PLUMAS BANCORP - Quarter Report: 2010 September (Form 10-Q)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

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

COMMISSION FILE NUMBER: 000-49883

PLUMAS BANCORP

(Exact Name of Registrant as Specified in Its Charter)

California		75-2987096
(State or Other Jurisdiction of Incorporation or		(I.R.S. Employer Identification No.)
Organization)
35 S. Lindan Avenue, Quincy, California		95971
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s Telephone Number, Including Area Code (530) 283-7305

Indicated by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 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 þ 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 (§232.405 of this chapter) 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o		Accelerated Filer o		Non-Accelerated Filer o		Smaller Reporting Company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of October 26, 2010 4,776,339 shares.

 

 

PART I — FINANCIAL INFORMATION

PLUMAS BANCORP

CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
(In thousands, except share data)

		September 30,				December 31,
		2010				2009
Assets
Cash and cash equivalents		$	63,228			$	59,493
Investment securities			63,523				87,950
Loans, less allowance for loan losses of $6,622 at September 30, 2010 and $9,568 at December 31, 2009			313,521				323,408
Premises and equipment, net			14,724				14,544
Intangible assets, net			518				648
Bank owned life insurance			10,376				10,111
Real estate and vehicles acquired through foreclosure			9,075				11,269
Accrued interest receivable and other assets			15,601				20,694
Total assets		$	490,566			$	528,117
Liabilities and Shareholders’ Equity
Deposits:
Non-interest bearing		$	118,402			$	111,958
Interest bearing			313,657				321,297
Total deposits			432,059				433,255
Short-term borrowings			—				20,000
Long-term debt			—				20,000
Accrued interest payable and other liabilities			9,508				6,321
Junior subordinated deferrable interest debentures			10,310				10,310
Total liabilities			451,877				489,886
Commitments and contingencies (Note 5)			—				—
Shareholders’ equity:
Serial preferred stock, no par value; 10,000,000 shares authorized; 11,949 issued and outstanding at September 30, 2010 and December 31, 2009			11,660				11,595
Common stock, no par value; 22,500,000 shares authorized; issued and outstanding — 4,776,339 shares at September 30, 2010 and December 31, 2009			5,985				5,970
Retained earnings			20,437				20,044
Accumulated other comprehensive income			607				622
Total shareholders’ equity			38,689				38,231
Total liabilities and shareholders’ equity		$	490,566			$	528,117

See notes to unaudited condensed consolidated financial statements.

PLUMAS BANCORP

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(In thousands, except per share data)

		For the Three Months								For the Nine Months
		Ended September 30,								Ended September 30,
		2010				2009				2010				2009
Interest Income:
Interest and fees on loans		$	4,764			$	5,090			$	14,266			$	15,556
Interest on investment securities:
Taxable			390				440				1,323				1,185
Exempt from Federal income taxes			4				123				119				360
Other			8				—				27				—
Total interest income			5,166				5,653				15,735				17,101
Interest Expense:
Interest on deposits			616				810				2,114				2,350
Interest on borrowings			1				21				135				56
Interest on junior subordinated deferrable interest debentures			84				84				235				294
Other			1				2				3				6
Total interest expense			702				917				2,487				2,706
Net interest income before provision for loan losses			4,464				4,736				13,248				14,395
Provision for Loan Losses			1,300				2,550				3,700				11,300
Net interest income after provision for loan losses			3,164				2,186				9,548				3,095
Non-Interest Income:
Service charges			917				970				2,747				2,823
Sale of merchant processing portfolio			—				—				1,435				—
Gain on sale of investments			200				—				780				—
Gain on sale of loans			360				205				600				215
Earnings on Bank owned life insurance policies			112				108				334				323
Other			199				252				644				680
Total non-interest income			1,788				1,535				6,540				4,041
Non-Interest Expenses:
Salaries and employee benefits			2,257				2,827				7,369				8,417
Occupancy and equipment			792				903				2,327				2,836
Provision for OREO losses			7				531				353				887
Other			1,591				1,482				4,760				4,901
Total non-interest expenses			4,647				5,743				14,809				17,041
Income (loss) before provision (benefit) for income taxes			305				(2,022	)			1,279				(9,905	)
Provision (Benefit) for Income Taxes			109				(882	)			373				(4,258	)
Net income (loss)		$	196			$	(1,140	)		$	906			$	(5,647	)
Preferred Stock Dividends and Discount Accretion			(171	)			(171	)			(513	)			(458	)
Net income (loss) available to common shareholders		$	25			$	(1,311	)		$	393			$	(6,105	)
Basic earnings (loss) per share		$	0.01			$	(0.27	)		$	0.08			$	(1.28	)
Diluted earnings (loss) per share		$	0.01			$	(0.27	)		$	0.08			$	(1.28	)

See notes to unaudited condensed consolidated financial statements.

PLUMAS BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In thousands)

		For the Nine Months
		Ended September 30,
		2010				2009
Cash Flows from Operating Activities:
Net income (loss)		$	906			$	(5,647	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Provision for loan losses			3,700				11,300
Change in deferred loan origination costs/fees, net			(109	)			(65	)
Depreciation and amortization			1,296				1,468
Stock-based compensation expense			15				193
Amortization of investment security premiums			370				174
Accretion of investment security discounts			(48	)			(42	)
Net (gain) loss on sale of other real estate			(47	)			157
Net (gain) loss on sale of vehicles owned			(17	)			42
Gain on sale of investments			(780	)			—
Gain on sale of loans held for sale			(600	)			(215	)
Loans originated for sale			(12,184	)			(5,442	)
Proceeds from secured borrowing			2,911				—
Proceeds from loan sales			9,072				5,478
Earnings on Bank owned life insurance policies			(265	)			(257	)
Provision for losses on other real estate			353				887
Decrease (increase) in accrued interest receivable and other assets			4,943				(4,673	)
(Decrease) increase in accrued interest payable and other liabilities			(69	)			637
Net cash provided by operating activities			9,447				3,995
Cash Flows from Investing Activities:
Proceeds from matured and called available-for-sale investment securities			25,841				8,000
Proceeds from matured and called held-to-maturity investment securities			—				1,729
Purchases of available-for-sale investment securities			(29,344	)			(51,132	)
Purchases of held-to-maturity investment securities			—				(1,520	)
Proceeds from principal repayments from available-for-sale government-guaranteed mortgage-backed securities			6,384				5,662
Proceeds from sale of available-for-sale securities			21,979				—
Net decrease (increase) in loans			8,698				(2,029	)
Proceeds from sale of other vehicles			157				219
Proceeds from sale of other real estate			3,105				1,595
Purchase of premises and equipment			(1,186	)			(201	)
Net cash provided by (used in) investing activities			35,634				(37,677	)

Continued on next page.

