. Total interest expense on deposits was $12.6 million for 2019 and $7.4 million for 2018. As a result of increasing short-term market interest rates and competition, the average rate paid on interest-bearing deposits was 0.60% in 2019 and 0.38% in 2018.
Provision and Allowance for Credit Losses
As a financial institution that assumes lending and credit risks as a principal element of its business, credit losses will be experienced in the normal course of business. The Company has established credit management policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio. The Company manages and controls credit risk through comprehensive underwriting and approval standards, dollar limits on loans & leases to one borrower (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction), and by restricting loans & leases made primarily to its principal market area where management believes it is best able to assess the applicable risk. Additionally, management has established guidelines to ensure the diversification of the Company’s credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. Management reports regularly to the Board of Directors regarding trends and conditions in the loan & lease portfolio and regularly conducts credit reviews of individual loans & leases. Loans & leases that are performing but have shown some signs of weakness are subject to more stringent reporting and oversight.
Allowance for Credit Losses
The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company's loan & lease portfolio as of the balance sheet date. The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan & lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of three primary components: specific reserves related to impaired loans & leases; general reserves for inherent losses related to loans & leases that are not impaired; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors.
A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. Loans & leases determined to be impaired are individually evaluated for impairment. When a loan or lease is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s or lease's effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s or lease's observable market price, or the fair value of the collateral if the loan or lease is collateral dependent. A loan or lease is collateral dependent if the repayment of the loan or lease is expected to be provided solely by the underlying collateral.
A restructuring of a loan or lease constitutes a troubled debt restructuring (“TDR”) under ASC 310-40, if the Company for economic or legal reasons related to the borrower's financial difficulties grants a more than insignificant concession to the borrower that it would not otherwise consider. Restructured loans or leases typically present an elevated level of credit risk, as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans & leases that are on nonaccrual status at the time they become TDR, remain on 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. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.earlier.
Non-interest Income. Non-interest income decreased $14.9 million, or 70.66%, to $6.2 million for 2022 compared with $21.1 million for the same period a year earlier. The determinationyear-over-year decrease in non-interest income was primarily due to: (1) a $10.7 million loss on the sale of investment securities versus a $2.6 gain for the general reserve for loans or leases that are collectively evaluated for impairment is basedsame period a year earlier; and (2) $2.2 million decline in gains/(losses) on estimates made by management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors that include economic trends in the Company's service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company's underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole.deferred compensation plan investments.
The Company maintains a separate allowance for each portfolio segment (loan & lease type). These portfolio segments include: (1) commercial real estate; (2) agricultural real estate; (3) real estate construction (including land and development loans); (4) residential 1st mortgages; (5) home equity lines and loans; (6) agricultural; (7) commercial; (8) consumer & other; and (9) equipment leases. See “Financial Condition – Loans & Leases” for examples of loans & leases made by the Company. The allowance for credit losses attributable to each portfolio segment, which includes both impaired loans & leases and loans & leases that are not impaired, is combined to determine the Company's overall allowance, which is included on the consolidated balance sheet.
The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a certain threshold to identify credit risks and assess overall collectability. For smaller balance loans & leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the loan or lease becomes contractually delinquent or when the borrower requests a modification. For larger balance loans or leases, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans & leases. These credit quality indicators are used to assign a risk rating to each individual loan or lease. These risk ratings are also subject to examination by independent specialists engaged by the Company. The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management’s assessment of the following for each portfolio segment: (1) inherent credit risk; (2) historical losses; and (3) other qualitative factors. These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment. See “Note 1 Significant Accounting Policies - Allowance for Credit Losses.”
The risk ratings can be grouped into five major categories, defined as follows:
Pass and Watch – A pass loan or lease is a strong credit with no existing or known potential weaknesses deserving of management's close attention. This category also includes “Watch” loans, which is a loan with an emerging weakness in either the individual credit or industry that requires additional attention. A credit may also be classified Watch if cash flows have not yet stabilized, such as in the case of a development project. Included in this category are all loans in which the Bank entered into a CARES Act modification.
Special Mention – A special mention loan or lease has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or lease position at some future date. Special mention loans & leases are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Substandard – A substandard loan or lease is not adequately protected by the current financial condition and paying capacity of the borrower or the value of the collateral pledged, if any. Loans or leases classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Well-defined weaknesses include a project's lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project's failure to fulfill economic expectations. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Doubtful – Loans or leases classified doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, highly questionable or improbable.
Loss – Loans or leases classified as loss are considered uncollectible. Once a loan or lease becomes delinquent and repayment becomes questionable, the Company will address collateral shortfalls with the borrower and attempt to obtain additional collateral. If this is not forthcoming and payment in full is unlikely, the Bank will estimate its probable loss and immediately charge-off some or all of the balance.
The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management's assessment of the following for each portfolio segment: (1) inherent credit risk; (2) historical losses; and (3) other qualitative factors. These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment described below:
Commercial Real Estate – Commercial real estate mortgage loans are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. Adverse economic developments or an overbuilt market impact commercial real estate projects and may result in troubled loans. Trends in vacancy rates of commercial properties impact the credit quality of these loans. High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flow to service debt obligations.
Real Estate Construction – Real estate construction loans, including land loans, are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types. A major risk arises from the necessity to complete projects within specified cost and time lines. Trends in the construction industry significantly impact the credit quality of these loans, as demand drives construction activity. In addition, trends in real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of construction projects.
Commercial – These loans are generally considered to possess a moderate inherent risk of loss because they are shorter-term; typically made to relationship customers; generally underwritten to existing cash flows of operating businesses; and may be collateralized by fixed assets, inventory and/or accounts receivable. Debt coverage is provided by business cash flows and economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans.
Agricultural Real Estate and Agricultural – These loans are generally considered to possess a moderate inherent risk of loss since they are typically made to relationship customers and are secured by crop production, livestock and related real estate. These loans are vulnerable to two risk factors that are outside the control of Company and borrowers: commodity prices and weather conditions.
Leases – Equipment leases are generally considered to possess a moderate inherent risk of loss. As lessor, the Company is subject to both the credit risk of the borrower and the residual value risk of the equipment. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.
Residential 1st Mortgages and Home Equity Lines and Loans – These loans are generally considered to possess a low inherent risk of loss, although this is not always true as evidenced by the correction in residential real estate values that occurred between 2007 and 2012. The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower's ability to repay in an orderly fashion. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.
Consumer & Other – A consumer installment loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period. Most installment loans are made for consumer purchases. Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans. Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.
In addition, the Company's and Bank's regulators, including the FRB, DFPI and FDIC, as an integral part of their examination process, review the adequacy of the allowance. These regulatory agencies may require additions to the allowance based on their judgment about information available at the time of their examinations.
Provision for Credit Losses
Changes in the provision for credit losses between years are the result of management’s evaluation, based upon information currently available, of the adequacy of the allowance for credit losses relative to factors such as the credit quality of the loan & lease portfolio, loan & lease growth, current credit losses, and the prevailing economic climate and its effect on borrowers’ ability to repay loans & leases in accordance with the terms of the notes.
The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have alleviated drought conditions in California. As a result, current reservoir levels are adequate and the availability of water in our primary service area should not be an issue. However, these recent weather patterns further reinforce the fact that the long-term risks associated with the availability of water are significant. See “Item 1A. Risk Factors” for additional information.
As discussed above in “COVID-19 (Coronavirus) Disclosure,” COVID-19 has had and continues to have a material impact on the U.S. and California economies. We are monitoring the impact on our borrowers, and working closely with them using all of the tools at our disposal, including the SBA PPP program, the FRB Main Street Lending Program and other loan restructuring strategies, to help them move through this period of reduced business activity. To account for growth in our loan portfolio and the economic uncertainty created by COVID-19, our provision for credit losses increased in 2020.
The provision for credit losses totaled $4.5 million in 2020 compared to $200,000 in 2019. Net charge offs during 2020 were $650,000 compared torecorded net charge offs of $454,000 during 2019 and net charge offs of $609,000 in 2018. The allowance for credit losses as a percentage of total loans and leases declined in 2020 from 2.05% to 1.89%. This decline was due to the increase in government guaranteed SBA loans under the PPP. Excluding these loans, the allowance for credit losses as a percentage of total loans was 2.04% at December 31, 2020. See “Critical Accounting Policies and Estimates – Allowance for Credit Losses” and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk.”
After reviewing all factors above, management concluded that the allowance for credit losses, as of December 31, 2020, and December 30, 2019 were adequate.
The following table summarizes the activity and the allocation of the allowance for credit losses for the years indicated. (in thousands)
| | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Allowance for Credit Losses Beginning of Year | | $ | 55,012 | | | $ | 55,266 | | | $ | 50,342 | | | $ | 47,919 | | | $ | 41,523 | |
Provision Charged to Expense | | | 4,500 | | | | 200 | | | | 5,533 | | | | 2,850 | | | | 6,335 | |
Charge-Offs: | | | | | | | | | | | | | | | | | | | | |
Commercial Real Estate | | | - | | | | - | | | | - | | | | 109 | | | | - | |
Agricultural Real Estate | | | - | | | | - | | | | - | | | | - | | | | - | |
Real Estate Construction | | | - | | | | - | | | | - | | | | - | | | | - | |
Residential 1st Mortgages | | | - | | | | - | | | | 31 | | | | 53 | | | | 21 | |
Home Equity Lines and Loans | | | 7 | | | | - | | | | 8 | | | | 3 | | | | 46 | |
Agricultural | | | - | | | | - | | | | - | | | | 374 | | | | - | |
Commercial | | | 1,101 | | | | 592 | | | | 613 | | | | - | | | | - | |
Consumer & Other | | | 66 | | | | 83 | | | | 115 | | | | 146 | | | | 105 | |
Total Charge-Offs | | | 1,174 | | | | 675 | | | | 767 | | | | 685 | | | | 172 | |
Recoveries: | | | | | | | | | | | | | | | | | | | | |
Commercial Real Estate | | | - | | | | - | | | | 2 | | | | 109 | | | | 2 | |
Agricultural Real Estate | | | 81 | | | | 38 | | | | - | | | | - | | | | - | |
Real Estate Construction | | | - | | | | - | | | | - | | | | - | | | | - | |
Residential 1st Mortgages | | | 52 | | | | 13 | | | | 15 | | | | 40 | | | | 26 | |
Home Equity Lines and Loans | | | 78 | | | | 28 | | | | 6 | | | | 8 | | | | 103 | |
Agricultural | | | - | | | | - | | | | 61 | | | | 17 | | | | - | |
Commercial | | | 280 | | | | 90 | | | | 20 | | | | 8 | | | | 47 | |
Consumer & Other | | | 33 | | | | 52 | | | | 54 | | | | 76 | | | | 55 | |
Total Recoveries | | | 524 | | | | 221 | | | | 158 | | | | 258 | | | | 233 | |
Net (Charge-Offs) Recoveries | | | (650 | ) | | | (454 | ) | | | (609 | ) | | | (427 | ) | | | 61 | |
Total Allowance for Credit Losses, End of Year | | $ | 58,862 | | | $ | 55,012 | | | $ | 55,266 | | | $ | 50,342 | | | $ | 47,919 | |
Ratios: | | | | | | | | | | | | | | | | | | | | |
Allowance for Credit Losses to: | | | | | | | | | | | | | | | | | | | | |
Total Loans & Leases at Year End | | | 1.89 | % | | | 2.05 | % | | | 2.14 | % | | | 2.27 | % | | | 2.19 | % |
Average Loans & Leases | | | 2.00 | % | | | 2.12 | % | | | 2.35 | % | | | 2.31 | % | | | 2.34 | % |
Consolidated Net (Charge-Offs) Recoveries to: | | | | | | | | | | | | | | | | | | | | |
Total Loans & Leases at Year End | | | (0.02 | %) | | | (0.02 | %) | | | (0.02 | %) | | | (0.02 | %) | | | 0.00 | % |
Average Loans & Leases | | | (0.02 | %) | | | (0.02 | %) | | | (0.03 | %) | | | (0.02 | %) | | | 0.00 | % |
The table below breaks out year-to-date activity by portfolio segment (in thousands):
December 31, 2020 | | Commercial Real Estate | | | Agricultural Real Estate | | | Real Estate Construction | | | Residential 1st Mortgages | | | Home Equity Lines & Loans | | | Agricultural | | | Commercial | | | Consumer & Other | | | Leases | | | Unallocated | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Year-To-Date Allowance for Credit Losses: | |
Beginning Balance- January 1, 2020 | | $ | 11,053 | | | $ | 15,128 | | | $ | 1,949 | | | $ | 855 | | | $ | 2,675 | | | $ | 8,076 | | | $ | 11,466 | | | $ | 456 | | | $ | 3,162 | | | $ | 192 | | | $ | 55,012 | |
Charge-Offs | | | - | | | | - | | | | - | | | | - | | | | (7 | ) | | | - | | | | (1,101 | ) | | | (66 | ) | | | - | | | | - | | | | (1,174 | ) |
Recoveries | | | - | | | | 81 | | | | - | | | | 52 | | | | 78 | | | | - | | | | 280 | | | | 33 | | | | - | | | | - | | | | 524 | |
Provision | | | 16,626 | | | | (6,576 | ) | | | (306 | ) | | | 53 | | | | (722 | ) | | | (3,262 | ) | | | (684 | ) | | | (90 | ) | | | (1,431 | ) | | | 892 | | | | 4,500 | |
Ending Balance- December 31, 2019 | | $ | 27,679 | | | $ | 8,633 | | | $ | 1,643 | | | $ | 960 | | | $ | 2,024 | | | $ | 4,814 | | | $ | 9,961 | | | $ | 333 | | | $ | 1,731 | | | $ | 1,084 | | | $ | 58,862 | |
Overall the Allowance for Credit Losses as of December 31, 2020 increased $3.9 million from December 31, 2019. Changes to the reserve during 2020 are due to changes in the underlying credit quality of the loan portfolio. Overall: (1) reserves for “Agricultural” and “Agricultural Real Estate” loans (which are currently thought to have more limited COVID-19 loss exposure since agricultural activity has substantially continued without significant issues) have been reduced significantly; (2) reserves for Commercial Real Estate (where our COVID-19 exposure is thought to be greater since many of these borrowers have been impacted by “non-essential” designations and “shelter-in-place” orders) have been increased significantly; and (3) the “Unallocated” reserve has been increased. See “Introduction - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure.
