Valley Commerce Bancorp - FORM 10-Q

Attached files

file	filename
EX-32.1 - EXHIBIT 32.1 - Valley Commerce Bancorp	ex32_1.htm
EX-31.2 - EXHIBIT 31.2 - Valley Commerce Bancorp	ex31_2.htm
EX-31.1 - EXHIBT 31.1 - Valley Commerce Bancorp	ex31_1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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: 000-51949

VALLEY COMMERCE BANCORP

(Name of small business issuer as specified in its charter)

California	46-1981399
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

701 W. Main Street

Visalia, California 93291

(Address of principal executive offices)

(559) 622-9000

(Issuer’s telephone number)

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

Yes x No o

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

Large Accelerated Filer	¨		Accelerated Filer	¨
Non-Accelerated Filer	¨		Smaller Reporting Company	x

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

The number of shares outstanding of the issuer’s Common Stock was 2,762,723 as of August 15, 2011.

INDEX

PART I - FINANCIAL INFORMATION	3

ITEM 1 - FINANCIAL STATEMENTS	4

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATONS	28

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	44

ITEM 4 – CONTROLS AND PROCEDURES	44

PART II - OTHER INFORMATION	45

ITEM 1 LEGAL PROCEEDINGS	45

ITEM 1A RISK FACTORS	45

ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	45

ITEM 3 DEFAULTS UPON SENIOR SECURITIES	45

ITEM 4 REMOVED AND RESERVED	46

ITEM 5 OTHER INFORMATION	46

ITEM 6 EXHIBITS	46

SIGNATURES	47

EXHIBIT INDEX	48

Index

PART I

Forward-Looking Information

Certain matters discussed in this Quarterly Report on Form 10-Q including, but not limited to, those described in Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, among others: (1) significant increases in competitive pressure in the banking and financial services industries; (2) changes in the interest rate environment, which could reduce anticipated or actual margins; (3) changes in the regulatory environment; (4) general economic conditions, either nationally or regionally and especially in the Company’s primary service area failing to improve or continuing to deteriorate and resulting in, among other things, a deterioration in credit quality and increases in the provision for loan loss; (5) operational risks, including data processing systems failures or fraud; (6) changes in business conditions and inflation; (7) changes in technology; (8) changes in monetary and tax policies; and (9) changes in the securities markets; (10) civil disturbances or terrorist threats or acts, or apprehension about the possible future occurrences or acts of this type; (11) outbreak or escalation of hostilities in which the United States is involved, any declaration of war by the U.S. Congress or any other national or international calamity, crisis or emergency; (12) changes in laws and regulations; (13) new or recently issued accounting pronouncements; (14) government policies, regulations, and their enforcement (including Bank Secrecy Act-related matters, taxing statutes and regulations; (15) restrictions on dividends that our subsidiaries are allowed to pay to us; (16) the ability to satisfy requirements related to the Sarbanes-Oxley Act and other regulation on internal control; and (17) management’s ability to manage these and other risks. Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluating the business prospects of the Company.

When the Company uses in this Quarterly Report on Form 10-Q the words “anticipate,” “estimate,” “expect,” “project,” “intend,” “commit,” “believe” and similar expressions, the Company intends to identify forward-looking statements. Such statements are not guarantees of performance and are subject to certain risks, uncertainties and assumptions, including those described in this Quarterly Report on Form 10-Q. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended, committed or believed. The future results and shareholder values of the Company may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements. For those statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Index

PART 1 – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

VALLEY COMMERCE BANCORP

CONDENSED CONSOLIDATED BALANCE SHEET

(UNAUDITED)

	June 30, 2011		December 31, 2010

Assets
Cash and due from banks	$	24,426,384	$	32,667,967
Available-for-sale investment securities, at fair value (Notes 3 and 13)		59,396,000		50,823,000
Loans, less allowance for loan and lease losses of $7,031,763 at June 30, 2011 and $6,698,952 at December 31, 2010 (Note 4, 5, and 13)		232,032,722		234,304,310
Bank premises and equipment, net (Note 6)		8,331,312		8,510,688
Cash surrender value of bank-owned life insurance		6,760,398		6,627,060
Accrued interest receivable and other assets		8,144,609		8,487,803

Total assets	$	339,091,425	$	341,420,828

Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing	$	91,153,586	$	91,202,570
Interest-bearing		198,800,204		203,075,230
Total deposits		289,953,790		294,277,800
Accrued interest payable and other liabilities		3,029,018		2,738,686
Long-term debt		2,357,014		2,561,650
Junior subordinated deferrable interest debentures		3,093,000		3,093,000
Total liabilities		298,432,822		302,671,136

Commitments and contingencies (Note 7)

Shareholders’ equity:
Serial preferred stock - no par value; 10,000,000 shares authorized, issued and outstanding – 7,700 shares class B and 385 shares class C at June 30, 2011 and December 31, 2010 (Note 12)		7,860,300		7,821,800
Common stock - no par value; 30,000,000 shares authorized; issued and outstanding – 2,762,723 shares at June 30, 2011 and 2,630,480 shares at December 31, 2010		27,402,563		26,137,158
Retained earnings		4,886,393		4,831,883
Accumulated other comprehensive income (loss), net of taxes (Note 3 and 10)		509,347		(41,149	)
Total shareholders’ equity		40,658,603		38,749,692

Total liabilities and shareholders’ equity	$	339,091,425	$	341,420,828

See notes to unaudited condensed consolidated financial statements.

Index

VALLEY COMMERCE BANCORP

CONDENSED CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2011			2010			2011			2010
Interest Income:
Interest and fees on loans	$	3,421,278		$	3,782,428		$	6,933,030		$	7,400,253
Interest on investment securities:
Taxable		263,475			190,070			470,937			372,906
Exempt from Federal income taxes		170,552			158,837			323,693			315,283
Interest on deposits in banks		13,634			18,411			33,933			32,751
Total interest income		3,868,939			4,149,746			7,761,593			8,121,193

Interest Expense:
Interest on deposits		383,019			651,640			780,587			1,313,272
Interest on long-term debt		30,916			48,333			62,709			94,612
Interest on junior subordinated deferrable interest debentures		27,989			28,137			55,842			55,617
Total interest expense		441,924			728,110			899,138			1,463,501

Net interest income before provision for loan losses		3,427,015			3,421,636			6,862,455			6,657,692

Provision for loan losses		-			650,000			225,000			1,250,000
Net interest income after provision for loan losses		3,427,015			2,771,636			6,637,455			5,407,692

Non-Interest Income:
Service charges		177,203			202,497			346,298			387,398
Gain on sale of available-for-sale investment securities, net		23,846			-			37,466			-
Mortgage loan brokerage fees		7,336			1,924			29,119			7,921
Earnings on cash surrender value of life insurance policies		73,391			78,949			145,842			146,456
Other		51,942			45,540			101,772			83,576
Total non-interest income		333,718			328,910			660,497			625,351

Non-Interest Expense:
Salaries and employee benefits		1,322,843			1,322,857			2,772,998			2,726,758
Occupancy and equipment		348,323			322,584			669,786			662,194
Other		813,285			798,859			1,617,922			1,681,330
Total non-interest expense		2,484,451			2,444,300			5,060,706			5,070,282

Income before provision for income taxes		1,276,282			656,246			2,237,246			962,761

Provision for income taxes		417,000			183,000			753,000			239,000

Net income	$	859,282		$	473,246		$	1,484,246		$	723,761
Dividends accrued and discount accreted on preferred Shares		(106,053	)		(98,387	)		(207,519	)		(193,569	)
Net income available to common shareholders	$	753,229		$	374,859		$	1,276,727		$	530,192

Basic earnings per share (Notes 2 and 6)	$	0.27		$	0.14		$	0.46		$	0.19

Diluted earnings per share (Notes 2 and 6)	$	0.27		$	0.14		$	0.46		$	0.19

See notes to unaudited condensed consolidated financial statements.

Index

VALLEY COMMERCE BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

	For the Six Months
	Ended June 30,
	2011			2010

Cash Flows from Operating Activities:
Net income	$	1,484,246		$	723,761
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		225,000			1,250,000
(Decrease) increase in deferred loan origination fees, net		(72,061	)		1,869
Depreciation		272,395			249,071
Gain on sale of available-for-sale investment securities, net		(37,466	)		-
Amortization of premiums on investment securities, net		201,877			147,575
Increase in cash surrender value of bank-owned life insurance		(133,338	)		(136,148	)

Stock-based compensation expense		84,219			26,256
(Gain) loss on disposition of premises and equipment		(158	)		5,544
Decrease in accrued interest receivable and other assets		409,834			758,582
(Decrease) increase in accrued interest payable and other liabilities		(65,822	)		379,506
Net cash provided by operating activities		2,368,726			3,406,016

Cash Flows from Investing Activities:
Proceeds from matured and called available-for-sale investment securities		20,000			-
Proceeds from sales of available-for-sale investment securities		5,910,430			-
Purchases of available-for-sale investment securities		(16,341,087	)		(5,096,574	)
Proceeds from principal repayments from available-for-sale mortgage-backed securities		2,608,669			3,233,255
Purchase of Federal Home Loan Bank Stock, net		(95,600	)		(241,700	)
Net increase (decrease) in loans		2,118,836			(10,535,250	)
Purchase of premises and equipment		(93,461	)		(763,991	)
Proceeds from sale of premises and equipment		600			-
Net cash used in investing activities		(5,871,613	)		(13,404,260	)

Continued on next page.

Index

VALLEY COMMERCE BANCORP

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

(Continued)

	For the Six Months
	Ended June 30,
	2011			2010

Cash Flows from Financing Activities:
Net (decrease) increase in noninterest-bearing and interest-bearing deposits	$	(1,819,531	)	$	1,423,133
Net decrease in time deposits		(2,504,480	)		(1,766,409	)
Cash dividends paid on preferred stock		(207,520	)		(210,992	)
Principal payments on long-term debt		(204,636	)		(998,036	)
Cash paid to repurchase fractional shares		(2,529	)		-
Net cash used in financing activities		(4,738,696	)		(1,552,304	)

Decrease in cash and cash equivalents		(8,241,583	)		(11,550,548	)
Cash and Cash Equivalents at Beginning of Year		32,667,967			39,077,786
Cash and Cash Equivalents at End of Period	$	24,426,384		$	27,527,238

Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest expense	$	905,906		$	1,478,735
Income taxes	$	785,000		$	-

Non-Cash Investing Activities:
Net change in unrealized gain on available-for-sale securities	$	935,423		$	441,256
Non-Cash Financing Activities:
Accrued dividends on preferred stock	$	207,520		$	210,992

See notes to unaudited condensed consolidated financial statements.

Index

VALLEY COMMERCE BANCORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

GENERAL

On February 2, 2002, Valley Commerce Bancorp (the "Company") was incorporated as a bank holding company for the purpose of acquiring Valley Business Bank (the "Bank") in a one bank holding company reorganization intended to provide the Company and the Bank greater flexibility to expand and diversify. The reorganization was completed on November 21, 2002, subsequent to which the Bank continued its operations as previously conducted, but as a wholly owned subsidiary of the Company.

The Bank commenced operations in 1996 under the name Bank of Visalia and changed its name during 2005 to Valley Business Bank. The Bank operates branches in Visalia, Fresno, Woodlake and Tipton, and Tulare. The Bank's primary source of revenue is generated from providing loans to customers who are predominately small and middle market businesses and individuals residing in the surrounding areas. The Bank's deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable legal limits. The Bank’s participation in the FDIC Transaction Account Guarantee Program expired on December 31, 2010. The Dodd-Frank Act extends unlimited deposit insurance to non-interest bearing transaction accounts through December 31, 2012. Under the Dodd-Frank Act, Negotiable Order of Withdrawal (“NOW”) accounts not paying more than 0.25% interest per annum are not included in the definition of non-interest bearing transaction accounts. These accounts and any other interest-bearing accounts will be insured based on the depositor’s ownership capacity, but not to exceed $250,000.

