bsrr-10q_20170930.htm

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

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

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 whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes ☒ No ☐

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. (Check one):

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 Section7(a)(2)(B) of the Securities Act. ☐

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

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, 15,218,740 shares outstanding as of November 1, 2017

	September 30, 2017			December 31, 2016
ASSETS	(unaudited)			(audited)
Cash and due from banks	$	52,358		$	79,087
Interest-bearing deposits in banks		2,249			41,355
Total cash & cash equivalents		54,607			120,442
Securities available-for-sale		583,200			530,083
Loans and leases:
Gross loans and leases		1,311,625			1,262,531
Allowance for loan and lease losses		(8,784	)		(9,701	)
Deferred loan and lease costs, net		2,705			2,924
Net loans and leases		1,305,546			1,255,754
Foreclosed assets		2,674			2,225
Premises and equipment, net		28,373			28,893
Goodwill		8,268			8,268
Other intangible assets, net		2,483			2,803
Company owned life insurance		45,270			43,706
Other assets		47,572			40,699
Total assets	$	2,077,993		$	2,032,873

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing	$	571,509		$	524,552
Interest bearing		1,208,070			1,170,919
Total deposits		1,779,579			1,695,471
Repurchase agreements		8,679			8,094
Federal funds purchased		1,600			—
Short-term borrowings		10,500			65,000
Subordinated debentures, net		34,544			34,410
Other liabilities		24,008			24,020
Total Liabilities		1,858,910			1,826,995

Commitments and contingent liabilities (Note 8)

Shareholders' equity
Common stock, no par value; 24,000,000 shares authorized; 13,840,429 and 13,776,589 shares issued
and outstanding at September 30, 2017 and
December 31, 2016, respectively		73,668			72,626
Additional paid-in capital		2,940			2,832
Retained earnings		141,870			132,180
Accumulated other comprehensive income (loss), net		605			(1,760	)
Total shareholders' equity		219,083			205,878
Total liabilities and shareholder's equity	$	2,077,993		$	2,032,873

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

	Three months ended September 30,				Nine months ended September 30,
Interest and dividend income	2017		2016		2017		2016
Loans and leases, including fees	$	16,543	$	15,121	$	47,349	$	41,360
Taxable securities		2,224		1,879		6,385		6,114
Tax-exempt securities		1,002		765		2,739		2,225
Federal funds sold and other		63		29		317		61
Total interest income		19,832		17,794		56,790		49,760
Interest expense
Deposits		1,032		575		2,588		1,573
Short-term borrowings		14		51		34		107
Subordinated debentures		351		261		1,009		663
Total interest expense		1,397		887		3,631		2,343
Net interest income		18,435		16,907		53,159		47,417
Provision for loan losses		—		—		300		—
Net interest income after provision for loan losses		18,435		16,907		52,859		47,417
Non-interest income
Service charges on deposits		2,916		2,686		8,263		7,535
Net gains on sale of securities available-for-sale		918		90		984		212
Other income		2,076		2,215		7,161		6,112
Total non-interest income		5,910		4,991		16,408		13,859
Other operating expense
Salaries and employee benefits		7,478		6,866		22,617		20,355
Occupancy and equipment		2,368		2,063		6,923		5,680
Other		5,599		7,192		16,698		17,280
Total other operating expense		15,445		16,121		46,238		43,315
Income before taxes		8,900		5,777		23,029		17,961
Provision for income taxes		3,158		1,848		7,533		5,911
Net income	$	5,742	$	3,929	$	15,496	$	12,050

PER SHARE DATA
Book value	$	15.83	$	15.12	$	15.83	$	15.12
Cash dividends	$	0.14	$	0.12	$	0.42	$	0.36
Earnings per share basic	$	0.41	$	0.28	$	1.12	$	0.90
Earnings per share diluted	$	0.41	$	0.28	$	1.11	$	0.89
Average shares outstanding, basic		13,839,111		13,790,107		13,824,173		13,446,567
Average shares outstanding, diluted		14,013,987		13,904,460		14,010,894		13,560,716

Total shareholder equity (in thousands)	$	219,083	$	208,528	$	219,083	$	208,528
Shares outstanding		13,840,429		13,789,501		13,840,429		13,789,501
Dividends Paid (in thousands)	$	1,937	$	1,666	$	5,805	$	4,851

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

	Three months ended September 30,						Nine months ended September 30,
	2017			2016			2017			2016
Net income	$	5,742		$	3,929		$	15,496		$	12,050
Other comprehensive income, before tax:
Unrealized gains (losses) on securities:
Unrealized holding gain (loss) arising during period		(713	)		(674	)		5,065			3,813
Less: reclassification adjustment for gains included in net income ⁽¹⁾		(918	)		(90	)		(984	)		(212	)
Other comprehensive (loss) income, before tax		(1,631	)		(764	)		4,081			3,601
Income tax expense related to items of other comprehensive income (loss), net of tax		686			362			(1,716	)		(1,452	)
Other comprehensive income (loss) gain		(945	)		(402	)		2,365			2,149

Comprehensive income	$	4,797		$	3,527		$	17,861		$	14,199

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

	Nine months ended September 30,
	2017			2016
Cash flows from operating activities:
Net income	$	15,496		$	12,050
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sales of securities		(984	)		(212	)
Gain on sales of loans		(3	)		—
Loss on disposal of fixed assets		66			—
(Gain) loss on sale on foreclosed assets		(12	)		3
Writedowns on foreclosed assets		75			275
Share-based compensation expense		459			180
Provision for loan losses		300			—
Depreciation and amortization		2,177			1,880
Net amortization on securities premiums and discounts		5,083			5,208
Amortization/(accretion) of discounts for loans acquired and net deferred loan fees		276			(303	)
(Increase) decrease in cash surrender value of life insurance policies		(1,188	)		249
Amortization of core deposit intangible		320			101
Decrease in interest receivable and other assets		4,004			11,830
Increase in other liabilities		(12	)		(8,995	)
Deferred income tax (benefit) provision		(336	)		1,998
Net cash provided by operating activities		25,721			24,264

Cash flows from investing activities:
Maturities of securities available for sale		1,165			1,195
Proceeds from sales/calls of securities available for sale		22,325			23,753
Purchases of securities available for sale		(151,711	)		(103,334	)
Principal pay downs on securities available for sale		75,086			72,463
Net purchases of FHLB stock		(235	)		(960	)
Net increase in loans receivable, net		(50,976	)		(31,086	)
Purchases of premises and equipment, net		(1,589	)		(4,016	)
Proceeds from sale premises and equipment		—			1,204
Proceeds from sales of foreclosed assets		99			982
Purchase of company owned life insurance		(376	)		(300	)
Net increase in partnership investment		(12,132	)		(8,338	)
Net cash from bank acquisition		—			15,502
Net cash used in investing activities		(118,344	)		(32,935	)

Cash flows from financing activities:
Increase in deposits		84,108			40,165
Decrease in borrowed funds		(54,500	)		(8,200	)
Increase in Fed funds purchased		1,600			2,500
Increase (decrease) in repurchase agreements		585			(2,635	)
Cash dividends paid		(5,804	)		(4,851	)
Repurchases of common stock		—			(1,723	)
Stock options exercised		799			234
Net cash provided by financing activities		26,788			25,490

(Decrease) increase in cash and due from banks		(65,835	)		16,819

Cash and cash equivalents
Beginning of period		120,442			48,623
End of period	$	54,607		$	65,442

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

Sierra Bancorp (the “Company”) is a California corporation headquartered in Porterville, California, and is a registered bank holding company under federal banking laws. The Company was formed to serve as the holding company for Bank of the Sierra (the “Bank”), and has been the Bank’s sole shareholder since August 2001. The Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. As of September 30, 2017, the Company’s only other subsidiaries were Sierra Statutory Trust II, Sierra Capital Trust III, and Coast Bancorp Statutory Trust II, which were formed solely to facilitate the issuance of capital trust pass-through securities (“TRUPS”). Pursuant to the Financial Accounting Standards Board (“FASB”) standard on the consolidation of variable interest entities, these trusts are not reflected on a consolidated basis in the Company’s financial statements. References herein to the “Company” include Sierra Bancorp and its consolidated subsidiary, the Bank, unless the context indicates otherwise.

Bank of the Sierra, a California state-chartered bank headquartered in Porterville, California, offers a full range of retail and commercial banking services in California’s South San Joaquin Valley, the Central Coast, Ventura County, and neighboring communities. The Bank was incorporated in September 1977, and opened for business in January 1978 as a one-branch bank with $1.5 million in capital. Our growth in the ensuing years has largely been organic in nature, but includes four whole-bank acquisitions: Sierra National Bank in 2000, Santa Clara Valley Bank in 2014, Coast National Bank in 2016, and Ojai Community Bank in October of 2017, subsequent to the reporting date of this 10-Q. Certain branching activity also occurred after the reporting date, namely the consolidation of our Oxnard loan production office into the Ventura branch (a former Ojai Community Bank location), the acquisition of the Woodlake branch from Citizens Business Bank, and the closure of our Fresno Herndon branch. We plan to open a new branch on Palm Avenue in Fresno in 2018, in close proximity to the former Herndon Branch but with easier access and superior visibility. Additional branching activity that has taken place in 2017 includes the opening of a de novo branch in Pismo Beach, California in the third quarter, preceded by the opening of a de novo branch on California Avenue in Bakersfield and the relocation of our Paso Robles branch earlier in the year. Counting our latest acquisitions and branching activity, as of the filing date of this report the Bank operates 39 full service branches and an online branch, and we maintain ATMs at all branch locations and seven non-branch locations. Details on our most recent acquisitions are provided in Note 13 to the financial statements, Recent Developments. In addition to our stand-alone offices the Bank has specialized lending units which include a real estate industries center, an agricultural credit center, and an SBA lending unit. We were close to $2.1 billion in total assets as of September 30, 2017, and for the past several years have claimed the distinction of being the largest bank headquartered in the South San Joaquin Valley. Total assets surpassed $2.3 billion subsequent to our recent acquisitions. The Bank’s deposit accounts, which totaled almost $1.8 billion at September 30, 2017, are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to maximum insurable amounts. Immediately after the acquisitions, total deposits exceeded $2.0 billion.

The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of Management, necessary for a fair statement of the results for such periods. Such adjustments can generally be considered as normal and recurring unless otherwise disclosed in this Form 10-Q. In preparing the accompanying financial statements, Management has taken subsequent events into consideration and recognized them where appropriate. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year. Certain amounts reported for 2016 have been reclassified to be consistent with the reporting for 2017. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission (the “SEC”).

In May 2014 the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU is the result of a joint project initiated by the FASB and the International Accounting Standards Board (IASB) to clarify the principles for recognizing revenue, and to develop common revenue standards and disclosure requirements that would: (1) remove

inconsistencies and weaknesses in revenue requirements; (2) provide a more robust framework for addressing revenue issues; (3) improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets; (4) provide more useful information to users of financial statements through improved disclosures; and (5) simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer. The guidance affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required with regard to contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This ASU is effective for annual reporting periods beginning after December 15, 2017, including interim periods therein, with early adoption permitted for reporting periods beginning after December 15, 2016. The Company plans to adopt ASU 2014-09 on January 1, 2018 utilizing the modified retrospective approach. Since the guidance does not apply to revenue associated with financial instruments such as loans and investments, which are accounted for under other provisions of GAAP, we do not expect it to impact interest income, our largest component of income. The Company is currently performing an overall assessment of revenue streams potentially affected by the ASU, including certain deposit related fees and interchange fees, to determine the impact this guidance will have on our consolidated financial statements.

In January 2016 the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This guidance primarily affects the accounting for equity securities with readily determinable fair values, by requiring that the changes in fair value for such securities will be reflected in earnings rather than in other comprehensive income. The accounting for other financial instruments such as loans, debt securities, and financial liabilities is largely unchanged. ASU 2016-01 also changes the presentation and disclosure requirements for financial instruments, including a requirement that public business entities use exit pricing when estimating fair values for financial instruments measured at amortized cost for disclosure purposes. ASU 2016-01 is generally effective for public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Based on Management’s evaluation of the provisions of ASU 2016-01 and the fact that we had no equity positions with readily determinable market values remaining at September 30, 2017, we do not anticipate any impact on our consolidated financial statements upon adoption of ASU 2016-01.

In February 2016 the FASB issued ASU 2016-02, Leases (Topic 842). The intention of this standard is to increase the transparency and comparability around lease obligations. Previously unrecorded off-balance sheet obligations will now be brought more prominently to light by presenting lease liabilities on the face of the balance sheet, accompanied by enhanced qualitative and quantitative disclosures in the notes to the financial statements. ASU 2016-02 is generally effective for public business entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company has leases on 21 branch locations and an administrative office building, which are considered operating leases and are not currently reflected in our financial statements. We expect that these lease agreements will be recognized on our consolidated statements of condition as right-of-use assets and corresponding lease liabilities subsequent to implementing ASU 2016-02, but we are still evaluating the extent to which this will impact our consolidated financial statements.

In March 2016 the FASB issued ASU 2016-09, Compensation–Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, as part of its simplification initiative. ASU 2016-09 became effective for public business entities for annual reporting periods beginning after December 15, 2016, and interim periods within that reporting period. Accordingly, the Company adopted ASU 2016-09 effective January 1, 2017. Prior guidance dictated that as they relate to share-based payments, tax benefits in excess of compensation costs (“windfalls”) were to be recorded in equity, and tax deficiencies (“shortfalls”) were to be recorded in equity to the extent of previous windfalls and then to the income statement. ASU 2016-09 reduced some of the administrative complexities by eliminating the need to track a windfall “pool,” but as we have already experienced, it also increases the volatility of income tax expense. ASU 2016-09 also removed the requirement to delay recognition of a windfall tax benefit until such time as it reduces current taxes payable. Under the new guidance, the benefit is recorded when it arises, subject to normal valuation allowance considerations. This change was applied by us on a modified retrospective basis, as required, with a cumulative-effect adjustment to opening retained earnings. Furthermore, all tax-related cash flows resulting from share-based payments are now reported as operating activities on the statement of cash flows, a change from the previous requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. However, cash paid by an employer when directly withholding shares for tax withholding purposes is classified as a financing activity. Under the new guidance, entities were permitted to make an accounting policy election for the impact of forfeitures on expense recognition for share-based payment awards. Forfeitures can be estimated in advance, as required previously, or recognized as they occur. Estimates are still required in certain

circumstances, such as at the time of modification of an award or issuance of a replacement award in a business combination. If elected, the change to recognize forfeitures when they occur would have been adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to opening retained earnings. We did not elect to recognize forfeitures as they occur, and continue to estimate potential forfeitures in advance.

In September 2016 the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which eliminates the probable initial recognition threshold for credit losses in current U.S. GAAP, and instead requires an organization to record a current estimate of all expected credit losses over the contractual term for financial assets carried at amortized cost. This is commonly referred to as the current expected credit losses (“CECL”) methodology. Expected credit losses for financial assets held at the reporting date will be measured based on historical experience, current conditions, and reasonable and supportable forecasts. Another change from existing U.S. GAAP involves the treatment of purchased credit deteriorated assets, which are more broadly defined than purchased credit impaired assets in current accounting standards. When such assets are purchased, institutions will estimate and record an allowance for credit losses that is added to the purchase price rather than being reported as a credit loss expense. Furthermore, ASU 2016-13 updates the measurement of credit losses on available-for-sale debt securities, by mandating that institutions record credit losses on available-for-sale debt securities through an allowance for credit losses rather than the current practice of writing down securities for other-than-temporary impairment. ASU 2016-13 will also require the enhancement of financial statement disclosures regarding estimates used in calculating credit losses. ASU 2016-13 does not change the existing write-off principle in U.S. GAAP or current nonaccrual practices, nor does it change accounting requirements for loans held for sale or certain other financial assets which are measured at the lower of amortized cost or fair value. As a public business entity that is an SEC filer, ASU 2016-13 becomes effective for the Company on January 1, 2020, although early application is permitted for 2019. On the effective date, institutions will apply the new accounting standard as follows: for financial assets carried at amortized cost, a cumulative-effect adjustment will be recognized on the balance sheet for any change in the related allowance for loan and lease losses generated by the adoption of the new standard; financial assets classified as purchased credit impaired assets prior to the effective date will be reclassified as purchased credit deteriorated assets as of the effective date, and will be grossed up for the related allowance for expected credit losses created as of the effective date; and, debt securities on which other-than-temporary impairment had been recognized prior to the effective date will transition to the new guidance prospectively with no change in their amortized cost basis. The Company commenced its transition efforts by establishing an implementation team, comprised of the Company’s executive officers and certain other members of our credit administration and finance departments and chaired by our Chief Credit Officer. Furthermore, after extensive discussion and due diligence, we engaged an external vendor to assist in our calculation of potential required reserves utilizing the CECL methodology and help validate our current reserving methodology. A preliminary evaluation indicates that the provisions of ASU 2016-13 will likely have a material impact on our consolidated financial statements, particularly the level of our allowance for credit losses and shareholders’ equity. While the potential extent of that impact has not yet been definitively determined, initial estimates indicate that our allowance for loan and lease losses could increase to as much as two times current levels if utilizing a discounted cash flow methodology with forecasting.

In January 2017 the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. Currently, Topic 805 specifies three elements of a business – inputs, processes, and outputs. While an integrated set of assets and activities (collectively referred to as a “set”) that is a business usually has outputs, outputs are not required. In addition, all the inputs and processes that a seller uses in operating a set are not required if market participants can acquire the set and continue to produce outputs, for example, by integrating the acquired set with their own inputs and processes. This led many transactions to be accounted for as business combinations rather than asset purchases under legacy GAAP. The primary goal of ASU 2017-01 is to narrow the definition of a business, and the guidance in this update provides a screen to determine when a set is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments in this update should be applied prospectively on or after the effective date. The Company is currently evaluating this ASU to determine the impact on its consolidated financial position, results of operations and cash flows.

In January 2017 the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment. This guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation, and goodwill impairment will simply be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The same one-step impairment test will be applied to goodwill at all reporting units, even those with zero or negative carrying amounts. Entities

will be required to disclose the amount of goodwill at reporting units with zero or negative carrying amounts. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2019. We have not been required to record any goodwill impairment to date, and after a preliminary review do not expect that this guidance would require us to do so given current circumstances. Nevertheless, we will continue to evaluate ASU 2017-04 to more definitely determine its potential impact on the Company’s consolidated financial position, results of operations and cash flows.

In March 2017 the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The amendments in this update shorten the amortization period for certain callable debt securities held at a premium, by requiring the premium to be amortized to the earliest call date. Under current guidance, the premium on a callable debt security is generally amortized as an adjustment to yield over the contractual life of the instrument, and any unamortized premium is recorded as a loss in earnings upon the debtor’s exercise of a call provision. Under ASU 2017-08, because the premium will be amortized to the earliest call date, entities will no longer recognize a loss in earnings if a debt security is called prior to the contractual maturity date. The amendments do not require an accounting change for securities held at a discount; discounts will continue to be amortized as an adjustment to yield over the contractual life of the debt instrument. ASU 2017-08 is effective for public business entities, including the Company, for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early adopts in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes that interim period. To apply ASU 2017-08, entities must use a modified retrospective approach, with the cumulative-effect adjustment recognized to retained earnings at the beginning of the period of adoption. Entities are also required to provide disclosures about a change in accounting principle in the period of adoption. The Company has evaluated the potential impact of this guidance, and does not expect the adoption of ASU 2017-08 to have a material impact on our financial statements or operations.

In May 2017 the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. This update was issued to provide clarity, reduce diversity in practice, and lower cost and complexity when applying the guidance in Topic 718. Under the updated guidance, an entity will be expected to account for the effects of an equity award modification unless all the following are met: 1) the fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified; 2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; 3) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The current disclosure requirements in Topic 718 continue to apply. ASU 2017-09 is effective for public business entities, including the Company, for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period for public business entities for reporting periods for which financial statements have not yet been issued. Since the Company has not modified equity awards in the past and does not expect to do so in the future, we do not anticipate any impact on our financial statements or operations from the adoption of ASU 2017-09.

During the nine months ended September 30, 2017 and 2016, cash paid for interest due on interest-bearing liabilities was $3.645 million and $2.362 million, respectively. There was $6.497 million in cash paid for income taxes during the nine months ended September 30, 2017, and $2.900 million for the nine months ended September 30, 2016. Assets totaling $648,000 and $847,000 were acquired in settlement of loans for the nine months ended September 30, 2017 and September 30, 2016, respectively. We received $99,000 in cash from the sale of foreclosed assets during the first nine months of 2017 relative to $837,000 during the first nine months of 2016, which represents sales proceeds less loans (if any) extended to finance such sales.

On March 16, 2017 the Company’s Board of Directors approved and adopted the 2017 Stock Incentive Plan (the “2017 Plan”), which became effective May 24, 2017, the date approved by the Company’s shareholders. The 2017 Plan replaced the Company’s 2007 Stock Incentive Plan (the “2007 Plan”), which expired by its own terms on March 15, 2017. Options to purchase 492,240 shares that were granted under the 2007 Plan were still outstanding as of September 30, 2017, and remain unaffected by that plan’s expiration. The 2017 Plan provides for the issuance of both “incentive” and “nonqualified” stock options to officers and employees, and of “nonqualified” stock options to non-employee directors and consultants of the Company. The 2017 Plan also provides for the issuance of restricted stock awards to these same classes of eligible participants, although no restricted stock awards have ever been issued by the Company. The total number of shares of the Company’s authorized but unissued stock reserved for issuance pursuant to

awards under the 2017 Plan is 850,000 shares; no awards have yet been granted under the 2017 Plan. The dilutive impact of stock options outstanding is discussed below in Note 6, Earnings per Share.

Pursuant to FASB’s standards on stock compensation, the value of each stock option granted is reflected in our income statement as employee compensation or directors’ expense by expensing its fair value as of the grant date in the case of immediately vested options, or by amortizing its grant date fair value over the vesting period for options with graded vesting. The Company is utilizing the Black-Scholes model to value stock options, and the “multiple option” approach is used to allocate the resulting valuation to actual expense. Under the multiple option approach an employee’s options for each vesting period are separately valued and amortized, which appears to be the preferred method for option grants with graded vesting. A pre-tax charge of $18,000 was reflected in the Company’s income statement during the third quarter of 2017 and $11,000 was charged during the third quarter of 2016, as expense related to stock options. For the first three quarters, the charges totaled $460,000 in 2017 and $180,000 in 2016.

The computation of earnings per share, as presented in the Consolidated Statements of Income, is based on the weighted average number of shares outstanding during each period. There were 13,839,111 weighted average shares outstanding during the third quarter of 2017, and 13,790,107 during the third quarter of 2016. There were 13,824,173 weighted average shares outstanding during the first nine months of 2017, and 13,446,567 during the first nine months of 2016.

Diluted earnings per share include the effect of the potential issuance of common shares, which for the Company is limited to shares that would be issued on the exercise of “in-the-money” stock options. For the third quarter of 2017, calculations under the treasury stock method resulted in the equivalent of 174,876 shares being added to basic weighted average shares outstanding for purposes of determining diluted earnings per share, while a weighted average of 120,700 stock options were excluded from the calculation because they were underwater and thus anti-dilutive. For the third quarter of 2016 the equivalent of 114,353 shares were added in calculating diluted earnings per share, while 146,900 anti-dilutive stock options were not factored into the computation. Likewise, for the first nine months of 2017 the equivalent of 186,721 shares were added to basic weighted average shares outstanding in calculating diluted earnings per share and a weighted average of 120,700 stock options that were anti-dilutive for the period were not included, compared to the addition of the equivalent of 114,149 shares and non-inclusion of 196,900 anti-dilutive options in calculating diluted earnings per share for first nine months of 2016.

As presented in the Consolidated Statements of Comprehensive Income, comprehensive income includes net income and other comprehensive income. The Company’s only source of other comprehensive income is unrealized gains and losses on available-for-sale investment securities. Gains or losses on investment securities that were realized and reflected in net income of the current period, which had previously been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose, are considered to be reclassification adjustments that are excluded from other comprehensive income in the current period.

The Company is a party to financial instruments with off‑balance‑sheet risk in the normal course of business. Those financial instruments currently consist of unused commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by counterparties for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as it does for originating loans included on the balance sheet. The following financial instruments represent off‑balance‑sheet credit risk (dollars in thousands):

Commitments to extend credit consist primarily of the unused or unfunded portions of the following: home equity lines of credit; commercial real estate construction loans, where disbursements are made over the course of construction; commercial revolving lines of credit; mortgage warehouse lines of credit; unsecured personal lines of credit; and formalized (disclosed) deposit account overdraft lines. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn upon, the unused portions of committed amounts do not necessarily represent future cash requirements. Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party, and the credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers.

At September 30, 2017, the Company was also utilizing a letter of credit in the amount of $86 million issued by the Federal Home Loan Bank on the Company’s behalf as security for certain deposits and to facilitate certain credit arrangements with the Company’s customers. That letter of credit is backed by loans which are pledged to the FHLB by the Company.

Note 9 – Fair Value Disclosures and Reporting, the Fair Value Option and Fair Value Measurements

FASB’s standards on financial instruments, and on fair value measurements and disclosures, require all entities to disclose in their financial statement footnotes the estimated fair values of financial instruments for which it is practicable to estimate such. In addition to disclosure requirements, FASB’s standard on investments requires that our debt securities which are classified as available for sale and any equity securities that have readily determinable fair values be measured and reported at fair value in our statement of financial position. Certain impaired loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value. FASB’s standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, but we have not elected the fair value option for any of those financial instruments.

Fair value measurement and disclosure standards also establish a framework for measuring fair values. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. Further, the standards establish a fair value hierarchy that encourages an entity to maximize the use of observable inputs and limit the use of unobservable inputs when measuring fair values. The standards describe three levels of inputs that may be used to measure fair values:

Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments. The estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to those instruments. In addition, the tax ramifications related to realized gains and losses could have a significant effect on fair value estimates but have not been considered in determining those estimates. Because no active market exists for a significant portion of our financial instruments, fair value disclosures are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. The estimates are subjective and involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly alter the fair values presented. The following methods and assumptions were used by the Company to estimate its financial instrument fair values disclosed at September 30, 2017 and December 31, 2016:

Estimated fair values for the Company’s financial instruments are as follows, as of the dates noted:

Fair Value of Financial Instruments
(dollars in thousands, unaudited)	September 30, 2017
			Estimated Fair Value
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Financial assets:
Cash and cash equivalents	$	54,607	$	54,610	$	—	$	—	$	54,610
Investment securities available for sale		583,200		—		583,200		—		583,200
Loans and leases, net held for investment		1,305,507		—		1,317,560		—		1,317,560
Collateral dependent impaired loans		39		—		39		—		39
Cash surrender value of life insurance policies		45,270		—		45,270		—		45,270
Other investments		8,741		—		8,741		—		8,741
Accrued interest receivable		6,676		—		6,676		—		6,676

Financial liabilities:
Deposits:
Noninterest-bearing	$	571,509	$	571,509	$	—	$	—	$	571,509
Interest-bearing		1,208,070		—		1,207,808		—		1,207,808
Fed funds purchased and repurchase agreements		10,279		—		10,279		—		10,279
Short-term borrowings		10,500		—		10,500		—		10,500
Subordinated debentures		34,544		—		24,095		—		24,095
Accrued interest payable		175		—		175		—		175

	December 31, 2016
			Estimated Fair Value
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
Financial assets:
Cash and cash equivalents	$	120,442	$	120,442	$	—	$	—	$	120,442
Investment securities available for sale		530,083		1,546		528,537		—		530,083
Loans and leases, net held for investment		1,255,348		—		1,266,447		—		1,266,447
Collateral dependent impaired loans		406		—		406		—		406
Cash surrender value of life insurance policies


California	33-0937517
(State of Incorporation)	(IRS Employer Identification No)

Large Accelerated Filer	☐	Accelerated Filer:	☒
Non‑accelerated Filer:	☐ (Do not check if a smaller reporting company)	Smaller Reporting Company:	☐
Emerging Growth Company:	☐

					Page
Part I - Financial Information					1
	Item 1. Financial Statements (Unaudited)				1
		Consolidated Balance Sheets			1
		Consolidated Statements of Income			2
		Consolidated Statements of Comprehensive Income			3
		Consolidated Statements of Cash Flows			4
		Notes to Consolidated Financial Statements (Unaudited)			5

	Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations				35
		Forward-Looking Statements			35
		Critical Accounting Policies			35
		Overview of the Results of Operations and Financial Condition			35
		Earnings Performance			37
			Net Interest Income and Net Interest Margin		37
			Provision for Loan and Lease Losses		41
			Non-Interest Income and Non-Interest Expense		42
			Provision for Income Taxes		45
		Balance Sheet Analysis			45
			Earning Assets		45
				Investments	45
				Loan and Lease Portfolio	47
				Nonperforming Assets	48
				Allowance for Loan and Lease Losses	49
				Off-Balance Sheet Arrangements	51
			Other Assets		51
			Deposits and Interest-Bearing Liabilities		52
				Deposits	52
				Other Interest-Bearing Liabilities	53
			Non-Interest Bearing Liabilities		53
		Liquidity and Market Risk Management			53
		Capital Resources			56

	Item 3. Qualitative & Quantitative Disclosures about Market Risk				57

	Item 4. Controls and Procedures				57

Part II - Other Information					58
	Item 1. - Legal Proceedings				58
	Item 1A. - Risk Factors				58
	Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds				58
	Item 3. - Defaults upon Senior Securities				58
	Item 4. - (Removed and Reserved)				58
	Item 5. - Other Information				58
	Item 6. - Exhibits				59

Signatures					60

	Notional Amount
Off-balance-sheet financial instruments:
Commitments to extend credit	$	639,177
Standby letters of credit		7,936