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Section 1: 10-Q (FORM 10-Q)

ovly20190930_10q.htm
 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

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

For the quarterly period ended September 30, 2019

 

 

OR

 

 

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-34142

 

OAK VALLEY BANCORP

(Exact name of registrant as specified in its charter)

 

California

 

26-2326676

State or other jurisdiction of

 

I.R.S. Employer

incorporation or organization

 

Identification No.

 

125 N. Third Ave., Oakdale, CA  95361

(Address of principal executive offices)

 

(209) 848-2265

Issuer’s telephone number

 

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

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

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock

OVLY

The Nasdaq Stock Market, LLC

 

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

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes     No 

 

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

 

Large accelerated filer 

 

Accelerated filer 

Non-accelerated filer 

 

Smaller reporting company 

 

 

 Emerging growth company 

 

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

 

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

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

State the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  8,210,637 shares of common stock outstanding as of November 1, 2019.

 



 

 

 

 

 

 

Oak Valley Bancorp

September 30, 2019

 

Table of Contents

 

 

 

Page

PART I – FINANCIAL INFORMATION

1

 

 

 

Item 1.

Financial Statements

2

 

 

 

Condensed Consolidated Balance Sheets at September 30, 2019 (Unaudited) and December 31, 2018

2

 

 

 

Condensed Consolidated Statements of Income for the three and nine-month periods ended September 30, 2019 and September 30, 2018 (Unaudited)

3

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and nine-month periods ended September 30, 2019 and September 30, 2018 (Unaudited)

4

 

 

 

Condensed Consolidated Statements of Changes of Shareholders’ Equity for the three and nine-month periods ended September 30, 2019 and September 30, 2018 (Unaudited)

5

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2019 and September 30, 2018 (Unaudited)

6

 

   

Notes to Condensed Consolidated Financial Statements

7

 

 

 

Item 2.

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

26

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

41

 

 

 

Item 4.

Controls and Procedures

41

 

 

 

PART II – OTHER INFORMATION

42

 

 

 

Item 1.

Legal Proceedings

42

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

Item 3.

Defaults Upon Senior Securities

42

Item 4.

Mine Safety Disclosures

42

Item 5.

Other Information

42

Item 6.

Exhibits

43

 

 

 

Table of Contents

 

 

PART I – FINANCIAL STATEMENTS

 

1

Table of Contents

 

Item 1. Financial Statements

 

 

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

 

(in thousands)

 

September 30,

   

December 31,

 
   

2019

   

2018

 

ASSETS

               

Cash and due from banks

  $ 106,009     $ 116,425  

Federal funds sold

    10,385       9,720  

Cash and cash equivalents

    116,394       126,145  
                 

Securities - available for sale

    193,601       206,712  

Securities - equity investments

    3,283       3,106  

Loans, net of allowance for loan loss of $9,005 and $8,685 as of September 30, 2019 and December 31, 2018, respectively

    722,446       702,220  

Cash surrender value of life insurance

    24,454       19,028  

Bank premises and equipment, net

    15,067       14,937  

Goodwill and other intangible assets, net

    3,863       3,942  

Interest receivable and other assets

    22,024       18,797  
                 
    $ 1,101,132     $ 1,094,887  
                 

LIABILITIES AND SHAREHOLDERS’ EQUITY

               
                 

Deposits

  $ 977,993     $ 986,495  

Interest payable and other liabilities

    13,819       9,354  

Total liabilities

    991,812       995,849  
                 

Shareholders’ equity

               

Common stock, no par value; 50,000,000 shares authorized, 8,210,637 and 8,194,805 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively

    25,435       25,429  

Additional paid-in capital

    3,636       3,358  

Retained earnings

    77,769       70,686  

Accumulated other comprehensive income (loss), net of tax

    2,480       (435 )

Total shareholders’ equity

    109,320       99,038  
                 
    $ 1,101,132     $ 1,094,887  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

2

Table of Contents

 

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

(dollars in thousands, except per share amounts)

 

THREE MONTHS ENDED
SEPTEMBER 30,

   

NINE MONTHS ENDED
SEPTEMBER 30,

 
   

2019

   

2018

   

2019

   

2018

 

INTEREST INCOME

                               

Interest and fees on loans

  $ 8,878     $ 8,149     $ 25,920     $ 23,348  

Interest on securities

    1,463       1,463       4,526       4,108  

Interest on federal funds sold

    46       55       153       139  

Interest on deposits with banks

    442       707       1,274       1,873  

Total interest income

    10,829       10,374       31,873       29,468  
                                 

INTEREST EXPENSE

                               

Deposits

    384       430       1,189       1,080  

Total interest expense

    384       430       1,189       1,080  
                                 

Net interest income

    10,445       9,944       30,684       28,388  

Provision for loan losses

    240       0       335       0  
                                 

Net interest income after provision for loan losses

    10,205       9,944       30,349       28,388  
                                 

OTHER INCOME

                               

Service charges on deposits

    415       388       1,211       1,126  

Debit card transaction fee income

    355       308       955       890  

Earnings on cash surrender value of life insurance

    174       130       426       381  

Mortgage commissions

    4       29       53       94  

Gains on sales and calls of securities

    27       3       137       80  

Gain on sale of OREO

    0       0       0       193  

Other

    300       279       1,010       716  

Total non-interest income

    1,275       1,137       3,792       3,480  
                                 

OTHER EXPENSES

                               

Salaries and employee benefits

    4,333       4,088       13,217       12,183  

Occupancy expenses

    911       882       2,658       2,757  

Data processing fees

    477       428       1,396       1,270  

Regulatory assessments (FDIC & DBO)

