PLUMAS BANCORP (PLBC) FY 2021 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

Plumas Bancorp is a bank holding company for Plumas Bank, a California state-chartered commercial bank. We derive our income primarily from interest received on real estate related, commercial, automobile and consumer loans and, to a lesser extent, interest on investment securities, fees received in connection with servicing deposit and loan customers and gains from the sale of government guaranteed loans. Our major operating expenses are the interest we pay on deposits and borrowings and general operating expenses. We rely on locally-generated deposits to provide us with funds for making loans.

We are subject to competition from other financial institutions and our operating results, like those of other financial institutions operating in California and Northern Nevada, are significantly influenced by economic conditions in California and Northern Nevada, including the strength of the real estate market. In addition, both the fiscal and regulatory policies of the federal and state government and regulatory authorities that govern financial institutions and market interest rates also impact the Bank’s financial condition, results of operations and cash flows.

Critical Accounting Policies

Our accounting policies are integral to understanding the financial results reported. Our most complex accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and internal control procedures that are intended to ensure valuation methods are applied in an environment that is designed and operating effectively and applied consistently from period to period. The following is a brief description of our current accounting policies involving significant management valuation judgments.

Allowance for Loan Losses. The allowance for loan losses is an estimate of credit losses inherent in the Company's loan portfolio that have been incurred as of the balance-sheet date. The allowance is established through a provision for loan losses which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of two primary components, specific reserves related to impaired loans and general reserves for inherent losses related to loans that are collectively evaluated for impairment.

We evaluate our allowance for loan losses quarterly. We believe that the allowance for loan losses is a “critical accounting estimate” because it is based upon management’s assessment of various factors affecting the collectability of the loans, including current economic conditions, past credit experience, delinquency status, the value of the underlying collateral, if any, and a continuing review of the portfolio of loans.

We cannot provide you with any assurance that economic difficulties or other circumstances which would adversely affect our borrowers and their ability to repay outstanding loans will not occur which would be reflected in increased losses in our loan portfolio, which could result in actual losses that exceed reserves previously established.

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The following discussion is designed to provide a better understanding of significant trends related to the Company's financial condition, results of operations, liquidity and capital. It pertains to the Company's financial condition, changes in financial condition and results of operations as of December 31, 2021 and 2020 and for each of the three years in the period ended December 31, 2021. The discussion should be read in conjunction with the Company's audited consolidated financial statements and notes thereto and the other financial information appearing elsewhere herein.

Overview

The Company recorded net income of $21.0 million for the year ended December 31, 2021, an increase of $6.5 million or 45% from net income of $14.5 million during the year ended December 31, 2020. Pretax income increased by $8.5 million, or 43%, to $28.5 million in 2021 from $20.0 million during the year ended December 31, 2020.  Results for the twelve months ended December 31, 2021, benefited from the acquisition of the Bank of Feather River (BFR), the wholly owned subsidiary of Feather River Bancorp, effective July 1, 2021. Total assets acquired from BFR, including goodwill, were $205 million. Loans acquired in the acquisition totaled $160 million and deposits totaled $177 million. Goodwill associated with the acquisition of Feather River Bancorp was $5.5 million and the core deposit intangible was $1.0 million.

In connection with the acquisition, the Company incurred a variety of non-recurring expenses. The non-recurring costs, exclusive of salaries and benefits, for the twelve months ended December 31, 2021, were $692 thousand consisting of $292 thousand in consulting costs including investment advisor fees, $171 thousand in legal expense, $175 thousand in outside service costs and $54 thousand in other expenses.

In addition to the acquisition of BFR, the Company benefited from an increase in PPP loan fees during the comparison periods, a reduction in salary expense related to the Employee Retention Credit (ERC) and a reduction in the provision for loan losses.  During the twelve months ended December 31, 2021, PPP fees net of the amortization of PPP origination costs were $6.1 million.  This compares to $2.6 million during the twelve months ended December 31, 2020.

During the second and third quarters of 2021 the Company qualified for the ERC. The ERC was made available under the Coronavirus Aid, Relief, and Economic Security Act and modified and extended under the Taxpayer Certainty and Disaster Tax Relief Act of 2020. We recorded an ERC of $1.1 million during the second quarter and $1.2 million during the third quarter as a reduction of salary and benefit expense.

The provision for loan losses declined from $3.2 million during the twelve months ended December 31, 2020, to $1.1 million during 2021.

Net interest income increased by $8.5 million to $46.9 million during 2021 from $38.4 million for the year ended December 31, 2020. This increase in net interest income resulted from an increase in interest income of $8.4 million and a decline in interest expense of $92 thousand. Interest and fees on loans, including loans held for sale, increased by $7.3 million, interest on investment securities increased by $978 thousand and interest on other interest earning assets increased by $135 thousand.

During the year ended December 31, 2021 non-interest income totaled $8.7 million, an increase of $253 thousand from the $8.5 million earned during 2020.  Non-interest expense increased by $2.3 million from $23.7 million during 2020 to $26.0 million during the twelve months ending December 31, 2021.

The provision for income taxes increased by $2.0 million from $5.5 million in 2020 to $7.5 million during the year ended December 31, 2021.

Total assets at December 31, 2021 were $1.6 billion, an increase of $502 million from $1.1 billion at December 31, 2020. This increase included increases of  $196 million in cash and due from banks, $129 million in net loans, $126 million in investment securities, $30 million in loans held for sale and $21 million in all other assets.

Mostly related to our acquisition of BFR, gross loans increased by $129.3 million, or 18%, from $709.3 million at December 31, 2020, to $838.6 million at December 31, 2021. Increases in loans included $53.5 million in agricultural loans, $66.6 million in commercial real estate loans, $26.2 million in construction loans and $4.4 million in residential real estate loans; these items were partially offset by a decrease of $17.4 million in commercial loans and $4.0 million in all other loan categories. Excluding PPP loan activity, commercial loans would have increased by $19 million. PPP loans totaled $35 million at December 31, 2021, and $71 million at December 31, 2020.  Loans held for sale represent the guaranteed portion of SBA 7(a) loans. As of  December 31, 2021 and December 31, 2020 the Company had $31.3 million and $693 thousand, respectively in SBA government guaranteed loans held for sale.

Total deposits increased by $465 million from $974 million at December 31, 2020, to $1.4 billion at December 31, 2021. We acquired $177 million in deposits upon the acquisition of BFR. Excluding BFR deposits, we attribute much of this increase to Pandemic related economic stimulus, a more cautious consumer, and continued growth in our customer base. The increase in deposits includes increases of $220 million in demand deposits, $134 million in savings accounts, $87 million in money market accounts, and $24 million in time deposits

Total shareholders’ equity increased by $33.9 million from $100.2 million at December 31, 2020, to $134.1 million at December 31, 2021. The $33.9 million includes earnings during the twelve-month period totaling $21.0 million, common stock issued in the acquisition of Feather River Bancorp totaling $18.7 million and stock option activity totaling $0.5 million. These items were partially offset by the payment of cash dividends totaling $3.1 million and a decrease in accumulated other comprehensive income of $3.2 million.

