UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2015 

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:  000-31977

CENTRAL VALLEY COMMUNITY BANCORP

(Exact name of registrant as specified in its charter)

CALIFORNIA	77-0539125
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
7100 N. Financial Dr., Suite 101, Fresno, CA	93720
(Address of principal executive offices)	(Zip Code)

559-298-1775

(Registrant’s telephone number, including area code)

[None]

(Former name, former address and former fiscal year, if changed since last report)

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

None	NASDAQ Capital Market
[Common Stock, $      par value per share]	[EXCHANGE]

Securities registered pursuant to Section 12(g) of the Act:  Common Stock, No Par Value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o	Accelerated filer  x
Non-accelerated filer  o	Smaller reporting company  o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No  x

As of June 30, 2015, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $103,500,000 based on the price at which the stock was last sold on June 30, 2015. 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, No Par Value	Outstanding at March 7, 2016
[Common Stock, No par value per share]	11,015,929	shares

DOCUMENTS INCORPORATED BY REFERENCE

Document	Parts into Which Incorporated
Proxy Statement for the Annual Meeting of Shareholders to be held May 18, 2016 (Proxy Statement)	Part III

TABLE OF CONTENTS

ITEM 1 -	DESCRIPTION OF BUSINESS	1
ITEM 1A -	RISK FACTORS	23
ITEM 1B -	UNRESOLVED STAFF COMMENTS	23
ITEM 2 -	DESCRIPTION OF PROPERTY	29
ITEM 3 -	LEGAL PROCEEDINGS	29
ITEM 4 -	MINE SAFETY DISCLOSURES	29
ITEM 5 -	MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	29
ITEM 6 -	SELECTED FINANCIAL DATA	30
ITEM 7-	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	32
ITEM 7A-	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	58
ITEM 8 -	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	61
ITEM 9 -	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	110
ITEM 9A -	CONTROLS AND PROCEDURES	110
ITEM 9B-	OTHER INFORMATION	111
ITEM 10 -	DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT	111
ITEM 11 -	EXECUTIVE COMPENSATION	111
ITEM 12 -	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS	111
ITEM 13 -	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS	111
ITEM 14 -	PRINCIPAL ACCOUNTING FEES AND SERVICES	112
ITEM 15 -	EXHIBITS, FINANCIAL STATEMENT SCHEDULES	112
SIGNATURES		113

ADDITIONAL INFORMATION; INQUIRIES

Under the Securities Exchange Act of 1934, Sections 13 and 15(d), periodic and current reports must be filed with the SEC.  We electronically file the following reports with the SEC:

•Form 10-K — Annual Report;

•Form 10-Q  — Quarterly Report;

•Form 8-K  — Report of Unscheduled Material Events; and

•Form DEF 14A — Proxy Statement.

We may file additional forms.  The SEC maintains an Internet site, www.sec.gov, in which all forms filed electronically may be accessed.  Additional shareholder information regarding the Company and our Directors is available on our website: www.cvcb.com.  None of the information on or hyperlinked from our website is incorporated into this Report.

Copies of the annual report on Form 10-K for the year ended December 31, 2015 may be obtained without charge upon written request to Dave Kinross, Chief Financial Officer, at the Company’s administrative offices,  7100 N. Financial Dr., Suite 101, Fresno, CA  93720.

Inquiries regarding Central Valley Community Bancorp’s accounting, internal controls or auditing concerns should be directed to Steven D. McDonald, chairman of the Board of Directors’ Audit Committee, at steve.mcdonald@cvcb.com or anonymously at www.ethicspoint.com or EthicsPoint, Inc. at 1-866-294-9588.

General inquiries about Central Valley Community Bancorp or Central Valley Community Bank should be directed to Cathy Ponte, Assistant Corporate Secretary at 1-800-298-1775.

PART I

ITEM 1 - DESCRIPTION OF BUSINESS

General

Central Valley Community Bancorp (the Company) was incorporated on February 7, 2000 as a California corporation, for the purpose of becoming the holding company for Central Valley Community Bank (the Bank), formerly known as Clovis Community Bank, a California state chartered bank, through a corporate reorganization.  In the reorganization, the Bank became the wholly-owned subsidiary of the Company, and the shareholders of the Bank became the shareholders of the Company.  The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the BHC Act), and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the Board of Governors).

At December 31, 2015, we had one banking subsidiary, the Bank.  Our principal business is to provide, through our banking subsidiary, financial services in our primary market area in California.  We serve seven contiguous counties in California’s central valley including Fresno County, Madera County, Merced County, Sacramento County, San Joaquin County, Stanislaus County, and Tulare County, and their surrounding areas through the Bank.  We do not currently conduct any operations other than through the Bank.  Unless the context otherwise requires, references to us refer to the Company and the Bank on a consolidated basis.  At December 31, 2015, we had consolidated total assets of approximately $1,276,736,000.  See Items 7 and 8, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Financial Statements.

Effective July 1, 2013, the Company and Visalia Community Bank (VCB) completed a merger under which Visalia Community Bank, with three full-service offices in Visalia and one in Exeter, merged with and into the Bank.

On August 18, 2011, the Company entered into a Securities Purchase Agreement (SPA) with the Small Business Lending Fund of the United States Department of the Treasury (the Treasury), under which the Company issued 7,000 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series C (Series C Preferred) to the Treasury for an aggregate purchase price of $7,000,000. Simultaneously, the Company agreed with Treasury under a Letter Agreement to redeem, for an aggregate price of $7,000,000, the 7,000 shares of the Company’s Series A Fixed Rate Cumulative Preferred Stock (Series A Stock) originally issued pursuant to the Treasury’s Capital Purchase Program (CPP) in 2009. The redemption of the Series A Stock resulted in an acceleration of the remaining discount booked at the time of the CPP transaction. In connection with the repurchase of the Series A Stock, the Company also repurchased the warrant (the Warrant) to purchase 79,037 shares of the Company’s common stock that was originally issued to Treasury in connection with the CPP transaction for total consideration of $185,000.

On December 31, 2013, the Company redeemed all 7,000 outstanding shares of its Series C Preferred from the Treasury, in exercise of its optional redemption rights pursuant to the terms of the Series C Preferred under the Company’s charter and the SPA. The Company paid the Treasury $7,087,500 in connection with the redemption, representing $1,000 per

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share of the Series C Preferred plus all accrued and unpaid dividends through the date of the redemption. The obligations of the Company under the SPA are terminated as a result of the redemption. No shares of Series C Preferred remain outstanding.

As of March 1, 2016, we had a total of 282 employees and 272 full time equivalent employees, including the employees of the Bank.

The Bank

The Bank was organized in 1979 and commenced business as a California state chartered bank in 1980.  The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (the FDIC) up to applicable limits.  The Bank is not a member of the Federal Reserve System.

