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

 

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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

 

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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

 

 

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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

 

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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.

 

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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