EDGAR 10-K Filing

Company CIK: 1130144
Filing Year: 2021
Filename: 1130144_10-K_2021_0001558370-21-002904.json

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ITEM 1. BUSINESS
Item 1.
Business

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ITEM 1A. RISK FACTORS
Item 1A.
Risk Factors

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ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.

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ITEM 2. PROPERTIES
ITEM 2. PROPERTIES
The Company’s administrative headquarters is housed in a 37,000 square foot, three-story office building located at 86 North Main Street, Porterville, California, and our main office consists of a one-story brick building located at 90 N. Main Street, Porterville, California, adjacent to our administrative headquarters. Both of those buildings are situated on unencumbered property owned by the Company. The Company also owns unencumbered property on which 18 of our other offices are located, namely the following branches: Bakersfield Ming, California City, Dinuba, Exeter, Farmersville, Fresno Shaw, Hanford, Lindsay, Lompoc, Porterville West Olive, San Luis Obispo, Santa Paula, Tehachapi Downtown, Tehachapi Old Town, Three Rivers, Tulare, Visalia Mooney and Woodlake. The remaining branches, as well as our technology center, loan production office in Rocklin, and remote ATM locations, are leased from unrelated parties. Management believes that existing back-office facilities are adequate to accommodate the Company’s operations for the immediately foreseeable future.

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ITEM 3. LEGAL PROCEEDINGS
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company is a party to claims and legal proceedings arising in the ordinary course of business. After taking into consideration information furnished by counsel to the Company as to the current status of these claims or proceedings to which the Company is a party, Management is of the opinion that the ultimate aggregate liability represented thereby, if any, will not have a material adverse effect on the financial condition of the Company.

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ITEM 4. MINE SAFETY DISCLOSURE
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(a) Market Information
Sierra Bancorp’s Common Stock trades on the NASDAQ Global Select Market under the symbol BSRR, and the CUSIP number for our stock is #82620P102. Trading in the Company’s Common Stock has not consistently occurred in high volumes, and such trading activity cannot always be characterized as an active trading market.
The following table summarizes trades of the Company’s Common Stock, setting forth the approximate high and low sales prices and volume of trading for the periods indicated, based upon information available via public sources:
Sale Price Of The Company's
Approximate Trading
Calendar
Common Stock
Volumes
Quarter End
High
Low
Shares
March 31, 2019
$
27.81
$
22.68
$
1,928,277
June 30, 2019
27.98
24.01
1,385,742
September 30, 2019
27.36
23.75
1,851,314
December 31, 2019
30.15
25.78
2,064,085
March 31, 2020
29.37
13.05
2,721,500
June 30, 2020
21.87
14.86
3,491,600
September 30, 2020
20.13
15.84
2,434,100
December 31, 2020
24.72
16.47
2,416,100
(b) Holders
As of January 31, 2021 there were an estimated 6,292 shareholders of the Company’s Common Stock. There were 757 registered holders of record on that date, and per Broadridge, an investor communication company, there were 5,535 beneficial holders with shares held under a street name, including “objecting beneficial owners” whose names and addresses are unavailable. Since some holders maintain multiple accounts, it is likely that the above numbers overstate the actual number of the Company’s shareholders.
(c) Dividends
The Company paid cash dividends totaling $12.2 million, or $0.80 per share in 2020 and $11.3 million, or $0.74 per share in 2019, which represents 34% of annual net earnings for 2020 and 32% for 2019. The Company’s general dividend policy is to pay cash dividends within the range of typical peer payout ratios, provided that such payments do not adversely affect the Company’s financial condition and are not overly restrictive to its growth capacity. However, in the past when many of our peers elected to suspend dividend payments, the Company’s Board determined that we should continue to pay a certain level of dividends without regard to peer payout ratios, as long as our core operating performance was adequate and policy or regulatory restrictions did not preclude such payments. That said, no assurance can be given that our financial performance in any given year will justify the continued payment of a certain level of cash dividend, or any cash dividend at all.
As a bank holding company that currently has no significant assets other than its equity interest in the Bank, the Company’s ability to declare dividends depends upon cash on hand as supplemented by dividends from the Bank. The Bank’s dividend practices in turn depend upon the Bank’s earnings, financial position, regulatory standing, ability to meet current and anticipated regulatory capital requirements, and other factors deemed relevant by the Bank’s Board of Directors. The authority of the Bank’s Board of Directors to declare cash dividends is also subject to statutory restrictions. Under California banking law, the Bank may at any time declare a dividend in an amount not to exceed the lesser of (i) its retained earnings, or (ii) its net income for the last three fiscal years reduced by distributions to the Bank’s shareholder during such
period. However, with the prior approval of the California Commissioner of Department of Financial Protection and Innovation, the Bank may declare a larger dividend, in an amount not exceeding the greatest of (i) the retained earnings of the Bank, (ii) the net income of the Bank for its last fiscal year, or (iii) the net income of the Bank for its current fiscal year.
The Company’s ability to pay dividends is also limited by state law. California law allows a California corporation to pay dividends if its retained earnings equal at least the amount of the proposed dividend plus any preferred dividend arrears amount. If a California corporation does not have sufficient retained earnings available for the proposed dividend, it may still pay a dividend to its shareholders if immediately after the dividend the value of the company’s assets would equal or exceed the sum of its total liabilities plus any preferred dividend arrears amount. In addition, during any period in which the Company has deferred the payment of interest otherwise due and payable on its subordinated debt securities, it may not pay any dividends or make any distributions with respect to its capital stock (see “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources”).
(d) Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information as of December 31, 2020 with respect to stock options and restricted stock units outstanding, and available under our 2017 Stock Incentive Plan and the now-terminated 2007 Stock Incentive Plan, which are our only equity compensation plans other than an employee benefit plan meeting the qualification requirements of Section 401(a) of the Internal Revenue Code:
Plan Category
Number of Securities to be Issued Upon Vesting of Restricted Stock Units
Number of Securities
to be Issued Upon Exercise
of Outstanding Options
Weighted-Average
Exercise Price of
Outstanding Options
Number of Securities
Remaining Available
for Future Issuance
Equity compensation plans approved by security holders
148,885
495,489
$
23.67
408,515
(e) Performance Graph
Below is a five-year performance graph comparing the cumulative total return on the Company’s common stock to the cumulative total returns of the NASDAQ Composite Index (a broad equity market index), the SNL Bank Index, and the SNL $1 billion to $5 billion Bank Index (the latter two qualifying as peer bank indices), assuming a $100 investment on December 31, 2014 and the reinvestment of dividends.
Period Ending
Index
12/31/2015
12/31/2016
12/31/2017
12/31/2018
12/31/2019
12/31/2020
Sierra Bancorp
100.00
154.87
157.99
146.24
182.19
155.42
NASDAQ Composite
100.00
108.87
141.13
137.12
187.44
271.64
SNL Bank $1B-$5B
100.00
143.87
153.37
134.37
163.35
138.81
SNL Bank
100.00
126.35
149.21
124.00
167.93
145.49
Source: S&P Global Market Intelligence
(f) Stock Repurchases
In September 2016 the Board authorized an additional 500,000 shares of common stock for repurchase under the Company’s existing stock buyback plan initially adopted in 2003. The 2003 repurchase plan has no expiration date, but from time-to-time, the Company will authorize additional shares to be repurchased if all previous authorizations have been exhausted. At this time, the Company has 344,862 shares remaining under the 2016 additional authorization, but has currently suspended repurchasing shares. The Company may resume repurchasing shares at a later date. The authorization of shares for repurchase does not provide assurance that a specific quantity of shares will be repurchased, and the program may be suspended at any time at Management’s discretion.

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ITEM 6. SELECTED FINANCIAL DATA
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected historical financial information concerning the Company, which should be read in conjunction with our audited consolidated financial statements, including the related notes, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein. The selected financial data as of December 31, 2020 and 2019, and for each of the years in the three year period ended December 31, 2018, is derived from our audited consolidated financial statements and related notes which are included in this Annual Report. The selected financial data presented for earlier years is from our audited financial statements which are not included in this Annual Report. Throughout this Annual Report, information is for the consolidated Company unless otherwise stated.
Selected Financial Data
(dollars in thousands, except per share data)
As of and for the years ended December 31,
Operating Data
Interest income
$
110,243
$
110,947
$
101,638
$
80,924
$
68,505
Interest expense
5,408
13,578
9,244
5,223
3,323
Net interest income before provision for loan and lease losses
104,835
97,369
92,394
75,701
65,182
Provision (benefit) for loan and lease losses
8,550
2,550
4,350
(1,140)
-
Noninterest income
26,150
23,477
21,564
21,779
19,238
Noninterest expense
75,912
70,578
70,024
65,441
58,053
Income before income taxes
46,523
47,718
39,584
33,179
26,367
Provision for income taxes
11,079
11,757
9,907
13,640
8,800
Net income
35,444
35,961
29,677
19,539
17,567
Selected Balance Sheet Summary
Total loans and leases, net
2,442,226
1,755,538
1,724,780
1,551,551
1,255,754
Allowance for loan and lease losses
17,738
9,923
9,750
9,043
9,701
Securities available for sale
543,974
600,799
560,479
558,329
530,083
Cash and due from banks
71,417
80,077
74,132
70,137
120,442
Foreclosed assets
1,082
5,481
2,225
Premises and equipment, net
27,505
27,435
29,500
29,388
28,893
Total interest-earning assets
2,989,709
2,370,858
2,286,952
2,118,875
1,827,192
Total assets
3,220,742
2,593,819
2,522,502
2,340,298
2,032,873
Total interest-bearing liabilities
1,898,104
1,558,080
1,561,039
1,417,590
1,277,416
Total deposits
2,624,606
2,168,374
2,116,340
1,988,386
1,695,471
Total liabilities
2,876,846
2,284,534
2,249,478
2,084,356
1,826,995
Total shareholders' equity
343,896
309,285
273,024
255,942
205,878
Per Share Data
Net income per basic share
2.33
2.35
1.94
1.38
1.30
Net income per diluted share
2.32
2.33
1.92
1.36
1.29
Book value
22.35
20.24
17.84
16.81
14.94
Cash dividends
0.80
0.74
0.64
0.56
0.48
Weighted average common shares outstanding basic
15,216,749
15,311,113
15,261,794
14,172,196
13,530,293
Weighted average common shares outstanding diluted
15,280,325
15,437,111
15,432,120
14,357,782
13,651,804
Key Operating Ratios:
Performance Ratios: (1)
Return on average equity
10.80%
12.23%
11.37%
8.82%
8.71%
Return on average assets
1.22%
1.40%
1.23%
0.93%
0.95%
Net interest spread (tax-equivalent) (4)
3.83%
3.90%
4.03%
3.90%
3.86%
Net interest margin (tax-equivalent)
3.95%
4.19%
4.24%
4.04%
3.95%
Dividend payout ratio
34.33%
31.49%
32.99%
40.61%
36.97%
Equity to assets ratio
11.28%
11.44%
10.80%
10.53%
10.93%
Efficiency ratio (tax-equivalent)
57.18%
57.46%
60.79%
65.52%
67.23%
Net loans to total Deposits at Period end
93.05%
80.96%
81.50%
78.03%
74.07%
Asset Quality Ratios: (1)
Non-performing loans to total loans (2)
0.31%
0.33%
0.30%
0.25%
0.50%
Non-performing assets to total loans and other real estate owned (2)
0.35%
0.37%
0.36%
0.60%
0.68%
Net (recoveries) charge-offs to average loans
0.04%
0.14%
0.22%
(0.04)%
0.06%
Allowance for loan and lease losses to total loans at period end
0.72%
0.56%
0.57%
0.58%
0.77%
Allowance for Loan and Lease Losses to Non-Performing Loans
233.46%
172.96%
189.10%
228.19%
152.41%
Regulatory Capital Ratios: (3)
Common equity tier 1 capital to risk-weighted assets
NA
13.27%
12.61%
12.84%
14.09%
Tier 1 capital to adjusted average assets (leverage ratio)
10.50%
11.91%
11.49%
11.32%
11.92%
Tier 1 capital to risk-weighted assets
NA
14.98%
14.38%
14.79%
16.53%
Total capital to risk-weighted assets
NA
15.48%
14.89%
15.32%
17.25%
(1) Asset quality ratios are end of period ratios. Performance ratios are based on average daily balances during the periods indicated.
(2) Performing TDR’s are not included in nonperforming loans and are therefore not included in the numerators used to calculate these ratios.
(3) For definitions and further information relating to regulatory capital requirements, see “Item 1, Business - Supervision and Regulation - Capital Adequacy Requirements” herein.
(4) Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion presents Management’s analysis of the Company’s financial condition as of December 31, 2020 and 2019, and the results of operations for each year in the three-year period ended December 31, 2020. The discussion should be read in conjunction with the Company’s consolidated financial statements and the notes related thereto presented elsewhere in this Form 10-K Annual Report (see Item 8 below).
Statements contained in this report or incorporated by reference that are not purely historical are forward looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended, including the Company’s expectations, intentions, beliefs, or strategies regarding the future. All forward-looking statements concerning economic conditions, growth rates, income, expenses, or other values which are included in this document are based on information available to the Company on the date noted, and the Company assumes no obligation to update any such forward-looking statements. It is important to note that the Company’s actual results could materially differ from those in such forward-looking statements. Risk factors that could cause actual results to differ materially from those in forward-looking statements include but are not limited to those outlined previously in Item 1A.
Critical Accounting Policies
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information and disclosures contained within those statements are significantly impacted by Management’s estimates and judgments, which are based on historical experience and incorporate various assumptions that are believed to be reasonable under current circumstances. Actual results may differ from those estimates under divergent conditions.
Critical accounting policies are those that involve the most complex and subjective decisions and assessments and have the greatest potential impact on the Company’s stated results of operations. In Management’s opinion, the Company’s critical accounting policies deal with the following areas: the establishment of an allowance for loan and lease losses, as explained in detail in Note 2 to the consolidated financial statements and in the “Provision for Loan and Lease Losses” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis; the valuation of impaired loans and foreclosed assets, as discussed in Note 2 to the consolidated financial statements; income taxes and deferred tax assets and liabilities, especially with regard to the ability of the Company to recover deferred tax assets as discussed in the “Provision for Income Taxes” and “Other Assets” sections of this discussion and analysis; and goodwill and other intangible assets, which are evaluated annually for impairment and for which we have determined that no impairment exists, as discussed in Note 2 to the consolidated financial statements and in the “Other Assets” section of this discussion and analysis. Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate the most recent expectations with regard to those areas.
Overview of the Results of Operations and Financial Condition
Results of Operations Summary
The Company recognized net income of $35.4 million in 2020 relative to $36.0 million in 2019 and $29.7 million in 2018. Net income per diluted share was $2.32 in 2020, as compared to $2.33 in 2019 and $1.92 for 2018. The Company’s return on average assets and return on average equity were 1.22% and 10.80%, respectively, in 2020, as compared to 1.40% and 12.23%, respectively, in 2019 and 1.23% and 11.37%, respectively, for 2018. Our financial results have been stable over the past year despite a higher level of loan and lease loss provisioning and elevated noninterest expenses, due to a higher volume of loans, and a strong base of core deposits, combined with a higher level of nonrecurring items, as discussed in greater detail in the applicable sections below. Furthermore, the Company’s financial performance was favorably affected by a substantially lower corporate income tax rate starting in 2018. The following is a summary of the major factors that impacted the Company’s results of operations for the years presented in the consolidated financial statements.
● Net interest income improved by 8% in 2020 over 2019 and 5% in 2019 over 2018, due primarily to a lower cost of interest-bearing liabilities and growth in earning assets. The increase in average earning
assets in 2020 over 2019 was due primarily to a $170.2 million increase in average balance of real estate loans, a $62.2 million increase in average balances of commercial loans, and a $87.1 million increase in average balances of mortgage warehouse loans, partially offset by decreases in other loan categories. The increase in real estate loans was organic, driven by concerted business development efforts by our loan production offices in 2020. The increase in commercial loans was due to the Company’s participation in the SBA Paycheck Protection Program (PPP) lending initiative, in order to assist our customers impacted by the COVID-19 Pandemic. The increase in average mortgage warehouse loans throughout 2020 was primarily a result of increased demand for housing and refinancing due to low rates in 2020 coupled with proactive mortgage warehouse pricing and marketing to mortgage lenders. The positive impact of average asset growth in 2020 was augmented by a 54 bps decrease in yield on interest bearing liabilities but was partially offset by a 60 basis point decline in yield on interest earning assets. The net interest margin in 2020 was 24 bps lower than 2019.
The increase in average earning assets in 2019 over 2018 was due primarily to a $90.0 million increase in average balance of real estate loans and a $48.1 million increase in average balances of mortgage warehouse loans, partially offset by decreases in other loan categories. The increase in real estate loans was driven primarily by organic growth in late 2018 and early 2019 but were offset by paydowns in the second half of 2019. The increase in average mortgage warehouse loans in 2019 was primarily a result of proactive pricing and marketing to mortgage lenders in the lower mortgage rate cycle in 2019. The positive impact of average asset growth in 2019 was partially offset by a 5 basis point decline in net interest margin due to the lower rate environment in the second half of 2019.
Net interest income has also been impacted by nonrecurring interest items, which added $0.38 million to interest income in 2020 relative to $0.82 million in 2019 and $0.28 million in 2018.
● We recorded a loan and lease loss provision of $8.6 million in 2020, as compared to $2.6 million in 2019 and $4.4 million in 2018. The 2020 provision was deemed necessary subsequent to our determination of the appropriate level for our allowance for loan and lease losses and was driven by strong loan growth in the second half of 2020 and continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy and our loan customers overall. In addition, we considered the impacts of credit quality, organic growth in non-owner occupied commercial real estate loan balances, reserves required for specifically identified impaired loan balances, and downgrades of certain loans deferred under section 4013 of the CARES Act. The 2019 and 2018 provisions were deemed necessary subsequent to our determination of the appropriate level for our allowance for loan and lease losses, taking into consideration overall credit quality, growth in outstanding loan balances, and reserves required for specifically identified impaired loan balances (including reserves in 2019 for a $2.8 million loan that was placed on non-accrual status shortly before the end of the third quarter and partially charged off in the fourth quarter of 2019.)
● Noninterest income increased by $2.7 million, or 11%, in 2020, and by $1.9 million or 9%, in 2019 over 2018. The increase in 2020 was primarily due to a $1.5 million gain from the wrap up of low-income housing tax credit fund investments, a decrease of $0.9 million in low-income housing tax credit fund expenses, an increase of $0.2 million in the valuation gain of restricted equity investments owned by the Company and a $0.6 million increase in the net gain on the sale of debt securities. Fluctuations in BOLI associated with deferred compensation plans contributed $0.2 million to the increase. The increase in 2019 was primarily due to favorable fluctuation in bank-owned life insurance (“BOLI”) income associated with deferred compensation income, and a nonrecurring charge in 2018 as described below.
● Noninterest expense increased by $5.3 million, or 8%, in 2020 as compared to 2019, and increased by $0.55 million, or 1%, in 2019 over 2018. The increase in noninterest expense in 2020 was due mostly to a $4.2 million increase in salaries and benefits expense. Deposit services and other professional services also contributed to the difference. The slight increase in noninterest expense in 2019 was due mostly to other real estate owned (“OREO”) expense and directors deferred compensation expense associated with the BOLI income described above.
● The Company recorded income tax provisions of $11.1 million, or 24% of pre-tax income in 2020; $11.8 million, or 25% of pre-tax income in 2019; and $9.9 million, or 25% of pre-tax income in 2018. As expected, the overall tax rate remained relatively stable throughout 2020, 2019 and 2018.
Financial Condition Summary
The Company’s assets totaled $3.2 billion at December 31, 2020 as compared to $2.6 billion at December 31, 2019. Total liabilities were $2.9 billion at December 31, 2020 as compared to $2.3 billion at the end of 2019, and shareholders’ equity totaled $343.9 million at December 31, 2020 compared to $309.3 million at December 31, 2019. The following is a summary of key balance sheet changes during 2020.
● Total assets increased by $626.9 million, or 24%. The increase resulted primarily from earning asset growth including $694.5 million of loan growth (net of deferred fees), partially offset by a $56.8 million decrease in investment securities.
● Loans and leases (net of deferred fees) were up $694.5 million, or 39%. Loan growth consisted mainly of a $507.9 million increase in non-agricultural real estate loans, as well as a $118.6 million increase in mortgage warehouse lines, and $119.4 million in SBA PPP loans.
● Deposit balances reflect net growth of $456.2 million, or 21%. Deposit growth in 2020 was primarily a result of organic growth of noninterest bearing or low-cost transaction accounts, including savings accounts. The increase in brokered deposits offset the decrease in customer time deposits.
● Total capital increased by $34.6 million, or 11%, ending the year with a balance of $343.9 million. The increase in capital is due mostly to the addition of net income and capital from stock options exercised, net of dividends paid.
IMPACT OF CORONAVIRUS DISEASE 2019 (COVID-19) PANDEMIC ON THE COMPANY’S OPERATIONS
Overview
On January 31, 2020, the United States Department of Health and Human Services declared a public health emergency with respect to the Coronavirus Disease 2019 (COVID-19). Subsequent to this date, federal, state, and local governmental agencies, regulatory agencies, and the Federal Reserve Board took actions impacting the Company including these more significant items:
● On March 3, 2020, the Federal Open Market Committee (FOMC) of the Federal Reserve Board lowered the federal funds rate by 50 basis points in its first emergency move since October 2008.
● On March 4, 2020, the Governor of the state of California declared a state of emergency to help make additional resources available and formalize emergency actions to address COVID-19.
● On March 6, 2020, the Federal Financial Institutions Examination Council (FFIEC) issued guidance to financial institutions reminding them to include pandemic planning in business continuity plans.
● Starting on March 9, 2020, the Board of Governors of the Federal Reserve System, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, and Conference of State Bank Supervisors began issuing various Interagency Guidance Statements to encourage financial institutions to meet the financial needs of customers affected by the Coronavirus.
● On March 11, 2020, the World Health Organization declared COVID-19 a pandemic.
● On March 15, 2020, the FOMC of the Federal Reserve Board lowered the federal funds rate by 100 basis points in its second emergency move in two weeks, this time on a Sunday. In addition, the FOMC announced that it would let banks borrow from the discount window for up to 90 days, reduced the reserve requirement ratios to zero percent, united with five other central banks to ensure dollars are available via swap lines, and increased bond holdings by at least $700 billion.
● Effective March 20, 2020, the state of California ordered the closure of all non-essential workplaces, restricting non-essential travel, and ordering a state-wide shelter-in-place order. This was followed by extensions of these orders in April and many local municipalities in which the Company operates issued orders mandating additional requirements to protect their citizens. Although many counties in California began phased reopening plans, due to recent increases in cases effective July 13, 2020, the Governor ordered that dine-in restaurants, wineries and tasting rooms, movie theaters, family entertainment centers, zoos and museums, and cardrooms immediately close all indoor operations. Effective August 31, 2020, a new simplified, four-tier guideline was implemented for counties to reopen. Counties must remain in a tier for at least three weeks before moving to the next tier. This four-tier guideline was suspended and a state-wide shelter-in-place order was reinstated on December 3, 2020, amid surging cases in California. California returned to its four-tier system on January 25, 2021.
● On March 22, 2020, the federal financial institution regulatory agencies (the agencies) issued guidance to financial institutions to suspend the requirements to classify certain loan modifications as troubled debt restructurings (TDRs). The guidance was subsequently modified on April 7, 2020 to conform with Section 4013 of the CARES Act. Further interagency guidance for financial institutions was issued in June, August, and September 2020.
● On March 27, 2020, the CARES Act was enacted by Congress and signed into law by the President to address the impact of the COVID-19 on the economy. Among other things, the CARES Act provided banking institutions with the option of deferring the implementation of the Current Expected Credit Loss (“CECL”) accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-13 and related amendments, Financial Instruments - Credit Losses (Topic 326) until later in 2020; confirmed that certain loan modifications would not be treated as a TDR; authorized the Small Business Administration to create the Paycheck Protection Program (PPP) which allows banking institutions to offer a certain amount of forgivable loans to primarily assist with funding payroll for small businesses; and provides a temporary reduction to the minimum ratio under the Community Bank Leverage Ratio framework.
● On December 21, 2020, the Consolidated Appropriation Act, 2021 was enacted by Congress and signed into law by the President on December 27, 2020. The bill is one of the largest spending measures ever enacted surpassing the CARES Act. The pandemic relief portion of the bill includes $284 billion in forgivable loans via the PPP, extension of the suspension of TDR identification, and the extension of the temporary delay of the implementation of CECL.
Impact of COVID-19 on the Company’s Operations
● The Company has had an $18.1 million increase in classified assets, including $1.4 million in non-accrual loans as a result of COVID-19 due to loans modified under the Interagency Guidance that are either not expected to make all principal and interest payments in a timely manner, or have had further modifications or assistance. Further, we had charge-offs as a result of COVID-19 of less than $0.02 million. Starting in April 2020, the Company took actions to mitigate the impact on credit losses including permitting short-term payment deferrals to current customers, as well as providing bridge loans and SBA PPP loans. For further information on the principal and interest deferrals, please see the “Nonperforming Assets” section below. However, the uncertainty of national and local economic conditions had a material impact on our provision for loan and lease losses. The Company elected under Section 4014 of the CARES Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020. In December 2020, the Consolidated Appropriations Act, 2021, extended the deferral of implementation of CECL from December 31, 2020, to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022. Although this deferral will still require CECL to be implemented as of January 1, 2022, the Company believes that the deferral will provide time to better assess the impact of the COVID-19 pandemic on the expected lifetime credit losses in our loan and lease portfolio. The most significant unknown factor is how long economic activity will be impacted by COVID-19, and in turn how deeply that will impact the markets in which we operate. Therefore, more time was needed to assess the impact of this economic uncertainty and related actions taken such as the stimulus provisions of the CARES Act on the Company’s allowance for loan and lease losses under the CECL methodology.
● In addition to the expected increase in provision for loan and lease losses, the Company expects that net interest income could be adversely impacted over time given pressure on net interest margin as a result of the FOMC’s emergency rate cuts in March 2020. For example, our net interest margin for the year ended December 31, 2020, was 3.95%, compared to a net interest margin of 4.19% for the same period in 2019. New loans booked in 2020 have been at lower rates and although deposit costs have also declined, deposit costs were already low or at their floors prior to these interest rate cuts. Further, the stay-at-home order and record unemployment resulting from the COVID-19 pandemic has reduced consumer spending which has reduced our fee income, primarily from overdraft activity.
● The COVID-19 pandemic has not adversely affected our capital or financial resources as of December 31, 2020. During the year ending 2020, total shareholders’ equity increased by $34.6 million, or 11%, to $343.9 million. A large component of this was an $12.5 million increase in accumulated other comprehensive income as a result of increases in the value of our investment portfolio due to lower interest rates. If interest rates rise, this component of equity would be expected to decline. In addition, the Company earned $35.4 million in net income for the year ending 2020 and paid dividends of $12.2 million. The Company also paid a twenty-one cent per share dividend on February 12, 2021. Although presently not expected, if the Company were to incur significant credit losses as a result of COVID-19’s impact on our customers’ ability to repay loans, capital could be adversely impacted. With respect to liquidity, the Company maintains strong primary and secondary liquidity sources as further described under “Liquidity and Market Risk Management” below.
● While we do not expect COVID-19 to affect our ability to account timely for the assets on our balance sheet, this could change in future periods. Certain valuation assumptions and judgments continue to change to account for pandemic-related circumstances such as widening credit spreads. However, we do not anticipate any significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP. As of December 31, 2020, our goodwill was not impaired. The Company performed a qualitative assessment of its goodwill at December 31, 2020 and concluded that it was not more likely than not that a goodwill impairment exists. The Company will continue to monitor its goodwill recorded on the balance sheet for potential impairment. In the event that we conclude that all or a portion of our goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. At December 31, 2020, we had goodwill of $27.4 million which represented 8% of total equity.
The Company continues to serve its customers. Out of our 40 branch locations, four are open with limited lobby hours, while 8 branches have limited lobby hours and a drive-up or walk-up facility. 23 branches are open for drive-up or walk-up only and five branches are currently closed except by appointment. Approximately 75% of our back-office and corporate employees are working remotely and it has not adversely affected our operations. In addition, none of our internal controls have significantly changed or are expected to change as a result of the remote work arrangements other than the use of remote approvals. The Company is prepared to continue operating in this manner until it is safe to begin bringing those working remotely back to our corporate offices and branches. As a result of the on-going COVID-19 pandemic, several of our branch lobbies remained closed as described above. In February 2021, the Board of Directors of the Company decided to explore the possibility of permanently closing up to five of the branches whose lobbies were closed during the pandemic. The branches being considered for permanent closure are outside of the bank’s primary market. The total lease breakage fee is estimated to be less than $0.3 million, in addition to the acceleration of the amortization of certain leasehold improvements. Any closures would likely occur in the third quarter of 2021 after timely notices are provided to customers.
● To date, the Company did not experience any challenges in implementing its business continuity plans. The Company’s Risk Management team began preparing in late January and early February with ordering of supplies such as hand sanitizer, masks and cleaning supplies, as well as laptops for those who did not have one. This enabled the Company to immediately communicate and implement plans to continue operations in our banking facilities while enabling those non-customer facing employees to immediately begin working remotely. The Company did not face any material resource constraints in implementing these plans.
● As a financial institution providing essential services, the Company expects continued demand for loans and deposits. As described above, it is expected that certain services may see declines in demand such as debit and credit card interchange given lower consumer spending. While overall net income is expected to decline, it presently is more a function of the interest rate environment than a change in overall demand for loan and deposit products.
● The Company loosened its vacation and sick-time policies to accommodate our employees who were affected by COVID-19. The Company has not had any temporary or permanent reductions in staff as a result of COVID-19.
Results of Operations
The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on deposits and other borrowed money. The second is noninterest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as BOLI and investment gains. The majority of the Company’s noninterest expense is comprised of operating costs that facilitate offering a full range of banking services to our customers.
Net Interest Income and Net Interest Margin
Net interest income was $104.8 million in 2020 as compared to $97.4 million in 2019 and $92.4 million in 2018. This equates to increases of 8% in 2020 and 5% in 2019. The level of net interest income we recognize in any given period depends on a combination of factors including the average volume and yield for interest-earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. Net interest income is also impacted by the acceleration of net deferred loan fees and costs for loans paid off early (including SBA PPP loans forgiven), reversal of interest for loans placed on non-accrual status, and the recovery of interest on loans that had been on non-accrual and were paid off, sold, or returned to accrual status.
The following table shows average balances for significant balance sheet categories and the amount of interest income or interest expense associated with each category for each of the past three years. The table also displays calculated yields on
each major component of the Company’s investment and loan portfolios, average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for the noted periods.
Distribution, Rate & Yield
(dollars in thousands, except footnotes)
Year Ended December 31,
Average
Income/
Average
Average
Income/
Average
Average
Income/
Average
Assets
Balance(1)
Expense
Rate/Yield(2)
Balance(1)
Expense
Rate/Yield(2)
Balance(1)
Expense
Rate/Yield(2)
Investments:
Federal funds sold/due from banks
$
25,228
$
0.62%
$
16,346
$
2.30%
$
13,237
$
1.80%
Taxable
379,024
8,199
2.16%
423,453
10,139
2.39%
422,848
9,548
2.26%
Non-taxable
216,387
5,707
3.34%
160,787
4,534
3.57%
140,300
4,060
2.89%
Equity
-
-
-
-
-
-
-
-
-
Total investments
620,639
14,062
2.51%
600,586
15,049
2.71%
576,385
13,846
2.40%
Loans and Leases: (3)
Real estate
1,610,686
79,175
4.92%
1,440,465
79,777
5.54%
1,350,425
73,006
5.41%
Agricultural
47,299
1,887
3.99%
50,042
2,973
5.94%
52,031
2,980
5.73%
Commercial
179,924
6,738
3.74%
117,679
5,918
5.03%
124,809
5,969
4.78%
Consumer
6,584
1,069
16.24%
8,497
1,340
15.77%
9,755
1,251
12.82%
Mortgage warehouse
221,319
7,135
3.22%
134,171
5,695
4.24%
86,030
4,415
5.13%
Other
2,878
6.15%
2,894
6.74%
2,682
6.38%
Total loans and leases
2,068,690
96,181
4.65%
1,753,748
95,898
5.47%
1,625,732
87,792
5.40%
Total interest earning assets (4)
2,689,329
110,243
4.16%
2,354,334
110,947
4.76%
2,202,117
101,638
4.66%
Other earning assets
13,103
12,421
10,514
Non-earning assets
207,590
202,810
204,316
Total assets
$
2,910,022
$
2,569,565
$
2,416,947
Liabilities and shareholders' equity
Interest bearing deposits:
Demand deposits
$
121,867
$
0.23%
$
106,849
$
0.30%
$
119,432
$
0.30%
NOW
497,984
0.08%
444,619
0.12%
425,596
0.11%
Savings accounts
336,620
0.07%
289,727
0.11%
298,021
0.11%
Money market
124,755
0.10%
124,625
0.15%
149,024
0.10%
Certificates of deposit<$100,000
77,119
0.42%
88,792
1,035
1.17%
81,940
0.75%
Certificates of deposit>$100,000
359,687
2,361
0.66%
396,465
7,896
1.99%
310,880
5,039
1.62%
Brokered deposits
36,071
0.68%
48,392
1,120
2.31%
16,822
1.81%
Total interest bearing deposits
1,554,103
3,948
0.25%
1,499,469
11,380
0.76%
1,401,715
7,260
0.52%
Borrowed funds:
Federal funds purchased
1,918
0.21%
0.32%
-
-
Repurchase agreements
34,614
0.40%
22,090
0.40%
14,332
0.40%
Short term borrowings
54,244
0.19%
13,229
2.06%
8,967
2.19%
TRUPS
35,031
1,217
3.47%
34,853
1,836
5.27%
34,673
1,731
4.99%
Total borrowed funds
125,807
1,460
1.16%
70,485
2,198
3.12%
57,994
1,984
3.42%
Total interest bearing liabilities
1,679,910
5,408
0.32%
1,569,954
13,578
0.86%
1,459,709
9,244
0.63%
Noninterest bearing demand deposits
862,274
664,061
665,941
Other liabilities
39,510
41,563
30,383
Shareholders' equity
328,328
293,987
260,914
Total liabilities and shareholders' equity
$
2,910,022
$
2,569,565
$
2,416,947
Interest income/interest earning assets
4.15%
4.76%
4.66%
Interest expense/interest earning assets
0.20%
0.58%
0.42%
Net interest income and margin(5)
$
104,835
3.95%
$
97,369
4.19%
$
92,394
4.24%
(1) Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.
(2) Yields and net interest margin have been computed on a tax equivalent basis.
(3) Loans are gross of the allowance for possible loan and lease losses. Net loan fees have been included in the calculation of interest income. Net loan fees (costs) and loan acquisition FMV amortization were $1.9 million, $(0.4) million, and $0.8 million for the years ended December 31, 2020, 2019, and 2018 respectively.
(4) Non-accrual loans are slotted by loan type and have been included in total loans for purposes of total interest earning assets.
(5) Net interest margin represents net interest income as a percentage of average interest-earning assets (tax-equivalent).
The Volume and Rate Variances table below sets forth the dollar difference for the comparative periods in interest earned or paid for each major category of interest-earning assets and interest-bearing liabilities, and the amount of such change attributable to fluctuations in average balances (volume) or differences in average interest rates. Volume variances are equal to the increase or decrease in average balances multiplied by prior period rates, and rate variances are equal to the
change in rates multiplied by prior period average balances. Variances attributable to both rate and volume changes, calculated by multiplying the change in rates by the change in average balances, have been allocated to the rate variance.
Volume & Rate Variances
(dollars in thousands)
Years Ended December 31,
2020 over 2019
2019 over 2018
Increase(decrease) due to
Increase(decrease) due to
Assets:
Volume
Rate
Net
Volume
Rate
Net
Investments:
Federal funds sold/due from time
$
$
(424)
$
(220)
$
$
$
Taxable
(1,064)
(876)
(1,940)
Non-taxable
1,568
(395)
1,173
(119)
Equity
-
-
-
-
-
-
Total investments
(1,695)
(987)
1,203
Loans and leases:
Real estate
9,427
(10,029)
(602)
4,868
1,903
6,771
Agricultural
(163)
(923)
(1,086)
(114)
(7)
Commercial
3,130
(2,310)
(341)
(51)
Consumer
(302)
(271)
(161)
Mortgage warehouse
3,699
(2,259)
1,440
2,471
(1,191)
1,280
Other
(1)
(17)
(18)
Total loans and leases
15,790
(15,507)
6,737
1,369
8,106
Total interest earning assets
$
16,498
$
(17,202)
$
(704)
$
7,391
$
1,918
$
9,309
Liabilities:
Interest bearing deposits:
Demand
$
$
(82)
$
(38)
$
(38)
$
(10)
$
(48)
NOW
(199)
(136)
Savings accounts
(137)
(87)
(9)
(6)
Money market
-
(53)
(53)
(24)
Certificates of deposit < $100,000
(136)
(573)
(709)
Certificates of deposit > $100,000
(732)
(4,803)
(5,535)
1,387
1,470
2,857
Brokered deposits
(285)
(589)
(874)
Total interest bearing deposits
(996)
(6,436)
(7,432)
1,960
2,160
4,120
Borrowed funds:
Borrowed funds:
Federal funds purchased
(2)
-
Repurchase agreements
(1)
-
Short term borrowings
(1,017)
(171)
(16)
Long term borrowings
-
-
-
-
-
-
TRUPS
(628)
(619)
Total borrowed funds
(1,648)
(738)
Total interest bearing liabilities
(86)
(8,084)
(8,170)
2,093
2,241
4,334
Net interest income
$
16,584
$
(9,118)
$
7,466
$
5,298
$
(323)
$
4,975
Net interest income in 2020 as compared to 2019 was impacted by a favorable volume variance of $16.6 million partially offset by an unfavorable $9.1 million rate variance. For 2019 relative to 2018, net interest income reflects a favorable volume variance of $5.3 million partially offset by an unfavorable $0.3 million rate variance.
The 2020 volume variance is due mostly to increases in average balances, resulting from the organic growth in commercial real estate loans, growth in commercial loans due to our participation in the SBA PPP program and higher utilization of mortgage warehouse lines. Given the low rate environment, loan demand for our mortgage warehouse lines have increased, as demonstrated by the $3.7 million favorable volume variance. The 2019 volume variance is due mostly to increases in
average balances of real estate loans and mortgage warehouse lines. However, the ending balance of real estate loans ended 2019 approximately 3% lower than the balance at December 31, 2018.
The Company’s net interest margin, which is tax-equivalent net interest income as a percentage of average interest-earning assets declined by 24 basis points to 3.95% in 2020, and declined by 5 basis points to 4.19% in 2019 as compared to 2018. There was an unfavorable rate variance of $9.1 million since the weighted average yield on interest-earning assets fell by 60 basis points and the weighted average cost of interest-bearing liabil­ities decreased by 54 basis points. The change in the yield on interest-earning assets representing a much larger base than that of the interest-bearing liabilities. The rate variance was negatively impacted by the following factors: A shift in our earning asset mix into lower-yielding loans and investments; increased line utilization of mortgage warehouse lines; $54.3 million in average balances of low-yielding SBA PPP loans; partially offset by lower costs of time-deposits and other interest-bearing liabilities. The 2019 unfavorable rate variance is due partially to a lower rate environment in 2019, as well as a shift in the mix of earning assets to lower yielding mortgage warehouse lines and non-taxable investment securities coupled with an increase in rates paid on time deposits. Investment yields decreased in 2020 but increased in 2019 over 2018. The decrease in 2020 was due to the lower rate environment and its impact on all debt securities. Net interest margin is expected to be affected by the overall rate environment. A continued low rate environment will result in lower earning asset yields, which will be offset by the acceleration of fee income from SBA PPP loans in the near term.
The increase in 2019 over 2018 was primarily due to a continued plan to shift to higher yielding municipal bonds. Rates paid on non-maturity deposits declined in 2020 but were approximately the same for 2019 over 2018. There was a 5 basis point decrease on money market accounts in 2020 but was 5 basis points higher in 2019 over 2018. The weighted average cost of interest-bearing liabilities went down 54 bps in 2020 but was up 23 bps in 2019. Since the Federal Open Markets Committee of the Federal Reserve System kept the federal funds target rate at historical lows throughout 2020, time deposit rates in 2020 dropped 126 bps due to the relatively short duration of our time deposit portfolio. The 2019 increase was primarily because of higher rates paid on time deposits (including brokered deposits added in the last half of 2018). Overnight borrowings and adjustable-rate trust-preferred securities (“TRUPS”) are also tied to short-term rates which began lowering in the second half of 2019, but still remained higher overall in 2019 as compared to 2018 and remained low throughout 2020. During the year, adjustments to interest income occur due to the following adjustments: interest income recovered upon the resolution of nonperforming loans, the reversal of interest income when a loan is placed on non-accrual status, and accelerated fees or prepayment penalties recognized for early payoffs of loans. Such adjustments totaled $0.39 million in 2019, $0.82 million in 2019, and $0.28 million in 2018. Further, discount accretion on loans from whole-bank acquisitions enhanced our net interest margin by approximately two basis points in 2020, four basis points in 2019, and seven basis points in 2018.
Provision for Loan and Lease Losses
The Company recorded a loan and lease loss provision of $8.6 million in 2020; $2.6 million in 2019, and $4.4 million in 2018. The Company is subject to the adoption of the Current Expected Credit Loss ("CECL") accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments - Credit Losses (Topic 326) in 2020. However, in March 2020, the Company elected under Section 4014 of the CARES Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020. In December 2020, the Consolidated Appropriations Act, 2021 extended the deferral of implementation of CECL from December 31, 2020, to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022. Therefore, the Company expects to implement CECL on January 1, 2022.
The Company initially elected in the first quarter of 2020 to postpone implementation and will now continue to postpone implementation in order to provide additional time to assess better the impact of the COVID-19 pandemic on the expected lifetime credit losses. At the time of the initial decision, there was a significant economic uncertainty on the local, regional, and national levels as a result of local and state stay-at-home orders, as well as relief measures provided at a national, state, and local level. Further, the Company took actions to serve our communities during the pandemic, including permitting short-term payment deferrals to current customers, as well as originating bridge loans and SBA PPP loans. It was determined that more time was needed to assess the impact of the uncertainty and related actions on the Company's allowance for loan and lease losses under the CECL methodology.
The growth in the provision for loan and lease losses in 2020, is due to the strong organic non-owner occupied commercial real estate loan growth generated in the second half of 2020 and the continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy. The provision was also impacted by downgrades of certain loans deferred under section 4013 of the CARES Act, including 10 loans for $1.4 million placed on non-accrual at the end of the deferral period. Management evaluated its qualitative risk factors under our current incurred loss model and adjusted these factors for economic conditions, changes in the mix of the portfolio due to loans subject to a payment deferral, potential changes in collateral values due to reduced cash flows, and external factors such as government actions. In particular, the uncertainty regarding our customers' ability to repay loans could be adversely impacted by COVID-19, temporary business shut-downs, and reduced consumer and business spending.
Two separate impaired loans impacted the provision for loan and lease losses in both 2019 and 2018. In 2019, additional reserve was booked in the third quarter 2019 for a $2.8 million loan placed on nonaccrual status resulting in a $1.2 million charge-off. The provision for 2018 includes $2.4 million for a large purchased participation loan that was placed on nonaccrual status in the third quarter 2018.
With the loan and lease loss provision recorded in 2020 we were able to maintain our allowance for loan and lease losses at a level that, in Management’s judgment, is adequate to absorb probable loan and lease losses related to specifically identified impaired loans as well as probable incurred losses in the remaining loan portfolio. Specifically identifiable and quantifiable loan and lease losses are immediately charged off against the allowance. The Company recorded net loan and lease losses of $0.7 million in 2020. The Company experienced net loan and lease losses of $2.4 million in 2019, including a $1.2 million charge-off on the loan placed on nonaccrual status in the third quarter 2019 as mentioned above. The Company experienced net loan and lease losses of $3.6 million in 2018, including a $2.4 million loss on the above-referenced participation loan. The loan and lease loss provision for 2020, 2019 and 2018 has been favorably impacted by the following factors: most charge-offs were recorded against pre-established reserves, which alleviated what otherwise might have been a need for reserve replenishment; loss rates for most loan types have been declining, thus having a positive impact on general reserves required for performing loans; and, new loans booked have been underwritten using continued tighter credit standards.
The Company’s policies for monitoring the adequacy of the allowance and determining loan amounts that should be charged off, and other detailed information with regard to changes in the allowance, are discussed in Note 2 to the consolidated financial statements and below under “Allowance for Loan and Lease Losses.” The process utilized to establish an appropriate allowance for loan and lease losses can result in a high degree of variability in the Company’s loan and lease loss provision, and consequently in our net earnings.
Noninterest Revenue and Operating Expense
The table below sets forth the major components of the Company’s noninterest revenue and operating expense for the years indicated, along with relevant ratios:
Non-Interest Income/Expense
(dollars in thousands)
Year Ended December 31,
% of Total
% of Total
% of Total
NONINTEREST INCOME:
Service charges on deposit accounts
$
11,765
44.99%
$
12,742
54.28%
$
12,439
57.69%
Checkcard fees
7,023
26.86%
6,584
28.04%
5,878
27.26%
Other service charges and fees
4,084
15.62%
4,231
18.02%
5,219
24.20%
Bank owned life insurance income
2,412
9.22%
2,184
9.30%
2.74%
Gain on sale of securities
1.49%
(198)
(0.84)%
0.01%
Loss on tax credit investment
(1,189)
(4.55)%
(2,079)
(8.86)%
(2,561)
(11.88)%
Other
1,665
6.37%
0.06%
(4)
(0.02)%
Total noninterest income
26,150
100.00%
23,477
100.00%
21,564
100.00%
As a % of average interest-earning assets
0.97%
1.00%
0.98%
OTHER OPERATING EXPENSES:
Salaries and employee benefits
40,178
52.93%
35,978
50.98%
36,133
51.61%
Occupancy costs
Furniture and equipment
2,028
2.67%
2,141
3.03%
2,632
3.76%
Premises
7,814
10.29%
7,704
10.91%
7,663
10.94%
Advertising and promotion costs
1,889
2.49%
2,568
3.64%
2,748
3.92%
Data processing costs
4,661
6.14%
4,564
6.47%
5,015
7.16%
Deposit services costs
8,483
11.17%
7,962
11.27%
5,413
7.73%
Loan services costs
Loan processing
1.16%
0.96%
1,142
1.64%
Foreclosed assets
0.33%
0.05%
(730)
(1.04)%
Other operating costs
Telephone and data communications
1,775
2.34%
1,529
2.17%
1,479
2.11%
Postage and mail
0.42%
0.62%
1.42%
Other
1,647
2.17%
1,798
2.55%
1,408
2.01%
Professional services costs
Legal and accounting
1,989
2.62%
2,072
2.94%
1,932
2.76%
Acquisition costs
-
0.00%
0.03%
0.64%
Other professional services costs
2,990
3.94%
2,492
3.53%
1,956
2.79%
Stationery and supply costs
0.59%
0.45%
1,387
1.98%
Sundry & tellers
0.74%
0.40%
0.57%
Total other operating expense
$
75,912
100.00%
$
70,578
100.00%
$
70,024
100.00%
As a % of average interest-earning assets
2.82%
3.00%
3.18%
Net noninterest income as a % of average interest-earning assets
(1.85)%
(2.00)%
(2.20)%
Efficiency ratio (1) (2)
57.18%
57.46%
60.79%
(1) Tax Equivalent
(2) Noninterest expense as a percentage of the sum of net interest income and noninterest income excluding net gains (losses) from securities and bank owned life insurance income.
Noninterest income improved in 2020 with a $2.7 million increase, or 11%, as compared to an increase of $1.9 million, or 9%, in 2019. Total noninterest income was 0.97% of average interest-earning assets in 2020 as compared to a ratio of 1.0% in 2019 and 0.98% in 2018. The ratio declined in 2020 due to a 14% increase in interest-earning assets.
The principal component of the Company’s noninterest revenue, service charges on deposit accounts, decreased by $1.0 million, or 8%, in 2020 as compared to 2019. The same line item declined by $0.3 million, or 2%, in 2019 over 2018. This line item is primarily driven by the volume of transaction accounts. As a percent of average transaction account balances, service charge income was 1.9% in 2020, and 1.0% in 2019 and 2018.
Checkcard fees consists of interchange fees from our customers’ use of debit cards for electronic funds transactions. This category increased by $0.4 million, or 7%, in 2020 as compared to 2019, and increased by $0.7 million, or 12%, in 2019 over 2018. The increases in 2020 and 2019 are primarily a result of growth in our deposit account base as well as increased usage of debit cards by our customers.
Other service charges and fees declined by $0.1 million, or 3%, in 2020 over 2019, and by $1.0 million, or 19%, in 2019 over 2018. The decrease in 2019, was due largely to two infrequent items occurring in 2018. In 2018, we had a $1.2 million write-up of our investment in Pacific Coast Bankers Bank (“PCBB”), due to Accounting Standards Update 2016-01 which required the Company to write the investment to fair value through earnings, as well as a $0.2 million special dividend received pursuant to our equity investment in the Federal Home Loan Bank of San Francisco (“FHLB”).
BOLI income generally fluctuates based on the market. In 2020 BOLI income increased by $0.2 million or 10%, and in 2019 BOLI income increased by $1.6 million, or 270%, over 2018. BOLI income is derived from two types of policies owned by the Company, namely “separate account” and “general account” life insurance, and the year over year variances are due in large part to fluctuations in income on separate account BOLI. The Company had $9.3 million invested in separate account BOLI at December 31, 2020, which produces income that helps offset expense accruals for deferred compensation accounts the Company maintains on behalf of certain directors and senior officers. Those accounts have returns pegged to participant-directed investment allocations that can include equity, bond, or real estate indices, and are thus subject to gains or losses which often contribute to significant fluctuations in income (and associated expense accruals). Gains on separate account BOLI totaled $1.4 million in 2020 as compared to $1.2 million in 2019, and net losses of $0.4 million in 2018. This resulted in a favorable variance of $0.2 million for 2020 as compared to 2019, and a favorable variance of $1.6 million in 2019 as compared to 2018. As noted, gains and losses on separate account BOLI are related to expense accruals or reversals associated with participant gains and losses on deferred compensation balances, thus the overall net impact on taxable income tends to be minimal. The Company’s books also reflect a net cash surrender value for general account BOLI of $43.2 million at December 31, 2020 as compared to $42.5 million at year-end 2019. General account BOLI produces income that is used to help offset expenses associated with executive salary continuation plans, director retirement plans and other employee benefits. Interest credit rates on general account BOLI do not change frequently so the income has typically been fairly consistent with $1.0 million, of general account BOLI income recorded for all three years ending December 31, 2020, 2019, and 2018.
The Company recognized a $0.4 million gain on the sale of investment securities in 2020, as compared to a $0.2 million loss in 2019 and a nominal gain in 2018. The gain in 2020 was due to a net gain on the sale of debt securities, in an effort to restructure the portfolio primarily to eliminate small residual balances and reduce potential credit risk on certain municipal holdings. The loss in 2019 was taken in order to sell several small balance and low-yielding bonds in order to replace them with fewer higher-yielding bonds. The earn back of the transaction was less than a year.
Loss on tax credit investment reflects pass-through expenses associated with our investments in low-income housing tax credit funds and other limited partnerships. Those expenses, which are netted out of revenue, decreased by $0.9 million, or 43%, in 2020 as compared to 2019. In 2019 as compared to 2018, these expenses decreased by $0.5 million, or 19%. The favorable variance in 2020 is due to the expiration of expense amortization on several funds which had reached the end of their useful tax benefit life. The largest contribution to the favorable variance in 2019, as well as the unfavorable variance in 2018 came from a $0.91 million adjustment to accelerate expense amortization on our tax credit investments, to ensure that the book value of each investment does not exceed its projected remaining tax benefits.
The other category, increased to $1.7 million from $0.01 million, in 2020 as compared to 2019. The primary reason for this increase is due to a $1.5 million gain from the wrap up of low-income housing tax credit fund investments and a $0.2 million valuation gain on restricted equity investments owned by the Company. There was a nominal increase in this category in 2019 as compared to 2018.
Total operating expense, or noninterest expense, increased by $5.3 million, or 8%, in 2020 as compared to 2019, and increased by $0.6 million, or 1%, in 2019 over 2018. The primary increase in 2020 was in salaries and benefits as discussed in further detail below. Although overall noninterest expense did not fluctuate significantly from 2019 to 2018, several line items fluctuated with the largest single item being deposit service costs of $2.6 million. This increase was mostly offset by several smaller changes in other line items. Noninterest expense as a percent of average interest-earning assets trended down each year. This ratio was 2.8% in 2020, 3.0% in 2019 and 3.2% in 2018.
The largest component of noninterest expense, salaries, and employee benefits, increased $4.2 million, or 12%, in 2020 as compared to 2019. The reason for this increase is due to several factors, including merit increases for employees due to annual performance evaluations, new loan production teams for the northern and southern California markets, and a focus on hiring additional senior-level staff and management. The same line item was down $0.2 million, or 0.4%, in 2019 as compared to 2018. Salary expense declined in 2019 as compared to 2018 in part due to selective staff reductions even though there was some increase to deferred compensation expenses as well as the normal annual salary increases. Components of compensation expense that can experience significant variability and are typically difficult to predict include salaries associated with successful loan originations, which are accounted for in accordance with Financial Accounting Standards Board (“FASB”) guidelines on the recognition and measurement of non-refundable fees and origination costs for lending activities, and accruals associated with employee deferred compensation plans. Loan origination salaries that were deferred from current expense for recognition over the life of related loans totaled $3.3 million in 2020, $3.7 million in 2019, and $4.2 million for 2018. Employee deferred compensation expense accruals totaled only $0.2 million in 2020, and 2019. Such deferred compensation expenses were nominal in 2018. As noted above in our discussion of BOLI income, employee deferred compensation plan accruals are related to separate account BOLI income and losses, as are directors deferred compensation accruals that are included in “other professional services,” and the net income impact of all income/expense accruals related to deferred compensation is usually minimal. Salaries and benefits were 53% of total operating expense in 2020, relative to 51% in 2019 and 52% in 2018. The number of full-time equivalent staff employed by the Company totaled 501 at the end of 2020, as compared to 513 at December 31, 2019 and 541 at December 31, 2018. Staff attrition throughout 2020, without the need for immediate replacements due to temporary branch lobby closures or limited branch lobby hours attributed to the COVID-19 pandemic, was the primary reason for the FTE decline. When branch lobbies resume normal operating hours and public access, full-time equivalent staff are expected to increase, however the exact timing of this change is not currently known. Efficiency initiatives implemented toward the end of the 2018 continuing throughout 2019 and 2020 were also drivers of the three year reduction in FTE.
Total rent and occupancy expense, including furniture and equipment costs, were about the same in 2020 as compared to 2019 and decreased by $0.5 million, or 4%, in 2019 over 2018. The decline in 2019 was primarily due to lower depreciation expenses and lower maintenance/repair costs in 2019.
Advertising and promotion costs decreased by 26% to $1.9 million in 2020 as compared to 2019, and decreased by $0.2 million, or 7%, in 2019 over 2018. The decrease in 2020 came from the cessation of special events and in-branch marketing campaigns necessitated by the COVID-19 pandemic and the stay in place orders instituted by the Governor of the state of California, at differing periods during much of 2020.
Data processing costs increased by $0.1 million, or 2%, in 2020 as compared to 2019 and decreased by $0.5 million, or 9%, in 2019 over 2018. Although as a whole the increase in 2020 was minimal, the Company did experience increases in loan management software expenses due to participation in the SBA PPP program and other costs incurred to implement remote working arrangements for staff; which was offset by lower core software provider costs and other data processing costs. The decrease in 2019 was primarily due to lower core software provider costs.
Deposit services costs increased by $0.5 million, or 7%, in 2020 as compared to 2019, and increased by $2.6 million, or 47%, in 2019 over 2018. Deposit costs have been impacted in both 2020 and 2019, by increases in debit card processing and ATM network costs due to higher customer activity levels. In 2020 we also increased our utilization of armored car
services to replenish ATM machines as an increased security precaution. In 2019, approximately $1.5 million of costs associated with statement printing costs that were previously recorded in other operations expenses and stationary & supplies expense were reclassified to data processing costs. The purpose of the reclassification was to better track the costs associated with producing paper statements for our customers so that we could better track progress against our strategy to lower such costs.
Loan services costs are comprised of loan processing costs, and net costs associated with foreclosed assets. Loan processing costs, which include expenses for property appraisals and inspections, loan collections, demand and foreclosure activities, loan servicing, loan sales, and other miscellaneous lending costs, increased by $0.4 million, or 60%, in 2020 as compared to 2019 and decreased by $0.5 million, or 41%, in 2018 over 2017. The increase in 2020 as well as the decrease in 2019 was due to smaller amounts in nearly every category of loan servicing. The decrease in 2019 was also due to the dramatic reduction in the amount of residential first mortgages made by the Company. Foreclosed assets costs are comprised of write-downs taken subsequent to reappraisals, OREO operating expense (including property taxes), and losses on the sale of foreclosed assets, net of rental income on OREO properties and gains on the sale of foreclosed assets. Those costs were just $0.2 million in 2020 as compared to a $0.04 million net gain in 2019 and costs of $0.7 million in 2018. These costs fluctuate based on market conditions of OREO relative to our holding value and the nature of the underlying property.
The “other operating costs” category includes telecommunications expense, postage, and other miscellaneous costs. Telecommunications expense increased by 16% to $1.8 million in 2020, as compared to $1.5 million in 2019. The increase was due to an upgrade of telecommunications circuits, as well as additional costs from work-at-home arrangements during the COVID-19 pandemic. The increased telecommunication costs in 2020, are not expected to continue at the same rate, as old duplicative circuits are removed from service. Such expense was $0.1 million, or 3%, higher in 2019 than in 2018. Postage expense decreased by $0.1 million, or 26%, in 2020 as compared to 2019 and decreased by $0.6 million or 56%, in 2019 relative to 2018. The decrease in 2020 was due to concentrated efforts to decrease our utilization of overnight mail services and increase usage of digital technologies. The significant decline in 2019 was due mostly to a reclassification of nearly the entire annual variance to deposit services costs related to paper statements as described above. The “Other” category under other operating costs decreased by $0.2 million, or 8%, in 2020 as compared to 2019 and up by $0.4 million, or 28%, in 2019 over 2018. The decrease in 2020 is due to the lack of participation in offsite conferences and training due to the COVID-19 pandemic. The increase in 2019 is due mostly to higher consulting and training costs as well as higher recruiting costs.
Total Professional Services costs increased by $0.4 million, or 9%, in 2020 as compared to 2019, as compared to a $0.3 million, or 6%, increase in 2019 as compared to 2018. Professional Services costs consists of legal and accounting, acquisition, and other professional services costs. Legal and Accounting costs decreased by $0.1 million, or 4%, in 2020 as compared to 2019, and increased by $0.1 million, or 7%, in 2019 as compared to 2018. The decrease in 2020 was due to lower internal audit costs as a result of moving some third party reviews inhouse. The increase in 2019 was mostly due to increased audit and compliance costs as a result of an enhanced risk management program. Acquisition costs, or one-time expenses directly attributable to our whole-bank and branch acquisitions, were nil in 2020, as compared to just $0.02 million in 2019 and $0.5 million in 2018. Acquisition costs are comprised primarily of termination fees for core processing contracts and certain other contracts, software conversion costs, financial advisor fees, legal costs, severance and retention amounts paid to employees of the acquired institutions, and the write-off of furniture, fixtures and equipment that were not utilized by the Company. Other professional services costs include FDIC assessments and other regulatory expenses, directors’ costs, and certain insurance costs among other things. This category increased by $0.5 million, or 20%, in 2020 as compared to 2019, and increased by $0.5 million, or 27%, in 2019 relative to 2018. The increase in 2020 is primarily from an increase in FDIC assessment expenses as we utilized all of the available small bank assessment credits after the first quarter of 2020. There was also a favorable swing in the director’s deferred compensation expense for both 2020 and 2019, which is mostly offset by higher BOLI income, as described above under the separate account BOLI. In addition, FDIC and State exam assessment expenses declined by $0.3 million in 2019 as compared to 2018.
Stationery and supply costs increased by $0.1 million, or 40%, in 2020 as compared to 2019 due primarily to specialized supplies attributed to the COVID-19 pandemic. This same category decreased by $1.1 million, or 77%, in 2019 over 2018, due to a reclassification of customer paper statement expense to deposit services costs as described above.
Sundry and teller costs of $0.6 million in 2020, $0.3 million in 2019, and $0.4 million in 2018 primarily reflect operational losses, including debit card disputes. These costs were $0.3 million higher in 2020 over 2019, mainly because of two large operational losses, and higher debit card losses, consistent with the higher volume of debit card transactions. In 2019 over 2018, these costs trended downward due to the implementation of new technology and education.
The Company’s tax-equivalent overhead efficiency ratio was 57.2% in 2020, 57.5% in 2019, and 60.8% in 2018. The overhead efficiency ratio represents total noninterest expense divided by the sum of fully tax-equivalent net interest and noninterest income, with the provision for loan and lease losses and investment gains/losses excluded from the equation. The ratio trended downward due to continued efforts to control costs, as well as higher income which is the denominator of the equation.
Income Taxes
Our income tax provision was $11.1 million, or 23.8% of pre-tax income in 2020 as compared to $11.8 million, or 24.6% of pre-tax income in 2019, and $9.9 million, or 25.0% of pre-tax income in 2018. The tax accrual rate was slightly lower in 2020 due to a higher proportion of non-taxable income, and approximately the same in 2019 as it was in 2018.
The Company sets aside a provision for income taxes on a monthly basis. The amount of that provision is determined by first applying the Company’s statutory income tax rates to estimated taxable income, which is pre-tax book income adjusted for permanent differences, and then subtracting available tax credits. Permanent differences include but are not limited to tax-exempt interest income, BOLI income, and certain book expenses that are not allowed as tax deductions. The Company’s investments in state, county and municipal bonds provided $5.7 million of federal tax-exempt income in 2020, $4.5 million in 2019, and $4.1 million in 2018. Moreover, in addition to life insurance proceeds of $0.07 million in 2020, net increases in the cash surrender value of bank-owned life insurance added $2.4 million to tax-exempt income in 2020; $2.2 million in 2019, and $0.6 million in 2018.
Our tax credits consist primarily of those generated by investments in low-income housing tax credit funds, and California state employment tax credits. We had a total of $3.5 million invested in low-income housing tax credit funds as of December 31, 2020 and $4.1 million as of December 31, 2019, which are included in other assets rather than in our investment portfolio. Those investments have generated substantial tax credits over the past few years, with about $0.5 million in credits available for the 2020 tax year; $0.5 million for the 2019 tax year, and $0.6 million in 2018. The credits are dependent upon the occupancy level of the housing projects and income of the tenants and cannot be projected with certainty. Furthermore, our capacity to utilize them will continue to depend on our ability to generate sufficient pre-tax income. We plan to invest in additional tax credit funds in the future, but if the economics of such transactions do not justify continued investments then the level of low-income housing tax credits will taper off in future years until they are substantially utilized by the end of 2028. That means that even if taxable income stayed at the same level through 2028, our tax accrual rate would gradually increase.
Financial Condition
Assets totaled $3.2 billion at December 31, 2020, an increase of $626.9 million, or 24%, for the year. Assets increased in 2020 primarily due to 694.5 million, or 39% increase, in net loans and leases. Deposits were up $456.2 million, or 21%. Total capital increased by $34.6 million, or 11%. The major components of the Company’s balance sheet are individually analyzed below, along with information on off-balance sheet activities and exposure.
Loan and Lease Portfolio
The Company’s loan and lease portfolio represents the single largest portion of invested assets, substantially greater than the investment portfolio or any other asset category, and the quality and diversification of the loan and lease portfolio are important considerations when reviewing the Company’s financial condition.
The Selected Financial Data table in Item 6 above reflects the amount of loans and leases outstanding at December 31 for each year from 2020 back to 2016, net of deferred fees and origination costs and the allowance for loan and lease losses. The Loan and Lease Distribution table that follows sets forth by loan type the Company’s gross loans and leases
outstanding, and the percentage distribution in each category at the dates indicated. The balances for each loan type include nonperforming loans, if any, but do not reflect any deferred or unamortized loan origination, extension, or commitment fees, or deferred loan origination costs. Although not reflected in the loan totals below and not currently comprising a material part of our lending activities, the Company also occasionally originates and sells, or participates out portions of, loans to non-affiliated investors.
Loan and Lease Distribution
(dollars in thousands)
As of December 31,
Real estate:
1-4 family residential construction
$
48,565
$
105,979
$
105,676
$
74,256
$
32,417
Other construction/land
71,980
91,413
109,023
58,779
40,650
1-4 family - closed-end
139,836
200,181
236,825
204,766
137,143
Equity lines
38,075
49,599
56,320
62,590
43,443
Multi-family residential
61,865
54,457
54,877
42,930
31,631
Commercial real estate - owner occupied
343,199
343,883
301,324
263,447
253,535
Commercial real estate - non-owner occupied
1,062,498
412,569
438,344
379,432
244,198
Farmland
129,905
144,033
151,541
140,516
134,480
Total real estate
1,895,923
1,402,114
1,453,930
1,226,716
917,497
Agricultural
44,872
48,036
49,103
46,796
46,229
Commercial and industrial
209,048
115,532
128,220
135,662
123,595
Mortgage warehouse lines
307,679
189,103
91,813
138,020
163,045
Consumer loans
5,589
7,780
8,862
10,626
12,165
Total loans and leases
$
2,463,111
$
1,762,565
$
1,731,928
$
1,557,820
$
1,262,531
Percentage of Total Loans and Leases
Real estate:
1-4 family residential construction
1.97%
6.01%
6.10%
4.77%
2.57%
Other construction/land
2.92%
5.19%
6.29%
3.77%
3.22%
1-4 family - closed-end
5.68%
11.36%
13.67%
13.14%
10.86%
Equity lines
1.55%
2.81%
3.25%
4.02%
3.44%
Multi-family residential
2.51%
3.09%
3.17%
2.76%
2.51%
Commercial real estate - owner occupied
13.93%
19.51%
17.40%
16.91%
20.08%
Commercial real estate - non-owner occupied
43.14%
23.41%
25.32%
24.36%
19.34%
Farmland
5.27%
8.17%
8.75%
9.02%
10.65%
Total real estate
76.97%
79.55%
83.95%
78.75%
72.67%
Agricultural
1.82%
2.73%
2.84%
3.00%
3.66%
Commercial and industrial
8.49%
6.55%
7.40%
8.71%
9.79%
Mortgage warehouse lines
12.49%
10.73%
5.30%
8.86%
12.91%
Consumer loans
0.23%
0.44%
0.51%
0.68%
0.96%
100.00%
100.00%
100.00%
100.00%
100.00%
The Company has experienced net growth in loan and lease balances in each of the last five years, despite fluctuations caused by variability in outstanding balances on mortgage warehouse lines, reductions associated with the resolution of impaired loans, weak loan demand in some years, tightened underwriting standards, and intense competition. This growth is due in part to acquisitions, including Coast National Bank in 2016 and Ojai Community Bank in 2017, as well as whole loan purchases and participations, and participation in the SBA PPP loan program in 2020. Organic loan growth has also been extremely robust in recent periods, particularly with regard to non-owner occupied commercial real estate loans.
For 2020, gross loans were up by $700.5 million, or 40%, due largely to $649.9 million of organic growth in non-agricultural real estate loans. This growth was a deliberate effort of our Northern and Southern market loan production
teams and was facilitated by the opening of a loan production office in Northern California (Rocklin, California) and an expansion of the loan team in Southern California.
Mortgage warehouse lines also contributed to the 2020 increase; up by $118.6 million, or 63%. Commercial and industrial loans were up by $93.5 million or 81% due to our participation in the SBA PPP loan program. Multi-family residential loans increased $7.4 million or 14%. These increases were partially offset by declines in all other loan categories. Mortgage warehouse lines increased by $97.2 million, or 106%, in 2019 primarily due to a strategy to focus on volume given the short duration of these loans. This growth strategy involved providing more competitive pricing to mortgage originators coupled with a stronger emphasis on calling efforts. The largest single decline in any other category of loans during 2019 was real estate loans of $51.8 million, or 4%, mostly due to a strategic decision to significantly reduce our activity of residential mortgages; as a result residential mortgage loan balances declined by approximately $43.4 million in 2019.
As demonstrated by the expansion of the lending teams, management remains focused on organic loan growth, however at a significantly lower rate than what was experienced in 2020. Our loan pipeline at December 31, 2020, softened due to a strategic shift to focus on further diversifying our loan mix, especially as it relates to non-owner occupied commercial real estate. No assurance can be provided with regard to future net growth in aggregate loan balances given occasional surges in prepayments, including forgiveness of PPP loans; fluctuations in mortgage warehouse lending; and maintaining concentrations in certain sectors within our risk management parameters.
As a part of their regulatory oversight, the federal regulators have issued guidelines on sound risk management practices with respect to a financial institution’s concentrations in commercial real estate (“CRE”) lending activities. These guidelines were issued in response to the agencies’ concerns that rising CRE concentrations might expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in the commercial real estate market. The guidelines identify certain concentration levels that, if exceeded, will expose the institution to additional supervisory analysis with regard to the institution’s CRE concentration risk. The guidelines, as amended, are designed to promote appropriate levels of capital and sound loan and risk management practices for institutions with a concentration of CRE loans. In general, the guidelines, as amended, establish the following supervisory criteria as preliminary indications of possible CRE concentration risk: (1) the institution’s total construction, land development and other land loans represent 100% or more of Tier 1 risk-based capital plus allowance for loan and lease losses; or (2) total CRE loans as defined in the regulatory guidelines represent 300% or more of Tier 1 risk-based capital plus allowance for loan and lease losses, and the institution’s CRE loan portfolio has increased by 50% or more during the prior 36 month period. At December 31, 2020, the Bank’s total construction, land development and other land loans represented 36% of Tier 1 risk-based capital plus allowance for loan and lease losses. At December 31, 2020, the Bank’s total CRE loans as defined in the regulatory guidelines represented 378% of Tier 1 risk-based capital plus allowance for loan and lease losses, and the Bank’s CRE loan portfolio has increased by more than 50% during the prior 36 month period. Therefore, the Bank believes that the guidelines are applicable to it as it has a potential concentration in CRE loans. The Bank and its board of directors have discussed the guidelines and believe that the Bank’s underwriting policies, management information systems, independent credit administration process, and monitoring of real estate loan concentrations are sufficient to address the risk management of CRE under the guidelines.
Loan and Lease Maturities
The following table shows the maturity distribution for total loans and leases outstanding as of December 31, 2020, including non-accruing loans, grouped by remaining scheduled principal payments:
Loans and Lease Maturity
(dollars in thousands)
As of December 31, 2020
Three months
Floating rate:
Fixed rate:
Three months
to twelve
One to five
Over five
due after one
due after one
or less
months
years
years
Total
year
year
Real estate
$
48,793
$
38,915
$
131,773
$
1,676,442
$
1,895,923
$
899,339
$
908,876
Agricultural
16,704
24,028
1,478
2,662
44,872
1,244
2,896
Commercial and industrial
9,878
18,713
152,189
28,268
209,048
23,799
156,658
Mortgage warehouse lines
70,132
237,547
-
-
307,679
-
-
Consumer loans
2,132
2,424
5,589
3,916
Total
$
146,067
$
319,676
$
287,572
$
1,709,796
$
2,463,111
$
925,022
$
1,072,346
Generally, the Company’s contractual life of loans matches the loan’s amortization period. Rates on loans longer than five years typically adjust starting before ten years and each five years thereafter. For a comprehensive discussion of the Company’s liquidity position, balance sheet repricing characteristics, and sensitivity to interest rates changes, refer to the “Liquidity and Market Risk” section of this discussion and analysis.
Off-Balance Sheet Arrangements
The Company maintains commitments to extend credit in the normal course of business, as long as there are no violations of conditions established in the outstanding contractual arrangements. Unused commitments to extend credit totaled $450 million at December 31, 2020 and $492 million at December 31, 2019, although it is not likely that all of those commitments will ultimately be drawn down. The decrease in 2020 is due in part to a higher utilization of mortgage warehouse lines in 2020. Unused commitments represented approximately 18% of gross loans outstanding at December 31, 2020 and 28% at December 31, 2019. The Company also had undrawn letters of credit issued to customers totaling $8.2 million and $8.6 million at December 31, 2020 and 209, respectively. Off-balance sheet obligations pose potential credit risk to the Company, and a $0.3 million reserve for unfunded commitments is reflected as a liability in our consolidated balance sheet at December 31, 2020, which was relatively unchanged from the previous year. The unused commitments related to mortgage warehouse are unconditionally cancellable at any time. The effect on the Company’s revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted because there is no guarantee that the lines of credit will ever be used. However, the “Liquidity” section in this Form 10-K outlines resources available to draw upon should we be required to fund a significant portion of unused commitments.
In addition to unused commitments to provide credit, the Company is utilizing a $105 million letter of credit issued by the Federal Home Loan Bank on the Company’s behalf as security for certain deposits and to facilitate certain credit arrangements with the Company’s customers. That letter of credit is backed by loans which are pledged to the FHLB by the Company. For more information regarding the Company’s off-balance sheet arrangements, see Note 13 to the consolidated financial statements in Item 8 herein.
Contractual Obligations
At the end of 2020, the Company had contractual obligations for the following payments, by type and period due:
Contractual Obligations
(dollars in thousands)
Payments Due by Period
Less Than
More Than
Total
1 Year
1-3 Years
3-5 Years
5 Years
Subordinated debentures
$
35,124
$
-
$
-
$
-
$
35,124
Operating leases
9,393
2,130
2,991
1,660
2,612
Other long-term obligations
1,439
1,321
Total
$
45,956
$
2,164
$
3,057
$
1,678
$
39,057
Nonperforming Assets
Nonperforming assets (“NPAs”) are comprised of loans for which the Company is no longer accruing interest, and foreclosed assets which primarily consists of OREO. If the Company grants a concession to a borrower in financial difficulty, the loan falls into the category of a troubled debt restructuring (“TDR”), which may be designated as either nonperforming or performing depending on the loan’s accrual status.
The following table presents comparative data for the Company’s NPAs and performing TDRs as of the dates noted:
Nonperforming Assets and Performing TDRs
(dollars in thousands)
As of December 31,
Real estate:
Other construction/land
$
-
$
$
$
$
1-4 family - closed-end
1,193
Equity lines
2,403
1,926
Multi-family residential
-
-
-
-
-
Commercial real estate - owner occupied
1,678
1,440
1,572
Commercial real estate - non-owner occupied
2,105
Farmland
1,642
TOTAL REAL ESTATE
6,298
5,055
3,585
2,522
5,125
Agricultural
-
-
-
Commercial and industrial
1,026
1,425
1,301
Consumer loans
TOTAL NONPERFORMING LOANS (1) (2)
$
7,598
$
5,737
$
5,156
$
3,963
$
6,365
Foreclosed assets
1,082
5,481
2,225
Total nonperforming assets
$
8,569
$
6,537
$
6,238
$
9,444
$
8,590
Performing TDRs (1)
$
11,382
$
8,415
$
10,920
$
12,413
$
14,182
Loans deferred under CARES Act (2)
$
29,500
$
-
$
-
$
-
$
-
Nonperforming loans as a % of total gross loans and leases
0.31%
0.33%
0.30%
0.25%
0.50%
Nonperforming assets as a % of total gross loans and leases and foreclosed assets
0.35%
0.37%
0.36%
0.60%
0.68%
(1) Performing TDRs are not included in nonperforming loans above, nor are they included in the numerators used to calculate the ratios disclosed in this table.
(2) Loans deferred under the CARES act are not included in nonperforming loans above, nor are they included in the numerators used to calculate the ratios disclosed in the table.
NPAs totaled $8.6 million, or 0.4% of gross loans and leases plus foreclosed assets at the end of 2020, up from $6.5 million, or 0.4% of gross loans and leases plus foreclosed assets at the end of 2019. $1.4 million of the increase in non-performing loans during 2020, was a result of 10 loans previously deferred under section 4013 of the CARES Act, that were unable to resume their scheduled payments at the end of the deferral period. NPAs were reduced by $3.2 million, or 34%, during 2018 in response to better economic conditions.
Nonperforming loans secured by real estate comprised $6.3 million of total nonperforming loans at December 31, 2020, an increase of $1.2 million, or 25%, since December 31, 2019. There were also increases of $0.4 million in commercial & industrial loans and $0.3 million in agricultural production loans. Consumer nonperforming loans were mostly unchanged during 2020. Nonperforming loan balances at December 31, 2020 include $3.9 million in TDRs and other loans that were paying as agreed, but which met the technical definition of nonperforming and were classified as such. We also had $29.5 million in loans deferred under the CARES Act, which are not treated as TDRs and were still accruing interest at December 31, 2020, and $11.4 million in loans classified as performing TDRs for which we were still accruing interest at December 31, 2020, an increase of $3.0 million, or 35%, relative to December 31, 2019. Notes 2 and 4 to the consolidated financial statements provide a more comprehensive disclosure of TDR balances and activity within recent periods.
Loan modifications not treated as TDRs were $29.5 million at December 31, 2020. Two loans for $6.3 million were extensions of loans previously modified, which had matured but needed additional time to resume payments. Of the total loans modified at year end, $14.7 million, or 50%, are hotels, and $14.0 million, or 47%, are lessors of non-residential buildings. Approximately 59% of loans currently under modification have maturities within 90 days, with the remaining 41% maturing within 180 days. All loans are well secured based on the most recent appraisal.
The balance of foreclosed assets had a carrying value of $1.0 million at December 31, 2020, comprised of 7 properties classified as OREO. At the end of 2019 foreclosed assets totaled $0.8 million, consisting of 10 properties classified as OREO and two mobile homes. All foreclosed assets are periodically evaluated and written down to their fair value less expected disposition costs, if lower than the then-current carrying value.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses. It is maintained at a level that is considered adequate to absorb probable losses on specifically identified impaired loans, as well as probable incurred losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when sufficient cash payments are received subsequent to the charge off. Note 2 to the consolidated financial statements provides a more comprehensive discussion of the accounting guidance we conform to and the methodology we use to determine an appropriate allowance for loan and lease losses, including information regarding the Company’s decision to defer implementation of Current Expected Credit Loss ("CECL") accounting method, which was further extended to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022, by the Consolidated Appropriations Act of 2021. It is expected that the Company’s Allowance for Credit Loss under CECL will be approximately 50% higher than the current Allowance for Loan and Lease Losses, with the initial adjustment being recorded as an adjustment to equity.
The Company’s allowance for loan and lease losses was $17.7 million, or 0.7% of gross loans at December 31, 2020, relative to $9.9 million, or 0.6% of gross loans at December 31, 2019. The increase in the allowance resulted from the addition of a $8.6 million loan and lease loss provision in 2020, less $0.7 million in net loan charge-offs. Reserves were established for losses inherent in incremental loan balances and unanticipated charge-offs in 2020. The net increase in the allowance might have been even larger if not for the following circumstances: charge-offs were recorded against pre-established reserves, which alleviated what otherwise might have been a need for reserve replenishment; all acquired loans were booked at their fair values, and thus did not initially require a loan and lease loss allowance; and loan and lease loss rates have been declining, having a positive impact on general reserves established for performing loans. The ratio of the allowance to nonperforming loans was 233% at December 31, 2020, relative to 173% at December 31, 2019, and 189% at December 31, 2018. As described above, a separate allowance of $0.3 million for potential losses inherent in unused commitments is included in other liabilities at December 31, 2020.
The table that follows summarizes the activity in the allowance for loan and lease losses for the periods indicated:
Allowance for Loan and Lease Losses
(dollars in thousands)
As of and for the years ended December 31,
Balances:
Average gross loans and leases outstanding during period
$
2,068,690
$
1,753,748
$
1,625,732
$
1,318,909
$
1,153,240
Gross loans and leases held for investment
$
2,463,111
$
1,762,565
$
1,731,928
$
1,557,820
$
1,262,531
Allowance for Loan and Lease Losses:
Balance at beginning of period
$
9,923
$
9,750
$
9,043
$
9,701
$
10,423
Provision (benefit) charged to expense
8,550
2,550
4,350
(1,140)
-
Charge-offs
Real estate:
1-4 family residential construction
-
-
-
-
-
Other construction/land
-
-
-
1-4 family - closed-end
-
-
Equity lines
-
-
Multi-family residential
-
-
-
-
Commercial real estate - owner occupied
-
-
-
Commercial real estate - non-owner occupied
-
1,190
2,341
-
Farmland
-
-
-
-
-
TOTAL REAL ESTATE
-
1,190
2,475
Agricultural
-
-
-
-
Commercial and industrial
1,274
Mortgage warehouse lines
-
-
-
-
-
Consumer loans
1,397
2,409
2,225
2,161
1,905
Total
1,833
4,873
5,308
3,085
3,211
Recoveries
Real estate:
1-4 family residential construction
-
-
-
-
-
Other construction/land
-
1-4 family - closed-end
1,959
Equity lines
Multi-family residential
-
-
-
-
-
Commercial real estate - owner occupied
-
-
Commercial real estate - non-owner occupied
-
-
Farmland
-
-
-
-
-
TOTAL REAL ESTATE
2,235
Agricultural
-
-
Commercial and industrial
Mortgage warehouse lines
-
-
-
-
-
Consumer loans
1,159
1,121
1,017
1,015
Total
1,098
2,496
1,665
3,567
2,489
Net loan charge-offs (recoveries)
2,377
3,643
(482)
Balance
$
17,738
$
9,923
$
9,750
$
9,043
$
9,701
RATIOS
Net loan and lease charge-offs (recoveries) to average loans and leases
0.04%
0.14%
0.22%
(0.04)%
0.06%
Allowance for loan and lease losses to gross loans and leases at end of period
0.72%
0.56%
0.56%
0.58%
0.77%
Allowance for loan and lease losses to non-performing loans
233.46%
172.96%
189.10%
228.19%
152.41%
Net loan and lease charge-offs (recoveries) to allowance for loan and lease losses at end of period
4.14%
23.95%
37.36%
(5.33)%
7.44%
Net loan charge-offs (recoveries) to provision (benefit) for loan and lease losses
8.60%
93.22%
83.75%
42.28%
-
As shown in the table above, the Company recorded a loan and lease loss provision of $8.6 million in 2020 compared to $2.6 million in 2019, and $4.4 million in 2018. Our allowance for probable losses on specifically identified impaired loans increased $0.2 million, or 20%, during 2020, whereas it was reduced by $1.2 million, or 59%, during 2019. The allowance
for probable losses inherent in non-impaired loans increased by $7.6 million, or 84%, as a result of potential economic conditions, downgrades of certain loans deferred under section 4013 of the Cares Act and the continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy and our loan customers, potential changes in collateral values due to reduced cash flows, and external factors such as government actions.
The “Provision for Loan and Lease Losses” section above includes additional details on our provision and its relationship to actual charge-offs.
Provided below is a summary of the allocation of the allowance for loan and lease losses for specific loan categories at the dates indicated. The allocation presented should not be viewed as an indication that charges to the allowance will be incurred in these amounts or proportions, or that the portion of the allowance allocated to a particular loan category represents the total amount available for charge-offs that may occur within that category.
Allocation of Allowance for Loan and Lease Losses
(dollars in thousands)
As of December 31,
Amount
%Total (1)
Loans
Amount
%Total (1)
Loans
Amount
%Total (1)
Loans
Amount
%Total (1)
Loans
Amount
%Total (1)
Loans
Real Estate
$
11,766
76.97%
$
5,635
79.55%
$
5,831
83.95%
$
4,786
78.75%
$
3,548
72.67%
Agricultural
1.82%
2.73%
2.84%
3.00%
3.66%
Commercial and industrial (2)
4,721
20.98%
2,685
17.28%
2,394
12.70%
2,772
17.57%
4,279
22.71%
Consumer loans
0.23%
1,278
0.44%
1,239
0.51%
1,231
0.68%
1,208
0.96%
Unallocated
-
-
-
-
-
Total
$
17,738
100.00%
$
9,923
100.00%
$
9,750
100.00%
$
9,043
100.00%
$
9,701
100.00%
(1) Represents percentage of loans in category to total loans
(2) Includes mortgage warehouse lines
The Company’s allowance for loan and lease losses at December 31, 2020 represents Management’s best estimate of probable losses in the loan portfolio as of that date, but no assurance can be given that the Company will not experience substantial losses relative to the size of the allowance. Furthermore, fluctuations in credit quality, changes in economic conditions, updated accounting, or regulatory requirements, and/or other factors could induce us to augment or reduce the allowance. The Company adopted the current expected credit losses methodology on January 1, 2020, however as previously noted under the Allowance for Loan and Lease Losses section above in March 2020, the Company elected under Section 4014 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020. In December 2020, the Consolidated Appropriations Act 2021, extended the deferral of implementation of CECL from December 31, 2020, to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022. The Company initially elected in the first quarter of 2020 to postpone implementation and will now continue to postpone implementation in order to provide additional time to assess better the impact of the COVID-19 pandemic on the expected lifetime credit losses. At the time the initial decision was made, there was a significant economic uncertainty on the local, regional, and national levels as a result of local and state stay-at-home orders, as well as relief measures provided at a national, state, and local level. Further, the Company took actions to serve our communities during the pandemic, including permitting short-term payment deferrals to current customers, as well as originating bridge loans and SBA PPP loans. It was determined that more time is still needed to assess the impact of the uncertainty and related actions on the Company's allowance for loan and lease losses under the CECL methodology.
Investments
The Company’s investments can at any given time consist of debt securities and marketable equity securities (together, the “investment portfolio”), investments in the time deposits of other banks, surplus interest-earning balances in our Federal Reserve Bank (“FRB”) account, and overnight fed funds sold. Surplus FRB balances and fed funds sold to correspondent banks typically represent the temporary investment of excess liquidity. The Company’s investments serve several purposes: 1) they provide liquidity to even out cash flows from the loan and deposit activities of customers; 2) they
provide a source of pledged assets for securing public deposits, bankruptcy deposits and certain borrowed funds which require collateral; 3) they constitute a large base of assets with maturity and interest rate characteristics that can be changed more readily than the loan portfolio, to better match changes in the deposit base and other funding sources of the Company; 4) they are another interest-earning option for surplus funds when loan demand is light; and 5) they can provide partially tax exempt income. Aggregate investments totaled $547.5 million, or 17% of total assets at December 31, 2020, as compared to $615.3 million, or 24% of total assets at December 31, 2019.
We had no fed funds sold at the end of the reporting periods, and interest-bearing balances held primarily in our Federal Reserve Bank account totaled $3.5 million at December 31, 2020, as compared to $14.5 million at December 31, 2019. The Company’s investment securities portfolio had a book balance of $544.0 million at December 31, 2020, compared to $600.8 million at December 31, 2019, reflecting a net decrease of $56.8 million for 2020. The Company carries investments at their fair market values. We currently have the intent and ability to hold our investment securities to maturity, but the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. The expected average life for bonds in our investment portfolio was 4.2 years and their average effective duration was 2.4 years at December 31, 2020, as compared to an expected average life of 4.4 years and an average effective duration of 3.2 years at year-end 2019.
The following Investment Portfolio table reflects the amortized cost and fair market values for each primary category of investment securities for the past three years:
Investment Portfolio-Available for Sale
(dollars in thousands)
As of December 31,
Amortized
Cost
Fair Market
Value
Amortized
Cost
Fair Market
Value
Amortized
Cost
Fair Market
Value
U.S. government agencies
$
1,725
$
1,800
$
12,125
$
12,145
$
15,553
$
15,212
Mortgage-backed securities
304,108
314,435
398,353
400,389
414,208
404,733
State and political subdivisions
212,011
227,739
181,900
188,265
140,181
140,534
Total securities
$
517,844
$
543,974
$
592,378
$
600,799
$
569,942
$
560,479
The net unrealized gain on our investment portfolio, or the amount by which aggregate fair market values exceeded the amortized cost, was $26.1 million at December 31, 2020 as compared to $8.4 million at December 31, 2019, an increase of $17.7 million. The change in 2020 was caused by lower market interest rates on fixed-rate bond values. The balance of U.S. Government agency securities in our portfolio declined by $10.3 million, or 85%, during 2020 due primarily to bond maturities and a strategy to utilize bond repayments to fund higher-yielding loans in 2020. Similarly, mortgage-backed securities decreased by $86.0 million, or 21% due to prepayments not being reinvested for the above-mentioned strategy. Municipal bond balances increased by $39.5 million, or 21%. The municipal bond purchases were mostly made in the first half of 2020. Municipal bonds purchased in recent periods have strong underlying ratings, and all municipal bonds in our portfolio undergo a detailed quarterly review for potential impairment.
Investment securities that were pledged as collateral for Federal Home Loan Bank borrowings, repurchase agreements, public deposits and other purposes as required or permitted by law totaled $232.0 million at December 31, 2020 and $234.8 million at December 31, 2019, leaving $312.0 million in unpledged debt securities at December 31, 2020 and $366.0 million at December 31, 2019. Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $52.9 million at December 31, 2020 and $71.0 million at December 31, 2019.
The table below groups the Company’s investment securities by their remaining time to maturity as of December 31, 2020, and provides weighted average yields for each segment. Since the actual timing of principal payments may differ from
contractual maturities when obligors have the right to prepay principal, maturities for mortgage-backed securities (including collateralized mortgage obligations) were determined by incorporating expected prepayments.
Maturity and Yield of Available for Sale Investment Portfolio
(dollars in thousands)
December 31, 2020
Within
One Year
After One
But Within
Five Years
After Five Years
But Within
Ten Years
After
Ten Years
Total
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
U.S. government agencies
$
-
-
$
1,800
2.71%
$
-
-
$
-
-
$
1,800
2.71%
Mortgage-backed securities
26,671
2.30%
280,347
2.18%
7,417
1.93%
-
-
314,435
2.18%
State and political subdivisions
3,857
4.18%
7,932
4.14%
28,745
3.49%
187,205
3.41%
227,739
3.46%
Total securities
$
30,528
$
290,079
$
36,162
$
187,205
$
543,974
Cash and Due from Banks
Interest-earning cash balances were discussed above in the “Investments” section, but the Company also maintains a certain level of cash on hand in the normal course of business as well as non-earning deposits at other financial institutions. Our balance of cash and due from banks depends on the timing of collection of outstanding cash items (checks), the amount of cash held at our branches and our reserve requirement, among other things, and is subject to significant fluctuations in the normal course of business. While cash flows are normally predictable within limits, those limits are fairly broad and the Company manages its short-term cash position through the utilization of overnight loans to, and borrowings from, correspondent banks, including the Federal Reserve Bank and the Federal Home Loan Bank. Should a large “short” overnight position persist for any length of time, the Company typically raises money through focused retail deposit gathering efforts or by adding brokered time deposits. If a “long” position is prevalent, we will let brokered deposits or other wholesale borrowings roll off as they mature, or we might invest excess liquidity into longer-term, higher-yielding bonds. The Company’s balance of noninterest earning cash and balances due from correspondent banks totaled $67.9 million, or 2% of total assets at December 31, 2020, and $65.6 million, or 3% of total assets at December 31, 2019. The average balance of non-earning cash and due from banks, which can be used to determine trends, was $72.0 million for 2020 and 2019 and $61.4 million for 2018.
Premises and Equipment
Premises and equipment are stated on our books at cost, less accumulated depreciation, and amortization. The cost of furniture and equipment is expensed as depreciation over the estimated useful life of the related assets, and leasehold improvements are amortized over the term of the related lease or the estimated useful life of the improvements, whichever is shorter.
The following premises and equipment table reflects the original cost, accumulated depreciation and amortization, and net book value of fixed assets by major category, for the years noted:
Premises and Equipment
(dollars in thousands)
As of December 31,
Accumulated
Accumulated
Accumulated
Depreciation
Depreciation
Depreciation
and
Net Book
and
Net Book
and
Net Book
Cost
Amortization
Value
Cost
Amortization
Value
Cost
Amortization
Value
Land
$
5,751
$
-
$
5,751
$
5,751
$
-
$
5,751
$
5,751
$
-
$
5,751
Buildings
21,580
11,005
10,575
21,526
10,407
11,119
21,579
10,140
11,439
Furniture and equipment
20,705
15,474
5,231
17,798
14,365
3,433
18,958
14,971
3,987
Leasehold improvements
15,226
9,278
5,948
15,357
8,269
7,088
15,023
7,601
7,422
Construction in progress
-
-
-
-
-
Total
$
63,262
$
35,757
$
27,505
$
60,476
$
33,041
$
27,435
$
62,212
$
32,712
$
29,500
The net book value of the Company’s premises and equipment was 1% of total assets at both December 31, 2020, and December 31, 2019. Depreciation and amortization included in occupancy and equipment expense totaled $2.8 million in 2020 and 2019.
Other Assets
Goodwill totaled $27.4 million at December 31, 2020, unchanged for the year and other intangible assets were $4.3 million, a decrease of $1.1 million, or 20%, as a result of amortization expense recorded on core deposit intangibles. The Company’s goodwill and other intangible assets are evaluated annually for potential impairment following FASB guidelines, and based on those analytics Management has determined that no impairment exists as of December 31, 2020.
The net cash surrender value of bank-owned life insurance policies increased to $52.5 million at December 31, 2020 from $50.5 million at December 31, 2019, due to the addition of BOLI income to net cash surrender values. Refer to the “Noninterest Revenue and Operating Expense” section above for a more detailed discussion of BOLI and the income it generates.
The remainder of other assets consists primarily of right-of-use assets tied to operating leases upon the adoption of Accounting Standards Update 2016-02 (Topic 842) in 2019, accrued interest receivable, deferred taxes, investments in bank stocks, other real estate owned, prepaid assets, investments in low income housing credits, and other miscellaneous assets. The total operating lease right-of-use asset recorded on the books is $10.3 million less accumulated amortization of $3.1 million. The bank stocks include Pacific Coast Bankers Bank stock and restricted stock related to the Federal Home Loan Bank of San Francisco stock held in conjunction with our FHLB borrowings and is not deemed to be marketable or liquid. Our net deferred tax asset is evaluated as of every reporting date pursuant to FASB guidance, and we have determined that no impairment exists.
Deposits
Deposits represent another key balance sheet category impacting the Company’s net interest margin and profitability metrics. Deposits provide liquidity to fund growth in earning assets, and the Company’s net interest margin is improved to the extent that growth in deposits is concentrated in less volatile and typically less costly non-maturity deposits such as demand deposit accounts, NOW accounts, savings accounts, and money market demand accounts. Information concerning average balances and rates paid by deposit type for the past three fiscal years is contained in the Distribution, Rate, and Yield table located in the previous section under “Results of Operations-Net Interest Income and Net Interest Margin.” A
distribution of the Company’s deposits showing the period-end balance and percentage of total deposits by type is presented as of the dates noted in the following table:
Deposit Distribution
(dollars in thousands)
Year Ended December 31,
Interest bearing demand deposits
$
109,938
$
91,212
$
101,243
$
118,533
$
132,586
Noninterest bearing demand deposits
943,664
690,950
662,527
635,434
524,552
NOW
558,407
458,600
434,483
405,057
366,238
Savings
368,420
294,317
283,953
283,126
215,693
Money market
131,232
118,933
123,807
171,611
119,417
CDAR's < $100,000
-
-
-
-
Customer time deposit < $100,000
73,046
81,247
93,156
82,885
75,633
Customer time deposits ≥ $100,000
339,899
383,115
367,171
291,740
261,101
Brokered deposits
100,000
50,000
50,000
-
-
Total deposits
$
2,624,606
$
2,168,374
$
2,116,340
$
1,988,386
$
1,695,471
Percentage of Total Deposits
Interest bearing demand deposits
4.19%
4.21%
4.78%
5.96%
7.82%
Noninterest bearing demand deposits
35.95%
31.86%
31.31%
31.96%
30.94%
NOW
21.28%
21.15%
20.53%
20.37%
21.60%
Savings
14.04%
13.57%
13.42%
14.24%
12.72%
Money market
5.00%
5.48%
5.85%
8.63%
7.04%
CDAR's < $100,000
-
-
-
-
0.01%
Customer Time deposit < $100,000
2.78%
3.75%
4.40%
4.17%
4.46%
Customer Time deposits > $100,000
12.95%
17.67%
17.35%
14.67%
15.40%
Brokered deposits
3.81%
2.31%
2.36%
-
-
Total
100.00%
100.00%
100.00%
100.00%
100.00%
Deposit balances reflect net growth of $456.2 million, or 21%, in 2020 and $52.0 million, or 2%, during 2019. The increase in 2020 and 2019 is primarily due to organic growth as both consumer and commercial existing customers increased their deposit account balances.
Noninterest bearing demand deposit balances were up $252.7 million, or 37%; NOW and interest bearing demand accounts increased by $118.5 million, or 22% in 2020. Overall non-maturity deposits increased by $457.6 million, or 28%, to $2.1 billion at December 31, 2020.
Management is of the opinion that a relatively high level of core customer deposits is one of the Company’s key strengths, and we continue to strive for core deposit retention and growth.
The scheduled maturity distribution of the Company’s time deposits at the end of 2020 was as follows:
Deposit Maturity Distribution
(dollars in thousands)
As of December 31, 2020
Three
months or
less
Three to
six months
Six to
twelve
months
One to
three
years
Over
three
years
Total
Time certificates of deposit < $100,000
143,801
10,623
13,338
3,852
1,432
173,046
Other time deposits ≥ $100,000
197,420
37,595
50,342
33,942
20,600
339,899
Total
$
341,221
$
48,218
$
63,680
$
37,794
$
22,032
$
512,945
Other Borrowings
The Company’s non-deposit borrowings may, at any given time, include fed funds purchased from correspondent banks, borrowings from the Federal Home Loan Bank, advances from the FRB, securities sold under agreements to repurchase, and/or junior subordinated debentures. The Company uses short-term FHLB advances and fed funds purchased on uncommitted lines to support liquidity needs created by seasonal deposit flows, to temporarily satisfy funding needs from increased loan demand, and for other short-term purposes. The FHLB line is committed, but the amount of available credit depends on the level of pledged collateral.
Total non-deposit interest-bearing liabilities increased $136.5 million, or 298%, in 2020, due to increases in overnight fed funds purchased, FHLB advances, and customer repurchase agreements. These increases were primarily to fund fluctuations in our mortgage warehouse loan balances. Non-deposit interest-bearing liabilities were down by $26.7 million, or 25%, in 2019, due to decreases in FHLB borrowings, partially offset by increases in customer repurchase agreements. The Company had $100.0 million in overnight fed funds purchased, $37.9 million in overnight FHLB advances, and $5.0 million in short-term borrowings from the FHLB at December 31, 2020, as compared to $20.0 million in overnight FHLB borrowings at December 31, 2019. There were no overnight federal funds purchased from other correspondent banks or advances from the FRB on our books at December 31, 2019. Repurchase agreements totaled over $39.1 million at year-end 2020 relative to a balance of $25.7 million at year-end 2019. Repurchase agreements represent “sweep accounts”, where commercial deposit balances above a specified threshold are transferred at the close of each business day into non-deposit accounts secured by investment securities. The Company had junior subordinated debentures totaling $35.1 million at December 31, 2020 and $34.9 million December 31, 2019, in the form of long-term borrowings from trust subsidiaries formed specifically to issue trust preferred securities. The small increase resulted from the amortization of discount on junior subordinated debentures that were part of our acquisition of Coast Bancorp in 2016.
The details of the Company’s short-term borrowings are presented in the table below, for the years noted:
Short-term Borrowings
(dollars in thousands)
Year Ended December 31,
Repurchase Agreements
Balance at December 31
$
39,138
$
25,711
$
16,359
Average amount outstanding
34,614
22,090
14,332
Maximum amount outstanding at any month end
41,449
27,712
17,672
Average interest rate for the year
0.40%
0.40%
0.40%
Fed funds purchased
Balance at December 31
$
100,000
$
-
$
-
Average amount outstanding
1,918
Maximum amount outstanding at any month end
100,000
-
Average interest rate for the year
0.21%
0.32%
0.00%
FHLB advances
Balance at December 31
$
42,900
$
20,000
$
56,100
Average amount outstanding
54,244
13,229
8,967
Maximum amount outstanding at any month end
195,100
63,700
56,100
Average interest rate for the year
0.19%
2.06%
2.19%
Other Noninterest Bearing Liabilities
Other liabilities are principally comprised of accrued interest payable, other accrued but unpaid expenses, and certain clearing amounts. The Company’s balance of other liabilities decreased by $0.4 million, or 1%, during 2020.
Capital Resources
The Company had total shareholders’ equity of $343.9 million at December 31, 2020 as compared to $309.3 million at December 31, 2019. The increase of $34.6 million, or 11%, is due to $35.4 million in net income and approximately $1.5 million in additional capital related to stock options, a $12.5 million increase in our accumulated other comprehensive income, net of $12.2 million in dividends paid and $2.6 million in stock repurchased. We maintained a very strong capital position throughout the recession and in the ensuing years, and our capital remains at relatively high levels in comparison to many of our peer banks.
The federal banking agencies published a final rule on November 13, 2019, that provided a simplified measure of capital adequacy for qualifying community banking organizations. A qualifying community banking organization that opts into the community bank leverage ratio framework and maintains a leverage ratio greater than 9 percent will be considered to have met the minimum capital requirements, the capital ratio requirements for the well capitalized category under the Prompt Corrective Action framework, and any other capital or leverage requirements to which the qualifying banking organization is subject. A qualifying community banking organization with a leverage ratio of greater than 9 percent may opt into the community bank leverage ratio framework if it has average consolidated total assets of less than $10 billion, has off-balance-sheet exposures of 25% or less of total consolidated assets, and has total trading assets and trading liabilities of 5 percent or less of total consolidated assets. Further, the bank must not be an advance approaches banking organization.
The final rule became effective January 1, 2020 and banks that met the qualifying criteria were able to elect to use the community bank leverage framework starting with the quarter ended March 31, 2020. The CARES Act reduced the required community bank leverage ratio to 8% until the earlier of December 31, 2020, or the national emergency is declared over. The federal bank regulatory agencies adopted an interim final rule to implement this change from the CARES Act. The Company and the Bank meet the criteria outlined in the final rule and the interim final rule and adopted the community bank leverage ratio framework in the first quarter 2020.The Company uses a variety of measures to evaluate its capital adequacy, including the community bank leverage ratio, which the Company adopted in 2020, and risk-based capital and leverage ratios in preceding years, that are calculated separately for the Company and the Bank. Management reviews these capital measurements on a quarterly basis and takes appropriate action to help ensure that they meet or surpass established internal and external guidelines. As permitted by the regulators for financial institutions that are not deemed to be “advanced approaches” institutions, the Company has elected to opt out of the Basel III requirement to include accumulated other comprehensive income in risk-based capital.
The following table sets forth the Company’s and the Bank’s regulatory capital ratios at the dates indicated:
December 31,
To Be Well Capitalized Under Prompt Corrective Action Regulations (CBLR Framework)
2020 (1)
Tier 1 (Core) Capital to average total assets
Sierra Bancorp and subsidiary
10.50%
8.00%
Bank of the Sierra
10.12%
8.00%
Common Equity Tier 1 Capital Ratio
Sierra Bancorp and subsidiary
13.27%
6.50%
Bank of the Sierra
14.75%
6.50%
Tier 1 Risk-Based Capital Ratio
Sierra Bancorp and subsidiary
14.98%
8.00%
Bank of the Sierra
14.75%
8.00%
Total Risk-Based Capital Ratio
Sierra Bancorp and subsidiary
15.48%
10.00%
Bank of the Sierra
15.25%
10.00%
Tier 1 (Core) Capital to average total assets
Sierra Bancorp and subsidiary
11.91%
5.00%
Bank of the Sierra
11.73%
5.00%
(1) The community bank leverage ratio minimum requirement is 8% as of December 31, 2020, 8.5% for calendar year 2021, and 9% for calendar year 2022 and beyond
At the end of 2020, as our Community Bank Leverage Ratio exceeded 8%, the Company and the Bank were both classified as “well capitalized,” the highest rating of the categories defined under the Bank Holding Company Act and the Federal Deposit Insurance Corporation Improvement Act of 1991, and our regulatory capital ratios remained above the median for peer financial institutions. Similar, under the Capital Adequacy Guidelines in 2019, the Company and the Bank were both classified as “well capitalized”. We do not foresee any circumstances that would cause the Company or the Bank to be less than “well capitalized”, although no assurance can be given that this will not occur. A more detailed table of regulatory capital ratios, which includes the capital amounts and ratios required to qualify as “well capitalized” as well as minimum capital ratios, appears in Note 15 to the Consolidated Financial Statements in Item 8 herein. For additional details on risk-based and leverage capital guidelines, requirements, and calculations and for a summary of changes to risk-based capital calculations which were recently approved by federal banking regulators, see “Item 1, Business - Supervision and Regulation - Capital Adequacy Requirements” and “Item 1, Business - Supervision and Regulation - Prompt Corrective Action Provisions” herein.
Liquidity and Market Risk Management
Liquidity
Liquidity management refers to the Company’s ability to maintain cash flows that are adequate to fund operations and meet other obligations and commitments in a timely and cost-effective manner. Detailed cash flow projections are reviewed by Management on a monthly basis, with various stress scenarios applied to assess our ability to meet liquidity needs under unusual or adverse conditions. Liquidity ratios are also calculated and reviewed on a regular basis. While
those ratios are merely indicators and are not measures of actual liquidity, they are closely monitored, and we are committed to maintaining adequate liquidity resources to draw upon should unexpected needs arise.
The Company, on occasion, experiences cash needs as the result of loan growth, deposit outflows, asset purchases or liability repayments. To meet short-term needs, we can borrow overnight funds from other financial institutions, draw advances via Federal Home Loan Bank lines of credit, or solicit brokered deposits if customer deposits are not immediately obtainable from local sources. Availability on lines of credit from correspondent banks and the FHLB totaled $710.4 million at December 31, 2020. The Company was also eligible to borrow approximately $58.1 million at the Federal Reserve Discount Window based on pledged assets at December 31, 2020. Furthermore, funds can be obtained by drawing down excess cash that might be available in the Company’s correspondent bank deposit accounts, or by liquidating unpledged investments or other readily saleable assets. In addition, the Company can raise immediate cash for temporary needs by selling under agreement to repurchase those investments in its portfolio which are not pledged as collateral. As of December 31, 2020, unpledged debt securities plus pledged securities in excess of current pledging requirements comprised $364.9 million of the Company’s investment balances, as compared to $437.0 million at December 31, 2019. Other sources of potential liquidity include but are not necessarily limited to any outstanding fed funds sold and vault cash. The Company has a higher level of actual balance sheet liquidity than might otherwise be the case, since we utilize a letter of credit from the FHLB rather than investment securities for certain pledging requirements. That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $104.9 million at December 31, 2020. Management is of the opinion that available investments and other potentially liquid assets, along with standby funding sources it has arranged, are more than sufficient to meet the Company’s current and anticipated short-term liquidity needs.
Primary and Secondary Liquidity Sources
December 31, 2020
December 31, 2019
Cash and Due From Banks
$
71,417
$
80,077
Unpledged Investment Securities
311,983
366,012
Excess Pledged Securities
52,892
70,955
FHLB Borrowing Availability
535,404
443,200
Unsecured Lines of Credit
175,000
80,000
Funds Available through Fed Discount Window
58,127
59,198
Totals
$
1,204,823
$
1,099,441
The Company did not experience a change in its ability to access traditional funding sources due to the COVID-19 pandemic. The Company had adequate sources of cash to accommodate pandemic related cash needs such as the ability to defer $424.0 million in loans under the CARES act and to fund $128.1 million in SBA PPP loans. There were no material operational expenditures related to the COVID-19 pandemic, other than $0.1 million for software purchased to accommodate the processing of SBA PPP loans. The Company is approved to borrow from the Federal Reserve’s Paycheck Protection Program Liquidity Facility (PPPLF) for any current balances of PPP loans at the time of borrowing. Should the Company wish to draw on the PPPLF, it would be required do so prior to June 30, 2021, and will be required to pledge individual SBA PPP loans as collateral. The loans are taken as collateral at their face value. Due to the Company's liquidity at December 31, 2020, and expected liquidity in the first quarter of 2021, it has elected not to utilize the PPPLF at this time.
The Company’s net loans to assets and available investments to assets ratios were 76% and 11%, respectively, at December 31, 2020, as compared to internal policy guidelines of “less than 78%” and “greater than 3%.” Other liquidity ratios reviewed periodically by Management and the Board include net loans to total deposits and wholesale funding to total assets (including ratios and sub-limits for the various components comprising wholesale funding), which were all well within policy guidelines at December 31, 2020.
The holding company’s primary uses of funds include operating expenses incurred in the normal course of business, shareholder dividends, and stock repurchases. Its primary source of funds is dividends from the Bank since the holding company does not conduct regular banking operations. Management anticipates that the Bank will have sufficient earnings to provide dividends to the holding company to meet its funding requirements for the foreseeable future and the Bank is not subject to any regulatory restrictions for paying dividends to the holding company, other than the legal and regulatory limitations on dividend payments, as outlined in Item 5(c) Dividends in this Form 10-K.
Interest Rate Risk Management
Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. The Company does not engage in the trading of financial instruments, nor does it have exposure to currency exchange rates. Our market risk exposure is primarily that of interest rate risk, and we have established policies and procedures to monitor and limit our earnings and balance sheet exposure to changes in interest rates. The principal objective of interest rate risk management is to manage the financial components of the Company’s balance sheet in a manner that will optimize the risk/reward equation for earnings and capital under a variety of interest rate scenarios.
To identify areas of potential exposure to interest rate changes, we utilize commercially available modeling software to perform monthly earnings simulations and calculate the Company’s market value of portfolio equity under varying interest rate scenarios. The model imports relevant information for the Company’s financial instruments and incorporates Management’s assumptions on pricing, duration, and optionality for anticipated new volumes. Various rate scenarios consisting of key rate and yield curve projections are then applied in order to calculate the expected effect of a given interest rate change on interest income, interest expense, and the value of the Company’s financial instruments. The rate projections can be shocked (an immediate and parallel change in all base rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from current actual levels).
In addition to a stable rate scenario, which presumes that there are no changes in interest rates, we typically use at least six other interest rate scenarios in conducting our rolling 12-month net interest income simulations: upward shocks of 100, 200, 300, and 400 basis points, and downward shocks of 100, 200, and 300 basis points. Those scenarios may be supplemented, reduced in number, or otherwise adjusted as determined by Management to provide the most meaningful simulations in light of economic conditions and expectations at the time. Given the current near zero interest rate environment it is unlikely that rates could decline much further beyond the downward shock of 100 basis points, therefore the downward shock scenarios of 200 and 300 basis points are temporarily being suspended after concurrence by the Company’s Board of Directors. We currently utilize an additional upward rate shock scenario of 400 basis points. Pursuant to policy guidelines, we generally attempt to limit the projected decline in net interest income relative to the stable rate scenario to no more than 5% for a 100 basis point (bp) interest rate shock, 10% for a 200 bp shock, 15% for a 300 bp shock, and 20% for a 400 bp shock. The Company had the following estimated net interest income sensitivity profiles over one-year, without factoring in any potential negative impact on spreads resulting from competitive pressures or credit quality deterioration:
December 31, 2020
December 31, 2019
Immediate change in Interest Rates (basis points)
% Change in Net Interest Income
$ Change in Net Interest Income
% Change in Net Interest Income
$ Change in Net Interest Income
+400
(1.56)%
$
(1,746)
3.11%
$
3,193
+300
(0.77)%
$
(861)
2.68%
$
2,753
+200
0.03%
$
1.80%
$
1,844
+100
0.51%
$
1.06%
$
1,085
Base
(7.67)%
$
(8,583)
(4.39)%
$
(4,505)
Our current simulations indicate that the Company’s net interest income will remain relatively flat over the next 12 months in the up 100 and 200 basis point scenarios but declines after that in a rising rate environment, indicating that the Company is liability sensitive; furthermore, a drop in interest rates could have a substantial negative impact on earnings. For the prior year ending December 31, 2019 the simulations projected sizeable increases in net interest income in rising rate scenarios, but balance sheet changes in 2020 such as the addition of fixed-rate loans and long-term adjustable-rate loans with longer reset periods, compounded by the Company’s increase in its current overnight borrowing position have significantly diminished that effect. If there were an immediate and sustained upward adjustment of 100 basis points in interest rates, all else being equal, net interest income over the next 12 months is projected to improve by only $0.6 million, or 0.51%, relative to a stable interest rate scenario, with the favorable variance diminishing as interest rates rise higher. If interest rates were to decline by 100 basis points, however, net interest income would likely be around $8.6 million lower than in a stable interest rate scenario, for a negative variance of 7.7%.
In addition to the net interest income simulations shown above, we run stress scenarios for the unconsolidated Bank modeling the possibility of no balance sheet growth, the potential runoff of “surge” core deposits which flowed into the Bank in the most recent economic cycle, and unfavorable movement in deposit rates relative to yields on earning assets (i.e., higher deposit betas). When no balance sheet growth is incorporated and a stable interest rate environment is assumed, projected annual net interest income is about $3.4 million lower than in our standard simulation. However, the stressed simulations reveal that the Company’s greatest potential pressure on net interest income would result from excessive non-maturity deposit runoff and/or unfavorable deposit rate changes in rising rate scenarios.
The economic value (or “fair value”) of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed. The difference between the projected fair value of the Company’s financial assets and the fair value of its financial liabilities is referred to as the economic value of equity (“EVE”), and changes in EVE under different interest rate scenarios are effectively a gauge of the Company’s longer-term exposure to interest rate fluctuations. Fair values for financial instruments are estimated by discounting projected cash flows (principal and interest) at anticipated replacement interest rates for each account type, while the fair value of non-financial accounts is assumed to equal their book value for all rate scenarios. An economic value simulation is a static measure utilizing balance sheet accounts at a given point in time, and the measurement can change substantially over time as the Company’s balance sheet evolves and interest rate and yield curve assumptions are updated.
The change in economic value under different interest rate scenarios depends on the characteristics of each class of financial instrument, including stated interest rates or spreads relative to current or projected market-level interest rates or spreads, the likelihood of principal prepayments, whether contractual interest rates are fixed or floating, and the average remaining time to maturity. As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline. The longer the duration of the financial instrument, the greater the impact a rate change will have on its value. In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on historical patterns and Management’s best estimates. The table below shows estimated changes in the Company’s EVE as of December 31, 2020, and 2019, under different interest rate scenarios relative to a base case of current interest rates:
December 31, 2020
December 31, 2019
Immediate change in Interest Rates (basis points)
% Change in Fair Value of Equity
$ Change in Fair Value of Equity
% Change in Fair Value of Equity
$ Change in Fair Value of Equity
+400
32.19%
$
163,713
19.38%
$
106,925
+300
28.81%
$
146,533
17.47%
$
96,382
+200
23.69%
$
120,513
14.19%
$
78,265
+100
14.60%
$
74,251
8.74%
$
48,325
Base
(7.26)%
$
(36,919)
(16.61)%
$
(91,610)
The table shows that our EVE will generally deteriorate in declining rate scenarios but should benefit from a parallel shift upward in the yield curve. The increase in value of the Company’s large volume of stable DDA balances is expected to outweigh the decrease in value of the fixed rate assets, causing the overall net increase in EVE in the up-shock scenarios. Our EVE deltas have increased given the relative starting points of our non-maturity deposits in the current rate environment. In other words, as the current rates are very low, the value of the non-maturity deposits is lower than it has been historically. The impact of an increase in rates has an expected greater magnitude impact on the value of such deposits.
We also run stress scenarios for the unconsolidated Bank’s EVE to simulate the possibility of slower loan prepayment speeds in the up-shock scenarios and faster prepayment speeds in the down-shock scenarios, as well as, unfavorable changes in deposit rates, and higher deposit decay rates. Model results are highly sensitive to changes in assumed decay rates for non-maturity deposits, in particular, with material unfavorable variances occurring relative to the standard simulations shown above as decay rates are increased. Furthermore, while not as extreme as the variances produced by increasing non-maturity deposit decay rates, EVE also displays a relatively high level of sensitivity to unfavorable changes in deposit rate betas in rising interest rate scenarios.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information concerning quantitative and qualitative disclosures of market risk called for by Item 305 of Regulation S-K is included as part of Item 7 above. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Market Risk Management”.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements and independent auditors’ reports listed below are included herein:
Page
I.
Reports of Independent Registered Public Accounting Firms from Eide Bailly LLP and Vavrinek, Trine, Day & Co., LLP
II.
Consolidated Balance Sheets - December 31, 2020 and 2019
III.
Consolidated Statements of Income - Years Ended December 31, 2020, 2019, and 2018
IV.
Consolidated Statements of Comprehensive Income - Years Ended December 31, 2020, 2019, and 2018
V.
Consolidated Statements of Changes in Shareholders’ Equity - Years Ended December 31, 2020, 2019, and 2018
VI.
Consolidated Statements of Cash Flows - Years Ended December 31, 2020, 2019, and 2018
VII.
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Sierra Bancorp and Subsidiary
Porterville, California
Opinion on the Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Sierra Bancorp and Subsidiary (the Company) as of December 31, 2020 and 2019, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the two year period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”).
We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control -Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the two year period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework: (2013) issued by COSO.
Basis for Opinion
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan and Lease Losses
As discussed in Note 4 to the Company’s consolidated financial statements, the Company has a gross loan and lease portfolio of $2.4 billion and related allowance for loan and lease losses of $17.7 million as of December 31, 2020. The Company’s allowance for loan and lease losses is a material and complex estimate requiring significant management’s judgment in the evaluation of the credit quality and the estimation of inherent losses within the loan and lease portfolio. The allowance for loan and lease losses includes a general reserve which is determined based on the results of a quantitative and a qualitative analysis of all loans not measured for impairment at the reporting date.
The Company’s general reserves cover non-impaired loans and are based on historical net loss rates for each portfolio segment by call report code, adjusted for the effects of qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the portfolio segment’s historical loss experience. Qualitative factors include consideration of the following: changes in lending policies and procedures; changes in international, national, regional, and local economic and business conditions and developments; changes in the nature and volume of the portfolio; changes in the experience, ability and depth of lending management and staff; changes in the volume and severity of past due, nonaccrual and other adversely graded loans; changes in quality of the loan review system; changes in the value of the underlying collateral for collateral-dependent loans; concentrations of credit; and the effect of the other external factors such as competition and legal and regulatory requirements...
Auditing these complex judgments and assumptions involves especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill or knowledge needed.
The primary procedures we performed to address this critical audit matter included:
● Testing the design and operating effectiveness of controls relating to management’s timely identification of problem loans, appropriate application of loan rating policy, consistency of application of accounting policies and appropriateness of assumptions used in the allowance for loan and lease losses calculation.
● Evaluating the reasonableness of assumptions and sources of data used by management in forming the loss factors by performing retrospective review of historic loan and lease loss experience and analyzing historical data used in developing the assumptions.
● Evaluating the appropriateness of inputs and factors that the Company used in forming the qualitative loss factors and assessing whether such inputs and factors were relevant, reliable, and reasonable for the purpose used.
● Testing the mathematical accuracy and computation of the allowance for loan and lease losses.
● Evaluating the period to period consistency with which qualitative loss factors are determined and applied.
/s/ Eide Bailly LLP
We have served as the Company’s auditor since 2019.
San Ramon, California
March 12, 2021
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
Sierra Bancorp and Subsidiary
Porterville, California
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of income and comprehensive income, changes in shareholders’ equity, and cash flows, for the year ended December 31, 2018, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the results of its operations and its cash flows for the year ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the entity’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to Sierra Bancorp in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risk of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Vavrinek, Trine, Day & Co., LLP
We have served as the Company's auditor since 2004.
Rancho Cucamonga, California
March 14, 2019
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2020 and 2019
(dollars in thousands)
ASSETS
Cash and due from banks
$
67,908
$
65,556
Interest bearing deposits in banks
3,509
14,521
Cash and cash equivalents
71,417
80,077
Securities available-for-sale
543,974
600,799
Loans and leases:
Gross loans and leases
2,463,111
1,762,565
Allowance for loan and lease losses
(17,738)
(9,923)
Deferred loan and lease (fees) costs, net
(3,147)
2,896
Net loans and leases
2,442,226
1,755,538
Foreclosed assets
Premises and equipment, net
27,505
27,435
Goodwill
27,357
27,357
Other intangible assets, net
4,307
5,381
Company owned life insurance
52,539
50,517
Other assets
50,446
45,915
$
3,220,742
$
2,593,819
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing
$
943,664
$
690,950
Interest bearing
1,680,942
1,477,424
Total deposits
2,624,606
2,168,374
Repurchase agreements
39,138
25,711
Short-term borrowings
142,900
20,000
Subordinated debentures, net
35,124
34,945
Other liabilities
35,078
35,504
Total liabilities
2,876,846
2,284,534
Commitments and contingent liabilities (Notes 6 & 13)
Shareholders' equity
Serial Preferred stock, no par value; 10,000,000 shares authorized; none issued; Common stock, no par value; 24,000,000 shares authorized; 15,388,423 and 15,284,538 shares issued and outstanding in 2020 and 2019, respectively
113,384
113,179
Additional paid-in capital
3,736
3,307
Retained earnings
208,371
186,867
Accumulated other comprehensive gain, net of taxes of $(7,725) in 2020 and $(2,490) in 2019
18,405
5,932
Total shareholders' equity
343,896
309,285
$
3,220,742
$
2,593,819
The accompanying notes are an integral part of these consolidated financial statements.
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2020, 2019 and 2018
(dollars in thousands, except per share data)
Interest and dividend income
Loans and leases, including fees
$
96,181
$
95,898
$
87,792
Taxable securities
8,199
10,139
9,548
Tax-exempt securities
5,707
4,534
4,060
Federal funds sold and other
Total interest income
110,243
110,947
101,638
Interest expense
Deposits
3,948
11,380
7,260
Short-term borrowings
Subordinated debentures
1,217
1,836
1,731
Total interest expense
5,408
13,578
9,244
Net interest income
104,835
97,369
92,394
Provision for loan and lease losses
8,550
2,550
4,350
Net interest income after provision for loan and lease losses
96,285
94,819
88,044
Noninterest income
Service charges on deposits
11,765
12,742
12,439
Checkcard fees
7,023
6,584
5,878
Net gains (losses) on sale of securities available-for-sale
(198)
Increase in cash surrender value of life insurance
2,412
2,184
Other income
4,560
2,165
2,654
Total noninterest income
26,150
23,477
21,564
Noninterest expense
Salaries and employee benefits
40,178
35,978
36,133
Occupancy and equipment
9,842
9,845
10,295
Acquisition costs
-
Other
25,892
24,733
23,147
Total noninterest expense
75,912
70,578
70,024
Income before income taxes
46,523
47,718
39,584
Provision for income taxes
11,079
11,757
9,907
Net income
$
35,444
$
35,961
$
29,677
Earnings per share
Basic
$
2.33
$
2.35
$
1.94
Diluted
$
2.32
$
2.33
$
1.92
Weighted average shares outstanding, basic
15,216,749
15,311,113
15,261,794
Weighted average shares outstanding, diluted
15,280,325
15,437,111
15,432,120
The accompanying notes are an integral part of these consolidated financial statements.
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2020, 2019 and 2018
(dollars in thousands, except footnotes)
Net income
$
35,444
$
35,961
$
29,677
Other comprehensive income, before tax
Unrealized gain (loss) on securities:
Unrealized holding gain (loss) arising during period
18,099
17,686
(6,154)
Reclassification adjustment for (gains) losses included in net income (1)
(390)
(2)
Other comprehensive gain (loss), before tax
17,709
17,884
(6,156)
Income tax (expense) benefit related to items of other comprehensive income
(5,236)
(5,286)
1,820
Total other comprehensive gain (loss), net of tax
12,473
12,598
(4,336)
Comprehensive income
47,917
48,559
25,341
(1) Amounts are included in net (gains) losses on securities available-for-sale on the Consolidated Statements of Income in noninterest income. Income tax (expense) benefit associated with the reclassification adjustment for the years ended 2020, 2019 and 2018 was $(115,000), $59,000 and $(1,000) respectively.
The accompanying notes are an integral part of these consolidated financial statements.
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Three Years Ended December 31, 2020
(dollars in thousands, except per share data)
Common Stock
Accumulated
Additional
Other
Paid In
Retained
Comprehensive
Shareholders'
Shares
Amount
Capital
Earnings
Gain (Loss)
Equity
Balance, January 1, 2018
15,223,360
$
111,138
$
2,937
$
144,197
$
(2,330)
$
255,942
Net Income
29,677
29,677
Other comprehensive loss, net of tax
(4,336)
(4,336)
Exercise of stock options
77,100
1,369
(238)
1,131
Stock based compensation expense
Stock issued-acquisition
-
-
(6)
(6)
Cash dividends - $.64 per share
(9,757)
(9,757)
Balance, December 31, 2018
15,300,460
112,507
3,066
164,117
(6,666)
273,024
Net Income
35,961
35,961
Other comprehensive gain, net of tax
12,598
12,598
Exercise of stock options
82,681
1,337
(249)
1,088
Stock based compensation expense
Stock repurchase
(98,603)
(665)
(1,879)
(2,544)
Cash dividends - $.74 per share
(11,332)
(11,332)
Balance, December 31, 2019
15,284,538
113,179
3,307
186,867
5,932
309,285
Net Income
35,444
35,444
Other comprehensive gain, net of tax
12,473
12,473
Exercise of stock options
67,050
1,034
(259)
Stock based compensation expense
148,885
Stock repurchase
(112,050)
(829)
(1,733)
(2,562)
Cash dividends - $.80 per share
(12,207)
(12,207)
Balance, December 31, 2020
15,388,423
$
113,384
$
3,736
$
208,371
$
18,405
$
343,896
The accompanying notes are an integral part of these consolidated financial statements.
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2020, 2019, and 2018
(dollars in thousands)
Cash flows from operating activities:
Net income
$
35,444
$
35,961
$
29,677
Adjustments to reconcile net income to net cash provided by operating activities:
(Gain) loss on sales of securities
(390)
(2)
Loss on disposal of fixed assets
-
Gain on sale of foreclosed assets
(10)
(107)
(1,423)
Writedown of foreclosed assets
Stock based compensation expense
Provision for loan and lease losses
8,550
2,550
4,350
Depreciation and amortization
3,025
2,988
3,174
Net amortization on securities premiums and discounts
4,789
4,449
5,452
Accretion of discounts for loans acquired and net deferred loan fees
(663)
(1,023)
(1,647)
Increase in cash surrender value of life insurance policies
(2,412)
(2,184)
(591)
Amortization of core deposit intangible
1,074
1,074
1,020
Increase in interest receivable and other assets
(488)
(9,224)
(6,106)
(Decrease) increase in other liabilities
(8,151)
9,662
(5,420)
Deferred income tax benefit
(2,611)
(97)
(308)
Increase in equity securities
(447)
(232)
(1,183)
Net amortization of partnership investment
1,505
2,127
2,625
Net cash provided by operating activities
40,027
46,737
30,446
Cash flows from investing activities:
Maturities and calls of securities available for sale
12,385
9,809
9,730
Proceeds from sales of securities available for sale
20,298
60,510
6,838
Purchases of securities available for sale
(71,816)
(190,168)
(122,818)
Principal paydowns on securities available for sale
109,267
92,766
92,494
Net purchases of FHLB stock
-
(833)
(300)
Loan originations and payments, net
(697,305)
(32,376)
(183,737)
Purchases of premises and equipment, net
(2,916)
(783)
(3,123)
Proceeds from sales of fixed assets
-
-
Proceeds from sales of foreclosed assets
2,445
7,955
13,188
Purchase of bank owned life insurance
(210)
(440)
(454)
Liquidation of bank-owned life insurance
-
Proceeds from BOLI death benefit
-
-
Net cash from bank acquisition
-
-
(6)
Net cash used in investing activities
(627,252)
(53,290)
(188,188)
Cash flows from financing activities:
Increase in deposits
456,232
52,034
127,954
Increase (decrease) in borrowed funds
22,900
(36,100)
34,200
Increase in repurchase agreements
13,427
9,352
8,209
Increase in fed funds purchased
100,000
-
-
Cash dividends paid
(12,207)
(11,332)
(9,757)
Repurchases of common stock
(2,562)
(2,544)
-
Stock options exercised
1,088
1,131
Net cash provided by financing activities
578,565
12,498
161,737
(Decrease) increase in cash and due from banks
(8,660)
5,945
3,995
Cash and cash equivalents, beginning of year
80,077
74,132
70,137
Cash and cash equivalents, end of year
$
71,417
$
80,077
$
74,132
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Years Ended December 31, 2020, 2019 and 2018
(dollars in thousands)
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest
$
6,007
$
13,769
$
8,707
Income taxes
$
14,490
$
12,000
$
11,300
Supplemental noncash disclosures:
Real estate acquired through foreclosure
$
2,562
$
$
7,805
Change in unrealized net gains (losses) on securities available-for-sale
$
17,709
$
17,884
$
(6,156)
Operating right-of-use asset pursuant to adoption of ASU 2016-02
$
-
$
8,308
$
-
Operating lease liability pursuant to adoption of ASU 2016-02
$
-
$
8,915
$
-
The accompanying notes are an integral part of these consolidated financial statements.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE BUSINESS OF SIERRA BANCORP
Sierra Bancorp (the “Company”) is a California corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is headquartered in Porterville, California. The Company was incorporated in November 2000 and acquired all of the outstanding shares of Bank of the Sierra (the “Bank”) in August 2001. The Company’s principal subsidiary is the Bank, and the Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. The Company’s only other direct subsidiaries are Sierra Statutory Trust II, Sierra Capital Trust III and Coast Bancorp Statutory Trust II, which were formed solely to facilitate the issuance of capital trust pass-through securities.
At December 31, 2020, the Bank operated 40 full service branch offices, an online branch and provides specialized lending services through an agricultural credit center, an SBA center, Mortgage Warehouse lending divisions and a dedicated loan production office in Rocklin, California. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. The Bank maintains a diversified loan portfolio comprised of agricultural, commercial, consumer, real estate, construction and mortgage loans. Loans are made in California within the market area of the South Central San Joaquin Valley, the Central Coast, Ventura County and neighboring communities. These areas have diverse economies with principal industries being agriculture, real estate and light manufacturing.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company and the consolidated accounts of its wholly-owned subsidiary, Bank of the Sierra. All significant intercompany balances and transactions have been eliminated. Certain reclassifications have been made to prior years’ balances to conform to classifications used in 2020. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (U.S. GAAP) and prevailing practices within the banking industry.
In accordance with U.S. GAAP, the Company’s investments in Sierra Statutory Trust II, Sierra Capital Trust III and Coast Bancorp Statutory Trust II are not consolidated and are accounted for under the equity method and included in other assets on the consolidated balance sheet. The subordinated debentures issued and guaranteed by the Company and held by the trusts are reflected on the Company’s consolidated balance sheet.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.
Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for loan and lease losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and lease losses and other real estate, management obtains independent appraisals for significant properties, evaluates the overall loan portfolio characteristics and delinquencies and monitors economic conditions.
Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash and deposits with other financial institutions with original maturities within 90 days, and federal funds sold. Net cash flows are reported for customer
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
loan and deposit transactions, interest bearing deposits in other financial institutions, and fed funds purchased and repurchase agreements.
Securities
Debt securities may be classified as held to maturity and carried at amortized cost when management has the positive ability and intent to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available for sale. Debt securities available for sale are carried at fair value with unrealized holding gains and losses reported in other comprehensive income, net of tax.
Interest income includes amortization of purchase premium or discount. Premiums or discounts on securities are amortized on the level-yield method without anticipating prepayments. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management determines the appropriate classification of its investments at the time of purchase and may only change the classification in certain limited circumstances. All transfers between categories are accounted for at fair value. Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are currently classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of the impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
FHLB Stock and Other Investments
The Bank is a member of the Federal Home Loan Bank ("FHLB") system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost in other assets, and periodically evaluated for impairment based on the ultimate recovery of par value. Both cash and stock dividends are reported as income. The Bank’s investment in FHLB stock was approximately $10.7 million at both December 31, 2020 and 2019.
Pursuant to the adoption of ASU 2016-01 on January 1, 2018, the Company elected the measurement alternative for measuring equity securities without readily determinable fair values at cost less impairment, plus or minus observable price changes in orderly transactions. The carrying amount of equity securities without readily determinable fair values is $2.5 million and $2.0 million at December 31, 2020 and 2019, respectively. Equity securities primarily consist of an investment in Pacific Coast Bankers’ Bank (“PCBB”). A remeasurement gain of $0.4 million, $0.2 million and $1.2 million was recorded to income during the years ended December 31, 2020, 2019 and 2018, on PCBB stock. $1.8 million in cumulative remeasurement gains have been recorded as of December 31,
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2020 on PCBB stock. Adjustments to the carrying value of PCBB stock were based on observable activity in the stock.
Loans Held for Sale
The Company may originate loans intended to be sold on the secondary market. Loans originated and intended for sale in the secondary market are carried at cost which approximates fair value since these loans are typically sold shortly after origination. The loan’s cost basis includes unearned deferred fees and costs, and premiums and discounts. If loans held for sale remain on our books for an extended period of time the fair value of those loans is determined using quoted secondary market prices. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.
Loans that might be held for sale by the Company typically consist of residential real estate loans. Loans classified as held for sale, if any, are disclosed in Note 4 to the consolidated financial statements.
Gains and losses on sales of loans are recognized at the time of sale and are calculated based on the difference between the selling price and the allocated book value of loans sold. Book value allocations are determined in accordance with U.S. GAAP. Any inherent risk of loss on loans sold is transferred to the buyer at the date of sale.
The Company has issued various representations and warranties associated with the sale of loans. These representations and warranties may require the Company to repurchase loans with underwriting deficiencies as defined per the applicable sales agreements and certain past due loans within 90 days of the sale. The Company did not experience losses during the years ended December 31, 2020, 2019, or 2018 regarding these representations and warranties.
Loans and Leases (Financing Receivables)
Our credit quality classifications of Loans and Leases include Pass, Special Mention, Substandard and Impaired. These classifications are defined in Note 4 to the consolidated financial statements.
Loans and leases that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, purchase premiums and discounts, write-downs, and an allowance for loan and lease losses. Loan and lease origination fees, net of certain deferred origination costs, and purchase premiums and discounts are recognized in interest income as an adjustment to yield of the related loans and leases over the contractual life of the loan using both the effective interest and straight line methods without anticipating prepayments.
Interest income for all performing loans, regardless of classification (Pass, Special Mention, Substandard and Impaired), is recognized on an accrual basis, with interest accrued daily. Costs associated with successful loan originations are netted from loan origination fees, with the net amount (net deferred loan fees) amortized over the contractual life of the loan in interest income. If a loan has scheduled periodic payments, the amortization of the net deferred loan fee is calculated using the effective interest method over the contractual life of the loan. If the loan does not have scheduled payments, such as a line of credit, the net deferred loan fee is recognized as interest income on a straight line basis over the contractual life of the loan. Fees received for loan commitments are recognized as interest income over the term of the commitment. When loans are repaid, any remaining unamortized balances of deferred fees and costs are accounted for through interest income.
Generally, the Company places a loan or lease on nonaccrual status and ceases recognizing interest income when it has become delinquent more than 90 days and/or when Management determines that the repayment of principal and
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
collection of interest is unlikely. The Company may decide that it is appropriate to continue to accrue interest on certain loans more than 90 days delinquent if they are well-secured by collateral and collection is in process. When a loan is placed on nonaccrual status, any accrued but uncollected interest for the loan is reversed out of interest income in the period in which the loan’s status changed. For loans with an interest reserve, i.e., where loan proceeds are advanced to the borrower to make interest payments, all interest recognized from the inception of the loan is reversed when the loan is placed on non-accrual. Once a loan is on non-accrual status subsequent payments received from the customer are applied to principal, and no further interest income is recognized until the principal has been paid in full or until circumstances have changed such that payments are again consistently received as contractually required. Generally, loans and leases are not restored to accrual status until the obligation is brought current and has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
Impaired loans are classified as either nonaccrual or accrual, depending on individual circumstances regarding the collectability of interest and principal according to the contractual terms.
Purchased Credit Impaired Loans
The Company purchases individual loans and groups of loans, some of which may show evidence of credit deterioration since origination. These purchased credit impaired (“PCI”) loans are recorded at the amount paid, since there is no carryover of the seller’s allowance for loan and lease losses. After acquisition, additional deterioration in credit is recognized by an increase in the allowance for loan and lease losses.
Such PCI loans are accounted for individually or aggregated into pools of loans based on common risk characteristics. The Company estimates the amount and timing of expected cash flows for the loan or pool, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan or pool (accretable yield). The excess of the loan’s or pool’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference).
Over the life of the loan or pool, expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded as a provision for loan and lease losses. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income
Loans Modified in a Troubled Debt Restructuring
Loans are considered to have been modified in a troubled debt restructuring (“TDR”) when due to a borrower’s financial difficulties the Company makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a TDR remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower’s ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status.
A TDR is generally considered to be in default when it appears likely that the customer will not be able to repay all principal and interest pursuant to the terms of the restructured agreement.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Allowance for Loan and Lease Losses
The allowance for loan and lease losses is maintained at a level which, in management’s judgment, is adequate to absorb loan and lease losses inherent in the loan and lease portfolio. The allowance for loan and lease losses is increased by a provision for loan and lease losses, which is charged to expense, and by principal recovered on charged-off balances. It is reduced by principal charge-offs. The amount of the allowance is based on management’s evaluation of the collectability of the loan and lease portfolio, changes in its risk profile, credit concentrations, historical trends, and economic conditions. This evaluation also considers the balance of impaired loans and leases. A loan or lease is impaired when it is probable that the Company will be unable to collect all contractual principal and interest payments due in accordance with the terms of the loan or lease agreement. The impairment on certain individually identified loans or leases is measured based on the present value of expected future cash flows discounted at the original effective interest rate of the loan or lease. As a practical expedient, impairment may be measured based on the loan’s or lease’s observable market price or the fair value of collateral if the loan or lease is collateral dependent. The amount of impairment, if any, is recorded through the provision for loan and lease losses and is added to the allowance for loan and lease losses, with any changes over time recognized as additional bad debt expense in our provision for loan and lease losses. Impaired loans with homogenous characteristics, such as one-to-four family residential mortgages and consumer installment loans, may be subjected to a collective evaluation for impairment, considering delinquency and repossession statistics, historical loss experience, and other factors.
General reserves cover non-impaired loans and are based on historical net loss rates for each portfolio segment by call report code, adjusted for the effects of qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the portfolio segment’s historical loss experience. Qualitative factors include consideration of the following: changes in lending policies and procedures; changes in international, national, regional, and local economic and business conditions and developments; changes in the nature and volume of the portfolio; changes in the experience, ability and depth of lending management and staff; changes in the volume and severity of past due, nonaccrual and other adversely graded loans; changes in quality of the loan review system; changes in the value of the underlying collateral for collateral-dependent loans; concentrations of credit; and the effect of the other external factors such as competition and legal and regulatory requirements.
Most of the Company’s business activity is with customers located in California within the Southern Central San Joaquin Valley; in the corridor stretching between Santa Paula and Santa Clarita in Southern California, and on the Central Coast. Therefore the Company’s exposure to credit risk is significantly affected by changes in the economy in those regions. The Company considers this concentration of credit risk when assessing and assigning qualitative factors in the allowance for loan and lease losses. Portfolio segments identified by the Company include Agricultural, Commercial and Industrial, Real Estate, Small Business Administration, and Consumer loans. Relevant risk characteristics for these portfolio segments generally include debt service coverage, loan-to-value ratios and financial performance on non-consumer loans; and credit scores, debt-to-income ratios, collateral type and loan-to-value ratios for consumer loans.
Though management believes the allowance for loan and lease losses to be adequate, ultimate losses may vary from their estimates. However, estimates are reviewed periodically, and as adjustments become necessary they are reported in earnings during the periods they become known. In addition, the FDIC and the California Department of Financial Protection and Innovation, as an integral part of their examination processes, review the allowance for loan and lease losses. These agencies may require additions to the allowance for loan and lease losses based on their judgment about information available at the time of their examinations.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Reserve for Off-Balance Sheet Commitments
In addition to the exposure to credit loss from outstanding loans, the Company is also exposed to credit loss from certain off-balance sheet commitments such as unused commitments from revolving lines of credit, mortgage warehouse lines of credit, construction loans and commercial and standby letters of credit. Because the available funds have not yet been disbursed on these commitments the estimated losses are not included in the calculation of the ALLL. The reserve for off-balance sheet commitments is an estimated loss contingency which is included in other liabilities on the Consolidated Balance Sheets. The adjustments to the reserve for off-balance sheet commitments are reported within noninterest expense. This reserve is for estimated losses that could occur when the Company is contractually obligated to make a payment under these instruments and must seek repayment from a party that may not be as financially sound in the current period as it was when the commitment was originally made.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The useful lives of premises range between twenty-five to thirty-nine years. The useful lives of furniture, fixtures and equipment range between three to twenty years. Leasehold improvements are amortized over the life of the asset or the term of the related lease, whichever is shorter. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in income for the period. The cost of maintenance and repairs is charged to expense as incurred.
Impairment of long-lived assets is evaluated by management based upon an event or changes in circumstances surrounding the underlying assets which indicate long-lived assets may be impaired.
Foreclosed Assets
Foreclosed assets include real estate and other property acquired in full or partial settlement of loan obligations. Upon acquisition, any excess of the recorded investment in the loan balance over the appraised fair market value, net of estimated selling costs, is charged against the allowance for loan and lease losses. A valuation allowance for losses on foreclosed assets is maintained to provide for subsequent declines in value. The allowance is established through a provision for losses on foreclosed assets which is included in other noninterest expense. Subsequent gains or losses on sales or write-downs resulting from permanent impairments are recorded in other noninterest expense as incurred. Operating costs after acquisition are expensed.
The Company had one foreclosed residential real estate property recorded at December 31, 2020, as a result of obtaining physical possession of the property. At December 31, 2020, the recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceeds were in process was $1.2 million.
Goodwill and Other Intangible Assets
The Company acquired Sierra National Bank in 2000, Santa Clara Valley Bank in 2014, Coast National Bank in 2016, and Ojai Community Bank and the Woodlake Branch of Citizen’s Business Bank in 2017. Goodwill resulting from business combinations after January 1, 2009 is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but are tested for impairment at least annually or more frequently if events and circumstances exist which indicate that an impairment test should be performed. The Company selected December 31, 2020 as the date to perform the annual impairment test for 2020. Goodwill is the only intangible asset with an indefinite life on our balance sheet. There was no impairment recognized for the years ended December 31, 2020, 2019, and 2018.
Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. The Company’s other intangible assets consist solely of core deposit intangible assets (CDI’s) arising from the acquisitions of Santa Clara Valley Bank, Coast National Bank, a Citizen’s Business Bank Porterville branch deposit portfolio, Ojai Community Bank, the Woodlake Branch of Citizen’s Business Bank and the Lompoc branch of Santa Maria Community Bank. All of the CDI’s are being amortized on a straight-line basis over eight years, except for the Citizen’s Business Bank Porterville branch deposit portfolio which is being amortized on a straight-line basis over five years.
Loan Commitments and Related Financial Instruments
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Details regarding these commitments and financial instruments are discussed in detail in Note 13 to the consolidated financial statements.
Income Taxes
The Company files its income taxes on a consolidated basis with its subsidiary. The allocation of income tax expense represents each entity’s proportionate share of the consolidated provision for income taxes.
Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax basis of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. We have determined that as of December 31, 2020 all tax positions taken to date are highly certain and, accordingly, no accounting adjustment has been made to the financial statements.
The Company recognizes interest and penalties related to uncertain tax positions as part of income tax expense.
Salary Continuation Agreements and Directors’ Retirement Plan
The Company has entered into agreements to provide members of the Board of Directors and certain key executives, or their designated beneficiaries, with annual benefits for up to fifteen years after retirement or death. The Company accrues for these future benefits from the effective date of the plan until the director’s or executive’s expected retirement date in a systematic and rational manner. At the consolidated balance sheet date, the amount of accrued
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
benefits equals the then present value of the benefits expected to be provided to the director or employee, any beneficiaries, and covered dependents in exchange for the director’s or employee’s services to that date.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes fluctuations in unrealized gains and losses on securities available for sale, net of an adjustment for the effects of realized gains and losses and any applicable tax. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of other comprehensive income that historically has not been recognized in the calculation of net income. Unrealized gains and losses on the Company’s available for sale securities, net of tax, are included in other comprehensive income after adjusting for the effects of realized gains and losses. Total comprehensive income and the components of accumulated other comprehensive income (loss) are presented in the consolidated statements of comprehensive income.
Stock-Based Compensation
At December 31, 2020, the Company had one stock-based compensation plan, the Sierra Bancorp 2017 Stock Incentive Plan (the “2017 Plan”), which was adopted by the Company’s Board of Directors on March 16, 2017 and approved by the Company’s shareholders on May 24, 2017. The 2017 Plan replaced the Company’s 2007 Stock Incentive Plan (the “2007” Plan), which expired by its own terms on March 15, 2017. Options to purchase shares granted under the 2007 Plan that remained outstanding were unaffected by that plan’s termination. The 2017 Plan covers 850,000 shares of the Company’s authorized but unissued common stock, subject to adjustment for stock splits and dividends, and provides for the issuance of both “incentive” and “nonqualified” stock options to salaried officers and employees, and of “nonqualified” stock options to non-employee directors. The 2017 Plan also provides for the issuance of restricted stock awards to these same classes of eligible participants.
Compensation cost and director’s expense is recognized for stock options and restricted stock awards issued to employees and directors and is recognized over the required service period, generally defined as the vesting period. The Company is using the Black-Scholes model to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. The “multiple option” approach for stock options is used to allocate the resulting valuation to actual expense for current period. Expected volatility is based on historical volatility of the Company’s common stock. The Company uses historical data to estimate stock option exercise and post-vesting termination behavior. The expected term of stock options granted is based on historical data and represents the period of time that options granted are expected to be outstanding subsequent to vesting, which takes into account that the options are not transferable. The risk-free interest rate for
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
the expected term of the stock option is based on the U.S. Treasury yield curve in effect at the time of the grant. The fair value of each stock option is estimated on the date of grant using the following assumptions:
Years Ended December 31,
Dividend yield
3.02%
2.62%
2.12%
Expected Volatility
25.06%
34.57%
26.26%
Risk-free interest rate
1.47%
2.70%
2.38%
Expected option life
6.4 years
5.4 years
5.3 years
Revenue Recognition
Revenue from contracts with customers subject to ASC 606 comprises the noninterest income earned by the Company in exchange for services provided to customers. Income associated with customer contracts generally involve transaction prices that are fixed and performance obligations which are satisfied as services are rendered. In most cases recognition occurs within a single financial reporting period as there is little or no judgement involved in the timing of revenues. We generally act in a principal capacity, on our own behalf, in most of our contracts with customers. In such transactions, we recognize revenue and the related costs to provide our services on a gross basis in our financial statements. Service Charges on Deposit Accounts comprise charges on retail and business accounts. Business customers can earn credits depending on account type and deposit balances maintained with the Company, which may be used to offset fees. Fees and credits are based on predetermined, agreed-upon rates. In some cases, we act in an agent capacity, deriving revenue through assisting other entities in transactions with our customers. In such transactions, we recognize revenue and those related costs to provide services on a gross basis in our financial statements. Debit card interchange income is derived from our customers’ use of various interchange and ATM/debit card networks which are the primary sources of revenue generated in an agent capacity.
Recent Accounting Pronouncements
In January 2016 the FASB issued ASU 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. Among other things, the guidance in this ASU (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or in the accompanying notes to the financial statements, and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. This amendment is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Entities are required to apply the amendment by means of a cumulative-effect adjustment as of the beginning of the fiscal year of adoption, except for the amendment related to equity securities without readily determinable fair values which should be applied prospectively to equity investments that exist as of the date of adoption. The Company adopted ASU 2016-01 effective January 1, 2018, and recorded an increase in equity securities without readily determinable
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
values and noninterest revenue for $1.2 million. In accordance with (iv) above, the Company measured the fair value of its loan portfolio at December 31, 2020 and 2019 using an exit price notion. See Note 20 Fair Value.
In February 25, 2016, the FASB issued Accounting Standards Update 2016-02, Leases (Topic 842). The new standard was issued to increase the transparency and comparability around lease obligations. Previously unrecorded off-balance sheet obligations will now be brought more prominently to light by bringing lease liabilities onto the balance sheet, accompanied by enhanced qualitative and quantitative disclosures in the notes to the financial statements. This Update is generally effective for public business entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company has several lease agreements, including 21 branch locations, one administrative office and three offsite ATM locations which fell under the requirements of Topic 842. Effective January 1, 2019 the Company adopted ASU 2016-02 recording a right of use asset totaling approximately $10 million, and a corresponding lease liability. See Note 6 to the consolidated financial statements for more detailed information.
In September 2016 the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which eliminates the probable initial recognition threshold for credit losses in current U.S. GAAP, and instead requires an organization to record a current estimate of all expected credit losses over the contractual term, adjusted by expected prepayments, for financial assets carried at amortized cost. This is commonly referred to as the current expected credit losses (“CECL”) methodology. Expected credit losses for financial assets held at the reporting date will be estimated for the contractual term of the financial asset, adjusted by prepayments, based on historical experience, current conditions, and reasonable and supportable forecasts of future economic conditions. Another change from existing U.S. GAAP involves the treatment of purchased credit deteriorated assets, which are more broadly defined than purchased credit impaired assets in current accounting standards. When such assets are purchased, institutions will estimate and record an allowance for credit losses, in contrast to acquired loans not identified as purchased credit deteriorated for which the allowance will be established through a charge to credit loss expense. Furthermore, ASU 2016-13 updates the measurement of credit losses on available-for-sale debt securities, by mandating that institutions record credit losses on available-for-sale debt securities through an allowance for credit losses rather than the current practice of writing down securities for other-than-temporary impairment. ASU 2016-13 will also require the enhancement of financial statement disclosures regarding estimates used in calculating credit losses. ASU 2016-13 does not change the existing write-off principle in U.S. GAAP or current nonaccrual practices, nor does it change accounting requirements for loans held for sale or certain other financial assets which are measured at the lower of amortized cost or fair value. As a public business entity that is an SEC filer, ASU 2016-13 was originally scheduled to become effective for the Company on January 1, 2020. In March 2020, the Company elected under Section 4014 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020. In December 2020, the Consolidated Appropriations Act 2021, extended the deferral of implementation of CECL from December 31, 2020, to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022. The Company will now continue to postpone implementation in order to provide additional time to assess better the impact of the COVID-19 pandemic on the expected lifetime credit losses. On the effective date, institutions will apply the new accounting standard as follows: for financial assets carried at amortized cost, a cumulative-effect adjustment will be recognized on the balance sheet for any change in the related allowance for loan and lease losses generated by the adoption of the new standard; any change in the reserve for unfunded commitments, included in other liabilities; and, debt securities on which other-than-temporary impairment had been recognized prior to the effective date will transition to the new guidance prospectively with no change in their amortized cost basis. The Company plans to implement CECL on January 1, 2022 and while the exact extent of the impact has not yet been definitively determined, the Company’s calculation as of December 31, 2020 indicates that our allowance for loan and lease losses will increase by approximately $8.9 million relative to current levels, under CECL while our reserve for unfunded commitments will increase by approximately $0.8 million. The Company plans to continue to sensitize
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
inputs, assumptions and methodologies within its CECL estimation process during 2021 as we prepare for implementation on January 1, 2022.
In January 2017 the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment. This guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation, and goodwill impairment will simply be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The same one-step impairment test will be applied to goodwill at all reporting units, even those with zero or negative carrying amounts. Entities will be required to disclose the amount of goodwill at reporting units with zero or negative carrying amounts. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2019. We have not been required to record any goodwill impairment to date, and do not expect that this guidance would require us to do so given current circumstances.
In March 2017 the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The amendments in this update shorten the amortization period for certain callable debt securities held at a premium, by requiring the premium to be amortized to the earliest call date. Under prior guidance, the premium on a callable debt security was generally amortized as an adjustment to yield over the contractual life of the instrument, and any unamortized premium was recorded as a loss in earnings upon the debtor’s exercise of a call provision. Under ASU 2017-08, because the premium is amortized to the earliest call date, entities no longer recognize a loss in earnings if a debt security is called prior to the contractual maturity date. The amendments did not require an accounting change for securities held at a discount; discounts will continue to be amortized as an adjustment to yield over the contractual life of the debt instrument. ASU 2017-08 became effective for public business entities, including the Company, for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. ASU 2017-08, required entities to use a modified retrospective approach, with the cumulative-effect adjustment recognized to retained earnings at the beginning of the period of adoption. Entities are also required to provide disclosures about a change in accounting principle in the period of adoption. The Company adopted ASU 2017-08 effective January 1, 2019 with no material impact on our financial statements or operations.
In August 2018 the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, as part of its disclosure framework project. Pursuant to this guidance, disclosures that will no longer be required include the following: transfers between Level 1 and Level 2 of the fair value hierarchy; transfers in and out of Level 3 for nonpublic entities, as well as purchases and issuances and the Level 3 roll forward; a company’s policy for determining when transfers between any of the three levels have occurred; the valuation processes used for Level 3 measurements; and, the changes in unrealized gains or losses presented in earnings for Level 3 instruments held at the balance sheet date for nonpublic entities. The following are additional disclosure requirements: for public entities, the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 instruments held at the balance sheet date; for public entities, the range and weighted average of significant unobservable inputs used for Level 3 measurements, although for certain unobservable inputs the entity will be allowed to disclose other quantitative information in place of the weighted average to the extent that it would be a more reasonable and rational method to reflect the distribution of unobservable inputs; for nonpublic entities, some form of quantitative information about significant unobservable inputs used in Level 3 fair value measurements; and, for certain investments in entities that calculate the net asset value, disclosures will be required about the timing of liquidation and redemption restrictions lapsing if the latter has been communicated to the reporting entity. The guidance also clarifies that the Level 3 measurement uncertainty disclosure should communicate information about the uncertainty at the balance sheet date. ASU 2018-13 is effective for all entities in fiscal years beginning after December 15, 2019, including interim
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
periods. In addition, an entity may early adopt any of the removed or modified disclosures immediately and delay adoption of the new disclosures until the effective date. The Company adopted ASU 2018-13 effective January 1, 2020 which impacts the disclosure requirements for fair value measurement.
In May 2019, the FASB issued ASU 2019-05, Financial Instruments-Credit Losses (Topic 326), which provides transition relief for entities adopting ASU 2016-13. ASU 2019-05 amends ASU 2016-13 to allow companies to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. An entity will apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). A prospective transition approach is required for debt securities for which an other-than-temporary impairment had been recognized before the effective date, in order to maintain the same amortized cost basis before and after the effective date of this update. Amounts previously recognized in accumulated other comprehensive income as of the date of adoption that relate to improvements in cash flows expected to be collected should continue to be accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after the date of adoption should be recorded in earnings when received. The fair value option election does not apply to held-to-maturity debt securities. Entities are required to make this election on an instrument-by-instrument basis. For public business entities that are SEC filers, including the Company, the amendments in ASU 2019-05 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company adopted ASU 2019-05 effective January 1, 2020 with no material impact on our financial statements or operations.
On March 22, 2020, a statement was issued by our banking regulators and titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” (the “Interagency Statement”) that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act, that passed on March 27, 2020, further provides that a qualified loan modification is exempt by law from classification as a troubled debt restructuring (“TDR”) as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. The Interagency Statement was subsequently revised in April 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators’ views on consumer protection considerations. In accordance with such guidance, we processed short-term modifications for 311 loans and $424.9 million made in response to COVID-19 to borrowers who were current and otherwise not past due. These include short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. See Note 4 for further information on remaining non-TDR loan modifications. The Interagency Guidance and Section 4013 are expected to have a material impact on the Company’s financial statements; however, this impact cannot be quantified at this time.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
3. SECURITIES AVAILABLE-FOR-SALE
The amortized cost and fair value of the securities available-for-sale are as follows (dollars in thousands):
December 31, 2020
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
U.S. government agencies
$
1,725
$
$
-
$
1,800
Mortgage-backed securities
304,108
10,389
(62)
314,435
State and political subdivisions
212,011
15,728
-
227,739
Total securities
$
517,844
$
26,192
$
(62)
$
543,974
December 31, 2019
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
U.S. government agencies
$
12,125
$
$
(104)
$
12,145
Mortgage-backed securities
398,353
3,354
(1,318)
400,389
State and political subdivisions
181,900
6,478
(113)
188,265
Total securities
$
592,378
$
9,956
$
(1,535)
$
600,799
For the years ended December 31, 2020, 2019, and 2018, proceeds from sales of securities available-for-sale were $20.3 million, $60.5 million, and $6.8 million, respectively. Gains and losses on the sale of investment securities are recorded on the trade date and are determined using the specific identification method.
Gross gains and losses from the sales and calls of securities for the years ended were as follows (dollars in thousands):
December 31,
Gross gains on sales and calls of securities
$
$
$
Gross losses on sales and calls of securities
(43)
(428)
(19)
Net gains (losses) on sales and calls of securities
$
$
(198)
$
The Company has reviewed all sectors and securities in the portfolio for impairment. During the year ended December 31, 2020 the Company realized gains through earnings from the sale and call of 60 debt securities for $0.43 million. The securities were sold with 9 other debt securities, for which a $0.04 million loss was realized. During the year ended December 31, 2019, the Company realized gains through earnings from the sale and call of 74 debt securities for $0.2 million. The securities were sold with 108 other debt securities, for which a $0.4 million loss was realized, to improve the structure of the portfolio at year-end. During the year ended December 31, 2018 the Company realized gains through earnings from the sale and call of 11 debt securities for $0.02 million. The securities were sold with 8 other debt securities, for which a $0.02 million loss was realized, to improve the structure of the portfolio at year end.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
At December 31, 2020 and 2019, the Company had 2 and 198 securities with unrealized gross losses, respectively. Information pertaining to these securities aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows (dollars in thousands):
December 31, 2020
Less than twelve months
Twelve months or longer
Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
Fair Value
U.S. government agencies
$
-
$
-
$
-
$
-
Mortgage-backed securities
(62)
4,286
-
-
State and political subdivisions
-
-
-
-
Total
$
(62)
$
4,286
$
-
$
-
December 31, 2019
Less than twelve months
Twelve months or longer
Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
Fair Value
U.S. government agencies
$
(32)
$
3,240
$
(72)
$
2,689
Mortgage-backed securities
(494)
100,518
(824)
78,538
State and political subdivisions
(113)
19,762
-
-
Total
$
(639)
$
123,520
$
(896)
$
81,227
The Company has concluded as of December 31, 2020 that all remaining securities, currently in an unrealized loss position, are not other-than-temporarily-impaired. This assessment was based on the following factors: 1) the Company has the ability to hold the securities, 2) the Company does not intend to sell the securities, 3) the Company does not anticipate it will be required to sell the securities before recovery, 4) and the Company expects to eventually recover the entire amortized cost basis of the securities.
The amortized cost and estimated fair value of securities available-for-sale at December 31, 2020 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without penalties (dollars in thousands):
Amortized Cost
Fair Value
Maturing within one year
$
3,812
$
3,857
Maturing after one year through five years
9,475
9,732
Maturing after five years through ten years
27,250
28,745
Maturing after ten years
173,199
187,205
Mortgage-backed securities
157,201
163,029
Collateralized mortgage obligations
146,907
151,406
$
517,844
$
543,974
Securities available-for-sale with amortized costs totaling $224.1 million and estimated fair values totaling $232.0 million were pledged to secure other contractual obligations and short-term borrowing arrangements at December 31, 2020 (see Note 10).
Securities available-for-sale with amortized costs totaling $233.0 million and estimated fair values totaling $234.8 million were pledged to secure other contractual obligations and short-term borrowing arrangements at December 31, 2019 (see Note 10).
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
At December 31, 2020, the Company’s investment portfolio included securities issued by 282 different government municipalities and agencies located within 29 states with a fair value of $227.7 million. The largest exposure to any single municipality or agency was $4.0 million (fair value) in three bonds issued for the purpose of paying costs to acquire and construct improvements of various township facilities by the Charter Township of Washington, to be repaid by future tax revenues.
The Company’s investments in bonds issued by states, municipalities and political subdivisions are evaluated in accordance with Supervision and Regulation Letter 12-15 (SR 12-15) issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Organization Ratings”, and other regulatory guidance. Credit ratings are considered in our analysis only as a guide to the historical default rate associated with similarly-rated bonds. There have been no significant differences in our internal analyses compared with the ratings assigned by the third party credit rating agencies.
The following table summarizes the amortized cost and fair values of general obligation and revenue bonds in the Company’s investment securities portfolio at the indicated dates, identifying the state in which the issuing municipality or agency operates for our largest geographic concentrations (dollars in thousands):
December 31, 2020
December 31, 2019
General obligation bonds
Amortized Cost
Fair Value
Amortized Cost
Fair Value
State of Issuance:
Texas
$
76,794
$
82,888
$
59,439
$
61,519
California
31,122
33,100
23,882
25,030
Washington
22,896
25,072
23,392
24,313
Other (21 and 24 states, respectively)
51,827
55,352
49,326
50,725
Total general obligation bonds
182,639
196,412
156,039
161,587
Revenue bonds
State of Issuance:
Texas
7,023
7,516
6,035
6,298
Washington
2,249
2,406
1,737
1,856
California
Other (14 and 13 states, respectively)
19,737
21,026
17,724
18,144
Total revenue bonds
29,372
31,327
25,861
26,678
Total obligations of states and political subdivisions
$
212,011
$
227,739
$
181,900
$
188,265
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The following table summarizes the amortized cost and fair value of revenue bonds in the Company’s investment securities portfolio at the indicated dates, identifying the revenue source of repayment for our largest source concentrations (dollars in thousands):
December 31, 2020
December 31, 2019
Revenue bonds
Amortized Cost
Fair Value
Amortized Cost
Fair Value
Revenue Source:
Water
$
12,609
$
13,526
$
7,515
$
7,775
Sewer
4,584
4,891
4,760
4,811
Sales tax
3,083
3,308
1,949
1,995
Lease
2,707
2,773
3,596
3,678
Other (8 and 9 sources, respectively)
6,389
6,829
8,041
8,419
Total revenue bonds
$
29,372
$
31,327
$
25,861
$
26,678
4. LOANS AND LEASES
The composition of the loan and lease portfolio is as follows (dollars in thousands):
December 31,
Real estate:
Secured by commercial and professional office properties, including construction and development
$
1,477,677
$
847,865
Secured by residential properties
288,341
410,216
Secured by farm land
129,905
144,033
Total real estate loans
1,895,923
1,402,114
Agricultural
44,872
48,036
Commercial and industrial
209,048
115,532
Mortgage warehouse lines
307,679
189,103
Consumer
5,589
7,780
Total loans
2,463,111
1,762,565
Deferred loan and lease origination (fee) cost, net
(3,147)
2,896
Allowance for loan and lease losses
(17,738)
(9,923)
Loans, net
$
2,442,226
$
1,755,538
The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention, substandard and impaired to characterize and qualify the associated credit risk. Loans classified as “loss” are immediately charged-off. The Company uses the following definitions of risk classifications:
Pass - Loans listed as pass include larger non-homogeneous loans not meeting the risk rating definitions below and smaller, homogeneous loans not assessed on an individual basis.
Special Mention - Loans classified as special mention have the potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Substandard - Loans classified as substandard are those loans with clear and well-defined weaknesses such as a highly leveraged position, unfavorable financial operating results and/or trends, or uncertain repayment sources or poor financial condition, which may jeopardize ultimate recoverability of the debt.
Impaired - A loan is considered impaired, when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Additionally, all loans classified as troubled debt restructurings are considered impaired.
Credit quality classifications as of December 31, 2020 were as follows (dollars in thousands):
Pass
Special
Mention
Substandard
Impaired
Total
Real estate:
1-4 family residential construction
$
40,044
$
8,521
$
-
$
-
$
48,565
Other construction/land
61,809
7,478
2,148
71,980
1-4 family - closed-end
130,559
4,922
1,356
2,999
139,836
Equity lines
30,479
2,581
4,957
38,075
Multi-family residential
57,934
3,597
-
61,865
Commercial real estate owner occupied
308,819
21,148
5,652
7,580
343,199
Commercial real estate non-owner occupied
1,026,041
10,827
25,048
1,062,498
Farmland
104,826
21,468
3,169
129,905
Total real estate
1,760,511
80,542
37,431
17,439
1,895,923
Agricultural
39,391
3,617
1,614
44,872
Commercial and industrial
194,876
11,819
1,259
1,094
209,048
Mortgage warehouse lines
307,679
-
-
-
307,679
Consumer loans
5,323
5,589
Total gross loans and leases
$
2,307,780
$
96,036
$
40,315
$
18,980
$
2,463,111
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Credit quality classifications as of December 31, 2019 were as follows (dollars in thousands):
Pass
Special
Mention
Substandard
Impaired
Total
Real estate:
1-4 family residential construction
$
105,979
$
-
$
-
$
-
$
105,979
Other construction/land
90,761
-
91,413
1-4 family - closed-end
194,572
2,425
3,020
200,181
Equity lines
43,111
1,995
4,421
49,599
Multi-family residential
54,104
-
-
54,457
Commercial real estate owner occupied
334,460
4,005
3,384
2,034
343,883
Commercial real estate non-owner occupied
409,289
1,164
2,105
412,569
Farmland
142,594
1,048
144,033
Total real estate
1,374,870
10,735
3,763
12,746
1,402,114
Agricultural
47,814
-
48,036
Commercial and industrial
100,584
13,415
115,532
Mortgage warehouse lines
189,103
-
-
-
189,103
Consumer loans
7,245
7,780
Total gross loans and leases
$
1,719,616
$
24,452
$
4,344
$
14,153
$
1,762,565
Loans may or may not be collateralized, and collection efforts are continuously pursued. Loans or leases may be restructured by management when a borrower has experienced some change in financial status causing an inability to meet the original repayment terms and where the Company believes the borrower will eventually overcome those circumstances and make full restitution. Loans and leases are charged off when they are deemed to be uncollectible, while recoveries are generally recorded only when cash payments are received subsequent to the charge-off.
The following tables present the activity in the allowance for loan and lease losses and the recorded investment in loans and impairment method by portfolio segment for each of the years ending December 31, 2020, 2019, and 2018 (dollars in thousands):
Commercial and
Real Estate
Agricultural
Industrial (1)
Consumer
Unallocated
Total
Allowance for credit losses:
Balance, December 31, 2017
$
4,786
2,772
1,231
9,043
Charge-offs
(2,474)
-
(608)
(2,226)
-
(5,308)
Recoveries
1,120
-
1,665
Provision
3,145
1,114
(16)
4,350
Balance, December 31, 2018
5,831
2,394
1,239
9,750
Charge-offs
(1,190)
-
(1,274)
(2,409)
-
(4,873)
Recoveries
-
1,159
-
2,496
Provision
(63)
1,289
2,550
Balance, December 31, 2019
5,635
2,685
1,278
9,923
Charge-offs
-
-
(436)
(1,397)
-
(1,833)
Recoveries
-
-
1,098
Provision
6,044
2,343
(43)
(83)
8,550
Balance, December 31, 2020
$
11,766
$
$
4,721
$
$
$
17,738
(1) Includes mortgage warehouse lines
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Loans evaluated for impairment:
December 31, 2020
December 31, 2019
December 31, 2018
Individually
Collectively
Individually
Collectively
Individually
Collectively
Real estate
$
17,439
$
1,878,484
$
12,745
$
1,389,368
$
13,501
$
1,440,429
Agricultural
44,622
48,031
49,097
Commercial and industrial (1)
1,094
515,633
303,658
1,744
218,289
Consumer
5,392
7,355
8,041
Total loans
$
18,980
$
2,444,131
$
14,153
$
1,748,412
$
16,072
$
1,715,856
(1) Includes mortgage warehouse lines
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Reserves based on method of evaluation for impairment:
December 31, 2020
December 31, 2019
December 31, 2018
Specific
General
Specific
General
Specific
General
Real estate
$
$
11,241
$
$
5,142
$
$
4,894
Agricultural
Commercial and industrial (1)
4,519
2,466
1,476
Consumer
1,164
1,088
Unallocated
-
-
-
Total loan and lease loss reserves
$
$
16,742
$
$
9,096
$
2,008
$
7,742
(1) Includes mortgage warehouse lines
The following tables present the recorded investment in nonaccrual loans and loans past due over 30 days as of December 31, 2020 and December 31, 2019 (dollars in thousands, except footnotes):
December 31, 2020
30-59 Days
60-89 Days
90 Days Or
More Past
Total Financing
Non-Accrual
Past Due
Past Due
Due(2)
Total Past Due
Current
Receivables
Loans(1)
Real Estate:
1-4 family residential construction
$
-
$
-
$
-
$
-
$
48,565
$
48,565
$
-
Other construction/land
-
-
-
-
71,980
71,980
-
1-4 family - closed-end
139,439
139,836
1,193
Equity lines
1,409
-
1,960
36,115
38,075
2,403
Multi-family residential
-
-
-
-
61,865
61,865
-
Commercial real estate owner occupied
1,187
1,366
341,833
343,199
1,678
Commercial real estate non-owner occupied
-
-
1,062,346
1,062,498
Farmland
-
129,252
129,905
Total real estate loans
1,720
1,435
1,373
4,528
1,891,395
1,895,923
6,298
Agricultural
-
-
44,622
44,872
Commercial and industrial
-
208,486
209,048
1,026
Mortgage warehouse lines
-
-
-
-
307,679
307,679
-
Consumer loans
-
-
5,551
5,589
Total gross loans and leases
$
2,083
$
1,435
$
1,860
$
5,378
$
2,457,733
$
2,463,111
$
7,598
(1) Included in Total Financing Receivables
(2) As of December 31, 2020 there were no loans over 90 days past due and still accruing.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
December 31, 2019
30-59 Days
60-89 Days
90 Days Or
More Past
Total Financing
Non-Accrual
Past Due
Past Due
Due(2)
Total Past Due
Current
Receivables
Loans(1)
Real Estate:
1-4 family residential construction
$
-
$
-
$
-
$
-
$
105,979
$
105,979
$
-
Other construction/land
-
-
91,397
91,413
1-4 family - closed-end
1,524
198,657
200,181
Equity lines
49,334
49,599
Multi-family residential
-
-
-
-
54,457
54,457
-
Commercial real estate owner occupied
1,552
-
1,640
342,243
343,883
1,440
Commercial real estate non-owner occupied
-
1,605
2,105
410,464
412,569
2,105
Farmland
-
-
-
-
144,033
144,033
Total real estate loans
2,730
2,430
5,550
1,396,564
1,402,114
5,055
Agricultural
-
-
-
-
48,036
48,036
-
Commercial and industrial
-
115,157
115,532
Mortgage warehouse lines
-
-
-
-
189,103
189,103
-
Consumer loans
7,711
7,780
Total gross loans and leases
$
2,945
$
$
2,432
$
5,994
$
1,756,571
$
1,762,565
$
5,737
(1) Included in Total Financing Receivables
(2) As of December 31, 2019 there were no loans over 90 days past due and still accruing.
Generally, the Company places a loan or lease on nonaccrual status and ceases recognizing interest income when it has become delinquent more than 90 days and/or when Management determines that the repayment of principal and collection of interest is unlikely. The Company may decide that it is appropriate to continue to accrue interest on certain loans more than 90 days delinquent if they are well-secured by collateral and collection is in process. When a loan is placed on nonaccrual status, any accrued but uncollected interest for the loan is reversed out of interest income in the period in which the loan’s status changed. Subsequent payments received from the customer are applied to principal, and no further interest income is recognized until the principal has been paid in full or until circumstances have changed such that payments are again consistently received as contractually required. As of December 31, 2020 there were 13 customers, for a total of $29.5 million, with payment deferrals either under section 4013 of the CARES Act or the April 7, 2020 Interagency Statement, that are not included in the table above.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Individually impaired loans as of December 31, 2020, December 31, 2019 and December 31, 2018 were as follows (dollars in thousands):
December 31, 2020
Unpaid Principal
Recorded
Average Recorded
Interest Income
Balance(1)
Investment(2)
Related Allowance
Investment
Recognized(3)
With an Allowance Recorded
Real estate:
1-4 family residential construction
$
-
$
-
$
-
$
-
$
-
Other construction/land
1-4 family - closed-end
2,078
2,077
2,141
Equity lines
2,875
2,875
2,989
Multifamily residential
Commercial real estate - owner occupied
6,076
6,076
6,135
Commercial real estate - non-owner occupied
-
-
-
-
-
Farmland
-
-
-
-
-
Total real estate
11,908
11,907
12,173
Agricultural
-
Commercial and industrial
1,152
Consumer loans
13,338
13,289
13,796
With no Related Allowance Recorded
Real estate:
1-4 family residential construction
$
-
$
-
$
-
$
-
$
-
Other construction/land
-
-
-
1-4 family - closed-end
-
-
Equity lines
2,160
2,082
-
2,127
Multifamily residential
-
-
-
-
-
Commercial real estate - owner occupied
1,624
1,504
-
1,590
-
Commercial real estate - non-owner occupied
-
-
Farmland
-
-
Total real estate
5,864
5,532
-
5,745
Agricultural
-
-
-
-
-
Commercial and industrial
-
-
Consumer loans
-
-
6,058
5,691
-
5,915
Total
$
19,396
$
18,980
$
$
19,711
$
(1) Contractual principal balance due from customer.
(2) Principal balance on Company’s books, less any direct charge offs.
(3) Interest income is recognized on performing balances on a regular accrual basis.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
December 31, 2019
Unpaid Principal
Recorded
Average Recorded
Interest Income
Balance(1)
Investment(2)
Related Allowance
Investment
Recognized(3)
With an Allowance Recorded
Real estate:
1-4 family residential construction
$
-
$
-
$
-
$
-
$
-
Other construction/land
1-4 family - closed-end
2,298
2,298
2,365
Equity lines
4,173
4,120
4,185
Multifamily residential
Commercial real estate- owner occupied
Commercial real estate- non-owner occupied
-
-
-
-
-
Farmland
-
Total real estate
8,310
8,138
8,336
Agricultural
-
Commercial and industrial
1,140
Consumer loans
9,694
9,465
9,951
With no Related Allowance Recorded
Real estate:
1-4 family residential construction
$
-
$
-
$
-
$
-
$
-
Other construction/land
-
1-4 family - closed-end
-
-
Equity Lines
-
Multifamily residential
-
-
-
-
-
Commercial real estate- owner occupied
1,560
1,440
-
1,477
-
Commercial real estate- non-owner occupied
3,295
2,105
-
3,267
-
Farmland
-
-
Total real estate
6,010
4,607
-
6,382
Agricultural
-
-
-
-
-
Commercial and industrial
-
-
Consumer loans
-
-
6,121
4,688
-
6,684
Total
$
15,815
$
14,153
$
$
16,635
$
(1) Contractual principal balance due from customer.
(2) Principal balance on Company’s books, less any direct charge offs.
(3) Interest income is recognized on performing balances on a regular accrual basis.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
December 31, 2018
Unpaid Principal
Recorded
Average Recorded
Interest Income
Balance(1)
Investment(2)
Related Allowance
Investment
Recognized(3)
With an Allowance Recorded
Real estate:
1-4 family residential construction
$
-
$
-
$
-
$
-
$
-
Other construction/land
1-4 family - closed-end
3,325
3,325
3,182
Equity lines
4,603
4,550
4,368
Multifamily residential
Commercial real estate- owner occupied
Commercial real estate- non-owner occupied
1,572
1,425
1,644
Farmland
-
-
-
-
-
Total real estate
11,308
10,834
10,941
Agricultural
-
Commercial and industrial
1,724
1,534
1,965
Consumer loans
13,851
13,138
2,008
13,821
With no Related Allowance Recorded
Real estate:
1-4 family residential construction
$
-
$
-
$
-
$
-
$
-
Other construction/land
-
-
1-4 family - closed-end
-
Equity Lines
-
-
Multifamily residential
-
-
-
-
-
Commercial real estate- owner occupied
-
-
Commercial real estate- non-owner occupied
-
-
-
-
-
Farmland
1,642
1,642
-
1,538
-
Total real estate
2,779
2,667
-
2,670
Agricultural
-
-
-
-
-
Commercial and industrial
-
-
Consumer loans
-
3,199
2,934
-
3,781
Total
$
17,050
$
16,072
$
2,008
$
17,602
$
(1) Contractual principal balance due from customer.
(2) Principal balance on Company’s books, less any direct charge offs.
(3) Interest income is recognized on performing balances on a regular accrual basis.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Included in loans above are troubled debt restructurings that were classified as impaired. The Company had $0.4 million and $0.5 million in commercial loans, $13.0 million and $8.2 million in real estate secured loans and $0.2 million and $0.4 million in consumer loans, which were modified as troubled debt restructurings and consequently classified as impaired at December 31, 2020 and 2019, respectively.
Additional commitments to existing customers with restructured loans totaled $0.05 million and $0.04 million at December 31, 2020 and 2019, respectively.
Interest income recognized on impaired loans was $0.5 million, $0.5 million, and $0.7 million, for the years ended December 31, 2020, 2019, and 2018, respectively. There was no interest income recognized on a cash basis on impaired loans for the years ended December 31, 2020, 2019, and 2018, respectively.
The following is a summary of interest income from non-accrual loans in the portfolio at year-end that was not recognized (dollars in thousands):
Years Ended December 31,
Non accrual loans
Interest that would have been recorded under the loans’ original terms
$
$
$
Less gross interest recorded
Foregone interest
$
$
$
Certain loans have been pledged to secure short-term borrowing arrangements (see Note 10). These loans totaled $1.1 billion and $777.7 million at December 31, 2020 and 2019, respectively.
Salaries and employee benefits totaling $3.3 million, $3.7 million, and $4.2 million, have been deferred as loan and lease origination costs to be amortized over the estimated lives of the related loans and leases for the years ended December 31, 2020, 2019, and 2018, respectively.
During the periods ended December 31, 2020 and 2019, the terms of certain loans were modified as troubled debt restructurings. Types of modifications applied to these loans include a reduction of the stated interest rate, a modification of term, an agreement to collect only interest rather than principal and interest for a specified period, or any combination thereof.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The following tables present troubled debt restructurings by type of modification during the period ending December 31, 2020, December 31, 2019 and December 31, 2018 (dollars in thousands):
December 31, 2020
Rate
Term
Interest Only
Rate & Term
Term & Interest
Modification
Modification
Modification
Modification
Modification
Total
Troubled debt restructurings
Real estate:
Other construction/land
$
-
$
$
-
$
-
$
-
$
1-4 family - closed-end
-
1,325
-
-
-
1,325
Equity lines
-
-
-
-
-
-
Multi-family residential
-
-
-
-
-
-
Commercial real estate owner occupied
-
5,515
-
-
5,853
Commercial real estate non-owner occupied
-
-
-
-
Farmland
-
-
-
-
-
-
Total real estate loans
-
7,368
-
-
7,706
Agricultural
-
-
-
-
-
-
Commercial and industrial
-
-
-
-
Consumer loans
-
-
-
-
-
-
$
-
$
7,511
$
-
$
-
$
$
7,849
December 31, 2019
Rate
Term
Interest Only
Rate & Term
Term & Interest
Modification
Modification
Modification
Modification
Modification
Total
Troubled debt restructurings
Real estate:
Other construction/land
$
-
$
$
-
$
-
$
-
$
1-4 family - closed-end
-
-
-
-
-
-
Equity lines
-
-
-
-
Multi-family residential
-
-
-
-
-
-
Commercial real estate owner occupied
-
-
-
-
-
-
Commercial real estate non-owner occupied
-
-
-
-
-
-
Farmland
-
-
-
-
-
-
Total real estate loans
-
-
-
-
Agricultural
-
-
-
-
-
-
Commercial and industrial
-
-
Consumer loans
-
-
-
$
$
$
-
$
$
-
$
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
December 31, 2018
Rate
Term
Interest Only
Rate & Term
Term & Interest
Modification
Modification
Modification
Modification
Modification
Total
Troubled debt restructurings
Real estate:
Other construction/land
$
-
$
-
$
-
$
-
$
-
$
-
1-4 family - closed-end
-
-
-
-
-
-
Equity lines
-
-
-
Multi-family residential
-
-
-
-
-
-
Commercial real estate owner occupied
-
-
-
-
-
-
Commercial real estate non-owner occupied
-
-
-
-
-
-
Farmland
-
-
-
-
-
-
Total real estate loans
-
-
-
Agricultural
-
-
-
-
Commercial and industrial
-
-
Consumer loans
-
-
-
-
$
-
$
$
$
$
-
$
1,304
The following tables present loans by class modified as troubled debt restructurings including any subsequent defaults during the period ending December 31, 2020, December 31, 2019 and December 31, 2018 (dollars in thousands):
Pre-Modification
Post-Modification
Outstanding
Outstanding
Number of
Recorded
Recorded
Reserve
December 31, 2020
Loans
Investment
Investment
Difference(1)
Real estate:
Other construction/land
$
$
$
1-4 family - closed-end
1,325
1,325
Equity lines
-
-
-
-
Multi-family residential
-
-
-
-
Commercial real estate - owner occupied
5,853
5,853
Commercial real estate - non-owner occupied
-
Farmland
-
-
-
-
Total real estate loans
7,707
7,706
Agricultural
-
-
-
-
Commercial and industrial
Consumer loans
-
-
-
-
$
7,850
$
7,849
$
(1) This represents the increase or (decrease) in the allowance for loans and lease losses reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan and lease loss methodology.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Pre-Modification
Post-Modification
Outstanding
Outstanding
Number of
Recorded
Recorded
Reserve
December 31, 2019
Loans
Investment
Investment
Difference(1)
Real estate:
Other construction/land
$
$
$
1-4 family - closed-end
-
-
-
-
Equity lines
-
Multi-family residential
-
-
-
-
Commercial real estate - owner occupied
-
-
-
-
Commercial real estate - non-owner occupied
-
-
-
-
Farmland
-
-
-
-
Total real estate loans
Agricultural
-
-
-
-
Commercial and industrial
(59)
Consumer loans
(47)
$
$
$
(32)
(1) This represents the increase or (decrease) in the allowance for loans and lease losses reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan and lease loss methodology.
Pre-Modification
Post-Modification
Outstanding
Outstanding
Number of
Recorded
Recorded
Reserve
December 31, 2018
Loans
Investment
Investment
Difference(1)
Real estate:
Other construction/land
-
$
-
$
-
$
-
1-4 family - closed-end
-
-
-
-
Equity lines
Multi-family residential
-
-
-
-
Commercial real estate - owner occupied
-
-
-
-
Commercial real estate - non-owner occupied
-
-
-
-
Farmland
-
-
-
-
Total real estate loans
Agricultural
Commercial and industrial
-
Consumer loans
-
$
1,304
$
1,304
$
(1) This represents the increase or (decrease) in the allowance for loans and lease losses reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan and lease loss methodology.
In the tables above, there were no TDRs that subsequently defaulted necessitating an increase in the allowance for loan and lease losses for the years ended December 31, 2020, 2019 and 2018. The total allowance for loan and lease
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
losses specifically allocated to the balances that were classified as TDRs during the year ended December 31, 2020 and 2019 is $0.6 million and $0.6 million, respectively.
Purchased Credit Impaired Loans
The Company has purchased loans from past acquisitions, some of which have shown evidence of credit deterioration since origination and it was probable at acquisition that all contractually required payments would not be collected. The carrying amount and unpaid principal balance of those loans are as follows (dollars in thousands):
December 31, 2020
Unpaid Principal Balance
Carrying Value
Real estate secured
$
$
-
Commercial and industrial
-
-
Consumer
-
-
Total purchased credit impaired loans
$
$
-
December 31, 2019
Unpaid Principal Balance
Carrying Value
Real estate secured
$
$
-
Commercial and industrial
-
-
Consumer
-
-
Total purchased credit impaired loans
$
$
-
For those purchased credit impaired loans disclosed above, the Company did not increase the allowance for loan and lease losses during 2020, 2019 and 2018. There is no accretable yield, or income expected to be collected on these purchased credit impaired loans. During the years ended December 31, 2020 and 2019, there were no purchased credit impaired loans acquired.
5. PREMISES AND EQUIPMENT
Premises and equipment at cost consisted of the following (dollars in thousands):
December 31,
Land
$
5,751
$
5,751
Buildings and improvements
21,580
21,526
Furniture, fixtures and equipment
20,705
17,798
Leasehold improvements
15,226
15,357
63,262
60,432
Less accumulated depreciation and amortization
35,757
33,041
Construction in progress
-
$
27,505
$
27,435
Depreciation and amortization included in occupancy and equipment expense totaled $2.8 million, $2.8 million, and $3.0 million, for the years ended December 31, 2020, 2019, and 2018, respectively.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
6. OPERATING LEASES
On January 1, 2019, we adopted a new accounting standard which required the recognition of certain operating leases on our balance sheet as lease right-of-use assets (reported as a component of other assets) and related lease liabilities (reported as a component of other liabilities). See Note 2-Summary of Significant Accounting Policies. The Company leases space under non-cancelable operating leases for 21 branch locations, three off-site ATM locations, one administrative building and a warehouse. Many of our leases include both lease (e.g., fixed payments including rent, taxes, and insurance costs) and non-lease components (e.g., common-area or other maintenance costs). Payments for taxes and insurance as well as non-lease components are not included in the accounting of the lease component, but are separately accounted for in occupancy expense. The Company recognized lease expense of $2.2 million for the years ended December 31, 2020 and 2019. Lease expense for the year ending December 31, 2018 prior to the adoption of ASU 2016-02, was $2.3 million. Most leases include one or more renewal options available to exercise. The exercise of lease renewal options is typically at the Company’s sole discretion; therefore, the majority of renewals to extend the lease terms are not included in our right-of-use assets and lease liabilities as they are not reasonably certain of exercise. We regularly evaluate the renewal options and when they are reasonably certain of exercise, we include the renewal period in our lease term. As most of our leases do not provide an implicit rate, we used our incremental borrowing rate in determining the present value of the lease payments.
There were no sale and leaseback transactions, leveraged leases, or lease transactions with related parties during the years ending December 31, 2020 and 2019.
At December 31, 2020, the Company’s right-of-use assets and operating lease liabilities were $7.2 million and $7.8 million, respectively. The weighted average remaining lease term for the lease liabilities was 6.8 years, and the weighted average discount rate of remaining payments was 5.5 percent. At December 31, 2019, the Company’s right-of-use assets and operating lease liabilities were $8.3 million and $8.9 million, respectively. The weighted average remaining lease term for the lease liabilities was 7.1 years, and the weighted average discount rate of remaining payments was 5.5 percent for the year ended December 31, 2019. Lease liabilities from new right-of-use assets obtained during the year ending December 31, 2020 and December 31, 2019 were $0.6 million and $0, respectively . There were no variable lease costs for the years ending December 31, 2020 and 2019. Cash paid on operating leases was $2.2 million for both years ending December 31, 2020 and 2019.
Future undiscounted lease payments for operating leases with initial terms of one year or more as of December 31, 2020 are as follows (dollars in thousands):
Year Ending December 31,
$
2,130
1,722
1,269
Thereafter
2,612
Total undiscounted lease payments
$
9,393
Less: imputed interest
(1,633)
Net lease liabilities
$
7,760
The Company generally has options to renew its facilities leases after the initial leases expire. The renewal options range from one to ten years.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
7. GOODWILL AND INTANGIBLE ASSETS
Goodwill
The rollforward of goodwill for each of the preceding three years is included in the table below (dollars in thousands):
Years Ended December 31,
Balance at January 1
$
27,357
$
27,357
$
27,357
Acquired goodwill
-
-
-
Impairment
-
-
-
Balance at December 31
$
27,357
$
27,357
$
27,357
Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value. Bank of the Sierra (the “Bank”) is the only subsidiary of the Company that meets the materiality criteria necessary to be deemed an operating segment, and because the Company exists primarily for the purpose of holding the stock of the Bank we have determined that only one unified operating segment or reporting unit (the consolidated Company) exists. The fair value of the consolidated Company is its market capitalization, as determined by quoted prices in active markets. If the Company’s market capitalization exceeds recorded shareholders’ equity, the book value, it can be reasonably presumed that no impairment exists. At December 31, 2020 (the measurement date that the Company selected), the Company’s stock closed at $23.92 which resulted in a market capitalization in excess of shareholders book equity. Therefore it was determined that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment at December 31, 2020.
Acquired Intangible Assets
Acquired intangible assets were as follows at year-end (dollars in thousands):
Years Ended December 31,
Gross
Carrying
Amount
Accumulated
Amortization
Gross
Carrying
Amount
Accumulated
Amortization
Core deposit intangibles
$
8,401
$
4,094
$
8,401
$
3,020
Aggregate amortization expense was $1.1 million, $1.1 million, and $1.0 million for 2020, 2019, and 2018.
Estimated amortization expense for each of the next five years and thereafter (dollars in thousands):
$
1,032
1,000
Thereafter
$
4,307
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8. OTHER ASSETS
Other assets consisted of the following (dollars in thousands):
December 31,
Accrued interest receivable
$
16,074
$
8,229
Deferred tax assets
3,463
Investment in qualified affordable housing projects
3,473
4,104
Investment in limited partnerships
1,848
2,722
Federal Home Loan Bank stock, at cost
10,727
10,727
Other
17,485
16,670
$
50,446
$
45,915
The Company has invested in limited partnerships that operate qualified affordable housing projects to receive tax benefits in the form of tax deductions from operating losses and tax credits. The Company accounts for these investments under the cost method and management analyzes these investments annually for potential impairment. The Company had $0.1 million in remaining capital commitments to these partnerships at December 31, 2020.
The Company holds certain equity investments that are not readily marketable securities and thus are classified as “other assets” on the Company’s balance sheet. These include investments in Pacific Coast Bankers Bancshares, California Economic Development Lending Initiative, and the Federal Home Loan Bank (“FHLB”). The largest of these is the Company’s $10.7 million investment in FHLB stock, carried at cost. Quarterly, the FHLB evaluates and adjusts the Company’s minimum stock requirement based on the Company’s borrowing activity and membership requirements. Any stock deemed in excess is automatically repurchased by the FHLB at cost.
9. DEPOSITS
Interest-bearing deposits consisted of the following (dollars in thousands):
December 31,
Interest bearing demand deposits
$
109,938
$
91,212
NOW
558,407
458,600
Savings
368,420
294,317
Money market
131,232
118,933
Time, under $250,000
287,530
261,916
Time, $250,000 or more
225,415
252,446
$
1,680,942
$
1,477,424
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Aggregate annual maturities of time deposits were as follows (dollars in thousands):
Year Ending December 31,
$
453,119
14,313
23,481
20,358
Thereafter
$
512,945
Interest expense recognized on interest-bearing deposits consisted of the following (dollars in thousands):
Year Ended December 31,
Interest bearing demand deposits
$
$
$
NOW
Savings
Money market
Time deposits
2,687
8,931
5,653
Brokered Deposits
1,120
$
3,948
$
11,380
$
7,260
10. OTHER BORROWING ARRANGEMENTS
At year end, short-term borrowings consisted of the following (dollars in thousands):
Average
balance
outstanding
Amount
Average
interest rate
during the year
Maximum
month-end
balance during
the year
Weighted
average
interest rate
at year-end
Average
balance
outstanding
Amount
Average
interest rate
during the year
Maximum
month-end
balance during
the year
Weighted
average
interest rate
at year-end
As of December 31:
Repurchase agreements
$
34,614
$
39,138
.40%
$
41,449
.40%
$
22,090
$
25,711
.40%
$
27,712
.40%
Short term borrowings
53,593
142,900
.19%
195,100
.12%
13,543
20,000
2.02%
63,700
1.69%
$
88,207
$
182,038
$
236,549
$
35,633
$
45,711
$
91,412
Each FHLB advance is payable at its maturity date, with a prepayment penalty for fixed rate advances. The advances were collateralized by $1.1 billion of first mortgage loans under a blanket lien arrangement at year end 2020. Based on this collateral and the Company’s holdings of FHLB stock, the Company was eligible to borrow up to the total of $642.0 million at year-end 2020, with a remaining borrowing capacity of $652.1 million if sufficient additional collateral was pledged.
The Company had no borrowings at December 31, 2020 and 2019, respectively from the FRB. The Company was eligible to borrow up to $58.1 million from FRB at year end 2020, which was collateralized by $75.2 million in first mortgage loans under a blanket lien arrangement.
The Company had no long-term borrowings at December 31, 2020 and 2019, respectively.
The Company had unsecured lines of credit with its correspondent banks which, in the aggregate, amounted to $275.0 million and $80.0 million at December 31, 2020 and 2019, respectively, at interest rates which vary with
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
market conditions. There was $100.0 million and $0 outstanding under these lines of credit at December 31, 2020 and December 31, 2019, respectively.
11. INCOME TAXES
The provision for income taxes follows (dollars in thousands):
Year Ended December 31,
Federal:
Current
$
7,979
$
7,081
$
5,780
Deferred
(1,697)
(228)
6,282
6,853
5,959
State:
Current
5,711
4,771
3,819
Deferred
(914)
4,797
4,904
3,948
$
11,079
$
11,757
$
9,907
The components of the net deferred tax asset, included in other assets, are as follows (dollars in thousands):
December 31,
Deferred tax assets:
Allowance for loan and lease losses
$
5,244
$
2,934
Foreclosed assets
Deferred compensation
4,147
3,895
Accrued reserves
Non accrual loans
Lease liability
2,283
2,461
Loan fair value adjustment
1,192
Capital losses carried forward
Net operating losses
1,751
1,909
State income tax deduction
1,170
1,019
Other
1,233
Total deferred tax assets
17,420
15,423
Deferred tax liabilities:
Deferred loan costs
(2,482)
(2,656)
Right-of-use asset
(2,127)
(2,456)
Intangibles
(832)
(1,248)
Premises and equipment
(750)
(325)
Net unrealized gain on securities available-for-sale
(7,725)
(2,490)
Other
(2,665)
(2,785)
Total deferred tax liabilities
(16,581)
(11,960)
Net deferred tax assets
$
$
3,463
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The expense for income taxes differs from amounts computed by applying the statutory Federal income tax rates to income before income taxes. The significant items comprising these differences consisted of the following (dollars in thousands):
Year Ended December 31,
Income tax expense at federal statutory rate
$
9,770
$
10,021
$
8,313
Increase (decrease) resulting from:
State franchise tax expense, net of federal tax effect
3,790
3,872
3,390
Tax exempt municipal income
(1,199)
(952)
(852)
Affordable housing tax credits
(518)
(538)
(632)
Excess tax benefit of stock-based compensation
(90)
(133)
(177)
Other
(674)
(513)
(135)
11,079
11,757
9,907
Effective tax rate
23.81%
24.64%
25.03%
The Company is subject to federal income tax and income tax of the state of California. Our federal income tax returns for the years ended December 31, 2017, 2018 and 2019 are open to audit by the federal authorities and our California state tax returns for the years ended December 31, 2016, 2017, 2018 and 2019 are open to audit by the state authorities.
The Company has net operating loss carry forwards of approximately $5.6 million for federal income and approximately $6.9 million for California franchise tax purposes. Net operating loss carry forwards, to the extent not used will begin to expire in 2031. Net operating loss carry forwards available from acquisitions are substantially limited by Section 382 of the Internal Revenue Code and benefits not expected to be realized due to the limitation have been excluded from the deferred tax asset and net operating loss carry forward amounts noted above.
There were no recorded interest or penalties related to uncertain tax positions as part of income tax for the years ended December 31, 2020, 2019, and 2018, respectively. We do not expect the total amount of unrecognized tax benefits to significantly increase or decrease within the next twelve months.
12. SUBORDINATED DEBENTURES
Sierra Statutory Trust II (“Trust II”), Sierra Capital Trust III (“Trust III”), and Coast Bancorp Statutory Trust II (“Trust IV”), (collectively, the “Trusts”) exist solely for the purpose of issuing trust preferred securities fully and unconditionally guaranteed by the Company. For financial reporting purposes, the Trusts are not consolidated and the Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Subordinated Debentures”) held by the Trusts and issued and guaranteed by the Company are reflected in the Company’s consolidated balance sheet in accordance with provisions of ASC Topic 810. Under applicable regulatory guidance, the amount of trust preferred securities that is eligible as Tier 1 capital is limited to twenty-five percent of the Company’s Tier 1 capital on a pro forma basis. At December 31, 2020, all $35.1 million of the Company’s trust preferred securities qualified as Tier 1 capital.
During the first quarter of 2004, Sierra Statutory Trust II issued 15,000 Floating Rate Capital Trust Pass-Through Securities (TRUPS II), with a liquidation value of $1,000 per security, for gross proceeds of $15,000,000. The entire proceeds of the issuance were invested by Trust II in $15,464,000 of Subordinated Debentures issued by the Company, with identical maturity, re-pricing and payment terms as the TRUPS II. The Subordinated Debentures, purchased by Trust II, represent the sole assets of the Trust II. Those Subordinated Debentures mature on March 17,
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2034, bear a current interest rate of 2.98% (based on 3-month LIBOR plus 2.75%), with re-pricing and payments due quarterly.
Those Subordinated Debentures are currently redeemable by the Company, subject to receipt by the Company of prior approval from the Federal Reserve Bank, on any March 17th, June 17th, September 17th, or December 17th. The redemption price is par plus accrued and unpaid interest, except in the case of redemption under a special event which is defined in the debenture.
The TRUPS II are subject to mandatory redemption to the extent of any early redemption of the related Subordinated Debentures and upon maturity of the Subordinated Debentures on March 17, 2034.
Trust II has the option to defer payment of the distributions for a period of up to five years, subject to certain conditions, including that the Company may not pay dividends on its common stock during such period. The TRUPS II issued in the offering were sold in private transactions pursuant to an exemption from registration under the Securities Act of 1933, as amended. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the TRUPS II.
During the second quarter of 2006, Sierra Capital Trust III issued 15,000 Floating Rate Capital Trust Pass-Through Securities (TRUPS III), with a liquidation value of $1,000 per security, for gross proceeds of $15,000,000. The entire proceeds of the issuance were invested by Trust III in $15,464,000 of Subordinated Debentures issued by the Company, with identical maturity, repricing and payment terms as the TRUPS III. The Subordinated Debentures, purchased by Trust III, represent the sole assets of the Trust III. Those Subordinated Debentures mature on September 23, 2036, bear a current interest rate of 1.64% (based on 3-month LIBOR plus 1.40%), with repricing and payments due quarterly.
Those Subordinated Debentures are redeemable by the Company, subject to receipt by the Company of prior approval from the Federal Reserve Bank, on any March 23rd, June 23rd, September 23rd, or December 23rd. The redemption price is par plus accrued and unpaid interest, except in the case of redemption under a special event which is defined in the debenture. The TRUPS III are subject to mandatory redemption to the extent of any early redemption of the related Subordinated Debentures and upon maturity of the Subordinated Debentures on September 23, 2036.
Trust III has the option to defer payment of the distributions for a period of up to five years, subject to certain conditions, including that the Company may not pay dividends on its common stock during such period. The TRUPS III issued in the offering were sold in private transactions pursuant to an exemption from registration under the Securities Act of 1933, as amended. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the TRUPS III.
During the third quarter of 2016, the Company acquired Coast Bancorp Statutory Trust II, which had issued 7,000 Floating Rate Capital Trust Pass-Through Securities (TRUPS IV), with a liquidation value of $1,000 per security, for gross proceeds of $7,000,000. The entire proceeds of the issuance were invested by Trust IV in $7,217,000 of Subordinated Debentures issued by Coast Bancorp with identical maturity, re-pricing and payment terms as the TRUPS IV. The Subordinated Debentures, purchased by Trust IV, represent the sole assets of the Trust IV. Those Subordinated Debentures mature on December 15, 2037, bear a current interest rate of 1.72% (based on 3-month LIBOR plus 1.50%), with re-pricing and payments due quarterly.
Those Subordinated Debentures are currently redeemable by the Company, subject to receipt by the Company of prior approval from the Federal Reserve Bank, on any March 15th, June 15th, September 15th, or December 15th. The
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
redemption price is par plus accrued and unpaid interest, except in the case of redemption under a special event which is defined in the debenture.
The TRUPS IV are subject to mandatory redemption to the extent of any early redemption of the related Subordinated Debentures and upon maturity of the Subordinated Debentures on December 15, 2037.
Coast Bancorp Statutory Trust II has the option to defer payment of the distributions for a period of up to five years, subject to certain conditions, including that the Company may not pay dividends on its common stock during such period. The TRUPS IV issued in the offering were sold in private transactions pursuant to an exemption from registration under the Securities Act of 1933, as amended. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the TRUPS IV.
13. COMMITMENTS AND CONTINGENCIES
Letter of Credit
The Company holds two letters of credit with the Federal Home Loan Bank of San Francisco totaling $104,854,000. A $100,000,000 letter of credit is pledged to secure public deposits at December 31, 2020 and a $4,854,000 standby letter of credit was obtained on behalf of one of our customers to guarantee financial performance. Should the standby letter of credit be drawn upon, the customer would reimburse the Company from an existing line of credit.
Federal Reserve Requirements
Banks are normally required to maintain reserves with the Federal Reserve Bank equal to a specified percentage of their reservable deposits less vault cash. The Federal Reserve Bank has temporarily eliminated the reserve requirement in response to the COVID-19 pandemic, in an effort to free up available cash for lending purposes. There were no reserve balances required to be maintained at the Federal Reserve Bank by the Company at December 31, 2020 and 2019.
Financial Instruments with Off-Balance-Sheet Risk
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments consist of commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet.
The Company’s exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and letters of credit as it does for loans included on the balance sheet.
The following financial instruments represent off-balance-sheet credit risk (dollars in thousands):
December 31,
Fixed-rate commitments to extend credit
$
75,291
$
80,674
Variable-rate commitments to extend credit
$
366,525
$
411,366
Standby letters of credit
$
8,104
$
8,619
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Commitments to extend credit consist primarily of the unused or unfunded portions of the following: home equity lines of credit; commercial real estate construction loans, where disbursements are made over the course of construction; commercial revolving lines of credit; mortgage warehouse lines of credit; unsecured personal lines of credit; and formalized (disclosed) deposit account overdraft lines. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments to extend credit are made at both fixed and variable rates of interest as stated in the table above. Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party, while commercial letters of credit represent the Company’s commitment to pay a third party on behalf of a customer upon fulfillment of contractual requirements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
Concentration in Real Estate Lending
At December 31, 2020, in management’s judgment the Company had, a concentration of loans secured by real estate. At that date, approximately 77% of the Company’s loans were real estate related. Balances secured by commercial buildings and construction and development loans represented 78% of all real estate loans, while loans secured by non-construction residential properties accounted for 15%, and loans secured by farmland were 7% of real estate loans. Although management believes the loans within these concentrations have no more than the normal risk of collectability, a decline in the performance of the economy in general or a decline in real estate values in the Company’s primary market areas, in particular, could have an adverse impact on collectability.
Concentration by Geographic Location
The Company extends commercial, real estate mortgage, real estate construction and consumer loans to customers primarily in the South Central San Joaquin Valley of California, specifically Tulare, Fresno, Kern, Kings and Madera counties; the Southern California corridor between Santa Paula and Santa Clarita in the counties of Ventura and Los Angeles; and the Coastal counties of San Luis Obispo, Ventura and Santa Barbara. The ability of a substantial portion of the Company’s customers to honor their contracts is dependent on the economy in these areas. Although the Company’s loan portfolio is diversified, there is a relationship in those regions between the local agricultural economy and the economic performance of loans made to non-agricultural customers.
Contingencies
The Company is subject to legal proceedings and claims which arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to such actions, of which the Company is aware, will not materially affect the consolidated financial position or results of operations of the Company.
14. SHAREHOLDERS’ EQUITY
Share Repurchase Plan
At December 31, 2020, the Company had a stock repurchase plan which has no expiration date. During the year ended December 31, 2020, the Company repurchased 112,050 shares. The total number of shares available for repurchase at December 31, 2020 was 268,301. Repurchases are generally made in the open market at market prices.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Earnings Per Share
A reconciliation of the numerators and denominators of the basic and diluted earnings per share computations is as follows:
For the Years Ended December 31,
Basic Earnings Per Share
Net income (dollars in thousands)
$
35,444
$
35,961
$
29,677
Weighted average shares outstanding
15,216,749
15,311,113
15,261,794
Basic earnings per share
$
2.33
$
2.35
$
1.94
Diluted Earnings Per Share
Net income (dollars in thousands)
$
35,444
$
35,961
$
29,677
Weighted average shares outstanding
15,216,749
15,311,113
15,261,794
Effect of dilutive stock options
63,576
125,998
170,326
Weighted average shares outstanding
15,280,325
15,437,111
15,432,120
Diluted earnings per share
$
2.32
$
2.33
$
1.92
Stock options for 348,328, 243,657, and 157,532 shares of common stock were not considered in computing diluted earnings per common share for 2020, 2019, and 2018, respectively, because they were antidilutive.
Stock Options
On March 16, 2017 the Company’s Board of Directors approved and adopted the 2017 Stock Incentive Plan (the “2017 Plan”), which became effective May 24, 2017 pursuant to the approval of the Company’s shareholders. The 2017 Plan replaced the Company’s 2007 Stock Incentive Plan (the “2007 Plan”), which expired by its own terms on March 15, 2017. Options to purchase 323,289 shares that were granted under the 2007 Plan were still outstanding as of December 31, 2020, and remain unaffected by that plan’s expiration. The 2017 Plan provides for the issuance of both “incentive” and “nonqualified” stock options to officers and employees, and of “nonqualified” stock options to non-employee directors and consultants of the Company. The 2017 Plan also provides for the issuance of restricted stock awards to these same classes of eligible participants. The total number of shares of the Company’s authorized but unissued stock reserved for issuance pursuant to awards under the 2017 Plan was initially 850,000 shares, and the number remaining available for grant as of December 31, 2020 was 408,515.
All options granted under the 2017 and 2007 Plans have been or will be granted at an exercise price of not less than 100% of the fair market value of the stock on the date of grant, exercisable in installments as provided in individual stock option agreements. In the event of a “Change in Control” as defined in the Plans, all outstanding options shall become exercisable in full (subject to certain notification requirements), and shall terminate if not exercised within a specified period of time unless such options are assumed by the successor corporation or substitute options are granted. Options also terminate in the event an optionee ceases to be employed by or to serve as a director of the Company or its subsidiaries, and the vested portion thereof must be exercised within a specified period after such cessation of employment or service.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
A summary of the Company’s stock option activity follows (shares in thousands, except exercise price):
Shares
Weighted Average
Exercise Price
Aggregate
Intrinsic
Value (1)
Shares
Weighted Average
Exercise Price
Shares
Weighted Average
Exercise Price
Outstanding,
beginning of year
$
21.08
$
18.45
$
16.33
Exercised
(67)
$
11.65
(83)
$
13.07
(77)
$
14.67
Granted
$
27.11
$
26.97
$
27.35
Canceled
(21)
$
26.01
(14)
$
26.77
(9)
$
26.73
Expired
(1)
$
10.73
-
$
-
-
$
-
Outstanding, end of year
$
23.67
$
1,340
$
21.08
$
18.45
Exercisable, end of year (2)
$
21.97
$
1,323
$
18.89
$
15.77
(1) The aggregate intrinsic value of stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2020. This amount changes based on changes in the market value of the Company’s stock.
(2) The weighted average remaining contractual life of stock options outstanding and exercisable on December 31, 2020 was 5.7 years and 6.1 years, respectively.
Information related to stock options during each year follows (dollars in thousands, except per share data):
Weighted-average grant-date fair value per share
$
4.76
$
6.60
$
5.94
Total intrinsic value of stock options exercised
$
$
1,150
$
Total fair value of stock options vested
$
$
$
$0.8 million in cash was received from the exercise of 66,470 shares during the period ended December 31, 2020 with a related tax benefit of $0.5 million.
The Company is using the Black-Scholes model to value stock options. In accordance with U.S. GAAP, charges of $0.4 million, $0.5 million, and $0.4 million are reflected in the Company’s income statements for the years ended December 31, 2020, 2019, and 2018, respectively, as pre-tax compensation and directors’ expense related to stock options. The related tax benefit of these options is $0.1 million, for each of the years ended December 31, 2020, 2019, and 2018.
Unamortized compensation expense associated with unvested stock options outstanding at December 31, 2020 was $0.4 million, which will be recognized over a weighted average period of 3.4 years.
Restricted Stock Grants
The Company’s restricted stock awards are time-vested, non-transferrable shares of common stock and are available to be granted to the Company’s employees and directors. The vesting period of restricted stock awards is determined at the time the awards are issued, and different awards may have different vesting terms; provided, however, that no installment of any restricted stock award shall become vested less than one year from the grant date. Restricted stock awards are valued utilizing the fair value of the Company’s stock at the grant date. During the year ending 2020,
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
148,885 shares were granted to employees and directors of the Company. These awards are expensed on a straight-line basis over the vesting period. As of December 31, 2020, there was $2.4 million of unamortized compensation and directors’ cost related to unvested restricted stock awards granted under the 2017 plan. That cost is expected to be amortized over a weighted average period of 4.1 years.
A summary of the Company’s nonvested shares for the year follows (shares in thousands, except grant date fair value):
Nonvested Shares
Shares
Weighted Average Grant-Date Fair Value
Nonvested at January 1, 2020
-
$
-
Granted
18.00
Vested
-
-
Forfeited
-
-
Nonvested at December 31, 2020
$
18.00
15. REGULATORY MATTERS
The Company and the Bank are subject to regulatory capital requirements administered by the Board of Governors of the Federal Reserve System and the FDIC. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.
The net unrealized gain or loss on available for sale securities is not included in computing regulatory capital. Management believes as of December 31, 2020, the Company and Bank meet all capital adequacy requirements to which they are subject.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized , significantly undercapitalized , and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end December 31, 2020 and 2019, notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank's categorization.
In 2019, the federal banking agencies jointly issued a final rule that provides for an optional, simplified measure of capital adequacy, the community bank leverage ratio framework (CBLR framework), for qualifying community banking organizations, consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act. The final rule became effective on January 1, 2020 and was elected by the Bank at that time. In April 2020, the federal banking agencies issued an interim final rule that makes temporary changes to the CBLR framework, pursuant to section 4012 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, and a second interim final rule that provides a graduated increase in the community bank leverage ratio requirement after the expiration of the temporary changes implemented pursuant to section 4012 of the CARES Act.
The community bank leverage ratio removes the requirement for qualifying banking organizations to calculate and report risk-based capital but rather only requires a Tier 1 to average assets (leverage) ratio. Qualifying banking
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
organizations that elect to use the community bank leverage ratio framework and that maintain a leverage ratio of greater than required minimums will be considered to have satisfied the generally applicable risk based and leverage capital requirements in the agencies' capital rules (generally applicable rule) and, if applicable, will be considered to have met the well capitalized ratio requirements for purposes of section 38 of the Federal Deposit Insurance Act. Under the interim final rules the community bank leverage ratio minimum requirement is 8% as of December 31, 2020, 8.5% for calendar year 2021, and 9% for calendar year 2022 and beyond. The interim rule allows for a two-quarter grace period to correct a ratio that falls below the required amount, provided that the bank maintains a leverage ratio of 7% as of December 31, 2020, 7.5% for calendar year 2021, and 8% for calendar year 2022 and beyond.
Under the final rule, an eligible banking organization can opt out of the CBLR framework and revert back to the risk-weighting framework without restriction. As of December 31, 2020, both the Company and Bank were qualifying community banking organizations as defined by the federal banking agencies and elected to measure capital adequacy under the CBLR framework.
Actual and required capital amounts (in thousands) and ratios are presented below at year end.
Actual
To Be Well Capitalized Under Prompt Corrective Action Regulations (CBLR Framework)
Capital Amount
Ratio
Capital Amount
Ratio
Tier 1 (Core) Capital to average total assets
Sierra Bancorp and subsidiary
$
330,200
10.50%
$
251,595
8.00%
Bank of the Sierra
$
318,194
10.12%
$
251,572
8.00%
Actual
Required for Capital Adequacy Purposes
To Be Well Capitalized Under Prompt Corrective Action Regulations
Capital Amount
Ratio
Capital Amount
Ratio
Capital Amount
Ratio
Common Equity Tier 1 Capital Ratio
Sierra Bancorp and subsidiary
$
271,799
13.27%
$
92,143
4.50%
$
133,095
6.50%
Bank of the Sierra
301,963
14.75%
92,130
4.50%
133,077
6.50%
Tier 1 Risk-Based Capital Ratio
Sierra Bancorp and subsidiary
$
306,744
14.98%
$
122,857
6.00%
$
163,809
8.00%
Bank of the Sierra
301,963
14.75%
122,840
6.00%
163,787
8.00%
Total Risk-Based Capital Ratio
Sierra Bancorp and subsidiary
$
316,981
15.48%
$
163,809
8.00%
$
204,762
10.00%
Bank of the Sierra
312,200
15.25%
163,787
8.00%
204,734
10.00%
Tier 1 (Core) Capital to average total assets
Sierra Bancorp and subsidiary
$
306,744
11.91%
$
103,016
4.00%
$
128,769
5.00%
Bank of the Sierra
301,963
11.73%
103,002
4.00%
128,753
5.00%
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Dividend Restrictions
The Company’s ability to pay cash dividends is dependent on dividends paid to it by the Bank, and is also limited by state corporation law. California law allows a California corporation to pay dividends if the company’s retained earnings equal at least the amount of the proposed dividend plus any preferred dividend arrears amount. If a California corporation does not have sufficient retained earnings available for the proposed dividend, it may still pay a dividend to its shareholders if immediately after the dividend the value of the company’s assets would equal or exceed the sum of its total liabilities plus any preferred dividend arrears amount.
Dividends from the Bank to the Company are restricted under California law to the lesser of the Bank’s retained earnings or the Bank’s net income for the latest three fiscal years, less dividends previously declared during that period, or, with the approval of the Department of Financial Protection and Innovation, to the greater of the retained earnings of the Bank, the net income of the Bank for its last fiscal year, or the net income of the Bank for its current fiscal year. As of December 31, 2020, the maximum amount available for dividend distribution under this restriction was approximately $59.1 million.
16. BENEFIT PLANS
Salary Continuation Agreements, Directors’ Retirement and Officer Supplemental Life Insurance Plans
The Company has entered into salary continuation agreements with its executive officers, and has established retirement plans for qualifying members of the Board of Directors. The plans provide for annual benefits for up to fifteen years after retirement or death. The benefit obligation under these plans totaled $5.1 million and $5.3 million and was fully accrued for the years ended December 31, 2020 and 2019, respectively. The expense recognized under these arrangements totaled $0.2 million, $0.3 million and $0.4 million for the years ended December 31, 2020, 2019 and 2018, respectively. Salary continuation benefits paid to former directors or executives of the Company or their beneficiaries totaled $0.4 million, $0.3 million and $0.3 million for the years ended December 31, 2020, 2019 and 2018. Certain officers of the Company have supplemental life insurance policies with death benefits available to the officers’ beneficiaries.
In connection with these plans the Company has purchased, or acquired through merger, single premium life insurance policies with cash surrender values totaling $43.2 million and $42.5 million at December 31, 2020 and 2019, respectively.
Officer and Director Deferred Compensation Plan
The Company has established a deferred compensation plan for certain members of the management group and a deferred fee plan for directors for the purpose of providing the opportunity for participants to defer compensation. The Company bears the costs for the plan’s administration and the interest earned on participant deferrals. The related administrative expense was not material for the years ended December 31, 2020, 2019 and 2018. In connection with this plan, life insurance policies with cash surrender values totaling $9.3 million and $8.0 million at December 31, 2020 and 2019, respectively, are included on the consolidated balance sheet in other assets.
401(k) Savings Plan
The 401(k) savings plan (the “Plan”) allows participants to defer, on a pre-tax basis, up to 15% of their salary (subject to Internal Revenue Service limitations) and accumulate tax-deferred earnings as a retirement fund. The Bank may
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
make a discretionary contribution to match a specified percentage of the first 6% of the participants’ contributions annually. The amount of the matching contribution was 90%, 95% and 75% for the years ended December 31, 2020, 2019 and 2018, respectively. The matching contribution is discretionary, vests over a period of five years from the participants’ hire date, and is subject to the approval of the Board of Directors. The Company contributed $1.1 million, $1.1 million, and $1.0 million to the Plan in 2020, 2019 and 2018, respectively.
17. NONINTEREST INCOME
The major grouping of noninterest revenue on the consolidated income statements includes several specific items: service charges on deposit accounts, gains on the sale of loans, credit card fees, check card fees, the net gain (loss) on sales and calls of investment securities available for sale, and the net increase (decrease) in the cash surrender value of life insurance.
Noninterest income also includes one general category of “other income” of which the following are major components (dollars in thousands):
Year Ended December 31,
Included in other income:
Amortization of limited partnerships
$
(1,189)
$
(2,079)
$
(2,561)
Dividends on equity investments
Unrealized gains recognized on equity investments
1,183
Other
4,638
3,223
3,071
Total other noninterest income
$
4,560
$
2,165
$
2,654
18. OTHER NONINTEREST EXPENSE
Other noninterest expense consisted of the following (dollars in thousands):
Year Ended December 31,
Legal, audit and professional
$
4,263
$
4,039
$
3,032
Data processing
4,661
4,564
5,015
Advertising and promotional
1,889
2,568
2,748
Deposit services
8,483
7,962
5,413
Stationery and supplies
1,387
Telephone and data communication
1,775
1,529
1,479
Loan and credit card processing
1,142
Foreclosed assets expense (income), net
(730)
Postage
Other
2,205
2,082
1,808
Assessments
Total other noninterest expense
$
25,892
$
24,733
$
23,147
19. RELATED PARTY TRANSACTIONS
During the normal course of business, the Bank enters into loans with related parties, including executive officers and directors. These loans are made with substantially the same terms, including rates and collateral, as loans to
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
unrelated parties. The following is a summary of the aggregate activity involving related party borrowers (dollars in thousands):
Year Ended December 31,
Balance, beginning of year
$
2,731
$
2,544
$
3,047
Disbursements
7,114
18,681
13,873
Amounts repaid
(8,051)
(18,494)
(14,376)
Balance, end of year
$
1,794
$
2,731
$
2,544
Undisbursed commitments to related parties
$
2,635
$
1,829
$
2,130
Deposits from related parties held by the Bank at December 31, 2020 and 2019 amounted to $6.1 million and $7.6 million, respectively.
20. FAIR VALUE
Fair value is defined by U.S. GAAP as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. U.S. GAAP also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
● Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
● Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.
● Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the factors that market participants would use in pricing an asset or liability.
The Company used the following methods and significant assumptions to estimate fair values for each category of financial asset noted below:
Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities.
Collateral-dependent impaired loans: A specific loss allowance is created for collateral dependent impaired loans, representing the difference between the face value of the loan and the current appraised value of its associated collateral, less estimated disposition costs.
Foreclosed assets: Repossessed real estate (OREO) and other assets are carried at the lower of cost or fair value. Fair value is the appraised value less expected selling costs for OREO and some other assets such as mobile homes, and for all other assets fair value is represented by the estimated sales proceeds as determined using reasonably available sources. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Fair values for other foreclosed assets are
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
adjusted as necessary, subsequent to a periodic re-evaluation of expected cash flows and the timing of resolution. If impairment is determined to exist, the book value of a foreclosed asset is immediately written down to its estimated impaired value through the income statement, thus the carrying amount is equal to the fair value and there is no valuation allowance.
Assets and liabilities measured at fair value on a recurring basis are summarized below (dollars in thousands):
Fair Value Measurements at December 31, 2020, using
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Realized
Gain/(Loss)
Securities:
U.S. government agencies
$
-
$
1,800
$
-
$
1,800
$
-
Mortgage-backed securities
-
314,435
-
314,435
-
State and political subdivisions
-
227,739
-
227,739
-
Total available-for-sale securities
$
-
$
543,974
$
-
$
543,974
$
-
Fair Value Measurements at December 31, 2019, using
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Realized
Gain/(Loss)
Securities:
U.S. government agencies
$
-
$
12,145
$
-
$
12,145
$
-
Mortgage-backed securities
-
400,389
-
400,389
-
State and political subdivisions
-
188,265
-
188,265
-
Total available-for-sale securities
$
-
$
600,799
$
-
$
600,799
$
-
Assets and liabilities measured at fair market value on a non-recurring basis are summarized below (dollars in thousands):
Year Ended December 31, 2020
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Collateral dependent impaired loans
$
-
$
$
-
$
Foreclosed assets
$
-
$
$
-
$
Year Ended December 31, 2019
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Collateral dependent impaired loans
$
-
$
1,692
$
-
$
1,692
Foreclosed assets
$
-
$
$
-
$
21. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Disclosures include estimated fair values for financial instruments for which it is practicable to estimate fair value. These estimates are made as of the respective balance sheet dates based on relevant market data and information
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
about the financial instruments. These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.
Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented. The following methods and assumptions were used by the Company to estimate the fair value of its financial instruments at December 31, 2020 and 2019:
Cash and cash equivalents, and fed funds sold: For cash and cash equivalents and fed funds sold, the carrying amount is estimated to be fair value.
Securities: The fair values of investment securities are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities when quoted prices for specific securities are not readily available.
Loans and leases: Fair values of loans, excluding loans held for sale, are based on the exit price notion set forth by ASU 2016-01 effective January 1, 2018 and estimated using discounted cash flow analyses. The estimation of fair values of loans results in a Level 3 classification as it requires various assumptions and considerable judgement to incorporate factors relevant when selling loans to market participants, such as funding costs, return requirements of likely buyers and performance expectations of the loans given the current market environment and quality of loans.
Loans held for sale: Since loans designated by the Company as held-for-sale are typically sold shortly after making the decision to sell them, realized gains or losses are usually recognized within the same period and fluctuations in fair values are thus not relevant for reporting purposes. If held-for-sale loans stay on our books for an extended period of time, the fair value of those loans is determined using quoted secondary-market prices.
Deposits: Fair values for non-maturity deposits are equal to the amount payable on demand at the reporting date, which is the carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a cash flow analysis, discounted at interest rates being offered at each reporting date by the Bank for certificates with similar remaining maturities.
Short-term borrowings: The carrying amounts approximate fair values for federal funds purchased, overnight FHLB advances, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days of the reporting dates. Fair values of other short-term borrowings are estimated by discounting projected cash flows at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Long-term borrowings: The fair values of the Company’s long-term borrowings are estimated using projected cash flows discounted at the Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Subordinated debentures: The fair values of subordinated debentures are determined based on the current market value for like instruments of a similar maturity and structure.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Carrying amount and estimated fair values of financial instruments were as follows (dollars in thousands):
Year Ended December 31, 2020
Estimated Fair Value
Carrying
Amount
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Financial Assets:
Cash and cash equivalents
$
71,417
$
71,417
$
-
$
-
$
71,417
Securities available for sale
543,974
-
543,974
-
543,974
Loans and leases held for investment
2,441,676
-
-
2,450,340
2,450,340
Collateral dependent impaired loans
-
-
Financial Liabilities:
Deposits:
Noninterest bearing
$
943,664
$
943,664
$
-
$
-
$
943,664
Interest bearing
1,680,942
-
1,680,814
-
1,680,814
Fed funds purchased and repurchase agreements
39,138
-
39,138
-
39,138
Short-term borrowings
142,900
-
142,896
-
142,896
Subordinated debentures
35,124
-
24,364
-
24,364
Notional
Amount
Off-balance-sheet financial instruments:
Commitments to extend credit
$
441,816
Standby letters of credit
8,104
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Carrying amount and estimated fair values of financial instruments were as follows (dollars in thousands):
Year Ended December 31, 2019
Estimated Fair Value
Carrying
Amount
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Financial Assets:
Cash and cash equivalents
$
80,077
$
80,076
$
-
$
-
$
80,076
Securities available for sale
600,799
-
600,799
-
600,799
Loans and leases held for investment
1,753,846
-
-
1,761,461
1,761,461
Collateral dependent impaired loans
1,692
-
1,692
-
1,692
Financial Liabilities:
Deposits:
Noninterest bearing
$
690,950
$
690,950
$
-
$
-
$
690,950
Interest bearing
1,477,424
-
1,477,497
-
1,477,497
Fed funds purchased and repurchase agreements
25,711
-
25,711
-
25,711
Short-term borrowings
20,000
-
20,000
-
20,000
Subordinated debentures
34,945
-
30,564
-
30,564
Notional
Amount
Off-balance-sheet financial instruments:
Commitments to extend credit
$
492,040
Standby letters of credit
8,619
22. QUALIFIED AFFORDABLE HOUSING PROJECT INVESTMENTS
The Company invests in qualified affordable housing projects. At December 31, 2020 and 2019, the balance of the investment for qualified affordable housing projects totaled $3.5 million and $4.1 million, respectively. These balances are reflected in the other assets line on the consolidated balance sheet. Unfunded commitments related to these investments in qualified affordable housing projects totaled $0.1 million and $1.3 million at December 31, 2020 and 2019, respectively.
During the years ended December 31, 2020, 2019 and 2018, the Company recognized amortization expense on these investments of $0.6 million, $1.8 million, and $2.5 million, respectively which was included within pretax income on the consolidated statements of income.
Additionally, during the years ended December 31, 2020 and 2019, the Company recognized tax credits and other benefits from its investment in affordable housing tax credits of $0.5 million. The Company had no impairment losses during the years ended December 31, 2020 and 2019.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
23. REVENUE FROM CONTRACTS WITH CUSTOMERS
All of the Company’s revenue from contracts with customers in the scope of ASC 606 is recognized within Noninterest Income. The following table presents the Company’s sources of Noninterest Income for the twelve months ended December 31, 2020 and 2019. Items outside the scope of ASC 606 are noted as such.
Year Ended December 31,
Noninterest income
Service charges on deposits
Returned item and overdraft fees
$
5,078
$
6,854
Other service charges on deposits
6,687
5,888
Debit card interchange income
7,023
6,584
Loss on limited partnerships(1)
(1,189)
(2,079)
Dividends on equity investments(1)
Unrealized gains recognized on equity investments(1)
Net gains (losses) on sale of securities(1)
(198)
Other(1)
7,050
5,407
Total noninterest income
$
26,150
$
23,477
Noninterest expense
Salaries and employee benefits(1)
$
40,178
$
35,978
Occupancy expense(1)
9,842
9,845
Gains on sale or OREO
(10)
(107)
Other(1)
25,902
24,862
Total noninterest expense
$
75,912
$
70,578
(1) Not within the scope of ASC 606. Revenue streams are not related to contracts with customers and are accounted for on an accrual basis under other provisions of GAAP.
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
24. PARENT ONLY CONDENSED FINANCIAL STATEMENTS
BALANCE SHEETS
Years Ended December 31, 2020 and 2019
(dollars in thousands)
ASSETS
Cash and due from banks
$
12,000
$
4,818
Investments in bank subsidiary
367,014
339,449
Investment in trust subsidiaries
1,145
1,145
Other assets
$
380,181
$
345,433
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Other liabilities
$
1,161
$
1,203
Subordinated debentures
35,124
34,945
Total liabilities
36,285
36,148
Shareholders' equity:
Common stock
117,120
116,486
Retained earnings
208,371
186,867
Accumulated other comprehensive gain, net of taxes
18,405
5,932
Total shareholders' equity
343,896
309,285
$
380,181
$
345,433
STATEMENTS OF INCOME
Years Ended December 31, 2020, 2019 and 2018
(dollars in thousands)
Income:
Dividend from subsidiary
$
23,000
$
17,200
$
7,750
Gain on sale of securities
-
-
-
Other operating income
-
-
Total income
23,043
17,200
7,750
Expense
Salaries and employee benefits
Other expenses
1,971
2,664
2,533
Total expenses
2,827
3,246
3,049
Income before income taxes
20,216
13,954
4,701
Income tax benefit
(823)
(1,138)
(1,150)
Income before equity in undistributed income of subsidiary
21,039
15,092
5,851
Equity in undistributed income of subsidiary
14,405
20,869
23,826
Net income
$
35,444
$
35,961
$
29,677
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2020, 2019 and 2018
(dollars in thousands)
Cash flows from operating activities:
Net income
$
35,444
$
35,961
$
29,677
Adjustments to reconcile net income to net cash provided by operating activities:
Undistributed net income of subsidiary
(14,405)
(20,869)
(23,826)
Decrease in other assets
(Decrease) increase in other liabilities
(41)
(2)
Net cash provided by operating activities
21,176
15,268
6,062
Cash flows from investing activities:
Cash paid in acquisitions, net
-
-
(6)
Net cash used by investing activities
-
-
(6)
Cash flows from financing activities:
Stock options exercised
1,088
1,131
Repurchase of common stock
(2,562)
(2,544)
-
Dividends paid
(12,207)
(11,332)
(9,757)
Net cash used in financing activities
(13,994)
(12,788)
(8,626)
Net decrease (increase) in cash and cash equivalents
7,182
2,480
(2,570)
Cash and cash equivalents, beginning of year
4,818
2,338
4,908
Cash and cash equivalents, end of year
$
12,000
$
4,818
$
2,338
25. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth the Company’s unaudited results of operations for the four quarters of 2020 and 2019. In management’s opinion, the results of operations reflect all adjustments (which include only recurring adjustments) necessary to present fairly the condensed results for such periods (dollars in thousands, except per share data).
2020 Quarter Ended
December 31,
September 30,
June 30,
March 31,
Interest income
$
29,762
$
29,044
$
25,386
$
26,051
Interest expense
1,244
2,264
Net interest income
28,832
28,074
24,142
23,787
Provision for loan and lease losses
2,200
2,350
2,200
1,800
Noninterest income
6,040
7,104
6,900
6,106
Noninterest expense
20,757
19,304
18,033
17,818
Net income before taxes
11,915
13,524
10,809
10,275
Provision for taxes
2,936
3,169
2,506
2,468
Net income
$
8,979
$
10,355
$
8,303
$
7,807
Diluted earnings per share
$
0.58
$
0.68
$
0.54
$
0.52
Cash dividend per share
$
0.20
$
0.20
$
0.20
$
0.20
SIERRA BANCORP AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2019 Quarter Ended
December 31,
September 30,
June 30,
March 31,
Interest income
$
27,775
$
27,901
$
27,788
$
27,483
Interest expense
2,953
3,526
3,589
3,510
Net interest income
24,822
24,375
24,199
23,973
Provision for loan and lease losses
1,350
Noninterest income
5,847
5,869
5,855
5,906
Noninterest expense
17,982
17,088
17,656
17,852
Net income before taxes
12,187
11,806
11,998
11,727
Provision for taxes
2,902
2,854
3,169
2,832
Net income
$
9,285
$
8,952
$
8,829
$
8,895
Diluted earnings per share
$
0.60
$
0.58
$
0.57
$
0.58
Cash dividend per share
$
0.19
$
0.19
$
0.18
$
0.18

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.

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ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13(a)-15(e) as of the end of the period covered by this report (the “Evaluation Date”) have concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities, particularly during the period in which this annual report was being prepared.
Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our Management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized, and reported within the time periods specified by the SEC.
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for the preparation, integrity, and reliability of the consolidated financial statements and related financial information contained in this annual report. The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America and, as such, include some amounts that are based on judgments and estimates of Management.
Management has established and is responsible for maintaining effective internal control over financial reporting. The Company’s internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of Management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. The system contains monitoring mechanisms, and actions are taken to correct deficiencies identified.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. This assessment was based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. This assessment included controls over the preparation of regulatory financial statements in accordance with the Federal Financial Institutions Examination Council’s Instructions for Preparation of Consolidated Reports of Condition and Income, and in accordance with the Board of
Governors of the Federal Reserve System’s Instructions for Preparation of Financial Statements for Bank Holding Companies (Consolidated and Parent Company Only). Based on this assessment, Management believes that the Company maintained effective internal control over financial reporting as of December 31, 2020.
Management is responsible for compliance with the federal and state laws and regulations concerning dividend restrictions and federal laws and regulations concerning loans to insiders designated by the FDIC as safety and soundness laws and regulations. Management assessed compliance by the Company’s insured financial institution, Bank of the Sierra, with the designated laws and regulations relating to safety and soundness. Based on this assessment, Management believes that Bank of the Sierra complied, in all significant respects, with the designated laws and regulations related to safety and soundness for the year ended December 31, 2020.
Our assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020 has been audited by Eide Bailly, an independent registered public accounting firm, as stated in their report appearing above in Item 8, Financial Statements and Supplementary Data.
Changes in Internal Control
There were no significant changes in the Company’s internal control over financial reporting or in other factors in the fourth quarter of 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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ITEM 9B. OTHER INFORMATION
ITEM 9B. OTHER INFORMATION.
None.
PART III

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required to be furnished pursuant to this item with respect to Directors and Executive Officers of the Company will be set forth under the caption “Election of Directors” in the Company’s proxy statement for the 2021 Annual Meeting of Shareholders (the “Proxy Statement”), which the Company will file with the SEC within 120 days after the close of the Company’s 2020 fiscal year in accordance with SEC Regulation 14A under the Securities Exchange Act of 1934. Such information is hereby incorporated by reference.
The information required to be furnished pursuant to this item with respect to compliance with Section 16(a) of the Exchange Act will be set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement, and is incorporated herein by reference.
The information required to be furnished pursuant to this item with respect to the Company’s Code of Ethics and corporate governance matters will be set forth under the caption “Corporate Governance” in the Proxy Statement, and is incorporated herein by reference.

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ITEM 11. EXECUTIVE COMPENSATION
ITEM 11. EXECUTIVE COMPENSATION
The information required to be furnished pursuant to this item will be set forth under the captions “Executive Officer and Director Compensation” and “Compensation Discussion and Analysis” in the Proxy Statement, and is incorporated herein by reference.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
Securities Authorized for Issuance under Equity Compensation Plans
The information required by Item 12 with respect to securities authorized for issuance under equity compensation plans is set forth under “Item 5 - Market for Registrant’s Common Equity and Issuer Repurchases of Equity Securities” above.
Other Information Concerning Security Ownership of Certain Beneficial Owners and Management
The remainder of the information required by Item 12 will be set forth under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Election of Directors” in the Proxy Statement, and is incorporated herein by reference.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required to be furnished pursuant to this item will be set forth under the captions “Related Party Transactions” and “Corporate Governance - Director Independence” in the Proxy Statement, and is incorporated herein by reference.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required to be furnished pursuant to this item will be set forth under the caption “Ratification of Appointment of Independent Registered Public Accounting Firm - Fees” in the Proxy Statement, and is incorporated herein by reference.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit #
Description
2.1
Agreement and Plan of Reorganization and Merger, dated as of April 24, 2017 by and between Sierra Bancorp and OCB Bancorp, as amended by Amendment No. 1 thereto dated May 4, 2017 and Amendment No. 2 thereto dated June 6, 2017 (1)
3.1
Restated Articles of Incorporation of Sierra Bancorp (2)
3.2
Amended and Restated By-laws of the Company (3)
4.1
Description of Securities
10.1
Salary Continuation Agreement for Kenneth R. Taylor (4)*
10.2
Salary Continuation Agreement and Split Dollar Agreement for James F. Gardunio (5)*
10.3
Split Dollar Agreement for Kenneth R. Taylor (6)*
10.4
Director Retirement and Split dollar Agreements Effective October 1, 2002, for Albert Berra, Morris Tharp, and Gordon Woods (6)*
10.5
401 Plus Non-Qualified Deferred Compensation Plan (6)*
10.6
Indenture dated as of March 17, 2004 between U.S. Bank N.A., as Trustee, and Sierra Bancorp, as Issuer (7)
10.7
Amended and Restated Declaration of Trust of Sierra Statutory Trust II, dated as of March 17, 2004 (7)
10.8
Indenture dated as of June 15, 2006 between Wilmington Trust Co., as Trustee, and Sierra Bancorp, as Issuer (8)
10.9
Amended and Restated Declaration of Trust of Sierra Capital Trust III, dated as of June 15, 2006 (8)
10.10
2007 Stock Incentive Plan (9)*
10.11
Sample Retirement Agreement Entered into with Each Non-Employee Director Effective January 1, 2007 (10)*
10.12
Salary Continuation Agreement for Kevin J. McPhaill (10)*
10.13
First Amendment to the Salary Continuation Agreement for Kenneth R. Taylor (10)*
10.14
Second Amendment to the Salary Continuation Agreement for Kenneth R. Taylor (11)*
10.15
First Amendment to the Salary Continuation Agreement for Kevin J. McPhaill (12)*
10.16
Indenture dated as of September 20, 2007 between Wilmington Trust Co., as Trustee, and Coast Bancorp, as Issuer (13)
10.17
Amended and Restated Declaration of Trust of Coast Bancorp Statutory Trust II, dated as of September 20, 2007 (13)
10.18
First Supplemental Indenture dated as of July 8, 2016, between Wilmington Trust Co. as Trustee, Sierra Bancorp as the “Successor Company”, and Coast Bancorp (13)
10.19
2017 Stock Incentive Plan (14)*
10.20
Employment agreements dated as of December 27, 2018 for Kevin McPhaill, CEO, James Gardunio, Chief Credit Officer, and Michael Olague, Chief Banking Officer (15)*
10.21
Employment agreement dated as of March 15, 2019 for Matthew Macia, EVP and CRO (16)*
10.22
Employment agreement dated as of November 15, 2019 for Christopher Treece, EVP and CFO (17)*
10.23
Employment agreement dated as of January 17. 2020 for Jennifer Johnson, EVP and CAO (18)*
Subsidiaries of Sierra Bancorp
23.1
Consent of Eide Bailly
23.2
Consent of Vavrinek, Trine, Day & Co., LLP
31.1
Certification of Chief Executive Officer (Section 302 Certification)
31.2
Certification of Chief Financial Officer (Section 302 Certification)
Certification of Periodic Financial Report (Section 906 Certification)
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
(1) Original agreement filed as an exhibit to the Form 8-K filed with the SEC on April 25, 2017 and incorporated herein by reference, and amendments thereto filed as appendices to the proxy statement/prospectus included in the Form S-4/A filed with the SEC on July 24, 2017 and incorporated herein by reference.
(2) Filed as Exhibit 3.1 to the Form 10-Q filed with the SEC on August 7, 2009 and incorporated herein by reference.
(3) Filed as an Exhibit to the Form 8-K filed with the SEC on February 21, 2007 and incorporated herein by reference.
(4) Filed as Exhibit 10.5 to the Form 10-Q filed with the SEC on May 15, 2003 and incorporated herein by reference.
(5) Filed as an Exhibit to the Form 8-K filed with the SEC on August 11, 2005 and incorporated herein by reference.
(6) Filed as Exhibits 10.10, 10.18 through 10.20, and 10.22 to the Form 10-K filed with the SEC on March 15, 2006 and incorporated herein by reference.
(7) Filed as Exhibits 10.9 and 10.10 to the Form 10-Q filed with the SEC on May 14, 2004 and incorporated herein by reference.
(8) Filed as Exhibits 10.26 and 10.27 to the Form 10-Q filed with the SEC on August 9, 2006 and incorporated herein by reference.
(9) Filed as Exhibit 10.20 to the Form 10-K filed with the SEC on March 15, 2007 and incorporated herein by reference.
(10) Filed as Exhibits 10.1 through 10.3 to the Form 8-K filed with the SEC on January 8, 2007 and incorporated herein by reference.
(11) Filed as Exhibit 10.23 to the Form 10-K filed with the SEC on March 13, 2014 and incorporated herein by reference.
(12) Filed as Exhibit 10.24 to the Form 10-Q filed with the SEC on May 7, 2015 and incorporated herein by reference.
(13) Filed as Exhibits 10.1 through 10.3 to the Form 8-K filed with the SEC on July 11, 2016 and incorporated herein by reference.
(14) Filed as Exhibit 10.1 to the Form 8-K filed with the SEC on March 17, 2017 and incorporated herein by reference.
(15) Filed as Exhibits 99.1, 99.3 and 99.4 to the Form 8-K filed with the SEC on December 28, 2018 and incorporated by reference.
(16) Filed as Exhibit 99.2 to the Form 8-K filed with the SEC on March 18, 2019 and incorporated by reference.
(17) Filed as Exhibit 99.1 to the Form 8-K filed with the SEC on November 11, 2019 and incorporated by reference.
(18) Filed as Exhibit 99.1 to the Form 8-K filed with the SEC on January 21, 2020 and incorporated by reference.
* Indicates management contract or compensatory plan or arrangement.
(b) Financial Statement Schedules
Schedules to the financial statements are omitted because the required information is not applicable or because the required information is presented in the Company’s Consolidated Financial Statements or related notes.