UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the quarterly period ended: March 31, 2019
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the transition period from to .
Commission File Number: 000-10661
TriCo Bancshares
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification Number)
63 Constitution Drive
Chico, California 95973
(Address of Principal Executive Offices)(Zip Code)
(530) 898-0300
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-acceleratedfiler, a smaller reporting company, or an emerging growth company. See definitions of “accelerated filer”, “large accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Indicate the number of shares outstanding for each of the issuer’s classes of common stock, as of the latest practical date:
Common stock, no par value: 30,451,030 shares outstanding as of May 6, 2019
TABLE OF CONTENTS
PART I – FINANCIAL INFORMATION
PART II – OTHER INFORMATION
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Item 1. Financial Statements (unaudited)
TRICO BANCSHARES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data; unaudited)
Assets:
Cash and due from banks
Cash at Federal Reserve and other banks
Cash and cash equivalents
Investment securities:
Marketable equity securities
Available for sale debt securities
Held to maturity debt securities
Restricted equity securities
Loans held for sale
Loans
Allowance for loan losses
Total loans, net
Premises and equipment, net
Cash value of life insurance
Accrued interest receivable
Goodwill
Other intangible assets, net
Operating leases,right-of-use
Other assets
Total assets
Liabilities and Shareholders’ Equity:
Liabilities:
Deposits:
Noninterest-bearing demand
Interest-bearing
Total deposits
Accrued interest payable
Operating lease liability
Other liabilities
Other borrowings
Junior subordinated debt
Total liabilities
Commitments and contingencies (Note 8)
Shareholders’ equity:
Preferred stock, no par value: 1,000,000 shares authorized, zero issued and outstanding at March 31, 2019 and December 31, 2018
Common stock, no par value: 50,000,000 shares authorized; 30,432,419 and 30,417,223 issued and outstanding at March 31, 2019 and December 31, 2018, respectively
Retained earnings
Accumulated other comprehensive loss, net of tax
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying notes to unaudited condensed consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data; unaudited)
Interest and dividend income:
Loans, including fees
Investments:
Taxable securities
Tax exempt securities
Dividends
Interest bearing cash at Federal Reserve and other banks
Total interest and dividend income
Interest expense:
Deposits
Total interest expense
Net interest income
Benefit from reversal of provision for loan losses
Net interest income after benefit from reversal of provision for loan losses
Noninterest income:
Service charges and fees
Gain on sale of loans
Asset management and commission income
Increase in cash value of life insurance
Other
Total noninterest income
Noninterest expense:
Salaries and related benefits
Total noninterest expense
Income before provision for income taxes
Provision for income taxes
Net income
Earnings per share:
Basic
Diluted
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CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands; unaudited)
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on available for sale securities arising during the period
Change in minimum pension liability
Other comprehensive income (loss)
Comprehensive income
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(In thousands, except share and per share data; unaudited)
Balance at January 1, 2018
Adoption ASU 2016-01
Adoption ASU 2018-02
Other comprehensive loss
Stock option vesting
RSU vesting
PSU vesting
RSUs released
Repurchase of common stock
Dividends paid ($ 0.17 per share)
Balance at March 31, 2018
Balance at January 1, 2019
Other comprehensive income
Stock options exercised
Dividends paid ($ 0.19 per share)
Balance at March 31, 2019
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of premises and equipment, and amortization
Amortization of intangible assets
Reversal of provision for loan losses
Amortization of investment securities premium, net
Originations of loans for resale
Proceeds from sale of loans originated for resale
Change in market value of mortgage servicing rights
Provision for losses on foreclosed assets
Gain on transfer of loans to foreclosed assets
Gain on sale of foreclosed assets
Loss on disposal of fixed assets
Gain on life insurance death benefit
(Gain) loss on marketable equity securities
Equity compensation vesting expense
Change in:
Interest receivable
Interest payable
Other assets and liabilities, net
Net cash from operating activities
Investing activities:
Proceeds from maturities of securities available for sale
Proceeds from maturities of securities held to maturity
Purchases of securities available for sale
Loan origination and principal collections, net
Proceeds from sale of other real estate owned
Proceeds from sale of premises and equipment
Purchases of premises and equipment
Net cash from investing activities
Financing activities:
Net increase in deposits
Net change in other borrowings
Repurchase of common stock, net
Dividends paid
Net cash used by financing activities
Net change in cash and cash equivalents
Cash and cash equivalents and beginning of year
Cash and cash equivalents at end of year
Supplemental disclosure of noncash activities:
Unrealized gain (loss) on securities available for sale
Loans transferred to foreclosed assets
Market value of shares tendered in-lieu of cash to pay for exercise of options and/or related taxes
Supplemental disclosure of cash flow activity:
Cash paid for interest expense
Cash paid for income taxes
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 –Summary of Significant Accounting Policies
Description of Business and Basis of Presentation
TriCo Bancshares (the “Company” or “we”) is a California corporation organized to act as a bank holding company for Tri Counties Bank (the “Bank”). The Company and the Bank are headquartered in Chico, California. The Bank is a California-chartered bank that is engaged in the general commercial banking business in 29 California counties. The Company has five capital subsidiary business trusts (collectively, the “Capital Trusts”) that issued trust preferred securities, including two organized by the Company and three acquired with the acquisition of North Valley Bancorp.
The consolidated financial statements are prepared in accordance with accounting policies generally accepted in the United States of America and general practices in the banking industry. All adjustments necessary for a fair presentation of these consolidated financial statements have been included and are of a normal and recurring nature. The financial statements include the accounts of the Company. All inter-company accounts and transactions have been eliminated in consolidation. For financial reporting purposes, the Company’s investments in the Capital Trusts of $1,714,000 are accounted for under the equity method and, accordingly, are not consolidated and are included in other assets on the consolidated balance sheet. The subordinated debentures issued and guaranteed by the Company and held by the Capital Trusts are reflected as debt on the Company’s consolidated balance sheet.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Annual Report”). The Company believes that the disclosures made are adequate to make the information not misleading.
Segment and Significant Group Concentration of Credit Risk
The Company grants agribusiness, commercial, consumer, and residential loans to customers located throughout northern and central California. The Company has a diversified loan portfolio within the business segments located in this geographical area. The Company currently classifies all its operation into one business segment that it denotes as community banking.
Geographical Descriptions
For the purpose of describing the geographical location of the Company’s operations, the Company has defined northern California as that area of California north of, and including, Stockton to the east and San Jose to the west; central California as that area of the state south of Stockton and San Jose, to and including, Bakersfield to the east and San Luis Obispo to the west; and southern California as that area of the state south of Bakersfield and San Luis Obispo.
Cash and Cash Equivalents
Net cash flows are reported for loan and deposit transactions and other borrowings. For purposes of the consolidated statement of cash flows, cash, due from banks with original maturities less than 90 days, interest-earning deposits in other banks, and Federal funds sold are considered to be cash equivalents.
Accounting Standards Adopted in 2019
The Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, Leases (Topic 842). ASU 2016-02, which among other things, requires lessees to recognize most leases on-balance sheet, increasing reported assets and liabilities. Lessor accounting remains substantially similar to current U.S. GAAP. The FASB has issued incremental guidance to Topic 842 standard through ASU No. 2018-11, 2018-20, and 2019-01. The Company has elected to use the transition relief approach as provided in ASU 2018-11, which permits the Company to use January 1, 2019 as both the application date and the adoption date, rather than the modified retrospective approach which would have required an application date of January 1, 2017 and adoption date of January 1, 2019. The Company also elected certain relief options offered within the new standard, which include the package of practical expedients, the option not to recognize a right-of-use asset (ROUA) and lease liability that arise from short-term leases (i.e. leases with terms of 12 months or less), and the option of hindsight when determining lease term. Substantially all of the Company’s lease agreements are considered operating
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leases and were not previously recognized on the Company’s balance sheets. As of January 1, 2019, the Company recorded a ROUA and corresponding lease liability for all applicable operating leases. While the guidance increased the Company’s gross assets and liabilities, the adoption of ASU 2016-02 did not have a material impact on the consolidated statements of income or the consolidated statements of cash flows. See Note 6 for more information.
The FASB issued ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs (Topic 310). ASU 2017-08 shortens the amortization period for certain callable debt securities held at a premium to require such premiums to be amortized to the earliest call date unless applicable guidance related to certain pools of securities is applied to consider estimated prepayments. Under prior guidance, entities were generally required to amortize premiums on individual, non-pooled callable debt securities as a yield adjustment over the contractual life of the security. ASU 2017-08 does not change the accounting for callable debt securities held at a discount.ASU 2017-08 was effective for the Company on January 1, 2019, and did not have an impact on the Company’s consolidated financial statements.