PLUMAS BANCORP
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In thousands)
(Continued)

		For the Nine Months
		Ended September 30,
		2010				2009
Cash Flows from Financing Activities:
Net (decrease) increase in demand, interest bearing and savings deposits		$	(1,816	)		$	41,944
Net increase in time deposits			620				10,501
Net decrease in borrowings			(40,000	)			(14,000	)
Net proceeds from exercise of stock options			—				5
Payment of cash dividends on preferred stock			(150	)			(325	)
Issuance of preferred stock, net of discount			—				11,517
Issuance of common stock warrant			—				407
Net cash (used in) provided by financing activities			(41,346	)			50,049
Increase in cash and cash equivalents			3,735				16,367
Cash and Cash Equivalents at Beginning of Year			59,493				18,791
Cash and Cash Equivalents at End of Period		$	63,228			$	35,158
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest expense		$	2,271			$	2,693
Income taxes		$	—			$	65
Non-Cash Investing Activities:
Real estate and vehicles acquired through foreclosure		$	1,312			$	14,207
Net change in unrealized income on available-for-sale securities		$	(15	)		$	161

See notes to unaudited condensed consolidated financial statements.

PLUMAS BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. GENERAL

During 2002, Plumas Bancorp (the “Company”) was incorporated as a bank holding company for the purpose of acquiring Plumas Bank (the “Bank”) in a one bank holding company reorganization. This corporate structure gives the Company and the Bank greater flexibility in terms of operation expansion and diversification. The Company formed Plumas Statutory Trust I (“Trust I”) for the sole purpose of issuing trust preferred securities on September 26, 2002. The Company formed Plumas Statutory Trust II (“Trust II”) for the sole purpose of issuing trust preferred securities on September 28, 2005.

The Bank operates eleven branches in California, including branches in Alturas, Chester, Fall River Mills, Greenville, Kings Beach, Portola, Quincy, Redding, Susanville, Tahoe City, and Truckee. In addition to its branch network, the Bank operates an administrative office in Reno, Nevada and a lending office specializing in government-guaranteed lending in Auburn, California. The Bank’s primary source of revenue is generated from providing loans to customers who are predominately small and middle market businesses and individuals residing in the surrounding areas.

The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. The Bank is participating in the Federal Deposit Insurance Corporation (FDIC) Transaction Account Guarantee Program. Under the program, through December 31, 2010, all noninterest-bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. Coverage under the Transaction Account Guarantee Program is in addition to and separate from the coverage under the FDIC’s general deposit insurance rules. On July 21, 2010, President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which, in part, permanently raises the current standard maximum deposit insurance amount to $250,000.

2. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The condensed consolidated financial statements include the accounts of the Company and the accounts of its wholly-owned subsidiary, Plumas Bank. Plumas Statutory Trust I and Plumas Statutory Trust II are not consolidated into the Company’s consolidated financial statements and, accordingly, are accounted for under the equity method. In the opinion of management, the unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the Company’s financial position at September 30, 2010 and December 31, 2009 and its results of operations for the three-month and nine-month periods ended September 30, 2010 and 2009 and its cash flows for the nine-month periods ended September 30, 2010 and 2009. Certain reclassifications have been made to prior period’s balances to conform to classifications used in 2010.

The unaudited condensed consolidated financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim reporting on Form 10-Q. Accordingly, certain disclosures normally presented in the notes to the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted. The Company believes that the disclosures are adequate to make the information not misleading. These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2009 Annual Report to Shareholders on Form 10-K. The results of operations for the three-month and nine-month periods ended September 30, 2010 may not necessarily be indicative of future operating results. In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the periods reported. Actual results could differ significantly from those estimates.

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

3. INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities at September 30, 2010 and December 31, 2009 consisted of the following:

		September 30, 2010
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
Debt securities:
U.S. Treasury securities		$	1,034,000			$	8,000							$	1,042,000
U.S. Government agencies			38,342,000				416,000								38,758,000
U.S. Government agencies collateralized by mortgage obligations			22,808,000				620,000								23,428,000
Obligations of states and political subdivisions			305,000							$	(10,000	)			295,000
		$	62,489,000			$	1,044,000			$	(10,000	)		$	63,523,000

Net unrealized gains on available-for-sale investment securities totaling $1,034,000 were recorded, net of $427,000 in tax expense, as accumulated other comprehensive income within shareholders’ equity at September 30, 2010. During the nine months ended September 30, 2010 the Company sold forty-eight available-for-sale securities for $21,979,000, recording a $780,000 gain on sale.

		December 31, 2009
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
Debt securities:
U.S. Treasury securities		$	1,059,000							$	(7,000	)		$	1,052,000
U.S. Government agencies			55,520,000			$	420,000				(51,000	)			55,889,000
U.S. Government agencies collateralized by mortgage obligations			18,925,000				362,000								19,287,000
Obligations of states and political subdivisions			11,387,000				360,000				(25,000	)			11,722,000
		$	86,891,000			$	1,142,000			$	(83,000	)		$	87,950,000

Net unrealized gains on available-for-sale investment securities totaling $1,059,000 were recorded, net of $437,000 in tax expense, as accumulated other comprehensive income within shareholders’ equity at December 31, 2009. During 2009 the Company sold one available-for-sale security for $86,000, recording a $1,000 gain on sale.

Investment securities with unrealized losses at September 30, 2010 are summarized and classified according to the duration of the loss period as follows:

		Less than 12 Months
		Fair				Unrealized
		Value				Losses
Debt securities:
Obligations of states and political subdivisions		$	295,000			$	10,000

Investment securities with unrealized losses at December 31, 2009 are summarized and classified according to the duration of the loss period as follows:

		Less than 12 Months
		Fair				Unrealized
		Value				Losses
Debt securities:
U.S. Treasury securities		$	1,052,000			$	7,000
U.S. Government agencies			10,787,000				51,000
Obligations of states and political subdivisions			1,208,000				25,000
		$	13,047,000			$	83,000

At September 30, 2010, the Company held 70 securities of which two obligations of states and political subdivisions were in a loss position. The unrealized loss relates to market rate conditions. The security continues to pay as scheduled. When analyzing an issuer’s financial condition, management considers the length of time and extent to which the market value has been less than cost; the historical and implied volatility of the security; the financial condition of the issuer of the security; and the Company’s intent and ability to hold the security to recovery. As of September 30, 2010, management does not have the intent to sell these securities nor does it believe it is more likely than not that it will be required to sell these securities before the recovery of its amortized cost basis. Based on the Company’s evaluation of the above and other relevant factors, the Company does not believe the securities that are in an unrealized loss position as of September 30, 2010 are other than temporarily impaired.

The amortized cost and estimated fair value of investment securities at September 30, 2010 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.

						Estimated
		Amortized				Fair
		Cost				Value
One year or less		$	2,047,000			$	2,062,000
After one year through five years			37,329,000				37,738,000
After five years through ten years			305,000				295,000
			39,681,000				40,095,000
Investment securities not due at a single maturity date:
Government-guaranteed mortgage-backed securities			22,808,000				23,428,000
		$	62,489,000			$	63,523,000

Investment securities with amortized costs totaling $44,149,000 and $72,154,000 and estimated fair values totaling $45,053,000 and $73,254,000 at September 30, 2010 and December 31, 2009, respectively, were pledged to secure deposits, including public deposits and treasury, tax and loan accounts.

