What changed in this filing

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Item 7. Management’s Discussion and Analysis

2022-03-10 compared with 2021-03-12 · 372 added, 372 removed, 572 unchanged (57% of the section changed)

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This discussion presents Management’s analysis of the Company’s financial condition as of December 31, 2021 and 2020, and the results of operations for each year in the three-year period ended December 31, 2021.

The discussion should be read in conjunction with the Company’s consolidated financial statements and the notes related thereto presented elsewhere in this Form 10-K Annual Report (see Item 8 below).

The discussion is best read in conjunction with the Company’s consolidated financial statements and the notes related thereto presented elsewhere in this Form 10-K Annual Report (see Item 8 below).

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATMENTS

Statements contained in this report or incorporated by reference that are not purely historical are forward looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended, including the Company’s expectations, intentions, beliefs, or strategies regarding the future.

All forward-looking statements concerning economic conditions, growth rates, income, expenses, or other values which are included in this document are based on information available to the Company on the date noted, and the Company assumes no obligation to update any such forward-looking statements.

It is important to note that the Company’s actual results could materially differ from those in such forward-looking statements.

Risk factors that could cause actual results to differ materially from those in forward-looking statements include but are not limited to those outlined previously in Item 1A.

Critical Accounting Policies

These forward-looking statements include, but are not limited to, statements about the Company’s plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “should”, “projects”, “seeks”, “estimates”, or the negative version of those words or other comparable words or phrases of a future or forward-looking nature.

It is important to note that the Company’s actual results could materially differ from those in such forward-looking statements and you should not place undue reliance on these forward-looking statements.

Risk factors and the Company’s ability to manage that risk could cause actual results to differ materially from those in forward-looking statements include but are not limited to those outlined previously in Item 1A.

Critical Accounting Estimates

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States.

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Actual results may differ from those estimates under divergent conditions.

Critical accounting policies are those that involve the most complex and subjective decisions and assessments and have the greatest potential impact on the Company’s stated results of operations.

In Management’s opinion, the Company’s critical accounting policies deal with the following areas:

Critical accounting estimates are those that involve the most complex and subjective decisions and assessments and have the greatest potential impact on the Company’s stated results of operations.

In Management’s opinion, the Company’s critical accounting estimates deal primarily with the following areas:

the establishment of an allowance for loan and lease losses, as explained in detail in Note 2 to the consolidated financial statements and in the “Provision for Loan and Lease Losses” and “Allowance for Loan and Lease Losses” sections of this discussion and analysis;

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Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate the most recent expectations with regard to those areas.

The following table presents selected historical financial information concerning the Company, which should be read in conjunction with our audited consolidated financial statements, including the related notes, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein.

Selected Financial Data

(dollars in thousands, except per share data)

As of and for the years ended December 31,

Operating Data

Provision for income taxes

Selected Balance Sheet Summary

Total loans and leases, net

Total deposits

Total liabilities

Total shareholders' equity

Net loans to total deposits

Per Share Data

Net income per basic share

Net income per diluted share

Cash dividends

Weighted average common shares outstanding basic

Weighted average common shares outstanding diluted

Key Operating Ratios:

Performance Ratios:

Return on average equity

Return on average assets

Average equity to average assets ratio

Net interest margin (tax-equivalent)

Efficiency ratio (tax-equivalent)

Asset Quality Ratios:

Non-performing loans to total loans (2)

Non-performing assets to total loans and other real estate owned (2)

Net (recoveries) charge-offs to average loans

Allowance for loan and lease losses to total loans at period end

Allowance for loan and lease losses to nonaccrual loans

Regulatory Capital Ratios:

Tier 1 capital to adjusted average assets (leverage ratio)

(1) Asset quality ratios are end of period ratios.

Performance ratios are based on average daily balances during the periods indicated.

(2) Performing TDR’s are not included in nonperforming loans and are therefore not included in the numerators used to calculate these ratios.

(3) For definitions and further information relating to regulatory capital requirements, see “Item 1, Business - Supervision and Regulation - Capital Adequacy Requirements” herein.

Overview of the Results of Operations and Financial Condition

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The Company’s return on average assets and return on average equity were 1.29% and 12.05%, respectively, in 2021, as compared to 1.22% and 10.80%, respectively, in 2020 and 1.40% and 12.23%, respectively, for 2019.

Our financial results have been stable over the past year despite a higher level of loan and lease loss provisioning and elevated noninterest expenses, due to a higher volume of loans, and a strong base of core deposits, combined with a higher level of nonrecurring items, as discussed in greater detail in the applicable sections below.

Furthermore, the Company’s financial performance was favorably affected by a substantially lower corporate income tax rate starting in 2018.

Our financial results reached record levels over the past year due to a lower level of loan and lease loss provisioning, higher average volume of loans, and a strong base of lower cost core deposits, and a higher level of noninterest income, as discussed in greater detail in the applicable sections below.

The following is a summary of the major factors that impacted the Company’s results of operations for the years presented in the consolidated financial statements.

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The increase in average earning

assets in 2020 over 2019 was due primarily to a $170.2 million increase in average balance of real estate loans, a $62.2 million increase in average balances of commercial loans, and a $87.1 million increase in average balances of mortgage warehouse loans, partially offset by decreases in other loan categories.

assets in 2021 over 2020 was due primarily to a $207.7 million increase in average balance of real estate loans, partially offset by decreases in all of the other loan categories.

We experienced a $73.3 million decline in average mortgage warehouse line utilization, and a $26.0 million decline in commercial loans mostly due to the forgiveness of SBA PPP loans.

The increase in real estate loans was primarily driven by the purchase of $208.0 million in 1-4 family residential real estate loans during the second half of 2021.

These loan purchases were designed as a bridge to organic loan growth as the Company recruits new lending teams across the footprint.

The positive impact of average asset growth in 2021 was augmented by a 10 bps decrease in yield on interest bearing liabilities.

These two favorable impacts on margin were partially offset by a 46 basis point decline in yield on interest earning assets.

The net interest margin in 2021 was 39 bps lower than 2020.

The increase in average earning assets in 2020 over 2019 was due primarily to a $170.2 million increase in average balance of real estate loans, a $62.2 million increase in average balances of commercial loans, and a $87.1 million increase in average balances of mortgage warehouse loans, partially offset by decreases in other loan categories.

The increase in real estate loans was organic, driven by concerted business development efforts by our loan production offices in 2020.

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The net interest margin in 2020 was 24 bps lower than 2019.

The increase in average earning assets in 2019 over 2018 was due primarily to a $90.0 million increase in average balance of real estate loans and a $48.1 million increase in average balances of mortgage warehouse loans, partially offset by decreases in other loan categories.

The increase in real estate loans was driven primarily by organic growth in late 2018 and early 2019 but were offset by paydowns in the second half of 2019.

The increase in average mortgage warehouse loans in 2019 was primarily a result of proactive pricing and marketing to mortgage lenders in the lower mortgage rate cycle in 2019.

The positive impact of average asset growth in 2019 was partially offset by a 5 basis point decline in net interest margin due to the lower rate environment in the second half of 2019.

Net interest income has also been impacted by nonrecurring interest items, which added $3.5 million to interest income in 2021 relative to $1.2 million in 2020 and $1.5 million in 2019.

● We recorded a loan and lease loss provision of $8.6 million in 2020, as compared to $2.6 million in 2019 and $4.4 million in 2018.

The 2020 provision was deemed necessary subsequent to our determination of the appropriate level for our allowance for loan and lease losses and was driven by strong loan growth in the second half of 2020 and continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy and our loan customers overall.

In addition, we considered the impacts of credit quality, organic growth in non-owner occupied commercial real estate loan balances, reserves required for specifically identified impaired loan balances, and downgrades of certain loans deferred under section 4013 of the CARES Act.

● We recorded a loan and lease loss benefit of $3.7 million in 2021, as compared to a $8.6 million provision in 2020 and $2.6 million provision in 2019.

The 2021 loan and lease loss benefit arose from our determination of the appropriate level for our allowance for loan and lease losses and was driven by declines in loan balances coupled with improved credit quality of existing loan balances and the influence of lower historical loan and lease losses.

We considered the continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy and our loan customers overall, making appropriate changes to the qualitative loss factors governing these areas.

The 2020 and 2019 provisions were deemed necessary subsequent to our determination of the appropriate level for our allowance for loan and lease losses, taking into consideration overall credit quality, growth in outstanding loan balances, and reserves required for specifically identified impaired loan balances (including reserves in 2019 for a $2.8 million loan that was placed on non-accrual status shortly before the end of the third quarter and partially charged off in the fourth quarter of 2019.)

● Noninterest income increased by $1.9 million, or 7%, in 2021, and by $2.7 million or 11%, in 2020 over 2019.

The increase in 2021 was primarily due to a $1.5 million increase in debit card interchange income, a $0.3 million increase in life insurance proceeds, a decrease of $0.7 million in low-income housing tax credit fund amortization, an increase of $0.4 million in the valuation gain of restricted equity investments owned by the Company, partially offset by a $0.4 million decrease in the net gain on the sale of debt securities and a $1.3 million negative variance caused by the sale of certain real estate assets in our low income housing tax credit funds that have reached their life expectancy.

Fluctuations in BOLI associated with deferred compensation plans contributed $0.2 million of the increase.

The increase in 2020 was primarily due to a $1.5 million gain from the wrap up of low-income housing tax credit fund investments, a decrease of $0.9 million in low-income housing tax credit fund expenses, an increase of $0.2 million in the valuation gain of restricted equity investments owned by the Company and a $0.6 million increase in the net gain on the sale of debt securities.

Fluctuations in BOLI associated with deferred compensation plans contributed $0.2 million to the increase.

The increase in 2019 was primarily due to favorable fluctuation in bank-owned life insurance (“BOLI”) income associated with deferred compensation income, and a nonrecurring charge in 2018 as described below.

● Noninterest expense increased by $7.6 million, or 10%, in 2021 as compared to 2020, and increased by $5.3 million, or 8%, in 2020 over 2019.

The increase in noninterest expense in 2021 was due mostly to a $2.3 million increase in salaries and benefits expense, a $3.8 million increase in professional services and a $1.2 million increase in data processing costs.

Deposit services and premises expense also contributed to the difference.

The increase in noninterest expense in 2020 was due mostly to a $4.2 million increase in salaries and benefits expense.

Deposit services and other professional services also contributed to the difference.

The slight increase in noninterest expense in 2019 was due mostly to other real estate owned (“OREO”) expense and directors deferred compensation expense associated with the BOLI income described above.

● The Company recorded income tax provisions of $14.2 million, or 24% of pre-tax income in 2021;

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● Total assets increased by $150.3 million, or 5%.

The increase resulted primarily from earning asset growth including $694.5 million of loan growth (net of deferred fees), partially offset by a $56.8 million decrease in investment securities.

● Loans and leases (net of deferred fees) were up $694.5 million, or 39%.

Loan growth consisted mainly of a $507.9 million increase in non-agricultural real estate loans, as well as a $118.6 million increase in mortgage warehouse lines, and $119.4 million in SBA PPP loans.

The increase resulted primarily from a $429.3 million increase in investment securities and a $186.1 million increase in cash and due from banks, partially offset by a $468.6 million decrease in net loan and lease balances.

● Loans and leases (net of deferred fees) declined $468.6 million, or 19%.

The decline in loan balances during 2021 was due mostly to lower utilization of mortgage warehouse lines resulting in a $206.5 million decline in overall mortgage warehouse outstanding balances due primarily to reduced refinancing activity.

Other significant declines included a $155.7 million decline in real estate loans mostly due to lower commercial real estate and construction loan balances, and a $99.3 million decrease in commercial and industrial loans, which was predominately due to Small Business Administration Paycheck Protection Program (“SBA PPP”) loan forgiveness.

● Deposit balances reflect net growth of $157.0 million, or 6%.

Deposit growth in 2020 was primarily a result of organic growth of noninterest bearing or low-cost transaction accounts, including savings accounts.

The increase in brokered deposits offset the decrease in customer time deposits.

Deposit growth in 2021 was primarily a result of organic growth of noninterest bearing or low-cost core transaction accounts, including savings accounts, while higher-cost time and wholesale brokered deposits decreased by $159.0 million, or 31%.

● Total capital increased by $18.6 million, or 5%, ending the year with a balance of $362.5 million.

The increase in capital is due mostly to the addition of net income and capital from stock options exercised, net of dividends paid.

The increase in capital is due mostly to the addition of net income and capital from stock options exercised, net of $13.2 million in dividends paid, $5.2 million in stock repurchases, and a $7.2 million unfavorable swing in accumulated other comprehensive income.

IMPACT OF CORONAVIRUS DISEASE 2019 (COVID-19) PANDEMIC ON THE COMPANY’S OPERATIONS

On January 31, 2020, the United States Department of Health and Human Services declared a public health emergency with respect to the Coronavirus Disease 2019 (COVID-19).

Subsequent to this date, federal, state, and local governmental agencies, regulatory agencies, and the Federal Reserve Board took actions impacting the Company including these more significant items:

● On March 3, 2020, the Federal Open Market Committee (FOMC) of the Federal Reserve Board lowered the federal funds rate by 50 basis points in its first emergency move since October 2008.

● On March 4, 2020, the Governor of the state of California declared a state of emergency to help make additional resources available and formalize emergency actions to address COVID-19.

● On March 6, 2020, the Federal Financial Institutions Examination Council (FFIEC) issued guidance to financial institutions reminding them to include pandemic planning in business continuity plans.

