Central Valley Community Bancorp Annual Report 2018

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FY2018 Annual Report · Central Valley Community Bancorp

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CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
Consolidated Balance Sheets

December 31, 2018 and 2017 (In thousands, except share amounts)

ASSETS

Cash and due from banks

Interest-earning deposits in other banks

Federal funds sold

Total cash and cash equivalents

Available-for-sale debt securities

Equity securities

Loans, less allowance for credit losses of $9,104 at December 31, 2018 and $8,778 at December 31, 2017

Bank premises and equipment, net

Bank owned life insurance

Federal Home Loan Bank stock

Goodwill

Core deposit intangibles

Accrued interest receivable and other assets

Total assets

LIABILITIES AND SHAREHOLDERS’ EQUITY

Deposits:

Non-interest bearing

Interest bearing

Total deposits

Short-term borrowings

Junior subordinated deferrable interest debentures

Accrued interest payable and other liabilities

Total liabilities

Commitments and contingencies (Note 12)

Shareholders’ equity:

Preferred stock, no par value; 10,000,000 shares authorized, none issued and outstanding

Common stock, no par value; 80,000,000 shares authorized; issued and outstanding: 13,754,965 at

December 31, 2018 and 13,696,722 at December 31, 2017

Retained earnings

Accumulated other comprehensive (loss) income, net of tax

Total shareholders’ equity

2018

2017

24,954

6,725

31,727

463,905

7,254

909,591

8,484

28,502

6,843

53,777

2,572

25,181

38,286

62,080

100,383

535,281

7,423

891,901

9,398

27,807

6,843

53,777

3,027

25,815

1,537,836

1,661,655

550,657

731,641

1,282,298

10,000

5,155

20,645

585,039

840,648

1,425,687

5,155

21,254

1,318,098

1,452,096

103,851

120,294

(4,407)

219,738

103,314

103,419

2,826

209,559

Total liabilities and shareholders’ equity

1,537,836

1,661,655

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

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
Consolidated Statements
of Income

For the Years Ended December 31, 2018, 2017, and 2016 (In thousands, except per share amounts)

2018

2017

2016

Interest income:

Interest and fees on loans
Interest on deposits in other banks
Interest and dividends on investment securities:

Taxable
Exempt from Federal income taxes

Total interest income

Interest expense:

Interest on deposits
Interest on junior subordinated deferrable interest debentures
Other

Total interest expense

Net interest income before provision for credit losses

Provision for (Reversal of) credit losses

Net interest income after provision for credit losses

Non-interest income:
Service charges
Appreciation in cash surrender value of bank owned life insurance
Interchange fees
Loan placement fees
Net realized gain on sale of credit card portfolio
Net realized gains on sales and calls of investment securities
Other-than-temporary impairment loss on investment securities
Federal Home Loan Bank dividends
Other income

Total non-interest income

Non-interest expenses:

Salaries and employee benefits
Occupancy and equipment
Regulatory assessments
Data processing expense
Professional services
ATM/Debit card expenses
Information technology
Directors’ expenses
Advertising
Internet banking expenses
Acquisition and integration expenses
Amortization of core deposit intangibles
Other expense

Total non-interest expenses

Income before provision for income taxes

Provision for income taxes

Net income

Basic earnings per common share

Diluted earnings per common share

Cash dividends per common share

49,936
459

10,254
3,538

64,187

1,153
199
132

1,484

62,703

62,653

2,986
695
1,462
708
462
1,314
-
590
2,107

10,324

26,221
5,972
619
1,666
1,475
739
1,113
465
758
732
217
455
4,636

45,068

27,909
6,620

21,289

1.55

1.54

0.31

43,534
424

6,526
6,892

57,376

969
147
21

1,137

56,239

(1,150)

57,389

3,053
621
1,458
706
-
2,802
-
443
1,753

10,836

24,738
5,186
652
1,740
1,509
750
818
597
638
705
1,828
234
5,011

44,406

23,819
9,793

14,026

1.12

1.10

0.24

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

34,051
289

5,876
6,460

46,676

975
121
-

1,096

45,580

(5,850)

51,430

2,849
558
1,228
1,083
-
1,920
(136)
630
1,459

9,591

21,881
4,754
642
1,707
1,258
633
531
530
576
678
1,782
149
3,801

38,922

22,099
6,917

15,182

1.34

1.33

0.24

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
Consolidated Statements
of Comprehensive Income

For the Years Ended December 31, 2018, 2017, and 2016 (In thousands)

NET INCOME
Other Comprehensive Income (Loss):

Unrealized gains (losses) on securities:

Unrealized holdings (losses) gains arising during the period
Less: reclassification for net gains included in net income
Less: reclassification for other-than-temporary impairment loss included in net income
Transfer of investment securities from held-to-maturity to available-for-sale
Amortization of net unrealized gains transferred

Other comprehensive (loss) income, before tax
Tax benefit (expense) related to items of other comprehensive income

Total other comprehensive (loss) income

Comprehensive income

2018

2017

2016

21,289

14,026

15,182

(9,159)
1,314
-
-
-

(10,473)
3,096

(7,377)

7,705
2,802
-
-
-

4,903
(2,062)

2,841

13,912

16,867

(9,924)
1,224
(136)
2,647
(64)

(8,429)
3,451

(4,978)

10,204

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

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
Consolidated Statements
of Changes in Shareholders’ Equity

For the Years Ended December 31, 2018, 2017, and 2016 (In thousands, except share amounts)

Balance, January 1, 2016
Net income
Other comprehensive loss
Restricted stock granted, forfeited and related tax benefit
Cash dividend ($0.24 per common share)
Stock issued for acquisition
Stock-based compensation expense
Stock options exercised and related tax benefit

Balance, December 31, 2016
Net income
Other comprehensive income
Reclassification associated with the adoption of ASU 2018-02
Stock issued under employee stock purchase plan
Restricted stock granted, (forfeited) and related tax benefit
Stock issued for acquisition
Stock-based compensation expense
Cash dividend ($0.24 per common share)
Stock options exercised and related tax benefit

Balance, December 31, 2017
Cumulative effect of equity securities gains reclassified

Adjusted Balance, January 1, 2018
Net income
Other comprehensive loss
Restricted stock granted, (forfeited) and related tax benefit
Stock issued under employee stock purchase plan
Stock-based compensation expense
Cash dividend ($0.31 per common share)
Stock options exercised and related tax benefit
Repurchase and retirement of common stock

Common Stock

Amount

Retained
Earnings

10,996,773
-
-
52,911
-
1,058,851
-
35,280

12,143,815
-
-
-
2,441
(2,360)
1,276,888
-
-
275,938

13,696,722
-

13,696,722
-
-
20,494
11,581
-
-
74,030
(47,862)

54,424
-
-
(2)
-
16,678
284
261

71,645
-
-
-
45
-
28,405
384
-
2,835

103,314
-

103,314
-
-
-
211
482
-
738
(894)

80,437
15,182
-
-
(2,715)
-
-
-

92,904
14,026
-
(501)
-

-
-
(3,010)
-

103,419
(144)

103,275
21,289
-
-
-
-
(4,270)
-
-

Accumulated
Other
Comprehensive
Income (Loss)
(Net of Taxes)

Total
Shareholders’
Equity

4,462
-
(4,978)
-
-
-
-
-

(516)
-
2,841
501
-

-
-
-
-

2,826
144

2,970
-
(7,377)
-
-
-
-
-
-

139,323
15,182
(4,978)
(2)
(2,715)
16,678
284
261

164,033
14,026
2,841
-
45
-
28,405
384
(3,010)
2,835

209,559
-

209,559
21,289
(7,377)
-
211
482
(4,270)
738
(894)

Balance, December 31, 2018

13,754,965

$ 103,851

$ 120,294

(4,407)

219,738

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

CENTRAL VALLEY COMMUNITY BANCORP AND SUBSIDIARY
Consolidated Statements
of Cash Flows

For the Years Ended December 31, 2018, 2017, and 2016 (In thousands)

CASH FLOWS FROM OPERATING ACTIVITIES:

Net income
Adjustments to reconcile net income to net cash provided by operating activities:

Net decrease (increase) in deferred loan costs
Depreciation
Accretion
Amortization
Stock-based compensation
Excess tax benefit from exercise of stock options
Provision for (reversal of ) credit losses
Other than temporary impairment losses on investment securities
Net realized gains on sales and calls of available-for-sale investment securities
Net realized gains on sales or calls of held-to-maturity investment securities
Net loss on sale and disposal of equipment
Write down of equity investments
Increase in bank owned life insurance, net of expenses
Net gain on sale of credit card portfolio
Net gain on bank owned life insurance
Net decrease (increase) in accrued interest receivable and other assets
Net (decrease) increase in accrued interest payable and other liabilities
Benefit for deferred income taxes

Net cash provided by operating activities

CASH FLOWS FROM INVESTING ACTIVITIES:

Net cash and cash equivalents acquired in acquisitions
Purchases of available-for-sale investment securities
Proceeds from sales or calls of available-for-sale investment securities
Proceeds from sales or calls of held-to-maturity investment securities
Proceeds from maturity and principal repayment of available-for-sale investment

securities

Proceeds from sale of credit card portfolio
Net increase in loans
Purchases of premises and equipment
Proceeds from bank owned life insurance
Proceeds from sale of premises and equipment

Net cash provided by (used in) investing activities

CASH FLOWS FROM FINANCING ACTIVITIES:

Net (decrease) increase in demand, interest-bearing and savings deposits
Net decrease in time deposits
Proceeds from short-term borrowings from Federal Home Loan Bank
Repayments of short-term borrowings to Federal Home Loan Bank
Proceeds of borrowings from other financial institutions
Repayments of borrowings from other financial institutions
Purchase and retirement of common stock
Proceeds from stock issued under employee stock purchase plan
Proceeds from exercise of stock options
Excess tax benefit from exercise of stock options
Cash dividend payments on common stock

Net cash used in financing activities

(Decrease) increase in cash and cash equivalents

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

CASH AND CASH EQUIVALENTS AT END OF YEAR

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

Cash paid during the year for:

Interest
Income taxes

Non-cash investing and financing activities:

Transfer of securities from held-to-maturity to available-for-sale
Unrealized gain on transfer of securities from held-to-maturity to available-for-sale
Transfer of loans to other assets
Common stock issued in acquisitions

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

2018

2017

2016

21,289

14,026

15,182

233
1,703
(898)
6,457
482
-
50
-
(1,314)
-
2
42
(695)
(462)
-
3,218
(599)
403

29,911

-
(225,970)
246,824
-

36,495
2,954
(20,477)
(791)
-
-

39,035

(112,134)
(31,253)
568,500
(558,500)
19,705
(19,705)
(894)
211
738
-
(4,270)

(137,602)

(68,656)
100,383

(92)
1,429
(766)
8,519
384
-
(1,150)
-
(2,802)
-
-
-
(621)
-
-
(2,263)
1,370
7,184

25,218

26,279
(226,740)
228,405
-

44,956
-
(25,542)
(859)
-
-

46,499

45,672
(48,044)
-
(7,000)
-
(400)
-
45
2,835
-
(3,010)

(9,902)

61,815
38,568

$
$

$
$
$
$

31,727

100,383

1,460
2,700

-
-
-
-

$
$

$
$
$
$

1,171
4,720

-
-
-
28,405

$
$

$
$
$
$

(851)
1,320
(1,142)
7,912
284
(30)
(5,850)
136
(1,224)
(696)
4
-
(558)
-
(190)
(4,711)
821
2,592

12,999

13,241
(278,664)
167,163
9,257

50,531
-
(29,930)
(861)
928
7

(68,328)

26,372
(25,038)
-
-
400
-
-
-
231
30
(2,715)

(720)

(56,049)
94,617

38,568

1,053
5,840

23,131
526
363
16,678

Notes to
Consolidated Financial Statements

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General - Central Valley Community Bancorp (the ‘‘Company’’) was incorporated
on February 7, 2000 and subsequently obtained approval from the Board of
Governors of the Federal Reserve System to be a bank holding company in
connection with its acquisition of Central Valley Community Bank (the ‘‘Bank’’).
The Company became the sole shareholder of the Bank on November 15, 2000
in a statutory merger, pursuant to which each outstanding share of the Bank’s
common stock was exchanged for one share of common stock of the Company.
Service 1st Capital Trust I (the Trust) is a business trust formed by Service

1st for the sole purpose of issuing trust preferred securities. The Company
succeeded to all the rights and obligations of Service 1st in connection with the
acquisition of Service 1st. The Trust is a wholly-owned subsidiary of the
Company.

The Bank operates 21 full service offices throughout California’s San Joaquin
Valley and Greater Sacramento Region. The Bank’s primary source of revenue is
providing loans to customers who are predominately small and middle-market
businesses and individuals.

The deposits of the Bank are insured by the Federal Deposit Insurance
Corporation (FDIC) up to applicable legal limits. Depositors’ accounts at an
insured depository institution, including all non-interest bearing transactions
accounts, will be insured by the FDIC up to the standard maximum deposit
insurance amount of $250,000 for each deposit insurance ownership category.

The accounting and reporting policies of the Company and the Bank conform

with accounting principles generally accepted in the United States of America
and prevailing practices within the banking industry.

Management has determined that because all of the banking products and
services offered by the Company are available in each branch of the Bank, all
branches are located within the same economic environment and management
does not allocate resources based on the performance of different lending or
transaction activities, it is appropriate to aggregate the Bank branches and report
them as a single operating segment. No customer accounts for more than
10 percent of revenues for the Company or the Bank.

Principles of Consolidation - The consolidated financial statements include the
accounts of the Company and the consolidated accounts of its wholly-owned
subsidiary, the Bank. Intercompany transactions and balances are eliminated in
consolidation.

For financial reporting purposes, Service 1st Capital Trust I, is a wholly-owned

subsidiary acquired in the merger of Service 1st Bancorp and formed for the
exclusive purpose of issuing trust preferred securities. The Company is not
considered the primary beneficiary of this trust (variable interest entity), therefore
the trust is not consolidated in the Company’s financial statements, but rather
the subordinated debentures are shown as a liability on the Company’s
consolidated financial statements. The Company’s investment in the common
stock of the Trust is included in accrued interest receivable and other assets on
the consolidated balance sheet.

Use of Estimates - The preparation of these financial statements in accordance
with U.S. generally accepted accounting principles requires management to make
estimates and judgments that affect the reported amount of assets, liabilities,
revenues and expenses. On an ongoing basis, management evaluates the estimates
used. Estimates are based upon historical experience, current economic conditions
and other factors that management considers reasonable under the circumstances.
These estimates result in judgments regarding the carrying values of assets and
liabilities when these values are not readily available from other sources, as well as
assessing and identifying the accounting treatments of contingencies and
commitments. These estimates and assumptions affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
may differ from these estimates under different assumptions.

Cash and Cash Equivalents - For the purpose of the statement of cash flows,
cash, due from banks with maturities less than 90 days, interest-earning deposits
in other banks, and Federal funds sold are considered to be cash equivalents.
Generally, Federal funds are sold and purchased for one-day periods. Net cash
flows are reported for customer loan and deposit transactions, interest-bearing
deposits in other banks, and Federal funds purchased.

Investment Securities - Investments are classified into the following categories:

• Available-for-sale securities, reported at fair value, with unrealized gains and

losses excluded from earnings and reported, net of taxes, as accumulated other
comprehensive income (loss) within shareholders’ equity.

• Held-to-maturity securities, which management has the positive intent and
ability to hold to maturity, reported at amortized cost, adjusted for the
accretion of discounts and amortization of premiums.

Management determines the appropriate classification of its investments at the

time of purchase and may only change the classification in certain limited
circumstances. All transfers between categories are accounted for at fair value in
the period which the transfer occurs. During the year ended December 31, 2018,
there were no transfers between categories.

Gains or losses on the sale of investment securities are computed on the

specific identification method. Interest earned on investment securities is reported
in interest income, net of applicable adjustments for accretion of discounts and
amortization of premiums. Premiums and discounts on securities are amortized
or accreted on the level yield method without anticipating prepayments, except
for mortgage backed securities where prepayments are anticipated.

An investment security is impaired when its carrying value is greater than its

fair value. Investment securities that are impaired are evaluated on at least a
quarterly basis and more frequently when economic or market conditions warrant
such an evaluation to determine whether such a decline in their fair value is
other than temporary. Management utilizes criteria such as the magnitude and
duration of the decline and the intent and ability of the Company to retain its
investment in the securities for a period of time sufficient to allow for an
anticipated recovery in fair value, in addition to the reasons underlying the
decline, to determine whether the loss in value is other than temporary. The
term ‘‘other than temporary’’ is not intended to indicate that the decline is
permanent, but indicates that the prospect for a near-term recovery of value is
not necessarily favorable, or that there is a lack of evidence to support a realizable
value equal to or greater than the carrying value of the investment. Once a
decline in value is determined to be other than temporary, and management does
not intend to sell the security or it is more likely than not that the Company
will not be required to sell the security before recovery, for debt securities, only
the portion of the impairment loss representing credit exposure is recognized as a
charge to earnings, with the balance recognized as a charge to other
comprehensive income. If management intends to sell the security or it is more
likely than not that the Company will be required to sell the security before
recovering its forecasted cost, the entire impairment loss is recognized as a charge
to earnings.

Loans - All loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at principal balances
outstanding net of deferred loan fees and costs, and the allowance for credit
losses. Interest is accrued daily based upon outstanding loan principal balances.
However, when a loan becomes impaired and the future collectability of interest
and principal is in serious doubt, the loan is placed on nonaccrual status and the
accrual of interest income is suspended. Any loan delinquent 90 days or more is
automatically placed on nonaccrual status. Any interest accrued but unpaid is
charged against income. Subsequent payments on these loans, or payments
received on nonaccrual loans for which the ultimate collectability of principal is
not in doubt, are applied first to principal until fully collected and then to
interest.

Interest income on loans is discontinued at the time the loan is 90 days

delinquent unless the loan is well-secured and in process of collection. Consumer
and credit card loans are typically charged off no later than 90 days past due.
Past due status is based on the contractual terms of the loan. In all cases, loans
are placed on nonaccrual or charged-off at an earlier date if collection of
principal or interest is considered doubtful. A loan placed on non-accrual status
may be restored to accrual status when principal and interest are no longer past
due and unpaid, or the loan otherwise becomes both well secured and in the
process of collection. When a loan is brought current, the Company must also
have reasonable assurance that the obligor has the ability to meet all contractual
obligations in the future, that the loan will be repaid within a reasonable period
of time, and that a minimum of six months of satisfactory repayment
performance has occurred.

Substantially all loan origination fees, commitment fees, direct loan origination
costs and purchase premiums and discounts on loans are deferred and recognized
as an adjustment of yield, and amortized to interest income over the contractual
term of the loan. The unamortized balance of deferred fees and costs is reported
as a component of net loans.

Notes to
Consolidated Financial Statements

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Acquired loans and Leases - Loans and leases acquired through purchase or
through a business combination are recorded at their fair value at the acquisition
date. Credit discounts are included in the determination of fair value; therefore,
an allowance for loan and lease losses is not recorded at the acquisition date.
Should the Company’s allowance for credit losses methodology indicate that the
credit discount associated with acquired, non-purchased credit impaired loans, is
no longer sufficient to cover probable losses inherent in those loans, the
Company will establish an allowance for those loans through a charge to
provision for credit losses. At the time of an acquisition, we evaluate loans to
determine if they are purchase credit impaired loans. Purchased credit impaired
loans are those acquired loans with evidence of credit deterioration for which
collection of all contractual payments was not considered probable at the date of
acquisition. This determination is made by considering past due and/or
nonaccrual status, prior designation of a troubled debt restructuring, or other
factors that may suggest we will not be able to collect all contractual payments.
Purchased credit impaired loans are initially recorded at fair value with the
difference between fair value and estimated future cash flows accreted over the
expected cash flow period as income only to the extent we can reasonably
estimate the timing and amount of future cash flows. In this case, these loans
would be classified as accruing. In the event we are unable to reasonably estimate
the timing and amount of future cash flows, or if the loan is acquired primarily
for the rewards of ownership of the underlying collateral, the loan is classified as
non-accrual. An acquired loan previously classified by the seller as a troubled
debt restructuring is no longer classified as such at the date of acquisition. Past
due status is reported based on contractual payment status.

All loans not otherwise classified as purchase credit impaired are recorded at
fair value with the discount to contractual value accreted over the life of the loan.

Allowance for Credit Losses - The allowance for credit losses (the ‘‘allowance’’) is
a valuation allowance for probable incurred credit losses in the Company’s loan
portfolio. The allowance is established through a provision for credit losses which
is charged to expense. Additions to the allowance are made to maintain the
adequacy of the total allowance after credit losses and loan growth. Credit
exposures determined to be uncollectible are charged against the allowance. Cash
received on previously charged off amounts is recorded as a recovery to the
allowance. The overall allowance consists of two primary components, specific
reserves related to impaired loans and general reserves for inherent losses related
to loans that are not impaired.

A loan is considered impaired when, based on current information and events,

it is probable that the Company will be unable to collect all amounts due,
including principal and interest, according to the contractual terms of the
original agreement. Factors considered by management in determining
impairment include payment status, collateral value, and the probability of
collecting scheduled principal and interest payments when due. Loans that
experience insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management determines the significance of payment delays
and payment shortfalls on a case-by-case basis, taking into consideration all of
the circumstances surrounding the loan and the borrower, including the length of
the delay, the reasons for the delay, the borrower’s prior payment record, and the
amount of the shortfall in relation to the principal and interest owed. Loans
determined to be impaired are individually evaluated for impairment. When a
loan is impaired, the Company measures impairment based on the present value
of expected future cash flows discounted at the loan’s effective interest rate, except
that as a practical expedient, it may measure impairment based on a loan’s
observable market price, or the fair value of the collateral if the loan is collateral
dependent. A loan is collateral dependent if the repayment of the loan is
expected to come solely from the sale or operation of underlying collateral.

A restructuring of a debt constitutes a troubled debt restructuring (TDR) if

the Company for economic or legal reasons related to the debtor’s financial
difficulties grants a concession to the debtor that it would not otherwise consider.
Restructured workout loans typically present an elevated level of credit risk as the
borrowers are not able to perform according to the original contractual terms.
Loans that are reported as TDRs are considered impaired and measured for
impairment as described above.

When determining the allowance for loan losses on acquired loans, we

bifurcate the allowance between legacy loans and acquired loans. Loans remain
designated as acquired until either (i) loan is renewed or (ii) loan is substantially
modified whereby modification results in a new loan. When determining the

allowance on acquired loans, the Company estimates probable incurred credit
losses as compared to the Company’s recorded investment, with the recorded
investment being net of any unaccreted discounts from the acquisition.

The determination of the general reserve for loans that are not impaired is

based on estimates made by management, including but not limited to,
consideration of a simple average of historical losses by portfolio segment (and in
certain cases peer loss data) over the most recent 20 quarters, and qualitative
factors including economic trends in the Company’s service areas, industry
experience and trends, geographic concentrations, estimated collateral values, the
Company’s underwriting policies, the character of the loan portfolio, and
probable losses inherent in the portfolio taken as a whole.

The Company segregates the allowance by portfolio segment. These portfolio

segments include commercial, real estate, and consumer loans. The relative
significance of risk considerations vary by portfolio segment. For commercial and
real estate loans, the primary risk consideration is a borrower’s ability to generate
sufficient cash flows to repay their loan. Secondary considerations include the
creditworthiness of guarantors and the valuation of collateral. In addition to the
creditworthiness of a borrower, the type and location of real estate collateral is an
important risk factor for real estate loans. The primary risk considerations for
consumer loans are a borrower’s personal cash flow and liquidity, as well as
collateral value. The allowance for credit losses attributable to each portfolio
segment, which includes both impaired loans and loans that are not impaired, is
combined to determine the Company’s overall allowance, which is included on
the consolidated balance sheet.

Commercial:

Commercial and industrial - Commercial and industrial loans are generally

underwritten to existing cash flows of operating businesses. Additionally,
economic trends influenced by unemployment rates and other key economic
indicators are closely correlated to the credit quality of these loans. Past due
payments may indicate the borrower’s capacity to repay their obligations may be
deteriorating.

Agricultural production - Loans secured by crop production and livestock are

especially vulnerable to two risk factors that are largely outside the control of
Company and borrowers: commodity prices and weather conditions.

Real Estate:

Owner-occupied commercial real estate - Real estate collateral secured by
commercial or professional properties with repayment arising from the owner’s
business cash flows. To meet this classification, the owner’s operation must
occupy no less than 50% of the real estate held. Financial profitability and
capacity to meet the cyclical nature of the industry and related real estate market
over a significant timeframe is essential.

Real estate construction and other land loans - Land and construction loans

generally possess a higher inherent risk of loss than other real estate portfolio
segments. A major risk arises from the necessity to complete projects within
specified costs and time lines. Trends in the construction industry significantly
impact the credit quality of these loans, as demand drives construction activity.
In addition, trends in real estate values significantly impact the credit quality of
these loans, as property values determine the economic viability of construction
projects.

Agricultural real estate - Agricultural loans secured by real estate generally
possess a higher inherent risk of loss caused by changes in concentration of
permanent plantings, government subsidies, and the value of the U.S. dollar
affecting the export of commodities.

Investor commercial real estate - Investor commercial real estate loans generally

possess a higher inherent risk of loss than other real estate portfolio segments,
except land and construction loans. Adverse economic developments or an
overbuilt market impact commercial real estate projects and may result in
troubled loans. Trends in vacancy rates of commercial properties impact the
credit quality of these loans. High vacancy rates reduce operating revenues and
the ability for properties to produce sufficient cash flows to service debt
obligations.

Notes to
Consolidated Financial Statements

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(Continued)

Other real estate - Primarily loans secured by agricultural real estate for
development and production of permanent plantings that have not reached
maximum yields. Also real estate loans where agricultural vertical integration
exists in packing and shipping of commodities. Risk is primarily based on the
liquidity of the borrower to sustain payment during the development period.

Consumer:

Equity loans and lines of credit - The degree of risk in residential real estate
lending depends primarily on the loan amount in relation to collateral value, the
interest rate and the borrower’s ability to repay in an orderly fashion. These loans
generally possess a lower inherent risk of loss than other real estate portfolio
segments. Economic trends determined by unemployment rates and other key
economic indicators are closely correlated to the credit quality of these loans.
Weak economic trends may indicate that the borrowers’ capacity to repay their
obligations may be deteriorating.

Installment and other consumer loans - An installment loan portfolio is usually

comprised of a large number of small loans scheduled to be amortized over a
specific period. Most installment loans are made directly for consumer purchases.
Other consumer loans include other open ended unsecured consumer loans.
Open ended unsecured loans generally have a higher rate of default than all other
portfolio segments and are also impacted by weak economic conditions and
trends. Open ended unsecured loans in homogeneous loan portfolio segments are
not evaluated for specific impairment.

Although management believes the allowance to be adequate, ultimate losses
may vary from its estimates. At least quarterly, the Board of Directors reviews the
adequacy of the allowance, including consideration of the relative risks in the
portfolio, current economic conditions and other factors. If the Board of
Directors and management determine that changes are warranted based on those
reviews, the allowance is adjusted. In addition, the Company’s primary regulators,
the FDIC and California Department of Business Oversight, as an integral part
of their examination process, review the adequacy of the allowance. These
regulatory agencies may require additions to the allowance based on their
judgment about information available at the time of their examinations.

Risk Rating - The Company assigns a risk rating to all loans, and periodically
performs detailed reviews of all such loans over a certain threshold to identify
credit risks and to assess the overall collectability of the portfolio. The most
recent review of risk rating was completed in December 2018. These risk ratings
are also subject to examination by independent specialists engaged by the
Company, and the Company’s regulators. During these internal reviews,
management monitors and analyzes the financial condition of borrowers and
guarantors, trends in the industries in which borrowers operate and the fair
values of collateral securing these loans. These credit quality indicators are used
to assign a risk rating to each individual loan. The risk ratings can be grouped
into five major categories, defined as follows:

Pass - A pass loan is a strong credit with no existing or known potential

weaknesses deserving of management’s close attention.

Special Mention - A special mention loan has potential weaknesses that deserve
management’s close attention. If left uncorrected, these potential weaknesses may
result in deterioration of the repayment prospects for the loan or in the
Company’s credit position at some future date. Special Mention loans are not
adversely classified and do not expose the Company to sufficient risk to warrant
adverse classification.

Substandard - A substandard loan is not adequately protected by the current
sound worth and paying capacity of the borrower or the value of the collateral
pledged, if any. Loans classified as substandard have a well-defined weakness or
weaknesses that jeopardize the liquidation of the debt. Well-defined weaknesses
include a project’s lack of marketability, inadequate cash flow or collateral
support, failure to complete construction on time, or the project’s failure to fulfill
economic expectations. They are characterized by the distinct possibility that the
Company will sustain some loss if the deficiencies are not corrected.

Doubtful - Loans classified doubtful have all the weaknesses inherent in those
classified as substandard with the added characteristic that the weaknesses make
collection or liquidation in full, on the basis of currently known facts, conditions
and values, highly questionable and improbable. The possibility of loss is
extremely high, but because of certain important and reasonably specific pending
factors, which may work to the advantage and strengthening of the asset, its
classification as an estimated loss is deferred until its more exact status may be
determined. Pending factors include proposed merger, acquisition, or liquidation
procedures, capital injection, perfecting liens on additional collateral, and
refinancing plans. Doubtful classification is considered temporary and short term.

Loss - Loans classified as loss are considered uncollectible and charged off

immediately.

The general reserve component of the allowance for credit losses also consists
of reserve factors that are based on management’s assessment of the following for
each portfolio segment: (1) inherent credit risk, (2) historical losses and (3) other
qualitative factors including economic trends in the Company’s service areas,
industry experience and trends, geographic concentrations, estimated collateral
values, the Company’s underwriting policies, the character of the loan portfolio,
and probable losses inherent in the portfolio taken as a whole. Inherent credit
risk and qualitative reserve factors are inherently subjective and are driven by the
repayment risk associated with each class of loans.

Bank Premises and Equipment - Land is carried at cost. Bank premises and
equipment are carried at cost less accumulated depreciation. Depreciation is
determined using the straight-line method over the estimated useful lives of the
related assets. The useful lives of Bank premises are estimated to be between
twenty and forty years. The useful lives of improvements to Bank premises,
furniture, fixtures and equipment are estimated to be three to ten years.
Leasehold improvements are amortized over the life of the asset or the term of
the related lease, whichever is shorter. When assets are sold or otherwise disposed
of, the cost and related accumulated depreciation are removed from the accounts,
and any resulting gain or loss is recognized in income for the period. The cost of
maintenance and repairs is charged to expense as incurred.

The Bank evaluates premises and equipment for financial impairment as events
or changes in circumstances indicate that the carrying amount of such assets may
not be fully recoverable.

Federal Home Loan Bank (FHLB) Stock - The Bank is a member of the FHLB
system. Members are required to own a certain amount of stock based on the
level of borrowings and other factors, and may invest in additional amounts.
FHLB stock is carried at cost, classified as a restricted security, and periodically
evaluated for impairment based on ultimate recovery of par value. Both cash and
stock dividends are reported as income.

Investments in Low Income Housing Tax Credit Funds - The Bank has invested
in limited partnerships that were formed to develop and operate affordable
housing projects for low or moderate income tenants throughout California. Our
ownership in each limited partnership is less than two percent. In accordance
with ASU No. 2014-01, Investments—Equity Method and Joint Ventures
(Topic 323), we elected to account for the investments in qualified affordable
housing tax credit funds using the proportional amortization method. Under the
proportional amortization method, the initial cost of the investment is amortized
in proportion to the tax credits and other tax benefits received and the net
investment performance is recognized as part of income tax expense (benefit).
Each of the partnerships must meet the regulatory minimum requirements for
affordable housing for a minimum 15-year compliance period to fully utilize the
tax credits. If the partnerships cease to qualify during the compliance period, the
credit may be denied for any period in which the project is not in compliance
and a portion of the credit previously taken is subject to recapture with interest.
The Company’s investment in Low Income Housing Tax Credit Funds is
reported in other assets on the consolidated balance sheet.

Other Real Estate Owned - Other real estate owned (OREO) is comprised of
property acquired through foreclosure proceedings or acceptance of deeds-in-lieu
of foreclosure. Losses recognized at the time of acquiring property in full or
partial satisfaction of debt are charged against the allowance for credit losses.
OREO, when acquired, is initially recorded at fair value less estimated disposition
costs, establishing a new cost basis. Fair value of OREO is generally based on an
independent appraisal of the property. Subsequent to initial measurement, OREO

Notes to
Consolidated Financial Statements

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(Continued)

is carried at the lower of the recorded investment or fair value less disposition
costs. If fair value declines subsequent to foreclosure, a valuation allowance is
recorded through noninterest expense. Revenues and expenses associated with
OREO are reported as a component of noninterest expense when incurred.

Foreclosed Assets - Assets acquired through or instead of loan foreclosure are
initially recorded at fair value less costs to sell when acquired, establishing a new
cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is
recorded through operations. Operating costs after acquisition are expensed.
Gains and losses on disposition are included in noninterest expense. The carrying
value of foreclosed assets was $0 at December 31, 2018 and $70,000 at
December 31, 2017, and is included in other assets on the consolidated balance
sheets.

Bank Owned Life Insurance - The Company has purchased life insurance policies
on certain key executives. Company owned life insurance is recorded at the
amount that can be realized under the insurance contract at the balance sheet
date, which is the cash surrender value adjusted for other charges or other
amounts due that are probable at settlement.

