What changed in this filing

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Item 7. Management’s Discussion and Analysis

2021-03-15 compared with 2020-03-13 · 382 added, 570 removed, 679 unchanged (58% of the section changed)

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Although the Company has initiated efforts to expand its geographic footprint into the East Bay area of San Francisco and Napa, California (see “Item 1.

Business – Service Area), the Company’s primary service area

remains the mid Central Valley of California, a region that can be significantly impacted by the seasonal needs of the agricultural industry.

Accordingly, discussion of the Company’s Financial Condition and Results of Operations is influenced by the

seasonal banking needs of its agricultural customers (e.g., during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and planting of crops.

Correspondingly, deposit balances

are replenished and loans repaid in late fall and winter as crops are harvested and sold).

Business – Service Area”), the Company’s primary service area remains the mid Central Valley of California, a region that can be significantly impacted by the seasonal needs of the agricultural industry.

Accordingly, discussion of the Company’s Financial Condition and Results of Operations is influenced by the seasonal banking needs of its agricultural customers (e.g., during the spring and summer customers draw down their deposit balances and increase loan borrowing to fund the purchase of equipment and planting of crops.

Correspondingly, deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold).

The Five-Year Period:

2016 through 2020

Through much of 2007 the economy in our primary service area was strong, the stock market rising and individuals and businesses doing well.

Then in October 2007 the financial markets started what would become a major

adjustment and an economic recession began, the impact of which is still being felt today in the Central Valley of California.

The Central Valley was one of the hardest hit areas in the country during the recession.

In many areas, housing prices

declined as much as 60% and unemployment reached 15% or more.

Although the economy has improved throughout most of the Central Valley, in many of the Company’s market segments housing prices remain below peak levels and unemployment levels remain

above those in other areas of the state and country.

By early 2020 the Company’s primary service area had significantly recovered from the recession that began in late 2007.

Then, late in the first quarter of 2020 the COVID-19 pandemic began, an event that would impact economies everywhere.

Importantly, agriculture has been designated as an “essential” industry during the pandemic, helping to mitigate economic stress in the Company’s primary service area.

Despite this challenging economic environment, in management’s opinion, the Company’s operating performance over the past five years has been exceptionally strong.

We used certain non-GAAP financial measures to provide supplemental information regarding our performance in 2017.

Income Tax Expense for the year ended 2017 included a one-time, non-cash $6.3 million charge related to

the re-measurement of the Company’s Deferred Tax Asset (“DTA”) as a result of the passage of the Tax Cuts and Jobs Act in 2017.

We believed that presenting Adjusted Net Income, excluding the impact of the DTA re-measurement charge, provides

additional clarity to the users of financial statements regarding core financial performance and allows for a better year-over-year comparison of trends in core profitability.

Income Tax Expense for the year ended 2017 included a one-time, non-cash $6.3 million charge related to the re-measurement of the Company’s Deferred Tax Asset (“DTA”) as a result of the passage of the Tax Cuts and Jobs Act in 2017.

We believed that presenting Adjusted Net Income, excluding the impact of the DTA re-measurement charge, provides additional clarity to the users of financial statements regarding core financial performance and allows for a better year-over-year comparison of trends in core profitability.

(in thousands, except per share data)

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Among other things, this legislation reduced the corporate tax rate from 35% to 21% beginning January 1, 2018.

Company believes that this reduction in the corporate tax rate will continue to have a significant positive impact on future financial performance, U.S.

generally accepted accounting principles require that all companies re-measure their DTA’s using

the new lower tax rate as of the date of enactment of the legislation.

As a result the Company’s net income for 2017 included a $6.3 million re-measurement reflected as a one-time, non-cash increase to income tax expense in the 4 th

Although the Company believes that this reduction in the corporate tax rate will continue to have a significant positive impact on future financial performance, U.S.

generally accepted accounting principles require that all companies re-measure their DTA’s using the new lower tax rate as of the date of enactment of the legislation.

As a result the Company’s net income for 2017 included a $6.3 million re-measurement reflected as a one-time, non-cash increase to income tax expense in the 4 th quarter.

Our situation is not unique in that the majority of all financial institutions reported significant DTA re-measurements in the 4 th quarter of 2017.

Excluding the impact of the $6.3 million DTA re-measurement, non-GAAP adjusted net

income for the year totaled $34.6 million, an increase of $5.0 million or 16.8% over the prior year, which would have resulted in an adjusted return on average assets of 1.15% and adjusted return on average equity of 11.79%.

Excluding the impact of the $6.3 million DTA re-measurement, non-GAAP adjusted net income for the year totaled $34.6 million, an increase of $5.0 million or 16.8% over the prior year, which would have resulted in an adjusted return on average assets of 1.15% and adjusted return on average equity of 11.79%.

Management believes that the Company’s performance compared very favorably to its peer banks during the five-year period ended December 31, 2020:

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See “Financial Condition – Capital.”

The Company continued to diversify its geographic footprint by acquiring (1) Delta National Bancorp with branches in Turlock, Manteca and Riverbank;

and (2) Bank of Rio Vista with branches in Rio Vista and Walnut Grove.

The Company’s asset quality remains very strong at the present time, when measured by:

(1) net charge-offs at 0.02% of average loans & leases during 2020;

(2) no non-accrual loans at December 31, 2019;

and (3) substandard loans

& leases totaling 0.61% of total loans & leases at December 31, 2019.

(2) non-accrual loans of $495,000 at December 31, 2020;

and (3) substandard loans & leases totaling 0.60% of total loans & leases at December 31, 2020.

See “Results of Operations – Provision and Allowance for Credit Losses” and “Financial Condition – Classified Loans & Leases and Non-Performing Assets.”

Because of our strong earnings performance, capital position, and asset quality, stockholders have benefited from the fact that cash dividends per share have increased 11.8% since 2014, and totaled $67.65 per share

over the five-year period.

Because of our strong earnings performance, capital position, and asset quality, stockholders have benefited from the fact that cash dividends per share have increased 14.34% since 2015, and totaled $69.50 per share over the five-year period.

The 2020 dividend of $14.75 per share represents a 1.94% yield based upon the December 31, 2020 closing stock price of $760 per share (See “Part II, Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters

and Issuer Purchases of Equity Securities”).

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities”).

Looking Forward:

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In management’s opinion, the following key issues will continue to influence the financial results of the Company in 2021 and future years:

The continuing impact of COVID-19.

The Company’s earnings are heavily dependent on its net interest margin, which is sensitive to such factors as:

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(2) the mix of our earning assets and interest-bearing liabilities;

and (3) competitor pricing

Between December 2015 and December 2018, the FRB increased short-term market rates by 2.25%.

However, beginning in August 2019 the FRB then dropped rates by .75%.

Although short-term rates may continue to drop in 2020, Management does

not expect them to change significantly.

Loans & Leases increased $1.0 billion, or 56.1% over the past five years, partially as a result of our expansion into Walnut Creek, Concord, Napa and equipment leasing, as well as our acquisitions of Delta Bank and Bank of Rio

However, we still face a very competitive business environment, and no assurances can be given that this recent growth in the loan & lease portfolio will continue.

Aggressive competitor pricing for loans, leases and deposits continues to require the Company to respond in order to retain key customers.

As a result of increases in short-term market interest rates, which began in 2015, the Company’s net interest margin increased from 3.87% for the year ended December 31, 2015 to 4.34% for the year ended December 31,

However, because of the decreases in short-term rates that began in August 2019, Management believes that the net interest margin will be lower in 2020.

Additionally, competitor pricing pressures may adversely affect the net interest margin in

See “Item 7A.

Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk.”

and (3) competitor pricing strategies.

Since early 2020 market interest rates have declined and remain at very low levels.

This has adversely impacted the Company’s NIM, and will, in all probability, continue to place pressure on NIM in 2021.

The Company’s results are impacted by changes in the credit quality of its borrowers.

Substandard loans & leases totaled $18.6 million or 0.60% of total loans & leases at December 31, 2020 vs.

$15.1 million or 0.59% of total

loans & leases at December 31, 2018.

$16.2 million or 0.61% of total loans & leases at December 31, 2019.

Management believes, based on information currently available, that these levels are adequately covered by the Company’s $58.9 million allowance for credit losses as of December 31, 2020.

“Results of Operations - Provision and Allowance for Credit Losses” and “Financial Condition – Classified Loans & Leases and Non-Performing Assets.” The Company’s provision for credit losses was $200,000 in 2019, compared to $5.5

million in 2018 and $2.9 million in 2017.

See “Results of Operations - Provision and Allowance for Credit Losses” and “Financial Condition – Classified Loans & Leases and Non-Performing Assets.” The Company’s provision for credit losses was $4.5 million in 2020, compared to $200,000 in 2019 and $5.5 million in 2018.

See “Item 1A.

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Since the passage of the Dodd-Frank Act in 2010, Congress has implemented broad changes to the regulation of consumer financial products and the financial services industry as a whole.

These changes have, and will continue to have, a

significant effect on the Company’s product offerings, pricing and profitability in areas such as debit and credit cards, home mortgages and deposit service charges.

The Company has (i) expanded its geographic footprint through denovo branch expansion in Walnut Creek, Napa, Lockeford and Concord, CA and through acquisition in Manteca, Riverbank, Rio Vista, and Walnut Grove, CA and (ii) established

equipment leasing as a new line of business.

Although Management believes that these initiatives will result in increased asset growth and earnings, along with reduced concentration risks, the start-up costs related to staff and

facilities are significant and will take time to recoup.

These changes have, and will continue to have, a significant effect on the Company’s product offerings, pricing and profitability in areas such as debit and credit cards, home mortgages and deposit service charges.

The Company has:

(i) expanded its geographic footprint through de novo branch expansion in Walnut Creek, Napa, Lockeford and Concord, CA and through acquisition in Manteca, Riverbank, Rio Vista, and Walnut Grove, CA;

and (ii) established equipment leasing as a new line of business.

Although Management believes that these initiatives will result in increased asset growth and earnings, along with reduced concentration risks, the start-up costs related to staff and facilities are significant and will take time to recoup.

The Company benefited significantly in 2018 and 2019, and should continue to benefit in future years, from the reduction of the federal corporate tax rate from 35% to 21% pursuant to the recently enacted Tax Cuts and Jobs Act.

However, if the new Biden administration increases federal corporate tax rates it will negatively impact the Company’s future financial results.

Results of Operations

31, 2019 and the material changes in financial condition, operating income, and expense of the Company and its subsidiaries as shown in the accompanying consolidated financial statements.

The following discussion and analysis is intended to provide a better understanding of Farmers & Merchants Bancorp and its subsidiaries’ performance during each of the years in the three-year period ended December 31, 2020 and the material changes in financial condition, operating income, and expense of the Company and its subsidiaries as shown in the accompanying consolidated financial statements.

Impact of Bank of Rio Vista Acquisition on Results of Operations

On October 10, 2018, Farmers & Merchants Bancorp completed the acquisition of Bank of Rio Vista.

Since the acquisition took place late in the year, and Bank of Rio Vista had only $217.5 million in assets (less than

6% of Farmers & Merchants Bancorp’s total assets), the impact on the Company’s 2018 Results of Operations was limited with the exception of legal fees, contract termination costs and systems conversion costs that were booked as non-interest

expense by the Company in 2018.

Since the acquisition took place late in the year, and Bank of Rio Vista had only $217.5 million in assets (less than 6% of Farmers & Merchants Bancorp’s total assets), the impact on the Company’s 2018 Results of Operations was limited with the exception of legal fees, contract termination costs and systems conversion costs that were booked as non-interest expense by the Company in 2018.

The gross amount of such expenses were $2.93 million.

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The tables on the following pages reflect the Company's average balance sheets and volume and rate analysis for the years ended 2020, 2019 and 2018.

Average balance amounts for assets and liabilities are the computed

average of daily balances.

Average balance amounts for assets and liabilities are the computed average of daily balances.

Net interest income is the amount by which the interest and fees on loans & leases and other interest-earning assets exceed the interest paid on interest-bearing sources of funds.

For the purpose of analysis, the

interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes.

For the purpose of analysis, the interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes.

This adjustment is referred to as “tax equivalent” adjustment and is noted wherever applicable.

presentation of net interest income and net interest margin on a tax equivalent basis is a common practice within the banking industry.

The presentation of net interest income and net interest margin on a tax equivalent basis is a common practice within the banking industry.

The Volume and Rate Analysis of Net Interest Income summarizes the changes in interest income and interest expense based on changes in average asset and liability balances (volume) and changes in average rates (rate).

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(1) changes in volume (change in volume multiplied by initial rate);

(2) changes in rate (change in rate

multiplied by initial volume);

(2) changes in rate (change in rate multiplied by initial volume);

and (3) changes in rate/volume, also called “changes in mix” (allocated in proportion to the respective volume and rate components).

The Company’s earning assets and interest bearing liabilities are subject to repricing at different times, which exposes the Company to income fluctuations when interest rates change.

In order to minimize income

fluctuations, the Company attempts to match asset and liability maturities.

In order to minimize income fluctuations, the Company attempts to match asset and liability maturities.

However, some maturity mismatch is inherent in the asset and liability mix.

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Interest Rate Spread (4)

Demand Deposits

Demand Deposits (Non-Interest Bearing)

All Other Liabilities

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Net Interest Income

Yields on municipal securities have been calculated on a fully taxable equivalent basis.

Loan interest income includes fee income and unearned discount in the amount of $5.8 million for the year ended December 31, 2019.

Non-accrual loans

and lease financing receivables have been included in the average balances.

Yields on securities available-for-sale are based on historical cost.

(1) Yields and interest income are calculated on an fully taxable equivalent basis using the current statutory federal tax rate.

(2) Average balances on loans & leases outstanding include non-performing loans, if any.

The amortized portion of net loan origination fees is included in interest income on loans & leases, representing an adjustment to the yield.

(3) Includes CARES Act Small Business Administration Paycheck Protection Program loans.

(4) Interest rate spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.

(5) Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets.

Farmers & Merchants Bancorp

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Total Earning Assets

Unrealized Loss on Securities Available-for-Sale

Unrealized Gain on Securities Available-for-Sale

Allowance for Credit Losses

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Loan interest income includes fee income and unearned discount in the amount of $5.8 million for the year ended December 31, 2019.

Non-accrual loans

and lease financing receivables have been included in the average balances.

Non-accrual loans and lease financing receivables have been included in the average balances.

Yields on securities available-for-sale are based on historical cost.

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Government Agency & Government-Sponsored Entities

Municipals - Taxable

Obligations of States and Political Subdivisions - Non-Taxable

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Total Earning Assets

Unrealized Gain on Securities Available-for-Sale

Unrealized Loss on Securities Available-for-Sale

Allowance for Credit Losses

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Loan interest income includes fee income and unearned discount in the amount of $5.5 million for the year ended December 31, 2018.

Non-accrual loans

and lease financing receivables have been included in the average balances.

Non-accrual loans and lease financing receivables have been included in the average balances.

Yields on securities available-for-sale are based on historical cost.

Farmers & Merchants Bancorp

Volume and Rate Analysis of Net Interest Revenue

(Interest and Rates on a Taxable Equivalent Basis)

Volume and Rate Analysis of Net Interest Income

(Rates on a Taxable Equivalent Basis)

(in thousands)

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Total Investment Securities

Loans & Leases:

Home Equity Lines and Loans

Total Loans & Leases

Total Earning Assets

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Interest Bearing Deposits:

Interest Bearing DDA

Savings and Money Market

Time Deposits

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Total Interest Bearing Liabilities

(1) Includes CARES Act Small Business Administration Paycheck Protection Program loans.

Rate/volume variance is allocated based on the percentage relationship of changes in volume and changes in rate to the total "net change." The above figures have been rounded to the nearest whole number.

Farmers & Merchants Bancorp

Volume and Rate Analysis of Net Interest Revenue

Volume and Rate Analysis of Net Interest Income

(Interest and Rates on a Taxable Equivalent Basis)

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Total Interest Bearing Deposits

Other Borrowed Funds

Subordinated Debt

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Net interest income increased 6.15% to $149.2 million during 2020.

On a fully tax equivalent basis, net interest income increased 12.0% and totaled $141.0 million during 2019 compared to $125.9 million for 2018.

more fully discussed below, the increase in net interest income was due primarily to a $289.1 million increase in average earning assets, and a 9 basis point increase in the net interest margin.

On a fully tax equivalent (TE) basis, net interest income increased 6.14% and totaled $149.6 million during 2020 compared to $141.0 million for 2019.

As more fully discussed below, the increase in net interest income was due primarily to a $599.1 million increase in average earning assets offset by a 45 basis point decrease in the net interest margin.

Net interest income on a tax equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin.

For 2019, the Company’s net interest margin was 4.34% compared to

4.25% in 2018 This increase in net interest margin was due primarily to an increase of 0.22% in the yield received on earning assets, offset somewhat by a 0.21% increase in the rates paid on interest bearing liabilities.

For 2020, the Company’s net interest margin was 3.89% compared to 4.34% in 2019.

This decrease in net interest margin was due primarily to a decrease of 0.61% in the yield received on earning assets, offset somewhat by a 0.23% decrease in the cost of interest bearing liabilities.

Average loans & leases totaled $2.9 billion for the year ended December 31, 2020;

an increase of $349.0 million compared to the year ended December 31, 2019.

Loans & leases increased from 79.4% of average

earning assets during 2018 to 79.7% in 2019.

The year-to-date yield on the loan & lease portfolio increased to 5.30% for the year ended December 31, 2019, compared to 5.10% for the year ended December 31, 2018.

This higher yield combined with the

impact of increased average loan & lease balances resulted in interest revenue from loans & leases increasing 14.5% to $137.2 million for 2019.

The Company continues to experience aggressive competitor pricing for loans & leases to which

it may need to respond in order to retain key customers.

A significant portion of this increase was due to loans funded under the SBA PPP.

Since April 2020, we have funded $347.4 million of loans for 1,540 of our small business customers.

(See “Introduction - COVID-19 (Coronavirus) Disclosure” for additional information).

Loans & leases decreased from 79.7% of average earning assets during 2019 to 76.4% in 2020.

The year-to-date yield on the loan & lease portfolio decreased to 4.88% for the year ended December 31, 2020, compared to 5.30% for the year ended December 31, 2019.

Some of this decrease was due to $347.4 million of PPP loans funded at a rate of 1.00% (plus accreted loan fees) with the remaining decrease due to an overall drop in market interest rates.

This lower yield was offset by the positive impact of increased average loan & lease balances resulting in interest revenue from loans & leases to increase by 4.48% to $143.4 million.

The Company continues to experience aggressive competitor pricing for loans & leases to which it may need to respond in order to retain key customers.

This could place negative pressure on future loan & lease yields and net interest margin.

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(1) mortgage-backed securities issued by government-sponsored entities;

securities issued by the U.S.

(2) debt securities issued by the U.S.

Treasury, government agencies and government-sponsored entities;

and (3) investment grade bank-qualified municipal bonds.

However, at certain times the Company selectively added investment grade corporate securities

(floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity.

Since the risk factor for these types of investments is generally lower than

that of loans & leases, the yield earned on investments is generally less than that of loans & leases.

Average investment securities decreased $35.6 million in 2019 compared to the average balance during 2018.

The average yield, on a tax equivalent basis, in the investment portfolio was 2.81% in 2019 compared to 2.44%

This overall increase in yield was caused primarily by an increase in the mix of mortgage-backed securities as a percentage of total securities and an increase in market interest rates.

As a result of the combined impact of these mix,

balance and yield changes, tax equivalent interest income on securities increased slightly by $710,000 to $12.0 million for the year ended December 31, 2019, compared to $11.3 million for the year ended December 31, 2018.

See “Financial Condition –

Investment Securities” for a discussion of the Company’s investment strategy in 2019.

Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates is shown on a tax equivalent basis, which is higher than net interest income

as reflected on the Consolidated Statements of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.

However, at certain times the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 7 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity.

Since the risk factor for these types of investments is generally lower than that of loans & leases, the yield earned on investments is generally less than that of loans & leases.

Average investment securities increased $156.6 million in 2020 compared to the average balance during 2019.

The average yield, on a tax equivalent basis, in the investment portfolio was 2.48% in 2020 compared to 2.81% in 2019.

This overall decrease in yield was caused primarily by a decrease in market interest rates.

As a result, of the combined impact of mix, balance and yield changes, tax equivalent interest income on securities increased $2.5 million to $14.5 million for the year ended December 31, 2020, compared to $12.0 million for the year ended December 31, 2019.

See “Financial Condition – Investment Securities” for a discussion of the Company’s investment strategy in 2020.

Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates, is shown on a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statements of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.

Interest-bearing deposits with banks and overnight investments in Federal Funds Sold are additional earning assets available to the Company.

Average interest-bearing deposits with

banks consisted primarily of FRB deposits.

Balances with the FRB earn interest at the Fed Funds rate, which decreased to 1.55% in December 2019.

Average interest-bearing deposits with banks for the year ended

December 31, 2019, was $232.6 million, a increase of $84.9 million compared to the average balance for the year ended December 31, 2018.

Interest income on interest-bearing deposits with banks for the year ended December 31, 2019, increased $2.2

million to $4.9 million from the year ended December 31, 2018.

Average interest-bearing deposits with banks consisted primarily of FRB deposits.

Balances with the FRB earn interest at the Fed Funds rate, which decreased to .10% in December 2020 compared to 1.55% in December 2019.

Average interest-bearing deposits with banks for the year ended December 31, 2020, was $326.2 million, an increase of $93.6 million compared to the average balance for the year ended December 31, 2019.

Interest income on interest-bearing deposits with banks for the year ended December 31, 2020, decreased $3.7 million to $1.2 million from the year ended December 31, 2019.

Average interest-bearing liabilities increased $286.1 million or 13.4% during the year ended December 31, 2020 compared to the average balance during 2019.

Of that increase:

(1) interest-bearing transaction deposits

increased $50.1 million;

(1) interest-bearing transaction deposits increased $118.5 million;

(2) savings and money market deposits increased $198.2 million;

and (3) time deposits increased $43.1 million.

See “Financial Condition – Deposits” for a discussion of trends in the Company’s deposit base.

Total interest

expense on deposits was $12.6 million for 2019 and $7.4 million for 2018.

As a result of increasing short-term market interest rates and competition, the average rate paid on interest-bearing deposits was 0.60% in 2019 and 0.38% in 2018.

“Overview – Looking Forward:

and (3) time deposits decreased $30.6 million (see “Financial Condition – Deposits”);

(4) FHLB advances remained unchanged (see “Financial Condition – Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings”);

and (5) subordinated debt remained unchanged (see “Financial Condition – Subordinated Debentures”).

A significant portion of this deposit growth was a result of funds from the SBA PPP being deposited into borrower accounts until those funds will be used for their operating expenses.

Total interest expense on deposits was $9.1 million for 2020 and $12.6 million for 2019.

As a result of the overall drop in market interest rates during 2020, and the decrease in higher yielding CD’s as a percentage of total deposits, the average rate paid on interest-bearing deposits was 0.38% in 2020 as compared to 0.60% in 2019.

See “Overview – Looking Forward:

2021 and Beyond” for a discussion of factors influencing the Company’s future deposit rates and their impact on net interest margin.

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On a fully tax equivalent basis, net interest income increased 12.0% and totaled $141.0 million during 2019 compared to $125.9 million for 2018.

more fully discussed below, the increase in net interest income was due primarily to a $142.3 million increase in average earning assets, and a 37 basis point increase in the net interest margin.

As more fully discussed below, the increase in net interest income was due primarily to a $289.1 million increase in average earning assets, and a 9 basis point increase in the net interest margin.

Net interest income on a tax equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest margin.

For 2018, the Company’s net interest margin was 4.25% compared to

3.88% in 2017.

This increase in net interest margin was due primarily to rising market interest rates that resulted in an increase in the yield on earning assets that exceeded the increase in the cost of interest-bearing liabilities.

For 2019, the Company’s net interest margin was 4.34% compared to 4.25% in 2018 This increase in net interest margin was due primarily to an increase of 0.22% in the yield received on earning assets, offset somewhat by a 0.21% increase in the rates paid on interest bearing liabilities.

Average loans & leases totaled $2.6 billion for the year ended December 31, 2019;

an increase of $239.7 million compared to the year ended December 31, 2018.

Loans & leases increased from 77.3% of average

earning assets during 2017 to 79.4% in 2018.

Loans & leases increased from 79.4% of average earning assets during 2018 to 79.7% in 2019.

The year-to-date yield on the loan & lease portfolio increased to 5.30% for the year ended December 31, 2019, compared to 5.10% for the year ended December 31, 2018.

This higher yield combined with the

impact of increased average loan & lease balances resulted in interest revenue from loans & leases increasing 16.7% to $119.8 million for 2018.

The Company continues to experience aggressive competitor pricing for loans & leases to which

it may need to respond in order to retain key customers.

This higher yield combined with the impact of increased average loan & lease balances resulted in interest revenue from loans & leases increasing 14.5% to $137.2 million for 2019.

The Company continues to experience aggressive competitor pricing for loans & leases to which it may need to respond in order to retain key customers.

This could place negative pressure on future loan & lease yields and net interest margin.

Average investment securities decreased $284,000 in 2018 compared to the average balance during 2017.

The investment portfolio is the other main component of the Company’s earning assets.

Historically, the Company invested primarily in:

(1) mortgage-backed securities issued by government-sponsored entities;

(2) debt securities issued by the U.S.

Treasury, government agencies and government-sponsored entities;

and (3) investment grade bank-qualified municipal bonds.

However, at certain times the Company selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity.

Since the risk factor for these types of investments is generally lower than that of loans & leases, the yield earned on investments is generally less than that of loans & leases.

Average investment securities decreased $35.6 million in 2019 compared to the average balance during 2018.

The average yield, on a tax equivalent basis, in the investment portfolio was 2.81% in 2019 compared to 2.44% in 2018.

This overall increase in yield was caused primarily by an increase in the mix of mortgage-backed securities as a percentage of total securities and a decrease in the balance of lower yielding Government Agency & Government-Sponsored

Entities investments.

As a result of the combined impact of these balance and yield changes, tax equivalent interest income on securities increased slightly by $482,000 to $11.3 million for the year ended December 31, 2018, compared to $10.8 million

for the year ended December 31, 2017.

This overall increase in yield was caused primarily by an increase in the mix of mortgage-backed securities as a percentage of total securities and an increase in market interest rates.

As a result of the combined impact of these mix, balance and yield changes, tax equivalent interest income on securities increased slightly by $710,000 to $12.0 million for the year ended December 31, 2019, compared to $11.3 million for the year ended December 31, 2018.

See “Financial Condition – Investment Securities” for a discussion of the Company’s investment strategy in 2019.

Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates is shown on

a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statements of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.

Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates is shown on a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statements of Income because of adjustments that relate to income on securities that are exempt from federal income taxes.

Interest-bearing deposits with banks and overnight investments in Federal Funds Sold are additional earning assets available to the Company.

Average interest-bearing deposits with

banks consisted primarily of FRB deposits.

Balances with the FRB earn interest at the Fed Funds rate, which increased to 2.40% in December 2018.

Average interest-bearing deposits with banks for the year ended

December 31, 2018, was $147.7 million, a decrease of $28.6 million compared to the average balance for the year ended December 31, 2017.

Interest income on interest-bearing deposits with banks for the year ended December 31, 2018, increased

$695,000 to $2.8 million from the year ended December 31, 2017.

Average interest-bearing liabilities increased $29.2 million or 1.5% during the twelve months ended December 31, 2018, primarily in lower cost interest-bearing DDA, and savings and money market deposits.

See “Financial

Condition – Deposits” for a discussion of trends in the Company’s deposit base.

Average interest-bearing deposits with banks consisted primarily of FRB deposits.

Balances with the FRB earn interest at the Fed Funds rate, which decreased to 1.55% in December 2019.

Average interest-bearing deposits with banks for the year ended December 31, 2019, was $232.6 million, an increase of $84.9 million compared to the average balance for the year ended December 31, 2018.

Interest income on interest-bearing deposits with banks for the year ended December 31, 2019, increased $2.2 million to $4.9 million from the year ended December 31, 2018.

Average interest-bearing liabilities increased $178.9 million or 9.2% during the year ended December 31, 2019 compared to the average balance during 2018.

Of that increase:

(1) interest-bearing transaction deposits increased $50.1 million;

(2) savings and money market deposits increased $85.7 million;

and (3) time deposits increased $43.1 million.

See “Financial Condition – Deposits” for a discussion of trends in the Company’s deposit base.

Total interest expense on deposits was $12.6 million for 2019 and $7.4 million for 2018.

The average rate paid on interest-bearing deposits was 0.38% in 2018 and 0.31% in

As a result of increasing short-term market interest rates and competition, the average rate paid on interest-bearing deposits was 0.60% in 2019 and 0.38% in 2018.

Provision and Allowance for Credit Losses

As a financial institution that assumes lending and credit risks as a principal element of its business, credit losses will be experienced in the normal course of business.

The Company has established credit management

policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio.

The Company manages and controls credit risk through comprehensive underwriting and approval standards, dollar limits on

loans & leases to one borrower (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction), and by restricting loans & leases made primarily to its principal market area where management

believes it is best able to assess the applicable risk.

Additionally, management has established guidelines to ensure the diversification of the Company’s credit portfolio such that even within key portfolio sectors such as real estate or

agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc.

Management reports regularly to the Board of Directors regarding trends and conditions in the loan & lease portfolio and regularly conducts

credit reviews of individual loans & leases.

The Company has established credit management policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio.

The Company manages and controls credit risk through comprehensive underwriting and approval standards, dollar limits on loans & leases to one borrower (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction), and by restricting loans & leases made primarily to its principal market area where management believes it is best able to assess the applicable risk.

Additionally, management has established guidelines to ensure the diversification of the Company’s credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc.

Management reports regularly to the Board of Directors regarding trends and conditions in the loan & lease portfolio and regularly conducts credit reviews of individual loans & leases.

Loans & leases that are performing but have shown some signs of weakness are subject to more stringent reporting and oversight.

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The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company's loan & lease portfolio as of the balance sheet date.

The allowance is established through a provision for

credit losses, which is charged to expense.

The allowance is established through a provision for credit losses, which is charged to expense.

Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan & lease growth.

Credit exposures determined to be uncollectible are charged against

the allowance.

Credit exposures determined to be uncollectible are charged against the allowance.

Cash received on previously charged off amounts is recorded as a recovery to the allowance.

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specific reserves related to impaired loans & leases;

general reserves for

inherent losses related to loans & leases that are not impaired;

general reserves for inherent losses related to loans & leases that are not impaired;

and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors.

A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the

contractual terms of the original agreement.

Loans & leases determined to be impaired are individually evaluated for impairment.

When a loan or lease is impaired, the Company measures impairment based on the present value of expected future cash

flows discounted at the loan’s or lease’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s or lease’s observable market price, or the fair value of the collateral if the loan or lease is

collateral dependent.

When a loan or lease is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s or lease's effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s or lease's observable market price, or the fair value of the collateral if the loan or lease is collateral dependent.

A loan or lease is collateral dependent if the repayment of the loan or lease is expected to be provided solely by the underlying collateral.

A restructuring of a loan or lease constitutes a troubled debt restructuring (“TDR”) under ASC 310-40, if the Company for economic or legal reasons related to the borrower’s financial difficulties grants a concession

to the borrower that it would not otherwise consider.

A restructuring of a loan or lease constitutes a troubled debt restructuring (“TDR”) under ASC 310-40, if the Company for economic or legal reasons related to the borrower's financial difficulties grants a more than insignificant concession to the borrower that it would not otherwise consider.

Restructured loans or leases typically present an elevated level of credit risk, as the borrowers are not able to perform according to the original contractual terms.

If the restructured loan or

lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual.

Loans & leases that are on nonaccrual

status at the time they become TDR, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent.

A loan or lease can be

removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms.

However, these loans or leases continue to be classified as impaired and are individually evaluated for

by portfolio segment, internal asset classifications, and qualitative factors that include economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s

underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole.

If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure, management may keep the loan or lease on accrual.

Loans & leases that are on nonaccrual status at the time they become TDR, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent.

A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms.

However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.

The determination of the general reserve for loans or leases that are collectively evaluated for impairment is based on estimates made by management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors that include economic trends in the Company's service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company's underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole.

The Company maintains a separate allowance for each portfolio segment (loan & lease type).

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(2) agricultural real estate;

(3) real estate construction

(including land and development loans);

(3) real estate construction (including land and development loans);

(4) residential 1 st mortgages;

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and (9) equipment leases.

See “Financial Condition – Loans & Leases”

for examples of loans & leases made by the Company.

The allowance for credit losses attributable to each portfolio segment, which includes both impaired loans & leases and loans & leases that are not impaired, is combined to determine the

Company’s overall allowance, which is included on the consolidated balance sheet.

