OAK VALLEY BANCORP Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

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Forward-looking statements



Some matters discussed in this Quarterly Report on Form 10-Q may be
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 and therefore may involve risks, uncertainties and
other factors which may cause the Company's actual results to be materially
different from the results expressed or implied by the Company's forward-looking
statements.  These statements generally appear with words such as "anticipate,"
"believe," "estimate," "may," "intend," and "expect."  Although management
believes that the assumptions and expectations reflected in such forward-looking
statements are reasonable, it can give no assurance that such expectations will
prove to be correct.  Factors that could cause actual results to differ from
results discussed in forward-looking statements include, but are not limited to:
the credit exposure of certain loan products and other components of our
business that could be impacted by the COVID-19 pandemic, changes in monetary,
fiscal or tax policy to address the continuing impact of COVID-19, any of which
could cause us to incur additional loan losses and adversely affect our results
of operations in the future, economic conditions (both generally and in the
markets where the Company operates); the continuing impact of the COVID-19
pandemic on our employees and customers; the success of our efforts to mitigate
the impact of the COVID-19 pandemic; competition from other providers of
financial services offered by the Company; changes in government regulation and
legislation; changes in interest rates; material unforeseen changes in the
financial stability and liquidity of the Company's credit customers; risks
associated with concentrations in real estate related loans; changes in
accounting standards and interpretations; and other risks as may be detailed
from time to time in the Company's filings with the Securities and Exchange
Commission, all of which are difficult to predict and which may be beyond the
control of the Company. Many of the foregoing risks and uncertainties are, and
will be, exacerbated by the COVID-19 pandemic and any worsening of the global
business and economic environment as a result. The Company undertakes no
obligation to revise forward-looking statements to reflect events or changes
after the date of this discussion or to reflect the occurrence of unanticipated
events.


Forward-looking statements speak only as of the date on which they are made, and the Company undertakes no obligation to update any forward-looking statements to reflect circumstances or events that occur after the date on which the forward-looking statements are made, whether as a result of new information, future developments or otherwise, except as required by law.



The following discussion explains the significant factors affecting the
Company's operations and financial position for the periods presented. The
discussion should be read in conjunction with the Company's financial statements
and the notes related thereto which appear or that are referenced to elsewhere
in this report, and with the audited consolidated financial statements and
accompanying notes included in the Company's 2021 Annual Report on Form 10-K.
Average balances, including balances used in calculating certain financial
ratios, are generally comprised of average daily balances.



The discussion and analysis of the Company's financial condition and results of
operations is based upon the Company's financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets and liabilities, revenues and expenses, and related disclosures of
contingent assets and liabilities at the date of the Company's financial
statements. Actual results may differ from these estimates under different
assumptions or conditions. This discussion and analysis includes management's
insight of the Company's financial condition and results of operations of Oak
Valley Bancorp and its subsidiary. Unless otherwise stated, the "Company" refers
to the consolidated entity, Oak Valley Bancorp, while the "Bank" refers to Oak
Valley Community Bank.





Introduction



Oak Valley Bancorp operates Oak Valley Community Bank as a community bank in the
general commercial banking business, with our primary market encompassing the
California Central Valley around Oakdale and Modesto, and the Eastern Sierras.
As such, unless otherwise noted, all references are about Oak Valley Bancorp.



Oak Valley Community Bank ("the Bank") is an insured bank under the Federal
Deposit Insurance Act and is a member of the Federal Reserve.  Since its
formation, the Bank has provided basic banking services to individuals and
business enterprises in Oakdale, California and the surrounding areas. The focus
of the Bank is to offer a range of commercial banking services designed for both
individuals and small to medium-sized businesses in the Central Valley and the
Eastern Sierras.



The Bank offers a complement of business checking and savings accounts for its
business customers.  The Bank also offers commercial and real estate loans, as
well as lines of credit.  Real estate loans are generally of a short-term nature
for both residential and commercial purposes.  Longer-term real estate loans are
generally made with adjustable interest rates and contain normal provisions for
acceleration.  In addition, the Bank offers traditional residential mortgages
through a third party.



The Bank also offers other services for both individuals and businesses
including online banking, remote deposit capture, merchant services, night
depository, extended hours, traveler's checks, wire transfer of funds, note
collection, and automated teller machines in a national network.  The Bank does
not currently offer international banking or trust services although the Bank
may make such services available to the Bank's customers through financial
institutions with which the Bank has correspondent banking relationships.  The
Bank does not offer stock transfer services, nor does it directly issue credit
cards.



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COVID-19 Impact and Outlook





The most significant impact to date of the coronavirus ("COVID-19") pandemic on
the Company's business has been to the quality of the loan portfolio and to net
interest income as short-term interest rates have sharply declined. In 2020, the
Company increased the qualitative factors used in the determination of the
adequacy of the allowance for loan and lease loss in anticipation of the impact
that COVID-19 will have on clients and their ability to fulfill their
obligations. In 2021, the financial stress subsided to some degree and credit
quality improved allowing the Company to reverse $635,000 in loan loss
provisions. The allowance for loan losses decreased to $10,762,000 and
$10,738,000 as of March 31, 2022 and December 31, 2021, respectively, as
compared with $11,297,000 as of December 31, 2020. The allowance for loan losses
as a percentage of total loans increased from 1.12% as of December 31, 2020 to
1.25% as of December 31, 2021 and March 22, 2022, as loan loss reserves relative
to gross loans remain at acceptable levels and credit quality remains stable.
The increase compared to 1.12% as of December 31, 2020 was due to the decrease
in outstanding PPP loans that do not require a loan loss reserve as they are
guaranteed by the federal government through the SBA program.



There is no certainty that the allowance for loan losses as of March 31, 2022
will be sufficient to absorb the losses that stem from the impact of COVID-19 on
the Company's clients. As the longer-term effects on clients from the COVID-19
pandemic become more apparent, it may be necessary to charge-off some or all of
the balance on certain loans and make further provisions to increase the
allowance for loan and lease losses. These potential additional provisions for
loan and lease losses will have a direct impact upon capital, including the
potential need to reevaluate a valuation allowance on our deferred tax asset. At
this time, the Company does not expect that there would be any material
impairment to the valuation of other long-lived assets, right of use assets, or
our investment securities.



Net interest income has already been impacted by the COVID-19 since early 2020
and certain risks still exist. Interest and fees on PPP loans are only temporary
and given that $327 million of the $345 million in funded PPP loans have been
forgiven as of March 31, 2022, we have seen a decrease in PPP related net
interest income, compared to the prior year, which will continue to decrease as
loans are forgiven and paid down. There is potential for additional negative
effects to net interest income related to the pandemic. First, interest rates
declined sharply at the end of the first quarter of 2020, causing a reduction in
the yield on our earning assets which will continue as assets mature and
reprice. Second, if the economy worsens to the point of another economic
recession, it could reduce the demand for loans and cause credit quality
deterioration leading to more non-accrual loans, for which interest income is
not recognized. Third, an increase in demand for liquidity by our clients could
result in a decrease in deposits and force us to rely on our lines of credit,
which could potentially increase our cost of funds.



Notwithstanding the foregoing, in May 2022, the Federal Open Market Committee
("FOMC") announced an increase in the federal funds rate target range by 0.50%,
resulting in a range of 0.75% to 1.00%, and while uncertain, it is expected that
the Federal Reserve will continue to increase interest rates in 2022 to slow the
effects of economic inflation tied to the COVID-19 pandemic. The Federal
Reserve's decision-making policies for short-term interest rates will continue
to impact the amount of net interest income we earn in the future. Further, as
of March 31, 2022, the Company and the Bank's on-balance sheet liquidity was
strong and combined with contingent liquidity resources, management believes
that the Bank has sufficient resources to meet the liquidity needs of its
clients. In response to COVID-19, the Federal Reserve has made other provisions
that could assist the Bank in satisfying its liquidity needs, such as reducing
the reserve requirement to zero, expanding access to the discount window through
collateral pledging and extension of term borrowings.



The extent to which the COVID-19 pandemic affects the Company's future financial
results and operations will depend on future developments, which are highly
uncertain and cannot be predicted, including new information which may emerge
concerning the duration and broad impacts of the pandemic, and current or future
actions in response thereto. See "Management's Discussion and Analysis of
Financial Position and Results of Operations" and Part II, Item 1A, Risk
Factors, for an additional discussion of risks related to COVID-19.

Critical accounting estimates



Critical accounting estimates are those estimates made in accordance with
generally accepted accounting principles that involve a significant level of
estimation and uncertainty and have had or are reasonably likely to have a
material impact on our financial condition and results of operations. We
consider accounting estimates to be critical to our financial results if (i) the
accounting estimate requires management to make assumptions about matters that
are highly uncertain, (ii) management could have applied different assumptions
during the reported period, and (iii) changes in the accounting estimate are
reasonably likely to occur in the future and could have a material impact on our
financial statements. Management has determined the following accounting
estimates and related policies to be critical:



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Goodwill Impairment



The Company applies a qualitative analysis of conditions in order to determine
if it is more likely than not that the carrying value is impaired. In the event
that the qualitative analysis suggests that the carrying value of goodwill may
be impaired, the Company uses several quantitative valuation methodologies in
evaluating goodwill for impairment that includes assumptions and estimates made
concerning the future earnings potential of the organization, and a market-based
approach that looks at values for organizations of comparable size, structure
and business model.



Estimates of fair value are based on a complex model using, among other things,
estimated cash flows and industry pricing multiples. The Company tests its
goodwill for impairment annually as of December 31 (the Measurement Date), and
quarterly if a triggering event causes concern of a possible goodwill impairment
charge. At each Measurement Date, the Company, in accordance with ASC
350-20-35-3, evaluates, based on the weight of evidence, the significance of all
qualitative factors to determine whether it is more likely than not that the
fair value of each of the reporting units is less than its carrying amount.



The assessment of qualitative factors at the most recent measurement date (December 31, 2021), indicated that it was no more likely than not that a disability existed; therefore, no further testing was performed.




Allowance for Loan Losses



Credit risk is inherent in the business of lending and making commercial loans.
Accounting for our allowance for loan losses involves significant judgment and
assumptions by management and is based on historical data and management's view
of the current economic environment. At least on a quarterly basis, our
management reviews the methodology and adequacy of allowance for loan losses and
reports its assessment to the Board of Directors for its review and approval.



The allowance for loan losses is an estimate of probable incurred losses with
regard to our loans. Our loan loss provision for each period is dependent upon
many factors, including loan growth, net charge-offs, changes in the composition
of the loans, delinquencies, management's assessment of the quality of the
loans, the valuation of problem loans and the general economic conditions in our
market area. We base our allowance for loan losses on an estimation of probable
losses inherent in our loan portfolio.



Our methodology for assessing loan loss allowances are intended to reduce the
differences between estimated and actual losses and involves a detailed analysis
of our loan portfolio, in three phases:



? the specific review of individual loans,

? segmentation and review of pools of loans with similar characteristics, and

? our discretionary estimate based on various subjective factors:



The first phase of our methodology involves the specific review of individual
loans to identify and measure impairment. We evaluate each loan by use of a risk
rating system, except for homogeneous loans, such as automobile loans and home
mortgages. Specific risk rated loans are deemed impaired if all amounts,
including principal and interest, will likely not be collected in accordance
with the contractual terms of the related loan agreement. Impairment for
commercial and real estate loans is measured either based on the present value
of the loan's expected future cash flows or, if collection on the loan is
collateral dependent, the estimated fair value of the collateral, less selling
and holding costs.



The second phase involves the segmenting of the remainder of the risk rated loan
portfolio into groups or pools of loans, together with loans with similar
characteristics, for evaluation. We determine the calculated loss ratio to each
loan pool based on its historical net losses and benchmark it against the levels
of other peer banks.



In the third phase, we consider relevant internal and external factors that may
affect the collectability of loan portfolio and each group of loan pool. The
factors considered are, but are not limited to:



? concentration of credits,


? the nature and volume of the loan portfolio,


? delinquency trends,



? non-accrual loan trends,



? problem loan trends,



? loss and recovery trends,



? quality of loan review,


? credit and management staff,

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? lending policies and procedures,

? economic and commercial conditions, and


? other external factors.