    28       110       240       338  

Other operating expenses

    1,408       1,312       4,189       3,909  

Total non-interest expense

    7,157       6,820       21,700       20,457  
                                 

Net income before provision for income taxes

    4,323       4,261       12,441       11,411  
                                 

Total provision for income taxes

    1,092       1,096       3,144       2,853  

Net Income

  $ 3,231     $ 3,165     $ 9,297     $ 8,558  
                                 

Net income per share

  $ 0.40     $ 0.39     $ 1.15     $ 1.06  
                                 

Net income per diluted share

  $ 0.40     $ 0.39     $ 1.15     $ 1.06  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

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OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

   

THREE MONTHS ENDED
SEPTEMBER 30,

   

NINE MONTHS ENDED
SEPTEMBER 30,

 

(in thousands)

 

2019

   

2018

   

2019

   

2018

 
                                 

Net income

  $ 3,231     $ 3,165     $ 9,297     $ 8,558  

Other comprehensive income:

                               

Unrealized gains on securities:

                               

Unrealized holding gains (losses) arising during the period

    742       (976 )     4,276       (2,559 )

Less: reclassification for net gains included in net income

    (27 )     (3 )     (137 )     (80 )

Other comprehensive gain (loss), before tax

    715       (979 )     4,139       (2,639 )

Tax (expense) benefit related to items of other comprehensive income

    (212 )     289       (1,224 )     780  

Total other comprehensive gain (loss)

    503       (690 )     2,915       (1,859 )

Comprehensive income

  $ 3,734     $ 2,475     $ 12,212     $ 6,699  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4

Table of Contents

 

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

 

   

THREE MONTHS ENDED SEPTEMBER 30, 2018 AND 2019

 
                                   

Accumulated

         
                   

Additional

           

Other

   

Total

 
   

Common Stock

   

Paid-in

   

Retained

   

Comprehensive

   

Shareholders’

 

(dollars in thousands)

 

Shares

   

Amount

   

Capital

   

Earnings

   

Income (Loss)

   

Equity

 
                                                 

Balances, July 1, 2018

    8,183,005     $ 25,422     $ 3,134     $ 65,606     $ (17 )   $ 94,145  

Restricted stock issued

    12,250       0       0       0       0       0  

Restricted stock forfeited

    (1,000 )     0       0       0       0       0  

Cash dividends declared $0.13 per share of common stock

    0       0       0       (1,064 )     0       (1,064 )

Stock based compensation

    0       0       110       0       0       110  

Other comprehensive loss

    0       0       0       0       (690 )     (690 )

Net income

    0       0       0       3,165       0       3,165  

Balances, September 30, 2018

    8,194,255     $ 25,422     $ 3,244     $ 67,707     $ (707 )   $ 95,666  
                                                 

Balances, July 1, 2019

    8,208,853     $ 25,435     $ 3,524     $ 75,647     $ 1,977     $ 106,583  

Restricted stock issued

    5,250       0       0       0       0       0  

Restricted stock forfeited

    (3,000 )     0       0       0       0       0  

Restricted stock surrendered for tax withholding

    (466 )     0       (6 )     0       0       (6 )

Cash dividends declared $0.135 per share of common stock

    0       0       0       (1,109 )     0       (1,109 )

Stock based compensation

    0       0       118       0       0       118  

Other comprehensive income

    0       0       0       0       503       503  

Net income

    0       0       0       3,231       0       3,231  

Balances, September 30, 2019

    8,210,637     $ 25,435     $ 3,636     $ 77,769     $ 2,480     $ 109,320  

 

   

NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2019

 
                                   

Accumulated

         
                   

Additional

           

Other

   

Total

 
   

Common Stock

   

Paid-in

   

Retained

   

Comprehensive

   

Shareholders’

 

(dollars in thousands)

 

Shares

   

Amount

   

Capital

   

Earnings

   

Income (Loss)

   

Equity

 
                                                 

Balances, January 1, 2018

    8,098,605     $ 24,773     $ 3,576     $ 61,429     $ 989     $ 90,767  

Restricted stock issued

    96,650       0       0       0       0       0  

Restricted stock forfeited

    (1,000 )     0       0       0       0       0  

Cash dividends declared $0.26 per share of common stock

    0       0       0       (2,117 )     0       (2,117 )

Stock based compensation

    0       0       317       0       0       317  

APIC reclassification

    0       649       (649 )     0       0       0  

Other comprehensive loss

    0       0       0       0       (1,859 )     (1,859 )

Reclassification from adoption of ASU 2016-01

    0       0       0       (163 )     163       0  

Net income

    0       0       0       8,558       0       8,558  

Balances, September 30, 2018

    8,194,255     $ 25,422     $ 3,244     $ 67,707     $ (707 )   $ 95,666  
                                                 

Balances, January 1, 2019

    8,194,805     $ 25,429     $ 3,358     $ 70,686     $ (435 )   $ 99,038  

Stock options exercised

    1,000       6       0       0       0       6  

Restricted stock issued

    26,095       0       0       0       0       0  

Restricted stock forfeited

    (4,500 )     0       0       0       0       0  

Restricted stock surrendered for tax withholding

    (6,763 )     0       (121 )     0       0       (121 )

Cash dividends declared $0.27 per share of common stock

    0       0       0       (2,214 )     0       (2,214 )

Stock based compensation

    0       0       399       0       0       399  

Other comprehensive income

    0       0       0       0       2,915       2,915  

Net income

    0       0       0       9,297       0       9,297  

Balances, September 30, 2019

    8,210,637     $ 25,435     $ 3,636     $ 77,769     $ 2,480     $ 109,320  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5

Table of Contents

 

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

   

NINE MONTHS ENDED
SEPTEMBER 30,

 

(dollars in thousands)

 

2019

   

2018

 
                 

CASH FLOWS FROM OPERATING ACTIVITIES:

               

Net income

  $ 9,297     $ 8,558  

Adjustments to reconcile net income to net cash from operating activities:

               

Provision for loan losses

    335       0  

Increase (decrease) in deferred fees/costs, net

    113       (324 )

Depreciation

    816       914  

Amortization of investment securities, net

    715       817  

Stock based compensation

    399       317  

Gain on sale of OREO property

    0       (193 )

Gain on calls and sale of available for sale securities

    (137 )     (80 )

Earnings on cash surrender value of life insurance

    (426 )     (381 )

Increase in interest payable and other liabilities

    4,977       512  

Decrease (increase) in interest receivable

    556       (10 )

(Increase) decrease in other assets

    (4,524 )     1,550  

Net cash from operating activities

    12,121       11,680  
                 

CASH FLOWS FROM INVESTING ACTIVITIES:

               

Purchases of available for sale securities

    (23,860 )     (46,068 )

Purchases of equity securities

    (68 )     (63 )

Proceeds from maturities, calls, and principal paydowns of securities available for sale

    40,423       16,701  

Investment in LIHTC

    (512 )     0  

Net increase in loans

    (20,674 )     (682 )

Purchase of FHLB Stock

    (404 )     (222 )

Purchase of BOLI policies

    (5,000 )     0  

Proceeds from sale of OREO

    0       447  

Purchases of premises and equipment

    (946 )     (1,550 )

Net cash used in investing activities

    (11,041 )     (31,437 )
                 

CASH FLOWS FROM FINANCING ACTIVITIES:

               

Shareholder cash dividends paid

    (2,214 )     (2,117 )

Net (decrease) increase in demand deposits and savings accounts

    (5,270 )     41,695  

Net decrease in time deposits

    (3,232 )     (6,153 )

Proceeds from exercise of stock options

    6       0  

Tax withholding payments on vested restricted shares surrendered

    (121 )     0  

Net cash (used in) from financing activities

    (10,831 )     33,425  
                 

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

    (9,751 )     13,668  
                 

CASH AND CASH EQUIVALENTS, beginning of period

    126,145       149,173  
                 

CASH AND CASH EQUIVALENTS, end of period

  $ 116,394     $ 162,841  
                 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

               

Cash paid during the period for:

               

Interest

  $ 1,200     $ 1,094  

Income taxes

  $ 3,420     $ 2,555  
                 

NON-CASH INVESTING ACTIVITIES:

               

Change in unrealized gain (loss) on securities

  $ 4,139     $ (2,755 )

Change in contributions payable to LIHTC limited partner investment

  $ (511 )   $ 0  

Lease right-of-use assets

  $ 4,550     $ 0  
                 

NON-CASH FINANCING ACTIVITIES:

               

Present value of lease obligations

  $ 4,947     $ 0  

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6

Table of Contents

 

OAK VALLEY BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

NOTE 1 – BASIS OF PRESENTATION

 

On July 3, 2008 (the “Effective Date”), a bank holding company reorganization was completed whereby Oak Valley Bancorp (“the Company”, “us”, “our”) became the parent holding company for Oak Valley Community Bank (the “Bank”).  On the Effective Date, a tax-free exchange was completed whereby each outstanding share of the Bank was converted into one share of the Company and the Bank became the sole wholly-owned subsidiary of the holding company.

 

The consolidated financial statements include the accounts of the parent company and its wholly-owned bank subsidiary. Unless otherwise stated, the “Company” refers to the consolidated entity, Oak Valley Bancorp, while the “Bank” refers to Oak Valley Community Bank. All material intercompany transactions have been eliminated. The interim consolidated financial statements included in this report are unaudited but reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the three and nine-month periods ended September 30, 2019 are not necessarily indicative of the results of a full year’s operations. Certain prior year amounts have been reclassified to conform to the current year presentation. There was no effect on net income or shareholders’ equity as previously reported as a result of reclassifications. For further information, refer to the audited consolidated financial statements and footnotes included in the Company’s Form 10-K for the year ended December 31, 2018.

 

Oak Valley Community Bank is a California state-chartered bank. The Company was incorporated under the laws of the State of California on May 31, 1990 and began operations in Oakdale on May 28, 1991. The Company operates branches in Oakdale, Sonora, Bridgeport, Bishop, Mammoth Lakes, Modesto, Manteca, Patterson, Turlock, Ripon, Stockton, Escalon, and Sacramento, California. The Bridgeport, Mammoth Lakes, and Bishop branches operate as a separate division, Eastern Sierra Community Bank. The Company’s primary source of revenue is providing loans to customers who are predominantly middle-market businesses.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant accounting estimates reflected in the Company’s consolidated financial statements include the allowance for loan losses, fair value measurements, and the determination, recognition and measurement of impaired loans. Actual results could differ from these estimates.

 

 

   

 

NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS

   

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU is a converged standard involving FASB and International Financial Reporting Standards that provides a single comprehensive revenue recognition model for all contracts with customers across transactions and industries. The core principal of the guidance is that an entity should recognize revenue to reflect the transfer of promised goods or services to customers in an amount and at a time that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Subsequent updates related to Revenue from Contracts with Customers (Topic 606) are as follows:

 

 

August 2015 ASU No. 2015-14 - Deferral of the Effective Date, institutes a one-year deferral of the effective date of this amendment to annual reporting periods beginning after December 15, 2017.

 

 

March 2016 ASU No. 2016-08 - Principal versus Agent Considerations (Reporting Revenue Gross versus Net), clarifies the implementation guidance on principal versus agent considerations and on the use of indicators that assist an entity in determining whether it controls a specified good or service before it is transferred to the customer.

 

 

April 2016 ASU No. 2016-10 - Identifying Performance Obligations and Licensing, provides guidance in determining performance obligations in a contract with a customer and clarifies whether a promise to grant a license provides a right to access or the right to use intellectual property.

 

 

May 2016 ASU No. 2016-12 - Narrow Scope Improvements and Practical Expedients, gives further guidance on assessing collectability, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition.

 

Topic 606 was adopted by the Company on January 1, 2018 and did not have a material impact on the Company’s consolidated financial statements. No additional disaggregated revenue disclosures are necessary because interest income sources are scoped out and there are no additional significant noninterest income sources to break out on the consolidated statement of income.

 

7

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU make improvements to GAAP related to financial instruments that include the following as applicable to us.

 

 

Equity investments, except for those accounted for under the equity method of accounting or those that result in consolidation of the investee, are required to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer.

 

 

Simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment - if impairment exists, this requires measuring the investment at fair value.

 

 

Eliminates the requirement for public companies to disclose the method(s) and significant assumptions used to estimate the fair value that is currently required to be disclosed for financial instruments measured at amortized cost on the balance sheet.

 

 

Public companies will be required to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes.

 

 

Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements.

 

 

The reporting entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets.

 

ASU 2016-01 is effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. This ASU was adopted by the Company on January 1, 2018 and impacted the Company’s financial statement disclosures but did not have a material impact on the Company’s financial condition or results of operations.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities, including leases classified as operating leases under previous GAAP, on the balance sheet and requiring additional disclosures of key information about leasing arrangements. ASU 2016-02 is effective for annual periods, including interim periods within those annual periods beginning after December 15, 2018 and was adopted under the current period adjustment method, which allows for prior period accumulated amounts to be recorded as of the effective date. The Company adopted this ASU effective January 1, 2019 and determined that the gross-up of its balance sheet from recording a right-of-use (“ROU”) asset and a lease liability for each lease as a result of adopting this ASU, did not have a material impact on the Company’s Consolidated financial statements. See Note 5 for further discussion of the Company’s leases and the impact of this ASU.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326). This update changes the methodology used by financial institutions under current U.S. GAAP to recognize credit losses in the financial statements.  Currently, U.S. GAAP requires the use of the incurred loss model, whereby financial institutions recognize in current period earnings, incurred credit losses and those inherent in the financial statements, as of the date of the balance sheet.    This guidance results in a new model for estimating the allowance for loan and lease losses, commonly referred to as the Current Expected Credit Loss (“CECL”) model.  Under the CECL model, financial institutions are required to estimate future credit losses and recognize those losses in current period earnings.  The amendments within the update are effective for fiscal years and all interim periods beginning after December 15, 2019, with early adoption permitted.  In October 2019, FASB approved an amendment that will delay the adoption of this ASU for three years for certain entities including the Company since we are classified as a Small Reporting Company. Upon adoption of the amendments within this update, the Company will be required to make a cumulative-effect adjustment to the opening balance of retained earnings in the year of adoption. The Company is currently in the process of evaluating the impact the adoption of this update will have on its financial statements. While the Company has not quantified the impact of this ASU, it does expect changing from the current incurred loss model to an expected loss model will result in an earlier recognition of losses.

 

In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The ASU was issued to address certain stranded tax effects in accumulated other comprehensive income as a result of the Tax Cuts and Jobs Act of 2017. The ASU provides companies with the option to reclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the change from the newly enacted corporate tax rate is recorded. The amount of the reclassification would be calculated on the basis of the difference between the historical and newly enacted tax rates for deferred tax liabilities and assets related to items within accumulated other comprehensive income. The ASU requires companies to disclose its accounting policy related to releasing income tax effects from accumulated other comprehensive income, whether it has elected to reclassify the stranded tax effects, and information about the other income tax effects that are reclassified. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods, therein, and early adoption is permitted for public business entities for which financial statements have not yet been issued. On January 1, 2018, the Company adopted the ASU and made a reclassification adjustment of $163,000 from accumulated other comprehensive income to retained earnings on the Consolidated Statements of Shareholders' Equity, related to the stranded tax effects due to the change in the federal corporate tax rate applied on the unrealized gains (losses) on investments on a portfolio basis, to reflect the provisions of this ASU.

 

8

 

 

 

NOTE 3 – SECURITIES

 

Equity Securities

 

The Company held equity securities with fair values of $3,283,000 and $3,106,000 as of September 30, 2019 and December 31, 2018, respectively. There were no sales of equity securities during the nine months ended September 30, 2019. Consistent with ASU 2016-01, these securities are carried at fair value with the changes in fair value recognized in the consolidated statements of income. Accordingly, the Company recognized an unrealized gain of $108,000 during the nine months ended September 30, 2019, as compared to a loss of $115,000 during the nine months ended September 30, 2018.

 

Debt Securities

 

Debt securities have been classified in the financial statements as available for sale. The amortized cost and estimated fair values of debt securities as of September 30, 2019 are as follows:

 

(dollars in thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 
                                 

Available-for-sale securities:

                               

U.S. agencies

  $ 31,026     $ 510     $ (26 )   $ 31,510  

Collateralized mortgage obligations

    1,680       9       (9 )     1,680  

Municipalities

    89,616       3,650       (1 )     93,265  

SBA pools

    6,982       18       (18 )     6,982  

Corporate debt

    19,253       143       (469 )     18,927  

Asset backed securities

    41,523       102       (388 )     41,237  
    $ 190,080     $ 4,432     $ (911 )   $ 193,601  

 

 

The following tables detail the gross unrealized losses and fair values of debt securities aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2019.

 

(dollars in thousands)

 

Less than 12 months

   

12 months or more

   

Total

 

Description of Securities

 

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

 

U.S. agencies

  $ 0       0     $ 3,395     $ (26 )   $ 3,395     $ (26 )

Collateralized mortgage obligations

    0       0       689       (9 )     689       (9 )

Municipalities

    0       0       412       (1 )     412       (1 )

SBA pools

    0       0       3,918       (18 )     3,918       (18 )

Corporate debt

    998       (2 )     8,845       (467 )     9,843       (469 )

Asset backed securities

    9,522       (97 )     19,927       (291 )     29,449       (388 )

Total temporarily impaired securities

  $ 10,520     $ (99 )   $ 37,186     $ (812 )   $ 47,706     $ (911 )

 

 

As of September 30, 2019, one municipality, six corporate debts, five U.S. agencies, five Small Business Administration pools, ten asset backed securities and two collateralized mortgage obligations make up the total debt securities in an unrealized loss position for greater than 12 months. As of September 30, 2019, five asset backed securities and one corporate debt make up the total debt securities in a loss position for less than 12 months. Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if the impairment is temporary or other than temporary. This evaluation encompasses various factors including, the nature of the investment, the cause of the impairment, the severity and duration of the impairment, credit ratings and other credit related factors such as third party guarantees and the volatility of the security’s fair value. Management has determined that no investment security is other than temporarily impaired. The unrealized losses are due primarily to interest rate changes. The Company does not intend to sell the securities and it is not likely that the Company will be required to sell the securities before the earlier of the forecasted recovery or the maturity of the underlying investment security.

 

9

 

The amortized cost and estimated fair value of debt securities as of September 30, 2019, segregated by contractual maturity or call date, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(dollars in thousands)

 

Amortized

   

Fair

 
   

Cost

   

Value

 

Available-for-sale securities:

               

Due in one year or less

  $ 32,877     $ 33,086  

Due after one year through five years

    47,129       48,685  

Due after five years through ten years

    40,975       41,936  

Due after ten years

    69,099       69,894  
    $ 190,080     $ 193,601  

 

 

The amortized cost and estimated fair values of debt securities as of December 31, 2018, are as follows:

 

(dollars in thousands)

 

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 
                                 

Available-for-sale securities:

                               

U.S. agencies

  $ 44,474     $ 135     $ (503 )   $ 44,106  

Collateralized mortgage obligations

    2,071       0       (59 )     2,012  

Municipalities

    92,257       1,404       (424 )     93,237  

SBA pools

    8,707       13       (47 )     8,673  

Corporate debt

    21,426       62       (901 )     20,587  

Asset backed securities

    38,395       119       (417 )     38,097  
    $ 207,330     $ 1,733     $ (2,351 )   $ 206,712  

 

 

The following tables detail the gross unrealized losses and fair values of debt securities segregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2018.

 

(dollars in thousands)

 

Less than 12 months

   

12 months or more

   

Total

 

Description of Securities

 

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

 

U.S. agencies

  $ 22,007     $ (230 )   $ 11,972     $ (273 )   $ 33,979     $ (503 )

Collateralized mortgage obligations

    93       (1 )     1,917       (58 )     2,010       (59 )

Municipalities

    9,630       (55 )     26,559       (369 )     36,189       (424 )

SBA pools

    3,284       (8 )     3,726       (39 )     7,010       (47 )

Corporate debt

    3,999       (59 )     11,645       (842 )     15,644       (901 )

Asset backed securities

    23,604       (412 )     1,853       (5 )     25,457       (417 )

Total temporarily impaired securities

  $ 62,617     $ (765 )   $ 57,672     $ (1,586 )   $ 120,289     $ (2,351 )

 

The Company recognized gross gains of $27,000 and $137,000 for the three and nine-month periods ended September 30, 2019, respectively, on certain available-for-sale securities that were called, compared to gains of $3,000 and $10,000, recorded for the same periods during 2018. There were no sales of available-for-sale securities during the three and nine-months ended September 30, 2019, as compared to one sale of a municipal bond resulting in a gain of $70,000 during the nine-month period of 2018.

 

Debt securities carried at $128,721,000 and $118,771,000 as of September 30, 2019 and December 31, 2018, respectively, were pledged to secure deposits of public funds.

 

10

 

 

 

NOTE 4 – LOANS

 

The Company’s customers are primarily located in Stanislaus, San Joaquin, Tuolumne, Inyo, and Mono Counties. As of September 30, 2019, approximately 79% of the Company’s loans are commercial real estate loans which include construction loans. Approximately 11% of the Company’s loans are for general commercial uses including professional, retail, and small business. Additionally, 5% of the Company’s loans are for residential real estate and other consumer loans. The remaining 5% are agriculture loans. Loan totals were as follows:

 

(in thousands)

 

 

September 30, 2019

   

December 31, 2018

 

Commercial real estate:

               

Commercial real estate- construction

  $ 50,260     $ 20,263  

Commercial real estate- mortgages

    450,870       460,701  

Land

    8,563       10,951  

Farmland

    68,572       62,604  

Commercial and industrial

    78,292       82,252  

Consumer

    1,146       1,314  

Consumer residential

    37,357       35,741  

Agriculture

    37,274       38,076  

Total loans

    732,334       711,902  
                 

Less:

               

Deferred loan fees and costs, net

    (883 )     (997 )

Allowance for loan losses

    (9,005 )     (8,685 )

Net loans

  $ 722,446     $ 702,220  

 

 

Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentration of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

 

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily made based on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. As of September 30, 2019 and December 31, 2018, commercial real estate loans equal to approximately 41% and 40%, respectively, of the outstanding principal balance of commercial real estate loans were secured by owner-occupied properties.

 

11

 

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates and financial analyses of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

Agricultural production, real estate and development lending is susceptible to credit risks including adverse weather conditions, pest and disease, as well as market price fluctuations and foreign competition. Agricultural loan underwriting standards are maintained by following Company policies and procedures in place to minimize risk in this lending segment. These standards consist of limiting credit to experienced farmers who have demonstrated farm management capabilities, requiring cash flow projections displaying margins sufficient for repayment from normal farm operations along with equity injected as required by policy, as well as providing adequate secondary repayment and sponsorship including satisfactory collateral support. Credit enhancement obtained through government guarantee programs may also be used to provide further support as available. 

 

The Company originates consumer loans utilizing common underwriting criteria specified in policy. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for 1-4 family residential loans, home equity lines and loans follow bank policy, which include, but are not limited to, a maximum loan-to-value percentage of 80%, a maximum housing and total debt ratio of 36% and 42%, respectively and other specified credit and documentation requirements.

 

The Company maintains an independent loan review program that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Bank’s policies and procedures.

 

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Non-accrual loans, segregated by class of loans, were as follows:

 

(in thousands)

 

September 30, 2019

   

December 31, 2018

 

Commercial real estate:

               

Commercial real estate- construction

  $ 0     $ 0  

Commercial real estate- mortgages

    0       0  

Land

    888       906  

Farmland

    0       0  

Commercial and industrial

    0       0  

Consumer

    0       0  

Consumer residential

    312       14  

Agriculture

    0       0  

Total non-accrual loans

  $ 1,200     $ 920  

 

Had non-accrual loans performed in accordance with their original contract terms, the Company would have recognized additional interest income of approximately $14,000 and $48,000 in the three and nine-month periods ended September 30, 2019, respectively, as compared to $16,000 and $53,000 in the same periods of 2018.

 

12

 

The following table analyzes past due loans including the past due non-accrual loans in the above table, segregated by class of loans, as of September 30, 2019 (in thousands):

 

September 30, 2019

 

30-59

Days

Past Due

   

60-90

Days Past

Due

   

Greater

Than 90

Days

Past Due

   

Total Past Due

   

Current

   

Total

   

Greater

Than 90

Days Past

Due and

Still

Accruing

 

Commercial real estate:

                                                       

Commercial R.E. - construction

  $ 0     $ 0     $ 0     $ 0     $ 50,260     $ 50,260     $ 0  

Commercial R.E. - mortgages

    0       0       0       0       450,870       450,870       0  

Land

    0       0       0       0       8,563       8,563       0  

Farmland

    0       0       0       0       68,572       68,572       0  

Commercial and industrial

    0       0       0       0       78,292       78,292       0  

Consumer

    0       0       0       0       1,146       1,146       0  

Consumer residential

    0       312       0       312       37,045       37,357       0  

Agriculture

    0       0       0       0       37,274       37,274       0  

Total

  $ 0     $ 312     $ 0     $ 312     $ 732,022     $ 732,334     $ 0  

 

 

The following table analyzes past due loans including the past due non-accrual loans in the above table, segregated by class of loans, as of December 31, 2018 (in thousands):

 

December 31, 2018

 

30-59

Days

Past Due

   

60-90

Days Past

Due

   

Greater

Than 90

Days

Past Due

   

Total Past Due

   

Current

   

Total

   

Greater

Than 90

Days Past

Due and

Still

Accruing

 

Commercial real estate:

                                                       

Commercial R.E. - construction

  $ 0     $ 0     $ 0     $ 0     $ 20,263     $ 20,263     $ 0  

Commercial R.E. - mortgages

    0       0       0       0       460,701       460,701       0  

Land

    0       0       906       906       10,045       10,951       0  

Farmland

    0       0       0       0       62,604       62,604       0  

Commercial and industrial

    0       2,100       0       2,100       80,152       82,252       0  

Consumer

    0       0       0       0       1,314       1,314       0  

Consumer residential

    0       62       0       62       35,679       35,741       0  

Agriculture

    0       0       0       0       38,076       38,076       0  

Total

  $ 0     $ 2,162     $ 906     $ 3,068     $ 708,834     $ 711,902     $ 0  

 

 

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. There was no interest income realized on impaired loans for the three and nine-months ended September 30, 2019 and 2018.

 

13

 

Impaired loans as of September 30, 2019 are set forth in the following table.

 

(in thousands)

 

Unpaid

Contractual

Principal

Balance

   

Recorded

Investment

With No

Allowance

   

Recorded

Investment

With

Allowance

   

Total

Recorded

Investment

   

Related

Allowance

 

September 30, 2019

                                       

Commercial real estate:

                                       

Commercial R.E. - construction

  $ 0     $ 0     $ 0     $ 0     $ 0  

Commercial R.E. - mortgages

    0       0       0       0       0  

Land

    895       0       888       888       680  

Farmland

    0       0       0       0       0  

Commercial and Industrial

    0       0       0       0       0  

Consumer

    0       0       0       0       0  

Consumer residential

    312       312       0       312       0  

Agriculture

    0       0       0       0       0  

Total

  $ 1,207     $ 312     $ 888     $ 1,200     $ 680  

 

 

Average recorded investment in impaired loans outstanding as of September 30, 2019 and 2018 is set forth in the following table.

 

(in thousands)

 

Average Recorded Investment for the
Three Months Ended September 30,

   

Average Recorded Investment for the
Nine Months Ended September 30,

 
   

2019

   

2018

   

2019

   

2018

 

Commercial real estate:

                               

Commercial R.E. - construction

  $ 0     $ 0     $ 0     $ 0  

Commercial R.E. - mortgages

    0       0       0       0  

Land

    890       942       901       2,018  

Farmland

    0       0       0       0  

Commercial and Industrial

    0       105       0       304  

Consumer

    0       0       0       0  

Consumer residential

    126       14       51       96  

Agriculture

    0       0       0       0  

Total

  $ 1,016     $ 1,061     $ 952     $ 2,418  

 

 

Impaired loans as of December 31, 2018 are set forth in the following table.

 

(in thousands)

 

Unpaid

Contractual

Principal

Balance

   

Recorded

Investment

With No

Allowance

   

Recorded

Investment

With

Allowance

   

Total

Recorded

Investment

   

Related

Allowance

   

Average

Recorded

Investment

 

December 31, 2018

                                               

Commercial real estate:

                                               

Commercial R.E. - construction

  $ 0     $ 0     $ 0     $ 0     $ 0     $ 0  

Commercial R.E. - mortgages

    0       0       0       0       0       0  

Land

    1,222       0       906       906       680       958  

Farmland

    0       0       0       0       0       0  

Commercial and Industrial

    32       0       0       0       0       176  

Consumer

    0       0       0       0       0       0  

Consumer residential

    15       14       0       14       0       14  

Agriculture

    0       0       0       0       0       0  

Total

  $ 1,269     $ 14     $ 906     $ 920     $ 680     $ 1,148  

 

14

 

Troubled Debt Restructurings – In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.

 

As of September 30, 2019, there was one loan that was considered to be a troubled debt restructuring totaling $888,000, which is included in non-accrual loans. As of December 31, 2018, there were four loans that were considered to be troubled debt restructurings, all of which are considered non-accrual totaling $920,000. As of September 30, 2019 and December 31, 2018 there were no unfunded commitments on loans classified as a troubled debt restructurings. The Company has allocated $680,000 of specific reserves to loans whose terms have been modified in troubled debt restructurings as of September 30, 2019 and December 31, 2018.

 

During the three and nine-months ended September 30, 2019, the same loan described above was modified as a troubled debt restructuring totaling $906,000 at the time it was modified, as compared to no troubled debt restructurings during the same periods of 2018. The modification of the terms of such loans typically includes one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date; or a temporary payment modification in which the payment amount allocated towards principal was reduced. In some cases, a permanent reduction of the accrued interest on the loan is conceded. The troubled debt restructuring during the three and nine-months ended September 30, 2019 did not modify the principal balance, did not increase the allowance for loan losses and there were no charge offs as a result of the loan modification.

 

There were no loans modified as troubled debt restructurings within the previous twelve months and for which there was a payment default during the three and nine-month periods ended September 30, 2019 and 2018. A loan is considered to be in payment default once it is ninety days contractually past due under the modified terms.

 

Loan Risk Grades– Quality ratings (Risk Grades) are assigned to all commitments and stand-alone notes. Risk grades define the basic characteristics of commitments or stand-alone note in relation to their risk. All loans are graded using a system that maximizes the loan quality information contained in loan review grades, while ensuring that the system is compatible with the grades used by bank examiners.

 

The Company grades loans using the following letter system:

 

1 Exceptional Loan

2 Quality Loan

3A Better Than Acceptable Loan

3B Acceptable Loan

3C Marginally Acceptable Loan

4 (W) Watch Acceptable Loan

5 Special Mention Loan

6 Substandard Loan

7 Doubtful Loan

8 Loss

 

1. Exceptional Loan - Loans with A+ credits that contain very little, if any, risk. Grade 1 loans are considered Pass. To qualify for this rating, the following characteristics must be present:

 

A high level of liquidity and whose debt-servicing capacity exceeds expected obligations by a substantial margin.

 

Where leverage is below average for the industry and earnings are consistent or growing without severe vulnerability to economic cycles.

 

Also included in this rating (but not mandatory unless one or more of the preceding characteristics are missing) are loans that are fully secured and properly margined by our own time instruments or U.S. blue chip securities. To be properly margined, cash collateral must be equal to, or greater than, 110% of the loan amount.

 

2. Quality Loan - Loans with excellent sources of repayment that conform in all respects to bank policy and regulatory requirements. These are also loans for which little repayment risk has been identified. No credit or collateral exceptions. Grade 2 loans are considered Pass. Other factors include:

 

Unquestionable debt-servicing capacity to cover all obligations in the ordinary course of business from well-defined primary and secondary sources.

 

Consistent strong earnings.

 

A solid equity base.

 

3A. Better than Acceptable Loan - In the interest of better delineating the loan portfolio’s true credit risk for reserve allocation, further granularity has been sought by splitting the grade 3 category into three classifications. The distinction between the three are bank-defined guidelines and represent a further refinement of the regulatory definition of a pass, or grade 3 loan. Grade 3A is characterized by:

 

Strong earnings with no loss in last three years and ample cash flow to service all debt well above policy guidelines.

 

Long term experienced management with depth and defined management succession.

 

The loan has no exceptions to policy.

 

Loan-to-value on real estate secured transactions is 10% to 20% less than policy guidelines.

 

Very liquid balance sheet that may have cash available to pay off our loan completely.

 

Little to no debt on balance sheet.

 

15

 

3B. Acceptable Loan - 3B loans are simply defined as all loans that are less qualified than 3A loans and are stronger than 3C loans. These loans are characterized by acceptable sources of repayment that conform to bank policy and regulatory requirements. Repayment risks are acceptable for these loans. Credit or collateral exceptions are minimal, are in the process of correction, and do not represent repayment risk. These loans:

 

Are those where the borrower has average financial strengths, a history of profitable operations and experienced management.

 

Are those where the borrower can be expected to handle normal credit needs in a satisfactory manner.

 

3C. Marginally Acceptable Loan - 3C loans have similar characteristics as that of 3Bs with the following additional characteristics:

 

Requires collateral.

 

A credit facility where the borrower has average financial strengths, but usually lacks reliable secondary sources of repayment other than the subject collateral.

 

Other common characteristics can include some or all of the following: minimal background experience of management, lacking continuity of management, a start-up operation, erratic historical profitability (acceptable reasons-well identified), lack of or marginal sponsorship of guarantor, and government guaranteed loans.

 

4W. Watch Acceptable Loan - Watch grade will be assigned to any credit that is adequately secured and performing but monitored for a number of indicators. These characteristics may include:

 

 

Any unexpected short-term adverse financial performance from budgeted projections or a prior period’s results (i.e., declining profits, sales, margins, cash flow, or increased reliance on leverage, including adverse balance sheet ratios, trade debt issues, etc.).

 

Any managerial or personal problems of company management, decline in the entire industry or local economic conditions, or failure to provide financial information or other documentation as requested.

 

Issues regarding delinquency, overdrafts, or renewals.

 

Any other issues that cause concern for the company.

 

Loans to individuals or loans supported by guarantors with marginal net worth and/or marginal collateral.

 

Weaknesses that are identified are short-term in nature.

 

Loans in this category are usually accounts the Bank would want to retain providing a positive turnaround can be expected within a reasonable time frame. Grade 4 loans are considered Pass.

 

5. Special Mention Loan - A special mention extension of credit is defined as having potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date result in the deterioration of the repayment prospects for the credit or the institution’s credit position. Extensions of credit that might be detailed in this category include the following:

 

The lending officer may be unable to properly supervise the credit because of an inadequate loan or credit agreement.

 

Questions exist regarding the condition of and/or control over collateral.

 

Economic or market conditions may unfavorably affect the obligor in the future.

 

A declining trend in the obligor’s operations or an imbalanced position in the balance sheet exists, but not to the point that repayment is jeopardized.

 

6. Substandard Loan - A “substandard” extension of credit is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Extensions of credit so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard credits, does not have to exist in individual extensions of credit classified as substandard.

 

7. Doubtful Loan - An extension of credit classified as “doubtful” has all the weaknesses inherent in one classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high but because of certain important and reasonably specific pending factors that may work to the advantage of and strengthen the credit, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include a proposed merger or acquisition, liquidation proceedings, capital injection, perfecting liens on additional collateral or refinancing plans. The entire loan need not be classified as doubtful when collection of a specific portion appears highly probable. An example of proper use of the doubtful category is the case of a company being liquidated, with the trustee-in-bankruptcy indicating a minimum disbursement of 40 percent and a maximum of 65 percent to unsecured creditors, including the Bank. In this situation, estimates are based on liquidation value appraisals with actual values yet to be realized. By definition, the only portion of the credit that is doubtful is the 25 percent difference between 40 and 65 percent.

 

A proper classification of such a credit would show 40 percent substandard, 25 percent doubtful, and 35 percent loss. A credit classified as doubtful should be resolved within a ‘reasonable’ period of time. Reasonable is generally defined as the period between examinations. In other words, a credit classified as doubtful at an examination should be cleared up before the next exam. However, there may be situations that warrant continuation of the doubtful classification a while longer.

 

16

 

8. Loss - Extensions of credit classified as “loss” are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the credit has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off, even though partial recovery may be affected in the future. It should not be the Company’s practice to attempt long-term recoveries while the credit remains on the books. Losses should be taken in the period in which they surface as uncollectible.

 

As of September 30, 2019 and December 31, 2018, there are no loans that are classified with a risk grade of 8- Loss.

 

 

The following table presents weighted average risk grades of the Company’s loan portfolio:

 

   

September 30, 2019

   

December 31, 2018

 
   

 

Weighted Average

Risk Grade

   

Weighted Average

Risk Grade

 

Commercial real estate:

               

Commercial real estate - construction

    3.00       3.00  

Commercial real estate - mortgages

    3.01       3.02  

Land

    3.72       3.58  

Farmland

    3.05       3.00  

Commercial and industrial

    3.05       3.08  

Consumer

    2.16       2.31  

Consumer residential

    3.03       3.01  

Agriculture

    3.20       3.12  

Total gross loans

    3.04       3.04  

 

 

The following table presents risk grade totals by class of loans as of September 30, 2019 and December 31, 2018. Risk grades 1 through 4 have been aggregated in the “Pass” line.

 

(in thousands)

 

Commercial R.E.
Construction

   

Commercial R.E.
Mortgages

   

Land

   

Farmland

   

Commercial and Industrial

   

Consumer

   

Consumer

Residential

   

Agriculture

   

Total

 
                                                                         

September 30, 2019

                                                                       

Pass

  $ 50,260     $ 448,066     $ 7,675     $ 66,967     $ 75,087     $ 1,121     $ 37,004     $ 33,600     $ 719,780  

Special mention

    -       2,804       -       1,605       825       -       -       3,674       8,908  

Substandard

    -       -       888       -       2,380       25       353       -       3,646  

Total loans

  $ 50,260     $ 450,870     $ 8,563     $ 68,572     $ 78,292     $ 1,146     $ 37,357     $ 37,274     $ 732,334  
                                                                         

December 31, 2018

                                                                       

Pass

  $ 20,263     $ 457,150     $ 10,045     $ 62,604     $ 77,254     $ 1,273     $ 35,698     $ 35,813     $ 700,100  

Special mention

    -       2,868       -       -       2,898       -       -       2,263       8,029  

Substandard

    -       683       906       -       2,100       41       43       -       3,773  

Total loans

  $ 20,263     $ 460,701     $ 10,951     $ 62,604     $ 82,252     $ 1,314     $ 35,741     $ 38,076     $ 711,902  

 

 

Allowance for Loan Losses. The allowance for loan losses is a reserve established by the Company through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

 

17

 

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

 

The Company’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Bank and the Company.

 

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 5 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

 

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similarly risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

 

General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Bank and the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Bank’s lending management and staff; (ii) the effectiveness of the Bank’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, moderate or low degree of risk. The results are then input into a “general allocation matrix” to determine an appropriate general valuation allowance.

 

Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy exceptions that exceed specified risk grades.

 

Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off automatically based on regulatory requirements.

 

18

 

The following table details activity in the allowance for loan losses by portfolio segment for the three and nine-months ended September 30, 2019 and 2018. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

Allowance for Loan Losses

 

For the Three and Nine Months Ended September 30, 2019 and 2018

 
                                                         

 

 

Commercial

   

Commercial

           

Consumer

                         

(in thousands)

 

Real Estate

   

and Industrial

   

Consumer

   

Residential

   

Agriculture

   

Unallocated

   

Total

 
Three Months Ended September 30, 2019                                                        

Beginning balance

  $ 6,675     $ 1,095     $ 33     $ 292     $ 672     $ 3     $ 8,770  

Charge-offs

    0       0       (6 )     0       0       0       (6 )

Recoveries

    0       0       1       0