Item 2.
|
Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
|
The following is management’s discussion and analysis of the major factors that influenced our financial performance for the three months ended
March 31, 2019. This analysis should be read in conjunction with our 2018 Annual Report to Shareholders on Form 10-K, and with the unaudited financial statements and notes as set forth in this report.
Forward–Looking Statements
This Form 10-Q contains various forward-looking statements, usually containing the words “estimate,” “project,” “expect,” “objective,” “goal,” or
similar expressions and includes assumptions concerning Farmers & Merchants Bancorp’s (together with its subsidiaries, the “Company” or “we”) operations, future results, and prospects. These forward-looking statements are based upon
current expectations and are subject to risks and uncertainties. In connection with the “safe-harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary statement identifying
important factors which could cause the actual results of events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions.
Such factors include, but are not limited to, the following: (1) economic conditions in the Central Valley of California; (2) significant changes
in interest rates and loan prepayment speeds; (3) credit risks of lending and investment activities; (4) changes in federal and state banking laws or regulations; (5) competitive pressure in the banking industry; (6) changes in governmental
fiscal or monetary policies; (7) uncertainty regarding the economic outlook resulting from the continuing war on terrorism, as well as actions taken or to be taken by the U.S. or other governments as a result of further acts or threats of
terrorism; (8) water management issues in California and the resulting impact on the Company’s agricultural customers; (9) expansion into new geographic markets and new lines of business; and (10) other factors discussed in Item 1A. Risk
Factors located in the Company’s 2018 Annual Report on Form 10-K.
Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company
undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.
Introduction
Farmers & Merchants Bancorp, or the Company, is a bank holding company formed March 10, 1999. Its subsidiary, Farmers & Merchants Bank of
Central California, or the Bank, is a California state-chartered bank formed in 1916. Banking services are provided in thirty branches in the Company's service area. The service area includes Sacramento, San Joaquin, Stanislaus, Merced and
Contra Costa. Napa and Solano Counties with branches in Sacramento, Elk Grove, Galt, Lodi, Stockton, Linden, Modesto, Turlock, Hilmar, Merced, Manteca, Riverbank, Napa, Walnut Creek, Concord, Rio Vista, Walnut Grove and Lockeford.
As a bank holding company, the Company is subject to regulation and examination by the Board of Governors of the Federal Reserve System (“FRB”). As
a California, state-chartered, non-fed member bank, the Bank is subject to regulation and examination by the California Department of Business Oversight (“DBO”) and the Federal Deposit Insurance Corporation (“FDIC”).
Overview
Although the Company has initiated efforts to expand its geographic footprint into the East Bay area of San Francisco and Napa, California (see
Item 1: Business – Service Area), the Company’s primary service area remains the mid Central Valley of California, a region that can be significantly impacted by the seasonal needs of the agricultural industry. Accordingly, discussion of
the Company’s Financial Condition and Results of Operations is influenced by the seasonal banking needs of its agricultural customers (e.g., during the spring and summer customers draw down their deposit balances and increase loan borrowing
to fund the purchase of equipment and planting of crops. Correspondingly, deposit balances are replenished and loans repaid in late fall and winter as crops are harvested and sold).
The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have
alleviated drought conditions in many areas of California, including those in the Company’s primary service area. As a result, reservoir levels are high and the availability of water in our primary service area should not be an issue.
However, the weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.
For the three months ended March 31, 2019, Farmers & Merchants Bancorp reported net income of $13,549,000, earnings per share of $17.27 and
return on average assets of 1.60%. Return on average shareholders’ equity was 16.96% for the three months ended March 31, 2019.
For the three months ended March 31, 2018, Farmers & Merchants Bancorp reported net income of $9,941,000, earnings per share of $12.24 and
return on average assets of 1.31%. Return on average shareholders’ equity was 13.14% for the three months ended March 31, 2018.
The following is a summary of the financial results for the three-month period ended March 31, 2019 compared to March 31, 2018.
•
|
Net income increased 36.3% to $13,549,000 from $9,941,000.
|
•
|
Earnings per share increased 41.1% to $17.27 from $12.24.
|
•
|
Total assets increased 11.0% to $3.4 billion from $3.1 billion.
|
•
|
Total loans & leases increased 14.7% to $2.6 billion from $2.2 billion.
|
•
|
Total deposits increased 11.4% to $3.0 billion from $2.7 billion.
|
The primary reasons for the Company’s $3.6 million or 36.3% increase in net income in the first quarter of 2019 as compared to the same period of
2018 were:
•
|
A $5.3 million increase in net interest income related to both the growth in earning assets and increased interest rates.
|
•
|
A $333,000 decrease in the provision for credit losses
|
These positive impacts were partially offset by:
•
|
A $429,000 increase in legal expense and a $724,000 decrease in other non-interest income related to non-recurring income received in 2018.
|
•
|
A $1.3 million increase in the provision for income taxes.
|
Results of Operations
Net Interest Income / Net Interest Margin
The tables on the following pages reflect the Company's average balance sheets and volume and rate analysis for the three month periods ended March
31, 2019 and 2018.
The average yields on earning assets and average rates paid on interest-bearing liabilities have been computed on an annualized basis for purposes
of comparability with full year data. Average balance amounts for assets and liabilities are the computed average of daily balances.
Net interest income is the amount by which the interest and fees on loans & leases and other interest-earning assets exceed the interest paid
on interest-bearing sources of funds. For the purpose of analysis, the interest earned on tax-exempt investments and municipal loans is adjusted to an amount comparable to interest subject to normal income taxes. This adjustment is referred
to as “tax equivalent” adjustment and is noted wherever applicable. The presentation of net interest income and net interest margin on a tax equivalent basis is a common practice within the banking industry.
The Volume and Rate Analysis of Net Interest Income summarizes the changes in interest income and interest expense based on changes in average
asset and liability balances (volume) and changes in average rates (rate). For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to: (1) changes in volume
(change in volume multiplied by initial rate); (2) changes in rate (change in rate multiplied by initial volume); and (3) changes in rate/volume, also called “changes in mix” (allocated in proportion to the respective volume and rate
components).
The Company’s earning assets and rate sensitive liabilities are subject to repricing at different times, which exposes the Company to income
fluctuations when interest rates change. In order to minimize income fluctuations, the Company attempts to match asset and liability maturities. However, some maturity mismatch is inherent in the asset and liability mix. See “Item 3.
Quantitative and Qualitative Disclosures about Market Risk – Interest Rate Risk.”