The Bank operates 21 full-service banking offices in Clovis, Exeter, Fresno, Kerman, Lodi, Madera, Merced, Modesto, Oakhurst, Prather, Sacramento, Stockton, Tracy, and Visalia.  The Oakhurst and Madera branches were added through the Bank of Madera County merger in 2005.  The Tracy, Stockton and Lodi offices were added through the merger with Service 1st Bank in November of 2008.  The Exeter and Visalia offices were added through the Visalia Community Bank merger in 2013. The Bank has a Real Estate Division, an Agribusiness Center and an SBA Lending Division in Fresno.  All real estate related transactions are conducted and processed through the Real Estate Division, including interim construction loans for single family residences and commercial buildings.  We offer permanent single family residential loans through our mortgage broker services.  Our total market share of deposits in Fresno, Madera, and Tulare counties were 4.76% in 2015 compared to 4.81% in 2014 based on FDIC deposit market share information published as of June 30, 2015.

The Bank of Madera County (BMC) was merged with and into the Bank on January 1, 2005.  The transaction was a combination of cash and stock and was accounted for under the purchase method of accounting.  BMC had two branches in Madera County which continue to be operated by the Bank.

In November of 2008, the Company acquired Service 1st and its banking subsidiary, S1 Bank, adding three branches located in Tracy, Stockton and Lodi, California.

In 2009, we opened a new full service office in Merced, California and relocated our Oakhurst office to a new smaller facility in a more desirable location.

In 2010, the Company expanded the existing Modesto loan production office opened in 2007, to a larger full-service branch.

In 2013, the Company acquired Visalia Community Bank, adding four branches located in Exeter and Visalia, California.

Branch expansions provide the Company with opportunities to expand its loan and deposit base; however, based on past experience, management expects these new offices may initially have a negative impact on earnings until the volume of business grows to cover fixed overhead expenses.  The Bank anticipates additional future branch openings to meet the growing service needs of its customers, although none are planned during 2016. After extensive analysis combined with the rising popularity of online and mobile banking trends, the Company has chosen to consolidate the Sunnyside office into our Fresno Downtown office in April 2016.

The Bank conducts a commercial banking business, which includes accepting demand, savings and time deposits and making commercial, real estate and consumer loans.  It also provides domestic and international wire transfer services and provides safe deposit boxes and other customary banking services.  The Bank also has offered Internet banking since 2000.  Internet banking consists of inquiry, account status, bill paying, account transfers, and cash management.  The Bank does not offer trust services or international banking services and does not currently plan to do so in the near future.

The Company terminated its interest in Central Valley Community Insurance Services, LLC (CVCIS) at the beginning of the third quarter of 2015. The Bank’s interest in CVCIS was originally established in 2006 for the purpose of providing health, commercial property and casualty insurance products and services primarily to business customers. The operating results of CVCIS were not significant to the Company’s operations. The termination of this entity did not have a material impact on the Company’s financial statements.

Since August of 1995 the Bank has been a party to an agreement with Investment Centers of America, pursuant to which Investment Centers of America provides Bank customers with access to investment services.  In connection with entering into this agreement, the Bank adopted a policy intended to comply with FDIC Regulation Section 337.4, which outlines the guidelines under which an insured non-member bank may be affiliated with a company that directly engages in the sale, distribution, or underwriting of stocks, bonds, debentures, notes, or other securities.

The Bank’s operating policy since its inception has emphasized serving the banking needs of individuals and the business and professional communities in the central valley area of California.  At December 31, 2015, we had total loans of $598,111,000.  Total commercial and industrial loans outstanding were $102,197,000, total agricultural land and production loans outstanding were $30,472,000, total real estate construction and other land loans outstanding were $38,685,000; total other real estate loans outstanding were $371,541,000, total equity loans and lines of credit were $42,296,000 and total consumer installment loans outstanding were $12,503,000.  We accept real estate, listed securities, savings and time deposits, automobiles, inventory, accounts receivable, machinery and equipment as collateral for loans.

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No individual or single group of related accounts is considered material in relation to the Bank’s assets or deposits, or in relation to the overall business of the Company.  However, at December 31, 2015 approximately 75.7% of our loan portfolio held for investment consisted of real estate-related loans, including construction loans, equity loans and lines of credit and commercial loans secured by real estate and 22.2% consisted of commercial loans.  See Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.  We believe that these concentrations are mitigated by the diversification of our loan portfolio among commercial, real estate and consumer loans.  In addition, our business activities currently are mainly concentrated in Fresno, Madera, Merced, Sacramento, San Joaquin, Stanislaus, and Tulare County, California.  Consequently, our results of operations and financial condition are dependent upon the general trends in this part of the California economy and, in particular, the residential and commercial real estate markets.  Further, our concentration of operations in this area of California exposes us to greater risk than other banking companies with a wider geographic base in the event of catastrophes, such as earthquakes, fires, droughts, and floods in this region, or as a result of energy shortages in California.

Our deposits are attracted from individual and commercial customers.  A material portion of our deposits have not been obtained from a single person or a few persons, the loss of any one or more of which would not have a material adverse effect on our business.

In order to attract loan and deposit business from individuals and small businesses, we maintain the following lobby hours at our branches:

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Branch	Monday — Thursday	Friday	Saturday
Clovis Main	9:00 a.m. to 4:00 p.m.   Drive Up 8:00 a.m. to 5:30 p.m.	9:00 a.m. to 6:00 p.m. Drive Up 8:00 a.m. to 6:00 p.m.	None
Fresno Downtown	9:00 a.m. to 4:00 p.m. Walk-up window 8:00 a.m. to 9:00 a.m.	9:00 a.m. to 5:00 p.m. Walk-up window 8:00 a.m. to 9:00 a.m.	None
Fig Garden Village	9:00 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m.	9:00 a.m. to 1:00 p.m.
Herndon & Fowler	9:00 a.m. to 5:00 p.m. Drive Up 8:30 a.m. to 5:30 p.m.	9:00 a.m. to 6:00 p.m. Drive Up 8:30 a.m. to 6:00 p.m.	9:00 a.m. to 1:00 p.m. Drive Up 9:00 a.m. to 1:00 p.m.
River Park	9:00 a.m. to 5:00 p.m. Drive Up 9:00 a.m. to 5:30 p.m.	9:00 a.m. to 6:00 p.m. Drive Up 9:00 a.m. to 6:00 p.m.	None
Sunnyside *	9:00 a.m. to 5:00 p.m. Drive Up 8:30 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m. Drive Up 8:30 a.m. to 6:00 p.m.	None
Kerman	9:00 a.m. to 5:00 p.m. Drive Up 8:30 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m. Drive Up 8:30 a.m. to 6:00 p.m.	None
Lodi	9:00 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m.	None
Madera	8:30 a.m. to 5:00 p.m.	8:30 a.m. to 6:00 p.m.	None
Merced	9:00 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m.	None
Modesto	9:00 a.m. to 5:00 p.m. Drive Up 8:30 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m. Drive Up 8:30 a.m. to 6:00 p.m.	None
Oakhurst	8:30 a.m. to 5:00 p.m.	8:30 a.m. to 6:00 p.m.	None
Prather (Foothill office)	9:00 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m.	9:00 a.m. to 1:00 p.m.
Sacramento Private Banking	9:00 a.m. to 4:00 p.m.	9:00 a.m. to 4:00 p.m.	None
Stockton	9:00 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m.	None
Tracy	9:00 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m.	None
Exeter	9:00 a.m. to 5:00 p.m. Drive Up 8:30 a.m. to 5:30 p.m.	9:00 a.m. to 6:00 p.m. Drive Up 8:30 a.m. to 6:00 p.m.	None
Caldwell	9:00 a.m. to 5:00 p.m. Drive Up 8:30 a.m. to 5:30 p.m.	9:00 a.m. to 6:00 p.m. Drive Up 8:30 a.m. to 6:00 p.m.	9:00 a.m. to 1:00 p.m. Drive Up 9:00 a.m. to 1:00 p.m.
Floral	9:00 a.m. to 5:00 p.m.	9:00 a.m. to 6:00 p.m.	None
Mission Oaks	9:00 a.m. to 5:00 p.m. Drive Up 8:30 a.m. to 5:30 p.m.	9:00 a.m. to 6:00 p.m. Drive Up 8:30 a.m. to 6:00 p.m.	None
Financial Drive	8:00 a.m. to 5:00 p.m.	8:00 a.m. to 5:00 p.m.	None

* The Sunnyside office is scheduled for closure and consolidation with the Fresno Downtown office in April 2016.

Automated teller machines operate at 19 branch locations. All operate 24 hours per day, seven days per week.  No automated teller machines are currently located at the Sacramento office.  Our Real Estate, Small Business Administration (SBA) Departments and Agribusiness office maintain business hours of 8:00 A.M. to 5:00 P.M., Monday through Friday, and extended hours are available upon customer request.

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To compete effectively, we rely substantially on local promotional activity, personal contacts by our officers, directors and employees, referrals by our shareholders, extended hours, personalized service and our reputation in the communities we serve.

In Fresno and Madera Counties, in addition to our 11 full-service branch locations serving the Bank’s primary service areas, as of June 30, 2015 there were 147 operating banking and credit union offices in our primary service area, which consists of the cities of Clovis, Fresno, Kerman, Oakhurst, Madera, and Prather, California. Prather does not contain any banking offices other than our office. The June 2015 FDIC Summary of Deposits report indicated the Company had 4.76% of the total deposits held by all depositories in Fresno County and 8.62% in Madera County.  In San Joaquin County, in addition to our three full service branch locations, as of June 30, 2015 there were 102 operating banking and credit union offices. The FDIC Summary of Deposits as of June 2015 report indicated the Company had 1.67% of total deposits held by all depositories in San Joaquin County. In Merced County, in addition to our one branch, as of June 30, 2015 there were 30 operating banking and credit union offices in our primary service area. In Sacramento County, in addition to our one branch, as of June 30, 2015 there were 225 operating banking and credit union offices in our primary service area.  In Stanislaus County, in addition to our one branch, there were 88 operating banking and credit union offices in our primary service area. In Tulare County, in addition to our four branches there were 55 operating banking and credit union offices in our primary service area. Business activity in our primary service area is oriented toward light industry, small business and agriculture.

The banking business in California generally, and our primary service area specifically, is highly competitive with respect to both loans and deposits, and is dominated by a relatively small number of major banks with many offices operating over a wide geographic area.  Among the advantages such major banks have over us is their ability to finance wide-ranging advertising campaigns and to allocate their investment assets, including loans, to regions of higher yield and demand.  Major banks offer certain services such as international banking and trust services which we do not offer directly but which we usually can offer indirectly through correspondent institutions.  In addition, by virtue of their greater total capitalization, such banks have substantially higher lending limits than we do.  Legal lending limits to an individual customer are limited to a percentage of our total capital. As of December 31, 2015, the Bank’s legal lending limits to individual customers were $17,173,000 for unsecured loans and $28,622,000 for unsecured and secured loans combined. As of December 31, 2015 the Bank’s largest lending relationships totaled $139,205,000 on an unsecured basis and $85,890,000 on a secured basis.

  For borrowers desiring loans in excess of the Bank’s lending limits, the Bank makes, and may in the future make, such loans on a participation basis with other community banks taking the amount of loans in excess of the Bank’s lending limits.  In other cases, the Bank may refer such borrowers to larger banks or other lending institutions.

Other entities, both governmental and in private industry, seeking to raise capital through the issuance and sale of debt or equity securities also provide competition for us in the acquisition of deposits.  Banks also compete with money market funds and other money market instruments, which are not subject to interest rate ceilings.  In recent years, increased competition has also developed from specialized finance and non-finance companies that offer wholesale finance, credit card, and other consumer finance services, including on-line banking services and personal finance software.  Competition for deposit and loan products remains strong, from both banking and non-banking firms, and affects the rates of those products as well as the terms on which they are offered to customers.

Technological innovation continues to contribute to greater competition in domestic and international financial services markets.  Technological innovation has, for example, made it possible for non-depository institutions to offer customers automated transfer payment services that previously have been traditional banking products.  In addition, customers now expect a choice of several delivery systems and channels, including telephone, mail, home computer, ATMs, remote deposit, mobile banking applications, self-service branches, and in-store branches.

Mergers between financial institutions have placed additional pressure on banks to streamline their operations, reduce expenses, and increase revenues to remain competitive.  In addition, competition has intensified due to federal and state interstate banking laws, which permit banking organizations to expand geographically with fewer restrictions than in the past.  Such laws allow banks to merge with other banks across state lines, thereby enabling banks to establish or expand banking operations in our market.  The competitive environment also is significantly impacted by federal and state legislation, which may make it easier for non-bank financial institutions to compete with us.

Statistical Disclosure

The information in the tables set out below should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are included in Items 7 and 8 of this annual report.

Distribution of Average Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential

Table A sets forth our average consolidated balance sheets for the years ended December 31, 2015, 2014, and 2013 and an analysis of interest rates and the interest rate differential for the years then ended.  Table B sets forth the changes in interest income and interest expense in 2015 and 2014 resulting from changes in volume and changes in rates.

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Investment Portfolio

The book value (amortized cost) of investment securities at December 31, 2015, 2014, and 2013 and the book value, maturities and weighted average yield of investment securities at December 31, 2015 are set forth in Table C.

Loan Portfolio

The composition of the loan portfolio at December 31, 2015, 2014, 2013, 2012, and 2011, is summarized in Table D. Maturities and sensitivity to changes in interest rates in the loan portfolio at December 31, 2015 are summarized in Table E. Table F shows the composition of nonaccrual, past due and restructured loans at December 31, 2015, 2014, 2013, 2012, and 2011. Set forth in the text accompanying Table F is a discussion of the Company’s policy for placing loans on nonaccrual status.

Summary of Loan Loss Experience

Table G sets forth an analysis of loan loss experience as of and for the years ended December 31, 2015, 2014, 2013, 2012, and 2011.

Set forth in the text accompanying Table G is a description of the factors which influenced management’s judgment in determining the amount of the additions to the allowance charged to operating expense in each fiscal year, a table showing the allocation of the allowance for credit losses to the various types of loans in the portfolio, as well as a discussion of management’s policy for establishing and maintaining the allowance for credit losses.

Deposits

Table H sets forth the average amount of and the average rate paid on major deposit categories for the years ended December 31, 2015, 2014, and 2013. Table I sets forth the maturity of time certificates of deposit of $100,000 or more at December 31, 2015.

Return on Equity and Assets

Table J sets forth certain financial ratios for the years ended December 31, 2015, 2014, and 2013.

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Table A

DISTRIBUTION OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS’

EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL

The following table sets forth consolidated average assets, liabilities and shareholders’ equity; interest income earned and interest expense paid; and the average yields earned or rates paid thereon for the years ended December 31, 2015, 2014, and 2013. The average balances reflect daily averages except nonaccrual loans, which were computed using quarterly averages.

	2015							2014							2013
(Dollars in thousands)	Average Balance			Interest Income/ Expense		Average Interest Rate		Average Balance			Interest Income/ Expense		Average Interest Rate		Average Balance			Interest Income/ Expense		Average Interest Rate
ASSETS:
Interest-earning deposits in other banks	$	64,963		$	209	0.32	%	$	53,781		$	175	0.32	%	$	46,672		$	164	0.35	%
Securities:
Taxable securities	285,585			4,793		1.68	%	296,014			5,538		1.87	%	235,487			2,375		1.01	%
Non-taxable securities (1)	178,247			9,569		5.37	%	163,778			8,837		5.40	%	163,494			8,755		5.35	%
Total investment securities	463,832			14,362		3.10	%	459,792			14,375		3.13	%	398,981			11,130		2.79	%
Federal funds sold	251			1		0.25	%	293			1		0.25	%	206			1		0.25	%
Total securities and interest-earning deposits	529,046			14,572		2.75	%	513,866			14,551		2.83	%	445,859			11,295		2.53	%
Loans (2)(3)	578,899			30,504		5.27	%	533,531			29,493		5.53	%	445,300			26,519		5.96	%
Federal Home Loan Bank stock	4,813			580		12.05	%	4,700			327		6.96	%	4,171			177		4.24	%
Total interest-earning assets (1)	1,112,758			$	45,656	4.10	%	1,052,097			$	44,371	4.22	%	895,330			$	37,991	4.24	%
Allowance for credit losses	(8,978		)					(8,147		)					(9,713		)
Nonaccrual loans	7,863							5,998							9,183
Other real estate owned	33							36							50
Cash and due from banks	25,019							23,905							21,296
Bank premises and equipment	9,664							10,511							7,816
Other non-earning assets	76,167							73,083							62,962
Total average assets	$	1,222,526						$	1,157,483						$	986,924

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	2015						2014						2013
(Dollars in thousands)	Average Balance		Interest Income/ Expense		Average Interest Rate		Average Balance		Interest Income/ Expense		Average Interest Rate		Average Balance		Interest Income/ Expense		Average Interest Rate
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Interest-bearing liabilities
Interest-bearing deposits:
Savings and NOW accounts	$	300,741	$	261	0.09	%	$	265,751	$	241	0.09	%	$	215,668	$	291	0.13	%
Money market accounts (MMA)	227,743		141		0.06	%	229,769		174		0.08	%	193,833		229		0.12	%
Time certificates of deposit, under $100,000	59,810		191		0.32	%	60,630		228		0.38	%	48,729		219		0.45	%
Time certificates of deposit, $100,000 and over	89,573		355		0.40	%	101,588		417		0.41	%	106,307		531		0.50	%
Total interest-bearing deposits	677,867		948		0.14	%	657,738		1,060		0.16	%	564,537		1,270		0.22	%
Other borrowed funds	5,156		99		1.89	%	5,155		96		1.83	%	5,645		116		2.05	%
Total interest-bearing liabilities	683,023		$	1,047	0.15	%	662,893		$	1,156	0.17	%	570,182		$	1,386	0.24	%
Non-interest bearing demand deposits	387,931						348,822						283,956
Other liabilities	16,510						15,354						13,040
Shareholders’ equity	135,062						130,414						119,746
Total average liabilities and shareholders’ equity	$	1,222,526					$	1,157,483					$	986,924
Interest income and rate earned on average earning assets (1)			$	45,656	4.10	%			$	44,371	4.22	%			$	37,991	4.24	%
Interest expense and interest cost related to average interest-bearing liabilities			1,047		0.15	%			1,156		0.17	%			1,386		0.24	%
Net interest income and net interest margin (4)			$	44,609	4.01	%			$	43,215	4.11	%			$	36,605	4.09	%

(1) Interest income is calculated on a fully tax equivalent basis, which includes Federal tax benefits relating to income earned on municipal bonds totaling $3,254, $3,005 and $2,977 in 2015, 2014 and 2013, respectively.

(2) Loan interest income includes loan fees of $255 in 2015, $272 in 2014, and $320 in 2013.

(3) Average loans do not include nonaccrual loans.

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

8

Table B

VOLUME AND RATE ANALYSIS

The following table sets forth, for the years indicated, a summary of the changes in interest earned and interest paid resulting from changes in asset and liability volumes and changes in rates.  The change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of absolute dollar amounts of change in each.

	Years Ended December 31,
	2015 Compared to 2014									2014 Compared to 2013
(In thousands)	Volume			Rate			Net			Volume			Rate			Net
Increase (decrease) due to changes in:
Interest income:
Interest-earning deposits in other banks	$	36		$	(2	)	$	34		$	21		$	(10	)	$	11
Investment securities:
Taxable	(195		)	(550		)	(745		)	731			2,432			3,163
Non-taxable (1)	780			(48		)	732			15			67			82
Total investment securities	585			(598		)	(13		)	746			2,499			3,245
Loans	2,507			(1,496		)	1,011			4,479			(1,505		)	2,974
FHLB Stock	7			246			253			25			125			150
Total earning assets (1)	3,135			(1,850		)	1,285			5,271			1,109			6,380
Interest expense:
Deposits:
Savings, NOW and MMA	30			(43		)	(13		)	169			(274		)	(105		)
Time certificates of deposit under $100,000	(3		)	(34		)	(37		)	27			(18		)	9
Time certificates of deposit $100,000 and over	(50		)	(12		)	(62		)	(23		)	(91		)	(114		)
Total interest-bearing deposits	(23		)	(89		)	(112		)	173			(383		)	(210		)
Other borrowed funds	1			2			3			(10		)	(10		)	(20		)
Total interest bearing liabilities	(22		)	(87		)	(109		)	163			(393		)	(230		)
Net interest income (1)	$	3,157		$	(1,763	)	$	1,394		$	5,108		$	1,502		$	6,610

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

9

Table C

INVESTMENT PORTFOLIO

The amortized cost of investment securities at December 31, 2015, 2014, and 2013 is set forth in the following table.  At December 31, 2015, we held no investment securities from any issuer which totaled over 10% of our shareholders’ equity.

Available-for-Sale Securities	Amortized Cost at December 31,
(In thousands)	2015		2014		2013
U.S. Government agencies	$	52,803	$	33,088	18,172
Obligations of states and political subdivisions	181,785		143,343		162,018
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	225,636		236,629		254,978
Private label residential mortgage backed securities	2,356		3,079		4,344
Other equity securities	7,500		7,500		7,596
Total Available-for-Sale Securities	$	470,080	$	423,639	$	447,108

Held-to-Maturity Securities	Amortized Cost at December 31,
(In thousands)	2015		2014		2013
Obligations of states and political subdivisions	$	31,712	$	31,964	$	—

The amortized cost, maturities and weighted average yield of investment securities at December 31, 2015 are summarized in the following table.

(Dollars in thousands)	In one year or less				After one through five years				After five through ten years				After ten years				Total
Available-for-Sale Securities	Amount		Yield(1)		Amount		Yield(1)		Amount		Yield(1)		Amount		Yield(1)		Amount		Yield(1)
Debt securities(2)
U.S. Government agencies	$	—	—		$	7,627	1.94	%	$	4,046	4.33	%	$	41,130	3.96	%	$	52,803	3.70	%
Obligations of states and political subdivisions	—		—		12,297		3.02	%	37,376		3.82	%	132,112		4.87	%	181,785		4.53	%
U.S. Government sponsored entities and agencies collateralized by residential mortgage obligations	3		7.60	%	30,331		3.48	%	20,810		2.95	%	174,492		4.22	%	225,636		4.00	%
Private label residential mortgage backed securities	—		—		212		4.73	%	6		5.00	%	2,138		5.89	%	2,356		5.78	%
Other equity securities	7,500		2.13	%	—		—		—		—		—		—		7,500		2.13	%
	$	7,503	2.32	%	$	50,467	3.14	%	$	62,238	3.56	%	$	349,872	4.44	%	$	470,080	4.18	%

(Dollars in thousands)	In one year or less				After one through five years				After five through ten years			After ten years			Total
Held-to-Maturity Securities	Amount		Yield(1)		Amount		Yield(1)		Amount	Yield(1)		Amount	Yield(1)		Amount	Yield(1)
Debt securities(2)
Obligations of states and political subdivisions	$	—	—	%	$	—	—	%	—	—	%	31,712	3.08	%	31,712	3.08	%

(1) Not computed on a tax equivalent basis.

(2) Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.  Expected maturities will also differ from contractual maturities due to unscheduled principal pay downs.

10

Table D

LOAN PORTFOLIO

The composition of the loan portfolio at December 31, 2015, 2014, 2013, 2012, and 2011 is summarized in the table below.

(In thousands)	2015			2014			2013			2012			2011
Commercial:
Commercial and industrial	$	102,197		$	89,007		$	87,082		$	77,956		$	78,089
Agricultural land and production	30,472			39,140			31,649			26,599			29,958
Total commercial	132,669			128,147			118,731			104,555			108,047
Real estate:
Owner occupied	168,910			176,804			156,781			114,444			113,183
Real estate construction and other land loans	38,685			38,923			42,329			33,199			33,047
Commercial real estate	117,244			106,788			86,117			53,797			62,523
Agricultural real estate	74,867			57,501			44,164			28,400			42,596
Other real estate	10,520			6,611			4,548			8,098			7,892
Total real estate	410,226			386,627			333,939			237,938			259,241
Consumer:
Equity loans and lines of credit	42,296			47,575			48,594			42,932			51,106
Consumer and installment	12,503			10,093			11,252			10,346			9,765
Total consumer	54,799			57,668			59,846			53,278			60,871
Deferred loan costs (fees), net	417			146			(159		)	(453		)	(764		)
Total gross loans (1)	598,111			572,588			512,357			395,318			427,395
Allowance for credit losses	(9,610		)	(8,308		)	(9,208		)	(10,133		)	(11,396		)
Total (1)	$	588,501		$	564,280		$	503,149		$	385,185		$	415,999

	2015		2014		2013		2012		2011
(1) Includes nonaccrual loans of:	$	2,413	$	14,052	$	7,586	$	9,695	$	14,434

11

Table E

LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES

The following table presents information concerning loan maturities and sensitivity to changes in interest rates of the indicated categories of our loan portfolio, as well as loans in those categories maturing after one year that have fixed or floating interest rates at December 31, 2015.

(In thousands)	One Year or Less		After One Through Five Years		After Five Years		Total
Loan Maturities:
Commercial and agricultural	$	90,970	$	24,245	$	17,454	$	132,669
Real estate construction and other land loans	33,985		3,504		1,196		38,685
Other real estate	27,348		35,719		308,474		371,541
Consumer and installment	8,146		10,295		36,358		54,799
	$	160,449	$	73,763	$	363,482	$	597,694
Sensitivity to Changes in Interest Rates:
Loans with fixed interest rates	$	32,353	$	47,006	$	46,578	$	125,937
Loans with floating interest rates (1)	128,096		26,757		316,904		471,757
	$	160,449	$	73,763	$	363,482	$	597,694

(In thousands)	One Year or Less		After One Through Five Years		After Five Years		Total
(1) Includes floating rate loans which are currently at their floor rate in accordance with their respective loan agreement	$	42,214	$	18,012	$	201,831	$	262,057

Table F

COMPOSITION OF NONACCRUAL, PAST DUE AND RESTRUCTURED LOANS

A summary of nonaccrual, restructured and past due loans at December 31, 2015, 2014, 2013, 2012, and 2011 is set forth below:

	December 31,
(Dollars in thousands)	2015			2014			2013			2012			2011
Nonaccrual	$	1,076		$	12,226		$	2,991		$	450		$	3,833
Restructured nonaccrual loans	1,337			1,826			4,595			9,245			10,601
	$	2,413		$	14,052		$	7,586		$	9,695		$	14,434
Interest foregone	$	340		$	716		$	661		$	693		$	954
Accruing loans past due 90 days or more	—			—			—			—			—
Accruing troubled debt restructurings	$	4,286		$	4,774		$	5,771		$	7,410		$	—
Nonaccrual loans to total loans	0.40		%	2.45		%	1.48		%	2.45		%	3.38		%

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

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

12

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

Included in nonaccrual loans at December 31, 2015 were four loans totaling $1,337,000 that were considered troubled debt restructurings (TDRs).  None of these TDR loans were in default at December 31, 2015. There are no outstanding commitments to lend additional funds to any of these borrowers.  Included in nonaccrual loans at December 31, 2014 were three loans that totaled $1,826,000 that were considered to be TDRs at December 31, 2014. At December 31, 2013, the Company had ten loans totaling $4,595,000 that were on nonaccrual and considered TDR. The Company had seven loans at December 31, 2012 totaling $9,245,000 that were considered to be TDRs. As of December 31, 2011, the Company had six loans totaling $10,601,000 that were on nonaccrual and considered TDR. See Note 5 of the Company’s audited Consolidated Financial Statements in Item 8 of this Annual Report concerning our recorded investment in loans for which impairment has been recognized.  Impaired loans are identified from internal credit review reports, past due reports, overdraft listings, and third party reports of examination.  Borrowers experiencing problems such as operating losses, marginal working capital, inadequate cash flow or business interruptions which jeopardize collection of the loan are also reviewed for possible impairment classification. 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans determined to be impaired are individually evaluated for impairment.  When a loan is impaired, the Company measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, it may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.  A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral.  We perform quarterly internal reviews on substandard loans.  We place loans on nonaccrual status and classify them as impaired when a reasonable doubt exists as to the collectability of interest and principal under the original contractual terms, or when loans are delinquent 90 days or more unless the loan is both well secured and in the process of collection.  Management maintains certain loans that have been brought current by the borrower (less than 30 days delinquent) on nonaccrual status until such time as management has determined that the loans are likely to remain current in future periods.  Foregone interest on nonaccrual loans totaled $340,000 for the year ended December 31, 2015 of which $104,000 was attributable to troubled debt restructurings. Foregone interest on nonaccrual loans was $716,000 and $661,000 for 2014 and 2013, respectively of which $139,000 and $279,000 was attributable to troubled debt restructurings, respectively. 

Other than as discussed above, as of December 31, 2015, we had no loans where known information about possible credit problems of borrowers caused management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as impaired loans.

13

Table G

SUMMARY OF LOAN LOSS EXPERIENCE

The following table summarizes loan loss experience as of and for the years ended December 31, 2015, 2014, 2013, 2012, and 2011.

(Dollars in thousands)	2015			2014			2013			2012			2011
Loans outstanding at December 31,	$	597,694		$	572,442		$	512,516		$	395,771		$	428,159
Average loans outstanding during the year	$	586,762		$	539,529		$	454,483		$	405,040		$	428,291
Allowance for credit losses:
Balance at beginning of year	$	8,308		$	9,208		$	10,133		$	11,396		$	11,014
Deduct loans charged off:
Commercial and industrial	(802		)	(7,423		)	(713		)	(123		)	(280		)
Agricultural production	—			(1,722		)	—			—			—
Owner occupied	—			(183		)	(281		)	(217		)	—
Real estate construction and other land loans	—			—			—			(319		)	(286		)
Commercial real estate	—			—			(4		)	(1,430		)	(26		)
Consumer loans	(159		)	(506		)	(448		)	(761		)	(940		)
Total loans charged off	(961		)	(9,834		)	(1,446		)	(2,850		)	(1,532		)
Add recoveries of loans previously charged off:
Commercial and industrial	954			171			315			515			286
Agricultural production	90			—			—			—			—
Owner occupied	—			150			—			45			—
Real estate construction and other land loans	32			364			16			—			52
Commercial real estate	—			—			—			—			176
Consumer loans	587			264			190			327			350
Total recoveries	1,663			949			521			887			864
Net recoveries (charge offs)	702			(8,885		)	(925		)	(1,963		)	(668		)
Add provision charged to operating expense	600			7,985			—			700			1,050
Balance at end of year	$	9,610		$	8,308		$	9,208		$	10,133		$	11,396
Allowance for credit losses as a percentage of outstanding loan balance	1.61		%	1.45		%	1.80		%	2.56		%	2.66		%
Net recoveries (charge offs) to average loans outstanding	0.12		%	(1.65		)%	(0.20		)%	(0.48		)%	(0.16		)%

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

The allowance for credit losses is reviewed at least quarterly by the Bank’s and our Board of Directors’ Audit/Compliance Committee.  Reserves are allocated to loan portfolio segments using percentages which are based on both historical risk elements such as delinquencies and losses and predictive risk elements such as economic, competitive and environmental factors.  We have adopted the specific reserve approach to allocate reserves to each impaired asset for the purpose of estimating potential loss exposure.  Although the allowance for credit losses is allocated to various portfolio categories, it is general in nature and available for the loan portfolio in its entirety.  Additions may be required based on the results of independent loan portfolio examinations, regulatory agency examinations, or our own internal review process.  Additions are also required when, in management’s judgment, the reserve does not properly reflect the potential loss exposure. 

During the year ended December 31, 2015, the Company recorded a provision for credit losses of $600,000. The amount of provision is primarily the result of our assessment of the overall adequacy of the allowance for credit losses considering a number of factors, including the increase or decrease in the volume of outstanding loans and the level of net recoveries during the year. The provision of $7,985,000 in 2014 was recorded in connection with the partial charge off of a single commercial and agricultural relationship. Net charge-offs were $8,885,000 in 2014. No provision was added to the allowance for credit losses for the year ended December 31, 2013, and net charge-offs were $925,000. The provision for credit

14

losses for the year ended December 31, 2012 was $700,000 and net charge-offs were $1,963,000. For 2011, the provision was $1,050,000 and net charge offs which were $668,000.

Using the criteria on the previous page, the allocation of the allowance for credit losses is set forth below:

	2015				2014				2013				2012				2011
Loan Type (Dollars in thousands)	Amount		Percent of Loans in Each Category to Total Loans		Amount		Percent of Loans in Each Category to Total Loans		Amount		Percent of Loans in Each Category to Total Loans		Amount		Percent of Loans in Each Category to Total Loans		Amount		Percent of Loans in Each Category to Total Loans
Commercial:
Commercial and industrial	3,143		17.1	%	2,753		15.5	%	1,928		17	%	2,071		19.7	%	1,924		18.3	%
Agricultural land and production	419		5.1	%	377		6.8	%	516		6.1	%	605		6.7	%	342		7	%
Real estate:
Owner occupied	1,556		28.2	%	1,380		30.9	%	1,697		30.6	%	2,153		28.9	%	1,578		26.4	%
Real estate construction and other land loans	694		6.5	%	837		6.8	%	1,289		8.3	%	1,035		8.4	%	2,954		7.7	%
Commercial real estate	1,686		19.6	%	1,201		18.7	%	1,406		16.8	%	1,886		13.6	%	2,043		14.6	%
Agricultural real estate	1,149		12.5	%	564		10	%	672		8.6	%	646		7.2	%	489		9.9	%
Other real estate	119		1.8	%	76		1.2	%	110		0.9	%	157		2	%	91		1.8	%
Consumer:
Equity loans and lines of credit	500		7.1	%	811		8.3	%	874		9.5	%	1,158		10.9	%	1,419		12	%
Consumer and installment	234		2.1	%	267		1.8	%	294		2.2	%	383		2.6	%	417		2.3	%
Unallocated reserves	110				42				422				39				139
Total allowance for credit losses	$	9,610	100	%	$	8,308	100	%	$	9,208	100	%	$	10,133	100	%	$	11,396	100	%

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

15

Table H

DEPOSITS

We have no known foreign deposits.  The following table sets forth the average amount of and the average rate paid on certain deposit categories which were in excess of 10% of average total deposits for the years ended December 31, 2015, 2014, and 2013.

	2015				2014				2013
(Dollars in thousands)	Balance		Rate		Balance		Rate		Balance		Rate
NOW accounts	$	222,839	0.10	%	$	197,630	0.11	%	$	163,034	0.15	%
Money market accounts	$	227,743	0.06	%	$	229,769	0.08	%	$	193,833	0.12	%
Time certificates of deposit	$	149,383	0.37	%	$	162,218	0.40	%	$	155,036	0.48	%
Non-interest bearing demand	$	387,931	—		$	348,822	—		$	283,956	—
Total deposits	$	1,065,798	0.09	%	$	1,006,560	0.11	%	$	848,493	0.15	%

Table I

TIME DEPOSITS

The following table sets forth the maturity of time certificates of deposit and other time deposits of $100,000 or more at December 31, 2015.

(In thousands)
Three months or less	$	33,923
Over 3 through 6 months	18,195
Over 6 through 12 months	20,980
Over 12 months	20,412
	$	93,510

Table J

FINANCIAL RATIOS

The following table sets forth certain financial ratios for the years ended December 31, 2015, 2014, and 2013.

	2015		2014		2013
Net income:
To average assets	0.90	%	0.46	%	0.84	%
To average shareholders’ equity	8.12	%	4.06	%	6.89	%
Dividends declared per share to net income per share	18.00	%	41.67	%	26.32	%
Average shareholders’ equity to average assets	11.05	%	11.27	%	12.13	%

Supervision and Regulation

GENERAL

The banking and financial services businesses in which we engage are highly regulated.  Such regulation is intended, among other things, to protect depositors whose deposits are insured by the FDIC and the banking system as a whole.  The monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors, also influence the commercial banking business.  The Board of Governors implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in United States Government securities, by adjusting the required level of reserves for financial intermediaries subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions.  The actions of the Board of Governors in these

16

areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits.  Indirectly such actions may also affect the ability of non-bank financial institutions to compete with the Bank.  The nature and impact of any future changes in monetary policies cannot be predicted.

The laws, regulations, and policies affecting financial services businesses are continuously under review by Congress and state legislatures, and federal and state regulatory agencies.  From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial intermediaries.  Proposals to change the laws and regulations governing the operations and taxation of banks, bank holding companies and other financial intermediaries are frequently made in Congress, in the California legislature and before various bank regulatory and other professional agencies.  Changes in the laws, regulations or policies that affect us cannot necessarily be predicted, but they may have a material effect on our business and earnings.

BANK HOLDING COMPANY REGULATION

The Company, as a bank holding company, is subject to regulation under the BHC Act, and is subject to the supervision and examination of the Board of Governors.  Pursuant to the BHC Act, we are required to obtain the prior approval of the Board of Governors before we may acquire all or substantially all of the assets of any bank, or ownership or control of voting shares of any bank if, after giving effect to such acquisition, we would own or control, directly or indirectly, more than five percent of such bank.

Under the BHC Act, we may not engage in any business other than managing or controlling banks or furnishing services to our subsidiaries that the Board of Governors deems to be so closely related to banking as to be a proper incident to banking.  We are also prohibited, with certain exceptions, from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company unless the company is engaged in banking activities or the Board of Governors determines that the activity is so closely related to banking to be a proper incident to banking.  The Board of Governors’ approval must be obtained before the shares of any such company can be acquired and, in certain cases, before any approved company can open new offices.

The BHC Act and regulations of the Board of Governors also impose certain constraints on the redemption or purchase by a bank holding company of its own shares of stock.

Our earnings and activities are affected by legislation, by actions of regulators, and by local legislative and administrative bodies and decisions of courts in the jurisdictions in which both the Company and the Bank conduct business.  For example, these include limitations on the ability of the Bank to pay dividends to the Company and the ability of the Company to pay dividends to its shareholders.  It is the policy of the Board of Governors that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition.  The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.  Various federal and state statutory provisions limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval.  In addition to these explicit limitations, the federal regulatory agencies are authorized to prohibit a banking subsidiary or bank holding company from engaging in an unsafe or unsound banking practice.  Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

In addition, banking subsidiaries of bank holding companies are subject to certain restrictions imposed by federal law in dealings with their holding companies and other affiliates.  Subject to certain exceptions set forth in the Federal Reserve Act and Regulation W, a bank can make a loan or extend credit to an affiliate, purchase or invest in the securities of an affiliate, purchase assets from an affiliate, accept securities of an affiliate as collateral security for a loan or extension of credit to any person or company, issue a guarantee, or accept letters of credit on behalf of an affiliate only if the aggregate amount of the above transactions of such subsidiary does not exceed 10 percent of such subsidiary’s capital stock and surplus on a per affiliate basis or 20 percent of such subsidiary’s capital stock and surplus on an aggregate affiliate basis.  Such transactions must be on terms and conditions that are consistent with safe and sound banking practices. A bank and its subsidiaries generally may not purchase a “low-quality asset,” as that term is defined in the Federal Reserve Act, from an affiliate.  Such restrictions also generally prevent a holding company and its other affiliates from borrowing from a banking subsidiary of the holding company unless the loans are secured by collateral.

A holding company and its banking subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or provision of services.  For example, with certain exceptions a bank may not condition an extension of credit on a customer obtaining other services provided by it, a holding company or any of its other bank affiliates, or on a promise by the customer not to obtain other services from a competitor.

The Board of Governors has cease and desist powers over parent bank holding companies and non-banking subsidiaries where actions of a parent bank holding company or its non-financial institution subsidiaries represent an unsafe or unsound practice or violation of law.  The Board of Governors has the authority to regulate debt obligations (other than commercial paper) issued by bank holding companies by imposing interest ceilings and reserve requirements on such debt obligations.

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We are also a bank holding company within the meaning of Section 3700 of the California Financial Code.  As such, we and our subsidiaries are subject to examination by the Department of Business Oversight (DBO).

Further, we are required by the Board of Governors to maintain certain capital levels.  See “Capital Standards.”

REGULATION OF THE BANK

Banks are extensively regulated under both federal and state law.  The Bank, as a California state-chartered bank, is subject to primary supervision, regulation and periodic examination by the DBO and the FDIC.  The Bank is not a member of the Federal Reserve System, but is nevertheless subject to certain regulations of the Board of Governors.

If, as a result of an examination of a bank, the FDIC should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC. Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate the Bank’s deposit insurance, which for a California chartered bank would result in a revocation of the Bank’s charter.  The DBO has many of the same remedial powers.

The Bank is a member of the FDIC, which currently insures customer deposits in each member bank to a maximum of $250,000 per depositor.  For this protection, the Bank is subject to the rules and regulations of the FDIC, and, as is the case with all insured banks, may be required to pay a semi-annual statutory assessment. All of a depositors’ accounts at an insured depository institution, including all non-interest bearing transactions accounts, will be insured by the FDIC up to the standard maximum deposit insurance amount of ($250,000) for each deposit insurance ownership category.

Various requirements and restrictions under the laws of the State of California and the United States affect the operations of the Bank. State and federal statutes and regulations relate to many aspects of the Bank’s operations, including standards for safety and soundness, reserves against deposits, interest rates payable on deposits, loans, investments, mergers and acquisitions, borrowings, dividends, locations of branch offices, fair lending requirements, Community Reinvestment Act activities, and loans to affiliates.

PAYMENT OF DIVIDENDS

THE COMPANY

Our shareholders are entitled to receive dividends when and as declared by our Board of Directors, out of funds legally available, subject to the dividends preference, if any, on preferred shares that may be outstanding, and also subject to the restrictions of the California Corporations Code.  See Note 14 of the Company’s audited Consolidated Financial Statements in Item 8 of this Annual Report concerning preferred stock issued through the Small Business Lending Fund of the United States Department of the Treasury on August 18, 2011. 

The principal source of cash revenue to the Company is dividends received from the Bank.  The Bank’s ability to make dividend payments to the Company is subject to state and federal regulatory restrictions.

THE BANK

Dividends payable by the Bank to the Company are restricted under California law to the lesser of the Bank’s retained earnings, or the Bank’s net income for the latest three fiscal years, less dividends paid during that period, or, with the approval of the DBO, to the greater of the retained earnings of the Bank, the net income of the Bank for its last fiscal year or the net income of the Bank for its current fiscal year.

In addition to the regulations concerning minimum uniform capital adequacy requirements described below, the FDIC has established guidelines regarding the maintenance of an adequate allowance for credit losses.  Therefore, the future payment of cash dividends by the Bank will generally depend, in addition to regulatory constraints, upon the Bank’s earnings during any fiscal period, the assessment of the Board of Directors of the capital requirements of the Bank and other factors, including the maintenance of an adequate allowance for credit losses.

CAPITAL STANDARDS

Banks and bank holding companies are subject to various capital requirements administered by state and federal banking agencies.  Capital adequacy guidelines involve quantitative measures of assets, liabilities and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.

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The Board of Governors, the FDIC and other federal banking agencies have issued risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations for both transactions reported on the balance sheet as assets, and transactions, such as letters of credit and recourse arrangements, which are reported as off-balance-sheet items.  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 100% for assets with relatively higher credit risk, such as business loans.

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 regulators measure risk-adjusted assets and off-balance-sheet items against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital.  Tier 1 capital consists of common stock, retained earnings, noncumulative perpetual preferred stock and minority interests in certain subsidiaries, less most other intangible assets.  Tier 2 capital may consist of a limited amount of the allowance for possible loan and lease losses and certain other instruments with some characteristics of equity.  The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. 

In December 2010, the internal Basel Committee on Bank Supervision (“Basel Committee”) released its final framework for strengthening international capital and liquidity regulation, now officially identified as “Basel III,” which, when fully  phased-in,  would require bank holding companies and their bank subsidiaries to maintain substantially more capital than currently required, with a greater emphasis on common equity. The Basel III capital framework, among other things: 

• introduces as a new capital measure, Common Equity Tier 1 (“CET1”), more commonly known in the United States as “Tier 1 Common,” and defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and expands the scope of the adjustments as compared to existing regulations;

• when fully phased in, requires banks to maintain: (i) a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%); (ii) an additional “SIFI buffer” for those large institutions deemed to be systemically important, ranging from 1.0% to 2.5%, and up to 3.5% under certain conditions; (iii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation); (iv) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation); and (v) as a newly adopted international standard, a minimum leverage ratio of 3%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (as the average for each quarter of the month-end ratios for the quarter); and

• an additional “countercyclical capital buffer,” generally to be imposed when national regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk, that would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented.

In July 2013, the U.S. banking agencies approved the U.S. version of Basel III. The federal bank regulatory agencies adopted version of Basel III revises the risk-based and leverage capital requirements and the method for calculating risk-weighted assets to make them consistent with Basel III and to meet the requirements of the Dodd-Frank Act.  Although many of the rules contained in these final regulations are applicable only to large, internationally active banks, some of them apply on a phased in basis to all banking organizations, including the Company and the Bank.  Among other things, the rules establish a new minimum common equity Tier 1 ratio (4.5% of risk-weighted assets), a higher minimum Tier 1 risk-based capital requirement (6.0% of risk-weighted assets) and a minimum non-risk-based leverage ratio (4.00% eliminating a 3.00% exception for higher rated banks). The new additional capital conservation buffer of 2.5% of risk weighted assets over each of the required capital ratios will be phased in from 2016 to 2019 and must be met to avoid limitations on the ability of the Company and the Bank to pay dividends, repurchase shares or pay discretionary bonuses.  The additional “countercyclical capital buffer” is also required for larger and more complex institutions.  The new rules assign higher risk weighting to exposures that are more than 90 days past due or are on nonaccrual status and certain commercial real estate facilities that finance the acquisition, development or construction of real property.  The rules also change the permitted composition of Tier 1 capital to exclude trust preferred securities, mortgage servicing rights and certain deferred tax assets and include unrealized gains and losses on available for sale debt and equity securities (with a one-time opt out option for Standardized Banks (banks with less than $250 billion of total consolidated assets and less than $10 billion of foreign exposures) which the Company and the Bank intend to exercise).  The rules, including alternative requirements for smaller community financial institutions like the Company and the Bank, would be phased in through 2019.  The implementation of the Basel III framework commenced on January 1, 2015. 

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A bank that does not achieve and maintain the required capital levels may be issued a capital directive by the FDIC to ensure the maintenance of required capital levels.  As discussed above, the Company and the Bank are required to maintain certain levels of capital.  The regulatory capital guidelines as well as the actual capitalization for the Bank and the Company on a consolidated basis as of December 31, 2015 are as follows:

Requirement		Actual
Adequately Capitalized	For the Bank to be Well Capitalized	Bank