4. LOANS

Outstanding loans are summarized below, in thousands:

		September 30,				December 31,
		2010				2009
Commercial		$	42,344			$	37,056
Agricultural			39,451				41,722
Real estate — mortgage			157,031				161,397
Real estate — construction and land development			31,694				38,061
Consumer			49,355				54,442
			319,875				332,678
Deferred loan costs, net			268				298
Allowance for loan losses			(6,622	)			(9,568	)
		$	313,521			$	323,408

Included in commercial loans at September 30, 2010 is $2,911,000 in guaranteed portions of SBA loans sold subject to a 90-day premium refund obligation. In accordance with new accounting standards for the sale of a portion of a loan, as more fully described in Note 13, we have recorded the proceeds from the sale of the guaranteed portions of SBA loans that are subject to a premium refund obligation as a secured borrowing and included such secured borrowings in other liabilities on the balance sheet. Once the premium refund obligation has elapsed the transaction will be recorded as a sale with the guaranteed portions of loans and the secured borrowing removed from the balance sheet and the resulting gain on sale recorded.

At September 30, 2010 and December 31, 2009, nonaccrual loans totaled $24,913,000 and $14,263,000, respectively.

Changes in the allowance for loan losses were as follows, in thousands:

		September 30,				December 31,
		2010				2009
Balance, beginning of year		$	9,568			$	7,224
Provision charged to operations			3,700				14,500
Losses charged to allowance			(7,208	)			(12,500	)
Recoveries			562				344
Balance, end of period		$	6,622			$	9,568

The following table presents information regarding impaired loans:

		September 30,				December 31,
		2010				2009
Balance of impaired loans carried at cost		$	17,911			$	5,512
Balance of impaired loans carried at fair value			8,847				9,435
Total recorded investment in impaired loans (net of allocated allowance of $1,168 at September 30, 2010 and $4,281 at December 31, 2009)		$	26,758			$	14,947

The impaired loans included in the table above were mostly comprised of collateral dependent real estate loans.

5. COMMITMENTS AND CONTINGENCIES

The Company is party to claims and legal proceedings arising in the ordinary course of business. In the opinion of the Company’s management, the amount of ultimate liability with respect to such proceedings will not have a material adverse effect on the financial condition or results of operations of the Company taken as a whole.

In the normal course of business, there are various outstanding commitments to extend credit, which are not reflected, in the financial statements, including loan commitments of $72,020,000 and $67,258,000 and stand-by letters of credit of $339,000 and $304,000 at September 30, 2010 and December 31, 2009, respectively.

Of the loan commitments outstanding at September 30, 2010, $10,996,000 are real estate construction loan commitments that are expected to fund within the next twelve months. The remaining commitments primarily relate to revolving lines of credit or other commercial loans, and many of these are expected to expire without being drawn upon. Therefore, the total commitments do not necessarily represent future cash requirements. Each loan commitment and the amount and type of collateral obtained, if any, are evaluated on an individual basis. Collateral held varies, but may include real property, bank deposits, debt or equity securities or business assets.

Stand-by letters of credit are conditional commitments written to guarantee the performance of a customer to a third party. These guarantees are primarily related to the purchases of inventory by commercial customers and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to customers and accordingly, evaluation and collateral requirements similar to those for loan commitments are used. The deferred liability related to the Company’s stand-by letters of credit was not significant at September 30, 2010 or December 31, 2009.

6. PREFERRED STOCK AND JUNIOR SUBORDINATED DEBENTURES

During the second quarter of 2010, Plumas Bancorp, at the request of the Federal Reserve Bank of San Francisco (FRB), suspended quarterly cash dividend payments on its Series A Preferred Stock. While Plumas Bancorp accrued for this obligation, it is currently in arrears in the amount of $299 thousand with the dividend payments on the Series A Preferred Stock as of September 30, 2010.

During the second quarter of 2010, Plumas Bancorp, at the request of the FRB, deferred regularly scheduled quarterly interest payments on its outstanding junior subordinated debentures relating to its two trust preferred securities. While Plumas Bancorp accrued for this obligation, it is currently in arrears with the interest payments on the junior subordinated debentures as permitted by the related documentation. As of September 30, 2010, the amount of the arrearage on the payments on the subordinated debt associated with the trust preferred securities is $160 thousand.

7. EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is computed by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options, result in the issuance of common stock which shares in the earnings of the Company. The treasury stock method has been applied to determine the dilutive effect of stock options in computing diluted earnings per share.

		For the Three Months								For the Nine Months
		Ended September 30,								Ended September 30,
(In thousands, except per share data)		2010				2009				2010				2009
Net Income (loss):
Net income (loss)		$	196			$	(1,140	)		$	906			$	(5,647	)
Dividends accrued and discount accreted on preferred shares			(171	)			(171	)			(513	)			(458	)
Net income (loss) available to common shareholders		$	25			$	(1,311	)		$	393			$	(6,105	)
Earnings Per Share:
Basic earnings (loss) per share		$	0.01			$	(0.27	)		$	0.08			$	(1.28	)
Diluted earnings (loss) per share		$	0.01			$	(0.27	)		$	0.08			$	(1.28	)
Weighted Average Number of Shares Outstanding:
Basic shares			4,776				4,776				4,776				4,776
Diluted shares			4,776				4,776				4,776				4,776

Shares of common stock issuable under stock options for which the exercise prices were greater than the average market prices were not included in the computation of diluted earnings per share due to their antidilutive effect. When a net loss occurs, no difference in earnings per share is calculated because the conversion of potential common stock is anti-dilutive. Stock options during the three months and nine months ended September 30, 2010 were excluded from the calculation of earnings per share as they were anti-dilutive.

8. COMPREHENSIVE INCOME (LOSS)

Total comprehensive income (loss) for the three months ended September 30, 2010 and 2009 totaled $57,000 and $(1,024,000), respectively. Comprehensive income (loss) is comprised of unrealized gains (losses), net of taxes, on available-for-sale investment securities, which were $(139,000) and $116,000 for the three months ended September 30, 2010 and 2009, respectively, together with net income (loss).

Total comprehensive income (loss) for the nine months ended September 30, 2010 and 2009 totaled $891,000 and $(5,486,000), respectively. Comprehensive income (loss) is comprised of unrealized gains (losses), net of taxes, on available-for-sale investment securities, which were $(15,000) and $161,000 for the nine months ended September 30, 2010 and 2009, respectively, together with net income (loss).

At September 30, 2010 and December 31, 2009, accumulated other comprehensive income totaled $607,000 and $622,000, respectively, and is reflected, net of taxes, as a component of shareholders’ equity.