| | Allowance Allocation at December 31, | |
(in thousands) | | 2020 Amount | | | Percent of Loans in Each Category to Total Loans | | | 2019 Amount | | | Percent of Loans in Each Category to Total Loans | | | 2018 Amount | | | Percent of Loans in Each Category to Total Loans | | | 2017 Amount | | | Percent of Loans in Each Category to Total Loans | | | 2016 Amount | | | Percent of Loans in Each Category to Total Loans | |
Commercial Real Estate | | $ | 27,679 | | | | 31.2 | % | | $ | 11,053 | | | | 31.6 | % | | $ | 11,609 | | | | 32.4 | % | | $ | 10,922 | | | | 31.1 | % | | $ | 11,110 | | | | 30.4 | % |
Agricultural Real Estate | | | 8,633 | | | | 20.7 | % | | | 15,128 | | | | 23.3 | % | | | 14,092 | | | | 22.7 | % | | | 12,085 | | | | 22.5 | % | | | 9,450 | | | | 21.2 | % |
Real Estate Construction | | | 1,643 | | | | 6.0 | % | | | 1,949 | | | | 4.3 | % | | | 1,249 | | | | 3.8 | % | | | 1,846 | | | | 4.5 | % | | | 3,223 | | | | 7.6 | % |
Residential 1st Mortgages | | | 960 | | | | 9.6 | % | | | 855 | | | | 9.5 | % | | | 880 | | | | 10.1 | % | | | 815 | | | | 11.7 | % | | | 865 | | | | 10.3 | % |
Home Equity Lines and Loans | | | 2,024 | | | | 1.1 | % | | | 2,675 | | | | 1.5 | % | | | 2,761 | | | | 1.6 | % | | | 2,324 | | | | 1.6 | % | | | 2,140 | | | | 1.7 | % |
Agricultural | | | 4,814 | | | | 8.5 | % | | | 8,076 | | | | 10.9 | % | | | 8,242 | | | | 11.3 | % | | | 8,159 | | | | 12.3 | % | | | 7,381 | | | | 14.7 | % |
Commercial | | | 9,961 | | | | 12.0 | % | | | 11,466 | | | | 14.4 | % | | | 11,656 | | | | 13.3 | % | | | 9,197 | | | | 12.0 | % | | | 8,515 | | | | 10.5 | % |
Consumer & Other | | | 333 | | | | 7.6 | % | | | 456 | | | | 0.6 | % | | | 494 | | | | 0.8 | % | | | 209 | | | | 0.3 | % | | | 200 | | | | 0.3 | % |
Leases | | | 1,731 | | | | 3.3 | % | | | 3,162 | | | | 3.9 | % | | | 4,022 | | | | 4.0 | % | | | 3,363 | | | | 4.0 | % | | | 3,586 | | | | 3.3 | % |
Unallocated | | | 1,084 | | | | - | | | | 192 | | | | - | | | | 261 | | | | - | | | | 1,422 | | | | - | | | | 1,449 | | | | - | |
Total | | $ | 58,862 | | | | 100.0 | % | | $ | 55,012 | | | | 100.0 | % | | $ | 55,266 | | | | 100.0 | % | | $ | 50,342 | | | | 100.0 | % | | $ | 47,919 | | | | 100.0 | % |
As of December 31, 2020, the allowance for credit losses was $58.9 million, which represented 1.89% of the total loan & lease balance (2.04% when government guaranteed SBA loans originated under the PPP beginning in April 2020 are excluded). At December 31, 2019, the allowance for credit losses was $55.0 million or 2.05% of the total loan & lease balance. The Company believes that the current allowance provides sufficiently for our exposure at the current time.
Non-Interest Income
Non-interest income includes: (1) service charges and fees from deposit accounts; (2) net gains and losses from investment securities; (3) increases in the cash surrender value of bank owned life insurance; (4) debit card and ATM fees; (5) net gains and losses on non-qualified deferred compensation plan; and (6) fees from other miscellaneous business services. See “Overview – Looking Forward: 2021 and Beyond.”
2020 Compared to 2019
Non‑interest income totaled $15.7 million for 2020, a decrease of $1.5 million or 8.96% from non-interest income of $17.2 million for 2019.
Debit card and ATM fees totaled $5.5 million in 2020, an increase of 8.13% or $416,000 from $5.1 million in 2019. This was primarily due to increased numbers of cardholders and increased account activity.
Service charges on deposit accounts totaled $2.6 million in 2020, a decrease of 28.2% or $1.0 million from $3.7 million in 2019. This decrease was primarily due to the Bank complying with the Governor of California’s request that banks not charge overdraft and other fees during the early stages of the COVID-19 crisis.
Net gains on deferred compensation plan investments were $1.8of $0.45 million in 20202022 compared to net gains of $2.6 million in 2019.2021. See Note 16,11, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles requireGAAP requires these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effectnet-effect on the Company’s net income.
Other non-interest income was $3.6Non-interest Expense. Non-interest expense increased $1.8 million, a decrease of $173,000 or 4.6% from 2019.
2019 Compared1.96%, to 2018
Non‑interest income totaled $17.2$93.6 million for 2019,2022 compared with $91.8 million for the same period a year ago. The year-over-year increase was primarily comprised of: (1) a $0.4 million increase in salaries and employee benefits; (2) a $0.6 million increase in legal expenses; (3) a $0.2 million increase in FDIC insurance; (4) a $0.2 million increase in marketing expenses; and (5) an increase of $2.0$2.5 million or 13.3% from non-interest incomein other miscellaneous expenses ($1.0 million of $15.2 million for 2018.
Net (loss) gain on investment securitieswhich was a net gain of $1,000provision for unused commitments). These increases were partially off-set by a $2.2 million decline in 2019 compared to a net loss of $1.3 million for 2018. See “Financial Condition-Investment Securities” for a discussion ofgain/(losses) on deferred compensation plan investments. For the year ended December 31, 2022, the Company’s investment strategy.
Debit card and ATM fees totaled $5.1 million in 2019, an increase of 17.3% or $755,000 from $4.4 million in 2018. Thisefficiency ratio was primarily due to increased numbers of cardholders and increased account activity.46.84% compared with 50.42% for the same period a year ago.
Net gains on deferred compensation plan investmentsobligations were $2.6$0.4 million in 20192022 compared to net gains of $1.1$2.6 million in 2018.2021. See Note 16,11, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles requireGAAP requires these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income.
Other non-interest income was $3.8 million, a decrease of $1.9 million or 33.2% from 2018. This decrease was primarily due to a $2.0 million decrease related to non-recurring income received in 2018 from: (1) the purchase of Bank of Rio Vista; and (2) the gain on sale of fixed assets.
Non-Interest Expense
Non-interest expense for the Company includes expenses for: (1) salaries and employee benefits; (2) net gains and losses on non-qualified deferred compensation plan; (3) occupancy; (4) equipment; (5) supplies; (6) legal fees; (7) professional services; (8) data processing; (9) marketing; (10) deposit insurance; and (11) ORE carrying costs and gains/losses on sale; and (12) other miscellaneous expenses.
2020 Compared to 2019
Overall, non-interest expense totaled $82.4 million for 2020, an increase of $164,000 or .20% from the year ended December 31, 2019.
Salaries and employee benefits increased $1.7 million or 3.1% in 2020, primarily related to: (1) general salary increases; and (2) increased contributions to retirement and profit sharing plans.
Net gains on deferred compensation plan investments were $2.6 million in 2019 comparedobligations to net gains of $1.8 million in 2020. See Note 16, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income.
Occupancy expense in 2020 totaled $4.6 million, an increase of $345,000 or 8.0% from 2019. This increase was primarily related to operating expenses associated with remodeling existing branch offices.
Marketing expenses decreased $332,000 from 2019 and totaled $922,000.
Legal expenses decreased $2.2 million from 2019 and totaled $128,000.
Other non-interest expense increased $1.5 million or 14.2%, to $12.5 million in 2020 compared to $10.9 million in 2019.
2019 Compared to 2018
Overall, non-interest expense totaled $82.2 million for 2019, an increase of $6.8 million or 9.0% from the year ended December 31, 2018.
Salaries and employee benefits increased $5.2 million or 10.3% in 2019, primarily related to: (1) new staff from the acquisition of the Bank of Rio Vista; (2) general salary increases; and (3) increased contributions to retirement and profit sharing plans.
Net gains on deferred compensation plan investments were $2.6 million in 2019 compared to net gains of $1.1 million in 2018. See Note 16, located in “Item 8. Financial Statements and Supplementary Data” for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no effectnet-effect on the Company’s net income.
Occupancy expense in 2019 totaled $4.3 million, an increase of $390,000 or 10.0% from 2018 and equipment expense in 2019 totaled $4.9 million, an increase of $618,000 or 14.4% from 2018. Both of these increases were primarily related to operating expenses associated with remodeling existing branch offices and adding new branches.
Legal expenses increased $1.4 million from 2018 and totaled $2.3 million.
Other non-interest expense increased $862,000, or 8.6%, to $10.9 million in 2019 compared to $10.1 million in 2018.
The preceding increases in non-interest expense were offset somewhat by non-recurring expenses from the acquisition of Bank of Rio Vista that totaled $3.0 million in 2018.
Income Taxes
The provision for income taxes decreased $60,000 forTax Expense. For the year ended December 31, 2020. The Company’s effective2022, income tax rateexpense was $24.7 million, compared with $22.0 million for 2020 was 24.65% compared to 25.6% forthe same period a year earlier. For the year ended December 2019. The Company’s31, 2022, the effective tax rate fluctuates fromwas 24.72% compared with 24.89% for the same period a year to year due primarily to changes in the mix of taxable and tax-exempt earning sources. The effective rates were lower than the combined Federal and State statutory rate of 30% due primarily to benefits regarding the cash surrender value of life insurance; credits associated with low income housing tax credit investments (LIHTC); and tax-exempt interest income on municipal securities and loans.ago.
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law changing the Company’s Federal corporate tax rate from 35% to 21%. The Company’s provision for income taxes decreased 45.61% to $14.0 million during 2018 compared to 2017 primarily as a result of: (1) the Federal corporate tax rate change and (2) the Company having amended and planning to amend tax returns in open tax years resulting in a reduction of $990,000 in the Company’s tax provision for 2018. See “Note 1. Significant Accounting Policies – Out of Period Adjustment.” The effective tax rate for 2018 was 23.8% compared to 47.9% during 2017.
Also due to the signing of the Tax Cuts and Jobs Act, during the 4th quarter of 2017, all companies were required to re-measure their deferred tax assets (DTA) and deferred tax liabilities (DTL) at the new corporate tax rate of 21%. This one-time re-measurement resulted in a $6.3 million increase to the Company’s income tax provision in 2017. This DTA re-measurement accompanied by an 8.7% increase in pre-tax earnings resulted in the tax provision increase in 2017.
With the exception of the one-time DTA re-measurement that took place in 2017, tax law causes the Company’s taxes payable to approximate or exceed the current provision for taxes on the income statement. Three provisions have had a significant effect on the Company’s current income tax liability: (1) the restrictions on the deductibility of credit losses; (2) deductibility of pension and other long-term employee benefits only when paid; and (3) the statutory deferral of deductibility of California franchise taxes on the Company’s federal return.
Financial Condition
Total assets grew $149.7 million, or 2.89%, to $5.3 billion at December 31, 2022 compared with $5.2 billion at December 31, 2021. Loans held for investment grew $275.2 million or 8.5% to $3.5 billion at December 31, 2022, compared with $3.2 billion at December 31, 2021. Exclusive of SBA PPP loans, the loan portfolio grew $346 million, or 10.69%, over December 31, 2021. This data constitutes non-GAAP financial data. The Company believes that excluding the temporary effect of the PPP loans furnishes useful information regarding the Company’s growth. Total deposits increased $119.1 million, or 2.57%, to $4.8 billion at December 31, 2022 compared with $4.6 billion at December 31, 2021. The increase in total assets and deposits was primarily the result of continued strong organic deposit growth.
Investment Securities and Federal Funds Sold
The investment portfolio provides the Company with an income alternative to loans & leases. The debt securities in the Company’s investment portfolio have historically been comprised primarily of: (1) mortgage-backed securities issued by federal government-sponsored entities; (2) debt securities issued by US Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times, the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 7 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity without subjecting the Company to the interest rate risk associated with mortgage-backed securities.Reserve Balances
The Company’s investment portfolio decreased by less than 1.0%, to $1.0 billion at December 31, 2020 was $876.72022. This decrease is net of the impact of $47.7 million compared to $567.6 million at December 31, 2019, an increase of $309.1 million or 54.5%.that the Company sold for interest rate risk management purposes. The Company uses its investment portfolio to help balance its overallmanage interest rate risk. Accordingly, when market rates are increasing it invests most of its funds in shorter term Treasury and Agency securities or shorter term (10, 15 and 20 year) mortgage backed securities. Conversely, when rates are falling, 30 year mortgage backed securities or longer term Treasury and Agency securities may be increased.
liquidity risks. The Company's total investment portfolio currentlyas of December 31, 2022 represents 19.3%18.72% of the Company’s total assets as compared to 15.3%19.45% at December 31, 2019.
As of December 31, 2020, the Company held $68.9 million of municipal investments, all classified as held-to-maturity (“HTM”). Of this balance $24.4 million were bank-qualified municipal bonds, and $44.5 million were private placement municipal bonds, warrants, and CRA qualified investments in our service area. In order to comply with Section 939A of the Dodd-Frank Act, the Company performs its own credit analysis on new purchases of municipal bonds. As of December 31, 2020, all of the Company’s bank-qualified municipal bond portfolio was rated at either the issue or issuer level, and all of these ratings were “investment grade.” The Company monitors the status of all municipal investments, and at the current time does not believe any of them to be exhibiting financial problems that could result in a loss in any individual security.
2021. Not included in the investment portfolio are interest bearing deposits with banks and overnight investments in Federal Funds Sold.Reserve balances. Interest bearing deposits with banks consisted primarily of FRB deposits.
The FRB currently pays interest on the deposits that banks maintain in their FRB accounts, whereas historically banks had to sell these Federal Funds to other banks in order to earn interest. Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB. Interest bearing deposits with banks totaled $317.5$515 million at December 31, 20202022 and $223.2$663 million at December 31, 2019.2021.
The Company classifies its investmentsinvestment securities as either held-to-maturity (“HTM”), trading, or available-for-sale (“AFS”). Securities are classified as held-to-maturity and are carried at amortized cost, net of an allowance for credit losses, when the Company has the intent and ability to hold the securities to maturity. Trading securities are securities acquired for short-term appreciationSee Note 2 “Investment Securities” to the Consolidated Financial Statements in “Item 8. Financial Statements and are carried at fair value, with unrealized gains and losses recordedSupplementary Data” in non-interest income. As of December 31, 2020 and December 31, 2019, there were no securities in the trading portfolio.this Annual Report on Form 10-K. Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, net of related income taxes. As of December 31, 2022, the Company held no investment securities from any issuer (other than the U.S. Treasury or an agency of the U.S. government or a government-sponsored entity) that totaled over 10% of our shareholders’ equity.
The carrying value of our portfolio of investment securities was as follows:
| | As of December 31, | |
(Dollars in thousands) | | 2022 | | | 2021 | |
Available-for-Sale Securities | | | | | | |
U.S. Treasury notes | | $ | 4,964 | | | $ | 10,089 | |
U.S. Government-sponsored securities | | | 4,427 | | | | 6,374 | |
Mortgage-backed securities(1) | | | 132,528 | | | | 251,120 | |
Collateralized mortgage obligations(1) | | | 1,054 | | | | 2,436 | |
Corporate securities | | | 9,581 | | | | - | |
Other | | | 310 | | | | 435 | |
Total available-for-sale securities | | $ | 152,864 | | | $ | 270,454 | |
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
| | As of December 31, | |
(Dollars in thousands) | | 2022 | | | 2021 | |
Held-to-Maturity Securities | | | | | | |
Mortgage-backed securities(1) | | $ | 702,858 | | | $ | 596,775 | |
Collateralized mortgage obligations(1) | | | 80,186 | | | | 73,781 | |
Municipal securities(2) | | | 61,909 | | | | 66,496 | |
Total held-to-maturity securities | | $ | 844,953 | | | $ | 737,052 | |
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
(2) Municipal securities are net of allowance for credit losses of $393 and $0, respectively.
Investment Portfolio
The following table summarizesshows the balancescarrying value for contractual maturities of investment securities and distributionsthe weighted average yields of such securities, including the benefit of tax-exempt securities:
Investment Securities | | As of December 31, 2022 | |
| | Within One Year | | | After One but Within Five Years | | | After Five but Within Ten Years | | | After Ten Years | | | Total | |
(Dollars in thousands) | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | |
Debt securities available-for-sale | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
U.S. Treasury notes | | $ | 4,964 | | | | 2.37 | % | | $ | - | | | | 0.00 | % | | $ | - | | | | 0.00 | % | | $ | - | | | | 0.00 | % | | $ | 4,964 | | | | 2.37 | % |
U.S. Government-sponsored securities | | | 3 | | | | 2.17 | % | | | 53 | | | | 2.29 | % | | | 380 | | | | 4.52 | % | | | 3,991 | | | | 4.52 | % | | | 4,427 | | | | 4.29 | % |
Mortgage-backed securities(1) | | | 13 | | | | 2.82 | % | | | 16,460 | | | | 2.31 | % | | | 15,156 | | | | 2.41 | % | | | 100,899 | | | | 1.82 | % | | | 132,528 | | | | 1.95 | % |
Collateralized mortgage obligations(1) | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 1,054 | | | | 2.35 | % | | | 1,054 | | | | 2.35 | % |
Corporate securities | | | - | | | | 0.00 | % | | | 9,581 | | | | 3.13 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 9,581 | | | | 3.13 | % |
Other | | | 310 | | | | 4.60 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 310 | | | | 4.60 | % |
Total debt securities available-for-sale | | $ | 5,290 | | | | 2.50 | % | | $ | 26,094 | | | | 2.61 | % | | $ | 15,536 | | | | 2.46 | % | | $ | 105,944 | | | | 1.93 | % | | $ | 152,864 | | | | 2.11 | % |
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the investment securities held on the dates indicated.U.S. Government.
| | Available for Sale | | | Held to Maturity | | | Available for Sale | | | Held to Maturity | | | Available for Sale | | | Held to Maturity | |
December 31: (in thousands) | | 2020 | | | 2019 | | | 2018 | |
U.S. Treasury Notes | | $ | 15,288 | | | $ | - | | | $ | 54,995 | | | $ | - | | | $ | 164,514 | | | $ | - | |
U.S. Government SBA | | | 8,160 | | | | - | | | | 10,798 | | | | - | | | | 15,447 | | | | - | |
Government Agency & Government Sponsored Entities | | | - | | | | - | | | | - | | | | - | | | | 3,039 | | | | - | |
Obligations of States and Political Subdivisions | | | - | | | | 68,933 | | | | - | | | | 60,229 | | | | - | | | | 53,566 | |
Mortgage Backed Securities | | | 737,873 | | | | - | | | | 441,078 | | | | - | | | | 307,045 | | | | - | |
Corporate Securities | | | 45,919 | | | | - | | | | - | | | | - | | | | - | | | | - | |
Other | | | 492 | | | | - | | | | 515 | | | | - | | | | 5,351 | | | | - | |
Total Book Value | | $ | 807,732 | | | $ | 68,933 | | | $ | 507,386 | | | $ | 60,229 | | | $ | 495,396 | | | $ | 53,566 | |
Fair Value | | $ | 807,732 | | | $ | 70,049 | | | $ | 507,386 | | | $ | 61,097 | | | $ | 495,396 | | | $ | 53,738 | |
| | As of December 31, 2022 | |
| | Within One Year | | | After One but Within Five Years | | | After Five but Within Ten Years | | | After Ten Years | | | Total | |
(Dollars in thousands) | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | |
Securities held-to-maturity | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Mortgage-backed securities(1) | | $ | - | | | | 0.00 | % | | $ | - | | | | 0.00 | % | | $ | 18,197 | | | | 1.22 | % | | $ | 684,661 | | | | 1.90 | % | | $ | 702,858 | | | | 1.88 | % |
Collateralized mortgage obligations(1) | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 80,186 | | | | 1.80 | % | | | 80,186 | | | | 1.80 | % |
Municipal securities | | | 883 | | | | 5.92 | % | | | 8,058 | | | | 3.98 | % | | | 15,670 | | | | 3.70 | % | | | 37,691 | | | | 4.83 | % | | | 62,302 | | | | 4.45 | % |
Total securities held-to-maturity | | $ | 883 | | | | 5.92 | % | | $ | 8,058 | | | | 3.98 | % | | $ | 33,867 | | | | 2.37 | % | | $ | 802,538 | | | | 2.03 | % | | $ | 845,346 | | | | 2.07 | % |
Analysis(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of Investment Securities Available-for-Salethe U.S. Government.
Investment Securities | | As of December 31, 2021 | |
| | Within One Year | | | After One but Within Five Years | | | After Five but Within Ten Years | | | After Ten Years | | | Total | |
(Dollars in thousands) | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | |
Securities available-for-sale | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
U.S. Treasury notes | | $ | 5,028 | | | | 2.33 | % | | $ | 5,061 | | | | 2.38 | % | | $ | - | | | | 0.00 | % | | $ | - | | | | 0.00 | % | | $ | 10,089 | | | | 2.36 | % |
U.S. Government-sponsored securities | | | 2 | | | | 1.80 | % | | | 148 | | | | 2.29 | % | | | 512 | | | | 1.55 | % | | | 5,712 | | | | 1.26 | % | | | 6,374 | | | | 1.30 | % |
Mortgage-backed securities(1) | | | 13 | | | | 1.50 | % | | | 21,155 | | | | 2.36 | % | | | 50,554 | | | | 2.36 | % | | | 179,398 | | | | 1.61 | % | | | 251,120 | | | | 1.83 | % |
Collateralized mortgage obligations(1) | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 2,436 | | | | 2.30 | % | | | 2,436 | | | | 2.30 | % |
Other | | | 435 | | | | 3.31 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 435 | | | | 3.31 | % |
Total securities available-for-sale | | $ | 5,478 | | | | 2.41 | % | | $ | 26,364 | | | | 2.36 | % | | $ | 51,066 | | | | 2.35 | % | | $ | 187,546 | | | | 1.61 | % | | $ | 270,454 | | | | 1.84 | % |
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
| | As of December 31, 2021 | |
| | Within One Year | | | After One but Within Five Years | | | After Five but Within Ten Years | | | After Ten Years | | | Total | |
(Dollars in thousands) | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | | | Amount | | | Yield | |
Securities held-to-maturity | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Mortgage-backed securities(1) | | $ | - | | | | 0.00 | % | | $ | - | | | | 0.00 | % | | $ | 10,641 | | | | 0.41 | % | | $ | 586,134 | | | | 1.72 | % | | $ | 596,775 | | | | 1.70 | % |
Collateralized mortgage obligations(1) | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | - | | | | 0.00 | % | | | 73,781 | | | | 1.71 | % | | | 73,781 | | | | 1.71 | % |
Municipal securities | | | 308 | | | | 1.10 | % | | | 8,487 | | | | 2.19 | % | | | 18,433 | | | | 3.42 | % | | | 39,268 | | | | 4.52 | % | | | 66,496 | | | | 3.90 | % |
Total securities held-to-maturity | | $ | 308 | | | | 1.10 | % | | $ | 8,487 | | | | 2.19 | % | | $ | 29,074 | | | | 2.32 | % | | $ | 699,183 | | | | 1.88 | % | | $ | 737,052 | | | | 1.90 | % |
(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.
Expected maturities may differ from contractual maturities because issuers may have the right to call obligations with or without penalties including prepayments on mortgage-backed securities. The following table isCompany evaluates securities for expected credit losses at least on a summary of the relative maturitiesquarterly basis, and yields of the Company's investment securities Available-for-Sale as of December 31, 2020.
December 31, 2020 (in thousands) | | Fair Value | | | Average Yield | |
U.S. Treasury | | | | | | |
One year or less | | $ | 5,020 | | | | 2.19 | % |
After one year through five years | | | 10,268 | | | | 2.36 | % |
Total U.S. Treasury Securities | | | 15,288 | | | | 2.30 | % |
U.S. Government Agency SBA | | | | | | | | |
After one year through five years | | | 333 | | | | 2.12 | % |
After five years through ten years | | | 488 | | | | 1.34 | % |
After ten years | | | 7,339 | | | | 1.28 | % |
Total U.S. Government Agency SBA Securities | | | 8,160 | | | | 1.31 | % |
Corporate Securities | | | | | | | | |
After one year through five years | | | 15,495 | | | | 1.51 | % |
After five years through ten years | | | 30,424 | | | | 2.12 | % |
Total Corporate Securities | | | 45,919 | | | | 1.92 | % |
Other | | | | | | | | |
One year or less | | | 492 | | | | 2.24 | % |
Total Other Securities | | | 492 | | | | 2.24 | % |
Mortgage Backed Securities | | | 737,873 | | | | 1.91 | % |
Total Investment Securities Available-for-Sale | | $ | 807,732 | | | | 1.91 | % |
Note: The average yield for floating rate securities is calculated using the current stated yield.more frequently when economic or market concerns warrant such evaluation.