Business Combinations - The Company accounts for acquisitions of businesses
using the acquisition method of accounting. Under the acquisition method, assets
and liabilities assumed are recorded at their estimated fair values at the date of
acquisition. Management utilizes various valuation techniques included
discounted cash flow analyses to determine these fair values. Any excess of the
purchase price over amounts allocated to the acquired assets, including
identifiable intangible assets, and liabilities assumed is recorded as goodwill.

Goodwill - Business combinations involving the Bank’s acquisition of the equity
interests or net assets of another enterprise give rise to goodwill. Total goodwill at
December 31, 2018 and 2017 represents the excess of the purchase price of
acquired businesses over the net fair value of assets, including identified
intangible assets, acquired and liabilities assumed in the transactions accounted
for under the purchase method of accounting. The value of goodwill is ultimately
derived from the Bank’s ability to generate net earnings after the acquisitions. A
decline in net earnings could be indicative of a decline in the fair value of
goodwill and result in impairment. For that reason, goodwill is assessed at least
annually for impairment.

The Company has selected September 30 as the date to perform the annual
impairment test. Management assessed qualitative factors including performance
trends and noted no factors indicating goodwill impairment. Goodwill is also
tested for impairment between annual tests if an event occurs or circumstances
change that would more likely than not reduce the fair value of the Company
below its carrying amount. No such events or circumstances arose during the
fourth quarter of 2018, so goodwill was not required to be retested. Goodwill is
the only intangible asset with an indefinite life on our balance sheet.

Intangible Assets - The intangible assets at December 31, 2018 represent the
estimated fair value of the core deposit relationships acquired in business
combinations. Core deposit intangibles are being amortized using the straight-line
method over an estimated life of five to ten years from the date of acquisition.
Management evaluates the remaining useful lives quarterly to determine whether
events or circumstances warrant a revision to the remaining periods of
amortization. Based on the evaluation, no changes to the remaining useful lives
was required. Management performed an annual impairment test on core deposit
intangibles as of September 30, 2018 and determined no impairment was
necessary. Core deposit intangibles are also tested for impairment between annual
tests if an event occurs or circumstances change that would more likely than not
reduce the fair value below its carrying amount. No such events or circumstances
arose during the fourth quarter of 2018, so core deposit intangibles were not
required to be retested.

Loan Commitments and Related Financial Instruments - Financial instruments
include off-balance sheet credit instruments, such as commitments to make loans
and commercial letters of credit, issued to meet customer financing needs. The
face amount of these items represents the exposure to loss, before considering
customer collateral or ability to repay. Such financial instruments are recorded
when they are funded.

Income Taxes - The Company files its income taxes on a consolidated basis with
the Bank. The allocation of income tax expense represents each entity’s
proportionate share of the consolidated provision for income taxes.

Income tax expense represents the total of the current year income tax due or
refundable and the change in deferred tax assets and liabilities. Deferred tax assets
and liabilities are recognized for the tax consequences of temporary differences
between the reported amounts of assets and liabilities and their tax bases.
Deferred tax assets and liabilities are adjusted for the effects of changes in tax
laws and rates on the date of enactment. On the balance sheet, net deferred tax
assets are included in accrued interest receivable and other assets.

The realization of deferred income tax assets is assessed and a valuation

allowance is recorded if it is ‘‘more likely than not’’ that all or a portion of the
deferred tax assets will not be realized. ‘‘More likely than not’’ is defined as
greater than a 50% chance. All available evidence, both positive and negative is
considered to determine whether, based on the weight of that evidence, a
valuation allowance is needed.

Accounting for Uncertainty in Income Taxes - The Company uses a
comprehensive model for recognizing, measuring, presenting and disclosing in the
financial statements tax positions taken or expected to be taken on a tax return.
A tax position is recognized as a benefit only if it is more likely than not that the
tax position would be sustained in a tax examination, with a tax examination
being presumed to occur. The amount recognized is the largest amount of tax
benefit that is greater than 50% likely of being realized on examination. For tax
positions not meeting the more likely than not test, no tax benefit is recorded.

Interest expense and penalties associated with unrecognized tax benefits, if any,

are classified as income tax expense in the consolidated statement of income.

Retirement Plans - Employee 401(k) plan expense is the amount of employer
matching contributions. Profit sharing plan expense is the amount of employer
contributions. Contributions to the profit sharing plan are determined at the
discretion of the Board of Directors. Deferred compensation and supplemental
retirement plan expense is allocated over years of service.

Earnings Per Common Share - Basic earnings per common share (EPS), which
excludes dilution, is computed by dividing income available to common
shareholders (net income after deducting dividends, if any, on preferred stock and
accretion of discount) by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that could
occur if securities or other contracts to issue common stock, such as stock
options or warrants, result in the issuance of common stock which shares in the
earnings of the Company. All data with respect to computing earnings per share
is retroactively adjusted to reflect stock dividends and splits and the treasury
stock method is applied to determine the dilutive effect of stock options in
computing diluted EPS.

Comprehensive Income - Comprehensive income consists of net income and
other comprehensive income. Other comprehensive income includes unrealized
gains and losses on securities available for sale which are also recognized as
separate components of equity.

Loss Contingencies - Loss contingencies, including claims and legal actions arising
in the ordinary course of business, are recorded as liabilities when the likelihood
of loss is probable and an amount or range of loss can be reasonably estimated.
Management does not believe there are such matters that will have a material
effect on the financial statements.

Restrictions on Cash - Cash on hand or on deposit with the Federal Reserve
Bank was required to meet regulatory reserve and clearing requirements.

Share-Based Compensation - Compensation cost is recognized for stock options
and restricted stock awards issued to employees, based on the fair value of these
awards at the date of grant. A Black-Scholes-Merton model is utilized to estimate
the fair value of stock options, while the market price of the Company’s common
stock at the date of grant is used for restricted stock awards. Additionally, the
compensation expense for the Company’s employee stock ownership plan is based
on the market price of the shares as they are committed to be released to
participant accounts. Compensation cost is recognized over the required service
period, generally defined as the vesting period. For awards with graded vesting,

Notes to
Consolidated Financial Statements

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(Continued)

compensation cost is recognized on a straight-line basis over the requisite service
period for the entire award.

Dividend Restriction - Banking regulations require maintaining certain capital
levels and may limit the dividends paid by the Bank to the Company or by the
Company to shareholders.

Fair Value of Financial Instruments - Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed in Note 3. Fair value estimates involve uncertainties and matters of
significant judgment regarding interest rates, credit risk, prepayments, and other
factors, especially in the absence of broad markets for particular items. Changes
in assumptions or in market conditions could significantly affect these estimates.

Recently Issued Accounting Standards:

FASB Accounting Standards Update (ASU) 2014-09 - Revenue from Contracts
with Customers (Topic 606): Revenue from Contracts with Customers was issued in
May 2014. This ASU is the result of a joint project initiated by the FASB and
the International Accounting Standards Board (IASB) to clarify the principles for
recognizing revenue, and to develop common revenue standards and disclosure
requirements that would: (1) remove inconsistencies and weaknesses in revenue
requirements; (2) provide a more robust framework for addressing revenue issues;
(3) improve comparability of revenue recognition practices across entities,
industries, jurisdictions, and capital markets; (4) provide more useful information
to users of financial statements through improved disclosures; and (5) simplify
the preparation of financial statements by reducing the number of requirements
to which an entity must refer. The guidance affects any entity that either enters
into contracts with customers to transfer goods or services or enters into
contracts for the transfer of nonfinancial assets. The core principle is that an
entity should recognize revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the consideration to which the
entity expects to be entitled in exchange for those goods or services. The
guidance provides steps to follow to achieve the core principle. An entity should
disclose sufficient information to enable users of financial statements to
understand the nature, amount, timing and uncertainty of revenue and cash
flows arising from contracts with customers. Qualitative and quantitative
information is required with regard to contracts with customers, significant
judgments and changes in judgments, and assets recognized from the costs to
obtain or fulfill a contract. This ASU is effective for annual reporting periods
beginning after December 15, 2017, including interim periods therein, with early
adoption permitted for reporting periods beginning after December 15, 2016.
The Company adopted ASU 2014-09 on January 1, 2018 utilizing the modified
retrospective approach. Since the guidance does not apply to revenue associated
with financial instruments such as loans and investments, which are accounted
for under other provisions of GAAP, there was no impact to interest income, our
largest component of income. The Company adopted this ASU effective
January 1, 2018 and it did not have a material impact on the Company’s
consolidated financial position, cash flows or results of operations. No cumulative
adjustment was required upon adoption.

The Company performed an overall assessment of revenue streams potentially
affected by the ASU, including certain deposit related fees and interchange fees,
to determine the potential impact of this guidance on our consolidated financial
statements. Approximately 90% of our revenue, including all of our net interest
income and a portion of our noninterest income, is out of scope of the guidance.
The contracts that are in scope of the guidance are primarily related to service
charges and fees on deposit accounts, debit card fees, ATM processing fees, and
other service charges, commissions and fees. We have completed analyzing the
individual contracts in scope and determined our revenue recognition practices
within the scope of the ASU as described below did not change in any material
regard upon adoption of the ASU.

Service Charges on Deposit Accounts: The Company earns fees from its
deposit customers for transaction-based, account maintenance, and overdraft
services. Transaction-based fees, which include services such as ATM use fees,
stop payment charges, statement rendering, and ACH fees, are recognized at the
time the transaction is executed as that is the point in time the Company fulfills
the customer’s request. Account maintenance fees, which relate primarily to

monthly maintenance, are earned over the course of a month, representing the
period over which the Company satisfies the performance obligation. Overdraft
fees are recognized at the point in time that the overdraft occurs. Service charges
on deposits are withdrawn from the customer’s account balance.

Merchant and Debit Card Fees: The Company earns interchange fees from
cardholder transactions conducted through the payment networks. Interchange
fees from cardholder transactions represent a percentage of the underlying
transaction value and are recognized daily, concurrently with the transaction
processing services provided to the cardholder.

FASB Accounting Standards Update (ASU) 2016-01 - Financial Instruments—
Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and
Financial Liabilities, was issued January 2016. The main provisions of the update
are to eliminate the available-for-sale classification of accounting for equity
securities and to adjust the fair value disclosures for financial instruments carried
at amortized costs such that the disclosed fair values represent an exit price as
opposed to an entry price. The provisions of this update will require that equity
securities be carried at fair market value on the balance sheet and any periodic
changes in value will be adjustments to the income statement. A practical
expedient is provided for equity securities without a readily determinable fair
value, such that these securities can be carried at cost less any impairment. ASU
No. 2016-01 was effective for fiscal years beginning after December 15, 2017,
including interim periods within those fiscal years. The impact of adoption of
this ASU by the Company was not material, but did result in a reclassification of
an equity investment from securities available-for-sale to equity securities. The
Company was required to adopt the ASU provisions on January 1, 2018, and for
those equity securities with readily determinable fair values, the Company elected
the modified retrospective transition approach with a cumulative effect
adjustment to the balance sheet. The impact of the adoption of this accounting
standard on the Company’s consolidated financial statements will be subject to
the price volatility of the equity investments. As a result of the adoption,
$144,000 of after-tax unrealized losses on equity securities was reclassified on
January 1, 2018, from accumulated other comprehensive income to beginning
retained earnings. In addition, the fair value disclosures for financial instruments
in Note 3 are computed using an exit price notion as required by the ASU.

FASB Accounting Standards Update (ASU) 2016-02 - Leases—Overall
(Subtopic 845), was issued February 2016. ASU 2016-02 will, among other
things, require lessees to recognize a lease liability, which is a lessee’s obligation to
make lease payments arising from a lease, measured on a discounted basis; and a
right-of-use asset, which is an asset that represents the lessee’s right to use, or
control the use of, a specified asset for the lease term. ASU 2016-02 does not
significantly change lease accounting requirements applicable to lessors; however,
certain changes were made to align, where necessary, lessor accounting with the
lessee accounting model and ASC Topic 606, ‘‘Revenue from Contracts with
Customers.’’ ASU 2016-02 will be effective for us on January 1, 2019 and
initially required transition using a modified retrospective approach for leases
existing at, or entered into after, the beginning of the earliest comparative period
presented in the financial statements. In July 2018, the FASB issued ASU
2018-11, ‘‘Leases (Topic 842)—Targeted Improvements,’’ which, among other
things, provides an additional transition method that would allow entities to not
apply the guidance in ASU 2016-02 in the comparative periods presented in the
financial statements and instead recognize a cumulative-effect adjustment to the
opening balance of retained earnings in the period of adoption. In December
2018, the FASB also issued ASU 2018-20, ‘‘Leases (Topic 842)—Narrow-Scope
Improvements for Lessors,’’ which provides for certain policy elections and changes
lessor accounting for sales and similar taxes and certain lessor costs. As of
January 1, 2019, the Company adopted ASU 2016-02 and has recorded a
right-of-use asset and lease liability of approximately $10 million on the balance
sheet for its operating leases where it is a lessee. We elected to apply certain
practical expedients provided under ASU 2016-02 whereby we will not reassess(i)
whether any expired or existing contracts are or contain leases, (ii) the lease
classification for any expired or existing leases and (iii) initial direct costs for any
existing leases. We also do not expect to apply the recognition requirements of
ASU 2016-02 to any short-term leases (as defined by related accounting
guidance). We expect to account for lease and non-lease components separately
because such amounts are readily determinable under our lease contracts and
because we expect this election will result in a lower impact on our balance sheet.

Notes to
Consolidated Financial Statements

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(Continued)

FASB Accounting Standards Update (ASU) 2016-13 - Measurement of Credit
Losses on Financial Instruments (Subtopic 326): Financial Instruments—Credit
Losses, commonly referred to as ‘‘CECL,’’ was issued June 2016. The provisions
of the update eliminate the probable initial recognition threshold under current
GAAP which requires reserves to be based on an incurred loss methodology.
Under CECL, reserves required for financial assets measured at amortized cost
will reflect an organization’s estimate of all expected credit losses over the
contractual term of the financial asset and thereby require the use of reasonable
and supportable forecasts to estimate future credit losses. Because CECL
encompasses all financial assets carried at amortized cost, the requirement that
reserves be established based on an organization’s reasonable and supportable
estimate of expected credit losses extends to held to maturity (‘‘HTM’’) debt
securities. Under the provisions of the update, credit losses recognized on
available for sale (‘‘AFS’’) debt securities will be presented as an allowance as
opposed to a write-down. In addition, CECL will modify the accounting for
purchased loans, with credit deterioration since origination, so that reserves are
established at the date of acquisition for purchased loans. Under current GAAP a
purchased loan’s contractual balance is adjusted to fair value through a credit
discount and no reserve is recorded on the purchased loan upon acquisition.
Since under CECL reserves will be established for purchased loans at the time of
acquisition, the accounting for purchased loans is made more comparable to the
accounting for originated loans. Finally, increased disclosure requirements under
CECL require organizations to present the currently required credit quality
disclosures disaggregated by the year of origination or vintage. The FASB expects
that the evaluation of underwriting standards and credit quality trends by
financial statement users will be enhanced with the additional vintage disclosures.
For public business entities that are SEC filers, the amendments of the update
will become effective beginning January 1, 2020.

The Company has formed an internal task force that is responsible for
oversight of the Company’s implementation strategy for compliance with
provisions of the new standard. The Company has also established a project
management governance process to manage the implementation across affected
disciplines. An external provider specializing in community bank loss driver and
CECL reserving model design as well as other related consulting services has
been retained, and we have begun to evaluate potential CECL modeling
alternatives. As part of this process, the Company has determined potential loan
pool segmentation and sub-segmentation under CECL, as well as begun to
evaluate the key economic loss drivers for each segment. Further, the Company
has begun developing internal controls around the CECL process, data,
calculations and implementation. The Company presently plans to generate and
evaluate model scenarios under CECL in tandem with its current reserving
processes for interim and annual reporting periods in 2019. While the Company
is currently unable to reasonably estimate the impact of adopting this new
guidance, management expects the impact of adoption will be significantly
influenced by the composition and quality of the Company’s loans and
investment securities as well as the economic conditions as of the date of
adoption. The Company also anticipates significant changes to the processes and
procedures for calculating the reserve for credit losses and continues to evaluate
the potential impact on our consolidated financial statements.

FASB Accounting Standards Update (ASU) 2017-04 - Intangibles Goodwill and
Other (Subtopic 350): Simplifying the Test for Goodwill Impairment, was issued
January 2017. The provisions of the update eliminate the existing second step of
the goodwill impairment test which provides for the allocation of reporting unit
fair value among existing assets and liabilities, with the net leftover amount
representing the implied fair value of goodwill. In replacement of the existing
goodwill impairment rule, the update will provide that impairment should be
recognized as the excess of any of the reporting unit’s goodwill over the fair value
of the reporting unit. Under the provisions of this update, the amount of the
impairment is limited to the carrying value of the reporting unit’s goodwill. For
public business entities that are SEC filers, the amendments of the update will
become effective in fiscal years beginning after December 15, 2019 with earlier
adoption permitted. The Company adopted ASU 2017-04 effective during the
first quarter of 2019 and it did not have a material impact on the Company’s
financial position, results of operations or cash flows.

FASB Accounting Standards Update (ASU) 2017-08 - Receivables—Nonrefundable
Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased

Callable Debt Securities, was issued March 2017. The provisions of the update
require premiums recognized upon the purchase of callable debt securities to be
amortized to the earliest call date in order to avoid losses recognized upon call.
For public business entities that are SEC filers, the amendments of the update
will become effective in fiscal years beginning after December 15, 2018. The
Company adopted this ASU effective January 1, 2019 and it did not have a
material impact on the Company’s financial position, results of operations or cash
flows.

FASB Accounting Standards Update (ASU) 2017-09 - Compensation—Stock
Compensation (Subtopic 718): Scope of Modification Accounting, was issued May
2017. The amendments in ASU 2017-09 provide guidance about which changes
to the terms or conditions of a share-based payment award require an entity to
apply modification accounting. An entity should account for the effects of a
modification unless all of the following conditions are met: the fair value of the
modified award is the same as the fair value of the original award immediately
before the original award is modified; the vesting conditions of the modified
award are the same as the vesting conditions of the original award immediately
before the original award is modified; and the classification of the modified
award as an equity instrument or a liability instrument is the same as the
classification of the original award immediately before the original award is
modified. The amendments in this Update should be applied prospectively to an
award modified on or after the adoption date. The amendments in this Update
are effective for annual periods, and interim periods within those annual periods,
beginning after December 31, 2017. The Company adopted this ASU effective
January 1, 2018 and it did not have a material impact on the Company’s
Consolidated Financial Statements.

FASB Accounting Standards Update (ASU) 2018-13 - Fair Value Measurement
(Subtopic 820): Disclosure Framework—Changes to the Disclosure Requirements for
Fair Value Measurement, was issued August 2018. The primary focus of
ASU 2018-13 is to improve the effectiveness of the disclosure requirements for
fair value measurements. The changes affect all companies that are required to
include fair value measurement disclosures. In general, the amendments in
ASU 2018-13 are effective for all entities for fiscal years and interim periods
within those fiscal years, beginning after December 15, 2019. An entity is
permitted to early adopt the removed or modified disclosures upon the issuance
of ASU 2018-13 and may delay adoption of the additional disclosures, which are
required for public companies only, until their effective date. Management is
currently evaluating the impact these changes will have on the Company’s
consolidated financial statements and disclosures.

2. ACQUISITIONS

On October 1, 2017, the Company completed the acquisition of Folsom Lake
Bank (‘‘FLB’’) for an aggregate transaction value of $28,475,000. FLB was
merged into the Bank, and the Company issued 1,276,888 shares of common
stock to the former shareholders of FLB. The Company also assumed the
outstanding FLB stock options. With the FLB acquisition, the Company added
two full service branches, located in Folsom, and Rancho Cordova, California.
The FLB Roseville branch was consolidated with the Company’s Roseville branch
in October 2017. FLB’s assets as of October 1, 2017 totaled approximately
$196,148,000.

In accordance with GAAP guidance for business combinations, the Company
recorded $13,466,000 of goodwill and $1,879,000 of other intangible assets on
the acquisition date. The other intangible assets are primarily related to core
deposits and are being amortized using a straight-line method over a period of
five years with no significant residual value. For tax purposes, purchase
accounting adjustments including goodwill are all non-taxable and/or
non-deductible. Acquisition related costs of $217,000 and $1,828,000 are
included in the income statement for the years ended December 31, 2018 and
2017, respectively.

The acquisition was consistent with the Company’s strategy to build a regional

presence in Central California. The acquisition offers the Company the
opportunity to increase profitability by introducing existing products and services
to the acquired customer base as well as add new customers in the expanded
region. Goodwill arising from the acquisition consisted largely of synergies and
the expected cost savings resulting from the combined operations.

Notes to
Consolidated Financial Statements

2. ACQUISITIONS (Continued)

The following table summarizes the consideration paid for FLB and the

amounts of the assets acquired and liabilities assumed recognized at the
acquisition date (in thousands):

Merger consideration:

Common stock issued . . . . . . . . . . . . . . . . . . . . . . . . .

$ 28,475

Fair Value of Total Consideration Transferred . . . . . . . . . . . . .

$ 28,475

Recognized amounts of identifiable assets acquired and liabilities

assumed:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Loans, net
Investments
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Core deposit intangible . . . . . . . . . . . . . . . . . . . . . . . . .
Premises and equipment
. . . . . . . . . . . . . . . . . . . . . . . .
Federal Home Loan Bank stock . . . . . . . . . . . . . . . . . . . .
Deferred taxes and taxes receivable . . . . . . . . . . . . . . . . . .
Bank owned life insurance . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets

$ 26,279
117,815
41,280
1,879
561
1,559
2,186
3,997
592

Total assets acquired . . . . . . . . . . . . . . . . . . . . . . . . .

196,148

Deposits
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deposit premium . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Short-term borrowings—Federal Home Loan Bank . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities

171,948
132
7,000
2,059

Total liabilities assumed . . . . . . . . . . . . . . . . . . . . . . .

181,139

Total identifiable net assets . . . . . . . . . . . . . . . . . . . .

15,009

Goodwill

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 13,466

The fair value of net assets acquired includes fair value adjustments to certain
loans that were not considered impaired as of the acquisition date. The fair value
adjustments were determined using discounted contractual cash flows. As such,
these loans were not considered impaired at the acquisition date and were not
subject to the guidance relating to purchased credit impaired loans, which have
shown evidence of credit deterioration since origination. Loans acquired that were
not subject to these requirements include non-impaired loans and customer
receivables with a fair value and gross contractual amounts receivable of
$117,815,000 and $121,872,000, respectively, on the date of acquisition. See
Note 5 for discussion of purchased credit impaired loans.

On October 1, 2016, the Company acquired Sierra Vista Bank, headquartered

in Folsom, California, wherein Sierra Vista Bank, with one branch in Folsom,
one branch in Fair Oaks, and one branch in Cameron Park, merged with and
into Central Valley Community Bancorp’s subsidiary, Central Valley Community
Bank, in a combined cash and stock transaction. Sierra Vista Bank’s assets as of
October 1, 2016 totaled approximately $155,154,000. The acquired assets and
liabilities were recorded at fair value at the date of acquisition. Under the terms
of the merger agreement, the Company issued an aggregate of approximately
1,058,851 shares of its common stock and cash totaling approximately
$9,468,000 to the former shareholders of Sierra Vista Bank.

In accordance with GAAP guidance for business combinations, the Company
recorded $10,314,000 of goodwill and $508,000 of other intangible assets on the
acquisition date. The other intangible assets are primarily related to core deposits
and are being amortized using a straight-line method over a period of five years
with no significant residual value. For tax purposes, purchase accounting
adjustments including goodwill are all non-taxable and/or non-deductible.
Acquisition related costs of $1,782,000 are included in the income statement for
the year ended December 31, 2016.

The acquisition was consistent with the Company’s strategy to build a regional

presence in Central California. The acquisition offers the Company the

opportunity to increase profitability by introducing existing products and services
to the acquired customer base as well as add new customers in the expanded
region. Goodwill arising from the acquisition consisted largely of synergies and
the cost savings resulting from the combined operations.

The following table summarizes the consideration paid for Sierra Vista Bank
and the amounts of the assets acquired and liabilities assumed recognized at the
acquisition date (in thousands):

Merger consideration:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Common stock issued . . . . . . . . . . . . . . . . . . . . . . . . .

9,468
16,793

Fair Value of Total Consideration Transferred . . . . . . . . . . . . .

$ 26,261

Recognized amounts of identifiable assets acquired and liabilities

assumed:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . .
Loans, net
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Core deposit intangible . . . . . . . . . . . . . . . . . . . . . . . . .
Premises and equipment
. . . . . . . . . . . . . . . . . . . . . . . .
Federal Home Loan Bank stock . . . . . . . . . . . . . . . . . . . .
Deferred taxes and taxes receivable . . . . . . . . . . . . . . . . . .
Bank owned life insurance . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other assets

$ 22,709
122,533
508
586
771
4,417
2,664
966

Total assets acquired . . . . . . . . . . . . . . . . . . . . . . . . .

155,154

Deposits
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deposit premium . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other liabilities

138,236
142
829

Total liabilities assumed . . . . . . . . . . . . . . . . . . . . . . .

139,207

Total identifiable net assets . . . . . . . . . . . . . . . . . . . .

15,947

Goodwill

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 10,314

The fair value of net assets acquired includes fair value adjustments to certain
loans that were not considered impaired as of the acquisition date. The fair value
adjustments were determined using discounted contractual cash flows. As such,
these loans were not considered impaired at the acquisition date and were not
subject to the guidance relating to purchased credit impaired loans, which have
shown evidence of credit deterioration since origination. Loans acquired that were
not subject to these requirements include non-impaired loans and customer
receivables with a fair value and gross contractual amounts receivable of
$121,902,000 and $124,396,000, respectively, on the date of acquisition. See
Note 5 for discussion of purchased credit impaired loans.

Pro Forma Results of Operations

The accompanying consolidated financial statements include the accounts of
Sierra Vista Bank since October 1, 2016 and Folsom Lake Bank since October 1,
2017. The following table presents pro forma results of operations information
for the periods presented as if the acquisitions had occurred on January 1, 2016
after giving effect to certain adjustments. The unaudited pro forma results of
operations for the years ended December 31, 2017 and 2016 include the
historical accounts of the Company, Folsom Lake Bank, and Sierra Vista Bank
and pro forma adjustments as may be required, including the amortization of
intangibles with definite lives and the amortization or accretion of any premiums
or discounts arising from fair value adjustments for assets acquired and liabilities
assumed. The pro forma information is intended for informational purposes only
and is not necessarily indicative of the Company’s future operating results or
operating results that would have occurred had the acquisitions been completed
at the beginning of each respective year. No assumptions have been applied to
the pro forma results of operations regarding possible revenue enhancements,

Notes to
Consolidated Financial Statements

2. ACQUISITIONS

(Continued)

The estimated carrying and fair values of the Company’s financial instruments

expense efficiencies or asset dispositions. (In thousands, except per-share
amounts):

Net interest income . . . . . . . . . . . . . . . . . . . . . .
Provision for (reversal of ) credit losses
. . . . . . . . . . .
Non-interest income . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . .
Non-interest expense

Income before provision for income taxes . . . . . . . . . .
. . . . . . . . . . . . . . . . . .
Provision for income taxes

For the Years Ended
December 31,

2017

2016

$61,059
(1,150)
11,240
51,415

22,034
9,168

$56,531
(5,800)
10,205
52,131

20,405
6,381

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . .

$12,866

$14,024

Net income available to common shareholders . . . . . . .

$12,866

$14,024

Basic earnings per common share . . . . . . . . . . . . . .

Diluted earnings per common share . . . . . . . . . . . . .

1.03

1.01

1.24

1.23

FAIR VALUE MEASUREMENTS

Fair Value Hierarchy

Fair value is the exchange price that would be received for an asset or paid to
transfer a liability (exit price) in the principal or most advantageous market for
the asset or liability in an orderly transaction between market participants on the
measurement date. In accordance with applicable guidance, the Company groups
its assets and liabilities measured at fair value in three levels, based on the
markets in which the assets and liabilities are traded and the reliability of the
assumptions used to determine fair value. Valuations within these levels are based
upon:

are as follows (in thousands):

December 31, 2018

Fair Value

Level 1

Level 2

Level 3

Total

Carrying
Amount

Financial assets:

Cash and due from

banks

$ 24,954 $ 24,954 $

- $

- $ 24,954

Interest-earning

deposits in other
banks

Federal funds sold
Available-for-sale
investment
securities
Equity securities
Loans, net
Federal Home Loan

Bank stock
Accrued interest
receivable
Financial liabilities:

Deposits
Short-term

borrowings

Junior subordinated
deferrable interest
debentures
Accrued interest

payable

6,725
48

-
-

6,725
48

463,905
7,254
909,591

6,843

6,429

-
7,254
-

463,905
-
-

-
-
899,214

463,905
7,254
899,214

N/A

2,323

4,074

6,429

1,282,298 1,031,369

95,633

- 1,127,002

10,000

5,155

134

Carrying
Amount

10,000

4,114

134

December 31, 2017

Fair Value

Level 1

Level 2

Level 3

Total

Level - 1 Quoted market prices (unadjusted) for identical instruments traded
in active exchange markets that the Company has the ability to access as of the
measurement date.

Financial assets:

Cash and due from

banks

38,286 $

- $

38,286

Level - 2 Quoted prices for similar instruments in active markets, quoted
prices for identical or similar instruments in markets that are not active, and
model-based valuation techniques for which all significant assumptions are
observable or can be corroborated by observable market data.

Level - 3 Model-based techniques that use at least one significant assumption

not observable in the market. These unobservable assumptions reflect the
Company’s estimates of assumptions that market participants would use on
pricing the asset or liability. Valuation techniques include management judgment
and estimation which may be significant.

Management monitors the availability of observable market data to assess the
appropriate classification of financial instruments within the fair value hierarchy.
Changes in economic conditions or model-based valuation techniques may
require the transfer of financial instruments from one fair value level to another.
In such instances, we report the transfer at the beginning of the reporting period.

Interest-earning deposits

in other banks
Federal funds sold
Available-for-sale

investment securities

Equity securities
Loans, net
Federal Home Loan

Bank stock
Accrued interest
receivable
Financial liabilities:

Deposits
Junior subordinated
deferrable interest
debentures

Accrued interest payable

62,080
17

535,281
7,423
891,901

6,843

7,168

62,080
17

-
7,423
-

-
-

535,281
-
-

-
-
899,191

62,080
17

535,281
7,423
899,191

N/A

3,256

3,855

7,168

1,425,687

1,296,048

127,966

1,424,014

5,155
110

-
-

-
72

3,550
38

3,550
110

These estimates do not reflect any premium or discount that could result from

offering the Company’s entire holdings of a particular financial instrument for
sale at one time, nor do they attempt to estimate the value of anticipated future
business related to the instruments. In addition, the tax ramifications related to
the realization of unrealized gains and losses can have a significant effect on fair
value estimates and have not been considered in any of these estimates.

These estimates are made at a specific point in time based on relevant market
data and information about the financial instruments. Because no market exists
for a significant portion of the Company’s financial instruments, fair value
estimates are based on judgments regarding current economic conditions, risk
characteristics of various financial instruments and other factors. These estimates
are subjective in nature and involve uncertainties and matters of significant

Notes to
Consolidated Financial Statements

FAIR VALUE MEASUREMENTS

(Continued)

judgment and therefore cannot be determined with precision. Changes in
assumptions could significantly affect the fair values presented.

The methods and assumptions used to estimate fair values are described as

follows:

(a) Cash and Cash Equivalents - The carrying amounts of cash and due from
banks, interest-earning deposits in other banks, and Federal funds sold
approximate fair values and are classified as Level 1.

(b) Investment Securities - Investment securities in Level 1 are mutual funds and
fair values are based on quoted market prices for identical instruments traded in
active markets. Fair values for investment securities classified in Level 2 are based
on quoted market prices for similar securities in active markets. For securities
where quoted prices or market prices of similar securities are not available, fair
values are calculated using discounted cash flows or other market indicators.

(c) Loans - Fair values of loans are estimated as follows: For variable rate loans
that reprice frequently and with no significant change in credit risk, fair values
are based on carrying values resulting in a Level 3 classification. Purchased credit
impaired (PCI) loans are measured at estimated fair value on the date of
acquisition. Carrying value is calculated as the present value of expected cash
flows and approximates fair value and included in Level 3. Fair values for other
loans are estimated using discounted cash flow analyses, using interest rates
currently being offered for loans with similar terms to borrowers of similar credit
quality resulting in a Level 3 classification. Impaired loans are initially valued at
the lower of cost or fair value. Impaired loans carried at fair value generally
receive specific allocations of the allowance for credit losses. For collateral
dependent real estate loans, fair value is commonly based on recent real estate
appraisals. These appraisals may utilize a single valuation approach or a
combination of approaches including comparable sales and the income approach.
Adjustments are routinely made in the appraisal process by the independent
appraisers to adjust for differences between the comparable sales and income data
available. Such adjustments are usually significant and typically result in a Level 3
classification of the inputs for determining fair value. Non-real estate collateral
may be valued using an appraisal, net book value per the borrower’s financial
statements, or aging reports, adjusted or discounted based on management’s
historical knowledge, changes in market conditions from the time of the
valuation, and management’s expertise and knowledge of the client and client’s
business, resulting in a Level 3 fair value classification. Impaired loans are
evaluated on a quarterly basis for additional impairment and adjusted accordingly.
The estimated fair values of financial instruments disclosed above as of
December 31, 2018 follow the guidance in ASU 2016-01 which prescribes an
‘‘exit price’’ approach in estimating and disclosing fair value of financial
instruments incorporating discounts for credit, liquidity, and marketability
factors. The fair values shown as of December 31, 2017 use an ‘‘entry price’’
approach.

(d) FHLB Stock - It is not practicable to determine the fair value of FHLB stock
due to restrictions placed on its transferability.

(e) Deposits - Fair value of demand deposit, savings, and money market accounts
are, by definition, equal to the amount payable on demand at the reporting date
(i.e., their carrying amount) resulting in a Level 1 classification. Fair value for
fixed and variable rate certificates of deposit are estimated using discounted cash
flow analyses using interest rates offered at each reporting date by the Company
for certificates with similar remaining maturities resulting in a Level 2
classification.

(f) Short-Term Borrowings - The carrying amounts of federal funds purchased,
borrowings under repurchase agreements, and other short-term borrowings,
generally maturing within ninety days, approximate their fair values resulting in a
Level 2 classification.

The fair values of the Company’s Subordinated Debentures are estimated using

discounted cash flow analyses based on the current borrowing rates for similar
types of borrowing arrangements resulting in a Level 3 classification.

(g) Accrued Interest Receivable/Payable - The fair value of accrued interest
receivable and payable is based on the fair value hierarchy of the related asset or
liability.

(h) Off-Balance Sheet Instruments - Fair values for off-balance sheet, credit-
related financial instruments are based on fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements
and the counterparties’ credit standing. The fair value of commitments is not
material.

Assets Recorded at Fair Value

The following tables present information about the Company’s assets and
liabilities measured at fair value on a recurring and non-recurring basis as of
December 31, 2018:

Recurring Basis

The Company is required or permitted to record the following assets at fair

value on a recurring basis under other accounting pronouncements (in
thousands):

Fair
Value

Level 1

Level 2

Level 3

Available-for-sale investment

securities
Debt Securities:

U.S. Government agencies $
Obligations of states and
political subdivisions

U.S. Government

sponsored entities and
agencies collateralized
by residential mortgage
obligations

Private label mortgage and
asset backed securities

Equity Securities

21,321 $

- $

21,321 $

81,504

234,930

126,150
7,254

-
7,254

81,504

234,930

126,150
-

Total assets measured at

fair value on a
recurring basis

$ 471,159 $

7,254 $ 463,905 $

-
-

Securities in Level 1 are mutual funds and fair values are based on quoted
market prices for identical instruments traded in active markets. Fair values for
available-for-sale investment securities in Level 2 are based on quoted market
prices for similar securities in active markets. For securities where quoted prices
or market prices of similar securities are not available, fair values are calculated
using discounted cash flows or other market indicators.

Management evaluates the significance of transfers between levels based upon

the nature of the financial instrument and size of the transfer relative to total
assets, total liabilities or total earnings. During the year ended December 31,
2018, no transfers between levels occurred.

There were no Level 3 assets measured at fair value on a recurring basis at
December 31, 2018. Also there were no liabilities measured at fair value on a
recurring basis at December 31, 2018.

Non-recurring Basis

The Company may be required, from time to time, to measure certain assets
and liabilities at fair value on a non-recurring basis. These include the following
assets and liabilities that are measured at the lower of cost or fair value that were

Notes to
Consolidated Financial Statements

FAIR VALUE MEASUREMENTS

(Continued)

Recurring Basis

recognized at fair value which was below cost at December 31, 2018 (in
thousands):

The Company is required or permitted to record the following assets at fair

value on a recurring basis under other accounting pronouncements (in
thousands):

Fair
Value

Level 1

Level 2

Level 3

Impaired loans:
Real estate:

Commercial real estate

Total assets measured at fair
value on a non-recurring
basis

134 $

- $

134

134 $

- $

134

Available-for-sale securities
Debt Securities:

U.S. Government agencies $
Obligations of states and
political subdivisions

U.S. Government

At the time a loan is considered impaired, it is valued at the lower of cost or
fair value. Impaired loans carried at fair value generally receive specific allocations
of the allowance for credit losses. For collateral dependent loans, fair value is
commonly based on recent real estate appraisals. These appraisals may utilize a
single valuation approach or a combination of approaches including comparable
sales and the income approach. Adjustments are routinely made in the appraisal
process by the independent appraisers to adjust for differences between the
comparable sales and income data available. Such adjustments are usually
significant and typically result in a Level 3 classification of the inputs for
determining fair value. Non-real estate collateral may be valued using an
appraisal, net book value per the borrower’s financial statements, or aging reports,
adjusted or discounted based on management’s historical knowledge, changes in
market conditions from the time of the valuation, and management’s expertise
and knowledge of the client and client’s business, resulting in a Level 3 fair value
classification. The fair value of impaired loans is based on the fair value of the
collateral. Impaired loans were determined to be collateral dependent and
categorized as Level 3 due to ongoing real estate market conditions resulting in
inactive market data, which in turn required the use of unobservable inputs and
assumptions in fair value measurements. Impaired loans evaluated under the
discounted cash flow method are excluded from the table above. The discounted
cash flow method as prescribed by ASC 310 is not a fair value measurement
since the discount rate utilized is the loan’s effective interest rate which is not a
market rate. There were no changes in valuation techniques used during the year
ended December 31, 2018.

Appraisals for collateral-dependent impaired loans are performed by certified
general appraisers (for commercial properties) or certified residential appraisers
(for residential properties) whose qualifications and licenses have been reviewed
and verified by the Company. Once received, the assumptions and approaches
utilized in the appraisal as well as the overall resulting fair value is compared with
independent data sources such as recent market data or industry-wide statistics.
Impaired loans that are measured for impairment using the fair value of the

collateral for collateral dependent loans in which the collateral value did not
exceed the loan balance had a principal balance of $161,000 with a valuation
allowance of $27,000 at December 31, 2018, resulting in a fair value of
$134,000. The valuation allowance represent specific allocation for the allowance
for credit losses for impaired loans.

During the year ended December 31, 2018 specific allocation for the
allowance for credit losses related to loans carried at fair value was $27,000,
compared to none during the year ended December 31, 2017. There were no net
charge-offs related to loans carried at fair value at December 31, 2018 and 2017.
There were no liabilities measured at fair value on a non-recurring basis at

December 31, 2018.

The following two tables present information about the Company’s assets and

liabilities measured at fair value on a recurring and nonrecurring basis as of
December 31, 2017:

Fair
Value

Level 1

Level 2

Level 3

66,587 $

- $

66,587 $

143,105

234,908

143,105

234,908

90,681
7,423

-
7,423

90,681
-

-
-

sponsored entities and
agencies collateralized
by residential mortgage
obligations

Private label residential
mortgage and asset
backed securities
Other equity securities

Total assets measured at

fair value on a recurring
basis

$ 542,704 $

7,423 $ 535,281 $

Management evaluates the significance of transfers between levels based upon

the nature of the financial instrument and size of the transfer relative to total
assets, total liabilities or total earnings. During the year ended December 31,
2017, no transfers between levels occurred.

There were no Level 3 assets measured at fair value on a recurring basis at
December 31, 2017. Also there were no liabilities measured at fair value on a
recurring basis at December 31, 2017.

Non-recurring Basis

Other repossessed assets

Total assets measured at

fair value on a
non-recurring basis

Fair
Value

Level 1

Level 2

Level 3

70 $

- $

70 $

- $

As of December 31, 2017, there were no loans measured using the fair value

of the collateral for collateral dependent loans.

There were no liabilities measured at fair value on a non-recurring basis at

December 31, 2017.

Notes to
Consolidated Financial Statements

INVESTMENT SECURITIES

The fair value of the available-for-sale investment portfolio reflected an

unrealized loss of $(6,257,000) at December 31, 2018 compared to an unrealized
gain of $4,089,000 at December 31, 2017. The unrealized (loss)/gain recorded is
net of $(1,850,000) and $1,186,000 in tax (benefits) liabilities as accumulated
other comprehensive income within shareholders’ equity at December 31, 2018
and 2017, respectively.

The following tables set forth the carrying values and estimated fair values of

our investment securities portfolio at the dates indicated (in thousands):

December 31, 2018

Gross
Amortized Unrealized Unrealized
Gains

Losses

Gross

Cost

Estimated
Fair Value

Available-for-Sale Securities
Debt Securities:

U.S. Government agencies $
Obligations of states and
political subdivisions

U.S. Government

sponsored entities and
agencies collateralized
by residential mortgage
obligations

Private label mortgage and
asset backed securities

21,723 $

- $

(402) $

21,321

79,886

2,205

(587)

81,504

239,388

129,165

253

756

(4,711)

234,930

(3,771)

126,150

Available-for-Sale Securities
Debt Securities:
U.S. Government agencies
Obligations of states and
political subdivisions

U.S. Government sponsored

entities and agencies
collateralized by residential
mortgage obligations
Private label residential

mortgage and asset backed
securities

$ 470,162 $

3,214 $

(9,471) $ 463,905

December 31, 2017

Gross
Amortized Unrealized Unrealized
Gains

Losses

Gross

Cost

Estimated
Fair Value

Available-for-Sale Securities
Debt Securities:

U.S. Government agencies $
Obligations of states and
political subdivisions

U.S. Government

sponsored entities and
agencies collateralized
by residential mortgage
obligations

Private label mortgage and
asset backed securities

65,994 $

667 $

(74) $

66,587

136,955

6,240

(90)

143,105

237,210

91,033

601

924

(2,903)

234,908

(1,276)

90,681

$ 531,192 $

8,432 $

(4,343) $ 535,281

Proceeds and gross realized gains (losses) on investment securities for the years

ended December 31, 2018, 2017, and 2016 are shown below (in thousands):

Years Ended December 31,

2018

2017

2016

Available-for-Sale Securities
Proceeds from sales or calls
Gross realized gains from sales or calls
Gross realized losses from sales or calls

Held-to-Maturity Securities
Proceeds from sales and calls
Gross realized gains from sales or calls

$ 167,163
$ 228,405
$ 246,824
2,223
4,701
1,976
$
$
$
(999)
(1,899) $
(662) $
$

$
$

— $
— $

9,257
696

Losses recognized in 2018, 2017, and 2016 were incurred in order to

reposition the investment securities portfolio based on the current rate

environment. The securities which were sold at a loss were acquired when the
rate environment was not as volatile. The securities which were sold were
primarily purchased several years ago to serve a purpose in the rate environment
in which the securities were purchased. The Company addressed risks in the
security portfolio by selling these securities and using the proceeds to purchase
securities that fit with the Company’s current risk profile.

The provision (benefit) for income taxes includes $388,000, $1,178,000, and
$515,000 income tax impact from the reclassification of unrealized net gains on
available-for-sale securities to realized net gains on available-for-sale securities for
the years ended December 31, 2018, 2017, and 2016, respectively.

Investment securities with unrealized losses at December 31, 2018 and 2017

are summarized and classified according to the duration of the loss period as
follows (in thousands):

December 31, 2018

Less than 12 Months 12 Months or More

Total

Fair
Value

Unrealized
Losses

Fair
Value

Unrealized
Losses

Fair
Value

Unrealized
Losses

$ 14,891 $

(254) $

6,430 $

(148) $ 21,321 $

(402)

10,056

(99)

22,945

(488)

33,001

(587)

61,866

(424)

124,673

(4,287)

186,539

(4,711)

31,325

(195)

84,784

(3,576)

116,109

(3,771)

$ 118,138 $

(972) $ 238,832 $

(8,499) $ 356,970 $

(9,471)

December 31, 2017

Less than 12 Months 12 Months or More

Total

Fair
Value

Unrealized
Losses

Fair
Value

Unrealized
Losses

Fair
Value

Unrealized
Losses

8,201 $

(47) $

6,741 $

(27) $ 14,942 $

1,627

(3)

3,357

(87)

4,984

(74)

(90)

82,604

(822)

64,488

(2,081)

147,092

(2,903)

88,312

(1,276)

—

— 88,312

(1,276)

$ 180,744 $

(2,148) $ 74,586 $

(2,195) $ 255,330 $

(4,343)

Available-for-Sale Securities
Debt Securities:
U.S. Government agencies
Obligations of states and
political subdivisions

U.S. Government sponsored

entities and agencies
collateralized by
residential mortgage
obligations

Private label residential
mortgage backed
securities

We periodically evaluate each investment security for other-than-temporary
impairment, relying primarily on industry analyst reports, observation of market
conditions and interest rate fluctuations. The portion of the impairment that is
attributable to a shortage in the present value of expected future cash flows
relative to the amortized cost should be recorded as a current period charge to
earnings. The discount rate in this analysis is the original yield expected at time
of purchase.

As of December 31, 2018, the Company performed an analysis of the
investment portfolio to determine whether any of the investments held in the
portfolio had an other-than-temporary impairment (OTTI). Management
evaluated all investment securities with an unrealized loss at December 31, 2018,
and identified those that had an unrealized loss for at least a consecutive
12 month period, which had an unrealized loss at December 31, 2018 greater
than 10% of the recorded book value on that date, or which had an unrealized
loss of more than $10,000. Management also analyzed any securities that may
have been downgraded by credit rating agencies.

For those bonds that met the evaluation criteria, management obtained and
reviewed the most recently published national credit ratings for those bonds. For

Notes to
Consolidated Financial Statements

INVESTMENT SECURITIES

(Continued)

those bonds that were obligations of states and political subdivisions with an
investment grade rating by the rating agencies, management also evaluated the
financial condition of the municipality and any applicable municipal bond
insurance provider and concluded during March 2016 that a $136,000 credit
related impairment related to one security with a fair value of $2,995,000 and a
pre-impairment amortized cost of $3,131,000 existed. The Company recorded an
other-than-temporary impairment loss of $136,000 during the twelve months
ended December 31, 2016. There were no OTTI losses recorded during the
twelve months ended December 31, 2018 or December 31,2017.

U.S. Government Agencies - At December 31, 2018, the Company held six U.S.
Government agency securities of which four were in a loss position for less than
12 months and two were in a loss position and had been in a loss position for
12 months or more. The unrealized losses on the Company’s investments in U.S.
Government Agencies were caused by interest rate changes. The contractual terms
of those investments do not permit the issuer to settle the securities at a price
less than the amortized costs of the investment. Because the decline in market
value is attributable to changes in interest rates and not credit quality, and
because the Company does not intend to sell, and it is more likely than not that
it will not be required to sell those investments until a recovery of fair value,
which may be maturity, the Company does not consider those investments to be
other-than-temporarily impaired at December 31, 2018.

Obligations of States and Political Subdivisions - At December 31, 2018, the
Company held 52 obligations of states and political subdivision securities of
which two were in a loss position for less than 12 months and eight were in a
loss position or had been in a loss position for 12 months or more. The
unrealized losses on the Company’s investments in obligations of states and
political subdivision securities were caused by interest rate changes. Because the
decline in market value is attributable to changes in interest rates and not credit
quality, and because the Company does not intend to sell, and it is more likely
than not that it will not be required to sell those investments until a recovery of
fair value, which may be maturity, the Company does not consider those
investments to be other-than-temporarily impaired at December 31, 2018.

U.S. Government Sponsored Entities and Agencies Collateralized by Residential
Mortgage Obligations - At December 31, 2018, the Company held 137 U.S.
Government sponsored entity and agency securities collateralized by residential
mortgage obligation securities of which 23 were in a loss position for less than
12 months and 60 have been in a loss position for more than 12 months. The
unrealized losses on the Company’s investments in U.S. Government sponsored
entity and agencies collateralized by residential mortgage obligations were caused
by interest rate changes. The contractual cash flows of those investments are
guaranteed or supported by an agency or sponsored entity of the U.S.
Government. Accordingly, it is expected that the securities would not be settled
at a price less than the amortized cost of the Company’s investment. Because the
decline in market value is attributable to changes in interest rates and not credit
quality, and because the Company does not intend to sell, and it is more likely
than not that it will not be required to sell those investments until a recovery of
fair value, which may be maturity, the Company does not consider those
investments to be other-than-temporarily impaired at December 31, 2018.

Private Label Mortgage and Asset Backed Securities - At December 31, 2018, the
Company had a total of 36 PLMBS with a remaining principal balance of
$129,165,000 and a gross and net unrealized loss of approximately $3,016,000.

Seven of these securities were in a loss position for less than 12 months and 18
have been in a loss position for more than 12 months at December 31, 2018.
Eight of these PLMBS with a remaining principal balance of $1,137,000 had
credit ratings below investment grade. The Company continues to monitor these
securities for changes in credit ratings or other indications of credit deterioration.
Because the decline in market value is attributable to changes in interest rates
and not credit quality, and because the Company does not intend to sell, and it
is more likely than not that it will not be required to sell those investments until
a recovery of fair value, which may be maturity, the Company does not consider
those investments to be other-than-temporarily impaired at December 31, 2018.
The following table provides a rollforward for the years ended December 31,

2018 and 2017 of investment securities credit losses recorded in earnings (in
thousands). The beginning balance represents the credit loss component for
which OTTI occurred on debt securities in prior periods. Additions represent the
first time a debt security was credit impaired or when subsequent credit
impairments have occurred on securities for which OTTI credit losses have been
previously recognized.

Beginning balance of credit losses recognized
Amounts related to credit loss for which an OTTI

charge was not previously recognized

Realized losses for securities sold

Ending balance of credit losses recognized

Years ended
December 31,

2018

2017

874

—
—

874

The amortized cost and estimated fair value of available-for-sale investment
securities at December 31, 2018 and 2017 by contractual maturity are shown in
the two tables below (in thousands). Expected maturities will differ from
contractual maturities because the issuers of the securities may have the right to
call or prepay obligations with or without call or prepayment penalties.

December 31, 2018

December 31, 2017

Amortized Estimated Amortized Estimated
Fair Value

Fair Value

Cost

Within one year
After one year through five years
After five years through ten years
After ten years

Investment securities not due at a single maturity date:

Treasuries
U.S. Government agencies
U.S. Government sponsored entities and agencies

collateralized by residential mortgage obligations

Private label mortgage and asset backed securities

— $

2,769
21,831
55,286

2,899
22,278
56,327

1,893 $
7,149
22,043
105,870

1,914
7,316
22,696
111,179

79,886

81,504

136,955

143,105

—
21,723

—
21,321

—
65,994

—
66,587

239,388
129,165

234,930
126,150

237,210
91,033

234,908
90,681

$ 470,162 $ 463,905 $ 531,192 $ 535,281

Investment securities with amortized costs totaling $80,001,000 and

$88,930,000 and fair values totaling $79,662,000 and $90,541,000 were pledged
as collateral for borrowing arrangements, public funds and for other purposes at
December 31, 2018 and 2017, respectively.

Notes to
Consolidated Financial Statements

LOANS AND ALLOWANCE FOR CREDIT LOSSES

Outstanding loans are summarized as follows (in thousands):

% of
December 31, Total
loans

2018

% of
December 31, Total
loans

2017

$286,934,000 as of December 31, 2018. The Bank’s credit limit varies according
to the amount and composition of the investment and loan portfolios pledged as
collateral.

Salaries and employee benefits totaling $2,453,000, $2,593,000, and
$2,344,000 have been deferred as loan origination costs for the years ended
December 31, 2018, 2017, and 2016, respectively.

Allowance for Credit Losses

Loan Type

Commercial:

Commercial and
industrial

Agricultural production

Real estate:

Owner occupied
Real estate construction
and other land loans
Commercial real estate
Agricultural real estate
Other real estate

Consumer:

Equity loans and lines of

credit

Consumer and
installment

Total consumer
Net deferred origination

costs

Total gross loans
Allowance for credit losses

101,533
7,998

11.1% $
0.9%

100,856
14,956

11.2%
1.7%

The allowance for credit losses (the ‘‘allowance’’) is a valuation allowance for
probable incurred credit losses in the Company’s loan portfolio. The allowance is
established through a provision for credit losses which is charged to expense.

Total commercial

109,531

12.0%

115,812

12.9% Additions to the allowance are expected to maintain the adequacy of the total

183,169

19.9%

204,452

22.7% uncollectible are charged against the allowance. Cash received on previously

allowance after credit losses and loan growth. Credit exposures determined to be

101,606
305,118
76,884
32,799

699,576

11.1%
33.2%
8.4%
3.6%

76.2%

96,460
269,254
76,081
31,220

677,467

75.2%

69,958

7.6%

76,404

8.5%

38,038

4.2%

29,637

3.4%

charged-off credits is recorded as a recovery to the allowance. The overall
10.7% allowance consists of two primary components, specific reserves related to
29.9% impaired loans and general reserves for probable incurred losses related to loans
8.4% that are not impaired.
3.5%

For all portfolio segments, the determination of the general reserve for loans
that are not impaired is based on estimates made by management, including but
not limited to, consideration of historical losses by portfolio segment (and in
certain cases peer loss data) over the most recent 20 quarters, and qualitative
factors including economic trends in the Company’s service areas, industry
experience and trends, geographic concentrations, estimated collateral values, the
Company’s underwriting policies, the character of the loan portfolio, and
probable losses inherent in the portfolio taken as a whole.

107,996

11.8%

106,041

11.9%

Changes in the allowance for credit losses were as follows (in thousands):

1,592

918,695
(9,104)

100.0%

1,359

900,679
(8,778)

100.0%

Total loans

909,591

891,901

At December 31, 2018 and 2017, loans originated under Small Business

Administration (SBA) programs totaling $22,297,000 and $25,925,000,
respectively, were included in the real estate and commercial categories.
Approximately $447,757,000 in loans were pledged under a blanket lien as
collateral to the FHLB for the Bank’s remaining borrowing capacity of

Balance, beginning of year

Provision (reversal) charged to

operations

Losses charged to allowance
Recoveries

Years Ended December 31,

2018

2017

2016

8,778

9,326

9,610

50
(210)
486

(1,150)
(464)
1,066

(5,850)
(883)
6,449

Balance, end of year

9,104

8,778

9,326

The following table shows the summary of activities for the allowance for credit losses as of and for the years ended December 31, 2018, 2017, and 2016 by

portfolio segment (in thousands):

Allowance for credit losses:
Beginning balance, January 1, 2018

(Reversal) provision charged to operations
Losses charged to allowance
Recoveries

Ending balance, December 31, 2018

Allowance for credit losses:
Beginning balance, January 1, 2017

(Reversal) provision charged to operations
Losses charged to allowance
Recoveries

Ending balance, December 31, 2017

Allowance for credit losses:
Beginning balance, January 1, 2016

(Reversal) provision charged to operations
Losses charged to allowance
Recoveries

Ending balance, December 31, 2016

Commercial

Real Estate

Consumer

Unallocated

Total

2,071
(513)
(94)
207

1,671

2,180
(762)
(207)
860

2,071

3,562
(6,048)
(621)
5,287

5,795
642
—
102

6,539

6,200
(449)
(22)
66

5,795

5,204
11
—
985

825
(60)
(116)
177

826

852
68
(235)
140

825

734
203
(262)
177

87
(19)
—
—

94
(7)
—
—

110
(16)
—
—

8,778
50
(210)
486

9,104

9,326
(1,150)
(464)
1,066

8,778

9,610
(5,850)
(883)
6,449

2,180

6,200

852

9,326

Notes to
Consolidated Financial Statements

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The following is a summary of the allowance for credit losses by impairment methodology and portfolio segment as of December 31, 2018 and December 31, 2017

(in thousands):

Allowance for credit losses:
Ending balance, December 31, 2018

Ending balance: individually evaluated for impairment

Ending balance: collectively evaluated for impairment

Ending balance, December 31, 2017

Ending balance: individually evaluated for impairment

Ending balance: collectively evaluated for impairment

Commercial

Real Estate

Consumer

Unallocated

Total

1,671

1,662

2,071

2,070

6,539

6,512

5,795

5,794

826

772

825

791

9,104

9,014

8,778

8,742

The following table shows the ending balances of loans as of December 31, 2018 and December 31, 2017 by portfolio segment and by impairment methodology (in

thousands):

Loans:
Ending balance, December 31, 2018

Ending balance: individually evaluated for impairment

Ending balance: collectively evaluated for impairment

Loans:
Ending balance, December 31, 2017

Ending balance: individually evaluated for impairment

Ending balance: collectively evaluated for impairment

Commercial

Real Estate

Consumer

Total

109,531

348

109,183

115,812

377

115,435

699,576

4,215

695,361

677,467

4,846

672,621

107,996

1,346

106,650

106,041

1,143

104,898

917,103

5,909

911,194

899,320

6,366

892,954

The following table shows the loan portfolio by class allocated by management’s internal risk ratings at December 31, 2018 (in thousands):

Pass

Special
Mention

Substandard

Doubtful

Total

Commercial:

Commercial and industrial
Agricultural production

Real Estate:

Owner occupied
Real estate construction and other land loans
Commercial real estate
Agricultural real estate
Other real estate

Consumer:

Equity loans and lines of credit
Consumer and installment

86,876
5,955

12,072
2,043

2,585
-

179,214
95,301
298,714
57,544
32,799

68,016
38,036

3,056
3,270
5,268
165
-

380
-

899
3,035
1,136
19,175
-

1,562
2

Total

862,455

26,254

28,394

-
-

-
-
-
-
-

-
-

101,533
7,998

183,169
101,606
305,118
76,884
32,799

69,958
38,038

917,103

Notes to
Consolidated Financial Statements

LOANS AND ALLOWANCE FOR CREDIT LOSSES

(Continued)

The following table shows the loan portfolio by class allocated by management’s internally assigned risk grade ratings at December 31, 2017 (in thousands):

Pass

Special
Mention

Substandard

Doubtful

Total

Commercial:

Commercial and industrial
Agricultural production

Real Estate:

Owner occupied
Real estate construction and other land loans
Commercial real estate
Agricultural real estate
Other real estate

Consumer:

Equity loans and lines of credit
Consumer and installment

84,745
10,848

196,838
90,927
261,746
48,274
29,867

74,535
29,634

8,217
206

4,795
1,625
4,147
1,270
1,165

483
-

7,894
3,902

2,819
3,908
3,361
26,537
188

1,386
3

Total

827,414

21,908

49,998

The following table shows an aging analysis of the loan portfolio by class and the time past due at December 31, 2018 (in thousands):

30-59 Days
Past Due

60-89 Days
Past Due

Commercial:

Commercial and industrial
Agricultural production

Real estate:

Owner occupied
Real estate construction and

other land loans
Commercial real estate
Agricultural real estate
Other real estate

Consumer:

Equity loans and lines of credit
Consumer and installment

255
-

215

-
-
-
-

953
7

Total

1,430

-
-

-
-
-
-

-
-

Greater
Than
90 Days
Past Due

-
-

1,439
-
-
-

-
-

Total Past
Due

Current

Total
Loans

Recorded
Investment
> 90 Days
Accruing

255
-

215

1,439
-
-
-

953
7

101,278
7,998

101,533
7,998

182,954

183,169

100,167
305,118
76,884
32,799

69,005
38,031

101,606
305,118
76,884
32,799

69,958
38,038

1,439

2,869

914,234

917,103

The following table shows an aging analysis of the loan portfolio by class and the time past due at December 31, 2017 (in thousands):

30-59 Days
Past Due

60-89 Days
Past Due

Greater
Than
90 Days
Past Due

Total Past
Due

Current

Total
Loans

Recorded
Investment
> 90 Days
Accruing

Commercial:

Commercial and industrial
Agricultural production

Real estate:

Owner occupied
Real estate construction and

other land loans
Commercial real estate
Agricultural real estate
Other real estate

Consumer:

Equity loans and lines of credit
Consumer and installment

-
-

-
-
-
-

149
26

-
-

-
-
-
1,165

-
-

1,397
-
-
-

-
-

1,397
-
-
1,165

149
26

100,856
14,956

204,452

95,063
269,254
76,081
30,055

76,255
29,611

96,460
269,254
76,081
31,220

76,404
29,637

Total

175

1,165

1,397

2,737

896,583

899,320

-
-

-
-
-
-
-

-
-

-
-
-
-

-
-

-
-
-
-

-
-

100,856
14,956

204,452
96,460
269,254
76,081
31,220

76,404
29,637

899,320

Non-
accrual

298
-

215

1,439
418
-
-

370
-

2,740

Non-
accrual

356
-

1,397
976
-
-

146
-

2,875

Notes to
Consolidated Financial Statements

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The following table shows information related to impaired loans by class at

December 31, 2017 (in thousands):

The following table shows information related to impaired loans by class at

December 31, 2018 (in thousands):

Recorded
Investment

Unpaid
Principal
Balance

Related
Allowance

With no related allowance recorded:
Commercial:

Commercial and industrial

259

493

Real estate:

Owner occupied
Real estate construction and other

land loans

Commercial real estate

Total real estate

Consumer:

Equity loans and lines of credit

Total with no related allowance

recorded

With an allowance recorded:
Commercial:

Commercial and industrial

Real estate:

Commercial real estate
Agricultural real estate

Total real estate

Consumer:

Equity loans and lines of credit

Total with an allowance recorded

215

2,613
1,182

4,010

248

4,517

161
44

205

1,098

1,392

215

2,676
1,414

4,305

285

5,083

162
44

206

1,103

1,399

Total

5,909

6,482

-
-

27
-

The recorded investment in loans excludes accrued interest receivable and net

loan origination fees, due to immateriality.

Recorded
Investment

Unpaid
Principal
Balance

Related
Allowance

With no related allowance recorded:
Commercial:

Commercial and industrial

355

553

Real estate:

Real estate construction and other

land loans

Commercial real estate

Total real estate

Consumer:

Equity loans and lines of credit

Total with no related allowance

recorded

With an allowance recorded:
Commercial:

Commercial and industrial

Real estate:

Agricultural real estate

Consumer:

Equity loans and lines of credit

Total with an allowance recorded

3,023
1,772

4,795

146

5,296

997

1,070

3,085
2,040

5,125

206

5,884

997

1,070

Total

6,366

6,954

-
-

The recorded investment in loans excludes accrued interest receivable and net

loan origination fees, due to immateriality.

Notes to
Consolidated Financial Statements

LOANS AND ALLOWANCE FOR CREDIT LOSSES (Continued)

The following presents by class, information related to the average recorded investment and interest income recognized on impaired loans for the years ended

December 31, 2018, 2017, and 2016 (in thousands):

With no related allowance recorded:
Commercial:

Commercial and industrial
Agricultural production

Total commercial

Real estate:

Owner occupied
Real estate construction and other land loans
Commercial real estate
Agricultural real estate
Other real estate

Total real estate

Consumer:

Equity loans and lines of credit
Consumer and installment

Total consumer

Year Ended December 31,
2018

Year Ended December 31,
2017

Year Ended December 31,
2016

Average
Recorded
Investment

Interest
Income
Recognized

Average
Recorded
Investment

Interest
Income
Recognized

Average
Recorded
Investment

Interest
Income
Recognized

311
-

311

-
-

404
-

404

-
-

115
42

157

17
2,857
1,542
1,173
702

6,291

217
-

217

-
85
51
159
-

295

-
-

24
1,228
1,370
-
-

2,622

132
6

138

-
114
53
-
-

167

-
-

162
2,393
903
173
-

3,631

598
41

639

-
-

-
196
55
-
-

251

-
-

Total with no related allowance recorded

6,819

295

3,164

167

4,427

251

With an allowance recorded:
Commercial:

Commercial and industrial
Agricultural production

Total commercial

Real estate:

Owner occupied
Real estate construction and other land loans
Commercial real estate
Agricultural real estate
Other real estate

Total real estate

Consumer:

Equity loans and lines of credit
Consumer and installment

Total consumer

Total with an allowance recorded

Total

55
-

-
-
200
49
86

335

1,054
3

1,057

1,447

8,266

4
-

-
-
12
3
-

57
-

371

38
-

-
1,827
470
43
-

2,340

239
1

240

2,618

5,782

1
-

-
-
-
3
-

32
-

203

441
104

545

120
171
548
-
-

839

203
19

222

3
-

-
-
-
-
-

-
-

1,606

6,033

254

Foregone interest on nonaccrual loans totaled $267,000, $210,000, and

$245,000 for the years ended December 31, 2018, 2017, and 2016, respectively.
Interest income recognized on cash basis during the years presented above was
not considered significant for financial reporting purposes.

Troubled Debt Restructurings:

As of December 31, 2018 and 2017, the Company has a recorded investment
in troubled debt restructurings of $3,220,000 and, $3,551,000, respectively. The
Company has allocated $50,000 and $36,000 of specific reserves for those loans
at December 31, 2018 and 2017, respectively. The Company has committed to

lend no additional amounts as of December 31, 2018 to customers with
outstanding loans that are classified as troubled debt restructurings.

For the years ended December 31, 2018, 2017, and 2016 the terms of certain

loans were modified as troubled debt restructurings. The modification of the
terms of such loans included one or a combination of the following: a reduction
of the stated interest rate of the loan or an extension of the maturity date at a
stated rate of interest lower than the current market rate for new debt with
similar risk. During the same periods, there were no troubled debt restructurings
in which the amount of principal or accrued interest owed from the borrower
were forgiven.

Notes to
Consolidated Financial Statements

LOANS AND ALLOWANCE FOR CREDIT LOSSES

(Continued)

The following table presents loans by class modified as troubled debt restructurings that occurred during the year ended December 31, 2018 (dollars in thousands):

Troubled Debt Restructurings:
Commercial:

Commercial and industrial

Real Estate:

Real Estate—Commercial

Total

Pre-
Modification
Outstanding
Recorded
Investment (1)

Number of
Loans

Principal
Modification

Post
Modification
Outstanding
Recorded
Investment (2)

Outstanding
Recorded
Investment

166

204

166

204

161

191

(1) Amounts represent the recorded investment in loans before recognizing effects of the TDR, if any.
(2) Balance outstanding after principal modification, if any borrower reduction to recorded investment.