9. STOCK-BASED COMPENSATION

In 2001 and 1991, the Company established Stock Option Plans for which 873,185 shares of common stock remain reserved for issuance to employees and directors and 558,455 shares are available for future grants under incentive and nonstatutory agreements as of September 30, 2010. The Company did not grant options during the nine months ended September 30, 2010 and 2009.

Compensation cost related to stock options recognized in operating results was $15,000 for the nine months ended September 30, 2010. The associated future income tax benefit recognized was $1,000 for the nine months ended September 30, 2010. Compensation cost related to stock options recognized in operating results was $193,000 for the nine months ended September 30, 2009. The associated future income tax benefit recognized was $15,000 for the nine months ended September 30, 2009.

Compensation cost related to stock options recognized in operating results was $43,000 and $64,000 for the quarters ended September 30, 2010 and 2009, respectively. The associated future income tax benefit recognized was $3,000 and $5,000 for the quarters ended September 30, 2010 and 2009, respectively.

The following table summarizes information about stock option activity for the nine months ended September 30, 2010:

										Weighted
										Average
						Weighted				Remaining
						Average				Contractual
						Exercise				Term				Intrinsic Value
		Shares				Price				(in years)				(in thousands)
Options outstanding at December 31, 2009			403,966			$	13.56
Options granted			—				—
Options exercised			—				—
Options cancelled			(89,236	)		$	14.01
Options outstanding at September 30, 2010			314,730			$	13.43				3.9			$	—
Options exercisable at September 30, 2010			258,137			$	13.26				3.7			$	—
Expected to vest after September 30, 2010			49,219			$	14.19				5.0			$	—

At September 30, 2010, there was $114,000 of total unrecognized compensation cost related to non-vested stock option awards which is expected to be recognized over a weighted-average period of 0.9 years. The total fair value of options vested during the nine months ended September 30, 2010 was $210,000.

10. INCOME TAXES

The Company files its income taxes on a consolidated basis with its subsidiary. The allocation of income tax expense (benefit) represents each entity’s proportionate share of the consolidated provision for income taxes.

Deferred tax assets and liabilities are recognized for the tax consequences of temporary differences between the reported amount of assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Based upon our analysis of available evidence, we have determined that it is “more likely than not” that all of our deferred income tax assets as of September 30, 2010 and December 31, 2009 will be fully realized and therefore no valuation allowance was recorded. On the consolidated balance sheet, net deferred tax assets are included in accrued interest receivable and other assets.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest expense and penalties associated with unrecognized tax benefits, if any, are classified as income tax expense in the consolidated statement of operations. There have been no significant changes to unrecognized tax benefits or accrued interest and penalties for the quarter ended September 30, 2010.

11. FAIR VALUE MEASUREMENT

Fair Value of Financial Instruments

The estimated fair values of the Company’s financial instruments are as follows, in thousands:

		September 30, 2010								December 31, 2009
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
Financial assets:
Cash and cash equivalents		$	63,228			$	63,228			$	59,493			$	59,493,000
Investment securities			63,523				63,523				87,950				87,950,000
Loans			313,521				311,302				323,408				325,589,000
Bank owned life insurance			10,376				10,376				10,111				10,111,000
Accrued interest receivable			1,944				1,944				2,487				2,487,000
Financial liabilities:
Deposits		$	432,059			$	432,627			$	433,255			$	433,311,000
Short-term borrowings			—				—				20,000				20,000
Long-term debt			—				—				20,000				19,817
Junior subordinated deferrable interest debentures			10,310				2,981				10,310				2,909
Accrued interest payable			692				692				476				476

These estimates do not reflect any premium or discount that could result from offering the Company’s entire holdings of a particular financial instrument for sale at one time, nor do they attempt to estimate the value of anticipated future business related to the instruments. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

The following methods and assumptions were used by management to estimate the fair value of its financial instruments at September 30, 2010 and December 31, 2009:

Cash and cash equivalents: For cash and cash equivalents, the carrying amount is estimated to be fair value.

Investment securities: For investment securities, fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are estimated using quoted market prices for similar securities and indications of value provided by brokers.

Loans: For variable-rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. Fair values of loans held for sale, if any, are estimated using quoted market prices for similar loans. The fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered at each reporting date for loans with similar terms to borrowers of comparable creditworthiness. The fair value of loans is adjusted for the allowance for loan losses. The carrying value of accrued interest receivable approximates its fair value.

The fair value of impaired loans is based on either the estimated fair value of underlying collateral or estimated cash flows, discounted at the loan’s effective rate. Assumptions regarding credit risk and cash flows are determined using available market information and specific borrower information.

Bank owned life insurance: The fair values of bank owned life insurance policies are based on current cash surrender values at each reporting date provided by the insurers.

Deposits: The fair values for demand deposits are, by definition, equal to the amount payable on demand at the reporting date represented by their carrying amount. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow analysis using interest rates offered at each reporting date by the Bank for certificates with similar remaining maturities. The carrying amount of accrued interest payable approximates its fair value.

Short-term borrowings: The carrying amount of the short-term borrowings approximates its fair value.

Long-term debt: The fair values for long-term FHLB term advances are estimated using discounted cash flow analyses, using interest rates currently being offered at each reporting date for FHLB advances with a similar maturity.

Junior subordinated deferrable interest debentures: The fair value of junior subordinated deferrable interest debentures was determined based on the current market value for like kind instruments of a similar maturity and structure.

Commitments to extend credit and letters of credit: The fair value of commitments are estimated using the fees currently charged to enter into similar agreements. Commitments to extend credit are primarily for variable rate loans and letters of credit. For these commitments, there is no significant difference between the committed amounts and their fair values and therefore, these items are not included in the table above.

Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the fair values presented.

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring and non recurring basis as of September 30, 2010 and December 31, 2009, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value:

Level 1: Quoted prices for identical instruments traded in active exchange markets.

Level 2: Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable or can be corroborated by observable market data.

Level 3: Model based techniques that use one significant assumption not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use on pricing the asset or liability. Valuation techniques include management judgment and estimation which may be significant.

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.

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

						Fair Value Measurements at September 30, 2010 Using
						Quoted Prices in
						Active Markets for				Significant Other				Significant
		Total Fair				Identical Assets				Observable Inputs				Unobservable
		Value				(Level 1)				(Level 2)				Inputs (Level 3)
Assets:
U.S. Treasury securities		$	1,042,000			$	1,042,000
U.S. Government agencies			38,758,000				38,758,000
U.S. Government agencies collateralized by mortgage obligations			23,428,000							$	23,428,000
Obligations of states and political subdivisions			295,000				295,000
		$	63,523,000			$	40,095,000			$	23,428,000

There were no transfers into or out of Levels 1 and 2 of the fair value hierarchy during the nine months ended September 30, 2010.

