UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark one)

☒

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2018

or

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to______________.

 

Commission File Number: 001-09383

 

WESTAMERICA BANCORPORATION

(Exact name of the registrant as specified in its charter)

 

CALIFORNIA	94-2156203
(State or Other Jurisdiction	(I.R.S. Employer
of Incorporation or Organization)	Identification Number)

 

1108 FIFTH AVENUE, SAN RAFAEL, CALIFORNIA 94901

(Address of principal executive offices) (zip code)

 

Registrant’s telephone number, including area code: (707) 863-6000

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of class:	Name of each exchange on which registered:
Common Stock, no par value	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 ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ☐ NO ☒

 

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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ☒ NO ☐

 

Indicate by check mark if whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files.) YES ☒ NO ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K (section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the 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, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☒	Accelerated filer ☐		Non-accelerated filer ☐
Smaller reporting company ☐		Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒

 

The aggregate market value of the Common Stock held by non-affiliates of the registrant as of June 30, 2018 as reported on the NASDAQ Global Select Market, was $1,072,647,598.47 . Shares of Common Stock held by each executive officer and director and by each person who owns 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

Number of shares outstanding of each of the registrant’s classes of common stock, as of the close of business on February 20, 2019: 26,889,495 Shares

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the definitive Proxy Statement relating to registrant’s Annual Meeting of Shareholders, to be held on April 25, 2019, are incorporated by reference in Items 10, 11, 12, 13 and 14 of Part III to the extent described therein.

 

TABLE OF CONTENTS

 

 

		Page
PART I
Item 1	Business	2
Item 1A	Risk Factors	9
Item 1B	Unresolved Staff Comments	14
Item 2	Properties	14
Item 3	Legal Proceedings	14
Item 4	Mine Safety Disclosures	15
PART II
Item 5	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	15
Item 6	Selected Financial Data	19
Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 7A	Quantitative and Qualitative Disclosures About Market Risk	46
Item 8	Financial Statements and Supplementary Data	46
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	93
Item 9A	Controls and Procedures	93
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	95
Item 13	Certain Relationships, Related Transactions and Director Independence	95
Item 14	Principal Accountant Fees and Services	95
PART IV
Item 15	Exhibits, Financial Statement Schedules	95
Signatures		96
Exhibit Index		97

 

FORWARD-LOOKING STATEMENTS

 

This Report on Form 10-K contains forward-looking statements about Westamerica Bancorporation for which it claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, future credit quality and performance, the appropriateness of the allowance for loan losses, loan growth or reduction, mitigation of risk in the Company’s loan and investment securities portfolios, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or board of directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", “estimates”, "intends", "targeted", "projected", “forecast”, "continue", "remain", "will", "should", "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

 

These forward-looking statements are based on Management’s current knowledge and belief and include information concerning the Company’s possible or assumed future financial condition and results of operations. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. These factors include but are not limited to (1) the length and severity of any difficulties in the global, national and California economies and the effects of government efforts to address those difficulties; (2) liquidity levels in capital markets; (3) fluctuations in asset prices including, but not limited to stocks, bonds, real estate, and commodities; (4) the effect of acquisitions and integration of acquired businesses; (5) economic uncertainty created by terrorist threats and attacks on the United States, the actions taken in response, and the uncertain effect of these events on the national and regional economies; (6) changes in the interest rate environment; (7) changes in the regulatory environment; (8) competitive pressure in the banking industry; (9) operational risks including a failure or breach in data processing or security systems or those of third party vendors and other service providers, including as a result of cyber attacks or fraud; (10) volatility of interest rate sensitive loans, deposits and investments; (11) asset/liability management risks and liquidity risks; (12) the effect of natural disasters, including earthquakes, hurricanes, fire, flood, drought, and other disasters, on the uninsured value of the Company’s assets and of loan collateral, the financial condition of debtors and issuers of investment securities, the economic conditions affecting the Company’s market place, and commodities and asset values; (13) changes in the securities markets and (14) the outcome of contingencies, such as legal proceedings. However, the reader should not consider the above-mentioned factors to be a complete set of all potential risks or uncertainties.

 

Forward-looking statements speak only as of the date they are made. The Company undertakes no obligation to update any forward-looking statements in this report to reflect circumstances or events that occur after the date forward looking statements are made, except as may be required by law. See also “Risk Factors” in Item 1A and other risk factors discussed elsewhere in this report.

 

 

PART I

 

ITEM 1. BUSINESS

 

Westamerica Bancorporation (the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (“BHCA”). Its legal headquarters are located at 1108 Fifth Avenue, San Rafael, California 94901. Principal administrative offices are located at 4550 Mangels Boulevard, Fairfield, California 94534 and its telephone number is (707) 863-6000. The Company provides a full range of banking services to individual and commercial customers in Northern and Central California through its subsidiary bank, Westamerica Bank (“WAB” or the “Bank”). The principal communities served are located in Northern and Central California, from Mendocino, Lake and Nevada Counties in the north to Kern County in the south. The Company’s strategic focus is on the banking needs of small businesses. In addition, the Bank owns 100% of the capital stock of Community Banker Services Corporation (“CBSC”), a company engaged in providing the Company and its subsidiaries with data processing services and other support functions.

 

The Company was incorporated under the laws of the State of California in 1972 as “Independent Bankshares Corporation” pursuant to a plan of reorganization among three previously unaffiliated Northern California banks. The Company operated as a multi-bank holding company until mid-1983, at which time the then six subsidiary banks were merged into a single bank named Westamerica Bank and the name of the holding company was changed to Westamerica Bancorporation.

 

The Company acquired five banks within its immediate market area during the early to mid 1990’s. In April 1997, the Company acquired ValliCorp Holdings, Inc., parent company of ValliWide Bank, the largest independent bank holding company headquartered in Central California. Under the terms of all of the merger agreements, the Company issued shares of its common stock in exchange for all of the outstanding shares of the acquired institutions. The subsidiary banks acquired were merged with and into WAB. These six  aforementioned business combinations were accounted for as poolings-of-interests.

 

During the period 2000 through 2005, the Company acquired three additional banks. These acquisitions were accounted for using the purchase accounting method.

 

On February 6, 2009, Westamerica Bank acquired the banking operations of County Bank (“County”) from the Federal Deposit Insurance Corporation (“FDIC”). On August 20, 2010, Westamerica Bank acquired assets and assumed liabilities of the former Sonoma Valley Bank (“Sonoma”) from the FDIC. The County and Sonoma acquired assets and assumed liabilities were measured at estimated fair values, as required by FASB ASC 805, Business Combinations.

 

At December 31, 2018, the Company had consolidated assets of approximately $5.6 billion, deposits of approximately $4.9 billion and shareholders’ equity of approximately $616 million. The Company and its subsidiaries employed 762 full-time equivalent staff as of December 31, 2018.

 

The Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports as well as beneficial ownership reports on Forms 3, 4 and 5 are available through the SEC’s website (https://www.sec.gov). Such documents as well as the Company’s director, officer and employee Code of Conduct and Ethics are also available free of charge from the Company by request to:

 

Westamerica Bancorporation

Corporate Secretary A-2M

Post Office Box 1200

Suisun City, California 94585-1200

 

Supervision and Regulation

 

The following is not intended to be an exhaustive description of the statutes and regulations applicable to the Company’s or the Bank’s business. The description of statutory and regulatory provisions is qualified in its entirety by reference to the particular statutory or regulatory provisions. Moreover, major new legislation and other regulatory changes affecting the Company, the Bank, and the financial services industry in general have occurred in the last several years and can be expected to occur in the future. The nature, timing and impact of new and amended laws and regulations cannot be accurately predicted.

 

Regulation and Supervision of Bank Holding Companies

 

The Company is a bank holding company subject to the BHCA. The Company reports to, is registered with, and may be examined by, the Board of Governors of the Federal Reserve System (“FRB”). The FRB also has the authority to examine the Company’s subsidiaries. The Company is a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and the Bank are subject to examination by, and may be required to file reports with, the Commissioner of the California Department of Business Oversight (the “Commissioner”).

 

The FRB has significant supervisory and regulatory authority over the Company and its affiliates. The FRB requires the Company to maintain certain levels of capital. See “Capital Standards.” The FRB also has the authority to take enforcement action against any bank holding company that commits any unsafe or unsound practice, or violates certain laws, regulations or conditions imposed in writing by the FRB. Under the BHCA, the Company is required to obtain the prior approval of the FRB before it acquires, merges or consolidates with any bank or bank holding company. Any company seeking to acquire, merge or consolidate with the Company also would be required to obtain the prior approval of the FRB.

 

The Company is generally prohibited under the BHCA from acquiring ownership or control of more than 5% of any class of voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than banking, managing banks, or providing services to affiliates of the holding company. However, a bank holding company, with the approval of the FRB, may engage, or acquire the voting shares of companies engaged, in activities that the FRB has determined to be closely related to banking or managing or controlling banks. A bank holding company must demonstrate that the benefits to the public of the proposed activity will outweigh the possible adverse effects associated with such activity.

 

The FRB generally prohibits a bank holding company from declaring or paying a cash dividend that would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements which might adversely affect a bank holding company’s financial position. Under the FRB policy, a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. See the section entitled “Restrictions on Dividends and Other Distributions” for additional restrictions on the ability of the Company and the Bank to pay dividends.

 

Transactions between the Company and the Bank are restricted under Regulation W. The regulation codifies prior interpretations of the FRB and its staff under Sections 23A and 23B of the Federal Reserve Act. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in “covered transactions” with affiliates: (a) to an amount equal to 10% of the bank’s capital and surplus, in the case of covered transactions with any one affiliate; and (b) to an amount equal to 20% of the bank’s capital and surplus, in the case of covered transactions with all affiliates. The Company is considered to be an affiliate of the Bank. A “covered transaction” includes, among other things, a loan or extension of credit to an affiliate; a purchase of securities issued by an affiliate; a purchase of assets from an affiliate, with some exceptions; and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.

 

Federal regulations governing bank holding companies and change in bank control (Regulation Y) provide for a streamlined and expedited review process for bank acquisition proposals submitted by well-run bank holding companies. These provisions of Regulation Y are subject to numerous qualifications, limitations and restrictions. In order for a bank holding company to qualify as “well-run,” both it and the insured depository institutions which it controls must meet the “well capitalized” and “well managed” criteria set forth in Regulation Y.

 

The Gramm-Leach-Bliley Act (the “GLBA”), or the Financial Services Act of 1999, repealed provisions of the Glass-Steagall Act, which had prohibited commercial banks and securities firms from affiliating with each other and engaging in each other’s businesses. Thus, many of the barriers prohibiting affiliations between commercial banks and securities firms have been eliminated.

 

The BHCA was also amended by the GLBA to allow new “financial holding companies” (“FHCs”) to offer banking, insurance, securities and other financial products to consumers. Specifically, the GLBA amended section 4 of the BHCA in order to provide for a framework for the engagement in new financial activities. A bank holding company (“BHC”) may elect to become an FHC if all its subsidiary depository institutions are well capitalized and well managed. If these requirements are met, a BHC may file a certification to that effect with the FRB and declare that it elects to become an FHC. After the certification and declaration is filed, the FHC may engage either de novo or through an acquisition in any activity that has been determined by the FRB to be financial in nature or incidental to such financial activity. BHCs may engage in financial activities without prior notice to the FRB if those activities qualify under the list of permissible activities in section 4(k) of the BHCA. However, notice must be given to the FRB within 30 days after an FHC has commenced one or more of the financial activities. The Company has not elected to become an FHC.

 

Regulation and Supervision of Banks

 

The Bank is a California state-chartered Federal Reserve member bank and its deposits are insured by the FDIC. The Bank is subject to regulation, supervision and regular examination by the California Department of Business Oversight (“DBO”) and the FRB. The regulations of these agencies affect most aspects of the Bank’s business and prescribe permissible types of loans and investments, the amount of required reserves, requirements for branch offices, the permissible scope of its activities and various other requirements.

 

In addition to federal banking law, the Bank is also subject to applicable provisions of California law. Under California law, the Bank is subject to various restrictions on, and requirements regarding, its operations and administration including the maintenance of branch offices and automated teller machines, capital requirements, deposits and borrowings, shareholder rights and duties, and investment and lending activities.

 

In addition, the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) imposes limitations on the activities and equity investments of state chartered, federally insured banks. FDICIA also prohibits a state bank from making an investment or engaging in any activity as a principal that is not permissible for a national bank, unless the Bank is adequately capitalized and the FDIC approves the investment or activity after determining that such investment or activity does not pose a significant risk to the deposit insurance fund.

 

On July 21, 2010, financial regulatory reform legislation entitled the "Dodd-Frank Wall Street Reform and Consumer Protection Act" (the "Dodd-Frank Act") was signed into law. The Dodd-Frank Act implemented far-reaching changes across the financial regulatory landscape, including provisions that, among other things:

 

•

Centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing, examining and (as to banks with $10 billion or more in assets) enforcing compliance with federal consumer financial laws.

•

Restricted the preemption of state law by federal law and disallowed subsidiaries and affiliates of national banks from availing themselves of such preemption.

•

Applied the same leverage and risk-based capital requirements that would apply to insured depository institutions to most bank holding companies.

•

Required bank regulatory agencies to seek to make their capital requirements for banks countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction.

•

Changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminated the ceiling on the size of the Deposit Insurance Fund ("DIF") and increased the floor of the size of the DIF.

•

Imposed comprehensive regulation of the over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institution itself.

•

Required large, publicly traded bank holding companies to create a risk committee responsible for the oversight of enterprise risk management.

•

Implemented corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, that would apply to all public companies, not just financial institutions.

•

Made permanent the $250 thousand limit for federal deposit insurance.

•

Repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.

•

Amended the Electronic Fund Transfer Act ("EFTA") to, among other things, give the FRB the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. While the Company’s assets are currently less than $10 billion, interchange fees charged by larger institutions may dictate the level of fees smaller institutions will be able to charge to remain competitive.

 

Provisions in the legislation that affect the payment of interest on demand deposits and interchange fees may increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate.

 

Capital Standards

 

The federal banking agencies have risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations for both transactions resulting in assets being recognized on the balance sheet as assets, and the extension of credit facilities such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. government securities, to 1250% for assets with relatively higher credit risk, such as certain securitizations. A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk-adjusted assets and off balance sheet items.

 

The federal banking agencies take into consideration concentrations of credit risk and risks from nontraditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation is made as a part of the institution’s regular safety and soundness examination. The federal banking agencies also consider interest rate risk (related to the interest rate sensitivity of an institution’s assets and liabilities, and its off balance sheet financial instruments) in the evaluation of a bank’s capital adequacy.

 

As of December 31, 2018, the Company’s and the Bank’s respective ratios exceeded applicable regulatory requirements. See Note 9 to the consolidated financial statements for capital ratios of the Company and the Bank, compared to minimum capital requirements and for the Bank the standards for well capitalized depository institutions.

 

On July 2, 2013, the Federal Reserve Board approved a final rule that implements changes to the regulatory capital framework for all banking organizations over a transitional period 2015 through 2018.

 

See the sections entitled “Capital Resources and Capital to Risk-Adjusted Assets” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional information.

 

Prompt Corrective Action and Other Enforcement Mechanisms

 

FDICIA requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios.

 

An institution that, based upon its capital levels, is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. 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 or any condition imposed in writing by the agency or any written agreement with the agency.

 

Safety and Soundness Standards

 

FDICIA has implemented certain specific restrictions on transactions and required federal banking regulators to adopt overall safety and soundness standards for depository institutions related to internal control, loan underwriting and documentation, and asset growth. Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, restricts the use of brokered deposits, limits the aggregate extensions of credit by a depository institution to an executive officer, director, principal shareholder or related interest, and reduces deposit insurance coverage for deposits offered by undercapitalized institutions for deposits by certain employee benefits accounts. The federal banking agencies may require an institution to submit an acceptable compliance plan as well as have the flexibility to pursue other more appropriate or effective courses of action given the specific circumstances and severity of an institution’s noncompliance with one or more standards.

 

Federal banking agencies require banks to maintain adequate valuation allowances for potential credit losses. The Company has an internal staff that continually reviews loan quality and reports to the Board of Directors. This analysis includes a detailed review of the classification and categorization of problem loans, assessment of the overall quality and collectability of the loan portfolio, consideration of loan loss experience, trends in problem loans, concentration of credit risk, and current economic conditions, particularly in the Bank’s market areas. Based on this analysis, Management, with the review and approval of the Board, determines the adequate level of allowance required. The allowance is allocated to different segments of the loan portfolio, but the entire allowance is available for the loan portfolio in its entirety.

 

Restrictions on Dividends and Other Distributions

 

The Company’s ability to pay dividends to its shareholders is subject to the restrictions set forth in the California General Corporation Law (“CGCL”). The CGCL provides that a corporation may make a distribution to its shareholders if (i) the corporation’s retained earnings equal or exceed the amount of the proposed distribution plus unpaid accrued dividends (if any) on securities with a dividend preference, or (ii) immediately after the dividend, the corporation’s total assets equal or exceed total liabilities plus unpaid accrued dividends (if any) on securities with a dividend preference.

 

The Company’s ability to pay dividends depends in part on the Bank’s ability to pay cash dividends to the Company. The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions. FDICIA prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions, including dividends, if, after such transaction, the institution would be undercapitalized.

 

In addition to the restrictions imposed under federal law, banks chartered under California law generally may only pay cash dividends to the extent such payments do not exceed the lesser of retained earnings of the bank or the bank’s net income for its last three fiscal years (less any distributions to shareholders during this period). In the event a bank desires to pay cash dividends in excess of such amount, the bank may pay a cash dividend with the prior approval of the Commissioner in an amount not exceeding the greatest of the bank’s retained earnings, the bank’s net income for its last fiscal year or the bank’s net income for its current fiscal year.

 

The federal banking agencies also have the authority to prohibit a depository institution or its holding company from engaging in business practices which are considered to be unsafe or unsound, possibly including payment of dividends or other payments under certain circumstances even if such payments are not expressly prohibited by statute. The Federal Reserve Board has issued guidance indicating its expectations that a bank holding company will inform and consult with Federal Reserve supervisory staff sufficiently in advance of (i) declaring and paying a dividend that could raise safety and soundness concerns (e.g., declaring and paying a dividend that exceeds earnings for the period for which the dividend is being paid); (ii) redeeming or repurchasing regulatory capital instruments when the bank holding company is experiencing financial weaknesses; or (iii) redeeming or repurchasing common stock or perpetual preferred stock that would result in a net reduction as of the end of the quarter in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred.

 

Premiums for Deposit Insurance

 

Substantially all of the deposits of the Bank are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank's capital level, asset quality and supervisory rating ("CAMELS rating").

 

In July 2010, Congress in the Dodd-Frank Act increased the minimum for the DIF reserve ratio, the ratio of the amount in the fund to insured deposits, from 1.15% to 1.35% and required that the ratio reach that level by September 30, 2020. Further, the Dodd-Frank Act made banks with $10 billion or more in assets responsible for the increase from 1.15% to 1.35%, among other provisions.

 

In October 2010, the FDIC adopted a new DIF restoration plan to ensure the DIF reaching 1.35% by September 30, 2020. In assessing its progress in restoring the reserves, at least semi-annually, the FDIC updates its loss and income projections for the fund and, if needed, increases or decreases assessment rates, following notice-and-comment rulemaking, if required.

 

In February 2011, the FDIC adopted a final rule effective April 1, 2011 to:

 

(1)

Redefine the deposit insurance assessment base from total domestic deposits to average total assets minus average tangible equity as required by the Dodd-Frank Act;

(2)

Change the deposit insurance assessment rates (which provide for progressively lower assessment rate schedules that will take effect when the reserve ratio exceeds 1.15%, 2%, and 2.5%) ;

(3)

Implement the Dodd-Frank Act DIF dividend provisions; and

(4)

Revise the risk-based assessment system for all “large” and “highly complex” insured depository institutions. “Large” depository institutions are defined generally as having more than $10 billion in assets and "highly complex" institutions have over $50 billion in assets and are fully owned by a parent with over $500 billion in assets. The Bank is neither a “large” nor “highly complex” institution.

 

In March, 2016, the FDIC issued a final rule to increase the DIF reserve ratio to the statutory minimum level of 1.35%, effective July 1, 2016, if the reserve ratio reached 1.15% before that date.

 

In August, 2016, the FDIC announced the DIF reserve ratio surpassed the 1.15% reserve ratio target, triggering three major changes:

 

(1)

The decline in the range of initial assessment rates for all banks from 5-35 basis points to 3-30 basis points;

(2)

The assessment of a quarterly surcharge on large banks equal to an annual rate of 4.5 basis points in addition to regular assessments; and

(3)

A revised method to calculate risk-based assessment rates for established small banks (under $1 billion in assets) pursuant to an FDIC final rule issued April, 2016.

 

In September 2018, the FDIC issued a Financial Institutions Letter stating the Deposit Insurance Fund Reserve Ratio reached 1.36%, exceeding the statutorily required minimum reserve ratio of 1.35% ahead of the September 30, 2020, deadline required under the Dodd-Frank Act. FDIC regulations provide for two changes to deposit insurance assessments upon reaching the minimum: (1) surcharges on insured depository institutions with total consolidated assets of $10 billion or more (large banks) will cease; and (2) small banks will receive assessment credits for the portion of their assessments that contributed to the growth in the reserve ratio from between 1.15% and 1.35%, to be applied when the reserve ratio is at or above 1.38%. In January 2019, the Bank, which meets the definition of a “small Bank”, was advised by the FDIC its assessment credit to be applied when the reserve ratio is at or above 1.38% is $1.4 million which will reduce future assessment expenses. The Company cannot provide any assurance as to the effect of any future changes in its deposit insurance premium rates.

 

Community Reinvestment Act and Fair Lending Developments

 

The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act (“CRA”) activities. The CRA generally requires the federal banking agencies to evaluate the record of financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods. In addition to substantive penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities including merger applications.

 

Financial Privacy Legislation and Customer Information Security

 

The GLBA, in addition to the previously described changes in permissible nonbanking activities permitted to banks, BHCs and FHCs, also required the federal banking agencies, among other federal regulatory agencies, to adopt regulations governing the privacy of consumer financial information. The Bank is subject to the FRB’s regulations in this area. The federal bank regulatory agencies have established standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (the “Guidelines”). Among other things, the Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against any anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.

 

U.S.A. PATRIOT Act

 

Title III of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) is the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001. It includes numerous provisions for fighting international money laundering and blocking terrorist access to the U.S. financial system. The goal of Title III is to prevent the U.S. financial system and the U.S. clearing mechanisms from being used by parties suspected of terrorism, terrorist financing and money laundering. The provisions of Title III of the USA Patriot Act which affect the Bank are generally set forth as amendments to the Bank Secrecy Act. These provisions relate principally to U.S. banking organizations’ relationships with foreign banks and with persons who are resident outside the United States. The USA Patriot Act does not impose any filing or reporting obligations for banking organizations, but does require certain additional due diligence and recordkeeping practices.

 

Sarbanes-Oxley Act of 2002

 

The stated goals of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. Sarbanes-Oxley generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports under the Securities Exchange Act of 1934 (the “Exchange Act”).

 

Sarbanes-Oxley includes very specific additional disclosure requirements and corporate governance rules, required the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues. Sarbanes-Oxley represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees and public company shareholders. Sarbanes-Oxley addresses, among other matters: (i) independent audit committees for reporting companies whose securities are listed on national exchanges or automated quotation systems and expanded duties and responsibilities for audit committees; (ii) certification of financial statements by the chief executive officer and the chief financial officer; (iii) the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; (iv) a prohibition on insider trading during pension plan blackout periods; (v) disclosure of off-balance sheet transactions; (vi) a prohibition on personal loans to directors and officers under most circumstances with exceptions for certain normal course transactions by regulated financial institutions; (vii) expedited electronic filing requirements related to trading by insiders in an issuer’s securities on Form 4; (viii) disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; (ix) accelerated filing of periodic reports; (x) the formation of the Public Company Accounting Oversight Board (“PCAOB”) to regulate public accounting firms and the audit of public companies that are subject to the securities laws; (xi) auditor independence; (xii) internal control evaluation and reporting; and (xiii) various increased criminal penalties for violations of securities laws.

 

Programs To Mitigate Identity Theft

 

In November 2007, federal banking agencies together with the National Credit Union Administration and Federal Trade Commission 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 circumstances. The regulations include guidelines that each institution must consider and, to the extent appropriate, include in its program.

 

Pending Legislation

 

Changes to state laws and regulations (including changes in interpretation or enforcement) can affect the operating environment of BHCs and their subsidiaries in substantial and unpredictable ways. From time to time, various legislative and regulatory proposals are introduced. These proposals, if codified, may change banking statutes and regulations and the Company’s operating environment in substantial and unpredictable ways. If codified, these proposals could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Company cannot accurately predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon our financial condition or results of operations. It is likely, however, that the current level of enforcement and compliance-related activities of federal and state authorities will continue and potentially increase.

 

Competition

 

The Bank’s principal competitors for deposits and loans are major banks and smaller community banks, savings and loan associations and credit unions. To a lesser extent, competitors include thrift and loans, mortgage brokerage companies and insurance companies. Other institutions, such as brokerage houses, mutual fund companies, credit card companies, and certain retail establishments offer investment vehicles that also compete with banks for deposit business. Federal legislation in recent years has encouraged competition between different types of financial institutions and fostered new entrants into the financial services market.

 

Legislative changes, as well as technological and economic factors, can be expected to have an ongoing impact on competitive conditions within the financial services industry. While the future impact of regulatory and legislative changes cannot be predicted with certainty, the business of banking will remain highly competitive.

 

ITEM 1A. RISK FACTORS

 

Readers and prospective investors in the Company’s securities should carefully consider the following risk factors as well as the other information contained or incorporated by reference in this Report.

 

The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that Management is not aware of or focused on or that Management currently deems immaterial may also impair the Company’s business operations. This Report is qualified in its entirety by these risk factors.

 

If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the company’s securities could decline significantly, and investors could lose all or part of their investment in the Company’s common stock.

 

Market and Interest Rate Risk

 

Changes in interest rates could reduce income and cash flow.

 

The Company’s income and cash flow depend to a great extent on the difference between the interest earned on loans and investment securities and the interest paid on deposits and other borrowings, and the Company’s success in competing for loans and deposits. The Company cannot control or prevent changes in the level of interest rates which fluctuate in response to general economic conditions, the policies of various governmental and regulatory agencies, in particular, the Federal Open Market Committee of the FRB, and pricing practices of the Company’s competitors. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the purchase of investments, the generation of deposits and other borrowings, and the rates received on loans and investment securities and paid on deposits and other liabilities. The discussion in this Report under “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset, Liability and Market Risk Management” and “- Liquidity and Funding” and “Item 7A Quantitative and Qualitative Disclosures About Market Risk” is incorporated by reference in this paragraph.

 

Changes in capital market conditions could reduce asset valuations.

 

Capital market conditions, including interest rates, liquidity, investor confidence, bond issuer credit worthiness, perceived counter-party risk, the supply of and demand for financial instruments, the financial strength of market participants, and other factors can materially impact the value of the Company’s assets. An impairment in the value of the Company’s assets could result in asset write-downs, reducing the Company’s asset values, earnings, and equity.

 

The value of securities in the Company’s investment securities portfolio may be negatively affected by disruptions in securities markets

 

The market for some of the investment securities held in the Company’s portfolio can be extremely volatile. Volatile market conditions may detrimentally affect the value of these securities, such as through reduced valuations due to the perception of heightened credit and liquidity risks. There can be no assurance that the declines in market value will not result in other than temporary impairments of these assets, which would lead to loss recognition that could have a material adverse effect on the Company’s net income and capital levels.

 

The weakness of other financial institutions could adversely affect the Company.

 

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. The Company routinely executes transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, and other institutional clients. Many of these transactions expose the Company to credit risk in the event of default of the Company’s counterparty or client. In addition, the Company’s credit risk may be increased when the collateral the Company holds cannot be realized or is liquidated at prices not sufficient to recover the full amount of the secured obligation. There is no assurance that any such losses would not materially and adversely affect the Company’s results of operations or earnings.

 

Shares of Company common stock eligible for future sale or grant of stock options and other equity awards could have a dilutive effect on the market for Company common stock and could adversely affect the market price.

 

The Articles of Incorporation of the Company authorize the issuance of 150 million shares of common stock (and two additional classes of 1 million shares each, denominated “Class B Common Stock” and “Preferred Stock”, respectively) of which approximately 26.7 million shares of common stock were outstanding at December 31, 2018. Pursuant to its stock option plans, at December 31, 2018, the Company had outstanding options for 946 thousand shares of common stock, of which 457 thousand were currently exercisable. As of December 31, 2018, 713 thousand shares of Company common stock remained available for grants under the Company’s equity incentive plans. Sales of substantial amounts of Company common stock in the public market could adversely affect the market price of its common stock.

 

The Company’s payment of dividends on common stock could be eliminated or reduced.

 

Holders of the Company’s common stock are entitled to receive dividends only when, as and if declared by the Company’s Board of Directors. Although the Company has historically paid cash dividends on the Company’s common stock, the Company is not required to do so and the Company’s Board of Directors could reduce or eliminate the Company’s common stock dividend in the future.

 

The Company could repurchase shares of its common stock at price levels considered excessive.

 

The Company repurchases and retires its common stock in accordance with Board of Directors-approved share repurchase programs. At December 31, 2018, approximately 1.8 million shares remained available to repurchase under such plans. The Company has been active in repurchasing and retiring shares of its common stock when alternative uses of excess capital, such as acquisitions, have been limited. The Company could repurchase shares of its common stock at price levels considered excessive, thereby spending more cash on such repurchases as deemed reasonable and effectively retiring fewer shares than would be retired if repurchases were effected at lower prices.

 

Risks Related to the Nature and Geographical Location of the Company’s Business

 

The Company invests in loans that contain inherent credit risks that may cause the Company to incur losses.

 

The risk that borrowers may not pay interest or repay their loans as agreed is an inherent risk of the banking business. The company mitigates this risk by adhering to sound and proven underwriting practices, managed by experienced and knowledgeable credit professionals. Nonetheless, the Company may incur losses on loans that meet its underwriting criteria, and these losses may exceed the amounts set aside as reserves. The Company can provide no assurance that the credit quality of the loan portfolio will not deteriorate in the future and that such deterioration will not adversely affect the Company or its results of operations.

 

The Company’s operations are concentrated geographically in California, and poor economic conditions may cause the Company to incur losses.

 

Substantially all of the Company’s business is located in California. A portion of the loan portfolio of the Company is dependent on real estate. At December 31, 2018, real estate served as the principal source of collateral with respect to approximately 55% of the Company’s loan portfolio. The Company’s financial condition and operating results will be subject to changes in economic conditions in California. The California economy was severely affected by the recessionary period of 2008 to 2009. Much of the California real estate market experienced a decline in values of varying degrees. This decline had an adverse impact on the business of some of the Company’s borrowers and on the value of the collateral for many of the Company’s loans. Generally, the counties surrounding and near San Francisco Bay have recovered more soundly from the recent recession than counties in the California “Central Valley,” from Sacramento in the north to Bakersfield in the south. Approximately 22% of the Company’s loans are to borrowers in the California “Central Valley.” Economic conditions in California’s diverse geographic markets can be vastly different and are subject to various uncertainties, including the condition of the construction and real estate sectors, the effect of drought on the agricultural sector and its infrastructure, and the California state and municipal governments’ budgetary and fiscal conditions. The Company can provide no assurance that conditions in any sector or geographic market of the California economy will not deteriorate in the future and that such deterioration will not adversely affect the Company.

 

The markets in which the Company operates are subject to the risk of earthquakes, fires, storms and other natural disasters.

 

All of the properties of the Company are located in California. Also, most of the real and personal properties which currently secure a majority of the Company’s loans are located in California. Further, the Company invests in securities issued by companies and municipalities operating throughout the United States, and in mortgage-backed securities collateralized by real property located throughout the United States. California and other regions of the United States are prone to earthquakes, brush and wildfires, flooding, drought and other natural disasters. In addition to possibly sustaining uninsured damage to its own properties, if there is a major earthquake, flood, drought, fire or other natural disaster, the Company faces the risk that many of its debtors may experience uninsured property losses, or sustained business or employment interruption and/or loss which may materially impair their ability to meet the terms of their debt obligations. A major earthquake, flood, prolonged drought, fire or other natural disaster in California or other regions of the United States could have a material adverse effect on the Company’s business, financial condition, results of operations and cash flows.

 

Adverse changes in general business or economic conditions could have a material adverse effect on the Company’s financial condition and results of operations.

 

A sustained or continuing weakness or weakening in business and economic conditions generally or specifically in the principal markets in which the Company does business could have one or more of the following adverse impacts on the Company’s business:

 

·

a decrease in the demand for loans and other products and services offered by the Company;

·

an increase or decrease in the usage of unfunded credit commitments;

·

an increase or decrease in the amount of deposits;

·

a decrease in non-depository funding available to the Company;

 

·

an impairment of certain intangible assets, including goodwill;

·

an increase in the number of clients and counterparties who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to the Company, which could result in a higher level of nonperforming assets, net charge-offs, provision for loan losses, reduced interest revenue and cash flows, and valuation adjustments on assets;

·

an impairment in the value of investment securities;

·

an impairment in the value of life insurance policies owned by the Company;

·

an impairment in the value of real estate owned by the Company.

