Organizational Structure
Farmers & Merchants Bancorp is a Delaware registered bank holding company organized in 1999. As a registered bank holding company, FMCB is subject to regulation, supervision, and examination by the Board of
Governors of the Federal Reserve System (“FRB”) and by the California Department of Financial Protection and Innovation (“DFPI”). The Company’s principal business is to serve as a holding company for the Bank and for other banking or banking related
subsidiaries, which the Company may establish or acquire. As a legal entity separate and distinct from its subsidiary, the Company’s principal source of funds is, and will continue to be, dividends paid by and other funds received from the Bank.
Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to the Company. See “Supervision and Regulation - Dividends and Other Transfer of Funds.” The Company’s outstanding common stock as of
December 31, 2021, consisted of 789,646 shares of common stock, $0.01 par value and no shares of preferred stock were issued or outstanding.
During 2003, the Company formed a wholly-owned Connecticut statutory business trust, FMCB Statutory Trust I, for the sole purpose of issuing trust-preferred securities. See Note 10 “Long-Term Subordinated Debentures”
located in Item 8. “Financial Statements and Supplementary Data” in this Annual Report of Form 10-K.
The Company operates all financial service activities through its wholly-owned banking subsidiary, Farmers & Merchants Bank of Central California, which was organized in 1916. The Bank was incorporated under the
laws of the State of California as a non-FRB member, California state-chartered bank subject to primary regulation, supervision and examination by the Federal Deposit Insurance Corporation (“FDIC”) and by the DFPI. The Bank’s two wholly-owned
subsidiaries are Farmers & Merchants Investment Corporation and Farmers/Merchants Corporation. Farmers & Merchants Investment Corporation is currently dormant and Farmers/Merchants Corporation acts as trustee on deeds of trust originated by
the Bank. The Bank’s deposit accounts are insured under the Federal Deposit Insurance Act, as amended (“FDIA”), up to applicable limits. See “Supervision and Regulation – Deposit Insurance”.
F & M Bancorp, Inc. was created in March 2002 to protect the name “F & M Bank.” During 2002, the Company completed a fictitious name filing in California to begin using the streamlined name, “F & M Bank,”
as part of a larger effort to enhance the Company’s image and build brand name recognition. Since 2002, the Company has converted all of its daily operating and image advertising to the “F & M Bank” name and the Company’s logo, slogan and signage
were redesigned to incorporate the trade name, “F & M Bank”.
Market Area
The Company’s primary service area is the mid Central Valley of California, including Sacramento, San Joaquin, Solano, Stanislaus and Merced counties, and the east region of the San Francisco Bay Area including Napa,
Alameda, and Contra Costa counties. The Company operates 29 full-service branches and 3 stand-alone ATMs. The Company’s market areas include the following Metropolitan Statistical Areas (“MSA”), which most recent data as of January 18, 2022:
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The Sacramento MSA (Sacramento County Only), with branches in Sacramento, Elk Grove, Galt and Walnut Grove. This county had a Population of 1.6 million and a Per Capita Income of approximately $58,307. The MSA includes significant
employment in the following sectors: government, education & health trade, and transportation & utilities. Unemployment was at 4.8%.
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The Stockton-Lodi MSA, with branches in Lodi, Linden, Stockton, Lockeford and Manteca. This MSA had a Population of 0.77 million and a Per Capita Income of approximately $51,816. The MSA includes significant employment in the following
sectors: trade, transportation & utilities, government, and education & health services. Unemployment was at 6.6%.
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The Vallejo-Fairfield MSA (Rio Vista Only, census tract 2535.00), with branches in Rio Vista. This census tract had a Population of 9,221 and a Weighted Average of Median Family Income of $64,022. The city includes significant employment
in the following industries: agriculture, manufacturing, tourism and other services. Unemployment was at 6.7%.
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The Modesto MSA, with branches in Modesto, Riverbank and Turlock. This MSA had a Population of 0.55 million and a Per Capita Income of approximately $48,954. The MSA includes significant employment in the following sectors: trade,
transportation & utilities, educational & health services, and government. Unemployment was at 6.2%.
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The Merced MSA, with branches in Hilmar and Merced. This MSA had a Population of 0.28 million and a Per Capita Income of approximately $43,914. The MSA includes significant employment in the following sectors: government, trade,
transportation & utilities, and farming. Unemployment was at 7.6%.
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The Oakland-Hayward-Berkeley MD, with branches in Concord, Walnut Creek, and Oakland. This MSA had a Population of 2.8 million and a Per Capita Income of approximately $89,201. The MSA includes significant employment in the following
sectors: professional & business services, educational & health services, trade, and transportation & utilities. Unemployment was at 4.4%.
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The Napa MSA, with a branch in Napa. This MSA had a Population of 0.14 million and a Per Capita Income of approximately $82,408. The MSA includes significant employment in the following sectors: manufacturing, leisure & hospitality,
trade, and transportation & utilities. Unemployment was at 4.2%.
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Through its network of banking offices, the Company emphasizes personalized service along with a broad range of banking services to businesses and individuals located in the service areas of its offices. Although the
Company focuses on marketing its services to small and medium-sized businesses, a broad range of retail banking services are also made available to the local consumer market.
The Company offers a wide range of deposit instruments. These include checking, savings, money market, time certificates of deposit, individual retirement accounts and online banking services for both business and
personal accounts.
The Company provides a broad complement of lending products, including commercial, commercial real estate, real estate construction, agribusiness, consumer, credit card, residential real estate loans, and equipment
leases. Commercial products include term loans, leases, lines of credit and other working capital financing and letters of credit. Financing products for individuals include automobile financing, lines of credit, residential real estate, home
improvement and home equity lines of credit.
The Company also offers a wide range of specialized services designed for the needs of its commercial accounts. These services include a credit card program for merchants, lockbox and other collection services, account
reconciliation, investment sweep, on-line account access, and electronic funds transfers by way of domestic and international wire and automated clearinghouse.
The Company makes investment products available to customers, including mutual funds and annuities. These investment products are offered through a third party, which employs investment advisors to meet with and
provide investment advice to the Company’s customers.
Competition
The banking and financial services industry in California generally, and in the Company’s market areas specifically, is highly competitive. The increasingly competitive environment is a result primarily of changes in
regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial service providers. The Company competes with other major commercial banks, diversified financial institutions, credit unions,
savings institutions, money market and other mutual funds, mortgage companies, and a variety of other non-banking financial services and advisory companies. Federal legislation encourages competition between different types of financial service
providers and has fostered new entrants into the financial services market. It is anticipated that this trend will continue. Using the financial holding company structure, insurance companies and securities firms may compete more directly with banks
and bank holding companies.
Many of our competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader range of financial services than the Company. In order to compete with other
financial service providers, the Company relies upon personal contact by its officers, directors, employees, and stockholders, along with various promotional activities and specialized services. In those instances where the Company is unable to
accommodate a customer’s needs, the Company may arrange for those services to be provided through its correspondents.
The market shares of the Bank and its largest competitors in the eight counties in California in which we operate, ranked by deposit market share at June 30, 2021 (the most recent data available), as reported by
S&P Global Market Intelligence, are as follows:
Largest
Competitor
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Number
of
Branches
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Deposit
Market
Share
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Wells Fargo Bank
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102
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20.54
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%
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Bank of the West
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52
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15.42
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%
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Bank of America
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82
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14.01
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%
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JPMorgan Chase Bank
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90
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10.46
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%
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U.S Bank
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45
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8.91
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%
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F&M Bank
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28
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2.85
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%
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Union Bank
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12
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2.83
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%
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Human Capital Resources
As of December 31, 2021, we employed 373 full-time equivalent employees. The Company believes that its employee relations are satisfactory. For the year ended December 31, 2021, salaries and employee benefits expense
totaled $64 million, representing 70% of our total non-interest expense. Expenses related to education, training, recruiting and placement exceeded $300,000 for the three-year period ended December 31, 2021.
We are led by an experienced management team with substantial experience in the markets that we serve and the financial products that we offer. Our business strategy focuses on providing products and services through
long-term relationship managers. As a result, our success depends heavily on the performance of our employees, as well as on our ability to attract, motivate and retain highly qualified employees at all levels of the Company. We believe that our work
environment contributes to employee satisfaction and retention.
We are committed to maintaining a work environment where every employee is treated with dignity and respect, free from the threat of discrimination and harassment. As stated in our Board approved (i) Code of Conduct
and (ii) Prohibited Harassment Policy, we expect these same standards apply to all stakeholders, to our interactions with customers, vendors and independent contractors.
We are firmly committed to providing equal employment and advancement opportunities to all qualified individuals and will not tolerate any discrimination or harassment of any kind. Team members are encouraged to
immediately report any discrimination or harassment to their supervisor and human resources.
Policies and Planning
We are proud to be an Equal Opportunity Employer and enforce those values throughout all of our operations. We prohibit discrimination in hiring or advancement against any individual on the basis of race, color,
religion, gender, sex, national origin, age, marital status, pregnancy, physical or mental disability, genetics, veteran status, sexual orientation, or any other characteristic protected by applicable law.
We strive to ensure our team members have access to working conditions that provide a safe and healthy environment, free from work-related injuries and illnesses. Many of our locations employ badges and keypads to
enter or to enter restricted areas of locations that have a public presence. As a company having been designated as an “essential industry” during the COVID-19 pandemic, we focused on safety and health regimens that are designed to protect our
employees who have reported to work during this difficult time. This has resulted in our ability to keep all of our branches open for business while providing a safe work environment for our employees.
Each year our annual planning and budgeting process involves an assessment of staffing levels and skills and results in the development of targets for recruitment and training. In addition, our Board of Directors
reviews all succession plans in place for key personnel.
Recruitment
We strive to recruit talent from both local educational institutions and the banking industry. The Company has full-time staff dedicated to our recruitment efforts and we utilize many of the major recruitment firms and
websites. Annually we visit local colleges and universities for job fairs and other recruitment events, which we believe allows us to identify those students who have the skills and aptitudes we need in the Company. The results of these efforts has
been a consistent flow of candidates to fill our staffing needs as we grow.
Compensation
Salary and Bonuses
We have job descriptions and salary grade ranges for all of our positions. Annually we use outside survey firms to provide information on market pay. We also pay performance-based bonuses to our employees. During 2021,
total bonus compensation amounted to over 30% of base salaries. We believe that this “pay-for-performance” approach allows us to effectively recruit and retain key employees.
Retirement Plans
All employees are eligible to participate in our Profit Sharing Plan after 1 year of service and having worked at least 1,000 hours. The Company makes contributions equal to 5% of the employee’s eligible compensation
and discretionary contributions determined annually by the Board of Directors. This is not a matching based program; employees receive these contributions regardless of whether they make individual contributions to our 401(K) program. During 2021
total expenses for the profit sharing plan amounted to over 10% of base salaries, a level that we believe helps us in recruitment and retention.
Medical and Other Benefits
In addition to competitive salaries, incentives and retirement benefits, we provide comprehensive medical, dental, and vision plans, health savings accounts, paid sick time, long-term disability, basic life and
AD&D insurance, flexible spending accounts, and employee assistance and wellness programs.
Training
Job Related
We support team members, should they wish to continue their education in subjects and fields that are directly related to our operations, activities, and objectives. We encourage our team members to pursue educational
opportunities that will help improve job performance and professional development. To further this goal, we reimburse tuition and certain fees for satisfactory completion of approved educational courses and certain certifications. Included are
college credit courses at accredited colleges and universities, continuing education courses and certification exams.
Diversity and Inclusion
To foster a deeper understanding regarding diversity and inclusion, the Company assigns all employees diversity and inclusion training - Diversity Made Simple. The diversity
course is mandatory for all staff. As of December 31, 2021, all employees have met their diversity and inclusion training obligations.
Harassment Prevention
The Company assigns all employees prohibitive harassment training. Every two years nonsupervisory employees receive one hour of harassment prevention training while supervisors
receive two hours of harassment prevention training. Newly hired employees are assigned harassment prevention and must complete the training within six months of hire or promotion. Following the initial training, all employees must complete training
every two years, at minimum. As of December 31, 2021, all employees have met their harassment prevention training requirements.
Performance Evaluation
The Company has implemented a Performance Planning, Coaching and Evaluation (“PPC&E”) system that requires each year that employees and their managers establish detailed goals and objectives. Annually, employees
are reviewed relative to their progress in achieving those goals, with the objective of reducing performance surprises and encouraging behavior that is consistent with Company objectives. We believe that this PPC&E discipline is important in
retaining and growing our employees.
Government Policies
The Company’s profitability, like most financial institutions, is primarily dependent on interest rate differentials. The difference between the interest rates paid by the Company on interest-bearing liabilities, such
as deposits and other borrowings, and the interest rates received by the Company on its interest-earning assets, such as loans and leases extended to its customers and securities held in its investment portfolio, comprise the major portion of the
Company’s earnings. These rates are highly sensitive to many factors that are beyond the control of the Company and the Bank, such as inflation, recession, unemployment, and the monetary policy of the FRB. The impact that changes in economic
conditions might have on the Company and the Bank cannot be predicted.
The business of the Company is also influenced by the monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the FRB. The FRB implements national monetary policies
(with objectives such as curbing inflation and such as maximum employment, stable prices, and moderate long-term interest rates) through its open-market operations in U.S. Government securities by adjusting the required level of reserves for
depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions.
The actions of the FRB in these areas influence the growth of bank loans and leases, investments, and deposits and affect interest rates earned on interest-earning assets and paid on interest-bearing liabilities. The
nature and impact on the Company of any future changes in monetary and fiscal policies cannot be predicted.
From time to time, legislative acts, as well as regulations, are enacted which have the effect of increasing the cost of doing business, limiting or expanding permissible activities, or affecting the competitive
balance between banks and other financial services providers. Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies, and other financial institutions and financial services providers are
frequently made in the U.S. Congress, in the state legislatures, and before various regulatory agencies. This legislation may change banking statutes and the operating environment of the Company and the Bank in substantial and unpredictable ways. If
enacted, such legislation or regulations could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings institutions, credit unions, and other financial
institutions. The Company cannot predict whether any of this potential legislation will be enacted, and if enacted, the effect that it, or any implemented regulations, would have on the financial condition or results of operations of the Company or
any of its subsidiaries.
Supervision and Regulation
General
Bank holding companies and banks are extensively regulated under both federal and state law. The regulation is intended primarily for the protection of the banking system and the Deposit Insurance Fund and clients of
insured depository institutions and not for the benefit of stockholders of the Company. This supervisory and regulatory framework subjects banks and bank holding companies to regular examination by their respective regulatory agencies, which
results in examination reports and ratings that, while not publicly available, can affect the conduct and growth of their businesses. These examinations consider not only compliance with applicable laws and regulations, but also capital levels,
asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where
the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.
Set forth below is a summary description of the material laws and regulations, which relate to the operations of the Company and the Bank. This description does not purport to be complete and is qualified in its
entirety by reference to the applicable laws and regulations.
The Company
The Company is a registered bank holding company and is subject to regulation under the Bank Holding Company Act of 1956, as amended (“BHCA”). Accordingly, the Company’s operations are subject to extensive regulation
and examination by the FRB. The Company is required to file with the FRB quarterly and annual reports and such additional information as the FRB may require pursuant to the BHCA. The FRB conducts periodic examinations of the Company.
The FRB may require that the Company terminate an activity, terminate control of, liquidate, or divest certain subsidiaries or affiliates when the FRB believes the activity or the control of the subsidiary or affiliate
constitutes a significant risk to the financial safety, soundness or stability of any of its banking subsidiaries. The FRB also has the authority to regulate provisions of certain bank holding company debt. Under certain circumstances, the Company
must file written notice and obtain approval from the FRB prior to purchasing or redeeming its equity securities.
Under the BHCA and regulations adopted by the FRB, a bank holding company and its non-banking subsidiaries are prohibited from requiring certain tie-in arrangements in connection with an extension of credit, lease or
sale of property, or furnishing of services. For example, with certain exceptions, a bank may not condition an extension of credit on a promise by its customer to obtain other services provided by it, its holding company or other subsidiaries, or on
a promise by its customer not to obtain other services from a competitor. In addition, federal law imposes certain restrictions on transactions between Farmers & Merchants Bancorp and its subsidiaries. Further, the Company is required by the FRB
to maintain certain levels of capital. See “Capital Standards”.
The Company is prohibited by the BHCA, except in certain statutorily prescribed instances, from acquiring direct or indirect ownership or control of more than 5% of the outstanding voting shares of any company that is
not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or furnishing services to its subsidiaries. However, the Company, subject to the prior notice and/or
approval of the FRB, may engage in any, or acquire shares of companies engaged in, activities that are deemed by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.
A bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the FRB’s
policy, that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity
and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. This support may be required at times when a bank holding company may not be able to provide such support. A
bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB’s regulations or both.
The Company is not a financial holding company for purposes of the BHCA.
The Company is also a bank holding company within the meaning of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the
DFPI.
The Company’s common stock are registered with the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As such, the Company is subject to the
reporting, proxy solicitation and other requirements and restrictions of the Exchange Act.
The Bank
The Bank, as a California-chartered non-FRB member bank, is subject to primary supervision, periodic examination and regulation by the DFPI and the FDIC. If, as a result of an examination of the Bank, the FDIC should
determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory, or that the Bank or its management is violating or has violated any law
or regulation, various remedies are available to the FDIC.
Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be
judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate the Bank’s deposit insurance, which for a
California-chartered bank would result in a revocation of the Bank’s charter. The DFPI has many of the same remedial powers.
Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statutes and regulations relate to many aspects of the Bank’s
operations, including reserves against deposits, ownership of deposit accounts, interest rates payable on deposits, loans and leases, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, and capital requirements.
Further, the Bank is required to maintain certain levels of capital. See “Capital Standards”.
The Dodd Frank Wall Street Reform and Consumer Protection Act (the “Dodd Frank Act”) - The Dodd-Frank Act implemented sweeping reform across the U.S.
financial regulatory framework, including, among other changes:
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creating a Financial Stability Oversight Council tasked with identifying and monitoring systemic risks in the financial system;
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creating the Consumer Financial Protection Bureau (“CFPB”), which is responsible for implementing, examining and enforcing compliance with federal consumer financial protection laws;
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requiring the FDIC to make its capital requirements for insured depository institutions countercyclical, so that capital requirements increase in times of economic expansion and decrease in times of economic contraction;
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imposing more stringent capital requirements on bank holding companies and subjecting certain activities, including interstate mergers and acquisitions, to heightened capital conditions;
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changing the assessment base for federal deposit insurance from the amount of the insured deposits held by the depository institution to the depository institution’s average total consolidated assets less tangible equity, eliminating the
ceiling on the size of the FDIC’s Deposit Insurance Fund and increasing the floor on the size of the FDIC’s Deposit Insurance Fund;
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eliminating all remaining restrictions on interstate banking by authorizing state banks to establish de novo banking offices in any state that would permit a bank chartered in that state to open a banking office at that location;
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repealing the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts; and
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in the so-called “Volcker Rule,” subject to numerous exceptions, prohibiting depository institutions and affiliates from certain investments in, and sponsorship of, hedge funds and private equity funds and from engaging in proprietary
trading.
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On May 24, 2018 President Trump signed the Economic Growth, Regulatory Relief and Consumer Protection Act (“Economic Growth Act”), which repeals or modifies certain provisions of the Dodd-Frank
Act and eases regulations on all but the largest banks.
The Economic Growth Act’s highlights include improving consumer access to mortgage credit that, among other things: (i) exempt banks with less than $10 billion in assets from the ability-to-repay
requirements for certain qualified residential mortgage loans; (ii) do not require appraisals for certain transactions valued at less than $400,000 in rural areas; (iii) exempt banks and credit unions that originate fewer than 500 open-end and 500
closed-end mortgages from the Home Mortgage Disclosure Act’s (“HMDA”) expanded data disclosures (the provision would not apply to nonbanks and would not exempt institutions from HMDA reporting altogether); (iv) amend the SAFE Mortgage Licensing Act
by providing registered mortgage loan originators in good standing with 120 days of transitional authority to originate loans when moving from a federal depository institution to a non-depository institution or across state lines; (v) require the
CFPB to clarify how Truth in Lending Disclosure (“TRID”) rules apply to mortgage assumption transactions and construction-to-permanent home loans as well as outline certain liabilities related to model disclosure use; and (vi) provide that federal
banking regulators may not impose higher capital standards on High Volatility Commercial Real Estate exposures unless they are for acquisition, development or construction (“ADC”), and clarifies ADC status. In addition, the Economic Growth Act’s
highlights also include regulatory relief for certain institutions, including among other things, simplifying capital calculations by requiring regulators to adopt a threshold for a community bank leverage ratio of between 8% to 10%.
Institutions under $10 billion in assets that meet such community bank leverage ratio will automatically be deemed to be well-capitalized, although regulators retain the flexibility to determine
that a depository institution may not qualify for the community bank leverage ratio test based on the institution’s risk profile, and exempts community banks from Section 13 of the BHCA if they have less than $10 billion in total consolidated
assets; and exempts banks with less than $10 billion in assets, and total trading assets and liabilities not exceeding more than five percent of their total assets, from the Volcker Rule restrictions on trading with their own capital.
The Economic Growth Act also added certain protections for consumers, including veterans and active duty military personnel, expanded credit freezes and created an identity theft protection
database. The Economic Growth Act also made changes applicable to bank holding companies, as it raises the threshold for automatic designation as a systemically important financial institution from $50 billion to $250 billion in assets, subjects
banks with $100 billion to $250 billion in total assets to periodic stress tests, exempts from stress test requirements entirely banks with under $100 billion in assets, and required the federal banking regulators , within 180 days of passage, to
raise the asset threshold under the Small Bank Holding Company Policy Statement from $1 billion to $3 billion. The Economic Growth Act also added certain protections for student borrowers.
Some aspects of the Dodd-Frank Act remain subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on us. In addition, the
Economic Growth Act modified several provisions in the Dodd-Frank Act, but these remain subject to implementing regulations. Although the reforms primarily target systemically important financial service providers (which the Bank is not), the
Dodd-Frank Act’s influence has and is expected to continue to filter down in varying degrees to smaller institutions over time. We will continue to evaluate the effect of the Dodd-Frank Act; however, in many respects, the ultimate impact of the
Dodd-Frank Act will not be fully known for years, and no current assurance may be given that the Dodd-Frank Act, or any other new legislative changes, will not have a negative impact on the results of operations and financial condition of the
Company and the Bank.
Capital Standards
The federal banking agencies have risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking
organization’s operations, both for transactions reported on the balance sheet as assets and for transactions, such as letters of credit and recourse arrangements, that are recorded as off-balance sheet items. In 2013, the FRB, FDIC, and Office of
the Comptroller of the Currency issued final rules (the “Basel III Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations.
The rules implement the Basel Committee’s December 2010 framework, commonly referred to as Basel III, for strengthening international capital standards, as well as implementing certain provisions
of the Dodd-Frank Act.
The Basel III Capital Rules became effective for the Company and the Bank on January 1, 2015 (subject to phase-in periods for some of their components). The Basel III Capital Rules: (i) introduce
a new capital measure called Common Equity Tier 1 (“CET1”), and a related regulatory capital ratio of CET1 to risk-weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments, which are instruments
treated as Tier 1 instruments under the prior capital rules that meet certain revised requirements; (iii) mandate that most deductions or adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and
(iv) expand the scope of the deductions from and adjustments to capital, as compared to existing regulations. Under the Basel III Capital Rules, for most banking organizations, the most common form of additional Tier 1 capital is noncumulative
perpetual preferred stock and the most common form of Tier 2 capital is subordinated notes and a portion of the allowance for credit losses, in each case, subject to the Basel III Capital Rules’ specific requirements.
Under the Basel III Capital Rules, the following are the minimum capital ratios applicable to the Company and the Bank:
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4.0% Tier 1 leverage ratio;
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4.5% CET1 to risk-weighted assets, plus the capital conservation buffer, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%;
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6.0% Tier 1 capital to risk-weighted assets, plus the capital conservation buffer, effectively resulting in a minimum Tier 1 capital ratio of at least 8.5%; and
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8.0% total capital to risk-weighted assets, plus the capital conservation buffer, effectively resulting in a minimum total capital ratio of at least 10.5%.
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The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that: (i) mortgage servicing rights, (ii) deferred tax
assets arising from temporary differences that could not be realized through net operating loss carrybacks, and (iii) significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category
exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1. Under the Basel III Capital Rules, the effects of certain accumulated other comprehensive income or loss items are not excluded for the purposes of determining regulatory
capital ratios; however, non-advanced approaches banking organizations (i.e., banking organizations with less than $250 billion in total consolidated assets or with less than $10 billion of on-balance sheet foreign exposures), including the Company
and the Bank, may make a one-time permanent election to exclude these items. The Company and the Bank made this election in 2015 in order to avoid significant variations in the level of capital depending upon the impact of interest rate
fluctuations on the fair value of its available-for-sale investment securities portfolio, changes of which are included in accumulated other comprehensive income or loss.
The Basel III Capital Rules prescribe a standardized approach for risk weightings that expands the risk weighting categories from the previous four Basel I-derived categories (0%, 20%, 50% and
100%) to a larger and more risk-sensitive number of categories, generally ranging from 0% for U.S. Government and agency securities, to 600% for certain equity exposures, depending on the nature of the assets. The Basel III capital rules generally
result in higher risk weights for a variety of asset classes. Additional aspects of the Basel III Capital Rules that are relevant to the Company and the Bank include:
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consistent with the Basel I risk-based capital rules, assigning exposures secured by single-family residential properties to either a 50% risk weight for first-lien mortgages that meet prudent underwriting standards or a 100% risk weight
category for all other mortgages;
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providing for a 20% credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable (set at 0% under the Basel I risk-based capital rules);
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assigning a 150% risk weight to all exposures that are nonaccrual or 90 days or more past due (set at 100% under the Basel I risk-based capital rules), except for those secured by single-family residential properties, which will be
assigned a 100% risk weight, consistent with the Basel I risk-based capital rules;
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applying a 150% risk weight instead of a 100% risk weight for certain high volatility commercial real estate acquisition, development and construction loans; and
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applying a 250% risk weight to the portion of mortgage servicing rights and deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks that are not deducted from CET1 capital
(set at 100% under the Basel I risk-based capital rules).
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As of December 31, 2021, the Company’s and the Bank’s capital ratios exceeded the minimum capital adequacy guideline percentage requirements of the federal banking agencies for a “well
capitalized” institution under the Basel III capital rules on a fully phased-in basis. With respect to the Bank, the Basel III capital rules also revise the prompt corrective action regulations pursuant to Section 38 of the FDIA.
In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms, which standards are commonly referred to as Basel
IV. Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including the recalibration of the risk weights and the introduction of new capital requirements for certain “unconditionally cancellable
commitments,” such as unused credit card lines of credit) and provides a new standardized approach for operational risk capital.
Under the Basel framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing in through January 1, 2027. Under the current U.S. capital rules,
operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Bank. The impact of Basel IV on us will depend on how it is implemented by the federal bank regulators.
Prompt Corrective Action (“PCA”)
The FDIA requires federal banking agencies to take PCA in respect of depository institutions that do not meet minimum capital requirements. The FDIA includes the following five capital tiers:
“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare with various relevant
capital measures and certain other factors, as established by regulation. The Basel III Capital Rules revised the PCA requirements effective January 1, 2015. Under the revised PCA provisions of the FDIA, an insured depository institution generally
will be classified in the following categories based on the capital measures indicated:
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Well
Capitalized
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Adequately
Capitalized
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Under-
capitalized
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Significantly
Under-
capitalized
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Critically
Under-
capitalized
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Risk-based capital to risk-weighted assets
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10.00%+
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8.00%+
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< 8.00%
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< 6.00%
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N/A
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Tier 1 capital to risk-weighted assets
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8.00%+
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6.00%+
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< 6.00%
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< 4.00%
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N/A
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CET1 capital to risk-weighted assets
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6.50%+
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4.50%+
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< 4.50%
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< 3.00%
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N/A
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Tier 1 leverage capital ratio
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5.00%+
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4.00%+
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< 4.00%
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< 3.00%
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N/A
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Tangible equity to assets
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N/A
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N/A
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N/A
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N/A
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< 2.00%
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Supplemental leverage ratio
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N/A
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3.00%+
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< 3.00%
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N/A
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N/A
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An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios, if it is determined to be operating in an unsafe or unsound
condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying PCA regulations and the capital category may not constitute an accurate
representation of the bank’s overall financial condition or prospects for other purposes.
The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company, if the
depository institution would thereafter be “undercapitalized.” “Undercapitalized” institutions are subject to growth limitations and are required to submit capital restoration plans. If a depository institution fails to submit an acceptable plan,
it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately
capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator by the bank regulators.
The capital classification of a bank holding company and a bank affects the frequency of regulatory examinations, the bank holding company’s and the bank’s ability to engage in certain activities
and the deposit insurance premium paid by the bank to the FDIC. As of December 31, 2021, we met the requirements to be classified as a “well-capitalized” based upon the aforementioned ratios for purposes of the prompt corrective action regulations,
as currently in effect.
The Community Bank Leverage Ratio
On November 4, 2019, the federal banking agencies jointly issued a final rule that provides for an optional, simplified measure of capital adequacy, known as the community bank leverage ratio
(“CBLR”) framework, for qualifying community banking organizations consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act. The CBLR framework is designed to reduce the capital burden by removing the
requirements for calculating and reporting risk-based capital ratios for qualifying community-banking organizations that opt into the framework. The final rule was effective on January 1, 2020.
In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9%, less than $10 billion in total consolidated assets,
off-balance-sheet exposures of 25% or less of total consolidated assets, and trading assets and liabilities of 5% or less of total consolidated assets. A qualifying community banking organization that opts into the CBLR framework and meets all
requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations. Such a community banking organization would not be subject to other risk-based and leverage
capital requirements (including the Basel III and Basel IV requirements). The CBLR is determined by dividing a financial institution’s tangible equity capital by its average total consolidated assets. The rule describes what is included in tangible
equity capital and average total consolidated assets. The CBLR framework was available for banks to use in their March 31, 2020, call report. A CBLR bank that ceases to meet any of the qualifying criteria in a future period but maintains a leverage
ratio greater than 8% will be allowed a grace period of two reporting periods to satisfy the CBLR qualifying criteria or to otherwise comply with the generally applicable capital requirements. Further, a CBLR bank may opt out of the framework at
any time, without restriction, by reverting to the generally applicable capital requirements. The Company and Bank did not opt into the CBLR framework.
Anti-Money Laundering and Office of Foreign Assets Control Regulation
Title III of the United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”), is designed to deny terrorists and criminals the ability to
obtain access to the U.S. financial system and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money.
The Patriot Act mandates financial services companies to have policies and procedures with respect to measures designed to address any or all of the following matters: (i) customer identification programs; (ii) money
laundering; (iii) terrorist financing; (iv) identifying and reporting suspicious activities and currency transactions; (v) currency crimes; and (vi) cooperation between financial institutions and law enforcement authorities. Regulatory authorities
routinely examine financial institutions for compliance with these obligations, and failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the
relevant laws or regulations, could have serious legal and reputational consequences for the institution, including causing applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required
or to prohibit such transactions even if approval is not required. Regulatory authorities have imposed cease and desist orders and civil money penalties against institutions found to be violating these obligations.
The U.S. Treasury’s Office of Foreign Assets Control (“OFAC”) administers and enforces economic and trade sanctions against targeted foreign countries and regimes under authority of various laws, including designated
foreign countries, nationals and others. OFAC publishes lists of specially designated targets and countries. Financial institutions are responsible for, among other things, blocking accounts of and transactions with such targets and countries,
prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Banking regulators examine banks for compliance with the economic sanctions regulations administered by OFAC and failure of a
financial institution to maintain and implement adequate OFAC programs, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.
Privacy Restrictions
The Gramm-Leach-Bliley Act (“GLBA”) requires financial institutions in the U.S. to provide certain privacy disclosures to customers and consumers, to comply with certain restrictions on the sharing and usage of
personally identifiable information, and to implement and maintain commercially reasonable customer information safeguarding standards.
The Company believes that it complies with all provisions of the GLBA and all implementing regulations and the Bank has developed appropriate policies and procedures to meet its responsibilities in connection with the
privacy provisions of GLBA.
Dividends and Other Transfer of Funds
Dividends from the Bank constitute the principal source of cash to the Company. The Company is a legal entity separate and distinct from the Bank. The Bank is subject to various statutory and regulatory restrictions on
its ability to pay dividends to the Company. Under such restrictions, the amount available for payment of dividends to the Company by the Bank totaled $143.2 million at December 31, 2021. During 2021, the Bank paid $9.9 million in dividends to the
Company.
The FDIC and the DFPI also have authority to prohibit the Bank from engaging in activities that, in their opinion, constitute unsafe or unsound practices in conducting its business. It is possible, depending upon the
financial condition of the bank in question and other factors, that the FDIC or the DFPI could assert that the payment of dividends or other payments might, under some circumstances, be an unsafe or unsound practice. Further, the FRB and the FDIC
have established guidelines with respect to the maintenance of appropriate levels of capital by banks and bank holding companies under their jurisdiction. Compliance with the standards set forth in such guidelines and the restrictions that are or may
be imposed under the prompt corrective action provisions of federal law could limit the amount of dividends that the Bank or the Company may pay. An insured depository institution is prohibited from paying management fees to any controlling persons
or, with certain limited exceptions, making capital distributions if after such transaction the institution would be undercapitalized. The DFPI may impose similar limitations on the Bank. See “Prompt Corrective Action” and “Capital Standards”, above,
for a discussion of these additional restrictions on capital distributions.
Transactions with Affiliates
The Bank is subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of the Company or other affiliates, the purchase of, or
investments in stock or other securities of the Company or other affiliates, the taking of such securities as collateral for loans and leases, and the purchase of assets of the Company or other affiliates. Such restrictions prevent the Company and
other affiliates from borrowing from the Bank unless the loans are secured by marketable obligations of designated amounts. Further, such secured loans and investments by the Bank to or in the Company or to or in any other affiliates are limited,
individually, to 10% of the Bank’s capital and surplus (as defined by federal regulations), and such secured loans and investments are limited, in the aggregate as to all affiliates, to 20% of the Bank’s capital and surplus (as defined by federal
regulations).
In addition, the Company and its operating subsidiaries generally may not purchase a low-quality asset from an affiliate, and other specified transactions between the Company or its operating subsidiaries and an
affiliate must be on terms and conditions that are consistent with safe and sound banking practices.
Also, the Company and its operating subsidiaries may engage in transactions with affiliates only on terms and under conditions that are substantially the same, or at least as favorable to the Company or its
subsidiaries, as those prevailing at the time for comparable transactions with (or that in good faith would be offered to) non-affiliated companies. California law also imposes certain restrictions with respect to transactions with affiliates.
Additionally, limitations involving the transactions with affiliates may be imposed on the Bank under the prompt corrective action provisions of federal law. See “Prompt Corrective Action”.
Safety and Soundness Standards
The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The
guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation; credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If
an institution fails to comply with any of the standards set forth in the guidelines, the financial institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If a financial
institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the
institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the financial institution’s rate of growth, require the financial institution to increase its capital, restrict the rates
the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds
for other enforcement action by the federal bank regulatory agencies, including cease and desist orders and civil money penalty assessments.
Since the financial crisis of 2008-2009, the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and strong internal controls when evaluating
the activities of the financial institutions they supervise. Properly managing risks has been identified as critical to the conduct of safe and sound banking activities and has become even more important as new technologies, product innovation, and
the size and speed of financial transactions have changed the nature of banking markets. The agencies have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market, liquidity, operational, legal, and
reputational risk.
In particular, recent regulatory pronouncements have focused on operational risk, which arises from the potential that inadequate information system, operational problems, breaches in internal
controls, fraud, or unforeseen catastrophes will result in unexpected losses. New products and services, third-party risk management and cyber-security are critical sources of operational risk that financial institutions are expected to address in
the current environment. The Bank is expected to have active board and senior management oversight; adequate policies, procedures, and limits; adequate risk measurement, monitoring, and management information systems; and comprehensive internal
controls.
Deposit Insurance
As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The premiums fund the Deposit Insurance Fund (“DIF”). The FDIC assesses a quarterly
deposit insurance premium on each insured institution based on risk characteristics of the institution and may also impose special assessments in emergency situations. Effective July 1, 2016, the FDIC changed the deposit insurance assessment system
for banks, such as the Bank, with less than $10 billion in assets that have been federally insured for at least five years. Among other changes, the FDIC eliminated risk categories for such banks and now uses the “financial ratios method” to
determine assessment rates for all such banks. Under the financial ratios method, the FDIC determines assessment rates based on a combination of financial data and supervisory ratings that estimate a bank’s probability of failure within three years.
The assessment rate determined by considering such information is then applied to the amount of the institution’s average assets minus average tangible equity to determine the institution’s insurance premium.
The Dodd-Frank Act required the FDIC to ensure that the DIF reserve ratio, which is the amount in the DIF as a percentage of all DIF-insured deposits, reached 1.35% by September 3, 2020. The
Dodd-Frank Act also altered the minimum designated reserve ratio for the DIF, increasing the minimum from 1.15% to 1.35%, and eliminated the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain
thresholds. At least semi-annually, the FDIC updates its loss and income projections for the DIF and, if needed, may increase or decrease the assessment rates, following notice and comment on proposed rulemaking if required. As a result, the Bank’s
FDIC deposit insurance premiums could increase.
The Bank’s FDIC premiums were $1.2 million, $517,000, and $624,000 for the three years ended December 31, 2021, 2020, and 2019, respectively. In 2020 and 2019, the Bank’s FDIC premiums were reduced by a one-time small
bank assessment credit applied by the FDIC. This assessment credit was not available in 2021. Future increases in insurance premiums could have adverse effects on the operating expenses and results of operations of the Company. Management cannot
predict what insurance assessment rates will be in the future.
Insurance of a bank’s deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated
any applicable law, regulation, rule, order, or condition imposed by the FDIC or the Bank’s primary regulator. Management of the Company is not aware of any practice, condition or violation that might lead to termination of the Company’s deposit
insurance.
Community Reinvestment Act (“CRA”) and Fair Lending
The Bank is subject to certain fair lending requirements involving lending, investing, and other CRA activities. CRA requires each insured depository institution to identify the communities served by the institution’s
offices and to identify the types of credit and investments the institution is prepared to extend within such communities including low and moderate-income neighborhoods. It also requires the institution’s regulators to assess the institution’s
performance in meeting the credit needs of its community and to consider such assessment in reviewing applications for mergers, acquisitions, relocation of existing branches, opening of new branches, and other transactions. A bank may be subject to
substantial penalties and corrective measures for a violation of certain fair lending laws.
A bank’s compliance with the Community Reinvestment Act is assessed using an evaluation system, which bases CRA ratings on an institution’s lending, service and investment performance. An unsatisfactory rating may be
the basis for denying a merger application. The Bank’s latest CRA examination was completed by the FDIC in May 2019 and the Bank received an overall Outstanding rating in complying with its CRA obligations. On December 12, 2019, the FDIC and the
Office of the Comptroller of the Currency (“OCC”) announced a proposal to modernize the agencies’ regulations under the CRA that have not been substantively updated for nearly 25 years. On May 20, 2020, the OCC issued a final rule for CRA
modernization; however, the FDIC did not join the OCC and finalize the rule.
Consumer Protection Regulations
Banks and other financial institutions are subject to numerous laws and regulations intended to protect consumers in their transactions with banks. These laws include, among others, laws
regarding unfair and deceptive acts and practices and usury laws, as well as the following consumer protection statutes: Truth in Lending Act, Truth in Savings Act, Electronic Fund Transfer Act, Expedited Funds Availability Act, Equal Credit
Opportunity Act, Fair and Accurate Credit Transactions Act, Fair Housing Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, Gramm-Leach-Bliley Act, Home Mortgage Disclosure Act, Right to Financial Privacy Act, Servicemembers Civil
Relief Act, Military Lending Act and Real Estate Settlement Procedures Act.
Many states and local jurisdictions have consumer protection laws analogous, and in addition, to those listed above. These federal, state and local laws regulate the manner in which financial
institutions deal with customers when taking deposits, making loans or conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, customer rescission rights, action by state and
local attorneys general and civil or criminal liability. Failure to comply with consumer protection requirements may also result in our failure to obtain any required bank regulatory approval for merger or acquisition transactions we may wish to
pursue or our prohibition from engaging in such transactions even if approval is not required.
The structure of federal consumer protection regulation applicable to all providers of consumer financial products and services changed significantly on July 21, 2011, when the CFPB commenced
operations to supervise and enforce consumer protection laws. The consumer protection provisions of the Dodd-Frank Act and the examination, supervision and enforcement of those laws and implementing regulations by the CFPB have created a more
intense and complex environment for consumer finance regulation. The CFPB has significant authority to implement and enforce federal consumer protection laws and new requirements for financial services products provided for in the Dodd-Frank Act,
as well as the authority to identify and prohibit unfair, deceptive or abusive acts and practices. The review of products and practices to prevent such acts and practices is a continuing focus of the CFPB, and of banking regulators more broadly.
The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination,
additional remediation efforts and possible penalties. In addition, the Dodd-Frank Act provides the CFPB with broad supervisory, examination and enforcement authority over various consumer financial products and services, including the ability to
require reimbursements and other payments to customers for alleged legal violations and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the
authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. The Dodd-Frank Act does not prevent states from adopting stricter consumer protection standards. State regulation of financial products and
potential enforcement actions could also adversely affect our business, financial condition or results of operations.
The CFPB is authorized to issue rules for both bank and nonbank companies that offer consumer financial products and services, subject to consultation with the prudential banking regulators. In
general, however, banks with assets of $10 billion or less, such as the Bank, will continue to be examined for consumer compliance by their primary bank regulator.
Notice and Approval Requirements Related to Control
Banking laws impose notice, approval and ongoing regulatory requirements on any stockholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution. These laws
include the BHCA and the Change in Bank Control Act. Among other things, these laws require regulatory filings by a stockholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or bank
holding company. The determination whether an investor “controls” a depository institution is based on all of the facts and circumstances surrounding the investment. As a general matter, a party is deemed to control a depository institution or other
company if the party owns or controls 25% or more of any class of voting stock. Subject to rebuttal, a party may be presumed to control a depository institution or other company if the investor owns or controls 10% or more of any class of voting
stock. Ownership by family members, affiliated parties, or parties acting in concert, is typically aggregated for these purposes. If a party’s ownership of the Company were to exceed certain thresholds, the investor could be deemed to “control” the
Company for regulatory purposes. This could subject the investor to regulatory filings or other regulatory consequences.
In addition, except under limited circumstances, bank holding companies are prohibited from acquiring, without prior approval:
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control of any other bank or bank holding company or all or substantially all the assets thereof; or
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more than 5% of the voting shares of a bank or bank holding company which is not already a subsidiary.
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Incentive Compensation
In 2010, the federal bank regulatory agencies issued comprehensive guidance intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and
soundness of those organizations by encouraging excessive risk-taking. The incentive compensation guidance sets expectations for banking organizations concerning their incentive compensation arrangements and related risk-management, control and
governance processes. The incentive compensation guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon three primary principles:
(1) balanced risk-taking incentives; (2) compatibility with effective controls and risk management; and (3) strong corporate governance. Any deficiencies in compensation practices that are identified may be incorporated into the organization’s
supervisory ratings, which can affect its ability to make acquisitions or take other actions. In addition, under the incentive compensation guidance, a banking organization’s federal supervisor may initiate enforcement action if the organization’s
incentive compensation arrangements pose a risk to the safety and soundness of the organization.
In 2016, several federal financial agencies (including the FRB and FDIC) re-proposed restrictions on incentive-based compensation pursuant to Section 956 of the Dodd-Frank Act for financial
institutions with $1 billion or more in total consolidated assets.
For institutions with at least $1 billion but less than $50 billion in total consolidated assets, the proposal would impose principles-based restrictions that are broadly consistent with existing
interagency guidance on incentive-based compensation. Such institutions would be prohibited from entering into incentive compensation arrangements that encourage inappropriate risks by the institution: (i) by providing an executive officer,
employee, director, or principal shareholder with excessive compensation, fees, or benefits; or (ii) that could lead to material financial loss to the institution. The comment period for these proposed regulations has closed, but a final rule has
not been published. Depending upon the outcome of the rule making process, the application of this rule to us could require us to revise our compensation strategy, increase our administrative costs and adversely affect our ability to recruit and
retain qualified employees. Further, as discussed above, the Basel III Capital Rules limit discretionary bonus payments to bank executives if the institution’s regulatory capital ratios fail to exceed certain thresholds that started being phased in
on January 1, 2016.
Available Information
Company reports filed with the SEC including the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and ownership reports filed by directors, executive officers
and principal stockholders can be accessed through the Company’s website at http://www.fmbonline.com. The link to the SEC is on the About Us page. The Company’s reports may also be accessed at the SEC’s
Internet website (http://www.sec.gov).
An investment in our common stock is subject to risks inherent in our business. The material risks and uncertainties that management believes may affect our business are described below. Before
making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this 10-K Report. The risks and uncertainties described below
are not the only ones facing our business. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. If any of the following risks actually
occur, our financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly, and you could lose all or part of your investment.
Risks Related to COVID-19 Pandemic
The outbreak of the COVID-19 pandemic has caused a significant global economic downturn which has, and is expected to, continue to adversely affect our business and
results of operations, and the future impacts of the pandemic on the global economy and our business, results of operations, liquidity and financial condition remain uncertain. The COVID-19 continues to cause economic disruption both
worldwide and in the markets we serve. The ultimate impacts of COVID-19 are uncertain and could have a material adverse effect on our business, financial condition, liquidity, and results of operations. The extent of these impacts will depend on
future developments, including among others, governmental, regulatory, and private sector actions and responses, new information that may emerge concerning the severity of COVID-19, and actions taken to contain or prevent further spread, none of
which can be predicted. COVID-19 has and continues to disrupt the business, activities, and operations of our clients, which may result in a significant decrease in our business, negatively impacting our liquidity position and financial results and
cause increased risk of delinquencies, defaults, foreclosures, declining collateral values, and other losses.
Our workforce has been, is, and may continue to be, impacted by COVID-19. We are taking precautions to protect the safety and well-being of our employees and clients, but no assurance can be given that our actions will
be adequate. The spread of COVID-19 could also negatively affect availability of key personnel and employee productivity, as well as the business and operations of third-party service providers who perform critical services for us.
During 2021, as vaccination rates increased across the markets we serve and governmental restrictions were eased, economic activity has improved. However, the COVID-19 virus continues to develop new strains, such as
the Delta and Omicron variants, which have increased infection rates, especially among unvaccinated persons. No assurance can be given that these or other variants of the virus will not lead to stricter governmental restrictions on economic activity
or have other materially adverse effects on business and the economy.
Even if the COVID-19 outbreak subsides, we may continue to experience materially adverse impacts to our business as a result of the national and global economic impact of the virus, including the availability of
credit, adverse impacts on our liquidity, and any recession that has occurred or may occur in the future.
The governmental stimulus measures introduced in response to the COVID-19 pandemic have increased, and can be expected to continue to increase, federal budget deficits and the national debt level. These events can be
expected to adversely affect the long-term sovereign credit rating of United States debt, and downgrades by the credit rating agencies with respect to the obligations of the U.S. federal government could occur, which could increase the U.S.
government’s borrowing costs, and worsen its fiscal challenges, as well as generate upward pressure on interest rates. This could, in turn, have adverse consequences for our borrowers and the level of business activity. For additional information
regarding the pandemic and its consequences for our business, see “COVID-19 (Coronavirus) Disclosure” above in this Annual Report on Form 10-K.
Risks Relating to the Industry and Geographic Area in Which We Operate
As a financial services company, our business and operations may be adversely affected by weak economic conditions. Our business operations, which primarily
consist of lending money to clients in the form of loans, borrowing money from clients in the form of deposits and investing in securities, are sensitive to general business and economic conditions in the United States. If the U.S. economy weakens,
our growth and profitability from our lending, deposit and investment operations could be constrained. In addition, economic conditions in foreign countries could affect the stability of global financial markets, which could hinder U.S. economic
growth. Our business is also significantly affected by monetary and related policies of the U.S. federal government and its agencies. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our
control. Adverse economic conditions and government policy responses to such conditions could have a material adverse effect on our financial condition and operations.
A large portion of our loan portfolio is tied to the real estate market where we operate and we may be negatively impacted by downturns in that market. A
significant percentage of our loans are real estate related, consisting of loans for construction and land development projects, and for the purchase, improvement or refinancing of residential and commercial real estate. A downturn in the real estate
market could increase loan delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. Real estate collateral provides an alternate source of repayment in the
event of default by the client and may deteriorate in value during the time the credit is extended. If values decline, it is also more likely that we would be required to increase our allowance for credit losses. If during a period of reduced real
estate values we are required to liquidate the property collateralizing a loan to satisfy the debt or to increase our allowance for credit losses, it could materially reduce our profitability and adversely affect our financial condition.
Although only 5.5% of our loan portfolio consisted of real estate construction, and acquisition and land development loans as of December 31, 2021, such loans generally have a higher degree of risk than long-term
financing of existing properties because repayment depends on the completion of the project and usually on the sale or long term financing of the property. The pandemic has had, and may continue to have, an impact on the ability of our clients to
complete these projects on time and within budget, particularly with respect to access to materials and labor and costs of the same. In addition, these loans are often “interest-only loans,” which normally require only the payment of interest
accrued prior to maturity. Interest-only loans carry greater risk than other loans because no principal is paid prior to maturity. This risk is particularly apparent during periods of rising interest rates and declining real estate values. If there
is a significant decline in the real estate market due to a material increase in interest rates or for other reasons, many of these loans could default and result in foreclosure. If we are forced to foreclose on a project prior to completion, we may
not be able to recover the entire unpaid portion of the loan or we may be required to fund additional money to complete the project or hold the property for an indeterminate period. In addition, real estate exposes us to incurring costs and
liabilities for environmental contamination and remediation. Any of these outcomes may result in losses and reduce our earnings.
The FDIC has given guidance recommending that if the sum of (i) certain categories of CRE loans and (ii) acquisition, development and construction loans (“ADC loans”) exceeds 300% of total risk-based capital, or if ADC
loans exceed 100% of total risk- based capital, heightened risk management practices should be employed to mitigate risk. As of December 31, 2021, our ratio for the sum of CRE and ADC loans was 170% and our ratio for ADC loans was 35%. Our
concentration in ADC loans is cyclical and tends to increase in the second and third quarters of each year as demand for ADC loans increases. An increase in ADC loan concentration could cause our ratio for ADC loans to increase and even exceed the
FDIC’s guideline. We have exceeded these guidance ratios at times in the past and may do so in the future. We actively monitor and believe that we effectively manage our CRE and ADC loan concentrations. If we exceed the FDIC’s guidelines and do not
effectively manage the risk of our CRE and ADC loans, we may be subject to regulatory scrutiny, including a requirement to raise additional capital, reduce our loan concentrations, or undertake other remedial actions.
We could suffer material credit losses if we do not appropriately manage our credit risk. There are risks inherent in making any loan, including risks in
dealing with individual clients, risks of non-payment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions. Changes in the economy may cause the assumptions that
we made at origination to change and may cause clients to be unable to make payments on their loans. There is no assurance that our credit risk monitoring and loan approval procedures are or will be adequate to address the inherent risks associated
with lending. Any failure to manage such risks may materially adversely affect our financial condition and results of operations.
The small- to medium-sized businesses that we lend to may have fewer resources to weather adverse business and economic developments, which may impair their ability
to repay a loan, and such impairment could adversely affect our operations and financial condition. Our business strategy targets primarily small- to medium-sized businesses, which frequently have
smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete, and may experience substantial volatility in operating results, any of which may impair a
client’s ability to repay a loan.
Small- to medium-sized businesses have been, and likely will continue to be, impacted by the COVID-19 pandemic, which may, in turn, affect the risk rating and collectability of our loans . Due to “stay at home” orders
and other pandemic management measures, many small- to medium-sized businesses were shut down for portions of 2020 and 2021. While many received SBA PPP loans or deferrals from the Bank , the long-term impact of the COVID-19 pandemic on such
businesses is not yet known. In addition, the success of a small- to medium-sized business often depends on the management skills, talents and efforts of one or a small number of people, and the death, disability or resignation of one or more of
these people could have a material adverse impact on the business and its ability to repay its loan. If general economic conditions negatively affect California and small- to medium-sized businesses are adversely affected or our clients are otherwise
affected by adverse business conditions or developments, our business, financial condition and operations could be adversely affected.
Our profitability depends on interest rates generally, and we may be adversely affected by changes in market interest rates. Our profitability depends in
substantial part on our net interest income. Our net interest income depends on many factors that are partly or completely outside of our control, including competition, federal, monetary and fiscal policies, and economic conditions generally. Our
net interest income will be adversely affected if market interest rates change so that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments. In addition, an increase in interest rates
could adversely affect clients’ ability to pay the principal or interest on existing loans or reduce their borrowings. This may lead to an increase in our non-performing assets, a decrease in loan originations, or a reduction in the value of and
income from our loans, any of which could have a material and negative effect on our operations. Fluctuations in market rates and other market disruptions are neither predictable nor controllable and may adversely affect our financial condition and
earnings.
During 2021, inflationary pressures have begun to affect many aspects of the U.S. economy, including gasoline and fuel prices, and global and domestic supply-chain issues have also had a disruptive effect on many
industries, including the agricultural industry. In response, the Federal Reserve Board has signaled an end to its quantitative easing program and the expectation of interest rate increases. The impact of these developments on the business of our
clients and on our business cannot be predicted with certainty but could present challenges in 2022 and beyond.
During 2021, the U.S. economy began to reflect relatively rapid rates of increase in the consumer price index and other economic indices; a prolonged elevated rate
of inflation could present risks for the U.S. banking industry and our business. During the latter part of 2021, the U.S. economy exhibited relatively rapid rates of increase in the consumer price index and other economic indices.
Pandemic-related supply chain disruptions may be contributing to this development. If the U.S. economy encounters a significant, prolonged rate of inflation, this could pose higher relative risks to the banking industry and our business. Such
inflationary periods have historically corresponded with relatively weaker earnings and higher loan losses for banks.
In the past, inflationary environments have caused financing conditions to tighten and have increased borrowing costs for some marginal borrowers, which, in turn, has impacted bank credit quality and loan growth.
Additionally, a sustained period of inflation could prompt broad-based selling of longer-duration, fixed-rate debt, which could have negative implications for equity and real estate markets. Small businesses and
leveraged loan borrowers can be challenged in a materially higher-rate environment. Higher interest rates can also present challenges for commercial real estate projects, pressuring valuations and loan-to-value ratios. The FRB has signaled that it
will be exiting quantitative easing in 2022 and expects over time to raise interest rates in response to the recent economic developments. Whether such actions by the FRB, if taken, will result in market volatility and adverse impacts on asset
prices and economic growth cannot be predicted with any certainty.
In addition, the recent outbreak of hostilities between Russia and Ukraine and global reactions thereto have increased U.S. domestic and global energy prices. Oil supply disruptions related to the Russia-Ukraine
conflict, and sanctions and other measures taken by the U.S. or its allies, could lead to higher costs for gas, food and goods in the U.S. and exacerbate the inflationary pressures on the economy, with potentially adverse impacts on our customers and
on our business, results of operations and financial condition.
We face strong competition from banks, credit unions and other financial services providers that offer banking services, which may limit our ability to attract and
retain banking clients. Competition in the banking industry generally, and in our geographic market specifically, is strong. Competitors include banks, as well as other financial services providers, such as savings and loan institutions,
consumer finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. Our competitors include several larger national and regional financial institutions whose greater resources may afford
them a marketplace advantage inasmuch as they may offer a wider array of banking services at better rates and be able to target a broader client base through more extensive promotional and advertising campaigns. Moreover, larger competitors may not
be as vulnerable as we are to downturns in the local economy and real estate market since they have a broader geographic area and their loan portfolio is more diversified. While our deposit base has increased, several banks have grown their deposit
market share in our markets faster than we have resulting in a declining relative deposit market share for us in our existing markets. We believe our declining relative market share in deposits has resulted primarily from aggressive marketing and
advertising, in-migration of more competitors, expanded delivery channels and more attractive rates offered by larger bank competitors. We also compete against community banks, credit unions and non-bank financial services companies that have strong
local ties. These smaller institutions are likely to cater to the same small to medium-sized businesses that we target. Additionally, financial technology companies allow clients to obtain loans via the Internet in an expeditious manner and have
become competitors. If we are unable to attract and retain customers, we may be unable to continue to grow our loan and deposit portfolios and our operations and financial condition may otherwise be adversely affected. Ultimately, we may be unable
to compete successfully against current and future competitors.
Our financial results may be impacted by the cyclicality and seasonality of our agricultural lending business. The Company has provided financing to
agricultural customers in the mid Central Valley of California throughout its history. We recognize the cyclical nature of the industry, often caused by fluctuating commodity prices, changing climatic conditions and the availability of seasonal
labor, and manage these risks accordingly. The Company remains committed to providing credit to agricultural customers and will always have a material exposure to this industry. Although the Company’s loan portfolio is believed to be
well-diversified, at various times during 2021 a significant portion of the Company’s loans (as much as 29%) were outstanding to agricultural borrowers. Commitments are well diversified across various commodities, including dairy, grapes, walnuts,
almonds, cherries, apples, pears, and various row crops. Additionally, many individual borrowers are themselves diversified across commodity types, reducing their exposure, and therefore the Company’s, to cyclical downturns in any one commodity.
The Company’s service areas can also be significantly impacted by the seasonal operations of the agricultural industry. As a result, the Company’s financial results can be influenced by the banking needs of its
agricultural customers. Generally speaking during the spring and summer customers draw down their deposit balances and increase loan borrowings to fund the purchase of equipment and the planting of crops. Deposit balances are replenished and loans
repaid in late fall and winter as crops are harvested and sold. Disruptions in the global supply chain arising from the pandemic may adversely affect the ability of some of our agricultural customers to efficiently export their agricultural products
and in turn may adversely affect their results of operations or financial condition and their ability to repay loans we have made to them.
The impact of climate change and changes in governmental regulations may affect the availability of water that could in turn affect our clients’ businesses. The
State of California has experienced severe drought conditions at times over the past several years. These weather patterns reinforce the fact that the long-term risks associated with the availability of water are significant. The farming belt of
the Central Valley is often cited as an example of an area that experienced extreme drought. However, not all areas of the state are impacted equally, and this is particularly true in the Central Valley, which stretches some 450 miles from
Bakersfield in the south to Redding in the north. The vast majority of the Company’s agricultural customers are located in the mid Central Valley, an area that benefits from the drainage of the Sacramento, American, Mokelumne and Stanislaus rivers.
In addition to the impact of climate has on the availability of water, State and Federal regulators ultimately manage this resource, which may also impact that access of our customers water. For example, in 2014, the
State of California passed the Sustainable Groundwater Management Act. All Water Districts must develop plans to comply with the Act, including groundwater recharge programs. Although the exact impact of compliance is not currently known, and even
prior to 2014 most of the water districts in the Bank’s service area had been developing and implementing management plans, it is possible that some water districts will have to ultimately fallow some ground to achieve compliance with the Act.
Changes to LIBOR may adversely affect the value of, and the return on, our financial instruments that are indexed to LIBOR. In
July 2017, the United Kingdom’s Financial Conduct Authority (the “FCA”) which regulates LIBOR announced that it would stop compelling banks to submit rates for the calculation of LIBOR after 2021. In March
2021, the FCA and LIBOR’s administrator, ICE Benchmarks Administration, announced that LIBOR would no longer be provided (i) for the one-week and two-month U.S. dollar settings and for various foreign currency settings after December 31, 2021, and
(ii) for the remaining U.S. dollar settings after June 30, 2023. In addition, the FRB has issued guidance urging market participants in the U.S. to cease using LIBOR as a reference rate for new contracts entered into after December 31, 2021. There
are on-going efforts to establish an alternative reference rate to LIBOR. The Secured Overnight Financing Rate (or SOFR) published by the Federal Reserve Bank of New York (the “FRBNY”) is considered a likely alternative reference rate suitable for
replacing LIBOR. SOFR is a broad measure of the cost of overnight borrowings collateralized by U.S. Treasury securities. The Alternative Reference Rates Committee, a group of private-market participants convened by the FRBNY to help ensure a
successful transition from U.S. dollar LIBOR to a new reference rate, has recommended adoption of SOFR as the alternative reference rate. The scope of the acceptance of SOFR and the consequent impact on rates, pricing, the value and liquidity of
our financial instruments and liquidity of such instruments and the ability to manage risk, including through derivatives, remain uncertain at this time. While some of our existing products or contracts include fallback provisions to alternative
reference rates, other products or contracts may not include adequate fallback provisions and may require consent of all parties to any modification. The market transition from LIBOR and similar benchmarks could adversely affect the return on and
pricing, liquidity and value of our outstanding products and contracts, cause market dislocations, increase the cost of and access to capital and increase the risk of disputes and litigation in connection with the interpretation and enforceability
of our outstanding products and contracts.
Risks Related to Our Growth
If we are not able to maintain our past levels of growth, our future prospects and competitive position could be diminished and our profitability could be reduced. We
may not be able to sustain our deposit, loan, and asset growth at the rate we have attained during the past several years, including the significant deposit growth experienced since the onset of the COVID-19 pandemic. Our growth over the past
several years has been driven primarily by agricultural and commercial real estate growth in our market areas, growth in non-real estate agricultural and commercial loans, commercial leasing, and residential real estate. A failure to attract and
retain high performing employees, heightened competition from other financial services providers, and an inability to attract additional core deposits and lending clients, among other factors, could limit our ability to grow as rapidly as we have in
the past and as such could have a negative effect on our financial condition and operations.
If we are unable to manage our growth effectively, we may incur higher than anticipated costs, and our ability to execute our growth strategy could be impaired. It
is our objective to continue to grow our assets and deposits by increasing our product and service offerings and expanding our operations organically. Our ability to manage growth successfully will depend on our ability to (i) identify suitable
markets for expansion; (ii) attract and retain qualified management; (iii) attract funding to support additional growth; (iv) maintain asset quality and cost controls; (v) maintain adequate regulatory capital and profitability to support our lending
activities; and (vi) may include finding attractive acquisition targets and successfully acquire and integrate the acquisitions in an efficient manner. If we do not manage our growth effectively, we may be unable to realize the benefit from our
investments in technology, infrastructure, and personnel that we have made to support our expansion. In addition, we may incur higher costs and realize less revenue growth, which would reduce our earnings and diminish our future prospects. Failing to
maintain effective financial and operational controls, as we grow, such as appropriate loan underwriting procedures, adequate allowances for credit losses and compliance with regulatory requirements could have a negative effect on our financial
condition and operations, such as increased credit losses, reduced earnings and potential regulatory restrictions on growth.
Entering new market areas, new lines of business, or new products and services may subject us to additional risks. A failure to successfully manage these risks may
have a material adverse effect on our business. As part of our growth strategy, we have implemented and may continue to enter new market areas and new lines of business. We have expanded into the East Bay area of San Francisco and Napa,
which are relatively new market areas for us. We introduced commercial equipment leasing as a new product line a few years ago. There are risks and uncertainties associated with these efforts, particularly in instances where such product lines are
not fully mature. In developing and marketing new lines of business and/or new products and services and/or shifting the focus of our asset mix and/or expanding into new markets, we may invest significant time and resources. Initial timetables may
not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives in these markets and shifting market preferences, may also affect the successful
implementation. Failure to successfully manage these risks could have an adverse effect on our business, financial condition and results of operations.
Risks Related to Our Personnel
We may have difficulty attracting additional necessary personnel, which may divert resources and limit our ability to successfully expand our operations. Our
business plan includes, and is dependent upon, our hiring and retaining highly qualified and motivated associates at every level. We have experienced, and expect to continue to experience, substantial competition in identifying, hiring and retaining
top-quality associates due to low unemployment rate and new financial institutions entering our markets. If we are unable to hire and retain qualified personnel, we may be unable to successfully execute our business strategy and manage our growth.
The unexpected loss of key officers would materially and adversely affect our ability to execute our business strategy, and diminish our future prospects. Our
success to date and our prospects for success in the future depend substantially on our senior management team. The loss of key members of our senior management team could materially and adversely affect our ability to successfully implement our
business plan and, as a result, our future prospects. The loss of senior management without qualified successors who can execute our strategy would also have an adverse impact on us.
As a community bank, our ability to maintain our positive reputation is critical to the success of our business. The failure to maintain that reputation may
materially and adversely affect our financial performance. Our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part,
by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our clients. If our reputation is negatively affected by the actions of our employees or
otherwise, our business and, therefore, our operating results may be materially and adversely affected.
Risks Related to Our Financial Practices
Our allowance for credit losses may not be adequate to cover actual losses. A significant source of risk arises from the possibility that we could sustain
losses due to loan defaults and non-performance on loans. We maintain an allowance for credit losses in accordance with U.S. generally accepted accounting principles to provide for such defaults and other non-performance. The determination of the
appropriate level of this allowance is an inherently difficult process and is based on numerous assumptions. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which
may be beyond our control. In addition, our underwriting policies, adherence to credit monitoring processes, and risk management systems and controls may not prevent unexpected losses. Our allowance for credit losses may not be adequate to cover
actual credit losses. Moreover, any increase in our allowance for credit losses will adversely affect our earnings.
In June 2016, the FASB issued Accounting Standards Update 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 became effective January 1, 2020, and substantially changed the
accounting for credit losses on loans and other financial assets held by banks, financial institutions and other organizations. The standard replaced existing incurred loss impairment guidance and established a single allowance framework for
financial assets carried at amortized cost. Upon adoption of ASU 2016-13, companies must recognize credit losses on these assets equal to management’s estimate of credit losses over the full remaining expected life. Companies must consider all
relevant information when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts. We adopted and implemented this accounting standard fully effective January 1, 2022. The
adoption of ASU 2016-13 did not have a material negative effect on the level of allowance for credit loss held by us or on our reported earnings. The potential negative effect that the adoption of this new accounting pronouncement may have on future
lending by us or the banking industry in general is still not well known. We believe that our allowance for credit losses as of December 31, 2021 was adequate to absorb credit losses inherent in our loan portfolio; however, we cannot assure that
such levels will be sufficient to cover actual or future losses.
Our financial and accounting estimates and risk management framework rely on analytical forecasting and models. The processes we use to estimate our inherent
credit losses and to measure the fair value of financial instruments, as well as the processes used to estimate the effects of changing interest rates and other market measures on our financial condition and operations, depend upon the use of
analytical and forecasting models. Some of our tools and metrics for managing risk are based upon our use of observed historical market behavior. We rely on quantitative models to measure risks and to estimate certain financial values. Models may be
used in such processes as determining the pricing of various products, grading loans and extending credit, measuring interest rate and other market risks, predicting losses, assessing capital adequacy and calculating regulatory capital levels, as
well as estimating the value of financial instruments and balance sheet items.
Poorly designed or implemented models present the risk that our business decisions based on information incorporating such models will be adversely affected due to the inadequacy of that information. Moreover, our
models may fail to predict future risk exposures if the information used in the model is incorrect, obsolete or not sufficiently comparable to actual events as they occur.
We seek to incorporate appropriate historical data in our models, but the range of market values and behaviors reflected in any period of historical data is not at all times predictive of future developments in any
particular period and the period of data we incorporate into our models may prove to be inappropriate for the period being modeled. In such case, our ability to manage risk would be limited and our risk exposure and losses could be significantly
greater than our models indicated. This could harm our reputation as well as our revenues and profits. Finally, information we provide to our regulators based on poorly designed or implemented models could also be inaccurate or misleading. Some of
the decisions that our regulators make, including those related to capital distributions to our stockholders, could be affected adversely due to their perception that the quality of the models used to generate the relevant information is
insufficient.
Impairment of investment securities could require charges to earnings, which would negatively affect our operations. We maintain a significant amount of our
assets in investment securities, and must periodically evaluate investment securities for impairment under previously adopted accounting guidance during 2021 or for current expected credit losses after the adoption of ASU 2016-13. We evaluate our
investment securities portfolio for other than temporary impairment as of each reporting date. At December 31, 2021, we had no investment securities that were other-than-temporarily impaired.
Changes in accounting standards could materially affect our financial statements. The Company’s consolidated financial statements are presented in accordance
with accounting principles generally accepted in the United States of America, called GAAP. The financial information contained within our consolidated financial statements is, to a significant extent, financial information that is based on
approximate measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or
relieving a liability. Other estimates that we use are fair value of our securities and expected useful lives of our depreciable assets. From time to time, the FASB and the SEC change the financial accounting and reporting standards that govern the
preparation of our financial statements or new interpretations of existing standards emerge. These changes can be difficult to predict and operationally complex to implement and can materially affect how we record and report our financial condition
and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, resulting in our restating prior period financial statements.
Risks Related to Our Access to Capital
We may be unable to, or choose not to, pay dividends on our common shares. We have consistently declared an annual cash dividend for over 86 years. Our
ability to continue to pay dividends depends on various factors. FMCB is a legal entity separate and distinct from the Bank, and does not conduct stand-alone operations, which means that the Bank must first pay dividend(s) to the Company. The FDIC,
the DFPI and California corporate and banking laws may, under certain circumstances, prohibit the Bank’s payment of dividends to FMCB. FRB policy requires bank holding companies to pay cash dividends on common shares only out of net income available
over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. FMCB’s Board of Directors may determine that, even though funds are available for dividend payments,
retaining the funds for other internal uses, such as expansion of our operations, is necessary or appropriate in light of our business plan and objectives. A failure to pay dividends may negatively affect your investment.
The price of our common shares may fluctuate significantly and our stock may have low trading volumes, which may make it difficult for you to resell common shares
owned by you at times or prices you find attractive. The stock market and, in particular, the market for financial institution stocks, has experienced significant volatility. The markets may produce downward pressure on stock prices for
certain issuers without regard to those issuers’ underlying financial strength. As a result, the trading volume in our common shares may fluctuate and cause significant price variations to occur. This may make it difficult for you to resell common
shares owned by you at times or at prices you find attractive.
The low trading volume in our common shares on the OTCQX means that our shares may have less liquidity than other companies, who shares are more broadly traded. We cannot ensure that the volume of trading in our
common shares or the price of our common shares will be maintained or will increase in the future. Our stock price can fluctuate significantly in response to a variety of factors discussed in this section, including, among other things: actual or
anticipated variations in quarterly results of operations; operating and stock price performance of other companies that investors deem comparable to our Company; news reports relating to trends, concerns and other issues in the financial services
industry; available investment liquidity in our market area since our stock is not listed on any exchange; and perceptions in the marketplace regarding our Company and/or its competitors.
If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable. We may need to raise
additional capital in the future to support our continued growth and to maintain our capital levels. Our ability to raise capital through the sale of additional securities will depend primarily upon our financial condition and the condition of
financial markets at that time. Accordingly, we may not be able to obtain additional capital in the amounts or on terms satisfactory to us. Our growth may be constrained if we are unable to generate or raise additional capital as needed.
Our funding sources may prove insufficient to provide liquidity, replace deposits and support our future growth. We rely on customer deposits, advances from
the Federal Home Loan Bank of San Francisco (“FHLB”), lines of credit at other financial institutions and the Federal Reserve Bank to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired,
we may not be able to replace such funds in the future if our financial condition, the financial condition of the FHLB or market conditions were to change. Our financial flexibility will be severely constrained if we are unable to maintain our access
to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase
proportionately to cover our costs. In this case, our profitability would be adversely affected. FHLB borrowings and other current sources of liquidity may not be available or, if available, not sufficient to provide adequate funding for operations.
Furthermore, our own actions could result in a loss of adequate funding. For example, our borrowing capacity at the FHLB could be reduced if we are deemed to have poor documentation or processes. Accordingly, we may be required to seek additional
higher-cost debt in the future to achieve our long-term business objectives. Additional borrowings, if sought, may not be available to us or, if available, may not be available on favorable terms. If additional financing sources are unavailable or
are not available on reasonable terms, our growth and future prospects could be adversely affected.
We may be adversely affected by the lack of soundness of other financial institutions or financial market utilities. Our ability to engage in routine funding
and other transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial institutions are interrelated because of trading, clearing, counterparty or other relationships. Defaults by, or
even rumors or questions about, one or more financial institutions or financial market utilities, or the financial services industry generally, may lead to market-wide liquidity problems and losses of client, creditor and counterparty confidence and
could lead to losses or defaults by us or by other financial institutions.
Risks Related to Cyber-security and Information Technology
Cyber-attacks or other security breaches could have a material adverse effect on our business. In the normal course of business, we collect, process, and
retain sensitive and confidential information regarding our clients. We also have arrangements in place with other third parties through which we share and receive information about their clients who are or may become our clients. Although we devote
significant resources and management focus to ensuring the integrity of our systems through information security and business continuity programs, our facilities and systems, and those of third-party service providers, are vulnerable to external or
internal security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming or human errors or other similar events.
Information security risks for financial institutions have increased recently in part because of new technologies, the use of the Internet and telecommunications technologies (including mobile devices) to conduct
financial and other business transactions, particularly during the pendency of the COVID-19 pandemic, and the increased sophistication and activities of organized crime, perpetrators of fraud, hackers, terrorists and others. In addition to
cyber-attacks or other security breaches involving the theft of sensitive and confidential information, hackers recently have engaged in attacks against large financial institutions, particularly denial of service attacks that are designed to disrupt
key business services, such as client-facing websites. We are not able to anticipate or implement effective preventive measures against all potential security breaches, because the techniques used change frequently and because attacks can originate
from a wide variety of sources. We employ detection and response mechanisms designed to contain and mitigate security incidents, but early detection may be thwarted by sophisticated attacks and malware designed to avoid detection.
We also face risks related to cyber-attacks and other security breaches in connection with credit and debit card transactions that typically involve the transmission of sensitive information regarding our clients
through various third parties, including merchant acquiring banks, payment processors, payment card networks and our core processors. Some of these parties have in the past been the target of security breaches and cyber-attacks, and because the
transactions involve third parties and environments such as the point of sale that we do not control or secure, future security breaches or cyber-attacks affecting any of these third parties could impact us through no fault of our own, and in some
cases we may have exposure and suffer losses for breaches or attacks relating to them. We also rely on numerous other third-party service providers to conduct other aspects of our business operations and face similar risks relating to them. While we
regularly conduct security assessments on these third parties, we cannot be sure that their information security protocols are sufficient at all times to withstand a cyber-attack or other security breach.
The access by unauthorized persons to, or the improper disclosure by us of, confidential information regarding our clients or our own proprietary information, software, methodologies, and business secrets could result
in significant legal and financial exposure, supervisory liability, damage to our reputation or a loss of confidence in the security of our systems, products and services, which could have a material adverse effect on our financial condition or
operations. Recently, there have been a number of well-publicized attacks or breaches affecting others in our industry that have heightened concern by consumers and have resulted in increased regulatory focus. Furthermore, cyber-attacks or other
breaches in the future, whether affecting others or us, could intensify consumer concern and regulatory focus and result in reduced use of our cards and increased costs, all of which could have a material adverse effect on our business. To the extent
we are involved in any future cyber-attacks or other breaches, our brand and reputation could be affected, and this could have a material adverse effect on our financial condition and operations. If we experience a cyber-attack, our insurance
coverage may not cover all losses, and furthermore, we may experience a loss of reputation.
We rely on our information technology and telecommunications systems and third-party servicers, and the failure of these systems could adversely affect our business.
Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. We rely on these systems to process new and renewal loans, provide client
service, facilitate collections and share data across our organization. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations.
Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience
interruptions. If sustained or repeated, a system failure or service denial could result in a deterioration of our ability to process new and renewal loans and provide client service or compromise our ability to collect loan payments in a timely
manner. Our ability to adopt new information technology and technological products needed to meet our clients’ banking needs may be limited if our third-party servicers are slow to adopt or choose not to adopt such new technology and products. Such
a failure to provide this technology and products to our clients could result in a loss of clients, which would negatively affect our financial condition and operations.
Other Operational Risks
Our risk management framework may not be effective in mitigating risks and losses to us. Our risk management framework is comprised of various processes,
systems and strategies, and is designed to manage the types of risk to which we are subject, including, among others, credit, market, liquidity, interest rate and compliance. Our framework also includes financial or other modeling methodologies that
involve management assumptions and judgment. Our risk management framework may not be effective under all circumstances and may not adequately mitigate any risk of loss to us. If our framework is not effective, we could suffer unexpected losses and
our financial condition, operations or business prospects could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.
We are subject to certain operating risks, related to client or employee fraud, which could harm our reputation and business. Employee error, or employee or
client misconduct, could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our
clients or improper use of confidential information. It is not always possible to prevent employee error and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee error could also
subject us to financial claims for negligence. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured, excess insurance coverage is denied or not available, it could have a material adverse effect
on our financial condition and operations.
We depend on the accuracy and completeness of information about clients and counterparties. In deciding whether to extend credit or enter into other
transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information. We also may rely on representations of clients and
counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. In deciding whether to extend credit, we may rely upon our clients’ representations that their
financial statements conform to U.S. generally accepted accounting principles, or GAAP, and present fairly, in all material respects, the financial condition, operations and cash flows of the client. We also may rely on client representations and
certifications, or other auditors’ reports, with respect to the business and financial condition of our clients. Our financial condition, operations, financial reporting and reputation could be negatively affected if we rely on materially misleading,
false, inaccurate or fraudulent information provided by or about clients and counterparties.
Catastrophic events including, but not limited to, hurricanes, tornadoes, earthquakes, fires, floods, prolonged drought, and pandemics may adversely affect the general economy,
financial and capital markets, specific industries, and the Bank. The Bank has significant operations and a significant customer base in regions where natural and other disasters may occur. These regions are known for being vulnerable to
natural disasters and other risks, such as earthquakes, fires, floods, and prolonged drought. These types of natural catastrophic events at times have disrupted the local economy, the Bank’s business and clients, and could pose physical risks to the
Bank’s property. In addition, catastrophic events, such as natural disasters or global pandemics, occurring in other regions of the world may have an impact on the Bank’s clients and in turn on the Bank. Although we have business continuity and
disaster recovery programs in place, a significant catastrophic event could materially adversely affect the Bank’s operating results.
The physical effects of climate change, as well as governmental and societal responses to climate change could materially adversely affect our operations, businesses
and customers. There is increasing concern over the risks of climate change and related environmental sustainability matters. The physical effects of climate change include rising average global temperatures, rising sea levels and an
increase in the frequency and severity of extreme weather events and natural disasters, including droughts, wildfires, floods, hurricanes and tornados. Most of the Company’s operations and customers are located in California, which could be adversely
impacted by severe weather events. Agriculture is especially dependent on climate, and climate impacts could include shifting average growing conditions, increased climate and weather variability, decreases in available water sources, and more
uncertainty in predicting climate and weather conditions, any or all of which could have a particularly adverse impact on our agricultural customers.
Additional legislation and regulatory requirements and changes in consumer preferences, including those associated with the transition to a low-carbon economy, could increase expenses of, or otherwise adversely affect,
the Company, its businesses or its customers. Our customers and we may face cost increases, asset value reductions, operating process changes, reduced availability of insurance, and the like, because of governmental actions or societal responses to
climate change.
New and/or more stringent regulatory requirements relating to climate change or environmental sustainability could materially affect the Company’s results of operations by increasing our compliance costs. Regulatory
changes or market shifts to low-carbon products could also affect the creditworthiness of some of our customers or reduce the value of assets securing loans, which may require the Company to adjust our lending portfolios and business strategies.
Risks Related to Our Regulatory Environment
We are subject to regulation, which increases the cost and expense of regulatory compliance, and may restrict our growth and our ability to acquire other financial
institutions. Supervision, regulation, and examination of the Company and the Bank by the bank regulatory agencies are intended primarily for the protection of consumers, bank clients and the Deposit Insurance Fund of the FDIC, rather than
holders of our common shares. As a bank holding company under federal law, we are subject to regulation under the BHCA, and the examination and reporting requirements of the FRB. In addition to supervising and examining us, the FRB, through its
adoption of regulations implementing the BHCA, places certain restrictions on the permissible activities for bank holding companies. Changes in the number or scope of permissible activities could have an adverse effect on our ability to realize our
strategic goals. As a California state-chartered bank that is not a member of the Federal Reserve System, the Bank is separately subject to regulation by both the FDIC and the DFPI. The FDIC and DFPI regulate numerous aspects of the Bank’s
operations, including adequate capital and financial condition, permissible types and amounts of extensions of credit and investments, permissible non-banking activities and restrictions on dividend payments. We may be required to invest significant
management attention and resources to evaluate and make any changes necessary to comply with applicable laws and regulations. This allocation of resources, as well as any failure to comply with applicable requirements, may negatively affect our
operations and financial condition.
Banking agencies periodically conduct examinations of our business, including compliance with laws and regulations, and our failure to comply with any regulatory
actions to which we become subject because such examinations could materially and adversely affect us. The DFPI, the FDIC, and the FRB periodically conduct examinations of our business, including compliance with laws and regulations.
Accommodating such examinations may require management to reallocate resources that would otherwise be used in the day-to-day operation of other aspects of our business. If, as a result of an examination, the DFPI or a federal banking agency were to
determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of our operations had become unsatisfactory, or that we or our management were in violation of any law or regulation,
it may take a number of different remedial actions as it deems appropriate. These actions could include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or
practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to assess civil monetary penalties against us, our officers or directors, to remove officers and directors and,
if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to clients, to terminate our deposit insurance. FDIC deposit insurance is critical to the continued operation of the Bank. If we become subject to such
regulatory actions, our business operations could be materially and adversely affected.
Changes in laws, government regulation and monetary policy may have a material adverse effect on our operations. Financial institutions have been the subject
of significant legislative and regulatory changes (including the continuing enactment and potential amendment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010) and may be the subject of further significant legislation or
regulation in the future, none of which is within our control. This may result in repeals of or amendments to, existing laws, treaties, regulations, guidance, reporting, recordkeeping requirements, and other government policies. Significant new laws
or regulations or changes in, or repeals of, existing laws or regulations, including those with respect to federal and state taxation, may cause our results of operations to differ materially. In addition, the costs and burden of compliance could
adversely affect our ability to operate profitably. Further, federal monetary policy significantly affects the Bank’s credit conditions, as well as the Bank’s clients, particularly as implemented through the FRB, primarily through open market
operations in U.S. government securities, the discount rate for bank borrowings and reserve requirements. A material change in any of these conditions could have a material impact on us, the Bank and the Bank’s clients, and therefore on our financial
condition and operations.
New and future rulemaking by the CFPB and other regulators, as well as enforcement of existing consumer protection laws, may have a material effect on our operations
and operating costs. The CFPB has the authority to implement and enforce a variety of existing federal consumer protection statutes and to issue new regulations. However, with respect to institutions of our size, it does not have primary
examination and enforcement authority. The authority to examine depository institutions with $10 billion or less in assets, such as the Bank, for compliance with federal consumer laws remains largely with our primary federal regulator, the FDIC.
However, the CFPB may participate in examinations of smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. In some cases, regulators such as the Federal Trade
Commission, or FTC, and the Department of Justice also retain certain rulemaking or enforcement authority, and we remain subject to certain state consumer protection laws. The CFPB has placed significant emphasis on consumer complaint management and
has established a public consumer complaint database to encourage consumers to file complaints they may have against financial institutions. We are expected to monitor and respond to these complaints, including those that we deem frivolous, and doing
so may require management to reallocate resources away from more profitable endeavors.
The CFPB has adopted a number of significant rules that affect nearly every aspect of the lifecycle of a residential mortgage. These rules implement the Dodd-Frank Act amendments to the Equal Credit Opportunity Act,
the Truth in Lending Act and the Real Estate Settlement Procedures Act. The rules require banks to, among other things: (i) develop and implement procedures to ensure compliance with a new “reasonable ability to repay” test and identify whether a
loan meets a new definition for a “qualified mortgage”; (ii) implement new or revised disclosures, policies and procedures for servicing mortgages including, but not limited to, early intervention with delinquent clients and specific loss mitigation
procedures for loans secured by a client’s principal residence; (iii) comply with additional restrictions on mortgage loan originator compensation; and (iv) comply with new disclosure requirements and standards for appraisals and escrow accounts
maintained for “higher priced mortgage loans.” These rules create operational and strategic challenges for us, as we are both a mortgage originator and a servicer.
We are subject to stringent capital requirements.
Pursuant to the Dodd-Frank Act, the federal banking agencies adopted final rules, or the U.S. Basel III Capital Rules, to update their general risk-based capital and leverage capital requirements to incorporate
agreements reflected in the Third Basel Accord adopted by the Basel Committee on Banking Supervision, or Basel III Capital Standards, as well as the requirements of the Dodd-Frank Act. The U.S. Basel III Capital Rules are described in more detail in
“Supervision and Regulation — Capital Standards” in this report on Form 10-K
The failure to meet the established capital requirements could result in one or more of our regulators placing limitations or conditions on our activities or restricting the commencement of new activities. Such
failure could subject us to a variety of enforcement remedies available to the federal regulatory authorities, including limiting our ability to pay dividends, issuing a directive to increase our capital and terminating our FDIC deposit insurance.
FDIC deposit insurance is critical to the continued operation of the Bank. Our failure to meet applicable regulatory capital requirements, or to maintain appropriate capital levels in general, could affect client and investor confidence, our ability
to grow, our costs of funds and FDIC insurance costs, our ability to pay dividends on common shares, our ability to make acquisitions, and our operations and financial condition, generally.
We may be required to contribute capital or assets to the Bank that could otherwise be invested or deployed more profitably elsewhere. Federal law and
regulatory policy impose a number of obligations on bank holding companies designed to reduce potential loss exposure to the clients of insured depository subsidiaries and to the FDIC’s DIF. For example, a bank holding company is required to serve as
a source of financial strength to its FDIC-insured depository subsidiaries and to commit financial resources to support such institutions where it might not do so otherwise. These situations include guaranteeing the compliance of an
“undercapitalized” bank with its obligations under a capital restoration plan.
A capital injection into the Bank may be required at times when we do not have the resources to provide it at the holding company level; therefore, we may be required to issue common shares or debt to obtain the
required capital. Issuing additional common shares would dilute our current stockholders’ percentage of ownership and could cause the price of our common shares to decline. Any debt would be entitled to a priority of payment over the claims of the
Company’s general unsecured creditors or equity holdings. Thus, any Company borrowing to make the required capital injection may be expensive and adversely affect our cash flows, financial condition, operations, and business prospects.
We face a risk of non-compliance and enforcement actions with respect to the Bank Secrecy Act (“BSA”) and other anti-money laundering statutes and regulations. Like
all U.S. financial institutions, we are subject to monitoring requirements under federal law, including anti-money laundering, or AML, and BSA matters. Since September 11, 2001, banking regulators have intensified their focus on AML and BSA
compliance requirements, particularly the AML provisions of the USA PATRIOT Act. There is also increased scrutiny of compliance with the rules enforced by the U.S. Treasury Department’s OFAC, which involve sanctions for dealing with certain persons
or countries. While the Bank has adopted policies, procedures and controls to comply with the BSA, other AML statutes and regulations and OFAC regulations, this aggressive supervision and examination and increased likelihood of enforcement actions
may increase our operating costs, which could negatively affect our operations and reputation.
We are subject to federal and state fair lending laws, and failure to comply with these laws could lead to material penalties. Federal and state fair lending
laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose non-discrimination lending requirements on financial institutions. The FDIC, the Department of Justice, the CFPB and other federal and state agencies are
responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the
fair lending laws and regulations could adversely impact our rating under the CRA, and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger
and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, financial condition and operations.
Regulations relating to privacy, information security and data protection could increase our costs, affect or limit how we collect and use personal information and
adversely affect our business opportunities. We are subject to various privacy, information security and data protection laws, including requirements concerning security breach notification, and these laws could negatively affect us.
Federal law imposes requirements for the safeguarding of certain client information. Various state and federal banking regulators and states have also enacted data security breach notification requirements with varying levels of individual,
consumer, regulatory or law enforcement notification in certain circumstances in the event of a security breach. Moreover, legislators and regulators in the United States are increasingly adopting or revising privacy, information security and data
protection laws that potentially could have a significant impact on our current and planned privacy, data protection and information security-related practices, our collection, use, sharing, retention and safeguarding of consumer or employee
information, and some of our current or planned business activities. This could also increase our costs of compliance and business operations and could reduce income from certain business initiatives.
Compliance with current or future privacy, data protection and information security laws (including those regarding security breach notification) affecting client or employee data to which we are subject could result
in higher compliance and technology costs and could restrict our ability to provide certain products and services, which could have a material adverse effect on our financial conditions or operations.
Our failure to comply with privacy, data protection and information security laws could result in potentially significant regulatory or governmental investigations or actions, litigation, fines, sanctions and damage to
our reputation, which could have a material adverse effect on our financial condition or operations.
Possible changes in the U.S. tax laws could adversely affect our business and result of operations in a variety of ways.
The Tax Cuts and Jobs Act (“TCJA”), signed into law on December 22, 2017, enacted sweeping changes to the U.S. federal tax laws generally, effective January 1, 2018. The TCJA reduced the corporate tax rate to 21% from
35%, which resulted in a net reduction in our annual income tax expense and which benefitted many of our corporate and other small business borrowers. However, our ability to utilize tax credits, such as those arising from low-income housing and
alternative energy investments, was constrained by the lower tax rate. There are presently pending in the U.S. Congress measures which would substantially increase the U.S. corporate tax rate. If enacted, such measures could adversely affect our
profitability and that of our customers.