Farmers & Merchants Bancorp
Year-to-Date Average Balances and Interest Rates
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
|
|
Three Months Ended March 31,
|
|
|
Three Months Ended March 31,
|
|
|
|
|
|
|
2019
|
|
|
|
|
|
|
|
|
2018
|
|
|
|
|
Assets
|
|
Balance
|
|
|
Interest
|
|
|
Annualized
Yield/Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Annualized
Yield/Rate
|
|
Interest Bearing Deposits With Banks
|
|
$
|
187,461
|
|
|
$
|
1,125
|
|
|
|
2.43
|
%
|
|
$
|
152,936
|
|
|
$
|
585
|
|
|
|
1.54
|
%
|
Investment Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasuries
|
|
|
46,617
|
|
|
|
195
|
|
|
|
1.67
|
%
|
|
|
92,107
|
|
|
|
297
|
|
|
|
1.29
|
%
|
U.S. Govt SBA
|
|
|
15,251
|
|
|
|
99
|
|
|
|
2.60
|
%
|
|
|
28,750
|
|
|
|
123
|
|
|
|
1.71
|
%
|
Government Agency & Government-Sponsored Entities
|
|
|
3,028
|
|
|
|
22
|
|
|
|
2.91
|
%
|
|
|
3,074
|
|
|
|
22
|
|
|
|
2.86
|
%
|
Obligations of States and Political Subdivisions - Non-Taxable
|
|
|
54,079
|
|
|
|
559
|
|
|
|
4.13
|
%
|
|
|
54,689
|
|
|
|
529
|
|
|
|
3.87
|
%
|
Mortgage Backed Securities
|
|
|
307,072
|
|
|
|
2,044
|
|
|
|
2.66
|
%
|
|
|
322,296
|
|
|
|
1,920
|
|
|
|
2.38
|
%
|
Other
|
|
|
5,183
|
|
|
|
67
|
|
|
|
5.17
|
%
|
|
|
3,010
|
|
|
|
18
|
|
|
|
2.39
|
%
|
Total Investment Securities
|
|
|
431,230
|
|
|
|
2,986
|
|
|
|
2.77
|
%
|
|
|
503,926
|
|
|
|
2,909
|
|
|
|
2.31
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans & Leases
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real Estate
|
|
|
1,778,866
|
|
|
|
22,694
|
|
|
|
5.17
|
%
|
|
|
1,548,359
|
|
|
|
19,044
|
|
|
|
4.95
|
%
|
Home Equity Line & Loans
|
|
|
39,610
|
|
|
|
596
|
|
|
|
6.10
|
%
|
|
|
34,735
|
|
|
|
448
|
|
|
|
5.19
|
%
|
Agricultural
|
|
|
259,108
|
|
|
|
3,628
|
|
|
|
5.68
|
%
|
|
|
251,784
|
|
|
|
3,028
|
|
|
|
4.84
|
%
|
Commercial
|
|
|
343,448
|
|
|
|
4,521
|
|
|
|
5.34
|
%
|
|
|
268,032
|
|
|
|
3,311
|
|
|
|
4.97
|
%
|
Consumer
|
|
|
17,773
|
|
|
|
254
|
|
|
|
5.80
|
%
|
|
|
5,293
|
|
|
|
76
|
|
|
|
5.77
|
%
|
Other
|
|
|
1,079
|
|
|
|
6
|
|
|
|
2.26
|
%
|
|
|
1,382
|
|
|
|
8
|
|
|
|
2.33
|
%
|
Leases
|
|
|
107,867
|
|
|
|
1,479
|
|
|
|
5.56
|
%
|
|
|
91,222
|
|
|
|
1,129
|
|
|
|
4.98
|
%
|
Total Loans & Leases
|
|
|
2,547,751
|
|
|
|
33,178
|
|
|
|
5.28
|
%
|
|
|
2,200,807
|
|
|
|
27,044
|
|
|
|
4.94
|
%
|
Total Earning Assets
|
|
|
3,166,442
|
|
|
$
|
37,289
|
|
|
|
4.78
|
%
|
|
|
2,857,669
|
|
|
$
|
30,538
|
|
|
|
4.30
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized (Loss) Gain on Securities Available-for-Sale
|
|
|
(4,019
|
)
|
|
|
|
|
|
|
|
|
|
|
(4,832
|
)
|
|
|
|
|
|
|
|
|
Allowance for Credit Losses
|
|
|
(55,238
|
)
|
|
|
|
|
|
|
|
|
|
|
(50,612
|
)
|
|
|
|
|
|
|
|
|
Cash and Due From Banks
|
|
|
56,206
|
|
|
|
|
|
|
|
|
|
|
|
46,527
|
|
|
|
|
|
|
|
|
|
All Other Assets
|
|
|
217,842
|
|
|
|
|
|
|
|
|
|
|
|
187,290
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
3,381,233
|
|
|
|
|
|
|
|
|
|
|
$
|
3,036,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities & Shareholders' Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing DDA
|
|
$
|
667,465
|
|
|
$
|
552
|
|
|
|
0.34
|
%
|
|
$
|
585,176
|
|
|
$
|
272
|
|
|
|
0.19
|
%
|
Savings and Money Market
|
|
|
910,793
|
|
|
|
730
|
|
|
|
0.33
|
%
|
|
|
825,514
|
|
|
|
330
|
|
|
|
0.16
|
%
|
Time Deposits
|
|
|
513,853
|
|
|
|
1,539
|
|
|
|
1.21
|
%
|
|
|
478,740
|
|
|
|
803
|
|
|
|
0.67
|
%
|
Total Interest Bearing Deposits
|
|
|
2,092,111
|
|
|
|
2,821
|
|
|
|
0.55
|
%
|
|
|
1,889,430
|
|
|
|
1,405
|
|
|
|
0.30
|
%
|
Federal Home Loan Bank Advances
|
|
|
4
|
|
|
|
-
|
|
|
|
0.00
|
%
|
|
|
4
|
|
|
|
-
|
|
|
|
0.00
|
%
|
Subordinated Debentures
|
|
|
10,310
|
|
|
|
145
|
|
|
|
5.70
|
%
|
|
|
10,310
|
|
|
|
117
|
|
|
|
4.56
|
%
|
Total Interest Bearing Liabilities
|
|
|
2,102,425
|
|
|
$
|
2,966
|
|
|
|
0.57
|
%
|
|
|
1,899,744
|
|
|
$
|
1,522
|
|
|
|
0.32
|
%
|
Interest Rate Spread
|
|
|
|
|
|
|
|
|
|
|
4.20
|
%
|
|
|
|
|
|
|
|
|
|
|
3.98
|
%
|
Demand Deposits (Non-Interest Bearing)
|
|
|
915,907
|
|
|
|
|
|
|
|
|
|
|
|
795,261
|
|
|
|
|
|
|
|
|
|
All Other Liabilities
|
|
|
43,375
|
|
|
|
|
|
|
|
|
|
|
|
38,464
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
3,061,707
|
|
|
|
|
|
|
|
|
|
|
|
2,733,469
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders' Equity
|
|
|
319,526
|
|
|
|
|
|
|
|
|
|
|
|
302,573
|
|
|
|
|
|
|
|
|
|
Total Liabilities & Shareholders' Equity
|
|
$
|
3,381,233
|
|
|
|
|
|
|
|
|
|
|
$
|
3,036,042
|
|
|
|
|
|
|
|
|
|
Net Interest Income and Margin on Total Earning Assets
|
|
|
|
|
|
|
34,323
|
|
|
|
4.40
|
%
|
|
|
|
|
|
|
29,016
|
|
|
|
4.12
|
%
|
Tax Equivalent Adjustment
|
|
|
|
|
|
|
(116
|
)
|
|
|
|
|
|
|
|
|
|
|
(110
|
)
|
|
|
|
|
Net Interest Income
|
|
|
|
|
|
$
|
34,207
|
|
|
|
4.38
|
%
|
|
|
|
|
|
$
|
28,906
|
|
|
|
4.07
|
%
|
Notes: Yields on municipal securities have been calculated on a fully taxable equivalent basis. Loan & lease interest income includes fee income
and unearned discount in the amount of $1.0 million and $1.5 million for the quarters ended March 31, 2019 and 2018, respectively. Yields on securities available-for-sale are based on historical cost.
Farmers & Merchants Bancorp
Volume and Rate Analysis of Net Interest Revenue
(Interest and Rates on a Taxable Equivalent Basis)
(in thousands)
|
|
Three Months Ended
Mar. 31, 2019 compared to Mar. 31, 2018
|
|
Interest Earning Assets
|
|
Volume
|
|
|
Rate
|
|
|
Net Chg.
|
|
Interest Bearing Deposits With Banks
|
|
$
|
153
|
|
|
|
387
|
|
|
$
|
540
|
|
Investment Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasuries
|
|
|
(174
|
)
|
|
|
72
|
|
|
|
(102
|
)
|
U.S. Govt SBA
|
|
|
(72
|
)
|
|
|
48
|
|
|
|
(24
|
)
|
Government Agency & Government-Sponsored Entities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Obligations of States and Political Subdivisions - Non-Taxable
|
|
|
(6
|
)
|
|
|
36
|
|
|
|
30
|
|
Mortgage Backed Securities
|
|
|
(93
|
)
|
|
|
217
|
|
|
|
124
|
|
Other
|
|
|
19
|
|
|
|
30
|
|
|
|
49
|
|
Total Investment Securities
|
|
|
(326
|
)
|
|
|
404
|
|
|
|
77
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans & Leases
|
|
|
|
|
|
|
|
|
|
|
|
|
Real Estate
|
|
|
2,920
|
|
|
|
730
|
|
|
|
3,650
|
|
Home Equity Line & Loans
|
|
|
68
|
|
|
|
80
|
|
|
|
148
|
|
Agricultural
|
|
|
91
|
|
|
|
509
|
|
|
|
600
|
|
Commercial
|
|
|
981
|
|
|
|
229
|
|
|
|
1,210
|
|
Consumer
|
|
|
178
|
|
|
|
-
|
|
|
|
178
|
|
Other
|
|
|
(2
|
)
|
|
|
-
|
|
|
|
(2
|
)
|
Leases
|
|
|
220
|
|
|
|
130
|
|
|
|
350
|
|
Total Loans & Leases
|
|
|
4,455
|
|
|
|
1,678
|
|
|
|
6,134
|
|
Total Earning Assets
|
|
|
4,282
|
|
|
|
2,469
|
|
|
|
6,751
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Bearing Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
Transaction
|
|
|
42
|
|
|
|
238
|
|
|
|
280
|
|
Savings and Money Market
|
|
|
37
|
|
|
|
363
|
|
|
|
400
|
|
Time Deposits
|
|
|
64
|
|
|
|
672
|
|
|
|
736
|
|
Total Interest Bearing Deposits
|
|
|
143
|
|
|
|
1,273
|
|
|
|
1,416
|
|
Other Borrowed Funds
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Subordinated Debentures
|
|
|
-
|
|
|
|
28
|
|
|
|
28
|
|
Total Interest Bearing Liabilities
|
|
|
143
|
|
|
|
1,301
|
|
|
|
1,444
|
|
Total Change
|
|
$
|
4,139
|
|
|
$
|
1,168
|
|
|
$
|
5,307
|
|
Notes: Rate/volume variance is allocated based on the percentage relationship of changes in volume and
changes in rate to the total "net change." The above figures have been rounded to the nearest whole number.
Net interest income increased $5.3 million or 18.3% to $34.2 million during the first quarter of 2019 compared to $28.9 million for the
first quarter of 2018. On a fully tax equivalent basis, net interest income increased 18.9% and totaled $34.3 million at March 31, 2019, compared to $29.0 million at March 31, 2018. As more fully discussed below, the increase in net
interest income was primarily due to a $308.8 million increase in average earning assets combined with a 44 basis point increase in the net interest margin.
Net interest income on a taxable equivalent basis, expressed as a percentage of average total earning assets, is referred to as the net interest
margin. For the quarter ended March 31, 2019, the Company’s net interest margin was 4.40% compared to 4.12% for the quarter ended March 31, 2018. This increase in net interest margin was primarily due to a 48 basis point increase in the
yield on earning assets offset by a 25 basis point increase in the cost of interest bearing liabilities.
Average loans & leases totaled $2.5 billion for the quarter ended March 31, 2019; an increase of $346.9 million compared to the average balance
for the quarter ended March 31, 2018. Loans & leases increased from 77.0% of average earning assets at March 31, 2018 to 80.5% at March 31, 2019. The annualized yield on the Company’s loan portfolio increased to 5.28% for the quarter
ended March 31, 2019, compared to 4.94% for the quarter ended March 31, 2018. This increase in yield was primarily due to an increase in market interest rates. Overall, the increase in loan & lease balances and the increase in yields
resulted in interest revenue from loans & leases increasing 22.7% to $33.2 million for quarter ended March 31, 2019. The Company continues to experience aggressive competitor pricing for loans & leases to which it may need to
continue to respond in order to retain key customers. This could place negative pressure on future loan & lease yields and net interest margin.
The investment portfolio is the other main component of the Company’s earning assets. Historically, the Company invested primarily in: (1)
mortgage-backed securities issued by government-sponsored entities; (2) debt securities issued by the U.S. Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at
certain times the Company selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of
equivalent maturity. Since the risk factor for these types of investments is generally lower than that of loans & leases, the yield earned on investments is generally less than that of loans & leases.
Average investment securities totaled $431.2 million for the quarter ended March 31, 2019; an decrease of $72.7 million compared to the average
balance for the quarter ended March 31, 2018. Tax equivalent interest income on securities increased $77,000 to $3.0 million for the quarter ended March 31, 2019, compared to $2.9 million for the quarter ended March 31, 2018. The average
investment portfolio yield, on a tax equivalent (TE) basis, was 2.77% for the quarter ended March 31, 2019, compared to 2.31% for the quarter ended March 31, 2018. This overall increase in yield was caused primarily by an increase in market
interest rates offset by a decline in the TE yield on municipal securities due to a decrease in the federal corporate tax rate. See “Financial Condition – Investment Securities” for a discussion of the Company’s investment strategy in 2019.
Net interest income on the Schedule of Year-to-Date Average Balances and Interest Rates is shown on a tax equivalent basis, which is higher than net interest income as reflected on the Consolidated Statements of Income because of
adjustments that relate to income on securities that are exempt from federal income taxes.
Interest bearing deposits with banks and overnight investments in Federal Funds Sold
are additional earning assets available to the Company.
Interest bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB
earn interest
at the Fed Funds rate, which was 2.40% in March 2019 compared to 1.75% in March 2018. Average interest bearing deposits with banks for the quarter ended March 31, 2019, was $187.5 million, an increase of $34.5 million compared to the
average balance for the quarter ended March 31, 2018. Interest income on interest bearing deposits with banks for the quarter ended March 31, 2019, increased $540,000 to $1.1 million compared to the quarter ended March 31, 2018.
Average interest-bearing liabilities increased $202.7 million or 10.67% during the first quarter of 2019. Of that increase: (1) interest-bearing
transaction deposits increased $82.3 million; (2) savings and money market deposits increased $85.3 million; (3) time deposits increased $35.1 million (see “Financial Condition – Deposits”); (4) FHLB advances remained unchanged (see
“Financial Condition – Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings”); and (5) subordinated debt remained unchanged (see “Financial Condition – Subordinated Debentures”).
Total interest expense on interest bearing deposits was $2.8 million for the first quarter of 2019 as compared to $1.4 million for the first
quarter of 2018. The average rate paid on interest-bearing deposits was 0.55% for the first quarter of 2019 compared to 0.30% for the first quarter of 2018. As a result of the increase in market interest rates over the past 36 months, the
Company is experiencing more aggressive competitor rates on interest bearing deposits which it may need to meet in order to retain key customers. This could place negative pressure on future deposit rates and net interest margin.
Provision and Allowance for Credit Losses
As a financial institution that assumes lending and credit risks as a principal element of its business, credit losses will be experienced in the
normal course of business. The Company has established credit management policies and procedures that govern both the approval of new loans & leases and the monitoring of the existing portfolio. The Company manages and controls credit
risk through comprehensive underwriting and approval standards, dollar limits on loans & leases to one borrower (the term “borrower” is used herein to describe a customer who has entered into either a loan or lease transaction), and by
restricting loans & leases made primarily to its principal market area where management believes it is best able to assess the applicable risk. Additionally, management has established guidelines to ensure the diversification of the
Company’s credit portfolio such that even within key portfolio sectors such as real estate or agriculture, the portfolio is diversified across factors such as location, building type, crop type, etc. Management reports regularly to the
Board of Directors regarding trends and conditions in the loan & lease portfolio and regularly conducts credit reviews of individual loans & leases. Loans & leases that are performing but have shown some signs of weakness are
subject to more stringent reporting and oversight.
