First Northern Community Bancorp: Form 10-Q for the period ended Mar 31, 2024

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, if any, and expectations. See Part I, Item 1A. “Risk Factors,” and the other risks described in our 2023 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 our Securities 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 SEC filings or other public statements, for example, we make forward-looking statements relating to the following topics, among others:

• 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
• Legal and regulatory actions, and future legislative and regulatory developments, including the effects of the Dodd-Frank Wall Street 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 U.S. economy
• 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 2008 financial crisis by the U.S. federal banking agencies and our current intention not to elect to use the community bank leverage ratio 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, expectations regarding collections and the timing thereof
• 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 credit losses, underwriting standards, and risk grading
• 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, loan demand, our strategy regarding loan modifications, delinquency rates and our underwriting standards and our expectations regarding our recognition of interest income on loans that were provided payment deferrals upon completion of the payment forbearance period
• Our deposit base including renewal of time deposits and the outlook for deposit balances
• The impact on our net interest income and net interest margin of changes in interest rates
• The effect of possible changes in the initiatives and policies of the federal and state bank regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, the Securities and Exchange Commission and other standard setters
• Tax rates and the impact of changes in the U.S. tax laws
• Our pension and retirement plan costs
• Our liquidity strategies and beliefs concerning the adequacy of our liquidity, sources and amounts of funds and ability to satisfactorily manage our liquidity
• 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 or other natural 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
• Possible changes in the fair values recorded on our financial statements of the assets acquired and liabilities assumed in our business combination completed in January 2023
• The possible effects on community banks and our business from the failures of other banks
• The possible adverse impacts on the banking industry and our business from a period of significant, prolonged inflation
• 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 2023 Annual Report on Form 10-K, and in our other reports to the SEC.

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 the Securities 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 ended December 31, 2023.

Our subsidiary, First Northern Bank of Dixon (the “Bank”), is a California state-chartered bank that derives most of its revenues from lending and deposit taking in the Sacramento Valley region of Northern 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 first quarter 2024 included:

• Net income of $4.3 million for the three months ended March 31, 2024, down 22.1% from $5.5 million earned for the same period last year. Net income for the three months ended March 31, 2023 includes a pre-tax bargain purchase gain totaling approximately $1.4 million.
• Diluted earnings per share of $0.28 for the three months ended March 31, 2024, down 22.2% from $0.36 for the three months ended March 31, 2023.
• Net interest income of $15.4 million for the three months ended March 31, 2024, down 3.9% from $16.0 million in the same period last year.
• Net interest margin of 3.49% for the three months ended March 31, 2024, down 1.70% from 3.55% for the three months ended March 31, 2023.
• Reversal of provision for credit losses of $0.3 million for the three months ended March 31, 2024, compared to no provision for credit losses for the three months ended March 31, 2023.
• Total assets of $1.89 billion as of March 31, 2024, up 0.8% from $1.87 billion as of December 31, 2023.
• Total net loans (including loans held-for-sale) of $1.047 billion as of March 31, 2024, down 0.5% from $1.052 billion as of December 31, 2023.
• Total investment securities of $558.4 million as of March 31, 2024, down 2.4% from $572.4 million as of December 31, 2023.
• Total deposits of $1.71 billion as of March 31, 2024, up 1.0% from $1.69 billion as of December 31, 2023.

SUMMARY

The Company recorded net income of $4,276,000 for the three months ended March 31, 2024, representing a decrease of $1,213,000 from net income of $5,489,000 for the same period in 2023. Net income for the three months ended March 31, 2023 includes a pre-tax bargain purchase gain totaling approximately $1.4 million.

The following tables present a summary of the results for the three months ended March 31, 2024 and 2023, and a summary of our financial condition at March 31, 2024 and December 31, 2023:

(in thousands except for per share amounts and ratios)

(in thousands except for ratios)

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Distribution of Average Statements of Condition and Analysis of Net Interest Income

(in thousands, except percentage amounts)

(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, net of deferred costs of approximately $(351) and $(36) for the three months ended March 31, 2024 and 2023, respectively.

(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.

Distribution of Average Statements of Condition and Analysis of Net Interest Income

(in thousands, except percentage amounts)

(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, net of deferred costs of approximately $(351) and $141 for the three months ended March 31, 2024 and December 31, 2023, respectively.

(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.

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 ended March 31, 2024 over the three months ended March 31, 2023 and the three months ended March 31, 2024 over the three months ended December 31, 2023. Changes not solely due to interest rate or volume have been allocated proportionately to interest rate and volume.

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CHANGES IN FINANCIAL CONDITION

The assets of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect a $37,698,000 or 25.3% increase in cash and cash equivalents, a $1,525,000 or 7.7% decrease in certificates of deposit, a $13,916,000 or 2.4% decrease in investment securities available-for-sale, and a $5,169,000 or 0.5% decrease in net loans held-for-investment from December 31, 2023 to March 31, 2024. The increase in cash and cash equivalents was primarily due to an increase in deposit balances coupled with decreases in investment securities and loans due to proceeds from maturities of available-for-sale securities and loan payoffs. The decreases in investment securities and certificates of deposit were due to maturities and repayments of investment securities and certificates of deposit. The decrease in net loans held-for-investment was primarily due to payoffs of agriculture loans, which was partially offset by originations of commercial, commercial real estate, residential mortgage and consumer loans.

The liabilities of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect an increase in total deposits of $16,428,000 or 1.0% from December 31, 2023 to March 31, 2024. The overall increase in total deposits was primarily due to seasonal fluctuations due to changes in market conditions and monetary policy.

CHANGES IN RESULTS OF OPERATIONS

Interest Income

The Federal Open Market Committee kept the Federal Reserve's benchmark rate range at 5.25% to 5.50% during the three months ended March 31, 2024.

Interest income on loans for the three months ended March 31, 2024 was up 18.4% from the same period in 2023, increasing from $11,377,000 to $13,475,000. The increase in interest income on loans for the three months ended March 31, 2024 as compared to the same period a year ago was primarily due to an increase in average balance of loans coupled with a 37 basis point increase in yield on loans.

Interest income on certificates of deposit for the three months ended March 31, 2024 was up 4.6% from the same period in 2023, increasing from $175,000 to $183,000. The increase was primarily due to a 56 basis point increase in certificates of deposit yields, which was partially offset by a decrease in average balances of certificates of deposit.

Interest income on interest-bearing due from banks for the three months ended March 31, 2024 was down 31.2% from the same period in 2023, decreasing from $2,225,000 to $1,532,000. The decrease was primarily due to a decrease in average interest-bearing due from banks balance, which was partially offset by a 62 basis point increase in interest-bearing due from yields.

Interest income on investment securities available-for-sale for the three months ended March 31, 2024 was up 4.8% from the same period in 2023, increasing from $2,956,000 to $3,097,000. The increase was primarily due to a 29 basis point increase in yields on investment securities, which was partially offset by a decrease in average balances of investment securities.

The Company had no Federal Funds sold balances during the three months ended March 31, 2024 and March 31, 2023.

Interest Expense

Interest expense on deposits for the three months ended March 31, 2024 was up 242.0% from the same period in 2023, increasing from $930,000 to $3,181,000. The increase in interest expense was primarily due to a 97 basis point increase in average interest-bearing deposits yield, which was partially offset by a decrease in average deposits.

Provision for Credit Losses

There was a reversal of provision for credit losses of $300,000 for the three months ended March 31, 2024, compared to no provision for credit losses for the three months ended March 31, 2023. The allowance for credit losses was approximately $16,246,000, or 1.52% of total loans, at March 31, 2024, compared to $16,596,000, or 1.55% of total loans, at December 31, 2023. During the quarter ended March 31, 2024, the levels of forecasted national unemployment and forecasted gross domestic product remained relatively stable. Those factors, coupled with a decrease in loans, were the reasons for the reversal of provision for credit losses for the quarter ended March 31, 2024.

Provision for Unfunded Lending Commitment Losses

There was a reversal of provision for unfunded lending commitment losses of $50,000 for the three months ended March 31, 2024, compared to no provision for unfunded lending commitments for the three months ended March 31, 2023.

Provisions for unfunded lending commitment losses are included in provision for credit losses in the Condensed Consolidated Statements of Income.

Non-Interest Income

Non-interest income was down 47.6% for the three months ended March 31, 2024 from the same period in 2023, decreasing from $2,873,000 to $1,507,000.

The decrease was primarily due to the bargain purchase gain totaling approximately $1.4 million recognized during the three months ended March 31, 2023. The bargain purchase gain was the result of the acquisition of the Colusa, Willows, and Orland branches in the first quarter of 2023.

Non-Interest Expenses

Total non-interest expenses were down 0.5% for the three months ended March 31, 2024 from the same period in 2023, decreasing from $11,284,000 to $11,227,000.

The decrease was primarily due to decreases in salaries and employee benefits, which was partially offset by increases in occupancy and equipment expenses. The decrease in salaries and employee benefits was primarily due to a decrease in profit sharing expense. The increase in occupancy and equipment expenses was partially due to a full quarter of expenses related to the acquired branches in the first quarter of 2023.

The following table sets forth other non-interest expenses by category for the three months ended March 31, 2024 and 2023.

(in thousands)

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 19.9% for the three months ended March 31, 2024 from the same period in 2023, decreasing from $2,081,000 to $1,666,000 primarily due to a decrease in pre-tax income. The effective tax rate was 28.0% and 27.5% for the three months ended March 31, 2024 and March 31, 2023, respectively.

Off-Balance Sheet Commitments

The following table shows the distribution of the Company’s undisbursed loan commitments at the dates indicated.

(in thousands)

The reserve for unfunded lending commitments amounted to $1,100,000 and $1,150,000 as of March 31, 2024 and December 31, 2023, 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.

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 the State of California and U.S. Government, including its agencies and its government-sponsored enterprises, by loan category at March 31, 2024 and December 31, 2023:

(dollars in thousands)

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 $8,784,000 at March 31, 2024 and were comprised of one commercial loan totaling $139,000, two agriculture loans totaling $2,728,000, four residential mortgage loans totaling $1,315,000, one residential construction loan totaling $4,000,000 and three consumer loans totaling $602,000. Non-accrual loans amounted to $3,998,000 at December 31, 2023 and were comprised of two agriculture loans totaling $2,871,000, three residential mortgage loans totaling $424,000 and four consumer loans totaling $703,000.

A loan is considered to be collateral dependent when repayment is expected to be provided substantially through the operation or sale of the collateral. The allowance for credit losses, or ACL, on collateral dependent loans is measured using the fair value of the underlying collateral, adjusted for costs to sell when applicable, less the amortized cost basis of the financial asset. It is generally the Company’s policy that if the value of the underlying collateral is determined to be less than the recorded amount of the loan, a charge-off will be taken.

As the following table illustrates, total non-performing assets, net of guarantees of the State of California and U.S. Government, including its agencies and its government-sponsored enterprises, increased $450,000 or 5.4% to $8,784,000 during the first three months of 2024. Non-performing assets, net of guarantees, represented 0.5% of total assets at March 31, 2024.

(dollars in thousands)

The Company had no loans 90 days or more past due and still accruing interest at March 31, 2024. The Company had two loans totaling $4,336,000 that were 90 days or more past due and still accruing at December 31, 2023.

Excluding the non-performing loans cited previously, loans totaling $18,438,000 and $12,327,000 were classified as substandard loans, representing potential problem loans at March 31, 2024 and December 31, 2023, respectively. Management believes that the allowance for credit losses at March 31, 2024 and December 31, 2023 appropriately reflected expected credit losses inherent in the loan portfolio at that date. The ratio of the allowance for credit losses to total loans at March 31, 2024 and December 31, 2023 was 1.52% and 1.55%, 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 of March 31, 2024 and December 31, 2023.