Management estimates the probable effect of such conditions based on our
judgment, experience and known or anticipated trends. Such estimation may be
reflected as an additional allowance to each group of loans, if necessary.
Management reviews these conditions with our senior credit officers. To the
extent that any of these conditions is evidenced by a specifically identifiable
problem credit or portfolio segment as of the month-end evaluation date,
management's estimate of the effect of such condition may be reflected as a
specific allowance applicable to such credit or portfolio segment.



Central to our credit risk management and our assessment of appropriate loss
allowance is our loan risk rating system. Under this system, the originating
credit officer assigns borrowers an initial risk rating based on a thorough
analysis of each borrower's financial capacity in conjunction with industry and
economic trends. Approvals are made based upon the amount of inherent credit
risk specific to the transaction and are reviewed for appropriateness by senior
line and credit administration personnel. Credits are monitored by line and
credit administration personnel for deterioration in a borrower's financial
condition which may impact the ability of the borrower to perform under the
contract. Although management has allocated a portion of the allowance to
specific loans, specific loan pools, and off-balance sheet credit exposures
(which are reported separately as part of other liabilities), the adequacy of
the allowance is considered in its entirety.



It is the policy of management to maintain the allowance for loan losses at a
level adequate for risks inherent in the overall loan portfolio, however, the
loan portfolio can be adversely affected if the state of California's economic
conditions and its real estate market in our general market area were to further
deteriorate or weaken. Additionally, further weakness of a prolonged nature in
the agricultural and general economy would have a negative impact on the local
market. The effect of such economic events, although uncertain and unpredictable
at this time, could result in an increase in the levels of nonperforming loans
and additional loan losses, which could adversely affect our future growth and
profitability. No assurance of the level of predicted credit losses can be given
with any certainty.





Income Taxes



Deferred income taxes are provided for the temporary differences between the
financial reporting basis and the tax basis of our assets and liabilities.
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled using the liability method.
As changes in tax laws or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.



We file income tax returns in the U.S. federal jurisdiction, and the state of
California. With few exceptions, we are no longer subject to U.S. federal or
state/local income tax examinations by tax authorities for years before 2017.





Fair Value Measurements



We use fair value measurements to record fair value adjustments to certain
assets and liabilities and to determine fair value disclosures. We base our fair
values on the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants at the
measurement date. Securities available for sale, derivatives, and loans held for
sale, if any, are recorded at fair value on a recurring basis. Additionally,
from time to time, we may be required to record certain assets at fair value on
a non-recurring basis, such as certain impaired loans held for investment and
securities held to maturity that are other-than-temporarily impaired. These
non-recurring fair value adjustments typically involve write-downs of individual
assets due to application of lower-of-cost or market accounting.



We have established and documented a process for determining fair value. We
maximize the use of observable inputs and minimize the use of unobservable
inputs when developing fair value measurements. Whenever there is no readily
available market data, management uses its best estimate and assumptions in
determining fair value, but these estimates involve inherent uncertainties and
the application of management's judgment. As a result, if other assumptions had
been used, our recorded earnings or disclosures could have been materially
different from those reflected in these financial statements. For detailed
information on our use of fair value measurements and our related valuation
methodologies, see Note 5 to the Consolidated Financial Statements Item 1 of
this report.




Overview of operating results and financial position



The purpose of this summary is to provide an overview of the items that
management focuses on when evaluating the condition of the Company and its
success in implementing its business and shareholder value strategies. The
Company's business strategy is to operate the Bank as a well-capitalized,
profitable and independent community-oriented bank. The Company's shareholder
value strategy has three major objectives: (1) enhancing shareholder value; (2)
making its retail banking franchise more valuable; and (3) efficiently utilizing
its capital.



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Management believes that the following were significant factors in the Company’s performance during the three-month period ended March 31, 2022:

• The Company recognized a net profit of $2,369,000 for the period of three months

finished March 31, 2022compared to $4,357,000 for the same period in 2021.

The decline in first quarter net income was mainly due to a decrease in loans

    interest and fees recognized on PPP loans.



• The Company has not recorded any provision for loan losses during the three-month periods

finished March 31, 2022 and 2021. No provision was justified during the first

three months of 2022, as our loan loss provision model determined that

    reserves were adequate throughout the quarter.



• Net interest income decreased $1,284,000 or 10.5% for the three-month period

finished March 31, 2022compared to the same period in 2021, due to a decrease

interest and fees recognized on PPP loans, which amount to $487,000 during

the three months have ended March 31, 2022compared to $2,590,000 compared to

the same period of 2021, which was partially offset by earnings growth

    assets.



• Non-interest revenue decreased by $8,000 or 0.7% for the three months ended

March 31, 2022compared to the same period in 2021. The decrease was

    primarily due to fair value changes in one equity security.



• Non-interest expense increased by $1,402,000 i.e. 18.2% for the quarter

period ended March 31, 2022compared to the same period in 2021. The

the increase is mainly attributable to the increase in staff and general operating expenses

related to the management of growing loan and deposit portfolios, and a reduction

deferred fees associated with funded PPP loans recognized as compensation for salary

    expense.



• Total assets decreased $18,459,000 or 0.9%, total net lending decreased by

$969,000 i.e. 0.1% and investment securities increased by $86,091,000 i.e. 32.3%

in each case of December 31, 2021 for March 31, 2022while the deposits

decreased by $7,661,000 or 0.4% for the same period. Therefore, the cash and

cash equivalent balances decreased by $109,042,000. the March 31, 2022 balance

sheet totals include $17.7 million in outstanding PPP loans. Total funding

since the start of the PPP lending program in 2020 has been $345 million and from

March 31, 2022we received $327 million in remittance payments from

    SBA.






Income Summary



For the three-month period ended March 31, 2022, the Company recorded net income
of $2,369,000, representing a decrease of $1,988,000, as compared to the same
period in 2021.  Return on average assets (annualized) was 0.50% for the
three-months ended March 31, 2022, as compared to 1.12% for the same period in
2021.  Annualized return on average common equity was 6.84% for the three-months
ended March 31, 2022, as compared to 13.44% for the same period in 2021. Net
income before provisions for income taxes decreased by $2,694,000 for the
three-month period ended March 31, 2022, from the comparable 2021 period.  The
income statement components of these variances are as follows:





Summary of the pre-tax income gap:


                                            Effect on Pre-Tax
                                                  Income
(In thousands)                             Increase (Decrease)
                                            Three Months Ended
                                              March 31, 2022
Change from 2021 to 2022 in:
Net interest income                        $             (1,284 )
Provision for loan losses                                     0
Non-interest income                                          (8 )
Non-interest expense                                     (1,402 )
Change in net income before income taxes   $             (2,694 )

These discrepancies will be explained in the discussion below.