● Starting on March 9, 2020, the Board of Governors of the Federal Reserve System, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, and Conference of State Bank Supervisors began issuing various Interagency Guidance Statements to encourage financial institutions to meet the financial needs of customers affected by the Coronavirus.

● On March 11, 2020, the World Health Organization declared COVID-19 a pandemic.

● On March 15, 2020, the FOMC of the Federal Reserve Board lowered the federal funds rate by 100 basis points in its second emergency move in two weeks, this time on a Sunday.

In addition, the FOMC announced that it would let banks borrow from the discount window for up to 90 days, reduced the reserve requirement ratios to zero percent, united with five other central banks to ensure dollars are available via swap lines, and increased bond holdings by at least $700 billion.

● Effective March 20, 2020, the state of California ordered the closure of all non-essential workplaces, restricting non-essential travel, and ordering a state-wide shelter-in-place order.

This was followed by extensions of these orders in April and many local municipalities in which the Company operates issued orders mandating additional requirements to protect their citizens.

Although many counties in California began phased reopening plans, due to recent increases in cases effective July 13, 2020, the Governor ordered that dine-in restaurants, wineries and tasting rooms, movie theaters, family entertainment centers, zoos and museums, and cardrooms immediately close all indoor operations.

Effective August 31, 2020, a new simplified, four-tier guideline was implemented for counties to reopen.

Counties must remain in a tier for at least three weeks before moving to the next tier.

This four-tier guideline was suspended and a state-wide shelter-in-place order was reinstated on December 3, 2020, amid surging cases in California.

California returned to its four-tier system on January 25, 2021.

● On March 22, 2020, the federal financial institution regulatory agencies (the agencies) issued guidance to financial institutions to suspend the requirements to classify certain loan modifications as troubled debt restructurings (TDRs).

The guidance was subsequently modified on April 7, 2020 to conform with Section 4013 of the CARES Act.

Further interagency guidance for financial institutions was issued in June, August, and September 2020.

● On March 27, 2020, the CARES Act was enacted by Congress and signed into law by the President to address the impact of the COVID-19 on the economy.

Among other things, the CARES Act provided banking institutions with the option of deferring the implementation of the Current Expected Credit Loss (“CECL”) accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-13 and related amendments, Financial Instruments – Credit Losses (Topic 326) until later in 2020;

confirmed that certain loan modifications would not be treated as a TDR;

authorized the Small Business Administration to create the Paycheck Protection Program (PPP) which allows banking institutions to offer a certain amount of forgivable loans to primarily assist with funding payroll for small businesses;

and provides a temporary reduction to the minimum ratio under the Community Bank Leverage Ratio framework.

● On December 21, 2020, the Consolidated Appropriation Act, 2021 was enacted by Congress and signed into law by the President on December 27, 2020.

The bill is one of the largest spending measures ever enacted surpassing the CARES Act.

The pandemic relief portion of the bill includes $284 billion in forgivable loans via the PPP, extension of the suspension of TDR identification, and the extension of the temporary delay of the implementation of CECL.

Subsequent to this date, federal, state, and local governmental agencies, regulatory agencies, and the Federal Reserve Board took many actions impacting the Company.

These actions included, among other things, the Federal Open Market Committee (FOMC) reducing the federal funds rate;

California issuing a state-wide shelter-in-place order and various other orders at the state and local levels restricting business operations, closing schools, and thereafter prescribing requirements for reopening;

and various pieces of federal legislation were passed to attempt to address the impact of COVID-19 on the economy.

Impact of COVID-19 on the Company’s Operations

● The Company has had an $18.1 million increase in classified assets, including $1.4 million in non-accrual loans as a result of COVID-19 due to loans modified under the Interagency Guidance that are either not expected to make all principal and interest payments in a timely manner, or have had further modifications or assistance.

Further, we had charge-offs as a result of COVID-19 of less than $0.02 million.

Starting in April 2020, the Company took actions to mitigate the impact on credit losses including permitting short-term payment deferrals to current customers, as well as providing bridge loans and SBA PPP loans.

● Starting in April 2020, the Company took actions to mitigate the impact on credit losses including permitting short-term payment deferrals to current customers, as well as providing bridge loans and SBA Paycheck Protection Program (PPP) loans.

The Company had $10.4 million in classified assets to one borrower at December 31, 2021, from loans modified under the CARES Act, as amended, that were either not expected to make all principal and interest payments in a timely manner, or would need further modifications or assistance.

For further information on the principal and interest deferrals, please see the “Nonperforming Assets” section below.

However, the uncertainty of national and local economic conditions had a material impact on our provision for loan and lease losses.

The Company elected under Section 4014 of the CARES Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020.

In December 2020, the Consolidated Appropriations Act, 2021, extended the deferral of implementation of CECL from December 31, 2020, to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022.

Although this deferral will still require CECL to be implemented as of January 1, 2022, the Company believes that the deferral will provide time to better assess the impact of the COVID-19 pandemic on the expected lifetime credit losses in our loan and lease portfolio.

The most significant unknown factor is how long economic activity will be impacted by COVID-19, and in turn how deeply that will impact the markets in which we operate.

Therefore, more time was needed to assess the impact of this economic uncertainty and related actions taken such as the stimulus provisions of the CARES Act on the Company’s allowance for loan and lease losses under the CECL methodology.

● In addition to the expected increase in provision for loan and lease losses, the Company expects that net interest income could be adversely impacted over time given pressure on net interest margin as a result of the FOMC’s emergency rate cuts in March 2020.

For example, our net interest margin for the year ended December 31, 2020, was 3.95%, compared to a net interest margin of 4.19% for the same period in 2019.

New loans booked in 2020 have been at lower rates and although deposit costs have also declined, deposit costs were already low or at their floors prior to these interest rate cuts.

Further, the stay-at-home order and record unemployment resulting from the COVID-19 pandemic has reduced consumer spending which has reduced our fee income, primarily from overdraft activity.

● The uncertainty of national and local economic conditions had an impact on our provision for loan and lease losses in both 2021 and 2020.

The Company elected to defer the adoption of the Current Expected Credit Loss ("CECL") accounting method under FASB Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) to January 1, 2022 .

The Company’s decision to defer the adoption of CECL was done primarily to provide additional time to better assess the impact of the COVID-19 pandemic on the expected lifetime credit losses.

At the time the decision was made, there was a significant change in economic uncertainty on the local, regional, and national levels as a result of local and state stay-at-home orders, as well as relief measures provided at a national, state, and local level.

Further, the Company has taken actions to serve our communities during the pandemic, including permitting short-term payment deferrals to current customers, as well as originating bridge loans and SBA PPP loans.

Upon adoption of CECL on January 1, 2022, the Company recorded a $10.4 million increase in the reserve for credit losses, which includes a $0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes.

● The Company expects that net interest income will continue to be adversely impacted given pressure on the net interest margin as a result of the current interest rate environment.

As described above, in March 2020, the FOMC cut short-term rates by 150 basis points to near zero.

The uncertainty with COVID-19 and the lower targeted fed funds rates also impacted other rates including the Prime Rate and treasury yields, which the Company uses to price many of its loans.

These lower rates impacted our net interest margin.

Our net interest margin for the year ended December 31, 2021, was 3.56%, compared to a net interest margin of 3.95% for the same period in 2020.

Additional liquidity from significant deposit growth in 2021 coupled with lower loan balances has negatively impacted our net interest margin.

This additional liquidity was mostly deployed in overnight funding and lower yielding investment securities.

The average balance of overnight cash was $269.9 million in 2021, earning an average yield of 14 bps.

The average balance of investment securities was $665.3 million for 2021 yielding 2.22% which is down 50 bps from 2020.

The overall impact of a lower net interest margin was more than offset by higher earning assets in 2021 as compared to 2020.

Additionally, the FOMC has indicated it is likely to raise interest rates in 2022, in an effort to fight inflation, which should help our net interest margin.

● The COVID-19 pandemic has not adversely affected our capital or financial resources as of December 31, 2021.

During the year ending 2021, total shareholders’ equity increased by $18.6 million, or 5%, to $362.5 million.

A large component of this was an $12.5 million increase in accumulated other comprehensive income as a result of increases in the value of our investment portfolio due to lower interest rates.

If interest rates rise, this component of equity would be expected to decline.

In addition, the Company earned $35.4 million in net income for the year ending 2020 and paid dividends of $12.2 million.

The Company also paid a twenty-one cent per share dividend on February 12, 2021.

The Company earned $43.0 million in net income during 2021 but had a decrease of $7.2 million in accumulated other comprehensive income as a result of decreases in the value of our investment portfolio due to higher interest rates.

If interest rates continue to rise, this component of equity would be expected to further decline.

In addition, during 2021, the Company repurchased stock for $5.2 million and paid dividends of $13.2 million.

The Company also paid a twenty-three cent per share dividend on February 14, 2022.

Although presently not expected, if the Company were to incur significant credit losses as a result of COVID-19’s impact on our customers’ ability to repay loans, capital could be adversely impacted.

With respect to liquidity, the Company maintains strong primary and secondary liquidity sources as further described under “Liquidity and Market Risk Management” below.

● While we do not expect COVID-19 to affect our ability to account timely for the assets on our balance sheet, this could change in future periods.

Certain valuation assumptions and judgments continue to change to account for pandemic-related circumstances such as widening credit spreads.

However, we do not anticipate any significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.

As of December 31, 2020, our goodwill was not impaired.

The Company performed a qualitative assessment of its goodwill at December 31, 2020 and concluded that it was not more likely than not that a goodwill impairment exists.

The Company will continue to monitor its goodwill recorded on the balance sheet for potential impairment.

In the event that we conclude that all or a portion of our goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings.

At December 31, 2020, we had goodwill of $27.4 million which represented 8% of total equity.

● The Company continues to serve its customers.

Out of our 40 branch locations, four are open with limited lobby hours, while 8 branches have limited lobby hours and a drive-up or walk-up facility.

23 branches are open for drive-up or walk-up only and five branches are currently closed except by appointment.

Approximately 75% of our back-office and corporate employees are working remotely and it has not adversely affected our operations.

In addition, none of our internal controls have significantly changed or are expected to change as a result of the remote work arrangements other than the use of remote approvals.

The Company is prepared to continue operating in this manner until it is safe to begin bringing those working remotely back to our corporate offices and branches.

As a result of the on-going COVID-19 pandemic, several of our branch lobbies remained closed as described above.

In February 2021, the Board of Directors of the Company decided to explore the possibility of permanently closing up to five of the branches whose lobbies were closed during the pandemic.

The branches being considered for permanent closure are outside of the bank’s primary market.

The total lease breakage fee is estimated to be less than $0.3 million, in addition to the acceleration of the amortization of certain leasehold improvements.

Any closures would likely occur in the third quarter of 2021 after timely notices are provided to customers.

Several of our branch locations, were closed during the height of the pandemic, but have since re-opened.

Most recently due to the surge of the Omicron variant, some branches have had to temporarily close their lobbies due to staffing issues, however walk-up or drive-up access is still available for the customers use.

Five branch locations were permanently closed in June 2021.

decision to close these branches was made as a result of a change in customer behaviors brought about by the COVID-19 pandemic along with an efficiency review.

All of the five closed locations were located outside of Tulare County, the Bank’s primary market area.

Many of our customers have found an added convenience and ease of transacting business through online and mobile banking services which precipitated our decision to close locations where in-person transaction volumes no longer warranted a traditional brick-and-mortar branch.

Overall deposits at these five closed branches increased during the period of time from announcement to closure and consolidation into a nearby branch.

The acceleration of amortization of leasehold improvements for these locations increased depreciation expense by $0.5 million year-to-date 2021.

Most of the staff at these five locations were relocated to existing branches with position vacancies however, four individuals elected to leave the Company.

It is projected that closing these five branch locations in June 2021 will result in annual noninterest expense savings of between $0.8 and $1.0 million.

● All of our back office and corporate office staff have returned to normal work arrangements, although remote and hybrid work provisions are now defined as “normal” work arrangements for certain corporate and back office employees, depending on the nature of the position.

In addition, none of our internal controls have changed or are expected to change as a result of these work arrangements other than the use of remote approvals.

● To date, the Company did not experience any challenges in implementing its business continuity plans.

The Company’s Risk Management team began preparing in late January and early February with ordering of supplies such as hand sanitizer, masks and cleaning supplies, as well as laptops for those who did not have one.

The Company’s Risk Management team began preparing in early 2020, with ordering of supplies such as hand sanitizer, masks cleaning supplies, as well as laptops for those who did not have one.

This enabled the Company to immediately communicate and implement plans to continue operations in our banking facilities while enabling those non-customer facing employees to immediately begin working remotely.

The Company did not face any material resource constraints in implementing these plans.

● As a financial institution providing essential services, the Company expects continued demand for loans and deposits.

As described above, it is expected that certain services may see declines in demand such as debit and credit card interchange given lower consumer spending.

While overall net income is expected to decline, it presently is more a function of the interest rate environment than a change in overall demand for loan and deposit products.

● As a financial institution providing essential services, the Company expects consistent demand for loans and deposits.

It is expected that SBA PPP loans will continue to be forgiven, with most of the remaining $31.8 million expected to be forgiven in 2022.

1-4 family residential real estate loan purchases of $208.0 million in the last half of 2021 were designed to bridge the gap until organic loan growth improves the Bank’s core pipeline.

The recent hiring of strategic lending team lift-outs are expected to expand the Bank’s agricultural and commercial and industrial (C&I) lending capabilities as well as refreshing mortgage warehouse loan programs and complementing existing commercial real estate lending initiatives.

