A Message to our Shareholders
Following is our 2016 Annual Report which presents the results of our financial activities for
2016, and what we believe as being equally as important, our non-financial activities like who
we are and what we are thinking. The feedback we have received is that our investors are
interested in a dedicated community bank that is operating in a safe and sound manner while
generating success in the long term, and we concur.
During 2016, we have retained a substantial portion of our senior staff while making some
positive additions and changes to “right-size” our organization for future growth. There has
been a top to bottom review of our processes and procedures and some significant
enhancements are being implemented in our continued effort to become more efficient and
improve our customer and employee satisfaction. One of our proudest aspects is the average
length of time our employees have lived and worked in Sonoma County and their involvement
in community activities. Giving back is an intricate part of who we are and who we plan to be
in the future.
Summit State Bank is focused on growing organically in Sonoma County by increasing our
market share in areas where we excel in customer service. To this end, we plan to continue
with five branches in the same locations and concentrate our deposit and loan growth within
this area. Our primary relationships are with small and medium sized businesses and local
non-profits. We have invested in the latest technology in order to offer a complete suite of
support for our customer’s needs. We offer meaningful products to choose from on both the
deposit and loan sides, and we like to include some fun along the way.
Sonoma County has a stable and diverse economy with a great demographic that fits our
profile. We feel poised for success with a great team, strong financial position, positive
reputation, and appropriate product offerings. The core 2016 financial results showed
improvements over previous years and trends in revenue and balance sheet growth that we
will build on in the years to come. Your interest and investment in our institution are greatly
appreciated and hopefully rewarding as well.
Looking forward to a solid future,
Allan Hemphill
Chairman of the Board
Jim Brush
President & CEO
FEDERAL DEPOSIT INSURANCE CORPORATION
Washington, D.C. 20429
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
[X]
For the Fiscal Year Ended December 31, 2016
[ ]
___ to ___.
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from
FDIC Certificate Number 32203
Summit State Bank
(Exact name of registrant as specified in its charter)
California
(State of incorporation)
94-2878925
(I.R.S. Employee Identification No.)
500 Bicentennial Way, Santa Rosa, California 95403
(Address of principal executive offices)
(707) 568-6000
(registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act::
Common Stock, no par value, registered on the NASDAQ Stock Market, LLC
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No
[X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes [ ]
No [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a no accelerated filer or smaller
reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Exchange Act). (Check one)
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [X]
Indicate by check mark if the registrant is a shell company, in Rule 12b(2) of the Exchange Act. Yes [ ] No [X]
The aggregate market value of the Common Stock held by nonaffiliates was approximately $55,006,000 (based upon the closing
price of shares of the registrant’s Common Stock, no par value, as reported by the NASDAQ Stock Market, LLC on June 30,
2016). The number of shares outstanding of the registrant’s common stock (no par value) at the close of business March 23, 2017
was 6,025,015.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the 2017 Annual Meeting of Shareholders to be filed within 120 days of the fiscal
year ended December 31, 2016 are incorporated by reference into Part III.
SUMMIT STATE BANK
TABLE OF CONTENTS
PART I
Item 1. Business .............................................................................................................................. 3
Information about Summit State Bank ................................................................................ 3
Services and Financial Products ......................................................................................... 4
Sources of Business ............................................................................................................ 6
Competition ......................................................................................................................... 6
Our Address, Telephone Number and Internet Website ..................................................... 7
Regulation and Supervision ................................................................................................ 7
Employees ......................................................................................................................... 18
Item 1A. Risk Factors .................................................................................................................... 18
Item 1B. Unresolved Staff Comments ........................................................................................... 25
Item 2. Properties ........................................................................................................................... 25
Item 3. Legal Proceedings .............................................................................................................. 26
Item 4. Mine Safety Disclosures .................................................................................................... 26
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities .......................................................................................... 27
Item 6. Selected Financial Data ..................................................................................................... 28
Item 7. Management’s Discussion and Analysis of Financial Condition and Results
of Operations ..................................................................................................................... 29
Item 7A. Quantitative and Qualitative Disclosures about Market Risk ......................................... 48
Item 8. Financial Statements and Supplementary Data ................................................................. 52
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure .......................................................................................................... 92
Item 9A. Controls and Procedures ................................................................................................. 92
Item 9B. Other Information ........................................................................................................... 93
PART III
Item 10. Directors, Executive Officers and Corporate Governance .............................................. 94
Item 11. Executive Compensation ................................................................................................. 94
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters ........................................................................................... 94
Item 13. Certain Relationships and Related Transactions, and Director Independence ................ 95
Item 14. Principal Accountant Fees and Services .......................................................................... 95
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PART IV
Item 15. Exhibits and Financial Statement Schedules ................................................................... 96
Item 16. Form 10-K Summary ....................................................................................................... 96
Signatures ....................................................................................................................................... 97
Exhibit Index .................................................................................................................................. 99
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SUMMIT STATE BANK
ANNUAL REPORT ON FORM 10-K
PART I
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain statements that are forward-looking within the meaning of the
Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future
performance and involve certain risks, uncertainties and assumptions that are difficult to predict.
Actual outcomes and results may differ materially from those expressed in, or implied by, our
forward-looking statements. Words such as “expects,” “anticipates,” “believes,” “estimates” and
other similar expressions or future or conditional verbs such as “will,” “should,” “would” and
“could” are intended to identify such forward-looking statements. Readers of this annual report of
the Summit State Bank (also referred to as we, us or our) should not rely solely on the forward-
looking statements and should consider all uncertainties and risks throughout the report.
Forward-looking statements, by their nature, are subject to risks, uncertainties and assumptions.
Our future results and shareholder values may differ significantly from those expressed in these
forward-looking statements. You are cautioned not to put undue reliance on any forward-looking
statement. The statements are representative only as of the date they are made, and we undertake
no obligation to update any forward-looking statement. However, your attention is directed to any
further disclosures made on related subjects in any subsequent reports we may file with the Federal
Deposit Insurance Corporation (“FDIC”), including on Forms 10-K, 10-Q and 8-K, in the event
we become required to make such filings.
ITEM 1. BUSINESS
INFORMATION ABOUT SUMMIT STATE BANK
General
Summit State Bank (the “Bank”) is a state-chartered commercial bank operating a traditional
community banking business within our primary service area of Sonoma County in California,
however we consider loans from Marin, Napa and San Francisco counties. We operate through
five offices located in Santa Rosa, Rohnert Park, Healdsburg and Petaluma.
The Bank was incorporated on December 20, 1982 and commenced operations as a California
state-chartered savings and loan in 1982. On January 15, 1999, the Bank received authority to
convert its charter to a California state-chartered commercial bank. On July 13, 2006, the Bank
completed an underwritten initial public offering and listed its stock on the Nasdaq Global Market
under the symbol SSBI. The Bank’s deposits are insured by the FDIC in accordance with the
Federal Deposit Insurance Act and the related regulations.
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We provide a broad array of financial services to small-to medium-sized businesses, and their
owners and employees, professionals and professional associations, entrepreneurs, high net worth
families, foundations, estates and to individual consumers. We believe that our principal
competitive advantages are personal service, flexibility and responsiveness to customer needs. Our
lending activities are primarily focused on commercial real estate, construction, and business loans
to our targeted clientele.
We emphasize relationship banking and we believe we offer our customers many of the
management capabilities of a large financial institution, together with the resourcefulness and
superior customer service of a community bank. Through our branches and the use of technology,
we offer a broad array of deposit products and services for both commercial and consumer
customers, including electronic banking, cash management services and electronic bill payment.
We provide a comprehensive set of loan products, such as commercial loans and leases, lines of
credit, commercial real estate loans, Small Business Administration, or SBA, loans, residential
mortgage loans, home equity lines of credit and construction loans. We believe that local decision
making ensures that our lending process is fast, efficient, and focused on maintaining our high
credit quality and underwriting standards.
The Bank’s only subsidiary is ALTO Service Corporation, which is a wholly owned subsidiary,
incorporated in California. Its purpose is to act as trustee on the Bank’s deeds of trust and perform
reconveyances. The assets of ALTO Service Corporation consist exclusively of cash on deposit
with the Bank. It has no employees and its operations and balance sheet are not material to the
Bank’s consolidated operating income or financial condition.
Services and Financial Products
Deposit Products
The Bank offers a wide range of deposit accounts designed to attract commercial businesses,
professionals, and residents in its primary service area. These accounts include personal and
business checking accounts, money market accounts, time certificates of deposit, sweep accounts
and specialized deposit accounts, including professional accounts, small business “packaged”
accounts, and tiered accounts designed to attract larger deposits, and Keogh and IRA accounts.
Lending Products
The Bank also offers a full complement of lending products designed to meet the specialized
needs of its customers, including commercial and industrial lines of credit and term loans, credit
lines to individuals, equipment loans, real estate and construction loans, small business loans of
which a portion may be guaranteed by the SBA, and business lines of credit. The Bank has the
designation of “Preferred Lender” by the SBA, which allows for expedited loan approval and
funding. The Bank also offers consumer loans, including auto loans, mortgage loans, home
improvement loans, and home equity lines of credit. The Bank offers loans in amounts which
exceed the Bank’s lending limits through participation arrangements with correspondent banks.
On a selective basis, the Bank also offers loans for accounts receivable and inventory financing,
loans to agriculture-related businesses, and equipment and expansion financing programs.
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Brokered Deposits and CDARS
The Bank will accept brokered deposits when it is determined to be advantageous over other
time deposits through its branch system. The Bank is a member of a special network (Promontory
Interfinancial Network) offering a time deposit product called CDARS and demand deposit
product called ICS. When a customer places a large deposit with the Bank as a network member,
the Bank can place the funds into certificates of deposit or demand accounts issued by other banks
in the network in increments of less than $250,000, so that both principal and interest are eligible
for complete FDIC protection. Other banks do the same thing with their customer funds. The
network banks exchange deposits on a dollar-for-dollar basis, bringing the full amount of the
original deposit back to the originating bank. Because the originating bank comes out “whole,” it
can make the full amount of deposits received available for community lending purposes or other
initiatives of its choosing. Deposits placed using CDARS and ICS meet the pass-through insurance
coverage guidelines established by the FDIC and the depositor can obtain up to $25 million in
FDIC insurance coverage. The deposits received by the Bank from other network members in
exchange for the Bank’s customers’ deposits placed in the program are reported as brokered
deposits for FFIEC Call Report purposes. Deposit funding raised through the CDARS products
can vary significantly between financial reporting periods. CDARS, ICS and other brokered
deposits totaled $65,854,000 or 17% of deposits at December 31, 2016, and $71,016,000 or 18%
of deposits at December 31, 2015.
State of California Approved Depository
The Bank is an approved depositary for the deposit of funds of the State of California. These
time deposits are placed by the Treasurer of the State of California and have maturities of three to
six months, and are collateralized by investment securities, mortgage loans or letters of credit
issued by the Federal Home Loan Bank (“FHLB”). These deposits totaled $48,500,000 or 13% of
deposits at December 31, 2016 and $48,500,000 or 12% of deposits at December 31, 2015.
Internet and Telephone Banking Services
The Bank offers a computerized internet banking system, accessible on the Internet at the Bank’s
website www.summitstatebank.com, that enables its customers to view account information,
access cash management services (including the initiation of automated clearinghouse payments),
make transfers between accounts, pay bills, make loan payments, pre-schedule deposit transfers
and request loan draws, and view both the front and back of cleared deposit items. The Bank also
offers telephone banking services that enable customers to obtain account information, make
transfers between accounts, make stop payments, check cleared items, and pre-schedule deposit
transfers and loan payments. The Bank has an “app” for cellular phones that allows check image
deposits, account inquiries and account transfers.
Other Services
Other services which the Bank offers include banking by appointment, online banking services,
direct payroll and social security deposits, letters of credit, access to national automated teller
5
machine networks, courier services, safe deposit boxes, night depository facilities, notary services,
travelers checks, lockbox, and banking by mail.
Management evaluates the Bank’s services on an ongoing basis, and adds or discontinues
services based upon customer needs, competitive factors, and the financial and other capabilities
of the Bank. Future services may also be significantly influenced by improvements and
developments in technology and evolving state and federal regulations.
Sources of Business
In marketing its services, the Bank capitalizes on its identity as a local, community bank, with
officers, Directors and shareholders who have business and personal ties to the community. Small
to medium-sized businesses are targeted, as well as nonprofit charities.
The Bank competes with other financial institutions in its service area through localized
promotional activities, personalized service, and personal contact with potential customers by
Executive Officers, Directors, employees and shareholders. Promotional activities include media
advertising, community advisory groups and Officer participation in community business and civic
groups. Officers and Directors are active members of the community who call personally on their
business contacts and acquaintances in the Sonoma County area to become customers.
The Bank employs business development officers to solicit loans and deposits from local
businesses and professionals.
Competition
The banking business in California generally, and in the Bank’s service area in particular, is
highly competitive with respect to both loans and deposits and is dominated by a relatively small
number of major banks that have offices operating over wide geographic areas. The Bank competes
for deposits and loans with these banks as well as with savings and loan associations, credit unions,
mortgage companies, money market funds, stock brokerage firms, insurance companies, and other
traditional and non-traditional financial institutions.
Major financial institutions with offices in the service area include Bank of America, Wells
Fargo Bank, and JP Morgan Chase. Regional and independent financial institutions with offices in
our service area include, among others, Umpqua Bank, Luther Burbank Savings, Exchange Bank,
and Westamerica Bank.
The major banks and some of the other institutions have the ability to finance extensive
advertising campaigns and to shift their resources to regions or activities of greater potential
profitability. Many of the competing banks and other institutions offer diversified financial
services which may not be directly offered by the Bank. The major banks also have substantially
more capital and higher lending limits.
6
The Bank competes for customers’ funds with governmental and private entities issuing debt or
equity securities or other forms of investments which may offer different or higher yields than
those available through bank deposits.
Existing and future state and federal legislation could significantly affect the Bank’s cost of
doing business, its range of permissible activities, and the competitive balance among major,
regional and independent banks, and other financial institutions. Management cannot predict the
impact these matters may have on commercial banking in general or on the business of the Bank
in particular.
To compete with the financial institutions operating in the Bank’s service area, the Bank relies
upon its independent status to provide flexibility and personalized service to its customers. The
Bank emphasizes personal contacts with potential customers by Executive Officers, Directors and
employees, develops local promotional activities, and seeks to develop specialized or streamlined
services for customers. To the extent customers desire loans in excess of its lending limits or
services not offered by the Bank, the Bank attempts to assist customers in obtaining such loans or
other services through participations with other banks or assistance from correspondent banks.
Our Address, Telephone Number and Internet Website
Our principal executive offices are located at 500 Bicentennial Way, Santa Rosa, California
95403, and our telephone number is (707) 568-6000. Information about us is available at
www.summitstatebank.com. The information on our website is not incorporated by reference into
and does not form a part of this report.
REGULATION AND SUPERVISION
Overview
Described below are the material elements of selected laws and regulations applicable to
the Bank. The descriptions are not intended to be complete and are qualified in their entirety by
reference to the full text of the statutes and regulations described. Changes in applicable laws or
regulations, and in their interpretation and application by regulatory agencies and other
governmental authorities, cannot be predicted, but may have a material effect on our business,
results of operations or financial condition of the business, or results of operations or financial
condition of our subsidiaries.
The Bank is extensively regulated by federal and state authorities. As a California state-
chartered commercial bank, the Bank is regulated, supervised and examined by the California
Department of Business Oversight’s Division of Financial Institutions (“DBO”) and the FDIC,
which is the Bank’s primary federal regulator. The regulations of the DBO and the FDIC govern
most aspects of the Bank’s business relating to dividends, investments, loans, borrowings, capital
requirements, certain check-clearing activities, branching, mergers and acquisitions, reserves
against deposits, the issuance of securities and numerous other areas. Although the bank is not a
member bank of the Federal Reserve System, it is subject to certain regulations of the Board of
7
Governors of the Federal Reserve System (the “Federal Reserve Board”), such as those dealing
with check clearing activities (Regulation CC), and establishment of reserves against deposits
(Regulation D). The Bank is also subject to the requirements and restrictions of various consumer
laws and regulations, as well as applicable provisions of California law, insofar as they do not
conflict with and are not preempted by federal banking laws. Supervision and examination of the
Bank by the regulatory agencies are generally intended to protect depositors and are not intended
for the protection of shareholders.
The Bank’s deposits are insured by the FDIC to the fullest extent permissible by law. As
an insurer of deposits, the FDIC issues regulations, conducts examinations, requires the filing of
reports and generally supervises the operations of all institutions to which it provides deposit
insurance. The approval of the FDIC is required for certain transactions in which the Bank may
engage, including any merger or consolidation by us, the acquisition of another bank, a change in
control over us, or the establishment or relocation of any of our branch offices. In reviewing
applications seeking approval of such transactions, the FDIC may consider, among other things,
the competitive effect and public benefits of the transactions, the capital position and financial and
managerial resources and future prospects of the organizations involved in the transaction, the
applicant’s performance record under the Community Reinvestment Act (see “Community
Reinvestment Act and Fair Lending Laws” below) and the effectiveness of the organizations
involved in the transaction in combating money laundering activities. The FDIC also has the power
to prohibit these and other transactions even if FDIC approval is not required, and could do so if
the Bank has otherwise failed to comply with all laws and regulations applicable to it. The FDIC
may pursue an enforcement action against a bank for unsafe and unsound practices in conducting
its business, or for violations of any law, rule or regulation or provision, any consent order with
any agency, any condition imposed in writing by the agency, or any written agreement with the
agency. Enforcement actions may include the imposition of a conservator or receiver, cease-and-
desist orders and written agreements, the termination of insurance of deposits, the imposition of
civil money penalties and removal and prohibition orders against institution-affiliated parties.
Statutes, regulations and policies affecting the banking industry are frequently under
review by the U.S. Congress and state legislatures, and by the federal and state agencies charged
with supervisory and examination authority over banking institutions. Changes in the banking and
financial services industry can be expected to occur in the future. Changes in the statutes,
regulations or policies that affect the Bank cannot be predicted and may have a material effect on
the Bank’s business and earnings. In addition, the regulatory agencies that have jurisdiction over
the Bank have broad discretion in exercising their supervisory powers and may affect the conduct
of our business or impose additional regulatory burdens.
California Law
California law governs the licensing and regulation of California commercial banks,
including organizational and capital requirements, fiduciary powers, investment authority, branch
offices and electronic terminals, declaration of dividends, changes of control and mergers, out of
state activities, interstate branching and banking, debt offerings, borrowing limits, limits on loans
to one obligor, liquidation, sale of shares or options in the Bank to its directors, officers, employees
8
and others, the purchase by the Bank of its own shares, and the issuance of capital notes or
debentures. The DBO is charged with our supervision and regulation.
With certain limited exceptions, unsecured loans to one person generally may not exceed
15% of the sum of a bank’s shareholders’ equity, allowance for loan losses and capital notes and
debentures, and both secured and unsecured loans to one person (excluding certain secured lending
and letters of credit) at any given time generally may not exceed 25% of the sum of a bank’s
shareholders’ equity, allowance for loan losses and capital notes and debentures. Except for
limitations on the amount of loans to a single borrower, loans secured by real or personal property
may be made to any person without regard to the location or nature of the collateral. The Bank is
required to invest its funds in accordance with limitations under California law and may only make
investments that are permissible investments for banks, subject to any limitations under any other
applicable law.
Under California law, the amount a bank generally may borrow may not exceed its
shareholders’ equity without the consent of the DBO. In addition to remedies available to the
FDIC, the Commissioner of the DBO may take possession of a bank if certain conditions exist
such as insufficient shareholders’ equity, unsafe or unauthorized operations, or violation of law.
The laws of the State of California affect the Bank’s business and operations. The
California Financial Code provides that if the DBO believes that a bank is violating its articles of
incorporation or state law, or is engaging in unsafe or injurious business practices, the DBO can
order that bank to comply with the law or to cease the unsafe or injurious practices and has
authority to impose civil money penalties. The DBO has the power to suspend or remove bank
officers, directors and employees who violate any law or regulation relating to the business of the
bank or breach any fiduciary duty to the bank, engage in any unsafe and unsound practices related
to the business of the bank, or are charged with or convicted of a felony involving dishonesty or
breach of trust. The DBO also has authority to take possession of and to liquidate a bank, to appoint
a conservator for a bank and to appoint the FDIC as receiver for a bank.
Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Act, which was enacted in July 2010, significantly restructured the
financial regulatory system in the United States. Provisions of the Dodd-Frank Act that have had
or may have a material effect on the Bank’s business include, among others, repealing the federal
prohibitions on the payment of interest on demand deposits, thereby permitting depository
institutions to pay interest on corporate transaction and other accounts, imposing additional
underwriting standards on mortgages and restricting so-called “high-cost mortgages,” and making
permanent the $250,000 limit for federal deposit insurance. The Dodd-Frank Act also centralized
responsibility for consumer financial protection by creating a new agency, the Consumer Financial
Protection Bureau (“CFPB”), responsible for implementing, examining and enforcing compliance
with federal consumer financial protection laws. Many aspects of the Dodd-Frank Act are the
subject of rulemakings.
The existing and future rulemakings issued under the Dodd-Frank Act have resulted, and
may continue to result, in a significant cost of compliance. The changes resulting from the Dodd-
9
Frank Act may impact the profitability of our business activities, require changes to certain of our
business practices, impose upon us more stringent capital, liquidity and leverage requirements or
otherwise materially and adversely affect us.
Capital Adequacy Guidelines
Federal bank regulatory agencies have adopted risk-based capital guidelines intended to
provide a measure of capital adequacy that reflects the degree of risk associated with a financial
institution’s operations. The capital standards require the maintenance of common equity Tier 1
capital, Tier 1 capital and total capital to risk-weighted assets, and a leverage ratio of total assets
to Tier 1 capital. Common equity Tier 1 capital is generally defined as common stockholders’
equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and
additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual
preferred stock and related surplus and minority interests in equity accounts of consolidated
subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional
Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related
surplus, meeting specified requirements, and may include cumulative preferred stock and long-
term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and
subordinated debt. Also, included in Tier 2 capital is the allowance for loan and lease losses limited
to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out
election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to
45% of pre-tax net unrealized gains on available-for-sale preferred stock with readily determinable
fair market values. Institutions that have not exercised the AOCI opt-out must incorporate AOCI,
including unrealized gains and losses on available-for-sale-securities, into common equity Tier 1
capital. The Bank exercised its opt-out election during the first quarter of calendar 2015.
Calculation of all types of regulatory capital is subject to deductions and adjustments specified in
the regulations.
The guidelines make regulatory capital requirements sensitive to the differences in risk
profiles among banking institutions, take off-balance-sheet items into account when assessing
capital adequacy, and minimize disincentives to holding liquid low-risk assets.
The guidelines require the Bank to maintain a minimum common equity Tier 1 capital ratio
of 4.5%, a Tier 1 capital ratio of 6%, a total capital ratio of 8%, and a Tier 1 leverage ratio of 4%.
The guidelines also establish a “capital conservation buffer” of 2.5% above the regulatory
minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The
capital conservation buffer is in the process of being phased in beginning in January 2016 at
0.625% of risk-weighted assets and increasing by that amount each year until fully implemented
in January 2019. The capital conservation buffer is designed to absorb losses during periods of
economic stress. Banking institutions that fail to maintain the capital conservation buffer will face
constraints on dividends, equity repurchases and compensation based on the amount of the
shortfall. The above capital ratios are minimum requirements. In practice, banks are expected to
operate with more than the minimum capital and the FDIC may establish greater minimum capital
requirements for specific institutions.
10
Prompt Corrective Action
Federal banking agencies, including the FDIC, have adopted regulations implementing a
system of prompt corrective action under the Federal Deposit Insurance Corporation Improvement
Act. Under the prompt corrective action provisions and implementing regulations, every institution
is classified into one of five categories, depending on its total risk-based capital ratio, its common
equity Tier 1 ratio, its Tier 1 risk-based capital ratio, its leverage ratio, and subjective factors. The
categories are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly
undercapitalized” and “critically undercapitalized.” To be considered well capitalized for purposes
of the prompt corrective action rules, a bank must maintain total risk-based capital of 10.0% or
greater, Tier 1 risk-based capital of 8.0% or greater, common equity Tier 1 capital of 6.5%, and a
leverage ratio of 5.0% or greater. An institution with a capital level that might qualify for well
capitalized or adequately capitalized status may nevertheless be treated as though it were in the
next lower capital category if its primary federal banking supervisory authority determines that an
unsafe or unsound condition or practice warrants that treatment.
A financial institution’s operations can be significantly affected by its capital classification
under the prompt corrective action rules. For example, an institution that is not well capitalized
generally is prohibited from accepting brokered deposits and offering interest rates on deposits
higher than the prevailing rate in its market without advance regulatory approval, which can have
an adverse effect on the bank’s liquidity. At each successively lower capital category, an insured
depository institution is subject to additional restrictions. Undercapitalized institutions are required
to take specified actions to increase their capital or otherwise decrease the risks to the federal
deposit insurance fund. Bank regulatory agencies generally are required to appoint a receiver or
conservator shortly after an institution becomes critically undercapitalized (with tangible equity to
total assets of 2% or less).
As of December 31, 2016, the Bank was well-capitalized and had a common equity Tier 1
capital ratio of 13.5%, a total risk-based capital ratio of 14.7%, a Tier-1 risk-based capital ratio of
13.5%, and a leverage ratio of 11.1%.
In addition to measures taken under the prompt corrective action provisions, commercial
banking organizations may be subject to potential enforcement actions by the federal banking
agencies for unsafe or unsound practices in conducting their businesses or for violations of any
law, rule, regulation, condition imposed in writing by the agency or written agreement with the
agency. Enforcement actions may include the issuance of formal and informal agreements, the
issuance of a cease-and-desist order that can be judicially enforced, the issuance of directives to
increase capital, the imposition of civil money penalties, the issuance of removal and prohibition
orders against institution-affiliated parties, the termination of insurance of deposits, the imposition
of a conservator or receiver, and the enforcement of such actions through injunctions or restraining
orders based upon a judicial determination that the agency would be harmed if such equitable relief
was not granted.
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Standards for Safety and Soundness
Federal law requires each federal banking agency to prescribe certain standards for all
insured depository institutions. These standards relate to, among other things, internal controls,
information systems and audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, compensation, and other operational and managerial standards as the
agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that
the federal banking agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the guidelines, the agency may require the
institution to submit to the agency an acceptable plan to achieve compliance with the standard. If
an institution fails to meet these standards, the appropriate federal banking agency may require the
institution to implement an acceptable compliance plan. Failure to implement such a plan can result
in further enforcement action, including the issuance of a “cease-and-desist” order or the
imposition of civil money penalties.
Deposit Insurance Premiums
The Deposit Insurance Fund of the FDIC insures deposits at insured depository institutions
such as the Bank. Deposit accounts in the Bank are insured by the FDIC generally up to a
maximum of $250,000 per separately insured depositor.
The FDIC has developed a risk-based assessment system providing that the assessment rate
for an insured depository institution varies according to the level of risk incurred in its activities.
Institutions are classified into one of four risk categories. The FDIC is able to assess higher rates
to institutions with a significant reliance on secured liabilities or a significant reliance on brokered
deposits but, for well-managed and well-capitalized institutions, only when accompanied by rapid
asset growth.
Assessments are based on the average consolidated total assets less tangible equity capital
of a financial institution. Assessment rates range from 2.5 to 9 basis points on the broader
assessment base for banks in the lowest risk category (“well capitalized” and CAMELS I or II)
and up to 30 to 45 basis points for banks in the highest risk category.
Effective July 1, 2016, the FDIC changed the way established small banks are assessed for
deposit insurance. The FDIC has eliminated the risk categories for banks, such as the Bank, that
have been FDIC insured for at least five years and have less than $10 billion in total assets, and
assessments are now based on financial measures and supervisory ratings derived from statistical
modeling estimating the probability of failure within three years. In conjunction with the Deposit
Insurance Fund reserve ratio achieving 1.15%, the assessment range (inclusive of possible
adjustments) for established small banks with CAMELS I or II ratings has been reduced to 1.5 to
16 basis points and the maximum assessment rate for established small banks with CAMELS III
through V ratings is 30 basis points.
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The FDIC has authority to increase insurance assessments. Any significant increases would
have an adverse effect on the operating expenses and results of operations of the Bank.
Management cannot predict what assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has
engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations
or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. The
Bank does not currently know of any practice, condition or violation that may lead to termination
of its deposit insurance.
Brokered Deposit Restrictions
Well-capitalized institutions are not subject to limitations on brokered deposits, while an
adequately capitalized institution is able to accept, renew or roll over brokered deposits only with
a waiver from the FDIC and subject to certain restrictions on the yield paid on such deposits.
Undercapitalized institutions are generally not permitted to accept, renew, or roll over brokered
deposits.
Limitations on Dividends
Under California law, the holders of the Bank’s common stock are entitled to receive
dividends out of funds legally available for the payment of dividends when and as declared by the
Board of Directors, provided the conditions described below are satisfied.
The payment of cash dividends by the Bank depends on various factors, including the
earnings and capital requirements of the Bank and other financial conditions. California law
provides that, as a state-licensed bank, the Bank may not make a cash distribution to its
shareholders in excess of the lesser of the following: (a) the Bank’s retained earnings or (b) the
Bank’s net income for its last three fiscal years, less the amount of any distributions made by the
Bank to its shareholders during that period. However, a bank such as the Bank, with the prior
approval of the DBO, may make a distribution to its shareholders of an amount not to exceed the
greatest of (1) the Bank’s retained earnings, (2) the Bank’s net income for its last fiscal year, or
(3) the Bank’s net income for the current fiscal year. If the DBO determines that the shareholders’
equity of the Bank is inadequate or that the making of a distribution by the Bank would be unsafe
or unsound, the DBO may order the Bank to refrain from making a proposed distribution.
The FDIC and the DBO have authority to prohibit a bank from engaging in business
practices that are considered to be unsafe or unsound. Depending upon the financial condition of
the bank and upon other factors, the FDIC or the DBO could assert that payments of dividends or
other payments by the Bank might be an unsafe or unsound practice.
Reserve Requirements
The Bank is also subject to the uniform reserve requirements of the Federal Reserve
Board’s Regulation D, which applies to all depository institutions with transaction accounts or
non-personal time deposits. During 2016, amounts in transaction accounts above $15.2 million
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and up to $110.2 million were required to have reserves held against them in the ratio of 3% of
such amounts. Amounts above $110.2 million required reserves of $2,850,000 plus 10% of the
amount in excess of $110.2 million. The Federal Reserve Board changes its reserve requirements
on an annual basis and the Bank is subject to new requirements for 2017. The Bank was in
compliance with its reserve requirements at December 31, 2016 and is in compliance with its
current reserve requirements.
Transactions with Related Parties and Insiders
Transactions between banks and their related parties or affiliates are limited by Sections
23A and 23B of the Federal Reserve Act. An affiliate of a bank is any company or entity that
controls, is controlled by or is under common control with the bank. In a holding company context,
the parent bank holding company and any companies which are controlled by such parent holding
company are affiliates of the bank.
Generally, Section 23A of the Federal Reserve Act and the FRB’s Regulation W limit the
extent to which a bank or its subsidiaries may engage in “covered transactions” with any one
affiliate to an amount equal to 10.0% of such bank’s capital stock and surplus, and contain an
aggregate limit on all such transactions with all affiliates to an amount equal to 20.0% of such
bank’s capital stock and surplus. The term ‘‘covered transaction’’ includes the making of loans,
purchase of assets, issuance of guarantees and other similar transactions. In addition, loans or other
extensions of credit by the bank to an affiliate are required to be collateralized in accordance with
regulatory requirements and the bank’s transactions with affiliates must be consistent with safe
and sound banking practices and may not involve the purchase by the bank of any low-quality
asset. Section 23B applies to covered transactions as well as certain other transactions and requires
that all such transactions be on terms substantially the same, or at least as favorable, to the
institution or subsidiary as those provided to non-affiliates.
Section 22(h) of the Federal Reserve Act and the FRB’s Regulation O govern extensions
of credit made by a bank to its directors, executive officers, and principal stockholders
(‘‘insiders’’). Among other things, these provisions require that extensions of credit to insiders be
made on terms that are substantially the same as, and follow credit underwriting procedures that
are not less stringent than, those prevailing for comparable transactions with unaffiliated persons
and that do not involve more than the normal risk of repayment or present other unfavorable
features. Further, such extensions may not exceed certain limitations on the amount of credit
extended to such persons, individually and in the aggregate, which limits are based, in part, on the
amount of the Bank’s capital. Extensions of credit in excess of certain limits must also be approved
by the board of directors.
Customer Privacy
Federal law currently contains extensive customer privacy protection provisions. Under
these provisions, a financial institution must provide to its customers, at the inception of the
customer relationship and annually thereafter, the institution’s policies and procedures regarding
the handling of customers’ nonpublic personal financial information. These provisions also
provide that, except for certain limited exceptions, a financial institution may not provide such
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personal information to unaffiliated third parties unless the institution discloses to the customer
that such information may be so provided and the customer is given the opportunity to opt out of
such disclosure. Further, under the “Interagency Guidelines Establishing Information Security
Standards,” banks must implement a comprehensive information security program that includes
administrative, technical, and physical safeguards to ensure the security and confidentiality of
customer information. Federal law makes it a criminal offense, except in limited circumstances, to
obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive
means.
Cybersecurity
Recent statements by federal regulators regarding cybersecurity indicate that financial
institutions should design multiple layers of security controls to establish lines of defense and to
ensure that their risk management processes also address the risk posed by compromised client
credentials, including security measures to reliably authenticate clients accessing Internet-based
services of the financial institution. Financial institution management is also expected to maintain
sufficient business continuity planning processes to ensure the rapid recovery, resumption and
maintenance of the institution’s operations after a cyber-attack involving destructive malware. A
financial institution is expected to develop appropriate processes to enable recovery of data and
business operations and address rebuilding network capabilities and restoring data if the institution
or its critical service providers fall victim to this type of cyber-attack. If the Bank fails to observe
regulatory guidance regarding appropriate cybersecurity safeguards we could be subject to various
regulatory sanctions, including financial penalties.
In the ordinary course of business, the Bank relies on electronic communications and
information systems to conduct its operations and to store sensitive data. The Bank employs an in-
depth, layered, defensive approach that incorporates security processes and technology to manage
and maintain cybersecurity controls. We employ a variety of preventative and detective tools to
monitor, block, and provide alerts regarding suspicious activity, as well as to report on any
suspected advanced persistent threats. Notwithstanding the strength of the Bank’s defensive
measures, the threat from cyber-attacks is severe, attacks are sophisticated and increasing in
volume, and attackers respond rapidly to changes in defensive measures. While to date, we have
not experienced a significant compromise, significant data loss or any material financial losses
related to cybersecurity attacks, our systems and those of our clients and third-party service
providers are under constant threat and it is possible that we could experience a significant event
in the future. Risks and exposures related to cybersecurity attacks are expected to remain high for
the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well
as due to the expanding use of Internet banking, mobile banking and other technology-based
products and services by the Bank and its clients.
Community Reinvestment Act and Fair Lending Laws
Under the Community Reinvestment Act of 1977 (“CRA”), the FDIC is required to assess
the record of all financial institutions regulated by it to determine if such institutions are meeting
the credit needs of the community (including low- and moderate-income neighborhoods) which
they serve. CRA performance evaluations are based on a four-tiered rating system: Outstanding,
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Satisfactory, Needs to Improve and Substantial Noncompliance. CRA performance evaluations
are considered in evaluating applications for such things as mergers, acquisitions and applications
to open branches. The Bank has a CRA rating of “Satisfactory”.
In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders
from discriminating in their lending practices on the basis of characteristics specified in those
statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act
could result in enforcement actions by the FDIC, the Department of Housing and Urban
Development, and the Department of Justice, and in private civil actions by borrowers.
Anti-Money Laundering and OFAC
Under federal law, financial institutions must maintain anti-money laundering programs
that include established internal policies, procedures and controls, a designated compliance officer,
an ongoing employee training program, and testing of the program by an independent audit
function. Financial institutions are also prohibited from entering into specified financial
transactions and account relationships and must meet enhanced standards for due diligence and
customer identification in their dealings with foreign financial institutions and foreign customers.
Financial institutions must take reasonable steps to conduct enhanced scrutiny of account
relationships to guard against money laundering and to report any suspicious transactions, and law
enforcement authorities have been granted increased access to financial information maintained
by financial institutions. Bank regulators routinely examine institutions for compliance with these
obligations, and they must consider an institution’s compliance in connection with the regulatory
review of applications, including applications for banking mergers and acquisitions. The
regulatory authorities have imposed “cease-and-desist” orders and civil money penalty sanctions
against institutions found to be violating these obligations.
The Office of Foreign Assets Control (“OFAC”) is responsible for helping to ensure that
U.S. entities do not engage in transactions with certain prohibited parties, as defined by various
Executive Orders and Acts of Congress. OFAC sends bank regulatory agencies lists of persons
and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially
Designated Nationals and Blocked Persons. If the Bank finds a name on any transaction, account
or wire transfer that is on an OFAC list, the Bank must freeze such account, file a suspicious
activity report and notify the appropriate authorities.
Programs to Mitigate Identity Theft
In November 2007, federal banking agencies together with the NCUA and FTC adopted
regulations under the Fair and Accurate Credit Transactions Act of 2003 to require financial
institutions and other creditors to develop and implement a written identity theft prevention
program to detect, prevent and mitigate identity theft in connection with certain new and existing
accounts. Covered accounts generally include consumer accounts and other accounts that present
a reasonably foreseeable risk of identity theft. Each institution's program must include policies
and procedures designed to: (i) identify indicators, or “red flags,” of possible risk of identity theft;
(ii) detect the occurrence of red flags; (iii) respond appropriately to red flags that are detected; and
(iv) ensure that the program is updated periodically as appropriate to address changing
16
circumstances. The regulations include guidelines that each institution must consider and, to the
extent appropriate, include in its program.
Guidance on Sound Incentive Compensation Policies
In 2010, the federal bank regulators jointly issued final guidance on sound incentive
compensation policies (“SICP”) intended to ensure that the incentive compensation policies of
banking organizations do not undermine safety and soundness by encouraging excessive risk-
taking. The SICP guidance, which covers all employees who have the ability to materially affect
the risk profile of an organization, is based on the principles that a banking organization's incentive
compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond
the organization's ability to effectively identify and manage risks, (ii) be compatible with effective
internal controls and risk management, and (iii) be supported by strong corporate governance,
including active and effective oversight by the organization’s board of directors. Any deficiencies
in compensation practices that are identified may be incorporated into the organization's
supervisory ratings, and result in enforcement actions.
Consumer Protection Laws
The Bank is subject to a number of federal and state laws designed to protect borrowers
and promote lending to various sectors of the economy. These laws include the Equal Credit
Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Fair and Accurate Credit
Transactions Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real
Estate Settlement Procedures Act, and various state law counterparts. Further, the Dodd-Frank Act
established the CFPB, which has the responsibility for making rules and regulations under the
federal consumer protection laws relating to financial products and services. The CFPB also has a
broad mandate to prohibit unfair or deceptive acts and practices and is specifically empowered to
require certain disclosures to consumers and draft model disclosure forms. Failure to comply with
consumer protection laws and regulations can subject financial institutions to enforcement actions,
fines and other penalties. The FDIC will examine the Bank for compliance with CFPB rules and
will enforce CFPB rules with respect to the Bank.
Federal and State Securities Laws
The Bank’s common stock is registered with the FDIC under section 12(i) of the Securities
Exchange Act of 1934 (the “Exchange Act”). As such, we are subject to the information, proxy
solicitation, insider trading restrictions and other requirements of the Exchange Act. Further, if the
Bank wishes to sell common stock or other securities to raise capital in the future, it will be subject
to the anti-fraud and other applicable provisions of state and federal securities laws.
Although the Bank is exempt from the registration requirements of the federal Securities
Act of 1933, and as such is not required to file a prospectus with the SEC, the FDIC, or any other
federal agency before commencing the sale of its stock, California does not exempt bank stock
offerings from securities registration and qualification requirements. A California-chartered bank
generally must obtain a permit from the DBO to sell its stock. The DBO will generally approve
the application if the DBO determines that the stock offering is fair, just, and equitable. The permit
17
required to sell stock applies to private placement transactions and public offerings conducted by
California-chartered banks.
Legislation and Proposed Changes
From time to time, legislation is enacted which has the effect of increasing the cost of doing
business, limiting or expanding permissible activities or affecting the competitive balance between
banks and other financial institutions. Proposals to change the laws and regulations governing the
operations and taxation of banks, bank holding companies and other financial institutions are
frequently made in Congress, in the California legislature and before various bank regulatory
agencies. For example, from time to time Congress has considered various proposals to eliminate
the federal thrift charter, create a uniform financial institutions charter, and conform holding
company regulation. Typically, the intent of this type of legislation is to strengthen the banking
industry. No prediction can be made as to the likelihood of any major changes or the impact that
new laws or regulations might have on the Bank.
Employees
As of December 31, 2016, the Bank employed a total of 74 employees in various capacities, all
located in California. The Bank’s employees are not represented by any union or covered by any
collective bargaining agreement. The Bank considers its relationships with its employees to be
good.
ITEM 1A. RISK FACTORS
The risks and uncertainties described below are not the only ones facing us. Additional
risks and uncertainties that management is not aware of or focused on or that management
currently deems immaterial may also impair our business operations. This report is qualified in its
entirety by these risk factors.
Economic or Market Risks
Current Market Developments May Adversely Affect Our Industry, Business and Results of
Operations.
Dramatic declines in the housing market during the prior years, with falling home prices
and increasing foreclosures and unemployment, have resulted in significant write-downs of asset
values by financial institutions, including government-sponsored entities and major commercial
and investment banks. These write-downs, initially of mortgage-backed securities but spreading
to credit default swaps and other derivative securities, have caused many financial institutions to
seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.
Many lenders and institutional investors, concerned about the stability of the financial markets
generally and the strength of counterparties, have reduced or ceased to provide funding to
borrowers, including other financial institutions. The resulting lack of available credit, lack of
confidence in the financial sector, increased volatility in the financial markets and reduced
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business activity could materially and adversely affect our business, financial condition and results
of operations.
The Bank’s Business May Be Adversely Affected By General Economic Conditions Including
Conditions in California.
The banking business is affected by general economic and political conditions, both
domestic and international, and by governmental monetary and fiscal policies. Conditions such as
inflation, recession, unemployment, volatile interest rates, money supply, scarce natural resources,
weather, natural disasters such as earthquakes, international disorders, etc., and other factors
beyond the Bank’s control may adversely affect the profitability of the Bank.
A substantial majority of the Bank’s assets and deposits are generated in Northern
California. As a result, poor economic conditions in Northern California may cause the Bank to
incur losses associated with higher default rates and decreased collateral values in its loan
portfolio. Economic conditions in Northern California are subject to various uncertainties at this
time, including the state’s budget deficit and the depreciation of real estate. If economic conditions
in California generally and Northern California in particular decline further, the Bank recognizes
that its level of problem assets could increase accordingly.
The Bank Is Highly Dependent on Real Estate and Events that Negatively Impact the Real
Estate Market Could Hurt Our Business.
A significant portion of our loan portfolio is dependent on real estate. At December 31,
2016, real estate served as the principal source of collateral with respect to approximately 87% of
our loan portfolio. A future decline in the value of the real estate securing our loans and real estate
owned by us could adversely impact our financial condition. In addition, acts of nature, including
earthquakes, brush fires and floods, which may cause uninsured damage and other loss of value to
real estate that secures these loans, may also negatively impact our financial condition. This is
particularly significant in light of the fact that substantially all of the real estate that makes up the
collateral of our real estate secured loans is located in Northern California, where earthquakes and
brush fires are common.
Lending and Other Operating Risks
Our Allowance for Loan Losses May Prove To Be Insufficient To Absorb Losses in Our Loan
Portfolio.
Lending money is a substantial part of our business. Every loan carries a certain risk that it will
not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to
assure repayment. This risk is affected by, among other things:
cash flow of the borrower and/or the project being financed;
the changes and uncertainties as to the future value of the collateral, in the case of a
collateralized loan;
the credit experience of a particular borrower;
changes in economic and industry conditions; and
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the duration of the loan.
The Bank maintains an allowance for loan losses, a reserve established through a provision
for loan losses charged to expense, which the Bank believes is appropriate to provide for probable
losses in its loan portfolio. The amount of this allowance is determined by Bank management
through a periodic review and consideration of several factors, including, but not limited to:
our general reserve, based on our historical default and loss experience as well as current
macroeconomic factors; and
our specific reserve, based on our evaluation of non-performing loans and their underlying
collateral.
The determination of the appropriate level of the allowance for loan losses inherently
involves a high degree of subjectivity and requires us to make significant estimates of current
credit risks and future trends, all of which may undergo material changes. Continuing deterioration
in economic conditions affecting borrowers, new information regarding existing loans,
identification of additional problem loans and other factors, both within and outside of our control,
may require an increase in the allowance for loan losses. In addition, bank regulatory agencies
periodically review our allowance for loan losses and may require an increase in the provision for
possible loan losses or the recognition of further loan charge-offs, based on judgments different
than those of management. In addition, if charge-offs in future periods exceed the allowance for
loan losses, we may need additional provisions to replenish the allowance for loan losses. Any
increases in the allowance for loan losses will result in a decrease in net income and, most likely,
capital, and may have a material negative effect on our financial condition and results of
operations.
Our Business is Subject to Liquidity Risk and Changes in Our Source of Funds May Affect
Our Performance and Financial Condition.
Our ability to make loans is directly related to our ability to secure funding. In addition to
local deposits, the Bank receives funding from FHLB advances, brokered deposits and State of
California time deposits, when such alternatives are attractive compared to the cost of attracting
additional local deposits. These alternative sources of funds, along with local time deposits, are
sensitive to interest rates and can affect the cost of funds and net interest margin. Liquidity risk
arises from the inability to meet obligations when they come due or to manage the unplanned
decreases or changes in funding sources. Although we believe we can continue to successfully
pursue a local deposit funding strategy, significant fluctuations in local deposit balances, or the
unavailability of one of the alternative sources of funds, may have an adverse effect on our
financial condition and results of operations.
Changes in interest rates may reduce our net income.
The income of the Bank depends to a great extent on the difference between the interest
rates earned on its loans, securities and other interest-earning assets and the interest rates paid on
its deposits and other interest-bearing liabilities. These rates are highly sensitive to many factors
that are beyond the Bank’s control, including general economic conditions and the policies of
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various governmental and regulatory agencies, in particular the Federal Reserve Board. A change
in interest rates could have a material adverse effect on the Bank’s results of operations, financial
condition and prospects by reducing the spread between income on interest earning assets and
interest paid on interest bearing liabilities. Generally, the value of fixed-rate securities fluctuates
inversely with changes in interest rates. Therefore, an increase in interest rates could cause the
fair value of the Bank’s securities investments to decrease. See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations “ “Liquidity and Capital Resources” on
page 49.
We Are Exposed to Risk of Environmental and Other Liabilities with Respect to Properties to
Which We Take Title.
In the course of our business, we may foreclose and take title to real estate, and could be
subject to environmental or other liabilities with respect to these properties. The Bank may be held
liable to a governmental entity or to third persons for property damage, personal injury,
investigation and clean-up costs incurred by these parties in connection with environmental
contamination, or the Bank may be required to investigate or clean up hazardous or toxic
substances, or chemical releases at a property. The costs associated with investigation or
remediation activities could be substantial. In addition, in the event the Bank becomes the owner
or former owner of a contaminated site, the Bank may be subject to common law claims by third
parties based on damages and costs resulting from environmental contamination emanating from
the property. If the Bank ever becomes subject to significant environmental liabilities, our
business, financial condition, liquidity and results of operations could be materially and adversely
affected.
Our Growth or Future Losses May Require Us To Raise Additional Capital in the Future, but
That Capital May Not Be Available When It Is Needed or the Cost of That Capital May Be
Very High.
Under applicable government regulations, the Bank is permitted to make unsecured loans
to any single borrower or group of related borrowers in an amount that will not exceed 15% of its
shareholders’ equity, plus the allowance for loan losses, capital notes and debentures, and secured
loans in an amount that, when combined with unsecured loans made to the same borrower or group
of related borrowers, will not exceed 25% of its shareholders’ equity, plus the allowance for loan
losses, capital notes and debentures (“Lending Limits”). Such Lending Limits make it more
difficult for the Bank to attract borrowers who have lending requirements in excess of those
Lending Limits and, as a result, the future success of the Bank depends on, among other things, its
ability to increase capital (and thereby the amount of the loans it will be able to make to borrowers)
by selling additional common stock, preferred stock or subordinated debt. The Bank has no plans
at this time to sell any such securities (except upon issuance of options to directors and employees
under its stock option plan). However, if the need to do so should arise, either because of the
Bank’s desire to make larger loans to accommodate customers or to meet regulatory capital
requirements as a result of growth or losses, there is no assurance that the Bank’s efforts to raise
such additional capital will be successful or that the sale of additional shares will not dilute the
ownership of current investors. Any dilution of current investors could be substantial. The Bank
seeks the participation of other banks and lending institutions, as co-lenders with it, for loans that
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exceed the Bank’s Lending Limits; however, there can be no assurance that other lending
institutions will be interested in doing so.
The Accuracy of the Bank’s Judgments and Estimates about Financial and Accounting
Matters Will Impact Operating Results and Financial Condition.
The Bank makes certain estimates and judgments in preparing its financial statements. The
quality and accuracy of those estimates and judgments will have an impact on the Bank’s operating
results and financial condition. Three items that are subject to material estimates and judgments
include the consideration of other than temporary impairment of investment securities and other
financial instruments, the recorded goodwill asset of $4,119,000 and the allowance for loan losses
of $4,765,000 as of December 31, 2016. Although management supports its estimates and
judgments by employing third party reviews, there are no assurances that regulatory reviews will
not result in a different conclusion or future events may occur that impact the recorded values
resulting in material fluctuations of financial results. See “Management’s Discussion and Analysis
of Financial Condition and Results of Operations “Critical Accounting Policies and Estimates” on
page 47.
Failure to Successfully Execute Our Strategy Could Adversely Affect Our Performance.
Along with the other factors listed herein, our financial performance and profitability
depends on our ability to execute our corporate growth strategy. Failure to grow may present
operating and other problems that could adversely affect our business, financial condition and
results of operations. Accordingly, there can be no assurance that the Bank will be able to execute
its growth strategy or maintain the level of profitability that it has recently experienced.
The Bank’s Information Systems May Experience an Interruption or Breach in Security.
The Bank relies heavily on communications and information systems to conduct its
business. Any failure, interruption or breach in security of these systems could result in failures or
disruptions in the Bank’s customer relationship management and systems. There can be no
assurance that any such failures, interruptions or security breaches will not occur or, if they do
occur, that they will be adequately corrected by the Bank. The occurrence of any such failures,
interruptions or security breaches could damage the Bank’s reputation, result in a loss of customer
business, subject the Bank to additional regulatory scrutiny, or expose the Bank to litigation and
possible financial liability, any of which could have a material adverse effect on the Bank’s
financial condition and results of operations.
The Bank May Be Adversely Affected by Disruptions to Our Network and Computer Systems or
To Those of Our Service Providers as A Result of Denial-Of-Service or Other Cyber Attacks.
We may experience disruptions or failures in our computer systems and network
infrastructure or in those of our service providers as a result of denial-of-service or other cyber
attacks in the future. We have developed and continue to invest in, systems and processes that are
designed to detect and prevent security breaches and cyber attacks. Due to the increasing
sophistication of such attacks, we may not be able to prevent denial-of-service or other cyber
22
attacks that could compromise our normal business operations, compromise the normal business
operations of our customers, or result in the unauthorized use of customers’ confidential and
proprietary information. The occurrence of any failure, interruption or security breach of network
and computer systems resulting from denial-of-service or other cyber attacks could damage our
reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or
expose us to civil litigation and possible financial liability, any of which could adversely affect our
business, results of operations or financial condition.
The Bank’s Controls and Procedures May Fail or Be Circumvented.
Management regularly reviews and updates the Bank’s internal control over financial
reporting, disclosure controls and procedures, and corporate governance policies and procedures.
Any system of controls and procedures, however well designed and operated, is based in part on
certain assumptions and can provide only reasonable, not absolute, assurances that the objectives
of the system are met. Any failure or circumvention of the Bank’s controls and procedures or
failure to comply with regulations related to controls and procedures could have a material adverse
effect on the Bank’s business, results of operations and financial condition.
Regulatory Risks
The Bank’s Business is Subject to Extensive Government Regulation and Legislation.
The Bank is subject to extensive state and federal regulation, supervision and legislation,
and the laws that govern the Bank and its operations are subject to change from time to time.
Applicable laws and regulations provide for the regular examination and supervision of
institutions; affect the cost of funds through reserve requirements and assessments on deposits;
limit or prohibit the payment of interest on demand deposits; limit the kinds of investments a bank
or bank holding company can make and the kinds of activities in which it can engage; and grant
the regulatory agencies broad enforcement authority in case of violations. The laws and regulations
increase the cost of doing business and have an adverse impact on the ability of the Bank to
compete efficiently with other financial services providers that are not similarly regulated. There
can be no assurance that future regulation or legislation will not impose additional requirements
and restrictions on the Bank in a manner that will adversely affect its results of operations, financial
condition and prospects. See “Information About Summit State Bank” “Competition” and
“Regulation and Supervision” on pages 6 and 7.
Changes in laws and regulations and the cost of compliance with new laws and regulations may
adversely affect our operations and our income.
We are subject to extensive regulation, supervision and examination by the DBO and the
FDIC. These regulatory authorities have extensive discretion in connection with their supervisory
and enforcement activities, including the ability to impose restrictions on a bank’s operations,
reclassify assets, determine the adequacy of a bank’s allowance for loan losses and determine the
level of deposit insurance premiums assessed. Because our business is highly regulated, the laws
and applicable regulations are subject to frequent change. Any change in these regulations and
23
oversight, whether in the form of regulatory policy, new regulations or legislation or additional
deposit insurance premiums could have a material impact on our operations.
The potential exists for additional federal or state laws and regulations, or changes in
policy, affecting lending and funding practices and liquidity standards. Moreover, bank regulatory
agencies have been active in responding to concerns and trends identified in examinations, and
have issued many formal enforcement orders requiring capital ratios in excess of regulatory
requirements. Bank regulatory agencies, such as the FDIC, DBO, Federal Reserve Board, and
CFPB, directly or indirectly govern the activities in which we may engage, primarily for the
protection of depositors and consumers, and not for the protection or benefit of potential investors.
In addition, new laws and regulations may increase our costs of regulatory compliance and of
doing business, and otherwise affect our operations. New laws and regulations may significantly
affect the markets in which we do business, the markets for and value of our loans and investments,
the fees we can charge and our ongoing operations, costs and profitability.
The Bank’s Ability to Declare Future Dividends Is Subject to Certain Limitations.
The Bank’s ability to pay dividends is limited by law, regulation and the financial condition
of the Bank. There can be no assurance that the Bank will continue to pay dividends at the rate
and frequency at which it has done so in the past or that any dividends will be declared and paid
in the future at all. See “Regulation and Supervision” “Limitations on Dividends” on page 13.
Competitive Risks.
The Bank’s Business Is Highly Competitive.
In California generally, and in the Bank’s service area specifically, major banks and regional banks
dominate the commercial banking market. By virtue of their larger capital bases, such institutions
have substantially greater financial, marketing and operational resources than the Bank and offer
diversified services that might not be directly offered by the Bank. The Bank competes with these
larger commercial banks and other financial institutions, such as savings and loan associations and
credit unions, which offer services traditionally offered only by banks. In addition, the Bank
competes with other institutions such as money market funds, brokerage firms, commercial finance
companies, leasing companies, and even retail stores seeking to penetrate the financial services
market. No assurance can be given, however, that the Bank’s efforts to compete with other banks
and financial institutions will continue to be successful. In addition, the costs of providing a high
level of personal service could adversely affect the Bank’s operating results. See “Information
About Summit State Bank” “Competition” on page 6.
The Bank Depends on Loan Originations to Grow Its Business.
The Bank’s success depends on, among other things, its ability to originate loans. The Bank’s
competitors may offer better terms or better service, or respond to changing capital and other
regulatory requirements better than the Bank is able to do. Some of the Bank’s competitors make
loans on terms that the Bank is not willing to match. Success in competing for loans depends on
such factors as:
24
•
•
Quality of service to borrowers, especially the time it takes to process loans;
Economic factors, such as interest rates;
Terms of the loans offered, such as rate adjustment provisions, adjustment caps, loan
•
maturities, loan-to-value ratios and loan fees; and
•
Size of the loan.
The Soundness of Other Financial Institutions Could Negatively Affect Us.
Our ability to engage in routine funding and other transactions could be negatively affected
by the actions and commercial soundness of other financial institutions. Financial services
institutions are interrelated as a result of trading, clearing, counterparty or other relationships.
Defaults by, or even rumors or questions about, one or more financial services institutions, or the
financial services industry generally, have led to market-wide liquidity problems and losses of
depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by
other institutions. The Bank could experience increases in deposits and assets as a result of the
difficulties or failures of other banks, which would increase the capital the Bank needs to support
its growth.
Our Share Price May Be Volatile.
As of December 31, 2016, there were 6,019,850 shares of our common stock issued and
outstanding (adjusted for the 2017 five-for-four stock split). The Bank’s common stock is listed
on the Nasdaq Global Market under the symbol “SSBI.” Factors such as announcements of
developments related to the Bank’s business, announcements by competitors, fluctuations in its
financial results, general conditions in the banking industry, economic conditions in the areas in
which the Bank does business, fluctuations in interest rates, and other factors could cause the
trading price of the shares to fluctuate substantially. In addition, in recent years the stock market
in general and the market for shares of small capitalization stocks and financial institutions in
particular have experienced extreme price fluctuations, which have often been unrelated to the
operating performance of affected companies. Such fluctuations could have a material adverse
effect on the market price of the Shares.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The Bank owns its head office building located at 500 Bicentennial Way, Santa Rosa, California.
The building has approximately 31,000 square feet of usable space. The Bank occupies
approximately 13,000 square feet as its headquarters. The remaining 18,000 square feet are
currently leased to 3 tenants, with lease terms maturing from 2018 to 2022. The Bank also leases
spaces for branch offices in three shopping centers and one commercial building. These leases
25
expire at various dates from 2019 through 2021 and include renewal and termination options and
rental adjustment provisions.
ITEM 3. LEGAL PROCEEDINGS
The nature of our business causes us to be involved in legal proceedings from time to time. As
of the date of this report, the Bank is not a party to any litigation where management anticipates
that the outcome will have a material effect on the consolidated financial position or results of
operations.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
26
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Bank’s common stock trades on the NASDAQ under the symbol “SSBI.” The quotations
shown below reflect for the periods indicated the high and low closing sales prices for our common
stock as reported by NASDAQ.
For the quarter ended
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
December 31, 2015
September 30, 2015
June 30, 2015
March 31, 2015
(1) Adjusted for the 2017 five-for-four stock split.
$
High
(1)
12.00
11.12
11.36
11.15
11.18
11.37
10.98
11.16
$
Low
(1)
10.52
10.55
10.58
10.48
10.33
10.25
10.33
10.13
Cash
dividends
declared
(1)
$
0.096
0.096
0.096
0.096
0.096
0.096
0.096
0.096
There were 163 common stock shareholders of record at December 31, 2016.
There were no issuer purchases of equity securities for the three month period ended December
31, 2016.
27
ITEM 6. SELECTED FINANCIAL DATA
(in thousands except per share data)
Income state ment data:
Interest income
Net interest income before provision for (reversal of) loan losses
Provision for (reversal of) loan losses
T otal non-interest income
T otal non-interest expense
Income before income taxes
Income taxes
Net income
Preferred dividend
Net income available to common shareholders
Se le cte d balance shee t data:
Assets
Loans, net
Earning assets
Deposits
Federal Home Loan Bank advances
Shareholders' equity
Balance sheet data - average
Assets
Loans, net
Earning assets
Deposits
Federal Home Loan Bank advances
Shareholders' equity
Se le cte d pe r common share data:
Earnings per common share - basic
Earnings per common share - diluted
Weighted average shares used to
Selected Financial Data
Year Ended December 31
2016
2015
2014
2013
2012
$
$
$
$
$
19,907
18,673
-
2,021
12,245
8,449
3,482
4,967
-
4,967
18,573
17,637
(800)
2,645
10,823
10,259
4,229
6,030
92
5,938
17,933
16,917
(1,400)
1,995
10,982
9,330
3,845
5,485
138
5,347
17,841
16,566
50
1,668
10,833
7,351
3,030
4,321
253
4,068
$
$
$
$
$
$
$
$
$
$
18,278
16,249
3,360
3,498
10,521
5,866
2,418
3,448
521
2,927
$
513,704
354,638
502,121
384,251
68,900
58,622
$
513,365
343,217
501,192
397,246
55,800
57,325
$
459,675
279,798
444,550
355,259
35,000
67,580
$
454,074
282,667
433,283
341,268
48,500
61,630
$
510,829
363,545
502,381
391,001
58,659
59,326
$
485,396
314,806
474,751
372,778
46,102
65,061
$
460,774
289,948
445,977
358,278
36,341
64,864
$
441,583
279,326
426,819
342,406
35,437
62,480
$
444,896
275,877
426,414
341,004
40,000
62,870
$
410,291
275,505
393,941
324,428
22,545
61,812
$
$
0.83
0.82
$
$
0.99
0.98
$
$
0.90
0.89
$
$
0.68
0.68
$
$
0.49
0.49
calculate earnings per common share - basic
6,005
5,979
5,973
5,952
5,931
Weighted average shares used to
calculate earnings per common share - diluted
Common shares oustanding at year end
Cash dividends per share
Book value per common share
T angible book value per common share (1)
Se le cte d ratios:
Return on average common equity
Return on average assets
Common dividend payout ratio
Net interest margin
Efficiency ratio (2)
Average equity to average assets
T ier 1 leverage capital ratio
Nonperforming assets to total assets
Nonperforming loans to total loans
Net charge-offs to average loans
Allowance for loan losses to total loans
6,036
6,020
0.38
9.74
9.05
$
$
$
6,048
5,979
0.38
9.59
8.90
$
$
$
6,038
5,973
0.35
9.03
8.34
$
$
$
5,992
5,972
0.34
8.03
7.34
$
$
$
5,933
5,931
0.29
8.30
7.60
$
$
$
8.37%
0.97%
46.43%
3.72%
61.22%
11.61%
11.08%
0.65%
0.93%
(0.01%)
1.33%
10.60%
1.24%
38.67%
3.72%
53.78%
13.40%
10.53%
0.31%
0.46%
(0.12%)
1.36%
10.44%
1.19%
39.31%
3.79%
58.81%
14.08%
13.72%
1.28%
0.64%
(0.39)%
1.81%
8.33%
0.98%
49.19%
3.88%
59.67%
14.15%
13.22%
2.29%
1.95%
0.14%
1.88%
6.08%
0.84%
58.35%
4.12%
60.45%
15.07%
13.37%
2.18%
1.72%
1.10%
2.04%
(1) Common tangible equity excludes goodwill.
(2) Non-interest expenses to net interest and non-interest income, net of securities gains (losses) and building legal settlement.
28
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion provides additional information about the financial condition of
Summit State Bank (“the Bank”) at December 31, 2016 and 2015 and results of operations for the
years ended December 31, 2016, 2015 and 2014. The following analysis should be read in
conjunction with the consolidated financial statements of the Bank and the notes thereto prepared
in accordance with accounting principles generally accepted in the United States.
Stock Split Adjustment
The Board of Directors declared a five-for-four stock split on January 23, 2017 to common
shareholders of record on February 28, 2017 and issued on March 14, 2017. The impact of this
stock split has been retroactively applied to periods presented with adjustments to the number of
common shares and per common share values as if the stock split had occurred as of the
beginning of each period presented.
Critical Accounting Policies and Estimates
The discussion and analysis of the Bank’s results of operations and financial condition are based
upon financial statements which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial statements requires the
Bank’s management to make estimates and judgments that affect the reported amounts of assets
and liabilities, income and expense, and the related disclosures of contingent assets and liabilities
at the date of these financial statements. These estimates are discussed in more detail under
“Critical Accounting Policies and Estimates.”
The Bank believes these estimates and assumptions to be reasonably accurate; however, actual
results may differ from these estimates under different assumptions or circumstances. Material
estimates that are particularly susceptible to significant change in the near-term relate to the
determination of the allowance for loan losses, consideration of goodwill impairment and
consideration of potential other than temporary impairment on investment securities and other
financial instruments.
Allowance for Loan Losses. The allowance for loan losses is determined first and foremost by
promptly identifying potential credit weaknesses that could jeopardize repayment. The Bank’s
process for evaluating the adequacy of the allowance for loan losses includes determining
estimated loss percentages for each credit based on the Bank’s historical loss experience and other
factors in the Bank’s credit grading system and accompanying risk analysis for determining an
adequate level of the allowance. The risks are assessed by rating each account based upon paying
habits, loan to collateral value ratio, financial condition and level of classifications. The allowance
for loan losses was $4,765,000 at December 31, 2016 compared to $4,731,000 at December 31,
2015.
29
The Bank maintains the allowance for loan losses to provide for probable incurred losses in the
loan portfolio. Additions to the allowance for loan losses are established through a provision
charged to expense. All loans which are judged to be uncollectible are charged against the
allowance while any recoveries are credited to the allowance. The Bank’s policy is to charge off
any known losses at the time of determination. Any unsecured loan more than 90 days delinquent
in payment of principal or interest and not in the process of collection is charged off in total.
Secured loans are evaluated on a case by case basis to determine the ultimate loss potential to us
subsequent to the liquidation of collateral. In those cases where we believe we are inadequately
protected, a charge-off will generally be made to reduce the loan balance to a level equal to the
liquidation value of the collateral unless we believe the collateral deficiency may be overcome by
borrower cash flows.
The Bank’s loan policy provides procedures designed to evaluate and assess the credit risk
factors associated with the loan portfolio, to enable the Bank to assess such credit risk factors prior
to granting new loans and to evaluate the sufficiency of the allowance for loan losses. The Bank
conducts an assessment of the allowance on a monthly basis and undertakes a more critical
evaluation quarterly. At the time of the quarterly review, the Board of Directors will examine and
approve the adequacy of the allowance. The quarterly evaluation includes an assessment of the
following factors: any external loan review and any recent regulatory examination, estimated
potential loss exposure on each pool of loans, concentrations of credit, value of collateral, the level
of delinquent and non-accrual loans, trends in loan volume, effects of any changes in lending
policies and procedures, changes in lending personnel, current economic conditions at the local,
state and national level and historical losses and recoveries.
Goodwill. We assess the carrying value of our goodwill at least annually in order to determine
if this intangible asset is impaired. In reviewing the carrying value of our goodwill, we assess the
recoverability of such assets by evaluating the fair value of the related business unit. If the carrying
amount of goodwill exceeds its fair value, an impairment loss is recognized for the amount of the
excess and the carrying value of goodwill is reduced accordingly. Any impairment would be
required to be recorded during the period identified.
Accounting standards require an annual evaluation of goodwill for impairment using various
estimates and assumptions. The market price of the Bank’s common stock at the close of business
on December 30, 2016 was $12.00 per common share compared to a book value of $9.74 per
common share (adjusted for the 2017 five-for-four stock split).
Investment Securities. We are obligated to assess, at each reporting date, whether there is an
“other-than-temporary” impairment to our investment securities. Such impairment, if related to
credit losses, must be recognized in current earnings rather than in other comprehensive income
or loss, net of tax. We examine all individual securities that are in an unrealized loss position at
each reporting date for other-than-temporary impairment (OTTI). Specific investment level factors
we examine to assess impairment include, the severity and duration of the unrealized loss, the
nature, financial condition and results of operations of the issuers of the securities and whether
there has been any cause for default on the securities or any adverse change in the rating of the
securities by the various rating agencies, as well as whether the decline in value is credit or liquidity
related. Additionally, we reexamine our financial resources and our overall intent and ability to
hold the securities until their fair values recover. There were no OTTI recorded in 2016, 2015 or
30
2014. We do not believe that we have any investment securities with material unrealized losses
that would be deemed to be “other-than-temporarily impaired” as of December 31, 2016.
Investment securities are discussed in more detail under “Investment Portfolio.”
Overview
The Bank is a community bank serving Sonoma, Napa, San Francisco and Marin Counties in
California. It operates through five offices located in Santa Rosa, Petaluma, Rohnert Park and
Healdsburg. The Bank was founded as a savings and loan in 1982 under the name Summit Savings.
On January 15, 1999, the Bank converted its charter to a California state-chartered commercial
bank and thereby became subject to regulation, supervision and examination by the California
Department of Business Oversight and the FDIC.
Results of Operations
Years Ended December 31, 2016, 2015 and 2014
(The impact of the five-for-four stock split declared and issued in 2017, has been retroactively
applied to periods presented with adjustments to the number of common shares and per common
share values as if the stock split had occurred as of the beginning of each period presented.)
The Bank’s primary source of income is net interest income, which is the difference between
interest income and fees derived from earning assets and interest paid on liabilities which fund
those assets. Net interest income, expressed as a percentage of total average interest earning assets,
is referred to as the net interest margin. The Bank’s net interest income is affected by changes in
the volume and mix of interest earning assets and interest bearing liabilities. It is also affected by
changes in yields earned on interest earning assets and rates paid on interest bearing deposits and
other borrowed funds. The Bank also generates non-interest income, including transactional fees,
service charges, office lease income, gains and losses on investment securities and gains on sold
government guaranteed loans originated by the Bank. Non-interest expenses consist primarily of
employee compensation and benefits, occupancy and equipment expenses and other operating
expenses. The Bank’s results of operations are also affected by its provision for loan losses. Results
of operations may also be significantly affected by other factors including general economic and
competitive conditions, mergers and acquisitions of other financial institutions within the Bank’s
market area, changes in market interest rates, government policies, and actions of regulatory
agencies.
Net Income
The Bank had net income and net income available for common stockholders of $4,967,000 or
$0.82 per diluted share, for the year ended December 31, 2016 compared to net income of
$6,030,000 and net income available for common stockholders of $5,938,000, or $0.98 per diluted
share, for the year ended December 31, 2015, and net income of $5,485,000 and net income
available for common stockholders of $5,347,000, or $0.89 per diluted share, for the year ended
December 31, 2014.
31
The return on average assets was 0.97%, 1.24% and 1.19% for the years ended December 31,
2016, 2015 and 2014, respectively. Although various factors affected the change in net income
between the years which are discussed in the following sections of this Management’s Discussion
and Analysis, the years 2015 and 2014 benefited by the reversal of provisions for loan losses and
net gains on the sale of other real estate owned. The return on average assets was 1.01% for 2015
and 1.00% for 2014, without the impacts of the reversals of the provision for loan losses and the
net gains on other real estate owned.
The return on average common equity was 8.37%, 10.60% and 10.44% for the years ended
December 31, 2016, 2015 and 2014, respectively.
Net Interest Income and Net Interest Margin
Net interest income was $18,673,000 and the net interest margin was 3.72% for the year ended
December 31, 2016, which represented a $1,036,000 or 5.9% increase over 2015. For the year
ended December 31, 2015, net interest income was $17,637,000 and the net interest margin was
3.72%, which was an increase of $720,000 or 4.3% over 2014. For the year ended December 31,
2014, net interest income was $16,917,000 and the net interest margin was 3.79%. At December
31, 2016, approximately 69% of the Bank’s assets were comprised of net loans and 23% were
comprised of investment securities compared to 67% of net loans and 26% of investment securities
at December 31, 2015.
The yield on average interest earning assets increased from 3.91% for the year ended December
31, 2015 to 3.96% for the year ended December 31, 2016. The increase was due to the general rise
in interest rates, with higher yields on interest-bearing balances with banks and federal funds sold.
Additionally, the higher percentage of loans as a percent of interest earning assets increased the
yield on average earning assets. The yield on average interest earning assets declined from 4.02%
for the year ended December 31, 2014, primarily because of declining yields on the Bank’s loan
portfolio. The changes in the overall yield on average earning assets between the years was
primarily attributable to the effects of changes in general market interest rates impacting the re-
pricing of the Bank’s variable rate loan portfolio and calls on higher yielding government agency
securities. Additionally, term real estate loans are refinanced and new loans are generated at the
lower current market interest rates.
In 2016, average earning assets increased 5.8% with average investment securities declining
14% and average loans increasing 15%. In 2015, average earning assets increased 6.5% with
average investment securities increasing 2.7% and average loans increasing 8.6%.
For the year ended December 31, 2016, the cost of average interest bearing liabilities was 0.36%
compared with a cost of average interest bearing liabilities of 0.28% for the year ended December
31, 2015 and 0.31% for the year ended December 31, 2014. The changes in cost of funds have
been driven by the changing market interest rates over the periods. Additionally, the Bank
experienced growth in lower cost demand, savings and money market deposits in 2014 through
2016.
32
The following table presents condensed average balance sheet information for the Bank,
together with interest rates earned and paid on the various sources and uses of its funds for each
of the periods presented. Average balances are based on daily average balances. Nonaccrual loans
are included in loans with any interest collected reflected on a cash basis.
Average Balance Sheets and Analysis of Net Interest Income
Ye ar Ende d De cember 31,
(Dollars in thousands)
Asse ts
Interest earning assets:
Interest-bearing deposits in banks
Federal funds sold
T ime deposits with banks
T axable investment securities
Loans, net of unearned income (1)
T otal earning assets/interest income
Non-earning assets
Allowance for loan losses
T otal assets
Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Deposits:
Interest-bearing demand deposits
Savings and money market
T ime deposits
FHLB advances
T otal interest-bearing liabilities/interest expense
Non interest-bearing deposits
Other liabilities
T otal liabilities
Shareholders' equity
T otal liabilities and shareholders' equity
Ave rage
Balance
$
18,019
1,864
485
118,468
363,545
502,381
13,199
(4,751)
510,829
$
$
58,098
82,523
142,749
58,659
342,029
107,631
1,843
451,503
59,326
510,829
$
2014
Average
Rate
Average
Balance
Intere st
Income/
Expense
Average
Rate
2016
Interest
Income /
Expe nse
$
74
7
8
3,269
16,549
19,907
Average
Rate
Ave rage
Balance
0.41%
0.37%
1.68%
2.76%
4.55%
3.96%
$
18,738
1,945
979
138,283
314,806
474,751
15,558
(4,913)
485,396
$
2015
Interest
Income /
Expe nse
$
41
3
14
3,992
14,523
18,573
0.22%
0.17%
1.45%
2.89%
4.61%
3.91%
$
18,040
1,801
1,601
134,587
289,948
445,977
20,059
(5,262)
460,774
$
$
39
3
20
3,823
14,048
17,933
0.22%
0.17%
1.25%
2.84%
4.85%
4.02%
$
35
148
666
167
1,016
0.07%
0.18%
0.43%
0.46%
0.31%
$
65
86
704
379
1,234
0.11%
0.10%
0.49%
0.65%
0.36%
$
53,883
90,315
144,175
46,102
334,475
84,405
1,455
420,335
65,061
485,396
$
$
54
135
568
179
936
0.10%
0.15%
0.39%
0.39%
0.28%
$
52,906
82,767
155,957
36,341
327,971
66,648
1,291
395,910
64,864
460,774
$
Net interest income and margin (2)
Net interest spread (3)
$
18,673
3.72%
3.60%
$
17,637
3.72%
3.63%
$
16,917
3.79%
3.71%
(1)
The net amortization of deferred fees and (costs) on loans included in interest income was $(118,000), $(189,000)
and $92,000 for the years ended December 31, 2016, 2015 and 2014, respectively.
(2) Net interest margin is computed by dividing net interest income by average total earning assets.
(3) Net interest spread is the difference between the average rate earned on average total earning assets and the
average rate paid on average total interest bearing liabilities.
33
The following table shows the change in interest income and interest expense and the amount
of change attributable to variances in volume and rates. The unallocated change in rate or volume
variance has been allocated between the rate and volume variances in proportion to the absolute
dollar amount in the change of each.
Volume and Yield/Rate Variances
2016 Compared to 2015
2015 Compared to 2014
Change Due to
Change Due to
(Dollars in thousands)
Volume
Rate
Net
Volume
Rate
Net
Interest income:
Interest-bearing deposits in banks
$
(2)
$
35
$
33
$
2
$
-
$
2
Federal funds sold
T ime deposits with banks
T axable investment securities
Loans, net
T otal interest income
Interest expense:
Interest-bearing demand deposits
Savings and money market
T ime deposits
FHLB advances
T otal interest expense
Increase (decrease) in net
interest income
-
(6)
(591)
2,221
1,622
4
(12)
(6)
58
44
4
-
(132)
(195)
(288)
7
(37)
142
142
254
4
(6)
(723)
2,026
1,334
11
(49)
136
200
298
-
(7)
106
1,167
1,268
1
13
(52)
40
2
-
1
63
(692)
(628)
18
(26)
(46)
(28)
(82)
-
(6)
169
475
640
19
(13)
(98)
12
(80)
$
1,578
$
(542)
$
1,036
$
1,266
$
(546)
$
720
Provision for Loan Losses
The Bank maintains an allowance for loan losses for probable incurred losses that are expected
as an incidental part of the banking business. Write-offs of loans are charged against the allowance
for loan losses, which is adjusted periodically to reflect changes in the volume of outstanding loans
and estimated losses due to changes in the financial condition of borrowers or the value of property
securing nonperforming loans, or changes in general economic conditions and other qualitative
factors. Additions to the allowance for loan losses are made through a charge against income
referred to as the “provision for loan losses.”
The Bank’s loan policy provides procedures designed to evaluate and assess the credit risk
factors associated with the loan portfolio, to enable management to assess such credit risk factors
prior to granting new loans and to evaluate the sufficiency of the allowance for loan losses.
Management conducts an assessment of the allowance for loan losses on a monthly basis and
undertakes a more critical evaluation quarterly. At the time of the quarterly review, the Board of
Directors evaluates and formally approves the adequacy of the allowance. The quarterly evaluation
includes an assessment of the following factors: any external loan review and regulatory
34
examination, estimated probable loss exposure on each pool of loans, concentrations of credit,
value of collateral, the level of delinquent and non-accrual loans, trends in loan volume, effects of
any changes in the lending policies and procedures, changes in lending personnel, current
economic conditions at the local, state and national level, and a migration analysis of historical
losses and recoveries for the prior twelve quarters.
At December 31, 2016, the Bank’s allowance for loan losses totaled $4,765,000 or 1.33% of
outstanding loans, compared with an allowance for loan losses of $4,731,000, or 1.36% of
outstanding loans at December 31, 2015 and $5,143,000, or 1.81% of outstanding loans at
December 31, 2014. For the year ended December 31, 2016, there was no provision for loan losses.
For the year ended December 31, 2015, the Bank reversed $800,000 in the Allowance for Loan
Losses, which is recorded as a negative provision for loan losses in the Consolidated Statements
of Income, and for the year ended December 31, 2014, the Bank reversed $1,400,000 in Allowance
for Loan Losses. The primary reason for no provision in 2016 and the reversals in 2015 and 2014,
were net recoveries of previously charged-off loans of $34,000 during 2016, $388,000 during 2015
and $1,131,000 during 2014.
Non-interest Income
The following table summarizes non-interest income recorded for the years indicated.
Non-interest Income
(in thousands)
Service charges on deposit accounts
Rental income
Net securities gains
Net gains on other real estate owned
Loan servicing, net
Other income
Total non-interest income
Year Ended December 31,
2015
2016
2014
$
$
$
748
559
692
-
12
10
2,021
702
532
157
1,125
10
119
2,645
614
523
239
73
12
534
1,995
$
$
$
Service charges on deposit accounts were $748,000 for the year ended December 31, 2016,
compared to $702,000 and $614,000 for the years ended December 31, 2015 and 2014. The Bank
has experienced an increase in demand deposits, and the increase in service charges has primarily
resulted from the addition of commercial analysis checking accounts and increased debit card
transactions.
The Bank owns its headquarters building with approximately half of the office space leased to
nonaffiliated tenants. The building space was fully leased for each of the years 2014 through 2016.
Lease income from this office building was $559,000, $532,000 and $523,000 for the years ended
December 31, 2016, 2015 and 2014. The leases have annual rent increases.
Net securities gains can vary significantly from year to year based on the amount of investment
securities sold or called and the net gain or loss realized. Additionally, gains or losses are highly
35
dependent on the interest rate environment and its impacts on the fair market value of investment
securities. In 2016, 2015 and 2014, the Bank sold or had calls on various government agency and
corporate bonds with a net gain of $692,000 in 2016, $157,000 in 2015 and $239,000 in 2014.
Net gains on other real estate owned arises when the Bank sells foreclosed properties. The gain
of $1,125,000 recorded in 2015 was the result of one property sold. The Bank has no other real
estate owned at December 31, 2016.
Other income for each of the years ended December 31, 2015 and 2014 was primarily
attributable to rental income on foreclosed properties owned by the Bank. The rental income on
these properties was $118,000 and $442,000 for 2015 and 2014.
Non-interest Expenses
The following table summarizes non-interest expenses recorded for the years indicated.
Non-interest Expenses
Year Ended December 31,
(in thousands)
2016
2015
2014
Salaries and employee benefits
$
6,562
$
5,646
$
5,530
Occupancy and equipment
Other expenses
T otal
1,229
4,454
1,313
3,864
1,347
4,105
$
12,245
$
10,823
$
10,982
Non-interest expenses, also referred to as operating expenses, is commonly expressed as a
percentage of average assets for the period and as a percentage of operating revenues, or the
efficiency ratio. The efficiency ratio divides the non-interest expenses by total revenues, which is
defined as net interest income plus non-interest income, excluding net security gains. The non-
interest expenses as a percent of annual average assets for 2016 was 2.4% and were 2.2% for 2015
and 2.4% for 2014. The efficiency ratio for 2016 was 61.2% and was 53.8% for 2015 and 58.8%
for 2014. The Bank realized a gain on the sale of other real estate owned in 2015 of $1,125,000.
If this gain is excluded in the calculation of the efficiency ratio, then it would be 57.0% for 2015.
The increase in the efficiency ratio in 2016 was partly the result of increased expenses incurred
with the severance of the Bank’s former President and Chief Executive Officer and increased
number of employees hired during the year.
Salaries and employee benefits expense increased $916,000 or 16% in 2016 compared to 2015.
The increase was attributable to severance costs associated with the former President and Chief
Executive Officer, increased number of employees hired during the year and general salary and
benefit increases. Salaries and employee benefits expense was relatively unchanged in 2014 to
2015. Annual salaries and bonuses have increased during the years and have been partially offset
by deferred loan origination costs attributable to loan generation during the years. The deferred
loan origination costs netted against salaries and employee benefits were $734,000, $950,000 and
36
$709,000 for the years ended December 31, 2016, 2015 and 2014. Full time equivalent employee
levels were 72, 60 and 60 at December 31, 2016, 2015 and 2014.
Occupancy and equipment expenses decreased 6.4% in 2016 compared to 2015 and decreased
2.5% in 2015 compared to 2014. Occupancy expenses include costs incurred with the Bank’s
owned headquarters building and four leased branch office buildings. The declines in expenses
were due to lower rental rates on the branch offices and reduced depreciation expense.
The following table summarizes the categories of other expenses.
Other Expenses
Year Ended December 31,
(in thousands)
2016
2015
2014
Data processing
Professional fees
Director fees and expenses
Nasdaq listing and regulatory license expense
Advertising and promotion
Deposit and other insurance premiums
Telephone and postage
Other real estate owned expenses
Other expenses
$
$
$
1,194
625
518
131
883
387
70
-
646
4,454
925
557
452
136
655
359
75
64
641
3,864
816
732
464
121
682
434
67
200
589
4,105
$
$
$
Data processing expenses are dependent on the Bank’s implementation of new electronic
delivery platforms such as mobile banking, and per account and transaction expenses from the
Bank’s third party data service provider increase, corresponding to the increase in the number of
new deposit and loan customers.
Professional fees vary depending on the use of legal, audit and consulting services. Director
fees and expenses vary dependent on the number of directors, travel expenses incurred by directors
for attendance of Board and committee meetings and director training expenses. Advertising and
promotion expenses are dependent on the Bank’s business development activities and targeted
nonprofit charity business customers.
Other Real Estate Owned (OREO) expenses pertain to the maintenance of owned properties
through foreclosure. The Bank sold all its OREO and no properties were owned at December 31,
2016. See “Non-interest Income” for a discussion of OREO lease income and net gains on sale of
OREO.
Miscellaneous other expenses are incurred as a result of general operations.
Provision for Income Taxes
The Bank accrues income tax expense based on the anticipated tax rates during the financial
period covered. The provision for income taxes for the years ended December 31, 2016, 2015 and
37
2014 was $3,482,000, $4,229,000 and $3,845,000. The combined effective Federal and State
corporate income tax rates for the years ended December 31, 2016, 2015 and 2014 were 41.2%.
Balance Sheet
December 31, 2016 and 2015
Investment Portfolio
Securities classified as available-for-sale for accounting purposes are recorded at their fair value
on the balance sheet. Securities classified as held-to-maturity are recorded at amortized cost. At
December 31, 2016, investment securities comprised 22.5% of total assets and 23.3% of earning
assets. At December 31, 2015, investment securities comprised 26.2% of total assets and 27.1%
of earning assets. At December 31, 2016, there were $7,976,000 in investment securities classified
as held-to-maturity and $5,988,000 at December 31, 2015. The increase in held-to-maturity
securities was attributable to securities being purchased. Investment securities classified held-to-
maturity are government sponsored agencies with interest rates that step-up over the life of the
bonds. Securities classified as available-for-sale were $107,771,000 and $128,599,000 for the
2016 and 2015 respective year ends. Changes in the fair value of available-for-sale securities (e.g.,
unrealized holding gains or losses) are reported as “other comprehensive income (loss),” net of
tax, and carried as accumulated other comprehensive income or loss within shareholders’ equity
until realized. The accumulated other comprehensive income was an unrealized loss position of
$885,000 at December 31, 2016 and an unrealized gain position of $501,000 at December 31,
2015.
The Bank utilizes the investment portfolio to manage liquidity and attract funding that requires
collateralization. At December 31, 2016, investment securities with a fair value of $29,097,000,
or 25% of the portfolio, were pledged to secure State of California and other municipal deposits.
This compares to $39,235,000, or 29% of the portfolio pledged at December 31, 2015. At
December 31, 2016, securities with a par value of $49,875,000 were callable within one year.
Investment Securities
December 31,
(in thousands)
2016
2015
2014
Held-to-maturity:
Government agencies
Available-for-sale:
U.S. Treasuries
Government agencies
Mortgage-backed securities - residential
Corporate debt
$
7,976
$
5,988
$
9,977
$
7,990
53,444
9,096
37,241
$
9,992
73,465
8,118
37,024
$
7,999
69,815
4,394
42,515
Total available-for-sale
107,771
128,599
124,723
Total investment securities
$
115,747
$
134,587
$
134,700
38
The composition of the investment portfolio by major category and contracted maturities or
repricing of debt investment securities at December 31, 2016 are shown below.
Contractual Maturity or Repricing Schedule and Weighted Average Yields of Securities
As of December 31, 2016
Within One Year
Yield
Amount
After One But Within
Five Years
After Five But Within
Ten Years
After Ten Years
Amount
Yield
Amount
Yield
Amount
Yield
(in thousands)
Held-to-maturity:
Government agencies
Available-for-sale:
U.S. Treasuries
Government agencies
Mortgage-backed securities - residential
Corporate debt
Total available-for-sale
Total investment securities
$
6,803
$
-
-
$
-
-
$
-
$
2,000
3,002
-
1,801
6,803
0.90%
1.25%
-
3.65%
1.78%
1.78%
$
5,990
12,023
-
27,069
45,082
$
45,082
0.80%
1.39%
-
3.79%
2.75%
2.75%
$
-
29,219
2.49%
-
8,371
37,590
$
37,590
-
3.67%
2.75%
2.75%
-
-
$
7,976
2.10%
$
-
9,200
9,096
-
18,296
$
26,272
-
2.41%
3.01%
-
2.71%
2.52%
As of December 31, 2016, the Bank did not own securities of any single issuer (other than
U.S. Government agencies) whose aggregate book value was in excess of 10% of the Bank’s total
equity at the time of purchase.
Loan Portfolio
Loan categories used in presentations in this report conform to the categorizations used by
regulatory Call Reports as described by the instructions issued by the Federal Financial
Interagency Examination Council (FFIEC).
The following table shows the composition of the Bank’s loan portfolio by amount and
percentage of total loans for each major loan category at the dates indicated.
(in thousands)
2016
%
2015
%
December 31,
2014
%
2013
%
2012
%
Loans
Commercial & agricultural (1)
Real Estate - commercial
Real estate - construction and land
Real Estate - single family
Real Estate - multifamily
Consumer & lease financing
$
81,519
190,976
7,897
51,044
27,533
434
22.7%
53.1%
2.2%
14.2%
7.7%
0.1%
$
75,018
175,374
11,341
63,899
21,664
652
21.6%
50.4%
3.3%
18.4%
6.2%
0.2%
$
68,371
145,565
11,175
46,590
13,095
145
24.0%
51.1%
3.9%
16.4%
4.6%
0.1%
$
63,848
150,292
11,419
50,963
11,411
146
22.2%
52.2%
4.0%
17.7%
4.0%
0.1%
$
66,097
133,967
10,723
51,649
18,632
558
23.5%
47.6%
3.8%
18.3%
6.6%
0.2%
359,403
100%
347,948
100%
284,941
100%
288,079
100%
281,626
100%
LESS:
Allowance for Loan Losses
T otal Loans, Net
(4,765)
$
354,638
(4,731)
$
343,217
(5,143)
$
279,798
(5,412)
$
282,667
(5,749)
$
275,877
(1) Includes loans secured by farmland.
39
The Bank experienced increased loan demand in 2016 and 2015. The 3.3% increase in net loans
outstanding at December 31, 2016 compared to December 31, 2015, was primarily from the
origination of commercial real estate loans which often have larger dollar balances.
At December 31, 2016, the Bank had approximately $46,109,000 in undisbursed loan
commitments, of which approximately $13,026,000 related to real estate loan types. This compares
with undisbursed commitments of approximately $37,772,000 at December 31, 2015, of which
approximately $11,932,000 related to real estate loan types. At December 31, 2016 and 2015, there
were $1,964,000 and $1,992,000, respectively, in standby letters of credit outstanding.
The following table shows the maturity distribution of Real Estate Construction and Land and
Commercial & Agricultural loans, including rate repricing intervals on variable rate loans, at
December 31, 2016. In the following table, the term variable (generally referring to loans for which
the interest rate will change immediately given a change in the underlying index) also includes
loans with adjustable rates (loans for which the rate may change, but which are also limited in
occurrence).
Loan Portfolio Maturity Structure at
December 31, 2016
(in thousands)
Within One
Year
After One
But Within
Five Years
After Five
Years
T otal
Real Estate - construction and land
$
7,084
$
813
$
-
$
7,897
Commercial & agricultural
19,126
26,811
35,582
81,519
T otal
Loans with:
Fixed interest rates
Floating interest rates
T otal
$
26,210
$
27,624
$
35,582
$
89,416
$
13,897
$
24,411
$
14,858
$
53,166
12,313
3,213
20,724
36,250
$
26,210
$
27,624
$
35,582
$
89,416
Loan Policies and Procedures
The Bank’s underwriting practices include an analysis of the borrower’s management, current
economic factors, the borrower’s ability to respond and adapt to economic changes outside its
direct control and verification of primary and secondary sources of repayment. Risk within the
loan portfolio is managed through the Bank’s loan policies and underwriting. These policies are
reviewed and approved annually by the Board of Directors.
• Management administers the loan policy, ensures proper loan documentation is maintained
and develops the methodology for monitoring loan quality and the level of the allowance
for loan losses and reports on these matters to the Board of Directors' Internal Asset Review
Committee and the Board of Directors.
40
• The Board of Directors' Loan Committee meets regularly to evaluate problem assets and
the adequacy of the allowance for loan losses. The Committee also reviews and makes
recommendations to the Board of Directors regarding the adequacy of the allowance for
loan losses, and is responsible for ensuring that an independent third party reviews the loan
portfolio at least annually. Resultant reports are sent to this Committee and to the Audit
Committee.
• The Board of Directors' Loan Committee is responsible for enforcement of the loan policy
and has additional responsibilities which include approving loans or loan relationships for
a customer that, when considered in the aggregate, exceed management's level of loan
authority for that customer.
• The Board of Directors' Audit Committee also engages a third party to perform a review
of management's asset and liability practices to ensure compliance with the Bank's policies.
• The Board of Directors retains overall responsibility for all loan functions and reviews
material loan relationships.
Loan approvals are granted according to established policies, and lending officers are assigned
approval authorities within their levels of training and experience. Interest rates reflect the risk
inherent in loans and collateral is generally taken for purchase-money financing. Collateral may
consist of accounts receivable, direct assignment of contracts, inventory, equipment and real estate.
Unsecured loans may be made when warranted by the financial strength of the borrower.
Nonperforming Assets
Nonperforming assets consist of nonperforming loans and other real estate owned.
Nonperforming loans are those for which the borrower fails to perform under the original terms of
the obligation and consist of nonaccrual loans and accruing loans past due 90 days or more.
Additionally, loans may be restructured due to deteriorating financial conditions and classified as
troubled debt restructurings (TDRs). The TDR’s may or may not be the same as those listed as
nonaccrual or 90 days or more past due loans.
41
The following are the nonperforming assets for the respective periods:
Nonperforming Assets
December 31,
(in thousands)
2016
2015
2014
2013
2012
Nonaccrual loans
$
3,351
$
1,610
$
1,815
$
5,614
$
4,840
Accruing loans past due 90 days or more
-
-
-
-
-
Total nonperforming loans
Other real estate owned
Total nonperforming assets
Nonperforming loans to total loans
Nonperforming assets to total assets
3,351
-
3,351
$
0.93%
0.65%
1,610
-
1,610
$
1,815
4,051
5,866
$
5,614
4,771
10,385
$
4,840
4,845
9,685
$
0.46%
0.31%
0.64%
1.28%
1.95%
2.29%
1.72%
2.18%
Allowance for loan losses to nonperforming loans
142.23%
293.86%
283.39%
96.40%
118.80%
Nonperforming loans at December 31, 2016, consisted of twelve (12) loans to eleven (11)
customers. Nonperforming loans included commercial real estate loans totaling $1,419,000, loans
collateralized by single and multifamily properties totaling $1,106,000 and $826,000 in
commercial and agricultural loans. The Bank had no specific allowance for loan losses allocated
to these loans due to the estimated value of underlying collateral.
There was no other real estate owned at December 31, 2016 and 2015.
The Bank may modify terms of loans to provide borrowers with relief if they are experiencing
financial difficulty and may not be able to meet the original terms of the loan. These modifications
classify the loan as a TDR. Loans that are classified as TDRs were $3,670,000 at December 31,
2016, of which $3,348,000 were considered performing loans and $322,000 are nonperforming
loans and are included in the table above. The performing TDRs of $3,348,000 are primarily
collateralized by single family residential or commercial real estate properties.
Allowance for Loan Losses
The Bank maintains the allowance for loan losses to provide for inherent losses in the loan
portfolio. Additions to the allowance for loan losses are established through a provision charged
to expense. All loans which are judged to be uncollectible are charged against the allowance while
any recoveries are credited to the allowance. The Bank’s policy is to charge off any known losses
at the time of determination. Any unsecured loan more than 90 days delinquent in payment of
principal or interest and not in the process of collection is charged off in total. Secured loans are
evaluated on a case by case basis to determine the ultimate loss potential to us subsequent to the
liquidation of collateral. In those cases where we believe we are inadequately protected, a charge-
off will be made to reduce the loan balance to a level equal to the liquidation value of the collateral.
42
The Bank’s loan policy provides procedures designed to evaluate and assess the credit risk
factors associated with the loan portfolio, to enable management to assess such credit risk factors
prior to granting new loans and to evaluate the sufficiency of the allowance for loan losses.
Management conducts an assessment of the allowance for loan losses on a monthly basis and
undertakes a more critical evaluation quarterly. At the time of the quarterly review, the Board of
Directors evaluates and approves the adequacy of the allowance. The quarterly evaluation includes
an assessment of the following factors: any external loan review and regulatory examination,
estimated probable loss exposure on each pool of loans, concentrations of credit, value of
collateral, the level of delinquent and non-accrual loans, trends in loan volume, effects of any
changes in lending policies and procedures, changes in lending personnel, current economic
conditions at the local, state and national level and a migration analysis of historical losses and
recoveries for the prior twelve quarters.
43
The following table sets forth an analysis of the allowance for loan losses and provision for loan
losses for the periods indicated.
Summary of Activity in the Allowance for Loan Losses
(Dollars in thousands)
Year Ended December 31
Balance at beginning of period
$
4,731
$
5,143
$
5,412
$
5,749
$
5,411
2016
2015
2014
2013
2012
Charge-offs:
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real Estate - single family
Real Estate - multifamily
Consumer & lease financing
Total loans charged-off
Recoveries:
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real Estate - single family
Real Estate - multifamily
Consumer & lease financing
Total recoveries
Net loans charged-off (recovered)
50
20
-
-
-
-
70
76
6
14
8
104
(34)
-
-
-
-
-
2
2
222
-
-
135
-
33
390
(388)
-
76
-
-
-
5
81
207
977
-
15
-
13
1,212
(1,131)
49
835
-
-
-
-
884
459
-
-
26
-
12
497
387
83
1,157
871
971
-
64
3,146
31
56
-
25
-
12
124
3,022
Provision for (reversal of) loan losses
Allowance for loan losses - end of period
-
4,765
$
(800)
4,731
$
(1,400)
5,143
$
50
5,412
$
3,360
5,749
$
Loans:
Average loans outstanding during period, net
of unearned income
Total loans at end of period, net of unearned income
Ratios:
Net loans charged-off to average net loans
Net loans charged-off to total loans
Allowance for loan losses to average net loans
Allowance for loan losses to total loans
Net loans charged-off to beginning allowance for loan losses
Net loans charged-off to provision for loan losses (1)
(1) Not meaningful
$
$
363,545
359,403
$
$
314,806
347,948
$
$
289,948
284,941
$
$
279,326
288,079
$
$
275,505
281,626
(0.01)%
(0.01%)
1.31%
1.33%
(0.72%)
NM
(0.12)%
(0.11)%
1.50%
1.36%
(7.54)%
48.50%
(0.39)%
(0.40)%
1.77%
1.80%
(20.90)%
0.14%
0.13%
1.94%
1.88%
6.73%
80.79%
774.00%
1.10%
1.07%
2.09%
2.04%
55.85%
89.94%
44
The following table summarizes the allocation of the allowance for loan losses by loan category
and the amount of loans in each category as a percentage of total loans in each category as of the
end of each year presented. The allocated and unallocated portions of the allowance for loan losses
are available to the entire portfolio.
Allocation of Allowance for Loan Losses
Year Ended December 31,
2016
2015
2014
2013
2012
(in thousands)
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family units
Real estate - multifamily
Consumer & lease financing
Other qualitative factors (1)
Unallocated
Total
Allowance
Allocation
$ 744
1,764
266
577
330
19
1,065
$ 4,765
Amount of
Category
Loans to
Total Loans
Allowance
Allocation
22.7% $ 1,008
53.1% 940
2.2% 57
14.2% 237
7.7% 43
0.1% 6
Amount of
Category
Loans to
Total Loans
21.6%
50.4%
3.3%
18.4%
6.2%
0.2%
Amount of
Category
Loans to
Total Loans
24.0%
51.1%
3.9%
16.4%
4.6%
0.1%
Allowance
Allocation
$ 534
1,861
216
141
13
10
Allowance
Allocation
$ 562
2,955
379
214
272
15
Amount of
Category
Loans to
Total Loans
22.2%
52.2%
4.0%
17.7%
4.0%
0.1%
2,440
100% $ 4,731
100%
2,368
$ 5,143
100%
1,015
$ 5,412
100%
Amount of
Category
Loans to
Total Loans
23.5%
47.6%
3.8%
18.3%
6.6%
0.2%
100%
Allowance
Allocation
$ 734
2,547
148
251
82
6
960
1,021
$ 5,749
(1) At December 31, 2013, the Bank allocated the allowance for other qualitative factors by portfolio segment. The other qualitative factors
allocation was not identifiable to separate portfolio segments in prior years.
The changes from year to year for the allocation by loan category are attributable to the growth
of the category and management’s assessment of the quality of the individual loans within the
category. Additionally, an other qualitative factors allocation is applied to each category of loans
and represents various qualitative factors in the determination of the adequacy of the allowance
for loan losses and include the size of individual credits, concentrations and general economic
conditions. Management considers these qualitative factors in their evaluation of the adequacy of
the allowance for loan losses.
