Forward-Looking Statements
Some matters discussed in this Quarterly Report on Form 10-Q may be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and therefore may involve risks, uncertainties and other factors which may cause the Company's actual results to be materially different from the results expressed or implied by the Company's forward-looking statements. These statements generally appear with words such as "anticipate," "believe," "estimate," "may," "intend," and "expect." Although management believes that the assumptions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct. Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to: the credit exposure of certain loan products and other components of our business that could be impacted by the COVID-19 pandemic and changing economic conditions; changes in monetary, fiscal or tax policy to address the continuing impact of COVID-19 and changing economic conditions including interest rate policies of the Federal Reserve Board, any of which could cause us to incur additional loan losses and adversely affect our results of operations in the future; economic conditions (both generally and in the markets where the Company operates) including unemployment levels, energy prices, inflation, supply chain issues, a decline in housing prices and the risk of a recession in the United States economy; the continuing impact of the COVID-19 pandemic and changing economic conditions on our employees and customers; the success of our efforts to mitigate the impact of the COVID-19 pandemic and changing economic conditions; competition from other providers of financial services offered by the Company; changes in government regulation and legislation; changes in interest rates and interest rate fluctuations; material unforeseen changes in the financial stability and liquidity of the Company's credit customers; risks associated with concentrations in real estate related loans; changes in accounting standards and interpretations; and other risks as may be detailed from time to time in the Company's filings with the Securities and Exchange Commission, all of which are difficult to predict and which may be beyond the control of the Company. Many of the foregoing risks and uncertainties are, and will be, exacerbated by the COVID-19 pandemic and any worsening of the global business and economic environment. The Company undertakes no obligation to revise forward-looking statements to reflect events or changes after the date of this discussion or to reflect the occurrence of unanticipated events.
Forward-looking statements speak only as of the date they are made, and the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made, whether as a result of new information, future developments or otherwise, except as may be required by law.
The following discussion explains the significant factors affecting the
Company's operations and financial position for the periods presented. The
discussion should be read in conjunction with the Company's financial statements
and the notes related thereto which appear or that are referenced to elsewhere
in this report, and with the audited consolidated financial statements and
accompanying notes included in the Company's 2021 Annual Report on Form 10-K.
Average balances, including balances used in calculating certain financial
ratios, are generally comprised of average daily balances.
The discussion and analysis of the Company's financial condition and results of
operations is based upon the Company's financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets and liabilities, revenues and expenses, and related disclosures of
contingent assets and liabilities at the date of the Company's financial
statements. Actual results may differ from these estimates under different
assumptions or conditions. This discussion and analysis includes management's
insight of the Company's financial condition and results of operations of Oak
Valley Bancorp and its subsidiary. Unless otherwise stated, the "Company" refers
to the consolidated entity, Oak Valley Bancorp, while the "Bank" refers to Oak
Valley Community Bank.
Introduction
Oak Valley Bancorp operates Oak Valley Community Bank as a community bank in the
general commercial banking business, with our primary market encompassing the
California Central Valley around Oakdale and Modesto, and the Eastern Sierras.
As such, unless otherwise noted, all references are about Oak Valley Bancorp.
Oak Valley Community Bank (the "Bank") is an insured bank under the Federal
Deposit Insurance Act and is a member of the Federal Reserve. Since its
formation, the Bank has provided basic banking services to individuals and
business enterprises in Oakdale, California and the surrounding areas. The focus
of the Bank is to offer a range of commercial banking services designed for both
individuals and small to medium-sized businesses in the Central Valley and the
Eastern Sierras.
The Bank offers a complement of business checking and savings accounts for its
business customers. The Bank also offers commercial and real estate loans, as
well as lines of credit. Real estate loans are generally of a short-term nature
for both residential and commercial purposes. Longer-term real estate loans are
generally made with adjustable interest rates and contain normal provisions for
acceleration. In addition, the Bank offers traditional residential mortgages
through a third party.
The Bank also offers other services for both individuals and businesses
including online banking, remote deposit capture, merchant services, night
depository, extended hours, traveler's checks, wire transfer of funds, note
collection, and automated teller machines in a national network. The Bank does
not currently offer international banking or trust services although the Bank
may make such services available to the Bank's customers through financial
institutions with which the Bank has correspondent banking relationships. The
Bank does not offer stock transfer services, nor does it directly issue credit
cards.
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COVID-19 Impact and Outlook
The most significant impact to date of the coronavirus ("COVID-19") pandemic on
the Company's business has been to the quality of the loan portfolio and to net
interest income as short-term interest rates sharply declined in 2020. In 2020,
the Company increased the qualitative factors used in the determination of the
adequacy of the allowance for loan and lease loss in anticipation of the impact
that COVID-19 will have on clients and their ability to fulfill their
obligations. In 2021, the financial stress subsided to some degree and credit
quality improved allowing the Company to reverse $635,000 in loan loss
provisions. The allowance for loan losses decreased to $10,997,000 and
$10,738,000 as of September 30, 2022 and December 31, 2021, respectively, as
compared with $11,297,000 as of December 31, 2020. The allowance for loan losses
as a percentage of total loans increased from 1.12% as of December 31, 2020 to
1.25% as of December 31, 2021 and to 1.21% as of September 30, 2022, as loan
loss reserves relative to gross loans remain at acceptable levels and credit
quality remains stable. The increase compared to 1.12% as of December 31, 2020
was mainly due to the loan growth during 2022 that has outpaced the provision
for loan losses which is dictated by our internal credit risk model, and the
decrease in outstanding PPP loans that do not require a loan loss reserve as
they are guaranteed by the federal government through the SBA program.
There is no certainty that the allowance for loan losses as of September 30,
2022 will be sufficient to absorb the losses that stem from the impact of
COVID-19 on the Company's clients. As the longer-term effects on clients from
the COVID-19 pandemic become more apparent, it may be necessary to charge-off
some or all of the balance on certain loans and make further provisions to
increase the allowance for loan and lease losses. These potential additional
provisions for loan and lease losses will have a direct impact upon capital,
including the potential need to reevaluate a valuation allowance on our deferred
tax asset. At this time, the Company does not expect that there would be any
material impairment to the valuation of other long-lived assets, right of use
assets, or our investment securities.
Net interest income has already been impacted by the COVID-19 since early 2020
and certain risks still exist. Interest and fees on PPP loans are only temporary
and given that $340 million of the $345 million in funded PPP loans have been
forgiven as of September 30, 2022, we have seen a decrease in PPP related net
interest income, compared to the prior year, which will continue to decrease as
loans are forgiven and paid down.
There is potential for additional negative effects to net interest income
related to the pandemic. First, interest rates declined sharply at the end of
the first quarter of 2020, causing a reduction in the yield on our earning
assets. Although yields have increased due to recent rate hikes starting in
March 2022, we would expect a reduction in interest income if rates were to
decline in an economic recession cycle. Second, if the economy worsens to the
point of another economic recession, it could reduce the demand for loans and
cause credit quality deterioration leading to more non-accrual loans, for which
interest income is not recognized. Third, an increase in demand for liquidity by
our clients could result in a decrease in deposits and force us to rely on our
lines of credit, which could potentially increase our cost of funds.