						Fair Value Measurements at December 31, 2009 Using
						Quoted Prices in
						Active Markets for				Significant Other				Significant
		Total Fair				Identical Assets				Observable Inputs				Unobservable
		Value				(Level 1)				(Level 2)				Inputs (Level 3)
Assets:
U.S. Treasury securities		$	1,052,000			$	1,052,000
U.S. Government agencies			55,889,000				55,889,000
U.S. Government agencies collateralized by mortgage obligations			19,287,000							$	19,287,000
Obligations of states and political subdivisions			11,722,000				11,722,000
		$	87,950,000			$	68,663,000			$	19,287,000

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. There were no changes in the valuation techniques used during 2010 or 2009. Changes in fair market value are recorded in other comprehensive income.

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

						Fair Value Measurements at September 30, 2010 Using
						Quoted Prices in				Significant Other				Significant
						Active Markets for				Observable				Unobservable
						Identical Assets				Inputs				Inputs				Total Gains
		Total Fair Value				(Level 1)				(Level 2)				(Level 3)				(Losses)
Assets:
Impaired loans		$	8,847,000							$	8,847,000							$	(774,000	)
Other real estate			9,055,000								9,055,000								(353,000	)
		$	17,902,000							$	17,902,000							$	(1,127,000	)

						Fair Value Measurements at December 31, 2009 Using
						Quoted Prices in				Significant Other				Significant
						Active Markets for				Observable				Unobservable
						Identical Assets				Inputs				Inputs				Total Gains
		Total Fair Value				(Level 1)				(Level 2)				(Level 3)				(Losses)
Assets:
Impaired loans		$	9,435,000							$	9,435,000							$	(5,127,000	)
Other real estate			11,204,000								11,204,000								(4,457,000	)
		$	20,639,000							$	20,639,000							$	(9,584,000	)

The following methods were used to estimate the fair value of each class of assets above.

Impaired Loans: The fair value of impaired loans is based on the fair value of the collateral, if collateral dependant or the present value of the expected cash flows discounted at the loan’s effective rate for those loans not collateral dependant. These loans had a principal balance of $10,015,000 with a related valuation allowance of $1,168,000 at September 30, 2010. There were no changes in the valuation techniques used during the nine months ended September 30, 2010 or the year ended December 31, 2009.

Other Real Estate: The fair value of other real estate is based on property appraisals at the time of transfer and as appropriate thereafter, less estimated costs to sell. Estimated costs to sell other real estate were based on standard market factors. Management periodically reviews other real estate to determine whether the property continues to be carried at the lower of its recorded book value or estimated fair value, net of estimated costs to sell.

12. BORROWING ARRANGEMENTS

Short-term borrowings at December 31, 2009 consisted of a $20,000,000 FHLB advance at 0.47% which matured and was repaid on January 19, 2010. Long-term borrowings at December 31, 2009 consisted of two $10,000,000 FHLB advances. During July 2010 the Company prepaid the two long term advances incurring a $226,000 prepayment penalty. There were no borrowings outstanding as of September 30, 2010.

13. ADOPTION OF NEW FINANCIAL ACCOUTNING STANDARDS

Accounting for Transfers of Financial Assets

In June 2009, the FASB issued ASC Topic 860 (previously SFAS No. 166), Accounting for Transfers of Financial Assets, an amendment of SFAS No. 140. This standard amends the derecognition accounting and disclosure guidance included in previously issued standards. This standard eliminates the exemption from consolidation for qualifying special-purpose entities (SPEs) and also requires a transferor to evaluate all existing qualifying SPEs to determine whether they must be consolidated in accordance with ASC Topic 810. This standard also provides more stringent requirements for derecognition of a portion of a financial asset and establishes new conditions for reporting the transfer of a portion of a financial asset as a sale. This standard is effective as of the beginning of the first annual reporting period that begins after November 15, 2009. Management adopted the provisions of this standard on January 1, 2010. See Note 4 for a description of the impact on the Company’s financial condition and results of operations.

Transfers and Servicing

In December 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-16, Transfers and Servicing (ASC Topic 860): Accounting for Transfers of Financial Assets, which updates the derecognition guidance in ASC Topic 860 for previously issued SFAS No. 166. This update reflects the Board’s response to issues entities have encountered when applying ASC 860, including: (1) requires that all arrangements made in connection with a transfer of financial assets be considered in the derecognition analysis, (2) clarifies when a transferred asset is considered legally isolated from the transferor, (3) modifies the requirements related to a transferee’s ability to freely pledge or exchange transferred financial assets, and (4) provides guidance on when a portion of a financial asset can be derecognized. This update is effective for financial asset transfers occurring after the beginning of an entity’s first fiscal year that begins after November 15, 2009. Management adopted the provisions of this standard on January 1, 2010 without a material impact on the Company’s financial condition or results of operations.

Fair Value Measurements and Disclosures

In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (“Topic 820”): Improving Disclosures about Fair Value Measurements (“ASU 10-06”). ASU 10-06 revises two disclosure requirements concerning fair value measurements and clarifies two others. It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers. It will also require the presentation of purchases, sales, issuances and settlements within Level 3 on a gross basis rather than a net basis. The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements. The Company’s disclosures about fair value measurements are presented in Note 10: Fair Value Measurements. These new disclosure requirements were adopted by the Company during the current period, with the exception of the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010. With respect to the portions of this ASU that were adopted during the current period, the adoption of this standard did not have a material impacted on the Company’s financial position, results of operations, cash flows, or disclosures. Management does not believe that the adoption of the remaining portion of this ASU will have a material impact on the Company’s financial position, results of operations, cash flows, or disclosures.

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. 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 will adopt the standard beginning with our December 31, 2010 financial statements. This standard will not have an impact on the Company’s financial position or results of operations.

PART I — FINANCIAL INFORMATION

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

Certain matters discussed in this Quarterly Report are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, among others, (1) significant increases in competitive pressures in the financial services industry; (2) changes in the interest rate environment resulting in reduced margins; (3) general economic conditions, either nationally or regionally, maybe less favorable than expected, resulting in, among other things, a deterioration in credit quality; (4) changes in regulatory environment; (5) loss of key personnel; (6) fluctuations in the real estate market; (7) changes in business conditions and inflation; (8) operational risks including data processing systems failures or fraud; and (9) changes in securities markets. Therefore, the information set forth herein should be carefully considered when evaluating the business prospects of Plumas Bancorp (the “Company”).

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

INTRODUCTION

The following discussion and analysis sets forth certain statistical information relating to the Company as of September 30, 2010 and December 31, 2009 and for the three and nine month periods ended September 30, 2010 and 2009. This discussion should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and notes thereto included in Plumas Bancorp’s Annual Report filed on Form 10-K for the year ended December 31, 2009.

Plumas Bancorp trades on The NASDAQ Capital Market under the ticker symbol “PLBC”.

CRITICAL ACCOUNTING POLICIES

There have been no changes to the Company’s critical accounting policies from those disclosed in the Company’s 2009 Annual Report to Shareholders’ on Form 10-K.

