First Northern Community Bancorp: Form 10-Q for the period ended Sep 30, 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 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 policies and 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 third quarter and year-to-date 2024 included:

• Net income of $14.2 million for the nine months ended September 30, 2024, down 3.3% from net income of $14.7 million earned for the same period last year. Net income of $5.5 million for the three months ended September 30, 2024, up 18.8% from net income of $4.6 million earned for the same period last year.
• Diluted income per share of $0.92 for the nine months ended September 30, 2024, down 4.2% from diluted income per share of $0.96 in the same period last year. Diluted income per share of $0.36 for the three months ended September 30, 2024, up 20.0% from diluted income per share of $0.30 for the same period last year.
• Net interest income of $47.8 million for the nine months ended September 30, 2024, down 3.6% from net interest income of $49.6 million for the same period last year. Net interest income of $16.5 million for the three months ended September 30, 2024, up 3.9% from net interest income of $15.9 million for the same period last year.
• Net interest margin of 3.60% for the nine months ended September 30, 2024, down 2.2% from net interest margin of 3.68% for the same period last year. Net interest margin of 3.65% for the three months ended September 30, 2024, up 4.0% from net interest margin of 3.51% for the same period last year.
• Provision for credit losses of $200 thousand for the nine months ended September 30, 2024, down 93.6% from $3.1 million for the same period last year. Reversal of provision for credit losses of $550 thousand for the three months ended September 30, 2024 compared to provision for credit losses of $500 thousand for the same period last year. The Company recognized a reversal of provision of $550 thousand during the three months ended September 30, 2024, primarily due to a substantial payoff of a non-performing commercial loan relationship.
• Total assets of $1.93 billion as of September 30, 2024, up 3.1% from $1.87 billion as of December 31, 2023.
• Total net loans (including loans held-for-sale) of $1.04 billion as of September 30, 2024, down 1.0% from $1.05 billion as of December 31, 2023.
• Total investment securities of $632.4 million as of September 30, 2024, up 10.5% from $572.4 million as of December 31, 2023.
• Total deposits of $1.73 billion as of September 30, 2024, up 2.3% from $1.69 billion as of December 31, 2023.

SUMMARY FINANCIAL DATA

The Company recorded net income of $14,188,000 for the nine months ended September 30, 2024, representing a decrease of $484,000, or 3.3%, from net income of $14,672,000 for the same period in 2023. The Company recorded net income of $5,488,000 for the three months ended September 30, 2024, representing an increase of $869,000, or 18.8%, from net income of $4,619,000 for the same period in 2023.

The following tables present a summary of the results for the three and nine months ended September 30, 2024 and 2023, and a summary of financial condition at September 30, 2024 and December 31, 2023.

(dollars in thousands except for per share amounts)

(in thousands except for ratios)

37

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 thereon is generally excluded. Loan interest income includes loan fees, net of deferred costs of approximately $4 and $(50) for the three months ended September 30, 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 thereon is generally excluded. Loan interest income includes loan fees, net of deferred costs of approximately $(448) and $(17) for the nine months ended September 30, 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 generally excluded. Loan interest income includes loan fees, net of deferred costs of approximately $4 and $(100) for the three months ended September 30, 2024 and June 30, 2024, 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 September 30, 2024 over the three months ended September 30, 2023, the nine months ended September 30, 2024 over the nine months ended September 30, 2023, and the three months ended September 30, 2024 over the three months ended June 30, 2024. Changes not solely due to interest rate or volume have been allocated proportionately to interest rate and volume.

41

CHANGES IN FINANCIAL CONDITION

The assets of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect a $14,707,000, or 9.9%, increase in cash and cash equivalents, a $466,000, or 2.4%, decrease in certificates of deposit, a $60,047,000, or 10.5%, increase in investment securities available-for-sale, and a $10,161,000, or 1.0%, decrease in net loans held-for-investment from December 31, 2023 to September 30, 2024. The increase in cash and cash equivalents was primarily due to an increase in deposit balances coupled with a decrease in loans due to proceeds from loan payoffs, net of loan originations, which was partially offset by an increase in investment securities due to net purchases of investment securities. The decrease in certificates of deposits was due to net maturities and repayments of certificates of deposit. The decrease in net loans held-for-investment was primarily due to net payoffs of agriculture, residential mortgage, and residential construction loans, which was partially offset by net originations of commercial, commercial real estate and consumer loans.

The liabilities of the Company set forth in the Unaudited Condensed Consolidated Balance Sheets reflect an increase in total deposits of $39,598,000, or 2.3%, from December 31, 2023 to September 30, 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 lowered the benchmark rate by 50 basis points to a target range of 4.75% - 5.00% during the quarter ended September 30, 2024.

Interest income on loans for the nine months ended September 30, 2024 was up 9.0% from the same period in 2023, increasing from $38,197,000 to $41,620,000, and was up 9.3% for the three months ended September 30, 2024 over the same period in 2023, increasing from $13,098,000 to $14,315,000. The increase in interest income on loans for the nine months ended September 30, 2024 as compared to the same period a year ago was primarily due to an increase in average balance of loans coupled with an 18 basis point increase in yield on loans. The increase in interest income on loans for the three months ended September 30, 2024 as compared to the same period a year ago was primarily due to an increase in average balance of loans coupled with a 39 basis point increase in yield on loans.

Interest income on certificates of deposit for the nine months ended September 30, 2024 was down 2.5% from the same period in 2023, decreasing from $556,000 to $542,000, and was down 3.1% for the three months ended September 30, 2024 over the same period in 2023, decreasing from $194,000 to $188,000. The decrease in interest income on certificates of deposit for the nine months ended September 30, 2024 as compared to the same period a year ago was primarily due to a decrease in average balances of certificates of deposit, which was partially offset by a 52 basis point increase in yield on certificates of deposit. The decrease in interest income on certificates of deposit for the three months ended September 30, 2024 as compared to the same period a year ago was primarily due to a decrease in average balances of certificates of deposit, which was partially offset by a 44 basis point increase in yield on certificates of deposit.

Interest income on interest-bearing due from banks for the nine months ended September 30, 2024 was down 20.8% from the same period in 2023, decreasing from $6,411,000 to $5,077,000, and was down 12.7% for the three months ended September 30, 2024 over the same period in 2023, decreasing from $1,870,000 to $1,632,000. The decrease in interest income on interest-bearing due from banks for the nine months ended September 30, 2024 as compared to the same period a year ago was primarily due to a decrease in average balances of interest-bearing due from banks, which was partially offset by a 42 basis point increase in yield on interest-bearing due from banks. The decrease in interest income on interest-bearing due from banks for the three months ended September 30, 2024 as compared to the same period a year ago was primarily due to a decrease in average balances of interest-bearing due from banks, which was partially offset by a 12 basis point increase in yield on interest-bearing due from banks.

Interest income on investment securities available-for-sale for the nine months ended September 30, 2024 was up 18.5% from the same period in 2023, increasing from $8,733,000 to $10,344,000, and was up 35.2% for the three months ended September 30, 2024 over the same period in 2023, increasing from $2,884,000 to $3,898,000. The increase in interest income on investment securities for the nine months ended September 30, 2024 as compared to the same period a year ago was primarily due to a 49 basis point increase in investment yields, which was partially offset by a decrease in average investment securities. The increase in interest income on investment securities for the three months ended September 30, 2024 as compared to the same period a year ago was primarily due to a 65 basis point increase in investment yields coupled with an increase in average investment securities.

Interest income on other earning assets for the nine months ended September 30, 2024 was up 40.8% from the same period in 2023, increasing from $557,000 to $784,000, and was up 22.0% for the three months ended September 30, 2024 over the same period in 2023, increasing from $214,000 to $261,000. This income is primarily derived from dividends received from the Federal Home Loan Bank. The increase in interest income on other earning assets for the nine months ended September 30, 2024 as compared to the same period a year ago was primarily due to a 250 basis point increase in yield on other earning assets coupled with an increase in average balances of other earning assets. The increase in interest income on other earning assets for the three months ended September 30, 2024 as compared to the same period a year ago was due to a 180 basis point increase in yield on other earning assets.

The Company had no Federal Funds sold balances during the three and nine months ended September 30, 2024 and September 30, 2023.

Interest Expense

Interest expense on deposits for the nine months ended September 30, 2024 was up 118.6% from the same period in 2023, increasing from $4,817,000 to $10,531,000, and was up 59.2% for the three months ended September 30, 2024 over the same period in 2023, increasing from $2,386,000 to $3,798,000. The increase in interest expense for the nine months ended September 30, 2024 as compared to the same period a year ago was primarily due to an 81 basis point increase in average interest-bearing deposit yield, which was partially offset by a decrease in average balance of interest-bearing liabilities. The increase in interest expense for the three months ended September 30, 2024 as compared to the same period a year ago was primarily due to a 59 basis point increase in average interest-bearing deposit yield, which was partially offset by a decrease in average balance of interest-bearing liabilities.

Provision for Credit Losses

Provision for credit losses for the nine months ended September 30, 2024 was down 93.6% from the same period in 2023, decreasing from $3,100,000 to $200,000, and was down 210.0% for the three months ended September 30, 2024 over the same period in 2023, decreasing from $500,000 to a reversal of provision of $550,000. The levels of forecasted national unemployment and forecasted gross domestic product remained relatively stable during the three and nine months ended September 30, 2024. The Company recognized a reversal of provision of $550 thousand during the three months ended September 30, 2024, primarily due to a substantial payoff of a non-performing commercial loan relationship.

Non-Interest Income

Non-interest income was down 26.4% for the nine months ended September 30, 2024 from the same period in 2023, decreasing from $6,155,000 to $4,529,000. The decrease was primarily driven by a bargain purchase gain recognized during the nine months ended September 30, 2023. The Company recognized a bargain purchase gain totaling approximately $1.4 million resulting from the acquisition of the Colusa, Willows, and Orland branches located in California in the first quarter of 2023.

Non-interest income was down 13.4% for the three months ended September 30, 2024 from the same period in 2023, decreasing from $1,776,000 to $1,538,000. The decrease was primarily due to decreases in other income and losses on sales of securities.

Non-Interest Expenses

Total non-interest expenses were down 0.2% for the nine months ended September 30, 2024 from the same period in 2023, decreasing from $32,534,000 to $32,460,000. The decrease was primarily due to a decrease in salaries and employee benefits, which was partially offset by increases in occupancy and equipment and other expenses. The decrease in salaries and employee benefits was primarily due to a decrease in full-time equivalent employees and decreases in contingent compensation and profit sharing expense. The increase in occupancy and equipment expenses was primarily due to an increase in depreciation expense due to a full nine months of expenses related to the acquired branches in the first quarter of 2023. The increase in other expenses was primarily due to increases in loan collection expenses, which was partially offset by a decrease in legal fees.

Total non-interest expenses were up 0.5% for the three months ended September 30, 2024 from the same period in 2023, increasing from $10,883,000 to $10,934,000. The decrease was primarily due to a decrease in salaries and employee benefits, which was partially offset by an increase in occupancy and equipment and data processing expense. The decrease in salaries and employee benefits was primarily due to a decrease in full-time equivalent employees. The increase in occupancy and equipment and data processing expense was primarily due to increases in service contracts partially due to a full year of additional processing related to new branches acquired in the first quarter of 2023.

The following table sets forth other non-interest expenses by category for the three and nine months ended September 30, 2024 and 2023.

(in thousands)

44

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 increased 0.6% for the nine months ended September 30, 2024 from the same period in 2023, increasing from $5,486,000 to $5,517,000, and increased 31.2% for the three months ended September 30, 2024 from the same period in 2023, increasing from $1,648,000 to $2,162,000. The effective tax rate was 28.0% and 27.2% for the nine months ended September 30, 2024 and September 30, 2023, respectively. The effective tax rate was 28.3% and 26.3% for the three months ended September 30, 2024 and September 30, 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 $950,000 and $1,150,000 as of September 30, 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 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 table summarizes the Company’s non-accrual loans net of guarantees of the State of California and U.S. Government by loan category at September 30, 2024 and December 31, 2023:

(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 $4,015,000 at September 30, 2024 and were comprised of one commercial loan totaling $139,000, one commercial real estate loan totaling $466,000, two agriculture loans totaling $2,380,000, four residential mortgage loans totaling $469,000 and three consumer loans totaling $561,000. 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 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 agencies, decreased $4,410,000, or 52.9%, to $3,924,000 during the first nine months of 2024. Non-performing assets, net of guarantees, represented 0.2% of total assets at September 30, 2024.

(dollars in thousands)

The Company had one loan totaling $48,000 that was 90 days or more past due and still accruing as of September 30, 2024. The Company had two loans totaling $4,336,000 that were 90 days or more past due and still accruing as of December 31, 2023.

Excluding the non-performing loans, net of guaranteed loans cited previously, loans totaling $13,876,000 and $12,327,000 were classified as substandard or doubtful loans, representing potential problem loans at September 30, 2024 and December 31, 2023, respectively. Management believes that the allowance for credit losses at September 30, 2024 and December 31, 2023 appropriately reflected expected credit losses in the loan portfolio at that date. The ratio of the allowance for credit losses to total loans was 1.55% at each of the periods ended September 30, 2024 and December 31, 2023.

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 September 30, 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 nine months ended September 30, 2024 and 2023, and for the year ended December 31, 2023:

Analysis of the Allowance for Credit Losses

(Amounts in thousands, except percentage amounts)

48

Deposits

Deposits are one of the Company’s primary sources of funds. At September 30, 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 from customers. These deposits are priced to remain competitive.

Maturities of time certificates of deposit of over $250,000 outstanding at September 30, 2024 and December 31, 2023 are summarized as follows:

(in thousands)

Approximately 40% and 37% of our deposits were uninsured as of September 30, 2024 and December 31, 2023, respectively.

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 Statements of Cash Flows. For the nine months ended September 30, 2024, net liquidity used in investing activities totaled $35,296,000.

The Company’s available-for-sale investment securities plus cash and cash equivalents in excess of reserve requirements and certificates of deposit totaled $815,566,000 on September 30, 2024, which was 42.2% of assets at that date. This was an increase of $74,288,000 from $741,278,000 and 39.6% of assets 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 September 30, 2024, the effective duration of our investment securities was 3.06 with projected principal cashflow of $50,012,000 for the remainder of 2024 available for reinvestment or liquidity needs. The Company had no held-to-maturity securities as of September 30, 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 Statements of Cash Flows. As of September 30, 2024, the Company had $0 in borrowings outstanding. For the nine months ended September 30, 2024, net liquidity provided by financing activities totaled $36,796,000, primarily due to a net increase in deposits. 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 nine months ended September 30, 2024, operating activities provided cash of $13,207,000.

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 60.2% and 62.2% as of September 30, 2024 and December 31, 2023, respectively.

Loan demand during the remainder of 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 the remainder of 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 September 30, 2024. Additionally, the Company has a line of credit with the FHLB, with a remaining borrowing capacity at September 30, 2024 of $394,192,000; 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 September 30, 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, excluding the capital conservation buffer, as of September 30, 2024.

(amounts in thousands except percentage amounts)

51

The Company believes that there have been no material changes in the quantitative and qualitative disclosures about market risk as of September 30, 2024, from those presented in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023, which are incorporated by reference herein.

(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 September 30, 2024. This conclusion is based on an evaluation conducted under the supervision and with the participation of management.

(b) During the quarter ended September 30, 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 Form 10-K, which is incorporated by reference herein, and to the following:

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 September 30, 2024, loans secured by real estate comprised approximately 87% of the total loans in the Bank’s portfolio. At September 30, 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. In August 2024, the California Department of Insurance issued proposed regulations intended to cause insurance companies to write more policies in wildfire distressed areas of California as a condition for using forward-looking wildfire modeling designed to more accurately assess wildfire risks and to reverse FAIR Plan growth. 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.

Increases in the Allowance for Credit Losses Would Adversely Affect the Bank’s Financial Condition and Results of Operations

The Bank’s allowance for credit losses on loans was approximately $16.4 million, or 1.55% of total loans, at September 30, 2024, compared to $16.6 million, or 1.55% of total loans, at December 31, 2023, and 418.5% of total non-performing loans net of guaranteed portions at September 30, 2024, compared to 199.1% of total non-performing loans, net of guaranteed portions at December 31, 2023. Reversal of provision for credit losses totaling $550 thousand and provision for credit losses totaling $500 thousand for the three-month periods ended September 30, 2024 and September 30, 2023, respectively. Provision for credit losses totaling $200 thousand and $3.1 million for the nine-month periods ended September 30, 2024 and September 30, 2023, respectively.

Material future additions to the allowance for estimated losses on loans may be necessary if material adverse changes in economic conditions in our markets were to continue to occur and the performance of the Bank’s loan portfolio were to deteriorate.

Other real estate owned is initially recorded at fair value less estimated costs to sell the property, thereby establishing the new cost basis of other real estate. Losses arising at the time of acquisition of such properties are charged against the allowance for credit losses. Subsequent to acquisition, such properties are carried at the lower of cost or fair value less estimated selling expenses, determined on an individual asset basis. Any deficiency resulting from the excess of cost over fair value less estimated selling expenses is recognized as a valuation allowance. Any subsequent increase in fair value up to its cost basis is recorded as a reduction of the valuation allowance. The FDIC and the California DFPI, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses on loans and the carrying value of its assets. Increases in the provision for credit losses on loans and valuation allowance on foreclosed assets would adversely affect the Bank’s financial condition and results of operations.

The Bank’s Dependence on Real Estate Lending Increases Our Risk of Losses

The Bank’s primary lending focus has historically been commercial (including agricultural), construction, and real estate mortgage. At September 30, 2024, loans secured by real estate comprised approximately 87% of the total loans in the Bank’s portfolio. At September 30, 2024, all of the Bank’s real estate mortgage and construction loans and approximately 1% of its commercial loans were secured fully or in part by deeds of trust on underlying real estate. The Company’s dependence on real estate increases the risk of loss in both the Bank’s loan portfolio and its holdings of other real estate owned if economic conditions in Northern California were to deteriorate. Deterioration of the real estate market in Northern California would have a material adverse effect on the Company’s business, financial condition, and results of operations.

The CFPB has adopted various regulations which have impacted, and will continue to impact, our residential mortgage lending business.