The increase in the allowance allocations for the various loan categories at December 31, 2016
compared to December 31, 2015 were attributable to an increase in internally classified loans and
general increase in total loans in the categories.
An unallocated allowance can arise from fluctuations in the amount of classified (“credit
grades”) and specific allocations to nonperforming loans between periods. Management and the
Board of Directors reviews the amount and reasons for unallocated allowances and whether it has
arisen due to periodic fluctuations in the credit grades or has arisen due to changes in qualitative
factors or changes in lending strategies. If the unallocated allowance has arisen from other than
periodic fluctuations in credit grades or other than potential temporary factors, then it may be
determined that a portion of the allowance for loan losses should be reversed.
The Bank adjusted the allowance for loan losses for the increase in unallocated allowance by
reversing $800,000 and $1,400,000 of the allowance in 2015 and 2014. These allowance reversals
were partially offset by $388,000 and $1,131,000 in net loan recoveries in 2015 and 2014. The
allowance for loan losses was reduced to 1.33% of gross loans for year end 2016 compared to
1.36% for year end 2015.
45
In addition to the allowance for loan losses, the Bank maintains an allowance for losses for
undisbursed loan commitments, which is reported in other liabilities on the consolidated balance
sheets. This allowance was $77,000 at December 31, 2016 and $44,000 2015.
Deposits
Deposits are the Bank’s primary source of funds. The Bank employs business development
officers and branch office personnel to solicit commercial demand deposits. The Bank focuses on
obtaining deposits from the communities it serves but occasionally may accept deposits from
outside its market area or receive brokered deposits.
The following table sets forth total deposits by type.
Deposits by Type
Year Ended December 31,
2016
2015
Balance
% of Total
Balance
% of Total
Demand Accounts
Savings and Money Market
Time Deposits
Total Deposits
$
174,546
80,450
129,255
$
384,251
45.4%
20.9%
33.6%
$
154,343
87,089
155,814
$
397,246
38.9%
21.9%
39.2%
The Bank has executed a strategy to increase demand and money market accounts as a
percentage of total deposits. Time deposits fundings are replaced by FHLB advances when the
interest rates of advances are lower. The change in the mix of the deposit composition has enabled
the Bank to lower the cost of funds and provided less sensitivity to rising interest rates.
The Bank offers local depositors with deposits in excess of $250,000 and who are concerned
with FDIC insurance limits, a deposit placement service through a program called CDARS and
ICS. Through this program amounts in excess of $250,000 can be placed in certificates of deposit
or demand accounts at other institutions and the Bank receives reciprocal deposits from other
institutions within the network. At December 31, 2016 and 2015, there were $22,387,000 and
$17,985,000 in CDARS time deposits and $23,415,000 and $17,824,000 in ICS demand deposits,
respectively. Although the originating depositors are local customers of the Bank, this exchange
of deposits for the purposes of FFIEC Call Reports, are classified as brokered deposits. In addition
to these deposits, the Bank had $20,052,000 and $35,206,000 at December 31, 2016 and 2015 in
wholesale brokered deposits.
Certain time deposits are received through a program run by the Treasurer of the State of
California to place public deposits with community banks. At December 31, 2016 and 2015, the
State of California had $48,500,000 in time deposits with the Bank with maturities of up to
six months and collateralized by investment securities or mortgage loans.
46
The following table sets forth the average balances by deposit category and the interest cost for
the periods indicated.
Average Deposit Balances and Rates Paid
Year Ended December 31,
2016
2015
2014
(in thousands)
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Non interest-bearing demand deposits
$
107,631
Interest-bearing demand deposits
Savings and money market
Time certificates under $100,000
Time certificates $100,000 or over
58,098
82,523
41,197
101,552
$
84,405
53,883
90,315
36,031
108,143
0.11%
0.10%
0.51%
0.48%
$
66,648
52,906
82,767
41,749
114,208
0.10%
0.15%
0.28%
0.28%
Total deposits
$
391,001
0.22%
$
372,777
0.16%
$
358,278
0.07%
0.18%
0.50%
0.39%
0.24%
The following table sets forth the maturities of time certificates of deposit of $100,000 or more
outstanding at December 31, 2016 and 2015.
Maturity of Time Deposits of $100,000 or More
(in thousands)
December 31, 2016
December 31, 2015
Time deposits of $100,000 or more maturing in:
Three months or less
Over three through six months
Over six to twelve months
Over twelve months
Total time deposits of $100,000 or more
Borrowings
$
$
56,031
13,116
14,537
11,584
95,268
74,543
4,967
16,302
10,748
106,560
$
$
Borrowings were $68,900,000 and $55,800,000 at December 31, 2016 and 2015. Borrowings
consisted of FHLB advances. At December 31, 2016, borrowings of $53,900,000 were due within
one year. Management utilizes FHLB advances when the terms are deemed advantageous
compared to raising time deposits and to manage overall liquidity. The increase in FHLB advances
were used to fund the additional loans originated during 2016.
Critical Accounting Policies and Estimates
The discussion and analysis of the Bank’s results of operations and financial condition are based
upon financial statements which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial statements requires the
Bank’s management to make estimates and judgments that affect the reported amounts of assets
47
and liabilities, income and expense, and the related disclosures of contingent assets and liabilities
at the date of these financial statements. See “Financial Statements and Supplementary Data”
“Notes to Consolidated Financial Statements” “Summary of Significant Accounting Policies” on
page 60.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
The Bank monitors earning asset and deposit levels, developments and trends in interest rates,
liquidity, capital adequacy and marketplace opportunities. Risks associated with interest rate
changes and market risk are managed through the Bank’s Asset Liability and Investment Policies.
These policies are reviewed and approved annually by the Board of Directors, and oversight is
provided by the Asset Liability and Investment Committee of the Board. Management responds
to all of these to protect and possibly enhance net interest income, while managing risks within
acceptable levels as set forth in the Bank’s policies. In addition, alternative business plans and
transactions are contemplated for their potential impact. This process is known as asset/liability
management and is carried out by changing the maturities and relative proportions of the various
types of loans, investments, deposits and borrowings in the ways described above.
The tool most commonly used to manage and analyze the interest rate sensitivity of a bank is
known as a computer simulation model. To quantify the extent of risks in both the Bank’s current
position and in transactions it might make in the future, the Bank uses a model to simulate the
impact of different interest rate scenarios on net interest income. The hypothetical impact of both
sudden (up to an immediate change in interest rates of +/- 4.00%) and smaller incremental interest
rate changes are modeled at least quarterly, representing the primary means the Bank uses for
interest rate risk management decisions.
The Bank is liability sensitive during a one year period meaning that during one year, more
liabilities will reprice than loans. Liability sensitive banks would expect an increase in the net
interest margin if interest rates decline and the net interest margin to decline when rates increase.
However various factors influence the change in the Bank’s margin when general market interest
rates change. These factors include, but are not limited to, the growth and mix of new assets,
deposit liabilities and borrowings, the extension or contraction of maturities of new and renewed
assets and liabilities, the particular shape of the general economic yield curve, and the general
influence on pricing by competition in the local market for loans and deposits. Additionally, when
economic rates change, there is an immediate impact from loans that are tied to a daily “prime
lending or other index rate.” The repricing of liabilities to offset this change requires time for
deposits to mature and renew. Based strictly on maturing time deposits and borrowings, and
without the other factors listed above, it normally will take three months for the Bank to reprice
liabilities to offset a prime rate change.
At December 31, 2016, the computer simulation model for a +2.00% interest rate shock, results
in the Bank’s net interest income for a twelve-month period to decrease by 8.3% or $1,559,000.
As current interest rates are at low levels, no meaningful projection is made for a rate reduction.
Computer simulation models use information from the Bank’s loan and deposit system at a static
point in time and bases the repricing of assets and liabilities on contractual terms, and certain
48
assumptions as to movements of various rate indexes and management assumptions regarding
when to reprice certain portfolios not linked to an index. The actual results experienced from
interest rate changes can vary from the results of the simulation.
The Bank monitors a ratio called the economic value of equity which is the theoretical projected
change in fair values of financial assets (loans, investment securities, deposits and borrowings)
that may impact equity for a given change in interest rates. Major assumptions used in determining
the fair values include maturities, repricing periods, and decay rates of non-maturity deposits. As
the calculation is highly dependent on assumptions, as well as the change in the shape of the yield
curve being modeled, it is not considered to be an exact calculation, but is used as an interest rate
risk monitoring tool. The computer simulation model for a +2.00% non-parallel interest rate shock
results in a 3.5% decline in the economic value of equity.
When preparing its modeling, the Bank makes significant assumptions about the lag in the rate
of change and impacts of optionality in various asset and liability categories. The Bank bases its
assumptions on past experience and comparisons with other banks, and tests the validity of its
assumptions by reviewing actual results with past projected expectations annually. As the impact
of changing interest rates depends on assumptions, actual experience can materially differ from
projections. The purpose of the model is to forecast the likely impact in order for management to
monitor exposures to interest rate risk and make adjustments to the balance sheet if needed.
Liquidity and Capital Resources
Maintenance of adequate liquidity requires that sufficient resources be available at all times to
meet cash flow requirements of the Bank. Liquidity in a banking institution is required primarily
to provide for deposit withdrawals and the credit needs of customers and to take advantage of
lending and investment opportunities as they arise. A bank may achieve desired liquidity from
both assets and liabilities. Cash and deposits held in other banks, federal funds sold, other short
term investments, maturing loans and investments, payments of principal and interest on loans and
investments, and potential loan sales are sources of asset liquidity. Deposit growth and access to
credit lines established with correspondent banks, primarily with the FHLB, Federal Reserve and
access to brokered certificates of deposits are sources of liability liquidity. The Bank reviews its
liquidity position on a regular basis based upon its current position and expected trends of loans
and deposits. Management believes that the Bank maintains adequate sources of liquidity to meet
its liquidity needs.
The Bank’s liquid assets, defined as cash, deposits with banks, Federal funds sold and unpledged
investment securities, totaled $112,987,000 and $108,153,000 at December 31, 2016 and
December 31, 2015, respectively, and constituted 22.0% and 21.1%, respectively, of total assets
on those dates.
At December 31, 2016, the Bank had $141,550,000 in borrowing lines of credit from the FHLB
and correspondent banks with $68,900,000 in outstanding advances from the FHLB. At December
31, 2015, these lines of credit available were $125,397,000 with $55,800,000 in FHLB advances
outstanding. The primary sources of cash during 2014, 2015 and 2016 were from cash generated
from operating activities, sales, calls and maturities of investment securities, increases in deposit
49
balances and additional FHLB advances. Primary uses of cash were for loan originations and
investment securities purchases.
Cash was primarily provided by $86.6 million in calls and maturities of investment securities,
$13.5 million in net change of demand, savings and money market deposits, $24.1 million in new
FHLB advances and operating activities of $5.2 million in 2016. Cash was used in 2016 primarily
to purchase $71 million in investment securities, fund a $10.8 million net change in loans, fund a
net change in certificates of deposit of $26.5 million and repay $11 million in FHLB advances.
Cash was primarily provided by $15.4 million in calls and maturities of investment securities,
$27.9 million in net change of demand, savings and money market deposits, $14 million in net
change in certificates of deposit, $35.8 million in new FHLB advances and operating activities of
$4.5 million in 2015. Cash was used in 2015 primarily to purchase $19.5 million in investment
securities, fund a $59.1 million net change in loans, repay $15 million in FHLB advances and
$13.8 million to retire preferred stock.
Cash was primarily provided by $16.5 million in calls and maturities of investment securities,
$25 million in net change of demand, savings and money market deposits, $6 million in new FHLB
advances, $4.6 million in a net decline in loans and operating activities of $4.8 million in 2014.
Cash was used in 2014 primarily to purchase $19.8 million in investment securities, repay $19.5
million in FHLB advances and $11 million in net decline in certificates of deposit.
The Board of Directors recognizes that a strong capital position is vital to growth, continued
profitability, and depositor and investor confidence. The policy of the Board of Directors is to
maintain sufficient capital at not less than the “well-capitalized” thresholds established by banking
regulators. However, in the current economic and regulatory environment the Bank has maintained
capital ratios in excess of regulatory requirements.
Shareholders’ equity also includes the Bank’s accumulated other comprehensive income or
(loss), net of taxes of ($885,000) at December 31, 2016 and $501,000 at December 31, 2015. Other
comprehensive income (loss) reflects the fair value adjustment, net of tax, of investment securities
classified as available-for-sale. This will fluctuate based on the amount of securities classified as
available-for-sale and changes in market interest rates. Total shareholders’ equity was $58,622,000
at December 31, 2016 and $57,325,000 at December 31, 2015.
Federal regulations establish guidelines for calculating “risk-adjusted” capital ratios and
minimum ratio requirements. Under these regulations, banks are required to maintain a total capital
ratio of 8.0%, common equity Tier 1 capital ratio of 4.5%, and Tier 1 risk-based capital (primarily
shareholders’ equity) of at least 6.0% of risk-weighted assets. The Bank had total capital ratio of
14.7%, common equity Tier 1 capital and Tier 1 risk-based capital ratios of 13.5% and 13.5%,
respectively, at December 31, 2016, and was “well-capitalized” under the regulatory guidelines.
In addition, regulators have adopted a minimum leverage ratio standard for Tier 1 capital to
average assets. The minimum ratio for top-rated institutions may be as low as 4%. However,
regulatory agencies have stated that most institutions should maintain ratios at least 1 to
2 percentage points above the 4% minimum. As of December 31, 2016, the Bank’s leverage ratio
50
was 11.1%. Capital levels for the Bank remain above established regulatory capital requirements.
The Bank excludes other comprehensive income for regulatory capital computations.
Quarterly dividends are paid out of retained earnings. The Bank paid $0.384 or $2,306,000 in
dividends on common stock during 2016 (adjusted for the 2017 five-for-four stock split). The
California Financial Code restricts total dividend payment of any bank in any calendar year
without permission 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. The Bank is not subject to this restriction
based on its current dividend levels as of December 31, 2016.
Although the Bank’s regulatory capital ratios are in excess of requirements and notwithstanding
the requirements of the California Financial Code, the Board of Directors reviews and declares
dividends on a quarterly basis and there is no assurance that future dividends will be declared.
Impact of Inflation
The primary impact of inflation on the Bank is its effect on interest rates. The Bank’s primary
source of income is net interest income, which is affected by changes in interest rates. The Bank
attempts to limit the impact of inflation on its net interest margin through management of rate-
sensitive assets and liabilities and analyses of interest rate sensitivity. The effect of inflation on
premises and equipment as well as on non-interest expenses has not been significant for the periods
presented.
51
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SUMMIT STATE BANK AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2016 AND 2015
AND FOR THE YEARS ENDED
DECEMBER 31, 2016, 2015 AND 2014
AND
REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
52
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Summit State Bank
We have audited the accompanying consolidated balance sheets of Summit State Bank (the “Bank”) as of December 31,
2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in shareholders’
equity, and cash flows for each of the three years in the period ended December 31, 2016. These consolidated financial
statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Bank is not required to have, nor were we
engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the Bank’s internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the
amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant
estimates made by management, as w e l l a s evaluating the overall consolidated financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
consolidated financial position of Summit State Bank as of December 31, 2016 and 2015, and the consolidated results of
its operations and its cash flows for e a c h o f t h e t h r e e y e a r s i n t h e p e r i o d e n d e d D e c e m b e r 3 1 , 2 0 1 6 in
conformity with accounting principles generally accepted in the United States of America.
San Francisco, California
March 23, 2017
53
SUMMIT STATE BANK AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands except share data)
ASSETS
Cash and due from banks
Federal funds sold
Total cash and cash equivalents
Time deposits with banks
Investment securities:
Held-to-maturity, at amortized cost
Available-for-sale (at fair value; amortized cost of $109,297
in 2016 and $127,735 in 2015)
Total investment securities
Loans, less allowance for loan losses of $4,765
in 2016 and $4,731 in 2015
Bank premises and equipment, net
Investment in Federal Home Loan Bank stock, at cost
Goodwill
Other Real Estate Owned
Accrued interest receivable and other assets
December 31,
2016
December 31,
2015
$
24,231
2,000
26,231
$
15,583
2,000
17,583
248
744
7,976
107,771
115,747
354,638
5,413
3,085
4,119
-
4,223
5,988
128,599
134,587
343,217
5,498
2,701
4,119
-
4,916
Total assets
$
513,704
$
513,365
LIABILITIES AND
SHAREHOLDERS' EQUITY
Deposits:
Demand - non interest-bearing
Demand - interest-bearing
Savings
Money market
Time deposits that meet or exceed the FDIC insurance limit
Other time deposits
Total deposits
Federal Home Loan Bank advances
Accrued interest payable and other liabilities
Total liabilities
Commitments and contingencies (Note 10)
Shareholders' equity
$
112,540
62,006
26,584
53,866
52,594
76,661
384,251
$
98,062
56,281
27,644
59,445
53,953
101,861
397,246
68,900
1,931
455,082
55,800
2,994
456,040
Preferred stock, no par value; 20,000,000 shares authorized;
no shares issued and outstanding
Common stock, no par value; shares authorized - 30,000,000 shares; issued
and outstanding 6,019,850 in 2016 and 5,978,963 in 2015
Retained earnings
Accumulated other comprehensive income (loss)
-
36,726
22,781
(885)
-
36,704
20,120
501
Total shareholders' equity
Total liabilities and shareholders' equity
58,622
513,704
$
$
57,325
513,365
The accompanying notes are an integral part of these audited consolidated financial statements.
54
SUMMIT STATE BANK AND SUBSIDIARY
CO NSO LIDATED STATEMENTS O F INC O ME
(In thousands except earnings per share data)
Interest income:
Interest and fees on loans
Interest on federal funds sold
Interest on investment securities and deposits in banks
Dividends on FHLB stock
T otal interest income
Interest expense:
Deposits
FHLB advances
T otal interest expense
Net interest income before provision for (reversal of) loan losses
Provision for (reversal of) loan losses
Net interest income after provision for (reversal of) loan losses
Non-interest income:
Service charges on deposit accounts
Rental income
Net securities gain
Net gain on other real estate owned
Loan servicing, net
Other income
T otal non-interest income
Non-interest expense:
Salaries and employee benefits
Occupancy and equipment
Other expenses
T otal non-interest expense
Income before provision for income taxes
Provision for income taxes
Net income
Less: preferred dividends
Net income available for common shareholders
Ye ar Ende d De cembe r 31,
2016
2015
2014
$
16,549
7
2,994
357
19,907
$
14,523
3
3,720
327
18,573
$
14,048
3
3,696
186
17,933
855
379
1,234
18,673
-
18,673
748
559
692
-
12
10
2,021
6,562
1,229
4,454
12,245
8,449
3,482
757
179
936
17,637
(800)
18,437
702
532
157
1,125
10
119
2,645
5,646
1,313
3,864
10,823
10,259
4,229
849
167
1,016
16,917
(1,400)
18,317
614
523
239
73
12
534
1,995
5,530
1,347
4,105
10,982
9,330
3,845
$
4,967
$
6,030
$
5,485
$
-
4,967
$
92
5,938
$
138
5,347
Basic earnings per common share
Diluted earnings per common share
$
$
0.83
0.82
$
$
0.99
0.98
$
$
0.90
0.89
Basic weighted average shares of common stock outstanding
Diluted weighted average shares of common stock outstanding
6,005
6,036
5,979
6,048
5,973
6,038
T he accompanying notes are an integral part of these audited consolidated financial statements.
55
SUMMIT STATE BANK AND SUBSIDIARY
CO NSO LIDATED STATEMENTS O F CO MPREHENSIVE INCO ME
(In thousands)
Ye ar Ende d De cember 31,
2016
2015
2014
Net income
$
4,967
$
6,030
$
5,485
Change in securities available-for-sale:
Unrealized holding gains (losses) on available-for-sale securites
arising during the period
Reclassification adjustment for (gains) realized in net income
(1,697)
(200)
4,838
on available-for-sale securities
(692)
(157)
(239)
Net unrealized gains (losses), before provision for income tax
Provision for income tax (expense) benefit
(2,389)
1,003
(357)
150
4,599
(1,931)
Total other comprehensive income (loss), net of tax
Comprehensive income
$
(1,386)
3,581
$
(207)
5,823
$
2,668
8,153
The accompanying notes are an integral part of these audited consolidated financial statements.
56
SUMMIT STATE BANK AND SUBSIDIARY
CO NSO LIDATED STATEMENTS O F CHANGES IN SHAREHO LDERS' EQ UITY
(In thousands e xce pt pe r share data)
Pre fe rre d Stock
Share s
Amount
Common Stock
Re taine d
Earnings
Accumulate d
O the r
Compre he nsive
Income (Loss)
Total
Share holde rs'
Equity
Balance, January 1, 2014
$
13,666
5,973
$
36,608
$
13,316
$
(1,960)
$
61,630
Net income
Other comprehensive income
Stock-based compensation expense
Preferred stock dividends
Exercise of stock options
Cash dividends - $.35 per share
34
4
5,485
(138)
(2,103)
2,668
5,485
2,668
34
(138)
4
(2,103)
Balance, December 31, 2014
13,666
5,973
36,646
16,560
708
67,580
Net income
Other comprehensive loss
Stock-based compensation expense
Retirement of preferred stock, net of issuance costs
(13,666)
Preferred stock dividends
Exercise of stock options
Cash dividends - $.38 per share
24
34
6
6,030
(84)
(92)
(2,294)
(207)
6,030
(207)
24
(13,750)
(92)
34
(2,294)
Balance, December 31, 2015
-
5,979
36,704
20,120
501
57,325
Net income
Other comprehensive loss
Stock-based compensation expense
Exercise of stock options
Cash dividends - $0.38 per share
41
21
1
4,967
(2,306)
(1,386)
4,967
(1,386)
21
1
(2,306)
Balance, December 31, 2016
$
-
6,020
$
36,726
$
22,781
$
(885)
$
58,622
The accompanying notes are an integral part of these audited consolidated financial statements.
57
SUMMIT STATE BANK AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
(In thousands)
2016
2015
2014
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation and amortization
Securities amortization and accretion, net
Net change in deferred loan fees
Provision for (reversal of) loan losses
Net gain on other real estate owned
Net securities gains
Net change in accrued interest
receivable and other assets
Net change in accrued interest
payable and other liabilities
Stock-based compensation expense
Net cash from operating activities
Cash flows from investing activities:
Net change in time deposits with banks
Purchases of held-to-maturity investment
securities
Purchases of available-for-sale investment
securities
Proceeds from sales of available-for-sale
investment securities
Proceeds from calls of held-to-maturity
investment securities
Proceeds from calls and maturities of available-for-sale
investment securities
Purchase of Federal Home Loan Bank stock
Net change in loans
Purchases of bank premises and equipment, net
Proceeds on sale of other real estate owned
Net cash from (used in) investing activities
$
4,967
$
6,030
$
5,485
312
598
(615)
-
-
(692)
1,696
(1,063)
21
5,224
496
(7,971)
(63,035)
878
6,000
80,673
(384)
(10,806)
(227)
-
5,624
390
599
(784)
(800)
(1,125)
(157)
425
643
(485)
(1,400)
(73)
(239)
(816)
1,314
1,158
24
4,519
496
(986)
(840)
34
4,864
745
(3,946)
(18,522)
(15,847)
3,459
5,000
10,363
-
(59,160)
(85)
2,501
(56,934)
1,916
9,558
6,940
(123)
4,754
(723)
793
4,067
(Continued)
58
SUMMIT STATE BANK AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
(In thousands)
2016
2015
2014
Cash flows from financing activities:
Net change in demand, savings
and money market deposits
Net change in certificates of deposit
Net change in short term FHLB advances
Issuance of long term FHLB advances
Repayment of long term FHLB advances
Retirement of preferred stock
Dividends paid on common stock
Dividends paid on preferred stock
Proceeds from exercise of stock options
Net cash from (used in) financing activities
13,564
(26,559)
9,100
15,000
(11,000)
-
(2,306)
-
1
(2,200)
27,942
14,045
35,800
-
(15,000)
(13,750)
(2,294)
(92)
34
25,035
(11,044)
(19,500)
6,000
-
-
(2,103)
(138)
4
46,685
(1,746)
Net change in cash and cash equivalents
8,648
(5,730)
7,185
Cash and cash equivalents at beginning
of year
17,583
23,313
16,128
Cash and cash equivalents at end of period
$
26,231
$
17,583
$
23,313
Supplemental disclosure of cash flow
information:
Cash paid during the period for:
Interest
Income taxes
Noncash investing activities:
$
$
1,260
3,590
$
$
947
3,065
$
$
1,011
3,270
Financing of other real estate owned sale
$
-
$
2,675
$
-
The accompanying notes are an integral part of these audited consolidated financial statements.
59
SUMMIT STATE BANK AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
On January 15, 1999, Summit State Bank (the “Bank”) received authority to transact business as a California
state-chartered commercial bank and is subject to regulation, supervision and examination by the California
Department of Business Oversight and the Federal Deposit Insurance Corporation. The Bank was organized
under a charter granted by the Department of Savings and Loan of the State of California under the name
Summit Savings. The Bank was incorporated on December 20, 1982. The Bank converted to a federal
savings bank under a charter granted by the Office of Thrift Supervision on May 24, 1990. The Bank
provides a variety of banking services to individuals and businesses in its primary service area of Sonoma
County, California. The Bank's branch locations include Santa Rosa, Petaluma, Rohnert Park and
Healdsburg. The Bank offers depository and lending services primarily to meet the needs of its business and
individual clientele. These services include a variety of transaction, money market, savings and time deposit
account alternatives. The Bank's lending activities are directed primarily towards commercial real estate,
construction and business loans. The Bank utilizes its subsidiary Alto Service Corporation for its deed of
trust services.
The accounting and reporting policies of the Bank and its subsidiary conform with accounting principles
generally accepted in the United States of America and prevailing practices within the banking industry.
Stock Split Adjustment
The Board of Directors declared a five-for-four stock split on January 23, 2017 to common shareholders of
record on February 28, 2017 and issued on March 14, 2017. The impact of this stock split has been
retroactively applied to periods presented with adjustments to the number of common shares and per common
share values as if the stock split had occurred as of the beginning of each period presented.
Principles of Consolidation
The consolidated financial statements include the accounts of the Bank and its wholly-owned subsidiary,
Alto Service Corporation. All significant intercompany accounts and transactions have been eliminated in
consolidation.
Reclassification
Some items in the prior year financial statements were reclassified to conform to the current presentation.
Reclassifications had no effect on prior year net income or shareholders’ equity.
Use of Estimates
The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles
requires management to make estimates and assumptions. These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ from these estimates. The
allowance for loan losses, goodwill impairment and fair values of investment securities and other financial
instruments are particularly subject to change.
60
Cash and Cash Equivalents
For the purpose of the consolidated statement of cash flows, the Bank considers cash and due from banks
with original maturities under 90 days and Federal funds sold to be cash equivalents. Generally, Federal
funds are sold for one-day periods. Net cash flows are reported for customer loan and deposit transactions,
time deposits in banks and short-term borrowings with an original maturity of 90 days or less.
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.
Gains or losses on the sale of investment securities are recorded on the trade date and 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 on the level yield method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis,
and more frequently when economic or market conditions warrant such an evaluation. For securities in an
unrealized loss position, management considers the extent and duration of the unrealized loss, and the
financial condition and near-term prospects of the issuer. Management also assesses whether it intends to
sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before
recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the
entire difference between amortized cost and fair value is recognized as impairment through earnings. For
debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two
components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement for
available-for-sale and held-to-maturity investments and 2) OTTI related to other factors, which is recognized
in other comprehensive income or (loss) for available-for-sale investments. The credit loss is defined as the
difference between the present value of the cash flows expected to be collected and the amortized cost basis.
Investment in Federal Home Loan Bank Stock
In order to borrow from the Federal Home Loan Bank of San Francisco (FHLB), the Bank is required to
maintain an investment in the capital stock of the FHLB. The investment is carried at cost and is generally
redeemable at par. Both cash and stock dividends are reported as income.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity are stated
at principal balances outstanding, net of deferred loan origination fees and costs and the allowance for loan
losses, adjusted for accretion of discounts or amortization of premiums. Interest is accrued daily based upon
outstanding loan balances. However, for all loan classes, when in the opinion of management, loans are
considered to be impaired and the future collectability of interest and principal is in serious doubt, loans are
placed on nonaccrual status and the accrual of interest income is suspended. Any interest previously accrued,
but unpaid, is charged against income. Payments received are applied to reduce principal to the extent
necessary to ensure collection. Subsequent payments on these loans, or payments received on nonaccrual
61
loans for which the ultimate collectability of principal is not in doubt, are applied first to earned but unpaid
interest and then to principal.
Substantially all loan origination fees, commitment fees, direct loan origination costs and purchase premiums
and discounts on loans are deferred and recognized in interest income using the level yield method, to be
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.
Non-accrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous
loans that are collectively evaluated for impairment and individually classified impaired loans. A loan is
moved to non-accrual status in accordance with the Bank’s policy, typically after 90 days of non-payment.
For loans whose contractual terms have been restructured in a manner which grants a concession to a
borrower experiencing financial difficulties (“troubled debt restructuring”), they are returned to accrual status
when there has been a sustained period of repayment performance (generally, six consecutive monthly
payments) according to the modified terms and there is reasonable assurance of repayment and of
performance.
Allowance for Loan Losses
The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are
charged against the allowance when management believes the un-collectability of a loan balance is
confirmed. Loans or portions of loans are charged off when there is a distinct probability of loss identified.
A distinct probability of loss exists when it has been determined that any remaining sources of repayment are
not sufficient to cover all outstanding principal. The probable loss is immediately calculated based on the
value of the remaining sources of repayment and charged to the allowance for loan losses. Subsequent
recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using
past loan loss experience, the nature and volume of the portfolio, information about specific borrower
situations and estimated collateral values, economic conditions, and other factors. Allocations of the
allowance may be made for specific loans, but the entire allowance is available for any loan that, in
management’s judgment, should be charged-off.
A loan is impaired when, based on current information and events, it is probable that the Bank will be unable
to collect all amounts due according to the contractual terms of the loan agreement. Commercial &
agricultural, real estate-commercial, real estate-construction and land, and real estate-multifamily loans are
individually evaluated for impairment. Large groups of smaller balance homogeneous loans such as real
estate-single family units and consumer & lease financing are collectively evaluated for impairment, and
accordingly, they are not separately identified for impairment disclosures. Impaired loans are measured on
the present value of expected future cash flows discounted at the loan’s original effective interest rate. As a
practical expedient, impairment may be measured based on the loan’s observable market price or the fair
value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than
the recorded investment in the loan, the impairment is recorded through an allocation of a portion of the
allowance for loan losses. Loans, for which the terms have been modified granting concessions to the
borrower that the Bank would not otherwise consider, and for which the borrower is experiencing financial
difficulties, are considered troubled debt restructurings and classified as impaired. Troubled debt
restructurings are measured at the present value of estimated future cash flows using the loan’s effective
interest rate at inception.
The allowance consists of specific and general components. The specific component relates to loans that are
individually classified as impaired. The general component covers loans that are both non-impaired and non-
classified and is based on historical loss experience adjusted for qualitative factors. The historical loss
experience is determined by portfolio segment and is based on the actual loss history experienced by the
Bank over the most recent eight years. This actual loss experience is supplemented with other economic
factors based on the risks present for each portfolio segment. These economic factors include consideration
of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-
offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and
62
underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and
depth of lending management and other relevant staff; national and local economic trends and conditions;
industry conditions; and effects of changes in credit concentrations. The following portfolio segments have
been identified: commercial & agricultural, real estate mortgage loans and consumer & lease financing. Real
estate mortgage loans have been further classified according to the following risk characteristics: commercial,
construction and land, single family units and multifamily units. Loan categories used in presentations in
this report conform to the categorizations used by regulatory Called Reports as described by the instructions
issued by the Federal Financial Interagency Examination Council (FFIEC).
Commercial and Agricultural Loans - Commercial and Agricultural credit is extended to commercial
customers for use in normal business operations to finance working capital needs, equipment purchases, farm
land, or other projects. The majority of these borrowers are customers doing business within our geographic
regions. These loans are generally underwritten individually and secured with the assets of the company and
the personal guarantee of the business owners. Commercial & Agricultural loans are made based primarily
on the historical and projected cash flow of the borrower and the underlying collateral provided by the
borrowers. This category includes loans secured by farmland.
Commercial and Multifamily Real Estate Loans - Commercial and multifamily real estate loans are subject
to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as
cash flow loans and the repayment of these loans is largely dependent on the successful operation of the
property. Loan performance may be adversely affected by factors impacting the general economy or
conditions specific to the real estate market such as geographic location and property type.
Construction and Land Real Estate Loans - Construction and Land Real Estate Loans are extended to
qualified commercial and individual customers and are underwritten and secured by the assets of the company
or individual. Commercial construction credits may also be secured with personal guarantees of the business
owner. Credits are underwritten to meet the general credit policy criteria for current and projected cash flow
coverage and loan-to-value. Terms for Construction and Land loans are typically of shorter duration and
have more restrictive advance rates than similar commercial credit or single family residences. Both types
of credit may be refinanced to a long –term loan upon completion of construction. The majority of these
credits are with customers doing business within the Bank’s geographic region.
Consumer and Lease Financing Loans - Consumer and Lease Financing loans are primarily comprised of
loans made directly to consumers. These loans have a specific underwriting matrix which consists of several
factors including debt to income, type of collateral and loan to collateral value, credit history and relationship
to the borrower. Consumer and Lease Financing lending uses risk-based pricing in the underwriting process.
Single Family Residential Loans - Single family residential mortgage loans represent loans to consumers for
the purchase or refinance of a residence. These loans are generally financed up to 30 years, and in most
cases, are extended to borrowers to finance their primary residence. Real estate market values at the time of
origination directly affect the amount of credit extended, and in the event of default, subsequent changes in
these values may impact the severity of losses. Additionally, commercial loans may be categorized as Single
Family Residential if the loan is secured by a mortgage on a home. These loans are underwritten as described
in Commercial and Agricultural Loans above and have terms such as interest rates and maturities as a
standard Commercial Loan.
The Bank is subject to periodic examinations by its federal and state regulatory examiners and may be
required by such regulators to recognize additions to the allowance for loan losses based on their assessment
of credit information available to them at the time of their examinations. The process of assessing the
adequacy of the allowance for loan losses is necessarily subjective. Further, and particularly in times of
economic downturns, it is reasonably possible that future credit losses may exceed historical loss levels and
may also exceed management’s current estimates of incurred credit losses inherent within the loan portfolio.
As such, there can be no assurance that future charge-offs will not exceed management’s current estimate of
what constitutes a reasonable allowance for credit losses.
63
Valuation of Goodwill
Goodwill and intangible assets acquired in a purchase business combination and determined to have an
indefinite useful life are not amortized, but tested for impairment at least annually. The Bank has selected
September 30 as the date to perform the annual impairment test. Intangible assets with definite useful lives
are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only
intangible asset with an indefinite life on our balance sheet.
Management assesses the carrying value of our goodwill at least annually in order to determine if this
intangible asset is impaired. In reviewing the carrying value of our goodwill, we assess the recoverability of
such assets by evaluating the fair value of the related business unit. If the carrying amount of goodwill
exceeds its fair value, an impairment loss is recognized for the amount of the excess and the carrying value
of goodwill is reduced accordingly. Any impairment would be required to be recorded during the period
identified.
The annual evaluation of goodwill for impairment uses various estimates and assumptions. The market price
of the Bank’s common stock at the close of business on December 30, 2016 was $12.00 per common share
compared to a book value of $9.74 per common share. Management performed an assessment of qualitative
factors to determine if it is more likely than not that the fair value of the Bank is less than its carrying value.
Based on the assessment it was determined that the implied fair value for the Bank is sufficiently above the
book value to support the current carrying value of goodwill.
Other Real Estate Owned
Other real estate owned includes real estate acquired in full or partial settlement of loan obligations. When
property is acquired, any excess of the Bank's recorded investment in the loan balance and accrued interest
income over the estimated fair market value of the property, less costs to sell, is charged against the allowance
for loan losses. A valuation allowance for losses on other real estate, if needed, is maintained to provide for
declines in value. The allowance is established through a provision for losses on other real estate which is
included in other expenses. Subsequent gains or losses on sales or write-downs resulting from impairment
are recorded in other income or expenses as incurred. Operating costs after acquisition are expensed and any
rental income from the properties are recorded as income. There was no other real estate owned at December
31, 2016 and 2015.
Bank Premises and Equipment
Land is carried at cost. Buildings, furniture, fixtures, 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 buildings are estimated to be 39 years and furniture, fixtures and equipment
are estimated to be 3 to 15 years. Leasehold improvements are amortized over the estimated useful 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.
Income Taxes
The Bank files its income taxes on a consolidated basis with its subsidiary. The allocation of income tax
expense (benefit) represents each entity's proportionate share of the consolidated provision for income taxes.
Income tax expense is 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 basis. Deferred tax assets and liabilities are
64
adjusted for the effects of changes in tax laws and rates on the date of enactment. A valuation allowance, if
needed, reduces deferred tax assets to the amount expected to be realized. On the consolidated balance sheet,
net deferred tax assets are included in accrued interest receivable and other assets.
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.
The Bank recognizes interest and/or penalties related to income tax matters in income tax expense. The Bank
has not accrued any potential interest and penalties as of December 31, 2016 and December 31, 2015 and for
the three years ended December 31, 2016 for uncertainties related to income taxes.
Earnings Per Common Share
Basic earnings per common share (EPS), which excludes dilution, is computed by dividing income available
to common shareholders by the weighted-average number of common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution that could occur if contracts to issue common stock,
such as stock options, result in the issuance of common stock which shares in the earnings of the Bank. Stock
options for 26,198, 66,869 and 81,109 shares of common stock were not considered in computing diluted
earnings per share for 2016, 2015 and 2014 because they were anti-dilutive.
The factors used in the earnings per common share computation follow:
(in thousands except earnings per share)
2016
2015
2014
Basic
Net income available for common shareholders
$
4,967
$
5,938
$
5,347
Weighted average common shares outstanding
6,005
5,979
5,973
Basic earnings per common share
$
0.83
$
0.99
$
0.90
Diluted
Net income available for common shareholders
$
4,967
$
5,938
$
5,347
Weighted average common shares
outstanding for basic earnings per
common share
Add: Dilutive effects of assumed exercises of
stock options
Average shares and dilutive potential common
shares
6,005
31
5,979
69
5,973
65
6,036
6,048
6,038
Diluted earnings per common share
$
0.82
$
0.98
$
0.89
Stock Based Compensation
Compensation cost is recognized for stock options and stock appreciation rights (“SARs) granted to
employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to
estimate the fair value of stock options and SARs. Compensation cost is recognized over the required service
period, generally defined as the vesting period.
Adoption of New Accounting Standards
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update
(ASU) No. 2015-09, Revenue from Contracts with Customers (Topic 606), superseding most industry-
specific revenue recognition guidance in the FASB Accounting Standards Codification. The core principle
65
of the new guidance 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 identifies specific steps that entities should apply in
order to achieve this principle. The ASU is effective for interim and annual periods beginning December
15, 2017 and must be applied retrospectively. The Bank is in the process of evaluating the impact of the
ASU's adoption on the Bank's consolidated financial statements.
In January 2016, the FASB issued ASU No. 2017-01, Financial Instruments – Overall (Subtopic 825-10):
Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance is intended
to improve the recognition and measurement of financial instruments. This ASU requires equity
investments (except those accounted for under the equity method of accounting, or those that result in
consolidation of the investee) to be measured at fair value with changes in fair value recognized in net
income. In addition, the amendment requires public business entities to use the exit price notion when
measuring the fair value of financial instruments for disclosure purposes and requires separate presentation
of financial assets and financial liabilities by measurement category and form of financial asset (i.e.,
securities or loans and receivables) on the balance sheet or the accompanying notes to the financial
statements. This ASU also eliminates the requirement for public business entities to disclose the method(s)
and significant assumptions used to estimate the fair value that is required to be disclosed for financial
instruments measured at amortized cost on the balance sheet. The amendment also requires a reporting
organization to present separately in other comprehensive income the portion of the total change in the fair
value of a liability resulting from a change in the instrument specific credit risk (also referred to as “own
credit”) when the organization has elected to measure the liability at fair value in accordance with the fair
value option for financial instruments. ASU No. 2017-01 is effective for financial statements issued for
fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early
adoption is permitted for certain provisions. The Bank is currently evaluating the impact of this ASU on
the Bank’s consolidated financial statements.
In February of 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic
842). This Update was issued to increase transparency and comparability among organizations by
recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about
leasing arrangements. The core principle of Topic 842 is that a lessee should recognize the assets and
liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with
FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those
lease assets and lease liabilities represents an improvement over previous GAAP, which did not require
lease assets and lease liabilities to be recognized for most leases. For public companies, the amendments in
this update are effective for fiscal years beginning after December 15, 2018, including interim periods
within those fiscal years. Lease commitments will be reflected on the balance sheet as lease assets and lease
liabilities. We are currently evaluating the provisions of this ASU to determine the potential impact the
new standard will have on our consolidated financial statements. Bank regulatory agencies have not
determined how this ASU will impact the computation of regulatory capital ratios.
In March of 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-09, Compensation -
Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The
amendments are intended to improve the accounting for employee share-based payments and affect all
organizations that issue share-based payment awards to their employees. Several aspects of the accounting
for share-based payment award transactions are simplified, including: (a) income tax consequences; (b)
classification of awards as either equity or liabilities; and (c) classification on the statement of cash flows.
For public companies, the amendments are effective for annual periods beginning after December 15, 2016,
and interim periods within those annual periods. Early adoption is permitted. Management does not
anticipate any impacts of this ASU on our consolidated financial statements.
In June of 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-13, Financial
Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The
amendments are intended to improve financial reporting by requiring timelier recording of credit losses on
loans and other financial instruments held by financial institutions and other organizations. The ASU
requires the measurement of all expected credit losses for financial assets held at the reporting date based
66
on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions
and other organizations will now use forward-looking information to better inform their credit loss
estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs
to those techniques will change to reflect the full amount of expected credit losses. Organizations will
continue to use judgment to determine which loss estimation method is appropriate for their circumstances.
The ASU requires enhanced disclosures to help investors and other financial statement users to better
understand significant estimates and judgments used in estimating credit losses, as well as the credit quality
and underwriting standards of an organization’s portfolio. These disclosures include qualitative and
quantitative requirements that provide additional information about the amounts recorded in the financial
statements. In addition, the ASU amends the accounting guidance for credit losses on available-for-sale
debt securities and purchased financial assets with credit deterioration. The amendment is effective for
fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early
application will be permitted for fiscal years, and interim periods within those fiscal years, beginning after
December 15, 2018. We are currently evaluating the provisions of the ASU to determine the potential
impact the new standard will have on our consolidated financial statements.
In January of 2017, the FASB issued Accounting Standards Update (“ASU”) No. 2017-04, Intangibles -
Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The amendments are
intended to simplify the subsequent measurement of goodwill, and the amendments eliminate Step 2 from
the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing
the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for
the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss
recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition,
income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit should be
considered when measuring the goodwill impairment loss, if applicable. The amendments also eliminate
the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative
assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity
still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative
impairment test is necessary. The amendments should be applied on a prospective basis. The nature of and
reason for the change in accounting principle should be disclosed upon transition. The amendment is
effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019.
Early application will be permitted for fiscal years, and interim periods within those fiscal years, beginning
after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests
performed on testing dates after January 1, 2017. Management does not anticipate any potential impact
from the new standard on our consolidated financial statements.
Operating segments
While the Bank’s chief decision makers monitor the revenue streams of the Bank’s various products and
services, operations are managed and financial performance is evaluated on a bank-wide basis. Operating
segments are aggregated into one segment as operating results for all segments are substantially the same.
67
2.
INVESTMENT SECURITIES
The amortized costs and estimated fair value of investment securities at December 31, 2016 and 2015
consisted of the following:
(in thousands)
Held-to-maturity:
December 31, 2016
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
Amortized
Cost
Government agencies
$
7,976
$
-
$
(263)
$
7,713
Available-for-sale:
U.S. Treasuries
Government agencies
Mortgage-backed securities - residential
Corporate debt
Total available-for-sale
Total investment securities
(in thousands)
Held-to-maturity:
Available-for-sale:
U.S. Treasuries
Government agencies
Mortgage-backed securities - residential
Corporate debt
Total available-for-sale
Total investment securities
$
$
$
8,018
55,438
9,184
36,657
109,297
117,273
1
$
262
12
937
1,212
1,212
$
(29)
(2,256)
(100)
(353)
(2,738)
(3,001)
7,990
53,444
9,096
37,241
107,771
115,484
$
$
$
December 31, 2015
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
Amortized
Cost
$
$
$
10,005
73,312
8,163
36,255
127,735
133,723
-
$
760
23
1,049
1,832
1,838
$
(13)
(607)
(68)
(280)
(968)
(1,108)
9,992
73,465
8,118
37,024
128,599
134,453
$
$
$
Government agencies
$
5,988
$
6
$
(140)
$
5,854
The activity related to recorded gross gains and gross losses of investment securities for the years ended
December 31, is reflected in the table below:
(in thousands)
2016
2015
2014
Year Ended December 31
Proceeds from sales
Proceeds from calls
Gross realized gains on sales and calls
Gross realized losses on sales and calls
$
878
$
3,459
$
1,916
37,933
744
(52)
3,469
218
(61)
3,532
256
17
Net unrealized gains or (losses) on available-for-sale investment securities totaling $(1,526,000), $864,000
and $1,220,000 are recorded, net of $(641,000), $363,000 and $513,000 in tax expense or (benefit), as
accumulated other comprehensive income within shareholders' equity at December 31, 2016, 2015 and 2014,
respectively.
There were no investment securities in a continuous unrealized loss position greater than 12 months at
December 31, 2016. At December 31, 2016, the Bank held 75 investment securities which were in an
unrealized loss position for less than twelve months. Management periodically evaluates each investment
security for other than temporary impairment, relying primarily on industry analyst reports and observation
of market conditions and interest rate fluctuations. All of the impairment appearing in the investment
securities portfolio valuations is considered to be temporary. The measured impairment in the securities
values is primarily attributable to changes in long-term interest rates, market shifts of the Treasury yield
68
curve and other variable market and economic conditions. The measured impairment in securities values did
not result from any significant or persistent deterioration in the underlying credit quality of any of the
investments. The securities portfolio consists primarily of debt securities with non-contingent contractual
cash flows. Full realization of the principal balance is expected upon final maturity. Management has the
intent and ability to hold the securities until recovery of the carrying value, which could be at the final
maturity. Investment securities with unrealized losses at December 31, 2016 and 2015 are summarized and
classified according to the duration of the loss period as follows:
(in thousands)
Debt Securities:
Held-to-maturity:
Government agencies
Available-for-sale:
U.S. Treasuries
Government agencies
Mortgage-backed securities - residential
Corporate debt
Total available-for-sale
Total investment securities
(in thousands)
Debt Securities:
Held-to-maturity:
Government agencies
Available-for-sale:
U.S. Treasuries
Government agencies
Mortgage-backed securities - residential
Corporate debt
Total available-for-sale
Total investment securities
December 31, 2016
Less than 12 Months
12 Months or More
Total
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
$
7,713
$
(263)
$
-
$
-
$
7,713
$
(263)
$
$
$
$
(29)
(2,256)
(100)
(353)
(2,738)
(3,001)
-
$
-
-
-
-
$
-
-
$
-
-
-
-
$
-
December 31, 2015
5,990
48,172
6,199
11,543
71,904
79,617
(29)
(2,256)
(100)
(353)
(2,738)
(3,001)
$
$
$
$
Less than 12 Months
12 Months or More
Total
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
$
980
$
(8)
$
1,868
$
(132)
$
2,848
$
(140)
$
$
$
$
(13)
(410)
(68)
(186)
(677)
(685)
-
$
7,307
-
2,196
9,503
11,371
$
-
$
(197)
-
(94)
(291)
(423)
$
9,992
38,968
7,075
7,214
63,249
66,097
(13)
(607)
(68)
(280)
(968)
(1,108)
$
$
$
$
5,990
48,172
6,199
11,543
71,904
79,617
9,992
31,661
7,075
5,018
53,746
54,726
The amortized cost and estimated fair value of investment securities at December 31, 2016 by contractual
maturity are shown below. 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.
(in thousands)
Amortized Cost
Fair Value
Amortized Cost
Fair Value
Held-to-Maturity
Available-for-Sale
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:
Mortgage-backed securities - residential
-
$
-
-
7,976
7,976
-
$
-
-
7,713
7,713
$
6,786
44,535
38,802
9,990
100,113
$
6,803
45,082
37,590
9,200
98,675
-
-
9,184
9,096
$
7,976
$
7,713
$
109,297
$
107,771
Investment securities with amortized costs totaling $29,404,000 and $38,906,000 and estimated fair values
totaling $29,097,000 and $39,235,000 were pledged to secure State of California and other municipal
deposits at December 31, 2016 and 2015 (see Note 6).
69
December 31,
2016
December 31,
2015
$
$
81,519
190,976
7,897
51,044
27,533
434
359,403
(4,765)
354,638
75,018
175,374
11,341
63,899
21,664
652
347,948
(4,731)
343,217
$
$
3.
LOANS
Outstanding loans are summarized as follows:
(in thousands)
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Allowance for loan losses
70
Changes in the allocation of allowance for loan losses by loan class for the years ended December 31, 2016, 2015 and
2014 are as follows:
(in thousands)
Year Ended December 31, 2016
Balance at
December 31, 2015
Provision
(reversal)
Charge-
offs
Recoveries
Balance at
December 31, 2016
$
$
$
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Unallocated
Total
1,008
940
57
237
43
6
2,440
4,731
$
(290)
838
209
326
287
5
(1,375)
$
-
(50)
(20)
-
-
-
-
-
(70)
$
$
$
$ 744
1,764
266
577
330
19
1,065
4,765
$
(in thousands)
Year Ended December 31, 2015
Balance at
December 31, 2014
Provision
(reversal)
Charge-
offs
Recoveries
Balance at
December 31, 2015
$
$
$
$
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Unallocated
Total
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Unallocated
Total
$
$
$
$
(in thousands)
Year Ended December 31, 2014
Balance at
December 31, 2013
Provision
(reversal)
Charge-
offs
Recoveries
Balance at
December 31, 2014
$
$
$
$
$
$
$
$
76
6
-
14
-
8
-
104
222
-
-
135
-
33
-
390
207
977
-
15
-
13
-
1,212
1,008
940
57
237
43
6
2,440
4,731
534
1,861
216
141
13
10
2,368
5,143
534
1,861
216
141
13
10
2,368
5,143
562
2,955
379
214
272
15
1,015
5,412
252
(921)
(159)
(39)
30
(35)
72
(800)
-
$
-
-
-
-
(2)
-
(2)
$
(235)
(1,995)
(163)
(88)
(259)
(13)
1,353
(1,400)
-
$
(76)
-
-
-
(5)
-
(81)
$
71
The following table presents the balance in the allowance for loan losses and loan balances by class and based on
impairment method as of December 31, 2016 and 2015:
December 31, 2016
Allowance for Loan Losses:
Loans:
(in thousands)
Individually
Evaluated for
Impairment
Collectively
Evaluated
for
Impairment
T otal Ending
Allowance Balance
Loans
Individually
Evaluated for
Impairment
Loans Collectively
Evaluated for
Impairment
T otal
Ending
Loans
Balance
Commercial & agricultural
$
337
$
407
$
744
$
1,646
$
79,873
$
81,519
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Unallocated
-
-
-
-
-
-
1,764
266
577
330
19
1,065
1,764
266
577
330
19
1,065
3,450
-
1,791
149
-
-
187,526
190,976
7,897
49,253
27,384
434
-
7,897
51,044
27,533
434
-
T otal
$
337
$
4,428
$
4,765
$
7,036
$
352,367
$
359,403
December 31, 2015
Allowance for Loan Losses:
Loans:
(in thousands)
Individually
Evaluated for
Impairment
Collectively
Evaluated
for
Impairment
T otal Ending
Allowance Balance
Loans
Individually
Evaluated for
Impairment
Loans Collectively
Evaluated for
Impairment
T otal
Ending
Loans
Balance
Commercial & agricultural
$
348
$
660
$
1,008
$
1,228
$
73,790
$
75,018
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Unallocated
-
-
-
-
-
-
940
57
237
43
6
2,440
940
57
237
43
6
2,440
2,654
-
1,442
170
-
-
172,720
175,374
11,341
62,457
21,494
652
-
11,341
63,899
21,664
652
-
T otal
$
348
$
4,383
$
4,731
$
5,494
$
342,454
$
347,948
The recorded investment in the aforementioned disclosure and the next several disclosures do not include accrued
interest receivable and net deferred fees because such amounts are not considered material. Accrued interest
receivable for the total loan portfolio was $1,078,000 and $1,193,000 and net deferred loan fees (costs) were
$(192,000) and $29,000 as of December 31, 2016 and 2015.
72
The following table presents impaired loans individually evaluated for impairment by class of loans:
(in thousands)
December 31, 2016
Recorded investment in impaired loans:
Commercial
&
agricultural
Real estate -
commercial
Real estate -
construction
and land
Real estate -
single family
Real estate -
multifamily
Consumer &
lease
financing
Total
With no related allowance recorded
$
1,309
$
3,450
$
-
$
1,791
$
149
$
-
$
6,699
With an allowance recorded
Total recorded investment in
impaired loans
Unpaid principal balance of impaired loans:
337
-
-
-
-
-
337
$
1,646
$
3,450
$
-
$
1,791
$
149
$
-
$
7,036
With no related allowance recorded
$
1,337
$
3,450
$
-
$
1,791
$
149
$
-
$
6,727
With an allowance recorded
337
-
-
-
-
-
337
Total unpaid principal balance of
impaired loans
$
1,674
$
3,450
$
-
$
1,791
$
149
$
-
$
7,064
Allowance for loan losses allocation
$
337
$
-
$
-
$
-
$
-
$
-
$
337
Average recorded investment in impaired loans
during the year ended December 31, 2016
Interest income recognized on impaired loans
during the year ended December 31, 2016
December 31, 2015
Recorded investment in impaired loans:
2,335
2,973
70
176
-
-
1,534
53
159
-
-
-
7,001
299
With no related allowance recorded
$
880
$
2,654
$
-
$
1,442
$
170
$
-
$
5,146
With an allowance recorded
Total recorded investment in
impaired loans
Unpaid principal balance of impaired loans:
348
-
-
-
-
-
348
$
1,228
$
2,654
$
-
$
1,442
$
170
$
-
$
5,494
With no related allowance recorded
$
880
$
2,654
$
-
$
1,470
$
170
$
-
$
5,174
With an allowance recorded
348
-
-
-
-
-
348
Total unpaid principal balance of
impaired loans
$
1,228
$
2,654
$
-
$
1,470
$
170
$
-
$
5,522
Allowance for loan losses allocation
$
348
$
-
$
-
$
-
$
-
$
-
$
348
Average recorded investment in impaired loans
during the year ended December 31, 2015
1,287
8,110
Interest income recognized on impaired loans
during the year ended December 31, 2015
Average recorded investment in impaired loans
during the year ended December 31, 2014
Interest income recognized on impaired loans
during the year ended December 31, 2014
46
368
1,480
11,214
56
345
8
1
24
2
1,505
60
2,450
86
180
-
198
-
-
-
-
-
11,090
475
15,366
489
73
The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days still
accruing by class of loans as of December 31, 2016 and 2015:
December 31, 2016
December 31, 2015
(in thousands)
Nonaccrual
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Total
$
826
1,419
-
957
149
-
3,351
$
Loans Past Due
Over 90 Days
Still Accruing
-
$
-
-
-
-
-
$
-
Loans Past Due
Over 90 Days
Still Accruing
-
$
-
-
-
-
-
$
-
Nonaccrual
$
350
494
-
596
170
-
1,610
$
The following table presents the aging of the recorded investment in past due loans, inclusive of nonaccrual loans,
as of December 31, 2016 by class of loans:
(in thousands)
30 - 59
Days
Past Due
60 - 89
Days
Past Due
Greater Than
90 Days
Past Due
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
169
$
-
-
50
-
-
-
$
-
-
-
-
-
$
612
208
-
421
-
-
Total
Past Due
Loans Not
Past Due
$
781
208
-
471
-
-
$
80,738
190,768
7,897
50,573
27,533
434
Total
$
81,519
190,976
7,897
51,044
27,533
434
Total
$
219
$
-
$
1,241
$
1,460
$
357,943
$
359,403
The following table presents the aging of the recorded investment in past due loans, inclusive of nonaccrual loans,
as of December 31, 2015 by class of loans:
(in thousands)
30 - 59
Days
Past Due
60 - 89
Days
Past Due
Greater Than
90 Days
Past Due
Total
Past Due
Loans Not
Past Due
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
-
$
-
-
49
170
-
-
$
-
-
248
-
-
-
$
222
-
-
-
-
-
$
222
-
297
170
-
$
75,018
175,152
11,341
63,602
21,494
652
Total
$
75,018
175,374
11,341
63,899
21,664
652
Total
$
219
$
248
$
222
$
689
$
347,259
$
347,948
A loan is considered past due if a scheduled payment of interest or principal that is due is unpaid for 30 days or
more.
Troubled Debt Restructurings
From time to time, the Bank may agree to modify the contractual terms of a borrower’s loan. In cases where such
modifications represent a concession to a borrower experiencing financial difficulty, the modification is
considered a troubled debt restructuring (“TDR”). At December 31, 2016 and 2015, loans modified in a TDR
totaled $3,670,000 and $3,863,000 which are included in the impaired loan disclosures above. The total TDRs
74
includes $322,000 and $327,000 that are also included in nonperforming loans at December 31, 2016 and 2015.
TDRs had specific loss allocations of $0 as of December 31, 2016 and 2015.
There were no loans modified as troubled debt restructurings during the years ended December 31, 2016 and
2015 and resulted in no additional allowances or charge-offs during the years ended December 31, 2016 and
2015. There were no loans modified as troubled debt restructurings for which there was a payment default
within twelve months following the modification during the years ended December 31, 2016 and 2015. A loan
is considered to be in payment default once it is 90 days contractually past due under the modified terms.
In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the
probability that the borrower will be in payment default on any of its debt in the foreseeable future without the
modification. This evaluation is performed under the Bank’s internal underwriting policy.
Credit Quality Indicators
The Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to
service their debt such as: current financial information, historical payment experience, credit documentation,
public information, and current economic trends, among other factors. The Bank analyzes loans individually by
classifying the loans as to credit risk. This analysis is performed on a quarterly basis for loans in excess of
$250,000. Smaller balances are graded at origination and updated based on payment status and other information
obtained from borrowers. The Bank uses the following definitions for risk ratings:
SPECIAL MENTION- Loans in this category are considered "criticized" from a regulatory point of view but
are not considered "classified" until the risk classification becomes substandard or worse. Loans in this category
represent above average risk and potential weakness which may, if not corrected, weaken the loan and threaten
repayment at some future date.
SUBSTANDARD- Loans in this category have well defined weakness that jeopardize full repayment of the debt,
although loss does not seem likely. Loss potential does not have to exist in individual loans in the Substandard
classification, but will be apparent in the aggregate. Typically, these loans have not met repayment plans as
agreed. The primary source of repayment may have failed to materialize; repayment may be dependent on
collateral liquidation or other secondary sources. Bankrupt borrowers and those with continuously past due
payments are considered substandard.
DOUBTFUL- Loans in this category have all the characteristics of substandard loans with the added
weakness that payment in full or liquidation in full is 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 strengthening of the loan, its classification as an estimated loss is deferred until the amount of the loss may be
more accurately determined.
PASS- Loans not meeting any of the three criteria above that are analyzed individually as part of the above
described process are considered to be pass rated loans.
75
Based on recent analysis performed as of December 31, 2016 and 2015, the risk category of loans by class
of loans is as follows:
2016
(in thousands)
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Pass
$
69,652
179,540
7,897
49,726
26,765
434
Special
Mention
$
501
3,299
-
-
-
-
Substandard
Doubtful
Total
$
11,366
8,137
-
1,318
768
-
-
$
-
-
-
-
-
$
81,519
190,976
7,897
51,044
27,533
434
Total
$
334,014
$
3,800
$
21,589
$
-
$
359,403
2015
(in thousands)
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Pass
$
69,601
166,819
11,341
62,540
20,857
652
Special
Mention
$
1,960
1,700
-
212
-
-
Substandard
Doubtful
Total
$
3,457
6,855
-
1,147
807
-
$
-
-
-
-
-
-
$
75,018
175,374
11,341
63,899
21,664
652
Total
$
331,810
$
3,872
$
12,266
$
-
$
347,948
Salaries and employee benefits totaling $734,000, $950,000 and $709,000 have been deferred as loan
origination costs for the years ended December 31, 2016, 2015 and 2014, respectively.
Loans totaling $216,673,000 and $217,912,000 were pledged to secure borrowings with the Federal Home
Loan Bank or State of California time deposits at December 31, 2016 and 2015, respectively (see Notes 6
and 8).
4.
OTHER REAL ESTATE OWNED
There was no other real estate owned (OREO) at year end December 31, 2016 and 2015. Sales of OREO
properties resulted in net gains of $0 in 2016, net gains of $1,125,000 in 2015 and net gains of $73,000 in
2014. Operating income, net of rental expenses on OREO was $0, $54,000 and $242,000 for the years ended
December 31, 2016, 2015 and 2014. The OREO sold in 2015 was partially financed by the Bank with a loan
of $2,675,000, which represented 66% of the book value and 52% of the sales price of the OREO.
76
5.
BANK PREMISES AND EQUIPMENT
Bank premises and equipment consisted of the following:
December 31,
(in thousands)
2016
2015
Land
Building
Furniture, fixtures and equipment
Leasehold improvements
Less accumulated depreciation and
amortization
$
1,184
7,590
2,305
781
11,860
$
1,184
7,590
2,347
785
11,906
(6,447)
5,413
$
(6,408)
5,498
$
Depreciation and amortization included in occupancy and equipment expense totaled $312,000, $390,000
and $425,000 for the years ended December 31, 2016, 2015 and 2014, respectively.
6.
INTEREST-BEARING DEPOSITS
The aggregate amount of maturities of all time deposits is as follows:
Year Ending
December 31,
2017
2018
2019
2020
2021
(in thousands)
109,366
$
17,242
2,278
174
195
129,255
$
Interest expense recognized on interest-bearing deposits was as follows:
Year Ended December 31,
(in thousands)
2016
2015
2014
Interest-bearing demand
Savings
Money market
Time deposits
$
$
$
65
10
76
704
855
54
8
127
568
757
35
9
139
666
849
$
$
$
Significant deposit relationships included $48,500,000 at December 31, 2016 and 2015 of public deposits
from the State of California with maturity terms of three to six months. Brokered deposits included in
deposits were $65,854,000 and $71,016,000 at December 31, 2016 and 2015, of which $45,802,000 and
$35,810,000 were through reciprocal deposit programs that are classified as brokered deposits by the FFIEC.
77
7.
BORROWINGS
The Bank has a total of $21,000,000 in Federal funds lines of credit with four correspondent banks at
December 31, 2016 with interest payable at the then current rate. The Bank maintains a letter of credit facility
totaling $4,000,000 with a correspondent bank to guarantee international letters of credit issued to certain
customers. There are $1,964,000 and $1,992,000 of letters of credit issued on behalf of the Bank’s customers
as of December 31, 2016 and 2015, respectively. There were no borrowings outstanding under the Federal
funds lines of credit as of December 31, 2016 or 2015.
8.
FEDERAL HOME LOAN BANK ADVANCES
Each advance is payable at its maturity date, with a prepayment penalty for fixed rate advances. The advances
were collateralized by $202,810,000 and $198,108,000 of loans under a blanket lien arrangement at
December 31, 2016 and 2015. Based on this collateral the Bank was eligible to borrow up to a total of
$120,551,000 and $125,397,000 of which $31,650,000 and $91,397,000 was available for additional
advances as of December 31, 2016 and 2015. Advance balances averaged $58,659,000 in 2016 and
$46,102,000 in 2015.
Advances from the Federal Home Loan Bank were $68,9000,000 at December 31, 2016, with maturities from
January 2017 through February 2018 and fixed rates from 0.55% to 1.00%, averaging 0.70%. Advances were
$35,000,000 at December 31, 2015, with maturities from January 2016 through June 2017 and fixed rates
from 0.27% to 1.05%, averaging 0.50%.
At December 31, 2016, FHLB fixed rate advances are scheduled to mature as follows:
(in thousands)
Weighted
Average
Interest Rate
Due on or before December 31, 2017
Due on or before December 31, 2018
0.62%
1.00%
December 31,
2016
$
$
$
53,900
15,000
68,900
78
9.
INCOME TAXES
The provision for income taxes for the years ended December 31, 2016, 2015 and 2014 consisted of the
following:
(in thousands)
2016
Current
Deferred
Provision for income taxes
Federal
State
Total
$
$
2,115
450
2,565
$
$
766
151
917
$
$
2,881
601
3,482
2015
Federal
State
Total
Current
Deferred
Provision for income taxes
2014
Current
Deferred
$
$
2,238
877
3,115
$
941
173
1,114
$
$
$
3,179
1,050
4,229
Federal
State
Total
$
$
2,868
(37)
2,831
$
950
64
1,014
$
$
$
3,818
27
3,845
Deferred tax assets (liabilities) are comprised of the following:
(in thousands)
Deferred tax assets:
Allowance for loan losses
Future benefit of state tax deduction
Net unrealized losses on available-for-sale
investment securities
Capital loss carryover
Other accruals
Total deferred tax assets
Deferred tax liabilities:
Federal Home Loan Bank stock dividends
Net unrealized gains on available-for-sale
investment securities
Deferred loan costs
Prepaid expenses and other
Bank premises and equipment
December 31,
2016
2015
$
598
326
$
415
354
640
-
103
1,667
(89)
-
(572)
(102)
(138)
-
82
211
1,062
(89)
(363)
-
(34)
(130)
Total deferred tax liabilities
Valuation allowance
Net deferred tax assets
(901)
-
766
$
(616)
(82)
364
$
79
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, 2016, 2015 and 2014 consisted of the following:
2016
2015
2014
(in thousands)
Amount
Rate %
Amount
Rate %
Amount
Rate %
Federal income tax expense,
at statutory rate
State franchise tax expense,
net of Federal tax effect and other
Total income tax expense
$
2,873
34.0%
$
3,488
34.0%
$
3,172
609
3,482
$
7.2%
41.2%
741
4,229
$
7.2%
41.2%
673
3,845
$
34.0%
7.2%
41.2%
The Bank had no unrecognized tax benefits and recorded no interest and penalties for the years ended
December 31, 2016 and 2015. The Bank does not expect a significant change in unrecognized tax benefits in
the next twelve months. The Bank and its subsidiary are subject to U.S. federal income tax as well as income
tax of the State of California. The Bank is no longer subject to examination by federal taxing authorities for
tax years 2012 and prior and by California taxing authorities for tax years 2011 and prior.
10.
COMMITMENTS AND CONTINGENCIES
Leases
The Bank leases various equipment and branch offices in Santa Rosa, Rohnert Park, Petaluma and
Healdsburg under non-cancelable operating leases. These leases include various renewal and termination
options and rental adjustment provisions. Rental expense included in occupancy and equipment expense
totaled $297,000, $288,000 and $279,000 for the years ended December 31, 2016, 2015 and 2014,
respectively. Future minimum lease payments for the next five years are as follows:
Year Ending
December 31,
2017
2018
2019
2020
2021
(in thousands)
342
$
362
335
221
128
1,388
$
The Bank has operating leases with third parties for office space in its head office building. The leases are
for periods from four to five years and contain renewal options. Rental income totaled $559,000, $532,000
and $523,000 for the years ended December 31, 2016, 2015 and 2014 respectively. Minimum future non-
cancellable lease payments from these operating leases are as follows:
Year Ending
December 31,
2017
2018
2019
2020
2021
(in thousands)
$
546
561
148
152
157
1,564
$
80
Federal Reserve Requirements
Banks are required to maintain reserves with the Federal Reserve Bank equal to a percentage of their
reservable deposits less vault cash. The reserve requirement was $7,580,000 and $5,828,000 as of December
31, 2016 and 2015.
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 clients 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 involve, to varying degrees, elements of credit and interest rate risk in excess of the amount
recognized on the consolidated balance sheets.
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 consolidated balance sheets.
The contractual amounts of financial instruments with off-balance-sheet risk at year end were as follows:
December 31,
(in thousands)
2016
Fixed
Rate
Variable
Rate
Commitments to make loans
Unused lines of credit
Standby letters of credit
$
3,090
13,665
-
$
4,638
32,444
1,964
2015
Fixed
Rate
$
8,843
9,507
-
Variable
Rate
$
1,700
28,267
1,992
Commitments to extend credit are agreements to lend to a client as long as there is no violation of any
condition established in the contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily represent future cash
requirements. The Bank evaluates each client's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank upon extension of the credit, is based on management's
credit evaluation of the borrower. Collateral held relating to these commitments varies, but may include
securities, equipment, accounts receivable, inventory and deeds of trust on residential real estate and income-
producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a
client 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 clients. 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,
2016 and 2015. The Bank recognizes these fees as revenue over the term of the commitment or when the
commitment is used.
At December 31, 2016, real estate loan commitments represent 28% of total commitments and are generally
secured by property with a loan-to-value ratio not to exceed 80%. Commercial loan commitments represent
approximately 72% of total commitments and are generally secured by collateral other than real estate or are
unsecured.
81
The FHLB has issued a $20,000,000 letter of credit on the Bank’s behalf to pledge for deposits from the State
of California. The letter of credit expires in May 2017.
Concentrations of Credit Risk
The Bank's business activity is primarily with clients located within Northern California. Although the Bank
has a diversified loan portfolio, a significant portion of its clients' ability to repay loans is dependent upon
the real estate market and various economic factors within Sonoma County. Generally, loans are secured by
various forms of collateral. The Bank's loan policy requires sufficient collateral be obtained as necessary to
meet the Bank's relative risk criteria for each borrower. The Bank's collateral consists primarily of real estate,
accounts receivable, inventory and other financial instruments.
Correspondent Banking Agreements
The Bank maintains funds on deposit with other federally insured financial institutions under correspondent
banking agreements, and $1,310,000 in deposits were uninsured at December 31, 2016.
Contingencies
The Bank 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 condition or results of operations of the Bank.
11.
SHAREHOLDERS' EQUITY
Regulatory Capital
The Bank is subject to certain regulatory capital requirements administered by the Federal Deposit Insurance
Corporation (FDIC). Failure to meet these minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect
on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures
of the Bank's consolidated assets, liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments
by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain
minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average
assets. Each of these components is defined in the regulations. Management believes that the Bank met all
its capital adequacy requirements as of December 31, 2016 and 2015.
At December 31, 2016, the Bank is considered well capitalized 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 below.
The Bank elected not to include Other Accumulated Comprehensive Income in the regulatory capital
calculations.
82
The Bank’s actual and required capital amounts and ratios consisted of the following:
2016
2015
(in thousands)
Amount
Ratio
Amount
Ratio
Common Equity Tier 1 Capital Ratio
Summit State Bank
$
55,388
13.5%
$
52,705
13.5%
Minimum requirement for "Well-Capitalized" institution
Minimum regulatory requirement
$
$
26,719
18,498
6.5%
4.5%
$
$
25,462
17,628
6.5%
4.5%
Tier 1 Capital Ratio
Summit State Bank
$
55,388
13.5%
$
52,705
13.5%
Minimum requirement for "Well-Capitalized" institution
Minimum regulatory requirement
$
$
32,886
24,664
8.0%
6.0%
$
$
31,338
23,504
8.0%
6.0%
Total Capital Ratio
Summit State Bank
$
60,230
14.7%
$
57,480
14.7%
Minimum requirement for "Well-Capitalized" institution
Minimum regulatory requirement
$
$
41,107
32,886
10.0%
8.0%
$
$
39,173
31,338
10.0%
8.0%
Tier 1 Leverage Ratio
Summit State Bank
$
55,388
11.1%
$
52,705
10.5%
Minimum requirement for "Well-Capitalized" institution
Minimum regulatory requirement
$
$
25,001
20,001
5.0%
4.0%
$
$
25,025
20,020
5.0%
4.0%
Dividends
Upon declaration by the Board of Directors, all shareholders of record will be entitled to receive dividends.
The California Financial Code restricts the total dividend payment of any bank in any calendar year without
permission 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, 2016, the current regular dividend (adjusted for the
2017 stock split) of $0.096 per quarter is not subject to the foregoing restrictions and approval.
Preferred Stock
On August 4, 2011, the Bank issued 13,750 shares for $13,750,000 of Fixed Rate Non-cumulative Perpetual
Preferred Stock, Series B (the “Preferred Stock”), which was recorded net of $84,000 in issuance costs. The
Preferred Stock was issued under the Small Business Lending Fund (SBLF) of the U.S. Department of the
Treasury and had an initial non-cumulative dividend rate of 5% per annum. The dividend rate was adjusted
lower each quarter depending on increases that occur in qualifying loans as described in the SBLF program.
The Preferred Stock was redeemed at par value of $13,750,000 on August 31, 2015.
Stock-Based Compensation Plans
The Bank has a 2007 and a 2013 Stock Option Plan (stock option plan or the Plan), which are shareholder-
approved, with each Plan permitting the grant of share options to its employees for up to 187,500 shares of
common stock. Option awards are generally granted with an exercise price equal to the market price of the
Bank’s common stock at the date of grant; those option awards have vesting periods of 5 years unless
83
otherwise approved by the Board of Directors and have 10-year contractual terms. As of December 31, 2016,
there were 187,500 shares available for future grants under the 2013 Plan.
The Bank has granted Stock Appreciation Rights (“SARs”) in 2016 to key employees. The SARs provide
long-term incentives to the employees by providing a cash payment of the difference between the market
price of the Bank’s common stock at time of exercise and the price at the grant date. The expiration of the
SARs are ten years and each has an annual vesting of 20% for the first five years. The compensation expense
is accrued each reporting period as a liability.
The fair value of each option and SARs award is estimated on the date of grant using a closed form option
valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities
are based on historical volatilities of an index consisting of financial institution stocks which should
approximate the future volatility of the Bank’s common stock. The Bank uses historical data to estimate
option and SARs exercise and post-vesting termination behavior. Employee and management options are
tracked separately. The expected term of options and SARs granted is based on historical data and represents
the period of time that options and SARs granted are expected to be outstanding, which takes into account
that the options and SARs are not transferable. The risk-free interest rate for the expected term of the option
and SARs is based on the U.S. Treasury yield curve in effect at the time of the grant.
For the years ended December 31, 2016 and 2015, there was $24,000 and $24,000 in compensation costs
related to non-vested stock options and SARs granted. As of December 31, 2016 and 2015, there was $68,000
and $18,000 of total unrecognized compensation costs related to non-vested stock options and SARs granted.
At December 31, 2016, there were 57,250 vested options outstanding with a range of exercise prices of $4.00
to $8.74 and 79,145 options exercised with a range of exercise prices of $3.72 to $8.74 during the year.