2.	BASIS OF PRESENTATION

The interim unaudited condensed consolidated financial statements of Valley Commerce Bancorp and subsidiary have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). These interim condensed consolidated financial statements include the accounts of Valley Commerce Bancorp and its wholly owned subsidiary Valley Business Bank (the “Bank”) (collectively, the “Company”). Valley Commerce Trust I, a wholly-owned subsidiary formed for the exclusive purpose of issuing trust preferred securities, is not consolidated into the Company's consolidated financial statements and, accordingly, is accounted for under the equity method. The Company’s investment in the Trust is included in accrued interest receivable and other assets on the consolidated balance sheet. All significant intercompany accounts and transactions have been eliminated in consolidation. All adjustments (consisting only of normal recurring adjustments) which, in the opinion of Management, are necessary for a fair presentation of the Company’s consolidated financial position at June 30, 2011 and December 31, 2010, the results of its operations for the three and six month periods ended June 30, 2011 and 2010 and its cash flows for the six months ended June 30, 2011 and 2010 have been included therein. Certain information and footnote disclosures normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted, however, the Company believes that the disclosures made are adequate to make the information not misleading. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2010 Annual Report on Form 10-K. The results of operations and cash flows for the interim periods presented are not necessarily indicative of the results for a full year.

The preparation of these condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.

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

Index

2.	BASIS OF PRESENTATION (Continued)

On May 24, 2011 the Company declared a 5% stock dividend payable on June 28, 2011 for all shareholders of record on June 14, 2011. All earnings per share and per share amounts have been retroactively adjusted to reflect the stock dividend.

3.	AVAILABLE-FOR-SALE INVESTMENT SECURITIES

The investment portfolio consists entirely of investment securities that were classified as available for sale at date of acquisition. The Company has established investment policies that are designed primarily to manage interest rate and liquidity risk, and secondarily to achieve income. Each investment security is evaluated quarterly for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations.

The amortized cost and estimated fair value of available-for-sale investment securities at the dates indicated consisted of the following:

	June 30, 2011
	Gross Amortized Cost		Gross Unrealized Gains		Estimated Unrealized Losses			Fair Value

Debt securities:
U.S. government agencies	$	11,528,635	$	233,996	$	(4,631	)	$	11,758,000
Mortgage-backed securities:
U.S. government agencies		17,323,510		412,421		(10,931	)		17,725,000
Small Business Administration		13,242,542		227,458		13,470,000
Municipal securities		16,435,812		232,112		(224,924	)		16,443,000

	$	58,530,499	$	1,105,987	$	(240,486	)	$	59,396,000

Net unrealized gains on available-for-sale investment securities totaling $865,501 were recorded, net of $356,154 in income taxes, as accumulated other comprehensive income within shareholders' equity at June 30, 2011. Proceeds and gross realized gains from the sale of available-for-sale investment securities for the three month period ended June 30, 2011 totaled $4,966,930 and $23,846, respectively. Proceeds and gross realized gains from the sale of available-for-sale investment securities for the six month period ended June 30, 2011 totaled $5,910,430 and $37,466, respectively. There were no investment securities sold at a loss during the six months ended June 30, 2010.

	December 31, 2010
	Gross Amortized Cost		Gross Unrealized Gains		Estimated Unrealized Losses			Fair Value

Debt securities:
U.S. Treasury securities	$	3,841,257	$	14,597	$	(55,854	)	$	3,800,000
U.S. government agencies		5,538,062		56,069		(61,131	)		5,533,000
Mortgage-backed securities:
U.S. government agencies		12,576,534		260,768		(67,302	)		12,770,000
Small Business Administration		14,387,246		201,758		(12,004	)		14,577,000
Municipal securities		14,549,823		22,643		(429,466	)		14,143,000
	$	50,892,922	$	555,835	$	(625,757	)	$	50,823,000

Index

3.	AVAILABLE-FOR-SALE INVESTMENT SECURITIES (Continued)

Net unrealized losses on available-for-sale investment securities totaling $69,922 were recorded, net of $28,773 in tax benefits, as accumulated other comprehensive loss within shareholders' equity at December 31, 2010. There were no securities sold during the six-month period ended June 30, 2010.

Investment securities with unrealized losses at June 30, 2011 are summarized and classified according to the duration of the loss period as follows:

	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

Debt securities:
U.S. government agencies	$	803,000	$	(4,631	)	$	-	$	-		$	803,000	$	(4,631	)
Mortgage-backed securities:
U.S. government agency		3,021,000		(10,931	)		-		-			3,021,000		(10,931	)
Municipal securities		3,625,000		(76,352	)		2,293,000		(148,572	)		5,918,000		(224,924	)
	$	7,449,000	$	(91,914	)	$	2,293,000	$	(148,572	)	$	9,742,000	$	(240,486	)

Investment securities with unrealized losses at December 31, 2010 are summarized and classified according to the duration of the loss period as follows:

	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

Debt securities:
U.S. treasuries	$	2,857,000		(55,854	)		-		-		$	2,857,000		(55,854	)
U.S. government agencies		2,079,000		(61,131	)		-		-			2,079,000		(61,131	)
Mortgage-backed securities:
U.S. government agencies		5,007,000		(67,302	)		-		-			5,007,000		(67,302	)
Small business administration		1,936,000		(10,413	)		821,000		(1,591	)		2,757,000		(12,004	)
Municipal securities		8,712,000		(172,566	)		2,174,000		( 256,900	)		10,886,000		(429,466	)
	$	20,591,000	$	(367,266	)	$	2,995,000	$	(258,491	)	$	23,586,000	$	(625,757	)

Management periodically evaluates each investment security for other-than-temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. As of June 30, 2011, the Company performed an analysis of the investment portfolio to determine whether any of the investments held in the portfolio had other-than-temporary impairment (OTTI). When analyzing the issuer’s financial condition, management considers the length of time and extent to which the market value has been less than cost; the historical and implied volatility of the security; the financial condition of the issuer of the security; and the Company’s intent and ability to hold the security to recovery. Management evaluated all available-for-sale investment securities with an unrealized loss at June 30, 2011 and identified those that had an unrealized loss for at least a consecutive 12 month period, which had an unrealized loss at June 30, 2011 greater than 10% of the recorded book value on that date, or which had an unrealized loss of more than $10,000. Management also analyzed any securities that may have been down graded by credit rating agencies. For those bonds that were municipal debt securities, the Company conducted a search for any recent information relevant to the financial condition of the municipality and any applicable municipal bond insurance provider.

OTTI that is credit-related is recognized in earnings while noncredit-related OTTI on securities not expected to be sold is recognized in other comprehensive income. An unrealized loss may eventually be realized if it is probable that either (1) the Company will not collect the entire contractual or estimated cash flow from that interest, or (2) the Company lacks the intent and ability to hold the interest until it is expected to recover. As discussed below, the Company’s impairment analysis as of June 30, 2011 resulted in all unrealized losses in the investment portfolio being recognized in other comprehensive income.

Index

3.	AVAILABLE-FOR-SALE INVESTMENT SECURITIES (Continued)

U.S government agencies

At June 30, 2011, the Company held 12 U.S. government agencies of which one was in a loss position for less than twelve months and none were in a loss position for twelve months or more. Management believes the unrealized losses on the Company's investments in U.S. government agencies were caused primarily by limited market liquidity and perceived credit risk on the part of investors. The contractual cash flows of these investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities will not be settled at a price less than the amortized cost of the Company's investment. Because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2011.

Mortgage-backed Securities

At June 30, 2011, the Company held 31 mortgage-backed obligations of which three were in a loss position for less than twelve months and none were in a loss position for twelve months or more. Management believes the unrealized losses on the Company's investments in mortgage obligations were caused primarily by limited market liquidity and perceived credit risk on the part of investors. The contractual cash flows of these investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities will not be settled at a price less than the amortized cost of the Company's investment. Because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2011.

Municipal Securities

At June 30, 2011, the Company held 48 obligations of states and political subdivision securities of which ten were in a loss position for less than twelve months and eight were in a loss position and had been in a loss position for twelve months or more. Management believes the unrealized losses on the Company's investments in obligations of states and political subdivision securities were due to the continued dislocation of the securities market and changes in market interest rates. All of these securities have continued to pay as scheduled despite their impairment due to current market conditions and there has been no observable deterioration in the credit rating or financial performance of the underlying municipality that in the opinion of management would impact the ultimate repayment of the security.

Municipal securities with unrealized losses as of June 30, 2011 are summarized in the table below.

Unrealized

Book

Market

Gain

State

Moody’s

S&P

Description

Value

(Loss)

Type

Issued

Issuer

Rating

Alisal USD

304,473

281,460

(23,013

)

MBIA

Barstow USD

413,875

401,460

(12,415

)

MBIA

Big Bear Lake

240,000

215,359

(24,641

)

REV

AMBAC

Big Bear Lake

249,161

224,333

(24,828

)

REV

AMBAC

El Rancho USD

403,450

403,264

(186

)

FGIC

Fort Bragg USD

222,326

200,390

(21,936

)

ZGO

FGIC

Gonzales USD

180,302

160,553

(19,749

)

ZGO

FSA

Aa3

AA+

Mountain View SD

410,455

406,932

(3,523

)

MBIA

Baa1

A+

Oroville ESD

368,334

335,861

(32,448

)

ZGO

FGIC

A+

Pacific Grove USD

470,505

459,620

(10,885

)

XLCA

Rancho Mirage PWRS

242,467

239,215

(3,252

)

REV

AMBAC

Aa2

Rocklin USD

313,718

312,922

(796

)

ZGO

FSA

Aa2

AA+

Clinton-McComb P Lib

419,443

413,427

(6,016

)

XLCA

AA-

Wapakoneta SWR

400,000

396,392

(3,608

)

REV

AMBAC

North Sewickley TWP

300,000

267,594

(32,406

)

REV

XLCA

Hunters Glen MUD

276,287

276,185

(102

)

FSA

Aa3

Ingleside ISD

412,284

408,288

(3,996

)

PSF

AAA

Progreso ISD

515,869

514,745

(1,124

)

PSF

Aaa

6,142,949

5,918,000

(224,924

)

Index

3.	AVAILABLE-FOR-SALE INVESTMENT SECURITIES (Continued)

Management’s periodic evaluation of municipal investments includes a determination that a withdrawn rating (WR) or no rating (NR) by a rating agency is not attributable to increased credit risk. The Company has established risk parameters within its investment policy that limits the Company’s exposure to the municipal market and serves to promote diversification and low risk within the municipal segment of the portfolio. Municipal investment purchases are designed primarily to manage interest rate risk and secondarily to achieve income. In addition, the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity. Therefore, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2011.

The amortized cost and estimated fair value of investment securities at June 30, 2011 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost		Estimated Fair Value

Within one year	$	-	$	-
After one year through five years		8,830,526		8,987,000
After five years through ten years		3,630,183		3,594,000
After ten years		15,503,738		15,620,000
		27,964,447		28,201,000
Investment securities not due at a single
maturity date:
Mortgage-backed securities		30,566,052		31,195,000

	$	58,530,499	$	59,396,000

There were $38,481,000 and $41,476,000 of investment securities pledged to secure public deposits at June 30, 2011 and December 31, 2010, respectively.