See “Financial Condition – Loans & Leases” for examples of loans & leases made by the Company.

The allowance for credit losses attributable to each portfolio segment, which includes both impaired loans & leases and loans & leases that are not impaired, is combined to determine the Company's overall allowance, which is included on the consolidated balance sheet.

The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a certain threshold to identify credit risks and assess overall collectability.

For smaller balance loans & leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the loan or lease becomes contractually delinquent or when the borrower requests a

modification.

For larger balance loans, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans & leases.

For larger balance loans or leases, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans & leases.

These credit quality indicators are used to assign a risk rating to each individual loan or lease.

These risk ratings are also subject to examination by independent specialists engaged by the Company.

The risk ratings can be grouped into five major

categories, defined as follows:

Pass – A pass loan or lease is a strong credit with no existing or known potential weaknesses deserving of management’s close attention.

The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management’s assessment of the following for each portfolio segment:

(1) inherent credit risk;

(2) historical losses;

and (3) other qualitative factors.

These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment.

See “Note 1 Significant Accounting Policies - Allowance for Credit Losses.”

The risk ratings can be grouped into five major categories, defined as follows:

Pass and Watch – A pass loan or lease is a strong credit with no existing or known potential weaknesses deserving of management's close attention.

This category also includes “Watch” loans, which is a loan with an emerging weakness in either the individual credit or industry that requires additional attention.

A credit may also be classified Watch if cash flows have not yet stabilized, such as in the case of a development project.

Included in this category are all loans in which the Bank entered into a CARES Act modification.

Special Mention – A special mention loan or lease has potential weaknesses that deserve management's close attention.

If left uncorrected, these potential weaknesses may result in deterioration of the repayment

prospects for the loan or lease position at some future date.

If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or lease position at some future date.

Special mention loans & leases are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Substandard – A substandard loan or lease is not adequately protected by the current financial condition and paying capacity of the borrower or the value of the collateral pledged, if any.

Loans or leases classified as

substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.

Well-defined weaknesses include a project’s lack of marketability, inadequate cash flow or collateral support, failure to complete construction on

time or the project’s failure to fulfill economic expectations.

Loans or leases classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.

Well-defined weaknesses include a project's lack of marketability, inadequate cash flow or collateral support, failure to complete construction on time or the project's failure to fulfill economic expectations.

They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans or leases classified doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on

currently known facts, conditions and values, highly questionable or improbable.

Loss – Loans or leases classified as loss are considered uncollectible.

Once a loan or lease becomes delinquent and repayment becomes questionable, the Company will address collateral shortfalls with the borrower and

attempt to obtain additional collateral.

Once a loan or lease becomes delinquent and repayment becomes questionable, the Company will address collateral shortfalls with the borrower and attempt to obtain additional collateral.

If this is not forthcoming and payment in full is unlikely, the Bank will estimate its probable loss and immediately charge-off some or all of the balance.

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Commercial Real Estate – Commercial real estate mortgage loans are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types.

Adverse economic

developments or an overbuilt market impact commercial real estate projects and may result in troubled loans.

Adverse economic developments or an overbuilt market impact commercial real estate projects and may result in troubled loans.

Trends in vacancy rates of commercial properties impact the credit quality of these loans.

High vacancy rates reduce operating revenues and

the ability for properties to produce sufficient cash flow to service debt obligations.

High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flow to service debt obligations.

Real Estate Construction – Real estate construction loans, including land loans, are generally considered to possess a higher inherent risk of loss than the Company’s commercial, agricultural and consumer loan types.

major risk arises from the necessity to complete projects within specified cost and time lines.

A major risk arises from the necessity to complete projects within specified cost and time lines.

Trends in the construction industry significantly impact the credit quality of these loans, as demand drives construction activity.

In addition, trends in

real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of construction projects.

In addition, trends in real estate values significantly impact the credit quality of these loans, as property values determine the economic viability of construction projects.

Commercial – These loans are generally considered to possess a moderate inherent risk of loss because they are shorter-term;

typically made to relationship customers;

generally underwritten to existing cash flows of

operating businesses;

generally underwritten to existing cash flows of operating businesses;

and may be collateralized by fixed assets, inventory and/or accounts receivable.

Debt coverage is provided by business cash flows and economic trends influenced by unemployment rates and other key economic indicators are closely

correlated to the credit quality of these loans.

Agricultural Real Estate and Agricultural – These loans are generally considered to possess a moderate inherent risk of loss since they are typically made to relationship customers and are secured by crop production,

livestock and related real estate.

Debt coverage is provided by business cash flows and economic trends influenced by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans.

These loans are vulnerable to two risk factors that are outside the control of Company and borrowers:

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Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan.

Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company

uses in structuring a lease.

Residential 1st Mortgages and Home Equity Lines and Loans – These loans are generally considered to possess a low inherent risk of loss, although this is not always true as evidenced by the correction in residential

real estate values that occurred between 2007 and 2012.

The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower’s ability to repay in an orderly

Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.

The degree of risk in residential real estate lending depends primarily on the loan amount in relation to collateral value, the interest rate and the borrower's ability to repay in an orderly fashion.

Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans.

Weak economic trends indicate that the borrowers’ capacity to repay their obligations may be

deteriorating.

Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.

Consumer & Other – A consumer installment loan portfolio is usually comprised of a large number of small loans scheduled to be amortized over a specific period.

Most installment loans are made for consumer

Most installment loans are made for consumer purchases.

Economic trends determined by unemployment rates and other key economic indicators are closely correlated to the credit quality of these loans.

Weak economic trends indicate that the borrowers’ capacity to repay their obligations may be

deteriorating.

In addition, the Company’s and Bank’s regulators, including the FRB, DBO and FDIC, as an integral part of their examination process, review the adequacy of the allowance.

These regulatory agencies may require additions

to the allowance based on their judgment about information available at the time of their examinations.

See Note 20, located in “Item 8.

Financial Statements and Supplementary Data” for a discussion of CECL and the accounting change which will impact our allowance for credit losses in 2020.

Weak economic trends indicate that the borrowers' capacity to repay their obligations may be deteriorating.

In addition, the Company's and Bank's regulators, including the FRB, DFPI and FDIC, as an integral part of their examination process, review the adequacy of the allowance.

These regulatory agencies may require additions to the allowance based on their judgment about information available at the time of their examinations.

Provision for Credit Losses

such as the credit quality of the loan & lease portfolio, loan & lease growth, current credit losses, and the prevailing economic climate and its effect on borrowers’ ability to repay loans & leases in accordance with the terms of the

The Central Valley of California was one of the hardest hit areas in the country during the recession.

In many areas, housing prices declined as much as 60% and unemployment reached 15% or more.

Although the economy

has improved throughout the Central Valley, in many of the Company’s market segments housing prices remain below peak levels and unemployment rates remain above those in other areas of the state and country.

While, in management’s opinion, the

Company’s levels of net charge-offs and non-performing assets as of December 31, 2019, compare very favorably to our peers at the present time, carefully managing credit risk remains a key focus of the Company.

Changes in the provision for credit losses between years are the result of management’s evaluation, based upon information currently available, of the adequacy of the allowance for credit losses relative to factors such as the credit quality of the loan & lease portfolio, loan & lease growth, current credit losses, and the prevailing economic climate and its effect on borrowers’ ability to repay loans & leases in accordance with the terms of the notes.

The State of California experienced drought conditions from 2013 through most of 2016.

Since 2016, reasonable levels of rain and snow have alleviated drought conditions in many areas of California, including those in

the Company’s primary service area.

As a result, reservoir levels are normal and the availability of water in our primary service area should not be an issue.

However, the weather patterns over the past 5 years further reinforce the fact that the

long-term risks associated with the availability of water are significant.

Since 2016, reasonable levels of rain and snow have alleviated drought conditions in California.

As a result, current reservoir levels are adequate and the availability of water in our primary service area should not be an issue.

However, these recent weather patterns further reinforce the fact that the long-term risks associated with the availability of water are significant.

See “Item 1A.

Risk Factors” for additional information.

The provision for credit losses totaled $200,000 in 2019 compared to $5.5 million in 2018.

Net charge offs during 2019 were $454,000 compared to net charge offs of $609,000 during 2018 and net charge offs of $427,000

The allowance for credit losses as a percentage of total loans and leases declined slightly in 2019 from 2.14% to 2.05%.

The Company determined that additional provisions in 2019 were not warranted given the continued strong credit quality

of the overall loan portfolio at December 31, 2019.

As discussed above in “COVID-19 (Coronavirus) Disclosure,” COVID-19 has had and continues to have a material impact on the U.S.

and California economies.

We are monitoring the impact on our borrowers, and working closely with them using all of the tools at our disposal, including the SBA PPP program, the FRB Main Street Lending Program and other loan restructuring strategies, to help them move through this period of reduced business activity.

To account for growth in our loan portfolio and the economic uncertainty created by COVID-19, our provision for credit losses increased in 2020.

The provision for credit losses totaled $4.5 million in 2020 compared to $200,000 in 2019.

Net charge offs during 2020 were $650,000 compared to net charge offs of $454,000 during 2019 and net charge offs of $609,000 in 2018.

The allowance for credit losses as a percentage of total loans and leases declined in 2020 from 2.05% to 1.89%.

This decline was due to the increase in government guaranteed SBA loans under the PPP.

Excluding these loans, the allowance for credit losses as a percentage of total loans was 2.04% at December 31, 2020.

See “Critical Accounting Policies and Estimates – Allowance for Credit Losses” and “Item 7A.

Quantitative and Qualitative Disclosures About Market Risk-Credit Risk.”

After reviewing all factors above, management concluded that the allowance for credit losses, as of December 31, 2020, and December 30, 2019 were adequate .

The following table summarizes the activity and the allocation of the allowance for credit losses for the years indicated.

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Residential 1st

Home Equity Lines

Year-To-Date Allowance for Credit Losses:

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Ending Balance- December 31, 2019

Overall, the Allowance for Credit Losses as of December 31, 2019 decreased $254,000 from December 31, 2018.

In 2019 there were no significant credit quality events or other impacts that caused changes in the allowance

allocated to individual categories of loans.

Overall the Allowance for Credit Losses as of December 31, 2020 increased $3.9 million from December 31, 2019.

Changes to the reserve during 2020 are due to changes in the underlying credit quality of the loan portfolio.

(1) reserves for “Agricultural” and “Agricultural Real Estate” loans (which are currently thought to have more limited COVID-19 loss exposure since agricultural activity has substantially continued without significant issues) have been reduced significantly;

(2) reserves for Commercial Real Estate (where our COVID-19 exposure is thought to be greater since many of these borrowers have been impacted by “non-essential” designations and “shelter-in-place” orders) have been increased significantly;

and (3) the “Unallocated” reserve has been increased.

See “Introduction - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure.

Allowance Allocation at December 31,

(in thousands)

Percent of Loans in Each Category to Total Loans

Commercial Real Estate

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Consumer & Other

As of December 31, 2019, the allowance for credit losses was $55.0 million, which represented 2.05% of the total loan & lease balance.

At December 31, 2018, the allowance for credit losses was $55.3 million or

2.14% of the total loan & lease balance.

The allowance for credit losses as a percentage of total loans and leases declined slightly in 2019 from 2.14% to 2.05%.

The Company determined that additional provisions in 2019 were not warranted given

the continued strong credit quality of the overall loan portfolio at December 31, 2019.

After reviewing all factors above, based upon information currently available, management concluded that the allowance for credit losses as of December 31, 2019,

is adequate .

As of December 31, 2020, the allowance for credit losses was $58.9 million, which represented 1.89% of the total loan & lease balance (2.04% when government guaranteed SBA loans originated under the PPP beginning in April 2020 are excluded).

At December 31, 2019, the allowance for credit losses was $55.0 million or 2.05% of the total loan & lease balance.

The Company believes that the current allowance provides sufficiently for our exposure at the current time.

Non-Interest Income

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(3) increases in the cash surrender value of bank owned life insurance;

card and ATM fees;

(5) net gains and losses on non-qualified deferred compensation plan investments;

(4) debit card and ATM fees;

(5) net gains and losses on non-qualified deferred compensation plan;

and (6) fees from other miscellaneous business services.

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2020 Compared to 2019

Non‑interest income totaled $17.2 million for 2019, an increase of $2.0 million or 13.3% from non-interest income of $15.2 million for 2018.

Net (loss) gain on investment securities was a net gain of $1,000 in 2019 compared to a net loss of $1.3 million for 2018.

See “Financial Condition-Investment Securities” for a discussion of the Company’s investment

Non‑interest income totaled $15.7 million for 2020, a decrease of $1.5 million or 8.96% from non-interest income of $17.2 million for 2019.

Debit card and ATM fees totaled $5.5 million in 2020, an increase of 8.13% or $416,000 from $5.1 million in 2019.

This was primarily due to increased numbers of cardholders and increased account activity.

Service charges on deposit accounts totaled $2.6 million in 2020, a decrease of 28.2% or $1.0 million from $3.7 million in 2019.

This decrease was primarily due to the Bank complying with the Governor of California’s request that banks not charge overdraft and other fees during the early stages of the COVID-19 crisis.

Net gains on deferred compensation plan investments were $1.8 million in 2020 compared to net gains of $2.6 million in 2019.

See Note 16, located in “Item 8.

Financial Statements and Supplementary Data” for a

description of these plans.

Financial Statements and Supplementary Data” for a description of these plans.

Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices.

Although Generally Accepted Accounting

Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income.

Other non-interest income was $3.8 million, a decrease of $1.9 million or 33.2% from 2018.

This decrease was primarily due to a $2.0 million decrease related to non-recurring income received in 2018 from:

purchase of Bank of Rio Vista;

and (2) the gain on sale of fixed assets.

Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income.

Other non-interest income was $3.6 million, a decrease of $173,000 or 4.6% from 2019.

2019 Compared to 2018

Non‑interest income totaled $15.2 million for 2018, a decrease of $1.5 million or 9.2% from non-interest income of $16.8 million for 2017.

Net (loss) gain on investment securities was a net loss of $1.3 million in 2018 compared to a net gain of $131,000 for 2017.

See “Financial Condition-Investment Securities” for a discussion of the Company’s investment

Non‑interest income totaled $17.2 million for 2019, an increase of $2.0 million or 13.3% from non-interest income of $15.2 million for 2018.

Net (loss) gain on investment securities was a net gain of $1,000 in 2019 compared to a net loss of $1.3 million for 2018.

See “Financial Condition-Investment Securities” for a discussion of the Company’s investment strategy.

Debit card and ATM fees totaled $5.1 million in 2019, an increase of 17.3% or $755,000 from $4.4 million in 2018.

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See Note 16, located in “Item 8.

Financial Statements and Supplementary Data” for a

description of these plans.

Financial Statements and Supplementary Data” for a description of these plans.

Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices.

Although Generally Accepted Accounting

Other non-interest income was $5.6 million, an increase of $727,000 or 14.9% from 2017.

This increase was primarily due to:

(1) $997,000 of income as a result of the remeasurement of the initial investment in Bank of

Rio Vista stock;

(2) FHLB dividend increases of $208,000;

(3) Check Order Income increases of $116,000;

and (4) increases in gain on sale of Leases of $76,000;

offset by a drop in the gain on sale of fixed assets by $900,000.

Other non-interest income was $3.8 million, a decrease of $1.9 million or 33.2% from 2018.

This decrease was primarily due to a $2.0 million decrease related to non-recurring income received in 2018 from:

(1) the purchase of Bank of Rio Vista;

and (2) the gain on sale of fixed assets.

Non-Interest Expense

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(1) salaries and employee benefits;

(2) net gains and losses on non-qualified deferred compensation plan investments;

(2) net gains and losses on non-qualified deferred compensation plan;

(3) occupancy;

(4) equipment;

(5) supplies;

(6) legal fees;

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(10) deposit insurance;

and (11) ORE carrying costs and gains/losses on sale;

and (12) other miscellaneous expenses.

2020 Compared to 2019

Overall, non-interest expense totaled $82.2 million for 2019, an increase of $6.8 million or 9.0% from the year ended December 31, 2018.

Overall, non-interest expense totaled $82.4 million for 2020, an increase of $164,000 or .20% from the year ended December 31, 2019.

Salaries and employee benefits increased $1.7 million or 3.1% in 2020, primarily related to:

(1) new staff from the acquisition of the Bank of Rio Vista;

(1) general salary increases;

and (3) increased contributions

to retirement and profit sharing plans.

and (2) increased contributions to retirement and profit sharing plans.

Net gains on deferred compensation plan investments were $2.6 million in 2019 compared to net gains of $1.8 million in 2020.

See Note 16, located in “Item 8.

Financial Statements and Supplementary Data” for a

description of these plans.

Financial Statements and Supplementary Data” for a description of these plans.

Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices.

Although Generally Accepted Accounting

Principles require these investment gains/losses be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no effect on the Company’s net income.

Occupancy expense in 2019 totaled $4.3 million, an increase of $390,000 or 10.0% from 2018 and equipment expense in 2019 totaled $4.9 million, an increase of $618,000 or 14.4% from 2018.

Both of these increases were

primarily related to operating expenses associated with remodeling existing branch offices and adding new branches.

Legal expenses increased $1.4 million from 2018 and totaled $2.3 million.

Other non-interest expense increased $862,000, or 8.6%, to $10.9 million in 2019 compared to $10.1 million in 2018.

The preceding increases in non-interest expense were offset somewhat by non-recurring expenses from the acquisition of Bank of Rio Vista that totaled $3.0 million in 2018.

Occupancy expense in 2020 totaled $4.6 million, an increase of $345,000 or 8.0% from 2019.

This increase was primarily related to operating expenses associated with remodeling existing branch offices.

Marketing expenses decreased $332,000 from 2019 and totaled $922,000.

Legal expenses decreased $2.2 million from 2019 and totaled $128,000.

Other non-interest expense increased $1.5 million or 14.2%, to $12.5 million in 2020 compared to $10.9 million in 2019.

2019 Compared to 2018

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(2) general salary increases;

and (3) increased contributions to

retirement and profit sharing plans.

and (3) increased contributions to retirement and profit sharing plans.

Net gains on deferred compensation plan investments were $2.6 million in 2019 compared to net gains of $1.1 million in 2018.

See Note 16, located in “Item 8.

Financial Statements and Supplementary Data” for a

description of these plans.

Financial Statements and Supplementary Data” for a description of these plans.

Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices.

Although Generally Accepted Accounting

Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no effect on the Company’s net income.

Occupancy expense in 2019 totaled $4.3 million, an increase of $390,000 or 10.0% from 2018 and equipment expense in 2019 totaled $4.9 million, an increase of $618,000 or 14.4% from 2018.

Both of these increases were

primarily related to operating expenses associated with remodeling existing branch offices.

Legal expenses increased $544,000 from 2017 and totaled $968,000.

This increase was primarily due to legal fees associated with the repurchase of stock and other operating matters.

Acquisition expenses related to the Bank of Rio Vista totaled $2.93 million.

A majority of this expense was comprised of:

(1) legal and other professional fees;

(2) contract termination costs;

and (3) conversion

expenses related to the core processing systems for both Bank of Rio Vista and F&M Bank.

The provision for income taxes increased $5.1 million for the year ended December 31, 2019.

Both of these increases were primarily related to operating expenses associated with remodeling existing branch offices and adding new branches.

Legal expenses increased $1.4 million from 2018 and totaled $2.3 million.

Other non-interest expense increased $862,000, or 8.6%, to $10.9 million in 2019 compared to $10.1 million in 2018.

The preceding increases in non-interest expense were offset somewhat by non-recurring expenses from the acquisition of Bank of Rio Vista that totaled $3.0 million in 2018.

The provision for income taxes decreased $60,000 for the year ended December 31, 2020.

The Company’s effective tax rate for 2020 was 24.65% compared to 25.6% for the year ended December 2019.

The Company’s

effective tax rate fluctuates from year to year due primarily to changes in the mix of taxable and tax-exempt earning sources.

The effective rates were lower than the combined Federal and State statutory rate of 32% due primarily to benefits

regarding the cash surrender value of life insurance;

The Company’s effective tax rate fluctuates from year to year due primarily to changes in the mix of taxable and tax-exempt earning sources.

The effective rates were lower than the combined Federal and State statutory rate of 30% due primarily to benefits regarding the cash surrender value of life insurance;

credits associated with low income housing tax credit investments (LIHTC);

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On December 22, 2017, the Tax Cuts and Jobs Act was signed into law changing the Company’s Federal corporate tax rate from 35% to 21%.

The Company’s provision for income taxes decreased 45.61% to $14.0 million during

2018 compared to 2017 primarily as a result of:

The Company’s provision for income taxes decreased 45.61% to $14.0 million during 2018 compared to 2017 primarily as a result of:

(1) the Federal corporate tax rate change and (2) the Company having amended and planning to amend tax returns in open tax years resulting in a reduction of $990,000 in the Company’s tax provision for 2018.

Significant Accounting Policies – Out of Period Adjustment.” The effective tax rate for 2018 was 23.8% compared to 47.9% during 2017.

Also due to the signing of the Tax Cuts and Jobs Act, during the 4 th quarter of 2017, all companies were required to re-measure their deferred tax assets (DTA) and deferred tax liabilities (DTL) at the new

corporate tax rate of 21%.

This one-time re-measurement resulted in a $6.3 million increase to the Company’s income tax provision in 2017.

This DTA re-measurement accompanied by an 8.7% increase in pre-tax earnings resulted in the tax provision

increase in 2017.

This DTA re-measurement accompanied by an 8.7% increase in pre-tax earnings resulted in the tax provision increase in 2017.

With the exception of the one-time DTA re-measurement that took place in 2017, tax law causes the Company’s taxes payable to approximate or exceed the current provision for taxes on the income statement.

provisions have had a significant effect on the Company’s current income tax liability:

Three provisions have had a significant effect on the Company’s current income tax liability:

(1) the restrictions on the deductibility of credit losses;

(2) deductibility of pension and other long-term employee benefits only when paid;

statutory deferral of deductibility of California franchise taxes on the Company’s federal return.

and (3) the statutory deferral of deductibility of California franchise taxes on the Company’s federal return.

Financial Condition

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and (3) investment grade bank-qualified municipal bonds.

However, at certain

times, the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity

without subjecting the Company to the interest rate risk associated with mortgage-backed securities.

However, at certain times, the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 7 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity without subjecting the Company to the interest rate risk associated with mortgage-backed securities.

The Company’s investment portfolio at December 31, 2020 was $876.7 million compared to $567.6 million at December 31, 2019, an increase of $309.1 million or 54.5%.

The Company uses its investment portfolio to help

balance its overall interest rate risk.

The Company uses its investment portfolio to help balance its overall interest rate risk.

Accordingly, when market rates are increasing it invests most of its funds in shorter term Treasury and Agency securities or shorter term (10, 15 and 20 year) mortgage backed securities.

Conversely, when rates

are falling, 30 year mortgage backed securities or longer term Treasury and Agency securities may be increased.

Conversely, when rates are falling, 30 year mortgage backed securities or longer term Treasury and Agency securities may be increased.

The Company's total investment portfolio currently represents 19.3% of the Company’s total assets as compared to 15.3% at December 31, 2019.

As of December 31, 2019, the Company held $60.2 million of municipal investments, of which $29.8 million were bank-qualified municipal bonds, all classified as held-to-maturity (“HTM”).

In order to comply with Section

939A of the Dodd-Frank Act, the Company performs its own credit analysis on new purchases of municipal bonds.

As of December 31, 2019, all of the Company’s bank-qualified municipal bond portfolio was rated at either the issue or issuer level, and all

of these ratings were “investment grade.” The Company monitors the status of all municipal investments, and at the current time does not believe any of them to be exhibiting financial problems that could result in a loss in any individual security.

As of December 31, 2020, the Company held $68.9 million of municipal investments, all classified as held-to-maturity (“HTM”).

Of this balance $24.4 million were bank-qualified municipal bonds, and $44.5 million were private placement municipal bonds, warrants, and CRA qualified investments in our service area.

In order to comply with Section 939A of the Dodd-Frank Act, the Company performs its own credit analysis on new purchases of municipal bonds.

As of December 31, 2020, all of the Company’s bank-qualified municipal bond portfolio was rated at either the issue or issuer level, and all of these ratings were “investment grade.” The Company monitors the status of all municipal investments, and at the current time does not believe any of them to be exhibiting financial problems that could result in a loss in any individual security.

Not included in the investment portfolio are interest bearing deposits with banks and overnight investments in Federal Funds Sold.

Interest bearing deposits with banks consisted primarily of FRB deposits.

currently pays interest on the deposits that banks maintain in their FRB accounts, whereas historically banks had to sell these Federal Funds to other banks in order to earn interest.

Since balances at the FRB are effectively risk free, the Company

elected to maintain its excess cash at the FRB.

The FRB currently pays interest on the deposits that banks maintain in their FRB accounts, whereas historically banks had to sell these Federal Funds to other banks in order to earn interest.

Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB.

Interest bearing deposits with banks totaled $317.5 million at December 31, 2020 and $223.2 million at December 31, 2019.

The Company classifies its investments as held-to-maturity, trading, or available-for-sale (“AFS”).

Securities are classified as held-to-maturity and are carried at amortized cost when the Company has the intent and

ability to hold the securities to maturity.

The Company classifies its investments as held-to-maturity (“HTM”), trading, or available-for-sale (“AFS”).

Securities are classified as held-to-maturity and are carried at amortized cost when the Company has the intent and ability to hold the securities to maturity.

Trading securities are securities acquired for short-term appreciation and are carried at fair value, with unrealized gains and losses recorded in non-interest income.

As of December 31, 2019 and December

31, 2018, there were no securities in the trading portfolio.

Securities classified as available-for-sale include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other

As of December 31, 2020 and December 31, 2019, there were no securities in the trading portfolio.

Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors.

These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, net of related income taxes.

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Mortgage Backed Securities

Corporate Securities

Total Book Value

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Treasury Securities

Government SBA

Government Agency SBA

After one year through five years

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After ten years

Government Securities

Government Agency SBA Securities

Corporate Securities

After one year through five years

After five years through ten years

Total Corporate Securities

One year or less

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The following table is a summary of the relative maturities and yields of the Company's investment securities Held-to-Maturity as of December 31, 2020.

Non-taxable Obligations of States and Political Subdivisions

have been calculated on a fully taxable equivalent basis.

Non-taxable Obligations of States and Political Subdivisions have been calculated on a fully taxable equivalent basis.

December 31, 2020 (in thousands)

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Common examples of loans & leases made by the Company include:

Commercial and Agricultural Real Estate - These are loans secured by farmland, commercial real estate, multifamily residential properties, and other non-farm, non-residential properties generally within our market

Commercial mortgage term loans can be made if the property is either income producing or scheduled to become income producing based upon acceptable pre-leasing, and the income will be the Bank's primary source of repayment for the loan.

are made both on owner occupied and investor properties;

Loans are made both on owner occupied and investor properties;

generally do not exceed 15 years (and may have pricing adjustments on a shorter timeframe);

have debt service coverage ratios of 1.00 or better with a target of greater than 1.25;

rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.

and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.

Real Estate Construction - These are loans for development and construction (the Company generally requires the borrower to fund the land acquisition) and are secured by commercial or residential real estate.

loans are generally made only to experienced local developers with whom the Bank has a successful track record;

These loans are generally made only to experienced local developers with whom the Bank has a successful track record;

for projects in our service area;

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Commercial construction loans are made only when there is a written take-out commitment from the Bank or an acceptable financial institution or government agency.

Most acquisition, development and construction loans are tied to the prime rate or

LIBOR with an appropriate spread based on the amount of perceived risk in the loan.

Most acquisition, development and construction loans are tied to the prime rate or LIBOR with an appropriate spread based on the amount of perceived risk in the loan.

Residential 1 st Mortgages - These are loans primarily made on owner occupied residences;

generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC;

however, we will make

loans on rural residential properties up to 40 acres.

however, we will make loans on rural residential properties up to 40 acres.

Most residential loans have terms from ten to twenty years and carry fixed rates priced off of treasury rates.

The Company has always underwritten mortgage loans based upon traditional

underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income.”

The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income.”

Home Equity Lines and Loans - These are loans made to individuals for home improvements and other personal needs.

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Combined Loan To Value (CLTV) does not exceed 80%;

scores are at or above 670;

FICO scores are at or above 670;

Total Debt Ratios do not exceed 43%;

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Lines of credit are extended to finance the seasonal needs of farmers during peak growing periods;

established for periods no longer than 12 to 24 months;

are usually established for periods no longer than 12 to 36 months;

are often secured by general filing liens on livestock, crops, crop proceeds and equipment;

and are most often tied to the prime rate with an appropriate spread based on the amount of perceived

risk in the loan.

and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan.

Term loans are primarily made for the financing of equipment, expansion or modernization of a processing plant, or orchard/vineyard development;

have maturities from five to seven years;

and fixed rates that are most often tied to

treasury indices with an appropriate spread based on the amount of perceived risk in the loan.

and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.

Commercial - These are loans and lines of credit to businesses that are sole proprietorships, partnerships, LLC’s and corporations.

Lines of credit are extended to finance the seasonal working capital needs of

customers during peak business periods;

Lines of credit are extended to finance the seasonal working capital needs of customers during peak business periods;

are usually established for periods no longer than 12 to 24 months;

are often secured by general filing liens on accounts receivable, inventory and equipment;

and are most often tied to the prime rate with an

appropriate spread based on the amount of perceived risk in the loan.

and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan.

Term loans are primarily made for the financing of equipment, expansion or modernization of a plant or purchase of a business;

have maturities from five to seven years;

rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.

and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.

Consumer - These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and unsecured lines of credit.

The Company has a minimal consumer loan

portfolio, and loans are primarily made as an accommodation to deposit customers.

The Company has a very minimal consumer loan portfolio, and loans are primarily made as an accommodation to deposit customers.

Leases - These are leases to businesses or individuals, for the purpose of financing the acquisition of equipment.

They can be either “finance leases” where the lessee retains the tax benefits of ownership but obtains

100% financing on their equipment purchases;

They can be either “finance leases” where the lessee retains the tax benefits of ownership but obtains 100% financing on their equipment purchases;

or “true tax leases” where the Company, as lessor, places reliance on equipment residual value and in doing so obtains the tax benefits of ownership.

Leases typically have a maturity of three to ten years,

and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk.

Leases typically have a maturity of three to ten years, and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk.

Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan.

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The Company accounts for leases with Investment Tax Credits (ITC) under the deferred method as established in ASC 740-10.

ITC are viewed and accounted for as a reduction of the cost of the related assets and presented

as deferred income on the Company’s financial statement.

ITC are viewed and accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement.

See “Item 7A.

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and (3) loan & lease structure.

See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed

discussion of risks by loan & lease type.

See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan & lease type.

The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan & lease type.

The Company’s policies require that loans & leases are approved

only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt.

The Company’s underwriting procedures for all loan & lease types require careful consideration of the borrower, the borrower’s

financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease.

The Company’s policies require that loans & leases are approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt.

The Company’s underwriting procedures for all loan & lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease.

Most loans & leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment;

cash flow is our primary source of repayment.

The quality and liquidity of collateral are

important and must be confirmed before the loan is made.

The quality and liquidity of collateral are important and must be confirmed before the loan is made.

In order to be responsive to borrower needs, the Company prices loans & leases:

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and (3) based upon different rate indices;

these structures are consistent with the Company’s interest rate risk management policies and procedures.

as long as these structures are consistent with the Company’s interest rate risk management policies and procedures.

See “Item 7A.

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This increase occurred as a result of:

(1) the Company’s

business development efforts directed toward credit-qualified borrowers;

(1) the Company’s business development efforts directed toward credit-qualified borrowers;

and (2) expansion of our service area into the East Bay of San Francisco and Napa;

No assurances can be made that this growth in the loan & lease portfolio will continue.

and (3) the origination of $347.4 million of PPP loans, of which $224.3 million remain outstanding at December 31, 2020 (See “Introduction - COVID-19 (Coronavirus) Disclosure” for additional information of the Company’s COVID-19 exposure).

No assurances can be made that this growth in the loan & lease portfolio will continue, and it is anticipated that the remainder of the PPP loans will be forgiven by the SBA in early 2021.

However, the Company does anticipate that it will participate in the 2021 PPP which may add some additional loans.

The following table sets forth the distribution of the loan & lease portfolio by type and percent as of December 31 of the years indicated.

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Allowance for Credit Losses

Loans & Leases, Net

Net Loans & Leases

Includes PPP loans.

There were no concentrations of loans exceeding 10% of total loans which were not otherwise disclosed as a category of loans in the above table.

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All loans & leases are assigned a credit risk grade using grading standards developed by bank regulatory agencies.

See “Results of Operations - Provision and Allowance for Credit Losses” for more detail on risk

See “Results of Operations - Provision and Allowance for Credit Losses” for more detail on risk grades.

The Company utilizes the services of a third-party independent loan & lease review firm to perform evaluations of individual loans & leases and review the credit risk grades the Company places on loans & leases.

Loans & leases

that are judged to exhibit a higher risk profile are referred to as “classified” and these loans & leases receive increased management attention.

As of December 31, 2019, classified loans & leases totaled $16.2 million compared to $15.1

million at December 31, 2018.

Loans & leases that are judged to exhibit a higher risk profile are referred to as “classified” and these loans & leases receive increased management attention.

As of December 31, 2020, classified loans & leases totaled $18.6 million compared to $16.2 million at December 31, 2019.

Classified loans & leases with higher levels of credit risk can be further designated as “impaired” loans & leases.

A loan or lease is considered impaired when, based on current information and events, it is

probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement.

See “Results of Operations - Provision and Allowance for Credit Losses” for further

See “Results of Operations - Provision and Allowance for Credit Losses” for further details.

Impaired loans & leases consist of:

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Non-Accrual Loans & Leases - Accrual of interest on loans & leases is generally discontinued when a loan or lease becomes contractually past due by 90 days or more with respect to interest or principal.

loans & leases are 90 days past due, but in management’s judgment are well secured and in the process of collection, they may not be classified as non-accrual.

When a loan or lease is placed on non-accrual status, all interest previously accrued

but not collected is reversed.

When loans & leases are 90 days past due, but in management's judgment are well secured and in the process of collection, they may not be classified as non-accrual.

When a loan or lease is placed on non-accrual status, all interest previously accrued but not collected is reversed.

Income on such loans & leases is then recognized only to the extent that cash is received and where the future collection of principal is probable.

There were no nonaccrual loans & leases at December 31, 2019

Restructured Loans & Leases - A restructuring of a loan or lease constitutes a TDR under ASC 310-40, if the Company for economic or legal reasons related to the debtor’s financial difficulties grants a concession

to the debtor that it would not otherwise consider.

At December 31, 2020, non-accrual loans & leases totaled $495,000.

There were no non-accrual loans & leases at December 2019.

Restructured Loans & Leases - A restructuring of a loan or lease constitutes a TDR under ASC 310-40, if the Company for economic or legal reasons related to the debtor's financial difficulties grants a concession to the debtor that it would not otherwise consider, except when subject to the CARES Act and H.R.

Restructured loans or leases typically present an elevated level of credit risk, as the borrowers are not able to perform according to the original contractual terms.

If the restructured loan or

Loans & leases that are on nonaccrual

status at the time they become TDR loans, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent.

A loan or lease can

be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms.

However, these loans or leases continue to be classified as impaired and are individually evaluated

for impairment.

Loans & leases that are on nonaccrual status at the time they become TDR loans or leases, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company generally believes to be six consecutive months of payments, or equivalent.

A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified terms.

However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.

At December 31, 2020, restructured loans totaled $7.9 million all of which were performing and at December 31, 2019, restructured loans totaled $12.1 million all of which were performing.

Other Real Estate - Loans where the collateral has been repossessed are classified as other real estate (“ORE”) or, if the collateral is personal property, the loan is classified as other assets on the

Company’s financial statements.

The following table sets forth the amount of the Company’s non-performing loans & leases and ORE as of December 31 of the years indicated.

Other Real Estate - Loans where the collateral has been repossessed are classified as other real estate ("ORE") or, if the collateral is personal property, the loan is classified as other assets on the Company's financial statements.

Not included in the table below, but relevant to a discussion of asset quality are loans that were granted some form of relief because of COVID-19 and are not considered TDRs because of the CARES Act and H.R.

Since April 2020 we have restructured $277.6 million of loans under the CARES Act and H.R.

133 guidelines (see “Part I, Introduction - COVID-19 (Coronavirus) Disclosure”).

The following table sets forth the amount of the Company's non-performing loans & leases (defined as non-accrual loans & leases plus accruing loans & leases past due 90 days or more) and ORE as of December 31 of the years indicated.

(in thousands)

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Non-Performing Loans & Leases as a Percent of Total Loans & Leases

future deterioration in economic conditions and/or collateral values will not result in future credit losses.

Although management believes that non-performing loans & leases are generally well-secured and that potential losses are provided for in the Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses.

See Note 6, located in “Item 8.

Financial Statements and Supplementary Data” for an allocation of the allowance classified to impaired loans

Financial Statements and Supplementary Data” for an allocation of the allowance classified to impaired loans & leases.

The Company reported $873,000 of ORE at December 31, 2020, and at December 31, 2019.

ORE at December 31, 2020 consisted of commercial land.

Except for those classified and non-performing loans & leases discussed above, the Company’s management is not aware of any loans & leases as of December 31, 2019, for which known financial problems of the

borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some

The Central Valley was one of the hardest hit areas in the country during the recession.

In many areas, housing prices declined as much as 60% and unemployment reached 15% or more.

Although the economy has strengthened throughout the

Central Valley, in many of the Company’s market segments housing prices remain below peak levels and unemployment levels remain above those in other areas of the state and country.

(i) those classified and non-performing loans & leases discussed above;

and (ii) those loans modified under the COVID-19 guidelines of the CARES Act and H.R.

133, the Company’s management is not aware of any loans & leases as of December 31, 2020, for which known financial problems of the borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some future date.

The State of California experienced drought conditions from 2013 through most of 2016.

Since 2016, reasonable levels of rain and snow have alleviated drought conditions in many areas of California,

including those in the Company’s primary service area.

As a result, reservoir levels are normal and the availability of water in our primary service area should not be an issue.

However, the weather patterns over the past 5 years further

reinforce the fact that the long-term risks associated with the availability of water are significant.

Since 2016, reasonable levels of rain and snow have alleviated drought conditions in California.

As a result, current reservoir levels are adequate and the availability of water in our primary service area should not be an issue.

However, the weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.

The agricultural industry is facing challenges associated with:

(1) weakness in export markets due to a stronger dollar and uncertainty in trade policies;

(2) tight labor markets and higher wages due to legislative changes at the state

and federal levels;

and (3) proposed changes in immigration policy and the resulting impact on the labor pool.

(1) downward pressures on commodity prices (somewhat offset by higher yields);

and (2) tight labor markets and higher wages due to legislative changes at the state and federal levels.

In an attempt to slow the accelerating spread of COVID-19, on March 16, 2020 the first cities and counties in Northern California were placed under “shelter-in-place” orders.

By March 19th, the Governor had placed the entire state under these orders.

Since that time most California counties have been in various levels of lockdown, including those in which the Company operates.

The Governor has developed guidance as to when a given county can re-open certain business and other activities, but all counties in which the Company operates remain under some level of restriction.

Businesses have been designated as “essential” or “non-essential.” Non-essential businesses have either been closed or had the scope of their activities significantly reduced.

Unemployment has increased.

The economic impact of this situation has already been severe, and continuing restrictions will only exacerbate the situation.

The duration of these restrictions is not known at this time nor is the pace of recovery once they are lifted, therefore, the Company cannot determine the ultimate impact on classified and non-performing loans and leases (see “Part I, Introduction - COVID-19 (Coronavirus) Disclosure”).

One of the key sources of funds to support earning assets is the generation of deposits from the Company’s customer base.

The ability to grow the customer base and subsequently deposits is a significant element in the

performance of the Company.

The ability to grow the customer base and subsequently deposits is a significant element in the performance of the Company.

The following table sets forth, by time remaining to maturity, the Company’s time deposits in amounts of $250,000 or more at December 31, 2020.

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Refer to the Year-To-Date Average Balances and Rate Schedules located in this "Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations” for information on separate deposit

Management's Discussion and Analysis of Financial Condition and Results of Operations" for information on separate deposit categories.

At December 31, 2020, deposits totaled $4.06 billion.

This represents an increase of 23.9% or $782.2 million from December 31, 2019.

In addition to the Company’s ongoing business development activities for deposits, the

following factors positively impacted year-over-year deposit growth:

In addition to the Company’s ongoing business development activities for deposits, the following factors positively impacted year-over-year deposit growth:

(1) the Company’s strong financial results and position and F&M Bank’s reputation as one of the most safe and sound banks in its market area;

and (2) the Company’s expansion of

its service area into Walnut Creek, Concord and Napa.

The company continues to experience significant competitive pressures on deposit rates.

The Company remains selective in how they respond to competitor rates, which may impact future deposit

Although total deposits have increased 7.0% since December 31, 2018, importantly, low cost transaction accounts have grown at a strong pace:

and (2) the Company’s expansion of its service area into Walnut Creek, Concord and Napa;

and (3) borrowers under the PPP depositing loan proceeds into their deposit accounts until those funds are used for operating expenses.

Although total deposits have increased 23.9% since December 31, 2019, importantly, low cost transaction accounts have grown at a strong pace as well as:

Demand and interest-bearing transaction accounts increased $612.8 million or 34.7% since December 31, 2019.

Savings and money market accounts have increased $265.5 million or 26.7% since December 31, 2019.

Time deposit accounts have increased $27.9 million or 5.7% since December 31, 2018.

Time deposit accounts have decreased $96.1 million or 18.6% since December 31, 2019.

Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings

Lines of Credit with the Federal Reserve Bank and Federal Home Loan Bank are other key sources of funds to support earning assets.

These sources of funds are also used to manage the Bank’s interest rate risk exposure;

These sources of funds are also used to manage the Company’s interest rate risk exposure;

and, as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio.

There were no FHLB advances at December 31, 2020 or 2019.

There were no Federal Funds purchased or advances from the FRB at December

31, 2019 or 2018.

There were no Federal Funds purchased or advances from the FRB at December 31, 2020 or 2019.

Long-Term Subordinated Debentures

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See Note 13, located in “Item 8.

Statements and Supplementary Data.” Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our TPS will continue to qualify as regulatory capital.

These securities accrue interest

at a variable rate based upon 3-month London InterBank Offered Rate (“LIBOR”) plus 2.85%.

Financial Statements and Supplementary Data.” Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our TPS will continue to qualify as regulatory capital.

These securities accrue interest at a variable rate based upon 3-month London InterBank Offered Rate (“LIBOR”) plus 2.85%.

Interest rates reset quarterly (the next reset is March 17, 2021) and the rate was 3.08% as of December 31, 2020.

The average rate paid for these securities was

5.37% in 2019 and 5.08% in 2018.

The average rate paid for these securities was 3.66% in 2020 and 5.37% in 2019.

Additionally, if the Company decided to defer interest on the subordinated debentures, the Company would be prohibited from paying cash dividends on the Company’s common stock.

The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements.

The Company engages in an ongoing assessment of its capital needs in order to support business

growth and to insure depositor protection.

The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection.

Shareholders’ Equity totaled $423.7 million at December 31, 2020, and $369.3 million at the end of 2019.

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies.

Failure to meet minimum capital requirements can initiate certain actions by regulators

that, if undertaken, could have a material effect on the Company and the Bank’s financial statements.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital

guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.

The Company’s and the Bank’s capital amounts and

classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

The implementation of Basel III requirements increased the required capital levels that the Company and the Bank must maintain.

The final rules included new minimum risk-based capital and leverage ratios which were

phased in over time.

The new minimum capital level requirements applicable to the Company and the Bank under the final rules are:

Failure to meet minimum capital requirements can initiate certain actions by regulators that, if undertaken, could have a material effect on the Company and the Bank's financial statements.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.

The Company’s and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

The minimum capital level requirements applicable to the Company and the Bank are:

(i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets (“RWA”);

(ii) a Tier 1 capital ratio of 6% of

(ii) a Tier 1 capital ratio of 6% of RWA;

(iii) a total capital ratio of 8% of RWA;

and (iv) a Tier 1 leverage ratio of 4% of total assets.

The final rules also established a “capital conservation buffer” of 2.5% above each of the new regulatory minimum capital ratios, which resulted in

the following minimum ratios:

A "capital conservation buffer" of 2.5% above each of the regulatory minimum capital ratios, which would result in the following minimum ratios:

(i) a common equity Tier 1 capital ratio of 7.0% of RWA;

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and (iii) a total capital ratio of 10.5% of RWA.

An institution will be subject to limitations on paying dividends,

engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount.

The final rules also permit the Company’s subordinated debentures issued in 2003 to continue to be counted as Tier 1 capital.

The final rules became effective as applied to the Company and the Bank on January 1, 2015, with a phase in period through January 1, 2019.

The Company believes that it is currently in compliance with all of these

capital requirements and that they will not result in any restrictions on the Company’s business activity.

In addition, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action.

There are no conditions or events since that notification

that management believes have changed the Bank’s category.

For further information on the Company’s and the Bank’s risk-based capital ratios, see Note 13, located in “Item 8.

Financial Statements and Supplementary Data”.

At this time, neither the

Company nor the Bank intend to opt into the new CBLR framework.

An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount.

The Company’s subordinated debentures issued in 2003 continue to be counted as Tier 1 capital.

As previously discussed, in order to supplement its regulatory capital base, during December 2003, the Company issued $10.0 million of trust preferred securities.

In accordance with the provisions of the

“Consolidation” topic of the FASB Accounting Standards Codification (“ASC”), the Company does not consolidate the subsidiary trust, which has issued the trust-preferred securities.

In accordance with the provisions of the “Consolidation” topic of the FASB Accounting Standards Codification (“ASC”), the Company does not consolidate the subsidiary trust, which has issued the trust-preferred securities.

In 1998, the Board approved the Company’s first common stock repurchase program.

This program has been extended and expanded several times since then, and most recently, on November 6, 2018, the Board of Directors

approved an extension of the $20 million stock repurchase program over the three-year period ending December 31, 2021.

This program has been extended and expanded several times since then, and most recently, on November 6, 2018, the Board of Directors approved an extension of the $20 million stock repurchase program over the three-year period ending December 31, 2021.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

There were no stock repurchases in 2020 or 2019 under the Common Stock Repurchase Plan.

However, in the third quarter of 2018 the Company did repurchase $31.2 million of shares, at $700 per share, in a single

transaction from the estate of a large shareholder.

The remaining dollar value of shares that may yet be purchased under the Company’s Common Stock Repurchase Plan is approximately $20 million.

On August 5, 2008, the Board of Directors approved a Share Purchase Rights Plan (the “Rights Plan”), pursuant to which the Company entered into a Rights Agreement dated August 5, 2008, with Computershare as Rights

The Rights Plan was set to expire on August 5, 2018.

On November 19, 2015, the Board of Directors approved a seven-year extension of the term of the Rights Plan.

Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the

term of the Rights Plan was extended from August 5, 2018 to August 5, 2025.

Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025.

The extension of the term of the Rights Plan was intended as a means to continue to guard against abusive takeover tactics and was not in response to any particular proposal.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” for further explanation.

On November 23, 2020, the Board of Directors of Farmers & Merchants Bancorp approved, and all applicable regulators provided statements of non-objection regarding, the Company’s repurchase and retirement of up to $8.5 million of its outstanding common stock during the fourth quarter of 2020 and the first half of 2021.

These repurchases will be done outside of the Company’s current repurchase plan.

All repurchases have been and will continue to be made at the then prevailing market prices.

In the fourth quarter of 2020 the Company repurchased $2.8 million of shares from shareholders.

During the first quarter of 2020, the Company issued a combined total 523 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans.

All of the shares were issued at a price of $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder.

The proceeds were contributed to the Bank as equity capital.

See Note 14, located in “Item 8.

Financial Statements and Supplementary Data.”

During 2019, the Company issued a combined total 9,312 shares of common stock to the Bank’s non-qualified deferred compensation retirement plans.

All of the shares were issued at prices ranging from $715.00 to $770.00

per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations

promulgated thereunder.

All of the shares were issued at prices ranging from $715.00 to $770.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder.

The proceeds were contributed to the Bank as equity capital.

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There were also 2,400 shares issued to individuals during 2018.

the shares were issued at prices ranging from $635.00 to $690.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section

4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder.

All of the shares were issued at prices ranging from $635.00 to $690.00 per share based upon valuations completed during the quarter of issuance by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations promulgated thereunder.

The proceeds were contributed to the Bank as equity capital.

During 2017, the Company issued 4,975 shares of common stock, which were contributed to the Bank’s non-qualified deferred compensation retirement plans.

The shares issued had prices ranging from $590 per share to $595

These share prices were based upon valuations completed by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of 1933, as amended, and the regulations

promulgated thereunder.

The proceeds from these issuances were contributed to the Bank as equity capital.

Critical Accounting Policies and Estimates

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting

principles generally accepted in the United States.

In preparing the Company’s financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses.

Management believes that the

most significant subjective judgments that it makes include the following:

Allowance for Credit Losses - As a financial institution, which assumes lending and credit risks as a principal element in its business, the Company anticipates that credit losses will be experienced in the normal

course of business.

Management believes that the most significant subjective judgments that it makes include the following:

Accordingly, the allowance for credit losses is maintained at a level considered adequate by management to provide for losses that are inherent in the portfolio.

The allowance is increased by provisions charged to operating

expense and reduced by net charge-offs.

The allowance is increased by provisions charged to operating expense and reduced by net charge-offs.

Management employs a systematic methodology for determining the allowance for credit losses.

On a quarterly basis, management reviews the credit quality of the loan & lease portfolio and considers problem

loans & leases, delinquencies, internal credit reviews, current economic conditions, loan & lease loss experience, and other factors in determining the adequacy of the allowance balance.

On a quarterly basis, management reviews the credit quality of the loan & lease portfolio and considers problem loans & leases, delinquencies, internal credit reviews, current economic conditions, loan & lease loss experience, and other factors in determining the adequacy of the allowance balance.

While the Company utilizes a systematic methodology in determining its allowance, the allowance is based on estimates, and ultimate losses may vary from current estimates.

The estimates are reviewed periodically

and, as adjustments become necessary, are reported in earnings in the periods in which they become known.

The estimates are reviewed periodically and, as adjustments become necessary, are reported in earnings in the periods in which they become known.

For additional information, see Note 6, located in “Item 8.

Financial Statements and Supplementary Data.”

See Note 20, located in “Item 8.

Financial Statements and Supplementary Data” for a discussion of CECL and the accounting change which will impact our allowance for credit losses in 2020.

Fair Value - The Company discloses the fair value of financial instruments and the methods and significant assumptions used to estimate those fair values.

The estimated fair value amounts have been determined by

the Company using available market information and appropriate valuation methodologies.

The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the

comparability of fair value disclosures between financial institutions.

In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected

Fair Value Measurements - The Company discloses the fair value of financial instruments and the methods and significant assumptions used to estimate those fair values.

The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies.

The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions.

In some cases, book value is a reasonable estimate of fair value due to the relatively short period of time between origination of the instrument and its expected realization.

For additional information, see “Item 7A.

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Income Taxes - The Company uses the liability method of accounting for income taxes.

This method results in the recognition of deferred tax assets and liabilities that are

reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled.

As changes in tax laws or rates are enacted, deferred tax assets and liabilities are

adjusted through the provision for income taxes.

This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled.

As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year.

This amount combined with the current taxes

payable or refundable results in the income tax expense for the current year.

This amount combined with the current taxes payable or refundable results in the income tax expense for the current year.

For additional information, see Note 1, located in “Item 8.

Financial Statements and Supplementary Data.”

Valuation of Goodwill - Goodwill is not amortized but instead is periodically tested for impairment.

Management performs this impairment analysis on an annual basis as of December 31.

Additionally, events or

circumstances are analyzed on an interim basis to determine if there is an indication of a potential impairment.

The impairment analysis requires management to make subjective judgments.

Events and factors that may significantly affect the

estimates include, among others, a significant decline in expected future cash flows, a significant adverse change in the business climate, slower growth rates or a significant and sustained decline in the price of our common stock, changes in

discount rates and specific industry and market conditions.

There can be no assurance that changes in circumstances, estimates or assumptions may result in additional impairment of all, or some portion of, goodwill.

Off-Balance-Sheet Arrangements

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(1) any obligation under a guarantee contract;

(2) a retained or contingent

interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity, or market risk support to that entity for such assets;

(2) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity, or market risk support to that entity for such assets;

(3) any obligation under certain derivative instruments;

obligation under a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or research and development services with

or (4) any obligation under a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or research and development services with the Company.

The Company had the following off balance sheet commitments as of the dates indicated.

(in thousands)

December 31, 2019

December 31, 2018

Commitments to Extend Credit

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Performance Guarantees Under Interest Rate Swap Contracts Entered Into Between Our Borrowing Customers and Third Parties

The Company’s exposure to credit loss in the event of nonperformance by the other party with regard to standby letters of credit, undisbursed loan commitments, and financial guarantees is represented by the

contractual notional amount of those instruments.

The Company's exposure to credit loss in the event of nonperformance by the other party with regard to standby letters of credit, undisbursed loan commitments, and financial guarantees is represented by the contractual notional amount of those instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.

The Company uses the same credit policies in making

commitments and conditional obligations as it does for recorded balance sheet items.

The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded balance sheet items.

The Company may or may not require collateral or other security to support financial instruments with credit risk.

Evaluations of each customer’s

creditworthiness are performed on a case-by-case basis.

Evaluations of each customer's creditworthiness are performed on a case-by-case basis.

Standby letters of credit are conditional commitments issued by the Company to guarantee performance of or payment for a customer to a third party.

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The following table presents, as of December 31, 2020, our significant and determinable contractual obligations by payment date.

The payment amounts represent those amounts contractually due to the recipient and do

not include any unamortized premiums or discounts, or other similar carrying value adjustments.

The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts, or other similar carrying value adjustments.

For further information on the nature of each obligation type, see applicable note disclosures located in “Item 8.

Financial Statements and

Supplementary Data.”

Financial Statements and Supplementary Data.”

(in thousands)

1 Year or Less

More Than 5 Years

Long-Term Subordinated Debentures

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(1) These amounts represent obligations to participants under the Company's various non-qualified deferred compensation plans.

All amounts have been fully funded

in to a Rabbi Trust as of December 31, 2019.

All amounts have been fully funded in to a Rabbi Trust as of December 31, 2020.

See Note 16 located in “Item 8.

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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