The following table presents loans by class modified as troubled debt restructurings that occurred during the year ended December 31, 2017 (dollars in thousands):

Troubled Debt Restructurings:
Real Estate:

Agricultural real estate

Consumer

Equity loans and line of credit

Total

Number of
Loans

Pre-Modification
Outstanding
Recorded
Investment (1)

Principal
Modification

Post
Modification
Outstanding
Recorded
Investment (2)

Outstanding
Recorded
Investment

490

549

1,066

1,125

1,059

1,110

The following table presents loans by class modified as troubled debt restructurings that occurred during the year ended December 31, 2016 (dollars in thousands):

Troubled Debt Restructurings:
Commercial:

Commercial and Industrial

Number of
Loans

Pre-Modification
Outstanding
Recorded
Investment (1)

Principal
Modification

Post
Modification
Outstanding
Recorded
Investment (2)

Outstanding
Recorded
Investment

A loan is considered to be in payment default once it is 90 days contractually

past due under the modified terms. There were no defaults on troubled debt

restructurings within 12 months following the modification during the years
ended December 31, 2018, 2017, and 2016.

Notes to
Consolidated Financial Statements

6. BANK PREMISES AND EQUIPMENT

Bank premises and equipment consisted of the following (in thousands):

Land
Buildings and improvements
Furniture, fixtures and equipment
Leasehold improvements

Less accumulated depreciation and

amortization

December 31,

2018

2017

1,131
6,753
12,665
4,369

24,918

1,131
6,754
12,345
4,594

24,824

(16,434)

(15,426)

8,484

9,398

Depreciation and amortization included in occupancy and equipment expense

totaled $1,703,000, $1,429,000 and $1,320,000 for the years ended
December 31, 2018, 2017, and 2016, respectively.

7. GOODWILL AND INTANGIBLE ASSETS

The change in goodwill during the years ended December 31, 2018, 2017, and
2016 is as follows (in thousands):

2018

2017

2016

Balance, beginning of year
Acquired goodwill
Impairment

Balance, end of year

53,777
-
-

53,777

40,231
13,546
-

53,777

29,917
10,314
-

40,231

Business combinations involving the Company’s acquisition of the equity

interests or net assets of another enterprise give rise to goodwill. Total goodwill at
December 31, 2018 and 2017 was $53,777,000. Total goodwill at December 31,
2018 consisted of $13,466,000, $10,394,000, $6,340,000, $14,643,000, and
$8,934,000 representing the excess of the cost of Folsom Lake Bank, Sierra Vista
Bank, Visalia Community Bank, Service 1st Bancorp, and Bank of Madera
County, respectively, over the net of the amounts assigned to assets acquired and
liabilities assumed in the transactions accounted for under the purchase method
of accounting. The value of goodwill is ultimately derived from the Company’s
ability to generate net earnings after the acquisitions and is not deductible for tax
purposes. A decline in net earnings could be indicative of a decline in the fair
value of goodwill and result in impairment. For that reason, goodwill is assessed
at least annually for impairment.

Goodwill is also tested for impairment between annual tests if an event occurs
or circumstances change that would more likely than not reduce the fair value of
the Company below its carrying amount. No such events or circumstances arose
during the fourth quarter of 2018, so goodwill was not required to be retested.
The intangible assets at December 31, 2018 represent the estimated fair value
of the core deposit relationships acquired in the acquisition of Folsom Lake Bank
in 2017 of $1,879,000, Sierra Vista Bank in 2016 of $508,000 and the 2013
acquisition of Visalia Community Bank of $1,365,000. Core deposit intangibles
are being amortized using the straight-line method over an estimated life of five
to ten years from the date of acquisition. At December 31, 2018, the weighted
average remaining amortization period is four years. The carrying value of
intangible assets at December 31, 2018 was $2,572,000, net of $1,180,000 in
accumulated amortization expense. The carrying value at December 31, 2017 was
$3,027,000, net of $725,000 in accumulated amortization expense. Management
evaluates the remaining useful lives quarterly to determine whether events or

circumstances warrant a revision to the remaining periods of amortization. Based
on the evaluation, no changes to the remaining useful lives was required.
Management performed an annual impairment test on core deposit intangibles as
of September 30, 2018 and determined no impairment was necessary.
Amortization expense recognized was $455,000 for 2018, $234,000 for 2017,
and $149,000 for 2016.

The following table summarizes the Company’s estimated core deposit
intangible amortization expense for each of the next five years (in thousands):

Years Ending December 31,

2019
2020
2021
2022
2023
Thereafter

Total

Estimated Core
Deposit
Intangible
Amortization

696
696
661
453
66
-

2,572

8. DEPOSITS

Interest-bearing deposits consisted of the following (in thousands):

Savings
Money market
NOW accounts
Time, $250,000 or more
Time, under $250,000

December 31,

2018

2017

114,565
267,820
252,439
30,902
65,915

116,534
299,638
296,406
34,441
93,629

731,641

840,648

Aggregate annual maturities of time deposits are as follows (in thousands):

Years Ending December 31,

2019
2020
2021
2022
2023
Thereafter

71,869
18,880
2,437
1,429
1,092
1,110

96,817

Interest expense recognized on interest-bearing deposits consisted of the

following (in thousands):

Savings
Money market
NOW accounts
Time certificates of deposit

Years Ended December 31,

2018

2017

2016

37
419
414
283

33
211
317
408

1,153

969

27
133
290
525

975

Notes to
Consolidated Financial Statements

9. BORROWING ARRANGEMENTS

Federal Home Loan Bank Advances - As of December 31, 2018, the Company
had $10,000,000 in Federal Home Loan Bank (FHLB) of San Francisco
advances. As of December 31, 2017, the Company had no FHLB advances.

Approximately $447,757,000 in loans were pledged under a blanket lien as

collateral to the FHLB for the Bank’s remaining borrowing capacity of
$286,934,000 as of December 31, 2018. FHLB advances are also secured by
investment securities with amortized costs totaling $326,000 and $416,000 and
market values totaling $337,000 and $440,000 at December 31, 2018 and 2017,
respectively. The Bank’s credit limit varies according to the amount and
composition of the investment and loan portfolios pledged as collateral.

Lines of Credit - The Bank had unsecured lines of credit with its correspondent
banks which, in the aggregate, amounted to $40,000,000 at December 31, 2018
and 2017, at interest rates which vary with market conditions. As of
December 31, 2018 and 2017, the Company had no in Federal funds purchased.

Federal Reserve Line of Credit - The Bank has a line of credit in the amount of
$4,364,000 and $6,740,000 with the Federal Reserve Bank of San Francisco
(FRB) at December 31, 2018 and 2017, respectively, which bears interest at the
prevailing discount rate collateralized by investment securities with amortized
costs totaling $4,498,000 and $7,431,000 and market values totaling $4,475,000
and $7,437,000, respectively. At December 31, 2018 and 2017, the Bank had no
outstanding borrowings with the FRB.

10.

JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES

Service 1st Capital Trust I is a Delaware business trust formed by Service 1st.

The Company succeeded to all of the rights and obligations of Service 1st in
connection with the merger with Service 1st as of November 12, 2008. The
Trust was formed on August 17, 2006 for the sole purpose of issuing trust
preferred securities fully and unconditionally guaranteed by Service 1st. Under
applicable regulatory guidance, the amount of trust preferred securities that is
eligible as Tier 1 capital is limited to 25% of the Company’s Tier 1 capital on a
pro forma basis. At December 31, 2018, all of the trust preferred securities that
have been issued qualify as Tier 1 capital. The trust preferred securities mature
on October 7, 2036, are redeemable at the Company’s option, and require
quarterly distributions by the Trust to the holder of the trust preferred securities
at a variable interest rate which will adjust quarterly to equal the three month
LIBOR plus 1.60%.

The Trust used the proceeds from the sale of the trust preferred securities to
purchase approximately $5,155,000 in aggregate principal amount of Service 1st’s
junior subordinated notes (the Notes). The Notes bear interest at the same
variable interest rate during the same quarterly periods as the trust preferred
securities. The Notes are redeemable by the Company on any January 7, April 7,
July 7, or October 7 or at any time within 90 days following the occurrence of
certain events, such as: (i) a change in the regulatory capital treatment of the
Notes (ii) in the event the Trust is deemed an investment company or (iii) upon
the occurrence of certain adverse tax events. In each such case, the Company
may redeem the Notes for their aggregate principal amount, plus any accrued but
unpaid interest.

The Notes may be declared immediately due and payable at the election of the

Holders of the trust preferred securities are entitled to a cumulative cash

distribution on the liquidation amount of $1,000 per security. For each
January 7, April 7, July 7 or October 7 of each year, the rate will be adjusted to
equal the three month LIBOR plus 1.60%. As of December 31, 2018, the rate
was 4.04%. Interest expense recognized by the Company for the years ended
December 31, 2018, 2017, and 2016 was $199,000, $147,000 and $121,000,
respectively.

11.

INCOME TAXES

The provision for income taxes for the years ended December 31, 2018, 2017,

and 2016 consisted of the following (in thousands):

2018
Current
Deferred

Provision for income taxes

2017
Current
Deferred
Re-measurement resulting

from Tax Act

Provision for income taxes

2016
Current
Deferred

Provision for income taxes

Federal

State

Total

3,995
(140)

3,855

1,188
3,328

3,535

8,051

3,720
1,100

4,820

2,689
76

2,765

1,224
518

1,742

605
1,492

2,097

6,684
(64)

6,620

2,412
3,846

3,535

9,793

4,325
2,592

6,917

The determination of the amount of deferred income tax assets which are
more likely than not to be realized is primarily dependent on projections of
future earnings, which are subject to uncertainty and estimates that may change
given economic conditions and other factors. The realization of deferred income
tax assets is assessed and a valuation allowance is recorded if it is more likely
than not that all or a portion of the deferred tax asset will not be realized. More
likely than not is defined as greater than a 50% chance. All available evidence,
both positive and negative is considered to determine whether, based on the
weight of the evidence, a valuation allowance is needed. Thus, Management
concludes no valuation allowance is necessary against deferred tax assets.

Notes to
Consolidated Financial Statements

11.

INCOME TAXES

(Continued)

Deferred tax assets (liabilities) consisted of the following (in thousands):

Deferred tax assets:

Allowance for credit losses
Deferred compensation
Unrealized loss on available-for-sale

investment securities

Net operating loss carryovers
Mark-to-market adjustment
Other deferred tax assets
Other-than-temporary impairment
Loan and investment impairment
Partnership income
State taxes

Total deferred tax assets

Deferred tax liabilities:

Finance leases
Unrealized gain on available-for-sale

investment securities
Core deposit intangible
FHLB stock
Loan origination costs
Bank premises and equipment

Total deferred tax liabilities

December 31,

2018

2017

2,380
4,347

1,850
2,407
53
445
192
1,450
55
575

2,100
4,415

-
2,549
87
386
192
1,793
68
375

13,754

11,965

(173)

-
(760)
(234)
(891)
(513)

(2,571)

(365)

(1,186)
(895)
(234)
(783)
(478)

(3,941)

Act for tax years beginning after December 31, 2017, alternative minimum tax
credit carryforwards are and not dependent on future income. As such, they have
been classified as a current tax receivable rather than a deferred tax asset. As of
December 31, 2018, the alternative minimum tax credit carryforwards have been
fully utilized. ASU 2016-09, ‘‘Compensation-Stock Compensation
(718) Improvements to Employee Share-Based Payment Accounting’’ requires the
Company to recognize all excess tax benefits or tax deficiencies through the
income statement as income tax expense/benefit. A tax benefit of $165,000 was
recognized during the year ended December 31, 2018 and a benefit of $853,000
was recognized during the year ended December 31, 2017.

The Company and its subsidiary file income tax returns in the U.S. federal
and California jurisdictions. The Company conducts all of its business activities
in the State of California. There are no pending U.S. federal or California
Franchise Tax Board income tax examinations by those taxing authorities. The
Company is no longer subject to the examination by U.S. federal taxing
authorities for the years ended before December 31, 2015 and by the state and
local taxing authorities for the years ended before December 31, 2014. A
reconciliation of the beginning and ending amount of unrecognized tax benefits
is as follows (in thousands):

Balance, beginning of year

Reductions due to the statute of limitations

for tax positions of prior years

Balance, end of year

December 31,

2018

2017

298

(83)

(215)

As of December 31, 2018, the Company has no unrecognized tax benefits and

does not expect this to change in the next 12 months.

Net deferred tax assets

11,183

8,024

During the years ended December 31, 2018 and 2017, the Company recorded

The provision for income taxes differs from amounts computed by applying
the statutory Federal income tax rates to operating income before income taxes.
The significant items comprising these differences for the years ended
December 31, 2018, 2017, and 2016 consisted of the following:

Federal income tax, at statutory rate
State taxes, net of Federal tax

benefit

Tax exempt investment security

income, net

Bank owned life insurance, net
Compensation—Stock

Compensation

Re-measurement resulting from Tax

Act

Change in uncertain tax positions
Other

Effective tax rate

2018

2017

2016

21.0 %

35.0 %

7.8 %

4.8 %

6.2 %

(2.7)%
(0.6)%

(10.1)%
(0.8)%

(10.3)%
(1.1)%

(0.6)%

(2.8)%

- %

- %
(0.3)%
(0.9)%

23.7 %

14.8 %
(0.9)%
1.1 %

41.1 %

- %
0.1 %
1.4 %

31.3 %

As of December 31, 2018, the Company had Federal and California net

operating loss (‘‘NOL’’) carry-forwards of $8,049,000 and $8,372,000,
respectively. These NOLs were acquired through business combinations and are
subject to IRC 382 and begin expiring in 2028, for federal and California
purposes. While they are subject to IRC Section 382, management has
determined that all of the NOLs are more than likely than not to be utilized.

As a result of the enactment of the Tax Cuts and Jobs Act (the ‘‘Tax Act’’) on

December 22, 2017, the federal tax rate applied to the Company’s net deferred
tax assets were re-measured to reflect the 2018 tax rates (the rates at which the
deferred tax items are expected to reverse). The change to the tax rates (including
the rate change applied to deferred taxes reflected in other comprehensive income
and certain tax-advantaged investments as reflected in other assets) resulted in an
increase to the Company’s 2017 tax provision of $3,535,000. As part of the Tax

no interest or penalties related to uncertain tax positions.

12. COMMITMENTS AND CONTINGENCIES

Leases - The Bank leases certain of its branch facilities and administrative offices
under noncancelable operating leases. Rental expense included in occupancy and
equipment and other expenses totaled $2,735,000, $2,533,000 and $2,300,000
for the years ended December 31, 2018, 2017, and 2016, respectively.

Future minimum lease payments on noncancelable operating leases are as

follows (in thousands):

Years Ending December 31,
2019
2020
2021
2022
2023
Thereafter

2,384
2,078
1,805
1,552
1,448
4,334

13,601

Federal Reserve Requirements - Banks are required to maintain reserves with the
Federal Reserve Bank equal to a percentage of their reservable deposits. The
amount of such reserve balances required at December 31, 2018 was
$14,858,000.

Correspondent Banking Agreements - The Bank maintains funds on deposit with
other federally insured financial institutions under correspondent banking
agreements. Uninsured deposits totaled $372,000 at December 31, 2018.

Financial Instruments With Off-Balance-Sheet Risk - The Bank is a party to
financial instruments with off-balance-sheet risk in the normal course of business
in order to meet the financing needs of its customers and to reduce its own
exposure to fluctuations in interest rates. These financial instruments consist of
commitments to extend credit and standby letters of credit. These instruments

Notes to
Consolidated Financial Statements

12. COMMITMENTS AND CONTINGENCIES

(Continued)

involve, to varying degrees, elements of credit and interest rate risk in excess of
the amount recognized on the balance sheet.

The Bank’s exposure to credit loss in the event of nonperformance by the
other party for commitments to extend credit and standby letters of credit is
represented by the contractual amount of those instruments. The Bank uses the
same credit policies in making commitments and standby letters of credit as it
does for loans included on the balance sheet.

The following financial instruments represent off-balance-sheet credit risk (in

thousands):

Commitments to extend credit
Standby letters of credit

December 31,

2018

2017

$
$

309,824
2,450

$
$

347,001
3,140

Commitments to extend credit consist primarily of unfunded commercial loan
commitments and revolving lines of credit, single-family residential equity lines of
credit and commercial and residential real estate construction loans. Construction
loans are established under standard underwriting guidelines and policies and are
secured by deeds of trust, with disbursements made over the course of
construction. Commercial revolving lines of credit have a high degree of industry
diversification. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being fully drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are generally secured and are issued by the Bank to
guarantee the financial obligation or performance of a customer to a third party.
The credit risk involved in issuing standby letters of credit is essentially the same
as that involved in extending loans to customers. The fair value of the liability
related to these standby letters of credit, which represents the fees received for
issuing the guarantees, was not significant at December 31, 2018 and 2017. The
Company recognizes these fees as revenue over the term of the commitment or
when the commitment is used.

At December 31, 2018, commercial loan commitments represent 54% of total

commitments and are generally secured by collateral other than real estate or
unsecured. Real estate loan commitments represent 39% of total commitments
and are generally secured by property with a loan-to-value ratio not to exceed
80%. Consumer loan commitments represent the remaining 7% of total
commitments and are generally unsecured. In addition, the majority of the Bank’s
loan commitments have variable interest rates.

At December 31, 2018 and 2017, the balance of a contingent allocation for

probable loan loss experience on unfunded obligations was $225,000 and
$326,000, respectively. The contingent allocation for probable loan loss
experience on unfunded obligations is calculated by management using an
appropriate, systematic, and consistently applied process. While related to credit
losses, this allocation is not a part of the ALLL and is considered separately as a
liability for accounting and regulatory reporting purposes. Changes in this
contingent allocation are recorded in other non-interest expense.

Concentrations of Credit Risk - At December 31, 2018, in management’s
judgment, a concentration of loans existed in commercial loans and real-estate-
related loans, representing approximately 95.8% of total loans of which 12%
were commercial and 83.8% were real-estate-related.

At December 31, 2017, in management’s judgment, a concentration of loans

existed in commercial loans and real-estate-related loans, representing
approximately 96.6% of total loans of which 12.9% were commercial and 83.7%
were real-estate-related.

Management believes the loans within these concentrations have no more than

the typical risks of collectability. However, in light of the current economic
environment, additional declines in the performance of the economy in general,
or a continued decline in real estate values or drought-related decline in
agricultural business in the Company’s primary market area could have an adverse
impact on collectability, increase the level of real-estate-related nonperforming
loans, or have other adverse effects which alone or in the aggregate could have a

material adverse effect on the financial condition, results of operations and cash
flows of the Company.

Contingencies - The Company is subject to legal proceedings and claims which
arise in the ordinary course of business. In the opinion of management, the
amount of ultimate liability with respect to such actions will not materially affect
the consolidated financial position or consolidated results of operations of the
Company.

13. SHAREHOLDERS’ EQUITY

Regulatory Capital - The Company and the Bank are subject to certain regulatory
capital requirements administered by the Board of Governors of the Federal
Reserve System and the FDIC. Failure to meet these minimum capital
requirements could result in mandatory or, discretionary actions by regulators
that, if undertaken, could have a direct material effect on the Company’s
consolidated financial statements.

The Company and the Bank each meet specific capital guidelines that involve
quantitative measures of their respective assets, liabilities and certain off-balance-
sheet items as calculated under regulatory accounting practices. The Company’s
and the Bank’s capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings and other factors.
The Bank is also subject to additional capital guidelines under the regulatory
framework for prompt corrective action. To be categorized as well capitalized, the
Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios as set forth in the following table. The most recent notification
from the FDIC categorized the Bank as well capitalized under these guidelines.
Management knows of no conditions or events since that notification that would
change the Bank’s category.

Capital ratios are reviewed by Management on a regular basis to ensure that
capital exceeds the prescribed regulatory minimums and is adequate to meet our
anticipated future needs. For all periods presented, the Bank’s ratios exceed the
regulatory definition of well capitalized under the regulatory framework for
prompt correct action and the Company’s ratios exceed the required minimum
ratios for capital adequacy purposes.

Effective January 1, 2015, bank holding companies with consolidated assets of
$1 billion or more ($3 Billion or more effective August 30, 2018) and banks like
Central Valley Community Bank must comply with new minimum capital ratio
requirements to be phased-in between January 1, 2015 and January 1, 2019,
which consist of the following: (i) a new common equity Tier 1 capital to total
risk weighted assets ratio of 4.5%; (ii) a Tier 1 capital to total risk weighted
assets ratio of 6% (increased from 4%); (iii) a total capital to total risk weighted
assets ratio of 8% (unchanged from current rules); and (iv) a Tier 1 capital to
adjusted average total assets (‘‘leverage’’) ratio of 4%.

In addition, a ‘‘capital conversation buffer’’ is established which, when fully
phased-in, will require maintenance of a minimum of 2.5% of common equity
Tier 1 capital to total risk weighted assets in excess of the regulatory minimum
capital ratio requirements described above. The 2.5% buffer will increase the
minimum capital ratios to (i) a common equity Tier 1 capital ratio of 7.0%,
(ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The
new buffer requirement is being phased-in between January 1, 2016 and
January 1, 2019. The capital conservation buffer as of December 31, 2018 was
1.875% and 1.250% as of December 31, 2017. If the capital ratio levels of a
banking organization fall below the capital conservation buffer amount, the
organization will be subject to limitations on (i) the payment of dividends;
(ii) discretionary bonus payments; (iii) discretionary payments under Tier 1
instruments; and (iv) engaging in share repurchases.

Management believes that the Company and the Bank met all their capital

adequacy requirements as of December 31, 2018 and 2017. There are no
conditions or events since those notifications that management believes have
changed those categories. The capital ratios for the Company and the Bank are
presented in the table below (exclusive of the capital conservation buffer).

The following table presents the Company’s and the Bank’s actual capital ratios

as of December 31, 2018 and December 31, 2017, as well as the minimum
capital ratios for capital adequacy for the Bank.

Notes to
Consolidated Financial Statements

13. SHAREHOLDERS’ EQUITY

(Continued)

(Dollars in thousands)
December 31, 2018
Tier 1 Leverage Ratio
Common Equity Tier 1 Ratio

(CET 1)

Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio

December 31, 2017

Tier 1 Leverage Ratio
Common Equity Tier 1 Ratio

(CET 1)

Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio

Actual Ratio

Minimum regulatory
requirement (1)

Amount

Ratio

Amount

Ratio

$ 171,149

11.48%

$ 166,149
$ 171,149
$ 180,478

15.13%
15.59%
16.44%

N/A

N/A
N/A
N/A

N/A

N/A
N/A
N/A

$ 153,676

9.71% $ 63,338

4.00%

$ 149,186
$ 153,676
$ 162,780

12.90% $ 52,081
13.28% $ 69,441
14.07% $ 92,588

5.75%
7.25%
9.25%

(1) The 2017 minimum regulatory requirement threshold includes the capital

conservation buffer of 1.250%.

The following table presents the Bank’s regulatory capital ratios as of

December 31, 2018 and December 31, 2017.

(Dollars in thousands)
December 31, 2018
Tier 1 Leverage Ratio
Common Equity Tier 1 Ratio

(CET 1)

Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio

December 31, 2017

Tier 1 Leverage Ratio
Common Equity Tier 1 Ratio

(CET 1)

Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio

Actual Ratio

Minimum regulatory
requirement (1)

Amount

Ratio

Amount

Ratio

$ 168,770

11.32% $ 59,639

4.00%

$ 168,770
$ 168,770
$ 178,099

15.38% $ 49,388
15.38% $ 65,850
16.23% $ 87,800

6.38%
7.88%
9.88%

$ 149,779
$ 149,779
$ 158,882

12.96% $ 52,040
12.96% $ 69,387
13.74% $ 92,516

5.75%
7.25%
9.25%

(1) The 2018 and 2017 minimum regulatory requirement threshold includes
the capital conservation buffer of 1.250% and 0.625%, respectively. These
ratios are not reflected on a fully phased-in basis, which will occur in
January 2019.

Dividends - During 2018, the Bank declared and paid cash dividends to the
Company in the amount of $2,850,000 in connection with the cash dividends to
the Company’s shareholders approved by the Company’s Board of Directors. The
Company declared and paid a total of $4,270,000 or $0.31 per common share
cash dividend to shareholders of record during the year ended December 31,
2018.

During 2017, the Bank declared and paid cash dividends to the Company in

the amount of $3,133,000, in connection with the cash dividends to the
Company’s shareholders approved by the Company’s Board of Directors. The
Company declared and paid a total of $3,010,000 or $0.24 per common share
cash dividend to shareholders of record during the year ended December 31,
2017.

During 2016, the Bank declared and paid cash dividends to the Company in
the amount of $13,010,000, in connection with the SVB acquisition, and cash
dividends approved by the Company’s Board of Directors. The Company
declared and paid a total of $2,715,000 or $0.24 per common share cash
dividend to shareholders of record during the year ended December 31, 2016.

The Company’s primary source of income with which to pay cash dividends is

dividends from the Bank. The California Financial Code restricts the total
amount of dividends payable by a bank at any time without obtaining the prior
approval of the California Department of Business Oversight to the lesser of
(1) the Bank’s retained earnings or (2) the Bank’s net income for its last three

fiscal years, less distributions made to shareholders during the same three-year
period. At December 31, 2018, $33,036,000 of the Bank’s retained earnings were
free of these restrictions.

A reconciliation of the numerators and denominators of the basic and diluted

earnings per common share computations is as follows (in thousands, except
share and per-share amounts):

For the Years Ended December 31,

2018

2017

2016

Basic Earnings Per Common

Share:
Net income
Weighted average shares

outstanding

21,289

14,026

15,182

13,699,823

12,472,095

11,331,166

Net income per common share

1.55

1.12

1.34

Diluted Earnings Per Common

Share:
Net income
Weighted average shares

outstanding

Effect of dilutive stock options

and warrants

Weighted average shares of

common stock and common
stock equivalents

Net income per diluted

common share

21,289

14,026

15,182

13,699,823

12,472,095

11,331,166

129,171

250,255

104,283

13,828,994

12,722,350

11,435,449

1.54

1.10

1.33

No outstanding options and restricted stock awards were anti-dilutive at

December 31, 2018, 2017, and 2016.

On December 31, 2018, the Company had five share-based compensation
plans, which are described below. The Plans do not provide for the settlement of
awards in cash and new shares are issued upon option exercise or restricted share
grants.

The Central Valley Community Bancorp 2000 Stock Option Plan (2000 Plan)

expired on November 15, 2010. The Central Valley Community Bancorp 2005
Omnibus Incentive Plan (2005 Plan) was adopted in May 2005 and expired
March 16, 2015. While outstanding arrangements to issue shares under these
plans, including options, continue in force until their expiration, no new options
will be granted under these plans. The plans require that the exercise price may
not be less than the fair market value of the stock at the date the option is
granted, and that the option price must be paid in full at the time it is exercised.
The options and awards under the plans expire on dates determined by the
Board of Directors, but not later than ten years from the date of grant. The
vesting period for the options, restricted common stock awards and option
related stock appreciation rights is determined by the Board of Directors and is
generally over five years.

In May 2015, the Company adopted the Central Valley Community Bancorp
2015 Omnibus Incentive Plan (2015 Plan). The plan provides for awards in the
form of incentive stock options, non-statutory stock options, stock appreciation
rights, and restricted stock. The plan also allows for performance awards that
may be in the form of cash or shares of the Company, including restricted stock.
The 2015 plan requires that the exercise price may not be less than the fair
market value of the stock at the date the option is granted, and that the option
price must be paid in full at the time it is exercised. The options and awards
under the plan expire on dates determined by the Board of Directors, but not
later than ten years from the date of grant. The vesting period for the options,
restricted common stock awards and option related stock appreciation rights is
determined by the Board of Directors and is over one to five years. The
maximum number of shares that can be issued with respect to all awards under

$ 149,779

9.46% $ 63,332

4.00%

14. SHARED-BASED COMPENSATION

Notes to
Consolidated Financial Statements

14. SHARED-BASED COMPENSATION

(Continued)

the plan is 875,000. Currently under the 2015 Plan, there are 809,996 shares
remain reserved for future grants as of December 31, 2018.

Effective June 2, 2017, the Company adopted an Employee Stock Purchase
Plan whereby our employees may purchase Company common shares through
payroll deductions of between one percent and 15 percent of pay in each pay
period. Shares are purchased at the end of an offering period at a discount of
10 percent from the lower of the closing market price on the Offering Date (first
trading day of each offering period) or the Investment Date (last trading day of
each offering period). The plan calls for 500,000 common shares to be set aside
for employee purchases, and there were 485,978 shares available for future
purchase under the plan as of December 31, 2018.

In October 2017, the Company adopted the Folsom Lake Bank 2007 Equity

Incentive Plan (2007 Plan). The plan provides for awards in the form of
incentive stock options, non-statutory stock options, stock appreciation rights,
and restricted stock. While outstanding arrangements to issue shares under this
plan, including options, continue in force until their expiration, no new options
will be granted under this plan. The options and awards under the plan expire
on dates determined by the Board of Directors, but not later than ten years from
the date of grant. The vesting period for the options, restricted common stock
awards and option related stock appreciation rights is determined by the Board of
Directors and is generally over five years. The maximum number of shares that
can be issued with respect to all awards under the plan is 313,360.

For the years ended December 31, 2018, 2017, and 2016, the compensation

cost recognized for share-based compensation was $482,000, $384,000, and
$284,000, respectively. The recognized tax benefit for share-based compensation
expense was $142,000, $805,000, and $44,000 for 2018, 2017, and 2016,
respectively.

Stock Options - The Company bases the fair value of the options granted on the
date of grant using a Black-Scholes Merton option pricing model that uses
assumptions based on expected option life and the level of estimated forfeitures,
expected stock volatility, risk free interest rate, and dividend yield. The expected
term and level of estimated forfeitures of the Company’s options are based on the
Company’s own historical experience. Stock volatility is based on the historical
volatility of the Company’s stock. The risk-free rate is based on the U. S.
Treasury yield curve for the periods within the contractual life of the options in
effect at the time of grant. The compensation cost for options granted is based
on the weighted average grant date fair value per share.

No options to purchase shares of the Company’s common stock were granted

during the years ending December 31, 2018, 2017 and 2016 from any of the
Company’s stock based compensation plans.

A summary of the combined activity of the Plans during the years then ended

is presented below (dollars in thousands, except per-share amounts):

Weighted
Average
Exercise
Price

Weighted
Average
Remaining
Contractual
Term (Years)

Aggregate
Intrinsic Value

240,695 $
(35,280) $
(3,200) $

6.83
6.55
8.77

202,215 $

6.87

3.26 $

2,647

313,360 $
(281,125) $
(1,580) $

11.79
10.47
8.11

232,870 $

9.13

2.87 $

2,574

Options outstanding at
January 1, 2016
Options exercised
Options forfeited

Options outstanding at
December 31, 2016

Options assumed in

acquisition
Options exercised
Options forfeited

Options outstanding at
December 31, 2017

Options exercised
Options forfeited

(74,030) $
(4,400) $

9.97
10.85

Options outstanding at
December 31, 2018

Options vested or

expected to vest at
December 31, 2018

Options exercisable at
December 31, 2018

154,440 $

8.68

2.81 $

1,554

154,440 $

8.68

2.81 $

1,554

154,440 $

8.68

2.81 $

1,554

Information related to the stock option plan during each year follows (in

thousands):

2018

2017

2016

Intrinsic value of options exercised
Cash received from options

exercised

Excess tax benefit realized for option

exercises

767

738

142

2,807

2,835

805

235

231

As of December 31, 2018, there is no unrecognized compensation cost related

to stock options granted under all Plans. All options are fully vested. The total
fair value of options vested was $170,000 for the year ended December 31,
2017, respectively.

Restricted Common Stock Awards - The 2005 Plan and 2015 Plan provide for
the issuance of shares to directors and officers. Restricted common stock grants
typically vest over a one to five-year period. Restricted common stock (all of
which are shares of our common stock) is subject to forfeiture if employment
terminates prior to vesting. The cost of these awards is recognized over the
vesting period of the awards based on the fair value of our common stock on the
date of the grant.

Notes to
Consolidated Financial Statements

14. SHARED-BASED COMPENSATION (Continued)

The following table presents the restricted common stock activity during the

years presented:

Nonvested outstanding shares at January 1, 2016
Granted
Vested
Forfeited

Nonvested outstanding shares at December 31,

2016
Vested
Forfeited

Nonvested outstanding shares at December 31,

2017
Granted
Vested
Forfeited

Nonvested outstanding shares at December 31,

2018

Weighted
Average
Grant
Date
Fair Value

$
$
$
$

$
$
$

$
$
$
$

12.34
14.10
12.38
12.95

13.35
13.34
14.07

13.33
20.76
13.09
14.37

15.98

53,028
54,650
(12,438)
(1,739)

93,501
(27,373)
(2,360)

63,768
22,204
(20,733)
(1,710)

63,529

During the years ended December 31, 2018, 2017, and 2016, 22,204, 0, and
54,650 shares of restricted common stock were granted from outstanding grants
under the 2005 and 2015 Plans. The restricted common stock had a weighted
average fair value of $20.76, and $14.10 per share on the date of grant during
the years ended December 31, 2018 and 2016, respectively. The shares awarded
to employees and directors under the restricted stock agreements vest on
applicable vesting dates only to the extent the recipient of the shares is then an
employee or a director of the Company or one of its subsidiaries, and each
recipient will forfeit all of the shares that have not vested on the date his or her
employment or service is terminated.

