PLUMAS BANCORP

In July, 2013, the federal bank regulatory agencies adopted rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks, sometimes called “Basel III,” that increased the minimum regulatory capital requirements for bank holding companies and banks and implemented strict eligibility criteria for regulatory capital instruments. The Basel III capital rules include a minimum common equity Tier 1 ratio of 4.5%, a Tier 1 capital ratio of 6.0%, a total risk-based capital ratio of 8.0%, and a minimum leverage ratio of 4.0% (calculated as Tier 1 capital to average consolidated assets). The minimum capital levels required to be considered “well capitalized” include a common equity Tier 1 ratio of 6.5%, a Tier 1 risk-based capital ratio of 8.0%, a total risk-based capital ratio of 10.0%  and a leverage ratio of 5.0%.  In addition, the Basel III capital rules require that banking organizations maintain an “a capital conservation buffer” of 2.5% above the minimum capital requirements in order to avoid restrictions on their ability to pay dividends, repurchase stock or pay discretionary bonuses. Including the capital conservation buffer of 2.5%, the Basel III capital rules require the following minimum ratios for a bank holding company or bank to be considered well capitalized: a common equity Tier 1 capital ratio of 7.0%; a Tier 1 capital ratio of 8.5%, and a total capital ratio of 10.5%. At December 31, 2019, the Company’s and the Bank’s capital ratios exceed the thresholds necessary to be considered “well capitalized” under the Basel III framework.

In a period of rising interest rates, the interest income the Company earns on its assets may not increase as rapidly as the interest expense it incurs on its liabilities.   Likewise, in a period of falling interest rates, the interest expense the Company incurs on its liabilities may not decrease as rapidly as the interest income earned on its assets. Historically, the Company’s liabilities have shorter contractual maturities than its assets. This creates a potential imbalance as interest change over time, which can create significant earnings volatility. In addition, in a prolonged low interest rate environment, the difference between the total interest income earned on interest earning assets and the total interest expense incurred on interest bearing liabilities may be compresses, reducing the Company’s net interest income, adversely affecting its operating results. .

The Company’s single largest expense is salary and benefit costs. During 2019, salary and benefit expense increased by $871 thousand, or 7%, to $13.0 million. Salary expense increased by $1.0 million related to annual merit and promotion increases, an increase of seven  Full Time Equivalent (FTE) employees and a full year of operations of our Carson City, Nevada branch. Other significant increases in salary and benefit expense include a decline of $226 thousand in the deferral of loan origination costs and an increase of $114 thousand in medical insurance expense.  Partially offsetting these items was a decline of $544 thousand in commission expense consistent with the decline in SBA sales. Other significant increases in non-interest expense include $349 thousand in occupancy and equipment expense, $236 thousand in amortization of core deposit intangible, $176 thousand in director compensation and expense and $157 thousand in outside service fees. The largest decreases in non-interest expense were  $228 thousand in gain on sale of OREO properties and reductions in professional fees of $221 thousand, deposit insurance expense of $172 thousand, other non-interest expense of $153 thousand and $115 thousand in the provision for change in OREO valuation.

Professional fees during the current period benefited from a reduction in consulting costs of $109 thousand and corporate legal costs of $127 thousand. Consulting costs were somewhat high during the 2018 period as they included an external review of our compliance management system and $29 thousand related to our acquisition of the Carson City, Nevada branch. Legal fees during the 2018 period included $44 thousand  related to the Carson City branch acquisition and $45 associated with litigation brought by a third-party municipality against one of our borrowers which could adversely affect our collateral position. Deposit insurance costs during the current period benefited from assessment credits we were able to apply to our deposit insurance billings. Plumas Bank was awarded assessment credits totaling $177 thousand which became available once the Deposit Insurance Fund Reserve Ratio reached at least 1.38. During the third quarter we were notified that the reserve ratio was 1.40 on June 30, 2019 and that our credits would be available to offset insurance assessments beginning with the April 1, 2019 assessment period. Other non-interest expense during the 2018 period was also higher than normal as it included a $50 thousand increase in the reserve for undisbursed loan commitments and costs associated with the pending termination of our lease at our Tahoe City, California branch. During 2018 we purchased a building in Tahoe City which, after remodeling is complete, will become the new home of our Tahoe City branch. Our lease obligation at our current location includes a termination penalty that during 2018 has been accrued into other expense.  During 2019 we sold three OREO properties recording a net gain on sale of $275 thousand.

In June 2016, the FASB issued ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments. ASU No. 2016-13 significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren’t measured at fair value through net income. The standard will replace today’s “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. We have purchased software to support the CECL calculation of the allowance for loan losses under ASU No 2016-13 and have engaged the software vendor to assist in the transition to the CECL model. The Company’s preliminary evaluation indicates the provisions of ASU No. 2016-13 are expected to impact the Company’s Consolidated Financial Statements, in particular the level of the reserve for credit losses. However, the Company continues to evaluate the extent of the potential impact.  On October 16, 2019, the FASB approved a proposal to change the effective date of ASU No. 2016-13 for smaller reporting companies, as defined by the SEC, and other non-SEC reporting entities delaying the effective date to fiscal years beginning after December 31, 2022, including interim periods within those fiscal periods.  As the Company is a smaller reporting company and has not adopted provisions of the standard early, the delay is applicable to the Company.