Analysis of Investment Securities Held-to-Maturity
The following table is a summary of the relative maturities and yields of the Company's investment securities Held-to-Maturity as of December 31, 2020. Non-taxable Obligations of States and Political Subdivisions have been calculated on a fully taxable equivalent basis.
December 31, 2020 (in thousands) | | Book Value | | | Average Yield | |
Obligations of States and Political Subdivisions | | | | | | |
One year or less | | $ | 8,309 | | | | 3.99 | % |
After one year through five years | | | 5,137 | | | | 3.55 | % |
After five years through ten years | | | 23,493 | | | | 3.49 | % |
After ten years | | | 31,994 | | | | 4.74 | % |
Total Obligations of States and Political Subdivisions | | | 68,933 | | | | 4.13 | % |
Total Investment Securities Held-to-Maturity | | $ | 68,933 | | | | 4.13 | % |
Loans & and Leases
Loans &and leases can be categorized by borrowing purpose and use of funds. Common examples of loans &and leases made by the Company include:
Commercial and Agricultural Real Estate - – These are loans secured by farmland, commercialowner-occupied real estate, non-owner-occupied real estate, owner-occupied farmland, and multifamily residential properties, and other non-farm, non-residential properties generally within our market area.properties. Commercial mortgage term loans can be made if the property is either income producing or scheduled to become income producing based upon acceptable pre-leasing, andor the income will be the Bank's primary source of repayment for the loan. Loans are made both on owner occupied and investor properties; maturities generally do not exceed 15 years (and may have pricing adjustments on a shorter timeframe) amortizations of up to 25 years (30 years for multifamily residential properties); have debt service coverage ratios of 1.00 or better with a target of greater than 1.25;1.25 or greater; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Real Estate Construction - – These are loans for acquisition, development and construction (the Company generally requires the borrower to fund the land acquisition) and are secured by commercial or residential real estate. These loans are generally made only to experienced local developers with whom the Bank has a successful track record; for projects in our service area; with Loan Toto Value (LTV) below 75%; and where the property can be developed and sold within 2 years. Commercial construction loans are made only when there is a writtenan approved take-out commitment from the Bank or an acceptable financial institution or government agency. Most acquisition, development and construction loans are tied to the prime rate or LIBOR with an appropriate spread based on the amount of perceived risk in the loan.
Single Family Residential 1st Mortgages -Real Estate – These are loans primarily made on owner occupied residences; generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC; however, weFHLMC. However, the Company will make loans on rural residential properties up to 4041 acres. Most residential loans have terms from ten to twentythirty years and carry fixed or variable rates priced off ofto treasury rates. The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income.”income” loans.
Home Equity Lines and Loans - – These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not exceed $250,000;$500,000; but can be made for up to $1,000,000 in high cost counties. Combined Loan To Value (CLTV) does not exceed 80%75%; FICO scores are at or above 670; Total Debt Ratios do not exceed 43%; and in some situations the Company is in a 1st lien position.position
Agricultural - – These are non-real estate loans and lines of credit made to farmers to finance agricultural production. Lines of credit are extended to finance the seasonal needs of farmers during peak growing periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on livestock, crops, crop proceeds and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a processing plant, or orchard/vineyard development; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan.
Commercial - – These are non-real estate loans and lines of credit to businesses that are sole proprietorships, partnerships, LLC’s and corporations. Lines of credit are extended to finance the seasonal working capital needs of customers during peak business periods; are usually established for periods no longer than 12 to 2436 months; are often secured by general filing liens on accounts receivable, inventory and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a plant or purchase of a business; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan.
Consumer - – These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and unsecured lines of credit. The Company has a very minimal consumer loan portfolio, and loans are primarily made as an accommodation to deposit customers.portfolio.
Commercial Leases - – These are leases primarily to businesses or individuals,and farmers for the purpose of financing the acquisition of equipment. They can be either “finance leases” where the lessee retains the tax benefits of ownership but obtains 100% financing on their equipment purchases; or “true tax leases” where the Company, as lessor, places reliance on equipment residual value and in doing so obtains the tax benefits of ownership. Leases typically have a maturity of three to ten years, and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use ofwith qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.
The Company accounts for leases with Investment Tax Credits (ITC)(“ITC”) under the deferred method as established in ASC 740-10. ITCITCs are viewed and accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement.
See “Item 7A. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” for a discussion about the credit risks the Company assumes and its overall credit risk management practices.
Each loan or lease type involves risks specific to the: (1) borrower; (2) collateral; and (3) loan & lease structure. See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan & lease type. The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan & lease type. The Company’s policies require that loans &and leases arebe approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt. The Company’s underwriting procedures for all loan & lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease.
Most loans &and leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment; cash flow is our primary source of repayment. The quality and liquidity of collateral are important and must be confirmed before the loan is made.
In order to be responsive to borrower needs, the Company prices loans &and leases: (1) on both a fixed rate and adjustable rate basis; (2) over different terms; and (3) based upon different rate indices;indices as long as these structures are consistent with the Company’s interest rate risk management policies and procedures. See “Item 7A. Quantitative and Qualitative Disclosures Aboutabout Market Risk-Interest Rate Risk” in this Annual Report on Form 10-K for further details.
Overall, the Company's loan & lease portfolio at December 31, 20202022 totaled $3.1$3.5 billion, an increase of $426.6$275.2 million or 16.0%8.50% over December 31, 2019.2021. Exclusive of SBA PPP loans, the loan portfolio grew $346.0 million, or 10.69%, over December 31, 2021. This increase in the non-PPP loans occurred as a result of: (1) the Company’s business development efforts directed toward credit-qualified borrowers; and (2) expansion of our service area into the East Bay of San Francisco and Napa; and (3)Napa County. This data constitutes non-GAAP financial data. The Company believes that excluding the origination of $347.4 million of PPP loans, of which $224.3 million remain outstanding at December 31, 2020 (See “Introduction - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure). No assurances can be made that this growth in the loan & lease portfolio will continue, and it is anticipated that the remaindertemporary effect of the PPP loans will be forgiven byfurnishes useful information regarding the SBA in early 2021. However, the Company does anticipate that it will participate in the 2021 PPP which may add some additional loans.Company’s growth.
The following table sets forth the distribution of the loan & lease portfolio by type and percent at the end of each period presented:
| | December 31, | |
| | 2022 | | | 2021 | |
(Dollars in thousands) | | Dollars | | | Percent of Total | | | Dollars | | | Percent of Total | |
Gross Loans and Leases | | | | | | | | | | | | |
Real estate: | | | | | | | | | | | | |
Commercial | | $ | 1,328,691 | | | | 37.73 | % | | $ | 1,167,516 | | | | 35.95 | % |
Agricultural | | | 726,938 | | | | 20.64 | % | | | 672,830 | | | | 20.72 | % |
Residential and home equity | | | 387,753 | | | | 11.01 | % | | | 350,581 | | | | 10.79 | % |
Construction | | | 166,538 | | | | 4.73 | % | | | 177,163 | | | | 5.45 | % |
Total real estate | | | 2,609,920 | | | | 74.11 | % | | | 2,368,090 | | | | 72.91 | % |
Commercial & industrial | | | 478,758 | | | | 13.59 | % | | | 427,799 | | | | 13.17 | % |
Agricultural | | | 314,525 | | | | 8.93 | % | | | 276,684 | | | | 8.52 | % |
Commercial leases | | | 112,629 | | | | 3.20 | % | | | 96,971 | | | | 2.99 | % |
Consumer and other(1) | | | 5,886 | | | | 0.17 | % | | | 78,367 | | | | 2.41 | % |
Total gross loans and leases | | $ | 3,521,718 | | | | 100.00 | % | | $ | 3,247,911 | | | | 100.00 | % |
(1) Includes SBA PPP loans of $0 and $70,765 as of December 31, of the years indicated.2022 and December 31, 2021, respectively.
| | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
(in thousands) | | Amount | | | Percent | | | Amount | | | Percent | | | Amount | | | Percent | | | Amount | | | Percent | | | Amount | | | Percent | |
Commercial Real Estate | | $ | 971,326 | | | | 31.2 | % | | $ | 846,486 | | | | 31.6 | % | | $ | 834,476 | | | | 32.4 | % | | $ | 691,639 | | | | 31.1 | % | | $ | 674,445 | | | | 30.9 | % |
Agricultural Real Estate | | | 643,014 | | | | 20.7 | % | | | 625,767 | | | | 23.3 | % | | | 584,625 | | | | 22.7 | % | | | 499,231 | | | | 22.5 | % | | | 467,685 | | | | 21.4 | % |
Real Estate Construction | | | 185,741 | | | | 6.0 | % | | | 115,644 | | | | 4.3 | % | | | 98,568 | | | | 3.8 | % | | | 100,206 | | | | 4.5 | % | | | 176,462 | | | | 8.1 | % |
Residential 1st Mortgages | | | 299,379 | | | | 9.6 | % | | | 255,253 | | | | 9.5 | % | | | 259,736 | | | | 10.1 | % | | | 260,751 | | | | 11.7 | % | | | 242,247 | | | | 11.1 | % |
Home Equity Lines and Loans | | | 34,239 | | | | 1.1 | % | | | 39,270 | | | | 1.5 | % | | | 40,789 | | | | 1.6 | % | | | 34,525 | | | | 1.6 | % | | | 31,625 | | | | 1.4 | % |
Agricultural | | | 264,372 | | | | 8.5 | % | | | 292,904 | | | | 10.9 | % | | | 290,463 | | | | 11.3 | % | | | 273,582 | | | | 12.3 | % | | | 295,325 | | | | 13.5 | % |
Commercial | | | 374,816 | | | | 12.0 | % | | | 384,795 | | | | 14.4 | % | | | 343,834 | | | | 13.3 | % | | | 265,703 | | | | 12.0 | % | | | 217,577 | | | | 10.0 | % |
Consumer & Other (1) | | | 235,529 | | | | 7.6 | % | | | 15,422 | | | | 0.6 | % | | | 19,412 | | | | 0.8 | % | | | 6,656 | | | | 0.3 | % | | | 6,913 | | | | 0.3 | % |
Leases | | | 103,117 | | | | 3.3 | % | | | 104,470 | | | | 3.9 | % | | | 106,217 | | | | 4.0 | % | | | 88,957 | | | | 4.0 | % | | | 70,986 | | | | 3.3 | % |
Total Gross Loans & Leases | | | 3,111,533 | | | | 100.0 | % | | | 2,680,011 | | | | 100.0 | % | | | 2,578,120 | | | | 100.0 | % | | | 2,221,250 | | | | 100.0 | % | | | 2,183,265 | | | | 100.0 | % |
Less: Unearned Income | | | 11,941 | | | | | | | | 6,984 | | | | | | | | 6,879 | | | | | | | | 5,955 | | | | | | | | 5,664 | | | | | |
Subtotal | | | 3,099,592 | | | | | | | | 2,673,027 | | | | | | | | 2,571,241 | | | | | | | | 2,215,295 | | | | | | | | 2,177,601 | | | | | |
Less: Allowance for Credit Losses | | | 58,862 | | | | | | | | 55,012 | | | | | | | | 55,266 | | | | | | | | 50,342 | | | | | | | | 47,919 | | | | | |
Net Loans & Leases | | $ | 3,040,730 | | | | | | | $ | 2,618,015 | | | | | | | $ | 2,515,975 | | | | | | | $ | 2,164,953 | | | | | | | $ | 2,129,682 | | | | | |
(1) | Includes PPP loans. There were no concentrations of loans exceeding 10% of total loans which were not otherwise disclosed as a category of loans in the above table. |
The following table shows the maturity distribution and interest rate sensitivity of the loan portfolio of the Company on December 31, 2020.
