UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		for the quarterly period ended: March 31, 2011

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		for the transition period from                                         to                                         .

Commission File Number: 000-10661

TriCo Bancshares

(Exact Name of Registrant as Specified in Its Charter)

CALIFORNIA		94-2792841
(State or Other Jurisdiction		(I.R.S. Employer
of Incorporation or Organization)		Identification Number)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the 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.

þ Yes      o No

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).

o Yes      o No

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

o Large accelerated filer		þ Accelerated filer		o Non-accelerated filer		o Smaller reporting company
				(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).

o Yes      þ No

Indicate the number of shares outstanding for each of the issuer’s classes of common stock, as of the latest practical date:

Common stock, no par value: 15,918,089 shares outstanding as of May 5, 2011

 

 

TriCo Bancshares
FORM 10-Q
TABLE OF CONTENTS

		Page
Forward-Looking Statements			1
PART I — FINANCIAL INFORMATION			2
Item 1 — Financial Statements			2
Financial Summary			37
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations			38
Item 3 — Quantitative and Qualitative Disclosures about Market Risk			57
Item 4 — Controls and Procedures			57
PART II — OTHER INFORMATION			57
Item 1 — Legal Proceedings			57
Item 1A — Risk Factors			57
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds			58
Item 6 — Exhibits			58
Signatures			59
Exhibits			60
EX-31.1
EX-31.2
EX-32.1
EX-32.2

FORWARD-LOOKING STATEMENTS

This report on Form 10-Q contains forward-looking statements about TriCo Bancshares (the “Company”) that are subject to the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the current knowledge and belief of the Company’s management (“Management”) and include information concerning the Company’s possible or assumed future financial condition and results of operations. When you see any of the words “believes”, “expects”, “anticipates”, “estimates”, or similar expressions, it may mean the Company is making forward-looking statements. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. The reader is directed to the Company’s annual report on Form 10-K for the year ended December 31, 2010, and Part II, Item 1A of this report for further discussion of factors which could affect the Company’s business and cause actual results to differ materially from those suggested by any forward-looking statement made in this report. Such Form 10-K and this report should be read to put any forward-looking statements in context and to gain a more complete understanding of the risks and uncertainties involved in the Company’s business. Any forward-looking statement may turn out to be wrong and cannot be guaranteed. The Company does not intend to update any forward-looking statement after the date of this report.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

TRICO BANCSHARES

(In thousands, except share data; unaudited)

		At March 31,				At December 31,
		2011				2010
Assets:
Cash and due from banks		$	54,527			$	57,254
Cash at Federal Reserve and other banks			351,767				313,812
Cash and cash equivalents			406,294				371,066
Securities available-for-sale			279,824				277,271
Restricted equity securities			9,133				9,133
Loans held for sale			2,834				4,988
Loans			1,387,660				1,419,571
Allowance for loan losses			(43,224	)			(42,571	)
Total loans, net			1,344,436				1,377,000
Foreclosed assets, net			8,983				9,913
Premises and equipment, net			18,552				19,120
Cash value of life insurance			50,991				50,541
Accrued interest receivable			6,941				7,131
Goodwill			15,519				15,519
Other intangible assets, net			495				580
Mortgage servicing rights			4,808				4,605
Indemnification asset			6,689				5,640
Other assets			40,239				37,282
Total assets		$	2,195,738			$	2,189,789
Liabilities and Shareholders’ Equity:
Liabilities:
Deposits:
Noninterest-bearing demand		$	427,116			$	424,070
Interest-bearing			1,432,796				1,428,103
Total deposits			1,859,912				1,852,173
Accrued interest payable			2,044				2,151
Reserve for unfunded commitments			2,690				2,640
Other liabilities			30,262				29,170
Other borrowings			57,781				62,020
Junior subordinated debt			41,238				41,238
Total liabilities			1,993,927				1,989,392
Commitments and contingencies (Note 18)
Shareholders’ equity:
Common stock, no par value: 50,000,000 shares authorized; issued and outstanding:
15,860,138 at March 31, 2011			81,819
15,860,138 at December 31, 2010							81,554
Retained earnings			118,906				117,533
Accumulated other comprehensive income, net of tax			1,086				1,310
Total shareholders’ equity			201,811				200,397
Total liabilities and shareholders’ equity		$	2,195,738			$	2,189,789

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

TRICO BANCSHARES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data; unaudited)

		Three months ended
		March 31,
		2011				2010
Interest and dividend income:
Loans, including fees		$	21,722			$	22,813
Debt securities:
Taxable			2,374				2,755
Tax exempt			140				208
Dividends			7				6
Interest bearing cash at Federal Reserve and other banks			191				154
Total interest and dividend income			24,434				25,936
Interest expense:
Deposits			1,827				3,058
Other borrowings			593				594
Junior subordinated debt			310				306
Total interest expense			2,730				3,958
Net interest income			21,704				21,978
Provision for loan losses			7,001				8,500
Net interest income after provision for loan losses			14,703				13,478
Noninterest income:
Service charges and fees			5,782				5,735
Gain on sale of loans			725				585
Commissions on sale of non-deposit investment products			360				267
Increase in cash value of life insurance			450				426
Other			2,033				534
Total noninterest income			9,350				7,547
Noninterest expense:
Salaries and related benefits			10,793				10,150
Other			8,878				8,653
Total noninterest expense			19,671				18,803
Income before income taxes			4,382				2,222
Provision for income taxes			1,582				664
Net income		$	2,800			$	1,558
Earnings per share:
Basic		$	0.18			$	0.10
Diluted		$	0.17			$	0.10

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

TRICO BANCSHARES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(In thousands, except share data; unaudited)

														Accumulated
		Shares of												Other
		Common				Common				Retained				Comprehensive
		Stock				Stock				Earnings				Income				Total
Balance at December 31, 2009			15,787,753			$	79,508			$	118,863			$	2,278			$	200,649
Comprehensive income:
Net income											1,558								1,558
Change in net unrealized loss on Securities available for sale, net															(225	)			(225	)
Total comprehensive income																			1,333
Stock option vesting							109												109
Stock options exercised			146,403				1,229												1,229
Tax benefit of stock options exercised							390												390
Repurchase of common stock			(74,018	)			(373	)			(991	)							(1,364	)
Dividends paid ($0.13 per share)											(2,062	)							(2,062	)
Balance at March 31, 2010			15,860,138			$	80,863			$	117,368			$	2,053			$	200,284
Balance at December 31, 2010			15,860,138			$	81,554			$	117,533			$	1,310			$	200,397
Comprehensive income:
Net income											2,800								2,800
Change in net unrealized gain on Securities available for sale, net															(224	)			(224	)
Total comprehensive income																			2,576
Stock option vesting							265												265
Dividends paid ($0.09 per share)											(1,427	)							(1,427	)
Balance at March 31, 2011			15,860,138			$	81,819			$	118,906			$	1,086			$	201,811

See accompanying notes to unaudited condensed consolidated financial statements.