LOANS

Outstanding loans are summarized below, in thousands:

	June 30, 2011			December 31, 2010
Commercial	$	50,111,378		$	46,293,872
Real estate – mortgage		162,223,513			165,202,316
Real estate – construction		20,373,052			23,437,082
Agricultural		4,420,746			4,303,655
Consumer		2,250,166			2,152,766
		239,378,855			241,389,691

Deferred loan fees, net		(314,370	)		(386,429	)
Allowance for loan and lease losses		(7,031,763	)		(6,698,952	)
	$	232,032,722		$	234,304,310

Changes in the allowance for loan and lease losses for the three and six months ended June 30, 2011 and 2010 were as follows:

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

Balance, beginning of period	$	6,930,851		$	6,822,349		$	6,698,952		$	6,231,065

Provision charged to operations		-			650,000			225,000			1,250,000
Losses charged to allowance		(4,356	)		(35,693	)		(4,356	)		(48,048	)
Recoveries		105,268			3,000			112,167			6,639
Balance, end of period	$	7,031,763		$	7,439,656		$	7,031,763		$	7,439,656

Index

5.	ALLOWANCE FOR LOAN AND LEASE LOSSES

The following tables show the allocation of the allowance for loan and lease losses at June 30, 2011 and December 31, 2010, and for the three and six months ended June 30, 2011 by portfolio segment and by impairment methodology:

As of and for the three months ended June 30, 2011

				Real		Real				Consumer
				Estate -		Estate -				And
	Commercial			Mortgage		Construction		Agricultural		Other		Unallocated		Total

Allowance for Loan and Lease Losses

Balance, beginning of period	$	2,773,473		$	698,069	$	3,341,076	$	45,320	$	72,914	$	-	$	6,930,852
Losses charged to the allowance		(4,356	)		-		-		-		-		-		(4,356	)
Recoveries on loans and leases
previously charged-off		5,277			99,990		-		-		-				105,267
Provision charged to operations		-			-		-		-		--				-
Balance, end of period	$	2,774,394		$	798,059	$	3,341,076	$	45,320	$	72,914	$	-	$	7,031,763

As of and for the period ended June 30, 2011

				Real		Real				Consumer
				Estate -		Estate -				And
	Commercial			Mortgage		Construction		Agricultural		Other			Unallocated		Total

Allowance for Loan and Lease Losses

Balance, beginning of period	$	2,641,106		$	608,792	$	3,327,863	$	40,409	$	80,782		$	-	$	6,698,952
Losses charged to the allowance		(4,356	)		-		-		-		-			-		(4,356	)
Recoveries on loans and leases
previously charged-off		12,177			99,990											112,167
Provision charged to operations		125,467			89,277		13,213		4,911		(7,868	)				225,000
Balance, end of period	$	2,774,394		$	798,059	$	3,341,076	$	45,320	$	72,914		$	-	$	7,031,763

Individually evaluated
for impairment	$	1,197,282		$	488,927	$	301,852	$	-	$	-		$	-	$	1,988,061
Collectively evaluated
for impairment		1,577,112			309,132		3,039,224		45,320		72,914			-		5,043,702
Total	$	2,774,394		$	798,059	$	3,341,076	$	45,320	$	72,914		$	-	$	7,031,763



Loans

Ending balance	$	50,111,378		$	162,223,513	$	20,373,052	$	4,420,746	$	2,250,166				$	239,378,855

Ending balance: individually
evaluated for impairment	$	2,736,316		$	9,139,305	$	4,067,686	$	-	$	-				$	15,943,307

Ending balance: collectively
evaluated for impairment	$	47,375,062		$	153,084,208	$	16,305,366	$	4,420,746	$	2,250,166				$	223,435,548

Index

5.	ALLOWANCE FOR LOAN AND LEASE LOSSES (continued)

As of December 31, 2010

			Real		Real
			Estate -		Estate -				Consumer
	Commercial		Mortgage		Construction		Agricultural		And Other		Unallocated		Total

Allowance for Loan and Lease Losses

Ending balance allocated
to portfolio segments	$	2,641,106	$	608,792	$	3,327,863	$	80,782	$	40,409	$	-	$	6,698,952

Ending balance: individually
evaluated for impairment	$	1,430,562	$	92,658	$	260,283	$	-	$	-	$	-	$	1,783,503

Ending balance: collectively
evaluated for impairment	$	1,210,544	$	516,134	$	3,067,580	$	80,782	$	40,409	$	-	$	4,915,449


Loans

Ending balance	$	46,293,872	$	165,202,316	$	23,437,082	$	4,303,655	$	2,152,766	$	-	$	241,389,691

Ending balance: individually
evaluated for impairment	$	3,112,068	$	1,776,842	$	6,595,040	$	-	$	-	$	-	$	11,483,950

Ending balance: collectively
evaluated for impairment	$	43,181,804	$	163,425,474	$	16,842,042	$	4,303,655	$	2,152,766	$	-	$	229,905,741

Index

5.	ALLOWANCE FOR LOAN AND LEASE LOSSES (continued)

Credit Quality Indicators

The Company assigns a risk rating to all loans except pools of homogeneous loans and periodically performs detailed reviews of all such loans over a certain threshold to identify credit risks and to assess the overall collectability of the portfolio. These risk ratings are also subject to examination by independent specialists engaged by the Company and by the Company's regulators. During these internal reviews, management monitors and analyzes the financial condition of borrowers and guarantors, trends in the industries in which borrowers operate and the fair values of collateral securing these loans. These credit quality indicators are used to assign a risk rating to each individual loan. The risk ratings are grouped into five major categories as follows: Pass, Watch, Special Mention, Substandard and Doubtful.

The following table shows the loan portfolio allocated by management's internal risk ratings at June 30, 2011 and December 31, 2010:

	Commercial Credit Exposure
	Credit Risk Profile by Internally Assigned Grade

As of June 30, 2011	Commercial		Real Estate - Mortgage		Real Estate - Construction		Consumer and Other		Agriculture		Total

Grade:
Pass	$	36,427,078	$	127,969,897	$	6,002,458	$	2,214,879	$	4,247,562	$	176,861,874
Watch		605,753		4,413,456		9,342,142		-		-		14,361,351
Special Mention		8,178,502		11,448,054		1,343,667		-		173,184		21,143,407
Substandard		4,900,045		18,392,106		3,684,785		35,287		-		27,012,223
Doubtful		-		-		-		-		-		-
Total	$	50,111,378	$	162,223,513	$	20,373,052	$	2,250,166	$	4,420,746	$	239,378,855

	Commercial Credit Exposure
	Credit Risk Profile by Internally Assigned Grade

As of December 31, 2010	Commercial		Real Estate -Mortgage		Real Estate -Construction		Consumer and Other		Agriculture		Total

Grade:
Pass	$	31,512,542	$	132,778,115	$	7,246,462	$	1,967,364	$	4,116,617	$	177,621,100
Watch		3,908,958		6,672,747		7,052,354		148,659		187,038		17,969,756
Special Mention		5,240,543		8,589,322		1,439,667		-		-		15,269,532
Substandard		5,631,829		17,162,132		7,698,599		36,743		-		30,529,303
Doubtful		-		-		-		-		-		-
Total	$	46,293,872	$	165,202,316	$	23,437,082	$	2,152,766	$	4,303,655	$	241,389,691

Index

5.	ALLOWANCE FOR LOAN AND LEASE LOSSES (continued)

The following tables show an aging analysis of the loan portfolio at June 30, 2011 and December 31, 2010:

	30-89 Days Past Due		90 Days and Still Accruing		Nonaccrual		Total Past Due		Current		Total
As of June 30, 2011

Commercial:
Commercial and industrial	$	37,248	$	-	$	1,083,976	$	1,121,224	$	19,382,543	$	20,503,767
Commercial lines		250,000		-		-		250,000		27,774,914		28,024,914
Commercial guaranteed		-		-		-		-		1,582,697		1,582,697
Agricultural:
Agricultural		-		-		-		-		3,834,299		3,834,299
Agricultural Capital assets		-		-		-		-		586,447		586,447
Real Estate-Construction:
Construction		-		-						12,592,008		12,592,008
Construction 1-4 family		-		-		748,172		748,172		2,480,032		3,228,204
Construction loan others		232,135		-		1,287,363		1,519,498		3,033,342		4,552,839
Real Estate-Mortgage:
Mortgage 1-4 family		-		-		-		-		10,844,471		10,844,471
Real Estate		1,156,165		-		5,792,358		6,948,522		139,299,536		146,248,058
Real Estate - Ag		-		-		-		-		1,586,786		1,586,786
Home Equity loans		-		-		-		-		3,544,198		3,544,198
Consumer:
Auto		-		-		-		-		121,580		121,580
Consumer		-		-		-		-		411,365		411,365
Other		-		-		-		-		1,717,222		1,717,222
Total	$	1,675,548	$	-	$	8,911,869	$	10,587,416	$	228,791,439	$	239,378,855

	30-89 Days Past Due		90 Days and Still Accruing		Nonaccrual		Total Past Due		Current		Total
As of December 31, 2010

Commercial:
Commercial and industrial	$	51,135	$	-	$	-	$	51,135	$	22,283,620	$	22,334,755
Commercial lines		-		-		747,054		747,054		21,806,591		22,553,645
Commercial guaranteed		556		-		-		556		1,404,916		1,405,472
Agricultural:
Agricultural		-		-		-		-		3,630,210		3,630,210
Agricultural Capital assets		-		-		-		-		673,445		673,445
Real Estate-Construction:										-		-
Construction		-		-		905,246		905,246		13,298,945		14,204,191
Construction 1-4 family		197,544		-		-		197,544		3,441,631		3,639,175
Construction loan others		-		-		-		-		5,593,716		5,593,716
Real Estate-Mortgage:
Mortgage 1-4 family		-		-		-		-		12,792,286		12,792,286
Real Estate		4,924		-		5,170,238		5,175,162		141,864,623		147,039,785
Real Estate - Ag		-		-		-		-		1,726,232		1,726,232
Home Equity loans		-		-		-		-		3,644,013		3,644,013
Consumer:
Auto		-		-		-		-		160,201		160,201
Consumer		-		-		-		-		446,960		446,960
Other		-		-		-		-		1,545,605		1,545,605
Total	$	254,159	$	-	$	6,822,538	$	7,076,697	$	234,312,994	$	241,389,691

Index

5.	ALLOWANCE FOR LOAN AND LEASE LOSSES (continued)

The following tables show information related to impaired loans for the period ended June 30, 2011 and for the year ended December 31, 2010:

			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
Impaired loans as of June 30, 2011

With no related allowance recorded:
Commercial	$	266,244	$	366,236	$	-	$	1,470,817	$	919
Real estate - mortgage		7,047,502		8,130,369		-		7,403,545		10,820
Real estate - construction		1,925,888		3,022,150		-		3,023,447		51,795

With an allowance recorded:
Commercial	$	2,368,453	$	2,370,080	$	1,197,282	$	2,352,302	$	76,117
Real estate – mortgage		1,008,938		1,008,936		488,927		1,011,771		32,642
Real estate – construction		980,308		1,045,536		301,852		1,048,962		5,794

Total:
Commercial	$	2,634,697	$	2,736,316	$	1,197,282	$	3,823,119	$	77,036
Real estate – mortgage		8,056,440		9,139,305		488,927		8,415,316		43,462
Real estate – construction		2,906,196		4,067,686		301,852		4,072,409		57,589

			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
Impaired loans as of December 31, 2010

With no related allowance recorded:
Commercial	$	790,042	$	884,488	$	-	$	981,444	$	3,111
Real estate - mortgage		4,219,223		5,182,771		-		5,226,383		119,642
Real estate - construction		764,604		1,854,589		-		1,857,234		103,874

With an allowance recorded:
Commercial	$	2,322,026	$	2,322,025	$	1,430,562	$	2,394,814	$	139,083
Real estate – mortgage		2,375,818		2,411,734		92,658		2,428,367		88,045
Real estate – construction		1,012,238		1,050,946		260,283		1,077,766		24,756

Total:
Commercial	$	3,112,068	$	3,206,513	$	1,430,562	$	3,376,258	$	142,194
Real estate – mortgage		6,595,040		7,594,505		92,658		7,654,750		207,687
Real estate – construction		1,776,842		2,905,535		260,283		2,935,000		128,630

Index

5.	ALLOWANCE FOR LOAN AND LEASE LOSSES (continued)

A summary of troubled debt restructured loans is set forth below:

Dollars in thousands
	June 30, 2011				December 31, 2010
	Amount		No. of Loans		Amount		No. of Loans

Nonperforming Loans	$	4,403,916		4	$	4,431,413		4
Performing Loans	$	1,404,193		6	$	1,324,348		4

Total troubled debt restructured loans	$	5,808,109		10	$	5,755,761		8

The modifications and concessions granted to troubled debt restructures generally consist of 6 to 12 months’ deferral of principal payments or an interest rate reduction or a lengthened amortization, or a combination thereof. Of the ten loans identified as troubled debt restructures at June 30, 2011, five were granted deferral of principal payments, two had interest rate reductions and lengthened amortization, one had deferral of principal payment and a rate reduction, and two had lengthened amortization. When a loan becomes a troubled debt restructure, it is normally placed in nonaccrual status until it is evident that the borrower will perform at the modified terms. The Company’s policy is to require satisfactory payments for a six month period before the loan will be considered for reinstatement to accrual status. The Company does not have commitments to lend additional funds to borrowers with loans whose terms have been modified in troubled debt restructurings.

A summary of modified loans that do not meet the definition of troubled debt restructures is set forth below:

	June 30, 2011

Commercial	$	835,278
Real Estate-Mortgage		10,945,823
Real Estate-Construction		-
Agricultural		-
Consumer and Other		-

Total	$	11,781,101

The Bank has granted concessions on loans that do not meet the definition of a troubled debt restructure. The loan terms were modified due to competitive pressures. The customers involved were highly creditworthy and were determined by management to be likely and able to move their business to a competing financial institution if their loan terms were not modified.

Foregone interest on nonaccrual loans totaled $468,737 and $250,593 for the periods ended June 30, 2011 and 2010, respectively, and $1,153,000 for the year ended December 31, 2010. There were no accruing loans past due 90 days or more at June 30, 2011 or December 31, 2010.

Index

6.	BANK PREMISES AND EQUIPMENT

Premises and equipment consisted of the following:

	June 30, 2011			December 31, 2010
Furniture and equipment	$	2,722,250		$	2,646,895
Premises		6,595,672			6,581,465
Leasehold improvements		207,342			207,342
Land		1,461,379			1,461,379
		10,986,643			10,897,081

Less accumulated depreciation and amortization		(2,655,331	)		(2,386,393	)
	$	8,331,312		$	8,510,688

7.	COMMITMENTS AND CONTINGENCIES

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

In the normal course of business, the Company has various outstanding commitments to extend credit which are not reflected in the financial statements, including loan commitments of $25.9 million and $29.8 million and letters of credit of $475,000 and $275,000 at June 30, 2011 and December 31, 2010, respectively.

At June 30, 2011, consumer loan commitments, which are generally unsecured, represent approximately 9% of total commitments. Agricultural loan commitments represent approximately 9% of total commitments and are generally secured by crops and/or real estate. Commercial loan commitments represent approximately 60% of total commitments and are generally secured by various assets of the borrower. Real estate loan commitments represent the remaining 22% of total commitments and are generally secured by property with a loan-to-value not to exceed 80%. In addition, the majority of the Bank’s commitments have variable interest rates. Total commitments do not necessarily represent future cash requirements. Each loan commitment and the amount and type of collateral obtained, if any, are evaluated on an individual basis. Collateral held varies, but may include real property, bank deposits, debt or equity securities or business assets.

Stand-by letters of credit are conditional commitments written to guarantee the performance of a customer to a third party. These guarantees are primarily related to the purchases of inventory by commercial customers and are typically short-term in nature. Credit risk is similar to that involved in extending loan commitments to customers and, accordingly, evaluation and collateral requirements similar to those for loan commitments are used. The deferred liability related to the Company’s stand-by letters of credit was not significant at June 30, 2011 or December 31, 2010.

Index

8.	STOCK BASED COMPENSATION

The Company has two active share based compensation plans; the Valley Commerce Bancorp 2007 Equity Incentive Plan (“Incentive Plan”) for which 101,300 shares of common stock are reserved for issuance to employees and directors under incentive and non-statutory agreements and the Valley Commerce Bancorp Amended and Restated 1997 Stock Option Plan (“Prior Plan”) for which 159,010 shares of common stock are reserved for issuance, however, no further grants may be made under this plan as it expired in February 2007. The Incentive Plan provides for awards of stock options, restricted stock awards, qualified performance-based awards and stock grants. The purpose of the Incentive Plan is to promote the long-term success of the Company and the creation of shareholder value. The Board of Directors believes that the availability of stock options and other forms of stock awards will be a key factor in the ability of the Company to attract and retain qualified individuals.

During the six-month period ended June 30, 2011, the Company awarded 1,000 shares of restricted stock. The restricted stock will vest in two-years from the date of grant.

In addition during the six-month period ended June 30, 2011 there were 2,100 incentive stock options and 8,400 non-qualified stock options granted to the Company’s officers and directors, respectively, at a price of $7.81 per option. There were no options granted during the six-month period ended June 30, 2010. There were no stock options issued in the three month period ended June 30, 2011 or 2010.

The fair value of each award granted is estimated on the grant date using the Black-Scholes option pricing model. Fair value of the grant is based on the weighted-average assumptions show in the table below.

	Six Months Ended
	June 30, 2011
Dividend yield		N/A
Expected option life	8.83 years
Expected volatility		46.9	%
Risk-free interest rate		1.23	%
Weighted average
Fair value of options granted	$	5.27

The expected life of awards granted represents the period of time that awards are expected to be outstanding. Expected volatility is based on historical volatility of the Company’s stock and other factors. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

Compensation expense is recognized over the vesting period on a straight line accounting basis. Compensation cost related to stock options recognized in operating results was $84,219and $26,256 for the six month periods ended June 30, 2011 and 2010, respectively. The tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) are classified as cash flow from financing activities in the statement of cash flows. There were no excess tax benefits during the periods ended June 30, 2011 or 2010.

Index

8.	STOCK BASED COMPENSATION (Continued)

The following table summarizes information about stock option activity for the six months ended June 30, 2011:

	For the Six Months Ended June 30, 2011
	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value (in thousands)

Incentive:
Options outstanding at January 1, 2011		60,641		$	9.88
Options granted		2,100			7.81
Options exercised
Options cancelled		(1,158	)		12.53
Options outstanding at June 30, 2011		61,583			9.76	4.00 years	$	54,199	(1)
Options vested or expected to vest after June 30, 2011		50,469			9.10	3.41 years	$	54,199	(1)
Options exercisable at June 30, 2011		49,782			9.10	3.41 years	$	54,199	(1)

Nonstatutory:
Options outstanding at January 1, 2011		66,803		$	10.50
Options granted		8,400			7.81
Options exercised
Options cancelled
Options outstanding at June 30, 2011		75,203			10.20	3.81 years	$	24,672	(1)
Options vested or expected to vest after June 30, 2011		73,684			10.13	3.72 years	$	24,672	(1)
Options exercisable at June 30, 2011		72,889			10.13	3.72 years	$	24,672	(1)

(1) 60,154 non-statutory options and 38,255 incentive options are excluded from intrinsic value from table above because the exercise price is greater than the stock price at June 30, 2011.

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock for options that were in-the-money at June 30, 2011. There were no options exercised during the six months ended June 30, 2011 and 2010. The total fair value of shares vested during the three months ended June 30, 2011 and 2010 was $0 and $38,994, respectively. The total fair value of shares vested during the six months ended June 30, 2011 and 2010 was $173,386 and $139,141, respectively.

Management estimates expected forfeitures and recognizes compensation costs only for those equity awards expected to vest. As of June 30, 2011, there was $99,950 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. The cost is expected to be realized over a weighted average period of three months and will be adjusted for subsequent changes in estimated forfeitures.

Index

9.	EARNINGS PER SHARE COMPUTATION

Basic earnings per share are computed by dividing income available to common shareholders by the weighted average common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur if outstanding stock options were exercised. Diluted earnings per share are computed by dividing income available to common shareholders by the weighted average common shares outstanding for the period plus the dilutive effect of options.

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2011			2010			2011			2010
Net Income:
Net income	$	859,282		$	473,246		$	1,484,246		$	723,761
Dividends accrued and discounts
accreted on preferred shares		(106,053	)		(98,387	)		(207,519	)		(193,569	)
Net income allocated to common
shareholders	$	753,229		$	374,859		$	1,276,727		$	530,192
Earnings Per Share:
Basic earnings per share	$	0.27		$	0.14		$	0.46		$	0.19
Diluted earnings per share	$	0.27		$	0.14		$	0.46		$	0.19
Weighted Average Number of Shares Outstanding:
Basic shares		2,762,723			2,739,560			2,762,469			2,739,560
Diluted shares		2,774,847			2,742,625			2,771,802			2,743,007

All earnings per share and weighted-average share amounts in the above table have been restated to reflect the 5% stock dividend in June 2011. There were 98,409 options excluded from the computation of diluted earnings per share for the three and six month periods ended June 30, 2011, respectively, and 108,589 excluded from the computation of diluted earnings per share for the three and six month periods ended June 30, 2010, respectively, as they were identified as anti-dilutive.

10.	COMPREHENSIVE INCOME

Comprehensive income includes net income and other comprehensive income. The Company's only source of other comprehensive income is derived from unrealized gains and losses on investment securities available for sale. The Company's comprehensive income was as follows:

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

Net income		$	859,282		$	473,246		$	1,484,246		$	723,761
Other comprehensive income:
Unrealized holding gain on available-for-sale
investment securities, net of tax			557,915			161,888			550,496			259,678
Total other comprehensive income		$	1,417,197		$	635,134		$	2,034,742		$	983,439

Index

11.	INCOME TAXES

The Company files its income taxes on a consolidated basis with its subsidiaries. The allocation of income tax expense represents each entity's proportionate share of the consolidated provision for income taxes.

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

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying condensed consolidated balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company recognizes accrued interest and penalties, if any, related to unrecognized tax benefits as a component of tax expense in the condensed consolidated statements of income. There have been no significant changes to unrecognized tax benefits or accrued interest and penalties for the six months ended June 30, 2011.

12.	PREFERRED STOCK

On January 30, 2009, the Company entered into a letter Agreement (the “Purchase Agreement”) with the United States Department of the Treasury (“Treasury”), pursuant to which the Company issued and sold (i) 7,700 shares of the Company’s Fixed Rate Cumulative Preferred Stock, Series B (the “Series B Preferred Stock”) and (ii) a warrant to purchase 385 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock Series C stock, (the “Warrant Preferred” or “Series C Preferred Stock”) for a combined purchase price of $7,700,000 and were recorded net of $20,793 in offering costs. The Treasury exercised the Warrant immediately upon issuance.

The Series B Preferred Stock Qualifies as Tier 1 capital and pays cumulative dividends quarterly at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Warrant Preferred pays cumulative dividends at a rate of 9% per annum until redemption. The terms governing the Series B Preferred Stock and the Series C Preferred Stock provide that either series may be redeemed by the Company after three years; however, the Warrant Preferred may not be redeemed until after all the Series B Preferred stock has been redeemed, and prior to the end of three years, the Series B Preferred stock and the Warrant Preferred may be redeemed by the Company only with proceeds from the sale of Qualifying equity securities of the Company (” Qualified Equity Offering”). The American Recovery and Reinvestment Act of 2009, which was enacted on February 17, 2009 permits the Company to redeem the Series B Preferred stock and the Warrant Preferred without a Qualified Equity Offering, subject to the Company’s consultation with the Board of Governors of the Federal Reserve System.

The Series B Preferred Stock and the Warrant Preferred were issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. The Company has agreed to register the Series B Preferred Stock and the Warrant Preferred as soon as practicable (but not later than 30 days) after demand by the United States Department of the Treasury. Neither the Series B Preferred Stock nor the Warrant Preferred will be subject to any contractual restrictions on transfer, except that Treasury and its transferees shall not effect any transfer of the Preferred which would require the Company to become subject to the periodic reporting requirements of Section 13 or 15(d) of the Exchange Act.

Index

12.	PREFERRED STOCK (Continued)

With respect to dividends on the Company’s common stock, Treasury’s consent shall be required for any increase in common dividends per share until the third anniversary of the date of its investment unless prior to such third anniversary the Series B Preferred Stock and the Warrant Preferred is redeemed in whole or the Treasury has transferred all of the Senior Preferred Series B Preferred Stock and Warrant Preferred to third parties. After the third anniversary and prior to the tenth anniversary, the Treasury’s consent shall be required for any increase in aggregate common dividends per share that no increase in common dividends may be made as a result of any dividend paid in common shares, any stock split or similar transaction. From and after the tenth anniversary, the Company shall be prohibited from paying common dividends or repurchasing any equity securities or trust preferred securities until all equity securities held by the Treasury are redeemed in whole of the Treasury has transferred all of such equity securities to third parties.