As of December 31, 2018, there were 63,529 shares of restricted stock that are

nonvested and expected to vest. Share-based compensation cost charged against
income for restricted stock awards was $459,000 for the year ended
December 31, 2018, $349,000 for the year ended December 31, 2017, and
$235,000 for the year ended December 31, 2016.

As of December 31, 2018, there was $677,000 of total unrecognized

compensation cost related to nonvested restricted common stock. Restricted stock
compensation expense is recognized on a straight-line basis over the vesting
period. This cost is expected to be recognized over a weighted average remaining
period of 2.04 years and will be adjusted for subsequent changes in estimated
forfeitures. Restricted common stock awards had an intrinsic value of $1,308,000
at December 31, 2018.

15. EMPLOYEE BENEFITS

401(k) and Profit Sharing Plan - The Bank has established a 401(k) and profit
sharing plan. The 401(k) plan covers substantially all employees who have
completed a one-month employment period. Participants in the profit sharing
plan are eligible to receive employer contributions after completion of 2 years of
service. Bank contributions to the profit sharing plan are determined at the
discretion of the Board of Directors. Participants are automatically vested 100%
in all employer contributions. The Bank contributed $900,000, $600,000, and
$380,000 to the profit sharing plan in 2018, 2017, and 2016, respectively.
Additionally, the Bank may elect to make a matching contribution to the
participants’ 401(k) plan accounts. The amount to be contributed is announced
by the Bank at the beginning of the plan year. For the years ended December 31,
2018, 2017, and 2016, the Bank made a 100% matching contribution on all
deferred amounts up to 3% of eligible compensation and a 50% matching
contribution on all deferred amounts above 3% to a maximum of 5%. For the
years ended December 31, 2018, 2017, and 2016, the Bank made matching
contributions totaling $748,000, $686,000, and $604,000, respectively.

Deferred Compensation Plans - The Bank has a nonqualified Deferred
Compensation Plan which provides directors with an unfunded, deferred
compensation program. Under the plan, eligible participants may elect to defer
some or all of their current compensation or director fees. Deferred amounts earn
interest at an annual rate determined by the Board of Directors (3.12% at
December 31, 2018). At December 31, 2018 and 2017, the total net deferrals
included in accrued interest payable and other liabilities were $3,842,000 and
$3,713,000, respectively.

In connection with the implementation of the above plan, single premium
universal life insurance policies on the life of each participant were purchased by
the Bank, which is the beneficiary and owner of the policies. The cash surrender
value of the policies totaled $9,436,000 and $9,187,000 and at December 31,
2018 and 2017, respectively. Income recognized on these policies, net of related
expenses, for the years ended December 31, 2018, 2017, and 2016, was
$249,000, $255,000, and $242,000, respectively.

In October 2015, the Board of Directors of the Company and the Bank

adopted a board resolution to create the Central Valley Community Bank
Executive Deferred Compensation Plan (the Executive Plan). Pursuant to the
Executive Plan, all eligible executives of the Bank may elect to defer up to
50 percent of their compensation for each deferral year. Deferred amounts earn
interest at an annual rate determined by the Board of Directors (3.12% at
December 31, 2018). At December 31, 2018 and 2017, the total net deferrals
included in accrued interest payable and other liabilities were $129,000 and
$86,000, respectively.

Salary Continuation Plans - The Board of Directors has approved salary
continuation plans for certain key executives. Under these plans, the Bank is
obligated to provide the executives with annual benefits for 10-15 years after
retirement. In connection with the acquisitions of Folsom Lake Bank (FLB),
Service 1st Bank, and Visalia Community Bank (VCB), the Bank assumed a
liability for the estimated present value of future benefits payable to former key
executives of FLB, Service 1st, and VCB. The liability relates to change in
control benefits associated with their salary continuation plans. The benefits are
payable to the individuals when they reach retirement age. These benefits are
substantially equivalent to those available under split-dollar life insurance policies
purchased by the Bank on the life of the executives. The expense recognized
under these plans for the years ended December 31, 2018, 2017, and 2016,
totaled $15,000, $561,000, and $489,000, respectively. Accrued compensation
payable under the salary continuation plans totaled $9,816,000 and $5,786,000
at December 31, 2018 and 2017, respectively. These benefits are substantially
equivalent to those available under split-dollar life insurance policies acquired.
In connection with these plans, the Bank purchased single-premium life

insurance policies with cash surrender values totaling $19,066,000 and
$18,620,000 at December 31, 2018 and 2017, respectively. Income recognized
on these policies, net of related expense, for the years ended December 31, 2018,
2017, and 2016 totaled $446,000, $366,000, and $316,000, respectively.

Employee Stock Purchase Plan - During 2017, the Company adopted an
Employee Stock Purchase Plan which allows employees to purchase the
Company’s stock at a discount to fair market value as of the date of purchase.
The Company bears all costs of administering the plan, including broker’s fees,
commissions, postage and other costs actually incurred.

16. LOANS TO RELATED PARTIES

During the normal course of business, the Bank enters into loans with related
parties, including executive officers and directors. The following is a summary of
the aggregate activity involving related-party borrowers (in thousands):

Balance, January 1, 2018
Disbursements
Amounts repaid

Balance, December 31, 2018

Undisbursed commitments to related parties, December 31,

2018

11,885
622
(769)

11,738

1,442

Notes to
Consolidated Financial Statements

17. PARENT ONLY CONDENSED FINANCIAL STATEMENTS

CONDENSED BALANCE SHEETS
December 31, 2018 and 2017
(In thousands)

ASSETS

Cash and cash equivalents
Investment in Bank subsidiary
Other assets

Total assets

LIABILITIES AND SHAREHOLDERS’ EQUITY

Liabilities:

Junior subordinated debentures due to subsidiary grantor trust
Other liabilities

Total liabilities

Shareholders’ equity:
Common stock
Retained earnings
Accumulated other comprehensive (loss) income, net of tax

Total shareholders’ equity

Total liabilities and shareholders’ equity

2018

2017

2,326
222,514
367

3,296
210,816
750

225,207

214,862

5,155
314

5,469

5,155
148

5,303

103,851
120,294
(4,407)

219,738

103,314
103,419
2,826

209,559

225,207

214,862

CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
For the Years Ended December 31, 2018, 2017, and 2016
(In thousands)

2018

2017

2016

Income:

Dividends declared by Subsidiary - eliminated in consolidation
Other income

Total income

Expenses:

Interest on junior subordinated deferrable interest debentures
Professional fees
Other expenses

Total expenses

Income before equity in undistributed net income of Subsidiary
Equity in undistributed net income of Subsidiary, net of distributions

Income before income tax benefit

Benefit from income taxes

Net income

Comprehensive income

2,850
6

2,856

199
217
548

964

1,892
19,075

20,967
322

21,289

13,912

3,133
4

3,137

147
231
1,019

1,397

1,740
11,754

13,494
532

14,026

16,867

13,010
4

13,014

121
133
779

1,033

11,981
2,852

14,833
349

15,182

10,204

Notes to
Consolidated Financial Statements

17. PARENT ONLY CONDENSED FINANCIAL STATEMENTS

(Continued)

CONDENSED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2018, 2017, and 2016
(In thousands)

Cash flows from operating activities:

Net income
Adjustments to reconcile net income to net cash provided by operating activities:

Undistributed net income of subsidiary, net of distributions
Stock-based compensation
Tax benefit from exercise of stock options
Net decrease (increase) in other assets
Net increase (decrease) in other liabilities
Benefit for deferred income taxes

Net cash provided by operating activities

Cash flows used in investing activities:

Investment in subsidiary

Cash flows from financing activities:

Cash dividend payments on common stock
Purchase and retirement of common stock
Proceeds from exercise of stock options
Proceeds from stock issued under employee stock purchase plan
Excess tax benefit from exercise of stock options

Net cash used in financing activities

(Decrease) increase in cash and cash equivalents

Cash and cash equivalents at beginning of year

Cash and cash equivalents at end of year

Supplemental Disclosure of Cash Flow Information:

Cash paid during the year for interest

Non-cash investing and financing activities:
Common stock issued in acquisitions

2018

2017

2016

21,289

14,026

15,182

(19,075)
482
-
372
166
11

3,245

(4,270)
(894)
738
211
-

(4,215)

(970)
3,296

2,326

185

(11,754)
384
-
(114)
(7)
155

2,690

(151)

(3,010)
-
2,880
-
-

(130)

2,409
887

3,296

142

28,405

(2,852)
284
(30)
(405)
64
98

12,341

(9,584)

(2,715)
-
231
-
30

(2,454)

303
584

887

112

16,678

Supplementary
Financial Information

The following supplementary financial information is not a part of the Company’s financial statements.

Net interest income
Provision for (Reversal of ) credit losses

Net interest income after provision for credit losses
Other non-interest income
Net realized gains (losses) on investment securities
Total non-interest expense
Provision for income taxes

Net income

Basic earnings per share

Diluted earnings per share

Unaudited Quarterly Statement of Operations Data
(In thousands, except per share amounts)

Q4 2018

Q3 2018

Q2 2018

Q1 2018

Q4 2017

Q3 2017

Q2 2017

Q1 2017

15,973 $

15,907 $

15,973
2,367
37
11,410
1,686

15,907
2,083
380
10,791
1,827

15,397 $
50

15,347
2,604
82
11,499
1,569

15,426 $

15,567 $

15,426
1,956
815
11,368
1,538

15,567
1,947
(6)
13,109
4,064

13,578 $
(900)

13,786 $
(150)

13,308
(100)

14,478
2,385
169
10,394
2,144

13,936
1,939
2,157
10,789
2,295

13,408
1,763
482
10,114
1,290

5,281 $

5,752 $

4,965 $

5,291 $

335 $

4,494 $

4,948 $

4,249

0.38 $

0.42 $

0.36 $

0.39 $

0.02 $

0.37 $

0.41 $

0.38 $

0.42 $

0.36 $

0.39 $

0.02 $

0.36 $

0.40 $

0.35

The results for the fourth quarter 2017 include the results of the assets and liabilities acquired from Folsom Lake Bank in addition to the continued organic growth
of the Company. The Company recorded additional tax expense of $3.54 million in the fourth quarter of 2017 related to the Tax Cuts and Jobs Act, which required
the Company to re-measure its net deferred tax assets and resulted in a reduction in diluted earnings per share of $0.26 in the quarter and $0.28 for the year.

Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm

The Shareholders and Board of Directors
Central Valley Community Bancorp and Subsidiary
Fresno, California

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Central Valley Community Bancorp and Subsidiary (the
‘‘Company’’) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in
shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes
(collectively referred to as the ‘‘financial statements’’). We also have audited the Company’s internal control over financial reporting as
of December 31, 2018, based on criteria established in Internal Control—Integrated Framework: (2013) issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the

Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the
three-year period ended December 31, 2018 in conformity with accounting principles generally accepted in the United States of
America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2018, based on criteria established in Internal Control—Integrated Framework: (2013) issued by COSO.

Basis for Opinions

The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial

reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying
Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s
financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public
accounting firm registered with the Public Company Accounting Oversight Board (United States) (‘‘PCAOB’’) and are required to be
independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations
of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or
fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial

statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included
examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included
evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation
of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered
necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability

of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in
accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect
on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

We have served as the Company’s auditor since 2011.

Sacramento, California
March 8, 2019

Selected
Consolidated Financial Data

Statements of Income

Total interest income
Total interest expense

Net interest income before provision for credit losses
Provision for (reversal of ) credit losses

Net interest income after provision for credit losses
Non-interest income
Non-interest expenses

Income before provision for (benefit from) income taxes
Provision for (benefit from) income taxes

Net income

Basic earnings per share

Diluted earnings per share

Cash dividends declared per common share

Balances at end of year:

Investment securities, Federal funds sold and deposits in other banks
Net loans
Total deposits
Total assets
Shareholders’ equity
Earning assets

Average balances:

Investment securities, Federal funds sold and deposits in other banks
Net loans
Total deposits
Total assets
Shareholders’ equity
Earning assets

Years Ended December 31,
(In thousands, except per-share amounts)

2018

2017

2016

2015

2014

64,187 $
1,484

57,376 $
1,137

46,676 $
1,096

41,822 $
1,047

62,703
50

62,653
10,324
45,068

27,909
6,620

56,239
(1,150)

57,389
10,836
44,406

23,819
9,793

45,580
(5,850)

51,430
9,591
38,922

22,099
6,917

40,775
600

40,175
9,387
36,016

13,546
2,582

41,039
1,156

39,883
7,985

31,898
8,164
35,338

4,724
(570)

21,289 $

14,026 $

15,182 $

10,964 $

5,294

1.55 $

1.12 $

1.34 $

1.00 $

1.54 $

1.10 $

1.33 $

1.00 $

0.31 $

0.24 $

0.18 $

0.48

0.20

December 31,
(In thousands)

2018

2017

2016

2015

2014

477,932 $
909,591
1,282,298
1,537,836
219,738
1,406,987

604,801 $
891,901
1,425,687
1,661,655
209,559
1,505,436

558,132 $
747,302
1,255,979
1,443,323
164,033
1,319,065

580,544 $
588,501
1,116,267
1,276,736
139,323
1,173,591

520,511
564,280
1,039,152
1,192,183
131,045
1,074,942

526,606 $
903,204
1,333,754
1,577,410
211,324
1,435,025

568,426 $
784,085
1,284,305
1,491,696
182,507
1,358,930

560,860 $
636,475
1,144,231
1,321,007
154,325
1,205,142

529,046 $
577,784
1,065,798
1,222,526
135,062
1,112,758

513,866
531,382
1,006,560
1,157,483
130,414
1,052,097

Data from 2017 reflects the partial year impact of the acquisition of Folsom Lake Bank on October 1, 2017. Data from 2016 reflects the partial year impact of the
acquisition of Sierra Vista Bank on October 1, 2016.

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

Management’s discussion and analysis should be read in conjunction with the

Company’s audited Consolidated Financial Statements, including the Notes
thereto, in Item 8 of this Annual Report.

Certain matters discussed in this report constitute forward-looking

statements within the meaning of the Private Securities Litigation Reform Act
of 1995. All statements contained herein that are not historical facts, such as
statements regarding the Company’s current business strategy and the
Company’s plans for future development and operations, are based upon
current expectations. These statements are forward-looking in nature and
involve a number of risks and uncertainties. Such risks and uncertainties
include, but are not limited to (1) significant increases in competitive pressure
in the banking industry; (2) the impact of changes in interest rates; (3) a
decline in economic conditions in the Central Valley; (4) the Company’s ability
to continue its internal growth at historical rates; (5) the Company’s ability to
maintain its net interest margin; (6) the decline quality of the Company’s
earning assets; (7) decline in credit quality; (8) changes in the regulatory
environment; (9) fluctuations in the real estate market; (10) changes in business
conditions and inflation; (11) changes in securities markets (12) risks associated
with acquisitions, relating to difficulty in integrating combined operations and
related negative impact on earnings, and incurrence of substantial expenses.
Therefore, the information set forth in such forward-looking statements should
be carefully considered when evaluating the business prospects of the Company.

When the Company uses in this Annual Report the words ‘‘anticipate,’’
‘‘estimate,’’ ‘‘expect,’’ ‘‘project,’’ ‘‘intend,’’ ‘‘commit,’’ ‘‘believe’’ and similar
expressions, the Company intends to identify forward-looking statements. Such
statements are not guarantees of performance and are subject to certain risks,
uncertainties and assumptions, including those described in this Annual Report.
Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may vary materially from
those anticipated, estimated, expected, projected, intended, committed or
believed. The future results and shareholder values of the Company may differ
materially from those expressed in these forward-looking statements. Many of
the factors that will determine these results and values are beyond the
Company’s ability to control or predict. For those statements, the Company
claims the protection of the safe harbor for forward-looking statements
contained in the Private Securities Litigation Reform Act of 1995. See also the
discussion of risk factors in Item 1A, ‘‘Risk Factors.’’

We are not able to predict all the factors that may affect future results. You

should not place undue reliance on any forward looking statement, which
speaks only as of the date of this Report on Form 10-K. Except as required by
applicable laws or regulations, we do not undertake any obligation to update or
revise any forward looking statement, whether as a result of new information,
future events or otherwise.

INTRODUCTION

Central Valley Community Bancorp (NASDAQ: CVCY) (the Company) was

incorporated on February 7, 2000. The formation of the holding company
offered the Company more flexibility in meeting the long-term needs of
customers, shareholders, and the communities it serves. The Company currently
has one bank subsidiary, Central Valley Community Bank (the Bank) and one
business trust subsidiary, Service 1st Capital Trust 1. The Company’s market area
includes the central valley area from Sacramento, California to Bakersfield,
California.

During 2018, we focused on asset quality and capital adequacy due to the

uncertainty created by the economy. We also focused on assuring that
competitive products and services were made available to our clients while
adjusting to the many new laws and regulations that affect the banking industry.
As of December 31, 2018, the Bank operated 21 full-service offices. The Bank
has a Real Estate Division, an Agribusiness Center and an SBA Lending Division
in Fresno. The Real Estate Division processes or assists in processing the majority
of the Bank’s real estate related transactions, including interim construction loans
for single family residences and commercial buildings. We offer permanent single
family residential loans through our mortgage broker services.

steady improvement. Housing in the Central Valley continues to be relatively
more affordable than the major metropolitan areas in California.

Agriculture and agricultural related businesses remain a critical part of the

Central Valley’s economy. The Valley’s agricultural production is widely
diversified, producing nuts, vegetables, fruit, cattle, dairy products, and cotton.
The continued future success of agriculture related businesses is highly dependent
on the availability of water and is subject to fluctuation in worldwide commodity
prices, currency exchanges, and demand. From time to time, California
experiences severe droughts or adverse weather issues, which could significantly
harm the business of our customers and the credit quality of the loans to those
customers. We closely monitor the water resources and the related issues affecting
our customers, and will remain vigilant for signs of deterioration within the loan
portfolio in an effort to manage credit quality and work with borrowers where
possible to mitigate any losses.

An additional negative affect on the agricultural is the ‘‘Tariff War’’, especially

with China. The increased tariffs on agricultural products by China has an
adverse effect on demand potentially causing financial difficulty for farmers. We
are closely monitoring how the agricultural industry is adapting through
developing new markets for their products.

OVERVIEW

Diluted earnings per share (EPS) for the year ended December 31, 2018 was
$1.54 compared to $1.10 and $1.33 for the years ended December 31, 2017 and
2016, respectively. Net income for 2018 was $21,289,000 compared to
$14,026,000 and $15,182,000 for the years ended December 31, 2017 and
2016, respectively. The increase in net income and EPS was primarily driven by
the increase in net interest income and decrease in provision for income taxes,
offset by the increase in non-interest expense, increase in provision for credit
losses, and decrease in non-interest income in 2018 compared to 2017. Total
assets at December 31, 2018 were $1,537,836,000 compared to $1,661,655,000
at December 31, 2017.

Return on average equity for 2018 was 10.07% compared to 7.69% and
9.84% for 2017 and 2016, respectively. Return on average assets for 2018 was
1.35% compared to 0.94% and 1.15% for 2017 and 2016, respectively. Total
equity was $219,738,000 at December 31, 2018 compared to $209,559,000 at
December 31, 2017. The increase in equity in 2018 compared to 2017 was
primarily driven by the retention of earnings, net of dividends paid, offset by a
decrease in unrealized gains on available-for-sale securities, net of estimated taxes,
recorded in accumulated other comprehensive income (AOCI).

Average total loans increased $118,785,000 or 14.97% to $912,128,000 in
2018 compared to $793,343,000 in 2017. In 2018, we recorded a provision for
credit losses of $50,000 compared to a reverse provision of $1,150,000 in 2017
and a reverse provision of $5,850,000 in 2016. The Company had
nonperforming assets consisting of $2,740,000 in nonaccrual loans at
December 31, 2018. At December 31, 2017, nonperforming assets totaled
$2,945,000. Net loan loss recoveries for 2018 were $276,000 compared to
$602,000 for 2017 and $5,566,000 for 2016. Refer to ‘‘Asset Quality’’ below for
further information.

Dividend Declared

On January 23, 2019, the Board of Directors declared a $0.10 per share cash

dividend payable on February 23, 2019 to shareholders of record as of
February 8, 2019.

Key Factors in Evaluating Financial Condition
and Operating Performance

In evaluating our financial condition and operating performance, we focus on

several key factors including:

• Return to our shareholders;
• Return on average assets;
• Development of revenue streams, including net interest income and

ECONOMIC CONDITIONS

Over the last several years the economy, as evidenced by the California and
Central Valley unemployment rates, and housing prices have shown slow but

non-interest income;

• Asset quality;
• Asset growth;
• Capital adequacy;

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

OVERVIEW

(Continued)

• Operating efficiency; and
• Liquidity.

Return to Our Shareholders

One measure of our return to our shareholders is the return on average equity
(ROE). ROE is a ratio that measures net income divided by average shareholders’
equity. Our ROE was 10.07% for the year ended 2018 compared to 7.69% and
9.84% for the years ended 2017 and 2016, respectively.

Our net income for the year ended December 31, 2018 increased $7,263,000
compared to 2017 and decreased $1,156,000 in 2017 compared to 2016. During
2018, net income compared to 2017 was positively impacted by the decrease in
tax expense. 2017 was negatively impacted by the re-measurement of our deferred
tax asset and corresponding increase in tax expense. Also contributing to the
increase during 2018 was an increase in net interest income, partially offset by an
increase in the provision for credit losses, an increase in non-interest expense and
a decrease in non-interest income.

Net interest income increased primarily because of increases in loan and
investment income, offset by increases in interest expense on deposits. The
impact to interest income from the accretion of the loan marks on acquired loans
was an increase of $1,158,000 and $1,048,000 for the years ended December 31,
2018 and 2017, respectively. For 2018, our net interest margin (NIM) increased
four basis points to 4.44% compared to 2017. Our net interest margin increased
as a result of yield changes, increase in interest rates, asset mix changes, and an
increase in average earning assets. The increase in net interest margin in the
period-to-period comparison resulted primarily from the increase in the effective
yield on interest earning deposits in other banks and Federal Funds sold, offset
by the decrease in the effective yield on average investment securities, and the
decrease in the yield on the Company’s loan portfolio. Net interest income
during 2018 was positively impacted by the collection of nonaccrual loans which
resulted in a recovery of interest income of approximately $720,000. The
recovery was partially offset by reversal of approximately $222,000 in interest
income on loans placed on nonaccrual during the year. Net interest income
during 2017 was positively impacted by the collection of nonaccrual loans which
resulted in a net recovery of interest income of approximately $1,325,000. The
recovery in 2017 was partially offset by reversal of approximately $12,000 in
interest income on loans placed on nonaccrual during the year.

Non-interest income decreased 4.72% in 2018 compared to 2017 primarily

due to a $1,488,000 decrease in net realized gains on sales and calls of
investment securities and a decrease in service charge income of $67,000. The
decrease in non-interest income was offset by a net gain of $462,000 on the sale
of the Company’s credit card portfolio, an increase in appreciation in cash
surrender value of bank owned life insurance of $74,000, and a $147,000
increase in Federal Home Loan Bank dividends.

Non-interest expenses increased $662,000 or 1.49% to $45,068,000 in 2018
compared to $44,406,000 in 2017. The net increase year over year was primarily
attributable to the FLB acquisition, which resulted in increases in salaries and
employee benefits of $1,483,000, occupancy and equipment expenses of
$786,000, operating losses of $302,000, information technology of $295,000,
advertising fees of $120,000, and amortization of core deposit intangibles of
$221,000,offset by decrease in acquisition and integration expenses of
$1,611,000, a decrease of $124,000 in credit card expenses, a decrease of
$132,000 in directors’ expenses, and a decrease of $74,000 in data processing
expenses, in 2018 compared to 2017. The Company recorded an income tax
provision of $6,620,000 for the year ended December 31, 2018, compared to
$9,793,000 for the year ended December 31, 2017. The Company recognized
additional tax expense in 2017 in the amount of $3,535,000 related to a tax law
change enacted in 2017. Basic EPS was $1.55 for 2018 compared to $1.12 and
$1.34 for 2017 and 2016, respectively. Diluted EPS was $1.54 for 2018
compared to $1.10 and $1.33 for 2017 and 2016, respectively. The increase in
EPS for 2018 is primarily due to the increase in net income.

Return on Average Assets

Our return on average assets (ROA) is a ratio that measures our performance
compared with other banks and bank holding companies. Our ROA for the year

ended 2018 was 1.35% compared to 0.94% and 1.15% for the years ended
December 31, 2017 and 2016, respectively. The 2018 increase in ROA is
primarily due to the increase in net income. Annualized ROA for our peer group
was 1.31% at December 31, 2018. Peer group information from SNL Financial
data includes bank holding companies in central California with assets from
$600 million to $3.5 billion.

Development of Revenue Streams

Over the past several years, we have focused on not only our net income, but

improving the consistency of our revenue streams in order to create more
predictable future earnings and reduce the effect of changes in our operating
environment on our net income. Specifically, we have focused on net interest
income through a variety of strategies, including increases in average interest
earning assets, and minimizing the effects of the recent interest rate changes on
our net interest margin by focusing on core deposits and managing the cost of
funds. Our net interest margin (fully tax equivalent basis) was 4.44% for the year
ended December 31, 2018, compared to 4.40% and 4.06% for the years ended
December 31, 2017 and 2016, respectively. We experienced an increase in 2018
net interest margin compared to 2017, resulting from the increase in the effective
yield on interest earning deposits in other banks and Federal Funds sold, offset
by the decrease in the effective yield on average investment securities, and the
decrease in the yield on the Company’s loan portfolio. The effective tax
equivalent yield on total earning assets increased six basis points, while the cost
of total interest-bearing liabilities increased slightly to 0.19% for the year ended
December 31, 2018. Our cost of total deposits in 2018 and 2017 was 0.09%
and 0.08%, respectively, compared to 0.09% for the same period in 2016. Our
net interest income before provision for credit losses increased $6,464,000 or
11.49% to $62,703,000 for the year ended 2018 compared to $56,239,000 and
$45,580,000 for the years ended 2017 and 2016, respectively.

Our non-interest income is generally made up of service charges and fees on

deposit accounts, fee income from loan placements, appreciation in cash
surrender value of bank owned life insurance, and net gains from sales and calls
of investment securities. Non-interest income in 2018 decreased $512,000 or
4.72% to $10,324,000 compared to $10,836,000 in 2017 and $9,591,000 in
2016. The decrease resulted primarily from decreases in net realized gains on
sales and calls of investment securities and service charge income, partially offset
by a increase in loan placement fees, net gain on the sale of the Company’s credit
card portfolio, interchange fees, appreciation in cash surrender value of bank
owned life insurance, and Federal Home Loan Bank dividends compared to
2017. Further detail on non-interest income is provided below.

Asset Quality

For all banks and bank holding companies, asset quality has a significant
impact on the overall financial condition and results of operations. Asset quality
is measured in terms of classified and nonperforming loans, and is a key element
in estimating the future earnings of a company. Total nonperforming assets were
$2,740,000 and $2,945,000 at December 31, 2018 and 2017, respectively.
Nonperforming assets totaled 0.30% of gross loans as of December 31, 2018 and
0.33% of gross loans as of December 31, 2017. Nonperforming loans were
$2,740,000 and $2,875,000 at December 31, 2018 and 2017, respectively. The
Company had no other real estate owned at December 31, 2018, December 31,
2017, and December 31, 2016. The carrying value of foreclosed assets was
$70,000 at December 31, 2017, and is included in other assets on the
consolidated balance sheets. No foreclosed assets were recorded at December 31,
2018 or December 31, 2016. Management maintains certain loans that have
been brought current by the borrower (less than 30 days delinquent) on
nonaccrual status until such time as management has determined that the loans
are likely to remain current in future periods.

The ratio of nonperforming loans to total loans was 0.30% as of

December 31, 2018 and 0.32% as of December 31, 2017. The allowance for
credit losses as a percentage of outstanding loan balance was 0.99% as of
December 31, 2018 and 0.98% as of December 31, 2017. The ratio of net
recoveries to average loans was 0.03% as of December 31, 2018 and 0.08% as of
December 31, 2017.

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

OVERVIEW

(Continued)

Asset Growth

As revenues from both net interest income and non-interest income are a
function of asset size, the continued growth in assets has a direct impact in
increasing net income and therefore ROE and ROA. The majority of our assets
are loans and investment securities, and the majority of our liabilities are
deposits, and therefore the ability to generate deposits as a funding source for
loans and investments is fundamental to our asset growth. Total assets decreased
7.45% during 2018 to $1,537,836,000 as of December 31, 2018 from
$1,661,655,000 as of December 31, 2017. Total gross loans increased 2.00% to
$918,695,000 as of December 31, 2018, compared to $900,679,000 at
December 31, 2017. Total investment securities and Federal funds sold decreased
13.18% to $471,207,000 as of December 31, 2018 compared to $542,721,000
as of December 31, 2017. Total deposits decreased 10.06% to $1,282,298,000 as
of December 31, 2018 compared to $1,425,687,000 as of December 31, 2017.
Our loan to deposit ratio at December 31, 2018 was 71.64% compared to
63.18% at December 31, 2017. The loan to deposit ratio of our peers was
82.00% at December 31, 2018. Peer group information from S&P Global
Market Intelligence data includes bank holding companies in central California
with assets from $600 million to $3.5 billion.

Capital Adequacy

At December 31, 2018, we had a total capital to risk-weighted assets ratio of
16.44%, a Tier 1 risk-based capital ratio of 15.59%, common equity Tier 1 ratio
of 15.13%, and a leverage ratio of 11.48%. At December 31, 2017, we had a
total capital to risk-weighted assets ratio of 14.07%, a Tier 1 risk-based capital
ratio of 13.28%, common equity Tier 1 ratio of 12.90%, and a leverage ratio of
9.71%. At December 31, 2018, on a stand-alone basis, the Bank had a total
risk-based capital ratio of 16.23%, a Tier 1 risk based capital ratio of 15.38%,
common equity Tier 1 ratio of 15.38%, and a leverage ratio of 11.32%. At
December 31, 2017, the Bank had a total risk-based capital ratio of 13.74%,
Tier 1 risk-based capital of 12.96% and a leverage ratio of 9.46%. Note 13 of the
audited Consolidated Financial Statements provides more detailed information
concerning the Company’s capital amounts and ratios. As of January 1, 2015,
bank holding companies with consolidated assets of $1 billion or more
($3 Billion or more effective August 30, 2018) and banks like Central Valley
Community Bank became subject to new capital requirements, and certain
provisions of the new rules are being phased in through 2019 under the
Dodd-Frank Act and Basel III. As of December 31, 2018, the Bank met or
exceeded all of their capital requirements inclusive of the capital buffer. The
Bank’s capital ratios exceeded the regulatory guidelines for a well-capitalized
financial institution under the Basel III regulatory requirements at December 31,
2018.

Operating Efficiency

Operating efficiency is the measure of how efficiently earnings before taxes are

generated as a percentage of revenue. A lower ratio represents greater efficiency.
The Company’s efficiency ratio (operating expenses, excluding amortization of
intangibles and foreclosed property expense, divided by net interest income plus
non-interest income, excluding net gains and losses from sale of securities) was
61.23% for 2018 compared to 62.03% for 2017 and 64.72% for 2016. The
improvement in the efficiency ratios in 2018 and 2017 was due to the growth in
revenues outpacing the growth in non-interest expense. The Company’s net
interest income before provision for credit losses plus non-interest income
increased 8.87% to $73,027,000 in 2018 compared to $67,075,000 in 2017 and
$55,171,000 in 2016, while operating expenses increased 1.49% in 2018,
14.09% in 2017, and 8.07% in 2016.

Liquidity

Liquidity management involves our ability to meet cash flow requirements

arising from fluctuations in deposit levels and demands of daily operations, which
include providing for customers’ credit needs, funding of securities purchases, and
ongoing repayment of borrowings. Our liquidity is actively managed on a daily
basis and reviewed periodically by our management and Directors’ Asset/Liability
Committee. This process is intended to ensure the maintenance of sufficient
funds to meet our needs, including adequate cash flows for off-balance sheet
commitments. Our primary sources of liquidity are derived from financing
activities which include the acceptance of customer and, to a lesser extent, broker
deposits, Federal funds facilities and advances from the Federal Home Loan Bank
of San Francisco. We have available unsecured lines of credit with correspondent
banks totaling approximately $40,000,000 and secured borrowing lines of
approximately $286,934,000 with the Federal Home Loan Bank. These funding
sources are augmented by collection of principal and interest on loans, the
routine maturities and pay downs of securities from our investment securities
portfolio, the stability of our core deposits, and the ability to sell investment
securities. Primary uses of funds include origination and purchases of loans,
withdrawals of and interest payments on deposits, purchases of investment
securities, and payment of operating expenses.

We had liquid assets (cash and due from banks, interest-earning deposits in
other banks, Federal funds sold, equity securities, and available-for-sale securities)
totaling $502,886,000 or 32.70% of total assets at December 31, 2018 and
$643,087,000 or 38.70% of total assets as of December 31, 2017.

RESULTS OF OPERATIONS

NET INCOME

Net income was $21,289,000 in 2018 compared to $14,026,000 and

$15,182,000 in 2017 and 2016, respectively. Basic earnings per share was $1.55,
$1.12, and $1.34 for 2018, 2017, and 2016, respectively. Diluted earnings per
share was $1.54, $1.10, and $1.33 for 2018, 2017, and 2016, respectively. ROE
was 10.07% for 2018 compared to 7.69% for 2017 and 9.84% for 2016. ROA
for 2018 was 1.35% compared to 0.94% for 2017 and 1.15% for 2016.

The increase in net income for 2018 compared to 2017 was primarily due to
a decrease in provision for income taxes and an increase in net interest income,
partially offset by an increase in the provision for credit losses, an increase in
non-interest expense and a decrease in non-interest income. The decrease in net
income for 2017 compared to 2016 was primarily attributed to an increase in
provision for income taxes and an increase in non-interest expense, partially offset
by an increase in the provision for credit losses, an increase in net interest
income, and an increase in non-interest income.

INTEREST INCOME AND EXPENSE

Net interest income is the most significant component of our income from
operations. Net interest income (the interest rate spread) is the difference between
the gross interest and fees earned on the loan and investment portfolios and the
interest paid on deposits and other borrowings. Net interest income depends on
the volume of and interest rate earned on interest-earning assets and the volume
of and interest rate paid on interest-bearing liabilities.

The following table sets forth a summary of average balances with

corresponding interest income and interest expense as well as average yield and
cost information for the periods presented. Average balances are derived from
daily balances, and nonaccrual loans are not included as interest-earning assets for
purposes of this table.

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

INTEREST INCOME AND EXPENSE (Continued)

Year Ended December 31, 2018
Interest
Income/
Expense

Average
Balance

Average
Interest Rate

Year Ended December 31, 2017
Interest
Income/
Expense

Average
Balance

Average
Interest Rate

Year Ended December 31, 2016
Interest
Income/
Expense

Average
Balance

Average
Interest Rate

SCHEDULE OF AVERAGE
BALANCES, AVERAGE YIELDS
AND RATES
(Dollars in thousands)
ASSETS

Interest-earning deposits in

other banks

Securities

Taxable securities
Non-taxable securities (1)

Total investment securities

Federal funds sold

Total securities and

interest-earning deposits

Loans (2) (3)

24,055 $

459

1.91%

36,709 $

424

1.16%

53,514 $

289

391,549
110,962

502,511
40

526,606
908,419

10,254
4,478

14,732
1

15,192
49,936

65,128

2.62%
4.04%

2.93%
2.10%

2.88%
5.50%

4.54%

6,526
10,443

16,969
-

17,393
43,534

60,927

2.10%
4.73%

3.19%
1.50%

3.06%
5.51%

4.48%

310,876
220,806

531,682
35

568,426
790,504

1,358,930 $

(9,258)
2,839
24,989
9,310
104,886

5,876
9,787

15,663
-

15,952
34,051

50,003

313,006
194,224

507,230
116

560,860
644,282

1,205,142 $

(10,098)
2,291
23,840
9,053
90,779

Total interest-earning assets

1,435,025 $

Allowance for credit losses
Nonaccrual loans
Cash and due from banks
Bank premises and equipment
Other assets

(8,924)
3,709
27,199
9,148
111,253

Total average assets

1,577,410

1,491,696

1,321,007

LIABILITIES AND

SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:

Savings and NOW accounts
Money market accounts
Time certificates of deposit

Total interest-bearing

deposits

Other borrowed funds

383,667 $
285,568
111,214

780,449
12,180

Total interest-bearing liabilities

792,629 $

Non-interest bearing demand

deposits

Other liabilities
Shareholders’ equity

553,305
20,152
211,324

Total average liabilities and

shareholders’ equity

1,577,410

451
419
283

1,153
331

1,484

0.12%
0.15%
0.25%

0.15%
2.72%

0.19%

382,071 $
264,581
137,666

784,318
6,930

350
211
408

969
168

791,248 $

1,137

0.09%
0.08%
0.30%

0.12%
2.42%

0.14%

337,804 $
249,620
139,656

727,080
5,157

317
133
525

975
121

732,237 $

1,096

499,987
17,954
182,507

417,151
17,294
154,325

1,491,696

1,321,007

0.54%

1.88%
5.04%

3.09%
0.51%

2.84%
5.29%

4.15%

0.09%
0.05%
0.38%

0.13%
2.35%

0.15%

Interest income and rate earned
on average earning assets

Interest expense and interest cost
related to average interest-
bearing liabilities

Net interest income and net

interest margin (4)

65,128

4.54%

60,927

4.48%

50,003

4.15%

1,484

0.19%

1,137

0.14%

1,096

0.15%

63,644

4.44%

59,790

4.40%

48,907

4.06%

(1) Interest income is calculated on a fully tax equivalent basis, which includes Federal tax benefits relating to income earned on municipal bonds totaling $940, $3,551, and $3,327 in 2018,

2017, and 2016, respectively.

(2) Loan interest income includes loan fees of $397 in 2018, $684 in 2017, and $134 in 2016.

(3) Average loans do not include nonaccrual loans.

(4) Net interest margin is computed by dividing net interest income by total average interest-earning assets.

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

INTEREST INCOME AND EXPENSE

(Continued)

The following table sets forth a summary of the changes in interest income

and interest expense due to changes in average asset and liability balances
(volume) and changes in average interest rates for the periods indicated. The
change in interest due to both rate and volume has been allocated to the change
in rate.

For the Years Ended
December 31, 2018
Compared to 2017

For the Years Ended
December 31, 2017
Compared to 2016

Volume

Rate

Net

Volume

Rate

Net

(In thousands)

(146) $

181 $

35 $

(90) $

225 $

135

1,694
(5,196)

2,034
(769)

3,728
(5,965)

(39)
1,339

689
(683)

650
656

(3,502)
1
6,493
-

1,265
-
(91)
-

(2,237)
1
6,402
-

1,300
-
7,728
123

6
-
1,755
(310)

1,306
-
9,483
(187)

2,846

1,355

4,201

9,061

1,676

10,737

292

309

111

(78)

(47)

(125)

(7)

(110)

(117)

(61)
127

245
36

184
163

281

347

42
41

(48)
6

(42)

(6)
47

Changes in Volume/Rate

Increase (decrease) due to

changes in:
Interest income:

Interest-earning deposits

in other banks
Investment securities:

Taxable
Non-taxable (1)

Total investment

securities

Federal funds sold
Loans
FHLB Stock

Total earning
assets (1)

Interest expense:
Deposits:

Savings, NOW and

MMA

Time certificate of

deposits

Total interest-bearing

deposits
Other borrowed funds

Total interest bearing

liabilities

Net interest income (1)

2,780 $

1,074 $

3,854 $

8,978 $

1,718 $ 10,696

(1) Computed on a tax equivalent basis for securities exempt from federal income

taxes.

Interest and fee income from loans increased $6,402,000 or 14.71% in 2018
compared to 2017. Interest and fee income from loans increased $9,483,000 or
27.85% in 2017 compared to 2016. The increase in 2018 is primarily
attributable to an increase in average total loans outstanding, offset by a slight
decrease in the yield on loans by one basis point. The net interest income during
2018 was positively impacted by the FLB acquisition in addition to the
collection of nonaccrual loans which resulted in a recovery of interest income of
approximately $720,000. The recovery was partially offset by reversal of
approximately $222,000 in interest income on loans placed on nonaccrual status
during the year. Net interest income during 2017 was positively impacted by the
collection of nonaccrual loans which resulted in a recovery of interest income of
approximately $1,325,000. The recovery was partially offset by reversal of
approximately $12,000 in interest income on loans placed on nonaccrual status
during the year.

Average total loans for 2018 increased $118,785,000 to $912,128,000

compared to $793,343,000 for 2017 and $646,573,000 for 2016. The yield on
loans for 2018 was 5.50% compared to 5.51% and 5.29% for 2017 and 2016,
respectively. The impact to interest income from the accretion of the loan marks
on acquired loans was an increase of $1,158,000 and $1,048,000 for the years
ended December 31, 2018 and 2017, respectively.

Interest income from total investments on a non tax-equivalent basis, (total
investments include investment securities, Federal funds sold, interest-bearing
deposits in other banks, and other securities), increased $409,000 or 2.95% in
2018 compared to 2017. The yield on average investments decreased 18 basis
points to 2.88% for the year ended December 31, 2018 from 3.06% for the year

ended December 31, 2017. Average total investments decreased $41,820,000 to
$526,606,000 in 2018 compared to $568,426,000 in 2017. In 2017, total
investment income on a non tax-equivalent basis increased $1,217,000 or 9.64%
compared to 2016.

Our investment portfolio consists primarily of securities issued by U.S.
Government sponsored entities and agencies collateralized by mortgage backed
obligations and obligations of states and political subdivision securities. However,
a significant portion of the investment portfolio is mortgage-backed securities
(MBS) and collateralized mortgage obligations (CMOs). At December 31, 2018,
we held $361,080,000 or 77.83% of the total market value of the investment
portfolio in MBS and CMOs with an average yield of 2.81%. We invest in
CMOs and MBS as part of our overall strategy to increase our net interest
margin. CMOs and MBS by their nature are affected by prepayments which are
impacted by changes in interest rates. In a normal declining rate environment,
prepayments from MBS and CMOs would be expected to increase and the
expected life of the investment would be expected to shorten. Conversely, if
interest rates increase, prepayments normally would be expected to decline and
the average life of the MBS and CMOs would be expected to extend. Premium
amortization and discount accretion of these investments affects our net interest
income. Our management monitors the prepayment trends of these investments
and adjusts premium amortization and discount accretion based on several
factors. These factors include the type of investment, the investment structure,
interest rates, interest rates on new mortgage loans, expectation of interest rate
changes, current economic conditions, the level of principal remaining on the
bond, the bond coupon rate, the bond origination date, and volume of available
bonds in market. The calculation of premium amortization and discount
accretion is by nature inexact, and represents management’s best estimate of
principal pay downs inherent in the total investment portfolio.

The cumulative net-of-tax effect of the change in market value of the

available-for-sale investment portfolio as of December 31, 2018 was an unrealized
loss of $4,407,000 and is reflected in the Company’s equity. At December 31,
2018, the effective duration of the investment portfolio was 3.54 years and the
market value reflected a pre-tax unrealized loss of $6,257,000. Management
reviews market value declines on individual investment securities to determine
whether they represent other-than-temporary impairment (OTTI). For the years
ended December 31, 2018 and 2017, no OTTI was recorded. For the year
ended December 31, 2016, OTTI was recorded in the amount of $136,000.
Future deterioration in the market values of our investment securities may require
the Company to recognize additional OTTI losses.

A component of the Company’s strategic plan has been to use its investment

portfolio to offset, in part, its interest rate risk relating to variable rate loans.
Measured at December 31, 2018, an immediate rate increase of 200 basis points
would result in an estimated decrease in the market value of the investment
portfolio by approximately $33,989,000. Conversely, with an immediate rate
decrease of 200 basis points, the estimated increase in the market value of the
investment portfolio would be $32,468,000. The modeling environment assumes
management would take no action during an immediate shock of 200 basis
points. However, the Company uses those increments to measure its interest rate
risk in accordance with regulatory requirements and to measure the possible
future risk in the investment portfolio. For further discussion of the Company’s
market risk, refer to Quantitative and Qualitative Disclosures about Market Risk.
Management’s review of all investments before purchase includes an analysis of

how the security will perform under several interest rate scenarios to monitor
whether investments are consistent with our investment policy. The policy
addresses issues of average life, duration, and concentration guidelines, prohibited
investments, impairment, and prohibited practices.

Total interest income in 2018 increased $6,811,000 to $64,187,000 compared

to $57,376,000 in 2017 and $46,676,000 in 2016. The increase was the result
of yield changes, increase in interest rates, asset mix changes, and an increase in
average earning assets. The tax-equivalent yield on interest earning assets
increased to 4.54% for the year ended December 31, 2018 from 4.48% for the
year ended December 31, 2017. Average interest earning assets increased to
$1,435,025,000 for the year ended December 31, 2018 compared to
$1,358,930,000 for the year ended December 31, 2017. Average interest-earning
deposits in other banks decreased $12,654,000 comparing 2018 to 2017. Average
yield on these deposits was 1.91% compared to 1.16% on December 31, 2018
and December 31, 2017 respectively. Average investments and interest-earning
deposits decreased $41,820,000 but the tax equivalent yield on those assets

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

INTEREST INCOME AND EXPENSE

(Continued)

decreased 18 basis points. Average total loans increased $118,785,000 and the
yield on average loans decreased one basis point.

The increase in total interest income for 2017 was the result of yield changes,

asset mix changes, and an increase in average earning assets. The yield on
interest-earning assets increased to 4.48% for the year ended December 31, 2017
from 4.15% for the year ended December 31, 2016. Average interest-earning
assets increased to $1,358,930,000 for the year ended December 31, 2017
compared to $1,205,142,000 for the year ended December 31, 2016.

Interest expense on deposits in 2018 increased $184,000 or 18.99% to
$1,153,000 compared to $969,000 in 2017 and increased as compared to
$975,000 in 2016. The yield on interest-bearing deposits increased 3 basis points
to 0.15% in 2018 from 0.12% in 2017. The yield on interest-bearing deposits
decreased one basis point to 0.12% in 2017 from 0.13% in 2016. Average
interest-bearing deposits were $780,449,000 for 2018 compared to $784,318,000
and $727,080,000 for 2017 and 2016, respectively.

Average other borrowings were $12,180,000 with an effective rate of 2.72%
for 2018 compared to $6,930,000 with an effective rate of 2.42% for 2017. In
2016, the average other borrowings were $5,157,000 with an effective rate of
2.35%. Included in other borrowings are the junior subordinated deferrable
interest debentures acquired from Service 1st, advances on lines of credit,
advances from the Federal Home Loan Bank (FHLB), and overnight borrowings.
The debentures carry a floating rate based on the three month LIBOR plus a
margin of 1.60%. The rate was 4.04% for 2018, 2.96% for 2017, and 2.48%
for 2016.

The cost of all interest-bearing liabilities was 0.19% and 0.14% basis points
for 2018 and 2017, respectively, compared to 0.15% for 2016. The cost of total
deposits increased to 0.09% for the year ended December 31, 2018, compared to
0.08% and 0.09% for the years ended December 31, 2017 and 2016,
respectively. Average demand deposits increased 10.66% to $553,305,000 in
2018 compared to $499,987,000 for 2017 and $417,151,000 for 2016. The
ratio of average non-interest demand deposits to average total deposits increased
to 41.48% for 2018 compared to 38.93% and 36.46% for 2017 and 2016,
respectively.

NET INTEREST INCOME BEFORE PROVISION FOR CREDIT LOSSES

Net interest income before provision for credit losses for 2018 increased

$6,464,000 or 11.49% to $62,703,000 compared to $56,239,000 for 2017 and
$45,580,000 for 2016. The increase in 2018 was due to the increase in average
earning assets while the yield on interest bearing liabilities increased 5 basis
point. Our net interest margin (NIM) increased 4 basis points. Yield on interest
earning assets increased 6 basis points. The change in the mix of average interest
earning assets also affected NIM. The increase in net interest margin in the
period-to-period comparison resulted primarily from the increase in the effective
yield on interest earning deposits in other banks and Federal Funds sold, offset
by the decrease in the effective yield on average investment securities, and the
decrease in the yield on the Company’s loan portfolio. Net interest income before
provision for credit losses increased $10,659,000 in 2017 compared to 2016,
primarily due to the increase in average earning assets. Average interest-earning
assets were $1,435,025,000 for the year ended December 31, 2018 with a NIM
of 4.44% compared to $1,358,930,000 with a NIM of 4.40% in 2017, and
$1,205,142,000 with a NIM of 4.06% in 2016. For a discussion of the repricing
of our assets and liabilities, refer to Quantitative and Qualitative Disclosure about
Market Risk.

PROVISION FOR CREDIT LOSSES

We provide for probable incurred credit losses through a charge to operating
income based upon the change in balance and composition of the loan portfolio,
delinquency levels, historical losses and nonperforming assets, economic and
environmental conditions and other factors which, in management’s judgment,
deserve recognition in estimating credit losses. Loans are charged off when they
are considered uncollectible or when continuance as an active earning bank asset
is not warranted.

The establishment of an adequate credit allowance is based on both an

accurate risk rating system and loan portfolio management tools. The Board of
Directors have established initial responsibility for the accuracy of credit risk

grades with the individual credit officer. The Credit Review Officer (CRO) will
review loans to ensure the accuracy of the risk grade and is empowered to change
any risk grade, as appropriate. The CRO is not involved in loan originations.
Quarterly, the credit officers must certify the current risk grade of the loans in
their portfolio. The CRO reviews the certifications. At least quarterly the CRO
reports his activities to the Board of Directors Audit Committee; and at least
annually the loan portfolio is reviewed by a third party credit reviewer and by
various regulatory agencies.

Quarterly, the Chief Credit Officer (CCO) sets the specific reserve for all
impaired credits. Additionally, the CCO is responsible to ensure that the general
reserves on non-impaired loans are properly set each quarter. This process
includes the utilization of loan delinquency reports, classified asset reports,
collateral analysis and portfolio concentration reports to assist in accurately
assessing credit risk and establishing appropriate reserves.

The allowance for credit losses is reviewed at least quarterly by the Board of
Directors Audit Committee and by the Board of Directors. General reserves are
allocated to loan portfolio categories using percentages which are based on both
historical risk elements such as delinquencies and losses and predictive risk
elements such as economic, competitive and environmental factors. We have
adopted the specific reserve approach to allocate reserves to each impaired credit
for the purpose of estimating potential loss exposure. Although the allowance for
credit losses is allocated to various portfolio categories, it is general in nature and
available for the loan portfolio in its entirety. Changes in the allowance for credit
losses may be required based on the results of independent loan portfolio
examinations, regulatory agency examinations, or our own internal review
process. Additions are also required when, in management’s judgment, the
allowance does not properly reflect the portfolio’s probable loss exposure.
Management believes that all adjustments, if any, to the allowance for credit
losses are supported by the timely and consistent application of methodologies
and processes resulting in detailed documentation of the allowance calculation
and other portfolio trending analysis.

The allocation of the allowance for credit losses is set forth below (in

thousands):

Loan Type

Commercial:

December 31,
2018

December 31,
2017

Commercial and industrial
Agricultural production

Real estate:

Owner occupied
Real estate construction and other land

loans

Commercial real estate
Agricultural real estate
Other real estate

Consumer:

Equity loans and lines of credit
Consumer and installment

Unallocated reserves

1,604
67

1,131

1,271
3,017
947
173

419
407
68

1,784
287

1,252

1,004
1,958
1,441
140

464
361
87

Total allowance for credit losses

9,104

8,778

Loans are charged to the allowance for credit losses when the loans are deemed
uncollectible. It is the policy of management to make additions to the allowance
so that it remains adequate to cover all probable incurred credit losses that exist
in the portfolio at that time. We assign qualitative and environmental factors
(Q factors) to each loan category. Q factors include reserves held for the effects
of lending policies, economic trends, and portfolio trends along with other
dynamics which may cause additional stress to the portfolio.

Managing high-risk credits identified through the risk evaluation methodology

includes developing a business strategy with the customer to mitigate our
potential losses. Management continues to monitor these credits with a view to
identifying as early as possible when, and to what extent, additional provisions
may be necessary. Management believes that the level of allowance for loan losses
allocated to commercial and real estate loans has been adjusted accordingly.
During the year ended December 31, 2018, the Company recorded a
provision for credit losses of $50,000 compared to a reverse provision of
$1,150,000 and a reverse provision of $5,850,000 for the same periods in 2017

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

PROVISION FOR CREDIT LOSSES

(Continued)

NON-INTEREST INCOME

and 2016, respectively. The recorded provision and reverse provisions to the
allowance for credit losses are primarily the result of our assessment of the overall
adequacy of the allowance for credit losses considering a number of factors as
discussed in the ‘‘Allowance for Credit Losses’’ section.

During the years ended December 31, 2018, 2017 and 2016 the Company
had net recoveries totaling $276,000, $602,000, and $5,566,000, respectively.
The net charge-off (recovery) ratio, which reflects net charge-offs (recoveries) to
average loans, was (0.03)%, (0.08)% and (0.86)% for 2018, 2017, and 2016,
respectively.

Nonperforming loans were $2,740,000 and $2,875,000 at December 31, 2018

and 2017, respectively. Nonperforming loans as a percentage of total loans were
0.30% at December 31, 2018 compared to 0.32% at December 31, 2017. The
Company had no other real estate owned at December 31, 2018, December 31,
2017, and December 31, 2016. The carrying value of foreclosed assets was
$70,000 at December 31, 2017, and is included in other assets on the
consolidated balance sheets. No foreclosed assets were recorded at December 31,
2018 or December 31, 2016. At December 31, 2018, we had $1,208,000 loans
past due, not including nonaccrual loans compared to $1,281,000 loans past due
at December 31, 2017.

Economic pressures may negatively impact the financial condition of borrowers

to whom the Company has extended credit and as a result when negative
economic conditions are anticipated, we may be required to make significant
provisions to the allowance for credit losses. The Bank conducts banking
operation principally in California’s Central Valley. The Central Valley is largely
dependent on agriculture. The agricultural economy in the Central Valley is
therefore important to our financial performance, results of operation and cash
flows. We are also dependent in a large part upon the business activity,
population growth, income levels and real estate activity in this market area. A
downturn in agriculture and the agricultural related businesses could have a
material adverse effect our business, results of operation and financial condition.
The agricultural industry has been affected by declines in prices and the rates of
price growth for various crops and other agricultural commodities. Similarly,
weaker prices could reduce the cash flows generated by farms and the value of
agricultural land in our local markets and thereby increase the risk of default by
our borrowers or reduce the foreclosure value of agricultural land and equipment
that serve as collateral of our loans. Further declines in commodity prices or
collateral values may increase the incidence of default by our borrowers.
Moreover, weaker prices might threaten farming operations in the Central Valley,
reducing market demand for agricultural lending. In particular, farm income has
seen recent declines, and in line with the downturn in farm income, farmland
prices are coming under pressure.

We have been and will continue to be proactive in looking for signs of

deterioration within the loan portfolio in an effort to manage credit quality and
work with borrowers where possible to mitigate losses. As of December 31, 2018,
there were $28.4 million in classified loans of which $19.2 million related to
agricultural real estate, $2.6 million to commercial and industrial loans,
$0.9 million to real estate owner occupied, $3.0 million to real estate
construction, and $1.1 million to commercial real estate. This compares to
$50.0 million in classified loans as of December 31, 2017 of which
$26.5 million related to agricultural real estate, $3.9 million to real estate
construction, $7.9 million to commercial and industrial, $3.9 million to
agricultural production, and $3.4 million to commercial real estate.

As of December 31, 2018, we believe, based on all current and available
information, the allowance for credit losses is adequate to absorb probable
incurred losses within the loan portfolio; however, no assurance can be given that
we may not sustain charge-offs which are in excess of the allowance in any given
period. Refer to ‘‘Allowance for Credit Losses’’ below for further information.

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES

Net interest income, after the provision for credit losses was $62,653,000 for

2018 compared to $57,389,000 and $51,430,000 for 2017 and 2016,
respectively.

Non-interest income is comprised of customer service charges, gains on sales

and calls of investment securities, income from appreciation in cash surrender
value of bank owned life insurance, loan placement fees, Federal Home Loan
Bank dividends, and other income. Non-interest income was $10,324,000 in
2018 compared to $10,836,000 and $9,591,000 in 2017 and 2016, respectively.
The $512,000 or 4.72% decrease in non-interest income in 2018 resulted
primarily from decreases in net realized gains on sales and calls of investment
securities and service charge income, partially offset by a increase in loan
placement fees, net gain on the sale of the Company’s credit card portfolio,
interchange fees, appreciation in cash surrender value of bank owned life
insurance, and Federal Home Loan Bank dividends compared to 2017. The
$1,245,00 or 12.98% increases in non-interest income in 2017 compared to
2016 was due to increases in net realized gains on sales and calls of investment
securities, service charge income, interchange fees, and other income, partially
offset by a decrease in Federal Home Loan Bank dividends, and loan placement
fees.

Customer service charges decreased $67,000 to $2,986,000 in 2018 compared

to $3,053,000 in 2017 and $2,849,000 in 2016. The increase in 2017 from
2016 resulted from increase in our customer base from the SVB and FLB
acquisitions.

During the year ended December 31, 2018, we realized net gains on sales and

calls of investment securities of $1,314,000, compared to $2,802,000 in 2017
and $1,920,000 in 2016. In 2016, we recorded an other-than-temporary
impairment loss of $136,000 as compared to none during the years ended
December 31, 2018, and 2017. The net gains in 2018, 2017, and 2016 were the
results of partial restructuring of the investment portfolio designed to improve
the future performance of the portfolio. See Note 4 to the audited Consolidated
Financial Statements for more detail.

Income from the appreciation in cash surrender value of bank owned life

insurance (BOLI) totaled $695,000 in 2018 compared to $621,000 and
$558,000 in 2017 and 2016, respectively. The Bank’s salary continuation and
deferred compensation plans and the related BOLI are used as retention tools for
directors and key executives of the Bank.

Interchange fees totaled $1,462,000 in 2018 compared to $1,458,000 and
$1,228,000 in 2017 and 2016, respectively. Part of the increases in 2018 and
2017 was attributable to the FLB and SVB acquisitions.

We earn loan placement fees from the brokerage of single-family residential
mortgage loans provided for the convenience of our customers. Loan placement
fees increased $2,000 in 2018 to $708,000 compared to $706,000 in 2017 and
$1,083,000 in 2016.

The Bank holds stock from the Federal Home Loan Bank in relationship with

its borrowing capacity and generally receives quarterly dividends. As of
December 31, 2018 and 2017, we held $6,843,000 in FHLB stock. Dividends in
2018 increased to $590,000 compared to $443,000 in 2017 and $630,000 in
2016.

A net gain of $462,000 on the sale of the Company’s credit card portfolio was

recorded during the year ended December 31, 2018. Other income increased to
$2,107,000 in 2018 compared to $1,753,000 and $1,459,000 in 2017 and
2016, respectively.

NON-INTEREST EXPENSES

Salaries and employee benefits, occupancy and equipment, regulatory
assessments, acquisition and integration-related expenses, data processing
expenses, ATM/Debit card expenses, license and maintenance contract expenses,
information technology, and professional services (consisting of audit, accounting,
consulting and legal fees) are the major categories of non-interest expenses.
Non-interest expenses increased $662,000 or 1.49% to $45,068,000 in 2018
compared to $44,406,000 in 2017, and $38,922,000 in 2016. The net increase
period-over-period is primarily due to the FLB and SVB acquisitions. Various
items are discussed below.

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

NON-INTEREST EXPENSES (Continued)

The following table describes significant components of other non-interest

expense as a percentage of average assets.

Our efficiency ratio, measured as the percentage of non-interest expenses
(exclusive of amortization of core deposit intangibles, other real estate owned,
and repossessed asset expenses) to net interest income before provision for credit
losses plus non-interest income (exclusive of realized gains or losses on sale and
calls of investments) was 61.23% for 2018 compared to 62.03% for 2017 and
64.72% for 2016. The improvement in the efficiency ratio in 2018 and 2017 is
due to the growth in revenues outpacing the growth in non-interest expense.

Salaries and employee benefits increased $1,483,000 or 5.99% to $26,221,000
in 2018 compared to $24,738,000 in 2017 and $21,881,000 in 2016. Full time
equivalents were 316 for the year ended December 31, 2018 compared to 334
for the year ended December 31, 2017. The increase in salaries and employee
benefits in 2018 compared to 2017 is a result of higher overall salary and benefit
expenses.

For the years ended December 31, 2018, 2017, and 2016, the compensation

cost recognized for share based compensation was $482,000, $384,000 and
$284,000, respectively. As of December 31, 2018, there was $677,000 of total
unrecognized compensation cost related to non-vested share-based compensation
arrangements granted under all plans. The cost is expected to be recognized over
a weighted average period of 2.04 years. See Notes 1 and 14 to the audited
Consolidated Financial Statements for more detail. No options to purchase shares
of the Company’s common stock were issued during the years ending
December 31, 2018 and 2017. Restricted common stock awards of 22,204 shares
were awarded in 2018. No restricted stock shares were awarded in 2017.
Occupancy and equipment expense increased $786,000 or 15.16% to

$5,972,000 in 2018 compared to $5,186,000 in 2017 and $4,754,000 in 2016.
The net increase year over year was primarily attributable to the FLB acquisition
and consolidation of three branches in addition to increased contract repairs
through out the entire Company. The addition of five new branches from the
FLB and SVB acquisitions resulted in an approximately $338,000 increase in rent
expense in 2017 as compared to 2016. The Company made no changes in its
depreciation expense methodology.

Regulatory assessments were $619,000 in 2018 compared to $652,000 and
$642,000 in 2017 and 2016, respectively. The assessment base for calculating the
amount owed is average assets minus average tangible equity. Beginning in the
third quarter of 2016, the FDIC approved a final rule revising DIF assessment
formulas which resulted in lower assessments for the Company. 2017 and 2016
were higher as compared to 2018 due to the additional assessments on the
acquired institutions.

Data processing expenses were $1,666,000 in 2018 compared to $1,740,000 in
2017 and $1,707,000 in 2016. The $74,000 or 4.25% decrease in 2018 is from
the consolidation of processes after the conversion of the acquired institutions
was completed in 2018. Acquisition and integration expenses related to the FLB
and SVB mergers were $217,000 in 2018 compared to $1,828,000 in 2017 and
$1,782,000 in 2016. Professional services decreased $34,000 in 2018 compared
to 2017.

Amortization of core deposit intangibles was $455,000 for 2018, $234,000 for

2017, and $149,000 for 2016. During 2018, amortization expense related to
FLB core deposit intangible (CDI) was $247,000, amortization expense related to
SVB core deposit intangible (CDI) was $72,000, and amortization expense
related to VCB CDI was $136,000. During 2017, amortization expense related
to FLB CDI was $47,000, SVB CDI was $50,000 and amortization expense
related to VCB CDI was $137,000. During 2016, amortization expense related
to SVB CDI was $12,000, and amortization expense related to VCB CDI was
$137,000.

ATM/Debit card expenses decreased $11,000 to $739,000 for the year ended

December 31, 2018 compared to $750,000 in 2017 and $633,000 in 2016.
Information technology expenses increased $295,000 to $1,113,000 for the year
ended December 31, 2018 compared to $818,000 and $531,000 in 2017 and
2016, respectively. Other non-interest expenses decreased $375,000 or 7.48% to
$4,636,000 in 2018 compared to $5,011,000 in 2017 and $3,801,000 in 2016.

For the years ended December 31,

Other
Expense Average
Assets

2018

Other
Expense Average
Assets

2017

Other
Expense Average
Assets

2016

Stationery/supplies
Amortization of software
Telephone
Alarm
Postage
Armored courier fees
Risk management expense
Loss on sale or write-down

of assets
Donations
Personnel other
Credit card expense
Education/training
Loan related expenses
General insurance
Travel and mileage Expense
Operating losses
Shareholder services
Other

Total other non-interest

expense

281
303
217
101
209
274
195

2
243
167
121
172
77
165
267
452
129
1,261

(Dollars in thousands)

0.02% $
0.02%
0.01%
0.01%
0.01%
0.02%
0.01%

-%
0.02%
0.01%
0.01%
0.01%
-%
0.01%
0.02%
0.03%
0.01%
0.08%

292
289
265
130
205
266
207

187
249
259
245
174
132
159
211
150
102
1,489

0.02% $
0.02%
0.02%
0.01%
0.01%
0.02%
0.01%

0.01%
0.02%
0.02%
0.02%
0.01%
0.01%
0.01%
0.01%
0.01%
0.01%
0.10%

247
257
357
103
200
227
150

4
171
161
196
154
35
159
146
175
83
976

0.02%
0.02%
0.03%
0.01%
0.02%
0.02%
0.01%

-%
0.01%
0.01%
0.01%
0.01%
-%
0.01%
0.01%
0.01%
0.01%
0.07%

4,636

0.29% $

5,011

0.34% $

3,801

0.29%

PROVISION FOR INCOME TAXES

Our effective income tax rate was 23.7% for 2018 compared to 41.1% for
2017 and 31.3% for 2016. The Company reported an income tax provision of
$6,620,000, $9,793,000, and $6,917,000 for the years ended December 31,
2018, 2017, and 2016, respectively. With the Tax Cuts and Jobs Act (the ‘‘Act’’)
enacted on December 22, 2017, the Company’s federal income tax rate changed
from 35% to 21% effective as of the beginning of 2018. The decrease in the
effective tax rate was the result of the change in the federal rate offset by a
sizable decrease in tax exempt interest. As a result of the enactment of the Act
the federal tax rate applied to the Company’s deferred taxes was adjusted as of
December 31, 2017 to reflect the 2018 tax rates (the rates at which the deferred
tax items are expected to reverse). The change to the tax rates (including the rate
change applied to deferred taxes reflected in other comprehensive income and
certain tax-advantaged investments as reflected in other assets) resulted in an
increase to the Company’s tax provision of $3,535,000 in 2017. As part of the
Act for tax years beginning after December 31, 2017, alternative minimum tax
credit carryforwards are refundable and are expected to be fully refunded by
2022. As such, they are not dependent on future taxable income to be realized
and have been classified as an other receivable. The effective tax rate in 2016 was
affected by the large negative provision for credit losses which resulted in higher
pretax and taxable income and also diluted the impact of the Company’s tax
exempt municipal bonds and other tax planning strategies.

Some items of income and expense are recognized in different years for tax
purposes than when applying generally accepted accounting principles leading to
timing differences between the Company’s actual tax liability, and the amount
accrued for this liability based on book income. These temporary differences
comprise the ‘‘deferred’’ portion of the Company’s tax expense or benefit, which
is accumulated on the Company’s books as a deferred tax asset or deferred tax
liability until such time as they reverse.

Realization of the Company’s deferred tax assets is primarily dependent upon
the Company generating sufficient future taxable income to obtain benefit from
the reversal of net deductible temporary differences and the utilization of tax
credit carryforwards and the net operating loss carryforwards for Federal and
California state income tax purposes. The amount of deferred tax assets
considered realizable is subject to adjustment in future periods based on estimates
of future taxable income. Under generally accepted accounting principles a
valuation allowance is required to be recognized if it is ‘‘more likely than not’’
that the deferred tax assets will not be realized. The determination of the
realization of the deferred tax assets is highly subjective and dependent upon

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

PROVISION FOR INCOME TAXES

(Continued)

judgment concerning management’s evaluation of both positive and negative
evidence, including forecasts of future income, cumulative losses, applicable tax
planning strategies, and assessments of current and future economic and business
conditions.

The Company had the net deferred tax assets of $11.183 million and

$8.024 million at December 31, 2018 and 2017, respectively. After consideration
of the matters in the preceding paragraph, the Company determined that it is
more likely than not that the net deferred tax assets at December 31, 2018 and
2017 will be fully realized in future years.

FINANCIAL CONDITION

SUMMARY OF CHANGES IN CONSOLIDATED BALANCE SHEETS

Total assets were $1,537,836,000 as of December 31, 2018, compared to

$1,661,655,000 as of December 31, 2017, a decrease of 7.45% or $123,819,000.
Total gross loans were $918,695,000 as of December 31, 2018, compared to
$900,679,000 as of December 31, 2017, an increase of $18,016,000 or 2.00%.
The total investment portfolio (including Federal funds sold and interest-earning
deposits in other banks) decreased 20.98% or $126,869,000 to $477,932,000.
Total deposits decreased 10.06% or $143,389,000 to $1,282,298,000 as of
December 31, 2018, compared to $1,425,687,000 as of December 31, 2017.
Shareholders’ equity increased $10,179,000 or 4.86% to $219,738,000 as of
December 31, 2018, compared to $209,559,000 as of December 31, 2017. The
increase in shareholders’ equity was driven by the retention of earnings, net of
dividends paid, offset by a decrease in net unrealized gains on available-for-sale
(AFS) securities recorded, net of estimated taxes, in accumulated other
comprehensive income (AOCI). Accrued interest payable and other liabilities
were $20,645,000 as of December 31, 2018, compared to $21,254,000 as of
December 31, 2017, a decrease of $609,000.

FAIR VALUE

The Company measures the fair value of its financial instruments utilizing a
hierarchical framework associated with the level of observable pricing scenarios
utilized in measuring financial instruments at fair value. The degree of judgment
utilized in measuring the fair value of financial instruments generally correlates to
the level of the observable pricing scenario. Financial instruments with readily
available actively quoted prices or for which fair value can be measured from
actively quoted prices generally will have a higher degree of observable pricing
and a lesser degree of judgment utilized in measuring fair value. Conversely,
financial instruments rarely traded or not quoted will generally have little or no
observable pricing and a higher degree of judgment utilized in measuring fair
value. Observable pricing scenarios are impacted by a number of factors,
including the type of financial instrument, whether the financial instrument is
new to the market and not yet established and the characteristics specific to the
transaction.

See Note 3 of the Notes to Consolidated Financial Statements for additional

information about the level of pricing transparency associated with financial
instruments carried at fair value.

INVESTMENTS

The following table reflects the balances for each category of securities at year

end:

Available-for-Sale Securities
(In thousands)
U.S. Government agencies
Obligations of states and political subdivisions
U.S. Government sponsored entities and agencies

collateralized by residential mortgage obligations

Private label mortgage and asset backed securities

Amortized Cost at December 31,

2018

2017

2016

21,723 $
79,886

65,994 $

136,955

69,005
288,543

239,388
129,165

237,210
91,033

181,785
1,807

Total Available-for-Sale Securities

470,162 $

531,192 $

541,140

Our investment portfolio consists primarily of U.S. Government sponsored

entities and agencies collateralized by mortgage backed obligations and
obligations of states and political subdivision securities and are classified at the
date of acquisition as available-for-sale or held-to-maturity. As of December 31,
2018, investment securities with a fair value of $79,662,000, or 17.17% of our
investment securities portfolio, were held as collateral for public funds, short and
long-term borrowings, treasury, tax, and for other purposes. Our investment
policies are established by the Board of Directors and implemented by our
Investment/Asset Liability Committee. They are designed primarily to provide
and maintain liquidity, to enable us to meet our pledging requirements for public
money and borrowing arrangements, to generate a favorable return on
investments without incurring undue interest rate and credit risk, and to
complement our lending activities.

Our investment portfolio as a percentage of total assets is generally higher than

our peers due primarily to our comparatively low loan-to-deposit ratio. Our
loan-to-deposit ratio at December 31, 2018 was 71.64% compared to 63.18% at
December 31, 2017. The loan to deposit ratio of our peers was 82.00% at
December 31, 2018. Peer group information from S&P Global Market
Intelligence data includes bank holding companies in central California with
assets from $600 million to $3.5 billion. The total investment portfolio,
including Federal funds sold and interest-earning deposits in other banks,
decreased 20.98% or $126,869,000 to $477,932,000 at December 31, 2018,
from $604,801,000 at December 31, 2017. The market value of the portfolio
reflected an unrealized loss of $6,257,000 at December 31, 2018, compared to
an unrealized gain of $4,089,000 at December 31, 2017.

Losses recognized in 2018, 2017, and 2016 were incurred in order to

reposition the investment securities portfolio based on the current rate
environment. The securities which were sold at a loss were acquired when the
rate environment was not as volatile. The securities which were sold were
primarily purchased strategically several years ago in view of the rate environment
at that time. The Company is addressing risks in the security portfolio by selling
these securities and using proceeds to purchase securities that meet the
Company’s current risk profile.

For those securities that met the evaluation criteria, management obtained and

reviewed the most recently published national credit ratings for those securities.
For those securities that were obligations of states and political subdivisions with
an investment grade rating by the rating agencies, management also evaluated the
financial condition of the municipality and any applicable municipal bond
insurance provider and concluded during March 2016 that a $136,000 credit
related impairment related to one security with a fair value of $2,995,000 and a
pre-impairment amortized cost of $3,131,000 existed. The Company recorded an
other-than-temporary impairment loss of $136,000 during the twelve months
ended December 31, 2016. There were no OTTI losses recorded during the
twelve months ended December 31, 2018 or December 31, 2017.

At December 31, 2018, the Company had a total of 36 private label mortgage

backed securities (PLMBS) with a remaining principal balance of $129,165,000
and a net unrealized loss of approximately $3,016,000. Eight of these PLMBS
with a remaining principal balance of $1,137,000 had credit ratings below
investment grade. The Company continues to monitor these securities for
changes in credit ratings or other indications of credit deterioration. No credit
related OTTI charges related to PLMBS were recorded during the years ended
December 31, 2018 or December 31, 2017.

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

INVESTMENTS

(Continued)

The amortized cost, maturities and weighted average yield of investment securities at December 31, 2018 are summarized in the following table.

(Dollars in thousands)
Available-for-Sale Securities
Debt securities(1)

U.S. Government agencies
Obligations of states and political subdivisions (2)
U.S. Government sponsored entities and agencies collateralized by

residential mortgage obligations

Private label residential mortgage and asset backed securities

In one year or
less

After one through After five through

five years

ten years

After ten years

Total

Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1)

-
-

-
47

-
-

-
2,769

$ 5,591
2.13% 21,831

6.16% $ 16,132
4.24% 55,286

5.48% $ 21,723
4.56% 79,886

5.65%
4.39%

-
4.75%

136
-

5.90%
-

266
15

5.18% 238,987
7.22% 129,102

3.93% 239,389
3.74% 129,164

3.94%
3.74%

4.75% $ 2,905

2.31% $27,703

4.63% $439,507

4.15% $470,162

4.04%

(1) Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or

prepayment penalties. Expected maturities will also differ from contractual maturities due to unscheduled principal pay downs.

(2) Not computed on a tax equivalent basis.

LOANS

Total gross loans increased $18,016,000 or 2.00% to $918,695,000 as of December 31, 2018, compared to $900,679,000 as of December 31, 2017.
The following table sets forth information concerning the composition of our loan portfolio as of December 31, 2018, 2017, 2016, 2015, and 2014.

Loan Type
(Dollars in thousands)
Commercial:

Commercial and industrial
Agricultural production

Total commercial

Real estate:

Owner occupied
Real estate-construction and other

land loans

Commercial real estate
Agricultural real estate
Other real estate

Total real estate

Consumer:

Equity loans and lines of credit
Consumer and installment

Total consumer

Deferred loan fees, net

Total gross loans (1)
Allowance for credit losses

Total loans (1)

(1) Includes nonaccrual loans of:

2018

2017

2016

2015

2014

Amount

% of Total
Loans

Amount

% of Total
Loans

Amount

% of Total
Loans

Amount

% of Total
Loans

Amount

% of Total
Loans

101,533
7,998

109,531

11.1% $
0.9%

12.0%

100,856
14,956

115,812

11.2% $
1.7%

88,652
25,509

11.7% $
3.4%

12.9%

114,161

15.1%

102,197
30,472

132,669

17.1% $
5.1%

89,007
39,140

22.2%

128,147

15.5%
6.8%

22.3%

183,169

19.9%

204,452

22.7%

191,665

25.3%

168,910

28.2%

176,804

30.9%

101,606
305,118
76,884
32,799

699,576

69,958
38,038

107,996
1,592

918,695
(9,104)

909,591

2,740

11.1%
33.2%
8.4%
3.6%

76.2%

7.6%
4.2%

11.8%

100.0%

96,460
269,254
76,081
31,220

677,467

76,404
29,637

106,041
1,359

900,679
(8,778)

891,901

2,875

10.7%
29.9%
8.4%
3.5%

75.2%

8.5%
3.4%

11.9%

100.0%

69,200
184,225
86,761
18,945

550,796

64,494
25,910

90,404
1,267

756,628
(9,326)

747,302

2,180

9.1%
24.3%
11.5%
2.7%

72.9%

8.5%
3.5%

12.0%

100.0%

38,685
117,244
74,867
10,520

410,226

42,296
12,503

54,799
417

598,111
(9,610)

588,501

2,413

6.5%
19.6%
12.5%
1.8%

68.6%

7.1%
2.1%

9.2%

100.0%

38,923
106,788
57,501
6,611

386,627

47,575
10,093

57,668
146

572,588
(8,308)

564,280

14,052

6.8%
18.7%
10.0%
1.2%

67.6%

8.3%
1.8%

10.1%

100.0%

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

LOANS

(Continued)

At December 31, 2018, loans acquired in the FLB, SVB and VCB acquisitions

had a balance of $189,719,000, of which $5,875,000 were commercial loans,
$158,025,000 were real estate loans, and $25,819,000 were consumer loans, and
at December 31, 2017, the acquired loans acquired had a balance of
$243,712,000, of which $12,554,000 were commercial loans, $197,004,000 were
real estate loans, and $34,154,000 were consumer loans.

At December 31, 2018, in management’s judgment, a concentration of loans

existed in commercial loans and real-estate-related loans, representing
approximately 95.8% of total loans of which 12% were commercial and 83.8%
were real-estate-related. This level of concentration is consistent with 96.6% at
December 31, 2017. Although we believe the loans within this concentration
have no more than the normal risk of collectability, a substantial decline in the
performance of the economy in general or a decline in real estate values in our

primary market areas, in particular, could have an adverse impact on
collectability, increase the level of real estate-related nonperforming loans, or have
other adverse effects which alone or in the aggregate could have a material
adverse effect on our business, financial condition, results of operations and cash
flows. The Company was not involved in any sub-prime mortgage lending
activities during the years ended December 31, 2018 and 2017.

We believe that our commercial real estate loan underwriting policies and
practices result in prudent extensions of credit, but recognize that our lending
activities result in relatively high reported commercial real estate lending levels.
Commercial real estate loans include certain loans which represent low to
moderate risk and certain loans with higher risks.

The Board of Directors review and approve concentration limits and

exceptions to limitations of concentration are reported to the Board of Directors
at least quarterly.

LOAN MATURITIES

The following table presents information concerning loan maturities and sensitivity to changes in interest rates of the indicated categories of our loan portfolio, as well

as loans in those categories maturing after one year that have fixed or floating interest rates at December 31, 2018.

(In thousands) (net of deferred costs)
Loan Maturities:
Commercial and agricultural
Real estate construction and other land loans
Other real estate
Consumer and installment

Sensitivity to Changes in Interest Rates:
Loans with fixed interest rates
Loans with floating interest rates (1)

(1) Includes floating rate loans which are currently at their floor rate in accordance with their respective

One Year or
Less

After One
Through Five
Years

After Five
Years

Total

58,040
89,665
29,220
9,730

186,655

78,693
107,962

186,655

3,424

25,372
9,687
117,222
13,724

166,005

93,650
72,355

166,005

12,659

26,119
3,130
450,652
84,542

564,443

80,447
483,996

564,443

357,319

109,531
102,482
597,094
107,996

917,103

252,790
664,313

917,103

373,402

loan agreement

NONPERFORMING ASSETS

Nonperforming assets consist of nonperforming loans, other real estate owned
(OREO), and repossessed assets. Nonperforming loans are those loans which have
(i) been placed on nonaccrual status; (ii) been classified as doubtful under our
asset classification system; or (iii) become contractually past due 90 days or more
with respect to principal or interest and have not been restructured or otherwise
placed on nonaccrual status. A loan is classified as nonaccrual when 1) it is
maintained on a cash basis because of deterioration in the financial condition of
the borrower; 2) payment in full of principal or interest under the original
contractual terms is not expected; or 3) principal or interest has been in default
for a period of 90 days or more unless the loan is both well secured and in the
process of collection. We measure all loans placed on nonaccrual status for
impairment based on the fair value of the underlying collateral or the net present
value of the expected cash flows.

Our consolidated financial statements are prepared on the accrual basis of

accounting, including the recognition of interest income on loans. Interest
income from nonaccrual loans is recorded only if collection of principal in full is
not in doubt and when cash payments, if any, are received.

Loans are placed on nonaccrual status and any accrued but unpaid interest
income is reversed and charged against income when the payment of interest or
principal is 90 days or more past due. Loans in the nonaccrual category are
treated as nonaccrual loans even though we may ultimately recover all or a
portion of the interest due. These loans return to accrual status when the loan
becomes contractually current, future collectability of amounts due is reasonably
assured, and a minimum of six months of satisfactory principal repayment

performance has occurred. See Note 5 of the Company’s audited Consolidated
Financial Statements in Item 8 of this Annual Report.

At December 31, 2018, total nonperforming assets totaled $2,740,000, or

0.18% of total assets, compared to $2,945,000, or 0.18% of total assets at
December 31, 2017. Nonperforming assets totaled 0.30% of gross loans as of
December 31, 2018 and 0.33% of gross loans as of December 31, 2017. Total
nonperforming assets at December 31, 2018, included nonaccrual loans totaling
$2,740,000, no OREO, and no repossessed assets. Nonperforming assets at
December 31, 2017 consisted of $2,875,000 in nonaccrual loans, no OREO,
and $70,000 in repossessed assets. At December 31, 2018, we had one loan
considered a troubled debt restructuring (‘‘TDR’’) totaling $50,000 which is
included in nonaccrual loans compared to one TDR totaling $59,000 at
December 31, 2017. We have no outstanding commitments to lend additional
funds to any of these borrowers. See Note 5 of the Company’s audited
Consolidated Financial Statements in Item 8 of this Annual Report concerning
our recorded investment in loans for which impairment has been recognized.

A summary of nonaccrual, restructured, and past due loans at December 31,

2018, 2017, 2016, 2015, and 2014 is set forth below. The Company had no
loans past due more than 90 days and still accruing interest at December 31,
2018 and 2017. Management is not aware of any potential problem loans, which
were current and accruing at December 31, 2018, where serious doubt exists as
to the ability of the borrower to comply with the present repayment terms.
Management can give no assurance that nonaccrual and other nonperforming
loans will not increase in the future.

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

NONPERFORMING ASSETS (Continued)

Composition of Nonaccrual, Past Due and Restructured Loans

(As of December 31, Dollars in thousands)
Nonaccrual Loans:

Commercial and industrial
Owner occupied real estate
Real estate construction and other land loans
Agricultural real estate
Commercial real estate
Equity loans and line of credit
Consumer and installment

Restructured loans (non-accruing):

Commercial and industrial
Owner occupied
Real estate construction and other land loans
Equity loans and line of credit

Total nonaccrual

Accruing loans past due 90 days or more

Total nonperforming loans

Interest foregone

Nonperforming loans to total loans

Accruing loans past due 90 days or more

Accruing troubled debt restructurings

Ratio of nonperforming loans to allowance for credit losses
Loans considered to be impaired

Related allowance for credit losses on impaired loans

2018

2017

2016

2015

2014

298
215
1,439
-
418
320
-

-
-
-
50

2,740
-

2,740

267

0.30%

3,170

30.10%
5,909

356
-
1,397
-
976
87
-

-
-
-
59

2,875
-

2,875

210

0.32%

3,491

32.75%
6,366

447
87
-
-
1,082
526
18

-
20
-
-

2,180
-

2,180

245

0.29%

3,089

23.38%
5,269

307

-
324
-
-
567
172
13

29
23
-
1,285

2,413
-

2,413

340

0.40%

4,774

25.11%
6,699

164

7,265
1,363
-
360
1,468
1,751
19

-
-
547
1,279

14,052
-

14,052

716

2.45%

4,774

169.14%
18,826

612

As of December 31, 2018 and 2017, we had impaired loans totaling

$5,909,000 and $6,366,000, respectively. We measure our impaired loans by
using the fair value of the collateral if the loan is collateral dependent and the
present value of the expected future cash flows discounted at the loan’s original
contractual interest rate if the loan is not collateral dependent. Impaired loans are
identified from internal credit review reports, past due reports, overdraft listings,
and third party reports of examination. Borrowers experiencing problems such as
operating losses, marginal working capital, inadequate cash flow or business
interruptions which jeopardize collection of the loan are also reviewed for
possible impairment classification. A loan is considered impaired when, based on
current information and events, it is probable that the Company will be unable
to collect all amounts due, including principal and interest, according to the
contractual terms of the original agreement. Factors considered by management
in determining impairment include payment status, collateral value, and the
probability of collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the significance
of payment delays and payment shortfalls on case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower’s prior
payment record, and the amount of the shortfall in relation to the principal and
interest owed. Loans determined to be impaired are individually evaluated for
impairment. When a loan is impaired, the Company measures impairment based

on the present value of expected future cash flows discounted at the loan’s
effective interest rate, except that as a practical expedient, it may measure
impairment based on a loan’s observable market price, or the fair value of the
collateral if the loan is collateral dependent. A loan is collateral dependent if the
repayment of the loan is expected to be provided solely by the underlying
collateral. For collateral dependent loans secured by real estate, we obtain external
appraisals which are updated at least annually to determine the fair value of the
collateral, and we record an immediate charge off for the difference between the
book value of the loan and the appraised value less selling costs of the collateral.
We perform quarterly internal reviews on substandard loans.

We place loans on nonaccrual status and classify them as impaired when it

becomes probable that we will not receive interest and principal under the
original contractual terms, or when loans are delinquent 90 days or more, unless
the loan is both well secured and in the process of collection. Management
maintains certain loans that have been brought current by the borrower (less than
30 days delinquent) on nonaccrual status until such time as management has
determined that the loans are likely to remain current in future periods. Foregone
interest on nonaccrual loans totaled $267,000 for the year ended December 31,
2018 of which $4,000 was attributable to troubled debt restructurings. Foregone
interest on nonaccrual loans totaled $210,000 and $245,000 for the years ended
December 31, 2017 and 2016, respectively of which $17,000 and $2,000 was
attributable to troubled debt restructurings, respectively.

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

NONPERFORMING ASSETS (Continued)

The following table provides a reconciliation of the change in non-accrual loans for the year ended December 31, 2018.

Balances
December 31,
2017

Additions to
Nonaccrual
Loans

Net Pay
Downs

Transfer to
Foreclosed
Collateral

Returns to
Accrual
Status

Charge
Offs

Balances
December 31,
2018

(In thousands)
Non-accrual loans:

Commercial and industrial
Real estate
Real estate construction and other land

loans

Equity loans and lines of credit
Consumer

Restructured loans (non-accruing):
Equity loans and lines of credit

356
976

40
1,379

(98)
(1,252)

1,397
87
-

42
283
12

-
(42)
-

(9)

Total non-accrual

2,875

1,756

(1,401)

-
-

-
-
-

-
(470)

-
-

-
(8)
-

-
-
(12)

(478)

(12)

298
633

1,439
320
-

2,740

OREO represents real property taken either through foreclosure or through a
deed in lieu thereof from the borrower. OREO is carried at the lesser of cost or
fair market value less selling costs. As of December 31, 2018 and December 31,
2017, the Bank had no OREO properties. The Company held no repossessed
assets at December 31, 2018 compared to $70,000 at December 31, 2017, which
is included in other assets on the consolidated balance sheets.

As of December 31, 2016 the Bank had no OREO properties. The carrying

vale of foreclosed assets was $362,000 at December 31, 2016.

ALLOWANCE FOR CREDIT LOSSES

We have established a methodology for determining the adequacy of the
allowance for credit losses made up of general and specific allocations. The
methodology is set forth in a formal policy and takes into consideration the need
for an overall allowance for credit losses as well as specific allowances that are
tied to individual loans. The allowance for credit losses is an estimate of probable
incurred credit losses in the Company’s loan portfolio. The allowance consists of
two primary components, specific reserves related to impaired loans and general
reserves for probable incurred losses related to loans that are not impaired.

For all portfolio segments, the determination of the general reserve for loans
that are not impaired is based on estimates made by management including, but
not limited to, consideration of historical losses by portfolio segment (and in
certain cases peer loss data) over the most recent 20 quarters, and qualitative
factors including economic trends in the Company’s service areas, industry
experience and trends, geographic concentrations, estimated collateral values, the
Company’s underwriting policies, the character of the loan portfolio, and
probable losses incurred in the portfolio taken as a whole. Management has
determined that the most recent 20 quarters was an appropriate look-back period
based on several factors including the current global economic uncertainty and
various national and local economic indicators, and a time period sufficient to
capture enough data due to the size of the portfolio to produce statistically
accurate historical loss calculations. We believe this period is an appropriate
look-back period.

In originating loans, we recognize that losses will be experienced and that the
risk of loss will vary with, among other things, the type of loan being made, the
creditworthiness of the borrower over the term of the loan, general economic
conditions and, in the case of a secured loan, the quality of the collateral
securing the loan. The allowance is increased by provisions charged against
earnings and recoveries, and reduced by net loan charge offs. Loans are charged
off when they are deemed to be uncollectible, or partially charged off when
portions of a loan are deemed to be uncollectible. Recoveries are generally
recorded only when cash payments are received.

The allowance for credit losses is maintained to cover probable incurred credit

losses in the loan portfolio. The responsibility for the review of our assets and
the determination of the adequacy lies with management and our Audit/
Compliance Committee. They delegate the authority to the Chief Credit Officer
(CCO) to determine the loss reserve ratio for each type of asset and to review, at
least quarterly, the adequacy of the allowance based on an evaluation of the
portfolio, past experience, prevailing market conditions, amount of government
guarantees, concentration in loan types and other relevant factors.

The allowance for credit losses is an estimate of the probable incurred credit

losses in our loan and lease portfolio. The allowance is based on principles of
accounting: (1) losses accrued for on loans when they are probable of occurring
and can be reasonably estimated and (2) losses accrued based on the differences
between the value of collateral, present value of future cash flows or values that
are observable in the secondary market and the loan balance.

Management adheres to an internal asset review system and loss allowance
methodology designed to provide for timely recognition of problem assets and
adequate valuation allowances to cover probable incurred losses. The Bank’s asset
monitoring process includes the use of asset classifications to segregate the assets,
largely loans and real estate, into various risk categories. The Bank uses the
various asset classifications as a means of measuring risk and determining the
adequacy of valuation allowances by using a nine-grade system to classify assets.
In general, all credit facilities exceeding 90 days of delinquency require
classification and are placed on nonaccrual.

572,442

539,529

9,208

(7,423)
(1,722)
(183)
-
(506)

(9,834)

171
-
150
364
-
264

949

(8,885)
7,985

8,308

1.45%

(1.65)%

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

ALLOWANCE FOR CREDIT LOSSES

(Continued)

The following table summarizes the Company’s loan loss experience, as well as provisions and recoveries (charge-offs) to the allowance and certain pertinent ratios for

the periods indicated:

(Dollars in thousands)
Loans outstanding at December 31,

Average loans outstanding during the year

Allowance for credit losses:

Balance at beginning of year
Deduct loans charged off:

Commercial and industrial
Agricultural production
Owner occupied
Commercial real estate
Consumer loans

Total loans charged off

Add recoveries of loans previously charged off:

Commercial and industrial
Agricultural production
Owner occupied
Real estate construction and other land loans
Commercial real estate
Consumer loans

Total recoveries

Net recoveries (charge offs)

(Reversal) Provision charged to credit losses

2018

2017

2016

2015

2014

917,103

912,128

8,778

(94)
-
-
-
(116)

(210)

207
-
21
-
81
177

486

276
50

899,320

793,343

9,326

(197)
(10)
(22)
-
(235)

(464)

850
10
49
-
17
140

1,066

602
(1,150)

755,361

646,573

9,610

(621)
-
-
-
(262)

(883)

3,656
1,631
-
702
283
177

6,449

5,566
(5,850)

597,694

586,762

8,308

(802)
-
-
-
(159)

(961)

954
90
-
32
-
587

1,663

702
600

Balance at end of year

9,104

8,778

9,326

9,610

Allowance for credit losses as a percentage of

outstanding loan balance

Net recoveries (charge offs) to average loans outstanding

0.99%

0.03%

0.98%

0.08%

1.23%

0.86%

1.61%

0.12%

Managing credits identified through the risk evaluation methodology includes

developing a business strategy with the customer to mitigate our losses. Our
management continues to monitor these credits with a view to identifying as
early as possible when, and to what extent, additional provisions may be
necessary.

The allowance for credit losses is reviewed at least quarterly by the Bank’s and
our Board of Directors’ Audit/Compliance Committee. Reserves are allocated to
loan portfolio segments using percentages which are based on both historical risk
elements such as delinquencies and losses and predictive risk elements such as

economic, competitive and environmental factors. We have adopted the specific
reserve approach to allocate reserves to each impaired asset for the purpose of
estimating potential loss exposure. Although the allowance for credit losses is
allocated to various portfolio categories, it is general in nature and available for
the loan portfolio in its entirety. Additions may be required based on the results
of independent loan portfolio examinations, regulatory agency examinations, or
our own internal review process. Additions are also required when, in
management’s judgment, the reserve does not properly reflect the potential loss
exposure.

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

ALLOWANCE FOR CREDIT LOSSES

(Continued)

The allocation of the allowance for credit losses is set forth below:

2018

2017

2016

2015

2014

Percent of
Loans in
Each
Category to
Total Loans

Amount

Percent of
Loans in
Each
Category to
Total Loans

Amount

Percent of
Loans in
Each
Category to
Total Loans

Amount

Percent of
Loans in
Each
Category to
Total Loans

Amount

Percent of
Loans in
Each
Category to
Total Loans

Amount

1,604
67

1,131

1,271
3,017
947
173

419
407
68

11.1% $
0.9%

19.9%

11.1%
33.2%
8.4%
3.6%

7.6%
4.2%

1,784
287

1,252

1,004
1,958
1,441
140

464
361
87

11.2% $
1.7%

22.7%

10.7%
29.9%
8.4%
3.5%

8.5%
3.4%

1,884
296

1,408

698
1,969
1,969
156

483
369
94

11.7% $
3.4%

25.3%

9.1%
24.3%
11.5%
2.7%

8.5%
3.5%

3,143
419

1,556

694
1,686
1,149
119

500
234
110

17.1% $
5.1%

28.2%

6.5%
19.6%
12.5%
1.8%

7.1%
2.1%

2,753
377

1,380

837
1,201
564
76

811
267
42

15.5%
6.8%

30.9%

6.8%
18.7%
10%
1.2%

8.3%
1.8%

Loan Type (Dollars in thousands)
Commercial:

Commercial and industrial
Agricultural production

Real estate:

Owner occupied
Real estate construction and other land

loans

Commercial real estate
Agricultural real estate
Other real estate

Consumer:

Equity loans and lines of credit
Consumer and installment

Unallocated reserves

Total allowance for credit losses

9,104

100% $

8,778

100.0% $

9,326

100% $

9,610

100% $

8,308

100%

Loans are charged to the allowance for credit losses when the loans are deemed
uncollectible. It is the policy of management to make additions to the allowance
so that it remains adequate to cover all probable loan charge offs that exist in the
portfolio at that time. We assign qualitative and environmental factors (Q
factors) to each loan category. Q factors include reserves held for the effects of
lending policies, economic trends, and portfolio trends along with other
dynamics which may cause additional stress to the portfolio.

As of December 31, 2018, the allowance for credit losses (ALLL) was

$9,104,000, compared to $8,778,000 at December 31, 2017, a net increase of
$326,000. The increase in the ALLL was due to net recoveries and by a
provision for credit losses during the year ended December 31, 2018 which was
necessitated by management’s observations and assumptions about the existing
credit quality of the loan portfolio. Net recoveries totaled $276,000 while the
provision for credit losses was $50,000. The balance of classified loans and loans
graded special mention, totaled $28,394,000 and $26,254,000 at December 31,
2018 and $49,998,000 and $21,908,000 at December 31, 2017. The balance of
undisbursed commitments to extend credit on construction and other loans and
letters of credit was $312,274,000 as of December 31, 2018, compared to
$350,141,000 as of December 31, 2017. At December 31, 2018 and 2017, the
balance of a contingent allocation for probable loan loss experience on unfunded
obligations was $225,000 and $326,000, respectively. The contingent allocation
for probable loan loss experience on unfunded obligations is calculated by
management using an appropriate, systematic, and consistently applied process.
While related to credit losses, this allocation is not a part of ALLL and is
considered separately as a liability for accounting and regulatory reporting
purposes. Risks and uncertainties exist in all lending transactions and our
management and Directors’ Loan Committee have established reserve levels based
on economic uncertainties and other risks that exist as of each reporting period.
The ALLL as a percentage of total loans was 0.99% at December 31, 2018,

and 0.98% at December 31, 2017. Total loans include FLB, SVB and VCB
loans that were recorded at fair value in connection with the acquisitions of
$189,719,000 at December 31, 2018 and $243,712,000 at December 31, 2017.
Excluding these acquired loans from the calculation, the ALLL to total gross
loans was 1.25% and 1.34% as of December 31, 2018 and 2017, respectively,
and general reserves associated with non-impaired loans to total non-impaired
loans was 1.25% and 1.34%, respectively. The loan portfolio acquired in the
mergers was booked at fair value with no associated allocation in the ALLL. The
size of the fair value discount remains adequate for all non-impaired acquired
loans; therefore, there is no associated allocation in the ALLL.

The Company’s loan portfolio balances in 2018 increased from 2017 through
organic growth. Management believes that the change in the allowance for credit
losses to total loans ratios is directionally consistent with the composition of
loans and the level of nonperforming and classified loans, partially offset by the

general economic conditions experienced in the central California communities
serviced by the Company and recent improvements in real estate collateral values.
The determination of the general reserve for loans that are not impaired is

based on estimates made by management including, but not limited to,
consideration of historical losses (or peer data) by portfolio segment over the
most recent 20 quarters, and qualitative factors. Assumptions regarding the
collateral value of various under-performing loans may affect the level and
allocation of the allowance for credit losses in future periods. The allowance may
also be affected by trends in the amount of charge offs experienced or expected
trends within different loan portfolios. However, the total reserve rates on
non-impaired loans include qualitative factors which are systematically derived
and consistently applied to reflect conservatively estimated losses from loss
contingencies at the date of the financial statements. Based on the above
considerations and given recent changes in historical charge-off rates included in
the ALLL modeling and the changes in other factors, management determined
that the ALLL was appropriate as of December 31, 2018.

Non-performing loans totaled $2,740,000 as of December 31, 2018, and

$2,875,000 as of December 31, 2017. The allowance for credit losses as a
percentage of nonperforming loans was 332.26% and 305.32% as of
December 31, 2018 and December 31, 2017, respectively. In addition,
management believes that the likelihood of recoveries on previously charged-off
loans continues to improve based on the collection efforts of management
combined with improvements in the value of real estate which serves as the
primary source of collateral for loans. Management believes the allowance at
December 31, 2018 is adequate based upon its ongoing analysis of the loan
portfolio, historical loss trends and other factors. However, no assurance can be
given that the Company may not sustain charge-offs which are in excess of the
allowance in any given period.