TRICO BANCSHARES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands; unaudited)

		For the three months ended March 31,
		2011				2010
Operating activities:
Net income		$	2,800			$	1,558
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of premises and equipment, and amortization			830				927
Amortization of intangible assets			85				65
Provision for loan losses			7,001				8,500
Amortization of investment securities premium, net			377				170
Originations of loans for resale			(32,499	)			(30,472	)
Proceeds from sale of loans originated for resale			35,131				30,787
Gain on sale of loans			(725	)			(585	)
Change in market value of mortgage servicing rights			60				49
Provision for losses on foreclosed assets			449				—
Gain on sale of foreclosed assets			(200	)			(40	)
Loss on disposal of fixed assets			9				25
Increase in cash value of life insurance			(450	)			(426	)
Stock option vesting expense			265				109
Stock option excess tax benefits			—				(390	)
Change in reserve for unfunded commitments			50				—
Change in:
Interest receivable			190				48
Interest payable			(107	)			(550	)
Other assets and liabilities, net			(2,951	)			1,709
Net cash from operating activities			10,315				11,484
Investing activities:
Proceeds from maturities of securities available-for-sale			22,139				20,254
Purchases of securities available-for-sale			(25,456	)			(101,255	)
Loan principal (increases) decreases, net			24,056				35,342
Proceeds from sale of foreclosed assets			2,205				233
Improvements of foreclosed assets			(17	)			—
Proceeds from sale of premises and equipment			1				1
Purchases of premises and equipment			(88	)			(1,161	)
Net cash from investing activities			22,840				(46,586	)
Financing activities:
Net increase in deposits			7,739				4,785
Net change in short-term other borrowings			(4,239	)			(5,801	)
Stock option excess tax benefits			—				390
Repurchase of common stock			—				(338	)
Dividends paid			(1,427	)			(2,062	)
Exercise of stock options			—				203
Net cash from financing activities			2,073				(2,823	)
Net change in cash and cash equivalents			35,228				(37,925	)
Cash and cash equivalents at beginning of period			371,066				346,589
Cash and cash equivalents at end of period		$	406,294			$	308,664
Supplemental disclosure of noncash activities:
Loans transferred to other real estate owned		$	1,523			$	2,047
Unrealized net gain on securities available for sale		$	(387	)		$	(388	)
Market value of shares tendered by employees in-lieu of cash to pay for exercise options and/or related taxes			—			$	1,026
Supplemental disclosure of cash flow activity:
Cash paid for interest expense		$	2,837			$	4,508
Cash paid for income taxes		$	2,620				—

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

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 — General Summary of Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. The results of operations reflect interim adjustments, all of which are of a normal recurring nature and which, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The interim results are not necessarily indicative of the results expected for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes as well as other information included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiary, Tri Counties Bank (the “Bank”). All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates, including those related to the adequacy of the allowance for loan losses, investments, intangible assets, income taxes and contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The allowance for loan losses, goodwill and other intangible assets, income taxes, and the valuation of mortgage servicing rights are the only accounting estimates that materially affect the Company’s consolidated financial statements.

Significant Group Concentration of Credit Risk

The Company grants agribusiness, commercial, consumer, and residential loans to customers located throughout the northern San Joaquin Valley, the Sacramento Valley and northern mountain regions of California. The Company has a diversified loan portfolio within the business segments located in this geographical area. The Company currently classifies all its operation into one business segment that it denotes as community banking.

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold.

Investment Securities

The Company classifies its debt and marketable equity securities into one of three categories: trading, available-for-sale or held-to-maturity. Trading securities are bought and held principally for the purpose of selling in the near term. Held-to-maturity securities are those securities which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held-to-maturity are classified as available-for-sale. During the three months ended March 31, 2011 and the year ended December 31, 2010, the Company did not have any securities classified as either held-to-maturity or trading.

Available-for-sale securities are recorded at fair value. Unrealized gains and losses, net of the related tax effect, on available-for-sale securities are reported as a separate component of other accumulated comprehensive income (loss) in shareholders’ equity until realized.

Premiums and discounts are amortized or accreted over the life of the related investment security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses are derived from the amortized cost of the security sold.

The Company assesses an other-than-temporary impairment (“OTTI”) based on whether it intends to sell a security or if it is likely that the Company would be required to sell the security before recovery of the amortized cost basis of the investment, which may be maturity. For debt securities, if we intend to sell the security or it is likely that we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If we do not intend to sell the security and it is not likely that we will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI. For investment securities held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the amount recorded in OCI increases the

carrying value of the investment and does not affect earnings. If there is an indication of additional credit losses the security is re-evaluated according to the procedures described above. No OTTI losses were recognized in the three months ended March 31, 2011 or the year ended December 31, 2010.

Restricted Equity Securities

Restricted equity securities represent the Company’s investment in the stock of the Federal Home Loan Bank of San Francisco (“FHLB”) and are carried at par value, which reasonably approximates its fair value. While technically these are considered equity securities, there is no market for the FHLB stock. Therefore, the shares are considered as restricted investment securities. Management periodically evaluates FHLB stock for other-than-temporary impairment. Management’s determination of whether these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (4) the liquidity position of the FHLB.

As a member of the FHLB system, the Company is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets, or FHLB advances. The Company may request redemption at par value of any stock in excess of the minimum required investment. Stock redemptions are at the discretion of the FHLB.

Loans Held for Sale

Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by aggregate outstanding commitments from investors of current investor yield requirements. Net unrealized losses are recognized through a valuation allowance by charges to noninterest income.

Mortgage loans held for sale are generally sold with the mortgage servicing rights retained by the Company. The carrying value of mortgage loans sold is reduced by the cost allocated to the associated mortgage servicing rights. Gains or losses on the sale of loans that are held for sale are recognized at the time of the sale and determined by the difference between net sale proceeds and the net book value of the loans less the estimated fair value of any retained mortgage servicing rights.

Loans and Allowance for Loan Losses

Loans originated by the Company, i.e., not purchased or acquired in a business combination, are reported at the principal amount outstanding, net of deferred loan fees and costs. Loan origination and commitment fees and certain direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loan’s yield over the actual life of the loan. Originated loans on which the accrual of interest has been discontinued are designated as nonaccrual loans.

Originated loans are placed in nonaccrual status when reasonable doubt exists as to the full, timely collection of interest or principal, or a loan becomes contractually past due by 90 days or more with respect to interest or principal and is not well secured and in the process of collection. When an originated loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of Management, the loan is estimated to be fully collectible as to both principal and interest.

An allowance for loan losses for originated loans is established through a provision for loan losses charged to expense. Originated loans and deposit related overdrafts are charged against the allowance for loan losses when Management believes that the collectability of the principal is unlikely or, with respect to consumer installment loans, according to an established delinquency schedule. The allowance is an amount that Management believes will be adequate to absorb probable losses inherent in existing loans and leases, based on evaluations of the collectability, impairment and prior loss experience of loans and leases. The evaluations take into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. The Company defines an originated loan as impaired when it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired originated loans are measured based on the present value of expected future cash flows discounted at the loan’s original effective interest rate. As a practical expedient, impairment may be measured based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance.

In situations related to originated loans where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that the Company would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). The Company strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where the Company grants the borrower new terms that provide for a reduction of either interest or principal, the Company measures any impairment on the restructuring as noted above for impaired loans. TDR loans are classified as impaired until they are fully paid off or charged off. Loans that are in nonaccrual status at the time they become TDR loans, remain in

nonaccrual status until the borrower demonstrates a sustained period of performance which the Company generally believes to be six consecutive months of payments, or equivalent. Otherwise, TDR loans are subject to the same nonaccrual and charge-off policies as noted above with respect to their restructured principal balance.

Credit risk is inherent in the business of lending. As a result, the Company maintains an allowance for loan losses to absorb losses inherent in the Company’s originated loan portfolio. This is maintained through periodic charges to earnings. These charges are included in the Consolidated Income Statements as provision for loan losses. All specifically identifiable and quantifiable losses are immediately charged off against the allowance. However, for a variety of reasons, not all losses are immediately known to the Company and, of those that are known, the full extent of the loss may not be quantifiable at that point in time. The balance of the Company’s allowance for originated loan losses is meant to be an estimate of these unknown but probable losses inherent in the portfolio.

The Company formally assesses the adequacy of the allowance for originated loan losses on a quarterly basis. Determination of the adequacy is based on ongoing assessments of the probable risk in the outstanding originated loan portfolio, and to a lesser extent the Company’s originated loan commitments. These assessments include the periodic re-grading of credits based on changes in their individual credit characteristics including delinquency, seasoning, recent financial performance of the borrower, economic factors, changes in the interest rate environment, growth of the portfolio as a whole or by segment, and other factors as warranted. Loans are initially graded when originated. They are re-graded as they are renewed, when there is a new loan to the same borrower, when identified facts demonstrate heightened risk of nonpayment, or if they become delinquent. Re-grading of larger problem loans occurs at least quarterly. Confirmation of the quality of the grading process is obtained by independent credit reviews conducted by consultants specifically hired for this purpose and by various bank regulatory agencies.

The Company’s method for assessing the appropriateness of the allowance for originated loan losses includes specific allowances for impaired originated loans and leases, formula allowance factors for pools of credits, and allowances for changing environmental factors (e.g., interest rates, growth, economic conditions, etc.). Allowance factors for loan pools are based on historical loss experience by product type. Allowances for impaired loans are based on analysis of individual credits. Allowances for changing environmental factors are Management’s best estimate of the probable impact these changes have had on the originated loan portfolio as a whole. The allowance for originated loans is included in the allowance for loan losses.

Acquired loans are valued as of acquisition date in accordance with Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Topic 805, Business Combinations. Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are referred to as purchased credit impaired (PCI) loans. PCI loans are accounted for under FASB ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. In addition, because of the significant credit discounts associated with the loans acquired in the Granite acquisition, the Company elected to account for all loans acquired in the Granite acquisition under FASB ASC Topic 310-30, and classify them all as PCI loans. Under FASB ASC Topic 805 and FASB ASC Topic 310-30, PCI loans are recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. Fair value is defined as the present value of the future estimated principal and interest payments of the loan, with the discount rate used in the present value calculation representing the estimated effective yield of the loan. Default rates, loss severity, and prepayment speed assumptions are periodically reassessed and our estimate of future payments is adjusted accordingly. The difference between contractual future payments and estimated future payments is referred to as the nonaccretable difference. The difference between estimated future payments and the present value of the estimated future payments is referred to as the accretable yield. The accretable yield represents the amount that is expected to be recorded as interest income over the remaining life of the loan. If after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be more than the originally estimated, an increase in the discount rate (effective yield) would be made such that the newly increased accretable yield would be recognized, on a level yield basis, over the remaining estimated life of the loan. If after acquisition, the Company determines that the estimated future cash flows of a PCI loan are expected to be less than the previously estimated, the discount rate would first be reduced until the present value of the reduced cash flow estimate equals the previous present value however, the discount rate may not be lowered below its original level at acquisition. If the discount rate has been lowered to its original level and the present value has not been sufficiently lowered, an allowance for loan loss would be established through a provision for loan losses charged to expense to decrease the present value to the required level. If the estimated cash flows improve after an allowance has been established for a loan, the allowance may be partially or fully reversed depending on the improvement in the estimated cash flows. Only after the allowance has been fully reversed may the discount rate be increased. PCI loans are put on nonaccrual status when cash flows cannot be reasonably estimated. PCI loans are charged off when evidence suggests cash flows are not recoverable. Foreclosed assets from PCI loans are recorded in foreclosed assets at fair value with the fair value at time of foreclosure representing cash flow from the loan. ASC 310-30 allows PCI loans with similar risk characteristics and acquisition time frame to be “pooled” and have their cash flows aggregated as if they were one loan.

Loans are also categorized as “covered” or “noncovered”. Covered loans refer to loans covered by a Federal Deposit Insurance Corporation (“FDIC”) loss sharing agreement. Noncovered loans refer to loans not covered by a FDIC loss sharing agreement.

Foreclosed Assets

Foreclosed assets include assets acquired through, or in lieu of, loan foreclosure. Foreclosed assets are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other noninterest expense. Foreclosed assets that are not subject to a FDIC loss-share agreement are referred to as noncovered foreclosed assets.

Foreclosed assets acquired through FDIC-assisted acquisitions that are subject to a FDIC loss-share agreement, and all assets acquired via foreclosure of covered loans are referred to as covered foreclosed assets. Covered foreclosed assets are reported exclusive of expected reimbursement cash flows from the FDIC. Foreclosed covered loan collateral is transferred into covered foreclosed assets at the loan’s carrying value, inclusive of the acquisition date fair value discount.