13.	FAIR VALUE MEASUREMENT

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis as of June 30, 2011. The table also indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Assets and liabilities measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010 are summarized below:

	June 30, 2011
Description	Fair Value		Level 1		Level 2		Level 3

Available-for-sale investment securities
Debt securities:
U.S. Government agencies	$	11,758,000	$	—	$	11,758,000	$	—
Mortgage-backed securities:
U.S. Government agencies		17,725,000		—		17,725,000		—
Small Business Administration		13,470,000		—		13,470,000		—
Municipal securities		16,443,000		—		16,443,000		—
Total assets measured at fair value	$	59,396,000	$	—	$	59,396,000	$	—

	December 31, 2010
Description	Fair Value		Level 1		Level 2		Level 3

Available-for-sale investment securities
Debt securities:
U.S. Treasury securities	$	3,800,000	$	—	$	3,800,000	$	—
U.S. Government agencies		5,533,000		—		5,533,000		—
Mortgage-backed securities:
U.S. Government agencies		12,770,000		—		12,770,000		—
Small Business Administration		14,577,000		—		14,577,000		—
Municipal securities		14,143,000		—		14,143,000		—
Total assets measured at fair value	$	50,823,000	$	—	$	50,823,000	$	—

Index

13.	FAIR VALUE MEASUREMENT (Continued)

Fair values for Level 2 available-for-sale investment securities are based on quoted market prices for similar securities. During the six month period ended June 30, 2011 and year ended December 31, 2010, there were no transfers in or out of Levels 1, 2, or 3.

The fair value of investment securities available for sale equals quoted market price, if available. If quoted market prices for identical securities are not available then fair value are estimated by independent sources using pricing models and/or quoted prices of investment securities with similar characteristics or discounted cash flows. The Company has categorized all of its investment securities available-for-sale as level 2, since U.S. Agency MBS are mainly priced in this manner. Changes in fair market value are recorded in other comprehensive income.

The Company had no liabilities measured at fair value on a recurring basis as of June 30, 2011 or December 31, 2010.

Assets measured at fair value on a non-recurring basis as of June 30, 2011 and December 31, 2010 are summarized below:

	Fair Value Measurements at June 30, 2011 Using
			Quoted Prices in		Significant Other		Significant
			Active Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs		Total Gains
	Total Fair Value		(Level 1)		(Level 2)		(Level 3)		(Losses)
Assets:
Impaired loans at:
Commercial	$	1,171,000	$	-	$	-	$	1,171,000	$	(255,000	)
Real estate – mortgage		3,467,000		-		2,947,000		520,000		193,000
Real estate - construction		1,317,000		-		1,227,000		90,000		(42,000	)
Agricultural		-		-		-		-		-
Consumer and other		-		-		-		-		-
	$	5,955,000	$	-	$	4,174,000	$	1,781,000	$	(104,000	)

	Fair Value Measurements at December 31, 2010 Using
			Quoted Prices in		Significant Other		Significant
			Active Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs		Total Gains
	Total Fair Value		(Level 1)		(Level 2)		(Level 3)		(Losses)
Assets:
Impaired loans at:
Commercial	$	1,906,000	$	-	$	-	$	1,906,000	$	(69,000	)
Real estate – mortgage		3,021,000		-		3,021,000		-		472,000
Real estate - construction		2,460,000		-		2,296,000		164,000		(1,099,000	)
Agricultural		-		-		-		-		-
Consumer and other		-		-		-		-		-
	$	7,387,000	$	-	$	5,317,000	$	2,070,000	$	(696,000	)

Index

13.	FAIR VALUE MEASUREMENT (Continued)

Impaired loans (loans which are not expected to repay all principal and interest amounts due in accordance with the original contractual terms) are measured at an observable market price (if available) or at the fair value of the loan’s collateral (if collateral dependent). Fair value of the loan’s collateral is determined by appraisals or independent valuation which is then adjusted for the estimated costs related to liquidation of the collateral. Management monitors the availability of observable market data to assess the appropriate classifications of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. Management’s ongoing review of appraisal information may also result in additional discounts or adjustments to the valuation based upon more recent market sales activity or more current appraisal information derived form properties of similar type and/or locale. A significant portion of the Bank’s impaired loans are measured using the estimated fair market value of the collateral less the estimated costs to sell. Therefore, the Company has categorized its impaired loans as level 2 and level 3. The Bank’s appraisal policy generally requires impaired loans to be appraised at six month intervals. Impaired loans with current appraisals that have been discounted to liquidation value through additional market research of comparable properties are included in Level 2, while appraisals that are not adjusted in this manner or which are based on projections of cash flows are included in Level 3. Any fair value adjustments are recorded in the period incurred as provision for loan losses expense on the Condensed Consolidated Statement of Income. The recorded investment in impaired loans was $7,943,000 and $9,171,000 with a valuation allowance of $1,988,000 and $1,784,000 at June 30, 2011 and December 31, 2010, respectively.

The Company did not change the methodology used to determine fair value for any financial instruments during 2011. There were no transfers between Level 1, Level 2, or Level 3 fair value measurements during the three months ended June 30, 2011.

Fair Value of Financial Instruments

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

	June 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value

Financial assets:
Cash and cash equivalents	$	24,426,384	$	24,426,384	$	32,667,967	$	32,667,967
Available-for-sale
investment securities		59,396,000		59,396,000		50,823,000		50,823,000
Loans, net		232,032,722		228,435,085		234,304,310		231,913,397
Cash surrender value of life
insurance policies		6,760,398		6,6760,398		6,627,060		6,627,060
Accrued interest receivable		1,240,153		1,240,153		1,209,657		1,209,657
FHLB stock		1,360,700		1,360,700		1,360,700		1,360,700

Financial liabilities:
Deposits	$	289,953,790	$	290,377,999	$	294,277,800	$	294,622,852
Long-term debt		2,357,014		2,715,577		2,561,650		2,847,132
Junior subordinated deferrable
interest debentures		3,093,000		804,180		3,093,000		804,180
Accrued interest payable		90,829		90,829		97,597		97,597

Index

14.	RECENT ACCOUNTING DEVELOPMENTS

Determination of Whether a Restructuring is a Troubled Debt Restructuring

In April 2011, FASB issued ASU 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. This ASU provides for a more consistent application of the accounting guidance for troubled debt restructurings. This ASU clarified guidance on a creditor’s evaluation of whether it has granted a concession to a borrower, and clarified guidance to determine if a borrower is experiencing financial difficulties. This ASU also finalized the disclosures required in a creditor’s financial statements related to troubled debt restructurings. This standard is effective for interim or annual periods beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. Early adoption is permitted. Management is assessing the impact this standard may have on the Company’s financial position, results of operations and cash flows.

Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs

In May 2011, FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs. The amendments to the FASB Accounting Standards Codification™ (Codification) in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. Management does not believe the adoption of this ASU will have a significant impact have on the Company’s financial position, results of operations and cash flows.

Presentation of Comprehensive Income

In June 2011, FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends the FASB Accounting Standards CodificationTM (Codification) to allow an entity the option 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. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments to the Codification in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. . Management does not believe the adoption of this ASU will have a significant impact have on the Company’s financial position, results of operations and cash flows.

Index

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

Certain matters discussed in this report constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements contained herein that are not historical facts, such as statements regarding the company’s current business strategy and the Company’s plans for future development and operations, are based upon current expectations. These statements are forward-looking in nature and involve a number of risks and uncertainties. Such risks and uncertainties include, among others: (1) significant increases in competitive pressure in the banking and financial services industries; (2) changes in the interest rate environment, which could reduce anticipated or actual margins; (3) changes in the regulatory environment; (4) general economic conditions, either nationally or regionally and especially in the Company’s primary service area failing to improve or continuing to deteriorate and resulting in, among other things, a deterioration in credit quality and increases in the provision for loan loss; (5) operational risks, including data processing systems failures or fraud; (6) changes in business conditions and inflation; (7) changes in technology; (8) changes in monetary and tax policies; and (9) changes in the securities markets; (10) civil disturbances or terrorist threats or acts, or apprehension about the possible future occurrences or acts of this type; (11) outbreak or escalation of hostilities in which the United States is involved, any declaration of war by the U.S. Congress or any other national or international calamity, crisis or emergency; (12) changes in laws and regulations; (13) new or recently issued accounting pronouncements; (14) government policies, regulations, and their enforcement (including Bank Secrecy Act-related matters, taxing statutes and regulations; (15) restrictions on dividends that our subsidiaries are allowed to pay to us; (16) the ability to satisfy requirements related to the Sarbanes-Oxley Act and other regulation on internal control; and (17) management’s ability to manage these and other risks. Therefore, the information set forth in such forward-looking statements should be carefully considered when evaluation the business prospects of the Company.

The Securities and Exchange Commission (SEC) maintains a web site which contains reports, proxy statements, and other information pertaining to registrants that file electronically with the SEC, including the Company. The internet address is: www.sec.gov. In addition, our periodic and current reports are available free of charge on our website at www.valleybusinessbank.net as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

Index

Introduction

Overview

Valley Commerce Bancorp (the Company) is the holding company for Valley Business Bank (the Bank), a California state chartered bank. The Company’s principal business is to provide financial services through its banking subsidiary in its primary market areas of Tulare and Fresno Counties in California. The Company derives its income primarily from interest and fees earned on loans and, to a lesser extent, interest on investment securities, fees for services provided to deposit customers, and fees from the brokerage of loans. The Bank’s major operating expenses are interest paid on deposits and borrowings and general operating expenses, consisting primarily of salaries and employee benefits and, to a lesser extent, occupancy and equipment, data processing, FDIC insurance premiums, and operations. The Company does not currently conduct any operations other than through the Bank.

The Company earned net income of $859,000, or $0.27 per diluted share for the three months ended June 30, 2011, compared to $473,000 or $0.14 per diluted share for the three months ended June 30, 2010. The Company earned net income of $1.5 million or $0.46 per diluted share, for the six-month period ended June 30, 2011, compared to $724,000, or $0.19 per diluted share, for the six-month period ended June 30, 2010. The annualized return on average assets was 0.87% for the six months ended June 30, 2011 and 0.43% for the same period of 2010. The annualized return on average common shareholders’ equity for the six month periods ended June 30, 2011 and 2010 was 7.57% and 3.91%, respectively. The increase in earnings was primarily due to decreases in the provision for loan losses.

At June 30, 2011, the Company’s total assets were $339.1 million, a $2.3 million decrease or 1% from total assets of $341.4 at December 31, 2010, and an increase of $1.2 million or compared to June 30, 2010. Total loans were $232.0 million at June 30, 2011, a decrease of $2.3 million or 1% compared to December 31, 2010, and a decrease of $12.1 million or 5% compared to June 30, 2010. The decline in loan volume in both periods was primarily attributable to loan paydowns and fewer opportunities for commercial real estate mortgage lending due to economic uncertainty.

Total deposits were $290.0 million at June 30, 2011, a decrease of $4.3 million or 1% from total deposits of $294.3 million at December 31, 2010, and a decrease of $4.0 million or 1% compared to June 30, 2010. The amount of brokered time deposits included in total deposits at June 30, 2011, December 31, 2010, and June 30, 2010 were $9.1 million, $9.2 million and $13.0 million, respectively. The decline in deposits was mostly due to the maturation of time deposits. The Company’s long term growth strategy is based on acquiring core deposits in its local market rather than relying heavily on brokered time deposits or other wholesale funding sources. The Company is presently utilizing brokered deposits to lessen the impact of a rising interest rate scenario on its net interest margin.

At June 30, 2011, the Company’s Leverage Ratio was 12.5% while its Tier 1 Risk-Based Capital Ratio and Total Risk-Based Capital Ratio were 16.6% and 17.8%, respectively. At December 31, 2010, the Company’s Leverage Ratio was 12.1% while its Tier 1 Risk-Based Capital Ratio and Total Risk-Based Capital Ratio were 16.2% and 17.5%, respectively. The Leverage, Tier 1 Risk-Based Capital and Total Risk-Based Capital Ratios at June 30, 2010 were 11.8%, 14.9% and 16.2%, respectively. The Company’s capital ratios increased during the six months ended June 30, 2011 primarily as a result of net income earned during the period and a decrease in risk-weighted assets, primarily real estate-mortgage and construction loans.

Index

Results of Operations for the Six Months Ended June 30, 2011 and 2010

Net Interest Income

The following table presents the Company’s average balance sheet, including weighted average yields and rates on a taxable-equivalent basis, for the six-month periods indicated:

	Average balances and weighted average yields and costs
	Six Months ended June 30,
	2011							2010
			Interest		Average					Interest		Average
	Average		income/		yield/			Average		income/		yield/
(dollars in thousands)	Balance		Expense		Cost			Balance		Expense		Cost
ASSETS
Due from banks	$	27,133	$	34		0.25	%	$	27,098	$	33		0.25	%
Available-for-sale investment securities:
Taxable		41,096		471		2.31	%		27,653		373		2.72	%
Exempt from Federal income taxes (1)		15,086		324		6.56	%		15,342		315		6.27	%
Total securities (1)		56,182		795		3.45	%		42,995		688		3.99	%
Loans (2) (3)		233,745		6,933		5.98	%		241,691		7,400		6.17	%
Total interest-earning assets (1)		317,060		7,762		5.04	%		311,784		8,121		5.36	%

Noninterest-earning assets, net of allowance for loan losses		28,391							31,478
Total assets	$	345,451						$	343,262

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Other interest bearing	$	122,180	$	300		0.50	%	$	122,013	$	379		0.63	%
Time deposits less than $100,000		21,884		107		0.99	%		25,569		199		1.57	%
Time deposits $100,000 or more		61,982		374		1.22	%		72,591		735		2.04	%
Total interest-bearing deposits		206,046		781		0.76	%		220,173		1,313		1.20	%
Long-term debt		2,476		63		5.13	%		3,556		95		5.39	%
Junior subordinated deferrable interest debentures		3,093		56		3.65	%		3,093		56		3.65	%
Total interest-bearing liabilities		211,615		900		0.86	%		226,822		1,464		1.30	%

Noninterest-bearing deposits		90,843							76,370
Other liabilities		3,443							2,738
Total liabilities		305,901							305,930
Shareholders’ equity		39,550							37,332
Total liabilities and shareholders’ equity	$	345,451						$	343,262

Net interest income and margin (1)			$	6,862		4.47	%			$	6,557		4.41	%

(1)	Interest income is not presented on a taxable-equivalent basis, however, the average yield was calculated on a taxable- equivalent basis by using a marginal tax rate of 34%.

(2)

Nonaccrual loans are included in total loans. Interest income is included on nonaccrual loans only to the extent cash payments have been received. There was $2 and $88 interest received on nonaccrual loans for the six-month periods ended June 30, 2011 and 2010, respectively. There was $57 and $0 interest reversed on loan transferred to nonaccrual status for the periods ended June 30, 2011 and 2010, respectively.

(3)	Interest income on loans includes amortized loan fees, net of costs, of $252 and $283 for 2011 and 2010, respectively.

Index

The following table sets forth a summary of the changes in interest income and interest expense from changes in average earning assets and interest-bearing liabilities (volume) and changes in average interest rates for the six-month periods ended June 30, 2011 and 2010.

Changes in net interest income due to changes in volumes and rates

	Six months ended June 30, 2011 vs. June 30, 2010 due to change in:
	Average			Average
	Volume			Rate (1)			Total

(In thousands)
Increase (decrease) in interest income:
Due from banks	$	-		$	1		$	1
Investment securities
Taxable		91			7			98
Exempt from Federal income taxes		(4	)		13			9
Total securities		87			20			107
Loans		(122	)		(345	)		(467	)
Total interest income	$	(35	)	$	(324	)	$	(359	)

Increase (decrease) in interest expense:
Other interest bearing deposits		-			(79	)		(79	)
Time deposits less than $100,000		(14	)		(78	)		(92	)
Time deposits $100,000 or more		(54	)		(307	)		(361	)
Total interest-bearing deposits		(68	)		(464	)		(532	)
Long-term debt		(15	)		(17	)		(32	)
Junior subordinated deferrable interest debentures		-			-			-
Total interest expense		(83	)		(481	)		(564	)
Increase in net interest income	$	48		$	157		$	205

(1)

Factors contributing to both changes in rate and volume have been attributed to changes in rates.

Net interest income before the provision for loan losses was $6.9 million for the six-month period ended June 30, 2011 compared to $6.7 million for the same period of 2010, an increase of $205,000 or 3%. Changes in the volumes of the Company’s interest-earning assets and interest-bearing liabilities caused the Company’s net interest income to increase by $48,000, and changes in interest rates on these same accounts caused net interest income to increase by $157,000.

The increase in net interest income was primarily caused by a reduction in the cost of funds, which was offset by decreases in average loan volume and declining yields on investment securities. The average rate paid on interest-bearing liabilities was 0.86% in the 2011 period compared to 1.30% in the 2010 period, a reduction of 44 basis points. Average total interest-bearing liabilities in the 2011 period decreased by $15.2 million or 7% compared to the 2010 period. This included a decrease of $14.3 million or 15% in average time deposits due to maturing time deposits that were not renewed. The Company’s long-term debt decreased by $1.1 million or 30% due to scheduled repayments.

The increase in net interest income from the decline in the cost of funds was offset by declining yields on interest-earning assets. Total interest income for the six-month periods ended June 30, 2011 and 2010 was $7.8 million and $8.1 million, respectively, a decrease of $360,000 or 4%, that was attributable to decreased loan volume and yield.

The Company’s interest income from loans decreased by $467,000 due to the impact of the average yield on loans decreasing from 6.17% in the 2010 period to 5.98% in the 2011 period, a change of 19 basis points. Average loans decreased by $7.9 million or 3%. The decrease in average loan yield was primarily due to normal repricing activity. At June 30, 2011, approximately 70% of the Company’s loan portfolio was comprised of variable rate loans of which 48% were at their floor rate.

Index

The yield on investment securities decreased from 3.99% in the 2010 period to 3.45% in the 2011 period. Growth of $13.2 in average investment securities caused interest income from investment securities to increase by $107,000.

The Company’s net interest margin on a taxable equivalent basis increased 6 basis points from 4.41% in the six-month period ended June 30, 2010 to 4.47% in the six-month period ended June 30, 2011. The improvement in the Company’s net interest margin was primarily attributable to the decrease in the average cost of funds, offset by the decrease in the yield on average assets.

Provision for Loan Losses

The provision for loan losses, which is included in operations to support management’s estimate of the required level of the allowance for loan losses, is based on credit experience and management’s ongoing evaluation of loan portfolio risk and economic conditions. There was a $225,000 provision recorded during the six months ended June 30, 2011 compared to a $1.25 million provision for the six-month period ended June 30, 2010. Management determined the provision for loan losses for the period ended June 30, 2011 after consideration of current economic conditions in the Bank’s primary markets and changes in the volume and valuation of impaired loans. See the sections below titled “Allowance for Loan Losses.”

Non-Interest Income

Non-interest income for the six-month periods ended June 30, 2011 and 2010 totaled $660,000 and $625,000, respectively, a decrease of $35,000 or 6%. The components of non-interest income during each period were as follows:

Non-interest income

	Six Months ended June 30,
(in thousands)	2011		2010		Increase (Decrease)
Service charges	$	346	$	387	$	(41	)
Gain on sale of available-for-sale investment securities		37		-		37
Mortgage loan brokerage fees		29		8		21
Earnings on cash surrender value of life insurance policies		146		146		-
Other		102		84		18
Total non-interest income	$	660	$	625	$	35

Service charges decreased by $41,000 due to decreases in analysis charges and reductions in NSF and overdrafts. Mortgage loan brokerage fees increased by $21,000 due to increased real estate loan underwriting activity. The gain on sale of investment securities resulted from sales made to reposition the investment portfolio for risk management purposes.

Index

Non-Interest Expense

For the first six months of 2011 and 2010, non-interest expense remained constant at $5.1 million. Salaries and employee benefit expense increased by $46,000 or 2% in the first half of 2011 due to the expense of stock options and restricted stock granted in the first quarter of 2011. In addition, there was a $54,000 or 26% increase in other expenses that primarily reflected increased fees for director meetings. These increases were offset by a $92,000 or 23% decrease in FDIC insurance cost due to reductions in the Temporary Liquidity Guarantee Program expense and a $66,000 or 26% decrease in professional and legal expenses due to reduced usage.

The following table describes the components of non-interest expense for the six-month periods ended June 30, 2011 and 2010:

Non-interest expense

	Six Months ended June 30,
(in thousands)	2011		2010		Increase (Decrease)
Salaries and employee benefits	$	2,773	$	2,727	$	46
Occupancy and equipment		670		663		7
Data processing		322		314		8
Operations		186		178		8
Professional and legal		192		258		(66	)
Advertising and business development		126		113		13
Telephone and postal		116		108		8
Supplies		102		97		5
Assessment and insurance		315		407		(92	)
Other expenses		259		205		54
Total non-interest expense	$	5,061	$	5,070	$	(9	)

Provision for Income Taxes

The provisions for income taxes for the six-month periods ended June 30, 2011 and 2010 was $753,000 and $239,000, respectively. The difference in the effective tax rate compared to the statutory tax rate is primarily the result of the Company’s investment in municipal securities and Company-owned life insurance policies whose income is exempt from Federal taxes. In addition, the Company receives certain tax benefits from the State of California Franchise Tax Board for operating and providing loans, as well as jobs, in designated “Enterprise Zones.” The effective tax rates for these periods were 33.7%, and 24.8%, respectively. The increase in the effective tax rate was primarily due to an increase in taxable revenues without a corresponding increase in revenues from tax exempt sources.

Index

Results of Operations for the Three Months Ended June 30, 2011

Net Interest Income

The following table presents the Company’s average balance sheet, including weighted average yields and rates on a taxable-equivalent basis, for the three-month periods indicated:

	Average balances and weighted average yields and costs
	Three Months ended June 30,
	2011							2010
			Interest		Average					Interest		Average
	Average		income/		yield/			Average		income/		yield/
(dollars in thousands)	Balance		Expense		Cost			Balance		Expense		Cost
ASSETS
Due from banks	$	32,773	$	14		0.17	%	$	30,460	$	18		0.24	%
Available-for-sale investment securities:
Taxable		44,220		263		2.39	%		28,738		190		2.65	%
Exempt from Federal income taxes (1)		16,379		171		6.34	%		15,344		159		6.30	%
Total securities (1)		60,599		434		3.46	%		44,082		349		3.92	%
Loans (2) (3)		234,208		3,421		5.86	%		242,725		3,783		6.25	%
Total interest-earning assets (1)		327,580		3,869		4.85	%		317,267		4,150		5.35	%

Noninterest-earning assets, net of allowance for loan losses		16,716							26,524
Total assets	$	344,296						$	343,791

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Other interest bearing	$	120,082	$	147		0.49	%	$	119,847	$	169		0.57	%
Time deposits less than $100,000		21,525		51		0.95	%		25,640		96		1.50	%
Time deposits $100,000 or more		62,650		185		1.18	%		73,741		387		2.11	%
Total interest-bearing deposits		204,257		383		0.75	%		219,228		652		1.19	%
Long-term debt		2,423		31		5.13	%		3,484		48		5.53	%
Junior subordinated deferrable interest debentures		3,093		28		3.63	%		3,093		28		3.63	%
Total interest-bearing liabilities		209,773		442		0.85	%		225,805		728		1.29	%

Noninterest bearing deposits		91,308							77,409
Other liabilities		3,233							3,059
Total liabilities		304,314							306,273
Shareholders’ equity		39,982							37,518
Total liabilities and shareholders’ equity	$	344,296						$	343,791

Net interest income and margin (1)			$	3,427		4.30	%			$	3,422		4.43	%

(1)	Interest income is not presented on a taxable-equivalent basis, however, the average yield was calculated on a taxable-equivalent basis by using a marginal tax rate of 34%.

(2)

Nonaccrual loans are included in total loans. Interest income is included on nonaccrual loans only to the extent cash payments have been received. There was $0 and $88 interest received on nonaccrual loans for the three month periods ended June 30, 2011 and 2010, respectively. There was $57 and $0 interest reversed on loan transferred to nonaccrual status for the periods ended June 30, 2011 and 2010, respectively.

(3)	Interest income on loans includes amortized loan fees, net of costs, of $129 and $145 for 2011 and 2010, respectively.

Index

Changes in net interest income due to changes in volumes and rates

	Three months ended June 30, 2011 vs.
	June 30, 2010 due to change in:
	Average			Average
	Volume			Rate (1)			Total

(In thousands)
Increase (decrease) in interest income:
Due from banks	$	1		$	(5	)	$	(4	)
Investment securities
Taxable		102			(29	)		73
Exempt from Federal income taxes		16			(4	)		12
Total securities		118			(33	)		85
Loans		(133	)		(229	)		(362	)
Total interest income		(14	)		(267	)		(281	)

Decrease in interest expense:
Other interest-bearing deposits		-			(22	)		(22	)
Time deposits less than $100,000		(15	)		(30	)		(45	)
Time deposits $100,000 or more		(58	)		(144	)		(202	)
Total interest-bearing deposits		(73	)		(196	)		69
Long-term debt		(15	)		(2	)		(17	)
Junior subordinated deferrable interest debentures		-			-			-
Total interest expense		(88	)		(198	)		(286	)
Increase (decrease) in net interest income	$	74		$	(69	)	$	5

(1) Factors contributing to both changes in rate and volume have been attributed to changes in rates.

Net interest income before the provision for loan losses was $3.4 million for the three-month periods ended June 30, 2011 and 2010. Changes in the volumes of the Company’s interest-earning assets and interest-bearing liabilities caused the Company’s net interest income to increase by $77,000 and changes in interest rates on these same accounts caused net interest income to decrease by $69,000.

The increase in net interest income was caused by a reduction in the Company’s cost of funds, which was offset by decreases in both average loan volume and declining yields on loans and investment securities. The average rate paid on interest-bearing liabilities was 0.85% in the 2011 period compared to 1.29% in the 2010 period, a reduction of 44 basis points. Average total interest-bearing liabilities in the 2011 period decreased by $16.0 million or 7% compared to the 2010 period. This included a decrease of $15.2 million or 15% in average time deposits due to maturing time deposits that were not renewed, and a $1.1 million or 30% decrease in the Company’s long-term debt due to scheduled repayments.

Total interest income for the three-month periods ended June 30, 2011 decreased from $4.1 million at June 30, 2010 to $3.9 million at June 30, 2011, a decrease of $281,000 or 7%. Primary causes for the decline in total interest income are reductions in the average loan volume during the quarter, as well as declining yield on loans and investment securities. The average yield on interest earning assets decreased from 5.35% in the 2010 period to 4.85% in the 2011 a decrease of 50 basis points.

The Company’s interest income from loans decreased by $362,000 due to a $8.5 million decrease in average loan volume and a $57,000 reversal of interest income from loans transferred to nonaccrual status. The yield on investment securities decreased from 3.92% in the 2010 period to 3.46% in the 2011 period which was offset by a $16.5 million or 37% increase in average volume. This resulted in earnings on investment securities to increase by $85,000 or 24%.

The Company’s net interest margin on a taxable equivalent basis decreased 13 basis points from 4.43% in the three-month period ended June 30, 2010 to 4.30% in the three-month period ended June 30, 2011. The deterioration in the Company’s net interest margin was primarily attributable to the average asset yields decreasing more than the cost of funds.

Index

Provision for Loan Losses

The provision for loan losses, which is included in operations to support management’s estimate of the required level of the allowance for loan losses, is based on credit experience and management’s ongoing evaluation of loan portfolio risk and economic conditions. There was no loan loss provision recorded during the three months ended June 30, 2011 compared to a $650,000 provision for the three-month period ended June 30, 2010. Management determined the provision for loan losses for the period ended June 30, 2011 after careful consideration of current economic conditions in the Bank’s primary markets and changes in the volume of impaired loans. See the sections below titled “Allowance for Loan and Lease Losses.”

Non-Interest Income

Non-interest income for the three-month periods ended June 30, 2011 and 2010 totaled $334,000 and $329,000, respectively, a decrease of $5,000 or 1%. The components of non-interest income during each period were as follows:

Non-interest income

	Three Months ended June 30,
(in thousands)	2011		2010		Increase (Decrease)
Service charges	$	177	$	202	$	(25	)
Gain on sale of available-for-sale investment securities, net		23		-		23
Mortgage loan brokerage fees		7		2		5
Earnings on cash surrender value of life insurance policies		74		79		(5	)
Other		53		46		7
Total non-interest income	$	334	$	329	$	5

Service charges decreased by $25,000 due to decreased analysis charges and reductions in NSF and overdrafts. Mortgage loan brokerage fees increased by $5,000 due to increased real estate underwriting fees. The gain on sale of investment securities resulted from sales made to reposition the investment portfolio for risk management purposes.

Non-Interest Expense

For the quarter ended June 30, 2011, non-interest expense totaled $2.5 million, consistent with the $2.4 million recorded during the second quarter of 2010. Salaries and employee benefits expense remained constant at $1.3 million in both quarterly periods. There was a $42,000 or 37% increase in other expenses that primarily reflected increased fees for director meetings, a $25,000 or 8% increase in occupancy and fixed asset expense due to costs associated with upgrading the bank’s technology platform, and an $18,000 or 32% increase in advertising and business development expense that reflected planned expenditures relating to growth initiatives. These were offset by a $40,000 or 31% decrease in professional and legal expenses due to reduced usage, and an $11,000 or 7% decrease in FDIC insurance assessments due to reductions in the Temporary Liquidity Guarantee Program expense.

Index

The following table describes the components of non-interest expense for the three-month periods ended June 30, 2011 and 2010:

Non-interest expense

	Three Months ended June 30,
(in thousands)	2011		2010		Increase (Decrease)
Salaries and employee benefits	$	1,323	$	1,323	$	-
Occupancy and equipment		348		323		25
Data processing		156		151		5
Operations		88		89		(1	)
Professional and legal		89		129		(40	)
Advertising and business development		75		57		18
Telephone and postal		52		56		(4	)
Supplies		56		49		7
Assessment and insurance		143		154		(11	)
Other expenses		155		113		42
Total non-interest expense	$	2,485	$	2,444	$	41

Provision for Income Taxes

The provision for income taxes for the three-month periods ended June 30, 2011 and 2010 was $417,000 and $183,000, respectively. The difference in the effective tax rate compared to the statutory tax rate is primarily the result of the Company’s investment in municipal securities and Company-owned life insurance policies whose income is exempt from Federal taxes. In addition, the Company receives certain tax benefits from the State of California Franchise Tax Board for operating and providing loans, as well as jobs, in designated “Enterprise Zones.” The effective tax rates for these periods were 32.7%, and 27.9%, respectively. The increase in the effective tax rate was primarily due to an increased in taxable revenues without a corresponding increase in revenues from tax exempt sources.

Financial Condition

Fair Value

The Company determines the fair values of financial instruments according to the guidance for fair value measurements and related disclosures. The guidance establishes a hierarchical disclosure framework associated with the level of observable pricing scenarios utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of the observable pricing scenario. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of observable pricing and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no observable pricing and a higher degree of judgment utilized in measuring fair value. Observable pricing scenarios are impacted by a number of factors, including the type of financial instruments, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. See Note 13 of the Notes to Condensed Consolidated Financial Statements for additional information about the financial instruments carried at fair value.

Index

Investment Securities

All existing investment securities are classified as available-for-sale securities. In classifying its investments as available-for-sale, the Company reports securities at fair value, with unrealized gains and losses excluded from earnings and reported, net of taxes, as accumulated other comprehensive income or loss within shareholders’ equity.

The following tables set forth the estimated market value of available-for-sale investment securities at the dates indicated:

Market value of securities available for sale

	June 30, 2011
(in thousands)	Amortized Cost		Unrealized Gain		Unrealized Loss			Fair Value
U.S. Government agencies	$	11,529	$	234	$	(5	)	$	11,758
Mortgage-backed securities:
U.S. Government agencies		17,323		412		(10	)		17,725
Small Business Administration		13,242		228		-			13,470
Municipal securities		16,436		232		(225	)		16,443
Total	$	58,530	$	1,106	$	(240	)	$	59,396

	December 31, 2010
(in thousands)	Amortized Cost		Unrealized Gain		Unrealized Loss			Fair Value
U.S. Treasury securities	$	3,841	$	15	$	(56	)	$	3,800
U.S. Government agencies		5,538		56		(61	)		5,533
Mortgage-backed securities:
U.S. Government agencies		12,577		261		(68	)		12,770
Small Business Administration		14,387		202		(12	)		14,577
Municipal securities		14,550		22		(429	)		14,143
Total	$	50,893	$	556	$	(626	)	$	50,823

Management periodically evaluates each investment security for other than temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. Management believes it will be able to collect all amounts due according to the contractual terms of the underlying investment securities and considers declines in the fair value of individual securities to be temporary.

The current investment portfolio has significant short and medium term cash flows from bond maturities and principal payments on mortgage backed securities. These funds can be used to fund new loans or reinvest in securities and should permit the Company to take advantage of future market rate increases to increase yields on both the loan and investment portfolios.

Index

Loans

The Company’s lending activities are geographically concentrated in the South San Joaquin Valley, primarily in Tulare and Fresno counties. The Company offers both fixed and floating rate loans and obtains collateral in the form of real property, business assets, and deposit accounts, but looks to business and personal cash flows as the primary source of repayment.

The following table sets forth the breakdown of loans outstanding by type at the dates indicated by amount and percentage of the portfolio:

(dollars in thousands)	June 30, 2011					December 31, 2010
Commercial	$	50,111		21	%	$	46,294		19	%
Real estate – mortgage (1)		162,224		67			165,202		68
Real estate – construction		20,373		9			23,437		10
Agricultural		4,421		2			4,304		2
Consumer and other		2,250		1			2,153		1
Subtotal		239,379		100	%		241,390		100	%
Deferred loan fees, net		(314	)				(387	)
Allowance for loan and lease losses		(7,032	)				(6,699	)
Total loans, net	$	232,033				$	234,304

(1) Consists primarily of commercial mortgage loans.

During the six months ended June 30, 2011, loans declined in the category of real estate – mortgage and commercial, real estate-construction and agriculture. The decline in loans was due to the volume of normal loan paydowns exceeding the volume of new loans originated by the Company and strong competition for quality loans in the Company’s target markets.

NONPERFORMING ASSETS

Non-performing loans at June 30, 2011 were comprised of eight customer relationships in nonaccrual status. Non-performing loans increased during 2011 due to the transfer of two real estate commercial loans and one commercial loan to nonaccrual status.

A summary of nonaccrual loans is set forth below:

Dollars in thousands
	June 30, 2011			December 31, 2010			June 30, 2010

Nonperforming Loans	$	8,912		$	6,822		$	6,703
Loans past due 90 days or more and
still accruing		-			-			-
Total nonperforming loans	$	8,912		$	6,822		$	6,703

Other real estate owned	$	-		$	-		$	-
Other vehicles owned		-			-			-
Total nonperforming assets	$	8,912		$	6,822		$	6,703

Specific Loss Reserve	$	160		$	284		$	1,065
Foregone Interest	$	469		$	743		$	251
% of Total Loans		3.72	%		2.91	%		2.66	%

The Company had no real estate acquired through foreclosure at any of these dates.

Index

Composition of Nonaccrual, Past Due and Restructured Loans

A summary of nonaccrual, restructured and past due loans is set forth below:

Dollars in thousands	June						December
	2011			2010			2010
Nonaccrual	$	5,217		$	584		$	2,929
Restructured nonaccrual loans		3,695			6,119			3,893
	$	8,912		$	6,703		$	6,822

Accruing loans past due 90 days or more		-			-			-

Nonaccrual loans to total loans		3.73	%		2.66	%		2.91	%

Our financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans. Interest income from nonaccrual loans is recorded only if collection of principal in full is not in doubt and when and if received.

Impaired Loans

A loan is considered impaired when collection of all amounts due according to the original contractual terms is not probable. The category of impaired loans is not coextensive with the category of nonaccrual loans, although the two categories may overlap in part or in full. At June 30, 2011, the recorded investment in loans that were considered to be impaired totaled $13.6 million. The specific allowance for loan losses for impaired loans at June 30, 2011 totaled $2.0 million. At December 31, 2010, the recorded investment in loans that were considered to be impaired totaled $11.5 million. The specific allowance for loan losses for impaired loans at December 31, 2010 totaled $1.8 million.