● The Company loosened its vacation and sick-time policies to accommodate our employees who were affected by COVID-19.

The Company has not had any temporary or permanent reductions in staff as a result of COVID-19.

The Company hired an additional 28 temporary employees throughout the pandemic related to higher demand for SBA PPP loan processing and forgiveness, and to provide enhanced customer service.

Those temporary assignments ended in the second quarter of 2021, although many of those employees have been redeployed within other areas of the Company.

Results of Operations

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The level of net interest income we recognize in any given period depends on a combination of factors including the average volume and yield for interest-earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities.

Net interest income is also impacted by the acceleration of net deferred loan fees and costs for loans paid off early (including SBA PPP loans forgiven), reversal of interest for loans placed on non-accrual status, and the recovery of interest on loans that had been on non-accrual and were paid off, sold, or returned to accrual status.

Net interest income is also impacted by the acceleration of net deferred loan fees and

costs for loans paid off early (including SBA PPP loans forgiven), reversal of interest for loans placed on non-accrual status, and the recovery of interest on loans that had been on non-accrual and were paid off, sold, or returned to accrual status.

The following table shows average balances for significant balance sheet categories and the amount of interest income or interest expense associated with each category for each of the past three years.

The table also displays calculated yields on

each major component of the Company’s investment and loan portfolios, average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for the noted periods.

Distribution, Rate & Yield

(dollars in thousands, except footnotes)

The table also displays calculated yields on each major component of the Company’s investment and loan portfolios, average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for the noted periods.

AVERAGE BALANCES AND RATES

(Dollars in Thousands, Unaudited)

Year Ended December 31,

Rate/Yield (2)

Federal funds sold/due from banks

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Savings accounts

Certificates of deposit<$100,000

Certificates of deposit > $100,000

Time deposits

Brokered deposits

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Short term borrowings

Long term debt

Total borrowed funds

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change in rates multiplied by prior period average balances.

Variances attributable to both rate and volume changes, calculated by multiplying the change in rates by the change in average balances, have been allocated to the rate variance.

Variances attributable to both rate and volume changes, calculated by multiplying the change in rates by the change in average balances, have been allocated to the mix variance.

Volume & Rate Variances

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Savings accounts

Certificates of deposit < $100,000

Certificates of deposit > $100,000

Time deposits

Brokered deposits

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Short term borrowings

Long term borrowings

Long term debt

Total borrowed funds

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Net interest income

Net interest income in 2020 as compared to 2019 was impacted by a favorable volume variance of $16.6 million partially offset by an unfavorable $9.1 million rate variance.

For 2019 relative to 2018, net interest income reflects a favorable volume variance of $5.3 million partially offset by an unfavorable $0.3 million rate variance.

The 2020 volume variance is due mostly to increases in average balances, resulting from the organic growth in commercial real estate loans, growth in commercial loans due to our participation in the SBA PPP program and higher utilization of mortgage warehouse lines.

Given the low rate environment, loan demand for our mortgage warehouse lines have increased, as demonstrated by the $3.7 million favorable volume variance.

The 2019 volume variance is due mostly to increases in

average balances of real estate loans and mortgage warehouse lines.

However, the ending balance of real estate loans ended 2019 approximately 3% lower than the balance at December 31, 2018.

Net interest income in 2021 as compared to 2020 was impacted by a favorable volume variance of $9.6 million partially offset by an unfavorable rate variance of $2.5 million and an unfavorable mix variance of $3.0 million.

For 2020 relative to 2019, net interest income reflects a favorable volume variance of $16.6 million partially offset by an unfavorable rate variance of $6.3 million and an unfavorable mix variance of $2.8 million.

The 2021 volume variance is due mostly to increases in average balances, resulting from the organic growth in commercial real estate loans, as well as increased investment portfolio balances.

The 2020 volume variance is due mostly to increases

in average balances, resulting from the organic growth in commercial real estate loans, growth in commercial loans due to our participation in the SBA PPP program and higher utilization of mortgage warehouse lines.

Given the low rate environment, loan demand for our mortgage warehouse lines had increased, as demonstrated by the $3.7 million favorable volume variance.

The Company’s net interest margin, which is tax-equivalent net interest income as a percentage of average interest-earning assets declined by 39 basis points to 3.56% in 2021, and declined by 24 basis points to 3.95% in 2020 as compared to 2019.

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The change in the yield on interest-earning assets representing a much larger base than that of the interest-bearing liabilities.

The rate variance was negatively impacted by the following factors:

A shift in our earning asset mix into lower-yielding loans and investments;

There was also an unfavorable mix variance of $3.0 million primarily from the origination of real estate secured loan volumes at lower interest rates and a decline in new commercial and industrial loan volumes, albeit at higher rates due to the forgiveness of SBA PPP loans.

The rate and mix variance was negatively impacted by the following factors:

A shift in our earning asset mix into lower-yielding loans and investments, including cash invested overnight;

$75.3 million in average balances of low-yielding SBA PPP loans;

partially offset by lower costs of time-deposits and other interest-bearing liabilities.

The 2020 unfavorable rate and mix variance is due to a shift in our earning asset mix into lower-yielding loans and investments;

increased line utilization of mortgage warehouse lines;

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partially offset by lower costs of time-deposits and other interest-bearing liabilities.

The 2019 unfavorable rate variance is due partially to a lower rate environment in 2019, as well as a shift in the mix of earning assets to lower yielding mortgage warehouse lines and non-taxable investment securities coupled with an increase in rates paid on time deposits.

Investment yields decreased in 2020 but increased in 2019 over 2018.

The decrease in 2020 was due to the lower rate environment and its impact on all debt securities.

Investment yields have continued to decrease in all three years presented.

The decrease in 2021 and 2020 was due to the lower rate environment and its impact on all debt securities.

Net interest margin is expected to be affected by the overall rate environment.

A continued low rate environment will result in lower earning asset yields, which will be offset by the acceleration of fee income from SBA PPP loans in the near term.

The increase in 2019 over 2018 was primarily due to a continued plan to shift to higher yielding municipal bonds.

Rates paid on non-maturity deposits declined in 2020 but were approximately the same for 2019 over 2018.

There was a 5 basis point decrease on money market accounts in 2020 but was 5 basis points higher in 2019 over 2018.

The weighted average cost of interest-bearing liabilities went down 54 bps in 2020 but was up 23 bps in 2019.

Since the Federal Open Markets Committee of the Federal Reserve System kept the federal funds target rate at historical lows throughout 2020, time deposit rates in 2020 dropped 126 bps due to the relatively short duration of our time deposit portfolio.

A continued relatively low rate environment will result in lower earning asset yields, although there are indications of interest rates increasing in 2022 which would slow the negative impact that was experienced over the past two years, however no assurance can be given in this regard.

Rates paid on non-maturity deposits were approximately the same in 2021 but declined for 2020 over 2019.

There was a 2 basis point decrease on money market accounts in 2021 and a 5 basis points decrease in 2020 over 2019.

The weighted average cost of interest-bearing liabilities went down 10 bps in 2021 and 54 bps in 2020.

Since the Federal Open Markets Committee of the Federal Reserve System kept the federal funds target rate at historical lows throughout 2021 and 2020, customer time deposit rates in 2021 dropped 31 bps and 122 bps in 2020 due to the relatively short duration of our time deposit portfolio.

The 2019 increase was primarily because of higher rates paid on time deposits (including brokered deposits added in the last half of 2018).

Overnight borrowings and adjustable-rate trust-preferred securities (“TRUPS”) are also tied to short-term rates which began lowering in the second half of 2019, but still remained higher overall in 2019 as compared to 2018 and remained low throughout 2020.

Overnight borrowings and adjustable-rate trust-preferred securities (“TRUPS”) are also tied to short-term rates which began lowering in the second half of 2019, but still remained lower overall in 2020 as compared to 2019 and remained low throughout 2021.

During the year, adjustments to interest income occur due to the following adjustments:

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Such adjustments totaled $3.5 million in 2021, $1.2 million in 2020, and $1.5 million in 2019.

Further, discount accretion on loans from whole-bank acquisitions enhanced our net interest margin by approximately two basis points in 2020, four basis points in 2019, and seven basis points in 2018.

Provision for Loan and Lease Losses

The Company recorded a loan and lease loss provision of $8.6 million in 2020;

$2.6 million in 2019, and $4.4 million in 2018.

The Company is subject to the adoption of the Current Expected Credit Loss ("CECL") accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) in 2020 .

However, in March 2020, the Company elected under Section 4014 of the CARES Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020.

In December 2020, the Consolidated Appropriations Act, 2021 extended the deferral of implementation of CECL from December 31, 2020, to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022.

Therefore, the Company expects to implement CECL on January 1, 2022.

The Company initially elected in the first quarter of 2020 to postpone implementation and will now continue to postpone implementation in order to provide additional time to assess better the impact of the COVID-19 pandemic on the expected lifetime credit losses.

At the time of the initial decision, there was a significant economic uncertainty on the local, regional, and national levels as a result of local and state stay-at-home orders, as well as relief measures provided at a national, state, and local level.

Further, the Company took actions to serve our communities during the pandemic, including permitting short-term payment deferrals to current customers, as well as originating bridge loans and SBA PPP loans.

It was determined that more time was needed to assess the impact of the uncertainty and related actions on the Company's allowance for loan and lease losses under the CECL methodology.

The growth in the provision for loan and lease losses in 2020, is due to the strong organic non-owner occupied commercial real estate loan growth generated in the second half of 2020 and the continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy.

Further, discount accretion on loans from whole-bank acquisitions enhanced our net interest margin by approximately two basis points in 2021, two basis points in 2020, and four basis points in 2019.

Provision for Loan and Lease Losses and Provision for Credit Losses

Credit risk is inherent in the business of making loans.

The Company sets aside an allowance for loan and lease losses, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for loan and lease losses.

The Company recorded a loan and lease loss benefit of $3.7 million in 2021;

a loan and lease loss provision of $8.6 million in 2020, and $2.6 million in 2019.

The Company is subject to the adoption of the Current Expected Credit Loss ("CECL") accounting method under FASB Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) in 2020 .

However, in March 2020, the Company elected to defer the adoption of the CECL accounting method under FASB Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) to January 1, 2022 .

The Company’s decision to defer the adoption of CECL was done primarily to provide additional time to better assess the impact of the COVID-19 pandemic on the expected lifetime credit losses.

Upon adoption of CECL, the Company was required to make an adjustment to equity, net of taxes, equal to the difference between the allowance for credit losses calculated under the CECL method and the allowance for loan and lease

losses as calculated under the incurred loss method as of December 31, 2021.

Therefore, on January 1, 2022, the Company recorded a $10.4 million increase in the allowance for credit losses, which includes a $0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes.

The Company's $12.2 million, favorable decline in provision for loan and lease losses for the year ending 2021 compared to the same period in 2020 is due mostly to lower historical loan loss rates, a decline in outstanding balances on loans, a change in the mix of loans, and net year-to-date 2021 recoveries of previously charged-off loan balances.

During 2021, management adjusted its qualitative risk factors under our current incurred loss model for improved economic conditions, improvements in the severity and volume of past due loans, and a reduction in the level of concentrations of credit in non-owner occupied real estate loans.

The growth in the provision for loan and lease losses in 2020, was due to the strong organic non-owner occupied commercial real estate loan growth generated in the second half of 2020 and the continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy.

The provision was also impacted by downgrades of certain loans deferred under section 4013 of the CARES Act, including 10 loans for $1.4 million placed on non-accrual at the end of the deferral period.

Management evaluated its qualitative risk factors under our current incurred loss model and adjusted these factors for economic conditions, changes in the mix of the portfolio due to loans subject to a payment deferral, potential changes in collateral values due to reduced cash flows, and external factors such as government actions.

In particular, the uncertainty regarding our customers' ability to repay loans could be adversely impacted by COVID-19, temporary business shut-downs, and reduced consumer and business spending.

Two separate impaired loans impacted the provision for loan and lease losses in both 2019 and 2018.

In 2019, additional reserve was booked in the third quarter 2019 for a $2.8 million loan placed on nonaccrual status resulting in a $1.2 million charge-off.

The provision for 2018 includes $2.4 million for a large purchased participation loan that was placed on nonaccrual status in the third quarter 2018.

With the loan and lease loss provision recorded in 2020 we were able to maintain our allowance for loan and lease losses at a level that, in Management’s judgment, is adequate to absorb probable loan and lease losses related to specifically identified impaired loans as well as probable incurred losses in the remaining loan portfolio.

Management evaluated its qualitative risk factors under the current incurred loss model and adjusted these factors for economic conditions, changes in the mix of the portfolio due to loans subject to a payment deferral, potential changes in collateral values due to reduced cash flows, and external factors such as government actions and the impact that COVID-19 may have on our customers.

In 2019, an additional reserve was booked in the third quarter 2019 for a $2.8 million loan placed on nonaccrual status resulting in a $1.2 million charge-off.

With the loan and lease loss benefit recorded in 2021 we were able to maintain our allowance for loan and lease losses at a level that, in Management’s judgment, is adequate to absorb probable loan and lease losses related to specifically identified impaired loans as well as probable incurred losses in the remaining loan portfolio.

Specifically identifiable and quantifiable loan and lease losses are immediately charged off against the allowance.

The Company recorded net loan and lease losses of $0.7 million in 2020.

The Company experienced net loan and lease losses of $2.4 million in 2019, including a $1.2 million charge-off on the loan placed on nonaccrual status in the third quarter 2019 as mentioned above.

