ANNUAL REPORT W. C. ( Chris ) Greenbeck Chairman of the Board. Jeffrey K. Ball President/CEO. To Our Shareholders and Friends:

Transcription

1 ANNUAL REPORT 2016 To Our Shareholders and Friends: 2016 was a milestone year for Friendly Hills Bank with the celebration of our ten year anniversary. When we opened the bank in September, 2006, we never could have anticipated the many challenges which would face the community banking sector over the next decade. Our industry has endured one of its most challenging periods in history with a combination of recessionary factors, low interest rates and an increasing regulatory burden. Due primarily to these factors many of the banks which opened ten years ago are no longer with us or have been consolidated into much larger banks. The reduction in the number of bank charters nationwide has resulted in fewer choices for consumers. But thanks to your continued support Friendly Hills Bank remains a valued alternative in the markets that we serve. Through these challenging times we have maintained our focus on balance sheet strength, consistent loan underwriting and an unmatched level of customer service. We passed on many short term opportunities which often involved increased risk and maintained our focus on client relationships. As net interest margins across the industry declined we passed on higher risk lending and instead invested in new products where we could bring enhanced value to those client relationships. Establishment of a payroll division has provided us with an opportunity to further assist local businesses while providing revenue from sources other than loans. These differentiating factors are reflected in our financial results for The bank experienced a 14% growth in total assets and a 79% growth in net income. The loan portfolio grew 10% while remaining well diversified and liquidity remains very strong providing ample resources to support continued growth. Capital also remains strong to support further growth with a total risk-based capital ratio of 17% compared to the regulatory requirement of 10%. The outlook for the community banking sector has recently changed with the anticipation of stronger growth, increasing interest rates and a willingness to make adjustments to many regulatory burdens which have had an unbalanced effect on smaller banks. Friendly Hills Bank is well positioned for this new environment with sufficient capital to support increased growth opportunities, a strong balance sheet which benefits from an increasing rate environment with over 95% core deposits and a diversified loan portfolio with strong asset quality. The company is directly involved in the prospects for regulatory change with Jeffrey Ball s recent nomination to lead the Government Relations Council for the American Bankers Association while also serving on their Board of Directors and Executive Committee during this critical time for the industry. We have entered 2017 with guarded optimism for this new environment and the many potential prospects for Friendly Hills Bank with our continued focus on long term shareholder value. The Board of Directors and management recognize that it is because of your continued confidence that the company is well positioned for the next ten years. We thank you for your support. Jeffrey K. Ball President/CEO W. C. ( Chris ) Greenbeck Chairman of the Board

2 FINANCIAL STATEMENTS WITH INDEPENDENT AUDITOR'S REPORT DECEMBER 31, 2016 AND 2015

3 DECEMBER 31, 2016 AND 2015 CONTENTS Independent Auditor's Report... 1 Page Financial Statements Balance Sheets December 31, 2016 and Statements of Operations For the years ended December 31, 2016 and Statements of Comprehensive Income (Loss) For the years ended December 31, 2016 and Statement of Changes in Shareholders' Equity For the years ended December 31, 2016 and Statements of Cash Flows For the years ended December 31, 2016 and Notes to Financial Statements... 7

4 INDEPENDENT AUDITOR'S REPORT Board of Directors and Shareholders of Friendly Hills Bank Whittier, California We have audited the accompanying financial statements of Friendly Hills Bank (the Bank), which are comprised of the balance sheets as of December 31, 2016 and 2015, and the related statements of operations, comprehensive income (loss), changes in shareholders' equity, and cash flows for the years then ended, and the related notes to the financial statements. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Friendly Hills Bank as of December 31, 2016 and 2015, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Rancho Cucamonga, California April 7,

5 BALANCE SHEETS DECEMBER 31, 2016 AND ASSETS Cash and due from banks $ 4,746,642 $ 3,904,250 Interest bearing deposits with other financial institutions 14,818,062 4,528,781 Cash and Cash Equivalents 19,564,704 8,433,031 Investment securities available-for-sale 42,182,597 43,311,526 Federal Home Loan Bank and other restricted stock 2,253,300 2,208,200 Loans, net of unearned income 74,986,245 67,875,717 Allowance for loan losses (1,525,021) (1,595,172) Loans, net 73,461,224 66,280,545 Premises and equipment, net 243, ,913 Bank owned life insurance 3,469,312 3,383,153 Deferred tax asset 719, ,488 Accrued interest receivable and other assets 967, ,988 Total Assets $ 142,862,149 $ 125,578,844 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Deposits: Noninterest-bearing deposits $ 47,517,317 $ 42,531,349 Interest-bearing deposits 68,012,143 54,353,635 Total Deposits 115,529,460 96,884,984 FHLB advances 11,000,000 13,000,000 Accrued interest payable and other liabilities 467, ,237 Total Liabilities 126,996, ,337,221 Commitments and Contingencies (Note 8 and Note 12) - - Shareholders' Equity Common stock, no par value,10,000,000 shares authorized; 1,939,200 and 1,616,000 shares issued and outstanding in 2016 and 2015, respectively 15,957,620 15,957,620 Additional paid-in-capital 1,091,322 1,091,322 Accumulated deficit (945,709) (1,650,919) Accumulated other comprehensive (loss) income, net of tax (237,571) (156,400) Total Shareholders' Equity 15,865,662 15,241,623 Total Liabilities and Shareholders' Equity $ 142,862,149 $ 125,578,844 The accompanying notes are an integral part of these financial statements. -2-

6 STATEMENTS OF OPERATIONS Interest Income Interest and fees on loans $ 3,501,920 $ 3,243,567 Interest on Federal funds sold 58,891 6,350 Interest on investment securities 775, ,559 Interest on deposits with other financial institutions 241, ,663 Total Interest Income 4,577,287 4,396,139 Interest Expense Interest expense on deposits 142, ,079 Interest expense on borrowings 175, ,724 Total Interest Expense 318, ,803 Net Interest Income 4,258,919 4,113,336 Noninterest Income Service charges on deposit accounts 92,044 94,898 Investment securities gain, net 35,641 1,100 Gain on OREO - 43,400 Payroll service 184, ,820 Other fees and miscellaneous income 169, ,239 Total Noninterest Income 482, ,457 Noninterest Expense Salaries and other employee benefits 2,393,649 2,458,183 Occupancy 333, ,950 Advertising and marketing 62,717 56,707 Professional services 162, ,889 Core and item processing 373, ,639 Stationary and supplies 27,754 23,998 Corporate insurance 55,953 56,026 Supervisory charges 91,694 88,929 Other 429, ,784 Total Noninterest Expense 3,931,307 3,998,105 Income Before Provision for Income Taxes 809, ,688 Provision for Income Taxes 104, ,718 Net Income $ 705,210 $ 393,970 Earnings Per Share (Basic and Diluted) $ 0.36 $ 0.20 The accompanying notes are an integral part of these financial statements. -3-

7 STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Net Income $ 705,210 $ 393,970 Other Comprehensive Loss: Change in Loss on Securities Available-for-Sale (101,938) (432,450) Reclassification of Realized Gain on Sale of Available-for-Sale Securities included in Net Income (35,641) (1,100) (137,579) (433,550) Income tax effect relating to available-for-sale securities (56,408) (108,684) Total Other Comprehensive Loss (81,171) (324,866) Total Comprehensive Income $ 624,039 $ 69,104 The accompanying notes are an integral part of these financial statements. -4-

8 STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY Shares Common Stock Accumulated Additional Other Total Paid-In Accumulated Comprehensive Shareholders' Outstanding Amount Capital Deficit Income (Loss) Equity Balance, January 1, ,939,200 $ 15,957,620 $ 1,091,322 $ (2,044,889) $ 168,466 $ 15,172,519 Net income , ,970 Other comprehensive loss (324,866) (324,866) Balance, December 31, ,939,200 15,957,620 1,091,322 (1,650,919) (156,400) 15,241,623 Net income , ,210 Other comprehensive loss (81,171) (81,171) Balance, December 31, ,939,200 $ 15,957,620 $ 1,091,322 $ (945,709) $ (237,571) $ 15,865,662 The accompanying notes are an integral part of these financial statements. -5-

9 STATEMENTS OF CASH FLOWS Cash Flows from Operating Activities Net income $ 705,210 $ 393,970 Adjustments to reconcile net income to net cash provided by operating activities: Net amortizations of premiums and discounts on investment securities available-for-sale 231, ,726 Depreciation and amortization 68, ,191 Gain on sale of securities available-for-sale (35,641) (1,100) Deferred income taxes 104, ,918 Increase in cash surrender value of life insurance (86,159) (87,205) (Increase) decrease in accrued interest receivable and other assets 16,198 (322,637) Increase in accrued interest payable and other liabilities 14,790 30,450 Net Cash Provided by Operating Activities 1,018, ,313 Cash Flows from Investing Activities Purchase of investment securities available-for-sale (13,202,266) (18,880,889) Proceeds from sale of investment securities available-for-sale 9,358,156 11,948,985 Principal paydowns on securities available-for-sale 4,639,858 5,787,293 Purchase of FHLB and FRB stock (45,100) (138,400) Net increase in loans (7,180,679) (7,007,389) Purchase of premises and equipment (101,178) (49,714) Net Cash Used in Investing Activities (6,531,209) (8,340,114) Cash Flows from Financing Activities Net increase in deposits 18,644,476 1,326,271 Proceeds from FHLB advances 47,300, ,960,000 Payments on FHLB advances (49,300,000) (119,710,000) Net Cash Provided by Financing Activities 16,644,476 5,576,271 Net Increase (Decrease) in Cash and Cash Equivalents 11,131,673 (2,095,530) Cash and Cash Equivalents, Beginning of Year 8,433,031 10,528,561 Cash and Cash Equivalents, End of Year $ 19,564,704 $ 8,433,031 Supplemental Cash Flow Information Interest paid $ 302,057 $ 282,402 Taxes paid $ 1,536 $ 800 Change in accumulated other comprehensive (loss) income $ (81,171) $ (324,766) The accompanying notes are an integral part of these financial statements. -6-

10 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations Friendly Hills Bank (the Bank) was incorporated in the State of California, commenced operations on September 18, 2006, and is organized as a single operating segment. The Bank operates two full-service branches in Whittier and Santa Fe Springs, California. Its principal source of revenue is providing loans to customers, who are predominately small and middle-market businesses and individuals located primarily in the Los Angeles and Orange County areas of California. Subsequent Events The Bank has evaluated subsequent events for recognition and disclosure through April 7, 2017, which is the date the financial statements were available to be issued. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash, due from banks, interest-bearing deposits with other financial institutions, and Federal funds sold. Generally, Federal funds are sold for periods of less than 90 days. Cash and Due from Banks Banking regulations require that banks maintain a percentage of their deposits as reserves in cash or on deposit with the Federal Reserve Bank (FRB). The Bank was in compliance with its reserve requirements as of December 31, 2016 and Investment Securities In accordance with U.S. Generally Accepted Accounting Principles (GAAP), investment securities are classified in three categories and accounted for as follows: debt and equity that the Bank has the positive intent and ability to hold to maturity are classified as held-to-maturity and are measured at amortized cost; debt and equity securities bought and held principally for the purpose of selling in the near term are classified as trading securities and are measured at fair value, with unrealized gains and losses included in earnings; debt and equity securities not classified as either held-to-maturity or trading securities are deemed as available-for-sale and are measured at fair value, with unrealized gains and losses, net of applicable taxes, reported in a separate component of stockholders' equity. Gains or losses on sales of investment securities are determined on the specific identification method. Premiums and discounts are amortized or accreted using the interest method over the expected lives of the related securities. -7-

11 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued Investment Securities, Continued Management evaluates securities for other-than-temporary impairment (OTTI) at least on a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows; OTTI related to credit loss, which must be recognized in the income statement and; OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings. Loans The Bank grants commercial real estate, commercial and industrial, construction and land development and consumer loans to borrowing customers. A substantial portion of the loan portfolio is represented by real estate loans in the Los Angeles and Orange County metropolitan areas. The ability of the Bank's borrowers to honor their contracts is dependent upon many factors, including the real estate market and general economic conditions in the Bank's area. Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances reduced by any charge-offs or specific valuation allowances and net of deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. Amortization of deferred loan fees is discontinued when a loan is placed on nonaccrual status. Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. The accrual of interest on loans is discontinued when principal or interest is past due 90 days based on the contractual terms of the loan or when, in the opinion of management, there is reasonable doubt as to collectability. When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on nonaccrual loans is subsequently recognized only to the extent that cash is received and the loan's principal balance is deemed collectible. Interest accruals are resumed on such loans only when they are brought current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to all principal and interest. -8-