GOODWILL AND INTANGIBLE ASSETS

Business combinations involving the Bank’s acquisition of the equity interests

or net assets of another enterprise give rise to goodwill. Total goodwill at
December 31, 2018 was $53,777,000 consisting of $13,466,000, $10,394,000,
$6,340,000, $14,643,000 and $8,934,000 representing the excess of the cost of
Folsom Lake Bank, Sierra Vista Bank, Visalia Community Bank, Service
1st Bancorp, and Bank of Madera County, respectively, over the net amounts
assigned to assets acquired and liabilities assumed in the transactions accounted
for under the purchase method of accounting. The value of goodwill is ultimately
derived from the Bank’s ability to generate net earnings after the acquisitions and
is not deductible for tax purposes. A significant decline in net earnings could be
indicative of a decline in the fair value of goodwill and result in impairment. For
that reason, goodwill is assessed at least annually for impairment.

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

GOODWILL AND INTANGIBLE ASSETS

(Continued)

DEPOSITS AND BORROWINGS

The intangible assets at December 31, 2018 represent the estimated fair value
of the core deposit relationships acquired in the 2017 acquisition of Folsom Lake
Bank of $1,879,000, the 2016 acquisition of Sierra Vista Bank of $508,000 and
the 2013 acquisition of Visalia Community Bank of $1,365,000. Core deposit
intangibles are being amortized using the straight-line method over an estimated
life of P5Y to ten years from the date of acquisition. The carrying value of
intangible assets at December 31, 2018 was $2,572,000, net of $1,180,000 in
accumulated amortization expense. The carrying value at December 31, 2017 was
$3,027,000, net of $725,000 in accumulated amortization expense. Management
evaluates the remaining useful lives quarterly to determine whether events or
circumstances warrant a revision to the remaining periods of amortization. Based
on the evaluation, no changes to the remaining useful lives was required.
Management performed an annual impairment test on core deposit intangibles as
of September 30, 2018 and determined no impairment was necessary. In
addition, management determined that no events had occurred between the
annual evaluation date and December 31, 2018 which would necessitate further
analysis. Amortization expense recognized was $455,000 for 2018, $234,000 for
2017 and $149,000 for 2016.

The following table summarizes the Company’s estimated core deposit
intangible amortization expense for each of the next five years (in thousands):

Years Ending December 31,
2019
2020
2021
2022
2023
Thereafter

Total

Estimated Core
Deposit
Intangible
Amortization

696
696
661
453
66
-

2,572

The Bank’s deposits are insured by the Federal Deposit Insurance Corporation

(FDIC) up to applicable legal limits. All of a depositor’s accounts at an insured
depository institution, including all non-interest bearing transactions accounts,
will be insured by the FDIC up to the standard maximum deposit insurance
amount of $250,000 for each deposit insurance ownership category.

Total deposits decreased $143,389,000 or 10.06% to $1,282,298,000 as of
December 31, 2018, compared to $1,425,687,000 as of December 31, 2017.
Interest-bearing deposits decreased $109,007,000 or 12.97% to $731,641,000 as
of December 31, 2018, compared to $840,648,000 as of December 31, 2017.
Non-interest bearing deposits decreased $34,382,000 or 5.88% to $550,657,000
as of December 31, 2018, compared to $585,039,000 as of December 31, 2017.
Average non-interest bearing deposits to average total deposits was 41.48% for
the year ended December 31, 2018 compared to 38.93% for the same period in
2017. Based on FDIC deposit market share information published as of June
2018, our total market share of deposits in Fresno, Madera, San Joaquin, and
Tulare counties was 3.42% in 2018 compared to 3.69% in 2017. Our total
market share in the other counties we operate in (El Dorado, Merced, Placer,
Sacramento, and Stanislaus), was less than 1.00% in 2018 and 2017.
The composition of the deposits and average interest rates paid at

December 31, 2018 and December 31, 2017 is summarized in the table below.

(Dollars in thousands)
NOW accounts
MMA accounts
Time deposits
Savings deposits

Total interest-bearing
Non-interest bearing

% of

December 31, Total Effective December 31, Total Effective

2018

Deposits Rate

2017

Deposits Rate

252,439
267,820
96,817
114,565

731,641
550,657

19.7% 0.16% $
20.9% 0.15%
7.6% 0.25%
8.9% 0.03%

57.1% 0.15%
42.9%

296,406
299,638
128,070
116,534

840,648
585,039

20.8% 0.12%
21.0% 0.08%
9.0% 0.30%
8.2% 0.03%

59.0% 0.12%
41.0%

Total deposits

1,282,298 100.0%

1,425,687 100.0%

We have no known foreign deposits. The following table sets forth the average amount of and the average rate paid on certain deposit categories which were in excess

of 10% of average total deposits for the years ended December 31, 2018, 2017, and 2016.

(Dollars in thousands)
Savings and NOW accounts

Money market accounts

Time certificates of deposit

Non-interest bearing demand

Total deposits

2018

2017

2016

Balance

Rate

Balance

Rate

Balance

Rate

383,667

285,568

111,214

553,305

0.12% $

382,071

0.09% $

337,804

0.15% $

264,581

0.08% $

249,620

0.25% $

137,666

0.30% $

139,656

499,987

417,151

1,333,754

0.09% $

1,284,305

0.08% $

1,144,231

0.09%

0.05%

0.38%

0.09%

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

DEPOSITS AND BORROWINGS (Continued)

The following table sets forth certain financial ratios for the years ended

December 31, 2018, 2017, and 2016.

The following table sets forth the maturity of time certificates of deposit and

other time deposits of $100,000 or more at December 31, 2018.

(In thousands)
Three months or less
Over 3 through 6 months
Over 6 through 12 months
Over 12 months

21,069
10,775
13,813
17,459

63,116

Net income:

To average assets
To average shareholders’ equity
Dividends declared per share to net

income per share

Average shareholders’ equity to

average assets

2018

2017

2016

1.35%
10.07%

0.94%
7.69%

1.15%
9.84%

20.00%

23.53%

19.20%

13.40%

12.23%

11.68%

As of December 31, 2018, the Company had $10,000,000 short-term Federal
Home Loan Bank (FHLB) of San Francisco advances. As of December 31, 2017,
the Company had no short-term or long-term FHLB borrowings. We maintain a
line of credit with the FHLB collateralized by government securities and loans.
Refer to Liquidity section below for further discussion of FHLB advances. The
Bank had unsecured lines of credit with its correspondent banks which, in the
aggregate, amounted to $40,000,000 at December 31, 2018 and 2017, at interest
rates which vary with market conditions. As of December 31, 2018 and 2017,
the Company had no overnight borrowings outstanding under these credit
facilities.

CAPITAL RESOURCES

Capital serves as a source of funds and helps protect depositors and

shareholders against potential losses. Historically, the primary sources of capital
for the Company have been internally generated capital through retained earnings
and the issuance of common and preferred stock.

The Company has historically maintained substantial levels of capital. The
assessment of capital adequacy is dependent on several factors including asset
quality, earnings trends, liquidity and economic conditions. Maintenance of
adequate capital levels is integral to providing stability to the Company. The
Company needs to maintain substantial levels of regulatory capital to give it
maximum flexibility in the changing regulatory environment and to respond to
changes in the market and economic conditions.

Our shareholders’ equity was $219,738,000 as of December 31, 2018,

compared to $209,559,000 as of December 31, 2017. The increase in
shareholders’ equity is the result of an increase in retained earnings from our net
income of $21,289,000, the exercise of stock options, including the related tax
benefit of $738,000, the effect of share-based compensation expense of $482,000,
stock issued under employee stock purchase plan of $211,000, offset by a
decrease in accumulated other comprehensive income (AOCI) of $7,233,000,
payment of common stock cash dividends of $4,270,000, repurchase and
retirement of common stock of $894,000, and cumulative effect of accounting
change on equity securities of $144,000.

During 2018, the Bank declared and paid cash dividends to the Company in

the amount of $2,850,000 in connection with the cash dividends to the
Company’s shareholders approved by the Company’s Board of Directors. The
Company declared and paid a total of $4,270,000 or $0.31 per common share
cash dividend to shareholders of record during the year ended December 31,
2018.

During 2017, the Bank declared and paid cash dividends to the Company in

the amount of $3,133,000 in connection with the cash dividends to the
Company’s shareholders approved by the Company’s Board of Directors. The
Company declared and paid a total of $3,010,000 or $0.24 per common share
cash dividend to shareholders of record during the year ended December 31,
2017.

During 2016, the Bank declared and paid cash dividends to the Company in

the amount of $13,010,000 in connection with the cash dividends to the
Company’s shareholders approved by the Company’s Board of Directors and the
cash portion of the SVB transaction. The Company declared and paid a total of
$2,715,000 or $0.24 per common share cash dividend to shareholders of record
during the year ended December 31, 2016.

Management considers capital requirements as part of its strategic planning
process. The strategic plan calls for continuing increases in assets and liabilities,
and the capital required may therefore be in excess of retained earnings. The
ability to obtain capital is dependent upon the capital markets as well as our
performance. Management regularly evaluates sources of capital and the timing
required to meet its strategic objectives.

The Board of Governors, the FDIC and other federal banking agencies have
issued risk-based capital adequacy guidelines intended to provide a measure of
capital adequacy that reflects the degree of risk associated with a banking
organization’s operations for both transactions reported on the balance sheet as
assets, and transactions, such as letters of credit and recourse arrangements, which
are reported as off-balance-sheet items.

The following table presents the Company’s regulatory capital ratios as of

December 31, 2018 and December 31, 2017.

Actual Ratio

Minimum regulatory
requirement (1)

Amount

Ratio

Amount

Ratio

(Dollars in thousands)

December 31, 2018

Tier 1 Leverage Ratio
Common Equity Tier 1 Ratio (CET 1)
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio

$ 171,149
$ 166,149
$ 171,149
$ 180,478

11.48%
15.13%
15.59%
16.44%

N/A
N/A
N/A
N/A

December 31, 2017
Tier 1 Leverage Ratio
Common Equity Tier 1 Ratio (CET 1)
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio

$ 153,676
$ 149,186
$ 153,676
$ 162,780

9.71% $
12.90% $
13.28% $
14.07% $

63,338
52,081
69,441
92,588

N/A
N/A
N/A
N/A

4.00%
5.75%
7.25%
9.25%

(1) The 2017 minimum regulatory requirement threshold includes the capital conservation

buffer of 1.250%.

The following table presents the Bank’s regulatory capital ratios as of

December 31, 2018 and December 31, 2017

Actual Ratio

Minimum regulatory
requirement (1)

Amount

Ratio

Amount

Ratio

(Dollars in thousands)

$ 168,770
$ 168,770
$ 168,770
$ 178,099

11.32% $
15.38% $
15.38% $
16.23% $

59,639
49,388
65,850
87,800

$ 149,779
$ 149,779
$ 149,779
$ 158,882

9.46% $
12.96% $
12.96% $
13.74% $

63,332
52,040
69,387
92,516

4.00%
6.38%
7.88%
9.88%

4.00%
5.75%
7.25%
9.25%

December 31, 2018
Tier 1 Leverage Ratio
Common Equity Tier 1 Ratio (CET 1)
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio

December 31, 2017
Tier 1 Leverage Ratio
Common Equity Tier 1 Ratio (CET 1)
Tier 1 Risk-Based Capital Ratio
Total Risk-Based Capital Ratio

(1) The 2018 and 2017 minimum regulatory requirement threshold includes the capital

conservation buffer of 1.250% and 0.625%, respectively. These ratios are not reflected
on a fully phased-in basis, which will occur in January 2019.

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

CAPITAL RESOURCES

(Continued)

The Company succeeded to all of the rights and obligations of the Service
1st Capital Trust I, a Delaware business trust, in connection with the acquisition
of Service 1st as of November 12, 2008. The Trust was formed on August 17,
2006 for the sole purpose of issuing trust preferred securities fully and
unconditionally guaranteed by Service 1st. Under applicable regulatory guidance,
the amount of trust preferred securities that is eligible as Tier 1 capital is limited
to 25% of the Company’s Tier 1 capital on a pro forma basis. At December 31,
2018, all of the trust preferred securities that have been issued qualify as Tier 1
capital. The trust preferred securities mature on October 7, 2036, are redeemable
at the Company’s option beginning five years after issuance, and require quarterly
distributions by the Trust to the holder of the trust preferred securities at a
variable interest rate which will adjust quarterly to equal the three month LIBOR
plus 1.60%.

The Trust used the proceeds from the sale of the trust preferred securities to
purchase approximately $5,155,000 in aggregate principal amount of Service 1st’s
junior subordinated notes (the Notes). The Notes bear interest at the same
variable interest rate during the same quarterly periods as the trust preferred
securities. The Notes are redeemable by the Company on any January 7, April 7,
July 7, or October 7 on or after October 7, 2012 or at any time within 90 days
following the occurrence of certain events, such as: (i) a change in the regulatory
capital treatment of the Notes (ii) in the event the Trust is deemed an investment
company or (iii) upon the occurrence of certain adverse tax events. In each such
case, the Company may redeem the Notes for their aggregate principal amount,
plus any accrued but unpaid interest.

The Notes may be declared immediately due and payable at the election of the

trustee or holders of 25% of the aggregate principal amount of outstanding
Notes in the event that the Company defaults in the payment of any interest
following the nonpayment of any such interest for 20 or more consecutive
quarterly periods. Holders of the trust preferred securities are entitled to a
cumulative cash distribution on the liquidation amount of $1,000 per security.
For each January 7, April 7, July 7 or October 7 of each year, the rate will be
adjusted to equal the three month LIBOR plus 1.60%. As of December 31,
2018, the rate was 4.04%. Interest expense recognized by the Company for the
years ended December 31, 2018, 2017, and 2016 was $199,000, $147,000 and
$121,000, respectively.

LIQUIDITY

Liquidity management involves our ability to meet cash flow requirements

arising from fluctuations in deposit levels and demands of daily operations, which
include funding of securities purchases, providing for customers’ credit needs and
ongoing repayment of borrowings. Our liquidity is actively managed on a daily
basis and reviewed periodically by our management and Directors’ Asset/Liability
Committees. This process is intended to ensure the maintenance of sufficient
funds to meet our needs, including adequate cash flows for off-balance sheet
commitments.

Our primary sources of liquidity are derived from financing activities which

include the acceptance of customer and, to a lesser extent, broker deposits,
Federal funds facilities and advances from the Federal Home Loan Bank of San
Francisco (FHLB). These funding sources are augmented by payments of
principal and interest on loans, the routine maturities and pay downs of securities
from the securities portfolio, the stability of our core deposits and the ability to
sell investment securities. As of December 31, 2018, the Company had
unpledged securities totaling $391,497,000 available as a secondary source of
liquidity and total cash and cash equivalents of $31,727,000. Cash and cash
equivalents at December 31, 2018 decreased 68.39% compared to December 31,
2017. Primary uses of funds include withdrawal of and interest payments on
deposits, origination and purchases of loans, purchases of investment securities,
and payment of operating expenses.

To augment our liquidity, we have established Federal funds lines with various

correspondent banks. At December 31, 2018, our available borrowing capacity
includes approximately $40,000,000 in Federal funds lines with our
correspondent banks and $286,934,000 in unused FHLB advances. At
December 31, 2018, we were not aware of any information that was reasonably
likely to have a material effect on our liquidity position.

The following table reflects the Company’s credit lines, balances outstanding,

and pledged collateral at December 31, 2018 and 2017:

Credit Lines
(In thousands)
Unsecured Credit Lines (interest rate varies with

market):
Credit limit
Balance outstanding

Federal Home Loan Bank (interest rate at

prevailing interest rate):
Credit limit
Balance outstanding
Collateral pledged
Fair value of collateral

Federal Reserve Bank (interest rate at prevailing

discount interest rate):
Credit limit
Balance outstanding
Collateral pledged
Fair value of collateral

December 31, December 31,

2018

2017

$
$

$
$
$
$

40,000 $
- $

40,000
-

286,934 $
10,000 $
448,083 $
399,027 $

234,689
-
357,393
316,160

4,364 $
- $
4,498 $
4,475 $

6,740
-
7,431
7,437

The liquidity of our parent company, Central Valley Community Bancorp, is
primarily dependent on the payment of cash dividends by its subsidiary, Central
Valley Community Bank, subject to limitations imposed by state and federal
regulations.

OFF-BALANCE SHEET ITEMS

In the normal course of business, the Company is a party to financial
instruments with off-balance sheet risk. These financial instruments include
commitments to extend credit and standby letters of credit. Such financial
instruments are recorded in the financial statements when they are funded or
related fees are incurred or received. The balance of commitments to extend
credit on undisbursed construction and other loans and letters of credit was
$312,274,000 as of December 31, 2018 compared to $350,141,000 as of
December 31, 2017. For a more detailed discussion of these financial
instruments, see Note 12 to the audited Consolidated Financial Statements in this
Annual Report.

Contractual Obligations

The contractual obligations of the Company, summarized by type of obligation

and contractual maturity, at December 31, 2018, are as follows:

Less Than
One Year

One to
Three
Years

Three to
Five
Years

After
Five
Years

Total

$ 1,257,349 $ 21,318 $

2,521 $

1,110 $ 1,282,298

-
2,384

-
3,883

-
3,000

5,155
4,334

5,155
13,601

(In thousands)
Deposits
Subordinated

notes

Operating leases

Total

$ 1,259,733 $ 25,201 $

5,521 $ 10,599 $ 1,301,054

Deposits represent both non-interest bearing and interest bearing deposits.
Interest bearing deposits include interest bearing transaction accounts, money
market and savings deposits and certificates of deposit. Deposits with
indeterminate maturities, such as demand, savings and money market accounts
are reflected as obligations due in less than one year.

Subordinated notes issued to a capital trust which was formed solely for the

purpose of issuing trust preferred securities. These subordinated notes were
acquired as a part of the merger with Service 1st. The aggregate amount
indicated above represents the full amount of the contractual obligation. All of
these securities are variable rate instruments. The trust preferred securities mature
on October 7, 2036, and are redeemable quarterly at the Company’s option.

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

OFF-BALANCE SHEET ITEMS

(Continued)

In the ordinary course of business, the Company is party to various operating

leases. For operating leases, the dollar balances reflected in the table above are
categorized by the due date of the lease payments. Operating leases represent the
total minimum lease payments under non-cancelable operating leases.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with the accounting

principles generally accepted in the United States (‘‘U.S. GAAP’’) requires
management to make a number of judgments, estimates and assumptions that
affect the reported amount of assets, liabilities, income and expense in the
financial statements. Various elements of our accounting policies, by their nature,
involve the application of highly sensitive and judgmental estimates and
assumptions. Some of these policies and estimates relate to matters that are
highly complex and contain inherent uncertainties. It is possible that, in some
instances, different estimates and assumptions could reasonably have been made
and used by management, instead of those we applied, which might have
produced different results that could have had a material effect on the financial
statements.

We have identified the following accounting policies and estimates that, due to

the inherent judgments and assumptions and the potential sensitivity of the
financial statements to those judgments and assumptions, are critical to an
understanding of our financial statements. We believe that the judgments,
estimates and assumptions used in the preparation of the Company’s financial
statements are appropriate. For a further description of our accounting policies,
see Note 1—Summary of Significant Accounting Policies in the financial statements
included in this Form 10-K.

Use of Estimates

The preparation of financial statements in conformity with accounting

principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

Allowance for Credit Losses

Our allowance for credit losses is an estimate of probable incurred losses in the

loan portfolio. Loans are charged-off against the allowance when management
believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries,
if any, are credited to the allowance for credit losses. Management’s methodology
for estimating the allowance balance consists of several key elements, which
include specific allowances on individual impaired loans and the formula driven
allowances on pools of loans with similar risks. The allowance is only an estimate
of the inherent loss in the loan portfolio and may not represent actual losses
realized over time, either of losses in excess of the allowance or of losses less than
the allowance. Our accounting for estimated loan losses is discussed and disclosed
primarily in Note 1 and 5 to the consolidated financial statements under the
heading ‘‘Allowance for Credit Losses’’ .

Business Combinations

The Company accounts for acquisitions of businesses using the acquisition

method of accounting. Under the acquisition method, assets acquired and
liabilities assumed are recorded at their estimated fair values at the date of
acquisition. This fair value may differ from the cost basis recorded on the
acquired institution’s financial statements. Management performs an initial
assessment to determine which assets and liabilities must be designated for fair
value analysis. Management typically engages experts in the field of valuation to
perform the valuation of significant assets and liabilities and, after assessing the

resulting fair value computation, will utilize such value in computing the initial
purchase accounting adjustments for the acquired assets. It is possible that these
values could be viewed differently through alternative valuation approaches or if
performed by different experts. Management is responsible for determining that
the values derived by experts are reasonable. Any excess of the purchase price over
amounts allocated to the acquired assets, including identifiable intangible assets,
and liabilities assumed is recorded as goodwill. The fair values of assets acquired
and liabilities assumed are subject to adjustment during the first twelve months
after the acquisition date if additional information becomes available to indicate a
more accurate or appropriate value for an asset or liability. See Note 1—under the
heading ‘‘Business Combinations’’, and Note 7- Goodwill and Intangible Assets in the
financial statements in this Form 10-K.

Goodwill and Other Intangible Assets

Goodwill and intangible assets are evaluated at least annually for impairment
or more frequently if events or circumstances, such as changes in economic or
market conditions, indicate that impairment may exist. When required, the
goodwill impairment test involves a two-step process. The first test for goodwill
impairment is done by comparing the reporting unit’s aggregate fair value to its
carrying value. Absent other indicators of impairment, if the aggregate fair value
exceeds the carrying value, goodwill is not considered impaired and no additional
analysis is necessary. If the carrying value of the reporting unit were to exceed the
aggregate fair value, a second test would be performed to measure the amount of
impairment loss, if any. To measure any impairment loss, the implied fair value
would be determined in the same manner as if the reporting unit were being
acquired in a business combination. If the implied fair value of goodwill is less
than the recorded goodwill, an impairment charge would be recorded for the
difference.

During 2011, the Financial Accounting Standards Board issued Accounting

Standards Update (‘‘ASU’’) 2011-08, Intangibles-Goodwill and Other
(Topic 350). Under the ASU, an entity is not required to calculate the fair value
of a reporting unit unless the entity determines that it is more likely than not
that its fair value is less than its carrying amount. Thus, before the first step of
goodwill impairment, the entity has the option to first assess qualitative factors to
determine whether the existence of events or circumstances leads to a
determination that the fair value of goodwill is less than carrying value. The
qualitative assessment includes, but is not limited to, macroeconomic and State
of California economic conditions, industry and market conditions and trends,
the Company’s financial performance, market capitalization, stock price, and any
Company-specific events relevant to the assessment. If after assessing the totality
of events or circumstances, an entity determines it is not more likely than not
that the fair value of a reporting unit is less than its carrying amount, then
performing the two-step process is unnecessary. As of December 31, 2018, based
on our qualitative assessment, there were no reporting units where we believed
that it was more likely than not that the fair value of a reporting unit was less
than its carrying amount, including goodwill. As a result, we had no reporting
units where there was a reasonable possibility of failing Step 1 of the goodwill
impairment test.

See Note 7’’Goodwill and Intangible Assets’’ in the financial statements in this

Form 10-K for further discussion.

INFLATION

The impact of inflation on a financial institution differs significantly from that
exerted on other industries primarily because the assets and liabilities of financial
institutions consist largely of monetary items. However, financial institutions are
affected by inflation in part through non-interest expenses, such as salaries and
occupancy expenses, and to some extent by changes in interest rates.

At December 31, 2018, we do not believe that inflation will have a material
impact on our consolidated financial position or results of operations. However,
if inflation concerns cause short term rates to rise in the near future, we may
benefit by immediate repricing of a portion of our loan portfolio. Refer to
Quantitative and Qualitative Disclosures About Market Risk for further
discussion.

Quantitative and Qualitative Disclosures About Market Risk

Interest rate risk (IRR) and credit risk constitute the two greatest sources of
financial exposure for insured financial institutions that operate like we do. IRR
represents the impact that changes in absolute and relative levels of market
interest rates may have upon our net interest income (NII). Changes in the NII
are the result of changes in the net interest spread between interest-earning assets
and interest-bearing liabilities (timing risk), the relationship between various rates
(basis risk), and changes in the shape of the yield curve.

We realize income principally from the differential or spread between the

interest earned on loans, investments, other interest-earning assets and the interest
incurred on deposits and borrowings. The volumes and yields on loans, deposits
and borrowings are affected by market interest rates. As of December 31, 2018,
72.44% of our loan portfolio was tied to adjustable-rate indices. The majority of
our adjustable rate loans are tied to prime and reprice within 90 days. Several of
our loans, tied to prime, are at their floors and will not reprice until prime plus
the factor is greater than the floor. The majority of our time deposits have a
fixed rate of interest. As of December 31, 2018, 75.36% of our time deposits
mature within one year or less.

Changes in the market level of interest rates directly and immediately affect
our interest spread, and therefore profitability. Sharp and significant changes to
market rates can cause the interest spread to shrink or expand significantly in the
near term, principally because of the timing differences between the adjustable
rate loans and the maturities (and therefore repricing) of the deposits and
borrowings.

Our management and Board of Directors’ Asset/Liability Committees (ALCO)

are responsible for managing our assets and liabilities in a manner that balances
profitability, IRR and various other risks including liquidity. The ALCO operates
under policies and within risk limits prescribed, reviewed, and approved by the
Board of Directors.

The ALCO seeks to stabilize our NII by matching rate-sensitive assets and
liabilities through maintaining the maturity and repricing of these assets and
liabilities at appropriate levels given the interest rate environment. When the
amount of rate-sensitive liabilities exceeds rate-sensitive assets within specified
time periods, NII generally will be negatively impacted by an increasing interest
rate environment and positively impacted by a decreasing interest rate
environment. Conversely, when the amount of rate-sensitive assets exceeds the
amount of rate-sensitive liabilities within specified time periods, net interest
income will generally be positively impacted by an increasing interest rate
environment and negatively impacted by a decreasing interest rate environment.
Our mix of assets consists primarily of loans and securities, none of which are
held for trading purposes. The value of these securities is subject to interest rate
risk, which we must monitor and manage successfully in order to prevent
declines in value of these assets if interest rates rise in the future. The speed and
velocity of the repricing of assets and liabilities will also contribute to the effects
on our NII, as will the presence or absence of periodic and lifetime interest rate
caps and floors.

Simulation of earnings is the primary tool used to measure the sensitivity of

earnings to interest rate changes. Earnings simulations are produced using a
software model that is based on actual cash flows and repricing characteristics for
all of our financial instruments and incorporates market-based assumptions
regarding the impact of changing interest rates on current volumes of applicable
financial instruments.

Interest rate simulations provide us with an estimate of both the dollar amount

and percentage change in NII under various rate scenarios. All assets and
liabilities are normally subjected to up to 400 basis point increases and decreases
in interest rates in 100 basis point increments. Under each interest rate scenario,
we project our net interest income. From these results, we can then develop
alternatives in dealing with the tolerance thresholds.

The assets and liabilities of a financial institution are primarily monetary in

nature. As such they represent obligations to pay or receive fixed and
determinable amounts of money that are not affected by future changes in prices.
Generally, the impact of inflation on a financial institution is reflected by
fluctuations in interest rates, the ability of customers to repay their obligations
and upward pressure on operating expenses. Although inflationary pressures are
not considered to be of any particular hindrance in the current economic
environment, they may have an impact on the company’s future earnings in the
event those pressures become more prevalent.

As a financial institution, the Company’s primary component of market risk is

interest rate volatility. Fluctuations in interest rates will ultimately impact both
the level of interest income and interest expense recorded on a large portion of
the Company’s assets and liabilities, and the market value of all interest earning
assets and interest bearing liabilities, other than those which possess a short term

to maturity. Virtually all of the Company’s interest earning assets and interest
bearing liabilities are located at the Bank level. Thus, virtually all of the
Company’s interest rate risk exposure lies at the Bank level other than
$5.2 million in subordinated notes issued by the Company’s subsidiary, Service
1st Capital Trust I. As a result, all significant interest rate risk procedures are
performed at the Bank level.

The fundamental objective of the Company’s management of its assets and

liabilities is to maximize the Company’s economic value while maintaining
adequate liquidity and an exposure to interest rate risk deemed by management
to be acceptable. Management believes an acceptable degree of exposure to
interest rate risk results from the management of assets and liabilities through
maturities, pricing and mix to attempt to neutralize the potential impact of
changes in market interest rates. The Company’s profitability is dependent to a
large extent upon its net interest income, which is the difference between its
interest income on interest earning assets, such as loans and investments, and its
interest expense on interest bearing liabilities, such as deposits and borrowings.
The Company is subject to interest rate risk to the degree that its interest
earning assets re-price differently than its interest bearing liabilities. The
Company manages its mix of assets and liabilities with the goals of limiting its
exposure to interest rate risk, ensuring adequate liquidity, and coordinating its
sources and uses of funds.

The Company seeks to control interest rate risk exposure in a manner that will

allow for adequate levels of earnings and capital over a range of possible interest
rate environments. The Company has adopted formal policies and practices to
monitor and manage interest rate risk exposure. Management believes historically
it has effectively managed the effect of changes in interest rates on its operating
results and believes that it can continue to manage the short-term effects of
interest rate changes under various interest rate scenarios.

Management employs asset and liability management software and engages
consultants to measure the Company’s exposure to future changes in interest
rates. The software measures the expected cash flows and re-pricing of each
financial asset/liability separately in measuring the Company’s interest rate
sensitivity. Based on the results of the software’s output, management believes the
Company’s balance sheet is evenly matched over the short term and slightly asset
sensitive over the longer term as of December 31, 2018. This means that the
Company would expect (all other things being equal) to experience a limited
change in its net interest income if rates rise or fall. The level of potential or
expected change indicated by the tables below is considered acceptable by
management and is compliant with the Company’s ALCO policies. Management
will continue to perform this analysis each quarter.

The hypothetical impacts of sudden interest rate movements applied to the
Company’s asset and liability balances are modeled quarterly. The results of these
models indicate how much of the Company’s net interest income is ‘‘at risk’’
from various rate changes over a one year horizon. This exercise is valuable in
identifying risk exposures. Management believes the results for the Company’s
December 31, 2018 balances indicate that the net interest income at risk over a
one year time horizon for a 100 basis points (‘‘bps’’), 200 bps, 300 bps, and
400 bps rate increase and a 100 bps decrease is acceptable to management and
within policy guidelines at this time. Given the low interest rate environment,
200 bps, 300 bps, and 400 bps decreases are not considered a realistic possibility
and are therefore not modeled.

The results in the table below indicate the change in net interest income the
Company would expect to see as of December 31, 2018, if interest rates were to
change in the amounts set forth:

Sensitivity Analysis of Impact of Rate Changes on Interest Income

$ Change from % Change from

Hypothetical Change in Rates
(Dollars in thousands)

Up 400 bps
Up 300 bps
Up 200 bps
Up 100 bps
Unchanged
Down 100 bps

Rates at
Projected Net December 31, December 31,
2018
Interest Income

Rates at

2018

67,200 $
66,500
65,500
65,200
64,900
60,900

2,300
1,600
600
300
-
(4,000)

3.54%
2.47%
0.92%
0.46%
-
(6.16)%

It is important to note that the above table is a summary of several forecasts

and actual results may vary from any of the forecasted amounts and such
difference may be material and adverse. The forecasts are based on estimates and

Quantitative and Qualitative Disclosures About Market Risk

assumptions made by management, and that may turn out to be different, and
may change over time. Factors affecting these estimates and assumptions include,
but are not limited to: 1) competitor behavior, 2) economic conditions both
locally and nationally, 3) actions taken by the Federal Reserve Board, 4) customer
behavior and 5) management’s responses to each of the foregoing. Factors that
vary significantly from the assumptions and estimates may have material and
adverse effects on the Company’s net interest income; therefore, the results of this
analysis should not be relied upon as indicative of actual future results.

The following table shows management’s estimates of how the loan portfolio is

segregated between variable-daily, variable other than daily and fixed rate loans,
and estimates of re-pricing opportunities for the entire loan portfolio at
December 31, 2018 and 2017:

Rate Type
(Dollars in thousands)

Variable rate
Fixed rate

December 31, 2018

December 31, 2017

Balance

Percent of
Total

Balance

Percent of
Total

$ 664,313
252,790

72.44% $ 634,900
27.56% 264,420

70.60%
29.40%

Total gross loans

$ 917,103

100.00% $ 899,320

100.00%

Approximately 72.44% of our loan portfolio is tied to adjustable rate indices
and 32.35% of our loan portfolio reprices within 90 days. As of December 31,

2018, we had 2,041 commercial and real estate loans totaling $546,984,000 with
floors ranging from 3.25% to 7.50% and ceilings ranging from 6.00% to
30.00%.

The following table shows the repricing categories of the Company’s loan

portfolio at December 31, 2018 and 2017:

Repricing
(Dollars in thousands)

< 1 Year
1-3 Years
3-5 Years
> 5 Years

December 31, 2018

December 31, 2017

Balance

$ 334,910
199,004
261,299
121,890

Percent of
Total

Balance

Percent of
Total

36.52% $ 318,985
21.70% 177,545
28.49% 200,471
13.29% 202,319

35.47%
19.74%
22.29%
22.50%

Total gross loans

$ 917,103

100.00% $ 899,320

100.00%

Assumptions are inherently uncertain, and, consequently, the model cannot
precisely measure net interest income or precisely predict the impact of changes
in interest rates on net interest income. Actual results will differ from simulated
results due to timing, magnitude and frequency of interest rate changes, as well
as changes in market conditions and management strategies which might
moderate the negative consequences of interest rate deviations.