(in thousands) | | One Year or Less | | | Over One Year to Five Years | | | Over Five Years | | | Total | |
Commercial Real Estate | | $ | 42,313 | | | $ | 275,256 | | | $ | 641,411 | | | $ | 958,980 | |
Agricultural Real Estate | | | 22,811 | | | | 150,752 | | | | 469,451 | | | | 643,014 | |
Real Estate Construction | | | 94,364 | | | | 87,484 | | | | 3,893 | | | | 185,741 | |
Residential 1st Mortgages | | | 1,180 | | | | 4,229 | | | | 293,970 | | | | 299,379 | |
Home Equity Lines and Loans | | | 13 | | | | 353 | | | | 33,873 | | | | 34,239 | |
Agricultural | | | 155,485 | | | | 97,736 | | | | 11,151 | | | | 264,372 | |
Commercial | | | 120,994 | | | | 199,704 | | | | 54,118 | | | | 374,816 | |
Consumer & Other | | | 699 | | | | 230,443 | | | | 4,387 | | | | 235,529 | |
Leases | | | 8,517 | | | | 50,720 | | | | 44,285 | | | | 103,522 | |
Total | | $ | 446,376 | | | $ | 1,096,677 | | | $ | 1,556,539 | | | $ | 3,099,592 | |
Rate Sensitivity: | | | | | | | | | | | | | | | | |
Fixed Rate | | $ | 66,042 | | | $ | 593,253 | | | $ | 1,027,705 | | | $ | 1,687,000 | |
Variable Rate | | | 380,334 | | | | 503,424 | | | | 528,834 | | | | 1,412,592 | |
Total | | $ | 446,376 | | | $ | 1,096,677 | | | $ | 1,556,539 | | | $ | 3,099,592 | |
Percent | | | 14.40 | % | | | 35.38 | % | | | 50.22 | % | | | 100.00 | % |
Classified Loans & Leases and Non-Performing Assets
All loans & leases are assigned a credit risk grade using grading standards developed by bank regulatory agencies. See “Results of Operations - Provision and Allowance for Credit Losses” for more detail on risk grades. The Company utilizes the services of a third-party independent loan & lease review firm to perform evaluations of individual loans & leases and review the credit risk grades the Company places on loans & leases. Loans & leases that are judged to exhibit a higher risk profile are referred to as “classified” and these loans & leases receive increased management attention. As of December 31, 2020, classified loans & leases totaled $18.6 million compared to $16.2 million at December 31, 2019.2022.
| | Loan Contractual Maturity | |
(Dollars in thousands) | | One Year or Less | | | After One But Within Five Years | | | After Five But Within Fifteen Years | | | After Fifteen Years | | | Total | |
Gross loan and leases: | | | | | | | | | | | | | | | |
Real estate: | | | | | | | | | | | | | | | |
Commercial | | $ | 61,340 | | | $ | 326,671 | | | $ | 889,041 | | | $ | 51,639 | | | $ | 1,328,691 | |
Agricultural | | | 26,588 | | | | 172,766 | | | | 452,249 | | | | 75,335 | | | | 726,938 | |
Residential and home equity | | | 384 | | | | 4,143 | | | | 117,421 | | | | 265,805 | | | | 387,753 | |
Construction | | | 94,238 | | | | 72,300 | | | | - | | | | - | | | | 166,538 | |
Total real estate | | | 182,550 | | | | 575,880 | | | | 1,458,711 | | | | 392,779 | | | | 2,609,920 | |
Commercial & industrial | | | 216,019 | | | | 181,520 | | | | 75,093 | | | | 6,126 | | | | 478,758 | |
Agricultural | | | 197,010 | | | | 98,898 | | | | 18,617 | | | | - | | | | 314,525 | |
Commercial leases | | | 45,503 | | | | 61,377 | | | | 5,749 | | | | - | | | | 112,629 | |
Consumer and other | | | 753 | | | | 3,989 | | | | 1,144 | | | | - | | | | 5,886 | |
Total gross loans and leases | | $ | 641,835 | | | $ | 921,664 | | | $ | 1,559,314 | | | $ | 398,905 | | | $ | 3,521,718 | |
Rate Structure for Loans | | | | | | | | | | | | | | | | | | | | |
Fixed Rate | | $ | 116,749 | | | $ | 475,248 | | | $ | 1,158,859 | | | $ | 255,628 | | | $ | 2,006,484 | |
Adjustable Rate | | | 525,086 | | | | 446,416 | | | | 400,455 | | | | 143,277 | | | | 1,515,234 | |
Total gross loans and leases | | $ | 641,835 | | | $ | 921,664 | | | $ | 1,559,314 | | | $ | 398,905 | | | $ | 3,521,718 | |
Classified loans & leases with higher levels of credit risk can be further designated as “impaired” loans & leases. A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement. See “Results of Operations - Provision and Allowance for Credit Losses” for further details. Impaired loans & leases consist of: (1) non-accrual loans & leases; and/or (2) restructured loans & leases that are still performing (i.e., accruing interest).
Non-Accrual Loans &and Leases - Accrual of interest on loans &and leases is generally discontinued when a loan or lease becomes contractually past due by 90 days or more with respect to interest or principal. When loans &and leases are 90 days past due, but in management's judgment are well secured and in the process of collection, they may not be classified as non-accrual.nonaccrual. When a loan or lease is placed on non-accrual status, all interest previously accrued but not collected is reversed. Income on such loans &and leases is then recognized only to the extent that cash is received and where the future collection of principal is probable. AtNon-accrual loans and leases totaled $571,000 and $516,000 for the years ended December 31, 2020, non-accrual loans & leases totaled $495,000. There were no non-accrual loans & leases at December 2019.2022 and 2021, respectively.
Restructured Loans &and Leases - A restructuring of a loan or lease constitutes a TDR under ASC 310-40, if the Company for economic or legal reasons related to the debtor's financial difficulties grants a concession to the debtorborrower that it would not otherwise consider, except when subject to the CARES Act and H.R. 133.133, as discussed below. Restructured loans or leases typically present an elevated level of credit risk, as the borrowers are not able to perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual. Loans &and leases that are on nonaccrualnon-accrual status at the time they become TDR loans or leases, remain on nonaccrualnon-accrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms. However, these loans or leases continue to be classified as impairedcollateral dependent and are individually evaluated for impairment.
At December 31, 2020,2022, restructured loans totaled $7.9$1.3 million compared with $2.3 million at December 31, 2021, all of which were performingperforming. See Note 4 “Loans and at December 31, 2019, restructured loans totaled $12.1 million all of which were performing.Leases” to the Consolidated Financial Statements in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.
Other Real Estate - Loans whereOwned – OREO represents real property taken either through foreclosure or through a deed in lieu thereof from the collateral has been repossessed are classified as other real estate ("ORE")borrower. The Company records all OREO properties at amounts equal to or ifless than the collateral is personal property,fair market value of the loan is classified as other assetsproperties based on the Company's financial statements.current independent appraisals reduced by estimated selling costs. The Company reported $873,000 of foreclosed OREO at December 31, 2022, and at December 31, 2021.
Not included in the table below, but relevant to a discussion of asset quality are loans that were granted some form of relief because of COVID-19 and arebut were not considered TDRs because of the CARES Act and H.R. 133. Since April 2020, we have restructured
$277.6$304.0 million of loans under the CARES Act and H.R. 133 guidelines (see “Part I, Introduction - COVID-19 (Coronavirus) Disclosure”).
At December 31, 2022, all loans that were restructured as part of the CARES Act, have returned to the contractual terms and conditions of the loans, without exception.
The following table sets forthsummarizes the amountloans for which the accrual of the Company's non-performinginterest has been discontinued and loans & leases (defined asmore than 90 days past due and still accruing interest, including those non-accrual loans & leases plus accruingthat are troubled debt restructured loans, & leases past due 90 days or more) and ORE as of December 31 of the years indicated.OREO (as hereinafter defined):
| | December 31, | |
(in thousands) | | 2020 | | | 2019 | | | 2018 | | | 2017 | | | 2016 | |
Non-Accrual Loans & Leases | | | | | | | | | | | | | | | |
Commercial Real Estate | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
Agricultural Real Estate | | | 495 | | | | - | | | | - | | | | - | | | | 1,304 | |
Real Estate Construction | | | - | | | | - | | | | - | | | | - | | | | - | |
Residential 1st Mortgages | | | - | | | | - | | | | - | | | | - | | | | 95 | |
Home Equity Lines and Loans | | | - | | | | - | | | | - | | | | - | | | | - | |
Agricultural | | | - | | | | - | | | | - | | | | - | | | | 243 | |
Commercial | | | - | | | | - | | | | - | | | | - | | | | 1,426 | |
Consumer & Other | | | - | | | | - | | | | - | | | | - | | | | 6 | |
Total Non-Accrual Loans & Leases | | | 495 | | | | - | | | | - | | | | - | | | | 3,074 | |
Accruing Loans & Leases Past Due 90 Days or More | | | | | | | | | | | | | | | | | | | | |
Commercial Real Estate | | | - | | | | - | | | | - | | | | - | | | | - | |
Agricultural Real Estate | | | - | | | | - | | | | - | | | | - | | | | - | |
Real Estate Construction | | | - | | | | - | | | | - | | | | - | | | | - | |
Residential 1st Mortgages | | | - | | | | - | | | | - | | | | - | | | | - | |
Home Equity Lines and Loans | | | - | | | | - | | | | - | | | | - | | | | - | |
Agricultural | | | - | | | | - | | | | - | | | | - | | | | - | |
Commercial | | | - | | | | - | | | | - | | | | - | | | | - | |
Consumer & Other | | | - | | | | - | | | | - | | | | - | | | | - | |
Total Accruing Loans & Leases Past Due 90 Days or More | | | - | | | | - | | | | - | | | | - | | | | - | |
Total Non-Performing Loans & Leases | | $ | 495 | | | $ | - | | | $ | - | | | $ | - | | | $ | 3,074 | |
Other Real Estate Owned | | $ | 873 | | | $ | 873 | | | $ | 873 | | | $ | 873 | | | $ | 3,745 | |
Total Non-Performing Assets | | $ | 1,368 | | | $ | 873 | | | $ | 873 | | | $ | 873 | | | $ | 6,819 | |
Restructured Loans & Leases (Performing) | | $ | 7,868 | | | $ | 12,105 | | | $ | 13,577 | | | $ | 6,301 | | | $ | 4,462 | |
Non-Performing Loans & Leases as a Percent of Total Loans & Leases | | | 0.02 | % | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % | | | 0.14 | % |
| | December 31, | |
(Dollars in thousands) | | 2022 | | | 2021 | |
Non-performing assets: | | | | | | |
Non-accrual loans and leases, not TDRs | | | | | | |
Real estate: | | | | | | |
Commercial | | $ | 403 | | | $ | - | |
Agricultural | | | - | | | | 18 | |
Residential and home equity | | | - | | | | - | |
Construction | | | 168 | | | | - | |
Total real estate | | | 571 | | | | 18 | |
Commercial & industrial | | | - | | | | - | |
Agricultural | | | - | | | | - | |
Commercial leases | | | - | | | | - | |
Consumer and other | | | - | | | | - | |
Subtotal | | | 571 | | | | 18 | |
Non-accrual loans and leases, are TDRs | | | | | | | | |
Real estate: | | | | | | | | |
Commercial | | | - | | | | - | |
Agricultural | | | - | | | | - | |
Residential and home equity | | | - | | | | - | |
Construction | | | - | | | | - | |
Total real estate | | | - | | | | - | |
Commercial & industrial | | | - | | | | - | |
Agricultural | | | - | | | | 498 | |
Commercial leases | | | - | | | | - | |
Consumer and other | | | - | | | | - | |
Subtotal | | | - | | | | 498 | |
Total non-performing loans and leases | | $ | 571 | | | $ | 516 | |
Other real estate owned ("OREO") | | $ | 873 | | | $ | 873 | |
Total non-performing assets | | $ | 1,444 | | | $ | 1,389 | |
Performing TDRs | | $ | 1,311 | | | $ | 1,824 | |
| | | | | | | | |
Selected ratios: | | | | | | | | |
Non-performing loans to total loans and leases | | | 0.02 | % | | | 0.02 | % |
Non-performing assets to total assets | | | 0.03 | % | | | 0.03 | % |
| | | | | | | | |
Although management believes that non-performing loans &and leases are generally well-secured and that potential losses are provided for in the Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses. See Note 6,4. “Loans and Leases”, located in “Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for an allocation of the allowance classified to impairedcollateral dependent loans &and leases.
The Company reported $873,00059
Except for: (i) those classified andfor non-performing loans &and leases discussed above; and (ii) those loans modified under the COVID-19 guidelines of the CARES Act and H.R. 133,above, the Company’s management is not aware of any loans &and leases as of December 31, 2020,2022, for which known financial problems of the borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some future date. However:
The State of California experienced drought conditions from 2013 through most of 2016. SinceAfter 2016, reasonable levels of rain and snow have alleviated drought conditions in California. As a result, current reservoirour primary service area, but the winter of 2020-2021 and 2021-2022 were once again dry (although 2023 has begun with significant levels are adequateof rain and snow). Despite this, the availability of water in our primary service area shouldwas not be an issue.issue for the 2022 growing season. However, the weather patterns over the past 5nine years further reinforce the fact that the long-term risks associated with the availability of water are significant.
The agricultural industry is facing challenges associated with: (1) downward pressures on commodity prices (somewhat offset by higher yields); and (2) tight labor markets and higher wages due to legislative changes at
While significant progress has been made in fighting the state and federal levels.
In an attempt to slowvaccines, the accelerating spreadeffects of COVID-19 on March 16, 2020 the first citiesare still with us, and counties in Northern California were placed under “shelter-in-place” orders. By March 19th, the Governor had placed the entire state under these orders. Since that time most California counties have been in various levels of lockdown, including those in which the Company operates. The Governor has developed guidance asit is impossible to when a given county can re-open certain business and other activities, but all counties in which the Company operates remain under some level of restriction. Businesses have been designated as “essential” or “non-essential.” Non-essential businesses have either been closed or had the scope of their activities significantly reduced. Unemployment has increased. The economic impact of this situation has already been severe, and continuing restrictions will only exacerbate the situation. The duration of these restrictions is not known at this time nor is the pace of recovery once they are lifted, therefore, the Company cannot determinepredict the ultimate impact on classified and non-performing loans and leases (see “Part I, IntroductionPart I. “Introduction - COVID-19 (Coronavirus) Disclosure”).
Allowance for Credit Losses—Loans and Leases
Deposits
OneThe Company maintains an allowance for credit losses (“ACL”) under the guidance of Financial Accounting Standards Board Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“CECL”). The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the key sourcestotal allowance after credit losses and loan & lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of fundsthree primary components: specific reserves related to support earning assets iscollateral dependent loans and leases; general reserves for current expected credit losses related to loans and leases that are not collateral dependent; and an unallocated component that takes into account the generation of deposits fromimprecision in estimating and allocating allowance balances associated with macro factors. See Note 1, located in “Item 8. Financial Statements and Supplementary Data” for a detailed discussion on the Company’s customer base. The ability to grow the customer base and subsequently deposits is a significant element in the performanceallowance for credit losses.
60
The following table sets forth the activity in our ACL for the periods indicated:
| | Year Ended December 31, | |
(Dollars in thousands) | | 2022 | | | 2021 | |
Allowance for credit losses: | | | | | | |
Balance at beginning of year | | $ | 61,007 | | | $ | 58,862 | |
Provision / (recapture) for credit losses | | | 6,057 | | | | 1,910 | |
Charge-offs: | | | | | | | | |
Real estate: | | | | | | | | |
Commercial | | | (170 | ) | | | - | |
Agricultural | | | - | | | | - | |
Residential and home equity | | | (25 | ) | | | - | |
Construction | | | - | | | | - | |
Total real estate | | | (195 | ) | | | - | |
Commercial & industrial | | | (324 | ) | | | - | |
Agricultural | | | - | | | | - | |
Commercial leases | | | - | | | | - | |
Consumer and other | | | (62 | ) | | | (44 | ) |
Total charge-offs | | | (581 | ) | | | (44 | ) |
Recoveries: | | | | | | | | |
Real estate: | | | | | | | | |
Commercial | | | - | | | | - | |
Agricultural | | | - | | | | - | |
Residential and home equity | | | 131 | | | | 98 | |
Construction | | | - | | | | - | |
Total real estate | | | 131 | | | | 98 | |
Commercial & industrial | | | 195 | | | | 99 | |
Agricultural | | | 53 | | | | 55 | |
Commercial leases | | | - | | | | - | |
Consumer and other | | | 23 | | | | 27 | |
Total recoveries | | | 402 | | | | 279 | |
Net charge-offs / recoveries | | | (179 | ) | | | 235 | |
| | | | | | | | |
Balance at end of year | | $ | 66,885 | | | $ | 61,007 | |
| | | | | | | | |
Selected financial information: | | | | | | | | |
Gross loans and leases held for investment | | $ | 3,512,361 | | | $ | 3,237,177 | |
Average loans and leases | | | 3,278,931 | | | | 3,084,339 | |
Non-performing loans and leases | | | 571 | | | | 516 | |
Allowance for credit losses to non-performing loans and leases | | | 11713.66 | % | | | 11823.06 | % |
Net charge-offs / (recoveries) to average loans and leases | | | 0.01 | % | | | (0.01 | %) |
Provision for credit losses to average loans and leases | | | 0.18 | % | | | 0.06 | % |
Allowance for credit losses to loans and leases held for investment | | | 1.90 | % | | | 1.88 | % |
The increase in ACL in both 2021 and 2022 was primarily related to higher expected probable losses inherent in the loan portfolio that was directly related to quantitative and qualitative factors associated with the current economic environment and overall growth in the loan portfolio.
The following table indicates management’s allocation of the ACL by time remaining to maturity,loan type as of each of the Company’s timefollowing dates:
| | December 31, | |
| | 2022 | | | 2021 | |
(Dollars in thousands) | | Dollars | | | Percent of Each Loan Type to Total Loans | | | Dollars | | | Percent of Each Loan Type to Total Loans | |
Allowance for credit losses: | | | | | | | | | | | | |
Real estate: | | | | | | | | | | | | |
Commercial | | $ | 18,055 | | | | 37.73 | % | | $ | 28,536 | | | | 35.95 | % |
Agricultural | | | 14,496 | | | | 20.64 | % | | | 9,613 | | | | 20.72 | % |
Residential and home equity | | | 7,508 | | | | 11.01 | % | | | 2,847 | | | | 10.79 | % |
Construction | | | 3,026 | | | | 4.73 | % | | | 1,456 | | | | 5.45 | % |
Total real estate | | | 43,085 | | | | 74.11 | % | | | 42,452 | | | | 72.91 | % |
Commercial & industrial | | | 11,503 | | | | 13.59 | % | | | 11,489 | | | | 13.17 | % |
Agricultural | | | 10,202 | | | | 8.93 | % | | | 5,465 | | | | 8.52 | % |
Commercial leases | | | 1,924 | | | | 3.20 | % | | | 938 | | | | 2.99 | % |
Consumer and other | | | 171 | | | | 0.17 | % | | | 663 | | | | 2.41 | % |
Total allowance for credit losses | | $ | 66,885 | | | | 100.00 | % | | $ | 61,007 | | | | 100.00 | % |
Deposits
Total deposits in amountswere $4.76 billion and $4.64 billion as of $250,000 or more at December 31, 2020.
(in thousands) | | | |
Time Deposits of $250,000 or More | | | |
Three Months or Less | | $ | 63,183 | |
Over Three Months Through Six Months | | | 50,761 | |
Over Six Months Through Twelve Months | | | 51,854 | |
Over Twelve Months | | | 20,146 | |
Total Time Deposits of $250,000 or More | | $ | 185,944 | |
Refer to the Year-To-Date Average Balances2022 and Rate Schedules located in this "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for information on separate deposit categories.
At December 31, 2020, deposits totaled $4.06 billion. This represents an increase of 23.9% or $782.2 million from December 31, 2019.2021, respectively. In addition to the Company’s ongoing business development activities for deposits, in management’s opinion the following factors positively impacted year-over-year deposit growth: (1) the Company’s strong financial results and position and F&M Bank’s reputation as one of the most safe and sound banks in its market area; and (2) the Company’s expansion of its service area into Walnut Creek, Oakland, Concord and Napa;Napa.
Non-interest bearing demand deposits increased to $1.76 billion, or 36.96% of total deposits, as of December 31, 2022 from $1.75 billion, or 37.72% of total deposits, as of December 31, 2021. Interest bearing deposits are comprised of interest-bearing transaction accounts, money market accounts, regular savings accounts, and (3) borrowers under the PPP depositing loan proceeds into their deposit accounts until those funds are used for operating expenses.certificates of deposit.
Although totalTotal deposits have increased 23.9%2.57% since December 31, 2019, importantly, low cost transaction accounts have grown at a strong pace as well as:2021:
Demand and interest-bearing transaction accounts increased $612.8totaled $2.88 billion at December 31, 2022, an increase of $36.1 million, or 34.7% since1.27% from $2.85 billion held at December 31, 2019.2021.
Savings and money market accounts have increased $265.5$144.1 million, or 26.7% since10.29%, to $1.54 billion at December 31, 2019.2022 compared with $1.40 billion at December 31, 2021.
TimeCertificates of deposit accounts have decreased $96.1$61.1 million, or 18.6% since15.56%, to $331.4 million at December 31, 2019.2022 compared with $392.5 million at December 31, 2021.
The following table shows the average amount and average rate paid on the categories of deposits for each of the periods presented:
| | As of December 31, | |
| | 2022 | | | 2021 | | | 2020 | |
(Dollars in thousands) | | Average Balance | | | Interest Expense | | | Average Rate | | | Average Balance | | | Interest Expense | | | Average Rate | | | Average Balance | | | Interest Expense | | | Average Rate | |
Total deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest bearing deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Demand | | $ | 1,120,198 | | | | 1,497 | | | | 0.13 | % | | $ | 1,024,009 | | | | 1,128 | | | | 0.11 | % | | $ | 787,306 | | | | 1,618 | | | | 0.21 | % |
Savings and money market | | | 1,542,310 | | | | 1,981 | | | | 0.13 | % | | | 1,352,258 | | | | 1,458 | | | | 0.11 | % | | | 1,128,623 | | | | 2,724 | | | | 0.24 | % |
Certificates of deposit greater than $250,000 | | | 157,623 | | | | 460 | | | | 0.29 | % | | | 170,040 | | | | 701 | | | | 0.41 | % | | | 220,952 | | | | 2,535 | | | | 1.15 | % |
Certificates of deposit less than $250,000 | | | 215,044 | | | | 411 | | | | 0.19 | % | | | 235,746 | | | | 730 | | | | 0.31 | % | | | 268,294 | | | | 2,236 | | | | 0.83 | % |
Total interest bearing deposits | | | 3,035,175 | | | | 4,349 | | | | 0.14 | % | | | 2,782,053 | | | | 4,017 | | | | 0.14 | % | | | 2,405,175 | | | | 9,113 | | | | 0.38 | % |
Non-interest bearing deposits | | | 1,751,797 | | | | | | | | | | | | 1,610,611 | | | | | | | | | | | | 1,232,874 | | | | | | | | | |
Total deposits | | $ | 4,786,972 | | | $ | 4,349 | | | | 0.09 | % | | $ | 4,392,664 | | | $ | 4,017 | | | | 0.09 | % | | $ | 3,638,049 | | | $ | 9,113 | | | | 0.25 | % |
Deposits are gathered from individuals and businesses in our market areas. The interest rates paid are competitively priced for each particular deposit product and structured to meet our funding requirements. The significant increase in short-term interest rates during 2022 has placed pressure on deposit pricing, and we will continue to manage this ongoing impact through careful deposit pricing. The average cost of deposits, including non-interest bearing deposits was 0.09% for all of 2022 and all of 2021.
The following table shows deposits with a balance greater than $250,000 at December 31, 2022 and 2021:
| | December 31 | |
(Dollars in thousands) | | 2022 | | | 2021 | |
Non-Maturity Deposits greater than $250,000 | | $ | 2,872,754 | | | $ | 2,708,576 | |
Certificates of deposit greater than $250,000, by maturity: | | | | | | | | |
Less than 3 months | | | 45,078 | | | | 59,591 | |
3 months to 6 months | | | 30,426 | | | | 37,182 | |
6 months to 12 months | | | 44,189 | | | | 59,945 | |
More than 12 months | | | 9,153 | | | | 12,147 | |
Total certificates of deposit greater than $250,000 | | $ | 128,846 | | | $ | 168,865 | |
Total deposits greater than $250,000 | | $ | 3,001,600 | | | $ | 2,877,441 | |
Refer to the Year-To-Date Average Balances and Rate Schedules located in this "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for information on separate deposit categories.
The Bank participates in a program wherein the State of California places time deposits with the Bank at the Bank’s option. At December 31, 2022 and 2021, the Bank had $3.0 million, of these deposits.
Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings
Lines of Credit with the Federal Reserve Bank and Federal Home Loan Bank are other key sources of funds to support earning assets. These sources of funds are also used to manage the Company’s interest rate risk exposure; and, as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio. There were no FHLB advances at December 31, 20202022 or 2019.2021. There were no Federal Funds purchased or advances from the FRB at December 31, 20202022 or 2019.2021.
Long-Term Subordinated Debentures
On December 17, 2003, the Company raised $10.0 million through the sale of subordinated debentures to an off-balance sheet trust and its sale of trust-preferred securities. See Note 13,9. “Long-Term Subordinated Debentures” located in “Item 8. Financial Statements and Supplementary Data.”Data” in this Annual Report on Form 10-K. Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our TPSTrust Preferred Securities will continue to qualify as regulatory capital.
These securities accrue interest at a variable rate based upon 3-month London InterBank Offered Rate (“LIBOR”)LIBOR plus 2.85%. Interest rates reset quarterly (the next reset is March 17, 2021)2023) and the rate was 3.08%7.59% as of December 31, 2020.2022. The average rate paid for these securities was 3.66%4.76% in 20202022 and 5.37%3.06% in 2019.2021. Additionally, if the Company decided to defer interest on the subordinated debentures, the Company would be prohibited from paying cash dividends on the Company’s common stock.
Capital Resources
The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders’ Equity totaled $423.7$485.3 million at December 31, 2020,2022, and $369.3$463.1 million at the end of 2019.2021.
The Company and the Bank are subject to various regulatory capital requirements administered byadequacy guidelines as outlined under Part 324 of the federal banking agencies.FDIC Rules and Regulations. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the CompanyCompany’s and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’sCompany and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’sCompany and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The minimumCompany believes that it is currently in compliance with all of these capital level requirements applicable toand that they will not result in any restrictions on the Company andCompany’s business activity.
Management believes that the Bank are: (i) a common equitymeets the requirements to be categorized as “well capitalized” under the FDIC regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 capital ratio of 4.5% of risk-weighted assets (“RWA”); (ii) a Tier 1 capital ratio of 6% of RWA; (iii) a total capital ratio of 8% of RWA;risk-based and (iv) a Tier 1 leverage ratio of 4% of total assets. A "capital conservation buffer" of 2.5% above each of the regulatory minimum capital ratios which would resultas set forth in the following minimum ratios: (i) a common equity Tier 1 capital ratiotables as of 7.0% of RWA; (ii) a Tier 1 capital ratio of 8.5% of RWA;December 31, 2022 and (iii) a total capital ratio of 10.5% of RWA. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. The Company’s subordinated debentures issued in 2003 continue to be counted as Tier 1 capital.2021.