12 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued Allowance for Loan Losses The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off. Amounts are charged-off when available information confirms that specific loans or portions thereof, are uncollectible. This methodology for determining charge-offs is consistently applied to each segment. The allowance consists of specific and general reserves. Specific reserves relate to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status, collateral value and the probability of collecting all amounts when due. Measurement of impairment is based on the expected future cash flows of an impaired loan, which are to be discounted at the loan's effective interest rate, or measured by reference to an observable market value, if one exists, or the fair value of the collateral for a collateral-dependent loan. The Bank selects the measurement method on a loan-by-loan basis except that collateral-dependent loans for which foreclosure is probable are measured at the fair value of the collateral. The Bank recognizes interest income on impaired loans based on its existing methods of recognizing interest income on nonaccrual loans. Loans, for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired with measurement of impairment based on expected future cash flows discounted using the loan's effective rate immediately prior to the restructuring. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Smaller balance, homogeneous loans are collectively evaluated for impairment. General reserves cover non-impaired loans and are based on historical loss rates for each portfolio segment, adjusted for the effects of qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the portfolio segment's historical loss experience. Qualitative factors include consideration of the following: changes in lending policies and procedures; changes in economic conditions, changes in the nature and volume of the portfolio; changes in the experience, ability and depth of lending management and other relevant staff; changes in the volume and severity of past due, nonaccrual and other adversely graded loans; changes in the loan review system; changes in the value of the underlying collateral for collateral-dependent loans; concentrations of credit and the effect of other external factors such as competition and legal and regulatory requirements. -9-

13 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued Allowance for Loan Losses, Continued Portfolio segments identified by the Bank include construction and land development, commercial real estate, non-owner occupied single family residential, commercial and industrial, home equity lines of credit and consumer loans. Relevant risk characteristics for these portfolio segments generally include debt service coverage, loan-to-value ratios and financial performance on non-consumer loans and credit scores, debt-to income, collateral type, and loan-to-value ratios for consumer loans. Premises and Equipment Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives, which ranges from three to seven years for furniture and equipment. Leasehold improvements are amortized using the straight-line method over the estimated useful lives of the improvements or the remaining lease term, whichever is shorter. Expenditures for betterments or major repairs are capitalized and those for ordinary repairs and maintenance are charged to operations as incurred. Federal Home Loan Bank (FHLB) and Other Restricted Stock The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors. The Bank also holds Pacific Coast Bankers Bancshares common and preferred stock, as well as stock with the Federal Reserve Bank. FHLB stock and Other Restricted Stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on the ultimate recovery of par value. Both cash and stock dividends are reported as income. Cash Surrender Value of Life Insurance The Bank has purchased life insurance on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contracts at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. Advertising Costs The Bank expenses the costs of advertising in the period incurred. -10-

14 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued Income Taxes Deferred income taxes are computed using the asset and liability method, which recognizes a liability or asset representing the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events that have been recognized in the financial statements. A valuation allowance is established to reduce the deferred tax asset to the level at which it is "more likely than not" that the tax asset or benefits will be realized. Realization of tax benefits of deductible temporary differences and operating loss carryforwards depends on having sufficient taxable income of an appropriate character within the carryforward periods. The Bank has adopted guidance issued by the Financial Accounting Standards Board (FASB) that clarifies the accounting for uncertainty in tax positions taken or expected to be taken on a tax return and provides that the tax effects from and uncertain tax position can be recognized in the financial statements only if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. Interest and penalties related to uncertain tax positions are recorded as part of income tax expense. Financial Instruments In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commercial letters of credit, and standby letters of credit as described in Note 12. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. Earnings Per Shares The basic earnings per share ratio excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. For the years ended December 31, 2016 and 2015, the effect of any outstanding options is anti-dilutive on earnings per share. Weighted average shares outstanding used in the computation of basic and diluted earnings per share was 1,939,200 in 2016 and Stock-Based Compensation The Bank recognizes the cost of employee services received in exchange for awards of stock options, or other equity instruments, based on the grant-date fair value of those awards. This cost is recognized over the period which an employee is required to provide services in exchange for the award, generally the vesting period. See Note 7 for additional information on the Bank's stock option plan. -11-

15 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued Risk and Uncertainties In the normal course of its business, the Bank encounters two significant types of risk: economic and regulatory. Economic risk is comprised of three components: interest rate risk, credit risk and market risk. The Bank is subject to interest rate risk to the degree that its interest-bearing liabilities mature and re-price at different speeds, or on a different basis, than its interest-bearing assets. Credit risk is the risk of default on the Bank's loan portfolio that results from the borrower's inability or unwillingness to make contractually required payments. Market risk results from changes in the value of assets and liabilities, which may impact, favorably or unfavorably, the reliability of those assets and liabilities. The Bank is subject to various government regulations which can change significantly from period to period. The Bank also undergoes periodic examinations by the regulatory agencies. This may subject its financial position to further changes with respect to asset valuations, amounts of required loss allowances, and operating restrictions as a result of the regulators' judgments based upon information available to them at the time of their examination. Comprehensive Income (Loss) Comprehensive income (loss) is reported in addition to net income for all periods presented. Comprehensive income (loss) is a more inclusive financial reporting methodology that includes disclosure of other comprehensive income or loss that historically has not been recognized in the calculation of net income. Unrealized gains and losses on the Bank's available-for-sale investment securities are included in other comprehensive income, adjusted for realized gains or losses included in net income. Total comprehensive income or loss and the components of accumulated other comprehensive income or loss is presented in the statement of changes in shareholders' equity and comprehensive income (loss). Recent Accounting Guidance Not Yet Effective In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No , Revenue from Contracts with Customers (Topic 606). This Update requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The following steps are applied in the updated guidance: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. These amendments are effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period and one year later for nonpublic business entities. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that period. The Bank is currently evaluating the effects of ASU on its financial statements and disclosures, if any. -12-