 

The 2008 - 2009 financial crisis led to the failure or merger of a number of financial institutions. Financial institution failures can result in further losses as a consequence of defaults on securities issued by them and defaults under contracts entered into with such entities as counterparties. The failure of institutions with FDIC insured deposits can cause the DIF reserve ratio to decline, resulting in increased deposit insurance assessments on surviving FDIC insured institutions. Weak economic conditions can significantly weaken the strength and liquidity of financial institutions.

 

The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, are highly dependent upon the business environment in the markets where the Company operates, in the State of California and in the United States as a whole. A favorable business environment is generally characterized by, among other factors, economic growth, healthy labor markets, efficient capital markets, low inflation, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by: declines in economic growth, high rates of unemployment, deflation, declines in business activity or consumer, investor or business confidence; limitations on the availability of or increases in the cost of credit and capital; increases in inflation; natural disasters; or a combination of these or other factors.

 

Such business conditions could adversely affect the credit quality of the Company’s loans, the demand for loans, loan volumes and related revenue, securities valuations, amounts of deposits, availability of funding, results of operations and financial condition.

 

Regulatory Risks

 

Restrictions on dividends and other distributions could limit amounts payable to the Company.

 

As a holding company, a substantial portion of the Company’s cash flow typically comes from dividends paid by the Bank. Various statutory provisions restrict the amount of dividends the Company’s subsidiaries can pay to the Company without regulatory approval. A reduction in subsidiary dividends paid to the Company could limit the capacity of the Company to pay dividends. In addition, if any of the Company’s subsidiaries were to liquidate, that subsidiary’s creditors will be entitled to receive distributions from the assets of that subsidiary to satisfy their claims against it before the Company, as a holder of an equity interest in the subsidiary, will be entitled to receive any of the assets of the subsidiary.

 

Adverse effects of changes in banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect the Company.

 

The Company is subject to significant federal and state regulation and supervision, which is primarily for the benefit and protection of the Company’s customers and not for the benefit of investors. In the past, the Company’s business has been materially affected by these regulations.

 

Laws, regulations or policies, including accounting standards and interpretations currently affecting the Company and the Company’s subsidiaries, may change at any time. Regulatory authorities may also change their interpretation of these statutes and regulations. Therefore, the Company’s business may be adversely affected by any future changes in laws, regulations, policies or interpretations or regulatory approaches to compliance and enforcement including future acts of terrorism, major U.S. corporate bankruptcies and reports of accounting irregularities at U.S. public companies.

 

Additionally, the Company’s business is affected significantly by the fiscal and monetary policies of the federal government and its agencies. The Company is particularly affected by the policies of the FRB, which regulates the supply of money and credit in the United States of America. Among the instruments of monetary policy available to the FRB are (a) conducting open market operations in U.S. government securities, (b) changing the discount rates of borrowings by depository institutions, (c) changing interest rates paid on balances financial institutions deposit with the FRB, and (d) imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the FRB may have a material effect on the Company’s business, results of operations and financial condition. Under long- standing policy of the FRB, a BHC is expected to act as a source of financial strength for its subsidiary banks. As a result of that policy, the Company may be required to commit financial and other resources to its subsidiary bank in circumstances where the Company might not otherwise do so.

 

Following the recessions of 2008 and 2009, the FRB provided vast amounts of liquidity into the banking system. The FRB purchased large quantities of U.S. government securities, including agency-backed mortgage securities, increasing the demand for such securities thereby reducing interest rates. Interest rates remained historically low through 2016 as the monetary policy of the Federal Open Market Committee (the “FOMC”) was highly accommodative. The FRB began reducing these asset purchase activities in the fourth quarter 2013 and the FOMC began removing monetary stimulus in December 2016 and has increased the federal funds rate by 2.00 percent to 2.50 percent through December 2018. The raised target range for the federal funds rate could reduce liquidity in the markets and cause interest rates to rise, thereby increasing funding costs to the Bank, reducing the availability of funds to the Bank to finance its existing operations, and causing fixed-rate investment securities and loans to decline in value.

 

Federal and state governments could pass legislation detrimental to the Company’s performance.

 

As an example, the Company could experience higher credit losses because of federal or state legislation or regulatory action that reduces the amount the Bank's borrowers are otherwise contractually required to pay under existing loan contracts. Also, the Company could experience higher credit losses because of federal or state legislation or regulatory action that limits or delays the Bank's ability to foreclose on property or other collateral or makes foreclosure less economically feasible. Federal, state and local governments could pass tax legislation causing the Company to pay higher levels of taxes.

 

The FDIC insures deposits at insured financial institutions up to certain limits. The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund. The FDIC may increase premium assessments to maintain adequate funding of the Deposit Insurance Fund.

 

The behavior of depositors in regard to the level of FDIC insurance could cause our existing customers to reduce the amount of deposits held at the Bank, and could cause new customers to open deposit accounts at the Bank. The level and composition of the Bank's deposit portfolio directly impacts the Bank's funding cost and net interest margin.

 

Systems, Accounting and Internal Control Risks

 

The accuracy of the Company’s judgments and estimates about financial and accounting matters will impact operating results and financial condition.

 

The discussion under “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” in this Report and the information referred to in that discussion is incorporated by reference in this paragraph. The Company 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 Company’s operating results and financial condition.

 

A new accounting standard will significantly change the manner in which the Company recognizes credit losses and may have a material impact on the Company’s results of operations, financial condition or liquidity.

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued a new accounting update, FASB ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The ASU changes the accounting for estimates for credit losses related to financial assets measured at amortized cost and certain other contracts. The ASU replaces the currently incurred loss model with model based on current expected credit loss (“CECL”), which will accelerate recognition of credit losses. Additionally credit losses relating to debt securities available-for-sale will be recorded through an allowance for credit losses under the new standard. The Company will be required to adopt the ASU provisions on January 1, 2010. The ASU will significantly change the manner in which the Company determines the adequacy of its allowance for loan losses. The Company is evaluating the impact the CECL model will have, but the Company may recognize a one-time cumulative-effect adjustment to its allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective. Any required adjustment to the allowance for loan losses resulting from this change in methodology will be accomplished through an offsetting after-tax-adjustment to shareholders’ equity. Moreover, the CECL model may create more volatility in the level of the allowance for loan losses after adoption. If the Company is required to materially increase the level of its allowance for loan losses for any reason, such increase could adversely affect its business, financial condition and results of operations.

 

The Company’s information systems may experience an interruption or breach in security.

 

The Company relies heavily on communications and information systems, including those of third party vendors and other service providers, to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s data processing, accounting, customer relationship management and other systems. Communication and information systems failures can result from a variety of risks including, but not limited to, events that are wholly or partially out of the Company’s control, such as telecommunication line integrity, weather, terrorist acts, natural disasters, accidental disasters, unauthorized breaches of security systems, energy delivery systems, cyber attacks, and other events. Although the Company devotes significant resources to maintain and regularly upgrade its systems and processes that are designed to protect the security of the Company’s computer systems, software, networks and other technology assets and the confidentiality, integrity and availability of information belonging to the Company and its customers, there is 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 Company or its vendors. The occurrence of any such failures, interruptions or security breaches could damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny, or expose the Company to litigation and possible financial liability, any of which could have a material adverse effect on the Company’s financial condition and results of operations.

 

The Company’s controls and procedures may fail or be circumvented.

 

Management regularly reviews and updates the Company’s internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. The Company maintains controls and procedures to mitigate against risks such as processing system failures and errors, and customer or employee fraud, and maintains insurance coverage for certain of these risks. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Events could occur which are not prevented or detected by the Company’s internal controls or are not insured against or are in excess of the Company’s insurance limits or insurance underwriters’ financial capacity. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.

  

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None

 

ITEM 2. PROPERTIES

 

Branch Offices and Facilities

 

Westamerica Bank is engaged in the banking business through 80 branch offices in 21 counties in Northern and Central California. WAB believes all of its offices are constructed and equipped to meet prescribed security requirements.

 

The Company owns 28 banking office locations and one centralized administrative service center facility and leases 58 facilities.  Most of the leases contain renewal options and provisions for rental increases, principally for changes in the cost of living index, and for changes in other operating costs such as property taxes and maintenance.

  

ITEM 3. LEGAL PROCEEDINGS

 

Due to the nature of its business, the Company is subject to various threatened or filed legal cases. Based on the advice of legal counsel, the Company does not expect such cases will have a material, adverse effect on its financial position or results of operations. Legal liabilities are accrued when obligations become probable and the amount can be reasonably estimated. In the third quarter 2018, the Company achieved a mediated settlement to dismiss a lawsuit, subject to court approval, and accrued a liability for $3,500 thousand.

 

The Company has determined that it will be obligated to provide refunds of revenue recognized in years prior to 2017 to some customers. The Company estimates the probable amount of these obligations will be $5,542 thousand and accrued a liability for such amount in 2017; the estimated liability is subject to revision.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable

 

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The Company’s common stock is traded on the NASDAQ Stock Market (“NASDAQ”) under the symbol “WABC”. The following table shows the high and the low sales prices for the common stock, for each quarter, as reported by NASDAQ:

 

		High				Low
2018:
First quarter		$	62.52			$	55.72
Second quarter			60.68				55.81
Third quarter			64.52				57.56
Fourth quarter			63.20				52.75
2017:
First quarter		$	64.07			$	54.12
Second quarter			57.78				51.31
Third quarter			59.54				49.54
Fourth quarter			63.03				53.96

 

As of January 31, 2019, there were approximately 5,500 shareholders of record of the Company’s common stock.

 

The Company has paid cash dividends on its common stock in every quarter since its formation in 1972. See Item 8, Financial Statements and Supplementary Data, Note 20 to the consolidated financial statements for recent quarterly dividend information. It is currently the intention of the Board of Directors of the Company to continue payment of cash dividends on a quarterly basis. There is no assurance, however, that any dividends will be paid since they are dependent upon earnings, cash balances, financial condition and capital requirements of the Company and its subsidiaries as well as policies of the FRB pursuant to the BHCA. See Item 1, “Business - Supervision and Regulation.”

 

The notes to the consolidated financial statements included in this Report contain additional information regarding the Company’s capital levels, capital structure, regulations affecting subsidiary bank dividends paid to the Company, the Company’s earnings, financial condition and cash flows, and cash dividends declared and paid on common stock.

 

 

 

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Stock performance

 

The following chart compares the cumulative return on the Company’s stock during the ten years ended December 31, 2018 with the cumulative return on the S&P 500 composite stock index and NASDAQ’S Bank Index. The comparison assumes $100 invested in each on December 31, 2008 and reinvestment of all dividends.

 

 

 

		December 31,
		2008				2009				2010				2011				2012				2013
Westamerica Bancorporation (WABC)		$	100.00			$	111.42			$	114.64			$	93.54			$	93.76			$	128.29
S&P 500 (SPX)			100.00				126.47				145.55				148.59				172.34				228.11
NASDAQ Bank Index (CBNK)			100.00				83.71				95.57				85.53				101.55				143.89

 

		December 31,
		2014				2015				2016				2017				2018
Westamerica Bancorporation (WABC)		$	114.86			$	109.95			$	152.39			$	143.47			$	134.59
S&P 500 (SPX)			259.26				257.61				288.10				343.35				322.05
NASDAQ Bank Index (CBNK)			150.96				161.07				221.80				228.93				188.40

 

 

 

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The following chart compares the cumulative return on the Company’s stock during the five years ended December 31, 2018 with the cumulative return on the S&P 500 composite stock index and NASDAQ’S Bank Index. The comparison assumes $100 invested in each on December 31, 2013 and reinvestment of all dividends.

 

 

		December 31,
		2013				2014				2015				2016				2017				2018
Westamerica Bancorporation (WABC)		$	100.00			$	89.53			$	85.71			$	118.79			$	111.83			$	104.91
S&P 500 (SPX)			100.00				113.65				112.93				126.30				150.52				141.18
NASDAQ Bank Index (CBNK)			100.00				104.91				111.94				154.15				159.10				130.93

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

The table below sets forth the information with respect to purchases made by or on behalf of Westamerica Bancorporation or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of common stock during the quarter ended December 31, 2018 (in thousands, except per share data).

 

		2018
Period		(a) Total Number of shares Purchased				(b) Average Price Paid per Share				(c) Number of Shares Purchased as Part of Publicly Announced Plans or Programs				(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
		(In thousands, except exercise price)
October 1 through October 31			-			$	-				-				1,750
November 1 through November 30			-				-				-				1,750
December 1 through December 31			-				-				-				1,750
Total			-			$	-				-				1,750

  

The Company repurchases shares of its common stock in the open market to optimize the Company’s use of equity capital and enhance shareholder value and with the intention of lessening the dilutive impact of issuing new shares under stock option plans, and other ongoing requirements.

 

No shares were repurchased during the period from October 1, 2018 through December 31, 2018. A program approved by the Board of Directors on July 26, 2018 authorizes the purchase of up to 1,750 thousand shares of the Company’s common stock from time to time prior to September 1, 2019.

 

 

 

 

 

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ITEM 6. SELECTED FINANCIAL DATA

 

The following financial information for the five years ended December 31, 2018 has been derived from the Company’s audited consolidated financial statements. This information should be read in conjunction with those statements, notes and other information included elsewhere herein.

 

WESTAMERICA BANCORPORATION

FINANCIAL SUMMARY

 

		For the Years Ended December 31,
		2018				2017				2016				2015				2014
		(In thousands, except per share data and ratios)
Interest and loan fee income		$	151,723			$	138,312			$	135,919			$	136,529			$	140,209
Interest expense			1,959				1,900				2,116				2,424				3,444
Net interest and loan fee income			149,764				136,412				133,803				134,105				136,765
(Reversal of) provision for loan losses			-				(1,900	)			(3,200	)			-				2,800
Noninterest income:
Equity securities (losses) gains			(52	)			7,955				-				-				-
Other noninterest income			48,201				48,673				46,574				47,867				51,787
Total noninterest income			48,149				56,628				46,574				47,867				51,787
Noninterest expense:
Loss contingency			3,500				5,542				3				-				-
Other noninterest expense			103,416				102,226				103,617				105,300				106,799
Total noninterest expense			106,916				107,768				103,620				105,300				106,799
Income before income taxes			90,997				87,172				79,957				76,672				78,953
Income tax provision			19,433				37,147				21,104				17,919				18,307
Net income		$	71,564			$	50,025			$	58,853			$	58,753			$	60,646
Average common shares outstanding			26,649				26,291				25,612				25,555				26,099
Average diluted common shares outstanding			26,756				26,419				25,678				25,577				26,160
Common shares outstanding at December 31,			26,730				26,425				25,907				25,528				25,745
Per common share:
Basic earnings		$	2.69			$	1.90			$	2.30			$	2.30			$	2.32
Diluted earnings			2.67				1.89				2.29				2.30				2.32
Book value at December 31,			23.03				22.34				21.67				20.85				20.45
Financial ratios:
Return on assets			1.27	%			0.92	%			1.12	%			1.16	%			1.22	%
Return on common equity			11.35	%			8.39	%			10.85	%			11.32	%			11.57	%
Net interest margin (FTE)(1)			2.98	%			2.95	%			3.03	%			3.36	%			3.70	%
Net loan losses to average loans			0.14	%			0.08	%			0.04	%			0.11	%			0.17	%
Efficiency ratio(2)			52.52	%			52.51	%			53.55	%			53.69	%			52.24	%
Equity to assets			11.05	%			10.71	%			10.46	%			10.30	%			10.46	%
Period end balances:
Assets		$	5,568,526			$	5,513,046			$	5,366,083			$	5,168,875			$	5,035,724
Loans			1,207,202				1,287,982				1,352,711				1,533,396				1,700,290
Allowance for loan losses			21,351				23,009				25,954				29,771				31,485
Investment securities			3,641,026				3,352,371				3,237,070				2,886,291				2,639,439
Deposits			4,866,839				4,827,613				4,704,741				4,540,659				4,349,191
Identifiable intangible assets and goodwill			123,602				125,523				128,600				132,104				135,960
Short-term borrowed funds			51,247				58,471				59,078				53,028				89,784
Federal Home Loan Bank advances			-				-				-				-				20,015
Shareholders' equity			615,591				590,239				561,367				532,205				526,603
Capital ratios at period end:
Total risk based capital			17.03	%			16.17	%			15.95	%			13.39	%			14.54	%
Tangible equity to tangible assets			9.04	%			8.63	%			8.26	%			7.94	%			7.97	%
Dividends paid per common share		$	1.60			$	1.57			$	1.56			$	1.53			$	1.52
Common dividend payout ratio			60	%			83	%			68	%			67	%			66	%

 

(1)

Yields on securities and certain loans have been adjusted upward to a "fully taxable equivalent" ("FTE") basis in order to reflect the effect of income which is exempt from federal income taxation at the current statutory tax rate.

(2)

The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income on an FTE basis and noninterest income).

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion addresses information pertaining to the financial condition and results of operations of Westamerica Bancorporation and subsidiaries (the “Company”) that may not be otherwise apparent from a review of the consolidated financial statements and related footnotes. It should be read in conjunction with those statements and notes found on pages 48 through 90, as well as with the other information presented throughout this Report.

 

Critical Accounting Policies

 

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the banking industry. Application of these principles requires the Company to make certain estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain accounting policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment writedown or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.

 

The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, Management has identified the allowance for loan losses accounting to be the accounting area requiring the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available. A discussion of the factors affecting accounting for the allowance for loan losses and purchased loans is included in the “Loan Portfolio Credit Risk” discussion below.

 

Financial Overview

 

Westamerica Bancorporation and subsidiaries’ (collectively, the “Company”) reported net income of $71.6 million or $2.67 diluted earnings per common share (“EPS”) in 2018. The 2018 results include a $585 thousand tax-exempt life insurance policy gain and a $3.5 million loss contingency settlement, which on an aggregate basis reduced EPS $0.07. In 2018, the Company achieved a mediated settlement to dismiss a lawsuit, subject to court approval, and accrued a liability for such amount. The 2018 results compare to net income of $50.0 million or $1.89 EPS for the year ended December 31, 2017 and net income of $58.9 million or $2.29 EPS for the year ended December 31, 2016. The 2017 results include $12.3 million in adjustments to net deferred tax asset values triggered by enactment of the Tax Cuts and Jobs Act of 2017 (the “Act”) which reduced EPS $0.48, recognition of a $5.5 million loss contingency, which reduced EPS $0.12, and securities gains of $8.0 million, which increased EPS $0.18.

 

The Company’s principal source of revenue is net interest and loan fee income, which represents interest and fees earned on loans and investment securities (“earning assets”) reduced by interest paid on deposits and other borrowings (“interest-bearing liabilities”). Market interest rates declined considerably following the recession of 2008 and 2009. Interest rates remained historically low through 2016 as the monetary policy of the Federal Open Market Committee (the “FOMC”) was highly accommodative. During this period, Management avoided originating long-dated, low-yielding loans given the potential impact of such assets on forward earning potential; as a result, loans declined and investment securities increased. The changed composition of the earning assets and low market interest rates pressured the net interest margin to lower levels. The FOMC began removing monetary stimulus in December 2016 and has increased the federal funds rate by 2.00 percent to 2.50 percent through December 2018, although longer-term rates have not increased by a similar magnitude. This recent increase in market interest rates has begun benefiting the Company’s earning asset yields. However, the rising market rates have not resulted in higher rates paid on deposits. The funding source of the Company’s earning assets is primarily customer deposits. The Company’s long-term strategy includes maximizing checking and savings deposits as these types of deposits are lower-cost and less sensitive to changes in interest rates compared to time deposits. The 2018 average volume of checking and savings deposits was 95 .6 percent of average total deposits.

 

Credit quality remained solid with nonperforming assets totaling $5.8 million at December 31, 2018 and net chargeoffs of $1.7 million in 2018. The Company did not recognize a provision for loan losses in 2018.

 

The Company presents its net interest margin and net interest income on an FTE basis using the current statutory federal tax rate. Management believes the FTE basis is valuable to the reader because the Company’s loan and investment securities portfolios contain a relatively large portion of municipal loans and securities that are federally tax exempt. The Company’s tax exempt loans and securities composition may not be similar to that of other banks, therefore in order to reflect the impact of the federally tax exempt loans and securities on the net interest margin and net interest income for comparability with other banks, the Company presents its net interest margin and net interest income on an FTE basis. Yields on tax-exempt securities and loans have been adjusted upward to reflect the effect of income exempt from federal income taxation at the federal statutory tax rate of 35% for 2017 and 2016. Due to the Act, the federal tax rate became 21% for 2018; as such, the upward adjustment to reflect the effect of income exempt from federal taxation is lower in 2018.

 

The Company’s significant accounting policies (see Note 1 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements below) are fundamental to understanding the Company’s results of operations and financial condition. The Company adopted the FASB ASU 2016-09, Improvements to Employee Share-Based Payment Accounting effective January 1, 2017. The 2018 and 2017 results reflect the Company’s prospective adoption of ASU 2016-09; the 2018 and 2017 income tax provision was $737 thousand and $698 thousand, respectively, lower than would have been under accounting standards prior to the adoption of ASU 2016-09.

 

Net Income

 

Following is a summary of the components of net income for the periods indicated:

 

		For the Years Ended December 31,
		2018				2017				2016
		($ in thousands, except per share data)
Net interest and loan fee income		$	149,764			$	136,412			$	133,803
FTE adjustment			5,646				12,182				13,142
Net interest and loan fee income (FTE)			155,410				148,594				146,945
Reversal of (provision for) loan losses			-				1,900				3,200
Noninterest income			48,149				56,628				46,574
Noninterest expense			(106,916	)			(107,768	)			(103,620	)
Income before income taxes (FTE)			96,643				99,354				93,099
Income taxes (FTE)			(25,079	)			(49,329	)			(34,246	)
Net income		$	71,564			$	50,025			$	58,853
Net income per average fully-diluted common share		$	2.67			$	1.89			$	2.29
Net income as a percentage of average shareholders' equity			11.35	%			8.39	%			10.85	%
Net income as a percentage of average total assets			1.27	%			0.92	%			1.12	%

  

Comparing 2018 with 2017, net income increased $21.5 million. Net interest and loan fee income increased in 2018 compared with 2017 mostly attributable to higher average balances of investments and higher yields on earning assets as market interest rates rose. The increase was offset by lower average balances of loans. Net interest and loan fee income (FTE) in 2018 included a lower FTE adjustment than in 2017 due to the reduced federal corporate tax as a result of enactment of the Act. The provision for loan losses remained zero, reflecting Management's evaluation of losses inherent in the loan portfolio. In 2018, noninterest income decreased $8.5 million compared with 2017 because 2017 results included $8.0 million in gains of sale of securities. The non-FTE book tax provision for 2018, which reflected the tax-exempt nature of a $585 thousand life insurance policy gain, was $19.4 million compared with $37.1 million for 2017, representing effective tax rates of 21.4% and 42.6%, respectively. The non-FTE book tax provision for 2017 includes $12.3 million in adjustments to net deferred tax asset values triggered by enactment of the Act. The federal statutory tax rate was reduced from 35% in 2017 to 21% in 2018 due to the Act. The non-FTE book tax provisions for 2018 and 2017 include tax benefits of $737 thousand and $698 thousand, respectively, for tax deductions from the exercise of employee stock options which exceed related compensation expenses recognized in the financial statements.

 

Comparing 2017 with 2016, net income decreased $8.8 million. Net interest and loan fee income increased in 2017 compared with 2016 mostly attributable to higher average balances of investments and higher net yield on taxable investments and interest-bearing cash, offset by lower average balances of loans and lower yields on those loans. The Company recorded a $1.9 million reversal of provision for loan losses in 2017 and a $3.2 million reversal of provision for loan losses in 2016, reflecting Management's evaluation of losses inherent in the loan portfolio. Noninterest income increased in 2017 compared with 2016 because 2017 included $8.0 million in gains on sale of securities and higher income from merchant processing services, partially offset by lower service charges on deposit accounts. Noninterest expense increased due to a $5.5 million loss contingency and an impairment charge of tax credit investments, partially offset by reductions in professional fees. The non-FTE tax book provision for 2017 was higher than in 2016 primarily due to a $12.3 million charge to re-measure the Company’s net deferred tax asset triggered by enactment of the Act. The 2017 income tax provision was $698 thousand lower than it would have been under accounting standards prior to the adoption of ASU 2016-09.

 

Net Interest and Loan Fee Income (FTE)

 

The Company's primary source of revenue is net interest income, or the difference between interest income earned on loans and investment securities and interest expense paid on interest-bearing deposits and other borrowings.

 

Components of Net Interest and Loan Fee Income (FTE)

 

		For the Years Ended December 31,
		2018				2017				2016
		($ in thousands)
Interest and loan fee income		$	151,723			$	138,312			$	135,919
Interest expense			(1,959	)			(1,900	)			(2,116	)
Net interest and loan fee income			149,764				136,412				133,803
FTE adjustment			5,646				12,182				13,142
Net interest and loan fee income (FTE)		$	155,410			$	148,594			$	146,945
Net interest margin (FTE)			2.98	%			2.95	%			3.03	%

  

Comparing 2018 with 2017, net interest and loan fee income increased $13.4 million due to higher average balances of investments (up $270 million) and higher yield on interest earning assets (up 0.03%), offset by lower average balances of loans (down $106 million). The FTE adjustment was lower in 2018 compared with 2017 mainly due to the reduced federal corporate tax rate as a result of enactment of the Act.

 

Comparing 2017 with 2016, net interest and loan fee income increased $2.6 million mostly due to higher average balances of investments (up $255 million) and higher yield on taxable investments (up 0.13%) and interest-bearing cash (up 0.59%), offset by lower average balances of loans (down $109 million) and lower net yield on those loans (down 0.16%).

 

The yield on earning assets (FTE) was 3.02% in 2018 and 2.99% in 2017, 3.08% in 2016. The 2018 yield on earning assets (FTE) reflected higher market interest rates which offset the impact of the reduced FTE adjustment.

 

The Company’s funding cost was 0.04% in 2018 compared with 0.04% in 2017 and 0.05% in 2016. Average balances of time deposits declined $58 million from 2016 to 2018 while lower-cost checking and savings deposits grew 8% in the same period. Average balances of checking and saving deposits accounted for 95.6% of average total deposits in 2018 compared with 94.8% in 2017 and 94.1% in 2016.

 

 

 

 

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Summary of Average Balances, Yields/Rates and Interest Differential

 

The following tables present information regarding the consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income earned from average interest earning assets and the resulting yields, and the amounts of interest expense incurred on average interest-bearing liabilities and the resulting rates. Average loan balances include nonperforming loans. Interest income includes reversal of previously accrued interest on loans placed on non-accrual status during the period and proceeds from loans on nonaccrual status only to the extent cash payments have been received and applied as interest income and accretion of purchased loan discounts. Yields on tax-exempt securities and loans have been adjusted upward to reflect the effect of income exempt from federal income taxation at the federal statutory tax rate of 35 percent for 2016 and 2017. Due to the Tax Cuts and Jobs Act of 2017, the federal tax rate is 21 percent for 2018; as such, the upward adjustment to reflect the effect of income exempt from federal taxation is lower in 2018.

 

Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

		For the Year Ended December 31, 2018
						Interest
		Average				Income/				Yields/
		Balance				Expense				Rates
		($ in thousands)
Assets
Investment securities:
Taxable		$	2,830,075			$	65,330				2.31	%
Tax-exempt (1)			747,522				24,610				3.29	%
Total investments (1)			3,577,597				89,940				2.51	%
Loans:
Taxable			1,153,549				57,240				4.96	%
Tax-exempt (1)			55,618				2,264				4.07	%
Total loans (1)			1,209,167				59,504				4.92	%
Total interest bearing cash			425,871				7,925				1.86	%
Total interest-earning assets (1)			5,212,635				157,369				3.02	%
Other assets			407,983
Total assets		$	5,620,618
Liabilities and shareholders' equity
Noninterest-bearing demand		$	2,209,924			$	-				-	%
Savings and interest-bearing transaction			2,447,652				1,275				0.05	%
Time less than $100,000			119,586				279				0.23	%
Time $100,000 or more			94,919				368				0.39	%
Total interest-bearing deposits			2,662,157				1,922				0.07	%
Short-term borrowed funds			59,992				37				0.06	%
Total interest-bearing liabilities			2,722,149				1,959				0.07	%
Other liabilities			57,848
Shareholders' equity			630,697
Total liabilities and shareholders' equity		$	5,620,618
Net interest spread (1) (2)											2.95	%
Net interest and fee income and interest margin (1) (3)						$	155,410				2.98	%

 

(1)

Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate.

(2)

Net interest spread represents the average yield earned on interest-earning assets less the average rate incurred on interest-bearing liabilities.

(3)

Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of interest-earning assets. The net interest margin is greater than the net interest spread due to the benefit of noninterest-bearing demand deposits.

 

Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

		For the Year Ended December 31, 2017
						Interest
		Average				Income/				Yields/
		Balance				Expense				Rates
		($ in thousands)
Assets
Investment securities:
Taxable		$	2,498,001			$	51,445				2.06	%
Tax-exempt (1)			809,136				31,737				3.92	%
Total investments (1)			3,307,137				83,182				2.52	%
Loans:
Taxable			1,252,474				59,700				4.77	%
Tax-exempt (1)			62,728				3,136				5.00	%
Total loans (1)			1,315,202				62,836				4.78	%
Total interest bearing cash			406,034				4,476				1.10	%
Total interest-earning assets (1)			5,028,373				150,494				2.99	%
Other assets			411,309
Total assets		$	5,439,682
Liabilities and shareholders' equity
Noninterest-bearing demand		$	2,095,522			$	-				-	%
Savings and interest-bearing transaction			2,380,841				1,123				0.05	%
Time less than $100,000			136,324				318				0.23	%
Time $100,000 or more			109,563				415				0.38	%
Total interest-bearing deposits			2,626,728				1,856				0.07	%
Short-term borrowed funds			69,671				44				0.06	%
Total interest-bearing liabilities			2,696,399				1,900				0.07	%
Other liabilities			51,405
Shareholders' equity			596,356
Total liabilities and shareholders' equity		$	5,439,682
Net interest spread (1) (2)											2.92	%
Net interest and fee income and interest margin (1) (3)						$	148,594				2.95	%

 

(1)

Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate.

(2)

Net interest spread represents the average yield earned on interest-earning assets less the average rate incurred on interest-bearing liabilities.

(3)

Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of interest-earning assets. The net interest margin is greater than the net interest spread due to the benefit of noninterest-bearing demand deposits.

 

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Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

		For the Year Ended December 31, 2016
						Interest
		Average				Income/				Yields/
		Balance				Expense				Rates
		($ in thousands)
Assets
Investment securities:
Taxable		$	2,212,234			$	42,718				1.93	%
Tax-exempt (1)			840,262				34,103				4.06	%
Total investments (1)			3,052,496				76,821				2.52	%
Loans:
Taxable			1,356,417				66,842				4.93	%
Tax-exempt (1)			67,842				3,530				5.20	%
Total loans (1)			1,424,259				70,372				4.94	%
Total interest bearing cash			365,243				1,868				0.51	%
Total interest-earning assets (1)			4,841,998				149,061				3.08	%
Other assets			404,146
Total assets		$	5,246,144
Liabilities and shareholders' equity
Noninterest-bearing demand		$	2,026,939			$	-				-	%
Savings and interest-bearing transaction			2,290,640				1,166				0.05	%
Time less than $100,000			154,022				402				0.26	%
Time $100,000 or more			118,750				509				0.43	%
Total interest-bearing deposits			2,563,412				2,077				0.08	%
Short-term borrowed funds			61,276				39				0.06	%
Total interest-bearing liabilities			2,624,688				2,116				0.08	%
Other liabilities			52,216
Shareholders' equity			542,301
Total liabilities and shareholders' equity		$	5,246,144
Net interest spread (1) (2)											3.00	%
Net interest and fee income and interest margin (1) (3)						$	146,945				3.03	%

 

(1)

Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate.

(2)

Net interest spread represents the average yield earned on interest-earning assets less the average rate incurred on interest-bearing liabilities.

(3)

Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of interest-earning assets. The net interest margin is greater than the net interest spread due to the benefit of noninterest-bearing demand deposits.

 

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Summary of Changes in Interest Income and Expense due to Changes in Average Asset & Liability Balances and Yields Earned & Rates Paid

 

The following tables set forth a summary of the changes in interest income and interest expense due to changes in average assets and liability balances (volume) and changes in average interest yields/rates for the periods indicated. Changes not solely attributable to volume or yields/rates have been allocated in proportion to the respective volume and yield/rate components.

 

Summary of Changes in Interest Income and Expense

 

		For the Year Ended December 31, 2018
		Compared with
		For the Year Ended December 31, 2017
		Volume				Yield/Rate				Total
		(In thousands)
Increase (decrease) in interest and loan fee income:
Investment securities:
Taxable		$	6,839			$	7,046			$	13,885
Tax-exempt (1)			(2,417	)			(4,710	)			(7,127	)
Total investments (1)			4,422				2,336				6,758
Loans:
Taxable			(4,715	)			2,255				(2,460	)
Tax-exempt (1)			(355	)			(517	)			(872	)
Total loans (1)			(5,070	)			1,738				(3,332	)
Total interest bearing cash			219				3,230				3,449
Total (decrease) in interest and loan fee income (1)			(429	)			7,304				6,875
Increase (decrease) in interest expense:
Deposits:
Savings and interest-bearing transaction			32				120				152
Time less than $100,000			(39	)			-				(39	)
Time $100,000 or more			(55	)			8				(47	)
Total interest-bearing deposits			(62	)			128				66
Short-term borrowed funds			(7	)			-				(7	)
Total (decrease) increase in interest expense			(69	)			128				59
(Decrease) increase in net interest and loan fee income (1)		$	(360	)		$	7,176			$	6,816

 

(1)

Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate.

 

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Summary of Changes in Interest Income and Expense

 

		For the Year Ended December 31, 2017
		Compared with
		For the Year Ended December 31, 2016
		Volume				Yield/Rate				Total
		(In thousands)
Increase (decrease) in interest and loan fee income:
Investment securities:
Taxable		$	5,518			$	3,209			$	8,727
Tax-exempt (1)			(1,263	)			(1,103	)			(2,366	)
Total investments (1)			4,255				2,106				6,361
Loans:
Taxable			(5,118	)			(2,024	)			(7,142	)
Tax-exempt (1)			(266	)			(128	)			(394	)
Total loans (1)			(5,384	)			(2,152	)			(7,536	)
Total interest bearing cash			209				2,399				2,608
Total (decrease) increase in interest and loan fee income (1)			(920	)			2,353				1,433
Increase (decrease) in interest expense:
Deposits:
Savings and interest-bearing transaction			46				(89	)			(43	)
Time less than $100,000			(46	)			(38	)			(84	)
Time $100,000 or more			(39	)			(55	)			(94	)
Total interest-bearing deposits			(39	)			(182	)			(221	)
Short-term borrowed funds			5				-				5
Total decrease in interest expense			(34	)			(182	)			(216	)
(Decrease) increase in net interest and loan fee income (1)		$	(886	)		$	2,535			$	1,649

 

(1)

Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate.

 

Provision for Loan Losses

 

The Company manages credit costs by consistently enforcing conservative underwriting and administration procedures and aggressively pursuing collection efforts with debtors experiencing financial difficulties. The provision for loan losses reflects Management's assessment of credit risk in the loan portfolio during each of the periods presented.

 

The Company provided no provision for loan losses in 2018. The Company recorded a reversal of the provision for loan losses of $1.9 million in 2017 and $3.2 million in 2016. Classified loans declined $9.3 million (which included nonperforming loans of $4.9 million) in 2018. The provision for loan losses was zero in 2018, reflecting Management's evaluation of losses inherent in the loan portfolio. At December 31, 2018, the Company had $5.7 million in residential real estate secured loans which are indemnified from loss by the FDIC up to eighty percent of principal; the indemnification expired February 6, 2019. For further information regarding credit risk, net credit losses and the allowance for loan losses, see the “Loan Portfolio Credit Risk” and “Allowance for Loan Losses” sections of this Report.

 

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Noninterest Income

 

Components of Noninterest Income 

 

		For the Years Ended December 31,
		2018				2017				2016
		(In thousands)
Service charges on deposit accounts		$	18,508			$	19,612			$	20,854
Merchant processing services			9,630				8,426				6,377
Debit card fees			6,643				6,421				6,290
Trust fees			2,938				2,875				2,686
ATM processing fees			2,752				2,610				2,411
Other service fees			2,567				2,584				2,571
Life insurance gains			585				-				-
Financial services commissions			499				639				568
Equity securities (losses) gains			(52	)			7,955				-
Other noninterest income			4,079				5,506				4,817
Total Noninterest Income		$	48,149			$	56,628			$	46,574

 

In 2018, noninterest income decreased $8.5 million compared with 2017 primarily because 2017 results included $8.0 million in gains on sale of securities. Service charges on deposit accounts decreased $1.1 million due to declines in fees for overdrafts, checking accounts and analyzed accounts. The decreases in other noninterest income were partially offset by an increase in merchant processing services fees of $1.2 million due to successful sales efforts and higher transaction volumes and a $585 thousand life insurance gain in 2018.

 

In 2017, noninterest income increased $10.1 million compared with 2016 mainly due to $8.0 million in gains on sale of securities. Merchant processing services fees increased $2.0 million due to successful sales efforts and higher transaction volumes. ATM processing fees and debit card fees increased $199 thousand and $131 thousand, respectively, primarily due to increased transaction volumes. Trust fees increased $189 thousand due to successful sales efforts. Offsetting the increase were service charges on deposits which decreased $1.2 million due to declines in fees charged on overdrawn and insufficient funds accounts (down $1.0 million) and lower fees on analyzed accounts (down $220 thousand).

 

Noninterest Expense

 

Components of Noninterest Expense 

 

		For the Years Ended December 31,
		2018				2017				2016
		(In thousands)
Salaries and related benefits		$	53,007			$	51,519			$	51,507
Occupancy and equipment			19,679				19,430				19,017
Outsourced data processing services			9,229				9,035				8,505
Loss contingency			3,500				5,542				3
Professional fees			2,842				2,161				3,980
Amortization of identifiable intangibles			1,921				3,077				3,504
Courier service			1,779				1,732				1,952
Impairment of tax credit investments			-				625				-
Other noninterest expense			14,959				14,647				15,152
Total Noninterest Expense		$	106,916			$	107,768			$	103,620

 

In 2018, noninterest expense decreased $852 thousand compared with 2017. The 2018 noninterest expense included a $3.5 million mediated settlement to dismiss a lawsuit, subject to court approval. The 2017 noninterest expense included a $5.5 million loss contingency and a $625 thousand impairment of low income housing limited partnership investments due to enactment of the Act. The 2017 loss contingency represents the Company’s estimated refunds to customers of revenue recognized in prior years. Salaries and related benefits increased $1.5 million primarily due to the annual merit increase cycle and higher incentives and employee benefit costs. Professional fees increased $681 thousand due to higher legal and consulting fees. Amortization of intangibles decreased $1.2 million as assets are amortized on a declining balance method.

 

In 2017, noninterest expense increased $4.1 million compared with 2016. The 2017 noninterest expense included a $5.5 million loss contingency and a $625 thousand impairment of low income housing limited partnership investments due to enactment of the Act. The loss contingency represents the Company’s estimated refunds to customers of revenue recognized in prior years. Expenses for occupancy and equipment increased $413 thousand due to technology upgrades. Outsourced data processing services expense increased $530 thousand primarily due to additional processing services. Professional fees decreased $1.8 million due to lower legal fees associated with nonperforming assets. Amortization of intangibles decreased $427 thousand as assets are amortized on a declining balance method. Other noninterest expense decreased $505 thousand primarily due to lower insurance premiums.

 

Provision for Income Tax

 

The Company’s income tax provision was $19.4 million in 2018 compared with $37.1 million in 2017 and $21.1 million in 2016, representing effective tax rates of 21.4%, 42.6% and 26.4%, respectively. The 2017 income tax provision included a $12.3 million charge to re-measure the Company’s net deferred tax asset triggered by enactment of the Tax Cuts and Jobs Act of 2017. The book tax provisions for 2018 and 2017 include tax benefits of $737 thousand and $698 thousand, respectively, for tax deductions from the exercise of employee stock options which exceed related compensation expenses recognized in the financial statements. The lower effective tax rate for 2018 reflects a reduction in the federal corporate tax rate as a result of enactment of the Act and the tax-exempt nature of a $585 thousand life insurance policy gain.

 

Investment Securities Portfolio

 

The Company maintains an investment securities portfolio consisting of securities issued by the U.S. Treasury, U.S. Government sponsored entities, agency and non-agency mortgage backed securities, state and political subdivisions, corporations, and other securities.

 

Management has increased the investment securities portfolio in response to deposit growth and loan volume declines. The average carrying value of the Company’s investment securities portfolio was $3.6 billion for the year ended December 31, 2018 compared with $3.4 billion for the year ended December 31, 2017.

 

Management continually evaluates the Company’s investment securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability, liquidity, and the level of interest rate risk to which the Company is exposed. These evaluations may cause Management to change the level of funds the Company deploys into investment securities and change the composition of the Company’s investment securities portfolio. In the year ended December 31, 2018, Management increased the holdings of corporate securities in order to improve yields without extending the duration of the bond portfolio.

 

At December 31, 2018, substantially all of the Company’s investment securities continue to be investment grade rated by one or more major rating agencies. In addition to monitoring credit rating agency evaluations, Management performs its own evaluations regarding the credit worthiness of the issuer or the securitized assets underlying asset-backed securities. The Company’s procedures for evaluating investments in securities are in accordance with guidance issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Agencies” (SR 12-15) and other regulatory guidance. There have been no significant differences in the Company’s internal analyses compared with the ratings assigned by the third party credit rating agencies.

 

During the third quarter 2018, the Atlantic hurricane season caused severe damage within many U.S. states. Management evaluated investment security exposures within the counties receiving disaster designations. The Company’s exposures are limited to municipal bond and utility provider corporate debt from issuers within South Carolina counties, the state of North Carolina and the Florida panhandle, and has determined that the storms had no material impact on the valuation of its investment securities.

 

Effective January 1, 2018, upon adoption of ASU 2016-01, equity securities included in the Company’s available for sale portfolio of $1,800 thousand were reclassified to equity securities. The reclassification of equity securities resulted in recording a cumulative effect adjustment to decrease retained earnings by $142 thousand, net of tax.

 

At December 31, 2018, the market value of equity securities was $1,747 thousand. During the year ended December 31, 2018, the Company recognized gross unrealized holding losses of $52 thousand in earnings.

 

The following table shows the fair value carrying amount of the Company’s equity securities and debt securities available for sale as of the dates indicated:

 

		At December 31,
		2018				2017				2016
		(In thousands)
Equity securities:
Mutual funds		$	1,747			$	1,800			$	1,815
FHLMC(1) and FNMA stock(2)			-				-				10,869
Other securities			-				-				656
Total equity securities			1,747				1,800				13,340
Debt securities available for sale:
U.S. Treasury securities			139,574				-				-
Securities of U.S. Government sponsored entities			164,018				119,319				138,660
Agency residential mortgage-backed securities (MBS)			853,871				767,706				691,499
Non-agency residential MBS			114				154				271
Agency commercial MBS			1,842				2,219				-
Securities of U.S. Government entities			1,119				1,590				2,025
Obligations of states and political subdivisions			179,091				185,221				183,411
Asset-backed securities			-				-				695
Corporate securities			1,315,041				1,115,498				860,857
Total debt securities available for sale			2,654,670				2,191,707				1,877,418
Total		$	2,656,417			$	2,193,507			$	1,890,758

 

⁽¹⁾ Federal Home Loan Mortgage Corporation

⁽²⁾ Federal National Mortgage Association

 

The following table sets forth the relative maturities and contractual yields of the Company’s debt securities available for sale (stated at fair value) at December 31, 2018. Yields on state and political subdivision securities have been calculated on a fully taxable equivalent basis using the current federal statutory rate. Mortgage-backed securities are shown separately because they are typically paid in monthly installments over a number of years.

 

Debt Securities Available for Sale Maturity Distribution

 

		At December 31, 2018
		Within one year				After one but  within five  years				After five but  within ten  years				After ten years				Mortgage- backed				Total
		($ in thousands)
U.S. Treasury securities		$	139,574			$	-			$	-			$	-			$	-			$	139,574
Interest rate			2.33	%			-	%			-	%			-	%			-	%			2.33	%
Securities of U.S. Government sponsored entities			990				163,028				-				-				-				164,018
Interest rate			2.00	%			2.28	%			-	%			-	%			-	%			2.28	%
Securities of U.S. Government entities			-				-				1,119				-				-				1,119
Interest rate			-	%			-	%			3.49	%			-	%			-	%			3.49	%
Obligations of states and political subdivisions			17,774				39,589				84,758				36,970				-				179,091
Interest rate			2.61	%			4.27	%			4.34	%			2.91	%			-	%			3.74	%
Corporate securities			103,638				1,211,403				-				-				-				1,315,041
Interest rate			2.28	%			2.72	%			-	%			-	%			-	%			2.69	%
Subtotal			261,976				1,414,020				85,877				36,970				-				1,798,843
Interest rate			2.33	%			2.71	%			4.33	%			2.91	%			-	%			2.73	%
MBS			-				-				-				-				855,827				855,827
Interest rate			-	%			-	%			-	%			-	%			2.28	%			2.28	%
Total		$	261,976			$	1,414,020			$	85,877			$	36,970			$	855,827			$	2,654,670
Interest rate			2.33	%			2.71	%			4.33	%			2.91	%			2.28	%			2.55	%

 

The following table shows the amortized cost carrying amount and fair value of the Company’s debt securities held to maturity as of the dates indicated:

 

		At December 31,
		2018				2017				2016
		(In thousands)
Securities of U.S. Government sponsored entities		$	-			$	-			$	581
Agency residential MBS			447,332				545,883				668,235
Non-agency residential MBS			3,387				4,462				5,370
Agency commercial MBS			-				9,041				9,332
Obligations of states and political subdivisions			533,890				599,478				662,794
Total		$	984,609			$	1,158,864			$	1,346,312
Fair value		$	971,445			$	1,155,342			$	1,340,741

 

The following table sets forth the relative maturities and contractual yields of the Company’s debt securities held to maturity at December 31, 2018. Yields on state and political subdivision securities have been calculated on a fully taxable equivalent basis using the current federal statutory rate. Mortgage-backed securities are shown separately because they are typically paid in monthly installments over a number of years.

 

Debt Securities Held to Maturity Maturity Distribution

 

		At December 31, 2018
		Within one year				After one but within five years				After five but within ten  years				After ten years				Mortgage- backed				Total
		($ in thousands)
Obligations of states and political subdivisions		$	86,172			$	214,137			$	232,544			$	1,037			$	-			$	533,890
Interest rate			2.15	%			2.73	%			3.62	%			3.53	%			-	%			3.00	%
MBS			-				-				-				-				450,719				450,719
Interest rate			-	%			-	%			-	%			-	%			2.07	%			2.07	%
Total		$	86,172			$	214,137			$	232,544			$	1,037			$	450,719			$	984,609
Interest rate			2.15	%			2.73	%			3.62	%			3.53	%			2.07	%			2.58	%

 

The following table summarizes total corporate securities by the industry sector in which the issuing companies operate:

 

		At December 31,
		2018								2017
		Market value				As a  percent of total corporate securities				Market value				As a  percent of total corporate securities
		($ in thousands)
Basic materials		$	30,410				2	%		$	35,219				3	%
Communications			49,642				4	%			50,763				5	%
Consumer, cyclical			58,430				5	%			12,592				1	%
Consumer, non-cyclical			169,851				13	%			133,476				12	%
Energy			19,668				1	%			-				0	%
Financial			531,512				40	%			525,932				47	%
Industrial			152,636				12	%			129,989				12	%
Technology			105,324				8	%			71,708				6	%
Utilities			197,568				15	%			155,819				14	%
Total corporate securities		$	1,315,041				100	%		$	1,115,498				100	%

 

The following tables summarize the total general obligation and revenue bonds issued by states and political subdivisions held in the Company’s investment securities portfolios as of the dates indicated, identifying the state in which the issuing government municipality or agency operates.

 

At December 31, 2018, the Company’s investment securities portfolios included securities issued by 583 state and local government municipalities and agencies located within 43 states. None of the Company’s investment securities were issued by Puerto Rican government entities. The largest exposure to any one municipality or agency was $9.3 million (fair value) represented by eight general obligation bonds.

 

		At December 31, 2018
		Amortized				Fair
		Cost				Value
		(In thousands)
Obligations of states and political subdivisions:
General obligation bonds:
California		$	104,607			$	105,730
Texas			56,653				56,286
New Jersey			35,501				35,527
Minnesota			29,609				29,593
Other (35 states)			267,402				266,136
Total general obligation bonds		$	493,772			$	493,272
Revenue bonds:
California		$	35,164			$	35,399
Kentucky			19,320				19,328
Colorado			14,564				14,539
Washington			13,034				13,228
Iowa			13,202				13,052
Indiana			12,007				12,034
Other (28 states)			113,047				112,805
Total revenue bonds		$	220,338			$	220,385
Total obligations of states and political subdivisions		$	714,110			$	713,657

 

 

 

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At December 31, 2017, the Company’s investment securities portfolios included securities issued by 647 state and local government municipalities and agencies located within 44 states. None of the Company’s investment securities were issued by Puerto Rican government entities. The largest exposure to any one municipality or agency was $10.0 million (fair value) represented by nine general obligation bonds.

 

		At December 31, 2017
		Amortized				Fair
		Cost				Value
		(In thousands)
Obligations of states and political subdivisions:
General obligation bonds:
California		$	104,330			$	106,311
Texas			66,636				66,699
New Jersey			39,387				39,612
Minnesota			30,485				30,707
Other (36 states)			292,102				294,779
Total general obligation bonds		$	532,940			$	538,108
Revenue bonds:
California		$	38,838			$	39,660
Kentucky			21,731				21,958
Iowa			17,304				17,287
Colorado			14,956				15,086
Washington			13,506				13,963
Indiana			12,914				13,054
Other (29 states)			130,196				131,301
Total revenue bonds		$	249,445			$	252,309
Total obligations of states and political subdivisions		$	782,385			$	790,417

 

At December 31, 2018 and 2017, the revenue bonds in the Company’s investment securities portfolios were issued by state and local government municipalities and agencies to fund public services such as water utility, sewer utility, recreational and school facilities, and general public and economic improvements. The revenue bonds were payable from 22 revenue sources at December 31, 2018 and at December 31, 2017. The revenue sources that represent 5% or more individually of the total revenue bonds are summarized in the following tables.

 

		At December 31, 2018
		Amortized				Fair
		Cost				Value
		(In thousands)
Revenue bonds by revenue source:
Water		$	46,326			$	46,671
Sales tax			28,264				28,517
Sewer			28,335				28,502
Lease (renewal)			17,013				17,051
College & University			13,919				13,714
Other (17 sources)			86,481				85,930
Total revenue bonds by revenue source		$	220,338			$	220,385

 

 

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		At December 31, 2017
		Amortized				Fair
		Cost				Value
		(In thousands)
Revenue bonds by revenue source:
Water		$	50,737			$	51,854
Sewer			30,427				31,030
Sales tax			30,233				30,777
Lease (renewal)			20,007				20,235
College & University			17,230				17,087
Other (17 sources)			100,811				101,326
Total revenue bonds by revenue source		$	249,445			$	252,309

 

See Note 2 to the consolidated financial statements for additional information related to the investment securities.

 

Loan Portfolio

 

The Company originates loans with the intent to hold such assets until principal is repaid. Management follows written loan underwriting policies and procedures which are approved by the Bank’s Board of Directors. Loans are underwritten following approved underwriting standards and lending authorities within a formalized organizational structure. The Board of Directors also approves independent real estate appraisers to be used in obtaining estimated values for real property serving as loan collateral. Prevailing economic trends and conditions are also taken into consideration in loan underwriting practices.

 

All loan applications must be for clearly defined legitimate purposes with a determinable primary source of repayment, and as appropriate, secondary sources of repayment. All loans are supported by appropriate documentation such as current financial statements, tax returns, credit reports, collateral information, guarantor asset verification, title reports, appraisals, and other relevant documentation.

 

Commercial loans represent term loans used to acquire durable business assets or revolving lines of credit used to finance working capital. Underwriting practices evaluate each borrower’s cash flow as the principal source of loan repayment. Commercial loans are generally secured by the borrower’s business assets as a secondary source of repayment. Commercial loans are evaluated for credit-worthiness based on prior loan performance and borrower financial information including cash flow, borrower net worth and aggregate debt.

 

Commercial real estate loans represent term loans used to acquire or refinance real estate to be operated by the borrower in a commercial capacity. Underwriting practices evaluate each borrower’s global cash flow as the principal source of loan repayment, independent appraisal of value of the property, and other relevant factors. Commercial real estate loans are generally secured by a first lien on the property as a secondary source of repayment.

 

Real estate construction loans represent the financing of real estate development. Loan principal disbursements are controlled through the use of project budgets, and disbursements are approved based on construction progress, which is validated by project site inspections. A first lien on the real estate serves as collateral to secure the loan.

 

Residential real estate loans generally represent first lien mortgages used by the borrower to purchase or refinance a principal residence. For interest-rate risk purposes, the Company offers only fully-amortizing, adjustable-rate mortgages. In underwriting first lien mortgages, the Company evaluates each borrower’s ability to repay the loan, an independent appraisal of the value of the property, and other relevant factors. The Company does not offer riskier mortgage products, such as non-amortizing “interest-only” mortgages and “negative amortization” mortgages.

 

For loans secured by real estate, the Bank requires title insurance to insure the status of its lien and each borrower is obligated to insure the real estate collateral, naming the Company as loss payee, in an amount sufficient to repay the principal amount outstanding in the event of a property casualty loss.

 

Consumer installment and other loans are predominantly comprised of indirect automobile loans with underwriting based on credit history and scores, personal income, debt service capacity, and collateral values.

 

Loan volumes have declined due to payoffs and problem loan workout activities, particularly with purchased loans, and reduced volumes of loan originations. The Company did not take an aggressive posture relative to loan portfolio growth during the post-recession period of historically low interest rates. Management increased investment securities as loan volumes declined.

 

The following table shows the composition of the loan portfolio of the Company by type of loan and type of borrower, on the dates indicated:

 

Loan Portfolio

 

		At December 31,
		2018				2017				2016				2015				2014
		(In thousands)
Commercial		$	275,080			$	335,996			$	354,697			$	382,748			$	391,815
Commercial real estate			580,480				568,584				542,171				637,456				718,604
Construction			3,982				5,649				2,555				3,951				13,872
Residential real estate			44,866				65,183				87,724				120,091				149,827
Consumer installment and other			302,794				312,570				365,564				389,150				426,172
Total loans		$	1,207,202			$	1,287,982			$	1,352,711			$	1,533,396			$	1,700,290

 

The following table shows the maturity distribution and interest rate sensitivity of commercial, commercial real estate, and construction loans at December 31, 2018. Balances exclude residential real estate loans and consumer loans totaling $347.7 million. These types of loans are typically paid in monthly installments over a number of years.

 

Loan Maturity Distribution

 

		At December 31, 2018
		Within One Year				One to Five Years				After Five Years				Total
		(In thousands)
Commercial and Commercial real estate		$	105,197			$	186,315			$	564,048			$	855,560
Construction			3,982				-				-				3,982
Total		$	109,179			$	186,315			$	564,048			$	859,542
Loans with fixed interest rates		$	42,082			$	75,003			$	42,152			$	159,237
Loans with floating or adjustable interest rates			67,097				111,312				521,896				700,305
Total		$	109,179			$	186,315			$	564,048			$	859,542

 

Commitments and Letters of Credit

 

The Company issues formal commitments on lines of credit to well-established and financially responsible commercial enterprises. Such commitments can be either secured or unsecured and are typically in the form of revolving lines of credit for seasonal working capital needs. Occasionally, such commitments are in the form of letters of credit to facilitate the customers’ particular business transactions. Commitment fees are generally charged for commitments and letters of credit. Commitments on lines of credit and letters of credit typically mature within one year. For further information, see the accompanying notes to the consolidated financial statements.

 

Loan Portfolio Credit Risk

 

The Company extends loans to commercial and consumer customers which expose the Company to the risk borrowers will default, causing loan losses. The Company’s lending activities are exposed to various qualitative risks. All loan segments are exposed to risks inherent in the economy and market conditions. Significant risk characteristics related to the commercial loan segment include the borrowers’ business performance and financial condition, and the value of collateral for secured loans. Significant risk characteristics related to the commercial real estate segment include the borrowers’ business performance and the value of properties collateralizing the loans. Significant risk characteristics related to the construction loan segment include the borrowers’ performance in successfully developing the real estate into the intended purpose and the value of the property collateralizing the loans. Significant risk characteristics related to the residential real estate segment include the borrowers’ financial wherewithal to service the mortgages and the value of the property collateralizing the loans. Significant risk characteristics related to the consumer loan segment include the financial condition of the borrowers and the value of collateral securing the loans.

 

The preparation of the financial statements requires Management to estimate the amount of losses inherent in the loan portfolio and establish an allowance for credit losses. The allowance for credit losses is maintained by assessing or reversing a provision for loan losses through the Company’s earnings. In estimating credit losses, Management must exercise judgment in evaluating information deemed relevant, such as financial information regarding individual borrowers, overall credit loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other information. The amount of ultimate losses on the loan portfolio can vary from the estimated amounts. Management follows a systematic methodology to estimate loss potential in an effort to reduce the differences between estimated and actual losses.

 

The Company closely monitors the markets in which it conducts its lending operations and follows a strategy to control exposure to loans with high credit risk. The Bank’s organization structure separates the functions of business development and loan underwriting; Management believes this segregation of duties avoids inherent conflicts of combining business development and loan approval functions. In measuring and managing credit risk, the Company adheres to the following practices.

 

·

The Bank maintains a Loan Review Department which reports directly to the audit committee of the Board of Directors. The Loan Review Department performs independent evaluations of loans to challenge the credit risk grades assigned by Management using grading standards employed by bank regulatory agencies. Those loans judged to carry higher risk attributes are referred to as “classified loans.” Classified loans receive elevated Management attention to maximize collection.

 

·

The Bank maintains two loan administration offices whose sole responsibility is to manage and collect classified loans.

 

Classified loans with higher levels of credit risk are further designated as “nonaccrual loans.” Management places classified loans on nonaccrual status when full collection of contractual interest and principal payments is in doubt. Uncollected interest previously accrued on loans placed on nonaccrual status is reversed as a charge against interest income. The Company does not accrue interest income on loans following placement on nonaccrual status. Interest payments received on nonaccrual loans are applied to reduce the carrying amount of the loan unless the carrying amount is well secured by loan collateral. “Nonperforming assets” include nonaccrual loans, loans 90 or more days past due and still accruing, and repossessed loan collateral (commonly referred to as “Other Real Estate Owned”).

  

Nonperforming Assets

 

		At December 31,
		2018				2017				2016				2015				2014
		(In thousands)
Nonperforming nonaccrual loans		$	998			$	1,641			$	3,956			$	14,648			$	17,494
Performing nonaccrual loans			3,870				4,285				4,429				350				110
Total nonaccrual loans			4,868				5,926				8,385				14,998				17,604
Accruing loans 90 or more days past due			551				531				497				295				502
Total nonperforming loans			5,419				6,457				8,882				15,293				18,106
Other real estate owned			350				1,426				3,095				9,264				6,374
Total nonperforming assets		$	5,769			$	7,883			$	11,977			$	24,557			$	24,480

 

Nonperforming assets have declined during 2018 due to payoffs, chargeoffs and sale of Other Real Estate Owned. At December 31, 2018, one loan secured by commercial real estate with a balance of $3.9 million was on nonaccrual status. The remaining four nonaccrual loans held at December 31, 2018 had an average carrying value of $250 thousand and the largest carrying value was $516 thousand.

 

Management believes the overall credit quality of the loan portfolio is reasonably stable; however, classified and nonperforming assets could fluctuate from period to period. The performance of any individual loan can be affected by external factors such as the interest rate environment, economic conditions, and collateral values or factors particular to the borrower. No assurance can be given that additional increases in nonaccrual and delinquent loans will not occur in the future.

  

Allowance for Credit Losses

 

The Company’s allowance for loan losses represents Management’s estimate of loan losses inherent in the loan portfolio. In evaluating credit risk for loans, Management measures loss potential of the carrying value of loans. As described above, payments received on nonaccrual loans may be applied against the principal balance of the loans until such time as full collection of the remaining recorded balance is expected.

 

The following table summarizes the allowance for loan losses, chargeoffs and recoveries for the periods indicated:

  

		For the Years Ended December 31,
		2018				2017				2016				2015				2014
		($ in thousands)
Analysis of the Allowance for Loan Losses
Balance, beginning of period		$	23,009			$	25,954			$	29,771			$	31,485			$	31,693
(Reversal of) provision for loan losses			-				(1,900	)			(3,200	)			-				2,800
Loans charged off:
Commercial			(513	)			(961	)			(2,023	)			(756	)			(2,152	)
Commercial real estate			(240	)			-				-				(449	)			(1,022	)
Construction			-				-				-				(431	)			-
Residential real estate			-				-				-				-				(30	)
Consumer and other installment			(4,124	)			(4,957	)			(4,749	)			(3,493	)			(4,214	)
Total chargeoffs			(4,877	)			(5,918	)			(6,772	)			(5,129	)			(7,418	)
Recoveries of loans previously charged off:
Commercial			1,447				762				4,028				1,174				2,275
Commercial real estate			-				88				554				290				213
Construction			-				1,899				-				45				53
Consumer and other installment			1,772				2,124				1,573				1,906				1,869
Total recoveries			3,219				4,873				6,155				3,415				4,410
Net loan losses			(1,658	)			(1,045	)			(617	)			(1,714	)			(3,008	)
Balance, end of period		$	21,351			$	23,009			$	25,954			$	29,771			$	31,485
Net loan losses as a percentage of average loans			0.14	%			0.08	%			0.04	%			0.11	%			0.17	%

 

The Company's allowance for loan losses is maintained at a level considered appropriate to provide for losses that can be estimated based upon specific and general conditions. These include conditions unique to individual borrowers, as well as overall loan loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other factors. A portion of the allowance is individually allocated to impaired loans whose full collectability of principal is uncertain. Such allocations are determined by Management based on loan-by-loan analyses. The Company evaluates for impairment all loans with outstanding principal balances in excess of $500 thousand which are classified or on nonaccrual status and all “troubled debt restructured” loans. The remainder of the loan portfolio is collectively evaluated for impairment based in part on quantitative analyses of historical loan loss experience of loan portfolio segments to determine standard loss rates for each segment. The loss rate for each loan portfolio segment reflects both the historical loss experience during a look-back period and a loss emergence period. Liquidating purchased consumer installment loans are evaluated separately by applying historical loss rates to forecasted liquidating principal balances to measure losses inherent in this portfolio segment. The loss rates are applied to segmented loan balances to allocate the allowance to the segments of the loan portfolio.

 

The remainder of the allowance is considered to be unallocated. The unallocated allowance is established to provide for probable losses that have been incurred as of the reporting date but not reflected in the allocated allowance. The unallocated allowance addresses additional qualitative factors consistent with Management's analysis of the level of risks inherent in the loan portfolio, which are related to the risks of the Company's general lending activity. Included in the unallocated allowance is the risk of losses that are attributable to national or local economic or industry trends which have occurred but have not yet been recognized in loan chargeoff history (external factors). The primary external factor evaluated by the Company and the judgmental amount of unallocated reserve assigned by Management as of December 31, 2018 is economic and business conditions $0.4 million. Also included in the unallocated allowance is the risk of losses attributable to general attributes of the Company's loan portfolio and credit administration (internal factors). The internal factors evaluated by the Company and the judgmental amount of unallocated reserve assigned by Management are: loan review system $0.9 million, adequacy of lending Management and staff $0.8 million and concentrations of credit $1.0 million.

 

The following table presents the allocation of the allowance for loan losses as of December 31 for the years indicated:

 

		At December 31,
		2018								2017								2016								2015								2014
		Allocation of the Allowance Balance				Loans as Percent of Total Loans				Allocation of the Allowance Balance				Loans as Percent of Total Loans				Allocation of the Allowance Balance				Loans as Percent of Total Loans				Allocation of the Allowance Balance				Loans as Percent of Total Loans				Allocation of the Allowance Balance				Loans as Percent of Total Loans
		($ in thousands)
Commercial		$	6,311				23	%		$	7,746				26	%		$	8,327				26	%		$	9,559				25	%		$	5,460				23	%
Commercial real estate			3,884				48	%			3,849				44	%			3,330				40	%			4,212				42	%			4,245				42	%
Construction			1,465				-	%			335				1	%			152				-	%			235				-	%			654				1	%
Residential real estate			869				4	%			995				5	%			1,330				7	%			1,801				8	%			2,241				9	%
Consumer installment and other			5,645				25	%			6,418				24	%			7,980				27	%			8,001				25	%			9,827				25	%
Unallocated portion			3,177				-	%			3,666				-	%			4,835				-	%			5,963				-	%			9,058				-	%
Total		$	21,351				100	%		$	23,009				100	%		$	25,954				100	%		$	29,771				100	%		$	31,485				100	%

 

The portion of the allowance for loan losses ascribed to loan segments changed from December 31, 2017 to December 31, 2018 based on Management’s evaluation of credit risk. The allowance for loan losses ascribed to commercial loans declined due to the improved financial performance of a specific borrower. The allowance for loan losses ascribed to construction loans increased based on an increased level of credit exposure relative to real property values. The allowance for loan losses ascribed to consumer installment loans declined due to Management’s measurement of a shortened loss emergence period.

 

		Allowance for Loan Losses
		For the Year Ended December 31, 2018
																		Consumer
						Commercial								Residential				Installment
		Commercial				Real Estate				Construction				Real Estate				and Other				Unallocated				Total
		(In thousands)
Allowance for loan losses:
Balance at beginning of period		$	7,746			$	3,849			$	335			$	995			$	6,418			$	3,666			$	23,009
(Reversal) provision			(2,369	)			275				1,130				(126	)			1,579				(489	)			-
Chargeoffs			(513	)			(240	)			-				-				(4,124	)			-				(4,877	)
Recoveries			1,447				-				-				-				1,772				-				3,219
Total allowance for loan losses		$	6,311			$	3,884			$	1,465			$	869			$	5,645			$	3,177			$	21,351

 

		Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment
		At December 31, 2018
		Commercial				Commercial Real Estate				Construction				Residential Real Estate				Consumer Installment and Other				Unallocated				Total
		(In thousands)
Allowance for loan losses:
Individually evaluated for impairment		$	2,752			$	-			$	-			$	-			$	-			$	-			$	2,752
Collectively evaluated for impairment			3,559				3,884				1,465				869				5,645				3,177				18,599
Purchased loans with evidence of credit deterioration			-				-				-				-				-				-				-
Total		$	6,311			$	3,884			$	1,465			$	869			$	5,645			$	3,177			$	21,351
Carrying value of loans:
Individually evaluated for impairment		$	9,921			$	8,217			$	-			$	717			$	-			$	-			$	18,855
Collectively evaluated for impairment			265,136				572,042				3,982				44,149				302,651				-				1,187,960
Purchased loans with evidence of credit deterioration			23				221				-				-				143				-				387
Total		$	275,080			$	580,480			$	3,982			$	44,866			$	302,794			$	-			$	1,207,202

 

Management considers the $21.4 million allowance for loan losses to be adequate as a reserve against probable incurred loan losses in the loan portfolio as of December 31, 2018.