Covered foreclosed assets are initially recorded at estimated fair value on the acquisition date based on similar market comparable valuations less estimated selling costs. Any subsequent valuation adjustments due to declines in fair value will be charged to noninterest expense, and will be mostly offset by noninterest income representing the corresponding increase to the FDIC indemnification asset for the offsetting loss reimbursement amount. Any recoveries of previous valuation adjustments will be credited to noninterest expense with a corresponding charge to noninterest income for the portion of the recovery that is due to the FDIC.

Premises and Equipment

Land is carried at cost. Buildings and equipment, including those acquired under capital lease, are stated at cost less accumulated depreciation and amortization. Depreciation and amortization expenses are computed using the straight-line method over the estimated useful lives of the related assets or lease terms. Asset lives range from 3-10 years for furniture and equipment and 15-40 years for land improvements and buildings.

Goodwill and Other Intangible Assets

Goodwill represents the excess of costs over fair value of net assets of businesses acquired. Goodwill and other intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment.

The Company has identifiable intangible assets consisting of core deposit intangibles (CDI) and minimum pension liability. CDI are amortized using an accelerated method over a period of ten years. Intangible assets related to minimum pension liability are adjusted annually based upon actuarial estimates.

Impairment of Long-Lived Assets and Goodwill

Long-lived assets, such as premises and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

As of December 31 of each year, goodwill is tested for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, the Company determines the fair value of a reporting unit and compares it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Currently, and historically, the Company is comprised of only one reporting unit that operates within the business segment it has identified as “community banking”.

Mortgage Servicing Rights

Mortgage servicing rights (MSR) represent the Company’s right to a future stream of cash flows based upon the contractual servicing fee associated with servicing mortgage loans. Our MSR arise from residential mortgage loans that we originate and sell, but retain the right to service the loans. For sales of residential mortgage loans, a portion of the cost of originating the loan is allocated to the servicing right based on the fair values of the loan and the servicing right. The net gain from the retention of the servicing right is included in gain on sale of loans in noninterest income when the loan is sold. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. MSR are included in other assets. Servicing fees are recorded in noninterest income when earned.

The determination of fair value of our MSR requires management judgment because they are not actively traded. The determination of fair value for MSR requires valuation processes which combine the use of discounted cash flow models and extensive analysis of current market data to arrive at an estimate of fair value. The cash flow and prepayment assumptions used in our discounted cash flow model are based on empirical data drawn from the historical performance of our MSR, which we believe are consistent with assumptions used by market participants valuing similar MSR, and from data obtained on the performance of similar MSR. The key assumptions used in the valuation of MSR include mortgage prepayment speeds and the discount rate. These variables can, and generally will, change from quarter to quarter as market conditions and projected interest rates change. The key risks inherent with MSR are prepayment speed and changes in interest rates. The Company uses an independent third party to determine fair value of MSR.

Indemnification Asset

The Company has elected to account for amounts receivable under loss-share agreements with the FDIC as indemnification assets in accordance with FASB ASC Topic 805, Business Combinations. FDIC indemnification assets are initially recorded at fair value, based on the discounted value of expected future cash flows under the loss-share agreements. The difference between the fair value and the undiscounted cash flows the Company expects to collect from the FDIC will be accreted into noninterest income over the life of the FDIC indemnification asset.

FDIC indemnification assets are reviewed quarterly and adjusted for any changes in expected cash flows based on recent performance and expectations for future performance of the covered portfolios. These adjustments are measured on the same basis as the related covered loans and covered other real estate owned. Any increases in cash flow of the covered assets over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the covered assets under those expected will increase the FDIC indemnification asset. Increases and decreases to the FDIC indemnification asset are recorded as adjustments to noninterest income.

Reserve for Unfunded Commitments

The reserve for unfunded commitments is established through a provision for losses — unfunded commitments charged to noninterest expense. The reserve for unfunded commitments is an amount that Management believes will be adequate to absorb probable losses inherent in existing commitments, including unused portions of revolving lines of credits and other loans, standby letters of credits, and unused deposit account overdraft privilege. The reserve for unfunded commitments is based on evaluations of the collectability, and prior loss experience of unfunded commitments. The evaluations take into consideration such factors as changes in the nature and size of the loan portfolio, overall loan portfolio quality, loan concentrations, specific problem loans and related unfunded commitments, and current economic conditions that may affect the borrower’s or depositor’s ability to pay.

Income Taxes

The Company’s accounting for income taxes is based on an asset and liability approach. The Company recognizes the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the future tax consequences that have been recognized in its financial statements or tax returns. The measurement of tax assets and liabilities is based on the provisions of enacted tax laws.

Off-Balance Sheet Credit Related Financial Instruments

In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.

Geographical Descriptions

For the purpose of describing the geographical location of the Company’s loans, the Company has defined northern California as that area of California north of, and including, Stockton; central California as that area of the state south of Stockton, to and including, Bakersfield; and southern California as that area of the state south of Bakersfield.

Reclassifications

Certain amounts reported in previous financial statements have been reclassified to conform to the presentation in this report. These reclassifications did not affect previously reported net income or total shareholders’ equity.

Recent Accounting Pronouncements

The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) Topic 805, “Business Combinations.” On January 1, 2009, new authoritative accounting guidance under ASC Topic 805, “Business Combinations,” became applicable to the Company’s accounting for business combinations closing on or after January 1, 2009. ASC Topic 805 applies to all transactions and other events in which one entity obtains control over one or more other businesses. ASC Topic 805 requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process required under previous accounting guidance whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their estimated fair value. ASC Topic 805 requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously the case under prior accounting guidance. Assets acquired and liabilities assumed in a business combination that arise from contingencies are to be recognized at fair value if fair value can be reasonably estimated. If fair value of such an asset or liability cannot be reasonably estimated, the asset or liability would generally be recognized in accordance with ASC Topic 450, “Contingencies.” Under ASC Topic 805, the requirements of

ASC Topic 420, “Exit or Disposal Cost Obligations,” would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting and, instead, that contingency would be subject to the probable and estimable recognition criteria of ASC Topic 450, “Contingencies.”

Further new authoritative accounting guidance under ASC Topic 810 “Consolidation” amends prior guidance to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. The new authoritative accounting guidance requires additional disclosures about the reporting entity’s involvement with variable-interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entity’s financial statements. The new authoritative accounting guidance under ASC Topic 810 was effective January 1, 2010 and did not have a significant impact on the Company’s financial statements.

Further new authoritative accounting guidance (Accounting Standards Update No. 2010-6) under ASC Topic 820 requires new disclosures for transfers in and out of Levels 1 and 2, including separate disclosure of significant amounts and a description of the reasons for the transfers and separate presentation of information about purchases, sales, issuances, and settlements (on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3). The Update clarifies existing disclosure requirements for level of disaggregation, which provides measurement disclosures for each class of assets and liabilities. Emphasizing that judgment should be used in determining the appropriate classes of assets and liabilities, and inputs and valuation techniques for both recurring and nonrecurring Level 2 and Level 3 fair value measurements. This new authoritative accounting guidance also includes conforming amendments to the guidance on employer’s disclosures about postretirement benefit plan assets changing the terminology of major categories of assets to classes of assets and providing a cross reference to the guidance in Subtopic 820-10 on how to determine appropriate classes to present fair value disclosures. The forgoing new authoritative accounting guidance under ASC Topic 820 became effective for the Company’s financial statements beginning January 1, 2010 and had no significant impact on the Company’s financial statements.

FASB ASC Topic 860, “Transfers and Servicing.” New authoritative accounting guidance under ASC Topic 860, “Transfers and Servicing,” amends prior accounting guidance to enhance reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. The new authoritative accounting guidance eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets. The new authoritative accounting guidance also requires additional disclosures about all continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period. The new authoritative accounting guidance under ASC Topic 860 became effective January 1, 2010 and did not have a significant impact on the Company’s financial statements.

FASB issued Accounting Standards Update (ASU) No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. The amendments in this Update temporarily delay the effective date of the disclosures about troubled debt restructurings in ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses for public entities. The delay is intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, the guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011. The amendments in this Update apply to all public-entity creditors that modify financing receivables within the scope of the disclosure requirements about troubled debt restructurings in Update 2010-20. The amendments in this Update do not affect nonpublic entities. As this ASU is disclosure-related only, our adoption of this ASU in 2011 will not impact the Company’s financial condition or results of operations.

FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This Update amends Topic 310 to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. The amendments in this Update apply to all entities, both public and nonpublic. The amendments in this Update affect all entities with financing receivables, excluding short-term trade accounts receivable or receivables measured at fair value or lower of cost or fair value. For public entities, the disclosures required by this Update as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. For nonpublic entities, the disclosures are effective for annual reporting periods ending on or after December 15, 2011. The amendments in this Update encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods ending after initial adoption. As this ASU is disclosure-related only, the adoption of this ASU did not impact the Bank’s financial condition or results of operations.

FASB issued ASU No. 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan is Part of a Pool That Is Accounted for as a Single Asset. This Update clarifies that modifications of loans that are accounted for within a pool under Subtopic 310-30, which provides guidance on accounting for acquired loans that have evidence of credit deterioration upon acquisition, do not result in the removal of those loans from the pool even if the modification would otherwise be considered a troubled debt restructuring. An entity

will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. The amendments do not affect the accounting for loans under the scope of Subtopic 310-30 that are not accounted for within pools. Loans accounted for individually under Subtopic 310-30 continue to be subject to the troubled debt restructuring accounting provisions within Subtopic 310-40. The amendments in this Update affect any entity that acquires loans subject to Subtopic 310-30, that accounts for some or all of those loans within pools, and that subsequently modifies one or more of those loans after acquisition. The amendments in this Update are effective for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. The amendments are to be applied prospectively. Early application is permitted. Upon initial adoption of the guidance in this Update, an entity may make a onetime election to terminate accounting for loans as a pool under Subtopic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration. Adoption of this ASU did not have a significant impact on the Company’s financial statements.

FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This Update requires: (1) disclosure of the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurement categories and the reasons for the transfers; and (2) separate presentation of purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs (Level 3). In addition, this Update clarifies the requirements of the following existing disclosures set forth in the Codification

Subtopic 820-10: (1) For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and (2) a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements. This Update is effective for interim and annual reporting periods beginning January 1, 2010, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning January 1, 2011, and for interim periods within those fiscal years. As this ASU is disclosure-related only, the adoption of this ASU did not impact the Company’s financial condition or results of operations.

FASB issued ASU No. 2010-28, Intangibles — Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. This update modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist such as if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. This update was effective for the Company on January 1, 2011 and is not expected have a significant impact on the Company’s financial statements.

FASB issued ASU No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. This update provides clarification regarding the acquisition date that should be used for reporting the pro forma financial information disclosures required by Topic 805 when comparative financial statements are presented. This update also requires entities to provide a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination. This update is effective for the Company prospectively for business combinations occurring after December 31, 2010.

Note 2 — Business Combinations

On May 28, 2010, the Office of the Comptroller of the Currency closed Granite Community Bank (“Granite”), Granite Bay, California and appointed the FDIC as receiver. That same date, the Bank assumed the banking operations of Granite from the FDIC under a whole bank purchase and assumption agreement with loss sharing. Under the terms of the loss sharing agreement, the FDIC will cover a substantial portion of any future losses on loans, related unfunded loan commitments, other real estate owned (OREO)/foreclosed assets and accrued interest on loans for up to 90 days. The FDIC will absorb 80% of losses and share in 80% of loss recoveries on the covered assets acquired from Granite. The loss sharing arrangements for non-single family residential and single family residential loans are in effect for 5 years and 10 years, respectively, and the loss recovery provisions are in effect for 8 years and 10 years, respectively, from the acquisition date. With this agreement, the Bank added one traditional bank branch in each of Granite Bay, Roseville and Auburn, California. This acquisition is consistent with the Bank’s community banking expansion strategy and provides further opportunity to fill in the Bank’s market presence in the greater Sacramento, California market.

The operations of Granite are included in the Company’s operating results from May 28, 2010, and through December 31, 2010 added revenue of $4,967,000, including a bargain purchase gain of $232,000, noninterest expense of $2,078,000 and a provision for loan losses of $1,608,000, that resulted in a contribution to net income after-tax of approximately $743,000. Such operating results are not necessarily indicative of future operating results. Granite’s results of operations prior to the acquisition are not included in the Company’s operating results. During the quarter ended September 30, 2010, the Company completed the conversion of Granite’s information and product delivery systems. As of December 31, 2010, nonrecurring expenses related to the Granite acquisition and systems conversion were approximately $250,000.

