TRICO BANCSHARES / 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS Cautionary Statements Regarding Forward-Looking Information The statements contained herein that are not historical facts are forward-looking statements based on management’s current expectations and beliefs concerning future developments and their potential effects on the Company. Such statements involve inherent risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There can be no assurance that future developments affecting us will be the same as those anticipated by management. We caution readers that a number of important factors could cause actual results to differ materially from those expressed in, or implied or projected by, such forward-looking statements. These risks and uncertainties include, but are not limited to, the following: the strength of the United States economy in general and the strength of the local economies in which we conduct operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the impact of changes in financial services policies, laws and regulations; technological changes; weather, natural disasters and other catastrophic events that may or may not be caused by climate change and their effects on economic and business environments in which the Company operates; the continuing adverse impact on the U.S. economy, including the markets in which we operate, due to the COVID-19 global pandemic, and the impact of a slowing U.S. economy and increased unemployment on the performance of our loan portfolio, the market value of our investment securities, the availability of sources of funding and the demand for our products; the costs or effects of mergers, acquisitions or dispositions we may make; the future operating or financial performance of the Company, including our outlook for future growth, changes in the level of our nonperforming assets and charge-offs; the appropriateness of the allowance for credit losses including the timing and effects of the implementation of the current expected credit losses model; any deterioration in values of California real estate, both residential and commercial; the effect of changes in accounting standards and practices; possible other-than-temporary impairment of securities held by us; changes in consumer spending, borrowing and savings habits; our ability to attract deposits and other sources of liquidity; changes in the financial performance and/or condition of our borrowers; our noninterest expense and the efficiency ratio; competition and innovation with respect to financial products and services by banks, financial institutions and non-traditional providers including retail businesses and technology companies; the challenges of integrating and retaining key employees; the costs and effects of litigation and of unexpected or adverse outcomes in such litigation; a failure in or breach of our operational or security systems or infrastructure, or those of our third-party vendors or other service providers, including as a result of cyber-attacks and the cost to defend against such attacks; the effect of a fall in stock market prices on our brokerage and wealth management businesses; and our ability to manage the risks involved in the foregoing. Additional factors that could cause results to differ materially from those described above can be found in our Annual Report on Form 10-K for the year ended December 31, 2019, which is on file with the Securities and Exchange Commission (the “SEC”) and available in the “Investor Relations” section of our website, https://www.tcbk.com/investor-relations and in other documents we file with the SEC. Annualized, pro forma, projections and estimates are not forecasts and may not reflect actual results. General As TriCo Bancshares (referred to in this report as “we”, “our” or the “Company”) has not commenced any business operations independent of Tri Counties Bank (the “Bank”), the following discussion pertains primarily to the Bank. Average balances, including such balances used in calculating certain financial ratios, are generally comprised of average daily balances for the Company. Within Management’s Discussion and Analysis of Financial Condition and Results of Operations, interest income, net interest income, net interest yield, and efficiency ratio are generally presented on a fully tax-equivalent (“FTE”) basis. The Company believes the use of these non-generally accepted accounting principles (non-GAAP) measures provides additional clarity in assessing its results, and the presentation of these measures on a FTE basis is a common practice within the banking industry. Interest income and net interest income are shown on a non-FTE basis in the Part I - Financial Information section of this Form 10-Q, and a reconciliation of the FTE and non-FTE presentations is provided below in the discussion of net interest income. Critical Accounting Policies and Estimates The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those that materially affect the financial statements and are related to the adequacy of the allowance for loan losses, investments, mortgage servicing rights, fair value measurements, retirement plans and intangible assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. A detailed discussion related to the Company’s accounting policies including those related to estimates on the allowance for loan losses, other than temporary impairment of investments and impairment of intangible assets, can be found in Note 1 of the consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2019. 41 Table of Contents Geographical Descriptions For the purpose of describing the geographical location of the Company’s operations, the Company has defined northern California as that area of California north of, and including, Stockton to the east and San Jose to the west; central California as that area of the state south of Stockton and San Jose, to and including, Bakersfield to the east and San Luis Obispo to the west; and southern California as that area of the state south of Bakersfield and San Luis Obispo. Financial Highlights Performance highlights and other developments for the Company as of or for the three and nine months ended September 30, 2020 included the following: • For the three and nine months ended September 30, 2020, the Company’s return on average assets was 0.95% and 0.79%, respectively, and the return on average equity was 7.79% and 6.13%, respectively. • As of September 30, 2020, the Company reported total loans, total assets and total deposits of $4.83 billion, $7.45 billion and $6.34 billion, respectively. • The loan to deposit ratio was 76.12% as of September 30, 2020, as compared to 76.84% at June 30, 2020 and 78.98% at September 30, 2019. • For the current quarter, net interest margin was 3.72% on a tax equivalent basis as compared to 4.44% in the quarter ended September 30, 2019, and a decrease of 38 basis points from the 4.10% in the trailing quarter. • Non-interest bearing deposits as a percentage of total deposits were 39.71% at September 30, 2020, as compared to 39.81% at June 30, 2020 and 33.56% at September 30, 2019. • The average rate of interest paid on deposits, including non-interest-bearing deposits, decreased to 0.09% for the third quarter of 2020 as compared with 0.12% for the trailing quarter, and also decreased by 14 basis points from the average rate paid of 0.23% during the same quarter of the prior year. • Non-performing assets to total assets were 0.34% at September 30, 2020, as compared to 0.31% as of June 30, 2020, and 0.31% at September 30, 2019. • Credit provision expense for loans and debt securities was $7.6 million during the quarter ended September 30, 2020, as compared to provision expense of $22.2 million during the trailing quarter ended June 30, 2020, and a reversal of provision totaling ($0.3) million for the three month period ended September 30, 2019. • Gain on sale of loans for the three and nine months ended September 30, 2020 totaled $3.0 million and $5.7 million, as compared to $1.2 million and $2.2 million for the equivalent periods ended September 30, 2019, respectively. • The efficiency ratio was 59.44% for the third quarter of 2020, as compared to 59.69% in the trailing quarter and 58.82% in the same quarter of the 2019 year. SBA Paycheck Protection Program and COVID Deferrals In March 2020, the SBA Paycheck Protection Program ("PPP") was created to help small businesses keep workers employed during the COVID-19 crisis. As a Small Business Administration (SBA) Preferred Lender, the Company was able to provide PPP loans to small business customers. As of the quarter ended September 30, 2020, the total balance outstanding of PPP loans totaled $437,793,000 as compared to total PPP originations of $438,510,000. In connection with the origination of these loans, the Company earned approximately $15,735,000 in loan fees, offset by deferred loan costs of approximately $763,000, the net of which will be recognized over the earlier of loan maturity, repayment or receipt of forgiveness confirmation. As of September 30, 2020 there was approximately $11,846,000 in net deferred fee income expected to be recognized. During the three and nine months ended September 30, 2020, the Company recognized $2,603,000 and $4,959,000, respectively, in interest and fees on PPP loans. 42 Table of Contents COVID Deferrals Following the passage of the CARES Act legislation, the "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus" was issued by federal bank regulators, which offers temporary relief from troubled debt restructuring accounting for loan payment deferrals for certain customers whose businesses are experiencing economic hardship due to Coronavirus. The Company is closely monitoring the effects of the pandemic on our loan and deposit customers. Our management team continues to be focused on assessing the risks in our loan portfolio and working with our customers to mitigate where possible, the risk of potential losses. The Company implemented loan programs to allow certain consumers and businesses impacted by the pandemic to defer loan principal and interest payments. The following is a summary of COVID related loan customer modifications with outstanding balances as of September 30, 2020: Modification Type Deferral Term (dollars in thousands) Balance of Modified Loans % of Total Category of Loans Interest Only Deferral Principal and Interest Deferral 90 Days 180 Days Commercial real estate: CRE non-owner occupied $ 80,314 5.0 % 96.0 % 4.0 % — % 100.0 % CRE owner occupied 12,959 2.2 64.3 35.7 10.2 89.8 Multifamily 8,996 1.5 75.7 24.3 24.3 75.7 Farmland — — — — — — Total commercial real estate loans 102,269 3.5 90.2 9.8 3.4 96.6 Consumer: SFR 1-4 1st lien — — — — — — SFR HELOCs and junior liens — — — — — — Other — — — — — — Total consumer loans — — — — — — Commercial and industrial 4,493 0.7 98.8 1.2 1.4 98.6 Construction 24,176 8.5 100.0 — — 100.0 Agriculture production — — — — — — Leases — — — — — — Total modifications $ 130,938 2.71 % 92.32 % 7.68 % 2.73 % 97.27 % Total loan modifications associated with CARES Act legislation made during the nine months ended September 30, 2020 total approximately $422.53 million of which $130.94 million remained outstanding under their modified terms as of September 30, 2020. Approximately $95.33 million and $35.61 million of the remaining balance of loans with modified terms are expected to conclude their modification period during the quarters ended December 31, 2020 and March 31, 2021, respectively. However, as long as the current pandemic and recessionary economic conditions continue, it is likely that additional borrowers may request an initial or subsequent modification to their loan terms. The total loan modifications made under the CARES Act during the 2020 year are inclusive of seven borrowers with loan balances totaling approximately $26.52 million who requested and were granted a second modification and deferral. Six of these second modification and deferrals were for a period of three additional months and as of September 30, 2020 had concluded the second deferral period and returned to their regular payment terms. The remaining borrower whom received a second loan modification was granted a six month deferral on an outstanding loan balance of $597,000 and is scheduled to return to payment status in January 2021. Management believes that its analysis of each borrower receiving a loan modification supports the ability of that borrower to return to their normal payment terms at the conclusion of the modification period; however, due to the fluidity of the current economic environment and the potential impact on borrowers no guarantees of that ability can be provided. As such management determined that a risk downgrade to each credit receiving a deferral modification was prudent until such time that the borrower's actual payment performance supports an upgrade to the pre-modification risk grade. 43 Table of Contents TRICO BANCSHARES Financial Summary (In thousands, except per share amounts; unaudited) Three months ended September 30, Nine months ended September 30, 2020 2019 2020 2019 Net interest income 63,454 64,688 $ 191,305 $ 192,873 (Provision for) reversal of credit losses (7,649) 329 (37,963) 1,392 Non-interest income 15,137 14,108 38,614 39,334 Non-interest expense (46,714) (46,344) (137,013) (138,493) Provision for income taxes (6,622) (9,386) (13,786) (25,924) Net income $ 17,606 $ 23,395 $ 41,157 $ 69,182 Per Share Data: Basic earnings per share $ 0.59 $ 0.77 $ 1.37 $ 2.27 Diluted earnings per share $ 0.59 $ 0.76 $ 1.37 $ 2.25 Dividends paid $ 0.22 $ 0.22 $ 0.66 $ 0.60 Book value at period end $ 30.31 $ 29.39 Average common shares outstanding 29,764 30,509 29,971 30,464 Average diluted common shares outstanding 29,844 30,629 30,083 30,643 Shares outstanding at period end 29,769 30,512 At period end: Loans, net 4,738,763 4,150,811 Total investment securities 1,473,935 1,397,753 Total assets 7,449,799 6,384,883 Total deposits 6,340,588 5,295,407 Other borrowings 27,055 16,423 Shareholders’ equity 902,262 896,665 Financial Ratios: During the period: Return on average assets (annualized) 0.95 % 1.44 % 0.79 % 1.44 % Return on average equity (annualized) 7.79 % 10.42 % 6.13 % 10.67 % Net interest margin (1) (annualized) 3.72 % 4.44 % 4.02 % 4.48 % Efficiency ratio 59.44 % 58.82 % 59.59 % 59.64 % Average equity to average assets 12.18 % 13.80 % 12.86 % 13.50 % At end of period: Equity to assets 12.11 % 14.04 % Total capital to risk-adjusted assets 15.23 % 15.20 % (1) Fully taxable equivalent (FTE) The Company reported net income of $17,606,000 for the quarter ended September 30, 2020, compared to $7,430,000 and $23,395,000 for the quarters ended June 30, 2020 and September 30, 2019, respectively. Diluted earnings per share were $0.59, $0.25 and $0.76 for the quarters ended September 30, 2020, June 30, 2020 and September 30, 2019, respectively. 44 Table of Contents Results of Operations The following discussion and analysis is designed to provide a better understanding of the significant changes and trends related to the Company and the Bank’s financial condition, operating results, asset and liability management, liquidity and capital resources and should be read in conjunction with the Condensed Consolidated Financial Statements of the Company and the Notes thereto located at Item 1 of this report. Net Interest Income The Company’s primary source of revenue is net interest income, or the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. Following is a summary of the components of FTE net income for the periods indicated (dollars in thousands): Three months ended September 30, Nine months ended September 30, 2020 2019 2020 2019 Interest income $ 65,438 $ 68,889 199,103 204,526 Interest expense (1,984) (4,201) (7,798) (11,653) FTE adjustment 254 289 811 929 Net interest income (FTE) $ 63,708 $ 64,977 $ 192,116 $ 193,802 Net interest margin (FTE) 3.72 % 4.44 % 4.02 % 4.48 % Acquired loans discount accretion, net: Amount (included in interest income) $ 1,876 $ 2,360 $ 6,211 $ 5,919 Net interest margin less effect of acquired loan discount accretion 3.61 % 4.28 % 3.89 % 4.34 % PPP loans yield: Amount (included in interest income) $ 2,603 $ — $ 4,959 $ — Net interest margin less effect of PPP loan yield 3.81 % — % 4.08 % — % Acquired loan discount accretion and PPP loan yield, net: Amount (included in interest income) $ 4,479 $ 2,360 $ 11,170 $ 5,919 Net interest margin less effect of acquired loan discount accretion and PPP yields 3.69 % 4.28 % 3.88 % 4.40 % Loans may be acquired at a premium or discount to par value, in which case, the premium is amortized (subtracted from) or accreted (added to) interest income over the remaining life of the loan. Generally, as time goes on, the effects of loan discount accretion and loan premium amortization decrease as the purchased loans mature or pay off early. Upon the early pay off of a loan, any remaining (unaccreted) discount or (unamortized) premium is immediately taken into interest income; and as loan payoffs may vary significantly from quarter to quarter, so may the impact of discount accretion and premium amortization on interest income. As a result of the uncertain economic environment and corresponding rate volatility, the prepayment rate of portfolio loans, inclusive of those acquired at a premium or discount, increased during the third quarter of 2020. During the three months ended September 30, 2020, June 30, 2020, March 31, 2020, and December 31, 2019, purchased loan discount accretion was $1,876,000, $2,587,000, $1,748,000, and $2,218,000, respectively. 45 Table of Contents Summary of Average Balances, Yields/Rates and Interest Differential Net interest income (FTE) during the three months ended September 30, 2020 decreased $1,237,000 or 1.9% to $63,708,000 compared to $64,945,000 during the three months ended June 30, 2020. Over the same period net interest margin declined 38 basis points to 3.72% as compared to 4.10% in the trailing quarter. The decline in net interest income (FTE) was due primarily to a decline in yield on interest earning assets, which was 3.83% for the quarter ended September 30, 2020, which represents a decrease of 43 basis points over the trailing quarter and a decrease of 89 basis points over the same quarter in the prior year. The index utilized in a significant portion of the Company’s variable rate loans, Wall Street Journal Prime, remained unchanged at 3.25% during the quarter ended September 30, 2020 as it has remained at 3.25% since the quarter ended March 31, 2020, but decreased from 4.75% at December 31, 2019 and 5.00% at September 30, 2019. The following table presents, for the three month periods indicated, information regarding the Company’s consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income from average interest-earning assets and resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual loans only to the extent cash payments have been received and applied to interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income thereon exempt from federal income taxation at the current statutory tax rate (dollars in thousands). For the three months ended September 30, 2020 September 30, 2019 Average Balance Interest Income/ Expense Rates Earned /Paid Average Balance Interest Income/ Expense Rates Earned /Paid Assets: Loans, excluding PPP $ 4,389,672 $ 55,436 5.02 % $ 4,142,602 $ 56,999 5.46 % PPP loans 437,892 2,603 2.36 % — — — % Investment securities - taxable 1,261,793 6,376 2.01 % 1,403,653 10,172 2.88 % Investment securities - nontaxable (1) 114,419 1,102 3.83 % 133,038 1,250 3.73 % Total investments 1,376,212 7,478 2.16 % 1,536,691 11,422 2.95 % Cash at Federal Reserve and other banks 611,719 175 0.11 % 130,955 757 2.29 % Total interest-earning assets 6,815,495 65,692 3.83 % 5,810,248 69,178 4.72 % Other assets 565,466 642,222 Total assets $ 7,380,961 $ 6,452,470 Liabilities and shareholders’ equity: Interest-bearing demand deposits $ 1,339,797 $ 56 0.02 % $ 1,240,548 $ 284 0.09 % Savings deposits 2,075,077 484 0.09 % 1,861,166 1,192 0.25 % Time deposits 387,922 872 0.89 % 447,669 1,574 1.39 % Total interest-bearing deposits 3,802,796 1,412 0.15 % 3,549,383 3,050 0.34 % Other borrowings 33,750 4 0.05 % 73,350 334 1.81 % Junior subordinated debt 57,475 568 3.93 % 57,156 817 5.67 % Total interest-bearing liabilities 3,894,021 1,984 0.20 % 3,679,889 4,201 0.45 % Noninterest-bearing deposits 2,475,842 1,777,852 Other liabilities 112,112 104,062 Shareholders’ equity 898,986 890,667 Total liabilities and shareholders’ equity $ 7,380,961 $ 6,452,470 Net interest spread (2) 3.63 % 4.27 % Net interest income and interest margin (3) $ 63,708 3.72 % $ 64,977 4.44 % (1) Fully taxable equivalent (FTE) (2) Net interest spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities. (3) Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of i nterest-earning assets, then annualized based on the number of days in the given period. 46 Table of Contents The following table presents, for the nine month periods indicated, information regarding the Company’s consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income from average interest-earning assets and resulting yields, and the amount of interest expense paid on interest- bearing liabilities. Average loan balances include nonperforming loans. Interest income includes proceeds from loans on nonaccrual loans only to the extent cash payments have been received and applied to interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income thereon exempt from federal income Nine months ended September 30, 2020 September 30, 2019 Average Balance Income/ Expense Yield/ Rate Average Balance Income/ Expense Yield/ Rate Assets: Loans, excluding PPP $ 4,360,942 $ 167,747 5.14 % $ 4,070,568 $ 166,888 5.48 % PPP loans 244,196 4,959 2.71 % — — — % Investment securities - taxable 1,249,823 22,637 2.42 % 1,420,426 31,849 3.00 % Investment securities - nontaxable (1) 117,745 3,515 3.99 % 138,580 4,024 3.88 % Total investments 1,367,568 26,152 2.55 % 1,559,006 35,873 3.08 % Cash at Federal Reserve and other banks 403,252 1,056 0.35 % 148,995 2,694 2.42 % Total interest-earning assets 6,375,958 199,914 4.19 % 5,778,569 205,455 4.75 % Other assets 595,617 643,130 Total assets $ 6,971,575 $ 6,421,699 Liabilities and shareholders’ equity: Interest-bearing demand deposits $ 1,293,071 289 0.03 % $ 1,263,312 860 0.09 % Savings deposits 1,971,348 2,190 0.15 % 1,892,122 3,631 0.26 % Time deposits 409,005 3,297 1.08 % 443,546 4,277 1.29 % Total interest-bearing deposits 3,673,424 5,776 0.21 % 3,598,980 8,768 0.33 % Other borrowings 26,223 13 0.07 % 35,814 384 1.43 % Junior subordinated debt 57,374 2,009 4.68 % 57,109 2,501 5.86 % Total interest-bearing liabilities 3,757,021 7,798 0.28 % 3,691,903 11,653 0.42 % Noninterest-bearing deposits 2,197,315 1,761,037 Other liabilities 120,486 101,947 Shareholders’ equity 896,753 866,812 Total liabilities and shareholders’ equity $ 6,971,575 $ 6,421,699 Net interest spread (2) 3.91 % 4.33 % Net interest income and interest margin (3) $ 192,116 4.02 % $ 193,802 4.48 % (1) Fully taxable equivalent (FTE) (2) Net interest spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities. (3) Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of i nterest-earning assets, then annualized based on the number of days in the given period. 47 Table of Contents Summary of Changes in Interest Income and Expense due to Changes in Average Asset and Liability Balances and Yields Earned and Rates Paid The following table sets forth, for the period identified, a summary of the changes in interest income and interest expense from changes in average asset and liability balances (volume) and changes in average interest rates for the periods indicated. Changes not solely attributable to volume or rates have been allocated in proportion to the respective volume and rate components. (in thousands) Three months ended September 30, 2020 compared with three months ended September 30, 2019 Volume Rate Total Increase (decrease) in interest income: Loans, including PPP $ 9,350 $ (8,310) $ 1,040 Investment securities (1) (2,652) (1,292) (3,944) Cash at Federal Reserve and other banks 2,752 (3,334) (582) Total interest-earning assets 9,450 (12,936) (3,486) Increase (decrease) in interest expense: Interest-bearing demand deposits 22 (250) (228) Savings deposits 134 (842) (708) Time deposits (208) (494) (702) Other borrowings (179) (151) (330) Junior subordinated debt 5 (254) (249) Total interest-bearing liabilities (226) (1,991) (2,217) Increase (decrease) in net interest income $ 9,676 $ (10,945) $ (1,269) (in thousands) Nine months ended September 30, 2020 compared with nine months ended September 30, 2019 Volume Rate Total Increase (decrease) in interest income: Loans, including PPP $ 14,647 $ (8,829) $ 5,818 Investment securities (1) (6,585) (3,136) (9,721) Cash at Federal Reserve and other banks 3,077 (4,715) (1,638) Total interest-earning assets 11,139 (16,680) (5,541) Increase (decrease) in interest expense: Interest-bearing demand deposits 27 (598) (571) Savings deposits 206 (1,647) (1,441) Time deposits (446) (534) (980) Other borrowings (137) (234) (371) Junior subordinated debt 16 (508) (492) Total interest-bearing liabilities (334) (3,521) (3,855) Increase (decrease) in net interest income $ 11,473 $ (13,159) $ (1,686) ( (1) Fully taxable equivalent (FTE) The following commentary regarding net interest income, interest income and interest expense may be best understood while referencing the Summary of Average Balances, Yields/Rates and Interest Differential and the Summary of Changes in Interest Income and Expense due to Changes in Average Asset and Liability Balances and Yields Earned and Rates Paid shown above. Net interest income (FTE) during the three months ended September 30, 2020 decreased $1,269,000 or 1.95% to $63,708,000 compared to $64,977,000 during the three months ended September 30, 2019. The overall decrease in net interest income (FTE) was due to a reduction in the average outstanding balance, and yields earned on investment securities, totaling $3,944,000 during the period. Declining interest rates continue to escalate pre-payment speeds on existing debt securities and promote new debt issuances at historically low coupon rates. As an offset, increases in average loan balances (including PPP) improved interest income by $9,350,000, however, loan yields were similarly hampered by low interest rates, resulting in declines in interest income of $8,310,000. 48 Table of Contents Net interest income (FTE) during the nine months ended September 30, 2020 decreased by $1,686,000 or 0.87% to $192,116,000 compared to $193,802,000 during the nine months ended September 30, 2019. Similar to the three month period noted above, the decrease in net interest income (FTE) is attributed primarily to declines in both the average outstanding balance, and yields earned on investment securities, totaling $9,721,000 for the nine month period ended 2020. Additionally, a reduction in loan interest rates caused a $8,829,000 decline in interest income, and declines in interest rates on cash and due from banks led to a $4,715,000 decline in interest income. As an offset, increases in average loan volume attributed to $14,647,000 in additional interest margin. Asset Quality and Loan Loss Provisioning The Company adopted CECL on January 1, 2020. During the three months ended September 30, 2020, the Company recorded a provision for credit losses of $7,649,000, as compared to $22,244,000 for the trailing quarter, and a reversal of provision expense of ($329,000) during the third quarter of 2019. The following table presents details of the provision for credit losses for the periods indicated: Three months ended Nine months ended (dollars in thousands) September 30, 2020 June 30, 2020 March 31, 2020 September 30, 2020 Addition to allowance for credit losses $ 7,649 $ 22,089 $ 8,000 $ 37,738 Addition to reserve for unfunded loan commitments — 155 70 225 Total provision for credit losses $ 7,649 $ 22,244 $ 8,070 $ 37,963 Prior to January 1, 2020 the Company accounted for the allowance for credit losses (ACL), formerly known as the allowance for loan losses under the incurred loan loss methodology. As of December 31, 2019 the allowance for loan losses was $30,616,000. Upon adoption of CECL on January 1, 2020, the Company recognized an increase in the ACL for loans totaling $18,913,000, including a reclassification of $481,000 from discounts on acquired loans to the allowance for credit losses, as a cumulative effect adjustment from change in accounting policies, with a corresponding decrease in retained earnings, net of $5,449,000 in taxes, of $12,983,000. The allowance for credit losses (ACL) was $87,575,000 as of quarter ended September 30, 2020, a net increase of $7,836,000 over the immediately preceding quarter. The Company utilizes a forecast period of approximately eight quarters and obtains the forecast data from publicly available sources as of the balance sheet date. This forecast data continues to evolve and included significant shifts in the magnitude of changes for both the unemployment and GDP factors leading up to the balance sheet date. Management noted that the majority of economic forecasts utilized in the ACL calculation have continued to identify an expanded duration of the current recessionary period as caused by the global pandemic and partially offset by the governmental stimulus that has been provided to date. The changes in loan volume and changes in credit quality associated with levels of classified, past due and non-performing loans, in addition to changes in qualitative factors, resulted in the need for a provision for credit losses of $7,649,000 and net recoveries totaled $187,000 during the current quarter. The portfolio-wide qualitative indicators for changes in California Unemployment and US Policy uncertainty contributed to the majority of the increase in credit reserves on loans as of September 30, 2020 as compared to the trailing quarter, adding approximately $9,556,000 to the required reserves. These increases were partially offset with a reduced need for reserves for concentration risks totaling $1,472,000 and reductions in specific reserves on individually evaluated loans of $321,000. During the nine months ended September 30, 2020 the ACL has increased by $38,046,000 or 76.8% to $87,575,000. Of that year-to-date increase, $308,000 is attributable to net recoveries; $3,175,000 is attributable to the net change in loan portfolio composition, risk grade migration and growth; while $34,563,000 is attributable to the net change in qualitative factors. Loans past due 30 days or more decreased by $6,100,000 during the quarter ended September 30, 2020 to $10,522,000, as compared to $16,622,000 at June 30, 2020. Non-performing loans were $22,963,000 at September 30, 2020 and $20,730,000 at June 30, 2020, a slight increase compared to the $16,864,000 and $18,565,000 as of December 31, 2019 and September 30, 2019, respectively. September 30, % of Total Loans June 30, % of Total Loans December 31, % of Total Loans (in thousands) 2020 2020 2019 Risk Rating: Pass $ 4,630,266 95.9 % $ 4,698,393 97.9 % $ 4,228,453 98.2 % Special Mention 147,343 3.1 % 61,883 1.3 % 44,217 1.0 % Substandard 48,729 1.0 % 41,129 0.8 % 34,696 0.8 % Total $ 4,826,338 $ 4,801,405 $ 4,307,366 Classified loans to total loans 1.01 % 0.86 % 0.81 % Loans past due 30+ days to total loans 0.22 % 0.35 % 0.25 % 49 Table of Contents The Company's loan portfolio for non-classified loans (loans graded special mention or better) remains generally consistent for the quarter ended September 30, 2020, as compared to the trailing quarter June 30, 2020, representing 99.0% and 99.1% of total loans outstanding, respectively. Loans risk graded special mention increased by approximately $89,918,000 during the quarter ended September 30, 2020 as compared to the trailing quarter. These downgrades to special mention were largely focused in one relationship of eight loans totaling approximately $56,600,000, secured by several commercial real estate properties which remain current as to payment status and are believed to have more than sufficient collateral support. The downgrade is related to recent management and oversight changes within the borrowing entity. Other components of the loan population downgraded to special mention during the quarter includes approximately $7,900,000 in COVID-19 related restructured loans, shared between two relationships. Total loans greater than 30 days past due downgraded to special mention during the quarter equaled approximately $501,000. There was one insignificant addition and no sales of other real estate owned during the three month period ended September 30, 2020. As of September 30, 2020, other real estate owned, which is included in other assets on the consolidated balance sheet, consisted of four properties with a carrying value of $2,057,000. Non-interest Income The following table summarizes the Company’s non-interest income for the periods indicated (in thousands): Three months ended September 30, (dollars in thousands) 2020 2019 $ Change % Change ATM and interchange fees $ 5,637 $ 5,427 $ 210 3.9 % Service charges on deposit accounts 3,334 4,327 (993) (22.9) % Other service fees 805 808 (3) (0.4) % Mortgage banking service fees 457 483 (26) (5.4) % Change in value of mortgage servicing rights 236 (455) 691 (151.9) % Total service charges and fees 10,469 10,590 (121) (1.1) % Increase in cash value of life insurance 773 773 — — % Asset management and commission income 667 721 (54) (7.5) % Gain on sale of loans 3,035 1,236 1,799 145.6 % Lease brokerage income 175 172 3 1.7 % Sale of customer checks 91 126 (35) (27.8) % Gain on sale of investment securities 7 107 (100) (93.5) % Gain on marketable equity securities — 22 (22) (100.0) % Other (80) 361 (441) (122.2) % Total other non-interest income 4,668 3,518 1,150 32.7 % Total non-interest income $ 15,137 $ 14,108 $ 1,029 7.3 % Non-interest income increased $1,029,000 or 7.3% to $15,137,000 during the three months ended September 30, 2020 compared to $14,108,000 during the comparable 2019 quarter. Mortgage loan origination volume demand increased during the period ended September 30, 2020 as a result of the continued favorable interest rate environment, leading to an increase in mortgage loan originations sold into the secondary market which generated an additional $1,799,000 gain on sale of loans, as compared to the same quarter of 2019. As a partial offset, fee generating deposit account activity remains depressed as a result of the COVID-19 pandemic, declining $993,000 during the three months ended September 30, 2020 compared to the same period in 2019. 50 Table of Contents The following table summarizes the Company’s non-interest income for the periods indicated (in thousands): Nine months ended September 30, (dollars in thousands) 2020 2019 $ Change % Change ATM and interchange fees $ 15,913 $ 15,412 $ 501 3.3 % Service charges on deposit accounts 10,426 12,389 (1,963) (15.8) % Other service fees 2,296 2,198 98 4.5 % Mortgage banking service fees 1,386 1,441 (55) (3.8) % Change in value of mortgage servicing rights (2,258) (1,652) (606) 36.7 % Total service charges and fees 27,763 29,788 (2,025) (6.8) % Increase in cash value of life insurance 2,203 2,294 (91) (4.0) % Asset management and commission income 2,244 2,102 142 6.8 % Gain on sale of loans 5,662 2,223 3,439 154.7 % Lease brokerage income 495 631 (136) (21.6) % Sale of customer checks 303 401 (98) (24.4) % Gain on sale of investment securities 7 107 (100) (93.5) % Gain on marketable equity securities 72 100 (28) (28.0) % Other (135) 1,688 (1,823) (108.0) % Total other non-interest income 10,851 9,546 1,305 13.7 % Total non-interest income $ 38,614 $ 39,334 $ (720) (1.8) % Non-interest income decreased $720,000 or 1.8% to $38,614,000 during the nine months ended September 30, 2020 compared to $39,334,000 during the comparable nine month period in 2019. Non-interest income for the nine months ended September 30, 2020 as compared to the same period in 2019 was negatively impacted by changes in deposit customer behaviors which have led to a reduction in fee generating account activity which is down $1,963,000 during the nine month period in 2020 as compared to the same period in 2019, has been partially offset by $501,000 in favorable card related activities and interchange income. In addition, the change in the fair value of the Company’s mortgage servicing assets, contributed to a $606,000 decline. Other non-interest income declined by $1,823,000, partially from decreases in the fair value of assets used to fund acquired deferred compensation plans totaling $718,000 for the nine months ended September 30, 2020 as compared to the same period 2019, as well as from an absence of one-time death benefits totaling $728,000 realized during the nine months ended September 30, 2019. The declines noted above were partially offset by $3,439,000 in gains from the sale of mortgage loans, which resulted from both increased volume and profit margins during the nine months ended September 30, 2020. 51 Table of Contents Non-interest Expense The following table summarizes the Company’s non-interest expense for the periods indicated (dollars in thousands): Three months ended September 30, 2020 2019 $ Change % Change Base salaries, net of deferred loan origination costs $ 18,754 $ 17,656 $ 1,098 6.2 % Incentive compensation 2,184 3,791 (1,607) (42.4) % Benefits and other compensation costs 8,383 5,452 2,931 53.8 % Total salaries and benefits expense 29,321 26,899 2,422 9.0 % Occupancy 3,440 3,711 (271) (7.3) % Data processing and software 3,561 3,411 150 4.4 % Equipment 1,549 1,679 (130) (7.7) % Intangible amortization 1,431 1,431 — — % Advertising 869 1,358 (489) (36.0) % ATM and POS network charges 1,314 1,343 (29) (2.2) % Professional fees 955 999 (44) (4.4) % Telecommunications 619 867 (248) (28.6) % Regulatory assessments and insurance 538 94 444 472.3 % Postage 118 438 (320) (73.1) % Operational losses 154 228 (74) (32.5) % Courier service 345 357 (12) (3.4) % Gain on sale of foreclosed assets — (50) 50 (100.0) % Loss on disposal of fixed assets 22 2 20 1,000.0 % Other miscellaneous expense 2,478 3,577 (1,099) (30.7) % Total other non-interest expense 17,393 19,445 (2,052) (10.6) % Total non-interest expense $ 46,714 $ 46,344 $ 370 0.8 % Average full time equivalent staff 1,105 1,160 (55) (4.7) % Non-interest expense increased by $370,000 or 0.8% to $46,714,000 during the three months ended September 30, 2020 as compared to $46,344,000 for the three months ended September 30, 2019. Total salary and benefit expense increased by $2,422,000 or 9.0% to $29,321,000 during the three months ended September 30, 2020 as compared to $26,899,000 for the same period in 2019. Salaries, net of deferred loan origination costs increased by $1,098,000 to $18,754,000 for the three-months ended September 30, 2020 due to a decrease in loan origination activity and therefore a reduction in deferred loan origination costs of $165,000 as well as employee severance costs of $400,000 associated with reductions in personnel. Benefits related expenses increased by $2,931,000 to $8,383,000 during the quarter primarily as a result of increases in expenses associated with retirement obligations and insurance costs. Partially offsetting this increase were declines in miscellaneous expenses, which decreased during the period by $1,099,000 or 30.7% to $2,478,000, and were specifically attributed to a $614,000 reduction in travel and outside training expenses as associated with the precautionary and restricted travel environment associated with the pandemic. Further, reductions in advertising expense totaled $489,000 or 36.0%, to $869,000 during the three months ended September 30, 2020 as compared to $1,358,000 for the same period in 2019. 52 Table of Contents The following table summarizes the Company’s non-interest expense for the periods indicated (dollars in thousands): Nine months ended September 30, 2020 2019 $ Change % Change Base salaries, net of deferred loan origination costs $ 53,654 $ 51,624 $ 2,030 3.9 % Incentive compensation 7,680 10,064 (2,384) (23.7) % Benefits and other compensation costs 22,314 17,058 5,256 30.8 % Total salaries and benefits expense 83,648 78,746 4,902 6.2 % Occupancy 10,713 11,223 (510) (4.5) % Data processing and software 10,585 10,114 471 4.7 % Equipment 4,411 5,298 (887) (16.7) % Intangible amortization 4,293 4,293 — — % Advertising 2,065 4,222 (2,157) (51.1) % ATM and POS network charges 3,897 3,936 (39) (1.0) % Professional fees 2,399 2,895 (496) (17.1) % Telecommunications 1,983 2,437 (454) (18.6) % Regulatory assessments and insurance 993 1,095 (102) (9.3) % Postage 691 1,063 (372) (35.0) % Operational losses 559 679 (120) (17.7) % Courier service 1,013 1,039 (26) (2.5) % Gain on sale of foreclosed assets (57) (246) 189 (76.8) % Loss on disposal of fixed assets 37 82 (45) (54.9) % Other miscellaneous expense 9,783 11,617 (1,834) (15.8) % Total other non-interest expense 53,365 59,747 (6,382) (10.7) % Total non-interest expense $ 137,013 $ 138,493 $ (1,480) (1.1) % Average full time equivalent staff 1,093 1,145 (52) (4.5) % Non-interest expense decreased by $1,480,000 or 1.1% to $137,013,000 during the nine months ended September 30, 2020 as compared to $138,493,000 for the same period in 2019. Reductions in advertising expenses totaling $2,157,000 or 51.1% to $2,065,000 contributed to this beneficial change, as did declines in miscellaneous expenses totaling $1,834,000 or 15.8% attributed primarily to a $1,681,000 reduction in travel and training expenses as a result of state-wide shelter-in-place restrictions and a reduction of $418,000 in third party services, which were partially offset by the indirect loan documentation and administrative costs associated with PPP lending activity. These declines were also offset by a net increase in salaries and benefits expense by $4,902,000 or 6.2% to $83,648,000 during the nine months ended September 30, 2020 as compared to $78,746,000 for the same period in 2019. While the increase in salaries was more than offset by the reductions in incentive compensation costs, increases in benefits and other compensation costs of $5,256,000 were caused by expenses associated with retirement obligations. Income Taxes The Company’s effective tax rate was 25.1% for the nine months ended September 30, 2020, as compared to 27.4% for the year ended December 31, 2019. The reduction in effective tax rate was made possible through the provisions of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) which provided the Company with an opportunity to file amended tax returns and generate proposed refunds of approximately $805,000. Other differences between the Company's effective tax rate and applicable federal and state statutory rates are due to the proportion of non-taxable revenue and low income housing tax credits as compared to the levels of pre-tax earnings. Financial Condition For financial reporting purposes, the Company does not separately track the changes in assets and liabilities based on branch location or regional geography. Organic growth, inclusive of seasonal fluctuation, also contributes to the year-over-year balance sheet changes. During the most recent quarter, loan growth of $24,933,000 was primarily attributed to organic non-PPP loan originations of $22,416,000 or 2.0% of loan balances, excluding PPP, during the quarter ended September 30, 2020. Investment securities increased to $1,473,935,000, a change of $120,207,000 or 35.5% from $1,353,728,000 at June 30, 2020. The Company purchased approximately $196,118,000 in 53 Table of Contents securities during the three months ended September 30, 2020, offset largely by an accelerated rate of prepayment or maturity of these debt instruments totaling $79,621,000 correlating with the historically low interest rate environment. The following is a comparison of the quarterly change in certain assets and liabilities: ($‘s in thousands) As of September 30, 2020 As of June 30, 2020 $ Change Annualized % Change Ending balances Total assets $ 7,449,799 $ 7,360,071 $ 89,728 4.9 % Total loans 4,826,338 4,801,405 24,933 2.1 % Total investments 1,473,935 1,353,728 120,207 35.5 % Total deposits 6,340,588 6,248,258 92,330 5.9 % Total noninterest-bearing deposits 2,517,819 2,487,120 30,699 4.9 % Total other borrowings 27,055 38,544 (11,489) (119.2) % The following is a comparison of the year over year change in certain assets and liabilities: As of September 30, $ Change % Change ($‘s in thousands) 2020 2019 Ending balances Total assets $ 7,449,799 $ 6,384,883 $ 1,064,916 16.7 % Total loans 4,826,338 4,182,348 643,990 15.4 % Total investments 1,473,935 1,397,753 76,182 5.5 % Total deposits 6,340,588 5,295,407 1,045,181 19.7 % Total noninterest-bearing deposits 2,517,819 1,777,357 740,462 41.7 % Total other borrowings 27,055 16,423 10,632 64.7 % Loan growth of $643,990,000 or 15.4% during the twelve month period ending September 30, 2020 consisted of approximately $425,947,000 from the PPP program, with the remainder of approximately $218,043,000 attributed to organic loan growth. Growth of deposit balances totaled $1,045,181,000 or 19.7% during the same comparative period. Expansion of Federal stimulus programs and the trends in consumer spending including reduced levels of business and personal travel likely attributed to the significant deposit growth during the quarter. Excess deposit proceeds have been temporarily allocated to cash and due from banks, which increased to $652,582,000 at September 30, 2020 from $259,047,000 as of September 30, 2019. Investment Securities Investment securities available for sale increased $192,819,000 to $1,142,957,000 as of September 30, 2020, compared to December 31, 2019. This increase is primarily supported by deposit growth and available cash reserves. Proceeds from the sale of investment securities totaled $229,000 and $125,247,000 during the nine month periods ended September 30, 2020 and 2019, respectively. Gross realized gains from the sale of investment securities totaled $7,000 during the three and nine months ended September 30, 2020, respectively. There were no gross realized losses on the sale of securities during 2020. Gross realized gains from the sale of investment securities totaled $335,000 during the three and nine months ended September 30, 2019, respectively. Gross realized losses from the sale of investment securities during the three and nine months ended September 30, 2019 totaled $228,000. Sale activity in the 2020 and 2019 periods related to the repositioning of the investment securities portfolio which was necessitated by changes in the broader rate environment. The following table presents the available for sale debt securities portfolio by major type as of September 30, 2020 and December 31, 2019: September 30, 2020 December 31, 2019 (dollars in thousands) Fair Value % Fair Value % Debt securities available for sale: Obligations of U.S. government agencies $ 573,888 50.2 % $ 472,980 49.8 % Obligations of states and political subdivisions 112,725 9.9 % 109,601 11.5 % Corporate bonds 2,552 0.2 % 2,532 0.3 % Asset backed securities 453,792 39.7 % 365,025 38.4 % Total debt securities available for sale $ 1,142,957 100.0 % $ 950,138 100.0 % 54 Table of Contents September 30, 2020 December 31, 2019 (dollars in thousands) Amortized Cost % Amortized Cost % Debt securities held to maturity: Obligations of U.S. government and agencies $ 299,797 96.5 % $ 361,785 96.3 % Obligations of states and political subdivisions 10,899 3.5 % 13,821 3.7 % Total debt securities held to maturity $ 310,696 100.0 % $ 375,606 100.0 % Investment securities held to maturity decreased $64,910,000 to $310,696,000 as of September 30, 2020, as compared to December 31, 2019. This decrease is attributable to principal repayments of $26,136,000, and amortization of net purchase premiums of $332,000. Loans The Company concentrates its lending activities in six principal areas: commercial real estate loans, consumer loans, commercial and industrial loans, construction loans, agriculture production loans and leases. The interest rates charged for the loans made by the Company vary with the degree of risk, the size and maturity of the loans, the borrower’s relationship with the Company and prevailing money market rates indicative of the Company’s cost of funds. The majority of the Company’s loans are direct loans made to individuals, farmers and local businesses. The Company relies substantially on local promotional activity and personal contacts by bank officers, directors and employees to compete with other financial institutions. The Company makes loans to borrowers whose applications include a sound purpose, a viable repayment source and a plan of repayment established at inception and generally backed by a secondary source of repayment. The following table shows the Company’s loan balances, net deferred loan costs and discounts, as of the dates indicated: (dollars in thousands) September 30, 2020 December 31, 2019 Commercial real estate $ 2,936,422 60.8 % $ 2,818,782 65.4 % Consumer 926,835 19.2 % 955,050 22.2 % Commercial and industrial 633,897 13.1 % 249,791 5.8 % Construction 284,933 5.9 % 249,827 5.8 % Agriculture production 40,613 0.8 % 32,633 0.79 % Leases 3,638 0.2 % 1,283 0.01 % Total loans $ 4,826,338 100.0 % $ 4,307,366 100.0 % At September 30, 2020 loans, including net deferred loan costs and discounts, totaled $4,826,338,000 which was a $422,343,000 (38.6%) annualized increase over the balances at December 31, 2019. As a Small Business Administration (SBA) Preferred Lender, the Company was able to provide PPP loans to small business customers. As of the quarter ended September 30, 2020, the total balance outstanding of PPP loans was $437,793,000 (approximately 2,900 loans) as compared to total PPP originations of $438,510,000. In connection with the origination of these loans, the Company earned approximately $15,735,000 in loan fees, offset by deferred loan costs of approximately $763,000, the net of which will be recognized over the earlier of loan maturity, repayment or receipt of forgiveness confirmation. As of September 30, 2020 there was approximately $11,846,000 in net deferred fee income expected to be recognized. During the three and nine months ended September 30, 2020, the Company recognized $2,603,000 and $4,959,000, respectively, in interest and fees on PPP loans. 55 Table of Contents Nonperforming Assets The following tables set forth the amount of the Company’s nonperforming assets ("NPA") as of the dates indicated. “Performing nonaccrual loans” are loans that may be current for both principal and interest payments, or are less than 90 days past due, but for which payment in full of both principal and interest is not expected, and are not well secured and in the process of collection: (dollars in thousands) September 30, 2020 December 31, 2019 Performing nonaccrual loans $ 17,932 $ 11,266 Nonperforming nonaccrual loans 4,986 5,579 Total nonaccrual loans 22,918 16,845 Loans 90 days past due and still accruing 45 19 Total nonperforming loans 22,963 16,864 Foreclosed assets 2,057 2,541 Total nonperforming assets $ 25,020 $ 19,405 Nonperforming assets to total assets 0.34 % 0.30 % Nonperforming loans to total loans 0.48 % 0.39 % Allowance for credit losses to nonperforming loans 381 % 182 % Changes in nonperforming assets during the three months ended September 30, 2020 (in thousands) Balance at June 30, 2020 New NPA / Valuation Adjustments Pay-downs /Sales /Upgrades Charge-offs/ (1) Write-downs Transfers to Foreclosed Assets Balance at September 30, 2020 Commercial real estate: CRE non-owner occupied $ 677 2,461 (128) — — $ 3,010 CRE owner occupied 2,409 1,397 (28) — — 3,778 Multifamily 2,024 — (2,024) — Farmland 1,819 238 (1) — — 2,056 Total commercial real estate loans 6,929 4,096 (2,181) — — 8,844 Consumer SFR 1-4 1st DT liens 6,719 1,144 (1,330) (2) (158) 6,373 SFR HELOCs and junior liens 5,665 385 (865) — — 5,185 Other 106 454 (183) (98) — 279 Total consumer loans 12,490 1,983 (2,378) (100) (158) 11,837 Commercial and industrial 1,710 851 (489) (94) — 1,978 Construction — 18 — — — 18 Agriculture production 445 — (159) — — 286 Leases — — — — — — Total nonperforming loans 21,574 6,948 (5,207) (194) (158) 22,963 Foreclosed assets 1,922 — — (23) 158 2,057 Total nonperforming assets $ 23,496 6,948 (5,207) — (217) — $ 25,020 (1) The table above does not include deposit overdraft charge-offs. Nonperforming assets increased during the three months ended September 30, 2020 $1,524,000 (6.5%) to $25,020,000 at September 30, 2020 compared to $23,496,000 at June 30, 2020. The increase in nonperforming assets during the third quarter of 2020 was primarily the result of new nonperforming loans of $6,948,000, which were partially offset by pay-downs of $5,207,000 and write-downs of $217,000. Non performing loans added during the third quarter of 2020 were primarily within commercial real estate, with non-owner occupied adding $2,461,000 and owner occupied additions totaling $1,397,000. Management believes these loans are well-secured as of September 30, 2020. Further, management is actively engaged in the collection and recovery efforts for all nonperforming assets and believes that the specific loan loss reserves associated with these loans is sufficient as of September 30, 2020. Loan charge-offs during the three months ended September 30, 2020 In the third quarter of 2020, the Company recorded $136,000 in loan charge-offs and $58,000 in deposit overdraft charge-offs less $334,000 in loan recoveries and $47,000 in deposit overdraft recoveries resulting in $187,000 of net recoveries. Loan charge-offs were not concentrated within any single loan or borrower relationship and were comprised entirely of individual charges of less than $100,000 each. 56 Table of Contents Changes in nonperforming assets during the nine months ended September 30, 2020 (in thousands) Balance at December 31, 2019 New NPA / Valuation Adjustments Pay-downs /Sales /Upgrades Charge-offs/ (1) Write-downs Transfers to Foreclosed Assets Balance at September 30, 2020 Commercial real estate: CRE non-owner occupied $ 642 2,527 (159) — — $ 3,010 CRE owner occupied 1,408 2,651 (281) — — 3,778 Multifamily 2,024 — (2,024) — — — Farmland 1,242 1,003 (189) — — 2,056 Total commercial real estate loans 5,316 6,181 (2,653) — — 8,844 Consumer SFR 1-4 1st DT liens 5,191 3,181 (1,828) (13) (158) 6,373 SFR HELOCs and junior liens 4,217 2,517 (1,526) (23) — 5,185 Other 51 702 (3) (471) — 279 Total consumer loans 9,459 6,400 (3,357) (507) (158) 11,837 Commercial and industrial 2,050 1,727 (1,111) (688) — 1,978 Construction — 18 — — — 18 Agriculture production 39 426 (179) — — 286 Leases — — — — — — Total nonperforming loans 16,864 14,752 (7,300) (1,195) (158) 22,963 Foreclosed assets 2,541 — (534) (108) 158 2,057 Total nonperforming assets $ 19,405 14,752 (7,834) — (1,303) — $ 25,020 (1) The table above does not include deposit overdraft charge-offs. Nonperforming assets increased during the first nine months of 2020 by $5,615,000 (28.9%) to $25,020,000 at September 30, 2020 compared to $19,405,000 at December 31, 2019. The increase in nonperforming assets during the third quarter of 2020 was primarily the result of new nonperforming loans of $14,752,000, which were partially offset by pay-downs of $7,834,000 and write-downs of $1,303,000. Loan charge-offs during the nine months ended September 30, 2020 During the nine months ended September 30, 2020, the Company recorded $952,000 in loan charge-offs and $243,000 in deposit overdraft charge-offs less $1,344,000 in loan recoveries and $159,000 in deposit overdraft recoveries resulting in $308,000 of net recoveries for the year to date period. The Components of the Allowance for Credit Losses for Loans The following table sets forth the allowance for credit losses as of the dates indicated: (dollars in thousands) September 30, 2020 June 30, 2020 March 31, 2020 January 1, 2020 December 31, 2019 Allowance for credit losses: Qualitative and forecast factor allowance $ 56,393 $ 48,548 $ 29,250 $ 21,830 $ 13,476 Cohort model allowance reserves 30,373 30,061 27,699 26,900 16,205 Total allowance for credit losses 86,766 78,609 56,949 48,730 29,681 Allowance for individually evaluated loans 809 1,130 962 799 935 Allowance for PCD loan losses — — — — n/a Allowance for PCI loan losses n/a n/a n/a n/a 6 Total allowance for credit losses $ 87,575 $ 79,739 $ 57,911 $ 49,529 $ 30,616 Allowance for credit losses for loans 1.81 % 1.66 % 1.32 % 1.16 % 0.71 % For additional information regarding the allowance for loan losses, including changes in specific, formula, and environmental factors allowance categories, see “Asset Quality and Loan Loss Provisioning” at “Results of Operations” , above. Based on the current conditions of the loan portfolio, management believes that the $87,575,000 allowance for loan losses at September 30, 2020 is adequate to absorb probable losses inherent in the Bank’s loan portfolio. No assurance can be given, however, that adverse economic conditions or other 57 Table of Contents circumstances will not result in increased losses in the portfolio. The following table summarizes the allocation of the allowance for credit losses between loan types and by percentage of the total allowance for loan losses as of the dates indicated: September 30, 2020 January 1, 2020 December 31, 2019 Commercial real estate $ 50,294 57.4 % 23,843 48.1 % $ 11,995 39.2 % Consumer 24,007 27.4 % 18,368 37.1 % 10,084 32.9 % Commercial and industrial 4,534 5.2 % 2,906 5.9 % 4,867 15.9 % Construction 7,640 8.7 % 4,321 8.7 % 3,388 11.1 % Agriculture production 1,093 1.2 % 82 0.2 % 261 0.9 % Leases 7 0.0 % 9 0.0 % 21 0.1 % Total allowance for credit losses $ 87,575 100.0 % 49,529 100.0 % $ 30,616 100.0 % The following table summarizes the allocation of the allowance for credit losses as a percentage of the total loans for each loan category as of the dates indicated: September 30, 2020 January 1, 2020 December 31, 2019 Commercial real estate $ 2,936,422 1.71 % $ 2,818,782 0.85 % $ 2,818,782 0.42 % Consumer 926,835 2.57 % 955,050 1.92 % 955,050 1.05 % Commercial and industrial 633,897 0.72 % 249,791 1.16 % 249,791 1.81 % Construction 284,933 2.68 % 249,827 1.73 % 249,827 1.36 % Agriculture production 40,613 2.69 % 32,633 0.25 % 32,633 1.82 % Leases 3,638 0.19 % 1,283 0.70 % 1,283 1.63 % Total allowance for credit losses $ 4,826,338 1.88 % $ 4,307,366 1.15 % $ 4,307,366 0.71 % 58 Table of Contents The following table summarizes the activity in the allowance for credit losses for the periods indicated (dollars in thousands): Three months ended September 30, Nine months ended September 30, (in thousands) 2020 2019 2020 2019 Allowance for credit losses: Balance at beginning of period $ 79,739 $ 32,868 $ 30,616 $ 32,582 Impact of adoption from ASU 2016-13 — — 18,913 — Provision for (reversal of) loan losses 7,649 (329) 37,738 (1,392) Loans charged-off: Commercial real estate: CRE non-owner occupied — — — — CRE owner occupied — (746) — (746) Multifamily — — — — Farmland — — — — Consumer: SFR 1-4 1st DT liens (2) — (13) (2) SFR HELOCs and junior liens — (3) (23) (3) Other (98) (189) (471) (548) Commercial and industrial (94) (565) (688) (1,222) Construction — — — — Agriculture production — (20) — (20) Leases — — — — Total loans charged-off (194) (1,523) (1,195) (2,541) Recoveries of previously charged-off loans: Commercial real estate: CRE non-owner occupied 23 9 223 1,397 CRE owner occupied 1 118 3 121 Multifamily — — — — Farmland — — — — Consumer: Home equity lines 2 47 414 53 Home equity loans 126 182 265 719 Other consumer 85 80 253 263 Commercial and industrial 142 83 323 325 Construction — — — — Agriculture production 2 1 22 10 Leases — — — — Total recoveries of previously charged-off loans 381 520 1,503 2,888 Net (charge-offs) recoveries 187 (1,003) 308 347 Balance at end of period $ 87,575 $ 31,536 $ 87,575 $ 31,537 Average total loans $ 4,827,564 $ 4,142,602 $ 4,605,138 $ 4,070,568 Ratios (annualized): Net recoveries (charge-offs) during period to average loans outstanding during period 0.02 % (0.10) % 0.01 % 0.02 % Provision for loan losses (benefit from reversal of) to average loans outstanding during period 0.63 % (0.03) % 1.64 % (0.07) % 59 Table of Contents Foreclosed Assets, Net of Allowance for Losses The following table details the components and summarize the activity in foreclosed assets, net of allowances for losses for the nine months ended September 30, 2020: (in thousands) Balance at December 31, 2019 Sales Valuation Adjustments Transfers from Loans Balance at September 30, 2020 Land & Construction $ 312 $ (312) $ — $ — $ — Residential real estate 1,048 (201) (129) 158 876 Commercial real estate 1,181 — — — 1,181 Total foreclosed assets $ 2,541 $ (513) $ (129) $ 158 $ 2,057 Deposits During the three and nine months ended September 30, 2020, the Company’s deposits increased $92,330,000 and $973,594,000, respectively, to $6,340,588,000. Included in the September 30, 2020 and December 31, 2019 certificate of deposit balances are $30,000,000, respectively, from the State of California. The Company participates in a deposit program offered by the State of California whereby the State may make deposits at the Company’s request subject to collateral and creditworthiness constraints. The negotiated rates on these State deposits are generally more favorable than other wholesale funding sources available to the Company. Off-Balance Sheet Arrangements See Note 7 to the condensed consolidated financial statements at Item 1 of Part I of this report for information about the Company’s commitments and contingencies including off-balance-sheet arrangements. Capital Resources The current and projected capital position of the Company and the impact of capital plans and long-term strategies are reviewed regularly by Management. On November 12, 2019 the Board of Directors approved the authorization to repurchase up to 1,525,000 shares of the Company's common stock (the 2019 Repurchase Plan), which approximates 5.0% of the shares outstanding as of the approval date. The actual timing of any share repurchases will be determined by the Company's management and therefore the total value of the shares to be purchased under the program is subject to change. The 2019 Repurchase Plan has no expiration date. During the three and nine months ended September 30, 2020, the Company repurchased zero and 813,862 shares with a market value of $0 and $7,669,000, respectively, under the 2019 Repurchase Plan. The Company’s primary capital resource is shareholders’ equity, which was $902,262,000 at September 30, 2020. This amount represents an increase of $16,576,000 during the quarter ended September 30, 2020 primarily as a result of an increase in accumulated other comprehensive income of $4,957,000, partially offset by $6,549,000 in cash dividends paid on common stock. The Company’s ratio of equity to total assets was 12.1% and 14.0% as of September 30, 2020 and December 31, 2019, respectively. We believe that the Company and the Bank were in compliance with applicable minimum capital requirements set forth in the final Basel III Capital rules as of September 30, 2020. The following summarizes the Company’s ratios of capital to risk-adjusted assets as of the dates indicated: September 30, 2020 December 31, 2019 Ratio Minimum Regulatory Requirement Ratio Minimum Regulatory Requirement Total capital 15.2 % 10.5 % 15.1 % 9.3 % Tier I capital 14.0 % 8.5 % 14.4 % 7.3 % Common equity Tier 1 capital 12.9 % 7.0 % 13.3 % 5.8 % Leverage 10.0 % 4.0 % 11.6 % 4.0 % See Note 8 and Note 14 to the condensed consolidated financial statements at Item 1 of Part I of this report for additional information about the Company’s capital resources. 60 Table of Contents As of September 30, 2020, we had an effective shelf registration statement on file with the Securities and Exchange Commission that allows us to issue various types of debt securities, as well as common stock, preferred stock, warrants, depositary shares representing fractional interest in shares of preferred stock, purchase contracts and units from time to time in one or more offerings. Each issuance under the shelf registration statement will require the filing of a prospectus supplement identifying the amount and terms of the securities to be issued. The registration statement does not limit the amount of securities that may be issued thereunder. Our ability to issue securities is subject to market conditions and other factors including, in the case of our debt securities, our credit ratings and compliance with the covenants in our credit agreement. Liquidity The Company’s principal source of asset liquidity is cash at the Federal Reserve Bank of San Francisco (“Federal Reserve”) and other banks and marketable investment securities available for sale. As of September 30, 2020, Federal Reserve cash reserve ratios have been temporarily reduced to zero as a response to the COVID-19 pandemic. The Company’s profitability during the first nine months of 2020 generated cash flows from operations of $78,584,000 compared to $76,266,000 during the first nine months of 2019. Net cash used by investing activities was $639,947,000 for the nine months ended September 30, 2020, compared to net cash from investing activities of $46,204,000 during the nine months ending 2019. Financing activities provided $937,438,000 during the nine months ended September 30, 2020, compared to $90,956,000 used during the nine months ended September 30, 2019. Deposit balance changes increased available liquidity by $973,594,000 during the nine months ended September 30, 2020, compared to a decrease of $71,059,000 for financing activity during the same period in 2019. Dividends paid used $19,758,000 and $18,285,000 of cash during the nine months ended September 30, 2020 and 2019, respectively. The Company’s liquidity is dependent on dividends received from the Bank. Dividends from the Bank are subject to certain regulatory restrictions.