The Company experienced net loan and lease losses of $3.6 million in 2018, including a $2.4 million loss on the above-referenced participation loan.

The loan and lease loss provision for 2020, 2019 and 2018 has been favorably impacted by the following factors:

The Company recorded net loan and lease recoveries of $0.2 million in 2021.

The Company experienced net loan and lease losses of $0.7 million in 2020 and $2.4 million in 2019, including a $1.2 million charge-off on the loan placed on nonaccrual status in the third quarter 2019 as mentioned above The loan and lease loss (benefit) provision for 2021, 2020 and 2019 has been favorably impacted by the following factors:

most charge-offs were recorded against pre-established reserves, which alleviated what otherwise might have been a need for reserve replenishment;

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and, new loans booked have been underwritten using continued tighter credit standards.

As mentioned previously the loan and lease loss benefit for 2021 was also positively impacted by $0.2 million in net recoveries.

The Company’s policies for monitoring the adequacy of the allowance and determining loan amounts that should be charged off, and other detailed information with regard to changes in the allowance, are discussed in Note 2 to the consolidated financial statements and below under “Allowance for Loan and Lease Losses.” The process utilized to establish an appropriate allowance for loan and lease losses can result in a high degree of variability in the Company’s loan and lease loss provision, and consequently in our net earnings.

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(2) Noninterest expense as a percentage of the sum of net interest income and noninterest income excluding net gains (losses) from securities and bank owned life insurance income.

Noninterest income improved in 2020 with a $2.7 million increase, or 11%, as compared to an increase of $1.9 million, or 9%, in 2019.

Noninterest income in 2021 increased $1.9 million, or 7%, as compared to an increase of $2.7 million, or 11%, in 2020.

Total noninterest income was 0.90% of average interest-earning assets in 2021 as compared to a ratio of 0.97% in 2020 and 1.0% in 2019.

The ratio declined in 2020 due to a 14% increase in interest-earning assets.

The principal component of the Company’s noninterest revenue, service charges on deposit accounts, decreased by $1.0 million, or 8%, in 2020 as compared to 2019.

The ratio declined in 2021 due to a 15% increase in average interest-earning assets.

The principal component of the Company’s noninterest revenue, service charges on deposit accounts, increased by $0.1 million, or 1%, in 2021 as compared to 2020.

The same line item declined by $1.0 million, or 8%, in 2020 over 2019.

This line item is primarily driven by the volume of transaction accounts.

As a percent of average transaction account balances, service charge income was 1.9% in 2020, and 1.0% in 2019 and 2018.

As a percent of average transaction account balances, service charge income was 1.0% in 2021, 1.9% in 2020 and 1.0% in 2019.

This line item consists of a variety of fees including service charges on corporate accounts, treasury management fees, charges on corporate and consumer accounts including treasury management fees, ATM fees, overdraft income, and monthly service charges on certain accounts.

Overdraft income on both consumer and corporate accounts totaled $4.9 million in 2021;

$5.1 million in 2020 and $6.9 million in 2019.

Checkcard fees consists of interchange fees from our customers’ use of debit cards for electronic funds transactions.

This category increased by $1.5 million, or 21%, in 2021 as compared to 2020, and increased by $0.4 million, or 7%, in 2020 over 2019.

The increases in 2020 and 2019 are primarily a result of growth in our deposit account base as well as increased usage of debit cards by our customers.

Other service charges and fees declined by $0.1 million, or 3%, in 2020 over 2019, and by $1.0 million, or 19%, in 2019 over 2018.

The decrease in 2019, was due largely to two infrequent items occurring in 2018.

In 2018, we had a $1.2 million write-up of our investment in Pacific Coast Bankers Bank (“PCBB”), due to Accounting Standards Update 2016-01 which required the Company to write the investment to fair value through earnings, as well as a $0.2 million special dividend received pursuant to our equity investment in the Federal Home Loan Bank of San Francisco (“FHLB”).

The increases in 2021 and 2020 are primarily a result of increased usage of debit cards by our customers.

Other service charges and fees increased by $0.7 million, or 17%, in 2021 over 2020, and declined by $0.1 million, or 3%, in 2020 over 2019.

This account includes certain transaction related fees including merchant income, currency orders, safe deposit box fees, wire fees, as well as dividends and changes in values related to our bank equity investments such as FHLB and Pacific Coast Bankers Bank (“PCBB”).

The increase in 2021, was due largely to a $0.9 million write-up of our investment in PCBB, due to Accounting Standards Update 2016-01 which required the Company to write the investment to fair value through earnings.

BOLI income generally fluctuates based on the market.

In 2020 BOLI income increased by $0.2 million or 10%, and in 2019 BOLI income increased by $1.6 million, or 270%, over 2018.

In both comparative years ending 2021 over 2020, and 2020 over 2019, BOLI income increased by $0.2 million or 10%.

BOLI income is derived from two types of policies owned by the Company, namely “separate account” and “general account” life insurance, and the year over year variances are due in large part to fluctuations in income on separate account BOLI.

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Gains on separate account BOLI totaled $1.7 million in 2021 as compared to $1.4 million in 2020, and net losses of $1.2 million in 2019.

This resulted in a favorable variance of $0.2 million for 2020 as compared to 2019, and a favorable variance of $1.6 million in 2019 as compared to 2018.

This resulted in favorable variances of $0.2 million for both comparative years ending 2021 as compared to 2020 and 2020 as compared to 2019.

As noted, gains and losses on separate account BOLI are related to expense accruals or reversals associated with participant gains and losses on deferred compensation balances, thus the overall net impact on taxable income tends to be minimal.

The Company’s books also reflect a net cash surrender value for general account BOLI of $43.2 million at December 31, 2020 as compared to $42.5 million at year-end 2019.

The Company’s books also reflect a net cash surrender value for general account BOLI of $43.2 million at December 31, 2021 and 2020.

General account BOLI produces income that is used to help offset expenses associated with executive salary continuation plans, director retirement plans and other employee benefits.

Interest credit rates on general account BOLI do not change frequently so the income has typically been fairly consistent with $1.0 million, of general account BOLI income recorded for all three years ending December 31, 2021, 2020, and 2019.

The Company recognized a $0.4 million gain on the sale of investment securities in 2020, as compared to a $0.2 million loss in 2019 and a nominal gain in 2018.

The Company recognized a nominal gain on the sale of investment securities in 2021 as compared to a $0.4 million gain in 2020, and a $0.2 million loss in 2019.

The gain in 2020 was due to a net gain on the sale of debt securities, in an effort to restructure the portfolio primarily to eliminate small residual balances and reduce potential credit risk on certain municipal holdings.

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In 2020 as compared to 2019, these expenses decreased by $0.9 million, or 43%.

The favorable variance in 2020 is due to the expiration of expense amortization on several funds which had reached the end of their useful tax benefit life.

The largest contribution to the favorable variance in 2019, as well as the unfavorable variance in 2018 came from a $0.91 million adjustment to accelerate expense amortization on our tax credit investments, to ensure that the book value of each investment does not exceed its projected remaining tax benefits.

The other category, increased to $1.7 million from $0.01 million, in 2020 as compared to 2019.

The favorable variances in both 2021 and 2020 is due to the expiration of expense amortization on several funds which had reached the end of their useful tax benefit life.

The largest contribution to the favorable variance in 2019 came from a

$0.91 million adjustment to accelerate expense amortization on our tax credit investments, to ensure that the book value of each investment does not exceed its projected remaining tax benefits.

The other category, decreased to $0.8 million from $1.7 million in 2021.

The primary reason for the decrease was from a 2020 non- recurring gain as discussed in the prior year comparison, but was partially offset by a gain from life insurance proceeds and the sale of fixed assets.

In 2020 as compared to 2019 the other category increased to $1.7 million from $0.01 million.

The primary reason for this increase is due to a $1.5 million gain from the wrap up of low-income housing tax credit fund investments and a $0.2 million valuation gain on restricted equity investments owned by the Company.

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Total operating expense, or noninterest expense, increased by $7.6 million, or 10%, in 2021 as compared to 2020, and increased by $5.3 million, or 8%, in 2020 over 2019.

The primary increase in 2020 was in salaries and benefits as discussed in further detail below.

Although overall noninterest expense did not fluctuate significantly from 2019 to 2018, several line items fluctuated with the largest single item being deposit service costs of $2.6 million.

This increase was mostly offset by several smaller changes in other line items.

The primary increase in 2021 was in legal and accounting costs as discussed in further detail below.

In 2020 the largest increase was in salaries and benefits.

Noninterest expense as a percent of average interest-earning assets trended down each year.

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The largest component of noninterest expense, salaries, and employee benefits increased $2.3 million, or 6% in 2021 as compared to 2020.

The reason for this increase is due to several factors, including merit increases for employees due to annual performance evaluations, new loan production teams for the northern and southern California markets, and a focus on hiring additional senior-level staff and management.

The same line item was down $0.2 million, or 0.4%, in 2019 as compared to 2018.

Salary expense declined in 2019 as compared to 2018 in part due to selective staff reductions even though there was some increase to deferred compensation expenses as well as the normal annual salary increases.

Components of compensation expense that can experience significant variability and are typically difficult to predict include salaries associated with successful loan originations, which are accounted for in accordance with Financial Accounting Standards Board (“FASB”) guidelines on the recognition and measurement of non-refundable fees and origination costs for lending activities, and accruals associated with employee deferred compensation plans.

The reason for the increase was mostly due to the $2.3 million decrease in deferred loan origination salaries associated with successful loan originations are accounted for in accordance with FASB guidelines on the recognition and measurement of non-refundable fees and origination costs for lending activities, and accruals associated with employee deferred compensation plans.

Loan origination salaries that were deferred from current expense for recognition over the life of related loans totaled $1.1 million in 2021, $3.3 million in 2020, and $3.7 million for 2019.

Employee deferred compensation expense accruals totaled only $0.2 million in 2020, and 2019.

Such deferred compensation expenses were nominal in 2018.

The $4.2 million increase, or 12%, in salaries and employee benefits in 2020 as compared to 2019 is due to several factors, including merit increases for employees due to annual performance evaluations, new loan production teams for the northern and southern California markets, and a focus on hiring additional senior-level staff and management.

Employee deferred compensation expense accruals totaled $0.2 million in 2021, 2020, and 2019.

As noted above in our discussion of BOLI income, employee deferred compensation plan accruals are related to separate account BOLI income and losses, as are directors deferred compensation accruals that are included in “other professional services,” and the net income impact of all income/expense accruals related to deferred compensation is usually minimal.

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The number of full-time equivalent staff employed by the Company totaled 480 at the end of 2021, as compared to 501 at December 31, 2020 and 513 at December 31, 2019.

Staff attrition throughout 2020, without the need for immediate replacements due to temporary branch lobby closures or limited branch lobby hours attributed to the COVID-19 pandemic, was the primary reason for the FTE decline.

When branch lobbies resume normal operating hours and public access, full-time equivalent staff are expected to increase, however the exact timing of this change is not currently known.

Efficiency initiatives implemented toward the end of the 2018 continuing throughout 2019 and 2020 were also drivers of the three year reduction in FTE.

Total rent and occupancy expense, including furniture and equipment costs, were about the same in 2020 as compared to 2019 and decreased by $0.5 million, or 4%, in 2019 over 2018.

The decline in 2019 was primarily due to lower depreciation expenses and lower maintenance/repair costs in 2019.

Staff attrition throughout 2021 and 2020, without the need for immediate replacements due to temporary branch lobby closures or limited branch lobby hours attributed to the COVID-19 pandemic, was the primary reason for the FTE decline.

As branch lobbies resumed normal operating hours and public access, during the summer of 2021, full-time equivalent staff were expected to increase, however finding talent was extremely challenging not only for the Company but for the entire industry.

2021 was the year of the “Great Resignation” with over 4.4 million people leaving their jobs according to the Bureau of Labor Statistics, with the recent surge in the Omicron variant is exacerbating the current talent shortage.

Total rent and occupancy expense, including furniture and equipment costs, were approximately the same in 2021, 2020 and 2019.

With the closure of five branch facilities in mid-2021, it is expected that rent and occupancy expense should decline in 2022, although no assurances can be given in that regard.

Advertising and promotion costs decreased by 19% to $1.5 million in 2021 as compared to 2019, and decreased by $0.7 million, or 26%, in 2020 over 2019.

The decrease in 2020 came from the cessation of special events and in-branch marketing campaigns necessitated by the COVID-19 pandemic and the stay in place orders instituted by the Governor of the state of California, at differing periods during much of 2020.

Data processing costs increased by $0.1 million, or 2%, in 2020 as compared to 2019 and decreased by $0.5 million, or 9%, in 2019 over 2018.

The decrease in 2021 came from the cessation of special events and in-branch marketing campaigns necessitated by the COVID-19 pandemic.

Data processing costs increased by $1.2 million, or 26%, in 2021 as compared to 2020 and increased by $0.1 million, or 2%, in 2020 over 2019.

The increase in 2021 was due to higher disaster recovery and data back-up costs as a result of outsourcing this work in late 2020 rather than performing it in-house, higher core processing costs as we expand our data warehousing capabilities, and higher loan management software costs for the expansion of digital loan Platform.

Although as a whole the increase in 2020 was minimal, the Company did experience increases in loan management software expenses due to participation in the SBA PPP program and other costs incurred to implement remote working arrangements for staff;

which was offset by lower core software provider costs and other data processing costs.

The decrease in 2019 was primarily due to lower core software provider costs.

Deposit services costs increased by $0.6 million, or 7%, in 2021 as compared to 2020, and increased by $0.5 million, or 7%, in 2020 over 2019.

Deposit costs have been impacted in both 2020 and 2019, by increases in debit card processing and ATM network costs due to higher customer activity levels.

In 2020 we also increased our utilization of armored car

services to replenish ATM machines as an increased security precaution.

In 2019, approximately $1.5 million of costs associated with statement printing costs that were previously recorded in other operations expenses and stationary & supplies expense were reclassified to data processing costs.

The purpose of the reclassification was to better track the costs associated with producing paper statements for our customers so that we could better track progress against our strategy to lower such costs.

Deposit costs have been impacted in both 2021 and 2020, by increases in debit card processing due to higher customer activity levels and increased utilization of armored car services.

These increases were partially offset by decreases in ATM servicing costs as we replaced most of our ATMs throughout 2021 with newer models that require less maintenance.

Loan services costs are comprised of loan processing costs, and net costs associated with foreclosed assets.

Loan processing costs, which include expenses for property appraisals and inspections, loan collections, demand and foreclosure activities, loan servicing, loan sales, and other miscellaneous lending costs, increased by $0.4 million, or 60%, in 2020 as compared to 2019 and decreased by $0.5 million, or 41%, in 2018 over 2017.

The increase in 2020 as well as the decrease in 2019 was due to smaller amounts in nearly every category of loan servicing.

The decrease in 2019 was also due to the dramatic reduction in the amount of residential first mortgages made by the Company.

Loan processing costs, which include expenses for property appraisals and inspections, loan collections, demand and foreclosure activities, loan servicing, loan sales, and other miscellaneous lending costs, decreased by $0.6 million, or 49%, in 2021 as compared to 2020 and increased by $0.4 million, or 60%, in 2020 over 2019.

The decrease in 2021 as well as the increase in 2020 was due to smaller amounts in nearly every category of loan servicing.

The decrease in 2021 was also due to the reduction in the volume of loans made by the Company.

Foreclosed assets costs are comprised of write-downs taken subsequent to reappraisals, OREO operating expense (including property taxes), and losses on the sale of foreclosed assets, net of rental income on OREO properties and gains on the sale of foreclosed assets.

Those costs were just $0.2 million in 2020 as compared to a $0.04 million net gain in 2019 and costs of $0.7 million in 2018.

These costs fluctuate based on market conditions of OREO relative to our holding value and the nature of the underlying property.

There were expenses of $0.1 million in 2021 as compared to $0.03 million in 2020 and nominal expenses in 2019.

These costs fluctuate based on market conditions of OREO relative to our holding value, the nature of the underlying properties and the volume of OREO properties in inventory.

At the end of 2021, the Company had only one OREO property remaining in inventory.

The “other operating costs” category includes telecommunications expense, postage, and other miscellaneous costs.

Telecommunications expense increased by 13% to $2.0 million in 2021, as compared to $1.8 million in 2020.

The increase was due to an upgrade of telecommunications circuits, as well as additional costs from work-at-home arrangements during the COVID-19 pandemic.

The increased telecommunication costs in 2020, are not expected to continue at the same rate, as old duplicative circuits are removed from service.

Such expense was $0.1 million, or 3%, higher in 2019 than in 2018.

Postage expense decreased by $0.1 million, or 26%, in 2020 as compared to 2019 and decreased by $0.6 million or 56%, in 2019 relative to 2018.

The decrease in 2020 was due to concentrated efforts to decrease our utilization of overnight mail services and increase usage of digital technologies.

The significant decline in 2019 was due mostly to a reclassification of nearly the entire annual variance to deposit services costs related to paper statements as described above.

The “Other” category under other operating costs decreased by $0.2 million, or 8%, in 2020 as compared to 2019 and up by $0.4 million, or 28%, in 2019 over 2018.

The telecommunications increase in 2021 was due to the improvement of our data infrastructure and a certain amount of redundancy during the transition.

The increase in 2020 was also due to an upgrade of telecommunications circuits, as well as additional costs from work-at-home arrangements during the COVID-19 pandemic.

Postage expense was slightly lower in 2021 as compared to 2020, but decreased by $0.1 million, or 26%, in 2020 as compared to 2019.

The decrease in 2021 and 2020 was due to concentrated efforts to decrease our utilization of overnight mail services and increase usage of digital technologies.

The “Other” category under other operating costs increased by $0.5 million, or 32% in 2021 as compared to 2020, and decreased by $0.2 million, or 8%, in 2020 as compared to 2019.

The increases in 2021 were mostly due to higher consulting costs and expenses on discontinued branch leases.

The decrease in 2020 is due to the lack of participation in offsite conferences and training due to the COVID-19 pandemic.

The increase in 2019 is due mostly to higher consulting and training costs as well as higher recruiting costs.

Total Professional Services costs increased by $0.4 million, or 9%, in 2020 as compared to 2019, as compared to a $0.3 million, or 6%, increase in 2019 as compared to 2018.

Total Professional Services costs increased by $3.8 million, or 77%, in 2021 as compared to 2020, and by $0.4 million, or 9%, in 2020 as compared to 2019.

Professional Services costs consists of legal and accounting, acquisition, and other professional services costs.

Legal and Accounting costs decreased by $0.1 million, or 4%, in 2020 as compared to 2019, and increased by $0.1 million, or 7%, in 2019 as compared to 2018.

The decrease in 2020 was due to lower internal audit costs as a result of moving some third party reviews inhouse.

The increase in 2019 was mostly due to increased audit and compliance costs as a result of an enhanced risk management program.

Acquisition costs, or one-time expenses directly attributable to our whole-bank and branch acquisitions, were nil in 2020, as compared to just $0.02 million in 2019 and $0.5 million in 2018.

Acquisition costs are comprised primarily of termination fees for core processing contracts and certain other contracts, software conversion costs, financial advisor fees, legal costs, severance and retention amounts paid to employees of the acquired institutions, and the write-off of furniture, fixtures and equipment that were not utilized by the Company.

Legal and Accounting costs increased by $2.8 million, or 141% in 2021 as compared to 2020, and decreased by $0.1 million, or 4%, in 2020 as compared to 2019.

The increase in 2021 was mostly due to an increase in legal costs, related legal reserves, and additional costs related to the outsourcing of certain audit functions.

The decrease in 2020 was due to lower internal audit costs as a result of moving some third-party branch reviews inhouse.

Other professional services costs include FDIC assessments and other regulatory expenses, directors’ costs, and certain insurance costs among other things.

This category increased by $0.5 million, or 20%, in 2020 as compared to 2019, and increased by $0.5 million, or 27%, in 2019 relative to 2018.

This category increased by $1.0 million or 34%, in 2021 as compared to 2020, and increased by $0.5 million, or 20%, in 2020 as compared to 2019.

The increase in 2021 was due to an increase in FDIC assessment expenses, increased director’s equity compensation expense, and professional services costs.

The increase in 2020 is primarily from an increase in FDIC assessment expenses as we utilized all of the available small bank assessment credits after the first quarter of 2020.

There was also a favorable swing in the director’s deferred compensation expense for both 2021 and 2020, which is mostly offset by higher BOLI income, as described above under the separate account BOLI.

In addition, FDIC and State exam assessment expenses declined by $0.3 million in 2019 as compared to 2018.

Stationery and supply costs increased by $0.1 million, or 40%, in 2020 as compared to 2019 due primarily to specialized supplies attributed to the COVID-19 pandemic.

This same category decreased by $1.1 million, or 77%, in 2019 over 2018, due to a reclassification of customer paper statement expense to deposit services costs as described above.

Sundry and teller costs of $0.6 million in 2020, $0.3 million in 2019, and $0.4 million in 2018 primarily reflect operational losses, including debit card disputes.

These costs were $0.3 million higher in 2020 over 2019, mainly because of two large operational losses, and higher debit card losses, consistent with the higher volume of debit card transactions.

In 2019 over 2018, these costs trended downward due to the implementation of new technology and education.

Stationery and supply costs decreased by $0.1 million, or 23%, in 2021 as compared to 2020 and increased by $0.1 million, or 40%, in 2020 as compared to 2019.The decrease in 2021 over 2020, is mostly due to efficiencies gained as a result of movement towards a digital working environment and less reliance on paper.

The increase in 2020 as compared to 2019 was attributed to specialized supplies due to the COVID-19 pandemic.

Sundry and teller costs of $0.6 million in 2021 were essentially the same in 2020, and were $0.3 million in 2019.

In 2021, as well as 2020 and 2019, debit card losses are elevated and trending upwards consistent with the higher volume of debit card transactions.

These costs were $0.3 million higher in 2020 over 2019, mainly because of two large operational losses.

The Company’s tax-equivalent overhead efficiency ratio was 59.9% in 2021, 57.2% in 2020, and 57.5% in 2019.

The overhead efficiency ratio represents total noninterest expense divided by the sum of fully tax-equivalent net interest and noninterest income, with the provision for loan and lease losses and investment gains/losses excluded from the equation.

The ratio trended downward due to continued efforts to control costs, as well as higher income which is the denominator of the equation.

Our income tax provision was $11.1 million, or 23.8% of pre-tax income in 2020 as compared to $11.8 million, or 24.6% of pre-tax income in 2019, and $9.9 million, or 25.0% of pre-tax income in 2018.

The tax accrual rate was slightly lower in 2020 due to a higher proportion of non-taxable income, and approximately the same in 2019 as it was in 2018.

The ratio trended downward in 2020, due to continued efforts to control costs, as well as higher income which is the denominator of the equation but spiked higher in 2021 due mainly to elevated nonrecurring noninterest expense.

Our income tax provision was $14.2 million, or 24.8% of pre-tax income in 2021 as compared to 2020 and $11.1 million, or 23.8% of pre-tax income in 2020 as compared to $11.8 million, or 24.6% of pre-tax income in 2019.

The tax accrual rate was higher in 2021 due to a lower proportion of non-taxable income, and slightly lower in 2020 due to a higher proportion of non-taxable income.

The Company sets aside a provision for income taxes on a monthly basis.

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The Company’s investments in state, county and municipal bonds provided $6.2 million of federal tax-exempt income in 2021, $5.7 million in 2020, and $4.5 million in 2019.

Moreover, in addition to life insurance proceeds of $0.07 million in 2020, net increases in the cash surrender value of bank-owned life insurance added $2.4 million to tax-exempt income in 2020;

$2.2 million in 2019, and $0.6 million in 2018.

Moreover, in addition to life insurance proceeds of $0.4 million in 2021, and $0.07 million in 2020, net increases in the cash surrender value of bank-owned life insurance added $2.6 million to tax-exempt income in 2021;

$2.4 million in 2020;

and $2.2 million in 2019.

Our tax credits consist primarily of those generated by investments in low-income housing tax credit funds, and California state employment tax credits.

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Assets totaled $3.4 billion at December 31, 2021, an increase of $150.3 million, or 5%, for the year.

Assets increased in 2020 primarily due to 694.5 million, or 39% increase, in net loans and leases.

Assets increased in 2021 primarily a result of increases in cash and due from banks and investments securities of $186.1 million and $429.3 million, respectively, net of a $468.6 million decrease in net loan balances.

Deposits were up $157.0 million, or 6%.

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The Company’s loan and lease portfolio represents the single largest portion of invested assets, substantially greater than the investment portfolio or any other asset category, and the quality and diversification of the loan and lease portfolio are important considerations when reviewing the Company’s financial condition.

The Selected Financial Data table in Item 6 above reflects the amount of loans and leases outstanding at December 31 for each year from 2020 back to 2016, net of deferred fees and origination costs and the allowance for loan and lease losses.

The Loan and Lease Distribution table that follows sets forth by loan type the Company’s gross loans and leases

outstanding, and the percentage distribution in each category at the dates indicated.

The Loan and Lease Distribution table that follows sets forth by loan type the Company’s gross loans and leases outstanding, and the percentage distribution in each category at the dates indicated.

The balances for each loan type include nonperforming loans, if any, but do not reflect any deferred or unamortized loan origination, extension, or commitment fees, or deferred loan origination costs.

Although not reflected in the loan totals below and not currently comprising a material part of our lending activities, the Company also occasionally originates and sells, or participates out portions of, loans to non-affiliated investors.

Although not reflected in the loan totals below and not currently comprising a

material part of our lending activities, the Company also occasionally originates and sells, or participates out portions of, loans to non-affiliated investors.

Loan and Lease Distribution

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Consumer loans

The Company has experienced net growth in loan and lease balances in each of the last five years, despite fluctuations caused by variability in outstanding balances on mortgage warehouse lines, reductions associated with the resolution of impaired loans, weak loan demand in some years, tightened underwriting standards, and intense competition.

This growth is due in part to acquisitions, including Coast National Bank in 2016 and Ojai Community Bank in 2017, as well as whole loan purchases and participations, and participation in the SBA PPP loan program in 2020.

Organic loan growth has also been extremely robust in recent periods, particularly with regard to non-owner occupied commercial real estate loans.

For 2020, gross loans were up by $700.5 million, or 40%, due largely to $649.9 million of organic growth in non-agricultural real estate loans.

This growth was a deliberate effort of our Northern and Southern market loan production

teams and was facilitated by the opening of a loan production office in Northern California (Rocklin, California) and an expansion of the loan team in Southern California.

Mortgage warehouse lines also contributed to the 2020 increase;

up by $118.6 million, or 63%.

Commercial and industrial loans were up by $93.5 million or 81% due to our participation in the SBA PPP loan program.

Multi-family residential loans increased $7.4 million or 14%.

These increases were partially offset by declines in all other loan categories.

Mortgage warehouse lines increased by $97.2 million, or 106%, in 2019 primarily due to a strategy to focus on volume given the short duration of these loans.

This growth strategy involved providing more competitive pricing to mortgage originators coupled with a stronger emphasis on calling efforts.

The largest single decline in any other category of loans during 2019 was real estate loans of $51.8 million, or 4%, mostly due to a strategic decision to significantly reduce our activity of residential mortgages;

as a result residential mortgage loan balances declined by approximately $43.4 million in 2019.

As demonstrated by the expansion of the lending teams, management remains focused on organic loan growth, however at a significantly lower rate than what was experienced in 2020.

Our loan pipeline at December 31, 2020, softened due to a strategic shift to focus on further diversifying our loan mix, especially as it relates to non-owner occupied commercial real estate.

No assurance can be provided with regard to future net growth in aggregate loan balances given occasional surges in prepayments, including forgiveness of PPP loans;

The Company’s loan and lease balances declined in 2021 due to management actions to reduce non-owner occupied commercial real estate concentrations after a period of strong growth in 2020, a decline in utilization of mortgage warehouse lines, and SBA PPP loan forgiveness.

Conversely, the Company experienced net growth in each of the four years from 2017 through 2020, despite fluctuations caused by variability in outstanding balances on mortgage warehouse lines, reductions associated with the resolution of impaired loans, weak loan demand in some years, tightened underwriting standards, and intense competition.

This growth over these four years was due in part to acquisitions, including Coast National Bank in 2016 and Ojai Community Bank in 2017, as well as whole loan purchases and participations, and participation in the SBA PPP loan program in 2020.

For 2021, gross loans were down by $473.4 million, or 19%, primarily as a result of a $206.5 million decline in mortgage warehouse line utilization, an $87.6 million decline in SBA PPP loans due mostly to forgiveness of such loans, and a net decrease of $155.7 million in real estate secured loans, primarily from construction and other commercial real estate loans.

The overall decline in real estate secured loans during 2021 was partially offset by an increase of $149.6 million in 1-4 family residential real estate loans due to the $208.0 million purchase of jumbo mortgage loans during the second half of 2021.

These mortgage loan purchases in 2021 and additional purchases in 2022, were designed as a bridge to organic loan growth with the Bank’s recent hiring of strategic lending team lift-outs as detailed below:

● The Bank’s mortgage warehouse team program will be refreshed and rebuilt under the direction and leadership of a new Mortgage Warehouse Market President, who was hired for this role in the fourth quarter of 2021.

● The Real Estate Industries Group (REIG) hired two new commercial real estate loan officers who are expected to continue the Bank’s commitment to serving the commercial real estate markets.

Commercial Loan Officers were appointed to complement the REIG.

In addition, further lending teams are currently being recruited along with additional underwriters to support the REIG.

● Expansion of the agricultural lending and commercial & industrial (C&I) lending capabilities of the Bank is a key third element.

In December 2021, the Company hired a new Agricultural and Commercial Lending President.

We are actively recruiting additional lenders to expand the Agricultural and C&I teams with key lender lift outs across our footprint.

Like the other groups, these relationship managers will be complemented with a team of portfolio managers who will assist with underwriting support, portfolio management, and identification of opportunities for additional credit extensions.

It is recognized that we are unable to rely upon relationship managers alone for loan growth.

Instead, a full team to support prudently underwritten loans is needed to minimize risk.

As demonstrated by the expansion of the lending teams, management remains focused on organic loan growth.

No assurance can be provided with regard to future net growth in aggregate loan balances given occasional surges in prepayments, continued forgiveness of PPP loans;

fluctuations in mortgage warehouse lending;

and maintaining concentrations in certain sectors within our risk management parameters.

For 2020, gross loans were up by $700.5 million, or 40%, due largely to $649.9 million of organic growth in commercial real estate non-owner occupied loans.

This growth was a deliberate effort of our Northern and Southern market loan production teams and was facilitated by the opening of a loan production office in Northern California (Roseville, California) and an expansion of the loan team in Southern California.

This growth was complimented by an increase of $118.6 million, or 63% in mortgage warehouse lines and an increase of $93.5 million, or 82% in commercial and industrial loans due to our participation in the SBA PPP loan program.

Multi-family residential loans increased $7.4 million or 14%.

These increases were partially offset by declines in all other loan categories.

As a part of their regulatory oversight, the federal regulators have issued guidelines on sound risk management practices with respect to a financial institution’s concentrations in commercial real estate (“CRE”) lending activities.

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or (2) total CRE loans as defined in the regulatory guidelines represent 300% or more of Tier 1 risk-based capital plus allowance for loan and lease losses, and the institution’s CRE loan portfolio has increased by 50% or more during the prior 36 month period.

This ratio was 378% at December 31, 2020 and declined to 249% at December 31, 2021.

At December 31, 2021, the Bank’s total construction, land development and other land loans represented 12% of Tier 1 risk-based capital plus allowance for loan and lease losses.

At December 31, 2020, the Bank’s total CRE loans as defined in the regulatory guidelines represented 378% of Tier 1 risk-based capital plus allowance for loan and lease losses, and the Bank’s CRE loan portfolio has increased by more than 50% during the prior 36 month period.

Therefore, the Bank believes that the guidelines are applicable to it as it has a potential concentration in CRE loans.

The Bank and its board of directors have discussed the guidelines and believe that the Bank’s underwriting policies, management information systems, independent credit administration process, and monitoring of real estate loan concentrations are sufficient to address the risk management of CRE under the guidelines.

The Bank believes as indicated by the guidelines that it does not have a concentration in CRE loans at December 31, 2021.

However, given that the Bank has recently had a CRE concentration ratio in excess of 300%, the Bank and its board of directors have discussed the guidelines and believe that the Bank’s underwriting policies, management information systems, independent credit administration process, and monitoring of real estate loan concentrations are sufficient to address the risk management of CRE under the guidelines.

Loan and Lease Maturities

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As of December 31, 2021

Due in One Year or Less

Due after One Year through Five Years

Due after Five Years through Fifteen Years

Due after Fifteen Years

Floating rate:

due after one

due after one year

Commercial and industrial

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Consumer loans

Generally, the Company’s contractual life of loans matches the loan’s amortization period.

Generally, the Company’s contractual life of loans matches the loan’s amortization period, which is generally 25 years.

Rates on loans longer than five years typically adjust starting before ten years and each five years thereafter.

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Unused commitments to extend credit totaled $561 million at December 31, 2021, and $450 million at December 31, 2020, although it is not likely that all of those commitments will ultimately be drawn down.

The decrease in 2020 is due in part to a higher utilization of mortgage warehouse lines in 2020.

The increase in 2021 is due in part to a lower utilization of mortgage warehouse lines in 2021.

Unused commitments represented approximately 22% of gross loans outstanding at December 31, 2021 and 18% at December 31, 2020.

The Company also had undrawn letters of credit issued to customers totaling $6.7 million and $8.2 million at December 31, 2021 and 2020, respectively.

Off-balance sheet obligations pose potential credit risk to the Company, and a $0.3 million reserve for unfunded commitments is reflected as a liability in our consolidated balance sheet at December 31, 2020, which was relatively unchanged from the previous year.

Off-balance sheet obligations pose potential credit risk to the Company, and a $0.2 million reserve for unfunded commitments is reflected as a liability in our consolidated balance sheet at December 31, 2021, down $0.1 million from the previous year.

The unused commitments related to mortgage warehouse are unconditionally cancellable at any time.

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However, the “Liquidity” section in this Form 10-K outlines resources available to draw upon should we be required to fund a significant portion of unused commitments.

In addition to unused commitments to provide credit, the Company is utilizing a $105 million letter of credit issued by the Federal Home Loan Bank on the Company’s behalf as security for certain deposits and to facilitate certain credit arrangements with the Company’s customers.

In addition to unused commitments to provide credit, the Company holds two letters of credit with the Federal Home Loan Bank of San Francisco totaling $128.6 million as security for certain deposits and to facilitate certain credit arrangements with the Company’s customers.

That letter of credit is backed by loans which are pledged to the FHLB by the Company.

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Subordinated debentures

Long term debt

Operating leases

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1-4 family - closed-end

Multi-family residential

Commercial real estate - owner occupied

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(2) Loans deferred under the CARES act are not included in nonperforming loans above, nor are they included in the numerators used to calculate the ratios disclosed in the table.

NPAs totaled $8.6 million, or 0.4% of gross loans and leases plus foreclosed assets at the end of 2020, up from $6.5 million, or 0.4% of gross loans and leases plus foreclosed assets at the end of 2019.

$1.4 million of the increase in non-performing loans during 2020, was a result of 10 loans previously deferred under section 4013 of the CARES Act, that were unable to resume their scheduled payments at the end of the deferral period.

NPAs were reduced by $3.2 million, or 34%, during 2018 in response to better economic conditions.

Nonperforming loans secured by real estate comprised $6.3 million of total nonperforming loans at December 31, 2020, an increase of $1.2 million, or 25%, since December 31, 2019.

There were also increases of $0.4 million in commercial & industrial loans and $0.3 million in agricultural production loans.

NPAs totaled $4.6 million, or 0.2% of gross loans and leases plus foreclosed assets at the end of 2021, down from $8.6 million, or 0.4% of gross loans and leases plus foreclosed assets at the end of 2020.

NPAs increased $2.0 million in 2020, of which $1.4 million was a result of 10 loans previously deferred under section 4013 of the CARES Act, that were unable to resume their scheduled payments at the end of the deferral period.

Nonperforming loans secured by real estate comprised $3.1 million of total nonperforming loans at December 31, 2021, a decrease of $3.1 million, or 50%, since December 31, 2020.

There was also an increase of $0.1 million in agricultural production loans but a decrease of $0.1 million in commercial and industrial loans.

Consumer nonperforming loans were mostly unchanged during 2021.

Nonperforming loan balances at December 31, 2021 include $3.0 million in TDRs and other loans that were paying as agreed, but which met the technical definition of nonperforming and were classified as such.

We also had $29.5 million in loans deferred under the CARES Act, which are not treated as TDRs and were still accruing interest at December 31, 2020, and $11.4 million in loans classified as performing TDRs for which we were still accruing interest at December 31, 2020, an increase of $3.0 million, or 35%, relative to December 31, 2019.

We also had $10.4 million in loans deferred under the CARES Act, which are not treated as TDRs and were still accruing interest at December 31, 2021, and $4.9 million in loans classified as performing TDRs for which we were still accruing interest at December 31, 2021, a decrease of $6.5 million, or 57%, relative to December 31, 2020.

Notes 2 and 4 to the consolidated financial statements provide a more comprehensive disclosure of TDR balances and activity within recent periods.

Loan modifications not treated as TDRs were $29.5 million at December 31, 2020.

Two loans for $6.3 million were extensions of loans previously modified, which had matured but needed additional time to resume payments.

Of the total loans modified at year end, $14.7 million, or 50%, are hotels, and $14.0 million, or 47%, are lessors of non-residential buildings.

Approximately 59% of loans currently under modification have maturities within 90 days, with the remaining 41% maturing within 180 days.

Loan modifications not treated as TDRs were $10.4 million at December 31, 2021 and are made to one borrower.

Of the total loans modified at year end, 100%, are lessors of non-residential buildings.

All of the loans currently under modification have maturities within 90 days.

All loans are well secured based on the most recent appraisal.

The balance of foreclosed assets had a carrying value of $1.0 million at December 31, 2020, comprised of 7 properties classified as OREO.

At the end of 2019 foreclosed assets totaled $0.8 million, consisting of 10 properties classified as OREO and two mobile homes.

The balance of foreclosed assets had a carrying value of $0.1 million at December 31, 2021, comprised of one property classified as OREO.

At the end of 2020 foreclosed assets totaled $1.0 million, consisting of 7 properties classified as OREO.

All foreclosed assets are periodically evaluated and written down to their fair value less expected disposition costs, if lower than the then-current carrying value.

Allowance for Loan and Lease Losses

Allowance for Loan and Lease Losses/Allowance for Credit Losses

The allowance for loan and lease losses, a contra-asset, is established through a provision for loan and lease losses.

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recoveries are generally recorded only when sufficient cash payments are received subsequent to the charge off.

Note 2 to the consolidated financial statements provides a more comprehensive discussion of the accounting guidance we conform to and the methodology we use to determine an appropriate allowance for loan and lease losses, including information regarding the Company’s decision to defer implementation of Current Expected Credit Loss ("CECL") accounting method, which was further extended to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022, by the Consolidated Appropriations Act of 2021.

It is expected that the Company’s Allowance for Credit Loss under CECL will be approximately 50% higher than the current Allowance for Loan and Lease Losses, with the initial adjustment being recorded as an adjustment to equity.

The Company’s allowance for loan and lease losses was $14.3 million, or 0.7% of gross loans at December 31, 2021, relative to $17.7 million, or 0.7% of gross loans at December 31, 2020.

The increase in the allowance resulted from the addition of a $8.6 million loan and lease loss provision in 2020, less $0.7 million in net loan charge-offs.

The decrease in the allowance resulted from the release of $3.7 million in loan and lease loss reserves in 2021, plus $0.2 million in net loan recoveries.

Reserves were established for losses inherent in incremental loan balances and unanticipated charge-offs in 2021.

The net increase in the allowance might have been even larger if not for the following circumstances:

The net decrease in the allowance might have resulted in an increase if not for the following circumstances:

charge-offs were recorded against pre-established reserves, which alleviated what otherwise might have been a need for reserve replenishment;

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As described above, a separate allowance of $0.2 million for potential losses inherent in unused commitments is included in other liabilities at December 31, 2021.

