EDGAR 10-K Filing

Company CIK: 1130144
Filing Year: 2023
Filename: 1130144_10-K_2023_0001558370-23-003238.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 17 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, Three Rivers, Tulare, Visalia Mooney and Woodlake. The remaining branches, as well as our technology center, loan production offices in Roseville and Templeton, 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
For information on litigation matters, see Note 14, Commitments and Contingencies, in Item 8 of this report.

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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 may not consistently 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, 2022
28.92
24.80
2,239,100
June 30, 2022
25.15
20.77
1,887,200
September 30, 2022
22.99
19.62
1,560,800
December 31, 2022
22.53
19.72
1,869,800
(b) Holders
As of January 31, 2023 there were an estimated 7,018 shareholders of the Company’s Common Stock. There were 758 registered holders of record on that date, and per Broadridge, an investor communication company, there were 6,260 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 $13.9 million, or $0.92 per share in 2022 and $13.2 million, or $0.87 per share in 2021, which represents 41% of annual net earnings for 2022 and 31% for 2021. 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 may 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, 2022 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
175,619
175,619
$
-
382,006
(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 S&P Bank Index, and the S&P $1 billion to $5 billion Bank Index (the latter two qualifying as peer bank indices), assuming a $100 investment on December 31, 2017 and the reinvestment of dividends.
Period Ending
Index
12/31/2017
12/31/2018
12/31/2019
12/31/2020
12/31/2021
12/31/2022
Sierra Bancorp
100.00
92.56
115.32
98.37
115.63
94.14
Nasdaq Composite Index
100.00
97.16
132.81
192.47
235.15
158.65
S&P U.S. SmallCap Banks Index
100.00
83.44
104.69
95.08
132.36
116.69
S&P U.S. BMI Banks Index
100.00
83.54
114.74
100.10
136.10
112.89
Source: S&P Global Market Intelligence
(f) Stock Repurchases
On October 20, 2022 the Board approved the 2022 Share Repurchase Plan by authorizing 630,000 shares of common stock for repurchase and expires on October 31, 2023. There were 370,000 shares purchased under the 2021 Share Repurchase Plan which had authorized 1,000,000 shares of common stock for repurchase and expired on October 31, 2022. There were no stock repurchase transactions during the fourth quarter of 2022 and all 630,000 shares of common stock authorized under the 2022 Share Repurchase Plan remain available for repurchase at the end of 2022.

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ITEM 6. SELECTED FINANCIAL DATA
ITEM 6.
[RESERVED]

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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, 2022 and 2021, and the results of operations for each year in the three-year period ended December 31, 2022. The discussion is best 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).
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATMENTS
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. These forward-looking statements include, but are not limited to, statements about the Company’s plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “should”, “projects”, “seeks”, “estimates”, or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. 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 correct, revise, or 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 and you should not place undue reliance on these forward-looking statements. Risk factors and the Company’s ability to manage that risk 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 Estimates
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 estimates 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 estimates deal primarily with the following areas: the establishment of an allowance for credit losses on loans and leases, as explained in detail in Note 2 to the consolidated financial statements and in the “Provision for Credit Losses on Loans and Leases” and “Allowance for Credit Losses on Loans and Leases” 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.
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.
Selected Financial Data
(dollars in thousands, except per share data)
As of and for the years ended December 31,
Operating Data
Provision for income taxes
11,256
14,187
11,079
Net income
33,659
43,012
35,444
Selected Balance Sheet Summary
Total loans and leases, net
2,029,757
1,973,605
2,442,226
Total assets
3,608,590
3,371,014
3,220,742
Total deposits
2,846,164
2,781,572
2,624,606
Total liabilities
3,305,008
3,008,520
2,876,846
Total shareholders' equity
303,582
362,494
343,896
Net loans to total deposits
71.32%
70.95%
93.05%
Per Share Data
Net income per basic share
2.25
2.82
2.33
Net income per diluted share
2.24
2.80
2.32
Book value
20.01
23.74
22.35
Cash dividends
0.93
0.87
0.80
Weighted average common shares outstanding basic
14,955,756
15,241,957
15,216,749
Weighted average common shares outstanding diluted
15,022,755
15,353,445
15,280,325
Key Operating Ratios:
Performance Ratios: (1)
Return on average equity
10.66%
12.05%
10.80%
Return on average assets
0.97%
1.29%
1.22%
Average equity to average assets ratio
9.06%
10.72%
11.28%
Net interest margin (tax-equivalent)
3.47%
3.56%
3.95%
Efficiency ratio (tax-equivalent) (4)
60.16%
59.92%
57.18%
Asset Quality Ratios: (1)
Non-performing loans to total loans (2)
0.95%
0.23%
0.31%
Non-performing assets to total loans and other real estate owned (2)
0.95%
0.23%
0.35%
Net (recoveries) charge-offs to average loans
0.58%
(0.01%)
0.04%
Allowance for credit losses on loans and leases to total loans at period end
1.12%
0.72%
0.72%
Allowance for credit losses on loans and leases to nonaccrual loans
117.78%
315.26%
233.46%
Regulatory Capital Ratios: (3)
Tier 1 capital to adjusted average assets (leverage ratio)
10.30%
10.43%
10.50%
(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) The efficiency ratio is a non-GAAP measure and is a calculation of 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.
Overview of the Results of Operations and Financial Condition
Results of Operations Summary
The Company recognized net income of $33.7 million in 2022 relative to $43.0 million in 2021 and $35.4 million in 2020. Net income per diluted share was $2.24 in 2022, as compared to $2.80 in 2021 and $2.32 for 2020. The Company’s return on average assets and return on average equity were 0.97% and 10.66%, respectively, in 2022, as compared to 1.29% and 12.05%, respectively, in 2021 and 1.22% and 10.80%, respectively, for 2020. Our financial results for 2022 were negatively impacted by a higher level of provisioning for credit losses on loans and leases, as discussed in greater detail in the applicable sections below. 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 1% in 2022 over 2021 due to both growth and mix of earning assets partially offset by an increase in the cost of interest-bearing liabilities, and 4% in 2021 over 2020, due
primarily to a lower cost of interest-bearing liabilities and growth in earning assets, partially offset by lower yields on earning assets. The increase in average earning assets in 2022 over 2021 was due primarily to purchases of investment securities, partially offset by decreases in the average balance of loans. We experienced an increase of $13.5 million in real estate loans primarily driven by the purchase of $173.1 million in high quality 1-4 family residential real estate loans, while all other loan categories declined due to pay-downs, maturities, charge-offs and reduced credit line utilization. The positive impact of average asset growth in 2022 along with a 15 bps increase in yield was negatively impacted by a 39 bps increase in yield on interest bearing liabilities due to certificates of deposits and shifting from a net sold position to a net purchased position. The net interest margin in 2022 was 9 bps lower than 2021.
● The increase in average earning assets in 2021 over 2020 was due primarily to a $207.7 million increase in average balance of real estate loans, partially offset by decreases in all of the other loan categories. We experienced a $73.3 million decline in average mortgage warehouse line utilization, and a $26.0 million decline in commercial loans mostly due to the forgiveness of SBA PPP loans. The increase in real estate loans was primarily driven by the purchase of $208.0 million in 1-4 family residential real estate loans during the second half of 2021. These loan purchases were made due to turnover of lending staff while the Company recruited new lending teams across the footprint. The positive impact of average asset growth in 2021 was augmented by a 10 bps decrease in yield on interest bearing liabilities. These two favorable impacts on margin were partially offset by a 46 basis point decline in yield on interest earning assets. The net interest margin in 2021 was 39 bps lower than 2020. Net interest income has also been impacted by nonrecurring interest items, which added $1.6 million to interest income in 2022 relative to $3.5 million in 2021 and $1.2 million in 2020.
● We recorded a provision for credit losses on loans and leases of $10.9 million in 2022, as compared to a $3.7 million benefit in 2021 and $8.6 million provision in 2020. The 2022 provision for credit losses on loans and leases loss benefit arose from the impact of $11.5 million in net charge-offs during the year ending 2022. The elevated net charge-offs were mostly due to two loan relationships; one dairy loan relationship with total charge-offs of $8.7 million and a single office building loan relationship that was sold at a $1.9 million discount due to an increased risk of default that would have likely led to a prolonged collection period. Refer to the discussion on loan services expense below, for more detailed information regarding the dairy loan relationship and events subsequent to year end 2022 regarding disposition of those assets. The 2021 loan and lease loss benefit arose from our determination of the appropriate level for our allowance for loan and lease losses and was driven by declines in loan balances coupled with improved credit quality of existing loan balances and the influence of lower historical loan and lease losses. We considered the continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy and our loan customers overall, making appropriate changes to the qualitative loss factors governing these areas.
● Noninterest income increased by $2.7 million, or 10%, in 2022, and by $1.9 million or 7%, in 2021 over 2020. The increase in 2022 was primarily due to a $0.7 million increase in service charge income, $1.5 million in gains on the sale of investment securities, a $0.8 million favorable change in other small business partnership expenses, and $3.2 million in gains on the sale of other assets. These favorable variances were partially offset by a $3.7 million unfavorable fluctuation in income on Bank-Owned Life Insurance (BOLI) associated with deferred compensation plans. The increase in 2021 was primarily due to a $1.5 million increase in debit card interchange income, a $0.3 million increase in life insurance proceeds, a decrease of $0.7 million in low-income housing tax credit fund amortization, an increase of $0.4 million in the valuation gain of restricted equity investments owned by the Company, partially offset by a $0.4 million decrease in the net gain on the sale of debt securities and a $1.3 million negative variance caused by the sale of certain real estate assets in our low income housing tax credit funds that have reached their life expectancy. Fluctuations in BOLI associated with deferred compensation plans contributed $0.2 million of the increase.
● Noninterest expense increased by $1.2 million, or 1%, in 2022 as compared to 2021, and increased by $7.6 million, or 10%, in 2021 over 2020. The increase in noninterest expense in 2022 was due mostly to a $4.6 million increase in salary and benefits expense primarily for new loan production teams and a $0.7 million restitution payment to customers charged nonsufficient fund fees on representments in the past five
years, partially offset by lower legal costs, telecommunications, and a positive variance in director’s deferred compensation expense which is linked to the unfavorable changes in bank-owned life insurance income. The increase in noninterest expense in 2021 was due mostly to a $2.3 million increase in salaries and benefits expense, a $3.8 million increase in professional services and a $1.2 million increase in data processing costs. Deposit services and premises expense also contributed to the difference.
● The Company recorded income tax provisions of $11.3 million, or 25% of pre-tax income in 2022; $14.2 million, or 24% of pre-tax income in 2021; and $11.1 million, or 24% of pre-tax income in 2020. The increase in tax rate in 2022 was due to the impact of the equity markets on our deferred compensation plan creating non-deductible losses on BOLI used to offset deferred compensation. This negative impact on tax rate was partially offset by an increase in municipal bond income and lower overall pre-tax income in 2022.
Financial Condition Summary
The Company’s assets totaled $3.6 billion at December 31, 2022 as compared to $3.4 billion at December 31, 2021. Total liabilities were $3.3 billion at December 31, 2022 as compared to $3.0 billion at the end of 2021, and shareholders’ equity totaled $325.7 million at December 31, 2022 compared to $362.5 million at December 31, 2021. The following is a summary of key balance sheet changes during 2022.
● Total assets increased by $237.6 million, or 7%. This was due mostly to loan growth and the purchase of investment securities, primarily funded through an increase in deposits and borrowed funds in 2022.
● Gross loans and leases increased $63.2 million, or 3%. This increase was predominantly due to the purchase of $173.1 million in high quality jumbo single family mortgage loan pools during the year. Organic loan production for the year ending 2022 was $292.2 million, as compared to $128.4 million for the comparative period in 2021. These loan increases were offset by $317.8 million in loan maturities, charge-offs and payoffs, which occurred mostly during the first nine months of the year. As interest rates began to rise, property values increased and as a result some of our borrowers sold their real estate. We also had a $29.7 million decline in PPP balances due to loan forgiveness by the SBA, and a decline in credit line utilization of $84.3 million. The decrease in line utilization includes a $35.7 million decline in mortgage warehouse line utilization due to higher interest rates reducing the demand for mortgages.
● Deposit balances reflect net growth of $64.6 million, or 2%. Deposit growth in 2022 was primarily from an increase in time deposits of $165.7 million offset by a decrease in other deposit balances of $101.1 million.
● Total capital decreased by $58.9 million, or 16%, ending the year with a balance of $303.6 million. The decrease in equity was primarily due to a $67.7 million unfavorable swing in accumulated other comprehensive income (loss), a one-time adjustment from the implementation of CECL on January 1, 2022, for $7.3 million, $13.9 million in dividends paid, and $4.9 million in share repurchases. The declines were partially offset by $33.7 million in net income. The remaining difference is related to stock options exercised and restricted stock granted during the year.
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 $109.6 million in 2022 as compared to $109.0 million in 2021 and $104.8 million in 2020. This equates to increases of 1% in 2022 and 4% in 2021. 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.
AVERAGE BALANCES AND RATES
(Dollars in Thousands, Unaudited)
Year Ended December 31,
Average
Income/
Yield/
Average
Income/
Yield/
Average
Income/
Yield/
Assets
Balance(1)
Expense
Rate(2)
Balance(1)
Expense
Rate(2)
Balance(1)
Expense
Rate(2)
Investments:
Interest-earning due from banks
$
91,420
$
0.57%
$
269,932
$
0.14%
$
25,228
$
0.62%
Taxable
808,750
25,789
3.19%
406,790
7,239
1.78%
379,024
8,199
2.16%
Non-taxable
319,682
8,805
3.49%
258,472
6,218
3.05%
216,387
5,707
3.34%
Total investments
1,219,852
35,113
3.07%
935,194
13,827
1.66%
620,639
14,062
2.51%
Loans and Leases: (3)
Real estate
1,831,874
77,708
4.24%
1,818,362
84,074
4.62%
1,610,686
79,175
4.92%
Agricultural
31,565
1,176
3.73%
42,866
1,598
3.73%
47,299
1,887
3.99%
Commercial
81,798
4,383
5.36%
153,880
7,828
5.09%
179,924
6,738
3.74%
Consumer
4,301
14.83%
4,993
16.64%
6,584
1,069
16.24%
Mortgage warehouse
54,606
2,695
4.94%
147,996
4,807
3.25%
221,319
7,135
3.22%
Other
2,139
4.96%
1,485
7.47%
2,878
6.15%
Total loans and leases
2,006,283
86,706
4.32%
2,169,582
99,249
4.57%
2,068,690
96,181
4.65%
Total interest earning assets (4)
3,226,135
121,819
3.85%
3,104,776
113,076
3.70%
2,689,329
110,243
4.16%
Other earning assets
15,685
15,043
13,103
Non-earning assets
243,340
208,665
207,590
Total assets
$
3,485,160
$
3,328,484
$
2,910,022
Liabilities and shareholders' equity
Interest bearing deposits:
Demand deposits
$
195,192
$
0.25%
$
143,171
$
0.23%
$
121,867
$
0.23%
NOW
532,692
0.06%
597,992
0.07%
497,984
0.08%
Savings accounts
476,128
0.06%
427,803
0.06%
336,620
0.07%
Money market
150,378
0.06%
140,365
0.08%
124,755
0.10%
Time deposits
317,806
4,914
1.55%
333,204
1,039
0.31%
436,806
2,687
0.62%
Brokered deposits
74,917
0.97%
81,041
0.28%
36,071
0.68%
Total interest bearing deposits
1,747,113
6,819
0.39%
1,723,576
2,390
0.14%
1,554,103
3,948
0.25%
Borrowed funds:
Federal funds purchased
16,980
4.08%
1,561
0.06%
1,918
0.21%
Repurchase agreements
110,387
0.29%
70,443
0.30%
34,614
0.40%
Short term borrowings
30,728
1,057
3.44%
3,625
0.06%
54,244
0.19%
Long term debt
49,172
1,713
3.48%
13,351
3.51%
-
-
-
Subordinated debentures
35,387
1,603
4.53%
35,208
2.78%
35,031
1,217
3.47%
Total borrowed funds
242,654
5,385
2.22%
124,188
1,660
1.34%
125,807
1,460
1.16%
Total interest bearing liabilities
1,989,767
12,204
0.61%
1,847,764
4,050
0.22%
1,679,910
5,408
0.32%
Noninterest bearing demand deposits
1,121,060
1,064,119
862,274
Other liabilities
58,538
59,723
39,510
Shareholders' equity
315,795
356,878
328,328
Total liabilities and shareholders' equity
$
3,485,160
$
3,328,484
$
2,910,022
Interest income/interest earning assets
3.85%
3.70%
4.15%
Interest expense/interest earning assets
0.38%
0.14%
0.20%
Net interest income and margin(5)
$
109,615
3.47%
$
109,026
3.56%
$
104,835
3.95%
(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 $0.9 million, $4.2 million, and $1.9 million for the years ended December 31, 2022, 2021, and 2020 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 mix variance.
Volume & Rate Variances
(dollars in thousands)
Years Ended December 31,
2022 over 2021
2021 over 2020
Increase(decrease) due to
Increase(decrease) due to
Assets:
Volume
Rate
Mix
Net
Volume
Rate
Mix
Net
Investments:
Federal funds sold/due from time
$
(245)
$
1,162
$
(768)
$
$
1,517
$
(125)
$
(1,178)
$
Taxable
7,153
5,733
5,664
18,550
(1,455)
(107)
(960)
Non-taxable
1,473
2,587
1,110
(500)
(99)
Total investments
8,381
7,796
5,109
21,286
3,229
(2,080)
(1,384)
(235)
Loans and leases:
Real estate
(6,939)
(52)
(6,366)
10,209
(4,704)
(606)
4,899
Agricultural
(421)
(1)
-
(422)
(177)
(124)
(289)
Commercial
(3,666)
(196)
(3,445)
(975)
2,415
(350)
1,090
Consumer
(115)
(91)
(193)
(259)
(6)
(238)
Mortgage warehouse
(3,033)
2,497
(1,576)
(2,112)
(2,365)
(17)
(2,328)
Other
(38)
(16)
(5)
(86)
(18)
(66)
Total loans and leases
(6,561)
(4,155)
(1,827)
(12,543)
6,347
(2,294)
(985)
3,068
Total interest earning assets
$
1,820
$
3,641
$
3,282
$
8,743
$
9,576
$
(4,374)
$
(2,369)
$
2,833
Liabilities:
Interest bearing deposits:
Demand
$
$
$
$
$
$
$
$
NOW
(48)
(83)
(122)
(18)
(4)
Savings accounts
(32)
(9)
Money market
(22)
(2)
(16)
(29)
(4)
(17)
Time deposits
(48)
4,113
(190)
3,875
(637)
(1,325)
(1,648)
Brokered deposits
(17)
(42)
(146)
(182)
(21)
Total interest bearing deposits
4,602
(215)
4,429
(127)
(1,547)
(1,558)
Borrowed funds:
Borrowed funds:
Federal funds purchased
(1)
(3)
(3)
Repurchase agreements
(6)
(4)
(34)
(35)
Short term borrowings
1,055
(95)
(72)
(100)
Long term debt
1,256
(3)
(8)
1,245
-
-
TRUPS
(243)
(1)
(238)
Total borrowed funds
1,405
1,527
3,725
(352)
Total interest bearing liabilities
1,447
5,395
1,312
8,154
(75)
(1,899)
(1,358)
Net interest income
$
$
(1,754)
$
1,970
$
$
9,651
$
(2,475)
$
(2,985)
$
4,191
Net interest income in 2022 as compared to 2021 was impacted by a favorable volume variance of $0.4 million and a favorable mix variance of $2.0 million, partially offset by an unfavorable rate variance of $1.8 million. For 2021 relative to 2020, net interest income reflects a favorable volume variance of $9.6 million partially offset by an unfavorable rate
variance of $2.5 million and an unfavorable mix variance of $3.0 million. The 2022 versus 2021 volume variance is due mostly to increases in average balances, resulting from growth in investment portfolio balances, mostly in floating rate commercial loan obligations, partially offset by a decline in average loan balances. The 2021 versus 2020 volume variance is due mostly to increases in average balances, resulting from the organic growth in commercial real estate loans, as well as increased investment portfolio balances. The 2021 versus 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 had increased, as demonstrated by the $3.7 million favorable volume variance. The Company’s net interest margin, which is tax-equivalent net interest income as a percentage of average interest-earning assets declined by 9 basis points to 3.47% in 2022, and declined by 39 basis points to 3.56% in 2021 as compared to 2020. Thenet interest margin compression was caused by an unfavorable rate variance of $1.8 million since the weighted average yield on interest-earning assets increased by only 15 basis points and the weighted average cost of interest-bearing liabil­ities increased by 39 basis points in 2022 compared to 2021. There was also a favorable mix variance of $2.0 million primarily from the purchase of CLOs at floating higher interest rates, which was partially offset by a decrease in loan and lease balances and an increase in higher cost interest bearing liabilities in 2022 compared to 2021. The decrease in 2021 was due to the lower rate environment and its impact on all debt securities.
Rates paid on non-maturity deposits were approximately the same in 2022 but declined for 2021 over 2020. Interest bearing demand accounts increased 2 basis points in 2022 but were the same in 2021 over 2020. There was a 2 basis point decrease on money market accounts in 2022 over 2021 and in 2021 over 2020. Since the Federal Open Markets Committee of the Federal Reserve System raised the federal funds target rate 425 basis points throughout 2022, both customer time and brokered deposits along with other borrowed funds were negatively impacted. The weighted average cost of interest-bearing liabilities increased 39 basis points in 2022 and declined 10 basis points in 2021. Customer time deposit rates in 2022 increased 124 basis points due to a floating rate time deposit product offered by the Bank along with a 69 basis point increase in the rate paid on brokered deposits. The Bank offers a time deposit product with a rate set to a spread to prime. The current spreads range from prime minus 400 bps to prime minus 325 bps. Given the significant increase in the prime rate during 2022, the interest on such deposits increased during 2022 coupled with additional balances added to such accounts.
The 2021 decrease of 31 basis points was due to the relatively short duration of our time deposit portfolio in a historically low-rate environment in 2021. Overnight borrowings and adjustable-rate trust-preferred securities (“TRUPS”) are also tied to short-term rates which increased during 2022, resulting in an unfavorable increase of 88 basis points. During 2021 the cost of these same overnight borrowings and TRUPS were relatively low. 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 $1.6 million in 2022, $3.5 million in 2021, and $1.2 million in 2020. Further, discount accretion on loans from whole-bank acquisitions enhanced our net interest margin by approximately one basis point in 2022, two basis points in 2021, and two basis points in 2020.
Provision for Loan and Lease Losses and Provision for Credit Losses
Credit risk is inherent in the business of making loans. The Company sets aside an allowance for credit losses on loans and leases, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for loan and lease losses. The Company recorded a provision for credit losses on loans and leases of $10.9 million in 2022; a benefit for loan and lease losses of $3.7 million in 2021, and a provision for loan and lease losses of $8.6 million in 2020. The Company was subject to the adoption of the Current Expected Credit Loss ("CECL") accounting method under FASB Accounting Standards Update 2016-03 and related amendments, Financial Instruments - Credit Losses (Topic 326) and implemented the update on January 1, 2022. Upon implementation the Company recorded a $10.4 million increase in the allowance for credit losses, which included a $0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes. The Company’s $14.5 million unfavorable increase for the year ending 2022 compared to the same period in 2021 is primarily due to the impact of $11.5 million in net charge-offs during the year ending 2022. The elevated net charge-offs were mostly due to two loan relationships; one dairy loan relationship with total charge-offs of $8.7 million and a single office building loan relationship that was sold at a $1.9 million discount due to an increased risk of default that would have likely led to a prolonged collection period.
The Company's $12.2 million, favorable decline in provision for loan and lease losses for the year ending 2021 compared to the same period in 2020 is due mostly to lower historical loan loss rates, a decline in outstanding balances on loans, a change in the mix of loans, and net year-to-date 2021 recoveries of previously charged-off loan balances. During 2021, management adjusted its qualitative risk factors under our current incurred loss model for improved economic conditions, improvements in the severity and volume of past due loans, and a reduction in the level of concentrations of credit in non-owner occupied real estate loans.
The growth in the provision for loan and lease losses in 2020, was 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 the 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 and the impact that COVID-19 may have on our customers.
With the provision for credit losses on loans and leases recorded in 2022 we were able to maintain our allowance for credit losses on loans and leases at a level that, in Management’s judgment, is adequate to absorb probable credit losses on loans and leases related to individually identified loans as well as probable credit 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 charge offs of $11.5 million in 2022. The Company experienced net loan and lease recoveries of $0.2 million in 2021 and net loan and lease charge-offs of $0.7 million in 2020. The provision for credit losses on loans and leases for 2022 was elevated due to the impact of two loan relationships as previously discussed above. The loan and lease loss (benefit) provision for 2021 and 2020 were 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 credit allowance, are discussed in Note 2 to the consolidated financial statements and below under “Allowance for Credit Losses on Loans and Leases.” The process utilized to establish an appropriate allowance for credit losses on loans and leases can result in a high degree of variability in the Company’s provision for credit losses on loans and leases, 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,
NONINTEREST INCOME:
Service charges on deposit accounts
$
12,535
$
11,846
$
11,765
Debit card fees
8,533
8,485
7,023
Other service charges and fees
2,872
2,939
2,964
Bank owned life insurance (loss) income
(996)
2,648
2,412
Gain on sale of securities
1,487
Gain (loss) on tax credit investment
(524)
(1,189)
Other
6,086
2,674
2,785
Total noninterest income
30,770
28,079
26,150
As a % of average interest-earning assets
0.95%
0.90%
0.97%
OTHER OPERATING EXPENSES:
Salaries and employee benefits
47,053
42,431
40,178
Occupancy costs
Furniture and equipment
1,847
1,720
2,028
Premises
7,871
8,117
7,814
Advertising and promotion costs
1,729
1,521
1,889
Data processing costs
6,202
5,890
4,661
Deposit services costs
9,492
9,049
8,483
Loan services costs
Loan processing
Foreclosed assets
Other operating costs
Telephone and data communications
1,563
2,013
1,775
Postage and mail
Other
2,725
2,176
1,647
Professional services costs
Legal and accounting
2,133
4,794
1,990
Other professional services costs
2,005
4,015
2,990
Stationery and supply costs
Sundry & tellers
Total other operating expense
$
84,803
$
83,556
$
75,912
As a % of average interest-earning assets
2.63%
2.69%
2.82%
Net noninterest income as a % of average interest-earning assets
(1.67%)
(1.79%)
(1.85%)
Efficiency ratio (1) (2)
60.16%
59.92%
57.18%
(1) Tax Equivalent
(2) The efficiency ratio is a non-GAAP measure and is a calculation of 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 in 2022 increased $2.7 million, or 10% as compared to an increase of $1.9 million, or 7%, in 2021. Total noninterest income was 0.95% of average interest-earning assets in 2022 as compared to a ratio of 0.90% in 2021 and 0.97% in 2020. The ratio increased in 2022 due to a 10% increase in noninterest income.
The principal component of the Company’s noninterest revenue, service charges on deposit accounts, increased by $0.7 million, or 6%, in 2022 as compared to 2021 and by $0.1 million, or 1%, in 2021 over 2020. This line item is primarily driven by the volume of transaction accounts. As a percent of average transaction account balances, service charge income was 1.0% in 2022, 1.0% in 2021 and 1.9% in 2020. This line item consists of a variety of fees including service charges on corporate accounts, treasury management fees, charges on corporate and consumer accounts including treasury management fees, ATM fees, overdraft income, and monthly service charges on certain accounts. Overdraft income on both consumer and corporate accounts totaled $4.6 million (net of restitution) in 2022; $4.9 million in 2021 and $5.1 million in 2020.
Debit card fees consists of interchange fees from our customers’ use of debit cards for electronic funds transactions. This category was relatively flat in 2022 and 2021 but increased by $1.5 million, or 21%, in 2021 as compared to 2020. The increases in 2021 were primarily a result of increased usage of debit cards by our customers as 2020 was impacted by the pandemic.
Other service charges and fees decreased by $0.1 million, or 2% in 2022 over 2021 and was mostly unchanged in 2021 over 2020.. This account includes certain transaction related fees including merchant income, currency orders, safe deposit box fees, and wire fees.
BOLI income generally fluctuates based on the market due to the Company’s “separate account” BOLI being invested in assets that closely mirror investments choices of deferred compensation participants. There is also a part of BOLI that is “general account” and receives a standard crediting rate from the carrier which remains relatively stable year over year. However, the separate-account BOLI used to offset deferred compensation fluctuates significantly from year-to-year as many of our deferred compensation participants are invested in equity-index style funds. In the comparative years ending 2022 over 2021, BOLI income decreased $3.6 million, however in 2021 over 2020, BOLI income increased by $0.2 million or 10%. The Company had $9.0 million invested in separate account BOLI at December 31, 2022. This separate account BOLI closely matched 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). Net losses on separate account BOLI totaled $2.0 million in 2022 as compared to gains of $1.7 million in 2021, and $1.4 million in 2020. This resulted in unfavorable variances of $3.7 million for the comparative years ending 2022 as compared to 2021 and favorable variances of $0.2 million for the comparative years ending 2021 as compared to 2020. 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, 2022 and 2021. 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, 2022, 2021, and 2020.
The Company recognized a $1.5 million gain on the sale of investment securities in 2022, as compared to a nominal gain in 2021 and a $0.4 million gain in 2020. In 2022 the Company restructured the securities portfolio to decrease effective duration, taking advantage of slight rallies in the Treasury market in early and late 2022. In 2020 of the Company sold 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 Gain(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 $0.8 million, or 148%, in 2022 as compared to 2021, and increased by $0.7 million, or 56%, in 2021 as compared to 2020. The variance in 2022 is due to a favorable adjustment of expenses, while in 2021 we had funds that had expired and had reached the end of their useful tax benefit life.
The other category, increased $3.4 million to $6.1 million in 2022 and decreased to $0.8 million from $1.7 million in 2021. In 2022 we had non-recurring gains from the sale of other assets including $2.6 million from the sale of Visa B shares. The primary reason for the decrease in 2021 was from a 2020 non- recurring gain as discussed in the prior year comparison, but was partially offset by a gain from life insurance proceeds and the sale of fixed assets.
Total operating expense, or noninterest expense, increased by $1.2 million, or 1%, in 2022 as compared to 2021, and by $7.6 million, or 10%, in 2021 as compared to 2020. The increase in 2022 is due mostly to a $4.6 million increase in salary and benefits expense and a $0.7 million restitution payment to customers charged nonsufficient fund fees on representments in the past five years, partially offset by lower legal costs, telecommunications, and a positive variance in director’s deferred compensation expense which is linked to the unfavorable changes in bank-owned life insurance income The primary increase in 2021 was in legal and accounting costs as discussed in further detail below. Noninterest expense as a percent of average interest-earning assets trended down each year. This ratio was 2.6% in 2022, 2.7% in 2021 and 2.8% in 2020.
The largest component of noninterest expense, salaries, and employee benefits increased $4.6 million or 11% in 2022 as compared to 2021, and increased $2.3 million, or 6% in 2021 as compared to 2020. The increase in 2022 was due mostly to the strategic hiring of new loan production teams, increases to the Company’s minimum wage, and standard annual increases to our employee’s base compensation. The increase in 2021, was mostly due to the $2.3 million decrease in deferred loan origination salaries associated with successful loan originations which are accounted for in accordance with 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 $2.3 million in 2022, $1.1 million in 2021, and $3.3 million for 2020.
Employee deferred compensation expense accruals totaled $0.1 million in 2022, and $0.2 million in 2021, and 2020. 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 55% of total operating expense in 2022, relative to 51% in 2021 and 53% in 2020. The number of full-time equivalent staff employed by the Company totaled 491 at the end of 2022, as compared to 480 at December 31, 2021 and 501 at December 31, 2020. The increase in FTE during 2022 was due to the strategic hiring of lending and management staff. Staff attrition throughout 2021, 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. As branch lobbies resumed normal operating hours and public access, during the summer of 2021, full-time equivalent staff were expected to increase, however finding talent was extremely challenging not only for the Company but for the entire industry. 2021 was the year of the “Great Resignation” with over 4.4 million people leaving their jobs according to the Bureau of Labor Statistics.
Total rent and occupancy expense, including furniture and equipment costs, decreased $0.1 million in 2022 as compared to 2021 due to the consolidation of five branch facilities in 2021. For 2021 and 2022 rent and occupancy expense was approximately the same.
Advertising and promotion costs increased $0.2 million or 14%, in 2022 over 2021 and decreased by 19% to $1.5 million in 2021 as compared to 2020. The increase in 2022 was due to the resumption of special events as COVID-19 restrictions were lifted. The decrease in 2021 came from the cessation of special events and in-branch marketing campaigns necessitated by the COVID-19 pandemic.
Data processing costs increased by $0.3 million or 5% in 2022 as compared to 2021 and increased by $1.2 million, or 26%, in 2021 as compared to 2020. The increase in 2022 was primarily from an increase in core processing costs. In late 2022, the Company renegotiated its core processing contract and expects annual savings from this renegotiation of approximately $1.0 million. The increase in 2021 was due to higher disaster recovery and data back-up costs as a result of outsourcing this work in late 2020 rather than performing it in-house, higher core processing costs as we expand our data warehousing capabilities, and higher loan management software costs for the expansion of digital loan Platform.
Deposit services costs increased by $0.4 million or 5% in 2022 as compared to 2021 and increased by $0.6 million, or 7%, in 2021 over 2020. Deposit costs have been impacted in both 2022 and 2021, by increases in debit card processing due to higher customer activity levels and increased utilization of armored car services. These increases in both years were partially offset by decreases in ATM servicing costs as we replaced most of our ATMs throughout 2021 with newer models
that require less maintenance. Additionally, in the second quarter of 2023, the Company is expecting to convert its debit card processing to a new provider which should result in lower processing 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 $0.1 million or 10% in 2022 as compared to 2021 and decreased by $0.6 million, or 49%, in 2021 as compared to 2020. The increase in 2022 was primarily due to an increase of $0.1 million in the provision for unfunded commitments. The decrease in 2021 was due to smaller amounts in nearly every category of loan servicing and precipitated by the reduction in the volume of loans 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. There were $0.1 million in expenses in both 2022 and 2021 as compared to $0.03 million in 2020. These costs fluctuate based on market conditions of OREO relative to our holding value, the nature of the underlying properties and the volume of OREO properties in inventory. At the end of 2022, the Company had no OREO properties remaining in inventory. Subsequent to year end, $18.1 million of nonaccrual loans within the aforementioned dairy relationship were foreclosed upon and were moved to other real estate owned or other foreclosed assets at net realizable value. The Company sold a portion of such assets in the first quarter of 2023 for $7.7 million, which constituted book value. The Company continues to actively work with interested buyers to sell the remaining assets of the dairy.
The “other operating costs” category includes telecommunications expense, postage, and other miscellaneous costs. Telecommunications expense decreased by 22% to $1.6 million in 2022 as compared to 2021, and increased by 13% to $2.0 million in 2021 over 2020. The telecommunications decrease in 2022 was due to the reduction of redundancy in lines during 2021, while the increase in 2021 was due to the improvement of our data infrastructure and a certain amount of redundancy during the transition. Postage expense increased by $0.1 million or 21% in 2022 as compared to 2021 and was slightly lower in 2021 as compared to 2020. The increase in 2022 was due to deposit account disclosure mailings from the change in our overdraft and NSF fee practices. The decrease in 2021 and 2020 was due to concentrated efforts to decrease our utilization of overnight mail services and increase usage of digital technologies. The “Other” category under other operating costs increased by $0.5 million or 25% in 2022 as compared to 2021 and increased by $0.5 million, or 32% in 2021 as compared to 2020. The increase in 2022 were primarily due to restitution payments to customers charged nonsufficient fund fees on representments in the past five years. The increase in 2021 were mostly due to higher consulting costs and expenses on discontinued branch leases.
Total Professional Services costs, which includes directors fees, decreased by $4.7 million or 53% in 2022 as compared to 2021 and increased by $3.8 million, or 77%, in 2021 as compared to 2020. Professional Services costs consists of legal and accounting, acquisition, and other professional services costs. Legal and Accounting costs decreased by $2.7 million or 56% in 2022 as compared to 2021 and increased by $2.8 million, or 141% in 2021 as compared to 2020. The decrease in 2022 was mostly due to a decrease in legal costs and related legal reserves, along with lower costs related to certain audit functions that were previously outsourced. The increase in 2021 was mostly due to an increase in legal costs, related legal reserves, and additional costs related to the outsourcing of certain audit functions. Other professional services costs include FDIC assessments and other regulatory expenses, directors’ costs, and certain insurance costs among other things. This category decreased by $2.0 million or 50% in 2022 as compared to 2021 and increased by $1.0 million or 34%, in 2021 as compared to 2020. The decrease in 2022 was mostly from the change in director’s deferred compensation expense which is linked to the fluctuation in BOLI income. The increase in 2021 was due to an increase in FDIC assessment expenses, increased director’s equity compensation expense, and professional services costs. There was also a favorable swing in the director’s deferred compensation expense for both 2022 and 2021, which is mostly offset by higher BOLI income, as described above under the separate account BOLI.
Stationery and supply costs increased by $0.1 million or 41% in 2022 as compared to 2021 and decreased by $0.1 million, or 23%, in 2021 as compared to 2020. The increase in 2022 was primarily from startup costs of new loan production offices while the decrease in 2021 over 2020, is mostly due to efficiencies gained as a result of movement towards a digital working environment and less reliance on paper.
Sundry and teller costs were $0.7 million in 2022, $0.6 million in 2021 and 2020. In 2022, as well as 2021 and 2020, debit card losses are elevated and trending upwards consistent with the higher volume of debit card transactions. These costs are expected to decline in 2023 with the change to a new debit card processor during the second quarter, although no assurance can be given that this will be the case.
The Company’s tax-equivalent overhead efficiency ratio was 60.2% in 2022, 59.9% in 2021, and 57.2% in 2020. 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 Company is continually working on efforts to control costs, as well as higher income which is the denominator of the equation. Several strategic projects in 2023 are expected to have a positive impact on this ratio.
Income Taxes
Our income tax provision was $11.3 million, or 25.1% of pre-tax income in 2022, $14.2 million, or 24.8% of pre-tax income in 2021 and $11.1 million, or 23.8% of pre-tax income in 2020. The tax accrual rate was higher in 2022 and 2021 due to a lower proportion of non-taxable income primarily due to losses on separate-account BOLI described above.
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 or loss, and certain book expenses that are not allowed as tax deductions. The Company’s investments in state, county and municipal bonds provided $8.8 million of federal tax-exempt income in 2022, $6.2 million in 2021, and $5.7 million in 2020. Moreover, in addition to life insurance proceeds of $0.4 million in both 2022 and 2021 and $0.07 million in 2020, net increases in the cash surrender value of bank-owned life insurance added $2.6 million to tax-exempt income in 2021; and $2.4 million in 2020, but reduced tax-exempt income by $1.0 million in 2022.
Our tax credits consist primarily of those generated by investments in low-income housing tax credit funds. We had a total of $10.1 million invested in low-income housing tax credit funds as of December 31, 2022 and $2.9 million as of December 31, 2021, 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 each of the three tax years: 2022, 2021, and 2020. 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 2037. That means that even if taxable income stayed at the same level through 2037, our tax accrual rate would gradually increase.
Financial Condition
Assets totaled $3.6 billion at December 31, 2022, an increase of $237.6 million, or 7%, for the year. Assets increased in 2022 primarily a result of a $298.5 million increase in investment securities, a $63.2 million increase in gross loans and leases, a $67.6 million increase in other assets, net of a $180.4 million decrease in cash and due from banks.
Deposits were up $64.6 million, or 2%. Total capital decreased by $58.9 million, or 16%. 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 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
$
-
$
21,368
$
48,490
$
105,715
$
105,187
Other construction/land
18,357
25,188
71,443
91,010
108,268
1-4 family - closed-end
417,092
290,236
140,280
200,742
237,530
Equity lines
21,638
26,915
38,472
50,091
56,932
Multi-family residential
91,485
53,385
61,834
54,432
54,893
Commercial real estate - owner occupied
323,895
334,581
343,607
344,412
302,052
Commercial real estate - non-owner occupied
891,197
880,279
1,059,685
412,454
438,349
Farmland
113,594
106,765
129,968
144,063
151,513
Total real estate
1,877,258
1,738,717
1,893,779
1,402,919
1,454,724
Agricultural
28,193
34,098
45,001
48,231
49,162
Commercial and industrial
77,695
109,213
207,784
117,230
129,712
Mortgage warehouse lines
65,439
101,184
307,679
189,103
91,813
Consumer loans
4,232
4,649
5,721
7,978
9,119
Total loans and leases
2,052,817
1,987,861
2,459,964
1,765,461
1,734,530
Allowance for credit losses on loans
(23,060)
(14,256)
(17,738)
(9,923)
(9,750)
Total loans and leases, net
$
2,029,757
$
1,973,605
$
2,442,226
$
1,755,538
$
1,724,780
Percentage of Total Loans and Leases
Real estate:
1-4 family residential construction
0.00%
1.07%
1.97%
5.99%
6.06%
Other construction/land
0.89%
1.27%
2.90%
5.16%
6.24%
1-4 family - closed-end
20.32%
14.60%
5.70%
11.37%
13.69%
Equity lines
1.05%
1.35%
1.56%
2.84%
3.28%
Multi-family residential
4.46%
2.69%
2.51%
3.08%
3.16%
Commercial real estate - owner occupied
15.78%
16.83%
13.97%
19.51%
17.41%
Commercial real estate - non-owner occupied
43.42%
44.28%
43.08%
23.36%
25.28%
Farmland
5.53%
5.37%
5.28%
8.16%
8.74%
Total real estate
91.45%
87.47%
76.98%
79.45%
83.88%
Agricultural
1.37%
1.72%
1.83%
2.73%
2.83%
Commercial and industrial
3.78%
5.48%
8.45%
6.64%
7.48%
Mortgage warehouse lines
3.19%
5.09%
12.51%
10.71%
5.29%
Consumer loans
0.21%
0.23%
0.23%
0.45%
0.53%
100.01%
100.00%
100.00%
100.00%
100.00%
The Company’s loan and lease balances increased in 2022, mostly from the purchase of high quality jumbo mortgage pools early in the year. The decline in 2021 was due to management actions to reduce non-owner occupied commercial real estate concentrations after a period of strong growth in 2020, a decline in utilization of mortgage warehouse lines, and SBA PPP loan forgiveness. Conversely, the Company experienced net growth in each of the three years from 2018 through 2020, 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 over these three years was due in part to acquisitions, as well as whole loan purchases and participations, and participation in the SBA PPP loan program in 2020.
For 2022, the Company had $173.1 million in loan purchases which were designed as a bridge to organic loan growth with the recent hiring of new ag loan production teams. These new ag loan production teams were hired to develop relationships within our footprint for both loans and deposits. These new loans should provide additional diversification of the loan portfolio and provide floating rate loan products which complement the fixed rate real estate loans. As demonstrated by the expansion of the lending teams both in 2022 and 2021, management remains focused on organic loan growth which totaled $292.2 million during 2022. No assurance can be provided with regard to future net growth in aggregate loan balances given occasional surges in prepayments, fluctuations in mortgage warehouse lending; and maintaining concentrations in certain sectors within our risk management parameters.
The overall decline in real estate secured loans during 2021 was partially offset by an increase of $149.6 million in 1-4 family residential real estate loans due to the $208.0 million purchase of jumbo mortgage loans during the second half of 2021.
For 2020, gross loans were up by $700.5 million, or 40%, due largely to $649.9 million of organic growth in commercial real estate non-owner occupied 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 (Roseville, California) and an expansion of the loan team in Southern California. This growth was complimented by an increase of $118.6 million, or 63% in mortgage warehouse lines and an increase of $93.5 million, or 82% in commercial and industrial loans 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.
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 credit losses loans and leases; or (2) total CRE loans as defined in the regulatory guidelines represent 300% or more of Tier 1 risk-based capital plus allowance for credit losses on loans and leases, and the institution’s CRE loan portfolio has increased by 50% or more during the prior 36 month period. This ratio was 249% at December 31, 2021 and declined to 246% at December 31, 2022. At December 31, 2022, the Bank’s total construction, land development and other land loans represented 5% of Tier 1 risk-based capital plus allowance for credit losses on loans and leases. The Bank believes as indicated by the guidelines that it does not have a concentration in CRE loans at December 31, 2022. 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, 2022, including non-accruing loans, grouped by remaining scheduled principal payments:
Loans and Lease Maturity
(dollars in thousands)
As of December 31, 2022
Due in One Year or Less
Due after One Year through Five Years
Due after Five Years through Fifteen Years
Due after Fifteen Years
Total
Floating rate: due after one year
Fixed rate: due after one year
Real estate
$
23,405
$
114,841
$
331,561
$
1,408,855
$
1,878,662
$
680,279
$
1,174,978
Agricultural
18,366
7,151
2,418
27,936
5,019
4,551
Commercial and industrial
23,759
29,642
22,767
76,778
23,098
29,921
Mortgage warehouse lines
65,439
-
-
-
65,439
-
-
Consumer loans
1,026
1,386
1,429
4,125
2,621
Total
$
131,995
$
153,020
$
357,030
$
1,410,895
$
2,052,940
$
708,874
$
1,212,071
Generally, the Company’s contractual life of loans matches the loan’s amortization period, which is generally 25 years. 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, excluding mortgage warehouse and overdraft lines, were $219.7 million at December 31, 2022, compared to $219.6 million at December 31, 2021. Total line utilization, excluding mortgage warehouse and overdraft lines, was 59% at December 31, 2022 and 61% at December 31, 2021 and was 32% at December 31, 2022 and 48% at December 31, 2021, including mortgage warehouse lines. Mortgage warehouse utilization declined to 10% at December 31, 2022, as compared to 27% at December 31, 2021. Total mortgage warehouse availability increased to $594.6 million at December 31, 2022 as compared to $276.8 million at December 31, 2021 due to adding new customers. It is not likely that all of those commitments will ultimately be drawn down. Unused commitments represented approximately 40% of gross loans outstanding at December 31, 2022 and 25% at December 31, 2021. The Company also had undrawn letters of credit issued to customers totaling $6.0 million and $6.7 million at December 31, 2022 and 2021, respectively. Off-balance sheet obligations pose potential credit risk to the Company, and a $0.8 million reserve for unfunded commitments is reflected as a liability in our consolidated balance sheet at December 31, 2022, up $0.6 million 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 holds two letters of credit with the Federal Home Loan Bank of San Francisco totaling $127.9 million 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 14 to the consolidated financial statements in Item 8 herein.
Contractual Obligations
At the end of 2022, 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
2-3 Years
4-5 Years
5 Years
Subordinated debentures
$
35,481
$
-
$
-
$
-
$
35,481
Long term debt
49,214
-
-
-
49,214
Operating leases
8,369
2,061
3,019
1,797
1,492
Other long-term obligations
9,688
1,814
7,304
Total
$
102,752
$
2,587
$
4,833
$
1,841
$
93,491
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
1,023
1,193
Equity lines
2,403
Commercial real estate - owner occupied
-
1,234
1,678
1,440
Commercial real estate - non-owner occupied
-
-
2,105
Farmland
15,812
-
1,642
TOTAL REAL ESTATE
16,500
3,149
6,298
5,055
3,585
Agricultural
2,855
-
-
Commercial and industrial
1,026
1,425
Consumer loans
TOTAL NONPERFORMING LOANS (1) (2)
$
19,579
$
4,522
$
7,598
$
5,737
$
5,156
Foreclosed assets
-
1,082
Total nonperforming assets
$
19,579
$
4,615
$
8,569
$
6,537
$
6,238
Performing TDRs (1)
$
4,522
$
4,910
$
11,382
$
8,415
$
10,920
Loans deferred under CARES Act (2)
$
-
$
10,411
$
29,500
$
-
$
-
Nonperforming loans as a % of total gross loans and leases
0.95%
0.23%
0.31%
0.32%
0.30%
Nonperforming assets as a % of total gross loans and leases and foreclosed assets
0.95%
0.23%
0.35%
0.37%
0.36%
(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 $19.6 million, or 1.0% of gross loans and leases plus foreclosed assets at the end of 2022, up from $4.6 million, or 0.2% of gross loans and leases plus foreclosed assets at the end of 2021. NPAs decreased $3.1 million or 50% in 2021.
Nonperforming loans secured by real estate comprised $16.5 million of total nonperforming loans at December 31, 2022, an increase of $13.4 million, since December 31, 2021. There was also an increase of $2.5 million in agricultural production loans but a decrease of $0.8 million in commercial and industrial loans. Consumer nonperforming loans were nominal at December 31, 2022. Nonperforming loan balances at December 31, 2022 include $0.6 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 $4.5 million in loans classified as performing TDRs for which we were still accruing interest at December 31, 2022, an decrease of $0.4 million, or 8%, relative to December 31, 2021. Notes 2 and 4 to the consolidated financial statements provide a more comprehensive disclosure of TDR balances and activity within recent periods.
The Company had no foreclosed assets at December 31, 2022. At the end of 2021 foreclosed assets totaled $0.1 million, which was comprised of one property that was subsequently sold in 2022. 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 Credit Losses/Allowance for Loan and Lease Losses
The allowance for credit losses on loans and leases, a contra-asset, is established through a provision for credit losses on loans and leases. The allowance for credit losses on loans and leases is at a level that, in Management’s judgment, is adequate to absorb probable credit losses on loans related to individually identified loans as well as probable credit losses 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 credit losses on loans and leases. The Company’s allowance for credit losses on loans and leases was $23.1 million, or 1.12% of gross loans at December 31, 2022, relative to $14.3 million, or 0.7% of gross loans at December 31, 2021. The increase in the allowance resulted from an increase in non-accrual loan balances, primarily as a result of a downgrade in the first quarter of 2022 of one loan relationship in the dairy industry consisting of four separate loans. At December 31, 2022, nonaccrual loans totaled $19.6 million compared to $4.5 million at December 31, 2021. All of the Company’s impaired assets are periodically reviewed and are either well-reserved based on current loss expectations or are carried at the fair value of the underlying collateral, net of expected disposition costs. The ratio of the allowance to nonperforming loans was 118% at December 31, 2022, relative to 315% at December 31, 2021, and 233% at December 31, 2020. As described above, a separate allowance of $0.8 million for potential losses inherent in unused commitments is included in other liabilities at December 31, 2022.
The Company recorded a provision for loan and lease losses of $10.9 million in 2022 as compared to a loan and lease loss benefit of $3.7 million in 2021, and a loan and lease loss provision of $8.6 million in 2020. Our allowance for probable losses on individually identified loans decreased $0.4 million, or 46%, during 2022, and $0.2 million, or 20%, during 2021. The allowance for probable losses inherent in the remaining portfolio increased by $9.2 million, or 68%. The primary reason for this increase is the $9.4 million CECL transition amount from the adoption of FASB Accounting Standards Update 2016-03 and related amendments, Financial Instruments - Credit Losses (Topic 326).
The following table sets forth the Company’s net charge-offs as a percentage to the average loan balances in each loan category, as well as other credit related ratios at or for the periods indicated:
Credit Ratios
(dollars in thousands, unaudited)
As of and for the years ended December 31,
Net Charge-offs (Recoveries)
Average Loan Balance
Percentage
Net Charge-offs (Recoveries)
Average Loan Balance
Percentage
Net Charge-offs (Recoveries)
Average Loan Balance
Percentage
Real estate:
1-4 family residential construction
$
-
$
5,927
-
$
-
$
36,245
-
$
-
$
85,934
-
Other construction/land
(260)
21,806
(1.19)%
(328)
35,906
(0.91)%
(40)
86,363
(0.05)%
1-4 family - closed-end
(87)
399,435
(0.02)%
160,522
0.04%
(13)
175,776
(0.01)%
Equity lines
(12)
23,189
(0.05)%
(13)
33,484
(0.04)%
(34)
44,306
(0.08)%
Multi-family residential
-
65,785
-
-
57,318
-
-
58,666
-
Commercial real estate - owner occupied
-
325,354
-
-
350,197
-
-
322,460
-
Commercial real estate - non-owner occupied
1,911
884,522
0.22%
(82)
1,021,759
(0.01)%
-
701,422
-
Farmland
4,418
105,856
4.17%
-
122,931
-
-
135,759
-
Total real estate
5,970
1,831,874
0.33%
(356)
1,818,362
(0.02)%
(87)
1,610,686
(0.01)%
Agricultural
4,788
31,565
15.17%
42,866
0.12%
-
47,299
-
Commercial and industrial
83,937
0.19%
(64)
155,365
(0.04)%
182,802
0.17%
Mortgage warehouse lines
-
54,606
-
-
147,996
-
-
221,319
-
Consumer loans
4,301
14.69%
4,993
4.05%
6,584
7.82%
Total
$
11,549
$
2,006,283
0.58%
$
(168)
$
2,169,582
(0.01)%
$
$
2,068,690
0.04%
Allowance for credit losses on loans and leases to gross loans and leases at end of period
1.12%
0.72%
0.72%
Nonaccrual loans to gross loans and leases at end of period
0.95%
0.23%
0.31%
Allowance for credit losses on loans and leases to nonaccrual loans
117.78%
315.26%
233.46%
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 Credit Losses on Loans and Leases
(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
$
21,274
91.45%
$
11,586
87.46%
$
11,766
87.46%
$
5,635
76.97%
$
5,831
79.55%
Agricultural
1.37%
1.71%
1.71%
1.82%
2.73%
Commercial and industrial (2)
1,274
6.97%
1,559
10.60%
4,721
10.60%
2,685
20.98%
2,394
17.28%
Consumer loans
0.21%
0.23%
0.23%
1,278
0.23%
1,239
0.44%
Unallocated
-
-
-
-
-
Total
$
23,060
100.00%
$
14,256
100.00%
$
17,738
100.00%
$
9,923
100.00%
$
9,750
100.00%
(1) Represents percentage of loans in category to total loans
(2) Includes mortgage warehouse lines
The Company’s allowance for credit losses on loans and leases at December 31, 2022 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, under FASB Accounting Standards Update 2016-03 and related amendments, Financial Instruments - Credit Losses (Topic 326) to January 1, 2022. 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. At the time the decision was made, there was a significant change in 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 has taken 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. Upon adoption of CECL, the Company was required to make an adjustment to equity, net of taxes, equal to the difference between the allowance for credit losses calculated under the CECL method and the allowance for loan and lease losses as calculated under the incurred loss method as of December 31, 2021. Therefore, on January 1, 2022, the Company recorded a $10.4 million increase in the allowance for credit losses, which includes a $0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes.
Investments
The Company’s investments may 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 $1.3 billion, or 35% of total assets at December 31, 2022, as compared to $1.2 billion, or 35% of total assets at December 31, 2021.
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 $3.2 million at December 31, 2022, as compared to $193.3 million at December 31, 2021. The average rate on the interest-bearing balances was 0.57% for 2022. In an effort to change the mix of lower rate earning assets, the Company worked diligently to identify higher yielding earning assets, within the Company’s risk profile for purchase. With respect to the investment portfolio, the Company purchased $181.5 million of AAA and AA-rated Collateralized Loan Obligations (“CLOs”) bringing the total CLOs to $498.4 million at December 31, 2022. These structured investments complement our fixed-rate earning assets, including fixed rate loans, as CLOs have rates that adjust quarterly.
The Company’s investment securities portfolio had a book balance of $1.3 billion at December 31, 2022, compared to $973.3 million at December 31, 2021, reflecting a net increase of $298.5 million, or 31%. The Company carries “available for sale” investments at their fair market values and “held to maturity” investments at amortized cost. We currently have the intent and ability to hold our investment securities to maturity, but the securities are all marketable. The expected effective duration was 1.83 years for available-for-sale investments and 6.4 years for held-to-maturity investments at December 31, 2022, as compared to 3.2 years for available-for-sale investments at December 31, 2021. The expected effective duration was 1.83 years for available-for-sale investments and 6.4 years for held-to-maturity investments at December 31, 2022, as compared to 3.2 years for available-for-sale investments at December 31, 2021.In the second and fourth quarters of 2022 the Company transferred $162.1 million and $198.3 million, respectively of “available for sale” investments to “held to maturity”. Those securities were transferred at fair market value on the date of the transfer. The transfer was initiated to reduce the effect of potential future rate increases on accumulated other comprehensive income due to changes in estimated fair value.. See Note 3, Investment Securities for additional information.
The following Investment Portfolio table reflects the carrying amount for each primary category of investment securities for the past three years:
Investment Portfolio-Available for Sale
(dollars in thousands)
As of December 31,
Carrying Amount
Percent
Carrying Amount
Percent
Carrying Amount
Percent
Available for sale
U.S. government agencies
$
50,599
3.98%
$
1,574
0.16%
$
1,800
0.33%
Mortgage-backed securities
122,532
9.63%
306,727
31.52%
314,435
57.80%
State and political subdivisions
205,980
16.20%
304,268
31.25%
227,739
41.87%
Corporate bonds
57,435
4.52%
28,529
2.93%
-
-
Collateralized loan obligations
498,377
39.19%
332,216
34.13%
-
-
Total available for sale
934,923
73.51%
973,314
100.00%
543,974
100.00%
Held to maturity
U.S. government agencies
6,047
0.48%
-
-
-
-
Mortgage-backed securities
157,473
12.38%
-
-
-
-
State and political subdivisions
173,361
13.63%
-
-
-
-
Total held to maturity
336,881
26.49%
-
-
-
-
Total securities
$
1,271,804
100.00%
$
973,314
100.00%
$
543,974
100.00%
Based on an analysis of its available for sale securities with unrealized losses as of December 31, 2022, The Company determined their decline in value was unrelated to credit loss and was primarily the result of interest rate changes and market spreads subsequent to acquisition. The fair value of debt securities is expected to recover as payments are received and the debt securities approach maturity. In addition, the Company determined there was a $0.1 million credit loss expected on the held-to-maturity debt securities portfolio which was recorded as an allowance for credit losses on held-to-maturity securities.
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 $183.5 million at December 31, 2022 and $167.2 million at December 31, 2021, leaving $1.1 billion in unpledged debt securities at December 31, 2022 and $806.1 million at December 31, 2021. Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $43.1 million at December 31, 2022 and $47.0 million at December 31, 2021.
The table below groups the Company’s investment securities by their remaining time to maturity as of December 31, 2022, and provides weighted average yields for each segment.
Maturity and Yield of Held-to-Maturity Investment Portfolio
(dollars in thousands)
December 31, 2022
Within
One Year
After One
But Within
Five Years
After Five Years
But Within
Ten Years
After
Ten Years
Mortgage-Backed Securities
Total
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Held to maturity
U.S. government agencies
$
-
-
$
2.81%
$
5,647
2.05%
$
-
-
$
-
-
$
6,047
2.10%
Mortgage-backed securities
-
-
-
-
-
-
-
-
157,473
2.07%
157,473
2.07%
State and political subdivisions
3.58%
1,659
4.00%
13,401
3.15%
157,692
3.64%
-
-
173,424
3.61%
Total securities
$
$
2,059
$
19,048
$
157,692
$
157,473
$
336,944
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 $72.8 million, or 2% of total assets at December 31, 2022, and $63.1 million, or 2% of total assets at December 31, 2021. The average balance of non-earning cash and due from banks, which can be used to determine trends, was $79.3 million for 2022, $75.7 million for 2021 and $72.0 million for 2020.
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
$
4,823
$
-
$
4,823
$
4,823
$
-
$
4,823
$
5,751
$
-
$
5,751
Buildings
21,170
11,864
9,306
21,006
11,284
9,722
21,580
11,005
10,575
Furniture and equipment
18,948
14,711
4,237
19,242
14,925
4,317
20,705
15,474
5,231
Leasehold improvements
14,732
10,620
4,112
14,682
9,973
4,709
15,226
9,278
5,948
Total
$
59,673
$
37,195
$
22,478
$
59,753
$
36,182
$
23,571
$
63,262
$
35,757
$
27,505
The net book value of the Company’s premises and equipment was 1% of total assets at both December 31, 2022, and December 31, 2021. Depreciation and amortization included in occupancy and equipment expense totaled $2.4 million in 2022 and $3.1 million in 2021.
Other Assets
Goodwill totaled $27.4 million at December 31, 2022, unchanged for the year and other intangible assets were $2.3 million, a decrease of $1.0 million, or 30%, 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, 2022.
The net cash surrender value of bank-owned life insurance policies decreased to $52.2 million at December 31, 2022 from $54.2 million at December 31, 2021, due to the decline of BOLI income from net cash surrender values. Refer to the “Noninterest Revenue and Operating Expense” section above for a more detailed discussion of BOLI and the income/expense it generates.
The remainder of other assets consists primarily of right-of-use assets tied to operating leases, accrued interest receivable, deferred taxes, investments in bank stocks, other real estate owned, prepaid assets, investments in low-income housing credits, investments in SBA loan funds, and other miscellaneous assets. The total operating lease right-of-use asset recorded on the books is $11.4 million less accumulated amortization of $4.5 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
$
150,875
$
129,783
$
109,938
$
91,212
$
101,243
Noninterest bearing demand deposits
1,088,199
1,084,544
943,664
690,950
662,527
NOW
490,707
614,770
558,407
458,600
434,483
Savings
456,980
450,785
368,420
294,317
283,953
Money market
139,795
147,793
131,232
118,933
123,807
Customer time deposits
399,608
293,897
412,945
464,362
460,327
Brokered deposits
120,000
60,000
100,000
50,000
50,000
Total deposits
$
2,846,164
$
2,781,572
$
2,624,606
$
2,168,374
$
2,116,340
Percentage of Total Deposits
Interest bearing demand deposits
5.30%
4.67%
4.19%
4.21%
4.78%
Noninterest bearing demand deposits
38.23%
38.99%
35.95%
31.86%
31.31%
NOW
17.24%
22.10%
21.28%
21.15%
20.53%
Savings
16.06%
16.21%
14.04%
13.57%
13.42%
Money market
4.91%
5.31%
5.00%
5.48%
5.85%
Customer time deposits
14.04%
10.57%
15.73%
21.42%
21.75%
Brokered deposits
4.22%
2.16%
3.81%
2.31%
2.36%
Total
100.00%
100.00%
100.00%
100.00%
100.00%
Deposit balances reflect net growth of $64.6 million, or 2%, in 2022 and $157.0 million, or 6%, during 2021. The increase in 2022 was primarily from brokered deposits while the increase in 2021 was primarily due to organic growth as both consumer and commercial existing customers increased their deposit account balances.
Noninterest bearing demand deposit balances were up $3.7 million; NOW and interest-bearing demand accounts decreased by $103.0 million, or 14% in 2022. Overall non-maturity deposits decreased by $0.1 million, or 4%, to $2.3 billion at December 31, 2022.
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 following table presents the estimated deposits exceeding the FDIC insurance limit:
Uninsured Deposits
(dollars in thousands)
Year Ended December 31,
Uninsured deposits
$
919,467
$
929,583
The estimated aggregate amount of time deposits in excess of the FDIC insurance limit is $97.8 million. The following table presents the maturity distribution of the estimated uninsured time deposits:
Uninsured Time Deposit Maturity Distribution
(dollars in thousands)
As of December 31, 2022
Three
months or
less
Over three months through six months
Over six months through twelve months
Over
twelve
months
Total
Uninsured time deposits
$
88,851
$
3,491
$
4,820
$
$
97,753
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 $221.5 million, or 116%, in 2022, due primarily to increases in overnight fed funds purchased, customer repurchase agreements, and FHLB advances. Non-deposit interest-bearing liabilities decreased $25.8 million, or 12%, in 2021, due primarily to decreases in overnight fed funds purchased, and FHLB advances. The decreases were partially offset by increases in customer repurchase agreements and long-term debt. The Company had $125.0 million in overnight fed funds purchased and $94.0 million in overnight FHLB advances at December 31, 2022 as compared to, no overnight fed funds purchased, overnight FHLB advances or short-term borrowings from the FHLB at December 31, 2021. Repurchase agreements totaled $109.2 million at year-end 2022 relative to a balance of $106.9 million at year-end 2021. 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 $35.5 million at December 31, 2022 and $35.3 million December 31, 2021, 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. Long term debt was $49.2 million at December 31, 2022 as compared to $49.1 million for the year ended December 31, 2021. The small increase resulted from the amortization of debt issuance costs.
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
$
109,169
$
106,937
$
39,138
Average amount outstanding
110,387
70,443
34,614
Maximum amount outstanding at any month end
118,014
106,937
41,449
Average interest rate for the year
0.29%
0.30%
0.40%
Fed funds purchased
Balance at December 31
$
125,000
$
-
$
100,000
Average amount outstanding
16,980
1,561
1,918
Maximum amount outstanding at any month end
125,000
-
100,000
Average interest rate for the year
4.08%
0.06%
0.21%
FHLB advances
Balance at December 31
$
94,000
$
-
$
42,900
Average amount outstanding
30,728
3,625
54,244
Maximum amount outstanding at any month end
103,100
5,000
195,100
Average interest rate for the year
3.44%
0.06%
0.19%
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 increased by $9.8 million, or 28%, during 2022. The primary reason for this increase was a commitment in low income housing tax credit funds and an increase in accrued interest payable due to the increase in interest rates during 2022.
Capital Resources
The Company had total shareholders’ equity of $303.6 million at December 31, 2022 as compared to $362.5 million at December 31, 2021. The decrease of $58.9 million, or 16%, is due to $33.7 million in net income and approximately $1.3 million in additional capital related to equity compensation, net of a $67.7 million decrease in our accumulated other comprehensive income, $13.9 million in dividends paid and $7.3 million from the cumulative effect of a change in accounting principal from the implementation of CECL, topic 326. One of our strategies for managing the potential for future unrealized losses in our securities portfolio to limit impacts to accumulated other comprehensive income and tangible capital was the movement of certain securities from available for sale to the held to maturity category, more fully discussed above under “Investments” and further below.
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) (1)
Tier 1 (Core) Capital to average total assets
Sierra Bancorp and subsidiary
10.30%
9.00%
Bank of the Sierra
10.99%
9.00%
Tier 1 (Core) Capital to average total assets
Sierra Bancorp and subsidiary
10.43%
8.50%
Bank of the Sierra
11.31%
8.50%
(1) Under interim transition final guidance, the community bank leverage ratio minimum requirement was reduced to 8.5% for calendar year 2021.
At the end of 2022, as our Community Bank Leverage Ratio exceeded 9.0%, 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. 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 16 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.
In addition to monitoring regulatory capital ratios, the Company monitors its tangible common equity ratio (TCE Ratio). The TCE Ratio declined from 9.93% at December 31, 2021 to 7.65% at December 31, 2022. This decline was primarily a result in a decrease in Accumulated Other Comprehensive Income due to the impact of higher interest rates on the value of investments available for sale. As the change in estimated fair value of securities available for sale are included in Other Comprehensive Income, if values decline due to changes in interest rates, liquidity, or spreads, equity is also reduced. Similarly, if values increase for the same reasons, equity is also increased. Although the Company elected to exclude changes in Accumulated Other Comprehensive Income for regulatory capital purposes, such changes do impact the stated book equity and tangible common equity. One of the reasons the Company purchases floating rate investments is to minimize the impact of changes in rates on tangible equity. Similarly, as described above, the Company moved $360.4
million in securities from available for sale to held to maturity. At December 31, 2022, approximately 66% of the Company’s investment portfolio is either floating rate or held to maturity.
The Company also looks at the double leverage ratio, which is a measure of the reliance on the holding company’s borrowings that are injected into the subsidiary Bank as capital. As holding company borrowings are primarily serviced by the receipt of dividends from the subsidiary Bank, this ratio is monitored as well as cash at the holding company for purposes of servicing the cash needs at the holding company level. This ratio is calculated by dividing subsidiary Bank capital by the holding company/consolidated capital. The Company generally maintains a double leverage ratio of under 125%. The double leverage ratio was 119.9% at December 31, 2022 as compared to 118.1% at December 31, 2021.
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 $955.9 million at December 31, 2022. The Company was also eligible to borrow approximately $42.3 million at the Federal Reserve Discount Window based on pledged assets at December 31, 2022. 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, 2022, unpledged debt securities plus pledged securities in excess of current pledging requirements comprised $1.1 billion of the Company’s investment balances, as compared to $853.2 million at December 31, 2021. 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 $127.9 million at December 31, 2022. 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.
At December 31, 2022 and December 31, 2021, the Company had the following sources of primary and secondary liquidity (dollars in thousands):
Primary and Secondary Liquidity Sources
December 31, 2022
December 31, 2021
Cash and due from banks
$
77,131
$
257,528
Unpledged investment securities
1,097,164
806,132
Excess pledged securities
43,096
47,024
FHLB borrowing availability
718,842
787,519
Unsecured lines of credit
237,000
305,000
Funds available through fed discount window
42,278
50,608
Totals
$
2,215,511
$
2,253,811
The Company’s primary liquidity ratio and net loans to deposits ratio was 40% and 72%, respectively, at December 31, 2022, as compared to internal policy guidelines of “greater than 15%” and “less than 95%.” Other liquidity ratios reviewed
periodically by Management and the Board include the Community Bank leverage ratio, net change in overnight position and wholesale funding to total assets (including ratios and sub-limits for the various components comprising wholesale funding). All ratios were within policy guidelines at December 31, 2022.
The holding company’s primary uses of funds include operating expenses incurred in the normal course of business, debt servicing, 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. At December 31, 2022, the holding company maintained a cash balance of $26.1 million. 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 eight 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, 300, and 400 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. 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 (dollars in thousands):
December 31, 2022
December 31, 2021
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
(4.02%)
$
(4,829)
16.59%
$
16,974
+300
(2.74%)
$
(3,291)
13.69%
$
14,009
+200
(1.43%)
$
(1,717)
9.98%
$
10,214
+100
(0.16%)
$
(195)
5.64%
$
5,772
Base
(2.76%)
$
(3,312)
(10.29%)
$
(10,529)
(6.49%)
$
(7,796)
NR
NR
(9.96%)
$
(11,977)
NR
NR
(12.83%)
$
(15,422)
NR
NR
The simulation for the period ending December 31, 2022, indicates that the Company is slightly liability sensitive, with net interest income decreasing in rising and declining rate scenarios, with a continued drop in interest rates having the most substantial negative impact. The change in the magnitude of the Company’s asset sensitivity based on its interest rate risk model at December 31, 2022, as compared to December 31, 2021, is due mostly to the level of overnight borrowings both in Fed Funds purchased and overnight FHLB borrowings and in customer time deposits tied to the prime interest rate. In addition, based on the magnitude of rate changes, interest rates on new loans did not increase at the rates modeled in 2021 and therefore, the beta on loan yields was lowered in modeling interest rate risk in 2022. Any change in interest rate in the model would expect to decrease net interest income. At December 31, 2022, the Company had $219.0 million in overnight borrowings as compared to none at December 31, 2021. At December 31, 2021, the Company had $193.2 million in overnight cash held with the Federal Reserve bank as compared to $3.2 million at December 31, 2022. The Company has approximately $594.6 million of unfunded mortgage warehouse lines at December 31, 2022. If rates decrease, it would be expected that a significant portion of the unfunded mortgage warehouse lines would become funded and thereby, mitigate the impact of lower rates on the balance sheet through higher utilization.
For the period ending December 31, 2021, the simulation indicated that the Company is asset sensitive, with sizeable increases in net interest income in rising rate scenarios, however a continued drop in interest rates could have a substantial negative impact. The change in the magnitude of the Company’s asset sensitivity based on its interest rate risk model at December 31, 2021, as compared to December 31, 2020, is due mostly to the level of overnight cash held as an interest bearing deposit at the Federal Reserve Bank. At December 31, 2021, the Company had $193.2 million in overnight cash with the Federal Reserve Bank compared to $2.4 million at December 31, 2020. As this cash is held overnight, any change in interest rate in the model would increase the yield on such overnight cash immediately, therefore, increasing the Company’s asset sensitivity.
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 $2.6 million lower, or 2% 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, which could reduce our net interest income by 14% in the event of a 30% decay/shift in such balances.
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, 2022, and 2021, under different interest rate scenarios relative to a base case of current interest rates (dollars in thousands):
December 31, 2022
December 31, 2021
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
6.90%
$
41,453
36.40%
$
210,185
+300
6.01%
$
36,093
32.66%
$
188,603
+200
4.55%
$
27,340
26.21%
$
151,341
+100
3.11%
$
18,680
15.54%
$
89,711
Base
(13.32%)
$
(80,005)
(22.25%)
$
(128,469)
(32.90%)
$
(197,558)
NR
NR
(30.32%)
$
(182,083)
NR
NR
(20.11%)
$
(120,782)
NR
NR
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 sensitivity is decreasing in the current interest rate environment and fell considerably over the last twelve months ending December 31, 2022 given the higher rate environment at December 31, 2022 as compared to December 31, 2021. Sensitively decreased from 16% to 3% in the Up 100 shock and decreased from 36% to 7% in the Up 400 shock. All up-shock scenarios fall within Policy guidelines. All the down shock scenarios have exceeded the Policy guidelines and will continue to exceed them until deposit rates move back up to more normalized higher levels.
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.

---

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”.

---

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements and independent auditors’ report listed below are included herein:
Page
I.
Report of Independent Registered Public Accounting Firm (Eide Bailly LLP San Ramon, California PCAOB ID 286)
II.
Consolidated Balance Sheets - December 31, 2022 and 2021
III.
Consolidated Statements of Income - Years Ended December 31, 2022, 2021, and 2020
IV.
Consolidated Statements of Comprehensive (Loss) Income - Years Ended December 31, 2022, 2021, and 2020
V.
Consolidated Statements of Changes in Shareholders’ Equity - Years Ended December 31, 2022, 2021, and 2020
VI.
Consolidated Statements of Cash Flows - Years Ended December 31, 2022, 2021, and 2020
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, 2022 and 2021, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2022, 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, 2022, 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, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2022, 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, 2022, based on criteria established in Internal Control-Integrated Framework: (2013) issued by COSO.
As discussed in notes 2 and 4, effective January 1, 2022, the company adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The Company recorded an increase to the allowance for credit losses - loans and leases of $9.5 million, an increase to allowance for credit losses on off balance sheet credit exposures of $0.9 million and a reduction to retained earnings of $7.3 million, net of deferred taxes of $3.1 million.
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
Critical audit matters (CAMs) arising from the audit and included in our auditor’s report are intended to inform investors and other financial statement users about matters that required especially challenging, subjective, or complex auditor judgment, and the relevant response or approach that we had to those matters. These matters relate to accounts or disclosures that are material to the financial statements, and include the following matters arising from the current period audit of the consolidated financial statements:
Allowance for Credit Losses - Loans and Leases
As discussed in Note 4 to the Company’s consolidated financial statements, the Company has a gross loan and lease portfolio of $2.1 billion and related allowance for credit losses - loans and leases (ACL) of $23.1 million as of December 31, 2022. The ACL represents management’s estimate of expected credit losses over the contractual life of the portfolio. The determination of the ACL is a material and complex estimate requiring significant management judgment in the evaluation of past events, current economic conditions and reasonable supportable forecasts, as well as qualitative adjustments applied on a portfolio segment basis. The qualitative adjustments are used to bring the ACL to the level management believes appropriate based on factors that are otherwise unaccounted for in the quantitative process.
Auditing these complex judgments and assumptions involves especially challenging auditor judgment due to the nature and extent of specialized skill or knowledge needed.
Our considerations and procedures performed to address this critical audit matter included:
o Obtaining an understanding of the Company’s process for establishing the ACL, including the models selected by management to estimate quantitative components of the ACL and qualitative adjustments made to the ACL. This includes the process utilized by management to challenge the model results and determine the best estimate of the ACL as of the balance sheet date.
o Evaluating the design and testing the operating effectiveness of controls relating to the development and approval of the ACL methodology, management’s identification, determination and controls related to the significant assumptions used in the models, controls around the reliability and accuracy of the data used in the models, analysis of the ACL results and management’s review and approval of the ACL.
o Evaluating the appropriateness of the model methodology used to incorporate a reasonable and supportable forecast period and reversion to historical loss rates by inspecting the model documentation and by comparing it to relevant industry practices.
o Determining whether the loan portfolio is segmented by similar risk characteristics by comparing to the Company’s business environment and relevant industry practices.
o Testing the completeness and accuracy of internal loan level data used as the basis for the calculation.
o Evaluating the reasonableness of forecasted economic scenarios provided by a third party.
o Evaluating the identification and measurement of the qualitative adjustments, including the basis for concluding an adjustment was warranted and compared the adjustments utilized by management to both internal portfolio metrics and external macroeconomic data to support the adjustments and evaluated the trends in such adjustments. We searched for and evaluated information that corroborates or contradicts management’s reasonable and supportable forecast as well as identification and measurement of qualitative factors.
/s/ Eide Bailly LLP
We have served as the Company’s auditor since 2019. Vavrinek, Trine, Day & Co., LLP, who joined Eide Bailly LLP in 2019, had served as the Company’s auditor since 2004.
San Ramon, California
March 9, 2023
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2022 and 2021
(dollars in thousands)
ASSETS
Cash and due from banks
$
72,803
$
63,147
Interest bearing deposits in banks
4,328
194,381
Cash and cash equivalents
77,131
257,528
Investment securities
Available-for-sale, net of zero allowance for credit losses at December 31, 2022 and December 31, 2021
934,923
973,314
Held-to-maturity, (fair value of $328,011 at December 31, 2022 and $0 at December 31, 2021)
336,944
-
Allowance for credit losses on held-to-maturity securities
(63)
-
Net, investment securities held-to-maturity
336,881
-
Loans and leases:
Gross loans and leases
2,052,940
1,989,726
Deferred loan and lease fees, net
(123)
(1,865)
Allowance for credit losses on loans and leases
(23,060)
(14,256)
Net loans and leases
2,029,757
1,973,605
Foreclosed assets
-
Premises and equipment, net
22,478
23,571
Goodwill
27,357
27,357
Other intangible assets, net
2,275
3,275
Company owned life insurance
52,169
54,242
Other assets
125,619
58,029
$
3,608,590
$
3,371,014
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing
$
1,088,199
$
1,084,544
Interest bearing
1,757,965
1,697,028
Total deposits
2,846,164
2,781,572
Repurchase agreements
109,169
106,937
Short-term borrowings
219,000
-
Long-term debt
49,214
49,141
Subordinated debentures, net
35,481
35,302
Allowance for credit losses on unfunded loan commitments
Other liabilities
45,140
35,365
Total liabilities
3,305,008
3,008,520
Commitments and contingent liabilities (Note 14)
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; 15,170,372 and 15,270,010 shares issued and outstanding in 2022 and 2021, respectively
112,928
113,007
Additional paid-in capital
4,148
3,910
Retained earnings
243,082
234,410
Accumulated other comprehensive (loss) gain, net of taxes of $23,746 in 2022 and $(4,687) in 2021
(56,576)
11,167
Total shareholders' equity
303,582
362,494
$
3,608,590
$
3,371,014
The accompanying notes are an integral part of these consolidated financial statements.
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2022, 2021 and 2020
(dollars in thousands, except per share data)
Interest and dividend income
Loans and leases, including fees
$
86,706
$
99,249
$
96,181
Taxable securities
25,789
7,239
8,199
Tax-exempt securities
8,805
6,218
5,707
Federal funds sold and other
Total interest income
121,819
113,076
110,243
Interest expense
Deposits
6,819
2,390
3,948
Short-term borrowings
2,069
Long-term debt
1,713
-
Subordinated debentures
1,603
1,217
Total interest expense
12,204
4,050
5,408
Net interest income
109,615
109,026
104,835
Provision (benefit) for credit losses on loans and leases
10,898
(3,650)
8,550
Benefit for credit losses on unfunded loan commitments
(294)
-
-
Provision for credit losses on held-to-maturity securities
-
-
Net interest income after provision for loan and lease losses
98,948
112,676
96,285
Noninterest income
Service charges on deposits
12,535
11,846
11,765
Debit card fees
8,533
8,485
7,023
Net gains (losses) on sale of securities available-for-sale
1,487
(Decrease) increase in cash surrender value of life insurance
(996)
2,648
2,412
Other income
9,211
5,089
4,560
Total noninterest income
30,770
28,079
26,150
Noninterest expense
Salaries and employee benefits
47,053
42,431
40,178
Occupancy and equipment
9,718
9,837
9,842
Other
28,032
31,288
25,892
Total noninterest expense
84,803
83,556
75,912
Income before income taxes
44,915
57,199
46,523
Provision for income taxes
11,256
14,187
11,079
Net income
$
33,659
$
43,012
$
35,444
Earnings per share
Basic
$
2.25
$
2.82
$
2.33
Diluted
$
2.24
$
2.80
$
2.32
Weighted average shares outstanding, basic
14,955,756
15,241,957
15,216,749
Weighted average shares outstanding, diluted
15,022,755
15,353,445
15,280,325
The accompanying notes are an integral part of these consolidated financial statements.