Allowance for Credit Losses (ACL)

The Company's ACL is maintained at a level believed by management to appropriately reflect expected credit losses inherent in the loan portfolio. The ACL 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 and utilizes historical loss trends and the remaining contractual lives of the loan portfolios to determine estimated credit losses through a reasonable and supportable forecast period. The ACL is based on estimates, and actual losses may vary from current estimates.

The following table summarizes the ACL of the Company during the three months ended March 31, 2024 and 2023, and for the year ended December 31, 2023:

Analysis of the Allowance for Credit Losses

(Amounts in thousands, except percentage amounts)

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Deposits

Deposits are one of the Company’s primary sources of funds. At March 31, 2024 and December 31, 2023, the Company had the following deposit mix:

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 (the current FDIC insurance limit) from customers. These deposits are priced to remain competitive.

Maturities of time certificates of deposits of over $250,000 or more outstanding at March 31, 2024 and December 31, 2023 are summarized as follows:

(in thousands)

Approximately 37% of our deposits were uninsured as of each of the periods ended March 31, 2024 and December 31, 2023.

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 refers to the Company’s ability to provide funds at an acceptable cost to meet loan demand and deposit withdrawals, as well as contingency plans to meet unanticipated funding needs or loss of funding sources. These objectives can be met from either the asset or liability side of the balance sheet.

Asset liquidity sources consist of the repayments and maturities of loans, selling of loans, short-term money market investments, maturities of securities and sales of securities from the available-for-sale portfolio. These activities are generally summarized as investing activities in the Condensed Consolidated Statement of Cash Flows. For the three months ended March 31, 2024, net liquidity provided by investing activities totaled $18,626,000.

The Company’s available-for-sale investment securities plus cash and cash equivalents in excess of reserve requirements and certificates of deposit totaled $763,535,000 on March 31, 2024, which was 40.5% of assets at that date. This was an increase of $22,257,000 from $741,278,000 and 39.6% as of December 31, 2023. The Company’s investment securities are generally shorter term in nature to provide ongoing cash flows for liquidity needs and/or reinvestment for interest rate risk management. On March 31, 2024, the effective duration of our investment securities was 2.99 with projected principal cashflow of $128,448,000 for the remainder of 2024 available for reinvestment or liquidity needs. The Company had no held-to-maturity securities as of March 31, 2024 and December 31, 2023.

Liquidity may also be impacted from liabilities through changes in deposits and borrowings outstanding. These activities are included under financing activities in the Condensed Consolidated Statement of Cash Flows. As of March 31, 2024, the Company had $0 in borrowings outstanding. For the three months ended March 31, 2024, net liquidity provided by financing activities totaled $16,421,000. While these sources of funds are expected to continue to provide significant amounts of funds in the future, their mix, as well as the possible use of other sources, will depend on future economic and market conditions.

Liquidity is also provided or used through the results of operating activities. For the three months ended March 31, 2024, operating activities provided cash of $2,651,000.

Liquidity is measured by various ratios, in management’s opinion, the most common being the ratio of net loans to deposits (including loans held-for-sale). This ratio was 61.3% and 62.2% as of March 31, 2024 and December 31, 2023, respectively.

Loan demand during 2024 will depend in part on economic and competitive conditions. The Company emphasizes the solicitation of non-interest-bearing demand deposits and money market checking accounts, which are the least sensitive to interest rates. The outlook for deposit balances during 2024 is subject to actions by the Federal Reserve and heightened competition.

To meet unanticipated funding requirements, the Company maintains short-term unsecured lines of credit with other banks which totaled $130,000,000 at March 31, 2024. Additionally, the Company has a line of credit with the FHLB, with a remaining borrowing capacity at March 31, 2024 of $404,630,000; 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.

In July 2013, the FRB and the other U.S. federal banking agencies adopted final rules making significant changes to the U.S. regulatory capital framework for U.S. banking organizations and to conform this framework to the guidelines published by the 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 (the U.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 final rules on January 1, 2015. The final 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 Tier 1 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.

Pursuant to the EGRRCPA, the FRB adopted a final rule, effective August 31, 2018, amending the Small Bank Holding Company and Savings 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 of December 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.

In August of 2020, the Federal banking agencies adopted the final version of the community bank leverage ratio framework rule (the “CBLR”), implementing two interim final rules adopted in April of 2020. The rule provides an optional, simplified measure of capital adequacy. Under the optional CBLR framework, the CBLR was 8.5 percent through calendar year 2021 and is 9 percent thereafter. The rule is applicable to all non-advanced approaches FDIC-supervised institutions with less than $10 billion in total consolidated assets. Banks not electing the CBLR framework will continue to be subject to the generally applicable risk-based capital rule. At the present time, the Company and the Bank do not intend to elect to use the CBLR framework.

As of March 31, 2024, 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 of March 31, 2024.

(amounts in thousands except percentage amounts)

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(a) We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission 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 timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also 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. Our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) have concluded that the design and operation of our disclosure controls and procedures are effective as of March 31, 2024. This conclusion is based on an evaluation conducted under the supervision and with the participation of management.

(b) During the quarter ended March 31, 2024, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

For a discussion of risk factors relating to our business, please refer to Part I, Item 1A of our 2023 Report on Form 10-K, which is incorporated by reference herein.

Several of California’s Largest Home Insurance Providers Have Recently Paused or Severely Limited Their Issuance of New Policies, or Their Renewal of Existing Policies, in the State, Which Could Increase the Bank’s Risk of Loss in its Loan Portfolio

At March 31, 2024, real estate mortgage (excluding loans held-for-sale) and construction loans (residential and other) comprised approximately 89% and 3%, respectively, of the principal amount of total loans in the Bank’s portfolio. At March 31, 2024, all of the Bank’s real estate mortgage and construction loans were secured fully or in part by deeds of trust on underlying real estate. Most of the Company’s customers, including its loan customers, are located in the State of California.

Recently, several of California’s largest home insurance providers, including State Farm, Allstate, Farmers, USAA, Travelers, Nationwide and Chubb, have either paused or severely limited their issuance of new policies, or their renewal of existing policies, in the state. Mounting claims from wildfire damages, the increasing cost of building and repairing homes in California, and a steep increase in reinsurance premiums, as well as state insurance regulations that make it difficult for insurers to adjust premiums in response to the evolving risk landscape, have challenged the capacity of insurance companies to sustainably and profitably offer home insurance in California. The result of these actions has been to significantly limit the availability of home insurance in California, where homeowners already face escalating property values and high wildfire, seismic, severe weather and other risks.

The California Department of Insurance enforces some safeguards to temporarily shield homeowners from the cancellation or non-renewal of home insurance policies in high-risk areas, particularly those prone to wildfires. In addition, the California Fair Access to Insurance Requirements (FAIR) Plan, a state-established risk pool, operates as an insurer of last resort, providing temporary coverage for California homeowners unable to obtain (generally at increased premium cost) such coverage from a traditional insurance carrier; however, enrollment in the FAIR Plan as a percentage of the total number of residential insurance policies in California has steadily increased over the past five years, particularly in counties with the highest wildfire risk, threatening the ongoing stability of the Plan. In late 2023, following the California Governor’s declaration of a State of Emergency regarding property insurance, the Insurance Commissioner of the State of California introduced a comprehensive package of executive actions aimed at insurance reform; however, there can be no assurance that these regulatory actions will increase insurance availability or stabilize and strengthen California’s insurance market.

Many homeowners in the State of California have been negatively impacted by the contraction of insurance options in the State and the resulting lack of access to affordable home insurance, which could adversely impact the ability of prospective homebuyers to obtain insurance, and escalating premiums and limited coverage options could result in limiting coverage in the event of loss. If any loss suffered by a loan customer of the Bank is not insured or exceeds applicable insurance limits, this could increase the risk of loss in the Bank’s loan portfolio, which could have a material adverse effect on the Company’s business, financial condition, and results of operations. For additional information, see “The Bank’s Dependence on Real Estate Lending Increases Our Risk of Losses” in Part I, Item 1A “Risk Factors” in our 2023 Annual Report on Form 10-K.