General
First Northern Community Bancorp (the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (“BHCA”). Its legal headquarters and principal
administrative offices are located at 195 N. First Street, Dixon, CA 95620 and its telephone number is (707) 678-3041. The Company provides a full range of community banking services to individual and corporate customers throughout the California
Counties of Solano, Yolo, Placer, and Sacramento as well as portions of El Dorado and Contra Costa Counties through its wholly-owned subsidiary bank, First Northern Bank of Dixon (“First Northern” or the “Bank”). The Company’s operating policy
since inception has emphasized the banking needs of individuals and small- to medium-sized businesses. In addition, the Bank owns 100% of the capital stock of Yolano Realty Corporation, a subsidiary created for the purpose of managing selected
other real estate owned properties.
The Bank was established in 1910 under a California state charter as Northern Solano Bank, and opened for business on February 1st of that year. On January 2, 1912, the First National Bank of
Dixon was established under a federal charter, and until 1955, the two entities operated side by side under the same roof and with the same management. In an effort to increase efficiency of operation, reduce operating expense, and improve
lending capacity, the two banks were consolidated on April 8, 1955, with the First National Bank of Dixon as the surviving entity. On January 1, 1980, the Bank’s federal charter was relinquished in favor of a California state charter, and the
Bank’s name was changed to First Northern Bank of Dixon.
In April of 2000, the shareholders of First Northern approved a corporate reorganization, which provided for the creation of the bank holding company. This reorganization, effected May 19,
2000, enabled the Company to better compete and grow in its competitive and rapidly changing marketplace.
The Bank has eleven full-service branches located in the cities of Auburn, Davis, Dixon, Fairfield, Rancho Cordova, Roseville, Sacramento, Vacaville, West Sacramento, Winters and Woodland. The
Bank has one satellite banking office inside a retirement community in the city of Davis and a residential mortgage loan office in Davis. The Bank engages financial advisors, through Raymond James Financial Services, Inc., who offer non-FDIC
insured investment and brokerage services throughout the region from offices strategically located in West Sacramento, Davis and Auburn. The Bank also has a commercial loan office in the Contra Costa County city of Walnut Creek that serves the
East Bay Area’s small- to medium-sized business lending needs. The Bank’s operations center is located in Dixon and provides back-office support including information services, central operations, and the central loan department. In 2019, the
Bank opened an additional administrative office in Sacramento.
The Bank is in the commercial banking business and generates most of its revenue by providing a wide range of products and services to small- and medium-sized businesses and individuals
including accepting demand, interest bearing transaction, savings, and time deposits, and making commercial, consumer, and real estate related loans. It also issues cashier’s checks, rents safe deposit boxes, and provides other customary banking
services.
First Northern offers a broad range of alternative investment products, fiduciary and other financial services through Raymond James Financial Services, Inc. First Northern also offers
equipment leasing, credit cards, merchant card processing, payroll services, and limited international banking services through third parties.
The Bank’s principal source of revenue comes from interest income. Interest income is primarily derived from interest and fees on loans and leases, interest on investments, and due from banks
interest bearing accounts. For the year ended December 31, 2021, these sources comprised approximately 83%, 15%, and 2%, respectively, of the Company’s interest income.
The Bank is a member of the Federal Deposit Insurance Corporation (“FDIC”) and all deposit accounts are insured by the FDIC to the maximum amount permitted by law, currently $250,000 per
depositor. Most of the Bank’s deposits are attracted from the market of northern and central Solano County, southern and central Yolo County and Placer County. The Bank’s deposits are not received from a single depositor or group of affiliated
depositors, the loss of any one which would have a materially adverse impact on the business of the Bank. A material portion of the Bank’s deposits are not concentrated within a single industry group of related industries.
As of December 31, 2021, the Company had consolidated assets of approximately $1.90 billion, liabilities of approximately $1.75 billion and stockholders’ equity of approximately $150.9 million.
The Company and its subsidiaries employed 190 full-time-equivalent employees as of December 31, 2021. The Company and the Bank consider their relationship with their employees to be good and have not experienced any interruptions of operations
due to labor disagreements.
Available Information
The Company makes available free of charge on its website, www.thatsmybank.com, its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and
amendments to those reports, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. These filings are also accessible on the SEC’s website at www.sec.gov. The
information found on the Company’s website shall not be deemed incorporated by reference by any general statement incorporating by reference this report into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934
and shall not otherwise be deemed filed under such Acts.
The Effect of Government Policy on Banking
The earnings and growth of the Bank are affected not only by local market area factors and general economic conditions, but also by government monetary and fiscal policies. For example, the
Board of Governors of the Federal Reserve System (“FRB”) influences the supply of money through its open market operations in U.S. Government securities, adjustments to the discount rates applicable to borrowings by depository institutions and
others and establishment of reserve requirements against both member and non-member financial institutions’ deposits. Such actions significantly affect the overall growth and distribution of loans, investments, and deposits and also affect
interest rates charged on loans and paid on deposits. The nature and impact of future changes in such policies on the business and earnings of the Company cannot be predicted. Additionally, state and federal tax policies can impact banking
organizations.
Because of the extensive regulation of commercial banking activities in the United States, the business of the Company is particularly susceptible to being affected by the enactment of federal
and state legislation which may have the effect of increasing or decreasing the cost of doing business, modifying permissible activities or enhancing the competitive position of other financial institutions. Any change in applicable laws,
regulations, or policies may have a material adverse effect on the business, financial condition, or results of operations, or prospects of the Company.
In May 2018, the President signed into law the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”) which amended various provisions of the Dodd-Frank Act as well as other federal banking
statutes, and generally authorized the FRB to tailor regulation to better reflect the character of the different banking firms that the FRB supervises. In August 2018, the FRB began implementing the EGRRCPA with several interim final rules
which, among other things, revised the FRB’s Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (the “policy statement”) to raise the consolidated assets threshold from $1 billion to $3 billion, allowing the Company
to qualify under the policy statement. This policy statement applies to bank holding companies with pro forma consolidated assets of less than $3 billion that (i) are not engaged in significant nonbanking activities either directly or through a
nonbank subsidiary; (ii) do not conduct significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; and (iii) do not have a material amount of debt or
equity securities outstanding (other than trust preferred securities) that are registered with the SEC. This policy statement permits qualifying bank holding companies, such as the Company, to operate with higher levels of debt, facilitating the
ability of community banks to issue debt and raise capital. Qualifying bank holding companies, such as the Company, also are permitted to be examined by a Federal banking agency every 18 months (as opposed to every 12 months) and are eligible to
use shorter call report forms. Whether and to what extent the EGRRCPA or new legislation will result in additional regulatory initiatives and policies, or modifications of existing regulations and policies, which may impact our business, cannot
be predicted at this time.
Supervision and Regulation of Bank Holding Companies
The Company is a bank holding company subject to the Bank Holding Company Act of 1956, as amended (“BHCA”). The Company reports to, registers with, and is subject to supervision and
examination by, the FRB. The FRB also has the authority to examine the Company’s subsidiaries. The costs of any examination by the FRB are payable by the Company.
The FRB has significant supervisory, regulatory and enforcement authority over the Company and its affiliates. The FRB requires the Company to maintain certain levels of capital. See “Capital
Standards” below for more information. The FRB also has the authority to take enforcement action against any bank holding company that commits any unsafe or unsound practice, or violates certain laws, regulations, or conditions imposed in
writing by the FRB. See “Prompt Corrective Action and Other Enforcement Mechanisms” below for more information. Such enforcement powers include the power to assess civil money penalties against any bank holding company violating any provision
of the BHCA or any regulation or order of the FRB under the BHCA. Knowing violations of the BHCA or regulations or orders of the FRB can also result in criminal penalties for the company and any individuals participating in such conduct. Under
long-standing FRB policy and provisions of the Dodd-Frank Act, bank holding companies are required to act as a source of financial and managerial strength to their subsidiary banks, and to commit resources to support their subsidiary banks. This
support may be required at times when a bank holding company may not have the resources to provide such support, or may not be inclined to provide such support under the then-existing circumstances.
Under the BHCA, a company generally must obtain the prior approval of the FRB before it exercises a controlling influence over a bank, or acquires, directly or indirectly, more than 5% of the
voting shares or substantially all of the assets of any bank or bank holding company. Thus, the Company is required to obtain the prior approval of the FRB before it acquires, merges, or consolidates with any bank or bank holding company. Any
company seeking to acquire, merge, or consolidate with the Company also would be required to obtain the prior approval of the FRB.
The Company is generally prohibited under the BHCA from acquiring ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from
engaging directly or indirectly in activities other than banking, managing banks, or providing services to affiliates of the holding company. However, a bank holding company, with the approval of the FRB, may engage, or acquire the voting shares
of companies engaged, in activities that the FRB has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. A bank holding company must demonstrate that the benefits to the public of
the proposed activity will outweigh the possible adverse effects associated with such activity.
The FRB generally prohibits a bank holding company from declaring or paying a cash dividend which would impose undue pressure on the capital of subsidiary banks or would be funded only through
borrowing or other arrangements that might adversely affect a bank holding company’s financial position. The FRB’s policy is that a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net
income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality, and overall financial condition. The Company is also subject to restrictions relating to
the payment of dividends under California corporate law. See “Restrictions on Dividends and Other Distributions” below for additional restrictions on the ability of the Company and the Bank to pay dividends.
Supervision and Regulation of the Bank
The Bank is subject to regulation, supervision and regular examination by the Financial Institutions Division of the California Department of Financial Protection and Innovation (“DFPI”) and
the FDIC. The regulations of these agencies affect most aspects of the Bank’s business and prescribe permissible types of loans and investments, the amount of required reserves, requirements for branch offices, the permissible scope of the
Bank’s activities and various other requirements. While the Bank is not a member of the FRB, it is directly subject to certain regulations of the FRB dealing with such matters as check clearing activities, establishment of banking reserves,
Truth-in-Lending (“Regulation Z”), and Equal Credit Opportunity (“Regulation B”). The Bank is also subject to regulations of (although not direct supervision and examination by) the Consumer Financial Protection Bureau (“CFPB”), which was
created by the Dodd-Frank Act. Among the CFPB’s responsibilities are implementing and enforcing federal consumer financial protection laws, reviewing the business practices of financial services providers for legal compliance, monitoring the
marketplace for transparency on behalf of consumers and receiving complaints and questions from consumers about consumer financial products and services. The Dodd-Frank Act added prohibitions on unfair, deceptive or abusive acts and practices to
the scope of consumer protection regulations overseen and enforced by the CFPB.
The banking industry is also subject to significantly increased regulatory controls and processes regarding the Bank Secrecy Act and anti-money laundering laws. Over the past decade, a number
of banks and bank holding companies announced the imposition of regulatory sanctions, including regulatory agreements and cease and desist orders and, in some cases, fines and penalties, by the bank regulators due to failures to comply with the
Bank Secrecy Act and other anti-money laundering legislation. In a number of these cases, the fines and penalties have been significant. Failure to comply with these additional requirements may also adversely affect the Bank’s ability to obtain
regulatory approvals for future initiatives requiring regulatory approval, including acquisitions.
Under California law, the Bank is subject to various restrictions on, and requirements regarding, its operations and administration including the maintenance of branch offices and automated
teller machines, capital and reserve requirements, deposits and borrowings, and investment and lending activities.
California law permits a state-chartered bank to invest in the stock and securities of other corporations, subject to a state-chartered bank receiving either general authorization or, depending
on the amount of the proposed investment, specific authorization from the DFPI. Federal banking laws, however, impose limitations on the activities and equity investments of state-chartered, federally insured banks. The FDIC rules on
investments prohibit a state bank from acquiring an equity investment of a type, or in an amount, not permissible for a national bank. FDIC rules also prohibit a state bank from engaging as a principal in any activity that is not permissible for
a national bank, unless the bank is adequately capitalized and the FDIC approves the activity after determining that such activity does not pose a significant risk to the deposit insurance fund. The FDIC rules on activities generally permit
subsidiaries of banks, without prior specific FDIC authorization, to engage in those activities that have been approved by the FRB for bank holding companies because such activities are so closely related to banking to be a proper incident
thereto. Other activities generally require specific FDIC prior approval, and the FDIC may impose additional restrictions on such activities on a case-by-case basis in approving applications to engage in otherwise impermissible activities.
The USA Patriot Act
Title III of the United and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) includes numerous provisions for
fighting international money laundering and blocking terrorism access to the U.S. financial system. The USA Patriot Act requires certain additional due diligence and record keeping practices, including, but not limited to, new customers,
correspondent and private banking accounts.
Part of the USA Patriot Act is the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”). Among its provisions, IMLAFATA requires each financial
institution to: (i) establish an anti-money laundering program; (ii) establish appropriate anti-money laundering policies, procedures, and controls; (iii) appoint a Bank Secrecy Act officer responsible for day-to-day compliance; and (iv) conduct
independent audits. In addition, IMLAFATA contains a provision encouraging cooperation among financial institutions, regulatory authorities, and law enforcement authorities with respect to individuals, entities and organizations engaged in, or
reasonably suspected of engaging in, terrorist acts or money laundering activities. IMLAFATA expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain
circumstances to requests for information from federal banking agencies within 120 hours. IMLAFATA also amends the BHCA and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution’s
anti-money laundering activities when reviewing an application under these Acts.
Pursuant to IMLAFATA, the Secretary of the Treasury, in consultation with the heads of other government agencies, has adopted measures applicable to banks, bank holding companies, and/or other
financial institutions. These measures include enhanced record keeping and reporting requirements for certain financial transactions that are of primary money laundering concern, due diligence requirements concerning the beneficial ownership of
certain types of accounts, and restrictions or prohibitions on certain types of accounts with foreign financial institutions.
Privacy Restrictions
The Gramm-Leach-Bliley Act (“GLBA”), which became law in 1999, in addition to the previous described changes in permissible non-banking activities permitted to banks, bank holding companies and
financial holding companies, also requires financial institutions in the U.S. to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, the GLBA
requires explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, prohibits disclosing such information except as provided in the banks’
policies and procedures and applicable law. These regulations also allow consumers to opt-out of the sharing of certain information between affiliates, and impose other requirements.
Certain state laws and regulations designed to protect the privacy and security of customer information also apply to us and our subsidiaries, including laws requiring notification to affected
individuals and regulators of data security breaches. For additional information, see “Information security breaches or other technological difficulties could adversely affect the Company” in Part I, Item 1A. “Risk Factors” in this report.
The Company believes that it complies with all provisions of GLBA and all implementing regulations, and that the Bank has developed appropriate policies and procedures to meet its
responsibilities in connection with the privacy provisions of GLBA.
California and other state legislatures have adopted privacy laws, including laws prohibiting sharing of customer information without the customer’s prior permission. These laws may make it
more difficult for the Company to share information with its marketing partners, reduce the effectiveness of marketing programs, and increase the cost of marketing programs.
In June 2018, the State of California enacted The California Consumer Privacy Act of 2018 (“CCPA”). This new law became effective on January 1, 2020, and provides consumers with expansive rights and controls over
their personal information which is obtained by or shared with “covered businesses”, which includes the Bank and most other banking institutions subject to California law. The CCPA gives consumers the right to
request disclosure of information collected about them and whether that information has been sold or shared with others, the right to request deletion of personal information subject to certain exceptions, the right to opt out of the sale of
the consumer’s personal information and the right not to be discriminated against because of choices regarding the consumer’s personal information. The CCPA provides for certain monetary penalties and for its enforcement by the California
Attorney General or consumers whose rights under the law are not observed. It also provides for damages as well as injunctive or declaratory relief if there has been unauthorized access, theft or disclosure of personal information due to
failure to implement reasonable security procedures. The CCPA contains several exemptions, including a provision to the effect that the CCPA does not apply where the information is collected, processed, sold or disclosed pursuant to the GLBA if
the GLBA is in conflict with the CCPA. The impact of the CCPA on the business of the Bank is yet to be determined, but it could result in increased operating expenses as well as additional exposure to the risk of litigation by or on behalf of
consumers.
In November 2020, California voters approved state-wide Proposition 24, also known as the California Privacy Rights and Enforcement Act of 2020 (the “CPREA”) which expanded and amended certain provisions of the
CCPA and created the California Privacy Protection Agency to enforce privacy rights for Californians and impose fines for violations of such rights. The CPREA requires businesses to not share a consumer’s personal information upon the consumer’s
request, provides consumers with an opt-out option for having their sensitive personal information used or disclosed for advertising or marketing, to obtain permission for collecting data on certain minors, and to correct a consumer’s inaccurate
information upon the consumer’s request. It also removed the ability of businesses to remedy violations before being penalized for violations and increased the penalties for such violations. Most of the provisions of the CPREA will take effect
in 2023 but some portions, such as the creation of the new state agency, went into effect immediately. The impact of these laws on the business of the Bank is yet to be determined, but they could result in increased operating expenses as well as
additional exposure to the risk of litigation by or on behalf of consumers.
Capital Standards
The FRB and the federal banking agencies have in place risk-based capital standards applicable to U.S. bank holding companies and banks. In July 2013, the FRB and the other U.S. federal banking agencies adopted
final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the guidelines published by the Basel Committee on Banking Supervision (“Basel Committee”) known as
the Basel III Global Regulatory Framework for Capital and Liquidity. The Basel Committee is a committee of banking supervisory authorities from major countries in the global financial system which formulates broad supervisory standards and
guidelines relating to financial institutions for implementation on a country-by-country basis. These rules adopted by the FRB and the other federal banking agencies (“the U.S. Basel III Capital Rules”) replaced the federal banking agencies’
general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules, in accordance with certain transition provisions.
Banks, such as First Northern, became subject to these rules on January 1, 2015. The rules implement higher minimum capital requirements, include a common equity Tier 1 capital requirement, and establish criteria
that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. The final rules provide for increased minimum capital ratios as follows: (a) a common equity Tier 1 capital ratio of
4.5%; (b) a Tier 1 capital ratio of 6%; (c) a total capital ratio of 8%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4%. Under these rules, in order to avoid certain limitations on capital distributions, including dividend
payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements (equal to 2.5% of
total risk-weighted assets). The capital conservation buffer is designed to absorb losses during periods of economic stress. First Northern believes that it was in compliance with these requirements at December 31, 2021.
Pursuant to the EGRRCPA, the FRB adopted a final rule, effective August 31, 2018, amending the Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (the “policy statement”) to increase
the consolidated assets threshold to qualify to utilize the provisions of the policy statement from $1 billion to $3 billion. Bank holding companies, such as the Company, are subject to capital adequacy requirements of the FRB; however, bank
holding companies which are subject to the policy statement are not subject to compliance with the regulatory capital requirements until they hold $3 billion or more in consolidated total assets. As a consequence, as of December 31, 2018, the
Company was not required to comply with the FRB’s regulatory capital requirements until such time that its consolidated total assets equal $3 billion or more or if the FRB determines that the Company is no longer deemed to be a small bank holding
company. However, if the Company had been subject to these regulatory capital requirements, it would have exceeded all regulatory requirements.
In August of 2020, the federal banking agencies adopted the final version of the community bank leverage ratio framework rule (the “CBLR”), implementing two interim final rules adopted in April of 2020. The rule
provides an optional, simplified measure of capital adequacy. Under the optional CBLR framework, the CBLR was 8.5% through calendar year 2021 and 9% thereafter. The rule is applicable to all non-advanced approaches FDIC-supervised institutions
with less than $10 billion in total consolidated assets. Banks not electing the CBLR framework will continue to be subject to the generally applicable risk-based capital rule. At the present time, the Company and the Bank do not intend to elect
to use the CBLR framework.
The following table presents the capital ratios for the Bank as of December 31, 2021 (calculated in accordance with the Basel III capital rules):
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The Bank
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2021
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Adequately
Capitalized
Ratio*
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Well
Capitalized
Ratio
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Capital
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Ratio
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Tier 1 Leverage Capital (to Average Assets)
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Common Equity Tier 1 Capital (to Risk-Weighted Assets)
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Tier 1 Capital (to Risk-Weighted Assets)
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Total Risk-Based Capital (to Risk-Weighted Assets)
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* Ratio for regulatory requirement excludes the capital conservation buffer of 2.50%.
The federal banking agencies must take into consideration concentrations of credit risk and risks from non-traditional activities, as well as an institution’s ability to manage those risks,
when determining the adequacy of an institution’s capital. This evaluation will be made as a part of the institution’s regular safety and soundness examination. The federal banking agencies must also consider interest rate risk (when the
interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in evaluating a Bank’s capital adequacy.
In January 2014, the Basel Committee issued an updated version of its leverage ratio and disclosure guidance (“Basel III leverage ratio”). The Basel Committee guidance continues to set a
minimum Basel III leverage ratio of 3%. The Basel Committee, in December 2017, adopted further revisions to the Basel III capital standards (“Basel IV”) which refined the definition of the leverage ratio “exposure measures” (the Basel III term
for non risk-weighted assets). Beginning January 1, 2023, the updates to the leverage ratio will be implemented.
Prompt Corrective Action and Other Enforcement Mechanisms
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository
institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. The law required each federal banking agency to promulgate regulations defining the following five categories in which an insured
depository institution will be placed, based on the level of its capital ratios: well capitalized, adequately capitalized, under-capitalized, significantly undercapitalized, and critically undercapitalized.
Under the prompt corrective action provisions of FDICIA, an insured depository institution generally will be classified in one of five capital categories ranging from “well-capitalized” to
“critically under-capitalized.”
An institution that, based upon its capital levels, is classified as “well capitalized,” “adequately capitalized” or “under-capitalized” may be treated as though it were in the next lower
capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital
category, an insured depository institution is subject to increased restrictions on its operations. Management believes that at December 31, 2021, the Company and the Bank exceeded the required ratios for classification as “well
capitalized.” Institutions that are “under-capitalized” or lower are subject to certain mandatory supervisory corrective actions. Failure to meet regulatory capital guidelines can result in a bank being required to raise additional capital. An
“under-capitalized” bank must develop a capital restoration plan and its parent holding company must generally guarantee compliance with the plan.
In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal regulators for
unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition
of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of
directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties and the enforcement of such actions through injunctions or restraining orders
based upon a judicial determination that the agency would be harmed if such equitable relief was not granted. Additionally, a holding company’s inability to serve as a source of strength to its subsidiary banking organizations could serve as a
further basis for a regulatory action against the holding company.
Safety and Soundness Standards
FDICIA also implemented certain specific restrictions on transactions and required federal banking regulators to adopt overall safety and soundness standards for depository institutions related
to internal control, loan underwriting and documentation and asset growth. Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, restricts the use of brokered deposits, limits the aggregate
extensions of credit by a depository institution to an executive officer, director, principal shareholder, or related interest, and reduces deposit insurance coverage for deposits offered by undercapitalized institutions for deposits by certain
employee benefits accounts.
The federal banking agencies may require an institution to submit to an acceptable compliance plan as well as have the flexibility to pursue other more appropriate or effective courses of
action given the specific circumstances and severity of an institution’s non-compliance with one or more standards.
Restrictions on Dividends and Other Distributions
The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory
restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and liquidity needs of the institution, as well as general business conditions. FDICIA prohibits insured depository institutions
from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions, including dividends, if, after such transaction, the institution would be undercapitalized.
The federal banking agencies also have authority to prohibit a depository institution from engaging in business practices, which are considered to be unsafe or unsound, possibly including
payment of dividends or other payments under certain circumstances even if such payments are not expressly prohibited by statute.
In addition to the restrictions imposed under federal law, banks chartered under California law generally may only pay cash dividends to the extent such payments do not exceed the lesser of
retained earnings of the bank’s net income for its last three fiscal years (less any distributions to shareholders during such period). In the event a bank desires to pay cash dividends in excess of such amount, the bank may pay a cash dividend
with the prior approval of the DFPI in an amount not exceeding the greatest of the bank’s retained earnings, the bank’s net income for its last fiscal year, or the bank’s net income for its current fiscal year.
Premiums for Deposit Insurance
The Bank is a member of the Deposit Insurance Fund (“DIF”) maintained by the FDIC. Through the DIF, the FDIC insures the deposits of the Bank up to prescribed limits for each
depositor. To maintain the DIF, member institutions are assessed an insurance premium based on their deposits and their institutional risk category. The FDIC determines an institution’s risk category by combining its supervisory ratings with
its financial ratios and other risk measures. The FDIC also has the authority to impose special assessments at any time it estimates that DIF reserves could fall to a level that would adversely affect public confidence. In September,
2020, the FDIC board of directors voted to adopt a restoration plan to restore the DIF reserve ratio to at least 1.35% within 8 years as required by the FDIC Act. This action was in response to the reserve ratio dropping to 1.30% primarily due
to the inflow of more than $1 trillion in estimated insured deposits in the first six month of 2020 resulting mainly from the pandemic, monetary policy actions, direct government assistance and an overall reduction in spending. No change was
made in the current schedule of assessment rates for all insured depository institutions. Deposit insurance assessments and assessment rates are subject to change by the FDIC and can be impacted by the overall
economy and the stability of the banking industry as a whole. There can be no assurance that the FDIC will not impose special assessments or increase annual assessments in the future. The ultimate effect on our business of legislative,
regulatory and economic developments on the DIF cannot be predicted with certainty.
Community Reinvestment Act and Fair Lending
The Bank is subject to certain fair lending requirements and reporting obligations involving its home mortgage lending operations and is also subject to the Community Reinvestment Act (“CRA”).
The CRA generally requires the federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of the Bank’s local communities, including low- and moderate-income neighborhoods. In addition to substantive
penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when reviewing other activities by the Bank, particularly
applications involving business expansion such as acquisitions or de novo branching.
On January 9, 2020, the FDIC and the Office of the Comptroller of the Currency (“OCC”) published a notice of proposed rule-making intended to modernize and strengthen the CRA
regulations to better achieve their underlying statutory purpose by clarifying which activities qualify for CRA credit, updating where activities count for CRA credit, creating a more transparent and objective method for measuring CRA
performance, and providing for more transparent, consistent, and timely CRA-related data collection, recordkeeping, and reporting. Later in 2020, the OCC adopted the new rule, which will apply to national banks, but the FDIC declined
to take action on its proposed rule, thus leaving in place the existing CRA regulatory framework. It cannot be predicted at this time as to whether the FDIC will eventually adopt such a proposed rule and, if it does so, what impact this rule may
have on FDIC-supervised institutions, such as the Bank.
Certain CFPB Rules
The Consumer Financial Protection Bureau (“CFPB”) has adopted an Ability-to-Repay rule that all newly originated residential mortgages must meet. The Ability-to-Repay rule establishes
guidelines that the lender must follow when reviewing an applicant’s income, obligations, assets, liabilities, and credit history and requires that the lender make a reasonable and good faith determination of an applicant’s ability to repay the
loan according to its terms. Lenders will be presumed to have met the Ability-to-Repay rule by originating loans that meet the criteria for “Qualified Mortgages”, which are set forth in detail in the rule. The mortgage loans originated by the
Bank with the intent to sell them to Freddie Mac meet the Qualified Mortgage criteria.
The CFPB has also adopted a rule on simplified and improved mortgage loan disclosures, otherwise known as Know Before You Owe. The rule provides that mortgage borrowers receive a loan estimate
three business days after application and a closing disclosure three days before closing. These forms replace disclosure forms previously provided to borrowers under other provisions of federal law. The rule provides for limitations on
application fees and increases in closing costs.
Any new regulatory requirements promulgated by the CFPB could have an adverse impact on our residential mortgage lending business as the industry adapts to the additional regulations. Our
business strategy, product offerings and profitability may change as the market adjusts to any additional regulations and as these requirements are interpreted by the regulators and courts.
Conservatorship and Receivership of Insured Depository Institutions
If any insured depository institution becomes insolvent and the FDIC is appointed its conservator or receiver, the FDIC may, under federal law, disaffirm or repudiate any contract to which such
institution is a party, if the FDIC determines that performance of the contract would be burdensome, and that disaffirmance or repudiation of the contract would promote the orderly administration of the institution’s affairs. Such disaffirmance
or repudiation would result in a claim by its holder against the receivership or conservatorship. The amount paid upon such claim would depend upon, among other factors, the amount of receivership assets available for the payment of such claim
and its priority relative to the priority of others. In addition, the FDIC as conservator or receiver may enforce most contracts entered into by the institution notwithstanding any provision providing for termination, default, acceleration, or
exercise of rights upon or solely by reason of insolvency of the institution, appointment of a conservator or receiver for the institution, or exercise of rights or powers by a conservator or receiver for the institution. The FDIC as conservator
or receiver also may transfer any asset or liability of the institution without obtaining any approval or consent of the institution’s shareholders or creditors.
The Dodd-Frank Act
The Dodd-Frank Act, enacted in 2010, has resulted in sweeping changes to the U.S. financial system and financial institutions, including us. Many of the law’s provisions have been implemented
by rules and regulations of the federal banking agencies. The law contains many provisions which have particular relevance to our business, including provisions that have resulted in adjustments to our FDIC deposit insurance premiums and that
resulted in increased capital and liquidity requirements, increased supervision, increased regulatory and compliance risks and costs and other operational costs and expenses, reduced fee-based revenues and restrictions on some aspects of our
operations, and increased interest expense on our demand deposits. In May 2018, the President signed into law the EGRRCPA, which amended various provisions of the Dodd-Frank Act as well as other federal banking statutes. See “The Effect of
Government Policy on Banking” above for additional information.
The environment in which financial institutions continue to operate since the U.S. financial crisis, including legislative and regulatory changes affecting capital, liquidity, supervision,
permissible activities, corporate governance and compensation, and changes in fiscal policy may have long-term effects on the business model and profitability of financial institutions that cannot now be foreseen.
Overdraft and Interchange Fees
The FRB’s Regulation E imposes restrictions on banks’ abilities to charge overdraft services and fees. The rule prohibits financial institutions from charging fees for paying overdrafts on ATM
and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. The Dodd-Frank Act, through a provision known as the Durbin Amendment, required the FRB to establish standards
for interchange fees that are “reasonable and proportional” to the cost of processing the debit card transaction and imposes other requirements on card networks. Under the rule, the maximum permissible interchange fee that a bank may receive is
the sum of $0.21 per transaction and five basis points multiplied by the value of the transaction, with an additional upward adjustment of no more than $0.01 per transaction if a bank develops and implements policies and procedures reasonably
designed to achieve fraud-prevention standards set by regulation. This regulation has resulted in decreased revenues and increased compliance costs for the banking industry and the Bank, and there can be no assurance that alternative sources of
revenues can be implemented to offset the impact of these developments.
Possible Future Legislation and Regulatory Initiatives
The economic and political environment of the past several years has led to a number of proposed legislative, governmental and regulatory initiatives, at both the federal and state levels,
certain of which are described above, that may significantly impact our industry. These and other initiatives could significantly change the competitive and operating environment in which we and our subsidiaries operate. We cannot predict whether
these or any other proposals will be enacted or the ultimate impact of any such initiatives on our operations, competitive situation, financial condition or results of operations.
The results of the 2020 national elections with the change of the U.S. President and the shift of control in the U.S. Senate could lead to new legislative and regulatory initiatives or the roll-back of initiatives
of the previous Administration which could have significant impact on the banking and financial services industry and on our business. We cannot assess at this time the degree to which this may occur.
The change of Administration in Washington, D.C. is also likely to result in changes in the leadership and other senior positions at the federal bank regulatory agencies. We cannot assess at this time the impact
such changes will have on the banking and financial services industry and on our business.
Competition
In the past, an independent bank’s principal competitors for deposits and loans have been other banks, savings and loan associations, and credit unions. Many of these competitors are large
financial institutions that have substantial capital, technology and marketing resources, which are well in excess of ours, although these larger institutions may be required to hold more regulatory capital and as a result, achieve lower returns
on equity. For agricultural loans, the Bank also competes with constituent entities with the Federal Farm Credit System. To a lesser extent, competition is also provided by thrift and loans, mortgage brokerage companies and insurance
companies. Other institutions, such as brokerage houses, mutual fund companies, credit card companies, and even retail establishments have offered new investment vehicles, which also compete with banks for deposit business. Additionally,
technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and payment systems. We also experience competition, especially for deposits,
from internet-based banking institutions and other financial companies, which do not always have a presence in our market footprint and have grown rapidly in recent years.
Current federal law has made it easier for out-of-state banks to enter and compete in California. Competition in our principal markets may further intensify as a result of the Dodd-Frank Act
which, among other things, permits out-of-state de novo branching by national banks, state banks and foreign banks from other states. While the impact of these changes cannot be predicted with certainty, it is clear that the business of banking
in California will remain highly competitive.
Competition in our industry is likely to further intensify as a result of continued consolidation of financial services companies, including consolidations of significance in our market area.
In order to compete with major financial institutions and other competitors in its primary service areas, the Bank relies upon the experience of its executive and senior officers in serving business clients, and upon its specialized services,
local promotional activities and the personal contacts made by its officers, directors and employees.
For customers whose loan demand exceeds the Bank’s legal lending limit, the Bank may arrange for such loans on a participation basis with correspondent banks. In the past, the seasonal swings,
discussed below in “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Liquidity”, have had some impact on the Bank’s liquidity. The management of investment maturities, sale of loan participations, federal
fund borrowings, qualification for funds under the Federal Reserve Bank’s seasonal credit program, and the ability to sell mortgages in the secondary market is intended to allow the Bank to satisfactorily manage its liquidity.
In addition to factors mentioned elsewhere in this Report, the factors contained below, among others, could cause our financial condition and results of operations to be materially and
adversely affected. If this were to happen, the value of our common stock could decline, perhaps significantly, and you could lose all or part of your investment.
The COVID-19 Pandemic Has Adversely Impacted our Business and Results of Operations, and the Ultimate Impact of the Pandemic on the U.S., California and Global Economies, and
on our Business, Results of Operations and Financial Condition, Will Depend on Future Developments, Which Are Highly Uncertain and Cannot be Predicted; However, the Effects of the Pandemic Have Had and Can Be Expected to Continue to Have an
Adverse Impact, Which Could Be Material
The COVID-19 pandemic has adversely impacted our business and results of operation, and the ultimate impact will depend on future developments, which are highly uncertain and
cannot be predicted, including the scope and duration of the pandemic and responsive actions taken by governmental and regulatory authorities. The pandemic and related governmental actions have negatively impacted the U.S., California and
global economies, disrupted supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, and increased unemployment levels. In addition, the pandemic has significantly increased economic
uncertainty, reduced economic activity, and resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities, including the markets where we have
operations. Governments in the U.S. and globally have taken steps to mitigate some of the more severe anticipated economic effects of the virus. During March 2020, the U.S. Congress adopted and the President signed into law the CARES Act,
which provided for some $2.2 trillion in federal funding for a variety of programs designed to stimulate the U.S. economy and to soften the economic consequences of the pandemic. During March 2020, in response to the pandemic, the FRB reduced
the federal funds rate 1.5 percentage points to .00 to .25 percent, and provided other monetary support to the financial markets and financial institutions in the U.S. Additionally, in December 2020, the Congress passed and the
President signed into law an additional $900 billion COVID-relief package. There can be no assurance that these and other governmental measures will be effective in combating the impact of the pandemic or
achieve their desired results in a timely fashion.
The pandemic began in the first quarter 2020 and continued to 2021. In response to the pandemic, the Bank proactively developed a COVID-19 Customer Support Plan designed to
provide relief to those business and consumer customers financially impacted by the pandemic. Among other actions, the Bank has offered loan assistance for those impacted by COVID-19, including waiver of late fees for qualifying consumer,
small business, commercial and agricultural loan customers for an initial period of 60 days which began in March 2020 and was later extended into the third quarter (waiver of late fees expired on October 1, 2020); payment relief options;
delinquencies resulting from impacts of COVID-19 will not be reported to the credit reporting bureaus; access to loan programs, including the Paycheck Protection Program (“PPP”) of the Small Business Administration (“SBA”) and the Bank’s strong
relationship with the State of California’s I-Bank; deposit account assistance, including waiver of overdraft/non-sufficient funds fees for all business and consumer customers for an initial period of 60 days which began in March 2020 and was
later extended to the third quarter of 2020 (the auto-waiver period expired on August 1, 2020); increased debit card limits on a case-by-case basis for consumer clients; deposit customer access to surcharge-free ATMs at over 50 locations within
the Bank’s local footprint and hundreds more throughout the state through the Bank’s membership in the MoneyPass ATM Network; and waiver of early withdrawal charges for customers wishing to withdraw funds from their Certificates of Deposit. Service
charges on deposit accounts decreased $608,000 in 2020 over 2019, decreasing from $1,979,000 to $1,371,000, partially due to the aforementioned relief provided. Service charges on deposit accounts increased $285,000 in 2021 over 2020, increasing
from $1,371,000 to $1,656,000. Future governmental and regulatory actions may require us to provide these and additional types of customer-related responses. Further impact to our results of
operations cannot be quantified at this time.
We do not yet know the full extent of the impacts of the COVID-19 pandemic, particularly if businesses remain closed, the impact on the national economy worsens, or more
customers draw on their lines of credit or seek additional loans to help finance their businesses. We provide financing to businesses in a number of industries that may be particularly vulnerable to industry-specific economic factors that can
adversely impact the performance of our commercial business, construction, commercial and multi-family real estate loan portfolios. Certain industries, such as the home building, commercial real estate, retail, agricultural, industrial,
and commercial industries, among others, have been, and can expected to continue to be, adversely impacted by the disruptive and recessionary market conditions caused by the pandemic, which could result in higher nonperforming assets for us and
elevated levels of charge-offs. Because of changing economic and market conditions affecting issuers, we also may be required to recognize impairments on the securities we hold.
Our business operations may also be disrupted if significant portions of our workforce, including employees of our third-party service providers, are unable to work effectively, including
because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. As of December 31, 2021, we have repopulated all offices, with some remaining on a hybrid schedule of working in the office and working
remotely. Remote work arrangements may exacerbate certain risks to our business, including an increased demand for information technology resources, increased risk of phishing and other cybersecurity attacks, and increased information security
risk involving, among other risks, the unauthorized dissemination of sensitive personal information or proprietary or confidential information about us, our customers or other third parties. The pandemic could also disrupt our operations due to
absenteeism by infected or ill members of management or other employees, or members of our Board of Directors, making it more difficult to conduct meetings for the management of our affairs. The operations of our clients, customers, suppliers,
and third-party service providers have also been, and are likely to be further, adversely impacted.
We may also experience financial losses due to a number of operational factors, including, among others: challenges to the availability and reliability of our network due to changes to normal
operations or third-party disruptions, including potential outages at network providers, call centers and other suppliers; increased cyber fraud risk related to COVID-19, as cybercriminals attempt to profit from the disruption, given increased
online banking, e-commerce and other online activity; and new or additional regulatory requirements, which could require additional resources and costs to address. Various banks that participated in the SBA’s PPP have become the subject of
purported class-action litigation regarding their activities under the program; there can be no assurance that such litigation will not be brought against other banks who participated in this program, including the Bank.
These factors may remain prevalent for a significant period of time and may continue to adversely affect our business, results of operations and financial condition even after the
pandemic has subsided. The extent to which these effects may occur will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its
severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In 2021, the widespread availability in the U.S. of new vaccines began to moderate the
impact of the pandemic, but various new strains of the virus emerged, including one with a higher rate of infectiousness even in vaccinated persons, that have continued the pandemic. There can be no assurance that further vaccine-resistant
strains of the virus will not emerge. Even after the pandemic has subsided, 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. A substantial majority of our assets, deposits and interest and fee income are generated in Northern California,
particularly in the Sacramento Valley region. In response to the COVID-19 pandemic, following a declaration of a state of emergency in early March 2020, the California state government issued a strict shelter-in-place order on March
19, 2020, instituting social distancing requirements and closing all non-essential businesses. Later in 2020, the California state government adopted a four-phase reopening plan. The ability of a county to move into a phase with fewer
restrictions on economic and social activities was dependent upon the county’s compliance with parameters such as the county’s case rate, test positivity rate, and a health equity metric. As of June 15, 2021, the Governor of California
terminated the executive orders that put into place the stay home order and phased out the vast majority of executive actions put in place since March 2020 as part of the pandemic response. The public health order effective June 15, 2021, has
limited restrictions, only related to masking and mega-events, as well as settings serving children and youth.
There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is
highly uncertain and subject to change. We do not yet know the full extent of the impacts of the pandemic on our business, results of operations and financial condition, or on the U.S., California or global economies or our market areas in
particular. Given the many challenges and uncertainties resulting from the coronavirus pandemic, there is a risk that conditions will be substantially different than we are currently expecting. However, the effects of the pandemic can be
reasonably expected to have an adverse impact, which could be material, on our business, results of operations and financial condition, and heighten many of our known risks described in this section.
The COVID-19 Pandemic and Related Governmental and Regulatory Actions have Negatively Impacted the U.S., California and Global Economies, Significantly Increased Economic
Uncertainty and Reduced Economic Activity, Resulting in Recessionary Economic and Financial Market Conditions, Which Are Likely to Have Resultant Adverse Consequences for the U.S. Financial Services Industry and for the Bank
While the U.S. economy experienced a period of significant expansion in recent years, the COVID-19 pandemic and related governmental and regulatory actions, the early economic effects of which began to be felt late
in the first quarter 2020 and have continued into 2021, have negatively impacted the U.S. and global economies, disrupted supply chains, created significant volatility and disruption in financial markets, and increased unemployment levels. In
addition, the pandemic has significantly increased economic uncertainty, reduced economic activity, and resulted in temporary and permanent closures of many businesses and the institution of social distancing and sheltering in place requirements
in many states and communities, including the markets where we have operations. We, and other financial services companies, are impacted to a significant degree by current economic conditions.
Governments in the U.S. and globally have taken steps to mitigate some of the more severe anticipated economic effects of the virus. During March 2020, the U.S. Congress adopted and the President signed into law
the CARES Act, which provided for some $2.2 trillion in federal funding for a variety of programs designed to stimulate the U.S. economy and to soften the economic consequences of the pandemic. Also, during March 2020, in response to the
pandemic, the FRB reduced the federal funds rate 1.5 percentage points to .00 to .25 percent, and provided other monetary support to the financial markets and financial institutions in the U.S. Additionally, in December 2020, the Congress passed
and the President signed into law an additional $900 billion COVID-relief package. There can be no assurance that these and other governmental measures will be effective or achieve their desired results in a timely fashion.
The various 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, while
federal, state and local tax revenue can be expected to decline along with economic activity. 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. Any such downgrades could increase over time the U.S. federal government’s cost of borrowing, which may worsen its fiscal challenges, as well as generate upward
pressure on interest rates generally in the U.S., which could, in turn, have adverse consequences for borrowers and the level of business activity.
The extent to which the COVID-19 outbreak ultimately impacts the national and global economies will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited
to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 outbreak has
subsided, the U.S., California and global economies may continue to experience materially adverse impacts and continuing or worsening recessionary conditions. We do not yet know the full extent of the impacts of the COVID-19 pandemic on the U.S.
or global economies or our market areas in particular; however, the pandemic can reasonably be expected to result in prolonged continuing or worsening recessionary economic and financial market conditions, which are likely to have adverse
consequences, which could be material, for the U.S. financial services industry and for the Bank.
Economic Conditions in the U.S. May Soften or Become Recessionary with Resultant Adverse Consequences for the U.S. Financial Services Industry and for the Bank
Following the financial crisis of 2008, adverse financial and economic developments impacted U.S. and global economies and financial markets and presented challenges for the banking and
financial services industry and for us. These developments included a general recession both globally and in the U.S. accompanied by substantial volatility in the financial markets.
In response, various significant economic and monetary stimulus measures were implemented by the U.S. government. The FRB also pursued a highly accommodative monetary policy aimed at keeping
interest rates at historically low levels although the FRB has more recently modified certain aspects of this policy by gradually increasing short-term interest rates and reducing its balance sheet. The U.S. economy has experienced a period of
significant expansion in recent years; however, this expansion is not likely to continue indefinitely and, at some point, economic conditions in the U.S. are likely to soften or become recessionary. We, and other financial services companies, are
impacted to a significant degree by current economic conditions. The U.S. government continues to face significant fiscal and budgetary challenges which, if not resolved, could result in renewed adverse U.S. economic conditions. These challenges
may be intensified over time if federal budget deficits were to increase and Congress and the Administration cannot effectively work to address them.
The overall level of the federal government’s debt, the extensive political disagreements regarding the government’s statutory debt limit and the continuing substantial federal budget deficits
led to a downgrade from “AAA” to “AA+” of the long-term sovereign credit rating of United States debt by one credit rating agency, although other credit rating agencies did not take such action. This risk could be exacerbated over time.
If substantial federal budget deficits were to continue in the years ahead, further downgrades by the credit rating agencies with respect to the obligations of the U.S. federal government could
occur. Any such further downgrades could increase over time the U.S. federal government’s cost of borrowing, which may worsen its fiscal challenges, as well as generate upward pressure on interest rates generally in the U.S. which could, in turn,
have adverse consequences for borrowers and the level of business activity. It is also possible that the federal government’s fiscal and budgetary challenges could be intensified over time as a result of the federal tax legislation signed into
law in December of 2017 if the reductions in tax rates along with greater government spending result in increased federal budget deficits. The long-term impact of this situation cannot be predicted.
The Bank is Subject to Lending Risks of Loss and Repayment Associated with Commercial Banking Activities Which are Likely to be Adversely Impacted by
the COVID-19 Pandemic
The Bank’s business strategy is to focus on commercial business loans (which includes agricultural loans), construction loans, and commercial and multi-family real estate loans. The principal factors affecting the
Bank’s risk of loss in connection with commercial business loans include the borrower’s ability to manage its business affairs and cash flows, general economic conditions, and, with respect to agricultural loans, weather and climate conditions.
In response to the COVID-19 pandemic, following a declaration of a state of emergency in early March of 2020, the California state government issued a strict shelter-in-place order on March 19, 2020, instituting
social distancing requirements and closing all non-essential businesses. Later in 2020, the California state government adopted a four-phase reopening plan. The ability of a county to move into a phase with fewer restrictions on economic and
social activities was dependent upon the county’s compliance with parameters such as the county’s case rate, test positivity rate, and a health equity metric. As of June 15, 2021, the Governor of California terminated the executive orders that
put into place the stay home order and phased out the vast majority of executive actions put in place since March 2020 as part of the pandemic response. The public health order effective June 15, 2021, has limited restrictions, only related to
masking and mega-events, as well as settings serving children and youth. Although many restrictions have now been relaxed, given the many uncertainties and challenges resulting from the coronavirus pandemic, it is difficult to predict when and
the extent to which, normal economic and operating conditions can resume in the state.
In the U.S. generally, and in California in particular, the pandemic has significantly increased economic uncertainty, reduced economic activity and increased unemployment levels. While many financial institutions,
including the Bank, have offered loan assistance and payment relief to qualifying consumer, small business, commercial, and agricultural loan customers impacted by the COVID-19 outbreak, the pandemic has had and can be expected to continue to
have significant economic consequences on many of our commercial loan customers, with commercial lending customers increasing line of credit balances or seeking additional loans to help finance their businesses, and increased risk of
delinquencies and defaults, particularly as restrictions on economic and social activities remain in effect for a prolonged period and many businesses remain closed. These events, in turn, have resulted and could continue to result in the
recognition of credit losses in our loan portfolios and increases in our allowance for loan losses, which could have an adverse effect, which could be material, on the Bank’s financial condition and results of operations.
For a number of years in the past decade, California has also experienced severe drought, wildfires or other natural disasters. It can be expected that these events will continue to occur from time to time in the
areas served by the Bank, and that the consequences of these natural disasters, including public utility public safety power outages when weather conditions and fire danger warrant, may adversely affect the Bank’s business and that of its
commercial loan customers, particularly in the agricultural sector.
Loans secured by commercial real estate are generally larger and involve a greater degree of credit and transaction risk than residential mortgage (one to four family) loans. Because payments on loans secured by
commercial and multi-family real estate properties are often dependent on successful operation or management of the underlying properties, repayment of such loans may be dependent on factors other than the prevailing conditions in the real estate
market or the economy. Real estate construction financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property’s value at completion of construction or development compared to the estimated cost (including interest) of construction. If the estimate of value proves to be inaccurate, the
Bank may be confronted with a project which, when completed, has a value which is insufficient to assure full repayment of the construction loan. For additional information, see “The Bank’s Dependence on Real Estate Lending Increases Our Risk of
Losses, Particularly Given the Continuing or Worsening Economic and Financial Market Conditions Caused by the COVID-19 Pandemic”, below in these “Risk Factors” in this Annual Report on Form 10-K.
Although the Bank manages lending risks through its underwriting and credit administration policies, no assurance can be given that such risks will not materialize, in which event, the Company’s financial
condition, results of operations, cash flows, and business prospects could be materially adversely affected.
Increases in the Allowance for Loan Losses Would Adversely Affect the Bank’s Financial Condition and Results of Operations
The Bank’s allowance for estimated losses on loans was approximately $14.0 million, or 1.61% of total loans, at December 31, 2021, compared to $15.4 million, or 1.73% of total loans, at December 31, 2020, and
137.3% of total non-performing loans net of guaranteed portions at December 31, 2021, compared to 102.0% of total non-performing loans, net of guaranteed portions at December 31, 2020. Reversal of provision
for loan losses totaled $1.5 million for the year ended December 31, 2021, compared to provision for loan losses of $3.1 million for the same period in 2020. The reversal of provision for loan losses during 2021 was primarily due to the
decrease in specific reserve on impaired loans to one borrower, coupled with an overall decrease in qualitative factors resulting from an improvement in economic conditions.
The COVID-19 pandemic and related responses to the pandemic by federal, state and local governments have negatively impacted the U.S., California and global economies, significantly increased economic uncertainty,
reduced economic activity, increased unemployment levels, and resulted in temporary and permanent closures of many businesses and restrictions on business and social activities in many states and communities, including many markets where we have
operations. The pandemic has resulted and can be expected to continue to result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses. Material future additions to the allowance for estimated
losses on loans may be necessary if such material adverse changes in economic conditions continue to occur and the performance of the Bank’s loan portfolio deteriorates.
In addition, the pandemic may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular, decreasing property values, increasing the risk of
defaults and reducing the value of real estate collateral. An allowance for losses on other real estate owned may also be required in order to reflect changes in the markets for real estate in which the Bank’s other real estate owned is located
and other factors which may result in adjustments which are necessary to ensure that the Bank’s foreclosed assets are carried at the lower of cost or fair value, less estimated costs to dispose of the properties. Moreover, the FDIC and the
California Department of Financial Protection and Innovation, as an integral part of their examination process, periodically review the Bank’s allowance for estimated losses on loans and the carrying value of its assets. Increases in the
provisions for estimated losses on loans and foreclosed assets would adversely affect the Bank’s financial condition and results of operations.
The Bank’s Dependence on Real Estate Lending Increases Our Risk of Losses, Particularly Given the Continuing or Worsening Economic and Financial Market Conditions Caused by the COVID-19 Pandemic
At December 31, 2021, approximately 71% of the Bank’s loans in principal amount (excluding loans held-for-sale) were secured by real estate. We do not yet know the full extent of the impacts of the COVID-19
pandemic on the U.S., California or global economies, or our market areas in particular. In 2021, the widespread availability in the U.S. of new vaccines began to moderate the impact of the pandemic, but various new strains of the virus emerged,
including one with a higher rate of infectiousness even in vaccinated persons, that have continued the pandemic. There can be no assurance that further vaccine-resistant strains of the virus will not emerge. In addition, a significant portion
of the population in California remains unvaccinated and therefore exposed to the pandemic. Accordingly, the risk remains that the pandemic could again worsen and result in prolonged recessionary economic and financial market conditions in the
market areas we serve. If this were to occur, the value of our real estate loan portfolio and the collateral supporting it could be adversely and materially impacted.
The Bank’s primary lending focus has historically been commercial (including agricultural), construction, and real estate mortgage. At December 31, 2021, real estate mortgage (excluding loans held-for-sale) and
construction loans (residential and other) comprised approximately 70% and 1%, respectively, of the total loans in the Bank’s portfolio. At December 31, 2021, all of the Bank’s real estate mortgage and construction loans and approximately 1% of
its commercial loans were secured fully or in part by deeds of trust on underlying real estate. The Company’s dependence on real estate increases the risk of loss in both the Bank’s loan portfolio and its holdings of other real estate owned if
economic conditions in Northern California were to deteriorate. Deterioration of the real estate market in Northern California would have a material adverse effect on the Company’s business, financial condition, and results of operations.
The CFPB has adopted various regulations which have impacted, and will continue to impact, our residential mortgage lending business.
Adverse Economic Factors Affecting Certain Industries the Bank Serves Could Adversely Affect Our Business
The Bank is subject to certain industry specific economic factors. For example, a portion of the Bank’s total loan portfolio is related to residential and commercial real estate,
especially in California. The COVID-19 pandemic, and its resulting recessionary economic and market conditions, may significantly affect the commercial and residential real estate markets in the U.S. generally, and in California in particular,
decreasing property values, increasing the risk of defaults and reducing the value of real estate collateral. Increases in residential mortgage loan interest rates could also have an adverse effect on the Bank’s operations by
depressing new mortgage loan originations, which in turn could negatively impact the Bank’s title and escrow deposit levels. Additionally, a downturn in the residential real estate and housing industries in California could have an adverse
effect on the Bank’s operations and the quality of its real estate and construction loan portfolio. Although the Bank does not engage in subprime or negative amortization lending, we are not immune to volatility in the real estate market. Real
estate valuations are influenced by demand, and demand is driven by economic factors such as employment rates and interest rates, which have been, and may continue to be, affected by the pandemic. These factors could adversely impact the quality
of the Bank’s residential construction, residential mortgage and construction related commercial portfolios in various ways, including by decreasing the value of the collateral for our loans, and thereby negatively affecting the Bank’s overall
loan portfolio.
The Bank provides financing to, and receives deposits from, businesses in a number of other industries that may be particularly vulnerable to industry-specific economic factors, including the home building,
commercial real estate, retail, agricultural, industrial, and commercial industries. Certain of these industries have been, and can expected to continue to be, adversely impacted by the disruptive and recessionary market conditions caused by the
pandemic, which could result in higher nonperforming assets and elevated levels of charge-offs.
Following the financial crisis of 2008, the home building industry in California was especially adversely impacted by the deterioration in residential real estate markets, which lead the Bank to take additional
provisions and charge-offs against credit losses in this portfolio. The recessionary economic and market conditions resulting from the COVID-19 pandemic may significantly affect the commercial and residential real estate markets in the U.S.
generally, and in California in particular, decreasing property values, increasing the risk of defaults and reducing the value of real estate collateral. Continued volatility in fuel prices and energy costs and drought conditions in California
could also adversely affect businesses in several of these industries. Industry specific risks are beyond the Bank’s control and could adversely affect the Bank’s portfolio of loans, potentially resulting in an increase in non-performing loans
or charge-offs and a slowing of growth or reduction in our loan portfolio.
In recent years, wildfires across California and in our market areas resulted in significant damage and destruction of property and equipment. The fire damage caused resulted in adverse economic impacts to those
affected markets and beyond and on the Bank’s customers. In addition, the major electric utility company in our region has adopted programs of electrical power shut-offs, often for multiple days, in wide areas of Northern California during
periods of high winds and high fire danger. Shut-offs of power by this utility have adversely impacted the business of some of our customers and also have resulted in some of our branches being temporarily closed. It can be expected that these
events will continue to occur from time to time in the areas served by the Bank, and that the consequences of these natural disasters, including programs of public utility public safety power outages when weather conditions and fire danger
warrant, may adversely affect the Bank’s business and that of its customers. It is also possible that climate change may be increasing the severity or frequency of adverse weather conditions, thus increasing the impact of these types of natural
disasters on our business and that of our customers.
The long-term impact of these developments on the markets we serve cannot be predicted at this time.
The Effects of Changes or Increases in, or Supervisory Enforcement of, Banking or Other Laws and Regulations or Governmental Fiscal or Monetary Policies Could Adversely Affect Us
We are subject to significant federal and state banking regulation and supervision, which is primarily for the benefit and protection of our customers and the Deposit Insurance Fund and not for
the benefit of investors in our securities. In the past, our business has been materially affected by these regulations. This will continue and likely intensify in the future. Laws, regulations or policies, including accounting standards and
interpretations, currently affecting us may change at any time. Regulatory authorities may also change their interpretation of and intensify their examination of compliance with these statutes and regulations. Therefore, our business may be
adversely affected by changes in laws, regulations, policies or interpretations or regulatory approaches to compliance and enforcement, as well as by supervisory action or criminal proceedings taken as a result of noncompliance, which could
result in the imposition of significant civil money penalties or fines. Changes in laws and regulations may also increase our expenses by imposing additional supervision, fees, taxes or restrictions on our operations. Compliance with laws and
regulations, especially new laws and regulations, increases our operating expenses and may divert management attention from our business operations.
Following the imposition in 2008 of a federal government conservatorship on the two government-sponsored enterprises (“GSEs”) in the housing finance industry, the Federal Home Loan Mortgage
Corporation and the Federal National Mortgage Association, various proposals have been advanced from time to time to reform the role of the GSEs in the housing finance market. These proposals, among other things, include reducing or eliminating
over time the role of the GSEs in guaranteeing mortgages and providing funding for mortgage loans, as well as the implementation of reforms relating to borrowers, lenders, and investors in the mortgage market, including reducing the maximum size
of a loan that the GSEs can guarantee, phasing in a minimum down payment requirement for borrowers, improving underwriting standards, and increasing accountability and transparency in the securitization process.
The GSEs remain in federal government conservatorship at this time and proposals for the reform of their role are not being actively pursued in Congress or by the current Administration.
However, this could change at any time and GSE reform could again become a subject under active consideration and if adopted, could well have a substantial impact on the mortgage market and could reduce our income from mortgage originations by
increasing mortgage costs or lowering originations. GSE reforms could also reduce real estate prices, which could reduce the value of collateral securing outstanding mortgage loans. This reduction of collateral value could negatively impact the
value or perceived collectability of these mortgage loans and may increase our allowance for loan losses. Such reforms may also include changes to the Federal Home Loan Bank System, which could adversely affect a significant source of term
funding for lending activities by the banking industry, including the Bank. These reforms may also result in higher interest rates on residential mortgage loans, thereby reducing demand, which could have an adverse impact on our residential
mortgage lending business.
In July 2013, the FRB and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to
conform this framework to the Basel III Global Regulatory Framework for Capital and Liquidity. For additional information, see “Business-Capital Standards” in Item 1 of this Form 10-K.
We maintain systems and procedures designed to comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of criminal or civil penalties
(which can be substantial) for noncompliance. In some cases, liability may attach even if the noncompliance was inadvertent or unintentional and even if compliance systems and procedures were in place at the time. There may be other negative
consequences from a finding of noncompliance, including restrictions on certain activities and damage to our reputation.
Additionally, our business is affected significantly by the fiscal and monetary policies of the U.S. federal government and its agencies. We are particularly affected by the policies of the
FRB, which regulates the supply of money and credit in the U.S. Under the Dodd-Frank Act and a long-standing policy of the FRB, a bank holding company is expected to act as a source of financial and managerial strength for its subsidiary banks.
As a result of that policy, we may be required to commit financial and other resources to our subsidiary bank in circumstances where we might not otherwise do so. Among the instruments of monetary policy available to the FRB are (a) conducting
open market operations in U.S. Government securities, (b) changing the discount rates on borrowings by depository institutions and the federal funds rate, and (c) imposing or changing reserve requirements against certain borrowings by banks and
their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the FRB can be
expected to have a material effect on our business, prospects, results of operations and financial condition.
Refer to “Business – Supervision and Regulation of Bank Holding Companies” and “Business – Supervision and Regulation of the Bank” in Item 1 of this Form 10-K for discussion of certain existing
and proposed laws and regulations that may affect our business.
The Bank is Subject to Interest Rate Risk
The income of the Bank depends to a great extent on “interest rate differentials” and the resulting net interest margins (i.e., the difference between the interest rates earned on the Bank’s
interest-earning assets such as loans and investment securities, and the interest rates paid on the Bank’s interest-bearing liabilities such as deposits and borrowings). These rates are highly sensitive to many factors, which are beyond the
Bank’s control, including, but not limited to, general economic conditions and the policies of various governmental and regulatory agencies, in particular, the FRB. We cannot predict with any certainty the nature and impact of such policies.
Changes in the relationship between short-term and long-term market interest rates or between different interest rate indices can also impact our interest rate differential, possibly resulting in a decrease in our interest income relative to
interest expense. In addition, changes in monetary policy, including changes in interest rates, influence the origination of loans, the purchase of investments and the generation of deposits and affect the rates received on loans and investment
securities and paid on deposits, which could have a material adverse effect on the Company’s business, financial condition, and results of operations.
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 well above the FRB’s long-term target could prompt broad-based selling of longer-duration, fixed-rate debt, which could have negative implications for
equity and real estate markets. Lower interest rates enable less credit-worthy borrowers to more readily meet their debt obligations. 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.
Our Ability to Pay Dividends is Subject to Legal Restrictions
As a bank holding company, our cash flow typically comes from dividends of the Bank. Various statutory and regulatory provisions restrict the amount of dividends the Bank can pay to the
Company without regulatory approval. The ability of the Company to pay cash dividends in the future also depends on the Company’s profitability, growth, and capital needs. In addition, California law restricts the ability of the Company to pay
dividends. For a number of years, the Company has paid stock dividends, but not cash dividends, to its shareholders. No assurance can be given that the Company will pay any dividends in the future or, if paid, such dividends will not be
discontinued. See “Business - Restrictions on Dividends and Other Distributions” above.
Competition Adversely Affects our Profitability
In California generally, and in the Bank’s primary market area specifically, major banks dominate the commercial banking industry. By virtue of their larger capital bases, such
institutions have substantially greater lending limits than those of the Bank. Competition is likely to further intensify as a result of the recent and increasing level of consolidation of financial services companies, particularly in our
market area resulting from various economic and market conditions. In obtaining deposits and making loans, the Bank competes with these larger commercial banks and other financial institutions, such as savings and loan associations, credit
unions and member institutions of the Farm Credit System, which offer many services that traditionally were offered only by banks. Using the financial holding company structure, insurance companies, and securities firms may compete more
directly with banks and bank holding companies. In addition, the Bank competes with other institutions such as mutual fund companies, brokerage firms, and even retail stores seeking to penetrate the financial services market. Current federal
law has also made it easier for out-of-state banks to enter and compete in the states in which we operate. Competition in our principal markets may further intensify as a result of the Dodd-Frank Act which, among other things, permits
out-of-state de novo branching by national banks, state banks and foreign banks from other states. We also experience competition, especially for deposits, from internet-based banking institutions and
other financial companies, which do not always have a physical presence in our market footprint and have grown rapidly in recent years. Also, technology and other changes increasingly allow parties to complete financial transactions
electronically, and in many cases, without banks. For example, consumers can pay bills and transfer funds over the internet and by telephone without banks. Non-bank financial service providers may have lower overhead costs and are subject to
fewer regulatory constraints. If consumers do not use banks to complete their financial transactions, we could potentially lose fee income, deposits and income generated from those deposits. During periods of declining interest rates,
competitors with lower costs of capital may solicit the Bank’s customers to refinance their loans. Furthermore, during periods of economic slowdown or recession, the Bank’s borrowers may face financial difficulties and be more receptive to
offers from the Bank’s competitors to refinance their loans. No assurance can be given that the Bank will be able to compete with these lenders. See “Business - Competition” above.
Government Regulation and Legislation Could Adversely Affect the Company
The Company and the Bank are subject to extensive state and federal regulation, supervision, and legislation, which govern almost all aspects of the operations of the Company and the Bank. The
business of the Bank is particularly susceptible to being affected by the enactment of federal and state legislation, which may have the effect of increasing the cost of doing business, modifying permissible activities, or enhancing the
competitive position of other financial institutions. Such laws are subject to change from time to time and are primarily intended for the protection of consumers, depositors and the Deposit Insurance Fund and not for the benefit of shareholders
of the Company. Regulatory authorities may also change their interpretation of these laws and regulations. The Company cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations
would have on the business and prospects of the Company, but it could be material and adverse. See “Business – Supervision and Regulation of the Bank” and “The effects of changes or increases in, or
supervisory enforcement of, banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect us” above.
We maintain systems and procedures designed to comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of criminal or civil penalties
(which can be substantial) for non-compliance. In some cases, liability may attach even if the non-compliance was inadvertent or unintentional and even if compliance systems and procedures were in place at the time. There may be other negative
consequences from a finding of non-compliance, including restrictions on certain activities and damage to the Company’s reputation.
Our Controls and Procedures May Fail or be Circumvented Which Could Have a Material Adverse Effect on the Company’s Financial Condition or Results of Operations
The Company maintains controls and procedures to mitigate against risks such as processing system failures and errors, and customer or employee fraud, and maintains insurance coverage for
certain of these risks. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met.
Events could occur which are not prevented or detected by the Company’s internal controls or are not insured against or are in excess of the Company’s insurance limits. Any failure or circumvention of the Company’s controls and procedures or
failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
Changes in Deposit Insurance Premiums Could Adversely Affect Our Business
As discussed above in Part I under the caption “Business – Premiums for Deposit Insurance,” in September, 2020, the FDIC board of directors voted to adopt a restoration plan for the Deposit
Insurance Fund to ensure that the ratio of the fund’s reserves to insured deposits reaches 1.35% within the next 8 years, as required by the Dodd-Frank Act. The FDIC could further increase deposit premiums or impose special assessments in the
future. Any further increases in the deposit insurance assessments the Bank pays would further increase our costs.
Negative Public Opinion Could Damage Our Reputation and Adversely Affect Our Earnings
Reputational risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion can result from the actual or perceived manner in
which we conduct our business activities, management of actual or potential conflicts of interest and ethical issues, lending practices, governmental enforcement actions, corporate governance deficiencies, use of social media, cyber-security
breaches and our protection of confidential client information, the implementation of environmental, social and governance (ESG) practices, or from actions taken by regulators or community organizations in response to such actions. Negative
public opinion can adversely affect our ability to keep and attract customers and employees and can expose us to claims and litigation and regulatory action and increased liquidity risk and could have a material adverse effect on the price of our
stock.
We May Not Be Able to Hire or Retain Additional Qualified Personnel and Recruiting and Compensation Costs May Increase as a Result of Turnover, Both of Which May Increase
Costs and Reduce Profitability and May Adversely Impact Our Ability to Implement Our Business Strategy
Our success depends upon the ability to attract and retain highly motivated, well-qualified personnel. We face significant competition in the recruitment and retention of qualified employees.
Executive compensation in the financial services sector has been controversial and the subject of regulation. The FDIC has proposed rules which would increase deposit premiums for institutions with compensation practices deemed to increase risk
to the institution. Over time, this guidance and the proposed rules, upon their adoption, could have the effect of making it more difficult for banks to attract and retain skilled personnel.
We May Be Adversely Affected by Unpredictable Catastrophic Events or Terrorist Attacks and Our Business Continuity and Disaster Recovery Plans May Not Adequately Protect Us
from Serious Disaster
The occurrence of catastrophic events such as wildfires (including programs of public utility public safety power outages when weather conditions and fire danger warrant), earthquakes, flooding
or other large-scale catastrophes and terrorist attacks could adversely affect our business, financial condition or results of operations if a catastrophe rendered both our production data center in Sacramento and our recovery data center in Las
Vegas unusable. There can be no assurance that our current disaster recovery plans and capabilities will protect us from serious disaster.
Changes in Accounting Standards Could Materially Impact 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. Along with other factors, we use historical loss factors to
determine the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical loss factors that we use. Other estimates that we use are fair value of our securities, expected
useful lives of our depreciable assets, fair value of stock options, calculation of deferred tax assets and liabilities, and the value of our mortgage servicing rights. We have not entered into derivative
contracts for our customers or for ourselves, which relate to interest rate, credit, equity, commodity, energy, or weather-related indices, other than forward commitments related to our loans held for sale portfolio. From time to time, the
FASB and SEC change the financial accounting and reporting standards that govern the preparation of our financial statements or new interpretations of existing standards emerge as standard industry practice. These changes can be difficult to
predict and operationally complex to implement and can materially impact 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.
In June 2016, the FASB issued Accounting Standards Update 2016-13, Measurement of Credit Losses on Financial
Instruments (“ASU 2016-13”). On October 16, 2019, the FASB voted to delay the adoption of ASU 2016-13 until January 1, 2023 for small reporting companies with less than $250 million in public
float as defined in the SEC’s rules. The Company qualifies for this delay in adoption. ASU 2016-13 will substantially change the accounting for credit losses on loans and other financial assets held by banks,
financial institutions and other organizations. The standard replaces existing incurred loss impairment guidance and establishes 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. The adoption of ASU 2016-13 could result in an increase in our allowance for loan losses as a result of changing from an “incurred loss” model,
which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. Furthermore, ASU 2016-13 will
necessitate that we establish an allowance for expected credit losses for certain debt securities and other financial assets. While we are currently unable to reasonably estimate the impact of adopting ASU 2016-13, we expect that the impact of
adoption will be significantly influenced by the composition, characteristics and quality of our loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.
There is a Limited Public Market for the Company’s Common Stock Which May Make It Difficult for Shareholders to Dispose of Their Shares
The Company’s common stock is not listed on any exchange. However, trades may be reported on the OTC Markets under the symbol “FNRN.” The Company is aware that JWTT, Inc., Monroe Securities
and Raymond James all currently make a market in the Company’s common stock. Management is aware that there are also private transactions in the Company’s common stock. However, the limited trading market for the Company’s common stock may make
it difficult for shareholders to dispose of their shares. Also, the price of the Company’s common stock may be affected by general market price movements as well as developments specifically related to the financial services sector, including
interest rate movements, quarterly variations, or changes in financial estimates by securities analysts and a significant reduction in the price of the stock of another participant in the financial services industry.
Advances and Changes in Technology, and the Company’s Ability to Adapt Its Technology, May Strain Our Available Resources and Could Adversely Impact Our Ability to Compete
and the Company’s Business and Operations
Advances and changes in technology can significantly impact the business and operations of the Company. The financial services industry is undergoing rapid technological change which regularly
involves the introduction of new products and services based on new or enhanced technologies. Examples include cloud computing, artificial intelligence and machine learning, biometric authentication and data protection enhancements, as well as
increased online and mobile device interaction with customers and increased demand for providing computer access to Bank accounts and the systems to perform banking transactions electronically. The Company’s merchant processing services require
the use of advanced computer hardware and software technology and rapidly changing customer and regulatory requirements. The Company’s ability to compete effectively depends on its ability to continue to adapt its technology on a timely and
cost-effective basis to meet these requirements. Our continued success and the maintenance of our competitive position depends, in part, upon our ability to meet the needs of our customers through the application of new technologies. If we fail
to maintain or enhance our competitive position with regard to technology, whether because we fail to anticipate customer needs and expectations or because our technological initiatives fail to perform as desired or are not timely implemented, we
may lose market share or incur additional expense. Our ability to execute our core operations and to implement technology and other important initiatives may be adversely affected if our resources are insufficient or if we are unable to allocate
available resources effectively.
In addition, the Company’s business and operations are susceptible to negative impacts from computer system failures, communication and power disruption, and unethical individuals with the
technological ability to cause disruptions or failures of the Company’s data processing systems.
Information Security Breaches or Other Technological Difficulties Could Adversely Affect the Company
Our operations rely on the secure processing, storage, transmission and reporting of personal, confidential and other sensitive information in our computer systems, networks and business
applications. Although we take protective measures, our computer systems, as well as the systems of our third-party providers, may be vulnerable to breaches or attacks, unauthorized access, misuse, computer viruses or other malicious code,
operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems, and other events that could have significant negative consequences to us. Such events could result
in interruptions or malfunctions in our or our customers’ operations, interception, misuse or mishandling of personal or confidential information, or processing of unauthorized transactions or loss of funds. These events could result in
litigation, regulatory enforcement actions, and financial losses that are either not insured against or not fully covered by our insurance, or result in regulatory consequences or reputational harm, any of which could harm our competitive
position, operating results and financial condition. We maintain cyber insurance, but this insurance may not cover all costs associated with cyber incidents or the consequences of personal or confidential information being compromised. These
types of incidents can remain undetected for extended periods of time, thereby increasing the associated risks. We may also be required to expend significant resources to modify our protective measures or to investigate and remediate
vulnerabilities or exposures arising from cybersecurity risks.
We depend on the continued efficacy of our technical systems, operational infrastructure, relationships with third parties and our employees in our day-to-day and ongoing operations. Our
increasing dependence upon automated systems to record and process transactions may further increase the risk that technical system flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.
With regard to the physical infrastructure that supports our operations, we have taken measures to implement backup systems and other safeguards, but our ability to conduct business may be adversely affected by any disruption to that
infrastructure. Failures in our internal control or operational systems, security breaches or service interruptions could impair our ability to operate our business and result in potential liability to customers, reputational damage and
regulatory intervention, any of which could harm our operating results and financial condition.
We may also be subject to disruptions of our operating systems arising from other events that are wholly or partially beyond our control, such as outages related to electrical, internet or
telecommunications, natural disasters (such as major seismic events), or unexpected difficulties with the implementation of our technology enhancement and replacement projects, which may give rise to disruption of service to customers and to
financial loss or liability. Our business recovery plan may not work as intended or may not prevent significant interruptions of our operations.
In recent years, it has been reported that several of the larger U.S. banking institutions have been the target of various denial-of-service or other cyberattacks (including attempts to inject
malicious code and viruses into computer systems) that have, for limited periods, resulted in the disruption of various operations of the targeted banks. These cyber-attacks originate from a variety of sophisticated sources who may be involved
with organized crime, linked to terrorist organizations or hostile countries and have extensive resources to disrupt the operations of the Bank or the financial system more generally. The potential for denial-of-service and other attacks requires
substantial resources to defend and may affect customer satisfaction and behavior. To date we have not experienced any material losses relating to cyberattacks or other information security breaches, but there can be no assurance that we will not
suffer such losses or information security breaches in the future. A successful cyber-attack could result in a material disruption of the Bank’s operations, exposure of confidential information and financial loss to the Bank, its clients,
customers and counterparties and could lead to significant exposure to litigation and regulatory fines, penalties and other sanctions as well as reputational damage. While we have a variety of cyber-security measures in place, the consequences to
our business, if we were to become a target of such attacks, cannot be predicted with any certainty.
In addition, there have been increasing efforts on the part of third parties to breach data security at financial institutions or with respect to financial transactions, including through the
use of social engineering schemes such as “phishing.” The ability of our customers to bank remotely, including online and though mobile devices, requires secure transmission of confidential information and increases the risk of data security
breaches which would expose us to claims by customers or others and which could adversely affect our reputation and could lead to a material loss.
We, and other banking institutions, are also at risk of increased losses from fraudulent conduct of criminals using increasingly sophisticated techniques which, in some cases, are part of
larger criminal organizations which allow them to be more effective. This criminal activity is taking many forms, including information theft, debit/credit card fraud, check fraud, mechanical devices affixed to ATM’s, social engineering, phishing
attacks to obtain personal information, or impersonation of customers through falsified or stolen credentials, business email compromise, and other criminal endeavors. We, and other banking institutions are also at risk of fraudulent or criminal
activities by employees, contractors, vendors and others with whom we do business. There is also the risk of errors by our employees and others responsible for the systems and controls on which we depend and any resulting failures of these
systems and controls could significantly harm the Company, including customer remediation costs, regulatory fines and penalties, litigation or enforcement actions, or limitations on our business activities.
Under the applicable Federal regulatory guidance, financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk
management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. In addition, a financial
institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A
financial institution is also expected to develop appropriate processes that enable recovery of data and business operations and that address rebuilding network capabilities and restoring data if the institution or its critical service
providers fall victim to this type of cyber-attack. A financial institution which fails to observe the regulatory guidance could be subject to various regulatory sanctions, including financial sanctions.
The Federal bank regulators have also issued a cybersecurity assessment tool, the output of which can assist a financial institution’s senior management and board of directors in assessing
the institution’s cybersecurity risk and preparedness. The first part of the assessment tool is the inherent risk profile, which aims to assist management in determining an institution’s level of cybersecurity risk. The second part of the
assessment tool is cybersecurity maturity, which is designed to help management assess whether their controls provide the desired level of preparedness. The Federal bank regulators plan to utilize the assessment tool as part of their
examination process when evaluating financial institutions’ cybersecurity preparedness in information technology and safety and soundness examinations and inspections. Failure to effectively utilize this tool would result in regulatory
criticism. Significant resources are required to adequately implement the tool and address any assessment concerns regarding preparedness. Management has conducted cyber-security assessments using this tool and expects to perform additional
periodic assessments to facilitate the identification and remediation of any concerns regarding our cyber-security preparedness.
Even if cyber-attacks and similar tactics are not directed specifically at the Bank, such attacks on other large financial institutions could disrupt the overall functioning of the financial
system and undermine consumer confidence in banks generally, to the detriment of other financial institutions, including the Bank. A data security breach at a large U.S. retailer resulted in the compromise of data related to credit and debit
cards of large numbers of customers requiring many banks, including the Bank, to reissue credit and debit cards for affected customers and reimburse these customers for losses sustained.
We maintain an insurance policy which we believe provides sufficient coverage at a manageable expense for an institution of our size and scope with similar technological systems. However, we
cannot assure that this policy would be sufficient to cover all financial losses, damages, penalties, including lost revenues, should we experience any one or more of our or a third-party’s systems failing or experiencing attack.
Environmental Hazards Could Have a Material Adverse Effect on the Company’s Business, Financial Condition, and Results of Operations
The Company, in its ordinary course of business, acquires real property securing loans that are in default, and there is a risk that hazardous substances or waste, contaminants or pollutants
could exist on such properties. The Company may be required to remove or remediate such substances from the affected properties at its expense, and the cost of such removal or remediation may substantially exceed the value of the affected
properties or the loans secured by such properties. Furthermore, the Company may not have adequate remedies against the prior owners or other responsible parties to recover its costs. Finally, the Company may find it difficult or impossible to
sell the affected properties either prior to or following any such removal. In addition, the Company may be considered liable for environmental liabilities in connection with its borrowers’ properties, if, among other things, it participates in
the management of its borrowers’ operations. The occurrence of such an event could have a material adverse effect on the Company’s business, financial condition, results of operations, and cash flows.
The Company May Not Be Successful in Raising Additional Capital Needed in the Future
If additional capital is needed in the future as a result of losses, our business strategy or regulatory requirements, there is no assurance that our efforts to raise such additional capital
will be successful or that shares sold in the future will be sold at prices or on terms equal to or better than the current market price. The inability to raise additional capital when needed or at prices and terms acceptable to us could
adversely affect our ability to implement our business strategies.
In the Future, the Company May Be Required to Recognize Impairment With Respect to Investment Securities, Which May Adversely Affect our Results of Operations
The Company’s securities portfolio currently includes securities with unrecognized losses. The Company may continue to observe declines in the fair market value of these securities.
Management evaluates the securities portfolio for any other-than-temporary impairment each reporting period, as required by generally accepted accounting principles. There can be no assurance, however, that future evaluations of the securities
portfolio will not require us to recognize impairment charges with respect to these and other holdings, which could adversely affect our results of operations.
Changes in the U.S. Tax Laws Will Impact Our Business and Results of Operations in a Variety of Ways, Some of Which Are Positive, and Others Which May Be Negative
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. These changes can be expected to impact our
business and results of operations in a variety of ways, some of which are expected to be positive and others which may be negative. 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 should also benefit 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, may be constrained
by the lower tax rate. We are continuing to monitor the full impact of these changes in the tax law on our tax positions. 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 impact our profitability and that of our business and commercial customers.
Our Operations, Businesses and Customers Could be Materially Adversely Affected by the Physical Effects of Climate Change, as well as Governmental and Societal Responses to Climate Change
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. Elevated temperatures and carbon dioxide levels can have large impacts on
appropriate nutrient levels, soil moisture, water availability, working condition, and various other critical performance conditions. Such climate-related impacts could disrupt our operations or the operations of customers or third parties on
which we rely, result in market volatility, negatively impact our customers’ ability to pay outstanding loans, damage collateral or result in the deterioration of the value of collateral or insurance shortfalls. These events could reduce the
Company’s earnings and cause volatility in the Company’s financial results for any fiscal quarter or year and have a material adverse effect on the Company’s financial condition and results of operations.
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
impact, the Company, its businesses or its customers. We and our customers may face cost increases, asset value reductions, operating process changes, reduced availability of insurance, and the like, as a result 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 impact 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.