16 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued Recent Accounting Guidance Not Yet Effective, Continued In January 2016, the FASB issued ASU , Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic ). Changes made to the current measurement model primarily affect the accounting for equity securities and readily determinable fair values, where changes in fair value will impact earnings instead of other comprehensive income. The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities is largely unchanged. The Update also changes the presentation and disclosure requirements for financial instruments including a requirement that public business entities use exit price when measuring the fair value of financial instruments measured at amortized cost for disclosure purposes. This Update is generally effective for public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years and one year later for nonpublic business entities. The Bank is currently evaluating the effects of ASU on its financial statements and disclosures. In February 2016, the FASB issued Accounting Standards Update (ASU) , Leases (Topic 842). The most significant change for lessees is the requirement under the new guidance to recognize right-of-use assets and lease liabilities for all leases not considered short-term leases, which is generally defined as a lease term of less than 12 months. This change will result in lessees recognizing right-of-use assets and lease liabilities for most leases currently accounted for as operating leases under current lease accounting guidance. The amendments in this Update are effective for interim and annual periods beginning after December 15, 2018, for public business entities and one year later for all other entities. The Bank is currently evaluating the effects of ASU on its financial statements and disclosures. In March 2016, the FASB issued ASU , Improvements to Employee Share-Based Payment Accounting (Topic 718). ASU includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. Under ASU , excess tax benefits and certain tax deficiencies will no longer be recorded in additional paid-in capital ("APIC"). Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement, and APIC pools will be eliminated. In addition, the guidance requires excess tax benefits be presented as an operating activity on the statement of cash flows rather than as a financing activity. ASU also permits an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. Forfeitures can be estimated, as required today, or recognized when they occur. This guidance is effective for public business entities for interim and annual reporting periods beginning after December 15, 2016, and for nonpublic business entities annual reporting periods beginning after December 15, 2017, and interim periods within the reporting periods beginning after December 15, Early adoption is permitted, but all of the guidance must be adopted in the same period. The Bank is currently evaluating the provisions of ASU to determine the potential impact on its financial statements and disclosures. -13-

17 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued Recent Accounting Guidance Not Yet Effective, Continued In June 2016, the FASB issued ASU No , Measurement of Credit Losses on Financial Instruments (Topic 326). This ASU 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. In issuing the standard, the FASB is responding to criticism that today's guidance delays recognition of credit losses. 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. As a result, entities will recognize improvements to estimated credit losses immediately in earnings rather than as interest income over time, as they do today. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU also expands the disclosure requirements regarding an entity's assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, public business entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU No is effective for interim and annual reporting periods beginning after December 15, 2019, for SEC filers, one year later for non SEC filing public business entities and annual reporting periods beginning after December 15, 2020, for nonpublic business entities and interim periods within the reporting periods beginning after December 15, Early adoption is permitted for interim and annual reporting periods beginning after December 15, Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). The Bank is currently evaluating the provisions of ASU No for potential impact on its financial statements and disclosures. -14-

18 NOTE 2 - INVESTMENT SECURITIES The amortized cost and fair values of securities with gross unrealized gains and losses follows: Gross Gross Amortized Unrealized Unrealized Fair December 31, 2016 Cost Gains Losses Value Securities Available-for-Sale CMO Securities $ 23,945,629 $ 58,197 $ (105,734) $ 23,898,092 Corporate Securities 9,550,000 35,274 (404,695) 9,180,579 Mortgage-backed Securities 9,089,632 32,009 (17,715) 9,103,926 Total $ 42,585,261 $ 125,480 $ (528,144) $ 42,182,597 December 31, 2015 Securities Available-for-Sale CMO Securities $ 26,774,001 $ 59,956 $ (204,095) $ 26,629,862 Corporate Securities 9,550,000 9,425 (178,402) 9,381,023 Mortgage-backed Securities 7,252,610 70,950 (22,919) 7,300,641 Total $ 43,576,611 $ 140,331 $ (405,416) $ 43,311,526 The amortized cost and fair value of debt securities by contractual maturity is shown below. Expected maturities will differ from contractual maturities, particularly with respect to collateralized mortgage obligations and mortgage backed securities, because the borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The Bank had no tax-exempt securities for the years ended December 31, 2016 or Amortized Fair Available-for-Sale 2016 Cost Value Due less than one year $ 1,000,000 $ 1,006,194 Due after one year through five years 65,684 66,824 Due after five years through ten years 11,788,903 11,577,032 Due after ten years 29,730,674 29,532,547 $ 42,585,261 $ 42,182,597 Available-for-Sale 2015 Due after one year through five years $ 1,109,529 $ 1,119,258 Due after five years through ten years 11,419,618 11,328,698 Due after ten years 31,047,464 30,863,570 $ 43,576,611 $ 43,311,526 The Bank pledged investment securities with a carrying value of approximately $0.3 million as of December 31, 2016 and 2015, for FHLB borrowings. -15-

19 NOTE 2 - INVESTMENT SECURITIES, Continued Proceeds from sales of investment securities available-for-sale during 2016 and 2015 were $9,358,156 and $11,948,985, respectively, with a gross gain of $35,641 and $1,100, respectively. Proceeds from maturities and principal reductions of available-for-sale securities in 2016 and 2015, were $4,639,858 and $5,787,293, respectively. The net unrealized loss on securities available-for-sale included in accumulated other comprehensive income during 2016 and 2015, was $(81,171) and $(324,866), respectively. At December 31, 2016, the Bank had 21 investments in a gross unrealized loss position for less than one year, and three that were in a gross unrealized loss position for more than one year. At December 31, 2015, the Bank had 23 investments in a gross unrealized loss position for less than one year, and three that were in a gross unrealized loss position for more than one year. The Bank regularly monitors investments for significant inclines/declines in fair value. As management does not intend to sell these securities and it is likely that it will not be required to sell these securities before their anticipated recovery. No declines are deemed to be other-than-temporary. NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES Loans consist of the following at December 31: Construction and land development $ 620,442 $ 1,017,641 Commercial real estate 63,049,088 52,920,683 Commercial and industrial 11,269,425 13,897,710 Consumer 63,972 77,978 75,002,927 67,914,012 Allowance for loan losses (1,525,021) (1,595,172) Deferred loan fees, net (16,682) (38,295) Net Loans $ 73,461,224 $ 66,280,545 Changes in the allowance for loan losses are as follows: Balance, beginning of year $ 1,595,172 $ 1,595,172 Loan charge-offs (70,151) - Balance, end of year $ 1,525,021 $ 1,595,

20 NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES, Continued The following tables presents the recorded investment in loans and impairment method as of December 31, 2016 and 2015, and the activity in the allowance for loan losses for the year then ended by portfolio segment: Construction Commercial and Land Commercial and December 31, 2016 Development Real Estate Industrial Consumer Total Allowance for Loan Losses: Beginning of Year $ 34,096 $ 1,202,444 $ 357,227 $ 1,405 $ 1,595,172 Provisions (12,045) (13,927) (45,065) 886 (70,151) End of Year $ 22,051 $ 1,188,517 $ 312,162 $ 2,291 $ 1,525,021 Reserves: General $ 22,051 $ 1,188,517 $ 312,162 $ 2,291 $ 1,525,021 Loans Evaluated for Impairment: Individually $ - $ 1,314,589 $ - $ - $ 1,314,589 Collectively 620,442 61,816,097 11,187,827 63,972 73,688,338 $ 620,442 $ 63,130,686 $ 11,187,827 $ 63,972 $ 75,002,927 December 31, 2015 Allowance for Loan Losses: Beginning of Year $ 12,016 $ 1,269,754 $ 312,149 $ 1,253 $ 1,595,172 Provisions 22,080 (67,310) 45, End of Year $ 34,096 $ 1,202,444 $ 357,227 $ 1,405 $ 1,595,172 Reserves: General $ 34,096 $ 1,202,444 $ 357,227 $ 1,405 $ 1,595,172 Loans Evaluated for Impairment: Individually $ - $ 1,599,474 $ - $ - $ 1,599,474 Collectively 1,017,641 51,321,209 13,897,710 77,978 66,314,538 $ 1,017,641 $ 52,920,683 $ 13,897,710 $ 77,978 $ 67,914,

21 NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES, Continued The Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. The Bank analyzes loans individually by classifying the loans as to credit risk. This analysis typically includes larger, non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. The Bank uses the following definitions for risk ratings: Pass - Loans considered as pass meet all of the Bank's underwriting criteria and are categorized into four different risk categories based on the level of protection provided to the bank by the paying capacity of the borrower and the value and marketability of the collateral. Special Mention - Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date. Substandard - Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledge, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Impaired - A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows as of December 31: Special December 31, 2016 Pass Mention Substandard Impaired Total Construction and land development $ 620,442 $ - $ - $ - $ 620,442 Commercial real estate 61,534, ,000 1,314,589 63,049,087 Commercial and industrial 11,187,827-81,599-11,269,426 Consumer 63, ,972 $ 73,406,739 $ - $ 281,599 $ 1,314,589 $ 75,002,927 December 31, 2015 Construction and land development $ 1,017,641 $ - $ - $ - $ 1,017,641 Commercial real estate 51,121, ,000 1,599,474 52,920,683 Commercial and industrial 13,897, ,897,710 Consumer 77, ,978 $ 66,114,538 $ - $ 200,000 $ 1,599,474 $ 67,914,

22 NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES, Continued The following table summarizes the payment status of the loan portfolio as of December 31: Days Days Days or More Not December 31, 2016 Past Due Past Due Past Due Past Due Total Nonaccrual Construction and land development $ - $ - $ - $ 620,442 $ 620,442 $ - Commercial real estate ,049,087 63,049,087 - Commercial and industrial ,269,426 11,269,426 - Consumer ,972 63,972 - $ - $ - $ - $ 75,002,927 $ 75,002,927 $ - December 31, 2015 Construction and land development $ - $ - $ - $ 1,017,641 $ 1,017,641 $ - Commercial real estate ,920,683 52,920,683 - Commercial and industrial ,897,710 13,897,710 - Consumer ,978 77,978 - $ - $ - $ - $ 67,914,012 $ 67,914,012 $ - Individually impaired loans were as follows as of December 31: Unpaid Average Interest Principal Recorded Related Recorded Income December 31, 2016 Balance Investment Allowance Investment Recognized Without a Related Allowance Recorded Commercial real estate $ 1,314,589 $ 1,314,589 $ - $ 1,417,313 $ 83,498 December 31, 2015 With Related Allowance Recorded Commercial real estate $ 1,599,474 $ 1,599,474 $ - $ 1,620,349 $ 102,659 There were no specific reserves to customers whose loan terms had been modified in troubled debt restricting ("TDRs") as of December 31, 2016 and

23 NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES, Continued The Bank has not committed to lend any additional amounts to customers with outstanding loans that are classified as troubled debt restructuring as of December 31, 2016 and At December 31, 2016, the Bank had two recorded investments in troubled debt restructuring in the amount of $1,314,589. The Bank did not allocate any specific reserves for the loan at December 31, 2016, and has not committed to lend any additional amounts. There were no new TDRs in 2016 and NOTE 4 - PREMISES AND EQUIPMENT Premises and equipment are as follows: Leasehold improvements $ 728,241 $ 666,937 Furniture, fixtures, and equipment 278, ,128 Computers 975, ,111 1,981,354 1,880,176 Accumulated depreciation and amortization (1,737,402) (1,669,263) $ 243,952 $ 210,913 Total depreciation expense for the years ended December 31, 2016 and 2015, was $68,139 and $201,191, respectively. NOTE 5 - DEPOSITS Interest-bearing and noninterest-bearing deposits consist of the following: NOW accounts $ 15,890,793 $ 9,448,614 Savings and money market 46,039,761 39,023,167 Time certificate of deposit accounts under $250,000 2,058,177 2,135,684 Time certificate of deposit accounts over $250,000 4,023,412 3,746,170 Total interest-bearing deposits 68,012,143 54,353,635 Total noninterest-bearing deposits 47,517,317 42,531,349 Total Deposits $ 115,529,460 $ 96,884,

24 NOTE 5 - DEPOSITS, Continued As of December 31, 2016, all noninterest-bearing deposits are demand deposits. The maturity of time certificates of deposit is as follows: Within one year $ 4,123,334 One year to three years 1,093,160 Over three years $ 865,095 6,081,589 NOTE 6 - INCOME TAXES The only tax expense for the years ended December 31, 2016 and 2015, was the State minimum franchise tax. Deferred taxes are a result of differences between income tax accounting and generally accepted accounting principles with respect to income and expense recognition. The following is the income taxes for the years ended December 31: Current: Federal $ - $ - State 1, Deferred: Federal 255, ,268 State 79,663 60,650 Change in valuation allowance (232,000) (6,000) Total Current Tax Expense $ 104,625 $ 224,