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
Years Ended December 31, 2022, 2021 and 2020
(dollars in thousands, except footnotes)
Net income
$
33,659
$
43,012
$
35,444
Other comprehensive (loss) gain, before tax
Unrealized (loss) gain on securities:
Unrealized holding (loss) gain arising during period
(94,689)
(10,265)
18,099
Reclassification adjustment for gains included in net income (1)
(1,487)
(11)
(390)
Other comprehensive (loss) gain, before tax
(96,176)
(10,276)
17,709
Income tax benefit (expense) related to items of other comprehensive income
28,433
3,038
(5,236)
Total other comprehensive (loss) gain , net of tax
(67,743)
(7,238)
12,473
Comprehensive (loss) income
$
(34,084)
$
35,774
$
47,917
(1) Amounts are included in net gains on securities available-for-sale on the Consolidated Statements of Income in noninterest income. Income tax expense associated with the reclassification adjustment for the years ended 2022, 2021 and 2020 was $440,000, $3,000, and $115,000 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, 2022
(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, 2020
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
Net Income
-
-
-
43,012
-
43,012
Other comprehensive loss, net of tax
-
-
-
-
(7,238)
(7,238)
Stock options exercised, net of shares surrendered for cashless exercises
25,452
(141)
-
-
Restricted stock granted
73,912
(680)
-
-
-
Restricted stock surrendered due to employee tax liability
(12,122)
(89)
-
(203)
-
(292)
Restricted stock forfeited / cancelled
(18,217)
-
-
-
-
-
Stock based compensation - stock options
-
-
-
-
Stock based compensation - restricted stock
-
-
-
-
Stock repurchase
(187,438)
(1,390)
-
(3,538)
-
(4,928)
Cash dividends - $.87 per share
-
-
-
(13,232)
-
(13,232)
Balance, December 31, 2021
15,270,010
113,007
3,910
234,410
11,167
362,494
Cumulative change in accounting principle
-
-
-
(7,315)
-
(7,315)
Net Income
-
-
-
33,659
-
33,659
Other comprehensive loss, net of tax
-
-
-
-
(67,743)
(67,743)
Stock options exercised, net of shares surrendered for cashless exercises
29,640
1,360
(1,046)
-
-
Restricted stock granted
70,465
-
-
-
-
-
Restricted stock surrendered due to employee tax liability
(15,309)
(114)
-
(227)
-
(341)
Restricted stock forfeited / cancelled
(1,872)
-
-
-
-
-
Stock based compensation - stock options
-
-
-
-
Stock based compensation - restricted stock
-
-
1,200
-
-
1,200
Stock repurchase
(182,562)
(1,325)
-
(3,526)
-
(4,851)
Cash dividends - $.92 per share
-
-
-
(13,919)
-
(13,919)
Balance, December 31, 2022
15,170,372
$
112,928
$
4,148
$
243,082
$
(56,576)
$
303,582
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, 2022, 2021, and 2020
(dollars in thousands)
Cash flows from operating activities:
Net income
$
33,659
$
43,012
$
35,444
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sales of securities
(1,487)
(11)
(390)
Loss (gain) on disposal of fixed assets
(180)
-
Gain on sale of foreclosed assets
(8)
(153)
(10)
Writedown of foreclosed assets
Stock based compensation expense
1,284
Provision (benefit) for loan and lease losses
10,898
(3,650)
8,550
Provision for credit losses on held-to-maturity securities
-
-
Depreciation and amortization
2,536
3,237
3,025
Net amortization on securities premiums and discounts
3,519
4,914
4,789
Accretion of discounts for loans acquired and net deferred loan fees
(279)
(411)
(663)
Decrease (increase) in cash surrender value of life insurance policies
(2,648)
(2,412)
Amortization of core deposit intangible
1,000
1,032
1,074
(Increase) decrease in interest receivable and other assets
(26,213)
6,435
(488)
Increase (decrease) in other liabilities
9,481
1,602
(8,151)
Deferred income tax (benefit) provision
(2,759)
(2,611)
Decrease (increase) in equity securities
(2,523)
(447)
Net amortization of partnership investment
1,505
Net cash provided by operating activities
33,572
52,656
40,027
Cash flows from investing activities:
Maturities and calls of securities available for sale
11,003
10,390
12,385
Proceeds from sales of securities available for sale
45,903
20,298
Purchases of securities available for sale
(526,498)
(568,174)
(71,816)
Principal paydowns on securities available for sale
72,831
113,117
109,267
Net purchases of FHLB stock
(336)
-
-
Loan originations and payments, net
(76,225)
472,589
(697,305)
Purchases of premises and equipment, net
(1,272)
(371)
(2,916)
Proceeds from sales of fixed assets
-
1,426
-
Proceeds from sales of foreclosed assets
2,445
Purchase of bank owned life insurance
(24)
(39)
(210)
Liquidation of bank-owned life insurance
-
Proceeds from BOLI death benefit
1,078
Amortization of debt issuance costs
-
-
Net increase in partnership investment
(7,562)
(10,400)
-
Net cash (used in) provided by investing activities
(480,996)
20,620
(627,252)
Cash flows from financing activities:
Increase in deposits
64,592
156,966
456,232
Increase (decrease) in borrowed funds
94,000
(42,900)
22,900
Increase in repurchase agreements
2,232
67,799
13,427
Increase (decrease) in fed funds purchased
125,000
(100,000)
100,000
Cash dividends paid
(13,919)
(13,232)
(12,207)
Repurchases of common stock
(5,192)
(5,220)
(2,562)
Stock options exercised
Proceeds from issuance of subordinated debt
-
49,141
-
Net cash provided by financing activities
267,027
112,835
578,565
(Decrease) increase in cash and due from banks
(180,397)
186,111
(8,660)
Cash and cash equivalents, beginning of year
257,528
71,417
80,077
Cash and cash equivalents, end of year
$
77,131
$
257,528
$
71,417
SIERRA BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Years Ended December 31, 2022, 2021 and 2020
(dollars in thousands)
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest
$
10,777
$
3,649
$
6,007
Income taxes
$
13,165
$
13,554
$
14,490
Supplemental noncash disclosures:
Real estate acquired through foreclosure
$
-
$
$
2,562
Change in unrealized net (losses) gains on investment securities
$
(96,176)
$
(10,276)
$
17,709
The accompanying notes are an integral part of these 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 its subsidiaries, two special purpose entities organized to facilitate repossessed assets, 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, 2022, the Bank operated 35 full service branch offices, an online branch and provides specialized lending services through a dedicated agricultural credit office, an SBA division, Mortgage Warehouse lending divisions and a dedicated loan production office in Roseville, California and an agricultural production office in Templeton, 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 2022. 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 credit 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 credit 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 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 classified as available for sale are carried at fair value with unrealized holding gains and losses reported in other comprehensive income, net of tax. Securities designated as held-to-maturity, are carried at the amortized cost basis of the securities in question, which includes purchase premium or discount in addition to any unamortized premium or discount representing the unrealized gain or loss on any individual security at the time it was transferred from the available for sale designation. Notably, the Company has elected the practical expedient under GAAP to exclude accrued interest from the amortized-cost-basis of held-to-maturity securities and does not evaluate accrued interest receivable for an allowance for credit losses because any past due interest receivable on its held-to-maturity portfolio is reversed from income timely. Accrued interest on held-to-maturity securities and available-for-sale securities continues to be included in other assets on the Company’s balance sheet and measured $2.7 million and $9.3 million, respectively, as of December 31, 2022.
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.
For available-for-sale debt securities in an unrealized loss position for which management has an intent to sell the security or considers it more likely-than-not that the security in question will be sold prior to a recovery of its amortized cost basis, the security will be written down to fair value through a direct charge to income. For the remainder of available sale debt securities in an unrealized loss position, which don’t meet the previously outlined criteria, management evaluates whether the decline in fair value is a reflection of credit deterioration or other factors. In performing this evaluation, management considers the extent which fair value has fallen below amortized cost, changes in ratings by rating agencies, and other information indicating a deterioration in repayment capacity of either the underlying issuer or the borrowers providing repayment capacity in a securitization. If management’s evaluation indicates that a credit loss exists then a present value of the expected cash flows is calculated and compared to the amortized cost basis of the security in question and to the degree that the amortized cost basis exceeds the present value an allowance for credit loss (“ACL”) is established, with the caveat that the maximum amount of the reserve on any individual security is the difference between the fair value and amortized cost balance of the security in question. Any unrealized loss that has not been recorded through an ACL is recognized in other comprehensive income. At December 31, 2022, the Company had no recorded Allowance for Credit Losses on its securities designated as available-for-sale.
Under CECL, held-to-maturity debt securities are evaluated for reserves in the same manner as loans. On April 1, 2022, the Company transferred $162.1 million of Agency, Mortgaged-Backed and Municipal securities from available-for-sale to held-to maturity. On October 1, 2022, a similar transfer of $198.3 million securities from available for sale to held-to-maturity was completed. The securities were transferred at their fair value as of the transfer date, with the related unrealized gain or loss as of the date of transfer included in the amortized cost basis of the transferred security and subject to amortization or accretion over each security’s remaining life. An unrealized loss of $30.7 million, on securities transferred from the available-for-sale to held-to-maturity categorization, remains as of December 31, 2022 and is included in accumulated other comprehensive income, net of tax. The remaining unrealized loss on the securities transferred from available-for-sale to held-to-maturity, will be accreted over the remaining term of the securities, with the amortized-cost basis of these securities and accumulated comprehensive income each increasing over time. Because of the implicit and explicit guarantees of the Federal Government on the Agency and Mortgage-Backed securities there is no expectation of future losses on any of these securities and no allowance for credit losses has been established for these securities. The Bank’s municipal bonds moved to the held-to-maturity designation all have credit ratings considered investment grade or equivalent. A discounted-cash-flow
reserve calculation was performed upon the transfer of these securities into the held-to-maturity designation and is updated on a quarterly basis. As of December 31, 2022, an allowance for credit losses of $0.06 million had been established on the Bank’s held-to-maturity portfolio and charged to provision expense during the year ended December 31, 2022. The company did not have any securities classified as held-to-maturity as of December 31, 2021.
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 $12.7 million at December 31, 2022, and $12.4 million at December 31, 2021.
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 $3.0 million and $3.3 million at December 31, 2022, and 2021, respectively. Equity securities primarily consist of an investment in Pacific Coast Bankers’ Bank (“PCBB”). A remeasurement (loss) gain of $(0.3) million, $0.9 million and $0.4 million was recorded to income during the years ended December 31, 2022, 2021 and 2020, on PCBB stock. $2.4 million in cumulative remeasurement gains have been recorded as of December 31, 2022, on PCBB stock. Adjustments to the carrying value of PCBB stock were based on a third-party valuation.
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, 2022, 2021, or 2020 regarding these representations and warranties.
Loans and Leases (Financing Receivables)
Our credit quality classifications of Loans and Leases include Pass, Special Mention and Substandard. These classifications are defined in Note 4 to the consolidated financial statements.
Loans and leases are reported on the amortized cost basis. The amortized cost basis of the Company’s loans is comprised of the principal balance outstanding, net of remaining deferred loan fees and costs, purchase premiums and discounts, and also net of any write-downs. Notably, the Company elected the practical expedient available
under CECL to exclude accrued interest receivable from the amortized cost basis of all categorizations of loans and resultingly did not estimate reserves on accrued interest receivable balances, as any past due interest income is reversed on a timely basis. Accrued interest receivable on the Company’s Loans and Leases continues to be included in other assets on the Company’s balance sheet and as of December 31, 2022, measured $6.4 million. 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), 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 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. Due to loans being placed on nonaccrual status, $0.1 million of interest receivable on loans was reversed from interest income for the year ended December 31, 2022.
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 Deteriorated Loans
Under CECL the legacy GAAP for purchased credit impaired (“PCI”) loans has been replaced with rules relating to loans designated as purchased credit deteriorated (“PCD”). PCD loans are loans acquired or purchased, which as of acquisition, had evidence of more than insignificant credit deterioration since origination. Due to the immaterial balance in the Company’s PCI loans as of December 31, 2021, management elected not to transition these loans into the PCD designation. As of December 31, 2022 the Company had no loans categorized as PCD. Loans designated as PCD upon acquisition or purchase, most commonly resulting from a business combination, have the credit portion of any fair value discount established as an ACL in the fair value of “Day One” accounting for the business combination. Any interest rate-related fair value adjustment on loans designated as PCD is recorded in the day one accounting and accreted or amortized over the loan’s expected life. Loans not designated as PCD have a separate ACL, in addition to a credit related fair value adjustment recorded on day-one, recorded subsequent to the business combination accounting and established through provision expense. This difference in accounting between loans designated as PCD and non-PCD is commonly referred to as the “CECL double count”. The FASB is currently in initial deliberations to modify the accounting for acquired loans and leases and is expected to bring the accounting for loans designated as PCD and non-PCD into closer alignment.
Allowance for Credit Losses - Loans and Leases
The Allowance for Credit Losses (“ACL”) on the loan portfolio is a valuation allowance deducted from the recorded balance in loans and leases. The ACL represents principal which is not expected to be collected over the contractual life of the loans, adjusted for expected prepayment, whereas under legacy GAAP the allowance represented only losses already incurred as of the balance sheet date. The ACL is increased by a provision for credit losses 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, using information from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Adjustments are also made for changes in risk profile, credit concentrations, historical trends, and other economic conditions.
The ACL for loans and leases is separated between a collective reserve evaluation, for loans where similar risk characteristics exist and an individual reserve evaluation for loans without similar risk characteristics. The collective evaluation of loans is performed at the portfolio segment level, using call code as the primary segmentation key but also considering similarity in quantitative reserve methodology. The Company’s ACL is categorized according to the following portfolio segments: 1-4 Family Real Estate, Commercial Real Estate, Farmland & Agricultural Production, Commercial & Industrial, Mortgage Warehouse, and Consumer. Management utilizes a discounted cash flow methodology to estimate the quantitative portion of collectively evaluated reserves for the 1-4 Family Real Estate, Commercial Real Estate, Commercial & Industrial and Mortgage Warehouse portfolio segments. Management utilizes a Remaining Life Quantitative Reserve Methodology for the Farmland & Agricultural Production, and Consumer portfolio segments. Within the portfolio segments utilizing the DCF quantitative reserve methodology, management has made the election to adjust the effective interest rate to consider the impact of expected prepayments.
Loans where similar risk characteristics exist are evaluated for the ACL in the collective reserve evaluation. The Company’s policy is that loans designated as nonaccrual no longer share risk characteristics similar to other loans evaluated collectively and as such, all nonaccrual loans are individually evaluated for reserves. As of December 31, 2022, the Bank’s nonaccrual loans comprised the entire population of loans individually evaluated. The Company’s policy is that nonaccrual loans also represent the subset of loans where borrowers are experiencing financial difficulty where an evaluation of the source of repayment is required to determine if the nonaccrual loan should be categorized as collateral dependent. It is the Company’s policy that the only loans and leases where the credit quality has deteriorated to the point where foreclosure is probable are the Company’s nonaccrual loans. 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 credit.
Though management believes the allowance for credit 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 credit losses. These agencies may require additions to the allowance for credit losses based on their judgment about information available at the time of their examinations.
Allowance for Credit Losses - 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, certain 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 allowance for credit losses on the loan portfolio. The implementation of CECL also impacted the Company’s ACL on unfunded loan commitments, as this ACL now represents expected credit losses over the contractual life of
commitments not identified as unconditionally cancellable by the Company. The Reserve for Unfunded Commitments is estimated using the same reserve or coverage rates calculated on collectively evaluated loans following the application of a funding rate to the amount of the unfunded commitment. The funding rate represents management’s estimate of the amount of the current unfunded commitment that will be funded over the remaining contractual life of the commitment and is based on historical data. Under CECL the ACL on unfunded loan commitments remains in Other Liabilities while any related provision expense has been moved to provision for credit loss expense from its prior presentation in noninterest expense. Prior period expense have not been reclassified for comparative purposes.
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 credit losses on loans and leases. 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 no foreclosed residential real estate properties recorded at December 31, 2022. At December 31, 2022, there were no consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceeds were in process.
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.
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, 2022, as the date to perform the annual impairment test for 2022. 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, 2022, 2021, and 2020.
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, 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.
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 14 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, 2022, 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 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, 2022, 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 the expected term of the stock option is based on the U.S. Treasury yield curve in effect at the time of the grant. No stock options were granted during the years ended December 31, 2022 and 2021. For the year ended 2020 the fair value of each stock option was estimated on the date of grant using the following assumptions: dividend yield, 3.02%; expected volatility, 25.06%; risk-free interest rate, 1.47%; expected option life, 6.4 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 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 an estimate of expected credit losses over the contractual term for financial assets carried at amortized cost (generally loans and held-to-maturity investment securities) in addition to certain off balance-sheet credit exposure. Under the current expected credit losses (“CECL”) methodology expected credit losses for financial assets are estimated over the contractual life of the financial asset, adjusted for expected prepayments, considering historical experience, current conditions, and reasonable and supportable forecasts. Additionally, under CECL the accounting for credit losses on available-for-sale debt securities is addressed through an allowance for credit losses which is a change from legacy GAAP which previously required the direct write-down of securities through the other-than-temporary impairment approach. The Company implemented CECL on January 1, 2022, using the modified retrospective approach to estimate lifetime expected losses on financial assets measured at amortized cost in addition to certain off balance sheet credit exposures. The January 1, 2022, increase in the Company’s allowance for credit losses, of $9.5 million on loans and leases and $0.9 million in off balance sheet credit exposures, net of the impact of deferred taxes, was reflected in a
transition adjustment of $7.3 million to retained earnings. There was no cumulative effect adjustment related to our available-for-sale investment portfolio upon adoption and the company had no securities designated as held-to-maturity as of January 1, 2022. Results for reporting periods beginning after December 31, 2021, are presented under CECL whereas prior comparative periods are presented under legacy GAAP. The following table illustrates the impact of the adoption of CECL, and the transition away from the incurred loss method, on January 1, 2022 (dollars in thousands). The impact to the Allowance for Credit losses (“ACL”) on the Loan Portfolio is broken out at the class level.
January 1, 2022
Reserves Under Incurred Loss
Reserves Under CECL
Transition Impact Gross
Impact of Deferred Taxes
Impact to Retained Earnings
Real estate:
1-4 family residential construction
$
$
$
(107)
$
$
(75)
Other construction/land
(8)
1-4 family - closed-end
1,618
2,310
(205)
Equity lines
(80)
(56)
Multi-family residential
(89)
Commercial real estate - owner occupied
2,217
3,444
1,227
(363)
Commercial real estate - non-owner occupied
6,199
14,380
8,181
(2,418)
5,762
Farmland
(397)
(280)
Total real estate
11,698
21,540
9,842
(2,910)
6,932
Agricultural
(83)
(58)
Commercial and industrial
1,060
1,418
(106)
Mortgage warehouse lines
(421)
(297)
Consumer loans
(242)
(170)
Total Allowance for Credit Losses - Loans
14,256
23,710
9,454
(2,795)
6,659
Allowance for unfunded Loan Commitments
1,134
(275)
3. INVESTMENT SECURITIES
Pursuant to FASB’s guidance on accounting for debt securities, available for sale securities are carried on the Company’s financial statements at their estimated fair market values, with monthly tax-effected “mark-to-market” adjustments made vis-à-vis accumulated other comprehensive income in shareholders’ equity. Held-to-maturity
securities are carried on the Company’s financial statements at their amortized cost, net of the allowance for credit losses.
The amortized cost and fair value of the securities available-for-sale and held-to-maturity are as follows (dollars in thousands):
December 31, 2022
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Allowance for Credit Losses
Estimated Fair
Value
Available-for-sale
U.S. government agencies
$
50,625
$
$
(75)
$
-
$
50,599
Mortgage-backed securities
129,948
-
(7,416)
-
122,532
State and political subdivisions
223,810
(18,437)
-
205,980
Corporate bonds
65,164
(7,739)
-
57,435
Collateralized loan obligations
515,032
(16,715)
-
498,377
Total available-for-sale securities
$
984,579
$
$
(50,382)
$
-
$
934,923
Amortized
Cost
Gross
Unrecognized
Gains
Gross
Unrecognized
Losses
Estimated Fair
Value
Allowance for Credit Losses
Held-to-maturity
U.S. government agencies
$
6,047
$
-
$
(621)
$
5,426
$
-
Mortgage-backed securities
157,473
-
(9,915)
147,558
-
State and political subdivisions
173,424
1,018
175,027
(63)
Total held-to-maturity securities
$
336,944
$
$
(9,518)
$
328,011
$
(63)
December 31, 2021
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Allowance for Credit Losses
Fair Value
Available-for-sale
U.S. government agencies
$
1,546
$
$
-
$
-
$
1,574
Mortgage-backed securities
303,912
4,772
(1,957)
-
306,727
State and political subdivisions
290,729
13,807
(268)
-
304,268
Corporate bonds
28,436
(1)
-
28,529
Collateralized loan obligations
332,836
(688)
-
332,216
Total available-for-sale securities
$
957,459
$
18,769
$
(2,914)
$
$
973,314
The Company did not record an ACL on the available-for-sale portfolio at December 31, 2022 or upon the implementation of CECL on January 1, 2022. As of both dates the Company considers the unrealized loss across the classes of major security-type to be related to fluctuations in market conditions, primarily interest rates, and not reflective of a deterioration in credit value. The Company maintains that it has intent and ability to hold these securities until the amortized cost basis of each security is recovered and likewise concluded as of both January 1, 2022 and December 31, 2022 that it was not more likely than not that any of the securities in an unrealized loss position would be required to be sold. The following bullets outline additional support for management’s conclusion that no amount of the unrealized loss of the securities in an unrealized loss position as of January 1, 2022 and December 31, 2022 was attributable to credit deterioration and a risk of loss, requiring an allowance for credit losses.
● US Government Agencies are supported by the full faith and credit-worthiness of the U.S. Federal Government and the management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either January 1, 2022 or December 31, 2022.
● Mortgage-backed securities issued by government sponsored entities (“GSEs”) carry an implicit guarantee by the U.S. Federal Government, as the GSEs can draw funds from the U.S. Federal Government up to a limit, with an
implied ability to draw funds beyond the limit. Management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either January 1, 2022 or December 31, 2022.
● Management routinely monitors third party credit grades of the municipal issuers in the Company’s state and political subdivisions portfolio and as of both January 1, 2022 and December 31, 2022 noted that all municipal securities in an unrealized loss position were either investment grade rated or guaranteed. On a quarterly basis management receives financial information from a third-party service in order to monitor the underlying issuer’s financial stability. In addition, management performs annual reviews of the underlying municipal issuers financial statements in order to evaluate stability and repayment capacity and has noted no concerns with any of the bonds in the Company’s State and Local portfolio. As of both January 1, 2022 and December 31, 2022 management concluded that no allowance for credit losses was warranted on any of the Company’s municipal securities and the unrealized loss position of each of the securities reflected fluctuations in market conditions, primarily interest rates, since the time of purchase.
● The Company has invested in corporate debt issuances of other financial institutions. Various financial metrics of each of the issuing financial institutions are reviewed by management quarterly, these metrics include credit quality, reserve adequacy, profitability and capital. Following review of the financial metrics available for each of the underlying institutions as of January 1, 2022 and December 31, 2022 management concluded that the unrealized loss position of these securities related exclusively to the fluctuation in market conditions, primarily interest rates, from the date of purchase, and were not reflective of any credit concerns with the issuing financial institution. These bonds were subject to a credit review by the credit administration department prior to their purchase and are subject to ongoing quarterly reviews.
● The Company has invested exclusively in AA and AAA tranches of various collateralized loan obligations, which are securitizations of commercial loans. Each purchase is subject to a credit, concentration, and structure review by the credit administration department prior to their purchase and are subject to ongoing quarterly reviews. Management monitors the credit rating of these investments on a quarterly basis in addition to various performance metrics available through a third-party informational service. Following review of financial metrics as of both January 1, 2022 and December 31, 2022 management concluded that the unrealized loss position of these securities related exclusively to the fluctuation in market conditions, primarily interest rate spreads, from the date of purchase, and were not reflective of any credit concerns with the tranches comprising the Company’s investments.
For the years ended December 31, 2022, 2021, and 2020, proceeds from sales of securities available-for-sale were $45.9 million, $0.1 million, and $20.3 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
$
1,487
$
$
Gross losses on sales and calls of securities
-
-
(43)
Net gains (losses) on sales and calls of securities
$
1,487
$
$
The Company has reviewed all sectors and securities in the portfolio for impairment. During the year ended December 31, 2022 the Company realized gains through earnings from the sale and call of 54 debt securities for $1.5 million. There were no securities sold during 2022 for which a loss was realized. During the year ended December 31, 2021, the Company realized gains through earnings from the sale and call of 21 debt securities for $0.01 million. There were no securities sold during 2021 for which a loss was realized. 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.
The following table summarizes available-for-sale debt securities that were in an unrealized loss position for which an ACL has not been recorded, based on the length of time the individual securities have been in an unrealized loss position, including the number of available-for-sale debt securities in an unrealized loss position, as of the dates indicated below (dollars in thousands):
December 31, 2022
Less than twelve months
Twelve months or longer
Total
Number of Securities
Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
Fair Value
Available-for-sale
U.S. government agencies
$
(75)
$
27,550
$
-
$
-
$
(75)
$
27,550
Mortgage-backed securities
(7,108)
119,260
(308)
3,227
(7,416)
122,487
State and political subdivisions
(15,732)
147,635
(2,705)
9,807
(18,437)
157,442
Corporate bonds
(7,644)
54,636
(95)
(7,739)
55,041
Collateralized loan obligations
(10,152)
309,102
(6,563)
169,743
(16,715)
478,845
Total available-for-sale
$
(40,711)
$
658,183
$
(9,671)
$
183,182
$
(50,382)
$
841,365
December 31, 2021
Less than twelve months
Twelve months or longer
Total
Number of Securities
Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
Fair Value
Gross
Unrealized
Losses
Fair Value
Available-for-sale
U.S. government agencies
-
$
-
$
-
$
-
$
-
$
-
$
-
Mortgage-backed securities
(1,797)
107,026
(160)
2,808
(1,957)
109,834
State and political subdivisions
(268)
30,170
-
-
(268)
30,170
Corporate bonds
(1)
-
-
(1)
Collateralized loan obligations
(688)
175,581
-
-
(688)
175,581
Total available-for-sale
$
(2,754)
$
313,276
$
(160)
$
2,808
$
(2,914)
$
316,084
The amortized cost and estimated fair value of investment securities available-for-sale and held-to-maturity at December 31, 2022 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):
December 31, 2022
Available-for-Sale
Held-to-Maturity
Amortized Cost
Fair Value
Amortized Cost
Fair Value
Maturing within one year
$
12,141
$
12,184
$
$
Maturing after one year through five years
21,013
20,831
2,059
2,032
Maturing after five years through ten years
119,649
111,513
19,048
17,431
Maturing after ten years
186,796
169,486
157,692
160,324
Securities not due at a single maturity date:
Mortgage-backed securities
129,948
122,532
157,473
147,558
Collateralized loan obligations
515,032
498,377
-
-
$
984,579
$
934,923
$
336,944
$
328,011
Securities with amortized costs totaling $186.7 million and carrying values totaling $183.5 million were pledged to secure other contractual obligations and short-term borrowing arrangements at December 31, 2022 (see Note 10).
Securities available-for-sale with amortized costs totaling $166.3 million and estimated fair values totaling $167.2 million were pledged to secure other contractual obligations and short-term borrowing arrangements at December 31, 2021 (see Note 10).
At December 31, 2022, the Company’s investment portfolio included securities issued by 406 different government municipalities and agencies located within 37 states with a fair value of $381.0 million. The largest exposure to any single municipality or agency was $5.1 million (fair value) in four general obligation bonds issued by the City of New York (NY). In addition the Company owned 51 subordinated debentures issued by bank holding companies totaling $57.4 million (fair value).
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, 2022
December 31, 2021
General obligation bonds
Amortized Cost
Fair Value
Amortized Cost
Fair Value
State of Issuance:
Texas
$
153,209
$
146,667
$
85,045
$
89,225
California
65,758
60,701
64,092
67,066
Washington
21,635
21,312
23,858
24,812
Other (29 and 21 states, respectively)
102,336
100,480
75,037
78,579
Total general obligation bonds
342,938
329,160
248,032
259,682
Revenue bonds
State of Issuance:
Texas
9,216
8,840
7,038
7,377
California
3,788
3,673
1,349
1,392
Washington
4,083
3,490
4,334
4,602
Other (20 and 14 states, respectively)
37,209
35,844
29,976
31,215
Total revenue bonds
54,296
51,847
42,697
44,586
Total obligations of states and political subdivisions
$
397,234
$
381,007
$
290,729
$
304,268
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, 2022
December 31, 2021
Revenue bonds
Amortized Cost
Fair Value
Amortized Cost
Fair Value
Revenue Source:
Water
$
21,246
$
19,977
$
15,534
$
16,220
Lease
7,035
7,250
6,556
6,718
Sewer
6,560
6,405
3,932
4,165
Sales tax
4,123
3,934
5,514
5,842
Local or guaranteed housing
3,040
2,951
1,020
1,121
Other (10 and 10 sources, respectively)
12,292
11,330
10,141
10,520
Total revenue bonds
$
54,296
$
51,847
$
42,697
$
44,586
4. LOANS AND LEASES AND ALLOWANCE FOR CREDIT LOSSES
We adopted the new current expected credit loss accounting guidance, CECL, and all related amendments as of January 1, 2022. Certain prior period credit quality disclosures related to impaired loans and individually and collectively evaluated loans were superseded with the current guidance and have not been included below as of December 31, 2022. Under CECL, disclosures are required on the amortized cost basis, whereas legacy GAAP required presentation on the recorded investment basis, with the primary difference being net deferred fees and costs. Unless specifically noted otherwise, December 31, 2022 disclosures are prepared on the amortized cost basis and December 31, 2021 and 2020 disclosures present information according to the recorded investment basis.
Accrued interest receivable on loans of $6.4 million and $6.8 million at December 31, 2022 and December 31, 2021 respectively is not included in the loans included in the table below but is included in other assets on the Company’s balance sheet. The December 31, 2022 balance in 1-4 family closed end loans reflects year-to-date 2022 loan purchases of $173.1 million. The majority of the disclosures in this footnote are prepared at the class level which is equivalent to the call report or call code classification. The final table in this section separates a roll forward of the Allowance for Credit Losses at the portfolio segment level. The following table presents loans by class as of December 31, 2022 and December 31, 2021 (dollars in thousands).
December 31,
Real estate:
1-4 family residential construction
$
-
$
21,369
Other construction/land
18,412
25,299
1-4 family - closed-end
416,116
289,457
Equity lines
21,330
26,588
Multi-family residential
91,691
53,458
Commercial real estate - owner occupied
323,873
334,446
Commercial real estate - non-owner occupied
893,846
882,888
Farmland
113,394
106,706
Total real estate
1,878,662
1,740,211
Agricultural
27,936
33,990
Commercial and industrial
76,779
109,791
Mortgage warehouse lines
65,439
101,184
Consumer loans
4,124
4,550
Subtotal
2,052,940
1,989,726
Less net deferred loan fees and costs
(123)
(1,865)
Allowance for credit losses on loans and leases
(23,060)
(14,256)
Net loans and leases
$
2,029,757
$
1,973,605
The following table presents the amortized cost basis of nonaccrual loans, according to loan class, with and without individually evaluated reserves as of December 31, 2022 (dollars in thousands):
December 31, 2022
Nonaccrual Loans
With no allowance for credit loss
With an allowance for credit loss
Total
Loans Past Due 90+ Accruing
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
-
-
-
-
Farmland
15,812
-
15,812
-
Total real estate
16,500
-
16,500
-
Agricultural
2,826
2,855
-
Commercial and industrial
Mortgage warehouse lines
-
-
-
-
Consumer loans
-
-
Total
$
19,409
$
$
19,579
$
The following table presents the impaired loans as of December 31, 2021, according to loan class, with and without an individually evaluated reserve according to the recorded investment basis (dollars in thousands). Impaired loans as of December 31, 2021 included both nonaccrual loans and performing TDRs. A separate breakout of nonaccrual loans by class as of December 31, 2021 is included in the past due loans table as of December 31, 2021, later in this footnote.
December 31, 2021
Unpaid Principal
Recorded
Average Recorded
Interest Income
Balance(1)
Investment(2)
Related Allowance
Investment
Recognized(3)
With an Allowance Recorded
Real estate:
Other construction/land
$
$
$
$
$
1-4 family - closed-end
1,048
1,048
1,096
Equity lines
2,005
1,993
2,056
Commercial real estate - owner occupied
1,249
1,248
1,278
Commercial real estate - non-owner occupied
Total real estate
5,010
4,997
5,175
Agricultural
-
Commercial and industrial
Consumer loans
6,175
6,162
6,474
With no Related Allowance Recorded
Real estate:
1-4 family - closed-end
-
-
Equity lines
-
Commercial real estate - owner occupied
1,353
1,234
-
1,282
-
Total real estate
2,789
2,670
-
2,841
Agricultural
-
-
Commercial and industrial
-
-
3,389
3,270
-
3,577
Total
$
9,564
$
9,432
$
$
10,051
$
(1) Contractual principal balance due from customer.
(2) Principal balance on Company’s books, less any direct charge offs.
(3) Interest income is recognized on performing balances on a regular accrual basis.
The Company did not recognize any interest on nonaccrual loans during 2022 and would have recognized an additional $1.0 million in interest income on nonaccrual loans had those loans not been designated as nonaccrual.
The following table presents the amortized cost basis of collateral-dependent loans by class as of December 31, 2022 (dollars in thousands):
December 31, 2022
Amortized Cost
Individual Reserves
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
-
-
Farmland
15,812
-
Total real estate
16,500
-
Agricultural
2,826
-
Commercial and industrial
Mortgage warehouse lines
-
-
Consumer loans
-
-
Total
$
19,543
$
During the fourth quarter the amortized cost balance of collateral-dependent loans declined by $7.2 million due to charge-offs recognized in the Farmland and Agricultural Production categories. These charge-offs are primarily the result of a reduction in the expected valuation of collateral on a single loan relationship. The weighted average loan-to-value ratio of collateral dependent loans was 67% at December 31, 2022. There were four collateral dependent loans in the process of foreclosure as of December 31, 2022.
The following table presents the aging of the amortized cost basis in past-due loans, according to class, as of December 31, 2022 (dollars in thousands):
December 31, 2022
30-59 Days Past Due
60-89 Days Past Due
Loans Past Due 90+ Days
Total Past Due
Loans not Past Due
Total Loans
Real estate:
1-4 family residential construction
$
-
$
-
$
-
$
-
$
-
$
-
Other construction/land
-
-
-
-
18,358
18,358
1-4 family - closed-end
1,259
1,525
415,568
417,093
Equity lines
-
-
21,603
21,638
Multi-family residential
-
-
-
-
91,485
91,485
Commercial real estate - owner occupied
-
-
-
-
323,895
323,895
Commercial real estate - non-owner occupied
-
-
-
-
891,195
891,195
Farmland
15,393
16,012
97,582
113,594
Total real estate
1,816
15,572
17,572
1,859,686
1,877,258
Agricultural
-
-
2,778
2,778
25,416
28,194
Commercial and industrial
1,093
76,601
77,694
Mortgage warehouse lines
-
-
-
-
65,439
65,439
Consumer loans
-
-
4,217
4,232
Total loans and leases
$
1,850
$
$
19,290
$
21,458
$
2,031,359
$
2,052,817
The following table presents the aging of the recorded investment in past-due and nonaccrual loans, according to class, as of December 31, 2021 (dollars in thousands):
December 31, 2021
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
$
-
$
-
$
-
$
-
$
21,369
$
21,369
$
-
Other construction/land
-
-
-
-
25,299
25,299
-
1-4 family - closed-end
1,532
-
1,664
287,793
289,457
1,023
Equity lines
-
-
26,558
26,588
Multi-family residential
-
-
-
-
53,458
53,458
-
Commercial real estate owner occupied
-
333,624
334,446
1,234
Commercial real estate non-owner occupied
-
-
-
-
882,888
882,888
-
Farmland
-
-
-
-
106,706
106,706
-
Total real estate loans
1,686
2,516
1,737,695
1,740,211
3,149
Agricultural
-
-
33,706
33,990
Commercial and industrial
-
109,035
109,791
Mortgage warehouse lines
-
-
-
-
101,184
101,184
-
Consumer loans
-
4,541
4,550
Total gross loans and leases
$
2,165
$
$
1,265
$
3,565
$
1,986,161
$
1,989,726
$
4,522
(1) Included in Total Financing Receivables
(2) As of December 31, 2021 there were no loans over 90 days past due and still accruing.
Troubled Debt Restructurings
A loan that is modified for a borrower who is experiencing financial difficulty is classified as a troubled debt restructuring (TDR) if the modification constitutes a concession. At December 31, 2022, the Company had a total of $4.9 million in TDRs, including $0.3 million in TDRs that were on non-accrual status. Generally, a non-accrual loan that has been modified as a TDR remains on non-accrual status for a period of at least six months to demonstrate
the borrower’s ability to comply with the modified terms. However, performance prior to the modification, or significant events that coincide with the modification, could result in a loan’s return to accrual status after a shorter performance period or even at the time of loan modification. Regardless of the period of time that has elapsed, if the borrower’s ability to meet the revised payment schedule is uncertain, then the loan will be kept on non-accrual status.
The Company may agree to different types of concessions when modifying a loan or lease. For the year ended December 31, 2022, there were no new TDRs and no modifications of existing TDRs. The tables below summarize TDRs which were modified during the years ended December 31, 2021 and December 31, 2020, by type of concession.
Troubled Debt Restructurings, by Type of Loan Modification
(dollars in thousands, unaudited)
December 31, 2021
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
-
1,000
-
-
1,083
Commercial real estate owner occupied
-
-
-
-
-
-
Commercial real estate non-owner occupied
-
-
-
-
Farmland
-
-
-
-
-
-
Total real estate loans
-
1,136
-
-
1,219
Agricultural
-
-
-
-
Commercial and industrial
-
-
-
-
Consumer loans
-
-
-
Small Business Administration Loans
-
-
-
-
-
-
Total
$
-
$
1,483
$
-
$
$
$
1,589
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
-
-
-
-
-
-
Total
$
-
$
7,511
$
-
$
-
$
$
7,849
Troubled Debt Restructurings
(dollars in thousands, unaudited)
Pre-Modification
Post-Modification
Outstanding
Outstanding
Number of
Recorded
Recorded
Reserve
December 31, 2021
Loans
Investment
Investment
Difference(1)
Real estate:
Other construction/land
-
$
-
$
-
$
-
1-4 family - closed-end
-
-
-
-
Equity lines
-
-
-
-
Multi-family residential
1,083
1,083
-
Commercial real estate - owner occupied
-
-
-
-
Commercial real estate - non-owner occupied
(1)
Farmland
-
-
-
-
Total real estate loans
1,220
1,219
(1)
Agricultural
Commercial and industrial
(1)
Consumer loans
Total
$
1,590
$
1,589
$
(1) This represents the change in the ACL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.
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
-
-
-
-
Total
$
7,850
$
7,849
$
(1) This represents the change in the ACL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology.
The Company had no finance receivables modified as TDRs within the previous twelve months that defaulted or were charged off during years ending December 31, 2022, 2021 and 2020.
The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention and substandard 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.
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.
The following tables present the amortized cost of loans and leases by credit quality classification in addition to loan and lease vintage as of December 31, 2022 (dollars in thousands):
Term Loans Amortized Cost Basis by Origination Year
Prior
Revolving Loans
Total Loans
Other construction/land
Pass
$
-
$
-
$
4,249
$
$
$
1,010
$
11,340
$
18,288
Substandard
-
-
-
-
-
-
Subtotal
-
-
4,319
1,010
11,340
18,358
1-4 family - closed-end
Pass
107,680
238,813
7,813
2,058
10,174
47,650
-
414,188
Special Mention
-
-
-
-
1,584
-
1,673
Substandard
-
-
-
-
1,201
-
1,232
Subtotal
107,680
238,813
7,813
2,058
10,294
50,435
-
417,093
Equity lines
Pass
-
18,837
20,280
Special Mention
-
-
-
-
-
1,006
Substandard
-
-
-
-
-
Subtotal
-
20,060
21,638
Multi-family residential
Pass
23,814
9,375
12,084
11,581
27,905
85,934
Special Mention
-
-
2,217
-
-
3,334
-
5,551
Subtotal
23,814
11,592
12,084
14,915
27,905
91,485
Commercial real estate - OO
Pass
38,408
25,996
64,335
38,121
36,038
106,293
8,343
317,534
Special Mention
-
-
-
2,265
3,143
Substandard
-
-
-
-
2,622
3,218
Subtotal
38,704
25,996
64,335
38,471
36,116
111,180
9,093
323,895
Commercial real estate - NOO
Pass
84,944
19,503
385,275
26,446
57,159
154,109
63,948
791,384
Special Mention
-
-
70,785
-
2,718
1,468
-
74,971
Substandard
-
-
14,733
-
7,066
3,041
-
24,840
Subtotal
84,944
19,503
470,793
26,446
66,943
158,618
63,948
891,195
Farmland
Pass
28,171
1,359
4,924
1,819
7,922
26,350
17,054
87,599
Special Mention
-
-
-
-
7,045
2,038
1,004
10,087
Substandard
-
-
-
-
3,417
12,491
-
15,908
Subtotal
28,171
1,359
4,924
1,819
18,384
40,879
18,058
113,594
Agricultural
Pass
7,530
1,027
1,821
13,594
24,894
Special Mention
-
-
-
-
-
-
Substandard
-
2,798
-
-
-
-
2,854
Subtotal
7,530
3,246
1,027
1,821
14,096
28,194
Commercial and industrial
Pass
5,994
5,032
7,325
6,190
4,310
7,222
32,477
68,550
Special Mention
3,067
-
1,616
3,772
8,843
Substandard
-
-
-
Subtotal
6,210
5,161
10,392
6,318
4,393
8,971
36,249
77,694
Mortgage warehouse lines
Pass
-
-
-
-
-
-
65,439
65,439
Subtotal
-
-
-
-
-
-
65,439
65,439
Consumer loans
Pass
1,162
2,177
4,157
Special Mention
-
-
-
-
Substandard
-
-
-
-
-
-
Subtotal
1,170
2,193
4,232
Total
$
298,223
$
295,136
$
575,323
$
77,008
$
150,277
$
388,469
$
268,381
$
2,052,817
The following table presents the Company’s loan portfolio on the recorded investment basis, according to loan class and credit grade as of December 31, 2021 (dollars in thousands):
Pass
Special
Mention
Substandard
Impaired
Total
Real estate:
1-4 family residential construction
$
19,669
$
1,700
$
-
$
-
$
21,369
Other construction/land
24,958
-
-
25,299
1-4 family - closed-end
282,717
4,703
1,836
289,457
Equity lines
23,277
2,641
26,588
Multi-family residential
49,986
3,472
-
-
53,458
Commercial real estate owner occupied
321,996
6,108
3,860
2,482
334,446
Commercial real estate non-owner occupied
841,728
26,364
14,429
882,888
Farmland
92,479
10,266
3,961
-
106,706
Total real estate
1,656,810
53,228
22,506
7,667
1,740,211
Agricultural
32,513
-
1,099
33,990
Commercial and industrial
98,367
9,989
1,223
109,791
Mortgage warehouse lines
101,184
-
-
-
101,184
Consumer loans
4,349
4,550
Total gross loans and leases
$
1,893,223
$
63,248
$
23,823
$
9,432
$
1,989,726
CECL replaces the legacy accounting for loans designated as purchased credit impaired (“PCI”) with loans designated as purchased credit deteriorated (“PCD”). PCD loans are loans acquired or purchased, which as of acquisition, had evidence of more than insignificant credit deterioration since origination. Due to the immaterial balance in the Company’s PCI loans as of December 31, 2021 management elected not to transition these loans into the PCD designation. As of December 31, 2022 the Company had no loans categorized as PCD.
As noted in footnote 2, on January 1, 2022 the Company implemented CECL and increased our ACL, previously the allowance for loan and lease losses, with a $9.5 million cumulative adjustment. The Company’s ACL is calculated quarterly, with any difference in the calculated ACL and the recorded ACL trued-up through an entry to the provision for credit losses. Management calculates the quantitative portion of collectively evaluated reserves for all loan categories, with the exception of Farmland, Agricultural Production and Consumer loans, using a discounted cash flow (“DCF”) methodology. For purposes of calculating the quantitative portion of collectively evaluated reserves on Farmland, Agricultural Production, and Consumer categories a Remaining Life methodology is utilized. For purposes of estimating the Company’s ACL, Management generally evaluates collectively evaluated loans by Federal Call code in order to group loans with similar risk characteristics together, however management has grouped loans in selected call codes together in determining portfolio segments, due to similar risk characteristics and reserve methodologies used for certain call code classifications.
The DCF quantitative reserve methodology incorporates the consideration of probability of default (“PD”) and loss given default (“LGD”) estimates to estimate periodic losses. The PD estimates are derived through the application of reasonable and supportable economic forecasts to call code specific regression models, derived from the consideration of historical bank-specific and peer loss-rate data. The loss rate data has been regressed against benchmark economic indicators, for which reasonable and supportable forecasts exist, in the development of the call-code specific regression models. Regression models are generally refreshed on an annual basis, in order to pull in more recent loss rate data. Reasonable and supportable forecasts of the selected economic metric are then input into the regression model to calculate an expected default rate. The expected default rates are then applied to expected monthly loan balances estimated through the consideration of contractual repayment terms and expected prepayments. The Company utilizes a four-quarter forecast period, after which the expected default rates revert to the historical average for each call code, over a four-quarter reversion period, on a straight-line basis. The
prepayment assumptions applied to expected cash flow over the contractual life of the loans are estimated based on historical, bank-specific experience, peer data and the consideration of current and expected conditions and circumstances including the level of interest rates. The prepayment assumptions may be updated by Management in the event that changing conditions impact Management’s estimate or additional historical data gathered has resulted in the need for a reevaluation. LGD utilized in the DCF is derived from the application of the Frye-Jacobs theory which relates LGD to PD based on historical peer data, as calculated by a third-party. Economic forecasts are considered over a four-quarter forecast period, with reversion to mean occurring on a straight-line basis over four quarters. The call code regression models utilized upon implementation of CECL on January 1, 2022, and as of December 31, 2022, were identical, and relied upon reasonable and supportable forecasts of the National Unemployment Rate. Management selected the National Unemployment Rate as the driver of quantitative portion of collectively reserves on loan classes reliant upon the DCF methodology, primarily as a result of high correlation coefficients identified in regression modeling, the availability of forecasts including the quarterly FOMC forecast, and given the widespread familiarity of stakeholders with this economic metric.
The quantitative reserves for Farmland, Agricultural Production and Consumer loans are calculated using a Remaining Life methodology where average historical bank specific and peer loss rates are applied to expected loan balances over an estimated remaining life of loans in calculation of the quantitative portion of collectively evaluated loans in these classes. The estimated remaining life is calculated using historical bank-specific loan attrition data. For the Farmland, Agricultural Production and Consumer classes of loans, reasonable and supportable forecasts of the National Unemployment rate, real GDP and the housing price index are considered through estimation of qualitative reserves.
Management recognizes that there are additional factors impacting risk of loss in the loan portfolio beyond what is captured in the quantitative portion of reserves on collectively evaluated loans. As current and expected conditions, may vary compared with conditions over the historical lookback period, which is utilized in the calculation of quantitative reserves, management considers whether additional or reduced reserve levels on collectively evaluated loans may be warranted given the consideration of a variety of qualitative factors. Several of the following qualitative factors (“Q-factors”) considered by management reflect the legacy regulatory guidance on Q-factors, whereas several others represent factors unique to the Company or unique to the current time period.
● Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices
● Changes in international, regional and local economic and business conditions, and developments that affect the collectability of the portfolio, as reflected in forecasts of the Housing Price Index, Real GDP and the National Unemployment Rate (Farmland & Agricultural Production and Consumer segments only)
● Changes in the nature and volume of the loan portfolio
● Changes in the experience, ability, and depth of lending management and other relevant staff
● Changes in the volume and severity of past due, non-accruals loans, and adversely classified loans, as reflected in changes of the relative level of loans classified as substandard and special mention
● Changes in the quality of the Bank’s loan review processes
● Changes in the value of underlying collateral for loans not identified as collateral dependent
● Changes in loan categorization concentrations
● Other external factors, which include, the influence of peer data on estimated quantitative reserves, residual COVID-19 related risk, expected impact of current and expected inflationary environment, reliance on the National Unemployment rate as opposed to the California unemployment rate in the calculation of quantitative reserves, the expected impact of current and expected geo-political conditions
The qualitative portion of the Company’s reserves on collectively evaluated loans are calculated using a combination of numeric frameworks and management judgement, to determine risk categorizations in each of the Q-factors presented above. The amount of qualitative reserves is also contingent upon the historical peer, life-of-loan-equivalent, loss rate ranges and the relative weighting of Q-factors according to management’s judgement.
Although collectively evaluated reserves are generally calculated separately at the call code or loan class level, management has grouped loan classes with similar risk characteristics into the following portfolio segments: 1-4 Family Real Estate, Commercial Real Estate, Farmland & Agricultural Production, Commercial & Industrial, Mortgage Warehouse and Consumer loans. Loans secured by 1-4 family residences have a different profile from loans secured by Commercial Real Estate. Generally, the borrowers for 1-4 Family loans are consumers whereas borrowers for Commercial Real Estate are often businesses. The COVID-19 pandemic illustrated how these different categories of real estate loans were subject to different risks, which was exacerbated by the widespread work-from-home model adopted by many companies during and since the pandemic. Farmland and Agricultural Production loans are included in a single segment as these loans are often times to the same borrowers, facing the same risks relating to commodity prices, water supply and drought conditions in addition to other environmental concerns. Commercial & Industrial loans are separated into a unique segment given the uniqueness of these loans, which are often revolving and secured by other business assets as opposed to real estate. Mortgage warehouse loans are also unique in the Company’s portfolio and warrant separate presentation as an individual portfolio segment, given the specific nature of these constantly revolving lines to mortgage originators and also attributable to a very limited loss history, even after consideration of peer data. Finally, the Company splits out Consumer loans as a separate segment as a result of the small balance, homogeneous terms that characterize these loans.
Management individually evaluates loans that do not share risk characteristics with other loans when estimating reserves. As of December 31, 2022, the only loans that Management considered to have different risk characteristics from other loans sharing the same Federal Call Report code were loans designated nonaccrual.
The following table presents the activity in the allowance for credit losses by portfolio segment for the year ended December 31, 2022 (dollars in thousands):
1-4 Family Real Estate
Commercial Real Estate
Farmland & Agricultural Production
Commercial & Industrial
Mortgage Warehouse
Consumer
Total
Allowance for credit losses:
Balance, December 31, 2021
$
1,909
$
9,052
$
1,202
$
1,060
$
$
14,256
Impact of adopting ASC 326
9,628
(480)
(421)
(242)
9,454
Charge-offs
-
(1,911)
(9,205)
(322)
-
(1,396)
(12,834)
Recoveries
-
-
1,286
Provision for credit losses
8,941
(26)
(19)
10,898
Balance, December 31, 2022
$
3,251
$
17,732
$
$
1,233
$
$
$
23,060
The $9.2 million in charge-offs recognized in the Farmland and Agricultural Production portfolio segment is primarily the result of a reduction in the expected valuation of collateral on a single loan relationship, recorded in the first and fourth quarters of 2022. The $1.9 million charge-off in Commercial Real Estate was recognized during the second quarter, when Management became aware of a borrower’s reduced ability to service their loan primarily as a result of increased vacancy rates related to the remote work which has increased following the pandemic.
The following table presents the activity in the allowance for loan and lease losses by portfolio segment for the years ended December 31, 2021 and 2020 (dollars in thousands):
Commercial and
Real Estate
Agricultural
Industrial (1)
Consumer
Unallocated
Total
Allowance for credit losses:
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
Charge-offs
(245)
(50)
(159)
(946)
-
(1,400)
Recoveries
-
-
1,568
Benefit
(536)
(3,226)
(8)
(3,650)
Balance, December 31, 2021
$
11,586
$
$
1,559
$
$
$
14,256
(1) Includes mortgage warehouse lines
5. PREMISES AND EQUIPMENT
Premises and equipment at cost consisted of the following (dollars in thousands):
December 31,
Land
$
4,823
$
4,823
Buildings and improvements
21,170
21,006
Furniture, fixtures and equipment
18,948
19,242
Leasehold improvements
14,732
14,682
Total premises and equipment, gross
59,673
59,753
Less accumulated depreciation and amortization
37,195
36,182
Total premises and equipment, net
$
22,478
$
23,571
Depreciation and amortization included in occupancy and equipment expense totaled $2.4 million, $3.1 million, and $2.8 million, for the years ended December 31, 2022, 2021, and 2020, respectively.
6. OPERATING LEASES
The Company leases space under non-cancelable operating leases for 18 branch locations, four off-site ATM locations, one administrative building, two loan production offices 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, 2022, 2021 and 2020. 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, 2022 and 2021.
At December 31, 2022, the Company’s right-of-use assets and operating lease liabilities were $6.9 million and $7.3 million, respectively. The weighted average remaining lease term for the lease liabilities was 5.8 years, and the weighted average discount rate of remaining payments was 4.7 percent. At December 31, 2021, the Company’s right-of-use assets and operating lease liabilities were $5.5 million and $6.2 million, respectively. The weighted average remaining lease term for the lease liabilities was 6.3 years, and the weighted average discount rate of remaining payments was 5.3 percent for the year ended December 31, 2021. Lease liabilities from new right-of-use assets obtained during the year ending December 31, 2022 and December 31, 2021 were $3.3 million and $0.5 million, respectively. There were no variable lease costs for the years ending December 31, 2022 and 2021. Cash paid on operating leases was $2.3 million and $2.2 million for the years ending December 31, 2022 and 2021, respectively.
Future undiscounted lease payments for operating leases with initial terms of one year or more as of December 31, 2022 are as follows (dollars in thousands):
Year Ending December 31,
$
2,061
1,696
1,323
Thereafter
1,492
Total undiscounted lease payments
$
8,369
Less: imputed interest
(1,106)
Net lease liabilities
$
7,263
The Company generally has options to renew its facilities leases after the initial leases expire. The renewal options range from one to ten years.
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, 2022 (the measurement date that the Company selected), the Company’s stock closed at $21.24 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, 2022.
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
$
6,126
$
8,401
$
5,126
Aggregate amortization expense was $1.0 million, $1.0 million, and $1.1 million for 2022, 2021, and 2020.
Estimated amortization expense for each of the next five years and thereafter (dollars in thousands):
$
-
Thereafter
-
Total
$
2,275
8. OTHER ASSETS
Other assets consisted of the following (dollars in thousands):
December 31,
Accrued interest receivable
$
18,354
$
11,246
Deferred tax assets
34,984
3,792
Investment in qualified affordable housing projects
10,051
2,940
Investment in limited partnerships
4,359
1,655
Investment in SBA loan fund
25,000
10,400
Federal Home Loan Bank stock, at cost
12,729
12,393
Other
20,142
15,603
Total
$
125,619
$
58,029
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 $7.0 million in remaining capital commitments to these partnerships at December 31, 2022.
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 $12.7 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
Time deposits that meet or exceed the FDIC Insurance limit of $250,000 at year-end 2022 and 2021 were $97.8 million and $115.2 million, respectively.
Aggregate annual maturities of time deposits were as follows (dollars in thousands):
Year Ending December 31,
$
485,172
31,222
1,725
Thereafter
Total
$
519,608
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
4,914
1,039
2,687
Brokered Deposits
Total
$
6,819
$
2,390
$
3,948
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
As of December 31:
Repurchase agreements
$
110,387
$
109,169
0.29%
$
118,014
0.29%
Short term borrowings
47,708
219,000
3.67%
219,000
3.67%
Total
$
158,095
$
328,169
$
337,014
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
$
70,443
$
106,937
0.30%
$
106,937
0.30%
Short term borrowings
5,186
-
0.06%
5,000
-
Total
$
75,629
$
106,937
$
111,937
Included in short term borrowings was $94.0 million outstanding in fixed-rate overnight FHLB advances at December 31, 2022 and no balance outstanding at December 31, 2021. Each FHLB advance is payable at its maturity date, with a prepayment penalty for fixed rate advances. The advances were collateralized by $1.3 billion of first
mortgage loans under a blanket lien arrangement at year end 2022. Based on this collateral and the Company’s holdings of FHLB stock, the Company was eligible to borrow up to the total of $922.1 million at year-end 2022, with a remaining borrowing capacity of $661.0 million if sufficient additional collateral was pledged.
The Company had no borrowings at December 31, 2022 and 2021 from the FRB. The Company was eligible to borrow up to $42.3 million from FRB at year end 2022, which was collateralized by $52.1 million in first mortgage loans under a blanket lien arrangement.
The Company had unsecured lines of credit with its correspondent banks which, in the aggregate, amounted to $362.0 million and $305.0 million at December 31, 2022 and 2021, respectively, at fixed interest rates which vary with market conditions. Included in short term borrowings above there was $125.0 million outstanding overnight under these lines of credit at December 31, 2022 and no balance outstanding at December 31, 2021.
11. LONG-TERM DEBT
At year-end, long-term debt was as follows (dollars in thousands):
Principal
Unamortized Debt Issuance Costs
Principal
Unamortized Debt Issuance Costs
Fixed - floating rate subordinated debentures, due 2031 (1)
$
50,000
$
$
50,000
$
$
50,000
$
$
50,000
$
(1) 3.25% fixed rate for five years then floating rate at 253.5 basis points over 3-month term SOFR.
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, 2022, all $35.5 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, 2034, bear a current interest rate of 2.97% (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 1.62% (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 1.70% (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 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. INCOME TAXES
The provision for income taxes follows (dollars in thousands):
Year Ended December 31,
Federal:
Current
$
6,071
$
8,186
$
7,979
Deferred
(1,697)
Total federal
6,304
8,321
6,282
State:
Current
4,874
5,916
5,711
Deferred
(50)
(914)
Total state
4,952
5,866
4,797
Total tax provision
$
11,256
$
14,187
$
11,079
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 credit losses on loans and leases
$
6,817
$
4,215
Foreclosed assets
-
Deferred compensation
4,158
4,511
Accrued reserves
1,022
Non-accrual loans
Lease liability
2,147
1,752
Loan fair value adjustment
Net operating losses
1,370
1,592
State income tax deduction
1,005
1,179
Other
1,211
Unrealized losses on securities available-for-sale
23,746
-
Total deferred tax assets
41,962
15,705
Deferred tax liabilities:
Deferred loan costs
(1,070)
(1,288)
Right-of-use asset
(2,034)
(1,618)
TRUPS accretion
(788)
(840)
FMV equity securities
(706)
(804)
Prepaids
(639)
(615)
Other
(517)
(565)
Intangibles
(337)
(579)
Premises and equipment
(887)
(917)
Net unrealized gain on securities available-for-sale
-
(4,687)
Total deferred tax liabilities
(6,978)
(11,913)
Net deferred tax assets
$
34,984
$
3,792
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
$
9,432
$
12,012
$
9,770
Increase (decrease) resulting from:
State franchise tax expense, net of federal tax effect
3,912
4,634
3,790
Tax exempt municipal income
(1,849)
(1,306)
(1,199)
Affordable housing tax credits
(530)
(524)
(518)
Excess tax benefit of stock-based compensation
(50)
(109)
(90)
Cash surrender value - life insurance
(556)
-
Other
(674)
Total
$
11,256
$
14,187
$
11,079
Effective tax rate
25.06%
24.80%
23.81%
The Company is subject to federal income tax and income tax of various states. Our federal income tax returns for the years ended December 31, 2019, 2020 and 2021 are open to audit by the federal authorities and our California state tax returns for the years ended December 31, 2018, 2019, 2020 and 2021 are open to audit by the state authorities.
The Company has net operating loss carry forwards of approximately $4.0 million for federal income and approximately $6.1 million for California franchise tax purposes. Net operating loss carry forwards, to the extent not used will begin to expire in 2033. 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, 2022, 2021, and 2020, respectively. We do not expect the total amount of unrecognized tax benefits to significantly increase or decrease within the next twelve months
14. COMMITMENTS AND CONTINGENCIES
Letter of Credit
The Company holds two letters of credit with the Federal Home Loan Bank of San Francisco totaling $127.9 million. A $125.0 million letter of credit is pledged to secure public deposits at December 31, 2022 and a $2.9 million 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, 2022 and 2021.
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
$
94,248
$
72,946
Variable-rate commitments to extend credit
$
795,269
$
481,082
Standby letters of credit
$
6,037
$
6,651
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, 2022, in management’s judgment the Company had a concentration of loans secured by real estate. At that date, approximately 92% of the Company’s loans were real estate related. Balances secured by commercial buildings and construction and development loans represented 66% of all real estate loans, while loans secured by non-construction residential properties accounted for 28%, and loans secured by farmland were 6% 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; 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.
Legal Matters
In the ordinary course of our business, the Company is subject to legal proceedings and claims which we believe are incidental to the operation of our business. The outcome of such legal actions and the timing of ultimate resolution are inherently difficult to predict. Upon consultation with legal counsel and based on information currently available to us, management does not expect the amount of any resulting liability, in addition to amounts already accrued and taking into consideration insurance which may be applicable, to have a material adverse effect on the consolidated financial position or results of operations of the Company. Given the nature, scope and complexity of the extensive legal and regulatory landscape applicable to banking (including laws and regulations governing consumer protection, fair lending, privacy, information security and anti-money laundering and anti-terrorism laws), we like all banking organizations, are subject to heightened legal and regulatory compliance and litigation risk.
The Company has established litigation and legal reserves, where appropriate, in accordance with FASB guidance over loss contingencies (ASC 450). The outcome of litigation and other legal and regulatory matters is inherently uncertain, however, and it is possible that one or more of the legal or regulatory matters currently pending or threatened could have a material adverse effect on our liquidity, consolidated financial position, and/or results of operations.
15. SHAREHOLDERS’ EQUITY
Share Repurchase Plan
At December 31, 2022, the Company had a stock repurchase plan which has no expiration date. During the year ended December 31, 2022, the Company repurchased 182,562 shares. The total number of shares available for repurchase at December 31, 2022 was 630,000. Repurchases are generally made in the open market at market prices.
Earnings Per Share
A reconciliation of the numerators and denominators of the basic and diluted earnings per share computations is as follows (dollars in thousands, except per share data):
For the Years Ended December 31,
Basic Earnings Per Share
Net income (dollars in thousands)
$
33,659
$
43,012
$
35,444
Weighted average shares outstanding
14,955,756
15,241,957
15,216,749
Basic earnings per share
$
2.25
$
2.82
$
2.33
Diluted Earnings Per Share
Net income (dollars in thousands)
$
33,659
$
43,012
$
35,444
Weighted average shares outstanding
14,955,756
15,241,957
15,216,749
Effect of dilutive equity awards
66,999
111,488
63,576
Weighted average shares outstanding
15,022,755
15,353,445
15,280,325
Diluted earnings per share
$
2.24
$
2.80
$
2.32
Stock options and unvested restricted stock awards for 293,586, 337,004, and 348,328 shares of common stock were not considered in computing diluted earnings per common share for 2022, 2021, and 2020, 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 135,449 shares that were granted under the 2007 Plan were still outstanding as of December 31, 2022, 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, 2022, was 382,006.
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.
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
$
24.15
$
23.67
$
21.08
Exercised or released
(30)
$
10.59
(33)
$
14.64
(67)
$
11.65
Granted
-
$
-
-
$
-
$
27.11
Canceled
(32)
$
27.32
(45)
$
26.36
(21)
$
26.01
Expired
(2)
$
10.21
(1)
$
10.58
(1)
$
10.73
Outstanding, end of year
$
25.06
$
$
24.15
$
23.67
Exercisable, end of year (2)
$
24.78
$
$
23.62
$
21.97
(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, 2022. 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, 2022 was 5.2 years and 5.0 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
Total intrinsic value of stock options exercised
$
$
$
Total fair value of stock options vested
$
$
$
$0.3 million in cash was received from the exercise of 29,640 shares during the period ended December 31, 2022, with a related tax benefit of $0.1 million. $0.3 million in cash was received from the exercise of 25,452 shares during the period ended December 31, 2021, with a related tax benefit of $0.1 million. $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 $0.1 million, $0.1 million, and $0.4 million are reflected in the Company’s income statements for the years ended December 31, 2022, 2021, and 2020, respectively, as pre-tax compensation and directors’ expense related to stock options. The related tax benefit of these options is $0.03 million for the years ended December 31, 2022 and 2021, and $0.1 million for the year ended December 31, 2020.
Unamortized compensation expense associated with unvested stock options outstanding at December 31, 2022 was $0.1 million, which will be recognized over a weighted average period of 2.0 years.
Restricted Stock Grants
The Company’s restricted stock awards are 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 2022, 70,465 shares were granted to employees and directors of the Company. These awards are expensed on a straight-line basis over the vesting period. Compensation expense related to restricted stock units for the years ended December 31, 2022, 2021 and 2020 was $1.2 million, $0.9 million, and $0.2 million respectively, and the recognized income tax benefit related to this expense was $0.4 million, $0.3 million, and $0.1 million, respectively. As of December 31, 2022, there was $2.9 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 2.4 years. The total fair value of shares vested during the year ended December 31, 2022 and 2021 was $1.3 million and $0.7 million, respectively. There were no shares vested during the year ended December 31, 2020.
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, 2022
$
21.72
Granted
21.32
Vested
(58)
21.97
Forfeited
(2)
27.16
Nonvested at December 31, 2022
$
21.42
16. 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, 2022, 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, 2022 and 2021, 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 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, 2022, 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 (dollars 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
$
371,980
10.30%
$
325,031
9.00%
Bank of the Sierra
$
396,856
10.99%
$
324,996
9.00%
Actual
To Be Well Capitalized Under Prompt Corrective Action Regulations
Capital Amount
Ratio
Capital Amount
Ratio
Tier 1 (Core) Capital to average total assets
Sierra Bancorp and subsidiary
$
356,800
10.43%
$
290,851
8.50%
Bank of the Sierra
$
387,059
11.31%
$
290,817
8.50%
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, 2022, the maximum amount available for dividend distribution under this restriction was approximately $66.3 million.
17. 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 $4.9 million and $5.1 million for the years ended December 31, 2022 and 2021 and was fully accrued for both years. The expense recognized
under these arrangements totaled $0.3 million, $0.4 million and $0.2 million for the years ended December 31, 2022, 2021 and 2020, respectively. Salary continuation benefits paid to former directors or executives of the Company or their beneficiaries totaled $0.4 million, $0.4 million and $0.4 million for the years ended December 31, 2022, 2021 and 2020. 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 at December 31, 2022 and 2021.
Officer and Director Deferred Compensation Plan
The Company has established a non-qualified 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 and the liability for the plan’s administration and the changes to income earned on participant deferrals. The related administrative expense was not material for the years ended December 31, 2022, 2021 and 2020. Although there is no requirement to fund this plan, the Company has purchased life insurance policies with cash surrender values totaling $9.0 million and $11.0 million at December 31, 2022 and 2021, respectively, which are specific account policies with underlying investments similar to the hypothetical investments elected inside the participant deferred compensation accounts.
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 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 80%, 95% and 90% for the years ended December 31, 2022, 2021 and 2020, 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 $1.2 million to the Plan in each of the years ended 2022 and 2021 and contributed $1.1 million to the Plan in 2020.
18. 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
$
$
(524)
$
(1,189)
Dividends on equity investments
Unrealized gains recognized on equity investments
(332)
Other
8,447
4,019
4,638
Total other noninterest income
$
9,211
$
5,089
$
4,560
19. OTHER NONINTEREST EXPENSE
Other noninterest expense consisted of the following (dollars in thousands):
Year Ended December 31,
Legal, audit, professional, and director's fees
$
3,061
$
7,652
$
4,263
Data processing
6,202
5,890
4,661
Advertising and promotional
1,728
1,521
1,889
Deposit services
9,492
9,049
8,483
Stationery and supplies
Telephone and data communication
1,563
2,013
1,775
Loan and credit card processing
Foreclosed assets expense (income), net
Postage
Other
3,415
2,780
2,205
Assessments
1,078
1,157
Total other noninterest expense
$
28,032
$
31,288
$
25,892
20. 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 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
$
1,067
$
1,794
$
2,731
Disbursements
4,059
1,983
7,114
Amounts repaid
(5,150)
(2,548)
(8,051)
Effect of changes in composition of related parties
(162)
-
Balance, end of year
$
-
$
1,067
$
1,794
Undisbursed commitments to related parties
$
$
2,156
$
2,635
Deposits from related parties held by the Bank at December 31, 2022 and 2021 amounted to $8.1 million and $9.9 million, respectively.
21. 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, live trading desk pricing from brokerages, 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. In certain circumstances live trading desk pricing from brokerages and third party internal models are used to value debt securities that we classify as Level 3.
Collateral-dependent loans: A specific loss allowance is created for collateral dependent 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 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, 2022, 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
$
-
$
50,599
$
-
$
50,599
$
-
Mortgage-backed securities
-
122,532
-
122,532
-
State and political subdivisions
-
205,980
-
205,980
-
Corporate bonds
-
-
57,435
57,435
-
Collateralized loan obligations
-
498,377
-
498,377
-
Total available-for-sale securities
$
-
$
877,488
$
57,435
$
934,923
$
-
Fair Value Measurements at December 31, 2021, 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
$
-
$
1,574
$
-
$
1,574
$
-
Mortgage-backed securities
-
306,727
-
306,727
-
State and political subdivisions
-
304,268
-
304,268
-
Corporate bonds
-
27,530
28,529
-
Collateralized loan obligations
-
136,509
195,707
332,216
-
Total available-for-sale securities
$
-
$
750,077
$
223,237
$
973,314
$
-
The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2022 and 2021 (dollars in thousands):
Collateralized Loan Obligations
Corporate Bonds
Balance of recurring Level 3 assets at January 1,
$
195,707
$
-
$
27,530
$
-
Purchases
-
195,707
29,905
27,530
Transfers out of Level 3
(195,707)
-
-
-
Balance of recurring Level 3 assets at December 31,
$
-
$
195,707
$
57,435
$
27,530
The following tables present quantitative information about recurring level 3 fair value measurements at December 31, 2022 (dollars in thousands):
Range
Fair Value
Valuation Technique(s)
Unobservable Input(s)
Min
Max
Weighted Average
Corporate Bonds
$
57,435
New issue pricing
Risk appetite
N/A
N/A
N/A
Secondary market pricing
Market volatility
Credit quality of issuer
Credit spread
The following table presents quantitative information about recurring level 3 fair value measurements at December 31, 2021 (dollars in thousands):
Range
Fair Value
Valuation Technique(s)
Unobservable Input(s)
Min
Max
Weighted Average
Corporate Bonds
$
27,530
New issue pricing
Risk appetite
N/A
N/A
N/A
Secondary market pricing
Market volatility
Credit quality of issuer
Credit spread
Collateralized Loan Obligations
195,707
New issue pricing
Constant prepayment rate
N/A
N/A
N/A
Secondary market pricing
Default rate
Credit quality of issuer
Recovery rate
Credit spread
$
223,237
Assets and liabilities measured at fair market value on a non-recurring basis are summarized below (dollars in thousands):
Year Ended December 31, 2022
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total
Collateral dependent loans
$
-
$
18,141
$
-
$
18,141
Foreclosed assets
$
-
$
-
$
-
$
-
Year Ended December 31, 2021
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
$
-
$
$
-
$
The following table presents quantitative information about level 3 fair value measurements for assets measured at fair value on a non-recurring basis at December 31, 2021 (dollars in thousands):
Range
Fair Value
Valuation Technique(s)
Unobservable Input(s)
Min
Max
Weighted Average
Impaired loans - commercial and industrial
$
Fair value of collateral
Collateral discount
50%
70%
56%
$
There were no assets measured at fair value on a non-recurring basis with level 3 fair value measurements at December 31, 2022.
22. 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 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, 2022 and 2021:
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, live trading desk pricing from brokerages, 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.
Mortgage loans: Fair value of mortgage loans, included in the table with loans and leases held for investment, 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 mortgage 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.
Collateral-dependent loans: A specific loss allowance is created for collateral dependent loans, representing the difference between the face value of the loan and the current appraised value of its associated collateral, less estimated disposition costs.
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.
Carrying amount and estimated fair values of financial instruments were as follows (dollars in thousands):
Year Ended December 31, 2022
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
$
77,131
$
77,131
$
-
$
-
$
77,131
Securities available-for-sale
934,923
-
877,488
57,435
934,923
Securities held-to-maturity
336,881
-
328,011
-
328,011
Loans and leases held for investment
2,011,616
-
-
1,909,822
1,909,822
Collateral dependent loans
18,141
-
18,141
-
18,141
Financial Liabilities:
Deposits:
Noninterest bearing
$
1,088,199
$
1,088,199
$
-
$
-
$
1,088,199
Interest bearing
1,757,965
-
1,756,443
-
1,756,443
Repurchase agreements
109,169
-
109,169
-
109,169
Short-term borrowings
219,000
-
219,000
-
219,000
Long-term borrowings
49,214
-
42,775
-
42,775
Subordinated debentures
35,481
-
37,171
-
37,171
Notional
Amount
Off-balance-sheet financial instruments:
Commitments to extend credit
$
889,517
Standby letters of credit
6,037
Carrying amount and estimated fair values of financial instruments were as follows (dollars in thousands):
Year Ended December 31, 2021
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
$
257,528
$
257,528
$
-
$
-
$
257,528
Securities available for sale
973,314
-
750,077
223,237
973,314
Loans and leases held for investment
1,973,207
-
-
1,960,966
1,960,966
Collateral dependent impaired loans
-
Financial Liabilities:
Deposits:
Noninterest bearing
$
1,084,544
$
1,084,544
$
-
$
-
$
1,084,544
Interest bearing
1,697,028
-
1,696,124
-
1,696,124
Fed funds purchased and repurchase agreements
106,937
-
106,937
-
106,937
Short-term borrowings
-
-
-
-
-
Long-term borrowings
49,141
-
49,118
-
49,118
Subordinated debentures
35,302
-
33,281
-
33,281
Notional
Amount
Off-balance-sheet financial instruments:
Commitments to extend credit
$
554,028
Standby letters of credit
6,651
23. QUALIFIED AFFORDABLE HOUSING PROJECT INVESTMENTS
The Company invests in qualified affordable housing projects. At December 31, 2022 and 2021, the balance of the investment for qualified affordable housing projects totaled $10.1 million and $2.9 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 $7.0 million and $0.1 million at December 31, 2022 and 2021, respectively.
During the years ended December 31, 2022, 2021 and 2020, the Company recognized amortization expense on these investments of $0.5 million, $0.5 million, and $0.6 million, respectively which was included within pretax income on the consolidated statements of income.
Additionally, during the years ended December 31, 2022, 2021 and 2020 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, 2022, 2021 and 2020.
24. 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, 2022 and 2021. Items outside the scope of ASC 606 are noted as such (dollars in thousands).
Year Ended December 31,
Noninterest income
Service charges on deposits
Returned item and overdraft fees
$
5,227
$
4,924
$
5,078
Other service charges on deposits
7,308
6,922
6,687
Debit card interchange income
8,533
8,485
7,023
Gain (loss) on limited partnerships(1)
(524)
(1,189)
Dividends on equity investments(1)
Unrealized (losses) gains recognized on equity investments(1)
(332)
Net gains on sale of securities(1)
1,487
Other(1)
7,451
6,667
7,050
Total noninterest income
$
30,770
$
28,079
$
26,150
Noninterest expense
Salaries and employee benefits(1)
$
47,053
$
42,431
$
40,178
Occupancy expense(1)
9,718
9,837
9,842
Gains on sale of OREO
(8)
(153)
(10)
Other(1)
28,040
31,441
25,902
Total noninterest expense
$
84,803
$
83,556
$
75,912
(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.
25. PARENT ONLY CONDENSED FINANCIAL STATEMENTS
BALANCE SHEETS
Years Ended December 31, 2022 and 2021
(dollars in thousands)
ASSETS
Cash and due from banks
$
26,099
$
20,143
Investments in bank subsidiary
363,507
428,054
Investment in trust subsidiaries
1,145
1,145
Other assets
4,162
Total assets
$
394,913
$
449,363
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Other liabilities
$
6,636
$
2,426
Long-term debt
49,214
49,141
Subordinated debentures
35,481
35,302
Total liabilities
91,331
86,869
Shareholders' equity:
Common stock
117,076
116,917
Retained earnings
243,082
234,410
Accumulated other comprehensive gain, net of taxes
(56,576)
11,167
Total shareholders' equity
303,582
362,494
Total liabilities and shareholders' equity
$
394,913
$
449,363
STATEMENTS OF INCOME
Years Ended December 31, 2022, 2021 and 2020
(dollars in thousands)
Income:
Dividend from subsidiary
$
28,000
$
3,200
$
23,000
Other operating income
-
-
Total income
28,000
3,200
23,043
Expense
Salaries and employee benefits
1,129
Other expenses
4,550
2,728
1,971
Total expenses
5,679
3,507
2,827
Income before income taxes
22,321
(307)
20,216
Income tax benefit
(1,679)
(1,037)
(823)
Income before equity in undistributed income of subsidiary
24,000
21,039
Equity in undistributed income of subsidiary
9,659
42,282
14,405
Net income
$
33,659
$
43,012
$
35,444
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2022, 2021 and 2020
(dollars in thousands)
Cash flows from operating activities:
Net income
$
33,659
$
43,012
$
35,444
Adjustments to reconcile net income to net cash provided by operating activities:
Undistributed net income of subsidiary
(9,659)
(42,282)
(14,405)
(Increase) decrease in other assets
(3,459)
Increase (decrease) in other liabilities
4,212
1,263
(41)
Net cash provided by operating activities
24,753
2,172
21,176
Cash flows from investing activities:
Investment in subsidiary
-
(25,000)
-
Net cash used by investing activities
-
(25,000)
-
Cash flows from financing activities:
Stock options exercised
Repurchase of common stock
(5,192)
(5,220)
(2,562)
Dividends paid
(13,919)
(13,232)
(12,207)
Issuance of debentures, net
-
49,141
-
Net cash (used) in provided by financing activities
(18,797)
30,971
(13,994)
Net increase in cash and cash equivalents
5,956
8,143
7,182
Cash and cash equivalents, beginning of year
20,143
12,000
4,818
Cash and cash equivalents, end of year
$
26,099
$
20,143
$
12,000
26. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth the Company’s unaudited results of operations for the four quarters of 2022 and 2021. 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).
2022 Quarter Ended
December 31,
September 30,
June 30,
March 31,
Interest income
$
35,603
$
31,929
$
28,206
$
26,081
Interest expense
6,240
3,017
1,621
1,325
Net interest income
29,363
28,912
26,585
24,756
Provision for loan and lease losses
6,483
1,259
2,419
Noninterest income
7,656
6,612
10,539
6,063
Noninterest expense
21,522
20,996
22,213
20,079
Net income before taxes
9,014
13,269
12,492
10,140
Provision for taxes
1,901
3,334
3,288
2,733
Net income
$
7,113
$
9,935
$
9,204
$
7,407
Diluted earnings per share
$
0.47
$
0.66
$
0.62
$
0.49
Cash dividend per share
$
0.23
$
0.23
$
0.23
$
0.23
2021 Quarter Ended
December 31,
September 30,
June 30,
March 31,
Interest income
$
27,897
$
27,629
$
28,092
$
29,458
Interest expense
1,331
Net interest income
26,566
26,716
27,189
28,555
Provision for loan and lease losses
(1,200)
(600)
(2,100)
Noninterest income
7,103
7,534
6,612
6,830
Noninterest expense
22,175
20,875
20,235
20,271
Net income before taxes
12,694
13,975
15,666
14,864
Provision for taxes
3,073
3,370
3,958
3,786
Net income
$
9,621
$
10,605
$
11,708
$
11,078
Diluted earnings per share
$
0.63
$
0.69
$
0.76
$
0.72
Cash dividend per share
$
0.22
$
0.22
$
0.21
$
0.21
27. SUBSEQUENT EVENTS
Subsequent to year end, $18.1 million of nonaccrual loans from a single dairy relationship were foreclosed upon and were moved to other real estate owned or other foreclosed assets at net realizable value. The Company sold a portion of such assets in the first quarter of 2023 for $7.7 million, which constituted book value. The Company continues to actively work with interested buyers to sell the remaining assets of the dairy.

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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, 2022. 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, 2022.
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, 2022.
Our assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2022 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 2022 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.

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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 2022 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
3.1
Restated Articles of Incorporation of Sierra Bancorp (1)
3.2
Amended and Restated By-laws of the Company (2)
4.1
Description of Securities (3)
4.2
3.25% Fixed to Floating Subordinated Debt issued September 24, 2021 (4)
10.1
Salary Continuation Agreement for Kenneth R. Taylor (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, and Michael Olague, Chief Banking Officer (15)*
10.22
Employment agreement dated as of November 15, 2019 for Christopher Treece, EVP and CFO (16)*
10.23
Employment agreement dated as of January 17, 2020 for Jennifer Johnson, EVP and CAO (17)*
10.24
Employment agreement dated as of December 14, 2020 for Hugh Boyle, Chief Credit Officer (18)*
10.25
Form Indemnification Agreement dated as of January 28, 2021 for Directors and Executive Officers (19)*
10.26
Split Dollar Master Agreement and Election Form Effective October 1, 2002, for Kevin McPhaill (20)*
10.28
Salary Continuation Agreement for James C. Holly (5)*
10.29
Split Dollar Agreement and Amendment thereto for James C. Holly (6)*
10.30
First Amendments to employment agreements dated as of January 19, 2023 for Kevin McPhaill, CEO, Christopher Treece, CFO, Hugh Boyle, CCO, Michael Olague, CBO, and Jennifer Johnson, CAO (21)*
Subsidiaries of Sierra Bancorp
23.1
Consent of Eide Bailly
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 - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL 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
Cover Page Interactive Data File - The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
(1) Filed as Exhibit 3.1 to the Form 10-Q filed with the SEC on August 7, 2009 and incorporated herein by reference.
(2) Filed as Exhibit 3.3 to the Form 8-K filed with the SEC on February 21, 2007 and incorporated herein by reference.
(3) Filed as Exhibit 4.1 to the Form 10-K filed with the SEC on March 12, 2021 and incorporated herein by reference.
(4) Filed as Exhibit 4.1 to the Form 8-K filed with the SEC on September 24, 2021 and incorporated herein by reference.
(5) Filed as Exhibits 10.5 and 10.7 to the Form 10-Q filed with the SEC on May 15, 2003 and incorporated herein by reference.
(6) Filed as Exhibits 10.10, 10.12, 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 and 99.4 to the Form 8-K filed with the SEC on December 28, 2018 and incorporated by reference.
(16) Filed as Exhibit 99.1 to the Form 8-K filed with the SEC on November 11, 2019 and incorporated by reference.
(17) Filed as Exhibit 99.1 to the Form 8-K filed with the SEC on January 21, 2020 and incorporated by reference.
(18) Filed as Exhibit 10.1 to the Form 8-K filed with the SEC on December 09, 2020 and incorporated herein by reference.
(19) Filed as Exhibit 10.1 to the Form 8-K filed with the SEC on January 29, 2021 and incorporated herein by reference.
(20) Filed as Exhibit 10.25 to the Form 10-Q filed with the SEC on November 3, 2022 and incorporated herein by reference.
(21) Filed as Exhibits 10.1 through 10.5 to the form 8-K filed with the SEC on January 19, 2023 and incorporated herein 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.