FORWARD-LOOKING STATEMENTS
This report may include forward-looking statements, which may include forecasts of our financial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not rely unduly on forward-looking statements. Actual results might differ significantly compared to our forecasts and expectations. See Part I, Item 1A. "Risk Factors," and the other risks described in our 2019 Annual Report on Form 10-K and Part II, Item 1A "Risk Factors" in this Quarterly Report on Form 10-Q and the other risks described in our Quarterly Reports on Form 10-Q for factors to be considered when reading any forward-looking statements in this filing. This report and other reports or statements which we may release may include forward-looking statements, which are subject to the "safe harbor" created by section 27A of the Securities Act of 1933, as amended, and section 21E of the Securities Exchange Act of 1934, as amended. We may make forward-looking statements in ourSecurities and Exchange Commission (SEC) filings, press releases, news articles and when we are speaking on behalf of the Company. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Often, they include the words "believe," "expect," "target," "anticipate," "intend," "plan," "seek," "strive," "estimate," "potential," "project," or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could," "might," or "may." These forward-looking statements are intended to provide investors with additional information with which they may assess our future potential. All of these forward-looking statements are based on assumptions about an uncertain future and are based on information available to us at the date of these statements. We do not undertake to update forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date any forward-looking statements are made.
In this document and in other
? Our business objectives, strategies and initiatives, our organizational
structure, the growth of our business and our competitive position and
prospects, and the effect of competition on our business and strategies
? Our assessment of significant factors and developments that have affected or
may affect our results
? Pending and recent legal and regulatory actions, and future legislative and
regulatory developments, including the effects of the
Reform and Protection Act (the "Dodd-Frank Act"), the Economic Growth,
Regulatory Relief and Consumer Protection Act (the "EGRRCPA"), and other
legislation and governmental measures introduced in response to the financial
crisis which began in 2008 and the ensuing recession affecting the banking
system, financial markets and the
federal Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"),
enacted in
coronavirus pandemic and the governmental actions in response thereto
? Regulatory and compliance controls, processes and requirements and their impact
on our business
? The costs and effects of legal or regulatory actions
? Expectations regarding draws on performance letters of credit and liabilities
that may result from recourse provisions in standby letters of credit
? Our intent to sell or hold, and the likelihood that we would be required to
sell, various investment securities
? Our regulatory capital requirements, including the capital rules established
after the financial crisis by the
intention not to elect to use the recently enacted community bank leverage
framework
? Expectations regarding our non-payment of a cash dividend on our common stock
in the foreseeable future
? Credit quality and provision for credit losses and management of asset quality
and credit risk, and expectations regarding collections
? Our allowances for credit losses, including the conditions we consider in
determining the unallocated allowance and our portfolio credit quality, the
adequacy of the allowance for loan losses, underwriting standards, and risk
grading 32
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? Our assessment of economic conditions and trends and credit cycles and their
impact on our business
? The seasonal nature of our business
? The impact of changes in interest rates and our strategy to manage our interest
rate risk profile and the possible effect of changes in residential mortgage
interest rates on new originations and refinancing of existing residential
mortgage loans
? Loan portfolio composition and risk grade trends, expected charge-offs,
portfolio credit quality, our strategy regarding troubled debt restructurings
("TDRs"), delinquency rates and our underwriting standards
? Our deposit base including renewal of time deposits
? The impact on our net interest income and net interest margin from the current
interest rate environment
? Possible changes in the initiatives and policies of the federal bank regulatory
agencies
? Tax rates and the impact of changes in the
Cuts and Jobs Act
? Our pension and retirement plan costs
? Our liquidity strategies and beliefs concerning the adequacy of our liquidity
position
? Critical accounting policies and estimates, the impact or anticipated impact of
recent accounting pronouncements or changes in accounting principles
? Expected rates of return, maturities, loss exposure, growth rates, yields and
projected results
? The possible impact of weather-related conditions, including drought, fire or
flooding, seismic events, and related governmental responses, including related
electrical power outages, on economic conditions, especially in the
agricultural sector
? Maintenance of insurance coverages appropriate for our operations
? Threats to the banking sector and our business due to cybersecurity issues and
attacks and regulatory expectations related to cybersecurity
? Our expectations regarding the adoption of the expected loss model for
determining the allowance for loan losses
? The effects of the coronavirus pandemic on the
economies and the actions of governments to reduce the spread of the virus and
to mitigate the resulting economic consequences
? Descriptions of assumptions underlying or relating to any of the foregoing
Readers of this document should not rely on any forward-looking statements, which reflect only our management's belief as of the date of this report. There are numerous risks and uncertainties that could and will cause actual results to differ materially from those discussed in our forward-looking statements. Many of these factors are beyond our ability to control or predict and could have a material adverse effect on our financial condition and results of operations or prospects. Such risks and uncertainties include, but are not limited to those listed in Item 1A "Risk Factors" of Part II of this Form 10-Q, Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of Part I of this Form 10-Q and "Risk Factors" and "Supervision and Regulation" in our 2019 Annual Report on Form 10-K, and in our other reports to theSEC . 33
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INTRODUCTION
This overview of Management's Discussion and Analysis highlights selected information in this report and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting estimates, you should carefully read this entire report and any other reports to theSecurities and Exchange Commission ("SEC"), together with our Consolidated Financial Statements and the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . Our subsidiary,First Northern Bank of Dixon (the "Bank"), is aCalifornia state-chartered bank that derives most of its revenues from lending and deposit taking in theSacramento Valley region ofNorthern California . Interest rates, business conditions and customer confidence all affect our ability to generate revenues. In addition, the regulatory and compliance environment and competition can present challenges to our ability to generate those revenues.
Significant results and developments during the second quarter and year-to-date 2020 included:
• Net income of
from
million for the three months ended
for the same period last year.
• Diluted income per share of
26.3% from diluted income per share of
Diluted income per share of
down 19.2% from diluted income per share of
year.
• Net interest income of
down 3.9% from
income of
from
decrease in loan interest income and due from banks, which was partially offset
by an increase in interest income on investment securities.
• Net interest margin of 3.36% for the six months ended
from 4.10% for the same period last year. Net interest margin of 3.13% for the
three months ended
last year.
• Provision for loan losses of
2020, compared to no provision for the same period last year. Provision for
loan losses of
to no provision for the same period last year. The increase was largely driven
by increases in qualitative factors due to declines in the general economic
environment as a result of the coronavirus pandemic.
• Total assets of
as ofDecember 31, 2019 .