Accounting Standards Pending Adoption
The FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326). ASU 2016-13 is the final guidance on the new current expected credit loss (‘‘CECL’’) model. ASU 2016-13, among other things, requires the incurred loss impairment methodology in current GAAP be replaced with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to estimate future credit loss estimates. As CECL encompasses all financial assets carried at amortized cost, the requirement that reserves be established based on an organization’s reasonable and supportable estimate of expected credit losses extends to held to maturity (‘‘HTM’’) debt securities. ASU 2016-13 amends the accounting for credit losses on available-for-sale securities (‘‘AFS’’), whereby credit losses will be presented as an allowance as opposed to a write-down. In addition, CECL will modify the accounting for purchased loans with credit deterioration since origination, so that reserves are established at the date of acquisition for purchased loans. Lastly, ASU 2016-13 requires enhanced disclosures on the significant estimates and judgments used to estimate credit losses, as well as on the credit quality and underwriting standards of an organization’s portfolio. These disclosures require organizations to present the currently required credit quality disclosures disaggregated by the year of origination or vintage. ASU 2016-13 allows for a modified retrospective approach with a cumulative effect adjustment to the balance sheet upon adoption (charge to retained earnings instead of the income statement). ASU 2016-13 will be effective for the Company on January 1, 2020, and early adoption is permitted. While the Company is currently evaluating the provisions of ASU 2016-13 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements, it has taken steps to prepare for the implementation when it becomes effective, such as forming an internal task force, gathering pertinent data, consulting with outside professionals, and evaluating its current IT systems. While detailed modeling efforts are ongoing, the validation of expected credit loss estimates will likely not be available until late in 2019. Management expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the first reporting period in which the new standard is effective, but cannot yet estimate the magnitude of the one-time adjustment or the overall impact of the new guidance on the Company’s financial position, results of operations or cash flows.
FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment (Topic 350): ASU 2017-04 eliminates step two of the goodwill impairment test (the hypothetical purchase price allocation used to determine the implied fair value of goodwill) when step one (determining if the carrying value of a reporting unit exceeds its fair value) is failed. Instead, entities simply will compare the fair value of a reporting unit to its carrying amount and record goodwill impairment for the amount by which the reporting unit’s carrying amount exceeds its fair value. ASU 2017-04 will be effective for the Company on January 1, 2020 and is not expected to have a significant impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASUNo. 2018-13, “Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU No. 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted. Entities are also allowed to elect early adoption the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. As ASU No. 2018-13 only revises disclosure requirements, it will not have a significant impact on the Company’s consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-14, “Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans.” This ASU makes minor changes to the disclosure requirements for employers that sponsor defined benefit pension and/or other postretirement benefit plans. ASU2018-14 is effective for fiscal years ending after December 15, 2020; early adoption is permitted. As ASU 2018-14 only revises disclosure requirements, it will not have a significant impact on the Company’s consolidated financial statements.
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Note 2—Business Combinations
Merger with FNB Bancorp
On July 6, 2018, the Company completed the acquisition of FNB Bancorp (“FNBB”) for an aggregate transaction value of $291,132,000. FNBB was merged into the Company, and the Company issued 7,405,277 shares of common stock to the former shareholders of FNBB. FNBB’s subsidiary, First National Bank of Northern California, merged into the Bank on the same day. The Company also paid $6.7 million to settle and retire all FNBB stock options outstanding as of the acquisition date. Upon the consummation of the merger, the Company added 12 branches within San Mateo, San Francisco, and Santa Clara counties.
In accordance with accounting for business combinations, the Company recorded $156,661,000 of goodwill and $27,605,000 of core deposit intangibles on the acquisition date. The core deposit intangibles will be amortized over the weighted average remaining life of 6.2 years with no significant residual value. For tax purposes, purchase prices accounting adjustments including goodwill are all non-taxable and /or non-deductible. Acquisition related costs of $476,000 are included in the consolidated statements of income for the three months ended March 31, 2018. There have been no acquisition costs incurred during the three months ended March 31, 2019.
The acquisition was consistent with the Company’s strategy to expand into the Bay Area market. The acquisition offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded region. Goodwill arising from the acquisition consisted largely of the estimated cost savings resulting from the combined operations.
The following table summarizes the consideration paid for FNBB and the amounts of assets acquired and liabilities assumed that were recorded at the acquisition date (in thousands).
Fair value of consideration transferred:
Fair value of shares issued
Cash consideration
Total fair value of consideration transferred
Assets acquired:
Securities available for sale
Premises and equipment
Core deposit intangible
Total assets acquired
Liabilities assumed:
Short-term borrowings—Federal Home Loan Bank
Total liabilities assumed
Total net assets acquired
Goodwill recognized
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A summary of the estimated fair value adjustments resulting in the goodwill recorded in the FNB Bancorp acquisition are presented below (in thousands):
Value of stock consideration paid to FNB Bancorp Shareholders
Less:
Cost basis net assets acquired
Fair value adjustments:
Investments
Premises and Equipment
Deferred income taxes
The fair value of net assets acquired includes fair value adjustments to certain loans that were not considered impaired (PNCI loans) as of the acquisition date. The fair value adjustments were determined using discounted contractual cash flows. As such, these loans were not considered impaired at the acquisition date and were not subject to the guidance relating to purchased credit impaired loans (PCI loans), which have shown evidence of credit deterioration since origination. The gross contractual amounts receivable and fair value for PNCI loans as of the acquisition date was $866,189,000 and $833,381,000, respectively. The gross contractual amounts receivable and fair value for PCI loans as of the acquisition date was $1,683,000 and $1,302,000, respectively. At the acquisition date, the Company was unable to estimate the expected contractual cash flows to be collected from the purchased credit impaired loans.
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Note 3—Investment Securities
The amortized cost and estimated fair values of investments in debt securities are summarized in the following tables:
Debt Securities Available for Sale
Obligations of U.S. government agencies
Obligations of states and political subdivisions
Corporate bonds
Asset backed securities
Total debt securities available for sale
Debt Securities Held to Maturity
Total debt securities held to maturity
There were no sales of investment securities during the three months ended March 31, 2019 and 2018. Investment securities with an aggregate carrying value of $587,233,000 and $597,591,000 at March 31, 2019 and December 31, 2018, respectively, were pledged as collateral for specific borrowings, lines of credit or local agency deposits.
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The amortized cost and estimated fair value of debt securities at March 31, 2019 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At March 31, 2019, obligations of U.S. government corporations and agencies with a cost basis totaling $1,048,332,000 consist almost entirely of residential real estate mortgage-backed securities whose contractual maturity, or principal repayment, will follow the repayment of the underlying mortgages. For purposes of the following table, the entire outstanding balance of these mortgage-backed securities issued by U.S. government corporations and agencies is categorized based on final maturity date. At March 31, 2019, the Company estimates the average remaining life of these mortgage-backed securities issued by U.S. government corporations and agencies to be approximately 5.5 years. Average remaining life is defined as the time span after which the principal balance has been reduced by half.
Debt Securities
Due in one year
Due after one year through five years
Due after five years through ten years
Due after ten years
Totals
Gross unrealized losses on debt securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:
Obligations of U.S. government agencies: Unrealized losses on investments in obligations of U.S. government agencies are caused by interest rate increases. The contractual cash flows of these securities are guaranteed by U.S. Government Sponsored Entities (principally Fannie Mae and Freddie Mac). It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At March 31, 2019, 93 debt securities representing obligations of U.S. government agencies had unrealized losses with aggregate depreciation of (1.3%) from the Company’s amortized cost basis.
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Obligations of states and political subdivisions: The unrealized losses on investments in obligations of states and political subdivisions were caused by increases in required yields by investors in these types of securities. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At March 31, 2019, 33 debt securities representing obligations of states and political subdivisions had unrealized losses with aggregate depreciation of (2.0%) from the Company’s amortized cost basis.
Asset backed securities: The unrealized losses on investments in asset backed securities were caused by increases in required yields by investors in these types of securities. At the time of purchase, each of these securities was rated AA or AAA and through March 31, 2019 has not experienced any deterioration in credit rating. The Company continues to monitor these securities for changes in credit rating or other indications of credit deterioration. Because management believes the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At March 31, 2019, 28 asset backed securities had unrealized losses with aggregate depreciation of (1.3%) from the Company’s amortized cost basis.
Marketable equity securities: All unrealized losses recognized during the reporting period were for equity securities still held at March 31, 2019.
Note 4 – Loans
A summary of loan balances follows (in thousands):
Mortgage loans on real estate:
Residential 1-4 family
Commercial
Total mortgage loan on real estate
Consumer:
Home equity lines of credit
Home equity loans
Total consumer loans
Construction:
Residential
Total construction
Total loans, net of deferred loan fees and discounts
Total principal balance of loans owed, net of charge-offs
Unamortized net deferred loan fees
Discounts to principal balance of loans owed, net of charge-offs
Total loans, net of unamortized deferred loan fees and discounts
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The following is a summary of the change in accretable yield for PCI during the periods indicated (in thousands):
Change in accretable yield:
Balance at beginning of period
Accretion to interest income
Reclassification (to) from nonaccretable difference
Balance at end of period
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Note 5 – Allowance for Loan Losses
The following tables summarize the activity in the allowance for loan losses, and ending balance of loans, net of unearned fees for the periods indicated.
Total mortgage loans on real estate
Total
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As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including, but not limited to, trends relating to (i) the level of criticized and classified loans, (ii) net charge-offs,(iii) non-performing loans, and (iv) delinquency within the portfolio.
The Company utilizes a risk grading system to assign a risk grade to each of its loans. Loans are graded on a scale ranging from Pass to Loss. A description of the general characteristics of the risk grades is as follows:
Pass – This grade represents loans ranging from acceptable to very little or no credit risk. These loans typically meet most if not all policy standards in regard to: loan amount as a percentage of collateral value, debt service coverage, profitability, leverage, and working capital.
Special Mention – This grade represents “Other Assets Especially Mentioned” in accordance with regulatory guidelines and includes loans that display some potential weaknesses which, if left unaddressed, may result in deterioration of the repayment prospects for the asset or may inadequately protect the Company’s position in the future. These loans warrant more than normal supervision and attention.
Substandard – This grade represents “Substandard” loans in accordance with regulatory guidelines. Loans within this rating typically exhibit weaknesses that are well defined to the point that repayment is jeopardized. Loss potential is, however, not necessarily evident. The underlying collateral supporting the credit appears to have sufficient value to protect the Company from loss of principal and accrued interest, or the loan has been written down to the point where this is true. There is a definite need for a well-defined workout/rehabilitation program.
Doubtful – This grade represents “Doubtful” loans in accordance with regulatory guidelines. An asset classified as Doubtful has all the weaknesses inherent in a loan classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and financing plans.
Loss – This grade represents “Loss” loans in accordance with regulatory guidelines. A loan classified as Loss is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan, even though some recovery may be affected in the future. The portion of the loan that is graded loss should be charged off no later than the end of the quarter in which the loss is identified.
The following tables present ending loan balances by loan category and risk grade for the periods indicated:
Total loans
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Consumer loans, whether unsecured or secured by real estate, automobiles, or other personal property, are susceptible to three primary risks; non-payment due to income loss, over-extension of credit and, when the borrower is unable to pay, shortfall in collateral value. Typically, payment performance will follow general economic trends in the marketplace driven primarily by rises in the unemployment rate; non-payment is likely due to loss of employment. Loss of collateral value can be due to market demand shifts, damage to collateral itself or a combination of the two. Problem consumer loans are generally identified by payment history and current performance of the borrower (delinquency). The Bank manages its consumer loan portfolios by monitoring delinquency and contacting borrowers to encourage repayment, suggesting modifications if appropriate, and, when continued scheduled payments become unrealistic, initiating repossession or foreclosure through appropriate channels.
Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner occupied real estate are primarily susceptible to changes in the business conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual fortunes of the business owner, and general economic conditions and changes in business cycles. These same risks apply to commercial loans whether secured by equipment or other personal property or unsecured. Losses on loans secured by owner occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often these shifts are a result of changes in general economic or market conditions or overbuilding and resultant over-supply. Losses are dependent on value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs.
Construction loans, whether owner occupied or non-owner occupied commercial real estate loans or residential development loans, are not only susceptible to the related risks described above but the added risks of construction itself including cost over-runs, mismanagement of the project, or lack of demand or market changes experienced at time of completion. Again, losses are primarily related to underlying collateral value and changes therein as described above.
Problem commercial loans are generally identified by periodic review of financial information which may include financial statements, tax returns, rent rolls and payment history of the borrower (delinquency). Based on this information the Bank may decide to take any of several courses of action including demand for repayment, additional collateral or guarantors, and, when repayment becomes unlikely through borrower’s income and cash flow, repossession or foreclosure of the underlying collateral.
Collateral values may be determined by appraisals obtained through Bank approved, licensed appraisers, qualified independent third parties, public value information (blue book values for autos), sales invoices, or other appropriate means. Appropriate valuations or revaluations are obtained at initiation of the credit and periodically, but not less than every twelve months depending on collateral type, once repayment is questionable and the loan has been classified.
Once a loan becomes delinquent and repayment becomes questionable, a Bank collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral. If this is not forthcoming and payment in full is unlikely, the Bank will estimate its probable loss, using a recent valuation as appropriate to the underlying collateral less estimated costs of sale, and charge the loan down to the estimated net realizable amount. Depending on the length of time until ultimate collection, the Bank may revalue the underlying collateral and take additional charge-offs as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when collateral is liquidated and actual loss is known. Unpaid balances on loans after or during collection and liquidation may also be pursued through lawsuit and attachment of wages or judgment liens on borrower’s other assets.
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The following table shows the ending balance of current and past due originated loans by loan category as of the date indicated:
Total originated loans
The following table shows the ending balance of current and past due PNCI loans by loan category as of the date indicated:
Total PNCI loans
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Interest income on originated nonaccrual loans that would have been recognized during the three months ended March 31, 2019 and 2018, if all such loans had been current in accordance with their original terms, totaled $279,000 and $285,000, respectively. Interest income actually recognized on these originated loans during the three months ended March 31, 2019 and 2018 was $33,000 and $22,000, respectively. Interest income on PNCI nonaccrual loans that would have been recognized during the three months ended March 31, 2019 and 2018, if all such loans had been current in accordance with their original terms, totaled $121,000 and $27,000, respectively. Interest income actually recognized on these PNCI loans during the three months ended March 31, 2019 and 2018 was $60,000 and $0.
The following table shows the ending balance of nonaccrual originated and PNCI loans by loan category as of the date indicated:
Total non accrual loans
Impaired originated loans are those where management has concluded that it is probable that the borrower will be unable to pay all amounts due in accordance with the original contractual terms of the loan agreement. The following tables show the recorded investment (financial statement balance), unpaid principal balance, average recorded investment, and interest income recognized for impaired Originated and PNCI loans, segregated by those with no related allowance recorded and those with an allowance recorded for the periods indicated.
21
22
Originated loans classified as TDRs and impaired were $9,547,000, $10,253,000, and $9,871,000 at March 31, 2019, December 31, 2018, and March 31, 2018, respectively. PNCI loans classified as TDRs and impaired were $823,000, $615,000, and $1,471,000 at March 31, 2019, December 31, 2018 and March 31, 2018, respectively. The Company had no significant obligations to lend additional funds on Originated or PNCI TDRs as of March 31, 2019, December 31, 2018, or March 31, 2018.
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The following tables show certain information regarding TDRs that occurred during the periods indicated:
Modifications classified as TDRs can include one or a combination of the following: rate modifications, term extensions, interest only modifications, either temporary or long-term, payment modifications, and collateral substitutions/additions.
For all new TDRs, an impairment analysis is conducted. If the loan is determined to be collateral dependent, any additional amount of impairment will be calculated based on the difference between estimated collectible value and the current carrying balance of the loan. This difference could result in an increased provision and is typically charged off. If the asset is determined not to be collateral dependent, the impairment is measured on the net present value difference between the expected cash flows of the restructured loan and the cash flows which would have been received under the original terms. The effect of this could result in a requirement for additional provision to the reserve. The effect of these required provisions for the period are indicated above.
Typically if a TDR defaults during the period, the loan is then considered collateral dependent and, if it was not already considered collateral dependent, an appropriate provision will be reserved or charge will be taken. The additional provisions required resulting from default of previously modified TDR’s are noted above.
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Note 6 – Leases
The Company adopted ASU 2016-02 “Leases” (Topic 842) as of January 1, 2019, which requires the Company to record a right-of-use asset (“ROUA”) on the consolidated balance sheets for those leases that convey rights to control use of identified assets for a period of time in exchange for consideration. The Company is also required to record a lease liability on the consolidated balance sheets for the present value of future payment commitments. All of the Company’s leases are comprised of operating leases in which the Company is lessee of real estate property for branches, ATM locations, and general administration and operations. The Company elected not to include short-term leases (i.e. leases with initial terms of twelve months or less) within the ROUA and lease liability. Known or determinable adjustments to the required minimum future lease payments were included in the calculation of the Company’s ROUA and lease liability. Adjustments to the required minimum future lease payments that are variable and will not be determinable until a future period, such as changes in the consumer price index, are included as variable lease costs. Additionally, expected variable payments for common area maintenance, taxes and insurance were unknown and not determinable at lease commencement and therefore, were not included in the determination of the Company’s ROUA or lease liability.
The value of the ROUA and lease liability is impacted by the amount of the periodic payment required, length of the lease term, and the discount rate used to calculate the present value of the minimum lease payments. The Company’s lease agreements often include one or more options to renew at the Company’s discretion. If at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company will include the extended term in the calculation of the ROU asset and lease liability. Topic 842 requires the use of the rate implicit in the lease whenever this rate is readily determinable. As this rate is rarely determinable, the Company utilizes its incremental borrowing rate at lease inception, on a collateralized basis, over a similar term. For operating leases existing prior to January 1, 2019, the rate for the remaining lease term as of January 1, 2019 was used. The lease liability is reduced based on the discounted present value of remaining payments as of each reporting period. The ROUA value is measured using the amount of lease liability and adjusted for prepaid or accrued lease payments, remaining lease incentives, unamortized direct costs (if any), and impairment (if any).
The following table presents the components of lease expense for the three months ended March 31 2019:
Operating lease cost
Short-term lease cost
Variable lease cost
Sublease income
Total lease cost
Prior to the adoption of ASU 2016-02, rent expense under operating leases was $921,000 during the three months ended March 31, 2018. Rent expense was offset by rent income of $10,000 during the three months ended March 31, 2018.
The following table presents supplemental cash flow information related to leases for the three months ended March 31, 2019:
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows for operating leases
ROUA obtained in exchange for operating lease liabilities
The following table presents the weighted average operating lease term and discount rate at March 31, 2019:
As of March 31, 2019:
Weighted-average remaining lease term
Weighted-average discount rate
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At March 31, 2019, future expected operating lease payments are as follows:
Periods ending December 31,
2019
2020
2021
2022
2023
Thereafter
Discount for present value of expected cash flows
Lease liability at March 31, 2019
Note 7 - Deposits
A summary of the balances of deposits follows (in thousands):
Interest-bearing demand
Savings
Time certificates, $250,000 and above
Other time certificates
Certificate of deposit balances of $50,000,000 and $60,000,000 from the State of California were included in time certificates, over $250,000, at March 31, 2019 and December 31, 2018, respectively. The Company participates in a deposit program offered by the State of California whereby the State may make deposits at the Company’s request subject to collateral and credit worthiness constraints. The negotiated rates on these State deposits are generally more favorable than other wholesale funding sources available to the Company. Overdrawn deposit balances of $1,207,000 and $1,469,000 were classified as consumer loans at March 31, 2019 and December 31, 2018, respectively.
Note 8 - Commitments and Contingencies
The following table presents a summary of the Bank’s commitments and contingent liabilities:
Financial instruments whose amounts represent risk:
Commitments to extend credit:
Commercial loans
Consumer loans
Real estate mortgage loans
Real estate construction loans
Standby letters of credit
Deposit account overdraft privilege
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Note 9 – Shareholders’ Equity
Dividends Paid
The Bank paid to the Company cash dividends in the aggregate amounts of $8,114,000 and $4,372,000 during the three months ended March 31, 2019 and 2018, respectively. The Bank is regulated by the Federal Deposit Insurance Corporation (FDIC) and the State of California Department of Business Oversight (DBO). Absent approval from the Commissioner of the DBO, California banking laws generally limit the Bank’s ability to pay dividends to the lesser of (1) retained earnings or (2) net income for the last three fiscal years, less cash distributions paid during such period.
Stock Repurchase Plan
On August 21, 2007, the Board of Directors adopted a plan to repurchase, as conditions warrant, up to 500,000 shares of the Company’s common stock on the open market. The timing of purchases and the exact number of shares to be purchased will depend on market conditions. This stock repurchase plan has no expiration date. As of March 31, 2019, the Company had repurchased 196,566 shares under this plan. During the three month periods ended March 31, 2019 and 2018, there were no shares of common stock repurchased under this plan.
Stock Repurchased Under Equity Compensation Plans
During the three months ended March 31, 2019 and 2018, employees tendered 16,418 and 134 shares, respectively, of the Company’s common stock with market value of $647,000, and $4,000, respectively, in lieu of cash to exercise options to purchase shares of the Company’s stock and to pay income taxes related to equity compensation plan instruments as permitted by the Company’s shareholder-approved equity compensation plans. The tendered shares were retired. The market value of tendered shares is the last market trade price at closing on the day an option is exercised. Stock repurchased under equity incentive plans are not included in the total of stock repurchased under the stock repurchase plan announced on August 21, 2007.
Note 10 - Stock Options and Other Equity-Based Incentive Instruments
Stock option activity during the three months ended March 31, 2019 is summarized in the following table:
Outstanding at December 31, 2018
Options granted
Options exercised
Options forfeited
Outstanding at March 31, 2019
The following table shows the number, weighted-average exercise price, intrinsic value, and weighted average remaining contractual life of options exercisable, options not yet exercisable and total options outstanding as of March 31, 2019:
Number of options
Weighted average exercise price
Intrinsic value (in thousands)
Weighted average remaining contractual term (yrs.)
The 1,125 options that are currently not exercisable as of March 31, 2019 are expected to vest, on a weighted-average basis, over the next six months. The Company did not modify any option grants during 2018 or the three months ended March 31, 2019.
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Restricted stock unit (RSU) activity is summarized in the following table for the dates indicated:
RSUs granted
RSUs added through dividend credits
RSUs forfeited/expired
The 66,914 of service condition vesting RSUs outstanding as of March 31, 2019 include a feature whereby each RSU outstanding is credited with a dividend amount equal to any common stock cash dividend declared and paid, and the credited amount is divided by the closing price of the Company’s stock on the dividend payable date to arrive at an additional amount of RSUs outstanding under the original grant. The dividend credits follow the same vesting requirements as the RSU awards and are not considered participating securities. The 66,914 of service condition vesting RSUs outstanding as of March 31, 2019 are expected to vest, and be released, on a weighted-average basis, over the next 1.2 years. The Company expects to recognize $1,465,000 of pre-tax compensation costs related to these service condition vesting RSUs between March 31, 2019 and their vesting dates. The Company did not modify any service condition vesting RSUs during 2018 or during the three months ended March 31, 2019.
The 45,536 of market plus service condition vesting RSUs outstanding as of March 31, 2019 are expected to vest, and be released, on a weighted-average basis, over the next 1.2 years. The Company expects to recognize $633,000 of pre-tax compensation costs related to these RSUs between March 31, 2019 and their vesting dates. As of March 31, 2019, the number of market plus service condition vesting RSUs outstanding that will actually vest, and be released, may be reduced to zero or increased to 68,304 depending on the total return of the Company’s common stock versus the total return of an index of bank stocks from the grant date to the vesting date. The Company did not modify any market plus service condition vesting RSUs during 2018 or during the three months ended March 31, 2019.
Note 11 - Noninterest Income and Expense
The following table summarizes the Company’s noninterest income for the periods indicated:
ATM and interchange fees
Service charges on deposit accounts
Other service fees
Mortgage banking service fees
Change in value of mortgage servicing rights
Total service charges and fees
Lease brokerage income
Sale of customer checks
Gain (loss) on marketable equity securities
Total other noninterest income
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The components of noninterest expense were as follows (in thousands):
Base salaries, net of deferred loan origination costs
Incentive compensation
Benefits and other compensation costs
Total salaries and benefits expense
Occupancy
Data processing and software
Equipment
Intangible amortization
Advertising
ATM and POS network charges
Professional fees
Telecommunications
Regulatory assessments and insurance
Merger and acquisition expense
Postage
Operational losses
Courier service
Other miscellaneous expense
Total other noninterest expense
Note 12 – Earnings Per Share
Basic earnings per share represent income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from assumed issuance. Potential common shares that may be issued by the Company relate from outstanding stock options and restricted stock units (RSUs), and are determined using the treasury stock method. Earnings per share have been computed based on the following:
Average number of common shares outstanding
Effect of dilutive stock options and restricted stock
Average number of common shares outstanding used to calculate diluted earnings per share
Options excluded from diluted earnings per share because the effect of these options was antidilutive
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Note 13 – Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of other comprehensive income.
The components of other comprehensive income (loss) and related tax effects are as follows:
Unrealized holding gains (losses) on available for sale securities before reclassifications
Amounts reclassified out of accumulated other comprehensive income:
Total amounts reclassified out of accumulated other comprehensive income
Unrealized holding gains (losses) on available for sale securities after reclassifications
Tax effect
Unrealized holding gains (losses) on available for sale securities, net of tax
Change in unfunded status of the supplemental retirement plans before reclassifications
Amortization of prior service cost
Amortization of actuarial losses
Change in unfunded status of the supplemental retirement plans after reclassifications
Change in unfunded status of the supplemental retirement plans, net of tax
Total other comprehensive income (loss)
The components of accumulated other comprehensive loss, included in shareholders’ equity, are as follows:
Net unrealized loss on available for sale securities
Unrealized holding loss on available for sale securities, net of tax
Unfunded status of the supplemental retirement plans
Unfunded status of the supplemental retirement plans, net of tax
Joint beneficiary agreement liability
Joint beneficiary agreement liability, net of tax
Accumulated other comprehensive loss
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Note 14 - Fair Value Measurement
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, income approach, and/or the cost approach. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability including assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset and the risk of nonperformance. Marketable equity securities, debt securitiesavailable-for-sale, loans held for sale, and mortgage servicing rights are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application impairment write-downs of individual assets.
The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observable nature of the assumptions used to determine fair value. These levels are:
Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3 - Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
Marketable equity securities and debt securities available for sale – Marketable equity securities and debt securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. The Company had no securities classified as Level 3 during any of the periods covered in these financial statements.
Loans held for sale – Loans held for sale are carried at the lower of cost or fair value. The fair value of loans held for sale is based on what secondary markets are currently offering for loans with similar characteristics. As such, we classify those loans subjected to recurring fair value adjustments as Level 2.
Impaired originated and PNCI loans – Originated and PNCI loans are not recorded at fair value on a recurring basis. However, from time to time, an originated or PNCI loan is considered impaired and an allowance for loan losses is established. Originated and PNCI loans for which it is probable that payment of interest and principal will not be made in accordance with the original contractual terms of the loan agreement are considered impaired. The fair value of an impaired originated or PNCI loan is estimated using one of several methods, including collateral value, fair value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired originated and PNCI loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. Impaired originated and PNCI loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value which uses substantially observable data, the Company records the impaired originated or PNCI loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value, or the appraised value contains a significant unobservable assumption, such as deviations from comparable sales, and there is no observable market price, the Company records the impaired originated or PNCI loan as nonrecurring Level 3.
Foreclosed assets - Foreclosed assets include assets acquired through, or in lieu of, loan foreclosure. Foreclosed assets are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations and the assets are carried at the lower of carrying amount or fair value less cost to sell. When the fair value of foreclosed assets is based on an observable market price or a current appraised value which uses substantially observable data, the Company records the impaired originated loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value, or the appraised value contains a significant unobservable assumption, such as deviations from comparable sales, and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3. Revenue and expenses from operations and changes in the valuation allowance are included in other noninterest expense.
Mortgage servicing rights - Mortgage servicing rights are carried at fair value. A valuation model, which utilizes a discounted cash flow analysis using a discount rate and prepayment speed assumptions is used in the computation of the fair value measurement. While the prepayment speed assumption is currently quoted for comparable instruments, the discount rate assumption currently requires a significant degree of management judgment and is therefore considered an unobservable input. As such, the Company classifies mortgage servicing rights subjected to recurring fair value adjustments as Level 3.
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The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis (in thousands):
Fair value at March 31, 2019
Debt securities available for sale:
Obligations of U.S. government corporations and agencies
Mortgage servicing rights
Total assets measured at fair value
Fair value at December 31, 2018
Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally corresponds with the Company’s quarterly valuation process. There were no transfers between any levels during the three months ended March 31, 2019 or the year ended December 31, 2018.
The following table provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the time periods indicated. Had there been any transfer into or out of Level 3 during the time periods indicated, the amount included in the “Transfers into (out of) Level 3” column would represent the beginning balance of an item in the period (interim quarter) during which it was transferred (in thousands):
Three months ended March 31,
2019: Mortgage servicing rights
2018: Mortgage servicing rights
The key unobservable inputs used in determining the fair value of mortgage servicing rights are mortgage prepayment speeds and the discount rate used to discount cash projected cash flows. Generally, any significant increases in the mortgage prepayment speed and discount rate utilized in the fair value measurement of the mortgage servicing rights will result in a negative fair value adjustments (and decrease in the fair value measurement). Conversely, a decrease in the mortgage prepayment speed and discount rate will result in a positive fair value adjustment (and increase in the fair value measurement).
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The following table presents quantitative information about recurring Level 3 fair value measurements at March 31, 2019 and December 31, 2018:
Mortgage Servicing Rights
As of December 31, 2018:
The tables below present the recorded investment in assets and liabilities measured at fair value on a nonrecurring basis, as of the dates indicated (in thousands):
Three months ended March 31, 2019
Fair value:
Impaired Originated & PNCI loans
Foreclosed assets
Year ended December 31, 2018
Three months ended March 31, 2018
The impaired originated and PNCI loan amount above represents impaired, collateral dependent loans that have been adjusted to fair value. When the Company identifies a collateral dependent loan as impaired, the Company measures the impairment using the current fair value of the collateral, less selling costs. Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals. If the Company determines that the value of the impaired loan is less than the recorded investment in the loan, the Company recognizes this impairment and adjust the carrying value of the loan to fair value through the allowance for loan and lease losses. The loss represents charge-offs or impairments on collateral dependent loans for fair value adjustments based on the fair value of collateral. The carrying value of loans fully charged-off is zero.
The foreclosed assets amount above represents impaired real estate that has been adjusted to fair value. Foreclosed assets represent real estate which the Company has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at fair value less costs to sell, which becomes the property’s new basis. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan and lease losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Fair value adjustments on other real estate owned are recognized within net loss on real estate owned. The loss represents impairments on real estate owned for fair value adjustments based on the fair value of the real estate.
The Company’s property appraisals are primarily based on the sales comparison approach and income approach methodologies, which consider recent sales of comparable properties, including their income generating characteristics, and then make adjustments to reflect the general assumptions that a market participant would make when analyzing the property for purchase. These adjustments may increase or decrease an appraised value and can vary significantly depending on the location, physical characteristics and income producing potential of each property. Additionally, the quality and volume of market information available at the time of the appraisal can vary from period to period and cause significant changes to the nature and magnitude of comparable sale adjustments. Given these variations, comparable sale adjustments are generally not a reliable indicator for how fair value will increase or decrease from period to period. Under certain circumstances, management discounts are applied based on specific characteristics of an individual property.
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The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at March 31, 2019:
Valuation
Technique
Unobservable Inputs
March 31, 2019
Foreclosed assets (Residential real estate)
The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at December 31, 2018:
Range,Weighted Average
December 31, 2018
Foreclosed assets (Commercial real estate)
Fair values for financial instruments are management’s estimates of the values at which the instruments could be exchanged in a transaction between willing parties. The Company uses the exit price notion when measuring the fair value of financial instruments. These estimates are subjective and may vary significantly from amounts that would be realized in actual transactions. In addition, other significant assets are not considered financial assets including, any mortgage banking operations, deferred tax assets, and premises and equipment. Further, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on the fair value estimates and have not been considered in any of these estimates.
Financial assets:
Level 1 inputs:
Level 2 inputs:
Securities held to maturity
Level 3 inputs:
Loans, net
Financial liabilities:
Off-balance sheet:
Commitments
Overdraft privilege commitments
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Note 15 - Regulatory Matters
The Company is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance-sheetitems as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total, Tier 1, and common equity Tier 1capital to risk-weighted assets, and of Tier 1 capital to average assets. The following tables present actual and required capital ratios as of March 31, 2019 and December 31, 2018 for the Company and the Bank under applicable Basel III Capital Rules. The minimum capital amounts presented include the minimum required capital levels as of March 31, 2019 and December 31, 2018 based on the thenphased-in provisions of the Basel III Capital Rules. As of January 1, 2019, the minimum required capital levels of the Basel III Capital Rules have been fullyphased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.
Total Capital (to Risk Weighted Assets):
Consolidated
Tri Counties Bank
Tier 1 Capital (to Risk Weighted Assets):
Common equity Tier 1 Capital (to Risk Weighted Assets):
Tier 1 Capital (to Average Assets):
As of March 31, 2019 and December 31, 2018, capital levels at the Company and the Bank exceed all capital adequacy requirements under the Basel III Capital Rules. Also, at March 31, 2019 and December 31, 2018, the Bank’s capital levels exceeded the minimum amounts necessary to be considered well capitalized under the current regulatory framework for prompt corrective action.
The Basel III Capital Rules require for all banking organizations to maintain a capital conservation buffer above the minimum risk-based capital requirements in order to avoid certain limitations on capital distributions, stock repurchases and discretionary bonus payments to executive officers. The capital conservation buffer is exclusively composed of common equity tier 1 capital, and it applies to each of the risk-based capital ratios but not the leverage ratio. At March 31, 2019, the Company and the Bank are in compliance with the capital conservation buffer requirement.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Cautionary Statements Regarding Forward-Looking Information
Certain statements contained in this Form 10-Q that are not historical facts are forward-looking statements based on management’s current expectations and beliefs concerning future developments and their potential effects on the Company. Such statements involve inherent risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There can be no assurance that future developments affecting us will be the same as those anticipated by management. We caution readers that a number of important factors could cause actual results to differ materially from those expressed in, or implied or projected by, such forward-looking statements. These risks and uncertainties include, but are not limited to, the following: the strength of the United States economy in general and the strength of the local economies in which we conduct operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the impact of changes in financial services policies, laws and regulations; technological changes; mergers and acquisitions (including costs or difficulties related to integration of acquired companies); changes in the level of our nonperforming assets and charge-offs; any deterioration in values of California real estate, both residential and commercial; the effect of changes in accounting standards and practices; possible other-than-temporary impairment of securities held by us; changes in consumer spending, borrowing and savings habits; our ability to attract deposits and other sources of liquidity; changes in the financial performance and/or condition of our borrowers; the impact of competition from other financial service providers; the possibility that any of the anticipated benefits of our recent merger with FNB Bancorp (“FNBB”) will not be realized or will not be realized within the expected time period, or that integration of FNBB’s operations will be more costly or difficult than expected; the challenges of integrating and retaining key employees; unanticipated regulatory or judicial proceedings; the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; and our ability to manage the risks involved in the foregoing. Additional factors that could cause results to differ materially from those described above can be found in in Part II Item 1A of this report and our Annual Report on Form 10-K for the year ended December 31, 2018, which is on file with the Securities and Exchange Commission (the “SEC”) and available in the “Investor Relations” section of our website, https://www.tcbk.com/investor-relations and in other documents we file with the SEC.
General
As TriCo Bancshares (referred to in this report as “we”, “our” or the “Company”) has not commenced any business operations independent of Tri Counties Bank (the “Bank”), the following discussion pertains primarily to the Bank. Average balances, including such balances used in calculating certain financial ratios, are generally comprised of average daily balances for the Company. Within Management’s Discussion and Analysis of Financial Condition and Results of Operations, interest income, net interest income, net interest yield, and efficiency ratio are generally presented on a fully tax-equivalent (“FTE”) basis. The Company believes the use of these non-generally accepted accounting principles (non-GAAP)measures provides additional clarity in assessing its results, and the presentation of these measures on a FTE basis is a common practice within the banking industry. Interest income and net interest income are shown on a non-FTE basis in the Part I – Financial Information section of this Form 10-Q, and a reconciliation of the FTE and non-FTEpresentations is provided below in the discussion of net interest income.
Critical Accounting Policies and Estimates
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those that materially affect the financial statements and are related to the adequacy of the allowance for loan losses, investments, mortgage servicing rights, fair value measurements, retirement plans and intangible assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. A detailed discussion related to the Company’s accounting policies including those related to estimates on the allowance for loan losses, other than temporary impairment of investments and impairment of intangible assets, can be found in Note 1 of the financial statements included in the Company’s annual report of Form 10-K for the year ended December 31, 2018.
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Financial Highlights
Performance highlights and other developments for the Company included the following:
Return on average assets was 1.41% and the return on average equity was 10.78% for the first quarter of 2019.
As of March 31, 2019, the Company reached record levels of total loans, total assets and total deposits which were $4.03 billion, $6.47 billion and $5.43 billion, respectively.
The loan to deposit ratio remained stable at 74.3% at March 31, 2019 as compared to 75.0% at December 31, 2018 and 75.2% at March 31, 2018.
Net interest margin grew 32 basis points to 4.46% on a tax equivalent basis as compared to 4.14% in the quarter ended March 31, 2018 and decreased by 7 basis points from the trailing quarter.
Non-interest bearing deposits as a percentage of total deposits were 32.4% at March 31, 2019, as compared to 32.8% at December 31, 2018 and 33.3% at March 31, 2018.
The average rate of interest paid on deposits, including noninterest-bearing deposits, remained low at 0.20%, with no change from the trailing quarter and an increase of 9 basis points from the average rate paid during the same quarter of the prior year.
Non-performing assets to total assets were 0.34% as of March 31, 2019 as compared to 0.47% and 0.54% at December 31, 2018 and March 31, 2018, respectively.
The balance of nonperforming loans decreased by $7.9 million and recoveries on previously charged-off loans significantly contributed to the $1.6 million reversal of the allowance for loan losses during the period.
The efficiency ratio increased slightly to 60.1% as compared to the trailing quarter, which had an efficiency ratio of 59.1%.
Financial Summary
(In thousands, except per share amounts; unaudited)
Noninterest income
Noninterest expense
Per share:
Basic Earnings per share
Diluted earnings per share
Book value at period end
Average common shares outstanding
Average diluted common shares outstanding
Shares outstanding at period end
At period end:
Total investment securities
Shareholders’ equity
Financial Ratios:
During the period (annualized):
Return on average assets
Return on average equity
Net interest margin1
Efficiency ratio
Equity to assets
Total capital to risk-adjusted assets
1 Fully taxable equivalent (FTE)
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Results of Operations
Overview
The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to the Company and the Bank’s financial condition, operating results, asset and liability management, liquidity and capital resources and should be read in conjunction with the Condensed Consolidated Financial Statements of the Company and the Notes thereto located at Item 1 of this report.
Net interest income (FTE)
Provision for income taxes (FTE)
The Company reported net income of $22,726,000 for the quarter ended March 31, 2019, compared to $23,211,000 and $13,910,000 for the trailing quarter and the three months ended March 31, 2018, respectively. Diluted earnings per share were $0.74 for the quarter ended March 31, 2019, compared to $0.76 and $0.60 for the trailing quarter and three months ended March 31, 2018.
Net Interest Income
The Company’s primary source of revenue is net interest income, or the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. Following is a summary of the components of FTE net income for the periods indicated (dollars in thousands):
Interest income
Interest expense
FTE adjustment
Net interest margin (FTE)
Acquired loans discount accretion, net:
Amount (included in interest income)
Effect on average loan yield
Effect on net interest margin (FTE)
Loans may be acquired at a premium or discount to par value, in which case, the premium is amortized (subtracted from) or accreted (added to) interest income over the remaining life of the loan. Generally, as time goes on, the effects of loan discount accretion and loan premium amortization decrease as the purchased loans mature or pay off early. Upon the early pay off of a loan, any remaining (unaccreted) discount or (unamortized) premium is immediately taken into interest income; and as loan payoffs may vary significantly from quarter to quarter, so may the impact of discount accretion and premium amortization on interest income. During the three months ended March 31, 2019, December 31, 2018 and March 31, 2018, purchased loan discount accretion was $1,655,000, $1,982,000, and $632,000, respectively. During the three months ended March 31, 2019, loans purchased at net premiums several years ago were repaid prior to expected maturity resulting in approximately $259,000 of accelerated amortization.
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Summary of Average Balances, Yields/Rates and Interest Differential
The following table presents, for the periods indicated, information regarding the Company’s consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income from average interest-earning assets and resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual loans only to the extent cash payments have been received and applied to interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income thereon exempt from federal income taxation at the current statutory tax rate (dollars in thousands).
Investment securities - taxable
Investment securities - nontaxable(1)
Total investments
Total interest-earning assets
Liabilities and shareholders’ equity:
Interest-bearing demand deposits
Savings deposits
Time deposits
Total interest-bearing deposits
Total interest-bearing liabilities
Noninterest-bearing deposits
Net interest spread(2)
Net interest income and interest margin(3)
Fully taxable equivalent (FTE)
Net interest spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.
Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets.
In general, the change in average balances of assets and liabilities were significantly impacted by the July 6, 2018 acquisition of FNB Bancorp. For financial reporting purposes, the Company does not separately track the changes in assets and liabilities based on branch location or regional geography. However, management believes that the assets and liabilities acquired in the acquisition provide a reasonable approximation of those balances as of March 31, 2019. In addition to the balance sheet changes which resulted from the acquisition of FNB Bancorp, total assets grew by $228,695,000 (4.8%) between March 2018 and March 2019. This growth was led by $129,915,000 (4.2%) of organic loan growth which was funded by $353,923,000 (8.7%) in organic deposit growth. The following is a comparison of the year over year change in certain assets and liabilities:
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Summary of Changes in Interest Income and Expense due to Changes in Average Asset and Liability Balances and Yields Earned and Rates Paid
The following table sets forth a summary of the changes in interest income and interest expense from changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. Changes not solely attributable to volume or rates have been allocated in proportion to the respective volume and rate components (in thousands).
Increase in interest income:
Investment securities (1)
Increase (decrease) in interest expense:
Increase in net interest income
The following commentary regarding net interest income, interest income and interest expense may be best understood while referencing the Summary of Average Balances, Yields/Rates and Interest Differential and the Summary of Changes in Interest Income and Expense due to Changes in Average Asset and Liability Balances and Yields Earned and Rates Paid shown above.
Net interest income (FTE) during the three months ended March 31, 2019 increased $18,894,000 or 41.7% to $64,192,000 compared to $45,298,000 during the three months ended March 31, 2018. The increase in net interest income (FTE) was due primarily to an increase in the average balance of loans, which contributed an additional $12,521,000 in interest income. As discussed above, increases in average balances were primarily the result of the FNB Bancorp acquisition. Increases in market rates added $4,094,000 to net interest income, due to increases in rates earned on interest-earnings assets outpacing increases paid in interest-bearing liabilities.
The index utilized in a significant portion of the Company’s variable rate loans, Wall Street Journal Prime, has increased by 1.50% to 5.50% at March 31, 2019 as compared to 4.00% at March 31, 2018. As compared to the same quarter in the prior year, average loan yields increased 38 basis points from 5.03% during the three months ended March 31, 2018 to 5.41% during the three months ended March 31, 2019. Of the 38 basis point increase in yields on loans, 30 basis points was attributable to increases in market rates while 8 basis points was from increased accretion of purchased loans.
As of March 31, 2019, the Bank’s $4,085,452,000 principal balance of loans, net of charge-offs, and not including deferred loan fees and purchase discounts, was made up of loans with principal balances totaling $1,391,682,000 that have fixed interest rates, and $2,693,770,000 of loans with interest rates that are variable. Included in the balance of variable rate loans as of March 31, 2019 were loans with principal balances of approximately $916,044,000 that had adjustable interest rates tied to the prime lending rate that adjust on or near the date of any prime rate change.
The organic growth in deposits was driven primarily by normal and expected seasonal trends as well as the impact of deposit customer’s receipt of insurance proceeds from the property and casualty losses incurred in connection with the wildfires in Northern California. This growth in deposits allowed for the repayment of overnight borrowings resulting in a reduction in interest expense of $329,000 which was partially offset by the changes in volumes and rates associated with deposit products. During the twelve months ended March 31, 2019, the Federal Funds Target Rate was increased four times in 25 basis point increments from 1.50% to 2.50%. During this same period, the Company’s cost of interest-bearing deposits increased from 16 basis points to 30 basis points.
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Asset Quality and Loan Loss Provisioning
The Company continued to experience improvement in the overall credit quality of its loan portfolio. At March 31, 2019, total nonperforming loans decreased to $19,565,000 or 0.48% of total loans from $27,494,000 or 0.68% of total loans as of December 31, 2018.
The Company recorded a benefit from the reversal of provision for loan losses of $1,600,000 during the three months ended March 31, 2019 as compared to a benefit from the reversal of provision of $236,000 in the same quarter of the prior year. The benefit from the reversal of the provision was necessitated in part by $1,082,000 in net recoveries on previously charged-off loans during the first quarter of 2019 as compared to net charge-offs of $114,000 in the first quarter of 2018. Additionally, while the Company remains cautious about the risks associated with trends in California real estate prices and the affordability of housing in the markets served by the Company, changes in home affordability and energy related index rates improved during the quarter ended March 31, 2019. The qualitative factors associated with these two measures reduced the level of calculated required reserves by approximately $1,059,000.
Noninterest Income
The following table summarizes the Company’s noninterest income for the periods indicated (in thousands):
Noninterest income decreased $426,000 (3.5%) to $11,864,000 during the three months ended March 31, 2019 compared to the three months ended March 31, 2018. The decrease in noninterest income was due primarily to a $756,000 (681.1%) decrease in the fair value of mortgage servicing rights, $234,000 (26.7%) decrease in asset management and commission income, $214,000 (34.2%) decrease in gain on sale of loans, and a $272,000 (73.3%) decrease on the gain on sale of foreclosed assets. Offsetting the decreases in non-interest income was an increase in ATM and interchange fees of $346,000 (8.2%), an increase in service charges on deposit accounts of $101,000 (2.7%), and an increase in the cash value of life insurance of $167,000 (27.5%). The fair value of the mortgage servicing asset decreased as compared to the first quarter in the prior year due to changes in the assumptions utilized in determining the fair value. Specifically, increased prepayment speeds and decreases in the 15 and 30 year mortgage rates were the largest contributors to the decline in fair value of the mortgage servicing asset.
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Noninterest Expense
The following table summarizes the Company’s noninterest expense for the periods indicated (dollars in thousands):
Average full time equivalent staff
Salary and benefit expenses increased $3,476,000 (16.1%) to $25,128,000 during the three months ended March 31, 2019 compared to $21,652,000 during the three months ended March 31, 2018. Base salaries, net of deferred loan origination costs increased $2,795,000 (20.0%) to $16,757,000. The increase in base salaries was due primarily to a 13.6% increase in average full time equivalent employees to 1,138 from 1,002 in the year-ago quarter. Commissions and incentive compensation increased $115,000 (4.7%) to $2,567,000 during the three months ended March 31, 2019 compared to the year-ago quarter due primarily to organic loan and deposit growth. Benefits & other compensation expense increased $566,000 (10.8%) to $5,804,000 during the three months ended March 31, 2019 due primarily to increases in the average full time equivalent employees, as mentioned above.
Other noninterest expense increased $3,875,000 (23.5%) to $20,385,000 during the three months ended March 31, 2019 compared to the three months ended March 31, 2018. The increase in other noninterest expense was due primarily to increased overhead operating costs related to the additional branches as a result of the prior year acquisition of FNB Bancorp. Highlighting those increases were intangible amortization, occupancy, data processing and software, and advertising expenses, which increased by $1,092,000, $1,093,000, $835,000 and $493,000, respectively, as compared to the prior year quarter. The increases in noninterest expenses were partially offset by decreased merger & acquisition expenses of $476,000.
Income Taxes
The Company’s effective tax rate was 28.6% for the quarter ended March 31, 2019 as compared to 28.1% for the same quarter in the prior year. As previously reported, the Company’s effective tax rate was 24.0% for the quarter ended December 31, 2018 which was benefited by certain tax method elections. Absent the benefits made possible through these elections, the Company’s effective tax rate would have been 27.5% for the quarter ended December 31, 2018.
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Financial Condition
Investment Securities
Investment securities available for sale decreased $1,520,000 to $1,113,516,000 as of March 31, 2019, compared to December 31, 2018. This decrease is attributable to maturities and principal repayments of $15,133,000 and amortization of net purchase price premiums of $335,000, which was offset by an increase in fair value of debt securities available for sale of $12,710,000. There were no sales or transfers of available-for-saleinvestment securities during the three month periods ended March 31, 2019 and 2018.
The following table presents the available for sale debt securities portfolio by major type as of March 31, 2019 and December 31, 2018:
Investment securities held to maturity decreased $13,920,000 to $431,016,000 as of March 31, 2019, as compared to December 31, 2018. This decrease is attributable to principal repayments of $13,684,000, and amortization of net purchase price premiums of $236,000.
The following table presents the held to maturity investment securities portfolio by major type as of March 31, 2019 and December 31, 2018:
Debt securities held to maturity:
Obligations of U.S. government and agencies
The Company concentrates its lending activities in four principal areas: real estate mortgage loans (residential and commercial loans), consumer loans, commercial loans (including agricultural loans), and real estate construction loans. The interest rates charged for the loans made by the Company vary with the degree of risk, the size and maturity of the loans, the borrower’s relationship with the Company and prevailing money market rates indicative of the Company’s cost of funds.
The majority of the Company’s loans are direct loans made to individuals, farmers and local businesses. The Company relies substantially on local promotional activity and personal contacts by bank officers, directors and employees to compete with other financial institutions. The Company makes loans to borrowers whose applications include a sound purpose, a viable repayment source and a plan of repayment established at inception and generally backed by a secondary source of repayment.
The following table shows the Company’s loan balances, net deferred loan costs and discounts, as of the dates indicated:
Real estate mortgage
Consumer
Real estate construction
At March 31, 2019 loans, including net deferred loan costs and discounts, totaled $4,034,331,000 which was a $12,317,000 (0.3%) increase over the balances at December 31, 2018.
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Asset Quality and Nonperforming Assets
Nonperforming Assets
The following tables set forth the amount of the Company’s nonperforming assets as of the dates indicated. “Performing nonaccrual loans” are loans that may be current for both principal and interest payments, or are less than 90 days past due, but for which payment in full of both principal and interest is not expected, and are not well secured and in the process of collection:
Performing nonaccrual loans
Nonperforming nonaccrual loans
Total nonaccrual loans
Loans 90 days past due and still accruing
Total nonperforming loans
Total nonperforming assets
Nonperforming assets to total assets
Nonperforming loans to total loans
Allowance for loan losses to nonperforming loans
Allowance for loan losses, unamortized loan fees, and discounts to loan principal balances owed
U.S. government, including its agencies and its government-sponsored agencies, guaranteed portion of nonperforming loans
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Changes in nonperforming assets during the three months ended March 31, 2019
Real estate mortgage:
Home equity lines
Other consumer
The table above does not include deposit overdraft charge-offs.
Nonperforming assets decreased during the first quarter of 2019 by $7,894,000 (26.5%) to $21,880,000 at March 31, 2019 compared to $29,774,000 at December 31, 2018. The decrease in nonperforming assets during the first quarter of 2019 was primarily the result of pay-downs and upgrades of nonperforming loans of $7,984,000, write-downs of $489,000 on nonperforming loans, and sales of foreclosed assets of $179,000, that were partially offset by new nonperforming assets of $660,000 and an increase in the valuation of a foreclosed property at the time of repossession.
The $7,984,000 in reduction of nonperforming loans during the first quarter of 2019 was mainly comprised of decreases within commercial real estate, and included payoffs of three loans to two relationships with a combined balance $6,818,000. The decrease in home equity lines and loans were comprised of decreases of $339,000 from 59 home equity lines of credit and $408,000 from 34 home equity loans.
Loan charge-offs during the three months ended March 31, 2019
In the first quarter of 2019, the Company recorded $614,000 in loan charge-offs and $112,000 in deposit overdraft charge-offs less $1,752,000 in loan recoveries and $56,000 in deposit overdraft recoveries resulting in $1,082,000 of net charge-offs. Primary causes of the loan charges taken in the first quarter of 2019 were gross charge-offs of $94,000 on 16 consumer loans and $520,000 on 5 C&I loans.
Total charge-offs were generally comprised of individual charges of less than $250,000 each. Generally losses are triggered by non-performance by the borrower and calculated based on any difference between the current loan amount and the current value of the underlying collateral less any estimated costs associated with the disposition of the collateral.
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Allowance for Loan Losses
The Components of the Allowance for Loan Losses
The following table sets forth the allowance for loan losses as of the dates indicated:
Allowance for originated and PNCI loan losses:
Environmental factors allowance
Formula allowance
Total allowance for originated and PNCI loan losses
Allowance for impaired loans
Allowance for PCI loan losses
Total allowance for loan losses
Allowance for loan losses to loans
For additional information regarding the allowance for loan losses, including changes in specific, formula, and environmental factors allowance categories, see “Provision for Loan Losses” at “Results of Operations” and “Allowance for Loan Losses” above. Based on the current conditions of the loan portfolio, management believes that the $32,064,000 allowance for loan losses at March 31, 2019 is adequate to absorb probable losses inherent in the Bank’s loan portfolio. No assurance can be given, however, that adverse economic conditions or other circumstances will not result in increased losses in the portfolio.
The following table summarizes the allocation of the allowance for loan losses between loan types and by percentage of the total allowance for loan losses as of the dates indicated:
The following table summarizes the allocation of the allowance for loan losses as a percentage of the total loans for each loan category as of the dates indicated:
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The following table summarizes the activity in the allowance for loan losses for the periods indicated (dollars in thousands):
Allowance for loan losses:
Loans charged off:
Total loans charged off
Recoveries of previously charged-off loans:
Total recoveries of previously charged off loans
Net recoveries (charge-offs)
Average total loans
Ratios (annualized):
Net charge-offs (recoveries) during period to average loans outstanding during period
Benefit from reversal of loan losses to average loans outstanding during period
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Foreclosed Assets, Net of Allowance for Losses
The following tables detail the components and summarize the activity in foreclosed assets, net of allowances for losses for the period indicated (dollars in thousands):
Land & Construction
Residential real estate
Commercial real estate
Total foreclosed assets
During the three months ended March 31, 2019, the Company’s deposits increased $63,796,000 to $5,430,262,000. Included in the March 31, 2019 and December 31, 2018 certificate of deposit balances are $50,000,000 and $60,000,000, respectively, from the State of California. The Company participates in a deposit program offered by the State of California whereby the State may make deposits at the Company’s request subject to collateral and creditworthiness constraints. The negotiated rates on these State deposits are generally more favorable than other wholesale funding sources available to the Company.
Off-Balance Sheet Arrangements
See Note 8 to the condensed consolidated financial statements at Item 1 of Part I of this report for information about the Company’s commitments and contingencies including off-balance-sheet arrangements.
Capital Resources
The current and projected capital position of the Company and the impact of capital plans and long-term strategies are reviewed regularly by Management.
The Company adopted and announced a stock repurchase plan on August 21, 2007 for the repurchase of up to 500,000 shares of the Company’s common stock from time to time as market conditions allow. The 500,000 shares authorized for repurchase under this plan represented approximately 3.2% of the Company’s approximately 15,815,000 common shares outstanding as of August 21, 2007. During the three months ended March 31, 2019, the Company did not repurchase any shares under this plan. This plan has no stated expiration date for the repurchases. As of March 31, 2019, the Company had repurchased 196,566 shares under this plan, which left 303,434 shares available for repurchase under the plan. Shares that are repurchased in accordance with the provisions of a Company stock option plan or equity compensation plan are not counted against the number of shares repurchased under the repurchase plan adopted on August 21, 2007.
The Company’s primary capital resource is shareholders’ equity, which was $853,278,000 at March 31, 2019. This amount represents an increase of $25,905,000 (3.1%) from December 31, 2018, the net result of comprehensive income for the period of $31,678,000, the effect of equity compensation vesting of $397,000, and the exercise of stock options of $647,000, that were partially offset by dividends paid of $5,782,000, and repurchase of common stock of $1,035,000. The Company’s ratio of equity to total assets was 13.2% and 13.0% as of March 31, 2019 and December 31, 2018, respectively. We believe that the Company and the Bank were in compliance with applicable minimum capital requirements set forth in the final Basel III Capital rules as of March 31, 2019. The following summarizes the Company’s ratios of capital to risk-adjusted assets as of the dates indicated:
Total capital
Tier I capital
Common equity Tier 1 capital
Leverage
See Note 9 and Note 15 to the condensed consolidated financial statements at Item 1 of Part I of this report for additional information about the Company’s capital resources.
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Liquidity
The Company’s principal source of asset liquidity is cash at the Federal Reserve Bank of San Francisco (“Federal Reserve”) and other banks and marketable investment securities available for sale. At March 31, 2019, cash at Federal Reserve and other banks in excess of reserve requirements and investment securities available for sale totaled $1,314,124,000, or 20.3% of total assets, representing an increase of $90,872,000 from $1,223,252,000, or 19.3% of total assets at December 31, 2018. This increase in cash and securities available for sale is due mainly to deposit growth and excess cash received from the maturity and principal repayment of investment securities that was not deployed for new loan originations during the three months ended March 31, 2019. The Company’s profitability during the first three months of 2019 generated cash flows from operations of $22,055,000 compared to $23,714,000 during the first three months of 2018. Net cash provided by investing activities was $14,867,000 during the three months ended March 31, 2019, compared to net cash used by investing activities of $60,408,000 during the three months ended March 31, 2018. Financing activities provided net cash of $54,253,000 during the three months ended March 31, 2019, compared to net provided by financing activities of $14,245,000 during the three months ended March 31, 2018. Deposit balance increases accounted for $63,796,000 and $75,273,000 of financing sources of funds during the three months ended March 31, 2019 and 2018, respectively. Dividends paid used $5,782,000 and $3,903,000 of cash during the three months ended March 31, 2019 and 2018, respectively. The Company’s liquidity is dependent on dividends received from the Bank. Dividends from the Bank are subject to certain regulatory restrictions.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company’s assessment of market risk as of March 31, 2019 indicates there are no material changes in the quantitative and qualitative disclosures from those in our Annual Report on Form 10-K for the year ended December 31, 2018.
Item 4. Controls and Procedures
The Company’s management, including its Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the Company’s disclosure controls and procedures as of March 31, 2019. Disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are controls and procedures designed to reasonably assure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported on a timely basis. Disclosure controls are also designed to reasonably assure that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2019.
During the three months ended March 31, 2019, there were no changes in our internal controls or in other factors that have materially affected or are reasonably likely to materially affect our internal controls over financial reporting.
Item 1 – Legal Proceedings
Due to the nature of our business, we are involved in legal proceedings that arise in the ordinary course of our business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
Item 1A – Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed under “Part I—Item 1A—Risk Factors” in our Form 10-K for the year ended December 31, 2018 which are incorporated by reference herein. These factors could materially adversely affect our business, financial condition, liquidity, results of operations and capital position, and could cause our actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report.
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
The following table shows the repurchases made by the Company or any affiliated purchaser (as defined in Rule10b-18(a)(3) under the Exchange Act) during the three months ended March 31, 2019:
Period
January 1-31, 2019
February 1-28, 2019
March 1-31, 2019
Includes shares purchased by the Company’s Employee Stock Ownership Plan and pursuant to various other equity incentive plans. See Note 9 to the condensed consolidated financial statements at Item 1 of Part I of this report, for a discussion of the Company’s stock repurchased under equity compensation plans.
Does not include shares that may be purchased by the Company’s Employee Stock Ownership Plan and pursuant to various other equity incentive plans.
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Item 6 – Exhibits
EXHIBIT INDEX
Exhibit No.
Exhibit
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
/s/ Peter G. Wiese
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