Allowance for Credit Losses
The allowance for credit losses is an estimate of probable incurred credit losses inherent in the Company's loan & lease portfolio as of the
balance sheet date. The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan &
lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of three primary
components: specific reserves related to impaired loans & leases; general reserves for inherent losses related to loans & leases that are not impaired; and an unallocated component that takes into account the imprecision in
estimating and allocating allowance balances associated with macro factors.
A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all
amounts due, including principal and interest, according to the contractual terms of the original agreement. Loans & leases determined to be impaired are individually evaluated for impairment. When a loan or lease is impaired, the
Company measures impairment based on the present value of expected future cash flows discounted at the loan’s or lease's effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s or lease's
observable market price, or the fair value of the collateral if the loan or lease is collateral dependent. A loan or lease is collateral dependent if the repayment of the loan or lease is expected to be provided solely by the underlying
collateral.
A restructuring of a loan or lease constitutes a troubled debt restructuring (“TDR”) under ASC 310-40, if the Company for economic or legal reasons
related to the borrower's financial difficulties grants a concession to the borrower that it would not otherwise consider. Restructured loans or leases typically present an elevated level of credit risk as the borrowers are not able to
perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure,
management may keep the loan or lease on accrual. Loans & leases that are on nonaccrual status at the time they become TDR, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the Company
generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its modified
terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.
The determination of the general reserve for loans or leases that are collectively evaluated for impairment is based on estimates made by
management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors that include economic trends in the Company's service areas, industry experience
and trends, geographic concentrations, estimated collateral values, the Company's underwriting policies, the character of the loan & lease portfolio, and probable losses inherent in the portfolio taken as a whole.
The Company maintains a separate allowance for each portfolio segment (loan & lease type). These portfolio segments include: (1) commercial
real estate; (2) agricultural real estate; (3) real estate construction (including land and development loans); (4) residential 1
st
mortgages; (5) home equity
lines and loans; (6) agricultural; (7) commercial; (8) consumer & other; and (9) equipment leases. See “Financial Condition – Loans & Leases” for examples of loans & leases made by the Company. The allowance for credit losses
attributable to each portfolio segment, which includes both impaired loans & leases and loans & leases that are not impaired, is combined to determine the Company's overall allowance, which is included on the consolidated balance
sheet.
The Company assigns a risk rating to all loans & leases and periodically performs detailed reviews of all such loans & leases over a
certain threshold to identify credit risks and assess overall collectability. For smaller balance loans & leases, such as consumer and residential real estate, a credit grade is established at inception, and then updated only when the
loan or lease becomes contractually delinquent or when the borrower requests a modification. For larger balance loans, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which
borrowers operate and the fair values of collateral securing these loans & leases. These credit quality indicators are used to assign a risk rating to each individual loan or lease. These risk ratings are also subject to examination by
independent specialists engaged by the Company. The general reserve component of the allowance for credit losses also consists of reserve factors that are based on management’s assessment of the following for each portfolio segment: (1)
inherent credit risk; (2) historical losses; and (3) other qualitative factors. These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment. See “Note 1 Significant Accounting
Policies - Allowance for Credit Losses”
In addition, the Company's and Bank's regulators, including the FRB, DBO and FDIC, as an integral part of their examination process, review the
adequacy of the allowance. These regulatory agencies may require additions to the allowance based on their judgment about information available at the time of their examinations.
Provision for Credit Losses
Changes in the provision for credit losses between years are the result of management’s evaluation, based upon information currently available, of
the adequacy of the allowance for credit losses relative to factors such as the credit quality of the loan & lease portfolio, loan & lease growth, current credit losses, and the prevailing economic climate and its effect on
borrowers’ ability to repay loans & leases in accordance with the terms of the notes.
The Central Valley of California was one of the hardest hit areas in the country during the recession. In many areas, housing prices declined as
much as 60% and unemployment reached 15% or more. Although the economy has improved throughout most of the Central Valley, in many of the Company’s market segments housing prices remain below peak levels and unemployment rates remain above
those in other areas of the state and country. While, in management’s opinion, the Company’s levels of net charge-offs and non-performing assets as of March 31, 2019, compare very favorably to our peers at the present time, carefully
managing credit risk remains a key focus of the Company.
The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have
alleviated drought conditions in many areas of California, including those in the Company’s primary service area. As a result, reservoir levels are high and the availability of water in our primary service area should not be an issue.
However, the weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.
Based upon the results of the Company’s credit loss review and analysis, no provision was required for credit losses during the first quarter of
2019 compared to $333,000 during the first quarter of 2018. Net charge-offs during the first quarter of 2019 were $360,000 compared to net recoveries of $2,000 in the first quarter of 2018. See “Overview – Looking Forward: 2019 and Beyond”,
“Critical Accounting Policies and Estimates – Allowance for Credit Losses” and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” located in the Company’s 2018 Annual Report on Form 10-K.
After reviewing all factors above, management concluded that the allowance for credit losses, as of March 31, 2019, and March 31, 2018 were
adequate
.
|
|
Three Months Ended
March 31,
|
|
Allowance for
Credit Losses
(in thousands)
|
|
2019
|
|
|
2018
|
|
Balance at Beginning of Period
|
|
$
|
55,266
|
|
|
$
|
50,342
|
|
Loans or Leases Charged Off
|
|
|
(400
|
)
|
|
|
(21
|
)
|
Recoveries of Loans or Leases Previously Charged Off
|
|
|
41
|
|
|
|
23
|
|
Provision Charged to Expense
|
|
|
0
|
|
|
|
333
|
|
Balance at End of Period
|
|
$
|
54,907
|
|
|
$
|
50,677
|
|
The table below breaks out current quarter activity by portfolio segment
(in thousands):
March 31, 2019
|
|
Commercial
Real Estate
|
|
|
Agricultural
Real Estate
|
|
|
Real Estate
Construction
|
|
|
Residential 1st
Mortgages
|
|
|
Home Equity
Lines & Loans
|
|
|
Agricultural
|
|
|
Commercial
|
|
|
Consumer &
Other
|
|
|
Leases
|
|
|
Unallocated
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year-To-Date Allowance for Credit Losses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning Balance- January 1, 2019
|
|
$
|
11,609
|
|
|
$
|
14,092
|
|
|
$
|
1,249
|
|
|
$
|
880
|
|
|
$
|
2,761
|
|
|
$
|
8,242
|
|
|
$
|
11,656
|
|
|
$
|
494
|
|
|
$
|
4,022
|
|
|
$
|
261
|
|
|
$
|
55,266
|
|
Charge-Offs
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(379
|
)
|
|
|
(21
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(400
|
)
|
Recoveries
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3
|
|
|
|
6
|
|
|
|
6
|
|
|
|
12
|
|
|
|
14
|
|
|
|
-
|
|
|
|
-
|
|
|
|
41
|
|
Provision
|
|
|
(209
|
)
|
|
|
401
|
|
|
|
(42
|
)
|
|
|
(20
|
)
|
|
|
(29
|
)
|
|
|
(800
|
)
|
|
|
644
|
|
|
|
(20
|
)
|
|
|
(14
|
)
|
|
|
89
|
|
|
|
-
|
|
Ending Balance- March 31, 2019
|
|
$
|
11,400
|
|
|
$
|
14,493
|
|
|
$
|
1,207
|
|
|
$
|
863
|
|
|
$
|
2,738
|
|
|
$
|
7,448
|
|
|
$
|
11,933
|
|
|
$
|
467
|
|
|
$
|
4,008
|
|
|
$
|
350
|
|
|
$
|
54,907
|
|
The Allowance for Credit Losses at March 31, 2019 decreased $359,000 from December 31, 2018. . The allowance allocated to the following portfolio
segment changed materially during the first three months of 2019:
|
•
|
The allowance for agricultural loans decreased $794,000 primarily due to balance decreases in this portfolio segment.
|
See “Management’s Discussion and Analysis - Financial Condition – Classified Loans & Leases and Non-Performing Assets” for further discussion
regarding these loan categories.