Information related to the stock option plan follows:
2016
2015
2014
Intrinsic value of options exercised
Cash received from option exercises
Tax benefit realized from option exercises
Weighted average fair value of options granted
$
447,000
1,000
12,000
-
$
27,000
34,000
11,000
-
$
4,000
4,000
-
-
84
A summary of the activity in the stock option plan follows:
Year Ended December 31, 2016
Outstanding at beginning of the year
Granted
Exercised
Forfeited or expired
Outstanding at end of the year
Vested or expected to vest
Exercisable at end of year
Year Ended December 31, 2015
Outstanding at beginning of the year
Granted
Exercised
Forfeited or expired
Outstanding at end of the year
Vested or expected to vest
Exercisable at end of year
Year Ended December 31, 2014
Outstanding at beginning of the year
Granted
Exercised
Forfeited or expired
Outstanding at end of the year
Vested or expected to vest
Exercisable at end of year
Shares
136,395
-
(79,145)
-
57,250
57,250
57,250
145,395
-
(6,000)
(3,000)
136,395
136,395
123,145
149,270
-
(875)
(3,000)
145,395
145,395
111,895
Weighted Average
Exercise Price
Weighted Average
Remaining
Contractual Term
Aggregate
Intrinsic Value
$
$
$
$
$
$
$
$
$
$
$
$
5.16
-
5.26
-
5.04
5.04
5.04
5.17
-
5.74
4.40
5.16
5.16
5.25
5.15
-
4.40
4.40
5.17
5.17
5.38
3 years
3 years
3 years
$
$
$
398,000
398,000
398,000
4 years
4 years
4 years
$
$
$
797,000
797,000
710,000
5 years
5 years
5 years
$
$
$
863,000
863,000
641,000
A summary of the activity for the SARs agreements follows:
Shares
Weighted Average
Exercise Price
Weighted Average
Remaining
Contractual Term
Aggregate
Intrinsic Value
Year Ended December 31, 2016
Outstanding at beginning of the year
Granted
Exercised
Forfeited or expired
Outstanding at end of the year
Vested or expected to vest
Exercisable at end of year
-
25,000
-
-
25,000
25,000
-
-
$
2.86
-
-
2.86
$
$
2.86
$
-
10 years
10 years
-
71,000
$
$
71,000
$
-
85
12.
OTHER EXPENSES
Other expenses consisted of the following:
(in thousands)
2016
2015
2014
Year Ended December 31,
Data processing
Professional fees
Director fees and expenses
Nasdaq listing and regulatory license expense
Advertising and promotion
Deposit and other insurance premiums
Telephone and postage
Other real estate owned expenses
Other expenses
13.
EMPLOYEE BENEFIT PLAN
401(k) Employee Savings Plan
$
$
$
1,194
625
518
131
883
387
70
-
646
4,454
925
557
452
136
655
359
75
64
641
3,864
816
732
464
121
682
434
67
200
589
4,105
$
$
$
The Bank has a 401(k) Employee Savings Plan (the "Plan"), qualified under the Internal Revenue Code
(Code), whereby participants may defer a percentage of their compensation, but not in excess of the
maximum allowed under the Code. Bank contributions, as determined by the Board of Directors, are
discretionary and vest immediately. Contributions by the Bank totaled $137,000, $129,000 and $86,000 for
the years ended December 31, 2016, 2015 and 2014, respectively.
14.
RELATED PARTY TRANSACTIONS
During the normal course of business, the Bank enters into loans with related parties, including executive
officers and directors. Other changes are the result of changes in related parties during the year. The following
is a summary of the aggregate activity involving related party borrowers. These loans are made at arm’s
length and are consistent with what other borrowers receive.
2016
2015
(in thousands)
Balance, January 1
New borrowings
Change in related parties
Amounts repaid
Balance, December 31
$
$
4,857
20
2,758
(1,104)
6,531
8,785
247
(3,367)
(808)
4,857
$
$
Undisbursed commitments to related parties
$
1,822
$
117
At December 31, 2016 and 2015, deposits of related parties amounted to $4,920,000 and $1,628,000,
respectively.
86
15.
FAIR VALUE
Accounting standards establish a fair value hierarchy which requires an entity to maximize the use of
observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard
describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has
the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar
assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the
assumptions that market participants would use in pricing an asset or liability.
The fair values of most securities available for sale are determined by matrix pricing, which is a mathematical
technique widely used in the industry to value debt securities without relying exclusively on quoted prices
for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted
securities (Level 2 inputs).
The fair value of impaired loans that are collateral dependent are generally based on 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
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.
Estimated fair values are disclosed for financial instruments for which it is practicable to estimate fair value.
These estimates are made at a specific point in time based on relevant market data and information about the
financial instruments. These estimates do not reflect any premium or discount that could result from offering
the Bank'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.
Because no active market exists for a significant portion of the Bank'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 judgment and therefore cannot be determined with precision. Changes in
assumptions could significantly affect the fair values presented.
The following methods and assumptions were used by the Bank to estimate the fair value of its financial
instruments at December 31, 2016 and 2015:
Cash and cash equivalents: For cash and cash equivalents consisting of cash, due from banks and federal
funds sold, the carrying amount is estimated to be fair value.
Time deposits with banks: Fair values for fixed-rate certificates of deposit are estimated using a discounted
cash flow analysis using interest rates being offered at each reporting date for certificates with similar
maturities.
Investment securities: For investment securities, fair values are based on quoted market prices, where
available. If quoted market prices are not available, fair values are estimated using quoted market prices for
similar securities and indications of value provided by brokers. The carrying amount of accrued interest
receivable approximates its fair value.
87
Loans, net of allowance: For variable-rate loans that reprice frequently with no significant change in credit
risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash
flow analyses, using interest rates being offered at each reporting date for loans with similar terms to
borrowers of comparable creditworthiness (without considering widening credit spreads due to market
illiquidity). The allowance for loan losses is considered to be a reasonable estimate of discount for credit risk.
The carrying amount of accrued interest receivable approximates its fair value.
Federal Home Loan Bank stock: The fair value for Federal Home Loan Bank Stock is subject to restrictions
on its transferability. It is redeemable only by the Federal Home Loan Bank at par value of $100 per share.
Deposits: The fair values for demand deposits are, by definition, equal to the amount payable on demand at
the reporting date represented by their carrying amount. Fair values for fixed-rate certificates of deposit are
estimated using a discounted cash flow analysis using interest rates being offered at each reporting date for
certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates
its fair value.
Short-term borrowings and long-term debt: The fair values of fixed rate borrowings are estimated using a
discounted cash flow analysis that applies interest rates being offered on similar debt instruments. The fair
values of variable rate borrowings are based on carrying value. The carrying amount of accrued interest
payable approximates its fair value.
Commitments to fund loans/standby letters of credit: The fair values of commitments are estimated using
the fees currently charged to enter into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. The differences between the carrying
value of commitments to fund loans or standby letters of credit and their fair value are not significant and,
therefore, are not included in the following table.
The following table presents a summary of the carrying value and fair value by level of financial instruments
on the Bank’s consolidated balance sheet at December 31, 2016 and 2015:
(in thousands)
Financial assets:
December 31, 2016
December 31, 2015
Carrying
Amount
Fair
Value
Fair
Value
Hierarchy
Carrying
Amount
Fair
Value
Fair
Value
Hierarchy
Cash and due from banks
Federal funds sold
Time deposits with banks
Investment securities - held-to-maturity
Investment securities - available-for-sale
Loans, net of allowance
Investment in FHLB stock
Accrued interest receivable
$
24,231
2,000
248
7,976
107,771
354,638
3,085
1,871
$
24,231
2,000
248
7,713
107,771
357,511
3,085
1,871
Financial liabilities:
Deposits
FHLB advances
Accrued interest payable
$
384,251
68,900
74
$
383,964
68,924
74
Level 1
Level 1
Level 2
Level 2
Level 2
Level 3
Level 2
Level 2
Level 2
Level 2
Level 2
$
15,583
2,000
744
5,988
128,599
343,217
2,701
2,164
$
15,583
2,000
744
5,854
128,599
349,317
2,701
2,164
$
397,246
55,800
48
$
397,010
55,812
48
Level 1
Level 1
Level 2
Level 2
Level 2
Level 3
Level 2
Level 2
Level 2
Level 2
Level 2
88
Assets Measured on a Recurring Basis
Assets measured at fair value on a recurring basis are summarized below:
Fair Value Measurements at December 31, 2016
(In thousands)
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
December 31, 2016
Assets:
Securities available-for-sale:
U.S. Treasuries
Government agencies
Mortgage-backed securities - residential
Corporate debt
Total securities available-for-sale
Assets:
Securities available-for-sale:
U.S. Treasuries
Government agencies
Mortgage-backed securities - residential
Corporate debt
Total securities available-for-sale
$
$
7,990
53,444
9,096
37,241
107,771
-
$
-
-
-
$
-
7,990
53,444
9,096
37,241
107,771
-
$
-
-
-
$
-
$
$
Fair Value Measurements at December 31, 2015
(In thousands)
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
December 31, 2015
$
$
9,992
73,465
8,118
37,024
128,599
-
$
-
-
-
$
-
9,992
73,465
8,118
37,024
128,599
-
$
-
-
-
$
-
$
$
There were no significant transfers between Level 1 and Level 2 or Level 3 during 2016 and 2015.
89
Assets Measured on a Non-Recurring Basis
Assets measured at fair value on a non-recurring basis are summarized below:
Assets:
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Impaired loans with specific loss allocations
December 31, 2016
$ -
-
-
-
-
-
$
-
Assets:
Commercial & agricultural
Real estate - commercial
Real estate - construction and land
Real estate - single family
Real estate - multifamily
Consumer & lease financing
Impaired loans with specific loss allocations
December 31, 2015
$ -
-
-
-
-
-
$
-
Fair Value Measurements at December 31, 2016
(In thousands)
Quoted Prices in
(Level 1)
Significant Other
(Level 2)
Significant
(Level 3)
$ -
-
-
-
-
-
$
-
$ -
-
-
-
-
-
$
-
-
$
-
-
-
-
-
$
-
Fair Value Measurements at December 31, 2015
(In thousands)
Quoted Prices in
(Level 1)
Significant Other
(Level 2)
Significant
(Level 3)
$ -
-
-
-
-
-
$
-
$ -
-
-
-
-
-
$
-
-
$
-
-
-
-
-
$
-
The following tables present the valuation techniques covering the majority of Level 3 non-recurring fair
value measurements and the most significant unobservable inputs used in those measurements as of
December 31, 2016 and 2015:
(in thousands)
As of December 31, 2016
Fair Value Methodology
Input
Low
High
Weighted
average
Real estate loans
$
-
Price-based
Appraised value
$
-
$
-
$
-
As of December 31, 2015
Fair Value Methodology
Input
Low
High
Weighted
average
Real estate loans
$
-
Price-based
Appraised value
$
-
$
-
$
-
Fair value estimates are determined as of a specific point in time utilizing quoted market prices, where
available, or various assumptions and estimates. As the assumptions and estimates change, the fair value
of the financial instruments will change. The use of assumptions and various techniques, as well as the
absence of secondary markets for certain financial instruments, will likely reduce the comparability of
value disclosures between companies.
Impaired loans are valued at the fair value less estimated disposal costs of collateral. Impaired loans with
specific loss allocations had a principal balance of $337,000 with a valuation allowance of $337,000 at
December 31, 2016. Impaired loans with specific loss allocations had a principal balance of $348,000 with
a valuation allowance of $348,000 at December 31, 2015.
16.
SUBSEQUENT EVENTS
Subsequent events are events or transactions that occur after the consolidated balance sheet date but before
the consolidated financial statements are issued. The Bank recognizes in the consolidated financial
90
statements the effects of all subsequent events that provide additional evidence about conditions that
existed at the date of the consolidated balance sheet, including these estimates inherent in the process of
preparing the consolidated financial statements. The Bank’s consolidated financial statements do not
recognize subsequent events that provide evidence about conditions that did not exist at the date of the
balance sheet but arose after the balance sheet date and before consolidated financial statements are
available to be issued. The Bank has evaluated subsequent events after December 31, 2016 for potential
recognition and disclosure matters.
The Board of Directors declared a five-for-four stock split on January 23, 2017 to common shareholders
of record on February 28, 2017 and issued on March 14, 2017. The impact of this stock split has been
retroactively applied to periods presented with adjustments to the number of common shares and per
common share values as if the stock split had occurred as of the beginning of each period presented.
On January 23, 2017, the Board of Directors declared a $0.096 (adjusted for the 2017 stock split) per
common share cash dividend to shareholders of record at the close of business on February 17, 2017, that
was paid on February 24, 2017.
17.
QUARTERLY FINANCIAL DATA (Unaudited)
2016
Earnings Per Common
Share
(in thousands except EPS data)
Interest
Income
Net Interest
Income
Net Income
Basic
Diluted
First quarter
Second quarter
Third quarter
Fourth quarter
$
5,034
5,058
4,844
4,971
$
4,703
4,756
4,545
4,669
$
1,328
1,254
1,198
1,187
$
0.22
0.21
0.20
0.20
$
0.22
0.21
0.19
0.20
2015
Earnings Per Common
Share
Interest
Income
Net Interest
Income
Net Income
Basic
Diluted
First quarter
Second quarter
Third quarter
Fourth quarter
$
4,378
4,570
4,751
4,874
$
4,155
4,351
4,509
4,622
$
1,722
1,746
1,280
1,282
$
0.28
0.29
0.21
0.22
$
0.28
0.28
0.21
0.22
91
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(A) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer,
evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2016.
The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities and Exchange Act of 1934, means controls and other procedures of a Bank that are
designed to ensure that information required to be disclosed by a company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized, and reported, within
the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that information required
to be disclosed by a company in the reports that it files and submits under the Exchange Act is
accumulated and communicated to the Bank’s management, including its principal executive and
principle financial officers, as appropriate to allow timely decisions regarding required disclosure.
Based on the evaluation of our disclosure controls and procedures as of December 31, 2016, our
chief executive officer and chief financial officer concluded that, as of such date, our disclosure
controls and procedures were effective.
The Audit Committee of the Board of Directors, which is composed solely of independent
directors, meets regularly with our independent registered public accounting firm, Moss Adams
LLP, and representatives of management to review accounting, financial reporting, internal control
and audit matters, as well as the nature and extent of the audit effort. The Audit Committee is
responsible for the engagement of the independent auditors. The independent auditors have free
access to the Audit Committee.
(B) Management’s Annual Report on Internal Control over Financial Reporting
The Bank’s management is responsible for establishing and maintaining adequate control over
financial reporting for the Bank, as such term is defined in Rules 13a-15(f) and 15d-15(f) under
the Securities Exchange Act of 1934. Under the supervision and with the participation of the
Bank’s management, including our principal executive and principal financial officers, the Bank
conducted an evaluation of the effectiveness of its internal control over financial reporting based
on the framework in Internal Control – Integrated Framework (1992) issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the “COSO Framework”). Based on this
evaluation under the COSO Framework, management concluded that its internal control over
financial reporting was effective as of December 31, 2016.
(C) Changes in Internal Control over Financial Reporting
92
During the quarter ended December 31, 2016, the Registrant did not make any significant
changes in, nor take any corrective actions regarding, its internal control over financial reporting
or other factors that has materially affected, or is reasonably likely to materially affect the
registrants’ internal control over financial reporting.
(D) Audit Report of the Independent Registered Public Accounting Firm
This annual report does not include an audit report of the Bank’s independent registered public
accounting firm regarding internal control over financial reporting. Management’s report was not
subject to attestation by the Bank’s independent registered public accounting firm pursuant to rules
of the Securities and Exchange Commission that permit the Bank to provide only management’s
report in this annual report.
ITEM 9B. OTHER INFORMATION
None.
93
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We intend to file a definitive proxy statement for the 2017 Annual Meeting of Shareholders (or
“the Proxy Statement”) with the FDIC within 120 days of December 31, 2016. Information
regarding directors of Summit State Bank will appear under the caption —Proposal 1: “Election
of Directors” in the Proxy Statement and is incorporated herein by reference. Information about
Summit State Bank’s Audit Committee Financial Expert will appear under the caption “The
Committees of the Board—Audit Committee” and is incorporated herein by reference. The Bank
has adopted a code of ethics applicable to all of our directors and employees, including the
principal executive officer, principal financial officer and principal accounting officer.
Information regarding section 16(a) filing requirements will appear under the caption “Section
16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement and is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will appear under the captions “EXECUTIVE
OFFICERS OF THE BANK,” “EXECUTIVE COMPENSATION, EMPLOYMENT
CONTRACTS” AND BOARD OF DIRECTORS’ REPORT ON COMPENSATON,” in the Proxy
Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table summarizes information as of December 31, 2016 relating to equity
compensation plans of Summit State Bank pursuant to which grants of options, restricted stock, or
other rights to acquire shares may be granted from time to time.
Number of
securities
to be issued
upon
exercise of
outstanding
options
Weighted
average
exercise
price of
outstanding
options
Number of
securities
remaining
available for
future issuance
under equity
compensation
plans (excluding
securities
reflected in
column (a))
57,250
$ 5.04
187,500
94
Plan category
Equity compensation plans:
Approved by security holders
Information regarding security ownership of certain beneficial owners and management and
related shareholder matters will appear under the caption “EQUITY COMPENSATION PLAN
INFORMATION,” “SECURITY OWNERSHIP OF MANAGEMENT” AND “PRINCIPAL
SHAREHOLDERS” in the Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
DIRECTOR INDEPENDENCE
Information regarding certain relationships and related transactions will appear under the
caption “TRANSACTIONS WITH RELATED PERSONS” in the Proxy Statement and is
incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding fees paid to our independent registered public accounting firm, will
appear under the caption —Proposal 2. Ratification of Selection of Independent Public Accounts
“FEES PAID TO INDEPENDENT PUBLIC ACCOUNTANTS” in the Proxy Statement and is
incorporated herein by reference.
95
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements
The following documents are filed as part of this report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2016 and 2015
Consolidated Statements of Income for each of the years in the three-year period ended December
31, 2016
Consolidated Statements of Comprehensive Income for each of the years in the three-year period
ended December 31, 2016
Consolidated Statements of Changes in Shareholders’ Equity for each of the years in the three-
year period ended December 31, 2016
Consolidated Statements of Cash Flows for each of the years in the three-year period ended
December 31, 2016
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Not applicable
3. Exhibits
(b) Exhibits Required by Item 601 of Regulation S-K
Reference is made to the Exhibit Index on page 99 for exhibits filed as part of this report.
(c) Additional Financial Statements
Not applicable.
ITEM 16. FORM 10-K SUMMARY
None.
96
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Summit State Bank
By
/s/ Dennis E. Kelley
Dennis E. Kelley
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
March 23, 2017
Summit State Bank
By
/s/ James E. Brush
James E. Brush
President and
Chief Executive Officer
(Principal Executive Officer)
March 23, 2017
97
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Registrant in the capacities and on the dates
indicated.
Dated: March 23, 2017
/s/ James E. Brush
James E. Brush, President and Chief Executive Officer
(Principal Executive Officer) and Director
Dated: March 23, 2017
Dated: March 23, 2017
Dated: March 23, 2017
Dated: March 23, 2017
/s/ Jeffery B. Allen
Jeffery B. Allen, Director
/s/ Josh C. Cox, Jr.
Josh C. Cox, Jr., Director
/s/ Bridget M. Doherty
Bridget M. Doherty, Director
/s/ Todd R. Fry
Todd R. Fry, Director
Dated: March 23, 2017
/s/ Allan J. Hemphill
Allan J. Hemphill, Chairman of the Board and Director
Dated: March 23, 2017
/s/ Dennis E. Kelley
Dennis E. Kelley, Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
Dated: March 23, 2017
Dated: March 23, 2017
Dated: March 23, 2017
Dated: March 23, 2017
Dated: March 23, 2017
/s/ Ronald A. Metcalfe
Ronald A. Metcalfe, Director
/s/ Richard E. Pope
Richard E. Pope, Director
/s/ Nicholas J. Rado
Nicholas J. Rado, Director
/s/ Marshall T. Reynolds
Marshall T. Reynolds, Director
/s/ John W. Wright
John W. Wright, Director
98
EXHIBIT
NO.
EXHIBIT INDEX
EXHIBIT
3.1
3.2
3.3
4.1
4.2
Articles of Incorporation of the registrant (1) (2) (3)
Amendment of Articles of Incorporation dated January 23, 2017
By-laws of the registrant (4)
Specimen of the registrant’s common stock certificate (1) (2) (3)
The total amount of the registrant’s long-term debt does not exceed 10 percent of the total
assets of the registrant and its subsidiaries on a consolidated basis. Pursuant to Item
601(b)(4)(iii)(A) of Regulation S-K, the registrant agrees to file any instrument with
respect to such long-term debt upon request of the FDIC.
2007 Stock Option Plan (4)
2013 Equity Incentive Plan (5)
10.1
10.2
10.3 Change in Control Agreement with Dennis Kelley (6)
10.4 Change in Control Agreement with Linda Bertauche (6)
10.5 Change in Control Agreement with Brandy Seppi (7)
10.6 Change in Control Agreement with Brian Reed (8)
10.7 Cash Incentive Bonus Plan (9)
10.8 Stock Appreciation Rights Agreement with Brian Reed (10)
10.9 Stock Appreciation Rights Agreement with Brandy Seppi (10)
14.1 Code of Ethics (11)
21.1 Subsidiaries of the registrant (1)
31.1 Rule 13a-14(a)/15d-14(a) Certification
31.2 Rule 13a-14(a)/15d-14(a) Certification
32.1 Section 1350 certifications
(1) Incorporated by reference from Summit State Bank’s Form 10 filed with the FDIC on June 19, 2006.
(2) Incorporated by reference from Summit State Bank’s Form 10/A Amendment No. 1 filed with the FDIC on July 12, 2006.
(3) Incorporated by reference from Summit State Bank’s Form 10/A Amendment No. 2 filed with the FDIC on July 13, 2006.
(4) Incorporated by reference from Summit State Bank’s Definitive Proxy Statement filed with the FDIC on April 27, 2007.
(5) Incorporated by reference from Summit State Bank’s Definitive Proxy Statement filed with the FDIC on June 10, 2013.
(6) Incorporated by reference from Summit State Bank’s Form 10-Q filed with the FDIC on November 13, 2014.
(7) Incorporated by reference from Summit State Bank’s Form 10-K filed with the FDIC on March 12, 2015.
(8) Incorporated by reference from Summit State Bank’s Form 8-K filed with the FDIC on February 14, 2017.
(9) Incorporated by reference from Summit State Bank’s Form 8-K filed with the FDIC on April 22, 2016.
(10) Incorporated by reference from Summit State Bank’s Form 8-K filed with the FDIC on December 14, 2016.
(11) Incorporated by reference from Summit State Bank’s Form 10-K filed with the FDIC on March 28, 2007.
99
EXHIBIT 3.2
Amendment of Articles of Incorporation dated January 23, 2017
100
EXHIBIT 31.1
Certification pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to §302 of the
Sarbanes-Oxley Act of 2002.
I, James E. Brush, Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Summit State Bank (the Registrant);
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial information included in
this report, fairly present in all material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in this report;
4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a- 15(e) and 15d-15(e))
and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-
15(f)) for the Registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the Registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, 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;
(c) Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls and
procedures as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the Registrant’s internal control over financial reporting
that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal
quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the Registrant’s internal control over financial reporting; and
5. The Registrant’s other certifying officer and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit
committee of Registrant’s Board of Directors (or persons performing the equivalent functions):
101
(a) all significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting, which are reasonably likely to adversely affect the Registrant’s
ability to record, process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other employees who have a
significant role in the Registrant’s internal control over financial reporting.
Dated: March 23, 2017
/s/ James E. Brush
James E. Brush
President and Chief Executive Officer
(Principal Executive Officer)
102
EXHIBIT 31.2
Certification pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to §302 of the
Sarbanes-Oxley Act of 2002.
I, Dennis E. Kelley, Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Summit State Bank (the Registrant);
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or
omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial information included in
this report, fairly present in all material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in this report;
4. The Registrant’s other certifying officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act Rules 13a- 15(e) and 15d-15(e))
and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-
15(f)) for the Registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the Registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over
financial reporting to be designed under our supervision, 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;
(c) Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls and
procedures as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the Registrant’s internal control over financial reporting
that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal
quarter in the case of an annual report) that has materially affected, or is reasonably likely to
materially affect, the Registrant’s internal control over financial reporting; and
5. The Registrant’s other certifying officer and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit
committee of Registrant’s Board of Directors (or persons performing the equivalent functions):
103
(a) all significant deficiencies and material weaknesses in the design or operation of internal
control over financial reporting, which are reasonably likely to adversely affect the Registrant’s
ability to record, process, summarize and report financial information; and
(b) any fraud, whether or not material, that involves management or other employees who have a
significant role in the Registrant’s internal control over financial reporting.
Dated: March 23, 2017
/s/ Dennis E. Kelley
Dennis E. Kelley
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
104
EXHIBIT 32.1
Certification pursuant to 18 U.S.C. §1350
In connection with the annual report on Form 10-K of Summit State Bank (the Registrant) for the
year ended December 31, 2016, as filed with the Federal Deposit Insurance Corporation, the
undersigned hereby certify pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the
Sarbanes-Oxley Act of 2002, that:
1) such Form 10-K fully complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934; and
2) the information contained in such Form 10-K fairly presents, in all material respects, the
financial condition and results of operations of the Registrant.
Dated: March 23, 2017
Dated: March 23, 2017
/s/ James E. Brush
James E. Brush
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Dennis E. Kelley
Dennis E. Kelley
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
105