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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2020
☐
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: 000-32897

UNITED SECURITY BANCSHARES
(Exact name of registrant as specified in its charter)
 
CALIFORNIA   91-2112732
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
     
2126 Inyo Street, Fresno, California
  93721
(Address of principal executive offices)   (Zip Code)
Registrants telephone number, including area code    (559) 248-4943

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐  No  ☒
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing 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 (§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 ☒ No ☐           

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a small reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐
Small reporting company ☒
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the 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
(Title of Class)

Shares outstanding as of September 30, 2020: 16,977,239
1
TABLE OF CONTENTS

Facing Page

Table of Contents

PART I. Financial Information  
       
   
       
   
3
   
4
5
   
6
   
8
   
10
     
 
42
     
   
42
   
44
   
51
   
63
   
64
     
66
 
66
PART II. Other Information
  Item 1.
68
  Item 2.
68
  Item 3.
68
  Item 4.
68
  Item 5.
68
  Item 6.
68
     
69
2
PART I. Financial Information


United Security Bancshares and Subsidiaries
Consolidated Balance Sheets – (unaudited)
September 30, 2020 and December 31, 2019
(in thousands except shares) September 30, 2020 December 31, 2019
Assets    
Cash and non-interest-bearing deposits in other banks $ 29,197  $ 27,291 
Due from Federal Reserve Bank ("FRB") 294,135  191,704 
Cash and cash equivalents 323,332  218,995 
Investment securities (at fair value)
Available-for-sale ("AFS") securities 87,917  76,312 
Marketable equity securities 3,865  3,776 
Total investment securities 91,782  80,088 
Loans 661,482  597,374 
Unearned fees and unamortized loan origination costs - net (1,038) (820)
Allowance for credit losses (8,708) (7,908)
Net loans 651,736  588,646 
Premises and equipment - net 9,379  9,380 
Accrued interest receivable 10,099  8,208 
Other real estate owned 5,018  6,753 
Goodwill 4,488  4,488 
Deferred tax assets - net 2,631  3,191 
Cash surrender value of life insurance 20,403  20,955 
Operating lease right-of-use assets 2,914  3,360 
Other assets 12,165  12,855 
Total assets $ 1,133,947  $ 956,919 
Liabilities & Shareholders' Equity    
Liabilities    
Deposits    
Non-interest-bearing $ 430,028  $ 311,950 
Interest-bearing 564,755  506,412 
Total deposits 994,783  818,362 
Accrued interest payable 36  59 
Operating lease liabilities 3,017  3,463 
Other liabilities 7,977  8,239 
Junior subordinated debentures (at fair value) 10,081  10,808 
Total liabilities 1,015,894  840,931 
Shareholders' Equity    
Common stock, no par value; 20,000,000 shares authorized; issued and outstanding: 16,977,239 at September 30, 2020 and 16,973,885 at December 31, 2019
59,289  58,973 
Retained earnings 59,084  57,647 
Accumulated other comprehensive loss (320) (632)
Total shareholders' equity 118,053  115,988 
Total liabilities and shareholders' equity $ 1,133,947  $ 956,919 
3
United Security Bancshares and Subsidiaries
Consolidated Statements of Income
(Unaudited)
 
  Three Months Ended September 30, Nine Months Ended September 30,
(In thousands except shares and EPS) 2020 2019 2020 2019
Interest Income:
Interest and fees on loans $ 7,563  $ 8,648  $ 23,622  $ 25,733 
Interest on investment securities 343  439  1,127  1,360 
Interest on deposits in FRB 62  1,330  667  4,052 
Total interest income 7,968  10,417  25,416  31,145 
Interest Expense:    
Interest on deposits 451  950  1,562  2,675 
Interest on other borrowed funds 49  111  229  352 
Total interest expense 500  1,061  1,791  3,027 
Net Interest Income 7,468  9,356  23,625  28,118 
Provision for Credit Losses 4  5  2,138  15 
Net Interest Income after Provision for Credit Losses 7,464  9,351  21,487  28,103 
Noninterest Income:    
Customer service fees 668  839  2,014  2,479 
Increase in cash surrender value of bank-owned life insurance 124  147  382  438 
Unrealized gain on fair value of marketable equity securities 4  18  89  128 
Gain on proceeds from bank-owned life insurance —  —  310  — 
(Loss) gain on fair value of junior subordinated debentures (18) 660  1,451  1,571 
Loss on dissolution of real estate investment trust —  (1) —  (115)
(Loss) gain on sale of assets —  (5) —  1 
Other 133  195  460  603 
Total noninterest income 911  1,853  4,706  5,105 
Noninterest Expense:
Salaries and employee benefits 2,722  2,775  8,131  8,307 
Occupancy expense 887  829  2,609  2,450 
Data processing 139  151  386  402 
Professional fees 724  864  1,981  2,423 
Regulatory assessments 121  (37) 283  138 
Director fees 94  95  282  281 
Correspondent bank service charges 19  14  52  42 
Net cost on operation and sale of OREO 35  71  968  223 
Other 469  573  1,663  1,677 
Total noninterest expense 5,210  5,335  16,355  15,943 
Income Before Provision for Taxes 3,165  5,869  9,838  17,265 
Provision for Taxes on Income 894  1,696  2,800  4,989 
Net Income $ 2,271  $ 4,173  $ 7,038  $ 12,276 
Net Income per common share
Basic $ 0.13  $ 0.25  $ 0.41  $ 0.72 
Diluted $ 0.13  $ 0.25  $ 0.41  $ 0.72 
Shares on which net income per common shares were based
Basic 16,977,239  16,953,744  16,975,648  16,950,474 
Diluted 17,000,501  16,990,162  16,993,180  16,981,619 
4
United Security Bancshares and Subsidiaries
Consolidated Statements of Comprehensive Income
(Unaudited)

(In thousands) Three Months Ended  
 September 30, 2020 		Three Months Ended  
 September 30, 2019 		Nine Months Ended 
 September 30, 2020 		Nine Months Ended 
 September 30, 2019
Net Income $ 2,271  $ 4,173  $ 7,038  $ 12,276 
Unrealized holdings gain (loss) on debt securities 334  (246) 1,161  317 
Unrealized gains on unrecognized post-retirement costs 20  14  60  42 
    Unrealized loss on junior subordinated debentures
(326) (501) (779) (1,748)
Other comprehensive gain (loss), before tax 28  (733) 442  (1,389)
Tax (expense) benefit related to debt securities (38) 76  (343) (94)
Tax expense related to unrecognized post-retirement costs (6) (4) (17) (12)
Tax benefit related to junior subordinated debentures 97  148  230  516 
Total other comprehensive gain (loss) 81  (513) 312  (979)
Comprehensive Income $ 2,352  $ 3,660  $ 7,350  $ 11,297 
5
United Security Bancshares and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
(unaudited)
  Common Stock    
(In thousands except shares) Number of Shares Amount Retained Earnings Accumulated Other Comprehensive (Loss) Gain  Total
Balance December 31, 2018 (1) 16,946,622  $ 58,624  $ 49,942  $ 674  $ 109,240 
(1) Excludes 59,217 unvested restricted shares
   Other comprehensive loss       (284) (284)
Dividends payable ($0.11 per share)
(1,869) (1,869)
Restricted stock units released 2,500  — 
Stock-based compensation expense   99      99 
Net income     4,007    4,007 
Balance March 31, 2019 (2) 16,949,122  $ 58,723  $ 52,080  $ 390  $ 111,193 
(2) Excludes 58,717 unvested restricted shares
  Other comprehensive loss       (182) (182)
Dividends payable ($0.11 per share)
(1,865) (1,865)
Restricted stock units released 4,622  — 
Stock-based compensation expense   95      95 
Net income     4,097    4,097 
Balance June 30, 2019 (3) 16,953,744  $ 58,818  $ 54,312  $ 208  $ 113,338 
(3) Excludes 55,713 unvested restricted shares
  Other comprehensive loss (513) (513)
Dividends payable ($0.11 per share)
(1,865) (1,865)
Stock-based compensation expense 78  78 
Net income 4,173  4,173 
Balance September 30, 2019 (4) 16,953,744  $ 58,896  $ 56,620  $ (305) $ 115,211 
(4) Excludes 55,713 unvested restricted shares
  Other comprehensive loss (327) (327)
Dividends payable ($0.11 per share)
(1,868) (1,868)
Restricted stock units released 20,141  — 
Stock-based compensation expense 77  77 
Net income 2,895  2,895 
Balance December 31, 2019 (5) 16,973,885  $ 58,973  $ 57,647  $ (632) $ 115,988 
(5) Excludes 35,572 unvested restricted shares
  Other comprehensive income 458  458 
Dividends payable ($0.11 per share)
(1,867) (1,867)
Restricted stock units released 350  — 
Tax benefit from restricted stock units released (1) (1)
Stock-based compensation expense 78  78 
Net income 2,754  2,754 
Balance March 31, 2020 (6) 16,974,235  $ 59,050  $ 58,534  $ (174) $ 117,410 
(6) Excludes 47,572 unvested restricted shares
6
Other comprehensive loss (227) (227)
Dividends payable ($0.11 per share)
(1,866) (1,866)
Restricted stock units released 3,004  — 
Stock-based compensation expense 131  131 
Net income 2,012  2,012 
Balance June 30, 2020 (7) 16,977,239  $ 59,181  $ 58,680  $ (401) $ 117,460 
(7) Excludes 44,568 unvested restricted shares
Other comprehensive loss 81  81 
Dividends payable ($0.11 per share)
(1,867) (1,867)
Stock-based compensation expense 108  108 
Net income 2,271  2,271 
Balance September 30, 2020 (8) 16,977,239  $ 59,289  $ 59,084  $ (320) $ 118,053 
(8) Excludes 44,568 unvested restricted shares
7
United Security Bancshares and Subsidiaries
Consolidated Statements of Cash Flows (unaudited)
  Nine months ended September 30,
(In thousands) 2020 2019
Cash Flows From Operating Activities:    
Net Income $ 7,038  $ 12,276 
Adjustments to reconcile net income to cash provided by operating activities:    
Provision for credit losses 2,138  15 
Depreciation and amortization 1,044  1,055 
Amortization of operating lease right-of-use assets (446) (575)
Amortization of premium/discount on investment securities, net 806  489 
Increase in accrued interest receivable (1,891) (2,181)
(Decrease) increase in accrued interest payable (23) 15 
Decrease in accounts payable and accrued liabilities (261) (1,996)
Decrease in unearned fees and unamortized loan origination costs, net 218  508 
Decrease (increase) in income taxes receivable (9) (359)
Unrealized gain on marketable equity securities (89) (128)
Stock-based compensation expense 316  272 
Benefit (provision) for deferred income taxes 199  (52)
Loss on sale of other real estate owned 113  — 
Write down on other real estate owned 727  — 
Gain on bank owned life insurance (310) — 
Increase in cash surrender value of bank-owned life insurance (382) (438)
Gain on fair value option of junior subordinated debentures (1,451) (1,571)
Loss on dissolution of real estate investment trust —  115 
Gain on sale of premises and equipment —  (1)
Net decrease in other assets 1,629  2,321 
Net cash provided by operating activities 9,366  9,765 
Cash Flows From Investing Activities:    
Purchase of correspondent bank stock (45) (52)
Purchases of available-for-sale securities (29,016) (23,017)
Principal payments of available-for-sale securities 17,766  11,407 
Net (increase) decrease in loans (65,446) 17,626 
Cash proceeds from sales of other real estate owned 895  — 
Investment in limited partnership (201) (300)
Cash proceeds from sale of premises and equipment —  12 
Proceeds from bank owned life insurance 1,243  — 
Capital expenditures of premises and equipment (1,043) (684)
Net cash (used in) provided by investing activities (75,847) 4,992 
Cash Flows From Financing Activities:    
Net increase in demand deposits and savings accounts 178,239  28,859 
Net decrease in time deposits (1,819) (14,280)
Dividends on common stock (5,602) (3,730)
Net cash provided by financing activities 170,818  10,849 
8
Net increase in cash and cash equivalents 104,337  25,606 
Cash and cash equivalents at beginning of period 218,995  220,337 
Cash and cash equivalents at end of period $ 323,332  $ 245,943 
9
United Security Bancshares and Subsidiaries - Notes to Consolidated Financial Statements - (Unaudited)
 
1.Organization and Summary of Significant Accounting and Reporting Policies
 
The consolidated financial statements include the accounts of United Security Bancshares (Company or USB) and its wholly owned subsidiary United Security Bank (Bank). Intercompany accounts and transactions have been eliminated in consolidation.

These unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information on a basis consistent with the accounting policies reflected in the audited consolidated financial statements of the Company included in its 2019 Annual Report on Form 10-K. These interim consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of a normal, recurring nature) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole.

Impact of New Financial Accounting Standards:

In June 2016, FASB issued ASU 2016-13, Financial Instruments- Credit Losses (Topic 326). The FASB is issuing this Update to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The Update requires enhanced disclosures and judgments in estimating credit losses and also amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. This original amendment was effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. In October 2019 FASB unanimously approved a vote to delay the effective date of this Standard to be effective for fiscal years beginning after December 15, 2022. The Company has formed a project team that is responsible for oversight of the Company’s implementation strategy for compliance with provisions of the new standard. An external provider specializing in community bank loss driver and CECL reserving model design as well as other related consulting services has been retained, and the Company continues to evaluate potential CECL modeling alternatives. As part of this process, the Company has determined potential loan pool segmentation and sub-segmentation under CECL, as well as evaluated the key economic loss drivers for each segment. The Company has begun to generate and evaluate model scenarios under CECL in tandem with its current reserving processes for interim and annual reporting beginning in March 2020. While the Company is currently unable to reasonably estimate the impact of adopting this new guidance, management expects the impact of adoption will be significantly influenced by the composition and quality of the Company’s loan portfolio as well as the economic conditions as of the date of adoption. The Company also anticipates significant changes to the processes and procedures for calculating the reserve for credit losses and continues to evaluate the potential impact on the Company's consolidated financial statements. Additionally, in regard to the recently approved delay in implementation, the Company continues to evaluate its expected implementation date.

On March 22, 2020, a statement was issued by various regulatory agencies titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” (the “Interagency Statement”) that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the CARES Act, that passed on March 27, 2020, further provides that a qualified loan modification is exempt by law from classification as a troubled debt restructuring (“TDR”) as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. The Interagency Statement was subsequently revised in April 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act, as well as setting forth the banking regulators’ views on consumer protection considerations. In accordance with such guidance, the Company offered short-term modifications made in response to COVID-19 to borrowers who are current and otherwise not past due. These include short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.

10
2.Investment Securities

Following is a comparison of the amortized cost and fair value of securities available-for-sale, as of September 30, 2020 and December 31, 2019:
(in 000's)  Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount)
September 30, 2020
Securities available-for-sale:
U.S. Government agencies $ 35,039  $ 155  $ (252) $ 34,942 
U.S. Government sponsored entities & agencies collateralized by mortgage obligations 42,054  857  (14) 42,897 
Asset-backed securities 3,866  —  (38) 3,828 
Municipal bonds 1,045  13  —  1,058 
Corporate bonds 5,000  192  —  5,192 
Total securities available for sale $ 87,004  $ 1,217  $ (304) $ 87,917 

(in 000's)  Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (Carrying Amount)
December 31, 2019
Securities available-for-sale:
U.S. Government agencies $ 28,737  $ 152  $ (190) $ 28,699 
U.S. Government sponsored entities & agencies collateralized by mortgage obligations 47,824  120  (331) 47,613 
Total securities available for sale $ 76,561  $ 272  $ (521) $ 76,312 
 
The amortized cost and fair value of securities available for sale at September 30, 2020, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties. Contractual maturities on collateralized mortgage obligations cannot be anticipated due to allowed paydowns.
  September 30, 2020
  Amortized Cost Fair Value (Carrying Amount)
(in 000's)
Due in one year or less $ —  $ — 
Due after one year through five years 300  300 
Due after five years through ten years 18,224  18,332 
Due after ten years 26,426  26,388 
Collateralized mortgage obligations 42,054  42,897 
  $ 87,004  $ 87,917 

There were no realized gains or losses on sales of available-for-sale securities for the three and nine month periods ended September 30, 2020 and September 30, 2019. There were no other-than-temporary impairment losses for the three and nine month periods ended September 30, 2020 and September 30, 2019.

At September 30, 2020, available-for-sale securities with an amortized cost of approximately $79,013,000 (fair value of $79,942,000) were pledged as collateral for FHLB borrowings, securitized deposits, and public funds balances.


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The following summarizes temporarily impaired investment securities:
(in 000's) Less than 12 Months 12 Months or More Total
September 30, 2020 Fair Value (Carrying Amount)  Unrealized Losses Fair Value (Carrying Amount)  Unrealized Losses Fair Value (Carrying Amount)  Unrealized Losses
Securities available for sale:
U.S. Government agencies $ 9,540  $ (83) 17,897  (169) $ 27,437  $ (252)
U.S. Government sponsored entities & agencies collateralized by mortgage obligations 317  (2) 2,068  (12) 2,385  (14)
Corporate bonds —  —  —  —  —  — 
Municipal bonds 300  —  —  —  300  — 
Asset-backed securities 3,828  (38) —  —  3,828  (38)
Total impaired securities $ 13,985  $ (123) $ 19,965  $ (181) $ 33,950  $ (304)
December 31, 2019            
Securities available for sale:            
U.S. Government agencies $ 3,961  $ (12) $ 15,989  $ (178) $ 19,950  $ (190)
U.S. Government sponsored entities & agencies collateralized by mortgage obligations 25,400  (187) 11,244  (144) 36,644  (331)
Total impaired securities $ 29,361  $ (199) $ 27,233  $ (322) $ 56,594  $ (521)
 
Temporarily impaired securities at September 30, 2020, were comprised of one asset-backed security, three municipal bonds, twelve U.S. government agency securities, and four U.S. government sponsored entities and agencies collateralized by mortgage obligations securities.

The Company evaluates investment securities for other-than-temporary impairment (OTTI) at least quarterly, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under ASC Topic 320, Investments – Debt and Equity Instruments.

The Company considers many factors in determining OTTI, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to the Company at the time of the evaluation.
 
Additionally, OTTI occurs when the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If the Company intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary-impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the other-than-temporary-impairment shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total other-than-temporary-impairment related to the credit loss is recognized in earnings, and is determined based on the difference between the present value of cash flows expected to be
12
collected and the current amortized cost of the security. The amount of the total other-than-temporary-impairment related to other factors shall be recognized in other comprehensive (loss) income, net of applicable taxes. The previous amortized cost basis less the other-than-temporary-impairment recognized in earnings shall become the new amortized cost basis of the investment.

Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary.

At September 30, 2020, the decline in fair value of the one asset-backed security, three municipal bonds, twelve U.S. government agency securities, and the four U.S. government sponsored entities and agencies collateralized by mortgage obligations securities is attributable to changes in interest rates, and not credit quality. Because the Company does not intend to sell these impaired securities, and it is more likely than not that it will not be required to sell these securities before its anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2020.

During the nine months ended September 30, 2020 and 2019, the Company recognized $89,000 and $128,000 of unrealized holding gains related to equity securities in the consolidated statements of income, respectively. For the quarters ended September 30, 2020 and September 30, 2019, the Company recognized unrealized holding gains of $4,000 and $18,000, respectively.

The Company had no held-to-maturity or trading securities at September 30, 2020 or December 31, 2019.

3.Loans

Loans are comprised of the following:
(in 000's) September 30, 2020 December 31, 2019
Commercial and industrial:
Commercial and business loans $ 39,218  $ 44,534 
Government program loans 26,524  744 
Total commercial and industrial 65,742  45,278 
Real estate mortgage:    
Commercial real estate 264,013  245,183 
Residential mortgages 45,722  45,881 
Home improvement and home equity loans 114  173 
Total real estate mortgage 309,849  291,237 
Real estate construction and development 171,889  138,784 
Agricultural 51,587  52,197 
Installment and student loans 62,415  69,878 
Total loans $ 661,482  $ 597,374 
 
The Company's loans are predominantly in the San Joaquin Valley and the greater Oakhurst/East Madera County area, as well as the Campbell area of Santa Clara County. Although the Company does participate in loans with other financial institutions, they are primarily in the state of California.

Commercial and industrial loans represent 10.0% of total loans at September 30, 2020 and are generally made to support the ongoing operations of small-to-medium sized commercial businesses. Commercial and industrial loans have a high degree of industry diversification and provide working capital, financing for the purchase of manufacturing plants and equipment, or funding for growth and general expansion of businesses. A substantial portion of commercial and industrial loans are secured by accounts receivable, inventory, leases, or other collateral including real estate. The remainder are unsecured; however, extensions of credit are predicated upon the financial capacity of the borrower. Repayment of commercial loans is generally from the cash flow of the borrower. Included within the balance of Commercial and industrial loans is $25,889,000 in Paycheck Protection Program ("PPP") loans administrated by the SBA. PPP loans have a two-year term and earn interest at 1%. The Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.
13

Real estate mortgage loans, representing 46.8% of total loans at September 30, 2020, are secured by trust deeds on primarily commercial property, but are also secured by trust deeds on single family residences. Repayment of real estate mortgage loans generally comes from the cash flow of the borrower and or guarantor(s).

•Commercial real estate mortgage loans comprise the largest segment of this loan category and are available on all types of income producing and non-income producing commercial properties, including: office buildings, shopping centers; apartments and motels; owner occupied buildings; manufacturing facilities and more. Commercial real estate mortgage loans can also be used to refinance existing debt. Commercial real estate loans are made under the premise that the loan will be repaid from the borrower's business operations, rental income associated with the real property, or personal assets.

•Residential mortgage loans are provided to individuals to finance or refinance single-family residences. Residential mortgages are not a primary business line offered by the Company, and a majority are conventional mortgages that were purchased as a pool.

•Home Improvement and Home Equity loans comprise a relatively small portion of total real estate mortgage loans. Home equity loans are generally secured by junior trust deeds, but may be secured by 1st trust deeds.

Real estate construction and development loans, representing 26.0% of total loans at September 30, 2020, consist of loans for residential and commercial construction projects, as well as land acquisition and development, or land held for future development. Loans in this category are secured by real estate including improved and unimproved land, as well as single-family residential, multi-family residential, and commercial properties in various stages of completion. All real estate loans have established equity requirements. Repayment on construction loans generally comes from long-term mortgages with other lending institutions obtained at completion of the project or from the sale of the constructed homes to individuals.

Agricultural loans represent 7.8% of total loans at September 30, 2020 and are generally secured by land, equipment, inventory and receivables. Repayment is from the cash flow of the borrower.

Installment loans, including student loans, represent 9.4% of total loans at September 30, 2020 and generally consist of student loans, loans to individuals for household, family and other personal expenditures, automobiles or other consumer items. See "Note 4 - Student Loans" for specific information on the student loan portfolio.

In the normal course of business, the Company is party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. At September 30, 2020 and December 31, 2019, these financial instruments include commitments to extend credit of $204,522,000 and $197,559,000, respectively, and standby letters of credit of $3,662,000 and $1,662,000, respectively. These instruments involve elements of credit risk in excess of the amount recognized on the consolidated balance sheet. The contract amounts of these instruments reflect the extent of the involvement the Company has in off-balance sheet financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Company uses the same credit policies as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. A majority of these commitments are at floating interest rates based on the Prime rate. Commitments generally have fixed expiration dates. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation. Collateral held varies but includes accounts receivable, inventory, leases, property, plant and equipment, residential real estate and income-producing properties.

Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

The Bank has entered into a Small Business Administration (SBA) 504 Loan Forward Purchase Commitment to buy a one hundred percent (100%) interest in up to $30 million, first mortgage, California SBA 504 loans on a flow basis with servicing released by the Seller.

14
Past Due Loans

The Company monitors delinquency and potential problem loans on an ongoing basis through weekly reports to the Loan Committee and monthly reports to the Board of Directors.

The following is a summary of delinquent loans at September 30, 2020 (in 000's):
September 30, 2020 Loans
30-60 Days Past Due 		Loans
61-89 Days Past Due 		Loans
90 or More
Days Past Due 		Total Past Due Loans Current Loans Total Loans Accruing
Loans 90 or
More Days Past Due
Commercial and business loans $ —  $ —  $ —  $ —  $ 39,218  $ 39,218  $ — 
Government program loans —  —  —  —  26,524  26,524  — 
Total commercial and industrial —  —  —  —  65,742  65,742  — 
Commercial real estate loans —  —  —  —  264,013  264,013  — 
Residential mortgages 266  —  —  266  45,456  45,722  — 
Home improvement and home equity loans —  —  —  —  114  114  — 
Total real estate mortgage 266  —  —  266  309,583  309,849  — 
Real estate construction and development loans —  —  8,573  8,573  163,316  171,889  — 
Agricultural loans —  —  477  477  51,110  51,587  — 
Installment and student loans 2,253  429  53  2,735  59,580  62,315  53 
Overdraft protection lines —  —  —  —  30  30  — 
Overdrafts —  —  —  —  70  70  — 
Total installment and student loans 2,253  429  53  2,735  59,680  62,415  53 
Total loans $ 2,519  $ 429  $ 9,103  $ 12,051  $ 649,431  $ 661,482  $ 53 

The following is a summary of delinquent loans at December 31, 2019 (in 000's):
December 31, 2019 Loans
30-60 Days Past Due 		Loans
61-89 Days Past Due 		Loans
90 or More
Days Past Due 		Total Past Due Loans Current Loans Total Loans Accruing
Loans 90 or
More Days Past Due
Commercial and business loans $ 568  $ —  $ 75  $ 643  $ 43,891  $ 44,534  $ — 
Government program loans —  —  —  —  744  744  — 
Total commercial and industrial 568  —  75  643  44,635  45,278  — 
Commercial real estate loans —  —  —  —  245,183  245,183  — 
Residential mortgages 28  —  —  28  45,853  45,881  — 
Home improvement and home equity loans —  —  —  —  173  173  — 
Total real estate mortgage 28  —  —  28  291,209  291,237  — 
Real estate construction and development loans —  —  8,825  8,825  129,959  138,784  — 
Agricultural loans 957  423  144  1,524  50,673  52,197  — 
Installment and student loans 292  657  386  1,335  68,280  69,615  386 
Overdraft protection lines —  —  —  —  33  33  — 
Overdrafts —  —  —  —  230  230  — 
Total installment and student loans 292  657  386  1,335  68,543  69,878  386 
Total loans $ 1,845  $ 1,080  $ 9,430  $ 12,355  $ 585,019  $ 597,374  $ 386 
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Nonaccrual Loans

Commercial, construction and commercial real estate loans are placed on nonaccrual status under the following circumstances:

- When there is doubt regarding the full repayment of interest and principal.

- When principal and/or interest on the loan has been in default for a period of 90-days or more, unless the asset is both well secured and in the process of collection that will result in repayment in the near future.

- When the loan is identified as having loss elements and/or is risk rated "8" Doubtful.

Other circumstances which jeopardize the ultimate collectability of the loan including certain troubled debt restructurings, identified loan impairment, and certain loans to facilitate the sale of OREO.

All loans, outside of student loans, where principal or interest is due and unpaid for 90 days or more are placed on nonaccrual and the accrual of interest for financial statement purposes is discontinued. Previously accrued but unpaid interest is reversed and charged against interest income. See Note 4 - Student Loans for specific information on the student loan portfolio.

When a loan is placed on nonaccrual status and subsequent payments of interest (and principal) are received, the interest received may be accounted for in two separate ways.

Cost recovery method: If the loan is in doubt as to full collection, the interest received in subsequent payments is diverted from interest income to a valuation reserve and treated as a reduction of principal for financial reporting purposes.

Cash basis: This method is only used if the recorded investment or total contractual amount is expected to be fully collectible, under which circumstances the subsequent payments of interest are credited to interest income as received.

Loans on non-accrual status are usually not returned to accrual status unless all delinquent principal and/or interest has been brought current, there is no identified element of loss, and current and continued satisfactory performance is expected (loss of the contractual amount not the carrying amount of the loan). Return to accrual is generally demonstrated through the timely receipt of at least six monthly payments on a loan with monthly amortization.

There were no remaining undisbursed commitments to extend credit on nonaccrual loans at September 30, 2020 or December 31, 2019.

The following is a summary of nonaccrual loan balances at September 30, 2020 and December 31, 2019 (in 000's).
September 30, 2020 December 31, 2019
Commercial and business loans $ —  $ 75 
Government program loans —  — 
Total commercial and industrial —  75 
Commercial real estate loans —  — 
Residential mortgages —  — 
Home improvement and home equity loans —  — 
Total real estate mortgage —  — 
Real estate construction and development loans 11,058  11,478 
Agricultural loans 477  144 
Installment and student loans —  — 
Total nonaccrual loans $ 11,535  $ 11,697 

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Impaired Loans

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 loan agreement.

The Company applies its normal loan review procedures in making judgments regarding probable losses and loan impairment. The Company evaluates for impairment those loans on nonaccrual status, graded doubtful, graded substandard or those that are troubled debt restructures. The primary basis for inclusion in impaired status under generally accepted accounting pronouncements is that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement.

A loan is not considered impaired if there is merely an insignificant delay or shortfall in the amounts of payments and the Company expects to collect all amounts due, including interest accrued, at the contractual interest rate for the period of the delay.

Review for impairment does not include large groups of smaller balance homogeneous loans that are collectively evaluated to estimate the allowance for loan losses. The Company’s present allowance for loan losses methodology, including migration analysis, captures required reserves for these loans in the formula allowance.

For loans determined to be impaired, the Company evaluates impairment based upon either the fair value of underlying collateral, discounted cash flows of expected payments, or observable market price.

-     For loans secured by collateral including real estate and equipment, the fair value of the collateral less selling costs will determine the carrying value of the loan. The difference between the recorded investment in the loan and the fair value, less selling costs, determines the amount of impairment. The Company uses the measurement method based on fair value of collateral when the loan is collateral dependent and foreclosure is probable. For loans that are not considered collateral dependent, a discounted cash flow methodology is used.

-     The discounted cash flow method of measuring the impairment of a loan is used for impaired loans that are not considered to be collateral dependent. Under this method, the Company assesses both the amount and timing of cash flows expected from impaired loans. The estimated cash flows are discounted using the loan's effective interest rate. The difference between the amount of the loan on the Bank's books and the discounted cash flow amounts determines the amount of impairment to be provided. This method is used for most of the Company’s troubled debt restructurings or other impaired loans where some payment stream is being collected.

-     The observable market price method of measuring the impairment of a loan is only used by the Company when the sale of loans or a loan is in process.
 
The method for recognizing interest income on impaired loans is dependent on whether the loan is on nonaccrual status or is a troubled debt restructure. For income recognition, the existing nonaccrual and troubled debt restructuring policies are applied to impaired loans. Generally, except for certain troubled debt restructurings which are performing under the restructure agreement, the Company does not recognize interest income received on impaired loans, but reduces the carrying amount of the loan for financial reporting purposes.

Loans other than certain homogeneous loan portfolios are reviewed on a quarterly basis for impairment. Impaired loans are written down to estimated realizable values by the establishment of specific reserves for loan utilizing the discounted cash flow method, or charge-offs for collateral-based impaired loans, or those using observable market pricing.
 
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The following is a summary of impaired loans at September 30, 2020 (in 000's).
September 30, 2020 Unpaid
Contractual
Principal Balance 		Recorded
Investment
With No Allowance (1) 		Recorded
Investment
With Allowance (1) 		Total
Recorded Investment 		Related Allowance Average
Recorded Investment (2) 		Interest Recognized (2)
Commercial and business loans $ 273  $ 274  $ —  $ 274  $ —  $ 627  $ 18 
Government program loans 219  220  —  220  —  241  11 
Total commercial and industrial 492  494  —  494  —  868  29 
Commercial real estate loans 2,027  1,148  888  2,036  171  2,058  90 
Residential mortgages 812  446  369  815  16  993  32 
Home improvement and home equity loans —  —  —  —  —  —  — 
Total real estate mortgage 2,839  1,594  1,257  2,851  187  3,051  122 
Real estate construction and development loans 11,058  11,058  —  11,058  —  11,264  210 
Agricultural loans 655  313  343  656  215  692  23 
Installment and student loans —  —  —  —  —  —  — 
Total impaired loans $ 15,044  $ 13,459  $ 1,600  $ 15,059  $ 402  $ 15,875  $ 384 

(1) The recorded investment in loans includes accrued interest receivable of $15.
(2) Information is based on nine months ended September 30, 2020.
    

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The following is a summary of impaired loans at December 31, 2019 (in 000's).
December 31, 2019 Unpaid
Contractual
Principal Balance 		Recorded
Investment
With No Allowance (1) 		Recorded
Investment
With Allowance (1) 		Total
Recorded Investment 		Related Allowance Average
Recorded Investment (2) 		Interest Recognized (2)
Commercial and business loans $ 1,484  $ 368  $ 1,128  $ 1,496  $ 606  $ 1,930  $ 116 
Government program loans 257  258  —  258  —  275  18 
Total commercial and industrial 1,741  626  1,128  1,754  606  2,205  134 
Commercial real estate loans 2,073  1,181  902  2,083  263  2,031  123 
Residential mortgages 1,060  517  546  1,063  20  1,577  56 
Home improvement and home equity loans —  —  —  —  —  —  — 
Total real estate mortgage 3,133  1,698  1,448  3,146  283  3,608  179 
Real estate construction and development loans 11,478  11,478  —  11,478  —  11,572  231 
Agricultural loans 684  262  432  694  256  726  57 
Installment and student loans —  —  —  —  —  14  — 
Total impaired loans $ 17,036  $ 14,064  $ 3,008  $ 17,072  $ 1,145  $ 18,125  $ 601 

(1) The recorded investment in loans includes accrued interest receivable of $36.
(2) Information is based on the year ended December 31, 2019.

In most cases, the Company uses the cash basis method of income recognition for impaired loans. In the case of certain troubled debt restructurings for which the loan is performing under the current contractual terms for a reasonable period of time, income is recognized under the accrual method.

The average recorded investment in impaired loans for the quarters ended September 30, 2020 and 2019 was $15,256,000 and $18,208,000, respectively. Interest income recognized on impaired loans for the quarters ended September 30, 2020 and 2019 was approximately $121,000 and $120,000, respectively. For impaired nonaccrual loans, interest income recognized under a cash-basis method of accounting was approximately $77,000 and $44,000 for the quarters ended September 30, 2020 and 2019, respectively.

The average recorded investment in impaired loans for the nine months ended September 30, 2020 and 2019 was $15,875,000 and $18,390,000, respectively. Interest income recognized on impaired loans for the nine months ended September 30, 2020 and 2019 was approximately $384,000 and $454,000, respectively. For impaired nonaccrual loans, interest income recognized under a cash-basis method of accounting was approximately $225,000 and $173,000 for the nine months ended September 30, 2020 and 2019, respectively.

Troubled Debt Restructurings

In certain circumstances, when the Company grants a concession to a borrower as part of a loan restructuring, the restructuring is accounted for as a troubled debt restructuring (TDR). TDRs are reported as a component of impaired loans.

A TDR is a type of restructuring in which the Company, for economic or legal reasons related to the borrower's financial difficulties, grants a concession (either imposed by court order, law, or agreement between the borrower and the Bank) to the
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borrower that it would not otherwise consider. Although the restructuring may take different forms, the Company's objective is to maximize recovery of its investment by granting relief to the borrower.

A TDR may include, but is not limited to, one or more of the following:

- A transfer from the borrower to the Company of receivables from third parties, real estate, other assets, or an equity interest in the borrower is granted to fully or partially satisfy the loan.

- A modification of terms of a debt such as one or a combination of:

◦The reduction (absolute or contingent) of the stated interest rate.
◦The extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk.
◦The reduction (absolute or contingent) of the face amount or maturity amount of debt as stated in the instrument or agreement.
◦The reduction (absolute or contingent) of accrued interest.
For a restructured loan to return to accrual status there needs to be, among other factors, at least 6 months successful payment history and continued satisfactory performance is expected. To this end, the Company typically performs a financial analysis of the credit to determine whether the borrower has the ability to continue to meet payments over the remaining life of the loan. This includes, but is not limited to, a review of financial statements and cash flow analysis of the borrower. Only after determination that the borrower has the ability to perform under the terms of the loans, will the restructured credit be considered for accrual status. Although the Company does not have a policy which specifically addresses when a loan may be removed from TDR classification, as a matter of practice, loans classified as TDRs generally remain classified as such until the loan either reaches maturity, a confirming loan is renewed at market terms, or its outstanding balance is paid off.

There were no TDR additions or defaults for the quarters ended September 30, 2020 or September 30, 2019. There was one addition during the nine months ended September 30, 2020 and none during the nine months ended September 30, 2019

The following tables illustrates TDR additions and defaults for the periods indicated:
Nine Months Ended September 30, 2020
($ in 000's) Number of
Contracts 		Pre-
Modification
Outstanding
Recorded
Investment 		Post-
Modification
Outstanding
Recorded
Investment 		Number of Contracts which Defaulted During Period Recorded Investment on Defaulted TDRs
Troubled Debt Restructurings
Commercial and business loans —  —  —  $ — 
Government program loans —  —  —  —  — 
Commercial real estate term loans —  —  —  —  — 
Single family residential loans —  —  —  —  — 
Home improvement and home equity loans —  —  —  —  — 
Real estate construction and development loans —  —  —  —  — 
Agricultural loans 1  179  179  —  — 
Installment and student loans —  —  —  —  — 
Overdraft protection lines —  —  —  —  — 
Total loans 1  $ 179  $ 179  —  $ — 

The Company makes various types of concessions when structuring TDRs including rate discounts, payment extensions, and other-than-temporary forbearance. At September 30, 2020, the Company had 9 restructured loans totaling $4,571,000 as compared to 13 restructured loans totaling $5,187,000 at December 31, 2019.

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The following tables summarize TDR activity by loan category for the quarters ended September 30, 2020 and September 30, 2019 (in 000's).
Three Months Ended
September 30, 2020 		Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural Installment
and Student Loans 		Total
Beginning balance $ —  $ 889  $ 1,037  $ —  $ 2,536  $ 693  $ —  $ 5,155 
Additions —  —  —  —  —  —  —  — 
Principal (reductions) additions —  (5) (491) —  (50) (38) —  (584)
Charge-offs —  —  —  —  —  —  —  — 
Ending balance $ —  $ 884  $ 546  $ —  $ 2,486  $ 655  $ —  $ 4,571 
Allowance for loan loss $ —  $ 171  $ 16  $ —  $ —  $ 215  $ —  $ 402 
Defaults $ —  $ —  $ —  $ —  $ —  $ —  $ —  $ — 

Three Months Ended
September 30, 2019 		Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural Installment
and Student Loans 		Total
Beginning balance $ 38  $ 907  $ 1,842  $ —  $ 2,738  $ 658  $ —  $ 6,183 
Additions —  —  —  —  —  —  —  — 
Principal (reductions) additions (18) (5) (771) —  (33) (30) —  (857)
Charge-offs —  —  —  —  —  (30) —  (30)
Ending balance $ 20  $ 902  $ 1,071  $ —  $ 2,705  $ 598  $ —  $ 5,296 
Allowance for loan loss $ —  $ 346  $ 15  $ —  $ —  $ 256  $ —  $ 617 
Defaults $ —  $ —  $ —  $ —  $ —  $ —  $ —  $ — 

The following tables summarize TDR activity by loan category for the nine months ended September 30, 2020 and September 30, 2019 (in 000's).

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Nine Months Ended
September 30, 2020 		Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural Installment
and Student Loans 		Total
Beginning balance $ 9  $ 898  $ 1,060  $ —  $ 2,654  $ 566  $ —  $ 5,187 
Additions —  —  —  —  —  179  —  179 
Principal (reductions) additions (9) (14) (514) —  (168) (90) —  (795)
Charge-offs —  —  —  —  —  —  —  — 
Ending balance $ —  $ 884  $ 546  $ —  $ 2,486  $ 655  $ —  $ 4,571 
Allowance for loan loss $ —  $ 171  $ 16  $ —  $ —  $ 215  $ —  $ 402 
Defaults $ —  $ —  $ —  $ —  $ —  $ —  $ —  $ — 

Nine Months Ended
September 30, 2019 		Commercial and Industrial Commercial Real Estate Residential Mortgages Home Improvement and Home Equity Real Estate Construction Development Agricultural Installment
and Student Loans 		Total
Beginning balance $ 75  $ 1,305  $ 2,029  $ —  $ 2,838  $ 812  $ —  $ 7,059 
Additions —  —  —  —  —  —  —  — 
Principal (reductions) additions (55) (403) (958) —  (133) (184) —  (1,733)
Charge-offs —  —  —  —  (30) —  (30)
Ending balance $ 20  $ 902  $ 1,071  $ —  $ 2,705  $ 598  $ —  $ 5,296 
Allowance for loan loss $ —  $ 346  $ 15  $ —  $ —  $ 256  $ —  $ 617 
Defaults $ —  $ —  $ —  $ —  $ —  $ —  $ —  $ — 

The Company is working with customers directly affected by COVID-19. The Company has offered and continues to be prepared to offer short-term assistance. As of September 30, 2020, the Company had executed 23 payment deferrals or modifications on outstanding loan balances of $69,814,000 in connection with the COVID-19 relief provided by the CARES Act. These deferrals were generally no more than six months in duration and were not considered troubled debt restructurings in accordance with the CARES Act.

The following tables summarize modification under the CARES Act by loan category as of September 30, 2020 (in 000's).
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Loan Category COVID-19 Modified Loan Balance Total Portfolio Balance
Commercial and Industrial: $ 667  $ 65,742 
Commercial Real Estate:
     Hospitality 39,757  53,711 
     Health Club 14,775  14,775 
     Construction and land development 10,836  130,202 
     Commercial/Office/Retail 2,687  101,195 
     Residential Mortgages —  45,722 
     Home improvement and home equity loans —  114 
     All other CRE 1,058  136,019 
Agricultural: —  51,587 
Installment and student loans: 34  62,415 
Total: $ 69,814  $ 661,482 

Credit Quality Indicators

As part of its credit monitoring program, the Company utilizes a risk rating system which quantifies the risk the Company estimates it has assumed during the life of a loan. The system rates the strength of the borrower and the facility or transaction, and is designed to provide a program for risk management and early detection of problems.

For each new credit approval, credit extension, renewal, or modification of existing credit facilities, the Company assigns risk ratings utilizing the rating scale identified in this policy. In addition, on an on-going basis, loans and credit facilities are reviewed for internal and external influences impacting the credit facility that would warrant a change in the risk rating. Each credit facility is to be given a risk rating that takes into account factors that materially affect credit quality.

When assigning risk ratings, the Company evaluates two risk rating approaches, a facility rating and a borrower rating as follows:

Facility Rating:

The facility rating is determined by the analysis of positive and negative factors that may indicate that the quality of a particular loan or credit arrangement requires that it be rated differently from the risk rating assigned to the borrower. The Company assesses the risk impact of these factors:

Collateral - The rating may be affected by the type and quality of the collateral, the degree of coverage, the economic life of the collateral, liquidation value and the Company's ability to dispose of the collateral.

Guarantees - The value of third party support arrangements varies widely. Unconditional guaranties from persons with demonstrable ability to perform are more substantial than that of closely related persons to the borrower who offer only modest support.

Unusual Terms - Credit may be extended on terms that subject the Company to a higher level of risk than indicated in the rating of the borrower.

Borrower Rating:

The borrower rating is a measure of loss possibility based on the historical, current and anticipated financial characteristics of the borrower in the current risk environment. To determine the rating, the Company considers at least the following factors:

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-    Quality of management
-    Liquidity
-    Leverage/capitalization
-    Profit margins/earnings trend
-    Adequacy of financial records
-    Alternative funding sources
-    Geographic risk
-    Industry risk
-    Cash flow risk
-    Accounting practices
-    Asset protection
-    Extraordinary risks

The Company assigns risk ratings to loans other than consumer loans and other homogeneous loan pools based on the following scale. The risk ratings are used when determining borrower ratings as well as facility ratings. When the borrower rating and the facility ratings differ, the lowest rating applied is:

-    Grades 1 and 2 – These grades include loans which are given to high quality borrowers with high credit quality and sound financial strength. Key financial ratios are generally above industry averages and the borrower’s strong earnings history or net worth. These may be secured by deposit accounts or high-grade investment securities.

-    Grade 3 – This grade includes loans to borrowers with solid credit quality with minimal risk. The borrower’s balance sheet and financial ratios are generally in line with industry averages, and the borrower has historically demonstrated the ability to manage economic adversity. Real estate and asset-based loans assigned this risk rating must have characteristics, which place them well above the minimum underwriting requirements for those departments. Asset-based borrowers assigned this rating must exhibit extremely favorable leverage and cash flow characteristics, and consistently demonstrate a high level of unused borrowing capacity.

-    Grades 4 and 5 – These include “pass” grade loans to borrowers of acceptable credit quality and risk. The borrower’s balance sheet and financial ratios may be below industry averages, but above the lowest industry quartile. Leverage is above and liquidity is below industry averages. Inadequacies evident in financial performance and/or management sufficiency are offset by readily available features of support, such as adequate collateral, or good guarantors having the liquid assets and/or cash flow capacity to repay the debt. The borrower may have recognized a loss over three or four years, however recent earnings trends, while perhaps somewhat cyclical, are improving and cash flows are adequate to cover debt service and fixed obligations. Real estate and asset-borrowers fully comply with all underwriting standards and are performing according to projections would be assigned this rating. These also include grade 5 loans which are “leveraged” or on management’s “watch list.” While still considered pass loans (loans given a grade 5), the borrower’s financial condition, cash flow or operations evidence more than average risk and short term weaknesses, these loans warrant a higher than average level of monitoring, supervision and attention from the Company, but do not reflect credit weakness trends that weaken or inadequately protect the Company’s credit position. Loans with a grade rating of 5 are not normally acceptable as new credits unless they are adequately secured or carry substantial endorser/guarantors.

-    Grade 6 – This grade includes “special mention” loans which are loans that are currently protected but are potentially weak. This generally is an interim grade classification and should usually be upgraded to an Acceptable rating or downgraded to Substandard within a reasonable time period. Weaknesses in special mention loans may, if not checked or corrected, weaken the asset or inadequately protect the Company’s credit position at some future date. Special mention loans are often loans with weaknesses inherent from the loan origination, loan servicing, and perhaps some technical deficiencies. The main theme in special mention credits is the distinct probability that the classification will deteriorate to a more adverse class if the noted deficiencies are not addressed by the loan officer or loan management.

-    Grade 7 – This grade includes “substandard” loans which are inadequately supported by the current sound net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans have a well-defined weakness or weaknesses that may impair the regular liquidation of the debt. Substandard loans exhibit a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Substandard loans also include impaired loans.

-    Grade 8 – This grade includes “doubtful” loans which exhibit the same characteristics as the Substandard loans with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing
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facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the loan, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include a proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.

-    Grade 9 – This grade includes loans classified “loss” which are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off the asset even though partial recovery may be achieved in the future.
 
The Company did not carry any loans graded as loss at September 30, 2020 or December 31, 2019.

The following tables summarize the credit risk ratings for commercial, construction, and other non-consumer related loans for September 30, 2020 and December 31, 2019:
September 30, 2020 Commercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural Total
(in 000's)
Grades 1 and 2 $ 26,154  $ 2,754  $ —  $ 30  $ 28,938 
Grade 3 —  735  —  —  735 
Grades 4 and 5 – pass 37,135  251,963  159,833  49,461  498,392 
Grade 6 – special mention 1,945  7,418  998  1,441  11,802 
Grade 7 – substandard 524  1,143  11,058  655  13,380 
Grade 8 – doubtful —  —  —  —  — 
Total $ 65,758  $ 264,013  $ 171,889  $ 51,587  $ 553,247 
December 31, 2019 Commercial and Industrial Commercial Real Estate Real Estate Construction and Development Agricultural Total
(in 000's)
Grades 1 and 2 $ 278  $ 2,806  $ —  $ —  $ 3,084 
Grade 3 —  981  —  —  981 
Grades 4 and 5 – pass 41,757  238,612  126,308  50,234  456,911 
Grade 6 – special mention 919  1,608  998  1,279  4,804 
Grade 7 – substandard 2,324  1,176  11,478  684  15,662 
Grade 8 – doubtful —  —  —  —  — 
Total $ 45,278  $ 245,183  $ 138,784  $ 52,197  $ 481,442 
 
The Company follows consistent underwriting standards outlined in its loan policy for consumer and other homogeneous loans but, does not specifically assign a risk rating when these loans are originated. Consumer loans are monitored for credit risk and are considered “pass” loans until some issue or event requires that the credit be downgraded to special mention or worse. Within the student loan portfolio, the Company does not grade these loan individually, but monitors credit quality indicators such as delinquency and program defined status codes such as forbearance.

The following tables summarize the credit risk ratings for consumer related loans and other homogeneous loans for September 30, 2020 and December 31, 2019:
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  September 30, 2020 December 31, 2019
  Residential Mortgages Home
Improvement and Home Equity 		Installment and Student Loans Total Residential Mortgages Home
Improvement and Home Equity 		Installment and Student Loans Total
(in 000's)
Not graded $ 32,738  $ 98  $ 61,974  $ 94,810  $ 33,059  $ 155  $ 68,752  $ 101,966 
Pass 12,453  16  388  12,857  12,542  18  740  13,300 
Special mention 354  —  —  354  88  —  386  474 
Substandard 177  —  53  230  192  —  —  192 
Doubtful —  —  —  —  —  —  —  — 
Total $ 45,722  $ 114  $ 62,415  $ 108,251  $ 45,881  $ 173  $ 69,878  $ 115,932 

 Allowance for Loan Losses

The Company analyzes risk characteristics inherent in each loan portfolio segment as part of the quarterly review of the adequacy of the allowance for loan losses. The following summarizes some of the key risk characteristics for the ten segments of the loan portfolio (Consumer loans include three segments):

Commercial and industrial loans – Commercial loans are subject to the effects of economic cycles and tend to exhibit increased risk as economic conditions deteriorate, or if the economic downturn is prolonged. The Company considers this segment to be one of higher risk given the size of individual loans and the balances in the overall portfolio.
 
Government program loans – This is a relatively a small part of the Company’s loan portfolio, but has historically had a high percentage of loans that have migrated from pass to substandard given their vulnerability to economic cycles.
 
Commercial real estate loans – This segment is considered to have more risk in part because of the vulnerability of commercial businesses to economic cycles as well as the exposure to fluctuations in real estate prices because most of these loans are secured by real estate. Losses in this segment have however been historically low because most of the loans are real estate secured, and the bank maintains appropriate loan-to-value ratios.
 
Residential mortgages – This segment is considered to have low risk factors both from the Company and peer statistics. These loans are secured by first deeds of trust. The losses experienced over the past sixteen quarters are isolated to approximately three loans and are generally the result of short sales.
 
Home improvement and home equity loans – Because of their junior lien position, these loans have an inherently higher risk level. Because residential real estate has been severely distressed in the recent past, the anticipated risk for this loan segment has increased.
 
Real estate construction and development loans –This segment of loans is considered to have a higher risk profile due to construction and market value issues in conjunction with normal credit risks.
 
Agricultural loans – This segment is considered to have risks associated with weather, insects, and marketing issues. In addition, concentrations in certain crops or certain agricultural areas can increase risk.

Installment and student loans (Includes consumer loans, student loans, overdrafts, and overdraft protection lines) – This segment is higher risk because many of the loans are unsecured. Additionally, in the case of student loans, there are increased risks associated with liquidity as there is a significant time lag between funding of a student loan and eventual repayment.

COVID-19 – As a result of the current economic environment caused by the COVID-19 virus, the Company is engaging in more frequent communication with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. While the Company has not yet experienced any charge-offs related to COVID-19, the allowance for credit loss calculation and resulting provision for credit losses are significantly impacted by changes in economic conditions resulting from significant increase in unemployment. Given that economic scenarios have darkened significantly since the pandemic was declared in early March 2020, the credit risk in the loan portfolio has increased resulting in the need for an additional reserve for credit loss.

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The following summarizes the activity in the allowance for credit losses by loan category for the quarters ended September 30, 2020 and 2019 (in 000's)

Three Months Ended Commercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment and Student Loans  Unallocated Total
September 30, 2020
Beginning balance $ 756  $ 812  $ 3,572  $ 836  $ 2,746  $ 140  $ 8,862 
Provision (reversal of provision) for credit losses (46) (147) 439  (68) (749) 575  4 
Charge-offs —  —  (106) —  (178) —  (284)
Recoveries 9  79  37  —  1  —  126 
Net recoveries (charge-offs) 9  79  (69) —  (177) —  (158)
Ending balance $ 719  $ 744  $ 3,942  $ 768  $ 1,820  $ 715  $ 8,708 
Period-end amount allocated to:              
Loans individually evaluated for impairment —  187  —  215  —  —  402 
Loans collectively evaluated for impairment 719  557  3,942  553  1,820  715  8,306 
Ending balance $ 719  $ 744  $ 3,942  $ 768  $ 1,820  $ 715  $ 8,708 



Three Months Ended Commercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment and Student Loans  Unallocated Total
September 30, 2019
Beginning balance $ 1,457  $ 864  $ 2,330  $ 1,132  $ 1,991  $ 678  $ 8,452 
Provision (recovery of provision) for credit losses (168) (109) (3) (227) 388  124  5 
Charge-offs —  —  —  (36) (263) —  (299)
Recoveries 7  52  —  —  13  —  72 
Net recoveries (charge-offs) 7  52  —  (36) (250) —  (227)
Ending balance $ 1,296  $ 807  $ 2,327  $ 869  $ 2,129  $ 802  $ 8,230 
Period-end amount allocated to:              
Loans individually evaluated for impairment 525  361  —  256  —  —  1,142 
Loans collectively evaluated for impairment 771  446  2,327  613  2,129  802  7,088 
Ending balance $ 1,296  $ 807  $ 2,327  $ 869  $ 2,129  $ 802  $ 8,230 

The following summarizes the activity in the allowance for credit losses by loan category for the nine months ended September 30, 2020 and 2019 (in 000's)

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Nine Months Ended Commercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment and Student Loans  Unallocated Total
September 30, 2020
Beginning balance $ 1,322  $ 712  $ 2,808  $ 761  $ 2,132  $ 173  $ 7,908 
Provision (recovery of provision) for credit losses (625) (56) 1,455  7  815  542  2,138 
Charge-offs —  —  (358) —  (1,134) —  (1,492)
Recoveries 22  88  37  —  7  —  154 
Net recoveries (charge-offs) 22  88  (321) —  (1,127) —  (1,338)
Ending balance $ 719  $ 744  $ 3,942  $ 768  $ 1,820  $ 715  $ 8,708 
Period-end amount allocated to:              
Loans individually evaluated for impairment —  187  —  215  —  —  402 
Loans collectively evaluated for impairment 719  557  3,942  553  1,820  715  8,306 
Ending balance $ 719  $ 744  $ 3,942  $ 768  $ 1,820  $ 715  $ 8,708 
Nine Months Ended Commercial and Industrial Real Estate Mortgage Real Estate Construction Development  Agricultural Installment and Student Loans  Unallocated Total
September 30, 2019
Beginning balance $ 1,673  $ 1,015  $ 2,424  $ 1,131  $ 1,559  $ 593  $ 8,395 
Provision (recovery of provision) for credit losses (441) (263) (97) (226) 833  209  15 
Charge-offs —  (5) —  (36) (377) —  (418)
Recoveries 64  60  —  —  114  —  238 
Net (charge-offs) recoveries 64  55  —  (36) (263) —  (180)
Ending balance $ 1,296  $ 807  $ 2,327  $ 869  $ 2,129  $ 802  $ 8,230 
Period-end amount allocated to:              
Loans individually evaluated for impairment 525  361  —  256  —  —  1,142 
Loans collectively evaluated for impairment 771  446  2,327  613  2,129  802  7,088 
Ending balance $ 1,296  $ 807  $ 2,327  $ 869  $ 2,129  $ 802  $ 8,230 

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The following summarizes information with respect to the loan balances at September 30, 2020 and 2019.
  September 30, 2020 September 30, 2019
Loans
Individually
Evaluated for Impairment 		Loans
Collectively
Evaluated for Impairment 		Total Loans Loans
Individually
Evaluated for Impairment 		Loans
Collectively
Evaluated for Impairment 		Total Loans
(in 000's)
Commercial and business loans $ 274  $ 38,944  $ 39,218  $ 1,652  $ 45,703  $ 47,355 
Government program loans 220  26,304  26,524  266  516  782 
Total commercial and industrial 494  65,248  65,742  1,918  46,219  48,137 
Commercial real estate loans 2,036  261,977  264,013  3,105  221,608  224,713 
Residential mortgage loans 815  44,907  45,722  1,074  49,988  51,062 
Home improvement and home equity loans —  114  114  —  184  184 
Total real estate mortgage 2,851  306,998  309,849  4,179  271,780  275,959 
Real estate construction and development loans 11,058  160,831  171,889  11,529  104,914  116,443 
Agricultural loans 656  50,931  51,587  736  59,364  60,100 
Installment and student loans —  62,415  62,415  —  69,489  69,489 
Total loans $ 15,059  $ 646,423  $ 661,482  $ 18,362  $ 551,766  $ 570,128 
4.Student Loans

Included in installment loans are $58,677,000 and $65,800,000 in student loans at September 30, 2020 and December 31, 2019, respectively, made to medical and pharmacy school students. Upon graduation the loan is automatically placed on deferment for 6 months. This may be extended up to 48 months for graduates enrolling in Internship, Medical Residency or Fellowship. As approved, the student may receive additional deferment for hardship or administrative reasons in the form of forbearance for a maximum of 24 months throughout the life of the loan. Accrued interest on loans that had not entered repayment status totaled $2,940,000 at September 30, 2020 and $4,689,000 at December 31, 2019. At September 30, 2020 there were 818 loans within repayment, deferment, and forbearance which represented $24,322,000, $7,044,000, and $5,174,000, respectively. At December 31, 2019, there were 855 loans within repayment, deferment, and forbearance which represented $24,986,000, $4,392,000 and $10,626,000, respectively. As of September 30, 2020 and December 31, 2019, the reserve against the student loan portfolio was $1,761,000 and $2,091,000, respectively. There were no TDRs within the portfolio as of September 30, 2020 or December 31, 2019. At September 30, 2020 and December 31, 2019, student loans totaling $53,000 were included in the substandard category and $386,000 in the special mention category, respectively.

ZuntaFi (previously known as Reunion Student Loan Finance Corporation (RSLFC)) is the third-party servicer for the student loan portfolio. ZuntaFi's services include application administration, processing, approval, documenting, funding, and collection. They also provide borrower file custodial responsibilities. Except in cases where applicants/loans do not meet program requirements, or extreme delinquency, ZuntaFi is responsible for complete program management. ZuntaFi is paid a monthly servicing fee based on the outstanding principal balance.

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The following tables summarize the credit quality indicators for outstanding student loans as of September 30, 2020 and December 31, 2019 (in 000's, except for number of borrowers):
  September 30, 2020 December 31, 2019
  Number of Loans Amount Accrued Interest Number of Loans Amount Accrued Interest
School 320 $ 12,758  $ 2,940  601  $ 24,198  $ 4,689 
Grace 212  9,379  2,434  49  1,598  394 
Repayment 547  24,322  577  507  24,986  203 
Deferment 162  7,044  445  124  4,392  204 
Forbearance 109  5,174  153  224  10,626  188 
Total 1,350  $ 58,677  $ 6,549  1,505  $ 65,800  $ 5,678 

School - The time in which the borrower is still actively in school at least half time. No payments are expected during this stage, though the borrower may begin immediate payments.

Grace - A six month period of time granted to the borrower immediately upon graduation, or if deemed no longer an active student. Interest continues to accrue. Upon completion of the six month grace period the loan is transferred to repayment status. Additionally, if applicable, this status may represent a borrower activated to military duty while in their in-school period, they will be allowed to return to that status once their active duty has expired. The borrower must return to an at least half time status within six months of the active duty end date in order to return to an in-school status.

Repayment - The time in which the borrower is no longer actively in school at least half time, and has not received an approved grace, deferment, or forbearance. Regular payment is expected from these borrowers under an allotted payment plan.

Deferment - May be granted up to 48 months for borrowers who have begun the repayment period on their loans but are (1) actively enrolled in an eligible school at least half time, or (2) are actively enrolled in an approved and verifiable medical residency, internship, or fellowship program.

Forbearance - The period of time during which the borrower may postpone making principal and interest payments, which may be granted for either hardship or administrative reasons. Interest will continue to accrue on loans during periods of authorized forbearance. If the borrower is delinquent at the time the forbearance is granted, the delinquency will be covered by the forbearance and all accrued and unpaid interest from the date of delinquency or if none, from the date of beginning of the forbearance period, will be capitalized at the end of each forbearance period. The term of the loan will not change and payments may be increased to allow the loan to pay off in the required time frame. A forbearance that results in only an insignificant delay in payment, is not considered a concessionary change in terms, provided the borrower affirms the obligation. Forbearance is not an uncommon status designation, this designation is standard industry practice, and is consistent with the succession of students migrating to employed medical professionals.

Student Loan Aging

Student loans are generally charged off at the end of the month during which an account becomes 120 days contractually past due. Accrued but unpaid interest related to charged off student loans is reversed and charged against interest income. For the three and nine months ended September 30, 2020, $9,000 and $59,000 in accrued interest receivable was reversed, due to charge-offs of $174,000 and $1,121,000, respectively, within the student loan portfolio. For the three and nine months ended September 30, 2019, $13,000 and $20,000 in accrued interest receivable was reversed, due to charge-offs of $235,000 and $338,000, respectively, within the student loan portfolio.
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The following tables summarize the student loan aging for loans in repayment and forbearance as of September 30, 2020 and December 31, 2019 (in 000's, except for number of borrowers):
  September 30, 2020 December 31, 2019
  Number of Borrowers Amount Number of Borrowers Amount
Current or less than 31 days 254  $ 26,755  295  $ 34,277 
31 - 60 days 21  2,259  4  292 
61 - 90 days 5  429  7  657 
91 - 120 days 1  53  6  386 
Total 281  $ 29,496  312  $ 35,612 
5.Deposits

Deposits include the following:
(in 000's) September 30, 2020 December 31, 2019
Noninterest-bearing deposits $ 430,028  $ 311,950 
Interest-bearing deposits:  
NOW and money market accounts 406,706  360,934 
Savings accounts 94,467  80,078 
Time deposits:  
Under $250,000 41,379  44,926 
$250,000 and over 22,203  20,474 
Total interest-bearing deposits 564,755  506,412 
Total deposits $ 994,783  $ 818,362 
 
6.Short-term Borrowings/Other Borrowings

At September 30, 2020, the Company had collateralized lines of credit with the Federal Reserve Bank of San Francisco totaling $341,410,000, as well as Federal Home Loan Bank (FHLB) lines of credit totaling $5,111,000. At September 30, 2020, the Company had an uncollateralized line of credit with Pacific Coast Bankers Bank (PCBB) totaling $10,000,000, a Fed Funds line of $10,000,000 with Union Bank, and a Fed Funds line of $20,000,000 with Zions First National Bank. All lines of credit are on an “as available” basis and can be revoked by the grantor at any time. These lines of credit have interest rates that are generally tied to the Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR. FHLB advances are collateralized by the Company’s stock in the FHLB, investment securities, and certain qualifying mortgage loans.

As of September 30, 2020, $5,582,000 in investment securities at FHLB were pledged as collateral for FHLB advances. Additionally, $519,013,000 in secured and unsecured loans were pledged at September 30, 2020, as collateral for borrowing lines with the Federal Reserve Bank. At September 30, 2020, the Company had no outstanding borrowings.
 
At December 31, 2019, the Company had collateralized lines of credit with the Federal Reserve Bank of San Francisco totaling $313,445,000, as well as Federal Home Loan Bank (“FHLB”) lines of credit totaling $5,815,000. At December 31, 2019, the Company had an uncollateralized line of credit with Pacific Coast Bankers Bank ("PCBB") and Union Bank totaling $10,000,000 each, with a Fed Funds line of $20,000,000 at Zions First National Bank. All lines of credit are on an “as available” basis and can be revoked by the grantor at any time. These lines of credit generally have interest rates tied to the Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR. FHLB advances are collateralized by the Company’s stock in the FHLB, investment securities, and certain qualifying mortgage loans.

As of December 31, 2019, $6,201,000 in investment securities at FHLB were pledged as collateral for FHLB advances. Additionally, $462,937,000 in secured and unsecured loans were pledged at December 31, 2019, as collateral for used and unused borrowing lines with the Federal Reserve Bank. At December 31, 2019, the Company had no outstanding borrowings.
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7.Leases

The Company leases land and premises for its branch banking offices, administration facilities, and ATMs. The initial terms of these leases expire at various dates through 2025. Under the provisions of most of these leases, the Company has the option to extend the leases beyond their original terms at rental rates adjusted for changes reported in certain economic indices or as reflected by market conditions. Lease terms may include options to extend or terminate the lease when it is reasonably certain the Company will exercise that option. As of September 30, 2020, the Company had 12 operating leases and no financing leases.

The components of lease expense were as follows:
Three Months Ended Nine Months Ended
(in 000's) September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019
Operating lease expense $ 191  $ 197  $ 570  $ 575 
Variable lease expense 51  7  169  115 
Total $ 242  $ 204  $ 739  $ 690 
Supplemental balance sheet information related to leases was as follows:
(in 000's) September 30, 2020
Operating cash flows from operating leases $ 571 
ROU assets obtained in exchange for new operating lease liabilities — 
Weighted-average remaining lease term in years for operating leases 5.86
Weighted-average discount rate for operating leases 5.15  %
Maturities of lease liabilities were as follows:
(in 000's) September 30, 2020
2021 $ 682 
2022 661 
2023 666 
2024 562 
2025 371 
Thereafter 556 
Total undiscounted cash flows 3,498 
Less: present value discount (481)
Present value of net future minimum lease payments $ 3,017 

8 Supplemental Cash Flow Disclosures
 
  Nine months ended September 30,
(in 000's) 2020 2019
Cash paid during the period for:    
Interest $ 1,814  $ 3,012 
Income taxes 2,380  4,890 
Noncash investing activities:    
Unrealized gain on unrecognized post retirement costs 60  42 
Unrealized gain on available for sale securities 1,161  317 
Unrealized loss on junior subordinated debentures (779) (1,748)
Cash dividend declared 1,867  1,865 
Adoption of ASU 2016-02: recognition of lease right-of-use (ROU) asset —  3,395 
Adoption of ASU 2016-02: recognition of lease liability —  3,486 
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9.Dividends on Common Stock

On September 22, 2020, the Company’s Board of Directors declared a cash dividend of $0.11 per share on the Company's common stock. The dividend was payable on October 16, 2020, to shareholders of record as of October 6, 2020. Approximately $1,867,000 was transferred from retained earnings to dividends payable to allow for distribution of the dividend to shareholders.

On June 23, 2020, the Company’s Board of Directors declared a cash dividend of $0.11 per share on the Company's common stock. The dividend was payable on July 15, 2020, to shareholders of record as of July 6, 2020. Approximately $1,866,000 was transferred from retained earnings to dividends payable to allow for distribution of the dividend to shareholders.

On March 24, 2020, the Company’s Board of Directors declared a cash dividend of $0.11 per share on the Company's common stock. The dividend was payable on April 15, 2020, to shareholders of record as of April 6, 2020. Approximately $1,867,000 was transferred from retained earnings to dividends payable to allow for distribution of the dividend to shareholders.

During 2017, the Board of Directors authorized the repurchase of up to $3 million of the outstanding common stock of the Company. The timing of the purchases will depend on certain factors, including but not limited to, market conditions and prices, available funds, and alternative uses of capital. The stock repurchase program may be carried out through open-market purchases, block trades, or negotiated private transactions. At this time, no shares have been repurchased.

10.Net Income per Common Share

The following table provides a reconciliation of the numerator and the denominator of the basic EPS computation with the numerator and the denominator of the diluted EPS computation:
  Three months ended September 30, Nine months ended September 30,
2020 2019 2020 2019
Net income (000's, except per share amounts) $ 2,271  $ 4,173  $ 7,038  $ 12,276 
Weighted average shares issued 16,977,239  16,953,744  16,975,648  16,950,474 
Add: dilutive effect of stock options 23,262  36,418  17,532  31,145 
Weighted average shares outstanding adjusted for potential dilution 17,000,501  16,990,162  16,993,180  16,981,619 
Basic earnings per share $ 0.13  $ 0.25  $ 0.41  $ 0.72 
Diluted earnings per share $ 0.13  $ 0.25  $ 0.41  $ 0.72 
Anti-dilutive stock options excluded from earnings per share calculation 75,000  60,000  88,000  60,000 

11.Taxes on Income
 
The Company periodically reviews its tax positions under the accounting standards related to uncertainty in income taxes, which defines the criteria that an individual tax position would have to meet for some or all of the income tax benefit to be recognized in a taxable entity’s financial statements. Under the guidelines, an entity should recognize the financial statement benefit of a tax position if it determines that it is more likely than not that the position will be sustained on examination. The term “more likely than not” means a likelihood of more than 50 percent. In assessing whether the more-likely-than-not criterion is met, the entity should assume that the tax position will be reviewed by the applicable taxing authority and all available information is known to the taxing authority.

The Company periodically evaluates its deferred tax assets to determine whether a valuation allowance is required based upon a determination that some or all of the deferred assets may not be ultimately realized. At September 30, 2020 and December 31, 2019, the Company had no recorded valuation allowance. The Company is no longer subject to IRS examination for years before 2015.
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The Company's policy is to recognize any interest or penalties related to uncertain tax positions in income tax expense. Interest and penalties recognized during the periods ended September 30, 2020 and 2019 were insignificant.

The Company reported a provision for income taxes of $2,800,000 for the nine months ended September 30, 2020 as compared to the $4,989,000 provision reported in the comparable period of 2019. The effective tax rate was 28.46% for the nine months ended September 30, 2020 as compared to 28.90% for the comparable period of 2019.

12.Junior Subordinated Debt/Trust Preferred Securities
 
Effective September 30, 2009 and beginning with the interest payment due October 1, 2009, the Company elected to defer interest payments on the Company's $15.0 million of junior subordinated debentures relating to its trust preferred securities for the allowable five-year period. Interest payments were subsequently resumed at the end of the allowable deferment. In September 2015, the Company redeemed $3.0 million at par value. The contractual principal balance of the Company's debentures relating to its trust preferred securities is $12.0 million as of September 30, 2020. The Company may redeem the junior subordinated debentures at any time at par.

The Company accounts for its junior subordinated debt issued under USB Capital Trust II at fair value. The Company believes the election of fair value accounting for the junior subordinated debentures better reflects the true economic value of the debt instrument on the balance sheet. As of September 30, 2020, the rate paid on the junior subordinated debt issued under USB Capital Trust II is 3-month LIBOR plus 129 basis points, and is adjusted quarterly.
 
At September 30, 2020, the Company performed a fair value measurement analysis on its junior subordinated debt using a cash flow model approach to determine the present value of those cash flows. The cash flow model utilizes the forward 3-month LIBOR curve to estimate future quarterly interest payments due over the life of the debt instrument. These cash flows were discounted at a rate which incorporates a current market rate for similar-term debt instruments, adjusted for additional credit and liquidity risks associated with the junior subordinated debt. We believe the 3.83% discount rate used represents what a market participant would consider under the circumstances based on current market assumptions. At September 30, 2020, the total cumulative gain recorded on the debt is $2,432,000.

The net fair value calculation performed as of September 30, 2020 resulted in a net pretax gain adjustment of $672,000 ($473,000, net of tax) for the nine months ended September 30, 2020 compared to a net pretax loss adjustment of $177,000 ($126,000, net of tax) for the nine months ended September 30, 2019.

For the nine months ended September 30, 2020, the net $672,000 ($473,000, net of tax) fair value gain adjustment was separately presented as a $1,451,000 gain ($1,022,000, net of tax) recognized on the consolidated statements of income, and a $779,000 loss ($549,000, net of tax) associated with the instrument-specific credit risk recognized in other comprehensive income. For the nine months ended September 30, 2019, the net $177,000 ($126,000, net of tax) fair value loss adjustment was separately presented as a $1,571,000 gain ($1,107,000, net of tax) recognized on the consolidated statements of income, and a $1,748,000 loss ($1,233,000, net of tax) associated with the instrument-specific credit risk recognized in other comprehensive income. The Company calculated the change in the discounted cash flows based on updated market credit spreads for the periods ended.

The net fair value calculation performed as of September 30, 2020 resulted in a net pretax loss adjustment of $344,000 ($243,000, net of tax) for the quarter ended September 30, 2020 compared to a net pretax gain adjustment of $159,000 ($112,000, net of tax) for the quarter ended September 30, 2019.

For the quarter ended September 30, 2020, the net $344,000 ($243,000, net of tax) fair value loss adjustment was separately presented as a $18,000 loss ($13,000, net of tax) recognized on the consolidated statements of income, and a $326,000 loss ($230,000, net of tax) associated with the instrument-specific credit risk recognized in other comprehensive income. For the quarter ended September 30, 2019, the net $159,000 ($112,000, net of tax) fair value gain adjustment was separately presented as a $660,000 gain ($465,000, net of tax) recognized on the consolidated statements of income, and a $501,000 loss ($353,000, net of tax) associated with the instrument-specific credit risk recognized in other comprehensive income. The Company calculated the change in the discounted cash flows based on updated market credit spreads for the periods ended.

13.Fair Value Measurements and Disclosure
 
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The following summary disclosures are made in accordance with the guidance provided by ASC Topic 825, Fair Value Measurements and Disclosures, which requires the disclosure of fair value information about both on- and off-balance sheet financial instruments where it is practicable to estimate that value.
 
Generally accepted accounting guidance clarifies the definition of fair value, describes methods used to appropriately measure fair value in accordance with generally accepted accounting principles and expands fair value disclosure requirements. This guidance applies whenever other accounting pronouncements require or permit fair value measurements.

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels (Level 1, Level 2, and Level 3). Level 1 inputs are unadjusted quoted prices in active markets (as defined) for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability, and reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk).
 
The table below is a summary of fair value estimates for financial instruments and the level of the fair value hierarchy within which the fair value measurements are categorized at the periods indicated:
September 30, 2020
(in 000's) Carrying Amount Estimated Fair Value Quoted Prices In Active Markets for Identical Assets Level 1 Significant Other Observable Inputs Level 2 Significant Unobservable Inputs Level 3
Financial Assets:          
Investment securities 91,782  91,782  3,865  87,917  — 
Loans 651,736  645,098  —  —  645,098 
Accrued interest receivable 10,099  10,099  —  10,099  — 
Financial Liabilities:          
Deposits:          
Noninterest-bearing 430,028  430,210  430,210  —  — 
NOW and money market 406,706  406,707  406,707  —  — 
Savings 94,467  94,467  94,467  —  — 
Time deposits 63,582  63,931  —  —  63,931 
Total deposits 994,783  995,315  931,384  —  63,931 
Junior subordinated debt 10,081  10,081  —  —  10,081 
Accrued interest payable 36  36  —  36  — 
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December 31, 2019
(in 000's) Carrying Amount Estimated Fair Value Quoted Prices In Active Markets for Identical Assets Level 1 Significant Other Observable Inputs Level 2 Significant Unobservable Inputs Level 3
Financial Assets:          
Investment securities 80,088  80,088  3,776  76,312  — 
Loans 588,646  581,695  —  —  581,695 
Accrued interest receivable 8,208  8,208  —  8,208  — 
Financial Liabilities:          
Deposits:          
Noninterest-bearing 311,950  311,950  311,950  —  — 
NOW and money market 360,934  360,934  360,934  —  — 
Savings 80,078  80,078  80,078  —  — 
Time deposits 65,400  65,236  —  —  65,236 
Total deposits 818,362  818,198  752,962  —  65,236 
Junior subordinated debt 10,808  10,808  —  —  10,808 
Accrued interest payable 59  59  —  59  — 
 
The Company performs fair value measurements on certain assets and liabilities as the result of the application of current accounting guidelines. Some fair value measurements, such as investment securities and junior subordinated debt are performed on a recurring basis, while others, such as impairment of loans, other real estate owned, goodwill and other intangibles, are performed on a nonrecurring basis.

The Company’s Level 1 financial assets consist of money market funds and highly liquid mutual funds for which fair values are based on quoted market prices. The Company’s Level 2 financial assets include highly liquid debt instruments of U.S. government agencies, collateralized mortgage obligations, and debt obligations of states and political subdivisions, whose fair values are obtained from readily-available pricing sources for the identical or similar underlying security that may, or may not, be actively traded. The Company’s Level 3 financial assets include certain instruments where the assumptions may be made by us or third parties about assumptions that market participants would use in pricing the asset or liability. From time to time, the Company recognizes transfers between Level 1, 2, and 3 when a change in circumstances warrants a transfer. There were no transfers in or out of Level 1 and Level 2 fair value measurements during the nine months ended September 30, 2020.

The following methods and assumptions were used in estimating the fair values of financial instruments measured at fair value on a recurring and non-recurring basis:

Investment Securities – Available for sale and marketable equity securities are valued based upon open-market price quotes obtained from reputable third-party brokers that actively make a market in those securities. Market pricing is based upon specific CUSIP identification for each individual security. To the extent there are observable prices in the market, the mid-point of the bid/ask price is used to determine fair value of individual securities. If that data is not available for the last 30 days, a Level 2-type matrix pricing approach based on comparable securities in the market is utilized. Level 2 pricing may include using a forward spread from the last observable trade or may use a proxy bond like a TBA mortgage to come up with a price for the security being valued. Changes in fair market value are recorded through other comprehensive loss as the securities are available for sale.
 
Impaired Loans - Fair value measurements for collateral dependent impaired loans are performed pursuant to authoritative accounting guidance and are based upon either collateral values supported by third party appraisals and observed market prices. Collateral dependent loans are measured for impairment using the fair value of the collateral. Changes are recorded directly as an adjustment to current earnings.

Other Real Estate Owned - Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell.  Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification.  In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

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Junior Subordinated Debt – The fair value of the junior subordinated debt was determined based upon a discounted cash flows model utilizing observable market rates and credit characteristics for similar debt instruments. In its analysis, the Company used characteristics that market participants generally use, and considered factors specific to (a) the liability, (b) the principal (or most advantageous) market for the liability, and (c) market participants with whom the reporting entity would transact in that market. Cash flows are discounted at a rate which incorporates a current market rate for similar-term debt instruments, adjusted for credit and liquidity risks associated with similar junior subordinated debt and circumstances unique to the Company. The Company believes that the subjective nature of these inputs, and credit concerns in the capital markets and inactivity in the trust preferred markets that have limited the observability of the market spreads, require the junior subordinated debt to be classified as a Level 3 fair value.
 
The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a recurring basis at September 30, 2020 and December 31, 2019:
September 30, 2020 December 31, 2019
Financial Instrument Valuation Technique Unobservable Input Weighted Average Financial Instrument Valuation Technique Unobservable Input Weighted Average
Junior Subordinated Debt Discounted cash flow Market credit risk adjusted spreads 3.83% Junior Subordinated Debt Discounted cash flow Market credit risk adjusted spreads 4.46%
Management believes that the credit risk adjusted spread utilized in the fair value measurement of the junior subordinated debentures carried at fair value is indicative of the nonperformance risk premium a willing market participant would require under current market conditions, that is, the inactive market. Management attributes the change in fair value of the junior subordinated debentures during the period to market changes in the nonperformance expectations and pricing of this type of debt. Generally, an increase in the credit risk adjusted spread and/or a decrease in the three month LIBOR swap curve will result in positive fair value adjustments (and decrease the fair value measurement).  Conversely, a decrease in the credit risk adjusted spread and/or an increase in the three month LIBOR swap curve will result in negative fair value adjustments (and increase the fair value measurement). The decrease in discount rate between the periods ended September 30, 2020 and December 31, 2019 is primarily due to decreases in rates for similar debt instruments.
 
37
The following tables summarize the Company’s assets and liabilities that were measured at fair value on a recurring and non-recurring basis as of September 30, 2020 (in 000’s):
Description of Assets September 30, 2020 Quoted Prices in
Active Markets
for Identical
Assets
(Level 1) 		Significant Other
Observable Inputs
(Level 2) 		Significant
Unobservable
Inputs
(Level 3)
AFS Securities (2):        
U.S. Government agencies $ 34,942  $ —  $ 34,942  $ — 
U.S. Government collateralized mortgage obligations 42,897  —  42,897  — 
Asset-backed securities 3,828  —  3,828  — 
Municipal bonds 1,058  —  1,058  — 
Corporate bond 5,192  —  5,192  — 
Total AFS securities 87,917  —  87,917  — 
Marketable equity securities (2) 3,865  3,865  —  — 
Impaired loans (1):        
RE construction & development 3,332  —  —  3,332 
Total impaired loans 3,332  —  —  3,332 
Other real estate owned (1) 5,018  —  —  5,018 
Total $ 95,114  $ 3,865  $ 87,917  $ 3,332 
Description of Liabilities September 30, 2020 Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1) 		Significant
Other
Observable
Inputs
(Level 2) 		Significant
Unobservable
Inputs
(Level 3)
Junior subordinated debt (2) $ 10,081  —  —  $ 10,081 
Total $ 10,081  —  —  $ 10,081 
(1)Nonrecurring
(2)Recurring

The following table presents quantitative information about Level 3 fair value measurements for the Company's assets measured at fair value on a non-recurring basis at September 30, 2020 (in 000's).
September 30, 2020
Financial Instrument Fair Value Valuation Technique Unobservable Input Adjustment Percentage
Impaired Loans:
RE construction & development $3,332 Fair Value of Collateral Method for Collateral Dependent Loans Adjustment for difference between appraised value and net realizable value 7.02%
Other Real Estate Owned: $5,018 Fair Value of Collateral Method for Collateral Dependent Loans Adjustment for difference between appraised value and net realizable value 13.69%

The following tables summarize the Company’s assets and liabilities that were measured at fair value on a recurring and non-recurring basis as of December 31, 2019 (in 000’s):
38
Description of Assets December 31, 2019 Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1) 		Significant
Other
Observable
Inputs
(Level 2) 		Significant
Unobservable
Inputs
(Level 3)
AFS Securities (2):        
U.S. Government agencies $ 28,699  $ —  $ 28,699  $ — 
U.S. Government collateralized mortgage obligations 47,613  —  47,613  — 
Total AFS securities 76,312  —  76,312  $ — 
Marketable equity securities (2) 3,776  3,776  —  — 
Impaired Loans (1):        
Real estate mortgage 144  —  —  144 
Total impaired loans 144  —  —  144 
Total $ 80,232  $ 3,776  $ 76,312  $ 144 
Description of Liabilities December 31, 2019 Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1) 		Significant
Other
Observable
Inputs
(Level 2) 		Significant
Unobservable
Inputs
(Level 3)
Junior subordinated debt (2) $ 10,808  $ —  $ —  $ 10,808 
Total $ 10,808  $ —  $ —  $ 10,808 
 
(1)Nonrecurring
(2)Recurring

The following table presents quantitative information about Level 3 fair value measurements for the Company's assets measured at fair value on a non-recurring basis at December 31, 2019 (in 000's).
December 31, 2019
Financial Instrument Fair Value Valuation Technique Unobservable Input Adjustment Percentage
Impaired Loans:
Real estate mortgage $144 Fair Value of Collateral Method for Collateral Dependent Loans Adjustment for difference between appraised value and net realizable value 6.00%

The following tables provide a reconciliation of assets and liabilities at fair value using significant unobservable inputs (Level 3) on a recurring basis during the quarters ended September 30, 2020 and 2019 (in 000’s):
39
  Three Months Ended September 30, 2020 Three Months Ended September 30, 2019 Nine Months Ended September 30, 2020 Nine Months Ended September 30, 2019
Reconciliation of Liabilities: Junior
Subordinated
Debt 		Junior
Subordinated
Debt 		Junior
Subordinated
Debt 		Junior
Subordinated
Debt
Beginning balance $ 9,771  $ 10,496  $ 10,808  $ 10,155 
Gross loss (gain) included in earnings 18  (660) (1,451) (1,571)
Gross loss related to changes in instrument specific credit risk 326  502  779  1,748 
Change in accrued interest (34) (8) (55) (2)
Ending balance $ 10,081  $ 10,330  $ 10,081  $ 10,330 
The amount of total loss (gain) for the period included in earnings attributable to the change in unrealized gains or losses relating to liabilities still held at the reporting date $ 18  $ (660) $ (1,451) $ (1,571)
14.Goodwill and Intangible Assets

At September 30, 2020, the Company had goodwill in the amount of $4,488,000 in connection with various business combinations and purchases. This amount was unchanged from the balance of $4,488,000 at December 31, 2019. While goodwill is not amortized, the Company does conduct periodic impairment analysis on goodwill at least annually or more often as conditions require. The Company performed an interim analysis of goodwill impairment, due to the triggering event of the current stock price falling below the Company's calculated book value. During the three and nine months ended September 30, 2020, the Company determined that COVID-19 was a triggering event based on adverse impact on our business and results of operations. At September 30, 2020, the Company completed its qualitative assessment of goodwill and concluded that it is more likely than not that the fair value of the reporting units exceeds the carrying value. However, it is reasonably possible if adverse economic conditions or recent decrease in our stock price and market capitalization as a results of the COVID-19 pandemic were to be deemed sustained in the future rather than temporary, it may significantly affect the fair value of our goodwill and result in impairment charges.

15.Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income, included in shareholders’ equity, are as follows:
September 30, 2020 December 31, 2019
(in 000's) Net unrealized loss on available for sale securities
Unfunded status of the supplemental retirement plans
Net unrealized gain on junior subordinated debentures
Net unrealized loss on available for sale securities
Unfunded status of the supplemental retirement plans
Net unrealized gain on junior subordinated debentures
Beginning balance $ (175) $ (675) $ 218  $ (372) $ (459) $ 1,505 
Current period comprehensive income (loss) 818  43  (549) 197  (216) (1,287)
Ending balance $ 643  $ (632) $ (331) $ (175) $ (675) $ 218 
Accumulated other comprehensive loss $ (320) $ (632)

16.Investment in York Monterey Properties

In the nine months ended September 30, 2020, the Bank wholly-owns an interest in subsidiary York Monterey Properties Inc., organized as a California corporation. The Bank capitalized the subsidiary through a transfer of eight unimproved lots at a historical cost of $5.3 million comprised of approximately 186.97 acres in the York Highlands subdivision of the Monterra Ranch residential development in Monterey County, California ("Properties") together with $250,000 in cash. The Bank transferred the Properties to York Monterey Properties Inc, in order to maintain ownership beyond the ten year regulatory holding period applicable to a national bank. The Bank acquired five of the lots through a non-judicial foreclosure on or about
40
May 29, 2009. In addition, the Bank purchased three of the lots from another bank. The Bank had continuously held the Properties since the date of foreclosure and acquisition. At the time of transfer, the Properties had reached the end of the ten year regulatory holding period limit.

As of September 30, 2020, the Bank's investment in York Monterey Properties Inc. totaled $4,759,000. York Monterey Properties Inc. is included within the consolidated financial statements of the Company, with $4,582,000 of the total investment recognized within the balance of other real estate owned on the consolidated balance sheets.

17.Subsequent Events
 
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.  Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.  Management has reviewed events occurring through the date the consolidated financial statements were issued and have identified no subsequent events requiring disclosure.
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Item 2  - Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Certain matters discussed or incorporated by reference in this Quarterly Report of Form 10-Q are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, but are not limited to, those described in Management’s Discussion and Analysis of Financial Condition and Results of Operations. Such risks and uncertainties include, but are not limited to, the following factors: i) the effects of the COVID-19 pandemic, including the effects of the steps being taken to address the pandemic and their impact on the Company’s market and employees; ii) Severe weather or natural disasters, such as wildfires, earthquakes, drought, or flood; iii) competitive pressures in the banking industry and changes in the regulatory environment; iv) exposure to changes in the interest rate environment and the resulting impact on the Company’s interest rate sensitive assets and liabilities; v) decline in the health of the economy nationally or regionally which could reduce the demand for loans or reduce the value of real estate collateral securing most of the Company’s loans; vi) credit quality deterioration that could cause an increase in the provision for loan losses; vii) Asset/Liability matching risks and liquidity risks; viii) volatility and devaluation in the securities markets, ix) expected cost savings from recent acquisitions are not realized, x) potential impairment of goodwill and other intangible assets, and xi) technology implementation problems and information security breaches. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company. For additional information concerning risks and uncertainties related to the Company and its operations, please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

United Security Bancshares (the “Company” or “Holding Company") is a California corporation incorporated during March of 2001 and is registered with the Board of Governors of the Federal Reserve System as a bank holding company under the Bank Holding Company Act of 1956, as amended. United Security Bank (the “Bank”) is a wholly-owned bank subsidiary of the Company and was formed in 1987. References to the Company are references to United Security Bancshares (including the Bank). References to the Bank are to United Security Bank, while references to the Holding Company are to the parent only, United Security Bancshares. The Company currently has eleven banking branches, which provide financial services in Fresno, Madera, Kern, and Santa Clara counties in the state of California.

Trends Affecting Results of Operations and Financial Position

The Company’s overall operations are impacted by a number of factors, including not only interest rates and margin spreads, which impact the results of operations, but also the composition of the Company’s balance sheet. One of the primary strategic goals of the Company is to maintain a mix of assets that will generate a reasonable rate of return without undue risk, and to finance those assets with a low-cost and stable source of funds. Liquidity and capital resources must also be considered in the planning process to mitigate risk and allow for growth.

Since the Bank primarily conducts banking operations in California’s Central Valley, its operations and cash flows are subject to changes in the economic condition of the Central Valley. Our business results are dependent in large part upon the business activity, population, income levels, deposits and real estate activity in the Central Valley, and declines in economic conditions can have adverse material effects upon the Bank. In addition, the Central Valley remains largely dependent on agriculture. A downturn in agriculture and agricultural related business could indirectly and adversely affect the Company as many borrowers and customers are involved in, or are impacted to some extent, by the agricultural industry. While a great number of our borrowers are not directly involved in agriculture, they would likely be impacted by difficulties in the agricultural industry since many jobs in our market areas are ancillary to the regular production, processing, marketing and sale of agricultural commodities. Beginning in 2011, the state of California recently experienced one of the worst droughts in recorded history. While the drought has subsequently been declared over, it is not possible to quantify the drought's impact on businesses and consumers located in the Company's market areas or to predict adverse economic impacts related to future droughts. In response to the prolonged drought, the California state legislature passed the Sustainable Groundwater Management Act with the purpose to ensure better local and regional management of groundwater use and sustainable groundwater management in California by 2042. The local districts will develop, prepare, and begin implementation of the Groundwater Sustainability Plans as early as 2020. The effect of such plans to Central Valley agriculture, if any, is still unknown.

COVID-19

The COVID-19 pandemic has already impacted the local economy in the Central Valley. Federal, State and local shelter-in-place recommendations were enacted in our markets in March 2020 causing many businesses to close and workers to be furloughed or lose jobs. Essential purpose entities such as medical professionals, food and agricultural businesses, and transportation and logistical businesses were exempted from the closures; however, unemployment rates are increasing in our
42
local market area. As of September 2020, the unemployment rate in Fresno County was 10.4%. Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts may have a material impact on our operations. While it is not possible to know the full universe or extent of these impacts as of the date this filing, we are disclosing potentially material items of which we are aware.

    Financial position and results of operations

Pertaining to the Company's September 30, 2020 financial condition and results of operations, COVID-19 has had an impact on the allowance for credit losses. While the Company has not yet experienced any charge-offs related to COVID-19, its allowance for credit loss calculation and resulting provision for credit losses are significantly impacted by changes in economic conditions resulting from significant increase in unemployment. Given that economic scenarios have darkened significantly since the pandemic was declared in early March, the credit risk in the loan portfolio has increased resulting in the need for an additional reserve for credit loss. Refer to the discussion of the allowance for credit loss in Note 3 of the unaudited financial statements as well as further discussion later on in MD&A. Should economic conditions worsen, the Company could experience further increases in its required allowance for credit loss and record additional provision expense.

The Company's interest income could be reduced due to COVID-19. In keeping with guidance from regulators, the Company is actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. Interest and fees will still accrue to income pursuant to normal GAAP accounting policies. Should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, the Company is unable to project the materiality of such an impact, but recognizes the breadth of the economic impact may affect its borrowers’ ability to repay in future periods.

    Capital and liquidity

As of September 30, 2020, the Company and Bank's capital ratios were in excess of all regulatory requirements. The Company's management team believes that while the Company and Bank have sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by further credit losses. The Company relies on cash on hand as well as dividends from the Bank to service its debt. If the Bank is unable to pay dividends for an extended period of time, the Company may not be able to service its debt.

The Company maintains access to multiple sources of liquidity. If an extended recession caused large numbers of its deposit customers to withdraw their funds, it might become more reliant on volatile or more expensive sources of funding. Wholesale funding markets are available to the Company, but rates for short-term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on net interest margin.

    Asset valuation

Currently, the Company does not expect COVID-19 to affect its ability to account timely for the assets on the balance sheet; however, this could change in future periods. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances such as widening credit spreads, the Company does not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.

The Company's stock closed below book value at the end of the first three quarters of 2020. Management deemed this to be a triggering event to perform a goodwill impairment test. As of September 30, 2020, goodwill was not impaired. COVID-19 could cause a further and sustained decline in the Company's stock price which could cause the Company to re-perform a goodwill impairment test and that could result in an impairment charge being recorded for that period. In the event that all or a portion of goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. At September 30, 2020, the Company had goodwill of $4,488,000, representing approximately 3.8% of equity.

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    Processes, controls and business continuity plan

The Company maintains a Business Continuity Plan to prepare, and respond to unforeseen circumstances, such as, natural disasters and pandemics. Upon the COVID-19 pandemic declaration, the Company invoked its Business Continuity Plan. Shortly after invoking the plan, the Company implemented protocols for team member safety, provided timely communication to team members and customers, established remote work capabilities to isolate certain personnel essential to critical business continuity operations, and initiated strategies for monitoring and responding to local COVID-19 impacts. Due to the nature of their functions, many team members continue to operate from physical Company locations, while effectively employing social distancing standards. The Company's Management Team continues to meet regularly to anticipate and respond to any future COVID-19 interruptions or developments. As of September 30, 2020, the Company does not anticipate significant challenges to its ability to maintain its systems and controls in light of the measures it has taken to prevent the spread of COVID-19. The Company does not currently face any material resource constraint through the implementation of its business continuity plans.

    Lending operations and accommodations to borrowers

In keeping with regulatory guidance to work with borrowers during this unprecedented situation, the Company is executing a payment deferral program for our commercial lending clients that are adversely affected by the pandemic. Depending on the demonstrated need of the client, the Company is deferring either the full loan payment or the principal component of the loan payment for up to six months. As of September 30, 2020, the Company had executed 23 payment deferrals or modifications on outstanding loan balances of $$69,814,000. In accordance with the CARES Act, these short term deferrals are not considered troubled debt restructurings. Loan segment breakout information related to the loan modifications is reported in Note 3- Loans.

With the passage of the Paycheck Protection Program (“PPP”), administered by the SBA, the Company participated in assisting our customers with applications for resources through the program. The PPP program ended on August 8, 2020. PPP loans have a two-year term and earn interest at 1%. The Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of September 30, 2020, there were over 200 approved SBA PPP loans representing $25,889,000 in funding and $1,028,000 in unearned fees.

The Company is working with customers directly affected by COVID-19. The Company is prepared to offer short-term assistance in accordance with regulatory guidelines. As a result of the current economic environment caused by the COVID-19 virus, the Company is engaging in more frequent communication with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. The Company is engaging in more frequent communication with the servicer and individual schools participating in the student loan portfolio to better understand the effects of COVID-19 on students in school or in clinical programs. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.

The Company continually evaluates its strategic business plan as economic and market factors change in its market area. The Company may see a short-term slowdown in new loan originations due to COVID-19. Balance sheet management, enhancing revenue sources, and maintaining market share will continue to be of primary importance during 2020 and beyond.

Results of Operations

On a year-to-date basis, the Company reported net income of $7,038,000 or $0.41 per share ($0.41 diluted), for the nine months ended September 30, 2020, as compared to $12,276,000, or $0.72 per share ($0.72 diluted), for the same period in 2019. The Company’s return on average assets was 0.93% for the nine months ended September 30, 2020, as compared to 1.70% for the nine months ended September 30, 2019. The Company’s return on average equity was 7.93% for the nine months ended September 30, 2020, as compared to 14.50% for the nine months ended September 30, 2019. The decrease in net income is due to the decrease in net interest income, resulting from lower interest rates, and the $2,138,000 provision for the credit losses recognized during the period ended September 30, 2020.

Net Interest Income

The following tables present condensed average balance sheet information, together with interest income and yields earned on average interest earning assets, and interest expense and rates paid on average interest-bearing liabilities for the three and nine month periods ended September 30, 2020 and 2019.

Table 1. Distribution of Average Assets, Liabilities and Shareholders’ Equity:
Interest rates and Interest Differentials
Three Months Ended September 30, 2020 and 2019
44

    2020     2019  
(dollars in thousands) Average Balance Interest Yield/Rate (2) Average Balance Interest Yield/Rate (2)
 
Assets:            
Interest-earning assets:            
Loans (1) $ 656,501  $ 7,563  4.58  % $ 579,035  $ 8,648  5.93  %
Investment securities (3) 94,076  342  1.45  % 71,168  439  2.45  %
Interest-bearing deposits in FRB 248,722  62  0.10  % 240,605  1,330  2.19  %
Total interest-earning assets 999,299  $ 7,967  3.17  % 890,808  $ 10,417  4.64  %
Allowance for credit losses (8,917)     (8,448)    
Noninterest-earning assets:          
Cash and due from banks 32,106      29,105     
Premises and equipment, net 9,399      9,546     
Accrued interest receivable 8,952      9,716     
Other real estate owned 5,204      5,745     
Other assets 42,128      43,490     
Total average assets $ 1,088,171      $ 979,962     
Liabilities and Shareholders' Equity:            
Interest-bearing liabilities:            
NOW accounts $ 131,465  $ 44  0.13  % $ 105,873  $ 39  0.15  %
Money market accounts 265,421  237  0.36  % 268,456  660  0.98  %
Savings accounts 91,164  26  0.11  % 81,363  42  0.20  %
Time deposits 63,747  144  0.90  % 68,745  209  1.21  %
Junior subordinated debentures 9,710  49  2.01  % 10,416  111  4.23  %
Total interest-bearing liabilities 561,507  $ 500  0.35  % 534,853  $ 1,061  0.79  %
Noninterest-bearing liabilities:            
Noninterest-bearing checking 398,282      319,547     
Accrued interest payable 94      203     
Other liabilities 9,595      10,116     
Total liabilities 969,478      864,719     
Total shareholders' equity 118,693      115,243     
Total average liabilities and shareholders' equity $ 1,088,171      $ 979,962     
Interest income as a percentage  of average earning assets     3.17  %     4.64  %
Interest expense as a percentage of average earning assets     0.20  %     0.47  %
Net interest margin     2.97  %     4.17  %

(1)Loan amounts include nonaccrual loans, but the related interest income has been included only if collected for the period prior to the loan being placed on a nonaccrual basis. Loan interest costs includes loan fee income of approximately $45,000 for the three months ended September 30, 2020 and loan fee income of $114,000 for the three months ended September 30, 2019.
(2)Interest income/expense is divided by actual number of days in the period times 366 days (365 days for 2019) in the yield calculation.
(3)Yields on investments securities, aside from marketable equity securities, are calculated based on average amortized cost balances rather than fair value, as changes in fair value are reflected as a component of shareholders' equity.
45

Interest rates and Interest Differentials
Nine Months Ended September 30, 2020 and 2019

    2020     2019  
(dollars in thousands) Average Balance Interest Yield/Rate (2) Average Balance Interest Yield/Rate (2)
 
Assets:            
Interest-earning assets:            
Loans (1) 632,221  $ 23,622  4.99  % $ 575,323  $ 25,733  5.98  %
Investment securities (3) 91,140  1,126  1.65  % 68,254  1,360  2.66  %
Interest-bearing deposits in FRB 203,574  667  0.44  % 231,807  4,052  2.34  %
Total interest-earning assets 926,935  $ 25,415  3.66  % 875,384  $ 31,145  4.76  %
Allowance for credit losses (8,650)     (8,449)    
Noninterest-earning assets:          
Cash and due from banks 29,948      28,898     
Premises and equipment, net 9,434      9,627     
Accrued interest receivable 8,193      9,060     
Other real estate owned 6,033      5,745     
Other assets 44,245      42,425     
Total average assets $ 1,016,138      $ 962,690     
Liabilities and Shareholders' Equity:            
Interest-bearing liabilities:            
NOW accounts $ 120,040  $ 119  0.13  % $ 107,590  $ 115  0.14  %
Money market accounts 253,844  903  0.48  % 254,081  1,731  0.91  %
Savings accounts 86,225  82  0.13  % 88,417  202  0.31  %
Time deposits 63,027  458  0.97  % 73,016  627  1.15  %
Junior subordinated debentures 9,640  229  3.17  % 10,296  352  4.57  %
Total interest-bearing liabilities 532,776  $ 1,791  0.45  % 533,400  $ 3,027  0.76  %
Noninterest-bearing liabilities:            
Noninterest-bearing checking 355,114      306,590     
Accrued interest payable 115      197     
Other liabilities 9,560      9,309     
Total liabilities 897,565      849,496     
Total shareholders' equity 118,573      113,194     
Total average liabilities and shareholders' equity $ 1,016,138      $ 962,690     
Interest income as a percentage  of average earning assets     3.66  %     4.76  %
Interest expense as a percentage of average earning assets     0.26  %     0.46  %
Net interest margin     3.40  %     4.30  %

(1)Loan amounts include nonaccrual loans, but the related interest income has been included only if collected for the period prior to the loan being placed on a nonaccrual basis. Loan interest income includes loan fee income of approximately $134,000 for the nine months ended September 30, 2020 and loan income of $79,000 for the nine months ended September 30, 2019.
46
(2)Interest income/expense is divided by actual number of days in the period times 366 days (365 days for 2019) in the yield calculation.
(3)Yields on investments securities, aside from marketable equity securities, are calculated based on average amortized cost balances rather than fair value, as changes in fair value are reflected as a component of shareholders' equity.

The prime rate decreased from 4.75% at December 31, 2019 to 3.25% during the first quarter of 2020, and remained unchanged through September 30, 2020. Future increases or decreases will affect both interest income and expense and the resultant net interest margin.

Both the Company's net interest income and net interest margin are affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." Both are also affected by changes in yields on interest-earning assets and rates paid on interest-bearing liabilities, referred to as "rate change." The following table sets forth the changes in interest income and interest expense for each major category of interest-earning asset and interest-bearing liability, and the amount of change attributable to volume and rate changes for the periods indicated.

Table 2.  Rate and Volume Analysis

Increase (decrease) for the three months ended September 30, 2020 compared to September 30, 2019
(in 000's) Total Rate Volume
Increase (decrease) in interest income:      
Loans $ (1,085) $ (2,137) $ 1,052 
Investment securities available for sale (96) (211) 115 
Interest-bearing deposits in other banks —  —  — 
Interest-bearing deposits in FRB (1,268) (1,269) 1 
Total interest income (2,449) (3,617) 1,168 
Increase (decrease) in interest expense:
Interest-bearing demand accounts (418) (458) 40 
Savings and money market accounts (16) (21) 5 
Time deposits (65) (51) (14)
Other borrowings —  —  — 
Subordinated debentures (62) (55) (7)
Total interest expense (561) (585) 24 
Increase (decrease) in net interest income $ (1,888) $ (3,032) $ 1,144 

For the three months ended September 30, 2020, total interest income decreased $2,449,000, or 23.51%, as compared to the three months ended September 30, 2019. In comparing the two periods, average interest earning assets increased $108,491,000, with an increase of $77,466,000 in loan balances, an increase of $22,908,000 in investment securities, and an increase of $8,117,000 in balances held at the Federal Reserve Bank. Investment securities yields decreased 100 basis points and loan yields decreased 134 basis points. The average yield on total interest-earning assets decreased 147 basis points. The decrease in yields are a result of repricing of variable rate loans, floating rate investment securities, and interest-bearing deposits in FRB at lower rates. Interest-bearing deposits in FRB are the Company's lowest-yielding interest-earning asset.

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Increase (decrease) for the nine months ended September 30, 2020 compared to September 30, 2019
(in 000's) Total Rate Volume
Increase (decrease) in interest income:      
Loans $ (2,111) $ (4,507) $ 2,396 
Investment securities available for sale (233) (608) 375 
Interest-bearing deposits in other banks —  —  — 
Interest-bearing deposits in FRB (3,385) (3,345) (40)
Total interest income (5,729) (8,460) 2,731 
Increase (decrease) in interest expense:
Interest-bearing demand accounts (824) (884) 60 
Savings and money market accounts (120) (115) (5)
Time deposits (169) (90) (79)
Other borrowings —  —  — 
Subordinated debentures (123) (102) (21)
Total interest expense (1,236) (1,191) (45)
Increase (decrease) in net interest income $ (4,493) $ (7,269) $ 2,776 

For the nine months ended September 30, 2020, total interest income decreased $5,729,000, or 18.39%, as compared to the nine months ended September 30, 2019. In comparing the two periods, average interest earning assets increased $51,551,000, with an increase of $56,898,000 in loan balances and an increase of $22,886,000 in investment securities, offset by a $28,233,000 decrease in balances held at the Federal Reserve Bank. Investment securities yields decreased 101 basis points and loan yields decreased 99 basis points. The average yield on total interest-earning assets decreased 110 basis points. The decreases in yields are a result of repricing of variable rate loans, floating rate investment securities, and interest-bearing deposits in FRB to lower rates. Interest-bearing deposits in FRB are the Company's lowest-yielding interest-earning asset.

The overall average yield on the loan portfolio decreased to 4.99% for the nine months ended September 30, 2020, as compared to 5.98% for the nine months ended September 30, 2019. The Company has sought to mitigate the low-interest rate environment with loan floors included in new and renewed loans when practical. At September 30, 2020, 58.5% of the Company's loan portfolio consisted of floating rate instruments, as compared to 54.2% of the portfolio at December 31, 2019, with the majority of those tied to the prime rate. Approximately 28.7%, or $110,871,000, of the floating rate loans had rate floors at September 30, 2020, making them effectively fixed-rate loans for certain decreases in interest rates. Loan balances totaling $24,510,000 have floor spreads of 100 basis points or more.

The Company’s net interest margin decreased to 3.40% for the nine months ended September 30, 2020, when compared to 4.30% for the nine months ended September 30, 2019. The net interest margin decreased primarily as a result of decreases in the yields on average earnings assets.

The Company’s disciplined deposit pricing efforts have helped keep the Company's cost of funds low. The rates paid on interest-bearing liabilities decreased to 0.45% for the nine months ended September 30, 2020, as compared to 0.76% for the nine months ended September 30, 2019. For the nine months ended September 30, 2020, total interest expense decreased approximately $1,236,000, or 40.83%, as compared to the nine months ended September 30, 2019. Between those two periods, average interest-bearing liabilities decreased by $624,000 due to decreases in savings accounts and time deposits, partially offset by increases in NOW accounts. While the Company may utilize brokered deposits as an additional source of funding, the Company held no brokered deposits at September 30, 2020.

Table 3. Interest-Earning Assets and Liabilities

The following table summarizes the year-to-date averages of the components of interest-earning assets as a percentage of total interest-earning assets and the components of interest-bearing liabilities as a percentage of total interest-bearing liabilities:
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YTD Average
9/30/2020 		YTD Average
12/31/19 		YTD Average
9/30/2019
Loans 68.22% 66.14% 65.73%
Investment securities available for sale 9.83% 8.20% 7.80%
Interest-bearing deposits in FRB 21.95% 25.66% 26.47%
Total interest-earning assets 100.00% 100.00% 100.00%
NOW accounts 22.53% 20.50% 20.17%
Money market accounts 47.65% 47.69% 47.63%
Savings accounts 16.18% 16.31% 16.58%
Time deposits 11.83% 13.55% 13.69%
Subordinated debentures 1.81% 1.95% 1.93%
Total interest-bearing liabilities 100.00% 100.00% 100.00%

Noninterest Income

Table 4. Changes in Noninterest Income

The following tables sets forth the amount and percentage changes in the categories presented for the three and nine month periods ended September 30, 2020 and 2019:

 
     (in 000's) 		Three Months Ended September 30, 2020 Three Months Ended September 30, 2019 Amount of
Change 		Percent
 Change
Customer service fees $ 668  839  $ (171) (20.38) %
Increase in cash surrender value of bank-owned life insurance 124  147  (23) (15.65) %
Unrealized gain on fair value of marketable equity securities 4  18  (14) (77.78) %
(Loss) gain on fair value of junior subordinated debentures (18) 660  (678) (102.73) %
Loss on dissolution of real estate investment trust —  (1) 1  (100.00) %
Loss on sale of assets —  (5) 5  (100.00) %
Other 133  195  (62) (31.79) %
Total noninterest income $ 911  $ 1,853  $ (942) (50.84) %

Noninterest income for the quarter ended September 30, 2020 decreased $942,000 to $911,000, compared to the quarter ended September 30, 2019. The decrease is mostly attributed to a decrease in the recorded fair value of junior subordinated debentures of $678,000 for the quarter ended September 30, 2020. The change in fair value of junior subordinated debentures recorded in non-interest income was caused by fluctuations in the LIBOR yield curve.

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     (in 000's) 		Nine Months Ended September 30, 2020 Nine Months Ended September 30, 2019 Amount of
Change 		Percent
 Change
Customer service fees $ 2,014  2,479  $ (465) (18.76) %
Increase in cash surrender value of bank-owned life insurance 382  438  (56) (12.79) %
Unrealized gain on fair value of marketable equity securities 89  128  (39) (30.47) %
Gain on death benefit proceeds from bank-owned life insurance 310 —  310  100.00  %
Gain on fair value of junior subordinated debentures 1,451  1,571  (120) (7.64) %
Loss on dissolution of real estate investment trust —  (115) 115  (100.00) %
Gain on sale of assets —  1  (1) (100.00) %
Other 460  603  (143) (23.71) %
Total noninterest income $ 4,706  $ 5,105  $ (399) (7.82) %

Noninterest income for the nine months ended September 30, 2020 decreased $399,000 to $4,706,000, compared to the nine months ended September 30, 2019. The decrease is mostly attributed to a decrease of $465,000 in customer service fees and a decrease of $120,000 in the recorded fair value of junior subordinated debentures for the nine months ended September 30, 2020. The change in fair value of junior subordinated debentures recorded in non-interest income was caused by fluctuations in the LIBOR yield curve. The decrease in customer service fees is the result of lower fees and surcharges related to insufficient funds and electronic transfers.

Noninterest Expense

Table 5. Changes in Noninterest Expense

The following tables sets forth the amount and percentage changes in the categories presented for the three and nine month periods ended September 30, 2020 and 2019:
 
     (in 000's) 		Three Months Ended September 30, 2020 Three Months Ended September 30, 2019 Amount of
Change 		Percent
 Change
Salaries and employee benefits $ 2,722  $ 2,775  $ (53) (1.91) %
Occupancy expense 887  829  58  7.00  %
Data processing 139  151  (12) (7.95) %
Professional fees 724  864  (140) (16.20) %
Regulatory assessments 121  (37) 158  (427.03) %
Director fees 94  95  (1) (1.05) %
Correspondent bank service charges 19  14  5  35.71  %
Net cost on operation of OREO 35  71  (36) (50.70) %
Other 469  573  (104) (18.15) %
Total expense $ 5,210  $ 5,335  $ (125) (2.34) %

Noninterest expense for the quarter ended September 30, 2020 decreased $125,000 to $5,210,000, compared to the quarter ended September 30, 2019. The decrease was attributed to decreases in professional fees and salaries and employee benefits, partially offset by an increase in occupancy expense. The decrease in salary and employee benefits expense is the result of reduced hours for various employees throughout the Company as a result of reduced branch hours. Branch hours were reduced in response to the COVID-19 pandemic. The decrease in professional fees for the quarter ended September 30, 2020 was related to decreases in legal fees compared to the quarter ended September 30, 2019.


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     (in 000's) 		Nine Months Ended September 30, 2020 Nine Months Ended September 30, 2019 Amount of
Change 		Percent
 Change
Salaries and employee benefits $ 8,131  $ 8,307  $ (176) (2.12) %
Occupancy expense 2,609  2,450  159  6.49  %
Data processing 386  402  (16) (3.98) %
Professional fees 1,981  2,423  (442) (18.24) %
Regulatory assessments 283  138  145  105.07  %
Director fees 282  281  1  0.36  %
Correspondent bank service charges 52  42  10  23.81  %
Net cost on operation of OREO 968  223  745  334.08  %
Other 1,663  1,677  (14) (0.83) %
Total expense $ 16,355  $ 15,943  $ 412  2.58  %

Noninterest expense for the nine months ended September 30, 2020 increased $412,000 to $16,355,000, compared to the nine months ended September 30, 2019. The increase was attributed to increases in net OREO costs and occupancy expense, partially offset by decreases in salaries and employee benefits and professional fees. The decrease in professional fees for the nine months ended September 30, 2020 was related to decreases in legal fees and consulting expense. Net cost on operation of OREO for the nine months ended September 30, 2020 includes a $727,000 write-down on OREO.

Income Taxes

The Company’s income tax expense is impacted to some degree by permanent taxable differences between income reported for book purposes and income reported for tax purposes, as well as certain tax credits which are not reflected in the Company’s pretax income or loss shown in the statements of operations and comprehensive income. As pretax income or loss amounts become smaller, the impact of these differences become more significant and are reflected as variances in the Company’s effective tax rate for the periods presented. In general, the permanent differences and tax credits affecting tax expense have a positive impact and tend to reduce the effective tax rates shown in the Company’s statements of income and comprehensive income.

The Company reviews its current tax positions at least quarterly based on the accounting standards related to uncertainty in income taxes which includes the criteria that an individual tax position would have to meet for some or all of the income tax benefit to be recognized in a taxable entity’s financial statements. Under the income tax guidelines, an entity should recognize the financial statement benefit of a tax position if it determines that it is more likely than not that the position will be sustained on examination. The term “more likely than not” means a likelihood of more than 50 percent. In assessing whether the more-likely-than-not criterion is met, the entity should assume that the tax position will be reviewed by the applicable taxing authority.
 
The Company has reviewed all of its tax positions as of September 30, 2020, and has determined that, there are no material amounts to be recorded under the current income tax accounting guidelines.

The Company's effective tax rate for the nine months ended September 30, 2020 was 28.46% compared to 28.90% for the nine months ended September 30, 2019.

Financial Condition

Total assets increased $177,028,000, or 18.50%, to a balance of $1,133,947,000 at September 30, 2020, from the balance of $956,919,000 at December 31, 2019, and increased $176,549,000, or 18.44%, from the balance of $957,398,000 at September 30, 2019. Total deposits of $994,783,000 at September 30, 2020, increased $176,421,000, or 21.56%, from the balance reported at December 31, 2019, and increased $174,560,000, or 21.28%, from the balance of $820,223,000 reported at September 30, 2019. Cash and cash equivalents increased $104,337,000, or 47.64%, between December 31, 2019 and September 30, 2020. Net loans increased $63,090,000, or 10.72%, to a balance of $651,736,000, and investment securities increased $11,694,000, or 14.60%, during the first nine months of 2020.

Earning assets averaged approximately $926,935,000 during the nine months ended September 30, 2020, as compared to $875,384,000 for the same period in 2019. Average interest-bearing liabilities decreased to $532,776,000 for the nine months ended September 30, 2020, from $533,400,000 reported for the comparative period of 2019.
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Loans

The Company's primary business is that of acquiring deposits and making loans, with the loan portfolio representing the largest and most important component of earning assets. Loans totaled $661,482,000 at September 30, 2020, an increase of $64,108,000, or 10.73%, when compared to the balance of $597,374,000 at December 31, 2019, and an increase of $91,354,000, or 13.81%, when compared to the balance of $570,128,000 reported at September 30, 2019. Loans on average increased $56,898,000, or 9.89%, between the nine months ended September 30, 2019 and September 30, 2020, with loans averaging $632,221,000 for the nine months ended September 30, 2020, as compared to $575,323,000 for the same period of 2019.

Table 6. Loans

The following table sets forth the amounts of loans outstanding by category at September 30, 2020 and December 31, 2019, the category percentages as of those dates, and the net change between the two periods presented.
 
  September 30, 2020 December 31, 2019    
(in 000's) Dollar Amount % of Loans Dollar Amount % of Loans Net Change % Change
Commercial and industrial $ 65,742  10.0  % $ 45,278  7.6  % $ 20,464  45.20  %
Real estate – mortgage 309,849  46.8  % 291,237  48.8  % 18,612  6.39  %
RE construction & development 171,889  26.0  % 138,784  23.2  % 33,105  23.85  %
Agricultural 51,587  7.8  % 52,197  8.7  % (610) (1.17) %
Installment and student loans 62,415  9.4  % 69,878  11.7  % (7,463) (10.68) %
Total gross loans $ 661,482  100.00  % $ 597,374  100.00  % $ 64,108  10.73  %

During the nine months ended September 30, 2020, the Company experienced increases in commercial and industrial loans, real estate mortgage loans, and real estate construction and development loans compared to the same period ended September 30, 2019. Commercial and industrial loans increased $20,464,000 between December 31, 2019 and September 30, 2020 and increased $17,605,000 between September 30, 2019 and September 30, 2020. Included in commercial and industrial loans as of September 30, 2020 are $25,889,000 in SBA PPP loans. Real estate mortgage loans increased $18,612,000 between December 31, 2019 and September 30, 2020 and increased $33,890,000 between September 30, 2019 and September 30, 2020. The real estate mortgage loan balance as of September 30, 2020 includes $22,143,000 in multifamily and $7,613,000 in residential adjustable rate mortgages purchased during 2020. Agricultural loans decreased $610,000 between December 31, 2019 and September 30, 2020 and decreased $8,513,000 between September 30, 2019 and September 30, 2020. Installment and student loans decreased $7,463,000 between December 31, 2019 and September 30, 2020 and decreased $7,074,000 between September 30, 2019 and September 30, 2020, primarily due to decreases in student loan balances.

Installment and student loans decreased $7,074,000 during the nine months ended September 30, 2020 as compared to the same period ended September 30, 2019, due to decreases in the student loan portfolio. Included in installment loans are $58,677,000 in student loans made to medical and pharmacy school students. The student loan portfolio consists of unsecured loans to medical and pharmacy students enrolled in medical and pharmacy schools in the US and the Caribbean. The medical student loans are made to US citizens attending medical schools in the US and Antigua, while the pharmacy student loans are made to pharmacy students attending pharmacy school in the US. Upon graduation the loan is automatically placed on deferment for six months. This may be extended up to 48 months for graduates enrolling in internship, medical residency or fellowship. If approved, the student may receive additional deferment for hardship or administrative reasons in the form of a forbearance for a maximum of 24 months throughout the life of the loan. The outstanding balance of student loans that have not entered repayment status totaled $22,137,000 at September 30, 2020. Accrued interest on loans that have not entered repayment status totaled $5,972,000 at September 30, 2020. At September 30, 2020 there were 818 loans within repayment, deferment, and forbearance which represented $24,322,000, $7,044,000, and $5,174,000 in outstanding balances, respectively. Underwriting is premised on qualifying credit scores. The weighted average credit score for the portfolio is in the mid-700s. In addition, there are non-student co-borrowers for roughly one-third of the portfolio that provide additional repayment capacity. Graduation and employment placement rates are high for both medical and pharmacy students. The average student loan balance per borrower as of September 30, 2020 is approximately $96,000. Loan interest rates range from 2.875 to 7.875.

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The Company classifies student loans delinquent more than 90 days as substandard. As of September 30, 2020 and December 31, 2019 reserves against the student loan portfolio totaled $1,761,000 and $2,091,000, respectively. There were no TDRs within the portfolio as of September 30, 2020 or December 31, 2019. During the nine months ended September 30, 2020, $59,000 in accrued interest receivable was reversed, due to charge-offs of $1,121,000 within the student loan portfolio.
ZuntaFi (previously known as Reunion Student Loan Finance Corporation (RSLFC)) is the third-party servicer for the student loan portfolio. ZuntaFi's services include application administration, processing, approval, documenting, funding, and collection. They also provide borrower file custodial responsibilities. Except in cases where applicants/loans do not meet program requirements, or extreme delinquency, ZuntaFi is responsible for complete program management. ZuntaFi is paid a monthly servicing fee based on the outstanding principal balance.
Commercial real estate loans (a component of real estate mortgage loans) continue to represent a significant portion of the total loan portfolio. Commercial real estate loans amounted to 39.91%, 41.04%, and 39.41%, of the total loan portfolio at September 30, 2020, December 31, 2019, and September 30, 2019, respectively. Real estate mortgage loans increased $18,612,000, or 6.39%, between December 31, 2019 and September 30, 2020, and increased $33,890,000 between September 30, 2019 and September 30, 2020. Residential mortgage loans are not generally originated by the Company, but some residential mortgage loans have been made over the past several years to facilitate take-out loans for construction borrowers who were unable to obtain permanent financing elsewhere. These loans are generally 30-year amortizing loans with maturities of between three and five years. Residential mortgages totaled $45,722,000, or 6.91%, of the portfolio at September 30, 2020, $45,881,000, or 7.68% of the portfolio at December 31, 2019, and $51,062,000 or 8.96% of the portfolio at September 30, 2019. Loan participations purchased decreased to $5,936,000, or 0.90% of the portfolio, at September 30, 2020. The Company held no loan participation purchases at September 30, 2019. Loan participations sold decreased from $7,140,000, or 1.3%, of the portfolio at September 30, 2019, to $4,866,000, or 0.8%, of the portfolio, at December 31, 2019, and remained the same at $4,866,000, or 0.7%, of the portfolio, at September 30, 2020.

Deposits

Deposit balances totaled $994,783,000 at September 30, 2020, representing an increase of $176,421,000, or 21.56%, from the balance of $818,362,000 reported at December 31, 2019, and an increase of $174,560,000, or 21.28%, from the balance of $820,223,000 reported at September 30, 2019.

Table 7. Deposits

The following table sets forth the amounts of deposits outstanding by category at September 30, 2020 and December 31, 2019, and the net change between the two periods presented.
(in 000's) September 30, 2020 December 31, 2019 Net
Change 		Percentage
Change
Noninterest-bearing deposits $ 430,028  $ 311,950  $ 118,078  37.85  %
Interest-bearing deposits:        
NOW and money market accounts 406,706  360,934  45,772  12.68  %
Savings accounts 94,467  80,078  14,389  17.97  %
Time deposits:        
Under $250,000 41,379  44,926  (3,547) (7.90) %
$250,000 and over 22,203  20,474  1,729  8.44  %
Total interest-bearing deposits 564,755  506,412  58,343  11.52  %
Total deposits $ 994,783  $ 818,362  $ 176,421  21.56  %

The Company's deposit base consists of two major components represented by noninterest-bearing (demand) deposits and interest-bearing deposits, totaling $430,028,000 and $564,755,000 at September 30, 2020, respectively. Interest-bearing deposits consist of time certificates, NOW and money market accounts, and savings deposits. Total interest-bearing deposits increased $58,343,000, or 11.52%, between December 31, 2019 and September 30, 2020, and noninterest-bearing deposits increased $118,078,000, or 37.85%, between the same two periods presented. Included in the increase of $58,343,000 in interest-bearing deposits during the nine months ended September 30, 2020, are increases of $14,389,000 in savings accounts and $45,772,000 in NOW and money market accounts, partially offset by decreases of $1,818,000 in time deposits,

Core deposits, as defined by the Company as consisting of all deposits other than time deposits of more than $250,000 and brokered deposits, continue to provide the foundation for the Company's principal sources of funding and liquidity. These core
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deposits amounted to 97.77% and 97.50% of total deposits at September 30, 2020 and December 31, 2019, respectively. The Company held no brokered deposits at September 30, 2020 and December 31, 2019.

On a year-to-date average, the Company experienced an increase of $48,556,000, or 5.85%, in total deposits between the nine months ended September 30, 2020 and the nine months ended September 30, 2019. Between these two periods, interest-bearing deposits increased $32,000, or 0.01%, and noninterest-bearing deposits increased $48,524,000, or 15.83%, on a year-to-date average basis.

Short-Term Borrowings

At September 30, 2020, the Company had collateralized lines of credit with the Federal Reserve Bank of San Francisco totaling $341,410,000, as well as Federal Home Loan Bank (FHLB) lines of credit totaling $5,111,000. At September 30, 2020, the Company had uncollateralized lines of credit with both Pacific Coast Bankers Bank (PCBB), Union Bank, and Zion's Bank, totaling $10,000,000, $10,000,000, and $20,000,000, respectively. These lines of credit generally have interest rates tied to either the Federal Funds rate, short-term U.S. Treasury rates, or LIBOR. All lines of credit are on an “as available” basis and can be revoked by the grantor at any time. At September 30, 2020 and September 30, 2019, the Company had no outstanding borrowings. The Company had collateralized FRB lines of credit of $313,445,000, collateralized FHLB lines of credit totaling $5,815,000, and uncollateralized lines of credit of $10,000,000 with PCBB, $10,000,000 with Union Bank, and $20,000,000 with Zions Bank at December 31, 2019.

Asset Quality and Allowance for Credit Losses

Lending money is the Company's principal business activity, and ensuring appropriate evaluation, diversification, and control of credit risks is a primary management responsibility. Losses are implicit in lending activities and the amount of such losses will vary, depending on the risk characteristics of the loan portfolio as affected by local economic conditions and the financial experience of borrowers.

The allowance for credit losses is maintained at a level deemed appropriate by management to provide for known and inherent risks in existing loans and commitments to extend credit. The adequacy of the allowance for credit losses is based upon management's continuing assessment of various factors affecting the collectability of loans and commitments to extend credit; including current economic conditions, past credit experience, collateral, and concentrations of credit. There is no precise method of predicting specific losses or amounts which may ultimately be charged off on particular segments of the loan portfolio. The conclusion that a loan may become uncollectible, either in part or in whole is subjective and contingent upon economic, environmental, and other conditions which cannot be predicted with certainty. When determining the adequacy of the allowance for credit losses, the Company follows, in accordance with GAAP, the guidelines set forth in the Revised Interagency Policy Statement on the Allowance for Loan and Lease Losses (Statement) issued by banking regulators in December 2006. The Statement is a revision of the previous guidance released in July 2001, and outlines characteristics that should be used in segmentation of the loan portfolio for purposes of the analysis including risk classification, past due status, type of loan, industry or collateral. It also outlines factors to consider when adjusting the loss factors for various segments of the loan portfolio, and updates previous guidance that describes the responsibilities of the board of directors, management, and bank examiners regarding the allowance for credit losses. Securities and Exchange Commission Staff Accounting Bulletin No. 102 was released during July 2001, and represents the SEC staff’s view relating to the incurred loss methodologies and supporting documentation for the Allowance for Loan and Lease Losses that should be observed by all public companies in complying with the federal securities laws and the Commission’s interpretations.  It is also generally consistent with the guidance published by the banking regulators.

The allowance for loan losses includes an asset-specific component, as well as a general or formula-based component. The Company segments the loan and lease portfolio into eleven (11) segments, primarily by loan class and type, that have homogeneity and commonality of purpose and terms for analysis under the formula-based component of the allowance. Those loans which are determined to be impaired under current accounting guidelines are not subject to the formula-based reserve analysis, and evaluated individually for specific impairment under the asset-specific component of the allowance.

The Company’s methodology for assessing the adequacy of the allowance for credit losses consists of several key elements, which include:

•The formula allowance
•Specific allowances for problem graded loans identified as impaired; and
•The unallocated allowance

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The formula allowance is calculated by applying loss factors to outstanding loans and certain unfunded loan commitments. Loss factors are based on the Company’s historical loss experience and on the internal risk grade of those loans, and may be adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the evaluation date. Factors that may affect collectability of the loan portfolio include:
 
•Levels of, and trends in delinquencies and nonaccrual loans;
•Trends in volumes and term of loans;
•Effects of any changes in lending policies and procedures including those for underwriting, collection, charge-off, and recovery;
•Experience, ability, and depth of lending management and staff;
•National and local economic trends and conditions and;
•Concentrations of credit that might affect loss experience across one or more components of the portfolio, including high-balance loan concentrations and participations.

Management determines the loss factors for problem graded loans (substandard, doubtful, and loss), special mention loans, and pass graded loans, based on a loss migration model. The migration analysis incorporates loan losses over the previous quarters as determined by management (time horizons adjusted as business cycles or environment changes) and loss factors are adjusted to recognize and quantify the loss exposure from changes in market conditions and trends in the Company’s loan portfolio. For purposes of this analysis, loans are grouped by internal risk classifications and categorized as pass, special mention, substandard, doubtful, or loss. Certain loans are homogeneous in nature and are therefore pooled by risk grade. These homogeneous loans include consumer installment and home equity loans. Special mention loans are currently performing but are potentially weak, as the borrower has begun to exhibit deteriorating trends which, if not corrected, could jeopardize repayment of the loan and result in further downgrades. Substandard loans have well-defined weaknesses which, if not corrected, could jeopardize the full satisfaction of the debt. A loan classified as doubtful has critical weaknesses that make full collection of the obligation improbable. Classified loans, as defined by the Company, include impaired loans and loans categorized as substandard, doubtful, and loss which are not considered impaired. At September 30, 2020, impaired and classified loans totaled $15,076,000, or 2.3%, of gross loans as compared to $17,664,000, or 3.2%, of gross loans at December 31, 2019.

The student loan portfolio is reviewed for allowance adequacy under the same guidelines as other loans in the Company's portfolio, with additional emphasis for specific risks associated with the portfolio. In general, the Company provides an additional reserve for a percentage of loans in forbearance and loans rated special mention.

Loan participations are reviewed for allowance adequacy under the same guidelines as other loans in the Company’s portfolio, with an additional participation factor added, if required, for specific risks associated with participations. In general, participations are subject to certain thresholds set by the Company, and are reviewed for geographic location as well as the well-being of the underlying agent bank.

Specific allowances are established based on management’s periodic evaluation of loss exposure inherent in impaired loans. For impaired loans, specific allowances are determined based on the net realizable value of the underlying collateral, the net present value of the anticipated cash flows, or the market value of the underlying assets. Formula allowances for classified loans, excluding impaired loans, are determined on the basis of additional risks involved with individual loans that may be in excess of risk factors associated with the loan portfolio as a whole. The specific allowance is different from the formula allowance in that the specific allowance is determined on a loan-by-loan basis based on risk factors directly related to a particular loan, as opposed to the formula allowance which is determined for a pool of loans with similar risk characteristics, based on past historical trends and other risk factors which may be relevant on an ongoing basis.

The unallocated portion of the allowance is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The conditions may include, but are not limited to, general economic and business conditions affecting the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentrations, and other business conditions.

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Table 8. Allowance for Loan Losses

The following table summarizes the specific allowance, formula allowance, and unallocated allowance at September 30, 2020 and December 31, 2019, as well as classified loans at those period-ends.
(in 000's) September 30, 2020 December 31, 2019
Specific allowance – impaired loans $ 402  $ 1,145 
Formula allowance – classified loans not impaired 7  59 
Formula allowance – special mention loans 318  355 
Total allowance for special mention and classified loans 727  1,559 
Formula allowance for pass loans 7,266  6,176 
Unallocated allowance 715  173 
Total allowance for loan losses $ 8,708  $ 7,908 
Impaired loans 15,059  17,072 
Classified loans not considered impaired 17  592 
Total classified loans / impaired loans $ 15,076  $ 17,664 
Special mention loans not considered impaired $ 11,890  $ 5,846 

Impaired loans decreased $2,013,000 between December 31, 2019 and September 30, 2020, and the specific allowance related to impaired loans decreased $743,000 between December 31, 2019 and September 30, 2020. The decrease in impaired loans is primarily due to a decrease in non-performing loans. The formula allowance related to classified and special mention unimpaired loans decreased by $89,000 between December 31, 2019 and September 30, 2020. The unallocated allowance increased from $173,000 at December 31, 2019 to $715,000 at September 30, 2020. There has been an increase in the required loss reserves as economic conditions have destabilized due to COVID-19. The Company has a concentration in loans to finance CRE, construction and land development activities not secured by real estate. These loans have inherently higher risk characteristics and management believes maintaining additional, unallocated reserves to address the losses inherent in these loans is reasonable and appropriate. The level of “pass” loans increased approximately $59,490,000 between December 31, 2019 and September 30, 2020. The related formula allowance increased $1,090,000 during the same period. The formula allowance for “pass loans” is derived from the loan loss factors under migration analysis.

The Company’s methodology includes features that are intended to reduce the difference between estimated and actual losses. The specific allowance portion of the analysis is designed to be self-correcting by taking into account the current loan loss experience based on that portion of the portfolio. By analyzing the estimated losses inherent in the loan portfolio on a quarterly basis, management is able to adjust specific and inherent loss estimates using the most recent information available. In performing the periodic migration analysis, management believes that historical loss factors used in the computation of the formula allowance need to be adjusted to reflect current changes in market conditions and trends in the Company’s loan portfolio. There are a number of other factors which are reviewed when determining adjustments in the historical loss factors. Those factors include: 1) trends in delinquent and nonaccrual loans, 2) trends in loan volume and terms, 3) effects of changes in lending policies, 4) concentrations of credit, 5) competition, 6) national and local economic trends and conditions, 7) experience of lending staff, 8) loan review and Board of Directors oversight, 9) high balance loan concentrations, and 10) other business conditions.

The general reserve requirements (ASC 450-70) decreased with the continued strengthening of local, state, and national economies and their impact on our local lending base, which has resulted in a lower qualitative component for the general reserve calculation. Our stake-in-the-ground methodology requires the Company to use December 31, 2005 as the starting point of the look back period to capture loss history and better capture an entire economic cycle. Time horizons are subject to Management's assessment of the current period, taking into consideration changes in business cycles and environment changes.

Management and the Company’s lending officers evaluate the loss exposure of classified and impaired loans on a weekly/monthly basis. The Company’s Loan Committee meets weekly and serves as a forum to discuss specific problem assets that pose significant concerns to the Company, and to keep the Board of Directors informed through committee minutes. All special mention and classified loans are reported quarterly on Problem Asset Reports and Impaired Loan Reports and are reviewed by
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senior management. Migration analysis and impaired loan analysis are performed on a quarterly basis and adjustments are made to the allowance as deemed necessary. The Board of Directors is kept abreast of any changes or trends in problem assets on a monthly basis, or more often if required.

The specific allowance for impaired loans is measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. The amount of impaired loans is not directly comparable to the amount of nonperforming loans disclosed later in this section. The primary differences between impaired loans and nonperforming loans are: i) all loan categories are considered in determining nonperforming loans while impaired loan recognition is limited to commercial and industrial loans, commercial and residential real estate loans, construction loans, and agricultural loans, and ii) impaired loan recognition considers not only loans 90 days or more past due, restructured loans and nonaccrual loans but may also include problem loans other than delinquent loans.

The Company considers a loan to be impaired when, based upon current information and events, it believes it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans include nonaccrual loans, troubled debt restructures, and performing loans in which full payment of principal or interest is not expected. Management bases the measurement of these impaired loans either on the fair value of the loan's collateral or the expected cash flows on the loan discounted at the loan's stated interest rates. Cash receipts on impaired loans not performing to contractual terms and that are on nonaccrual status are used to reduce principal balances. Impairment losses are included in the allowance for credit losses through a charge to the provision, if applicable.

In most cases, the Company uses the cash basis method of income recognition for impaired loans. In the case of certain troubled debt restructuring, for which the loan has been performing for a prescribed period of time under the current contractual terms, income is recognized under the accrual method. At September 30, 2020, included in impaired loans, were troubled debt restructures totaling $4,571,000, of which $2,962,000 were on nonaccrual. The remaining $1,609,000 in troubled debt restructures were considered current with regards to payments, and were performing according to their modified contractual terms.

The Company is working with customers directly affected by COVID-19. The Company has offered and continues to be prepared to offer short-term assistance. As of September 30, 2020, the Company had executed 23 payment deferrals or modifications on outstanding loan balances of $69,814,000 in connection with the COVID-19 relief provided by the CARES Act. These deferrals were generally no more than six months in duration and were not considered troubled debt restructurings in accordance with the CARES Act.

The following tables summarize modification under the CARES Act by loan category as of September 30, 2020 (in 000's).
Loan Category COVID-19 Modified Loan Balance Total Portfolio Balance
Commercial and Industrial: $ 667  $ 65,742 
Commercial Real Estate:
     Hospitality 39,757  53,711 
     Health Club 14,775  14,775 
     Construction and land development 10,836  130,202 
     Commercial/Office/Retail 2,687  101,195 
     Residential Mortgages —  45,722 
     Home improvement and home equity loans —  114 
     All other CRE 1,058  136,019 
Agricultural: —  51,587 
Installment and student loans: 34  62,415 
Total: $ 69,814  $ 661,482 


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Commercial and industrial loans and real estate mortgage loans, respectively, comprised approximately 3.28% and 18.93% of total impaired loan balances at September 30, 2020. Of the $494,000 in commercial and industrial impaired loans reported at September 30, 2020, two loans, with a total recorded investment of $494,000, were secured by real estate. Specific collateral related to impaired loans is reviewed for current appraisal information, economic trends within geographic markets, loan-to-value ratios, and other factors that may impact the value of the loan collateral. Adjustments are made to collateral values as needed for these factors. Of total impaired loans at September 30, 2020, approximately $14,403,000, or 95.6%, are secured by real estate. The majority of impaired real estate construction and development loans are for the purpose of residential construction, residential and commercial acquisition and development, and land development. Residential construction loans are made for the purpose of building residential 1-4 single family homes. Residential and commercial acquisition and development loans are made for the purpose of purchasing land, developing that land if required, and developing real estate or commercial construction projects on those properties. Land development loans are made for the purpose of converting raw land into construction-ready building sites.

Table 9. Impaired Loans and Specific Reserves

The following table summarizes the components of impaired loans and their related specific reserves at September 30, 2020 and December 31, 2019. 
  Impaired Loan Balance Reserve Impaired Loan Balance Reserve
(in 000’s) September 30, 2020 September 30, 2020 December 31, 2019 December 31, 2019
Commercial and industrial $ 494  $ —  $ 1,754  $ 606 
Real estate – mortgage 2,851  187  3,146  283 
RE construction & development 11,058  —  11,478  — 
Agricultural 656  215  694  256 
Installment and student loans —  —  —  — 
Total impaired loans $ 15,059  $ 402  $ 17,072  $ 1,145 

Included in impaired loans are loans modified in troubled debt restructurings (TDRs), where concessions have been granted to borrowers experiencing financial difficulties in an attempt to maximize collection. The Company makes various types of concessions when structuring TDRs including rate reductions, payment extensions, and forbearance. At September 30, 2020, approximately $1,430,000 of the total $4,571,000 in TDRs was comprised of real estate mortgages. An additional $2,486,000 was related to real estate construction and development loans. There were no reserve amounts for real estate construction and development impaired loans at December 31, 2019 and September 30, 2020, due to the value of the collateral securing those loans.

As of September 30, 2020, the Company had executed 23 payment deferrals or modifications on outstanding loan balances of $69,814,000 in connection with the COVID-19 relief provided by the CARES Act. These deferrals were generally no more than six months in duration and were not considered troubled debt restructurings based on interagency guidance issued in March 2020.
 
Total troubled debt restructurings decreased 11.88% between September 30, 2020 and December 31, 2019. Nonaccrual TDRs increased by 5.90% and accruing TDRs decreased by 32.65% over the same period. Total residential mortgages and real estate construction TDRs decreased $696,000 to a percentage total of 15.09%.

Table 10. TDRs

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The following tables summarize TDRs by type, classified separately as nonaccrual or accrual, which are included in impaired loans at September 30, 2020 and December 31, 2019.
  Total TDRs Nonaccrual TDRs Accruing TDRs
(in 000's) September 30, 2020 September 30, 2020 September 30, 2020
Commercial and industrial $ —  $ —  $ — 
Real estate mortgage:      
Commercial real estate 884  —  884 
Residential mortgages 546  —  546 
Total real estate mortgage 1,430  —  1,430 
RE construction & development 2,486  2,486  — 
Agricultural 655  477  179 
Total troubled debt restructurings $ 4,571  $ 2,963  $ 1,609 
 
  Total TDRs Nonaccrual TDRs Accruing TDRs
 (in 000's) December 31, 2019 December 31, 2019 December 31, 2019
Commercial and industrial $ 9  $ —  $ 9 
Real estate mortgage:      
Commercial real estate 898  —  898 
Residential mortgages 1,060  —  1,060 
Total real estate mortgage 1,958  —  1,958 
RE construction & development 2,654  2,654  — 
Agricultural 566  144  422 
Total troubled debt restructurings $ 5,187  $ 2,798  $ 2,389 

Of the $4,571,000 in total TDRs at September 30, 2020, $2,963,000 were on nonaccrual status at period-end. Of the $5,187,000 in total TDRs at December 31, 2019, $2,798,000 were on nonaccrual status at period-end. As of September 30, 2020, the Company had no commercial real estate (CRE) workouts whereby an existing loan was restructured into multiple new loans (i.e., A Note/B Note structure).
 
A restructured loan may return to accrual status after 6 months successful payment history if continued satisfactory performance is expected. The Company typically performs a financial analysis of the credit to determine whether the borrower has the ability to continue to meet payments over the remaining life of the loan. This includes, but is not limited to, a review of financial statements and a cash flow analysis of the borrower. Only after determination that the borrower has the ability to perform under the terms of the loans will the restructured credit be considered for accrual status.

Table 11. Credit Quality Indicators for Outstanding Student Loans

The following table summarizes the credit quality indicators for outstanding student loans as of September 30, 2020 and December 31, 2019 (in 000's, except for number of borrowers):
  September 30, 2020 December 31, 2019
  Number of Loans Amount Accrued Interest Number of Loans Amount Accrued Interest
School 320  $ 12,758  $ 2,940  601  $ 24,198  $ 4,689 
Grace 212  9,379  2,434  49  1,598  394 
Repayment 547  24,322  577  507  24,986  203 
Deferment 162  7,044  445  124  4,392  204 
Forbearance 109  5,174  153  224  10,626  188 
Total 1,350  $ 58,677  $ 6,549  1,505  $ 65,800  $ 5,678 

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Included in installment loans are $58,677,000 and $65,800,000 in student loans at September 30, 2020 and December 31, 2019, respectively, made to medical and pharmacy school students. Accrued interest on loans that had not entered repayment status totaled $5,972,000 at September 30, 2020 and $5,475,000 at December 31, 2019. At September 30, 2020 there were 818 loans within repayment, deferment, and forbearance which represented $24,322,000, $7,044,000, and $5,174,000, respectively. At December 31, 2019, there were 855 loans within repayment, deferment, and forbearance which represented $24,986,000, $4,392,000 and $10,626,000, respectively. As of September 30, 2020 and December 31, 2019 the reserve against the student loan portfolio was $1,761,000 and $2,091,000, respectively.

Loan interest rates on the student loan portfolio range from 2.875% to 7.875% and 4.75% to 9.75% at September 30, 2020 and December 31, 2019, respectively.

Table 12. Nonperforming Assets
 
The following table summarizes the components of nonperforming assets as of September 30, 2020 and December 31, 2019 (in 000's), and the percentage of nonperforming assets to total gross loans, total assets, and the allowance for loan losses:
(in 000's) September 30, 2020 December 31, 2019
Nonaccrual loans (1) $ 11,535  $ 11,697 
Restructured loans 1,609  2,389 
Loans past due 90 days or more, still accruing 53  386 
Total nonperforming loans 13,197  14,472 
Other real estate owned 5,018  6,753 
Total nonperforming assets $ 18,215  $ 21,225 
Nonperforming loans to total gross loans 2.00  % 2.42  %
Nonperforming assets to total assets 1.61  % 2.22  %
Allowance for loan losses to nonperforming loans 65.98  % 54.64  %
 (1) Included in nonaccrual loans at September 30, 2020 and December 31, 2019 are restructured loans totaling $2,962,000 and $2,797,000, respectively.

Nonperforming assets, which are primarily related to the real estate loan and other real estate owned portfolio, decreased $3,010,000 from a balance of $21,225,000 at December 31, 2019 to a balance of $18,215,000 at September 30, 2020, and remained relatively high compared to peers during the nine months ended September 30, 2020. The ratio of the allowance for loan losses to nonperforming loans increased from 54.64% at December 31, 2019 to 65.98% at September 30, 2020.

The following table summarizes the nonaccrual totals by loan category for the periods shown:
Balance Balance Change from
 (in 000's) September 30, 2020 December 31, 2019 December 31, 2019
Nonaccrual Loans:
Commercial and industrial $ —  $ 75  $ (75)
Real estate - mortgage —  —  — 
RE construction & development 11,058  11,478  (420)
Agricultural 477  144  333 
Installment and student loans —  —  — 
Total nonaccrual loans $ 11,535  $ 11,697  $ (162)

Loans past due more than 30 days receive increased management attention and are monitored for increased risk. The Company continues to move past due loans to nonaccrual status in an ongoing effort to recognize and address loan problems as early and most effectively as possible. As impaired loans, nonaccrual and restructured loans are reviewed for specific reserve allocations, the allowance for credit losses is adjusted accordingly.

Except for the nonaccrual loans included in the above table, or those included in the impaired loan totals, there were no loans at September 30, 2020 where the known credit problems of a borrower caused the Company to have serious doubts as to the
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ability of such borrower to comply with the present loan repayment terms and which would result in such loan being included as a nonaccrual, past due, or restructured loan at some future date.

Nonaccrual loans, totaling $11,535,000 at September 30, 2020, decreased $162,000 from the balance of $11,697,000 reported at December 31, 2019, with real estate mortgage and real estate construction loans comprising 95.86% of total nonaccrual loans at September 30, 2020. In determining the adequacy of the underlying collateral related to these loans, management monitors trends within specific geographical areas, loan-to-value ratios, appraisals, and other credit issues related to the specific loans. Impaired loans decreased $2,013,000 during the nine months ended September 30, 2020 to a balance of $15,059,000 at September 30, 2020. Other real estate owned through foreclosure decreased to $5,018,000 for the period ended September 30, 2020 as compared to the balance of $6,753,000 recorded at December 31, 2019. Nonperforming assets as a percentage of total assets decreased from 2.22% at December 31, 2019 to 1.61% at September 30, 2020.

The following table summarizes various nonperforming components of the loan portfolio, the related allowance for credit losses and provision for credit losses for the periods shown.
(in 000's) September 30, 2020 December 31, 2019 September 30, 2019
Provision for credit losses year-to-date $ 2,138  $ 20  $ 15 
Allowance as % of nonperforming loans 65.98  % 54.64  % 52.99  %
Nonperforming loans as % total loans 2.00  % 2.42  % 2.72  %
Restructured loans as % total loans 0.69  % 0.87  % 0.93  %

Management continues to monitor economic conditions in the real estate market for signs of deterioration or improvement which may impact the level of the allowance for loan losses required to cover identified losses in the loan portfolio. Focus has been placed on monitoring and reducing the level of problem assets, while working with borrowers to find more options, including loan restructures. Restructured loan balances are comprised of 9 loans totaling $4,571,000 at September 30, 2020, compared to 13 loans totaling $5,187,000 at December 31, 2019.
 
The following table summarizes special mention loans by type at September 30, 2020 and December 31, 2019.
(in thousands) September 30, 2020 December 31, 2019
Commercial and industrial $ 1,945  $ 919 
Real estate mortgage:    
Commercial real estate 7,418  1,608 
Residential mortgages 354  88 
Total real estate mortgage 7,772  1,696 
RE construction & development 998  998 
Agricultural 1,441  1,279 
Installment and student loans —  386 
Total special mention loans $ 12,156  $ 5,278 
 
The Company focuses on competition and other economic conditions within its market area and other geographical areas in which it does business, which may ultimately affect the risk assessment of the portfolio. The Company continues to experience increased competition from major banks, local independents and non-bank institutions which creates pressure on loan pricing. The Company continues to place increased emphasis on reducing both the level of nonperforming assets and the level of losses on the disposition of these assets. It is in the best interest of both the Company and the borrowers to seek alternative options to foreclosure in an effort to reduce the impacts on the real estate market. As part of this strategy, the Company enters into troubled debt restructurings, when it improves collection prospects. While business and consumer spending have shown improvement over the last several years, it is difficult to forecast the impact COVID-19 will have on the economy. Local unemployment rates in the San Joaquin Valley have improved, but are expected to substantially increase due to closure of non-essential business and shelter-in-place orders. Management recognizes the increased risk of loss due to the Company's exposure to local and worldwide economic conditions, as well as potentially volatile real estate markets, and takes these factors into consideration when analyzing the adequacy of the allowance for credit losses.

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The following table provides a summary of the Company's allowance for possible credit losses, provisions made to that allowance, and charge-off and recovery activity affecting the allowance for the nine months ended September 30, 2020 and September 30, 2019.

Table 13. Allowance for Credit Losses - Summary of Activity
 
(in 000's) September 30, 2020 September 30, 2019
Total loans outstanding at end of period before deducting allowances for credit losses $ 660,444  $ 569,500 
Average loans outstanding during period 632,221  575,323 
Balance of allowance at beginning of period 7,908  8,395 
Loans charged-off:    
Real estate (358) (5)
Commercial and industrial —  — 
Agricultural —  (36)
Installment and student loans (1,134) (377)
Total loans charged-off (1,492) (418)
Recoveries of loans previously charged-off:    
Real estate 125  60 
Commercial and industrial 22  64 
Installment and student loans 7  114 
Total loan recoveries 154  238 
Net loans charged-off (1,338) (180)
Provision charged to operating expense 2,138  15 
Balance of allowance for credit losses at end of period $ 8,708  $ 8,230 
Net loan charged-off to total average loans (annualized) 0.28  % 0.04  %
Net loan charged-off to loans at end of period (annualized) 0.05  % 0.06  %
Allowance for credit losses to total loans at end of period 1.32  % 1.45  %
Net loan charged-off to allowance for credit losses (annualized) 3.84  % 4.37  %
Provision for credit losses to net charged-off (annualized) (319.58) % (11.11) %

Provisions for credit losses are determined on the basis of management's periodic credit review of the loan portfolio, consideration of past loan loss experience, current and future economic conditions, and other pertinent factors. Management believes its estimate of the allowance for credit losses adequately covers estimated losses inherent in the loan portfolio and, based on the condition of the loan portfolio, management believes the allowance is sufficient to cover risk elements in the loan portfolio. For the nine months ended September 30, 2020, a $2,138,000 provision was recorded to the allowance for credit losses as compared to a $15,000 provision recorded for the nine months ended September 30, 2019.

Net charge-offs during the nine months ended September 30, 2020 totaled $1,338,000 as compared to net charge-offs of $180,000 for the nine months ended September 30, 2019. The Company charged-off, or had partial charge-offs on 26 loans during the nine months ended September 30, 2020, as compared to fourteen loans during the same period ended September 30, 2019, and 35 loans during the year ended December 31, 2019. The annualized percentage of net charge-offs to average loans was 0.28% for the nine months ended September 30, 2020. Annualized percentage net charge-offs were 0.09% for the year ended December 31, 2019. Annualized percentage net recoveries were 0.04% for the nine months ended September 30, 2019. The Company's loans net of unearned fees increased from $569,500,000 at September 30, 2019 to $660,444,000 at September 30, 2020.

The allowance at September 30, 2020 was 1.32% of outstanding loan balances at September 30, 2020, as compared to 1.33% at December 31, 2019, and 1.45% at September 30, 2019.
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At September 30, 2020 and September 30, 2019, unfunded loan commitment reserves of $572,000 and $592,000, respectively, were reported in other liabilities. Management believes that the 1.32% credit loss allowance at September 30, 2020 is adequate to absorb known and inherent risks in the loan portfolio. No assurance can be given, however, regarding economic conditions or other circumstances which may adversely affect the Company's service areas and result in future losses to the loan portfolio.

Asset/Liability Management – Liquidity and Cash Flow

The primary functions of asset/liability management are to provide adequate liquidity and maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities. In a changing-rate environment, imbalances between interest-sensitive assets and interest-sensitive liabilities will impact earnings. For example, in an increasing-rate environment if interest-sensitive liabilities reprice sooner than interest sensitive assets, net interest income will be negatively impacted.

Liquidity

Liquidity management may be described as the ability to maintain sufficient cash flows to fulfill financial obligations, including loan funding commitments and customer deposit withdrawals, without straining the Company’s equity structure. To maintain an adequate liquidity position, the Bank relies on, in addition to cash and cash equivalents, cash inflows from deposits and short-term borrowings, repayments of principal on loans and investments, and interest income received. The Bank's principal cash outflows are for loan origination, purchases of investment securities, depositor withdrawals and payment of operating expenses.

The Bank continues to emphasize liability management as part of its overall asset/liability strategy. Through the discretionary acquisition of short term borrowings, the Bank has, when needed, been able to provide liquidity to fund asset growth while, at the same time, better utilizing its capital resources, and better controlling interest rate risk.  This does not preclude the Bank from selling assets such as investment securities to fund liquidity needs but, with favorable borrowing rates, the Bank has maintained a positive yield spread between borrowed liabilities and the assets which those liabilities fund. If, at some time, rate spreads become unfavorable, the Bank has the ability to utilize an asset management approach and, either control asset growth or fund further growth with maturities or sales of investment securities. At September 30, 2020, the Bank had no borrowings, as its deposit base currently provides funding sufficient to support its asset values.

The Banks liquid asset base which generally consists of cash and due from banks, federal funds sold, securities purchased under agreements to resell (reverse repos) and investment securities, is maintained at a level deemed sufficient to provide the cash outlay necessary to fund loan growth and accommodate any customer deposit runoff that may occur. Additional liquidity requirements may be funded with overnight or term borrowing arrangements with various correspondent banks, FHLB and the Federal Reserve Bank. Within this framework is the objective of maximizing the yield on earning assets. This is generally achieved by maintaining a high percentage of earning assets in loans, which historically have represented the Company's highest yielding asset. At September 30, 2020, the loan portfolio totaled 58.2% of total assets and the loan to deposit ratio was 65.5%, compared to 62.3% and 71.9%, respectively, at December 31, 2019. Liquid assets at September 30, 2020, included cash and cash equivalents totaling $323,332,000 as compared to $218,995,000 at December 31, 2019. Other sources of liquidity include collateralized lines of credit from the Federal Home Loan Bank, and from the Federal Reserve Bank totaling $346,521,000 and uncollateralized lines of credit from Pacific Coast Banker's Bank (PCBB) of $10,000,000, Union Bank of $10,000,000, and Zion's Bank of $20,000,000 at September 30, 2020.

The liquidity of the Holding Company, United Security Bancshares, is primarily dependent on the payment of cash dividends by its subsidiary, the Bank, subject to limitations imposed by the Financial Code of the State of California. During the nine months ended September 30, 2020, the Holding Company has received $6,027,000 in cash dividends from the Bank.

Cash Flow

The period-end balances of cash and cash equivalents for the periods shown are as follows (from Consolidated Statements of Cash Flows – in 000’s):

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  (in 000's) Balance
December 31, 2018 $ 220,337 
September 30, 2019 $ 245,943 
December 31, 2019 $ 218,995 
September 30, 2020 $ 323,332 

Cash and cash equivalents increased $104,337,000 during the nine months ended September 30, 2020, compared to an increase of $25,606,000 during the nine months ended September 30, 2019.

The Company had a net cash inflow from operating activities of $9,366,000 for the nine months ended September 30, 2020 and a cash inflow from operations totaling $9,765,000 for the period ended September 30, 2019. The Company experienced net cash outflows from investing activities of $75,847,000 related to a $65,446,000 increase in loan balances and purchases of available-for-sale securities of $29,016,000. For the nine months ended September 30, 2019, the Company experienced net cash inflows from investing activities of $4,992,000 related to a $17,626,000 decrease in loan balances and principal payments on available-for-sale securities of $11,407,000.

During the nine months ended September 30, 2020, the Company experienced net cash inflows from financing activities totaling $170,818,000, primarily as the result of increases of $178,239,000 in demand deposits and savings accounts, partially offset by decreases of $1,819,000 in time deposits. For the nine months ended September 30, 2019, the Company experienced net cash inflows of $10,849,000 primarily as the result of increases of $28,859,000 in demand deposits and savings accounts, offset by decreases of $14,280,000 in time deposits.

The Company has the ability to increase or decrease loan growth, increase or decrease deposits and borrowings, or a combination of both to manage balance sheet liquidity.

Regulatory Matters

Capital Adequacy

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements adopted by the Board of Governors of the Federal Reserve System (the “Board of Governors”).  Failure to meet minimum capital requirements can initiate certain mandates and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.  Under capital adequacy guidelines and the regulatory framework, the consolidated Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

The Company has adopted a capital plan that includes guidelines and trigger points to ensure sufficient capital is maintained at the Bank and the Company, and that capital ratios are maintained at a level deemed appropriate under regulatory guidelines given the level of classified assets, concentrations of credit, ALLL, current and projected growth, and projected retained earnings. The capital plan also contains contingency strategies to obtain additional capital as required to fulfill future capital requirements for both the Bank, as a separate legal entity, and the Company on a consolidated basis. The capital plan requires the Bank to maintain a ratio of tangible shareholders' equity to total tangible assets equal to or greater than 9%. The Bank’s ratio of tangible shareholders’ equity to total tangible assets was 12.4% and 12.1% at September 30, 2020 and 2019, respectively.

The Company uses a variety of measures to evaluate its capital adequacy, including the leverage ratios which is calculated separately for the Company and the Bank. Management reviews these capital measurements on a quarterly basis and takes appropriate action to help ensure that they meet or surpass established internal and external guidelines. The following table sets forth the Company’s and the Bank's actual capital positions at September 30, 2020:

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Table 14. Capital Ratios
 
Ratios at September 30, 2020 Ratios at December 31, 2019 Minimum Requirement to be Well Capitalized (3) Minimum requirement for Community Bank Leverage Ratio (2) (4)
Total capital to risk weighted assets (1)
Company N/A 17.98% 10.00% N/A
Bank N/A 17.78% 10.00% N/A
Tier 1 capital to risk-weighted assets (1)
Company N/A 16.81% 8.00% N/A
Bank N/A 16.61% 8.00% N/A
Common equity tier 1 capital to risk-weighted assets (1)
Company N/A 15.39% 6.50% N/A
Bank N/A 16.61% 6.50% N/A
Tier 1 capital to adjusted average assets ("Leverage Ratio")
Company 11.38% 12.82% 5.00% 8.00%
Bank 11.24% 12.83% 5.00% 8.00%
(1) Current data is not applicable as the Bank and Company have adopted the Community Bank Leverage Ratio Framework as of the third quarter of 2020.
(2) The minimum required Community Bank Leverage Ratio is 9.00%, but the CARES Act temporarily lowers this to 8% as described below.
(3) The Company was subject to these minimum requirements under the regulatory framework for Prompt Corrective Action at December 31, 2019.
(4) If the subsidiary bank’s Leverage Ratio exceeds the minimum ratio under the Community Bank Leverage Ratio Framework, it is deemed to be “well capitalized” under all other regulatory capital requirements. The Company may revert back to the regulatory framework for Prompt Corrective Action if the subsidiary bank’s Leverage Ratio falls below the minimum under the Community Bank Leverage Ratio Framework.

The federal banking agencies published a final rule on November 13, 2019, that provided a simplified measure of capital adequacy for qualifying community banking organizations. A qualifying community banking organization that opts into the community bank leverage ratio framework and maintains a leverage ratio greater than 9 percent will be considered to have met the minimum capital requirements, the capital ratio requirements for the well capitalized category under the Prompt Corrective Action framework, and any other capital or leverage requirements to which the qualifying banking organization is subject. A qualifying community banking organization with a leverage ratio of greater than 9 percent may opt into the community bank leverage ratio framework if it has average consolidated total assets of less than $10 billion, has off-balance-sheet exposures of 25% or less of total consolidated assets, and has total trading assets and trading liabilities of 5 percent or less of total consolidated assets. Further, the bank must not be an advance approaches banking organization.

The final rule became effective January 1, 2020 and banks that meet the qualifying criteria can elect to use the community bank leverage framework starting with the quarter ended March 31, 2020. The CARES Act reduced the required community bank leverage ratio to 8% until the earlier of December 31, 2020, or the national emergency is declared over. The federal bank regulatory agencies adopted an interim final rule to implement this change from the CARES Act. The Company and the Bank meet the criteria outlined in the final rule and the interim final rule and have adopted the community bank leverage ratio framework in the third quarter 2020.

As of September 30, 2020, the Company and the Bank meet all capital adequacy requirements to which they are subject. Management believes that, under the current regulations, both will continue to meet their minimum capital requirements in the foreseeable future.

Dividends

Dividends paid to shareholders by the Holding Company are subject to restrictions set forth in the California General
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Corporation Law. As applicable to the Holding Company, the California General Corporation Law provides that the Holding Company may make a distribution to its shareholders if retained earnings immediately prior to the dividend payout are at least equal to the amount of the proposed distribution or if immediately after the distribution, the value of the Holding Company’s assets would equal or exceed the sum of its total liabilities. The primary source of funds with which dividends will be paid to shareholders will come from cash dividends received by the Company from the Bank.

On April 25, 2017, the Board of Directors announced the authorization of the repurchase of up to $3,000,000 of the outstanding stock of the Holding Company. This amount represents 2.6% of total shareholders' equity of $118,053,000 at September 30, 2020. The timing of the purchases will depend on certain factors including, but not limited to, market conditions and prices, available funds, and alternative uses of capital. The stock repurchase program may be carried out through open-market purchases, block trades, or negotiated private transactions. During the nine months ended September 30, 2020, the Company did not repurchase any of the shares available.

During the nine months ended ended September 30, 2020, the Bank paid $6,027,000 in cash dividends to the Holding Company which funded the Holding Company’s operating costs and payments of interest on its junior subordinated debt.

On September 22, 2020, the Company’s Board of Directors declared a cash dividend of $0.11 per share on the Company's common stock. The dividend was payable on October 16, 2020, to shareholders of record as of October 6, 2020. Approximately $1,867,000 was transferred from retained earnings to dividends payable to allow for distribution of the dividend to shareholders.

On June 23, 2020, the Company’s Board of Directors declared a cash dividend of $0.11 per share on the Company's common stock. The dividend was payable on July 15, 2020, to shareholders of record as of July 6, 2020. Approximately $1,866,000 was transferred from retained earnings to dividends payable to allow for distribution of the dividend to shareholders.

On March 24, 2020, the Company’s Board of Directors declared a cash dividend of $0.11 per share on the Company's common stock. The dividend was payable on April 15, 2020, to shareholders of record as of April 6, 2020. Approximately $1,867,000 was transferred from retained earnings to dividends payable to allow for distribution of the dividend to shareholders.

The Bank, as a state-chartered bank, is subject to dividend restrictions set forth in the California Financial Code, as administered by the Commissioner of the Department of Financial Protection and Innovation (Commissioner). As applicable to the Bank, the Financial Code provides that the Bank may not pay cash dividends in an amount which exceeds the lesser of the retained earnings of the Bank or the Bank’s net income for the last three fiscal years (less the amount of distributions to the Holding Company during that period of time). If the above test is not met, cash dividends may only be paid with the prior approval of the Commissioner, in an amount not exceeding the Bank’s net income for its last fiscal year or the amount of its net income for the current fiscal year. Such restrictions do not apply to stock dividends, which generally require neither the satisfaction of any tests nor the approval of the Commissioner. Notwithstanding the foregoing, if the Commissioner finds that the shareholder's equity of the Bank is not adequate or that the declaration of a dividend would be unsafe or unsound, the Commissioner may order the Bank not to pay any dividend. The Reserve Bank may also limit dividends paid by the Bank.

Reserve Balances

The Bank is required to maintain average reserve balances with the Federal Reserve Bank. During 2005, the Company implemented a deposit reclassification program which allows the Company to reclassify a portion of transaction accounts to non-transaction accounts for reserve purposes. The deposit reclassification program is provided by a third-party vendor and has been approved by the Federal Reserve Bank.  At September 30, 2020, the Bank was not subject to a reserve requirement.


Item 3  - Quantitative and Qualitative Disclosures about Market Risk

The Company’s assessment of market risk as of September 30, 2020 indicates there are no material changes in the quantitative and qualitative disclosures from those in our Annual Report on Form 10-K for the year ended December 31, 2019.

Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

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The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
 
As of September 30, 2020, the end of the period covered by this report, an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures was carried out. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company's internal control over financial reporting that occurred during the quarter ended September 30, 2020, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and fraud.  A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met.  Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.  The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

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PART II. Other Information

Item 1. Legal Proceedings

The Company is involved in various legal proceedings in the normal course of business. In the opinion of Management, any liability resulting from such proceedings would not have a material adverse effect on the Company’s financial condition or results of operations.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
None during the quarter ended September 30, 2020.
 
Item 3. Defaults Upon Senior Securities

Not applicable
 
Item 4. Mine Safety Disclosures

Not applicable
 
Item 5. Other Information

Not applicable
 
Item 6. Exhibits:

(a)Exhibits:
 
* Data required by Accounting Standards Codification (ASC) 260, Earnings per Share, is provided in Note 10 to the consolidated financial statements in this report.
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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
  United Security Bancshares
   
Date: October 30, 2020 /S/ Dennis R. Woods
  Dennis R. Woods
  President and Chief Executive Officer
   
  /S/ Bhavneet Gill
  Bhavneet Gill
  Senior Vice President and Chief Financial Officer
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