Notwithstanding the foregoing, in September 2022, the Federal Open Market
Committee ("FOMC") announced an increase in the federal funds rate target range
by 0.75%, resulting in a range of 3.00% to 3.25%, and while uncertain, it is
expected that the Federal Reserve will continue to increase interest rates in
2022 to slow the effects of economic inflation tied to the COVID-19 pandemic and
the global economic environment. The Federal Reserve's decision-making policies
for short-term interest rates will continue to impact the amount of net interest
income we earn in the future. Further, as of September 30, 2022, the Company and
the Bank's balance sheet liquidity was strong, and when combined with contingent
liquidity resources, management believes that the Bank has sufficient resources
to meet the liquidity needs of its clients.
The extent to which the COVID-19 pandemic affects the Company's future financial
results and operations will depend on future developments, which are highly
uncertain and cannot be predicted, including new information which may emerge
concerning the duration and broad impacts of the pandemic, and current or future
actions in response thereto. See "Management's Discussion and Analysis of
Financial Position and Results of Operations" and Part II, Item 1A, Risk
Factors, for an additional discussion of risks related to COVID-19.
Critical Accounting Estimates
Critical accounting estimates are those estimates made in accordance with
generally accepted accounting principles that involve a significant level of
estimation and uncertainty and have had or are reasonably likely to have a
material impact on our financial condition and results of operations. We
consider an accounting estimate to be critical to our financial results if (i)
the accounting estimate requires management to make assumptions about matters
that are highly uncertain, (ii) management could have applied different
assumptions during the reported period, and (iii) changes in the accounting
estimate are reasonably likely to occur in the future and could have a material
impact on our financial statements. Management has determined the following
accounting estimates and related policies to be critical:
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Table of Contents Goodwill Impairment The Company applies a qualitative analysis of conditions in order to determine if it is more likely than not that the carrying value is impaired. In the event that the qualitative analysis suggests that the carrying value of goodwill may be impaired, the Company uses several quantitative valuation methodologies in evaluating goodwill for impairment that includes assumptions and estimates made concerning the future earnings potential of the organization, and a market-based approach that looks at values for organizations of comparable size, structure and business model. Estimates of fair value are based on a complex model using, among other things, estimated cash flows and industry pricing multiples. The Company tests its goodwill for impairment annually as of December 31 (the Measurement Date), and quarterly if a triggering event causes concern of a possible goodwill impairment charge. At each Measurement Date, the Company, in accordance with ASC 350-20-35-3, evaluates, based on the weight of evidence, the significance of all qualitative factors to determine whether it is more likely than not that the fair value of each of the reporting units is less than its carrying amount.
The assessment of qualitative factors at the most recent Measurement Date (December 31, 2021), indicated that it was not more likely than not that impairment existed; as a result, no further testing was performed.
Allowance for Loan Losses Credit risk is inherent in the business of lending and making commercial loans. Accounting for our allowance for loan losses involves significant judgment and assumptions by management and is based on historical data and management's view of the current economic environment. At least on a quarterly basis, our management reviews the methodology and adequacy of allowance for loan losses and reports its assessment to the Board of Directors for its review and approval. The allowance for loan losses is an estimate of probable incurred losses with regard to our loans. Our loan loss provision for each period is dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loans, delinquencies, management's assessment of the quality of the loans, the valuation of problem loans and the general economic conditions in our market area. We base our allowance for loan losses on an estimation of probable losses inherent in our loan portfolio. Our methodology for assessing loan loss allowances are intended to reduce the differences between estimated and actual losses and involves a detailed analysis of our loan portfolio, in three phases:
? the specific review of individual loans,
? the segmenting and review of loan pools with similar characteristics, and
? our judgmental estimate based on various subjective factors.
The first phase of our methodology involves the specific review of individual loans to identify and measure impairment. We evaluate each loan by use of a risk rating system, except for homogeneous loans, such as automobile loans and home mortgages. Specific risk rated loans are deemed impaired if all amounts, including principal and interest, will likely not be collected in accordance with the contractual terms of the related loan agreement. Impairment for commercial and real estate loans is measured either based on the present value of the loan's expected future cash flows or, if collection on the loan is collateral dependent, the estimated fair value of the collateral, less selling and holding costs. The second phase involves the segmenting of the remainder of the risk rated loan portfolio into groups or pools of loans, together with loans with similar characteristics, for evaluation. We determine the calculated loss ratio to each loan pool based on its historical net losses and benchmark it against the levels of other peer banks. In the third phase, we consider relevant internal and external factors that may affect the collectability of loan portfolio and each group of loan pool. The factors considered are, but are not limited to: ? concentration of credits,
? nature and volume of the loan portfolio,
? delinquency trends,
? non-accrual loan trends,
? problem loan trends,
? loss and recovery trends,
? quality of loan review,
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? lending and management staff,
? lending policies and procedures,
? economic and business conditions, and
? other external factors.
Management estimates the probable effect of such conditions based on our
judgment, experience and known or anticipated trends. Such estimation may be
reflected as an additional allowance to each group of loans, if necessary.
Management reviews these conditions with our senior credit officers. To the
extent that any of these conditions is evidenced by a specifically identifiable
problem credit or portfolio segment as of the month-end evaluation date,
management's estimate of the effect of such condition may be reflected as a
specific allowance applicable to such credit or portfolio segment.
Central to our credit risk management and our assessment of appropriate loss
allowance is our loan risk rating system. Under this system, the originating
credit officer assigns borrowers an initial risk rating based on a thorough
analysis of each borrower's financial capacity in conjunction with industry and
economic trends. Approvals are made based upon the amount of inherent credit
risk specific to the transaction and are reviewed for appropriateness by senior
line and credit administration personnel. Credits are monitored by line and
credit administration personnel for deterioration in a borrower's financial
condition which may impact the ability of the borrower to perform under the
contract. Although management has allocated a portion of the allowance to
specific loans, specific loan pools, and off-balance sheet credit exposures
(which are reported separately as part of other liabilities), the adequacy of
the allowance is considered in its entirety.
It is the policy of management to maintain the allowance for loan losses at a
level adequate for risks inherent in the overall loan portfolio, however, the
loan portfolio can be adversely affected if the State of California's economic
conditions and the real estate market in our general market area deteriorate or
weaken. Additionally, further weakness of a prolonged nature in the agricultural
sector or general economy would have a negative impact on the local market. The
effect of such economic events, although uncertain and unpredictable at this
time, could result in an increase in the levels of nonperforming loans and
additional loan losses, which could adversely affect our future growth and
profitability. No assurance of the level of predicted credit losses can be given
with any certainty.
Income Taxes
Deferred income taxes are provided for the temporary differences between the
financial reporting basis and the tax basis of our assets and liabilities.
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled using the liability method.
As changes in tax laws or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.
We file income tax returns in the U.S. federal jurisdiction, and the State of
California. With few exceptions, we are no longer subject to U.S. federal, state
or local income tax examinations by tax authorities for years before 2017.