• Total net loans (including loans held-for-sale) of
30, 2020, up 27.0% from
was largely driven by Paycheck Protection Program (PPP) loans totaling
million as of
• Total investment securities of
from
• Total deposits of
billion as of
• FHLB advances of
as of
Recovery Advances Program and are short-term borrowings with a 0% interest
rate. SinceMarch 13, 2020 ,the United States has been operating under a state of emergency declared byPresident Trump in response to the spread of the coronavirus and the COVID-19 disease which it causes. OnMarch 4, 2020 ,California GovernorGavin Newsom declared a similar state-wide emergency. Also, early in March, a number of county and other local health agencies inCalifornia declared emergencies and issued "stay-at-home" ordinances for all persons other than workers at "essential businesses". DuringMarch 2020 and continuing thereafter, the pandemic and governmental responses have resulted in recessionary economic, labor and financial market conditions acrossthe United States and in our markets inCalifornia , including dramatic increases in unemployment. In response, the FRB reduced its federal funds rate by 1.5 percentage points to .00 to .25 percent. In addition, in lateMarch 2020 , theU.S. government enacted the CARES Act, a$2.2 trillion economic stimulus package, the largest inU.S. history, in an effort to lessen the impact of the pandemic on consumers and businesses. 34
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These developments have had an impact on our business. Our commercial real estate loan portfolio exposure to industries most affected by the stay-at-home order includes 5.8% to retail properties and business; 1.4% to restaurants; and 0.9% to the hospitality/hotel sector atJune 30, 2020 . Loans to these customers are generally secured by real estate with relatively low loan-to-value ratios and strong guarantors. There is concern that borrowers will draw on their credit lines to support cashflow disruptions caused by the stay at home ordinances. Most of the Bank's optional advance lines of credit are "controlled" with advances supported by certain assets pledged to the bank for repayment or specific budgeted expense. The Bank monitors credit line advances daily and has not noted any significant, unusual loan advances. We have also granted customer relief in a variety of ways, including extended grace periods on residential and commercial mortgages, commercial loans, and automobile loan and lease payments, refraining from reporting payment deferrals to credit bureaus and waiving or refunding certain fees. The increase in our provision for loan and lease losses to$800,000 and$1,450,000 for the second quarter and year to date 2020, compared to no provision for the same periods in 2019, was largely driven by the economic impacts of the pandemic on our borrowers. The Bank, in the first part ofApril 2020 , commenced participation in the Paycheck Protection Program (PPP) of theSmall Business Administration (SBA) which is aimed at providing relief from the pandemic to small businesses through loans by banks guaranteed by the SBA. In the initial phase of the program, the Bank approved approximately 650 applications for loans under the PPP covering approximately$184 million in funding. The program was suspended after the initial Congressional appropriation of$349 billion was exhausted. A second phase of the program, involving a Congressional appropriation of some$310 billion , was initiated onApril 27, 2020 . As ofJune 30, 2020 , the Bank had approved approximately 670 applications in this second phase, covering approximately$51 million in funding. A total of approximately$235 million in PPP loans were originated during the second quarter of 2020. These PPP loan originations resulted in approximately$7.8 million in SBA processing fees which will be recognized as an adjustment to the effective yield over the loans projected life. A total of approximately$2 million of PPP processing fees has been recognized in interest income on loans for the three and six months endedJune 30, 2020 . The Company expects that a significant portion of the loans it has made under the PPP will be forgiven during the remainder of 2020 under the terms of the program, as borrowers satisfy the requirement of applying at least 60% of the loan proceeds to support their payroll expenses. Thereafter, the Company expects to be reimbursed by the SBA for the amounts forgiven pursuant to the terms of the PPP. Loans which do not qualify for the forgiveness will remain on the Bank's books, subject to the SBA's guarantee. The Bank has also continued to actively assist our communities by providing temporary loan relief under Section 4013 of the Coronavirus Aid, Relief and Economic Security ('CARES') Act to customers who have been negatively impacted by COVID. This relief included loan modifications which included temporary forbearance programs (both full payment deferrals and interest only payments). The total amount of loans that have been provided temporary forbearance relief totaled approximately$94.2 million as ofJune 30, 2020 . For loans that were provided full payment deferrals the Bank has made a policy election to cease recognizing interest during the terms of the payment suspension. Upon completion of the payment forbearance period the foregone interest will be capitalized as deferred interest and recognized as a yield adjustment over the remaining life of the loan. Loans on interest-only plans continued to accrue interest income as the loans have continued to make payments over the course of the forbearance period. Of the$94.2 . million in total forbearances approximately$82.7 million were provided full payment deferrals for terms ranging from three to six months which resulted in the loss of interest income of approximately$0.9 million for the three and six months endedJune 30, 2020 which partially offsets the recognition of PPP loan origination fee income previously discussed. Although banks inCalifornia are defined as "essential businesses" under theCalifornia governmental actions and thus are allowed to remain open, in order to protect the health of our employees, approximately 40% of our employees are now working remotely, a majority of whom would normally be working in our branches or offices. We anticipate the majority of those employees working remotely to return to our branches and offices effectiveAugust 3, 2020 , wearing face coverings, social distancing and using proper hygiene practices.
For additional information on the possible effects of the pandemic on our business, see Part II., Item 1.A., "Risk Factors", in this Report on Form 10-Q.
35
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SUMMARY FINANCIAL DATA
The Company recorded net income of$5,384,000 for the six months endedJune 30, 2020 , representing a decrease of$2,007,000 or 27.2% from net income of$7,391,000 for the same period in 2019. The Company recorded net income of$2,705,000 for the three months endedJune 30, 2020 , representing a decrease of$701,000 or 20.6% from net income of$3,406,000 for the same period in 2019.