The return on average assets was 1.52% for 2021, up from 1.43% for 2020. The return on average equity was 17.8% for 2021, up from 15.5% for 2020.

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COVID-19

On March 11, 2020, the World Health Organization declared the outbreak of a novel coronavirus (“COVID-19”) as a global pandemic, which continues to spread throughout the United States and around the world. The declaration of a global pandemic indicates that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The outbreak of COVID-19 could adversely impact a broad range of industries in which the Company’s customers operate and impair their ability to fulfill their financial obligations to the Company. On March 3, 2020, the Federal Open Market Committee reduced the target federal funds rate by 50 basis points to 1.00% to 1.25%. This rate was further reduced to a target range of 0% to 0.25% on March 16, 2020. These reductions in interest rates and other effects of the COVID-19 outbreak may adversely affect the Company’s financial condition and results of operations. As a result of the spread of the COVID-19 coronavirus, economic uncertainties have arisen which are likely to negatively impact net interest income, the provision for loan losses and non-interest income. Other financial impact could occur though such potential impact is unknown at this time.

COVID-19 Loan Forbearance Programs

Section 4013 of the Coronavirus Aid, Relief and Economic Security Act (CARES Act) provides that a qualified loan modification is exempt by law from classification as a Troubled Debt Restructuring pursuant to U.S. Generally Accepted Accounting Principles (GAAP). In addition, FIL-36-2020 issued by the FDIC on April 7, 2020 encourages financial institutions to work constructively with borrowers affected by COVID-19; states that the FDIC will not criticize institutions for prudent loan modifications; and views prudent loan modification programs to financial institution customers affected by COVID-19 as positive actions that can effectively manage or mitigate adverse impacts on borrowers due to COVID-19, and lead to improved loan performance and reduced credit risk. Pursuant to this  guidance in 2020 we instituted loan forbearance programs to assist borrowers with managing cash flows disrupted due to COVID-19. As of December 31, 2021, there were no loan forbearance agreements outstanding related to this program.

U.S. Small Business Administration Paycheck Protection Program

The CARES Act also provided for the Paycheck Protection Program (PPP) and additional legislation extended this program into 2021; we have actively participated in the PPP program.  The remaining principal balance of PPP loans at December 31, 2021 was $34.6 million and the remaining balance of deferred fees related to these loans totaled $1.3 million.  For the years ending December 31, 2021 and 2020 we recognized PPP fees, net of costs, totaling $6.1 and $2.6 million, respectively.

Merger Agreement with Feather River Bancorp, Inc.

On July 1, 2021, pursuant to a previously announced Agreement and Plan of Reorganization and Merger dated as of March 10, 2021 (the “Merger Agreement”) between the Company and Feather River Bancorp, Inc. (“FRB”), FRB merged with and into the Company with the Company continuing as the surviving corporation (the “Merger”). Immediately after the Merger, Bank of Feather River, the wholly owned bank subsidiary of FRB (“BFR”), merged with and into the Bank, with the Bank continuing as the surviving bank.  BFR has become our Yuba City branch. The Merger and Bank Merger are collectively referred to as the “Transaction.”

As part of its business strategy, the Company regularly reviews its business strategies and opportunities to enhance the value of its franchise, including through acquisitions. The Transaction is consistent with the Company’s business strategy, which will (1) expand Plumas’ geographic presence into new markets in Northern California, (2) diversify and bring new expertise to Plumas’ agricultural lending business, and (3) strengthen the Company’s talent base.

Pursuant to the terms of the definitive merger agreement between the Company and FRB, each issued and outstanding share of common stock of FRB (the “Common Shares”), was converted into the right to receive, at the election of each holder of Common Shares, either (i) shares of common stock of the Company (“Plumas Common Stock”) or (ii) cash (the “Merger Consideration”). Shareholder elections were subject to proration such that aggregate Merger Consideration payable by the Company was comprised of (i) $4,738,583 in cash (the “Aggregate Cash Amount”) and (ii) 598,020 shares of Plumas Common Stock (the “Aggregate Plumas Share Amount”). Holders of Common Shares received either $19.14 in cash or 0.614 shares of Plumas Common Stock. The value of the total deal consideration was approximately $23.4 million, which is based upon the volume-weighted average trading price of Plumas common stock for the 10 trading days ending on the last trading day immediately preceding July 1, 2021, the closing date of the Merger.

Immediately after the Transaction, the newly combined company, operating as Plumas Bancorp with its banking subsidiary, Plumas Bank, had total assets of approximately $1.5 billion.  The estimated fair value of assets acquired at July 1, 2021 was $205.0 million consisting of $28.4 million in cash, $160.4 million in net loans, $1.0 million in core deposit intangible, $5.5 million in goodwill and $9.7 million in other assets. The estimated fair value of deposits assumed totaled $176.7 million consisting of $89.5 million in non-interest bearing transaction accounts, $9.3 million in savings accounts, $45.6 million in money market accounts and $32.3 million in time deposits.

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Results of Operations

Net Interest Income

The following table presents, for the years indicated, the distribution of consolidated average assets, liabilities and shareholders' equity. Average balances are based on average daily balances. It also presents the amounts of interest income from interest-earning assets and the resultant yields expressed in both dollars and yield percentages, as well as the amounts of interest expense on interest-bearing liabilities and the resultant cost expressed in both dollars and rate percentages. Nonaccrual loans are included in the calculation of average loans while nonaccrued interest thereon is excluded from the computation of yields earned.

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The following table sets forth changes in interest income and interest expense, for the years indicated and the amount of change attributable to variances in volume, rates and the combination of volume and rates based on the relative changes of volume and rates:

2021 compared to 2020. Net interest income is the difference between interest income and interest expense. Net interest income increased by $8.5 million to $46.9 million during 2021 from $38.4 million for the year ended December 31, 2020. This increase in net interest income resulted from an increase in interest income of $8.4 million and a decline in interest expense of $92 thousand. Interest and fees on loans, including loans held for sale, increased by $7.3 million, interest on investment securities increased by $978 thousand and interest on other interest earning assets increased by $135 thousand. Net interest margin for the year ended December 31, 2021 decreased 39 basis points to 3.63%, down from 4.02% during 2020.

The following table compares loan balances by type at December 31, 2021 and 2020.

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The $7.3 million increase in interest and fees on loans and loans held for sale resulted from an increase in average balance of $102 million and an increase in yield of 26 basis points to 5.41%.  Included in interest income during 2021 were the amortization of PPP fees, net of costs, of $6.1 million, an increase of $3.5 million from the same period in 2020.  PPP fees include normal amortization on our PPP portfolio and the effect of PPP loan forgiveness.  Excluding the effect of the PPP loans, loan yield would have declined by 18 basis points to 5.05% during 2021 and would have increased to 5.23% during 2020. This reduction in adjusted loan yield is consistent with a decline in market interest rates during the comparison periods.  Interest on investment securities increased by $978 thousand as an increase in average balance of $80 million was partially offset by a decline in yield of 31 basis points from 2.15% during 2020 to 1.84% during 2021.Yield on taxable investment securities declined by 37 basis points and yield on non-taxable investment securities declined by 28 basis points.  Interest on cash balances, which primarily relates to interest on cash balances held at the Federal Reserve Bank of San Francisco (FRB), increased by $135 thousand related to an increase in average balance of $157 million partially offset by a decline in the average rate paid on these balances from 0.22% during 2020 to 0.14% during 2021.

Interest expense on deposits decreased by $52 thousand to $780 thousand during 2021, down from $832 thousand during 2020 . The largest components of this decrease were  declines of $77 thousand in interest on NOW accounts, and $6 thousand in interest on time deposits. The decline in NOW interest expense is related to the elimination of our NOW deposit product in November 2020. The largest increase in interest expense on deposits was an increase of $29 thousand in interest on money market accounts related to an increase in average balance of  $110 million mostly offset by a decline in rate paid of 10 basis points from 24 basis points during 2020 to 14 basis points during 2021.  The average rate paid on interest bearing deposits declined from 0.18% during  2020 to 0.13% during 2021, while average interest bearing deposits increased by $123 million to $586 million.

Interest expense on junior subordinated debentures decreased by $37 thousand from $385 thousand during 2020 to $348 thousand during 2021.  This decrease was related to a decrease in rate paid on junior subordinated debentures from 3.73% during 2020 to 3.38% during 2021.  For most of the first half of  2020  interest on the debentures fluctuated with changes in the 3-month LIBOR rate. On May 26, 2020 we entered into two separate interest rate swap agreements, effectively converting the $10 million in Subordinated Debentures to fixed obligations effective with the quarterly payments due in September, 2020.  The swaps have a 10 year maturity and fix the LIBOR rate on the Subordinated Debentures at approximately 75 basis points.

Net interest margin is net interest income expressed as a percentage of average interest-earning assets. As a result of the changes noted above, the net interest margin for 2021 decreased by 39 basis points to 3.63%.

2020 compared to 2019. Net interest income was $38.4 million for the year ended December 31, 2020 up $841 thousand, or 2%, from $37.6 million during 2019. The $841 thousand included an increase of $322 thousand in interest income, from $39.3 million during 2019 to $39.6 million during the current year and a decrease of $519 thousand in interest expense. Interest and fees on loans increased by $1.7 million, interest on investment securities decreased by $961 thousand and interest on interest-earning bank deposits decreased by $422 thousand.

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Interest and fees on loans was $36.0 million during 2020. Average loan balances were $699.3 million for 2020, up $110.5 million from $588.8 million during 2019.  The increase in interest and fees on loans was related to the amortization of loan fees/costs on PPP loans and growth in the Company's loan portfolio.  During  2020 we recorded amortization of loan fees, net of loan costs, on PPP loans totaling $2.6 million.  This includes normal amortization on our PPP portfolio and the effect of  PPP loan forgiveness. The average yield on loans was 5.15% for 2020 down 67 basis points from 5.82% for 2019. We attribute much of the decrease in yield to a decrease in market interest rates including a 174 basis points decrease in the average prime rate, partially offset by the effect of the acceleration of  PPP fee amortization related to  loan forgiveness. At December 31, 2020 approximately 19% of the Company’s loan portfolio was comprised of loans tied to the prime rate or an equivalent rate.

Interest on investment securities decreased by $961 thousand related to a decrease in average balance of  $11.6 million from $171.1 million in 2019 to $159.5 million in 2020 and a decline in yield of 42 basis points from 2.57% during 2019 to 2.15% in 2020.  Interest income on interest bearing deposits, which totaled $210 thousand in 2020 and $632 thousand in 2019, primarily relates to interest on cash balances held at the FRB. The $422 thousand decrease in interest on interest bearing deposits was related to a decrease in the average rate paid on interest earning deposits of 183 basis points from 2.05% during 2019 to 0.22% in 2020 which is consistent with the change in average federal funds rate during this period.  The effect of the decrease in yield was partially offset by an increase in average interest earning deposits of $64.7 million from $30.9 million during 2019 to $95.6 million in 2020.

Interest expense on deposits decreased by $369 thousand from $1.2 millon for the twelve months ended December 31, 2019 to $832 thousand during 2020.  The largest component of this decline was a $190 thousand decline in interest expense on time deposits mostly related to the maturity of  higher rate time deposits in our Carson City branch.  Average time deposits at the Carson City branch declined by $8.7 million from $11.2 million during the twelve months ended December 31, 2019 to $2.5 million during the year ended December 31, 2020. Related to a decline in market rates we also experienced declines in interest expense on other deposits categories the largest of which was $133 thousand in money market interest expense.

Interest expense on other interest-bearing liabilities decreased by $150 thousand from $546 thousand during the year ended December 31, 2019 to $396 thousand during the current year related to a decrease in effective rate paid on junior subordinated debentures from 5.15% during 2019 to 3.73% during 2020. Interest on the debentures totaled $385 thousand during 2020 and $531 thousand during 2019. This decline was related to a decline in the LIBOR rate during the comparison periods as well as the effect of the interest rate swaps entered into on May 26, 2020.

As a result of the changes noted above, the net interest margin for 2020 decreased to 4.02%, from 4.75% during 2019.

Provision for Loan Losses

During the year ended December 31, 2021 we recorded a provision for loan losses of $1.1 million down $2.1 million from $3.2 million during the year ended December 31, 2020. See “Analysis of Asset Quality and Allowance for Loan Losses” for further discussion of loan quality trends and the provision for loan losses.

The allowance for loan losses is maintained at a level that management believes will be appropriate to absorb inherent losses on existing loans based on an evaluation of the collectability of the loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower's ability to repay their loan. The allowance for loan losses is based on estimates, and ultimate losses may vary from the current estimates.

These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the periods in which they become known. Based on information currently available, management believes that the allowance for loan losses is appropriate to absorb potential risks in the portfolio. However, no assurance can be given that the Company may not sustain charge-offs which are in excess of the allowance in any given period.

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Non-Interest Income

The following table sets forth the components of non-interest income for the years ended December 31, 2021, 2020 and 2019.

2021 compared to 2020. During 2021, non-interest income totaled $8.7 million, an increase of $253 thousand from the $8.5 million earned during 2020. This increase included increases in several categories of non-interest income, the largest of which were $711 thousand in interchange income, which was mostly related to an increase in the size of the bank, and $230 thousand in other income. The increase in other income mostly relates to insurance proceeds related to fire damage at our Greenville, California branch.  These items were partially offset by decreases of $336 thousand in gains on sale of loans,  a $218 thousand gain on sale of  an administrative building and a $209 thousand loss on sale of investment securities classified as available for sale.  While gains on sale of loans decreased by $336 thousand, loans held for sale increased by $30.6 million to $31.3 million.  Loans held for sale consist of the guaranteed portion of SBA 7(a) loans.  During the year ended December 31, 2021 the Company sold twenty-nine available-for-sale investment securities for total proceeds of $20 million recording a $209 thousand loss on sale.

2020 compared to 2019. During the twelve months ended December 31, 2020, non-interest income totaled $8.5 million, an increase of $328 thousand from $8.1 million during 2019. This increase included a one-time gain of $218 thousand on sale of one of the Company’s administrative buildings. A portion of this building was used as record storage for Plumas Bank while the rest of the building was available for rental to third parties. Plumas Bank has entered into a five-year lease at a cost of $1,600 per month on that portion of the property used for its record storage. Other significant increases in non-interest income were $194 thousand in interchange fees and $477 thousand in gain on sale of SBA loans.  The largest declines in non-interest income were $372 thousand in service charges on deposit accounts, $114 thousand in gain on sale of  investments and $79 thousand in Federal Home Loan Bank of San Francisco (“FHLB”) dividends.

The increase in interchange income is mostly related to an increase in the size of the Bank. Proceeds from SBA loan sales totaled $29.0 million during 2020 and $19.5 million during 2019. The largest component of the decline in service charges on deposit accounts was a decline in NSF fees. We attribute the decline in NSF fees primarily to a more cautious consumer, an increase in business deposits which includes the effect of PPP lending and a temporary waiver of NSF fees for those customers adversely affected by the pandemic. Beginning in the third quarter of 2020 we returned to our standard policies for  the waiving  of NSF fees. No investment securities were sold during 2020; during 2019 we sold fifty-five available for sale securities for total proceeds of $19.7 million recording a $114 thousand gain on sale. The reduction in FHLB dividends relates to a special dividend recorded during the first quarter of 2019 and a reduction in the dividend rate paid by the FHLB.

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Non-Interest Expense

The following table sets forth the components of other non-interest expense for the years ended December 31, 2021, 2020 and 2019.

2021 compared to 2020. During the twelve months ended December 31, 2021, total non-interest expense increased by $2.3 million from the comparable period in 2020. The largest components of this increase were increases of $882  thousand in outside service fees, $623 thousand in professional fees and $621 thousand in occupancy and equipment expense.  Increases in outside service fees include operating costs associated with our Yuba City branch including data processing, item  processing, statement processing, online banking expenses and network administration totaling $183 thousand and merger related costs of $175 thousand. Other significant increases in outside service fees include $121 thousand in interchange expense consistent with the increase in interchange income and $210 thousand in costs related to outsourcing of various Human Resources functions effective April 1, 2021.  Professional fees included legal, investment banking, consulting and accounting costs related to the acquisition of Bank of Feather River totaling $482 thousand.  In addition to merger related costs, the single largest increases in professional fees were  $82 thousand in costs related to converting our loan files to a digital document imaging system and $66 thousand in consulting costs related to implementation of the current expected credit losses methodology for estimating allowances for credit losses. Both of these projects are ongoing. The largest single increase in occupancy and equipment costs was $325 thousand in occupancy and equipment costs at the Yuba City branch.

Partially offsetting the increases in non-interest expense was a decline of $490 thousand in salary and benefit expense. During the second and third quarters of 2021 the Company qualified for the Employee Retention Credit (ERC). The ERC was made available under the Coronavirus Aid, Relief, and Economic Security Act and modified and extended under the Taxpayer Certainty and Disaster Tax Relief Act of 2020.  We recorded an ERC of $2.3 million during the current period as a reduction of salary and benefit expense. In addition to the ERC, the deferral of loan origination costs, which reduces salary and benefit expense, increased by $1.2 million which was mostly related to SBA loan production activities.  These items were partially offset by an increase in other components of salary and benefit expense, the largest of which were an increase of $1.1 million in bonus expense consistent with the increase in income during the comparable periods and an increase in commission expense of $622 thousand related to an increase in SBA activity as well as commissions earned on PPP loan production and forgiveness activities and an increase in salary expense of $1.2 million of which $721 thousand was related to the Yuba City branch.

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2020 compared to 2019. During the twelve months ended December 31, 2020, non-interest expense increased by $922 thousand. Increases in expense included $273 thousand in salary and benefit expense, $338 thousand in outside services fees, $266 thousand in gain on sale of OREO, $187 thousand in deposit insurance expense and $124 thousand in advertising expense.  The largest reduction in non-interest expense was $210 thousand in business development expense.

During 2020 salary and benefit expense increased by $273 thousand, or 2%, to $13.3 million. Salary expense increased by $333 thousand related to annual merit and promotion increases partially offset by a decline of  3.5 FTE. Other significant increases in salary and benefit costs included $221 thousand in commissions related to the increase in SBA loan sales, $138 thousand in officer salary continuation expense mostly related to a decline in the discount rate used to calculate the current liability for future benefits from 5% to 4% and $109 thousand in payroll taxes.  Partially offseting these items was a decline in bonus expense of $600 thousand to $715 thousand. Bonuses are based primarily on achieving targeted levels of net income.  In 2020, we did not meet our income targets due to the decline in market interest rates and the impact of the higher loan loss provision related to the pandemic resulting in a reduction in the bonus accrual from 2019 levels where targets were met. The largest components of the increase in outside service fees were costs associated with growth in our interchange income, an increase in costs related to the management of our computer network including the installation of a new advanced backup and recovery system and a $26 thousand employee recruitment fee. The decline in gain on sale of OREO mostly relates to the sale of two properties at a gain of $266 thousand in the fourth quarter of 2019.  During 2019, deposit insurance costs benefited from assessment credits we were able to apply to our deposit insurance billings. The increase in advertising expense was mostly related to a digital and traditional advertising campaign focused on the Northern Nevada marketplace. It is our belief that Northern Nevada represents a significant growth opportunity for Plumas Bank. The largest decrease in non-interest expense during the comparison period was $210 thousand in business development expense. The reduction in business development expense, which includes travel, training and entertainment expenses, was mostly related to the pandemic.

Provision for Income Taxes. The Company recorded an income tax provision of $7.5 million, or 26.2% of pre-tax income for the year ended December 31, 2021. This compares to an income tax provision of $5.5 million, or 27.5% of pre-tax income during 2020. The percentages for 2021 and 2020 differ from statutory rates as tax exempt items of income such as earnings on Bank owned life insurance and municipal loan and securities interest decrease taxable income.  The effect of these items during 2021 was somewhat offset by nondeductible merger expenses. The net decrease in the effective tax rate in 2021 is primarily related to the ERC which is not taxable for state income tax.

Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amount of assets and liabilities and their tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is "more likely than not" that all or a portion of the deferred tax asset will not be realized. "More likely than not" is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Based upon the analysis of available evidence, management has determined that it is "more likely than not" that all deferred income tax assets as of December 31, 2021 and 2020 will be fully realized and therefore no valuation allowance was recorded.

Financial Condition

Loan Portfolio. Mostly related to the acquisition of BFR, gross loans, which exclude loans held for sale, increased by $129 million, or 18% to $839 million at December 31, 2021. Increases in loans included $53.5 million in agricultural loans, $66.6 million in commercial real estate loans, $26.2 million in construction loans and $4.4 million in residential real estate loans. The largest decline in loans was $17.4 million in commercial loans which included a decline in PPP loans, which are in the commercial category, of  $36.1 million from $70.7 million at December 31, 2020 to $34.6 million at December 31, 2021. Unearned fees, net of costs, on PPP loans totaled $1.3 million at December 31, 2021.  Although the Company offers a broad array of financing options, it continues to concentrate its focus on small to medium sized commercial businesses. These loans offer diversification as to industries and types of businesses, thus limiting material exposure in any industry concentrations. The Company offers both fixed and floating rate loans and obtains collateral in the form of real property, business assets and deposit accounts, but looks to business and personal cash flows as its primary source of repayment.

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As shown in the following table the Company's largest lending categories are commercial real estate loans, auto loans, agricultural loans and commercial loans.

The Company’s real estate related loans, including real estate mortgage loans, real estate construction and land development loans, consumer equity lines of credit, and agricultural loans secured by real estate comprised 72% of the total loan portfolio at December 31, 2021. Moreover, the business activities of the Company currently are focused in the California counties of Plumas, Nevada, Placer, Lassen, Modoc, Shasta, Sierra, and Sutter and in Washoe and Carson City Counties in Northern Nevada. Consequently, the results of operations and financial condition of the Company are dependent upon the general trends in these economies and, in particular, the commercial real estate markets. In addition, the concentration of the Company's operations in these areas of Northeastern California and Northwestern Nevada exposes it to greater risk than other banking companies with a wider geographic base in the event of catastrophes, such as earthquakes, fires and floods in these regions.

The rates of interest charged on variable rate loans are set at specific increments to indexes such as the published prime interest rate or U.S. Treasury rates and vary with changes in these indexes. The frequency in which variable rate loans reprice can vary from one day to several years. At December 31, 2021 and December 31, 2020, approximately 76% and 68%, respectively of the Company's loan portfolio was comprised of variable rate loans. Loans indexed to the prime interest rate or an equivalent rate totaled approximately 25% of the Company’s loan portfolio; these loans reprice within one day to three months of a change in the prime rate. At December 31, 2021 and December 31, 2020, 55% and 43%, respectively of the variable loans were at their respective floor rate. While real estate mortgage, agricultural, commercial and consumer lending remain the foundation of the Company's historical loan mix, some changes in the mix have occurred due to the changing economic environment and the resulting change in demand for certain loan types. The most significant change in loan mix was the increase in Agricultural loans, which increased from 10.3% of the portfolio at December 31, 2020 to 15.1% as December 31, 2021 related to the acquisition of BFR.

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The following table sets forth the maturity of gross loan categories as of December 31, 2021. Also provided with respect to such loans are the amounts due after one year, classified according to sensitivity to changes in interest rates:

Amount due after one year at fixed interest rates:

Amount due after one year at variable interest rates:

Analysis of Asset Quality and Allowance for Loan Losses. The Company attempts to minimize credit risk through its underwriting and credit review policies. The Company’s credit review process includes internally prepared credit reviews as well as contracting with an outside firm to conduct periodic credit reviews. The Company’s management and lending officers evaluate the loss exposure of classified and impaired loans on a quarterly basis, or more frequently as loan conditions change. The Management Asset Resolution Committee (MARC) reviews the asset quality of criticized and past due loans monthly and reports the findings to the full Board of Directors. In management's opinion, this loan review system helps facilitate the early identification of potential criticized loans. MARC also provides guidance for the maintenance and timely disposition of OREO properties including developing financing and marketing programs to incent individuals to purchase OREO. MARC consists of the Bank’s Chief Executive Officer, Chief Financial Officer and Chief Credit Officer, and the activities are governed by a formal written charter. The MARC meets monthly and reports to the Board of Directors.

The allowance for loan losses is established through charges to earnings in the form of the provision for loan losses. Loan losses are charged to and recoveries are credited to the allowance for loan losses. The allowance for loan losses is maintained at a level deemed appropriate by management to provide for known and inherent risks in the loan portfolio. The adequacy of the allowance for loan losses is based upon management's continuing assessment of various factors affecting the collectability of loans including current economic conditions, maturity of the portfolio, size of the portfolio, industry concentrations, borrower credit history, collateral, the existing allowance for loan losses, independent credit reviews, current charges and recoveries to the allowance for loan losses and the overall quality of the portfolio as determined by management, regulatory agencies, and independent credit review consultants retained by the Company. There is no precise method of predicting specific losses or amounts which may ultimately be charged off on particular segments of the loan portfolio. The collectability of a loan is subjective to some degree, but must relate to the borrower’s financial condition, cash flow, quality of the borrower’s management expertise, collateral and guarantees, and state of the local economy.

Formula allocations are calculated by applying loss factors to outstanding loans with similar characteristics. Loss factors are based on the Company’s historical loss experience as adjusted for changes in the business cycle and may be adjusted for significant factors that, in management's judgment, affect the collectability of the   portfolio as of the evaluation date. Historical loss data from the beginning of the latest business cycle are incorporated in the loss factors.

The discretionary allocation is based upon management’s evaluation of various loan segment conditions that are not directly measured in the determination of the formula and specific allowances. The conditions may include, but are not limited to, general economic and business conditions affecting the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentrations, and other business conditions.   We have added a new specific pandemic qualitative factor to our allowance for loan loss calculation and have increased the qualitative factor related to economic conditions. These changes resulted in the need for additional loan loss provision during 2020. See  Item 1A - Risk Factors for a discussion of the COVID-19 global pandemic and its potential effect on the Company's current and future financial position and results of operations.

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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. The CECL model does not apply to available-for-sale (“AFS”) debt securities. For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU No. 2016- 13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. 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. The Company has begun its implementation efforts by establishing an implementation team chaired by the Company’s Chief Credit Officer and composed of members of the Company’s credit administration and accounting departments. We have purchased software to support the CECL calculation of the allowance for loan losses under ASU No 2016-13. During the second quarter of 2021 we engaged a consultant to perform a model validation of our CECL model and to assist us in documenting all aspects of 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.

During the years ended December 31, 2021 and 2020 we recorded a provision for loan losses of $1.1 million and $3.2 million, respectively.  Net charge-offs totaled $675 thousand during the year ended December 31, 2021, an increase of $159 thousand from $516 thousand during the year ended December 31, 2020.  Net charge-offs as a percentage of average loans increased from 0.07% during 2020 to 0.09% during the year ended December 31, 2021.

The following table provides selected credit ratios as of December 31, 2021, 2020 and 2019:

The allowance for loan losses totaled $10.4 million at December 31, 2021 and $9.9 million at December 31, 2020. Specific reserves related to impaired loans decreased by $146 thousand from $174 thousand at December 31, 2020 to $28 thousand at December 31, 2021.  At December 31, 2021 and 2020, the Company's recorded investment in impaired loans totaled $4.9 million and $2.2 million, respectively. At least quarterly the Company evaluates each specific reserve and if it determines that the loss represented by the specific reserve is uncollectable it records a charge-off for the uncollectable portion. General reserves were $10.3 million at December 31, 2021 and $9.7 million at December 31, 2020. The allowance for loan losses as a percentage of total loans decreased from 1.40% at December 31, 2020 to 1.23% at December 31, 2021. The percentage of general reserves to unimpaired loans totaled 1.24% at December 31, 2021 and 1.37% at December 31, 2020. Excluding loans acquired from BFR and recorded at fair value, the allowance for loan losses as a percentage of total loans at December 31, 2021 would have been 1.45%.

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The following table provides a breakdown of the allowance for loan losses:

The Company places loans 90 days or more past due on nonaccrual status unless the loan is well secured and in the process of collection. A loan is considered to be in the process of collection if, based on a probable specific event, it is expected that the loan will be repaid or brought current. Generally, this collection period would not exceed 90 days. When a loan is placed on nonaccrual status the Company's general policy is to reverse and charge against current income previously accrued but unpaid interest. Interest income on such loans is subsequently recognized only to the extent that cash is received and future collection of principal is deemed by management to be probable. Where the collectability of the principal or interest on a loan is considered to be doubtful by management, it is placed on nonaccrual status prior to becoming 90 days delinquent.

Impaired loans are measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. The amount of impaired loans is not directly comparable to the amount of nonperforming loans disclosed later in this section. The primary difference between impaired loans and nonperforming loans is that impaired loan recognition considers not only loans 90 days or more past due, restructured loans and nonaccrual loans but also may include identified problem loans other than delinquent loans where it is considered probable that we will not collect all amounts due to us (including both principal and interest) in accordance with the contractual terms of the loan agreement.

A restructuring of a debt constitutes a troubled debt restructuring (TDR) if the Company, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. Restructured workout loans typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms. Loans that are reported as TDRs are considered impaired and measured for impairment as described above.

Loans restructured (TDRs) and not included in nonperforming loans in the following table totaled $0.9 million at December 31, 2021, 2020 and 2019. For additional information related to restructured loans see Note 5 of the Company's Consolidated Financial Statements in Item 8 - Financial Statements and Supplementary Data of this Annual Report on Form 10-K

The following table sets forth the amount of the Company's nonperforming assets as of the dates indicated.

Nonperforming loans at December 31, 2021 were $4.9 million, an increase of $2.4 million from the $2.5 million balance at December 31, 2020. Specific reserves on nonaccrual loans totaled $0 at December 31, 2021 and $143 thousand at December 31, 2020, respectively. Performing loans past due thirty to eighty-nine days were $3.5 million at December 31, 2021 up from $1.2 million at December 31, 2020. Performing loans past due thirty to eighty-nine days were $3.7 million at December 31, 2019.

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A substandard loan is not adequately protected by the current sound worth and paying capacity of the borrower or the value of the collateral pledged, if any. Total substandard loans increased by $3.7 million from $1.8 million at December 31, 2020 to $5.5 million at December 31, 2021. Loans classified as special mention increased by $1.9 million from $3.1 million at December 31, 2020 to $5.0 million at December 31, 2021.

Loans Held for Sale. Included in the loan portfolio are loans which are 75% to 90% guaranteed by the Small Business Administration (SBA), US Department of Agriculture Rural Business Cooperative Service (RBS) and Farm Services Agency (FSA). The guaranteed portion of these loans may be sold to a third party, with the Bank retaining the unguaranteed portion. The Company can receive a premium in excess of the adjusted carrying value of the loan at the time of sale.

As of  December 31, 2021 and December 31, 2020 the Company had $31.3 million and $693 thousand, respectively in SBA government guaranteed loans held for sale. Loans held for sale are recorded at the lower of cost or fair value and therefore may be reported at fair value on a non-recurring basis. The fair values for loans held for sale are based on either observable transactions of similar instruments or formally committed loan sale prices.

OREO represents real property acquired by the Bank either through foreclosure or through a deed in lieu thereof from the borrower. Repossessed assets include vehicles and other commercial assets acquired under agreements with delinquent borrowers. OREO holdings represented three properties totaling $487 thousand at December 31, 2021  and three properties totaling $403 thousand at December 31, 2020. Nonperforming assets as a percentage of total assets were 0.33% at December 31, 2021 and 0.27% at December 31, 2020.

The following table provides a summary of the change in the number and balance of OREO properties for the years ended December 31, 2021 and 2020, dollars in thousands:

Investment Portfolio and Federal Reserve Balances. Total investment securities were $305.9 million as of December 31, 2021 and $179.6 million as of December 31, 2020. Unrealized gains on available-for-sale investment securities totaling $1.7 million were recorded, net of $493 thousand in tax expense, as accumulated other comprehensive income within shareholders' equity at December 31, 2021. Unrealized gains on available-for-sale investment securities totaling $6.6 million were recorded, net of $1.95 million in tax expense, as accumulated other comprehensive income within shareholders' equity at December 31, 2020.

During the year ended December 31, 2021 the Company sold twenty-nine available-for-sale investment securities for total proceeds of $20.0 million recording a $209 thousand loss on sale. No investment securities were sold during the year ended December 31, 2020.

The investment portfolio at December 31, 2021 consisted of $151.0 million in securities of U.S. Government-sponsored agencies, $57.2 million in securities of U.S. Government agencies and 188 municipal securities totaling $97.7 million. The investment portfolio at December 31, 2020 consisted of $110.7 million in securities of U.S. Government-sponsored agencies, $10.5 million  in securities of U.S. Government agencies  and 135 municipal securities totaling $58.4 million.

There were no Federal funds sold at December 31, 2021 or December 31, 2020; however, the Bank maintained interest earning balances at the Federal Reserve Bank totaling $320.5 million at December 31, 2021 and $143.7 million at December 31, 2020. The balance, at December 31, 2021, earned interest at the rate of 0.15%.

The Company classifies its investment securities as available-for-sale or held-to-maturity. Currently all securities are classified as available-for-sale. Securities classified as available-for-sale may be sold to implement the Company's asset/liability management strategies and in response to changes in interest rates, prepayment rates and similar factors.

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The following table summarizes the maturities of the Company's securities at their carrying value, which represents fair value, and their weighted average tax equivalent yields at December 31, 2021. Mortgage-backed securities are included in maturity categories based on their stated maturity date. Expected maturities may differ from contractual maturities because the issuers may have the right to call or prepay obligations.

Deposits. Deposits represent the Bank's primary source of funds. Deposits are primarily core deposits in that they are demand, savings and time deposits generated from local businesses and individuals. These sources are considered to be relatively stable, long-term relationships thereby enhancing steady growth of the deposit base without major fluctuations in overall deposit balances. The Company experiences, to a small degree, some seasonality with the slower growth period between November through April, and the higher growth period from May through October. To assist in meeting any funding demands, the Company maintains a secured borrowing arrangement with the FHLB. Total deposits increased by $465 million from $974 million at December 31, 2020 to $1.4 billion at December 31, 2021. We acquired $177 million in deposits upon the acquisition of BFR. Excluding BFR deposits, we attribute much of this increase to Pandemic related economic stimulus, a more cautious consumer, and continued growth in our customer base. The increase in deposits includes increases of $220 million in demand deposits, $134 million in savings accounts, $87 million in money market accounts, and $24 million in time deposits. At December 31, 2021, 51% of the Company’s deposits were in the form of non-interest-bearing demand deposits and only 4% were time deposits. The Company has no brokered deposits.

The following tables show the distribution of deposits by type at December 31, 2021 and 2020 and the average balance and rates paid on deposits for the three years ending December 31, 2021:

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The following table shows the Company's time deposits  in excess of the FDIC insurance limit and time deposits otherwise uninsured at December 31, 2021 (dollars in thousands):

Time deposits of $250,000 or more are generally from the Company's local business and individual customer base. The potential impact on the Company's liquidity from the withdrawal of these deposits is discussed at the Company's asset and liability management committee meetings, and is considered to be minimal.

Short-term Borrowing Arrangements.  The Company is a member of the FHLB and can borrow up to $253 million from the FHLB secured by commercial and residential mortgage loans with carrying values totaling $493 million. The Company is required to hold FHLB stock as a condition of membership. At December 31, 2021 the Company held $4.5 million of FHLB stock which is recorded as a component of other assets. Based on this level of stock holdings the Company can borrow up to $164.8 million. To borrow the full $253 million in available credit the Company would need to purchase $2.4 million in additional FHLB stock. In addition to its FHLB borrowing line, the Company has unsecured short-term borrowing agreements with three of its correspondent banks in the amounts of $50 million, $20 million and $10 million. There were $5 million in outstanding borrowings to the FHLB at December 31, 2020 and no borrowings outstanding at December 31, 2021. The $5 million matured on May 7, 2021.   There were no outstanding borrowings to the correspondent banks at December 31, 2021 and December 31, 2020.

Note Payable. The Company maintains a $15 million line of credit facility with one of its correspondent banks (the "Note").  Interest on the Note is payable at the "Prime Rate".  There were no borrowings on the Note during 2021 or 2020. The Note is secured by 100 shares of Plumas Bank stock representing the Company's 100% ownership interest in Plumas Bank. Under the Note, the Bank is subject to several negative and affirmative covenants including, but not limited to, providing timely financial information, maintaining specified levels of capital, restrictions on additional borrowings, and meeting or exceeding certain capital and asset quality ratios. The Bank was in compliance with all such covenants related to the Note at December 31, 2021 and December 31, 2020.

On January 25, 2022 the Company replaced this facility with a $15 million Loan Agreement (the “Loan Agreement”) and Promissory Note (the “Term Note”). The Term Note matures on January 25, 2035 and can be prepaid at any time.  During the initial three years of the Loan Agreement the Term Note functions as an interest only revolving line of credit.  Beginning on year four the Term Note converts into a term loan requiring semi-annual principal and interest payments and no further advances can be made. The proceeds of this lending facility shall be used by the Company for general corporation purposes, and to provide capital injections into the Bank. The Term Note bears interest at a fixed rate of 3.85% for the first 5 years and then at a floating interest rate linked to WSJ Prime Rate for the remaining eight year term. The Loan Agreement provides for a $187,500 loan fee. The Note is secured by the common stock of the Bank. The Loan Agreement contains certain financial and non-financial covenants, which include, but are not limited to, a minimum leverage ratio at the Bank, a minimum total risk-based capital ratio at the Bank, a maximum Texas Ratio at the Bank, a minimum level of Tier 1 capital at the Bank  and a return on average assets needed to generate a 1.25X debt service coverage ratio. The Loan Agreement also contains customary events of default, including, but not limited to, failure to pay principal or interest, the commencement of certain bankruptcy proceedings, and certain adverse regulatory events affecting the Company or the Bank. Upon the occurrence of an event of default under the Loan Agreement, the Company’s obligations under the Loan Agreement may be accelerated.

Repurchase Agreements. The Bank offers a repurchase agreement product for its larger  customers which use securities sold under agreements to repurchase as an alternative to interest-bearing deposits. Securities sold under agreements to repurchase totaling $17.3 million and $13.9 million at December 31, 2021 and December 31, 2020, respectively, are secured by U.S. Government agency securities with a carrying amount of $23.0 million and $19.8 million at December 31, 2021 and December 31, 2020, respectively. Interest paid on this product is similar to that which is paid on the Bank’s money market accounts; however, these are not deposits and are not FDIC insured.

Junior Subordinated Deferrable Interest Debentures. Plumas Statutory Trust I and II are business trust subsidiaries formed by the Company with capital of $364 thousand and $184 thousand, respectively, for the sole purpose of issuing trust preferred securities fully and unconditionally guaranteed by the Company. During 2002, Trust I issued 6,000 Floating Rate Capital Trust Pass-Through Securities ("Trust Preferred Securities"), with a liquidation value of $1,000 per security, for gross proceeds of $6,000,000. During 2005, Trust II issued 4,000 Trust Preferred Securities with a liquidation value of $1,000 per security, for gross proceeds of $4,000,000. The entire proceeds were invested by Trust I in the amount of $6,186,000 and Trust II in the amount of $4,124,000 in Floating Rate Junior Subordinated Deferrable Interest Debentures (the "Subordinated Debentures") issued by the Company, with identical maturity, repricing and payment terms as the Trust Preferred Securities. The Subordinated Debentures represent the sole assets of Trusts I and II.

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Trust I’s Subordinated Debentures mature on September 26, 2032, bear a current interest rate of 3.62% (based on 3-month LIBOR plus 3.40%), with repricing and payments due quarterly. Trust II’s Subordinated Debentures mature on September 28, 2035, bear a current interest rate of 1.68% (based on 3-month LIBOR plus 1.48%), with repricing and payments due quarterly. The interest rate of the Trust Preferred Securities issued by Trust I adjust on each quarterly anniversary date to equal the 3-month LIBOR plus 3.40%. The Trust Preferred Securities issued by Trust II adjust on each quarterly anniversary date to equal the 3-month LIBOR plus 1.48%. Both Trusts I and II have the option to defer payment of the distributions for a period of up to five years, as long as the Company is not in default on the payment of interest on the Subordinated Debentures.

Interest expense recognized by the Company for the years ended December 31, 2021, 2020 and 2019 related to the subordinated debentures was $348,000, $385,000 and $531,000, respectively.

Interest Rate Swaps. On May 26, 2020 we entered into two separate interest rate swap agreements with notional amounts totaling $10 million, effectively converting the $10 million in Subordinated Debentures to fixed obligations.  The swaps have a 10 year maturity and fix the labor rate on the Subordinated Debentures at approximately 75 basis points. These agreements have been designated and qualify as cash flow hedging instruments and, as such changes in the fair value are recorded in accumulated other comprehensive income/loss to the extent the agreements are effective hedges. The swaps were determined to be fully effective during all periods presented. As such, no amount of ineffectiveness has been included in net income. Therefore, the aggregate fair value of the swaps is recorded in other assets with changes in fair value recorded in other comprehensive income. The amount included in accumulated other comprehensive income would be reclassified to current earnings should the hedges no longer be considered effective. The Company expects the hedges to remain fully effective during the remaining terms of the swaps.  At December 31, 2021  and December 31, 2020 the carrying value of the swaps, which was included in other assets, was an unrealized gain of $607 thousand and $142 thousand, respectively.

Capital Resources

Total shareholders’ equity increased by $33.9 million from $100.2 million at December 31, 2020, to $134.1 million at December 31, 2021. The $33.9 million includes earnings during the twelve-month period totaling $21.0 million, common stock issued in the acquisition of Feather River Bancorp totaling $18.7 million and stock option activity totaling $0.5 million. These items were partially offset by the payment of cash dividends totaling $3.1 million and a decrease in accumulated other comprehensive income of $3.2 million.

It is the policy of the Company to periodically distribute excess retained earnings to the shareholders through the payment of cash dividends. The Board of Directors believes that such dividends help promote shareholder value and capital adequacy by enhancing the marketability of the Company’s stock. All authority to provide a return to the shareholders in the form of a cash or stock dividend or split rests with the Board of Directors. The Board periodically, but on no regular schedule, reviews the appropriateness of a cash dividend payment. The Company’s ability to pay dividends is limited by California and federal law and the policies and regulations of the FRB as well as restrictions on the Subordinated Debentures. During 2021 the Company paid quarterly cash dividends of $0.14 per share on each of November 15, 2021, August 16, 2021, May 17, 2021 and February 15, 2021. During 2020 the Company paid three quarterly $0.12  per share dividends one each on May 15, 2020, August 14, 2020 and November 16, 2020.  During 2019 semi-annual cash dividends were paid as follows:  $0.23 per share on May 15, 2019 and November 15, 2019.

Capital Standards. The Company uses a variety of measures to evaluate its capital adequacy. Management reviews these capital measurements on a monthly basis and takes appropriate action to ensure that they are within established internal and external guidelines. The FDIC has promulgated risk-based capital guidelines for all state non-member banks such as the Bank. These guidelines establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures.

In July, 2013, the federal bank regulatory agencies adopted rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. depository organizations, sometimes called “Basel III,” that increased the minimum regulatory capital requirements for bank holding companies and depository institutions 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 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, 2021, the Company’s and the Bank’s capital ratios exceeded the thresholds necessary to be considered “well capitalized” under the Basel III framework.

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Under the FRB’s Small Bank Holding Company and Savings and Loan Holding Company Policy Statement (the “Policy Statement”), qualifying bank holding companies with less than $3 billion in consolidated assets are exempt from the Basel III consolidated capital rules. The Company qualifies for treatment under the Policy Statement and is not currently subject to the Basel III consolidated capital rules at the bank holding company level. The Basel III capital rules continue to apply to the Bank.

In 2019, the federal bank regulators issued a rule establishing a “community bank leverage ratio” (the ratio of a bank’s tier 1 capital to average total consolidated assets) that qualifying institutions with less than $10 billion in assets may elect to use in lieu of the generally applicable leverage and risk-based capital requirements under Basel III. A qualifying banking organization that elects to use the new ratio will be considered to have met all applicable federal regulatory capital and leverage requirements, including the minimum capital levels required to be considered “well capitalized, ” if it maintains community bank leverage ratio capital exceeding 9%.  The new rule became effective on January 1, 2020.  Plumas Bank has chosen not to opt into the community bank leverage ratio at this time.

The following table sets forth the Bank's actual capital amounts and ratios (dollar amounts in thousands):

(1) Does not include amounts required to maintain the capital conservation buffer under the new capital rules

Management believes that the Bank met all its capital adequacy requirements as of December 31, 2021.

The current and projected capital positions of the Bank and the impact of capital plans and long-term strategies are reviewed regularly by management. The Company policy is to maintain the Bank’s ratios above the prescribed well-capitalized ratios at all times.

Off-Balance Sheet Arrangements

Loan Commitments. In the normal course of business, there are various commitments outstanding to extend credits that are not reflected in the financial statements. Commitments to extend credit and letters of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Annual review of commercial credit lines, letters of credit and ongoing monitoring of outstanding balances reduces the risk of loss associated with these commitments. As of December 31, 2021, the Company had $162.5 million in unfunded loan commitments and $12 thousand in letters of credit. This compares to $144.4 million in unfunded loan commitments and $531 thousand in letters of credit at December 31, 2020. Of the $162.5 million in unfunded loan commitments, $109.2 million and $53.3 million represented commitments to commercial and consumer customers, respectively. Of the total unfunded commitments at December 31, 2021, $91.7 million were secured by real estate, of which $48.2 million was secured by commercial real estate and $43.5 million was secured by residential real estate mostly in the form of equity lines of credit. The commercial loan commitments not secured by real estate primarily represent business lines of credit, while the consumer loan commitments not secured by real estate primarily represent revolving credit card lines and overdraft protection lines. Since some of the commitments are expected to expire without being drawn upon the total commitment amounts do not necessarily represent future cash requirements.

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Operating Leases. The Company leases three depository branches, one of which is a land lease on which we own the building, three lending offices, two administrative offices and two non-branch automated teller machine locations.  The expiration dates of the leases vary, with the first such lease expiring during 2022 and the last such lease expiring during 2044. Including variable lease expense, total rent expense for the years ended December 31, 2021, 2020 and 2019 was $507,000,  $407,000 and $465,000, respectively.

Liquidity

The Company manages its liquidity to provide the ability to generate funds to support asset growth, meet deposit withdrawals (both anticipated and unanticipated), fund customers' borrowing needs, satisfy maturity of short-term borrowings and maintain reserve requirements. The Company’s liquidity needs are managed using assets or liabilities, or both. On the asset side, in addition to cash and due from banks, the Company maintains an investment portfolio which includes unpledged U.S. Government-sponsored agency securities that are classified as available-for-sale. On the liability side, liquidity needs are managed by charging competitive offering rates on deposit products and the use of established lines of credit.

The Company is a member of the FHLB and can borrow up to $253 million from the FHLB secured by commercial and residential mortgage loans with carrying values totaling $493 million. See “Short-term Borrowing Arrangements” for additional information on our FHLB borrowing capacity. In addition to its FHLB borrowing line, the Company has unsecured short-term borrowing agreements with three of its correspondent banks in the amounts of $50 million, $20 million and $10 million. There were no outstanding borrowings to the correspondent banks under these agreements at December 31, 2021 and 2020.  There was a $5 million outstanding balance on the FHLB line at December 31 2020.  This borrowing matured on May 7, 2021 and was non-interest bearing. There was no outstanding balance on the FHLB borrowing line at December 31, 2021.

Customer deposits are the Company’s primary source of funds. Total deposits increased by $465 million from $974 million at December 31, 2020 to $1.4 billion at December 31, 2021. Deposits are held in various forms with varying maturities. The Company’s securities portfolio, Federal funds sold, FHLB advances, and cash and due from banks serve as the primary sources of liquidity, providing adequate funding for loans during periods of high loan demand. During periods of decreased lending, funds obtained from the maturing or sale of investments, loan payments, and new deposits are invested in short-term earning assets, such as cash held at the FRB, Federal funds sold and investment securities, to serve as a source of funding for future loan growth. Management believes that the Company’s available sources of funds, including borrowings, will provide adequate liquidity for its operations in the foreseeable future.