Fair Value Measurements
We use fair value measurements to record fair value adjustments to certain
assets and liabilities and to determine fair value disclosures. We base our fair
values on the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the
measurement date. Securities available for sale, derivatives, and loans held for
sale, if any, are recorded at fair value on a recurring basis. Additionally,
from time to time, we may be required to record certain assets at fair value on
a non-recurring basis, such as certain impaired loans held for investment and
securities held to maturity that are other-than-temporarily impaired. These
non-recurring fair value adjustments typically involve write-downs of individual
assets due to application of lower-of-cost or market accounting.
We have established and documented a process for determining fair value. We
maximize the use of observable inputs and minimize the use of unobservable
inputs when developing fair value measurements. Whenever there is no readily
available market data, management uses its best estimate and assumptions in
determining fair value, but these estimates involve inherent uncertainties and
the application of management's judgment. As a result, if other assumptions had
been used, our recorded earnings or disclosures could have been materially
different from those reflected in these financial statements. For detailed
information on our use of fair value measurements and our related valuation
methodologies, see Note 5 to the Consolidated Financial Statements Item 1 of
this report.
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Overview of Results of Operations and Financial Condition
The purpose of this summary is to provide an overview of the items that management focuses on when evaluating the condition of the Company and its success in implementing its business and shareholder value strategies. The Company's business strategy is to operate the Bank as a well-capitalized, profitable and independent community-oriented bank. The Company's shareholder value strategy has three major objectives: (1) enhancing shareholder value; (2) making its retail banking franchise more valuable; and (3) efficiently utilizing its capital.
Management believes the following were important factors in the Company's performance during the three- and nine-month periods ended September 30, 2022:
• The Company recognized net income of $6,800,000 and $13,427,000 for the three-
and nine-month periods ended September 30, 2022, respectively, as compared to
$4,554,000 and $12,870,000 for the same periods in 2021. The third quarter and
nine-month period net income increases were mainly due to strong growth in our
loan and investment portfolios and higher yields on earning assets.
• The Company recognized loan loss provisions of $200,000 during the three- and
nine-month periods ended September 30, 2022, as compared to no provisions
during the same periods of 2021. The $200,000 provision during 2022 was
related to loan growth and was consistent with our internal credit risk model.
• Net interest income increased $3,476,000 or 26.1% and $3,437,000 or 9.2% for
the three- and nine-month periods ended September 30, 2022, respectively,
compared to the same periods in 2021. The net interest income increase was
mainly due to growth and higher yields on earning assets.
• Non-interest income increased by 308,000 or 23.6% and $267,000 or 6.9% for the
three- and nine-months ended September 30, 2022, respectively, as compared to
the same periods in 2021. The increase was primarily due to fair value changes
on one limited partnership equity investment.
• Non-interest expense increased by $963,000 or 11.5% and $3,354,000 or 13.8%
for the three- and nine-month periods ended September 30, 2022, respectively,
as compared to the same periods in 2021. The increase in the three-month
period was primarily due to staffing increases and general operating costs
related to servicing the growing loan and deposit portfolios. In addition, the
nine-month period increase included a reduction in deferred costs associated
with funded PPP loans recorded against salary expense.
• Total assets decreased $2,008,000 or 0.1%, total net loans increased by
$52,092,000 or 6.1% and investment securities increased by $246,713,000 or
92.7% in each case from December 31, 2021 to September 30, 2022, whiledeposits increased by $23,916,000 or 1.3% for the same period. Consequently,
cash and cash equivalent balances decreased by $333,207,000 or 42.8%. The
September 30, 2022 balance sheet totals include $5.0 million in outstanding
PPP loans. Total funding since commencement of the PPP loan program in 2020
was $345 million and as of September 30, 2022, we have received $340 million
in forgiveness payments from the SBA.
Income Summary
For the three- and nine-month periods ended September 30, 2022, the Company
recorded net income of $6,800,000 and $13,427,000, respectively, representing
increases of $2,246,000 and $557,000, as compared to the same periods in 2021.
Return on average assets (annualized) was 1.35% and 0.92% for the three- and
nine-months ended September 30, 2022, respectively, as compared to 1.00% and
1.01% for the same periods in 2021. Annualized return on average common equity
was 21.96% and 13.79% for the three- and nine-months ended September 30, 2022,
respectively, as compared to 13.01% and 12.74% for the same periods in 2021. Net
income before provisions for income taxes increased by $2,621,000 and $150,000
for the three- and nine-month periods ended September 30, 2022, respectively,
from the same periods in 2021. The income statement components of these
variances are as follows:
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Pre-Tax Income Variance Summary:
Effect on Pre-Tax Effect on Pre-Tax
(In thousands) Income Income
Increase (Decrease) Increase (Decrease)
Three Months Ended Nine Months Ended
September 30, 2022 September 30, 2022
Change from 2021 to 2022 in:
Net interest income $ 3,476 $ 3,437
Provision for loan losses (200 ) (200 )
Non-interest income 308 267
Non-interest expense (963 ) (3,354 )
Change in net income before income taxes $ 2,621 $ 150
These variances will be explained in the discussion below.
Net Interest Income
Net interest income is the largest source of the Company's operating income.
For the three- and nine-month periods ended September 30, 2022, net interest
income was $16,772,000 and $40,963,000, respectively, which represents an
increase of $3,476,000 or 26.1% and $3,437,000 or 9.2%, from the comparable
periods in 2021. The increase was due to earning asset growth within our loan
and investment portfolios, as compared to the comparable 2021 periods. In
addition, the FOMC rate increases that began in March 2022 have had a positive
impact on earning asset yields. The year-to-date net interest income increase
includes a reduction in interest and fees on PPP loans from $7,472,000 during
the first nine months of 2021 to $881,000 during the same period of 2022.
The net interest margin (net interest income as a percentage of average interest
earning assets) was 3.61% and 3.05% for the three- and nine-month periods ended
September 30, 2022, respectively, as compared to 3.17% and 3.22% for the same
periods in 2021. The year-to-date decrease in net interest margin is primarily
due to the decrease in PPP loan interest and fees, and strong deposit growth
resulting in high levels of lower-yielding cash equivalent balances. The earning
asset yield increased by 45 basis points for the three-month period and
decreased by 19 basis points for the nine-month period ended September 30, 2022,
as compared to the same periods of 2021. The upward trend during the third
quarter was due to the deployment of lower yielding cash equivalent balances
into the loan and investment security portfolios and the positive impact of the
recent FOMC rate increases.
The cost of funds on interest-bearing liabilities was unchanged for the
three-month period and decreased by 2 basis points for the nine-month period of
2022, as compared to the same periods in 2021. The Company continues to
recognize strong core deposit growth as evidenced by the increase in average
non-interest-bearing demand deposit balances of $52.4 million, for the
nine-month period ended September 30, 2022, as compared to the same period of
2021. Deposit balances were bolstered by funded PPP loans during the first
quarter of 2021, as the funded amounts were credited directly to the borrowers'
deposit accounts.
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The following tables show the relative impact of changes in average balances of
interest earning assets and interest-bearing liabilities, and interest rates
earned and paid by the Company on those assets and liabilities for the three-
and nine-month periods ended September 30, 2022 and 2021:
Net Interest Analysis
Three Months Ended September 30, 2022 Three Months Ended September 30, 2021
Avg
(in thousands) Interest Avg Interest Rate/
Average Income / Rate/ Average Income / Yield
Balance Expense Yield (5) Balance Expense (5)
Assets:
Earning assets:
Gross loans (1) (2) $ 904,322 $ 9,977 4.38 % $ 908,666 $ 12,003 5.24 %
Investment securities
(2) 540,727 4,840 3.55 % 229,831 1,583 2.73 %
Federal funds sold 15,508 87 2.23 % 38,896 13 0.13 %
Interest-earning
deposits 455,055 2,832 2.47 % 521,117 205 0.16 %
Total
interest-earning
assets 1,915,612 17,736 3.67 % 1,698,510 13,804 3.22 %
Total noninterest
earning assets 78,336 114,257
Total Assets 1,993,948 1,812,767
Liabilities and Shareholders' Equity:
Interest-bearing
liabilities:
Interest-earning DDA 498,151 118 0.09 % 396,837 107 0.11 %
Money market deposits 427,792 126 0.12 % 366,955 94 0.10 %
Savings deposits 172,476 21 0.05 % 145,003 17 0.05 %
Time deposits
$250,000 and under 21,529 14 0.26 22,012 15 0.27 %
Time deposits over
$250,000 18,063 12 0.26 % 17,171 14 0.32 %
Total
interest-bearing
liabilities 1,138,011 291 0.10 % 947,978 247 0.10 %
Noninterest-bearing
liabilities:
Noninterest-bearing
deposits 708,416 709,627
Other liabilities 24,642 16,317
Total
noninterest-bearing
liabilities 733,058 725,944
Shareholders' equity 122,879 138,845
Total liabilities and
shareholders' equity $ 1,993,948 $ 1,812,767
Net interest income $ 17,445 $ 13,557
Net interest spread
(3) 3.57 % 3.12 %
Net interest margin
(4) 3.61 % 3.17 %
______________________________________
(1) Loan fees have been included in the calculation of interest income.
(2) Yields and interest income on municipal securities and loans have been adjusted to their fully-taxable equivalents, based on a federal marginal tax rate of 21.0%.
(3) Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.
(4) Represents net interest income as a percentage of average interest-earning assets.
(5) Annual interest rates are computed by dividing the interest income/expense by the number of days in the period multiplied by 365.
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Nine months ended Nine months ended
September 30, 2022 September 30, 2021
Avg Avg
(in thousands) Interest Rate/ Interest Rate/
Average Income / Yield Average Income / Yield
Balance Expense (5) Balance Expense (5)
Assets:
Earning assets:
Gross loans (1) (2) $ 879,303 $ 28,556 4.34 % $ 974,744 $ 34,095 4.68 %
Investment securities
(2) 438,703 10,681 3.26 % 220,135 4,569 2.77 %
Federal funds sold 20,035 143 0.95 % 34,562 26 0.10 %
Interest-earning
deposits 526,654 3,895 0.99 % 358,326 330 0.12 %
Total
interest-earning
assets 1,864,695 43,275 3.10 % 1,587,767 39,020 3.29 %
Total noninterest
earning assets 91,829 109,932
Total assets 1,956,524 1,697,699
Liabilities and Shareholders'
Equity:
Interest-bearing
liabilities:
Interest-earning DDA 473,748 302 0.09 % 368,429 331 0.12 %
Money market deposits 418,614 335 0.11 % 346,888 275 0.11 %
Savings deposits 167,222 61 0.05 % 137,088 50 0.05 %
Time deposits
$250,000 and under 21,750 43 0.26 % 16,967 45 0.35 %
Time deposits over
$250,000 18,250 36 0.26 % 21,878 42 0.26 %
Other Borrowings 0 0 0.00 % 0 0 0.00 %
Total
interest-bearing
liabilities 1,099,584 777 0.09 % 891,250 743 0.11 %
Noninterest-bearing
liabilities:
Noninterest-bearing
deposits 708,573 656,184
Other liabilities 18,179 15,168
Total
noninterest-bearing
liabilities 726,752 671,352
Shareholders' equity 130,188 135,097
Total liabilities and
shareholders' equity $ 1,956,524 $ 1,697,699
Net interest income $ 42,498 $ 38,277
Net interest spread
(3) 3.01 % 3.17 %
Net interest margin
(4) 3.05 % 3.22 %
______________________________________
(1) Loan fees have been included in the calculation of interest income.
(2) Yields and interest income on municipal securities and loans have been adjusted to their fully-taxable equivalents, based on a federal marginal tax rate of 21.0%.
(3) Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.
(4) Represents net interest income as a percentage of average interest-earning assets.
(5) Annual interest rates are computed by dividing the interest income/expense by the number of days in the period multiplied by 365.
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Shown in the following tables are the relative impacts on net interest income of changes in the average outstanding balances (volume) of earning assets and interest-bearing liabilities and the rates earned and paid by the Company on those assets and liabilities for the three- and nine-month periods ended September 30, 2022 and 2021. Changes in interest income and expense that are not attributable specifically to either rate or volume are allocated to the rate column below.
Rate / Volume Variance Analysis
For the Three Months Ended
September 30, 2022 Compared to September 30, 2021
Increase (Decrease)
in interest income and expense
(in thousands) due to changes in:
Volume Rate Total
Interest income:
Gross loans (1) (2) $ (57 ) $ (1,969 ) $ (2,026 )
Investment securities (2) 2,141 1,116 3,257
Federal funds sold (8 ) 82 74
Interest-earning deposits (26 ) 2,653 2,627
Total interest income $ 2,050 $ 1,882 $ 3,932
Interest expense: Interest-earning DDA 27 (16 ) 11 Money market deposits 16 16 32 Savings deposits 3 1 4 Time deposits $250,000 and under 0 (1 ) (1 ) Time deposits over $250,000 1 (3 ) (2 ) Total interest expense $ 47 $ (3 ) $ 44 Change in net interest income $ 2,003 $ 1,885 $ 3,888
__________________________________
(1) Loan fees have been included in the calculation of interest income.
(2) Interest income on municipal securities and loans has been adjusted to their fully-taxable equivalents, based on a federal marginal tax rate of 21.0%.
The table above reflects an increase of $2,003,000 in net interest income due to
changes in volume combined with the overall change in mix of balances and strong
earning asset growth during the third quarter of 2022, as compared to the same
period of 2021. Changes in earning asset yields and rates on interest-bearing
liabilities resulted in an increase of $1,885,000 to net interest income, over
the same period. This increase was mainly due to the positive impact of recent
FOMC rate increases on our earning asset yields, and investment security
purchases with yields higher than our existing portfolio.
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For the Nine Months Ended September 30,
2022 Compared to September 30, 2021
Increase (Decrease)
in interest income and expense
(in thousands) due to changes in:
Volume Rate Total
Interest income:
Gross loans (1) (2) $ (3,338 ) $ (2,201 ) $ (5,539 )
Investment securities (2) 4,536 1,576 6,112
Federal funds sold (11 ) 128 117
Interest-earning deposits 156 3,409 3,565
Total interest income $ 1,343 $ 2,912 $ 4,255
Interest expense:
Interest-earning DDA $ 95 $ (124 ) $ (29 )
Money market deposits 57 3 60
Savings deposits 11 0 11
Time deposits $250,000 and under 13 (15 ) (2 )
Time deposits over $250,000 (7 ) 1 (6 )
Total interest expense $ 169 $ (135 ) $ 34
Change in net interest income $ 1,174 $ 3,047 $ 4,221
The table above reflects an increase of $1,174,000 in net interest income due to
changes in volume combined with the overall change in mix of balances during the
first nine months of 2022 as compared to the same period of 2021. The increase
in net interest income was due to higher average balances in investment security
portfolio, which was partially offset by a decrease in PPP loan balances in 2022
compared to the same period of 2021. Changes in earning asset yields and rates
on interest-bearing liabilities resulted in an increase of $3,047,000 to net
interest income, over the same period. This increase was mainly due to the
rising yields of interest-earning deposits and investment securities, which was
offset partially by the decline in PPP loan fees.
Provision for Loan Losses
The Company makes provisions for loan losses when required to bring the total
allowance for loan and lease losses to a level deemed appropriate for the level
of risk in the loan portfolio. At least quarterly, management conducts an
assessment of the overall quality of the loan portfolio and general economic
trends in the local market. The determination of the appropriate level for the
allowance is based on that review, considering such factors as historical
experience, the volume and type of lending conducted, the amount of and
identified potential loss associated with specific non-performing loans,
regulatory policies, general economic conditions, and other factors related to
the collectability of loans in the portfolio.
The Company recorded loan loss provisions of $200,000 during the three- and
nine-months ended September 30, 2022, as compared to no provisions during the
same periods of 2021. The $200,000 recorded during the third quarter of 2022 was
consistent with the output of our internal credit risk model, and was mainly due
to loan growth throughout 2022, as credit quality remained strong with
non-accrual loans remaining at a zero balance throughout the quarter ending
September 30, 2022. Qualitative risk factor adjustments of approximately $1.6
million were made to the allowance for loan loss reserve during 2020 related to
the impact of the COVID-19 pandemic. Management reviewed the qualitative factors
within the allowance for loan loss calculation and determined that a
macro-economic adjustment was necessary to account for the potential negative
impact of the financial strain that is being experienced by certain borrowers.
Economic conditions and the financial stability of certain borrowers impacted by
the pandemic have improved since 2020, resulting in a reduction of the
qualitative risk factor adjustment to $1.1 million as of September 30, 2022.
Management will continue to closely monitor the economic impacts to our loan
portfolio and may need to make further qualitative adjustments depending on the
severity and longevity of the COVID-19 pandemic as well as other factors that
may impact the economy and the financial condition of our borrowers.
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Table of Contents Non-Interest Income Non-interest income represents service charges on deposit accounts and other non-interest related charges and fees, including fees from mortgage commissions and investment service fee income. For the three- and nine-month periods ended September 30, 2022, non-interest income was $1,611,000 and $4,150,000, respectively, representing increases of $308,000 or 23.6% and $267,000 or 6.9%, compared to the same periods in 2021.
The following tables show the major components of non-interest income:
(in thousands) For the Three Months Ended September 30,
2022 2021 $ Change % Change
Service charges on deposits $ 407 $ 320 $ 87 27.2 %
Debit card transaction fee income 441 442 (1 ) -0.2 %
Earnings on cash surrender value of life
insurance 189 183 6 3.3 %
Mortgage commissions 17 52 (35 ) -67.3 %
Gains on calls of available-for-sale
securities 0 0 0 0.0 %
Other income 557 306 251 82.0 %
Total non-interest income $ 1,611 $ 1,303 $ 308 23.6 %
(in thousands) For the Nine Months Ended September 30,
2022 2021 $Change % Change Service charges on deposits $ 1,192 $ 939 $ 253
26.9 % Debit card transaction fee income 1,303 1,250 53 4.2 % Earnings on cash surrender value of life insurance 559 531 28 5.3 % Mortgage commissions 72 136 (64 ) -47.1 % Gains on calls of available-for-sale securities 0 1 (1 ) -100.0 % Other income 1,024 1,026 (2 ) -0.2 % Total non-interest income $ 4,150 $ 3,883 $ 267 6.9 % Service charges on deposits increased by $87,000 and $253,000 for the three- and nine-months ended September 30, 2022, respectively, compared to the same periods in 2021. The increase was due to strong growth of our core customer base, which resulted in higher service fee and overdraft fee income related to servicing deposit accounts. Debit card transaction fee income decreased by $1,000 and increased by $53,000 for the three- and nine-months ended September 30, 2022, respectively, compared to the same periods in 2021. The year-to-date increase during 2022 is attributable to an increase in the number of transaction deposit accounts and shifts in business and consumer spending patterns to electronic payment methods beginning in 2020, amid the COVID-19 pandemic. Earnings on cash surrender value of life insurance increased by $6,000 and $28,000 for the three- and nine-months ended September 30, 2022, respectively, compared to the same periods in 2021, corresponding to the purchase of new life insurance policies on certain directors and officers during the second quarter of 2021, and higher yields earned in 2022.
Mortgage commissions decreased by $35,000 and $64,000 for the three- and nine-months ended September 30, 2022, respectively, as compared to the same periods of 2021, as the demand for home purchases and refinancing has decreased from last year due in part to higher interest rates.
Other income increased by $251,000 and decreased by $2,000 for the three- and
nine-month periods ended September 30, 2022, respectively, as compared to the
same periods of 2021, mainly due to a fair value gain of $274,000 on one limited
partnership equity investment that was recorded during the third quarter. The
year-to-date totals were offset by a fair value loss recorded on one equity
security.
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Table of Contents Non-Interest Expense
Non-interest expense represents salaries and benefits, occupancy expenses, professional expenses, outside services, and other miscellaneous expenses necessary to conduct business.
The following tables show the major components of non-interest expenses:
(in thousands) For the Three Months Ended September 30,
2022 2021 $ Change % Change
Salaries and employee benefits $ 5,750 $ 5,205 $ 545 10.5 %
Occupancy expenses 1,063 989 74 7.5 %
Data processing fees 590 526 64 12.2 %
Regulatory assessments (FDIC & DFPI) 219 141 78 55.3 %
Other operating expenses 1,748 1,546 202 13.1 %
Total non-interest expense $ 9,370 $ 8,407 $ 963 11.5 %
(in thousands) For the Nine Months Ended September 30,
2022 2021 $ Change % Change
Salaries and employee benefits $ 17,084 $ 15,000 $ 2,084 13.9 %
Occupancy expenses 3,089 2,940 149 5.1 %
Data processing fees 1,737 1,551 186 12.0 %
Regulatory assessments (FDIC & DFPI) 741 390 351 90.0 %
Other operating expenses 5,045 4,461 584 13.1 %
Total non-interest expense $ 27,696 $ 24,342 $ 3,354 13.8 %
Non-interest expenses increased by $963,000 or 11.5% and $3,354,000 or 13.8% for
the three- and nine-months ended September 30, 2022, respectively, as compared
to the same periods of 2021. Salaries and employee benefits increased $545,000
and $2,084,000 for the three- and nine-months ended September 30, 2022,
respectively, as compared to the same periods of 2021. The increase in the
three-month period is due to additional staffing expense required to support the
continued loan and deposit growth. Additionally, the nine-month period increase
is offset by a decrease in deferred cost adjustments on funded PPP loans that
are recorded against salary expense.
Occupancy expenses increased by $74,000 and $149,000 for the three- and nine-months ended September 30, 2022, respectively, as compared to the same periods of 2021, mainly due to rent expense and general operating costs related to branch facilities.
Data processing fees increased by $64,000 and $186,000 for the three- and
nine-month periods ended September 30, 2022, as compared to the same periods of
2021, primarily due to servicing costs on the growing number of loan and deposit
accounts.
Federal Deposit Insurance Corporation ("FDIC") and California Department of
Financial Protection and Innovation ("DFPI") regulatory assessments increased by
$78,000 and $351,000 for the three- and nine-months ended September 30, 2022,
respectively, as compared to the same periods in 2021, mainly due to substantial
increases in our deposit balances. The initial base assessment rate for
financial institutions varies based on the overall risk profile of the
institution as defined by the FDIC and the Company's risk profile has remained
at stable levels but there were modest increases in the assessment rate during
2021 and 2022 related to normal business cycles. The assessment rate remains at
a relatively low level due to our strong credit quality, earnings and risk-based
capital ratios. Management recognizes that assessments could increase further
depending on deposit growth throughout the remainder of 2022, as the FDIC
assessment rates are applied to average quarterly total liabilities as the
primary basis.
Other expense increased by $202,000 and $584,000 for the three- and nine-months
ended September 30, 2022, respectively, as compared to the same periods in 2021,
due to increases in a variety of general operating expenses, which is expected
given the expansion of the Company's business portfolios.
Management anticipates that non-interest expense will continue to increase as
the Company continues to grow. However, management remains committed to
cost-control and efficiency, and expects to keep these increases to a minimum
relative to growth.
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Income Taxes
The Company recorded provisions for income taxes of $2,013,000 and $3,790,000
for the three- and nine-month periods ended September 30, 2022, respectively,
representing an increase of $375,000 and a decrease of $407,000 compared to the
provisions recorded in the comparable periods of 2021. The effective income tax
rate on income from continuing operations was 22.8% and 22.0% for the three- and
nine-months ended September 30, 2022, respectively, compared to 26.5% and 24.6%
for the comparable periods of 2021. These provisions reflect accruals for taxes
at the applicable rates for federal income tax and California franchise tax
based upon reported pre-tax income, and adjusted for the effects of all
permanent differences between income for tax and financial reporting purposes
(such as earnings on qualified municipal securities, bank owned life insurance
and certain tax-exempt loans). The disparity between the effective tax rates for
the year-to-date period of 2022 as compared to 2021 is primarily due to tax
credits from low-income housing projects as well as tax free-income on municipal
securities and loans that comprised a larger proportion of pre-tax income in
2022 as compared to 2021.
On August 16, 2022, President Biden signed into law the Inflation Reduction Act
of 2022, which, among other things, implements a new 15% corporate alternative
minimum tax for certain large corporations, a 1% excise tax on stock buybacks,
and several tax incentives to promote clean energy and climate initiatives.
These provisions are effective beginning January 1, 2023. Based on its current
analysis of the provisions, the Company does not expect this legislation to have
a material impact on its consolidated financial statements.
Asset Quality
Non-performing assets consist of loans on non-accrual status, including loans
restructured on non-accrual status, where the terms of repayment have been
renegotiated resulting in a reduction or deferral of interest or principal,
loans 90 days or more past due and still accruing interest and other real estate
owned ("OREO").
Loans are generally placed on non-accrual status when they become 90 days past
due, unless management believes the loan is adequately collateralized and in the
process of collection. The past due loans may or may not be adequately
collateralized, but collection efforts are continuously pursued. Loans may be
restructured by management when a borrower has experienced some changes in
financial status, causing an inability to meet the original repayment terms, and
where management believes the borrower will eventually overcome those
circumstances and repay the loan in full. OREO consists of properties acquired
by foreclosure or similar means and which management intends to offer for sale.
Non-accrual loans totaled $0 as of September 30, 2022 and December 31, 2021. As
of September 30, 2022 there was one consumer loan totaling $20,000 classified as
a troubled debt restructuring that was modified by extending the term during the
first quarter of 2022. As of December 31, 2021, the Company did not have any
loans classified as troubled debt restructurings.
OREO as December 31, 2021 consisted of one property, a residential land property
acquired through foreclosure that was written down to a zero balance because the
public utilities have not been obtainable, therefore, rendering these land lots
unmarketable at this time. During the second quarter of 2022, that property was
sold for the amount of property taxes owed to the county, therefore, we received
no sales proceeds on the sale. Except for this transaction, there were no sales,
acquisitions or fair value adjustments of OREO properties during the nine-months
ended September 30, 2022 and 2021.
The following table presents information about the Bank's non-performing assets,
including asset quality ratios as of September 30, 2022 and December 31, 2021:
Non-Performing Assets
(in thousands) September 30, December 31,
2022 2021
Loans in non-accrual status $ 0 $ 0
Loans past due 90 days or more and accruing 0 0
Total non-performing loans 0 0
Other real estate owned 0 0
Total non-performing assets $ 0 $ 0
Allowance for loan losses $ 10,997 $ 10,738
Asset quality ratios:
Non-performing assets to total assets 0.00 % 0.00 %
Non-performing loans to total loans 0.00 % 0.00 %
Allowance for loan losses to total loans 1.21 % 1.25 %
Allowance for loan losses to total non-performing loans NA NA
Non-performing assets remained at $0 as of September 30, 2022 and December 31, 2021, due to strong credit quality within our loan portfolio.
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Allowance for Loan and Lease Losses
Due to credit risk inherent in the lending business, the Company routinely sets aside allowances through charges to earnings. Such charges are not only made for the outstanding loan portfolio, but also for off-balance sheet items, such as commitments to extend credits or letters of credit. Charges for the outstanding loan portfolio have been credited to the allowance for loan losses, whereas charges for off-balance sheet items have been credited to the reserve for off-balance sheet items, which is presented as a component of other liabilities. The Company recorded loan loss provisions of $200,000 during the three- and nine-months ended September 30, 2022, as compared to no provisions recorded during the same periods of 2021. Provisions of approximately $1.6 million were made in 2020 to adjust for the impact of the COVID-19 pandemic. Management reviewed the qualitative factors within the allowance for loan loss calculation and determined that a macro-economic adjustment was necessary to account for the potential negative impact of the financial strain that is being experienced by certain borrowers. Economic conditions and the financial stability of certain borrowers impacted by the pandemic have improved since 2020, resulting in a reduction of the qualitative risk factor adjustment to $1.1 million as of September 30, 2022. Management will continue to closely monitor the economic impacts to our loan portfolio and may need to make further qualitative adjustments depending on the severity and longevity of the COVID-19 pandemic. The allowance for loan losses increased by $259,000 to $10,997,000 as of September 30, 2022, as compared to $10,738,000 as of December 31, 2021, due to the $200,000 loan loss provisions and net loan recoveries of $59,000 during the first nine months of 2022. These factors combined with the increase in the gross loan balance resulted in a decrease in the allowance for loan losses as a percentage of total loans to 1.21% as of September 30, 2022 from 1.25% as of December 31, 2021. PPP loan balances, which do not require a loan loss reserve as they are guaranteed by the federal government through the SBA program, have had an impact on the loan loss reserve percentage, as the balances have been paid down to $5.0 million outstanding as of September 30, 2022.
The Company will continue to monitor the adequacy of the allowance for loan losses and make additions to the allowance in accordance with the analysis referred to above. Because of uncertainties inherent in estimating the appropriate level of the allowance for loan losses, actual results may differ from management's estimate of credit losses and the related allowance.
The Company makes provisions for loan losses when required to bring the total
allowance for loan and lease losses to a level deemed appropriate for the level
of risk in the loan portfolio. At least quarterly, management conducts an
assessment of the overall quality of the loan portfolio and general economic
trends in the local market. The determination of the appropriate level for the
allowance is based on that review, considering such factors as historical
experience, the volume and type of lending conducted, the amount of and
identified potential loss associated with specific non-performing loans,
regulatory policies, general economic conditions, and other factors related to
the collectability of loans in the portfolio.
Although management believes the allowance as of September 30, 2022 was adequate
to absorb probable losses from any known and inherent risks in the portfolio, no
assurance can be given that the adverse effect of current and future economic
conditions on the Company's service areas, or other variables, will not result
in increased losses in the loan portfolio in the future.
Investment Activities
Investments are a key source of interest income. Management of the investment
portfolio is set in accordance with strategies developed and overseen by the
Company's Investment Committee. Investment balances, including cash equivalents
and interest-bearing deposits in other financial institutions, are subject to
change over time based on the Company's asset/liability funding needs and
interest rate risk management objectives. The Company's liquidity levels take
into consideration anticipated future cash flows and all available sources of
credits, and are maintained at levels management believes are appropriate to
assure future flexibility in meeting anticipated funding needs.
Cash Equivalents
The Company holds federal funds sold, unpledged available-for-sale securities
and salable government guaranteed loans to help meet liquidity requirements and
provide temporary holdings until the funds can be otherwise deployed or
invested. As of September 30, 2022, and December 31, 2021, the Company had
$445,060,000 and $778,267,000, respectively, in cash and cash equivalents.
Investment Securities
Management of the investment securities portfolio focuses on providing an
adequate level of liquidity and establishing an interest rate-sensitive
position, while earning an adequate level of investment income without taking
undue risk. Investment securities that the Company intends to hold until
maturity are classified as held-to-maturity securities, and all other investment
securities are classified as available-for-sale or equity securities.
Currently, all of the investment securities are classified as available-for-sale
except for one mutual fund classified as an equity security with a carrying
value of $2,948,000 as of September 30, 2022. The carrying values of
available-for-sale investment securities are adjusted for unrealized gains or
losses as a valuation allowance and any gain or loss is reported on an after-tax
basis as a component of other comprehensive income. The carrying values of
equity securities are adjusted for unrealized gains or losses through
noninterest income in the consolidated statement of income.
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Management has evaluated the investment securities portfolio to determine if the
impairment of any security in an unrealized loss position is temporary or other
than temporary. The Company conducts a periodic review and evaluation of the
securities portfolio to determine if the value of any security has declined
below its carrying value. If such decline is determined to be other than
temporary, the Company would adjust the carrying amount of the security by
writing down the security to fair value through a charge to current period
income or a charge to accumulated other comprehensive income depending on the
nature of the impairment and managements intent or requirement to sell the
security. Management has determined that no investment security is other than
temporarily impaired. The unrealized losses are due primarily to interest rate
changes.
Deposits
Total deposits as of September 30, 2022 were $1,830,882,000, a $23,916,000 or
1.3% increase from the deposit total of $1,806,966,000 as of December 31, 2021.
Average deposits increased by $260,723,000 to $1,808,157,000 for the nine-month
period ended September 30, 2022 as compared to the same period in 2021.
Management believes the Company attracted deposits due to the safety and
soundness of the Bank and our focus on customer service.
Deposits Outstanding
September 30, December 31, Nine Month Change
(in thousands) 2022 2021 $ %
Demand $ 1,205,671 $ 1,210,153 $ (4,482 ) (0.4 %)
MMDA 415,672 401,072 14,600 3.6 %
Savings 170,894 155,231 15,663 10.1 %
Time < $250K 21,318 21,948 (630 ) (2.9 %)
Time >$250K 17,327 18,562 (1,235 ) (6.7 %)
$ 1,830,882 $ 1,806,966 $ 23,916 1.3 %
Because the Company's client base is comprised primarily of commercial and
industrial accounts, individual account balances are generally higher than those
of consumer-oriented banks. Five clients carry deposit balances of more than 1%
of total deposits, but none had a deposit balance of more than 3% of total
deposits as of September 30, 2022. Management believes that the Company's
funding concentration risk is not significant and is mitigated by the ample
sources of funds the Bank has access to.
Since the deposit growth strategy emphasizes core deposit growth, the Company
has avoided relying on brokered deposits as a consistent source of funds. The
Company had no brokered deposits as of September 30, 2022 and December 31, 2021.
Borrowings
Although deposits are the primary source of funds for lending and investment
activities and for general business purposes, the Company may obtain advances
from the Federal Home Loan Bank ("FHLB") as an alternative to retail deposit
funds. As of September 30, 2022 and December 31, 2021, there were no outstanding
FHLB advances or borrowings of any kind, as the Company continues to rely on
deposit growth as its primary source of funding. See "Liquidity Management"
below for the details on the FHLB borrowings program.
Capital Ratios
The Company is regulated by the Federal Reserve Bank ("FRB") and is subject to
the securities registration and public reporting regulations of the Securities
and Exchange Commission. As a California state-chartered bank, the Company's
banking subsidiary is subject to primary supervision, examination and regulation
by the DFPI and the Federal Reserve Board. The Federal Reserve Board is the
primary federal regulator of state member banks. The Bank is also subject to
regulation by the FDIC, which insures the Bank's deposits as permitted by law.
Management is not aware of any recommendations of regulatory authorities or
otherwise which, if they were to be implemented, would have a material effect on
the Company's or Bank's liquidity, capital resources, or operations.
The U.S. Basel III rules contain capital standards regarding the composition of
capital, minimum capital ratios and counter-party credit risk capital
requirements. The Basel III rules also include a definition of common equity
Tier 1 capital and require that certain levels of such common equity Tier 1
capital be maintained. The rules also include a capital conservation buffer,
which imposes a common equity requirement above the new minimum that can be
depleted under stress and could result in restrictions on capital distributions
and discretionary bonuses under certain circumstances, as well as a new
standardized approach for calculating risk-weighted assets. Under the Basel III
rules, we must maintain a ratio of common equity Tier 1 capital to risk-weighted
assets of at least 4.5%, a ratio of Tier 1 capital to risk-weighted assets of at
least 6%, a ratio of total capital to risk-weighted assets of at least 8% and a
minimum Tier 1 leverage ratio of 4.0%. In addition to the preceding
requirements, all financial institutions subject to the Rules, including both
the Company and the Bank, are required to establish a "conservation buffer,"
consisting of common equity Tier 1 capital, which is at least 2.5% above each of
the preceding common equity Tier 1 capital ratio, the Tier 1 risk-based ratio
and the total risk-based ratio. An institution that does not meet the
conservation buffer will be subject to restrictions on certain activities
including payment of dividends, stock repurchases and discretionary bonuses to
executive officers.
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Failure to meet minimum capital requirements can trigger regulatory actions that could have a material adverse effect on the Company's financial statements and operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that rely on quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's and Bank's amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The following tables present a comparison of our actual capital ratios to the minimum required ratios as of the dates indicated:
(in thousands) Regulatory
Actual Minimum
Capital ratios for Bank: Amount Ratio Amount Ratio
As of September 30, 2022
Total capital (to Risk- Weighted
Assets) $ 155,457 11.8 % $ 138,040 >10.5%
Tier I capital (to Risk- Weighted
Assets) $ 143,935 11.0 % $ 111,747 >8.5%
Common Equity Tier 1 Capital (to Risk
Weighted Assets) $ 143,935 11.0 % $ 92,027 >7.0%
Tier I capital (to Average Assets) $ 143,935 7.1 % $ 80,830 >4.0%
As of December 31, 2021 Total capital (to Risk- Weighted Assets) $ 143,871 13.6 % $ 110,780 >10.5% Tier I capital (to Risk- Weighted Assets) $ 132,664 12.6 % $ 89,679 >8.5% Common Equity Tier 1 Capital (to Risk Weighted Assets) $ 132,664 12.6 % $ 73,853 >7.0% Tier I capital (to Average Assets) $ 132,664 7.00 % $
76,310 >4.0%
Capital ratios for the Company:
As of September 30, 2022 Total capital (to Risk- Weighted Assets) $ 155,673 11.8 % $ 138,049 >10.5% Tier I capital (to Risk- Weighted Assets) $ 144,151 11.0 % $ 111,754 >8.5% Common Equity Tier 1 Capital (to Risk Weighted Assets) $ 144,151 11.0 % $ 92,033 >7.0% Tier I capital (to Average Assets) $ 144,151 7.1 % $
80,832 >4.0%
As of December 31, 2021
Total capital (to Risk- Weighted
Assets) $ 143,984 13.7 % $ 110,784 >10.5%
Tier I capital (to Risk- Weighted
Assets) $ 132,777 12.6 % $ 89,683 >8.5%
Common Equity Tier 1 Capital (to Risk
Weighted Assets) $ 132,777 12.6 % $ 73,856 >7.0%
Tier I capital (to Average Assets) $ 132,777 7.0 % $ 76,313 >4.0%
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Table of Contents
Liquidity and Capital Resources
Material Cash Commitments
The following tables summarizes short- and long-term material cash requirements
as of September 30, 2022, which we believe that we will be able to fund these
obligations through cash generated from our operations and available alternative
sources of funds (dollars in thousands):
Less than 1 More than 1
year year Total
Operating lease obligations $ 1,203 $ 5,191 $ 6,394 Supplemental retirement plans
122 5,234 5,356 Time deposit maturities 27,891 10,754 38,645 Total $ 29,216 $ 21,179 $ 50,395 Since the Company is a holding company and does not conduct regular banking operations, its primary sources of liquidity are dividends from the Bank. Under the California Financial Code, payment of a dividend from the Bank to the Company is restricted to the lesser of the Bank's retained earnings or the amount of the Bank's undistributed net profits from the previous three fiscal years. The primary uses of funds for the Company are stockholder dividends, investment in the Bank and ordinary operating expenses. Management anticipates that there will be sufficient earnings at the Bank level to provide dividends to the Company to meet its funding requirements for the next twelve months. Maintenance of adequate liquidity requires that sufficient resources be available at all times to meet the Company's cash flow requirements. Liquidity in a banking institution is required primarily to provide for deposit withdrawals and the credit needs of its customers and to take advantage of investment opportunities as they arise. Liquidity management involves the ability to convert assets into cash or cash equivalents without incurring significant loss, and to raise cash or maintain funds without incurring excessive additional cost. For this purpose, the Company maintains a portion of funds in cash and cash equivalents, salable government guaranteed loans and securities available for sale. The Company obtains funds from the repayment and maturity of loans as well as deposit inflows, investment security maturities and paydowns, Federal funds purchased, FHLB advances, and other borrowings. The Company's primary use of funds are the origination of loans, the purchase of investment securities, withdrawals of deposits, maturity of certificate of deposits, repayment of borrowings and dividends to common stockholders. The Company's liquid assets as of September 30, 2022 were $744.0 million compared to $858.2 million as of December 31, 2021. The Company's liquidity level measured as the percentage of liquid assets to total assets was 37.9% as of September 30, 2022, compared to 43.7% as of December 31, 2021. Liquid assets decreased during the first nine months of 2022, mainly due to strong growth in the loan and investment portfolios, resulting in lower levels of cash. Management anticipates that cash and cash equivalents on hand and other sources of funds will provide adequate liquidity for operating, investing and financing needs and regulatory liquidity requirements for at least the next twelve months. Management monitors the Company's liquidity position daily, balancing loan funding/payments with changes in deposit activity and overnight investments. As a secondary source of liquidity, the Company relies on advances from the FHLB to supplement the supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB are typically secured by a portion of the loan portfolio. The FHLB determines limitations on the amount of advances by assigning a percentage to each eligible loan category that will count towards the borrowing capacity. As of September 30, 2022, the Company's borrowing capacity from the FHLB was approximately $325 million and there were no outstanding advances. The Company also maintains 2 lines of credit with correspondent banks to purchase up to $70 million in federal funds, for which there were no advances as of September 30, 2022.
During the period of uncertainty and volatility related to the COVID-19 pandemic, we will continue to monitor our liquidity.
Off-Balance Sheet Arrangements
During the ordinary course of business, the Company provides various forms of
credit lines to meet the financing needs of customers. These commitments, which
represent a credit risk to us, are not represented in any form on the balance
sheets.
As of September 30, 2022 and December 31, 2021, the Company had commitments to
extend credit of $203.5 million and $181.1 million, respectively, which includes
obligations under letters of credit of $3.2 million and $3.3 million,
respectively.
The effect on the Company's revenues, expenses, cash flows and liquidity from
the unused portion of the commitments to provide credit cannot be reasonably
predicted because there is no guarantee that the lines of credit will be used.
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