See “Note 3. Allowance for Credit Losses” for additional details regarding the provision and allowance for credit losses.
Non-Interest Income
Non-interest income includes: (1) service charges and fees from deposit accounts;
(2) net gains and losses from investment securities; (3
) increases in the cash surrender value of bank owned life insurance; (4) debit card and ATM fees; (5) net gains and losses on non-qualified deferred compensation plans; and
(6) fees from other miscellaneous business services.
Overall, non-interest income decreased $201,000 or 4.3% for the three months ended March 31, 2019, compared to the same period of 2018. This
decrease was primarily due to a $724,000 decrease related to non-recurring income received in 2018, somewhat offset by: (1) a $263,000 increase in the net gain on deferred compensation investments (Balances in non-qualified deferred
compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be
recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no effect on the Company’s net income); (2) a $161,000 increase in debit card and ATM fees; (3) a $59,000 increase in
service charges; and (5) a $40,000 increase in cash surrender value of life insurance.
Non-Interest Expense
Non-interest expense for the Company includes expenses for: (1) salaries and employee benefits; (2) net gains and losses on non-qualified deferred
compensation plan investments; (3) occupancy; (4) equipment; (5) supplies; (6) legal fees; (7) professional services; (8) data processing; (9) marketing; (10) deposit insurance; (11) ORE carrying costs and gains/losses on sale; and (12)
other miscellaneous expenses.
Overall, non-interest expense increased $509,000 or 2.6% for the three months ended March 31, 2019, compared to the same period in 2018. This
increase was primarily comprised of: (1) a $263,000 increase in the net gain on deferred compensation investments (Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates
based upon trends in interest rates and stock prices. Although Generally Accepted Accounting Principles require these investment gains/losses be recorded in non-interest income, an offsetting entry is also required to be made to
non-interest expense resulting in no effect on the Company’s net income); (2) increased legal fees of $429,000; and (3) a $252,000 increase in occupancy and equipment expenses. These increases were partially offset by: (1) a $103,000
decrease in salaries and employee benefits; and (2) a decrease in “Other” expenses of $332,000, primarily due to decreases in professional fees and other miscellaneous expenses.
Income Taxes
The Bank’s provision for income taxes increased 39.2% to $4.7 million for the first quarter of 2019 compared to the first quarter of 2018 primarily
as a result of increase income over prior year. The effective tax rate for the first quarter of 2019 was 25.7% compared to 25.3% for the first quarter of 2018. The Company’s effective tax rate fluctuates from quarter to quarter due
primarily to changes in the mix of taxable and tax-exempt earning sources. The effective rates were lower than the combined Federal and State statutory rate of 30% due primarily to benefits regarding the cash surrender value of life
insurance; credits associated with low income housing tax credit investments (LIHTC); and tax-exempt interest income on municipal securities and loans.
With the exception of the one-time DTA re-measurement that took place in 2017, tax law causes the Company’s taxes payable to approximate or exceed
the current provision for taxes on the income statement. Three provisions have had a significant effect on the Company’s current income tax liability: (1) the restrictions on the deductibility of credit losses; (2) deductibility of pension
and other long-term employee benefits only when paid; and (3) the statutory deferral of deductibility of California franchise taxes on the Company’s federal return.
Financial Condition
This section discusses material changes in the Company’s balance sheet at March 31, 2019, as compared to December 31, 2018 and to March 31, 2018.
As previously discussed (see “Overview”) the Company’s financial condition can be influenced by the seasonal banking needs of its agricultural customers.
Investment Securities and Federal Funds Sold
The investment portfolio provides the Company with an income alternative to loans & leases. The debt securities in the Company’s investment
portfolio have historically been comprised primarily of: (1) mortgage-backed securities issued by federal government-sponsored entities; (2) debt securities issued by US Treasury, government agencies and government-sponsored entities; and
(3) investment grade bank-qualified municipal bonds. However, at certain times, the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 5 years) to the portfolio in
order to obtain yields that exceed government agency securities of equivalent maturity without subjecting the Company to the interest rate risk associated with mortgage-backed securities.
The Company’s investment portfolio at March 31, 2019 was $545.7 million compared to $549.0 million at the end of 2018, a decrease of $3.3 million
or .06%. At March 31, 2018, the investment portfolio totaled $549.3 million. To protect against future increases in market interest rates, while at the same time generating some reasonable level of current yields, the Company currently
invests most of its available funds in either shorter term U.S. Treasury, government agency & government-sponsored entity securities or shorter term (10, 15, and 20 year) mortgage-backed securities.
The Company's total investment portfolio currently represents 16.1% of the Company’s total assets as compared to 16.0% at December 31, 2018, and
17.9% at March 31, 2018.
As of March 31, 2019, the Company held $54.4 million of municipal investments, of which $35.7 million were bank-qualified municipal bonds, all
classified as HTM. In order to comply with Section 939A of the Dodd-Frank Act, the Company performs its own credit analysis on new purchases of municipal bonds. As of March 31, 2019, ninety-nine percent of the Company’s bank-qualified
municipal bond portfolio is rated at either the issue or issuer level, and all of these ratings are “investment grade.” The Company monitors the status of all municipal investments with particular attention paid to the approximately one
percent ($400,000) of the portfolio that is not rated, and at the current time does not believe any of them to be exhibiting financial problems that could result in a loss in any individual security.
Not included in the investment portfolio are interest bearing deposits with banks and overnight investments in Federal Funds Sold. Interest bearing
deposits with banks consisted of FRB deposits. The FRB currently pays interest on the deposits that banks maintain in their FRB accounts, whereas historically banks had to sell these Federal Funds to other banks in order to earn interest.
Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB. Interest bearing deposits with banks totaled $43.4 million at March 31, 2019, $84.5 million at December 31, 2018 and $97.0
million at March 31, 2018.
The Company classifies its investments as HTM, trading, or AFS. Securities are classified as HTM and are carried at amortized cost when the Company
has the intent and ability to hold the securities to maturity. Trading securities are securities acquired for short-term appreciation and are carried at fair value, with unrealized gains and losses recorded in non-interest income. As of
March 31, 2019, December 31, 2018 and March 31, 2018, there were no securities in the trading portfolio. Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk,
satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, net of related income
taxes.
Loans
&
Leases
Loans & leases can be categorized by borrowing purpose and use of funds. Common examples of loans & leases made by the Company include:
Commercial and Agricultural Real Estate - These are loans secured by farmland, commercial real estate, multifamily residential properties, and
other non-farm, non-residential properties generally within our market area. Commercial mortgage term loans can be made if the property is either income producing or scheduled to become income producing based upon acceptable pre-leasing,
and the income will be the Bank's primary source of repayment for the loan. Loans are made both on owner occupied and investor properties; generally do not exceed 10 years (and may have pricing adjustments on a shorter timeframe); have debt
service coverage ratios of 1.00 or better with a target of greater than 1.25; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Real Estate Construction - These are loans for development and construction (the Company generally requires the borrower to fund the land
acquisition) and are secured by commercial or residential real estate. These loans are generally made only to experienced local developers with whom the Bank has a successful track record; for projects in our service area; with Loan To
Value (LTV) below 75%; and where the property can be developed and sold within 2 years. Commercial construction loans are made only when there is a written take-out commitment from the Bank or an acceptable financial institution or
government agency. Most acquisition, development and construction loans are tied to the prime rate or LIBOR with an appropriate spread based on the amount of perceived risk in the loan.
Residential 1
st
Mortgages - These are loans primarily made on
owner occupied residences; generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC; however, we will make loans on rural residential properties up to 40 acres. Most residential loans have terms from ten
to twenty years and carry fixed rates priced off of treasury rates. The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or
low doc,” or “stated income.”
Home Equity Lines and Loans - These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not
exceed $250,000; Combined Loan To Value (CLTV) does not exceed 80%; FICO scores are at or above 670; Total Debt Ratios do not exceed 43%; and in some situations the Company is in a 1
st
lien position.
Agricultural - These are loans and lines of credit made to farmers to finance agricultural production. Lines of credit are extended to finance the
seasonal needs of farmers during peak growing periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on livestock, crops, crop proceeds and equipment; and are most often tied
to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a processing plant, or orchard/vineyard development;
have maturities from five to seven years; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Commercial - These are loans and lines of credit to businesses that are sole proprietorships, partnerships, LLC’s and corporations. Lines of credit
are extended to finance the seasonal working capital needs of customers during peak business periods; are usually established for periods no longer than 12 to 24 months; are often secured by general filing liens on accounts receivable,
inventory and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a
plant or purchase of a business; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.
Consumer - These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and
unsecured lines of credit. The Company has a very minimal consumer loan portfolio, and loans are primarily made as an accommodation to deposit customers.
Leases –These are leases to businesses or individuals, for the purpose of financing the acquisition of equipment. They can be either “finance
leases” where the lessee retains the tax benefits of ownership but obtains 100% financing on their equipment purchases; or “true tax leases” where the Company, as lessor, places reliance on equipment residual value and in doing so obtains
the tax benefits of ownership. Leases typically have a maturity of three to ten years, and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk. Credit risks are
underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed through the use of qualified, independent appraisers that establish the residual values the Company uses in
structuring a lease.
The Company accounts for leases with Investment Tax Credits (ITC) under the deferred method as established in ASC 740-10. ITC are viewed and
accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement.
See “Item 3. Quantitative and Qualitative Disclosures About Market Risk-Credit Risk” for a discussion about the credit risks the Company assumes
and its overall credit risk management practices.
Each loan or lease type involves risks specific to the: (1) borrower; (2) collateral; and (3) loan & lease structure. See “Results of
Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan & lease type. The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan
& lease type. The Company’s policies require that loans & leases are approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt. The Company’s underwriting
procedures for all loan & lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or
lease.
Most loans & leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment; cash flow is our primary
source of repayment. The quality and liquidity of collateral are important and must be confirmed before the loan is made.
In order to be responsive to borrower needs, the Company prices loans & leases: (1) on both a fixed rate and adjustable rate basis; (2) over
different terms; and (3) based upon different rate indices; as long as these structures are consistent with the Company’s interest rate risk management policies and procedures. See “Item 3. Quantitative and Qualitative Disclosures About
Market Risk-Interest Rate Risk” for further details.
Overall, the Company's loan & lease portfolio at March 31, 2019 totaled $2.6 billion, an increase of $328.9 million or 14.7% over March 31,
2018. This increase occurred as a result of: (1) the Company’s business development efforts directed toward credit-qualified borrowers; (2) expansion in the equipment leasing business; (3) expansion of our service area into the East Bay of
San Francisco and Napa; and (4) the acquisition of the Bank of Rio Vista which added $80.5 million to loan balances. No assurances can be made that this growth in the loan & lease portfolio will continue.
Loans & leases at March 31, 2019 decreased $7.3 million from $2.6 billion at December 31, 2018. This relatively small overall decrease was
primarily a result of $33.5 million in normal seasonal pay downs of loans made to the Company’s agricultural customers, somewhat offset by growth in other portfolio segments.
The following table sets forth the distribution of the loan & lease portfolio by type and percent as of the periods indicated.
Loan & Lease Portfolio
|
|
March 31, 2019
|
|
|
December 31, 2018
|
|
|
March 31, 2018
|
|
(in thousands)
|
|
$
|
|
|
|
%
|
|
|
$
|
|
|
|
%
|
|
|
$
|
|
|
|
%
|
|
Commercial Real Estate
|
|
$
|
823,028
|
|
|
|
32.0
|
%
|
|
$
|
834,476
|
|
|
|
32.4
|
%
|
|
$
|
705,063
|
|
|
|
31.5
|
%
|
Agricultural Real Estate
|
|
|
603,601
|
|
|
|
23.5
|
%
|
|
|
584,625
|
|
|
|
22.7
|
%
|
|
|
508,400
|
|
|
|
22.7
|
%
|
Real Estate Construction
|
|
|
99,837
|
|
|
|
3.9
|
%
|
|
|
98,568
|
|
|
|
3.8
|
%
|
|
|
96,315
|
|
|
|
4.3
|
%
|
Residential 1st Mortgages
|
|
|
258,359
|
|
|
|
10.1
|
%
|
|
|
259,736
|
|
|
|
10.1
|
%
|
|
|
264,137
|
|
|
|
11.8
|
%
|
Home Equity Lines and Loans
|
|
|
40,072
|
|
|
|
1.6
|
%
|
|
|
40,789
|
|
|
|
1.6
|
%
|
|
|
34,691
|
|
|
|
1.5
|
%
|
Agricultural
|
|
|
257,004
|
|
|
|
10.0
|
%
|
|
|
290,463
|
|
|
|
11.3
|
%
|
|
|
261,427
|
|
|
|
11.7
|
%
|
Commercial
|
|
|
364,439
|
|
|
|
14.2
|
%
|
|
|
343,834
|
|
|
|
13.3
|
%
|
|
|
274,682
|
|
|
|
12.3
|
%
|
Consumer & Other
|
|
|
18,418
|
|
|
|
0.7
|
%
|
|
|
19,412
|
|
|
|
0.8
|
%
|
|
|
6,685
|
|
|
|
0.3
|
%
|
Leases
|
|
|
105,823
|
|
|
|
4.0
|
%
|
|
|
106,217
|
|
|
|
4.0
|
%
|
|
|
89,678
|
|
|
|
3.9
|
%
|
Total Gross Loans & Leases
|
|
|
2,570,581
|
|
|
|
100.0
|
%
|
|
|
2,578,120
|
|
|
|
100.0
|
%
|
|
|
2,241,078
|
|
|
|
100.0
|
%
|
Less: Unearned Income
|
|
|
6,613
|
|
|
|
|
|
|
|
6,879
|
|
|
|
|
|
|
|
5,995
|
|
|
|
|
|
Subtotal
|
|
|
2,563,968
|
|
|
|
|
|
|
|
2,571,241
|
|
|
|
|
|
|
|
2,235,083
|
|
|
|
|
|
Less: Allowance for Credit Losses
|
|
|
54,907
|
|
|
|
|
|
|
|
55,266
|
|
|
|
|
|
|
|
50,677
|
|
|
|
|
|
Net Loans & Leases
|
|
$
|
2,509,061
|
|
|
|
|
|
|
$
|
2,515,975
|
|
|
|
|
|
|
$
|
2,184,406
|
|
|
|
|
|
Classified Loans & Leases and Non-Performing Assets
All loans & leases are assigned a credit risk grade using grading standards developed by bank regulatory agencies. See “Results of Operations -
Provision and Allowance for Credit Losses” for more detail on risk grades. The Company utilizes the services of a third-party independent loan review firm to perform evaluations of individual loans & leases and review the credit risk
grades the Company places on loans & leases. Loans & leases that are judged to exhibit a higher risk profile are referred to as “classified loans & leases,” and these loans & leases receive increased management attention. As
of March 31, 2019, classified loans totaled $15.1 million compared to $14.7 million at December 31, 2018 and $8.2 million at March 31, 2018.
Classified loans & leases with higher levels of credit risk can be further designated as “impaired” loans & leases. A loan or lease is
considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement.
See “Results of Operations - Provision and Allowance for Credit Losses” for further details. Impaired loans & leases consist of: (1) non-accrual loans & leases; and/or (2) restructured loans & leases that are still performing
(i.e., accruing interest).
Non-Accrual Loans & leases
-
Accrual of interest on
loans & leases is generally discontinued when a loan or lease becomes contractually past due by 90 days or more with respect to interest or principal. When loans & leases are 90 days past due, but in management's judgment are well
secured and in the process of collection, they may not be classified as non-accrual. When a loan or lease is placed on non-accrual status, all interest previously accrued but not collected is reversed. Income on such loans & leases is
then recognized only to the extent that cash is received and where the future collection of principal is probable. There were no non-accrual loans & leases at March 31, 2019, December 31, 2018 or March 31, 2018
.
Restructured Loans & Leases - A restructuring of a loan or lease constitutes a TDR under ASC 310-40, if the Company for economic or legal
reasons related to the debtor's financial difficulties grants a concession to the debtor that it would not otherwise consider. Restructured loans or leases typically present an elevated level of credit risk as the borrowers are not able to
perform according to the original contractual terms. If the restructured loan or lease was current on all payments at the time of restructure and management reasonably expects the borrower will continue to perform after the restructure,
management may keep the loan or lease on accrual. Loans & leases that are on nonaccrual status at the time they become TDR loans, remain on nonaccrual status until the borrower demonstrates a sustained period of performance, which the
Company generally believes to be six consecutive months of payments, or equivalent. A loan or lease can be removed from TDR status if it was restructured at a market rate in a prior calendar year and is currently in compliance with its
modified terms. However, these loans or leases continue to be classified as impaired and are individually evaluated for impairment.
As of March 31, 2019, restructured loans & leases on accrual totaled $13.7 million as compared to $13.6 million at December 31, 2018.
Restructured loans on accrual at March 31, 2018 were $6.2 million.
Other Real Estate
-
Loans where the collateral has been
repossessed are classified as other real estate ("ORE") or, if the collateral is personal property, the loan is classified as other assets on the Company's financial statements.
The following table sets forth the amount of the Company's non-performing loans & leases (defined as non-accrual loans & leases plus
accruing loans & leases past due 90 days or more) and ORE as of the dates indicated.
Non-Performing Assets
(in thousands)
|
|
March 31, 2019
|
|
|
Dec. 31, 2018
|
|
|
March 31, 2018
|
|
Non-Performing Loans & Leases
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
81
|
|
Other Real Estate
|
|
|
873
|
|
|
|
873
|
|
|
|
873
|
|
Total Non-Performing Assets
|
|
$
|
873
|
|
|
$
|
873
|
|
|
$
|
954
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Performing Loans & Leases as a % of Total Loans & Leases
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
|
|
0.00
|
%
|
Restructured Loans & Leases (Performing)
|
|
$
|
13,697
|
|
|
$
|
13,577
|
|
|
$
|
6,246
|
|
Although management believes that non-performing loans & leases are generally well-secured and that potential losses are provided for in the
Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses. Specific reserves of $0, $0, and $4,000 have been
established for non-performing loans & leases at March 31, 2019, December 31, 2018 and March 31, 2018, respectively.
Foregone interest income on non-accrual loans & leases, which would have been recognized during the period, if all such loans & leases had
been current in accordance with their original terms, totaled $0 for the periods ended March 31, 2019, December 31, 2018, March 31, 2018.
The Company reported $873,000 of ORE at March 31, 2019, December 31, 2018, and at March 31, 2018.
Except for those classified and non-performing loans & leases discussed above, the Company’s management is not aware of any loans & leases
as of March 31, 2019, for which known financial problems of the borrower would cause serious doubts as to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would
result in the loan or lease being designated as non-performing at some future date. However:
•
|
The Central Valley was one of the hardest hit areas in the country during the recession. In many areas, housing prices declined as much as 60% and unemployment
reached 15% or more. Although the economy has strengthened throughout most of the Central Valley, for the most part housing prices remain below peak levels and unemployment levels remain above those in other areas of the state
and country.
|
•
|
The State of California experienced drought conditions from 2013 through most of 2016. Since 2016, reasonable levels of rain and snow have alleviated drought
conditions in many areas of California, including those in the Company’s primary service area. As a result, reservoir levels are high and the availability of water in our primary service area should not be an issue. However, the
weather patterns over the past 5 years further reinforce the fact that the long-term risks associated with the availability of water are significant.
|
•
|
The agricultural industry is facing challenges associated with: (1) weakness in export markets due to a stronger dollar and proposed changes in trade policies; (2)
tight labor markets and higher wages due to legislative changes at the state and federal levels; and (3) proposed changes in immigration policy and the resulting impact on the labor pool.
|
See “Part I, Item 1A. Risk Factors” in the Company’s 2018 Annual Report on Form 10-K.
Deposits
One of the key sources of funds to support earning assets is the generation of deposits from the Company’s customer base. The ability to grow the
customer base, and subsequently deposits, is a significant element in the performance of the Company.
The Company's deposit balances at March 31, 2019 have increased $306.6 million or 11.4% compared to March 31, 2018. In addition to the Company’s
ongoing business development activities for deposits, the following factors positively impacted year-over-year deposit growth: (1) the Company’s strong financial results and position and F&M Bank’s reputation as one of the most safe and
sound banks in its market area; (2) the Company’s expansion of its service area into Walnut Creek and Concord; and (3) the acquisition of the Bank of Rio Vista which added $191.6 million in deposit balances. Market interest rates have been
increasing over the past 24 months, resulting in significant competitive pressures on deposit rates. The Company remains selective in how they respond to competitor rates, which may impact future deposit growth.
Although total deposits have increased 11.4% since March 31, 2018, importantly, low cost transaction accounts continue to grow at a strong pace as
well:
•
|
Demand and interest-bearing transaction accounts increased $183.0 million or 13.2% since March 31, 2018.
|
•
|
Savings and money market accounts have increased $81.7 million or 9.8% since March 31, 2018.
|
•
|
Time deposit accounts have increased $42.0 million or 8.7% since March 31, 2018.
|
The Company's deposit balances at March 31, 2019 have decreased $54.8 million or 1.79% compared to December 31, 2018. Savings and money market
deposits increased 1.0% or $9.3 million while demand and interest-bearing transaction accounts decreased by $98.9 million or 5.9% and time deposit accounts increased by $34.8 million or 7.1%. Deposit trends in the first half of the year can
be impacted by the seasonal needs of our agricultural customers.
Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings
Lines of credit with the Federal Reserve Bank and the Federal Home Loan Bank are other key sources of funds to support earning assets. These
sources of funds are also used to manage the Company’s interest rate risk exposure, and as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio. There were no FHLB Advances at March
31, 2019, December 31, 2018, or March 31, 2018. There were no Federal Funds purchased or advances from the FRB at March 31, 2019, December 31, 2018 or March 31, 2018.
As of March 31, 2019 the Company has additional borrowing capacity of $563.6 million with the Federal Home Loan Bank and $463.8 million with the
Federal Reserve Bank. Any borrowings under these lines would be collateralized with loans that have been accepted for pledging at the FHLB and FRB.
Long-Term Subordinated Debentures
On December 17, 2003, the Company raised $10 million through an offering of trust-preferred securities (“TPS”). See Note 13 located in “Item 8.
Financial Statements and Supplementary Data” of the Company’s 2018 Annual Report on Form 10-K. Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our TPS will continue
to qualify as regulatory capital (See “Capital”). These securities accrue interest at a variable rate based upon 3-month LIBOR plus 2.85%. Interest rates reset quarterly and were 5.46% as of March 31, 2019, 5.64% at December 31, 2018 and
5.03% at March 31, 2018. The average rate paid for these securities for the first quarter of 2019 was 5.66% and 4.56% for the first quarter of 2018. Additionally, if the Company decided to defer interest on the subordinated debentures, the
Company would be prohibited from paying cash dividends on the Company’s common stock.
Capital
The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an
ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders’ Equity totaled $330.3 million at March 31, 2019, $311.2 million at December 31, 2018, and $305.9 million at March
31, 2018.
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain actions by regulators that, if undertaken, could have a material effect on the Company and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Company’s and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The implementation of Basel III requirements increased the required capital levels that the Company and the Bank must maintain. The final rules
include new minimum risk-based capital and leverage ratios, which were fully phased in on January 1, 2019. The new minimum capital level requirements applicable to the Company and the Bank under the final rules are: (i) a common equity Tier
1 capital ratio of 4.5% of risk-weighted assets (“RWA”); (ii) a Tier 1 capital ratio of 6% of RWA; (iii) a total capital ratio of 8% of RWA; and (iv) a Tier 1 leverage ratio of 4% of total assets. The final rules established a "capital
conservation buffer" of 2.5% above each of the new regulatory minimum capital ratios, which results in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0% of RWA; (ii) a Tier 1 capital ratio of 8.5% of RWA; and
(iii) a total capital ratio of 10.5% of RWA. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. The final
rules also permit the Company’s subordinated debentures issued in 2003 to continue to be counted as Tier 1 capital. The Company is currently in compliance with all of these new capital requirements and they do not result in any restrictions
on the Company’s business activity.
In addition, the most recent notification from the FDIC categorized the Bank as “well capitalized” under the regulatory framework for prompt
corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.
(in thousands)
|
|
Actual
|
|
|
Current
Regulatory
Capital
Requirements
|
|
|
Well Capitalized
Under Prompt
Corrective Action
|
|
The Company:
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
As of March 31, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital Ratio
|
|
$
|
363,213
|
|
|
|
11.89
|
%
|
|
$
|
244,342
|
|
|
|
8.0
|
%
|
|
|
N/A
|
|
|
|
N/A
|
|
Common Equity Tier 1 Capital Ratio
|
|
$
|
314,824
|
|
|
|
10.31
|
%
|
|
$
|
137,443
|
|
|
|
4.5
|
%
|
|
|
N/A
|
|
|
|
N/A
|
|
Tier 1 Capital Ratio
|
|
$
|
324,824
|
|
|
|
10.64
|
%
|
|
$
|
183,257
|
|
|
|
6.0
|
%
|
|
|
N/A
|
|
|
|
N/A
|
|
Tier 1 Leverage Ratio
|
|
$
|
324,824
|
|
|
|
9.64
|
%
|
|
$
|
134,786
|
|
|
|
3.0
|
%
|
|
|
N/A
|
|
|
|
N/A
|
|
(in thousands)
|
|
Actual
|
|
|
Current
Regulatory
Capital
Requirements
|
|
|
Well Capitalized
Under Prompt
Corrective Action
|
|
The Bank:
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
|
Amount
|
|
|
Ratio
|
|
As of March 31, 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Capital Ratio
|
|
$
|
362,846
|
|
|
|
11.88
|
%
|
|
$
|
244,329
|
|
|
|
8.0
|
%
|
|
$
|
305,411
|
|
|
|
10.0
|
%
|
Common Equity Tier 1 Capital Ratio
|
|
$
|
324,459
|
|
|
|
10.62
|
%
|
|
$
|
137,435
|
|
|
|
4.5
|
%
|
|
$
|
198,517
|
|
|
|
6.5
|
%
|
Tier 1 Capital Ratio
|
|
$
|
324,459
|
|
|
|
10.62
|
%
|
|
$
|
183,247
|
|
|
|
6.0
|
%
|
|
$
|
244,329
|
|
|
|
8.0
|
%
|
Tier 1 Leverage Ratio
|
|
$
|
324,459
|
|
|
|
9.63
|
%
|
|
$
|
134,758
|
|
|
|
3.0
|
%
|
|
$
|
168,448
|
|
|
|
5.0
|
%
|
As previously discussed (see “Long-Term Subordinated Debentures”), in order to supplement its regulatory capital base, during December 2003 the
Company issued $10 million of trust preferred securities. On March 1, 2005, the Federal Reserve Board issued its final rule effective April 11, 2005, concerning the regulatory capital treatment of trust preferred securities (“TPS”) by bank
holding companies (“BHCs”). Under the final rule BHCs may include TPS in Tier 1 capital in an amount equal to 25% of the sum of core capital net of goodwill. Any portion of trust-preferred securities not qualifying as Tier 1 capital would
qualify as Tier 2 capital subject to certain limitations. The Company has received notification from the Federal Reserve Bank of San Francisco that all of the Company’s trust preferred securities currently qualify as Tier 1 capital.
The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the
Company’s financial statements, but rather the subordinated debentures are shown as a liability.
In 1998, the Board approved the Company’s first common stock repurchase program. This program has been extended and expanded several times since
then, and most recently, on November 6, 2018, the Board of Directors approved an extension of the $20 million stock repurchase program over the three-year period ending December 31, 2021. See “Item 5. Market for Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities” of the Company’s 2018 Annual Report on Form 10-K for additional information.
There were no stock repurchases during the first quarter of 2019 or 2018. The remaining dollar value of shares that may yet be purchased under the
Company’s Common Stock Repurchase Plan is approximately $20 million.
On August 5, 2008, the Board of Directors approved a Share Purchase Rights Plan (the “Rights Plan”), pursuant to which the Company entered into a
Rights Agreement dated August 5, 2008, with Computershare as Rights Agent. The Rights Plan was set to expire on August 5, 2018. On November 19, 2015, the Board of Directors approved a seven-year extension of the term of the Rights Plan.
Pursuant to an Amendment to the Rights Agreement dated February 18, 2016, the term of the Rights Plan was extended from August 5, 2018 to August 5, 2025. The extension of the term of the Rights Plan was intended as a means to continue to
guard against abusive takeover tactics and was not in response to any particular proposal. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of the Company’s 2018
Annual Report on Form 10-K for further explanation.
During the first quarter of 2019, the Company issued 3,586 shares of common stock to the Bank’s non-qualified defined contribution retirement
plans. These shares were issued at a price of $715.00 per share based upon a valuation completed by a nationally recognized bank consulting and advisory firm and in reliance upon the exemption in Section 4(a)(2) of the Securities Act of
1933, as amended, and the regulations promulgated thereunder. The proceeds were contributed to the Bank as equity capital. There were no shares issued during the first quarter of 2018.
Critical Accounting Policies and Estimates
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” is based upon the Company’s consolidated financial
statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the Company’s financial statements management makes estimates and judgments that affect the reported amounts
of assets, liabilities, revenues and expenses. These judgments govern areas such as the allowance for credit losses, the fair value of financial instruments and accounting for income taxes.
For a full discussion of the Company’s critical accounting policies and estimates see “Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations” in the Company’s 2018 Annual Report on Form 10-K.