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, 2016

Commission file number: 000-33063

 

Sierra Bancorp

(Exact name of Registrant as specified in its charter)

 

California 33-0937517
(State of Incorporation) (IRS Employer Identification No)

 

86 North Main Street, Porterville, California 93257

(Address of principal executive offices) (Zip Code)

 

(559) 782-4900

(Registrant’s telephone number, including area code)

 

Not Applicable

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

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes R No £

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes R No £

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

 

Large accelerated filer £ Accelerated filer R
Non-accelerated filer £ (Do not check if a smaller reporting company) Smaller Reporting Company £

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes £ No R

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common stock, no par value, 13,791,101 shares outstanding as of November 1, 2016

 

 

 

 
FORM 10-Q

 

Table of Contents

 

  Page
Part I - Financial Information 1
Item 1. Financial Statements (Unaudited) 1
Consolidated Balance Sheets 1
Consolidated Statements of Income 2
Consolidated Statements of Comprehensive Income 3
Consolidated Statements of Cash Flows 4
Notes to Consolidated Financial Statements (Unaudited) 5
   
Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations 31
Forward-Looking Statements 31
Critical Accounting Policies 31
Overview of the Results of Operations and Financial Condition 32
Earnings Performance 33
Net Interest Income and Net Interest Margin 33
Provision for Loan and Lease Losses 37
Non-interest Income and Non-Interest Expense 38
Provision for Income Taxes 41
Balance Sheet Analysis 41
Earning Assets 41
Investments 41
Loan and Lease Portfolio 42
Nonperforming Assets 43
Allowance for Loan and Lease Losses 45
Off-Balance Sheet Arrangements 46
Other Assets 46
Deposits and Interest-Bearing Liabilities 47
Deposits 47
Other Interest-Bearing Liabilities 48
Other Non-Interest Bearing Liabilities 48
Liquidity and Market Risk Management 48
Capital Resources 51
   
Item 3. Qualitative & Quantitative Disclosures about Market Risk 52
   
Item 4. Controls and Procedures 52
   
Part II - Other Information 53
Item 1. - Legal Proceedings 53
Item 1A. - Risk Factors 53
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds 53
Item 3. - Defaults upon Senior Securities 53
Item 4. - Mine Safety Disclosures 53
Item 5. - Other Information 53
Item 6. - Exhibits 54
   
Signatures 55

 

 

 

 

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

 

SIERRA BANCORP

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

 

   September 30, 2016   December 31, 2015 
ASSETS  (unaudited)   (audited) 
Cash and due from banks  $56,903   $46,627 
Interest-bearing deposits in banks   8,539    1,996 
          Total cash & cash equivalents   65,442    48,623 
Securities available for sale   535,580    507,582 
Loans and leases:          
     Gross loans and leases   1,256,330    1,132,856 
     Allowance for loan and lease losses   (9,880)   (10,423)
     Deferred loan and lease fees, net   2,956    2,169 
          Net loans and leases   1,249,406    1,124,602 
Premises and equipment, net   28,781    21,990 
Foreclosed assets   2,782    3,193 
Company owned life insurance   44,191    44,140 
Goodwill   7,932    6,908 
Other intangible assets, net   2,909    930 
Other assets   36,217    38,569 
   $1,973,240   $1,796,537 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Deposits:          
     Non-interest bearing  $498,391   $432,251 
     Interest bearing   1,135,440    1,032,377 
          Total deposits   1,633,831    1,464,628 
Federal funds purchased and repurchase agreements   9,270    9,405 
Short-term borrowings   71,600    75,300 
Long-term borrowings   -    2,000 
Junior subordinated debentures   34,365    30,928 
Other liabilities   15,646    23,936 
       Total Liabilities   1,764,712    1,606,197 
           
Commitments and contingent liabilities (Note 8)          
           
Shareholders’ equity          
     Common stock, no par value; 24,000,000 shares          
       authorized; 13,789,501 and 13,254,088 shares issued          
       and outstanding at September 30, 2016 and          
       December 31, 2015, respectively   72,370    62,404 
     Additional paid in capital   2,764    2,689 
     Retained earnings   128,699    122,701 
     Accumulated other comprehensive income, net   4,695    2,546 
       Total shareholders’ equity   208,528    190,340 
   $1,973,240   $1,796,537 

 

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

 

1 

 

 

SIERRA BANCORP
CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share data, unaudited)

 

   Three months ended
September 30,
   Nine months ended
September 30,
 
   2016   2015   2016   2015 
Interest and dividend income                    
Loans and leases, including fees  $15,121   $12,924   $41,360   $38,124 
Taxable securities   1,879    1,847    6,114    6,191 
Tax-exempt securities   765    746    2,225    2,202 
Federal funds sold and other   29    7    61    26 
Total interest income   17,794    15,524    49,760    46,543 
Interest expense                    
Deposits   575    452    1,573    1,345 
Short-term borrowings   51    12    107    43 
Long-term borrowings   -    2    -    9 
Subordinated debentures   261    181    663    533 
Total interest expense   887    647    2,343    1,930 
Net Interest Income   16,907    14,877    47,417    44,613 
Provision for loan losses   -    -    -    - 
Net interest income after provision for loan losses   16,907    14,877    47,417    44,613 
Non-interest income                    
Service charges on deposits   2,686    2,611    7,535    6,880 
Net gains on sale of securities available-for-sale   90    108    212    431 
Other income   2,215    1,542    6,112    5,611 
Total non-interest income   4,991    4,261    13,859    12,922 
Other operating expense                    
Salaries and employee benefits   6,866    5,904    20,355    18,924 
Occupancy and equipment   2,063    1,834    5,680    5,160 
Other   7,192    4,547    17,280    14,412 
Total other operating expense   16,121    12,285    43,315    38,496 
Income before taxes   5,777    6,853    17,961    19,039 
Provision for income taxes   1,848    2,443    5,911    6,335 
Net income  $3,929   $4,410   $12,050   $12,704 
                     
PER SHARE DATA                    
Book value  $15.12   $14.12   $15.12   $14.12 
Cash dividends  $0.12   $0.11   $0.36   $0.31 
Earnings per share basic  $0.28   $0.33   $0.90   $0.94 
Earnings per share diluted  $0.28   $0.33   $0.89   $0.93 
Average shares outstanding, basic   13,790,107    13,358,895    13,446,567    13,531,370 
Average shares outstanding, diluted   13,904,460    13,482,364    13,560,716    13,656,747 
                     
Total shareholder equity (in thousands)  $208,528   $187,052   $208,528   $187,052 
Shares outstanding   13,789,501    13,248,048    13,789,501    13,248,048 
Dividends Paid  $1,666,175   $1,474,639   $4,850,886   $4,205,218 

 

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

 

2 

 

  

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands, unaudited)

 

   Three months ended
September 30,
   Nine months ended
September 30,
 
   2016   2015   2016   2015 
                 
Net Income  $3,929   $4,410   $12,050   $12,704 
Other comprehensive income, before tax:                    
   Unrealized gains on securities:                    
         Unrealized holding (losses) gains arising during period   (674)   1,284    3,813    (1,225)
         Less: reclassification adjustment for gains (1)
         included in net income
   (90)   (108)   (212)   (431)
Other comprehensive (loss) income, before tax   (764)   1,176    3,601    (1,656)
   Income tax expense (benefit) related to items of other                    
         comprehensive income (loss), net of tax   362    (494)   (1,452)   632 
Other comprehensive income (loss) gain   (402)   682    2,149    (1,024)
                     
Comprehensive Income  $3,527   $5,092   $14,199   $11,680 

 

(1)Amounts are included in net gains on investment securities available-for-sale on the Consolidated Statements of Income in non-interest revenue. Income tax expense associated with the reclassification adjustment for the three months ended September 30, 2016 and 2015 was $38 thousand and $45 thousand respectively. Income tax expense associated with the reclassification adjustment for the nine months ended September 30, 2016 and 2015 was $89 thousand and $181 thousand respectively.

 

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

 

3 

 

 

SIERRA BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands, unaudited)

 

   Nine months ended
September 30,
 
   2016   2015 
Cash flows from operating activities:          
     Net income  $12,050   $12,704 
     Adjustments to reconcile net income to net cash          
        provided by operating activities:          
    Gain on sales of securities   (212)   (431)
    Gain on sales of loans   -    (6)
    Loss on disposal of fixed assets   -    62 
    Loss (gain) on sale on foreclosed assets   3    (166)
    Writedowns on foreclosed assets   275    193 
    Share-based compensation expense   180    33 
    Provision for loan losses   -    - 
    Depreciation   1,880    1,694 
    Net accretion on purchased loans   (391)   (634)
    Net amortization on securities premiums and discounts   5,208    5,217 
    Decrease in unearned net loan fees   787    299 
    Increase in cash surrender value of life insurance policies   (51)   (686)
    Proceeds from sale of loans   -    323 
    Increase in loans held-for-sale   -    (317)
    Decrease in interest receivable and other assets   3,593    3,845 
    Increase in other liabilities   (8,995)   (4,730)
    Deferred Income Tax Provision (benefit)   1,998    (1,182)
    Excess tax benefit from equity based compensation   93    92 
          Net cash provided by operating activities   16,418    16,310 
           
Cash flows from investing activities:          
    Maturities of securities available for sale   1,195    580 
    Proceeds from sales/calls of securities available for sale   23,753    24,408 
    Purchases of securities available for sale   (103,334)   (97,899)
    Principal pay downs on securities available for sale   72,463    68,753 
    Purchases of FHLB stock   -    (504)
    Proceeds from redemption of FHLB stock   (960)   - 
    Net increase in loans receivable, net   (31,785)   (84,776)
    Purchases of premises and equipment, net   (4,016)   (2,136)
    Proceeds from sale premises and equipment   1,204    56 
    Proceeds from sales of foreclosed assets   982    1,454 
    Cash acquired in bank acquisition   15,502    - 
          Net cash used in investing activities   (24,996)   (90,064)
           
Cash flows from financing activities:          
    Increase in deposits   40,165    62,419 
    (Decrease) increase in borrowed funds   (8,200)   19,300 
    Increase in Fed funds purchased   2,500    - 
    Decrease (increase) in repurchase agreements   (2,635)   2,864 
    Cash dividends paid   (4,851)   (4,205)
    Repurchases of common stock   (1,723)   (7,956)
    Stock options exercised   234    317 
    Proceeds from issuance of subordinated debt   -    - 
    Excess tax benefit from equity based compensation   (93)   (92)
          Net cash provided by financing activities   25,397    72,647 
           
       Increase (decrease) in cash and due from banks   16,819    (1,107)
           
Cash and cash equivalents          
     Beginning of period   48,623    50,095 
     End of period  $65,442   $48,988 

  

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

 

4 

 

 

Sierra Bancorp

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2016

(Unaudited)

 

Note 1 – The Business of Sierra Bancorp

 

Sierra Bancorp (the “Company”) is a California corporation headquartered in Porterville, California, and is a registered bank holding company under federal banking laws. The Company was formed to serve as the holding company for Bank of the Sierra (the “Bank”), and has been the Bank’s sole shareholder since August 2001. The Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. As of September 30, 2016, the Company’s only other subsidiaries were Sierra Statutory Trust II, Sierra Capital Trust III, and Coast Bancorp Statutory Trust II, which were formed solely to facilitate the issuance of capital trust pass-through securities (“TRUPS”). Pursuant to the Financial Accounting Standards Board (“FASB”) standard on the consolidation of variable interest entities, these trusts are not reflected on a consolidated basis in the Company’s financial statements. References herein to the “Company” include Sierra Bancorp and its consolidated subsidiary, the Bank, unless the context indicates otherwise.

 

Bank of the Sierra is a California state-chartered bank also headquartered in Porterville, California. The Bank was incorporated in September 1977, and opened for business in January 1978 as a one-branch bank with $1.5 million in capital and eleven employees. Our growth in the ensuing years has been largely organic, but also includes three whole-bank acquisitions: Sierra National Bank in the year 2000, Santa Clara Valley Bank in 2014, and Coast National Bank in July of 2016 (see Note 13 to the financial statements, Acquisition, for details on the acquisition of Coast Bancorp [“Coast”], the holding company for Coast National Bank, by Sierra Bancorp). With our latest acquisition the Bank now operates 33 full-service branches and a loan production office, and offers a full range of retail and commercial banking services in California’s South Central Valley and neighboring communities, the Central Coast, and select Southern California locations including Ventura County and the Santa Clarita Valley. Our most recent branching activity occurred in the second quarter of 2016, with the opening of a de novo branch in Sanger, California and the purchase of a competitor bank’s Porterville branch which was consolidated into our main office (see Note 14 to the financial statements, Recent Developments, for details on the branch acquisition). Furthermore, we have received regulatory approvals for another branch in Bakersfield, California, which is under construction and should be ready to commence operations by the first quarter of 2017, as well as a proposed de novo branch in Pismo Beach, California, although the timing for that branch opening remains uncertain. In addition to our stand-alone offices the Bank has specialized lending units which include a real estate industries center, an agricultural credit center, and an SBA lending unit. We also have ATMs at all branch locations and offsite ATMs at six different non-branch locations. We were close to $2.0 billion in total assets as of September 30, 2016, and for the past several years have claimed the distinction of being the largest bank headquartered in the South San Joaquin Valley. The Bank’s deposit accounts are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to maximum insurable amounts.

 

Note 2 – Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of Management, necessary for a fair statement of the results for such periods. Such adjustments can generally be considered as normal and recurring unless otherwise disclosed in this Form 10-Q. In preparing the accompanying financial statements, Management has taken subsequent events into consideration and recognized them where appropriate. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year. Certain amounts reported for 2015 have been reclassified to be consistent with the reporting for 2016. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission (the “SEC”).

 

Note 3 – Current Accounting Developments

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU is the result of a joint project initiated by the FASB and the International Accounting Standards Board (IASB) to clarify the principles for recognizing revenue, and to develop common revenue standards and disclosure requirements that would: (1) remove inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosures; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. The guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required with regard to contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This ASU is effective for annual reporting periods beginning after December 15, 2017, including interim periods therein, with early adoption permitted for reporting periods beginning after December 15, 2016. The Company does not expect to adopt this guidance early and is currently evaluating the potential effects of the guidance on its financial statements and disclosures.

 

5 

 

 

In June 2014 the FASB issued ASU 2014-12, Compensation–Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. These amendments to existing guidance require that a performance target be treated as a “performance condition” if it affects vesting and can be achieved after the requisite service period. To account for such awards, a reporting entity should apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest, and should be adjusted to reflect those awards that ultimately vest. The requisite period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. It was adopted by the Company for the first quarter of 2016, and because our stock compensation practices do not currently utilize performance-based criteria there was no impact upon our financial statements or operations upon adoption.

 

In April 2015 the FASB issued ASU 2015-03, Interest–Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, to simplify the presentation of debt issuance costs related to a recognized debt liability by reflecting those costs as a direct deduction from the carrying amount of debt liability, consistent with debt discounts. ASU 2015-15 was subsequently issued in August 2015 to clarify the SEC staff’s position on presenting and measuring debt issuance costs incurred in connection with line-of-credit arrangements. ASU 2015-03, as modified by ASU 2015-15, became effective for interim and annual periods beginning after December 15, 2015, and we adopted this guidance for the first quarter of 2016 without any material effect on our consolidated financial statements.

 

In January 2016 the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance primarily affects the accounting for equity securities with readily determinable fair values, by requiring that the changes in fair value for such securities will be reflected in earnings rather than in other comprehensive income. The accounting for other financial instruments such as loans, debt securities, and financial liabilities is largely unchanged. ASU 2016-01 also changes the presentation and disclosure requirements for financial instruments, including a requirement that public business entities use exit pricing when estimating fair values for financial instruments measured at amortized cost for disclosure purposes. ASU 2016-01 is generally effective for public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are evaluating the potential effects of this guidance on our financial statements and disclosures, but do not currently expect it to have a material impact upon adoption.

 

In February 2016 the FASB issued ASU 2016-02, Leases (Topic 842). This new standard is being issued to increase the transparency and comparability around lease obligations. Previously unrecorded off-balance sheet obligations will now be brought more prominently to light by presenting lease liabilities on the face of the balance sheet, accompanied by enhanced qualitative and quantitative disclosures in the notes to the financial statements. ASU 2016-02 is generally effective for public business entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the potential impact of this guidance on its financial statements and disclosures.

 

In March 2016 the FASB issued ASU 2016-09, Compensation–Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, as part of its simplification initiative. Currently, as they relate to share-based payments, tax benefits in excess of compensation costs (“windfalls”) are recorded in equity, and tax deficiencies (“shortfalls”) are recorded in equity to the extent of previous windfalls, and then to the income statement. ASU 2016-09 will reduce some of the administrative complexities by eliminating the need to track a windfall “pool,” but could increase the volatility of income tax expense. This change is required to be applied prospectively to all excess tax benefits and tax deficiencies resulting from settlements after the date of adoption. ASU 2016-09 also removes the requirement to delay recognition of a windfall tax benefit until it reduces current taxes payable. Under the new guidance, the benefit will be recorded when it arises, subject to normal valuation allowance considerations. This change is required to be applied on a modified retrospective basis, with a cumulative-effect adjustment to opening retained earnings. Furthermore, all tax-related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the current requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. However, cash paid by an employer when directly withholding shares for tax withholding purposes should be classified as a financing activity. Under the new guidance, entities are also permitted to make an accounting policy election for the impact of forfeitures on expense recognition for share-based payment awards. Forfeitures can be estimated in advance, as required today, or recognized as they occur. Estimates will still be required in certain circumstances, such as at the time of modification of an award or issuance of a replacement award in a business combination. If elected, the change to recognize forfeitures when they occur needs to be adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to opening retained earnings. ASU 2016-09 is effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. We are currently evaluating the potential impact of this guidance on our financial statements and disclosures.

 

6 

 

 

In June 2016 the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which eliminates the probable initial recognition threshold for credit losses in current U.S. GAAP, and instead requires an organization to record a current estimate of all expected credit losses over the contractual term for financial assets carried at amortized cost. This is commonly referred to as the current expected credit losses (“CECL”) methodology. Expected credit losses for financial assets held at the reporting date will be measured based on historical experience, current conditions, and reasonable and supportable forecasts. Another change from existing U.S. GAAP involves the treatment of purchased credit deteriorated assets, which are more broadly defined than purchased credit impaired assets in current accounting standards. When such assets are purchased, institutions will estimate and record an allowance for credit losses that is added to the purchase price rather than being reported as a credit loss expense. Furthermore, ASU 2016-13 updates the measurement of credit losses on available-for-sale debt securities, by mandating that institutions record credit losses on available-for-sale debt securities through an allowance for credit losses rather than the current practice of writing down securities for other-than-temporary impairment. ASU 2016-13 will also require the enhancement of financial statement disclosures regarding estimates used in calculating credit losses. ASU 2016-13 does not change the existing write-off principle in U.S. GAAP or current nonaccrual practices, nor does it change accounting requirements for loans held for sale or certain other financial assets which are measured at the lower of amortized cost or fair value. As a public business entity that is an SEC filer, ASU 2016-13 becomes effective for the Company on January 1, 2020, although early application is permitted for 2019. On the effective date, institutions will apply the new accounting standard as follows: for financial assets carried at amortized cost, a cumulative-effect adjustment will be recognized on the balance sheet for any change in the related allowance for loan and lease losses generated by the adoption of the new standard; financial assets classified as purchased credit impaired assets prior to the effective date will be reclassified as purchased credit deteriorated assets as of the effective date, and will be grossed up for the related allowance for expected credit losses created as of the effective date; and, debt securities on which other-than-temporary impairment had been recognized prior to the effective date will transition to the new guidance prospectively with no change in their amortized cost basis. We are currently evaluating the potential impact of this guidance on our financial statements and disclosures, and in general expect an increase in our allowance for loan and lease losses upon adoption.

 

Note 4 – Supplemental Disclosure of Cash Flow Information

 

During the nine months ended September 30, 2016 and 2015, cash paid for interest due on interest-bearing liabilities was $2.341 million and $1.957 million, respectively. There was $2.890 million in cash paid for income taxes during the nine months ended September 30, 2016, and $6.390 million in cash paid for income taxes for the nine months ended September 30, 2015. Assets totaling $847,000 and $1.004 million were acquired in settlement of loans for the nine months ended September 30, 2016 and September 30, 2015, respectively. We received $982,000 in cash from the sale of foreclosed assets during the first nine months of 2016 relative to $1.454 million during the first nine months of 2015, which represents sales proceeds less loans (if any) extended to finance such sales.

 

Cash flow information relative to the Coast acquisition is disclosed in the following table:

 

   Nine months ended
September 30,
 
   2016   2015 
Assets acquired (liabilities assumed and capital created) in acquisition (see note 13):  (dollars in thousands, unaudited) 
      Cash and cash equivalents  $18,931   $- 
      Securities  $23,363   $- 
      Loans  $94,264   $- 
      Premises and equipment  $5,844   $- 
      Core deposit intangibles  $1,827   $- 
      Goodwill  $1,024   $- 
      Deferred tax asset  $326   $- 
      Other assets  $3,571   $- 
      Deposits  $(129,038)  $- 
      Other liabilities  $(705)  $- 
      Borrowings  $(2,500)  $- 
      TRUPS  $(3,422)  $- 
      Common Stock  $(10,205)  $- 

 

Note 5 – Share Based Compensation

 

The 2007 Stock Incentive Plan (the “2007 Plan”) was adopted by the Company in 2007. Our 1998 Stock Option Plan was concurrently terminated, although options to purchase 28,500 shares that were granted under that plan were still outstanding as of September 30, 2016 and remain unaffected by the plan’s termination. The 2007 Plan provides for the issuance of both “incentive” and “nonqualified” stock options to officers and employees, and of “nonqualified” stock options to non-employee directors of the Company. The 2007 Plan also provides for the issuance of restricted stock awards to these same classes of eligible participants, on such terms and conditions as are established at the discretion of the Board of Directors or the Compensation Committee, although no restricted stock awards have been issued by the Company. The total number of shares of the Company’s authorized but unissued stock reserved for issuance pursuant to awards under the 2007 Plan was initially 1,500,000 shares, although due to awards granted since the inception of the plan the number remaining available for grant had declined to 748,420 at September 30, 2016. No equity awards can be issued under the 2007 Plan on or after March 15, 2017, when the plan expires, but any award granted under the plan prior to March 15, 2017 had, or will have, an original life of 10 years and thus may extend beyond that date. The dilutive impact of stock options outstanding is discussed below in Note 6, Earnings per Share.

 

7 

 

 

Pursuant to FASB’s standards on stock compensation, the value of each stock option granted is reflected in our income statement as employee compensation or directors’ expense by amortizing the value over the vesting period for options with graded vesting, or by expensing it as of the grant date for immediately vested options. The Company is utilizing the Black-Scholes model to value stock options, and the “multiple option” approach is used to allocate the resulting valuation to actual expense. Under the multiple option approach an employee’s options for each vesting period are separately valued and amortized, which appears to be the preferred method for option grants with graded vesting. A pre-tax charge of $11,000 was reflected in the Company’s income statement during the third quarter of 2016 and $14,000 was charged during the third quarter of 2015, as expense related to stock options. For the first nine months, the charges totaled $180,000 in 2016 and $33,000 in 2015.

 

Note 6 – Earnings per Share

 

The computation of earnings per share, as presented in the Consolidated Statements of Income, is based on the weighted average number of shares outstanding during each period. There were 13,790,107 weighted average shares outstanding during the third quarter of 2016, and 13,358,895 during the third quarter of 2015. There were 13,446,567 weighted average shares outstanding during the first nine months of 2016, and 13,531,370 during the first nine months of 2015.

 

Diluted earnings per share include the effect of the potential issuance of common shares, which for the Company is limited to shares that would be issued on the exercise of “in-the-money” stock options. For the third quarter of 2016, calculations under the treasury stock method resulted in the equivalent of 114,353 shares being added to basic weighted average shares outstanding for purposes of determining diluted earnings per share, while a weighted average of 146,900 stock options were excluded from the calculation because they were underwater and thus anti-dilutive. For the third quarter of 2015 the equivalent of 123,469 shares were added in calculating diluted earnings per share while 169,300 anti-dilutive stock options were excluded. Likewise, for the first nine months of 2016 the equivalent of 114,149 shares were added to basic weighted average shares outstanding in calculating diluted earnings per share and a weighted average of 196,900 stock options that were anti-dilutive for the period were excluded, compared to the inclusion of the equivalent of 125,377 shares and exclusion of 171,700 anti-dilutive options in calculating diluted earnings per share for first nine months of 2015.

 

Note 7 – Comprehensive Income

 

As presented in the Consolidated Statements of Comprehensive Income, comprehensive income includes net income and other comprehensive income. The Company’s only source of other comprehensive income is unrealized gains and losses on available-for-sale investment securities. Gains or losses on investment securities that were realized and reflected in net income of the current period, which had previously been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose, are considered to be reclassification adjustments that are excluded from other comprehensive income in the current period.

 

Note 8 – Financial Instruments with Off-Balance-Sheet Risk

 

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business. Those financial instruments currently consist of unused commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by counterparties for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as it does for originating loans included on the balance sheet. The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):

 

   September 30, 2016   December 31, 2015 
Commitments to extend credit  $399,273   $354,890 
Standby letters of credit  $8,456   $16,654 

 

Commitments to extend credit consist primarily of the unused or unfunded portions of the following: home equity lines of credit; commercial real estate construction loans, where disbursements are made over the course of construction; commercial revolving lines of credit; mortgage warehouse lines of credit; unsecured personal lines of credit; and formalized (disclosed) deposit account overdraft lines. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn upon, the unused portions of committed amounts do not necessarily represent future cash requirements. Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party, and the credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers.

 

At September 30, 2016, the Company was also utilizing a letter of credit in the amount of $97 million issued by the Federal Home Loan Bank on the Company’s behalf as security for certain deposits and to facilitate certain credit arrangements with the Company’s customers. That letter of credit is backed by loans which are pledged to the FHLB by the Company.

 

8 

 

 

Note 9 – Fair Value Disclosures and Reporting, the Fair Value Option and Fair Value Measurements

 

FASB’s standards on financial instruments, and on fair value measurements and disclosures, require all entities to disclose in their financial statement footnotes the estimated fair values of financial instruments for which it is practicable to estimate fair values. In addition to disclosure requirements, FASB’s standard on investments requires that our debt securities which are classified as available for sale and our equity securities that have readily determinable fair values be measured and reported at fair value in our statement of financial position. Certain impaired loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value. FASB’s standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, but we have not elected the fair value option for any of those financial instruments.

 

Fair value measurement and disclosure standards also establish a framework for measuring fair values. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. Further, the standards establish a fair value hierarchy that encourages an entity to maximize the use of observable inputs and limit the use of unobservable inputs when measuring fair values. The standards describe three levels of inputs that may be used to measure fair values:

 

·Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
·Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.
·Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the factors that market participants would likely consider in pricing an asset or liability.

 

Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments. The estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to realized gains and losses could have a significant effect on fair value estimates but have not been considered in those estimates. Because no active market exists for a significant portion of our financial instruments, fair value disclosures are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. The estimates are subjective and involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly alter the fair values presented. The following methods and assumptions were used by the Company to estimate its financial instrument fair values disclosed at September 30, 2016 and December 31, 2015:

 

·Cash and cash equivalents and fed funds sold: The carrying amount is estimated to be fair value.
·Investment securities: Fair values are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities when quoted prices for specific securities are not readily available.
·Loans and leases: For variable-rate loans and leases that re-price frequently with no significant change in credit risk or interest rate spread, fair values are based on carrying values. Fair values for other loans and leases are estimated by discounting projected cash flows at interest rates being offered at each reporting date for loans and leases with similar terms, to borrowers of comparable creditworthiness. The carrying amount of accrued interest receivable approximates its fair value.
·Loans held for sale: Since loans designated by the Company as available-for-sale are typically sold shortly after making the decision to sell them, realized gains or losses are usually recognized within the same period and fluctuations in fair values are not relevant for reporting purposes. If available-for-sale loans are on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.
·Collateral-dependent impaired loans: Collateral-dependent impaired loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable.
·Cash surrender value of life insurance policies: Fair values are based on net cash surrender values at each reporting date.
·Investments in, and capital commitments to, limited partnerships: The fair values of our limited partner investments in low-income housing tax credit funds and other limited partnership investments are estimated using quarterly indications of value provided by the general partners. The fair values of undisbursed capital commitments are assumed to be the same as their book values.
·Other investments: Certain investments for which no secondary market exists are carried at cost and the carrying amount for those investments typically approximates their estimated fair value, unless an impairment analysis indicates the need for adjustments.
·Deposits: Fair values for non-maturity deposits are equal to the amount payable on demand at the reporting date, which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a cash flow analysis, discounted at interest rates being offered at each reporting date by the Bank for certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.
·Short-term borrowings: Current carrying amounts are used as an approximation of fair values for federal funds purchased, overnight advances from the Federal Home Loan Bank (“FHLB”), borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days of the reporting dates. Fair values of other short-term borrowings are estimated by discounting projected cash flows at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
·Long-term borrowings: Fair values are estimated using projected cash flows discounted at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
·Subordinated debentures: Fair values are determined based on the current market value for like instruments of a similar maturity and structure.
·Commitments to extend credit and letters of credit: If funded, the carrying amounts for currently unused commitments would provide an equivalent measure of fair values for the newly created financial assets at the funding date. However, because of the high degree of uncertainty with regard to whether or not those commitments will ultimately be funded, fair values for loan commitments and letters of credit in their current undisbursed state cannot reasonably be estimated, and only notional values are disclosed in the table below.

 

9 

 

 

Estimated fair values for the Company’s financial instruments are as follows, as of the dates noted:

 

Fair Value of Financial Instruments

(dollars in thousands, unaudited)

 

  September 30, 2016 
       Estimated Fair Value 
   Carrying
Amount
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable Inputs
(Level 2)
   Significant
Unobservable Inputs
(Level 3)
   Total 
Financial assets:                         
Cash and cash equivalents  $65,442   $65,537   $-   $-   $65,537 
Investment securities available for sale   535,580    1,129    534,451    -    535,580 
Loans and leases, net held for investment   1,249,241    -    1,271,560    -    1,271,560 
Collateral dependent impaired loans   165    -    165    -    165 
Cash surrender value of life insurance policies   44,191    -    44,191    -    44,191 
Other investments   8,506    -    8,506    -    8,506 
Investment in limited partnership   8,338    -    8,338    -    8,338 
Accrued interest receivable   5,918    -    5,918    -    5,918 
                          
Financial liabilities:                         
Deposits:                         
   Noninterest-bearing  $498,391   $498,391   $-   $-   $498,391 
   Interest-bearing   1,135,440    -    1,135,685    -    1,135,685 
Fed funds purchased and
   repurchase agreements
   9,270    -    9,270    -    9,270 
Short-term borrowings   71,600    -    71,600    -    71,600 
Long-term borrowings   -    -    -    -    - 
Subordinated debentures   34,365    -    23,288    -    23,288 
Limited partnership capital commitment   2,751    -    2,751    -    2,751 
Accrued interest payable   97    -    97    -    97 

 

   Notional Amount 
Off-balance-sheet financial instruments:     
Commitments to extend credit  $399,273 
Standby letters of credit   8,456 

 

   December 31, 2015 
       Estimated Fair Value 
   Carrying
Amount
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Observable Inputs
(Level 2)
   Significant
Unobservable Inputs
(Level 3)
   Total 
Financial assets:                         
Cash and cash equivalents  $48,623   $48,623   $-   $-   $48,623 
Investment securities available for sale   507,582    1,296    506,286    -    507,582 
Loans and leases, net held for investment   1,120,773    -    1,136,386    -    1,136,386 
Collateral dependent impaired loans   3,829    -    3,829    -    3,829 
Cash surrender value of life insurance policies   44,140    -    44,140    -    44,140 
Other Investments   7,546    -    7,546    -    7,546 
Investment in limited partnership   6,217    -    6,217    -    6,217 
Accrued interest receivable   5,808    -    5,808    -    5,808 
                          
Financial liabilities:                         
Deposits:                         
   Noninterest-bearing  $432,251   $432,251   $-   $-   $432,251 
   Interest-bearing   1,032,377    -    1,032,547    -    1,032,547 
Fed funds purchased and
   repurchase agreements
   9,405    -    9,405    -    9,405 
Short-term borrowings   75,300    -    75,300    -    75,300 
Long-term borrowings   2,000    -    2,001    -    2,001 
Subordinated debentures   30,928    -    7,383    -    7,383 
Limited partnership capital commitment   795    -    795    -    795 
Accrued interest payable   116    -    116    -    116 

 

   Notional Amount 
Off-balance-sheet financial instruments:     
Commitments to extend credit  $354,890 
Standby letters of credit   16,654 

 

10 

 

 

For financial asset categories that were actually reported at fair value as of September 30, 2016 and December 31, 2015, the Company used the following methods and significant assumptions:

 

·Investment securities: Fair values are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities.
·Collateral-dependent impaired loans: Collateral-dependent impaired loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable.
·Foreclosed assets: Repossessed real estate (known as other real estate owned, or “OREO”) and other foreclosed assets are carried at the lower of cost or fair value. Fair value is the appraised value less expected selling costs for OREO and some other assets such as mobile homes, and fair values for any other foreclosed assets are represented by estimated sales proceeds as determined using reasonably available sources. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Fair values for other foreclosed assets are adjusted as necessary, subsequent to a periodic re-evaluation of expected cash flows and the timing of resolution. If impairment is determined to exist, the book value of a foreclosed asset is immediately written down to its estimated impaired value through the income statement, thus the carrying amount is equal to the fair value and there is no valuation allowance.

 

Assets reported at fair value on a recurring basis are summarized below:

 

Fair Value Measurements - Recurring

(dollars in thousands, unaudited)                

 

   Fair Value Measurements at September 30, 2016, using     
                     
   Quoted Prices in Active Markets for
Identical Assets (Level 1)
   Significant Observable Inputs
(Level 2)
   Significant Unobservable Inputs
(Level 3)
   Total   Realized Gain/(Loss) 
Investment securities                         
US Government agencies  $-   $24,811   $-   $24,811   $- 
Mortgage-backed securities   -    396,029    -    396,029    - 
State and political subdivisions   -    113,611    -    113,611    - 
Other securities   1,129    -    -    1,129    - 
                          
Total available-for-sale securities  $1,129   $534,451   $-   $535,580   $- 

 

   Fair Value Measurements at December 31, 2015, using     
                     
   Quoted Prices in Active Markets for
Identical Assets (Level 1)
   Significant Observable Inputs
(Level 2)
   Significant Unobservable Inputs
(Level 3)
   Total   Realized Gain/(Loss) 
Investment securities                         
US Government agencies  $-   $29,042   $-   $29,042   $- 
Mortgage-backed securities   -    375,061    -    375,061    - 
State and political subdivisions   -    102,183    -    102,183    - 
Other securities   1,296    -    -    1,296    - 
                          
Total available-for-sale securities  $1,296   $506,286   $-   $507,582   $- 

 

11 

 

 

Assets reported at fair value on a nonrecurring basis are summarized below:

 

Fair Value Measurements - Nonrecurring

(dollars in thousands, unaudited)              

 

   Fair Value Measurements at September 30, 2016, using 
                 
   Quoted Prices in Active Markets for
Identical Assets (Level 1)
   Significant Observable Inputs
(Level 2)
   Significant Unobservable Inputs
(Level 3)
   Total 
Impaired loans                    
      Real Estate:                    
        1-4 family residential construction  $-   $-   $-   $- 
        Other construction/land   -    70    -    70 
        1-4 family - closed-end   -    -    -    - 
        Equity lines   -    -    -    - 
        Multi-family residential   -    -    -    - 
        Commercial real estate - owner occupied   -    -    -    - 
        Commercial real estate - non-owner occupied   -    69    -    69 
        Farmland   -    -    -    - 
           Total real estate   -    139    -    139 
      Agriculture   -    -    -    - 
      Commercial and industrial   -    -    -    - 
      Consumer loans   -    26    -    26 
Total impaired loans   -    165    -    165 
Foreclosed assets  $-   $2,782   $-   $2,782 
      Total assets measured on a nonrecurring basis  $-   $2,947   $-   $2,947 

 

   Fair Value Measurements at December 31, 2015, using 
                 
   Quoted Prices in Active Markets for
Identical Assets (Level 1)
   Significant Observable Inputs
(Level 2)
   Significant Unobservable Inputs
(Level 3)
   Total 
Impaired loans                    
      Real Estate:                    
        1-4 family residential construction  $-   $-   $-   $- 
        Other construction/land   -    179    -    179 
        1-4 family - closed-end   -    499    -    499 
        Equity lines   -    30    -    30 
        Multi-family residential   -    -    -    - 
        Commercial real estate - owner occupied   -    26    -    26 
        Commercial real estate - non-owner occupied   -    3,053    -    3,053 
        Farmland   -    -    -    - 
           Total real estate   -    3,787    -    3,787 
      Agriculture   -    0    -    - 
      Commercial and industrial   -    0    -    - 
      Consumer loans   -    43    -    43 
Total impaired loans   -   $3,830    -    3,830 
Foreclosed assets  $-   $3,193   $-   $3,193 
      Total assets measured on a nonrecurring basis  $-   $7,023   $-   $7,023 

 

The table above includes collateral-dependent impaired loan balances for which a specific reserve has been established or on which a write-down has been taken. Information on the Company’s total impaired loan balances and specific loss reserves associated with those balances is included in Note 11 below, and in Management’s Discussion and Analysis of Financial Condition and Results of Operation in the “Nonperforming Assets” and “Allowance for Loan and Lease Losses” sections.

 

The unobservable inputs are based on Management’s best estimates of appropriate discounts in arriving at fair market value. Increases or decreases in any of those inputs could result in a significantly lower or higher fair value measurement. For example, an increase or decrease in actual loss rates would create a directionally opposite change in the fair value of unsecured impaired loans.

 

12 

 

 

Note 10 – Investments

 

Investment Securities

 

Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. Pursuant to FASB’s guidance on accounting for debt and equity securities, available for sale securities are carried on the Company’s financial statements at their estimated fair market values, with monthly tax-effected “mark-to-market” adjustments made vis-à-vis accumulated other comprehensive income in shareholders’ equity.

  

Amortized Cost And Estimated Fair Value

 

The amortized cost and estimated fair value of investment securities available-for-sale are as follows (dollars in thousands, unaudited):

 

   September 30, 2016 
   Amortized Cost   Gross Unrealized Gains   Gross Unrealized Losses   Estimated Fair Value 
                 
                 
                 
US Government agencies  $24,555   $277   $(21)  $24,811 
Mortgage-backed securities   392,831    3,957    (759)   396,029 
State and political subdivisions   109,663    4,027    (79)   113,611 
Other securities   500    629    -    1,129 
     Total investment securities  $527,549   $8,890   $(859)  $535,580 

 

   December 31, 2015 
   Amortized Cost   Gross Unrealized Gains   Gross Unrealized Losses   Estimated Fair Value 
                 
                 
                 
US Government agencies  $28,801   $303   $(62)  $29,042 
Mortgage-backed securities   374,683    2,440    (2,062)   375,061 
State and political subdivisions   99,093    3,146    (56)   102,183 
Other securities   575    721    -    1,296 
     Total investment securities  $503,152   $6,610   $(2,180)  $507,582 

  

13 

 

 

At September 30, 2016 and December 31, 2015, the Company had 120 securities and 175 securities, respectively, with unrealized losses. Management has evaluated those securities as of the respective dates, and does not believe that any of the unrealized losses are other than temporary. Gross unrealized losses on our investment securities as of the indicated dates are disclosed in the table below, categorized by investment type and by the duration of time that loss positions on individual securities have continuously existed (over or under twelve months).

 

Investment Portfolio - Unrealized Losses

(dollars in thousands, unaudited)

 

   September 30, 2016 
   Less than twelve months   Twelve months or more 
   Gross
Unrealized
Losses
   Fair Value   Gross
Unrealized
Losses
   Fair Value 
                 
US Government agencies  $(21)  $8,791   $-   $- 
Mortgage-backed securities   (403)   75,402    (356)   48,182 
State and political subdivisions   (79)   7,794    -    - 
    Total  $(503)  $91,987   $(356)  $48,182 

  

   December 31, 2015 
   Less than twelve months   Twelve months or more 
         
US Government agencies  $(62)  $10,329   $-   $- 
Mortgage-backed securities   (1,608)   187,734    (454)   35,511 
State and political subdivisions   (17)   3,409    (39)   3,847 
    Total  $(1,687)  $201,472   $(493)  $39,358 

 

The table below summarizes the Company’s gross realized gains and losses as well as gross proceeds from the sales of securities, for the periods indicated:

 

Investment Portfolio - Realized Gains/(Losses)

(dollars in thousands, unaudited)              

 

   Three months ended
September 30,
   Nine months ended
September 30,
 
   2016   2015   2016   2015 
Proceeds from sales, calls and maturities                    
    of securities available for sale  $19,723   $198   $24,948   $24,988 
Gross gains on sales, calls and maturities                    
   of securities available for sale  $90   $108   $250   $630 
Gross losses on sales, calls and maturities                    
   of securities available for sale   -    -    (38)   (199)
Net gains on sale of securities available for sale  $90   $108   $212   $431 

 

14 

 

 

The amortized cost and estimated fair value of investment securities available-for-sale at September 30, 2016 and December 31, 2015 are shown below, grouped by the remaining time to contractual maturity dates. The expected life of investment securities may not be consistent with contractual maturity dates, since the issuers of the securities could have the right to call or prepay obligations with or without penalties.

 

Estimated Fair Value of Contractual Maturities

(dollars in thousands, unaudited)

 

   September 30, 2016 
   Amortized Cost   Fair Value 
         
Maturing within one year  $5,997   $6,123 
Maturing after one year through five years   262,158    265,993 
Maturing after five years through ten years   42,306    43,665 
Maturing after ten years   49,086    50,579 
           
Investment securities not due at a single maturity date:          
          U.S Government agencies collateralized by          
          mortgage obligations   167,502    168,091 
          Other securities   500    1,129 
   $527,549   $535,580 

 

   December 31, 2015 
   Amortized Cost   Fair Value 
         
Maturing within one year  $3,657   $3,706 
Maturing after one year through five years   242,719    244,733 
Maturing after five years through ten years   50,144    51,308 
Maturing after ten years   50,413    51,671 
           
Investment securities not due at a single maturity date:          
          U.S Government agencies collateralized by          
          mortgage obligations   155,644    154,868 
          Other securities   575    1,296 
   $503,152   $507,582 

 

At September 30, 2016, the Company’s investment portfolio included securities issued by 314 different government municipalities and agencies located within 32 states with a fair value of $113.6 million. The largest exposure to any single municipality or agency was a $926,000 (fair value) bond issued by the Northern Inyo County Hospital District in California, to be repaid by property taxes.

 

The Company’s investments in bonds issued by states, municipalities and political subdivisions are evaluated in accordance with Supervision and Regulation Letter 12-15 issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Organization Ratings,” and other regulatory guidance. Credit ratings are considered in our analysis only as a guide to the historical default rate associated with similarly-rated bonds. There have been no significant differences in our internal analyses compared with the ratings assigned by the third party credit rating agencies.

 

15 

 

 

The following table summarizes the amortized cost and fair values of general obligation and revenue bonds in the Company’s investment securities portfolio at the indicated dates, identifying the state in which the issuing municipality or agency operates for our largest geographic concentrations:

 

Revenue and General Obligation Bonds by Location

(dollars in thousands, unaudited)

 

  September 30, 2016   December 31, 2015 
             
    Amortized     Fair Market    Amortized     Fair Market  
General obligation bonds   Cost    Value    Cost    Value 
State of issuance                    
California  $23,109   $23,384   $20,473   $21,642 
Texas   19,977    20,493    16,575    16,954 
Illinois   10,216    10,511    9,997    10,191 
Ohio   9,041    9,287    7,610    7,748 
Washington   6,009    6,213    5,905    6,081 
Arizona   1,801    1,870    2,039    2,108 
Utah   950    1,002    953    990 
Other states   19,533    21,198    20,334    20,848 
Total General Obligation Bonds   90,636    93,958    83,886    86,562 
                     
Revenue bonds                    
State of issuance                    
Texas   5,744    5,913    3,732    3,863 
Utah   4,852    5,024    4,434    4,519 
Washington   1,304    1,374    1,791    1,827 
California   1,256    1,291    1,002    1,028 
Ohio   317    318    318    319 
Other states   5,554    5,733    3,930    4,065 
Total Revenue Bonds   19,027    19,653    15,207    15,621 
                     
                     
Total Obligations of States                    
     and Political Subdivisions  $109,663   $113,611   $99,093   $102,183 

 

The revenue bonds in the Company’s investment securities portfolios were issued by government municipalities and agencies to fund public services such as utilities (water, sewer, and power), educational facilities, and general public and economic improvements. The primary sources of revenue for these bonds are delineated in the table below, which shows the amortized cost and fair market values for the largest revenue concentrations as of the indicated dates.

 

Revenue Bonds by Type

(dollars in thousands, unaudited)

 

   September 30, 2016   December 31, 2015 
         
    Amortized     Fair Market    Amortized     Fair Market 
Revenue bonds   Cost    Value    Cost    Value 
Revenue source:                    
Water  $4,269   $4,387   $3,942   $4,052 
College & University   3,411    3,575    2,975    3,103 
Sales Tax   2,987    3,084    2,630    2,663 
Lease   2,495    2,563    2,040    2,100 
Electric & Power   942    958    679    691 
Other sources   4,923    5,086    2,941    3,012 
Total Revenue Bonds  $19,027   $19,653   $15,207   $15,621 

 

16 

 

 

Low-Income Housing Tax Credit (“LIHTC”) Fund Investments

 

The Company has the ability to invest in limited partnerships which own housing projects that qualify for federal and/or California state tax credits, by mandating a specified percentage of low-income tenants for each project. The tax credits flow through to investors, supplementing any returns that might be derived from an increase in property values. Because rent levels are lower than standard market rents and the projects are generally highly leveraged, each project also typically generates tax-deductible operating losses that are allocated to the limited partners.

 

The Company invested in seven LIHTC fund limited partnerships from 2001 through 2007, and in the second quarter of 2016 we committed $3 million to another such fund. Our investments to date have all been in California-focused funds which help the Company meet its obligations under the Community Reinvestment Act. We utilize the equity method of accounting for our LIHTC fund investments. Under the equity method, our balance sheet initially reflects an asset that represents the total cash expected to be invested over the life of the partnership. Any commitments or contingent commitments for future investment are reflected as a liability. The income statement treatment under the equity method reflects tax credits received by the Company “below the line” within the income tax provision, while fund operating results are included “above the line” in non-interest income. As noted above, operating results are typically losses that are netted against non-interest income.

 

As of September 30, 2016 our total LIHTC investment balance was $7.1 million, which includes $2.1 million in remaining commitments for additional capital contributions to the limited partnerships. There were $515,000 in tax credits derived from our LIHTC investments that were recognized during the nine months ended September 30, 2016, and a pass-through operating loss of $788,000 associated with those investments was included in pre-tax income for the same time period. Our LIHTC investments are evaluated annually for potential impairment, and we have concluded that the carrying value of the investments is stated fairly and is not impaired.

 

Note 11 – Credit Quality and Nonperforming Assets

 

Credit Quality Classifications

 

The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention, substandard and impaired to characterize the associated credit risk. Balances classified as “loss” are immediately charged off. The Company conforms to the following definitions for risk classifications utilized:

 

·Pass: Larger non-homogeneous loans not meeting the risk rating definitions below, and smaller homogeneous loans that are not assessed on an individual basis.
·Special mention: Loans which have potential issues that deserve the close attention of Management. If left uncorrected, those potential weaknesses could eventually diminish the prospects for full repayment of principal and interest according to the contractual terms of the loan agreement, or could result in deterioration of the Company’s credit position at some future date.
·Substandard: Loans that have at least one clear and well-defined weakness that could jeopardize the ultimate recoverability of all principal and interest, such as a borrower displaying a highly leveraged position, unfavorable financial operating results and/or trends, uncertain repayment sources or a deteriorated financial condition.
·Impaired: A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include all nonperforming loans and restructured troubled debt (“TDRs”). A TDR may be nonperforming or performing, depending on its accrual status and the demonstrated ability of the borrower to comply with restructured terms (see “Troubled Debt Restructurings” section below for additional information on TDRs).

 

17 

 

 

Credit quality classifications for the Company’s loan balances were as follows, as of the dates indicated:

 

Credit Quality Classifications

(dollars in thousands, unaudited)                    

 

   September 30, 2016 
   Pass   Special Mention   Substandard   Impaired   Total 
             
Real Estate:                         
     1-4 family residential construction  $31,239   $-   $-   $-   $31,239 
     Other construction/land   24,292    5,575    -    1,102    30,969 
     1-4 family - closed end   129,265    636    418    6,686    137,005 
     Equity lines   35,387    1,658    698    4,006    41,749 
     Multi-family residential   29,881    -    -    413    30,294 
     Commercial real estate - owner occupied   238,739    4,144    3,000    2,504    248,387 
     Commercial real estate - non-owner occupied   209,662    4,798    3,242    1,820    219,522 
     Farmland   131,746    1,039    2,846    295    135,926 
             Total real estate   830,211    17,850    10,204    16,826    875,091 
                          
Agricultural   51,826    725    -    89    52,640 
Commercial and industrial   108,296    19,294    351    2,146    130,087 
Mortgage Warehouse   185,865    -    -    -    185,865 
Consumer loans   10,588    277    34    1,748    12,647 
Total gross loans and leases  $1,186,786   $38,146   $10,589   $20,809   $1,256,330 

 

   December 31, 2015 
   Pass   Special Mention   Substandard   Impaired   Total 
             
Real Estate:                         
     1-4 family residential construction  $13,784   $1,157   $-   $-   $14,941 
     Other construction/land   35,901    135    -    1,323    37,359 
     1-4 family - closed end   127,972    2,498    387    6,499    137,356 
     Equity lines   39,966    199    957    3,111    44,233 
     Multi-family residential   26,178    -    -    1,044    27,222 
     Commercial real estate - owner occupied   196,211    12,075    7,322    3,100    218,708 
     Commercial real estate - non-owner occupied   155,223    4,505    170    5,209    165,107 
     Farmland   130,285    1,563    724    610    133,182 
             Total real estate   725,520    22,132    9,560    20,896    778,108 
                          
Agricultural   46,197    40    -    -    46,237 
Commercial and industrial   108,931    933    755    2,588    113,207 
Mortgage Warehouse   180,355    -    -    -    180,355 
Consumer loans   12,718    178    16    2,037    14,949 
Total gross loans and leases  $1,073,721   $23,283   $10,331   $25,521   $1,132,856 

 

 

18 

 

 

Past Due and Nonperforming Assets

 

Nonperforming assets are comprised of loans for which the Company is no longer accruing interest, and foreclosed assets, including mobile homes and OREO. OREO consists of real properties acquired by foreclosure or similar means, which the Company is offering or will offer for sale. Nonperforming loans and leases result when reasonable doubt surfaces with regard to the ability of the Company to collect all principal and interest. At that point, we stop accruing interest on the loan or lease in question and reverse any previously-recognized interest to the extent that it is uncollected or associated with interest-reserve loans. Any asset for which principal or interest has been in default for 90 days or more is also placed on non-accrual status even if interest is still being received, unless the asset is both well secured and in the process of collection. An aging of the Company’s loan balances is presented in the following tables, by number of days past due as of the indicated dates:

 

Loan Portfolio Aging

(dollars in thousands, unaudited)                          

 

   September 30, 2016 
   30-59 Days Past Due   60-89 Days Past Due   90 Days Or More Past Due(1)   Total Past Due   Current   Total Financing Receivables   Non-Accrual Loans(2) 
                 
Real Estate:                                   
     1-4 family residential construction  $-   $-   $-   $-   $31,239   $31,239   $- 
     Other construction/land   -    -    427    427    30,542    30,969    590 
     1-4 family - closed end   59    540    -    599    136,406    137,005    975 
     Equity lines   142    45    365    552    41,197    41,749    1,898 
     Multi-family residential   -    -    -    -    30,294    30,294    - 
     Commercial real estate - owner occupied   396    35    -    431    247,956    248,387    1,485 
     Commercial real estate - non-owner occupied   -    -    -    -    219,522    219,522    69 
     Farmland   -    -    -    -    135,926    135,926    295 
             Total real estate   597    620    792    2,009    873,082    875,091    5,312 
                                    
Agricultural   -    24    65    89    52,551    52,640    89 
Commercial and industrial   862    73    63    998    129,089    130,087    438 
Mortgage warehouse lines   -    -    -    -    185,865    185,865    - 
Consumer   225    28    -    253    12,394    12,647    446 
Total gross loans and leases  $1,684   $745   $920   $3,349   $1,252,981   $1,256,330   $6,285 

 

(1)As of September 30, 2016 there were no loans over 90 days past due and still accruing.
(2)Included in total financing receivables

 

   December 31, 2015 
   30-59 Days Past Due   60-89 Days Past Due   90 Days Or More Past Due(1)   Total Past Due   Current   Total Financing Receivables   Non-Accrual Loans(2) 
                 
Real Estate:                                   
     1-4 family residential construction  $612   $545   $-   $1,157   $13,784   $14,941   $- 
     Other construction/land   18    129    63    210    37,149    37,359    457 
     1-4 family - closed end   1,065    917    566    2,548    134,808    137,356    2,298 
     Equity lines   199    247    484    930    43,303    44,233    1,770 
     Multi-family residential   -    630    -    630    26,592    27,222    630 
     Commercial real estate - owner occupied   232    129    260    621    218,087    218,708    2,325 
     Commercial real estate - non-owner occupied   -    -    -    -    165,107    165,107    262 
     Farmland   -    -    -    -    133,182    133,182    610 
             Total real estate   2,126    2,597    1,373    6,096    772,012    778,108    8,352 
                                    
Agricultural   -    -    -    -    46,237    46,237    - 
Commercial and industrial   127    153    86    366    112,841    113,207    710 
Mortgage warehouse lines   -    -    -    -    180,355    180,355    - 
Consumer   98    9    45    152    14,797    14,949    572 
Total gross loans and leases  $2,351   $2,759   $1,504   $6,614   $1,126,242   $1,132,856   $9,634 

 

(1)As of December 31, 2015 there were no loans over 90 days past due and still accruing.
(2)Included in total financing receivables

19 

 

 

Troubled Debt Restructurings

 

A loan that is modified for a borrower who is experiencing financial difficulty is classified as a troubled debt restructuring if the modification constitutes a concession. At September 30, 2016, the Company had a total of $17.4 million in TDRs, including $2.9 million in TDRs that were on non-accrual status. Generally, a non-accrual loan that has been modified as a TDR remains on non-accrual status for a period of at least six months to demonstrate the borrower’s ability to comply with the modified terms. However, performance prior to the modification, or significant events that coincide with the modification, could result in a loan’s return to accrual status after a shorter performance period or even at the time of loan modification. Regardless of the period of time that has elapsed, if the borrower’s ability to meet the revised payment schedule is uncertain then the loan will be kept on non-accrual status. Moreover, a TDR is generally considered to be in default when it appears that the customer will not likely be able to repay all principal and interest pursuant to restructured terms.

 

The Company may agree to different types of concessions when modifying a loan or lease. The tables below summarize TDRs which were modified during the noted periods, by type of concession:

 

Troubled Debt Restructurings, by Type of Loan Modification

(dollars in thousands, unaudited)

 

   Three months ended September 30, 2016 
     
   Rate Modification   Term Modification   Interest Only Modification   Rate & Term Modification   Term & Interest Only Modification   Total 
                         
Real estate:                        
Other construction/land  $-   $-   $-   $-   $-   $- 
1-4 family - closed-end   -    -    -    178    -    178 
Equity lines   -    135    -    97    -    232 
Multi-family residential   -    -    -    -    -    - 
Commercial real estate - owner occupied   -    -    -    -    -    - 
Farmland   -    -    -    258    -    258 
Total real estate loans   -    135    -    533    -    668 
 Commercial and industrial   -    -    -    -    -    - 
 Consumer loans   -    5    -    -    -    5 
   $-   $140   $-   $533   $-   $673 

 

   Three months ended September 30, 2015 
   Rate Modification   Term Modification   Interest Only Modification   Rate & Term Modification   Term & Interest Only Modification   Total 
                         
Real Estate:                        
Other construction/land  $-   $-   $-   $-   $-   $- 
1-4 family - closed-end   -    -    -    4,388    -    4,388 
Equity lines   -    256    -    -    -    256 
Multi-family residential   -    -    -    -    -    - 
Commercial real estate - owner occupied   -    -    -    -    -    - 
Farmland   -    -    -    -    -    - 
Total real estate loans   -    256    -    4,388    -    4,644 
Commercial and industrial   -    45    -    -    -    45 
Consumer loans   -    10    -    -    -    10 
   $-   $311   $-   $4,388   $-   $4,699 

 

20 

 

 

Troubled Debt Restructurings, by Type of Loan Modification

(dollars in thousands, unaudited)

 

   Nine months ended September 30, 2016 
     
   Rate Modification   Term Modification   Interest Only Modification   Rate & Term Modification   Term & Interest Only Modification   Total 
                         
Real estate:                              
Other construction/land  $-   $17   $-   $-   $-   $17 
1-4 family - closed-end   -    -    547    437    -    984 
Equity lines   -    1,415    -    97    -    1,512 
Multi-family residential   -    -    -    132    -    132 
Commercial real estate - owner occupied   -    -    -    266    -    266 
Farmland   -    -    -    258    -    258 
Total real estate loans   -    1,432    547    1,190    -    3,169 
Commercial and industrial   -    -    -    -    -    - 
Consumer loans   -    25    -    60    -    85 
   $-   $1,457   $547   $1,250   $-   $3,254 

 

   Nine months ended September 30, 2015 
   Rate Modification   Term Modification   Interest Only Modification   Rate & Term Modification   Term & Interest Only Modification   Total 
                         
Real Estate:                              
Other construction/land  $-   $111   $-   $-   $-   $111 
1-4 family - closed-end   -    -    -    4,614    -    4,614 
Equity lines   -    607    -    290    -    897 
Multi-family residential   -    418    -    -    -    418 
Commercial real estate - owner occupied   -    -    -    -    -    - 
Farmland   -    -    -    -    -    - 
Total real estate loans   -    1,136    -    4,904    -    6,040 
Commercial and industrial   -    113         -    -    113 
Consumer loans   -    10         -    -    10 
   $-   $1,259   $-   $4,904   $-   $6,163 

 

21 

 

 

The following tables present, by class, additional details related to loans classified as TDRs during the referenced periods, including the recorded investment in the loan both before and after modification and balances that were modified during the period:

 

   Three months ended September 30, 2016 
                     
       Pre-   Post-         
       Modification   Modification         
       Outstanding   Outstanding         
   Number of   Recorded   Recorded   Reserve     
   Loans   Investment   Investment   Difference(1)   Reserve 
Real Estate:                        
Other Construction/Land  0   $-   $-   $-   $- 
1-4 family - closed-end  3    178    178    41    80 
Equity Lines  3    232    232    15    17 
Multi-family residential  0    -    -    -    - 
Commercial RE- owner occupied  0    -    -    -    - 
Farmland  1    258    258    (26)   - 
Total Real Estate Loans       668    668    30    97 
                         
Commercial and Industrial  0    -    -    -    - 
Consumer loans  1    4    5    -    - 
       $672   $673   $30   $97 

 

(1)This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.

 

   Three months ended September 30, 2015 
                     
       Pre-   Post-         
       Modification   Modification         
       Outstanding   Outstanding         
   Number of   Recorded   Recorded   Reserve     
   Loans   Investment   Investment   Difference(1)   Reserve 
Real Estate:                        
Other Construction/Land  0   $-   $-   $-   $- 
1-4 family - closed-end  9    4,388    4,388    148    85 
Equity Lines  2    256    256    10    74 
Multi-family residential  0    -    -    -    - 
Commercial RE- owner occupied  0    -    -    -    - 
Total Real Estate Loans       4,644    4,644    158    159 
                         
Commercial and Industrial  1    45    45    2    2 
Consumer loans  1    10    10    1    - 
       $4,699   $4,699   $161   $161 

 

(1)This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.

 

22 

 

 

   Nine months ended September 30, 2016 
                     
       Pre-   Post-         
       Modification   Modification         
   Number of   Outstanding   Outstanding   Reserve     
   Loans   Recorded   Recorded   Difference(1)   Reserve 
Real Estate:                        
Other Construction/Land  1   $17   $17   $-   $2 
1-4 family - closed-end  8    984    984    116    107 
Equity Lines  13    1,512    1,512    (27)   46 
Multi-family residential  1    132    132    -    6 
Commercial RE- owner occupied  1    266    266    -    4 
Farmland  1    258    258    (26)   - 
Total Real Estate Loans       3,169    3,169    63    165 
                         
Commercial and Industrial  0    -    -    -    - 
Consumer loans  4    84    85    (7)   6 
       $3,253   $3,254   $56   $171 

 

(1)This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.

 

   Nine months ended September 30, 2015 
                     
       Pre-   Post-         
       Modification   Modification         
   Number of   Outstanding   Outstanding   Reserve     
   Loans   Recorded   Recorded   Difference(1)   Reserve 
Real Estate:                        
Other Construction/Land  2   $111   $111   $4   $1 
1-4 family - closed-end  11    4,614    4,614    154    86 
Equity Lines  9    897    897    152    296 
Multi-family residential  1    418    418    -    1 
Commercial RE- owner occupied  0    -    -    -    - 
Total Real Estate Loans       6,040    6,040    310    384 
                         
Commercial and Industrial  4    113    113    (17)   23 
Consumer loans  1    10    10    1    - 
       $6,163   $6,163   $294   $407 

 

(1)This represents the change in the ALLL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.

 

The company had no finance receivables modified as TDRs within the previous twelve months that defaulted or were charged off during the three month or nine month periods ended September 30, 2016 and 2015 respectively.

 

23 

 

 

Purchased Credit Impaired Loans

 

The Company may acquire loans which show evidence of credit deterioration since origination. These purchased credit impaired (“PCI”) loans are recorded at the amount paid, since there is no carryover of the seller’s allowance for loan losses. Potential losses on PCI loans subsequent to acquisition are recognized by an increase in the allowance for loan losses. PCI loans are accounted for individually or are aggregated into pools of loans based on common risk characteristics. The Company estimates the amount and timing of expected cash flows, and expected cash receipts in excess of the amount paid for the loan(s) are recorded as interest income over the remaining life of the loan or pool of loans (accretable yield). The excess of contractual principal and interest over expected cash flows is not recorded (nonaccretable difference). Expected cash flows are periodically re-evaluated throughout the life of the loan or pool of loans. If the present value of the expected cash flows is determined at any time to be less than the carrying amount, a reserve is recorded. If the present value of the expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.

 

Our acquisitions of Santa Clara Valley Bank in the fourth quarter of 2014 and Coast in the third quarter of 2016 included certain loans which have shown evidence of credit deterioration since origination, and for which it was probable at acquisition that all contractually required payments would not be collected. The carrying amount and unpaid principal balance of those PCI loans was as follows, as of the dates indicated (dollars in thousands):

 

Purchased Credit Impaired Loans:

(dollars is thousands, unaudited)      

 

   September 30, 2016 
         
   Unpaid Principal Balance   Carrying Value 
         
Real estate secured  $1,555   $541 
Commercial and industrial   43    23 
Consumer   -    - 
Total purchased credit impaired loans  $1,598   $564 

 

   December 31, 2015 
         
   Unpaid Principal Balance   Carrying Value 
           
Real estate secured  $1,158   $188 
Commercial and industrial   38    - 
Consumer   1    - 
Total purchased credit impaired loans  $1,197   $188 

 

An allowance for loan losses totaling $112,000 was allocated for PCI loans as of September 30, 2016, as compared to $121,000 at December 31, 2015. We also recorded approximately $48,000 in discount accretion on PCI loans during the nine months ended September 30, 2016.

 

24 

 

 

Note 12 – Allowance for Loan and Lease Losses

 

The Company’s allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses. The allowance is maintained at a level that is considered adequate to absorb probable losses on certain specifically identified loans, as well as probable incurred losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when cash payments are received subsequent to the charge off. We employ a systematic methodology, consistent with FASB guidelines on loss contingencies and impaired loans, for determining the appropriate level of the allowance for loan and lease losses and adjusting it at least quarterly. Pursuant to that methodology, impaired loans and leases are individually analyzed and a criticized asset action plan is completed specifying the financial status of the borrower and, if applicable, the characteristics and condition of collateral and any associated liquidation plan. A specific loss allowance is created for each impaired loan, if necessary.

 

The following tables disclose the unpaid principal balance, recorded investment, average recorded investment, and interest income recognized for impaired loans on our books as of the dates indicated. Balances are shown by loan type, and are further broken out by those that required an allowance and those that did not, with the associated allowance disclosed for those that required such. Included in the valuation allowance for impaired loans shown in the tables below are specific reserves allocated to TDRs, totaling $1.460 million at September 30, 2016 and $1.486 million at December 31, 2015.

 

Impaired Loans

(dollars in thousands, unaudited)

 

  September 30, 2016 
   Unpaid Principal
Balance(1)
   Recorded
Investment(2)
   Related
Allowance
  
Average
Recorded
 Investment
   Interest Income
Recognized(3)
 
With an allowance recorded                    
Real Estate:                    
Other construction/land   273   $237   $15   $295   $11 
1-4 Family - closed-end   8,025    6,078    206    8,116    335 
Equity lines   3,551    3,466    193    3,645    48 
Multi-family residential   413    413    6    422    33 
Commercial real estate- owner occupied   1,366    1,366    508    1,793    135 
Commercial real estate- non-owner occupied   1,899    1,751    36    1,977    99 
Farmland   -    -    -    -    - 
Total real estate   15,527    13,311    964    16,248    661 
Agriculture   24    24    24    24    - 
Commercial and industrial   1,942    1,942    505    2,190    72 
Consumer loans   1,730    1,730    297    1,907    76 
    19,223    17,007    1,790    20,369    809 
With no related allowance recorded                         
Real estate:                         
Other construction/land   984    865    -    1,457    21 
1-4 family - closed-end   669    608    -    687    2 
Equity lines   569    540    -    583    - 
Multi-family residential   -    -    -    -    - 
Commercial real estate- owner occupied   1,138    1,138    -    2,480    - 
Commercial real estate- non-owner occupied   79    69    -    278    - 
Farmland   295    295    -    100    - 
Total real estate   3,734    3,515    -    5,585    23 
Agriculture   65    65    -    65    - 
Commercial and industrial   207    205    -    386    1 
Consumer loans   141    17    -    226    - 
    4,147    3,802    -    6,262    24 
Total  $23,370   $20,809   $1,790   $26,631   $833 

 

(1)Contractual principal balance due from customer.
(2)Principal balance on Company’s books, less any direct charge offs.
(3)Interest income is recognized on performing balances on a regular accrual basis.

 

25 

 

          

    December 31, 2015  
    Unpaid Principal Balance(1)     Recorded Investment(2)     Related Allowance     Average Recorded Investment     Interest Income Recognized(3)  
                                   
                                   
With an allowance recorded                                        
Real estate:                                        
Other construction/land   $ 919     $ 769     $ 83     $ 967     $ 42  
1-4 family - closed-end     8,085       6,137       290       6,157       255  
Equity lines     2,339       2,269       214       2,374       17  
Multifamily residential     414       414       1       417       5  
Commercial real estate- owner occupied     1,272       1,272       589       1,405       139  
Commercial real estate- non-owner occupied     3,350       3,350       1,712       3,390       164  
Farmland     -       -       -       -       -  
Total real estate     16,379       14,211       2,889       14,710       622  
Commercial and industrial     2,572       2,559       683       2,857       97  
Consumer loans     2,023       2,022       343       2,298       112  
      20,974       18,792       3,915       19,865       831  
With no related allowance recorded                                        
Real estate:                                        
Other construction/land     554       554       -       566       -  
1-4 family - closed-end     585       362       -       602       34  
Equity lines     843       842       -       840       -  
Multifamily residential     630       630       -       633       -  
Commercial real estate- owner occupied     1,828       1,828       -       2,251       -  
Commercial real estate- non-owner occupied     2,006       1,859       -       2,102       118  
Farmland     610       610       -       629       -  
Total real estate     7,056       6,685       -       7,623       152  
Agriculture                                        
Commercial and industrial     45       29       -       77       -  
Consumer loans     160       15       -       256       -  
      7,261       6,729       -       7,956       152  
Total   $ 28,235     $ 25,521     $ 3,915     $ 27,821     $ 983  

 

(1)Contractual principal balance due from customer.
(2)Principal balance on Company’s books, less any direct charge offs.
(3)Interest income is recognized on performing balances on a regular accrual basis.

 

The specific loss allowance for an impaired loan generally represents the difference between the book value of the loan and either the fair value of underlying collateral less estimated disposition costs, or the loan’s net present value as determined by a discounted cash flow analysis. The discounted cash flow approach is typically used to measure impairment on loans for which it is anticipated that repayment will be provided from cash flows other than those generated solely by the disposition or operation of underlying collateral. However, historical loss rates may be used to determine a specific loss allowance if they indicate a higher potential reserve need than the discounted cash flow analysis. Any change in impairment attributable to the passage of time is accommodated by adjusting the loss allowance accordingly.

 

For loans where repayment is expected to be provided by the disposition or operation of the underlying collateral, impairment is measured using the fair value of the collateral. If the collateral value, net of the expected costs of disposition where applicable, is less than the loan balance, then a specific loss reserve is established for the shortfall in collateral coverage. If the discounted collateral value is greater than or equal to the loan balance, no specific loss reserve is required. At the time a collateral-dependent loan is designated as nonperforming, a new appraisal is ordered and typically received within 30 to 60 days if a recent appraisal is not already available. We generally use external appraisals to determine the fair value of the underlying collateral for nonperforming real estate loans, although the Company’s licensed staff appraisers may update older appraisals based on current market conditions and property value trends. Until an updated appraisal is received, the Company uses the existing appraisal to determine the amount of the specific loss allowance that may be required. The specific loss allowance is adjusted, as necessary, once a new appraisal is received. Updated appraisals are generally ordered at least annually for collateral-dependent loans that remain impaired. Current appraisals were available or in process for 93% of the Company’s impaired real estate loan balances at September 30, 2016. Furthermore, the Company analyzes collateral-dependent loans on at least a quarterly basis, to determine if any portion of the recorded investment in such loans can be identified as uncollectible and would therefore constitute a confirmed loss. All amounts deemed to be uncollectible are promptly charged off against the Company’s allowance for loan and lease losses, with the loan then carried at the fair value of the collateral, as appraised, less estimated costs of disposition if applicable. Once a charge-off or write-down is recorded, it will not be restored to the loan balance on the Company’s accounting books.

 

26 

 

 

Our methodology also provides for the establishment of a “general” allowance for probable incurred losses inherent in loans and leases that are not impaired. Unimpaired loan balances are segregated by credit quality, and are then evaluated in pools with common characteristics. At the present time, pools are based on the same segmentation of loan types presented in our regulatory filings. While this methodology utilizes historical loss data and other measurable information, the credit classification of loans and the establishment of the allowance for loan and lease losses are both to some extent based on Management’s judgment and experience. Our methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan and lease losses that Management believes is appropriate at each reporting date. Quantitative information includes our historical loss experience, delinquency and charge-off trends, and current collateral values. Qualitative factors include the general economic environment in our markets and, in particular, the condition of the agricultural industry and other key industries. Lending policies and procedures (including underwriting standards), the experience and abilities of lending staff, the quality of loan review, credit concentrations (by geography, loan type, industry and collateral type), the rate of loan portfolio growth, and changes in legal or regulatory requirements are additional factors that are considered. The total general reserve established for probable incurred losses on unimpaired loans was $8.090 million at September 30, 2016.

 

There were no material changes to the methodology used to determine our allowance for loan and lease losses during the three months ended September 30, 2016, although in recognition of relatively low loan loss rates in recent periods upward adjustments were made to the ranges for qualitative factor multipliers. We continue to consider the estimated impact of drought conditions and lower oil prices on credit quality, in evaluating the adequacy of our allowance. As we add new products and expand our geographic coverage, and as the economic environment changes, we expect to enhance our methodology to keep pace with the size and complexity of the loan and lease portfolio and respond to pressures created by external forces. We engage outside firms on a regular basis to assess our methodology and perform independent credit reviews of our loan and lease portfolio. In addition, the Company’s external auditors, the FDIC, and the California DBO review the allowance for loan and lease losses as an integral part of their audit and examination processes. Management believes that the current methodology is appropriate given our size and level of complexity.

 

The tables that follow detail the activity in the allowance for loan and lease losses for the periods noted:

 

Allowance for Credit Losses and Recorded Investment in Financing Receivables

(dollars in thousands, unaudited)                        

  

   Three months ended September 30, 2016 
   Real Estate   Agricultural
Products
  

 

Commercial and
 Industrial

   Consumer   Unallocated   Total 
                         
Allowance for credit losses:                        
Beginning Balance  $4,482   $416   $3,741   $1,244   $159   $10,042 
Charge-offs   -    -    (23)   (458)   -    (481)
Recoveries   8    3    97    211    -    319 
Provision   (945)   (118)   930    126    7    - 
                               
Ending Balance  $3,545   $301   $4,745   $1,123   $166   $9,880 

  

   Nine months ended September 30, 2016 
   Real Estate   Agricultural
Products
  

 

Commercial and
 Industrial

   Consumer   Unallocated   Total 
                         
Allowance for credit losses:                        
Beginning Balance  $4,784   $722   $2,533   $1,262   $1,122   $10,423 
Charge-offs   (280)   -    (197)   (1,443)   -    (1,920)
Recoveries   405    7    257    708    -    1,377 
Provision   (1,364)   (428)   2,152    596    (956)   - 
                               
Ending Balance  $3,545   $301   $4,745   $1,123   $166   $9,880 
                               
Reserves:                              
Specific  $964   $24   $505   $297   $-   $1,790 
General   2,581    277    4,240    826    166    8,090 
                               
Ending Balance  $3,545   $301   $4,745   $1,123   $166   $9,880 
                               
Loans evaluated for impairment:                              
Individually  $16,826   $89   $2,146   $1,748   $-   $20,809 
Collectively   858,265    52,551    313,806    10,899    -    1,235,521 
                               
Ending Balance  $875,091   $52,640   $315,952   $12,647   $-   $1,256,330 

  

27 

 

 

   Year ended December 31, 2015 
   Real Estate   Agricultural
Products
   Commercial and
Industrial
   Consumer   Unallocated   Total 
                         
Allowance for credit losses:                        
Beginning Balance  $6,243   $986   $1,944   $1,765   $310   $11,248 
Charge-offs   (705)   -    (395)   (1,740)   -    (2,840)
Recoveries   751    81    225    958    -    2,015 
Provision   (1,505)   (345)   759    279    812    - 
                               
Ending Balance  $4,784   $722   $2,533   $1,262   $1,122   $10,423 
                               
Reserves:                              
Specific  $2,889   $-   $683   $343   $-   $3,915 
General   1,895    722    1,850    919    1,122    6,508 
                               
Ending Balance  $4,784   $722   $2,533   $1,262   $1,122   $10,423 
                               
Loans evaluated for impairment:                              
Individually  $20,896   $-   $2,588   $2,037   $-   $25,521 
Collectively   757,212    46,237    290,974    12,912    -    1,107,335 
                               
Ending Balance  $778,108   $46,237   $293,562   $14,949   $-   $1,132,856 

 

Note 13 – Acquisition

 

In January 2016 the Company entered into a definitive agreement to acquire Coast Bancorp, the holding company for Coast National Bank. The transaction closed on July 8, 2016, and immediately following the acquisition Coast National Bank was merged with and into Bank of the Sierra. Coast National Bank was a community bank with branch offices in San Luis Obispo, Paso Robles, and Arroyo Grande, and a loan production office in Atascadero, California. Shortly after transaction closing, the Atascadero location was converted into a full-service branch office. The aggregate consideration tendered by the Company in its acquisition of Coast consisted of 599,226 shares of Sierra Bancorp common stock and $3.3 million in cash. One-time acquisition costs added $1.695 million to the Company’s pre-tax non-interest expense in the third quarter of 2016 and $2.037 million for the first nine months of 2016. There are additional non-recurring acquisition costs that the Company will expense or accrue for by year-end, but the amount of such costs cannot yet be determined with any degree of certainty.

 

In accordance with GAAP, acquired assets and liabilities are reflected on the Company’s books at their estimated fair values and there was no carryover of the allowance for loan losses that had previously been recorded by Coast. At the merger date the Coast acquisition contributed approximately $94 million to the Company’s outstanding loan balances, $23 million to investment securities, $7 million to time certificates with other banks, and $129 million to total deposits. The acquired investment balances included $15 million in corporate bonds and other securities that were sold by the Company shortly after the acquisition. The transaction also involved Sierra Bancorp’s acquisition of 100% of the voting equity of Coast Bancorp Statutory Trust II, and Sierra Bancorp’s assumption of $7 million in associated junior subordinated debentures which were booked at their fair value of $3.4 million. The Company recorded a deferred income tax asset of $326,000, goodwill of $1.0 million, and a core deposit intangible of $1.8 million in conjunction with the acquisition. Goodwill represents the excess of consideration transferred over the fair values of the identifiable net assets acquired. The core deposit intangible is being amortized on a straight line basis over eight years, commencing at the date of acquisition.

 

28 

 

 

The following table discloses the assets acquired and liabilities assumed from Coast as of July 8, 2016, and the provisional fair value adjustments and amounts recorded by the Company in 2016 under the acquisition method of accounting:

 

(dollars in thousands, unaudited)  Book Value   Fair Value Adjustments   Fair Value 
Assets Acquired               
Cash and cash equivalents  $18,923   $8   $18,931 
Investment securities   23,572    (209)   23,363 
Loans, gross   97,732    (3,468)   94,264 
Deferred loan fees   (326)   326    - 
Allowance for loan losses   (1,592)   1,592    - 
Deferred income taxes   4,656    (4,330)   326 
Core deposit intangible   -    1,827    1,827 
Other assets   6,871    2,544    9,415 
Total assets acquired  $149,836   $(1,710)  $148,126 
                
Liabilities Assumed               
Deposits  $129,038   $-   $129,038 
Other Liabilities   10,526   $(3,899)   6,627 
Total liabilities assumed   139,564    (3,899)   135,665 
Excess of assets acquired over liabilities assumed  $10,272   $2,189    12,461 
Consideration paid             13,485 
Goodwill recognized            $1,024 

 

The fair values are preliminary estimates and are subject to adjustment for up to one year after the merger date or when additional information relative to the closing date fair values becomes available and such information is considered final, whichever is earlier.

 

For loans acquired from Coast, the contractual amounts due, expected cash flows to be collected, interest component and fair value as of the acquisition date were as follows:

 

Acquired Loans

(dollars in thousands, unaudited)

 

  Purchased Credit Impaired Loans   All Other Acquired Loans 
           
Contractual amounts due  $2,116   $95,641 
Cash flows not expected to be collected   680    - 
Expected cash flows   1,436    95,641 
Interest component of expected cash flows   -    2,813 
Fair value of acquired loans  $1,436   $92,828 

 

In accordance with generally accepted accounting principles, there was no carry over of the allowance for loan losses that had been previously recorded by Coast.

 

29 

 

 

The operating results of the Company for the nine months ending September 30, 2016 include the operating results of Coast since the acquisition date. The following table presents the net interest and other income, net income and earnings per share as if the acquisition of Coast were effective January 1, 2016, 2015 and 2014. There were no material, nonrecurring adjustments to the pro forma net interest and other income, net income and earnings per share presented below:

 

(dollars in thousands, unaudited)  Nine Months Ended
September 30,
 
   2016   2015   2014 
     
Net interest income  $52,411   $48,128   $41,374 
                
Net income  $14,469   $19,411   $11,440 
                
Basic earnings per share  $1.08   $1.44   $0.82 
                
Diluted earnings per share  $1.07   $1.43   $0.81 

 

Note 14 – Recent Developments

 

On May 13, 2016, the Company acquired certain loans and deposits from Citizens Business Bank concurrent with the closure of that bank’s Porterville branch. At the time of acquisition there were a total of $10 million in deposits and $1 million in loans, which we consolidated into our Porterville Main office.

 

On July 8, 2016, the Company completed its acquisition of Coast Bancorp (see Note 13 to the financial statements, Acquisition).

 

30 

 

 

PART I - FINANCIAL INFORMATION

ITEM 2

MANAGEMENT’S DISCUSSION AND

ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

 

FORWARD-LOOKING STATEMENTS

 

This Form 10-Q includes forward-looking statements that involve inherent risks and uncertainties. Words such as “expects”, “anticipates”, “believes”, “projects”, and “estimates” or variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed, forecast in, or implied by such forward-looking statements.

 

A variety of factors could have a material adverse impact on the Company’s financial condition or results of operations, and should be considered when evaluating the Company’s potential future financial performance. They include, but are not limited to, the potential impact of extreme drought conditions on businesses and consumers located in the Company’s market areas; unfavorable economic conditions in the Company’s service areas; risks associated with fluctuations in interest rates; liquidity risks; increases in nonperforming assets and credit losses that could occur, particularly in times of weak economic conditions or rising interest rates; reductions in the market value of available-for-sale securities that could result if interest rates increase substantially or an issuer has real or perceived financial difficulties; the Company’s ability to attract and retain skilled employees; the Company’s ability to successfully deploy new technology; the success of acquisitions or branch expansion; and risks associated with the multitude of current and prospective laws and regulations to which the Company is and will be subject. Risk factors that could cause actual results to differ materially from results that might be implied by forward-looking statements include the risk factors disclosed in the Company’s Form 10-K for the fiscal year ended December 31, 2015.

 

CRITICAL ACCOUNTING POLICIES

 

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information and disclosures contained within those statements are significantly impacted by Management’s estimates and judgments, which are based on historical experience and incorporate various assumptions that are believed to be reasonable under current circumstances. Actual results may differ from those estimates under divergent conditions.

 

Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and have the greatest potential impact on the Company’s stated results of operations. In Management’s opinion, the Company’s critical accounting policies deal with the following areas: the establishment of the allowance for loan and lease losses, as explained in detail in Note 12 to the consolidated financial statements and in the “Provision for Loan and Lease Losses” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis; the valuation of impaired loans and foreclosed assets, as discussed in Note 11 to the consolidated financial statements; income taxes and deferred tax assets and liabilities, especially with regard to the ability of the Company to recover deferred tax assets as discussed in the “Provision for Income Taxes” and “Other Assets” sections of this discussion and analysis; and goodwill and other intangible assets, which are evaluated annually for impairment and for which we have determined that no impairment exists, as discussed in the “Other Assets” section of this discussion and analysis. Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate our most recent expectations with regard to those areas.

 

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OVERVIEW OF THE RESULTS OF OPERATIONS

AND FINANCIAL CONDITION

 

results of operations Summary

 

Third Quarter 2016 compared to Third Quarter 2015

 

Net income for the quarter ended September 30, 2016 was $3.929 million, representing a decline of $481,000, or 11%, relative to net income of $4.410 million for the quarter ended September 30, 2015. Basic and diluted earnings per share for the third quarter of 2016 were both $0.28, compared to $0.33 basic and diluted earnings per share for the third quarter of 2015. The Company’s annualized return on average equity was 7.50% and annualized return on average assets was 0.81% for the quarter ended September 30, 2016, compared to 9.32% and 1.03%, respectively, for the quarter ended September 30, 2015. The primary drivers behind the variance in third quarter net income are as follows:

 

·Total non-interest expense reflects an increase of $3.836 million, or 31%, due to non-recurring acquisition costs totaling $1.695 million that were recognized in the third quarter of 2016, as well as ongoing costs stemming from the acquisition that are included in personnel costs, occupancy expense, marketing expense, data processing costs, and deposit costs. Non-acquisition increases are also evident in personnel costs, debit card processing costs, and foreclosed assets expense. Lower telecommunications expense helped offset some of the other expense increases.

 

·Net interest income was up by $2.030 million, or 14%, due to growth in average interest-earning assets totaling $198 million, or 13%, and an improvement of three basis points in our net interest margin. There was no loan loss provision recorded in either quarter.

 

·Total non-interest income increased by $730,000, or 17%, due primarily to higher income on Bank-owned life insurance (“BOLI”), increased activity-based fees from commercial customers, higher debit card interchange income, and lower costs associated with our limited partnership investments (which costs are reflected as an offset to income).

 

·The Company’s provision for income taxes was 32% of pre-tax income in the third quarter of 2016 relative to 36% in the third quarter of 2015. Lower pre-tax income and higher non-taxable BOLI income generally reduced the tax accrual rate for 2016, but the impact of those factors was partially negated for the third quarter by declining tax credits.

 

First Nine Months of 2016 compared to First Nine Months of 2015

 

Net income for the first nine months of 2016 was $12.050 million, representing a decline of $654,000, or 5%, relative to net income of $12.704 million for the first nine months of 2015. For the first nine months of 2016 basic earnings per share were $0.90 and diluted earnings per share were $0.89, compared to $0.94 basic earnings per share and $0.93 diluted earnings per share for the first nine months of 2015. The Company’s annualized return on average equity was 8.08% and annualized return on average assets was 0.89% for the nine months ended September 30, 2016, compared to a return on equity of 9.02% and return on assets of 1.01% for the nine months ended September 30, 2015. The primary drivers behind the variance in year-to-date net income are as follows:

 

·Total non-interest expense increased by $4.819 million, or 13%, due to non-recurring acquisition costs of $2.037 million in the first nine months of 2016, in addition to relatively large increases in personnel costs, occupancy expense, debit card processing costs, foreclosed assets expense, and legal/accounting costs. The expense increases were offset in part by a non-recurring reversal of certain director retirement plan accruals in the first quarter of 2016, and lower telecommunications costs.

 

·Net interest income increased $2.804 million, or 6%, due to the positive impact of an increase of $117 million, or 8%, in average interest-earning assets that was partially offset by a five basis point drop in our net interest margin. There was no loan loss provision recorded in either period.

 

·Total non-interest income was up $937,000, or 7%, due to fees earned from increased activity on commercial accounts, higher overdraft income, higher debit card interchange income, and lower costs associated with our limited partnership investments, offset in part by lower gains from the sale of investments and lower dividends on our FHLB stock.

 

·The Company’s provision for income taxes was 33% of pre-tax income for the first nine months of 2016 and 2015. As with the quarter, lower pre-tax income and higher non-taxable BOLI income exerted downward pressure on our tax accrual rate for 2016, but the impact of those factors was almost entirely offset for the year-to-date period by declining tax credits.

 

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Financial Condition Summary

 

September 30, 2016 relative to December 31, 2015

 

The Company’s assets totaled $1.973 billion at September 30, 2016, relative to total assets of $1.797 billion at December 31, 2015. Total liabilities were $1.765 billion at September 30, 2016 compared to $1.606 billion at the end of 2015, and shareholders’ equity totaled $209 million at September 30, 2016 compared to $190 million at December 31, 2015. The acquisition of Coast Bancorp (“Coast”) on July 8, 2016 had a significant impact on the Company’s balance sheet growth for the first nine months of 2016, including increases in loans, investments, deposits and TRUPS, as noted below, as well as the addition of a $1.827 million core deposit intangible and an increase of $1.024 million in goodwill on the acquisition date. The following is a summary of key balance sheet changes during the first nine months of 2016:

 

·Cash and balances due from banks increased $17 million, or 35%, due in part to $7 million in time deposits at other financial institutions that came from the Coast acquisition, as well as cash required for former Coast branches and our new Sanger branch.

 

·Investment securities were up $28 million due in part to new bond purchases, as well as the net addition of approximately $9 million in securities from the Coast acquisition.

 

·Gross loans increased by $123 million, or 11%, due to the addition of $94 million in loans via the Coast acquisition and organic growth in real estate loans, agricultural production loans, and outstanding balances on mortgage warehouse lines. Loan growth for the period was also augmented by an $11 million increase in loan participations purchased by Bank of the Sierra.

 

·Total nonperforming assets, namely non-accrual loans and foreclosed assets, were reduced by $4 million, or 29%, including the return to accrual status of our single largest remaining nonperforming loan. There were approximately $2 million in nonperforming loans included with the Coast acquisition, but most of those balances had been sold by September 30, 2016. The Company’s ratio of nonperforming assets to total loans plus foreclosed assets was 0.72% at September 30, 2016, compared to 1.13% at December 31, 2015 and 1.69% at September 30, 2015.

 

·Deposit balances reflect net growth of $169 million, or 12%, including balances from Coast that totaled $129 million at the acquisition date, deposits from our branch acquisition in May which totaled $10 million at the acquisition date, and a $20 million increase in time deposits from the State of California. Pure organic growth has been relatively limited thus far in 2016.

 

·Junior subordinated debentures increased by over $3 million due to $7 million in trust-preferred securities from Coast that were booked at their fair value, but other borrowings were reduced by $6 million, or 7%.

 

·Total capital reflects an increase of $18 million, or 10%, due to the impact of shares issued as part of the consideration for the acquisition, a rising level of retained earnings, and an increase in accumulated other comprehensive income, net of the cost of common stock repurchased by the Company. Our consolidated total risk-based capital ratio increased slightly, to 17.04% at September 30, 2016 from 17.01% at year-end 2015, and remains strong relative to peer banks.

 

EARNINGS PERFORMANCE

 

The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on deposits and other borrowed money. The second is non-interest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as bank-owned life insurance. The majority of the Company’s non-interest expense is comprised of operating costs that facilitate offering a full range of banking services to our customers.

 

NET INTEREST INCOME AND NET INTEREST MARGIN

 

Net interest income increased by $2.030 million, or 14%, for the third quarter of 2016 relative to the third quarter of 2015, and by $2.804 million, or 6%, for the first nine months of 2016 compared to the first nine months of 2015. The level of net interest income we recognize in any given period depends on a combination of factors including the average volume and yield for interest-earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. Net interest income is also impacted by the reversal of interest for loans placed on non-accrual status during the reporting period, and the recovery of interest on loans that had been on non-accrual and were paid off, sold or returned to accrual status.

 

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The following