CENTRAL VALLEY COMMUNITY BANCORP - Quarter Report: 2008 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

		(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2008
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		FOR THE TRANSITION PERIOD FROM                        TO

 

COMMISSION FILE NUMBER: 000—31977

 

CENTRAL VALLEY COMMUNITY BANCORP

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number (559) 298-1775

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  x    No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  o    No  x

 

As of May 7, 2008 there were 5,982,341 shares of the registrant’s common stock outstanding

 

 

CENTRAL VALLEY COMMUNITY BANCORP

 

2007 QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

 

PART 1: FINANCIAL INFORMATION	3
ITEM 1: FINANCIAL STATEMENTS	3
ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	27
ITEM 4. CONTROLS AND PROCEDURES	28
PART II OTHER INFORMATION	29
ITEM 1 LEGAL PROCEEDINGS	29
ITEM 1A RISK FACTORS	32
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS	29
ITEM 3 DEFAULTS UPON SENIOR SECURITIES	29
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	29
ITEM 5 OTHER INFORMATION	29
ITEM 6 EXHIBITS	29
SIGNATURES	30

 

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PART 1: FINANCIAL INFORMATION

 

ITEM 1: FINANCIAL STATEMENTS

 

CENTRAL VALLEY COMMUNITY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(In thousands, except share amounts)		March 31, 2008			December 31, 2007
ASSETS
Cash and due from banks		$	18,291		$	17,108
Federal funds sold		828			14,536
Total cash and cash equivalents		19,119			31,644
Available-for-sale investment securities, at fair value (amortized cost of $101,092 at March 31, 2008 and $84,139 at December 31, 2007)		101,224			84,373
Loans, less allowance for credit losses of $3,976 at March 31, 2008 and $3,887 at December 31, 2007		344,668			337,241
Bank premises and equipment, net		5,742			5,767
Bank owned life insurance		6,785			6,723
Federal Home Loan Bank stock		2,050			2,022
Goodwill		8,934			8,934
Accrued interest receivable, intangibles and other assets		7,039			6,981
Total assets		$	495,561		$	483,685
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Non-interest bearing		$	127,608		$	128,120
Interest bearing		282,659			274,442
Total deposits		410,267			402,562
Short-term borrowings		5,000			20,000
Long-term debt		19,000			—
Accrued interest payable and other liabilities		6,652			6,929
Total liabilities		440,919			429,491
Commitments and contingencies
Shareholders’ equity:
Preferred stock, no par value: 10,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, no par value; 80,000,000 authorized; outstanding 5,982,316 at March 31, 2008, 5,975,316 at December 31,2007		13,689			13,571
Retained earnings		40,874			40,483
Accumulated other comprehensive income, net of tax		79			140
Total shareholders’ equity		54,642			54,194
Total liabilities and shareholders’ equity		$	495,561		$	483,685

 

See notes to unaudited condensed consolidated financial statements.

 

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CENTRAL VALLEY COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

		For the Three Months
		Ended March 31
(In thousands except per share amounts)		2008			2007
INTEREST INCOME:
Interest and fees on loans		$	6,485		$	6,573
Interest on Federal funds sold		71			144
Interest and dividends on investment securities:
Taxable		904			897
Exempt from Federal income taxes		229			241
Total interest income		7,689			7,855
INTEREST EXPENSE:
Interest on deposits		1,676			1,823
Other		164			64
Total interest expense		1,840			1,887
Net interest income before provision for credit losses		5,849			5,968
PROVISION FOR CREDIT LOSSES		135			120
Net interest income after provision for credit losses		5,714			5,848
NON-INTEREST INCOME:
Service charges		803			692
Appreciation in cash surrender value of bank owned life insurance		62			55
Loan placement fees		33			65
Net realized gains on sales and calls of investment securities		—			44
Federal Home Loan Bank stock dividends		27			28
Gain on sale and disposal of equipment		—			4
Other income		313			271
Total non-interest income		1,238			1,159
NON-INTEREST EXPENSES:
Salaries and employee benefits		2,869			2,708
Occupancy and equipment		635			650
Other expense		1,468			1,347
Total non-interest expenses		4,972			4,705
Income before provision for income taxes		1,980			2,302
PROVISION FOR INCOME TAXES		675			850
Net income		$	1,305		$	1,452
Basic earnings per share		$	0.22		$	0.24
Diluted earnings per share		$	0.21		$	0.23
Cash dividends per share		$	0.10		$	—

 

See notes to unaudited condensed consolidated financial statements.

 

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CENTRAL VALLEY COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE YEAR ENDED DECEMBER 31, 2007

AND THE THREE MONTH PERIOD ENDED MARCH 31, 2008

(Unaudited)

 

(In thousands except share and per share amounts)		Shares		Amount			Retained Earnings			Accumulated Other Comprehensive (Loss)/ Income (Net of Taxes)			Total Shareholders’ Equity			Total Comprehensive Income
Balance, January 1, 2007		6,037,656		$	14,007		$	35,888		$	(117	)	$	49,778
Comprehensive income:
Net income							6,280						6,280			$	6,280
Other comprehensive loss, net of tax:
Net change in unrealized gain (loss) on available-for-sale investment securities										257			257			257
Total comprehensive income																$	6,537
Cash dividend - $.10 per share							(595		)				(595		)
Repurchase and retirement of common stock		(186,800	)	(1,617		)	(1,090		)				(2,707		)
Stock-based compensation expense				221									221
Stock options exercised and related tax benefit		124,460		960									960
Balance, December 31, 2007		5,975,316		13,571			40,483			140			54,194
Comprehensive income:
Net income							1,305						1,305			$	1,305
Other comprehensive loss, net of tax:
Net change in unrealized gains on available-for-sale investment securities										(61		)	(61		)	(61		)
Total comprehensive income																$	1,244
Cash dividend - $.10 per share							(598		)				(598		)
Stock options exercised and related tax benefit		7,000		55									55
Stock-based compensation expense				63									63
Cumulative effect of adopting EITF 06-4							(316		)				(316		)
Balance, March 31, 2008		5,982,316		$	13,689		$	40,874		$	79		$	54,642

 

See notes to unaudited condensed consolidated financial statements.

 

5

 

CENTRAL VALLEY COMMUNITY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007

(Unaudited)

 

(In thousands)		2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	1,305		$	1,452
Adjustments to reconcile net income to net cash provided by operating activities:
Net decrease in deferred loan fees		(131		)	(8		)
Depreciation, accretion and amortization, net		274			286
Stock-based compensation		63			37
Tax benefit from exercise of stock options		(8		)	(35		)
Provision for credit losses		135			120
Net realized gains on sales and calls of available-for-sale investment securities		—			(44		)
Net gain on sale and disposal of equipment		—			(4		)
Increase in bank owned life insurance, net of expenses		(62		)	(55		)
FHLB stock dividends		(27		)	(28		)
Net (increase) decrease in accrued interest receivable and other assets		(61		)	175
Net (decrease) increase in accrued interest payable and other liabilities		(586		)	203
Provision for deferred income taxes		(11		)	(5		)
Net cash provided by operating activities		891			2,094
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available-for-sale investment securities		(24,200		)	(2,572		)
Proceeds from sales or calls of available-for-sale investment securities		—			5,699
Proceeds from maturity of available-for-sale investment securities		3,500			2,150
Proceeds from principal repayments of available-for-sale investment securities		3,758			3,983
Net decrease in interest bearing deposits in other banks		—			85
Net increase in loans		(7,430		)	(4,853		)
Purchases of premises and equipment		(206		)	(1,140		)
Proceeds from sale of premises and equipment		—			4
Net cash (used in) provided by investing activities		(24,578		)	3,356
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand, interest bearing and savings deposits		6,802			(31,926		)
Net increase in time deposits		903			5,049
Proceeds from borrowings from Federal Home Loan Bank		80,000			32,500
Repayments to Federal Home Loan Bank		(76,000		)	(34,500		)
Repayments of borrowings from other financial institutions		—			(312		)
Share repurchase and retirement		—			(602		)
Proceeds from exercise of stock options		47			90
Tax benefit from exercise of stock options		8			35
Cash paid for dividends		(598		)	—
Net cash provided by (used in) financing activities		11,162			(29,666		)
Decrease in cash and cash equivalents		(12,525		)	(24,216		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		31,644			48,116
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	19,119		$	23,900
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense		$	1,912		$	1,806
Income taxes		$	180		$	1,180
Non-Cash Investing Activities:
Net pre-tax change in unrealized (losses) gains on available-for-sale investment securities		$	(102	)	$	268
Non-Cash Financing Activities:
Tax Benefit from stock options exercised		$	8		$	35

 

See notes to unaudited condensed consolidated financial statements.

 

6

 

CENTRAL VALLEY COMMUNITY BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1.  Basis of Presentation

 

The interim unaudited condensed consolidated financial statements of Central Valley Community Bancorp and subsidiary have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the SEC). These interim condensed consolidated financial statements include the accounts of Central Valley Community Bancorp and its wholly owned subsidiary Central Valley Community Bank (the Bank) (collectively, the Company). All significant intercompany accounts and transactions have been eliminated in consolidation.  Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The Company believes that the disclosures are adequate to make the information presented not misleading. These interim condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s 2007 Annual Report to Shareholders on Form 10-K. In the opinion of management, all adjustments, consisting of only normal recurring adjustments, necessary to present fairly the Company’s financial position and shareholders’ equity at March 31, 2008 and December 31, 2007, and the results of its operations and its cash flows for the three month interim periods ended March 31, 2008 and March 31, 2007 have been included. Certain reclassifications have been made to prior year amounts to conform to the 2008 presentation. The results of operations for interim periods are not necessarily indicative of results for the full year.

 

The preparation of these condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of 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.

 

Management has determined that since all of the banking products and services offered by the Company are available in each branch of the Bank, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank branches and report them as a single operating segment. No customer accounts are for more than 10 percent of revenues for the Company or the Bank.

 

Note 2.  Stock-Based Compensation

 

The Company has three stock-based compensation plans which are described as follows:

 

During 1992, the Bank established a Stock Option Plan for which shares are reserved for issuance to employees and directors under incentive and nonstatutory agreements.  The Company assumed all obligations under this plan as of November 15, 2000, and options to purchase shares of the Company’s common stock were substituted for options to purchase shares of common stock of the Bank.  Outstanding options under this plan are exercisable until their expiration, however, no new options will be granted under this plan.

 

On November 15, 2000, the Company adopted, and subsequently amended on December 20, 2000, the Central Valley Community Bancorp 2000 Stock Option Plan for which 833,284 shares remain reserved for issuance for options already granted to employees and directors under incentive and nonstatutory agreements and 8,536 remain reserved for future grants.  The plan requires that the option price may not be less than the fair market value of the stock at the date the option is granted, and that the option price must be paid in full at the time it is exercised.  The options under the plan expire on dates determined by the Board of Directors, but not later than ten years from the date of grant.  The vesting period is determined by the Board of Directors and is generally over five years.

 

In May 2005, the Company adopted the Central Valley Community Bancorp 2005 Omnibus Incentive Plan (2005 Plan).  The plan provides for awards in the form of incentive stock options, non-statutory stock options, stock appreciation rights, and restricted stock.  The plan also allows for performance awards that may be in the form of cash or shares of the Company, including restricted stock.  The maximum number of shares that can be issued with respect to all awards under the plan is 476,000.  Currently under the 2005 Plan, there are 15,000 shares reserved for issuance for options already granted to employees and 461,000 remain reserved for future grants as of March 31, 2008.   The plan requires that the exercise price may not be less than 100% of the fair market value of the stock at the date the option is granted, and that the option price must be paid in full at the time it is exercised.  The options and awards under the plan expire on dates determined by the Board of Directors, but not later than 10 years from the date of grant.  The vesting period for the options and option related stock appreciation rights is determined by the Board of Directors and is generally over five years.

 

Stock Option Compensation

 

For the three month periods ended March 31, 2008 and 2007, the compensation cost recognized for stock option compensation was $63,000 and $37,000, respectively.  The recognized tax benefit for stock option compensation expense was $8,000 and $35,000, for the three month periods ended March 31, 2008 and 2007, respectively.  As of March 31, 2008, there was $764,000 of total unrecognized

 

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compensation cost related to non-vested share-based compensation arrangements granted under all Plans.  The cost is expected to be recognized over a weighted average period of three and one half years.

 

The Company bases the fair value of the options granted on the date of grant using a Black-Scholes option pricing model that uses assumptions based on expected option life and the level of estimated forfeitures, expected stock volatility, risk free interest rate, and dividend yield.  The “simplified” method described in SEC Staff Accounting Bulletin No. 107 was used to determine the expected term of the Company’s options in 2007.  Stock volatility is based on the historical volatility of the Company’s stock.  The risk-free rate is based on the U. S. Treasury yield curve for the periods within the contractual life of the options in effect at the time of grant.  The compensation cost for options granted is based on the weighted average grant date fair value per share.

 

No options have been granted in either the 2000 Plan or the 2005 Plan in 2008.  In the fourth quarter of 2007, the Board of Directors of the Company approved the cancellation of 15,000 stock options granted on May 1, 2006 and 78,900 stock options granted on April 23, 2007.  The Board granted new options to the directors, senior managers and other employees in the same numbers and to the same employees who were holders of the cancelled options. The grant date of the new options was October 17, 2007 and the options were granted with an exercise price equal to the fair market value on the grant date of $12.00 per share.  The modification affected 60 employees and 8 directors and the total incremental compensation cost recognized in 2007 for the modification was $29,000.

 

Stock Option Activity

 

A summary of the combined activity of the plans follows:

 

		Three months ended March 31, 2008
				Weighted			Weighted		Average
				Average			Average Remaining		Intrinsic
				Exercise			Contractual		Value
		Shares		Price			Term		(In thousands)
Options outstanding, beginning of period		861,834		$	7.22				$	3,712
Options granted		—		—
Options exercised		(7,000	)	$	6.78
Options canceled		(6,550	)	$	12.82
Options outstanding, end of period		848,284		$	7.18		4.49		$	3,676
Options vested or expected to vest at March 31, 2008		815,729		$	6.99		6.42		$	3,666
Options exercisable, end of period		655,324		$	5.62		3.42		$	3,654

 

The total intrinsic value of options exercised in the three months ended March 31, 2008 and 2007, was $20,000 and $206,000, respectively.

 

Note 3. Earnings per share

 

Basic earnings per share (EPS), which excludes dilution, is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options, stock appreciation rights settled in stock or restricted stock awards, result in the issuance of common stock which shares in the earnings of the Company. There was no difference in the net income used in the calculation of basic earnings per share and diluted earnings per share.

 

A reconciliation of the numerators and denominators of the basic and diluted EPS computations is as follows:

 

		Three Months Ended
		March 31,
(In thousands except share and per share amounts)		2008			2007
Basic Earnings Per Share:
Net income		$	1,305		$	1,452
Weighted average shares outstanding		5,976,948			6,016,983
Net income per share		$	0.22		$	0.24

 

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		Three Months Ended
		March 31,
(In thousands except share and per share amounts)		2007			2006
Diluted Earnings Per Share:
Net income		$	1,305		$	1,452
Weighted average shares outstanding		5,976,948			6,016,983
Effect of dilutive stock options		299,666			402,647
Weighted average shares of common stock and common stock equivalents		6,276,614			6,419,630
Net income per diluted share		$	0.21		$	0.23

 

Note 4.  Fair Value of Assets and Liabilities

 

On January 1, 2008, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 157 (SFAS 157), Fair Value Measurements.  SFAS 157 defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements.  There was no cumulative effect adjustment to beginning retained earnings recorded upon adoption and no impact on the financial statements in the first quarter of 2008.

 

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring and non recurring basis as of March 31, 2008, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

					Fair Value Measurements
					at March 31, 2008, Using
(In thousands)		Fair Value March 31, 2008			Quoted Prices in Active Markets for Identical Assets (Level 1)			Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets and liabilities measured on a recurring basis:
Available-for-sale investment securities		$	101,224		$	2,952		$	89,893		$	8,379
Total assets and liabilities measured at fair value on a recurring basis		$	101,224		$	2,952		$	89,893		$	8,379
Assets and liabilities measured on a non-recurring basis:
Impaired loans		$	109		$	—		$	109		$	—
Total assets and liabilities measured at fair value on a non-recurring basis		$	109		$	—		$	109		$	—

 

The fair value of available-for-sale investment securities is based on actual market price determinations from third party evaluation vendors.  The fair value of impaired loans is based on the fair value of the collateral for all collateral dependent loans and for other impaired loans is estimated using a discounted cash flow model.

 

9

 

Fair Value Measurements Using Significant Unobservable Inputs

(Level 3)

 

(In thousands)		Available-for-sale Investment Securities
Beginning balance		$	9,012
Total unrealized gains or losses included in other comprehensive income		101
Purchases, sales and principal payments		(734		)
Transfers in and/or out of Level 3		—
Ending balance		$	8,379

 

The amount of total gains for the three month period ended March 31, 2008 is reported as part of unrealized gains or losses included in other comprehensive income on the statement of changes in shareholders equity.

 

Note 5. Comprehensive Income

 

Total comprehensive income is comprised of net earnings and net unrealized gains and losses on available-for-sale investment securities, which is the Company’s only source of other comprehensive income.  Total comprehensive income for the three-month periods ended March 31, 2008 and 2007 was $1,244,000 and $1,613,000, respectively.

 

Note 6.  Commitments and Contingencies

 

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for loans.

 

Commitments to extend credit amounting to $127,247,000 and $135,638,000 were outstanding at March 31, 2008 and December 31, 2007, respectively. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.

 

Undisbursed lines of credit amounting to $70,905,000 and $77,933,000 were outstanding at March 31, 2008 and December 31, 2007, respectively. Undisbursed lines of credit are revolving lines of credit whereby customers can repay principal and advance principal during the term of the loan at their discretion and most expire between one and twelve months.

 

The Company has undisbursed portions of construction loans totaling $13,328,000 and $15,868,000 as of March 31, 2008 and December 31, 2007, respectively. These commitments are agreements to lend to a customer, subject to meeting certain construction progress requirements. The underlying construction loans have fixed expiration dates.

 

Standby letters of credit and financial guarantees amounting to $469,000 and $969,000 were outstanding at March 31, 2008 and December 31, 2007, respectively. Standby letters of credit and financial guarantees are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements. Most guarantees carry a one year term or less. The fair value of the liability related to these standby letters of credit, which represents the fees received for issuing the guarantees, was not significant at March 31, 2008 and December 31, 2007.  The Company recognizes these fees as revenue over the term of the commitment or when the commitment is used.

 

The Company generally requires collateral or other security to support financial instruments with credit risk. Management does not anticipate any material loss will result from the outstanding commitments to extend credit, standby letters of credit and financial guarantees.

 

The Company is subject to legal proceedings and claims which arise in the ordinary course of business.  In the opinion of management, the amount of ultimate liability with respect to such actions will not materially affect the consolidated financial position or consolidated results of operations of the Company.

 

Note 7.  Income Taxes

 

The Company files its income taxes on a consolidated basis with its subsidiaries.  The allocation of income tax expense (benefit) represents each entity’s proportionate share of the consolidated provision for income taxes.  Deferred tax assets and liabilities are recognized for the

 

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tax consequences of temporary differences between the reported amounts of assets and liabilities and their tax bases.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.  On the consolidated balance sheets, net deferred tax assets are included in accrued interest receivable and other assets.

 

Accounting for uncertainty in income taxes - The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority.  The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.   The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of tax expense in the consolidated statements of income.   There have been no significant changes to unrecognized tax benefits or accrued interest and penalties for the quarter ended March 31, 2008.

 

Note 8.  Stock Repurchase

 

On November 20, 2007, the Board of Directors approved a stock repurchase plan authorizing the purchase of shares of the Company’s common stock up to a total cost of approximately $1,000,000 during the period from November 21, 2007 to May 21, 2008.  Under the plan, the Company repurchased 24,300 shares in 2007 at an average price of $12.55 for a total cost of $305,000.  No shares have been repurchased under the plan in 2008.

 

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Certain matters discussed in this report constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  All statements contained herein that are not historical facts, such as statements regarding the Company’s current business strategy and the Company’s plans for future development and operations, are based upon current expectations.  These statements are forward-looking in nature and involve a number of risks and uncertainties.  Such risks and uncertainties include, but are not limited to (1) significant increases in competitive pressure in the banking industry; (2) the impact of changes in interest rates, a decline in economic conditions at the international, national or local level on the Company’s results of operations, the Company’s ability to continue its internal growth at historical rates, the Company’s ability to maintain its net interest margin, and the quality of the Company’s earning assets; (3) changes in the regulatory environment; (4) fluctuations in the real estate market; (5) changes in business conditions and inflation; (6) changes in securities markets; and (7) risks associated with acquisitions, relating to difficulty in integrating combined operations and related negative impact on earnings, and incurrence of substantial expenses.  Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluating the business prospects of the Company.

 

When the Company uses in this Quarterly Report on Form 10-Q the words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar expressions, the Company intends to identify forward-looking statements.  Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Quarterly Report on Form 10-Q.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed.  The future results and shareholder values of the Company may differ materially from those expressed in these forward-looking statements.  Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict.  For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

On January 1, 2008, the Company adopted Financial Accounting Standards Board (FASB) issued Statement No. 157 (SFAS 157), Fair Value Measurements.  SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.  See Note 4 to the Condensed Consolidated Financial Statements for additional information related to implementation of SFAS 157.  The Company adopted SFAS 157 on January 1, 2008 and there was no cumulative effect adjustment to beginning retained earnings recorded upon adoption and no impact on the financial statements in the first quarter of 2008.

 

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In September 2006, the FASB ratified the consensuses reached by the Task Force on Issue No. 06-4 (EITF 06-04), Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.  A question arose when an employer enters into an endorsement split-dollar life insurance arrangement related to whether the employer should recognize a liability for the future benefits or premiums to be provided to the employee.  EITF 06-04 indicates that an employer should recognize a liability for future benefits and that a liability for the benefit obligation has not been settled through the purchase of an endorsement type policy.  The Company adopted the provisions of EITF 06-04 on January 1, 2008 and a liability of $316,000 was recorded with the corresponding reduction as a cumulative-effect adjustment to beginning retained earnings.

 

There have been no other changes to the Company’s critical accounting policies from those discussed in the Company’s 2007 Annual Report to Shareholders on Form 10-K.

 

This discussion should be read in conjunction with our unaudited condensed consolidated financial statements, including the notes thereto, appearing elsewhere in this report.

 

OVERVIEW

 

First Three Months of 2008

 

For the three months ended March 31, 2008, our consolidated net income was $1,305,000 compared to net income of $1,452,000 for the same period in 2007.  Diluted EPS was $0.21 for the first three months of 2008 compared to $0.23 for the first three months of 2007.  The decrease in net income was primarily due to the decrease in interest rates reflective of the 300 basis points decline in rates by the Federal Reserve Bank since September 2007.  Generally, our interest earning assets tend to reprice faster than our interest bearing liabilities and as a result the decline in the interest rates compressed our net interest margin.  Net interest income decreased $119,000.  This was offset by an increase in non-interest income of $79,000, however the provision for credit losses increased $15,000 and non-interest expense increased $267,000 in the first three months of 2008 compared to 2007.  The increase in non-interest expenses was mainly due to increases in salaries and other operating expenses.

 

Annualized return on average equity (ROE) for the first three months of 2008 was 9.55%, compared to 11.55% for the same period in 2007.  Annualized return on average assets (ROA) was 1.08% for the first three months of 2008, compared to 1.23% for the same period in 2007.  Total average equity was $54,665,000 for the first three months of 2008 compared to $50,311,000 for the first three months 2007.  Equity increased primarily as a result of the net income included in retained earnings and proceeds from exercise of stock options offset by the repurchase of shares of the Company’s common stock, the payment of cash dividends and the cumulative effect adjustment recorded related to our split dollar life insurance policies.

 

In comparing the first three months of 2008 to the same period in 2007, total loans continued to increase.  Average total loans increased $22,841,000 or 7.2% in the first three months of 2008 compared to the first three months of 2007 while average interest bearing liabilities increased $15,022,000 or 5.3% comparing the same periods.  The yields on earning assets decreased 35 basis points and the rates paid on interest bearing liabilities decreased 19 basis points. As a result, net interest margin for the first three months of 2008 was 5.40% compared to 5.66% for the same period in 2007, a decline of 26 basis points comparing the two periods.  Asset quality continues to be strong.  The Bank had three non-accrual loans totaling $109,000 at March 31, 2008, compared to four totaling $179,000 at December 31, 2007 and none at March 31, 2007.  We had no other real estate owned at March 31, 2008, December 31, 2007, or March 31, 2007.

 

Central Valley Community Bancorp (Company)

 

We are a central California-based bank holding company for a one-bank subsidiary, Central Valley Community Bank (Bank).  We provide traditional commercial banking services to small and medium-sized businesses and individuals in the communities along the Highway 99 corridor in the Fresno and Madera Counties of central California.  Additionally, we have a private banking office in Sacramento County and a loan production office in Stanislaus County.  As a bank holding company, the Company is subject to supervision, examination and regulation by the Federal Reserve Bank.

 

At March 31, 2008, we had total loans of $348,644,000, total assets of $495,561,000, total deposits of $410,267,000, and shareholders’ equity of $54,642,000.

 

Central Valley Community Bank (Bank)

 

The Bank commenced operations in January 1980 as a state-chartered bank.  As a state-chartered bank, the Bank is subject to primary supervision, examination and regulation by the Department of Financial Institutions.  The Bank’s deposits are insured by the Federal Deposit Insurance Corporation up to the applicable limits thereof, and the Bank is subject to supervision, examination and regulations of the FDIC.

 

The Bank operates 12 branches which serve the communities of Fresno, Clovis, Kerman, Prather, Oakhurst, Madera, and Sacramento; and a loan production office which serves the Modesto community.  Additionally the Bank operates Real Estate, Agribusiness and SBA departments that originate loans in California.  According to the June 30, 2007 FDIC data, the Bank’s seven branches in Fresno County (Clovis, Fresno, Kerman, and Prather) had a 4.1% combined deposit market share of all depositories including credit unions, thrifts, and savings banks.

 

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The Bank anticipates additional branch openings in the future to meet the growing service needs of its customers.  The branch expansions provide the Company with opportunities to expand its loan and deposit base.  During 2007 we opened a new loan production office in Modesto and relocated our Kerman office to a new expanded facility.  In the first quarter of 2008, the Bank began construction on a new building to relocate its in-store office to a stand alone facility.  Management expects that new offices will initially have a negative impact on earnings until the volume of business grows to cover fixed overhead expenses.

 

Key Factors in Evaluating Financial Condition and Operating Performance

 

As a publicly traded community bank holding company, we focus on several key factors including:

 

· Return to our stockholders;

· Return on average assets;

· Development of core revenue streams, including net interest income and non-interest income;

· Asset quality;

· Asset growth; and

· Operating efficiency.

 

Return to Our Stockholders

 

Our return to our stockholders is measured in the form of return on average equity (ROE).  Our annualized ROE was 9.55% for the three months ended March 31, 2008 compared to 11.55% for the three months ended March 31, 2007.  Trailing 12 month ROE for the period ended March 31, 2008 was 11.61% compared to 12.13% for the trailing twelve months ended December 31, 2007 and 14.60% for the trailing 12 months ended March 31, 2007.  The decrease in ROE is primarily due to the decrease in net income coupled with the overall increase in the level of capital.

 

Our net income for the three months ended March 31, 2008 decreased $147,000 or 10.1% to $1,305,000 compared to $1,452,000 for the three months ended March 31, 2007.  Net income decreased due to a decrease in net interest income, an increase in the provision for credit losses and an increase in non-interest expenses offset by an increase in non-interest income.   Net interest margin (NIM) decreased 26 basis points comparing the three month periods ended March 31, 2008 and 2007.   Diluted EPS was $0.21 for the three months ended March 31, 2008 compared to $0.23 for the same period in 2007.  The decrease in NIM is attributed to the 300 basis points decline in Fed funds interest rates since September 2007 and mirrored by a 300 basis point decline in our Prime rate.

 

Return on Average Assets

 

Our return on average assets (ROA) is a measure we use to compare our performance with other banks and bank holding companies.  Our annualized ROA for the three months ended March 31, 2008 was 1.08% compared to 1.23% for the three months ended March 31, 2007.  Trailing 12 month ROA for the period ended March 31, 2008 was 1.28% compared to 1.32% for the trailing 12 months ended December 31, 2007 and 1.47% for the trailing 12 months ended March 31, 2007.  The decrease in ROA compared to December 2007 is due to the decrease in net income relative to our increase in average assets.  Average assets for the three months ended March 31, 2008 were $484,809,000 compared to $477,321,000 for the year ended December 31, 2007 and $473,733,000 for the three months ended March 31, 2007.  ROA for our peer group was 1.07% for the twelve months ended December 31, 2007.  Peer group data from SNL Financial includes certain bank holding companies in central California with assets from $400 million to $1 billion.

 

Development of Core Earnings

 

Over the past several years, we have focused on not only improving net income, but improving the consistency of our revenue streams in order to create more predictable future earnings and reduce the effect of changes in our operating environment on our net income.  Specifically, we have focused on net interest income through a variety of processes, including increases in average interest earning assets as a result of loan generation and retention, and minimizing the effects of the recent interest rate decline on our net interest margin by focusing on core deposits and managing the cost of funds.  The Company’s annualized net interest margin for the first three months of 2008 (fully tax equivalent basis) was 5.40%, compared to 5.66% for the same period in 2007.  The decrease is a reflection of the 300 basis points decline in rates by the Federal Reserve Bank (FRB) since September 2007 coupled with competition for deposits and liquidity that continue to challenge most financial institutions.  The decline in rates put pressure on our net interest margin due to our asset sensitivity with loans re-pricing faster than interest bearing deposits.   In comparing the two periods, the effective yield on total earning assets decreased 35 basis points while the cost of total interest bearing liabilities decreased 19 basis points.  Net interest income for the first three months of 2008 was $5,849,000 compared to $5,968,000 for the same period in 2007.

 

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On a trailing 12-month basis, NIM was 5.68% for the period ended March 31, 2008, compared to 5.74% for the trailing 12 months ended December 31, 2007 and 5.77% for the trailing 12 months ended March 31, 2007.  The decrease is principally due to the decline in rates by the FRB as mentioned above.

 

Our non-interest income is generally made up of service charges and fees on deposit accounts, fee income from loan placements, and appreciation in cash surrender value of bank owned life insurance and other income.  Non-interest income for the first three months of 2008 increased $79,000 or 6.8% to $1,238,000 compared to $1,159,000 for the three months ended March 31, 2007 due to an increase in income from service charges and an increase in other income, offset by decreases in realized gains from sales of available-for-sale investment securities and loan placement fees.  Further detail of non-interest income is provided below.

 

Asset Quality

 

For all banks and bank holding companies, asset quality has a significant impact on the overall financial condition and results of operations.  Asset quality is measured in terms of percentage of total loans and total assets, and is a key element in estimating the future earnings of a company.  The Company had three non-performing loans totaling $109,000 as of March 31, 2008, four totaling $179,000 at December 31, 2007, and none as of March 31, 2007.  Management maintains certain loans that have been brought current by the borrower (less than 30 days delinquent) on non-accrual status until such time as management has determined that the loans are likely to remain current in future periods.  The Company did not have any other real estate owned at March 31, 2008, December 31, 2007, or March 31, 2007.

 

Asset Growth

 

As revenues from both net interest income and non-interest income are a function of asset size, the continued growth in assets has a direct impact in increasing net income and therefore ROE and ROA.  The majority of our assets are loans and investment securities, and the majority of our liabilities are deposits, and therefore the ability to generate deposits as a funding source for loans and investments is fundamental to our asset growth.  Total assets increased 2.5% during the first three months of 2008 to $495,561,000 as of March 31, 2008 compared to $483,685,000 as of December 31, 2007.  Total gross loans increased 2.2% to $348,644,000 as of March 31, 2008 compared to $341,128,000 as of December 31, 2007.  Total deposits increased 1.9% to $410,267,000 as of March 31, 2008 compared to $402,562,000 as of December 31, 2007.  Our loan to deposit ratio at March 31, 2008 increased to 85.0% compared to 84.7% at December 31, 2007.  The loan to deposit ratio of our peers was 93.5% at December 31, 2007.  Further discussion of loans and deposits is below.

 

Operating Efficiency

 

Operating efficiency is the measure of how efficiently earnings before taxes are generated as a percentage of revenue.  The Company’s efficiency ratio (operating expenses, excluding amortization of intangibles, divided by net interest income plus non-interest income, excluding gains from sales of securities) was 69.4% for the first three months of 2008 compared to 65.7% for the three months ended March 31, 2007.  The decline in the efficiency ratio is due to the increase in operating expenses exceeding the increase in revenues.  The Company’s net interest income before provision for credit losses plus non-interest income decreased 0.5% to $7,087,000 for the three months ended March 31, 2008 compared to $7,127,000 for the same period in 2007, while non-interest expenses less amortization of intangibles increased 5.7% to $4,918,000 from $4,651,000 for the same period in 2007.

 

RESULTS OF OPERATIONS

 

Net Income for the First Three months of 2008 Compared to the Three months ended March 31, 2007:

 

Net income decreased to $1,305,000 for the three months ended March 31, 2008 compared to $1,452,000 for the three months ended March 31, 2007.  Basic earnings per share were $0.22 and $0.24 for the three months ended March 31, 2008 and 2007, respectively.  Diluted earnings per share were $0.21 and $0.23 for the three months ended March 31, 2008 and 2007, respectively.  Annualized ROE was 9.55% for the three months ended March 31, 2008 compared to 11.55% for the three months ended March 31, 2007.  Annualized ROA for the three months ended March 31, 2008 was 1.08% compared to 1.23% for the three months ended March 31, 2007.

 

Net income for the three months ended March 31, 2008 compared to the same period in the prior year decreased due mainly to the decrease in net interest income and increases in non-interest expenses and the provision for credit losses partially offset by increases in non-interest income.  Net interest income after provision for credit losses decreased principally due to the effect of the compression on the net interest margin as well as an increase in the provision for credit losses.  Non-interest expenses increased primarily due to salaries and benefits and other operating expenses.  Further discussion of non-interest expenses is below.

 

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Interest Income and Expense

 

Net interest income is the most significant component of our income from operations.  Net interest income (the “interest rate spread”) is the difference between the gross interest and fees earned on the loan and investment portfolio and the interest paid on deposits and other borrowings.  Net interest income depends on the volume of and interest rate earned on interest earning assets and the volume of and interest rate paid on interest bearing liabilities.

 

The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average interest rate information for the periods presented.  Average balances are derived from daily balances, and non-accrual loans are not included as interest earning assets for purposes of this table.

 

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CENTRAL VALLEY COMMUNITY BANCORP

SCHEDULE OF AVERAGE BALANCES AND AVERAGE YIELDS AND RATES

(Dollars in thousands)

 

		FOR THE THREE MONTHS ENDED MARCH 31, 2008								FOR THE THREE MONTHS ENDED MARCH 31, 2007
		Average Balance			Interest Income/Expense			Average Interest Rate		Average Balance			Interest Income/Expense			Average Interest Rate
ASSETS
Interest-earning deposits in other banks		$	—		$	—				$	261		$	2		3.07	%
Securities
Taxable securities		68,070			904			5.31	%	75,577			895			4.74	%
Non-taxable securities (1)		24,733			347			5.61	%	26,084			365			5.60	%
Total investment securities		92,803			1,251			5.39	%	101,661			1,260			4.96	%
Federal funds sold		8,509			71			3.30	%	11,111			144			5.18	%
Total securities		101,312			1,322			5.22	%	113,033			1,406			4.98	%
Loans (2) (3)		340,260			6,485			7.64	%	317,444			6,573			8.28	%
Federal Home Loan Bank stock		2,024			27			5.34	%	1,904			28			5.88	%
Total interest-earning assets		443,596			$	7,834		7.06	%	432,381			$	8,007		7.41	%
Allowance for credit losses		(3,934		)						(3,783		)
Non-accrual loans		103								78
Cash and due from banks		15,697								18,074
Bank premises & equipment		5,805								5,183
Other non-earning assets		23,542								21,800
Total average assets		$	484,809							$	473,733
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Savings and NOW accounts		$	73,395		$	63		0.34	%	$	76,594		$	114		0.60	%
Money market accounts		90,838			500			2.21	%	96,717			626			2.59	%
Time certificates of deposit, under $100,000		51,784			516			4.00	%	47,164			452			3.83	%
Time certificates of deposit, $100,000 and over		59,987			597			3.99	%	56,485			631			4.47	%
Total interest-bearing deposits		276,004			1,676			2.44	%	276,960			1,823			2.63	%
Other borrowed funds		20,528			164			3.20	%	4,550			64			5.63	%
Total interest-bearing liabilities		296,532			$	1,840		2.49	%	281,510			$	1,887		2.68	%
Non-interest bearing demand deposits		128,270								136,879
Other liabilities		5,342								5,033
Shareholders’ equity		54,665								50,311
Total average liabilities and shareholders’ equity		$	484,809							$	473,733
Interest income and rate earned on average earning assets					$	7,834		7.06	%				$	8,007		7.41	%
Interest expense and interest cost related to average interest-bearing liabilities					1,840			2.49	%				1,887			2.68	%
Net interest income and net interest margin (4)					$	5,994		5.40	%				$	6,120		5.66	%

 

(1)  Calculated on a fully tax equivalent basis, which includes Federal tax benefits relating to income earned on municipal bonds totaling $118 and $124 in 2008 and 2007, respectively.

(2)  Loan interest income includes loan fees of $212 in 2008 and $173 in 2007.

(3)  Average loans do not include non-accrual loans.

(4)  Net interest margin is computed by dividing net interest income by total average interest-earning assets.

 

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Interest and fee income from loans decreased 1.3% in the first three months of 2008 compared to the same period in 2007.  The decrease in 2008 is attributable to a 64 basis point decrease in the yield on loans which was 7.64% for the first three months of 2008 compared to 8.28% in 2007, partially offset by the increases in the average balance of loans.  The decrease in yield reflects the 300 basis point declines in rates as discussed previously.  Average total loans for the first three months of 2008 increased 7.2% to $340,363,000 compared to $317,522,000 for the same period in 2007.   An increase in the number of regional and community banks opening branches and loan centers in the Central Valley of California has created strong competition for loans.  This competition is often reflected in aggressive loan pricing.  We are committed to providing our customers with the best price; however we are also committed to increasing our value to shareholders and strong asset quality.

 

Interest income from total investments (total investments include investment securities, Federal funds sold, interest bearing deposits with other banks, and other securities) on a non fully tax equivalent basis decreased $78,000 in the first three months of 2008 compared to the same period in 2007, due to the 10.4% decrease in average balances of total investments, partially offset by a 24 basis point increase in yields to 5.22% for the three months ended March 31, 2008 compared to 4.98% for the same period in 2007.  Income from investments represents 20.6% of net interest income for the three months ended March 31, 2008 compared to 21.5% for the same period in 2007.

 

In an effort to increase yields, without accepting unreasonable risk, a significant portion of the investment portfolio is in high quality mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs).  At March 31, 2008, we held $65,958,000 or 68.1% of the total market value of the investment portfolio in MBS and CMOs with an average yield of 5.6%.  We understand the interest rate risks and prepayment risks associated with MBS and CMOs.  In a declining interest rate environment, prepayments from MBS and CMOs could be expected to increase and the expected life of the investment could be expected to shorten.  Conversely, if interest rates increase, prepayments could be expected to decline and the average life of the MBS and CMOs could be expected to extend.  Additionally, changes in interest rates are reflected in the market value of the investment portfolio.  During declining interest rates, the investment portfolio could be expected to have market value gains and in increasing rate environments, the market value could be expected to be negative.  The change in market value, net of the tax-effect, of the available-for-sale investment portfolio is also reflected in the Company’s equity.  At March 31, 2008, the average life of the investment portfolio was 4.8 years and the market value reflected a pre-tax unrealized gain of $132,000.  The investment portfolio does not include any sub-prime mortgage instruments.

 

A component of the Company’s strategic plan has been to use its investment portfolio to offset, in part, its interest rate risk relating to variable rate loans.  At March 31, 2008, an immediate rate increase of 200 basis points would result in an estimated decrease in the market value of the investment portfolio by approximately $6,965,000.  Conversely, with an immediate rate decrease of 200 basis points, the estimated increase in the market value of the investment portfolio is $6,572,000.  The modeling environment assumes management would take no action during an immediate shock of 200 basis points.  The Company uses those increments to measure its interest rate risk in accordance with regulatory requirements and to measure the possible future risk in the investment portfolio.  For further discussion of the Company’s market risk, refer to Item 3 - Quantitative and Qualitative Disclosures about Market Risk.

 

Management’s review of all investments before purchase includes an analysis of how the security will perform under several interest rate scenarios to monitor whether investments are consistent with our investment policy.  The policy addresses issues of average life, duration, and concentration guidelines, prohibited investments, impairment, and prohibited practices.

 

Total interest income for the first three months of 2007 decreased $166,000, to $7,689,000 compared to $7,855,000 for the three months ended March 31, 2007.  The decrease was due to the 35 basis point decrease in the yield on earning assets offset by the increases in volume.  The yield on interest earning assets decreased to 7.06% for the three months ended March 31, 2008 compared to 7.41% for the three months ended March 31, 2007.  Average interest earning assets increased to $443,596,000 for the three months ended March 31, 2008 compared to $432,381,000 for the three months ended March 31, 2007.  The $11,215,000 increase in average earning assets can be attributed to our own organic growth in loans funded by a decrease in the investment securities from principal pay downs and maturities and a decrease in the level of Fed funds sold.

 

Interest expense on deposits for the three months ended March 31, 2008 decreased $147,000 or 8.1% to $1,676,000 compared to $1,823,000 for the three months ended March 31, 2007.  This decrease was principally due to a 19 basis point decrease in deposit rates due to the repricing of deposits in the current interest rate environment.  Average interest-bearing deposits decreased slightly to $276,004,000 for the three months ended March 31, 2008 compared to $276,960,000 for the same period in 2007.  Average transaction accounts (including interest bearing checking, money market accounts and non interest bearing demand deposits) decreased 5.3% to $273,291,000 for the three months ended March 31, 2008 compared to $288,674,000 for the three months ended March 31, 2007.  Total average CDs increased 7.8% to $111,771,000 from $103,649,000.  The overall cost of our deposits decreased to 1.66% for the quarter ended March 31, 2008 compared to 1.76% for the quarter ended March 31, 2007.

 

Average other borrowed funds increased to $20,528,000 with an effective rate of 3.20% for the three months ended March 31, 2008 compared to $4,550,000 with an effective rate of 5.63% for the three months ended March 31, 2007.  Other borrowings are advances from the Federal Home Loan Bank (FHLB).  The FHLB advances are fixed rate short-term and long term borrowings.  Short-term advances were utilized to provide liquidity during the period and long-term advances were utilized as part of a leveraged strategy in the first quarter to purchase investments.  See the section on Financial Condition for more detail.

 

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Net Interest Income before Provision for Credit Losses

 

Net interest income before provision for credit losses for the three months ended March 31, 2008 was $5,849,000 compared to $5,968,000 for the same period in 2007, representing a decrease of $119,000 or 2.0%.  Net interest margin for the three months ended March 31, 2008 was 5.40% compared to 5.66% for the same period in 2007.  This decrease was due to the decrease in the yield on total average earning assets which decreased 35 basis points offset by a 19 basis point decrease in the average rate paid on interest-bearing liabilities.  Total average earning assets increased $11,215,000 or 2.6% to $443,596,000 for the three months ended March 31, 2008 from $432,381,000 for the three months ended March 31, 2007.    For a discussion of the repricing of our assets and liabilities, see “Item 3 – Quantitative and Qualitative Disclosure about Market Risk.”

 

Provision for Credit Losses

 

We provide for possible credit losses by a charge to operating income based upon the composition of the loan portfolio, past delinquency levels, losses and non-performing assets, economic and environmental conditions and other factors which, in management’s judgment, deserve recognition in estimating credit losses.  Loans are charged off when they are considered uncollectible or of such little value that continuance as an active earning bank asset is not warranted.

 

The establishment of an adequate credit allowance is based on both an accurate risk rating system and loan portfolio management tools.  The Board has established initial responsibility for the accuracy of credit risk grades with the individual credit officer.  The grading is then submitted to the Chief Credit Administrator (CCA), who reviews the grades for accuracy and makes recommendations to Credit Review who gives final approval.  The risk grading and reserve allocations are analyzed annually by a third party credit reviewer and by various regulatory agencies.

 

Quarterly, the CCA sets the specific reserve for all adversely risk-graded credits.  This process includes the utilization of loan delinquency reports, classified asset reports, and portfolio concentration reports to assist in accurately assessing credit risk and establishing appropriate reserves.  Reserves are also allocated to credits that are not adversely graded.  Historical loss experience within the portfolio along with peer bank loss experiences are used in determining the level of the reserves held.

 

The allowance for credit losses is reviewed at least quarterly by the Board’s Audit/Compliance Committee and by the Board of Directors.  Reserves are allocated to loan portfolio categories using percentages which are based on both historical risk elements such as delinquencies and losses and predictive risk elements such as economic, competitive and environmental factors.  We have adopted the specific reserve approach to allocate reserves to each adversely graded asset, as well as to each impaired asset for the purpose of estimating potential loss exposure.  Although the allowance for credit losses is allocated to various portfolio categories, it is general in nature and available for the loan portfolio in its entirety.  Additions may be required based on the results of independent loan portfolio examinations, regulatory agency examinations, or our own internal review process.  Additions are also required when, in management’s judgment, the allowance does not properly reflect the portfolio’s potential loss exposure.

 

The allocation of the allowance for credit losses is set forth below:

 

Loan Type (Dollars in thousands)		March 31, 2008 Amount			% of Total Loans		December 31, 2007 Amount			% Total Loans
Commercial & industrial		$	1,185		28.4	%	$	1,254		27.1	%
Agricultural land and production		567			8.8	%	501			9.4	%
Real estate		1,457			41.2	%	1,353			40.3	%
Real estate - construction and other land loans		236			12.7	%	312			14.2	%
Equity loans and lines of credit		167			7.1	%	157			7.2	%
Consumer & installment		227			1.7	%	236			1.7	%
Other		21			0.1	%	23			0.1	%
Non-specific reserve		116					51
Total allowance for credit losses		$	3,976				$	3,887

 

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