The following tables present a summary of the results for the three and six
months ended
Three Months Three Months Six Months Six Months Ended June 30, Ended June 30, Ended June 30, Ended June 30, 2020 2019 2020 2019 (in thousands except for per share amounts) For the Period: Net Income $ 2,705 $ 3,406 $ 5,384 $ 7,391 Basic Earnings Per Common Share $ 0.21 $ 0.27 $ 0.42 $ 0.58 Diluted Earnings Per Common Share $ 0.21 $ 0.26 $ 0.42 $ 0.57 Net Income to Average Assets (annualized) 0.70 % 1.11 % 0.75 % 1.21 % Net Income to Average Equity (annualized) 7.54 % 11.31 % 7.71 % 12.54 % Average Equity to Average Assets 9.27 % 9.86 % 9.76 % 9.63 % December 31, June 30, 2020 2019 (in thousands except for ratios) At Period End: Total Assets$ 1,612,057 $ 1,292,591 Total Investment Securities, at fair value 335,998 342,897 Total Loans, Net (including loans held-for-sale)$ 981,942 $ 773,003 Total Deposits$ 1,438,203 $ 1,138,632 Loan-To-Deposit Ratio 68.3 % 67.9 % 36
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FIRST NORTHERN COMMUNITY BANCORP Distribution of Average Statements of Condition and Analysis of Net Interest Income (in thousands, except percentage amounts) Three months ended Three months ended June 30, 2020 June 30, 2019 Average Yield/ Average Yield/ Balance Interest Rate (4) Balance Interest Rate (4) Assets Interest-earning assets: Loans (1)$ 919,301 $ 9,702 4.23 %$ 730,215 $ 9,856 5.41 % Certificate of deposits 22,486 123 2.19 % 11,757 85 2.90 % Interest bearing due from banks 163,031 36 0.09 % 99,589 553 2.23 % Investment securities, taxable 324,040 1,667 2.06 % 292,656 1,597 2.19 % Investment securities, non-taxable (2) 19,929 124 2.50 % 11,656 70 2.41 % Other interest earning assets 6,502 83 5.12 % 6,446 108 6.72 % Total average interest-earning assets 1,455,289 11,735 3.23 % 1,152,319 12,269 4.27 % Non-interest-earning assets: Cash and due from banks 35,907 27,271 Premises and equipment, net 6,375 6,262 Other real estate owned - 1,081 Interest receivable and other assets 50,343 35,396 Total average assets$ 1,547,914 $ 1,222,329 Liabilities and Stockholders' Equity: Interest-bearing liabilities: Interest-bearing transaction deposits 347,261 81 0.09 % 304,217 111 0.15 % Savings and MMDA's 386,804 218 0.23 % 327,631 246 0.30 % Time,$250,000 or less 38,046 57 0.60 % 42,163 56 0.53 % Time, over$250,000 13,309 29 0.87 % 16,748 39 0.93 % Total average interest-bearing liabilities 785,420 385 0.20 % 690,759 452 0.26 % Non-interest-bearing liabilities: Federal Home Loan Bank advances 5,275 - Non-interest-bearing demand deposits 595,343 396,000 Interest payable and other liabilities 18,358 15,108 Total liabilities 1,404,396 1,101,867 Total average stockholders' equity 143,518 120,462 Total average liabilities and stockholders' equity$ 1,547,914 $ 1,222,329 Net interest income and net interest margin (3)$ 11,350 3.13 %$ 11,817 4.11 %
(1) Average balances for loans include loans held-for-sale and non-accrual loans
and are net of the allowance for loan losses, but non-accrued interest
thereon is excluded. Loan interest income includes loan fees of approximately
respectively. Loan fees for the three months ended
three months ended
(2) Interest income and yields on tax-exempt securities are not presented on a
taxable-equivalent basis.
(3) Net interest margin is computed by dividing net interest income by total
average interest-earning assets.
(4) For disclosure purposes, yield /rates are annualized by dividing the number
of days in the reported period by 365. 37
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FIRST NORTHERN COMMUNITY BANCORP Distribution of Average Statements of Condition and Analysis of Net Interest Income (in thousands, except percentage amounts) Six months ended Six months ended June 30, 2020 June 30, 2019 Average Yield/ Average Yield/ Balance Interest Rate (4) Balance Interest Rate (4) Assets Interest-earning assets: Loans (1)$ 836,798 $ 18,937 4.54 %$ 737,092 $ 19,468 5.33 % Certificate of deposits 20,323 237 2.34 % 10,383 151 2.93 % Interest bearing due from banks 139,268 455 0.66 % 93,581 1,128 2.43 % Investment securities, taxable 326,667 3,424 2.10 % 296,241 3,230 2.20 % Investment securities, non-taxable (2) 18,108 224 2.48 % 11,141 120 2.17 % Other interest earning assets 6,538 207 6.35 % 6,234 223 7.21 % Total average interest-earning assets 1,347,702 23,484 3.49 % 1,154,672 24,320 4.25 % Non-interest-earning assets: Cash and due from banks 34,590 27,058 Premises and equipment, net 6,452 6,409 Other real estate owned - 1,087 Interest receivable and other assets 43,216 33,999 Total average assets$ 1,431,960 $ 1,223,225 Liabilities and Stockholders' Equity: Interest-bearing liabilities: Interest-bearing transaction deposits 339,462 239 0.14 % 307,022 237 0.16 % Savings and MMDA's 365,943 486 0.27 % 328,592 409 0.25 % Time,$250,000 or less 38,475 113 0.59 % 43,033 112 0.52 % Time, over$250,000 13,459 65 0.97 % 17,093 65 0.77 % Total average interest-bearing liabilities 757,339 903 0.24 % 695,740 823 0.24 % Non-interest-bearing liabilities: Federal Home Loan Bank Advances 2,637 - Non-interest-bearing demand deposits 513,453 395,628 Interest payable and other liabilities 18,799 14,006 Total liabilities 1,292,228 1,105,374 Total average stockholders' equity 139,732 117,851 Total average liabilities and stockholders' equity$ 1,431,960 $ 1,223,225 Net interest income and net interest margin (3)$ 22,581 3.36 %$ 23,497 4.10 %
(1) Average balances for loans include loans held-for-sale and non-accrual loans
and are net of the allowance for loan losses, but non-accrued interest
thereon is excluded. Loan interest income includes loan fees of approximately
respectively. Loan fees for the six months ended
six months ended
(2) Interest income and yields on tax-exempt securities are not presented on a
taxable-equivalent basis.
(3) Net interest margin is computed by dividing net interest income by total
average interest-earning assets.
(4) For disclosure purposes, yield /rates are annualized by dividing the number
of days in the reported period by 365. 38
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FIRST NORTHERN COMMUNITY BANCORP Distribution of Average Statements of Condition and Analysis of Net Interest Income (in thousands, except percentage amounts) Three months ended Three months ended June 30, 2020 March 31, 2020 Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Assets Interest-earning assets: Loans (1)$ 919,301 $ 9,702 4.23 %$ 754,296 $ 9,235 4.91 % Certificates of deposit 22,486 123 2.19 % 18,159 114 2.52 % Interest bearing due from banks 163,031 36 0.09 % 115,507 419 1.45 % Investment securities, taxable 324,040 1,667 2.06 % 329,293 1,757 2.14 % Investment securities, non-taxable (2) 19,929 124 2.50 % 16,287 100 2.46 % Other interest earning assets 6,502 83 5.12 % 6,574 124 7.57 % Total average interest-earning assets 1,455,289 11,735 3.23 % 1,240,116 11,749 3.80 % Non-interest-earning assets: Cash and due from banks 35,907 33,271 Premises and equipment, net 6,375 6,529 Other real estate owned - - Interest receivable and other assets 50,343 36,089 Total average assets$ 1,547,914 $ 1,316,005 Liabilities and Stockholders' Equity: Interest-bearing liabilities: Interest-bearing transaction deposits 347,261 81 0.09 % 331,663 158 0.19 % Savings and MMDA's 386,804 218 0.23 % 345,082 268 0.31 % Time,$250,000 and under 38,046 57 0.60 % 38,418 56 0.58 % Time, over$250,000 13,309 29 0.87 % 14,097 36 1.02 % Total average interest-bearing liabilities 785,420 385 0.20 % 729,260 518 0.28 % Non-interest-bearing liabilities: Federal Home Loan Bank Advances 5,275 - Non-interest-bearing demand deposits 595,343 431,675 Interest payable and other liabilities 18,358 19,236 Total liabilities 1,404,396 1,180,171 Total average stockholders' equity 143,518 135,834 Total average liabilities and stockholders' equity$ 1,547,914 $ 1,316,005 Net interest income and net interest margin (3)$ 11,350 3.13 %$ 11,231 3.63 %
(1) Average balances for loans include loans held-for-sale and non-accrual loans
and are net of the allowance for loan losses, but non-accrued interest is
excluded. Loan interest income includes loan fees of approximately
and
respectively. Loan fees for the three months ended
three months ended
(2) Interest income and yields on tax-exempt securities are not presented on a
taxable equivalent basis.
(3) Net interest margin is computed by dividing net interest income by total
average interest-earning assets.
(4) For disclosure purposes, yield/rates are annualized by dividing the number of
days in the reported period by 365. 39
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INDEX Analysis of Changes in Interest Income and Interest Expense (Dollars in thousands) Following is an analysis of changes in interest income and expense (dollars in thousands) for the three months endedJune 30, 2020 over the three months endedJune 30, 2019 , the six months endedJune 30, 2020 over the six months endedJune 30, 2019 , and the three months endedJune 30, 2020 over the three months endedMarch 31, 2020 . Changes not solely due to interest rate or volume have been allocated proportionately to interest rate and volume. Three Months Ended Six Months Ended Three Months Ended June 30, 2020 June 30, 2020 June 30, 2020 Over Over Over Three Months Ended Six Months Ended Three Months Ended June 30, 2019 June 30, 2019 March 31, 2020 Interest Interest Interest Volume Rate Change Volume Rate Change Volume Rate Change
Increase (Decrease) in Interest Income:
Loans$ 2,268 $ (2,422) $ (154) $ 2,526 $ (3,057) $ (531) $ 1,800 $ (1,333) $ 467 Certificates of Deposit 63 (25) 38 122 (36) 86 25 (16) 9 Due From Banks 219 (736) (517) 394 (1,067) (673) 123 (506) (383) Investment Securities - Taxable 167 (97) 70 340 (146) 194 (27) (63) (90) Investment Securities - Non-taxable 51 3 54 84 20 104 22 2 24 Other Assets 1 (26) (25) 11 (27) (16) (1) (40) (41)$ 2,769 $ (3,303) $ (534) $ 3,477 $ (4,313) $ (836) $ 1,942 $ (1,956) $ (14)
Increase (Decrease) in Interest Expense:
Deposits: Interest-Bearing Transaction Deposits$ 16 $ (46) $ (30) $ 29 $ (27) $ 2 $ 7 $ (84) $ (77) Savings & MMDAs 38 (66) (28) 45 32 77 28 (78) (50) Time Certificates (12) 3 (9) (64) 65 1 (1) (5) (6)$ 42 $ (109) $ (67) $ 10 $ 70 $ 80 $ 34 $ (167) $ (133) Increase (decrease) in Net Interest Income:$ 2,727 $ (3,194) $ (467) $ 3,467 $ (4,383) $ (916) $ 1,908 $ (1,789) $ 119 40
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CHANGES IN FINANCIAL CONDITION
The assets of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect a$113,611,000 or 101.9% increase in cash and cash equivalents, a$5,638,000 or 38.4% increase in certificates of deposit, a$6,899,000 or 2.0% decrease in investment securities available-for-sale, a$211,221,000 or 27.5% increase in net loans held-for-investment, and a$2,282,000 or 55.3% decrease in loans held-for-sale fromDecember 31, 2019 toJune 30, 2020 . The increase in cash and cash equivalents was primarily due to an increase in deposit balances. The increase in certificates of deposit was due to allocating the cash flows from payments on and maturities of available-for-sale securities towards additional purchases of certificates of deposit. The decrease in investment securities was primarily due to maturities and calls of available for sale securities that was allocated towards purchases of certificates of deposits. The increase in net loans held-for-investment was primarily due to PPP loans originated in the second quarter of 2020 totaling approximately$235 million which are classified as commercial loans. The decrease in loans held-for-sale was due to the timing of funding and sale of the loans held-for-sale pipeline. The liabilities of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect an increase in total deposits of$299,571,000 or 26.3% fromDecember 31, 2019 toJune 30, 2020 . The overall increase in total deposits was primarily attributable to PPP loans originated in the second quarter of 2020. The Company required PPP loans to fund to a First Northern demand deposit account which resulted in a significant increase in demand deposits during the quarter. The PPP program also resulted in new customer relationships coupled with increased savings rates as a result of current economic uncertainties. During the second quarter of 2020, the Company requested and received advances totaling$10 million through the FHLB's COVID-19 Relief and Recovery Advances Program. The advances are short-term borrowings with a 0% interest rate.
CHANGES IN RESULTS OF OPERATIONS
Interest Income
TheFederal Open Market Committee , in response to the economic effects of the pandemic, decreased the Federal Funds rate by 150 basis points to 0.00% to 0.25% during the six months endedJune 30, 2020 . Interest income on loans for the six months endedJune 30, 2020 was down 2.7% from the same period in 2019, decreasing from$19,468,000 to$18,937,000 , and was down 1.6% for the three months endedJune 30, 2020 over the same period in 2019, decreasing from$9,856,000 to$9,702,000 . The decrease in interest income on loans for the three and six months endedJune 30, 2020 was primarily due to a 79 basis point and 118 basis point decrease in loan yields, respectively. The decrease in loan yields compared to prior periods is due several factors: adjustable rate loans re-pricing at lower rates as a result of recent declines in interest rates and related indices, which is mitigated to some extent by the inclusion of interest rate floors on the majority of our variable rate loans; the accommodation of certain fixed rate loan customers to re-price their existing loans at lower rates to retain existing relationships in a competitive rate environment; an increase in non-accrual loan balances; our policy election to cease interest recognition for loans provided temporary full payment deferrals during the term of the forbearance period (generally ranging from three to six months) under Section 4013 CARES Act (see FN 2) and the origination of$235 million of PPP loans at an interest rate of 1%. Loans provided full payment deferrals under the CARES act totaled$82.7 million onJune 30, 2020 which resulted in the loss of interest income of approximately$0.9 million for the three and six months endedJune 30, 2020 . Partially offsetting these impacts was the recognition of processing fees received by the SBA related to the origination of the PPP loans. The Company received a total of approximately$7.8 million in processing fees from the SBA during the three months endedJune 30, 2020 . These fees are required to be recognized as an adjustment to the effective yield over the life of the loan. For the three and six months endedJune 30, 2020 the Bank recognized$1,981,000 of these processing fees which is included as a component of interest income on loans. The remaining balance of approximately$5.8 million will be recognized over remaining life of the PPP loans. Interest income on certificates of deposit for the six months endedJune 30, 2020 was up 57.0% from the same period in 2019, increasing from$151,000 to$237,000 , and was up 44.7% for the three months endedJune 30, 2020 over the same period in 2019, increasing from$85,000 to$123,000 . The increase in interest income on certificates of deposit for the six months endedJune 30, 2020 as compared to the same period a year ago was primarily due to an increase in average balances of certificates of deposit, which was partially offsect by a 59 basis point decrease in yield on certificates of deposit. The increase in interest income on certificates of deposit for the three months endedJune 30, 2020 as compared to the same period a year ago was primarily due to an increase in average certificates of deposit, which was partially offset by a 71 basis point decrease in yield on certificates of deposit. Interest income on interest-bearing due from banks for the six months endedJune 30, 2020 was down 59.7% from the same period in 2019, decreasing from$1,128,000 to$455,000 , and was down 93.5% for the three months endedJune 30, 2020 over the same period in 2019, decreasing from$553,000 to$36,000 . This income is primarily derived from interest on excess reserves held at theFederal Reserve . The decrease in interest income on interest-bearing due from banks for the six months endedJune 30, 2020 as compared to the same period a year ago was primarily due to reductions in the Federal Funds Rate resulting in a 177 basis point decrease in yield on interest-bearing due from banks, which was partially offset by an increase in average balances of interest-bearing due from banks. The increase in interest income on interest-bearing due from banks for the three months endedJune 30, 2020 as compared to the same period a year ago was primarily due to reductions in the Federal Funds Rate, resulting in a 214 basis point decrease in yield on interest-bearing due from banks, which was partially offset by an increase in average balances of interest-bearing due from banks. 41
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Interest income on investment securities available-for-sale for the six months endedJune 30, 2020 was up 8.9% from the same period in 2019, increasing from$3,350,000 to$3,648,000 , and was up 7.4% for the three months endedJune 30, 2020 over the same period in 2019, increasing from$1,667,000 to$1,791,000 . The increase in interest income on investment securities for the six months endedJune 30, 2020 as compared to the same period a year ago was primarily due to an increase in average investment securities, which was partially offset by an 8 basis point decrease in investment yields. The increase in interest income on investment securities for the three months endedJune 30, 2020 as compared to the same period a year ago was primarily due to an increase in average investment securities, which was partially offset by an 11 basis point decrease in investment yields. Interest income on other earning assets for the six months endedJune 30, 2020 was down 7.2% from the same period in 2019, decreasing from$223,000 to$207,000 , and was down 23.2% for the three months endedJune 30, 2020 over the same period in 2019, decreasing from$108,000 to$83,000 . This income is primarily derived from dividends received by theFederal Home Loan Bank . The decrease in interest income on other assets for the six months endedJune 30, 2020 as compared to the same period a year ago was primarily due to an 86 basis point decrease in yield on other earning assets as a result of decreased FHLB dividend rates. The decrease in interest income on other earning assets for the three months endedJune 30, 2020 as compared to the same period a year ago was primarily due to a 160 basis point decrease in yield on other earning assets as a result of decreased FHLB dividend rates.
The Company had no Federal Funds sold balances during the three and six months
ended
Interest Expense
Interest expense on deposits for the six months endedJune 30, 2020 was up 9.7% from the same period in 2019, increasing from$823,000 to$903,000 , and was down 14.8% for the three months endedJune 30, 2020 over the same period in 2019, decreasing from$452,000 to$385,000 . The increase in interest expense during the six months endedJune 30, 2020 was primarily due to an increase in the average balance of interest-bearing liabilities. The decrease in interest expense during the three months endedJune 30, 2020 was primarily due to a 6 basis point decrease in the Company's average cost of funds, which was partially offset by an increase in the average balance of interest-bearing liabilities. The Company received FHLB advances of$10 million during the three months endedJune 30, 2020 . The advances are short-term borrowings with a 0% interest rate. The Company had no FHLB advances or other borrowing balances during the three months endedJune 30, 2019 . Provision for Loan Losses Provision for loan losses totaled$1,450,000 for the six months endedJune 30, 2020 compared to no provision for loan losses for the same period in 2019. Provision for loan losses totaled$800,000 for the three months endedJune 30, 2020 compared to no provision for loan losses for the same period in 2019. The allowance for loan losses was approximately$13,631,000 or 1.36% of total loans, atJune 30, 2020 , compared to$12,356,000 , or 1.58% of total loans, atDecember 31, 2019 . The allowance for loan losses is maintained at a level considered adequate by management to provide for probable loan losses inherent in the loan portfolio. The decrease in the ratio of allowance to total loans fromDecember 31, 2019 toJune 30, 2020 was primarily due to PPP loans of approximately$232 million outstanding as ofJune 30, 2020 , which are fully guaranteed by the SBA. The increase in the provision for loan losses during the three and six months endedJune 30, 2020 compared to the same period in 2019 was due to an increase in net charge-offs, coupled with adjustments to qualitative factors resulting from the downturn in economic conditions associated with the COVID-19 pandemic.
Provision for Unfunded Lending Commitment Losses
Provision for unfunded lending commitment losses totaled$110,000 and$40,000 for the six months endedJune 30, 2020 andJune 30, 2019 , respectively. Provision for unfunded lending commitment losses totaled$10,000 and$(40,000) for the three months endedJune 30, 2020 andJune 30, 2019 , respectively. The changes in the provision for unfunded lending commitments is primarily due to adjustment to qualitative factors resulting from the downturn in economic conditions associated with the COVID-19 pandemic.
The provision for unfunded lending commitment losses is included in other non-interest expense in the Condensed Consolidated Statements of Income.
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Non-Interest Income
Non-interest income was down 6.6% for the six months endedJune 30, 2020 from the same period in 2019, decreasing from$3,530,000 to$3,297,000 . Non-interest income was down 1.4% for the three months endedJune 30, 2020 from the same period in 2019, decreasing from$1,671,000 to$1,648,000 . The decrease was primarily due to decreases in service charges on deposit accounts, mortgage brokerage income, loan servicing income, debit card income, and other income, which was partially offset by an increase in gains on sales of loans held-for-sale. The decrease in service charges on deposit accounts was primarily a result of the COVID-19 pandemic and the Bank's decision to waive overdraft/NSF fees for all business and consumer customers for an initial period of 60 days which began in March and was later extended into the third quarter. This assistance has resulted in increased fee waiver activity, reducing reported service charge income. The decrease in mortgage brokerage income was primarily a result of decreased mortgage brokerage volume. The decrease in loan servicing income was primarily due to impairment expense recognized on mortgage servicing rights asset. The decrease in debit card income was primarily due to a decrease in transaction volumes. The decrease in other income year to date was primarily due to a gain on sale of land recognized during the six months endedJune 30, 2019 that was not repeated during the same period in 2020. The increase in gains on sales of loans held-for-sale was primarily due to an increase in loan origination volumes as a result of the recent decline in interest rates and uptick in refinancing activity.
Non-Interest Expenses
Total non-interest expenses were up 1.5% for the six months ended
The increase was primarily due to increases in salaries and employee benefits, occupancy and equipment, and data processing, which was partially offset by a decrease in other real estate owned expense. The increase in salaries and employee benefits was primarily due to an increase in the number of full-time equivalent employees. The increase in occupancy and equipment expense was primarily due to rent expense and other expenses associated with the opening of an administrative office space and branch during the second half of 2019. The increase in data processing expense was primarily due to costs associated with enhanced IT infrastructure and the conversion of our online banking platform during the first half of 2020. The decrease in other real estate owned expense was due to a writedown on an other real estate owned property during the six months endedJune 30, 2019 .
Total non-interest expenses were down 3.4% for the three months ended
The decrease was primarily due to a decrease in other real estate owned expense, which was partially offset by increases in occupancy and equipment and data processing. The decrease in other real estate owned expense was due to a writedown on an other real estate owned property during the three months endedJune 30, 2019 . The increase in occupancy and equipment expense was primarily due to rent expense and other expenses associated with the opening of an administrative office space and branch during the second half of 2019. The increase in data processing expense was primarily due to costs associated with enhanced IT infrastructure and the conversion of our online banking platform during the first half of 2020. 43
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The following table sets forth other non-interest expenses by category for the
three and six months ended
(in thousands) Three Three months months Six months Six months ended ended ended ended June 30, June 30, June 30, June 30, 2020 2019 2020 2019 Other non-interest expenses Provision for (reversal of) unfunded loan commitments$ 10 $ (40 ) $ 110 $ 40 FDIC assessments 130 80 130 170 Contributions 32 61 81 127 Legal fees 125 159 209 231 Accounting and audit fees 114 114 228 224 Consulting fees 120 186 194 264 Postage expense 44 47 66 74 Telephone expense 31 31 59 64 Public relations 30 82 92 130 Training expense 16 47 43 81 Loan origination expense 65 32 110 82 Computer software depreciation 17 22 34 54 Sundry losses 15 63 79 117 Loan collection expense 68 7 102 (45 ) Interchange fees 107 150 242 259 Other non-interest expense 313 324 573 651
Total other non-interest expenses
Income Taxes The Company's tax rate, the Company's income before taxes and the amount of tax relief provided by non-taxable earnings affect the Company's provision for income taxes. Provision for income taxes decreased 30.1% for the six months endedJune 30, 2020 from the same period in 2019, decreasing from$2,813,000 to$1,967,000 , and decreased 22.8% for the three months endedJune 30, 2020 from the same period in 2019, decreasing from$1,277,000 to$986,000 . The decrease in provision for income taxes was primarily due to a decrease in pre-tax income.
Off-Balance Sheet Commitments
The following table shows the distribution of the Company's undisbursed loan commitments at the dates indicated.
(in thousands) June 30, 2020 December 31, 2019 Undisbursed loan commitments$ 196,073 $ 198,534 Standby letters of credit 2,974 2,455 Commitments to sell loans 6,688 1,240$ 205,735 $ 202,229 The reserve for unfunded lending commitments amounted to$950,000 and$840,000 as ofJune 30, 2020 andDecember 31, 2019 , respectively. The reserve for unfunded lending commitments is included in other liabilities on the Condensed Consolidated Balance Sheets. See Note 7 of the Notes to Condensed Consolidated Financial Statements of this Form 10-Q, "Financial Instruments with Off-Balance Sheet Risk," for additional information. 44
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Asset Quality
The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk-rating standards and criteria similar to those employed by state and federal banking regulatory agencies. The federal bank regulatory agencies utilize the following definitions for assets adversely classified for supervisory purposes:
• Substandard Assets - A substandard asset is inadequately protected by the
current sound worth and paying capacity of the obligor or of the collateral
pledged, if any. Assets so classified must have a well-defined weakness or
weaknesses that jeopardize the liquidation of the debt. They are characterized
by the distinct possibility that the institution will sustain some loss if the
deficiencies are not corrected.
• Doubtful Assets - An asset classified doubtful has all the weaknesses inherent
in one classified substandard with the added characteristic that the weaknesses
make collection or liquidation in full, on the basis of currently existing
facts, conditions, and values, highly questionable or improbable.
Other Real Estate Owned and loans rated Substandard and Doubtful are deemed "classified assets". This category, which includes both performing and non-performing assets, receives an elevated level of attention regarding collection.
The following tables summarize the Company's non-accrual loans net of guarantees of theState of California andU.S. Government by loan category atJune 30, 2020 andDecember 31, 2019 : AtJune 30, 2020
At
Gross Guaranteed Net Gross Guaranteed Net (in thousands) Commercial$ 450 $ 170 $ 280 $ 266 $ 170 $ 96 Commercial real estate 5,708 39 5,669 466 45 421 Agriculture 9,145 - 9,145 - - - Residential mortgage 170 - 170 172 - 172 Residential construction - - - - - - Consumer 883 - 883 253 - 253 Total non-accrual loans$ 16,356 $ 209 $ 16,147 $ 1,157 $ 215 $ 942
See Note 2 of the Notes to Condensed Consolidated Financial Statements for discussion on the Bank's policy election as a result of the CARES Act.
It is generally the Company's policy to discontinue interest accruals once a loan is past due for a period of 90 days as to interest or principal payments unless the loan is well secured and in process of collection. When a loan is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected or there is an extended period of positive performance and a high probability that the loan will continue to pay according to original terms. Non-accrual loans amounted to$16,356,000 atJune 30, 2020 and were comprised of four commercial loans totaling$450,000 , four commercial real estate loans totaling$5,708,000 , three agriculture loans totaling$9,145,000 , one residential mortgage loan totaling$170,000 , and seven consumer loans totaling$883,000 . Non-accrual loans amounted to$1,157,000 atDecember 31, 2019 and were comprised of three commercial loans totaling$266,000 , two commercial real estate loans totaling$466,000 , one residential mortgage loan totaling$172,000 and four consumer loans totaling$253,000 . If the loan is considered collateral dependent, it is generally the Company's policy to charge-off the portion of any non-accrual loan that the Company does not expect to collect by writing the loan down to the estimated net realizable value of the underlying collateral. 45
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Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Non-performing impaired loans totaled$16,356,000 and$1,157,000 as ofJune 30, 2020 andDecember 31, 2019 , respectively. The increase in non-performing impaired loans fromDecember 31, 2019 toJune 30, 2020 was primarily due to two commercial real estate loans comprising one lending relationship and three agriculture loans comprising one lending relationship. A restructuring of a loan can constitute a TDR if the Company for economic or legal reasons related to the borrower's financial difficulties grants a concession to the borrower that it would not otherwise consider. A loan that is restructured as a TDR is considered an impaired loan. Performing impaired loans, which consisted of loans modified as TDRs, totaled$2,669,000 and$3,318,000 atJune 30, 2020 andDecember 31, 2019 , respectively. The Company expects to collect all principal and interest due from performing impaired loans. These loans are not on non-accrual status. The majority of the non-performing impaired loans, in management's opinion, were adequately collateralized based on recently obtained appraised property values or were guaranteed by a governmental entity. See "Allowance for Loan Losses" below for additional information. No assurance can be given that the existing or any additional collateral will be sufficient to secure full recovery of the obligations owed under these loans. OnMarch 22, 2020 , the federal bank regulatory agencies issued joint guidance advising that the agencies have confirmed with the staff of theFinancial Accounting Standards Board that short-term modifications due to COVID-19 made on a good faith basis to borrowers who were current prior to relief, are not TDRs. The CARES Act also provided relief from TDR classification for certain COVID-19 loan modifications. The Bank elected not to classify modifications that meet the criteria under either the CARES Act or the criteria specified by the regulatory agencies as TDRs. As the following table illustrates, total non-performing assets, net of guarantees of theState of California andU.S. Government , including its agencies and its government-sponsored agencies, increased$15,205,000 or 1,614% to$16,147,000 during the first six months of 2020. Non-performing assets, net of guarantees, represented 1.0% of total assets atJune 30, 2020 . AtJune 30, 2020
At
Gross Guaranteed Net Gross Guaranteed Net (dollars in thousands) Non-accrual loans$ 16,356 $ 209 $ 16,147 $ 1,157 $ 215 $ 942 Loans 90 days past due and still accruing - - - - - - Total non-performing loans 16,356 209 16,147 1,157 215 942 Other real estate owned - - - - - - Total non-performing assets$ 16,356 $ 209 $ 16,147 $
1,157$ 215 $ 942 Non-performing loans (net of guarantees) to total loans 1.6 % 0.1 % Non-performing assets (net of guarantees) to total assets 1.0 % 0.1 % Allowance for loan and lease losses to non-performing loans (net of guarantees) 84.4 % 1,311.7 %
The Company had no loans 90 days or more past due and still accruing at
Excluding the non-performing loans cited previously, loans totaling$8,818,000 and$8,749,000 were classified as substandard or doubtful loans, representing potential problem loans atJune 30, 2020 andDecember 31, 2019 , respectively. In Management's opinion, the potential loss related to these problem loans was sufficiently covered by the Bank's existing loan loss reserve (Allowance for Loan Losses) atJune 30, 2020 andDecember 31, 2019 . The ratio of the Allowance for Loan Losses to total loans atJune 30, 2020 andDecember 31, 2019 was 1.36% and 1.58%, respectively. Other real estate owned ("OREO") consists of property that the Company has acquired by deed in lieu of foreclosure or through foreclosure proceedings, and property that the Company does not hold title to but is in actual control of, known as in-substance foreclosure. The estimated fair value of the property is determined prior to transferring the balance to OREO. The balance transferred to OREO is the estimated fair value of the property less estimated cost to sell. Impairment may be deemed necessary to bring the book value of the loan equal to the appraised value. Appraisals or loan officer evaluations are then conducted periodically thereafter charging any additional impairment to the appropriate expense account. The Company had no OREO as ofJune 30, 2020 andDecember 31, 2019 . 46
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Allowance for Loan Losses
The Company's Allowance for Loan Losses is maintained at a level believed by management to be adequate to provide for loan and other credit losses that can be reasonably anticipated. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. The Company contracts with vendors for credit reviews of the loan portfolio as well as considers current economic conditions, loan loss experience, and other factors in determining the adequacy of the reserve balance. The allowance for loan losses is based on estimates, and actual losses may vary from current estimates.
The following table summarizes the Allowance for Loan Losses of the Company
during the six months ended
Analysis of the Allowance for Loan Losses (Amounts in thousands, except percentage amounts) Six months ended Year ended June 30, December 31, 2020 2019 2019 Balance at beginning of period$ 12,356 $ 12,822 $ 12,822 Provision for loan losses 1,450 - - Loans charged-off: Commercial (184 ) (150 ) (638 ) Commercial Real Estate - - - Agriculture - - (98 ) Residential Mortgage - - - Residential Construction - - - Consumer (13 ) (15 ) (43 ) Total charged-off (197 ) (165 ) (779 ) Recoveries: Commercial 12 83 209 Commercial Real Estate - - - Agriculture - - - Residential Mortgage - 72 74 Residential Construction - 21 21 Consumer 10 5 9 Total recoveries 22 181 313 Net charge-offs (175 ) 16 (466 ) Balance at end of period$ 13,631 $ 12,838 $ 12,356 Ratio of net charge-offs to average loans outstanding during the period (annualized) (0.04 %) 0.00 % (0.06 %) Allowance for loan losses To total loans at the end of the period 1.36 % 1.72 % 1.58 % To non-performing loans, net of guarantees at the end of the period 84.4 % 814.1 % 1,311.7 % The decrease in the ratio of allowance to total loans fromDecember 31, 2019 toJune 30, 2020 was primarily due to PPP loans of approximately$232 million outstanding as ofJune 30, 2020 , which are fully guaranteed by the SBA. The increase in the provision for loan losses during the three and six months endedJune 30, 2020 compared to the same period in 2019 was due to an increase in net charge-offs, coupled with adjustments to qualitative factors resulting from the downturn in economic conditions associated with the COVID-19 pandemic. The decrease in the ratio of allowance for loan losses to non-performing loans, net of guarantees fromDecember 31, 2019 toJune 30, 2020 was primarily due to the increase in non-performing loans. The increase in non-performing impaired loans fromDecember 31, 2019 toJune 30, 2020 was primarily due to two commercial real estate loans comprising one lending relationship and three agriculture loans comprising one lending relationship. 47
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Deposits
Deposits are one of the Company's primary sources of funds. AtJune 30, 2020 , the Company had the following deposit mix: 28.2% in savings and MMDA deposits, 3.6% in time deposits, 24.9% in interest-bearing transaction deposits and 43.3% in non-interest-bearing transaction deposits. AtDecember 31, 2019 , the Company had the following deposit mix: 30.2% in savings and MMDA deposits, 4.7% in time deposits, 27.9% in interest-bearing transaction deposits and 37.2% in non-interest-bearing transaction deposits. Non-interest-bearing transaction deposits increase the Company's net interest income by lowering its cost of funds. The Company obtains deposits primarily from the communities it serves. The Company believes that no material portion of its deposits has been obtained from or is dependent on any one person or industry. The Company accepts deposits in excess of$250,000 from customers.
Maturities of time certificates of deposits of over
(in thousands) June 30, 2020 December 31, 2019 Three months or less $ 2,882 $ 4,738 Over three to twelve months 7,240 5,104 Over twelve months 3,452 6,035 Total$ 13,574 $ 15,877
Liquidity and Capital Resources
In order to serve our market area and comply with banking regulations, the Company must maintain adequate liquidity and adequate capital. Liquidity is measured by various ratios; in management's opinion, the most common is the ratio of net loans to deposits (including loans held-for-sale). This ratio was 68.3% onJune 30, 2020 . In addition, onJune 30, 2020 , the Company had the following short-term investments (based on remaining maturity and/or next repricing date):$22,451,000 in securities due within one year or less; and$60,440,000 in securities due in one to five years. To meet unanticipated funding requirements, the Company maintains short-term unsecured lines of credit with other banks which totaled$122,000,000 atJune 30, 2020 . Additionally, the Company has a line of credit with the FHLB, with a remaining borrowing capacity atJune 30, 2020 of$323,091,000 ; credit availability is subject to certain collateral requirements.
The Company's primary source of liquidity on a stand-alone basis is dividends from the Bank. Dividends from the Bank are subject to regulatory restrictions.
InJuly 2013 , the FRB and the otherU.S. federal banking agencies adopted final rules making significant changes to theU.S. regulatory capital framework forU.S. banking organizations and to conform this framework to the guidelines published by theBasel Committee on Banking Supervision ("Basel Committee") known as the Basel III Global Regulatory Framework for Capital and Liquidity. The Basel Committee is a committee of banking supervisory authorities from major countries in the global financial system which formulates broad supervisory standards and guidelines relating to financial institutions for implementation on a country-by-country basis. These rules adopted by the FRB and the other federal banking agencies (theU.S. Basel III Capital Rules) replaced the federal banking agencies' general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules, in accordance with certain transition provisions. Banks, such as First Northern, became subject to the new rules onJanuary 1, 2015 . The new rules implement higher minimum capital requirements, include a new common equity Tier 1 capital requirement, and establish criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. The final rules provide for increased minimum capital ratios as follows: (a) a common equity Tier1 capital ratio of 4.5%; (b) a Tier 1 capital ratio of 6%; (c) a total capital ratio of 8%; and (d) a Tier 1 leverage ratio to average consolidated assets of 4%. Under these rules, in order to avoid certain limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements (equal to 2.5% of total risk-weighted assets). The capital conservation buffer is designed to absorb losses during periods of economic stress. 48
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Pursuant to the Economic Growth Regulatory Relief and Consumer Protection Act (the "EGRRCPA"), the FRB adopted a final rule, effectiveAugust 31, 2018 , amending theSmall Bank Holding Company andSavings and Loan Holding Company Policy Statement (the "policy statement") to increase the consolidated assets threshold to qualify to utilize the provisions of the policy statement from$1 billion to$3 billion . Bank holding companies, such as the Company, are subject to capital adequacy requirements of the FRB; however, bank holding companies which are subject to the policy statement are not subject to compliance with the regulatory capital requirements until they hold$3 billion or more in consolidated total assets. As a consequence, as ofDecember 31, 2018 , the Company was not required to comply with the FRB's regulatory capital requirements until such time that its consolidated total assets equal$3 billion or more or if the FRB determines that the Company is no longer deemed to be a small bank holding company. However, if the Company had been subject to these regulatory capital requirements, it would have exceeded all regulatory requirements. InNovember 2019 , the bank regulatory agencies jointly adopted a final rule, that became effectiveJanuary 1, 2020 , that provided for a simple measure of capital adequacy for certain community banking organizations, consistent with the EGRRCPA. Under the rule, depository institutions and depository institution holding companies that have less than$10 billion in total consolidated assets, such as the Company and the Bank, and that meet other qualifying criteria, including a leverage ratio (equal to tier 1 capital divided by average total consolidated assets) of greater than 9 percent, are eligible to opt into the community bank leverage ratio framework. InApril 2020 , the federal bank regulatory agencies issued an interim final rule that made temporary changes to the community bank leverage ratio framework, pursuant to the CARES Act. As of the second quarter 2020, a banking organization with a leverage ratio of 8 percent or greater (and that meets other qualifying criteria) may elect to use the community bank leverage ratio framework. The temporary changes to the community bank leverage ratio framework implemented by this interim final rule will cease to be effective as of the earlier of the termination date of the national emergency concerning the coronavirus disease declared by the President onMarch 13, 2020 , orDecember 31, 2020 . Concurrently, the federal bank regulatory agencies issued an interim final rule that provides for a transition from the temporary 8 percent community bank leverage ratio requirement to the 9 percent community bank leverage ratio requirement under the final rule. Under the transition rule, the community bank leverage ratio will be 8 percent in the second quarter through fourth quarter of calendar year 2020, 8.5 percent in calendar year 2021, and 9 percent thereafter. Qualifying community banking organizations that elect to use the community bank leverage ratio framework and that maintain a leverage ratio of greater than 8 percent (subject to transition to 9 percent beginning after calendar year 2021) will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the agencies' capital rules and, if applicable, will be considered to have met the well-capitalized ratio requirements for purposes of the FDIA. At the present time, the Company does not intend to elect to use the community bank leverage framework. As ofJune 30, 2020 , the Bank's capital ratios exceeded applicable regulatory requirements. The following table presents the capital ratios for the Bank, compared to the regulatory standards for well-capitalized depository institutions, as ofJune 30, 2020 . (amounts in
thousands except percentage amounts)
Actual Well Capitalized Ratio Capital Ratio Requirement Leverage$ 134,712 8.75 % 5.0 % Common Equity Tier 1$ 134,712 15.43 % 6.5 % Tier 1 Risk-Based$ 134,712 15.43 % 8.0 % Total Risk-Based$ 145,668 16.69 % 10.0 % 49
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