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Net Interest Income



Net interest income is the largest source of the Company's operating income.
For the three-month period ended March 31, 2022, net interest income was
$10,958,000, which represented a decrease of $1,284,000 or 10.5%, from the
comparable period in 2021. The decrease was primarily due to a decrease in
interest and fees on PPP loans from $2,590,000 during the first quarter of 2021
to $487,000 during the three-months ended March 31, 2022.



The net interest margin (net interest income as a percentage of average interest
earning assets) was 2.51% for the three-month period ended March 31, 2022,
compared to 3.43% for the same period in 2021. The decrease in net interest
margin is primarily due to the decrease in PPP loan interest and fees, strong
deposit growth resulting in high levels of low-yielding cash equivalent
balances, and the negative impact that the 2020 FOMC interest rate cuts had on
our yield on earning assets. Earning asset yield decreased by 92 basis points
for the three-month period ended March 31, 2022, as compared to the same period
of 2021. Lessening this downward trend, was the deployment of low yielding cash
equivalent balances into the organic loan portfolio and investment security
portfolio.



The cost of funds on interest-bearing liabilities decreased by 3 basis points
for the three-month period of 2022, respectively, as compared to the same period
in 2021. The Company continues to recognize strong core deposit growth as
evidenced by the increase in average non-interest-bearing demand deposit
balances of $112 million, for the three-month period ended March 31, 2022, as
compared to the same period of 2021. Deposit balances were bolstered by funded
PPP loans during the first quarter of 2021, as the funded amounts were credited
directly to the borrowers' deposit accounts.



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The following tables show the relative impact of changes in average balances of
interest earning assets and interest-bearing liabilities, and interest rates
earned and paid by the Company on those assets and liabilities for the
three-month periods ended March 31, 2022 and 2021:



Net Interest Analysis



                                                  Three months ended                            Three months ended
                                                    March 31, 2022                                March 31, 2021
                                                       Interest          Avg                         Interest          Avg
                                         Average       Income /         Rate/          Average       Income /         Rate/
(in thousands)                           Balance        Expense       Yield (5)        Balance        Expense       Yield (5)
Assets:
Earning assets:
Gross loans (1) (2)                    $   847,994     $   9,143            4.37 %   $ 1,024,144     $  11,205            4.44 %
Investment securities (2)                  306,690         2,110            2.79 %       208,159         1,457            2.84 %
Federal funds sold                          24,174            10            0.17 %        30,732             6            0.08 %
Interest-earning deposits                  642,101           256            0.16 %       212,733            49            0.09 %
Total interest-earning assets            1,820,959        11,519            2.57 %     1,475,768        12,717            3.49 %
Total noninterest earning assets           112,833                                       103,006
Total assets                             1,933,792                                     1,578,774
Liabilities and Shareholders'
Equity:
Interest-bearing liabilities:
Interest-earning DDA                       446,906            94            0.09 %       339,519           102            0.12 %
Money market deposits                      411,677           104            0.10 %       322,331            89            0.11 %
Savings deposits                           160,930            21            0.05 %       126,419            16            0.05 %
Time deposits $250,000 and under             2,185            14            0.26 %        21,818            15            0.28 %
Time deposits over $250,000                 18,427            11            0.24 %        16,354            14            0.35 %
Total interest-bearing liabilities       1,060,125           244            0.09 %       826,441           236            0.12 %
Noninterest-bearing liabilities:
Noninterest-bearing deposits               718,256                                       605,790
Other liabilities                           15,031                                        15,118
Total noninterest-bearing
liabilities                                733,287                                       620,908
Shareholders' equity                       140,380                                       131,425
Total liabilities and shareholders'
equity                                 $ 1,933,792                                   $ 1,578,774
Net interest income                                    $  11,275                                     $  12,481
Net interest spread (3)                                                     2.47 %                                        3.38 %
Net interest margin (4)                                                     2.51 %                                        3.43 %



______________________________________

(1) Loan fees have been included in the calculation of interest income.

(2) Yields and interest income on municipal securities and loans have been adjusted to their fully taxable equivalents, based on a federal marginal tax rate of 21.0%.

(3) Represents the average rate earned on interest-bearing assets less the average rate paid on interest-bearing liabilities.

(4) Represents net interest income as a percentage of average interest-earning assets.

(5) Annual interest rates are calculated by dividing the interest income/expense by the number of days in the period multiplied by 365.

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Shown in the following tables are the relative impacts on net interest income of
changes in the average outstanding balances (volume) of earning assets and
interest-bearing liabilities and the rates earned and paid by the Company on
those assets and liabilities for the three-month periods ended March 31, 2022
and 2021.  Changes in interest income and expense that are not attributable
specifically to either rate or volume are allocated to the rate column below.




Analysis of flow/volume deviations

(In thousands)



                                       For the Three Months Ended March 31,
                                                   2022 vs 2021
                                                Increase (Decrease)
                                          in interest income and expense
(in thousands)                                  due to changes in:
                                      Volume              Rate           Total
Interest income:
Gross loans (1) (2)                $      (1,927 )     $     (135 )     $ (2,062 )
Investment securities (2)                    690              (37 )          653
Federal funds sold                            (1 )              5              4
Interest-earning deposits                    100              107            207
Total interest income              $      (1,138 )     $      (60 )     $ (1,198 )

Interest expense:
Interest-earning DDA               $          32       $      (40 )     $     (8 )
Money market deposits                         25              (10 )           15
Savings deposits                               4                1              5
Time deposits $250,000 and under               0               (1 )           (1 )
Time deposits over $250,000                    2               (5 )           (3 )
Total interest expense             $          63       $      (55 )     $      8

Change in net interest income      $      (1,201 )     $       (5 )     $ (1,206 )



__________________________________

(1) Loan fees have been included in the calculation of interest income.

(2) Interest income on securities and municipal loans have been adjusted to their fully taxable equivalents, based on a federal marginal tax rate of 21.0%.



The table above reflects a decrease of $1,201,000 in net interest income due to
changes in volume combined with the overall change in mix of balances during the
first quarter of 2022 as compared to the same period of 2021. This reduction was
mainly due to a decrease in PPP loan balances in the first quarter of 2022
compared to the same period of 2021. Changes in earning asset yields and rates
on interest-bearing liabilities resulted in a decrease of $5,000 to net interest
income, over the same period. This decrease was mainly due to a decline in PPP
loan fees as described above, which was partially offset by the increase in
gross loan yield due to the reduction of PPP loan balances that yielded just 1%.



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Provision for Loan Losses



The Company makes provisions for loan losses when required to bring the total
allowance for loan and lease losses to a level deemed appropriate for the level
of risk in the loan portfolio.  At least quarterly, management conducts an
assessment of the overall quality of the loan portfolio and general economic
trends in the local market.  The determination of the appropriate level for the
allowance is based on that review, considering such factors as historical
experience, the volume and type of lending conducted, the amount of and
identified potential loss associated with specific non-performing loans,
regulatory policies, general economic conditions, and other factors related to
the collectability of loans in the portfolio.



The Company recorded no loan loss provisions during the three-months ended March
31, 2022 and no provisions during the same period of 2021. No loan loss
provisions were warranted during the first three months of 2022 because credit
quality remained strong as evidenced by non-accrual loans remaining at a zero
balance and the allowance for loan loss model determined that reserves were
adequate throughout the quarter. The gross loan decrease during the quarter was
mainly related to PPP loans, which do not require a reserve because they are
guaranteed by the federal government through the SBA program. Qualitative risk
factor adjustments of approximately $1.6 million were made to the allowance for
loan loss reserve during 2020 related to the impact of the COVID-19 pandemic.
Management reviewed the qualitative factors within the allowance for loan loss
calculation and determined that a macro-economic adjustment was necessary to
account for the potential negative impact of the financial strain that is being
experienced by certain borrowers. Management will continue to closely monitor
the economic impacts to our loan portfolio and may need to make further
qualitative adjustments depending on the severity and longevity of the COVID-19
pandemic.





Non-Interest Income



Non-interest income represents service charges on deposit accounts and other
non-interest related charges and fees, including fees from mortgage commissions
and investment service fee income.  For the three-month period ended March 31,
2022, non-interest income was $1,168,000, representing a decrease of $8,000 or
0.7%, compared to the same period in 2021.



The following tables present the main components of non-interest income:


(in thousands)                                      For the Three Months Ended March 31,
                                           2022              2021          $ Change        % Change
Service charges on deposits             $       376       $       295     $        81            27.5 %
Debit card transaction fee income               413               381              32             8.4 %
Earnings on cash surrender value of
life insurance                                  182               164              18            11.0 %
Mortgage commissions                             35                31               4            12.9 %
Other income                                    162               305            (143 )         -46.9 %
Total non-interest income               $     1,168       $     1,176     $        (8 )          -0.7 %








Service charges on deposits increased by $81,000 for the three-months ended
March 31, 2022, compared to the same period in 2021. The first quarter increase
was due to higher deposit account balances corresponding to PPP loans and
government stimulus payments, coupled with changes in customer spending patterns
amid the COVID-19 pandemic that resulted in lower overdraft fees in 2021
compared to 2022. This trend is in addition to strong growth of our core
customer base and corresponding service fee income related to servicing loan and
deposit accounts.



Debit card transaction fee income increased by $32,000 for the three-months
ended March 31, 2022, compared to the same period in 2021. The increase during
2022 is attributable to changes that begun in 2020 in business and consumer
spending patterns have shifted to electronic payment methods amid the COVID-19
pandemic.


Life insurance cash value benefit increased by $18,000 for the three months ended March 31, 2022compared to the same period in 2021, corresponding to the subscription of new life insurance policies on certain directors and officers during the second quarter of 2021.



Mortgage commissions increased by $4,000 for the three-months ended March 31,
2022, as compared to the same period of 2021, as the demand for home purchases
and refinancing has increased from last year.



Other income decreased by $143,000 for the three-month period ended March 31,
2022, as compared to the same period of 2021. The first quarter decrease was
mainly due to an increase in fair value changes on one equity security.



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Non-Interest Expense


Non-interest expenses represent salaries and benefits, occupancy expenses, professional expenses, external services and other miscellaneous expenses necessary to conduct business.

The following tables present the main components of non-interest expenses:


(in thousands)                                      For the Three Months Ended March 31,
                                           2022              2021          $ Change        % Change
Salaries and employee benefits          $     5,676       $     4,742     $       934            19.7 %
Occupancy expenses                            1,035               966              69             7.1 %
Data processing fees                            559               494              65            13.2 %
Regulatory assessments (FDIC & DFPI)            261               117             144           123.1 %
Other operating expenses                      1,591             1,401             190            13.6 %
Total non-interest expense              $     9,122       $     7,720     $     1,402            18.2 %






Non-interest expenses increased by $1,402,000 or 18.2% for the three-months
ended March 31, 2022, as compared to the same period of 2021.  Salaries and
employee benefits increased $934,000 for the three-months ended March 31, 2022,
as compared to the same period of 2021. The increase is due to additional
staffing expense required to support the continued loan and deposit growth and a
decrease in deferred cost adjustments on funded PPP loans that are recorded
against salary expense.



Occupancy expenses increased by $69,000 for the three-months ended March 31,
2022, as compared to the same period of 2021, mainly due to rent expense and
general operating costs related to branch facilities.



Data processing fees increased by $65,000 for the three-month period ended March
31, 2022, as compared to the same period of 2021, primarily due to servicing
costs on the growing number of loan and deposit accounts.



FDIC and California Department of Financial Protection and Innovation (DFPI)
regulatory assessments increased by $144,000 for the three-months ended March
31, 2022, as compared to the same period in 2021, mainly due to substantial
increases in our deposit balances.  The initial base assessment rate for
financial institutions varies based on the overall risk profile of the
institution as defined by the FDIC and the Company's risk profile has remained
at stable levels but there were modest increases in the assessment rate during
2021 and 2022 related to normal business cycles. The assessment rate remains at
a relatively low level due to our strong credit quality, earnings and risk-based
capital ratios. Management recognizes that assessments could increase further
depending on deposit growth throughout the remainder of 2022, as the FDIC
assessment rates are applied to average quarterly total liabilities as the
primary basis.



Other expense increased by $190,000 for the three-months ended March 31, 2022,
as compared to the same period in 2021, due to increases in a variety of general
operating expenses, which is not unusual given the expansion of the Company's
business portfolios.



Management anticipates that non-interest expense will continue to increase as
the Company continues to grow.  However, management remains committed to
cost-control and efficiency, and expects to keep these increases to a minimum
relative to growth.





Income Taxes



The Company reported provisions for income taxes of $635,000 for the three-month
period ended March 31, 2022, representing a decrease of $706,000 compared to the
provisions reported in the comparable period of 2021. The effective income tax
rate on income from continuing operations was 21.1% for the three-months ended
March 31, 2022, compared to 23.5% for the comparable period of 2021. These
provisions reflect accruals for taxes at the applicable rates for federal income
tax and California franchise tax based upon reported pre-tax income, and
adjusted for the effects of all permanent differences between income for tax and
financial reporting purposes (such as earnings on qualified municipal
securities, bank owned life insurance and certain tax-exempt loans). The
disparity between the effective tax rates for the year-to-date period of 2022 as
compared to 2021 is primarily due to tax credits from low-income housing
projects as well as tax free-income on municipal securities and loans that
comprised a larger proportion of pre-tax income in 2022 as compared to 2021.





Asset Quality


Non-performing assets include loans in non-recognition status, including restructured loans in non-recognition status, whose repayment terms have been renegotiated resulting in a reduction or deferral of interest or principal, defaulted loans for 90 days or more and still accrued interest and OREO.

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Loans are generally placed on non-accrual status when they become 90 days past
due, unless management believes the loan is adequately collateralized and in the
process of collection. The past due loans may or may not be adequately
collateralized, but collection efforts are continuously pursued. Loans may be
restructured by management when a borrower has experienced some changes in
financial status, causing an inability to meet the original repayment terms, and
where management believes the borrower will eventually overcome those
circumstances and repay the loan in full. OREO consists of properties acquired
by foreclosure or similar means and which management intends to offer for sale.



Non-accrual loans totaled $0 as of March 31, 2022 and December 31, 2021.  As of
March 31, 2022 there was one consumer loan totaling $21,000 classified as a
troubled debt restructuring that was modified by extending the term. As of
December 31, 2021, the Company did not have any loans classified as troubled
debt restructurings.



OREO as of March 31, 2022 and December 31, 2021 consisted of one property, a
residential land property acquired through foreclosure that was written down to
a zero balance because the public utilities have not been obtainable, therefore,
rendering these land lots unmarketable at this time. There were no sales,
acquisitions or fair value adjustments of OREO properties during the first three
months of 2022 and 2021.


The following table presents information on the Bank’s non-performing assets, including asset quality ratios at March 31, 2022 and December 31, 2021:


Non-Performing Assets



(in thousands)                                         March 31,         December 31,
                                                         2022                2021
Loans in non-accrual status                         $             0     $             0
Loans past due 90 days or more and accruing                       0                   0
Total non-performing loans                                        0                   0
Other real estate owned                                           0                   0
Total non-performing assets                         $             0     $             0

Allowance for loan losses                           $        10,762     $        10,738

Asset quality ratios:
Non-performing assets to total assets                          0.00 %              0.00 %
Non-performing loans to total loans                            0.00 %              0.00 %
Allowance for loan losses to total loans                       1.25 %              1.25 %
Allowance for loan losses to total non-performing
loans                                                            NA                  NA





Non-performing assets remained at $0 from March 31, 2022 and December 31, 2021due to the strong credit quality within our loan portfolio.

Allowance for losses on loans and leases



Due to credit risk inherent in the lending business, the Company routinely sets
aside allowances through charges to earnings. Such charges are not only made for
the outstanding loan portfolio, but also for off-balance sheet items, such as
commitments to extend credits or letters of credit. Charges for the outstanding
loan portfolio have been credited to the allowance for loan losses, whereas
charges for off-balance sheet items have been credited to the reserve for
off-balance sheet items, which is presented as a component of other
liabilities.  The Company recorded no loan loss provisions during the
three-months ended March 31, 2022 and 2021.



Provisions of approximately $1.6 million were made in 2020 to adjust for the
impact of the COVID-19 pandemic. Management reviewed the qualitative factors
within the allowance for loan loss calculation and determined that a
macro-economic adjustment was necessary to account for the potential negative
impact of the financial strain that is being experienced by certain borrowers.
Management will continue to closely monitor the economic impacts to our loan
portfolio and may need to make further qualitative adjustments depending on the
severity and longevity of the COVID-19 pandemic.



The allowance for loan losses increased by $24,000 to $10,762,000 as of March
31, 2022, as compared to $10,738,000 as of December 31, 2021, due to net loan
recoveries of $24,000 during the first three months of 2022. The PPP loans were
paid down to $17.7 million outstanding as of March 31, 2022 and do not require a
loan loss reserve as they are guaranteed by the federal government through the
SBA program. These factors combined with the decrease in the gross loan balance
had no impact on the allowance for loan losses as a percentage of total loans as
it remained at 1.25% as of March 31, 2022 and December 31, 2021.



The Company will continue to monitor the adequacy of the loan loss provision and will make additions to the provision in accordance with the analysis mentioned above. Due to the inherent uncertainties in estimating the appropriate level of loan loss allowance, actual results may differ from management’s estimate of credit losses and the related allowance.

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The Company makes provisions for loan losses when required to bring the total
allowance for loan and lease losses to a level deemed appropriate for the level
of risk in the loan portfolio.  At least quarterly, management conducts an
assessment of the overall quality of the loan portfolio and general economic
trends in the local market.  The determination of the appropriate level for the
allowance is based on that review, considering such factors as historical
experience, the volume and type of lending conducted, the amount of and
identified potential loss associated with specific non-performing loans,
regulatory policies, general economic conditions, and other factors related to
the collectability of loans in the portfolio.



Although management believes the allowance as of March 31, 2022 was adequate to
absorb probable losses from any known and inherent risks in the portfolio, no
assurance can be given that the adverse effect of current and future economic
conditions on the Company's service areas, or other variables, will not result
in increased losses in the loan portfolio in the future.





Investment Activities



Investments are a key source of interest income. Management of the investment
portfolio is set in accordance with strategies developed and overseen by the
Company's Investment Committee. Investment balances, including cash equivalents
and interest-bearing deposits in other financial institutions, are subject to
change over time based on the Company's asset/liability funding needs and
interest rate risk management objectives. The Company's liquidity levels take
into consideration anticipated future cash flows and all available sources of
credits, and are maintained at levels management believes are appropriate to
assure future flexibility in meeting anticipated funding needs.



Cash Equivalents



The Company holds federal funds sold, unpledged available-for-sale securities
and salable government guaranteed loans to help meet liquidity requirements and
provide temporary holdings until the funds can be otherwise deployed or
invested. As of March 31, 2022, and December 31, 2021, the Company had
$669,225,000 and $778,267,000, respectively, in cash and cash equivalents.



Investment Securities



Management of the investment securities portfolio focuses on providing an
adequate level of liquidity and establishing an interest rate-sensitive
position, while earning an adequate level of investment income without taking
undue risk. Investment securities that the Company intends to hold until
maturity are classified as held-to-maturity securities, and all other investment
securities are classified as available-for-sale or equity securities.
Currently, all of the investment securities are classified as available-for-sale
except for one mutual fund classified as an equity security with a carrying
value of $3,229,000 as of March 31, 2022. The carrying values of
available-for-sale investment securities are adjusted for unrealized gains or
losses as a valuation allowance and any gain or loss is reported on an after-tax
basis as a component of other comprehensive income. The carrying values of
equity securities are adjusted for unrealized gains or losses through
noninterest income in the consolidated statement of income.



Management has evaluated the investment securities portfolio to determine if the
impairment of any security in an unrealized loss position is temporary or other
than temporary.  The Company conducts a periodic review and evaluation of the
securities portfolio to determine if the value of any security has declined
below its carrying value. If such decline is determined to be other than
temporary, the Company would adjust the carrying amount of the security by
writing down the security to fair value through a charge to current period
income or a charge to accumulated other comprehensive income depending on the
nature of the impairment and managements intent or requirement to sell the
security. Management has determined that no investment security is other than
temporarily impaired.  The unrealized losses are due primarily to interest rate
changes.





Deposits



Total deposits as of March 31, 2022 were $1,799,305,000, a $7,661,000 or 0.4%
decrease from the deposit total of $1,806,966,000 as of December 31, 2021.
Average deposits increased by $346,150,000 to $1,778,381,000 for the three-month
period ended March 31, 2022 as compared to the same period in 2021. Management
believes the Company attracted deposits due to the safety and soundness of the
Bank and our focus on customer service.



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Deposits Outstanding



                  March 31,       December 31,        Three Month Change
(in thousands)      2022              2021               $             %

Demand           $ 1,171,157     $    1,210,153     $   (38,996 )     (3.2% )
MMDA                 421,386            401,072          20,314         5.1 %
Savings              167,007            155,231          11,776         7.6 %
Time < $250K          21,699             21,948            (249 )     (1.1% )
Time > $250K          18,056             18,562            (506 )     (2.7% )
                 $ 1,799,305     $    1,806,966     $    (7,661 )     (0.4% )






Because the Company's client base is comprised primarily of commercial and
industrial accounts, individual account balances are generally higher than those
of consumer-oriented banks. Four clients carry deposit balances of more than 1%
of total deposits, but none had a deposit balance of more than 3% of total
deposits as of March 31, 2022. Management believes that the Company's funding
concentration risk is not significant and is mitigated by the ample sources of
funds the Bank has access to.



Since the deposit growth strategy emphasizes core deposit growth, the Company
has avoided relying on brokered deposits as a consistent source of funds. The
Company had no brokered deposits as of March 31, 2022 and December 31, 2021.





Borrowings



Although deposits are the primary source of funds for lending and investment
activities and for general business purposes, the Company may obtain advances
from the Federal Home Loan Bank ("FHLB") as an alternative to retail deposit
funds. As of March 31, 2022 and December 31, 2021, there were no outstanding
FHLB advances or borrowings of any kind, as the Company continues to rely on
deposit growth as its primary source of funding. See "Liquidity Management"
below for the details on the FHLB borrowings program.





Capital Ratios



The Company is regulated by the Federal Reserve Bank ("FRB") and is subject to
the securities registration and public reporting regulations of the Securities
and Exchange Commission. As a California state-chartered bank, the Company's
banking subsidiary is subject to primary supervision, examination and regulation
by the California Department of Financial Protection and Innovation ("DFPI") and
the Federal Reserve Board. The Federal Reserve Board is the primary federal
regulator of state member banks. The Bank is also subject to regulation by the
FDIC, which insures the Bank's deposits as permitted by law. Management is not
aware of any recommendations of regulatory authorities or otherwise which, if
they were to be implemented, would have a material effect on the Company's or
Bank's liquidity, capital resources, or operations.



The U.S. Basel III rules contain capital standards regarding the composition of
capital, minimum capital ratios and counter-party credit risk capital
requirements. The Basel III rules also include a definition of common equity
Tier 1 capital and require that certain levels of such common equity Tier 1
capital be maintained. The rules also include a capital conservation buffer,
which imposes a common equity requirement above the new minimum that can be
depleted under stress and could result in restrictions on capital distributions
and discretionary bonuses under certain circumstances, as well as a new
standardized approach for calculating risk-weighted assets. Under the Basel III
rules, we must maintain a ratio of common equity Tier 1 capital to risk-weighted
assets of at least 4.5%, a ratio of Tier 1 capital to risk-weighted assets of at
least 6%, a ratio of total capital to risk-weighted assets of at least 8% and a
minimum Tier 1 leverage ratio of 4.0%. In addition to the preceding
requirements, all financial institutions subject to the Rules, including both
the Company and the Bank, are required to establish a "conservation buffer,"
consisting of common equity Tier 1 capital, which is at least 2.5% above each of
the preceding common equity Tier 1 capital ratio, the Tier 1 risk-based ratio
and the total risk-based ratio. An institution that does not meet the
conservation buffer will be subject to restrictions on certain activities
including payment of dividends, stock repurchases and discretionary bonuses to
executive officers.



Failure to meet minimum capital requirements can trigger regulatory actions that
could have a material adverse effect on the Company's financial statements and
operations. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Company and Bank must meet specific capital
guidelines that rely on quantitative measures of assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Company's and Bank's amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.



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The following tables provide a comparison of our actual capital ratios to the minimum required ratios as of the dates indicated:


(in thousands)                                                                Regulatory
                                                      Actual                    Minimum
Capital ratios for Bank:                       Amount         Ratio        Amount      Ratio

As of March 31, 2022
Total capital (to Risk- Weighted Assets)      $ 144,950          12.9 %   $ 118,128   >10.5%
Tier I capital (to Risk- Weighted Assets)     $ 133,725          11.9 %   $  95,627    >8.5%
Common Equity Tier 1 Capital (to Risk
Weighted Assets)                              $ 133,725          11.9 %   $  78,752    >7.0%
Tier I capital (to Average Assets)            $ 133,725           6.9 %   $ 

77,023 > 4.0%

As of December 31, 2021
Total capital (to Risk- Weighted Assets)      $ 143,871          13.6 %   $ 110,780   >10.5%
Tier I capital (to Risk- Weighted Assets)     $ 132,664          12.6 %   $  89,679    >8.5%
Common Equity Tier 1 Capital (to Risk
Weighted Assets)                              $ 132,664          12.6 %   $  73,853    >7.0%
Tier I capital (to Average Assets)            $ 132,664          7.00 %   $ 

76,310 > 4.0%

Company equity ratios:

As of March 31, 2022
Total capital (to Risk- Weighted Assets)      $ 145,220          12.9 %   $ 118,144   >10.5%
Tier I capital (to Risk- Weighted Assets)     $ 133,995          11.9 %   $  95,640    >8.5%
Common Equity Tier 1 Capital (to Risk
Weighted Assets)                              $ 133,995          11.9 %   $  78,762    >7.0%
Tier I capital (to Average Assets)            $ 133,995           7.0 %   $ 

77,027 > 4.0%

As of December 31, 2021
Total capital (to Risk- Weighted Assets)      $ 143,984          13.7 %   $ 110,784   >10.5%
Tier I capital (to Risk- Weighted Assets)     $ 132,777          12.6 %   $  89,683    >8.5%
Common Equity Tier 1 Capital (to Risk
Weighted Assets)                              $ 132,777          12.6 %   $  73,856    >7.0%
Tier I capital (to Average Assets)            $ 132,777           7.0 %   $  76,313    >4.0%








Liquidity Management



Since the Company is a holding company and does not conduct regular banking
operations, its primary sources of liquidity are dividends from the Bank. Under
the California Financial Code, payment of a dividend from the Bank to the
Company is restricted to the lesser of the Bank's retained earnings or the
amount of the Bank's undistributed net profits from the previous three fiscal
years. The primary uses of funds for the Company are stockholder dividends,
investment in the Bank and ordinary operating expenses. Management anticipates
that there will be sufficient earnings at the Bank level to provide dividends to
the Company to meet its funding requirements for the next twelve months.



Maintenance of adequate liquidity requires that sufficient resources be
available at all times to meet the Company's cash flow requirements. Liquidity
in a banking institution is required primarily to provide for deposit
withdrawals and the credit needs of its customers and to take advantage of
investment opportunities as they arise. Liquidity management involves the
ability to convert assets into cash or cash equivalents without incurring
significant loss, and to raise cash or maintain funds without incurring
excessive additional cost. For this purpose, the Company maintains a portion of
funds in cash and cash equivalents, salable government guaranteed loans and
securities available for sale. The Company obtains funds from the repayment and
maturity of loans as well as deposit inflows, investment security maturities and
paydowns, Federal funds purchased, FHLB advances, and other borrowings. The
Company's primary use of funds are the origination of loans, the purchase of
investment securities, withdrawals of deposits, maturity of certificate of
deposits, repayment of borrowings and dividends to common stockholders. The
Company's liquid assets as of March 31, 2022 were $839.2 million compared to
$858.2 million as of December 31, 2021.  The Company's liquidity level measured
as the percentage of liquid assets to total assets was 43.1% as of March 31,
2022, compared to 43.7% as of December 31, 2021. Liquid assets decreased during
the first three months of 2022, mainly due to the deposit decrease of $7.7
million and core loan growth, excluding PPP loans, of $11.5 million, resulting
in lower levels of cash. Management anticipates that cash and cash equivalents
on hand and other sources of funds will provide adequate liquidity for
operating, investing and financing needs and regulatory liquidity requirements
for at least the next twelve months. Management monitors the Company's liquidity
position daily, balancing loan funding/payments with changes in deposit activity
and overnight investments.



As a secondary source of liquidity, the Company relies on advances from the FHLB
to supplement the supply of lendable funds and to meet deposit withdrawal
requirements. Advances from the FHLB are typically secured by a portion of the
loan portfolio. The FHLB determines limitations on the amount of advances by
assigning a percentage to each eligible loan category that will count towards
the borrowing capacity. As of March 31, 2022, the Company's borrowing capacity
from the FHLB was approximately $329.1 million and there were no outstanding
advances. The Company also maintains 2 lines of credit with correspondent banks
to purchase up to $70 million in federal funds, for which there were no advances
as of March 31, 2022.



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During the period of uncertainty and volatility related to the COVID-19 pandemic, we will continue to monitor our liquidity.

Off-balance sheet arrangements



During the ordinary course of business, the Company provides various forms of
credit lines to meet the financing needs of customers. These commitments, which
represent a credit risk to us, are not represented in any form on the balance
sheets.


From March 31, 2022 and December 31, 2021the Company had undertaken to grant a loan of $179.4 million and $181.1 millionrespectively, which includes obligations under letters of credit of $3.0 million and $3.3 millionrespectively.



The effect on the Company's revenues, expenses, cash flows and liquidity from
the unused portion of the commitments to provide credit cannot be reasonably
predicted because there is no guarantee that the lines of credit will be used.



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