As previously discussed, in order to supplement its regulatoryThe following table sets forth our capital base, during December 2003, the Company issued $10.0 million of trust preferred securities. In accordance with the provisions of the “Consolidation” topic of the FASB Accounting Standards Codification (“ASC”), the Company does not consolidate the subsidiary trust, which has issued the trust-preferred securities.ratios:
| | Minimum to be Categorized as "Well Capitalized" under Prompt Corrective Action Regulations | | | As of December 31, | |
(Dollars in thousands) | | 2022 | | | 2021 | |
Farmers & Merchants Bancorp | | | | | | | | | |
CET1 capital to risk-weighted assets | | N/A | | | | 11.57 | % | | | 11.68 | % |
Tier 1 capital to risk-weighted assets | | N/A | | | | 11.80 | % | | | 11.94 | % |
Risk-based capital to risk-weighted assets | | N/A | | | | 13.06 | % | | | 13.19 | % |
Tier 1 leverage capital ratio | | N/A | | | | 9.36 | % | | | 8.92 | % |
| | | | | | | | | | | |
Farmers & Merchants Bank | | | | | | | | | | | |
CET1 capital to risk-weighted assets | | 6.50% |
| | | 11.79 | % | | | 11.91 | % |
Tier 1 capital to risk-weighted assets | | 8.00% |
| | | 11.79 | % | | | 11.91 | % |
Risk-based capital to risk-weighted assets | | 10.00% |
| | | 13.04 | % | | | 13.17 | % |
Tier 1 leverage capital ratio | | 5.00% |
| | | 9.35 | % | | | 8.91 | % |
In 1998, the Board approved the Company’s first common stock repurchase program. This program has been extended and expanded several times since then, and most recently, on
On November 6, 2018,15, 2021, the Board of Directors approved an extensionreauthorized the Company’s share repurchase program for up to $20.0 million of the $20 millionCompany’s common stock repurchase program over(“Repurchase Plan”), representing approximately 4% of outstanding shareholders’ equity. Repurchases by the three-year period ending December 31, 2021. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”
There were no stock repurchases in 2020 or 2019Company under the Common Stock Repurchase Plan. The remaining dollar value of shares that may yet be purchased under the Company’s Common Stock Repurchase Plan is approximately $20 million.
may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means. On August 5, 2008,November 8, 2022, the Board of Directors approved a Share Purchase Rights Plan (the “Rightsauthorized an extension to its share repurchase program through December 31, 2024 for an additional $20.0 million of the Company’s common stock (“Repurchase Plan”), pursuant to which the Company entered into a Rights Agreement dated August 5, 2008, with Computershare as Rights Agent. The Rights Plan was set to expire on August 5, 2018. On November 19, 2015, the Boardrepresents approximately 4% of Directors approved a seven-year extension of the term of the Rights Plan. Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025. The extension of the term of the Rights Plan was intended as a means to continue to guard against abusive takeover tactics and was not in response to any particular proposal. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for further explanation.outstanding shareholders’ equity.
On November 23, 2020, the Board of Directors of Farmers & Merchants Bancorp approved, and all applicable regulators provided statements of non-objection regarding, the Company’s repurchase and retirement of up to $8.5 million of its outstanding common stock during the fourth quarter of 2020 and the first half of 2021. These repurchases will be done outside of the Company’s current repurchase plan. All repurchases have been and will continue to be made at the then prevailing market prices. In the fourth quarter of 2020During 2022, the Company repurchased $2.8 million21,309 shares under the Repurchase Plan, for a total of shares from shareholders.$20.3 million.
During the first quarter of 2020, the Company issued a combined total 523 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at a price of $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital. See Note 14, located in “Item 8. Financial Statements and Supplementary Data.”
During 2019, the Company issued a combined total 9,312 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. All of the shares were issued at prices ranging from $715.00 to $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital. See Note 14, located in “Item 8. Financial Statements and Supplementary Data.”
During 2018, the Company issued a combined total 13,520 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans. There were also 2,400 shares issued to individuals during 2018. All of the shares were issued at prices ranging from $635.00 to $690.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital.
Critical Accounting Policies and Estimates
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the Company’s financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. Management believes that the most significant subjective judgments that it makes include the following:
Allowance for Credit Losses - As a financial institution, which assumes lending and credit risks as a principal element in its business, the Company anticipates that credit losses will be experienced in the normal course of business. Accordingly, the allowance for credit losses is maintained at a level considered adequate by management to provide for losses that are inherent in the portfolio. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. Management employs a systematic methodology for determining the allowance for credit losses. On a quarterly basis, management reviews the credit quality of the loan & lease portfolio and considers problem loans & leases, delinquencies, internal credit reviews, current economic conditions, loan & lease loss experience, and other factors in determining the adequacy of the allowance balance.
While the Company utilizes a systematic methodology in determining its allowance, the allowance is based on estimates, and ultimate losses may vary from current estimates. The estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known. For additional information, see Note 6, located in “Item 8. Financial Statements and Supplementary Data.”
Fair Value Measurements - The Company discloses the fair value of financial instruments and the methods and significant assumptions used to estimate those fair values. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected realization. For additional information, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Credit Risk” and Notes 17 and 18 located in “Item 8. Financial Statements and Supplementary Data.”
Income Taxes - The Company uses the liability method of accounting for income taxes. This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year. This amount combined with the current taxes payable or refundable results in the income tax expense for the current year. For additional information, see Note 1, located in “Item 8. Financial Statements and Supplementary Data.”
Off-Balance-Sheet Arrangements
Off-balance-sheet arrangements are any contractual arrangement to which an unconsolidatedentity is a party, under which the Company has: (1) any obligation under a guarantee contract; (2) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity, or market risk support to that entity for such assets; (3) any obligation under certain derivative instruments; or (4) any obligation under a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or research and development services with the Company. The Company had the following off balance sheet commitments as of the dates indicated.
(in thousands) | | December 31, 2020 | | | December 31, 2019 | |
Commitments to Extend Credit | | $ | 1,040,844 | | | $ | 919,982 | |
Letters of Credit | | | 18,846 | | | | 20,346 | |
Performance Guarantees Under Interest Rate Swap Contracts Entered Into Between Our Borrowing Customers and Third Parties | | | 2,786 | | | | 1,513 | |
The following table sets forth our off-balance sheet lending commitments as of December 31, 2022:
| | | | | Amount of Commitment Expiration per Period | |
(Dollars in thousands) | | Total Committed Amount | | | Less than One Year | | | One to Three Years | | | Three to Five Years | | | After Five Years | |
Off-balance sheet commitments | | | | | | | | | | | | | | | |
Commitments to extend credit | | $ | 1,141,036 | | | $ | 423,956 | | | $ | 203,186 | | | $ | 476,671 | | | $ | 37,223 | |
Standby letters of credit | | | 17,138 | | | | 10,770 | | | | 4,468 | | | | 1,470 | | | | 430 | |
Total off-balance sheet commitments | | $ | 1,158,174 | | | $ | 434,726 | | | $ | 207,654 | | | $ | 478,141 | | | $ | 37,653 | |
The Company's exposure to credit loss in the event of nonperformance by the other party with regard to standby letters of credit, undisbursed loan commitments, and financial guarantees is represented by the contractual notional amount of those instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded balance sheet items. The Company may or may not require collateral or other security to support financial instruments with credit risk. Evaluations of each customer's creditworthiness are performed on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Company to guarantee performance of or payment for a customer to a third party.third-party. Most standby letters of credit are issued for 12have maturity dates ranging from 1 to 60 months or less.with final expiration in January 2027. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Additionally, the Company maintains a reserve for off balance sheet commitments, which totaled $ 2.1 million and $315,000 at December 31, 201202022 and 2019. We do not anticipate any material losses as a result of these transactions.2021, respectively.
Aggregate Contractual Obligations and Commitments
The following table presents, as of December 31, 2020, our significant and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts, or other similar carrying value adjustments. For further information on the nature of each obligation type, see applicable note disclosures located in “Item 8. Financial Statements and Supplementary Data.”
(in thousands) | | Total | | | 1 Year or Less | | | 2-3 Years | | | 4-5 Years | | | More Than 5 Years | |
Long-Term Subordinated Debentures | | | 10,310 | | | | - | | | | - | | | | - | | | | 10,310 | |
Deferred Compensation (1) | | | 68,077 | | | | 1,315 | | | | 2,118 | | | | 1,058 | | | | 63,586 | |
Total | | $ | 78,387 | | | $ | 1,315 | | | $ | 2,118 | | | $ | 1,058 | | | $ | 73,896 | |
(1) These amounts represent obligations to participants under the Company's various non-qualified deferred compensation plans. All amounts have been fully funded in to a Rabbi Trust as of December 31, 2020. See Note 16 located in “Item 8. Financial Statements and Supplementary Data.”
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Risk Management
The Company has adopted risk management policies and procedures, which aim to ensure the proper control and management of all risk factors inherent in the operation of the Company, most importantly credit risk, interest rate risk and liquidity risk. These risk factors are not mutually exclusive. It is recognized that any product or service offered by the Company may expose the Company to one or more of these risk factors.
Credit Risk
Credit risk is the risk to earnings or capital arising from an obligor’s failure to meet the terms of any contract or otherwise fail to perform as agreed. Credit risk is found in all activities where success depends on counterparty, issuer, or borrower performance.
Credit risk in the investment portfolio and correspondent bank accounts is addressed through defined limits in the Company’s policy statements. In addition, certain securities carry insurance to enhance credit quality of the bond.
In order to control credit risk in the loan & lease portfolio the Company has established credit management policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio. The Company manages and controls credit risk through comprehensive underwriting and approval standards, dollar limits on loans & leases to one borrower, and by restricting loans & leases made primarily to its principal market area where management believes it is best able to assess the applicable risk. Additionally, management has established guidelines to ensure the diversification of the Company’s credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. However, as a financial institution that assumes credit risks as a principal element of its business, credit losses will be experienced in the normal course of business. The allowance for credit losses is maintained- unfunded loan commitments was $2.1 million at a level considered by managementDecember 31, 2022 compared to be adequate$0.3 million at December 31, 2021. The increase in ACL in 2022 was primarily related to provide for riskshigher expected probable losses inherent in the loan & leaseportfolio that was directly related to quantitative and qualitative factors associated with the current economic environment and overall growth in the loan portfolio. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs.
Liquidity
The Company’s methodologyability to have readily available funds sufficient to repay maturing liabilities is of primary importance to depositors, creditors and regulators. Our liquidity, represented by cash borrowing lines, federal funds and available-for-sale securities, is a result of our operating, investing and financing activities and related cash flows. In order to ensure funds are available at all times, we devote resources to projecting the amount of funds that will be required and we maintain relationships with a diversified client base so funds are accessible. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets. We had the following borrowing lines available at December 31, 2022:
| | As of December 31, 2022 | |
(Dollars in thousands) | | Total Credit Line Limit | | | Current Credit Line Available | | | Outstanding Amount | | | Remaining Credit Line Available | | | Value of Collateral Pledged | |
Additional liquidity sources: | | | | | | | | | | | | | | | |
Federal Home Loan Bank | | $ | 757,866 | | | $ | 757,866 | | | $ | - | | | $ | 757,866 | | | $ | 1,225,175 | |
Federal Reserve BIC | | | 650,925 | | | | 650,925 | | | | - | | | | 650,925 | | | | 883,754 | |
FHLB Fed Funds | | | 18,000 | | | | 18,000 | | | | - | | | | 18,000 | | | | - | |
US Bank Fed Funds | | | 35,000 | | | | 35,000 | | | | - | | | | 35,000 | | | | - | |
PCBB Fed Funds | | | 50,000 | | | | 50,000 | | | | - | | | | 50,000 | | | | - | |
Total additional liquidity sources | | $ | 1,511,791 | | | $ | 1,511,791 | | | $ | - | | | $ | 1,511,791 | | | $ | 2,108,929 | |
We believe our liquid assets and short-term borrowing credit lines are adequate to meet our cash flow needs for assessingloan funding and deposit cash withdrawal for the appropriatenessforeseeable future. As of December 31, 2022, we had $958 million in cash and unencumbered investment securities; $2.1 million in investment securities and $2.1 billion in loans pledged as collateral on short-term borrowing credit lines. We have the allowanceoption of either borrowing on our credit lines or selling these investment securities for cash flow needs.
On a long-term basis, our liquidity will be met by changing the relative distribution of our asset portfolios by reducing our investment or loan volumes, or selling or encumbering assets. Further, we will increase liquidity by soliciting higher levels of deposit accounts through promotional activities and/or borrowing from our correspondent banks as well as the FHLB. At the current time, our long-term liquidity needs primarily relate to funds required to support loan originations and commitments and deposit withdrawals.
We believe we can meet all of these needs from existing liquidity sources.
Our liquidity is applied on a regular basis and considers all loans & leases. The systematic methodology consistscomprised of three parts.primary classifications: cash flows from or used in operating activities; cash flows from or used in investing activities; and cash flows from or used in financing activities. Net cash provided by or used in operating activities has consisted primarily of net income adjusted for certain non-cash income and expense items such as the credit loss provision, investment and other amortization and depreciation.