25 NOTE 6 - INCOME TAXES, Continued The following is a summary of the components of the net deferred tax asset accounts recognized in the accompanying balance sheet: Deferred Tax Assets: Organizational costs $ 97,000 $ 117,000 Operating loss carryforwards 275, ,000 Allowance for loan losses due to tax limitations 28,000 28,000 Depreciation differences 181, ,000 Unrealized loss on investment securities 165, ,000 Other, net 20,270 80, ,270 1,058,694 Valuation Allowance - (232,000) Deferred Tax Liabilities: Cash basis reporting for income tax purposes 20,000 2,000 Deferred loan costs (67,000) (60,000) (47,000) (58,000) Net Deferred Tax Assets $ 719,270 $ 768,694 In 2016, management determined that it was more likely than not that the remainder of the deferred tax asset would be realized. The Bank has net operating loss carryforwards of approximately $600,000 for Federal income tax and $950,000 for State income tax purposes. Federal and California net operating loss carryforwards, to the extent not used, will expire through The Bank is subject to Federal and State of California income taxes. The Federal and State income tax returns for the years ended December 31, 2013 through 2015, are open to audit by the Federal authorities and 2012 through 2015 for State authorities. -22-

26 NOTE 7 - STOCK OPTION PLAN The Bank's 2006 Stock Option Plan (the Plan) was approved by its shareholders in November Under the terms of the Plan, officers and key employees may be granted both nonqualified and incentive stock options and directors and other consultants, who are not also an officer or employee, may only be granted nonqualified stock options. The Plan provides for options to purchase 68,400 shares of common stock at a price not less than 100 percent of the fair market value of the stock on the date of grant. Stock options expire no later than ten years from the date of the grant and generally vest over four years. The Plan provides for accelerated vesting if there is a change of control, as defined in the Plan. The Bank did not have any stock-based compensation cost in 2016 and The fair value of each option grant was estimated on the date of grant using the Black-Scholes optionpricing model. A summary of the status of the Bank's stock option plan and changes during the year is presented below: Weighted- Weighted- Average Average Shares Exercise Price Shares Exercise Price Balance, beginning of year 342,900 $ ,900 $ 7.70 Options expired (274,500) Balance, end of year 68,400 $ ,900 $ 7.70 Options exercisable, end of year 68,400 $ ,900 $ 7.70 As of December 31, 2016, the Bank did not have any unrecognized compensation cost related to the outstanding stock options. There was $126,830 in intrinsic value in the options as of December 31, 2016 and $0 in NOTE 8 - COMMITMENTS AND CONTINGENCIES The Bank leases office facilities and equipment under operating leases which expire through April 1, Rental expense was $194,995 and $219,610 in 2016 and 2015, respectively. Future minimum rental payments under the operating leases as of December 31, 2016, are as follows: Year Ending Amount 2017 $ 179, , , , ,415 Thereafter 109,982 Total $ 907,290 The Bank is not currently a party to any legal proceedings. -23-

27 NOTE 9 - OTHER BORROWINGS At year-end, advances from the FHLB were as follows: Balance at end of year $ 11,000,000 $ 13,000,000 Weighted average interest rate at end of year 1.33% 1.23% Weighted average interest rate for the year 1.51% 1.21% FHLB advances are secured with eligible collateral consisting of the unpaid principal balance of $77,607,667 of pledged loans. Advances from the FHLB are subject to the FHLB's collateral and underwriting requirements. Unused borrowing capacity based on pledged collateral was $37,414,261 and $31,259,799 as of December 31, 2016 and 2015, respectively. Additionally, based on FHLB underwriting, advances are limited to the lesser of $35,791,693 or 25 percent of the Bank's total assets. Unused borrowing capacity under this limitation was $24,791,693 as of December 31, The maturities of FHLB advances were as follows: Year Ending Average December 31, Amount Interest Rate 2018 $ 1,250, % ,500, % ,750, % ,500, % ,000, % Total $ 11,000,000 At December 31, 2016 and 2015, the Bank has an unsecured revolving line of credit with Pacific Coast Bankers Bank and Zions Bank, providing for Federal fund purchases up to a total of $5,500,000. Borrowings are payable on demand and interest on outstanding borrowings accrues at rates negotiated at the time of the borrowing. In addition, the Bank has a borrowing relationship with the Federal Reserve Bank through the Federal Reserve Discount Window. As of December 31, 2016 and 2015, the Bank did not have any outstanding borrowings on these lines of credit. -24-

28 NOTE 10 - FAIR VALUE DISCLOSURES The Bank determines the fair market values of certain financial instruments based on the fair value hierarchy established by Financial Accounting Standards, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. The following provides a summary of the hierarchical levels used to measure fair value: Level 1 - Quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 asset and liabilities may include debt and equity securities that are traded in an active exchange market and that are highly liquid and are actively traded in over-thecounter markets. Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities may include debt securities with quoted prices that are traded less frequently than exchange-traded instruments and other instruments whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes U.S. Government and agency mortgage-backed debt securities, corporate debt securities, derivative contracts, residential mortgage, and loans held-for-sale. Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. Fair Value Measurements The Bank used the following methods and significant assumptions to estimate fair value: Securities The fair value of securities available-for-sale are determined by obtaining quoted prices on nationally recognized exchanges (Level 1) or matrix pricing which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather relying on the security's relationship to other benchmark quoted securities resulting in a Level 2 classification. -25-