Allowance for Loan and Lease Losses

The Company maintains an allowance for loan and lease losses to provide for estimated credit losses that, as of the balance sheet date, it is probable the Company will incur. Loans determined to be impaired are evaluated individually by management for determination of the specific loss, if any, that exists as of the balance sheet date. In addition, reserve factors are assigned to currently performing loans based on historical loss rates as adjusted for current economic conditions, trends in the level and volume of past due and classified loans, and other qualitative factors.

The allowance for loan and lease losses totaled $7.0 million or 2.94% of total loans at June 30, 2011. This compared to $7.4 million or 2.95% of total loans at June 30, 2010 and $6.7 million or 2.78% at December 31, 2010. The Company recorded $108,000 in net recoveries during the six months ended June 30, 2011 compared to net charge-offs of $41,000 during the six months ended June 30, 2010, and net charge-offs of $1.6 million during the twelve months ended December 31, 2010.

The allowance for loan and lease losses is established through charges to earnings in the form of the provision for loan losses. Loan losses are charged to and recoveries are credited to the allowance for loan and lease losses. The allowance for loan and lease losses is maintained at a level deemed appropriate by management to provide for known and inherent risks in loans. The adequacy of the allowance for loan and lease losses is based upon management’s continuing assessment of various factors affecting the collectability of loans; including current economic conditions, maturity of the portfolio, size of the portfolio, industry concentrations, borrower credit history, collateral, the existing allowance for loan and lease losses, independent credit reviews, current charges and recoveries to the allowance for loan and lease losses and the overall quality of the portfolio as determined by management, regulatory agencies, and independent credit review consultants retained by the Company. There is no precise method of predicting specific losses or amounts which may ultimately be charged off on particular segments of the loan portfolio. The collectability of a loan is subjective to some degree, but must relate to the borrower’s financial condition, cash flow, quality of the borrower’s management expertise, collateral and guarantees, and state of the local economy.

Index

The following table summarizes the changes in the allowance for loan and lease losses for the periods indicated:

Changes in allowance for loan and lease losses

	Six Months Ended			Six Months Ended			Year Ended
(dollars in thousands)	June 30, 2011			June 30, 2010			December 31, 2010

Balance at beginning of period	$	6,699		$	6,231		$	6,231
Charge-offs:
Commercial and agricultural		(4	)		(36	)		(35	)
Real estate mortgage		-						(1,530	)
Real estate construction		-			-			-
Consumer		-			(12	)		(28	)
Total charge-offs		(4	)		(48	)		(1,593	)
Recoveries:
Commercial and agricultural		12			7			11
Real estate mortgage		100			-			-
Real estate construction		-			-			-
Consumer		-			-			-
Total recoveries		112			7			11
Net recoveries/(charge-offs)		108			(41	)		(1,582	)
Provision for loan losses		225			1,250			2,050
Balance at end of period	$	7,032		$	7,440		$	6,699
Net recoveries (charge-offs) to average loans outstanding		0.05	%		(0.02	)%		(0.65	)%
Average loans outstanding	$	234,084		$	242,083		$	243,519
Ending allowance to total loans outstanding		2.94	%		2.95	%		2.78	%

Premises and Equipment

(in thousands)	June 30, 2011			December 31, 2010

Furniture and equipment	$	2,722		$	2,647
Premises		6,596			6,582
Leasehold improvements		207			207
Land		1,461			1,461
		10,986			10,897

Less accumulated depreciation and amortization		(2,655	)		(2,386	)
Total	$	8,331		$	8,511

Depreciation and amortization expense included in occupancy and equipment expense totaled $272,000 and $512,000 for the six-month period ended June 30, 2011 and year ended December 31, 2010.

Index

Deposits

Total deposits were $290.0 million at June 30, 2011, a $4.3 million or 1% decrease from the December 31, 2010 total of $294.3 million. Interest-bearing deposits decreased by $1.8 million or 1% and time deposits decreased by $2.4 million or 3%, respectively, during the six month period ended June 30, 2011. Brokered deposits included in time deposits at June 30, 2011 and December 31, 2010 were $9.1 million and $9.2 million, respectively. The Company utilized brokered deposits to lessen the negative impact of a rising rate scenario on its net interest margin.

Total deposits at June 30, 2011 and December 31, 2010 are summarized in the following table:

Deposit Portfolio

(dollars in thousands)	June 30, 2011				December 31, 2010
Non-interest bearing	$	91,154	31	%	$	91,203	31	%
Interest bearing		117,675	41			119,446	41
Brokered deposits		9,063	3			9,162	3
Time deposits		72,062	25			74,467	25
Total	$	289,954	100	%	$	294,278	100	%

Federal Home Loan Bank Borrowings

The Company has utilized borrowings from the FHLB during periods when market conditions for growing the deposit base were unfavorable and for risk management purposes. At June 30, 2011, the Company had outstanding fixed rate debt from the Federal Home Loan Bank totaling $2.4 million at December 31, 2010, had fixed rate debt totaling $2.6 million. At June 30, 2011, the weighted average rate on borrowings was 5.13%. The remaining principal balance of debt is scheduled to mature at various dates ending in January 2012.

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Junior Subordinated Deferrable Interest Debentures

Junior subordinated deferrable interest debentures were issued in connection with the Company’s issuance of trust preferred securities for gross proceeds of $3.0 million in the second quarter of 2003. The $3.1 million of junior subordinated deferrable interest debentures at June 30, 2011 was unchanged from December 31, 2010. The rate of interest paid on these debentures was 3.65% at June 30, 2011 compared to 3.69% at December 31, 2010.

Capital Resources

The Company’s shareholders’ equity was $40.7 million at June 30, 2011 and $38.7 million at December 31, 2010. The increase resulted primarily from net income of $1.5 million for the six months ended June 30, 2011.

Management considers capital needs as part of its strategic planning process. The ability to obtain capital is dependent upon the capital markets as well as the Company’s performance. Management regularly evaluates sources of capital and the timing required to meet its strategic objectives.

The following table summarizes the Company’s Risk-Based Capital Ratios as of June 30, 2011 and December 31, 2010:

Capital and capital adequacy ratios

	June 30, 2011					December 31, 2010
(dollars in thousands)	Amount		Ratio			Amount		Ratio
Leverage Ratio
Valley Commerce Bancorp and Subsidiary	$	43,149		12.5	%	$	41,791		12.1	%
Minimum regulatory requirement	$	13,772		4.0	%	$	13,859		4.0	%

Valley Business Bank	$	43,124		12.5	%	$	41,663		12.0	%
Minimum requirement for “Well- Capitalized” institution	$	17,215		5.0	%	$	17,324		5.0	%
Minimum regulatory requirement	$	13,767		4.0	%	$	13,854		4.0	%

Tier 1 Risk-Based Capital Ratio
Valley Commerce Bancorp and Subsidiary	$	43,149		16.6	%	$	41,791		16.2	%
Minimum regulatory requirement	$	10,412		4.0	%	$	10,323		4.0	%

Valley Business Bank	$	43,124		16.6	%	$	41,663		16.2	%
Minimum requirement for “Well- Capitalized” institution	$	15,614		6.0	%	$	15,479		6.0	%
Minimum regulatory requirement	$	10,409		4.0	%	$	10,319		4.0	%

Total Risk-Based Capital Ratio
Valley Commerce Bancorp and Subsidiary	$	43,865		17.8	%	$	45,060		17.5	%
Minimum regulatory requirement	$	20,824		8.0	%	$	20,645		8.0	%

Valley Business Bank	$	43,865		17.8	%	$	44,931		17.4	%
Minimum requirement for “Well- Capitalized” institution	$	26,023		10.0	%	$	25,798		10.0	%
Minimum regulatory requirement	$	20,818		8.0	%	$	20,639		8.0	%

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At June 30, 2011 and December 31, 2010, all of the Company’s capital ratios were in excess of minimum regulatory requirements, and Valley Business Bank exceeded the minimum requirements of a “well capitalized” institution.

Trust preferred securities are included in Tier 1 Capital subject to regulatory limitation. At June 30, 2011 and December 31, 2010, $3.0 million of trust securities was included in Tier 1 Capital.

The amount of preferred stock issued to the Treasury represents approximately 3% of the Company’s risk adjusted assets and serves as Tier 1 capital. Accordingly, the impact to the Company’s risk-based capital ratios at June 30, 2011 is an increase of approximately 300 basis points.

Liquidity

Liquidity is the ability to provide funds to meet customers’ loan and deposit needs and to fund operations in a timely and cost effective manner. The Company’s primary source of funds is deposits. On an ongoing basis, management anticipates funding needs for loans, asset purchases, maturing deposits, and other needs and initiates deposit promotions as needed. Management measures the Company’s liquidity position monthly through the use of short-term and medium-term internal liquidity calculations. These are monitored on an ongoing basis by the Board of Directors and the Company’s Asset Liability Management Committee.

The Company has a successful history of establishing and retaining deposit relationships with business customers and periodically utilizes collateralized borrowing lines and wholesale funding resources to supplement local deposit growth. These include borrowing lines with FHLB, FRB, and correspondent banks, and utilization of brokered time deposits.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4 – CONTROLS AND PROCEDURES

(a) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

(b) CHANGES IN INTERNAL CONTROLS

There was no change in the Company’s internal control over financial reporting identified in connection with the evaluation described in paragraph (a) above that occurred during the Company’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II – OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

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

ITEM 1A – RISK FACTORS

In addition to the other information set forth in this report, the factors discussed in Part I, “Item 1A – Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 could materially affect its business, financial condition or future results. The risks described in the Company’s Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known or currently deemed to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.

Credit Downgrade Risk, Risk-Based Capital Impact and European Market Risk

On August 5, 2011, Standard & Poor’s downgraded the U.S. long-term credit rating from “AAA” to “AA+. This was the first downgrade of the U.S. credit rating in history. Prior to the action taken by S&P, Moody’s placed the U.S. government under review for a possible credit ratings downgrade, but on August 2, 2011, Moody’s confirmed the U.S. government’s “AAA” credit rating while stating that the rating outlook was negative. Also, on August 2, 2011, Fitch affirmed its existing U.S. government credit rating, but stated that the rating was under review. It is uncertain whether Moody’s and Fitch will change their credit ratings. It is also uncertain whether future additional downgrades may occur by such rating agencies.

The federal bank regulatory agencies jointly issued guidance on August 5, 2011 regarding the impact of the S&P downgrade upon risk-based capital treatment. The agencies advised banks that for risk-based capital purposes, the risk weights for U.S. Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change. The agencies also advised that treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected.

Except as stated in the federal bank regulatory agency guidance, the effects of credit agency downgrade of the U.S. government’s long-term credit rating, or in the credit ratings of instruments issued, insured or guaranteed by related institutions, agencies or instrumentalities is uncertain, but such downgrades could result in risks to the Bank and the general economic conditions in the U.S. and in the Bank’s market areas, which we are unable to predict. In addition, there is existing uncertainty about the effects upon the U.S. economy of the financial instability of several countries in the European Union and the risks of debt defaults posed by those countries. These economic circumstances could have a significant adverse effect on our business, results of operations and financial condition, which in turn could adversely affect our stock price.

ITEM 2 – CHANGES IN SECURITIES AND USE OF PROCEEDS

None.

ITEM 3 – DEFAULTS UPON SENIOR SECURITIES

None.

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ITEM 4 – REMOVED AND RESERVED

ITEM 5 – OTHER INFORMATION

None.

ITEM 6 – EXHIBITS

An Exhibit Index has been attached as part of this quarterly report and is incorporated herein by reference.

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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the Company caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	VALLEY COMMERCE BANCORP

Date: August 12, 2011	By:	/s/ Allan W. Stone
		Allan W. Stone
		President and Chief Executive Officer

Date: August 12, 2011	By:	/s/ Roy O. Estridge
		Roy O. Estridge, Chief Financial Officer and Chief Operating Officer

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Exhibit Index

31.1	Rule 13a-14(a)/15d-14(a) Certification

31.2	Rule 13a-14(a)/15d-14(a) Certification

32.1	Section 1350 Certifications

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