The assets acquired and liabilities assumed for the Granite acquisition have been accounted for under the acquisition method of accounting (formerly the purchase method). The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the acquisition dates. The fair values of the assets acquired and liabilities assumed were determined based on the requirements of the Fair Value Measurements and Disclosures topic of the FASB ASC. The foregoing fair value amounts are subject to change for up to one year after the closing date of each acquisition as additional information relating to closing date fair values becomes available. The amounts are also subject to adjustments based upon final settlement with the FDIC. In addition, the tax treatment of FDIC assisted acquisitions is complex and subject to interpretations that may result in future adjustments of deferred taxes as of the acquisition date. The terms of the agreements provide for the FDIC to indemnify the Bank against claims with respect to liabilities of Granite not assumed by the Bank and certain other types of claims identified in the agreement. The application of the acquisition method of accounting resulted in the recognition of a bargain purchase gain of $232,000 in the Granite acquisition. A summary of the net assets received in the Granite acquisition, at their estimated fair values, is presented below:

		Granite
(in thousands)		May 28, 2010
Asset acquired:
Cash and cash equivalents		$	18,764
Securities available-for-sale			2,954
Restricted equity securities			696
Covered loans			64,802
Premises and equipment			17
Core deposit intangible			562
Covered foreclosed assets			4,629
FDIC indemnification asset			7,466
Other assets			392
Total assets acquired		$	100,282
Liabilities assumed:
Deposits		$	95,001
Other borrowings			5,000
Other liabilities			49
Total liabilities assumed			100,050
Net assets acquired/bargain purchase gain		$	232

The acquired loan portfolio and foreclosed assets are referred to as “covered loans” and “covered foreclosed assets”, respectively, and these are recorded in Loans and Foreclosed assets, respectively, in the Company’s consolidated balance sheet. Collectively these balances are referred to as “covered assets”.

In FDIC-assisted transactions, only certain assets and liabilities are transferred to the acquirer and, depending on the nature and amount of the acquirer’s bid, the FDIC may be required to make a cash payment to the acquirer. In the Granite acquisition, net assets with a cost basis of $4,345,000 were transferred to the Bank. In the Granite acquisition, the Company recorded a bargain purchase gain of $232,000 representing the excess of the estimated fair value of the assets acquired over the estimated fair value of the liabilities assumed.

The Bank did not immediately acquire all the real estate, banking facilities, furniture or equipment of Granite as part of the purchase and assumption agreement. However, the Bank had the option to purchase or lease the real estate and furniture and equipment from the FDIC. During the quarter ended September 30, 2010, the Bank elected to close the Roseville branch and assume the leases for the Granite Bay and Auburn branches. The Bank purchased the existing furniture and equipment in the Granite Bay and Auburn branches from the FDIC for approximately $100,000.

A summary of the estimated fair value adjustments resulting in the bargain purchase gain in the Granite acquisition are presented below:

		Granite
(in thousands)		May 28, 2010
Cost basis net assets acquired		$	4,345
Cash payment received from FDIC			3,940
Fair value adjustments:
Securities available-for-sale			(118	)
Loans			(13,189	)
Foreclosed assets			(2,616	)
Core deposit intangible			562
FDIC indemnification asset			7,466
Deposits			(209	)
Other			51
Bargain purchase gain		$	232

The following table reflects the estimated fair value of the acquired loans at the acquisition date:

		Granite
(in thousands)		May 28, 2010
Principal balance loans acquired		$	77,991
Discount			(13,189	)
Covered loans, net		$	64,802

In estimating the fair value of the covered loans at the acquisition date, we (a) calculated the contractual amount and timing of undiscounted principal and interest payments and (b) estimated the amount and timing of undiscounted expected principal and interest payments. The difference between these two amounts represents the nonaccretable difference.

On the acquisition date, the amount by which the undiscounted expected cash flows exceed the estimated fair value of the acquired loans is the “accretable yield”. The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the loans.

The following table presents a reconciliation of the undiscounted contractual cash flows, nonaccretable difference, accretable yield, and fair value of covered loans for each respective acquired loan portfolio at the acquisition dates:

		Granite
(in thousands)		May 28, 2010
Undiscounted contractual cash flows		$	99,179
Undiscounted cash flows not expected to be collected (nonaccretable difference)			(11,226	)
Undiscounted cash flows expected to be collected			87,953
Accretable yield at acquisition			(23,151	)
Estimated fair value of Loans acquired at acquisition		$	64,802

Note 3 — Investment Securities

The amortized cost and estimated fair values of investments in debt and equity securities are summarized in the following tables:

		March 31, 2011
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		(in thousands)
Securities Available-for-Sale
Obligations of U.S. government corporations and agencies		$	259,436			$	7,956			$	(543	)		$	266,849
Obligations of states and political subdivisions			11,839				148				(12	)			11,975
Corporate debt securities			1,000				—				—				1,000
Total securities available-for-sale		$	272,275			$	8,104			$	(555	)		$	279,824

		December 31, 2010
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		(in thousands)
Securities Available-for-Sale
Obligations of U.S. government corporations and agencies		$	255,884			$	8,623			$	(326	)		$	264,181
Obligations of states and political subdivisions			12,452				141				(52	)			12,541
Corporate debt securities			1,000				—				(451	)			549
Total securities available-for-sale		$	269,336			$	8,764			$	(829	)		$	277,271

No investment securities were sold during the three months ended March 31, 2011 or the year ended December 31, 2010. Investment securities with an aggregate carrying value of $131,063,000 and $140,100,000 at March 31, 2011 and December 31, 2010, respectively, were pledged as collateral for specific borrowings, lines of credit and local agency deposits.

The amortized cost and estimated fair value of debt securities at March 31, 2011 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At March 31, 2011, obligations of U.S. government corporations and agencies with a cost basis totaling $259,436,000 consist almost entirely of mortgage-backed securities whose contractual maturity, or principal repayment, will follow the repayment of the underlying mortgages. For purposes of the following table, the entire outstanding balance of these mortgage-backed securities issued by U.S. government corporations and agencies is categorized based on final maturity date. At March 31, 2011, the Company estimates the average remaining life of these mortgage-backed securities issued by U.S. government corporations and agencies to be approximately 3.4 years. Average remaining life is defined as the time span after which the principal balance has been reduced by half.

		Amortized				Estimated
		Cost				Fair Value
		(in thousands)
Investment Securities
Due in one year			—				—
Due after one year through five years		$	28,892			$	29,877
Due after five years through ten years			77,422				77,956
Due after ten years			165,961				171,991
Totals		$	272,275			$	279,824

Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:

		Less than 12 months								12 months or more								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Loss				Value				Loss				Value				Loss
March 31, 2011		(in thousands)
Securities Available-for-Sale:
Obligations of U.S. government corporations and agencies		$	53,071			$	(543	)			—				—			$	53,071			$	(543	)
Obligations of states and political subdivisions			1,803				(1	)			531				(11	)			2,334				(12	)
Total securities available-for-sale		$	54,874			$	(544	)		$	531			$	(11	)		$	55,405			$	(555	)

		Less than 12 months								12 months or more								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Loss				Value				Loss				Value				Loss
December 31, 2010		(in thousands)
Securities Available-for-Sale:
Obligations of U.S. government corporations and agencies		$	54,760			$	(326	)			—				—			$	54,760			$	(326	)
Obligations of states and political subdivisions			1,345				(22	)			513				(30	)			1,858				(52	)
Corporate debt securities			—				—				549				(451	)			549				(451	)
Total securities available-for-sale		$	56,105			$	(348	)		$	1,062			$	(481	)		$	57,167			$	(829	)

Obligations of U.S. government corporations and agencies: Unrealized losses on investments in obligations of U.S. government corporations and agencies are caused by interest rate increases. The contractual cash flows of these securities are guaranteed by U.S. Government Sponsored Entities (principally Fannie Mae and Freddie Mac). It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At March 31, 2011, four debt securities representing obligations of U.S. government corporations and agencies had an unrealized loss with aggregate depreciation of 1.01% from the Company’s amortized cost basis.

Obligations of states and political subdivisions: The unrealized losses on investments in obligations of states and political subdivisions were caused by increases in required yields by investors in these types of securities. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At March 31, 2011, three debt securities representing obligations of states and political subdivisions had unrealized losses with aggregate depreciation of 0.49% from the Company’s amortized cost basis.

Corporate debt securities: The unrealized losses on investments in corporate debt securities were caused by increases in required yields by investors in similar types of securities. It is expected that the securities would not be settled at a price less than the amortized cost of the investment. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell and more likely than not will not be required to sell, these investments are not considered other-than-temporarily impaired. At March 31, 2011, the Company had one corporate debt security and it did not have an unrealized loss.

Note 4 — Loans

A summary of the balances of loans follows (in thousands):

		March 31, 2011												December 31, 2010
		Originated				PCI				Total				Originated				PCI				Total
Mortgage loans on real estate:
Residential 1-4 family		$	122,817			$	6,401			$	129,218			$	123,623			$	7,597			$	131,220
Commercial			673,021				24,967				697,988				682,103				25,739				707,842
Total mortgage loan on real estate			795,838				31,368				827,206				805,726				33,336				839,062
Consumer:
Home equity lines of credit			326,932				7,120				334,052				329,080				7,072				336,152
Home equity loans			15,954				—				15,954				17,588				—				17,588
Auto Indirect			20,246				—				20,246				24,577				—				24,577
Other			15,952				—				15,952				15,622				—				15,622
Total consumer loans			379,264				7,120				386,384				386,867				7,072				393,939
Commercial			122,218				9,016				131,234				133,032				10,364				143,396
Construction:
Residential			19,316				4,481				23,797				19,459				4,463				23,922
Commercial			20,955				—				20,955				21,029				—				21,029
Total construction			40,271				4,481				44,752				40,488				4,463				44,951
Total loans			1,337,591				51,985				1,389,576				1,366,113				55,235				1,421,348
Net deferred loan (fees) costs			(1,916	)			—				(1,916	)			(1,777	)			—				(1,777	)
Total loans, net of deferred loan fees		$	1,335,675			$	51,985			$	1,387,660			$	1,364,336			$	55,235			$	1,419,571
Noncovered loans		$	1,335,675				—			$	1,335,675			$	1,364,336				—			$	1,364,336
Covered loans			—				51,985				51,985				—				55,235				55,235
Total loans		$	1,335,675			$	51,985			$	1,387,660			$	1,364,336			$	55,235			$	1,419,571
Allowance for loan loss		$	(40,315	)		$	(2,909	)		$	(43,224	)		$	(40,963	)		$	(1,608	)		$	(42,571	)
		Three months ended March 31, 2011												Three months ended March 31, 2010
		Originated				PCI				Total				Originated				PCI				Total
Change in accretable yield:
Balance at beginning of period			—			$	17,717			$	17,717				—				—				—
Acquisitions-			—				—				—				—				—				—
Accretion to interest income			—				(1,034	)			(1,034	)			—				—				—
Reclassification (to) from Nonaccretable difference			—				(2,284	)			(2,284	)			—				—				—
Balance at end of period			—			$	14,399			$	14,399				—				—				—

Throughout these financial statements, and in particular in this Note 4 and Note 5, when we refer to “Loans” or “Allowance for loan losses” we mean all categories of loans, including originated and PCI. When we are not referring to all categories of loans, we will indicate which we are referring to — originated or PCI.

Note 5 — Allowance for Loan Losses

The following tables summarize the activity in the allowance for loan losses, and ending balance of loans, net of unearned fees for the periods indicated.

		Allowance for Loan Losses — Three months ended March 31, 2011
		RE Mortgage								Home Equity								Auto				Other								Construction
(in thousands)		Resid.				Comm.				Lines				Loans				Indirect				Consum.				C&I				Resid.				Comm.				Total
Beginning balance		$	3,007			$	12,700			$	15,054			$	795			$	1,229			$	701			$	5,991			$	1,824			$	1,270			$	42,571
Charge-offs			(1,125	)			(368	)			(3,601	)			—				(135	)			(229	)			(1,556	)			(35	)			—				(7,049	)
Recoveries			112				28				161				2				127				209				21				2				39				701
Provision			1,550				(333	)			4,682				114				(740	)			23				2,511				(396	)			(410	)			7,001
Ending balance		$	3,544			$	12,027			$	16,296			$	911			$	481			$	704			$	6,967			$	1,395			$	899			$	43,224
Ending balance:
Individ. evaluated for impairment		$	1,055			$	917			$	1,772			$	14			$	161			$	16			$	166			$	136			$	595			$	4,832
Loans pooled for evaluation		$	2,471			$	10,953			$	13,972			$	897			$	319			$	689			$	4,781			$	1,258			$	143			$	35,483
Loans acquired with deteriorated credit quality		$	18			$	157			$	553				—				—				—			$	2,020				—			$	161			$	2,909

		Loans, net of unearned fees — As of March 31, 2011
		RE Mortgage								Home Equity								Auto				Other								Construction
(in thousands)		Resid.				Comm.				Lines				Loans				Indirect				Consum.				C&I				Resid.				Comm.				Total
Ending balance:
Total loans		$	128,474			$	695,089			$	335,682			$	16,035			$	20,240			$	16,185			$	131,242			$	23,772			$	20,941			$	1,387,660
Individ. evaluated for impairment		$	12,735			$	55,867			$	9,091			$	779			$	1,125			$	77			$	5,158			$	6,756			$	7,471			$	99,059
Loans pooled for evaluation		$	109,338			$	614,255			$	319,471			$	15,256			$	19,115			$	16,108			$	117,068			$	12,535			$	13,470			$	1,236,616
Loans acquired with deteriorated credit quality		$	6,401			$	24,967			$	7,120				—				—				—			$	9,016			$	4,481				—			$	51,985