Our primary investing activities are the origination of loans, and purchases and sales of investment securities. As of December 31, 2022, we had unfunded loan commitments of $1.1 billion and unfunded letters of credit of $17.1 million. We anticipate that we will have sufficient funds available to meet current loan commitments.
Item 7A. | Quantitative and Qualitative Disclosures about Market Risk |
Part 1 - includes a detailed analysis of the loan & lease portfolio in two phases. The first phase is conducted in accordance with the “Receivables” topic of the FASB ASC. Individual loans & leases are reviewed to identify them for impairment. A loan or lease is impaired when principal and interest are deemed uncollectible in accordance with the original contractual terms of the loan or lease. Impairment is measured as either the expected future cash flows discounted at each loan’s or lease’s effective interest rate, the fair value of the loan’s or lease’s collateral if the loan or lease is collateral dependent, or an observable market price of the loan or lease, if one exists. Upon measuring the impairment, the Company will ensure an appropriate level of allowance is present or established.
Central to the first phase of the analysis of the loan & lease portfolioMarket risk is the risk rating system. The originating credit officer assigns each borrower an initial risk rating, which is based primarily on a thorough analysis of that borrower’s financial position in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior credit administration personnel. Credits are monitored by credit administration personnel for deteriorationloss in a borrower’s financial condition, which would impactinstrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. Our market risk arises primarily from interest rate risk inherent in our lending and deposit taking activities. Management actively monitors and manages our interest rate risk exposure. We do not have any market-risk sensitive instruments entered into for trading purposes. We manage our interest-rate sensitivity by matching the ability of the borrowerre-pricing opportunities on our earning assets to perform under the contract. Risk ratings are adjusted as necessary. Risk ratings are reviewed by both the Company’s independent third-party credit examiners and bank examiners from the DFPI and FDIC.those on our funding liabilities.
Based onManagement uses various asset/liability strategies to manage the risk rating system, specific allowancesre-pricing characteristics of our assets and liabilities designed to ensure that exposure to interest rate fluctuations is limited within our guidelines of acceptable levels of risk-taking. Hedging strategies, including the terms and pricing of loans and deposits, and managing the deployment of our securities, are establishedused to reduce mismatches in cases where management has identified significant conditions or circumstances related to a credit that management believes indicates that the loan or leaseinterest rate re-pricing opportunities of portfolio assets and their funding sources.
Our Asset Liability Management Committee (“ALCO”), which is impaired and there is a probabilitycomprised of loss. Management performs a detailed analysis of these loans & leases, including, but not limited to, cash flows, appraisalsmembers of the collateral, conditionsBoard of Directors and executive officers, manages market risk. ALCO monitors interest rate risk by analyzing the marketplace for liquidatingpotential impact on net interest income from potential changes in interest rates, and considers the collateral,impact of alternative strategies or changes in balance sheet structure. ALCO manages our balance sheet in part to maintain the potential impact of changes in interest rates on net interest income within acceptable ranges despite changes in interest rates.
Our exposure to interest rate risk is reviewed on at least a quarterly basis by ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine our change in net interest income in the event of hypothetical changes in interest rates. If potential changes to net interest income resulting from hypothetical interest rate changes are not within risk tolerances determined by ALCO, and assessmentapproved by the full Board of Directors, Management may make adjustments to the guarantors. Management then determinesCompany’s asset and liability mix to bring interest rate risk levels within the inherent loss potentialBoard approved limits.
Net Interest Income Simulation. In order to measure interest rate risk, we used a simulation model to project changes in net interest income that result from forecasted changes in interest rates. This analysis calculates the difference between net interest income forecasted using a rising and allocates a portion offalling interest rate scenario and a net interest income forecast using a base market interest rate derived from the allowance for losses as a specific allowancecurrent treasury yield curve. The income simulation model includes various assumptions regarding the re-pricing relationships for each of our products. Many of our assets are floating rate loans, which are assumed to re-price immediately, and to the same extent as the change in market rates according to their contracted index.
Some loans and investment vehicles include the opportunity of prepayment (embedded options), and accordingly the simulation model uses national indexes to estimate these credits.prepayments and assumes the reinvestment of the proceeds at current yields. Our non-term deposit products re-price more slowly, usually changing less than the change in market rates and at our discretion.
This analysis indicates the impact of changes in net interest income for the given set of rate changes and assumptions. It assumes the balance sheet grows modestly, but that its structure will remain similar to the structure as of the period presented. It does not account for all factors that affect this analysis, including changes by management to mitigate the effect of interest rate changes or secondary impacts such as changes to our credit risk profile as interest rates change.
The second phase is conductedFurthermore, loan prepayment-rate estimates and spread relationships change regularly. Interest rate changes create changes in actual loan prepayment rates that will differ from the market estimates incorporated in this analysis. Changes that vary significantly from the assumptions may have significant effects on our net interest income.
For the rising and falling interest rate scenarios, the base market interest rate forecast was increased or decreased, on an instantaneous and sustained basis, by segmenting the loan & lease portfolio by risk rating and into groups of loans & leases with similar characteristics in accordance with the “Contingency” topic200 basis points. As of the FASB ASC. In this second phase, groupsperiods presented, our net interest margin exposure related to these hypothetical changes in market interest rates was within the current guidelines established by us. Our simulation model highlights the fact that our balance sheet is asset sensitive, which means that our net interest income rises in a rising interest rate environment.
The ratio of variable to fixed-rate loans & leases with similar characteristics are reviewedin our loan portfolio, the ratio of short-term (maturing at a given time within 12 months) to long-term loans, and the appropriate allowance factor is appliedratio of our demand, money market and savings deposits to CDs (and their time periods), are the primary factors affecting the sensitivity of our net interest income to changes in market interest rates. Our short-term loans are typically priced at prime plus a margin, and our long-term loans are typically priced based on the historical average charge-off ratea FHLB index for each particular groupcomparable maturities, plus a margin. The composition of loansour rate-sensitive assets or leases.
Part 2 - considers qualitative internal and external factors that may affect a loan or lease’s collectability, is based upon management’s evaluation of various conditions, the effects of which are not directly measured in the determination of the historical and specific allowances. The evaluation of the inherent loss with respect to these conditionsliabilities is subject to change and could result in a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments. The conditions evaluated in connection withmore unbalanced position that would cause market rate changes to have a greater impact on our net interest margin.
Gap Analysis. Another way to measure the second element of the analysis of the allowance include, but are not limited to the following conditions that existed as of the balance sheet date:
general economic and business conditions affecting the key service areas of the Company;
credit quality trends (including trends in collateral values, delinquencies and non-performing loans & leases);
loan & lease volumes, growth rates and concentrations;
loan & lease portfolio seasoning;
specific industry and crop conditions;
recent loss experience; and
duration of the current business cycle.
Part 3 - An unallocated allowance generally occurs due to the imprecision in estimating and allocating allowance balances associated with macro factors such as: (1) economic conditions in the Central Valley; and (2) the long-term risks associated with the availability of water in the Central Valley.
Management reviews all of these conditions in discussion with the Company’s senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable impaired credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specifically identifiable impaired credit or portfolio segment as of the evaluation date, management’s evaluation of the inherent loss related to such condition is reflected in the second element of the allowance or in the unallocated allowance.
Management believes, that based upon the preceding methodology, and using information currently available, the allowance for credit losses at December 31, 2020 was adequate. No assurances can be givenimpact that future events may not resultchanges in increases in delinquencies, non-performing loans & leases, orinterest rates will have on net loan & lease charge-offs that would require increases ininterest income is through a cumulative gap measure. The gap represents the provision for credit losses and thereby adversely affect the resultsnet position of operations.
Interest Rate Risk
The mismatch between maturities of interest sensitive assets and liabilities resultssubject to re-pricing in uncertainty inspecified periods. A gap analysis highlights the Company’s earningsdistribution of re-pricing opportunities of our interest earning assets and economic value and is referred to asinterest-bearing liabilities, the interest rate risk. The Company does not attempt to predict interest rates and positions the balance sheet in a manner, which seeks to minimize, to the extent possible, the effects of changing interest rates.
The Company measuressensitivity gap (that is, interest rate risk in terms of potential impact on both its economic value and earnings. The methods for governing the amount ofsensitive assets less interest rate risk include: (1) analysis of asset and liability mismatches (Gap analysis); (2) the utilization of a simulation model; and (3) limits on maturities of investment, loan & lease, and deposit products, which reduces the market volatility of those instruments.
The Gap analysis measures, at specific time intervals, the divergence betweensensitive liabilities), cumulative interest earning assets and interest bearing liabilities, for which repricing opportunities will occur. A positive difference, or Gap, indicates thatthe cumulative interest rate sensitivity gap, the ratio of cumulative interest earning assets will reprice faster thanto cumulative interest-bearing liabilities. This will generally produce a greater net interest margin during periods of rising interest ratesliabilities and a lower net interest margin during periods of declining interest rates. Conversely, a negative Gap will generally produce a lower net interest margin during periods of rising interest rates and a greater net interest margin during periods of decreasing interest rates.
The interest rates paid on deposit accounts do not always move in unison with the rates charged on loans & leases. In addition, the magnitude of changes in the rates charged on loans & leases is not always proportionate to the magnitude of changes in the rate paid for deposits. Consequently, changes in interest rates do not necessarily result in an increase or decrease in the net interest margin solelycumulative gap as a resultpercentage of total assets and total interest earning assets as of the differences between repricing opportunities of earning assets or interest bearing liabilities.
periods presented. The Companyanalysis also utilizessets forth the results of a dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. The sensitivity of the Company’s net interest income is measured over a rolling one-year horizon.
The simulation model estimates the impact of changing interest rates on interest income from alltime periods during which interest earning assets and the interest expense paid on all interest bearing liabilities reflected onwill mature or may re-price in accordance with their contractual terms. The interest rate relationships between the Company’s balance sheet. This sensitivity analysis is compared to policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon assuming no balance sheet growth, given a 200 basis point upwardre-priceable assets and a 100 basis point downward shiftre-priceable liabilities are not necessarily constant and may be affected by many factors, including the behavior of clients in interest rates. A shift in rates over a 12-month period is assumed. Results that exceed policy limits, if any, are analyzed for risk tolerance and reported to the Board with appropriate recommendations. At December 31, 2020, the Company’s estimated net interest income sensitivityresponse to changes in interest rates.
Gap analysis has certain limitations. Measuring the volume of re-pricing or maturing assets and liabilities does not always measure the full impact on the portfolio value of equity or net interest income. Gap analysis does not account for rate caps on products, dynamic changes such as increasing prepayment speeds as interest rates decrease, basis risk, embedded options or the benefit of no-rate funding sources. The relation between product rate re-pricing and market rate changes (basis risk) is not the same for all products. The majority of interest earning assets generally re-price along with a movement in market rates, while non-term deposit rates in general move more slowly and usually incorporate only a fraction of the change in market rates.
Products categorized as a percent ofnon-rate sensitive, such as our non-interest bearing demand deposits, in the gap analysis behave like long-term fixed rate funding sources. Management uses income simulation, net interest income was a slight decrease in net interest incomerate shocks and market value of .03% if rates increase by 200 basis points and a decrease in net interest income of 0.2% if rates decline 100 basis points.
The estimated sensitivity does not necessarily represent a Company forecast and the results may not be indicative of actual changes to the Company’s net interest income. These estimates are based upon a number of assumptions including: the nature and timing ofportfolio equity as its primary interest rate levels including yield curve shape; prepayments on loans & leases and securities; pricing strategies on loans & leases and deposits; replacement of asset and liability cash flows; and other assumptions. While the assumptions used are based on current economic and local market conditions, there is no assurance as to the predictive nature of these conditions including how customer preferences or competitor influences might change.
Liquidity Risk
Liquidity risk is the risk to earnings or capital resulting from the Company’s inability to meet its obligations when they come due without incurring unacceptable losses. It includes the ability to manage unplanned decreases or changes in funding sources and to recognize or address changes in market conditions that affect the Company’s ability to liquidate assets or acquire funds quickly and with minimum loss of value. The Company endeavors to maintain a cash flow adequate to fund operations, handle fluctuations in deposit levels, respond to the credit needs of borrowers, and to take advantage of investment opportunities as they arise.
The Company’s principal operating sources of liquidity include (see “Item 8. Financial Statements and Supplementary Data – Consolidated Statements of Cash Flows”) cash and cash equivalents, cash provided by operating activities, principal payments on loans & leases, proceeds from the maturity or sale of investments, and growth in deposits. To supplement these operating sources of funds the Company maintains Federal Funds credit lines of $118 million and repurchase lines of $112 million with major banks. As of December 31, 2020, the Company has additional borrowing capacity of $630.5 million with the Federal Home Loan Bank and $438 million with the Federal Reserve Bank. Borrowings under these lines are collateralized with loans or securities that have been accepted for pledging at the FHLB and FRB.
At December 31, 2020, the Company had available sources of liquidity, which included cash and cash equivalents and unpledged investment securities available-for-sale of approximately $583.4 million, which represents 13% of total assets.management tools.