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The volume variance calculated for 2015 over 2014 was a favorable $8.819 million, due primarily to a $203 million
increase in the average balance of interest-earning assets resulting from our acquisition of Santa Clara Valley Bank,
organic growth, and loan purchases. The volume variance was enhanced by the fact that the average balance of loans
grew by 20% relative to only 7% growth in the average balance of lower-yielding investments, as well as a shift within
investments out of lower-yielding balances held at the Federal Reserve Bank. It was unfavorably impacted by the fact
that lower-yielding mortgage warehouse loans and agricultural loans experienced disproportionate growth relative to
other loan categories.
The impact of interest rate changes resulted in an unfavorable rate variance of $1.018 million in net interest income for
2015 relative to 2014. Despite the fact that our yield on earning assets and cost of interest-bearing liabilities were both
down by six basis points, the rate variance was negative due to the volume differential between our interest-earning
assets and interest-bearing liabilities. That differential averaged $422 million for 2014, the base period for the rate
variance calculation, thus the decrease in our earning asset yield was applied to a much higher balance than the rate
decrease for interest-bearing liabilities and had a greater impact on net interest income. Investment yields were lower
due to the reinvestment of portfolio cash flows in a historically low interest rate environment, and the weighted average
yield on loans declined due to the impact of continued competition on loan rates and relatively robust growth in lower-
yielding mortgage warehouse loans. Our weighted average cost of interest-bearing liabilities was down because of a
drop in deposit rates, combined with a lower overall rate on non-deposit borrowings resulting from disproportionate
growth in low-cost short-term borrowings.
The Company’s net interest margin, which is tax-equivalent net interest income as a percentage of average interest-
earning assets, is affected by the same factors discussed above relative to rate and volume variances. Our net interest
margin was 3.99% in 2015, a drop of only 2 basis points relative to 2014. The principal developments impacting our
net interest margin in 2015 include lower yields on loans and investments, and a shift within loans to lower-yielding
loan segments. Partially alleviating the negative pressures on loan rates was higher non-recurring interest income such
as net interest recovered on non-accrual loans and prepayment penalties, which totaled $825,000 in 2015 relative to
$505,000 in 2014. Lower deposit rates also helped offset the negative factors impacting our net interest margin.
Provision for Loan and Lease Losses
Credit risk is inherent in the business of making loans. The Company sets aside an allowance for loan and lease losses,
a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision
for loan and lease losses. A loan loss provision was not required for 2015, but we recorded a loan loss provision of
$350,000 in 2014.
The Company’s loan loss provision has been sufficient to maintain our allowance for loan and lease losses at a level
that, in Management’s judgment, is adequate to absorb probable loan losses related to specifically-identified impaired
loans as well as probable incurred losses in the remaining loan portfolio. Specifically identifiable and quantifiable loan
losses are immediately charged off against the allowance. Net loans charged off by the Company totaled $825,000 in
2015 relative to $779,000 in 2014, but those charge-offs were primarily recorded against reserves established in previ-
ous periods and thus did not necessitate reserve replenishment. Additional factors impacting our allowance for loan
and lease losses and lack of provisioning in recent periods include the following: loan growth has occurred in portfolio
segments with low historical loss rates, and credit quality improvement is evident in the remainder of the loan portfolio
due to tighter loan underwriting standards implemented subsequent to the recession.
The Company’s policies for monitoring the adequacy of the allowance and determining loan amounts that should be
charged off, and other detailed information with regard to changes in the allowance, are discussed below under
“Allowance for Loan and Lease Losses.” The process utilized to establish an appropriate allowance for loan and lease
losses can result in a high degree of variability in the Company’s loan loss provision, and consequently in our net
earnings.
Non-interest Revenue and Operating Expense
The table below sets forth the major components of the Company’s non-interest revenue and operating expense, along
with relevant ratios, for the years indicated: