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Oak Valley Bancorp - Quarter Report: 2011 June (Form 10-Q)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2011

 

OR

 

o         TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-34142

 

OAK VALLEY BANCORP

(Exact name of registrant as specified in its charter)

 

California

 

26-2326676

State or other jurisdiction of

 

I.R.S. Employer

incorporation or organization

 

Identification No.

 

125 N. Third Ave., Oakdale, CA  95361

(Address of principal executive offices)

 

(209) 848-2265

Issuer’s telephone number

 

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  o     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):

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company x

(Do not check if a smaller reporting company)

 

 

 

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

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

State the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  7,713,794 shares of common stock outstanding as of July 31, 2011.

 

 

 



Table of Contents

 

Oak Valley Bancorp

June 30, 2011

 

Table of Contents

 

 

 

 

Page

PART I — FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Consolidated Financial Statements

 

3

 

 

 

 

Condensed Consolidated Balance Sheets at June 30, 2011(Unaudited), and December 31, 2010

 

3

 

 

 

Condensed Consolidated Statements of Income (Unaudited) for the Three and Six Month Periods Ended June 30, 2011 and June 30, 2010

 

4

 

 

 

Condensed Consolidated Statements of Changes of Shareholders’ Equity for the Six-Month Period Ended June 30, 2011 (Unaudited) and the Year Ended December 31, 2010

 

5

 

 

 

Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six-Month Periods Ended June 30, 2011 and June 30, 2010

 

6

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

25

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

41

 

 

 

 

Item 4.

Controls and Procedures

 

41

 

 

 

 

PART II — OTHER INFORMATION

 

42

 

 

 

 

Item 1.

Legal Proceedings

 

42

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

42

Item 3.

Defaults Upon Senior Securities

 

42

Item 4.

[Removed and Reserved]

 

42

Item 5.

Other Information

 

42

Item 6.

Exhibits

 

42

 

2



Table of Contents

 

PART I — FINANCIAL STATEMENTS

 

Item 1. Consolidated Financial Statements (Unaudited)

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED BALANCE SHEETS

AT JUNE 30, 2011 (UNAUDITED) AND DECEMBER 31, 2010

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Cash and due from banks

 

$

67,245,471

 

$

28,091,916

 

Federal funds sold

 

10,045,000

 

40,845,000

 

Cash and cash equivalents

 

77,290,471

 

68,936,916

 

 

 

 

 

 

 

Securities available for sale

 

78,861,655

 

53,267,982

 

Loans, net of allowance for loan loss of $8,591,039 at June 30, 2011 and $8,254,929 at December 31, 2010

 

381,193,600

 

395,206,208

 

Bank premises and equipment, net

 

12,795,628

 

10,173,822

 

Other real estate owned

 

244,375

 

778,174

 

Interest receivable and other assets

 

21,876,139

 

24,033,316

 

 

 

 

 

 

 

 

 

$

572,261,868

 

$

552,396,418

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

$

496,211,645

 

$

476,738,850

 

Interest payable and other liabilities

 

2,416,178

 

2,999,836

 

Federal Home Loan Bank advances

 

6,000,000

 

8,000,000

 

 

 

 

 

 

 

Total liabilities

 

504,627,823

 

487,738,686

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Preferred stock, no par value; $1,000 per share liquidation preference, 10,000,000 shares authorized and 13,500 issued and outstanding at June 30, 2011 and December 31, 2010

 

13,097,267

 

13,013,945

 

Common stock, no par value; 50,000,000 shares authorized, 7,713,794 and 7,702,127 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively

 

24,013,443

 

24,003,549

 

Additional paid-in capital

 

2,104,218

 

2,080,218

 

Retained earnings

 

26,210,381

 

24,016,466

 

Accumulated other comprehensive income, net of tax

 

2,208,736

 

1,543,554

 

 

 

 

 

 

 

Total shareholders’ equity

 

67,634,045

 

64,657,732

 

 

 

 

 

 

 

 

 

$

572,261,868

 

$

552,396,418

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3



Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2011 AND JUNE 30, 2010

 

 

 

THREE MONTHS ENDED JUNE 30,

 

SIX MONTHS ENDED JUNE 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

INTEREST INCOME

 

 

 

 

 

 

 

 

 

Interest and fees on loans

 

$

5,922,684

 

$

6,388,670

 

$

11,864,362

 

$

12,827,195

 

Interest on securities available for sale

 

768,334

 

592,369

 

1,462,409

 

1,176,644

 

Interest on federal funds sold

 

11,604

 

2,316

 

26,822

 

3,874

 

Interest on deposits with banks

 

23,489

 

3,507

 

40,160

 

7,788

 

Total interest income

 

6,726,111

 

6,986,862

 

13,393,753

 

14,015,501

 

 

 

 

 

 

 

 

 

 

 

INTEREST EXPENSE

 

 

 

 

 

 

 

 

 

Deposits

 

407,011

 

657,887

 

847,532

 

1,527,293

 

Federal Home Loan Bank advances

 

18,815

 

84,880

 

40,488

 

183,255

 

Federal funds purchased

 

 

 

 

110

 

Total interest expense

 

425,826

 

742,767

 

888,020

 

1,710,658

 

 

 

 

 

 

 

 

 

 

 

Net interest income

 

6,300,285

 

6,244,095

 

12,505,733

 

12,304,843

 

PROVISION FOR LOAN LOSSES

 

300,000

 

1,005,000

 

900,000

 

2,010,000

 

 

 

 

 

 

 

 

 

 

 

Net interest income after provision for loan losses

 

6,000,285

 

5,239,095

 

11,605,733

 

10,294,843

 

 

 

 

 

 

 

 

 

 

 

OTHER INCOME

 

 

 

 

 

 

 

 

 

Service charges on deposits

 

282,041

 

259,366

 

540,136

 

515,005

 

Earnings on cash surrender value of life insurance

 

86,660

 

100,699

 

214,958

 

204,685

 

Mortgage commissions

 

16,947

 

25,008

 

26,820

 

44,135

 

Other

 

294,296

 

347,121

 

569,272

 

614,970

 

Total non-interest income

 

679,944

 

732,194

 

1,351,186

 

1,378,795

 

 

 

 

 

 

 

 

 

 

 

OTHER EXPENSES

 

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

2,379,400

 

2,150,184

 

4,713,390

 

4,340,511

 

Occupancy

 

675,716

 

659,410

 

1,332,247

 

1,340,918

 

Data processing fees

 

239,891

 

236,662

 

498,526

 

473,195

 

OREO expenses

 

101,500

 

216,043

 

350,279

 

563,844

 

Regulatory assessments

 

198,000

 

258,000

 

396,000

 

516,000

 

Other

 

806,477

 

796,132

 

1,636,380

 

1,527,223

 

Total non-interest expense

 

4,400,984

 

4,316,431

 

8,926,822

 

8,761,691

 

 

 

 

 

 

 

 

 

 

 

Net income before provision for income taxes

 

2,279,245

 

1,654,858

 

4,030,097

 

2,911,947

 

 

 

 

 

 

 

 

 

 

 

PROVISION FOR INCOME TAXES

 

829,984

 

616,073

 

1,415,360

 

925,521

 

NET INCOME

 

$

1,449,261

 

$

1,038,785

 

$

2,614,737

 

$

1,986,426

 

 

 

 

 

 

 

 

 

 

 

Preferred stock dividends and accretion

 

210,411

 

210,411

 

420,822

 

420,822

 

NET INCOME AVAILABLE TO COMMON SHAREHOLDERS

 

$

1,238,850

 

$

828,374

 

$

2,193,915

 

$

1,565,604

 

 

 

 

 

 

 

 

 

 

 

NET INCOME PER COMMON SHARE

 

$

0.16

 

$

0.11

 

$

0.28

 

$

0.20

 

 

 

 

 

 

 

 

 

 

 

NET EARNINGS PER DILUTED COMMON SHARE

 

$

0.16

 

$

0.11

 

$

0.28

 

$

0.20

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4


 


Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE YEAR ENDED DECEMBER 31, 2010 AND THE SIX-MONTH PERIOD ENDED JUNE 30, 2011 (UNAUDITED)

 

 

 

YEAR ENDED DECEMBER 31, 2010 AND SIX MONTHS ENDED JUNE 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Preferred Stock

 

Paid-in

 

Retained

 

Comprehensive

 

Comprehensive

 

Shareholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Earnings

 

Income

 

Income

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances, January 1, 2010

 

7,681,877

 

$

23,933,440

 

13,500

 

$

12,847,297

 

$

1,997,747

 

$

20,230,683

 

 

 

$

1,683,084

 

$

60,692,251

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

20,250

 

$

70,109

 

 

 

 

 

 

 

 

 

 

 

 

 

$

70,109

 

Preferred stock accretion

 

 

 

 

 

 

 

$

166,648

 

 

 

$

(166,648

)

 

 

 

 

0

 

Preferred stock dividend payments

 

 

 

 

 

 

 

 

 

 

 

(675,000

)

 

 

 

 

(675,000

)

Stock based compensation

 

 

 

 

 

 

 

 

 

82,471

 

 

 

 

 

 

 

82,471

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net changes in unrealized gain on available-for-sale securities (net of income tax benefit of $17,015)

 

 

 

 

 

 

 

 

 

 

 

 

 

(24,334

)

(24,334

)

(24,334

)

Reclassification of realized gains (net of income tax benefit of $80,549)

 

 

 

 

 

 

 

 

 

 

 

 

 

(115,196

)

(115,196

)

(115,196

)

Net income

 

 

 

 

 

 

 

 

 

 

 

4,627,431

 

4,627,431

 

 

 

4,627,431

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

$

4,487,901

 

 

 

 

 

Balances, December 31, 2010

 

7,702,127

 

$

24,003,549

 

13,500

 

$

13,013,945

 

$

2,080,218

 

$

24,016,466

 

 

 

$

1,543,554

 

$

64,657,732

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

3,037

 

$

9,894

 

 

 

 

 

 

 

 

 

 

 

 

 

$

9,894

 

Restricted stock issued

 

8,630

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock accretion

 

 

 

 

 

 

 

$

83,322

 

 

 

$

(83,322

)

 

 

 

 

 

 

Preferred stock dividend payments

 

 

 

 

 

 

 

 

 

 

 

(337,500

)

 

 

 

 

(337,500

)

Stock based compensation

 

 

 

 

 

 

 

 

 

24,000

 

 

 

 

 

 

 

24,000

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net changes in unrealized gain on available-for-sale securities (net of income tax of $481,094)

 

 

 

 

 

 

 

 

 

 

 

 

 

688,030

 

688,030

 

688,030

 

Reclassification of realized gains (net of income tax benefit of $15,976)

 

 

 

 

 

 

 

 

 

 

 

 

 

(22,848

)

(22,848

)

(22,848

)

Net income

 

 

 

 

 

 

 

 

 

 

 

2,614,737

 

2,614,737

 

 

 

2,614,737

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

$

3,279,919

 

 

 

 

 

Balances, June 30, 2011

 

7,713,794

 

$

24,013,443

 

13,500

 

$

13,097,267

 

$

2,104,218

 

$

26,210,381

 

 

 

$

2,208,736

 

$

67,634,045

 

 

The accompanying notes are an integral part of these consolidated financial statements

 

5


 


Table of Contents

 

OAK VALLEY BANCORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2011 AND JUNE 30, 2010

 

 

 

SIX MONTHS ENDED JUNE 30,

 

 

 

2011

 

2010

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

2,614,737

 

$

1,986,426

 

Adjustments to reconcile net earnings to net cash from operating activities:

 

 

 

 

 

Provision for loan losses

 

900,000

 

2,010,000

 

Depreciation

 

455,581

 

474,744

 

Amortization and (accretion), net

 

2,660

 

(2,926

)

Stock based compensation

 

24,000

 

45,376

 

OREO write downs and losses on sale

 

290,609

 

390,732

 

Gain on called available for sale securities

 

(38,824

)

(126,531

)

Increase in BOLI cash surrender value

 

(214,958

)

(204,685

)

Decrease in interest payable and other liabilities

 

(583,658

)

(155,179

)

(Increase) decrease in interest receivable

 

(74,607

)

77,188

 

Decrease in other assets

 

1,981,625

 

241,631

 

Net cash from operating activities

 

5,357,165

 

4,736,776

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of available for sale securities

 

(28,235,484

)

(6,886,836

)

Proceeds from maturities, calls, and principal paydowns of securities available for sale

 

3,808,274

 

5,702,938

 

Net decrease in loans

 

13,112,608

 

12,490,979

 

Proceeds from sale of OREO

 

243,190

 

588,293

 

Net purchases of premises and equipment

 

(3,077,387

)

(699,880

)

Net cash (used in) from investing activities

 

(14,148,799

)

11,195,494

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

FHLB advanced funds

 

0

 

7,100,000

 

FHLB payments

 

(2,000,000

)

(20,800,000

)

Federal funds advances

 

0

 

480,000

 

Federal funds payments

 

0

 

(480,000

)

Preferred stock dividend payment

 

(337,500

)

(337,500

)

Net increase in demand deposits and savings accounts

 

30,991,066

 

14,121,613

 

Net decrease in time deposits

 

(11,518,271

)

(7,576,393

)

Proceeds from sale of common stock and exercise of stock options

 

9,894

 

0

 

Net cash from (used in) financing activities

 

17,145,189

 

(7,492,280

)

 

 

 

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

 

8,353,555

 

8,439,990

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, beginning of period

 

68,936,916

 

21,648,548

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, end of period

 

$

77,290,471

 

$

30,088,538

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

923,490

 

$

1,911,309

 

Income taxes

 

$

2,561,119

 

$

1,611,000

 

 

 

 

 

 

 

NON-CASH INVESTING ACTIVITIES:

 

 

 

 

 

Real estate acquired through foreclosure

 

$

0

 

$

641,400

 

Change in unrealized gain on available-for-sale securities

 

$

1,130,300

 

$

165,221

 

 

 

 

 

 

 

NON-CASH FINANCING ACTIVITIES:

 

 

 

 

 

Accretion of preferred stock

 

$

83,323

 

$

83,324

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6



Table of Contents

 

OAK VALLEY BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 — BASIS OF PRESENTATION

 

On July 3, 2008 (the “Effective Date”), a bank holding company reorganization was completed whereby Oak Valley Bancorp (the “Company”) became the parent holding company for Oak Valley Community Bank ( the “Bank”).  On the Effective Date, each outstanding share of the Bank was converted into one share of Oak Valley Bancorp and the Bank became a wholly-owned subsidiary of the holding company.

 

The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America (GAAP) and with general practices within the banking industry. In preparing financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from those estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses, the estimation of compensation expense related to stock options granted to employees and directors, and valuation allowances associated with deferred tax assets, the recognition of which are based on future taxable income.

 

The interim consolidated financial statements included in this report are unaudited but reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the interim periods presented. All such adjustments are of a normal recurring nature. The results of operations for the three and six month periods ended June 30, 2011 are not necessarily indicative of the results of a full year’s operations.  For further information, refer to the audited consolidated financial statements and footnotes included in the Company’s Form 10-K for the year ended December 31, 2010.

 

NOTE 2 — RECENT ACCOUNTING PRONOUNCEMENTS

 

FASB ASC Topic 310 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.”  In July 2010, FASB issued Accounting Standards Update 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (Topic 310).  This standard expands disclosures about credit quality of financing receivables and the allowance for loan losses. The standard will require the Company to expand disclosures about the credit quality of our loans and the related reserves against them. The extra disclosures will include disaggregated matters related to our past due loans, credit quality indicators, and modifications of loans. The Company adopted the standard beginning with our December 31, 2010 financial statements. This standard did not have an impact on the Company’s financial position or results of operations.

 

In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  The ASU clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring (“TDR”), both for purposes of recording an impairment loss and for disclosure of a TDR. In evaluating whether a restructuring constitutes a TDR, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. The amendments to ASU Topic 310, Receivables, clarify the guidance on a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. ASU No. 2011-02 is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption.

 

In May 2011, the FASB issued ASU No. 2011-04 Fair Value Measurement (Topic 820) Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The ASU improves the comparability of fair value measurements presented and disclosed in accordance with U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRSs) by changing the wording used to describe many of the requirements in U.S GAAP for measuring fair value and disclosure of information. The amendments to this ASU provide explanation on how to measure fair value but do not require any additional fair value measurements and does not establish valuation standards or affect valuation practices outside of financial reporting. The amendments clarify existing fair value measurements and disclosure requirements to include application of the highest and best use and valuation premises concepts; measuring fair value of an instrument classified in a reporting entity’s shareholders’ equity; and disclosures requirements regarding quantitative information about unobservable inputs categorized within Level 3 of the fair value hierarchy. In addition, clarification is provided for measuring the fair value of financial instruments that are managed in a portfolio and the application of premiums and discounts in a fair value measurement. For public entities, ASU 2011-04 is effective during interim and annual periods beginning after December 15, 2011. We do not expect this ASU to have a significant impact on our financial condition or result of operations.

 

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In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-05 Comprehensive Income (Topic 220) Presentation of Comprehensive Income. The ASU improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. The amendments to Topic 220, Comprehensive Income, require entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Entities are no longer permitted to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. Any adjustments for items are that reclassified from other comprehensive income to net income are to be presented on the face of the entities financial statement regardless the method of presentation for comprehensive income.  The amendments do not change items to be reported in comprehensive income or when an item of other comprehensive income must be reclassified to net income, nor do the amendments change the option to present the components of other comprehensive income either net of related tax effects or before related tax effects. ASU 2011-05 is effective for fiscal years, and interim periods beginning on or after December 15, 2011. We do not expect this ASU to have an impact on our financial condition or result of operations as it affects presentation only.

 

NOTE 3 — SECURITIES

 

The amortized cost and estimated fair values of debt securities as of June 30, 2011 are as follows:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated Fair
Market Value

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

49,284,102

 

2,307,811

 

$

 

 

$

51,591,913

 

Collateralized mortgage obligations

 

9,283,389

 

360,204

 

 

9,643,593

 

Municipalities

 

12,580,226

 

1,087,568

 

(4,073

)

13,663,721

 

SBA Pools

 

1,265,298

 

 

(4,307

)

1,260,991

 

Mutual Fund

 

2,695,005

 

15625

 

(9,193

)

2,701,437

 

 

 

$

75,108,020

 

$

3,771,208

 

$

(17,573

)

$

78,861,655

 

 

The following tables detail the gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2011.

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

Description of Securities

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

 

$

 

$

 

 

$

 

$

 

Collateralized mortgage obligations

 

 

 

 

 

 

 

Municipalities

 

435,841

 

(4,073

)

 

 

435,841

 

(4,073

)

SBA Pools

 

 

 

1,256,170

 

(4,307

)

1,256,170

 

(4,307

)

Mutual Fund

 

990,807

 

(9,193

)

 

 

990,807

 

(9,193

)

Total temporarily impaired securities

 

$

1,426,648

 

$

(13,266

)

$

1,256,170

 

$

(4,307

)

$

2,682,818

 

$

(17,573

)

 

At June 30, 2011, a total of two SBA pools make up the total amount of securities in an unrealized loss position for greater than 12 months.  Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if the impairment is temporary or other than temporary.  Management has determined that no investment security is other than temporarily impaired. The unrealized losses are due solely to interest rate changes and the Company does not intend to sell the securities and it is not likely that we will be required to sell the securities before the earlier of the forecasted recovery or the maturity of the underlying investment security.

 

The amortized cost and estimated fair value of debt securities at June 30, 2011, by contractual maturity or call date, are shown below.

 

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Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

 

 

 

Estimated

 

 

 

Amortized

 

Fair

 

 

 

Cost

 

Value

 

Available-for-sale securities:

 

 

 

 

 

Due in one year or less

 

$

10,972,008

 

$

11,064,010

 

Due after one year through five years

 

7,610,314

 

8,341,141

 

Due after five years through ten years

 

18,833,504

 

20,180,135

 

Due after ten years

 

37,692,194

 

39,276,369

 

 

 

$

75,108,020

 

$

78,861,655

 

 

The amortized cost and estimated fair values of debt securities as of December 31, 2010, are as follows:

 

 

 

Amortized Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Market
Value

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

28,678,709

 

1,566,549

 

$

(54,870

)

$

30,190,388

 

Collateralized mortgage obligations

 

7,946,854

 

189,926

 

 

8,136,780

 

Municipalities

 

9,870,381

 

931,375

 

(2,257

)

10,799,499

 

SBA Pools

 

1,517,332

 

 

(11,236

)

1,506,096

 

Mutual Fund

 

2,631,371

 

14,063

 

(10,215

)

2,635,219

 

 

 

$

50,644,647

 

$

2,701,913

 

$

(78,578

)

$

53,267,982

 

 

The following tables detail the gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2010.

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

Description of Securities

 

Fair
Value

 

Unrealized
Loss

 

Fair
Value

 

Unrealized
Loss

 

Fair
Value

 

Unrealized
Loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

3,101,384

 

$

(54,870

)

$

 

$

 

$

3,101,384

 

$

(54,870

)

Collateralized mortgage obligations

 

 

 

 

 

 

 

Municipalities

 

427,130

 

(2,257

)

 

 

427,130

 

(2,257

)

SBA Pools

 

 

 

1,499,228

 

(11,236

)

1,499,228

 

(11,236

)

Mutual Fund

 

989,786

 

(10,215

)

 

 

989,786

 

(10,215

)

Total temporarily impaired securities

 

$

4,518,300

 

$

(67,342

)

$

1,499,228

 

$

(11,236

)

$

6,017,528

 

$

(78,578

)

 

At December 31, 2010, two SBA pools make up the total amount of securities in an unrealized loss position for greater than 12 months. Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if the impairment is temporary or other than temporary. Management has determined that no investment security is other than temporarily impaired. The unrealized losses are due solely to interest rate changes and the Company does not intend to sell the securities and it is not likely that we will be required to sell the securities before the earlier of the forecasted recovery or the maturity of the underlying investment security.

 

The Company recognized a gain of $12,940 and $38,824 for the three and six month periods ended June 30, 2011, respectively, on certain available-for-sale securities that were partially called, which compares to $70,692 and $126,531 in the same periods of 2010. 

 

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There were no sales of available-for-sale securities during the first six months of 2011 and 2010.

 

Securities carried at $54,341,950 and $46,405,847 at June 30, 2011 and December 31, 2010, respectively, were pledged to secure deposits of public funds.

 

NOTE 4 — LOANS

 

The Company’s customers are primarily located in Stanislaus, San Joaquin, Tuolumne, Inyo, and Mono Counties. As of June 30, 2011, approximately 82% of the Company’s loans are commercial real estate loans which includes construction loans. Approximately 8% of the Company’s loans are for general commercial uses including professional, retail, and small business. Additionally, 7% of the Company’s loans are for residential real estate and other consumer loans. The remaining 3% are agriculture loans.

 

Loan totals were as follows:

 

 

 

June 30, 2011

 

December 31, 2010

 

Commercial real estate:

 

 

 

 

 

Commercial real estate- construction

 

$

11,343,650

 

$

13,669,527

 

Commercial real estate- mortgages

 

273,951,413

 

289,208,721

 

Land

 

17,454,598

 

18,975,637

 

Farmland

 

16,028,348

 

14,876,426

 

Commercial and industrial

 

31,752,353

 

30,755,651

 

Consumer

 

1,316,196

 

1,242,300

 

Consumer residential

 

26,629,718

 

21,843,935

 

Agriculture

 

12,044,371

 

13,621,952

 

Total loans

 

390,520,647

 

404,194,149

 

 

 

 

 

 

 

Less:

 

 

 

 

 

Deferred loan fees and costs, net

 

(736,008

)

(733,012

)

Allowance for loan losses

 

(8,591,039

)

(8,254,929

)

Net loans

 

$

381,193,600

 

$

395,206,208

 

 

Loan Origination/Risk Management.  The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

 

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

 

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.

 

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Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At June 30, 2011, approximately 38.5% of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.

 

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

 

The Company originates consumer loans utilizing a computer-based credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans follow bank policy, which include, but are not limited to, a maximum loan-to-value percentage of 80%, a maximum housing and total debt ratio of 36% and 42%, respectively and other specified credit and documentation requirements.

 

The Company maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

 

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Non-accrual loans, segregated by class of loans, were as follows:

 

 

 

June 30, 2011

 

December 31, 2010

 

Commercial real estate:

 

 

 

 

 

Commercial real estate- construction

 

$

1,460,932

 

$

3,252,081

 

Commercial real estate- mortgages

 

4,174,385

 

4,190,665

 

Land

 

3,338,116

 

3,810,473

 

Farmland

 

0

 

0

 

Commercial and industrial

 

27,223

 

221,723

 

Consumer

 

0

 

0

 

Consumer residential

 

0

 

0

 

Agriculture

 

0

 

0

 

Total non-accrual loans

 

$

9,000,656

 

$

11,474,942

 

 

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Had non-accrual loans performed in accordance with their original contract terms, the Company would have recognized additional interest income of approximately $180,000 and $366,000 in three and six month periods ended June 30, 2011, respectively, as compared to $157,000 and $355,000 in the same periods of 2010.

 

The following table analyzes past due loans including the non-accrual loans in the above table, segregated by class of loans, as of June 30, 2011:

 

 

 

30-59
Days Past
Due

 

60-89
Days Past
Due

 

Greater
Than 90
Days Past
Due

 

Total Past
Due

 

Current

 

Greater
Than 90
Days Past
Due and
Still
Accruing

 

June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

0

 

$

0

 

$

501,915

 

$

501,915

 

$

10,841,735

 

$

0

 

Commercial R.E. - mortgages

 

0

 

0

 

4,174,385

 

4,174,385

 

269,777,027

 

0

 

Land

 

0

 

0

 

2,056,232

 

2,056,232

 

15,398,366

 

0

 

Farmland

 

0

 

0

 

0

 

0

 

16,028,348

 

0

 

Commercial and industrial

 

0

 

0

 

0

 

0

 

31,752,353

 

0

 

Consumer

 

43,924

 

0

 

0

 

43,924

 

1,272,273

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

26,629,718

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

12,044,371

 

0

 

Total

 

$

43,924

 

$

0

 

$

6,732,532

 

$

6,776,456

 

$

383,744,191

 

$

0

 

 

The following table analyzes past due loans including the non-accrual loans in the above table, segregated by class of loans, as of December 31, 2010:

 

 

 

30-59
Days Past
Due

 

60-89
Days Past
Due

 

Greater
Than 90
Days Past
Due

 

Total Past
Due

 

Current

 

Greater
Than 90
Days Past
Due and
Still
Accruing

 

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

0

 

$

0

 

$

2,663,126

 

$

2,663,126

 

$

11,006,401

 

$

0

 

Commercial R.E. - mortgages

 

1,473,940

 

2,865,492

 

1,325,173

 

5,664,605

 

283,544,116

 

0

 

Land

 

0

 

0

 

3,810,473

 

3,810,473

 

15,165,164

 

0

 

Farmland

 

0

 

0

 

0

 

0

 

14,876,426

 

0

 

Commercial and industrial

 

0

 

0

 

0

 

0

 

30,755,651

 

0

 

Consumer

 

0

 

0

 

0

 

0

 

1,242,300

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

21,843,935

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

13,621,952

 

0

 

Total

 

$

1,473,940

 

$

2,865,492

 

$

7,798,772

 

$

12,138,204

 

$

392,055,945

 

$

0

 

 

Impaired Loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, 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

 

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the collateral. Interest payments on impaired loans are typically applied to principal unless collectibility of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

Impaired loans as of June 30, 2011 and December 31, 2010 are set forth in the following table. No interest income was recognized on impaired loans subsequent to their classification as impaired.

 

 

 

Unpaid
Contractual
Principal
Balance

 

Recorded
Investment
With No
Allowance

 

Recorded
Investment
With
Allowance

 

Total
Recorded
Investment

 

Related
Allowance

 

Average
Recorded
Investment

 

June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

1,538,363

 

$

959,017

 

$

501,915

 

$

1,460,932

 

$

68,910

 

$

2,159,501

 

Commercial R.E. - mortgages

 

4,469,681

 

1,308,893

 

2,865,492

 

4,174,385

 

436,692

 

4,471,175

 

Land

 

7,707,585

 

706,732

 

2,631,384

 

3,338,116

 

400,140

 

3,714,154

 

Farmland

 

0

 

0

 

0

 

0

 

0

 

0

 

Commercial and Industrial

 

29,023

 

27,223

 

0

 

27,223

 

0

 

154,890

 

Consumer

 

0

 

0

 

0

 

0

 

0

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

0

 

0

 

Agriculture

 

0

 

0

 

0

 

0

 

0

 

0

 

Total

 

$

13,744,652

 

$

3,001,865

 

$

5,998,791

 

$

9,000,656

 

$

905,742

 

$

10,499,720

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial R.E. - construction

 

$

3,405,167

 

$

1,427,776

 

$

1,824,305

 

$

3,252,081

 

$

179,725

 

$

4,430,245

 

Commercial R.E. - mortgages

 

4,469,681

 

4,190,665

 

0

 

4,190,665

 

0

 

1,900,081

 

Land

 

7,710,271

 

739,732

 

3,070,741

 

3,810,473

 

768,118

 

4,231,514

 

Farmland

 

0

 

0

 

0

 

0

 

0

 

0

 

Commercial and industrial

 

222,023

 

221,723

 

0

 

221,723

 

0

 

207,384

 

Consumer

 

0

 

0

 

0

 

0

 

0

 

0

 

Consumer residential

 

0

 

0

 

0

 

0

 

0

 

2,417

 

Agriculture

 

0

 

0

 

0

 

0

 

0

 

0

 

Total

 

$

15,807,142

 

$

6,579,896

 

$

4,895,046

 

$

11,474,942

 

$

947,843

 

$

10,771,641

 

 

Quality ratings (Risk Grades) are assigned to all commitments and stand-alone notes. Risk grades define the basic characteristics of commitments or stand-alone note in relation to their risk. All loans are graded using a system that maximizes the loan quality information contained in loan review grades, while ensuring that the system is compatible with the grades used by bank examiners.

 

We grade loans using the following letter system:

 

1 Exceptional Loan

2 Quality Loan

3A Better Than Acceptable Loan

3B Acceptable Loan

3C Marginally Acceptable Loan

4 (W) Watch Acceptable Loan

5 Other Loans Especially Mentioned

6 Substandard Loan

7 Doubtful Loan

8 Loss

 

13



Table of Contents

 

1. Exceptional Loan - Loans with A+ credits that contain very little, if any, risk. To qualify for this rating, the following characteristics must be present:

·A high level of liquidity and whose debt-servicing capacity exceeds expected obligations by a substantial margin.

·Where leverage is below average for the industry and earnings are consistent or growing without severe vulnerability to economic cycles.

·Also included in this rating (but not mandatory unless one or more of the preceding characteristics are missing) are loans that are fully secured and properly margined by our own time instruments or U.S. blue chip securities. To be properly margined cash collateral must be equal to, or greater than, 110% of the loan amount.

 

2. Quality Loan - Loans with excellent sources of repayment that conform in all respects to bank policy and regulatory requirements. These are also loans for which little repayment risk has been identified. No credit or collateral exceptions. Other factors include:

·Unquestionable debt-servicing capacity to cover all obligations in the ordinary course of business from well-defined primary and secondary sources.

·Consistent strong earnings.

·A solid equity base.

 

3A. Better than Acceptable Loan - In the interest of better delineating the loan portfolio’s true credit risk for reserve allocation, further granularity has been sought by splitting the grade 3 category into three classifications. The distinction between the three are bank-defined guidelines and represent a further refinement of the regulatory definition of a pass, or grade 3 loan. Grade 3A is the stronger third of the pass category, but is not strong enough to be a grade 2 and is characterized by:

·Strong earnings with no loss in last three years and ample cash flow to service all debt well above policy guidelines.

·Long term experienced management with depth and defined management succession.

·The loan has no exceptions to policy.

·Loan-to-value on real estate secured transactions is 10% to 20% less than policy guidelines.

·Very liquid balance sheet that may have cash available to pay off our loan completely.

·Little to no debt on balance sheet.

 

3B. Acceptable Loan - 3B loans are simply defined as all loans that are less qualified than 3A loans and are stronger than 3C loans. These loans are characterized by acceptable sources of repayment that conform to bank policy and regulatory requirements. Repayment risks are acceptable for these loans. Credit or collateral exceptions are minimal, are in the process of correction, and do not represent repayment risk. These loans:

·Are those where the borrower has average financial strengths, a history of profitable operations and experienced management.

·Are those where the borrower can be expected to handle normal credit needs in a satisfactory manner.

 

3C. Marginally Acceptable - 3C loans have similar characteristics as that of 3Bs with the following additional characteristics:

Requires collateral. A credit facility where the borrower has average financial strengths, but usually lacks reliable secondary sources of repayment other than the subject collateral.  Other common characteristics can include some or all of the following: minimal background experience of management, lacking continuity of management, a start-up operation, erratic historical profitability (acceptable reasons-well identified), lack of or marginal sponsorship of guarantor, and government guaranteed loans.

 

4W Watch Acceptable - Watch grade will be assigned to any credit that is adequately secured and performing but monitored for a number of indicators. These characteristics may include any unexpected short-term adverse financial performance from budgeted projections or prior period’s results (i.e., declining profits, sales, margins, cash flow, or increased reliance on leverage, including adverse balance sheet ratios, trade debt issues, etc.). Additionally, any managerial or personal problems of company management, decline in the entire industry or local economic conditions failure to provide financial information or other documentation as requested; issues regarding delinquency, overdrafts, or renewals; and any other issues that cause concern for the company. Loans to individuals or loans supported by guarantors with marginal net worth and/or marginal collateral. Weakness identified in a Watch credit is short-term in nature.  Loans in this category are usually accounts the Company would want to retain providing a positive turnaround can be expected within a reasonable time frame.

 

5 Other Loans Especially Mentioned (Special Mention) - A special mention extension of credit is defined as having potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date result in the deterioration of the repayment prospects for the credit or the institution’s credit position. Extensions of credit that might be detailed in this category include the following:

·The lending officer may be unable to properly supervise the credit because of an inadequate loan or credit agreement.

·Questions exist regarding the condition of and/or control over collateral.

·Economic or market conditions may unfavorably affect the obligor in the future.

·A declining trend in the obligor’s operations or an imbalanced position in the balance sheet exists, but not to the point that repayment is jeopardized.

 

6 Substandard Loan - A “substandard” extension of credit is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Extensions of credit so classified must have a well-defined weakness or weaknesses that

 

14



Table of Contents

 

jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard credits, does not have to exist in individual extensions of credit classified substandard.

 

7 Doubtful Loan - An extension of credit classified “doubtful” has all the weaknesses inherent in one classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high but because of certain important and reasonably specific pending factors that may work to the advantage of and strengthen the credit, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors may include a proposed merger or acquisition, liquidation proceedings, capital injection, perfecting liens on additional collateral or refinancing plans. The entire loan need not be classified doubtful when collection of a specific portion appears highly probable. An example of proper use of the doubtful category is the case of a company being liquidated, with the trustee-in-bankruptcy indicating a minimum disbursement of 40 percent and a maximum of 65 percent to unsecured creditors, including the Company. In this situation, estimates are based on liquidation value appraisals with actual values yet to be realized. By definition, the only portion of the credit that is doubtful is the 25 percent difference between 40 and 65 percent.

 

A proper classification of such a credit would show 40 percent substandard, 25 percent doubtful, and 35 percent loss. A credit classified as doubtful should be resolved within a ‘reasonable’ period of time. Reasonable is generally defined as the period between examinations. In other words, a credit classified doubtful at an examination should be cleared up before the next exam. However, there may be situations that warrant continuation of the doubtful classification a while longer.

 

8. Loss - Extensions of credit classified “loss” are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the credit has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off, even though partial recovery may be affected in the future. It should not be the Company’s practice to attempt long-term recoveries while the credit remains on the books. Losses should be taken in the period in which they surface as uncollectible.

 

The following table presents weighted average risk grades of our loan portfolio:

 

 

 

June 30, 2011

 

December 31, 2010

 

 

 

Weighted Average
Risk Grade

 

Weighted Average
Risk Grade

 

Commercial real estate:

 

 

 

 

 

Commercial real estate - construction

 

3.39

 

4.83

 

Commercial real estate - mortgages

 

3.29

 

3.27

 

Land

 

5.23

 

5.37

 

Farmland

 

3.26

 

3.45

 

Commercial and Industrial

 

3.10

 

3.28

 

Consumer

 

2.83

 

2.77

 

Consumer residential

 

3.04

 

3.01

 

Agriculture

 

3.18

 

3.20

 

Total gross loans

 

3.34

 

3.42

 

 

15



Table of Contents

 

The following table presents risk grade totals by class of loans as of June 30, 2011.  Risk grades 1 through 4 have been aggregated in the “Pass” line.

 

Dollars in thousands

 

Commercial
R.E.
Construction

 

Commercial
R.E.
Mortgages

 

Land

 

Farmland

 

Commercial and
Industrial

 

Consumer

 

Consumer
Residential

 

Agriculture

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

9,882,719

 

$

251,481,349

 

$

4,603,463

 

$

14,617,476

 

$

30,724,877

 

$

1,255,897

 

$

26,232,542

 

$

11,311,478

 

$

350,109,801

 

Special mention

 

 

11,747,488

 

 

 

94,218

 

 

 

 

11,841,706

 

Substandard

 

1,460,931

 

10,722,576

 

12,851,135

 

1,410,872

 

933,258

 

60,299

 

397,176

 

732,893

 

28,569,140

 

Doubtful

 

 

 

 

 

 

 

 

 

 

Total loans

 

$

11,343,650

 

$

273,951,413

 

$

17,454,598

 

$

16,028,348

 

$

31,752,353

 

$

1,316,196

 

$

26,629,718

 

$

12,044,371

 

$

390,520,647

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pass

 

$

10,417,446

 

$

265,361,186

 

$

4,076,121

 

$

12,225,807

 

$

28,295,716

 

$

1,225,072

 

$

21,723,935

 

$

12,593,405

 

$

355,918,688

 

Special mention

 

 

10,352,335

 

 

1,190,402

 

1,573,044

 

 

 

278,548

 

13,394,329

 

Substandard

 

3,252,081

 

13,495,200

 

14,899,516

 

1,460,217

 

886,891

 

17,228

 

120,000

 

749,999

 

34,881,132

 

Doubtful

 

 

 

 

 

 

 

 

 

 

Total loans

 

$

13,669,527

 

$

289,208,721

 

$

18,975,637

 

$

14,876,426

 

$

30,755,651

 

$

1,242,300

 

$

21,843,935

 

$

13,621,952

 

$

404,194,149

 

 

Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period.  In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

 

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

 

The Company’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Company.

 

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 5 or higher, a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts

 

16



Table of Contents

 

owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

 

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similarly risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

 

General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Company’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, moderate or low degree of risk. The results are then input into a “general allocation matrix” to determine an appropriate general valuation allowance.

 

Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy exceptions that exceed specified risk grades.

 

Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off automatically based on regulatory requirements.

 

17



Table of Contents

 

The following table details activity in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2011 and 2010. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

Allowance for Loan Losses

For the Three and Six Months Ended June 30, 2011 and 2010

 

 

 

Commercial

 

Commercial

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

Real Estate

 

and industrial

 

Consumer

 

Residential

 

Agriculture

 

Unallocated

 

Total

 

Three Months Ended June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

7,237,899

 

$

694,079

 

$

51,642

 

$

274,859

 

$

126,223

 

$

380,324

 

$

8,765,026

 

Charge-offs

 

(481,329

)

0

 

(991

)

0

 

0

 

0

 

(482,320

)

Recoveries

 

 

 

6,276

 

2,041

 

16

 

0

 

0

 

8,333

 

Provision

 

21,098

 

67,691

 

(9,062

)

119,048

 

32,896

 

68,329

 

300,000

 

Ending balance

 

$

6,777,668

 

$

768,046

 

$

43,630

 

$

393,923

 

$

159,119

 

$

448,653

 

$

8,591,039

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

6,577,011

 

$

686,303

 

$

61,115

 

$

375,349

 

$

152,526

 

$

402,625

 

$

8,254,929

 

Charge-offs

 

(536,368

)

(35,000

)

(2,856

)

0

 

0

 

0

 

(574,224

)

Recoveries

 

 

 

6,276

 

4,024

 

34

 

0

 

0

 

10,334

 

Provision

 

737,025

 

110,467

 

(18,653

)

18,540

 

6,593

 

46,028

 

900,000

 

Ending balance

 

$

6,777,668

 

$

768,046

 

$

43,630

 

$

393,923

 

$

159,119

 

$

448,653

 

$

8,591,039

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

5,593,806

 

$

569,320

 

$

41,283

 

$

147,146

 

$

128,277

 

$

282,423

 

$

6,762,255

 

Charge-offs

 

(124,823

)

0

 

(1,713

)

(29,001

)

0

 

0

 

(155,537

)

Recoveries

 

0

 

1,218

 

1,202

 

0

 

0

 

0

 

2,420

 

Provision

 

835,951

 

13,962

 

665

 

49,790

 

9,032

 

95,600

 

1,005,000

 

Ending balance

 

$

6,304,934

 

$

584,500

 

$

41,437

 

$

167,935

 

$

137,309

 

$

378,023

 

$

7,614,138

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

5,844,793

 

$

648,523

 

$

43,822

 

$

201,741

 

$

142,009

 

$

139,334

 

$

7,020,222

 

Charge-offs

 

(1,386,133

)

0

 

(4,265

)

(29,001

)

0

 

0

 

(1,419,399

)

Recoveries

 

0

 

1,218

 

2,097

 

0

 

0

 

0

 

3,315

 

Provision

 

1,846,274

 

(65,241

)

(217

)

(4,805

)

(4,700

)

238,689

 

2,010,000

 

Ending balance

 

$

6,304,934

 

$

584,500

 

$

41,437

 

$

167,935

 

$

137,309

 

$

378,023

 

$

7,614,138

 

 

18



Table of Contents

 

The following table details the allowance for loan losses and ending gross loan balances as of June 30, 2011 and December 31, 2010, summarized by collective and individual evaluation methods of impairment.

 

 

 

Commercial

 

Commercial

 

 

 

Consumer

 

 

 

 

 

 

 

 

 

Real Estate

 

and industrial

 

Consumer

 

Residential

 

Agriculture

 

Unallocated

 

Total

 

June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses for loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

905,742

 

$

0

 

$

0

 

$

0

 

$

0

 

$

0

 

$

905,742

 

Collectively evaluated for impairment

 

5,871,926

 

768,046

 

43,630

 

393,923

 

159,119

 

448,653

 

7,685,297

 

 

 

$

6,777,668

 

$

768,046

 

$

43,630

 

$

167,935

 

$

137,309

 

$

448,653

 

$

8,591,039

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending gross loan balances:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

8,973,433

 

$

27,223

 

$

0

 

$

0

 

$

0

 

$

0

 

$

9,000,656

 

Collectively evaluated for impairment

 

$

309,804,576

 

$

31,725,130

 

$

1,316,196

 

$

26,629,718

 

$

12,044,371

 

$

0

 

$

381,519,991

 

 

 

$

318,778,009

 

$

31,752,353

 

$

1,316,196

 

$

26,629,718

 

$

12,044,371

 

$

0

 

$

390,520,647

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses for loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

947,843

 

$

0

 

$

0

 

$

0

 

$

0

 

$

0

 

$

947,843

 

Collectively evaluated for impairment

 

$

5,629,168

 

$

686,303

 

$

61,115

 

$

375,349

 

$

152,526

 

$

402,625

 

$

7,307,086

 

 

 

$

6,577,011

 

$

686,303

 

$

61,115

 

$

375,349

 

$

152,526

 

$

402,625

 

$

8,254,929

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ending balances of loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Individually evaluated for impairment

 

$

11,253,219

 

$

221,723

 

$

0

 

$

0

 

$

0

 

0

 

$

11,474,942

 

Collectively evaluated for impairment

 

$

325,477,092

 

$

30,533,928

 

$

1,242,300

 

$

21,843,935

 

$

13,621,952

 

0

 

$

392,719,207

 

 

 

$

336,730,311

 

$

30,755,651

 

$

1,242,300

 

$

21,843,935

 

$

13,621,952

 

$

0

 

$

404,194,149

 

 

Changes in the allowance off-balance-sheet commitments were as follows:

 

 

 

THREE MONTHS ENDED JUNE 30,

 

SIX MONTHS ENDED JUNE 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Balance, beginning of year

 

$

120,770

 

$

153,870

 

$

157,001

 

$

171,900

 

Provision Charged to Operations for Off Balance Sheet

 

12,308

 

(32

)

(23,923

)

(18,062

)

Balance, end of year

 

$

133,078

 

$

153,838

 

$

133,078

 

$

153,838

 

 

The method for calculating the allowance for off-balance-sheet loan commitments is based on an allowance percentage which is less than other outstanding loan types because they are at a lower risk level.  This allowance percentage, based on many factors including historical losses and existing economic conditions, is evaluated by management periodically and is applied to the total undisbursed loan commitment balance to calculate the allowance for off-balance-sheet commitments.

 

At June 30, 2011 and December 31, 2010, loans carried at $316,963,944 and $331,288,636, respectively, were pledged as collateral on advances from the Federal Home Loan Bank.

 

NOTE 5 — OTHER REAL ESTATE OWNED

 

As of June 30, 2011, the Company owned two properties with balances of $244,375 that were classified as other real estate owned, as compared to three properties with outstanding balances of $778,174 as of December 31, 2010.  Each of these properties was acquired through loan foreclosure.

 

Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at the lower of carrying amount of the loan or fair value of the property at the date of foreclosure less selling costs.  Subsequent to foreclosure, valuations are periodically performed and any subject revisions in the estimate of fair value are reported as adjustment to the carrying value of the real estate, provided the adjusted carrying amount does not exceed the original amount at foreclosure.  Revenues and expenses from operations and changes in the valuation allowance are included in other operating expenses.

 

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NOTE 6— OTHER POST-RETIREMENT BENEFIT PLANS

 

During January 2008, the Company awarded certain officers a salary continuation plan (the “Plan”).  Under the Plan, the participants will be provided with a fixed annual retirement benefit for twenty years after retirement. The Company is also responsible for certain pre-retirement death benefits under the Plan. In connection with the implementation of the Plan, the Company purchased single premium life insurance policies on the life of each of the officers covered under the Plan. The Company is the owner and partial beneficiary of these life insurance policies. The assets of the Plan, under Internal Revenue Service regulations, are owned by the Company and are available to satisfy the Company’s general creditors.

 

During January 2008 the Company awarded two of its directors a director retirement plan (“DRP”). Under the DRP, the participants will be provided with a fixed annual retirement benefit for ten years after retirement. The Company is also responsible for certain pre-retirement death benefits under the DRP. In connection with the implementation of the DRP, the Company purchased single premium life insurance policies on the life of each director covered under the DRP. The Company is the owner and partial beneficiary of these life insurance policies. The assets of the DRP, under Internal Revenue Service regulations, are the property of the Company and are available to satisfy the Company’s general creditors.

 

Future compensation under both plans is earned for services rendered through retirement. The Company accrues for the salary continuation liability based on anticipated years of service and vesting schedules provided under the plans. The Company’s current benefit liability is determined based on vesting and the present value of the benefits at a corresponding discount rate. The discount rate used is an equivalent rate for investment-grade bonds with lives matching those of the service periods remaining for the salary continuation contracts, which average approximately 20 years.  The salary continuation liability as of June 30, 2011 and December 31, 2010 was $1,428,394 and $1,300,062, respectively, and is reported in interest payable and other liabilities on the condensed consolidated balance sheet.

 

During January 2008, the Company purchased $4.7 million in bank owned life insurance policies and entered into split-dollar life insurance agreements with certain officers and directors.  In connection with the implementation of the split-dollar agreements, the Company purchased single premium life insurance policies on the life of each of the officers and directors covered by the split-dollar life insurance agreements. The Company is the owner of the policies and the partial beneficiary in an amount equal to the cash surrender value of the policies.

 

The combined cash surrender value of all Bank-owned life insurance policies recorded in other assets on the condensed consolidated balance sheet was $11,313,594 and $11,098,636 at June 30, 2011 and December 31, 2010, respectively.

 

NOTE 7 — FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS

 

Fair values of financial instruments — The financial statements include various estimated fair value information as of June 30, 2011 and December 31, 2010. Such information, which pertains to the Company’s financial instruments, does not purport to represent the aggregate net fair value of the Company. Further, the fair value estimates are based on various assumptions, methodologies, and subjective considerations, which vary widely among different financial institutions and which are subject to change. The following methods and assumptions are used by the Company.

 

Cash and cash equivalents — The carrying amounts of cash and cash equivalents approximate their fair value.

 

Securities (including mortgage-backed securities) — Fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

 

Loans receivable — The fair values for variable rate loans and all other loans (e.g., real estate construction and mortgage, commercial, and installment loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  The allowance for loan losses is considered to be a reasonable estimate of loan discount for credit quality concerns.

 

Deposit liabilities — The fair values estimated for demand deposits (interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e. their carrying amounts). The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of the aggregate expected monthly maturities on time deposits.

 

Federal Home Loan Bank (FHLB) advances — Rates currently available to the Company for borrowings with similar terms and remaining maturities are used to estimate the fair value of the existing debt.

 

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Interest payable and receivable — The carrying amounts of interest payable and receivable approximate their fair value.

 

Off-balance-sheet instruments — Fair values for the Company’s off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the credit standing of the counterparties.

 

The estimated fair values of the Company’s financial instruments at June 30, 2011 are as follows:

 

 

 

 

 

Estimated

 

 

 

Carrying

 

Fair

 

 

 

Amount

 

Value

 

Financial assets:

 

 

 

 

 

Cash and cash equivalents

 

$

77,290,471

 

$

77,290,471

 

Securities available for sale

 

78,861,655

 

78,861,655

 

Loans, net

 

381,193,600

 

392,050,741

 

Interest receivable

 

1,716,469

 

1,716,469

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

Deposits

 

(496,211,645

)

(496,809,352

)

FHLB advance

 

(6,000,000

)

(6,022,265

)

Interest payable

 

(131,807

)

(131,807

)

 

 

 

 

 

 

Off-balance-sheet assets (liabilities):

 

 

 

 

 

Commitments and standby letters of credit

 

 

 

(518,952

)

 

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The estimated fair values of the Company’s financial instruments at December 31, 2010 are as follows:

 

 

 

Carrying

 

Fair

 

 

 

Amount

 

Value

 

Financial assets:

 

 

 

 

 

Cash and cash equivalents

 

$

 68,936,916

 

$

 68,936,916

 

Securities available for sale

 

53,267,982

 

53,267,982

 

Loans, net

 

395,206,208

 

400,399,726

 

Interest receivable

 

1,641,862

 

1,641,862

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

Deposits

 

(476,738,850

)

(477,261,566

)

FHLB advance

 

(8,000,000

)

(8,028,835

)

Interest payable

 

(167,277

)

(167,277

)

 

 

 

 

 

 

Off-balance-sheet assets (liabilities):

 

 

 

 

 

Commitments and standby letters of credit

 

 

 

(599,443

)

 

Fair value measurements defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follow:

 

Level 1:  Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2:  Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3:  Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

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.  Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstance that caused the transfer, which generally corresponds with the Company’s quarterly valuation process.

 

Assets and liabilities measured at fair value on a recurring and non-recurring basis are summarized below:

 

 

 

Fair Value Measurements at June 30, 2011

 

 

 

June 30, 2011

 

Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Assets and liabilities measured on a recurring basis:

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

51,591,913

 

$

 

$

51,591,913

 

$

 

Collateralized mortgage obligations

 

9,643,593

 

 

9,643,593

 

 

Municipalities

 

13,663,721

 

 

13,663,721

 

 

SBA Pools

 

1,260,991

 

 

1,260,991

 

 

Mutual Fund

 

2,701,437

 

2,701,437

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets and liabilities measured on a non-recurring basis:

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

6,401,942

 

$

 

$

 

$

6,401,942

 

Other real estate owned

 

$

244,375

 

$

 

$

 

$

244,375

 

 

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Fair Value Measurements at December 31, 2010

 

 

 

December 31,
2010

 

Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Assets and liabilities measured on a recurring basis:

 

 

 

 

 

 

 

 

 

Available-for-sale securities

 

 

 

 

 

 

 

 

 

U.S. agencies

 

$

30,190,388

 

$

 

$

30,190,388

 

$

 

Collateralized mortgage obligations

 

8,136,780

 

 

8,136,780

 

 

Municipalities

 

10,799,499

 

 

10,799,499

 

 

SBA Pools

 

1,506,096

 

 

1,506,096

 

 

Mutual Fund

 

2,635,219

 

2,635,219

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets and liabilities measured on a non-recurring basis:

 

 

 

 

 

 

 

 

 

Impaired Loans

 

$

3,947,203

 

$

 

$

 

$

3,947,203

 

Other real estate owned

 

$

778,174

 

$

 

$

 

$

778,174

 

 

Losses recognized from non-recurring fair value adjustments for the three and six month periods ended June 30, 2011 and 2010 are presented on the following table:

 

 

 

THREE MONTHS ENDED JUNE 30,

 

SIX MONTHS ENDED JUNE 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

 

$

481,329

 

$

35,632

 

$

428,800

 

$

1,081,758

 

Other real estate owned

 

72,339

 

253,621

 

72,339

 

469,713

 

Total loss from non-recurring fair value adjustments

 

$

553,668

 

$

289,253

 

$

501,139

 

$

1,551,471

 

 

The fair value of securities available for sale equals quoted market price, if available.  If quoted market prices are not available, fair value is determined using quoted market prices for similar securities.  Changes in fair market value are recorded in other comprehensive income net of tax.

 

The fair value measurement applies to impaired loans, which includes impaired loans measured at an observable market price (if available), or at the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the collateral.  At June 30, 2011, impaired loans that were charged down to the fair value of the collateral or that had a specific loan loss reserve had a principal balance of $7,307,684 with a valuation allowance of $905,742.  Upon being classified as impaired, either a charge off or a specific reserve or both may be taken to reduce the balance of each loan to an estimate of the collateral fair market value less cost to dispose. This estimate was a level 3 valuation.

 

Fair value of other real estate owned is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the property.  Total fair market value at June 30, 2011 was $244,375 which was a level 3 valuation.  Any market value write downs are charged directly to operating expenses.  The Company is required by internal bank policies to order real estate appraisals on OREO properties every six months.  In addition, management evaluates the book values on a quarterly basis for reasonableness and makes fair value adjustments as necessary.

 

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Table of Contents

 

NOTE 8 — EARNINGS (LOSS) PER SHARE

 

Earnings per share (EPS) is calculated based on the weighted average common shares outstanding during the period.  Basic EPS excludes dilution and is calculated by dividing net income available to common shareholders by the weighted average common shares outstanding.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.

 

 

 

THREE MONTHS ENDED

 

 

 

JUNE 30,

 

In thousands (except share and per share amounts)

 

2011

 

2010

 

BASIC EARNINGS PER SHARE

 

 

 

 

 

 

 

 

 

 

 

Net income available to common shareholders

 

$

1,238,850

 

$

828,374

 

Weighted average shares outstanding

 

7,713,794

 

7,681,877

 

Net income per common share

 

$

0.16

 

$

0.11

 

 

 

 

 

 

 

DILUTED EARNINGS PER SHARE

 

 

 

 

 

 

 

 

 

 

 

Net income available to common shareholders

 

$

1,238,850

 

$

828,374

 

Weighted average shares outstanding

 

7,713,794

 

7,681,877

 

Effect of dilutive stock options

 

18,609

 

38,563

 

Effect of dilutive warrants

 

12,790

 

 

Weighted average shares of common stock and common stock equivalents

 

7,745,193

 

7,720,440

 

Net income per diluted common share

 

$

0.16

 

$

0.11

 

 

 

 

SIX MONTHS ENDED

 

 

 

JUNE 30,

 

In thousands (except share and per share amounts)

 

2011

 

2010

 

BASIC EARNINGS PER SHARE

 

 

 

 

 

 

 

 

 

 

 

Net income available to common shareholders

 

$

2,193,915

 

$

1,565,604

 

Weighted average shares outstanding

 

7,712,604

 

7,681,877

 

Net income per common share

 

$

0.28

 

$

0.20

 

 

 

 

 

 

 

DILUTED EARNINGS PER SHARE

 

 

 

 

 

 

 

 

 

 

 

Net income available to common shareholders

 

$

2,193,915

 

$

1,565,604

 

Weighted average shares outstanding

 

7,712,604

 

7,681,877

 

Effect of dilutive stock options

 

19,148

 

31,435

 

Effect of dilutive warrants

 

11,955

 

 

Weighted average shares of common stock and common stock equivalents

 

7,743,707

 

7,713,312

 

Net income per diluted common share

 

$

0.28

 

$

0.20

 

 

During the three and six month periods ended June 30, 2011, anti-dilutive weighted average options to purchase 219,625 shares of common stock, were outstanding for both periods with prices ranging from $7.05 to $15.67.  Anti-dilutive weighted average stock options of 231,187 were outstanding during the same three and six month periods of 2010, with prices ranging from $4.58 to $15.67.  These options were not included in the computation of diluted EPS because the options’ exercise price was greater than the average market price of the common shares.  These options begin to expire in 2013.  Weighted average warrants of 350,346 issued to the U.S. Treasury Capital Purchase Program were dilutive for the three and six month periods of 2011, as the exercise price of $5.78 was less than the average market price of common shares.  These warrants were anti-dilutive for the three and six month periods of 2010, as the exercise price was more than the average market price of common shares.

 

NOTE 9 — SUBSEQUENT EVENTS

 

On August 11, 2011, we entered into a Securities Purchase Agreement with the Secretary of the Treasury (the “Treasury”), pursuant to which the Company issued and sold to the Treasury 13,500 shares of its Non-Cumulative Perpetual Preferred Stock, Series B (“Series B Preferred Stock”), having a liquidation preference of $1,000 per share for aggregate proceeds of $13,500,000.   The Securities Purchase Agreement was entered into, and the Series B Preferred Stock was issued, pursuant to the Treasury’s Small Business Lending Fund program (“SBLF”), a $30 billion fund established under the Small Business Jobs Act of 2010, that encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion.

 

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Table of Contents

 

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion explains the significant factors affecting our operations and financial position for the periods presented. The discussion should be read in conjunction with our financial statements and the notes related thereto which appear or that are referenced to elsewhere in this report, and with the audited consolidated financial statements and accompanying notes included in our 2010 Annual Report on Form 10-K, as amended.  Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.

 

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

 

Forward-Looking Statements

 

Some matters discussed in this Form 10-Q may be “forward-looking statements” within the meaning of the Private Litigation Reform Act of 1995 and therefore may involve risks, uncertainties and other factors which may cause our actual results to be materially different from the results expressed or implied by our forward-looking statements.  These statements generally appear with words such as “anticipate,” “believe,” “estimate,” “may,” “intend,” and “expect.”  Although management believes that the assumptions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to be correct.  Factors that could cause actual results to differ from results discussed in forward-looking statements include, but are not limited to: economic conditions (both generally and in the markets where the Company operates); competition from other providers of financial services offered by the Company; changes in government regulation and legislation; changes in interest rates; material unforeseen changes in the financial stability and liquidity of the Company’s credit customers; risks associated with concentrations in real estate related loans; changes in accounting standards and interpretations; and other risks as may be detailed from time to time in the Company’s filings with the Securities and Exchange Commission, all of which are difficult to predict and which may be beyond the control of the Company or the Company.  The Company undertakes no obligation to revise forward-looking statements to reflect events or changes after the date of this discussion or to reflect the occurrence of unanticipated events.

 

Forward-looking statements speak only as of the date they are made, and the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made, whether as a result of new information, future developments or otherwise, except as may be required by law.

 

Critical Accounting Estimates

 

Management has determined the following five accounting policies to be critical:

 

Asset Impairment Judgments

 

Certain of our assets are carried in our statements of financial condition at fair value or at the lower of cost or fair value. Valuation allowances are established when necessary to recognize impairment of such assets. We periodically perform analyses to test for impairment of various assets. In addition to our impairment analyses related to loans, another significant impairment analysis relates to other than temporary declines in the value of our securities.

 

Our available for sale portfolio is carried at estimated fair value, with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income in shareholders’ equity. We conduct a periodic review and evaluation of the securities portfolio to determine if the value of any security has declined below its carrying value and whether such decline is other than temporary. If such decline is deemed other than temporary, we would adjust the carrying amount of the security by writing down the security to fair market value through a charge to current period income. The market values of our securities are significantly affected by changes in interest rates.

 

In general, as interest rates rise, the market value of fixed-rate securities will decrease; as interest rates fall, the market value of fixed-rate securities will increase. With significant changes in interest rates, we evaluate our intent and ability to hold the security for a sufficient time to recover the recorded principal balance. Estimated fair values for securities are based on published or securities dealers’ market values. Market volatility is unpredictable and may impact such values.

 

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Table of Contents

 

Allowance for Loan Losses

 

Accounting for allowance for loan losses involves significant judgment and assumptions by management and is based on historical data and management’s view of the current economic environment. At least on a quarterly basis, our management reviews the methodology and adequacy of allowance for loan losses and reports its assessment to the Board of Directors for its review and approval.

 

We base our allowance for loan losses on an estimation of probable losses inherent in our loan portfolio. Our methodology for assessing loan loss allowances are intended to reduce the differences between estimated and actual losses and involves a detailed analysis of our loan portfolio in three phases:

 

· the specific review of individual loans,

 

· the segmenting and review of loan pools with similar characteristics and,

 

· our judgmental estimate based on various subjective factors.

 

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

 

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

 

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

 

· concentration of credits,

 

· nature and volume of the loan portfolio,

 

· delinquency trends,

 

· non-accrual loan trend,

 

· problem loan trend,

 

· loss and recovery trend,

 

· quality of loan review,

 

· lending and management staff,

 

· lending policies and procedures,

 

· economic and business conditions, and

 

· other external factors including regulatory review.

 

Our management estimates the probable effect of such conditions based on our judgment, experience and known or anticipated trends. Such estimation may be reflected as an additional allowance to each group of loans, if necessary. Management reviews these conditions with our senior credit officers. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment. Where any of these conditions is not evidenced by a specific, identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the inherent loss related to such condition is reflected in the unallocated allowance.

 

Central to our credit risk management and our assessment of appropriate loss allowance is our loan risk rating system. Under

 

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Table of Contents

 

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

 

Non-Accrual Loan Policy

 

Interest on loans is credited to income as earned and is accrued only if deemed collectible. Accrual of interest is discontinued when a loan is over 90 days delinquent or if management believes that collection is highly uncertain. Generally, payments received on nonaccrual loans are recorded as principal reductions. Interest income is recognized after all principal has been repaid or an improvement in the condition of the loan has occurred that would warrant resumption of interest accruals.  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due.

 

Stock-Based Compensation

 

The Company recognizes in the statement of income the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees’ requisite service period (generally the vesting period).  The Company uses the straight-line recognition of expenses for awards with graded vesting.  The Company utilizes a binomial pricing model for all grants.  Expected volatility is based on the historical volatility of the price of the Company’s stock for the period equal to the contractual stock option term. The Company uses historical data to estimate option exercise and stock option forfeiture rates within the valuation model. The expected term of options granted for the binomial model is derived from applying a historical suboptimal exercise factor to the contractual term of the grant. For binomial pricing, the risk-free rate for periods is equal to the U.S. Treasury yield at the time of grant and commensurate with the contractual term of the grant.

 

Other Real Estate Owned

 

Other real estate owned, which represents real estate acquired through foreclosure, or deed in lieu of foreclosure in satisfaction of commercial and real estate loans, is carried at the lower of cost or estimated fair value less the estimated selling costs of the real estate. The fair value of the property is based upon a current appraisal. The difference between the fair value of the real estate collateral and the loan balance at the time of transfer is recorded as a loan charge off if fair value is lower. Subsequent to foreclosure, management periodically performs valuations and the OREO property is carried at the lower of carrying value or fair value, less costs to sell. The determination of a property’s estimated fair value incorporates (1) revenues projected to be realized from disposal of the property, (2) construction and renovation costs, (3) marketing and transaction costs, and (4) holding costs (e.g., property taxes, insurance and homeowners’ association dues). Any subsequent declines in the fair value of the OREO property after the date of transfer are recorded through a write-down of the asset. Any subsequent operating expenses or income, reduction in estimated fair values, and gains or losses on disposition of such properties are charged or credited to current operations.

 

Introduction

 

Oak Valley Community Bank commenced operations in May 1991.  We are an insured bank under the Federal Deposit Insurance Act and are a member of the Federal Reserve.  Since its formation, the Company has provided basic banking services to individuals and business enterprises in Oakdale, California and the surrounding areas. The focus of the Company is to offer a range of commercial banking services designed for both individuals and small to medium-sized businesses in the two main areas of service of the Company: the Central Valley and the Eastern Sierras.

 

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

 

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

 

Effective July 3, 2008, Oak Valley Community Bank became a subsidiary of Oak Valley Bancorp, a newly established bank holding company. Oak Valley Bancorp operates Oak Valley Community Bank as a community bank in the general commercial banking

 

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business, with our primary market encompassing the California Central Valley around Oakdale and Modesto, and the Eastern Sierras. As such, unless otherwise noted, all references are about Oak Valley Bancorp (the “Company”).

 

Overview of Results of Operations and Financial Condition

 

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

 

Management believes the following were important factors in the Company’s performance during the three and six month periods ended June 30, 2011:

 

·                  Thanks to our deep roots in the communities that we serve, our focus on customer care and our selectivity in lending, during the first six months of 2011, our performance has been better than most institutions of our size that compete in our market.  Despite the severity of the recession affecting our primary market areas, we have been able to increase our core deposits to $459.4 million and have posted net income available to common shareholders of $0.16 and $0.28 per diluted share for the three and six month periods of 2011, respectively.  While recently published economic data indicate that the current downturn may be easing, it is not clear when or at what speed the recession will end. To the extent that the recession continues, it will affect the market areas that we serve and our results accordingly.

 

·                      The Company recognized net income available to common shareholders of $1,239,000 and $2,194,000 for the three and six month periods ended June 30, 2011, respectively, as compared to $828,000 and $1,566,000 for the same periods in 2010.  The Company recognized net income before preferred stock dividends and accretion of $1,449,000 and $2,615,000 for the second quarter and six month period of 2011, respectively.  The factors contributing to these results will be discussed below.

 

·                  The Company recognized $210,000 and $421,000, respectively, in the second quarter and six month period of 2011 and 2010 associated with the accrual for preferred stock dividends and accretion of the preferred stock discount in connection with the 13,500 shares of Series A Preferred Stock that the U.S. Treasury purchased from the Company in December 2008 under the TARP Program. So long as such preferred stock remains outstanding, it will pay quarterly cumulative dividends at a rate of 5% per year for the first five years and thereafter at a rate of 9% per year.

 

·                      The Company has taken significant steps to reduce the risk of loan losses.  In the three and six month periods ended June 30, 2011, the provision for loan loss was $300,000 and $900,000, respectively, which was a decrease of $705,000 and $1,110,000 compared to the same periods in 2010.  The decrease was mainly due to management’s assessment of the appropriate level for the allowance for loan losses and a decrease in the level of non-accrual loans. The Company continues to monitor its loan portfolio with the objective of avoiding defaults or write-downs.  Despite these actions, the possibility of additional losses cannot be eliminated, but the Board of Directors and all employees continue to work hard to make the best of these continuing challenging conditions.

 

·                      Net interest income increased $56,000 or 0.9% and $201,000 or 1.6% for the three and six month periods ended June 30, 2011, respectively, compared to the same periods in 2010.  This increase was primarily due to the increase in average earning assets of $52.7 million and $46.1 million for the three and six month periods ended June 30, 2011, respectively, as compared to the same periods of 2010.

 

·                      Non-interest income decreased by $52,000 or 7.1% and $28,000 or 2.0% for the second quarter and six month period of 2011, respectively, as compared to the same periods in 2010.  The decrease was primarily due to a decrease in gains on called securities and mortgage commissions, which was partially offset by an increase in service charges on deposits as described below.

 

·                      Non-interest expense increased by $85,000 or 2.0% and $165,000 or 1.9% for the three and six month periods ended June 30, 2011, respectively, as compared to the same periods in 2010.  The primary reason for the increase was an increase in salaries and benefits and occupancy associated with new branch openings, which was offset in part by the reduction in the write downs of OREO property values as described below.

 

·                      Total assets increased $19.9 million or 3.6% from December 31, 2010.  Total net loans decreased by $14.0 million or 3.5% and investment securities increased by $25.6 million or 48.0% from December 31, 2010 to June 30, 2011, while deposits increased by $19.5 million or 4.1% for the same period.

 

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Income Summary

 

For the three and six month periods ended June 30, 2011, the Company recorded net income available to common shareholders of $1,239,000 and $2,194,000, respectively, representing increases of $411,000 and $628,000 as compared to the same periods in 2010.  Return on average assets (annualized) was 1.03% and 0.94% for the second quarter and six month period of 2011, respectively, as compared with 0.81% and 0.78% for the same periods in 2010.  Annualized return on average common equity was 9.33% and 8.42% for the second quarter and six month period of 2011, respectively, as compared to 6.84% and 6.54% for the same periods of 2010.

 

Net income before provisions for income taxes and preferred stock dividends and accretion was up $624,000 and $1,118,000 for the second quarter and six month period of 2011 from the comparable 2010 periods.  The income statement components of these variances are as follows:

 

Pre-Tax Income Variance Summary:

 

 

 

Effect on Pre-Tax 
Income
Increase (Decrease)

 

Effect on Pre-Tax 
Income
Increase (Decrease)

 

(In thousands)

 

Three Months

 

Six Months

 

Change from 2010 to 2011 in:

 

 

 

 

 

Net interest income

 

$

56

 

$

201

 

Provision for loan losses

 

705

 

1,110

 

Non-interest income

 

(52

)

(28

)

Non-interest expense

 

(85

)

(165

)

Change in income before income taxes

 

$

624

 

$

1,118

 

 

These variances will be explained in the discussion below.

 

Net Interest Income

 

Net interest income is the largest source of the Company’s operating income.  For the three and six month periods ended June 30, 2011, net interest income was $6.30 million and $12.51 million, respectively, which represented increases of $56,000 or 0.9% and $201,000 or 1.6%, from the comparable periods in 2010.

 

The net interest margin (net interest income as a percentage of average interest earning assets) was 4.86% and 4.89% for the three and six month periods ended June 30, 2011, respectively, a decrease of 50 and 40 basis points, as compared to the same periods in 2010.  The decrease in the net interest margin in the first six months of 2011 was primarily attributable to the increased average cash and cash equivalent balances of $46.0 million which are earning 0.23% and thus driving down the overall yield on earning assets.

 

Offsetting these low yielding cash balances, is the impact that the historically low market interest rate environment had on our liability sensitive balance sheet which caused our average cost of funds to decrease faster than the average yield on interest earning assets.  The total cost of funds decreased 36 and 46 basis points in the second quarter and six month period of 2011, respectively, compared to 2010 due to a shift from high cost CDs and FHLB borrowed funds into demand deposit and money market accounts.  In addition, average non-interest-bearing demand deposit balances increased by $25.7 million for the six month period of 2011, as compared to the same period of 2010.  Compared to cost of funds, the decrease in our loan yield was not as significant at only 22 and 19 basis points for the three and six month periods of 2011, respectively, compared to the same periods of 2010.  The yield on loans has remained stable partly as a result of the significant portion of our loans that are at their contractual rate floors.

 

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The following tables shows the relative impact of changes in average balances of interest earning assets and interest bearing liabilities, and interest rates earned and paid by the Company on those assets and liabilities for the three and six month periods ended June 30, 2011 and 2010:

 

Net Interest Analysis

 

 

 

Three Months Ended June 30, 2011

 

Three Months Ended June 30, 2010

 

(Dollars in thousands)

 

Average 
Balance

 

Interest 
Income / 
Expense

 

Avg 
Rate/ 
Yield

 

Average 
Balance

 

Interest 
Income / 
Expense

 

Avg 
Rate/ 
Yield

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross loans (1) (2)

 

$

394,445

 

$

5,925

 

6.02%

 

$

411,593

 

$

6,402

 

6.24%

 

Investment securities (2)

 

72,839

 

840

 

4.63%

 

49,379

 

654

 

5.31%

 

Federal funds sold

 

19,959

 

12

 

0.24%

 

3,983

 

2

 

0.23%

 

Interest-earning deposits

 

38,533

 

23

 

0.24%

 

8,160

 

4

 

0.17%

 

Total interest-earning assets

 

525,776

 

6,800

 

5.19%

 

473,115

 

7,062

 

5.99%

 

Total noninterest earning assets

 

41,069

 

 

 

 

 

39,574

 

 

 

 

 

Total Assets

 

566,845

 

 

 

 

 

512,689

 

 

 

 

 

Liabilities and Shareholders’ Equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market deposits

 

243,915

 

202

 

0.33%

 

209,087

 

371

 

0.71%

 

NOW deposits

 

66,880

 

33

 

0.20%

 

59,474

 

49

 

0.33%

 

Savings deposits

 

19,349

 

19

 

0.39%

 

14,573

 

15

 

0.42%

 

Time certificates of deposit $100,000 or more

 

37,376

 

93

 

1.00%

 

46,203

 

130

 

1.13%

 

Other time deposits

 

25,913

 

60

 

0.93%

 

27,776

 

93

 

1.34%

 

Other borrowings

 

7,077

 

19

 

1.08%

 

19,126

 

85

 

1.78%

 

Total interest-bearing liabilities

 

400,510

 

426

 

0.43%

 

376,239

 

743

 

0.79%

 

Noninterest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

96,866

 

 

 

 

 

71,790

 

 

 

 

 

Other liabilities

 

2,716

 

 

 

 

 

2,613

 

 

 

 

 

Total noninterest-bearing liabilities

 

99,582

 

 

 

 

 

74,403

 

 

 

 

 

Shareholders’ equity

 

66,753

 

 

 

 

 

62,047

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

566,845

 

 

 

 

 

$

512,689

 

 

 

 

 

Net interest income

 

 

 

$

6,374

 

 

 

 

 

$

6,319

 

 

 

Net interest spread (3)

 

 

 

 

 

4.76%

 

 

 

 

 

5.20%

 

Net interest margin (4)

 

 

 

 

 

4.86%

 

 

 

 

 

5.36%

 

 


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

 

(2) Yields on municipal securities and loans have been adjusted to their fully-taxable equivalents, based on a federal marginal tax rate of 34.0%.

 

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

 

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

 

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Table of Contents

 

 

 

Six months ended

 

Six months ended

 

 

 

June 30, 2011

 

June 30, 2010

 

(Dollars in thousands)

 

Average 
Balance

 

Interest 
Income / 
Expense

 

Avg 
Rate/ 
Yield

 

Average 
Balance

 

Interest 
Income / 
Expense

 

Avg 
Rate/ 
Yield

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross loans (1) (2)

 

$

395,883

 

$

11,870

 

6.05%

 

$

415,290

 

$

12,855

 

6.24%

 

Investment securities (2)

 

67,550

 

1,600

 

4.78%

 

48,223

 

1,305

 

5.46%

 

Federal funds sold

 

23,195

 

27

 

0.23%

 

3,463

 

4

 

0.23%

 

Interest-earning deposits

 

34,593

 

40

 

0.23%

 

8,113

 

8

 

0.19%

 

Total interest-earning assets

 

521,221

 

13,537

 

5.24%

 

475,089

 

14,172

 

6.02%

 

Total noninterest earning assets

 

39,304

 

 

 

 

 

38,910

 

 

 

 

 

Total Assets

 

560,525

 

 

 

 

 

513,999

 

 

 

 

 

Liabilities and Shareholders’ Equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market deposits

 

238,383

 

414

 

0.35%

 

208,909

 

821

 

0.79%

 

NOW deposits

 

65,125

 

68

 

0.21%

 

58,650

 

98

 

0.34%

 

Savings deposits

 

18,867

 

38

 

0.41%

 

14,501

 

32

 

0.44%

 

Time certificates of deposit $100,000 or more

 

39,532

 

197

 

1.00%

 

44,302

 

320

 

1.55%

 

Other time deposits

 

27,102

 

131

 

0.97%

 

32,062

 

257

 

1.49%

 

Other borrowings

 

7,536

 

40

 

1.07%

 

21,847

 

183

 

1.69%

 

Total interest-bearing liabilities

 

396,545

 

888

 

0.45%

 

380,271

 

1,711

 

0.91%

 

Noninterest-bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

94,994

 

 

 

 

 

69,262

 

 

 

 

 

Other liabilities

 

2,972

 

 

 

 

 

2,664

 

 

 

 

 

Total noninterest-bearing liabilities

 

97,966

 

 

 

 

 

71,926

 

 

 

 

 

Shareholders’ equity

 

66,014

 

 

 

 

 

61,802

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

560,525

 

 

 

 

 

$

513,999

 

 

 

 

 

Net interest income

 

 

 

$

12,649

 

 

 

 

 

$

12,461

 

 

 

Net interest spread (3)

 

 

 

 

 

4.79%

 

 

 

 

 

5.11%

 

Net interest margin (4)

 

 

 

 

 

4.89%

 

 

 

 

 

5.29%

 

 


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

 

(2) Yields on municipal securities and loans have been adjusted to their fully-taxable equivalents, based on a federal marginal tax rate of 34.0%.

 

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

 

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

 

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Shown in the following tables are the relative impacts on net interest income of changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by the Company on those assets and liabilities for the three and six month periods ended June 30, 2011 and 2010.  Changes in interest income and expense that are not attributable specifically to either rate or volume are allocated to the rate column below.

 

Rate / Volume Variance Analysis

(In thousands)

 

 

 

For the Three Months Ended June 30, 2011

 

 

 

2011 vs 2010

 

 

 

Increase (Decrease)

 

 

 

in interest income and expense

 

 

 

due to changes in:

 

 

 

Volume

 

Rate

 

Total

 

Interest income:

 

 

 

 

 

 

 

Gross loans (1)

 

$

(267

)

$

(210

)

$

(477

)

Investment securities

 

311

 

(125

)

186

 

Federal funds sold

 

9

 

1

 

10

 

Interest-earning deposits

 

13

 

6

 

19

 

Total interest income

 

$

66

 

$

(328

)

$

(262

)

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

Money market deposits

 

62

 

(231

)

(169

)

NOW deposits

 

6

 

(22

)

(16

)

Savings deposits

 

5

 

(1

)

4

 

Time CD $100K or more

 

(25

)

(12

)

(37

)

Other time deposits

 

(6

)

(27

)

(33

)

Other borrowings

 

(53

)

(13

)

(66

)

Total interest expense

 

$

(11

)

$

(306

)

$

(317

)

 

 

 

 

 

 

 

 

Change in net interest income

 

$

77

 

$

(22

)

$

55

 

 


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

 

The table above reflects the current low interest rate environment has impacted assets slightly more than liabilities as indicated by the decrease of $22,000 in net interest income due to the rate change for the second quarter of 2011.  This is not typical for the Company, as we have historically been liability sensitive in recent years.  However, purchases of investment securities in the past 12 months at market interest rates lower than our overall portfolio reflects a decrease of $125,000 due to the lower yield of the new securities. The decreased loan volume was offset by the increase in investment securities and combined with the overall change in mix of balances resulted in an increase of $78,000 to net interest income over the same period.

 

 

 

For the Six Months Ended June 30

 

 

 

2011 vs 2010

 

 

 

Increase (Decrease)

 

 

 

in interest income and expense

 

 

 

due to changes in:

 

 

 

Volume

 

Rate

 

Total

 

Interest income:

 

 

 

 

 

 

 

Gross loans (1)

 

$

(601

)

$

(384

)

$

(985

)

Investment securities

 

523

 

(228

)

295

 

Federal funds sold

 

22

 

1

 

23

 

Interest-earning deposits

 

25

 

7

 

32

 

Total interest income

 

$

(31

)

$

(604

)

$

(635

)

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

Money market deposits

 

116

 

(523

)

(407

)

NOW deposits

 

11

 

(41

)

(30

)

Savings deposits

 

9

 

(3

)

6

 

Time CD $100K or more

 

(34

)

(89

)

(123

)

Other time deposits

 

(41

)

(85

)

(126

)

Other borrowings

 

(120

)

(23

)

(143

)

Total interest expense

 

$

(59

)

$

(764

)

$

(823

)

 

 

 

 

 

 

 

 

Change in net interest income

 

$

28

 

$

160

 

$

188

 

 

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

 

The table above reflects the current low interest rate environment has impacted liabilities more than assets as indicated by the increase of $160,000 in net interest income due to the rate change for the three month period of 2011.  The decreased loan volume was offset by the increase in investment securities and combined with the overall change in mix of balances resulted in an increase of $28,000 to net interest income over the same period.