 

See Note 3 to the consolidated financial statements for additional information related to the loan portfolio, loan portfolio credit risk, and allowance for loan losses.

 

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Asset/Liability and Market Risk Management

 

Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk, liquidity and funding. The fundamental objective of the Company's management of assets and liabilities is to maximize its economic value while maintaining adequate liquidity and a conservative level of interest rate risk.

 

Interest Rate Risk

 

Interest rate risk is a significant market risk affecting the Company. Many factors affect the Company’s exposure to interest rates, such as general economic and financial conditions, customer preferences, historical pricing relationships, and re-pricing characteristics of financial instruments. Financial instruments may mature or re-price at different times. Financial instruments may re-price at the same time but by different amounts. Short-term and long-term market interest rates may change by different amounts. The timing and amount of cash flows of various financial instruments may change as interest rates change. In addition, the changing levels of interest rates may have an impact on loan demand and demand for various deposit products.

 

The Company’s earnings are affected not only by general economic conditions, but also by the monetary and fiscal policies of the United States government and its agencies, particularly the FOMC. The monetary policies of the FOMC can influence the overall growth of loans, investment securities, and deposits and the level of interest rates earned on loans and investment securities and paid for deposits and other borrowings. The nature and impact of future changes in monetary policies are generally not predictable.

 

Management attempts to manage interest rate risk while enhancing the net interest margin and net interest income. At times, depending on expected increases or decreases in market interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, Management may adjust the Company's interest rate risk position. The Company's results of operations and net portfolio values remain subject to changes in interest rates and to fluctuations in the difference between long and short-term interest rates.

 

Management monitors the Company’s interest rate risk using a purchased simulation model, which is periodically validated using supervisory guidance issued by the Board of Governors of the Federal Reserve System, SR 11-7 “Guidance on Model Risk Management.” Management measures its exposure to interest rate risk using both a static and dynamic composition of financial instruments. Within the static composition simulation, cash flows are assumed redeployed into like financial instruments at prevailing rates and yields. Within the dynamic composition simulation, Management makes assumptions regarding the expected change in the volume of financial instruments given the assumed change in market interest rates. Both simulations are used to measure expected changes in net interest income assuming various levels of change in market interest rates.

 

The Company’s asset and liability position was slightly “asset sensitive” at December 31, 2018, depending on the interest rate assumptions applied to each simulation model. An “asset sensitive” position results in a slightly larger change in interest income than in interest expense resulting from application of assumed interest rate changes.

 

At December 31, 2018, Management’s measurements of estimated changes in net interest income were:

 

Static Simulation:
Assumed Immediate Parallel Shift in Interest Rates			-1.00	%			0.00	%			+1.00%
First Year Change in Net Interest Income			-7.50	%			0.00	%			+5.30%
Dynamic Simulation:
Assumed Change in Interest Rates Over 1 Year			-1.00	%			0.00	%			+1.00%
First Year Change in Net Interest Income			-3.60	%			0.00	%			+2.80%

 

Simulation estimates depend on, and will change with, the size and mix of the actual and projected composition of financial instruments at the time of each simulation.

 

The Company does not currently engage in trading activities or use derivative instruments to manage interest rate risk, even though such activities may be permitted with the approval of the Company's Board of Directors.

 

Market Risk - Equity Markets

 

Equity price risk can affect the Company. Preferred or common stock holdings, as permitted by banking regulations, can fluctuate in value. Changes in value of preferred or common stock holdings are recognized in the Company's income statement.

 

Fluctuations in the Company's common stock price can impact the Company's financial results in several ways. First, the Company has at times repurchased and retired its common stock; the market price paid to retire the Company's common stock affects the level of the Company's shareholders' equity, cash flows and shares outstanding. Second, the Company's common stock price impacts the number of dilutive equivalent shares used to compute diluted earnings per share. Third, fluctuations in the Company's common stock price can motivate holders of options to purchase Company common stock through the exercise of such options thereby increasing the number of shares outstanding and potentially adding volatility to the book tax provision. Finally, the amount of compensation expense and tax deductions associated with share based compensation fluctuates with changes in and the volatility of the Company's common stock price.

 

Market Risk - Other

 

Market values of loan collateral can directly impact the level of loan chargeoffs and the provision for loan losses. The financial condition and liquidity of debtors issuing bonds and debtors whose mortgages or other obligations are securitized can directly impact the credit quality of the Company’s investment securities portfolio requiring the Company to recognize other than temporary impairment charges. Other types of market risk, such as foreign currency exchange risk, are not significant in the normal course of the Company's business activities.

 

Liquidity and Funding

 

The objective of liquidity management is to manage cash flow and liquidity reserves so that they are adequate to fund the Company's operations and meet obligations and other commitments on a timely basis and at a reasonable cost. The Company achieves this objective through the selection of asset and liability maturity mixes that it believes best meet its needs. The Company's liquidity position is enhanced by its ability to raise additional funds as needed in the wholesale markets.

 

In recent years, the Company's deposit base has provided the majority of the Company's funding requirements. This relatively stable and low-cost source of funds, along with shareholders' equity, provided 98 percent of funding for average total assets in the year ended December 31, 2018 and 2017. The stability of the Company’s funding from customer deposits is in part reliant on the confidence clients have in the Company. The Company places a very high priority in maintaining this confidence through conservative credit and capital management practices and by maintaining an appropriate level of liquidity.

 

Liquidity is further provided by assets such as balances held at the Federal Reserve Bank, investment securities, and amortizing loans. The Company's investment securities portfolio provides a substantial secondary source of liquidity. The Company held $3.6 billion in total investment securities at December 31, 2018. Under certain deposit, borrowing and other arrangements, the Company must hold and pledge investment securities as collateral. At December 31, 2018, such collateral requirements totaled approximately $728 million.

 

Liquidity risk can result from the mismatching of asset and liability cash flows, or from disruptions in the financial markets. The Company performs liquidity stress tests on a periodic basis to evaluate the sustainability of its liquidity. Under the stress testing, the Company assumes outflows of funds increase beyond expected levels. Measurement of such heightened outflows considers the composition of the Company’s deposit base, including any concentration of deposits, non-deposit funding such as short-term borrowings, and unfunded lending commitments. The Company evaluates its stock of highly liquid assets to meet the assumed higher levels of outflows. Highly liquid assets include cash and amounts due from other banks from daily transaction settlements, reduced by branch cash needs and Federal Reserve Bank reserve requirements, and investment securities based on regulatory risk-weighting guidelines. Based on the results of the most recent liquidity stress test, Management is satisfied with the liquidity condition of the Bank and the Company. However, no assurance can be given the Bank or Company will not experience a period of reduced liquidity.

 

Management continually monitors the Company’s cash levels. Loan demand from credit worthy borrowers will be dictated by economic and competitive conditions. The Company aggressively solicits non-interest bearing demand deposits and money market checking deposits, which are the least sensitive to changes in interest rates. The growth of these deposit balances is subject to heightened competition, the success of the Company's sales efforts, delivery of superior customer service, new regulations and market conditions. The Company does not aggressively solicit higher-costing time deposits; as a result, Management anticipates such deposits will decline. Changes in interest rates, most notably rising interest rates, could impact deposit volumes. Depending on economic conditions, interest rate levels, liquidity management and a variety of other conditions, deposit growth may be used to fund loans or purchase investment securities. However, due to possible volatility in economic conditions, competition and political uncertainty, loan demand and levels of customer deposits are not certain. Shareholder dividends are expected to continue subject to the Board's discretion and continuing evaluation of capital levels, earnings, asset quality and other factors.

 

Westamerica Bancorporation ("Parent Company") is a separate entity apart from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Parent Company is responsible for the payment of dividends declared for its shareholders, and interest and principal on any outstanding debt. The Parent Company currently has no debt. Substantially all of the Parent Company's revenues are obtained from subsidiary dividends and service fees.

 

The Bank’s dividends paid to the Parent Company, proceeds from the exercise of stock options, and Parent Company cash balances provided adequate cash for the Parent Company to pay shareholder dividends of $43 million in 2018 and $41 million in 2017, and retire common stock in the amount of $524 thousand in 2018 and $314 thousand in 2017. Payment of dividends to the Parent Company by the Bank is limited under California and Federal laws. The Company believes these regulatory dividend restrictions will not have an impact on the Parent Company's ability to meet its ongoing cash obligations.

 

Contractual Obligations

 

Deposits and sort-term borrowings are detailed on pages 43 and 44. The following table sets forth the known contractual obligations, except deposits, short-term borrowing arrangements and post-retirement benefit plans, of the Company:

 

		At December 31, 2018
		Within One Year				Over One to Three Years				Over Three to Five Years				After Five Years				Total
		(In thousands)
Operating Lease Obligations		$	5,996			$	7,150			$	3,144			$	1,044			$	17,334
Purchase Obligations			8,301				16,991				-				-				25,292
Total		$	14,297			$	24,141			$	3,144			$	1,044			$	42,626

 

Operating lease obligations have not been reduced by minimum sublease rentals of $1 million due in the future under noncancelable subleases. Operating lease obligations may be retired prior to the contractual maturity as discussed in the notes to the consolidated financial statements. The purchase obligation consists of the Company’s minimum liabilities under contracts with third-party automation services providers .

 

Capital Resources

 

The Company has historically generated high levels of earnings, which provide a means of accumulating capital. The Company's net income as a percentage of average shareholders' equity (“return on equity” or “ROE”) has been 11.3% in 2018, 8.4% in 2017 and 10.9% in 2016. The Company also raises capital as employees exercise stock options. Capital raised through the exercise of stock options was $13 million in 2018, $25 million in 2017 and $24 million in 2016.

 

The Company paid common dividends totaling $43 million in 2018, $41 million in 2017 and $40 million in 2016, which represent dividends per common share of $1.60, $1.57 and $1.56, respectively. The Company's earnings have historically exceeded dividends paid to shareholders. The amount of earnings in excess of dividends provides the Company resources to finance growth and maintain appropriate levels of shareholders' equity. In the absence of profitable growth opportunities, the Company has at times repurchased and retired its common stock as another means to return earnings to shareholders. The Company repurchased and retired 9 thousand shares valued at $524 thousand in 2018, 6 thousand shares valued at $314 thousand in 2017 and 137 thousand shares valued at $6 million in 2016.

 

The Company's primary capital resource is shareholders' equity, which was $616 million at December 31, 2018 compared with $590 million at December 31, 2017. The Company's ratio of equity to total assets was 11.05% at December 31, 2018 and 10.71% at December 31, 2017.

 

The Company performs capital stress tests on a periodic basis to evaluate the sustainability of its capital. Under the stress testing, the Company assumes various scenarios such as deteriorating economic and operating conditions, unanticipated asset devaluations, and significant operational lapses. The Company measures the impact of these scenarios on its earnings and capital. Based on the results of the most recent stress tests, Management is satisfied with the capital condition of the Bank and the Company. However, no assurance can be given the Bank or Company will not experience a period of reduced earnings or a reduction in capital from unanticipated events and circumstances.

 

Capital to Risk-Adjusted Assets

 

On July 2, 2013, the Federal Reserve Board approved a final rule that implements changes to the regulatory capital framework for all banking organizations. The rule’s provisions which most affected the regulatory capital requirements of the Company and the Bank:

 

·

Introduced a new “Common Equity Tier 1” capital measurement,

·

Established higher minimum levels of capital,

·

Introduced a “capital conservation buffer,”

·

Increased the risk-weighting of certain assets, and

·

Established limits on the amount of deferred tax assets with any excess treated as a deduction from Tier 1 capital.

 

Under the final rule, a banking organization that is not subject to the “advanced approaches rule” may make a one-time election not to include most elements of Accumulated Other Comprehensive Income, including net-of-tax unrealized gains and losses on debt securities available for sale, in regulatory capital. Neither the Company nor the Bank is subject to the “advanced approaches rule” and both made the election not to include most elements of Accumulated Other Comprehensive Income in regulatory capital.

 

Banking organizations that are not subject to the “advanced approaches rule” began complying with the final rule on January 1, 2015; on such date, the Company and the Bank became subject to the revised definitions of regulatory capital, the new minimum regulatory capital ratios, and various regulatory capital adjustments and deductions according to transition provisions and timelines. All banking organizations began calculating standardized total risk-weighted assets on January 1, 2015. The transition period for the capital conservation buffer for all banking organizations began on January 1, 2016 and ended January 1, 2019, when the 2.5% capital conservation buffer was fully implemented. Any bank subject to the rule which is unable to maintain its “capital conservation buffer” above the minimum regulatory capital ratios will be restricted in the payment of discretionary executive compensation and shareholder distributions, such as dividends and share repurchases.

 

The final rule did not supersede provisions of the Federal Deposit Insurance Corporation Improvement Act (FDICIA) requiring federal banking agencies to take prompt corrective action (PCA) to resolve problems of insured depository institutions. The final rule revised the PCA thresholds to incorporate the higher minimum levels of capital, including the “common equity tier 1” ratio.

 

The capital ratios for the Company and the Bank under the new capital framework are presented in the tables below, on the dates indicated.

 

																		To Be
										Required for								Well-capitalized
										Capital Adequacy Purposes								Under Prompt
		At December 31, 2018								Effective				Effective				Corrective Action
		Company				Bank				January 1, 2018				January 1, 2019				Regulations (Bank)
Common Equity Tier I Capital			16.30	%			13.01	%			6.375	%(1)			7.00	%(2)			6.50	%
Tier I Capital			16.30	%			13.01	%			7.875	%(1)			8.50	%(2)			8.00	%
Total Capital			17.03	%			13.94	%			9.875	%(1)			10.50	%(2)			10.00	%
Leverage Ratio			9.51	%			7.55	%			4.000	%			4.00	%			5.00	%

 

⁽¹⁾ Includes 1.875% capital conservation buffer.

⁽²⁾ Includes 2.5% capital conservation buffer.

 

																		To Be
										Required for								Well-capitalized
										Capital Adequacy Purposes								Under Prompt
		At December 31, 2017								Effective				Effective				Corrective Action
		Company				Bank				January 1, 2017				January 1, 2019				Regulations (Bank)
Common Equity Tier I Capital			15.36	%			12.50	%			5.75	%(3)			7.00	%(4)			6.50	%
Tier I Capital			15.36	%			12.50	%			7.25	%(3)			8.50	%(4)			8.00	%
Total Capital			16.17	%			13.52	%			9.25	%(3)			10.50	%(4)			10.00	%
Leverage Ratio			8.86	%			7.16	%			4.00	%			4.00	%			5.00	%

 

⁽³⁾ Includes 1.25% capital conservation buffer.

⁽⁴⁾ Includes 2.5% capital conservation buffer.

 

In June 2016, the Financial Accounting Standards Board issued an update to the accounting standards for credit losses known as the "Current Expected Credit Losses" (CECL) methodology, which replaces the existing incurred loss methodology for certain financial assets. The Company intends to timely adopt the CECL methodology January 1, 2020, which involves an implementing accounting entry to retained earnings. In December 2018, the federal bank regulatory agencies approved a final rule which will be effective April 1, 2019 modifying their regulatory capital rules and providing an option to phase in over a period of three years the day-one regulatory capital effects of implementing the CECL methodology. The Company has not determined whether it will elect the three year phase in period for the day-one regulatory capital effects. See Note 1 to the consolidated financial statements, “Summary of Significant Accounting Policies: Recently Issued Accounting Standards” for more information on the CECL methodology.

 

The Company and the Bank routinely project capital levels by analyzing forecasted earnings, credit quality, shareholder dividends, asset volumes, share repurchase activity, stock option exercise proceeds, and other factors. Based on current capital projections, the Company and the Bank expect to maintain regulatory capital levels exceeding the highest effective regulatory standard and pay quarterly dividends to shareholders. No assurance can be given that changes in capital management plans will not occur.

 

Deposit Categories

 

The Company primarily attracts deposits from local businesses and professionals, as well as through retail savings and checking accounts, and, to a more limited extent, certificates of deposit.

 

The following table summarizes the Company’s average daily amount of deposits and the rates paid for the periods indicated:

 

Deposit Distribution and Average Rates Paid

 

		For the Years Ended December 31,
		2018												2017												2016
		Average Balance				Percentage of Total Deposits				Rate				Average Balance				Percentage of Total Deposits				Rate				Average Balance				Percentage of Total Deposits				Rate
		($ In thousands)
Noninterest-bearing demand		$	2,209,924				45.4	%			-	%		$	2,095,522				44.4	%			-	%		$	2,026,939				44.1	%			-	%
Interest bearing:
Transaction			928,277				19.0	%			0.04	%			888,116				18.8	%			0.03	%			862,581				18.8	%			0.03	%
Savings			1,519,375				31.2	%			0.06	%			1,492,725				31.6	%			0.02	%			1,428,059				31.1	%			0.06	%
Time less than $100 thousand			119,586				2.5	%			0.23	%			136,324				2.9	%			0.17	%			154,022				3.4	%			0.26	%
Time $100 thousand or more			94,919				1.9	%			0.39	%			109,563				2.3	%			0.38	%			118,750				2.6	%			0.43	%
Total (1)		$	4,872,081				100.0	%			0.04	%		$	4,722,250				100.0	%			0.04	%		$	4,590,351				100.0	%			0.05	%

 

⁽¹⁾ The rates for total deposits reflect the value of noninterest-bearing deposits.

 

The Company’s strategy includes building the value of its deposit base by building balances of lower-costing deposits and avoiding reliance on higher-costing time deposits. From 2016 to 2018 higher costing time deposits declined from 6% to 4% of total deposits. The Company’s average balances of checking and savings accounts represented 96% of average balances of total deposits in 2018 compared with 95% in 2017 and 94% in 2016.

 

Total time deposits were $195 million and $232 million at December 31, 2018 and 2017, respectively. The following table sets forth, by time remaining to maturity, the Company’s total domestic time deposits. The Company has no foreign time deposits.

 

Time Deposits Maturity Distribution

 

		At December 31, 2018
		(In thousands)
2019		$	144,482
2020			26,229
2021			13,574
2022			5,463
2023			5,473
Thereafter			30
Total		$	195,251

 

The following sets forth, by time remaining to maturity, the Company’s domestic time deposits in amounts of $100 thousand or more:

 

Time Deposits $100,000 or more Maturity Distribution

 

		At December 31, 2018
		(In thousands)
Three months or less		$	27,718
Over three through six months			14,785
Over six through twelve months			21,932
Over twelve months			28,162
Total		$	92,597

 

Short-term Borrowings

 

The following table sets forth the short-term borrowings of the Company:

 

Short-Term Borrowings Distribution

 

		At December 31,
		2018				2017				2016
		(In thousands)
Securities sold under agreements to repurchase the securities		$	51,247			$	58,471			$	59,078
Total short-term borrowings		$	51,247			$	58,471			$	59,078

 

Further detail of federal funds purchased and other borrowed funds is as follows:

 

		For the Years Ended December 31,
		2018				2017				2016
		($ in thousands)
Federal funds purchased balances and rates paid on outstanding amount:
Average balance for the year		$	1			$	5			$	5
Maximum month-end balance during the year			-				-				-
Average interest rate for the year			-	%			1.53	%			0.77	%
Average interest rate at period end			-	%			-	%			-	%
Securities sold under agreements to repurchase the securities balances and rates paid on outstanding amount:
Average balance for the year		$	59,991			$	69,666			$	61,271
Maximum month-end balance during the year			68,894				82,126				74,815
Average interest rate for the year			0.06	%			0.06	%			0.06	%
Average interest rate at period end			0.06	%			0.06	%			0.06	%

 

Financial Ratios

 

The following table shows key financial ratios for the periods indicated:

 

		At and For the Years Ended December 31,
		2018				2017				2016
Return on average total assets			1.27	%			0.92	%			1.12	%
Return on average common shareholders' equity			11.35	%			8.39	%			10.85	%
Average shareholders' equity as a percentage of:
Average total assets			11.22	%			10.96	%			10.34	%
Average total loans			52.16	%			45.34	%			38.08	%
Average total deposits			12.95	%			12.63	%			11.81	%
Common dividend payout ratio			60	%			83	%			68	%

 

 

 

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company’s Board of Directors.

 

Credit risk and interest rate risk are the most significant market risks affecting the Company, and equity price risk can also affect the Company’s financial results. These risks are described in the preceding sections regarding “Loan Portfolio Credit Risk,” and “Asset/Liability and Market Risk Management.” Other types of market risk, such as foreign currency exchange risk and commodity price risk, are not significant in the normal course of the Company’s business activities.

 

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

INDEX TO FINANCIAL STATEMENTS

 

	Page
Management’s Internal Control Over Financial Reporting	47
Consolidated Balance Sheets as of December 31, 2018 and 2017	48
Consolidated Statements of Income for the years ended December 31, 2018, 2017 and 2016	49
Consolidated Statements of Comprehensive Income for the years ended December 31, 2018, 2017 and 2016	50
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2018, 2017 and 2016	51
Consolidated Statements of Cash Flows for the years ended December 31, 2018, 2017 and 2016	52
Notes to the Consolidated Financial Statements	53
Report of Independent Registered Public Accounting Firm	91

 

 

 

 

 

 

 

 

 

 

 

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Management of Westamerica Bancorporation and subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2018. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of Management and Directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Management performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2018 based upon criteria in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, Management determined that the Company’s internal control over financial reporting was effective as of December 31, 2018 based on the criteria in Internal Control - Integrated Framework (2013) issued by COSO.

 

The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting. Their opinion and attestation on internal control over financial reporting appear on page 91.

 

Dated: February 28, 2019

 

 

 

 

WESTAMERICA BANCORPORATION

CONSOLIDATED BALANCE SHEETS

 

 

See accompanying notes to consolidated financial statements.

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF INCOME

 

 

See accompanying notes to consolidated financial statements.

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

See accompanying notes to consolidated financial statements.

 

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

 

 

See accompanying notes to consolidated financial statements.

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See accompanying notes to consolidated financial statements.

⁽¹⁾ Federal Deposit Insurance Corporation ("FDIC")

 

WESTAMERICA BANCORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

 

Shareholders and the Board of Directors of

Westamerica Bancorporation

San Rafael, California

 

 

Opinions on the Financial Statements and Internal Control over Financial Reporting

 

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

 

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

 

Basis for Opinions

 

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

 

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

 

 

(Continued)

 

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

 

Definition and Limitations of Internal Control Over Financial Reporting

 

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

 

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

 

 

 

/s/ Crowe LLP                                                

Crowe LLP

 

We have served as the Company's auditor since 2015.

 

Sacramento, California

February 28, 2019

 

 

 

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

None.

  

ITEM 9A. CONTROLS AND PROCEDURES

 

The Company’s principal executive officer and principal financial officer have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, as of December 31, 2018.

 

Based upon their evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective to ensure that material information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported as and when required and that such information is communicated to the Company’s management, including the principal executive officer and the principal financial officer, to allow for timely decisions regarding required disclosures. The evaluation did not identify any change in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. Management’s Report on Internal Control Over Financial Reporting and the attestation Report of Independent Registered Public Accounting Firm are found on pages 47 and 91, respectively.

 

ITEM 9B. OTHER INFORMATION

 

None.

 

 

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PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS OF THE REGISTRANT AND CORPORATE GOVERNANCE

 

The information regarding Directors of the Registrant and compliance with Section 16(a) of the Securities Exchange Act of 1934 required by this Item 10 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the captions “Board of Directors and Committees”, “Proposal 1 — Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Proxy Statement for its 2018 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.

 

Executive Officers

 

The executive officers of the Company and Westamerica Bank serve at the pleasure of the Board of Directors and are subject to annual appointment by the Board at its first meeting following the Annual Meeting of Shareholders. It is anticipated that each of the executive officers listed below will be reappointed to serve in such capacities at that meeting.

 

Name of Executive		Position		Held Since
David L. Payne		Mr. Payne, born in 1955, is the Chairman of the Board, President and Chief Executive Officer of the Company. Mr. Payne is President and Chief Executive Officer of Gibson Printing and Publishing Company and Gibson Radio and Publishing Company which are newspaper, commercial printing and real estate investment companies headquartered in Vallejo, California.		1984
John “Robert” Thorson		Mr. Thorson, born in 1960, is Senior Vice President and Chief Financial Officer of the Company. Mr. Thorson joined Westamerica Bancorporation in 1989, was Vice President and Manager of Human Resources from 1995 until 2001 and was Senior Vice President and Treasurer from 2002 until 2005.		2005
Russell W. Rizzardi		Mr. Rizzardi, born in 1955, is Senior Vice President and Chief Credit Administrator of Westamerica Bank. Mr. Rizzardi joined Westamerica Bank in 2007. He has been in the banking industry since 1979 and was previously with Wells Fargo Bank and U.S. Bank.		2008
George ”Steve” Ensinger		Mr. Ensinger, born in 1954, is Senior Vice President and Division Manager of Human Resources of the Company. Mr. Ensinger joined Westamerica Bancorporation in 2014 and has held a variety of senior positions in Human Resources prior to joining the Company.		2014
Brian J. Donohoe		Mr. Donohoe, born in 1981, is Senior Vice President and Manager of the Operations & Systems Administration of Community Banker Services Corporation. Mr. Donohoe joined Westamerica Bancorporation in 1999 and has held a variety of positions in the Banking Division and the Operations & Systems Division, most recently, Vice President and Manager of Business Services until 2018.		2019

 

The Company has adopted a Code of Ethics (as defined in Item 406 of Regulation S-K of the Securities Act of 1933) that is applicable to its senior financial officers including its chief executive officer, chief financial officer, and principal accounting officer.

 

ITEM 11. EXECUTIVE COMPENSATION

 

The information required by this Item 11 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the captions “Executive Compensation” in the Company’s Proxy Statement for its 2019 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.

 

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

 

The information required by this Item 12 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the caption “Stock Ownership” in the Company’s Proxy Statement for its 2019 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.

 

Securities Authorized For Issuance Under Equity Compensation Plans

 

The following table summarizes the status of the Company’s equity compensation plans as of December 31, 2018:

 

		At December 31, 2018
Plan category		Number of securities to be issued upon exercise of outstanding options, warrants and rights				Weighted-average exercise price of outstanding options, warrants and rights				Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
		(In thousands, except exercise price)
		(a)				(b)				(c)
Equity compensation plans approved by security holders			946			$	54				713
Equity compensation plans not approved by security holders			-				N/A				-
Total			946			$	54				713

 

ITEM 13. CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

 

The information required by this Item 13 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the caption “Certain Relationships and Related Party Transactions” in the Company’s Proxy Statement for its 2019 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.

  

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information required by this Item 14 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the caption “Proposal 3 – Ratification of Independent Auditor” in the Company’s Proxy Statement for its 2019 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.

 

 

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a)	1.	Financial Statements:   See Index to Financial Statements on page 46. The consolidated financial statements included in Item 8 are filed as part of this Report.
(a)	2.	Financial statement schedules required. No financial statement schedules are filed as part of this Report since the required information is included in the consolidated financial statements, including the notes thereto, or the circumstances requiring inclusion of such schedules are not present.
(a)	3.	Exhibits:   The exhibit list required by this item is incorporated by reference to the Exhibit Index filed with this Report.

  

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.

 

WESTAMERICA BANCORPORATION

 

/s/ John “Robert” Thorson                             

John “Robert” Thorson

Senior Vice President

and Chief Financial Officer

(Principal Financial and Accounting Officer)

 

Date: February 28, 2019

 

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 and in the capacities and on the date indicated.

 

Signature		Title		Date
/s/ David L. Payne David L. Payne		Chairman of the Board and Directors President and Chief Executive Officer (Principal Executive Officer)		February 28, 2019
/s/ John “Robert” Thorson John “Robert” Thorson		Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)		February 28, 2019
/s/ Etta Allen Etta Allen		Director		February 28, 2019
/s/ Louis E. Bartolini Louis E. Bartolini		Director		February 28, 2019
/s/ E. Joseph Bowler E. Joseph Bowler		Director		February 28, 2019
/s/ Patrick D. Lynch Patrick D. Lynch		Director		February 28, 2019
/s/ Catherine C. MacMillan Catherine C. MacMillan		Director		February 28, 2019
/s/ Ronald A. Nelson Ronald A. Nelson		Director		February 28, 2019
/s/ Edward B. Sylvester Edward B. Sylvester		Lead Independent Director		February 28, 2019

 

EXHIBIT INDEX

 

Exhibit Number
3(a)	Restated Articles of Incorporation (composite copy), incorporated by reference to Exhibit 3(a) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997, filed with the Securities and Exchange Commission on March 30, 1998.
3(b)	By-laws, as amended (composite copy), incorporated by reference to Exhibit 3.2 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on March 26, 2018.
3(c)	Certificate of Determination of Fixed Rate Cumulative Perpetual Preferred Stock, Series A of Westamerica Bancorporation dated February 10, 2009, incorporated by reference to Exhibit 99.1 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on February 13, 2009.
4(c)	Warrant to Purchase Common Stock pursuant to the Letter Agreement between the Company and the United States Department of the Treasury dated February 13, 2009 incorporated by reference to Exhibit 4.2 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on February 19, 2009.
10(a)*	Amended and Restated Stock Option Plan of 1995, incorporated by reference to Exhibit A to the Registrant’s definitive Proxy Statement pursuant to Regulation 14(a) filed with the Securities and Exchange Commission on March 17, 2003.
10(d)*	Westamerica Bancorporation Chief Executive Officer Deferred Compensation Agreement by and between Westamerica Bancorporation and David L. Payne, dated December 18, 1998 incorporated by reference to Exhibit 10(e) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999, filed with the Securities and Exchange Commission on March 29, 2000.
10(e)*	Description of Executive Cash Bonus Program incorporated by reference to Exhibit 10(e) to Exhibit 2.1 of Registrant’s Form 8-K filed with the Securities and Exchange Commission on March 14, 2005.
10(f)*	Non-Qualified Annuity Performance Agreement with David L. Payne dated November 19, 1997 incorporated by reference to Exhibit 10(f) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the Securities and Exchange Commission on March 15, 2005.
10(g)*	Amended and Restated Westamerica Bancorporation Stock Option Plan of 1995 Nonstatutory Stock Option Agreement Form incorporated by reference to Exhibit 10(g) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the Securities and Exchange Commission on March 15, 2005.
10(h)*	Amended and Restated Westamerica Bancorporation Stock Option Plan of 1995 Restricted Performance Share Grant Agreement Form incorporated by reference to Exhibit 10(h) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the Securities and Exchange Commission on March 15, 2005.
10(i)*	Amended Westamerica Bancorporation and Subsidiaries Deferred Compensation Plan (As restated effective January 1, 2005) dated December 31, 2008 incorporated by reference to Exhibit 10(i) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008, filed with the Securities and Exchange Commission on February 27, 2009.
10(j)*	Amended and Restated Westamerica Bancorporation Deferral Plan (Adopted October 26, 1995) dated December 31, 2008 incorporated by reference to Exhibit 10(j) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008, filed with the Securities and Exchange Commission on February 27, 2009.
10(k)*	Form of Restricted Performance Share Deferral Election pursuant to the Westamerica Bancorporation Deferral Plan incorporated by reference to Exhibit 10(i) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005, filed with the Securities and Exchange Commission on March 10, 2006.
10(l)	Purchase and Assumption Agreement by and between Federal Deposit Insurance Corporation and Westamerica Bank dated February 6, 2009, incorporated by reference to Exhibit 99.2 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on February 11, 2009.
10(m)	Letter Agreement between the Company and the United States Department of the Treasury dated February 13, 2009 incorporated by reference to Exhibit 10.1 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on February 19, 2009.
10(s)*	Amended and Restated Stock Option Plan of 1995, incorporated by reference to Exhibit A to the Registrant’s definitive Proxy Statement pursuant to Regulation 14(a) filed with the Securities and Exchange Commission on March 13, 2012.

 

10(t)	Data Processing Agreement by and between Fidelity Information Services and Westamerica Bancorporation incorporated by reference to Exhibit 10(t) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed with the Securities and Exchange Commission on February 28, 2017.
11.1	Statement re computation of per share earnings incorporated by reference to Note 18 of the notes to the consolidated financial statements of this Report.
14	Code of Ethics incorporated by reference to Exhibit 14 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, filed with the Securities and Exchange Commission on March 10, 2004.
21	Subsidiaries of the registrant.
23.1	Consent of Crowe LLP
31.1	Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)
31.2	Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

____________

*

Indicates management contract or compensatory plan or arrangement.

 

 

The exhibits listed above are available through the SEC’s website (https://www.sec.gov). Alternatively, the Company will furnish to shareholders a copy of any exhibit listed above, but not contained herein, upon written request to the Office of the Corporate Secretary A-2M, Westamerica Bancorporation, P.O. Box 1200, Suisun City, California 94585-1200, and payment to the Company of $.25 per page.

 

 

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