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emergency in January 2015 after projecting a material budget gap resulting from declining oil prices. With oil prices
down substantially over the past year, County officials expect a related decline in oil property values and a material
decline in property taxes. Kern County currently has ample reserves that it can access and it also plans to cut
expenses to help address the issue, thus industry observers do not expect the County to file bankruptcy. However,
economic multipliers to a contracting oil industry include the prospects of a depressed residential housing market and
a drop in commercial real estate values. The Company’s direct exposure to the oil industry is not material, but if our
borrowers are indirectly impacted and/or non-oil property values decline, our level of nonperforming assets and loan
charge-offs could increase.
Concentrations of real estate loans have negatively impacted our performance in the past, and could subject us
further risks in the event of another real estate recession or natural disaster.
Our loan portfolio is heavily
concentrated in real estate loans, particularly commercial real estate. At December 31, 2014, 73% of our loan
portfolio consisted of real estate loans, and a sizeable portion of the remaining loan portfolio has real estate collateral
as a secondary source of repayment or as an abundance of caution. Real estate loans on commercial buildings
represented approximately 50% of all real estate loans, while construction/development and land loans were 4%,
loans secured by residential properties accounted for 26%, and loans secured by farmland were 21% of real estate
loans. The Company’s $24.7 million balance of nonperforming assets at December 31, 2014 includes nonperforming
real estate loans totaling $19.0 million, and $4.0 million in foreclosed assets comprised primarily of OREO.
The Central Valley residential real estate market experienced significant deflation in property values during 2008 and
2009, and foreclosures occurred at relatively high rates during and after the recession. While residential real estate
values in our market areas currently appear to be stabilized or slightly increasing, if they were to slide further, or if
commercial real estate values decline materially, the Company could experience additional migration into
nonperforming assets. An increase in nonperforming assets could have a material adverse effect on our financial
condition and results of operations by reducing our income and increasing our expenses. Deterioration in real estate
values might also further reduce the amount of loans the Company makes to businesses in the construction and real
estate industry, which could negatively impact our organic growth prospects. Similarly, the occurrence of a natural
disaster like those California has experienced in the past, including earthquakes, fires, and flooding, could impair the
value of the collateral we hold for real estate secured loans and negatively impact our results of operations.
In addition, banking regulators give commercial real estate loans extremely close scrutiny due to risks relating to the
cyclical nature of the real estate market and related risks for lenders with high concentrations of such loans. The
regulators have required banks with relatively high levels of CRE loans to implement enhanced underwriting
standards, internal controls, risk management policies and portfolio stress testing, which has resulted in higher
allowances for possible loan losses. Expectations for higher capital levels have also materialized. Any required
increase in our allowance for loan losses could adversely affect our net income, and any requirement that we maintain
higher capital levels could adversely impact financial performance measures such as earnings per share.
Our concentration of commercial real estate, construction and land development, and commercial and
industrial loans exposes us to increased lending risks.
Commercial real estate, construction and land development,
and commercial and industrial loans and leases (including agricultural production loans), which comprised
approximately 53% of our total loan portfolio as of December 31, 2014, expose the Company to a greater risk of loss
than residential real estate and consumer loans, which comprised a smaller percentage of the total loan portfolio.
Commercial real estate and land development loans typically involve larger loan balances to single borrowers or
groups of related borrowers compared to residential loans. Consequently, an adverse development with respect to
one commercial loan or credit relationship exposes us to greater risk of loss than an adverse development with
respect to one residential mortgage loan.
Repayment of our commercial loans is often dependent on the cash flows of the borrowers, which may be
unpredictable, and the collateral securing these loans may fluctuate in value.
At December 31, 2014, we had
$142 million or 15% of total loans in commercial loans and leases (including agricultural production loans).
Commercial lending involves risks that are different from those associated with real estate lending. Real estate
lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to
collateral values and liquidation of the underlying real estate collateral being viewed as the primary source of
repayment in the event of borrower default. Our commercial loans are primarily made based on the cash flows of the