 

Non-Interest Income

 

Non-interest income represents service charges on deposit accounts and other non-interest related charges and fees, including fees from mortgage commissions and investment service fee income.  For the three and six month periods ended June 30, 2011, non-interest income was $680,000 and $1,351,000, respectively, a decrease of $52,000 or 7.1% and $28,000 or 2.0%, compared to the same periods in 2010.

 

The following tables show the major components of non-interest income:

 

 

 

For the Three Months Ended June 30,

 

 

 

2011

 

2010

 

$ change

 

% change

 

Service charges on deposits

 

$

282,041

 

$

259,366

 

$

22,675

 

8.7%

 

Earnings on cash surrender value of life insurance

 

86,660

 

100,699

 

(14,039

)

(13.9)%

 

Mortgage commissions

 

16,947

 

25,008

 

(8,061

)

(32.2)%

 

Other income

 

294,296

 

347,121

 

(52,825

)

(15.2)%

 

Total non-interest income

 

$

679,944

 

$

732,194

 

$

(52,250

)

(7.1)%

 

 

 

 

For the Six Months Ended June 30,

 

 

 

2011

 

2010

 

$ change

 

% change

 

Service charges on deposits

 

$

540,136

 

$

515,005

 

$

25,131

 

4.9%

 

Earnings on cash surrender value of life insurance

 

214,958

 

204,685

 

10,273

 

5.0%

 

Mortgage commissions

 

26,820

 

44,135

 

(17,315

)

(39.2)%

 

Other income

 

569,272

 

614,970

 

(45,698

)

(7.4)%

 

Total non-interest income

 

$

1,351,186

 

$

1,378,795

 

$

(27,609

)

(2.0)%

 

 

The decrease to total non-interest income for the second quarter and six month period ending June 30, 2011 is due primarily to a decrease in gains on called securities of $58,000 and $88,000, respectively, as compared to the same periods of 2010.  Gains on called securities are included in the “other income” line item in the above table.  In addition, mortgage commissions decreased by $8,000 and $17,000 for the three and six months periods of 2011, respectively, as compared to the same periods of 2010. Offsetting these decreases was an increase in service charges on deposits of $23,000 and $25,000 for the three and six month periods of 2011, respectively, as compared to

 

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the same periods of 2010.

 

Non-Interest Expense

 

Non-interest expense represents salaries and benefits, occupancy expenses, professional expenses, outside services, and other miscellaneous expenses necessary to conduct business.

 

The following tables show the major components of non-interest expenses:

 

 

 

For the Three Months Ended June 30,

 

 

 

2011

 

2010

 

$ change

 

% change

 

Salaries and employee benefits

 

$

2,379,400

 

$

2,150,184

 

$

229,216

 

10.7%

 

Occupancy

 

675,716

 

659,410

 

16,306

 

2.5%

 

Data processing fees

 

239,891

 

236,662

 

3,229

 

1.4%

 

OREO expenses

 

101,500

 

216,043

 

(114,543

)

(53.0)%

 

Regulatory assessments (FDIC & DFI)

 

198,000

 

258,000

 

(60,000

)

(23.3)%

 

Other

 

806,477

 

796,132

 

10,345

 

1.3%

 

Total non-interest income

 

$

4,400,984

 

$

4,316,431

 

$

84,553

 

2.0%

 

 

 

 

For the Six Months Ended June 30,

 

 

 

2011

 

2010

 

$ change

 

% change

 

Salaries and employee benefits

 

$

4,713,390

 

$

4,340,511

 

$

372,879

 

8.6%

 

Occupancy

 

1,332,247

 

1,340,918

 

(8,671

)

(0.6)%

 

Data processing fees

 

498,526

 

473,195

 

25,331

 

5.4%

 

OREO expenses

 

350,279

 

563,844

 

(213,565

)

(37.9)%

 

Assessments (FDIC & DFI)

 

396,000

 

516,000

 

(120,000

)

(23.3)%

 

Other

 

1,636,380

 

1,527,223

 

109,157

 

7.1%

 

Total non-interest income

 

$

8,926,822

 

$

8,761,691

 

$

165,131

 

1.9%

 

 

Non-interest expenses increased by $85,000 or 2.0% and $165,000 or 1.9% for the three and six months ended June 30, 2011, respectively, as compared to the same periods of 2010.  Salaries and employee benefits increased $229,000 and $373,000 for the three and six months ended June 30, 2011, respectively, as compared to the same periods of 2010, primarily as a result of hiring new employees for new branch openings and additional bonus accruals corresponding to the Company’s performance metrics.  The new branch openings also resulted in an increase in occupancy expenses of $16,000 for the second quarter, but occupancy expenses were down by $9,000 on a year to date basis as compared to the prior year.  Data processing fees increased by $3,000 and $25,000 for the three and six month periods of 2011, respectively, as a result of an increased number of transaction accounts.

 

Other operating expenses increased by $10,000 and $109,000 for the three and six months ended June 30, 2011, respectively, primarily as a result of impaired loan expenses of $28,000 and $101,00 in the three and six month periods of 2011.  These expenses were incurred as a result of an agreement with a borrower to fund overhead costs on an impaired residential development loan.  No impaired loan expenses were recorded in the first six months of 2010.

 

OREO expenses were $102,000 and $350,000 in the second quarter and six month period of 2011, respectively, compared to $216,000 and $564,000 for the comparable periods of 2010.  The vast majority of these expenses resulted from OREO write downs totaling $71,000 and $291,000 for the three and six month periods of 2011, respectively, as compared to $179,000 and $391,000 for the same periods of 2010.  The remaining expense included in OREO expenses is attributed to general overhead such as property taxes and utilities associated with the properties classified as other real estate owned.  There have been multiple sales of the OREO properties which has reduced our OREO inventory from six properties as of June 30, 2010 to two properties as of June 30, 2011.  There was one sale of an OREO property recorded in the second quarter of 2011.

 

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FDIC and DFI (California Department of Financial Institutions) regulatory assessments were $198,000 and $396,000 for the three and six months ended June 30, 2011, respectively, a decrease of $60,000 and $120,000 as compared to the comparable periods of 2010.  The initial base assessment rate for financial institutions varies based on the overall risk profile of the institution as defined by the FDIC.  The decrease in the second quarter and first six months of 2011is due to a lower base assessment rate as the Company has improved its overall risk ratings.  The decrease in expense was in spite of a higher deposit base in 2011 as compared to 2010, as the FDIC assessment rates are applied to average quarterly deposits.

 

Management anticipates that noninterest expense will continue to increase as we continue to grow.  However, management remains committed to cost-control and efficiency, and we expect to keep these increases to a minimum relative to growth.

 

Income Taxes

 

We reported a provision for income taxes of $830,000, and $1,415,000 for the three and six month periods of 2011, respectively, an increase of $214,000 and $489,000 as compared to the provision of $616,000 and $926,000 reported in the comparable periods of 2010.  The effective income tax rate on income from continuing operations was 36.4% and 35.1% for the second quarter and six month period of 2011, respectively, compared to 37.2% and 31.8% for the comparable periods of 2010.  These provisions reflect accruals for taxes at the applicable rates for federal income tax and California franchise tax based upon reported pre-tax income, and adjusted for the effects of all permanent differences between income for tax and financial reporting purposes (such as earnings on qualified municipal securities, BOLI and certain tax-exempt loans).  The disparity between the effective tax rates in 2011 as compared to 2010 on a year-to-date basis is primarily due to tax credits from California Enterprise Zones and low income housing projects as well as tax free-income on loans within these enterprise zones and municipal securities and loans that comprise a larger proportion of pre-tax income in 2010 as compared to 2011.

 

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Table of Contents

 

Asset Quality

 

Nonperforming assets consist of loans on non-accrual status, loans 90 days or more past due and still accruing interest, loans restructured, where the terms of repayment have been renegotiated resulting in a reduction or deferral of interest or principal, and other real estate owned (“OREO”).

 

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

 

Non-accrual loans totaled $9.0 million at June 30, 2011, as compared to $11.5 million at December 31, 2010.  The non-accrual loans as of June 30, 2011 are loans made to seven borrowers primarily for purposes of real estate construction and commercial real estate.  As of June 30, 2011, we had five loans considered troubled debt restructurings totaling $2.9 million, four of which are included in nonaccrual loans and the other was placed back on accrual status in the first quarter of 2011.

 

OREO totaled $244,000 as of June 30, 2011 and consists of two properties that were acquired through foreclosure including residential land lots and a commercial real estate property.

 

The following table presents information about the Company’s non-performing loans, including asset quality ratios as of June 30, 2011 and December 31, 2010:

 

Non-Performing Assets

 

 

 

June 30,

 

December 31,

 

(in thousands)

 

2011

 

2010

 

Loans in nonaccrual status

 

$

9,001

 

$

11,475

 

Loans past due 90 days or more and accruing

 

 

 

Restructured loans

 

 

 

Total nonperforming loans

 

9,001

 

11,475

 

Other real estate owned

 

244

 

778

 

Total nonperforming assets

 

$

9,245

 

$

12,253

 

 

 

 

 

 

 

Allowance for loan losses

 

$

8,591

 

$

8,255

 

 

 

 

 

 

 

Asset quality ratios:

 

 

 

 

 

Non-performing assets to total assets

 

1.62%

 

2.22%

 

Non-performing loans to total loans

 

2.30%

 

2.84%

 

Allowance for loan losses to total loans

 

2.20%

 

2.04%

 

Allowance for loan losses to total non-performing loans

 

95.44%

 

71.94%

 

 

Allowance for Loan and Lease Losses (“ALLL”)

 

In anticipation of credit risk inherent in our lending business, we routinely set aside allowances through charges to earnings. Such charges are not only made for the outstanding loan portfolio, but also for off-balance sheet items, such as commitments to extend credits or letters of credit. Charges made for the outstanding loan portfolio have been credited to the allowance for loan losses, whereas charges for off-balance sheet items have been credited to the reserve for off-balance sheet items, which is presented as a component of other liabilities.  The Company recorded loan loss provisions of $300,000 and $900,000 for the three and six month periods in 2011, respectively, which represented a $705,000 and $1,110,000 decrease, as compared to the provisions recorded in the same periods of 2010.

 

The allowance for loan losses increased by $336,000 or 4.1%, to $8.6 million at June 30, 2011, as compared with $8.3 million at December 31, 2010.  The Company recognized the increase in the allowance for loan losses during the first six months of the year due to the loan loss provision of $900,000 which was partially offset by net loan charge-offs of $564,000.  The weak business climate has continued to adversely impact the financial conditions of certain Bank clients in addition to decrease collateral values.  The increase to the allowance for loan losses combined with the decrease in our loan portfolio resulted in an increase in the allowance for loan losses as a percentage of total loans to 2.20% at June 30, 2011, as compared to 2.04% at December 31, 2010.

 

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

 

The following table provides an analysis of the changes in the ALLL for the six month periods ended June 30, 2011 and 2010:

 

 

 

Six Months Ended
June 30,

 

(dollars in thousands)

 

2011

 

2010

 

Balance at beginning of period

 

$

8,255

 

$

7,020

 

Provision for loan losses

 

900

 

2,010

 

Loans charged off

 

(574

)

(1,419

)

Recoveries of previous charge-offs

 

10

 

3

 

Net charge-offs

 

(564

)

(1,416

)

Balance at end of period

 

$

8,591

 

$

7,614

 

 

 

 

 

 

 

Allowance for loan losses to total loans

 

2.20%

 

1.85%

 

Net charge-offs to average loans (annualized)

 

0.28%

 

0.69%

 

Provision for loan losses to average loans (annualized)

 

0.45%

 

0.98%

 

 

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

 

Although management believes the allowance at June 30, 2011 was adequate to absorb probable losses from any known and inherent risks in the portfolio, no assurance can be given that the adverse effect of current and future economic conditions on our service areas, or other variables, will not result in increased losses in the loan portfolio in the future.

 

Investment Activities

 

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

 

Cash Equivalents and Interest-bearing Deposits in other Financial Institutions

 

The Company holds federal funds sold, unpledged available-for-sale securities and salable government guaranteed loans to help meet liquidity requirements and provide temporary holdings until the funds can be otherwise deployed or invested. As of June 30, 2011, and December 31, 2010, we had $77.3 million and $68.9 million, respectively, in cash and cash equivalents.

 

Investment Securities

 

Management of our investment securities portfolio focuses on providing an adequate level of liquidity and establishing an interest rate-sensitive position, while earning an adequate level of investment income without taking undue risk. Investment securities that we intend to hold until maturity are classified as held-to-maturity securities, and all other investment securities are classified as available-for-sale.  Currently, all of our investment securities are classified as available-for-sale. The carrying values of available-for-sale investment securities are adjusted for unrealized gains or losses as a valuation allowance and any gain or loss is reported on an after-tax basis as a component of other comprehensive income.

 

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

 

Deposits

 

Total deposits at June 30, 2011 were $496.2 million, a $19.5 million or 4.1% increase from the deposit total of $476.7 million at December 31, 2010.  Average deposits increased $56.3 million to $484.0 million for the six month period ended June 30, 2011 as compared to the same period in 2010. We attracted deposits due to the safety and soundness of the Company and our focus on customer service.

 

 

 

June 30,

 

December 31,

 

Six months change

 

(in thousands)

 

2011

 

2010

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

Demand

 

$

100,171

 

$

102,422

 

$

(2,251

)

(2.2)%

 

NOW

 

69,853

 

60,992

 

8,861

 

14.5%

 

MMDA

 

246,416

 

221,814

 

24,602

 

11.1%

 

Savings

 

18,085

 

18,306

 

(221

)

(1.2)%

 

Time < $100K

 

24,737

 

28,054

 

(3,317

)

(11.8)%

 

Time > $100K

 

36,950

 

45,151

 

(8,201

)

(18.2)%

 

 

 

$

496,212

 

$

476,739

 

$

19,473

 

4.1%

 

 

Because our client base is comprised primarily of commercial and industrial accounts, individual account balances are generally higher than those of consumer-oriented banks.  Five of our clients carry deposit balances of more than 1% of our total deposits, one of which had a deposit balance of more than 3% of total deposits at June 30, 2011.

 

Since our deposit growth strategy emphasizes core deposit growth we have avoided relying on brokered deposits as a consistent source of funds.  The only brokered deposits the Company holds are from CDARS, a certificate of deposit program that exchanges funds with other network banks to offer full FDIC insurance coverage to the customer.  The Company had $1.4 million in brokered deposits as of June 30, 2011 as compared to $3.8 million at December 31, 2010.

 

Borrowings

 

Although deposits are the primary source of funds for our lending and investment activities and for general business purposes, we may obtain advances from the Federal Home Loan Bank of San Francisco (“FHLB”) as an alternative to retail deposit funds. Our outstanding FHLB advances decreased by $2.0 million at June 30, 2011 to $6.0 million, as compared to $8.0 million at December 31, 2010 due to elevated liquidity levels from increased deposits and loan payments that allowed us to pay the advances off.  The outstanding FHLB advances as of June 30, 2011 are term advances that begin to mature in the third quarter of 2011 and will be fully matured in the first quarter of 2012. The outstanding advances have a weighted average interest rate of 1.01% and are all considered short-term as they have remaining maturities of less than one year as of June 30, 2011.  See “Liquidity Management” below for the details on the FHLB borrowings program.

 

Capital Ratios

 

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

 

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Table of Contents

 

The following table shows the Oak Valley Community Bank’s and Oak Valley Bancorp’s capital ratios, as calculated under regulatory guidelines, compared to the regulatory minimum capital ratios and the regulatory minimum capital ratios needed to qualify as a “well-capitalized” institution at June 30, 2011 and December 31, 2010:

 

Oak Valley Community Bank Capital Ratios —

(dollars in thousands)

 

 

 

 

 

 

 

Amount of Capital Required

 

 

 

 

 

 

 

To Be

 

To Be Adequately

 

 

 

Actual

 

Well-Capitalized

 

Capitalized

 

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

As of June 30, 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Capital (to Risk-Weighted Assets)

 

$

70,856

 

16.1%

 

$

43,983

 

10%

 

$

35,186

 

8%

 

Tier 1 Capital (to Risk-Weighted Assets)

 

$

65,315

 

14.9%

 

$

26,390

 

6%

 

$

17,593

 

4%

 

Tier 1 Capital (to Average Assets)

 

$

65,315

 

11.5%

 

$

28,341

 

5%

 

$

22,673

 

4%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2010:

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Capital (to Risk-Weighted Assets)

 

$

68,742

 

14.9%

 

$

46,090

 

10%

 

$

36,872

 

8%

 

Tier 1 Capital (to Risk-Weighted Assets)

 

$

62,946

 

13.7%

 

$

27,654

 

6%

 

$

18,436

 

4%

 

Tier 1 Capital (to Average Assets)

 

$

62,946

 

11.5%

 

$

27,330

 

5%

 

$

21,864

 

4%

 

 

Oak Valley Bancorp Capital Ratios —

(dollars in thousands)

 

 

 

 

 

 

 

Amount of Capital Required

 

 

 

 

 

 

 

To Be

 

To Be Adequately

 

 

 

Actual

 

Well-Capitalized

 

Capitalized

 

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

As of June 30, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Capital (to Risk-Weighted Assets)

 

$

70,966

 

16.1%

 

N/A

 

N/A

 

$

35,189

 

8%

 

Tier 1 Capital (to Risk-Weighted Assets)

 

$

65,425

 

14.9%

 

N/A

 

N/A

 

$

17,595

 

4%

 

Tier 1 Capital (to Average Assets)

 

$

65,425

 

11.5%

 

N/A

 

N/A

 

$

22,674

 

4%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2010:

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Capital (to Risk-Weighted Assets)

 

$

68,910

 

15.0%

 

N/A

 

N/A

 

$

36,874

 

8%

 

Tier 1 Capital (to Risk-Weighted Assets)

 

$

63,114

 

13.7%

 

N/A

 

N/A

 

$

18,437

 

4%

 

Tier 1 Capital (to Average Assets)

 

$

63,114

 

11.6%

 

N/A

 

N/A

 

$

21,865

 

4%

 

 

Liquidity Management

 

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

 

Maintenance of adequate liquidity requires that sufficient resources be available at all times to meet our cash flow requirements. Liquidity in a banking institution is required primarily to provide for deposit withdrawals and the credit needs of its customers and to take advantage of investment opportunities as they arise. Liquidity management involves our ability to convert assets into cash or cash equivalents without incurring significant loss, and to raise cash or maintain funds without incurring excessive additional cost. For this purpose, we maintain a portion of our funds in cash and cash equivalents, salable government guaranteed loans and securities available for sale. We obtain funds from the repayment and maturity of loans as well as deposit inflows, investment security maturities and paydowns, Federal funds purchased, FHLB advances, and other borrowings.  Our primary uses of funds are the origination of loans, the purchase of investment securities, withdrawals of deposits, maturity of certificate of deposits, repayment of borrowings and dividends to common and preferred stockholders. Our liquid assets at June 30, 2011 were $162.9 million compared to $129.0 million at December 31, 2010.  Our liquidity level measured as the percentage of liquid assets to total assets was 28.5% and 23.3%

 

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at June 30, 2011 and December 31, 2010, respectively. We anticipate that cash and cash equivalents on hand and other sources of funds will provide adequate liquidity for our operating, investing and financing needs and our regulatory liquidity requirements for the foreseeable future. Management monitors our liquidity position daily, balancing loan funding/payments with changes in deposit activity and overnight investments.

 

As a secondary source of liquidity, we rely on advances from the FHLB to supplement our supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB are typically secured by a portion of our loan portfolio. The FHLB determines limitations on the amount of advances by assigning a percentage to each eligible loan category that will count towards the borrowing capacity.  As of June 30, 2011, our borrowing capacity from the FHLB was approximately $129.5 million and the outstanding balance was $6.0 million, or approximately 4.6% of our borrowing capacity. We also maintain 2 lines of credit with correspondent banks to purchase up to $17.5 million in federal funds, for which there were no advances as of June 30, 2011.

 

Off-Balance-Sheet Arrangements

 

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

 

As of June 30, 2011 and December 31, 2010, we had commitments to extend credit of $51.9 million and $59.9 million, respectively, which includes obligations under letters of credit of $0.7 million and $1.4 million, respectively.

 

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

 

Recent Legislation and Other Regulatory Initiatives

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), a landmark financial reform bill comprised of new rules and restrictions that will impact banks going forward. It includes key provisions aimed at preventing a repeat of the 2008 financial crisis and a new process for winding down failing, systemically important institutions in a manner as close to a controlled bankruptcy as possible.  The Act includes other key provisions as follows:

 

(1) The Act establishes a new Financial Stability Oversight Council to monitor systemic financial risks. The Board of Governors of the Federal Reserve (“Fed”) is given extensive new authorities to impose strict controls on large bank holding companies with total consolidated assets equal to or in excess of $50 billion and systemically significant nonbank financial companies to limit the risk they might pose for the economy and to other large interconnected companies. The Fed can also take direct control of troubled financial companies that are considered systemically significant.

 

(2) The Act also establishes a new independent Federal regulatory body for consumer protection within the Federal Reserve System known as the Bureau of Consumer Financial Protection (the “Bureau”), which will assume responsibility for most consumer protection laws (except the Community Reinvestment Act). It will also be in charge of setting appropriate consumer banking fees and caps. The Office of Comptroller of the Currency will continue to have authority to preempt state banking and consumer protection laws if these laws “prevent or significantly” interfere with the business of banking.

 

(3) The Act restricts the amount of trust preferred securities (“TPS”) that may be considered as Tier 1 Capital. For depository institution holding companies below $15 billion in total assets, TPS issued before May 19, 2010 will be grandfathered, so their status as Tier 1 capital does not change. However going forward, TPS will be disallowed as Tier 1 capital. Beginning January 1, 2013, bank holding companies above $15 billion in assets will have a three-year phase-in period to fill the capital gap caused by the disallowance of the TPS issued before May 19, 2010.

 

(4) The Act effects changes in the FDIC assessment base with stricter oversight.  A new council of regulators led by the U.S. Treasury will set higher requirements for the amount of cash banks must keep on hand. FDIC insurance coverage is made permanent at the $250 thousand level retroactive to January 1, 2008 and unlimited FDIC insurance is provided for noninterest-bearing transaction accounts in all banks effective December 31, 2010 through the end of 2012. Further, the Act removes the prohibition on payments of interest on demand deposit accounts as of July 21, 2011.  Thus, if a depositor sweeps any amount in excess of $250 thousand from a noninterest-bearing transaction account to an interest bearing demand deposit, there is no FDIC insurance coverage on the portion that is over $250 thousand coverage limit.

 

(5) The Act places certain limitations on investment and other activities by depository institutions, holding companies and their affiliates.

 

The impact of the Act on our banking operations is still uncertain due to the large volume of new rules still subject to adoption and interpretation.

 

SBLF Offering and TARP Repurchase

On August 11, 2011, we completed the private placement sale of 13,500 shares of our Non-Cumulative Perpetual Preferred Stock, Series B, for aggregate consideration of $13.5 million, which is $1,000 per share, to the United States Treasury. 

 

Concurrently with this transaction, also on August 11, 2011, the Company fully redeemed all of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A under the TARP Capital Purchase Program for $13.5 million.  The redemption was funded by the proceeds from the $13.5 million private placement of the Company’s Non-Cumulative Perpetual Preferred Stock, Series B issued to the United States Treasury. 

 

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Table of Contents

 

Item 3.                                                                               Quantitative and Qualitative Disclosures About Market Risk

 

Not applicable.

 

Item 4.                                                                               Controls and Procedures

 

The Company’s Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures, as defined in Exchange Act Rules 13 a-15(e)and 15(d)-15(e) promulgated under the Exchange Act, as of the end of the period covered by this report (the “Evaluation Date”) have concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company would be made known to them by others within the Company, particularly during the period in which this report was being prepared.  Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

There were no significant changes in our internal control over financial reporting during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting subsequent to the Evaluation Date, nor there were any significant deficiencies or material weaknesses in such controls requiring corrective actions.

 

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Table of Contents

 

PART II - OTHER INFORMATION

 

Item 1.                                                                               Legal Proceedings

 

There are no pending, or to management’s knowledge, any threatened, material legal proceedings to which we are a defendant, or to which any of our properties are subject.  There are no material legal proceedings to which any director, any nominee for election as a director, any executive officer, or any associate of any such director, nominee or officer is a party adverse to us.

 

Item 2.                                                                               Unregistered Sales of Equity Securities and Use of Proceeds

 

We did not have any unregistered sales of our equity securities during the three months ended June 30, 2011.

 

Item 3.                                                                               Defaults Upon Senior Securities

 

None.

 

Item 4.                                                                               (Removed and Reserved)

 

None.

 

Item 5.                                                                               Other Information

 

None.

 

Item 6.                                                                               Exhibits

 

The following exhibits are filed as part of this report or hereby incorporated by reference to filings previously made with the SEC:

 

3.1

 

Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form 10-12B filed with the Securities and Exchange Commission on July 31, 2008).

3.2

 

First Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form 10-12B filed with the Securities and Exchange Commission on July 31, 2008).

3.3

 

Bylaws (incorporated by reference to Exhibit 3.3 to the Company’s Registration Statement on Form 10-12B filed with the Securities and Exchange Commission on July 31, 2008).

3.4

 

Certificate of Amendment of Bylaws (incorporated by reference to Exhibit 3.5 to the Company’s Registration Statement on Form 8-A12B filed with the Securities and Exchange Commission on January 14, 2009).

4.1

 

Certificate of Determination filed with the California Secretary of State for Fixed Rate Cumulative Perpetual Preferred Stock, Series A (incorporated by reference to Exhibit 3.4 to the Company’s Registration Statement on Form 8-A12B filed with the Securities and Exchange Commission on January 14, 2009).

4.2

 

Warrant to Purchase Common Stock dated December 5, 2008 (incorporated by reference to Exhibit 3.4 to the Company’s Registration Statement on Form 8-A12B filed with the Securities and Exchange Commission on January 14, 2009).

31.01

 

Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.02

 

Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.01

 

Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema Document

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

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Table of Contents

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

Oak Valley Bancorp

Date: August 11, 2011

By:

/s/    RICHARD A. MCCARTY

 

 

Richard A. McCarty

 

 

Executive Vice President and Chief Financial Officer

 

 

(Principal Financial Officer and duly authorized signatory)

 

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Table of Contents

 

EXHIBIT INDEX

 

Exhibit

 

Description

 

 

 

31.01

 

Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2003

31.02

 

Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2003

32.01

 

Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003

101.INS

 

XBRL Instance Document

101.SCH

 

XBRL Taxonomy Extension Schema Document

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

44