29 NOTE 10 - FAIR VALUE DISCLOSURES, Continued Collateral Dependent Impaired Loans A loan is considered impaired when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impairment is measured based on the fair value of the underlying collateral or the discounted expected future cash flows. The Bank measures impairment on all nonaccrual loans for which it has established specific reserves as part of the specific allocated allowance component of the allowance for loan losses. As such, the Bank records impaired loans as non-recurring Level 3 when the fair value of the underlying collateral is based on recent real estate appraisals and/or evaluations. These appraisals and/or evaluations may utilize a single valuation approach or a combination of approaches including comparable sales, cost, and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income and other available data. Such adjustments are usually significant and typically result in a Level classification of the inputs for determining fair value. The valuation technique used for all Level 3 nonrecurring loans is the sales comparison approach less a reserve for past due taxes and selling costs ranging from 5 percent to 10 percent. The following table provides a summary of the financial instruments the Bank measures at fair value on a recurring and nonrecurring basis as of December 31, 2016: Fair Value Measurements Using Quoted Prices in Other Significant Active Markets for Observable Unobservable Total Fair Identical Assets Inputs Inputs Gains As of December 31, 2016: Value (Level 1) (Level 2) (Level 3) (Losses) Assets and liabilities measured on a recurring basis: Securities Available-for-Sale CMO Securities $ 23,898,092 $ - $ 23,898,092 $ - $ - Corporate Securities 9,180,579-9,180, Mortgage-backed Securities 9,103,926-9,103, Total $ 42,182,597 $ - $ 42,182,597 $ - $ - Assets and liabilities measured on a nonrecurring basis: Collateral-dependent impaired loans Commercial real estate $ 1,314,589 $ - $ - $ 1,314,589 $

30 NOTE 10 - FAIR VALUE DISCLOSURES, Continued The following table provides a summary of the financial instruments the Bank measures at fair value on a recurring and nonrecurring basis as of December 31, 2015: Fair Value Measurements Using Quoted Prices in Other Significant Active Markets for Observable Unobservable Identical Assets Inputs Inputs Total Gains As of December 31, 2015: Fair Value (Level 1) (Level 2) (Level 3) (Losses) Assets and liabilities measured on a recurring basis: Securities Available-for-Sale CMO Securities $ 26,629,862 $ - $ 26,629,862 $ - $ - Corporate Securities 9,381,023-9,381, Mortgage-backed Securities 7,300,641-7,300, Total $ 43,311,526 $ - $ 43,311,526 $ - $ - Assets and liabilities measured on a nonrecurring basis: Collateral-dependent impaired loans Commercial real estate $ 1,599,474 $ - $ - $ 1,599,474 $ - NOTE 11 - FAIR VALUE OF FINANCIAL STATEMENTS The fair value of financial instruments is the amount at which the asset or obligation could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument. Because no market value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding the current interest rate environment and future expected loss experience, economic conditions, cash flows, and risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of judgment, and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on financial instruments both on and off the balance sheet without attempting to estimate the value of anticipated future business, and the value of assets and liabilities that are not considered financial instruments. Additionally, tax consequences related to the realization of the unrealized gains and losses can have a potential effect on fair value estimates and have not been considered in many of the estimates. -27-

31 NOTE 11 - FAIR VALUE OF FINANCIAL STATEMENTS, Continued The following methods and assumptions were used by the Bank in estimating fair values of financial instruments not previously presented: Cash and Due From Bank - The carrying amounts reported in the balance sheet for cash and due from banks approximates the fair values of those assets due to the short-term nature of the assets and are classified as Level 1. Interest Bearing Deposits With Other Financial Institutions - The carrying amounts reported in the balance sheet for interest bearing deposits in other financial institutions approximates the fair value of these assets due to the short-term nature of the assets and are classified as Level 1. Investment Securities Available for Sale - Fair values for investment securities are based on evaluating pricing models that vary by asset class and incorporate available trade, bid, and other market information. Evaluated pricing applications apply available information, as applicable, through processes such as benchmark curves, benchmarking to like securities, sector groupings, and matrix pricing. Fair values for securities are based on quoted market prices, where available, and are classified as Level 1. If quoted market prices are not available, fair valued are based on quoted market prices of comparable instruments and are classified as Level 2. Federal Home Loan Bank Stock and Other Restricted Stock - The fair value of Federal Home Loan Bank Stock and other restricted stock are not readily determinable due to the lack of its transferability and are classified as Level 1. Loans - For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values resulting in a Level 2 classification. The fair values for other loans are estimated using discounted cash flow analysis, and using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality are classified as Level 2. The carrying amount of accrued interest receivable approximates its fair value as a Level 1 classification. Impaired Loans - The fair value of collateral dependent impaired loans adjusted for specific allocations of the allowance for loan losses is generally based on recent real estate appraisals and/or evaluations. These appraisals and/or evaluations may utilize a single valuation approach or a combination of approaches including comparable sales, cost, and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income and other available data. Such adjustments are usually significant and typically result in a Level classification of the inputs for determining fair value. The valuation technique used for all Level 3 nonrecurring loans is the sales comparison approach less a reserve for past due taxes and selling costs ranging from five percent to ten percent. Deposits - Fair values for all deposits are estimated using a discounted cash flow calculation using decay rates for the maturity date and the FHLB yield curve for the discount rate. All deposits are therefore classified as Level 2. The carrying amount of accrued interest payable approximates its fair value as a Level 1 classification. FHLB Borrowings - The Fair value of long-term debt is based on rates currently available to the Bank for debt with similar terms and remaining maturities. -28-

32 NOTE 11 - FAIR VALUE OF FINANCIAL STATEMENTS, Continued Off-Balance Sheet Instruments - The majority of the Bank's commitments to extend credit carry current market interest rates if converted to loans. Because these commitments are generally unassignable by either the Bank or the borrower, they only have value to the Bank and the borrower. The fair value hierarchy level and estimated fair value of significant financial instruments at December 31, 2016 and 2015, are summarized as follows: December 31, 2016 December 31, 2015 Fair Value Carrying Fair Carrying Fair Hierarchy Amount Value Amount Value Assets Cash and due from banks Level 1 $ 4,746,642 $ 4,747,358 $ 3,904,250 $ 3,904,250 Interest-bearing deposits with other financial institutions Level 1 14,818,062 1,507,565 4,528,781 4,528,781 Investment securities available-for-sale Level 2 42,182,597 42,182,597 43,311,526 43,311,526 Federal Home Loan Bank stock and other restricted stock Level 1 2,253,300 2,253,300 2,208,200 2,208,200 Loans held for investment, net Level 2 72,146,634 68,012,562 64,681,072 62,781,356 Collateral dependent impaired loans Level 3 1,314,589 1,314,589 1,599,474 1,599,474 Accrued interest receivable Level 1 286, , , ,564 Liabilities Deposits Level 2 $ 115,529,460 $ 107,157,388 $ 96,884,984 $ 90,138,077 Accrued interest payable Level 1 22,732 22,732 6,422 6,422 FHLB borrowings Level 2 11,000,000 11,000,000 13,000,000 13,000,000 NOTE 12 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying balance sheet. The Bank's exposure to credit losses in the event of nonperformance by the other parties for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. -29-

33 NOTE 12 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK, Continued The following is a summary of contractual or notional amounts of off-balance sheet financial instruments that represent credit risk: Financial instruments whose contract amounts represent credit risks: Commitments to extend credit $ 22,804,597 $ 17,906,283 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any conditions established in the contract. Except for home equity lines of credit, commitments generally have fixed expiration dates of not more than 12 months and may require payment of a fee. Since many of the commitments are not expected to be drawn upon, the total commitment amounts may not represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation. Collateral held varies but may include marketable investment securities, accounts receivable, inventory, property, plant and equipment, and real properties. NOTE 13 - RELATED-PARTY TRANSACTIONS In the ordinary course of business, the Bank may grant loans to certain officers and directors and the companies with which they are associated. In the Bank's opinion, all loans and loan commitments to such parties will be made on substantially the same terms including interest rates and collateral, as those prevailing at the time of comparable transactions with other persons. The Bank did not have any of these loans outstanding at December 31, 2016 and In addition, the Bank had an unused letter of credit to a related party at $635,000 in December 31, 2016 and $10,000 for Deposits from certain directors, executives, and shareholders and their related interest with which they are associated held by the Bank at December 31, 2016 and 2015, amounted to approximately $9,884,657 and $3,334,766, respectively. The Bank also used the services of one director for nominal dollar amounts during the years ended December 31, 2016 and In management's opinion, the terms and conditions associated with these arrangements are comparable to those of transactions with affiliated parties. -30-

34 NOTE 14 - REGULATORY MATTERS The Bank is subject to various regulatory capital requirements administered by the Federal banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Under capital adequacy guidelines, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. These quantitative measures are established by regulation and require that minimum amounts and ratios of total, Tier 1 capital, and Common Equity Tier 1 to risk-weighted assets and of Tier 1 capital to average assets be maintained as set forth in the table below. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The final rules implementing Basel Committee on Banking Supervision's capital guidelines for U.S. banks (Basel III rules) became effective for the Bank on January 1, 2015, with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, The net unrealized gain or loss on available-for-sale securities is not included in computing regulatory capital. Management believes the Bank met all of their capital adequacy requirements as of December 31, 2016 and The Bank is also subject to additional capital guidelines under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum ratios of total and Tier 1 capital to risk-weighted assets and Tier 1 capital to average assets as set forth in the table on the following page. The most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized under these guidelines. There are no conditions or events since that notification that management believes have changed the Bank's category. -31-

35 NOTE 14 - REGULATORY MATTERS, Continued The following table presents actual and required capital ratios as of December 31, 2015, for the Bank under the Basel III Rules: To Be Well-Capitalized For Capital Under Prompt Actual Adequacy Purposes Corrective Provisions Amount Ratio Amount Ratio Amount Ratio As of December 31, 2016: Total capital (to risk-weighted assets) $ 16,057, % $ 7,615, % $ 9,519, % Tier 1 capital (to risk-weighted assets) 14,859, % 5,711, % 7,615, % Tier 1 capital (to average assets) 14,859, % 5,730, % 7,163, % Common Equity Tier 1 Capital (to Risk-Weighted Assets) 14,859, % 4,283, % 6,187, % As of December 31, 2015: Total capital (to risk-weighted assets) $ 15,391, % $ 6,787, % $ 8,484, % Tier 1 capital (to risk-weighted assets) 14,319, % 5,089, % 6,786, % Tier 1 capital (to average assets) 14,319, % 5,141, % 6,426, % Common Equity Tier 1 Capital (to Risk-Weighted Assets) 14,319, % 3,818, % 5,515, % NOTE 15 - ACQUISITION On April 1, 2015, the Bank entered into an asset purchase agreement with a local business in exchange for cash of $480,000. The purchase of the assets included primarily the business name, customer lists, and goodwill. The business operates a payroll processing service for multiple businesses primarily in Southern California. The acquisition is accounted for under the acquisition method of accounting. The acquired assets, and identifiable intangible assets are recorded at their respective acquisition date fair values. Fair values are preliminary and subject to refinement for up to one year after the closing date of the merger as additional information regarding the closing date fair values become available. The assets acquired based on fair values amounted to $96,000 in customer relationships and goodwill of $384,000. The customer list is being amortized over an 8 year period. The goodwill is not being amortized, but will be tested for impairment at least annually or more frequent if events and circumstances exist which indicate that an impairment test should be performed. -32-

36

37 EXECUTIVE OFFICERS Jeffrey K. Ball President/Chief Executive Officer Elizabeth M. Buckingham Executive Vice President/Chief Operating Officer Daniel L. Erickson Executive Vice President/Chief Financial Officer Dan McGregor Executive Vice President/Chief Credit Officer BOARD OF DIRECTORS Jeffrey K. Ball President/Chief Executive Officer Richard A. Casford CEO & Founder, Whittier Mailing Products, Inc. W.C. ( Chris ) Greenbeck Chairman of the Board Managing General Partner, Downey Land Limited Robert L. Haendiges Attorney, Law Offices of Robert L. Haendiges Janice A. Legoza Retired, Former Vice Chancellor for Finance and Administration, Brandman University, part of the Chapman University system Kent A. Roberts Executive Consultant, Ballard & Tighe Publishers D.E. ( Bill ) Wood Retired, Former Owner and President, Community Honda Transfer Agent Computershare Trust Company, N.A. 250 Royall Street Canton, MA (800) Market Makers Jacob Forney Raymond James One Embarcadero Center, Suite 650 San Francisco, CA (800) Michael Natzic D.A. Davidson P.O. Box 1688 Big Bear Lake, CA (800) Joey Warmenhoven Thomas Thiel Wedbush Securities One SW Columbia St., Suite 1000 Portland, OR (866) Independent Auditors Vavrinek, Trine, Day & Co., LLP Foothill Blvd., Suite 300 Rancho Cucamonga, CA Whittier Office Whittier Blvd. Whittier, CA Phone (562) Fax (562) Member FDIC Santa Fe Springs Office Telegraph Rd., Suite 100 Santa Fe Springs, CA Phone (562) Fax (562) Market Symbol: FHLB Payroll Office Whittier Blvd. Whittier, CA Phone (562) Fax (562)