The table that follows summarizes the activity in the allowance for loan and lease losses for the periods indicated:

Allowance for Loan and Lease Losses

(dollars in thousands)

The Company recorded a loan and lease loss benefit of $3.7 million in 2021 compared to a loan and lease loss provision of $8.6 million in 2020, and $2.6 million in 2019.

Our allowance for probable losses on specifically identified impaired loans decreased $0.2 million, or 20%, during 2021, whereas it increased $0.2 million, or 20%, during 2020.

The allowance for probable losses inherent in non-impaired loans decreased by $3.3 million, or 20%, as a result of continued improvements in the overall economy, a reduction in historical loss rates, net loan recoveries in 2021, a change in the mix of loans, and lower outstanding balances of net loans and leases.

The following table sets forth the Company’s net charge-offs as a percentage to the average loan balances in each loan category, as well as other credit related ratios at or for the periods indicated:

Credit Ratios

(dollars in thousands, unaudited)

As of and for the years ended December 31,

Average gross loans and leases outstanding during period

Gross loans and leases held for investment

Allowance for Loan and Lease Losses:

Balance at beginning of period

Provision (benefit) charged to expense

1-4 family residential construction

Other construction/land

1-4 family - closed-end

Multi-family residential

Commercial real estate - owner occupied

Commercial real estate - non-owner occupied

TOTAL REAL ESTATE

Commercial and industrial

Mortgage warehouse lines

Consumer loans

Net Charge-offs (Recoveries)

Average Loan Balance

Net Charge-offs (Recoveries)

Average Loan Balance

Net Charge-offs (Recoveries)

Average Loan Balance

1-4 family residential construction

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Consumer loans

Net loan charge-offs (recoveries)

Net loan and lease charge-offs (recoveries) to average loans and leases

Allowance for loan and lease losses to gross loans and leases at end of period

Allowance for loan and lease losses to non-performing loans

Net loan and lease charge-offs (recoveries) to allowance for loan and lease losses at end of period

Net loan charge-offs (recoveries) to provision (benefit) for loan and lease losses

As shown in the table above, the Company recorded a loan and lease loss provision of $8.6 million in 2020 compared to $2.6 million in 2019, and $4.4 million in 2018.

Our allowance for probable losses on specifically identified impaired loans increased $0.2 million, or 20%, during 2020, whereas it was reduced by $1.2 million, or 59%, during 2019.

The allowance

for probable losses inherent in non-impaired loans increased by $7.6 million, or 84%, as a result of potential economic conditions, downgrades of certain loans deferred under section 4013 of the Cares Act and the continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy and our loan customers, potential changes in collateral values due to reduced cash flows, and external factors such as government actions.

The “Provision for Loan and Lease Losses” section above includes additional details on our provision and its relationship to actual charge-offs.

Nonaccrual loans to gross loans and leases at end of period

Allowance for loan and lease losses to nonaccrual loans

Provided below is a summary of the allocation of the allowance for loan and lease losses for specific loan categories at the dates indicated.

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Furthermore, fluctuations in credit quality, changes in economic conditions, updated accounting, or regulatory requirements, and/or other factors could induce us to augment or reduce the allowance.

The Company adopted the current expected credit losses methodology on January 1, 2020, however as previously noted under the Allowance for Loan and Lease Losses section above in March 2020, the Company elected under Section 4014 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to defer the implementation of CECL until the earlier of when the national emergency related to the outbreak of COVID-19 ends or December 31, 2020.

In December 2020, the Consolidated Appropriations Act 2021, extended the deferral of implementation of CECL from December 31, 2020, to the earlier of the first day of the fiscal year, beginning after the national emergency terminates or January 1, 2022.

At the time the initial decision was made, there was a significant economic uncertainty on the local, regional, and national levels as a result of local and state stay-at-home orders, as well as relief measures provided at a national, state, and local level.

It was determined that more time is still needed to assess the impact of the uncertainty and related actions on the Company's allowance for loan and lease losses under the CECL methodology.

The Company’s investments can at any given time consist of debt securities and marketable equity securities (together, the “investment portfolio”), investments in the time deposits of other banks, surplus interest-earning balances in our Federal Reserve Bank (“FRB”) account, and overnight fed funds sold.

The Company adopted the current expected credit losses methodology on January 1, 2020, under FASB Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) to January 1, 2022.

However, as previously noted under the Allowance for Loan and Lease Losses section above in March 2020, the Company elected under Section 4014 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to defer the implementation of CECL.

The Company’s investments may at any given time consist of debt securities and marketable equity securities (together, the “investment portfolio”), investments in the time deposits of other banks, surplus interest-earning balances in our Federal Reserve Bank (“FRB”) account, and overnight fed funds sold.

Surplus FRB balances and fed funds sold to correspondent banks typically represent the temporary investment of excess liquidity.

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1) they provide liquidity to even out cash flows from the loan and deposit activities of customers;

provide a source of pledged assets for securing public deposits, bankruptcy deposits and certain borrowed funds which require collateral;

2) they provide a source of pledged assets for securing public deposits, bankruptcy deposits and certain borrowed funds which require collateral;

3) they constitute a large base of assets with maturity and interest rate characteristics that can be changed more readily than the loan portfolio, to better match changes in the deposit base and other funding sources of the Company;

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and 5) they can provide partially tax exempt income.

Aggregate investments totaled $547.5 million, or 17% of total assets at December 31, 2020, as compared to $615.3 million, or 24% of total assets at December 31, 2019.

Aggregate investments totaled $1.2 billion, or 35% of total assets at December 31, 2021, as compared to $547.5 million, or 17% of total assets at December 31, 2020.

We had no fed funds sold at the end of the reporting periods, and interest-bearing balances held primarily in our Federal Reserve Bank account totaled $193.3 million at December 31, 2021, as compared to $3.5 million at December 31, 2020.

The Company’s investment securities portfolio had a book balance of $544.0 million at December 31, 2020, compared to $600.8 million at December 31, 2019, reflecting a net decrease of $56.8 million for 2020.

The average rate on the interest-bearing balances was 0.14% for 2021.

Due to the low rate on this investment, the Company worked diligently to identify earning assets for purchase.

With respect to the investment portfolio, the Company purchased $332.8 million of AAA and AA-rated Collateralized Loan Obligations (“CLOs”).

These structured investments complement our fixed-rate earning assets as CLOs have rates that adjust quarterly.

In addition, certain loan purchases The Company’s investment securities portfolio had a book balance of $973.3 million at December 31, 2021, compared to $544.0 million at December 31, 2020, reflecting a net increase of $429.3 million, or 79%.

The Company carries investments at their fair market values.

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State and political subdivisions

Corporate bonds

Collateralized loan obligations

Total securities

The net unrealized gain on our investment portfolio, or the amount by which aggregate fair market values exceeded the amortized cost, was $26.1 million at December 31, 2020 as compared to $8.4 million at December 31, 2019, an increase of $17.7 million.

The change in 2020 was caused by lower market interest rates on fixed-rate bond values.

The net unrealized gain on our investment portfolio, or the amount by which aggregate fair market values exceeded the amortized cost, was $15.9 million at December 31, 2021 as compared to $26.1 million at December 31, 2020, a decrease of $10.2 million.

The change in 2021 was caused by higher market interest rates on fixed-rate bond values.

The balance of U.S.

Government agency securities in our portfolio declined by $10.3 million, or 85%, during 2020 due primarily to bond maturities and a strategy to utilize bond repayments to fund higher-yielding loans in 2020.

Similarly, mortgage-backed securities decreased by $86.0 million, or 21% due to prepayments not being reinvested for the above-mentioned strategy.

Municipal bond balances increased by $39.5 million, or 21%.

The municipal bond purchases were mostly made in the first half of 2020.

Government agency securities in our portfolio declined by $0.2 million, or 13%, during 2021 due primarily to bond maturities.

Similarly, mortgage-backed securities decreased by $7.7 million, or 2% due to prepayments not being reinvested.

Municipal bond balances increased by $76.5 million, or 34% due to purchases.

Municipal bonds purchased in recent periods have strong underlying ratings, and all municipal bonds in our portfolio undergo a detailed quarterly review for potential impairment.

CLOs, all AAA or AA rated, were purchased during 2021 for $332.2 million as an asset class diversification strategy as management continues to utilize available liquidity and improve asset sensitivity, as described above.

Investment securities that were pledged as collateral for Federal Home Loan Bank borrowings, repurchase agreements, public deposits and other purposes as required or permitted by law totaled $167.2 million at December 31, 2021 and $232.0 million at December 31, 2020, leaving $806.1 million in unpledged debt securities at December 31, 2021 and $312.0 million at December 31, 2020.

Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $47.0 million at December 31, 2021 and $52.9 million at December 31, 2020.

The table below groups the Company’s investment securities by their remaining time to maturity as of December 31, 2020, and provides weighted average yields for each segment.

Since the actual timing of principal payments may differ from

contractual maturities when obligors have the right to prepay principal, maturities for mortgage-backed securities (including collateralized mortgage obligations) were determined by incorporating expected prepayments.

Maturity and Yield of Available for Sale Investment Portfolio

(dollars in thousands)

December 31, 2020

After Five Years

government agencies

Mortgage-backed securities

State and political subdivisions

Total securities

Cash and Due from Banks

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The Company’s balance of noninterest earning cash and balances due from correspondent banks totaled $63.1 million, or 2% of total assets at December 31, 2021, and $67.9 million, or 2% of total assets at December 31, 2020.

The average balance of non-earning cash and due from banks, which can be used to determine trends, was $72.0 million for 2020 and 2019 and $61.4 million for 2018.

The average balance of non-earning cash and due from banks, which can be used to determine trends, was $75.7 million for 2021 and $72.0 million for 2020 and 2019.

Premises and Equipment

Premises and equipment are stated on our books at cost, less accumulated depreciation, and amortization.

The cost of furniture and equipment is expensed as depreciation over the estimated useful life of the related assets, and leasehold improvements are amortized over the term of the related lease or the estimated useful life of the improvements, whichever is shorter.

The cost of furniture and equipment is expensed as depreciation over the estimated useful life of the related assets, and leasehold

improvements are amortized over the term of the related lease or the estimated useful life of the improvements, whichever is shorter.

The following premises and equipment table reflects the original cost, accumulated depreciation and amortization, and net book value of fixed assets by major category, for the years noted:

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The net book value of the Company’s premises and equipment was 1% of total assets at both December 31, 2021, and December 31, 2020.

Depreciation and amortization included in occupancy and equipment expense totaled $2.8 million in 2020 and 2019.

Depreciation and amortization included in occupancy and equipment expense totaled $3.1 million in 2021 and $2.8 million in 2020.

Goodwill totaled $27.4 million at December 31, 2021, unchanged for the year and other intangible assets were $3.3 million, a decrease of $1.0 million, or 24%, as a result of amortization expense recorded on core deposit intangibles.

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Refer to the “Noninterest Revenue and Operating Expense” section above for a more detailed discussion of BOLI and the income it generates.

The remainder of other assets consists primarily of right-of-use assets tied to operating leases upon the adoption of Accounting Standards Update 2016-02 (Topic 842) in 2019, accrued interest receivable, deferred taxes, investments in bank stocks, other real estate owned, prepaid assets, investments in low income housing credits, and other miscellaneous assets.

The remainder of other assets consists primarily of right-of-use assets tied to operating leases, accrued interest receivable, deferred taxes, investments in bank stocks, other real estate owned, prepaid assets, investments in low-income housing credits, investments in SBA loan funds, and other miscellaneous assets.

The total operating lease right-of-use asset recorded on the books is $10.0 million less accumulated amortization of $4.6 million.

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Noninterest bearing demand deposits

CDAR's < $100,000

Customer time deposit < $100,000

Customer time deposits

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Noninterest bearing demand deposits

CDAR's < $100,000

Customer Time deposit < $100,000

Customer time deposits

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Management is of the opinion that a relatively high level of core customer deposits is one of the Company’s key strengths, and we continue to strive for core deposit retention and growth.

The scheduled maturity distribution of the Company’s time deposits at the end of 2020 was as follows:

Deposit Maturity Distribution

The following table presents the estimated deposits exceeding the FDIC insurance limit:

Uninsured Deposits

(dollars in thousands)

Year Ended December 31,

Uninsured deposits

The estimated aggregate amount of time deposits in excess of the FDIC insurance limit is $58.2 million.

The following table presents the maturity distribution of the estimated uninsured time deposits:

Uninsured Time Deposit Maturity Distribution

(dollars in thousands)

As of December 31, 2021

Time certificates of deposit < $100,000

Other time deposits ≥ $100,000

Over three months through six months

Over six months through twelve months

Uninsured time deposits

Other Borrowings

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The FHLB line is committed, but the amount of available credit depends on the level of pledged collateral.

Total non-deposit interest-bearing liabilities increased $136.5 million, or 298%, in 2020, due to increases in overnight fed funds purchased, FHLB advances, and customer repurchase agreements.

Total non-deposit interest-bearing liabilities decreased $25.8 million, or 12%, in 2021, due primarily to decreases in overnight fed funds purchased, and FHLB advances.

The decreases were partially offset by increases in customer repurchase agreements and long-term debt.

Non-deposit interest-bearing liabilities increased $136.5 million, or 298%, in 2020, due to increases in overnight fed funds purchased, FHLB advances, and customer repurchase agreements.

These increases were primarily to fund fluctuations in our mortgage warehouse loan balances.

Non-deposit interest-bearing liabilities were down by $26.7 million, or 25%, in 2019, due to decreases in FHLB borrowings, partially offset by increases in customer repurchase agreements.

The Company had $100.0 million in overnight fed funds purchased, $37.9 million in overnight FHLB advances, and $5.0 million in short-term borrowings from the FHLB at December 31, 2020, as compared to $20.0 million in overnight FHLB borrowings at December 31, 2019.

There were no overnight federal funds purchased from other correspondent banks or advances from the FRB on our books at December 31, 2019.

Repurchase agreements totaled over $39.1 million at year-end 2020 relative to a balance of $25.7 million at year-end 2019.

The Company had no overnight fed funds purchased, overnight FHLB advances or short-term borrowings from the FHLB at December 31, 2021, as compared to $100.0 million in overnight fed funds purchased, $37.9 million in overnight FHLB advances and $5.0 million in short-term borrowings from the FHLB at December 31, 2020.

Repurchase agreements totaled $106.9 million at year-end 2021 relative to a balance of $39.1 million at year-end 2020.

Repurchase agreements represent “sweep accounts”, where commercial deposit balances above a specified threshold are transferred at the close of each business day into non-deposit accounts secured by investment securities.

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The small increase resulted from the amortization of discount on junior subordinated debentures that were part of our acquisition of Coast Bancorp in 2016.

Long term debt increased to $49.1 million for the year ended December 31, 2021, from the issuance of $50 million in 3.25% fixed – floating subordinated debt with a ten-year maturity in the third quarter of 2021.

The Company contributed $25 million of additional capital to the Bank in the fourth quarter of 2021 and is utilizing the remainder of the funds for general corporate purposes, which includes repurchasing shares of common stock, among other things.

The details of the Company’s short-term borrowings are presented in the table below, for the years noted:

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Other liabilities are principally comprised of accrued interest payable, other accrued but unpaid expenses, and certain clearing amounts.

The Company’s balance of other liabilities decreased by $0.4 million, or 1%, during 2020.

The Company’s balance of other liabilities increased by $0.5 million, or 1%, during 2021.

Capital Resources

The Company had total shareholders’ equity of $362.5 million at December 31, 2021 as compared to $343.9 million at December 31, 2020.

The increase of $34.6 million, or 11%, is due to $35.4 million in net income and approximately $1.5 million in additional capital related to stock options, a $12.5 million increase in our accumulated other comprehensive income, net of $12.2 million in dividends paid and $2.6 million in stock repurchased.

We maintained a very strong capital position throughout the recession and in the ensuing years, and our capital remains at relatively high levels in comparison to many of our peer banks.

The increase of $18.6 million, or 5%, is due to $43.0 million in net income and approximately $1.2 million in additional capital related to equity compensation, net of a $7.2 million decrease in our accumulated other comprehensive income, $13.2 million in dividends paid and $5.2 million in stock repurchased.

The federal banking agencies published a final rule on November 13, 2019, that provided a simplified measure of capital adequacy for qualifying community banking organizations.

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The federal bank regulatory agencies adopted an interim final rule to implement this change from the CARES Act.

The Company and the Bank meet the criteria outlined in the final rule and the interim final rule and adopted the community bank leverage ratio framework in the first quarter 2020.The Company uses a variety of measures to evaluate its capital adequacy, including the community bank leverage ratio, which the Company adopted in 2020, and risk-based capital and leverage ratios in preceding years, that are calculated separately for the Company and the Bank.

leverage ratios in preceding years, that are calculated separately for the Company and the Bank.

Management reviews these capital measurements on a quarterly basis and takes appropriate action to help ensure that they meet or surpass established internal and external guidelines.

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Bank of the Sierra

Common Equity Tier 1 Capital Ratio

Sierra Bancorp and subsidiary

Bank of the Sierra

Tier 1 Risk-Based Capital Ratio

Sierra Bancorp and subsidiary

Bank of the Sierra

Total Risk-Based Capital Ratio

Sierra Bancorp and subsidiary

Bank of the Sierra

Tier 1 (Core) Capital to average total assets

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At the end of 2021, as our Community Bank Leverage Ratio exceeded 8.5%, the Company and the Bank were both classified as “well capitalized,” the highest rating of the categories defined under the Bank Holding Company Act and the Federal Deposit Insurance Corporation Improvement Act of 1991, and our regulatory capital ratios remained above the median for peer financial institutions.

Similar, under the Capital Adequacy Guidelines in 2019, the Company and the Bank were both classified as “well capitalized”.

We do not foresee any circumstances that would cause the Company or the Bank to be less than “well capitalized”, although no assurance can be given that this will not occur.

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Liquidity ratios are also calculated and reviewed on a regular basis.

those ratios are merely indicators and are not measures of actual liquidity, they are closely monitored, and we are committed to maintaining adequate liquidity resources to draw upon should unexpected needs arise.

While those ratios are merely indicators and are not measures of actual liquidity, they are closely monitored, and we are committed to maintaining adequate liquidity resources to draw upon should unexpected needs arise.

The Company, on occasion, experiences cash needs as the result of loan growth, deposit outflows, asset purchases or liability repayments.

To meet short-term needs, we can borrow overnight funds from other financial institutions, draw advances via Federal Home Loan Bank lines of credit, or solicit brokered deposits if customer deposits are not immediately obtainable from local sources.

Availability on lines of credit from correspondent banks and the FHLB totaled $710.4 million at December 31, 2020.

obtainable from local sources.

Availability on lines of credit from correspondent banks and the FHLB totaled $1.1 billion at December 31, 2021.

The Company was also eligible to borrow approximately $51.0 million at the Federal Reserve Discount Window based on pledged assets at December 31, 2021.

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Management is of the opinion that available investments and other potentially liquid assets, along with standby funding sources it has arranged, are more than sufficient to meet the Company’s current and anticipated short-term liquidity needs.

At December 31, 2021 and December 31, 2020, the Company had the following sources of primary and secondary liquidity (dollars in thousands):

Primary and Secondary Liquidity Sources

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The Company did not experience a change in its ability to access traditional funding sources due to the COVID-19 pandemic.

The Company had adequate sources of cash to accommodate pandemic related cash needs such as the ability to defer $424.0 million in loans under the CARES act and to fund $128.1 million in SBA PPP loans.

The Company had adequate sources of cash to accommodate pandemic related cash needs over the past two years such as the ability to defer $424.0 million in loans under the CARES act and to fund $177.9 million in SBA PPP loans.

There were no material operational expenditures related to the COVID-19 pandemic, other than $0.1 million for software purchased to accommodate the processing of SBA PPP loans.

The Company is approved to borrow from the Federal Reserve’s Paycheck Protection Program Liquidity Facility (PPPLF) for any current balances of PPP loans at the time of borrowing.

Should the Company wish to draw on the PPPLF, it would be required do so prior to June 30, 2021, and will be required to pledge individual SBA PPP loans as collateral.

The loans are taken as collateral at their face value.

Due to the Company's liquidity at December 31, 2020, and expected liquidity in the first quarter of 2021, it has elected not to utilize the PPPLF at this time.

The Company’s net loans to assets and available investments to assets ratios were 59% and 31%, respectively, at December 31, 2021, as compared to internal policy guidelines of “less than 78%” and “greater than 3%.” Other liquidity ratios reviewed periodically by Management and the Board include net loans to total deposits and wholesale funding to total assets (including ratios and sub-limits for the various components comprising wholesale funding), which were all well within policy guidelines at December 31, 2021.

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Our market risk exposure is primarily that of interest rate risk, and we have established policies and procedures to monitor and limit our earnings and balance sheet exposure to changes in interest rates.

The principal objective of interest rate risk management is to manage the financial components of the Company’s balance sheet in a manner that will optimize the risk/reward equation for earnings and capital under a variety of interest rate scenarios.

The principal objective of interest rate risk management

is to manage the financial components of the Company’s balance sheet in a manner that will optimize the risk/reward equation for earnings and capital under a variety of interest rate scenarios.

To identify areas of potential exposure to interest rate changes, we utilize commercially available modeling software to perform monthly earnings simulations and calculate the Company’s market value of portfolio equity under varying interest rate scenarios.

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The rate projections can be shocked (an immediate and parallel change in all base rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from current actual levels).

In addition to a stable rate scenario, which presumes that there are no changes in interest rates, we typically use at least six other interest rate scenarios in conducting our rolling 12-month net interest income simulations:

In addition to a stable rate scenario, which presumes that there are no changes in interest rates, we typically use at least eight other interest rate scenarios in conducting our rolling 12-month net interest income simulations:

upward shocks of 100, 200, 300, and 400 basis points, and downward shocks of 100, 200, and 300 basis points.

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Given the current near zero interest rate environment it is unlikely that rates could decline much further beyond the downward shock of 100 basis points, therefore the downward shock scenarios of 200 and 300 basis points are temporarily being suspended after concurrence by the Company’s Board of Directors.

We currently utilize an additional upward rate shock scenario of 400 basis points.

Pursuant to policy guidelines, we generally attempt to limit the projected decline in net interest income relative to the stable rate scenario to no more than 5% for a 100 basis point (bp) interest rate shock, 10% for a 200 bp shock, 15% for a 300 bp shock, and 20% for a 400 bp shock.

The Company had the following estimated net interest income sensitivity profiles over one-year, without factoring in any potential negative impact on spreads resulting from competitive pressures or credit quality deterioration:

December 31, 2021

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$ Change in Net Interest Income

Our current simulations indicate that the Company’s net interest income will remain relatively flat over the next 12 months in the up 100 and 200 basis point scenarios but declines after that in a rising rate environment, indicating that the Company is liability sensitive;

furthermore, a drop in interest rates could have a substantial negative impact on earnings.

For the prior year ending December 31, 2019 the simulations projected sizeable increases in net interest income in rising rate scenarios, but balance sheet changes in 2020 such as the addition of fixed-rate loans and long-term adjustable-rate loans with longer reset periods, compounded by the Company’s increase in its current overnight borrowing position have significantly diminished that effect.

If there were an immediate and sustained upward adjustment of 100 basis points in interest rates, all else being equal, net interest income over the next 12 months is projected to improve by only $0.6 million, or 0.51%, relative to a stable interest rate scenario, with the favorable variance diminishing as interest rates rise higher.

The simulation for the period ending December 31, 2021, indicates that the Company is asset sensitive, with sizeable increases in net interest income in rising rate scenarios, however a continued drop in interest rates could have a substantial negative impact.

The change in the magnitude of the Company’s asset sensitivity based on its interest rate risk model at December 31, 2021, as compared to December 31, 2020, is due mostly to the level of overnight cash held as an interest bearing deposit at the Federal Reserve Bank.

At December 31, 2021, the Company had $193.2 million in overnight cash with the Federal Reserve Bank compared to $2.4 million at December 31, 2020.

As this cash is held overnight, any change in interest rate in the model would increase the yield on such overnight cash immediately, therefore, increasing the Company’s asset sensitivity.

For the prior year ending December 31, 2020 the simulations indicate that the Company’s net interest income will remain relatively flat over the next 12 months in the up 100 and 200 basis point scenarios but declines after that in a rising rate environment, indicating that the Company was potentially liability sensitive;

furthermore, a drop in interest rates could have had a substantial negative impact on earnings.

If there were an immediate and sustained upward adjustment of 100 basis points in interest rates, all else being equal, net interest income over the next 12 months is projected to improve by $5.8 million, or 6%, relative to a stable interest rate scenario, with the favorable variance increasing as interest rates rise higher.

If interest rates were to decline by 100 basis points, however, net interest income would likely be around $10.5 million lower than in a stable interest rate scenario, for a negative variance of 10%.

In addition to the net interest income simulations shown above, we run stress scenarios for the unconsolidated Bank modeling the possibility of no balance sheet growth, the potential runoff of “surge” core deposits which flowed into the Bank in the most recent economic cycle, and unfavorable movement in deposit rates relative to yields on earning assets (i.e., higher deposit betas).

When no balance sheet growth is incorporated and a stable interest rate environment is assumed, projected annual net interest income is about $3.4 million lower than in our standard simulation.

When no balance sheet growth is incorporated and a stable interest rate environment is assumed, projected annual net interest income is about $9.5 million lower, or 9% than in our standard simulation.

However, the stressed simulations reveal that the Company’s greatest potential pressure on net interest income would result from excessive non-maturity deposit runoff and/or unfavorable deposit rate changes in rising rate scenarios.

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The change in economic value under different interest rate scenarios depends on the characteristics of each class of financial instrument, including stated interest rates or spreads relative to current or projected market-level interest rates or spreads, the likelihood of principal prepayments, whether contractual interest rates are fixed or floating, and the average remaining time to maturity.

As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline.

As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios

and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline.

The longer the duration of the financial instrument, the greater the impact a rate change will have on its value.

In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on historical patterns and Management’s best estimates.

The table below shows estimated changes in the Company’s EVE as of December 31, 2020, and 2019, under different interest rate scenarios relative to a base case of current interest rates:

The table below shows estimated changes in the Company’s EVE as of December 31, 2021, and 2020, under different interest rate scenarios relative to a base case of current interest rates (dollars in thousands):

December 31, 2021

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Our EVE deltas have increased given the relative starting points of our non-maturity deposits in the current rate environment.

In other words, as the current rates are very low, the value of the non-maturity deposits is lower than it has been historically.

Specifically, as the current rates are very low, the value of the non-maturity deposits is lower than it has been historically.

The impact of an increase in rates has an expected greater magnitude impact on the value of such deposits.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis