ovly20160831_10q.htm

  

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

   

For the quarterly period ended September 30, 2016

 

 

OR

 

 

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-34142

 

OAK VALLEY BANCORP

(Exact name of registrant as specified in its charter)

 

California

 

26-2326676

State or other jurisdiction of

 

I.R.S. Employer

incorporation or organization

 

Identification No.

 

125 N. Third Ave., Oakdale, CA  95361

(Address of principal executive offices)

 

(209) 848-2265

Issuer’s telephone number

 

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   No 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes     No 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer 

 

Accelerated filer 

 

 

 

Non-accelerated filer 

 

Smaller reporting company 

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  No 

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

State the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  8,091,455 shares of common stock outstanding as of November 10, 2016.

 

 
 

 

 

Oak Valley Bancorp

September 30, 2016

 

Table of Contents

 

 

 

 

Page

PART I – FINANCIAL INFORMATION

 

3

 

 

 

 

Item 1.

Financial Statements

 

3

 

 

 

 

Condensed Consolidated Balance Sheets at September 30, 2016 (Unaudited) and December 31, 2015

 

3

 

 

 

 

Condensed Consolidated Statements of Income for the Three and Nine month periods Ended September 30, 2016 and September 30, 2015 (Unaudited)

 

4

 

   

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine month periods Ended September 30, 2016 and September 30, 2015 (Unaudited)

  5

 

 

 

 

Condensed Consolidated Statements of Changes of Shareholders’ Equity for the Year Ended December 31, 2015 and the Nine-month period Ended September 30, 2016 (Unaudited)

 

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine-month periods Ended September 30, 2016 and September 30, 2015 (Unaudited)

 

7

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

8

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

32

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

48

 

 

 

 

Item 4.

Controls and Procedures

 

48

 

 

 

 

PART II – OTHER INFORMATION

 

49

 

 

 

 

Item 1.

Legal Proceedings

 

49
Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

49

Item 3.

Defaults Upon Senior Securities

 

49

Item 4.

Mine Safety Disclosures

 

49

Item 5.

Other Information

 

49

Item 6.

Exhibits

 

50

 

 

 
2

 

  

PART I – FINANCIAL STATEMENTS

 

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

(dollars in thousands)

 

September 30,

   

December 31,

 
   

2016

   

2015

 

ASSETS

               

Cash and due from banks

  $ 133,243     $ 174,778  

Federal funds sold

    14,020       15,825  

Cash and cash equivalents

    147,263       190,603  
                 

Securities available for sale

    160,077       131,546  

Loans, net of allowance for loan loss of $7,767 and $7,356 at September 30, 2016 and December 31, 2015, respectively

    592,650       530,394  

Bank premises and equipment, net

    13,712       14,277  

Other real estate owned

    1,485       2,066  

Interest receivable and other assets

    31,831       28,152  
                 
    $ 947,018     $ 897,038  
                 

LIABILITIES AND SHAREHOLDERS’ EQUITY

               
                 

Deposits

  $ 859,756     $ 814,691  

Interest payable and other liabilities

    4,404       4,084  

Total liabilities

    864,160       818,775  
                 

Shareholders’ equity

               

Common stock, no par value; 50,000,000 shares authorized, 8,093,555 and 8,078,155 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively

    24,682       24,682  

Additional paid-in capital

    3,412       3,217  

Retained earnings

    52,198       48,795  

Accumulated other comprehensive income, net of tax

    2,566       1,569  

Total shareholders’ equity

    82,858       78,263  
                 
    $ 947,018     $ 897,038  

 

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
3

 

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

(dollars in thousands, except per share amounts)

 

THREE MONTHS ENDED
SEPTEMBER 30,

   

NINE MONTHS ENDED
SEPTEMBER 30,

 
   

2016

   

2015

   

2016

   

2015

 

INTEREST INCOME

                               

Interest and fees on loans

  $ 6,807     $ 5,515     $ 20,484     $ 16,293  

Interest on securities available for sale

    1,045       914       3,038       2,687  

Interest on federal funds sold

    4       8       18       24  

Interest on deposits with banks

    169       72       492       212  

Total interest income

    8,025       6,509       24,032       19,216  
                                 

INTEREST EXPENSE

                               

Deposits

    196       155       555       461  

Total interest expense

    196       155       555       461  
                                 

Net interest income

    7,829       6,354       23,477       18,755  

Provision for (reversal of) loan losses

    90       0       415       (125 )
                                 

Net interest income after provision for (reversal of) loan losses

    7,739       6,354       23,062       18,880  
                                 

OTHER INCOME

                               

Service charges on deposits

    341       307       1,011       927  

Earnings on cash surrender value of life insurance

    102       108       305       322  

Mortgage commissions

    49       26       144       114  

Net gain on sales and calls of securities

    10       3       28       186  

Other

    575       521       1,682       1,599  

Total non-interest income

    1,077       965       3,170       3,148  
                                 

OTHER EXPENSES

                               

Salaries and employee benefits

    3,225       2,852       9,950       8,790  

Occupancy expenses

    819       743       2,470       2,214  

Data processing fees

    435       366       1,346       1,077  

Regulatory assessments (FDIC & DBO)

    178       123       505       368  

Other operating expenses

    1,267       1,215       4,027       3,141  

Total non-interest expense

    5,924       5,299       18,298       15,590  
                                 

Net income before provision for income taxes

    2,892       2,020       7,934       6,438  
                                 

PROVISION FOR INCOME TAXES

    962       638       2,591       2,020  

NET INCOME

  $ 1,930     $ 1,382     $ 5,343     $ 4,418  
                                 

NET INCOME PER COMMON SHARE

  $ 0.24     $ 0.17     $ 0.67     $ 0.55  
                                 

NET INCOME PER DILUTED COMMON SHARE

  $ 0.24     $ 0.17     $ 0.66     $ 0.55  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
4

 

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

 

 

   

THREE MONTHS ENDED
SEPTEMBER 30,

   

NINE MONTHS ENDED

SEPTEMBER 30,

 

(in thousands)

 

2016

   

2015

   

2016

   

2015

 
                                 

Net income

  $ 1,930     $ 1,382     $ 5,343     $ 4,418  

Other comprehensive income (loss):

                               

Unrealized holding (losses) gains on securities arising during the current period, net of tax effect of ($108) thousand and $709 thousand for the three and nine month periods ended September 30, 2016 and 2015, respectively, and $290 thousand and ($492) thousand for the comparable 2015 periods

    (154 )     415       1,014       (704 )

Reclassification adjustment due to net gains realized on sales and calls of securities, net of tax effect of $4 thousand and $11 thousand for the three and nine months ended September 30, 2016, respectively, and $1 thousand and $77 thousand for the comparable 2015 periods

    (6 )     (2 )     (17 )     (109 )

Other comprehensive income (loss)

    (160 )     413       997       (813 )

Comprehensive income

  $ 1,770     $ 1,795     $ 6,340     $ 3,605  

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
5

 

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

 

 

   

YEAR ENDED DECEMBER 31, 2015 AND NINE MONTHS ENDED SEPTEMBER 30, 2016

 
                                   

Accumulated

         
                   

Additional

           

Other

   

Total

 
   

Common Stock

   

Paid-in

   

Retained

   

Comprehensive

   

Shareholders’

 

(dollars in thousands)

 

Shares

   

Amount

   

Capital

   

Earnings

   

Income (Loss)

   

Equity

 
                                                 

Balances, January 1, 2015

    8,074,855     $ 24,682     $ 2,910     $ 45,582     $ 1,867     $ 75,041  

Tax benefit on stock based compensation

                    46                       46  

Restricted stock issued

    6,000                                       0  

Restricted stock forfeited

    (2,700 )                                     0  

Cash dividends declared

                            (1,695 )             (1,695 )

Stock based compensation

                    261                       261  

Other comprehensive loss

                                    (298 )     (298 )

Net income

                            4,908               4,908  

Balances, December 31, 2015

    8,078,155     $ 24,682     $ 3,217     $ 48,795     $ 1,569     $ 78,263  
                                                 

Restricted stock issued

    17,000                                     $ 0  

Restricted stock forfeited

    (1,600 )                                        

Cash dividends declared

                            (1,940 )             (1,940 )

Stock based compensation

                    195                       195  

Other comprehensive income

                                    997       997  

Net income

                            5,343               5,343  

Balances, September 30, 2016

    8,093,555     $ 24,682     $ 3,412     $ 52,198     $ 2,566     $ 82,858  

 

 

The accompanying notes are an integral part of these consolidated financial statements

 

 
6

 

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

   

NINE MONTHS ENDED
SEPTEMBER 30,

 

(dollars in thousands)

 

2016

   

2015

 
                 

CASH FLOWS FROM OPERATING ACTIVITIES:

               

Net income

  $ 5,343     $ 4,418  

Adjustments to reconcile net earnings to net cash from operating activities:

               

Provision (reversal of provision) for loan losses

    415       (125 )

Decrease in deferred fees/costs, net

    (29 )     (123 )

Depreciation

    948       892  

Amortization of investment securities, net

    270       132  

Stock based compensation

    195       197  

Gain on sale of premises and equipment

    (4 )     (5 )

OREO write downs and losses on sale

    88       50  

Gain on sales and calls of available for sale securities

    (28 )     (186 )

Earnings on cash surrender value of life insurance

    (305 )     (322 )

Gain on BOLI death benefit

    (2 )     (66 )

Increase (decrease) in interest payable and other liabilities

    320       (1,044 )

Decrease in interest receivable

    52       75  

Increase in other assets

    (228 )     (178 )

Net cash from operating activities

    7,035       3,715  
                 

CASH FLOWS FROM INVESTING ACTIVITIES:

               

Purchases of available for sale securities

    (47,182 )     (34,506 )

Proceeds from maturities, calls, and principal paydowns of securities available for sale

    20,103       24,958  

Net increase in loans

    (62,895 )     (22,876 )

Purchase of FHLB Stock

    (79 )     0  

Purchase of BOLI policies

    (4,000 )     0  

Proceeds from sale of OREO

    746       0  

Proceeds from redemption of BOLI policies

    186       292  

Proceeds from sales of premises and equipment

    4       5  

Net purchases of premises and equipment

    (383 )     (562 )

Net cash used in investing activities

    (93,500 )     (32,689 )
                 

CASH FLOWS FROM FINANCING ACTIVITIES:

               

Shareholder cash dividends paid

    (1,940 )     (1,696 )

Net increase in demand deposits and savings accounts

    40,612       43,078  

Net increase (decrease) in time deposits

    4,453       (82 )

Net cash from financing activities

    43,125       41,300  
                 

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

    (43,340 )     12,326  
                 

CASH AND CASH EQUIVALENTS, beginning of period

    190,603       144,288  
                 

CASH AND CASH EQUIVALENTS, end of period

  $ 147,263     $ 156,614  
                 
                 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

               

Cash paid during the period for:

               

Interest

  $ 558     $ 466  

Income taxes

  $ 1,434     $ 3,545  
                 

NON-CASH INVESTING ACTIVITIES:

               

Real estate acquired through foreclosure

  $ 253     $ 0  

Change in unrealized gain (loss) on available-for-sale securities

  $ 1,694     $ (1,382 )

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
7

 

 

OAK VALLEY BANCORP

 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 – BASIS OF PRESENTATION

 

On July 3, 2008 (the “Effective Date”), a bank holding company reorganization was completed whereby Oak Valley Bancorp (“the Company”) became the parent holding company for Oak Valley Community Bank ( the “Bank”).  On the Effective Date, a tax-free exchange was completed whereby each outstanding share of the Bank was converted into one share of the Company and the Bank became the sole wholly-owned subsidiary of the holding company.

 

On December 23, 2015, the Company completed its acquisition of Mother Lode Bank (“MLB”), a California state-chartered bank headquartered in Sonora, California, in a transaction in which Mother Lode Bank was merged with and into the Bank, with the Bank as the surviving company in the transaction. The purchase price for Mother Lode Bank was approximately $7.3 million. As of the acquisition date, Mother Lode Bank’s total assets were $78.7 million and total deposits were $71.1 million.

 

Oak Valley Community Bank is a California State chartered bank. The Bank was incorporated under the laws of the state of California on May 31, 1990, and began operations in Oakdale on May 28, 1991. The Company operates branches in Oakdale, Sonora, Bridgeport, Bishop, Mammoth Lakes, Modesto, Manteca, Patterson, Turlock, Ripon, Stockton, Tracy and Escalon, California. The Bridgeport, Mammoth Lakes, and Bishop branches operate as a separate division, Eastern Sierra Community Bank. The Company’s primary source of revenue is providing loans to customers who are predominantly middle-market businesses.

 

The consolidated financial statements include the accounts of the Company and its wholly-owned bank subsidiary. All material intercompany transactions have been eliminated. In the opinion of Management, the consolidated financial statements contain all adjustments necessary to present fairly the financial position, results of operations, changes in shareholders’ equity and cash flows.  All adjustments are of a normal, recurring nature.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant accounting estimates reflected in the Company’s consolidated financial statements include the allowance for loan losses, determination of non-accrual loans, other-than-temporary impairment of investment securities, the fair value measurements, deferred compensation plans, and the determination, recognition and measurement of impaired loans. Actual results could differ from these estimates.

 

The interim consolidated financial statements included in this report are unaudited but reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the three and nine month periods ended September 30, 2016 are not necessarily indicative of the results of a full year’s operations. Certain prior year amounts have been reclassified to conform to the current year presentation. There was no effect on net income or shareholders’ equity as a result of reclassifications. For further information, refer to the audited consolidated financial statements and footnotes included in the Company’s Form 10-K for the year ended December 31, 2015.

 

   

NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS

   

 

In September, 2015, the FASB issued ASU No. 2015-16, Simplifying the Accounting for Measurement Period Adjustments (Topic 805). This ASU eliminates the requirement to restate prior period financial statements for measurement period adjustments to assets acquired and liabilities assumed in a business combination. The new guidance under this update requires the cumulative impact of measurement period adjustments be recognized in the period the adjustment is determined. This update does not change what constitutes a measurement period adjustment, nor does it change the length of the measurement period. The new standard is effective for interim annual periods beginning after December 15, 2015 and should be applied prospectively to measurement period adjustments that occur after the effective date. The adoption of this update is not expected to have a material impact on the Company’s consolidated financial statements.

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this ASU make improvements to GAAP related to financial instruments that include the following as applicable to us.

 

 

Equity investments, except for those accounted for under the equity method of accounting or those that result in consolidation of the investee, are required to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer.

 

 
8

 

 

 

Simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment - if impairment exists, this requires measuring the investment at fair value.

 

 

Eliminates the requirement for public companies to disclose the method(s) and significant assumptions used to estimate the fair value that is currently required to be disclosed for financial instruments measured at amortized cost on the balance sheet.

 

 

Public companies will be required to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes.

 

 

Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements.

 

 

The reporting entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets.

 

ASU 2016-01 is effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. This ASU will impact our financial statement disclosures, however, we do not expect this ASU to have a material impact on our financial condition or results of operations.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This ASU was issued to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities, including leases classified as operating leases under previous GAAP, on the balance sheet and requiring additional disclosures of key information about leasing arrangements. ASU 2016-02 is effective for annual periods, including interim periods within those annual periods beginning after December 15, 2018 and requires a modified retrospective approach to adoption. Early application of the amendments is permitted. We are currently evaluating the provisions of this ASU and will be monitoring developments and additional guidance to determine the potential outcome the amendments will have on our financial condition and results of operations.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326). This update changes the methodology used by financial institutions under current U.S. GAAP to recognize credit losses in the financial statements.  Currently, U.S. GAAP requires the use of the incurred loss model, whereby financial institutions recognize in current period earnings, incurred credit losses and those inherent in the financial statements, as of the date of the balance sheet.    This guidance results in a new model for estimating the allowance for loan and lease losses, commonly referred to as the Current Expected Credit Loss (“CECL”) model.  Under the CECL model, financial institutions are required to estimate future credit losses and recognize those losses in current period earnings.  The amendments within the update are effective for fiscal years and all interim periods beginning after December 15, 2019, with early adoption permitted.  Upon adoption of the amendments within this update, the Company will be required to make a cumulative-effect adjustment to the opening balance of retained earnings in the year of adoption. The Company is currently in the process of evaluating the impact the adoption of this update will have on its financial statements.

 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments (Topic 230). This update clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows with the objective of reducing the existing diversity in practice related to eight specific cash flow issues. The amendments in this update are effective for annual periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of the amendments within this update will have a material impact on the Company’s financial statements.

 

 

NOTE 3 – ACQUISITION

 

On December 23, 2015, in effort to expand our market presence and enhance shareholder value, the Company acquired Mother Lode Bank ("MLB"), via a merger with and into the Bank, upon the consummation of which all outstanding common shares and unexercised options to purchase MLB common stock were cancelled, in exchange for $7,336,000 in cash (the "MLB Acquisition"). On January 29, 2016, the two acquired MLB branches in Sonora were closed after management determined that our two existing branches in Sonora would be able to support our acquired customers. The assets acquired and liabilities assumed, both tangible and intangible, were recorded at their fair values as of the acquisition date in accordance with ASC 805.

 

During the third quarter of 2016, the Company determined that deferred tax assets acquired from MLB totaling $2,651,000, mainly from net operating loss carryforwards, cannot be utilized by the Company. As a result, the Company decreased deferred tax assets and increased goodwill by $2,651,000 as of the December 23, 2015 acquisition date in the tables below. Additionally, all related financial statement disclosures have been revised. These revisions did not impact previously reported net income or shareholders equity.

 

 
9

 

 

The following table reflects the estimated fair values of the assets acquired and liabilities assumed related to the MLB Acquisition:

 

(Dollars in thousands)

 

Acquisition Date
December 23, 2015

 

Assets:

       

Cash and cash equivalents

  $ 30,804  

Loans

    42,831  

Core deposit intangible

    1,031  

Goodwill

    3,312  

Other assets

    738  

Total assets acquired

  $ 78,717  
         

Liabilities:

       

Deposits:

       

Non-interest bearing

  $ 36,177  

Interest bearing

       

Transaction accounts

    6,112  

Savings accounts

    15,727  

Money market accounts

    7,602  

Other time accounts

    5,507  

Total deposits

    71,125  
         

Other liabilities

    256  

Total liabilities assumed

  $ 71,381  
         

Merger consideration

  $ 7,336  

  

 
10

 

 

The following table presents the net assets acquired from MLB and the estimated fair value adjustments:

 

(Dollars in thousands)

 

Acquisition Date
December 23, 2015

 

Book value of net assets acquired from Mother Lode Bank

  $ 4,884  
         

Fair value adjustments:

       

Loans

    (2,960 )

Reversal of Allowance for Loan Loss

    1,279  

Core deposit intangible asset

    1,031  

Other assets & liabilities, net

    (210 )

Total purchase accounting adjustments

  $ (860 )
         

Fair value of net assets acquired from Mother Lode Bank

  $ 4,024  
         

Merger consideration

    7,336  

Less: fair value of net assets acquired

    (4,024 )

Goodwill

  $ 3,312  

 

 

As a result of the MLB Acquisition, we recorded $3,312,000 in goodwill, which represents the excess of the total purchase price paid over the fair value of the assets acquired, net of the fair values of liabilities assumed. Goodwill mainly reflects expected value created through the combined operations of MLB and the Company. At December 31, 2015, we determined that the fair value of our traditional community banking activities (provided through our branch network) exceeded the carrying amount. Therefore, no impairment on goodwill has been recorded. The following is a description of the methods used to determine the fair values of significant assets and liabilities at acquisition date presented above.

 

Loans

 

The fair values for acquired loans were developed based upon the present values of the expected cash flows utilizing market-derived discount rates. Expected cash flows for each acquired loan were projected based on contractual cash flows adjusted for expected prepayment, expected default (i.e. probability of default and loss severity), and principal recovery.

 

Prepayment rates were applied to the principal outstanding based on the type of loan, where appropriate. Prepayments were based on a constant prepayment rate (“CPR”) applied across the life of a loan. The annual CPRs were between 0% and 5%, depending on the characteristics of the loan pool (e.g. construction, commercial real estate, etc.).

 

Non-credit-impaired loans with similar characteristics were grouped together and were treated in the aggregate when applying the discount rate on the expected cash flows. Aggregation factors considered included the type of loan and related collateral, risk classification, fixed or variable interest rate, term of loan and whether or not the loan was amortizing. See Note 5 for additional information.

 

Core Deposit Intangible

 

The core deposit intangible represents the estimated future benefits of acquired deposits and is booked separately from the related deposits. The value of the core deposit intangible asset was determined using a discounted cash flow approach to arrive at the cost differential between the core deposits (non-maturity deposits such as transaction, savings and money market accounts) and alternative funding sources. A core deposit intangible asset of $1,031,000 was recorded on December 23, 2015, of which $39,000 and $120,000 was amortized during the three and nine month periods ended September 30, 2016, respectively. The core deposit intangible is amortized on an accelerated basis over an estimated ten-year life, and it is evaluated periodically for impairment. No impairment loss was recognized as of September 30, 2016.

 

Acquisition Related Expenses

 

Acquisition-related expenses are recognized as incurred and continue until all systems have been converted and operational functions become fully integrated. We incurred one-time third-party acquisition-related expenses in the consolidated statements of income totaling $49,000 and $190,000 during the three and nine month periods ended September 30, 2016, respectively. The conversion of the operating systems was completed in April 2016.

 

 
11

 

 

NOTE 4 – SECURITIES

 

The amortized cost and estimated fair values of debt securities as of September 30, 2016 are as follows:

 

(dollars in thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 
                                 

Available-for-sale securities:

                               

U.S. agencies

  $ 28,940     $ 1,078     $ (3 )   $ 30,015  

Collateralized mortgage obligations

    4,329       18       (3 )     4,344  

Municipalities

    73,649       3,923       (19 )     77,553  

SBA pools

    5,209       1       (9 )     5,201  

Corporate debt

    21,347       113       (395 )     21,065  

Asset backed securities

    19,003       4       (218 )     18,789  

Mutual fund

    3,240       0       (130 )     3,110  
    $ 155,717     $ 5,137     $ (777 )   $ 160,077  

 

 

The following tables detail the gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2016.

 

(dollars in thousands)

 

Less than 12 months

   

12 months or more

   

Total

 

Description of Securities

 

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

 

U.S. agencies

  $ 744     $ (3 )   $ 0     $ 0     $ 744     $ (3 )

Collateralized mortgage obligations

    3,270       (3 )     0       0       3,270       (3 )

Municipalities

    5,572       (15 )     427       (4 )     5,999       (19 )

SBA pools

    2,152       (5 )     772       (4 )     2,924       (9 )

Corporate debt

    12,162       (372 )     972       (23 )     13,134       (395 )

Asset backed securities

    5,128       (45 )     10,165       (173 )     15,293       (218 )

Mutual fund

    0       0       3,109       (130 )     3,109       (130 )

Total temporarily impaired securities

  $ 29,028     $ (443 )   $ 15,445     $ (334 )   $ 44,473     $ (777 )

 

 

At September 30, 2016, there was one U.S municipality, two SBA pools, three corporate debts, six asset backed securities and one mutual fund that comprised the total securities in an unrealized loss position for greater than 12 months and one U.S. agency, two collateralized mortgage obligations, six municipalities, one SBA pool, seven corporate debts and two asset backed securities that make up the total securities in a loss position for less than 12 months. Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if the impairment is temporary or other than temporary. This evaluation encompasses various factors including, the nature of the investment, the cause of the impairment, the severity and duration of the impairment, credit ratings and other credit related factors such as third party guarantees and volatility of the security’s fair value. Management has determined that no investment security is other than temporarily impaired. The unrealized losses are due primarily to interest rate changes and the Company does not intend to sell the securities and it is not likely that we will be required to sell the securities before the earlier of the forecasted recovery or the maturity of the underlying investment security.

 

 
12

 

 

The amortized cost and estimated fair value of investment securities at September 30, 2016, by contractual maturity or call date, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(dollars in thousands)

 

Amortized

   

Fair

 
   

Cost

   

Value

 

Available-for-sale securities:

               

Due in one year or less

  $ 10,008     $ 10,696  

Due after one year through five years

    48,629       49,721  

Due after five years through ten years

    62,904       64,489  

Due after ten years

    34,176       35,171  
    $ 155,717     $ 160,077  

 

 

The amortized cost and estimated fair values of debt securities as of December 31, 2015, are as follows:

 

(dollars in thousands)

 

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair Value

 
                                 

Available-for-sale securities:

                               

U.S. agencies

  $ 31,815     $ 1,142     $ (89 )   $ 32,868  

Collateralized mortgage obligations

    2,729       17       (27 )     2,719  

Municipalities

    66,535       2,248       (197 )     68,586  

SBA pools

    811       0       (5 )     806  

Corporate debt

    13,497       44       (121 )     13,420  

Asset backed securities

    10,321       0       (183 )     10,138  

Mutual fund

    3,172       0       (163 )     3,009  
    $ 128,880     $ 3,451     $ (785 )   $ 131,546  

 

 

The following tables detail the gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2015.

 

(dollars in thousands)

 

Less than 12 months

   

12 months or more

   

Total

 

Description of Securities

 

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

   

Fair

Value

   

Unrealized

Loss

 

U.S. agencies

  $ 7,129     $ (30 )   $ 1,800     $ (59 )   $ 8,929     $ (89 )

Collateralized mortgage obligations

    0       0       1,266       (27 )     1,266       (27 )

Municipalities

    11,451       (123 )     3,680       (74 )     15,131       (197 )

SBA pools

    0       0       807       (5 )     807       (5 )

Corporate debt

    9,376       (121 )     0       0       9,376       (121 )

Asset backed securities

    5,351       (78 )     4,787       (105 )     10,138       (183 )

Mutual fund

    0       0       3,009       (163 )     3,009       (163 )

Total temporarily impaired securities

  $ 33,307     $ (352 )   $ 15,349     $ (433 )   $ 48,656     $ (785 )

 

We recognized gross gains of $10,000 and $29,000 for the three and nine month periods ended September 30, 2016, respectively, on certain available-for-sale securities that were called or sold, which compares to $3,000 and $218,000 in the same periods of 2015. There were no securities sold during the first nine months of 2016, compared to two available-for-sale securities sold during the first nine months of 2015, which resulted in a gross loss of $32,000 on one sale and a gross gain of $13,000 on the other sale.

 

Securities carried at $83,423,000 and $65,902,000 at September 30, 2016 and December 31, 2015, respectively, were pledged to secure deposits of public funds.

 

 
13

 

 

NOTE 5 – LOANS

 

Our customers are primarily located in Stanislaus, San Joaquin, Tuolumne, Inyo, and Mono Counties. As of September 30, 2016, approximately 78% of the Company’s loans are commercial real estate loans which include construction loans. Approximately 11% of the Company’s loans are for general commercial uses including professional, retail, and small business. Additionally, 6% of the Company’s loans are for residential real estate and other consumer loans. The remaining 5% are agriculture loans. Loan totals were as follows:

 

(in thousands)

 

September 30, 2016

   

December 31, 2015

 

Commercial real estate:

               

Commercial real estate- construction

  $ 18,861     $ 19,363  

Commercial real estate- mortgages

    384,164       363,644  

Land

    9,561       10,239  

Farmland

    56,651       29,801  

Commercial and industrial

    68,073       63,776  

Consumer

    736       774  

Consumer residential

    36,756       32,588  

Agriculture

    27,767       20,847  

Total loans

    602,569       541,032  
                 

Less:

               

Deferred loan fees and costs, net

    (2,152 )     (3,282 )

Allowance for loan losses

    (7,767 )     (7,356 )

Net loans

  $ 592,650     $ 530,394  

 

 

Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentration of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

 

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, our management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At September 30, 2016 and December 31, 2015, commercial real estate loans equal to approximately 41.4% and 44.3%, respectively, of the outstanding principal balance of our commercial real estate loans were secured by owner-occupied properties.

 

 
14

 

 

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

Agricultural production, real estate and development lending is susceptible to credit risks including adverse weather conditions, pest and disease, as well as market price fluctuations and foreign competition. Agricultural loan underwriting standards are maintained by following Company policies and procedures in place to minimize risk in this lending segment. These standards consist of limiting credit to experienced farmers who have demonstrated farm management capabilities, requiring cash flow projections displaying margins sufficient for repayment from normal farm operations along with equity injected as required by policy, as well as providing adequate secondary repayment and sponsorship including satisfactory collateral support. Credit enhancement obtained through government guarantee programs may also be used to provide further support as available. 

 

The Company originates consumer loans utilizing common underwriting criteria specified in policy. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for 1-4 family, home equity lines and loans follow bank policy, which include, but are not limited to, a maximum loan-to-value percentage of 80%, a maximum housing and total debt ratio of 36% and 42%, respectively and other specified credit and documentation requirements.

 

The Company maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Bank’s policies and procedures.

 

Purchased Credit-Impaired (“PCI”) Loans. We evaluated loans purchased in the Acquisition in accordance with accounting guidance in ASC 310-30 related to loans acquired with deteriorated credit quality. Acquired loans are considered credit-impaired if there is evidence of significant deterioration of credit quality since origination and it is probable, at the acquisition date, that we will be unable to collect all contractually required payments receivable. Management has determined certain loans purchased in the MLB Acquisition to be PCI loans based on credit indicators such as nonaccrual status, past due status, loan risk grade, loan-to-value ratio, etc. Revolving credit agreements (e.g., home equity lines of credit and revolving commercial loans) are not considered PCI loans as cash flows cannot be reasonably estimated.

 

For acquired loans not considered credit-impaired, the difference between the contractual amounts due (principal amount) and the fair value is accounted for subsequently through accretion. We recognize discount accretion based on the acquired loan’s contractual cash flows using an effective interest rate method. The accretion is recognized through the net interest margin.

 

The following table presents the fair value of purchased credit-impaired and other loans acquired from Mother Lode Bank as of the acquisition date:

 

   

December 23, 2015

 

(in thousands)

 

Purchased

credit-impaired

loans

   

Other purchased

loans

   

Total

 
                         

Contractually required payments including interest

  $ 1,982     $ 44,007     $ 45,989  

Less: nonaccretable difference

    (1,103 )     0       (1,103 )

Cash flows expected to be collected (undiscounted)

    879       44,007       44,886  

Accretable yield

    (14 )     (2,041 )     (2,055 )

Fair value of purchased loans

  $ 865     $ 41,966     $ 42,831  

 

 
15

 

  

The following table reflects the outstanding balance and related carrying value of PCI loans as of September 30, 2016 and December 31, 2015:

 

(in thousands)

 

September 30, 2016

   

December 31, 2015

 

Commercial real estate:

 

Unpaid principal

balance

   

Carrying value

   

Unpaid principal

balance

   

Carrying value

 

Commercial real estate- construction

  $ 0     $ 0     $ 0     $ 0  

Commercial real estate- mortgages

    0       0       196       118  

Land

    280       33       795       269  

Farmland

    0       0       0       0  

Commercial and industrial

    499       499       794       478  

Consumer

    0       0       0       0  

Consumer residential

    0       0       0       0  

Agriculture

    0       0       0       0  

Total purchased credit-impaired loans

  $ 779     $ 532     $ 1,785     $ 865  

 

 

For the PCI loans, the accretable yield represents the excess of the cash flows expected to be collected at acquisition over the fair value of the loans at the acquisition date, and is accreted into interest income over the estimated remaining life of the purchased credit-impaired loans using the effective yield method, provided that the timing and amount of future cash flows is reasonably estimable. The cash flows expected to be collected are updated each quarter based on current assumptions regarding default rates, loss severities, and other factors that are reflective of current market conditions. Probable decreases in expected cash flows after acquisition result in the recognition of impairment as a specific allowance for loan losses or a charge-off to the allowance. The accretable yield balance for PCI loans was $14,000 at December 31, 2015, all of which was accreted to interest income during the first quarter of 2016, as each of the PCI loans had short-term maturities. The nonaccretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date and can fluctuate due to changes in expected cash flows during the life of the PCI loans.

 

 

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Non-accrual loans, segregated by class of loans, were as follows:

 

(in thousands)

 

September 30,

2016

   

December 31, 2015

 

Commercial real estate:

               

Land

  $ 2,305     $ 2,739  

Farmland

    0       51  

Commercial and industrial

    309       322  

Agriculture

    0       2,704  

Total non-accrual loans

  $ 2,614     $ 5,816  

 

 

Excluded from the above non-accrual loan table are the carrying values of Purchased Credit Impaired loans acquired in the MLB Acquisition.

 

Had non-accrual loans performed in accordance with their original contract terms, we would have recognized additional interest income of approximately $38,000 and $118,000 in the three and nine month periods ended September 30, 2016, respectively, as compared to $71,000 and $224,000 in the same periods of 2015.

 

 
16

 

 

The following table analyzes past due loans including the non-accrual loans in the above table, segregated by class of loans, as of September 30, 2016 (in thousands):

 

September 30, 2016

 

30-59

Days

Past Due

   

60-89

Days

Past Due

   

Greater

Than 90

Days

Past Due

   

Total

Past Due

   

Current

   

Purchased

Credit

Impaired

Loans

   

Total

   

Greater

Than 90

Days Past

Due and

Still

Accruing

 

Commercial real estate:

                                                               

Commercial R.E. - construction

  $ 0     $ 0     $ 0     $ 0     $ 18,861     $ 0     $ 18,861     $ 0  

Commercial R.E. - mortgages

    0       0       0       0       384,164       0       384,164       0  

Land

    289       0       2,296       2,585       6,943       33       9,561       0  

Farmland

    0       0       0       0       56,651       0       56,651       0  

Commercial and industrial

    0       0       304       304       67,270       499       68,073       0  

Consumer

    27       0       0       27       709       0       736       0  

Consumer residential

    0       0       0       0       36,756       0       36,756       0  

Agriculture

    0       0       0       0       27,767       0       27,767       0  

Total

  $ 316     $ 0     $ 2,600     $ 2,916     $ 599,121     $ 532     $ 602,569     $ 0  

 

 

The following table analyzes past due loans including the non-accrual loans in the above table, segregated by class of loans, as of December 31, 2015 (in thousands):

 

December 31, 2015

 

30-59

Days

Past

Due

   

60-89

Days

Past

Due

   

Greater

Than

90

Days

Past

Due

   

Total

Past

Due

   

Current

   

Purchased

Credit

Impaired

Loans

   

Total

   

Greater

Than 90

Days

Past Due

and Still

Accruing

 

Commercial real estate:

                                                               

Commercial R.E. - construction

  $ 0     $ 0     $ 0     $ 0     $ 19,363     $ 0     $ 19,363     $ 0  

Commercial R.E. – mortgages

    0       0       0       0       363,526       118       363,611       0  

Land

    0       0       2,261       2,261       7,709       269       10,239       0  

Farmland

    1,182       0       51       1,233       28,568       0       29,801       0  

Commercial and industrial

    352       0       312       664       62,634       478       63,776       0  

Consumer

    0       0       0       0       774       0       774       0  

Consumer residential

    0       0       0       0       32,588       0       32,588       0  

Agriculture

    0       2,704       0       2,704       18,143       0       20,847       0  

Total

  $ 1,534     $ 2,704     $ 2,624     $ 6,862     $ 533,305     $ 865     $ 541,032     $ 0  

 

 

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. There was no interest income realized on impaired loans for the three months ended September 30, 2016 and 2015.

 

 
17

 

 

Impaired loans as of September 30, 2016 and December 31, 2015 are set forth in the following tables. PCI loans are excluded from the tables below, as they have not experienced post acquisition declines in cash flows expected to be collected.

 

(in thousands)

 

Unpaid

Contractual

Principal

Balance

   

Recorded

Investment

With No

Allowance

   

Recorded

Investment

With

Allowance

   

Total

Recorded

Investment

   

Related

Allowance

 

September 30, 2016

                                       

Commercial real estate:

                                       

Commercial R.E. - construction

  $ 0     $ 0     $ 0     $ 0     $ 0  

Commercial R.E. - mortgages

    0       0       0       0       0  

Land

    2,712       744       1,561       2,305       680  

Farmland

    0       0       0       0       0  

Commercial and Industrial

    354       309       0       309       0  

Consumer

    0       0       0       0       0  

Consumer residential

    0       0       0       0       0  

Agriculture

    0       0       0       0       0  

Total

  $ 3,066     $ 1,053     $ 1,561     $ 2,614     $ 680  
                                         

December 31, 2015

                                       

Commercial real estate: