EDGAR 10-K Filing

Company CIK: 1114927
Filing Year: 2021
Filename: 1114927_10-K_2021_0001140361-21-007530.json

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ITEM 1. BUSINESS
ITEM 1 - BUSINESS
General
First Northern Community Bancorp (the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (“BHCA”). Its legal headquarters and principal administrative offices are located at 195 N. First Street, Dixon, CA 95620 and its telephone number is (707) 678-3041. The Company provides a full range of community banking services to individual and corporate customers throughout the California Counties of Solano, Yolo, Placer, and Sacramento as well as portions of El Dorado and Contra Costa Counties through its wholly-owned subsidiary bank, First Northern Bank of Dixon (“First Northern” or the “Bank”). The Company’s operating policy since inception has emphasized the banking needs of individuals and small- to medium-sized businesses. In addition, the Bank owns 100% of the capital stock of Yolano Realty Corporation, a subsidiary created for the purpose of managing selected other real estate owned properties.
The Bank was established in 1910 under a California state charter as Northern Solano Bank, and opened for business on February 1st of that year. On January 2, 1912, the First National Bank of Dixon was established under a federal charter, and until 1955, the two entities operated side by side under the same roof and with the same management. In an effort to increase efficiency of operation, reduce operating expense, and improve lending capacity, the two banks were consolidated on April 8, 1955, with the First National Bank of Dixon as the surviving entity. On January 1, 1980, the Bank's federal charter was relinquished in favor of a California state charter, and the Bank's name was changed to First Northern Bank of Dixon.
In April of 2000, the shareholders of First Northern approved a corporate reorganization, which provided for the creation of the bank holding company. This reorganization, effected May 19, 2000, enabled the Company to better compete and grow in its competitive and rapidly changing marketplace.
The Bank has eleven full service branches located in the cities of Auburn, Davis, Dixon, Fairfield, Rancho Cordova, Roseville, Sacramento, Vacaville, West Sacramento, Winters and Woodland. The Bank has one satellite banking office inside a retirement community in the city of Davis and a residential mortgage loan office in Davis. The Bank engages financial advisors, through Raymond James Financial Services, Inc., who offer non-FDIC insured investment and brokerage services throughout the region from offices strategically located in West Sacramento, Davis and Auburn. The Bank also has a commercial loan office in the Contra Costa County city of Walnut Creek that serves the East Bay Area's small- to medium-sized business lending needs. The Bank’s operations center is located in Dixon and provides back-office support including information services, central operations, and the central loan department. In 2019, the Bank opened an additional administrative office in Sacramento.
The Bank is in the commercial banking business and generates most of its revenue by providing a wide range of products and services to small- and medium-sized businesses and individuals including accepting demand, interest bearing transaction, savings, and time deposits, and making commercial, consumer, and real estate related loans. It also issues cashier's checks, rents safe deposit boxes, and provides other customary banking services.
First Northern offers a broad range of alternative investment products, fiduciary and other financial services through Raymond James Financial Services, Inc. First Northern also offers equipment leasing, credit cards, merchant card processing, payroll services, and limited international banking services through third parties.
The Bank’s principal source of revenue comes from interest income. Interest income is primarily derived from interest and fees on loans and leases, interest on investments, and due from banks interest bearing accounts. For the year ended December 31, 2020, these sources comprised approximately 83%, 14%, and 2%, respectively, of the Company’s interest income.
The Bank is a member of the Federal Deposit Insurance Corporation ("FDIC") and all deposit accounts are insured by the FDIC to the maximum amount permitted by law, currently $250,000 per depositor. Most of the Bank's deposits are attracted from the market of northern and central Solano County and southern and central Yolo County. The Bank’s deposits are not received from a single depositor or group of affiliated depositors, the loss of any one which would have a materially adverse impact on the business of the Bank. A material portion of the Bank’s deposits are not concentrated within a single industry group of related industries.
As of December 31, 2020, the Company had consolidated assets of approximately $1.66 billion, liabilities of approximately $1.50 billion and stockholder’s equity of approximately $150.7 million. The Company and its subsidiaries employed 214 full-time-equivalent employees as of December 31, 2020. The Company and the Bank consider their relationship with their employees to be good and have not experienced any interruptions of operations due to labor disagreements.
Available Information
The Company makes available free of charge on its website, www.thatsmybank.com, its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. These filings are also accessible on the SEC’s website at www.sec.gov. The information found on the Company’s website shall not be deemed incorporated by reference by any general statement incorporating by reference this report into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934 and shall not otherwise be deemed filed under such Acts.
The Effect of Government Policy on Banking
The earnings and growth of the Bank are affected not only by local market area factors and general economic conditions, but also by government monetary and fiscal policies. For example, the Board of Governors of the Federal Reserve System (“FRB”) influences the supply of money through its open market operations in U.S. Government securities, adjustments to the discount rates applicable to borrowings by depository institutions and others and establishment of reserve requirements against both member and non-member financial institutions’ deposits. Such actions significantly affect the overall growth and distribution of loans, investments, and deposits and also affect interest rates charged on loans and paid on deposits. The nature and impact of future changes in such policies on the business and earnings of the Company cannot be predicted. Additionally, state and federal tax policies can impact banking organizations.
Because of the extensive regulation of commercial banking activities in the United States, the business of the Company is particularly susceptible to being affected by the enactment of federal and state legislation which may have the effect of increasing or decreasing the cost of doing business, modifying permissible activities or enhancing the competitive position of other financial institutions. Any change in applicable laws, regulations, or policies may have a material adverse effect on the business, financial condition, or results of operations, or prospects of the Company.
In May 2018, the President signed into law the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”) which amended various provisions of the Dodd-Frank Act as well as other federal banking statutes, and generally authorized the FRB to tailor regulation to better reflect the character of the different banking firms that the FRB supervises. In August 2018, the FRB began implementing the EGRRCPA with several interim final rules which, among other things, revised the FRB’s Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (the “policy statement”) to raise the consolidated assets threshold from $1 billion to $3 billion, allowing the Company to qualify under the policy statement. This policy statement applies to bank holding companies with pro forma consolidated assets of less than $3 billion that (i) are not engaged in significant nonbanking activities either directly or through a nonbank subsidiary; (ii) do not conduct significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; and (iii) do not have a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the SEC. This policy statement permits qualifying bank holding companies, such as the Company, to operate with higher levels of debt, facilitating the ability of community banks to issue debt and raise capital. Qualifying bank holding companies, such as the Company, also are permitted to be examined by a Federal banking agency every 18 months (as opposed to every 12 months) and are eligible to use shorter call report forms. Whether and to what extent the EGRRCPA or new legislation will result in additional regulatory initiatives and policies, or modifications of existing regulations and policies, which may impact our business, cannot be predicted at this time.
Supervision and Regulation of Bank Holding Companies
The Company is a bank holding company subject to the Bank Holding Company Act of 1956, as amended (“BHCA”). The Company reports to, registers with, and is subject to supervision and examination by, the FRB. The FRB also has the authority to examine the Company’s subsidiaries. The costs of any examination by the FRB are payable by the Company.
The FRB has significant supervisory, regulatory and enforcement authority over the Company and its affiliates. The FRB requires the Company to maintain certain levels of capital. See “Capital Standards” below for more information. The FRB also has the authority to take enforcement action against any bank holding company that commits any unsafe or unsound practice, or violates certain laws, regulations, or conditions imposed in writing by the FRB. See “Prompt Corrective Action and Other Enforcement Mechanisms” below for more information. Such enforcement powers include the power to assess civil money penalties against any bank holding company violating any provision of the BHCA or any regulation or order of the FRB under the BHCA. Knowing violations of the BHCA or regulations or orders of the FRB can also result in criminal penalties for the company and any individuals participating in such conduct. Under long-standing FRB policy and provisions of the Dodd-Frank Act, bank holding companies are required to act as a source of financial and managerial strength to their subsidiary banks, and to commit resources to support their subsidiary banks. This support may be required at times when a bank holding company may not have the resources to provide such support, or may not be inclined to provide such support under the then-existing circumstances.
Under the BHCA, a company generally must obtain the prior approval of the FRB before it exercises a controlling influence over a bank, or acquires, directly or indirectly, more than 5% of the voting shares or substantially all of the assets of any bank or bank holding company. Thus, the Company is required to obtain the prior approval of the FRB before it acquires, merges, or consolidates with any bank or bank holding company. Any company seeking to acquire, merge, or consolidate with the Company also would be required to obtain the prior approval of the FRB.
The Company is generally prohibited under the BHCA from acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than banking, managing banks, or providing services to affiliates of the holding company. However, a bank holding company, with the approval of the FRB, may engage, or acquire the voting shares of companies engaged, in activities that the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. A bank holding company must demonstrate that the benefits to the public of the proposed activity will outweigh the possible adverse effects associated with such activity.
The FRB generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements that might adversely affect a bank holding company’s financial position. The FRB’s policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality, and overall financial condition. The Company is also subject to restrictions relating to the payment of dividends under California corporate law. See “Restrictions on Dividends and Other Distributions” below for additional restrictions on the ability of the Company and the Bank to pay dividends.
Supervision and Regulation of the Bank
The Bank is subject to regulation, supervision and regular examination by the Financial Institutions Division of the California Department of Financial Protection and Innovation ("DFPI") and the FDIC. The regulations of these agencies affect most aspects of the Bank’s business and prescribe permissible types of loans and investments, the amount of required reserves, requirements for branch offices, the permissible scope of the Bank’s activities and various other requirements. While the Bank is not a member of the FRB, it is directly subject to certain regulations of the FRB dealing with such matters as check clearing activities, establishment of banking reserves, Truth-in-Lending (“Regulation Z”), and Equal Credit Opportunity (“Regulation B”). The Bank is also subject to regulations of (although not direct supervision and examination by) the Consumer Financial Protection Bureau (“CFPB”), which was created by the Dodd-Frank Act. Among the CFPB’s responsibilities are implementing and enforcing federal consumer financial protection laws, reviewing the business practices of financial services providers for legal compliance, monitoring the marketplace for transparency on behalf of consumers and receiving complaints and questions from consumers about consumer financial products and services. The Dodd-Frank Act added prohibitions on unfair, deceptive or abusive acts and practices to the scope of consumer protection regulations overseen and enforced by the CFPB.
The banking industry is also subject to significantly increased regulatory controls and processes regarding the Bank Secrecy Act and anti-money laundering laws. In recent years, a number of banks and bank holding companies announced the imposition of regulatory sanctions, including regulatory agreements and cease and desist orders and, in some cases, fines and penalties, by the bank regulators due to failures to comply with the Bank Secrecy Act and other anti-money laundering legislation. In a number of these cases, the fines and penalties have been significant. Failure to comply with these additional requirements may also adversely affect the Bank's ability to obtain regulatory approvals for future initiatives requiring regulatory approval, including acquisitions.
Under California law, the Bank is subject to various restrictions on, and requirements regarding, its operations and administration including the maintenance of branch offices and automated teller machines, capital and reserve requirements, deposits and borrowings, and investment and lending activities.
California law permits a state chartered bank to invest in the stock and securities of other corporations, subject to a state chartered bank receiving either general authorization or, depending on the amount of the proposed investment, specific authorization from the DFPI. Federal banking laws, however, impose limitations on the activities and equity investments of state chartered, federally insured banks. The FDIC rules on investments prohibit a state bank from acquiring an equity investment of a type, or in an amount, not permissible for a national bank. FDIC rules also prohibit a state bank from engaging as a principal in any activity that is not permissible for a national bank, unless the bank is adequately capitalized and the FDIC approves the activity after determining that such activity does not pose a significant risk to the deposit insurance fund. The FDIC rules on activities generally permit subsidiaries of banks, without prior specific FDIC authorization, to engage in those activities that have been approved by the FRB for bank holding companies because such activities are so closely related to banking to be a proper incident thereto. Other activities generally require specific FDIC prior approval, and the FDIC may impose additional restrictions on such activities on a case-by-case basis in approving applications to engage in otherwise impermissible activities.
The USA Patriot Act
Title III of the United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) includes numerous provisions for fighting international money laundering and blocking terrorism access to the U.S. financial system. The USA Patriot Act requires certain additional due diligence and record keeping practices, including, but not limited to, new customers, correspondent and private banking accounts.
Part of the USA Patriot Act is the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”). Among its provisions, IMLAFATA requires each financial institution to: (i) establish an anti-money laundering program; (ii) establish appropriate anti-money laundering policies, procedures, and controls; (iii) appoint a Bank Secrecy Act officer responsible for day-to-day compliance; and (iv) conduct independent audits. In addition, IMLAFATA contains a provision encouraging cooperation among financial institutions, regulatory authorities, and law enforcement authorities with respect to individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering activities. IMLAFATA expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours. IMLAFATA also amends the BHCA and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing an application under these Acts.
Pursuant to IMLAFATA, the Secretary of the Treasury, in consultation with the heads of other government agencies, has adopted and proposed measures applicable to banks, bank holding companies, and/or other financial institutions. These measures include enhanced record keeping and reporting requirements for certain financial transactions that are of primary money laundering concern, due diligence requirements concerning the beneficial ownership of certain types of accounts, and restrictions or prohibitions on certain types of accounts with foreign financial institutions.
Privacy Restrictions
The Gramm-Leach-Bliley Act (“GLBA”), which became law in 1999, in addition to the previous described changes in permissible non-banking activities permitted to banks, bank holding companies and financial holding companies, also requires financial institutions in the U.S. to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, the GLBA requires explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, prohibits disclosing such information except as provided in the banks’ policies and procedures and applicable law. These regulations also allow consumers to opt-out of the sharing of certain information between affiliates, and impose other requirements.
Certain state laws and regulations designed to protect the privacy and security of customer information also apply to us and our other subsidiaries., including laws requiring notification to affected individuals and regulators of data security breaches. For additional information, see “Information security breaches or other technological difficulties could adversely affect the Company” in Part I, Item 1A. “Risk Factors” in this report.
The Company believes that it complies with all provisions of GLBA and all implementing regulations, and that the Bank has developed appropriate policies and procedures to meet its responsibilities in connection with the privacy provisions of GLBA.
California and other state legislatures have adopted privacy laws, including laws prohibiting sharing of customer information without the customer’s prior permission. These laws may make it more difficult for the Company to share information with its marketing partners, reduce the effectiveness of marketing programs, and increase the cost of marketing programs.
In June 2018, the State of California enacted The California Consumer Privacy Act of 2018 (“CCPA”). This new law became effective on January 1, 2020, and provides consumers with expansive rights and controls over their personal information which is obtained by or shared with “covered businesses”, which includes the Bank and most other banking institutions subject to California law. The CCPA gives consumers the right to request disclosure of information collected about them and whether that information has been sold or shared with others, the right to request deletion of personal information subject to certain exceptions, the right to opt out of the sale of the consumer’s personal information and the right not to be discriminated against because of choices regarding the consumer’s personal information. The CCPA provides for certain monetary penalties and for its enforcement by the California Attorney General or consumers whose rights under the law are not observed. It also provides for damages as well as injunctive or declaratory relief if there has been unauthorized access, theft or disclosure of personal information due to failure to implement reasonable security procedures. The CCPA contains several exemptions, including a provision to the effect that the CCPA does not apply where the information is collected, processed, sold or disclosed pursuant to the GLBA if the GLBA is in conflict with the CCPA. The impact of the CCPA on the business of the Bank is yet to be determined, but it could result in increased operating expenses as well as additional exposure to the risk of litigation by or on behalf of consumers.
In November 2020, California voters approved state-wide Proposition 24, also known as the California Privacy Rights and Enforcement Act of 2020 (the “CPREA") which expanded and amended certain provisions of the CCPA and created the California Privacy Protection Agency to enforce privacy rights for Californians and impose fines for violations of such rights. The CPREA requires businesses to not share a consumer’s personal information upon the consumer’s request, provides consumers with an opt-out option for having their sensitive personal information used or disclosed for advertising or marketing, to obtain permission for collecting data on certain minors, and to correct a consumer’s inaccurate information upon the consumer’s request. It also removed the ability of businesses to remedy violations before being penalized for violations and increased the penalties for such violations. Most of the provisions of the CPREA will take effect in 2023 but some portions, such as the creation of the new state agency, will go into effect immediately. The impact of these laws on the business of the Bank is yet to be determined, but they could result in increased operating expenses as well as additional exposure to the risk of litigation by or on behalf of consumers.
Capital Standards
The FRB and the federal banking agencies have in place risk-based capital standards applicable to U.S. bank holding companies and banks. In July 2013, the FRB and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the guidelines published by the Basel Committee on Banking Supervision ("Basel Committee") known as the Basel III Global Regulatory Framework for Capital and Liquidity. The Basel Committee is a committee of banking supervisory authorities from major countries in the global financial system which formulates broad supervisory standards and guidelines relating to financial institutions for implementation on a country-by-country basis. These rules adopted by the FRB and the other federal banking agencies ("the U.S. Basel III Capital Rules") replaced the federal banking agencies’ general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules, in accordance with certain transition provisions.
Banks, such as First Northern, became subject to the new rules on January 1, 2015. The new rules implement higher minimum capital requirements, include a new common equity Tier 1 capital requirement, and establish criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. The final rules provide for increased minimum capital ratios as follows: (a) a common equity Tier1 capital ratio of 4.5%; (b) a Tier 1 capital ratio of 6%; (c) a total capital ratio of 8%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4%. Under these rules, in order to avoid certain limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements (equal to 2.5% of total risk-weighted assets). The capital conservation buffer is designed to absorb losses during periods of economic stress. First Northern believes that it was in compliance with these requirements at December 31, 2020.
Pursuant to the EGRRCPA, the FRB adopted a final rule, effective August 31, 2018, amending the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (the “policy statement”) to increase the consolidated assets threshold to qualify to utilize the provisions of the policy statement from $1 billion to $3 billion. Bank holding companies, such as the Company, are subject to capital adequacy requirements of the FRB; however, bank holding companies which are subject to the policy statement are not subject to compliance with the regulatory capital requirements until they hold $3 billion or more in consolidated total assets. As a consequence, as of December 31, 2018, the Company was not required to comply with the FRB’s regulatory capital requirements until such time that its consolidated total assets equal $3 billion or more or if the FRB determines that the Company is no longer deemed to be a small bank holding company. However, if the Company had been subject to these regulatory capital requirements, it would have exceeded all regulatory requirements.
In August of 2020, the federal banking agencies adopted the final version of the community bank leverage ratio framework rule (the “CBLR”), implementing two interim final rules adopted in April of 2020. The rule provides an optional, simplified measure of capital adequacy. Under the optional CBLR framework, the CBLR will be 8.5 percent through calendar year 2021 and 9 percent thereafter. The rule is applicable to all non-advanced approaches FDIC-supervised institutions with less than $10 billion in total consolidated assets. Banks not electing the CBLR framework will continue to be subject to the generally applicable risk-based capital rule. At the present time, the Company and the Bank do not intend to elect to use the CBLR framework.
The following table presents the capital ratios for the Bank as of December 31, 2020 (calculated in accordance with the Basel III capital rules):
The Bank
Adequately
Capitalized
Well
Capitalized
Capital
Ratio
Ratio
Ratio
Tier 1 Leverage Capital (to Average Assets)
$
141,569
8.4
%
4.0
%
5.0
%
Common Equity Tier 1 Capital (to Risk-Weighted Assets)
141,569
16.2
%
4.5
%
6.5
%
Tier 1 Capital (to Risk-Weighted Assets)
141,569
16.2
%
6.0
%
8.0
%
Total Risk-Based Capital (to Risk-Weighted Assets)
152,535
17.5
%
8.0
%
10.0
%
The federal banking agencies must take into consideration concentrations of credit risk and risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a part of the institution’s regular safety and soundness examination. The federal banking agencies must also consider interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in evaluating a Bank’s capital adequacy.
In January 2014, the Basel Committee issued an updated version of its leverage ratio and disclosure guidance ("Basel III leverage ratio"). The Basel Committee guidance continues to set a minimum Basel III leverage ratio of 3%. The Basel Committee, in December 2017, adopted further revisions to the Basel III capital standards ("Basel IV") which refined the definition of the leverage ratio “exposure measures” (the Basel III term for non risk-weighted assets). Beginning January 1, 2022, the updates to the leverage ratio will be implemented.
Prompt Corrective Action and Other Enforcement Mechanisms
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The law required each federal banking agency to promulgate regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, under-capitalized, significantly undercapitalized, and critically undercapitalized.
Under the prompt corrective action provisions of FDICIA, an insured depository institution generally will be classified in one of five capital categories ranging from "well-capitalized" to "critically under-capitalized."
An institution that, based upon its capital levels, is classified as “well capitalized,” “adequately capitalized” or “under-capitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to increased restrictions on its operations. Management believes that at December 31, 2020, the Company and the Bank exceeded the required ratios for classification as “well capitalized." Institutions that are “under-capitalized” or lower are subject to certain mandatory supervisory corrective actions. Failure to meet regulatory capital guidelines can result in a bank being required to raise additional capital. An “under-capitalized” bank must develop a capital restoration plan and its parent holding company must generally guarantee compliance with the plan.
In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders based upon a judicial determination that the agency would be harmed if such equitable relief was not granted. Additionally, a holding company’s inability to serve as a source of strength to its subsidiary banking organizations could serve as an additional basis for a regulatory action against the holding company.
Safety and Soundness Standards
FDICIA also implemented certain specific restrictions on transactions and required federal banking regulators to adopt overall safety and soundness standards for depository institutions related to internal control, loan underwriting and documentation and asset growth. Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, restricts the use of brokered deposits, limits the aggregate extensions of credit by a depository institution to an executive officer, director, principal shareholder, or related interest, and reduces deposit insurance coverage for deposits offered by undercapitalized institutions for deposits by certain employee benefits accounts.
The federal banking agencies may require an institution to submit to an acceptable compliance plan as well as have the flexibility to pursue other more appropriate or effective courses of action given the specific circumstances and severity of an institution’s non-compliance with one or more standards.
Restrictions on Dividends and Other Distributions
The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and liquidity needs of the institution, as well as general business conditions. FDICIA prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions, including dividends, if, after such transaction, the institution would be undercapitalized.
The federal banking agencies also have authority to prohibit a depository institution from engaging in business practices, which are considered to be unsafe or unsound, possibly including payment of dividends or other payments under certain circumstances even if such payments are not expressly prohibited by statute.
In addition to the restrictions imposed under federal law, banks chartered under California law generally may only pay cash dividends to the extent such payments do not exceed the lesser of retained earnings of the bank’s net income for its last three fiscal years (less any distributions to shareholders during such period). In the event a bank desires to pay cash dividends in excess of such amount, the bank may pay a cash dividend with the prior approval of the DFPI in an amount not exceeding the greatest of the bank’s retained earnings, the bank’s net income for its last fiscal year, or the bank’s net income for its current fiscal year.
Premiums for Deposit Insurance
The Bank is a member of the Deposit Insurance Fund (“DIF”) maintained by the FDIC. Through the DIF, the FDIC insures the deposits of the Bank up to prescribed limits for each depositor. To maintain the DIF, member institutions are assessed an insurance premium based on their deposits and their institutional risk category. The FDIC determines an institution’s risk category by combining its supervisory ratings with its financial ratios and other risk measures. The FDIC also has the authority to impose special assessments at any time it estimates that DIF reserves could fall to a level that would adversely affect public confidence. In September, 2020, the FDIC board of directors voted to adopt a restoration plan to restore the DIF reserve ration to at least 1.35 percent within 8 years as required by the FDIC Act. This action was in response to the reserve ratio dropping to 1.30 percent primarily due to the inflow of more than $1 trillion in estimated insured deposits in the first six month of 2020 resulting mainly from the pandemic, monetary policy actions, direct government assistance and an overall reduction in spending. No change was made in the current schedule of assessment rates for all insured depository institutions. Deposit insurance assessments and assessment rates are subject to change by the FDIC and can be impacted by the overall economy and the stability of the banking industry as a whole. There can be no assurance that the FDIC will not impose special assessments or increase annual assessments in the future. The ultimate effect on our business of legislative, regulatory and economic developments on the DIF cannot be predicted with certainty.
Community Reinvestment Act and Fair Lending
The Bank is subject to certain fair lending requirements and reporting obligations involving its home mortgage lending operations and is also subject to the Community Reinvestment Act (“CRA”). The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of the Bank’s local communities, including low- and moderate-income neighborhoods. In addition to substantive penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when reviewing other activities by the Bank, particularly applications involving business expansion such as acquisitions or de novo branching.
On January 9, 2020, the FDIC and the Office of the Comptroller of the Currency ("OCC") published a notice of proposed rule-making intended to modernize and strengthen the CRA regulations to better achieve their underlying statutory purpose by clarifying which activities qualify for CRA credit, updating where activities count for CRA credit, creating a more transparent and objective method for measuring CRA performance, and providing for more transparent, consistent, and timely CRA-related data collection, recordkeeping, and reporting. Later in 2020, the OCC adopted the new rule, which will apply to national banks, but the FDIC declined to take action on its proposed rule, thus leaving in place the existing CRA regulatory framework. It cannot be predicted at this time as to whether the FDIC will eventually adopt such a proposed rule and, if it does so, what impact this rule may have on FDIC-supervised institutions, such as the Bank.
Certain CFPB Rules
The Consumer Financial Protection Bureau ("CFPB") has adopted an Ability-to-Repay rule that all newly originated residential mortgages must meet. The Ability-to-Repay rule establishes guidelines that the lender must follow when reviewing an applicant’s income, obligations, assets, liabilities, and credit history and requires that the lender make a reasonable and good faith determination of an applicant’s ability to repay the loan according to its terms. Lenders will be presumed to have met the Ability-to-Repay rule by originating loans that meet the criteria for “Qualified Mortgages”, which are set forth in detail in the rule. The mortgage loans originated by the Bank with the intent to sell them to Freddie Mac meet the Qualified Mortgage criteria.
The CFPB has also adopted a rule on simplified and improved mortgage loan disclosures, otherwise known as Know Before You Owe. The rule provides that mortgage borrowers receive a loan estimate three business days after application and a closing disclosure three days before closing. These forms replace disclosure forms previously provided to borrowers under other provisions of federal law. The rule provides for limitations on application fees and increases in closing costs.
Any new regulatory requirements promulgated by the CFPB could have an adverse impact on our residential mortgage lending business as the industry adapts to the additional regulations. Our business strategy, product offerings and profitability may change as the market adjusts to any additional regulations and as these requirements are interpreted by the regulators and courts.
Conservatorship and Receivership of Insured Depository Institutions
If any insured depository institution becomes insolvent and the FDIC is appointed its conservator or receiver, the FDIC may, under federal law, disaffirm or repudiate any contract to which such institution is a party, if the FDIC determines that performance of the contract would be burdensome, and that disaffirmance or repudiation of the contract would promote the orderly administration of the institution’s affairs. Such disaffirmance or repudiation would result in a claim by its holder against the receivership or conservatorship. The amount paid upon such claim would depend upon, among other factors, the amount of receivership assets available for the payment of such claim and its priority relative to the priority of others. In addition, the FDIC as conservator or receiver may enforce most contracts entered into by the institution notwithstanding any provision providing for termination, default, acceleration, or exercise of rights upon or solely by reason of insolvency of the institution, appointment of a conservator or receiver for the institution, or exercise of rights or powers by a conservator or receiver for the institution. The FDIC as conservator or receiver also may transfer any asset or liability of the institution without obtaining any approval or consent of the institution’s shareholders or creditors.
The Dodd-Frank Act
The Dodd-Frank Act, enacted in 2010, has resulted in sweeping changes to the U.S. financial system and financial institutions, including us. Many of the law’s provisions have been implemented by rules and regulations of the federal banking agencies. The law contains many provisions which have particular relevance to our business, including provisions that have resulted in adjustments to our FDIC deposit insurance premiums and that resulted in increased capital and liquidity requirements, increased supervision, increased regulatory and compliance risks and costs and other operational costs and expenses, reduced fee-based revenues and restrictions on some aspects of our operations, and increased interest expense on our demand deposits. In May 2018, the President signed into law the EGRRCPA, which amended various provisions of the Dodd-Frank Act as well as other federal banking statutes. See “The Effect of Government Policy on Banking” above for additional information.
The environment in which financial institutions continue to operate since the U.S. financial crisis, including legislative and regulatory changes affecting capital, liquidity, supervision, permissible activities, corporate governance and compensation, and changes in fiscal policy may have long-term effects on the business model and profitability of financial institutions that cannot now be foreseen.
Overdraft and Interchange Fees
The FRB's Regulation E imposes restrictions on banks’ abilities to charge overdraft services and fees. The rule prohibits financial institutions from charging fees for paying overdrafts on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. The Dodd-Frank Act, through a provision known as the Durbin Amendment, required the FRB to establish standards for interchange fees that are “reasonable and proportional” to the cost of processing the debit card transaction and imposes other requirements on card networks. Under the rule, the maximum permissible interchange fee that a bank may receive is the sum of $0.21 per transaction and five basis points multiplied by the value of the transaction, with an additional upward adjustment of no more than $0.01 per transaction if a bank develops and implements policies and procedures reasonably designed to achieve fraud-prevention standards set by regulation. This regulation has resulted in decreased revenues and increased compliance costs for the banking industry and the Bank, and there can be no assurance that alternative sources of revenues can be implemented to offset the impact of these developments.
Possible Future Legislation and Regulatory Initiatives
The economic and political environment of the past several years has led to a number of proposed legislative, governmental and regulatory initiatives, at both the federal and state levels, certain of which are described above, that may significantly impact our industry. These and other initiatives could significantly change the competitive and operating environment in which we and our subsidiaries operate. We cannot predict whether these or any other proposals will be enacted or the ultimate impact of any such initiatives on our operations, competitive situation, financial condition or results of operations.
The results of the 2020 national elections with the change of the U.S. President and the shift of control in the U.S. Senate could lead to new legislative and regulatory initiatives or the roll-back of initiatives of the previous Administration which could have significant impact on the banking and financial services industry and on our business. We cannot assess at this time the degree to which this may occur.
The change of Administration in Washington, D.C. is also likely to result in changes in the leadership and other senior positions at the federal bank regulatory agencies. We cannot assess at this time the impact such changes will have on the banking and financial services industry and on our business.
Competition
In the past, an independent bank’s principal competitors for deposits and loans have been other banks, savings and loan associations, and credit unions. Many of these competitors are large financial institutions that have substantial capital, technology and marketing resources, which are well in excess of ours, although these larger institutions may be required to hold more regulatory capital and as a result, achieve lower returns on equity. For agricultural loans, the Bank also competes with constituent entities with the Federal Farm Credit System. To a lesser extent, competition is also provided by thrift and loans, mortgage brokerage companies and insurance companies. Other institutions, such as brokerage houses, mutual fund companies, credit card companies, and even retail establishments have offered new investment vehicles, which also compete with banks for deposit business. Additionally, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and payment systems. We also experience competition, especially for deposits, from internet-based banking institutions and other financial companies, which do not always have a presence in our market footprint and have grown rapidly in recent years.
Current federal law has made it easier for out-of-state banks to enter and compete in California. Competition in our principal markets may further intensify as a result of the Dodd-Frank Act which, among other things, permits out-of-state de novo branching by national banks, state banks and foreign banks from other states. While the impact of these changes cannot be predicted with certainty, it is clear that the business of banking in California will remain highly competitive.
Competition in our industry is likely to further intensify as a result of continued consolidation of financial services companies, including consolidations of significance in our market area. In order to compete with major financial institutions and other competitors in its primary service areas, the Bank relies upon the experience of its executive and senior officers in serving business clients, and upon its specialized services, local promotional activities and the personal contacts made by its officers, directors and employees.
For customers whose loan demand exceeds the Bank’s legal lending limit, the Bank may arrange for such loans on a participation basis with correspondent banks. In the past, the seasonal swings, discussed below in “Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity”, have had some impact on the Bank’s liquidity. The management of investment maturities, sale of loan participations, federal fund borrowings, qualification for funds under the Federal Reserve Bank’s seasonal credit program, and the ability to sell mortgages in the secondary market is intended to allow the Bank to satisfactorily manage its liquidity.

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ITEM 1A. RISK FACTORS
ITEM 1A - RISK FACTORS
In addition to factors mentioned elsewhere in this Report, the factors contained below, among others, could cause our financial condition and results of operations to be materially and adversely affected. If this were to happen, the value of our common stock could decline, perhaps significantly, and you could lose all or part of your investment.
The COVID-19 Pandemic Has Adversely Impacted our Business and Results of Operations, and the Ultimate Impact of the Pandemic on the U.S., California and Global Economies, and on our Business, Results of Operations and Financial Condition, Will Depend on Future Developments, Which Are Highly Uncertain and Cannot be Predicted; However, the Effects of the Pandemic Have Had and Can Be Expected to Continue to Have an Adverse Impact, Which Could Be Material
The COVID-19 pandemic has adversely impacted our business and results of operation, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and responsive actions taken by governmental and regulatory authorities. The pandemic and related governmental actions have negatively impacted the U.S., California and global economies, disrupted supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, and increased unemployment levels. In addition, the pandemic has significantly increased economic uncertainty, reduced economic activity, and resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities, including the markets where we have operations. Governments in the U.S. and globally have taken steps to mitigate some of the more severe anticipated economic effects of the virus. During March 2020, the U.S. Congress adopted and the President signed into law the CARES Act, which provided for some $2.2 trillion in federal funding for a variety of programs designed to stimulate the U.S. economy and to soften the economic consequences of the pandemic. During March 2020, in response to the pandemic, the FRB reduced the federal funds rate 1.5 percentage points to .00 to .25 percent, and provided other monetary support to the financial markets and financial institutions in the U.S. The Federal Reserve has indicated that such low rates can be expected to continue for the next several years. Additionally, in December 2020, the Congress passed and the President signed into law an additional $900 billion COVID-relief package. There can be no assurance that these and other governmental measures will be effective in combating the impact of the pandemic or achieve their desired results in a timely fashion.
In response to the pandemic, the Bank proactively developed a COVID-19 Customer Support Plan designed to provide relief to those business and consumer customers financially impacted by the pandemic. Among other actions, the Bank has offered loan assistance for those impacted by COVID-19, including waiver of late fees for qualifying consumer, small business, commercial and agricultural loan customers for an initial period of 60 days which began in March and was later extended into the third quarter (waiver of late fees expired on October 1, 2020); payment relief options; delinquencies resulting from impacts of COVID-19 will not be reported to the credit reporting bureaus; access to loan programs, including the Paycheck Protection Program ("PPP") of the Small Business Administration (SBA) and the Bank’s strong relationship with the State of California’s I-Bank; deposit account assistance, including waiver of overdraft/non-sufficient funds fees for all business and consumer customers for an initial period of 60 days which began in March and was later extended to the third quarter of 2020 (auto-waiver period expired on August 1, 2020); increased debit card limits on a case by case basis for consumer clients; deposit customer access to surcharge-free ATMs at over 50 locations within the Bank’s local footprint and hundreds more throughout the state through the Bank’s membership in the MoneyPass ATM Network; and waiver of early withdrawal charges for customers wishing to withdraw funds from their Certificates of Deposit. Service charges on deposit accounts decreased $608,000 in 2020 over 2019, decreasing from $1,979,000 to $1,371,000, partially due to the aforementioned relief provided. Future governmental and regulatory actions may require us to provide these and additional types of customer-related responses. Further impact to our results of operations cannot be quantified at this time.
The pandemic, the early economic effects of which began to be felt late in the first quarter 2020 and have continued into 2021, will adversely affect our revenue, and continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed, the impact on the national economy worsens, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. We provide financing to businesses in a number of industries that may be particularly vulnerable to industry-specific economic factors that can adversely impact the performance of our commercial business, construction, commercial and multi-family real estate loan portfolios. Certain industries, such as the home building, commercial real estate, retail, agricultural, industrial, and commercial industries, among others, have been, and can expected to continue to be, adversely impacted by the disruptive and recessionary market conditions caused by the pandemic, which could result in higher nonperforming assets for us and elevated levels of charge-offs. Because of changing economic and market conditions affecting issuers, we also may be required to recognize impairments on the securities we hold.
Our business operations may also be disrupted if significant portions of our workforce, including employees of our third-party service providers, are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. As of December 31, 2020, some of our employees continued to work remotely rather than in our offices and branches, the majority of whom would not have been remote workers before the pandemic. Remote work arrangements may exacerbate certain risks to our business, including an increased demand for information technology resources, increased risk of phishing and other cybersecurity attacks, and increased information security risk involving, among other risks, the unauthorized dissemination of sensitive personal information or proprietary or confidential information about us, our customers or other third-parties. The pandemic could also disrupt our operations due to absenteeism by infected or ill members of management or other employees, or members of our Board of Directors, making it more difficult to conduct meetings for the management of our affairs. The operations of our clients, customers, suppliers, and third-party service providers have also been, and are likely to be further, adversely impacted.
We may also experience financial losses due to a number of operational factors, including, among others: challenges to the availability and reliability of our network due to changes to normal operations or third-party disruptions, including potential outages at network providers, call centers and other suppliers; increased cyber fraud risk related to COVID-19, as cybercriminals attempt to profit from the disruption, given increased online banking, e-commerce and other online activity; and new or additional regulatory requirements, which could require additional resources and costs to address. Various banks who participated in the SBA’s PPP have become the subject of purported class-action litigation regarding their activities under the program; there can be no assurance that such litigation will not be brought against other banks who participate in this program, including the Bank.
These factors may remain prevalent for a significant period of time and may continue to adversely affect our business, results of operations and financial condition even after the pandemic has subsided. The extent to which these effects may occur will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of the national and global economic impact of the virus, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future. A substantial majority of our assets, deposits and interest and fee income are generated in Northern California, particularly in the Sacramento Valley region. In response to the COVID-19 pandemic, following a declaration of a state of emergency in early March, the California state government issued a strict shelter-in-place order on March 19, 2020, instituting social distancing requirements and closing all non-essential businesses. Later in 2020, the California state government adopted a four-phase reopening plan. The ability of a county to move into a phase with fewer restrictions on economic and social activities is dependent upon the county’s compliance with parameters such as the county’s case rate, test positivity rate, and a health equity metric. As of this time, the California state government, as well as the county health departments in our market area, continue to limit business re-openings in certain sectors and/or with capacity and other restrictions.
There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. We do not yet know the full extent of the impacts of the pandemic on our business, results of operations and financial condition, or on the U.S., California or global economies or our market areas in particular. Given the many challenges and uncertainties resulting from the coronavirus pandemic, there is a risk that conditions will be substantially different than we are currently expecting. However, the effects of the pandemic can be reasonably expected to have an adverse impact, which could be material, on our business, results of operations and financial condition, and heighten many of our known risks described in this section.
The COVID-19 Pandemic and Related Governmental and Regulatory Actions have Negatively Impacted the U.S., California and Global Economies, Significantly Increased Economic Uncertainty and Reduced Economic Activity, Resulting in Recessionary Economic and Financial Market Conditions, Which Are Likely to Have Resultant Adverse Consequences for the U.S. Financial Services Industry and for the Bank
While the U.S. economy experienced a period of significant expansion in recent years, the COVID-19 pandemic and related governmental and regulatory actions, the early economic effects of which began to be felt late in the first quarter 2020 and have continued into 2021, have negatively impacted the U.S. and global economies, disrupted supply chains, created significant volatility and disruption in financial markets, and increased unemployment levels. In addition, the pandemic has significantly increased economic uncertainty, reduced economic activity, and resulted in temporary and permanent closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities, including the markets where we have operations. We, and other financial services companies, are impacted to a significant degree by current economic conditions.
Governments in the U.S. and globally have taken steps to mitigate some of the more severe anticipated economic effects of the virus. During March 2020, the U.S. Congress adopted and the President signed into law the CARES Act, which provided for some $2.2 trillion in federal funding for a variety of programs designed to stimulate the U.S. economy and to soften the economic consequences of the pandemic. Also, during March 2020, in response to the pandemic, the FRB reduced the federal funds rate 1.5 percentage points to .00 to .25 percent, and provided other monetary support to the financial markets and financial institutions in the U.S. The Federal Reserve has indicated that such low rates can be expected to continue for the next several years. Additionally, in December 2020, the Congress passed and the President signed into law an additional $900 billion COVID-relief package. There can be no assurance that these and other governmental measures will be effective or achieve their desired results in a timely fashion.
The various governmental stimulus measures introduced in response to the COVID-19 pandemic have increased, and can be expected to continue to increase, federal budget deficits and the national debt level, while federal, state and local tax revenue can be expected to decline along with economic activity. These events can be expected to adversely affect the long-term sovereign credit rating of United States debt, and downgrades by the credit rating agencies with respect to the obligations of the U.S. federal government could occur. Any such downgrades could increase over time the U.S. federal government’s cost of borrowing, which may worsen its fiscal challenges, as well as generate upward pressure on interest rates generally in the U.S., which could, in turn, have adverse consequences for borrowers and the level of business activity.
The extent to which the COVID-19 outbreak ultimately impacts the national and global economies will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 outbreak has subsided, the U.S., California and global economies may continue to experience materially adverse impacts and continuing or worsening recessionary conditions. We do not yet know the full extent of the impacts of the COVID-19 pandemic on the U.S. or global economies or our market areas in particular; however, the pandemic can reasonably be expected to result in prolonged continuing or worsening recessionary economic and financial market conditions, which are likely to have adverse consequences, which could be material, for the U.S. financial services industry and for the Bank.
Economic Conditions in the U.S. May Soften or Become Recessionary with Resultant Adverse Consequences for the U.S. Financial Services Industry and for the Bank
Following the financial crisis of 2008, adverse financial and economic developments impacted U.S. and global economies and financial markets and presented challenges for the banking and financial services industry and for us. These developments included a general recession both globally and in the U.S. accompanied by substantial volatility in the financial markets.
In response, various significant economic and monetary stimulus measures were implemented by the U.S. government. The FRB also pursued a highly accommodative monetary policy aimed at keeping interest rates at historically low levels although the FRB has more recently modified certain aspects of this policy by gradually increasing short-term interest rates and reducing its balance sheet. The U.S. economy has experienced a period of significant expansion in recent years; however, this expansion is not likely to continue indefinitely and, at some point, economic conditions in the U.S. are likely to soften or become recessionary. We, and other financial services companies, are impacted to a significant degree by current economic conditions. The U.S. government continues to face significant fiscal and budgetary challenges which, if not resolved, could result in renewed adverse U.S. economic conditions. These challenges may be intensified over time if federal budget deficits were to increase and Congress and the Administration cannot effectively work to address them.
The overall level of the federal government's debt, the extensive political disagreements regarding the government's statutory debt limit and the continuing substantial federal budget deficits led to a downgrade from “AAA” to “AA+” of the long-term sovereign credit rating of United States debt by one credit rating agency, although other credit rating agencies did not take such action. This risk could be exacerbated over time.
If substantial federal budget deficits were to continue in the years ahead, further downgrades by the credit rating agencies with respect to the obligations of the U.S. federal government could occur. Any such further downgrades could increase over time the U.S. federal government’s cost of borrowing, which may worsen its fiscal challenges, as well as generate upward pressure on interest rates generally in the U.S. which could, in turn, have adverse consequences for borrowers and the level of business activity. It is also possible that the federal government’s fiscal and budgetary challenges could be intensified over time as a result of the federal tax legislation signed into law in December of 2017 if the reductions in tax rates along with greater government spending result in increased federal budget deficits. The long-term impact of this situation cannot be predicted.
The Bank is Subject to Lending Risks of Loss and Repayment Associated with Commercial Banking Activities Which are Likely to be Adversely Impacted by the COVID-19 Pandemic
The Bank’s business strategy is to focus on commercial business loans (which includes agricultural loans), construction loans, and commercial and multi-family real estate loans. The principal factors affecting the Bank’s risk of loss in connection with commercial business loans include the borrower’s ability to manage its business affairs and cash flows, general economic conditions, and, with respect to agricultural loans, weather and climate conditions.
In response to the COVID-19 pandemic, following a declaration of a state of emergency in early March, the California state government issued a strict shelter-in-place order on March 19, 2020, instituting social distancing requirements and closing all non-essential businesses. Later in 2020, the California state government adopted a four-phase reopening plan. The ability of a county to move into a phase with fewer restrictions on economic and social activities is dependent upon the county’s compliance with parameters such as the county’s case rate, test positivity rate, and a health equity metric. As of this time, the California state government, as well as the county health departments in our market area, continue to limit business re-openings in certain sectors and/or with capacity and other restrictions. Although certain restrictions have been relaxed, given the many uncertainties and challenges resulting from the coronavirus pandemic, it is difficult to predict when and the extent to which, normal economic and operating conditions can resume in the state.
In the U.S. generally, and in California in particular, the pandemic has significantly increased economic uncertainty, reduced economic activity and increased unemployment levels. While many financial institutions, including the Bank, have offered loan assistance and payment relief to qualifying consumer, small business, commercial, and agricultural loan customers impacted by the COVID-19 outbreak, the pandemic has had and can be expected to continue to have significant economic consequences on many of our commercial loan customers, with commercial lending customers increasing line of credit balances or seeking additional loans to help finance their businesses, and increased risk of delinquencies and defaults, particularly as restrictions on economic and social activities remain in effect for a prolonged period and many businesses remain closed. These events, in turn, have resulted and could continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for loan losses, which could have an adverse effect, which could be material, on the Bank’s financial condition and results of operations,
For a number of years in the past decade, California has also experienced severe drought, wildfires or other natural disasters. It can be expected that these events will continue to occur from time to time in the areas served by the Bank, and that the consequences of these natural disasters, including public utility public safety power outages when weather conditions and fire danger warrant, may adversely affect the Bank’s business and that of its commercial loan customers, particularly in the agricultural sector.
Loans secured by commercial real estate are generally larger and involve a greater degree of credit and transaction risk than residential mortgage (one to four family) loans. Because payments on loans secured by commercial and multi-family real estate properties are often dependent on successful operation or management of the underlying properties, repayment of such loans may be dependent on factors other than the prevailing conditions in the real estate market or the economy. Real estate construction financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development compared to the estimated cost (including interest) of construction. If the estimate of value proves to be inaccurate, the Bank may be confronted with a project which, when completed, has a value which is insufficient to assure full repayment of the construction loan. For additional information, see “The Bank’s Dependence on Real Estate Lending Increases Our Risk of Losses, Particularly Given the Continuing or Worsening Economic and Financial Market Conditions Caused by the COVID-19 Pandemic”, below in these “Risk Factors” in this Report on Form 10-K.
Although the Bank manages lending risks through its underwriting and credit administration policies, no assurance can be given that such risks will not materialize, in which event, the Company’s financial condition, results of operations, cash flows, and business prospects could be materially adversely affected.
Increases in the Allowance for Loan Losses Would Adversely Affect the Bank’s Financial Condition and Results of Operations
The Bank’s allowance for estimated losses on loans was approximately $15.4 million, or 1.73% of total loans, at December 31, 2020, compared to $12.4 million, or 1.58% of total loans, at December 31, 2019, and 102.0% of total non-performing loans net of guaranteed portions at December 31, 2020, compared to 1,311.7% of total non-performing loans, net of guaranteed portions at December 31, 2019. Provision for loan losses totaled $3.1 million for the year ended December 31, 2020, compared to no provision for loan losses for the same period in 2019. The increase in provision for loan losses during 2020 and the increase in the ratio of allowance to total loans from December 31, 2019 to December 31, 2020 was primarily due to increases in qualitative factors adversely affecting our loan portfolio resulting from the downturn in economic conditions associated with the COVID-19 pandemic. Also driving the increase was a specific reserve on one loan totaling $2.1 million at December 31, 2020. The increase in allowance to total loans was partially offset by PPP loans of approximately $155 million outstanding as of December 31, 2020, which are fully guaranteed by the SBA.
The COVID-19 pandemic and related responses to the pandemic by federal, state and local governments have negatively impacted the U.S., California and global economies, significantly increased economic uncertainty, reduced economic activity, increased unemployment levels, and resulted in temporary and permanent closures of many businesses and restrictions on business and social activities in many states and communities, including many markets where we have operations. The pandemic, the early economic effects of which began to be felt late in the first quarter of 2020 and have continued into 2021, has resulted and can be expected to continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed or indoor operations limited, the impact on the national and local economies worsens, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Material future additions to the allowance for estimated losses on loans may be necessary if such material adverse changes in economic conditions continue to occur and the performance of the Bank’s loan portfolio deteriorates.
In addition, the pandemic may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular, decreasing property values, increasing the risk of defaults and reducing the value of real estate collateral. An allowance for losses on other real estate owned may also be required in order to reflect changes in the markets for real estate in which the Bank’s other real estate owned is located and other factors which may result in adjustments which are necessary to ensure that the Bank’s foreclosed assets are carried at the lower of cost or fair value, less estimated costs to dispose of the properties. Moreover, the FDIC and the DBO, as an integral part of their examination process, periodically review the Bank’s allowance for estimated losses on loans and the carrying value of its assets. Increases in the provisions for estimated losses on loans and foreclosed assets would adversely affect the Bank’s financial condition and results of operations.
The Bank’s Dependence on Real Estate Lending Increases Our Risk of Losses, Particularly Given the Continuing or Worsening Economic and Financial Market Conditions Caused by the COVID-19 Pandemic
At December 31, 2020, approximately 68% of the Bank’s loans in principal amount (excluding loans held-for-sale) were secured by real estate. We do not yet know the full extent of the impacts of the COVID-19 pandemic on the U.S., California or global economies or our market areas in particular; however, the pandemic has dramatically and adversely impacted economic conditions and can be expected to result in prolonged continuing or worsening recessionary economic and financial market conditions. In response to the COVID-19 pandemic, following a declaration of a state of emergency in early March, the California state government issued a strict shelter-in-place order on March 19, 2020, instituting social distancing requirements and closing all non-essential businesses. Later in 2020, the California state government adopted a four-phase reopening plan. The ability of a county to move into a phase with fewer restrictions on economic and social activities is dependent upon the county’s compliance with parameters such as the county’s case rate, test positivity rate, and a health equity metric. As of this time, the California state government, as well as the county health departments in our market area, continue to limit business re-openings in certain sectors and/or with capacity and other restrictions. The value of the Bank’s real estate collateral has been, and could in the future continue to be, adversely affected by this prolonged reduction in economic activity and the economic recession in California, with has had resulting adverse impacts, which could be material, on the real estate market in Northern California.
The Bank’s primary lending focus has historically been commercial (including agricultural), construction, and real estate mortgage. At December 31, 2020, real estate mortgage (excluding loans held-for-sale) and construction loans (residential and other) comprised approximately 67% and 1%, respectively, of the total loans in the Bank’s portfolio. At December 31, 2020, all of the Bank’s real estate mortgage and construction loans and approximately 1% of its commercial loans were secured fully or in part by deeds of trust on underlying real estate. The Company’s dependence on real estate increases the risk of loss in both the Bank’s loan portfolio and its holdings of other real estate owned if economic conditions in Northern California further deteriorate. Deterioration of the real estate market in Northern California would have a material adverse effect on the Company’s business, financial condition, and results of operations.
The CFPB has adopted various regulations which have impacted, and will continue to impact, our residential mortgage lending business.
Adverse Economic Factors Affecting Certain Industries the Bank Serves Could Adversely Affect Our Business
The Bank is subject to certain industry specific economic factors. For example, a portion of the Bank’s total loan portfolio is related to residential and commercial real estate, especially in California. The COVID-19 pandemic, and its resulting recessionary economic and market conditions, may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular, decreasing property values, increasing the risk of defaults and reducing the value of real estate collateral. Increases in residential mortgage loan interest rates could also have an adverse effect on the Bank’s operations by depressing new mortgage loan originations, which in turn could negatively impact the Bank’s title and escrow deposit levels. Additionally, a downturn in the residential real estate and housing industries in California could have an adverse effect on the Bank’s operations and the quality of its real estate and construction loan portfolio. Although the Bank does not engage in subprime or negative amortization lending, we are not immune to volatility in the real estate market. Real estate valuations are influenced by demand, and demand is driven by economic factors such as employment rates and interest rates, which have been, and can be expected to continue to be, affected by the pandemic. These factors could adversely impact the quality of the Bank’s residential construction, residential mortgage and construction related commercial portfolios in various ways, including by decreasing the value of the collateral for our loans, and thereby negatively affecting the Bank’s overall loan portfolio.
The Bank provides financing to, and receives deposits from, businesses in a number of other industries that may be particularly vulnerable to industry-specific economic factors, including the home building, commercial real estate, retail, agricultural, industrial, and commercial industries. Certain of these industries have been, and can expected to continue to be, adversely impacted by the disruptive and recessionary market conditions caused by the pandemic, which could result in higher nonperforming assets and elevated levels of charge-offs.
Following the financial crisis of 2008, the home building industry in California was especially adversely impacted by the deterioration in residential real estate markets, which lead the Bank to take additional provisions and charge-offs against credit losses in this portfolio. The recessionary economic and market conditions resulting from the COVID-19 pandemic may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular, decreasing property values, increasing the risk of defaults and reducing the value of real estate collateral. Continued volatility in fuel prices and energy costs and the return of the drought in California could also adversely affect businesses in several of these industries. Industry specific risks are beyond the Bank’s control and could adversely affect the Bank’s portfolio of loans, potentially resulting in an increase in non-performing loans or charge-offs and a slowing of growth or reduction in our loan portfolio.
Recent wildfires across California and in our market area resulted in significant damage and destruction of property and equipment. The fire damage caused resulted in adverse economic impacts to those affected markets and beyond and on the Bank's customers. In addition, the major electric utility company in our region has adopted programs of electrical power shut-offs, often for multiple days, in wide areas of Northern California during periods of high winds and high fire danger. Shut-offs of power by this utility have adversely impacted the business of some of our customers and also have resulted in some of our branches being temporarily closed. It can be expected that these events will continue to occur from time to time in the areas served by the Bank, and that the consequences of these natural disasters, including programs of public utility public safety power outages when weather conditions and fire danger warrant, may adversely affect the Bank’s business and that of its customers. It is also possible that climate change may be increasing the severity or frequency of adverse weather conditions, thus increasing the impact of these types of natural disasters on our business and that of our customers.
The long-term impact of these developments on the markets we serve cannot be predicted at this time.
The Effects of Changes or Increases in, or Supervisory Enforcement of, Banking or Other Laws and Regulations or Governmental Fiscal or Monetary Policies Could Adversely Affect Us
We are subject to significant federal and state banking regulation and supervision, which is primarily for the benefit and protection of our customers and the Deposit Insurance Fund and not for the benefit of investors in our securities. In the past, our business has been materially affected by these regulations. This will continue and likely intensify in the future. Laws, regulations or policies, including accounting standards and interpretations, currently affecting us may change at any time. Regulatory authorities may also change their interpretation of and intensify their examination of compliance with these statutes and regulations. Therefore, our business may be adversely affected by changes in laws, regulations, policies or interpretations or regulatory approaches to compliance and enforcement, as well as by supervisory action or criminal proceedings taken as a result of noncompliance, which could result in the imposition of significant civil money penalties or fines. Changes in laws and regulations may also increase our expenses by imposing additional supervision, fees, taxes or restrictions on our operations. Compliance with laws and regulations, especially new laws and regulations, increases our operating expenses and may divert management attention from our business operations.
Proposals to reform the housing finance market in the U.S. could also significantly affect our business. These proposals, among other things, include reducing or eliminating over time the role of the GSEs in guaranteeing mortgages and providing funding for mortgage loans, as well as the implementation of reforms relating to borrowers, lenders, and investors in the mortgage market, including reducing the maximum size of a loan that the GSEs can guarantee, phasing in a minimum down payment requirement for borrowers, improving underwriting standards, and increasing accountability and transparency in the securitization process.
While the specific nature of these reforms and their impact on the financial services industry in general, and on the Bank in particular, is uncertain at this time, such reforms, if enacted, are likely to have a substantial impact on the mortgage market and could potentially reduce our income from mortgage originations by increasing mortgage costs or lowering originations. The GSE reforms could also reduce real estate prices, which could reduce the value of collateral securing outstanding mortgage loans. This reduction of collateral value could negatively impact the value or perceived collectability of these mortgage loans and may increase our allowance for loan losses. Such reforms may also include changes to the Federal Home Loan Bank System, which could adversely affect a significant source of term funding for lending activities by the banking industry, including the Bank. These reforms may also result in higher interest rates on residential mortgage loans, thereby reducing demand, which could have an adverse impact on our residential mortgage lending business.
In July 2013, the FRB and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the Basel III Global Regulatory Framework for Capital and Liquidity. For additional information, see “Business-Capital Standards” in Item 1 of this Form 10-K.
We maintain systems and procedures designed to comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of criminal or civil penalties (which can be substantial) for noncompliance. In some cases, liability may attach even if the noncompliance was inadvertent or unintentional and even if compliance systems and procedures were in place at the time. There may be other negative consequences from a finding of noncompliance, including restrictions on certain activities and damage to our reputation.
Additionally, our business is affected significantly by the fiscal and monetary policies of the U.S. federal government and its agencies. We are particularly affected by the policies of the FRB, which regulates the supply of money and credit in the U.S. Under the Dodd-Frank Act and a long-standing policy of the FRB, a bank holding company is expected to act as a source of financial and managerial strength for its subsidiary banks. As a result of that policy, we may be required to commit financial and other resources to our subsidiary bank in circumstances where we might not otherwise do so. Among the instruments of monetary policy available to the FRB are (a) conducting open market operations in U.S. Government securities, (b) changing the discount rates on borrowings by depository institutions and the federal funds rate, and (c) imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the FRB can be expected to have a material effect on our business, prospects, results of operations and financial condition.
Refer to “Business - Supervision and Regulation of Bank Holding Companies" and "Business - Supervision and Regulation of the Bank” in Item 1 of this Form 10-K for discussion of certain existing and proposed laws and regulations that may affect our business.
California Economic Conditions, Have Been, and Can Reasonably be Expected to Continue to be, Adversely Affected by the COVID-19 Pandemic, Which Could Adversely Affect the Bank’s Business
The Bank’s operations and a substantial majority of the Bank’s assets and deposits are generated and concentrated primarily in Northern California, particularly the counties of Placer, Sacramento, Solano, and Yolo, and are likely to remain so for the foreseeable future. At December 31, 2020, the majority of the Bank’s loan portfolio in principal amount (excluding loans held-for-sale) consisted of real estate-related loans, all of which were secured by collateral located in Northern California. As a result, a downturn in the economic conditions in Northern California may cause the Bank to incur losses associated with high default rates and decreased collateral values in its loan portfolio. Economic conditions in California are subject to various uncertainties including deterioration in the California real estate market and housing industry, particularly as a result of the COVID-19 pandemic.
In response to the pandemic, following a declaration of a state of emergency in early March, the California state government issued a strict shelter in place order on March 19, 2020, instituting social distancing requirements and closing all non-essential businesses. The shelter in place order does not have a specific termination date. Although certain restrictions in the order have been relaxed, given the many uncertainties and challenges resulting from the coronavirus pandemic, it is difficult to predict when, and the extent to which, normal economic and operating conditions can resume in the state.
In the U.S. generally, and in California in particular, the pandemic has significantly increased economic uncertainty, reduced economic activity and increased unemployment levels. While many financial institutions, including the Bank, have offered payment relief to mortgage and home equity line of credit customers impacted by the COVID-19 outbreak, among other customer-related responses, the pandemic may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular. There can be no assurance that home prices and the value of real estate collateral in California will not decline, and that the risk of defaults will not increase, as a result of the recessionary financial and market conditions created by the COVID-19 pandemic.
In addition, although the State of California has historically experienced budget shortfalls or deficits, during the past several years, California’s budgetary situation improved considerably. However, the various economic and health measures introduced by the legislature and the governor of the State of California in response to the COVID-19 pandemic have increased state spending at a time when the current economic slowdown can be expected to result in reduced state tax revenues, perhaps for a prolonged period.
Also, municipalities and other governmental units within California have experienced budgetary difficulties and several California municipalities filed for protection under the Bankruptcy Code. As a result, concerns have arisen regarding the outlook for the governmental obligations of California municipalities and other governmental units. If the budgetary and fiscal difficulties of the California state government and California municipalities and other governmental units recur or economic conditions in California decline, we expect that our level of problem assets could increase and our prospects for growth could be impaired.
For a number of years in the past decade, California has also experienced severe drought, wildfires, or other natural disasters. It can be expected that these events will continue to occur from time to time in the areas served by the Bank, and that the consequences of these natural disasters, including public utility safety power outages when weather conditions and fire danger warrant, may adversely affect the Bank’s business and that of its customers. It is also possible that climate change may be increasing the severity or frequency of adverse weather conditions, thus increasing the impact of these types of natural disasters on our business and that of our customers.
The Bank is Subject to Interest Rate Risk
The income of the Bank depends to a great extent on “interest rate differentials” and the resulting net interest margins (i.e., the difference between the interest rates earned on the Bank’s interest-earning assets such as loans and investment securities, and the interest rates paid on the Bank’s interest-bearing liabilities such as deposits and borrowings). These rates are highly sensitive to many factors, which are beyond the Bank’s control, including, but not limited to, general economic conditions and the policies of various governmental and regulatory agencies, in particular, the FRB. We cannot predict with any certainty the nature and impact of such policies. Changes in the relationship between short-term and long-term market interest rates or between different interest rate indices can also impact our interest rate differential, possibly resulting in a decrease in our interest income relative to interest expense. In addition, changes in monetary policy, including changes in interest rates, influence the origination of loans, the purchase of investments and the generation of deposits and affect the rates received on loans and investment securities and paid on deposits, which could have a material adverse effect on the Company’s business, financial condition, and results of operations.
Our Ability to Pay Dividends is Subject to Legal Restrictions
As a bank holding company, our cash flow typically comes from dividends of the Bank. Various statutory and regulatory provisions restrict the amount of dividends the Bank can pay to the Company without regulatory approval. The ability of the Company to pay cash dividends in the future also depends on the Company’s profitability, growth, and capital needs. In addition, California law restricts the ability of the Company to pay dividends. For a number of years, the Company has paid stock dividends, but not cash dividends, to its shareholders. No assurance can be given that the Company will pay any dividends in the future or, if paid, such dividends will not be discontinued. See “Business - Restrictions on Dividends and Other Distributions” above.
Competition Adversely Affects our Profitability
In California generally, and in the Bank’s primary market area specifically, major banks dominate the commercial banking industry. By virtue of their larger capital bases, such institutions have substantially greater lending limits than those of the Bank. Competition is likely to further intensify as a result of the recent and increasing level of consolidation of financial services companies, particularly in our market area resulting from various economic and market conditions. In obtaining deposits and making loans, the Bank competes with these larger commercial banks and other financial institutions, such as savings and loan associations, credit unions and member institutions of the Farm Credit System, which offer many services that traditionally were offered only by banks. Using the financial holding company structure, insurance companies, and securities firms may compete more directly with banks and bank holding companies. In addition, the Bank competes with other institutions such as mutual fund companies, brokerage firms, and even retail stores seeking to penetrate the financial services market. Current federal law has also made it easier for out-of-state banks to enter and compete in the states in which we operate. Competition in our principal markets may further intensify as a result of the Dodd-Frank Act which, among other things, permits out-of-state de novo branching by national banks, state banks and foreign banks from other states. We also experience competition, especially for deposits, from internet-based banking institutions and other financial companies, which do not always have a physical presence in our market footprint and have grown rapidly in recent years. Also, technology and other changes increasingly allow parties to complete financial transactions electronically, and in many cases, without banks. For example, consumers can pay bills and transfer funds over the internet and by telephone without banks. Non-bank financial service providers may have lower overhead costs and are subject to fewer regulatory constraints. If consumers do not use banks to complete their financial transactions, we could potentially lose fee income, deposits and income generated from those deposits. During periods of declining interest rates, competitors with lower costs of capital may solicit the Bank’s customers to refinance their loans. Furthermore, during periods of economic slowdown or recession, the Bank’s borrowers may face financial difficulties and be more receptive to offers from the Bank’s competitors to refinance their loans. No assurance can be given that the Bank will be able to compete with these lenders. See “Business - Competition” above.
Government Regulation and Legislation Could Adversely Affect the Company
The Company and the Bank are subject to extensive state and federal regulation, supervision, and legislation, which govern almost all aspects of the operations of the Company and the Bank. The business of the Bank is particularly susceptible to being affected by the enactment of federal and state legislation, which may have the effect of increasing the cost of doing business, modifying permissible activities, or enhancing the competitive position of other financial institutions. Such laws are subject to change from time to time and are primarily intended for the protection of consumers, depositors and the Deposit Insurance Fund and not for the benefit of shareholders of the Company. Regulatory authorities may also change their interpretation of these laws and regulations. The Company cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on the business and prospects of the Company, but it could be material and adverse. See “Business - Supervision and Regulation of the Bank” and "The effects of changes or increases in, or supervisory enforcement of, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us" above.
We maintain systems and procedures designed to comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of criminal or civil penalties (which can be substantial) for non-compliance. In some cases, liability may attach even if the non-compliance was inadvertent or unintentional and even if compliance systems and procedures were in place at the time. There may be other negative consequences from a finding of non-compliance, including restrictions on certain activities and damage to the Company’s reputation.
Our Controls and Procedures May Fail or be Circumvented Which Could Have a Material Adverse Effect on the Company's Financial Condition or Results of Operations
The Company maintains controls and procedures to mitigate against risks such as processing system failures and errors, and customer or employee fraud, and maintains insurance coverage for certain of these risks. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Events could occur which are not prevented or detected by the Company’s internal controls or are not insured against or are in excess of the Company’s insurance limits. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
Changes in Deposit Insurance Premiums Could Adversely Affect Our Business
As discussed above in Part I under the caption “Business - Premiums for Deposit Insurance,” the FDIC adopted a “restoration” plan for the Deposit Insurance Fund to ensure that the ratio of the fund’s reserves to insured deposits reaches 1.35% within the next 8 years, as required by the Dodd-Frank Act. The FDIC could further increase deposit premiums or impose special assessments in the future. Any further increases in the deposit insurance assessments the Bank pays would further increase our costs.
Negative Public Opinion Could Damage Our Reputation and Adversely Affect Our Earnings
Reputational risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion can result from the actual or perceived manner in which we conduct our business activities, management of actual or potential conflicts of interest and ethical issues, lending practices, governmental enforcement actions, corporate governance deficiencies, use of social media, cyber-security breaches and our protection of confidential client information, or from actions taken by regulators or community organizations in response to such actions. Negative public opinion can adversely affect our ability to keep and attract customers and employees and can expose us to claims and litigation and regulatory action and increased liquidity risk.
We May Not Be Able to Hire or Retain Additional Qualified Personnel and Recruiting and Compensation Costs May Increase as a Result of Turnover, Both of Which May Increase Costs and Reduce Profitability and May Adversely Impact Our Ability to Implement Our Business Strategy
Our success depends upon the ability to attract and retain highly motivated, well-qualified personnel. We face significant competition in the recruitment and retention of qualified employees. Executive compensation in the financial services sector has been controversial and the subject of regulation. The FDIC has proposed rules which would increase deposit premiums for institutions with compensation practices deemed to increase risk to the institution. Over time, this guidance and the proposed rules, upon their adoption, could have the effect of making it more difficult for banks to attract and retain skilled personnel.
We May Be Adversely Affected by Unpredictable Catastrophic Events or Terrorist Attacks and Our Business Continuity and Disaster Recovery Plans May Not Adequately Protect Us from Serious Disaster
The occurrence of catastrophic events such as wildfires (including programs of public utility public safety power outages when weather conditions and fire danger warrant), earthquakes, flooding or other large-scale catastrophes and terrorist attacks could adversely affect our business, financial condition or results of operations if a catastrophe rendered both our production data center in Sacramento and our recovery data center in Las Vegas unusable. Although we enhanced our disaster recovery capabilities in 2017 through the completion of the new, out of region backup center in Las Vegas, there can be no assurance that our current disaster recovery plans and capabilities will protect us from serious disaster.
Changes in Accounting Standards Could Materially Impact Our Financial Statements
The Company’s consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America, called GAAP. The financial information contained within our consolidated financial statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. Along with other factors, we use historical loss factors to determine the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical loss factors that we use. Other estimates that we use are fair value of our securities and expected useful lives of our depreciable assets. We have not entered into derivative contracts for our customers or for ourselves, which relate to interest rate, credit, equity, commodity, energy, or weather-related indices, other than forward commitments related to our loans held for sale portfolio. From time to time, the FASB and SEC change the financial accounting and reporting standards that govern the preparation of our financial statements or new interpretations of existing standards emerge as standard industry practice. These changes can be difficult to predict and operationally complex to implement and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, resulting in our restating prior period financial statements.
In June 2016, the FASB issued Accounting Standards Update 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). On October 16, 2019, the FASB voted to delay the adoption of ASU 2016-13 until January 1, 2023 for small reporting companies with less than $250 million in public float as defined in the SEC's rules. The Company qualifies for this delay in adoption. ASU 2016-13 will substantially change the accounting for credit losses on loans and other financial assets held by banks, financial institutions and other organizations. The standard replaces existing incurred loss impairment guidance and establishes a single allowance framework for financial assets carried at amortized cost. Upon adoption of ASU 2016-13, companies must recognize credit losses on these assets equal to management’s estimate of credit losses over the full remaining expected life. Companies must consider all relevant information when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts. The adoption of ASU 2016-13 could result in an increase in our allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. Furthermore, ASU 2016-13 will necessitate that we establish an allowance for expected credit losses for certain debt securities and other financial assets. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of adoption will be significantly influenced by the composition, characteristics and quality of our loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.
There is a Limited Public Market for the Company’s Common Stock Which May Make It Difficult for Shareholders to Dispose of Their Shares
The Company’s common stock is not listed on any exchange. However, trades may be reported on the OTC Markets under the symbol “FNRN.” The Company is aware that D.A Davidson, Raymond James, Wedbush Morgan Securities, and Monroe Securities all currently make a market in the Company’s common stock. Management is aware that there are also private transactions in the Company’s common stock. However, the limited trading market for the Company’s common stock may make it difficult for shareholders to dispose of their shares. Also, the price of the Company’s common stock may be affected by general market price movements as well as developments specifically related to the financial services sector, including interest rate movements, quarterly variations, or changes in financial estimates by securities analysts and a significant reduction in the price of the stock of another participant in the financial services industry.
Advances and Changes in Technology, and the Company’s Ability to Adapt Its Technology, May Strain Our Available Resources and Could Adversely Impact Our Ability to Compete and the Company’s Business and Operations
Advances and changes in technology can significantly impact the business and operations of the Company. The financial services industry is undergoing rapid technological change which regularly involves the introduction of new products and services based on new or enhanced technologies. Examples include cloud computing, artificial intelligence and machine learning, biometric authentication and data protection enhancements, as well as increased online and mobile device interaction with customers and increased demand for providing computer access to Bank accounts and the systems to perform banking transactions electronically. The Company’s merchant processing services require the use of advanced computer hardware and software technology and rapidly changing customer and regulatory requirements. The Company’s ability to compete effectively depends on its ability to continue to adapt its technology on a timely and cost-effective basis to meet these requirements. Our continued success and the maintenance of our competitive position depends, in part, upon our ability to meet the needs of our customers through the application of new technologies. If we fail to maintain or enhance our competitive position with regard to technology, whether because we fail to anticipate customer needs and expectations or because our technological initiatives fail to perform as desired or are not timely implemented, we may lose market share or incur additional expense. Our ability to execute our core operations and to implement technology and other important initiatives may be adversely affected if our resources are insufficient or if we are unable to allocate available resources effectively.
In addition, the Company’s business and operations are susceptible to negative impacts from computer system failures, communication and power disruption, and unethical individuals with the technological ability to cause disruptions or failures of the Company’s data processing systems.
Information Security Breaches or Other Technological Difficulties Could Adversely Affect the Company
Our operations rely on the secure processing, storage, transmission and reporting of personal, confidential and other sensitive information in our computer systems, networks and business applications. Although we take protective measures, our computer systems, as well as the systems of our third-party providers, may be vulnerable to breaches or attacks, unauthorized access, misuse, computer viruses or other malicious code, operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems, and other events that could have significant negative consequences to us. Such events could result in interruptions or malfunctions in our or our customers’ operations, interception, misuse or mishandling of personal or confidential information, or processing of unauthorized transactions or loss of funds. These events could result in litigation, regulatory enforcement actions, and financial losses that are either not insured against or not fully covered by our insurance, or result in regulatory consequences or reputational harm, any of which could harm our competitive position, operating results and financial condition. We maintain cyber insurance, but this insurance may not cover all costs associated with cyber incidents or the consequences of personal or confidential information being compromised. These types of incidents can remain undetected for extended periods of time, thereby increasing the associated risks. We may also be required to expend significant resources to modify our protective measures or to investigate and remediate vulnerabilities or exposures arising from cybersecurity risks.
We depend on the continued efficacy of our technical systems, operational infrastructure, relationships with third parties and our employees in our day-to-day and ongoing operations. Our increasing dependence upon automated systems to record and process transactions may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. With regard to the physical infrastructure that supports our operations, we have taken measures to implement backup systems and other safeguards, but our ability to conduct business may be adversely affected by any disruption to that infrastructure. Failures in our internal control or operational systems, security breaches or service interruptions could impair our ability to operate our business and result in potential liability to customers, reputational damage and regulatory intervention, any of which could harm our operating results and financial condition.
We may also be subject to disruptions of our operating systems arising from other events that are wholly or partially beyond our control, such as outages related to electrical, internet or telecommunications, natural disasters (such as major seismic events), or unexpected difficulties with the implementation of our technology enhancement and replacement projects, which may give rise to disruption of service to customers and to financial loss or liability. Our business recovery plan may not work as intended or may not prevent significant interruptions of our operations.
In recent years, it has been reported that several of the larger U.S. banking institutions have been the target of various denial-of-service or other cyberattacks (including attempts to inject malicious code and viruses into computer systems) that have, for limited periods, resulted in the disruption of various operations of the targeted banks. These cyber-attacks originate from a variety of sophisticated sources who may be involved with organized crime, linked to terrorist organizations or hostile countries and have extensive resources to disrupt the operations of the Bank or the financial system more generally. The potential for denial-of-service and other attacks requires substantial resources to defend and may affect customer satisfaction and behavior. To date we have not experienced any material losses relating to cyberattacks or other information security breaches, but there can be no assurance that we will not suffer such losses or information security breaches in the future. A successful cyber-attack could result in a material disruption of the Bank’s operations, exposure of confidential information and financial loss to the Bank, its clients, customers and counterparties and could lead to significant exposure to litigation and regulatory fines, penalties and other sanctions as well as reputational damage. While we have a variety of cyber-security measures in place, the consequences to our business, if we were to become a target of such attacks, cannot be predicted with any certainty.
In addition, there have been increasing efforts on the part of third parties to breach data security at financial institutions or with respect to financial transactions, including through the use of social engineering schemes such as “phishing.” The ability of our customers to bank remotely, including online and though mobile devices, requires secure transmission of confidential information and increases the risk of data security breaches which would expose us to claims by customers or others and which could adversely affect our reputation and could lead to a material loss.
We, and other banking institutions, are also at risk of increased losses from fraudulent conduct of criminals using increasingly sophisticated techniques which, in some cases, are part of larger criminal organizations which allow them to be more effective. This criminal activity is taking many forms, including information theft, debit/credit card fraud, check fraud, mechanical devices affixed to ATM’s, social engineering, phishing attacks to obtain personal information, or impersonation of customers through falsified or stolen credentials, business email compromise, and other criminal endeavors. We, and other banking institutions are also at risk of fraudulent or criminal activities by employees, contractors, vendors and others with whom we do business. There is also the risk of errors by our employees and others responsible for the systems and controls on which we depend and any resulting failures of these systems and controls could significantly harm the Company, including customer remediation costs, regulatory fines and penalties, litigation or enforcement actions, or limitations on our business activities.
Under the applicable Federal regulatory guidance, financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. In addition, a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes that enable recovery of data and business operations and that address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. A financial institution which fails to observe the regulatory guidance could be subject to various regulatory sanctions, including financial sanctions.
The Federal bank regulators have also issued a cybersecurity assessment tool, the output of which can assist a financial institution’s senior management and board of directors in assessing the institution’s cybersecurity risk and preparedness. The first part of the assessment tool is the inherent risk profile, which aims to assist management in determining an institution’s level of cybersecurity risk. The second part of the assessment tool is cybersecurity maturity, which is designed to help management assess whether their controls provide the desired level of preparedness. The Federal bank regulators plan to utilize the assessment tool as part of their examination process when evaluating financial institutions’ cybersecurity preparedness in information technology and safety and soundness examinations and inspections. Failure to effectively utilize this tool would result in regulatory criticism. Significant resources are required to adequately implement the tool and address any assessment concerns regarding preparedness. Management has conducted cyber-security assessments using this tool and expects to perform additional periodic assessments to facilitate the identification and remediation of any concerns regarding our cyber-security preparedness.
Even if cyber-attacks and similar tactics are not directed specifically at the Bank, such attacks on other large financial institutions could disrupt the overall functioning of the financial system and undermine consumer confidence in banks generally, to the detriment of other financial institutions, including the Bank. A data security breach at a large U.S. retailer resulted in the compromise of data related to credit and debit cards of large numbers of customers requiring many banks, including the Bank, to reissue credit and debit cards for affected customers and reimburse these customers for losses sustained.
We maintain an insurance policy which we believe provides sufficient coverage at a manageable expense for an institution of our size and scope with similar technological systems. However, we cannot assure that this policy would be sufficient to cover all financial losses, damages, penalties, including lost revenues, should we experience any one or more of our or a third-party’s systems failing or experiencing attack.
Environmental Hazards Could Have a Material Adverse Effect on the Company’s Business, Financial Condition, and Results of Operations
The Company, in its ordinary course of business, acquires real property securing loans that are in default, and there is a risk that hazardous substances or waste, contaminants or pollutants could exist on such properties. The Company may be required to remove or remediate such substances from the affected properties at its expense, and the cost of such removal or remediation may substantially exceed the value of the affected properties or the loans secured by such properties. Furthermore, the Company may not have adequate remedies against the prior owners or other responsible parties to recover its costs. Finally, the Company may find it difficult or impossible to sell the affected properties either prior to or following any such removal. In addition, the Company may be considered liable for environmental liabilities in connection with its borrowers’ properties, if, among other things, it participates in the management of its borrowers’ operations. The occurrence of such an event could have a material adverse effect on the Company’s business, financial condition, results of operations, and cash flows.
The Company may not be successful in raising additional capital needed in the future
If additional capital is needed in the future as a result of losses, our business strategy or regulatory requirements, there is no assurance that our efforts to raise such additional capital will be successful or that shares sold in the future will be sold at prices or on terms equal to or better than the current market price. The inability to raise additional capital when needed or at prices and terms acceptable to us could adversely affect our ability to implement our business strategies.
In the Future, the Company May Be Required to Recognize Impairment With Respect to Investment Securities, Which May Adversely Affect our Results of Operations
The Company’s securities portfolio currently includes securities with unrecognized losses. The Company may continue to observe declines in the fair market value of these securities. Management evaluates the securities portfolio for any other-than-temporary impairment each reporting period, as required by generally accepted accounting principles. There can be no assurance, however, that future evaluations of the securities portfolio will not require us to recognize impairment charges with respect to these and other holdings, which could adversely affect our results of operations.
The Changes in the U.S. Tax Laws, the Majority of Which Were Effective January 1, 2018, Will Impact Our Business and Results of Operations in a Variety of Ways, Some of Which Are Positive, and Others Which May Be Negative
The Tax Cuts and Jobs Act (“TCJA”), signed into law on December 22, 2017, enacted sweeping changes to the U.S. federal tax laws generally effective January 1, 2018. These changes can be expected to impact our business and results of operations in a variety of ways, some of which are expected to be positive and others which may be negative. The TCJA reduced the corporate tax rate to 21% from 35%, which resulted in a net reduction in our annual income tax expense and which should also benefit many of our corporate and other small business borrowers. However, our ability to utilize tax credits, such as those arising from low-income housing and alternative energy investments, may be constrained by the lower tax rate. We are continuing to monitor the full impact of these changes in the tax law on our tax positions.

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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 and the Bank are engaged in the banking business through 14 offices in five counties in Northern California operating out of three offices in Solano County, six in Yolo County, two in Sacramento County, two in Placer County and one in Contra Costa County. In addition, the Company owns three vacant lots, two in northern Solano County and one in eastern Sacramento County, for possible future bank sites.
The Bank owns three branch office locations and two administrative facilities and leases 11 facilities. Most of the leases contain multiple renewal options and provisions for rental increases, principally for changes in the cost of living index, property taxes and maintenance.
See Item 1 “Business - General” in this report for more information regarding our properties.

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ITEM 3. LEGAL PROCEEDINGS
ITEM 3 - LEGAL PROCEEDINGS
Neither the Company nor the Bank is a party to any material pending legal proceeding, nor is any of its property the subject of any material pending legal proceeding, except ordinary routine litigation arising in the ordinary course of the Bank’s business and incidental to its business, none of which is expected to have a material adverse impact upon the Company’s or the Bank’s business, financial position or results of operations.

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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 STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is not listed on any exchange. However, trades may be reported on the OTC Markets under the symbol “FNRN.” The Company is aware that D.A. Davidson, Raymond James, Wedbush Morgan Securities, and Monroe Securities, all currently make a market in the Company’s common stock. Management is aware that there are also private transactions in the Company’s common stock, and the data set forth below may not reflect all such transactions.
The following table summarizes the range of reported high and low bid quotations of the Company’s Common Stock for each quarter during the last two fiscal years and is based on information provided by D.A. Davidson. The quotations reflect the price that would be received by the seller without retail mark-up, mark-down or commissions and may not have represented actual transactions:
QUARTER/YEAR
HIGH*
LOW*
4th Quarter 2020
$
10.00
$
7.80
3rd Quarter 2020
$
7.81
$
7.38
2nd Quarter 2020
$
8.09
$
7.34
1st Quarter 2020
$
10.84
$
7.43
4th Quarter 2019
$
10.43
$
10.02
3rd Quarter 2019
$
10.43
$
9.99
2nd Quarter 2019
$
10.79
$
10.03
1st Quarter 2019
$
10.44
$
9.33
* Price adjusted for stock dividends in the indicated periods for the 5% stock dividends payable March 25, 2021 and March 25, 2020, as described below.
As of March 1, 2021, there were approximately 1,407 holders of record of the Company’s common stock, no par value.
In the prior two fiscal years and to date, the Company has declared the following stock dividends:
Shareholder Record Date
Dividend Percentage
Date Payable
February 28, 2019
5%
March 29, 2019
February 28, 2020
5%
March 25, 2020
February 26, 2021
5%
March 25, 2021
The Company does not expect to pay a cash dividend in the foreseeable future. Our ability to declare and pay dividends is affected by certain regulatory restrictions. See “Business - Restrictions on Dividends and Other Distributions” above. The Company made no repurchases of common stock in the 12 months ended December 31, 2020.
For information regarding securities authorized for issuance under equity compensation plans, see Part III, Item 12 of this Report on Form 10-K.

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ITEM 6. SELECTED FINANCIAL DATA
ITEM 6 - SELECTED FINANCIAL DATA
The selected consolidated financial data below have been derived from the Company’s audited consolidated financial statements. The selected consolidated financial data set forth below as of December 31, 2017 and 2016 have been derived from the Company’s historical consolidated financial statements not included in this Report. The financial information for 2020, 2019, and 2018, should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which is in Part II (Item 7) of this Report and with the Company’s audited consolidated financial statements and the notes thereto, which are included in Part II (Item 8) of this Report.
Consolidated Financial Data as of and for the years ended December 31,
(in thousands, except share and per share amounts)
Interest and Dividend Income
$
48,864
$
48,993
$
45,617
$
40,017
$
35,967
Interest Expense
(1,484
)
(1,859
)
(1,268
)
(1,079
)
(1,157
)
Net Interest Income
47,380
47,134
44,349
38,938
34,810
Provision for Loan Losses
(3,050
)
-
(2,100
)
(600
)
(1,800
)
Net Interest Income after Provision for Loan Losses
44,330
47,134
42,249
38,338
33,010
Non-Interest Income
7,809
7,197
7,209
8,128
7,278
Non-Interest Expense
(35,477
)
(33,940
)
(32,163
)
(29,400
)
(27,352
)
Income before Taxes
16,662
20,391
17,295
17,066
12,936
Provision for Taxes
(4,501
)
(5,670
)
(4,744
)
(8,318
)
(4,885
)
Net Income
$
12,161
$
14,721
$
12,551
$
8,748
$
8,051
Basic Income Per Share
$
0.90
$
1.10
$
0.94
$
0.66
$
0.60
Diluted Income Per Share
$
0.90
$
1.08
$
0.93
$
0.65
$
0.60
Total Assets
$
1,655,376
$
1,292,591
$
1,249,845
$
1,217,658
$
1,166,763
Total Investments
$
435,080
$
342,897
$
314,637
$
280,741
$
277,079
Total Loans, including Loans Held-for-Sale, net(1)
$
885,020
$
773,003
$
765,688
$
740,152
$
673,096
Total Deposits
$
1,478,162
$
1,138,632
$
1,124,612
$
1,104,740
$
1,063,696
Total Equity
$
150,657
$
132,915
$
112,461
$
100,044
$
92,298
Weighted Average Shares of Common Stock outstanding used for Basic Income Per Share Computation (2)
13,462,764
13,414,705
13,382,484
13,348,706
13,324,451
Weighted Average Shares of Common Stock outstanding used for Diluted Income Per Share Computation (2)
13,582,844
13,579,683
13,567,587
13,517,977
13,409,954
Return on Average Total Assets
0.79
%
1.18
%
1.03
%
0.74
%
0.74
%
Net Income/Average Equity
8.41
%
11.88
%
12.00
%
8.88
%
8.87
%
Net Income/Average Deposits
0.88
%
1.33
%
1.14
%
0.82
%
0.81
%
Average Loans/Average Deposits
65.01
%
66.78
%
67.03
%
63.40
%
63.57
%
Average Equity to Average Total Assets
9.36
%
9.91
%
8.58
%
8.36
%
8.31
%
(1) Includes PPP loans totaling $155 million as of December 31, 2020.
(2) All years have been restated to give retroactive effect for stock dividends issued and stock splits.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Introduction
This overview highlights selected information in this Annual Report on Form 10-K and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates, you should carefully read this entire Annual Report on Form 10-K. For a discussion of changes in results of operations comparing the years ended December 31, 2019 and 2018, for the Company and its subsidiary, see Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 5, 2020.
Our subsidiary, First Northern Bank of Dixon, is a California state-chartered bank that derives most of its revenues from lending and deposit taking in the Sacramento Valley region of Northern California. Interest rates, business conditions and customer confidence all affect our ability to generate revenues. In addition, the regulatory environment and competition can challenge our ability to generate those revenues.
Financial highlights for 2020 include:
The Company reported net income of $12.2 million for 2020, a 17.4% decrease compared to net income of $14.7 million for 2019. Net income per common share for 2020 was $0.90, a decrease of 18.2% compared to net income per common share of $1.10 for 2019. Net income per common share on a fully diluted basis was $0.90 for 2020, a decrease of 16.7% compared to net income per common share on a fully diluted basis of $1.08 for 2019.
Net interest income totaled $47.4 million for 2020, an increase of 0.5% from $47.1 million in 2019, primarily due to increases in interest income on loans and a decrease in interest expense on deposits, which was partially offset by decreases in interest income on due from bank balances, investment securities, and other earning assets.
Provision for loan losses totaled $3.1 million in 2020, compared to no provision for loan losses in 2019. The increase was largely driven by increases in qualitative factors due to declines in the general economic environment as a result of the coronavirus pandemic.
Non-interest income totaled $7.8 million in 2020, an increase of 8.5% from $7.2 million in 2019. Gain on sale of loans held-for sale and gain on sale of available-for-sale securities increased in 2020 compared to 2019, which was partially offset by a decrease in service charges on deposit accounts and other non-interest income. The decrease in service charges on deposit accounts was primarily a result of the COVID-19 pandemic and the Bank's decision to waive overdraft/NSF fees for all business and consumer customers for an initial period of 60 days which began in March and was later extended into the third quarter. The auto-waiver period expired on August 1, 2020. This assistance resulted in increased fee waiver activity, reducing reported service charge income.
Non-interest expenses totaled $35.5 million for 2020, up 4.5% from $33.9 million in 2019. The increase was primarily due to increases in salaries and employee benefits due to increased staffing levels, occupancy and equipment expense due to the full year rent expense and other expenses associated with the opening of an administrative office space and a branch in the second half of 2019, and other expenses. The decrease was partially offset by a decrease in data processing expenses primarily due to costs incurred in 2019 that were not repeated in 2020, associated with outsourcing of core processing and network infrastructure to third parties, and other real estate owned expense primarily due to a write-down on other real estate owned in 2019, that was not repeated in 2020.
The Company reported total assets of $1.66 billion as of December 31, 2020, up 28.1% from $1.29 billion as of December 31, 2019.
Investments increased to $435.1 million as of December 31, 2020, a 26.9% increase from $342.9 million as of December 31, 2019. U.S. Treasury securities totaled $38.9 million as of December 31, 2020, down 10.1% from $43.3 million as of December 31, 2019; securities of U.S. government agencies and corporations totaled $106.5 million, up 97.7% from $53.9 million as of December 31, 2019; obligations of state and political subdivisions totaled $32.9 million, up 21.6% from $27.0 million as of December 31, 2019; collateralized mortgage obligations totaled $73.5 million, down 7.5% from $79.4 million as of December 31, 2019; and mortgage-backed securities totaled $183.3 million, up 31.6% from $139.3 million as of December 31, 2019.
Loans (including loans held-for-sale), net of allowance, increased to $885.0 million as of December 31, 2020, a 14.5% increase from $773.0 million as of December 31, 2019. Commercial loans totaled $255.9 million as of December 31, 2020, up 141.1% from $106.1 million as of December 31, 2019; commercial real estate loans were $454.1 million, up 0.5% from $451.8 million as of December 31, 2019; agriculture loans were $95.0 million, down 17.9% from $115.8 million as of December 31, 2019; residential mortgage loans were $64.5 million, down 0.7% from $64.9 million as of December 31, 2019; residential construction loans were $4.2 million, down 72.2% from $15.2 million as of December 31, 2019; and consumer loans totaled $19.5 million, down 27.4% from $26.8 million as of December 31, 2019.
Deposits increased to $1.48 billion as of December 31, 2020, a 29.8% increase from $1.14 billion as of December 31, 2019.
FHLB advances totaling $5.0 million as of December 31, 2020, compared to no FHLB advances as of December 31, 2019. The $5.0 million advance is a short-term borrowing with a 0% interest rate that was received through the FHLB's COVID-19 Relief and Recovery Advances Program.
Stockholders' equity increased to $150.7 million as of December 31, 2020, a 13.4% increase from $132.9 million as of December 31, 2019.
Recent Developments Related to COVID-19
Since March 13, 2020, the United States has been operating under a state of emergency declared by President Trump in response to the spread of the coronavirus and the COVID-19 disease which it causes. On March 4, 2020, California Governor Gavin Newsom declared a similar state-wide emergency. Also, early in March, a number of county and other local health agencies in California declared emergencies and issued “stay-at-home” ordinances for all persons other than workers at “essential businesses”. Later in 2020, the California state government adopted a four-phase reopening plan. The ability of a county to move into a phase with fewer restrictions on social and economic activities is dependent upon the county’s compliance with parameters such as the county’s case rate, test positivity rate, and a health equity metric. As of this time, the California state government, as well as the county health departments in our market area, continue to limit business re-openings in certain sectors and/or with capacity and other restrictions. During March 2020 and continuing thereafter, the pandemic and governmental responses have resulted in recessionary economic, labor and financial market conditions across the United States and in our markets in California, including dramatic increases in unemployment. In response, the FRB reduced its federal funds rate by 1.5 percentage points to the current target range of .00 to .25 percent. In addition, in late March 2020, the U.S. government enacted the CARES Act, a $2.2 trillion economic stimulus package, the largest in U.S. history, plus an additional $900 billion stimulus package in December 2020, in an effort to lessen the impact of the pandemic on consumers and businesses.
These developments have had an impact on our business. Our commercial real estate loan portfolio exposure to industries most affected by the stay-at-home order and subsequent limitations on business activities includes 6.2% to retail properties and business; 1.5% to restaurants; and 1.1% to the hospitality/hotel sector at December 31, 2020. Loans to these customers are generally secured by real estate with relatively low loan-to-value ratios and strong guarantors. There is concern that borrowers will draw on their credit lines to support cashflow disruptions caused by the continuing restrictions on business activities. Most of the Bank’s optional advance lines of credit are “controlled” with advances supported by certain assets pledged to the Bank for repayment or specific budgeted expense. The Bank monitors credit line advances daily and has not noted any significant, unusual loan advances as of December 31, 2020. We have also granted customer relief in a variety of ways, including extended grace periods on residential and commercial mortgages, commercial loans, and automobile loan and lease payments, refraining from reporting payment deferrals to credit bureaus and waiving or refunding certain fees. The Bank, in the first part of April 2020, commenced participation in the PPP of the SBA which is aimed at providing relief from the pandemic to small businesses through loans by banks guaranteed by the SBA. In the initial phase of the program, the Bank approved approximately 650 applications for loans under the PPP covering approximately $184 million in funding. The program was suspended after the initial Congressional appropriation of $349 billion was exhausted. A second phase of the program, involving a Congressional appropriation of some $310 billion, was initiated on April 27, 2020. The Bank approved approximately 670 applications for PPP loans in this second phase, covering approximately $51 million in funding. A total of approximately $235 million in PPP loans were originated by the Bank in 2020. These PPP loan originations resulted in approximately $7.8 million in SBA processing fees which will be recognized as an adjustment to the effective yield over the loans projected life. A total of approximately $5.9 million of PPP processing fees was recognized in interest income for the year ended December 31, 2020. In 2020, the Bank received $80 million in payoffs and reimbursements from the SBA for the amounts forgiven pursuant to the terms of the PPP. The Bank had PPP loans totaling $155 million as of December 31, 2020. The Company expects that a significant portion of the PPP loans remaining will be forgiven during 2021 under the terms of the program, as borrowers satisfy the requirement of applying at least 60% of the loan proceeds to support their payroll expenses. Loans which do not qualify for the forgiveness will remain on the Bank’s books, subject to the SBA’s guarantee.
First Northern Bank has continued to actively assist our communities by providing temporary loan relief under Section 4013 of the CARES Act to customers who have been adversely impacted by the pandemic. This relief has included loan modifications which provided temporary forbearance programs (both full payment deferrals and interest only payments). The Bank provided temporary forbearance relief for borrowers over the course of 2020 totaling approximately $102 million, resulting in the net deferral of interest income of approximately $1.2 million for the year ended December 31, 2020. For loans that were provided full payment deferrals under Section 4013, the Bank made a policy election to cease recognizing interest income during the term of the payment suspension. Upon completion of the payment forbearance period, and resumption of performance under the original loan terms, the foregone interest is capitalized as deferred interest and recognized as a yield adjustment over the remaining loan term. Loans on interest-only plans continued to accrue interest income given continued payment performance over the course of the forbearance period. A majority of loans completed their forbearance period during the fourth quarter of 2020. Two loans totaling $7.0 million were on an interest only forbearance plan and one loan totaling $0.8 million was on a principal and interest forbearance plan at December 31, 2020.
Although banks in California are defined as “essential businesses” under the California governmental actions and thus are allowed to remain open, some of our employees have elected to work remotely, a majority of whom would normally be working in our branches or offices. In our branches and offices we continue to enforce the use of face coverings, social distancing and using proper hygiene practices.
Critical Accounting Policies and Estimates
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, income and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to the allowance for loan losses, other real estate owned, investments, and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements:
Allowance for Loan Losses
The Company believes the allowance for loan losses accounting policy is critical because the loan portfolio represents the largest asset on the consolidated balance sheet, and there is significant judgment used in determining the adequacy of the allowance for loan losses. The Company maintains an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is based on the Company’s periodic evaluation of the factors mentioned below, as well as other pertinent factors. The allowance for loan losses consists of an allocated component and a general component. The components of the allowance for loan losses represent an estimate. The allocated component of the allowance for loan losses reflects expected losses resulting from analyses developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on regular analyses of all loans where the internal credit rating is at or below a predetermined classification. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The historical loan loss element is determined using analysis that examines loss experience.
The allocated component of the allowance for loan losses also includes consideration of concentrations and changes in portfolio mix and volume. The general portion of the allowance reflects the Company’s estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. Uncertainty surrounding the strength and timing of economic cycles also affects estimates of loss. There are many factors affecting the allowance for loan losses; some are quantitative while others require qualitative judgment. Although the Company believes its process for determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from Company estimates, additional provision for credit losses could be required that could adversely affect earnings or financial position in future periods.
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. For a loan that has been restructured in a troubled debt restructuring, the contractual terms of the loan agreement refer to the contractual terms specified by the original loan agreement, not the contractual terms specified by the restructuring agreement. An impaired loan is measured based upon the present value of future cash flows discounted at the loan’s effective rate, the loan’s observable market price, or the fair value of collateral if the loan is collateral dependent. If the measurement of the impaired loan is less than the recorded investment in the loan, an impairment is recognized by a charge to the allowance for loan losses.
Other-than-temporary Impairment in Debt Securities
Debt securities with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed interest rate debt securities, from rising interest rates. At each consolidated financial statement date, management assesses each debt security in an unrealized loss position to determine if impaired debt securities are temporarily impaired or if the impairment is other than temporary. This assessment includes consideration regarding the duration and severity of impairment, the credit quality of the issuer and a determination of whether the Company intends to sell the security, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. Other-than-temporary impairment is recognized in earnings if one of the following conditions exists: 1) the Company’s intent is to sell the security; 2) it is more likely than not that the Company will be required to sell the security before the impairment is recovered; or 3) the Company does not expect to recover its amortized cost basis. If, by contrast, the Company does not intend to sell the security and will not be required to sell the security prior to recovery of the amortized cost basis, the Company recognizes only the credit loss component of other-than-temporary impairment in earnings. The credit loss component is calculated as the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of the future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income.
Fair Value Measurements
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a non-recurring basis, such as loans held-for-sale, loans held-for-investment and certain other assets. These non-recurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally corresponds with the Company’s quarterly valuation process. For additional discussion, see Note 13 to the Consolidated Financial Statements in this Form 10-K.
Share-Based Payment
The Company determines the fair value of stock options at grant date using the Black-Scholes-Merton pricing model that takes into account the stock price at the grant date, the exercise price, the expected dividend yield, stock price volatility, and the risk-free interest rate over the expected life of the option. The Black-Scholes-Merton model requires the input of highly subjective assumptions including the expected life of the stock-based award and stock price volatility. The estimates used in the model involve inherent uncertainties and the application of Management’s judgment. As a result, if other assumptions had been used, our recorded stock-based compensation expense could have been materially different from that reflected in these financial statements. The fair value of non-vested restricted common shares generally equals the stock price at grant date. In addition, we estimate the expected forfeiture rate and only recognize expense for those share-based awards expected to vest. If our actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different. For additional discussion, see Note 15 to the Consolidated Financial Statements in this Form 10-K.
Accounting for Income Taxes
Income taxes reported in the consolidated financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences that have been recognized in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the consolidated financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more-likely-than-not that they will be realized. In evaluating our ability to recover the deferred tax assets, Management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, Management develops assumptions including the amount of future state and federal pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. The Company files consolidated federal and combined state income tax returns.
A "more-likely-than-not" recognition threshold must be met before a tax benefit can be recognized in the consolidated financial statements. For tax positions that meet the more-likely-than-not threshold, an enterprise may recognize only the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. To the extent tax authorities disagree with these tax positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. For additional discussion, see Note 18 to the Consolidated Financial Statements in this Form 10-K.
Mortgage Servicing Rights
Transfers and servicing of financial assets and extinguishments of liabilities are accounted for and reported based on consistent application of a financial-components approach that focuses on control. Transfers of financial assets that are sales are distinguished from transfers that are secured borrowings. Retained servicing rights on loans sold are measured by allocating the previous carrying amount of the transferred assets between the loans sold and retained interest, if any, based on their relative fair value at the date of transfer. Fair values are estimated using discounted cash flows based on a current market interest rate. The Company recognizes a gain and a related asset for the fair value of the rights to service loans for others when loans are sold.
The recorded value of mortgage servicing rights is included in other assets on the Consolidated Balance Sheets initially at fair value, and is amortized in proportion to, and over the period of, estimated net servicing revenues. The Company assesses capitalized mortgage servicing rights for impairment based upon the fair value of those rights at each reporting date. For purposes of measuring impairment, the rights are stratified based upon the product type, term and interest rates. Fair value is determined by discounting estimated net future cash flows from mortgage servicing activities using discount rates that approximate current market rates and estimated prepayment rates, among other assumptions. The amount of impairment recognized, if any, is the amount by which the capitalized mortgage servicing rights for a stratum exceeds their fair value. Impairment, if any, is recognized through a valuation allowance for each individual stratum.
Impact of Recently Issued Accounting Standards
The CARES Act was passed by Congress and signed into law on March 27, 2020. Section 4013 of the CARES Act stipulates that a financial institution may elect to not apply GAAP requirements to loan modifications related to the COVID-19 pandemic that would otherwise be categorized as a TDR, and suspends the determination of loan modifications related to the COVID-19 pandemic from being treated as TDR’s. The relief from TDR guidance applies to modifications of loans that were not more than 30 days past due as of December 31, 2019, and modifications that occur beginning on March 1, 2020, until the earlier of: sixty days after the date on which the national emergency related to the COVID-19 outbreak is terminated or December 31, 2020. The suspension of TDR accounting and reporting guidance may not be applied to any adverse impact on the credit of a borrower that is not related to the COVID-19 pandemic. In December 2020, the Consolidated Appropriations Act, 2021 was signed into law. Section 541 of this legislation, “Extension of Temporary Relief From Troubled Debt Restructurings and Insurer Clarification,” extends Section 4013 of the CARES Act to the earlier of January 1, 2022 or 60 days after the termination of the national emergency declared relating to COVID-19. Future TDRs are indeterminable and will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.
On April 3, 2020, the SEC Office of the Chief Accountant issued a public statement communicating that for eligible entities that elect to apply Section 4013 of the CARES Act, the SEC staff would not object that this is in accordance with GAAP for the periods for which such elections are available. In June 2020, the American Institute of Certified Public Accountants published Q&A Section 2130.41 regarding a technical question regarding the recognition of interest income on Section 4013 loans which provided multiple permitted policy elections regarding the recognition of interest on Section 4013 restructured loans.
The Bank has continued to actively assist its communities by providing temporary loan relief under Section 4013 of the CARES Act. This relief included loan modifications which include forbearance programs (both full payment deferrals and interest only payments) to customers who have been negatively impacted by the pandemic. For loans that have been provided temporary full payment deferrals, the Bank has made a policy election to cease recognition of interest income during the term of the payment deferrals (generally three to six months). Upon completion of the forbearance period, the foregone interest over the deferral period is capitalized as deferred interest and recognized as an adjustment to the effective interest rate over the remaining life of the loan using the effective yield method. Loans that were provided interest only payment relief will continue to accrue interest over the interest-only period provided that the loans continue to perform as agreed. This policy election does not impact the Bank’s existing policies regarding non-accrual determinations if reasonable doubt exists as to the full and timely collection of interest or principal or when a loan becomes contractually past due by ninety days or more with respect to interest or principal regardless of whether a loan was modified under Section 4013 of the CARES Act. On March 22, 2020, the federal bank regulatory agencies issued joint guidance advising that the agencies have confirmed with the staff of the Financial Accounting Standards Board that short-term modifications due to COVID-19, made on a good faith basis to borrowers who were current prior to relief, are not TDRs. The CARES Act also provided relief from TDR classification for certain COVID-19 loan modifications. The Bank elected not to classify modifications that meet the criteria under either the CARES Act or the criteria specified by the regulatory agencies as TDRs.
In March 2020, the FASB issued ASU 2020-02, Financial Instruments-Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842). This ASU adds an SEC paragraph pursuant to the issuance of SEC Staff Accounting Bulletin No. 119 on loan losses to the FASB Codification Topic 326. This ASU also updates the SEC section of the Codification for the change in the effective date of Topic 842. This ASU is effective upon addition to the FASB Codification. The Company adopted ASU 2016-02, Leases (Topic 842) on January 1, 2019. ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) is effective on January 1, 2023 for smaller reporting companies with less than $250 million in public float as defined in the SEC's rules (such as the Company). While the Company is currently unable to reasonably estimate the impact of adopting ASU 2016-13, it expects that the impact of adoption will be significantly influenced by the composition, characteristics and quality of the Company’s loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.
In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. The amendments in ASU 2020-03 make narrow-scope improvements to various aspects of the financial instruments guidance, including the current expected credit losses (CECL) standard issued in 2016. The ASU is part of the FASB’s ongoing Codification improvement project aimed at clarifying specific areas of accounting guidance to help avoid unintended application. The items addressed in that project generally are not expected to have a significant effect on current accounting practice or create a significant administrative cost for most entities. Effective dates for each amendment vary. The Company does not expect the adoption of this update to have a significant impact on its financial statements.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848). This ASU provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. This ASU provides optional expedients and exceptions for contracts, hedging relationships, and other transactions that reference LIBOR or other reference rates expected to be discontinued because of reference rate reform. This ASU is effective for all entities as of March 12, 2020 through December 31, 2022. The Company is in the process of evaluating the provisions of this ASU, but does not expect it to have a material impact on our consolidated financial statements.
In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope. This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company is in the process of evaluating the provisions of this ASU, but does not expect it to have a material impact on our consolidated financial statements.
STATISTICAL INFORMATION AND DISCUSSION
The following statistical information and discussion should be read in conjunction with the Selected Financial Data included in Part II (Item 6) and the audited consolidated financial statements and accompanying notes included in Part II (Item 8) of this Annual Report on Form 10-K.
The following tables present information regarding the consolidated average assets, liabilities and stockholders’ equity, the amounts of interest income from average earning assets and the resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include non-performing loans. Interest income includes proceeds from loans on non-accrual status only to the extent cash payments have been received and applied as interest income. Tax-exempt income is not shown on a tax equivalent basis.
Distribution of Assets, Liabilities and Stockholders’ Equity;
Interest Rates and Interest Differential
(Dollars in thousands)
Average
Balance
Percent
Average
Balance
Percent
Average
Balance
Percent
ASSETS
Cash and Due From Banks
$
221,140
14.3
%
$
127,977
10.2
%
$
139,957
11.5
%
Certificates of Deposit
19,210
1.2
%
12,538
1.0
%
4,160
0.3
%
Investment Securities
358,005
23.2
%
319,418
25.5
%
293,259
24.1
%
Loans (1)
894,626
57.9
%
741,466
59.3
%
739,243
60.6
%
Stock in Federal Home Loan Bank and other equity securities, at cost
6,509
0.4
%
6,405
0.5
%
5,884
0.5
%
Other Real Estate Owned
-
-
0.1
%
0.0
%
Other Assets
46,388
3.0
%
41,899
3.4
%
36,460
3.0
%
Total Assets
$
1,545,878
100.0
%
$
1,250,543
100.0
%
$
1,219,148
100.0
%
LIABILITIES &
STOCKHOLDERS’ EQUITY
Deposits:
Demand
$
577,559
37.3
%
$
408,551
32.7
%
$
394,106
32.3
%
Interest-Bearing Transaction Deposits
356,867
23.1
%
308,917
24.7
%
307,727
25.2
%
Savings and MMDAs
387,490
25.0
%
334,672
26.8
%
333,788
27.4
%
Time Certificates
54,147
3.5
%
58,128
4.6
%
67,177
5.5
%
Federal Home Loan Bank Advances
5,656
0.4
%
-
-
-
-
Other Liabilities
19,493
1.3
%
16,313
1.3
%
11,743
1.0
%
Stockholders’ Equity
144,666
9.4
%
123,962
9.9
%
104,607
8.6
%
Total Liabilities and Stockholders’ Equity
$
1,545,878
100.0
%
$
1,250,543
100.0
%
$
1,219,148
100.0
%
(1) Average balances for loans include loans held-for-sale and non-accrual loans and are net of the allowance for loan losses.
Net Interest Earnings
Average Balances, Yields and Rates
(Dollars in thousands)
Assets
Average
Balance
Interest
Income/
Expense
Yields
Earned/
Rates
Paid
Average
Balance
Interest
Income/
Expense
Yields
Earned/
Rates
Paid
Average
Balance
Interest
Income/
Expense
Yields
Earned/
Rates
Paid
Total Loans, Including Loan Fees(1)
$
894,626
$
40,569
4.53
%
$
741,466
$
39,097
5.27
%
$
739,243
$
37,189
5.03
%
Due From Banks
188,021
0.31
%
98,593
2,148
2.18
%
114,350
2,163
1.89
%
Certificates of Deposit
19,210
2.28
%
12,538
2.83
%
4,160
2.50
%
Investment Securities:
Taxable
336,586
6,406
1.90
%
306,473
6,637
2.17
%
283,500
5,500
1.94
%
Non-taxable (2)
21,419
2.33
%
12,945
2.32
%
9,759
1.47
%
Total Investment Securities
358,005
6,904
1.93
%
319,418
6,937
2.17
%
293,259
5,643
1.92
%
Other Earning Assets
6,509
5.70
%
6,405
7.12
%
5,884
8.80
%
Total Earning Assets
$
1,466,371
$
48,864
3.33
%
$
1,178,420
$
48,993
4.16
%
$
1,156,896
$
45,617
3.94
%
Cash and Due from Banks
33,119
29,384
25,607
Other Real Estate Owned
-
Interest Receivable and Other Assets
46,388
41,899
36,460
Total Assets
$
1,545,878
$
1,250,543
$
1,219,148
(1) Average balances for loans include loans held-for-sale and non-accrual loans and are net of the allowance for loan losses, but non-accrued interest thereon is excluded. Includes amortization of deferred loan fees and costs.
(2) Interest income and yields on tax-exempt securities are not presented on a taxable equivalent basis.
Continuation of
Net Interest Earnings
Average Balances, Yields and Rates
(Dollars in thousands)
Liabilities and Stockholders' Equity
Average
Balance
Interest
Income/
Expense
Yields
Earned/
Rates
Paid
Average
Balance
Interest
Income/
Expense
Yields
Earned/
Rates
Paid
Average
Balance
Interest
Income/
Expense
Yields
Earned/
Rates
Paid
Interest-Bearing Deposits:
Interest-Bearing
Transaction Deposits
$
356,867
$
0.10
%
$
308,917
$
0.16
%
$
307,727
$
0.14
%
Savings and MMDAs
387,490
0.20
%
334,672
0.29
%
333,788
0.17
%
Time Certificates
54,147
0.63
%
58,128
0.64
%
67,177
0.42
%
Total Interest-Bearing Deposits
798,504
1,484
0.19
%
701,717
1,859
0.26
%
708,692
1,268
0.18
%
Demand Deposits
577,559
408,551
394,106
Total Deposits
1,376,063
$
1,484
0.11
%
1,110,268
$
1,859
0.17
%
1,102,798
$
1,268
0.11
%
Federal Home Loan Bank Advances
5,656
-
-
Interest payable and Other Liabilities
19,493
16,313
11,743
Stockholders’ Equity
144,666
123,962
104,607
Total Liabilities and Stockholders’ Equity
$
1,545,878
$
1,250,543
$
1,219,148
Net Interest Income and
Net Interest Margin (1)
$
47,380
3.23
%
$
47,134
4.00
%
$
44,349
3.83
%
Net Interest Spread (2)
3.14
%
3.90
%
3.76
%
(1) Net interest margin is computed by dividing net interest income by total average interest-earning assets.
(2) Net interest spread represents the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities.
Analysis of Changes
in Interest Income and Interest Expense
(Dollars in thousands)
Following is an analysis of changes in interest income and expense (dollars in thousands) for 2020 over 2019. Changes not solely due to interest rate or volume have been allocated proportionately to interest rate and volume.
2020 Over 2019
Volume
Interest
Rate
Change
Increase (Decrease) in Interest Income:
Loans
$
7,409
$
(5,937
)
$
1,472
Due From Banks
1,091
(2,657
)
(1,566
)
Certificates of Deposit
(79
)
Investment Securities - Taxable
(859
)
(231
)
Investment Securities - Non-taxable
Other Earning Assets
(92
)
(85
)
9,494
(9,623
)
(129
)
Increase (Decrease) in Interest Expense:
Deposits:
Interest-Bearing Transaction Deposits
(213
)
(147
)
Savings and MMDAs
(332
)
(195
)
Time Certificates
(27
)
(6
)
(33
)
(551
)
(375
)
Increase in Net Interest Income:
$
9,318
$
(9,072
)
$
INVESTMENT PORTFOLIO
Composition of Investment Securities
The mix of investment securities held by the Company at December 31 of the previous three fiscal years is as follows (dollars in thousands):
Investment securities available-for-sale (at fair value):
U.S. Treasury Securities
$
38,891
$
43,255
$
50,682
Securities of U.S. Government Agencies and Corporations
106,558
53,912
42,076
Obligations of State and Political Subdivisions
32,882
27,031
19,168
Collateralized Mortgage Obligations
73,460
79,420
63,799
Mortgage-Backed Securities
183,289
139,279
138,912
Total Investments
$
435,080
$
342,897
$
314,637
Maturities of Investment Securities
The following table summarizes the contractual maturity (dollars in thousands) and projected yields of the Company’s investment securities as of December 31, 2020. The yields on tax-exempt securities are shown on a tax equivalent basis. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. In addition, factors such as prepayments and interest rates may affect the yield on carrying value of mortgage related securities.
Period to Maturities
Within One Year
After One But
Within Five Years
After Five But
Within Ten Years
Amount
Yield
Amount
Yield
Amount
Yield
Investment securities available-for-sale (at fair value):
U.S. Treasury Securities
$
11,140
1.67
%
$
27,751
1.77
%
$
-
-
Securities of U.S. Government Agencies and Corporations
3,544
1.76
%
48,060
0.96
%
53,853
1.09
%
Obligations of State and Political Subdivisions
1,763
3.14
%
4,403
3.00
%
5,398
3.75
%
Collateralized Mortgage Obligations
-
-
2,346
2.02
%
7,064
1.92
%
Mortgage-Backed Securities
2.12
%
8,650
2.02
%
67,918
2.03
%
TOTAL
$
16,458
1.85
%
$
91,210
1.43
%
$
134,233
1.72
%
After Ten Years
Total
Amount
Yield
Amount
Yield
Investment securities available-for-sale (at fair value):
U.S. Treasury Securities
$
-
-
$
38,891
1.74
%
Securities of U.S. Government Agencies and Corporations
1,101
2.35
%
106,558
1.07
%
Obligations of State & Political Subdivisions
21,318
2.78
%
32,882
2.99
%
Collateralized Mortgage Obligations
64,050
1.84
%
73,460
1.86
%
Mortgage-Backed Securities
106,710
1.10
%
183,289
1.49
%
TOTAL
$
193,179
1.54
%
$
435,080
1.58
%
LOAN PORTFOLIO
Composition of Loans
The mix of loans, net of deferred origination fees and costs and allowance for loan losses and excluding loans held-for-sale, at December 31, for the previous five fiscal years is as follows (dollars in thousands):
December 31,
Balance
Percent
Balance
Percent
Balance
Percent
Commercial
$
255,926
28.7
%
$
106,140
13.6
%
$
125,177
16.1
%
Commercial Real Estate
454,053
50.8
%
451,774
58.0
%
420,106
54.2
%
Agriculture
95,048
10.6
%
115,751
14.8
%
123,626
15.9
%
Residential Mortgage
64,497
7.2
%
64,943
8.3
%
51,064
6.6
%
Residential Construction
4,223
0.5
%
15,212
1.9
%
20,124
2.6
%
Consumer
19,467
2.2
%
26,825
3.4
%
35,397
4.6
%
893,214
100.0
%
780,645
100.0
%
775,494
100.0
%
Allowance for loan losses
(15,416
)
(12,356
)
(12,822
)
Net deferred origination fees and costs
(1,968
)
TOTAL
$
875,830
$
768,873
$
763,393
Balance
Percent
Balance
Percent
Commercial
$
135,015
18.0
%
$
126,311
18.6
%
Commercial Real Estate
398,346
53.2
%
344,210
50.6
%
Agriculture
113,555
15.2
%
101,905
15.0
%
Residential Mortgage
42,081
5.6
%
40,237
5.9
%
Residential Construction
21,299
2.8
%
23,650
3.5
%
Consumer
38,900
5.2
%
43,250
6.4
%
749,196
100.0
%
679,563
100.0
%
Allowance for loan losses
(11,133
)
(10,899
)
Net deferred origination fees and costs
1,049
1,106
TOTAL
$
739,112
$
669,770
As shown in the comparative figures for loan mix during 2020 and 2019, total loans increased as a result of increases in commercial and commercial real estate loans, which was partially offset by decreases in agriculture, residential mortgage, residential construction and consumer loans. The increase in commercial loans was primarily due to PPP loans totaling approximately $155 million at December 31, 2020.
Included in net deferred origination fees at December 31, 2020 was approximately $1.9 million in unearned PPP loan fees. The Company received a total of approximately $7.8 million in processing fees from the SBA during 2020. These fees are required to be recognized as an adjustment to the effective yield over the life of the loan. During 2020, the Company recognized approximately $5.9 million of these processing fees, which are included as a component of interest income on loans. The balance of approximately $1.9 million will be recognized over the remaining life of the PPP loans.
Commercial loans are primarily for financing the needs of a diverse group of businesses located in the Bank’s market area. Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Real estate construction loans are generally for financing the construction of single-family residential homes for individuals and builders we believe are well-qualified. These loans are secured by real estate and have short maturities. Residential mortgage loans, which are secured by real estate, include owner-occupied and non-owner occupied properties in the Bank’s market area. Loans are considered agriculture loans when the primary source of repayment is from the sale of an agricultural or agricultural-related product or service. Such loans are secured and/or unsecured to producers and processors of crops and livestock. The Bank also makes loans to individuals for investment purposes.
Maturities and Sensitivities of Loans to Changes in Interest Rates
Loan maturities of the loan portfolio at December 31, 2020 are as follows (dollars in thousands) (excludes loans held-for-sale):
Maturing
Fixed Rate
Variable
Rate
Total
Within one year
$
17,849
$
56,933
$
74,782
After one year through five years
243,625
42,984
286,609
After five years
145,188
386,635
531,823
Total
$
406,662
$
486,552
$
893,214
Non-Accrual, Past Due, OREO and Restructured Loans
It is generally the Company’s policy to discontinue interest accruals once a loan is past due for a period of 90 days as to interest or principal payments. When a loan is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and an appropriate period of performance has been demonstrated.
The following tables summarize the Company’s non-accrual loans by loan category (dollars in thousands), net of guarantees of the State of California and U.S. Government, including its agencies and its government-sponsored agencies at December 31, 2020, 2019, 2018, 2017, and 2016.
At December 31, 2020
At December 31, 2019
Gross
Guaranteed
Net
Gross
Guaranteed
Net
Commercial
$
$
$
$
$
$
Commercial real estate
4,875
4,841
Agriculture
9,130
-
9,130
-
-
-
Residential mortgage
-
-
Residential construction
-
-
-
-
-
-
Consumer
-
-
Total non-accrual loans
$
15,211
$
$
15,114
$
1,157
$
$
At December 31, 2018
At December 31, 2017
Gross
Guaranteed
Net
Gross
Guaranteed
Net
Commercial
$
$
$
$
1,057
$
$
1,025
Commercial real estate
1,724
1,654
Agriculture
4,830
4,054
-
-
-
Residential mortgage
-
-
Residential construction
-
-
-
-
-
-
Consumer
-
-
Total non-accrual loans
$
6,252
$
1,132
$
5,120
$
3,767
$
$
3,665
At December 31, 2016
Gross
Guaranteed
Net
Commercial
$
5,000
$
2,000
$
3,000
Commercial real estate
Agriculture
-
-
-
Residential mortgage
-
Residential construction
-
-
-
Consumer
-
Total non-accrual loans
$
6,297
$
2,081
$
4,216
Non-accrual loans amounted to $15,211,000 at December 31, 2020, and were comprised of four commercial loans totaling $363,000, three commercial real estate loans totaling $4,875,000, three agriculture loans totaling $9,130,000, one residential mortgage loan totaling $153,000 and five consumer loans totaling $690,000. Non-accrual loans amounted to $1,157,000 at December 31, 2019, and were comprised of three commercial loans totaling $266,000, two commercial real estate loans totaling $466,000, one residential mortgage loan totaling $172,000 and four consumer loans totaling $253,000.
If interest on non-accrual loans had been accrued, such interest income would have approximated $1,038,000 and $139,000 during the years ended December 31, 2020 and 2019, respectively. The increase in lost interest was primarily due to two commercial real estate loans comprising one relationship and three agriculture loans and one consumer loan comprising one relationship that were placed on non-accrual in 2020. Income actually recognized for these loans approximated $71,000 and $475,000 for the years ended December 31, 2020 and 2019, respectively.
Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Non-performing impaired loans are non-accrual loans and loans that are 90 days or more past due and still accruing. Total non-performing impaired loans at December 31, 2020 and 2019, consisting of loans on non-accrual status totaled $15,211,000 and $1,157,000, respectively. A restructuring of a loan can constitute a troubled debt restructuring if the Company for economic or legal reasons related to the borrower’s financial difficulties grants a concession to the borrower that it would not otherwise consider. A loan that is restructured in a troubled debt restructuring is considered an impaired loan. Performing impaired loans, which consisted of loans modified as troubled debt restructurings, totaled $2,260,000 and $3,318,000 at December 31, 2020 and 2019, respectively. The Company expects to collect all principal and interest due from performing impaired loans. These loans are not on non-accrual status. No assurance can be given that the existing or any additional collateral will be sufficient to secure full recovery of the obligations owed under these loans.
The Company had no loans 90 days past due and still accruing as of the periods ended December 31, 2020 and 2019.
As the following table illustrates, total non-performing assets, which consists of loans on non-accrual status, loans past due 90-days and still accruing and Other Real Estate Owned ("OREO") net of guarantees of the State of California and U.S. Government, including its agencies and its government-sponsored agencies, increased $14,172,000, or 1504.5%, to $15,114,000 from December 31, 2019 to December 31, 2020. Non-performing assets net of guarantees represent 0.9% and 0.1% of total assets at December 31, 2020 and 2019, respectively. The Bank’s management believes that the $15,211,000 in non-accrual loans were appropriately reflected at their fair value at December 31, 2020. However, no assurance can be given that the existing or any additional collateral will be sufficient to secure full recovery of the obligations owed under these loans.
At December 31, 2020
At December 31, 2019
Gross
Guaranteed
Net
Gross
Guaranteed
Net
(dollars in thousands)
Non-accrual loans
$
15,211
$
$
15,114
$
1,157
$
$
Loans 90 days past due and still accruing
-
-
-
-
-
-
Total non-performing loans
15,211
15,114
1,157
Other real estate owned
-
-
-
-
-
-
Total non-performing assets
15,211
15,114
1,157
Non-performing loans (net of guarantees) to total loans
1.7
%
0.1
%
Non-performing assets (net of guarantees) to total assets
0.9
%
0.1
%
Allowance for loan and lease losses to non-performing loans (net of guarantees)
102.0
%
1,311.7
%
At December 31, 2018
At December 31, 2017
Gross
Guaranteed
Net
Gross
Guaranteed
Net
(dollars in thousands)
Non-accrual loans
$
6,252
$
1,132
$
5,120
$
3,767
$
$
3,665
Loans 90 days past due and still accruing
-
-
-
-
Total non-performing loans
6,252
1,132
5,120
3,812
3,710
Other real estate owned
1,092
-
1,092
-
-
-
Total non-performing assets
7,344
1,132
6,212
3,812
3,710
Non-performing loans (net of guarantees) to total loans
0.7
%
0.5
%
Non-performing assets (net of guarantees) to total assets
0.5
%
0.3
%
Allowance for loan and lease losses to non-performing loans (net of guarantees)
250.4
%
300.1
%
At December 31, 2016
Gross
Guaranteed
Net
(dollars in thousands)
Non-accrual loans
$
6,297
$
2,081
$
4,216
Loans 90 days past due and still accruing
-
-
-
Total non-performing loans
6,297
2,081
4,216
Other real estate owned
-
-
-
Total non-performing assets
6,297
2,081
4,216
Non-performing loans (net of guarantees) to total loans
0.6
%
Non-performing assets (net of guarantees) to total assets
0.4
%
Allowance for loan and lease losses to non-performing loans (net of guarantees)
258.5
%
OREO consists of property that the Company has acquired by deed in lieu of foreclosure or through foreclosure proceedings, and property that the Company does not hold title to but is in actual control of, known as in-substance foreclosure. The estimated fair value of the property is determined prior to transferring the balance to OREO. The balance transferred to OREO is the estimated fair value of the property less estimated cost to sell. Impairment may be deemed necessary to bring the book value of the loan equal to the appraised value. Appraisals or loan officer evaluations are then conducted periodically thereafter charging any additional impairment to the appropriate expense account. The Company had no OREO as of the years ended December 31, 2020 and 2019.
Potential Problem Loans
The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk rating standards and criteria similar to those employed by state and federal banking regulatory agencies. The federal banking regulatory agencies utilize the following definitions for assets adversely classified for supervisory purposes: “Substandard Assets: a substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.” “Doubtful Assets: An asset classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. OREO and loans rated Substandard and Doubtful are deemed “classified assets.” This category, which includes both performing and non-performing assets, receives an elevated level of attention regarding collection.
Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses. These loans are generally secured by the receivables, equipment, and other real property of the business and are susceptible to the related risks described above. Problem commercial loans are generally identified by periodic review of financial information that may include financial statements, tax returns, and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified.
Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner occupied real estate are primarily susceptible to changes in the market conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions, and changes in business cycles. These same risks apply to commercial loans whether secured by equipment, receivables, or other personal property or unsecured. Problem commercial real estate loans are generally identified by periodic review of financial information that may include financial statements, tax returns, payment history of the borrower, and site inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Losses on loans secured by owner-occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resultant over-supply of space. Losses are dependent on the value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified.
Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or service. Agricultural loans are generally secured by inventory, receivables, equipment, and other real property. Agricultural loans primarily are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as changing weather conditions. Problem agricultural loans are generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified.
Residential mortgage loans, which are secured by real estate, are primarily susceptible to three risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower’s cash flow to sustain payments, and shortfalls in collateral value. In general, non-payment is due to loss of employment and follows general economic trends in the marketplace, particularly the upward movement in the unemployment rate, loss of collateral value, and demand shifts. Problem residential mortgage loans are generally identified via payment default. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified.
Construction loans, whether owner occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction itself, including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion. Again, losses are primarily related to underlying collateral value and changes therein as described above. Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, or repossession or foreclosure of the underlying collateral. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified.
Consumer loans, whether unsecured or secured, are primarily susceptible to four risks: non-payment due to diminished or lost income, over-extension of credit, a lack of borrower’s cash flow to sustain payments, and shortfall in collateral value. In general, non-payment is due to loss of employment and will follow general economic trends in the marketplace, particularly the upward movements in the unemployment rate, loss of collateral value, and demand shifts. Problem consumer loans are generally identified via payment default. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified.
Once a loan becomes delinquent or repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal payment. If this is not forthcoming and payment of principal and interest in accordance with the contractual terms of the loan agreement becomes unlikely, the Company will consider the loan to be impaired and will estimate its probable loss, using the present value of future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. For collateral dependent loans, the Company will utilize a recent valuation of the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount. Depending on the length of time until final collection, the Company may periodically revalue the estimated loss and take additional charge-offs or specific reserves as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when the collateral is liquidated and the actual loss is confirmed. Unpaid balances on loans after or during collection and liquidation may also be pursued through legal action and attachment of wages or judgment liens on the borrower's other assets.
Excluding the non-performing loans cited previously, loans totaling $11,878,000 and $8,749,000 were classified as substandard or doubtful loans, representing potential problem loans at December 31, 2020 and 2019, respectively. In Management’s opinion, the potential loss related to these problem loans was sufficiently covered by the Bank’s existing loan loss reserve (Allowance for Loan Losses) at December 31, 2020 and 2019. The ratio of the Allowance for Loan Losses to total loans at December 31, 2020 and 2019 was 1.73% and 1.58%, respectively.
SUMMARY OF LOAN LOSS EXPERIENCE
The Company’s allowance for credit losses is maintained at a level considered adequate to provide for losses that can be estimated based upon specific and general conditions. These include conditions unique to individual borrowers, as well as overall credit loss experience, the amount of past due, non-performing loans and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other factors. A portion of the allowance is specifically allocated to classified loans whose full collectability is uncertain. Such allocations are determined by Management based on loan-by-loan analyses. In addition, loans with similar characteristics not usually criticized using regulatory guidelines are analyzed based on the historical loss rates and delinquency trends, grouped by the number of days the payments on these loans are delinquent. Last, allocations are made to non-criticized and classified commercial loans and residential real estate loans based on historical loss rates, and other statistical data. The remainder of the allowance is considered to be unallocated. The unallocated allowance is established to provide for probable losses that have been incurred as of the reporting date but not reflected in the allocated allowance. It addresses additional qualitative factors consistent with Management’s analysis of the level of risks inherent in the loan portfolio, which are related to the risks of the Company’s general lending activity. Included in the unallocated allowance is the risk of losses that are attributable to national or local economic or industry trends which have occurred but have yet been recognized in past loan charge-off history (external factors). The external factors evaluated by the Company include: economic and business conditions, external competitive issues, and other factors. Also included in the unallocated allowance is the risk of losses attributable to general attributes of the Company’s loan portfolio and credit administration (internal factors). The internal factors evaluated by the Company include: loan review system, adequacy of lending Management and staff, loan policies and procedures, problem loan trends, concentrations of credit, and other factors. By their nature, these risks are not readily allocable to any specific loan category in a statistically meaningful manner and are difficult to quantify. Management assigns a range of estimated risk to the qualitative risk factors described above based on Management’s judgment as to the level of risk and assigns a quantitative risk factor from the range of loss estimates to determine the appropriate level of the unallocated portion of the allowance. Management considered the $15,416,000 allowance for credit losses to be adequate as a reserve against losses as of December 31, 2020.
Analysis of the Allowance for Loan Losses
(Dollars in thousands)
Balance at Beginning of Year
$
12,356
$
12,822
$
11,133
$
10,899
$
9,251
Provision for Loan Losses
3,050
-
2,100
1,800
Loans Charged-Off:
Commercial
(212
)
(638
)
(509
)
(681
)
(446
)
Commercial Real Estate
-
-
(142
)
-
(15
)
Agriculture
-
(98
)
-
-
-
Residential Mortgage
-
-
-
(121
)
(13
)
Residential Construction
-
-
-
-
-
Consumer
(15
)
(43
)
(34
)
(33
)
(65
)
Total Charged-Off
(227
)
(779
)
(685
)
(835
)
(539
)
Recoveries:
Commercial
Commercial Real Estate
-
-
-
-
-
Agriculture
-
-
-
-
Residential Mortgage
-
Residential Construction
-
Consumer
Total Recoveries
Net Recoveries (Charge-offs)
(466
)
(411
)
(366
)
(152
)
Balance at End of Year
$
15,416
$
12,356
$
12,822
$
11,133
$
10,899
Ratio of Net Recoveries (Charge-Offs)
During the Year to Average Loans
Outstanding During the Year
0.00
%
(0.06
%)
(0.05
%)
(0.05
%)
(0.02
%)
Allowance as a percentage of Total Loans
1.73
%
1.58
%
1.65
%
1.49
%
1.60
%
Allowance as a percentage of Non-performing loans, net of guarantees
102.0
%
1,311.7
%
250.4
%
300.1
%
258.5
%
Allocation of the Allowance for Loan Losses
The Allowance for Loan Losses has been established as a general component available to absorb probable inherent losses throughout the loan portfolio. The following table is an allocation of the Allowance for Loan Losses balance on the dates indicated (dollars in thousands):
December 31, 2020
December 31, 2019
December 31, 2018
Allocation of
Allowance for Loan Losses Balance
Allowance as
a % of Total
Allowance
Loans as a
% of Total
Loans, net
Allocation of
Allowance for
Loan Losses
Balance
Allowance as a
% of Total
Allowance
Loans as a
% of Total
Loans, net
Allocation of
Allowance for
Loan Losses
Balance
Allowance as a %
of Total
Allowance
Loans as a % of
Total Loans, net
Loan Type:
Commercial
$
2,252
14.6
%
28.7
%
$
2,354
19.1
%
13.6
%
$
3,198
25.0
%
16.1
%
Commercial Real Estate
7,915
51.3
%
50.8
%
6,846
55.4
%
58.0
%
5,890
45.9
%
54.2
%
Agriculture
3,834
25.0
%
10.6
%
2,054
16.6
%
14.8
%
1,632
12.7
%
15.9
%
Residential Mortgage
4.1
%
7.2
%
3.8
%
8.3
%
5.0
%
6.6
%
Residential Construction
0.8
%
0.5
%
1.6
%
1.9
%
2.5
%
2.6
%
Consumer
1.4
%
2.2
%
1.9
%
3.4
%
2.2
%
4.6
%
Unallocated
2.8
%
-
1.6
%
-
6.7
%
-
Total
$
15,416
100.0
%
100.0
%
$
12,356
100.0
%
100.0
%
$
12,822
100.0
%
100.0
%
December 31, 2017
December 31, 2016
Allocation of
Allowance
for Loan
Losses
Balance
Allowance
as a % of
Total
Allowance
Loans as a %
of Total
Loans, net
Allocation of
Allowance
for Loan
Losses
Balance
Allowance
as a % of
Total
Allowance
Loans as a %
of Total
Loans, net
Loan Type:
Commercial
$
2,625
23.7
%
18.0
%
$
3,571
32.8
%
18.3
%
Commercial Real Estate
5,460
49.0
%
53.2
%
3,910
35.9
%
50.9
%
Agriculture
1,547
13.9
%
15.2
%
1,262
11.6
%
15.0
%
Residential Mortgage
5.6
%
5.6
%
6.0
%
5.9
%
Residential Construction
3.2
%
2.8
%
4.0
%
3.5
%
Consumer
3.1
%
5.2
%
4.6
%
6.4
%
Unallocated
1.5
%
-
5.1
%
-
Total
$
11,133
100.0
%
100.0
%
$
10,899
100.0
%
100.0
%
The Bank believes that any breakdown or allocation of the allowance into loan categories lends an appearance of exactness, which does not exist, because the allowance is available for all loans. The allowance breakdown shown above is computed taking actual experience into consideration but should not be interpreted as an indication of the specific amount and allocation of actual charge-offs that may ultimately occur.
Deposits
The following table sets forth the average amount and the average rate paid on each of the listed deposit categories (dollars in thousands) during the periods specified:
Average
Amount
Average Rate
Average
Amount
Average Rate
Average
Amount
Average Rate
Deposit Type:
Non-interest-Bearing Demand
$
577,559
-
$
408,551
-
$
394,106
-
Interest-Bearing Demand (NOW)
$
356,867
0.10
%
$
308,917
0.16
%
$
307,727
0.14
%
Savings and MMDAs
$
387,490
0.20
%
$
334,672
0.29
%
$
333,788
0.17
%
Time
$
54,147
0.63
%
$
58,128
0.64
%
$
67,177
0.42
%
The following table sets forth by time remaining to maturity the Bank’s time deposits over $250,000 (dollars in thousands) as of December 31, 2020:
Three months or less
$
5,110
Over three months through twelve months
5,877
Over twelve months
3,656
Total
$
14,643
Short-Term Borrowings
Short-term borrowings totaling $5,000,000 as of December 31, 2020 consisted of an advance with the FHLB through its COVID-19 Relief and Recovery Advances Program. The advance matures in 0.4 years and has a 0% interest rate. The advance is secured under terms of a blanket collateral agreement by a pledge of FHLB stock and certain other qualifying collateral such as commercial and mortgage loans. Average outstanding balances of short-term borrowings were $5,656,000 and $0 during 2020 and 2019, respectively. As of December 31, 2020, the Company had a remaining collateral borrowing capacity with the FHLB of $292,046,000 and, at such date, also had unsecured formal lines of credit totaling $122,000,000 with correspondent banks. The Company had no short-term borrowings as of December 31, 2019.
The Company had no Federal Funds purchased during the years ended December 31, 2020 and 2019.
Long-Term Borrowings
The Company had no long-term borrowings at December 31, 2020 and 2019. There were no average outstanding balances of long-term borrowings during 2020 and 2019.
Supplemental Compensation Plans
The Company and the Bank maintain an unfunded non-contributory defined benefit pension plan (“Salary Continuation Plan”) and related split dollar plan for a select group of highly compensated employees. Eligibility to participate in the Salary Continuation Plan is limited to a select group of management or highly compensated employees of the Bank that are designated by the Board. Additionally, the Company and the Bank adopted a supplemental executive retirement plan (“SERP”) in 2006. The SERP is intended to integrate the various forms of retirement payments offered to executives. There are currently three participants in the SERP. At December 31, 2020, the accrued benefit liability was $7,127,000, of which $4,173,000 was recorded in interest payable and other liabilities and $2,954,000 was recorded in accumulated other comprehensive income (loss), net, in the Consolidated Balance Sheets. At December 31, 2019, the accrued benefit liability was $5,871,000, of which $3,891,000 was recorded in interest payable and other liabilities and $1,980,000 was recorded in accumulated other comprehensive income (loss), net, in the Consolidated Balance Sheets.
The Company and the Bank maintain an unfunded non-contributory defined benefit pension plan (“Directors’ Retirement Plan”) and related split dollar plan for the directors of the Bank. At December 31, 2020, the accrued benefit liability was $831,000, of which $757,000 was recorded in interest payable and other liabilities and $74,000 was recorded in accumulated other comprehensive income (loss), net, in the Consolidated Balance Sheets. At December 31, 2019, the accrued benefit liability was $820,000, of which $798,000 was recorded in interest payable and other liabilities and $22,000 was recorded in accumulated other comprehensive income (loss), net, in the Consolidated Balance Sheets.
For additional information, see Note 17 to the Consolidated Financial Statements in this Form 10-K.
Overview
Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
Net income for the year ended December 31, 2020, was $12.2 million, representing a decrease of $2.6 million, or 17.4%, compared to net income of $14.7 million for the year ended December 31, 2019. The decrease in net income was principally attributable to a $3.1 million increase in provision for loan loss and $1.5 million increase in non-interest expenses, which was partially offset by a $0.4 million decrease in interest expense, $0.6 million increase in non-interest income, and $1.2 million decrease in provision for income taxes.
Total assets increased by $362.8 million, or 28.1%, to $1.66 billion as of December 31, 2020, compared to $1.29 billion at December 31, 2019. The increase in total assets was primarily due to a $155.7 million increase in cash and cash equivalents, $92.2 million increase in investment securities, and $112.0 million increase in net loans (including loans held-for-sale). Total deposits increased $339.5 million, or 29.8%, to $1.48 billion as of December 31, 2020, compared to $1.14 billion at December 31, 2019.
Results of Operations
Net Interest Income
Net interest income is the excess of interest and fees earned on the Bank’s loans, investment securities, federal funds sold and banker’s acceptances over the interest expense paid on deposits, mortgage notes and other borrowed funds which are used to fund those assets. Net interest income is primarily affected by the yields and mix of the Bank’s interest-earning assets and interest-bearing liabilities outstanding during the period. The $129,000 decrease in the Bank's interest and dividend income in 2020 from 2019 was driven by decreased interest rates, which was partially offset by increased volumes. Decreasing interest rates drove decreases in interest income from loans, due from bank balances, and investment securities by $5,937,000, $2,736,000, and $858,000, respectively. This was partially offset by increasing volume growth that drove increases in interest income from loans, due from bank balances, and investment securities by $7,409,000, $1,253,000, and $825,000, respectively. Also included in interest income on loans in 2020 was approximately $5.9 million in PPP loan fees recognized. The $375,000 decrease in the Bank's interest expense on deposits was primarily driven by a $551,000 decrease due to decreasing interest rates, which was partially offset by a $176,000 increase driven by volume growth. See “Analysis of Changes in Interest Income and Interest Expense” set forth on page 39 of this Annual Report on Form 10-K for a discussion of the effects of interest rates and loan/deposit volume on net interest income.
The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, was 4.75% at December 31, 2019. In March 2020, the prime rate decreased 150 basis points to 3.25%, where it remained through December 31, 2020. The effective federal funds rate, which is the cost of immediately available overnight funds, was at a target range of 1.50 % to 1.75% at December 31, 2019. In March 2020, the target range for the federal funds rate decreased 150 basis points to 0% to 0.25% where it remained through December 31, 2020. The decrease in the target range for the federal funds rate in March 2020 was largely an emergency measure by the Federal Reserve aimed at blunting the economic impact of COVID-19.
We are primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on our net interest income and net interest margin in a rising interest rate environment.
The nature and impact of future changes in interest rates and monetary policy on the business and earnings of the Company cannot be predicted. For additional information, see “The Effects of Changes or Increases in, or Supervisory Enforcement of, Banking or Other Laws and Regulations or Governmental Fiscal or Monetary Policies Could Adversely Affect Us” in “Risk Factors (Item 1A) of this Report on Form 10-K.
Interest income on loans for 2020 was up 3.8% from 2019, increasing from $39,097,000 to $40,569,000. The increase in interest income on loans was primarily due to the recognition of processing fees from the SBA related to the origination of the PPP loans. The Company received a total of approximately $7.8 million in processing fees from the SBA during 2020. These fees are required to be recognized as an adjustment to the effective yield over the life of the loan. In 2020 the Bank recognized $5.9 million of these processing fees which are included as a component of interest income on loans. The remaining balance of approximately $1.9 million will be recognized over the remaining life of the PPP loans. The increase in interest income on loans was offset by a 74 basis point decrease in loan yields compared to 2019. The decrease in loan yields compared to the prior period is due to several factors: adjustable rate loans re-pricing at lower rates as a result of recent declines in interest rates and related indices, which is mitigated to some extent by the inclusion of interest rate floors on the majority of our variable rate loans; the accommodation of certain fixed rate loan customers to re-price their existing loans at lower rates to retain existing relationships in a competitive rate environment; an increase in non-accrual loan balances; our policy election to cease interest recognition for loans provided temporary full payment deferrals during the term of the forbearance period (generally ranging from three to six months) under Section 4013 of the CARES Act (see Note 1 of the Notes to Condensed Consolidated Financial Statements) and the origination of $235 million of PPP loans at an interest rate of 1%. The Bank provided temporary forbearance relief for borrowers over the course of 2020 totaling approximately $102 million, resulting in the net deferral of interest income of approximately $1.2 million for the year ended December 31, 2020. A majority of loans completed its forbearance period during the fourth quarter of 2020. Two loans totaling $7.0 million were on an interest only forbearance plan and one loan totaling $0.8 million was on a principal and interest forbearance plan at December 31, 2020.
Interest income on interest-bearing due from banks for 2020 was down 72.9% from 2019, decreasing from $2,148,000 to $582,000. The decrease in interest income on interest-bearing due from banks was the result of a 187 basis point decrease in yield on interest-bearing due from banks, which was partially offset by a 90.7% increase in average balances of interest-bearing due from banks. The decrease in yield was primarily due to the decrease in the effective federal funds rate as discussed above.
Interest income on certificates of deposit for 2020 was up 23.4% from 2019, increasing from $355,000 to $438,000. The increase in interest income on certificates of deposit was the result of a 53.2% increase in average balances of certificates of deposit, which was partially offset by a 55 basis point decrease in yield on certificates of deposit.
Interest income on investment securities for 2020 was down 0.48% from 2019, decreasing from $6,937,000 to $6,904,000. The decrease in interest income on investment securities was the result of a 24 basis point decrease in investment securities yields, which was partially offset by a 12.1% increase in average investment securities volume. The Bank deployed excess liquidity into the investment portfolio over the course of 2020, although reinvestment rates were generally lower than existing yields in the portfolio, which decreased overall portfolio yields. Investment securities yields were 1.93% and 2.17% for 2020 and 2019, respectively.
Interest expense on deposits for 2020 was down 20.2% from 2019, decreasing from $1,859,000 to $1,484,000. The decrease in interest expense on deposits was the result of a 7 basis point decrease in interest rates paid on interest-bearing deposits, which was partially offset by a 13.8% increase in average balances of interest-bearing deposits.
The mix of deposits for the previous three years was as follows (dollars in thousands):
Average
Balance
Percent
Average
Balance
Percent
Average
Balance
Percent
Non-interest-Bearing Demand
$
577,559
42.0
%
$
408,551
36.9
%
$
394,106
35.7
%
Interest-Bearing Demand (NOW)
356,867
25.9
%
308,917
27.8
%
307,727
27.9
%
Savings and MMDAs
387,490
28.2
%
334,672
30.1
%
333,788
30.3
%
Time
54,147
3.9
%
58,128
5.2
%
67,177
6.1
%
Total
$
1,376,063
100.0
%
$
1,110,268
100.0
%
$
1,102,798
100.0
%
The Bank’s net interest margin (net interest income divided by average earning assets) was 3.23% in 2020 and 4.00% in 2019. The net spread between the rate for total earning assets and the rate for interest-bearing deposits and borrowed funds decreased 76 basis points from 2019 to 2020. The decrease in the net spread was primarily due to an overall decrease in interest rates on earning assets, coupled with an increase in average due from banks as a percentage of total average earning assets, which was partially offset by a decrease in interest rates on interest-bearing deposits.
Provision for Loan Losses
The provision for loan losses is established by charges to earnings based on management’s overall evaluation of the collectability of the loan portfolio. Based on this evaluation, the provision for loan losses increased to $3,100,000 in 2020 from no provision in 2019, primarily due to increases in qualitative factors adversely affecting our loan portfolio resulting from the downturn in economic conditions associated with the COVID-19 pandemic. Also driving the increase was a specific reserve on one loan totaling $2.1 million at December 31, 2020. The amount of loans charged-off decreased in 2020 to $227,000 from $779,000 in 2019, and recoveries decreased to $237,000 in 2020 from $313,000 in 2019. The ratio of the Allowance for Loan Losses to total loans at December 31, 2020 was 1.73% compared to 1.58% at December 31, 2019. The ratio of the Allowance for Loan Losses to total non-accrual loans and loans past due 90 days or more, net of guarantees was 102.0% at December 31, 2020, compared to 1311.70% at December 31, 2019. The decrease was primarily due to the increase in nonaccrual loans, net of guarantees totaling $14.2 million.
Non-Interest Income and Expenses
Non-interest income consisted primarily of service charges on deposit accounts, net gain on sale of available-for-sale securities, net realized gains on loans held-for-sale, debit card income and other income. Service charges on deposit accounts decreased $608,000 in 2020 over 2019. The decrease in service charges on deposit accounts was primarily a result of the COVID-19 pandemic and the Bank's decision to waive overdraft/NSF fees for all business and consumer customers for an initial period of 60 days which began in March and was later extended into the third quarter. The auto-waiver period expired on August 1, 2020. This assistance resulted in increased fee waiver activity, reducing reported service charge income. Net gains on sale of available-for-sale securities increased $299,000 in 2020 over 2019 primarily due to the sale of municipal securities in 2020. Net realized gains on loans held-for-sale increased $1,633,000 in 2020 over 2019. The increase in gains on sales of loans held-for-sale was primarily due to an increase in loan origination volumes as a result of the decline in interest rates and uptick in refinancing activity during 2020. Other income decreased $726,000 in 2020 over 2019. The decrease was primarily due to a gain on sale of land recognized in 2019 that was not repeated during 2020, decrease in mortgage brokerage income due to decreased mortgage brokerage volume, and decrease in loan servicing income due to impairment expense recognized on mortgage servicing rights asset.
Non-interest expenses consisted primarily of salaries and employee benefits, occupancy and equipment expense, data processing expense and other expenses. Non-interest expenses increased to $35,477,000 in 2020 from $33,940,000 in 2019, representing an increase of $1,537,000, or 4.5%.
Following is an analysis of the increase or decrease in the components of non-interest expenses (dollars in thousands) during the periods specified:
2020 over 2019
Amount
Percent
Salaries and Employee Benefits
$
1,133
5.2
%
Occupancy and Equipment
16.0
%
Data Processing
(129
)
(4.6
%)
Stationery and Supplies
(8
)
(2.7
%)
Advertising
(16
)
(3.7
%)
Directors Fees
9.4
%
OREO Expense and Impairment
(305
)
(100.3
%)
Other Expense
7.0
%
Total
$
1,537
4.5
%
The increase in salaries and employee benefits in 2020 was primarily due to a 7% increase in regular salaries, a 17% increase in commissions and an 11% increase in group insurance, which was partially offset by a 20% decrease in profit sharing expense. The increase in regular salaries expense and group insurance was primarily due to increased staffing levels and salary increases. The increase in commissions was primarily due to an increase in mortgage originations due to the decline in interest rates and uptick in refinancing activity in 2020. The decrease in profit sharing expense was primarily due to the decrease in income before tax compared to 2019. The increase in occupancy and equipment expense was primarily due to a full year of rent expense and other expenses associated with the opening of an administrative office space in the third quarter of 2019, and a new branch in the fourth quarter of 2019. The decrease in data processing expense was primarily due to costs incurred in 2019 that was not repeated in 2020 associated with outsourcing core processing and network infrastructure to third parties. The decrease in other real estate owned expense was primarily due to a writedown on an other real estate owned property in 2019 that was not repeated in 2020. The increase in other expenses was primarily due to a increases in FDIC assessments and loan collection expenses.
Income Taxes
The provision for income taxes is primarily affected by the tax rate, the level of earnings before taxes and the level of tax-exempt income. In 2020, tax expense decreased to $4,501,000 from $5,670,000 in 2019, due to a decrease in income before taxes. Non-taxable municipal bond income was $498,000 and $300,000 for the years ended December 31, 2020 and 2019, respectively.
Liquidity
Liquidity is defined as the ability to generate cash at a reasonable cost to fulfill lending commitments and support asset growth, while satisfying the withdrawal demands of deposit customers and any debt repayment requirements. The Bank’s principal sources of liquidity are core deposits and loan and investment payments and proceeds of sale and prepayments. Providing a secondary source of liquidity is the available-for-sale investment portfolio. The Company held $435,080,000 in total investment securities at December 31, 2020. Under certain deposit, borrowing, and other arrangements, the Company must hold and pledge investment securities as collateral. At December 31, 2020, such collateral requirements totaled approximately $41,916,000. As a smaller source of liquidity, the Bank can utilize existing credit arrangements.
The Company’s primary source of liquidity on a stand-alone basis is dividends from the Bank. As discussed in Part I (Item 1) of this Annual Report on Form 10-K, dividends from the Bank are subject to regulatory and corporate law restrictions.
Liquidity risk can result from the mismatching of asset and liability cash flows, or from disruptions in the financial markets. The Bank experiences seasonal swings in deposits, which impact liquidity. Management has sought to address these seasonal swings by scheduling investment maturities and developing seasonal credit arrangements with the Federal Home Loan Bank, Federal Reserve Bank and Federal Funds lines of credit with correspondent banks. In addition, the ability of the Bank’s real estate department to originate and sell loans into the secondary market has provided another tool for the management of liquidity. As of December 31, 2020, the Company has not created any special purpose entities to securitize assets or to obtain off-balance sheet funding.
The liquidity position of the Bank is managed daily, thus enabling the Bank to adapt its position according to market fluctuations. Liquidity is measured by various ratios, the most common of which is the ratio of net loans (including loans held-for-sale) to deposits. This ratio was 59.9% on December 31, 2020, and 67.9% on December 31, 2019. At December 31, 2020 and 2019, the Bank’s ratio of core deposits to total assets was 88.4% and 86.9%, respectively. Core deposits include demand deposits, interest-bearing transaction deposits, savings and money market deposit accounts, and time deposits $250,000 or less. Core deposits are important in maintaining a strong liquidity position as they represent a stable and relatively low-cost source of funds. Management believes that the Bank’s liquidity position was adequate in 2020. This is best illustrated by the change in the Bank’s net non-core ratio, which explains the degree of reliance on non-core liabilities to fund long-term assets. At December 31, 2020, the Bank’s net core funding dependence ratio, the difference between non-core funds, time deposits $250,000 or more and brokered time deposits under $250,000, and short-term investments to long-term assets, was (18.64)% as of December 31, 2020, and (7.96%) as of December 31, 2019. This ratio indicated at December 31, 2020, the Bank did not significantly rely upon non-core deposits and borrowings to fund the Bank’s long-term assets, namely loans and investments. The Bank believes that by maintaining adequate volumes of short-term investments and implementing competitive pricing strategies on deposits, it can ensure adequate liquidity to support future growth. The Bank also believes that its liquidity position remains strong to meet both present and future financial obligations and commitments, events or uncertainties that have resulted or are reasonably likely to result in material changes with respect to the Bank’s liquidity.
Commitments
The following table details the amounts and expected maturities of commitments as of December 31, 2020 (amounts in thousands):
Maturities by period
Commitments
Total
Less than 1
year
1-3 years
3-5 years
More than 5
years
Commitments to extend credit
Commercial
$
96,675
$
70,405
$
15,664
$
4,411
$
6,195
Commercial Real Estate
5,409
-
-
4,885
Agriculture
28,411
24,574
3,054
Residential Mortgage
-
-
-
Residential Construction
1,327
-
-
1,230
Consumer
57,059
20,317
7,449
7,869
21,424
Commitments to sell loans
1,052
1,052
-
-
-
Standby Letters of Credit
1,731
1,731
-
-
-
Total
$
191,880
$
118,700
$
23,843
$
12,549
$
36,788
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. 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.
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. These loans have been sold to third parties without recourse, subject to customary default, representations and warranties, recourse for breaches of the terms of the sales contracts and payment default recourse.
Financial instruments, whose contract amounts represent credit risk at December 31 of the indicated years, were as follows (amounts in thousands):
Undisbursed loan commitments
$
189,097
$
198,534
Standby letters of credit
1,731
2,455
Commitments to sell loans
1,052
1,240
$
191,880
$
202,229
The Bank expects its liquidity position to remain strong in 2021, as the Bank expects to continue to grow into existing markets. Our liquidity position is continuously monitored and adjustments are made to balance between sources and uses of funds as deemed appropriate. The Bank believes that it has the means to provide adequate liquidity for funding normal operations in 2021.
Capital
The Company believes a strong capital position is essential to the Company’s continued growth and profitability. A solid capital base provides depositors and shareholders with a margin of safety, while allowing the Company to take advantage of profitable opportunities, support future growth and provide protection against any unforeseen losses.
At December 31, 2020, stockholders’ equity totaled $150.7 million, an increase of $17.7 million from $132.9 million at December 31, 2019. The increase was primarily due to net income of $12.2 million. Also affecting capital in 2020 was paid-in capital in the amount of $0.7 million resulting from employee stock purchases and stock plan accruals. See “Business - Capital Standards” in Part I, Item 1 of this report on Form 10-K, for additional information.
The capital of the Company and the Bank historically have been maintained at a level that is in excess of regulatory guidelines for a “well capitalized” institution. The policy of annual stock dividends has, over time, allowed the Company to match capital and asset growth through retained earnings and a managed program of geographic growth.

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Management’s Report on Internal Control over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2020 and 2019
Consolidated Statements of Income for Years Ended December 31, 2020, 2019, and 2018
Consolidated Statements of Comprehensive Income for Years Ended December 31, 2020, 2019, and 2018
Consolidated Statement of Stockholders’ Equity for Years Ended December 31, 2020, 2019, and 2018
Consolidated Statements of Cash Flows for Years Ended December 31, 2020, 2019, and 2018
Notes to Consolidated Financial Statements
Management’s Report
FIRST NORTHERN COMMUNITY BANCORP AND SUBSIDIARY
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of First Northern Community Bancorp and subsidiary (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2020. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America (“GAAP”). 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 Company’s assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and the board of directors; and (iii) provide reasonable assurance regarding prevention, or timely detection and correction of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management recognizes that even a highly effective internal control system has inherent risks, including the possibility of human error and the circumvention or overriding of controls, and that the effectiveness of an internal control system can change with circumstances. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting.
Under the supervision and with the participation of management, including the principal executive officer and principal financial officer, the Company conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020, based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management of the Company has concluded that the Company maintained effective internal control over financial reporting as of December 31, 2020.
/s/ Louise A. Walker
Louise A. Walker
President/Chief Executive Officer/Director
(Principal Executive Officer)
/s/ Kevin Spink
Kevin Spink
Executive Vice President/Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
March 5, 2021
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of
First Northern Community Bancorp
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of First Northern Community Bancorp and subsidiary (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2020 and 2019, and the consolidated results of its operations and its cash flows for the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to 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 audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting in accordance with the standards of the PCAOB. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting in accordance with the standards of the PCAOB. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to 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. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan Losses
As described in Notes 1 and 4 to the consolidated financial statements, the Company’s allowance for loan losses balance was $15.4 million at December 31, 2020. The allowance for loan losses is maintained to provide for estimated losses inherent in existing loans on evaluations of collectability and prior loss experience. Individual loans are reviewed for impairment, while all other loans, including individually evaluated loans determined to not be impaired are collectively evaluated for impairment. The evaluations take into consideration internal and external factors such as trends in portfolio volume, maturity and composition, overall portfolio quality, loan concentrations, levels of and trends in charge-offs and recoveries, current and anticipated economic conditions that may affect the borrowers’ ability to pay, and national and local economic trends and conditions.
We identified management’s risk rating of loans and the estimation of qualitative factors, both of which are used in the allowance for loan losses calculation, as a critical audit matter. The Company manages risk ratings through the analysis of initial credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. Determination of the risk rating involves significant management judgement. The qualitative factors consist of management’s analysis of the level of risks inherent in the loan portfolio, which are related to the risks of the Company’s general lending activity, including the risk of losses that are attributable to national or local economic or industry trends which have occurred but have yet been recognized in past loan charge-off history, and the risk of losses attributable to general attributes of the Company’s loan portfolio and credit administration. Auditing management’s judgments regarding the determination of risk ratings and qualitative factors applied to the allowance for loan losses involved a high degree of subjectivity.
The primary procedures we performed to address this critical audit matter included:
• Testing design, implementation, and operating effectiveness of controls relating to management’s calculation of the allowance for loan losses.
• Evaluating the appropriateness of the methodology and assumptions used in the calculation of the allowance for loan losses and testing the calculation itself, including completeness and accuracy of the data, application of the loan risk ratings determined by management, application of the qualitative factors determined by management, and recalculation of the allowance for loan losses balance.
• Testing a risk-based targeted selection of loans to gain substantive evidence that the Company is appropriately risk rating the loans in accordance with its policies and that the risk ratings for the loans are appropriate.
• Evaluating management’s analysis and supporting documentation related to the qualitative factors, and testing whether the qualitative factors used in the calculation of the allowance for loan losses are supported by the analysis provided by management.
/s/ MOSS ADAMS LLP
Los Angeles, California
March 5, 2021
We have served as the Company’s auditor since 2006.
FIRST NORTHERN COMMUNITY BANCORP
AND SUBSIDIARY
Consolidated Balance Sheets
December 31, 2020 and 2019
(in thousands, except shares and share amounts)
Assets
Cash and cash equivalents
$
267,177
$
111,493
Certificates of deposit
16,923
14,700
Investment securities - available-for-sale, at fair value (includes securities pledged to creditors with the right to sell or repledge of $41,916 at December 31, 2020 and $37,943 at December 31, 2019)
435,080
342,897
Loans (net of allowance for loan losses of $15,416 at December 31, 2020 and $12,356 at December 31, 2019)
875,830
768,873
Loans held-for-sale
9,190
4,130
Stock in Federal Home Loan Bank and other equity securities, at cost
6,480
6,574
Premises and equipment, net
6,513
6,594
Interest receivable and other assets
38,183
37,330
Total Assets
$
1,655,376
$
1,292,591
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Demand
$
645,538
$
423,095
Interest-bearing transaction deposits
390,126
317,681
Savings and MMDAs
385,908
344,415
Time, $250,000 or less
41,947
37,564
Time, over $250,000
14,643
15,877
Total Deposits
1,478,162
1,138,632
Federal Home Loan Bank advances
5,000
-
Interest payable and other liabilities
21,557
21,044
Total Liabilities
1,504,719
1,159,676
Commitments and contingencies (Note 11)
Stockholders’ Equity:
Common stock, no par value; 16,000,000 shares authorized; 13,634,463 and 12,919,132 shares issued and outstanding at December 31, 2020 and 2019, respectively
107,527
100,187
Additional paid-in capital
Retained earnings
37,115
31,617
Accumulated other comprehensive income, net
5,038
Total Stockholders’ Equity
150,657
132,915
Total Liabilities and Stockholders’ Equity
$
1,655,376
$
1,292,591
See accompanying notes to consolidated financial statements.
FIRST NORTHERN COMMUNITY BANCORP
AND SUBSIDIARY
Consolidated Statements of Income
Years Ended December 31, 2020, 2019 and 2018
(in thousands, except per share amounts)
Interest and dividend income:
Interest and fees on loans
$
40,569
$
39,097
$
37,189
Due from banks interest bearing accounts
1,020
2,503
2,267
Investment securities:
Taxable
6,406
6,637
5,500
Non-taxable
Other earning assets
Total interest and dividend income
48,864
48,993
45,617
Interest expense:
Time deposits over $250,000
Other deposits
1,359
1,715
1,190
Total interest expense
1,484
1,859
1,268
Net interest income
47,380
47,134
44,349
Provision for loan losses
3,050
-
2,100
Net interest income after provision for loan losses
44,330
47,134
42,249
Non-interest income:
Service charges on deposit accounts
1,371
1,979
1,994
Net gain (loss) on sale of available-for-sale securities
(3
)
(20
)
Net gain on sale of loans held-for-sale
2,247
Debit card income
2,191
2,177
2,144
Other income
1,704
2,430
2,754
Total non-interest income
7,809
7,197
7,209
Non-interest expenses:
Salaries and employee benefits
23,079
21,946
20,795
Occupancy and equipment
3,661
3,156
2,775
Data processing
2,683
2,812
2,190
Stationery and supplies
Advertising
Directors fees
Other real estate owned (recovery) expense
(1
)
Other expense
5,036
4,706
5,322
Total non-interest expenses
35,477
33,940
32,163
Income before provision for income tax
16,662
20,391
17,295
Provision for income tax
(4,501
)
(5,670
)
(4,744
)
Net income
$
12,161
$
14,721
$
12,551
Basic income per share
$
0.90
$
1.10
$
0.94
Diluted income per share
$
0.90
$
1.08
$
0.93
See accompanying notes to consolidated financial statements.
FIRST NORTHERN COMMUNITY BANCORP
AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2020, 2019 and 2018
(in thousands)
Net income
$
12,161
$
14,721
$
12,551
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) on securities arising during the current period, net of tax effect of $2,358, $2,187, and ($355) for the years ended December 31, 2020, 2019, and 2018, respectively
5,846
5,426
(884
)
Reclassification adjustment due to (gains) losses realized on sales of securities, net of tax effect of ($85), $1, and $6 for the years ended December 31, 2020, 2019, and 2018, respectively
(211
)
Officers’ retirement plan equity adjustments, net of tax effect of ($280), ($85), and $82 for the years ended December 31, 2020, 2019, and 2018, respectively
(694
)
(213
)
Directors’ retirement plan equity adjustments, net of tax effect of ($15), ($17), and 10 for the years ended December 31, 2020, 2019, and 2018, respectively
(37
)
(45
)
Total other comprehensive income (loss), net of tax effect of $1,978, $2,086, and ($257) for the years ended December 31, 2020, 2019, and 2018, respectively
4,904
5,170
(639
)
Comprehensive income
$
17,065
$
19,891
$
11,912
See accompanying notes to consolidated financial statements.
FIRST NORTHERN COMMUNITY BANCORP
AND SUBSIDIARY
Consolidated Statement of Stockholders’ Equity
Years Ended December 31, 2020, 2019 and 2018
(in thousands, except share data)
Common Stock
Shares
Amounts
Additional
Paid-in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income/(Loss)
Total
Balance at December 31, 2017
11,630,129
$
85,583
$
$
17,881
$
(4,397
)
$
100,044
Net income
12,551
12,551
Other comprehensive loss, net of tax
(639
)
(639
)
Stock dividend adjustment
(240
)
-
5% stock dividend declared in 2019
583,514
6,280
(6,280
)
-
Cash in lieu of fractional shares
(159
)
(10
)
(10
)
Stock-based compensation
Common shares issued related to restricted stock grants and ESPP
33,722
Stock options exercised, net
5,978
-
-
Balance at December 31, 2018
12,253,812
$
92,618
$
$
23,902
$
(5,036
)
$
112,461
Net income
14,721
14,721
Other comprehensive income, net of tax
5,170
5,170
Stock dividend adjustment
1,401
(330
)
-
5% stock dividend declared in 2020
615,196
6,668
(6,668
)
-
Cash in lieu of fractional shares
(116
)
(8
)
(8
)
Stock-based compensation
Common shares issued related to restricted stock grants and ESPP, net of restricted stock reversals
48,839
Balance at December 31, 2019
12,919,132
$
100,187
$
$
31,617
$
$
132,915
Net income
12,161
12,161
Other comprehensive income, net of tax
4,904
4,904
Stock dividend adjustment
1,310
(348
)
-
5% stock dividend declared in 2021
649,260
6,307
(6,307
)
-
Cash in lieu of fractional shares
(166
)
(8
)
(8
)
Stock-based compensation
Common shares issued related to restricted stock grants and ESPP, net of restricted stock reversals
51,993
Stock options exercised, net
12,934
-
-
Balance at December 31, 2020
13,634,463
$
107,527
$
$
37,115
$
5,038
$
150,657
See accompanying notes to consolidated financial statements.
FIRST NORTHERN COMMUNITY BANCORP
AND SUBSIDIARY
Consolidated Statements of Cash Flows
Years Ended December 31, 2020, 2019 and 2018
(in thousands)
Cash flows from operating activities:
Net income
$
12,161
$
14,721
$
12,551
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
3,050
-
2,100
Stock-based compensation
Depreciation and amortization of bank premises and equipment
Accretion and amortization of securities, net
2,010
1,683
2,530
Net (gain) loss on sale/call of available-for-sale securities
(296
)
Net gain on sale of loans held-for-sale
(2,247
)
(614
)
(337
)
Impairment on other real estate owned
-
-
Gain on sale of bank premises and equipment
-
(281
)
-
(Benefit) provision for deferred income taxes
(1,429
)
(1,210
)
Valuation adjustment on mortgage servicing rights
-
-
Proceeds from sales of loans held-for-sale
79,013
33,796
21,966
Originations of loans held-for-sale
(81,826
)
(35,017
)
(22,884
)
Increase in deferred loan origination fees and costs, net
2,552
Amortization of operating lease right-of-use asset
1,270
-
Increase in interest receivable and other assets
(2,837
)
(768
)
(596
)
Net increase in interest payable and other liabilities
(734
)
Net cash provided by operating activities
12,590
16,564
15,679
Cash flows from investing activities:
Proceeds from maturities of available-for-sale securities
41,995
47,955
23,860
Proceeds from sales of available-for-sale securities
14,201
20,796
2,487
Principal repayments on available-for-sale securities
66,784
50,781
50,186
Purchase of available-for-sale securities
(208,969
)
(141,862
)
(114,198
)
Net increase in Certificates of Deposit
(2,223
)
(7,105
)
(5,611
)
Proceeds from redemption (purchases) of stock in Federal Home Loan Bank and other equity securities, at cost
(555
)
(452
)
Net increase in loans
(112,559
)
(5,617
)
(27,801
)
Purchases of bank premises and equipment, net
(862
)
(1,056
)
(963
)
Proceeds from the sale of bank premises and equipment
-
-
Proceeds from sales of other real estate owned
-
-
Net cash used in investing activities
(201,539
)
(35,211
)
(72,492
)
Cash flows from financing activities:
Net increase in deposits
339,530
14,020
19,872
Increase in Federal Home Loan Bank advances
5,000
-
-
Cash dividends paid in lieu of fractional shares
(8
)
(8
)
(10
)
Common stock issued
Net cash provided by financing activities
344,633
14,108
19,953
Net increase (decrease) in cash and cash equivalents
155,684
(4,539
)
(36,860
)
Cash and cash equivalents at beginning of year
111,493
116,032
152,892
Cash and cash equivalents at end of year
$
267,177
$
111,493
$
116,032
Supplemental Consolidated Statements of Cash Flows Information (Note 20)
See accompanying notes to consolidated financial statements.
FIRST NORTHERN COMMUNITY BANCORP
AND SUBSIDIARY
Notes to Consolidated Financial Statements
Years Ended December 31, 2020, 2019 and 2018
(in thousands, except shares and share amounts)
(1) Summary of Significant Accounting Policies
First Northern Community Bancorp (the “Company”) is a bank holding company whose only subsidiary, First Northern Bank of Dixon (“Bank”), a California state-chartered bank, conducts general banking activities, including collecting deposits and originating loans, and serves Solano, Yolo, Sacramento, Placer, El Dorado, and Contra Costa Counties. All intercompany transactions between the Company and the Bank have been eliminated in consolidation. The consolidated financial statements also include the accounts of Yolano Realty Corporation, a wholly-owned subsidiary of the Bank. Yolano Realty Corporation was formed in September 2009 for the purpose of managing selected other real estate owned properties. Yolano Realty Corporation was an inactive subsidiary in 2020.
The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates applied in the preparation of the accompanying consolidated financial statements. For the Company, the most significant accounting estimates are the allowance for loan losses, recognition and measurement of impaired loans, other-than-temporary impairment of securities, fair value measurements, share based compensation, valuation of mortgage servicing rights and deferred tax asset realization. A summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements follows.
(a) Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company considers due from banks, federal funds sold for one-day periods and short-term bankers acceptances to be cash equivalents. At times, the Company maintains deposits with other financial institutions in amounts that may exceed federal deposit insurance coverage. Management regularly evaluates the credit risk associated with correspondent banks.
(b) Investment Securities
Investment securities consist of U.S. Treasury securities, U.S. Agency securities, obligations of states and political subdivisions, obligations of U.S. Corporations, collateralized mortgage obligations and mortgage-backed securities. At the time of purchase of a security the Company designates the security as held-to-maturity or available-for-sale, based on its investment objectives, operational needs, and intent to hold. The Company does not purchase securities with the intent to engage in trading activity.
Held-to-maturity securities are recorded at amortized cost, adjusted for amortization or accretion of premiums or discounts. Available-for-sale securities are recorded at fair value with unrealized holding gains and losses, net of the related tax effect, reported as a separate component of stockholders’ equity until realized. The amortized cost of securities is adjusted for amortization of premiums and accretion of discounts to the earliest call date using the effective interest method. Such amortization and accretion is included in investment income, along with interest and dividends. The cost of securities sold is based on the specific identification method; realized gains and losses resulting from such sales are included in earnings.
Investments with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed interest rate investments, from rising interest rates. At each consolidated financial statement date, management assesses each investment to determine if impaired investments are temporarily impaired or if the impairment is other than temporary. This assessment includes consideration regarding the duration and severity of impairment, the credit quality of the issuer and a determination of whether the Company intends to sell the security, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. Other-than-temporary impairment is recognized in earnings if one of the following conditions exists: 1) the Company’s intent is to sell the security; 2) it is more likely than not that the Company will be required to sell the security before the impairment is recovered; or 3) the Company does not expect to recover its amortized cost basis. If, by contrast, the Company does not intend to sell the security and will not be required to sell the security prior to recovery of the amortized cost basis, the Company recognizes only the credit loss component of other-than-temporary impairment in earnings. The credit loss component is calculated as the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of the future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income.
(c) Federal Home Loan Bank Stock and Other Equity Securities, at Cost
Federal Home Loan Bank ("FHLB") stock represents an equity interest that does not have a readily determinable fair value because its ownership is restricted and it lacks a market (liquidity). FHLB stock and other securities are recorded at cost.
(d) Loans
Loans are reported at the principal amount outstanding, net of deferred loan fees and costs and the allowance for loan losses. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. For a loan that has been restructured, the contractual terms of the loan agreement refer to the contractual terms specified by the original loan agreement, not the contractual terms specified by the restructuring agreement. Restructured loans are loans on which concessions in terms have been granted because of the borrowers’ financial difficulties. A restructuring constitutes a troubled debt restructuring, and thus an impaired loan, if the restructuring constitutes a concession and the debtor is experiencing financial difficulties. An impaired loan is measured based upon the present value of future cash flows discounted at the loan’s effective rate, the loan’s observable market price, or the fair value of collateral if the loan is collateral dependent. Interest on impaired loans is recognized on a cash basis. If the measurement of the impaired loan is less than the recorded investment in the loan, an impairment is recognized by a charge to the allowance for loan losses.
Unearned discount on installment loans is recognized as income over the terms of the loans by the interest method. Interest on other loans is calculated by using the simple interest method on the daily balance of the principal amount outstanding.
Loan fees net of certain direct costs of origination, which represent an adjustment to interest yield are deferred and amortized over the contractual term of the loan using the interest method. Processing fees received from the SBA for PPP loans are recognized as an adjustment to the effective yield over the loans projected life.
Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full and timely collection of interest or principal or when a loan becomes contractually past due by ninety days or more with respect to interest or principal. When a loan is placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest. Accrual of interest on loans that are troubled debt restructurings commence after a sustained period of performance. Interest is generally accrued on such loans in accordance with the new terms.
(e) Loans Held-for-Sale
Loans originated and held-for-sale are carried at the lower of cost or estimated fair value in the aggregate. Net fees and costs of originating loans held for sale are deferred and are included in the basis for determining the gain or loss on sales of loans held for sale. Net unrealized losses are recognized through a valuation allowance by charges to income.
(f) Allowance for Loan Losses
The allowance for loan losses is established through a provision charged to expense. It is the Company’s policy to charge-off loans when the following exists: management determines that a loss is expected or when specified by regulatory examination; impairment analysis shows an impaired amount, which requires a partial charge-off; interest and/or principal are past due 90 days or more unless the credit is both well secured and in process of collection; consumer loans become 90 days delinquent, except those well secured by real estate collateral and in the process of collection; loan is canceled as part of a court judgment.
The allowance is an amount that management believes will be adequate to absorb losses inherent in existing loans and overdrafts on evaluations of collectability and prior loss experience. The loan portfolio is segregated into loan types to facilitate the assessment of risk to pools of loans based on historical charge-off experience and internal and external factors. Non-accrual loans, troubled debt restructurings and loans with a risk rating of 5 (special mention) or worse and an aggregate exposure of $500,000 or more are reviewed for impairment, while all other loans, including individually evaluated loans determined not to be impaired, are collectively evaluated for impairment. The evaluations take into consideration internal and external factors such as trends in portfolio volume, maturity and composition, overall portfolio quality, loan concentrations, levels of and trends in charge-offs and recoveries, current and anticipated economic conditions that may affect the borrowers’ ability to pay and national and local economic trends and conditions. While management uses these evaluations to determine the allowance for loan losses, additional provisions may be necessary based on changes in the factors used in the evaluations.
Material estimates relating to the determination of the allowance for loan losses are particularly susceptible to significant change in the near term. Management believes that the allowance for loan losses was adequate at December 31, 2020. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additional allowance based on their judgment about information available to them at the time of their examination.
(g) Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed substantially by the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are depreciated over the estimated useful lives of the improvements or the terms of the related leases, whichever is shorter. The useful lives used in computing depreciation are as follows:
Buildings and improvements
15 to 50 years
Furniture and equipment
3 to 10 years
(h) Other Real Estate Owned
Other real estate acquired by foreclosure is carried at fair value less estimated selling costs. Prior to foreclosure, the value of the underlying loan is written down to the fair value of the real estate to be acquired by a charge to the allowance for loan losses, if necessary. Fair value of other real estate owned is generally determined based on an appraisal of the property. Any subsequent operating expenses or income, reduction in estimated values and gains or losses on disposition of such properties are included in other operating expenses.
Gain recognition on the disposition of real estate is dependent upon the transaction meeting certain criteria relating to the nature of the property sold and the terms of the sale. Under certain circumstances, revenue recognition may be deferred until these criteria are met.
The Bank held no other real estate owned (“OREO”) as of December 31, 2020 and 2019.
(i) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
Long-lived assets and certain identifiable intangibles are required to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company currently has no identifiable intangible assets. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
(j) Pension Benefit Plans
The Company and the Bank maintain unfunded non-contributory defined benefit pension plans for a select group of highly compensated employees and directors, as well as a supplemental executive retirement plan. Net periodic benefit cost is recognized over the approximate service period of plan participants and includes discount rate assumptions. See Note 17 of Notes to Consolidated Financial Statements.
(k) Revenue from Contracts with Customers
The following are descriptions of the Company’s sources of Non-interest income within the scope of Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606):
Service charges on deposit accounts
Service charges on deposit accounts include account maintenance and analysis fees and transaction-based fees. Account maintenance and analysis fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis. The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees consist of non-sufficient funds fees, wire fees, overdraft fees and fees on other products and services and are charged to deposit customers for specific services provided to the customer. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer.
Investment and brokerage services income
The Bank earns investment and brokerage services fees for providing a broad range of alternative investment products and services through Raymond James Financial Services, Inc. Brokerage fees are generally earned in two ways. Brokerage fees for managed accounts charge a set annual percentage fee based on the underlying portfolio value and are earned and recognized on a quarterly basis. Brokerage fees for a standard commission account are charged on a per transaction fee and are earned and recognized at the time of the transaction.
Debit card income
Debit card income represent fees earned on Bank-issued debit card transactions. The Bank earns interchange fees from debit cardholder transactions through the related payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the cardholders’ account. Certain expenses directly associated with the debit card are recorded on a net basis with the interchange income.
Other income
Other income within the scope of Topic 606 include check sales fees, bankcard fees, and merchant fees. Check sales fees, based on check sales volume, are received from check printing companies and are recognized monthly. Bankcard fees are earned from the Bank’s credit card program and are recognized monthly as the service period is completed. Merchant fees are earned for card payment services provided to its merchant customers. The Bank has a contract with a third party to provide card payment services to merchants that contract for those services. Merchant fees are recognized monthly as the service period is completed.
(l) Gain or Loss on Sale of Loans and Servicing Rights
Transfers and servicing of financial assets and extinguishments of liabilities are accounted for and reported based on consistent application of a financial-components approach that focuses on control. Transfers of financial assets that are sales are distinguished from transfers that are secured borrowings. A sale is recognized when the transaction closes and the proceeds are other than beneficial interests in the assets sold. A gain or loss is recognized to the extent that the sales proceeds and the fair value of the servicing asset exceed or are less than the book value of the loan.
The Company recognizes a gain and a related asset for the fair value of the rights to service loans for others when loans are sold. The Company sold substantially all of its conforming long-term residential mortgage loans originated during the years ended December 31, 2020, 2019, and 2018 for cash proceeds equal to the fair value of the loans.
Mortgage servicing rights ("MSR") in loans sold are measured by allocating the previous carrying amount of the transferred assets between the loans sold and retained interest, if any, based on their relative fair value at the date of transfer. The Company determines its classes of servicing assets based on the asset type being serviced along with the methods used to manage the risk inherent in the servicing assets, which includes the market inputs used to value the servicing assets. The Company measures and reports its residential mortgage servicing assets initially at fair value and amortizes the servicing rights in proportion to, and over the period of, estimated net servicing revenues. Management assesses servicing rights for impairment as of each financial reporting date. Fair value adjustments that encompass market-driven valuation changes and the runoff in value that occurs from the passage of time are each separately reported.
In determining the fair value of the MSR, the Company uses quoted market prices when available. Subsequent fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of the MSR, the present value of expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, delinquency and foreclosure rates, and ancillary fee income. This model is periodically validated by an independent external model validation group. The model assumptions and the MSR fair value estimates are also compared to observable trades of similar portfolios as well as to MSR broker valuations and industry surveys, as available. Key assumptions used in measuring the fair value of MSR as of December 31 were as follows:
Constant prepayment rate
20.22
%
12.10
%
Discount rate
10.00
%
10.01
%
Weighted average life (years)
3.96
5.50
The expected life of the loan can vary from management’s estimates due to prepayments by borrowers, especially when rates fall. Prepayments in excess of management’s estimates would negatively impact the recorded value of the mortgage servicing rights. The value of the mortgage servicing rights is also dependent upon the discount rate used in the model, which we base on current market rates. Management reviews this rate on an ongoing basis based on current market rates. A significant increase in the discount rate would reduce the value of mortgage servicing rights.
(m) Income Taxes
The Company accounts for income taxes under the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A liability for uncertain tax positions is recorded for unrecognized tax benefits related to uncertain tax positions where it is more likely than not that the position will be sustained upon examination by a taxing authority. Interest and/or penalties related to income taxes are reported as a component of provision for income taxes.
(n) Share Based Compensation
The Company accounts for share based compensation transactions whereby the Company receives employee services in exchange for equity instruments, including stock options and restricted stock. The Company recognizes in the consolidated statements of income the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over their requisite service period (generally the vesting period). The fair value of options granted is determined on the date of the grant using a Black-Scholes-Merton pricing model. The grant date fair value of restricted stock is determined by the closing market price of the day prior to the grant date. The Company issues new shares of common stock upon the exercise of stock options. See Note 15 of Notes to Consolidated Financial Statements.
(o) Earnings Per Share (“EPS”)
Basic EPS includes no dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period, excluding non-vested restricted shares. Diluted EPS reflects the potential dilution of securities that could share in the earnings of an entity. The number of potential common shares included in annual diluted EPS is a year to date average of the number of potential common shares included in each quarter’s diluted EPS computation under the treasury stock method. The calculation of weighted average shares includes two classes of the Company’s outstanding common stock: common stock and restricted stock awards. Holders of restricted stock also receive dividends at the same rate as common shareholders, subject to vesting restrictions, and they both share equally in undistributed earnings. See Note 14 of Notes to Consolidated Financial Statements.
(p) Advertising Costs
Advertising costs were $418, $434, and $373 for the years ended December 31, 2020, 2019, and 2018, respectively. Advertising costs are expensed as incurred.
(q) Comprehensive Income
Accounting principles generally accepted in the United States require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gain and losses on available-for-sale securities and directors’ and officers’ retirement plans, are reported as a separate component of the equity section of the consolidated balance sheet. Such items, along with net income, are components of comprehensive income.
(r) Stock Dividend
On January 23, 2020, the Company announced that its Board of Directors had declared a 5% stock dividend which resulted in 616,506 shares, which was paid on March 25, 2020 to shareholders of record as of February 28, 2020. On January 27, 2021, the Company announced that its Board of Directors had declared a 5% stock dividend which will result in an estimate of 649,260 shares, which will be paid on March 25, 2021 to shareholders of record as of February 26, 2021.
The earnings per share data for all periods presented have been adjusted to give retroactive effect to stock dividends and stock splits, including the 5% stock dividend declared on January 27, 2021. December 31, 2020 figures included in the Consolidated Balance Sheets and Consolidated Statement of Changes in Stockholders’ Equity have been adjusted to reflect the estimated impact of the 2021 stock dividend. Figures that have been adjusted include common stock shares issued and outstanding, Common stock balance and Retained earnings balance. The December 31, 2019, 2018 and 2017 balances included in the Consolidated Balance Sheets and Statement of Changes in Stockholders’ Equity have not been adjusted to retroactively reflect the stock dividends, but instead show the historical rollforward of stock dividends declared.
(s) Segment Reporting
The "Segment Reporting" topic of the FASB ASC requires that public companies report certain information about operating segments. It also requires that public companies report certain information about their products and services, the geographic areas in which they operate, and their major customers. The Company is a holding company for a community bank, which offers a wide array of products and services to its customers. Pursuant to its banking strategy, emphasis is placed on building relationships with its customers, as opposed to building specific lines of business. As a result, the Company is not organized around discernible lines of business and prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change. Therefore, the Company only reports one segment.
(t) Impact of Recently Issued Accounting Standards
The CARES Act was passed by Congress and signed into law on March 27, 2020. Section 4013 of the CARES Act provides that a financial institution may elect to not apply GAAP requirements to loan modifications related to the COVID-19 pandemic that would otherwise be categorized as a TDR, and suspends the determination of loan modifications related to the COVID-19 pandemic from being treated as TDR’s. The relief from TDR guidance applies to modifications of loans that were not more than 30 days past due as of December 31, 2019, and modifications that occur beginning on March 1, 2020 until the earlier of: sixty days after the date on which the national emergency related to the COVID-19 outbreak is terminated or December 31, 2020. The suspension of TDR accounting and reporting guidance may not be applied to any adverse impact on the credit of a borrower that is not related to the COVID-19 pandemic. In December 2020, the Consolidated Appropriations Act, 2021 was signed into law. Section 541 of this legislation, “Extension of Temporary Relief From Troubled Debt Restructurings and Insurer Clarification,” extends Section 4013 of the CARES Act to the earlier of January 1, 2022 or 60 days after the termination of the national emergency declared relating to COVID-19. Future TDRs are indeterminable and will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.
On April 3, 2020, the SEC Office of the Chief Accountant issued a public statement communicating that for eligible entities that elect to apply Section 4013 of the CARES Act, the SEC staff would not object that this is in accordance with GAAP for the periods for which such elections are available. In June 2020, the American Institute of Certified Public Accountants published Q&A Section 2130.41 regarding a technical question regarding the recognition of interest income on Section 4013 loans which provided multiple permitted policy elections regarding the recognition of interest on Section 4013 restructured loans.
The Bank has continued to actively assist its communities by providing temporary loan relief under Section 4013 of the CARES Act. This relief included loan modifications which include forbearance programs (both full payment deferrals and interest only payments) to customers who have been negatively impacted by the pandemic. For loans that have been provided temporary full payment deferrals, the Bank has made a policy election to cease recognition of interest income during the term of the payment deferrals (generally three to six months). Upon completion of the forbearance period, the foregone interest over the deferral period is capitalized as deferred interest and recognized as an adjustment to the effective interest rate over the remaining life of the loan using the effective yield method. Loans that were provided interest only payment relief will continue to accrue interest over the interest only period provided that the loans continue to perform as agreed. This policy election does not impact the Bank’s existing policies regarding non-accrual determinations if reasonable doubt exists as to the full and timely collection of interest or principal or when a loan becomes contractually past due by ninety days or more with respect to interest or principal regardless of whether a loan was modified under Section 4013 of the CARES Act. On March 22, 2020, the federal bank regulatory agencies issued joint guidance advising that the agencies have confirmed with the staff of the Financial Accounting Standards Board that short-term modifications due to COVID-19, made on a good faith basis to borrowers who were current prior to relief, are not TDRs. The CARES Act also provided relief from TDR classification for certain COVID-19 loan modifications. The Bank elected not to classify modifications that meet the criteria under either the CARES Act or the criteria specified by the regulatory agencies as TDRs.
In March 2020, the FASB issued ASU 2020-02, Financial Instruments-Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842). This ASU adds an SEC paragraph pursuant to the issuance of SEC Staff Accounting Bulletin No. 119 on loan losses to the FASB Codification Topic 326. This ASU also updates the SEC section of the Codification for the change in the effective date of Topic 842. This ASU is effective upon addition to the FASB Codification. The Company adopted ASU 2016-02, Leases (Topic 842) on January 1, 2019. ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) is effective on January 1, 2023 for smaller reporting companies with less than $250 million in public float as defined in the SEC's rules (such as the Company). While the Company is currently unable to reasonably estimate the impact of adopting ASU 2016-13, it expects that the impact of adoption will be significantly influenced by the composition, characteristics and quality of the Company’s loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.
In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. The amendments in ASU 2020-03 make narrow-scope improvements to various aspects of the financial instruments guidance, including the current expected credit losses (CECL) standard issued in 2016. The ASU is part of the FASB’s ongoing Codification improvement project aimed at clarifying specific areas of accounting guidance to help avoid unintended application. The items addressed in that project generally are not expected to have a significant effect on current accounting practice or create a significant administrative cost for most entities. Effective dates for each amendment vary. The Company does not expect the adoption of this update to have a significant impact on its financial statements.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848). This ASU provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. This ASU provides optional expedients and exceptions for contracts, hedging relationships, and other transactions that reference LIBOR or other reference rates expected to be discontinued because of reference rate reform. This ASU is effective for all entities as of March 12, 2020 through December 31, 2022. The Company is in the process of evaluating the provisions of this ASU, but does not expect it to have a material impact on our consolidated financial statements.
In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope. This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company is in the process of evaluating the provisions of this ASU, but does not expect it to have a material impact on our consolidated financial statements.
(2) Cash and Due from Banks
The Bank is required to maintain reserves with the Federal Reserve Bank based on a percentage of deposit liabilities. No aggregate reserves were required at December 31, 2020 and 2019. The Bank has met its average reserve requirements during 2020, 2019, and 2018 and the minimum required balance at December 31, 2020 and 2019.
(3) Investment Securities
The amortized cost, unrealized gains and losses and estimated fair values of investments in debt and other securities at December 31, 2020 are summarized as follows:
Amortized
cost
Unrealized
gains
Unrealized
losses
Estimated
fair value
Investment securities available-for-sale:
U.S. Treasury securities
$
37,910
$
$
(1
)
$
38,891
Securities of U.S. government agencies and corporations
105,506
1,317
(265
)
106,558
Obligations of states and political subdivisions
31,013
1,878
(9
)
32,882
Collateralized mortgage obligations
71,531
1,937
(8
)
73,460
Mortgage-backed securities
179,021
4,359
(91
)
183,289
Total debt securities
$
424,981
$
10,473
$
(374
)
$
435,080
The amortized cost, unrealized gains and losses and estimated fair values of investments in debt and other securities at December 31, 2019 are summarized as follows:
Amortized
cost
Unrealized
gains
Unrealized
losses
Estimated
fair value
Investment securities available-for-sale:
U.S. Treasury Securities
$
42,667
$
$
(13
)
$
43,255
Securities of U.S. government agencies and corporations
53,525
(46
)
53,912
Obligations of states and political subdivisions
26,311
(29
)
27,031
Collateralized mortgage obligations
79,470
(399
)
79,420
Mortgage-backed securities
138,733
(453
)
139,279
Total debt securities
$
340,706
$
3,131
$
(940
)
$
342,897
Gross realized gains from sales and calls of available-for-sale securities were $342, $81, and $0 for the years ended December 31, 2020, 2019, and 2018, respectively. Gross realized losses from sales of available-for-sale securities were $46, $84, and $20 for the years ended December 31, 2020, 2019, and 2018, respectively.
The amortized cost and estimated fair value of debt and other securities at December 31, 2020, by contractual maturity, are shown in the following table:
Amortized
cost
Estimated
fair value
Maturity in years:
Due in one year or less
$
16,281
$
16,447
Due after one year through five years
78,502
80,214
Due after five years through ten years
58,501
59,251
Due after ten years
21,145
22,419
Subtotal
174,429
178,331
MBS and CMO
250,552
256,749
Total
$
424,981
$
435,080
Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. In addition, factors such as prepayments and interest rates may affect the yield on the carrying value of mortgage-related securities.
An analysis of gross unrealized losses of the available-for-sale investment securities portfolio as of December 31, 2020, follows:
Less than 12 months
12 months or more
Total
Fair Value
Unrealized
losses
Fair Value
Unrealized
losses
Fair Value
Unrealized
losses
U.S. Treasury securities
$
4,276
$
(1
)
$
-
$
-
$
4,276
$
(1
)
Securities of U.S. government agencies and corporations
58,164
(265
)
-
-
58,164
(265
)
Obligations of states and political subdivisions
1,603
(9
)
-
-
1,603
(9
)
Collateralized mortgage obligations
1,697
(8
)
-
-
1,697
(8
)
Mortgage-backed securities
30,208
(91
)
-
-
30,208
(91
)
Total
$
95,948
$
(374
)
$
-
$
-
$
95,948
$
(374
)
No decline in value was considered “other-than-temporary” during 2020. Eight securities, all considered investment grade, which had a fair value of $95,948 and a total unrealized loss of $374 have been in an unrealized loss position for less than twelve months as of December 31, 2020. No securities have been in an unrealized loss position for more than twelve months as of December 31, 2020. The unrealized losses on the Company's investment securities were caused by market conditions for these types of investments, particularly changes in risk-free interest rates. The Company does not intend to sell the securities and has concluded it is not more likely than not that it will be required to sell these securities prior to recovery of their anticipated cost basis. Therefore, the Company does not consider these investments to be other than temporarily impaired as of December 31, 2020.
The fair value of investment securities could decline in the future if the general economy deteriorates, inflation increases, credit ratings decline, the issuer's financial condition deteriorates, or the liquidity for securities declines. As a result, other than temporary impairments may occur in the future.
An analysis of gross unrealized losses of the available-for-sale investment securities portfolio as of December 31, 2019, follows:
Less than 12 months
12 months or more
Total
Fair Value
Unrealized
losses
Fair Value
Unrealized
losses
Fair Value
Unrealized
losses
U.S. Treasury Securities
$
10,113
$
(8
)
$
2,015
$
(5
)
$
12,128
$
(13
)
Securities of U.S. government agencies and corporation
13,187
(44
)
1,998
(2
)
15,185
(46
)
Obligations of states and political subdivision
4,645
(29
)
-
-
4,645
(29
)
Collateralized mortgage obligations
21,763
(129
)
21,132
(270
)
42,895
(399
)
Mortgage-backed securities
11,970
(28
)
44,433
(425
)
56,403
(453
)
Total
$
61,678
$
(238
)
$
69,578
$
(702
)
$
131,256
$
(940
)
Investment securities carried at $41,916 and $37,943 at December 31, 2020 and 2019, respectively, were pledged to secure public deposits or for other purposes as required or permitted by law.
(4) Loans
The composition of the Company’s loan portfolio, by loan class, at December 31, is as follows:
Commercial
$
255,926
$
106,140
Commercial Real Estate
454,053
451,774
Agriculture
95,048
115,751
Residential Mortgage
64,497
64,943
Residential Construction
4,223
15,212
Consumer
19,467
26,825
893,214
780,645
Allowance for loan losses
(15,416
)
(12,356
)
Net deferred origination fees and costs
(1,968
)
Loans, net
$
875,830
$
768,873
The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk rating standards and criteria similar to those employed by state and federal banking regulatory agencies.
Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses. These loans are generally secured by the receivables, equipment, and other real property of the business and are susceptible to the related risks described above. Problem commercial loans are generally identified by periodic review of financial information that may include financial statements, tax returns, and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation.
Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner-occupied real estate are primarily susceptible to changes in the market conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles. These same risks apply to Commercial loans whether secured by equipment, receivables or other personal property or unsecured. Problem commercial real estate loans are generally identified by periodic review of financial information that may include financial statements, tax returns, payment history of the borrower, and site inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Losses on loans secured by owner occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resulting over-supply of space. Losses are dependent on the value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means.
Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or service. Agricultural loans are generally secured by inventory, receivables, equipment, and other real property. Agricultural loans primarily are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as adverse weather conditions such as drought or floods. Problem agricultural loans are generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary.
Residential mortgage loans, which are secured by real estate, are primarily susceptible to four risks; non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfalls in collateral value. In general, non-payment is usually due to loss of employment and follows general economic trends in the economy, particularly the upward movement in the unemployment rate, loss of collateral value, and demand shifts.
Construction loans, whether owner-occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction, including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion. Losses are primarily related to underlying collateral value and changes therein as described above. Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, or repossession or foreclosure of the underlying collateral. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation.
Consumer loans, whether unsecured or secured, are primarily susceptible to four risks: non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfall in collateral value. In general, non-payment is usually due to loss of employment and will follow general economic trends in the economy, particularly the upward movements in the unemployment rate, loss of collateral value, and demand shifts.
Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Collateral valuations are obtained at origination of the credit. Once repayment is questionable, and the loan has been deemed classified, collateral valuations are obtained periodically (generally annually but may be more frequent depending on the collateral type).
At December 31, 2020, approximately 29% in principal amount of the Company’s loans were for general commercial uses, including professional, retail and small businesses. Approximately 51% in principal amount of the Company’s loans were secured by commercial real estate, which consists primarily of loans secured by commercial properties and construction and land development loans. Approximately 11% in principal amount of the Company’s loans were for agriculture, approximately 7% in principal amount of the Company’s loans were residential mortgage loans, approximately 0% in principal amount of the Company’s loans were residential construction loans and approximately 2% in principal amount of the Company’s loans were consumer loans.
Once a loan becomes delinquent or repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal payment. If this is not forthcoming and payment of principal and interest in accordance with the contractual terms of the loan agreement becomes unlikely, the Company will consider the loan to be impaired and will estimate its probable loss, using the present value of future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. For collateral dependent loans, the Company will utilize a recent valuation of the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount. Depending on the length of time until final collection, the Company may periodically revalue the estimated loss and take additional charge-offs or specific reserves as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when the collateral is liquidated and the actual loss is confirmed. Unpaid balances on loans after or during collection and liquidation may also be pursued through legal action and attachment of wages or judgment liens on the borrower's other assets.
At December 31, 2020 and 2019, all loans were pledged under a blanket collateral lien to secure actual and potential borrowings from the Federal Home Loan Bank.
Non-accrual and Past Due Loans
The Company’s loans by delinquency and non-accrual status, as of December 31, 2020 and 2019, was as follows:
Current &
Accruing
30-59 Days
Past Due &
Accruing
60-89 Days
Past Due &
Accruing
90 Days or
more Past Due
& Accruing
Nonaccrual
Total Loans
December 31, 2020
Commercial
$
255,563
$
-
$
-
$
-
$
$
255,926
Commercial Real Estate
449,178
-
-
-
4,875
454,053
Agriculture
85,918
-
-
-
9,130
95,048
Residential Mortgage
64,344
-
-
-
64,497
Residential Construction
4,223
-
-
-
-
4,223
Consumer
18,777
-
-
-
19,467
Total
$
878,003
$
-
$
-
$
-
$
15,211
$
893,214
December 31, 2019
Commercial
$
105,741
$
-
$
$
-
$
$
106,140
Commercial Real Estate
451,215
-
-
451,774
Agriculture
115,751
-
-
-
-
115,751
Residential Mortgage
64,771
-
-
-
64,943
Residential Construction
15,212
-
-
-
-
15,212
Consumer
26,472
-
-
26,825
Total
$
779,162
$
$
$
-
$
1,157
$
780,645
Non-accrual loans amounted to $15,211 at December 31, 2020 and were comprised of four commercial loans totaling $363, three commercial real estate loans totaling $4,875, three agriculture loans totaling $9,130, one residential mortgage loan totaling $153, and five consumer loans totaling $690. Non-accrual loans amounted to $1,157 at December 31, 2019, and were comprised of three commercial loans totaling $266, two commercial real estate loans totaling $466, one residential mortgage loans totaling $172, and four consumer loan totaling $253. All non-accrual loans are measured for impairment based upon the present value of future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of collateral, if the loan is collateral dependent. If the measurement of the non-accrual loan is less than the recorded investment in the loan, an impairment is recognized through the establishment of a specific reserve sufficient to cover expected losses and/or a charge-off against the allowance for loan losses. If the loan is considered to be collateral dependent, it is generally the Company's policy to charge-off the portion of any non-accrual loan that the Company does not expect to collect by writing the loan down to the estimated net realizable value of the underlying collateral. There were no commitments to lend additional funds to borrowers whose loan was on non-accrual status at December 31, 2020 and December 31, 2019.
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. Loans to be considered for impairment include non-accrual loans, troubled debt restructurings and loans with a risk rating of 5 (special mention) or worse and an aggregate exposure of $500,000 or more. Once identified, impaired loans are measured individually for impairment using one of three methods: present value of expected cash flows discounted at the loan's effective interest rate; the loan's observable market price; or fair value of collateral if the loan is collateral dependent. In general, any portion of the recorded investment in a collateral dependent loan in excess of the fair value of the collateral that can be identified as uncollectible, and is, therefore, deemed a confirmed loss, is promptly charged-off against the allowance for loan losses.
Impaired loans, segregated by loan class, as of December 31, 2020 and 2019, were as follows:
Unpaid
Contractual
Principal
Balance
Recorded
Investment
with no
Allowance
Recorded
Investment
with
Allowance
Total
Recorded
Investment
Related
Allowance
December 31, 2020
Commercial
$
1,087
$
$
$
1,024
$
Commercial Real Estate
5,146
4,875
-
4,875
-
Agriculture
9,189
4,165
4,965
9,130
2,093
Residential Mortgage
1,046
1,036
Residential Construction
-
Consumer
Total
$
17,925
$
10,246
$
7,225
$
17,471
$
2,347
December 31, 2019
Commercial
$
1,694
$
$
1,385
$
1,651
$
Commercial Real Estate
Agriculture
-
-
-
-
-
Residential Mortgage
1,152
1,084
Residential Construction
-
Consumer
Total
$
4,625
$
1,157
$
3,318
$
4,475
$
The average recorded investment in impaired loans and the amount of interest income recognized on impaired loans during the years ended December 31, 2020, 2019, and 2018, was as follows:
December 31, 2020
December 31, 2019
December 31, 2018
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
Average
Recorded
Investment
Interest
Income
Recognized
Commercial
$
1,344
$
$
2,184
$
$
2,986
$
Commercial Real Estate
3,489
1,681
Agriculture
5,481
-
1,922
-
Residential Mortgage
1,062
1,219
1,834
Residential Construction
Consumer
Total
$
12,677
$
$
7,008
$
$
8,518
$
None of the interest on impaired loans was recognized using a cash basis of accounting for the years ended December 31, 2020, 2019, and 2018.
Troubled Debt Restructurings
The Company's loan portfolio includes certain loans that have been modified in a Troubled Debt Restructuring ("TDR"), which are loans on which concessions in terms have been granted because of the borrowers' financial difficulties and, as a result, the Company receives less than the current market-based compensation for the loan. These concessions may include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are placed on non-accrual status at the time of restructure and may be returned to accruing status after considering the borrower's sustained repayment performance for a reasonable period, generally six months.
When a loan is modified, it is measured based upon the present value of future cash flows discounted at the contractual interest rate of the original loan agreement, or the fair value of collateral less selling costs if the loan is collateral dependent. If the value of the modified loan is less than the recorded investment in the loan, impairment is recognized through a specific allowance or a charge-off of the loan.
The Company had $2,325 and $3,413 in TDR loans as of December 31, 2020 and 2019, respectively. Specific reserves for TDR loans totaled $253 and $273 as of December 31, 2020 and 2019, respectively. TDR loans performing in compliance with modified terms totaled $2,260 and $3,318 as of December 31, 2020 and 2019, respectively. There were no commitments to advance additional funds on existing TDR loans as of December 31, 2020.
On March 22, 2020, the federal bank regulatory agencies issued joint guidance advising that the agencies have confirmed with the staff of the Financial Accounting Standards Board that short-term modifications due to COVID-19, made on a good faith basis to borrowers who were current prior to relief, are not TDRs. The CARES Act also provided relief from TDR classification for certain COVID-19 loan modifications. The Bank elected not to classify modifications that meet the criteria under either the CARES Act or the criteria specified by the regulatory agencies as TDRs.
There were no loans modified as TDRs during the year ended December 31, 2020.
Loans modified as troubled debt restructurings during the years ended December 31, 2019 and 2018, were as follows:
Year Ended December 31, 2019
Number of
Contracts
Pre-modification
outstanding
recorded
investment
Post-
modification
outstanding
recorded
investment
Residential Construction
$
$
Total
$
$
Year Ended December 31, 2018
Number of
Contracts
Pre-modification
outstanding
recorded
investment
Post-
modification
outstanding
recorded
investment
Consumer
$
$
Total
$
$
Loan modifications generally involve reductions in the interest rate, payment extensions, forgiveness of principal, or forbearance. No loans were modified as a TDR within the previous 12 months that subsequently defaulted during the years ended December 31, 2020, 2019 and 2018. The Company considers a loan to be in payment default when it is 90 days or more past due.
Credit Quality Indicators
All new loans are rated using the credit risk ratings and criteria adopted by the Company. Risk ratings are adjusted as future circumstances warrant. All credits risk rated 1, 2, 3 or 4 equate to a Pass as indicated by Federal and State regulatory agencies; a 5 equates to a Special Mention; a 6 equates to Substandard; a 7 equates to Doubtful; and an 8 equates to a Loss. General definitions for each risk rating are as follows:
Risk Rating “1” - Pass (High Quality): This category is reserved for loans fully secured by Company CDs or savings accounts and properly margined (as defined in the Company’s Credit Policy) and actively traded securities (including stocks, as well as corporate, municipal and U.S. Government bonds).
Risk Rating “2” - Pass (Above Average Quality): This category is reserved for borrowers with strong balance sheets that are well structured with manageable levels of debt and good liquidity. Cash flow is sufficient to service all debt, including the Company’s, as agreed. Historical earnings, cash flow, and payment performance have all been strong and trends are positive and consistent. Collateral protection is better than the Company’s Credit Policy guidelines.
Risk Rating “3” - Pass (Average Quality): Credits within this category are considered to be of average, but acceptable, quality. Loan characteristics, including term and collateral advance rates, meet the Company’s Credit Policy guidelines; unsecured lines to borrowers with above average liquidity and cash flow may be considered for this category; the borrower’s financial strength is well documented, with adequate, but consistent, cash flow to meet all obligations. Liquidity should be sufficient and leverage should be moderate. Monitoring of collateral may be required, including a borrowing base or construction budget. Alternative financing is typically available.
Risk Rating “4” - Pass (Below Average Quality): Credits within this category are considered sound, but merit additional attention due to industry concentrations within the borrower’s customer base, problems within their industry, deteriorating financial or earnings trends, declining collateral values, increased frequency of past due payments and/or overdrafts, discovery of documentation deficiencies which may impair our borrower’s ability to repay, or the Company’s ability to liquidate collateral. Financial performance is average but inconsistent. There also may be changes of ownership, management or professional advisors, which could be detrimental to the borrower’s future performance.
Risk Rating “5” - Special Mention (Criticized): Loans in this category are currently protected by their collateral value and have no loss potential identified, but have potential weaknesses which may, if not monitored or corrected, weaken our ability to collect payments from the borrower or satisfactorily liquidate our collateral position. Loans where terms have been modified due to their failure to perform as agreed may be included in this category. Adverse trends in the borrower’s operation, such as reporting losses or inadequate cash flow, increasing and unsatisfactory leverage, or an adverse change in economic or market conditions may have weakened the borrower’s business and impaired their ability to repay based on original terms. The condition or value of the collateral has deteriorated to the point where adequate protection for our loan may be jeopardized in the future. Loans in this category are in transition and, generally, do not remain in this category beyond 12 months. During this time, efforts are focused on strategies aimed at upgrading the credit or locating alternative financing.
Risk Rating “6” - Substandard (Classified): Loans in this category are inadequately protected by the borrower’s net worth, capacity to repay or collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. There exists a strong possibility of loss if the deficiencies are not corrected. Loans that are dependent on the liquidation of collateral to repay are included in this category, as well as borrowers in bankruptcy or where legal action is required to effect collection of our debt.
Risk Rating “7” - Doubtful (Classified): Loans in this category indicate all of the weaknesses of a Substandard classification, however, collection of loan principal, in full, is highly questionable and improbable; possibility of loss is very high, but there is still a possibility that certain collection strategies may, yet, be successful, rendering a definitive loss difficult to estimate, at this time. Loans in this category are in transition and, generally, do not remain in this category more than 6 months.
Risk Rating “8” - Loss (Classified):
Active Charge-Off. Loans in this category are considered uncollectible and of such little value that their removal from the Company’s books is required. The charge-off is pending or already processed. Collateral positions have been or are in the process of being liquidated and the borrower/guarantor may or may not be cooperative in repayment of the debt. Recovery prospects are unknown at this time, but we are still actively engaged in the collection of the loan.
Inactive Charge-Off. Loans in this category are considered uncollectible and of such little value that their removal from the Company’s books is required. The charge-off is pending or already processed. Collateral positions have been liquidated and the borrower/guarantor has nothing of any value remaining to apply to the repayment of our loan. Any further collection activities would be of little value.
The following table presents the risk ratings by loan class as of December 31, 2020 and 2019.
Pass
Special
Mention
Substandard
Doubtful
Loss
Total
December 31, 2020
Commercial
$
244,327
$
10,731
$
$
-
$
-
$
255,926
Commercial Real Estate
431,381
9,255
13,417
-
-
454,053
Agriculture
83,493
-
11,555
-
-
95,048
Residential Mortgage
64,018
-
-
-
64,497
Residential Construction
4,223
-
-
-
-
4,223
Consumer
18,697
-
-
-
19,467
Total
$
846,139
$
19,986
$
27,089
$
-
$
-
$
893,214
December 31, 2019
Commercial
$
104,944
$
$
$
-
$
-
$
106,140
Commercial Real Estate
427,991
17,739
6,044
-
-
451,774
Agriculture
105,573
7,823
2,355
-
-
115,751
Residential Mortgage
64,596
-
-
-
64,943
Residential Construction
15,212
-
-
-
-
15,212
Consumer
25,933
-
-
26,825
Total
$
744,249
$
26,490
$
9,906
$
-
$
-
$
780,645
Allowance for Loan Losses
The following table details activity in the allowance for loan losses by loan category for the years ended December 31, 2020, 2019 and 2018.
Commercial
Commercial
Real Estate
Agriculture
Residential
Mortgage
Residential
Construction
Consumer
Unallocated
Total
Balance as of December 31, 2019
$
2,354
$
6,846
$
2,054
$
$
$
$
$
12,356
Provision for loan losses
(91
)
1,069
1,780
(73
)
(43
)
3,050
Charge-offs
(212
)
-
-
-
-
(15
)
-
(227
)
Recoveries
-
-
-
-
-
Net charge-offs
(11
)
-
-
-
-
-
Ending Balance
2,252
7,915
3,834
15,416
Period-end amount allocated to:
Loans individually evaluated for impairment
-
2,093
-
2,347
Loans collectively evaluated for impairment
2,241
7,915
1,741
13,069
Balance as of December 31, 2020
$
2,252
$
7,915
$
3,834
$
$
$
$
$
15,416
Commercial
Commercial
Real Estate
Agriculture
Residential
Mortgage
Residential
Construction
Consumer
Unallocated
Total
Balance as of December 31, 2018
$
3,198
$
5,890
$
1,632
$
$
$
$
$
12,822
Provision for loan losses
(415
)
(251
)
(138
)
(9
)
(663
)
-
Charge-offs
(638
)
-
(98
)
-
-
(43
)
-
(779
)
Recoveries
-
-
-
Net charge-offs
(429
)
-
(98
)
(34
)
-
(466
)
Ending Balance
2,354
6,846
2,054
12,356
Period-end amount allocated to:
Loans individually evaluated for impairment
-
-
Loans collectively evaluated for impairment
2,328
6,827
2,054
12,083
Balance as of December 31, 2019
$
2,354
$
6,846
$
2,054
$
$
$
$
$
12,356
Commercial
Commercial
Real Estate
Agriculture
Residential
Mortgage
Residential
Construction
Consumer
Unallocated
Total
Balance as of December 31, 2017
$
2,625
$
5,460
$
1,547
$
$
$
$
$
11,133
Provision for loan losses
1,036
(19
)
(173
)
(92
)
2,100
Charge-offs
(509
)
(142
)
-
-
-
(34
)
-
(685
)
Recoveries
-
-
-
Net charge-offs
(463
)
(142
)
-
-
(411
)
Ending Balance
3,198
5,890
1,632
12,822
Period-end amount allocated to:
Loans individually evaluated for impairment
-
-
Loans collectively evaluated for impairment
2,702
5,869
1,632
11,967
Balance as of December 31, 2018
$
3,198
$
5,890
$
1,632
$
$
$
$
$
12,822
The Company’s investment in loans as of December 31, 2020, 2019, and 2018 related to each balance in the allowance for loan losses by loan category and disaggregated on the basis of the Company’s impairment methodology was as follows:
Commercial
Commercial
Real Estate
Agriculture
Residential
Mortgage
Residential
Construction
Consumer
Total
December 31, 2020
Loans individually evaluated for impairment
$
1,024
$
4,875
$
9,130
$
1,036
$
$
$
17,471
Loans collectively evaluated for impairment
254,902
449,178
85,918
63,461
3,571
18,713
875,743
Ending Balance
$
255,926
$
454,053
$
95,048
$
64,497
$
4,223
$
19,467
$
893,214
December 31, 2019
Loans individually evaluated for impairment
$
1,651
$
$
-
$
1,084
$
$
$
4,475
Loans collectively evaluated for impairment
104,489
451,058
115,751
63,859
14,521
26,492
776,170
Ending Balance
$
106,140
$
451,774
$
115,751
$
64,943
$
15,212
$
26,825
$
780,645
December 31, 2018
Loans individually evaluated for impairment
$
2,902
$
$
4,830
$
1,551
$
$
$
10,874
Loans collectively evaluated for impairment
122,275
419,464
118,796
49,513
19,564
35,008
764,620
Ending Balance
$
125,177
$
420,106
$
123,626
$
51,064
$
20,124
$
35,397
$
775,494
(5) Mortgage Operations
The Company recognizes a gain or loss and a related asset for the fair value of the rights to service loans for others when loans are sold. The Company sold substantially its entire portfolio of conforming long-term residential mortgage loans originated during the year ended December 31, 2020 for cash proceeds equal to the fair value of the loans. At December 31, 2020 and 2019, the Company serviced real estate mortgage loans for others totaling $206,208 and $208,862, respectively.
The recorded value of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues. The Company assesses capitalized mortgage servicing rights for impairment based upon the fair value of those rights at each reporting date. For purposes of measuring impairment, the rights are stratified based upon the product type, term and interest rates. Fair value is determined by discounting estimated net future cash flows from mortgage servicing activities using discount rates that approximate current market rates and estimated prepayment rates, among other assumptions. The amount of impairment recognized, if any, is the amount by which the capitalized mortgage servicing rights for a stratum exceeds their fair value. Impairment, if any, is recognized through a valuation allowance for each individual stratum. Changes in the carrying amount of mortgage servicing rights are reported in earnings under other operating income on the consolidated statements of income.
The following table summarizes the activity related to the Company’s mortgage servicing rights assets for the years ended December 31, 2020, 2019 and 2018. Mortgage servicing rights are included in Interest Receivable and Other Assets on the consolidated balance sheets.
December 31,
Additions
Reductions
December 31,
Mortgage servicing rights
$
1,481
$
$
(428
)
$
1,628
Valuation allowance
-
(386
)
-
(386
)
Mortgage servicing rights, net of valuation allowance
$
1,481
$
$
(428
)
$
1,242
December 31,
Additions
Reductions
December 31,
Mortgage servicing rights
$
1,579
$
$
(296
)
$
1,481
Valuation allowance
-
-
-
-
Mortgage servicing rights, net of valuation allowance
$
1,579
$
$
(296
)
$
1,481
December 31,
Additions
Reductions
December 31,
Mortgage servicing rights
$
1,712
$
$
(274
)
$
1,579
Valuation allowance
-
-
-
-
Mortgage servicing rights, net of valuation allowance
$
1,712
$
$
(274
)
$
1,579
At December 31, 2020 and December 31, 2019, the estimated fair market value of the Company's mortgage servicing rights asset was $1,242 and $1,631, respectively. The changes in fair value of mortgage servicing rights during 2020 was primarily due to changes in prepayment speeds. The changes in fair value of mortgage servicing rights during 2019 was primarily due to changes in prepayment speeds and principal balances.
The Company received contractually specified servicing fees of $528, $523, and $549 for the years ended December 31, 2020, 2019, and 2018, respectively. Contractually specified servicing fees are included in Other Income on the consolidated statements of income.
(6) Premises and Equipment
Premises and equipment consist of the following at December 31 of the indicated years:
Land
$
2,292
$
2,292
Buildings
5,725
5,095
Furniture and equipment
12,991
12,791
Leasehold improvements
2,214
2,184
23,222
22,362
Less accumulated depreciation and amortization
16,709
15,768
$
6,513
$
6,594
Depreciation and amortization expense, included in occupancy and equipment expense, was $943, $721, and $565 for the years ended December 31, 2020, 2019, and 2018, respectively.
(7) Interest Receivable and other assets
Interest receivable and other assets consisted of the following at December 31 of the indicated years:
Interest receivable
$
5,099
$
4,295
Mortgage servicing rights asset (see Note 5)
1,242
1,481
Officer’s Life Insurance
17,185
16,725
Deferred tax assets, net (see Note 18)
2,930
3,481
Operating lease right of use asset
5,913
6,962
Prepaid and other
5,814
4,386
$
38,183
$
37,330
(8) Short-Term and Long-Term Borrowings
Short-term borrowings totaling $5,000 as of December 31, 2020, consisted of an advance with the FHLB through its COVID-19 Relief and Recovery Advances Program. The advance matures in 0.4 years and has a 0% interest rate. The advance is secured under terms of a blanket collateral agreement by a pledge of FHLB stock and certain other qualifying collateral such as commercial and mortgage loans. As of December 31, 2020, the Company had a remaining collateral borrowing capacity with the FHLB of $292,046 and, at such date, also had unsecured formal lines of credit totaling $122,000 with correspondent banks. The Company had no short-term borrowings as of December 31, 2019.
The Company had no Federal Funds purchased during the years ended December 31, 2020 and 2019.
The Company had no long-term borrowings during the years ended December 31, 2020 and 2019.
(9) Leases
The Bank leases ten branch and administrative locations under operating leases expiring on various dates through 2030. Leases with an initial term of 12 months or less are not recorded on the balance sheet and lease expense is recognized on a straight-line basis over the lease term. For lease agreements entered into or reassessed after the adoption of Topic 842, the Bank combines lease and nonlease components. The Bank had no financing leases as of December 31, 2020.
Most leases include options to renew, with renewal terms that can extend the lease term from 3 to 10 years. The exercise of lease renewal options is at the Bank’s sole discretion. Most leases are currently in the extension period. For the remaining leases with options to renew, the Bank has not included the extended lease terms in the calculation of lease liabilities as the options are not reasonably certain of being exercised. Certain lease agreements include rental payments that are adjusted periodically for inflation. The Bank's lease agreements do not contain any residual value guarantees or restrictive covenants.
The Bank uses its FHLB advance fixed rates, which are the Bank’s incremental borrowing rates for secured borrowings, as the discount rates to calculate lease liabilities.
The Company had right-of-use assets totaling $5,913 and $6,962 as of December 31, 2020 and December 31, 2019, respectively. The Company had lease liabilities totaling $6,453 and $7,483 as of December 31, 2020 and December 31, 2019, respectively. The Company recognized lease expenses totaling $1,275 and $1,049 for the years ended December 31, 2020 and December 31, 2019, respectively. Lease expenses include expenses related to short-term leases and recognition of deferred gain on sale-leaseback. Lease expense is included in Occupancy and equipment expense on the Income Statement.
The table below summarizes the maturity of remaining lease liabilities at December 31:
(in thousands)
$
1,174
1,083
2026 and thereafter
2,192
Total lease payments
7,054
Less: interest
(601
)
Present value of lease liabilities
$
6,453
The following table presents supplemental cash flow information related to leases for the year ended December 31:
(in thousands)
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases
$
1,148
$
Right-of-use assets obtained in exchange for new operating lease liabilities
$
$
7,827
The following table presents the weighted average operating lease term and discount rate at December 31:
Weighted-average remaining lease term - operating leases, in years
7.23
8.01
Weighted-average discount rate - operating leases
2.43
%
2.52
%
(10) 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 to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Financial instruments, whose contract amounts represent credit risk at December 31 of the indicated periods, were as follows:
Undisbursed loan commitments
$
189,097
$
198,534
Standby letters of credit
1,731
2,455
Commitments to sell loans
1,052
1,240
$
191,880
$
202,229
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. 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. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank issues both financial and performance standby letters of credit. The financial standby letters of credit are primarily to guarantee payment to third parties. At December 31, 2020, there were no financial standby letters of credit outstanding. The performance standby letters of credit are typically issued to municipalities as specific performance bonds. At December 31, 2020, there was $1,731 issued in performance standby letters of credit and the Bank carried no liability. The Bank has experienced no draws on these letters of credit and does not expect to in the future; however, should a triggering event occur, the Bank either has collateral in excess of the letter of credit or imbedded agreements of recourse from the customer. The Bank has set aside a reserve for unfunded commitments in the amount of $950 and $840 at December 31, 2020 and 2019, respectively, which is recorded in “interest payable and other liabilities” on the consolidated balance sheets.
Commitments to extend credit and standby letters of credit bear similar credit risk characteristics as outstanding loans. As of December 31, 2020, the Company had no off-balance sheet derivatives requiring additional disclosure.
Mortgage loans sold to investors may be sold with servicing rights retained, for which the Company makes only standard legal representations and warranties as to meeting certain underwriting and collateral documentation standards. In the past two years, the Company has not had to repurchase any loans due to deficiencies in underwriting or loan documentation. Management believes that any liabilities that may result from such recourse provisions are not significant.
(11) Commitments and Contingencies
The Company is obligated for rental payments under certain operating lease agreements, some of which contain renewal options. Total rental expense for all leases included in net occupancy and equipment expense amounted to approximately $1,275, $1,049, and $878 for the years ended December 31, 2020, 2019, and 2018, respectively. See Note 9 for a summary of future minimum payments under non-cancelable operating leases with initial or remaining terms in excess of one year.
At December 31, 2020, the aggregate maturities for time deposits were as follows:
Year ending December 31:
$
43,489
7,158
3,567
2,307
$
56,590
The Company is subject to various legal proceedings in the normal course of its business. In the opinion of management, after having consulted with legal counsel, the outcome of the pending legal proceedings should not have a material adverse effect on the consolidated financial condition or results of operations of the Company.
(12) Capital Adequacy and Restriction on Dividends
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the Company’s and the Bank's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors.
Quantitative measures established by regulation to help ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below).
In July 2013, the FRB and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the guidelines published by the Basel Committee known as the Basel III Global Regulatory Framework for Capital and Liquidity. The Basel Committee is a committee of banking supervisory authorities from major countries in the global financial system which formulates broad supervisory standards and guidelines relating to financial institutions for implementation on a country-by-country basis. These rules adopted by the FRB and the other federal banking agencies (the U.S. Basel III Capital Rules) replaced the federal banking agencies’ general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules, in accordance with certain transition provisions.
Banks, such as First Northern, became subject to the new rules on January 1, 2015. The new rules implement higher minimum capital requirements, include a new common equity Tier 1 capital requirement, and establish criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. The final rules provide for increased minimum capital ratios as follows: (a) a common equity Tier 1 capital ratio of 4.5%; (b) a Tier 1 capital ratio of 6%; (c) a total capital ratio of 8%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4%. Under these rules, in order to avoid certain limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements (equal to 2.5% of total risk-weighted assets). The capital conservation buffer is designed to absorb losses during periods of economic stress.
Pursuant to the EGRRCPA, the FRB adopted a final rule, effective August 31, 2018, amending the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (the “policy statement”) to increase the consolidated assets threshold to qualify to utilize the provisions of the policy statement from $1 billion to $3 billion. Bank holding companies, such as the Company, are subject to capital adequacy requirements of the FRB; however, bank holding companies which are subject to the policy statement are not subject to compliance with the regulatory capital requirements until they hold $3 billion or more in consolidated total assets. As a consequence, as of December 31, 2018, the Company was not required to comply with the FRB’s regulatory capital requirements until such time that its consolidated total assets equal $3 billion or more or if the FRB determines that the Company is no longer deemed to be a small bank holding company. However, if the Company had been subject to these regulatory capital requirements, it would have exceeded all regulatory requirements.
In August of 2020, the federal banking agencies adopted the final version of the community bank leverage ratio framework rule (the “CBLR”), implementing two interim final rules adopted in April of 2020. The rule provides an optional, simplified measure of capital adequacy. Under the optional CBLR framework, the CBLR will be 8.5 percent through calendar year 2021 and 9 percent thereafter. The rule is applicable to all non-advanced approaches FDIC-supervised institutions with less than $10 billion in total consolidated assets. Banks not electing the CBLR framework will continue to be subject to the generally applicable risk-based capital rule. At the present time, the Company and the Bank do not intend to elect to use the CBLR framework.
Management believes, as of December 31, 2020, that the Bank met all capital adequacy requirements to which it is subject. As of December 31, 2020, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must meet the minimum ratios as set forth below. As of the date hereof, there have been no conditions or events since that notification that management believes have changed the institution’s category.
The Bank had Tier I Leverage, Common Equity Tier 1, Tier I Risk-Based and Total Risk-Based capital above the “well capitalized” levels at December 31, 2020 and 2019, respectively, as set forth in the following table (calculated in accordance with the Basel III capital rules):
The Bank
Adequately
Capitalized
Well
Capitalized
Capital
Ratio
Capital
Ratio
Ratio
Ratio
Tier 1 Leverage Capital (to Average Assets)
$
141,569
8.4
%
$
129,237
9.9
%
4.0
%
5.0
%
Common Equity Tier 1 Capital (to Risk-Weighted Assets)
141,569
16.2
%
129,237
14.6
%
4.5
%
6.5
%
Tier 1 Capital (to Risk-Weighted Assets)
141,569
16.2
%
129,237
14.6
%
6.0
%
8.0
%
Total Risk-Based Capital (to Risk-Weighted Assets)
152,535
17.5
%
140,342
15.8
%
8.0
%
10.0
%
Cash dividends declared by the Bank are restricted under California State banking laws 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 those periods.
(13) Fair Value Measurement
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale and trading securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a non-recurring basis, such as loans held-for-sale, loans held-for-investment and certain other assets. These non-recurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally corresponds with the Company’s quarterly valuation process.
Assets Recorded at Fair Value on a Recurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis as of December 31, 2020 and 2019.
December 31, 2020
Total
Quoted Prices
in Active
Markets for
Identical
Assets (Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
U.S. Treasury securities
$
38,891
$
38,891
$
-
$
-
Securities of U.S. government agencies and corporations
106,558
-
106,558
-
Obligations of states and political subdivisions
32,882
-
32,882
-
Collateralized mortgage obligations
73,460
-
73,460
-
Mortgage-backed securities
183,289
-
183,289
-
Total investments at fair value
$
435,080
$
38,891
$
396,189
$
-
December 31, 2019
Total
Quoted Prices
in Active
Markets for
Identical
Assets (Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
U.S. Treasury securities
$
43,255
$
43,255
$
-
$
-
Securities of U.S. government agencies and corporations
53,912
-
53,912
-
Obligations of states and political subdivisions
27,031
-
27,031
-
Collateralized mortgage obligations
79,420
-
79,420
-
Mortgage-backed securities
139,279
-
139,279
-
Total investments at fair value
$
342,897
$
43,255
$
299,642
$
-
There were no transfers of assets measured at fair value on a recurring basis between level 1 and level 2 of the fair value hierarchy.
Assets Recorded at Fair Value on a Non-recurring Basis
Assets measured at fair value on a non-recurring basis are included in the table below by level within the fair value hierarchy as of December 31, 2020 and 2019.
December 31, 2020
Total
Level 1
Level 2
Level 3
Impaired loans
$
$
-
$
-
$
Mortgage servicing rights
1,242
-
-
1,242
Total assets at fair value
$
1,270
$
-
$
-
$
1,270
December 31, 2019
Total
Level 1
Level 2
Level 3
Impaired loans
$
$
-
$
-
$
Total assets at fair value
$
$
-
$
-
$
There were no liabilities measured at fair value on a recurring or non-recurring basis at December 31, 2020 and 2019.
Key methods and assumptions used in measuring the fair value of impaired loans and other real estate owned as of December 31, 2020 and 2019 were as follows:
Method
Assumption Inputs
Impaired loans
Collateral, market, income, enterprise, liquidation and discounted cash flows
External appraised values, management assumptions regarding market trends or other relevant factors, selling costs generally ranging from 6% to 10%, or the amount and timing of cash flows based on the loan's effective interest rate.
Mortgage servicing rights
Discounted cash flows
Present value of expected future cash flows was estimated using a discount rate factor of 10.00% as of December 31, 2020. A constant prepayment rate of 20.22% as of December 31, 2020 was utilized.
The following section describes the valuation methodologies used for assets recorded at fair value.
Investment Securities Available-for-Sale
Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, if available. If quoted market prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions, and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets where valuations include significant unobservable assumptions.
Impaired Loans
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, the Company measures impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. Those impaired loans not requiring charge-off or specific allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.
At December 31, 2020, certain impaired loans were considered collateral dependent and were evaluated based on the fair value of the underlying collateral securing the loan. Impaired loans where a charge-off is recorded based on the fair value of collateral require classification in the fair value hierarchy. When a loan is evaluated based on the fair value of the underlying collateral securing the loan, the Company records the impaired loan as non-recurring Level 3 given the valuation includes significant unobservable assumptions.
Mortgage Servicing Rights
Mortgage servicing rights (MSRs) are subject to impairment testing. All mortgage servicing rights are initially measured and recorded at fair value at the time loans are sold. The fair value of MSRs is determined based on the price that would be received to sell the MSRs in an orderly transaction between market participants at the measurement date. Subsequent fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of the mortgage servicing rights, the present value of expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, delinquency and foreclosure rates, and ancillary fee income. At December 31, 2020, the discount rate and constant prepayment rate used in measuring the fair value of the Company’s mortgage servicing rights was 10.00% and 20.22%, respectively.
The model used to calculate the fair value of the Company’s mortgage servicing rights is periodically validated. The model assumptions and the mortgage servicing rights fair value estimates are also compared to observable trades of similar portfolios as well as to mortgage servicing rights broker valuations and industry surveys, as available. If the valuation model reflects a value less than the carrying value, mortgage servicing rights are adjusted to fair value through a valuation allowance as determined by the model. As such, the Company classifies mortgage servicing rights subjected to non-recurring fair value adjustments as Level 3.
Disclosures about Fair Value of Financial Instruments
The following table summarizes fair value estimates for financial instruments for the years ended December 31, 2020 and 2019, excluding financial instruments recorded at fair value on a recurring basis (summarized in the first table in this note).
Level
Carrying
amount
Fair value
Carrying
amount
Fair value
Financial assets:
Cash and cash equivalents
$
267,177
$
267,177
$
111,493
$
111,493
Certificates of deposit
16,923
17,455
14,700
14,984
Other equity securities
6,480
6,480
6,574
6,574
Loans receivable:
Net loans
875,830
830,448
768,873
723,507
Loans held-for-sale
9,190
9,522
4,130
4,213
Interest receivable
5,099
5,099
4,295
4,295
Mortgage servicing rights
1,242
1,242
1,481
1,631
Financial liabilities:
Deposits
1,478,162
1,457,051
1,138,632
1,035,644
Interest payable
Limitations
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument and expected exit prices. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, 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 estimates.
Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include deferred tax liabilities and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in many of the estimates.
(14) Outstanding Shares and Earnings Per Share
All income per share amounts have been adjusted to give retroactive effect to stock dividends and stock splits, including the 5% stock dividend declared on January 27, 2021, payable on March 25, 2021, to shareholders of record as of February 26, 2021.
Earnings Per Share
Basic and diluted earnings per share for the years ended December 31 were computed as follows:
(in thousands, except per share amounts)
Basic earnings per share:
Net income
$
12,161
$
14,721
$
12,551
Weighted average common shares outstanding
13,462,764
13,414,705
13,382,484
Basic earnings per share
$
0.90
$
1.10
$
0.94
Diluted earnings per share:
Net income
$
12,161
$
14,721
$
12,551
Weighted average common shares outstanding
13,462,764
13,414,705
13,382,484
Effect of dilutive shares
120,080
164,978
185,103
Adjusted weighted average common shares outstanding
13,582,844
13,579,683
13,567,587
Diluted earnings per share
$
0.90
$
1.08
$
0.93
Options not included in the computation of diluted earnings per share because they would have had an anti-dilutive effect amounted to 424,476 shares, 237,495 shares, and 95,109 shares for the years ended December 31, 2020, 2019, and 2018, respectively. Restricted stock not included in the computation of diluted earnings per share because they would have had an anti-dilutive effect amounted to 43,859 shares, 0 shares, and 0 shares for the years ended December 31, 2020, 2019, and 2018, respectively.
(15) Stock Compensation Plans
The total number of shares authorized, number of shares outstanding, weighted average exercise prices, exercise prices and weighted average grant date fair value have been adjusted to give retroactive effect to stock dividends and stock splits, including the 5% stock dividend declared on January 27, 2021, payable on March 25, 2021 to shareholders of record as of February 26, 2021.
The Company has one stock option plan. Under the 2016 Stock Incentive Plan (the "Plan"), the Company may grant option grants, stock appreciation rights, restricted stock, or stock units to an employee for an amount up to 50,000 total shares in any calendar year. In January 2020, the Company’s Board of Directors amended the Plan to increase the maximum number of shares of options, stock appreciation rights, restricted stock, or stock units and performance based awards that any participant may receive under the Plan in any calendar year from 25,000 to 50,000. With respect to awards granted to non-employee directors under the Plan during the term of the Plan, the total number of shares of common stock which may be issued upon exercise or settlement of such awards is 100,000 shares and no outside director may receive option grants, stock appreciation rights, restricted stock or stock units for more than 3,000 shares total in any calendar year. There are 810,949 shares authorized under the 2016 Stock Incentive Plan. The 2016 Stock Incentive Plan will terminate on March 15, 2026.
The Compensation Committee of the Board of Directors is authorized to prescribe the terms and conditions of each option, including exercise price, vestings, or duration of the option. Generally, option grants vest at a rate of 25% per year after the first anniversary of the date of grant and restricted stock awards vest at a rate of 100% after four years. Options expire 10 years after the date of grant. Options are granted with an exercise price of the fair value of the related common stock on the date of grant.
Stock option activity for the Company’s Stock Incentive Plan during the year ended December 31, 2020 is as follows:
Stock Options
Number
of shares
Weighted
average
exercise price
Balance at December 31, 2019
446,642
$
7.90
Granted
186,991
10.66
Exercised
(25,971
)
4.17
Cancelled/Forfeited
-
-
Balance at December 31, 2020
607,662
$
8.91
The following table presents information on stock options for the year ended December 31, 2020:
Number of
Shares
Weighted
Average
Exercise Price
Aggregate
Intrinsic
Value
Weighted
Average
Remaining
Contractual
Term
Options exercised
25,971
$
4.17
$
-
Stock options outstanding and expected to vest:
607,662
$
8.91
$
6.72
Stock options vested and currently exercisable:
298,442
$
7.27
$
4.89
The weighted average grant date fair value per share of options granted during the years ended December 31 was $1.34 in 2020, $1.65 in 2019, and $2.14 in 2018.
The intrinsic value of options exercised during the years ended December 31 was $122 in 2020, $0 in 2019 and $81 in 2018. The fair value of awards vested during the years ended December 31 was $149 in 2020, $141 in 2019 and $114 in 2018.
At December 31, 2020, the range of exercise prices for all outstanding options ranged from $3.31 to $11.26.
As of December 31, 2020, there was $320 of total unrecognized compensation related to non-vested stock options. This cost is expected to be recognized over a weighted average period of approximately 2.4 years.
For the years ended December 31, 2020, 2019, and 2018, there was $181, $150, and $140, respectively, of recognized compensation related to stock options.
The Company determines fair value at grant date using the Black-Scholes-Merton pricing model that takes into account the stock price at the grant date, the exercise price, the risk-free interest rate, the volatility of the underlying stock and the expected life of the option.
The weighted average assumptions used in the pricing model are noted in the following table. The expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. Expected volatility is based on both the implied volatilities from the traded option on the Company’s stock and historical volatility on the Company’s stock.
The Company expenses the fair value of the option on a straight line basis over the vesting period. The Company estimates forfeitures and only recognizes expense for those shares that actually vest.
The following table shows our weighted average assumptions used in valuing stock options granted for the years ended December 31:
Risk-Free Interest Rate
1.42
%
2.47
%
2.57
%
Expected Dividend Yield
0.00
%
0.00
%
0.00
%
Expected Life in Years
5.00
5.00
5.00
Expected Price Volatility
10.18
%
11.86
%
14.44
%
In addition to stock options, the Company also grants restricted stock awards to directors, certain officers and employees. The restricted shares awarded become fully vested after one to four years of continued employment or service from the date of grant. Restricted shares are forfeited if officers and employees terminate prior to the lapsing of restrictions.
The following table presents information about non-vested restricted stock awards outstanding for the year ended December 31, 2020:
Restricted Stock Awards
Number of
shares
Weighted
average
grant date
fair value
Balance at December 31, 2019
138,244
$
9.26
Granted
43,769
10.61
Vested
(32,358
)
6.25
Cancelled/Forfeited
(901
)
10.23
Balance at December 31, 2020
148,754
$
10.30
The aggregate intrinsic value of restricted stock awards vested in calendar years 2020, 2019, and 2018, was $344, $364, and $323, respectively.
The weighted average fair value per share of restricted stock awards granted during the years ended December 31 was $10.61 in 2020, $9.87 in 2019, and $11.26 in 2018.
As of December 31, 2020, there was $709 of total unrecognized compensation related to non-vested restricted stock awards. This cost is expected to be recognized over a weighted average period of approximately 2.5 years.
For the year ended December 31, 2020, 2019, and 2018, there was $374, $308, and $262, respectively, of recognized compensation related to restricted stock awards.
Employee Stock Purchase Plan
The total number of shares authorized, number of shares purchased and stock price have been adjusted to give retroactive effect to stock dividends and stock splits, including the 5% stock dividend declared on January 27, 2021, payable March 25, 2021, to shareholders of record as of February 26, 2021.
The Company has an Employee Stock Purchase Plan ("ESPP"). Under the 2016 ESPP, the Company is authorized to issue to an eligible employee shares of common stock. There are 325,543 shares authorized under the 2016 ESPP, which include authorized but unissued shares under the 2006 Amended ESPP. The 2016 ESPP will expire on March 16, 2026.
The ESPP is implemented by participation periods of not more than twenty-seven months each. The Board of Directors determines the commencement date and duration of each participation period. An eligible employee is one who has been continually employed for at least ninety (90) days prior to commencement of a participation period. Under the terms of the Plan, employees can choose to have up to 10 percent of their compensation withheld to purchase the Company’s common stock each participation period. The purchase price of the stock is 85 percent of the lower of the fair value on the last trading day before the Date of Participation or the fair value on the last trading day during the participation period. Approximately 37 percent of eligible employees are participating in the Plan in the current participation period, which began November 24, 2020 and will end November 23, 2021.
Under the Plan, at the annual stock purchase date of November 23, 2020, there were $107 in contributions, and 13,722 shares were purchased at a price of $7.77. For the year ended December 31, 2020, 2019, and 2018, there was $19, $17, and $22, respectively, of recognized compensation related to ESPP issuances. Compensation cost is reported in salaries and employee benefits expense in the consolidated statements of income.
(16) Profit Sharing Plan
The Bank maintains a profit sharing plan for the benefit of its employees. Employees who have completed 1000 hours of service and are actively employed on the last day of the plan year are eligible. Under the terms of this plan, a portion of the Bank’s profits, as determined by the Board of Directors, will be set aside and maintained in a trust fund for the benefit of qualified employees. Contributions to the plan, included in salaries and employee benefits in the consolidated statements of income, were $1,786, $2,230 and $2,104 in 2020, 2019, and 2018, respectively. The profit sharing plan also has a 401(k) feature that allows employees to contribute to the profit sharing plan, even if they are not eligible for a contribution from the Bank. An employee is eligible to make contributions through the 401(k) feature on the 1st of the month following 90 days of employment.
(17) Supplemental Compensation Plans
EXECUTIVE SALARY CONTINUATION PLAN
Pension Benefit Plans
The Company and the Bank maintain an unfunded non-contributory defined benefit pension plan (“Salary Continuation Plan”) and related split dollar plan for a select group of highly compensated employees. The plan provides defined annual benefit levels between $50 and $125 depending on responsibilities at the Bank. The retirement benefits are paid for 10 years following retirement at age 65. Reduced retirement benefits are available after age 55 and 10 years of service.
Eligibility to participate in the Salary Continuation Plan is limited to a select group of management or highly compensated employees of the Bank that are designated by the Board.
Additionally, the Company and the Bank adopted a supplemental executive retirement plan (“SERP”) in 2006. The SERP is intended to integrate the various forms of retirement payments offered to executives. There are currently three participants in the SERP.
The SERP benefit is calculated using 3-year average salary plus 7-year average bonus (average compensation). For each year of service, the benefit formula credits 2% to 2.5% of average compensation up to a cumulative maximum of 50%. Therefore, for an executive serving 20 to 25 years, the target benefit is 50% of average compensation.
The target benefit is reduced for other forms of retirement income provided by the Bank. Reductions are made for 50% of the social security benefit expected at age 65 and for the accumulated value of contributions the Bank makes to the executive’s profit sharing plan. For purposes of this reduction, contributions to the profit sharing plan are accumulated each year at a 3-year average of the yields on 10-year Treasury securities. Retirement benefits are paid monthly for 120 months, plus 6 months for each full year of service over 10 years, up to a maximum of 180 months.
Reduced benefits are payable for retirement prior to age 65. Should retirement occur prior to age 65, the benefit determined by the formula described above is reduced 5% for each year payments commence prior to age 65. Therefore, the new SERP benefit is reduced 50% for retirement at age 55. No benefit is payable for voluntary terminations prior to age 55.
The Bank uses a December 31, measurement date for these plans.
For the Year Ended December 31,
Change in benefit obligation
Benefit obligation at beginning of year
$
5,871
$
5,322
$
5,419
Service cost
Interest cost
Plan loss (gain)
1,092
(184
)
Benefits Paid
(272
)
(272
)
(272
)
Benefit obligation at end of year
$
7,127
$
5,871
$
5,322
Change in plan assets
Employer Contribution
$
$
$
Benefits Paid
(272
)
(272
)
(272
)
Fair value of plan assets at end of year
$
-
$
-
$
-
Reconciliation of funded status
Funded status
$
(7,127
)
$
(5,871
)
$
(5,322
)
Unrecognized net plan loss
2,919
1,943
1,643
Unrecognized prior service cost
Net amount recognized
$
(4,173
)
$
(3,891
)
$
(3,640
)
Amounts recognized in the consolidated balance sheets consist of:
Accrued benefit liability
$
(7,127
)
$
(5,871
)
$
(5,322
)
Accumulated other comprehensive loss
2,954
1,980
1,682
Net amount recognized
$
(4,173
)
$
(3,891
)
$
(3,640
)
The Company expects to recognize approximately $207 of the unrecognized net actuarial loss and prior service cost as a component of net periodic benefit cost in 2021.
For the Year Ended December 31,
Components of net periodic benefit cost
Service cost
$
$
$
Interest cost
Amortization of prior service cost
Recognized actuarial loss
Net periodic benefit cost
Additional Information
Minimum benefit obligation at year end
$
7,127
$
5,871
$
5,322
Increase (decrease) in minimum liability included in other comprehensive income (loss)
$
$
$
(287
)
Assumptions used to determine benefit obligations at December 31
Discount rate used to determine net periodic benefit cost for years ended December 31
3.00
%
4.10
%
3.40
%
Discount rate used to determine benefit obligations at December 31
2.30
%
3.00
%
4.10
%
Future salary increases
6.20
%
5.70
%
5.70
%
Plan Assets
The Bank informally funds the liabilities of the Salary Continuation Plan through life insurance purchased on the lives of plan participants. This informal funding does not meet the definition of “plan assets” under pension accounting standards. Therefore, assets held for this purpose are not disclosed as part of the Salary Continuation Plan.
Cash Flows
Contributions and Estimated Benefit Payments
For unfunded plans, contributions to the Salary Continuation Plan are the benefit payments made to participants. The Bank paid $272 in benefit payments during fiscal 2021. The following benefit payments, which reflect expected future service, are expected to be paid in future fiscal years:
Year ending December 31,
Pension Benefits
$
2026-2030
1,733
Disclosure of settlements and curtailments:
There were no events during fiscal 2021 that would constitute a curtailment or settlement.
DIRECTORS’ RETIREMENT PLAN
Pension Benefit Plans
On July 19, 2001, the Company and the Bank approved an unfunded non-contributory defined benefit pension plan (“Directors’ Retirement Plan”) and related split dollar plan for the directors of the Bank. The plan provides a retirement benefit equal to $1 per year of service as a director, up to a maximum benefit amount of $15. The retirement benefit is payable for ten years following retirement at age 65. Reduced retirement benefits are available after age 55 and ten years of service.
The Bank uses a December 31 measurement date for the Directors’ Retirement Plan.
For the Year Ended December 31,
Change in benefit obligation
Benefit obligation at beginning of year
$
$
$
Service cost
-
Interest cost
Plan loss (gain)
(37
)
Benefits paid
(60
)
(60
)
(69
)
Benefit obligation at end of year
$
$
$
Change in plan assets
Employer contribution
$
$
$
Benefits paid
(60
)
(60
)
(69
)
Fair value of plan assets at end of year
$
-
$
-
$
-
Reconciliation of funded status
Funded status
$
(831
)
$
(820
)
$
(787
)
Unrecognized net plan gain
(40
)
Net amount recognized
$
(757
)
$
(798
)
$
(827
)
Amounts recognized in the statement of financial position consist of:
Accrued benefit liability
$
(831
)
$
(820
)
$
(787
)
Accumulated other comprehensive loss (income)
(40
)
Net amount recognized
$
(757
)
$
(798
)
$
(827
)
For the Year Ended December 31,
Components of net periodic benefit cost
Service cost
$
-
$
$
Interest cost
Recognized actuarial gain
-
-
-
Net periodic benefit cost
Additional Information
Minimum benefit obligation at year end
$
$
$
Increase (decrease) in minimum liability included in other comprehensive income (loss)
$
$
$
(36
)
Assumptions used to determine benefit obligations at December 31
Discount rate used to determine net periodic benefit cost for years ended December 31
2.40
%
3.70
%
3.00
%
Discount rate used to determine benefit obligations at December 31
1.30
%
2.40
%
3.70
%
Plan Assets
The Bank informally funds the liabilities of the Directors’ Retirement Plan through life insurance purchased on the lives of plan participants. This informal funding does not meet the definition of “plan assets” under pension accounting standards. Therefore, assets held for this purpose are not disclosed as part of the Directors’ Retirement Plan.
Cash Flows
Contributions and Estimated Benefit Payments
For unfunded plans, contributions to the Directors’ Retirement Plan are the benefit payments made to participants. The Bank paid $60 in benefit payments during fiscal 2021. The following benefit payments, which reflect expected future service, are expected to be paid in future fiscal years:
Year ending December 31,
Pension Benefits
$
2026-2030
Disclosure of settlements and curtailments:
There were no events during fiscal 2021 that would constitute a curtailment or settlement.
EXECUTIVE ELECTIVE DEFERRED COMPENSATION PLAN - 2001 EXECUTIVE DEFERRAL PLAN
On July 19, 2001, the Bank approved a revised Executive Elective Deferred Compensation Plan (“2001 Executive Deferral Plan”) for certain officers to provide them the ability to make elective deferrals of compensation due to tax law limitations on benefit levels under qualified plans. Deferred amounts earn interest at an annual rate determined by the Bank’s Board. The plan is a non-qualified plan funded with Bank owned life insurance policies taken on the lives of the participating officers. During the year ended December 31, 2001, the Bank purchased insurance making a single-premium payment aggregating $1,125, which is reported in other assets on the Consolidated Balance Sheets. The Bank is the beneficiary and owner of the policies. The cash surrender value of the related insurance policies as of December 31, 2020 and 2019 totaled $2,682 and $2,614, respectively. The increase in accrued liability for the 2001 Executive Deferral Plan totaled $9 and $12 during the years ended December 31, 2020 and 2019, respectively. The expenses for the 2001 Executive Deferral Plan for the years ended December 31, 2020, 2019, and 2018 totaled $9, $12, and $12, respectively.
DIRECTOR ELECTIVE DEFERRED FEE PLAN - 2001 DIRECTOR DEFERRAL PLAN
On July 19, 2001, the Bank approved a Director Elective Deferred Fee Plan (“2001 Director Deferral Plan”) for directors to provide them the ability to make elective deferrals of director's fees. Deferred amounts earn interest at an annual rate determined by the Bank’s Board. The plan is a non-qualified plan funded with Bank owned life insurance policies taken on the lives of the participating directors. The Bank is the beneficiary and owner of the policies. The cash surrender value of the related insurance policies as of December 31, 2020 and 2019 totaled $148 and $144, respectively. The increase in accrued liability for the 2001 Director Deferral Plan totaled $1 during each of the years ended December 31, 2020 and 2019. The expenses for the 2001 Director Deferral Plan totaled $1 for each of the years ended December 31, 2020, 2019, and 2018.
(18) Income Taxes
The provision for income tax expense consisted of the following for the years ended December 31:
Current:
Federal
$
3,689
$
3,056
$
3,654
State
2,241
2,164
2,300
5,930
5,220
5,954
Deferred:
Federal
(929
)
(711
)
State
(500
)
(22
)
(499
)
(1,429
)
(1,210
)
$
4,501
$
5,670
$
4,744
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2020 and 2019 consisted of:
Deferred tax assets:
Allowance for loan losses
$
4,838
$
3,901
Deferred compensation
Retirement compensation
1,456
1,378
Stock option compensation
Postretirement benefits
Current state franchise taxes
Non-accrual interest
Sale-leaseback
Lease liability
1,900
2,212
Other
Deferred tax assets
10,676
9,059
Deferred tax liabilities:
Fixed assets depreciation
1,357
1,455
FHLB dividends
Tax credit - loss on pass-through
Deferred loan costs
Mortgage servicing rights
Investment securities unrealized gain
2,903
Right of Use Asset
1,748
2,058
Other
Total deferred tax liabilities
7,746
5,578
Net deferred tax assets (see Note 7)
$
2,930
$
3,481
Based upon the level of historical taxable income and projections for future taxable income over the periods during which the deferred tax assets are deductible, management believed it is more-likely-than-not the Company will realize the benefits of these deductible differences.
At December 31, 2020, the Company had no state net operating loss carry forwards and no federal tax credit carry forwards.
A reconciliation of income taxes computed at the federal statutory rate and the provision for income taxes for the years ended December 31 is as follows:
Federal statutory income tax rate
21.0
%
21.0
%
21.0
%
Increase (decrease) in tax rate due to:
State franchise tax, net of federal benefit
8.3
%
8.3
%
8.2
%
Reduction for tax exempt interest
(1.7
)%
(1.2
)%
(0.8
)%
Cash surrender value of life insurance
(0.6
)%
(0.5
)%
(0.5
)%
Other tax credits
0.0
%
(0.1
)%
(0.5
)%
Other
0.1
%
0.3
%
0.0
%
Effective income tax rate
27.1
%
27.8
%
27.4
%
Accounting for Uncertainty in Income Taxes
The Company had no unrecognized tax benefits for the years ended December 31, 2020 and 2019. The Company recognized no changes in unrecognized tax benefits during 2020 and 2019 due to the expiration of a statute of limitations. The Company had no significant uncertain tax positions as of December 31, 2020 and December 31, 2019. The Company does not currently anticipate any significant increase or decrease in unrecognized tax benefits during 2021.
The Company classifies interest and penalties as a component of the provision for income taxes. At December 31, 2020, there were no unrecognized interest and penalties. The tax years ended December 31, 2019, 2018 and 2017 remain subject to examination by the Internal Revenue Service. The tax years ended December 31, 2019, 2018, 2017 and 2016 remain subject to examination by the California Franchise Tax Board. The deductibility of these tax positions will be determined through examination by the appropriate tax authorities or the expiration of the tax statute of limitations.
On March 27, 2020, the CARES Act was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits NOL carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allows NOLs incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. The Company has evaluated the impact of the CARES Act and determined that none of the changes would result in a material income tax benefit to the Company.
On December 27, 2020, the Consolidated Appropriations Act, 2021 was signed into law and extends several provisions of the CARES Act. As of December 31, 2020, the Company has determined that neither this Act nor changes to income tax laws or regulations in other jurisdictions have a significant impact on our effective tax rate.
(19) Accumulated Other Comprehensive Income/(Loss)
The following table details activity in accumulated other comprehensive income (loss) for the year ended December 31, 2020.
Unrealized Gains
(Losses) on
Securities
Officers’
retirement
plan
Directors’
retirement
plan
Accumulated
Other
Comprehensive
Income/(loss)
Balance as of December 31, 2019
$
1,561
$
(1,411
)
$
(16
)
$
Current period other comprehensive income (loss), net of tax
5,635
(694
)
(37
)
4,904
Balance as of December 31, 2020
$
7,196
$
(2,105
)
$
(53
)
$
5,038
The following table details activity in accumulated other comprehensive income/(loss) for the year ended December 31, 2019.
Unrealized Gains
(Losses) on
Securities
Officers’
retirement
plan
Directors’
retirement
plan
Accumulated
Other
Comprehensive
Income/(loss)
Balance as of December 31, 2018
$
(3,867
)
$
(1,198
)
$
$
(5,036
)
Current period other comprehensive income (loss), net of tax
5,428
(213
)
(45
)
5,170
Balance as of December 31, 2019
$
1,561
$
(1,411
)
$
(16
)
$
The following table details activity in accumulated other comprehensive income/(loss) for the year ended December 31, 2018.
Unrealized Gains
(Losses) on
Securities
Officers’
retirement
plan
Directors’
retirement
plan
Accumulated
Other
Comprehensive
Income/(loss)
Balance as of December 31, 2017
$
(2,997
)
$
(1,403
)
$
$
(4,397
)
Current period other comprehensive (loss) income, net of tax
(870
)
(639
)
Balance as of December 31, 2018
$
(3,867
)
$
(1,198
)
$
$
(5,036
)
(20) Supplemental Consolidated Statements of Cash Flows Information
Supplemental disclosures to the Consolidated Statements of Cash Flows for the years ended December 31, are as follows:
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest
$
1,517
$
1,841
$
1,266
Income taxes
5,400
4,560
4,105
Supplemental disclosure of non-cash investing and financing activities:
Stock dividend distributed
7,016
6,610
6,046
Fair value adjustment of securities available for sale, net of tax of $2,273, $2,188, and $(349) for the years ended December 31, 2020, 2019, and 2018, respectively
5,635
5,428
(870
)
Loans held-for-investment transferred to other real estate owned
-
-
1,092
Recognition of right-of-use assets obtained in exchange for operating lease liabilities
7,827
-
(21) Parent Company Financial Information
This information should be read in conjunction with the other notes to the consolidated financial statements. The following presents summary balance sheets and summary statements of income and cash flows information for the years ended December 31:
Balance Sheets
Assets
Cash
$
4,049
$
3,544
Investment in wholly-owned subsidiary
146,608
129,371
Total assets
$
150,657
$
132,915
Liabilities and stockholders’ equity
Liabilities
-
-
Stockholders’ equity
150,657
132,915
Total liabilities and stockholders’ equity
$
150,657
$
132,915
Statements of Income
Dividends from subsidiary
$
-
$
-
$
-
Other operating expenses
(242
)
(247
)
(226
)
Income tax benefit
Loss before undistributed earnings of subsidiary
(172
)
(174
)
(160
)
Equity in undistributed earnings of subsidiary
12,333
14,895
12,711
Net income
$
12,161
$
14,721
$
12,551
Statements of Cash Flows
Net income
$
12,161
$
14,721
$
12,551
Adjustments to reconcile net income to net cash provided by operating activities
Stock-based compensation
Equity in undistributed earnings of subsidiary
(12,333
)
(14,895
)
(12,711
)
Net cash provided by operating activities
Cash flows from financing activities:
Common stock issued
Cash in lieu of fractional shares
(8
)
(8
)
(10
)
Net cash provided by financing activities
Net change in cash
Cash at beginning of year
3,544
3,155
2,810
Cash at end of year
$
4,049
$
3,544
$
3,155
(22) Related Party Transactions
The Bank, in the ordinary course of business, has loan and deposit transactions with directors and executive officers. In management’s opinion, these transactions were on substantially the same terms as comparable transactions with other customers of the Bank. The amount of such deposits totaled approximately $7,093, $4,542 and $5,186 at December 31, 2020, 2019, and 2018, respectively.
The following is an analysis of the activity of loans to executive officers and directors for the years ended December 31:
Outstanding balance, beginning of year
$
3,113
$
1,729
$
2,472
Credit granted
1,662
2,178
1,682
Repayments / Reductions
(811
)
(794
)
(2,425
)
Outstanding balance, end of year
$
3,964
$
3,113
$
1,729

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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
None.

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ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9A - CONTROLS AND PROCEDURES
Disclosure controls and procedures
The Company maintains “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”), that are designed to ensure that information required to be disclosed in reports that the Company files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to management, including the Company’s chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. The Company’s disclosure controls and procedures have been designed to meet and management believes that they meet reasonable assurance standards. Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, the chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures were effective to ensure that material information relating to the Company, including its consolidated subsidiary, is made known to them by others within those entities.
Internal controls over financial reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. This internal control system has been designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of the Company’s published consolidated financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. As required by Rule 13a-15(d), management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of our internal control over financial reporting to determine whether any changes occurred during the period covered by this Annual Report on Form 10-K that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that there has been no such change during the last quarter of the fiscal year covered by this Annual Report on Form 10-K that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. See “Management’s Report” included in Item 8 of this Annual Report on Form 10-K for management’s report on the adequacy of internal control over financial reporting.

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

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The information called for by this item with respect to director and executive officer information is incorporated by reference herein from the sections of the Company’s proxy statement for its 2021 Annual Meeting of Shareholders entitled “Executive Officers,” “Security Ownership of Certain Beneficial Owners and Management,” “Executive Compensation” “Report of Audit Committee,” and “Nomination and Election of Directors.” Item 405 of Regulation S-K calls for disclosure of any known late filing or failure by an insider to file a report required by Section 16(a) of the Exchange Act. To the extent disclosure for delinquent reports is being made, it can be found in, and is incorporated herein by reference to, the section of the Company’s proxy statement for its 2021 Annual Meeting of Shareholders entitled “Delinquent Section 16(a) Reports”.
The Company has adopted a Code of Conduct, which complies with the Code of Ethics requirements of the Securities and Exchange Commission. A copy of the Code of Conduct is posted on the “Investor Relations” page of the Company’s website, or is available, without charge, upon the written request of any shareholder directed to Devon Camara-Soucy, Corporate Secretary, First Northern Community Bancorp, 195 North First Street, Dixon, California 95620. The Company intends to disclose promptly any amendment to, or waiver from any provision of, the Code of Conduct applicable to senior financial officers, and any waiver from any provision of the Code of Conduct applicable to directors, on the “Investor Relations” page of its website.
The Company’s website address is www.thatsmybank.com.

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ITEM 11. EXECUTIVE COMPENSATION
ITEM 11 - EXECUTIVE COMPENSATION
The information called for by this item is incorporated by reference herein from the sections of the Company’s proxy statement for its 2021 Annual Meeting of Shareholders entitled “Nomination and Election of Directors,” “Transactions with Related Persons,” “Director Compensation,” and “Executive Compensation.”

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information concerning ownership of the equity stock of the Company by certain beneficial owners and management is incorporated herein by reference from the sections of the Company’s proxy statement for the 2021 Annual Meeting of Shareholders entitled “Security Ownership of Certain Beneficial Owners and Management” and “Nomination and Election of Directors.”
Stock Purchase Equity Compensation Plan Information
The following table shows the Company’s equity compensation plans approved by security holders. The table also indicates the number of securities to be issued upon exercise of outstanding options, weighted-average exercise price of outstanding options, non-vested restricted stock and the number of securities remaining available for future issuance under the Company’s equity compensation plans as of December 31, 2020. All amounts have been adjusted to give retroactive effect to stock dividends and stock splits, including the 5% stock dividend declared on January 27, 2021, payable on March 25, 2021 to shareholders of record as of February 26, 2021. The plans included in this table are the Company’s 2006 Stock Incentive Plan and 2016 Stock Incentive Plan. See "Stock Compensation Plans" in Note 15 of Notes to Consolidated Financial Statements included in this Report.
Plan category
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
Weighted-average
exercise price of
outstanding
options, warrants
and rights
Number of
securities to be
issued upon
vesting of
restricted stock
Weighted-
average grant
date fair value
of restricted
stock
Number of securities
remaining available for future
issuance under equity
compensation plans
(excluding securities reflected
in the first column)
Equity compensation plans approved by security holders
607,662
$
8.91
148,754
$
10.30
131,196
Equity compensation plans not approved by security holders
-
-
-
-
-
Total
607,662
$
8.91
148,754
$
10.30
131,196

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information called for by this item is incorporated herein by reference from the sections of the Company’s proxy statement for its 2021 Annual Meeting of Shareholders entitled “Director Independence” and “Transactions with Related Persons.”

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information called for by this item is incorporated herein by reference from the section of the Company’s proxy statement for its 2021 Annual Meeting of Shareholders entitled “Audit and Non-Audit Fees.”
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements:
Reference is made to the Index to Financial Statements under Item 8 in Part II of this Form 10-K.
(a)(2) Financial Statement Schedules:
All schedules to the Company’s Consolidated Financial Statements are omitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated Financial Statements or accompanying notes.
(a)(3) Exhibits:
The following is a list of all exhibits filed as part of this Annual Report on Form 10-K:
Exhibit
Exhibit Number
3.1
Amended Articles of Incorporation of the Company - incorporated herein by reference to Exhibit 3.1 to the Company’s Annual Report for the year ended December 31, 2018
3.2
Amended and Restated Bylaws of the Company (as amended) - incorporated herein by reference to Exhibit 3.2 to the Company’s Annual Report for the year ended December 31, 2018
4.1
Description of the Registrant’s Common Stock - incorporated herein by reference to Exhibit 4.1 to the Company's Annual Report for the year ended December 31, 2019
10.1
First Northern Community Bancorp 2000 Stock Option Plan - incorporated herein by reference to Exhibit 4.1 of the Company’s Registration Statement on Form S-8 dated May 25, 2000*
10.2
First Northern Community Bancorp Outside Directors 2000 Non-statutory Stock Option Plan - incorporated herein by reference to Exhibit 4.3 of the Company’s Registration Statement dated Form S-8 on May 25, 2000*
10.3
Amended First Northern Community Bancorp Employee Stock Purchase Plan - incorporated herein by reference to Appendix B of the Company’s Definitive Proxy Statement on Schedule 14A for its 2006 Annual Meeting of Shareholders*
10.4
First Northern Community Bancorp 2000 Stock Option Plan Forms “Incentive Stock Option Agreement” and “Notice of Exercise of Stock Option” - incorporated herein by reference to Exhibit 4.2 of the Company’s Registration Statement on Form S-8 dated May 25, 2000*
10.5
First Northern Community Bancorp 2000 Outside Directors 2000 Non-statutory Stock Option Plan Forms “Non-statutory Stock Option Agreement” and “Notice of Exercise of Stock Option” - incorporated herein by reference to Exhibit 4.4 of the Company’s Registration Statement on Form S-8 dated May 25, 2000*
10.6
First Northern Community Bancorp 2000 Employee Stock Purchase Plan Forms “Participation Agreement” and “Notice of Withdrawal” - incorporated herein by reference to Exhibit 4.6 of the Company’s Registration Statement on Form S-8 dated May 25, 2000*
10.7
Amended and Restated Employment Agreement entered into as of July 23, 2001 by and between First Northern Bank of Dixon and Don Fish - incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001*
10.8
Employment Agreement entered into as of July 23, 2001 by and between First Northern Bank of Dixon and Owen J. Onsum - incorporated herein by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001*
10.9
Employment Agreement for Louise A. Walker, President and Chief Executive Officer - incorporated herein by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the three months ended June 30, 2012*
10.10
Employment Agreement entered into as of July 23, 2001 by and between First Northern Bank of Dixon and Robert Walker - incorporated herein by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001*
10.11
Form of Director Retirement and Split Dollar Agreements between First Northern Bank of Dixon and Lori J. Aldrete, Frank J. Andrews Jr., John M. Carbahal, Gregory DuPratt, John F. Hamel, Diane P. Hamlyn, Foy S. McNaughton, William Jones, Jr. and David Schulze - incorporated herein by reference to Exhibit 10.11 to Company’s Annual Report on Form 10-K for the year ended December 31, 2001*
10.12
Form of Salary Continuation and Split Dollar Agreement between First Northern Bank of Dixon and Owen J. Onsum, Louise A. Walker, Don Fish, and Robert Walker - incorporated herein by reference to Exhibit 10.12 to Company’s Annual Report on Form 10-K for the year ended December 31, 2001*
10.13
Amended Form of Director Retirement and Split Dollar Agreements between First Northern Bank of Dixon and Lori J. Aldrete, Frank J. Andrews Jr., John M. Carbahal, Gregory DuPratt, John F. Hamel, Diane P. Hamlyn, Foy S. McNaughton, William Jones, Jr. and David Schulze - incorporated herein by reference to Exhibit 10.13 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004*
10.14
Amended Form of Salary Continuation and Split Dollar Agreement between First Northern Bank of Dixon and Owen J. Onsum, Louise A. Walker, Don Fish, and Robert Walker - incorporated herein by reference to Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004*
10.15
Form of Salary Continuation Agreement between Pat Day and First Northern Bank of Dixon - incorporated herein by reference to Exhibit 10.15 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006*
10.16
Form of Supplemental Executive Retirement Plan Agreement between First Northern Bank of Dixon and Owen J. Onsum and Louise A. Walker - incorporated herein by reference to Exhibit 10.16 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006*
10.17
First Northern Bancorp 2006 Stock Incentive Plan - incorporated by reference to Appendix A of the Company’s Definitive Proxy Statement on Schedule 14A for its 2006 Annual Meeting of Shareholders*
10.18
First Northern Bank Annual Incentive Compensation Plan - incorporated herein by reference to Exhibit 10.18 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2006*
10.20
First Northern Community Bancorp 2006 Stock Option Plan Forms “Stock Option Agreement” and “Notice of Exercise of Stock Option” - incorporated herein by reference to Exhibit 10.20 to the Company’s Annual Report for the year ended December 31, 2009 *
10.21
First Northern Community Bancorp 2006 Stock Incentive Plan “Restricted Stock Agreement - incorporated by reference to Exhibit 10.21 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009 *
10.22
Employment Agreement for Jeremiah Z. Smith, Executive Vice President and Chief Financial Officer - incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2012*
10.23
Employment Agreement for Patrick S. Day, Executive Vice President and Chief Credit Officer - incorporated herein by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2012*
10.24
First Northern Bancorp 2016 Stock Incentive Plan - incorporated by reference to Appendix A of the Company’s Definitive Proxy Statement on Schedule 14A for its 2015 Annual Meeting of Shareholders*.
10.25
First Northern Bancorp 2016 Employee Stock Purchase Plan - incorporated by reference to Appendix B of the Company’s Definitive Proxy Statement on Schedule 14A for its 2015 Annual Meeting of Shareholders*.
10.26
Amended and Restated Executive Deferral Plan of First Northern Bank effective July 20, 2017 - incorporated herein by reference to Exhibit 10.26 of the Company’s Quarterly Report on Form 10-Q for the quarter-ended September 30, 2017*
10.27
Executive Retirement/Retention Participation Agreement for Joe Danelson, Executive Vice President and Chief Credit Officer - incorporated herein by reference to Exhibit 10.27 of the Company’s Quarterly Report on Form 10-Q for the quarter-ended September 30, 2017*
10.28
Executive Retirement/Retention Participation Agreement for Jeremiah Z. Smith, Senior Executive Vice President and Chief Financial Officer & Chief Operating Officer - incorporated herein by reference to Exhibit 10.28 of the Company’s Quarterly Report on Form 10-Q for the quarter-ended September 30, 2017*
10.29
Form of Supplemental Executive Retirement Plan Agreement between First Northern Bank of Dixon and Jeremiah Z. Smith, Senior Executive Vice President and Chief Operating Officer - incorporated herein by reference to Exhibit 10.29 of the Company’s Quarterly Report on Form 10-Q for the quarter-ended March 31, 2018*
10.30
Form of Supplemental Executive Retirement Plan Agreement between First Northern Bank of Dixon and Kevin Spink, Executive Vice President and Chief Financial Officer.- incorporated herein by reference to Exhibit 10.30 of the Company’s Quarterly Report on Form 10-Q for the quarter-ended March 31, 2018*
10.31
Change of Control Agreement between First Northern Bank of Dixon and Joe Danelson, Executive Vice President and Chief Credit Officer.- incorporated herein by reference to Exhibit 10.31 of the Company’s Quarterly Report on Form 10-Q for the quarter-ended March 31, 2018*
10.32
Change of Control Agreement between First Northern Bank of Dixon and Jeffrey Adamski, Executive Vice President and Senior Loan Officer.- incorporated herein by reference to Exhibit 10.32 of the Company’s Quarterly Report on Form 10-Q for the quarter-ended March 31, 2018*
10.33
Executive Retirement/Retention Participation Agreement for Jeffrey Adamski, Executive Vice President and Senior Loan Officer.- incorporated herein by reference to Exhibit 10.33 of the Company’s Quarterly Report on Form 10-Q for the quarter-ended March 31, 2018*
10.34
Amended Form of Salary Continuation Agreement between First Northern Bank of Dixon and Bruce Orris, Executive Vice President and Chief Information Officer.- incorporated herein by reference to Exhibit 10.34 of the Company’s Quarterly Report on Form 10-Q for the quarter-ended March 31, 2018*
10.35
Amended 2016 Stock Incentive Plan - provided herewith
Subsidiary of the Company - provided herewith
23.1
Consent of independent registered public accounting firm - provided herewith
31.1
Rule 13(a) - 14(a) / 15(d) -14(a) Certification of the Company’s Chief Executive Officer - provided herewith
31.2
Rule 13(a) - 14(a) / 15(d) -14(a) Certification of the Company’s Chief Financial Officer - provided herewith
32.1**
Section 1350 Certification of the Chief Executive Officer - provided herewith
32.2**
Section 1350 Certification of the Chief Financial Officer - provided herewith
Pursuant to Rule 405 of Regulation S-T, the following financial information from the Registrant’s Annual Report on Form 10-K for the twelve months ended December 31, 2020, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statement of Comprehensive Income; (iv) Consolidated Statements of Stockholders’ Equity; (v) Consolidated Statements of Cash Flows; and (vi) Notes to Consolidated Financial Statements.
* Management contract or compensatory plan, contract, or arrangement.
** In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 34-47986, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-K and will not be deemed “filed” for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act.