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

IMPACT OF RECENT LEGISLATION.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes provisions affecting large and small financial institutions alike, including several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future. Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, permanently raises the current standard maximum deposit insurance amount to $250,000, and impose new capital requirements on bank and thrift holding companies. The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. The Bancorp’s management continues to review the provisions of the Dodd-Frank Act, many of which are phased-in over the next several months and years, and assess its probable impact on the operations of the Bancorp. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and the Bancorp in particular, is uncertain at this time.

OVERVIEW

The Company recorded net income of $906 thousand or $0.08 per share for the nine months ended September 30, 2010, up from a net loss of $5.6 million or ($1.28) per share for the nine months ended September 30, 2009. This increase in earnings resulted from a decline in the provision for loan losses of $7.6 million, an increase in non-interest income of $2.5 million and a decrease in non-interest expense of $2.2 million. These items were partially offset by a decline in net interest income of $1.2 million and an increase in the provision for income taxes of $4.6 million.

During the year ended December 31, 2009 we recorded a loan loss provision of $14.5 million including $11.3 million during the first nine months of 2009. Most of the 2009 provision for loan losses can be attributed to declines in collateral value and increases in net charges-offs related to our real estate construction and land development loan portfolio. During 2009 we significantly reduced our exposure to these loans as demonstrated by a decline in loan balances in this portfolio of $35.7 million from $73.8 million at December 31, 2008 to $38.1 million at December 31, 2009. We further reduced these balances to $31.7 million at September 30, 2010. See “Provision for Loan Losses” and “Analysis of Allowance for Loan losses” for a further discussion of our loan loss provision.

For the nine months ended September 30, 2010 non-interest income benefited from two large gains. We sold our merchant processing portfolio in June 2010 recording a gain on sale of $1.4 million. In addition, we sold $21.2 million in securities recording a gain on sale of $780 thousand. The three largest items resulting in the $2.2 million reduction in non-interest expense were a $1.0 million decline in salaries and employee benefits, a $534 thousand reduction in the provision for losses on OREO (other real estate owned) and a $509 thousand decline in occupancy and equipment costs.

Primarily related to a decrease in loan balances interest and fees on loans declined by $1.3 million resulting in a decline in net interest income of $1.2 million.

Pre-tax earnings increased by $11.2 million from a loss of $9.9 million during the nine months ended September 30, 2009 to income of $1.3 million during the current nine month period. This resulted in an increase in the provision for income taxes from a benefit of $4.3 million during the 2009 period to expense of $373 thousand during the current nine month period.

Net income (loss) allocable to common shareholders increased from a net loss of $6.1 million or ($1.28) per share during the nine months ended September 30, 2009 to net income of $393 thousand or $0.08 per share during the current nine month period. Income (loss) allocable to common shareholders is calculated by subtracting dividends accrued and discount amortized on preferred stock from net income / (loss).

Total assets at September 30, 2010 were $491 million, a decrease of $37 million from the $528 million at December 31, 2009. Cash and due from banks increased by $3.7 million from $59.5 million at December 31, 2009 to $63.2 million at September 30, 2010. Investment securities declined by $24 million from $87.9 million at December 31, 2009 to $63.5 million at September 30, 2010. Included in the decline in investment securities were sales totaling $21.2 million with a gain on sale of $780 thousand. Net loans decreased by $9.9 million which included net charge-offs of $6.6 million during the nine months ended September 30, 2010. Short-term borrowings, which totaled $20 million at December 31, 2009, matured in January of 2010. Long-term borrowings, which also totaled $20 million at December 31, 2009, were paid off during July, 2010. Deposits decreased by $1.2 million from $433.3 million at December 31, 2009 to $432.1 million at September 30, 2010. The decline in borrowings and deposits was slightly offset by a $3.2 million increase in other liabilities. Included in other liabilities is a $2.9 million secured borrowing which represents SBA loans sold but subject to a 90-day premium recourse provision. We are required to maintain this liability and the related loans on the balance sheet until the premium recourse period has passed. Once the 90 days has passed and no premium recourse remains we will remove the sold loans from assets, derecognize the secured borrowing and record the gain on sale.

The annualized return (loss) on average assets was 0.24% for the nine months ended September 30, 2010 up from (1.58)% for the nine months ended September 30, 2009. The annualized return (loss) on average common equity was 1.9% for the nine months ended September 30, 2010 up from (23.9)% for the nine months ended September 30, 2009.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010

Net interest income before provision for loan losses. Net interest income, on a nontax-equivalent basis, for the nine months ended September 30, 2010 was $13.2 million, a decline of $1.2 million from the $14.4 million earned during the same period in 2009. The largest component of the decrease in net interest income was a decline in the average balance of loans. Other changes, resulting in a decrease in net interest income, included a decline in yield on the Company’s investment portfolio and an increase in the average balance of deposits. These items were partially offset by declines in rates paid on deposit and subordinated debentures and an increase in the average balance of investment securities and other interest earning assets. Net interest margin for the nine months ended September 30, 2010 decreased 32 basis points, or 7%, to 4.29%, down from 4.61% for the same period in 2009.

Interest income decreased $1.4 million or 8%, to $15.7 million for the nine months ended September 30, 2010 primarily as a result of a $34.9 million decline in the average balance of loans. Interest and fees on loans decreased $1.3 million to $14.3 million for the nine months ended September 30, 2010 as compared to $15.6 million during the first nine months of 2009. The Company’s average loan balances were $326 million for the nine months ended September 30, 2010, down from $360 million for the same period in 2009. The decline in loan balances includes net charge-offs which totaled $8.7 million from October 1, 2009 to September 30, 2010. The average rate earned on the Company’s loan balances increased 9 basis points to 5.86% during the first nine months of 2010 compared to 5.77% during the first nine months of 2009. The increase in loan yield reflects a decline in average nonaccrual loan balances. Average nonaccrual loans totaled $28.3 million during the nine months ended September 30, 2009 and $16.7 million during the current nine month period. Interest income on investment securities decreased by $103 thousand related to a decline in yield of 90 basis points. The decline in yield is primarily related to the replacement of matured and sold investment securities with new investments with market yields below those which they replaced. Interest income on other interest-earning assets, which totaled $27 thousand in 2010 and zero in 2009, relates to interest on balances held at the Federal Reserve.

Interest expense on deposits decreased by $236 thousand, or 10%, to $2.1 million for the nine months ended September 30, 2010. This decrease primarily relates to a decrease in the average rate paid on NOW, money market and time deposits partially offset by an increase in the average balance of these accounts.

Interest expense on NOW accounts decreased by $154 thousand related to a decrease in the average rate paid of 26 basis points from 0.69% during the 2009 period to 0.43% during the nine months ended September 30, 2010. This was partially offset by an increase in the average balance in these accounts of $8.8 million. The increase in NOW accounts is primarily related to an interest bearing transaction account designed for local public agencies which we have successfully marketed to several of the municipalities in our service area. Recently we have significantly lowered the rate paid on this account resulting in the decrease in interest paid on NOW accounts. Deposits related to this account averaged $34.2 million during the 2010 period and $23.5 million during the nine months ended September 30, 2009.

Interest expense on money market deposits declined by $80 thousand primarily related to a decline in the rate paid on these accounts from 0.84% during the nine months ended September 30, 2009 to 0.57% during the current nine month period. Interest expense on time deposits increased by $4 thousand and totaled $1.5 million for both nine month periods. Average time deposits totaled $126.3 million during the 2010 period, up $24.9 million from $101.4 million during the nine months ended September 30, 2009. The average rate paid on time deposits decreased from 2.03% during the nine months ended September 30, 2009 to 1.64% during the current nine month period. This decrease primarily relates to a decline in market rates in the Company’s service area. The increase in time deposits is related to a promotional time deposit product we began offering in September, 2009 and continued to offer until April 30, 2010.

Interest on borrowings increased by $79 thousand related to an increase in the rate paid on borrowings as we chose to extend the term of our borrowings; however, this was partially offset by a $59 thousand decline in interest paid on junior subordinated debentures.

Interest expense on long-term borrowings totaled $129 thousand during the nine months ended September 30, 2010. We chose to prepay these borrowings during July 2010 as we had significant excess liquidity and no longer projected a need for these long-term borrowings. We incurred a $226 thousand prepayment penalty on these advances which we anticipate will be more than offset by future savings in interest expense. There were no long-term borrowings outstanding during the 2009 period. Interest on short-term borrowings decreased by $51 thousand to $5 thousand related to a decline in average balance of $23.7 million from $25.0 million during the first nine months of 2009 to $1.3 million during the current period. Interest expense paid on junior subordinated debentures, which fluctuates with changes in the 3-month London Interbank Offered Rate (LIBOR), decreased by $59 thousand as a result of a decrease in LIBOR.

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

		For the Nine Months Ended September 30, 2010												For the Nine Months Ended September 30, 2009
		Average Balance				Interest				Yield/				Average Balance				Interest				Yield/
		(in thousands)				(in thousands)				Rate				(in thousands)				(in thousands)				Rate
Interest-earning assets:
Loans (1) (2)		$	325,558			$	14,266				5.86	%		$	360,412			$	15,556				5.77	%
Investment securities (1)			71,470				1,442				2.70	%			57,376				1,545				3.60	%
Other			15,521				27				0.23	%			16				—				0.32	%
Total interest-earning assets			412,549				15,735				5.10	%			417,804				17,101				5.47	%
Cash and due from banks			41,538												26,467
Other assets			49,389												34,437
Total assets		$	503,476											$	478,708
Interest-bearing liabilities:
NOW deposits		$	102,348				327				0.43	%		$	93,584				481				0.69	%
Money market deposits			42,239				179				0.57	%			41,030				259				0.84	%
Savings deposits			50,499				63				0.17	%			50,282				69				0.18	%
Time deposits			126,302				1,545				1.64	%			101,364				1,541				2.03	%
Total deposits			321,388				2,114				0.88	%			286,260				2,350				1.10	%
Short-term borrowings			1,319				5				0.51	%			25,006				56				0.30	%
Long-term borrowings			13,333				130				1.30	%			—				—				—	%
Other interest-bearing liabilities			123				3				3.26	%			215				6				3.73	%
Junior subordinated debentures			10,310				235				3.05	%			10,310				294				3.81	%
Total interest-bearing liabilities			346,473				2,487				0.96	%			321,791				2,706				1.12	%
Non-interest bearing deposits			109,135												106,714
Other liabilities			8,956												5,723
Shareholders’ equity			38,912												44,480
Total liabilities & equity		$	503,476											$	478,708
Cost of funding interest-earning assets (3)											0.81	%											0.86	%
Net interest income and margin (4)						$	13,248				4.29	%						$	14,395				4.61	%

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

		2010 over 2009 change in net interest income
		for the nine months ended September 30
		(in thousands)
		Volume (1)				Rate (2)				Mix (3)				Total
Interest-earning assets:
Loans		$	(1,504	)		$	237			$	(23	)		$	(1,290	)
Investment securities			380				(387	)			(96	)			(103	)
Other			36				—				(9	)			27
Total interest income			(1,088	)			(150	)			(128	)			(1,366	)
Interest-bearing liabilities:
NOW deposits			45				(182	)			(17	)			(154	)
Money market deposits			8				(85	)			(3	)			(80	)
Savings deposits			—				(6	)			—				(6	)
Time deposits			379				(301	)			(74	)			4
Short-term borrowings			(53	)			39				(37	)			(51	)
Long-term borrowings			—				—				130				130
Other interest-bearing liabilities			(3	)			(1	)			1				(3	)
Junior subordinated debentures			—				(59	)			—				(59	)
Total interest expense			376				(595	)			—				(219	)
Net interest income		$	(1,464	)		$	445			$	(128	)		$	(1,147	)

Provision for loan losses. During the nine months ended September 30, 2010 we recorded a provision for loan losses of $3.7 million down $7.6 million from the $11.3 million provision recorded during the nine months ended September 30, 2009.

The allowance for loan losses is maintained at a level that management believes will be appropriate to absorb inherent losses on existing loans based on an evaluation of the collectibility of the loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to repay their loan. The allowance for loan losses is based on estimates, and ultimate losses may vary from the current estimates. These estimates are reviewed periodically and, as adjustments become necessary, they are reported in earnings in the periods in which they become known.

Net charge-offs totaled $6.6 million during the nine months ended September 30, 2010 and $10.2 million during the same period in 2009. Net charge-offs as an annualized percentage of average loans decreased from 3.77% during the nine months ended September 30, 2009 to 2.73% during the current period. While we incurred significant charge-offs during the 2010 period, $3.1 million of the charge-offs had been incorporated in the allowance for loan losses at December 31, 2009 as specific reserves on impaired loans. The allowance for loan losses totaled $6.6 million at September 30, 2010 and $8.4 million at September 30, 2009. The decrease in the allowance for loan losses from September 30, 2009 is attributable to a $1.3 million decrease in specific reserves related to impaired loans from $2.5 million at September 30, 2009 to $1.2 million at September 30, 2010 and a decrease of $35 million in average loan balances. General reserves decreased by $381 thousand to $5.5 million at September 30, 2010 primarily related to a decline in loan balances. Related to the decrease in specific reserves on impaired loans, the allowance for loan losses as a percentage of total loans decreased from 2.43% at September 30, 2009 to 2.07% at September 30, 2010.

Based on information currently available, management believes that the allowance for loan losses is appropriate to absorb potential risks in the portfolio. However, no assurance can be given that the Company may not sustain charge-offs which are in excess of the allowance in any given period. See “Nonperforming Loans” and “Analysis of Allowance for Loan Losses” for further discussion of loan quality trends and the provision for loan losses.

Non-interest income. During the nine months ended September 30, 2010 non-interest income increased by $2.5 million to $6.5 million, from $4.0 million during the nine months ended September 30, 2009. This increase was primarily related to three items, the largest of which was a $1.4 million gain on the sale of our merchant processing portfolio. During June 2010 we entered into an alliance with a world-wide merchant processing leader. In conjunction with this alliance we sold our merchant processing business, recording a one-time gain of $1.4 million. The Company believes that this alliance provides our customers with a superior merchant processing solution. Additionally we sold $21.2 million in securities recording a gain on sale of $780 thousand. We chose to sell substantially all of our municipal securities portfolio as part of our overall asset/liability management strategy and related to the favorable market price for these securities. In addition, we sold $10.4 million in U.S. government agency securities to lock in significant gains that were available on these securities. Finally, we recorded a gain on sale of SBA loans of $600 thousand representing the sale of $8.3 million in loans. Additional SBA loans totaling $2.9 million were sold during the third quarter; however, the gain on sale generated will not be recorded until the 90-day premium recourse period on SBA loan sales has expired. During the fourth quarter, assuming no premiums are refunded, the Company will recognize a gain on sale of approximately $221 thousand; however, it will also incur commission expense of approximately $76 thousand.

Loan service fees increased by $45 thousand to $133 thousand for the nine months ended September 30, 2010. Loan service fees are primarily related to fees earned for servicing the sold portion of SBA loans and the increase in this category is consistent with the increase in sold SBA loans.

Service charges on deposits accounts declined by $76 thousand primarily related to a decline in overdraft fees as new regulations placed additional restrictions on the Bank in charging overdraft fees on ATM and Point of Sale transactions. Merchant processing fees declined by $69 thousand related to the sale of our merchant processing portfolio in June.

The following table describes the components of non-interest income for the nine-month periods ending September 30, 2010 and 2009, dollars in thousands:

		For the Nine Months
		Ended September 30,								Dollar				Percentage
		2010				2009				Change				Change
Service charges on deposit accounts		$	2,747			$	2,823			$	(76	)			-2.7	%
Sale of merchant processing portfolio			1,435				—				1,435				100	%
Gain on sale of securities			780				—				780				100	%
Gain on sale of loans			600				215				385				179.1	%
Earnings on life insurance policies			334				323				11				3.4	%
Merchant processing income			142				211				(69	)			-32.7	%
Loan service fees			133				88				45				51.1	%
Customer service fees			100				92				8				8.7	%
Safe deposit box and night depository income			48				49				(1	)			-2.0	%
Investment services income			44				61				(17	)			-27.9	%
Other			177				179				(2	)			-1.1	%
Total non-interest income		$	6,540			$	4,041			$	2,499				61.8	%

Non-interest expenses. We continue to focus on cost control initiatives which have resulted in significant savings in most categories of non-interest expense. In addition during the second quarter of 2010 we reduced our head count by approximately 10% which has resulted in significant savings in salary and benefits during the third quarter. During the nine months ended September 30, 2010, total non-interest expense decreased by $2.2 million, or 13%, to $14.8 million, down from $17.0 million for the comparable period in 2009. This decrease in non-interest expense was primarily the result of savings in salaries and employee benefits, occupancy and equipment costs, provision for OREO losses and a reduction in losses on the sale of OREO and OVO (Other Vehicles Owned). These items were partially offset by increases in outside service fees and OREO carrying expenses.

Salaries and employee benefits decreased by $1.0 million primarily related to four items. Salary expense, excluding commissions, declined by $509 thousand related to reduced staffing in all areas with the exception of loan production and problem assets. While the Company has effectively reduced personnel in most functional areas, we have increased staffing in our problem asset department to effectively manage our increased level of nonperforming assets. Additionally, we have increased staffing in our SBA department and our commercial lending department as we see opportunities for loan growth in these areas. Commission expense, which relates to SBA personnel and is included in salary expense, increased by $113 thousand resulting from the increase in SBA sales. Stock compensation expense decreased by $154 thousand. During the first quarter of 2010 we recorded an adjustment to the estimated forfeiture rate associated with option expense. Finally, we have eliminated discretionary bonuses in 2010 resulting in a decrease in bonus expense of $346 thousand and during the second quarter of 2010 we discontinued the company matching contributions to our 401k plan saving $120 thousand.

The decline in occupancy and equipment expense primarily relates to the savings realized from the purchase of our Redding branch. On March 31, 2010 we purchased the building housing our Redding branch at a cost of $1.0 million. Previously we had leased this building. Under the terms of the lease agreement we were provided free rent for a period of time; however, in accordance with accounting principals we recognized monthly rent expense equal to the total payments required under the lease dividend by the term of the lease in months. At the time of the purchase we reversed this accrual recognizing a $184 thousand reduction in occupancy costs. In addition to the one-time savings from the reversal of accrued rent we benefit from reduced operating costs on this building as the owner rather than a renter. Occupancy costs also benefited from a milder winter resulting in reduced utility and snow removal costs. Equipment costs benefited from a $118 thousand reduction in depreciation expense.

Losses on the sale of OREO and OVO totaled $200 thousand during the first nine months of 2009; however during 2010 we recorded net gains on sale of OREO and OVO totaling $64 thousand. We also greatly reduced our provision for OREO losses from $887 thousand during the nine months ended September 30, 2009 to $353 thousand during the nine months ended September 30, 2010.

Other reductions in expense include savings in FDIC insurance, professional fees, telephone, loan collection costs, business development, advertising, director expense, courier expense, and supplies costs. In total these costs were down $491 thousand for the first nine months of 2010.

Outside service fees increased by $308 thousand related to the outsourcing of daily management of our computer network operations and the installation of a new internet banking platform. Consistent with the increase in average OREO (See “Nonperforming Assets”) OREO carrying expenses increased by $333 thousand.

The following table describes the components of non-interest expense for the nine-month periods ending September 30, 2010 and 2009, dollars in thousands:

		For the Nine Months
		Ended September 30,								Dollar				Percentage
		2010				2009				Change				Change
Salaries and employee benefits		$	7,369			$	8,417			$	(1,048	)			-12.5	%
Occupancy and equipment			2,327				2,836				(509	)			-17.9	%
Outside service fees			896				588				308				52.4	%
FDIC insurance and assessments			800				905				(105	)			-11.6	%
OREO Expense			534				201				333				165.7	%
Professional fees			509				598				(89	)			-14.9	%
Provision for OREO losses			353				887				(534	)			-60.2	%
Telephone and data communication			257				301				(44	)			-14.6	%
Loan and collection expenses			225				252				(27	)			-10.7	%
Business development			197				241				(44	)			-18.3	%
Advertising and shareholder relations			180				249				(69	)			-27.7	%
Armored car and courier			180				210				(30	)			-14.3	%
Director compensation			174				221				(47	)			-21.3	%
Postage			162				154				8				5.2	%
Deposit premium amortization			130				130				—				—	%
Stationery and supplies			103				139				(36	)			-25.9	%
(Gain) loss on sale of OREO and OVO			(64	)			200				(264	)			-132.0	%
Other			477				512				(35	)			-6.8	%
Total non-interest expense		$	14,809			$	17,041			$	(2,232	)			-13.1	%