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The recent drop in oil prices could have an adverse impact on our customers and their ability to make payments
to us, particularly in areas such as Kern County where oil production is a significant economic driver.
Kern
County, which is home to about three quarters of California’s oil production, declared a fiscal emergency in January
2015 after projecting a material budget gap resulting from declining oil prices. With oil prices down substantially in
recent periods, there have been related declines in oil property values and property taxes. Kern County currently has
ample fiscal reserves which 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 does not have direct exposure to oil producers, but our indirect exposure via loans outstanding to borrowers
involved in servicing oil companies totaled $43 million at December 31, 2015. If cash flows are disrupted for those
service providers, or if other 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, 2015, 69% 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 49% of all real estate loans, while construction/development and land loans were 7%, loans secured by
residential properties accounted for 27%, and loans secured by farmland were 17% of real estate loans. The Company’s
$12.8 million balance of nonperforming assets at December 31, 2015 includes nonperforming real estate loans totaling
$8.4 million, and $3.2 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, 2015, 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, 2015, we had $159
million or 14% 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