		Allowance for Loan Losses — Three months ended March 31, 2010
		RE Mortgage								Home Equity								Auto				Other								Construction
(in thousands)		Resid.				Comm.				Lines				Loans				Indirect				Consum.				C&I				Resid.				Comm.				Total
Beginning balance		$	2,618			$	5,071			$	13,483			$	940			$	1,986			$	616			$	6,958			$	2,067			$	1,734			$	35,473
Charge-offs			(455	)			(2,567	)			(2,242	)			(408	)			(526	)			(340	)			(526	)			(1,037	)			—				(8,101	)
Recoveries			—				27				44				—				160				202				14				21				—				468
Provision			(32	)			4,148				3,143				375				25				179				621				(747	)			788				8,500
Ending balance		$	2,131			$	6,679			$	14,428			$	907			$	1,645			$	657			$	7,067			$	304			$	2,522			$	36,340
Ending balance:
Individ. evaluated for impairment		$	330			$	494			$	3,573			$	225			$	493			$	88			$	1,245			$	304			$	108			$	6,860
Loans pooled for evaluation		$	1,802			$	6,185			$	10,855			$	682			$	1,152			$	569			$	5,822				—				2,413			$	29,480
Loans acquired with deteriorated credit quality			—				—				—				—				—				—				—				—				—				—

		Loans, net of unearned fees — As of March 31, 2010
		RE Mortgage								Home Equity								Auto				Other								Construction
(in thousands)		Resid.				Comm.				Lines				Loans				Indirect				Consum.				C&I				Resid.				Comm.				Total
Ending balance:
Total loans		$	141,260			$	701,015			$	341,772			$	21,486			$	39,804			$	13,777			$	148,745			$	33,610			$	13,720			$	1,455,189
Individ. evaluated for impairment		$	5,866			$	38,686			$	10,415			$	523			$	1,804			$	211			$	3,325			$	13,876			$	1,755			$	76,461
Loans pooled for evaluation		$	135,394			$	662,329			$	331,357			$	20,963			$	38,000			$	13,566			$	145,420			$	19,734			$	11,965			$	1,378,728
Loans acquired with deteriorated credit quality			—				—				—				—				—				—				—				—				—				—

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including, but not limited to, trends relating to (i) the level of criticized and classified loans, (ii) net charge-offs, (iii) non-performing loans, and (iv) delinquency within the portfolio.

The Company utilizes a risk grading system to assign a risk grade to each of its loans. Loans are graded on a scale ranging from Pass to Loss. A description of the general characteristics of the risk grades is as follows:

•

Pass — This grade represents loans ranging from acceptable to very little or no credit risk. These loans typically meet most if not all policy standards in regard to: loan amount as a percentage of collateral value, debt service coverage, profitability, leverage, and working capital.

•

Special Mention — This grade represents “Other Assets Especially Mentioned” in accordance with regulatory guidelines and includes loans that display some potential weaknesses which, if left unaddressed, may result in deterioration of the repayment prospects for the asset or may inadequately protect the Company’s position in the future. These loans warrant more than normal supervision and attention.

•

Substandard — This grade represents “Substandard” loans in accordance with regulatory guidelines. Loans within this rating typically exhibit weaknesses that are well defined to the point that repayment is jeopardized. Loss potential is, however, not necessarily evident. The underlying collateral supporting the credit appears to have sufficient value to protect the Company from loss of principal and accrued interest, or the loan has been written down to the point where this is true. There is a definite need for a well defined workout/rehabilitation program.

•

Doubtful — This grade represents “Doubtful” loans in accordance with regulatory guidelines. An asset classified as Doubtful has all the weaknesses inherent in a loan 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. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and financing plans.

•

Loss — This grade represents “Loss” loans in accordance with regulatory guidelines. A loan classified as Loss is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan, even though some recovery may be affected in the future. The portion of the loan that is graded loss should be charged off no later than the end of the quarter in which the loss is identified.

The following tables present ending loan balances by loan category and risk grade for the periods indicated:

		Credit Quality Indicators — As of March 31, 2011
		RE Mortgage								Home Equity								Auto				Other								Construction
(in thousands)		Resid.				Comm.				Lines				Loans				Indirect				Consum.				C&I				Resid.				Comm.				Total
Originated loans:
Pass		$	105,379			$	541,680			$	312,098			$	15,050			$	18,473			$	15,972			$	102,260			$	8,992			$	8,236			$	1,128,140
Special mention			895				57,226				969				20				42				10				11,790				3,395				4,786				79,133
Substandard			15,799				71,216				15,492				965				1,725				203				8,176				6,904				7,919				128,399
Loss			—				—				3				—				—				—				—				—				—				3
Total		$	122,073			$	670,122			$	328,562			$	16,035			$	20,240			$	16,185			$	122,226			$	19,291			$	20,941			$	1,335,675
PCI loans		$	6,401			$	24,967			$	7,120				—				—				—			$	9,016			$	4,481				—			$	51,985
Total loans		$	128,474			$	695,089			$	335,682			$	16,035			$	20,240			$	16,185			$	131,242			$	23,772			$	20,941			$	1,387,660

		Credit Quality Indicators — As of December 31, 2010
		RE Mortgage								Home Equity								Auto				Other								Construction
(in thousands)		Resid.				Comm.				Lines				Loans				Indirect				Consum.				C&I				Resid.				Comm.				Total
Originated loans:
Pass		$	106,967			$	543,492			$	312,315			$	16,740			$	22,405			$	15,363			$	108,511			$	8,190			$	8,940			$	1,142,923
Special mention			1,259				60,171				1,884				23				45				11				14,518				3,395				4,397				85,703
Substandard			14,664				75,582				16,538				913				2,207				255				10,020				7,857				7,674				135,710
Total		$	122,890			$	679,245			$	330,737			$	17,676			$	24,657				15,629			$	133,049			$	19,442			$	21,011			$	1,364,336
PCI loans		$	7,597			$	25,739			$	7,072				—				—				—			$	10,364			$	4,463				—			$	55,235
Total loans		$	130,487			$	704,984			$	337,809			$	17,676			$	24,657			$	15,629			$	143,413			$	23,905			$	21,011			$	1,419,571